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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2018
OR
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 001-34737
LEGACYTEXAS FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
Maryland
 
 
 
27-2176993
(State or other jurisdiction of incorporation or organization)
 
 
 
(I.R.S. Employer Identification No.)
 
 
 
 
 
5851 Legacy Circle, Plano, Texas
 
 
 
75024
(Address of Principal Executive Offices)
 
 
 
(Zip Code)
Registrant’s telephone number, including area code: (972) 578-5000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
    
Large accelerated filer x
 
Accelerated filer o
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
Emerging growth company o
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class: Common Stock
 
Shares Outstanding as of October 22, 2018:
 
 
48,492,319




LEGACYTEXAS FINANCIAL GROUP, INC.
FORM 10-Q
September 30, 2018
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 






PART 1 - FINANCIAL INFORMATION        Item 1. Financial Statements
LEGACYTEXAS FINANCIAL GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share data)
 
September 30,
2018
 
December 31,
2017
ASSETS
(unaudited)
 
 
Cash and due from financial institutions
$
64,681

 
$
61,713

Short-term interest-bearing deposits in other financial institutions
189,634

 
231,743

Total cash and cash equivalents
254,315

 
293,456

Securities available for sale, at fair value
455,454

 
419,717

Securities held to maturity (fair value: September 30, 2018 — $142,746;
December 31, 2017— $174,926)
145,148

 
173,509

Loans held for sale, at fair value
22,175

 
16,707

Loans held for investment:
 
 
 
Loans held for investment (net of allowance for loan losses of $66,354 at September 30, 2018 and $71,301 at December 31, 2017)
6,707,553

 
6,418,271

Loans held for investment - Warehouse Purchase Program
1,054,505

 
1,320,846

Total loans held for investment
7,762,058

 
7,739,117

Federal Home Loan Bank ("FHLB") stock and other restricted securities, at cost
60,596

 
64,790

Bank-owned life insurance
58,692

 
57,684

Premises and equipment, net
72,291

 
69,693

Goodwill
178,559

 
178,559

Other assets
73,504

 
72,964

Total assets
$
9,082,792

 
$
9,086,196

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Deposits
 
 
 
Non-interest-bearing demand
$
1,798,109

 
$
1,635,622

Interest-bearing demand
780,474

 
1,029,375

Savings and money market
2,562,399

 
2,735,296

Time
1,638,776

 
1,367,390

Total deposits
6,779,758

 
6,767,683

FHLB advances
932,317

 
1,043,163

Repurchase agreements
40,408

 
84,676

Subordinated debt
134,890

 
134,522

Accrued expenses and other liabilities
155,820

 
96,278

Total liabilities
8,043,193

 
8,126,322

Commitments and contingent liabilities (See Note 10)


 


Shareholders’ equity
 
 
 
Preferred stock, $.01 par value; 10,000,000 shares authorized; 0 shares issued — September 30, 2018 and December 31, 2017

 

Common stock, $.01 par value; 90,000,000 shares authorized; 48,491,169 shares issued —
September 30, 2018 and 48,117,390 shares issued — December 31, 2017
485

 
481

Additional paid-in capital
617,270

 
603,884

Retained earnings
444,848

 
370,858

Accumulated other comprehensive income (loss), net
(11,481
)
 
(3,429
)
Unearned Employee Stock Ownership Plan (ESOP) shares; 1,152,378 shares at September 30, 2018 and 1,192,093 shares at December 31, 2017
(11,523
)
 
(11,920
)
Total shareholders’ equity
1,039,599

 
959,874

Total liabilities and shareholders’ equity
$
9,082,792

 
$
9,086,196

See accompanying notes to consolidated financial statements.

3


LEGACYTEXAS FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(Dollars in thousands, except per share data)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Interest and dividend income
 
 
 
 
 
 
 
Loans, including fees
$
102,267

 
$
89,084

 
$
291,468

 
$
256,104

Taxable securities
3,254

 
2,694

 
9,297

 
7,981

Nontaxable securities
614

 
713

 
1,930

 
2,207

Interest-bearing deposits in other financial institutions
1,368

 
1,524

 
3,434

 
3,211

FHLB and FRB stock and other
644

 
448

 
1,675

 
1,243

 
108,147

 
94,463

 
307,804

 
270,746

Interest expense
 
 
 
 
 
 
 
Deposits
15,077

 
10,271

 
40,841

 
25,740

FHLB advances
5,198

 
2,944

 
12,009

 
7,003

Repurchase agreements and other borrowings
2,205

 
2,284

 
6,745

 
6,771

 
22,480

 
15,499

 
59,595

 
39,514

Net interest income
85,667

 
78,964

 
248,209

 
231,232

Provision for credit losses
2,656

 
7,157

 
35,797

 
35,713

Net interest income after provision for credit losses
83,011

 
71,807

 
212,412

 
195,519

Non-interest income
 
 
 
 
 
 
 
Service charges and other fees
8,626

 
9,291

 
25,397

 
27,618

Net gain on sale of mortgage loans held for sale
1,597

 
1,982

 
5,074

 
5,766

Bank-owned life insurance income
482

 
435

 
1,408

 
1,297

Net gain (loss) on securities transactions
(10
)
 
(20
)
 
(138
)
 
(39
)
Gain on sale and disposition of assets
977

 
352

 
3,037

 
1,908

Other
1,555

 
186

 
2,199

 
131

 
13,227

 
12,226

 
36,977

 
36,681

Non-interest expense
 
 
 
 
 
 
 
Salaries and employee benefits
25,053

 
24,175

 
76,442

 
72,010

Advertising
824

 
980

 
3,070

 
2,976

Occupancy and equipment
3,960

 
3,299

 
11,800

 
10,609

Outside professional services
1,151

 
1,230

 
3,783

 
3,589

Regulatory assessments
750

 
1,011

 
2,635

 
3,267

Data processing
5,362

 
4,287

 
15,210

 
12,059

Office operations
2,232

 
2,378

 
6,756

 
7,058

Other
2,860

 
2,935

 
8,566

 
8,068

 
42,192

 
40,295

 
128,262

 
119,636

Income before income tax expense
54,046

 
43,738

 
121,127

 
112,564

Income tax expense
11,225

 
15,029

 
24,707

 
37,730

Net income
$
42,821

 
$
28,709

 
$
96,420

 
$
74,834

 
 
 
 
 
 
 
 
Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.91

 
$
0.61

 
$
2.05

 
$
1.60

Diluted
$
0.89

 
$
0.61

 
$
2.02

 
$
1.58

Dividends declared per share
$
0.16

 
$
0.15

 
$
0.48

 
$
0.45

 
 
 
 
 
 
 
 
See accompanying notes to consolidated financial statements.



4


LEGACYTEXAS FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
(Dollars in thousands)
 
Three Months Ended
 
Nine Months Ended
 
September 30,
 
September 30,
 
2018
 
2017
 
2018
 
2017
Net income
$
42,821

 
$
28,709

 
$
96,420

 
$
74,834

Change in unrealized gains (losses) on securities available for sale
(3,013
)
 
103

 
(9,390
)
 
2,529

Reclassification of amount realized through securities transactions
10

 
20

 
138

 
39

Tax effect
631

 
(43
)
 
1,941

 
(900
)
Reclassification of income tax effects of the Tax Cuts and Jobs Act
(see Note 9 for more information)

 

 
(741
)
 

Other comprehensive income (loss), net of tax
(2,372
)
 
80

 
(8,052
)
 
1,668

Comprehensive income
$
40,449

 
$
28,789

 
$
88,368

 
$
76,502

 
 
 
 
 
 
 
 
See accompanying notes to consolidated financial statements.


5



LEGACYTEXAS FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(unaudited)
(Dollars in thousands, except share and per share data)
 
Common Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss), Net
 
Unearned
ESOP Shares
 
Total
Shareholders’
Equity
For the nine months ended September 30, 2018
 
 
 
 
 
 
 
 
Balance at January 1, 2018
$
481

 
$
603,884

 
$
370,858

 
$
(3,429
)
 
$
(11,920
)
 
$
959,874

Net income

 

 
25,762

 

 

 
25,762

Other comprehensive (loss), net of tax

 

 

 
(4,470
)
 

 
(4,470
)
Reclassification of income tax effects of the Tax Cuts and Jobs Act (see Note 9 for more information)

 

 
741

 

 

 
741

Dividends declared, ($0.16 per share)

 

 
(7,708
)
 

 

 
(7,708
)
ESOP shares earned, (13,238 shares)

 
447

 

 

 
131

 
578

Share-based compensation expense

 
2,055

 

 

 

 
2,055

Activity in employee stock plans, (147,576 shares)
2

 
2,660

 

 

 

 
2,662

Balance at March 31, 2018
$
483

 
$
609,046

 
$
389,653

 
$
(7,899
)
 
$
(11,789
)
 
$
979,494

Net income

 

 
27,837

 

 

 
27,837

Other comprehensive (loss), net of tax

 

 

 
(1,210
)
 

 
(1,210
)
Dividends declared, ($0.16 per share)

 

 
(7,725
)
 

 

 
(7,725
)
ESOP shares earned, (13,238 shares)

 
427

 

 

 
133

 
560

Share-based compensation expense

 
1,398

 

 

 

 
1,398

Activity in employee stock plans, (46,254 shares)

 
1,096

 

 

 

 
1,096

Balance at June 30, 2018
$
483

 
$
611,967

 
$
409,765

 
$
(9,109
)
 
$
(11,656
)
 
$
1,001,450

Net income

 

 
42,821

 

 

 
42,821

Other comprehensive (loss), net of tax

 

 

 
(2,372
)
 

 
(2,372
)
Dividends declared, ($0.16 per share)

 

 
(7,738
)
 

 

 
(7,738
)
ESOP shares earned, (13,238 shares)

 
450

 

 

 
133

 
583

Share-based compensation expense

 
2,385

 

 

 

 
2,385

Activity in employee stock plans, (179,949 shares)
2

 
2,468

 

 

 

 
2,470

Balance at September 30, 2018
$
485

 
$
617,270

 
$
444,848

 
$
(11,481
)
 
$
(11,523
)
 
$
1,039,599

 
 
 
 
 
 
 
 
 
 
 
 

6


 
Common Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income (Loss), Net
 
Unearned
ESOP Shares
 
Total
Shareholders’
Equity
For the nine months ended September 30, 2017
 
 
 
 
 
 
 
 
Balance at January 1, 2017
$
479

 
$
589,408

 
$
310,641

 
$
(2,713
)
 
$
(12,450
)
 
$
885,365

Net income

 

 
18,190

 

 

 
18,190

Other comprehensive income, net of tax

 

 

 
662

 

 
662

Dividends declared, ($0.15 per share)

 

 
(7,183
)
 

 

 
(7,183
)
ESOP shares earned, (13,238 shares)

 
420

 

 

 
132

 
552

Share-based compensation expense

 
1,562

 

 

 

 
1,562

Activity in employee stock plans, (63,935 shares)

 
769

 

 

 

 
769

Balance at March 31, 2017
$
479

 
$
592,159

 
$
321,648

 
$
(2,051
)
 
$
(12,318
)
 
$
899,917

Net income

 

 
27,935

 

 

 
27,935

Other comprehensive income, net of tax

 

 

 
926

 

 
926

Dividends declared, ($0.15 per share)

 

 
(7,199
)
 

 

 
(7,199
)
ESOP shares earned, (13,238 shares)

 
361

 

 

 
132

 
493

Share-based compensation expense

 
1,843

 

 

 

 
1,843

Activity in employee stock plans, (69,246 shares)
1

 
1,367

 

 

 

 
1,368

Balance at June 30, 2017
$
480

 
$
595,730

 
$
342,384

 
$
(1,125
)
 
$
(12,186
)
 
$
925,283

Net income

 

 
28,709

 

 

 
28,709

Other comprehensive income, net of tax

 

 

 
80

 

 
80

Dividends declared, ($0.15 per share)

 

 
(7,203
)
 

 

 
(7,203
)
ESOP shares earned, (13,238 shares)

 
366

 

 

 
133

 
499

Share-based compensation expense

 
2,014

 

 

 

 
2,014

Activity in employee stock plans, (30,680 shares)

 
710

 

 

 

 
710

Balance at September 30, 2017
$
480

 
$
598,820

 
$
363,890

 
$
(1,045
)
 
$
(12,053
)
 
$
950,092

 
 
 
 
 
 
 
 
 
 
 
 

See accompanying notes to consolidated financial statements.

7


LEGACYTEXAS FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(Dollars in thousands)

 
Nine Months Ended September 30,
 
2018
 
2017
Cash flows from operating activities
 
 
 
Net income
$
96,420

 
$
74,834

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for credit losses
35,797

 
35,713

Depreciation and amortization
5,125

 
5,369

Deferred tax benefit
2,489

 
(4,277
)
Premium amortization and accretion of securities, net
2,949

 
3,273

Accretion related to acquired loans
(1,478
)
 
(2,567
)
Net (gain) loss on securities transactions
138

 
39

ESOP compensation expense
1,721

 
1,544

Share-based compensation expense
5,838

 
5,419

Excess tax benefit on vesting of stock awards
894

 
1,307

Net gain on loans held for sale
(5,074
)
 
(5,766
)
Loans originated or purchased for sale
(138,702
)
 
(148,853
)
Proceeds from sale of loans held for sale
138,308

 
149,943

FHLB stock dividends
(675
)
 
(375
)
Bank-owned life insurance income
(1,408
)
 
(1,297
)
(Gain) on sale and disposition of repossessed assets, premises and equipment
(811
)
 
(1,723
)
Net change in deferred loan fees/costs
(3,475
)
 
(7,663
)
Net change in accrued interest receivable
(4,782
)
 
(1,256
)
Net change in other assets
(6,257
)
 
1,275

Net change in other liabilities
61,317

 
87,013

Net cash provided by operating activities
188,334

 
191,952

Cash flows from investing activities
 
 
 
Available-for-sale securities:
 
 
 
Maturities, prepayments and calls
1,859,278

 
2,010,107

Purchases
(1,906,774
)
 
(2,066,094
)
Held-to-maturity securities:
 
 
 
Maturities, prepayments and calls
33,132

 
28,729

Purchases
(5,388
)
 

Originations of Warehouse Purchase Program loans
(16,416,019
)
 
(16,110,560
)
Proceeds from pay-offs of Warehouse Purchase Program loans
16,682,360

 
16,037,972

Net change in loans held for investment, excluding Warehouse Purchase Program loans
(320,481
)
 
(586,200
)
Redemption (purchase) of FHLB and Federal Reserve Bank stock and other
4,869

 
(6,692
)
Purchases of premises and equipment
(7,681
)
 
(2,321
)
Proceeds from sale of assets
9,211

 
6,238

Net cash (used in) investing activities
(67,493
)
 
(688,821
)

8


CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)

 
Nine Months Ended September 30,
 
2018
 
2017
Cash flows from financing activities
 
 
 
Net change in deposits
12,075

 
394,892

Proceeds from FHLB advances
925,000

 
175,000

Repayments on FHLB advances
(1,035,846
)
 
(10,536
)
Repayments of borrowings
(44,268
)
 
(5,618
)
Payment of dividends
(23,171
)
 
(21,585
)
Activity in employee stock plans
6,228

 
2,847

Net cash provided by (used in) financing activities
(159,982
)
 
535,000

Net change in cash and cash equivalents
(39,141
)
 
38,131

Beginning cash and cash equivalents
293,456

 
289,212

Ending cash and cash equivalents
$
254,315

 
$
327,343

Supplemental noncash disclosures:
 
 
 
Transfers from loans to other real estate owned
$
25

 
$
4,360

See accompanying notes to consolidated financial statements.

9

Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)


Note 1 - Basis of Financial Statement Presentation
The accompanying consolidated interim financial statements of LegacyTexas Financial Group, Inc. (the “Company”) have been prepared in accordance with U.S. generally accepted accounting principles ("US GAAP") and with the rules and regulations of the Securities and Exchange Commission for interim financial reporting. Accordingly, they do not include all of the information and footnotes required for complete financial statements. In the opinion of management, all normal and recurring adjustments which are considered necessary to fairly present the results for the interim periods presented have been included. Certain items in prior periods were reclassified to conform to the current presentation. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2017 (“2017 Form 10-K”). Interim results are not necessarily indicative of results for a full year.
In preparing the financial statements, management is required to make estimates and assumptions that affect the recorded amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the period. Actual results could differ from those estimates. For further information with respect to significant accounting policies followed by the Company in preparation of its consolidated financial statements, refer to the 2017 Form 10-K.
The accompanying Unaudited Consolidated Interim Financial Statements include the accounts of the Company, whose business primarily consists of the operations of its wholly owned subsidiary, LegacyTexas Bank (the “Bank”). All significant intercompany transactions and balances are eliminated in consolidation.

10

Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Note 2 - Revenue Recognition

Revenue recognized from contracts with customers, which is accounted for under Accounting Standards Codification ("ASC") 606, is entirely included in the Company's non-interest income. Interest income and certain types of non-interest income are not accounted for under ASC 606 as it is accounted for under other accounting standards. Significant revenue streams recognized by the Company from contracts with customers accounted for under ASC 606 for the three and nine months ended September 30, 2018 and 2017, are below:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Card services income
(a)
$
3,270

 
$
3,015

 
$
9,623

 
$
8,959

Service charges on deposits
(b)
2,129

 
1,858

 
5,859

 
5,496

Title income
(c)
836

 
1,260

 
3,089

 
4,257

Gains (losses) on the sale of other real estate owned
(d)
1,263

 
(15
)
 
1,232

 
169


(a) Card services income -
Card services income includes interchange income, which is income earned by the Company for each transaction a cardholder performs at a merchant. This performance obligation is settled on a daily basis as transactions are processed. Card services income also includes revenue earned from companies who provide our customers with debit cards and/or provide card processing services in exchange for the Company’s promotion of their card programs to the Company's depositors. These payments are remitted based on contractual terms that dictate how much payment is remitted based on volume expectations. This performance obligation settles on a daily basis as our customers use cards and card processing services at merchants.

(b) Service charges on deposits -
The Company receives non-interest income for providing services related to deposit accounts, including fee income generated from non-sufficient funds transactions, wire transfers, ATM activity and treasury management services. This income is recorded when incurred in the case of deposit account service charges or when collected in the case of miscellaneous one-time fees, like wire transfer fees. Since most deposit agreements have a day-to-day term, the performance obligation between the Company and the depositor is satisfied on a daily basis, or as incurred.

(c) Title income -
Title services offered by the Company through its wholly-owned subsidiary, LegacyTexas Title, consists of referring title insurance policies to other title companies and performing real estate closing duties for a set fee. The performance obligation (referring title policies to other title insurance agencies and handling customary closing services) settles daily at each real estate closing.

(d) Gains/losses on the sale of other real estate owned -
The performance obligation in the sale of other real estate owned typically will be delivery of control over the property to the buyer. If the Company is not providing financing, the transaction price is typically identified in the purchase and sale agreement. However, if the Company provides seller financing, the Company must determine a transaction price, depending on if the sale contract is at market terms and taking into account the credit risk inherent in the sales arrangement.

The performance obligations described in (b), (c), and (d) above are typically related to contracts that have an original expected duration of less than one year.

In regards to card services income, because the Company has a right to consideration from card service providers in the form of transaction-based and support income, and from cardholders in the form of interchange income in an amount that corresponds directly with the value to the card service provider and cardholder of the Company's performance completed to date, the Company recognizes revenue as incurred when transactions with merchants settle on a daily basis.

The Company has made no significant judgments in applying the revenue guidance prescribed in ASC 606 that affect the determination of the amount and timing of revenue from the above-described contracts with customers.


11

Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

The Company has applied ASC 606 using the modified retrospective approach effective on January 1, 2018 to all existing contracts with customers covered under the scope of the standard. The Company did not have an aggregate effect of modification resulting from adoption of ASC 606, and no financial statement line items were affected by this change in accounting standard.                         

  


12

Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Note 3 - Earnings Per Common Share
Basic earnings per common share is computed by dividing net income (which has been adjusted for distributed and undistributed earnings to participating securities) by the weighted-average number of common shares outstanding for the period, reduced for average unallocated ESOP shares and average unvested restricted stock awards. Unvested restricted stock awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method described in ASC 260-10-45-60B. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock (such as stock awards and options) were exercised or converted to common stock, or resulted in the issuance of common stock that then shared in the Company’s earnings. Diluted earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding for the period increased for the dilutive effect of unexercised stock options and unvested restricted stock awards. The dilutive effect of the unexercised stock options and unvested restricted stock awards is calculated under the treasury stock method utilizing the average market value of the Company’s stock for the period. A reconciliation of the numerator and denominator of the basic and diluted earnings per common share computation for the three and nine months ended September 30, 2018 and 2017 is as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Basic earnings per share:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Net income
$
42,821

 
$
28,709

 
$
96,420

 
$
74,834

Distributed and undistributed earnings to participating securities
(149
)
 
(92
)
 
(284
)
 
(275
)
Income available to common shareholders
$
42,672

 
$
28,617

 
$
96,136

 
$
74,559

Denominator:
 
 
 
 
 
 
 
Weighted average common shares outstanding
48,431,637

 
48,028,265

 
48,306,520

 
47,971,249

Less: Average unallocated ESOP shares
(1,161,108
)
 
(1,214,061
)
 
(1,174,216
)
 
(1,227,169
)
  Average unvested restricted stock awards
(164,874
)
 
(149,971
)
 
(138,651
)
 
(171,856
)
Average shares for basic earnings per share
47,105,655

 
46,664,233

 
46,993,653

 
46,572,224

Basic earnings per common share
$
0.91

 
$
0.61

 
$
2.05

 
$
1.60

Diluted earnings per share:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Income available to common shareholders
$
42,672

 
$
28,617

 
$
96,136

 
$
74,559

Denominator:
 
 
 
 
 
 
 
Average shares for basic earnings per share
47,105,655

 
46,664,233

 
46,993,653

 
46,572,224

Dilutive effect of share-based compensation plan
649,786

 
494,496

 
646,829

 
515,604

Average shares for diluted earnings per share
47,755,441

 
47,158,729

 
47,640,482

 
47,087,828

Diluted earnings per common share
$
0.89

 
$
0.61

 
$
2.02

 
$
1.58

Share awards excluded in the computation of diluted earnings per share because the exercise price was greater than the common stock average market price and were therefore antidilutive
133,310

 
514,487

 
349,753

 
563,116




13

Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Note 4 - Securities
The amortized cost, related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) and the fair value of securities available for sale ("AFS") were as follows:
September 30, 2018
Amortized Cost
 
Gross Unrealized Gains
 
Gross
Unrealized
Losses
 
Fair Value
Agency residential mortgage-backed securities 1
$
161,897

 
$
291

 
$
5,655

 
$
156,533

Agency commercial mortgage-backed securities 1
9,078

 

 
225

 
8,853

Agency residential collateralized mortgage obligations 1
266,393

 

 
8,379

 
258,014

US government and agency securities
1,500

 
20

 

 
1,520

Municipal bonds
31,119

 
10

 
595

 
30,534

Total securities
$
469,987

 
$
321

 
$
14,854

 
$
455,454

December 31, 2017
 
 
 
 
 
 
 
Agency residential mortgage-backed securities 1
$
191,216

 
$
419

 
$
2,169

 
$
189,466

Agency commercial mortgage-backed securities 1
9,360

 

 
125

 
9,235

Agency residential collateralized mortgage obligations 1
187,637

 
4

 
3,425

 
184,216

US government and agency securities
1,590

 
81

 

 
1,671

Municipal bonds
35,196

 
241

 
308

 
35,129

Total securities
$
424,999

 
$
745

 
$
6,027

 
$
419,717

1 
Mortgage-backed securities and collateralized mortgage obligations are issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
The amortized cost (carrying amount), related gross unrealized gains and losses and fair value of securities held to maturity ("HTM") were as follows:
September 30, 2018
Amortized Cost
 
Gross Unrealized Gains
 
Gross
Unrealized
Losses
 
Fair Value
Agency residential mortgage-backed securities 1
$
49,966

 
$
233

 
$
1,642

 
$
48,557

Agency commercial mortgage-backed securities 1
21,999

 
19

 
487

 
21,531

Agency residential collateralized mortgage obligations 1
19,607

 
14

 
195

 
19,426

Municipal bonds
53,576

 
372

 
716

 
53,232

Total securities
$
145,148

 
$
638

 
$
3,040

 
$
142,746

December 31, 2017
 
 
 
 
 
 
 
Agency residential mortgage-backed securities 1
$
57,334

 
$
616

 
$
646

 
$
57,304

Agency commercial mortgage-backed securities 1
27,435

 
589

 
98

 
27,926

Agency residential collateralized mortgage obligations 1
27,112

 
265

 
99

 
27,278

Municipal bonds
61,628

 
1,079

 
289

 
62,418

Total securities
$
173,509

 
$
2,549

 
$
1,132

 
$
174,926

1 
Mortgage-backed securities and collateralized mortgage obligations are issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.


14

Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

The amortized cost (carrying amount) and fair value of held to maturity debt securities and the fair value of available for sale debt securities at September 30, 2018 by contractual maturity are set forth in the table below. Securities with contractual payments not due at a single maturity date, including mortgage-backed securities and collateralized mortgage obligations, are shown separately.
 
HTM
 
AFS
 
Amortized Cost
 
Fair Value
 
Fair Value
Due in one year or less
$
252

 
$
254

 
$
3,331

Due after one to five years
14,876

 
15,022

 
13,018

Due after five to ten years
37,551

 
37,085

 
13,358

Due after ten years
897

 
871

 
2,347

Agency residential mortgage-backed securities
49,966

 
48,557

 
156,533

Agency commercial mortgage-backed securities
21,999

 
21,531

 
8,853

Agency residential collateralized mortgage obligations
19,607

 
19,426

 
258,014

Total
$
145,148

 
$
142,746

 
$
455,454



Securities with a carrying value of $216,213 and $256,451 at September 30, 2018 and December 31, 2017, respectively, were pledged to secure public deposits, repurchase agreements and for other purposes required or permitted by law.
At September 30, 2018 and December 31, 2017, there were no holdings of securities of any one issuer, other than the U.S. Government and its agencies of U.S. Government Sponsored Enterprises, in an amount greater than 10% of shareholders' equity.
There were no sales of securities during the three and nine months ended September 30, 2018 or 2017.


15

Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Securities with unrealized losses at September 30, 2018 and December 31, 2017, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:
AFS
Less than 12 Months
 
12 Months or More
 
Total
September 30, 2018
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Agency residential mortgage-backed securities 1
$
21,137

 
$
527

 
$
112,214

 
$
5,128

 
$
133,351

 
$
5,655

Agency commercial mortgage-backed securities 1

 

 
8,853

 
225

 
8,853

 
225

Agency residential collateralized mortgage obligations 1
141,702

 
2,544

 
116,312

 
5,835

 
258,014

 
8,379

Municipal bonds
19,717

 
299

 
7,688

 
296

 
27,405

 
595

Total temporarily impaired
$
182,556

 
$
3,370

 
$
245,067

 
$
11,484

 
$
427,623

 
$
14,854

December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
Agency residential mortgage-backed securities 1
$
59,545

 
$
412

 
$
100,214

 
$
1,757

 
$
159,759

 
$
2,169

Agency commercial mortgage-backed securities 1
9,235

 
125

 

 

 
9,235

 
125

Agency residential collateralized mortgage obligations 1
128,869

 
1,860

 
49,171

 
1,565

 
178,040

 
3,425

Municipal bonds
10,114

 
72

 
6,583

 
236

 
16,697

 
308

Total temporarily impaired
$
207,763

 
$
2,469

 
$
155,968

 
$
3,558

 
$
363,731

 
$
6,027



HTM
Less than 12 Months
 
12 Months or More
 
Total
September 30, 2018
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Agency residential mortgage-backed securities 1
$
10,642

 
$
209

 
$
26,893

 
$
1,433

 
$
37,535

 
$
1,642

Agency commercial mortgage-backed securities 1
16,420

 
309

 
3,308

 
178

 
19,728

 
487

Agency residential collateralized mortgage obligations 1
11,185

 
37

 
6,200

 
158

 
17,385

 
195

Municipal bonds
8,573

 
128

 
15,469

 
588

 
24,042

 
716

Total temporarily impaired
$
46,820

 
$
683

 
$
51,870

 
$
2,357

 
$
98,690


$
3,040

December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
Agency residential mortgage-backed securities 1
$
20,397

 
$
206

 
$
16,909

 
$
440

 
$
37,306

 
$
646

Agency commercial mortgage-backed securities 1
3,685

 
26

 
3,484

 
72

 
7,169

 
98

Agency residential collateralized mortgage obligations 1
8,008

 
64

 
2,267

 
35

 
10,275

 
99

Municipal bonds
9,313

 
80

 
10,486

 
209

 
19,799

 
289

Total temporarily impaired
$
41,403

 
$
376

 
$
33,146

 
$
756

 
$
74,549

 
$
1,132

1 
Mortgage-backed securities and collateralized mortgage obligations are issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
Other-than-Temporary Impairment
In determining other-than-temporary impairment for debt securities, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than amortized cost; (2) the financial condition and near-term prospects of the issuer; (3) whether the market decline was affected by macroeconomic conditions; and (4) whether the Company has the intent and ability to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
As of September 30, 2018, 354 securities had unrealized losses, 192 of which had been in an unrealized loss position for over 12 months at September 30, 2018. The Company does not believe these unrealized losses are other-than-temporary and expects full collection of the carrying amount of these securities. At September 30, 2018, the Company does not intend to sell the securities in an unrealized loss position, and it is not more-likely-than-not that the Company will be required to sell the securities prior to recovery of amortized cost. All principal and interest payments are being received on time and in full.


16

Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Note 5 - Loans
Loans consist of the following.
 
September 30,
2018
 
December 31,
2017
Loans held for sale, at fair value
$
22,175

 
$
16,707

 
 
 
 
Loans held for investment:
 
 
 
Commercial real estate
$
3,012,352

 
$
3,019,339

Commercial and industrial
2,111,510

 
1,927,049

Construction and land
278,278

 
277,864

Consumer real estate
1,318,038

 
1,213,434

Other consumer
43,874

 
45,506

Gross loans held for investment, excluding Warehouse Purchase Program
6,764,052

 
6,483,192

Net of:
 
 
 
Deferred costs (fees) and discounts, net
9,855

 
6,380

Allowance for loan losses
(66,354
)
 
(71,301
)
Net loans held for investment, excluding Warehouse Purchase Program
6,707,553

 
6,418,271

Warehouse Purchase Program
1,054,505

 
1,320,846

Total loans held for investment
$
7,762,058

 
$
7,739,117




17

Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Activity in the allowance for loan losses for the three and nine months ended September 30, 2018 and 2017, segregated by portfolio segment and evaluation for impairment, is set forth below. The below activity does not include Warehouse Purchase Program loans, which are collectively evaluated for impairment and are purchased under several contractual requirements, providing safeguards to the Company. To date, the Company has not experienced a loss on its Warehouse Purchase Program loans and no allowance for loan losses has been allocated to them. At September 30, 2018 and 2017, the allowance for loan impairment related to purchased credit impaired ("PCI") loans totaled $248 and $233, respectively.
For the three months ended September 30, 2018
Commercial Real Estate
 
Commercial and Industrial
 
Construction and Land
 
Consumer Real Estate
 
Other Consumer
 
Total
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
21,676

 
$
32,872

 
$
3,674

 
$
4,997

 
$
1,226

 
$
64,445

Charge-offs

 
(591
)
 

 
(56
)
 
(275
)
 
(922
)
Recoveries

 
54

 

 
9

 
68

 
131

Provision expense (benefit)
(468
)
 
1,743

 
454

 
764

 
207

 
2,700

Ending balance
$
21,208

 
$
34,078

 
$
4,128

 
$
5,714

 
$
1,226

 
$
66,354

For the nine months ended September 30, 2018

 

 

 

 

 

Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
21,587

 
$
39,005

 
$
4,644

 
$
4,838

 
$
1,227

 
$
71,301

Charge-offs
(239
)
 
(40,116
)
 

 
(56
)
 
(775
)
 
(41,186
)
Recoveries

 
104

 

 
29

 
171

 
304

Provision expense (benefit)
(140
)
 
35,085

 
(516
)
 
903

 
603

 
35,935

Ending balance
$
21,208

 
$
34,078

 
$
4,128

 
$
5,714

 
$
1,226

 
$
66,354

Allowance ending balance:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
7

 
$
1,089

 
$

 
$
224

 
$
26

 
$
1,346

Collectively evaluated for impairment
21,201

 
32,989

 
4,128

 
5,490

 
1,200

 
65,008

Loans:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
3,739

 
7,176

 

 
2,416

 
7

 
13,338

Collectively evaluated for impairment
3,008,379

 
2,104,231

 
278,278

 
1,314,933

 
43,696

 
6,749,517

PCI loans
234

 
103

 

 
689

 
171

 
1,197

Ending balance
$
3,012,352

 
$
2,111,510

 
$
278,278

 
$
1,318,038

 
$
43,874

 
$
6,764,052


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Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

For the three months ended September 30, 2017
Commercial Real Estate
 
Commercial and Industrial
 
Construction and Land
 
Consumer Real Estate
 
Other Consumer
 
Total
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
20,122

 
$
45,161

 
$
4,056

 
$
4,513

 
$
1,239

 
$
75,091

Charge-offs

 
(12,265
)
 

 

 
(231
)
 
(12,496
)
Recoveries

 
50

 

 
10

 
89

 
149

Provision expense
1,374

 
5,233

 
236

 
314

 
143

 
7,300

Ending balance
$
21,496

 
$
38,179

 
$
4,292

 
$
4,837

 
$
1,240

 
$
70,044

For the nine months ended September 30, 2017
 
 
 
 
 
 
 
 
 
 
 
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance
$
18,303

 
$
35,464

 
$
5,075

 
$
4,484

 
$
1,250

 
$
64,576

Charge-offs
(16
)
 
(30,351
)
 
(418
)
 
(52
)
 
(1,065
)
 
(31,902
)
Recoveries
205

 
296

 
75

 
34

 
560

 
1,170

Provision expense (benefit)
3,004

 
32,770

 
(440
)
 
371

 
495

 
36,200

Ending balance
$
21,496

 
$
38,179

 
$
4,292

 
$
4,837

 
$
1,240

 
$
70,044

Allowance ending balance:
 
 
 
 
 
 
 
 
 
 

Individually evaluated for impairment
$
55

 
$
8,325

 
$

 
$
130

 
$
39

 
$
8,549

Collectively evaluated for impairment
21,441

 
29,854

 
4,292

 
4,707

 
1,201

 
61,495

Loans:
 
 
 
 
 
 
 
 
 
 

Individually evaluated for impairment
4,064

 
65,560

 

 
2,475

 
45

 
72,144

Collectively evaluated for impairment
3,006,971

 
1,776,603

 
282,536

 
1,194,547

 
46,035

 
6,306,692

PCI loans
5,498

 
182

 

 
889

 
197

 
6,766

Ending balance
$
3,016,533

 
$
1,842,345

 
$
282,536

 
$
1,197,911

 
$
46,277

 
$
6,385,602

The allowance for loan losses and related provision expense are susceptible to change if the credit quality of our loan portfolio changes, which is evidenced by many factors, including but not limited to charge-offs and non-performing loan trends. Generally, consumer real estate lending has a lower credit risk profile compared to other consumer lending (such as automobile loans). Commercial real estate and commercial and industrial lending, however, can have higher risk profiles than consumer loans due to these loans being larger in amount and non-homogeneous in structure and term. Changes in economic conditions, the mix and size of the loan portfolio, and individual borrower conditions can dramatically impact our level of allowance for loan losses in relatively short periods of time.
The allowance for loan losses is maintained to cover incurred losses that are estimated in accordance with US GAAP. It is our estimate of credit losses inherent in our loan portfolio at each balance sheet date. Our methodology for analyzing the allowance for loan losses consists of general and specific components. For the general component, we stratify the loan portfolio into homogeneous groups of loans that possess similar loss potential characteristics and apply a loss ratio to these groups of loans to estimate the credit losses in the loan portfolio. We use both historical loss ratios and qualitative loss factors assigned to major loan collateral types to establish general component loss allocations, inclusive of estimated loss emergence periods. Qualitative loss factors are based on management's judgment of company, market, industry or business specific data and external economic indicators, which are not yet reflected in the historical loss ratios, and that could impact the Company's specific loan portfolios. The Allowance for Loan Loss Committee sets and adjusts qualitative loss factors by regularly reviewing changes in underlying loan composition and the seasonality of specific portfolios. The Allowance for Loan Loss Committee also considers credit quality and trends relating to delinquency, non-performing and adversely rated loans within the Company's loan portfolio when evaluating qualitative loss factors. Additionally, the Allowance for Loan Loss Committee adjusts qualitative factors to account for the potential impact of external economic factors, including the unemployment rate, vacancy and capitalization rates and other pertinent economic data specific to our primary market area and lending portfolios.
For the specific component, the allowance for loan losses includes loans where management has concerns about the borrower's ability to repay and on individually analyzed loans found to be impaired. Management evaluates current information and events regarding a borrower's ability to repay its obligations and considers a loan to be impaired when the ultimate collectability of amounts due, according to the contractual terms of the loan agreement, is in doubt. If an impaired loan is collateral-dependent,

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LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

the fair value of the collateral, less the estimated cost to sell, is used to determine the amount of impairment. If an impaired loan is not collateral-dependent, estimated discounted cash flows are used to determine the amount of impairment, if any. For impaired loans, the amount of the impairment can be adjusted, based on current data, until such time as the actual basis is established by acquisition of the collateral or until the basis is collected. Impairment losses are reflected in the allowance for loan losses through a charge to the provision for credit losses. Subsequent recoveries are credited to the allowance for loan losses. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement. Cash receipts on impaired loans for which the accrual of interest has been discontinued are applied first to principal.
Large groups of smaller-balance homogeneous loans are collectively evaluated for impairment. As a result, the Company does not separately identify consumer real estate loans less than $417 or individual consumer non-real estate secured loans for impairment disclosures. The Company considers these loans to be homogeneous in nature due to the smaller dollar amount and the similar underwriting criteria.
Changes in the allowance for off-balance sheet credit losses on lending-related commitments and guarantees on credit card debt, included in "accrued expenses and other liabilities" on the consolidated balance sheets, are summarized in the following table. Please see Note 10 - Commitments and Contingent Liabilities for more information.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Beginning balance
$
835

 
$
1,229

 
$
929

 
$
1,573

Charge-offs on lending-related commitments

 

 

 

(Benefit) for credit losses on lending-related commitments
(44
)
 
(143
)
 
(138
)
 
(487
)
Ending balance
$
791

 
$
1,086

 
$
791

 
$
1,086


Impaired loans at September 30, 2018 and December 31, 2017, were as follows1:
September 30, 2018
 
Unpaid
Contractual Principal
Balance
 
Recorded
Investment With No Allowance
 
Recorded
Investment With Allowance
 
Total Recorded Investment
 
Related
Allowance
Commercial real estate
 
$
4,137

 
$
3,739

 
$

 
$
3,739

 
$

Commercial and industrial
 
13,432

 
5,785

 
1,391

 
7,176

 
1,089

Consumer real estate
 
2,888

 
2,411

 
5

 
2,416

 
5

Other consumer
 
42

 
3

 
4

 
7

 
4

Total
 
$
20,499

 
$
11,938

 
$
1,400

 
$
13,338

 
$
1,098

December 31, 2017
 
 
 
 
 
 
 
 
 
 
Commercial real estate
 
$
4,411

 
$
4,134

 
$

 
$
4,134

 
$

Commercial and industrial
 
89,713

 
48,463

 
35,542

 
84,005

 
10,502

Consumer real estate
 
3,545

 
2,985

 
7

 
2,992

 
7

Other consumer
 
71

 
16

 
19

 
35

 
13

Total
 
$
97,740

 
$
55,598

 
$
35,568

 
$
91,166

 
$
10,522

1 
No Warehouse Purchase Program loans were impaired at September 30, 2018 or December 31, 2017. Loans reported do not include PCI loans.

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Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Income on impaired loans for the three and nine months ended September 30, 2018 and 2017, was as follows1:
 
 
Three Months Ended September 30,
 
 
2018
 
2017
 
 
Average
Recorded
Investment
 
Interest
Income
Recognized
 
Average
Recorded
Investment
 
Interest
Income
Recognized
Commercial real estate
 
$
3,721

 
$
2

 
$
4,132

 
$
2

Commercial and industrial
 
9,221

 

 
80,717

 

Consumer real estate
 
2,644

 
11

 
2,515

 
3

Other consumer
 
11

 
1

 
50

 
1

Total
 
$
15,597

 
$
14

 
$
87,414

 
$
6

 
 
Nine Months Ended September 30,
 
 
2018
 
2017
Commercial real estate
 
$
4,709

 
$
6

 
$
4,493

 
$
6

Commercial and industrial
 
37,116

 

 
85,724

 

Construction and land
 

 

 
2,955

 

Consumer real estate
 
2,807

 
27

 
2,772

 
9

Other consumer
 
20

 
3

 
332

 
3

Total
 
$
44,652

 
$
36

 
$
96,276

 
$
18

1 
Loans reported do not include PCI loans.
Past due status is based on the contractual terms of the loan. Loans that are past due 30 days are considered delinquent. Interest income on loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Non-mortgage consumer loans are typically charged off no later than 120 days past due. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and larger individually classified impaired loans.
All interest accrued but not received for loans placed on nonaccrual status is reversed against interest income. Subsequent receipts on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
No loans past due over 90 days were still accruing interest at September 30, 2018 or December 31, 2017. At September 30, 2018, no PCI loans were considered non-performing loans. No Warehouse Purchase Program loans were non-performing at September 30, 2018 or December 31, 2017. Non-performing (nonaccrual) loans were as follows:
 
September 30, 2018
 
December 31, 2017
Commercial real estate
$
3,739

 
$
4,134

Commercial and industrial
7,178

 
84,003

Consumer real estate
6,617

 
6,190

Other consumer
50

 
76

Total
$
17,584

 
$
94,403


A loan that has been modified is considered a troubled debt restructuring (“TDR”) when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made for the borrower's benefit that would not otherwise be considered for a borrower or transaction with similar credit risk characteristics. Modifications to loan terms may include a modification of the contractual interest rate to a below-market rate (even if the modified rate is higher than the original rate), forgiveness of accrued interest, forgiveness of a portion of principal, an extended repayment period or a deed in lieu of foreclosure or other transfer of assets other than cash to fully or partially satisfy a debt. The Company's policy is to place all TDRs on nonaccrual for a minimum period of six months. Loans qualify for return to accrual status once they have

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LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

demonstrated performance with the restructured terms of the loan agreement for a minimum of six months and the collection of principal and interest under the revised terms is deemed probable. All TDRs are considered to be impaired loans.
The outstanding balances of TDRs are shown below:
 
September 30, 2018
 
December 31, 2017
Nonaccrual TDRs(1)
$
6,401

 
$
17,294

Performing TDRs (2)
929

 
768

Total
$
7,330

 
$
18,062

Outstanding commitments to lend additional funds to borrowers with TDR loans

 

1 
Nonaccrual TDR loans are included in the nonaccrual loan totals.
2 
Performing TDR loans are loans that have been performing under the restructured terms for at least six months and the Company is accruing interest on these loans.
The following tables provide the recorded balances of loans modified as a TDR during the three and nine months ended September 30, 2018. No loans were modified as a TDR during the three months and nine months ended September 30, 2017.
 
Three Months ended September 30, 2018
 
Nine Months Ended September 30, 2018
 
Principal Deferrals
 
Combination of Rate Reduction and Principal Deferral
 
Total
 
Principal Deferrals
 
Combination of Rate Reduction and Principal Deferral
 
Total
Commercial real estate
$
3,573

 
$

 
$
3,573

 
$
3,573

 
$

 
$
3,573

Commercial and industrial
274

 
47

 
321

 
346

 
47

 
393

Total
$
3,847

 
$
47

 
$
3,894

 
$
3,919

 
$
47

 
$
3,966


No loans modified as a TDR during the three and nine months ended September 30, 2018 or 2017, experienced a subsequent payment default in the preceding twelve months. A payment default is defined as a loan that was 90 days or more past due.
Loans acquired with evidence of credit quality deterioration at acquisition, for which it was probable that the Company would not be able to collect all contractual amounts due, were accounted for as PCI loans. The carrying amount of PCI loans included in the consolidated balance sheets and the related outstanding balances at September 30, 2018 and December 31, 2017 are set forth in the table below. The outstanding balance represents the total amount owed, including accrued but unpaid interest, and any amounts previously charged off.
 
September 30, 2018
 
December 31, 2017
Carrying amount 1
$
949

 
$
3,295

Outstanding balance
1,210

 
3,992

1 
The carrying amounts are reported net of allowance for loan losses of $248 and $269 as of September 30, 2018 and December 31, 2017.
Changes in the accretable yield for PCI loans for the three and nine months ended September 30, 2018 and 2017 are as follows:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Beginning balance
$
2,098

 
$
2,480

 
$
2,279

 
$
2,515

Reclassifications from nonaccretable
77

 
103

 
138

 
425

Disposals
(1,446
)
 
(18
)
 
(1,493
)
 
(9
)
Accretion
(76
)
 
(177
)
 
(271
)
 
(543
)
Balance at end of period
$
653

 
$
2,388

 
$
653

 
$
2,388



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LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Below is an analysis of the age of recorded investment in loans that were past due at September 30, 2018 and December 31, 2017. No Warehouse Purchase Program loans were delinquent at September 30, 2018 or December 31, 2017 and therefore are not included in the following tables.
September 30, 2018
30-59 Days Past Due
 
60-89 Days Past Due
 
90 Days and Greater Past Due
 
Total Loans Past Due
 
Current Loans 1
 
Total Loans
Commercial real estate
$
556

 
$
364

 
$

 
$
920

 
$
3,011,432

 
$
3,012,352

Commercial and industrial
26,064

 
326

 
979

 
27,369

 
2,084,141

 
2,111,510

Construction and land
3,754

 

 

 
3,754

 
274,524

 
278,278

Consumer real estate
892

 
3,396

 
1,938

 
6,226

 
1,311,812

 
1,318,038

Other consumer
218

 
52

 

 
270

 
43,604

 
43,874

Total
$
31,484

 
$
4,138

 
$
2,917

 
$
38,539

 
$
6,725,513

 
$
6,764,052

December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
9,414

 
$

 
$
250

 
$
9,664

 
$
3,009,675

 
$
3,019,339

Commercial and industrial
918

 
284

 
7,350

 
8,552

 
1,918,497

 
1,927,049

Construction and land
9,354

 

 

 
9,354

 
268,510

 
277,864

Consumer real estate
16,436

 
2,928

 
1,367

 
20,731

 
1,192,703

 
1,213,434

Other consumer
891

 
34

 
2

 
927

 
44,579

 
45,506

Total
$
37,013

 
$
3,246

 
$
8,969

 
$
49,228

 
$
6,433,964

 
$
6,483,192

1 
Includes acquired PCI loans with a total carrying value of $1,197 and $3,338 at September 30, 2018 and December 31, 2017, respectively.
For loans collateralized by real property and commercial and industrial loans, credit exposure is monitored by internally assigned grades used for classification of loans. A loan is considered “special mention” when management has determined that there is a potential weakness that deserves management's close attention. Loans rated as "special mention" are not adversely classified according to regulatory classifications and do not expose the Company to sufficient risk to warrant adverse classification. A loan is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged, if any. “Substandard” loans include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected, and the loan may or may not meet the criteria for impairment. Loans classified as “doubtful” have all of the weaknesses of those classified as “substandard” with the added characteristic that the weaknesses present makes “collection or liquidation in full,” on the basis of currently existing facts, conditions and values, “highly questionable and improbable.” All other loans that do not fall into the above mentioned categories are considered “pass” loans. Updates to internally assigned grades are made monthly and/or upon significant developments.
For other consumer loans (non-real estate), credit exposure is monitored by payment history of the loans. Non-performing other consumer loans are on nonaccrual status and are generally greater than 90 days past due.

23

Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

The recorded investment in loans by credit quality indicators at September 30, 2018 and December 31, 2017, was as follows:
Real Estate and Commercial and Industrial Credit Exposure
Credit Risk Profile by Internally Assigned Grade
September 30, 2018
 
Commercial Real Estate
 
Commercial and Industrial
 
Construction and Land
 
Consumer Real Estate
Grade: 1
 
 
 
 
 
 
 
 
Pass
 
$
2,990,106

 
$
2,003,250

 
$
278,278

 
$
1,308,804

Special Mention
 
16,750

 
59,867

 

 
1,278

Substandard
 
5,496

 
48,390

 

 
7,580

Doubtful
 

 
3

 

 
376

Total
 
$
3,012,352

 
$
2,111,510

 
$
278,278

 
$
1,318,038

December 31, 2017
 
 
 
 
 
 
 
 
Grade: 1
 
 
 
 
 
 
 
 
Pass
 
$
2,980,656

 
$
1,787,238

 
$
277,864

 
$
1,203,236

Special Mention
 
30,656

 
43,161

 

 
1,408

Substandard
 
8,027

 
96,546

 

 
7,762

Doubtful
 

 
104

 

 
1,028

Total
 
$
3,019,339

 
$
1,927,049

 
$
277,864

 
$
1,213,434

1 
PCI loans are included in the substandard or doubtful categories. These categories are consistent with the "substandard" and "doubtful" categories as defined by regulatory authorities.
Warehouse Purchase Program Credit Exposure
All Warehouse Purchase Program loans were graded pass as of September 30, 2018 and December 31, 2017.
Other Consumer Credit Exposure
Credit Risk Profile Based on Payment Activity
 
September 30, 2018
 
December 31, 2017
Performing
$
43,824

 
$
45,430

Non-performing
50

 
76

Total
$
43,874

 
$
45,506




24

Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Note 6 - Fair Value    
ASC 820, “Fair Value Measurements and Disclosures”, establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Prices or valuation techniques that require inputs that are both significant and unobservable in the market. These instruments are valued using the best information available, some of which is internally developed, and reflects a reporting entity’s own assumptions about the risk premiums that market participants would generally require and the assumptions they would use.
Assets and Liabilities Measured on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are summarized below.
 
 
Fair Value Measurements Using Level 2
 
 
September 30, 2018
 
December 31, 2017
Assets:
 
 
 
 
Agency residential mortgage-backed securities
 
$
156,533

 
$
189,466

Agency commercial mortgage-backed securities
 
8,853

 
9,235

Agency residential collateralized mortgage obligations
 
258,014

 
184,216

US government and agency securities
 
1,520

 
1,671

Municipal bonds
 
30,534

 
35,129

Total securities available for sale
 
$
455,454

 
$
419,717

 
 
 
 
 
Loans held for sale 1
 
$
22,175

 
$
16,707

Derivative financial instruments:
 
 
 
 
Interest rate lock commitments
 
491

 
358

Forward mortgage-backed securities trades
 
69

 
7

Loan customer counterparty
 
42

 

Financial institution counterparty
 
2,744

 
1,735

Liabilities:
 
 
 
 
Derivative financial instruments:
 
 
 
 
Interest rate lock commitments
 

 

Forward mortgage-backed securities trades
 
10

 
18

Loan customer counterparty
 
2,744

 
1,735

Financial institution counterparty
 
42

 

1 
At September 30, 2018 and December 31, 2017, loans held for sale had an aggregate outstanding principal balance of $21,617 and $16,242, respectively. There were no mortgage loans held for sale that were 90 days or greater past due or on non-accrual at September 30, 2018 or December 31, 2017.
The following methodologies were used to measure the fair value of financial assets and liabilities valued on a recurring basis:
Securities available for sale - The fair values of securities available for sale are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs).

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Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Residential mortgage loans held for sale - Mortgage loans held for sale, which are sold on a servicing released basis, are valued using a market approach by utilizing either: (i) the fair value of securities backed by similar mortgage loans, adjusted for certain factors to approximate the fair value of a whole mortgage loan, including the value attributable to mortgage servicing and credit risk, (ii) current commitments to purchase loans or (iii) recent observable market trades for similar loans, adjusted to credit risk and other individual loan characteristics. As these prices are derived from market observable inputs, the Company classifies these valuations as Level 2 in the fair value disclosures. Interest income on mortgage loans held for sale is recognized based on the contractual rates and reflected in interest income on loans held for sale in the consolidated income statement. The Company has no continuing involvement in any residential mortgage loans sold.
Derivative instruments:
Interest rate lock commitments ("IRLCs") - The estimated fair values of IRLCs utilize current secondary market prices for underlying loans and estimated servicing value with similar coupons, maturity and credit quality, subject to the anticipated loan funding probability (Pull-through rate). The fair value of IRLCs is subject to change primarily due to changes in interest rates and the estimated Pull-through rate. These commitments are classified as Level 2 in the fair value disclosures, as the valuations are based on observable market inputs.
Forward mortgage-backed securities trades - These forward mortgage-backed securities trades are exchange-traded or traded within highly active dealer markets. In order to determine the fair value of these instruments, the Company utilized the exchange price or dealer market price for the particular derivative contract; therefore these contracts are classified as Level 2. The estimated fair values are subject to change primarily due to changes in interest rates.
Loan customer counterparty and financial institution counterparty - The Company also enters into certain interest rate derivative positions that are not designated as hedging instruments. The estimated fair value of these commercial loan interest rate swaps are obtained from a pricing service that provides the swaps' unwind value (Level 2 inputs). Please see Note 7 - Derivative Financial Instruments for more information.
Assets and Liabilities Measured on a Non-Recurring Basis

Assets measured at fair value on a non-recurring basis are summarized below. There were no liabilities measured at fair value on a non-recurring basis at September 30, 2018 or December 31, 2017.
 
 
Fair Value Measurements Using Level 3
 
 
September 30, 2018
 
December 31, 2017
Assets:
 
 
 
 
Impaired loans
 
$
302

 
$
25,046

Foreclosed assets:
 
 
 
 
Commercial real estate
 

 
6,694

Construction and land
 

 
859

Consumer real estate
 

 
192

Other
 
698

 
687


Methodologies used to measure the fair value of financial assets and liabilities valued on a non-recurring basis are shown below:
Impaired loans - Impaired loans that are collateral dependent are measured for impairment using the fair value of the collateral adjusted by additional Level 3 inputs, such as discounts of market value, estimated marketing costs and estimated legal expenses. Impaired loans secured by real estate, receivables or inventory had discounts determined by management on an individual loan basis. Impaired loans that are not collateral dependent are measured for impairment by a discounted cash flow analysis using a net present value calculation that utilizes data from the loan file before and after the modification.
Foreclosed assets - These loans are measured at the lower of book or fair value less costs to sell using third party appraisals, listing agreements or sale contracts, which may be adjusted by additional Level 3 inputs, such as discounts of market value, estimated marketing costs and estimated legal expenses. Management may also consider additional adjustments on specific properties due to the age of the appraisal, expected holding period, lack of comparable sales, or if the other real estate owned is a special use property. At September 30, 2018, the Company had $558 in residential mortgage loans in the process of

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LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

foreclosure.
The Credit Risk Management department evaluates the valuations on impaired loans and foreclosed assets at least quarterly. The valuations on impaired loans are reviewed at least quarterly by the Allowance for Loan Loss Committee and are considered in the calculation of the allowance for loan losses. Unobservable inputs, such as discounts to collateral, are monitored and adjusted if market conditions change.
Fair value of financial instruments not recorded at fair value
The carrying amount and fair value information of financial instruments not recorded at fair value in their entirety on a recurring basis on the Company's consolidated balance sheets at September 30, 2018 and at December 31, 2017, were as follows:
 
 
 
 
Fair Value Measurement Using
September 30, 2018
 
Carrying
Amount
 
Level 1
 
Level 2
 
Level 3
Financial assets
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
254,315

 
$
254,315

 
$

 
$

Securities held to maturity
 
145,148

 

 
142,746

 

Loans held for investment, net
 
6,707,553

 

 

 
6,697,449

Loans held for investment - Warehouse Purchase Program
 
1,054,505

 

 

 
1,054,590

FHLB and other restricted securities, at cost
 
60,596

 

 
60,596

 

Accrued interest receivable
 
29,378

 
29,378

 

 

Financial liabilities
 
 
 
 
 
 
 
 
Deposits
 
$
6,779,758

 
$

 
$

 
$
6,219,470

FHLB advances
 
932,317

 

 

 
932,404

Repurchase agreements
 
40,408

 

 

 
37,079

Subordinated debt
 
134,890

 

 

 
140,048

Accrued interest payable
 
5,727

 
5,727

 

 

December 31, 2017
 
 
 
 
 
 
 
 
Financial assets
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
293,456

 
$
293,456

 
$

 
$

Securities held to maturity
 
173,509

 

 
174,926

 

Loans held for investment, net
 
6,418,271

 

 

 
6,484,949

Loans held for investment - Warehouse Purchase Program
 
1,320,846

 

 

 
1,337,612

FHLB and other restricted securities, at cost
 
64,790

 

 
64,790

 

Accrued interest receivable
 
24,596

 
24,596

 

 

Financial liabilities
 
 
 
 
 
 
 
 
Deposits
 
$
6,767,683

 
$

 
$

 
$
6,326,572

FHLB advances
 
1,043,163

 

 

 
1,043,416

Repurchase agreement
 
84,676

 

 

 
81,041

Subordinated debt
 
134,522

 

 

 
141,972

Accrued interest payable
 
2,729

 
2,729

 

 






27

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LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)


The following methods and assumptions were used to estimate the fair values of each class of financial instrument presented:
Cash and cash equivalents - Due to their short term nature, the carrying amount approximates the estimated fair value.
Securities held to maturity - The fair values of these securities is determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs).
Loans held for investment (including Warehouse Purchase Program loans) - Pursuant to the adoption of ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities, for values reported for the 2018 period, fair value is based on cash flows, adjusted for credit and prepayments, discounted using current market yields. For values reported prior to 2018, fair value is based on cash flows, adjusted for prepayments, discounted using then- current market offering rates, including a credit spread.
FHLB stock and other restricted securities - The fair value on these securities is their cost basis due to restrictions on transferability.
Accrued interest receivable - Due to their short term nature, the carrying amount approximates the estimated fair value.
Deposits - Fair value is calculated using the FHLB advance curve to discount cash flows based on the estimated life of the deposits.
FHLB advances - Fair value is calculated using the FHLB advance curve to discount cash flows based on the contractual repayment schedule.
Repurchase agreement - The fair value is based on discounting the estimated cash flows using the current rate at which similar borrowings would be made with similar terms and remaining maturities.
Subordinated debt - The estimated fair value is based on current market rates on similar debt in the market.
Accrued interest payable - Due to their short term nature, the carrying amount approximates the estimated fair value.
The fair value of off-balance sheet items is based on the current fees or costs that would be charged to enter into or terminate such arrangements and are not considered significant to this presentation.

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LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Note 7 - Derivative Financial Instruments

The following table provides the outstanding notional balances and fair values of outstanding derivative positions at September 30, 2018 and December 31, 2017.
 
September 30, 2018
 
December 31, 2017
 
Outstanding Notional Balance
 
Asset Derivative Fair Value
 
Liability Derivative Fair Value
 
Outstanding Notional Balance
 
Asset Derivative Fair Value
 
Liability Derivative Fair Value
IRLCs
$
16,010

 
$
491

 
$

 
$
10,337

 
$
358

 
$

Forward mortgage-backed securities trades
27,633

 
69

 
10

 
19,788

 
7

 
18

Commercial loan interest rate swaps and caps:
 
 
 
 
 
 
 
 
 
Loan customer counterparty
$
132,188

 
$
42

 
$
2,744

 
$
114,594

 
$

 
$
1,735

Financial institution counterparty
132,188

 
2,744

 
42

 
114,594

 
1,735

 

These financial instruments are not designated as hedging instruments and are used for asset and liability management and commercial customers' financing needs. All derivatives are carried at fair value in either other assets or other liabilities.
IRLCs - In the normal course of business, the Company enters into IRLCs with consumers to originate mortgage loans at a specified interest rate. These commitments, which contain fixed expiration dates, offer the borrower an interest rate guarantee provided the loan meets underwriting guidelines and closes within the timeframe established by the Company.
Forward mortgage-backed securities trades - The Company manages the changes in fair value associated with changes in interest rates related to IRLCs by using forward sold commitments known as forward mortgage-backed securities trades. These instruments are typically entered into at the time the IRLC is made.
Interest rate swaps and caps - These derivative positions relate to transactions in which we enter into an interest rate swap or cap with a customer, while at the same time entering into an offsetting interest rate swap or cap with another financial institution. An interest rate swap transaction allows our customer to effectively convert a variable rate loan to a fixed rate. In connection with each swap, we agree to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, we agree to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. In connection with each interest rate cap, we sell a cap to the customer and agree to pay interest if the underlying index exceeds the strike price defined in the cap agreement.  Simultaneously we purchase a cap with matching terms from another financial institution which agrees to pay us if the underlying index exceeds the strike price.
The commercial loan customer counterparty weighted average received and paid interest rates for interest rate swaps outstanding at September 30, 2018 and December 31, 2017 are presented in the following table.

 
 
Weighted-Average Interest Rate
September 30, 2018
 
December 31, 2017
Received
 
Paid
 
Received
 
Paid
Loan customer counterparty
 
2.65
%
 
3.18
%
 
2.52
%
 
2.54
%


Our credit exposure on interest rate swaps is limited to the net favorable value of all swaps by each counterparty, which was approximately $42 at September 30, 2018 and $32 at December 31, 2017. This credit exposure is partly mitigated as transactions with customers are generally secured by the collateral, if any, securing the underlying transaction being hedged. Our credit exposure, net of collateral pledged, relating to interest rate swaps with upstream financial institution counter-parties was approximately $2,792 at September 30, 2018.  A credit support annex is in place and allows the bank to call collateral from upstream financial institution counter-parties. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values. Our cash collateral pledged for interest rate swaps and included in our interest-bearing deposits, which totaled $1,990 at September 30, 2018 and $1,950 at December 31, 2017, is in excess of our credit exposure.

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Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

The initial and subsequent changes in the fair value of IRLCs and the forward sales of mortgage-back securities are recorded in net gain on sale of mortgage loans. These gains and losses were not attributable to instrument-specific credit risk. For interest rate swaps and caps, because we act as an intermediary for our customer, changes in the fair value of the underlying derivative contracts substantially offset each other and do not have a material impact on our results of operations. Income (loss) for the three and nine months ended September 30, 2018 and 2017 was as follows:

Derivatives not designated as hedging instruments
Three Months Ended September 30,
 
Nine Months Ended September 30,
2018
 
2017
 
2018
 
2017
IRLCs
$
55

 
$
(89
)
 
$
133

 
$
112

Forward mortgage-backed securities trades
88

 
(226
)
 
539

 
(485
)



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Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Note 8 - Share-based Compensation

Compensation cost charged to income for share-based compensation is presented below.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Restricted stock
$
1,438

 
$
902

 
$
3,080

 
$
2,627

Stock options
947

 
1,112

 
2,758

 
2,792

Income tax benefit
501

 
705

 
1,226

 
1,897



A summary of activity in the Company's active share-based compensation plans ("Plans") for the nine months ended September 30, 2018 is presented below.
 
Time-Vested Restricted Shares Outstanding
 
Performance-Based Restricted Shares Outstanding
 
Stock Options Outstanding
 
Number of Shares
 
Weighted-Average Grant Date Fair Value per Share 1
 
Number of Shares
 
Weighted-Average Grant Date Fair Value per Share 2
 
Number of Shares
 
Weighted-
Average
Exercise Price
per Share
Beginning balance
128,588

 
$
27.27

 
73,008

 
$
42.21

 
2,207,243

 
$
26.88

Granted
121,710

 
43.46

 
26,550

3 
42.82

 
1,200

 
43.12

Vested/exercised
(56,940
)
 
22.18

 
(20,600
)
 
44.04

 
(253,674
)
 
24.55

Forfeited/expired
(1,605
)
 
43.89

 

 

 
(101,014
)
 
30.86

Ending balance
191,753

 
$
38.92

 
78,958

 
$
42.60

 
1,853,755

 
$
26.99


1 
For restricted stock awards with time-based vesting conditions, the grant date fair value is based upon the closing stock price as quoted on the Nasdaq Stock Market on the grant date.
2 
For restricted stock awards with performance-based vesting conditions, the value of the award is based upon the closing stock price as quoted on the Nasdaq Stock Market on the date of vesting. Until the final value is determined on the vesting date, the Company estimates the fair value based upon the closing stock price as quoted on the Nasdaq Stock Market near the last business day of each month.
3 
The 26,550 performance-based shares granted are represented in the table at target; however, if certain performance metrics are met at vesting, the shares may be awarded at up to 200% of their target amount, with an additional 20% increase or decrease in the total share award at vesting depending on the Company's Total Shareholder Return percentage for the determined period.
The total unrecognized compensation expense as of September 30, 2018, related to the Plans is presented below.
 
Unrecognized Compensation Expense
 
Weighted-Average Period of Expense
Non-vested restricted shares
$
6,904

 
1.8
Non-vested stock options
$
4,410

 
1.5



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Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Note 9 - Income Taxes
The Tax Cuts and Jobs Act (the "Act"), which was enacted on December 22, 2017, made key changes to the U.S. tax law, including the reduction of the U.S. federal corporate tax rate from 35% to 21%. As ASC 740, Income Taxes, requires the effects of changes in tax rates and laws on deferred tax balances to be recognized in the period in which the legislation is enacted, the Company remeasured its deferred tax assets and liabilities based on the rates at which they are expected to reverse in the future, which is 21%. The Company is still analyzing certain aspects of the Act, and refining its calculations, which could potentially affect the measurement of these balances or give rise to new deferred tax amounts. The provisional amount recorded in the 2017 period related to the remeasurement of our deferred tax asset was $13,493.
During the first quarter of 2018, the Company elected early adoption of the provisions of ASU 2018-02, which allowed the Company to reclassify the income tax effects of the Act on items within accumulated other comprehensive income to retained earnings. This reclassification, which reduced other comprehensive income and increased retained earnings by $741 related entirely to unrealized gains and losses on available for sale securities.
A summary of the net deferred tax assets as of September 30, 2018 and December 31, 2017, is presented below:
 
September 30, 2018
 
December 31, 2017
Net deferred tax assets
$
19,692

 
$
20,240

Estimated annual effective tax rate
21
%
 
 




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Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Note 10 - Commitments and Contingent Liabilities
In the normal course of business, the Company enters into various transactions which, in accordance with US GAAP, are not included in its consolidated balance sheets. The Company enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and standby letters of credit which involve, to varying degrees, elements of credit and interest rate risk. Credit losses up to the face amount of these instruments could occur, although material losses are not anticipated. The Company's credit policies applied to loan originations are also applied to these commitment requests, including obtaining collateral at the exercise of the commitment.
The contractual amounts of financial instruments with off‑balance sheet risk at September 30, 2018 and December 31, 2017, are summarized below. Please see Part I-Item 2-"Off-Balance Sheet Arrangements, Contractual Obligations and Commitments" of this Form 10-Q for information related to commitment maturities.
 
September 30, 2018
 
December 31, 2017
Unused commitments to extend credit
$
1,700,471

 
$
1,600,794

Unused capacity on Warehouse Purchase Program loans
881,495

 
738,412

Standby letters of credit
42,410

 
34,091

Total unused commitments/capacity
$
2,624,376

 
$
2,373,297


Unused commitments to extend credit - The Company enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Since many commitments expire without being drawn upon, the total contractual amount of commitments does not necessarily represent future cash requirements of the Company. Substantially all of the Company's commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of future loan funding.
Unused capacity on Warehouse Purchase Program loans - In regard to unused capacity on Warehouse Purchase Program loans, the Company has established maximum purchase facility amounts, but reserves the right, at any time, to refuse to buy any mortgage loans offered for sale by each customer, for any reason in the Company's sole and absolute discretion.
Standby letters of credit - Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
In addition to the commitments above, the Company guarantees the credit card debt of certain customers to the merchant bank that issues the credit cards. These guarantees are in place for as long as the guaranteed credit card is open. At September 30, 2018 and December 31, 2017, these credit card guarantees totaled $2,023 and $5,257, respectively. This amount represents the maximum potential amount of future payments under the guarantee, which the Company is responsible for in the event of customer non-payment.
The Company funds an allowance for credit losses on off-balance sheet lending-related commitments and guarantees on credit card debt through a charge to provision for credit losses on the Company's consolidated statement of income. At September 30, 2018 and December 31, 2017, this allowance for credit losses on off-balance sheet lending-related commitments and guarantees on credit card debt, included in "other liabilities" on the Company's consolidated balance sheets, totaled $791 and $929, respectively.
In addition to the commitments above, the Company had overdraft protection available in the amounts of $85,573 and $84,727 at September 30, 2018 and December 31, 2017, respectively.
The Company, at September 30, 2018 and December 31, 2017, had FHLB letters of credit of $897,565 and $944,370, respectively, pledged to secure public deposits, repurchase agreements and for other purposes required or permitted by law.
At September 30, 2018 and December 31, 2017, the Company had $830 and $1,680, respectively, of unfunded commitments recorded in other liabilities in its consolidated balance sheet related to investments in community development-oriented private equity funds used for Community Reinvestment Act purposes.


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Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Note 11 - Recent Accounting Developments    
Effect of Newly Issued But Not Yet Effective Accounting Standards
In February 2016, the FASB issued ASU 2016-02, Leases. This ASU requires lessees to put most leases on their balance sheets but recognize expenses in the income statement in a manner similar to current accounting treatment. This ASU changes the guidance on sale-leaseback transactions, initial direct costs and lease execution costs, and, for lessors, modifies the classification criteria and the accounting for sales-type and direct financing leases. For public business entities, this ASU is effective for annual periods beginning after December 15, 2018, and interim periods therein. We expect to adopt the guidance in the first quarter of 2019 using an optional transition method with a cumulative effect adjustment to retained earnings without restating the 2018 and 2017 financial statements for comparable amounts. The Company has implemented a lease management system to assist in centralizing, maintaining and accounting for all leases and is finalizing its evaluation of the standard on its financial statements and disclosures, as well as any additional changes to processes and internal controls to ensure we meet the standard's reporting and disclosure requirements. While the increase to our consolidated total assets related to operating lease right-of-use assets will increase our risk-weighted assets and decrease our capital ratios, we do not expect these changes to be material.
In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. This ASU removes the thresholds that companies apply to measure credit losses on financial instruments measured at amortized cost, such as loans, receivables, and held-to-maturity debt securities. Under current US GAAP, companies generally recognize credit losses when it is probable that the loss has been incurred. This revised guidance will remove all recognition thresholds and will require companies to recognize an allowance for lifetime expected credit losses. Credit losses will be immediately recognized through net income; the amount recognized will be based on the current estimate of contractual cash flows not expected to be collected over the financial asset’s contractual term. ASU 2016-13 also amends the credit loss measurement guidance for available for sale debt securities. For public business entities, this ASU is effective for financial statements issued for fiscal years and for interim periods within those fiscal years beginning after December 15, 2019. The Company has begun testing of its financial models to calculate lifetime expected credit losses and is continuing to evaluate the impact of this ASU on its financial statements and disclosures.
In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities. This ASU amends the hedge accounting model to enable entities to better portray their risk management activities in their financial statements, by expanding an entity's ability to hedge nonfinancial and financial risk components and reduce complexity in fair value hedges of interest rate risk. This ASU eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. Additionally, this ASU also eases certain documentation and assessment requirements and modifies the accounting for components excluded from the assessment of hedge effectiveness. For public business entities, this ASU is effective for financial statements issued for fiscal years and for interim periods within those fiscal years beginning after December 15, 2018. The Company is finalizing its evaluation of the impact of this ASU on its disclosures, and does not expect this ASU to have a significant impact on its financial statements.
In August 2018, the FASB issued ASU 2018-13, Changes to the Disclosure Requirements for Fair Value Measurement. This ASU modifies the disclosure requirements on fair value measurements by requiring that Level 3 fair value disclosures include the range and weighted average of significant unobservable inputs used to develop those fair value measurements. For certain unobservable inputs, an entity may disclose other quantitative information in lieu of the weighted average if the entity determines that other quantitative information would be a more reasonable and rational method to reflect the distribution of unobservable inputs used to develop Level 3 fair value measurements. For public business entities, this ASU is effective for financial statements issued for fiscal years and for interim periods within those fiscal years, beginning after December 15, 2019. The adoption of this ASU is not expected to have a significant impact on the Company's financial statements and disclosures.




34

Table of Contents
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Note 12Subsequent Events
The Company evaluated events from the date of the consolidated financial statements on September 30, 2018 through the issuance of those consolidated financial statements included in this Quarterly Report on Form 10-Q dated October 24, 2018. No additional events were identified requiring recognition in and/or disclosures in the consolidated financial statements.

35


Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Special Note Regarding Forward-Looking Statements

This document and other filings by the Company with the Securities and Exchange Commission (the “SEC”), as well as press releases or other public or stockholder communications released by the Company, may contain forward-looking statements, including, but not limited to, (i) statements regarding our financial condition, results of operations and business, (ii) statements about our plans, objectives, expectations and intentions and other statements that are not historical facts and (iii) other statements identified by the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," "intends" or similar expressions that are intended to identify "forward-looking statements", within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current beliefs and expectations of the Company’s management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.
The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements: the expected cost savings, synergies and other financial benefits from acquisition or disposition transactions might not be realized within the expected time frames or at all and costs or difficulties relating to integration matters might be greater than expected; changes in economic conditions; fluctuations in interest rates; the risks of lending and investing activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses; our ability to access cost-effective funding; fluctuations in real estate values and both residential and commercial real estate market conditions; demand for loans and deposits in our market area; fluctuations in the price of oil, natural gas and other commodities; competition; changes in management's business strategies; our ability to successfully integrate any assets, liabilities, customers, systems and management personnel we have acquired or may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; results of examinations of us by the Board of Governors of the Federal Reserve System ("FRB") and our bank subsidiary by the Texas Department of Banking ("TDOB") or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings; legislative or regulatory changes that adversely affect our business including the revenue impact from, and any mitigation actions taken in response, to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”); changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board; and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services; changes in the regulatory and tax environments in which the Company operates, including the impact of the "Tax Cuts and Jobs Act" (the "TCJA") on the Company's deferred tax asset, and the anticipated impact of the TCJA on the Company's future earnings; and the other risks set forth under Risk Factors under Item 1A. of the Company's Form 10-K for the year ended December 31, 2017 ("2017 Form 10-K").

The factors listed above could materially affect our financial performance and could cause our actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.

We do not undertake - and specifically decline any obligation - to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. When considering forward-looking statements, you should keep in mind these risks and uncertainties. You should not place undue reliance on any forward-looking statement, which speaks only as of the date made. You should refer to our periodic and current reports filed with the SEC for specific risks that could cause actual results to be significantly different from those expressed or implied by any forward-looking statements.

Overview
LegacyTexas Financial Group, Inc. is a Maryland corporation and LegacyTexas Bank is its wholly owned principal operating subsidiary. Unless the context otherwise requires, references in this document to the “Company” refer to LegacyTexas Financial Group, Inc., and references to the “Bank” refer to LegacyTexas Bank. References to “we,” “us,” and “our” mean LegacyTexas Financial Group, Inc. and LegacyTexas Bank, as the context requires.

36


The Bank is regulated by the TDOB and the FRB with back-up oversight by the Federal Deposit Insurance Corporation ("FDIC"). Additionally, the Bank is a Federal Reserve member bank required to have certain reserves and stock set by the FRB and a member of the Federal Home Loan Bank of Dallas, one of the 12 regional banks in the Federal Home Loan Bank System (“FHLB”). The Company is regulated by the FRB.
Business Strategies
Our principal business consists of attracting retail deposits from the general public and the business community and investing those funds, along with borrowed funds, in commercial real estate loans, secured and unsecured commercial and industrial loans, as well as permanent loans secured by first and second mortgages on one- to four-family residences and consumer loans. Additionally, the Warehouse Purchase Program loans allow mortgage banking company customers to close one- to four-family real estate loans in their own name and manage its cash flow needs until the loans are sold to investors. Our operating revenues are derived principally from interest earned on interest-earning assets, including loans and investment securities and service charges and fees on deposits and other account services. Our primary sources of funds are deposits, FHLB advances and other borrowings, and payments received on loans and securities. We offer a variety of deposit accounts that provide a wide range of interest rates and terms, generally including savings, money market, term certificate and demand accounts.
Our principal objective is to be an independent, commercially-oriented, customer-focused financial services company, providing outstanding service and innovative products in our primary market area of North Texas. Our Board of Directors has adopted a strategy designed to maintain growth and profitability, a strong capital position and high asset quality.
Performance Highlights

Net income for the three months ended September 30, 2018 was $42.8 million, an increase of $14.1 million, or 49.2%, from net income of $28.7 million for the three months ended September 30, 2017. The increase in net income was driven by higher interest income on loans, increased non-interest income and a lower provision for credit losses, which was partially offset by higher interest and non-interest expense.

The net interest margin for the three months ended September 30, 2018 was 3.90%, a 19 basis point increase from the three months ended September 30, 2017.

Assets totaled $9.08 billion at September 30, 2018, which generated basic earnings per share for the three months ended September 30, 2018 of $0.91 and $2.05 for the nine months ended September 30, 2018.
 
Gross loans held for investment at September 30, 2018, excluding Warehouse Purchase Program loans, grew $280.9 million from December 31, 2017, while Warehouse Purchase Program loans, which totaled $1.05 billion at September 30, 2018, decreased by $266.3 million from December 31, 2017.

Total deposits at September 30, 2018 grew $12.1 million from December 31, 2017, as the Company's efforts to grow non-interest-bearing demand deposits resulted in a $162.5 million increase in these deposits to $1.80 billion at September 30, 2018. Non-interest-bearing deposits totaled 26.5% of total deposits at September 30, 2018.

Non-performing loans declined by $76.8 million from December 31, 2017, totaling $17.6 million at September 30, 2018.
Critical Accounting Estimates
Certain of our accounting estimates are important to the portrayal of our financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances which could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers. Management believes that determining the allowance for loan losses is its most critical accounting estimate. Our accounting policies are discussed in detail in Note 1 of the Notes to Consolidated Financial Statements contained in Item 8 of our 2017 Form 10-K.
Allowance for Loan Loss. The allowance for loan losses and related provision expense are susceptible to change if the credit quality of our loan portfolio changes, which is evidenced by many factors, including but not limited to charge-offs

37


and non-performing loan trends. Generally, consumer real estate lending has a lower risk profile compared to other consumer lending (such as automobile loans). Commercial real estate and commercial and industrial lending, however, can have higher risk profiles than consumer loans due to these loans being larger in amount and more susceptible to fluctuations in industry, market and economic conditions. While management uses available information to recognize losses on loans, changes in economic conditions, the mix and size of the loan portfolio and individual borrower conditions can dramatically impact our level of allowance for loan losses in relatively short periods of time. Management believes that the allowance for loan losses is maintained at a level that represents coverage of our best estimate of credit losses in the loan portfolio as of September 30, 2018.
Management evaluates current information and events regarding a borrower's ability to repay its obligations and considers a loan to be impaired when the ultimate collectability of amounts due, according to the contractual terms of the loan agreement, is in doubt. If an impaired loan is collateral-dependent, the fair value of the collateral, less the estimated cost to sell, is used to determine the amount of impairment. If an impaired loan is not collateral-dependent, the impairment amount is determined using the negative difference, if any, between the estimated discounted cash flows and the loan amount due. For impaired loans, the amount of the impairment can be adjusted, based on current data, until such time as the actual basis is established by acquisition of the collateral or until the basis is collected. Impairment losses are reflected in the allowance for loan losses through a charge to the provision for credit losses. Subsequent recoveries are credited to the allowance for loan losses. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement. Cash receipts on impaired loans for which the accrual of interest has been discontinued are applied first to principal.

38


Comparison of Financial Condition at September 30, 2018 and December 31, 2017
General. Total assets decreased by $3.4 million to $9.08 billion at September 30, 2018 from $9.09 billion at December 31, 2017, primarily due to a $266.3 million, or 20.2%, decrease in Warehouse Purchase Program loans and a $39.1 million, or 13.3%, decrease in cash and cash equivalents, which was partially offset by a $280.9 million, or 4.3%, increase in gross loans held for investment, excluding Warehouse Purchase Program loans.
Loans. Gross loans held for investment increased by $14.5 million, or 0.2%, to $7.82 billion at September 30, 2018 from $7.80 billion at December 31, 2017, while loans held for sale increased by $5.5 million, or 32.7%, for the same period.
    
 
September 30,
2018
 
December 31,
2017
 
Dollar
Change
 
Percent
Change
 
(Dollars in thousands)
Commercial real estate
$
3,012,352

 
$
3,019,339

 
$
(6,987
)
 
(0.2
)%
Commercial and industrial
2,111,510

 
1,927,049

 
184,461

 
9.6

Construction and land
278,278

 
277,864

 
414

 
0.1

Consumer real estate
1,318,038

 
1,213,434

 
104,604

 
8.6

Other consumer
43,874

 
45,506

 
(1,632
)
 
(3.6
)
Gross loans held for investment, excluding Warehouse Purchase Program loans
6,764,052

 
6,483,192

 
280,860

 
4.3

Warehouse Purchase Program
1,054,505

 
1,320,846

 
(266,341
)
 
(20.2
)
Gross loans held for investment
7,818,557

 
7,804,038

 
14,519

 
0.2

Loans held for sale
22,175

 
16,707

 
5,468

 
32.7

Gross loans
$
7,840,732

 
$
7,820,745

 
$
19,987

 
0.3
 %

Gross loans held for investment at September 30, 2018, excluding Warehouse Purchase Program loans, grew $280.9 million, or 4.3%, from December 31, 2017, which included growth in the commercial and industrial, consumer real estate, and construction and land loan portfolios. Commercial and industrial and consumer real estate loans at September 30, 2018 increased by $184.5 million and $104.6 million, respectively, from December 31, 2017, while construction and land loans increased by $414,000 for the same period. These increases were partially offset by decreases of $7.0 million and $1.6 million in commercial real estate and other consumer loans, respectively, from December 31, 2017.
Reserve-based energy loans, which are reported as commercial and industrial loans, totaled $547.4 million at September 30, 2018, up $15.7 million from $531.7 million at December 31, 2017. Substantially all of the reserve-based energy loans are secured by deeds of trust on properties containing proven oil and natural gas reserves.
  
At September 30, 2018, our reserve-based energy portfolio (reported above at $547.4 million) was secured by collateral that consisted of 60% crude oil reserves and 40% natural gas reserves. We encourage, and in some cases even require, borrowers to utilize commodity hedges, in order to stabilize cash flows during volatile commodity price environments.  Hedges are used to guard against falling prices, and the goal is that the duration of the hedge will last long enough for prices to come back from any significant decline.  Hedges will typically include minimum and maximum allowed percentage of production, a minimum and maximum allowed term, and a minimum price.

In addition to the reserve-based energy loans, the Bank has loans categorized as "Midstream and Other," which are typically related to the transmission of oil and natural gas and would only be indirectly impacted by declining commodity prices. At September 30, 2018, "Midstream and Other" loans had a total outstanding balance of $34.8 million, up $19.4 million from $15.4 million at December 31, 2017.

Warehouse Purchase Program loans decreased by $266.3 million, or 20.2%, to $1.05 billion at September 30, 2018 from $1.32 billion at December 31, 2017. Although not bound by any legally binding commitment, when a purchase decision is made, the Bank purchases a 100% participation interest in the loans originated by our mortgage banking company customers. The mortgage banking company closes mortgage loans consistent with underwriting standards established by approved investors and, once all pertinent documents are received, the participation interest is delivered by the Bank to the investor selected by the originator and approved by us. Warehouse Purchase Program loans funded during the third quarter of 2018 consisted of 44% conforming, 42% government loans and 14% of other loan types, including Jumbo loans.

39


Allowance for Loan Losses. The allowance for loan losses is maintained to cover incurred losses that are estimated in accordance with US GAAP. It is our estimate of credit losses inherent in our loan portfolio at each balance sheet date. Our methodology for analyzing the allowance for loan losses consists of general and specific components. For more information about the Company's calculation of its allowance for loan losses, please see Item 1 (Financial Statements) - Note 5 - "Loans" under Part 1 of this report.
Acquired loans initially are recorded at fair value, which includes an estimate of credit losses expected to be realized over the remaining lives of the loans, and therefore no corresponding allowance for loan losses is recorded for these loans at acquisition. An allowance will be recorded in later periods if additional losses are subsequently anticipated. Methods utilized to estimate the required allowance for loan losses for acquired loans not deemed credit-impaired at acquisition are similar to originated loans; however, the estimate of loss is limited to the amount that the calculated allowance for loan losses exceeds the remaining purchase discount.
Purchased credit impaired ("PCI") loans are not considered non-performing loans, and accordingly, are not included in the non-performing loans to total loans ratio as a numerator, but are included in total loans reflected in the denominator. The result is a downward trend in the ratio when compared to prior periods, assuming all other factors stay the same. Similarly, other asset quality ratios, such as the allowance for loan losses to total loans ratio will reflect a downward trend, assuming all other factors stay the same, due to the impact of PCI loans on the denominator with no corresponding impact in the numerator.
Our non-performing loans, which consist of nonaccrual loans, include both smaller balance homogeneous loans that are collectively evaluated for impairment and larger individually evaluated impaired loans. Loans generally are placed on nonaccrual status when the loan becomes 90 days or more delinquent. Non-performing loans include loans that are not contractually past due but have been placed on nonaccrual status due to the loan's designation as a troubled debt restructuring or if there is a distinct possibility that the Company will sustain some loss if deficiencies existing within a loan are not corrected. In all cases, loans are placed on nonaccrual status (or charged-off) at an earlier date when the collection of principal and/or interest becomes doubtful or other factors involving the loan warrant placing the loan on nonaccrual status.
Non-performing loans to total loans held for investment, excluding Warehouse Purchase Program loans, was 0.26% at September 30, 2018 compared to 1.46% at December 31, 2017. Including Warehouse Purchase Program loans, non-performing loans to total loans held for investment was 0.22% at September 30, 2018 compared to 1.21% at December 31, 2017. Non-performing loans decreased by $76.8 million to $17.6 million at September 30, 2018 from $94.4 million at December 31, 2017. During the second quarter of 2018, the Company recorded a $12.5 million charge-off on the resolution of an impaired $14.0 million energy relationship, as well as charge-offs totaling $14.7 million on two impaired corporate healthcare finance relationships, both of which remain classified as non-performing and impaired and totaled a combined $3.4 million at September 30, 2018. Also, during the first quarter of 2018, the Company recorded a $10.5 million charge-off in connection with the resolution of a $36.7 million reserve-based energy relationship, classified as non-performing and impaired at December 31, 2017, through a new loan to a new borrower, which was a substandard performing loan at September 30, 2018. For more information about the Company's non-performing loans, please see Note 5 of the Condensed Notes to Unaudited Consolidated Interim Financial Statements contained in Item 1 of this report.
Our allowance for loan losses was $66.4 million at September 30, 2018 compared to $71.3 million at December 31, 2017, or 0.85% of total loans held for investment (including Warehouse Purchase Program loans) at September 30, 2018 compared to 0.91% at December 31, 2017. Despite the decrease, it was believed that the level of the allowance was acceptable because our allowance for loan losses to non-performing loans was 377.35% at September 30, 2018 compared to 75.53% at December 31, 2017. Net charge-offs for the nine months ended September 30, 2018 totaled $40.9 million, an increase of $10.2 million from the nine months ended September 30, 2017, due to the energy-related and healthcare-related loan charge-offs discussed above.
Classified Assets. Loans and other assets, such as securities and foreclosed assets, that are considered by management to be of lesser quality are classified as "substandard," "doubtful" or "loss." An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses of those classified as "substandard," with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Assets classified as "loss" are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. PCI loans are included in the "substandard" and "doubtful" categories.

40


We regularly review the assets in our portfolio to determine whether any should be considered as classified. Total classified assets represented 6.0% of our total equity and 0.7% of our total assets at September 30, 2018 compared to 12.7% of our total equity and 1.3% of our total assets at December 31, 2017. The aggregate amount of classified assets at the dates indicated was as follows:
 
September 30,
2018
 
December 31,
2017
 
(Dollars in thousands)
Doubtful
$
379

 
$
1,134

Substandard
61,704

 
112,632

Total classified loans
62,083

 
113,766

Foreclosed assets
698

 
8,432

Total classified assets
$
62,781

 
$
122,198

Substandard loans at September 30, 2018 decreased by $50.9 million from December 31, 2017, with substandard non-performing energy loans totaling $1.3 million at September 30, 2018, down $57.1 million from December 31, 2017, which was primarily due to the resolution of the energy relationships discussed above in "Allowance for Loan Losses." The Company continues to take action to improve the risk profile of the criticized energy loans by instituting monthly commitment reductions, obtaining additional collateral, obtaining additional guarantor support and/or requiring additional equity injections or asset sales. Foreclosed assets at September 30, 2018 decreased by $7.7 million from December 31, 2017 due to the sale of a foreclosed medical facility in the third quarter of 2018, which generated a $1.3 million gain.
The Company also has potential problem loans, considered "other loans of concern," that are currently performing and do not meet the criteria for impairment, but where there is the distinct possibility that we might sustain some loss if credit deficiencies are not corrected. These possible credit problems may result in the future inclusion of these loans in the non-performing asset categories and consisted of $43.2 million in loans that were classified as "substandard," but were still accruing interest and were not considered impaired at September 30, 2018 (excluding PCI loans), compared to $15.4 million at December 31, 2017. The $27.8 million increase in other loans of concern from December 31, 2017 was primarily due to a $28.8 million increase in classified performing energy loans. Other loans of concern have been considered in management's analysis of potential loan losses.
Securities. Our securities portfolio increased $7.4 million, or 1.2%, to $600.6 million at September 30, 2018 from $593.2 million at December 31, 2017. During the nine months ended September 30, 2018, purchases totaling $1.91 billion offset paydowns and maturities of securities totaling $1.89 billion.
Deposits. Total deposits increased $12.1 million, or 0.2%, to $6.78 billion at September 30, 2018 from $6.77 billion at December 31, 2017, primarily due to growth in non-interest-bearing demand and time deposits.
 
September 30,
2018
 
December 31, 2017
 
Dollar
Change
 
Percent
Change
 
(Dollars in thousands)
Non-interest-bearing demand
$
1,798,109

 
$
1,635,622

 
$
162,487

 
9.9
 %
Interest-bearing demand
780,474

 
1,029,375

 
(248,901
)
 
(24.2
)
Savings and money market
2,562,399

 
2,735,296

 
(172,897
)
 
(6.3
)
Time
1,638,776

 
1,367,390

 
271,386

 
19.8

Total deposits
$
6,779,758

 
$
6,767,683

 
$
12,075

 
0.2
 %

Time deposits increased by $271.4 million compared to December 31, 2017, while non-interest-bearing demand deposits increased by $162.5 million for the same period. These increases were partially offset by declines of $248.9 million and $172.9 million in interest-bearing demand and savings and money market deposits, respectively, compared to December 31, 2017.
Borrowings. FHLB advances decreased by $110.8 million, or 10.6%, to $932.3 million at September 30, 2018 from $1.04 billion at December 31, 2017, while overnight repurchase agreements decreased by $44.3 million, or 52.3%, to $40.4

41


million at September 30, 2018 from $84.7 million at December 31, 2017. At September 30, 2018, the Company was eligible to borrow an additional $2.09 billion from the FHLB.
The table below shows FHLB advances by maturity and weighted average rate at September 30, 2018:
 
Balance
 
Weighted Average Rate
 
(Dollars in thousands)
Less than 90 days
$
926,909

 
2.19
%
90 days to less than one year
958

 
5.50

One to three years
2,950

 
5.49

After three to five years
1,005

 
5.51

After five years
495

 
5.44

Total
$
932,317

 
2.21
%
Additionally, we have seven available federal funds lines of credit with other financial institutions totaling $250.0 million and were eligible to borrow $81.1 million from the Federal Reserve Bank discount window.
At September 30, 2018, subordinated debt totaled $134.9 million, which included $122.8 million of fixed-to-floating rate subordinated notes (reported net of $2.2 million in debt issuance costs.) The $134.9 million of subordinated debt also included $12.1 million of trust preferred securities that were acquired through the merger with LegacyTexas Group, Inc. All subordinated debt is reported net of purchase accounting fair value adjustments and debt issuance costs.
Accrued Expenses and Other Liabilities. Accrued expenses and other liabilities increased $59.5 million, or 61.8%, to $155.8 million at September 30, 2018 from $96.3 million at December 31, 2017. This increase was primarily due to timing of escrow payments.
Shareholders’ Equity. Total shareholders' equity increased by $79.7 million, or 8.3%, to $1.04 billion at September 30, 2018 from $959.9 million at December 31, 2017.
 
September 30,
2018
 
December 31, 2017
 
Dollar
Change
 
Percent
Change
 
(Dollars in thousands)
Common stock
$
485

 
$
481

 
$
4

 
0.8
 %
Additional paid-in capital
617,270

 
603,884

 
13,386

 
2.2

Retained earnings
444,848

 
370,858

 
73,990

 
20.0

Accumulated other comprehensive income (loss), net
(11,481
)
 
(3,429
)
 
(8,052
)
 
234.8

Unearned ESOP shares
(11,523
)
 
(11,920
)
 
397

 
(3.3
)
Total shareholders’ equity
$
1,039,599

 
$
959,874

 
$
79,725

 
8.3
 %
The increase in shareholders' equity at September 30, 2018, compared to December 31, 2017, was primarily due to net income of $96.4 million recognized during the nine months ended September 30, 2018, which was partially offset by the payment of quarterly dividends totaling $0.48 per common share, or $23.2 million, during the nine months ended September 30, 2018.

42


Comparison of Results of Operations for the Three Months Ended September 30, 2018 and 2017
General. Net income for the three months ended September 30, 2018 was $42.8 million, an increase of $14.1 million, or 49.2%, from net income of $28.7 million for the three months ended September 30, 2017. The increase in net income was driven by a $13.2 million increase in interest income on loans, a $4.5 million decrease in the provision for credit losses, and a $1.0 million increase in non-interest income, which was partially offset by a $7.0 million increase in interest expense and a $1.9 million increase in non-interest expense. Basic earnings per share for the three months ended September 30, 2018 was $0.91, a $0.30 increase from $0.61 for the three months ended September 30, 2017. Diluted earnings per share for the three months ended September 30, 2018 was $0.89, a $0.28 increase from $0.61 for the three months ended September 30, 2017.
Interest Income. Interest income increased by $13.7 million, or 14.5%, to $108.1 million for the three months ended September 30, 2018 from $94.5 million for the three months ended September 30, 2017.
 
Three Months Ended September 30,
 
Dollar Change
 
Percent Change
 
2018
 
2017
 
 
 
(Dollars in thousands)
Interest and dividend income
 
 
 
 
 
 
 
Loans, including fees
$
102,267

 
$
89,084

 
$
13,183

 
14.8
 %
Securities
3,868

 
3,407

 
461

 
13.5

Interest-bearing deposits in other financial institutions
1,368

 
1,524

 
(156
)
 
(10.2
)
FHLB and Federal Reserve Bank stock and other
644

 
448

 
196

 
43.8

 
$
108,147

 
$
94,463

 
$
13,684

 
14.5
 %
The $13.7 million increase in interest income for the three months ended September 30, 2018 compared to the three months ended September 30, 2017 was primarily due to a $13.2 million increase in interest income on loans, which was driven by increased volume in the commercial real estate, commercial and industrial and consumer real estate loan portfolios, as well as higher yields earned on all loan portfolios. The average balance of commercial and industrial loans increased by $237.7 million from the third quarter of 2017, while the average yield earned on this portfolio increased by 78 basis points for the same period, resulting in a $7.1 million increase in interest income. The average yield earned on the commercial and industrial portfolio for the quarter ended September 30, 2018 was positively impacted by four increases in the Fed Funds rate totaling 100 basis points since September 2017, as well as the resolution of multiple non-performing relationships over the past year. The average balance of commercial real estate loans increased by $162.5 million from the third quarter of 2017, resulting in a $2.7 million increase in interest income, while the average balance of consumer real estate loans increased by $118.4 million for the same period, which led to a $1.8 million increase in interest income. Although the average balance of Warehouse Purchase Program loans decreased by $95.0 million from the third quarter of 2017, the average yield earned on this portfolio increased by 86 basis points, resulting in a $1.4 million increase in interest income compared to the third quarter of 2017.
 
Interest income on loans for the third quarter of 2018 included $330,000 in accretion of purchase accounting fair value adjustments on acquired loans, which primarily consisted of $132,000 on acquired commercial real estate loans, $77,000 on acquired commercial and industrial loans and $120,000 on acquired consumer loans.
Interest Expense. Interest expense increased by $7.0 million, or 45.0%, to $22.5 million for the three months ended September 30, 2018 from $15.5 million for the three months ended September 30, 2017.

 
Three Months Ended September 30,
 
Dollar Change
 
Percent Change
 
2018
 
2017
 
 
 
(Dollars in thousands)
Interest expense
 
 
 
 
 
 
 
Deposits
$
15,077

 
$
10,271

 
$
4,806

 
46.8
 %
FHLB advances
5,198

 
2,944

 
2,254

 
76.6

Repurchase agreements and other borrowings
2,205

 
2,284

 
(79
)
 
(3.5
)
 
$
22,480

 
$
15,499

 
$
6,981

 
45.0
 %
The increase in interest expense for the three months ended September 30, 2018 compared to the same period in 2017 was primarily due to higher average rates on deposits and borrowings, as well as an increase of $265.4 million in the average balance of time deposits. A $24.0 million decrease in the average balance of borrowings from the third quarter of 2017 was

43


more than offset by a 79 basis point increase in the average rate, resulting in a $2.2 million year-over-year increase in interest expense on borrowed funds.
Net Interest Income. Net interest income increased by $6.7 million, or 8.5%, to $85.7 million for the three months ended September 30, 2018 from $79.0 million for the three months ended September 30, 2017. The net interest margin for the third quarter of 2018 was 3.90%, a 19 basis point increase from the third quarter of 2017. The average yield on earning assets for the third quarter of 2018 was 4.92%, a 48 basis point increase from the third quarter of 2017. The average cost of interest-bearing liabilities for the third quarter of 2018 was 1.43%, up 46 basis points from the third quarter of 2017.
Provision for Credit Losses. The Company recorded a provision for credit losses of $2.7 million for the quarter ended September 30, 2018, down $4.5 million from $7.2 million for the quarter ended September 30, 2017. The decrease in provision expense from the three months ended September 30, 2017 was primarily due to decreased charge-offs during the quarter ended September 30, 2018. Net charge-offs totaled $791,000 for the three months ended September 30, 2018, down $11.6 million from the three months ended September 30, 2017. For more information about the Company's allowance for loan losses, please see "Management's Discussion and Analysis - Comparison of Financial Condition at September 30, 2018 and December 31, 2017 - Allowance for Loan Losses" contained in Item 2 of this report.
Non-interest Income. Non-interest income increased by $1.0 million, or 8.2%, to $13.2 million for the three months ended September 30, 2018 from $12.2 million for the three months ended September 30, 2017.
 
Three Months Ended September 30,
 
Dollar Change
 
Percent Change
 
2018
 
2017
 
 
 
(Dollars in thousands)
Non-interest income
 
 
 
 
 
 
 
Service charges and other fees
$
8,626

 
$
9,291

 
$
(665
)
 
(7.2
)%
Net gain on sale of mortgage loans held for sale
1,597

 
1,982

 
(385
)
 
(19.4
)
Bank-owned life insurance income
482

 
435

 
47

 
10.8

Net loss on securities transactions
(10
)
 
(20
)
 
10

 
50.0

Gain on sale and disposition of assets
977

 
352

 
625

 
177.6

Other
1,555

 
186

 
1,369

 
N/M1

 
$
13,227

 
$
12,226

 
$
1,001

 
8.2
 %
1N/M - not meaningful
The $1.0 million increase in non-interest income from the third quarter of 2017 was primarily due to a $1.4 million increase in other non-interest income, which included a $1.5 million net increase in the value of investments in community development-oriented private equity funds used for Community Reinvestment Act purposes (the "CRA Funds") recorded in the third quarter of 2018, compared to a $134,000 net increase in the CRA funds recorded in the third quarter of 2017. Gain (loss) on sale and disposition of assets for the third quarter of 2018 included $1.3 million in gains on the sale of foreclosed properties, which was partially offset by a $471,000 loss recorded on the anticipated disposition of a leased branch location, with the branch expected to close in the fourth quarter of 2018. Service charges and other fees decreased by $665,000 from the third quarter of 2017, which was driven by decreases in title premiums, Warehouse Purchase Program fee income, commercial loan fee income (consisting of syndication, arrangement, non-usage and pre-payment fees) and brokerage income, after the Company discontinued its brokerage services in the third quarter of 2017. These decreases in service charges and other fees were partially offset by increased commercial account analysis fee and debit card interchange income recorded in the 2018 period. Net gains on the sale of mortgage loans held for sale during the third quarter of 2018 decreased by $385,000 compared to the third quarter of 2017, which included gains recognized on $52.4 million of one-to four-family mortgage loans that were sold or committed for sale and fair value changes on mortgage derivatives and mortgage fees collected during the third quarter of 2017, compared to $38.7 million for the third quarter of 2018.


44


Non-interest Expense. Non-interest expense increased by $1.9 million, or 4.7%, to $42.2 million for the three months ended September 30, 2018, from $40.3 million for the three months ended September 30, 2017.
 
Three Months Ended September 30,
 
Dollar Change
 
Percent Change
 
2018
 
2017
 
 
 
(Dollars in thousands)
Non-interest expense
 
 
 
 
 
 
 
Salaries and employee benefits
$
25,053

 
$
24,175

 
$
878

 
3.6
 %
Advertising
824

 
980

 
(156
)
 
(15.9
)
Occupancy and equipment
3,960

 
3,299

 
661

 
20.0

Outside professional services
1,151

 
1,230

 
(79
)
 
(6.4
)
Regulatory assessments
750

 
1,011

 
(261
)
 
(25.8
)
Data processing
5,362

 
4,287

 
1,075

 
25.1

Office operations
2,232

 
2,378

 
(146
)
 
(6.1
)
Other
2,860

 
2,935

 
(75
)
 
(2.6
)
 
$
42,192

 
$
40,295

 
$
1,897

 
4.7
 %

The $1.9 million increase in non-interest expense from the third quarter of 2017 was primarily due to a $1.1 million increase in data processing expense as the Company has outsourced certain segments of its data processing operations and invested in system upgrades. This outsourcing resulted in a reduction in full-time equivalent employees in the technology area, which partially offset the increase in salaries and employee benefits expense. Salaries and employee benefits expense increased by $878,000 from the third quarter of 2017, which was driven by an increase in performance incentive accruals based on decreased non-performing assets, increased share-based compensation expenses, and lower deferred salary costs related to loan originations that will be accounted for over the lives of the related loans. These increases in salaries and employee benefits expense were partially offset by lower health care costs, severance costs, and commissions related to lower mortgage loan production during the third quarter of 2018, as well as the above-mentioned reduction in staff in the technology area. Occupancy and equipment expense increased by $661,000 from the third quarter of 2017 primarily due to an early termination fee collected from a tenant in the third quarter of 2017 that was not repeated in the current period. These increases were partially offset by decreases from the third quarter of 2017 in regulatory assessments expense of $261,000, advertising expense of $156,000, and office operations expense of $146,000.
Income Tax Expense. For the three months ended September 30, 2018, we recognized income tax expense of $11.2 million on our pre-tax income, which was an effective tax rate of 20.8%, compared to income tax expense of $15.0 million for the three months ended September 30, 2017, which was an effective tax rate of 34.4%. The decrease in the effective tax rate was primarily due to the enactment of the Tax Cuts and Jobs Act ("TCJA"), which made key changes to the U.S. tax law, including the reduction of the U.S. federal corporate tax rate from 35% to 21%. Additionally, during the fourth quarter of 2017, the Company filed an advance consent application for change in accounting method with the Internal Revenue Service (the "IRS") to change the Company's tax method of accounting for its loan portfolio. The Company has received affirmative consent from the IRS, and this anticipated change will impact the Company's deferred tax asset and income tax expense in the fourth quarter of 2018.
The Company is still analyzing certain aspects of the TCJA and loan portfolio tax accounting change and refining its calculations, which could potentially affect the measurement of these balances or give rise to new deferred tax amounts. We expect to complete our analysis of the above-mentioned tax changes within the one-year transition period given in SEC Staff Accounting Bulletin 118.
    

45


Comparison of Results of Operations for the Nine Months Ended September 30, 2018 and 2017

General. Net income for the nine months ended September 30, 2018 was $96.4 million, an increase of $21.6 million, or 28.8%, from net income of $74.8 million for the nine months ended September 30, 2017. The increase in net income was driven by increased net interest income and decreased income tax expense, partially offset by increased non-interest expense. Basic earnings per share for the nine months ended September 30, 2018 was $2.05, an increase of $0.45 from $1.60 for the nine months ended September 30, 2017. Diluted earnings per share for the nine months ended September 30, 2018 was $2.02, an increase of $0.44 from $1.58 for the nine months ended September 30, 2017.

Interest Income. Interest income increased by $37.1 million, or 13.7%, to $307.8 million for the nine months ended September 30, 2018 from $270.7 million for the nine months ended September 30, 2017.
 
Nine Months Ended September 30,
 
Dollar Change
 
Percent Change
 
2018
 
2017
 
 
 
(Dollars in thousands)
Interest and dividend income
 
 
 
 
 
 
 
Loans, including fees
$
291,468

 
$
256,104

 
$
35,364

 
13.8
%
Securities
11,227

 
10,188

 
1,039

 
10.2

Interest-bearing deposits in other financial institutions
3,434

 
3,211

 
223

 
6.9

FHLB and Federal Reserve Bank stock and other
1,675

 
1,243

 
432

 
34.8

 
$
307,804

 
$
270,746

 
$
37,058

 
13.7
%

The $37.1 million increase in interest income for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 was primarily due to a $35.4 million, or 13.8%, increase in interest income on loans, which was driven by increased volume in all loan portfolios, with the exception of construction and land and other consumer loans, as well as higher yields earned on all loan portfolios. The average balance of commercial real estate loans increased by $234.6 million from the nine months ended September 30, 2017, resulting in a $9.9 million increase in interest income. The average balance of commercial and industrial loans increased by $157.8 million from the nine months ended September 30, 2017, while the average yield earned on this portfolio increased by 52 basis points, resulting in a $13.7 million increase in interest income. The average yield earned on the commercial and industrial portfolio for the nine months ended September 30, 2018 was positively impacted by four increases in the Fed Funds rate, totaling 100 basis points since September 2017, as well as the resolution of multiple non-performing relationships over the past year. The average balance of consumer real estate loans increased by $131.4 million from the nine months ended September 30, 2017, increasing interest income by $5.2 million. The average balance of Warehouse Purchase Program loans increased by $19.0 million compared to the nine months ended September 30, 2017, while the average yield earned increased by 79 basis points, resulting in a $6.7 million increase in interest income. These increases in interest income were partially offset by a $261,000 decline in interest income recorded on construction and land loans, the average balance of which declined by $15.2 million from the nine months ended September 30, 2017.

Interest Expense. Interest expense increased by $20.1 million, or 50.8%, to $59.6 million for the nine months ended September 30, 2018 from $39.5 million for the nine months ended September 30, 2017.
 
Nine Months Ended September 30,
 
Dollar Change
 
Percent Change
 
2018
 
2017
 
 
 
(Dollars in thousands)
Interest expense
 
 
 
 
 
 
 
Deposits
$
40,841

 
$
25,740

 
$
15,101

 
58.7
 %
FHLB advances
12,009

 
7,003

 
5,006

 
71.5

Repurchase agreements and other borrowings
6,745

 
6,771

 
(26
)
 
(0.4
)
 
$
59,595

 
$
39,514

 
$
20,081

 
50.8
 %

The increase in interest expense for the nine months ended September 30, 2018 compared to the same period in 2017, was primarily due to an increase in interest expense on deposits, which was driven by increased rates paid on all deposit categories during the nine months ended September 30, 2018 compared to the same period in 2017, which included a 62 basis

46


point increase in the average rate paid on time deposits, a 20 basis point increase in the average rate paid on interest-bearing demand deposits, and a 25 basis point increase in the average rate paid on savings and money market deposits. Additionally, the average balance of time deposits increased by $220.9 million from the nine months ended September 30, 2017. Interest expense on borrowings for the nine months ended September 30, 2018 increased by $5.0 million compared to the nine months ended September 30, 2017, due to an 82 basis point increase in the average rate paid on borrowings, despite a $103.3 million decline in the average balance.

Net Interest Income. Net interest income increased by $17.0 million, or 7.3%, to $248.2 million for the nine months ended September 30, 2018 from $231.2 million for the nine months ended September 30, 2017. The net interest margin increased by seven basis point to 3.89% for the nine months ended September 30, 2018 from 3.82% for the same period last year. The net interest rate spread decreased by seven basis points to 3.54% for the nine months ended September 30, 2018 from 3.61% for the same period last year. The average yield on earning assets for the nine months ended September 30, 2018 was 4.83%, a 35 basis point increase from the nine months ended September 30, 2017, while the average cost of interest-bearing liabilities increased by 42 basis points.
Provision for Credit Losses. The provision for credit losses was $35.8 million for the nine months ended September 30, 2018, an increase of $84,000 from $35.7 million for the nine months ended September 30, 2017. Net charge-offs totaled $40.9 million for the nine months ended September 30, 2018, up $10.2 million from the nine months ended September 30, 2017. For more information about the Company's allowance for loan losses, please see "Management's Discussion and Analysis - Comparison of Financial Condition at September 30, 2018 and December 31, 2017 - Allowance for Loan Losses" contained in Item 2 of this report.
Non-interest Income. Non-interest income increased by $296,000, or 0.8%, to $37.0 million for the nine months ended September 30, 2018 from $36.7 million for the nine months ended September 30, 2017.
 
Nine Months Ended September 30,
 
Dollar Change
 
Percent Change
 
2018
 
2017
 
 
 
(Dollars in thousands)
Non-interest income
 
 
 
 
 
 
 
Service charges and other fees
$
25,397

 
$
27,618

 
$
(2,221
)
 
(8.0
)%
Net gain on sale of mortgage loans held for sale
5,074

 
5,766

 
(692
)
 
(12.0
)
Bank-owned life insurance income
1,408

 
1,297

 
111

 
8.6

Net loss on securities transactions
(138
)
 
(39
)
 
(99
)
 
(253.8
)
Gain on sale and disposition of assets
3,037

 
1,908

 
1,129

 
59.2

Other
2,199

 
131

 
2,068

 
N/M1

 
$
36,977

 
$
36,681

 
$
296

 
0.8
 %
1N/M - not meaningful
The increase in non-interest income for the nine months ended September 30, 2018 compared to the nine months ended September 30, 2017 was primarily due to a $2.1 million increase in other non-interest income and a $1.1 million increase in gain on sale and disposition of assets. Other non-interest income included a $1.6 million net increase in the value of the CRA Funds recorded during the nine months ended September 30, 2018, compared to an $84,000 net decrease in the CRA Funds for the nine months ended September 30, 2017. Additionally, other non-interest income for the nine months ended September 30, 2018 included a $402,000 yield maintenance fee on a bond pre-payment was received in the first quarter of 2018. Gain on sale and disposition of assets for the nine months ended September 30, 2018 included $2.3 million in proceeds resulting from an insurance settlement related to a misappropriation of approximately $2.5 million in vault cash from one of the former LegacyTexas Bank branches acquired in 2015, as well as $1.2 million in net gains recorded on the sale of foreclosed properties, which was partially offset by a $471,000 loss recorded on the anticipated disposition of a leased branch location, with the branch expected to close in the fourth quarter of 2018. Comparatively, gain on sale and disposition of assets for the nine months ended September 30, 2017 included $1.7 million in gains recorded on the sale of one branch location and one parcel of land.
Service charges and other fees decreased by $2.2 million compared to the nine months ended September 30, 2017, which included decreases in title premiums, commercial loan fee income (consisting of syndication, arrangement, non-usage and pre-payment fees), Warehouse Purchase Program fee income, and brokerage income after the Company discontinued its brokerage services in the third quarter of 2017. These decreases in service charges and other fees were partially offset by an

47


increase in debit card interchange and commercial account analysis fee income compared to the nine months ended September 30, 2017.
Net gains on the sale of mortgage loans held for sale during the nine months ended September 30, 2018 decreased by $692,000 compared to the nine months ended September 30, 2017, which included gains recognized on $148.4 million of one- to four-family mortgage loans that were sold or committed for sale and fair value changes on mortgage derivatives and mortgage fees collected during the 2017 period, compared to $138.6 million for the nine months ended September 30, 2018.
Non-interest Expense. Non-interest expense increased by $8.6 million, or 7.2%, to $128.3 million for the nine months ended September 30, 2018 from $119.6 million for the nine months ended September 30, 2017.
 
Nine Months Ended September 30,
 
Dollar Change
 
Percent Change
 
2018
 
2017
 
 
 
(Dollars in thousands)
Non-interest expense
 
 
 
 
 
 
 
Salaries and employee benefits
$
76,442

 
$
72,010

 
$
4,432

 
6.2
 %
Advertising
3,070

 
2,976

 
94

 
3.2

Occupancy and equipment
11,800

 
10,609

 
1,191

 
11.2

Outside professional services
3,783

 
3,589

 
194

 
5.4

Regulatory assessments
2,635

 
3,267

 
(632
)
 
(19.3
)
Data processing
15,210

 
12,059

 
3,151

 
26.1

Office operations
6,756

 
7,058

 
(302
)
 
(4.3
)
Other
8,566

 
8,068

 
498

 
6.2

 
$
128,262

 
$
119,636

 
$
8,626

 
7.2
 %
The increase in non-interest expense from the nine months ended September 30, 2017 included a $4.4 million increase in salaries and employee benefits expense, which was driven by an increase in performance incentive accruals based on decreased non-performing assets, lower deferred salary costs related to loan originations that will be accounted for over the lives of the related loans, as well as increased severance costs, share-based compensation and ESOP expenses, and merit increases awarded in the 2018 period. These increases in salaries and employee benefits expense were partially offset by lower health care costs, staff reductions in the technology area, and decreased commissions related to lower mortgage loan production recorded during the nine months ended September 30, 2018. Also, in connection with the enactment of the Tax Cuts and Jobs Act ("TCJA"), in 2018, the Company awarded all full-time employees whose salary was under $100,000 a $1,000 bonus, which resulted in $679,000 of additional salary expense, and increased the Company's minimum wage to $15 from $11 per hour for all non-commission-based employees. Data processing expense increased by $3.2 million compared to the nine months ended September 30, 2017, as the Company has outsourced certain segments of its data processing operations and invested in system upgrades. Occupancy and equipment expense increased by $1.2 million during the nine months ended September 30, 2018 due to an early termination fee collected from a tenant in the third quarter of 2017, which in turn terminated future rental income from this tenant. Other non-interest expense increased by $498,000 due to higher debit card fraud and lending-related expenses during the 2018 period, partially offset by reduced brokerage expenses after the Company discontinued its brokerage services in the third quarter of 2017. These increased non-interest expenses compared to the nine months ended September 30, 2017 were partially offset by a $632,000 reduction in regulatory assessment expense and a $302,000 reduction in office operations expense.
Income Tax Expense. For the nine months ended September 30, 2018, we recognized income tax expense of $24.7 million on our pre-tax income, which was an effective tax rate of 20.4%, compared to income tax expense of $37.7 million for the nine months ended September 30, 2017, which was an effective tax rate of 33.5%. The decrease in the effective tax rate was primarily due to the enactment of the TCJA, which made key changes to the U.S. tax law, including the reduction of the U.S. federal corporate tax rate from 35% to 21%. Additionally, during the fourth quarter of 2017, the Company filed an advance consent application for change in accounting method with the Internal Revenue Service (the "IRS") to change the Company's tax method of accounting for its loan portfolio. The Company has received affirmative consent from the IRS, and this anticipated change will impact the Company's deferred tax asset and income tax expense in the fourth quarter of 2018.
The Company is still analyzing certain aspects of the TCJA and loan portfolio tax accounting change and refining its calculations, which could potentially affect the measurement of these balances or give rise to new deferred tax amounts. We expect to complete our analysis of the above-mentioned tax changes within the one-year transition period given in SEC Staff Accounting Bulletin 118.

48


Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table presents, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. Also presented are the weighted average yields on interest-earning assets, rates paid on interest-bearing liabilities and the resultant spread. All average balances are daily average balances. Non-accruing loans have been included in the table as loans carrying a zero yield. Yields earned and rates paid are calculated at the portfolio level using the actual number of days in each month over the actual number of days in the year, with the exception of the securities portfolios and the consumer real estate and loans held for sale loan portfolios, which are calculated using 30 days in a month over 360 days in a year.
 
 
Three Months Ended September 30,
 
(Dollars in thousands)
2018
 
2017
Interest-earning assets:
Average
Outstanding
Balance
 
Interest
Earned/Paid
 
Yield/
Rate
 
Average
Outstanding
Balance
 
Interest
Earned/Paid
 
Yield/
Rate
 
Commercial real estate
$
3,016,889

 
$
39,127

 
5.15
%
 
$
2,854,343

 
$
36,392

 
5.06
%
 
Warehouse Purchase Program
1,097,879

 
12,938

 
4.68

 
1,192,920

 
11,493

 
3.82

 
Commercial and industrial
2,088,318

 
30,431

 
5.78

 
1,850,645

 
23,331

 
5.00

 
Construction and land
271,829

 
3,707

 
5.41

 
279,189

 
3,628

 
5.16

 
Consumer real estate
1,295,353

 
15,117

 
4.67

 
1,176,955

 
13,345

 
4.54

 
Other consumer
44,508

 
652

 
5.81

 
47,169

 
670

 
5.64

 
Loans held for sale
26,121

 
295

 
4.52

 
23,154

 
225

 
3.89

 
Less: deferred fees and allowance for loan loss
(55,974
)
 

 

 
(70,048
)
 

 

 
Loans receivable 1
7,784,923

 
102,267

 
5.22

 
7,354,327

 
89,084

 
4.81

 
Agency mortgage-backed securities
247,212

 
1,396

 
2.26

 
308,851

 
1,617

 
2.09

 
Agency collateralized mortgage obligations
268,512

 
1,806

 
2.69

 
182,166

 
1,040

 
2.28

 
Investment securities
95,793

 
666

 
2.77

 
109,395

 
750

 
2.74

 
FHLB and FRB stock and other restricted securities
66,966

 
644

 
3.85

 
52,429

 
448

 
3.42

 
Interest-earning deposit accounts
272,670

 
1,368

 
1.99

 
444,310

 
1,524

 
1.36

Total interest-earning assets
8,736,076

 
108,147

 
4.92

 
8,451,478

 
94,463

 
4.44

Non-interest-earning assets
431,531

 
 
 
 
 
438,436

 
 
 
 
Total assets
$
9,167,607

 
 
 
 
 
$
8,889,914

 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand
$
760,889

 
1,251

 
0.65

 
$
875,097

 
1,474

 
0.67

 
Savings and money market
2,654,990

 
6,177

 
0.92

 
2,857,790

 
4,859

 
0.68

 
Time
1,683,475

 
7,649

 
1.80

 
1,418,108

 
3,938

 
1.10

 
Borrowings
1,154,079

 
7,403

 
2.55

 
1,178,031

 
5,228

 
1.76

Total interest-bearing liabilities
6,253,433

 
22,480

 
1.43

 
6,329,026

 
15,499

 
0.97

Non-interest-bearing demand
1,752,095

 
 
 
 
 
1,481,654

 
 
 
 
Non-interest-bearing liabilities
140,047

 
 
 
 
 
138,628

 
 
 
 
Total liabilities
8,145,575

 
 
 
 
 
7,949,308

 
 
 
 
Total shareholders’ equity
1,022,032

 
 
 
 
 
940,606

 
 
 
 
Total liabilities and shareholders’ equity
$
9,167,607

 
 
 
 
 
$
8,889,914

 
 
 
 
Net interest income and margin
 
 
$
85,667

 
3.90
%
 
 
 
$
78,964

 
3.71
%
Net interest income and margin (tax-equivalent basis) 2
 
 
$
85,796

 
3.90
%
 
 
 
$
79,214

 
3.72
%
Net interest rate spread
 
 
 
 
3.49
%
 
 
 
 
 
3.47
%
Net earning assets
$
2,482,643

 
 
 
 
 
$
2,122,452

 
 
 
 
Average interest-earning assets to average interest-bearing liabilities
139.70
%
 
 
 
 
 
133.54
%
 
 
 
 
1 
Calculated net of deferred fees, loan discounts, loans in process and allowance for loan losses.
2 
In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment (a non-GAAP measure) has been computed using a federal income tax rate of 21% for 2018 and 35% for 2017. Tax-exempt investments and loans had an average balance of $86.1 million and $98.8 million for the three months ended September 30, 2018 and 2017, respectively.

49


 
 
Nine Months Ended September 30,
 
(Dollars in thousands)
2018
 
2017
Interest-earning assets:
Average
Outstanding
Balance
 
Interest
Earned/Paid
 
Yield/
Rate
 
Average
Outstanding
Balance
 
Interest
Earned/Paid
 
Yield/
Rate
 
Commercial real estate
$
3,021,772

 
$
115,425

 
5.11
%
 
$
2,787,137

 
$
105,539

 
5.06
%
 
Warehouse Purchase Program
1,046,639

 
35,147

 
4.49

 
1,027,604

 
28,408

 
3.70

 
Commercial and industrial
1,999,114

 
83,673

 
5.60

 
1,841,291

 
69,958

 
5.08

 
Construction and land
267,766

 
10,641

 
5.31

 
282,968

 
10,902

 
5.15

 
Consumer real estate
1,263,135

 
43,848

 
4.63

 
1,131,782

 
38,647

 
4.55

 
Other consumer
44,391

 
1,899

 
5.72

 
49,828

 
2,077

 
5.57

 
Loans held for sale
25,515

 
835

 
4.36

 
19,506

 
573

 
3.92

 
Less: deferred fees and allowance for loan loss
(61,771
)
 

 

 
(68,259
)
 

 

 
Loans receivable 1
7,606,561

 
291,468

 
5.12

 
7,071,857

 
256,104

 
4.84

 
Agency mortgage-backed securities
259,936

 
4,332

 
2.22

 
318,442

 
5,013

 
2.10

 
Agency collateralized mortgage obligations
246,114

 
4,839

 
2.62

 
164,041

 
2,872

 
2.33

 
Investment securities
97,948

 
2,056

 
2.80

 
110,890

 
2,303

 
2.77

 
FHLB and FRB stock and other restricted securities
60,846

 
1,675

 
3.67

 
49,317

 
1,243

 
3.36

 
Interest-earning deposit accounts
248,767

 
3,434

 
1.85

 
367,536

 
3,211

 
1.17

Total interest-earning assets
8,520,172

 
307,804

 
4.83

 
8,082,083

 
270,746

 
4.48

Non-interest-earning assets
430,306

 
 
 
 
 
438,441

 
 
 
 
Total assets
$
8,950,478

 
 
 
 
 
$
8,520,524

 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand
$
894,846

 
5,269

 
0.79

 
$
860,009

 
3,817

 
0.59

 
Savings and money market
2,659,132

 
16,278

 
0.82

 
2,738,732

 
11,672

 
0.57

 
Time
1,584,076

 
19,294

 
1.63

 
1,363,178

 
10,251

 
1.01

 
Borrowings
1,017,855

 
18,754

 
2.46

 
1,121,124

 
13,774

 
1.64

Total interest-bearing liabilities
$
6,155,909

 
59,595

 
1.29

 
6,083,043

 
39,514

 
0.87

Non-interest-bearing demand
1,674,965

 
 
 
 
 
1,411,693

 
 
 
 
Non-interest-bearing liabilities
122,827

 
 
 
 
 
107,211

 
 
 
 
Total liabilities
7,953,701

 
 
 
 
 
7,601,947

 
 
 
 
Total shareholders’ equity
996,777

 
 
 
 
 
918,577

 
 
 
 
Total liabilities and shareholders’ equity
$
8,950,478

 
 
 
 
 
$
8,520,524

 
 
 
 
Net interest income and margin
 
 
$
248,209

 
3.89
%
 
 
 
$
231,232

 
3.82
%
Net interest income and margin (tax-equivalent basis) 2
 
 
$
248,614

 
3.90
%
 
 
 
$
232,004

 
3.84
%
Net interest rate spread
 
 
 
 
3.54
%
 
 
 
 
 
3.61
%
Net earning assets
$
2,364,263

 
 
 
 
 
$
1,999,040

 
 
 
 
Average interest-earning assets to average interest-bearing liabilities
138.41
%
 
 
 
 
 
132.86
%
 
 
 
 
1 
Calculated net of deferred fees, loan discounts, loans in process and allowance for loan losses.
2 
In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment (a non-GAAP measure) has been computed using a federal income tax rate of 21% for 2018 and 35% for 2017. Tax-exempt investments and loans had an average balance of $89.8 million and $101.7 million for the nine months ended September 30, 2018 and 2017, respectively.



50


Rate/Volume Analysis
The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the changes related to outstanding balances and those due to changes in interest rates. The change in interest attributable to rate has been determined by applying the change in rate between periods to average balances outstanding in the earlier period. The change in interest due to volume has been determined by applying the rate from the earlier period to the change in average balances outstanding between periods. Changes attributable to both rate and volume which cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.

 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018 versus 2017
 
2018 versus 2017
 
Increase (Decrease) Due to
 
Total Increase (Decrease)
 
Increase (Decrease) Due to
 
Total Increase (Decrease)
 
Volume
 
Rate
 
 
Volume
 
Rate
 
 
(Dollars in thousands)
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
2,100

 
$
635

 
$
2,735

 
$
8,955

 
$
931

 
$
9,886

Warehouse Purchase Program
(969
)
 
2,414

 
1,445

 
535

 
6,204

 
6,739

Commercial and industrial
3,207

 
3,893

 
7,100

 
6,275

 
7,440

 
13,715

Construction and land
(97
)
 
176

 
79

 
(597
)
 
336

 
(261
)
Consumer real estate
1,373

 
399

 
1,772

 
4,550

 
651

 
5,201

Other consumer
(39
)
 
21

 
(18
)
 
(231
)
 
53

 
(178
)
Loans held for sale
31

 
39

 
70

 
191

 
71

 
262

Loans receivable
5,606

 
7,577

 
13,183

 
19,678

 
15,686

 
35,364

Agency mortgage-backed securities
(341
)
 
120

 
(221
)
 
(962
)
 
281

 
(681
)
Agency collateralized mortgage obligations
557

 
209

 
766

 
1,579

 
388

 
1,967

Investment securities
(94
)
 
10

 
(84
)
 
(271
)
 
24

 
(247
)
FHLB and FRB stock and other restricted securities
135

 
61

 
196

 
310

 
122

 
432

Interest-earning deposit accounts
(713
)
 
557

 
(156
)
 
(1,253
)
 
1,476

 
223

Total interest-earning assets
5,150

 
8,534

 
13,684

 
19,081

 
17,977

 
37,058

Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand
(188
)
 
(35
)
 
(223
)
 
160

 
1,292

 
1,452

Savings and money market
(365
)
 
1,683

 
1,318

 
(348
)
 
4,954

 
4,606

Time
843

 
2,868

 
3,711

 
1,875

 
7,168

 
9,043

Borrowings
(108
)
 
2,283

 
2,175

 
(1,367
)
 
6,347

 
4,980

Total interest-bearing liabilities
182

 
6,799

 
6,981

 
320

 
19,761

 
20,081

Net interest income
$
4,968

 
$
1,735

 
$
6,703

 
$
18,761

 
$
(1,784
)
 
$
16,977




51


Liquidity
Management maintains a liquidity position that it believes will adequately provide funding for loan demand and deposit run-off that may occur in the normal course of business. The Company relies on a number of different funding sources in order to meet its potential liquidity demands. The primary funding sources are increases in deposit accounts and cash flows from loan payments and the securities portfolio.
Management also has several secondary sources of funds available to meet potential liquidity demands. At September 30, 2018, we had additional borrowing capacity of $2.09 billion with the FHLB and $250.0 million in federal funds lines of credit available with other financial institutions. We may also use the discount window at the Federal Reserve Bank as a source of short-term funding. Federal Reserve Bank borrowing capacity varies based upon securities pledged to the discount window line. At September 30, 2018, securities pledged had a collateral value of $81.1 million.
At September 30, 2018, we had classified 75.8% of our securities portfolio as available for sale (including pledged securities), providing an additional source of liquidity. Management believes that because active markets exist and our securities portfolio is of high quality, our available for sale securities are marketable. Selling participations in loans we originate, including portions of commercial real estate loans, creates another source of liquidity and allows us to manage borrower concentration risk as well as interest rate risk.
Liquidity management is both a daily and long-term function of business management. Short-term excess liquidity is generally placed in short-term investments, such as overnight deposits at the Federal Reserve Bank and correspondent banks. On a longer term basis, we maintain a strategy of investing in various lending products and investment securities, including mortgage-backed securities.
Planning for our normal business liquidity needs, both expected and unexpected, is done on a daily and short-term basis through the cash management function. On a longer-term basis it is accomplished through the budget and strategic planning functions, with support from internal asset/liability management software model projections.
The Liquidity Committee monitors liquidity positions and projections. Liquidity contingency planning is added to the Committee's process by focusing on possible scenarios that would stress liquidity beyond the Bank's normal business liquidity needs. These scenarios may include macro-economic and bank specific situations focusing on high probability-high impact, high probability-low impact, low probability-high impact, and low probability-low impact stressors.
Management recognizes that the factors and conditions leading up to and occurring during a liquidity stress event cannot be precisely defined or listed. Nevertheless, management believes that liquidity stress events can be categorized into sources and uses of liquidity, and levels of severity, with responses that apply to various situations.
The Company, which is a separate legal entity from the Bank and must provide for its own liquidity, had liquid assets of $29.6 million on an unconsolidated basis at September 30, 2018. In addition to its operating expenses, the Company is responsible for paying any dividends declared to its shareholders, funds paid out for Company stock repurchases, and payments on trust-preferred securities and subordinated debt held at the Company level. The Company has the ability to receive dividends or capital distributions from the Bank, although there are regulatory restrictions on the ability of the Bank to pay dividends. See “How We Are Regulated - Limitations on Dividends and Other Capital Distributions” under Item 1 and Note 16 of the Notes to Consolidated Financial Statements contained in Item 8 of the Company's 2017 Form 10-K.
The Company uses its sources of funds primarily to meet its expenses, pay maturing deposits and fund withdrawals, and to fund loan commitments. Total approved loan commitments (including Warehouse Purchase Program commitments, unused lines of credit and letters of credit) amounted to $2.62 billion and $2.37 billion at September 30, 2018, and December 31, 2017, respectively. It is management's policy to offer deposit rates that are competitive with other local financial institutions. Based on this management strategy, we believe that a majority of maturing deposits will remain with the Company. Certificates of deposit scheduled to mature in one year or less at September 30, 2018 totaled $1.20 billion with a weighted average rate of 1.79%.
During the nine months ended September 30, 2018, cash and cash equivalents decreased by $39.1 million, or 13.3%, to $254.3 million at September 30, 2018 from $293.5 million at December 31, 2017. Operating activities provided cash of $188.3 million, which was more than offset by financing activities of $160.0 million and investing activities of $67.5 million. Primary sources of cash for the nine months ended September 30, 2018 included proceeds from pay-offs of Warehouse Purchase Program loans totaling $16.68 billion, proceeds from maturities, prepayments and calls on available-for-sale securities totaling $1.86 billion, proceeds from FHLB advances totaling $925.0 million, proceeds from the sale of loans held for sale

52


totaling $138.3 million, and a $12.1 million increase in deposits. Primary uses of cash for the nine months ended September 30, 2018 included originations of Warehouse Purchase Program loans totaling $16.42 billion, purchases of available-for-sale securities totaling $1.91 billion, repayments on FHLB advances totaling $1.04 billion and net fundings of loans held for investment totaling $320.5 million.
Please see Item 1A (Risk Factors) under Part 1 of the Company's 2017 Form 10-K for information regarding liquidity risk.
Off-Balance Sheet Arrangements, Contractual Obligations and Commitments
The following table presents our longer term contractual obligations and commitments to extend credit to our borrowers, in aggregate and by payment due dates (not including any interest amounts). In addition to the commitments below, the Company had overdraft protection available to its depositors in the amount of $85.6 million and credit card guarantees outstanding in the amount of $2.0 million at September 30, 2018.
 
September 30, 2018
 
Less than
One Year
 
One
through
Three Years
 
Four
through
Five Years
 
After Five
Years
 
Total
 
(Dollars in thousands)
Contractual obligations:
 
 
 
 
 
 
 
 
 
Deposits without a stated maturity
$
5,140,982

 
$

 
$

 
$

 
$
5,140,982

Certificates of deposit
1,196,142

 
398,304

 
42,348

 
1,982

 
1,638,776

FHLB advances 1
927,867

 
2,950

 
1,005

 
495

 
932,317

Repurchase agreements
40,408

 

 

 

 
40,408

Subordinated debt 1

 

 

 
140,464

 
140,464

Private equity fund for Community Reinvestment Act purposes
830

 

 

 

 
830

Operating leases (premises)
6,186

 
11,369

 
9,807

 
15,941

 
43,303

Total contractual obligations
$
7,312,415

 
$
412,623

 
$
53,160

 
$
158,882

 
7,937,080

Off-balance sheet loan commitments: 2
 
 
 
 
 
 
 
 
 
Unused commitments to extend credit
$
851,055

 
$
503,840

 
$
268,070

 
$
77,506

 
1,700,471

Unused capacity on Warehouse Purchase Program loans 3
881,495

 

 

 

 
881,495

Standby letters of credit
41,025

 
689

 
541

 
155

 
42,410

Total loan commitments
$
1,773,575

 
$
504,529

 
$
268,611

 
$
77,661

 
2,624,376

Total contractual obligations and loan commitments
 
 
 
 
 
 
 
 
$
10,561,456

1 
FHLB advances and subordinated debt are shown at their contractual amounts.
2 
Loans having no stated maturity are reported in the “Less than One Year” category.
3 
In regards to unused capacity on Warehouse Purchase Program loans, the Company has established a maximum purchase facility amount, but reserves the right, at any time, to refuse to buy any mortgage loans offered for sale by its mortgage banking company customers for any reason in the Company's sole and absolute discretion.



53


Capital Resources
Consistent with our goal to operate a sound and profitable organization, our policy is for the Company and its subsidiary bank to maintain “well-capitalized” status under the FRB regulations. Based on capital levels at September 30, 2018 and December 31, 2017, the Bank and the Company were considered to be well-capitalized. At September 30, 2018, the Bank's equity totaled $1.12 billion. Our consolidated equity totaled $1.04 billion, or 11.4% of total assets, at September 30, 2018. Warehouse Purchase Program loan volumes can increase significantly on the last day of the month, potentially leading to a significant difference between the ending and average balance of Warehouse Purchase Program loans. At September 30, 2018, Warehouse Purchase Program loans totaled $1.05 billion, compared to an average balance of $1.10 billion for the three months ended September 30, 2018. Because the capital ratios below are calculated using ending risk-weighted assets and Warehouse Purchase Program loans are risk-weighted at 100%, an end of period increase in these balances can significantly impact the Company's reported capital ratios.
 
Actual
 
Required for Capital Adequacy Purposes
 
To Be Well-Capitalized
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
September 30, 2018
(Dollars in thousands)
Total risk-based capital
 
 
 
 
 
 
 
 
 
 
 
Company
$
1,074,883

 
12.88
%
 
$
667,830

 
8.00
%
 
$
834,787

 
10.00
%
Bank
1,019,546

 
12.21

 
667,790

 
8.00

 
834,738

 
10.00

Tier 1 risk-based capital
 
 
 
 
 
 
 
 
 
 
 
Company
884,915

 
10.60

 
500,872

 
6.00

 
500,872

 
6.00

Bank
952,401

 
11.41

 
500,843

 
6.00

 
667,790

 
8.00

Common equity tier 1 risk-based capital
 
 
 
 
 
 
 
 
 
 
Company
872,848

 
10.46

 
375,654

 
4.50

 
n/a 1

 
n/a 1

Bank
952,401

 
11.41

 
375,632

 
4.50

 
542,580

 
6.50

Tier 1 leverage
 
 
 
 
 
 
 
 
 
 
 
Company
884,915

 
9.83

 
360,126

 
4.00

 
n/a 1

 
n/a 1

Bank
952,401

 
10.58

 
360,171

 
4.00

 
450,214

 
5.00

December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
Total risk-based capital
 
 
 
 
 
 
 
 
 
 
 
Company
$
991,713

 
11.87
%
 
$
668,142

 
8.00
%
 
$
835,178

 
10.00
%
Bank
939,655

 
11.25

 
668,096

 
8.00

 
835,120

 
10.00

Tier 1 risk-based capital
 
 
 
 
 
 
 
 
 
 
 
Company
796,887

 
9.54

 
501,107

 
6.00

 
501,107

 
6.00

Bank
867,424

 
10.39

 
501,072

 
6.00

 
668,096

 
8.00

Common equity tier 1 risk-based capital
 
 

 
 
 
 
 
 
 
 
Company
784,960

 
9.40

 
375,830

 
4.50

 
n/a 1

 
n/a 1

Bank
867,424

 
10.39

 
375,804

 
4.50

 
542,828

 
6.50

Tier 1 leverage
 
 
 
 
 
 
 
 
 
 
 
Company
796,887

 
9.17

 
347,731

 
4.00

 
n/a 1

 
n/a 1

Bank
867,424

 
9.98

 
347,808

 
4.00

 
434,759

 
5.00

1 Not applicable
 
 
 
 
 
 
 
 
 
 
 
Pursuant to the capital regulations of the FRB and the other federal banking agencies, the Company and the Bank must maintain a capital conservation buffer consisting of additional common equity tier 1 capital greater than 2.5% of risk-weighted assets above the required minimum levels of risk-based common equity tier 1 capital, tier 1 capital and total capital in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses. For our fiscal year ending December 31, 2018, the capital conservation buffer rule requires a buffer of greater than 1.875% of risk-weighted assets, which amount will increase by 0.625% yearly until the requirement is fully phased-in on January 1, 2019, when the buffer must exceed 2.5% of risk-weighted assets. At September 30, 2018, the Company's and the Bank's common equity tier 1 capital exceeded the required capital conservation buffer.

54


Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Asset/Liability Management
Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. However, market rates change over time. Like other financial institutions, our results of operations are impacted by changes in market interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in market interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.
How We Measure Our Risk of Interest Rate Changes. As part of our attempt to manage our exposure to changes in market interest rates and comply with applicable regulations, we calculate and monitor our interest rate risk. In doing so, we analyze and manage assets and liabilities based on their interest rates and contractual cash flows, timing of maturities, prepayment potential, repricing opportunities, and sensitivity to actual or potential changes in market interest rates.
The Company is subject to interest rate risk to the extent that its interest-bearing liabilities, primarily deposits, FHLB advances and other borrowings, reprice more rapidly or slowly, or at different rates (basis risk) than its interest-earning assets, primarily loans and investment securities.
The Bank calculates interest rate risk by entering relevant contractual and projected information into its asset/liability management software simulation model. Data required by the model includes balance, rate, pay down schedule, and maturity. For items that contractually reprice, the repricing index, spread, and frequency are entered, including any initial, periodic, and lifetime interest rate caps and floors.
The Bank has adopted an asset and liability management policy. This policy sets the foundation for monitoring and managing the potential for adverse effects of material prolonged increases or decreases in interest rates on our results of operations. The Board of Directors sets the asset and liability policy for the Bank, which is implemented by the Asset/Liability Management Committee.
The purpose of the Asset/Liability Management Committee is to monitor, communicate, coordinate, and direct asset/liability management consistent with our business plan and board-approved policies. The Committee directs and monitors the volume and mix of assets and funding sources, taking into account relative costs and spreads, interest rate sensitivity and liquidity needs. The objectives are to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, interest rate risk, growth, and profitability goals.
The Committee meets on a quarterly basis to, among other things, protect capital through earnings stability over the interest rate cycle, maintain our well-capitalized status, and provide a reasonable return on investment. The Committee recommends appropriate strategy changes based on this review. The Committee is responsible for reviewing and reporting the effects of policy implementation and strategies to the Board of Directors at least quarterly. Senior managers oversee the process on a daily basis.
A key element of the Bank’s asset/liability management strategy is to protect earnings by managing the inherent maturity and repricing mismatches between its interest-earning assets and interest-bearing liabilities. The Bank generally manages such earnings exposure through the addition of loans, investment securities and deposits with risk mitigating characteristics and by entering into appropriate term FHLB advance agreements.
As part of its efforts to monitor and manage interest rate risk, the Bank uses the economic value of equity (“EVE”) methodology adopted by the Federal Financial Institutions Examination Council ("FFIEC") as part of its capital regulations. In essence, the EVE approach calculates the difference between the present value of expected cash flows from assets and liabilities. In addition to monitoring selected measures of EVE, management also calculates and monitors potential effects on net interest income resulting from increases or decreases in market interest rates. This approach uses the earnings at risk (“EAR”) methodology adopted by the Joint Agency Policy Statement on Interest Rate Risk as part of its capital regulations. EAR calculates estimated net interest income using a flat balance sheet approach over a twelve month time horizon. The EAR process is used in conjunction with EVE measures to identify interest rate risk on both a global and account level basis. Management and the Board of Directors review EVE and EAR measurements at least quarterly to review historical trends, projected measurements, and to determine whether the Bank's interest rate exposure is within the limits established by the Board of Directors.

55


The Bank's asset/liability management strategy sets acceptable limits for the percentage change in EVE and EAR given changes in interest rates. For instantaneous, parallel, and sustained interest rate increases or decreases of 100 basis points, the Bank's policy indicates that change in EVE should not decrease by more than 5%, and for increases of 200, 300, and 400 basis points, the change in EVE should not exceed a 10%, 12.5% and 15% decrease, respectively. For an instantaneous, parallel, and sustained interest rate increase or decrease of 100 basis points, the Bank's policy indicates that the change in EAR should not exceed a 7% decrease, and for increases of 200, 300, and 400 basis points, the change in EAR should not exceed decreases of 10%, 13% and 15%, respectively.
As illustrated in the tables below, the Bank was within policy limits for all scenarios tested. The tables presented below, as of September 30, 2018, and December 31, 2017, are internal analyses of our interest rate risk as measured by changes in EVE and EAR for instantaneous, parallel, and sustained shifts for all market rates and yield curves, in 100 basis point increments, up 400 basis points and down 100 basis points.
As illustrated in the tables below, our EVE would be negatively impacted by a parallel, instantaneous, and sustained increase in market rates. Such an increase in rates would negatively impact EVE as a result of the duration of assets, including loans and investments, being longer than the duration of liabilities, primarily deposit accounts and FHLB borrowings. In rising rate environments, deposits are more beneficial to the Bank’s EVE than comparable wholesale funding. As illustrated in the table below, at September 30, 2018, our EAR would be positively impacted by a parallel, instantaneous, and sustained increase in market rates. Our EVE and EAR would also be negatively impacted by a 100 basis point decline in market rates.
September 30, 2018
Change in Interest Rates in Basis Points
 
Economic Value of Equity
 
Earnings at Risk (12 months)
 
Estimated EVE
 
Estimated Increase / (Decrease) in EVE
 
 EVE Ratio %
 
Estimated Net Interest Income
 
Increase / (Decrease) in Estimated Net Interest Income
 
 
$ Amount
 
$ Change
 
% Change
 
 
 
$ Amount
 
$ Change
 
% Change
 
 
(Dollars in thousands)
400

 
1,377,997

 
(134,679
)
 
(8.90
)
 
16.55
 
392,972

 
23,547

 
6.37

300

 
1,411,976

 
(100,700
)
 
(6.66
)
 
16.68
 
387,029

 
17,604

 
4.77

200

 
1,449,929

 
(62,747
)
 
(4.15
)
 
16.84
 
381,302

 
11,877

 
3.21

100

 
1,486,977

 
(25,699
)
 
(1.70
)
 
16.97
 
375,434

 
6,009

 
1.63


 
1,512,676

 

 

 
16.97
 
369,425

 

 

(100
)
 
1,464,761

 
(47,915
)
 
(3.17
)
 
16.19
 
356,678

 
(12,747
)
 
(3.45
)
December 31, 2017
Change in Interest Rates in Basis Points
 
Economic Value of Equity
 
Earnings at Risk (12 months)
 
Estimated EVE
 
Estimated Increase / (Decrease) in EVE
 
 EVE Ratio %
 
Estimated Net Interest Income
 
Increase / (Decrease) in Estimated Net Interest Income
 
 
$ Amount
 
$ Change
 
% Change
 
 
 
$ Amount
 
$ Change
 
% Change
 
 
(Dollars in thousands)
400

 
1,250,757

 
(125,669
)
 
(9.13
)
 
14.89
 
358,384

 
15,210

 
4.43

300

 
1,289,760

 
(86,666
)
 
(6.30
)
 
15.09
 
355,186

 
12,012

 
3.50

200

 
1,322,187

 
(54,239
)
 
(3.94
)
 
15.21
 
351,794

 
8,620

 
2.51

100

 
1,348,578

 
(27,848
)
 
(2.02
)
 
15.26
 
348,173

 
4,999

 
1.46


 
1,376,426

 

 

 
15.34
 
343,174

 

 

(100
)
 
1,315,702

 
(60,724
)
 
(4.41
)
 
14.45
 
334,954

 
(8,220
)
 
(2.40
)



56


The Bank's EVE was $1.51 billion, or 16.97%, of the market value of portfolio assets as of September 30, 2018, a $136.3 million increase from $1.38 billion, or 15.34%, of the market value of portfolio assets as of December 31, 2017. Based upon the assumptions utilized, an immediate 200 basis point increase in market interest rates would result in a $62.7 million decrease in our EVE at September 30, 2018 compared to a $54.2 million decrease at December 31, 2017, and would result in a 13 basis point decrease in our EVE ratio to 16.84% at September 30, 2018 compared to a 13 basis point decrease to 15.21% at December 31, 2017. An immediate 100 basis point decrease in market interest rates would result in a $47.9 million decrease in our EVE at September 30, 2018 compared to a $60.7 million decrease at December 31, 2017, and would result in a 78 basis point decrease in our EVE ratio to 16.19% at September 30, 2018, as compared to an 89 basis point decrease in our EVE ratio to 14.45% at December 31, 2017.
The Bank's projected EAR for the twelve months ending September 30, 2019 is $369.4 million, compared to $343.2 million for the twelve months ending December 31, 2018. Based on the assumptions utilized, an immediate 200 basis point increase in market rates would result in an $11.9 million, or 3.21%, increase in net interest income for the twelve months ending September 30, 2019 compared to an $8.6 million, or 2.51%, increase for the twelve months ending December 31, 2018. An immediate 100 basis point decrease in market rates would result in a $12.7 million, or 3.45%, decrease in net interest income for the twelve months ending September 30, 2019 compared to an $8.2 million, or 2.40%, decrease for the twelve months ending December 31, 2018.
We have implemented a strategic plan to mitigate interest rate risk. This plan includes the ongoing review of our current and projected mix of fixed rate versus variable rate loans, investments, deposits, and borrowings. When available and appropriate, high quality adjustable rate assets are purchased or originated. These assets generally may reduce our sensitivity to upward interest rate shocks. On the liability side of the balance sheet, borrowings are added as appropriate. These borrowings will be of a size and term so as to mitigate the impact of duration mismatches, reducing our sensitivity to upward interest rate shocks. These strategies are implemented as needed and as opportunities arise to mitigate interest rate risk without materially sacrificing earnings.
In managing our mix of assets and liabilities, while considering the relationship between long and short term interest rates, market conditions, and consumer preferences, we may place somewhat greater emphasis on maintaining or increasing the Bank’s net interest margin than on strictly matching the interest rate sensitivity of its assets and liabilities.
Management also believes that at times the increased net income which may result from a mismatch in the actual maturity, repricing, or duration of its asset and liability portfolios can provide sufficient returns to justify the increased exposure to sudden and unexpected increases or decreases in interest rates which may result from such a mismatch. Management believes that the Bank’s level of interest rate risk is acceptable under this approach.
In evaluating the Bank’s exposure to market interest rate movements, certain shortcomings inherent in the method of analysis presented in the foregoing table must be considered. For example, although certain assets and liabilities may have similar maturities or repricing characteristics, their interest rate drivers may react in different degrees to changes in market interest rates (basis risk). Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market interest rates. Additionally, certain assets, such as adjustable rate mortgages, have features which restrict changes in interest rates over the life of the asset (time to initial interest rate reset; interest rate reset frequency; initial, periodic, and lifetime caps and floors). Further, in the event of a significant change in market interest rates, loan and securities prepayment and time deposit early withdrawal levels may deviate significantly from those assumed in the table above. Assets with prepayment options and liabilities with early withdrawal options are being monitored, with assumptions stress tested on a regular basis. Current market rates and customer behavior are being considered in the management of interest rate risk. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. The Bank considers all of these factors in monitoring its exposure to interest rate risk. Of note, the current historically low interest rate environment has resulted in asymmetrical interest rate risk. The interest rates on certain repricing assets and liabilities cannot be fully shocked downward.
The Board of Directors and management believe that the Bank’s ability to successfully manage and mitigate its exposure to interest rate risk is strengthened by several key factors. For example, the Bank manages its balance sheet duration and overall interest rate risk by placing a preference on originating and retaining adjustable rate loans. In addition, the Bank borrows at various maturities from the FHLB to mitigate mismatches between the asset and liability portfolios. Furthermore, the investment securities portfolio is used as a primary interest rate risk management tool through the duration and repricing targeting of purchases and sales.

57


Item 4.
Controls and Procedures
An evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of September 30, 2018. Based on that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of the end of the period covered by this quarterly report. There has been no change in the Company's internal controls over financial reporting during the quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
While the Company believes the present design of its disclosure controls and procedures is effective to achieve its goals, future events affecting its business may cause the Company to modify its disclosure controls and procedures. The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all error and fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns in controls or procedures can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual actions of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.


58


PART II - OTHER INFORMATION

Item 1.
Legal Proceedings
We are involved from time to time as plaintiff or defendant in various legal actions arising in the normal course of our businesses. While the ultimate outcome of pending proceedings cannot be predicted with certainty, it is the opinion of management, after consultation with counsel representing us in such proceedings, that the resolution of these proceedings should not have a material adverse effect on our consolidated financial position or results of operations.
Item 1A.
Risk Factors

There have been no material changes to the risk factors previously disclosed in the Company's 2017 Form 10-K.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
The Company did not repurchase any of its common stock during the quarter ended September 30, 2018.
Item 3.
Defaults upon Senior Securities
Not applicable.

Item 4.
Mine Safety Disclosures
Not applicable.
Item 5.
Other Information
Not applicable.


59


Item 6.
 
Exhibits
Exhibit Number
 
Description
 
 
 
2.1
 
Agreement and Plan of Merger, dated as of November 25, 2013, by and between the Registrant and LegacyTexas Group, Inc. (incorporated herein by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on November 25, 2013 (File No. 001-34737))
 
 
 
2.2
 
Amendment No. One to the Agreement and Plan of Merger, dated as of February 19, 2014, by and between the Registrant and LegacyTexas Group, Inc. (incorporated herein by reference to Exhibit 2.3 of the Registrant’s Annual Report on Form 10-K filed with the SEC on February 26, 2014 (File No. 001-34737))
 
 
 
2.3
 
Amendment No. Two to the Agreement and Plan of Merger, dated as of August 29, 2014, by and between the Registrant and LegacyTexas Group, Inc. (incorporated herein by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on August 29, 2014 (File No. 001-34737))
 
 
 
3.1
 
Charter of the Registrant (incorporated herein by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on May 25, 2017 (File No. 001-34737))
 
 
 
3.2
 
Bylaws of the Registrant, as amended  (incorporated herein by reference to Exhibit 3.2 of the Registrant’s Quarterly Report on Form 10-Q filed with the SEC on July 25, 2017 (File No. 001-34737))
 
 
 
4.1
 
Certificate of Registrant’s Common Stock (incorporated herein by reference to Exhibit 4.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on January 6, 2015 (File No. 001-34737))
 
 
 
4.2
 
The Registrant hereby agrees to furnish to the Commission, upon request, the instruments defining the rights of the holders of each issue of long-term debt of the Registrant and its consolidated subsidiaries.
 
 
 
10.1
 
ViewPoint Bank Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.7 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 0-24566-01))
 
 
 
10.2
 
Amended and Restated ViewPoint Bank Supplemental Executive Retirement Plan (incorporated herein by reference to Exhibit 10.8 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 0-24566-01))
 
 
 
10.3
 
2018 Executive Annual Incentive Plan (incorporated herein by reference to Exhibit 10.3 to the Registrant’s Annual Report on Form 10-K filed with the SEC on February 8, 2018 (File No. 001-34737))
 
 
 
10.4
 
Change in Control and Severance Benefits Agreement entered into between the Registrant and Mays Davenport (incorporated herein by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the SEC on November 25, 2013 (File No. 001-34737))
 
 
 
10.5
 
Form of Change In Control and Severance Benefits Agreement entered into between the Registrant and the following executive officers: Scott A. Almy, Charles D. Eikenberg, Thomas S. Swiley, and Mark L. Williamson (incorporated herein by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the SEC on December 2, 2013 (File No. 001-34737))
 
 
 
10.6
 
Amended and Restated Executive Employment Agreement entered into between the Registrant and Kevin J. Hanigan (incorporated herein by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K filed with the SEC on December 2, 2013 (File No. 001-34737))
 
 
 
10.7
 
Registrant's 2007 Equity Incentive Plan (incorporated herein by reference to Appendix A to the proxy statement filed with the SEC on March 30, 2007 (File No. 001-32992))
 
 
 
10.8
 
Registrant's 2012 Equity Incentive Plan (incorporated herein by reference to Appendix A to the Registrant's proxy statement filed with the SEC on April 4, 2012 (File No. 001-34737))
 
 
 
10.9
 
Form of Incentive Stock Option Agreement under the 2012 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.2 to the Registrant's Registration Statement on Form S-8 filed with the SEC on June 14, 2012 (File No. 333-182122))
 
 
 

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10.10
 
Form of Non-Qualified Stock Option Agreement under the 2012 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.3 to the Registrant's Registration Statement on Form S-8 filed with the SEC on June 14, 2012 (File No. 333-182122))
 
 
 
10.11
 
Form of Restricted Stock Agreement (Time-Based) under the 2012 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.4 to the Registrant's Registration Statement on Form S-8 filed with the SEC on June 14, 2012 (File No. 333-182122))
 
 
 
10.12
 
Form of Restricted Stock Agreement (Performance-Based) under the 2012 Equity Incentive Plan (incorporated herein by reference to Exhibit 10.5 to the Registrant's Registration Statement on Form S-8 filed with the SEC on June 14, 2012 (File No. 333-182122))
 
 
 
10.13
 
Form of 2012 Equity Incentive Plan Restricted Stock Award and Non-Solicitation Agreement (incorporated herein by reference to Exhibit 10.10 to the Registrant's Quarterly Report on Form 10-Q filed with the SEC on July 26, 2016 (File No. 001-34737))
 
 
 
10.14
 
Form of 2012 Equity Incentive Plan Non-Employee Restricted Stock Award Agreement (incorporated herein by reference to Exhibit 10.11 to the Registrant's Quarterly Report on Form 10-Q filed with the SEC on July 26, 2016 (File No. 001-34737))
 
 
 
10.15
 
Registrant's 2017 Omnibus Incentive Plan (incorporated herein by reference to Appendix A to the Registrant's proxy statement filed with the SEC on April 14, 2017 (File No. 001-34737))
 
 
 
10.16
 
Form of Incentive Stock Option Agreement under the 2017 Omnibus Incentive Plan (incorporated herein by reference to Exhibit 99.2 to the Registrant’s Registration Statement on Form S-8 filed with the SEC on November 7, 2017 (File No. 333-221398))
 
 
 
10.17
 
Form of Non-Qualified Stock Option Agreement under the 2017 Omnibus Incentive Plan (incorporated herein by reference to Exhibit 99.3 to the Registrant’s Registration Statement on Form S-8 filed with the SEC on November 7, 2017 (File No. 333-221398))
 
 
 
10.18
 
Form of Restricted Stock Agreement (Management) under the 2017 Omnibus Incentive Plan (Time-Based vesting) (incorporated herein by reference to Exhibit 99.4 to the Registrant’s Registration Statement on Form S-8 filed with the SEC on November 7, 2017 (File No. 333-221398))
 
 
 
10.19
 
Form of Restricted Stock Agreement (Management) under the 2017 Omnibus Incentive Plan (Performance-Based vesting) (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on March 2, 2018 (File No. 001-34737))
 
 
 
10.20
 
Form of Restricted Stock Agreement (Non-Employee Director) under the 2017 Omnibus Incentive Plan (Time-Based vesting) (incorporated herein by reference to Exhibit 99.6 to the Registrant’s Registration Statement on Form S-8 filed with the SEC on November 7, 2017 (File No. 333-221398))
 
 
 
11
 
Statement regarding computation of per share earnings (See Note 3 of the Condensed Notes to Unaudited Consolidated Interim Financial Statements included in this Form 10-Q)
 
 
 
31.1
 
 
 
 
31.2
 
 
 
 
32
 
 
 
 
101
 
Financial statements from Quarterly Report on Form 10-Q of the Registrant for the quarter ended September 30, 2018, formatted in eXtensible Business Reporting Language (XBRL): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Condensed Notes to Unaudited Consolidated Interim Financial Statements. An instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.



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SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
LegacyTexas Financial Group, Inc.
(Registrant)

Date:
October 24, 2018
 
By:
/s/ Kevin J. Hanigan
 
 
 
 
Kevin J. Hanigan,
 
 
 
 
President and Chief Executive Officer
 
 
 
 
(Duly Authorized Officer)
 
 
 
 
 
Date:
October 24, 2018
 
By:
/s/ J. Mays Davenport
 
 
 
 
J. Mays Davenport
 
 
 
 
Executive Vice President and Chief Financial Officer
 
 
 
 
(Principal Financial and Accounting Officer)


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