(4) LOANS AND ALLOWANCE FOR LOAN LOSSES

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

		September 30,		December 31,
		2011		2010

Commercial	$	3,049,524	$	2,592,924
Construction		442,408		270,008
Real estate		1,751,672		1,759,758
Consumer		23,954		21,470
Leases		65,943		95,607
Gross loans held for investment		5,333,501		4,739,767
Deferred income (net of direct origination costs)		(30,917)		(28,437)
Allowance for loan losses		(67,897)		(71,510)
Total loans held for investment, net		5,234,687		4,639,820
Loans held for sale		1,909,567		1,194,209
Total	$	7,144,254	$	5,834,029

We continue to lend primarily in Texas. As of September 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.

We purchase participations in mortgage loans primarily for sale in the secondary market through our mortgage warehouse lending division. Accordingly, these loans are classified as held for sale and are carried at the lower of cost or fair value, determined on an aggregate basis.

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 September 30, 2011 and December 31, 2010 (in thousands):

September 30, 2011
			Commercial		Construction		Real Estate		Consumer		Leases		Total
Grade:
	Pass	$	2,957,001	$	409,714	$	1,625,334	$	23,589	$	57,871	$	5,073,509
	Special mention		40,505		1,739		32,810		50		4,637		79,741
	Substandard-accruing		39,344		9,667		64,361		6		159		113,537
	Non-accrual		12,674		21,288		29,167		309		3,276		66,714
Total loans held for
	investment	$	3,049,524	$	442,408	$	1,751,672	$	23,954	$	65,943	$	5,333,501

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 nine months ended September 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			11,289		3,024		(7,379)		3,616		7,135		4,438		22,123
Charge-offs			7,170		-		18,837		317		980		-		27,304
Recoveries			798		248		305		5		212		-		1,568
Net charge-offs			6,372		(248)		18,532		312		768		-		25,736
Ending balance		$	20,835	$	10,608	$	12,138	$	3,610	$	11,772	$	8,934	$	67,897

Period end amount allocated to:
	Loans individually evaluated
	for impairment	$	3,064	$	312	$	2,568	$	52	$	353	$	-	$	6,349
	Loans collectively evaluated
	for impairment		-		-		-		-		-		-		-
Ending balance		$	3,064	$	312	$	2,568	$	52	$	353	$	-	$	6,349

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

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. When a loan is placed on non-accrual status, all previously accrued and unpaid interest is reversed. Interest income is subsequently recognized on a cash basis as long as the remaining unpaid principal amount of the loan is deemed to be fully collectible. If collectability is questionable, then cash payments are applied to principal. The table below summarizes our non-accrual loans by type and purpose as of September 30, 2011 (in thousands):

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 September 30, 2011 (in thousands)

		Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial
Business loans	$	1,688	$	2,249	$	-	$	2,665	$	-
Construction
Market risk		19,354		19,354		-		19,564		119
Real estate
Market risk		7,740		10,460		-		10,151		-
Commercial		5,379		5,379		-		2,142		-
Secured by 1-4 family		1,349		1,349		-		450		-
Total impaired loans with no allowance
recorded	$	35,510	$	38,791	$	-	$	34,972	$	119

With an allowance recorded:
Commercial
Business loans	$	10,986	$	12,490	$	3,064	$	10,708	$	-
Construction
Market risk		1,934		1,934		312		2,367		-
Real estate
Market risk		13,450		16,739		2,165		21,978		-
Commercial		191		191		29		191		-
Secured by 1-4 family		1,058		1,058		374		1,949		-
Consumer		309		309		52		319		-
Leases		3,276		3,276		353		1,678		-
Total impaired loans with an allowance
recorded	$	31,204	$	35,997	$	6,349	$	39,190	$	-

Combined:
Commercial
Business loans	$	12,674	$	14,739	$	3,064	$	13,373	$	-
Construction
Market risk		21,288		21,288		312		21,931		119
Real estate
Market risk		21,190		27,199		2,165		32,129		-
Commercial		5,570		5,570		29		2,333		-
Secured by 1-4 family		2,407		2,407		374		2,399		-
Consumer		309		309		52		319		-
Leases		3,276		3,276		353		1,678		-
Total impaired loans with an allowance
recorded	$	66,714	$	74,788	$	6,349	$	74,162	$	119

Average impaired loans outstanding during the nine months ended September 30, 2011 and 2010 totaled $74.2 million and $148.3 million, respectively.

The table below provides an age analysis of our past due loans that are still accruing as of September 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	$	4,525	$	2,224	$	3,003	$	9,752	$	2,439,355	$	2,449,107	$	3,003
Energy		-		-		-		-		587,743		587,743		-
Construction
Market risk		89		-		-		89		410,617		410,706		-
Secured by 1-4 family		-		-		-		-		10,415		10,415		-
Real estate
Market risk		4,070		1,288		-		5,358		1,320,407		1,325,765		-
Commercial		11,433		-		-		11,433		302,337		313,770		-
Secured by 1-4 family		6,085		123		-		6,208		76,761		82,969		-
Consumer		509		-		-		509		23,136		23,645		-
Leases		52		37		-		89		62,578		62,667		-
Total loans held for investment	$	26,763	$	3,672	$	3,003	$	33,438	$	5,233,349	$	5,266,787	$	3,003

(1) Loans past due 90 days and still accruing includes premium finance loans of $2.5 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.

Restructured loans are loans on which, due to the borrower's financial difficulties, we have granted a concession that we would not otherwise consider. This may include a transfer of real estate or other assets from the borrower, a modification of loan terms, or a combination of the two. Modifications of terms that could potentially qualify as a restructuring include reduction of contractual interest rate, extension of the maturity date at a contractual interest rate lower than the current rate for new debt with similar risk, or a reduction of the face amount of debt, or either forgiveness of either principal or accrued interest. As of September 30, 2011, we have $25.0 million in loans considered restructured that are not already on nonaccrual. Of the nonaccrual loans at September 30, 2011, $23.2 million met the criteria for restructured. A loan continues to qualify as restructured until a consistent payment history or change in borrower's financial condition has been evidenced, generally no less than twelve months. A loan is placed back on accrual status when both principal and interest are current and it is probable that we will be able to collect all amounts due (both principal and interest) according to the terms of the loan agreement.

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

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

Commercial business loans	3	$	2,140	$	1,984
Construction market risk	1		2,620		1,915
Real estate market risk	9		43,374		37,569
Real estate - 1-4 family	1		1,217		1,349
Total new restructured loans in 2011	14	$	49,351	$	42,817

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 $6.5 million decrease in the post-restructuring recorded investment compared to the pre-restructuring recorded investment is due to $4.5 million in charge-offs and $2.0 million in paydowns. At September 30, 2011, $16.1 million of the above loans restructured in 2011 are on non-accrual.

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

The loan above was subsequently foreclosed and is included in the September 30, 2011 OREO balance.