5. Non-Covered Loans and Allowance for Non-Covered Loan Losses

Non-covered loans refer to loans not covered by the FDIC loss-share agreements. Covered loans are discussed in Note 6 to the consolidated financial statements. Non-covered loans summarized by portfolio segment are as follows (in thousands).

	March 31,			December 31,
	2015			2014
Commercial and industrial (1)	$	2,221,727		$	1,758,851
Real estate	2,067,259			1,694,835
Construction and land development	493,293			413,643
Consumer	52,408			53,147
	4,834,687			3,920,476
Allowance for non-covered loan losses	(39,365		)	(37,041		)
Total non-covered loans, net of allowance	$	4,795,322		$	3,883,435

(1) Includes margin loans to customers and correspondents of $608.6 million and $378.4 million atMarch 31, 2015 and December 31, 2014, respectively.

The Bank has lending policies in place with the goal of establishing an asset portfolio that will provide a return on stockholders’ equity sufficient to maintain capital to assets ratios that meet or exceed established regulations. Loans are underwritten with careful consideration of the borrower’s financial condition, the specific purpose of the loan, the primary sources of repayment and any collateral pledged to secure the loan.

Underwriting procedures address financial components based on the size or complexity of the credit. The financial components include, but are not limited to, current and projected cash flows, shock analysis and/or stress testing, and trends in appropriate balance sheet and statement of operations ratios. Collateral analysis includes a complete description of the collateral, as well as determining values, monitoring requirements, loan to value ratios, concentration risk, appraisal requirements and other information relevant to the collateral being pledged. Guarantor analysis includes liquidity and cash flow analysis based on the significance the guarantors are expected to serve as secondary repayment sources. The Bank’s underwriting standards are governed by adherence to its loan policy. The loan policy provides for specific guidelines by portfolio segment, including commercial and industrial, real estate, construction and land development, and consumer loans. Within each individual portfolio segment, permissible and impermissible loan types are explicitly outlined. Within the loan types, minimum requirements for the underwriting factors listed above are provided.

The Bank maintains a loan review department that reviews credit risk in response to both external and internal factors that potentially impact the performance of either individual loans or the overall loan portfolio. The loan review process reviews the creditworthiness of borrowers and determines compliance with the loan policy. The loan review process complements and reinforces the risk identification and assessment decisions made by lenders and credit personnel. Results of these reviews are presented to management and the Bank’s board of directors.

In connection with the Bank Transactions, the Company acquired non-covered loans both with and without evidence of credit quality deterioration since origination. The following table presents the carrying values and the outstanding balances of the non-covered PCI loans (in thousands).

	March 31,		December 31,
	2015		2014
Carrying amount	$	114,868	$	48,909
Outstanding balance	151,037		67,740

Changes in the accretable yield for the non-covered PCI loans were as follows (in thousands).

	Three Months Ended March 31,
	2015			2014
Balance, beginning of period	$	12,814		$	17,601
Additions	14,579			—
Reclassifications from (to) nonaccretable difference, net (1)	281			3,475
Disposals of loans	(448		)	(603		)
Accretion	(2,749		)	(2,760		)
Balance, end of period	$	24,477		$	17,713

(1) Reclassifications from nonaccretable difference are primarily due to net increases in expected cash flows in the quarterly recasts. Reclassifications to nonaccretable difference occur when accruing loans are moved to nonaccrual and expected cash flows are no longer predictable and the accretable yield is eliminated.

The remaining nonaccretable difference for non-covered PCI loans was $48.5 million and $18.4 million at March 31, 2015 and December 31, 2014, respectively.

Impaired loans exhibit a clear indication that the borrower’s cash flow may not be sufficient to meet principal and interest payments, which is generally when a loan is 90 days past due unless the asset is both well secured and in the process of collection. Non-covered impaired loans include non-accrual loans, troubled debt restructurings (“TDRs”), PCI loans and partially charged-off loans.

The amounts shown in following tables include loans accounted for on an individual basis, as well as Pooled Loans. For Pooled Loans, the recorded investment with allowance and the related allowance consider impairment measured at the pool level. Non-covered impaired loans are summarized by class in the following tables (in thousands).

	Unpaid		Recorded		Recorded		Total
	Contractual		Investment with		Investment with		Recorded		Related
March 31, 2015	Principal Balance		No Allowance		Allowance		Investment		Allowance
Commercial and industrial:
Secured	$	75,888	$	29,554	$	9,934	$	39,488	$	3,081
Unsecured	3,727		—		—		—		—
Real estate:
Secured by commercial properties	88,406		48,941		14,306		63,247		2,039
Secured by residential properties	27,651		20,233		1,203		21,436		92
Construction and land development:
Residential construction loans	400		233		—		233		—
Commercial construction loans and land development	16,205		8,153		2,101		10,254		134
Consumer	5,215		97		1,452		1,549		45
	$	217,492	$	107,211	$	28,996	$	136,207	$	5,391

	Unpaid		Recorded		Recorded		Total
	Contractual		Investment with		Investment with		Recorded		Related
December 31, 2014	Principal Balance		No Allowance		Allowance		Investment		Allowance
Commercial and industrial:
Secured	$	51,036	$	14,096	$	11,783	$	25,879	$	3,341
Unsecured	4,120		92		68		160		—
Real estate:
Secured by commercial properties	29,865		7,243		15,536		22,779		1,878
Secured by residential properties	4,701		1,583		1,390		2,973		85
Construction and land development:
Residential construction loans	—		—		—		—		—
Commercial construction loans and land development	16,108		8,062		1,819		9,881		154
Consumer	5,785		171		1,967		2,138		282
	$	111,615	$	31,247	$	32,563	$	63,810	$	5,740

Average investment in non-covered impaired loans is summarized by class in the following table (in thousands).

	Three Months Ended March 31,
	2015		2014
Commercial and industrial:
Secured	$	32,684	$	33,997
Unsecured	80		1,335
Real estate:
Secured by commercial properties	43,013		32,874
Secured by residential properties	12,205		2,852
Construction and land development:
Residential construction loans	117		—
Commercial construction loans and land development	10,068		17,718
Consumer	1,844		4,120
	$	100,011	$	92,896

Non-covered non-accrual loans, excluding those classified as held for sale, are summarized by class in the following table (in thousands).

	March 31,		December 31,
	2015		2014
Commercial and industrial:
Secured	$	23,141	$	16,488
Unsecured	81		160
Real estate:
Secured by commercial properties	420		438
Secured by residential properties	693		1,253
Construction and land development:
Residential construction loans	—		—
Commercial construction loans and land development	726		703
Consumer	—		—
	$	25,061	$	19,042

At March 31, 2015 and December 31, 2014, non-covered non-accrual loans included non-covered PCI loans of $6.1 million and $6.6 million, respectively, for which discount accretion has been suspended because the extent and timing of cash flows from these non-covered PCI loans can no longer be reasonably estimated. In addition to the non-covered non-accrual loans in the table above, $1.4 million and $3.0 million of real estate loans secured by residential properties and classified as held for sale were in non-accrual status at March 31, 2015 and December 31, 2014, respectively.

Interest income including recoveries and cash payments recorded on non-covered impaired loans was $0.6 million and $1.4 million during the three months ended March 31, 2015 and 2014, respectively.

The Bank classifies loan modifications as TDRs when it concludes that it has both granted a concession to a debtor and that the debtor is experiencing financial difficulties. Loan modifications are typically structured to create affordable payments for the debtor and can be achieved in a variety of ways. The Bank modifies loans by reducing interest rates and/or lengthening loan amortization schedules. The Bank also reconfigures a single loan into two or more loans (“A/B Note”). The typical A/B Note restructure results in a “bad” loan which is charged off and a “good” loan or loans the terms of which comply with the Bank’s customary underwriting policies. The debt charged off on the “bad” loan is not forgiven to the debtor.

The outstanding balance of TDRs granted in the three months ended March 31, 2015 and 2014, respectively, is shown in the following tables (in thousands). At March 31, 2015 and December 31, 2014, the Bank had $0.6 million and $0.5 million in unadvanced commitments to borrowers whose loans have been restructured in TDRs.

	Recorded Investment in Loans Modified by
			Interest Rate		Payment Term		Total
Three Months Ended March 31, 2015	A/B Note		Adjustment		Extension		Modification
Commercial and industrial:
Secured	$	—	$	—	$	—	$	—
Unsecured	—		—		—		—
Real estate:
Secured by commercial properties	—		—		—		—
Secured by residential properties	—		—		—		—
Construction and land development:
Residential construction loans	—		—		—		—
Commercial construction loans and land development	—		—		75		75
Consumer	—		—		—		—
	$	—	$	—	$	75	$	75

	Recorded Investment in Loans Modified by
			Interest Rate		Payment Term		Total
Three Months Ended March 31, 2014	A/B Note		Adjustment		Extension		Modification
Commercial and industrial:
Secured	$	—	$	—	$	—	$	—
Unsecured	—		—		—		—
Real estate:
Secured by commercial properties	—		—		345		345
Secured by residential properties	—		—		258		258
Construction and land development:
Residential construction loans	—		—		—		—
Commercial construction loans and land development	—		—		142		142
Consumer	—		—		—		—
	$	—	$	—	$	745	$	745

There were no TDRs granted in the three months ended March 31, 2015 and 2014, for which a payment was at least 30 days past due in the three months ended March 31, 2015 and 2014, respectively.

An analysis of the aging of the Bank’s non-covered loan portfolio is shown in the following tables (in thousands).

															Accruing Loans
															(Non-PCI)
	Loans Past Due		Loans Past Due		Loans Past Due		Total		Current		PCI		Total		Past Due
March 31, 2015	30-59 Days		60-89 Days		90 Days or More		Past Due Loans		Loans		Loans		Loans		90 Days or More
Commercial and industrial:
Secured	$	2,451	$	7,216	$	9,449	$	19,116	$	2,073,061	$	19,903	$	2,112,080	$	—
Unsecured	285		—		—		285		109,362		—		109,647		—
Real estate:
Secured by commercial properties	346		—		—		346		1,306,125		62,827		1,369,298		—
Secured by residential properties	955		147		—		1,102		676,031		20,828		697,961		—
Construction and land development:
Residential construction loans	297		—		—		297		74,601		233		75,131		—
Commercial construction loans and land development	13,335		—		600		13,935		394,699		9,528		418,162		—
Consumer	356		19		—		375		50,484		1,549		52,408		—
	$	18,025	$	7,382	$	10,049	$	35,456	$	4,684,363	$	114,868	$	4,834,687	$	—

															Accruing Loans
															(Non-PCI)
	Loans Past Due		Loans Past Due		Loans Past Due		Total		Current		PCI		Total		Past Due
December 31, 2014	30-59 Days		60-89 Days		90 Days or More		Past Due Loans		Loans		Loans		Loans		90 Days or More
Commercial and industrial:
Secured	$	6,073	$	964	$	8,022	$	15,059	$	1,620,000	$	13,374	$	1,648,433	$	—
Unsecured	35		3		—		38		110,312		68		110,418		—
Real estate:
Secured by commercial properties	67		—		—		67		1,173,504		22,341		1,195,912		—
Secured by residential properties	454		1,187		—		1,641		495,472		1,810		498,923		—
Construction and land development:
Residential construction loans	175		—		—		175		64,871		—		65,046		—
Commercial construction loans and land development	4,319		—		575		4,894		334,525		9,178		348,597		—
Consumer	414		37		—		451		50,558		2,138		53,147		—
	$	11,537	$	2,191	$	8,597	$	22,325	$	3,849,242	$	48,909	$	3,920,476	$	—

In addition to the non-covered loans shown in the table above, $24.2 million and $19.2 million of loans included in loans held for sale were 90 days past due and accruing interest at March 31, 2015 and December 31, 2014, respectively. These loans are guaranteed by U.S. government agencies and include loans that are subject to repurchase, or have been repurchased, by PrimeLending.

Management tracks credit quality trends on a quarterly basis related to: (i) past due levels, (ii) non-performing asset levels, (iii) classified loan levels, (iv) net charge-offs, and (v) general economic conditions in the state and local markets.

The Bank utilizes a risk grading matrix to assign a risk grade to each of the loans in its portfolio. A risk rating is assigned based on an assessment of the borrower’s management, collateral position, financial capacity, and economic factors. The general characteristics of the various risk grades are described below.

Pass — “Pass” loans present a range of acceptable risks to the Bank. Loans that would be considered virtually risk-free are rated Pass — low risk. Loans that exhibit sound standards based on the grading factors above and present a reasonable risk to the Bank are rated Pass — normal risk. Loans that exhibit a minor weakness in one or more of the grading criteria but still present an acceptable risk to the Bank are rated Pass — high risk.

Special Mention — “Special Mention” loans have potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in a deterioration of the repayment prospects for the loans and weaken the Bank’s credit position at some future date. Special Mention loans are not adversely classified and do not expose the Bank to sufficient risk to require adverse classification.

Substandard — “Substandard” loans are inadequately protected by the current sound worth and paying capacity of the obligor or the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Many substandard loans are considered impaired.

PCI — “PCI” loans exhibited evidence of credit deterioration at acquisition that made it probable that all contractually required principal payments would not be collected.

The following tables present the internal risk grades of non-covered loans, as previously described, in the portfolio by class (in thousands).

March 31, 2015	Pass		Special Mention		Substandard		PCI		Total
Commercial and industrial:
Secured	$	2,029,291	$	878	$	62,008	$	19,903	$	2,112,080
Unsecured	109,555		—		92		—		109,647
Real estate:
Secured by commercial properties	1,284,575		702		21,194		62,827		1,369,298
Secured by residential properties	672,096		1,353		3,684		20,828		697,961
Construction and land development:
Residential construction loans	74,898		—		—		233		75,131
Commercial construction loans and land development	407,387		—		1,247		9,528		418,162
Consumer	50,822		—		37		1,549		52,408
	$	4,628,624	$	2,933	$	88,262	$	114,868	$	4,834,687

December 31, 2014	Pass		Special Mention		Substandard		PCI		Total
Commercial and industrial:
Secured	$	1,566,208	$	1,105	$	67,746	$	13,374	$	1,648,433
Unsecured	110,256		—		94		68		110,418
Real estate:
Secured by commercial properties	1,151,454		712		21,405		22,341		1,195,912
Secured by residential properties	492,549		—		4,564		1,810		498,923
Construction and land development:
Residential construction loans	65,046		—		—		—		65,046
Commercial construction loans and land development	338,078		—		1,341		9,178		348,597
Consumer	50,968		—		41		2,138		53,147
	$	3,774,559	$	1,817	$	95,191	$	48,909	$	3,920,476

Allowance for Loan Losses

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses inherent in the existing portfolio of loans.

It is management’s responsibility at the end of each quarter, or more frequently as deemed necessary, to analyze the level of the allowance for loan losses to ensure that it is appropriate for the estimated credit losses in the portfolio consistent with the Interagency Policy Statement on the Allowance for Loan and Lease Losses and the Receivables and Contingencies Topics of the ASC. Estimated credit losses are the probable current amount of loans that the Company will be unable to collect given facts and circumstances as of the evaluation date. When management determines that a loan or portion thereof is uncollectible, the loan, or portion thereof, is charged off against the allowance for loan losses, or for acquired loans accounted for in pools, charged against the pool discount. Recoveries on charge-offs of loans acquired in the Bank Transactions that occurred prior to their acquisition represent contractual cash flows not expected to be collected and are recorded as accretion income. Recoveries on acquired loans charged-off subsequent to their acquisition are credited to the allowance for loan loss, except for recoveries on loans accounted for in pools, which are credited to the pool discount. The Bank’s loan portfolio is designated into two populations: acquired loans and originated loans. The allowance for loan losses is calculated separately for acquired and originated loans.

PCI loans acquired in the PlainsCapital Merger are accounted for on an individual loan basis, while PCI loans acquired in each of the FNB Transaction and SWS Merger are accounted for both in pools and at the individual loan level. Cash flows expected to be collected are recast quarterly for each loan or pool. These evaluations require the continued use and updating of key assumptions and estimates such as default rates, loss severity given default and prepayment speed assumptions (similar to those used for the initial fair value estimate). Management judgment must be applied in developing these assumptions. If expected cash flows for a loan or pool decreases, an increase in the allowance for loan losses is made through a charge to the provision for loan losses. If expected cash flows for a loan or pool increase, any previously established allowance for loan losses is reversed and any remaining difference increases the accretable yield which will be taken into income over the remaining life of the loan.

The allowance for both originated and acquired loans is subject to regulatory examinations and determinations as to appropriateness, which may take into account such factors as the methodology used to calculate the allowance and the size of the allowance.

Changes in the allowance for non-covered loan losses, distributed by portfolio segment, are shown below (in thousands).

	Commercial and						Construction and
Three Months Ended March 31, 2015	Industrial			Real Estate			Land Development			Consumer			Total
Balance, beginning of period	$	18,999		$	11,131		$	6,450		$	461		$	37,041
Provision charged to (recapture from) operations	1,871			1,807			(608		)	(276		)	2,794
Loans charged off	(942		)	(278		)	—			(34		)	(1,254		)
Recoveries on charged off loans	715			44			—			25			784
Balance, end of period	$	20,643		$	12,704		$	5,842		$	176		$	39,365

	Commercial and						Construction and
Three Months Ended March 31, 2014	Industrial			Real Estate			Land Development			Consumer			Total
Balance, beginning of period	$	16,865		$	8,331		$	7,957		$	88		$	33,241
Provision charged to (recapture from) operations	(57		)	1,319			17			109			1,388
Loans charged off	(807		)	—			—			(74		)	(881		)
Recoveries on charged off loans	725			32			122			18			897
Balance, end of period	$	16,726		$	9,682		$	8,096		$	141		$	34,645

The non-covered loan portfolio was distributed by portfolio segment and impairment methodology as shown below (in thousands).

	Commercial and				Construction and
March 31, 2015	Industrial		Real Estate		Land Development		Consumer		Total
Loans individually evaluated for impairment	$	17,785	$	106	$	525	$	—	$	18,416
Loans collectively evaluated for impairment	2,184,039		1,983,498		483,007		50,859		4,701,403
PCI Loans	19,903		83,655		9,761		1,549		114,868
	$	2,221,727	$	2,067,259	$	493,293	$	52,408	$	4,834,687

	Commercial and				Construction and
December 31, 2014	Industrial		Real Estate		Land Development		Consumer		Total
Loans individually evaluated for impairment	$	11,842	$	1,420	$	703	$	—	$	13,965
Loans collectively evaluated for impairment	1,733,567		1,669,264		403,762		51,009		3,857,602
PCI Loans	13,442		24,151		9,178		2,138		48,909
	$	1,758,851	$	1,694,835	$	413,643	$	53,147	$	3,920,476

The allowance for non-covered loan losses was distributed by portfolio segment and impairment methodology as shown below (in thousands).

	Commercial and				Construction and
March 31, 2015	Industrial		Real Estate		Land Development		Consumer		Total
Loans individually evaluated for impairment	$	457	$	—	$	—	$	—	$	457
Loans collectively evaluated for impairment	17,562		10,573		5,708		131		33,974
PCI Loans	2,624		2,131		134		45		4,934
	$	20,643	$	12,704	$	5,842	$	176	$	39,365

	Commercial and				Construction and
December 31, 2014	Industrial		Real Estate		Land Development		Consumer		Total
Loans individually evaluated for impairment	$	421	$	—	$	—	$	—	$	421
Loans collectively evaluated for impairment	15,658		9,168		6,296		179		31,301
PCI Loans	2,920		1,963		154		282		5,319
	$	18,999	$	11,131	$	6,450	$	461	$	37,041