INDEPENDENT BANK GROUP, INC. Cautionary Note Regarding Forward Looking Statements The Quarterly Report on Form 10-Q, our other filing 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 that are subject to risks and uncertainties and are made pursuant to the safe harbor provisions of Section 27A of the Securities Act, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and other related federal security laws. These forward-looking statements include information about our possible or assumed 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, 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, but not exclusively, 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 our 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 our future financial results and performance and could cause those results or performance to differ materially from those expressed in the forward-looking statements. These possible events or factors include, but are not limited to: •the disruption to local, regional, national and global economic activity caused by infectious disease outbreaks, including the recent outbreak of coronavirus, or COVID-19, and the significant impact that such outbreak has had and may have on our growth, operations, earnings and asset quality; •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 inTexas andColorado ; •worsening business and economic conditions nationally, regionally and in our target markets, particularly inTexas andColorado , and the geographic 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 inTexas andColorado ; •changes in asset quality, including increases in default rates on loans and higher levels of nonperforming loans and loan charge-offs generally, and specifically resulting from the economic dislocation caused by the COVID-19 pandemic; •concentration of the loan portfolio ofIndependent Bank , before and after 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 ofIndependent Bank to make loans with acceptable net interest 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 generally, and specifically as a result of the effect of the COVID-19 pandemic; •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 byIndependent 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; 39 -------------------------------------------------------------------------------- Table of Contents •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 ofIndependent Bank and the financial institutions that we acquire and that affect the net interest income, other future cash flows, or the market value of the assets of each ofIndependent Bank and 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, including the economic dislocation resulting from the COVID-19 pandemic, that affect the amount and value of the assets ofIndependent 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, including the economic dislocation resulting from the COVID-19 pandemic; •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 andIndependent 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, theFinancial 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 ofFDIC insurance and other coverage; •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 ofIndependent Bank , the effects of the 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 we expect; •the impact of investments that the Company orIndependent 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 generally, and specifically as a result of the COVID-19 pandemic; •changes occur in business conditions and inflation generally, and specifically as a result of the COVID-19 pandemic; •an increase in the rate of personal or commercial customers' bankruptcies generally, and specifically as a result of the COVID-19 pandemic; •technology-related changes are harder to make or are more expensive than expected; 40 -------------------------------------------------------------------------------- Table of Contents •attacks on the security of, and breaches of, the Company's andIndependent Bank's digital information systems, the costs we orIndependent Bank incur to provide security against such attacks and any costs and liability the Company orIndependent Bank incurs in connection with any breach of those systems; •the potential impact of technology and "FinTech" entities on the banking industry generally; •the other factors that are described or referenced in Part I, Item 1A, of the Company's Annual Report on Form 10-K filed with theSEC onMarch 2, 2020 , as amended by the Company's Annual Report on Form 10-K/A filed with theSEC onMarch 6, 2020 , the Company's Quarterly Reports on Form 10-Q, in each case under the caption "Risk Factors"; and •other economic, competitive, governmental, regulatory, technological and geopolitical factors affecting the Company's operations, pricing and services. We urge you to consider all of these risks, uncertainties and other factors carefully in evaluating all such forward-looking statements made by us. As a result of these and other matters, including changes in facts, assumptions not being realized or other factors, 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 in this prospectus or made by us in any report, filing, document or information incorporated by reference in this prospectus, speaks only as of the date on which it is made. We undertake no obligation to update any such 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. We believe that these assumptions or bases have been chosen in good faith and that they are reasonable. However, we caution you that assumptions as to future occurrences or results almost always vary from actual future occurrences or results, and the differences between assumptions and actual occurrences and results can be material. Therefore, we caution you not to place undue reliance on the forward-looking statements contained in this prospectus or incorporated by reference herein. 41 -------------------------------------------------------------------------------- Table of Contents Overview This Management's Discussion and Analysis (MD&A) of Financial Condition and Results of Operations analyzes the major elements of the Company's financial condition and results of operation as reflected in the interim consolidated financial statements and accompanying notes appearing in this Quarterly Report on Form 10-Q. This section should be read in conjunction with the Company's interim consolidated financial statements and accompanying notes included elsewhere in this report and with the consolidated financial statements included in the Annual Report on Form 10-K, as amended, for the year endedDecember 31, 2019 . 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. As ofSeptember 30, 2020 , the Company operated 93 full service banking locations in north, central and southeastTexas regions, and along theColorado Front Range region, with 61 Texas locations and 32 Colorado locations. The Company's headquarters are located at7777 Henneman Way ,McKinney, Texas 75070 and its telephone number is (972) 562-9004. The Company's website address is www.ibtx.com. Information contained on the Company's website is not incorporated by reference into this Quarterly Report on Form 10-Q and is not part of this or any other report. 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, communication and technology 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. Recent Developments: COVID-19 InMarch 2020 , the outbreak of the Coronavirus Disease 2019 (COVID-19) was recognized as a pandemic by theWorld Health Organization . The spread of COVID-19 has caused economic and social disruption resulting in unprecedented uncertainty, volatility and disruption in financial markets, and has placed significant health, economic and other major pressures throughout the communities we serve,the United States and globally. While some industries have been impacted more severely than others, all businesses have been impacted to some degree This disruption has resulted in the shuttering of businesses across the country, significant job loss, material decreases in oil and gas prices and in business valuations, changes in consumer behavior related to pandemic fears, and aggressive measures by the federal government. Towards the end of second quarter 2020, many of the more restrictive government orders eased on a national level and more specifically in the Company's markets ofTexas andColorado , allowing businesses to reopen at varying capacity levels, which has boosted commercial and consumer activity during the third quarter 2020. However, the risk of a resurgence in infections and possible reimplementation of restrictions remains significant. The CARES Act and Other Regulations OnMarch 27, 2020 , the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law. It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors through programs like the Paycheck Protection Program (PPP). The CARES Act also includes a range of other provisions designed to support theU.S. economy and mitigate the impact of COVID-19 on financial institutions and their customers, including through the authorization of various programs and measures that theU.S. Department of the Treasury , theSmall Business Administration , theFederal Reserve Board , and other federal 42 -------------------------------------------------------------------------------- Table of Contents banking agencies may or are required to implement. Further, in response to the COVID-19 outbreak, theFederal Reserve Board has implemented or announced a number of facilities to provide emergency liquidity to various segments of theU.S. economy and financial market. Under the CARES Act, financial institutions are permitted to delay the implementation of ASU 2016-13, Financial Instruments - Credit Losses (CECL) until the earlier of the termination date of the national emergency declaration by the President or byDecember 31, 2020 . The Company has elected such provision and will defer the adoption of CECL until such time has occurred with an effective retrospective implementation date ofJanuary 1, 2020 . Refer to Note 1, Summary of Significant Accounting Policies, to the Company's consolidated financial statements included elsewhere in this report. Additionally, in a related action to the CARES Act, the joint federal bank regulatory agencies issued an interim final rule effectiveMarch 31, 2020 , that allows banking organizations that implement CECL this year to elect to mitigate the effects of the CECL accounting standard on their regulatory capital for two years. This two-year delay is in addition to the three-year transition period that the agencies had already made available. Upon such point of adoption of CECL during 2020, the Company will elect to defer the regulatory capital effects of CECL in accordance with the interim final rule. The CARES Act also includes a provision that permits a financial institution to elect to suspend temporarily troubled debt restructuring accounting under ASC Subtopic 310-40 in certain circumstances (section 4013). To be eligible under section 4013, a loan modification must be (1) related to COVID-19; (2) executed on a loan that was not more than 30 days past due as ofDecember 31, 2019 ; and (3) executed betweenMarch 1, 2020 , and the earlier of (A) 60 days after the date of termination of the National Emergency or (B)December 31, 2020 . In response to this section of the CARES Act, the federal banking agencies issued a revised interagency statement onApril 7, 2020 that, in consultation with theFinancial Accounting Standards Board , confirmed that for loans not subject to section 4013, short-term modifications made on a good faith basis in response to COVID-19 to borrowerswho were current prior to any relief are not troubled debt restructurings under ASC Subtopic 310-40. This includes short-term (e.g., up to six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented. The company continues to monitor developments related to the pandemic and its impact on the Company's business, customers, employees, counterparties, vendors, and service providers. During the nine months endedSeptember 30, 2020 , the most notable financial impact to the Company's results of operations include a higher provision for loan losses primarily as a result of deterioration in macroeconomic variables, as well as lower service charge income and deposit and loan related expenses, as more fully discussed throughout this MD&A. In response to the COVID-19 pandemic, the Company has taken several actions to offer various forms of support to our employees, customers, and communities that have experienced impacts during this unprecedented time. In addition, the Company continues to take deliberate actions to ensure the continued health and strength of its balance sheet in order to serve its clients and communities.
Employees, Customers and Communities
•The Company is supporting the health and safety of its employees and customers, and complying with government directives, through responsible operations administered under its board approved business continuity plan and protocols resulting in minimal impacts to operations: •All branches are currently open and operating under reduced hours. Branch lobbies have been adjusted to encourage social distancing, surfaces are regularly sanitized and employees are required to wear face coverings when interacting with customers. •The Company increased customer education regarding mobile banking applications and developed aCOVID-19 Resource Center accessible on the Company's website. •Since earlyMarch 2020 , the Company has restricted employee travel and implemented work-from-home measures at minimal cost and with limited disruption to operations and customer experience. •The Company has participated in the CARES Act (PPP). As ofSeptember 30, 2020 , the Company has originated$826.0 million to 6,383 customers. Management believes that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program. 43 -------------------------------------------------------------------------------- Table of Contents •The Company continues to actively work with its borrowers on an individual, one-on-one basis to assess and understand the impact of pandemic-related economic hardships and provide prudent modifications allowing for payment deferrals or payment relief where appropriate. ThroughSeptember 30, 2020 , the Company has granted temporary COVID-19 modifications on over 2,100 loans totaling approximately$2.6 billion . The number of loans on active payment deferral has significantly declined since the beginning of the pandemic, and the vast majority of borrowerswho were provided temporary payment relief have returned to paying as originally agreed. As ofSeptember 30, 2020 , 322 loans with a total outstanding balance of$683.4 million remain in deferral status, of which$353.0 million are on second deferrals. Under the guidance noted above, such modifications are currently exempt from the accounting guidance for TDRs (Refer to Note 4, Loans, Net and Allowance for Loan Losses, to the Company's consolidated financial statements included elsewhere in this report). As ofOctober 16, 2020 , the amount of loans with active deferrals declined to$548.0 million across 239 accounts, which represents 4.5% of the Company's outstanding total loans held for investment balances, excluding PPP loans, as of third quarter end and 1.2% of the Company's outstanding total loan accounts at third quarter end. The$548.0 million in active deferrals, of which$329.7 million are second deferrals, include$204.1 million , or 37.2%, in hotel and motel;$87.3 million , or 15.9%, in retail;$18.3 million , or 3.3%, in office;$154.2 million , or 28.1%, in other commercial real estate (CRE) and construction and development (C&D); and$72.3 million , or 13.2% in general C&I, with the remainder spread throughout other portfolios. •The Company has made donations totaling over$100,000 to support food banks across its footprint to provide 355,000 meals to those most vulnerable during the crisis. Capital and Liquidity •Capital remains strong, with ratios of the Company, and its subsidiary bank, well above the standards to be considered well-capitalized under regulatory requirements. •Liquidity remains strong and continues to reflect excess balances, with cash and securities representing approximately 14.8% of total assets as ofSeptember 30, 2020 . The Company maintains the ability to access considerable sources of contingent liquidity at theFederal Home Loan Bank and theFederal Reserve . Management considers the Company's current liquidity position to be adequate to meet short-term and long-term liquidity needs. Refer to the section captioned "Liquidity Management" elsewhere in this discussion for additional information. Credit and Asset Quality •As noted above, the Company elected to defer the adoption of the CECL accounting standard and has continued its consistent application of the incurred loss method for estimating the allowance for loan losses and applicable provision. Due to the macroeconomic environment brought on by the pandemic and energy price volatility, the Company recorded$23.1 million and$7.6 million in provision for loan losses during second and third quarter 2020, respectively, increasing the allowance for loan losses to$87.5 million atSeptember 30, 2020 . Management believes that the allowance adequately supports inherent credit losses within the loan portfolio. Refer to the section captioned "Provision" and "Allowance for Loan Loss" elsewhere in this discussion for additional information. •During third quarter 2020, the Company adjusted the risk grades of several of its loans as the pandemic's impacts on borrowers became clearer. Classified loans have increased year to date by$75.2 million to$189.5 million , or 1.6% of loans held for investment, net of mortgage warehouse purchase loans, as ofSeptember 30, 2020 . Loans on special mention also increased by$128.3 million during the year. These increases are mainly reflective of the migration of several hotel loans as well as a few loans in the office and senior living portfolios. This prudent adjustment of risk grades is reflective of the Company's longstanding credit culture with a lender focus to continue to facilitate constructive engagement with borrowers through these challenging times. Overall, asset quality remains solid, reflecting the Company's disciplined underwriting and conservative lending philosophy which has supported strong credit performance during prior financial crises. Refer to Note 4, Loans, Net and Allowance for Loan Losses, to the Company's consolidated financial statements included elsewhere in this report and to the section captioned "Asset Quality" elsewhere in this discussion for additional information. 44 -------------------------------------------------------------------------------- Table of Contents •While all industries could experience adverse impacts as a result of the COVID-19 pandemic, the Company has an increased level of COVID-19 industry exposure risk in the following loan categories as ofSeptember 30, 2020 : •Commercial real estate (CRE) loans were$6.1 billion with an average loan size in the CRE portfolio is$1.2 million . •Construction and Development (C&D) loans were$1.6 billion . The average loan size in the C&D portfolio was$661.2 thousand and the average loan-to-value was 57.8%. Construction activity continues acrossTexas andColorado , and 98.4% of the Company's C&D loans are located within these states. Of the Company's C&D loans, 39.3% are for owner-occupied properties. •The Company's Retail CRE loans were approximately$1.7 billion , with the average loan size of$1.7 million . The mix of the portfolio consists of loans secured by 72.6% in strip centers properties, 15.2% in free standing/single tenant properties, 10.4% in mixed use properties, and 1.8% in big box properties. •The Company has approximately$444.3 million of loans secured by hotel and motel properties, with the average loan size of$5.6 million and the average loan-to-value of 52.7%. The mix of the portfolio consists of 64.0% of loans secured by limited service properties, 14.7% secured by full-service properties, 13.4% secured by extended stay properties, and 7.9% secured by boutique/independent properties. •Energy loans were$219.7 million , or 1.9% of total loans held for investment, excluding mortgage warehouse purchase loans. Energy loans are secured 90.5% by exploration and production of oil and gas, and 9.5% by energy services companies. Energy allowance for loan losses represents 6.1% of the total energy loan portfolio. This pandemic crisis has been impactful and the timing and magnitude of recovery cannot be predicted. The Company continues to closely monitor the impact of COVID-19 on its customers and the communities it serves; however, the extent to which the pandemic will impact operations and financial results during the remainder of 2020 is uncertain. Certain Events Affect Year-over-Year Comparability The Company completed the acquisition of Guaranty Bancorp, aColorado corporation and its subsidiary,Guaranty Bank and Trust Company (Guaranty), onJanuary 1, 2019 . As a result of the acquisition, the Company added 32 full service banking locations along theColorado Front Range including locations throughout theDenver metropolitan area and alongI-25 toFort Collins , expanding the Company's footprint inColorado . This acquisition increased total assets by$3.9 billion , gross loans by$2.8 billion and deposits by$3.1 billion . During 2019, the Company completed a rebalancing of its retail footprint by consolidating branches inTexas andColorado . This consolidation process resulted in the reduction of seven branches inColorado and four branches inTexas during second quarter 2019 and oneColorado reduction as well as a branch sale during third quarter of 2019. In addition, during fourth quarter of 2019, the Company sold the trust business acquired in the Guaranty acquisition. The comparability of the Company's results of operations for the three and nine months endedSeptember 30, 2020 and 2019 is affected by these transactions. Termination of proposed merger with Texas Capital Bancshares, Inc.: The Company and Texas Capital Bancshares, Inc. (TCBI) and its subsidiary,Texas Capital Bank , had entered into an Agreement and Plan of Merger (Merger Agreement), dated as ofDecember 9, 2019 , providing for the merger of TCBI with and into the Company. OnMay 22, 2020 , the Company and TCBI entered into a mutual agreement (Agreement) to terminate the Merger Agreement. Discussion and Analysis of Results of Operations for the Three and Nine Months EndedSeptember 30, 2020 and 2019 The following discussion and analysis of the Company's results of operations compares the operations for the three and nine months endedSeptember 30, 2020 with the three and nine months endedSeptember 30, 2019 . The results of operations for the three and nine months endedSeptember 30, 2020 are not necessarily indicative of the results of operations that may be expected for all of the year endingDecember 31, 2020 . 45 -------------------------------------------------------------------------------- Table of Contents Results of Operations For the three months endedSeptember 30, 2020 , net income was$60.1 million ($1.39 per common share on a diluted basis) compared with net income of$55.6 million ($1.30 per common share on a diluted basis) for the three months endedSeptember 30, 2019 . The Company posted annualized returns on average equity of 9.73% and 9.68%, returns on average assets of 1.43% and 1.50% and efficiency ratios of 44.69 and 48.27% for the three months endedSeptember 30, 2020 and 2019, respectively. The efficiency ratio is calculated by dividing total noninterest expense (which excludes the provision for loan losses and the amortization of other intangible assets) by net interest income plus noninterest income. For the nine months endedSeptember 30, 2020 , net income was$142.9 million ($3.31 per common share on a diluted basis) compared with$142.5 million ($3.29 per common share on a diluted basis) for the nine months endedSeptember 30, 2019 . The Company posted annualized returns on average equity of 7.91% and 8.48%, returns on average assets of 1.19% and 1.33% and efficiency ratios of 49.33% and 53.09% for the nine months endedSeptember 30, 2020 and 2019, 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. 46 -------------------------------------------------------------------------------- Table of Contents Net interest income was$132.0 million for the three months endedSeptember 30, 2020 , an increase of$6.6 million , or 5.3%, from$125.4 million for the three months endedSeptember 30, 2019 . This increase in net interest income is due to decreased funding costs due to a declining rate environment during the year over year period. Average interest earning assets increased$2.0 billion or 15.2%, to$14.9 billion for the three months endedSeptember 30, 2020 compared to$13.0 billion for the three months endedSeptember 30, 2019 . The increase is primarily related to increased average loan balances including Paycheck Protection Program (PPP) loans and mortgage warehouse loans, as well as increased average interest-bearing deposits with correspondent banks. The yield on average interest earning assets decreased 102 basis points from 5.06% for the three months endedSeptember 30, 2019 to 4.04% for the three months endedSeptember 30, 2020 . The decrease is due primarily to lower rates on interest-earning assets due to decreases in the Fed Funds rate over the period coupled with increased volume of average interest-bearing deposits, in addition to decreased loan yields as a result of decreased loan accretion and the addition of lower yielding PPP loans to the portfolio. The average cost of interest-bearing liabilities decreased 95 basis points to 0.77% for the three months endedSeptember 30, 2020 compared to 1.72% for the three months endedSeptember 30, 2019 . The decrease is primarily due to lower rates offered on our deposit products, primarily promotional certificate of deposit products and money market accounts, as well as rate decreases on short-term FHLB advances and our other debt. The aforementioned changes resulted in a 32 basis point decrease in the net interest margin for the three months endedSeptember 30, 2020 at 3.52% compared to 3.84% for the three months endedSeptember 30, 2019 . The decrease was primarily due to lower asset yields, increased liquidity and a decrease in loan accretion income offset by the lower cost of funds of interest bearing liabilities. Net interest income was$383.6 million for the nine months endedSeptember 30, 2020 , an increase of$6.9 million , or 1.8%, from$376.7 million for the nine months endedSeptember 30, 2019 . The increase is due to a$1.7 billion increase, or 13.2%, in average interest-earning assets to$14.3 billion for the nine months endedSeptember 30, 2020 compared to$12.6 billion for nine months endedSeptember 30, 2019 , as well as decreased funding costs due to a declining rate environment during the year over year period. The increase in average interest-earning assets is primarily related to increased average loan balances including Paycheck Protection Program (PPP) loans and mortgage warehouse loans, as well an increase in average interest-bearing deposits with correspondent banks due to significant deposit growth during 2020. The average yield on interest earning assets decreased 88 basis points from 5.18% for the nine months endedSeptember 30, 2019 to 4.30% for the nine months endedSeptember 30, 2020 while the average rate paid on interest bearing liabilities decreased 65 basis points from 1.67% to 1.02% over the same period. The decrease from the prior year was primarily due to overall lower rates on interest-earning assets and liabilities due to decreases in the Fed Funds rate for the year over year period. The primary driver for decreased average yield on interest earning assets was lower loan yields as a result of decreased loan accretion and the addition of lower yielding PPP loans to the portfolio, coupled with increased volume of average interest-bearing deposits earning at lower rates. The decrease in the cost of interest-bearing liabilities is due to the lower rates offered on deposit products, primarily checking, promotional certificate of deposit products and money market accounts as well as lower rates paid on short-term FHLB advances and junior subordinated debt. The net interest margin for the nine months endedSeptember 30, 2020 decreased 41 basis points to 3.59% compared to 4.00% for the nine months endedSeptember 30, 2019 . 47 -------------------------------------------------------------------------------- Table of Contents Average Balance Sheet Amounts, Interest Earned and Yield Analysis. The following table present average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the three and nine months endedSeptember 30, 2020 and 2019. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances. Three Months Ended September 30, 2020 2019 Average Average Outstanding Yield/ Outstanding Yield/ (dollars in thousands) Balance Interest Rate (4) Balance Interest Rate (4) Interest-earning assets: Loans (1)$ 12,586,647 $ 144,138 4.56 %$ 11,341,768 $ 154,664 5.41 % Taxable securities 705,918 4,507 2.54 777,494 5,374 2.74 Nontaxable securities 351,759 2,126 2.40 329,989 2,074 2.49 Interest bearing deposits and other 1,287,320 1,027 0.32 513,524 3,195
2.47
Total interest-earning assets 14,931,644 151,798 4.04 12,962,775 165,307 5.06 Noninterest-earning assets 1,782,251 1,779,843 Total assets$ 16,713,895 $ 14,742,618 Interest-bearing liabilities: Checking accounts$ 4,619,454 $ 5,512 0.47 %$ 3,950,978 $ 12,088 1.21 % Savings accounts 631,862 270 0.17 564,480 348 0.24 Money market accounts 2,471,550 4,361 0.70 2,101,064 10,923 2.06 Certificates of deposit 1,590,734 5,536 1.38 1,863,935 10,027 2.13 Total deposits 9,313,600 15,679 0.67 8,480,457 33,386 1.56 FHLB advances 594,022 714 0.48 453,370 2,730 2.39 Other borrowings 209,532 2,928 5.56 212,824 3,036 5.66 Junior subordinated debentures 53,955 470 3.47 53,757 762
5.62
Total interest-bearing liabilities 10,171,109 19,791 0.77 9,200,408 39,914 1.72 Noninterest-bearing checking accounts 3,991,014 3,160,832 Noninterest-bearing liabilities 94,349 101,500 Stockholders' equity 2,457,423 2,279,878 Total liabilities and equity$ 16,713,895 $ 14,742,618 Net interest income$ 132,007 $ 125,393 Interest rate spread 3.27 % 3.34 % Net interest margin (2) 3.52 3.84 Net interest income and margin (tax equivalent basis) (3)$ 132,978 3.54$ 126,308
3.87
Average interest-earning assets to
interest-bearing liabilities 146.80 140.89
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Table of Contents
Nine Months Ended September 30,
2020 2019
Average Average
Outstanding Yield/ Outstanding Yield/
(dollars in thousands) Balance Interest Rate (4) Balance Interest Rate (4)
Interest-earning assets:
Loans (1) $ 12,142,159 $ 434,648 4.78 % $ 11,048,706 $ 457,626 5.54 %
Taxable securities 740,252 14,499 2.62 775,732 16,101 2.78
Nontaxable securities 343,233 6,359 2.47 332,487 6,426 2.58
Interest bearing deposits and other 1,041,217 3,938 0.51 447,041 8,393 2.51
Total interest-earning assets 14,266,861 459,444 4.30 12,603,966 488,546 5.18 Noninterest-earning assets 1,790,569 1,770,708 Total assets$ 16,057,430 $ 14,374,674 Interest-bearing liabilities: Checking accounts$ 4,434,686 $ 22,529 0.68 %$ 3,902,517 $ 32,839 1.13 % Savings accounts 593,646 795 0.18 531,552 1,004 0.25 Money market accounts 2,276,036 16,714 0.98 2,025,704 31,575 2.08 Certificates of deposit 1,704,720 22,039 1.73 1,768,956 27,132 2.05 Total deposits 9,009,088 62,077 0.92 8,228,729 92,550 1.50 FHLB advances 693,248 3,629 0.70 466,603 8,324 2.39 Other borrowings 196,305 8,408 5.72 200,115 8,674 5.80 Junior subordinated debentures 53,906 1,710 4.24 53,708 2,310
5.75
Total interest-bearing liabilities 9,952,547 75,824 1.02 8,949,155 111,858 1.67 Noninterest-bearing checking accounts 3,597,192 3,093,390 Noninterest-bearing liabilities 92,646 84,933 Stockholders' equity 2,415,045 2,247,196 Total liabilities and equity$ 16,057,430 $ 14,374,674 Net interest income$ 383,620 $ 376,688 Interest rate spread 3.28 % 3.51 % Net interest margin (2) 3.59 4.00 Net interest income and margin (tax equivalent basis) (3)$ 386,476 3.62$ 379,440
4.03
Average interest-earning assets to interest-bearing liabilities 143.35 140.84 ____________ (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 three and nine months endedSeptember 30, 2020 and 2019. (4) Yield and rates for the three and nine month periods are annualized. 49 -------------------------------------------------------------------------------- Table of Contents 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 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 recorded a$7.6 million provision for loan losses for the three months endedSeptember 30, 2020 compared to$5.2 million for the comparable period in 2019. Provision expense for the nine months endedSeptember 30, 2020 was$39.1 million compared to$13.2 million for the same period in 2019. Provision expense is generally reflective of organic loan growth as well as charge-offs or specific reserves taken during the respective period. The increase from prior year is primarily due to general provision expense incurred during 2020 due to economic factors related to the COVID-19 and energy price volatility. The increase is also reflective of an$8.9 million net increase in specific reserves for the nine months endingSeptember 30, 2020 , including specific reserve allocations of$1.4 million on a commercial loan and$6.9 million on an energy credit. Net charge-offs were$184 thousand and$5.9 million for the three months endedSeptember 30, 2020 and 2019, respectively, and$3.1 million and$7.6 million for the nine months endedSeptember 30, 2020 and 2019, respectively. Net charge-offs for the nine months endedSeptember 30, 2020 were elevated primarily due to second quarter 2020 charge-offs on a$1.1 million commercial loan,$735 thousand commercial real estate loan and$563 thousand energy credit. Net charge-offs for the nine months endedSeptember 30, 2019 were elevated primarily due to third quarter 2019 charge-offs on two commercial credits totaling$5.6 million and first quarter 2019 commercial loan charge-offs of$1.5 million . Noninterest Income The following table sets forth the components of noninterest income for the three and nine months endedSeptember 30, 2020 and 2019 and the period-over-period variations in such categories of noninterest income: Three Months Ended September 30, Variance Nine Months Ended September 30, Variance (dollars in thousands) 2020 2019 2020 v. 2019 2020 2019 2020 v. 2019 Noninterest Income Service charges on deposit accounts$ 2,173 $ 2,805 $ (632) (22.5) %$ 6,881 $ 9,247 $ (2,366) (25.6) % Investment management and trust 1,924 2,497 (573) (22.9) % 5,556 7,238 (1,682) (23.2) % Mortgage banking revenue 14,722 4,824 9,898 205.2 % 27,726 11,619 16,107 138.6 % Gain on sale of loans - 6,779 (6,779) N/M 647 6,779 (6,132) N/M Gain on sale of branch - 1,549 (1,549) N/M - 1,549 (1,549) N/M Gain on sale of other real estate - 539 (539) N/M 37 851 (814) N/M Gain on sale of securities available for sale - - - N/M 382 265 117 N/M Gain (loss) on sale and disposal of premises and equipment 34 (315) 349 N/M 311 (585) 896 N/M Increase in cash surrender value of BOLI 1,335 1,402
(67) (4.8) % 4,007 4,135 (128) (3.1) % Other 4,977 7,244 (2,267) (31.3) % 19,604 18,849 755 4.0 % Total noninterest income$ 25,165 $ 27,324 $ (2,159) (7.9) %$ 65,151 $ 59,947 $ 5,204 8.7 % ____________ N/M - not meaningful Total noninterest income decreased$2.2 million , or 7.9% and increased$5.2 million , or 8.7% for the three and nine months endedSeptember 30, 2020 over same periods in 2019, respectively. Significant changes in the components of noninterest income are discussed below. 50 -------------------------------------------------------------------------------- Table of Contents Service charges on deposit accounts. Service charges on deposit accounts decreased$632 thousand , or 22.5% and$2.4 million , or 25.6%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. Service charge income related to transaction volumes such as non-sufficient funds and service charge fees have been adversely impacted by the pandemic during 2020. Investment management and trust. Investment management and trust decreased$573 thousand , or 22.9%, and$1.7 million , or 23.2%, for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The decrease is primarily a result of the sale of the trust business in fourth quarter 2019 coupled with a decline in assets under management, resulting from the market decline during 2020. Mortgage banking revenue. Mortgage banking revenue increased$9.9 million , or 205.2% and increased$16.1 million , or 138.6% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The increase was primarily reflective of increased mortgage origination and refinance activity resulting from the low interest rate environment during 2020. Revenue was also positively impacted by the favorable market conditions during 2020, which resulted in fair value gains on our derivative hedging instruments of$982 thousand and$2.7 million for the three and nine months endedSeptember 30, 2020 , respectively, compared to a gain of$106 thousand and a loss of$519 thousand for the same periods in 2019, respectively. Other. Other noninterest income decreased$2.3 million , or 31.3% and increased$755 thousand , or 4.0% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The decrease from the prior year three month period is primarily due to decreases of$1.9 million in interchange income as a result of the Durbin amendment becoming effective for the Company starting third quarter 2020, as well as, a decrease of$1.2 million in swap dealer income, offset by an increase of$810 thousand in mortgage warehouse fees. The change for the year over year nine month period is due to the recovery of a$3.5 million contingency reserve on an acquired SBA loan participation sold in addition to higher mortgage warehouse fees offset by$2.4 million in interchange income as well as a decrease in swap dealer income. Noninterest Expense Noninterest expense decreased$3.5 million , or 4.6% and decreased$10.6 million , or 4.4% for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The following table sets forth the components of the Company's noninterest expense for the three and nine months endedSeptember 30, 2020 and 2019 and the period-over-period variations in such categories of noninterest expense: Three Months Ended September Nine Months Ended September 30, Variance 30, Variance (dollars in thousands) 2020 2019 2020 v. 2019 2020 2019 2020 v. 2019 Noninterest Expense Salaries and employee benefits$ 42,253 $ 37,645 $ 4,608 12.2 %$ 115,341 $ 120,557 $ (5,216) (4.3) % Occupancy 9,717 9,402 315 3.4 29,132 27,978 1,154 4.1 Communications and technology 5,716 5,758 (42) (0.7) 17,193 16,598 595 3.6 FDIC assessment (credit) 1,597 (2,139) 3,736 N/M 5,338 71 5,267 N/M Advertising and public relations 492 467 25 5.4 1,965 1,942 23 1.2 Other real estate owned expenses, net 43 152 (109) (71.7) 459 302 157 52.0 Impairment of other real estate 46 - 46 N/M 784 1,424 (640) (44.9) Amortization of other intangible assets 3,175 3,235 (60) (1.9) 9,526 9,705 (179) (1.8) Professional fees 2,871 2,057 814 39.6 9,266 4,771 4,495 94.2 Acquisition expense, including legal 47 9,465 (9,418) (99.5) 16,225 28,175 (11,950) (42.4) Other 7,452 10,906 (3,454) (31.7) 25,678 29,998 (4,320) (14.4) Total noninterest expense$ 73,409 $ 76,948 $ (3,539) (4.6) %$ 230,907 $ 241,521 $ (10,614) (4.4) % ____________ N/M - not meaningful 51
-------------------------------------------------------------------------------- Table of Contents Salaries and employee benefits. Salaries and employee benefits increased$4.6 million , or 12.2% and decreased$5.2 million , or 4.3% for the three and nine months endedSeptember 30, 2020 , respectively, compared to the same periods in 2019. The increase in third quarter 2020 as compared to third quarter 2019 is primarily due to higher salaries and accrued bonus expense due to higher headcount for the year over year period, partially offset by$911 thousand of conversion bonuses and severance and retention expenses related to the Guaranty transaction and a branch restructuring completed in third quarter 2019. In addition, third quarter 2020 increase is reflective of$1.1 million in elevated commission expense due to significantly increased mortgage production during the quarter. The decrease in salaries and benefits expense for the nine months endedSeptember 30, 2020 compared to the same period in 2019 is primarily due to deferred salaries costs of$10.3 million related to the originations of the PPP loans and other COVID-related loan modifications/deferrals during second quarter 2020, as well as elevated severance and retention expense incurred in 2019 totaling$5.4 million related to employees not retained from the Guaranty acquisition and the 2019 branch restructuring. In addition, the relative change in salaries and benefits expense for the nine months endedSeptember 30, 2020 compared to the same period in 2019 is reflective of$3.4 million in elevated commission expense, as well as 2020 increases of$2.8 million in severance expense and accelerated stock grant amortization related to departmental and business line restructurings,$1.4 million of bonuses and overtime related to PPP loan activity and increases for pandemic related special circumstance pay.FDIC assessment.FDIC assessment increased$3.7 million and$5.3 million for the three and nine months endedSeptember 30, 2020 , respectively, as compared to the same periods in 2019. The increase in theFDIC assessment from the comparable year over year periods was impacted by a$3.2 million Small Bank Assessment Credit recorded in third quarter 2019. In addition, theFDIC assessment was impacted by the Company becoming a large institution under regulatory guidelines, effectiveJanuary 1, 2020 , which resulted in higher assessment costs from the year over year periods. Professional fees. Professional fees increased$814 thousand , or 39.6%, and$4.5 million , or 94.2%, for the three and nine months endedSeptember 30, 2020 , respectively, compared to the same periods in 2019. Professional fees increased due to higher legal expenses related to ongoing acquired litigation, and increased consulting expenses related to a compliance project and new system implementations. Acquisition expenses. Acquisition expenses decreased$9.4 million and$12.0 million for the three and nine months endedSeptember 30, 2020 , respectively, compared to the same periods in 2019. Acquisition expense decreased compared to the same periods in prior year primarily due to elevated expenses in 2019 related to the Guaranty transaction including$8.7 million in change in control payments to Guaranty executives as well as an increase in professional fees, conversion-related expenses, and contract termination fees, including$6.9 million related to Guaranty's debit card provider expensed in third quarter of 2019. Off-setting these decreases are elevated expenses in 2020 related to the terminated merger including$8.8 million in integration costs and$6.0 million in legal and advisory fees. Other noninterest expense. Other noninterest expense decreased$3.5 million , or 31.7% and decreased$4.3 million , or 14.4% for the three and nine months endedSeptember 30, 2020 , respectively, compared to the same periods in 2019. The decrease in other noninterest expense for both the three and nine month periods is primarily due to lower deposit-related expenses and auto and travel expenses due to the pandemic disruption in 2020, while the decline for the quarter to quarter period also reflects lower loan expenses and impairment charges. In addition, the decrease in the nine month period is reflective of an operations loss recognized in second quarter 2019 which was partially recovered in second quarter 2020, resulting in a net total loss of$974 thousand for the year over year period. Income Tax Expense Income tax expense was$16.1 million and$35.8 million for the three and nine months endedSeptember 30, 2020 , respectively, and$14.9 million and$39.4 million for the same periods in 2019. The effective tax rates were 21.1% and 20.0% for the three and nine months endedSeptember 30, 2020 , respectively, compared to 21.1% and 21.7% for the same periods in 2019. The lower effective tax rate for the nine months endedSeptember 30, 2020 is primarily a result of the 2019 provision to return adjustment related to state income tax and an adjustment to the Company's estimated 2020 state income tax rates recorded in second quarter 2020, as well as an$856 thousand tax benefit recorded in first quarter 2020 due to the net operating loss carryback provision allowed through the enactment of the CARES Act. In addition, the change for the nine month comparable periods is reflective of a higher effective tax rate in 2019 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 for the period. 52 -------------------------------------------------------------------------------- Table of Contents Discussion and Analysis of Financial Condition The following is a discussion and analysis of the Company's financial condition as ofSeptember 30, 2020 andDecember 31, 2019 . Assets The Company's total assets increased by$2.2 billion , or 14.4%, to$17.1 billion as ofSeptember 30, 2020 from$15.0 billion atDecember 31, 2019 . The increase is due primarily to organic growth in addition to loan and deposit growth related to the PPP program. Loan Portfolio The Company's loan portfolio is the largest category of the Company's earning assets. The following table presents the balance and associated percentage of each major category in the Company's loan portfolio as ofSeptember 30, 2020 andDecember 31, 2019 : (dollars in thousands) September 30, 2020 December 31, 2019 Commercial (1)(2)$ 3,677,220 28.4 %$ 2,482,356 21.3 % Real estate: Commercial 6,056,583 46.7 5,872,653 50.4 Commercial construction, land and land development 1,261,913 9.7 1,236,623 10.6 Residential (3) 1,496,595 11.5 1,550,872 13.3 Single-family interim construction 320,387 2.5 378,120 3.2 Agricultural 86,049 0.7 97,767 0.9 Consumer 59,146 0.5 32,603 0.3 Other 381 - 621 - Total loans 12,958,274 100.0 % 11,651,615 100.0 % Deferred loan fees (2) (12,696) (1,695) Allowance for loan losses (87,491) (51,461) Total loans, net$ 12,858,087 $ 11,598,459 ____________
(1) Includes mortgage warehouse purchase loans of
As ofSeptember 30, 2020 andDecember 31, 2019 , total loans, net of allowance for loan losses and deferred fees, totaled$12.9 billion and$11.6 billion , respectively, which is an increase of 10.9% between the two dates. The increase is primarily due to$826.0 million of net PPP loans funded during 2020 as well as increases in the mortgage loans held for sale and mortgage warehouse purchase loans volumes during 2020 due to the low mortgage rate environment. 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. 53 -------------------------------------------------------------------------------- Table of Contents 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. 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. 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. As a result of the current economic environment caused by the COVID-19 outbreak, the Company has worked with its borrowers on an individual, one-on-one basis to assess and understand the impact of pandemic-related economic hardship on the borrowers and provide prudent modifications allowing for short-term payment deferrals or other payment relief where appropriate. The deferred payments along with interest accrued during the deferral period are due and payable on the maturity date. Under applicable accounting and regulatory guidance, such modifications are not considered troubled debt restructurings. It is possible that the Company's asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged. 54 -------------------------------------------------------------------------------- Table of Contents 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. (dollars in thousands) September 30, 2020 December 31, 2019 Nonaccrual loans Commercial $ 16,279 $ 3,130 Real estate: Commercial real estate, construction, land and land development 4,257 6,461 Residential real estate 2,161 1,820 Agricultural 680 114 Consumer 43 22 Total nonaccrual loans (1) 23,420 11,547
Loans delinquent 90 days or more and still accruing Commercial
296 14,529
Real estate: Commercial real estate, construction, land and land development
15,719 -
Total loans delinquent 90 days or more and still accruing 16,015 14,529
Troubled debt restructurings, not included in nonaccrual loans
Real estate: Commercial real estate, construction, land and land development 1,825 352 Residential real estate 181 188
Total troubled debt restructurings, not included in nonaccrual loans
2,006 540
Total nonperforming loans 41,441 26,616
Other real estate owned and other repossessed assets:
Real estate: Commercial real estate, construction, land and land development
1,167 4,819
Single family interim construction 475 -
Consumer 114 114
Total other real estate owned and other repossessed assets 1,756 4,933
Total nonperforming assets $ 43,197 $ 31,549
Ratio of nonperforming loans to total loans held for investment (2)
0.36 % 0.24 %
Ratio of nonperforming assets to total assets 0.25 0.21
____________
(1) Nonaccrual loans include troubled debt restructurings of$601 thousand and$668 thousand atSeptember 30, 2020 andDecember 31, 2019 , respectively and excludes loans acquired with deteriorated credit quality of$7.0 million and$10.9 million as ofSeptember 30, 2020 andDecember 31, 2019 , respectively. (2) Excluding mortgage warehouse purchase loans of$1.2 billion and$687.3 million as ofSeptember 30, 2020 andDecember 31, 2019 , respectively. Nonaccrual loans increased to$23.4 million atSeptember 30, 2020 from$11.5 million as ofDecember 31, 2019 . Troubled debt restructurings that were not on nonaccrual status totaled$2.0 million atSeptember 30, 2020 , increasing from$540 thousand atDecember 31, 2019 . The increase in nonaccrual loans was primarily due to a$13.8 million commercial energy loan, reflected in loans 90 days past due and still accruing as ofDecember 31, 2019 , as well as a$1.7 million commercial loan placed on nonaccrual, offset by a$1.1 million energy credit paydown and partial charge-off, a$1.1 million commercial loan charge-off and a$1.9 million single family construction loan placed in foreclosure during the nine months endedSeptember 30, 2020 . The increase in troubled debt restructurings was primarily due to a$1.5 million commercial real estate loan modified during first quarter 2020. Total loans delinquent 90 days or more and still accruing is elevated as ofSeptember 30, 2020 due to a$15.7 million commercial real estate loan which has matured and is pending workout at the end of third quarter. The net decrease in other real estate owned and repossessed assets is primarily due to the sale of three properties totaling$3.0 million . 55 -------------------------------------------------------------------------------- Table of Contents As ofSeptember 30, 2020 , the Company had a total of 96 substandard and doubtful loans with an aggregate principal balance of$116.7 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. Allowance for Loan Losses. As permitted under the CARES Act, the Company elected to defer the adoption of the current expected credit loss (CECL) accounting standard and has continued its consistent application of the incurred loss method for estimating the allowance for loan losses and applicable provision. 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. As ofSeptember 30, 2020 , the allowance for loan losses amounted to$87.5 million , or 0.75% of total loans held for investment, excluding mortgage warehouse purchase loans, compared with$51.5 million , or 0.47% as ofDecember 31, 2019 . The dollar and percentage increases from year end is primarily due to added reserves for economic concerns related to the pandemic, as well as$2.4 million in charge-offs and specific reserve increases of$6.9 million and$1.4 million placed on an energy and commercial credit, respectively. The allowance for loan losses to nonperforming loans has increased from 193.35% atDecember 31, 2019 to 211.12% atSeptember 30, 2020 . Nonperforming loans have increased from$26.6 million atDecember 31, 2019 to$41.4 million atSeptember 30, 2020 . 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 Company recognized a net gain of$0 and$382 thousand on the sale of securities for the three and nine months endedSeptember 30, 2020 , respectively, and a net gain of$0 and$265 thousand on the sale of securities for the three and nine month endedSeptember 30, 2019 , respectively. Securities represented 6.3% and 7.3% of the Company's total assets atSeptember 30, 2020 andDecember 31, 2019 , 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 ofSeptember 30, 2020 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 atSeptember 30, 2020 , is temporary and no other-than-temporary impairment has been realized in the Company's consolidated financial statements. 56 -------------------------------------------------------------------------------- Table of Contents Capital Resources and Regulatory Capital Requirements Total stockholder's equity was$2.5 billion atSeptember 30, 2020 compared to$2.3 billion atDecember 31, 2019 , an increase of approximately$136.6 million . The increase was primarily due to net income of$142.9 million earned by the Company during the nine months endedSeptember 30, 2020 , stock based compensation of$6.3 million and an increase of$19.8 million in unrealized gain on available for sale securities offset by dividends paid of$32.3 million . As ofSeptember 30, 2020 , the Company and the Bank exceeded the Basel III capital ratio requirements under prompt corrective action and other regulatory requirements, as detailed in the table below: As of September 30, 2020 Required to be considered well Required minimum capitalized (Bank Actual Consolidated Actual Bank capital - Basel III only) Ratio Ratio Ratio Ratio Tier 1 capital to average assets ratio 9.15 % 10.97 % 4.00 % ?5.00% Common equity tier 1 capital to risk weighted assets ratio 10.24 12.77 7.00 ?6.50 Tier 1 capital to risk weighted assets ratio 10.66 12.77 8.50 ?8.00 Total capital to risk weighted assets ratio 13.29 13.42 10.50 ?10.00 Stock Repurchase Program. The Company established share repurchase programs in prior years which would allow the Company to purchase its common stock in the open market or in privately negotiated transactions. In general, stock repurchase programs allow the Company to proactively manage its capital position and return excess capital to shareholders. InOctober 2018 , the Company announced the reestablishment of its stock repurchase program. The program authorized the Company to repurchase up to$75.0 million of its common stock throughOctober 1, 2019 . InOctober 2019 , the stock repurchase program was renewed and extended throughDecember 31, 2020 . As ofDecember 31, 2019 , the Company repurchased a total of 897,738 shares of Company stock at a total cost of$49.0 million under this program. No repurchases were made during the nine month period endedSeptember 30, 2020 . OnOctober 22, 2020 , the Company's Board of Directors approved the renewal of its stock repurchase program prior to its expiration date, with an increased maximum limit of$150.0 million of common stock available to repurchase throughOctober 31, 2021 . Liquidity Management 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 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. 57 -------------------------------------------------------------------------------- Table of Contents 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 ofSeptember 30, 2020 , the Company had established federal funds lines of credit with nine unaffiliated banks totaling$365.0 million with no borrowings against the lines at that time. The Company also participates in an exchange that provides direct overnight borrowings with other financial institutions with a borrowing capacity of$664.0 million with none outstanding as ofSeptember 30, 2020 . The Company has an unsecured line of credit totaling$100.0 million with an unrelated commercial bank. There were no borrowings against the line as ofSeptember 30, 2020 . Based on the values of stock, securities, and loans pledged as collateral, as ofSeptember 30, 2020 , the Company had additional borrowing capacity with the FHLB of$4.1 billion . In addition, the Company maintains a secured line of credit with theFederal Reserve Bank with availability to borrow$746.8 million atSeptember 30, 2020 . InApril 2020 , the Company began originating loans to qualified small businesses under the CARES Act PPP administered by the SBA. As ofSeptember 30, 2020 , the Company has 6,383 loans outstanding totaling$826.0 million . DuringApril 2020 , the Company borrowed a$300.0 million advance from the FHLB that provided supplemental funding for the PPP loan originations. The short-term, full-recourse advance bore interest at an annualized rate of 0.35% and expired onJuly 15, 2020 . During second quarter 2020, the Company participated in theFederal Reserve's PPP Facility, which, throughSeptember 30, 2020 , extended loans to bankswho were loaning money to small businesses under the PPP. The amounts borrowed under the facility during second quarter 2020 totaled$7.6 million , bore interest at a rate of 0.35% and matured at the same time as the maturity date of the PPP loan pledged to secure the borrowing. As ofSeptember 30, 2020 , the Company had repaid all borrowings under the PPP Facility. Federal bank regulatory agencies issued an interim final rule that permits banks to neutralize the regulatory capital effects of participating in the PPP and the PPP Facility. Specifically, all PPP loans have a zero percent risk weight under applicable risk-based capital rules. Additionally, a bank may exclude all PPP loans pledged as collateral to the PPP Facility from its average total consolidated assets for the purposes of calculating its leverage ratio, while PPP loans that are not pledged as collateral to the PPP Facility will be included. 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. InSeptember 2020 , the Company completed the issuance and sale of$130.0 million in aggregate principal of unsecured 4.00% fixed-to-floating subordinated debentures. Refer to Note 5, Other Borrowings, to the Company's consolidated financial statements included elsewhere in this report. Other than the debt issuance noted above and normal changes in the ordinary course of business, there have been no significant changes in the types of contractual obligations or amounts due sinceDecember 31, 2019 . 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. 58 -------------------------------------------------------------------------------- Table of Contents 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.Independent Bank's commitments to extend credit and outstanding standby letters of credit were$2.3 billion and$25.0 million , respectively, as ofSeptember 30, 2020 . 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. 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 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 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 still 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. 59 -------------------------------------------------------------------------------- Table of Contents Allowance for Loan Losses. ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires a new credit loss methodology, the current expected credit loss (CECL) model, became effective for the Company onJanuary 1, 2020 . As provided to financial institutions under the CARES Act, the Company elected to defer the adoption of the CECL accounting standard and has continued its consistent application of the incurred loss method. Refer to Note 1, Summary of Significant Accounting Policies, in the notes to the Company's consolidated financial statements included elsewhere in this report for additional information. 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.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 quantitative impairment test is unnecessary. If the Company concludes otherwise, then it is required to perform an impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. The Company performs its impairment test annually as ofDecember 31 . During the period endedMarch 31, 2020 , the economic turmoil and market volatility resulting from the coronavirus (COVID-19) pandemic crisis resulted in a substantial decrease in the Company's stock price and market capitalization. Management believed such decrease was a triggering indicator requiring an interim goodwill impairment quantitative analysis which resulted in no impairment charge for the period endedMarch 31, 2020 . Subsequently, the Company's stock price and market capitalization has seen continued improvement throughSeptember 30, 2020 . Refer to Note 1, Summary of Significant Accounting Policies, in the notes to the Company's consolidated financial statements included elsewhere in this report for additional information. 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 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 1, Summary of Significant Accounting Policies, of the Company's 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. 60 --------------------------------------------------------------------------------
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