10-Q 1 vbtx-10qx93018.htm 10-Q Document


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
☒ 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

☐ 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: 001-36682
 
VERITEX HOLDINGS, INC.
(Exact name of registrant as specified in its charter)
 
Texas
 
27-0973566
(State or other jurisdiction of
 
(I.R.S. employer
incorporation or organization)
 
identification no.)
 
 
 
8214 Westchester Drive, Suite 800
 
 
Dallas, Texas
 
75225
(Address of principal executive offices)
 
(Zip code)
 
(972) 349-6200
(Registrant’s telephone number, including area code)
 
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 ☒ No ☐

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ☒ No ☐

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 ☐
 
Accelerated filer ☒
 
 
 
 
 
 
 
Non-accelerated filer ☐
 
Smaller reporting company ☐
 
 
(Do not check if a smaller reporting company)
 
 
 
 
 
 
 
 
 
 
 
Emerging growth company ☒
 
 
 
 
 
 
 
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. ☒
 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

As of October 24, 2018, there were 24,227,086 outstanding shares of the registrant’s common stock, par value $0.01 per share.




VERITEX HOLDINGS, INC.
 
 
 
 
 
Page
 
 
 
 
 
 
 
 
 


2



PART I. FINANCIAL INFORMATION 
Item 1. Financial Statements
VERITEX HOLDINGS, INC. AND SUBSIDIARY
Condensed Consolidated Balance Sheets (Unaudited)
September 30, 2018 and December 31, 2017
(Dollars in thousands, except par value information) 
 
 
September 30,
 
December 31,
 
 
2018
 
2017
ASSETS
 
 
 
 
Cash and due from banks
 
$
31,204

 
$
38,243

Interest bearing deposits in other banks
 
230,586

 
110,801

Total cash and cash equivalents
 
261,790

 
149,044

Investment securities
 
256,237

 
228,117

Loans held for sale
 
1,425

 
841

Loans, net of allowance for loan losses of $17,909 and $12,808, respectively
 
2,426,590

 
2,220,682

Accrued interest receivable
 
8,291

 
7,676

Bank-owned life insurance
 
21,915

 
21,476

Bank premises, furniture and equipment, net
 
77,346

 
75,251

Non-marketable equity securities
 
27,417

 
13,732

Investment in unconsolidated subsidiary
 
352

 
352

Other real estate owned
 

 
449

Intangible assets, net of accumulated amortization of $6,555 and $3,468, respectively
 
16,603

 
20,441

Goodwill
 
161,447

 
159,452

Other assets
 
16,433

 
14,518

Branch assets held for sale
 

 
33,552

Total assets
 
$
3,275,846

 
$
2,945,583

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
 
Deposits:
 
 
 
 
Noninterest-bearing
 
$
661,754

 
$
612,830

Interest-bearing
 
1,994,500

 
1,665,800

Total deposits
 
2,656,254

 
2,278,630

Accounts payable and accrued expenses
 
6,875

 
5,098

Accrued interest payable and other liabilities
 
5,759

 
5,446

Advances from Federal Home Loan Bank
 
73,055

 
71,164

Junior subordinated debentures
 
11,702

 
11,702

Subordinated notes
 
4,989

 
4,987

Other borrowings
 

 
15,000

Branch liabilities held for sale
 

 
64,627

Total liabilities
 
2,758,634

 
2,456,654

Commitments and contingencies (Note 6)
 

 
 
Stockholders’ equity:
 
 
 
 
Common stock, $0.01 par value; 75,000,000 shares authorized at September 30, 2018 and December 31, 2017; 24,191,622 and 24,109,515 shares issued and outstanding at September 30, 2018 and December 31, 2017, respectively (excluding 10,000 shares held in treasury)
 
242

 
241

Additional paid-in capital
 
448,117

 
445,517

Retained earnings
 
74,143

 
44,627

Unallocated Employee Stock Ownership Plan shares; 9,771 shares at September 30, 2018 and December 31, 2017
 
(106
)
 
(106
)
Accumulated other comprehensive loss
 
(5,114
)
 
(1,280
)
Treasury stock, 10,000 shares at cost
 
(70
)
 
(70
)
Total stockholders’ equity
 
517,212

 
488,929

Total liabilities and stockholders’ equity
 
$
3,275,846

 
$
2,945,583

See accompanying Notes to Condensed Consolidated Financial Statements.

3



VERITEX HOLDINGS, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Income (Unaudited)
For the Three and Nine Months Ended September 30, 2018 and 2017
(Dollars in thousands, except per share amounts)
 
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
 
2018
 
2017
 
2018
 
2017
Interest income:
 
 
 
 
 
 
 
 
Interest and fees on loans
 
$
35,074

 
$
20,706

 
$
99,432

 
$
45,613

Interest on investment securities
 
1,722

 
941

 
4,697

 
2,251

Interest on deposits in other banks
 
1,016

 
629

 
2,316

 
1,787

Interest on other
 
6

 
3

 
15

 
4

Total interest income
 
37,818

 
22,279

 
106,460

 
49,655

Interest expense:
 
 
 
 
 
 
 
 
Interest on deposit accounts
 
7,762

 
2,812

 
18,507

 
6,201

Interest on borrowings
 
880

 
338

 
2,051

 
696

Total interest expense
 
8,642

 
3,150

 
20,558

 
6,897

Net interest income
 
29,176

 
19,129

 
85,902

 
42,758

Provision for loan losses
 
3,057

 
752

 
5,239

 
2,585

Net interest income after provision for loan losses
 
26,119

 
18,377

 
80,663

 
40,173

Noninterest income:
 
 
 
 
 
 
 
 
Service charges and fees on deposit accounts
 
809

 
669

 
2,588

 
1,733

(Loss) gain on sales of investment securities
 
(34
)
 
205

 
(22
)
 
205

Net gain on sales of loans and other assets owned
 
270

 
705

 
1,267

 
2,259

Bank-owned life insurance
 
194

 
188

 
575

 
561

Rental income
 
414

 

 
1,343

 

Other
 
857

 
210

 
2,132

 
520

Total noninterest income
 
2,510

 
1,977

 
7,883

 
5,278

Noninterest expense:
 
 
 
 
 
 
 
 
Salaries and employee benefits
 
7,394

 
5,921

 
23,225

 
13,471

Occupancy and equipment
 
2,890

 
1,596

 
8,267

 
3,622

Professional fees
 
4,297

 
1,973

 
7,803

 
3,959

Data processing and software expense
 
697

 
719

 
2,601

 
1,451

FDIC assessment fees
 
288

 
410

 
827

 
1,061

Marketing
 
306

 
436

 
1,213

 
905

Amortization of intangibles
 
798

 
223

 
2,632

 
413

Telephone and communications
 
236

 
230

 
1,076

 
438

Other
 
1,340

 
1,014

 
4,077

 
2,434

Total noninterest expense
 
18,246

 
12,522

 
51,721

 
27,754

Net income from operations
 
10,383

 
7,832

 
36,825

 
17,697

Income tax expense
 
1,448

 
2,650

 
7,309

 
5,802

Net income
 
$
8,935

 
$
5,182

 
$
29,516

 
$
11,895

Preferred stock dividends
 
$

 
$
42

 
$

 
$
42

Net income available to common stockholders
 
$
8,935

 
$
5,140

 
$
29,516

 
$
11,853

Basic earnings per share
 
$
0.37

 
$
0.26

 
$
1.22

 
$
0.70

Diluted earnings per share
 
$
0.36

 
$
0.25

 
$
1.20

 
$
0.69


See accompanying Notes to Condensed Consolidated Financial Statements.



4



VERITEX HOLDINGS, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Comprehensive Income (Unaudited)
For the Three and Nine Months Ended September 30, 2018 and 2017
(Dollars in thousands)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Net income
 
$
8,935

 
$
5,182

 
$
29,516

 
$
11,895

Other comprehensive (loss) income:
 
 
 
 
 
 
 
 
Unrealized (losses) gains on securities available for sale arising during the period, net
 
(1,359
)
 
378

 
(4,875
)
 
2,000

Reclassification adjustment for (losses) gains included in net income
 
(34
)
 
205

 
(22
)
 
205

Other comprehensive (loss) income, before tax
 
(1,325
)
 
173

 
(4,853
)
 
1,795

Income tax (benefit) expense
 
(278
)
 
60

 
(1,019
)
 
609

Other comprehensive (loss) income, net of tax
 
(1,047
)
 
113

 
(3,834
)
 
1,186

Comprehensive income
 
$
7,888

 
$
5,295

 
$
25,682

 
$
13,081


See accompanying Notes to Condensed Consolidated Financial Statements.



5



Summary of VERITEX HOLDINGS, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Changes in Stockholders’ Equity (Unaudited) 
For the Nine Months Ended September 30, 2018 and 2017
(Dollars in thousands)

 
 
Common Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Unallocated 
Employee
Stock
Ownership
Plan Shares
 
Treasury
Stock
 
 
 
 
Shares
 
Amount
 
 
 
 
 
 
Total
Balance at December 31, 2017
 
24,109,515

 
$
241

 
$
445,517

 
$
44,627

 
$
(1,280
)
 
$
(106
)
 
$
(70
)
 
$
488,929

Restricted stock units vested, net of 14,978 shares withheld to cover tax withholdings
 
74,706

 
1

 
(446
)
 

 

 

 

 
(445
)
Exercise of employee stock options, net of 4,391 and 1,691 of shares withheld for cashless exercise and to cover tax withholdings, respectively
 
7,401

 

 
(29
)
 

 

 

 

 
(29
)
Stock based compensation
 

 

 
3,075

 

 

 

 

 
3,075

Net income
 

 

 

 
29,516

 

 

 

 
29,516

Other comprehensive loss
 

 

 

 

 
(3,834
)
 

 

 
(3,834
)
Balance at September 30, 2018
 
24,191,622

 
$
242

 
$
448,117

 
$
74,143

 
$
(5,114
)
 
$
(106
)
 
$
(70
)
 
$
517,212



 
 
Common Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Loss
 
Unallocated 
Employee
Stock
Ownership
Plan Shares
 
Treasury
Stock
 
 
 
 
Shares
 
Amount
 
 
 
 
 
 
Total
Balance at December 31, 2016
 
15,195,328

 
$
152

 
$
211,173

 
$
29,290

 
$
(1,248
)
 
$
(209
)
 
$
(70
)
 
$
239,088

Restricted stock units vested, net 7,667 shares withheld to cover tax withholdings
 
27,744

 

 
(206
)
 

 

 

 

 
(206
)
Exercise of employee stock options, net of 1,095 shares withheld to cover tax withholdings
 
17,949

 

 
169

 

 

 

 

 
169

Issuance of common stock for acquisition of Sovereign Bancshares, Inc., net of offering costs of $426
 
5,117,642

 
51

 
135,908

 

 

 

 

 
135,959

Sale of common stock in public offering, net of offering costs of $304
 
2,285,050

 
24

 
56,657

 

 

 

 

 
56,681

Issuance of preferred stock, series D in connection with the acquisition of Sovereign Bancshares, Inc.
 

 

 
24,500

 

 

 

 

 
24,500

Redemption of preferred stock, series D
 

 

 
(24,500
)
 

 

 

 

 
(24,500
)
Stock based compensation
 

 

 
1,199

 

 

 

 

 
1,199

Net income
 

 

 

 
11,895

 

 

 

 
11,895

Preferred stock, series D dividend
 

 

 

 
(42
)
 

 

 

 
(42
)
Other comprehensive income
 

 

 

 

 
1,186

 

 

 
1,186

Balance at September 30, 2017
 
22,643,713

 
$
227

 
$
404,900

 
$
41,143

 
$
(62
)
 
$
(209
)
 
$
(70
)
 
$
445,929

See accompanying Notes to Condensed Consolidated Financial Statements.



6



VERITEX HOLDINGS, INC. AND SUBSIDIARY
Condensed Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, 2018 and 2017
(Dollars in thousands)
 
 
For the Nine Months Ended September 30,
 
 
2018
 
2017
Cash flows from operating activities:
 
 
 
 
Net income
 
$
29,516

 
$
11,895

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Depreciation and amortization
 
5,348

 
1,588

Provision for loan losses
 
5,239

 
2,585

Accretion of loan purchase discount
 
(6,882
)
 
(828
)
Stock-based compensation expense
 
3,075

 
1,199

Excess tax benefit from stock compensation
 
(168
)
 
(233
)
Net amortization of premiums on investment securities
 
1,478

 
1,217

Change in cash surrender value of bank-owned life insurance
 
(439
)
 
(440
)
Loss on sales of investment securities
 
(22
)
 
(205
)
Gain on sales of loans held for sale
 
(566
)
 
(705
)
Gain on sales of SBA loans
 
(701
)
 
(1,562
)
Net loss on sales of other real estate owned
 

 
8

Amortization of subordinated note discount and debt issuance costs
 
2

 
45

Net originations of loans held for sale
 
(28,361
)
 
(30,975
)
Write down on other real estate owned
 
156

 
37

Proceeds from sales of loans held for sale
 
28,343

 
34,709

Net gain on sale of branches
 
(349
)
 

Decrease (increase) in accrued interest receivable and other assets
 
670

 
(312
)
Increase (decrease) in accounts payable, accrued expenses, accrued interest payable and other liabilities
 
2,502

 
(1,683
)
Net cash provided by operating activities
 
38,841

 
16,340

Cash flows from investing activities:
 
 
 
 
Cash settlement for sale of held for sale branches
 
(31,810
)
 

Purchases of securities available for sale
 
(90,005
)
 
(70,621
)
Sales of securities available for sale
 
30,961

 
118,165

Proceeds from maturities, calls and pay downs of investment securities
 
24,615

 
17,317

Cash paid in excess of cash received for acquisition of Sovereign Bancshares, Inc.
 

 
(11,440
)
(Purchases) sales of non-marketable equity securities, net
 
(13,685
)
 
3,834

Net loans originated
 
(217,055
)
 
(187,283
)
Proceeds from sale of SBA loans
 
9,443

 
24,273

Net additions to bank premises and equipment
 
(3,194
)
 
(2,208
)
Proceeds from sales of other real estate owned
 
291

 
161

Net cash used in investing activities
 
(290,439
)
 
(107,802
)
Cash flows from financing activities:
 
 
 
 
Net change in deposits
 
377,927

 
56,662

Net change in advances from Federal Home Loan Bank
 
1,891

 
(80,106
)
Net proceeds from sale of common stock in public offering
 

 
56,681

Net change in other borrowings
 
(15,000
)
 

Redemption of preferred stock - series D
 

 
(24,500
)
Dividends paid on preferred stock - series D
 

 
(227
)
Proceeds from exercise of employee stock options
 
27

 
175

Payments to tax authorities for stock-based compensation
 
(501
)
 
(212
)
Offering costs paid in connection with acquisition
 

 
(426
)
Net cash provided by financing activities
 
364,344

 
8,047

Net increase (decrease) in cash and cash equivalents
 
112,746

 
(83,415
)
Cash and cash equivalents at beginning of period
 
149,044

 
234,791

Cash and cash equivalents at end of period
 
$
261,790

 
$
151,376

See accompanying Notes to Condensed Consolidated Financial Statements.

7



VERITEX HOLDINGS, INC. AND SUBSIDIARY 
Notes to Condensed Consolidated Financial Statements 
(Dollars in thousands, except for per share amounts) 

1. Summary of Significant Accounting Policies
Nature of Organization
Veritex Holdings, Inc. (“Veritex” or the “Company”), a Texas corporation and bank holding company, was incorporated in July 2009 and was formed for the purpose of acquiring one or more financial institutions located in Dallas, Texas and surrounding areas.
Veritex, through its wholly-owned subsidiary, Veritex Community Bank (the “Bank”), is a Texas state banking organization, with corporate offices in Dallas, Texas, and currently operates 20 branches and one mortgage office located in the Dallas-Fort Worth metroplex and one branch in the Houston metropolitan area. The Bank provides a full range of banking services to individual and corporate customers, which include commercial and retail lending, and the acceptance of checking and savings deposits. The Texas Department of Banking and the Board of Governors of the Federal Reserve System are the primary regulators of the Company and the Bank, which perform periodic examinations to ensure regulatory compliance.
Basis of Presentation
The accompanying unaudited condensed consolidated financial statements include the accounts of Veritex and the Bank as its wholly-owned subsidiary.

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles in the United States of America (“GAAP”), but do not include all of the information and footnotes required for complete financial statements. Intercompany transactions and balances are eliminated in consolidation. In management’s opinion, these interim unaudited condensed consolidated financial statements include all adjustments of a normal recurring nature necessary for a fair statement of the Company’s condensed consolidated financial position at September 30, 2018 and December 31, 2017, condensed consolidated results of operations for the three and nine months ended September 30, 2018 and 2017, condensed consolidated stockholders’ equity for the nine months ended September 30, 2018 and 2017 and condensed consolidated cash flows for the nine months ended September 30, 2018 and 2017.

Accounting measurements at interim dates inherently involve greater reliance on estimates than at year end and the results for the interim periods shown herein are not necessarily indicative of results to be expected for the full year due in part to global economic and financial market conditions, interest rates, access to sources of liquidity, market competition and interruptions of business processes. These interim unaudited condensed consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and notes thereto for the year ended December 31, 2017 included within the Company’s Form 10-K as filed with the Securities and Exchange Commission on March 14, 2018.

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the condensed consolidated financial statements and accompanying notes. These estimates and assumptions may also affect disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from these estimates.
Segment Reporting
The Company has one reportable segment. All of the Company’s activities are interrelated, and each activity is dependent and assessed based on how each of the activities of the Company supports the others. For example, lending is dependent upon the ability of the Company to fund itself with deposits and borrowings while managing the interest rate and credit risk. Accordingly, all significant operating decisions are based upon analysis of the Bank as one segment or unit. The Company’s chief operating decision-maker, the Chief Executive Officer, uses the consolidated results to make operating and strategic decisions.
Reclassifications
Some items in the prior year financial statements were reclassified to conform to the current presentation.

8



Revenue from Contracts with Customers
The Company records revenue from contracts with customers in accordance with Accounting Standards Codification Topic 606, “Revenue from Contracts with Customers” (“Topic 606”). Under Topic 606, the Company must identify the contract with a customer, identify the performance obligations in the contract, determine the transaction price, allocate the transaction price to the performance obligations in the contract, and recognize revenue when (or as) the Company satisfies a performance obligation. Significant revenue has not been recognized in the current reporting period that results from performance obligations satisfied in previous periods.
The Company’s primary sources of revenue are derived from interest income on financial assets that are not within the scope of Topic 606. The Company has evaluated the nature of its contracts with customers and determined that further disaggregation of revenue from contracts with customers into more granular categories beyond what is presented in the Condensed Consolidated Statements of Income was not necessary. The Company generally fully satisfies its performance obligations under its contracts with customers as services are rendered and the transaction prices are typically fixed and charged either on a periodic basis or based on activity. Because performance obligations are satisfied as services are rendered and the transaction prices are fixed, there is little judgment involved in applying Topic 606 that significantly affects the determination of the amount and timing of revenue from contracts with customers.
Earnings Per Share
Earnings per share (“EPS”) are based upon the weighted-average shares outstanding. The table below sets forth the reconciliation between weighted average shares used for calculating basic and diluted EPS for the three and nine months ended September 30, 2018 and 2017:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Earnings (numerator)
 
 
 
 
 
 
 
 
Net income
 
$
8,935

 
$
5,182

 
$
29,516

 
$
11,895

Less: preferred stock dividends
 

 
42

 

 
42

Net income available to common stockholders

 
$
8,935

 
$
5,140

 
$
29,516

 
$
11,853

Shares (denominator) in thousands
 
 
 
 
 
 
 
 
Weighted average shares outstanding for basic EPS
 
24,176

 
19,976

 
24,151

 
16,813

Dilutive effect of employee stock-based awards
 
437

 
416

 
436

 
419

Adjusted weighted average shares outstanding
 
24,613

 
20,392

 
24,587

 
17,232

Earnings per share:
 
 
 
 
 
 
 
 
Basic
 
$
0.37

 
$
0.26

 
$
1.22

 
$
0.70

Diluted
 
$
0.36

 
$
0.25

 
$
1.20

 
$
0.69


For the three and nine months ended September 30, 2018 and 2017, there were no antidilutive shares excluded from the diluted EPS weighted average shares outstanding.

Adoption of New Accounting Standards
In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, “Revenue from Contracts with Customers” (“ASU 2014-09”), which requires an entity to recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The ASU replaces most existing revenue recognition guidance in GAAP. The new standard was effective for the Company on January 1, 2018. Adoption of ASU 2014-09 did not have a material impact on the Company’s condensed consolidated financial statements and related disclosures as the Company’s primary sources of revenues are derived from interest income on financial assets that are not within the scope of ASU 2014-09. The Company’s revenue recognition pattern for revenue streams within the scope of ASU 2014-09, including but not limited to service charges on deposit accounts, did not change significantly from current practice. The standard permits the use of either the full retrospective or modified retrospective transition method. The Company elected to use the modified retrospective transition method which requires

9



application of ASU 2014-09 to uncompleted contracts at the date of adoption. However, periods prior to the date of adoption will not be retrospectively revised as the impact of the ASU on uncompleted contracts at the date of adoption was not material.
In January 2016, the FASB issued ASU No. 2016-01, “Financial Instruments – Overall: Recognition and Measurement of Financial Assets and Financial Liabilities” (“ASU 2016-01”), which amends certain aspects of recognition, measurement, presentation, and disclosure of financial instruments. ASU 2016-01, among other things, (i) requires equity investments, with certain exceptions, to be measured at fair value with changes in fair value recognized in net income, (ii) simplifies the impairment assessment of equity investments without readily determinable fair values by requiring a qualitative assessment to identify impairment, (iii) eliminates the requirement for public business entities to disclose the methods and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet, (iv) requires public business entities to use the exit price notion when measuring the fair value of financial instruments for disclosure purposes, (v) requires an entity to present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments, (vi) requires separate presentation of financial assets and financial liabilities by measurement category and form of financial asset on the balance sheet or the accompanying notes to the financial statements and (vii) clarifies that an entity should evaluate the need for a valuation allowance on a deferred tax asset related to available-for-sale. The adoption of ASU 2016-01 on January 1, 2018 did not have a material impact on the Company’s condensed consolidated financial statements. In accordance with (iv) above, the Company measured the fair value of its loan portfolio prospectively using an exit price notion. See Note 7 – “Fair Value Disclosures” for further information regarding the valuation of these loans.
Recent Accounting Pronouncements
ASU 2017-04 “Intangibles - Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment” (“ASU 2017-04”) eliminates Step 2 from the goodwill impairment test. In addition, the amendment eliminates the requirements for any reporting unit with a zero or negative carrying amount to perform a qualitative assessment and, if it fails that qualitative test, to perform Step 2 of the goodwill impairment test. For public companies, ASU 2017-04 is effective for fiscal years beginning after December 15, 2019 with early adoption permitted for interim or annual goodwill impairment tests performed on testing dates after January 1, 2017. The Company is in the process of evaluating the impact of this pronouncement, which is not expected to have a significant impact on the consolidated financial statements.

ASU 2016-13, “Financial Instruments—Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments” (“ASU 2016-13”), amends guidance on reporting credit losses for assets held at amortized cost basis and available for sale debt securities. For assets held at amortized cost basis, Topic 326 eliminates the probable initial recognition threshold in current GAAP and, instead, requires an entity to reflect its current estimate of all expected credit losses. The allowance for credit losses is a valuation account that is deducted from the amortized cost basis of the financial assets to present the net amount expected to be collected. For available for sale debt securities, credit losses should be measured in a manner similar to current GAAP, however Topic 326 will require that credit losses be presented as an allowance rather than as a write-down. ASU 2016-13 affects entities holding financial assets and net investment in leases that are not accounted for at fair value through net income. The amendments affect loans, debt securities, trade receivables, net investments in leases, off-balance sheet credit exposures, reinsurance receivables, and any other financial assets not excluded from the scope that have the contractual right to receive cash. For public business entities, ASU 2016-13 is effective for financial statements issued for fiscal years beginning after December 15, 2019, and interim periods therein. The Company is continuing to evaluate the impact of the adoption of ASU 2016-13 and is uncertain of the impact on the consolidated financial statements at this point in time.
ASU 2016-02, “Leases (Topic 842)” (“ASU 2016-02”), is intended to improve the reporting of leasing transactions to provide users of financial statements with more decision-useful information. Topic 842 was subsequently amended by ASU 2018-11, “Targeted Improvements.” ASU 2016-02 will require organizations that lease assets to recognize a right-of-use (“ROU”) asset and lease liability on the balance sheet for all leases with a term longer than 12 months. Leases will be classified as finance or operating, with classification affecting the pattern and classification of expense recognition in the income statement.

10



ASU 2016-02 is effective for fiscal years beginning after December 15, 2018, including interim periods within those fiscal years. Early adoption is permitted. A modified retrospective transition approach is required, applying the new standard to all leases existing at the date of initial application. An entity may choose to use either (i) its effective date or (ii) the beginning of the earliest comparative period presented in the financial statements as its date of initial application. If an entity chooses the second option, the transition requirements for existing leases also apply to leases entered into between the date of initial application and the effective date. The entity must also recast its comparative period financial statements and provide the disclosures required by the new standard for the comparative periods. We expect to adopt the new standard on January 1, 2019 and use the effective date as our date of initial application. Consequently, financial information will not be updated and the disclosures required under the new standard will not be provided for dates and periods before January 1, 2019.
ASU 2016-02 provides a number of optional practical expedients in transition. We expect to elect the ‘package of practical expedients’ as both the lessee and lessor, which permits us not to reassess under the new standard our prior conclusions about lease identification, lease classification and initial direct costs. The new standard also provides practical expedients for an entity’s ongoing accounting. We currently expect to elect the short-term lease recognition exemption for leases that qualify. This means, for those leases that qualify, we will not recognize ROU assets and leases liabilities for any lease that has a lease term at commencement date of 12 months or less and does not include a purchase option. We also currently expect to elect the practical expedient to not separate lease and non-lease components for all leases. We expect that this standard will have a material effect on our consolidated balance sheets but will not have a material impact on our consolidated statements of income. While we continue to assess all the effects of adoption, we currently believe the most significant effects relate to (i) the recognition of new ROU assets and lease liabilities on our balance sheet for our property and equipment operating leases and (ii) providing significant new disclosures about our lease activities. We do not expect a significant change in our leasing activities between now and adoption.

11




2. Supplemental Statement of Cash Flows
Other supplemental cash flow information is presented below: 
 
 
Nine Months Ended September 30,
 
 
2018
 
2017
Supplemental Disclosures of Cash Flow Information:
 
 
 
 
Cash paid for interest
 
$
19,939

 
$
6,714

Cash paid for income taxes
 
6,025

 
6,025

Supplemental Disclosures of Non-Cash Flow Information:
 
 
 
 
Net foreclosure of other real estate owned and repossessed assets
 
$
8

 
$

Non-cash assets acquired(1)
 
 
 
 
Investment securities
 
$

 
$
166,307

Loans
 
(4,050
)
 
750,856

Accrued interest receivable
 

 
3,437

Bank premises, furniture and equipment
 
1,162

 
21,512

Non-marketable equity securities
 

 
6,751

Other real estate owned
 

 
282

Intangible assets
 
(956
)
 
8,662

Goodwill
 
1,995

 
108,967

Other assets
 
1,806

 
10,331

Total assets
 
$
(43
)
 
$
1,077,105

Non-cash liabilities assumed(1)
 
 
 
 
Deposits
 
$
303

 
$
809,366

Accounts payable and accrued expenses (2)
 

 
5,189

Accrued interest payable and other liabilities
 
(260
)
 
1,616

Advances from Federal Home Loan Bank
 

 
80,000

Junior subordinated debentures
 

 
8,609

Total liabilities
 
43

 
904,780

Non-cash equity assumed
 
 
 


Preferred stock - series D
 

 
24,500

Total equity
 

 
24,500

5,117,642 shares of common stock issued in connection with acquisition
 
$

 
$
136,385

(1) Represents adjustments to provisional estimates recorded for acquisitions of Sovereign Bancshares, Inc. (“Sovereign”) and Liberty Bancshares, Inc. (“Liberty”). Refer to Note 12 Business Combinations for further discussion.
(2) Accounts payable and accrued expenses included in accrued preferred stock dividends of $185.


12



3. Investment Securities
Debt and equity securities have been classified in the condensed consolidated balance sheets according to management’s intent. The amortized cost, related gross unrealized gains and losses recognized in accumulated other comprehensive loss, and the fair value of securities are as follows:
 
 
September 30, 2018
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Available for Sale
 
 
 
 
 
 
 
 
U.S. government agencies
 
$
9,094

 
$

 
$
241

 
$
8,853

Corporate bonds
 
26,534

 
2

 
276

 
26,260

Municipal securities
 
43,309

 
12

 
543

 
42,778

Mortgage-backed securities
 
94,088

 
9

 
3,212

 
90,885

Collateralized mortgage obligations
 
89,162

 
12

 
2,238

 
86,936

Asset-backed securities
 
523

 
2

 

 
525

 
 
$
262,710

 
$
37

 
$
6,510

 
$
256,237


 
 
December 31, 2017
 
 
Amortized
Cost
 
Gross
Unrealized
Gains
 
Gross
Unrealized
Losses
 
Fair Value
Available for Sale
 
 
 
 
 
 
 
 
U.S. government agencies
 
$
10,829

 
$
9

 
$
18

 
$
10,820

Corporate bonds
 
17,500

 
330

 

 
17,830

Municipal securities
 
55,499

 
189

 
211

 
55,477

Mortgage-backed securities
 
91,734

 
58

 
1,068

 
90,724

Collateralized mortgage obligations
 
53,559

 
9

 
925

 
52,643

Asset-backed securities
 
616

 
7

 

 
623

 
 
$
229,737

 
$
602

 
$
2,222

 
$
228,117

The following tables disclose the Company’s investment securities that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 months or more:
 
 
September 30, 2018
 
 
Less Than 12 Months
 
12 Months or More
 
Totals
 
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
 
Fair
Value
 
Unrealized
Loss
Available for Sale
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government agencies
 
$
8,352

 
$
215

 
$
501

 
$
26

 
$
8,853

 
$
241

Corporate bonds
 
23,556

 
276

 

 

 
23,556

 
276

Municipal securities
 
30,524

 
299

 
7,052

 
244

 
37,576

 
543

Mortgage-backed securities
 
49,926

 
1,507

 
39,483

 
1,705

 
89,409

 
3,212

Collateralized mortgage obligations
 
50,214

 
986

 
26,223

 
1,252

 
76,437

 
2,238

 
 
$
162,572

 
$
3,283

 
$
73,259

 
$
3,227

 
$
235,831

 
$
6,510


13



 
 
December 31, 2017
 
 
Less Than 12 Months
 
12 Months or More
 
Totals
 
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
Fair
 
Unrealized
 
 
Value
 
Loss
 
Value
 
Loss
 
Value
 
Loss
Available for Sale
 
 
 
 
 
 
 
 
 
 
 
 
U.S. government agencies
 
$
3,470

 
$
4

 
$
629

 
$
14

 
$
4,099

 
$
18

Municipal securities
 
14,593

 
79

 
7,092

 
132

 
21,685

 
211

Mortgage-backed securities
 
52,075

 
513

 
29,485

 
555

 
81,560

 
1,068

Collateralized mortgage obligations
 
31,581

 
395

 
20,305

 
530

 
51,886

 
925

 
 
$
101,719

 
$
991

 
$
57,511

 
$
1,231

 
$
159,230

 
$
2,222


The number of investment positions in an unrealized loss position totaled 170 and 118 at September 30, 2018 and December 31, 2017, respectively. The Company does not believe these unrealized losses are “other than temporary.” In estimating other than temporary impairment losses, management considers, among other things, the length of time and the extent to which the fair value has been less than cost and the Company’s financial condition and near-term prospects. Additionally, (i) management does not have the intent to sell investment securities prior to recovery and/or maturity, (ii) it is more likely than not that the Company will not have to sell these securities prior to recovery and/or maturity and (iii) the length of time and extent that fair value has been less than cost is not indicative of recoverability. The unrealized losses noted are interest rate related due to the level of interest rates at September 30, 2018 compared to the time of purchase. The Company has reviewed the ratings of the issuers and has not identified any issues related to the ultimate repayment of principal as a result of credit concerns regarding these securities.
The amortized costs and estimated fair values of securities available for sale, by contractual maturity, as of the dates indicated, are shown in the table below. Expected maturities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayments penalties. Mortgage-backed securities, collateralized mortgage obligations and asset-backed securities typically are issued with stated principal amounts, and the securities are backed by pools of mortgage loans and other loans that have varying maturities. The term of mortgage-backed, collateralized mortgage obligations and asset-backed securities thus approximates the term of the underlying mortgages and loans and can vary significantly due to prepayments. Therefore, these securities are not included in the maturity categories below.
 
 
September 30, 2018
 
 
Available For Sale
 
 
Amortized
Cost
 
Fair
Value
Due in one year or less
 
$
2,401

 
$
2,401

Due from one year to five years
 
18,848

 
18,534

Due from five years to ten years
 
42,543

 
42,137

Due after ten years
 
15,145

 
14,819

 
 
78,937

 
77,891

Mortgage-backed securities
 
94,088

 
90,885

Collateralized mortgage obligations
 
89,162

 
86,936

Asset-backed securities
 
523

 
525

 
 
$
262,710

 
$
256,237


14



 
 
December 31, 2017
 
 
Available For Sale
 
 
Amortized
Cost
 
Fair
Value
Due in one year or less
 
$
2,328

 
$
2,330

Due from one year to five years
 
29,654

 
29,991

Due from five years to ten years
 
34,480

 
34,474

Due after ten years
 
17,366

 
17,332

 
 
83,828

 
84,127

Mortgage-backed securities
 
91,734

 
90,724

Collateralized mortgage obligations
 
53,559

 
52,643

Asset-backed securities
 
616

 
623

 
 
$
229,737

 
$
228,117


Proceeds from sales of investment securities available for sale and gross gains and losses for the nine months ended September 30, 2018 and 2017 were as follows:
 
 
Nine Months Ended September 30,
 
 
2018
 
2017
Proceeds from sales
 
$
30,961

 
$
118,165

Gross realized gains
 
335

 
335

Gross realized losses
 
357

 
130


There was a blanket floating lien on all securities held by the Company to secure Federal Home Loan Bank advances as of September 30, 2018 and December 31, 2017.

4. Loans and Allowance for Loan Losses
Loans in the accompanying condensed consolidated balance sheets are summarized as follows:
 
 
September 30,
2018
 
December 31,
2017
Real estate:
 
 
 
 
Construction and land
 
$
294,143

 
$
277,825

Farmland
 
10,853

 
9,385

1 - 4 family residential
 
289,808

 
236,542

Multi-family residential
 
50,317

 
106,275

Commercial real estate
 
1,069,088

 
909,292

Commercial
 
723,140

 
684,551

Consumer
 
7,166

 
9,648

 
 
2,444,515

 
2,233,518

Deferred loan fees
 
(16
)
 
(28
)
Allowance for loan losses
 
(17,909
)
 
(12,808
)
 
 
$
2,426,590

 
$
2,220,682

Included in the net loan portfolio as of September 30, 2018 and December 31, 2017 was an accretable discount related to purchased performing and purchased credit impaired (“PCI”) loans acquired within a business combination in the approximate amounts of $10,899 and $12,135, respectively. The discount is being accreted into income on a level-yield basis over the life of the loans. In addition, included in the net loan portfolio as of September 30, 2018 and December 31, 2017 is a discount on retained loans from sale of originated Small Business Administration (“SBA”) loans of $1,635 and $1,189, respectively.

15



The majority of the loan portfolio is comprised of loans to businesses and individuals in the Dallas-Fort Worth metroplex and the Houston metropolitan area. This geographic concentration subjects the loan portfolio to the general economic conditions within these areas. 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 was adequate to cover estimated losses on loans as of September 30, 2018 and December 31, 2017.
Non-Accrual and Past Due Loans
Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. Loans are placed on non-accrual status when, in management’s opinion, the borrower may be unable to meet payment obligations as they become due, as well as when required by regulatory provisions. Loans may be placed on non-accrual status regardless of whether or not such loans are considered past due. When interest accrual is discontinued, all unpaid accrued interest is reversed. Interest income is subsequently recognized only to the extent cash payments are received in excess of principal due. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
Non-accrual loans aggregated by class of loans, as of September 30, 2018 and December 31, 2017, are as follows:
 
 
Non-Accrual Loans
 
 
September 30,
2018
 
December 31,
2017
Real estate:
 
 
 
 
Construction and land
 
$
2,107

 
$

Farmland
 

 

1 - 4 family residential
 

 

Multi-family residential
 

 

Commercial real estate
 

 
61

Commercial
 
19,712

 
398

Consumer
 
3

 
6

 
 
$
21,822

 
$
465

At September 30, 2018, non-accrual loans included PCI loans of $17,158 for which discount accretion has been suspended because the extent and timing of cash flows from these PCI loans can no longer be reasonably estimated. There were no PCI loans classified as non-accrual at December 31, 2017.
During the three and nine months ended September 30, 2018, interest income not recognized on non-accrual loans was $331 and $371. During the three and nine months ended September 30, 2017, interest income not recognized on non-accrual loans was minimal.


16



An age analysis of past due loans, aggregated by class of loans, as of September 30, 2018 and December 31, 2017 is as follows:
 
 
September 30, 2018
 
 
30 to 59 Days
 
60 to 89 Days
 
90 Days or Greater
 
Total Past Due
 
Total Current
 
PCI
 
Total
Loans
 
Total 90 Days Past Due and Still Accruing(1)
Real estate:
 
    
 
    
 
    
 
    
 
    
 
 
 
    
 
    
Construction and land
 
$

 
$
795

 
$

 
$
795

 
$
293,348

 
$

 
$
294,143

 
$

Farmland
 

 

 

 

 
10,816

 
37

 
10,853

 

1 - 4 family residential
 
426

 
35

 

 
461

 
289,259

 
88

 
289,808

 

Multi-family residential
 

 

 

 

 
50,317

 

 
50,317

 

Commercial real estate
 
1,340

 
2,661

 
259

 
4,260

 
1,047,874

 
16,954

 
1,069,088

 
259

Commercial
 
3,092

 
320

 
3,998

 
7,410

 
692,957

 
22,773

 
723,140

 
3,998

Consumer
 
23

 

 
45

 
68

 
7,098

 

 
7,166

 
45

 
 
$
4,881

 
$
3,811

 
$
4,302

 
$
12,994

 
$
2,391,669

 
$
39,852

 
$
2,444,515

 
$
4,302

(1) Loans 90 days past due and still accruing excludes $267 of PCI loans as of September 30, 2018.


 
 
December 31, 2017
 
 
30 to 59 Days
 
60 to 89 Days
 
90 Days or Greater
 
Total Past Due
 
Total Current(1)
 
PCI
 
Total
Loans
 
Total 90 Days Past Due and Still Accruing(2)
Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Construction and land
 
$
320

 
$

 
$

 
$
320

 
$
277,505

 
$

 
$
277,825

 
$

Farmland
 
104

 

 

 
104

 
9,232

 
49

 
9,385

 

1 - 4 family residential
 
1,274

 
139

 

 
1,413

 
235,030

 
99

 
236,542

 

Multi-family residential
 

 

 

 

 
106,275

 

 
106,275

 

Commercial real estate
 
1,830

 

 

 
1,830

 
890,145

 
17,317

 
909,292

 

Commercial
 
1,849

 
389

 
389

 
2,627

 
651,777

 
30,147

 
684,551

 

Consumer
 
39

 
51

 
18

 
108

 
9,540

 

 
9,648

 
18

 
 
$
5,416

 
$
579

 
$
407

 
$
6,402

 
$
2,179,504

 
$
47,612

 
$
2,233,518

 
$
18

(1) To conform to the current period presentation, $15,123 of loans were reclassified from 1-4 family residential to multi-family residential within the total current column. Additionally, PCI loan balances were reclassified from the total current column to the PCI column.
(2) Loans 90 days past due and still accruing excludes $3,300 of PCI loans as of December 31, 2017.

Loans past due 90 days and still accruing increased from $18 as of December 31, 2017 to $4,302 as of September 30, 2018. These loans are also considered well-secured, an are in the process of collection with plans in place for the borrowers to bring the notes fully current or to subsequently be renewed. The Company believes that it will collect all principal and interest due on each of the loans past due 90 days and still accruing.
Impaired Loans
Impaired loans are those loans where it is probable the Company will be unable to collect all amounts due in accordance with the original contractual terms of the loan agreement, including scheduled principal and interest payments. All troubled debt restructurings (“TDRs”) are considered impaired loans. Impaired loans are measured based on either the present value of expected future cash flows discounted at the loan’s effective interest rate, the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent. Substantially all of the Company’s impaired loans are measured at the fair value of the collateral. Impaired loans, or portions thereof, are charged off when deemed uncollectible.

17



Impaired loans and TDRs at September 30, 2018 and December 31, 2017 are summarized in the following tables.
 
 
September 30, 2018(1)
 
 
Unpaid
Contractual
Principal
Balance
 
Recorded
Investment
with No
Allowance
 
Recorded
Investment
With
Allowance
 
Total
Recorded
Investment
 
Related
Allowance
 
Average
Recorded
Investment
YTD
Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Construction and land
 
$
2,107

 
$
2,107

 
$

 
$
2,107

 
$

 
$
2,284

Farmland
 

 

 

 

 

 

1 - 4 family residential
 
160

 
160

 

 
160

 

 
160

Multi-family residential
 

 

 

 

 

 

Commercial real estate
 
366

 
366

 

 
366

 

 
370

Commercial
 
2,929

 
295

 
2,634

 
2,929

 
378

 
3,057

Consumer
 
66

 
66

 

 
66

 

 
74

Total
 
$
5,628

 
$
2,994

 
$
2,634

 
$
5,628

 
$
378

 
$
5,945

(1) ) Loans reported exclude PCI loans.

 
 
December 31, 2017(1)
 
 
Unpaid
Contractual
Principal
Balance
 
Recorded
Investment
with No
Allowance
 
Recorded
Investment
With
Allowance
 
Total
Recorded
Investment
 
Related
Allowance
 
Average
Recorded
Investment
YTD
Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Construction and land
 
$

 
$

 
$

 
$

 
$

 
$

Farmland
 

 

 

 

 

 

1 - 4 family residential
 
161

 
161

 

 
161

 

 
163

Multi-family residential
 

 

 

 

 

 

Commercial real estate
 
434

 
434

 

 
434

 

 
445

Commercial
 
398

 
282

 
116

 
398

 
12

 
499

Consumer
 
75

 
75

 

 
75

 

 
87

Total
 
$
1,068

 
$
952

 
$
116

 
$
1,068

 
$
12

 
$
1,194

(1) Loans reported exclude PCI loans.

Interest payments on impaired loans are typically applied to principal unless collectability of the principal amount is reasonably assured, in which case interest is recognized on a cash basis.

Troubled Debt Restructuring
Modifications of terms for the Company’s loans and their inclusion as TDRs are based on individual facts and circumstances. Loan modifications that are included as TDRs may involve a reduction of the stated interest rate of the loan, an extension of the maturity date at a stated rate of interest lower than the current market rate for new debt with similar risk, or deferral of principal payments, regardless of the period of the modification. The recorded investment in TDRs was $1,207 and $618 as of September 30, 2018 and December 31, 2017, respectively.

18



During the nine months ended September 30, 2018 certain loans were modified as TDRs, the terms of which are summarized in the following table. During the same period in 2017, no loans were modified as TDRs.

 
 
 
 
 
 
During the nine months ended September 30, 2018
 
 
 
 
 
 
Post-Modification Outstanding Recorded Investment
 
 
Number of Loans
 
Pre-Modification Outstanding Recorded Investment
 
Adjusted Interest Rate
 
Extended Maturity
 
Extended Maturity and Restructured Payments
 
Extended Maturity, Restructured Payments and Adjusted Interest Rate
Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Construction and land
 

 
$

 
$

 
$

 
$

 
$

Farmland
 

 

 

 

 

 

1 - 4 family residential
 

 

 

 

 

 

Multi-family residential
 

 

 

 

 

 

Commercial real estate
 

 

 

 

 

 

Commercial
 
3

 
628

 

 
612

 

 

Consumer
 

 

 

 

 

 

Total
 
3

 
$
628

 
$

 
$
612

 
$

 
$

All TDRs are measured individually for impairment. Of the three loans restructured during the nine months ended September 30, 2018, one was past due and two were performing as agreed to the modified terms. A specific allowance for loan loss of $68 was recorded for one of the three loans as of the nine months ended September 30, 2018. Two of the three loans are on non-accrual status as of September 30, 2018.
There were no loans modified as TDR loans within the previous 12 months and for which there was a payment default during the nine months ended September 30, 2018 and 2017. A default for purposes of this disclosure is a TDR loan in which the borrower is 90 days past due or results in the foreclosure and repossession of the applicable collateral.
Interest income recorded during the three and nine months ended September 30, 2018 and 2017 on TDR loans and interest income that would have been recorded had the terms of the loans not been modified was minimal.
The Company has not committed to lend additional amounts to customers with outstanding loans classified as TDRs as of September 30, 2018 or December 31, 2017.
Credit Quality Indicators
From a credit risk standpoint, the Company classifies its loans in one of the following categories: (i) pass, (ii) special mention, (iii) substandard or (iv) doubtful. Loans classified as loss are charged-off. Loans not rated special mention, substandard, doubtful or loss are classified as pass loans.
The classifications of loans reflect a judgment about the risks of default and loss associated with the loan. The Company reviews the ratings on criticized credits monthly. Ratings are adjusted to reflect the degree of risk and loss that is felt to be inherent in each credit as of each monthly reporting period. All classified credits are evaluated for impairment. If impairment is determined to exist, a specific reserve is established. The Company’s methodology is structured so that specific reserves are increased in accordance with deterioration in credit quality (and a corresponding increase in risk and loss) or decreased in accordance with improvement in credit quality (and a corresponding decrease in risk and loss).
Credits rated special mention show clear signs of financial weaknesses or deterioration in credit worthiness, however, such concerns are generally not so pronounced that the Company expects to experience significant loss within the short-term. Such credits typically maintain the ability to perform within standard credit terms and credit exposure is not as prominent as credits with a lower rating.

19



Credits rated substandard are those in which the normal repayment of principal and interest may be, or has been, jeopardized by reason of adverse trends or developments of a financial, managerial, economic or political nature, or important weaknesses which exist in collateral. A protracted workout on these credits is a distinct possibility. Prompt corrective action is therefore required to strengthen the Company’s position, and/or to reduce exposure and to assure that adequate remedial measures are taken by the borrower. Credit exposure becomes more likely in such credits and a serious evaluation of the secondary support to the credit is performed.
Credits rated doubtful are those in which full collection of principal appears highly questionable, and in which some degree of loss is anticipated, even though the ultimate amount of loss may not yet be certain and/or other factors exist which could affect collection of debt. Based upon available information, positive action by the Company is required to avert or minimize loss. Credits rated doubtful are generally also placed on non-accrual.
Credits classified as PCI are those that, at acquisition date, had the characteristics of substandard loans and it was probable, at acquisition, that all contractually required principal and interest payments would not be collected. The Company evaluates these loans quarterly on a projected cash flow basis.
The following tables summarize the Company’s internal ratings of its loans, including PCI loans, as of September 30, 2018 and December 31, 2017:                                        
 
 
September 30, 2018
 
 
Pass
 
Special
Mention
 
Substandard
 
Doubtful
 
PCI
 
Total
Real estate:
 

 

 

 

 

 

Construction and land
 
$
289,816

 
$
2,220

 
$
2,107

 
$

 
$

 
$
294,143

Farmland
 
10,816

 

 

 

 
37

 
10,853

1 - 4 family residential
 
289,101

 
305

 
314

 

 
88

 
289,808

Multi-family residential
 
50,317

 

 

 

 

 
50,317

Commercial real estate
 
1,035,028

 
5,081

 
12,025

 

 
16,954

 
1,069,088

Commercial
 
685,727

 
7,022

 
7,618

 

 
22,773

 
723,140

Consumer
 
6,984

 

 
182

 

 

 
7,166

Total
 
$
2,367,789

 
$
14,628

 
$
22,246

 
$

 
$
39,852

 
$
2,444,515


 
 
December 31, 2017
 
 
Pass(1)
 
Special
Mention
 
Substandard
 
Doubtful
 
PCI
 
Total
Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Construction and land
 
$
277,186

 
$
639

 
$

 
$

 
$

 
$
277,825

Farmland
 
9,336

 

 

 

 
49

 
9,385

1 - 4 family residential
 
235,781

 
462

 
200

 

 
99

 
236,542

Multi-family residential
 
106,275

 

 

 

 

 
106,275

Commercial real estate
 
882,523

 
8,771

 
681

 

 
17,317

 
909,292

Commercial
 
634,796

 
18,337

 
1,155

 
116

 
30,147

 
684,551

Consumer
 
9,540

 

 
108

 

 

 
9,648

Total
 
$
2,155,437

 
$
28,209

 
$
2,144

 
$
116

 
$
47,612

 
$
2,233,518

(1) To conform to the current period presentation, $15,123 was reclassified from 1-4 family residential to multi-family residential within the pass column. There were no reclassifications between internal rating buckets.

20



An analysis of the allowance for loan losses for the nine months ended September 30, 2018 and 2017 and year ended December 31, 2017 is as follows:
 
 
Nine Months Ended September 30, 2018
 
Year Ended December 31, 2017
 
Nine Months Ended September 30, 2017
Balance at beginning of period
 
$
12,808

 
$
8,524

 
$
8,524

Provision charged to earnings
 
5,239

 
5,114

 
2,585

Charge-offs
 
(171
)
 
(839
)
 
(622
)
Recoveries
 
33

 
9

 
5

Net charge-offs
 
(138
)
 
(830
)
 
(617
)
Balance at end of period
 
$
17,909

 
$
12,808

 
$
10,492

The allowance for loan losses as a percentage of total loans was 0.73%0.57% and 0.55% as of September 30, 2018, December 31, 2017 and September 30, 2017, respectively.
The following tables summarize the activity in the allowance for loan losses by portfolio segment for the periods indicated. There were no allowance for loan losses related to PCI loans at December 31, 2017 and September 30, 2017.
 
 
Nine Months Ended September 30, 2018
 
 
Real Estate
 
 
 
 
 
 
 
 
Construction,
Land and
Farmland
 
Residential
 
Commercial Real Estate
 
Commercial
 
Consumer
 
Total
Balance at beginning of period
 
$
1,315

 
$
1,473

 
$
4,410

 
$
5,588

 
$
22

 
$
12,808

Provision (recapture) charged to earnings
 
552

 
324

 
1,726

 
2,633

 
4

 
5,239

Charge-offs
 

 

 

 
(150
)
 
(21
)
 
(171
)
Recoveries
 

 

 

 
33

 

 
33

Net charge-offs
 

 

 

 
(117
)
 
(21
)
 
(138
)
Balance at end of period
 
$
1,867

 
$
1,797

 
$
6,136

 
$
8,104

 
$
5

 
$
17,909

Period-end amount allocated to:
 
 
 
 
 
 
 
 
 
 
 
 
  Specific reserves
 

 

 

 
378

 

 
378

  PCI reserves
 

 

 

 
1,302

 

 
1,302

  General reserves
 
1,867

 
1,797

 
6,136

 
6,424

 
5

 
16,229

Total
 
$
1,867

 
$
1,797

 
$
6,136

 
$
8,104

 
$
5

 
$
17,909


 
 
For the 12/31/2017
 
 
Real Estate
 
 
 
 
 
 
 
 
Construction,
Land and
Farmland
 
Residential
 
Commercial Real Estate
 
Commercial
 
Consumer
 
Total
Balance at beginning of period
 
$
1,415

 
$
1,116

 
$
3,003

 
$
2,955

 
$
35

 
$
8,524

Provision (recapture) charged to earnings
 
(100
)
 
368

 
1,407

 
3,452

 
(13
)
 
5,114

Charge-offs
 

 
(11
)
 

 
(828
)
 

 
(839
)
Recoveries
 

 

 

 
9

 

 
9

Net charge-offs
 

 
(11
)
 

 
(819
)
 

 
(830
)
Balance at end of period
 
$
1,315

 
$
1,473

 
$
4,410

 
$
5,588

 
$
22

 
$
12,808

Period-end amount allocated to:
 
 
 
 
 
 
 
 
 
 
 
 
  Specific reserves
 

 

 

 
12

 

 
12

  General reserves
 
1,315

 
1,473

 
4,410

 
5,576

 
22

 
12,796

Total
 
$
1,315

 
$
1,473

 
$
4,410

 
$
5,588

 
$
22

 
$
12,808



21



 
 
For the 9/30/2017
 
 
Real Estate
 
 
 
 
 
 
 
 
Construction,
Land and
Farmland
 
Residential
 
Commercial Real Estate
 
Commercial
 
Consumer
 
Total
Balance at beginning of year
 
$
1,415

 
$
1,116

 
$
3,003

 
$
2,955

 
$
35

 
$
8,524

Provision (recapture) charged to earnings
 
(252
)
 
415

 
973

 
1,462

 
(13
)
 
2,585

Charge-offs
 

 
(11
)
 

 
(611
)
 

 
(622
)
Recoveries
 

 

 

 
5

 

 
5

Net charge-offs (recoveries)
 

 
(11
)
 

 
(606
)
 

 
(617
)
Balance at end of period
 
$
1,163

 
$
1,520

 
$
3,976

 
$
3,811

 
$
22

 
$
10,492

Period-end amount allocated to:
 
 
 
 
 
 
 
 
 
 
 
 
  Specific reserves
 

 

 

 
156

 

 
156

  General reserves
 
1,163

 
1,520

 
3,976

 
3,655

 
22

 
10,336

Total
 
$
1,163

 
$
1,520

 
$
3,976

 
$
3,811

 
$
22

 
$
10,492

The Company’s recorded investment in loans as of September 30, 2018 and December 31, 2017 related to the balance in the allowance for loan losses on the basis of the Company’s impairment methodology is as follows:
 
 
September 30, 2018
 
 
Real Estate
 
 
 
 
 
 
 
 
Construction,
Land and
Farmland
 
Residential
 
Commercial Real Estate
 
Commercial
 
Consumer
 
Total
Loans individually evaluated for impairment
 
$
2,107

 
$
160

 
$
366

 
$
2,929

 
$
66

 
$
5,628

Loans collectively evaluated for impairment
 
302,852

 
339,877

 
1,051,768

 
697,438

 
7,100

 
2,399,035

PCI loans
 
37

 
88

 
16,954

 
22,773

 

 
39,852

Total
 
$
304,996

 
$
340,125

 
$
1,069,088

 
$
723,140

 
$
7,166

 
$
2,444,515


 
 
December 31, 2017
 
 
Real Estate
 
 
 
 
 
 
 
 
Construction,
Land and
Farmland
 
Residential
 
Commercial Real Estate
 
Commercial
 
Consumer
 
Total
Loans individually evaluated for impairment
 
$

 
$
161

 
$
434

 
$
398

 
$
75

 
$
1,068

Loans collectively evaluated for impairment
 
287,161

 
342,557

 
891,541

 
654,006

 
9,573

 
2,184,838

PCI loans
 
49

 
99

 
17,317

 
30,147

 

 
47,612

Total
 
$
287,210

 
$
342,817

 
$
909,292

 
$
684,551

 
$
9,648

 
$
2,233,518

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 condensed 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
$
39,852

 
$
47,612

Outstanding balance
50,781

 
63,940


22



Changes in the accretable yield for PCI loans for the three and nine months ended September 30, 2018 are included in table below. There was no accretable yield balance for PCI loans for the three or nine months ended September 30, 2017 as management was still evaluating the non-accretable and accretable difference associated with the Sovereign acquisition.
 
 
Three Months Ended September 30, 2018
 
Nine Months Ended September 30, 2018
Balance at beginning of period
 
$
7,335

 
$
2,723

Purchase accounting adjustments
 

 
1,459

Reclassifications from nonaccretable
 
278

 
6,499

Accretion
 
(820
)
 
(3,888
)
Balance at end of period
 
$
6,793

 
$
6,793

In addition, during the three and nine months ended September 30, 2018, the Company received cash collections in excess of expected cash flows on PCI loans of $1,999 and $3,759, respectively. There were no cash collections in excess of expected cash flows on PCI loans for the three or nine months ended September 30, 2017.
Servicing Assets
The Company was servicing loans of approximately $71,609 and $44,720 as of September 30, 2018 and 2017, respectively. A summary of the changes in the related servicing assets are as follows:
 
 
Nine Months Ended September 30,
 
 
2018
 
2017
Balance at beginning of period
 
$
1,215

 
$
601

Servicing asset acquired through acquisition
 

 
454

Increase from loan sales
 
204

 
273

Amortization charged to income
 
(278
)
 
(130
)
Balance at end of period
 
$
1,141

 
$
1,198

The estimated fair value of the servicing assets approximated the carrying amount at September 30, 2018, December 31, 2017 and September 30, 2017. Fair value is estimated by discounting estimated future cash flows from the servicing assets using discount rates that approximate current market rates over the expected lives of the loans being serviced. A valuation allowance is recorded when the fair value is below the carrying amount of the asset. As of September 30, 2018 and 2017, there was no valuation allowance recorded.
The Company may also receive a portion of subsequent interest collections on loans sold that exceed the contractual servicing fees. In that case, the Company records an interest-only strip based on its relative fair market value and the other components of the loans. There was no interest-only strip receivable recorded at September 30, 2018 and December 31, 2017.
5. Income Taxes
The Company’s tax provision was $7,309 and $5,802 resulting in an effective tax rate of 19.8% and 32.8%, respectively, for the nine months ended September 30, 2018 and 2017. The Company’s effective tax rate, before the net impact of discrete items, was approximately 20.2% and 34.4% for the nine months ended September 30, 2018 and 2017, respectively. The decrease in the effective tax rate in the comparative periods was primarily due to the enactment of the Tax Cuts and Jobs Act (the “Tax Act”) on December 22, 2017, which lowered the Company’s federal statutory tax rate, effective on January 1, 2018.
The Company’s provision for the nine months ended September 30, 2018 was primarily impacted by a discrete tax expense totaling $722 as a result of the Company re-measuring its deferred taxes upon finalization of the fair value estimates of the deferred tax assets acquired in the Sovereign and Liberty acquisitions during the nine months ended September 30, 2018. For further information, see Note 12 – “Business Combinations”. The discrete tax provision was partially offset by a net discrete tax benefit of $688 resulting from the Company’s revised estimate of deferred taxes based on the finalization of its 2017 U.S. federal income tax return and $168 of a discrete tax benefit from the recognition of excess tax benefits on share-based payment awards during the nine months ended September 30, 2018. The revision in the estimate of deferred taxes primarily related to bank premises

23



and equipment as the Company completed a cost segregation study on its corporate building for the 2017 tax return during the nine months ended September 30, 2018. For the nine months ended September 30, 2017, the Company’s provision was impacted by a net discrete tax benefit of $285 primarily associated with the recognition of excess tax benefit on share-based payment awards.
The Company’s tax provision was $1,448 and $2,650, resulting in an effective tax rate of 13.9% and 33.8%, respectively, for the three months ended September 30, 2018 and 2017. The Company’s effective tax rate, before the net impact of discrete tax items, was approximately 20.7% and 34.2% for the three months ended September 30, 2018 and 2017, respectively. The decrease in the effective tax rate in the comparative periods was primarily due to the enactment of the Tax Act, as discussed above. The Company’s provision for the three months ended September 30, 2018 was primarily impacted by discrete tax benefits from the $688 revision in estimated deferred taxes discussed above and $12 from the recognition of excess tax benefits on share-based payment awards. For the three months ended September 30, 2017, the Company’s provision was impacted by a net discrete tax benefit of $30 primarily associated with the recognition of excess tax benefit on share-based payment awards.
The Company has finalized its evaluation of the authoritative guidance of the Tax Act and interpretation of the Tax Act by regulatory bodies and does not expect any additional material impact.
6. Commitments and Contingencies
Litigation
The Company may from time to time be involved in legal actions arising from normal business activities. Management believes that the ultimate liability, if any, resulting from these actions will not materially affect the financial position or results of operations of the Company.
Lessee: Cease-Use Liability

As part of the Sovereign acquisition and the Company’s evaluation of its acquired facilities owned or leased for ongoing economic benefit, a decision was made to cease using two acquired leases in the fourth quarter of 2017 for leases that expire between 2026 and 2029. In accordance with accounting for exit and disposal activities, the Company recognized a liability in 2017 for lease exit costs incurred when it no longer derived economic benefits from the related leases. In January 2018, the Company entered into an assignment agreement to assign one of its branch leases to a third party for one of the two leases that the Company ceased using during 2017. As a result of the lease assignment, the Company reversed $669 of the cease-use liability during the nine months ended September 30, 2018.

A cease-use liability of $674 and $1,407 is included in accrued interest payable and other liabilities in the condensed consolidated balance sheets as of September 30, 2018 and December 31, 2017, respectively. The below table is a roll-forward of the cease-use liability from December 31, 2017 to September 30, 2018.
 
 
Cease-Use Liability
Balance at December 31, 2017
 
$
1,407

Payments
 
(64
)
Reversal upon lease assignment
 
(669
)
Balance at September 30, 2018
 
$
674

Qualified Affordable Housing Investment
Starting in 2017, the Company began investing in certain qualified housing projects. As of September 30, 2018 and December 31, 2017, the balance of the investment for qualified affordable housing projects was $3,759 and $1,982, respectively. This balance is reflected in non-marketable equity securities on the condensed consolidated balance sheets. The total unfunded commitment related to the investment in certain qualified housing projects totaled $3,020 and $1,765 as of September 30, 2018 and December 31, 2017, respectively. The Company expects to fulfill these commitments during the year ended 2034.


24



7. Fair Value Disclosures
The following table summarizes assets measured at fair value on a recurring basis as of September 30, 2018 and December 31, 2017, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
 
 
Fair Value
Measurements Using
 
 
 
 
Level 1
Inputs
 
Level 2
Inputs
 
Level 3
Inputs
 
Total
Fair Value
As of September 30, 2018
 
 
 
 
 
 
 
 
   Investment securities available for sale
 
$

 
$
256,237

 
$

 
$
256,237

As of December 31, 2017
 
 
 
 
 
 
 
 
   Investment securities available for sale
 
$

 
$
228,117

 
$

 
$
228,117

There were no liabilities measured at fair value on a recurring basis as of September 30, 2018 or December 31, 2017.
There were no transfers between Level 2 and Level 3 during the nine months ended September 30, 2018 and 2017.
The following table summarizes assets measured at fair value on a non-recurring basis as of September 30, 2018 and December 31, 2017, segregated by the level of the valuation inputs within the fair value hierarchy utilized to measure fair value:
 
 
Fair Value
Measurements Using
 
 
 
 
Level 1
Inputs
 
Level 2
Inputs
 
Level 3
Inputs
 
Total
Fair Value
As of September 30, 2018
 
    
 
    
 
    
 
    
  Assets:
 
 
 
 
 
 
 
 
Impaired loans(1)
 
$

 
$

 
$
19,792

 
$
19,792

As of December 31, 2017
 
 
 
 
 
 
 
 
  Assets:
 
 
 
 
 
 
 
 
Impaired loans
 
$

 
$

 
$
116

 
$
116

Other real estate owned
 
$

 
$

 
$
449

 
$
449

(1) Impaired loans include $17,158 of PCI loans.
At September 30, 2018, impaired loans had a carrying value of $19,792, with $1,680 specific allowance for loan loss allocated. At December 31, 2017, impaired loans had a carrying value of $116, with $12 specific allowance for loan loss allocated.
There were no liabilities measured at fair value on a non-recurring basis as of September 30, 2018 or December 31, 2017.
For Level 3 financial assets measured at fair value as of September 30, 2018 and December 31, 2017, the significant unobservable inputs used in the fair value measurements were as follows:
September 30, 2018
 
 
 
 
Valuation
 
Unobservable
 
Weighted
Assets/Liabilities
 
Fair Value
 
Technique
 
Input(s)
 
Average
Impaired loans
 
$
19,792

 
Collateral Method
 
Adjustments for selling costs
 
8
%
December 31, 2017
 
 
 
 
Valuation
 
Unobservable
 
Weighted
Assets/Liabilities
 
Fair Value
 
Technique
 
Input(s)
 
Average
Impaired loans
 
$
116

 
Collateral Method
 
Adjustments for selling costs
 
8
%
Other real estate owned
 
$
449

 
Collateral Method
 
Adjustments for selling costs
 
8
%

25



Fair Value of Financial Instruments
Please refer to Note 16 of the Company’s 2017 Annual Report on Form 10-K for its methods of determining the fair value of financial instruments presented in this Note. The methods are consistent with its methodologies disclosed in the Company’s 2017 Annual Report on Form 10-K, except for the valuation of loans which was impacted by the adoption of ASU 2016-01. In accordance with ASU 2016-01, the fair value of loans, excluding previously presented impaired loans measured at fair value on a non-recurring basis, is estimated using a discounted cash flow analyses. The discount rates used to determine fair value use interest rate spreads that reflect factors such as liquidity, credit, and prepayment risk of the loans. Loans are considered a Level 3 classification.
The estimated fair values and carrying values of all financial instruments under current authoritative guidance as of September 30, 2018 and December 31, 2017 were as follows:
 
 
 
 
Fair Value
 
 
Carrying
Amount
 
Level 1
 
Level 2
 
Level 3
September 30, 2018
 
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
261,790

 
$

 
$
261,790

 
$

Loans held for sale
 
1,425

 

 
1,425

 

Loans, net
 
2,426,590

 

 

 
2,443,749

Accrued interest receivable
 
8,291

 

 
8,291

 

Bank-owned life insurance
 
21,915

 

 
21,915

 

Servicing asset
 
1,141

 

 
1,141

 

Non-marketable equity securities
 
352

 

 
352

 

Financial liabilities:
 
 
 
 
 
 
 
 
Deposits
 
$
2,656,254

 
$

 
$
2,576,838

 
$

Advances from FHLB
 
73,055

 

 
73,100

 

Accrued interest payable
 
988

 

 
988

 

Junior subordinated debentures
 
11,702

 

 
11,702

 

Subordinated notes
 
4,989

 

 
4,989

 

December 31, 2017
 
 
 
 
 
 
 
 
Financial assets:
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
149,044

 
$

 
$
149,044

 
$

Loans held for sale
 
841

 

 
841

 

Loans, net
 
2,220,682

 

 

 
2,234,094

Accrued interest receivable
 
7,676

 

 
7,676

 

Bank-owned life insurance
 
21,476

 

 
21,476

 

Servicing asset
 
1,243

 

 
1,243

 

Non-marketable equity securities
 
13,732

 

 
13,732

 

Financial instruments, assets held for sale
 
31,828

 
 
 
5,515

 
26,313

Financial liabilities:
 
 
 
 
 
 
 
 
Deposits
 
$
2,278,630

 
$

 
$
2,164,498

 
$

Advances from FHLB
 
71,164

 

 
70,110

 

Accrued interest payable
 
445

 

 
445

 

Junior subordinated debentures
 
11,702

 

 
11,702

 

Subordinated notes
 
4,987

 

 
4,987

 

Other borrowings
 
15,000

 

 
15,000

 

Financial instruments, liabilities held for sale
 
64,300

 

 
64,300

 



26



8. Financial Instruments with Off-Balance Sheet Risk
The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit. Those instruments involve, to varying degrees, elements of credit risk in excess of the amount recognized in the condensed consolidated balance sheets.
The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of those instruments. The Company uses the same credit policies in making commitments and conditional obligations as it does for on balance sheet instruments.
The following table sets forth the approximate amounts of these financial instruments as of September 30, 2018 and December 31, 2017:
 
 
September 30,
 
December 31,
 
 
2018
 
2017
Commitments to extend credit
 
$
860,931

 
$
606,451

Standby and commercial letters of credit
 
7,367

 
9,299

 
 
$
868,298

 
$
615,750

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Management evaluates each customer’s creditworthiness on a case-by-case basis. The amount of collateral obtained, if deemed necessary upon extension of credit, is based on management’s credit evaluation of the borrower.
Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. Standby letters of credit generally have fixed expiration dates or other termination clauses and may require payment of a fee. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers. The Company’s policy for obtaining collateral and the nature of such collateral is essentially the same as that involved in making commitments to extend credit.
Although the maximum exposure to loss is the amount of such commitments, management currently anticipates no material losses from such activities.
9. Stock and Incentive Plans
2010 Stock Option and Equity Incentive Plan
During the nine months ended September 30, 2018 and 2017, the Company did not award any restricted stock units, non-performance based stock options or performance-based stock options under the 2010 Incentive Plan. Stock compensation expense related to the 2010 Incentive Plan recognized in the accompanying condensed consolidated statements of income totaled $11 and $21 for the three and nine months ended September 30, 2018 and $20 and $62 for the three and nine months ended September 30, 2017, respectively.

27



A summary of option activity under the 2010 Incentive Plan for the nine months ended September 30, 2018 and 2017, and changes during the periods then ended is presented below:
 
 
2010 Incentive Plan
 
 
Non-Performance Based Stock Options
 
 
Shares
Underlying
Options
 
Weighted
Exercise
Price
 
Weighted
Average
Contractual
Term
 
Aggregate Intrinsic Value
Outstanding at January 1, 2017
 
325,500

 
$
10.15

 
4.56 years
 
 
Exercised
 
(17,500
)
 
10.00

 

 
 
Outstanding at September 30, 2017
 
308,000

 
$
10.16

 
3.84 years
 
 
Options exercisable at September 30, 2017
 
297,000

 
$
10.12

 
3.77 years
 
 
 
 
 
 
 
 
 
 
 
Outstanding at January 1, 2018
 
305,000

 
$
10.16

 
3.59 years
 
$
5,316

Exercised
 
(11,500
)
 
10.48

 

 
204

Outstanding at September 30, 2018
 
293,500

 
$
10.15

 
2.78 years
 
$
5,315

Options exercisable at September 30, 2018
 
289,500

 
$
10.13

 
2.75 years
 
$
5,249


As of September 30, 2018, December 31, 2017 and September 30, 2017, there was approximately $4$8 and $12, respectively, of unrecognized compensation expense related to non-performance based stock options. The unrecognized compensation expense at September 30, 2018 is expected to be recognized over the remaining weighted average requisite service period of 0.44 years.
A summary of the status of the Company’s restricted stock units under the 2010 Incentive Plan as of September 30, 2018 and 2017, and changes during the nine months then ended is as follows:
 
 
2010 Incentive Plan
 
 
Nonperformance-based restricted stock units

 
 
Units
 
Weighted
Average
Grant Date
Fair Value
Outstanding at January 1, 2017
 
27,750

 
$
11.92

Vested into shares
 
(1,000
)
 
10.85

Forfeited
 
(500
)
 
10.85

Outstanding at September 30, 2017
 
26,250

 
$
11.98

 
 
 
 
 
Outstanding at January 1, 2018
 
24,250

 
$
13.19

Vested into shares
 
(23,750
)
 
12.14

Forfeited
 
(500
)
 
10.85

Outstanding at September 30, 2018
 

 
$

As of September 30, 2018, December 31, 2017 and September 30, 2017 there was $4, $15 and $37 of total unrecognized compensation expense related to unvested restricted stock units.

28



A summary of the fair value of the Company’s stock options exercised and restricted stock units vested under the 2010 Incentive Plan as of September 30, 2018 and 2017 is presented below:
 
 
Fair Value of Options Exercised or Restricted Stock Units Vested as of September 30,
 
 
2018
 
2017
Non-performance based stock options exercised
 
328

 
488

Non-performance based restricted stock units vested
 
713

 
26

2014 Omnibus Plan
During the nine months ended September 30, 2018, the Company awarded 54,650 non-performance based restricted stock units, 40,269 performance based restricted stock units, and 125,593 non-performance based stock options under the 2014 Omnibus Plan. During the nine months ended September 30, 2017, the Company awarded 37,625 non-performance based restricted stock units, 25,522 performance based restricted stock units and 70,440 non-performance-based stock options under the 2014 Omnibus Plan.

The non-performance options granted during the nine months ended September 30, 2018 vest equally over three years from the grant date. The performance based restricted stock units granted during the nine months ended September 30, 2018 include a performance criteria based on the Company’s total stockholder return relative to a market index that determines the number of restricted stock units that may vest equally over a three-year period from the date of grant. The non-performance restricted stock units granted during the nine months ended September 30, 2018 vest equally over a three-year period from the date of grant.

Compensation expense for option and restricted stock unit awards granted under the 2014 Omnibus Plan was approximately $928 and $3,054 for the three and nine months ended September 30, 2018 and $388 and $1,137 for the three and nine months ended September 30, 2017, respectively.
The fair value of each option award is estimated on the grant date using the Black-Scholes option-pricing model with the following assumptions used for the grants for the nine months ended September 30, 2018 and 2017:
 
 
Nine Months Ended September 30
 
 
2018
 
2017
Dividend yield
 
0.00%
 
0.00%
Expected life
 
5.0 to 7.5 years
 
5.0 to 7.5 years
Expected volatility
 
27.28% to 37.55%
 
31.60% to 37.55%
Risk-free interest rate
 
1.06% to 2.94%
 
1.06% to 2.32%
The expected life is based on the amount of time that options granted are expected to be outstanding. The dividend yield assumption is based on the Company’s history. The expected volatility is based on historical volatility of the Company. The risk-free interest rates are based upon yields of U.S. Treasury issues with a term equal to the expected life of the option being valued.

29



A summary of the status of the Company’s stock options under the 2014 Omnibus Plan as of September 30, 2018 and 2017, and changes during the nine months then ended, is as follows:
 
 
2014 Omnibus Plan
 
 
Non-performance Based Stock Options
 
 
Shares
Underlying
Options
 
Weighted
Exercise
Price
 
Weighted
Average
Contractual
Term
 
Aggregate Intrinsic Value
Outstanding at January 1, 2017
 
128,366

 
$
15.32

 
8.69 years
 
 
Granted
 
70,440

 
26.87

 

 
 
Forfeited
 
(3,465
)
 
21.24

 

 
 
Exercised
 
(1,544
)
 
15.00

 

 
 
Outstanding at September 30, 2017
 
193,797

 
$
19.34

 
8.45 years
 
 
Options exercisable at September 30, 2017
 
53,804

 
$
15.01

 
7.74 years
 
 
 
 
 
 
 
 
 
 
 
Outstanding at January 1, 2018
 
332,706

 
$
22.71

 
8.86 years
 
$
1,614

Granted
 
125,593

 
27.95

 

 
 
Forfeited
 
(2,076
)
 
27.59

 

 


Exercised
 
(1,983
)
 
14.95

 

 
26

Outstanding at September 30, 2018
 
454,240

 
$
24.12

 
8.42 years
 
$
1,858

Options exercisable at September 30, 2018
 
122,329

 
$
18.38

 
7.29 years
 
$
1,209

Weighted average fair value of options granted during the period
 
 
 
$
9.66

 
 
 
 

As of September 30, 2018, December 31, 2017 and September 30, 2017 there was $2,330$1,958 and $832 of total unrecognized compensation expense related to options awarded under the 2014 Omnibus Plan, respectively. The unrecognized compensation expense at September 30, 2018 is expected to be recognized over the remaining weighted average requisite service period of 2.27 years.

A summary of the status of the Company’s non-performance based restricted stock units under the 2014 Omnibus Plan as of September 30, 2018 and 2017, and changes during the nine months then ended, is as follows:
 
 
2014 Omnibus Plan
 
 
Non-performance Based
 
 
Restricted Stock Units
 
 
Units
 
Weighted
Average
Grant Date
Fair Value
Outstanding at January 1, 2017
 
67,956

 
$
13.79

Granted
 
37,625

 
27.37

Vested into shares
 
(14,550
)
 
24.67

Forfeited
 
(2,250
)
 
27.93

Options exercisable at September 30, 2017
 
88,781

 
$
17.41

 
 
 
 
 
Outstanding at January 1, 2018
 
150,722

 
$
13.29

Granted
 
54,650

 
29.29

Vested into shares
 
(39,311
)
 
27.19

Forfeited
 
(3,929
)
 
26.85

Outstanding at September 30, 2018
 
162,132

 
$
23.85



30



A summary of the status of the Company’s performance based restricted stock units under the 2014 Omnibus Plan as of September 30, 2018 and 2017, and changes during the nine months then ended, is as follows:

 
 
2014 Omnibus Plan
 
 
Performance Based
 
 
Restricted Stock Units
 
 
Units
 
Weighted
Average
Grant Date
Fair Value
Outstanding at January 1, 2017
 
51,197

 
$
8.72

Granted
 
25,522

 
24.34

Vested into shares
 
(19,861
)
 
15.34

Forfeited
 
(2,014
)
 
15.68

Options exercisable at September 30, 2017
 
54,844

 
$
13.33

 
 
 
 
 
Outstanding at January 1, 2018
 
53,594

 
$
8.72

Granted
 
40,269

 
27.59

Vested into shares
 
(26,623
)
 
18.83

Forfeited
 
(898
)
 
27.59

Outstanding at September 30, 2018
 
66,342

 
$
25.56

As of September 30, 2018, December 31, 2017 and September 30, 2017 there was $3,928, $3,592 and $1,805 of total unrecognized compensation related to restricted stock units awarded under the 2014 Omnibus Plan, respectively.
A summary of the fair value of the Company’s stock options exercised and restricted stock units vested under the 2014 Omnibus Plan as of September 30, 2018 and 2017 is presented below:
 
 
Fair Value of Options Exercised or Restricted Stock Units Vested as of September 30,
 
 
2018
 
2017
Non-performance based stock options exercised
 
54

 
41

Non-performance based restricted stock units vested
 
1,173

 
395

Performance based restricted stock units vested
 
745

 
530

10. Significant Concentrations of Credit Risk
Most of the Company’s business activity is with customers located within the Dallas-Fort Worth metroplex and Houston metropolitan area. Such customers are normally also depositors of the Company.
The distribution of commitments to extend credit approximates the distribution of loans outstanding. Commercial and standby letters of credit were granted primarily to commercial borrowers.
The contractual amounts of credit related financial instruments such as commitments to extend credit, credit card arrangements and letters of credit represent the amounts of potential accounting loss should the contract be fully drawn upon, the customer default, and the value of any existing collateral become worthless.

31



11. Capital Requirements and Restrictions on Retained Earnings
The Company, on a consolidated basis, and the Bank are subject to various regulatory capital requirements administered by federal banking agencies. Failure to meet minimum capital requirements can lead to the initiation of certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company must meet specific capital guidelines that involve quantitative measures of the Company’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings, and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total, CET1 and Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of September 30, 2018 and December 31, 2017 that the Company and the Bank met all capital adequacy requirements to which they were subject.
As of September 30, 2018 and December 31, 2017, the Company’s and the Bank’s capital ratios exceeded those levels necessary to be categorized as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized,” the Company and the Bank must maintain minimum total risk-based, CET1, Tier 1 risk-based and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since September 30, 2018 that management believes have changed the Company’s categorization as “well capitalized.”

32



A comparison of the Company’s and Bank’s actual capital amounts and ratios to required capital amounts and ratios is presented in the following table:
 
 
Actual
 
 
 
For Capital 
Adequacy Purposes
 
 
 
To Be Well
Capitalized Under
Prompt Corrective
Action Provisions
 
 
Amount
 
Ratio
 
 
 
Amount
 
 
 
Ratio
 
 
 
Amount
 
 
 
Ratio
As of September 30, 2018
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
$
381,915

 
13.22
%
 
 
 
$
231,113

 
 
 
8.0
%
 
 
 
n/a

 
 
 
n/a

Bank
 
340,023

 
11.75
%
 
 
 
231,505

 
 
 
8.0
%
 
 
 
$
289,381

 
 
 
10.0
%
Tier 1 capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
359,054

 
12.43
%
 
 
 
173,316

 
 
 
6.0
%
 
 
 
n/a

 
 
 
n/a

Bank
 
322,113

 
11.13
%
 
 
 
173,646

 
 
 
6.0
%
 
 
 
231,528

 
 
 
8.0
%
Common equity tier 1 to risk-weighted assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
347,353

 
12.02
%
 
 
 
130,041

 
 
 
4.5
%
 
 
 
n/a

 
 
 
n/a

Bank
 
322,113

 
11.13
%
 
 
 
130,234

 
 
 
4.5
%
 
 
 
188,116

 
 
 
6.5
%
Tier 1 capital (to average assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
359,054

 
11.74
%
 
 
 
122,335

 
 
 
4.0
%
 
 
 
n/a

 
 
 
n/a

Bank
 
322,113

 
10.53
%
 
 
 
122,360

 
 
 
4.0
%
 
 
 
152,950

 
 
 
5.0
%
As of December 31, 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Total capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
$
342,521

 
13.16
%
 
 
 
$
208,219

 
 
 
8.0
%
 
 
 
n/a

 
 
 
n/a

Bank
 
296,207

 
11.37
%
 
 
 
208,413

 
 
 
8.0
%
 
 
 
$
260,516

 
 
 
10.0
%
Tier 1 capital (to risk-weighted assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
324,726

 
12.48
%
 
 
 
156,118

 
 
 
6.0
%
 
 
 
n/a

 
 
 
n/a

Bank
 
283,399

 
10.88
%
 
 
 
156,286

 
 
 
6.0
%
 
 
 
208,382

 
 
 
8.0
%
Common equity tier 1 to risk-weighted assets
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
313,024

 
12.03
%
 
 
 
11,791

 
 
 
4.5
%
 
 
 
n/a

 
 
 
n/a

Bank
 
283,399

 
10.88
%
 
 
 
117,215

 
 
 
4.5
%
 
 
 
169,310

 
 
 
6.5
%
Tier 1 capital (to average assets)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Company
 
324,726

 
12.92
%
 
 
 
100,534

 
 
 
4.0
%
 
 
 
n/a

 
 
 
n/a

Bank
 
283,399

 
11.28
%
 
 
 
100,496

 
 
 
4.0
%
 
 
 
125,620

 
 
 
5.0
%

33



12. Business Combinations
All acquisitions were accounted for using the acquisition method of accounting. Accordingly, the assets and liabilities of the acquired entities were recorded at their estimated fair values at the acquisition date. ASC 820 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market willing participants at the measurement date. The Company determines the estimated fair values after review and consideration of relevant information, including discounted cash flows, quoted market prices, third party valuations, and estimates made by management. The excess of the purchase price over the estimated fair value of the net assets for tax-free acquisitions is recorded as goodwill, none of which is deductible for tax purposes. Acquisition-related costs are recognized separately from the acquisition and are expensed as incurred. The results of operations for each acquisition have been included in the Company’s consolidated financial results beginning on the respective acquisition date.
Sovereign Bancshares, Inc.
On August 1, 2017, the Company acquired Sovereign, a Texas corporation and parent company of Sovereign Bank. The Company issued 5,117,642 shares of its common stock and paid out $56,215 in cash to Sovereign in consideration for the acquisition. Additionally, under the terms of the merger agreement, each share of Sovereign SBLF Preferred Stock, no par value, issued and outstanding immediately prior to the effective time was converted into one share of Veritex Series D Preferred Stock.
The business combination was accounted for under the acquisition method of accounting. Under this method of accounting, assets acquired and liabilities assumed are recorded at their estimated fair values. The excess cost over fair value of net assets acquired is recorded as goodwill. As the consideration paid for Sovereign exceeded the provisional value of the net assets acquired, goodwill of $111,301 was recorded related to the acquisition. This goodwill resulted from the combination of expected operational synergies and increased market share in the Dallas-Fort Worth metroplex and Houston metropolitan area. Goodwill is not tax deductible.

34



Fair Value
The following table presents the amounts recorded on the condensed consolidated balance sheets on the acquisition date of August 1, 2017, showing the estimated fair value as reported at December 31, 2017, the measurement period adjustments and the fair value determined to be final as of March 31, 2018.
 
Estimate at December 31, 2017
 
Measurement Period Adjustments
 
Final Fair Value
Assets
 
 
 
 
 
Cash and cash equivalents
$
44,775

 
$

 
$
44,775

Investment securities
166,307

 

 
166,307

Loans
752,450

 
(4,622
)
 
747,828

Accrued interest receivable
3,102

 

 
3,102

Bank premises, furniture and equipment
17,805

 
474

 
18,279

Non-marketable equity securities
6,751

 

 
6,751

Other real estate owned
282

 

 
282

Intangible assets
8,454

 
749

 
9,203

Goodwill
109,091

 
2,210

 
111,301

Other assets
13,148

 
1,189

 
14,337

Total Assets
$
1,122,165

 
$

 
$
1,122,165

 
 
 
 
 
 
Liabilities
 
 
 
 
 
Deposits
$
809,366

 
$

 
$
809,366

Accounts payable and accrued expenses
6,284

 

 
6,284

Accrued interest payable and other liabilities
806

 

 
806

Advances from Federal Home Loan Bank
80,000

 

 
80,000

Junior subordinated debentures
8,609

 

 
8,609

Total liabilities
$
905,065

 
$

 
$
905,065

 
 
 
 
 
 
Preferred stock - series D
24,500

 

 
24,500

Total stockholders’ equity
24,500

 

 
24,500

 
 
 
 
 
 
Consideration
 
 
 
 
 
Market value of common stock issued
$
136,385

 
$

 
$
136,385

Cash paid
56,215

 

 
56,215

Total fair value of consideration
$
192,600

 
$

 
$
192,600

Acquisition-related Expenses
For the three and nine months ended September 30, 2018, the Company incurred no pre-tax merger and acquisition expenses related to the Sovereign acquisition. For the same periods in 2017, the company incurred $1,305 and $1,435, respectively, of pre-tax merger and acquisition expenses related to the Sovereign acquisition. Acquisition expenses are included in professional fees in the condensed consolidated statements of income.
Acquired Loans and Purchased Credit Impaired Loans
Acquired loans were recorded at fair value based on a discounted cash flow valuation methodology that considers, among other things, projected default rates, loss given defaults and recovery rates. No allowance for credit losses was carried over from Sovereign.

35



The Company has identified certain acquired loans as PCI. PCI loan identification considers payment history and past due status, debt service coverage, loan grading, collateral values and other factors that may indicate deterioration of credit quality since origination.

The following table discloses the fair value and contractual value of loans acquired from Sovereign on August 1, 2017:
 
PCI loans
 
Other Acquired Loans
 
Total Acquired Loans
Real Estate
$
17,708

 
$
518,261

 
$
535,969

Commercial
29,877

 
180,730

 
210,607

Consumer

 
1,252

 
1,252

     Total fair value
47,585

 
700,243

 
747,828

Contractual principal balance
$
67,985

 
$
707,071

 
$
775,056


The following table presents additional information about PCI loans acquired from Sovereign on August 1, 2017:
 
PCI Loans
Contractually required principal and interest
$
85,125

Non-accretable difference
33,064

Cash flows expected to be collected
$
52,061

Accretable difference
4,476

Fair value of PCI loans
$
47,585

Intangible Assets
The following table discloses the fair value of intangible assets acquired from Sovereign on August 1, 2017:
 
Gross Intangible Assets
Core deposit intangibles(1)
$
8,452

Servicing asset(2)
317

Intangible lease assets(3)
434

 
$
9,203

(1) The Company estimated a useful life of 7.7 years for core deposit intangibles.
(2) The Company estimated a weighted-average useful life of 6.1 years for servicing asset which will be amortized on a straight line basis.
(3) The Company estimated a weighted-average useful life of 5.0 years for intangible lease assets which will be amortized on a straight line basis

Advances from Federal Home Loan Bank
The Company assumed from Sovereign $80,000 in advances from the Federal Home Loan Bank as of August 1, 2017 that matured in full from August 1, 2017 to December 31, 2017.
Redemption of Veritex Series D Preferred Stock
On August 8, 2017, the Company redeemed all 24,500 shares of the Veritex Series D Preferred Stock at its liquidation value of $1,000 per share plus accrued dividends for a total redemption amount of $24,727. The Company assumed $185 of accrued dividends in connection with the acquisition of Sovereign on August 1, 2017 out of the $227 in dividends paid in 2017. The redemption was approved by the Company’s primary federal regulator and was funded with the Company’s surplus capital. The redemption terminates the Company’s participation in the Small Business Lend Fund (“SBLF”) program.

36



Liberty Bancshares, Inc.
On December 1, 2017, the Company acquired Liberty, a Texas corporation and parent company of Liberty Bank. The Company issued 1,449,944 shares of its common stock and paid out $25,009 in cash to Liberty in consideration for the acquisition.
The business combination was accounted for under the acquisition method of accounting. As the consideration paid for Liberty exceeded the provisional value of the net assets acquired, goodwill of $23,281 was recorded related to the acquisition. This goodwill resulted from the combination of expected operational synergies and increased market share in Tarrant County. Goodwill is not tax deductible.
Fair Value
The following table presents the amounts recorded on the condensed consolidated balance sheets on the acquisition date of December 1, 2017, showing the estimated fair value as reported at December 31, 2017, the measurement period adjustments and the fair value determined to be final as of June 30, 2018.
 
Estimate at December 31, 2017
 
Measurement Period Adjustments
 
Final Fair Value
Assets
 
 
 
 
 
Cash and cash equivalents
$
57,384

 
$

 
$
57,384

Investment securities
54,137

 

 
54,137

Loans
312,608

 
572

 
313,180

Accrued interest receivable
1,191

 

 
1,191

Bank premises, furniture and equipment
6,145

 
688

 
6,833

Non-marketable equity securities
2,096

 

 
2,096

Other real estate owned
166

 

 
166

Intangible assets
7,519

 
(1,705
)
 
5,814

Goodwill
23,496

 
(215
)
 
23,281

Other assets
2,509

 
617

 
3,126

Total assets
$
467,251

 
$
(43
)
 
$
467,208

Liabilities
 
 
 
 
 
Deposits
$
395,851

 
$
(303
)
 
$
395,548

Accounts payable and accrued expenses
1,287

 
260

 
1,547

Accrued interest payable and other liabilities
142

 

 
142

Subordinated notes(1)
4,625

 

 
4,625

Total liabilities
$
401,905

 
$
(43
)
 
$
401,862

 
 
 
 
 
 
Consideration
 
 
 
 
 
Market value of common stock issued
$
40,337

 
$

 
$
40,337

Cash paid
25,009

 

 
25,009

Total fair value of consideration
$
65,346

 
$

 
$
65,346

(1) The subordinated note was paid off in full on December 1, 2017, subsequent to closing.

Acquisition-related Expenses
For the three months ended September 30, 2018, the Company incurred no pre-tax merger and acquisition expenses related to the Liberty acquisition and for the nine months ended September 30, 2018, incurred $335 of pre-tax merger and acquisition expenses related to the Liberty acquisition. The Company incurred $86 acquisition expenses related to the Liberty acquisition for the three and nine months ended September 30, 2017. Acquisition expenses are included in professional fees in the consolidated statements of income.

37



Acquired Loans and Purchased Credit Impaired Loans
Acquired loans were recorded at fair value based on a discounted cash flow valuation methodology that considers, among other things, projected default rates, loss given defaults and recovery rates. No allowance for credit losses was carried over from Liberty.
The Company has identified certain acquired loans as PCI. PCI loan identification considers payment history and past due status, debt service coverage, loan grading, collateral values and other factors that may indicate deterioration of credit quality since origination. Accretion of purchase discounts on PCI loans is based on estimated future cash flows, regardless of contractual maturities, that include undiscounted expected principal and interest payments and use credit risk, interest rate and prepayment risk models to incorporate management’s best estimate of current key assumptions such as default rates, loss severity and payment speeds. Accretion of purchase discounts on acquired non-impaired loans will be recognized on a level-yield basis based on contractual maturity of individual loans per ASC 310-20.
The following table discloses the fair value and contractual value of loans acquired from Liberty on December 1, 2017:
 
PCI loans
 
Other acquired loans
 
Total Acquired Loans
Real Estate
$
868

 
$
257,578

 
$
258,446

Commercial
307

 
49,695

 
50,002

Consumer

 
4,732

 
4,732

     Total fair value
1,175

 
312,005

 
313,180

Contractual principal balance
$
1,748

 
$
316,119

 
$
317,867


The following table presents additional information about PCI loans acquired from Liberty on December 1, 2017:
 
PCI Loans
Contractually required principal and interest
$
2,316

Non-accretable difference
711

Cash flows expected to be collected
$
1,605

Accretable difference
430

Fair value of PCI loans
$
1,175

Intangible Assets
The acquisition also resulted in a core deposit intangible of $5,814, which will be amortized on an accelerated basis over the estimated life of 10.0 years.
Pending Merger with Green Bancorp, Inc.
On July 23, 2018, the Company entered into a definitive agreement with Green Bancorp, Inc. (“Green”), the parent holding company for Green Bank, N.A. (“Green Bank”), in an all-stock merger valued at approximately $1,000,000. The agreement provides for the merger of Green and Green Bank with and into Veritex and Veritex Community Bank, respectively. Each share of Green common stock will be converted into the right to receive 0.79 shares of Veritex common stock upon closing. The closing of this transaction is subject to approval by the Company’s and Green’s shareholders, regulatory approvals and other customary closing conditions and is expected to occur in the first quarter of 2019.

13. Intangible Assets
Intangible assets in the accompanying condensed consolidated balance sheets are summarized as follows:

38



 
As of September 30, 2018
 
Weighted
 
Gross
 
 
 
Net
 
Amortization
 
Intangible
 
Accumulated
 
Intangible
 
Period
 
Assets
 
Amortization
 
Assets
Core deposit intangibles
8.1 years
 
$
16,051

 
$
3,944

 
$
12,107

Servicing asset
6.8 years
 
1,825

 
684

 
1,141

Intangible lease assets
2.8 years
 
5,282

 
1,927


3,355

 
 
 
$
23,158

 
$
6,555

 
$
16,603

 
 
As of December 31, 2017
 
Weighted
 
Gross
 
 
 
Net
 
Amortization
 
Intangible
 
Accumulated
 
Intangible
 
Period
 
Assets
 
Amortization
 
Assets
Core deposit intangibles
8.7 years
 
$
17,007

 
$
2,694

 
$
14,313

Servicing asset
6.8 years
 
1,621

 
406

 
1,215

Intangible lease assets
3.3 years
 
5,281

 
368

 
4,913

 
 
 
$
23,909

 
$
3,468

 
$
20,441

 
For the nine months ended September 30, 2018 and September 30, 2017, amortization expense related to intangible assets of approximately $3,087 and $413, respectively, is included within amortization of intangibles, occupancy and equipment, and other income within the condensed consolidated statements of income.
14. Branch Assets and Liabilities Held for Sale
On October 23, 2017, the Company entered into a Purchase and Assumption Agreement to sell certain assets and liabilities associated with two branch locations in the Austin metropolitan market. The associated assets and liabilities were included in branch assets and liabilities held for sale as of December 31, 2017. On January 1, 2018, the Company completed the sale of these assets and liabilities to Horizon Bank, SSB (“Horizon”), resulting in a $33,557 cash settlement payment to Horizon during the three months ended March 31, 2018, which included the repayment of a $1,000 deposit liability recorded within other liabilities as of December 31, 2017, and the recognition of a $355 gain on the sale reported in other non-interest income for the nine months ended September 30, 2018. The completion of this sale resulted in the Company exiting the Austin metropolitan market.
In the fourth quarter of 2017, the Company ceased using one of its Dallas, Texas branch buildings. The associated building and improvements were included in branch assets held for sale as of December 31, 2017. On August 6, 2018, the Company completed the sale of the branch location to Texas Trust Credit Union (“Texas Trust”), resulting in a $1,747 cash settlement during the three months ended September 30, 2018, which included the recognition of a loss of $6 on the sale reported in other non-interest expenses.

39



The following table presents the assets and liabilities held for sale as of September 30, 2018 and December 31, 2017:
 
 
September 30, 2018
 
December 31, 2017
Assets
 
 
 
 
Cash and cash equivalents
 

 
334

Loans
 

 
26,313

Accrued interest receivable
 

 
63

Bank premises, furniture and equipment
 

 
5,118

Intangible assets
 

 
1,724

Total assets
 

 
33,552

Liabilities
 
 
 
 
Deposits
 

 
64,282

Accounts payable and accrued expenses
 

 
2

Deferred tax liability
 

 
327

Accrued interest payable and other liabilities
 

 
16

Total liabilities
 

 
64,627



40



Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our condensed consolidated financial statements and notes thereto appearing in Item 1 of Part I of this Quarterly Report on Form 10-Q (this “Report”) as well as with our condensed financial statements and notes thereto appearing in our Annual Report on Form 10-K for the year ended December 31, 2017. Except where the content otherwise requires or when otherwise indicated, the terms “Company,” “we,” “us,” “our,” and “our business” refer to Veritex Holdings, Inc. and our banking subsidiary, Veritex Community Bank.

This discussion and analysis contains forward-looking statements that are subject to certain risks and uncertainties and are based on certain assumptions that we believe are reasonable but may prove to be inaccurate. Certain risks, uncertainties and other factors, including those set forth under “Special Cautionary Notice Regarding Forward-Looking Statements”, may cause actual results to differ materially from those projected results discussed in the forward-looking statements appearing in this discussion and analysis. We assume no obligation to update any of these forward-looking statements. For additional information concerning forward-looking statements, please read “—Special Cautionary Notice Regarding Forward-Looking Statements” below.

Overview

We are a bank holding company headquartered in Dallas, Texas. Through our wholly-owned subsidiary, Veritex Community Bank, a Texas state chartered bank, we provide relationship-driven commercial banking products and services tailored to meet the needs of small to medium-sized businesses and professionals. Beginning at our inception in 2010, we initially targeted customers and focused our acquisitions primarily in the Dallas metropolitan area, which we consider to be Dallas and the adjacent communities in North Dallas. As a result of our acquisitions of Sovereign Bancshares, Inc. (“Sovereign”) and Liberty Bancshares Inc. (“Liberty”) in 2017, our current primary market now includes the broader Dallas-Fort Worth metroplex, which also encompasses Arlington, as well as the Houston metropolitan area. As we continue to grow, we may expand to other metropolitan markets within the State of Texas.

On July 23, 2018, the Company entered into a definitive agreement with Green Bancorp, Inc. (“Green”), the parent holding company for Green Bank, N.A. (“Green Bank”), in an all-stock merger valued at approximately $1 billion. The agreement provides for the merger of Green and Green Bank with and into Veritex and Veritex Community Bank, respectively. Each share of Green common stock will be converted into the right to receive 0.79 shares of Veritex common stock upon closing. The closing of this transaction is subject to approval by the Company’s and Green’s shareholders, regulatory approvals and other customary closing conditions and is expected to occur in the first quarter of 2019.
Our business is conducted through one reportable segment, community banking, we generate the majority of our revenues from interest income on loans, customer service and loan fees, gains on sale of Small Business Administration (“SBA”) guaranteed loans and mortgage loans and interest income from securities. We incur interest expense on deposits and other borrowed funds and noninterest expense, such as salaries and employee benefits and occupancy expenses. We analyze our ability to maximize income generated from interest earning assets and expense of our liabilities through our net interest margin. Net interest margin is a ratio calculated as net interest income divided by average interest-earning assets. Net interest income is the difference between interest income on interest-earning assets, such as loans and securities, and interest expense on interest-bearing liabilities, such as deposits and borrowings, which are used to fund those assets.

Changes in the market interest rates and interest rates we earn on interest-earning assets or pay on interest-bearing liabilities, as well as the volume and types of interest-earning assets, interest-bearing and noninterest-bearing liabilities and stockholders’ equity, are usually the largest drivers of periodic changes in net interest spread, net interest margin and net interest income. Fluctuations in market interest rates are driven by many factors, including governmental monetary policies, inflation, deflation, macroeconomic developments, changes in unemployment, the money supply, political and international conditions and conditions in domestic and foreign financial markets. Periodic changes in the volume and types of loans in our loan portfolio are affected by, among other factors, economic and competitive conditions in Texas and specifically in the Dallas-Fort Worth metroplex, as well as developments affecting the real estate, technology, financial services, insurance, transportation, manufacturing and energy sectors within our target market and throughout the State of Texas.

41



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

General

Net income available to common stockholders for the nine months ended September 30, 2018 was $29.5 million, an increase of $17.6 million, or 149.0%, from net income available to common stockholders of $11.9 million for the nine months ended September 30, 2017.
Basic earnings per share (“EPS”) for the nine months ended September 30, 2018 was $1.22, an increase of $0.52 from $0.70 for the nine months ended September 30, 2017. Diluted EPS for the nine months ended September 30, 2018 was $1.20, an increase of $0.51 from $0.69 for the nine months ended September 30, 2017.
Net Interest Income

For the nine months ended September 30, 2018, net interest income totaled $85.9 million and net interest margin and net interest spread were 4.17% and 3.77%, respectively. For the nine months ended September 30, 2017, net interest income totaled $42.8 million and net interest margin and net interest spread were 3.54% and 3.24%, respectively. The increase in net interest income of $43.1 million was due to $53.8 million in increased interest income on loans resulting from organic loan growth, increased volumes in all loan categories resulting from loans acquired from the acquisitions of Sovereign and Liberty in 2017 and benefits of increases in the prime rate in new and renewed loans. The increase of $53.8 million in interest income on loans included $6.9 million in accretion during the nine months ended September 30, 2018 on loans acquired from Sovereign and Liberty. This increase was offset in part by a $12.3 million increase in interest-bearing deposits expense resulting from organic deposit growth and deposits assumed from the acquisitions of Sovereign and Liberty during 2017. Average loan balances increased $1.1 billion compared to the nine months ended September 30, 2017. The increase in net interest margin and net interest spread was primarily attributable to a 106 basis point increase in the average yield on interest-earning assets. This increase was due to a change in the mix of interest-earning assets, as average loans as a percentage of total average interest-earning assets represented 85.1% for the nine months ended September 30, 2018 compared to 77.0% for the nine months ended September 30, 2017. Loans traditionally provide higher average yields than other interest earning assets such as investment securities and interest-bearing deposits in other banks.

For the nine months ended September 30, 2018, interest expense totaled $20.6 million and the average rate paid on interest-bearing liabilities was 1.40%. For the nine months ended September 30, 2017, interest expense totaled $6.9 million and the average rate paid on interest-bearing liabilities was 0.87%. The increase in interest expense of $13.7 million was due to growth in average interest bearing-liabilities of $902.0 million, or 84.9%, primarily due to the increase in interest bearing-liabilities assumed from the acquisitions of Sovereign and Liberty and organic growth in average interest bearing deposits, advances from Federal Home Loan Bank (“FHLB”) and other borrowings.














42



The following table presents, for the periods indicated, an analysis of net interest income by each major category of interest-earning assets and interest–bearing liabilities, the average amounts outstanding and the interest earned or paid on such amounts. The table also sets forth the average rate earned on interest-earning assets, the average rate paid on interest-bearing liabilities, and the net interest margin on average total interest-earning assets for the same periods. Interest earned on loans that are classified as non-accrual is not recognized in income; however, the balances are reflected in average outstanding balances for the period. For the nine months ended September 30, 2018 and 2017, interest income not recognized on non-accrual loans was $371 thousand . Any non-accrual loans have been included in the table as loans carrying a zero yield.

 
 
For the Nine Months Ended September 30,
 
 
2018
 
2017
 
 
 
 
Interest
 
 
 
 
 
Interest
 
 
 
 
Average
 
Earned/
 
Average
 
Average
 
Earned/
 
Average
 
 
Outstanding
 
Interest
 
Yield/
 
Outstanding
 
Interest
 
Yield/
 
 
Balance
 
Paid
 
Rate
 
Balance
 
Paid
 
Rate
 
 
(Dollars in thousands)
Assets
     
     
     
     
     
     
 
     
     
     
     
     
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
Total loans(1)
 
$
2,342,797

 
$
99,432

 
5.67
%
 
$
1,242,706

 
$
45,613

 
4.91
%
Securities available for sale
 
241,764

 
4,697

 
2.60

 
149,026

 
2,251

 
2.02

Interest-earning deposits in other banks
 
168,329

 
2,316

 
1.84

 
221,595

 
1,787

 
1.08

Investment in subsidiary
 
336

 
15

 
5.97

 
151

 
4

 
3.54

Total interest-earning assets
 
2,753,226

 
106,460

 
5.17

 
1,613,478

 
49,655

 
4.11

Allowance for loan losses
 
(14,309
)
 
 
 
 
 
(9,200
)
 
 
 
 
Noninterest-earning assets
 
356,190

 
 
 
 
 
137,315

 
 
 
 
Total assets
 
$
3,095,107

 
 
 
 
 
$
1,741,593

 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 
$
1,848,679

 
$
18,507

 
1.34
%
 
$
1,009,313

 
$
6,201

 
0.82
%
Advances from FHLB
 
99,138

 
1,325

 
1.79

 
43,313

 
319

 
0.98

Other borrowings
 
16,768

 
727

 
5.80

 
9,995

 
377

 
5.04

Total interest-bearing liabilities
 
1,964,585

 
20,559

 
1.40

 
1,062,621

 
6,897

 
0.87

Noninterest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing deposits
 
614,107

 
 
 
 
 
385,428

 
 
 
 
Other liabilities
 
12,310

 
 
 
 
 
4,438

 
 
 
 
Total noninterest-bearing liabilities
 
626,417

 
 
 
 
 
389,866

 
 
 
 
Stockholders’ equity
 
504,105

 
 
 
 
 
289,106

 
 
 
 
Total liabilities and stockholders’ equity
 
$
3,095,107

 
 
 
 
 
$
1,741,593

 
 
 
 
Net interest rate spread(2)
 
 
 
 
 
3.77
%
 
 
 
 
 
3.24
%
Net interest income
 
 
 
$
85,901

 
 
 
 
 
$
42,758

 
 
Net interest margin(3)
 
 
 
 
 
4.17
%
 
 
 
 
 
3.54
%
________________________________
(1) 
Includes average outstanding balances of loans held for sale of $1,258 and $2,270 and deferred loan fees of $23 and $25 for the nine months ended September 30, 2018 and 2017, respectively.
(2) 
Net interest spread is the average yield on interest-earning assets minus the average rate on interest-bearing liabilities.
(3) 
Net interest margin is equal to net interest income divided by average interest‑earning assets.

43




The following table presents the changes in interest income and interest expense for the periods indicated for each major component of interest-earning assets and interest-bearing liabilities and distinguishes between the changes attributable to changes in volume and interest rates. For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated to rate.
 
 
For the Nine Months Ended
 
 
September 30, 2018 vs. 2017
 
 
Increase (Decrease)
 
 
 
 
Due to Change in
 
 
 
 
Volume
 
Rate
 
Total
 
 
(Dollars in thousands)
Interest-earning assets:
 
 
 
 
 
 
Total loans
 
$
40,378

 
$
13,441

 
$
53,819

Securities available for sale
 
1,401

 
1,045

 
2,446

Investment in subsidiary
 
5

 
6

 
11

Interest-earning deposits in other banks
 
(430
)
 
959

 
529

Total increase in interest income
 
41,354

 
15,451

 
56,805

Interest-bearing liabilities:
 
 
 
 
 
 

Interest-bearing deposits
 
5,157

 
7,149

 
12,306

Advances from FHLB
 
411

 
595

 
1,006

Other borrowings
 
255

 
95

 
350

Total increase in interest expense
 
5,823

 
7,839

 
13,662

Increase in net interest income
 
$
35,531

 
$
7,612

 
$
43,143

Provision for Loan Losses
Our provision for loan losses is a charge to income in order to bring our allowance for loan losses to a level deemed appropriate by management. For a description of the factors taken into account by management in determining the allowance for loan losses see “—Financial Condition—Allowance for Loan Losses.” The provision for loan losses was $5.2 million for the nine months ended September 30, 2018, compared to $2.6 million for the same period in 2017, an increase of $2.7 million, or 102.7%. The increase in provision recorded for the nine months ended September 30, 2018 was a result of continued organic loan growth as well as a recorded provision on purchased credit impaired (“PCI”) loans. In addition, net charge-offs decreased $479 thousand for the nine months ended September 30, 2018 compared to the same period in 2017

Noninterest Income
The following table presents, for the periods indicated, the major categories of noninterest income:
 
 
For the 
 
 
 
 
Nine Months Ended
 
 
 
 
September 30,
 
Increase
 
 
2018
 
2017
 
(Decrease)
 
 
(Dollars in thousands)
Noninterest income:
 
 
 
 
 
 
Service charges and fees on deposit accounts
 
$
2,588

 
$
1,733

 
$
855

(Loss) gain on sales of investment securities
 
(22
)
 
205

 
(227
)
Net gain on sales of loans and other assets owned
 
1,267

 
2,259

 
(992
)
Bank-owned life insurance
 
575

 
561

 
14

Rental Income
 
1,343

 

 
1,343

Other
 
2,132

 
520

 
1,612

Total noninterest income
 
$
7,883

 
$
5,278

 
$
2,605


44



Noninterest income for the nine months ended September 30, 2018 increased $2.6 million, or 49.4%, to $7.9 million compared to noninterest income of $5.3 million for the same period in 2017. The primary components of the increase were as follows:

Service charges and fees on deposit accounts. We earn service charges and fees from our customers for deposit-related activities. The income from these deposit activities constitutes a significant and predictable component of our noninterest income. Service charges and fees from deposit account activities were $2.6 million for the nine months ended September 30, 2018, an increase of $855 thousand, or 49.3%, over the same period in 2017. The increase was primarily attributable to organic growth in the number of deposit accounts and accounts assumed from the Sovereign and Liberty acquisitions.

Gain on sales of loans and other assets owned. We originate SBA guaranteed loans and long-term fixed-rate mortgage loans for resale into the secondary market. Income from the sales of loans was $1.3 million for the nine months ended September 30, 2018 compared to $2.3 million for the same period of 2017. This decrease of $1.0 million was primarily due to a decrease in sales of SBA-guaranteed loans resulting in a decrease in incremental gains of $859 thousand. The reduction in sales is due to the decrease in premium rates on the loans below the interest rates earned by keeping the loan in the company’s portfolio.

Rental income. Rental income was $1.3 million for the nine months ended September 30, 2018, an increase of $1.3 million compared to the same period of 2017. This increase resulted from the purchase of our corporate headquarters building during the fourth quarter of 2017 and the corresponding rental income from leasing space to tenants.

Other. Other noninterest income was $2.1 million for the nine months ended September 30, 2018, an increase of $1.6 million compared to the same period of 2017. The increase was primarily due to a $355 thousand gain from the completion of the sale of certain assets and liabilities associated with two branch locations in the Austin market, and a $265 thousand increase in dividend income, including a bi-annual Federal Reserve Bank stock dividend attributable to additional purchases of Federal Reserve Bank stock of $190 during the nine months ended September 30, 2018. The increase was also due to organic growth from the Sovereign and Liberty acquisitions.
    
Noninterest Expense

The following table presents, for the periods indicated, the major categories of noninterest expense:
 
 
For the Nine Months Ended
 
Increase
 
 
September 30,
 
(Decrease)
 
 
2018
 
2017
 
2018 vs. 2017
 
 
(Dollars in thousands)
Salaries and employee benefits
 
$
23,225

 
$
13,471

 
$
9,754

Non-staff expenses:
 
 
 
 
 
 
Occupancy and equipment
 
8,267

 
3,622

 
4,645

Professional fees
 
7,803

 
3,959

 
3,844

Data processing and software expense
 
2,601

 
1,451

 
1,150

FDIC assessment fees
 
827

 
1,061

 
(234
)
Marketing
 
1,213

 
905

 
308

Amortization of intangibles
 
2,632

 
413

 
2,219

Telephone and communications
 
1,076

 
438

 
638

Other
 
4,077

 
2,434

 
1,643

Total noninterest expense
 
$
51,721

 
$
27,754

 
$
23,967

 

45



Noninterest expense for the nine months ended September 30, 2018 increased $24.0 million, or 86.4%, to $51.7 million compared to noninterest expense of $27.8 million for the nine months ended September 30, 2017. The most significant components of the increase were as follows:

Salaries and employee benefits. Salaries and employee benefits include payroll expense, the cost of incentive compensation, benefit plans, health insurance and payroll taxes. The level of employee expense is impacted by the amount of direct loan origination costs, which are required to be deferred in accordance with ASC 310-20 (formerly FAS91). Salaries and employee benefits were $23.2 million for the nine months ended September 30, 2018, an increase of $9.8 million, or 72.4%, compared to the same period in 2017. The increase was primarily attributable to increased employee compensation of $9.2 million and payroll taxes of $640 thousand resulting from a higher headcount of 334 employees as of September 30, 2018 as compared to 270 employees as of September 30, 2017. The increased headcount is primarily due to the addition of full-time equivalent employees related to the Sovereign and Liberty acquisitions. Incentive costs increased $2.3 million which included lender incentive increases of $806 thousand and employee stock compensation increases of $1.3 million. The increase in employee stock compensation included $421 thousand of share based compensation expense from awarding 50 shares to each Veritex employee, as announced in the first quarter of 2018, which were issued in the second quarter of 2018. These increases in salaries and employee benefits were partially offset by deferred direct origination costs, which increased $3.5 million as a result of organic growth in loans during the nine months ended September 30, 2018 compared to the same period in 2017.
 
Occupancy and equipment. Occupancy and equipment expense includes lease expense, building depreciation and related facilities costs as well as furniture, fixture and equipment depreciation, small equipment purchases and maintenance expense. Our expense associated with occupancy and equipment was $8.3 million for the nine months ended September 30, 2018 compared to $3.6 million for the same period in 2017. The increase of $4.7 million, or 128.2%, was primarily due to a $1.5 million consent fee paid in connection with the execution of an assignment agreement in the first quarter of 2018 to assign one of our branch leases that we ceased using during 2017. The increase was also related to amortization of our lease intangible of $624 thousand, depreciation expense of $977 thousand, and property taxes of $992 thousand recognized in the nine months ended September 30, 2018 with the purchase of our corporate headquarters in December 2017.
 
Professional fees. This category includes legal, investment bank, director, stock transfer agent fees and other public company services, information technology support, audit services and regulatory assessment expense. Professional fees were $7.8 million for the nine months ended September 30, 2018 compared to $4.0 million for the same period in 2017, an increase of $3.8 million, or 97.1%. This increase was primarily the result of increased merger related legal and professional service fees. For the nine months ended September 30, 2018, the Company incurred $3.1 million of legal and professional service fees associated with the pending merger with Green as compared to legal and professional service fees of $1.7 million for the same period in 2017 due to the mergers with Sovereign and Liberty. The increase was also due to the closing of the sale of two branches in Austin and the execution of an assignment agreement entered into in January 2018 to assign one of our branch leases.

Data processing and software expenses. Data processing expenses were $2.6 million for the nine months ended September 30, 2018, an increase of $1.2 million, or 79.3%, compared to the same period in 2017. The increase was attributable to core processing expense incurred due to the increase in account transaction volumes and the expense associated with converting Liberty’s operating systems into the Veritex information technology infrastructure during the nine months ended September 30, 2018.

Amortization of intangibles. Amortization of intangibles includes the amortization associated with core deposit intangibles, servicing asset and other intangible assets. Our expense associated with amortization of intangibles was $2.6 million for the nine months ended September 30, 2018 compared to $413 thousand for the same period in 2017. The increase of $2.2 million was primarily due to the addition of intangible assets associated with the Sovereign and Liberty acquisitions that closed on August 1, 2017 and December 1, 2017, respectively, as well as the purchase of our corporate headquarters in December 2017.

 Other. This category includes operating and administrative expenses including loan operations and collections, supplies and printing, online and card interchange expense, ATM/debit card processing, postage and delivery, bank-owned life insurance (“BOLI”) mortality expense, insurance and security expenses. Other noninterest expense increased $1.7 million, or 67.5%, to $4.1 million for the nine months ended September 30, 2018, compared to $2.4 million for the same period in 2017. The increase was primarily related to increases in insurance expenses of $287 thousand, security expenses of $254 thousand, office supplies of $205 thousand, automobile and travel expenses of $185 thousand and ATM and interchange expenses of $125 thousand primarily as a result of the Sovereign and Liberty acquisitions. Amortization of the affordable housing investment also increased $178 thousand as a result of another investment made during the nine months ended September 30, 2018.


46



Income Tax Expense
 
The amount of income tax expense is a function of our pre-tax income, tax-exempt income and other nondeductible expenses. Deferred tax assets and liabilities reflect current statutory income tax rates in effect in which the deferred tax assets and liabilities are expected to be realized or settled as of the nine months ended September 30, 2018. As changes in tax laws or statutory tax rates are enacted, deferred tax assets and liabilities are adjusted through the provision of income taxes. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. As of September 30, 2018, we did not believe a valuation allowance was necessary.
 
For the nine months ended September 30, 2018, income tax expense totaled $7.3 million, an increase of $1.5 million, or 26.0%, compared to $5.8 million for the same period in 2017. The increase was primarily attributable to the $19.1 million increase in pre-tax income recognized during the nine months ended September 30, 2018, partially offset by a decrease in the effective tax rate due to the enactment of the Tax Act on December 22, 2017 which lowered our federal statutory tax rate, effective on January 1, 2018.

Also, we recognized a discrete tax expense of $722 thousand during the nine months ended September 30, 2018 upon the finalization of the estimates of deferred tax assets acquired in the Sovereign and Liberty acquisitions. We also recognized a discrete tax benefit of $688 thousand during the nine months ended September 30, 2018 resulting from the our revised estimate of deferred taxes based on the finalization of our 2017 U.S. federal income tax return. The revision in the estimate of deferred taxes primarily related to bank premises and equipment as we completed a cost segregation study on our corporate building for the 2017 tax return during the nine months ended September 30, 2018.

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

General

Net income available to common stockholders for the three months ended September 30, 2018 was $8.9 million, an increase of $3.8 million, or 73.8%, from net income available to common stockholders of $5.1 million for the three months ended September 30, 2017.
Basic EPS for the three months ended September 30, 2018 was $0.37, an increase of $0.11 from $0.26 for the three months ended September 30, 2017. Diluted EPS for the three months ended September 30, 2018 was $0.36, an increase of $0.11 from $0.25 for the three months ended September 30, 2017.
Net Interest Income

For the three months ended September 30, 2018, net interest income totaled $29.2 million and net interest margin and net interest spread were 4.00% and 3.53%, respectively. For the three months ended September 30, 2017, net interest income totaled $19.1 million and net interest margin and net interest spread were 3.78% and 3.49%, respectively. The increase in net interest income before provision for loan losses was primarily driven by higher loan balances and yields resulting from loans acquired from the acquisitions of Sovereign and Liberty, continued organic loan growth and benefits of increases in the prime rate in new and renewed loans during the three months ended September 30, 2018 compared to the three months ended September 30, 2017. For the three months ended September 30, 2018, average loan balance increased by $789.0 million compared to the three months ended September 30, 2017, which resulted in a $14.4 million increase in interest income. This increase was partially offset by an increase in the average rate paid on interest-bearing liabilities which resulted in a $5.0 million increase in interest on deposit accounts. The increase in net interest margin and net interest spread was primarily attributable to a 78 basis point increase in the average yield on interest-earning assets. This increase was due to a change in the mix of interest-earning assets, as average loans as a percentage of total average interest-earning assets represented 84.1% for the three months ended September 30, 2018 compared to 81.9% for the three months ended September 30, 2017. Loans traditionally provide higher average yields than other interest earning assets such as investment securities and interest-bearing deposits in other banks.

For the three months ended September 30, 2018, interest expense totaled $8.6 million and the average rate paid on interest-bearing liabilities was 1.66%. For the three months ended September 30, 2017, interest expense totaled $3.2 million and the average rate paid on interest-bearing liabilities was 0.92%. The increase in interest expense of $5.4 million was due to growth in average interest bearing-liabilities of $709.4 million, or 52.1%, primarily due to the increase in interest bearing-liabilities assumed from the acquisitions of Sovereign and Liberty, organic growth in average interest bearing deposits, advances from FHLB and other borrowings and and increases in the prime rate.

47



The following table presents, for the periods indicated, an analysis of net interest income by each major category of interest-earning assets and interest–bearing liabilities, the average amounts outstanding and the interest earned or paid on such amounts. The table also sets forth the average rate earned on interest-earning assets, the average rate paid on interest-bearing liabilities, and the net interest margin on average total interest-earning assets for the same periods. Interest earned on loans that are classified as non-accrual is not recognized in income; however, the balances are reflected in average outstanding balances for the period. For the three months ended September 30, 2018, interest income not recognized on non-accrual loans was $331 thousand. For the three months ended September 30, 2017, interest income not recognized on non-accrual loans was minimal. Any non-accrual loans have been included in the table as loans carrying a zero yield.

 
 
For the Three Months Ended September 30,
 
 
2018
 
2017
 
 
 
 
Interest
 
 
 
 
 
Interest
 
 
 
 
Average
 
Earned/
 
Average
 
Average
 
Earned/
 
Average
 
 
Outstanding
 
Interest
 
Yield/
 
Outstanding
 
Interest
 
Yield/
 
 
Balance
 
Paid
 
Rate
 
Balance
 
Paid
 
Rate
 
 
(Dollars in thousands)
Assets
     
     
     
     
     
     
 
     
     
     
     
     
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
Total loans(1)
 
$
2,432,095

 
$
35,074

 
5.72
%
 
$
1,643,077

 
$
20,706

 
5.00
%
Securities available for sale
 
254,242

 
1,722

 
2.69

 
191,265

 
941

 
1.95

Interest-earning deposits in other banks
 
203,750

 
1,016

 
1.98

 
171,461

 
629

 
1.46

Investment in subsidiary
 
352

 
6

 
6.76

 
265

 
3

 
4.49

Total interest-earning assets
 
2,890,439

 
37,818

 
5.19

 
2,006,068

 
22,279

 
4.41

Allowance for loan losses
 
(16,160
)
 
 
 
 
 
(9,910
)
 
 
 
 
Noninterest-earning assets
 
358,935

 
 
 
 
 
202,352

 
 
 
 
Total assets
 
$
3,233,214

 
 
 
 
 
$
2,198,510

 
 
 
 
Liabilities and Stockholders’ Equity
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing deposits
 
$
1,933,832

 
$
7,762

 
1.59
%
 
$
1,294,187

 
$
2,812

 
0.86
%
Advances from FHLB
 
120,114

 
630

 
2.08

 
53,222

 
160

 
1.19

Other borrowings
 
16,690

 
250

 
5.94

 
13,793

 
178

 
5.12

Total interest-bearing liabilities
 
2,070,636

 
8,642

 
1.66

 
1,361,202

 
3,150

 
0.92

Noninterest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Noninterest-bearing deposits
 
635,952

 
 
 
 
 
452,426

 
 
 
 
Other liabilities
 
11,750

 
 
 
 
 
6,898

 
 
 
 
Total noninterest-bearing liabilities
 
647,702

 
 
 
 
 
459,324

 
 
 
 
Stockholders’ equity
 
514,876

 
 
 
 
 
377,984

 
 
 
 
Total liabilities and stockholders’ equity
 
$
3,233,214

 
 
 
 
 
$
2,198,510

 
 
 
 
Net interest rate spread(2)
 
 
 
 
 
3.53
%
 
 
 
 
 
3.49
%
Net interest income
 
 
 
$
29,176

 
 
 
 
 
$
19,129

 
 
Net interest margin(3)
 
 
 
 
 
4.00
%
 
 
 
 
 
3.78
%
________________________________
(1) 
Includes average outstanding balances of loans held for sale of $1,091 and $1,553 and deferred loan fees of $20 and $18 for the three months ended September 30, 2018 and 2017, respectively.
(2) 
Net interest spread is the average yield on interest-earning assets minus the average rate on interest-bearing liabilities.
(3) 
Net interest margin is equal to net interest income divided by average interest‑earning assets.

48




The following table presents the changes in interest income and interest expense for the periods indicated for each major component of interest-earning assets and interest-bearing liabilities and distinguishes between the changes attributable to changes in volume and interest rates. For purposes of this table, changes attributable to both rate and volume that cannot be segregated have been allocated to rate.
 
 
For the Three Months Ended September 30,
 
 
2018 vs. 2017
 
 
Increase (Decrease)
 
 
 
 
Due to Change in
 
 
 
 
Volume
 
Rate
 
Total
 
 
(Dollars in thousands)
Interest-earning assets:
 
 
 
 
 
 
Total loans
 
$
9,943

 
$
4,425

 
$
14,368

Securities available for sale
 
310

 
471

 
781

Investment in subsidiary
 
1

 
2

 
3

Interest-earning deposits in other banks
 
118

 
269

 
387

Total increase in interest income
 
10,372

 
5,167

 
15,539

Interest-bearing liabilities:
 
 
 
 
 
 

Interest-bearing deposits
 
1,390

 
3,560

 
4,950

Advances from FHLB
 
201

 
269

 
470

Other borrowings
 
37

 
35

 
72

Total increase in interest expense
 
1,628

 
3,864

 
5,492

Increase in net interest income
 
$
8,744

 
$
1,303

 
$
10,047

Provision for Loan Losses
Our provision for loan losses is a charge to income in order to bring our allowance for loan losses to a level deemed appropriate by management. For a description of the factors taken into account by management in determining the allowance for loan losses, see “—Financial Condition—Allowance for Loan Losses.” The provision for loan losses was $3.1 million for the three months ended September 30, 2018, compared to $752 thousand for the same period in 2017, an increase of $2.3 million, or 306.5%. The provision recorded for the three months ended September 30, 2018 was a result of an increase in our loans as well an increase on the recorded provision on purchased credit impaired loans of $1.3 million compared to the three months ended September 30, 2017.


49



Noninterest Income
The following table presents, for the periods indicated, the major categories of noninterest income:
 
 
For the 
 
 
 
 
Three Months Ended September 30,
 
Increase
 
 
2018
 
2017
 
(Decrease)
 
 
(Dollars in thousands)
Noninterest income:
 
 
 
 
 
 
Service charges and fees on deposit accounts
 
$
809

 
$
669

 
$
140

(Loss) gain on sales of investment securities
 
(34
)
 
205

 
(239
)
Net gain on sales of loans and other assets owned
 
270

 
705

 
(435
)
Bank-owned life insurance
 
194

 
188

 
6

Rental Income
 
414

 

 
414

Other
 
857

 
210

 
647

Total noninterest income
 
$
2,510

 
$
1,977

 
$
533

Noninterest income for the three months ended September 30, 2018 increased $533 thousand, or 27.0%, to $2.5 million compared to noninterest income of $2.0 million for the same period in 2017. The primary components of the increase were as follows:

Gain on sales of loans and other assets owned. We originate SBA guaranteed loans and long-term fixed-rate mortgage loans for resale into the secondary market. Income from the sales of loans was $270 thousand for the three months ended September 30, 2018 compared to $705 thousand for the same period of 2017. This decrease of $435 thousand was primarily due to a decrease in sales of SBA-guaranteed loans resulting in a decrease in incremental gains of $416 thousand. The reduction in sales is due to the decrease in premium rates paid on the SBA loans below the interest rates earned by keeping the loan in the company’s portfolio.

Rental income. Rental income was $414 thousand for the three months ended September 30, 2018, an increase of $414 thousand compared to the same period of 2017. This increase resulted from the purchase of our corporate headquarters building during the fourth quarter of 2017 and the corresponding rental income from leasing space to tenants.

Other. Other noninterest income was $857 thousand for the three months ended September 30, 2018, an increase of $647 thousand compared to the same period of 2017. The increase in other income was primarily due to increases in late charges of $55 thousand and other loan related fees of $145 thousand attributable to loan and deposit organic growth and growth due to the Sovereign and Liberty acquisitions.
    

50



Noninterest Expense
The following table presents, for the periods indicated, the major categories of noninterest expense:
 
 
For the Three Months Ended September 30,
 
Increase (Decrease)
 
 
2018
 
2017
 
2018 vs. 2017
 
 
(Dollars in thousands)
Salaries and employee benefits
 
$
7,394

 
$
5,921

 
$
1,473

Non-staff expenses:
 
 
 
 
 
 
Occupancy and equipment
 
2,890

 
1,596

 
1,294

Professional fees
 
4,297

 
1,973

 
2,324

Data processing and software expense
 
697

 
719

 
(22
)
FDIC assessment fees
 
288

 
410

 
(122
)
Marketing
 
306

 
436

 
(130
)
Amortization of intangibles
 
798

 
223

 
575

Telephone and communications
 
236

 
230

 
6

Other
 
1,340

 
1,014

 
326

Total noninterest expense
 
$
18,246

 
$
12,522

 
$
5,724

 
Noninterest expense for the three months ended September 30, 2018 increased $5.7 million, or 45.7%, to $18.2 million compared to noninterest expense of $12.5 million for the three months ended September 30, 2017. The most significant components of the increase were as follows:

Salaries and employee benefits. Salaries and employee benefits include payroll expense, the cost of incentive compensation, benefit plans, health insurance and payroll taxes. The level of employee expense is impacted by the amount of direct loan origination costs, which are required to be deferred in accordance with ASC 310-20 (formerly FAS91). Salaries and employee benefits were $7.4 million for the three months ended September 30, 2018, an increase of $1.5 million, or 24.9%, compared to the same period in 2017. The increase was primarily attributable to increased employee compensation of $1.9 million and payroll taxes of $222 thousand resulting from a higher headcount of 334 employees as of September 30, 2018 as compared to 270 employees as of September 30, 2017. The increased headcount is primarily due to the addition of full-time equivalent employees related to the Sovereign and Liberty acquisitions. Incentive costs increased $720 thousand which included employee stock compensation increases of $298 thousand that were also related to the higher headcount in 2018 as compared to 2017. These increases in salaries and employee benefits were partially offset by deferred direct origination costs, which increased $1.5 million as a result of organic growth in loans during the three months ended September 30, 2018 compared to the same period in 2017.
 
Occupancy and equipment. Occupancy and equipment expense includes lease expense, building depreciation and related facilities costs as well as furniture, fixture and equipment depreciation, small equipment purchases and maintenance expense. Our expense associated with occupancy and equipment was $2.9 million for the three months ended September 30, 2018 compared to $1.6 million for the same period in 2017. The increase of $1.3 million, or 81.1%, was primarily due to an increase in lease and depreciation expense of $96 thousand from our acquisitions of Sovereign and Liberty in the third and fourth quarters of 2017. We also incurred higher property taxes, building expenses and depreciation expense of $234 thousand, $532 thousand and $191 thousand, respectively, as a result of our purchase of our corporate headquarters in December 2017, as well as depreciation expense of equipment of $99 thousand.
Professional fees. This category includes legal, investment bank, director, stock transfer agent fees and other public company services, information technology support, audit services and regulatory assessment expense. Professional fees were $4.3 million for the three months ended September 30, 2018 compared to $2.0 million for the same period in 2017, an increase of $2.3 million, or 117.8%. This increase was primarily the result of increased merger related legal and professional service fees. During the three months ended September 30, 2018, the Company incurred $2.7 million of legal and professional service fees associated with the pending merger with Green as compared to legal and professional service fees of $1.4 million for the same period in 2017 due to the mergers with Sovereign and Liberty.

51



Amortization of intangibles. Amortization of intangibles includes the amortization associated with core deposit intangibles, servicing asset and other intangible assets. Our expense associated with amortization of intangibles was $798 thousand for the three months ended September 30, 2018 compared to $223 thousand for the same period in 2017. The increase of $575 thousand was primarily due to intangible assets associated with Sovereign and Liberty acquisitions, which increased our amortization expense by $208 thousand, as well as our lease commission intangible asset related to our purchase of our corporate headquarters, which increased our amortization expense by $366 thousand.
 
Income Tax Expense
 
The amount of income tax expense is a function of our pre-tax income, tax-exempt income and other nondeductible expenses. Deferred tax assets and liabilities reflect current statutory income tax rates in effect for the period in which the deferred tax assets and liabilities are expected to be realized or settled. As changes in tax laws or statutory tax rates are enacted, deferred tax assets and liabilities are adjusted through the provision of income taxes. Valuation allowances are established when necessary to reduce deferred tax assets to the amount expected to be realized. As of September 30, 2018, we did not believe a valuation allowance was necessary.
 
For the three months ended September 30, 2018, income tax expense totaled $1.4 million , a decrease of $1.3 million, or 45.4%, compared to $2.7 million for the same period in 2017. The decrease was primarily attributable to the enactment of the Tax Act on December 22, 2017 which lowered our federal statutory tax rate, effective on January 1, 2018.

We also recognized a discrete tax benefit of $688 thousand during the three months ended September 30, 2018 resulting from our revised estimate of deferred taxes based on the finalization of our 2017 U.S. federal income tax return. The revision in the estimate of deferred taxes primarily related to bank premises and equipment as we completed a cost segregation study on our corporate building for the 2017 tax return during the three months ended September 30, 2018.
Financial Condition
 
Our total assets increased $330.3 million, or 11.2%, from $2.9 billion as of December 31, 2017 to $3.3 billion as of September 30, 2018. Our asset growth was due to the successful execution of our strategy to establish deep relationships in the Dallas-Fort Worth metroplex and the Houston metropolitan area. We believe these relationships will continue to bring in new customer accounts and grow balances from existing loan and deposit customers.
 
Loan Portfolio
 
Our primary source of income is interest on loans to individuals, professionals, small to medium-sized businesses and commercial companies located in the Dallas-Fort Worth metroplex and Houston metropolitan area. Our loan portfolio consists primarily of commercial loans and real estate loans secured by commercial real estate properties located in our primary market area. Our loan portfolio represents the highest yielding component of our earning asset base.
 
As of September 30, 2018, total loans were $2.4 billion. Excluding $26.3 million in loans that were sold in connection with the sale of two branch locations during the first quarter of 2018, total loans increased $237.3 million, or 21.2%, compared to $2.2 billion as of December 31, 2017. The increase was primarily due to continued organic growth in new originations from the addition of experienced commercial bankers and our continued penetration in our primary market. In addition to these amounts, $1.4 million and $841 thousand in loans were classified as held for sale as of September 30, 2018 and December 31, 2017, respectively.
 
Total loans as a percentage of deposits were 92.0% and 98.0% as of September 30, 2018 and December 31, 2017, respectively. Total loans as a percentage of assets were 74.6% and 75.8% as of September 30, 2018 and December 31, 2017, respectively.


52



The following table summarizes our loan portfolio by type of loan as of the dates indicated:
 
 
As of September 30,
 
As of December 31,
 
 
2018
 
2017
 
 
Amount
 
Percent
 
Amount
 
Percent
 
 
(Dollars in thousands)
Commercial
 
$
723,140

 
29.6
%
 
$
684,551

 
30.6
%
Real estate:
 
 
 
 
 
 
 
 
Construction and land
 
294,143

 
12.0
%
 
277,825

 
12.4
%
Farmland
 
10,853

 
0.5
%
 
9,385

 
0.4
%
1 - 4 family residential
 
289,808

 
11.9
%
 
236,542

 
10.6
%
Multi-family residential
 
50,317

 
2.0
%
 
106,275

 
4.8
%
Commercial real estate
 
1,069,088

 
43.7
%
 
909,292

 
40.7
%
Consumer
 
7,166

 
0.3
%
 
9,648

 
0.5
%
Total loans held for investment
 
$
2,444,515

 
100
%
 
$
2,233,518

 
100
%
Total loans held for sale
 
$
1,425

 
 
 
$
841

 
 


Nonperforming Assets

The following table presents information regarding non-performing assets at the dates indicated: 
 
 
As of September 30,
 
As of December 31,
 
 
2018
 
2017
 
 
(Dollars in thousands)
Non-accrual loans(1)
 
$
21,822

 
$
465

Accruing loans 90 or more days past due(2)
 
4,302

 
18

Total nonperforming loans
 
26,124

 
483

Other real estate owned:
 
 
 
 
Commercial real estate, construction, land and land development
 

 
449

Total other real estate owned
 

 
449

Total nonperforming assets
 
$
26,124

 
$
932

Restructured loans—non-accrual
 
257

 
15

Restructured loans—accruing
 
950

 
603

Ratio of nonperforming loans to total loans
 
1.07
%
 
0.02
%
Ratio of nonperforming assets to total assets
 
0.80
%
 
0.03
%
(1) Includes $17.2 million of PCI loans that were placed on non-accrual status during the three-months ended September 30, 2018.
(2) Loans 90 days past due and still accruing excludes $267 of PCI loans as of September 30, 2018.

The following table presents information regarding non-accrual loans by category as of the dates indicated:
 
 
As of September 30,
 
As of December 31,
 
 
2018
 
2017
 
 
(Dollars in thousands)
Real estate:
 
 
 
 
Construction and land
 
$
2,107

 
$

Farmland
 

 

1 - 4 family residential
 

 

Multi-family residential
 

 

Commercial real estate
 

 
61

Commercial
 
19,712

 
398

Consumer
 
3

 
6

Total
 
$
21,822

 
$
465

 

53



Potential Problem Loans

The following tables summarize our internal ratings of our loans as of the dates indicated.
 
 
September 30, 2018
 
 
Pass
 
Special
Mention
 
Substandard
 
Doubtful
 
PCI
 
Total
Real estate:
 

 

 

 

 

 

Construction and land
 
$
289,816

 
$
2,220

 
$
2,107

 
$

 
$

 
$
294,143

Farmland
 
10,816

 

 

 

 
37

 
10,853

1 - 4 family residential
 
289,101

 
305

 
314

 

 
88

 
289,808

Multi-family residential
 
50,317

 

 

 

 

 
50,317

Commercial real estate
 
1,035,028

 
5,081

 
12,025

 

 
16,954

 
1,069,088

Commercial
 
685,727

 
7,022

 
7,618

 

 
22,773

 
723,140

Consumer
 
6,984

 

 
182

 

 

 
7,166

Total
 
$
2,367,789

 
$
14,628

 
$
22,246

 
$

 
$
39,852

 
$
2,444,515

 
 
December 31, 2017
 
 
Pass
 
Special
Mention
 
Substandard
 
Doubtful
 
PCI
 
Total
Real estate:
 
 
 
 
 
 
 
 
 
 
 
 
Construction and land
 
$
277,186

 
$
639

 
$

 
$

 
$

 
$
277,825

Farmland
 
9,336

 

 

 

 
49

 
9,385

1 - 4 family residential
 
235,781

 
462

 
200

 

 
99

 
236,542

Multi-family residential
 
106,275

 

 

 

 

 
106,275

Commercial real estate
 
882,523

 
8,771

 
681

 

 
17,317

 
909,292

Commercial
 
634,796

 
18,337

 
1,155

 
116

 
30,147

 
684,551

Consumer
 
9,540

 

 
108

 

 

 
9,648

Total
 
$
2,155,437

 
$
28,209

 
$
2,144

 
$
116

 
$
47,612

 
$
2,233,518

 
Allowance for loan losses
As of September 30, 2018, the allowance for loan losses totaled $17.9 million, or 0.73%, of total loans. As of December 31, 2017, the allowance for loan losses totaled $12.8 million, or 0.57%, of total loans. The allowance for loan losses as a percentage of total loans was determined by the qualitative factors around the nature, volume and mix of the loan portfolio. The increase in the allowance for loan loss as a percentage of loans from December 31, 2017 was attributable to continued execution and success of our organic growth strategy and an increase in specific reserves on certain non-performing loans. Ending balances for the purchase discount related to impaired and non-impaired acquired loans were $10.9 million and $12.1 million, as of September 30, 2018 and December 31, 2017, respectively. PCI loans were $39.9 million and $47.6 million as of September 30, 2018 and December 31, 2017, respectively.

54



The following table presents, as of and for the periods indicated, an analysis of the allowance for loan losses and other related data:
 
 
Nine Months Ended
 
 Nine Months Ended
 
 
September 30, 2018
 
September 30, 2017
 
 
(Dollars in thousands)
Average loans outstanding(1)
 
$
2,341,562

 
$
1,240,461

Gross loans outstanding at end of period(1)
 
$
2,444,086

 
$
1,907,509

Allowance for loan losses at beginning of period
 
$
12,808

 
$
8,524

Provision for loan losses
 
5,239

 
2,585

Charge-offs:
 
 
 
 
Residential
 

 
(11
)
Commercial
 
(150
)
 
(611
)
Consumer
 
(21
)
 

Total charge-offs
 
(171
)
 
(622
)
Recoveries:
 
 
 
 
Commercial
 
33

 
5

Total recoveries
 
33

 
5

Net charge-offs
 
(138
)
 
(617
)
Allowance for loan losses at end of period
 
$
17,909

 
$
10,492

Ratio of allowance to end of period loans
 
0.73
%
 
0.55
%
Ratio of net charge-offs to average loans
 
0.01
%
 
0.05
%
(1) 
Excludes loans held for sale and deferred loan fees.

We believe the successful execution of our growth strategy through key acquisitions and organic growth is demonstrated by the upward trend in loan balances from December 31, 2017 to September 30, 2018. Loan balances increased from $2.2 billion as of December 31, 2017 to $2.4 billion as of September 30, 2018. Our allowance has increased consistently with the growth in our loan portfolio during the same period. In addition, our allowance for the nine months ended September 30, 2018 was impacted by a recorded provision on PCI loans of $1.3 million. Further, net charge-offs have been immaterial, representing less than 0.10% of average loan balances for the nine months ended September 30, 2018 and 2017.
 
Although we believe that we have established our allowance for loan losses in accordance with accounting principles generally accepted in the United States (“GAAP”) and that the allowance for loan losses was adequate to provide for known and inherent losses in the portfolio at all times shown above, future provisions will be subject to ongoing evaluations of the risks in our loan portfolio. If we experience economic declines or if asset quality deteriorates, material additional provisions could be required.

55



The following table shows the allowance for loan losses among our loan categories and certain other information as of the dates indicated. The allocation of the allowance for loan losses as shown in the table should neither be interpreted as an indication of future charge-offs, nor as an indication that charge-offs in future periods will necessarily occur in these amounts or in the indicated proportions. The total allowance is available to absorb losses from any loan category.
 
 
 
As of
 
As of
 
 
September 30, 2018
 
December 31, 2017
 
 
 
 
Percent
 
 
 
Percent
 
 
Amount
 
of Total
 
Amount
 
of Total
 
 
(Dollars in thousands)
Real estate:
 
    
 
    
 
    
 
    
Construction and land
 
$
1,807

 
10.0
%
 
$
1,269

 
9.9
%
Farmland
 
60

 
0.3

 
46

 
0.4

1 - 4 family residential
 
1,445

 
8.1

 
1,192

 
9.3

Multi-family residential
 
352

 
2.0

 
281

 
2.2

Commercial real estate
 
6,136

 
34.3

 
4,410

 
34.4

Total real estate
 
$
9,800

 
54.7
%
 
$
7,198

 
56.2
%
Commercial
 
8,104

 
45.3

 
5,588

 
43.6

Consumer
 
5

 

 
22

 
0.2

Total allowance for loan losses
 
$
17,909

 
100.0
%
 
$
12,808

 
100.0
%
 
Securities
We use our securities portfolio to provide a source of liquidity, provide an appropriate return on funds invested, manage interest rate risk, meet collateral requirements and meet regulatory capital requirements. As of September 30, 2018, the carrying amount of investment securities totaled $256.2 million, an increase of $28.1 million, or 12.3%, compared to $228.1 million as of December 31, 2017, which is primarily due to security purchases of $90.0 million in the nine months ended September 30, 2018. This increase is partially offset by sales, paydowns and maturities of $55.5 million the nine months ended September 30, 2018. Securities represented 7.8% and 7.7% of total assets as of September 30, 2018 and December 31, 2017, respectively.
All of our mortgage-backed securities and collateralized mortgage obligations are issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored entities. We do not hold any Fannie Mae or Freddie Mac preferred stock, corporate equity, collateralized debt obligations, collateralized loan obligations, structured investment vehicles, private label collateralized mortgage obligations, subprime, Alt–A, or second lien elements in our investment portfolio. As of September 30, 2018, our investment portfolio did not contain any securities that are directly backed by subprime or Alt-A mortgages.
 
Certain investment securities have a fair value at less than their historical cost. Management evaluates securities for other-than-temporary impairment (“OTTI”) on at least a quarterly basis and more frequently when economic of market conditions warrant such an evaluation. Management does not (i) have the intent to sell any investment securities prior to recovery and/or maturity, (ii) believe it is more likely than not that the Company will not have to sell these securities prior to recovery and/or maturity and (iii) believe that the length of time and extent that fair value has been less than cost is not indicative of recoverability. For those securities in an unrealized loss position, the unrealized losses are largely due to interest rate changes. Management believes any unrealized loss in the Company’s securities at September 30, 2018 is temporary and no credit impairment has been realized in the Company’s condensed consolidated financial statements.
As of September 30, 2018 and December 31, 2017, we did not own securities of any one issuer other than U.S. government agency securities for which aggregate cost exceeded 10.0% of the condensed consolidated stockholders’ equity as of such respective dates.
Deposits
Total deposits as of September 30, 2018 were $2.7 billion, an increase of $377.6 million, or 16.6%, compared to $2.3 billion as of December 31, 2017. The increase from December 31, 2017 was primarily the result of a $87.4 million and $50.4 million increase in financial money market accounts and non-interest bearing demand deposits, respectively.

56



Borrowings
We utilize short-term and long-term borrowings to supplement deposits to fund our lending and investment activities, each of which is discussed below.
Federal Home Loan Bank Advances. The FHLB allows us to borrow on a blanket floating lien status collateralized by certain securities and loans. As of September 30, 2018 and December 31, 2017, total borrowing capacity of $957.7 million and $721.6 million, respectively, was available under this arrangement and $73.1 million and $71.2 million, respectively, was outstanding with a weighted average interest rate of 2.08% for the three months ended September 30, 2018 and 1.04% for the year ended December 31, 2017. Our current FHLB advances mature within five years. Other than FHLB borrowings, we had no other short-term borrowings at the dates indicated.
Federal Funds Purchased. Federal funds purchased are unsecured overnight borrowings from other financial institutions. At December 31, 2017, the Company has $15.0 million in federal funds purchased carried at a rate of 2.00% which matured and was paid off on January 1, 2018. At September 30, 2018, the Company had no federal funds purchased outstanding.

Branch assets and liabilities held for sale

As of December 31, 2017, branch assets and liabilities held for sale were $33,552 and $64,627, respectively. During the nine months ended September 30, 2018, these branch asset and liabilities were all sold. As of September 30, 2018, no branch assets or liabilities were held for sale on the Company’s balance sheet. For further information, see Note 14 – “Branch Assets and Liabilities Held for Sale” in the accompanying Notes to Condensed Consolidated Financial Statements.

Liquidity and Capital Resources
Liquidity
Liquidity involves our ability to raise funds to support asset growth and acquisitions or reduce assets to meet deposit withdrawals and other payment obligations, to maintain reserve requirements and otherwise to operate on an ongoing basis and manage unexpected events. For the nine months ended September 30, 2018 and the year ended December 31, 2017, our liquidity needs were primarily met by core deposits, wholesale borrowings, proceeds from the sale of common stock in an underwritten public offering during 2017, security and loan maturities and amortizing investment and loan portfolios. Use of brokered deposits, purchased funds from correspondent banks and overnight advances from the FHLB and the Federal Reserve Bank are available and have been utilized to take advantage of the cost of these funding sources. We maintained two lines of credit with commercial banks that provide for extensions of credit with an availability to borrow up to an aggregate $75.0 million and $55.0 million as of September 30, 2018 and December 31, 2017, respectively. There were no advances under these lines of credit outstanding as of September 30, 2018 and December 31, 2017.

57



The following table illustrates, during the periods presented, the mix of our funding sources and the average assets in which those funds are invested as a percentage of our average total assets for the period indicated. Average assets totaled $3.1 billion for the nine months ended September 30, 2018 and $2.0 billion for the year ended December 31, 2017.
 
 
For the
 
For the
 
 
Nine Months Ended
 
Year Ended
 
 
September 30, 2018
 
December 31, 2017
Sources of Funds:
 
 
 
 
Deposits:
 
 
 
 
Noninterest-bearing
 
19.8
%
 
21.5
%
Interest-bearing
 
59.7

 
58.0

Advances from FHLB
 
3.2

 
2.6

Other borrowings
 
0.5

 
0.7

Other liabilities
 
0.5

 
0.3

Stockholders’ equity
 
16.3

 
16.9

Total
 
100.0
%
 
100.0
%
Uses of Funds:
 
 
 
 
Loans
 
75.2
%
 
72.3
%
Securities available for sale
 
7.8

 
8.6

Interest-bearing deposits in other banks
 
5.4

 
10.2

Other noninterest-earning assets
 
11.6

 
8.9

Total
 
100.0
%
 
100.0
%
Average noninterest-bearing deposits to average deposits
 
24.9
%
 
27.0
%
Average loans to average deposits
 
94.5
%
 
90.8
%
Our primary source of funds is deposits, and our primary use of funds is loans. We do not expect a change in the primary source or use of our funds in the foreseeable future. Our average loans net of allowance for loan loss increased 62.5% for the nine months ended September 30, 2018 compared to the year ended December 31, 2017. We invest excess deposits in interest-bearing deposits at other banks, the Federal Reserve, or liquid investments securities until these monies are needed to fund loan growth.
As of September 30, 2018, we had outstanding $860.9 million in commitments to extend credit and $7.4 million in commitments associated with outstanding standby and commercial letters of credit. As of December 31, 2017, we had outstanding $606.5 million in commitments to extend credit and $9.3 million in commitments associated with outstanding standby and commercial letters of credit. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the total outstanding may not necessarily reflect the actual future cash funding requirements.
As of September 30, 2018, we had cash and cash equivalents of $261.8 million compared to $149.0 million as of December 31, 2017.
Analysis of Cash Flows
 
 
For the
 
For the
 
 
Nine Months Ended
 
Nine Months Ended
 
 
September 30, 2018
 
September 30, 2017
Net cash provided by operating activities
 
$
38,841

 
$
16,340

Net cash used in investing activities
 
(290,439
)
 
(107,802
)
Net cash provided by financing activities
 
364,344

 
8,047

Net change in cash and cash equivalents
 
$
112,746

 
$
(83,415
)
Cash Flows Provided by Operating Activities
For the nine months ended September 30, 2018, net cash provided by operating activities increased by $22.5 million when compared to the same period in 2017. The increase in cash from operating activities was primarily related to a $17.6 million

58



in net income and a decrease in net originations of loans held for sale of $2.6 million partially offset by a decrease of $6.4 million in proceeds from the sale of loans held for sale.
Cash Flows Used in Investing Activities
For the nine months ended September 30, 2018, net cash used in investing activities increased by $182.6 million when compared to the same period in 2017. The increase in cash used in investing activities was primarily attributable to an $87.2 million decrease in sales of securities available for sale as a result of the Company selling acquired Sovereign securities that did not fit our investment strategy in the third quarter of 2017, with no corresponding sale in the nine months ended September 30, 2018. In addition, the increase was due to an increase of $29.8 million in net loans originated, an increase of $19.4 million cash paid to purchase available for sale securities and $31.8 million of cash used to settle the sale of two branches during the nine months ended September 30, 2018.
Cash Flows Provided in Financing Activities
For the nine months ended September 30, 2018, net cash provided by financing activities increased by $356.3 million when compared to the same period in 2017. The increase in cash provided by financing activities was primarily attributable to a $321.3 million increase in funding from deposits.
As of the nine months ended September 30, 2018 and 2017, we had no exposure to future cash requirements associated with known uncertainties or capital expenditures of a material nature.
Capital Resources
Total stockholders’ equity increased to $517.2 million as of September 30, 2018, compared to $488.9 million as of December 31, 2017, an increase of $28.3 million, or 5.8%. The increase from December 31, 2017 was primarily the result of $29.5 million in net income during the three months ended September 30, 2018 and was partially offset by other comprehensive loss of $3.8 million.
Capital management consists of providing equity to support our current and future operations. The bank regulators view capital levels as important indicators of an institution’s financial soundness. As a general matter, FDIC-insured depository institutions and their holding companies are required to maintain minimum capital relative to the amount and types of assets they hold. We are subject to regulatory capital requirements at the bank holding company and bank levels. See Note 11 “Capital Requirements and Restrictions on Retained Earnings” to our condensed consolidated financial statements in this Report for additional discussion regarding the regulatory capital requirements applicable to us and the Bank. As of September 30, 2018 and December 31, 2017, the Company and the Bank were in compliance with all applicable regulatory capital requirements, and the Bank was classified as “well capitalized,” for purposes of the prompt corrective action regulations. As we employ our capital and continue to grow our operations, our regulatory capital levels may decrease depending on our level of earnings. However, we expect to monitor and control our growth in order to remain in compliance with all regulatory capital standards applicable to us.
The following table presents the actual capital amounts and regulatory capital ratios for us and the Bank as of the dates indicated.

59



 
 
As of September 30,
 
As of December 31,
 
 
2018
 
2017
 
 
Amount
 
Ratio
 
Amount
 
Ratio
 
 
(Dollars in thousands)
Company
 
 
 
 
 
 
 
 
Total capital (to risk-weighted assets)
 
$
381,915

 
13.22
%
 
$
342,521

 
13.16
%
Tier 1 capital (to risk-weighted assets)
 
359,054

 
12.43

 
324,726

 
12.48

Common equity tier 1 (to risk-weighted assets)
 
347,353

 
12.02

 
313,024

 
12.03

Tier 1 capital (to average assets)
 
359,054

 
11.74

 
324,726

 
12.92

Bank
 
 
 
 
 
 
 
 
Total capital (to risk-weighted assets)
 
$
340,023

 
11.75
%
 
$
296,207

 
11.37
%
Tier 1 capital (to risk-weighted assets)
 
322,113

 
11.13

 
283,399

 
10.88

Common equity tier 1 (to risk-weighted assets)
 
322,113

 
11.13

 
283,399

 
10.88

Tier 1 capital (to average assets)
 
322,113

 
10.53

 
283,399

 
11.28

Contractual Obligations
In the ordinary course of the Company’s operations, the Company enters into certain contractual obligations, such as future cash payments associated with our contractual obligations pursuant to its FHLB advance, non-cancelable future operating leases and qualified affordable housing investment and other borrowed funds. The Company believes that it will be able to meet its contractual obligations as they come due through the maintenance of adequate cash levels. The Company expects to maintain adequate cash levels through profitability, loan and securities repayment and maturity activity and continued deposit gathering activities. The Company has in place various borrowing mechanisms for both short-term and long-term liquidity needs.
Other than normal changes in the ordinary course of business and changes discussed within “Financial ConditionBorrowings,” there have been no significant changes in the types of contractual obligations or amounts due since December 31, 2017.
Off-Balance Sheet Items
In the normal course of business, the Company enters into various transactions, which, in accordance with GAAP, are not included in its condensed consolidated balance sheets. However, the Company has only limited off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on the Company’s financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources. The Company enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and issue standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the condensed consolidated balance sheets.
The Company’s commitments to extend credit and outstanding standby letters of credit were $860.9 million and $7.4 million, respectively, as of September 30, 2018. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements. The Company manages the Company’s liquidity in light of the aggregate amounts of commitments to extend credit and outstanding standby letters of credit in effect from time to time to ensure that the Company will have adequate sources of liquidity to fund such commitments and honor drafts under such letters of credit.
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. Substantially all of the Company’s commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding. The Company minimizes its exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures.

60



Standby Letters of Credit
Standby letters of credit are written conditional commitments that the Company issues to guarantee the performance of a customer to a third party. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. The maximum potential amount of future payments the Company could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, the customer is obligated to reimburse the Company for the amount paid under this standby letter of credit.
Impact of Inflation
Our condensed consolidated financial statements and related notes included elsewhere herein have been prepared in accordance with GAAP. These require the measurement of financial position and operating results in terms of historical dollars, without considering changes in the relative value of money over time due to inflation or recession.
Unlike many industrial companies, substantially all of our assets and liabilities are monetary in nature. As a result, interest rates have a more significant impact on our performance than the effects of general levels of inflation. Interest rates may not necessarily move in the same direction or in the same magnitude as the prices of goods and services. However, other operating expenses do reflect general levels of inflation.
Critical Accounting Policies
Our accounting policies are fundamental to understanding our management’s discussion and analysis of our results of operations and financial condition. We have identified certain significant accounting policies which involve a higher degree of judgment and complexity in making certain estimates and assumptions that affect amounts reported in our consolidated financial statements. The significant accounting policies which we believe to be the most critical in preparing our consolidated financial statements relate to loans and allowance for loan losses, business combinations, investment securities, and loans held for sale. Since December 31, 2017, there have been no changes in critical accounting policies as further described under “Critical Accounting Policies” and in Note 1 to the Consolidated Financial Statements in our 2017 Form 10-K.
Special Cautionary Notice Regarding Forward-Looking Statements
This document includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. Forward-looking statements are based on various facts and derived utilizing numerous important assumptions and are subject to known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Forward-looking statements include the information concerning our future financial performance, business and growth strategy, projected plans and objectives, as well as projections of macroeconomic and industry trends, which are inherently unreliable due to the multiple factors that impact economic trends, and any such variations may be material. Statements preceded by, followed by or that otherwise include the words “believes,” “expects,” “anticipates,” “intends,” “projects,” “estimates,” “plans” and similar expressions or future or conditional verbs such as “will,” “should,” “would,” “may” and “could” are generally forward-looking in nature and not historical facts, although not all forward-looking statements include the foregoing. You should understand that the following important factors could affect our future results and cause actual results to differ materially from those expressed in the forward-looking statements:
risks related to the concentration of our business in Texas, and specifically within the Dallas-Fort Worth metroplex and the Houston metropolitan area, including risks associated with any downturn in the real estate sector and risks associated with a decline in the values of single family homes in the Dallas-Fort Worth metroplex and the Houston metropolitan area;
uncertain market conditions and economic trends nationally, regionally and particularly in the Dallas-Fort Worth metroplex and Texas;
changes in market interest rates that affect the pricing of our loans and deposits and our net interest income;
risks related to our strategic focus on lending to small to medium-sized businesses;
the sufficiency of the assumptions and estimates we make in establishing reserves for potential loan losses;
our ability to implement our growth strategy, including identifying and consummating suitable acquisitions;
risks related to the integration of any acquired businesses, including exposure to potential asset quality and credit quality risks and unknown or contingent liabilities, the time and costs associated with integrating systems, technology platforms, procedures and personnel, the need for additional capital to finance such transactions, and possible failures in realizing the anticipated benefits from acquisitions;

61



our ability to recruit and retain successful bankers that meet our expectations in terms of customer relationships and profitability;
our ability to retain executive officers and key employees and their customer and community relationships;
risks associated with our limited operating history and the relatively unseasoned nature of a significant portion of our loan portfolio;
risks associated with our commercial real estate and construction loan portfolios, including the risks inherent in the valuation of the collateral securing such loans;
risks associated with our commercial loan portfolio, including the risk for deterioration in value of the general business assets that generally secure such loans;
potential changes in the prices, values and sales volumes of commercial and residential real estate securing our real estate loans;
risks related to the significant amount of credit that we have extended to a limited number of borrowers and in a limited geographic area;
our ability to maintain adequate liquidity and to raise necessary capital to fund our acquisition strategy and operations or to meet increased minimum regulatory capital levels;
potential fluctuations in the market value and liquidity of our investment securities;
the effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;
our ability to maintain an effective system of disclosure controls and procedures and internal controls over financial reporting;
risks associated with fraudulent and negligent acts by our customers, employees or vendors;
our ability to keep pace with technological change or difficulties when implementing new technologies;
risks associated with difficulties and/or terminations with third-party service providers and the services they provide;
risks associated with system failures or failures to prevent breaches of our network security;
our ability to successfully execute the acquisition of Green;
our actual cost savings resulting from the acquisition of Green are less than expected, we are unable to realize those cost savings as soon as expected or we incur additional or unexpected costs;
our revenues after the Green acquisition are less than expected;
potential impairment on the goodwill we have recorded or may record in connection with business acquisitions;
our ability to comply with various governmental and regulatory requirements applicable to financial institutions;
the impact of recent and future legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators, such as the Dodd-Frank Act;
governmental monetary and fiscal policies, including the policies of the Federal Reserve;
our ability to comply with supervisory actions by federal and state banking agencies;
changes in the scope and cost of FDIC, insurance and other coverage; and
systemic risks associated with the soundness of other financial institutions

Other factors not identified above, including those described under the headings “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” in our Annual Report on Form 10-K for the year ended December 31, 2017, as well as the information contained in this Quarterly Report on Form 10-Q may also cause actual results to differ materially from those described in our forward-looking statements. Most of these factors are difficult to anticipate and are generally beyond our control. You should consider these factors in connection with considering any forward-looking statements that may be made by us. We undertake no obligation to release publicly any revisions to any forward-looking statements, to report events or to report the occurrence of unanticipated events unless we are required to do so by law.
Item 3.  Quantitative and Qualitative Disclosures About Market Risk

The Company manages market risk, which, as a financial institution is primarily interest rate volatility, through the Asset-Liability Committee of the Bank, in accordance with policies approved by its board of directors. The Company uses an interest rate risk simulation model and shock analysis to test the interest rate sensitivity of net interest income and fair value of equity, and the impact of changes in interest rates on other financial metrics.

As a financial institution, our primary component of market risk is interest rate volatility. Our asset, liability and funds management policy provides management with the guidelines for effective funds management, and we have established a measurement system for monitoring our net interest rate sensitivity position. We manage our sensitivity position within our established guidelines.

62



Fluctuations in interest rates will ultimately impact both the level of income and expense recorded on most of our assets and liabilities, and the market value of all interest-earning assets and interest-bearing liabilities, other than those which have a short term to maturity. Interest rate risk is the potential of economic losses due to future interest rate changes. These economic losses can be reflected as a loss of future net interest income and/or a loss of current fair market values. The objective is to measure the effect on net interest income and to adjust the balance sheet to minimize the inherent risk while at the same time maximizing income.
We manage our exposure to interest rates by structuring our balance sheet in the ordinary course of business. We do not enter into instruments such as leveraged derivatives, interest rate swaps, financial options, financial future contracts or forward delivery contracts for the purpose of reducing interest rate risk. Based upon the nature of our operations, we are not subject to foreign exchange or commodity price risk. We do not own any trading assets.
Our exposure to interest rate risk is managed by the Asset-Liability Committee of the Bank, in accordance with policies approved by its board of directors. The committee formulates strategies based on appropriate levels of interest rate risk. In determining the appropriate level of interest rate risk, the committee considers the impact on earnings and capital of the current outlook on interest rates, potential changes in interest rates, regional economies, liquidity, business strategies and other factors. The committee meets regularly to review, among other things, the sensitivity of assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, purchase and sale activities, commitments to originate loans and the maturities of investments and borrowings. Additionally, the committee reviews liquidity, cash flow flexibility, maturities of deposits and consumer and commercial deposit activity. Management employs methodologies to manage interest rate risk which include an analysis of relationships between interest-earning assets and interest-bearing liabilities, and an interest rate shock simulation model.
We use interest rate risk simulation models and shock analysis to test the interest rate sensitivity of net interest income and fair value of equity, and the impact of changes in interest rates on other financial metrics. Contractual maturities and re-pricing opportunities of loans are incorporated in the model as are prepayment assumptions, maturity data and call options within the investment portfolio. Average life of our non-maturity deposit accounts are based on standard regulatory decay assumptions and are incorporated into the model. The assumptions used are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various management strategies.
On a quarterly basis, we run two simulation models including a static balance sheet and dynamic growth balance sheet. These models test the impact on net interest income and fair value of equity from changes in market interest rates under various scenarios. Under the static and dynamic growth models, rates are shocked instantaneously and ramped rate changes over a 12-month horizon based upon parallel and non-parallel yield curve shifts. Parallel shock scenarios assume instantaneous parallel movements in the yield curve compared to a flat yield curve scenario. Non-parallel simulation involves analysis of interest income and expense under various changes in the shape of the yield curve. Internal policy regarding internal rate risk simulations currently specifies that for instantaneous parallel shifts of the yield curve, estimated net interest income at risk for the subsequent one-year period should not decline by more than 12.5% for a 100 basis point shift, 15.0% for a 200 basis point shift, and 20.0% for a 300 basis point shift.
The following table summarizes the simulated change in net interest income and fair value of equity over a 12-month horizon as of the dates indicated:
 
 
As of September 30, 2018
 
As of December 31, 2017
 
 
Percent Change
 
Percent Change
 
Percent Change
 
Percent Change
Change in Interest
 
in Net Interest
 
in Fair Value
 
in Net Interest
 
in Fair Value
Rates (Basis Points)
 
Income
 
of Equity
 
Income
 
of Equity
+ 300
 
9.97
 %
 
(3.51
)%
 
9.45
 %
 
3.61
 %
+ 200
 
7.01
 %
 
(0.80
)%
 
7.07
 %
 
4.82
 %
+ 100
 
3.82
 %
 
0.51
 %
 
4.13
 %
 
4.10
 %
Base
 
0.49
 %
 
 %
 
 %
 
 %
−100
 
(4.14
)%
 
(4.16
)%
 
(3.77
)%
 
(5.69
)%
The results are primarily due to behavior of demand, money market and savings deposits during such rate fluctuations. We have found that, historically, interest rates on these deposits change more slowly than changes in the discount and federal funds

63



rates. This assumption is incorporated into the simulation model and is generally not fully reflected in a gap analysis. The assumptions incorporated into the model are inherently uncertain and, as a result, the model cannot precisely measure future net interest income or precisely predict the impact of fluctuations in market interest rates on net interest income. Actual results will differ from the model’s simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and the application and timing of various strategies.
Item 4.  Controls and Procedures

Evaluation of disclosure controls and procedures — As of the end of the period covered by this Report, the Company carried out an evaluation, under the supervision and with the participation of its management, including its Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of its disclosure controls and procedures. In designing and evaluating the disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management was required to apply judgment in evaluating its controls and procedures. Based on this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer concluded that the Company’s disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)) were effective as of the end of the period covered by this Report.

Changes in internal control over financial reporting — There were no changes in the Company’s internal control over financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) during the quarter ended September 30, 2018 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

64



PART II. OTHER INFORMATION

Item 1. Legal Proceedings

We are from time to time subject to claims and litigation arising in the ordinary course of business. These claims and litigation may include, among other things, allegations of violation of banking and other applicable regulations, competition law, labor laws and consumer protection laws, as well as claims or litigation relating to intellectual property, securities, breach of contract and tort. We intend to defend ourselves vigorously against any pending or future claims and litigation.

At this time, in the opinion of management, the likelihood is remote that the impact of such proceedings, either individually or in the aggregate, would have a material adverse effect on our combined results of operations, financial condition or cash flows. However, one or more unfavorable outcomes in any claim or litigation against us could have a material adverse effect for the period in which they are resolved. In addition, regardless of their merits or their ultimate outcomes, such matters are costly, divert management’s attention and may materially adversely affect our reputation, even if resolved in our favor.

Item 1A. Risk Factors

In evaluating an investment in our common stock, investors should consider carefully, among other things, the risk factors previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2017, as well as the information contained in this Quarterly Report on Form 10-Q and our other reports and registration statements filed with the SEC.
There has been no material change in the risk factors previously disclosed in our Annual Report on Form 10-K for the year ended December 31, 2017.
Item 2.  Unregistered Sales of Equity Securities and Use of Proceeds

None.

Item 3.  Defaults Upon Senior Securities

None.

Item 4.  Mine Safety Disclosures

Not Applicable.

Item 5.  Other Information

None.


65



Item 6.  Exhibits
 
Exhibit
Number
    
Description of Exhibit
 

 
 
 
 
 
 
 
 
 
101*
 
The following materials from Veritex Holdings’ Quarterly Report on Form 10-Q for the quarter ended September 30, 2018, formatted in XBRL (Extensible Business Reporting Language), furnished herewith: (i) Condensed Consolidated Balance Sheets, (ii) Condensed Consolidated Statements of Operations, (iii) Condensed Consolidated Statements of Comprehensive Income (Loss), (iv) Condensed Consolidated Statements of Changes in Shareholders’ Equity, (v) Condensed Consolidated Statements of Cash Flows, and (vi) Notes to Condensed Consolidated Financial Statements.
______________________________
* Filed with this Quarterly Report on Form 10-Q
** Furnished with this Quarterly Report on Form 10-Q


66



SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
 
 
 
 
 
VERITEX HOLDINGS, INC.
 
 
(Registrant)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Date: October 25, 2018
 
/s/ C. Malcolm Holland, III
 
 
C. Malcolm Holland, III
 
 
Chairman and Chief Executive Officer
 
 
(Principal Executive Officer)
 
 
 
 
 
 
 
 
 
 
 
 
Date: October 25, 2018
 
/s/ Noreen E. Skelly
 
 
Noreen E. Skelly
 
 
Chief Financial Officer
 
 
(Principal Financial and Accounting Officer)
 
 
 
 
 
 
 
 
 

67