(4) LOANS AND ALLOWANCE FOR LOAN LOSSES

At June 30, 2011 and December 31, 2010, loans were as follows (in thousands):

		June 30,		December 31,
		2011		2010

Commercial	$	2,942,657	$	2,592,924
Construction		414,832		270,008
Real estate		1,745,670		1,759,758
Consumer		20,653		21,470
Leases		72,425		95,607
Gross loans held for investment		5,196,237		4,739,767
Deferred income (net of direct origination costs)		(31,944)		(28,437)
Allowance for loan losses		(67,748)		(71,510)
Total loans held for investment, net		5,096,545		4,639,820
Loans held for sale		1,122,330		1,194,209
Total	$	6,218,875	$	5,834,029

We continue to lend primarily in Texas. As of June 30, 2011, a substantial majority of the principal amount of the loans held for investment in our portfolio was to businesses and individuals in Texas. This geographic concentration subjects the loan portfolio to the general economic conditions within this area. The risks created by this concentration have been considered by management in the determination of the adequacy of the allowance for loan losses. Management believes the allowance for loan losses is adequate to cover estimated losses on loans at each balance sheet date.

The reserve for loan losses is comprised of specific reserves for impaired loans and an estimate of losses inherent in the portfolio at the balance sheet date, but not yet identified with specified loans. We regularly evaluate our reserve for loan losses to maintain an adequate level to absorb estimated loan losses inherent in the loan portfolio. Factors contributing to the determination of reserves include the credit worthiness of the borrower, changes in the value of pledged collateral, and general economic conditions. All loan commitments rated substandard or worse and greater than $500,000 are specifically reviewed for loss potential. For loans deemed to be impaired, a specific allocation is assigned based on the losses expected to be realized from those loans. For purposes of determining the general reserve, the portfolio is segregated by product types to recognize differing risk profiles among categories, and then further segregated by credit grades. Credit grades are assigned to all loans. Each credit grade is assigned a risk factor, or reserve allocation percentage. These risk factors are multiplied by the outstanding principal balance and risk-weighted by product type to calculate the required reserve. A similar process is employed to calculate a reserve assigned to off-balance sheet commitments, specifically unfunded loan commitments and letters of credit, and any needed reserve is recorded in other liabilities. Even though portions of the allowance may be allocated to specific loans, the entire allowance is available for any credit that, in management's judgment, should be charged off.

We have several pass credit grades that are assigned to loans based on varying levels of risk, ranging from credits that are secured by cash or marketable securities, to watch credits which have all the characteristics of an acceptable credit risk but warrant more than the normal level of monitoring. Within our criticized/classified credit grades are special mention, substandard, and doubtful. Special mention loans are those that are currently protected by sound worth and paying capacity of the borrower, but that are potentially weak and constitute an additional credit risk. The loan has the potential to deteriorate to a substandard grade due to the existence of financial or administrative deficiencies. Substandard loans are inadequately protected by sound worth and paying capacity of the borrower and of the collateral pledged. Substandard loans have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Substandard loans can be accruing or can be on nonaccrual depending on the circumstances of the individual loans. Loans classified as doubtful have all the weaknesses inherent in substandard loans with the added characteristics that the weaknesses make collection or liquidation in full highly questionable and improbable. The possibility of loss is extremely high. All doubtful loans are on nonaccrual.

The reserve allocation percentages assigned to each credit grade have been developed based primarily on an analysis of our historical loss rates. The allocations are adjusted for certain qualitative factors for such things as general economic conditions, changes in credit policies and lending standards. Historical loss rates are adjusted to account for current environmental conditions which we believe are likely to cause loss rates to be higher or lower than past experience. Each quarter we produce an adjustment range for environmental factors unique to us and our market. Changes in the trend and severity of problem loans can cause the estimation of losses to differ from past experience. In addition, the reserve considers the results of reviews performed by independent third party reviewers as reflected in their confirmations of assigned credit grades within the portfolio. The portion of the allowance that is not derived by the allowance allocation percentages compensates for the uncertainty and complexity in estimating loan and lease losses including factors and conditions that may not be fully reflected in the determination and application of the allowance allocation percentages. We evaluate many factors and conditions in determining the unallocated portion of the allowance, including the economic and business conditions affecting key lending areas, credit quality trends and general growth in the portfolio. The allowance is considered adequate and appropriate, given management's assessment of potential losses within the portfolio as of the evaluation date, the significant growth in the loan and lease portfolio, current economic conditions in the Company's market areas and other factors.

The methodology used in the periodic review of reserve adequacy, which is performed at least quarterly, is designed to be dynamic and responsive to changes in portfolio credit quality. The changes are reflected in the general reserve and in specific reserves as the collectability of larger classified loans is evaluated with new information. As our portfolio has matured, historical loss ratios have been closely monitored, and our reserve adequacy relies primarily on our loss history. Currently, the review of reserve adequacy is performed by executive management and presented to our board of directors for their review, consideration and ratification on a quarterly basis.

The following tables summarize the credit risk profile of our loan portfolio by internally assigned grades and nonaccrual status as of June 30, 2011 and December 31, 2010 (in thousands):

June 30, 2011
			Commercial		Construction		Real Estate		Consumer		Leases		Total
Grade:
	Pass	$	2,833,156	$	379,897	$	1,593,744	$	20,271	$	60,628	$	4,887,696
	Special mention		38,826		222		33,051		53		1,060		73,212
	Substandard-accruing		56,954		12,459		78,167		6		9,859		157,445
	Non-accrual		13,721		22,254		40,708		323		878		77,884
Total loans held for
	investment	$	2,942,657	$	414,832	$	1,745,670	$	20,653	$	72,425	$	5,196,237

December 31, 2010
			Commercial		Construction		Real Estate		Consumer		Leases		Total
Grade:
	Pass	$	2,461,769	$	243,843	$	1,549,400	$	20,312	$	78,715	$	4,354,039
	Special mention		45,754		19,856		59,294		76		1,552		126,532
	Substandard-accruing		42,858		6,288		88,567		376		9,017		147,106
	Non-accrual		42,543		21		62,497		706		6,323		112,090
Total loans held for
	investment	$	2,592,924	$	270,008	$	1,759,758	$	21,470	$	95,607	$	4,739,767

The following table details activity in the reserve for loan losses by portfolio segment for the six months ended ended June 30, 2011. Allocation of a portion of the reserve to one category of loans does not preclude its availability to absorb losses in other categories.

(in thousands)			Commercial		Construction		Real Estate		Consumer		Leases		Unallocated		Total

Beginning balance		$	15,918	$	7,336	$	38,049	$	306	$	5,405	$	4,496	$	71,510
Provision for possible loan losses			6,518		(998)		5,935		93		(1,366)		5,539		15,721
Charge-offs			5,647		-		13,788		317		996		-		20,748
Recoveries			689		243		153		4		176		-		1,265
Net charge-offs			4,958		(243)		13,635		313		820		-		19,483
Ending balance		$	17,478	$	6,581	$	30,349	$	86	$	3,219	$	10,035	$	67,748

Period end amount allocated to:
	Loans individually evaluated
	for impairment	$	3,154	$	370	$	6,628	$	55	$	205	$	-	$	10,412
	Loans collectively evaluated
	for impairment		-		-		-		-		-		-		-
Ending balance		$	3,154	$	370	$	6,628	$	55	$	205	$	-	$	10,412

Activity in the reserve for loan losses during the six months ended June 30, 2010 was as follows (in thousands):

Balance at the beginning of the period		$	67,931
Provision for loan losses			28,783
Net charge-offs:
	Loans charged-off		21,991
	Recoveries		158
Net charge-offs			21,833
Balance at the end of the period		$	74,881

Generally we place loans on non-accrual when there is a clear indication that the borrower's cash flow may not be sufficient to meet payments as they become due, which is generally when a loan is 90 days past due. The table below summarizes our non-accrual loans by type and purpose as of June 30, 2011 (in thousands):

Commercial
Business loans	$	13,721
Construction
Market risk		22,254
Real estate
Market risk		37,599
Commercial		714
Secured by 1-4 family		2,395
Consumer		323
Leases		878
Total non-accrual loans	$	77,884

A loan held for investment is considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due (both principal and interest) according to the terms of the loan agreement. The following table details our impaired loans, by portfolio class as of June 30, 2011. We had no impaired loans without an allowance at June 30, 2011.

(in thousands)		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With an allowance recorded:
Commercial
Business loans	$	13,721	$	22,061	$	3,154	$	19,902	$	-
Energy		-		-		-		13,334		-
Construction
Market risk		22,254		22,254		370		9,178		-
Real estate
Market risk		37,599		49,849		6,013		50,457		-
Commercial		714		714		29		4,727		-
Secured by 1-4 family		2,395		2,395		586		2,501		-
Consumer		323		323		55		554		-
Leases		878		878		205		2,961		-
Total impaired loans with an allowance
recorded	$	77,884	$	98,474	$	10,412	$	103,614	$	-

Average impaired loans outstanding during the six months ended June 30, 2011 and 2010 totaled $103.6 million and $159.0 million, respectively.

The table below provides an age analysis of our past due loans that are still accruing as of June 30, 2011 (in thousands):

						Greater								Greater Than
		30-59 Days		60-89 Days		Than 90		Total Past						90 Days and
		Past Due		Past Due		Days		Due		Current		Total		Accruing⁽¹⁾
Commercial
Business loans	$	9,080	$	10,595	$	2,947	$	22,622	$	2,382,653	$	2,405,275	$	2,947
Energy		-		-		-		-		523,664		523,664		-
Construction
Market risk		944		-		-		944		380,320		381,264		-
Secured by 1-4 family		-		-		-		-		11,314		11,314		-
Real estate
Market risk		10,945		4,642		5,902		21,489		1,285,367		1,306,856		5,902
Commercial		-		835		-		835		315,692		316,527		-
Secured by 1-4 family		209		775		1,484		2,468		79,111		81,579		1,484
Consumer		62		69		-		131		20,197		20,328		-
Leases		1,301		-		-		1,301		70,245		71,546		-
Total loans held for investment	$	22,541	$	16,916	$	10,333	$	49,790	$	5,068,563	$	5,118,353	$	10,333

(1) Loans past due 90 days and still accruing includes premium finance loans of $2.7 million. These loans are generally secured by obligations of insurance carriers to refund premiums on cancelled insurance policies. The refund of premiums from the insurance carriers can take 180 days or longer from the cancellation date.

The following table summarizes, as of June 30, 2011, loans that have been restructured during 2011 (in thousands):

			Pre-Restructuring		Post-Restructuring
	Number of		Oustanding Recorded		Outstanding Recorded
	Contracts		Investment		Investment

Commercial business loans	3	$	2,140	$	2,140
Construction market risk	1		2,620		2,566
Real estate market risk	7		41,625		38,349
Real estate - 1-4 family	1		1,217		1,217
Total new restructured loans in 2011	12	$	47,602	$	44,272

The restructured loans generally include terms to reduce the interest rate and extend payment terms. We have not forgiven any principal on the above loans.

The following table summarizes, as of June 30, 2011, loans that were restructured within the last 12 months that have subsequently defaulted (in thousands):

Both loans were subsequently foreclosed. One of the properties was subsequently sold, and the other is included in the June 30, 2011 OREO balance.