INDEPENDENT BANK GROUP, INC. This discussion and analysis of the Company's financial condition and results of operations should be read in conjunction with the Company's consolidated financial statements and the accompanying notes included elsewhere in this Annual Report on Form 10-K. Certain risks, uncertainties and other factors, including those set forth under "Risk Factors" in Part I, Item 1A, and elsewhere in this Annual Report on Form 10-K, may cause actual results to differ materially from those projected results discussed in the forward-looking statements appearing in this discussion and analysis. Cautionary Note Regarding Forward Looking Statements This Annual Report on Form 10-K, our other filings with theSEC , and other press releases, documents, reports and announcements that we make, issue or publish may contain statements that we believe are "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 (the "Act") that are subject to risks and uncertainties and are made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and other related federal security laws. These forward-looking statements are statements or projections with respect to matters such as our future results of operations, including our future revenues, income, expenses, provision for taxes, effective tax rate, earnings per share and cash flows, our future capital expenditures and dividends, our future financial condition and changes therein, including changes in our loan portfolio and allowance for loan losses, our future capital structure or changes therein, the plan and objectives of management for future operations, our future or proposed acquisitions and the integration thereof, the future or expected effect of acquisitions on our operations, results of operations and financial condition, our future economic performance and the statements of the assumptions underlying any such statement. Such statements are typically identified by the use in the statements of words or phrases such as "aim," "anticipate," "estimate," "expect," "goal," "guidance," "intend," "is anticipated," "is estimated," "is expected," "is intended," "objective," "plan," "projected," "projection," "will affect," "will be," "will continue," "will decrease," "will grow," "will impact," "will increase," "will incur," "will reduce," "will remain," "will result," "would be," variations of such words or phrases (including where the word "could," "may" or "would" is used rather than the word "will" in a phrase) and similar words and phrases indicating that the statement addresses some future result, occurrence, plan or objective. The forward-looking statements that we make are based on the Company's current expectations and assumptions regarding its business, the economy, and other future conditions. Because forward-looking statements relate to future results and occurrences, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. The Company's actual results may differ materially from those contemplated by the forward-looking statements, which are neither statements of historical fact nor guarantees or assurances of future performance. Many possible events or factors could affect the future financial results and performance of the Company and could cause such results or performance to differ materially from those expressed in forward-looking statements. These factors include, but are not limited to, the following: • our ability to sustain our current internal growth rate and total growth rate; • changes in geopolitical, business and economic events, occurrences and conditions, including changes in rates of inflation or deflation,
nationally, regionally and in our target markets, particularly in
and
• worsening business and economic conditions nationally, regionally and in
our target markets, particularly in
areas in those states in which we operate;
• our dependence on our management team and our ability to attract, motivate
and retain qualified personnel;
• the concentration of our business within our geographic areas of operation
in Texas and Colorado ;
• changes in asset quality, including increases in default rates on loans
and higher levels of nonperforming loans and loan charge-offs;
• concentration of the loan portfolio of
the completion of acquisitions of financial institutions, in commercial
and residential real estate loans and changes in the prices, values and
sales volumes of commercial and residential real estate;
• the ability of
margins and levels of risk of repayment and to otherwise invest in assets
at acceptable yields and presenting acceptable investment risks;
• inaccuracy of the assumptions and estimates that the managements of our
Company and the financial institutions that we acquire make in
establishing reserves for probable loan losses and other estimates;
• lack of liquidity, including as a result of a reduction in the amount of
sources of liquidity we currently have;
• material increases or decreases in the amount of deposits held by
Independent Bank or other financial institutions that we acquire and the
cost of those deposits;
• our access to the debt and equity markets and the overall cost of funding
our operations;
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• regulatory requirements to maintain minimum capital levels or maintenance
of capital at levels sufficient to support our anticipated growth;
• changes in market interest rates that affect the pricing of the loans and
deposits of each of
we acquire and that affect the net interest income, other future cash
flows, or the market value of the assets of each of
the financial institutions that we acquire, including investment
securities;
• fluctuations in the market value and liquidity of the securities we hold
for sale, including as a result of changes in market interest rates;
• effects of competition from a wide variety of local, regional, national
and other providers of financial, investment and insurance services;
• changes in economic and market conditions that affect the amount and value
of the assets of Independent Bank and of financial institutions that we
acquire;
• the institution and outcome of, and costs associated with, litigation and
other legal proceedings against one of more of the Company, Independent
Bank and financial institutions that we acquire or to which any of such
entities is subject;
• the occurrence of market conditions adversely affecting the financial
industry generally;
• the impact of recent and future legislative regulatory changes, including
changes in banking, securities, and tax laws and regulations and their
application by the Company's regulators, and changes in federal government
policies, as well as regulatory requirements applicable to, and resulting
from regulatory supervision of, the Company and Independent Bank as a
financial institution with total assets greater than $10 billion ;
• changes in accounting policies, practices, principles and guidelines, as
may be adopted by the bank regulatory agencies, the Financial Accounting
Standards Board , theSEC and thePublic Company Accounting Oversight Board , as the case may be;
• governmental monetary and fiscal policies, including changes resulting
from the implementation of the new Current Expected Credit Loss accounting
standard;
• changes in the scope and cost of
• the effects of war or other conflicts, acts of terrorism (including cyber
attacks) or other catastrophic events, including natural disasters such as
storms, droughts, tornadoes, hurricanes and flooding, that may affect
general economic conditions;
• our actual cost savings resulting from previous or future acquisitions 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 previous or future acquisitions are less than expected;
• the liquidity of, and changes in the amounts and sources of liquidity
available to, us, before and after the acquisition of any financial
institutions that we acquire;
• deposit attrition, operating costs, customer loss and business disruption
before and after our completed acquisitions, including, without
limitation, difficulties in maintaining relationships with employees, may
be greater than we expected;
• the effects of the combination of the operations of financial institutions
that we have acquired in the recent past or may acquire in the future with
our operations and the operations of
integration of such operations being unsuccessful, and the effects of such
integration being more difficult, time-consuming or costly than expected
or not yielding the cost savings that we expect, including but not limited
to those identified below for the merger between the Company and TCBI;
• the impact of investments that the Company or Independent Bank may have
made or may make and the changes in the value of those investments;
• the quality of the assets of financial institutions and companies that we
have acquired in the recent past or may acquire in the future being
different than we determined or determine in our due diligence
investigation in connection with the acquisition of such financial
institutions and any inadequacy of loan loss reserves relating to, and
exposure to unrecoverable losses on, loans acquired;
• our ability to continue to identify acquisition targets and successfully
acquire desirable financial institutions to sustain our growth, to expand
our presence in our markets and to enter new markets;
• general business and economic conditions in our markets change or are less
favorable than expected;
• changes occur in business conditions and inflation;
• an increase in the rate of personal or commercial customers' bankruptcies;
• technology-related changes are harder to make or are more expensive than
expected;
• attacks on the security of, and breaches of, the Company's and Independent
Bank's digital information systems, the costs the Company or Independent
Bank incur to provide security against such attacks and any costs and
liability we or
those systems;
• the potential impact of technology and "FinTech" entities on the banking
industry generally;
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• the other factors that are described or referenced in Part I, Item 1A. of
this Annual Report on Form 10-K under the caption "Risk Factors."; and
• other economic, competitive, governmental, regulatory, technological and
geopolitical factors affecting the Company's operations, pricing and
services.
In addition to the general factors listed above, additional factors specifically pertaining to the ongoing merger between the Company and TCBI that could also cause the results of performance to differ materially from those expressed in forward looking statements include the following: • the occurrence of any event, change or other circumstances that could give
rise to the right of one or both of the parties to terminate the merger
agreement;
• the outcome of pending or threatened litigation, or of matters before
regulatory agencies, whether currently existing or commencing in the
future, including litigation related to the merger;
• delays in completing the transaction;
• the failure to obtain necessary regulatory approvals (and the risk that
such approvals may result in the imposition of conditions that could
adversely affect the combined company or the expected benefits of the
transaction) and shareholder approvals or to satisfy any of the other
conditions to the closing of the merger on a timely basis or at all;
• the possibility that the anticipated benefits of the transaction are not
realized when expected or at all, including as a result of the impact of,
or problems arising from, the integration of the two companies or as a
result of the strength of the economy and competitive factors in the areas
where the Company and TCBI do business;
• the possibility that the transaction may be more expensive to complete
than anticipated, including as a result of unexpected factors or events;
• the impact of purchase accounting with respect to the merger, or anychange in assumptions used regarding the assets purchased and liabilities
assumed to determine their fair value;
• diversion of management's attention from ongoing business operations and
opportunities;
• potential adverse reactions or changes to business or employee
relationships, including those resulting from the announcement or
completion of the transition;
• the ability to complete the transaction and integration of the Company and
TCBI successfully, which may take longer than anticipated or be more
costly than anticipated or have unanticipated adverse results relating to
the Company or TCBI's existing businesses;
• the challenges of integrating, retaining, and hiring key personnel;
• failure to attract new customers and retain existing customers in the
manner anticipated;
• any interruption or breach of security as a result of systems integration,
resulting in failures or disruption in customer account management,
general ledger, deposit, loan or other systems;
• changes in the Company's stock price before closing, including as a result
of the financial performance of TCBI prior to closing;
• the dilution caused by the Company's issuance of additional shares of its
capital stock in connections with the transaction;
• operational issues stemming from, and/or capital spending necessitated by,
the potential need to adapt to industry changes in information technology
systems, on which the Company and TCBI are highly dependent; and
• changes in the Company's credit ratings or in the Company's ability to
access the capital markets.
We urge you to consider all of these risks, uncertainties and other factors
carefully in evaluating all such forward-looking statements that we may make. As
a result of these and other matters, including changes in facts and assumptions
not being realized, the actual results relating to the subject matter of any
forward-looking statement may differ materially from the anticipated results
expressed or implied in that forward-looking statement. Any forward-looking
statement made by the Company in any report, filing, press release, document,
report or announcement speaks only as of the date on which it is made. The
Company undertakes no obligation to update any forward-looking statement,
whether as a result of new information, future developments or otherwise, except
as may be required by law.
A forward looking-statement may include a statement of the assumptions or bases
underlying the forward-looking statement. The Company has chosen these
assumptions or bases in good faith and believes that they are reasonable.
However, the Company cautions you that assumptions or bases almost always vary
from actual results, and the differences between assumptions or bases and actual
results can be material. The Company undertakes no obligation to publicly update
or otherwise revise any forward-looking statements, whether as a result of new
information, future events or otherwise, except as required by law.
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Overview
The Company was organized as a bank holding company in 2002. OnJanuary 1, 2009 , the Company was merged withIndependent Bank Group Central Texas, Inc. , and, since that time, has pursued a strategy to create long-term shareholder value through organic growth of our community banking franchise in our market areas and through selective acquisitions of complementary banking institutions with operations in the Company's market areas or in new market areas. OnApril 8, 2013 , the Company consummated the initial public offering, or IPO, of its common stock which is traded on the Nasdaq Global Select Market. The Company's principal business is lending to and accepting deposits from businesses, professionals and individuals. The Company conducts all of the Company's banking operations throughIndependent Bank , which is aTexas state banking corporation and the Company's principal subsidiary (the Bank). The Company derives its income principally from interest earned on loans and, to a lesser extent, income from securities available for sale. The Company also derives income from non-interest sources, such as fees received in connection with various deposit services, mortgage banking operations and investment advisory services. From time to time, the Company also realizes gains on the sale of assets. The Company's principal expenses include interest expense on interest-bearing customer deposits, advances from theFederal Home Loan Bank of Dallas (FHLB) and other borrowings, operating expenses such as salaries, employee benefits, occupancy costs, data processing and communication costs, expenses associated with other real estate owned, other administrative expenses, amortization of intangibles, acquisition expenses, provisions for loan losses and the Company's assessment forFDIC deposit insurance. The Company intends for this discussion and analysis to provide the reader with information that will assist in understanding the Company's financial statements, the changes in certain key items in those financial statements from period to period and the primary factors that accounted for those changes. This discussion relates to the Company and its consolidated subsidiaries and should be read in conjunction with the Company's consolidated financial statements as ofDecember 31, 2019 and 2018 and for the years endedDecember 31, 2019 , 2018 and 2017, and the accompanying notes, appearing elsewhere in this Annual Report on Form 10-K. The Company's year ends onDecember 31 . The following discussion and analysis presents the more significant factors that affected our financial condition as ofDecember 31, 2019 and 2018 and results of operations for each of the years then ended. Refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2018 Annual Report on Form 10K filed with theSEC onFebruary 28, 2019 , for discussion of our results of operations for the years endedDecember 31, 2018 and 2017. Certain Events Affect Year-over-Year Comparability Acquisitions The Company completed an acquisition in 2019, 2018 and 2017. These acquisitions increased total assets, gross loans and deposits on their respective acquisition date as detailed below. (dollars in millions) Acquisition Date Total Assets Gross Loans Deposits Carlile Bancshares, Inc. April 1, 2017$2,444 $1,384 $1,825 Integrity Bancshares, Inc. June 1, 2018 852 652 593 Guaranty Bancorp January 1, 2019 3,943 2,790 3,109 The Company issued an aggregate 24,056,428 shares of common stock in connection with these acquisitions. In addition, the Company issued 448,500 shares of common stock in 2017 to enhance our capital position. The comparability of the Company's consolidated results of operations for the years endedDecember 31, 2019 , 2018 and 2017 are affected by these acquisitions and stock issuances. Discussion and Analysis of Results of Operations The following discussion and analysis of the Company's results of operations compares its results of operations for the years endedDecember 31, 2019 and 2018. 41
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Results of Operations The Company's net income available to common shareholders increased by$64.5 million , or 50.3%, to$192.7 million ($4.46 per common share on a diluted basis) for the year endedDecember 31, 2019 , from$128.3 million ($4.33 per common share on a diluted basis) for the year endedDecember 31, 2018 . The increase resulted from a$245.6 million increase in interest income, a$36.0 million increase in noninterest income partially offset by a$21.8 million increase in income tax expense, a$67.1 million increase in interest expense and a$123.2 million increase in noninterest expense. The Company's net income for the year endedDecember 31, 2019 , and, therefore, the Company's return on average assets and the Company's return on average equity, were adversely affected by$33.4 million of acquisition-related expenses primarily related to the Guaranty acquisition. The Company posted returns on average common equity of 8.50% and 8.69%, returns on average assets of 1.32% and 1.35%, and efficiency ratios of 53.01% and 52.35% for the years endedDecember 31, 2019 and 2018, respectively. The efficiency ratio is calculated by dividing total noninterest expense (which does not include the provision for loan losses and the amortization of core deposits intangibles) by net interest income plus noninterest income. The Company's dividend payout ratio was 22.42% and 12.47% and the equity to assets ratio was 15.64% and 16.31% for the years endedDecember 31, 2019 and 2018, respectively. Net Interest Income The Company's net interest income is its interest income, net of interest expenses. Changes in the balances of the Company's earning assets and its deposits, FHLB advances and other borrowings, as well as changes in the market interest rates, affect the Company's net interest income. The difference between the Company's average yield on earning assets and its average rate paid for interest-bearing liabilities is its net interest spread. Noninterest-bearing sources of funds, such as demand deposits and stockholders' equity, also support the Company's earning assets. The impact of the noninterest-bearing sources of funds is reflected in the Company's net interest margin, which is calculated as annualized net interest income divided by average earning assets. The Company earned net interest income of$504.8 million for the year endedDecember 31, 2019 , an increase of$178.5 million , or 54.7%, from$326.3 million for the year endedDecember 31, 2018 . The increase in net interest income from the previous year was primarily due to increased average earning assets and acquired loan accretion resulting primarily from the acquisition of Guaranty Bancorp, as well as organic earning assets growth and overall higher interest rates for the year over year period. The Company's net interest margin for 2019 decreased to 3.95% from 3.97% in 2018, and the Company's interest rate spread for 2019 decreased to 3.47% from the 3.59% interest rate spread for 2018. The average balance of interest-earning assets for 2019 increased by$4.6 billion , or 55.6%, to$12.8 billion from an average balance of$8.2 billion for 2018. The increase from the prior year was primarily due to$3.4 billion in earning assets acquired in the Guaranty transaction as well as organic growth. The Company's net interest margin for the year endedDecember 31, 2019 was positively impacted by a 15 basis point increase in the weighted-average yield on interest-earning assets to 5.11% for the year endedDecember 31, 2019 , from 4.96% for the year endedDecember 31, 2018 . The increase from the prior year is due primarily to higher loan yields resulting from increased acquired loan accretion mainly resulting from the Guaranty transaction. The year endedDecember 31, 2019 includes$46.1 million of loan accretion compared to$13.5 million included as ofDecember 31, 2018 . In addition, higher taxable securities yields contributed to the increase in the net interest margin. The cost of interest bearing liabilities, including borrowings, was 1.64% for the year endedDecember 31, 2019 compared to 1.37% for the year endedDecember 31, 2018 . The increase from the prior year is primarily due to higher rates offered on our deposits, primarily related to commercial money market accounts and promotional certificates of deposit, resulting from both market competition as well as overall higher deposit rates which were tied to higherFed Fund rates in effect for the year over year period due to the Fed rate 100 basis point increase during 2018. In addition, the cost of interest bearing liabilities were adversely impacted by higher average rates on short-term FHLB advances used for liquidity. 42
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Average Balance Sheet Amounts, Interest Earned and Yield Analysis. The following table presents average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the years endedDecember 31, 2019 , 2018 and 2017. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances.
For the Years Ended
2019 2018 2017
Average Average Average
Outstanding Yield/ Outstanding Yield/ Outstanding Yield/
(dollars in thousands) Balance Interest Rate Balance Interest Rate Balance Interest Rate
Interest-earning assets:
Loans (1) $ 11,179,161 $ 611,589 5.47 % $ 7,254,635 $ 384,791 5.30 % $ 5,871,990 $ 290,357 4.94 %
Taxable securities 770,927 21,324 2.77 603,474 14,007 2.32 481,323 8,229 1.71 %
Nontaxable securities 329,687 8,482 2.57 177,348 4,580 2.58 157,086 3,877 2.47 %
Interest bearing deposits
and other 504,309 11,537 2.29 179,411 3,912 2.18 409,976 5,451 1.33 %
Total interest-earning
assets 12,784,084 $ 652,932 5.11 8,214,868 $ 407,290 4.96 6,920,375 $ 307,914 4.45 %
Noninterest-earning assets 1,771,231 1,264,066 1,046,046
Total assets $ 14,555,315 $ 9,478,934 $ 7,966,421
Interest-bearing
liabilities:
Checking accounts $ 3,953,986 $ 44,171 1.12 % $ 2,943,519 $ 26,593 0.90 % $ 2,630,477 $ 13,305 0.51 %
Savings accounts 540,741 1,335 0.25 290,325 703 0.24 263,381 380 0.14
Money market accounts 2,047,554 40,837 1.99 998,916 19,043 1.91 605,064 6,168 1.02
Certificates of deposit 1,795,391 37,041 2.06 1,009,644 14,428 1.43 1,002,753 8,665 0.86
Total deposits 8,337,672 123,384 1.48 5,242,404 60,767 1.16 4,501,675 28,518 0.63
FHLB advances 464,404 10,173 2.19 515,479 10,264 1.99 483,923 5,858 1.21
Other borrowings and
repurchase agreements 201,066 11,590 5.76 137,549 8,398 6.11 117,162 6,898 5.89
Junior subordinated
debentures 53,733 3,028 5.64 27,761 1,609 5.80 25,252 1,162 4.60
Total interest-bearing
liabilities 9,056,875 148,175 1.64 5,923,193 81,038 1.37 5,128,012 42,436 0.83
Noninterest-bearing
checking accounts 3,139,805 2,052,675 1,671,872
Noninterest-bearing
liabilities 91,532 26,378 26,964
Stockholders' equity 2,267,103 1,476,688 1,139,573
Total liabilities and
equity $ 14,555,315 $ 9,478,934 $ 7,966,421
Net interest income $ 504,757 $ 326,252 $ 265,478
Interest rate spread 3.47 % 3.59 % 3.62 %
Net interest margin (2) 3.95 3.97 3.84
Net interest income and
margin (tax equivalent
basis) (3) $ 508,498 3.98 $ 328,090 3.99 $ 268,235 3.88
Average interest earning
assets to interest bearing
liabilities 141.15 138.69 134.95
____________
(1) Average loan balances include nonaccrual loans.
(2) Net interest margins for the periods presented represent: (i) the difference
between interest income on interest-earning assets and the interest expense
on interest-bearing liabilities, divided by (ii) average interest-earning
assets for the period.
(3) A tax-equivalent adjustment has been computed using a federal income tax rate
of 21% for the years ended December 31, 2019 and 2018 and 35% for the year
ended December 31, 2017 .
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Interest Rates and Operating Interest Differential. Increases and decreases in
interest income and interest expense result from changes in average balances
(volume) of interest-earning assets and interest-bearing liabilities, as well as
changes in average interest rates. The following table shows the effect that
these factors had on the interest earned on the Company's interest-earning
assets and the interest incurred on the Company's interest-bearing liabilities.
The effect of changes in volume is determined by multiplying the change in
volume by the previous year's average rate. Similarly, the effect of rate
changes is calculated by multiplying the change in average rate by the prior
year's volume. For purpose of the following table, changes attributable to both
volume and rate, which cannot be segregated, have been allocated to the changes
due to volume and the changes due to rate in proportion to the relationship of
the absolute dollar amount of change in each.
For the Year Ended December 31, 2019 v. 2018 For the Year Ended December 31, 2018 v. 2017
Increase (Decrease) Due to Total Increase Increase (Decrease) Due to Total Increase
(dollars in thousands) Volume Rate (Decrease) Volume Rate (Decrease)
Interest-earning
assets
Loans $ 214,103 $ 12,695 $ 226,798 $ 72,165 $ 22,269 $ 94,434
Taxable securities 4,306 3,011 7,317 2,398 3,380 5,778
Nontaxable securities 3,920 (18 ) 3,902 517 186 703
Interest bearing
deposits and other 7,419 206 7,625 (3,983 ) 2,444 (1,539 )
Total interest-earning
assets $ 229,748 $ 15,894 $ 245,642 $ 71,097 $ 28,279 $ 99,376
Interest-bearing
liabilities
Checking accounts $ 10,267 $ 7,311 $ 17,578 $ 1,747 $ 11,541 $ 13,288
Savings accounts 603 29 632 42 281 323
Limited access money
market accounts 20,958 836 21,794 5,510 7,365 12,875
Certificates of
deposit 14,439 8,174 22,613 60 5,703 5,763
Total deposits 46,267 16,350 62,617 7,359 24,890 32,249
FHLB advances (1,069 ) 978 (91 ) 405 4,001 4,406
Other borrowings and
repurchase agreements 3,696 (504 ) 3,192 1,237 263 1,500
Junior subordinated
debentures 1,464 (45 ) 1,419 124 323 447
Total interest-bearing
liabilities 50,358 16,779 67,137 9,125 29,477 38,602
Net interest income $ 179,390 $ (885 ) $ 178,505 $ 61,972 $ (1,198 ) $ 60,774
Interest Income. The Company's total interest income increased $245.6 million ,
or 60.3%, to $652.9 million for the year ended December 31, 2019 , from $407.3
million for the year ended December 31, 2018 . The following tables set forth the
major components of the Company's interest income for the years ended
December 31, 2019 and 2018 and the period-over-period variations in such
categories of interest income:
For the Years Ended For the Years Ended
December 31, Variance December 31, Variance
(dollars in thousands) 2019 2018 2019 v. 2018 2018 2017 2018 v. 2017
Interest income
Interest and fees on
loans $ 611,589 $ 384,791 $ 226,798 58.9 %
21,324 14,007 7,317 52.2 14,007 8,229 5,778 70.2
Interest on nontaxable
securities 8,482 4,580 3,902 85.2 4,580 3,877 703 18.1
Interest on
interest-bearing
deposits and other 11,537 3,912 7,625 194.9
3,912 5,451 (1,539 ) (28.2 )
Total interest income
The Company's interest and fees on loans increased 58.9% for the year endedDecember 31, 2019 , compared to the year endedDecember 31, 2018 , and was primarily attributable to a$3.9 billion increase in the average balance of the Company's loans to$11.2 billion during the year ended 2019 as compared with the average balance of$7.3 billion for the year ended 2018. The increase primarily resulted from$2.8 billion in loans held for investment acquired with the Guaranty transaction as well as disciplined organic growth in the Company's loan portfolio of 4.8% for the year over year period. The interest the Company earned on taxable securities, which consists primarily of government agency and residential pass-through securities, increased 52.2% for the year endedDecember 31, 2019 from the year endedDecember 31, 2018 as a result of an increase in the average portfolio balance from$603.5 million for the year endedDecember 31, 2018 to$770.9 million for 44 --------------------------------------------------------------------------------
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the year endedDecember 31, 2019 . This increase was primarily attributable to taxable securities acquired through the Guaranty acquisition. The interest the Company earned on nontaxable securities increased 85.2% for the year endedDecember 31, 2019 as a result of an 85.9% increase in the average balance of nontaxable securities from$177.3 million for the year endedDecember 31, 2018 to$329.7 million for the year endedDecember 31, 2019 , primarily related to additions from the Guaranty transaction. The 194.9% increase in the Company's interest on interest-bearing deposits and other for the year endedDecember 31, 2019 , from the year endedDecember 31, 2018 was primarily attributable to a 181.1% increase in the average balance from$179.4 million for the year endedDecember 31, 2018 to$504.3 million for the year endedDecember 31, 2019 . The higher average balance in 2019 was primarily due to a favorable liquidity position resulting from slower loan growth and an increase in our organic deposit growth during the year. Interest Expense. Total interest expense on the Company's interest-bearing liabilities increased$67.1 million , or 82.8%, to$148.2 million for the year endedDecember 31, 2019 , from$81.0 million in the prior year. The following table sets forth the major components of the Company's interest expense for the years endedDecember 31, 2019 and 2018 and the period-over-period variations in such categories of interest expense: For the Years Ended For the Years Ended December 31, Variance December 31, Variance (dollars in thousands) 2019 2018 2019 v. 2018 2018 2017 2018 v. 2017 Interest Expense Interest on deposits$ 123,384 $ 60,767 $ 62,617 103.0 %$ 60,767 $ 28,518 $ 32,249 113.1 % Interest of FHLB advances 10,173 10,264 (91 ) (0.9 ) 10,264 5,858 4,406 75.2 Interest on other borrowings and repurchase agreements 11,590 8,398 3,192 38.0 8,398 6,898 1,500 21.7 Interest on junior subordinated debentures 3,028 1,609 1,419 88.2 1,609 1,162 447 38.5 Total interest expense$ 148,175 $ 81,038 $ 67,137 82.8 %$ 81,038 $ 42,436 $ 38,602 91.0 % Interest expense on deposits increased by$62.6 million , or 103.0% for the year over year period, primarily due to increased average deposit balances as well as the rising rate environment during 2019. Average interest-bearing deposit balances increased 59.0% year-over-year from$5.2 billion in 2018 to$8.3 billion in 2019 primarily due to$2.1 billion of interest-bearing deposits acquired in the Guaranty acquisition as well as strong organic growth of 10.4% during 2019. The average rate on the Company's deposits increased by 32 basis points to 1.48% for 2019 compared to 1.16% for 2018. This increase in cost of funds primarily resulted from higher rates offered on commercial money market accounts, checking accounts and promotional certificates of deposit during the majority of 2019 due to competition in our markets but also due in part to increased interest rates on deposit products tied to Fed Funds rates. Interest expense on FHLB advances for 2019 decreased by$91 thousand , or 0.9%, due primarily to a decrease in average balance of such advances over the period, from$515.5 million in 2018 to$464.4 million in 2019, resulting from the use of short-term FHLB advances as needed for liquidity and to fund mortgage warehouse purchase loans as well as rate decreases during the last half of 2019 on short-term FHLB advances. Interest expense on other borrowings and repurchase agreements for 2019 increased by$3.2 million , or 38.0% from 2018, primarily as a result of the interest expense recognized on$40 million subordinated debentures acquired in the Guaranty transaction as well as interest expense related to the Company's revolving line of credit with an average year to date outstanding balance of$21.6 million . Interest expense on junior subordinated debentures increased$1.4 million , or 88.2% from the prior year due to$25.8 million in junior subordinated debentures assumed in the Guaranty transaction offset by lower effective interest rates on these instruments in 2019. Provision for Loan Losses Management actively monitors the Company's asset quality and provides specific loss provisions when necessary. Provisions for loan losses are charged to income to bring the total allowance for loan losses to a level deemed appropriate by management 45
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based on such factors as historical loss experience, trends in classified loans and past dues, the volume, concentrations and growth in the loan portfolio, current economic conditions and the value of collateral. Loans are charged-off against the allowance for loan losses when appropriate. Although management believes it uses the best information available to make determinations with respect to the provision for loan losses, future adjustments may be necessary if economic conditions differ from the assumptions used in making the determination. The Company increased its allowance for loan losses to$51.5 million atDecember 31, 2019 , by making provisions for loan losses totaling$14.8 million during the year endedDecember 31, 2019 . This is an increase of$4.9 million , or 50.2% in provision expense compared to total provision expense of$9.9 million made by the Company in 2018. Provision expense is primarily reflective of organic loan growth and net charge-offs during the year. The increased provision from prior year was due to higher net charge-offs totaling$8.1 million in 2019, which is 0.07% of the Company's average loans outstanding during the period. The 2019 charge-offs were primarily related to partial charge-offs of two commercial credit relationships totaling$5.6 million . The balance of the provision for loan losses was made based on the Company's assessment of the credit quality of the Company's loan portfolio and in view of the amount of the Company's net charge-offs in that period. The Company did not make any provision for loan losses with respect to the loans acquired in the Guaranty acquisition completed onJanuary 1, 2019 because, in accordance with acquisition accounting standards, the Company recorded the loans acquired in the acquisition at fair value without a reserve and determined that the Company's fair value adjustments appropriately reflected the probability of losses on those loans as of the acquisition date. Company does not believe there has been any material deterioration of credit of these acquired loans since the acquisition. As ofDecember 31, 2019 , the discount on acquired loans totaled$93.6 million . See Note 1, Summary of Significant Accounting Policies, and Note 6, Loans, net and Allowance for Loan Losses, in the accompanying notes to the consolidated financial statements included elsewhere in this report. Noninterest Income The following table sets forth the major components of noninterest income for the years endedDecember 31, 2019 and 2018 and the period-over-period variations in such categories of noninterest income: For the Years Ended For the Years Ended December 31, Variance December 31, Variance (dollars in thousands) 2019 2018 2019 v. 2018 2018 2017 2018 v. 2017 Noninterest income: Service charges on deposit accounts$ 24,500 $ 14,224 $ 10,276 72.2 %$ 14,224 $ 12,955 $ 1,269 9.8 % Investment management and trust 9,330 - 9,330 100.0 - - - - Mortgage banking revenue 15,461 15,512 (51 ) (0.3 )
15,512 13,755 1,757 12.8 Gain on sale of loans 6,779
- 6,779 100.0 - 351 (351 ) (100.0 )
Gain on sale of
branches 1,549 - 1,549 100.0 - 2,917 (2,917 ) (100.0 )
Gain on sale of trust
business 1,319 - 1,319 100.0 - - - -
Gain (loss) on sale of
other real estate 875 269 606 N/M 269 (160 ) 429 N/M
Gain on sale of
repossessed assets - - - - - 1,010 (1,010 ) (100.0 )
Gain (loss) on sale of
securities available
for sale 275 (581 ) 856 N/M (581 ) 124 (705 ) N/M
(Loss) gain on sale of
premises and equipment (585 ) 123 (708 ) N/M 123 (21 ) 144 N/M
Increase in cash
surrender value of BOLI 5,525 3,170 2,355 74.3 3,170 2,748 422 15.4
Other 13,148 9,507 3,641 38.3 9,507 7,608 1,899 25.0
Total noninterest
income $ 78,176 $ 42,224 $ 35,952 85.1 % $ 42,224 $ 41,287 $ 937 2.3 %
____________
N/M - Not meaningful
Noninterest income increased $36.0 million , or 85.1%, to $78.2 million for the
year ended 2019 from $42.2 million for the year ended 2018. Significant changes
in the components of noninterest income are discussed below.
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Service charges. Service charges on deposit accounts increased$10.3 million , or 72.2%, for the year endedDecember 31, 2019 , as compared to the same period in 2018. The increase in service charges reflects an increase in deposit accounts due to the acquisition of Guaranty inJanuary 2019 as well as a full year of service charges on the deposits acquired in the 2018 Integrity acquisition. Investment management and trust. The wealth management subsidiary and trust division were acquired in the Guaranty transaction onJanuary 1, 2019 . Gain on sale of loans. The Company recognized a net gain of$6.8 million for the year endedDecember 31, 2019 resulting from sales of consumer and residential mortgage loan pools acquired in the Guaranty transaction. Gain on sale of branch. The Company recognized a net gain of$1.5 million for the year endedDecember 31, 2019 resulting from the sale of a branch during third quarter 2019. Gain on sale of trust business. The Company recognized a net gain of$1.3 million for the year endedDecember 31, 2019 from the sale of the trust business inOctober 2019 . The trust business was acquired with the Guaranty transaction. Increase in cash surrender value of bank owned life insurance. The cash surrender value of bank owned life insurance increased$2.4 million , or 74.3% from$3.2 million in 2018 to$5.5 million in 2019. The increase is a result of$81 million in policies acquired in the Guaranty transaction as well as a full year of income on policies from the 2018 Integrity acquisition. Other noninterest income. Other noninterest income increased$3.6 million , or 38.3%, for the year endedDecember 31, 2019 compared to the same period in 2018. The net increase is primarily due to the additional accounts acquired in the Guaranty transaction as well as an increase in acquired loan recoveries, swap dealer income and mortgage warehouse fees during 2019 offset by lower earnings credits on correspondent bank accounts. Noninterest Expense Noninterest expense increased$123.2 million , or 62.1%, to$321.9 million for the year ended 2019 from$198.6 million for the year ended 2018. The increase from 2018 to 2019 is primarily due to increases in salaries and benefits expenses, occupancy, data processing expenses, communications expense, impairment of other real estate, amortization of intangibles, acquisition expense and other noninterest expenses. The increases primarily reflect increased expenses related to the Guaranty acquisition completed onJanuary 1, 2019 , a full year of expenses related to the Integrity acquisition completed onJune 1, 2018 as well as organic growth within the Company. 47 --------------------------------------------------------------------------------
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The following table sets forth the major components of the Company's noninterest
expense for the years ended
For the Years Ended For the Years Ended
December 31, Variance December 31, Variance
(dollars in thousands) 2019 2018 2019 v. 2018 2018 2017 2018 v. 2017
Noninterest expense:
Salaries and employee
benefits $ 162,683 $ 111,697 $ 50,986 45.6 % $ 111,697 $ 95,741 $ 15,956 16.7 %
Occupancy 37,654 24,786 12,868 51.9 24,786 22,079 2,707 12.3
Data processing 17,103 10,754 6,349 59.0 10,754 8,597 2,157 25.1
FDIC assessment 1,065 3,306 (2,241 ) (67.8 ) 3,306 4,311 (1,005 ) (23.3 ) Advertising and public relations
2,527 1,907 620 32.5 1,907 1,452 455 31.3 Communications
5,145 3,353 1,792 53.4 3,353 2,860 493 17.2 Other real estate owned expenses, net
418 318 100 31.4 318 304 14 4.6
Impairment of other real
estate 1,801 85 1,716 N/M 85 1,412 (1,327 ) (94.0 )
Amortization of other
intangible assets 12,880 5,739 7,141 124.4 5,739 4,639 1,100 23.7 Professional fees
7,936 4,556 3,380 74.2 4,556 4,564 (8 ) (0.2 )
Acquisition expense,
including legal 33,445 6,157 27,288 443.2 6,157 12,898 (6,741 ) (52.3 )
Other 39,207 25,961 13,246 51.0 25,961 17,956 8,005 44.6
Total noninterest
expense $ 321,864 $ 198,619 $ 123,245 62.1 % $ 198,619 $ 176,813 $ 21,806 12.3 %
____________
N/M - not meaningful
Salaries and employee benefits. Salaries and employee benefits expense, which
historically has been the largest component of the Company's noninterest
expense, increased $51.0 million , or 45.6%, for the year ended December 31,
2019 , compared to the year ended December 31, 2018 . The increase is primarily
due to additional headcount related to the Guaranty acquisition as well as
organic growth during the year. Additionally, severance and retention payments
were made totaling $5.7 million related primarily to the Guaranty transaction
but also related to our branch restructuring and trust business sale. In
addition, there was a $3.0 million expense related to the separation arrangement
with a former executive officer that occurred during the fourth quarter of 2019.
The increase is also a result of a full year of expense in 2019 compared to
seven months in 2018 related to the Integrity acquisition as well as a full year
of expense related to the increase in 401(k) contribution match, which changed
mid-year 2018 resulting from a modification to the Company's plan.
Occupancy expense. Occupancy expense increased $12.9 million , or 51.9%, for the
year ended December 31, 2019 , compared to the year ended December 31, 2018 . The
increase is primarily reflective of 32 additional branches acquired in the
Guaranty transaction as well as the new corporate headquarters being placed into
service during the second quarter of 2019.
Data processing. Data processing fees increased $6.3 million , or 59.0%, for the
year ended December 31, 2019 , compared to the same period in 2018. The increase
over the same prior period is reflective of increased costs due to the
additional accounts, employees and locations added related to the Guaranty
acquisition during 2019 as well as a full year of cost related to Integrity in
2019 compared to seven months in 2018.
FDIC assessment. FDIC assessment expense decreased $2.2 million , or 67.8%, for
the year ended December 31, 2019 , compared to the same period in 2018. The
decrease is due to primarily as a result of a $3.2 million Small Bank Assessment
Credit recorded in third quarter 2019.
Communications. Communications expense increased $1.8 million , or 53.4% for the
year ended December 31, 2019 over the same period in 2018. The increase was
primarily due to higher data line expense related to the additional branches and
accounts acquired in the Guaranty acquisition.
Impairment of other real estate. Other real estate impairments were higher in
2019 primarily due to writedowns taken on branch locations closed and moved to
other real estate owned as part of our branch restructuring in 2019.
Other intangible assets amortization. Other intangible assets amortization
increased $7.1 million , or 124.4%, for the year ended December 31, 2019 compared
to the same period in 2018. The increase is due to the increase of $71.5 million
in core deposit and customer intangibles recorded in connection with the
acquisition of Guaranty.
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Professional fees. Professional fees increased$3.4 million , or 74.2%, for the year endedDecember 31, 2019 compared to the same period in 2018. The increase is primarily due to higher audit costs, higher legal expenses related to ongoing acquired litigation and increased consulting expenses related to various projects and new system implementations. Acquisition expense. Acquisition expense is primarily legal, advisory and accounting fees associated with services to facilitate the acquisition of other banks. Acquisition expenses also include data processing conversion costs and contract termination costs. Total acquisition expenses for the year endedDecember 31, 2019 , increased$27.3 million , or 443.2% over the same period in 2018. The increase in acquisition expenses is primarily due to$8.7 million in change in control payments to Guaranty executives in the first quarter of 2019 as well as an increase in professional fees, Guaranty conversion-related expenses and contract termination fees, including$6.9 million related to Guaranty's debit card provider expensed in the third quarter of 2019 and$5.8 million related to the announced merger of equals with Texas Capital Bancshares, Inc., primarily for investment banker and due diligence-related costs. Other. Other noninterest expense for the year endedDecember 31, 2019 increased by$13.2 million , or 51.0%, compared to the same period in 2018. The increase in noninterest expense primarily reflects the additional headcount, branch locations and accounts acquired in the Guaranty transaction but also due to higher deposit- and loan-related expenses for the year over year period. In addition, we recorded a$1.4 million loss contingency reserve related to chargebacks on a merchant card deposit account acquired with Guaranty during second quarter 2019 as well as$1.2 million in impairments on other assets related to a CRA SBIC fund and a lease right of use asset on a closed branch recorded in third quarter 2019. Income Tax Expense Income tax expense was$53.5 million for the year endedDecember 31, 2019 , which is an effective tax rate of 21.7%. Income tax expense was$31.7 million for the year endedDecember 31, 2018 , which is an effective tax rate of 19.8%. The higher effective tax rates in 2019 are due to$1.4 million in deductibility limitations related to the change in control payments made to Guaranty employees and nondeductible acquisition expenses in addition to increased state income tax expense. No valuation allowance for deferred tax assets was recorded atDecember 31, 2019 and 2018, as management believes it is more likely than not that all of the deferred tax assets will be realized. 49 --------------------------------------------------------------------------------
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Quarterly Financial Information The following table presents certain unaudited consolidated quarterly financial information regarding the Company's results of operations for the quarters endedDecember 31 ,September 30 ,June 30 andMarch 31 in the years endedDecember 31, 2019 and 2018. This information should be read in conjunction with the Company's consolidated financial statements as of and for the years endedDecember 31, 2019 and 2018 appearing elsewhere in this Annual Report on Form 10-K. Quarter
Ended 2019
December 31 September 30 June 30 March 31
(dollars in thousands, except per share
data) (unaudited)
Interest income $ 164,386 $ 165,307 $ 167,663 $ 155,576
Interest expense 36,317 39,914 38,020 33,924
Net interest income 128,069 125,393 129,643 121,652
Provision for loan losses 1,609 5,233 4,739 3,224
Net interest income after provision for
loan losses 126,460 120,160 124,904 118,428
Noninterest income 18,229 27,324 16,199 16,424
Noninterest expense 80,343 76,948 77,978 86,595
Income before income taxes 64,346 70,536 63,125 48,257
Provision for income taxes 14,110 14,903 13,389 11,126
Net income $ 50,236 $ 55,633 $ 49,736 $ 37,131
Comprehensive income $ 49,606 $ 58,450 $ 63,388 $ 48,907
Basic earnings per share $ 1.17 $ 1.30 $ 1.15 $ 0.85
Diluted earnings per share 1.17 1.30 1.15 0.85
Quarter Ended 2018
December 31 September 30 June 30 March 31
(dollars in thousands, except per share
data) (unaudited)
Interest income $ 112,805 $ 109,289 $ 97,082 $ 88,114
Interest expense 25,697 23,021 18,173 14,147
Net interest income 87,108 86,268 78,909 73,967
Provision for loan losses 2,910 1,525 2,730 2,695
Net interest income after provision for
loan losses 84,198 84,743 76,179 71,272
Noninterest income 9,887 12,749 10,133 9,455
Noninterest expense 51,848 52,655 49,158 44,958
Income before income taxes 42,237 44,837 37,154 35,769
Provision for income taxes 8,273 9,141 7,519 6,805
Net income $ 33,964 $ 35,696 $ 29,635 $ 28,964
Comprehensive income $ 39,879 $ 31,633 $ 28,644 $ 20,518
Basic earnings per share $ 1.11 $ 1.17 $ 1.02 $ 1.02
Diluted earnings per share 1.11 1.17 1.02 1.02
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Discussion and Analysis of Financial Condition The following discussion and analysis of the Company's financial condition discusses and analyzes the financial condition of the Company as ofDecember 31, 2019 and 2018 and certain changes in that financial condition fromDecember 31, 2018 toDecember 31, 2019 . Assets The Company's total assets increased by$5.1 billion , or 51.9%, to$15.0 billion as ofDecember 31, 2019 from$9.8 billion atDecember 31, 2018 due to the Guaranty acquisition and organic growth during the period. Loan Portfolio The Company's loan portfolio is the largest category of the Company's earning assets. The following table presents the balance and associated percentage of each major category in the Company's loan portfolio as ofDecember 31, 2019 , 2018, 2017, 2016 and 2015: 2019 2018 2017 2016 2015 (dollars in thousands) Amount % of Total Amount % of Total Amount % of Total Amount % of Total Amount % of Total Commercial (1)$ 2,482,356 21.3 %$ 1,361,104 17.2 %$ 1,059,984 16.3 %$ 630,805 13.7 %$ 731,818 18.3 % Real estate: Commercial 5,872,653 50.4 4,141,356 52.3 3,369,892 51.7 2,459,221 53.7 1,949,734 48.7 Commercial construction, land and land development 1,236,623 10.6 905,421
11.4 744,868 11.5 531,481 11.6 419,611 10.5 Residential (2)
1,550,872 13.3 1,082,248 13.7 931,495 14.3 644,340 14.1 620,289 15.5
Single-family interim
construction 378,120 3.2 331,748 4.2 289,680 4.4 235,475 5.1 187,984 4.7
Agricultural 97,767 0.9 66,638 0.8 82,583 1.3 53,548 1.2 50,178 1.3
Consumer 32,603 0.3 31,759 0.4 34,639 0.5 27,530 0.6 41,966 1.0
Other 621 - 253 - 304 - 166 - 124 -
11,651,615 100.0 % 7,920,527 100.0 % 6,513,445 100.0 % 4,582,566 100.0 % 4,001,704 100.0 %
Deferred loan fees (1,695 ) (3,303 ) (2,568 ) (2,117 ) (1,553 )
Allowance for loan
losses (51,461 ) (44,802 ) (39,402 ) (31,591 ) (27,043 )
Total loans, net $ 11,598,459 $ 7,872,422 $ 6,471,475 $ 4,548,858 $ 3,973,108
____________
(1) Includes mortgage warehouse purchase loans of
respectively.
(2) Includes loans held for sale of
2015, respectively.
As ofDecember 31, 2019 , the Company's loan portfolio, net of the allowance for loan losses and deferred fees, totaled$11.6 billion , which is an increase of 47.3% over total net loans atDecember 31, 2018 and for which the majority of the increase was due to$2.8 billion acquired in the Guaranty acquisition and the remaining was organic loan growth during the year. The principal categories of the Company's loan portfolio are discussed below: Commercial loans. The Company provides a mix of variable and fixed rate commercial loans. The loans are typically made to small-and medium-sized manufacturing, wholesale, retail, energy related service businesses and medical practices for working capital needs and business expansions. Commercial loans generally include lines of credit and loans with maturities of five years or less. The loans are generally made with operating cash flows as the primary source of repayment, but may also include collateralization by inventory, accounts receivable, equipment and/or personal guarantees. Additionally, our commercial loan portfolio includes loans made to customers in the energy industry, which is a complex, technical and cyclical industry. Experienced bankers with specialized energy lending experience originate our energy loans. Companies in this industry produce, extract, develop, exploit and explore for oil and natural gas. Loans are primarily collateralized with proven producing oil and gas reserves based on a technical evaluation of these reserves. The Company has a mortgage warehouse purchase program providing mortgage inventory financing for residential mortgage loans originated by mortgage banker clients across a broad geographic scale. Proceeds from the sale of mortgages is the primary source of repayment for warehouse inventory financing via approved investor takeout commitments. These loans are reported as commercial loans since the loans are secured 51
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by notes receivable, not real estate. The mortgage warehouse purchase loans outstanding totaled$687.3 million , as ofDecember 31, 2019 and$170.3 million , as ofDecember 31, 2018 . The Company's commercial loan portfolio increased$1.1 billion , or 82.4%, to$2.5 billion as ofDecember 31, 2019 , from$1.4 billion as ofDecember 31, 2018 . The increase in this portfolio type for the current year is primarily due to loans acquired in the Guaranty acquisition as well as organic loan growth, including an increase in the warehouse portfolio for the year over year period. Commercial real estate loans. The Company's commercial real estate loans generally are used by customers to finance their purchase of office buildings, retail centers, medical facilities and mixed-use buildings. Approximately 30% and 33% of the Company's commercial real estate loans as ofDecember 31, 2019 and 2018, respectively, were owner-occupied. Such loans generally involve less risk than loans on investment property. The Company expects that commercial real estate loans will continue to be a significant portion of the Company's total loan portfolio and an area of emphasis in the Company's lending operations. Commercial real estate loans increased$1.7 billion , or 41.8%, to$5.9 billion as ofDecember 31, 2019 from$4.1 billion as ofDecember 31, 2018 . The increase was due to the loans added in the Guaranty acquisition as well as organic loan growth in this loan type during the year. Commercial construction, land and land development loans. The Company's commercial construction, land and land development loans comprise loans to fund commercial construction, land acquisition and real estate development construction. Although the Company continues to make commercial construction loans, land acquisition and land development loans on a selective basis, the Company does not expect the Company's lending in this area to result in this category of loans being a significantly greater portion of the Company's total loan portfolio. Commercial construction, land and land development loans increased$331.2 million , or 36.6% to$1.2 billion atDecember 31, 2019 from$905.4 million atDecember 31, 2018 , due to the addition of the loans acquired through Guaranty and through organic loan growth in this type of loan. Residential Real Estate Loans. The Company's residential real estate loans, excluding mortgage loans held for sale, are primarily made with respect to and secured by single-family homes, which are both owner-occupied and investor owned and include a limited amount of home equity loans, with a relatively small average loan balance spread across many individual borrowers. The Company offers a variety of mortgage loan portfolio products which generally are amortized over five to thirty years. Loans collateralized by 1-4 family residential real estate generally have been originated in amounts of no more than 80% of appraised value. The Company requires mortgage title insurance and hazard insurance. The Company retains the majority of these portfolio loans for its own account rather than selling them into the secondary market. By doing so, the Company incurs interest rate risk as well as the risks associated with nonpayments on such loans. The Company's loan portfolio also includes a number of multi-family housing real estate loans. The Company expects that the Company will continue to make residential real estate loans, with an emphasis on single-family housing loans, so long as housing values in the Company's markets do not deteriorate from current prevailing levels and the Company is able to make such loans consistent with the Company's current credit and underwriting standards. The Company's residential real estate loan portfolio grew by$468.6 million , or 43.3%, to a balance of$1.6 billion as ofDecember 31, 2019 from$1.1 billion as ofDecember 31, 2018 . The increase in this category was due to both organic loan growth and loans acquired in the Guaranty transaction. Single-Family Interim Construction Loans. The Company makes single-family interim construction loans to home builders and individuals to fund the construction of single-family residences with the understanding that such loans will be repaid from the proceeds of the sale of the homes by builders or, in the case of individuals building their own homes, with the proceeds of a permanent mortgage loan. Such loans are secured by the real property being built and are made based on the Company's assessment of the value of the property on an as-completed basis. The Company expects to continue to make single-family interim construction loans so long as demand for such loans continues and the market for single-family housing and the values of such properties remain stable or continue to improve in the Company's markets. The balance of single-family interim construction loans in the Company's loan portfolio increased by$46.4 million , or 14.0%, to$378.1 million as ofDecember 31, 2019 from$331.7 million as ofDecember 31, 2018 . The increase during the year was due to both organic growth and loans acquired in the Guaranty transaction. 52
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Other Categories of Loans. Other categories of loans included in the Company's loan portfolio include agricultural loans made to farmers and ranchers relating to their operations and consumer loans made to individuals for personal purposes, including automobile purchase loans and personal loans. None of these categories of loans represents more than 1% of the Company's total loan portfolio as ofDecember 31, 2019 and 2018 and such categories continue to be a very small percentage of the Company's total loan portfolio. The following table sets forth the contractual maturities, including scheduled principal repayments, of the Company's loan portfolio (which includes balloon notes) and the distribution between fixed and adjustable interest rate loans as ofDecember 31, 2019 : Within One Year One Year to Five Years After Five Years Total (dollars in thousands) Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Fixed Rate Adjustable Rate Commercial$ 831,364 $ 431,455$ 358,848 $ 521,844$ 137,841 $ 201,004$ 1,328,053 $ 1,154,303 Real estate: Commercial real estate 443,549 117,668 2,246,171 722,085 702,946 1,640,234 3,392,666 2,479,987 Commercial construction, land and land development 96,172 161,856 321,541 384,541 43,447 229,066 461,160 775,463 Residential real estate 103,287 34,314 496,798 43,790 404,976 467,707 1,005,061 545,811 Single-family interim construction 60,926 190,582 17,604 33,982 57,930 17,096 136,460 241,660 Agricultural 12,929 14,805 33,486 5,379 8,312 22,856 54,727 43,040 Consumer 6,015 7,744 14,779 2,798 816 451 21,610 10,993 Other 621 - - - - - 621 - Total loans$ 1,554,863 $ 958,424$ 3,489,227 $ 1,714,419 $ 1,356,268 $ 2,578,414 $ 6,400,358 $ 5,251,257 Asset Quality Nonperforming Assets. The Company has established procedures to assist the Company in maintaining the overall quality of the Company's loan portfolio. In addition, the Company has adopted underwriting guidelines to be followed by the Company's lending officers and require significant senior management review of proposed extensions of credit exceeding certain thresholds. When delinquencies exist, the Company rigorously monitors the levels of such delinquencies for any negative or adverse trends. The Company's loan review procedures include approval of lending policies and underwriting guidelines byIndependent Bank's board of directors, an annual independent loan review, approval of large credit relationships byIndependent Bank's Executive Loan Committee and loan quality documentation procedures. The Company, like other financial institutions, is subject to the risk that its loan portfolio will be subject to increasing pressures from deteriorating borrower credit due to general economic conditions. The Company discontinues accruing interest on a loan when management of the Company believes, after considering the Company's collection efforts and other factors, that the borrower's financial condition is such that collection of interest of that loan is doubtful. Loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans, including troubled debt restructurings, that are placed on nonaccrual status or charged off is reversed against interest income. Cash collections on nonaccrual loans are generally credited to the loan receivable balance, and no interest income is recognized on those loans until the principal balance has been collected. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured. The Company did not make any changes in the Company's nonaccrual policy during the years of 2019 or 2018. Placing a loan on nonaccrual status has a two-fold impact on net interest earnings. First, it may cause a charge against earnings for the interest which had been accrued in the current year but not yet collected on the loan. Second, it eliminates future interest income with respect to that particular loan from the Company's revenues. Interest on such loans are not recognized until the entire principal is collected or until the loan is returned to performing status. Real estate the Company has acquired as a result of foreclosure or by deed-in-lieu of foreclosure is classified as other real estate owned until sold. The Company's policy is to initially record other real estate owned at fair value less estimated costs to sell at the date of foreclosure. After foreclosure, other real estate is carried at the lower of the initial carrying amount (fair value less estimated costs to sell or lease), or at the value determined by subsequent appraisals or internal valuations of the other real estate. 53
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The Company obtains appraisals of real property that secure loans and may update
such appraisals of real property securing loans categorized as nonperforming
loans and potential problem loans, in each case as required by regulatory
guidelines. In instances where updated appraisals reflect reduced collateral
values, an evaluation of the borrower's overall financial condition is made to
determine the need, if any, for possible write-downs or appropriate additions to
the allowance for loan losses.
The Company periodically modifies loans to extend the term or make other
concessions to help a borrower with a deteriorating financial condition stay
current on their loan and to avoid foreclosure. The Company generally does not
forgive principal or interest on loans or modify the interest rates on loans to
rates that are below market rates. Under applicable accounting standards, such
loan modifications are generally classified as troubled debt restructurings.
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The following table sets forth the allocation of the Company's nonperforming
assets among the Company's different asset categories as of the dates indicated.
The Company classifies nonperforming loans (excluding loans acquired with
deteriorated credit quality) as nonaccrual loans, loans past due 90 days or more
and still accruing interest or loans modified under restructurings as a result
of the borrower experiencing financial difficulties. The balances of
nonperforming loans reflect the net investment in these assets, including
deductions for purchase discounts.
As of December 31,
(dollars in thousands) 2019 2018 2017 2016 2015
Nonaccrual loans
Commercial $ 3,130 $ 5,224 $ 10,304 $ 7,718 $ 7,366
Real estate:
Commercial real estate, construction, land
and land development 6,461 1,329 2,716 5,885 591
Residential real estate 1,820 1,775 998 866 552
Single-family interim construction - 3,578 - 884 -
Agricultural 114 - - - 170
Consumer 22 32 55 273 111
Total nonaccrual loans (1) 11,547 11,938 14,073 15,626 8,790
Loans delinquent 90 days or more and still
accruing
Commercial 14,529 - 8 - -
Real estate:
Commercial real estate, construction, land
and land development - - 120 - -
Residential real estate - - 8 - -
Consumer - 5 - - -
Total loans delinquent 90 days or more and
still accruing 14,529 5 136 - -
Troubled debt restructurings, not included
in nonaccrual loans
Commercial - 114 - 1 16
Real estate:
Commercial real estate, construction, land
and land development 352 405 455 1,204 3,480
Residential real estate 188 168 730 1,011 2,574
Consumer - - 20 - -
Total troubled debt restructurings, not
included in nonaccrual loans 540 687 1,205 2,216 6,070
Total nonperforming loans 26,616 12,630 15,414 17,842 14,860
Other real estate owned and other
repossessed assets (Bank only):
Commercial - - - - 1,050
Commercial real estate, construction, land
and land development 4,819 4,200 5,400 783 2,168
Residential real estate - - 764 1,189 -
Single-family interim construction - - 963 - -
Consumer 114 114 114 4 14
Total other real estate owned and other
repossessed assets 4,933 4,314 7,241 1,976 3,232
Total nonperforming assets $ 31,549 $ 16,944 $ 22,655 $ 19,818 $ 18,092
Ratio of nonperforming loans to total loans
(2) 0.24 % 0.16 % 0.24 % 0.39 % 0.37 %
Ratio of nonperforming assets to total
assets 0.21 0.17 0.26 0.34 0.36
____________
(1) Nonaccrual loans include troubled debt restructurings of
thousand,
2019, 2018, 2017, 2016 and 2015, respectively and excludes loans acquired
with deteriorated credit quality of
respectively.
(2) Excluding mortgage warehouse purchase loans of
million,
2016 and 2015, respectively.
The Company had$11.5 million and$11.9 million in loans on nonaccrual status (excluding loans acquired with deteriorated credit quality) as ofDecember 31, 2019 and 2018, respectively. The decrease fromDecember 31, 2018 toDecember 31, 2019 was primarily due to a$2.9 million partial charge-off on a commercial energy loan relationship and a$3.2 million pay-off of a 55 --------------------------------------------------------------------------------
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single-family interim construction loan offset by nonaccrual loan additions of three commercial real estate loans totaling$5.3 million during the year. The Company did not recognize any interest income on nonaccrual loans during 2019 or 2018 while the loans were in nonaccrual status. The amount of interest the Company included in the Company's net interest income for the years ended 2019 and 2018 with respect to nonperforming loans was$901 thousand and$248 thousand , respectively. Additional interest income that the Company would have recognized on these nonperforming loans had they been current in accordance with their original terms was$481 thousand and$707 thousand during the years ended 2019 and 2018, respectively. Loans delinquent 90 days or more and still accruing increased to$14.5 million as ofDecember 31, 2019 . The increase was due to a$14.5 million commercial energy loan that had matured and was pending workout at the end of fourth quarter 2019. As ofDecember 31, 2019 , the Company had a total of 84 substandard and doubtful loans with an aggregate principal balance of$53.5 million that were not currently impaired loans or purchase credit impaired loans, nonaccrual loans, 90 days past due loans or troubled debt restructurings, but where the Company had information about possible credit problems of the borrowers that caused the Company's management to have serious concerns as to the ability of the borrowers to comply with present loan repayment terms and that could result in those loans becoming nonaccrual loans, 90 days past due loans or troubled debt restructurings in the future. The Company generally continues to use the classification of acquired loans classified as nonaccrual or 90 days and accruing as of the acquisition date. The Company does not classify acquired loans as troubled debt restructurings, or TDRs, unless the Company modifies an acquired loan subsequent to acquisition that meets the TDR criteria. Reported delinquency of the Company's purchased loan portfolio is based upon the contractual terms of the loans. As ofDecember 31, 2019 , the Company had other real estate owned and other repossessed assets of$4.9 million , which is an increase from the balance of$4.3 million for prior year. The increase is primarily due to$3.1 million of additions related to three former branch properties closed in second quarter as part of the announced footprint consolidation, offset by the dispositions of two properties totaling$2.2 million from the year over year period. The Company utilizes an asset risk classification system in compliance with guidelines established by the state and federal banking regulatory agencies as part of the Company's efforts to improve asset quality. In connection with examinations of insured institutions, examiners have the authority to identify problem assets and, if appropriate, classify them. There are three classifications for problem assets: "substandard," "doubtful," and "loss." Substandard assets have one or more defined weaknesses and are characterized by the distinct possibility that the insured institution will sustain some loss if the deficiencies are not corrected. Doubtful assets have the weaknesses of substandard assets with the additional characteristic that the weaknesses make collection or liquidation in full questionable and there is a high probability of loss based on currently existing facts, conditions and values. An asset classified as loss is not considered collectible and is of such little value that continuance as an asset is not warranted. The Company produces a problem asset report that is reviewed byIndependent Bank's board of directors monthly. That report also includes "pass/watch" loans and special mention. Pass/watch loans have a potential weakness that requires more frequent monitoring. Special mention credits have weaknesses that require attention. Officers and senior management review these loans monthly to determine if a more severe rating is warranted. Allowance for Loan Losses. The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. The Company's allowance for loan losses represents the Company's estimate of probable and reasonably estimable loan losses inherent in loans held for investment as of the respective balance sheet date. The Company's methodology for assessing the adequacy of the allowance for loan losses includes a general allowance for performing loans, which are grouped based on similar characteristics, and an allocated allowance for individual impaired loans. Actual credit losses or recoveries are charged or credited directly to the allowance. The Company establishes a general allowance for loan losses that the Company believes to be adequate for the losses the Company estimates to be inherent in the Company's loan portfolio. In making the Company's evaluation of the credit risk of the loan portfolio, the Company considers factors such as the volume, growth and composition of the loan portfolio, the effect of changes in the local real estate market on collateral values, trends in past dues, the experience of the lender, changes in lending policy, the effects on the loan portfolio of current economic indicators and their probable impact on borrowers, historical loan loss experience, the amount of nonperforming loans and related collateral and the evaluation of the Company's loan portfolio by the loan review function. 56
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The Company may assign a specific allowance to individual loans based on an
impairment analysis. Loans are considered impaired when it is probable that the
Company will be unable to collect all amounts due according to the contractual
terms of the loan agreement. The amount of impairment is based on an analysis of
the most probable source of repayment, including the present value of the loan's
expected future cash flows, the estimated market value or the fair value of the
underlying collateral. Loans evaluated for impairment include all commercial,
real estate, agricultural loans and TDRs.
The Company follows a loan review program to evaluate the credit risk in the
loan portfolio. Throughout the loan review process, the Company maintains an
internally classified loan watch list, which, along with a delinquency list of
loans, helps management assess the overall quality of the Company's loan
portfolio and the adequacy of the allowance for loan losses. Charge-offs occur
when the Company deems a loan to be uncollectible.
Analysis of the Allowance for Loan Losses. The following table sets forth the
allowance for loan losses by category of loan:
As of December 31,
2019 2018 2017 2016 2015
(dollars in % of % of % of % of % of
thousands) Amount Total Loans(1) Amount Total Loans(1) Amount Total Loans(1) Amount Total Loans(1) Amount Total Loans(1)
Commercial loans $ 12,844 21.3 % $ 11,793 17.2 % $ 10,599 16.3 % $ 8,593 13.7 % $ 10,573 18.3 %
Real estate:
Commercial real
estate, construction,
land and land
development 33,085 61.0 27,795 63.7 23,301 63.2 18,399 65.3 13,007 59.2
Residential real
estate 3,678 13.3 3,320 13.7 3,447 14.3 2,760 14.1 2,339 15.5
Single-family interim
construction 1,606 3.2 1,402 4.2 1,583 4.4 1,301 5.1 769 4.7
Agricultural 332 0.9 241 0.8 250 1.3 207 1.2 215 1.3
Consumer 226 0.3 186 0.4 205 0.5 242 0.6 164 1.0
Other 5 - 3 - (32 ) - 29 - 8 -
Unallocated (315 ) - 62 - 49 - 60 - (32 ) -
Total allowance for
loan losses $ 51,461 100.0 % $ 44,802 100.0 % $ 39,402 100.0 % $ 31,591 100.0 % $ 27,043 100.0 %
____________(1) Represents the percentage of Independent's total loans included in each loan
category.
As ofDecember 31, 2019 , the allowance for loan losses amounted to$51.5 million , or 0.47%, of total loans held for investment, excluding mortgage warehouse purchase loans, compared with$44.8 million , or 0.58%, as ofDecember 31, 2018 . The dollar increase during 2019 is primarily due to additional general reserves for organic loan growth. The decrease in the allowance for loan losses as a percentage of loans from prior year reflects loans acquired in the Guaranty transaction that were recorded at fair value without an allowance at acquisition. As ofDecember 31, 2019 , the discount on acquired loans totaled$93.6 million compared to$25.2 million as ofDecember 31, 2018 . The allowance for loan losses as a percentage of nonperforming loans decreased from 354.73% atDecember 31, 2018 , to 193.35% atDecember 31, 2019 , due to increase in total nonperforming loans primarily resulting from the$14.5 million commercial energy loan that had matured and pending workout as of year-end as discussed above under the nonperforming asset section. As ofDecember 31, 2019 , the Company had made a specific allowance for loan losses of$358 thousand for impaired loans totaling$12.1 million , compared with a specific allowance of$2.7 million for impaired loans totaling$14.6 million as ofDecember 31, 2018 . The decrease in specific reserves was due primarily to a partial charge-off of$1.5 million on a commercial energy loan relationship in addition to the removal of a$1.0 million specific reserve on another commercial energy loan due to a settlement pay-off and resulting$827 thousand charge-off. The decrease in impaired loans during 2019 was primarily due to a$2.9 million partial charge-off on the energy relationship noted above with the specific reserve of$1.5 million , the settlement pay-off of a$1.9 million energy loan noted above, as well as pay-offs totaling$4 million for a single-family interim construction loan and a commercial loan, offset by the additions of a commercial loan and two commercial real estate loans totaling$6.3 million . Although the allowance for loan losses to nonperforming loans has decreased significantly over the periods presented in the Company's consolidated financial statements appearing in this Annual Report on Form 10-K, the Company believes the allowance is appropriate and has been derived from consistent application of its methodology. The allowance is primarily related to loans evaluated collectively and will continue to increase as the Company's loan portfolio grows. Additional provision expense will vary depending on future credit quality trends within the portfolio. Refer to Note 1, Summary of 57 --------------------------------------------------------------------------------
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Significant Accounting Policies, and Note 6, Loans, Net and Allowance for Loan Losses, in the notes to the Company's audited consolidated financial statements included elsewhere in this report for additional details of the allowance for loan losses. The following table provides an analysis of the provisions for loan losses, net charge-offs and recoveries for the years endedDecember 31, 2019 , 2018, 2017, 2016 and 2015 and the effects of those items on the Company's allowance for loan losses: As of and for the Years Ended December 31, (dollars in thousands) 2019 2018 2017 2016 2015 Allowance for loan losses-balance at beginning of year$ 44,802 $ 39,402 $ 31,591 $ 27,043 $ 18,552 Charge-offs Commercial (7,709 ) (3,863 ) (81 ) (4,384 ) (606 ) Real estate: Commercial real estate, construction, land and land development (3 ) (435 ) (15 ) (54 ) (69 ) Residential real estate (140 ) (6 ) - (401 ) (9 ) Single-family interim construction (3 ) - (134 ) - - Consumer (79 ) (93 ) (182 ) (27 ) (52 ) Other (430 ) (228 ) (190 ) (104 ) (124 ) Total charge-offs (8,364 ) (4,625 ) (602 ) (4,970 ) (860 ) Recoveries Commercial 90 84 28 13 28 Real estate: Commercial real estate, construction, land and land development 4 20 31 10 42 Residential real estate - 3 4 12 5 Consumer 48 5 46 8 14 Other 76 53 39 35 31 Total recoveries 218 165 148 78 120 Net charge-offs (8,146 ) (4,460 ) (454 ) (4,892 ) (740 ) Provision for loan losses 14,805 9,860 8,265 9,440 9,231 Allowance for loan losses-balance at end of year$ 51,461 $ 44,802 $ 39,402 $ 31,591 $ 27,043 Ratios Net charge-offs to average loans outstanding 0.07 % 0.06 % 0.01 % 0.12 % 0.02 % Allowance for loan losses to nonperforming loans at end of year 193.35 354.73 255.62 177.06 181.99 Allowance for loan losses to total loans at end of year (1) 0.47 0.58 0.62 0.69 0.68 ____________
(1) Calculation excludes loans held for sale and mortgage warehouse purchase
loans from total loans.
The Company's ratio of allowance to loan losses to total loans as ofDecember 31, 2019 was 0.47%, down slightly from 0.58% atDecember 31, 2018 . The decrease in the allowance for loan losses as a percentage of loans from prior year reflects that loans acquired in the Guaranty transaction were recorded at fair value without an allowance at acquisition date. The ratio of net charge-offs to average loans outstanding during the year endedDecember 31, 2019 increased to 0.07% from 0.06% for the year endedDecember 31, 2018 . The increase in charge-offs during 2019 was primarily related to energy charge-offs. 58 --------------------------------------------------------------------------------
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Securities Available for Sale The Company's investment strategy aims to maximize earnings while maintaining liquidity in securities with minimal credit, interest rate and duration risk. The types and maturities of securities purchased are primarily based on the Company's current and projected liquidity and interest rate sensitivity positions. The following table sets forth the book value, which is equal to fair market value because all investment securities the Company held were classified as available for sale as of the applicable date, and the percentage of each category of securities as ofDecember 31, 2019 , 2018 and 2017: As of December 31, 2019 2018 2017 (dollars in thousands) Book Value % of Total Book Value % of Total Book Value % of Total Securities available for sale U.S. Treasury securities$ 48,796 4.5 %$ 29,643 4.3 %$ 37,154 4.9 %
Government agency securities 179,296 16.5 150,230
21.9 211,509 27.7
Obligations of state and
municipal subdivisions 343,859 31.7 185,007 27.0 229,613 30.1
Corporate bonds 7,218 0.7 - - - -
Residential pass-through
securities 505,567 46.5 320,470 46.8 274,377 35.9
Other securities 1,200 0.1 - - 10,349 1.4
Total securities available
for sale $ 1,085,936 100.0 % $ 685,350 100.0 %
The Company recognized net gains on the sale of securities of$275 thousand for the year endedDecember 31, 2019 and net losses on the sale of securities of$581 thousand for the year endedDecember 31, 2018 . Securities represented 7.3% and 7.0% of the Company's total assets atDecember 31, 2019 and 2018, respectively. Certain investment securities are valued at less than their historical cost. Management evaluates securities for other-than-temporary impairment (OTTI) on at least a quarterly basis and more frequently when economic or market conditions warrant such an evaluation. Management does not intend to sell any debt securities it holds and believes the Company more likely than not will not be required to sell any debt securities it holds before their anticipated recovery, at which time the Company will receive full value for the securities. Management has the ability and intent to hold the securities classified as available for sale that were in a loss position as ofDecember 31, 2019 for a period of time sufficient for an entire recovery of the cost basis of the securities. For those securities that are impaired, the unrealized losses are largely due to interest rate changes. The fair value is expected to recover as the securities approach their maturity date. Management believes any impairment in the Company's securities atDecember 31, 2019 is temporary and no other-than-temporary impairment has been realized in the Company's consolidated financial statements. 59
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The following table sets forth the book value, scheduled maturities and weighted average yields for the Company's investment portfolio as ofDecember 31, 2019 : % of Total Investment Weighted (dollars in thousands) Book Value Securities Average YieldU.S. Treasury securities Maturing within one year$ 5,037 0.5 % 1.54 % Maturing in one to five years 43,759 4.0 2.30 Maturing in five to ten years - - - Maturing after ten years - - - Total U.S. Treasury securities$ 48,796 4.5 % 2.22 % Government agency securities Maturing within one year$ 17,114 1.6 % 1.87 % Maturing in one to five years 55,782 5.1 2.03 Maturing in five to ten years 60,070 5.5 2.69 Maturing after ten years 46,330 4.3 2.62 Total government agency securities$ 179,296 16.5 % 2.39 % Obligations of state and municipal subdivisions Maturing within one year$ 9,922 0.9 % 2.16 % Maturing in one to five years 79,710 7.4 2.31 Maturing in five to ten years 105,517 9.7 2.49 Maturing after ten years 148,710 13.7 2.92 Total obligations of state and municipal subdivisions$ 343,859 31.7 % 2.62 % Corporate bonds Maturing within one year$ 2,015 0.2 % 3.20 % Maturing in one to five years 5,203 0.5 % 3.82 Maturing in five to ten years - - % - Maturing after ten years - - % - Total corporate bonds$ 7,218 0.7 % 3.64 % Residential pass through securities Maturing within one year $ - - % - % Maturing in one to five years 28,561 2.6 3.00 Maturing in five to ten years 111,626 10.3 2.55 Maturing after ten years 365,380 33.6 3.08 Total residential pass through securities$ 505,567 46.5 % 2.96 % Other securities Maturing within one year $ - - % - % Maturing in one to five years 450 - 2.44 Maturing in five to ten years 750 0.1 2.07 Maturing after ten years - - - Total other securities$ 1,200 0.1 % 2.25 % Total investment securities$ 1,085,936 100.0 % 2.73 % 60
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The following table summarizes the amortized cost of securities classified as available for sale and their approximate fair values as of the dates shown:
Gross
Gross Unrealized Unrealized
(dollars in thousands) Amortized Cost Gains Losses Fair Value
Securities available for sale
As of December 31, 2019
U.S. treasuries $ 48,060 $ 743 $ (7 ) $ 48,796
Government agency securities 178,953 926 (583 ) 179,296
Obligations of state and municipal
subdivisions 332,715 11,150 (6 ) 343,859
Corporate bonds 7,011 207 - 7,218
Mortgage-backed securities guaranteed by
FHLMC, FNMA and GNMA 493,915 11,981 (329 ) 505,567
Other securities 1,200 - - 1,200
$ 1,061,854 $ 25,007 $ (925 ) $ 1,085,936
As of December 31, 2018
U.S. treasuries $ 30,110 $ - $ (467 ) $ 29,643
Government agency securities 152,969 80 (2,819 ) 150,230
Obligations of state and municipal
subdivisions 187,366 727 (3,086 ) 185,007
Mortgage-backed securities guaranteed by
FHLMC, FNMA and GNMA 326,168 128 (5,826 ) 320,470
$ 696,613 $ 935$ (12,198 ) $ 685,350 As ofDecember 31, 2017 U.S. treasuries $ 37,480 $ -$ (326 ) $ 37,154 Government agency securities 213,649 83 (2,223 ) 211,509 Obligations of state and municipal subdivisions 228,782 2,118 (1,287 ) 229,613 Residential pass through securities guaranteed by FNMA, GNMA and FHLMC 274,356 1,229 (1,208 ) 274,377 Other securities 10,397 - (48 ) 10,349$ 764,664 $ 3,430 $ (5,092 ) $ 763,002 The Company's available for sale securities, carried at fair value, increased$400.6 million , or 58.4%, during 2019. The increase in 2019 was primarily due to the investments acquired in the Guaranty transaction. Residential pass-through securities (mortgage backed securities) are securities that have been developed by pooling a number of real estate mortgages that are principally issued by federal agencies. These securities are deemed to have high credit ratings, and minimum regular monthly cash flows of principal and interest are guaranteed by the issuing agencies. UnlikeU.S. Treasury andU.S. government agency securities, which have a lump sum payment at maturity, mortgage-backed securities provide cash flows from regular principal and interest payments and principal prepayments throughout the lives of the securities. Premiums and discounts on mortgage-backed securities are amortized over the expected life of the security and may be impacted by prepayments. As such, mortgage-backed securities which are purchased at a premium will generally suffer decreasing net yields as interest rates drop because home owners tend to refinance their mortgages resulting in prepayments and an acceleration of premium amortization, Securities purchased at a discount will generally obtain higher net yields in a decreasing interest rate environment as prepayments result in acceleration of discount accretion. Cash and Cash Equivalents Cash and cash equivalents increased by$434.4 million , or 332.2% to$565.2 million atDecember 31, 2019 from$130.8 million atDecember 31, 2018 . Cash and cash equivalent balances can vary due to cash needs and volatility of several large title company and commercial accounts. In addition, during the fourth quarter of 2018, the Company intentionally deployed its cash in an effort to limit growth and manage total assets under$10 billion through the end of 2018, thereby delaying the impact of the Durbin Amendment limitation on interchange income. GoodwillGoodwill represents the excess of the consideration paid over the fair value of the net assets acquired. The Company's total goodwill was$994.0 million atDecember 31, 2019 and$721.8 million as ofDecember 31, 2018 . The increase in the goodwill balance fromDecember 31, 2018 toDecember 31, 2019 is a result of$272.2 million in goodwill recognized from the acquisition of Guaranty. 61 --------------------------------------------------------------------------------
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Liabilities
Total liabilities increased$4.4 billion , or 53.1%, to$12.6 billion as ofDecember 31, 2019 , from$8.2 billion as ofDecember 31, 2018 , primarily due to$3.1 billion in deposit accounts,$142.7 million in FHLB advances and$40.0 million in subordinated debt acquired in the Guaranty transaction in addition to$24.5 million in borrowings against the Company's unsecured revolving line of credit with an unrelated commercial bank and organic deposit growth of$1.1 billion . Deposits Deposits representIndependent Bank's primary source of funds. The Company continues to focus on growing core deposits through the Company's relationship driven banking philosophy and community-focused marketing programs. Total deposits increased$4.2 billion , or 54.3%, to$11.9 billion as ofDecember 31, 2019 from$7.7 billion as ofDecember 31, 2018 . The increase is primarily due to organic growth as well as$3.1 billion in deposit accounts acquired in the Guaranty transaction. Brokered deposits totaled$894.1 million and$356.3 million atDecember 31, 2019 and 2018, respectively. As ofDecember 31, 2019 and 2018, noninterest-bearing demand, interest-bearing checking, savings deposits and limited access money market accounts accounted for 84.7% and 85.5%, respectively, of the Company's total deposits, while individual retirement accounts and certificates of deposit made up 15.3% and 14.5%, respectively, of total deposits. Noninterest-bearing demand deposits totaled$3.2 billion , or 27.1% of total deposits, as ofDecember 31, 2019 , compared with$2.1 billion , or 27.7% of total deposits, as ofDecember 31, 2018 . The total cost of deposits increased 25 basis points from 0.83% atDecember 31, 2018 to 1.08% atDecember 31, 2019 . The average cost of interest-bearing deposits was 1.48% per annum for 2019 compared with 1.16% for 2018. The increase in cost of funds was due to higher rates offered on our deposits products which were tied to higher Fed Funds rates from the year over year period. The following table summarizes the Company's average deposit balances and weighted average rates for the periods presented: As of December 31, 2019 2018 2017 Weighted Weighted Weighted (dollars in thousands) Average Balance Average Rate
Average Balance Average Rate Average Balance Average Rate
Deposit Type
Noninterest-bearing demand accounts
- % $ 2,052,675 - % $ 1,671,872 - %
Interest-bearing checking accounts 3,953,986 1.12
2,943,519 0.90 2,630,477 0.51
Savings accounts 540,741 0.25 290,325 0.24 263,381 0.14
Limited access money market
accounts 2,047,554 1.99 998,916 1.91 605,064 1.02
Certificates of deposit, including
individual retirement accounts
(IRA) 1,795,391 2.06 1,009,644 1.43 1,002,753 0.86
Total deposits $ 11,477,477 1.08 % $ 7,295,079 0.83 % $ 6,173,547 0.46 %
The following table sets forth the maturity of time deposits (including IRA
deposits) of
Maturity within:
Three to Six Six to Twelve After Twelve
(dollars in thousands) Three Months Months Months Months Total
Individual retirement
accounts $ 7,549 $ 7,112 $ 12,856 $ 9,572 $ 37,089
Certificates of deposit
(excluding CDARS) 283,137 298,348 586,626 223,866 1,391,977
CDARS 13,562 16,563 5,622 9,282 45,029
Total $ 304,248 $ 322,023 $ 605,104 $ 242,720 $ 1,474,095
Short-Term Borrowings
The Company's deposits have historically provided the Company with a major
source of funds to meet the daily liquidity needs of the Company's customers and
fund growth in earning assets. However, from time to time the Company may also
engage in short-term borrowings. At December 31, 2019 and 2018, the Company had
$124.5 million and $50.0 million , respectively, in short-term borrowings
outstanding, of which $100.0 million and $50.0 million , at December 31, 2019 and
2018, respectively,
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were short-term FHLB advances and$24.5 million of which were borrowings against its revolving line of credit atDecember 31, 2019 . These were recorded on the balance sheet under FHLB advances and other borrowings. The Company has not historically needed to engage in significant short-term borrowing through sources such as federal funds purchased, securities sold under agreements to repurchase or Federal Reserve Discount Window advances to meet the daily liquidity needs of the Company's customers or fund growth in earning assets. FHLB Advances In addition to deposits, the Company utilizes FHLB advances either as a short-term funding source or a longer-term funding source and to manage the Company's interest rate risk on the Company's loan portfolio. FHLB advances can be particularly attractive as a longer-term funding source to balance interest rate sensitivity and reduce interest rate risk. The Company's FHLB borrowings totaled$325.0 million as ofDecember 31, 2019 , compared with$290.0 million as ofDecember 31, 2018 . The change in FHLB borrowings from prior year reflects the use of short-term FHLB advances as needed for liquidity and to fund mortgage warehouse purchase loans. As ofDecember 31, 2019 and 2018, the Company had$3.7 billion and$2.0 billion , respectively, in unused and available advances from the FHLB. AtDecember 31, 2019 , the Company's FHLB advances are collateralized by assets, including a blanket pledge of certain loans with a carrying value of$4.5 billion and FHLB stock. As ofDecember 31, 2019 and 2018, the Company had$1.1 billion and$729.9 million , respectively, in undisbursed advance commitments (letters of credit) with the FHLB. The FHLB letters of credit were obtained in lieu of pledging securities to secure public fund deposits that are over theFDIC insurance limit. There were no disbursements against the advance commitments as ofDecember 31, 2019 or 2018. The following table provides a summary of the Company's FHLB advances at the dates indicated: As of December 31, (dollars in thousands) 2019 2018 2017 Fixed-rate, fixed term, at rates from 1.33% to 2.59%, with a weighted-average of 2.17% (maturing January 2020 through July 2021)$ 325,000 $ - $ - Fixed-rate, fixed term, at rates from 1.02% to 2.59%, with a weighted-average of 2.17% (maturing January 2019 through July 2021) - 290,000 - Fixed-rate, fixed term, at rates from 1.02% to 5.57%, with a weighted-average of 1.43% (maturing January 2018 through January 2026) -
- 530,667
As of
Principal Amount to Mature
As of
Maturing Within December 31, 2019
First Year $ 300,000
Second Year 25,000
Third Year -
Fourth Year -
Fifth Year -
Thereafter -
$ 325,000
Other Long-Term Indebtedness
As of December 31, 2019 and 2018, the Company had $177.8 million and $137.3
million , respectively, of long-term indebtedness (other than FHLB advances and
junior subordinated debentures) outstanding, which included subordinated
debentures. The increase from December 31, 2018 to December 31, 2019 was due to
$40.0 million of subordinated debentures acquired in the Guaranty transaction as
well as the discount accretion and origination fee amortization on the
debentures.
As of December 31, 2019 , the Company's long-term gross indebtedness of $110
million , $40 million and $30 million will mature on August 1, 2024 , July 20,
2026 and December 31, 2027 , respectively, with the $40 million and $30 million
debentures having an optional redemption date of July 20, 2021 and December 31,
2022 , respectively.
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Junior Subordinated Debentures As ofDecember 31, 2019 and 2018, the Company had outstanding an aggregate principal amount of$57.3 million and$31.6 million , respectively, of nine series of junior subordinated securities issued to nine unconsolidated subsidiary trusts. Each series of debentures was purchased by one of the trusts with the net proceeds of the issuance by such trust of floating rate trust preferred securities. These junior subordinated debentures are unsecured and will mature betweenMarch 2033 andSeptember 2037 . Each of the series of debentures bears interest at a per annum rate equal to three-month LIBOR plus a spread that ranges from 1.60% to 3.25%, with a weighted average rate of 4.46%. Interest on each series of these debentures is payable quarterly, although the Company may, from time to time defer the payment of interest on any series of these debentures. A deferral of interest payments would, however, restrict the Company's right to declare and pay cash distributions, including dividends on the Company's common stock, or making distributions with respect to any of the Company's future debt instruments that rank equally or are junior to such debentures. The Company may redeem the debentures, which are intended to qualify as Tier 1 capital, at the Company's option, subject to approval of theFederal Reserve . Capital Resources and Liquidity Management Capital Resources The Company's stockholders' equity is influenced by the Company's earnings, the sales and redemptions of common stock that the Company makes, stock based compensation expense, the dividends the Company pays on its common stock, and, to a lesser extent, any changes in unrealized holding gains or losses occurring with respect to the Company's securities available for sale. Total stockholder's equity was$2.3 billion atDecember 31, 2019 , compared with$1.6 billion atDecember 31, 2018 , an increase of approximately$733.3 million . The increase was primarily due to stock issued in the Guaranty acquisition for a total, net of offering costs, of$601.1 million . In addition, net income earned for the year totaling$192.7 million , stock based compensation of$7.8 million and an increase of$27.6 million in unrealized gain on available for sale securities offset by a cumulative adjustment for change in accounting principles of$926 thousand , stock repurchased by the Company totaling$51.7 million and dividends paid of$43.3 million . Liquidity Management Liquidity refers to the measure of the Company's ability to meet the cash flow requirements of depositors and borrowers, while at the same time meeting the Company's operating, capital and strategic cash flow needs, all at a reasonable cost. The Company's asset and liability management policy is intended to maintain adequate liquidity and, therefore, enhance the Company's ability to raise funds to support asset growth, meet deposit withdrawals and lending needs, maintain reserve requirements, and otherwise sustain operations. The Company accomplishes this through management of the maturities of the Company's interest-earning assets and interest-bearing liabilities. The Company believes that the Company's present position is adequate to meet the Company's current and future liquidity needs. The Company continuously monitors the Company's liquidity position to ensure that assets and liabilities are managed in a manner that will meet all of the Company's short-term and long-term cash requirements. The Company manages the Company's liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of the Company's shareholders. The Company also monitors its liquidity requirements in light of interest rate trends, changes in the economy, and the scheduled maturity and interest rate sensitivity of the investment and loan portfolios and deposits. Liquidity risk management is an important element in the Company's asset/liability management process. The Company's short-term and long-term liquidity requirements are primarily to fund on-going operations, including payment of interest on deposits and debt, extensions of credit to borrowers, capital expenditures and shareholder dividends. These liquidity requirements are met primarily through cash flow from operations, redeployment of pre-paid and maturing balances in the Company's loan and investment portfolios, debt financing and increases in customer deposits. The Company's liquidity position is supported by management of liquid assets and liabilities and access to alternative sources of funds. Liquid assets include cash, interest-bearing deposits in banks, federal funds sold, securities available for sale and maturing or prepaying balances in the Company's investment and loan portfolios. Liquid liabilities include core deposits, brokered deposits, federal funds purchased, securities sold under repurchase agreements and other borrowings. Other sources of liquidity include the sale of loans, the ability to acquire additional national market non-core deposits, the issuance of additional collateralized borrowings such as FHLB advances, the issuance of debt securities, borrowings through theFederal Reserve's discount window and the 64
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issuance of equity securities. For additional information regarding the Company's operating, investing and financing cash flows, see the Consolidated Statements of Cash Flows provided in the Company's consolidated financial statements. In addition to the liquidity provided by the sources described above, the Company maintains correspondent relationships with other banks in order to sell loans or purchase overnight funds should additional liquidity be needed. As ofDecember 31, 2019 and 2018 the Company had established federal funds lines of credit with various unaffiliated banks totaling$375 million and$365 million , respectively. Based on the values of stock, securities, and loans pledged as collateral, as ofDecember 31, 2019 and 2018, the Company had additional borrowing capacity with the FHLB of$3.7 billion and$2.0 billion , respectively. The Company also maintains a secured line of credit with theFederal Reserve Bank with an availability to borrow approximately$895.1 million and$738.9 million atDecember 31, 2019 and 2018, respectively. Approximately$1.2 billion and$978.3 million of commercial loans were pledged as collateral atDecember 31, 2019 and 2018, respectively. There were no borrowings against this line as ofDecember 31, 2019 or 2018. The Company also participates in an exchange that provides direct overnight borrowings with other financial institutions. The funds are provided on an unsecured basis. Borrowing availability totaled$484.0 million and$204.0 million atDecember 31, 2019 and 2018, respectively. There were no borrowings as ofDecember 31, 2019 and 2018. The Company has a$100 million unsecured revolving line of credit with an unrelated commercial bank. The line bears interest at LIBOR plus 1.75% and matured onJanuary 17, 2020 . As ofDecember 31, 2019 , the line had$24.5 million outstanding. As ofDecember 31, 2018 , there was no borrowings against the line. The Company is required to meet certain financial covenants on a quarterly basis, which includes maintaining$5 million in cash atIndependent Bank Group and meeting minimum capital ratios and bears a non-usage fee of 0.30% per year on the unused commitment at the end of each fiscal quarter. OnJanuary 17, 2020 , the line of credit was renewed. As ofMarch 2, 2020 , the Company had no borrowings against this line. The Company is a corporation separate and apart fromIndependent Bank and, therefore, the Company must provide for the Company's own liquidity. The Company's main source of funding is dividends declared and paid to the Company byIndependent Bank . Statutory and regulatory limitations exist that affect the ability ofIndependent Bank to pay dividends to the Company. Management believes that these limitations will not impact the Company's ability to meet the Company's ongoing short-term cash obligations. For additional information regarding dividend restrictions, see "Risk Factors-Risks Related to the Company's Business" in Part I, Item 1A, and "Supervision and Regulation" under Part I, Item 1, "Business." Regulatory Capital Requirements The Company's capital management consists of providing equity to support the Company's current and future operations. The Company is subject to various regulatory capital requirements administered by state and federal banking agencies, including the TDB,Federal Reserve and theFDIC . Failure to meet minimum capital requirements may prompt certain actions by regulators that, if undertaken, could have a direct material adverse effect on the Company's financial condition and results of operations. 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. Tier 2 capital for the Company includes permissible portions of the Company's subordinated notes. The permissible portion of qualified subordinated notes decreases 20% per year during the final five years of the term of the notes. The Company is subject to the Basel III regulatory capital framework (the "Basel III Capital Rules"). The implementation of the capital conservation buffer was effective for the Company onJanuary 1, 2016 at the 0.625% level and was phased-in over a four-year period increasing by 0.625% each year, until it reached 2.5% onJanuary 1, 2019 . The capital conservation buffer is designed to absorb losses during periods of economic stress and requires increased capital levels for the purpose of capital distributions and other payments. Failure to meet the full amount of the buffer will result in restrictions on the Company's ability to make capital distributions, including dividend payments and stock repurchases and to pay discretionary bonuses to executive officers. In connection with the adoption of the Basel III Capital Rules, we elected to opt-out of the requirement to include most components of accumulated other comprehensive income in regulatory capital. Accordingly, amounts reported as accumulated other comprehensive income/loss related to securities available for sale do not increase or reduce regulatory capital and are not included in the calculation of risk-based capital and leverage ratios. Regulatory agencies for banks and bank holding companies 65 --------------------------------------------------------------------------------
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utilize capital guidelines designed to measure capital and take into consideration the risk inherent in both on-balance sheet and off-balance sheet items. Please refer to Note 21, Regulatory Matters, in the notes to the Company's audited consolidated financial statements included elsewhere in this report for additional details. TheFDIC has promulgated regulations setting the levels at which an insured institution such asIndependent Bank would be considered well-capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized.Independent Bank is considered well-capitalized for purposes of the applicable prompt corrective action regulations. As ofDecember 31, 2019 and 2018, the Company and Bank exceeded all capital ratio requirements under prompt corrective action and other regulatory requirements, as detailed in the table below. The minimum required capital amounts presented as ofDecember 31, 2019 include the minimum required capital levels as ofJanuary 1, 2019 when the Basel III Capital Rules have been fully phased-in. As of December 31, 2019 Required Required to Minimum be Capital - Considered Basel III Well Actual Actual Fully Capitalized Consolidated Bank Phased-In (Bank Only) Ratio Ratio Ratio Ratio
Tier 1 capital to average assets ratio 9.32% 10.70% 4.00%
?5.00%
Common equity tier 1 to risk-weighted assets ratio 9.76 11.70 7.00
?6.50
Tier 1 capital to risk-weighted assets ratio 10.19 11.70 8.50
?8.00
Total capital to risk-weighted assets
ratio 11.83 12.11 10.50 ?10.00
As of December 31, 2018
Required to
be
Considered
Required Well
Actual Actual Minimum Capitalized
Consolidated Bank Capital (Bank Only)
Ratio Ratio Ratio RatioTier 1 capital to average assets ratio 9.57% 10.91% 4.00%
?5.00%
Common equity tier 1 to risk-weighted assets ratio 10.05 11.86 4.50
?6.50
Tier 1 capital to risk-weighted assets ratio 10.41 11.86 6.00
?8.00
Total capital to risk-weighted assets ratio 12.58 12.39 8.00
?10.00
Share Repurchase Program. OnOctober 24, 2018 , the Company announced the reestablishment of its share repurchase program. The program authorizes the purchase by the Company of up to$75 million of its common stock and was authorized to continue throughOctober 1, 2019 . OnOctober 17, 2019 , the repurchase program was renewed and authorized to continue throughDecember 31, 2020 . Under the Basel III Capital Rules, the Company may not repurchase its common stock (or repurchase or redeem any of its preferred stock or subordinated notes) without the prior approval of theFederal Reserve Board . The Company has repurchased a total of 897,738 shares at a total cost of$49.0 million throughMarch 2, 2020 . Shares of Company stock repurchased to settle employee tax withholding related to vesting of stock awards during the period endedDecember 31, 2019 totaled 55,106 at a total cost of$2.6 million and were not included under this program. See Part II, Item 5 - Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases ofEquity Securities , in this report for additional information. Contractual Obligations In the ordinary course of the Company's operations, the Company enters into certain contractual obligations, such as obligations for operating leases and other arrangements with respect to deposit liabilities, FHLB advances 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. 66 --------------------------------------------------------------------------------
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The following table contains supplemental information regarding the Company's
total contractual obligations as of
Payments Due
One to Three Three to Five After Five
(dollars in thousands) Within One Year Years Years Years Total
Deposits without a stated maturity
- $ - $ 10,111,420
Time deposits 1,531,507 277,555 20,854 - 1,829,916
FHLB advances 300,000 25,000 - - 325,000
Subordinated debt - - 110,000 70,000 180,000
Junior subordinated debentures - - - 57,324 57,324
Operating leases 5,964 10,774 7,650 8,454 32,842
Total contractual obligations
138,504
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 the items mentioned above, there have been no significant changes in the types of contractual obligations or amounts due sinceDecember 31, 2018 . See Note 13, Leases, in the accompanying notes to the Company's audited consolidated financial statements included elsewhere in this report for details of contractual lease obligations. Off-Balance Sheet Arrangements In the normal course of business, the Company enters into various transactions, which, in accordance with accounting principles generally accepted inthe United States , are not included in the Company's 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.Independent Bank enters into these transactions to meet the financing needs of the Company's 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 consolidated balance sheets. Commitments to Extend Credit.Independent Bank enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all ofIndependent Bank's commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding.Independent Bank minimizes its exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures. Standby Letters of Credit. Standby letters of credit are written conditional commitments thatIndependent Bank 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,Independent Bank would be required to fund the commitment. The maximum potential amount of future paymentsIndependent Bank could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, the customer is obligated to reimburseIndependent Bank for the amount paid under this standby letter of credit. Commitments to extend credit were$2.3 billion and$1.8 billion , as ofDecember 31, 2019 and 2018, respectively. Outstanding standby letters of credit were$23.4 million and$15.0 million , as ofDecember 31, 2019 and 2018, respectively. 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. 67 --------------------------------------------------------------------------------
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The Company guarantees the distributions and payments for redemption or liquidation of the trust preferred securities issued by the Company's wholly owned subsidiary trusts to the extent of funds held by the trusts. Although this guarantee is not separately recorded, the obligation underlying the guarantee is fully reflected on the Company's consolidated balance sheets as junior subordinated debentures, which debentures are held by the Company's subsidiary trusts. The junior subordinated debentures currently qualify as Tier 1 capital under theFederal Reserve capital adequacy guidelines. Refer to Note 12, Junior Subordinated Debentures, in the notes to the Company's audited consolidated financial statements included elsewhere in this report for additional details. Asset/Liability Management and Interest Rate Risk The principal objective of the Company's asset and liability management function is to evaluate the interest rate risk within the balance sheet and pursue a controlled assumption of interest rate risk while maximizing net income and preserving adequate levels of liquidity and capital. The Investment Committee ofIndependent Bank's board of directors has oversight ofIndependent Bank's asset and liability management function, which is managed by the Company's Treasurer. The Treasurer meets with the Company's Chief Financial Officer and senior executive team regularly to review, among other things, the sensitivity of the Company's assets and liabilities to market interest rate changes, local and national market conditions and market interest rates. That group also reviews the liquidity, capital, deposit mix, loan mix and investment positions of the Company. The Company's management and the board of directors are responsible for managing interest rate risk and employing risk management policies that monitor and limit the Company's exposure to interest rate risk. Interest rate risk is measured using net interest income simulations and market value of portfolio equity analyses. These analyses use various assumptions, including the nature and timing of interest rate changes, yield curve shape, prepayments on loans, securities and deposits, deposit decay rates, pricing decisions on loans and deposits, reinvestment/ replacement of asset and liability cash flows. Instantaneous parallel rate shift scenarios are modeled and utilized to evaluate risk and establish exposure limits for acceptable changes in net interest margin. These scenarios, known as rate shocks, simulate an instantaneous change in interest rates and use various assumptions, including, but not limited to, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment and replacement of asset and liability cash flows. The Company also analyzes the economic value of equity as a secondary measure of interest rate risk. This is a complementary measure to net interest income where the calculated value is the result of the market value of assets less the market value of liabilities. The economic value of equity is a longer term view of interest rate risk because it measures the present value of the future cash flows. The impact of changes in interest rates on this calculation is analyzed for the risk to the Company's future earnings and is used in conjunction with the analyses on net interest income. The Company conducts periodic analyses of our sensitivity to interest rate risks through the use of a third-party proprietary interest-rate sensitivity model. That model has been customized to our specifications. The analyses conducted by use of that model are based on current information regarding our actual interest-earnings assets, interest-bearing liabilities, capital and other financial information that we supply. The third party uses that information in the model to estimate our sensitivity to interest rate risk. The Company's interest rate risk model indicated that it was in a slightly asset sensitive position in terms of interest rate sensitivity as ofDecember 31, 2019 . The table below illustrates the impact of an immediate and sustained 200 and 100 basis point increase and a 100 basis point decrease in interest rates on net interest income based on the interest rate risk model as ofDecember 31, 2019 : Hypothetical Shift in Interest Rates (in bps) % Change in Projected Net Interest Income 200 2.34% 100 1.07 (100) 0.28 These are good faith estimates and assume that the composition of the Company's interest sensitive assets and liabilities existing at each year-end will remain constant over the relevant twelve-month measurement period and that changes in market interest rates are instantaneous and sustained across the yield curve regardless of duration of pricing characteristics of specific assets or liabilities. Also, this analysis does not contemplate any actions that the Company might undertake in response to changes in market interest rates. The Company believes these estimates are not necessarily indicative of what actually could 68
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occur in the event of immediate interest rate increases or decreases of this magnitude. As interest-bearing assets and liabilities re-price in different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions, the Company anticipates that its future results will likely be different from the foregoing estimates, and such differences could be material. Many assumptions are used to calculate the impact of interest rate fluctuations. Actual results may be significantly different than the Company's projections due to several factors, including the timing and frequency of rate changes, market conditions and the shape of the yield curve. The computations of interest rate risk shown above do not include actions that the Company's management may undertake to manage the risks in response to anticipated changes in interest rates and actual results may also differ due to any actions taken in response to the changing rates. As part of the Company's asset/liability management strategy, the Company's management has emphasized the origination of shorter duration loans to limit the negative exposure to rate changes.The average duration of the loan portfolio is less than four years. The Company's strategy with respect to liabilities has been to emphasize transaction accounts, particularly noninterest or low interest-bearing nonmaturing deposit accounts, which are less sensitive to changes in interest rates. In response to this strategy, nonmaturing deposit accounts have been a large portion of total deposits and totaled 84.7% and 85.5% of total deposits as ofDecember 31, 2019 and 2018, respectively. The Company had brokered deposits, including CDARS totaling$894.1 million and$356.3 million , atDecember 31, 2019 and 2018, respectively. The Company intends to focus on the Company's strategy of increasing noninterest or low interest-bearing nonmaturing deposit accounts, but may consider the use brokered deposits as a stable source of lower cost funding. Inflation and Changing Prices The largest component of earnings for the Company is net interest income, which is affected by changes in interest rates. Changes in interest rates are also influenced by changes in the rate of inflation, although not necessarily at the same rate or in the same magnitude. In management's opinion, changes in interest rates have a more significant impact to the Company's operations than do changes in inflation. However, inflation, does impact the operating costs of the Company, primarily employment costs and other services. Critical Accounting Policies and Estimates The preparation of the Company's consolidated financial statements in accordance withU.S. generally accepted accounting principles, or GAAP, requires the Company to make estimates and judgments that affect the Company's reported amounts of assets, liabilities, income and expenses and related disclosure of contingent assets and liabilities. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under current circumstances, results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. The Company evaluates its estimates on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions. Accounting policies, as described in detail in the notes to the Company's audited consolidated financial statements are an integral part of the Company's financial statements. A thorough understanding of these accounting policies is essential when reviewing the Company's reported results of operations and the Company's financial position. The Company believes that the critical accounting policies and estimates discussed below require the Company to make difficult, subjective or complex judgments about matters that are inherently uncertain. Changes in these estimates, that are likely to occur from period to period, or the use of different estimates that the Company could have reasonably used in the current period, would have a material impact on the Company's financial position, results of operations or liquidity. Acquired Loans. The Company's accounting policies require that the Company evaluates all acquired loans for evidence of deterioration in credit quality since origination and to evaluate whether it is probable that the Company will collect all contractually required payments from the borrower. Acquired loans from the transactions accounted for as a business combination include both loans with evidence of credit deterioration since their origination date and performing loans. The Company accounts for performing loans under ASC Paragraph 310-20, Nonrefundable Fees and Other Costs, with the related difference in the initial fair value and unpaid principal balance (the discount) recognized as interest income on a level yield basis over the life of the loan. The Company accounts for the nonperforming loans acquired in accordance with ASC Paragraph 310-30, Loans and Debt Securities Acquired with 69 --------------------------------------------------------------------------------
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Deteriorated Credit Quality. At the date of the acquisition, acquired loans are recorded at their fair value with no valuation allowance. For purchase credit impaired loans, the Company recognizes the difference between the undiscounted cash flows the Company expects (at the time the Company acquires the loan) to be collected and the investment in the loan, or the "accretable yield," as interest income using the interest method over the life of the loan. The Company does not recognize contractually required payments for interest and principal that exceed undiscounted cash flows expected at acquisition, or the "nonaccretable difference," as a yield adjustment, loss accrual or valuation allowance. Increases in the expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over the loan's remaining life, while decreases in expected cash flows are recognized as impairment. Valuation allowances on these impaired loans reflect only losses incurred after the acquisition. Upon an acquisition, the Company generally continues to use the classification of acquired loans classified nonaccrual or 90 days and accruing. The Company does not classify acquired loans as TDRs unless the Company modifies an acquired loan subsequent to acquisition that meets the TDR criteria. Reported delinquency of the Company's purchased loan portfolio is based upon the contractual terms of the loans. Allowance for Loan Losses. The allowance for loan losses represents management's estimate of probable and reasonably estimable credit losses inherent in the loan portfolio. In determining the allowance, the Company estimates losses on individual impaired loans, or groups of loans which are not impaired, where the probable loss can be identified and reasonably estimated. On a quarterly basis, the Company assesses the risk inherent in the Company's loan portfolio based on qualitative and quantitative trends in the portfolio, including the internal risk classification of loans, historical loss rates, changes in the nature and volume of the loan portfolio, industry or borrower concentrations, delinquency trends, detailed reviews of significant loans with identified weaknesses and the impacts of local, regional and national economic factors on the quality of the loan portfolio. Based on this analysis, the Company records a provision for loan losses in order to maintain the allowance at appropriate levels. Determining the amount of the allowance is considered a critical accounting estimate, as it requires significant judgment and the use of subjective measurements, including management's assessment of overall portfolio quality. The Company maintains the allowance at an amount the Company believes is sufficient to provide for estimated losses inherent in the Company's loan portfolio at each balance sheet date, and fluctuations in the provision for loan losses may result from management's assessment of the adequacy of the allowance. Changes in these estimates and assumptions are possible and may have a material impact on the Company's allowance, and therefore the Company's financial position, liquidity or results of operations. OnJanuary 1, 2020 , the Company adopted a new accounting standard which replaces the "incurred loss" model for measuring credit losses discussed above with a new "expected loss" model. Refer to Note 2, Recent Accounting Pronouncements, in the notes to the Company's audited consolidated financial statements included elsewhere in this report for additional details.Goodwill and Other Intangible Assets. The excess purchase price over the fair value of net assets from acquisitions, or goodwill, is evaluated for impairment at least annually and on an interim basis if an event or circumstance indicates that it is likely an impairment has occurred. The Company first assesses qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, the Company determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, then performing a two step impairment test is unnecessary. If the Company concludes otherwise, then it is required to perform the first step of the two step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. In testing for impairment in the past, the fair value of net assets is estimated based on an analysis of the Company's market value. Determining the fair value of goodwill is considered a critical accounting estimate because the allocation of the fair value of goodwill to assets and liabilities requires significant management judgment and the use of subjective measurements. Variability in the market and changes in assumptions or subjective measurements used to allocate fair value are reasonably possible and may have a material impact on the Company's financial position, liquidity or results of operations. Core deposit intangibles and other acquired customer relationship intangibles lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability. Other intangible assets are being amortized on a straight-line basis over their estimated useful lives ranging from ten to thirteen years. Other intangible assets are tested for impairment 70 --------------------------------------------------------------------------------
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whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value. Recently Issued Accounting Pronouncements The Company has evaluated new accounting pronouncements that have recently been issued and have determined that there are no new accounting pronouncements that should be described in this section that will materially impact the Company's operations, financial condition or liquidity in future periods. Refer to Note 2 of the Company's audited consolidated financial statements for a discussion of recent accounting pronouncements that have been adopted by the Company or that will require enhanced disclosures in the Company's financial statements in future periods.
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