LegacyTexas Financial Group, Inc. - FORM 10-Q - April 25, 2017

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EX-32 - EXHIBIT 32 - LegacyTexas Financial Group, Inc.exhibit32020170331.htm
EX-31.2 - EXHIBIT 31.2 - LegacyTexas Financial Group, Inc.exhibit31220170331.htm
EX-31.1 - EXHIBIT 31.1 - LegacyTexas Financial Group, Inc.exhibit31120170331.htm
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2017
OR
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from                      to                     
Commission file number 001-34737
LEGACYTEXAS FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
Maryland
 
 
 
27-2176993
(State or other jurisdiction of incorporation or organization)
 
 
 
(I.R.S. Employer Identification No.)
 
 
 
 
 
5851 Legacy Circle, Plano, Texas
 
 
 
75024
(Address of Principal Executive Offices)
 
 
 
(Zip Code)
Registrant’s telephone number, including area code: (972) 578-5000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act. (Check one):
    
Large accelerated filer x
 
Accelerated filer o
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
Emerging growth company o
 
 
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class: Common Stock
 
Shares Outstanding as of April 24, 2017:
 
 
47,940,133



LEGACYTEXAS FINANCIAL GROUP, INC.
FORM 10-Q
March 31, 2017
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 





PART 1 - FINANCIAL INFORMATION        Item 1. Financial Statements
LEGACYTEXAS FINANCIAL GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except share and per share data)
 
March 31,
2017
 
December 31,
2016
ASSETS
(unaudited)
 
 
Cash and due from financial institutions
$
60,073

 
$
59,823

Short-term interest-bearing deposits in other financial institutions
294,955

 
229,389

Total cash and cash equivalents
355,028

 
289,212

Securities available for sale, at fair value
381,831

 
354,515

Securities held to maturity (fair value: March 31, 2017 — $203,394,
December 31, 2016— $212,981)
200,541

 
210,387

Loans held for sale, at fair value
19,315

 
21,279

Loans held for investment:
 
 
 
Loans held for investment (net of allowance for loan losses of $70,656 at March 31, 2017 and $64,576 at December 31, 2016)
6,197,429

 
5,998,596

Loans held for investment - Warehouse Purchase Program
846,973

 
1,055,341

Total loans held for investment
7,044,402

 
7,053,937

Federal Home Loan Bank ("FHLB") stock and other restricted securities, at cost
43,156

 
43,266

Bank-owned life insurance
56,768

 
56,477

Premises and equipment, net
72,312

 
74,226

Goodwill
178,559

 
178,559

Other assets
84,630

 
80,397

Total assets
$
8,436,542

 
$
8,362,255

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Deposits
 
 
 
Non-interest-bearing demand
$
1,449,656

 
$
1,383,951

Interest-bearing demand
873,085

 
903,314

Savings and money market
2,679,538

 
2,710,307

Time
1,377,367

 
1,367,904

Total deposits
6,379,646

 
6,365,476

FHLB advances
830,195

 
833,682

Repurchase agreements
76,880

 
86,691

Subordinated debt
134,155

 
134,032

Accrued expenses and other liabilities
115,749

 
57,009

Total liabilities
7,536,625

 
7,476,890

Commitments and contingent liabilities (See Note 10)


 


Shareholders’ equity
 
 
 
Preferred stock, $.01 par value; 10,000,000 shares authorized; 0 shares issued — March 31, 2017 and December 31, 2016
—

 
—

Common stock, $.01 par value; 90,000,000 shares authorized; 47,940,133 shares issued —
March 31, 2017 and 47,876,198 shares issued December 31, 2016
479

 
479

Additional paid-in capital
592,159

 
589,408

Retained earnings
321,648

 
310,641

Accumulated other comprehensive income (loss), net
(2,051
)
 
(2,713
)
Unearned Employee Stock Ownership Plan (ESOP) shares; 1,231,808 shares at March 31, 2017 and 1,245,046 shares at December 31, 2016
(12,318
)
 
(12,450
)
Total shareholders’ equity
899,917

 
885,365

Total liabilities and shareholders’ equity
$
8,436,542

 
$
8,362,255

See accompanying notes to consolidated financial statements.

3

LEGACYTEXAS FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(Dollars in thousands, except per share data)
 
Three Months Ended March 31,
 
2017
 
2016
Interest and dividend income
 
 
 
Loans, including fees
$
83,103

 
$
68,806

Taxable securities
2,562

 
2,312

Nontaxable securities
755

 
774

Interest-bearing deposits in other financial institutions
732

 
330

FHLB and Federal Reserve Bank stock and other
384

 
386

 
87,536

 
72,608

Interest expense
 
 
 
Deposits
7,110

 
4,122

FHLB advances
1,632

 
1,673

Repurchase agreements and other borrowings
2,246

 
1,462

 
10,988

 
7,257

Net interest income
76,548

 
65,351

Provision for credit losses
22,301

 
8,800

Net interest income after provision for credit losses
54,247

 
56,551

Non-interest income
 
 
 
Service charges and other fees
8,431

 
8,181

Net gain on sale of mortgage loans held for sale
1,628

 
1,580

Bank-owned life insurance income
422

 
426

Net gain (loss) on securities transactions
(19
)
 
—

Gain on sale and disposition of assets
1,399

 
4,072

Other
269

 
396

 
12,130

 
14,655

Non-interest expense
 
 
 
Salaries and employee benefits
24,444

 
22,337

Advertising
817

 
1,036

Occupancy and equipment
3,654

 
3,691

Outside professional services
1,156

 
816

Regulatory assessments
985

 
1,133

Data processing
3,895

 
3,290

Office operations
2,276

 
2,468

Other
2,525

 
2,771

 
39,752

 
37,542

Income before income tax expense
26,625

 
33,664

Income tax expense
8,435

 
11,582

Net income
$
18,190

 
$
22,082

 
 
 
 
Earnings per share:
 
 
 
Basic
$
0.39

 
$
0.48

Diluted
$
0.38

 
$
0.48

Dividends declared per share
$
0.15

 
$
0.14

 
 
 
 
See accompanying notes to consolidated financial statements.


4

LEGACYTEXAS FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
(Dollars in thousands)
 
Three Months Ended
 
March 31,
 
2017
 
2016
Net income
$
18,190

 
$
22,082

Change in unrealized gains on securities available for sale
999

 
3,039

Reclassification of amount realized through securities transactions
19

 
—

Tax effect
(356
)
 
(1,065
)
Other comprehensive income, net of tax
662

 
1,974

Comprehensive income
$
18,852

 
$
24,056

See accompanying notes to consolidated financial statements.


5


LEGACYTEXAS FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(unaudited)
(Dollars in thousands, except share and per share data)
For the three months ended March 31, 2016
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income, Net
 
Unearned
ESOP Shares
 
Total
Shareholders’
Equity
Balance at January 1, 2016
$
476

 
$
576,753

 
$
240,496

 
$
(133
)
 
$
(13,516
)
 
$
804,076

Net income
—

 
—

 
22,082

 
—

 
—

 
22,082

Other comprehensive income, net of tax
—

 
—

 
—

 
1,974

 
—

 
1,974

Dividends declared ($0.14 per share)
—

 
—

 
(6,670
)
 
—

 
—

 
(6,670
)
ESOP shares earned (35,742 shares)
—

 
404

 
—

 
—

 
293

 
697

Share-based compensation expense
—

 
997

 
—

 
—

 
—

 
997

Activity in employee stock plans (0 shares)
—

 
(104
)
 
—

 
—

 
—

 
(104
)
 Balance at March 31, 2016
$
476

 
$
578,050

 
$
255,908

 
$
1,841

 
$
(13,223
)
 
$
823,052

For the three months ended March 31, 2017
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2017
$
479

 
$
589,408

 
$
310,641

 
$
(2,713
)
 
$
(12,450
)
 
$
885,365

Net income
—

 
—

 
18,190

 
—

 
—

 
18,190

Other comprehensive income, net of tax
—

 
—

 
—

 
662

 
—

 
662

Dividends declared ($0.15 per share)
—

 
—

 
(7,183
)
 
—

 
—

 
(7,183
)
ESOP shares earned (13,238 shares)
—

 
420

 
—

 
—

 
132

 
552

Share-based compensation expense
—

 
1,562

 
—

 
—

 
—

 
1,562

Activity in employee stock plans (63,935 shares)
—

 
769

 
—

 
—

 
—

 
769

 Balance at March 31, 2017
$
479

 
$
592,159

 
$
321,648

 
$
(2,051
)
 
$
(12,318
)
 
$
899,917


See accompanying notes to consolidated financial statements.

6

LEGACYTEXAS FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(Dollars in thousands)

 
Three Months Ended March 31,
 
2017
 
2016
Cash flows from operating activities
 
 
 
Net income
$
18,190

 
$
22,082

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for credit losses
22,301

 
8,800

Depreciation and amortization
1,790

 
1,761

Deferred tax benefit
(2,541
)
 
(3,622
)
Premium amortization and accretion of securities, net
1,106

 
1,030

Accretion related to acquired loans
(943
)
 
(1,246
)
Net loss on securities transactions
19

 
—

ESOP compensation expense
552

 
697

Share-based compensation expense
1,562

 
997

Excess tax benefit on vesting of stock awards
832

 
—

Net gain on loans held for sale
(1,628
)
 
(1,580
)
Loans originated or purchased for sale
(39,927
)
 
(43,061
)
Proceeds from sale of loans held for sale
43,519

 
49,561

FHLB stock dividends
(120
)
 
(134
)
Bank-owned life insurance income
(422
)
 
(426
)
(Gain) on sale and disposition of repossessed assets, premises and equipment
(1,359
)
 
(3,940
)
Net change in deferred loan fees/costs
(5,073
)
 
(2,343
)
Net change in accrued interest receivable
1,125

 
(321
)
Net change in other assets
(913
)
 
952

Net change in other liabilities
58,515

 
26,468

Net cash provided by operating activities
96,585

 
55,675

Cash flows from investing activities
 
 
 
Available-for-sale securities:
 
 
 
Maturities, prepayments and calls
766,985

 
14,266

Purchases
(794,153
)
 
(21,123
)
Held-to-maturity securities:
 
 
 
Maturities, prepayments and calls
9,591

 
11,565

Originations of Warehouse Purchase Program loans
(4,258,685
)
 
(3,746,783
)
Proceeds from pay-offs of Warehouse Purchase Program loans
4,467,053

 
3,761,941

Net change in loans held for investment, excluding Warehouse Purchase Program loans
(218,855
)
 
(212,558
)
Redemption (purchase) of FHLB and Federal Reserve Bank stock and other
230

 
8,561

Purchases of premises and equipment
(781
)
 
(780
)
Proceeds from sale of assets
3,388

 
13,466

Net cash (used in) investing activities
(25,227
)
 
(171,445
)

7

CONSOLIDATED STATEMENTS OF CASH FLOWS (Continued)
(Dollars in thousands)

 
Three Months Ended March 31,
 
2017
 
2016
Cash flows from financing activities
 
 
 
Net change in deposits
14,170

 
76,138

Proceeds from FHLB advances
—

 
515,000

Repayments on FHLB advances
(3,487
)
 
(753,272
)
Repayments of borrowings
(9,811
)
 
(14,190
)
Payment of dividends
(7,183
)
 
(6,670
)
Activity in employee stock plans
769

 
(104
)
Net cash (used in) financing activities
(5,542
)
 
(183,098
)
Net change in cash and cash equivalents
65,816

 
(298,868
)
Beginning cash and cash equivalents
289,212

 
615,639

Ending cash and cash equivalents
$
355,028

 
$
316,771

Supplemental noncash disclosures:
 
 
 
Transfers from loans to other real estate owned
$
3,737

 
$
10,590

See accompanying notes to consolidated financial statements.

8
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)


NOTE 1 - BASIS OF FINANCIAL STATEMENT PRESENTATION
The accompanying consolidated interim financial statements of LegacyTexas Financial Group, Inc. (the “Company”) have been prepared in accordance with U.S. generally accepted accounting principles ("US GAAP") and with the rules and regulations of the Securities and Exchange Commission for interim financial reporting. Accordingly, they do not include all of the information and footnotes required for complete financial statements. In the opinion of management, all normal and recurring adjustments which are considered necessary to fairly present the results for the interim periods presented have been included. Certain items in prior periods were reclassified to conform to the current presentation. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2016 (“2016 Form 10-K”). Interim results are not necessarily indicative of results for a full year.
In preparing the financial statements, management is required to make estimates and assumptions that affect the recorded amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the period. Actual results could differ from those estimates. For further information with respect to significant accounting policies followed by the Company in preparation of its consolidated financial statements, refer to the 2016 Form 10-K.
The accompanying Unaudited Consolidated Interim Financial Statements include the accounts of the Company, whose business primarily consists of the operations of its wholly owned subsidiary, LegacyTexas Bank (the “Bank”). All significant intercompany transactions and balances are eliminated in consolidation.

9
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)


NOTE 2 - SHARE TRANSACTIONS
On March 1, 2016, the Company announced the resumption of its existing stock repurchase program. The open-ended stock repurchase program, which commenced in August 2012, allows for the repurchase of up to 1,978,871 shares in the open market and in negotiated transactions, depending on market conditions. At March 31, 2017, 441,750 shares have been repurchased under this stock repurchase program, leaving 1,537,121 shares available for future repurchases under the program. The Company has a trading plan with Sandler O’Neill & Partners, LP, which complies with Rule 10b5-1 of the Securities Exchange Act of 1934, as amended, to facilitate repurchases of its common stock pursuant to the above mentioned stock repurchase program. No shares of Company stock were repurchased under this program during the three months ended March 31, 2017.

10
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 3 - EARNINGS PER COMMON SHARE
Basic earnings per common share is computed by dividing net income (which has been adjusted for distributed and undistributed earnings to participating securities) by the weighted-average number of common shares outstanding for the period, reduced for average unallocated ESOP shares and average unvested restricted stock awards. Unvested restricted stock awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method described in Accounting Standards Codification ("ASC") 260-10-45-60B. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock (such as stock awards and options) were exercised or converted to common stock, or resulted in the issuance of common stock that then shared in the Company’s earnings. Diluted earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding for the period increased for the dilutive effect of unexercised stock options and unvested restricted stock awards. The dilutive effect of the unexercised stock options and unvested restricted stock awards is calculated under the treasury stock method utilizing the average market value of the Company’s stock for the period. A reconciliation of the numerator and denominator of the basic and diluted earnings per common share computation for the three months ended March 31, 2017 and 2016 is as follows:
 
Three Months Ended March 31,
 
2017
 
2016
Basic earnings per share:
 
 
 
Numerator:
 
 
 
Net income
$
18,190

 
$
22,082

Distributed and undistributed earnings to participating securities
(79
)
 
(128
)
Income available to common shareholders
$
18,111

 
$
21,954

Denominator:
 
 
 
Weighted average common shares outstanding
47,897,062

 
47,645,826

Less: Average unallocated ESOP shares
(1,240,486
)
 
(1,353,156
)
  Average unvested restricted stock awards
(202,918
)
 
(268,420
)
Average shares for basic earnings per share
46,453,658

 
46,024,250

Basic earnings per common share
$
0.39

 
$
0.48

Diluted earnings per share:
 
 
 
Numerator:
 
 
 
Income available to common shareholders
$
18,111

 
$
21,954

Denominator:
 
 
 
Average shares for basic earnings per share
46,453,658

 
46,024,250

Dilutive effect of share-based compensation plan
606,648

 
128,051

Average shares for diluted earnings per share
47,060,306

 
46,152,301

Diluted earnings per common share
$
0.38

 
$
0.48

Share awards excluded in the computation of diluted earnings per share because the exercise price was greater than the common stock average market price and were therefore antidilutive
129,008

 
1,696,399



11
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 4 - SECURITIES
The amortized cost, related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss), and the fair value of securities available for sale ("AFS") were as follows:
March 31, 2017
Amortized Cost
 
Gross Unrealized Gains
 
Gross
Unrealized
Losses
 
Fair Value
Agency residential mortgage-backed securities 1
$
217,460

 
$
535

 
$
2,090

 
$
215,905

Agency commercial mortgage-backed securities 1
9,407

 
—

 
94

 
9,313

Agency residential collateralized mortgage obligations 1
118,471

 
48

 
1,411

 
117,108

US government and agency securities
2,008

 
102

 
—

 
2,110

Municipal bonds
37,644

 
144

 
393

 
37,395

Total securities
$
384,990

 
$
829

 
$
3,988

 
$
381,831

December 31, 2016
 
 
 
 
 
 
 
Agency residential mortgage-backed securities 1
$
220,744

 
$
635

 
$
2,828

 
$
218,551

Agency commercial mortgage-backed securities 1
9,422

 
—

 
75

 
9,347

Agency residential collateralized mortgage obligations 1
87,959

 
22

 
1,452

 
86,529

US government and agency securities
2,150

 
101

 
—

 
2,251

Municipal bonds
38,417

 
47

 
627

 
37,837

Total securities
$
358,692

 
$
805

 
$
4,982

 
$
354,515

1 Mortgage-backed securities and collateralized mortgage obligations are issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
The amortized cost (carrying amount), unrealized gains and losses, and fair value of securities held to maturity ("HTM") were as follows:
March 31, 2017
Amortized Cost
 
Gross Unrealized Gains
 
Gross
Unrealized
Losses
 
Fair Value
Agency residential mortgage-backed securities 1
$
70,110

 
$
1,055

 
$
620

 
$
70,545

Agency commercial mortgage-backed securities 1
27,874

 
769

 
125

 
28,518

Agency residential collateralized mortgage obligations 1
37,086

 
642

 
37

 
37,691

Municipal bonds
65,471

 
1,678

 
509

 
66,640

Total securities
$
200,541

 
$
4,144

 
$
1,291

 
$
203,394

December 31, 2016
 
 
 
 
 
 
 
Agency residential mortgage-backed securities 1
$
74,881

 
$
1,147

 
$
817

 
$
75,211

Agency commercial mortgage-backed securities 1
28,023

 
836

 
166

 
28,693

Agency residential collateralized mortgage obligations 1
40,707

 
697

 
33

 
41,371

Municipal bonds
66,776

 
1,635

 
705

 
67,706

Total securities
$
210,387

 
$
4,315

 
$
1,721

 
$
212,981

1 Mortgage-backed securities and collateralized mortgage obligations are issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.


12
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

The amortized cost (carrying amount) and fair value of held to maturity debt securities and the fair value of available for sale debt securities at March 31, 2017 by contractual maturity are set forth in the table below. Securities with contractual payments not due at a single maturity date, including mortgage-backed securities and collateralized mortgage obligations, are shown separately.
 
HTM
 
AFS
 
Amortized Cost
 
Fair Value
 
Fair Value
Due in one year or less
$
2,437

 
$
2,464

 
$
2,505

Due after one to five years
9,419

 
9,753

 
13,367

Due after five to ten years
46,453

 
47,443

 
16,514

Due after ten years
7,162

 
6,980

 
7,119

Agency residential mortgage-backed securities
70,110

 
70,545

 
215,905

Agency commercial mortgage-backed securities
27,874

 
28,518

 
9,313

Agency residential collateralized mortgage obligations
37,086

 
37,691

 
117,108

Total
$
200,541

 
$
203,394

 
$
381,831


Securities with a carrying value of $220,489 and $224,674 at March 31, 2017 and December 31, 2016, respectively, were pledged to secure public deposits, repurchase agreements and for other purposes required or permitted by law. There were no sales of securities during the three months ended March 31, 2017 or 2016.

Securities with unrealized losses at March 31, 2017 and December 31, 2016, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:
AFS
Less than 12 Months
 
12 Months or More
 
Total
March 31, 2017
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Agency residential mortgage-backed securities 1
$
160,912

 
$
2,018

 
$
7,012

 
$
72

 
$
167,924

 
$
2,090

Agency commercial mortgage-backed securities 1
9,313

 
94

 
—

 
—

 
9,313

 
94

Agency residential collateralized mortgage obligations 1
97,625

 
1,382

 
2,034

 
29

 
99,659

 
1,411

Municipal bonds
16,044

 
290

 
2,901

 
103

 
18,945

 
393

Total temporarily impaired
$
283,894

 
$
3,784

 
$
11,947

 
$
204

 
$
295,841

 
$
3,988

December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
Agency residential mortgage-backed securities 1
$
167,503

 
$
2,770

 
$
7,516

 
$
58

 
$
175,019

 
$
2,828

Agency commercial mortgage-backed securities 1
9,347

 
75

 
—

 
—

 
9,347

 
75

Agency residential collateralized mortgage obligations 1
72,822

 
1,420

 
2,649

 
32

 
75,471

 
1,452

Municipal bonds
26,911

 
512

 
3,412

 
115

 
30,323

 
627

Total temporarily impaired
$
276,583

 
$
4,777

 
$
13,577

 
$
205

 
$
290,160

 
$
4,982















13
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

HTM
Less than 12 Months
 
12 Months or More
 
Total
March 31, 2017
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
 
Fair Value
 
Unrealized Loss
Agency residential mortgage-backed securities 1
$
42,034

 
$
620

 
$
—

 
$
—

 
$
42,034

 
$
620

Agency commercial mortgage-backed securities 1
7,270

 
125

 
—

 
—

 
7,270

 
125

Agency residential collateralized mortgage obligations 1
5,527

 
13

 
1,720

 
24

 
7,247

 
37

Municipal bonds
19,249

 
464

 
1,323

 
45

 
20,572

 
509

Total temporarily impaired
$
74,080


$
1,222

 
$
3,043

 
$
69

 
$
77,123


$
1,291

December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
Agency residential mortgage-backed securities 1
$
41,375

 
$
817

 
$
—

 
$
—

 
$
41,375

 
$
817

Agency commercial mortgage-backed securities 1
7,273

 
166

 
—

 
—

 
7,273

 
166

Agency residential collateralized mortgage obligations 1
6,322

 
11

 
1,451

 
22

 
7,773

 
33

Municipal bonds
19,362

 
658

 
1,045

 
47

 
20,407

 
705

Total temporarily impaired
$
74,332

 
$
1,652

 
$
2,496

 
$
69

 
$
76,828

 
$
1,721

1 Mortgage-backed securities and collateralized mortgage obligations are issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
Other-than-Temporary Impairment
In determining other-than-temporary impairment for debt securities, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than amortized cost; (2) the financial condition and near-term prospects of the issuer; (3) whether the market decline was affected by macroeconomic conditions; and (4) whether the Company has the intent and ability to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value.
As of March 31, 2017, 223 securities had unrealized losses, 21 of which had been in an unrealized loss position for over 12 months at March 31, 2017. The Company does not believe these unrealized losses are other-than-temporary and, at March 31, 2017, had the intent and ability to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. All principal and interest payments are being received on time and in full.


14
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 5 - LOANS
Loans consist of the following:
 
March 31,
2017
 
December 31,
2016
Loans held for sale, at fair value
$
19,315

 
$
21,279

 
 
 
 
Loans held for investment:
 
 
 
Commercial real estate
$
2,786,477

 
$
2,670,455

Commercial and industrial
2,028,347

 
1,971,160

Construction and land
290,258

 
294,894

Consumer real estate
1,109,459

 
1,074,923

Other consumer
50,722

 
53,991

Gross loans held for investment, excluding Warehouse Purchase Program
6,265,263

 
6,065,423

Net of:
 
 
 
Deferred costs (fees) and discounts, net
2,822

 
(2,251
)
Allowance for loan losses
(70,656
)
 
(64,576
)
Net loans held for investment, excluding Warehouse Purchase Program
6,197,429

 
5,998,596

Warehouse Purchase Program
846,973

 
1,055,341

Total loans held for investment
$
7,044,402

 
$
7,053,937


Activity in the allowance for loan losses for the three months ended March 31, 2017 and 2016, segregated by portfolio segment and evaluation for impairment, is set forth below. The below activity does not include Warehouse Purchase Program loans, which are collectively evaluated for impairment and are purchased under several contractual requirements, providing safeguards to the Company. To date, the Company has not experienced a loss on these loans and no allowance for loan losses has been allocated to them. At March 31, 2017 and 2016, the allowance for loan impairment related to purchased credit impaired ("PCI") loans totaled $225 and $178, respectively.
For the three months ended March 31, 2017
Commercial Real Estate
 
Commercial and Industrial
 
Construction and Land
 
Consumer Real Estate
 
Other Consumer
 
Total
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance - January 1, 2017
$
18,303

 
$
35,464

 
$
5,075

 
$
4,484

 
$
1,250

 
$
64,576

Charge-offs
(16
)
 
(16,530
)
 
(418
)
 
(35
)
 
(247
)
 
(17,246
)
Recoveries
205

 
40

 
—

 
12

 
369

 
626

Provision expense
866

 
21,912

 
(98
)
 
(76
)
 
96

 
22,700

Ending balance - March 31, 2017
$
19,358

 
$
40,886

 
$
4,559

 
$
4,385

 
$
1,468

 
$
70,656

Allowance ending balance:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
37

 
$
9,337

 
$
—

 
$
180

 
$
371

 
$
9,925

Collectively evaluated for impairment
19,321

 
31,549

 
4,559

 
4,205

 
1,097

 
60,731

Loans:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
4,336

 
94,494

 
310

 
2,783

 
973

 
102,896

Collectively evaluated for impairment
2,776,564

 
1,933,645

 
289,948

 
1,105,793

 
49,520

 
6,155,470

PCI loans
5,577

 
208

 
—

 
883

 
229

 
6,897

Ending balance
$
2,786,477

 
$
2,028,347

 
$
290,258

 
$
1,109,459

 
$
50,722

 
$
6,265,263


15
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

For the three months ended March 31, 2016
Commercial Real Estate
 
Commercial and Industrial
 
Construction and Land
 
Consumer Real Estate
 
Other Consumer
 
Total
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance - January 1, 2016
$
14,123

 
$
24,975

 
$
3,013

 
$
3,992

 
$
990

 
$
47,093

Charge-offs
—

 
(383
)
 
—

 
—

 
(198
)
 
(581
)
Recoveries
6

 
36

 
—

 
43

 
87

 
172

Provision expense
1,145

 
6,803

 
417

 
217

 
218

 
8,800

Ending balance - March 31, 2016
$
15,274

 
$
31,431

 
$
3,430

 
$
4,252

 
$
1,097

 
$
55,484

Allowance ending balance:
 
 
 
 
 
 
 
 
 
 

Individually evaluated for impairment
$
402

 
$
4,680

 
$
—

 
$
130

 
$
55

 
$
5,267

Collectively evaluated for impairment
14,872

 
26,751

 
3,430

 
4,122

 
1,042

 
50,217

Loans:
 
 
 
 
 
 
 
 
 
 

Individually evaluated for impairment
1,467

 
30,120

 
31

 
7,061

 
104

 
38,783

Collectively evaluated for impairment
2,315,238

 
1,609,736

 
267,512

 
964,199

 
64,894

 
5,221,579

PCI loans
7,633

 
186

 
—

 
855

 
276

 
8,950

Ending balance
$
2,324,338

 
$
1,640,042

 
$
267,543

 
$
972,115

 
$
65,274

 
$
5,269,312

The allowance for loan losses and related provision expense are susceptible to change if the credit quality of our loan portfolio changes, which is evidenced by many factors, including but not limited to charge-offs and non-performing loan trends. Generally, consumer real estate lending has a lower credit risk profile compared to other consumer lending (such as automobile loans). Commercial real estate and commercial and industrial lending, however, can have higher risk profiles than consumer loans due to these loans being larger in amount and non-homogeneous in structure and term. Changes in economic conditions, the mix and size of the loan portfolio and individual borrower conditions can dramatically impact our level of allowance for loan losses in relatively short periods of time.
The allowance for loan losses is maintained to cover incurred losses that are estimated in accordance with US GAAP. It is our estimate of credit losses inherent in our loan portfolio at each balance sheet date. Our methodology for analyzing the allowance for loan losses consists of general and specific components. For the general component, we stratify the loan portfolio into homogeneous groups of loans that possess similar loss potential characteristics and apply a loss ratio to these groups of loans to estimate the credit losses in the loan portfolio. We use both historical loss ratios and qualitative loss factors assigned to major loan collateral types to establish general component loss allocations, inclusive of estimated loss emergence periods. Qualitative loss factors are based on management's judgment of company, market, industry or business specific data and external economic indicators, which are not yet reflected in the historical loss ratios, and that could impact the Company's specific loan portfolios. The Allowance for Loan Loss Committee sets and adjusts qualitative loss factors by regularly reviewing changes in underlying loan composition and the seasonality of specific portfolios. The Allowance for Loan Loss Committee also considers credit quality and trends relating to delinquency, non-performing and adversely rated loans within the Company's loan portfolio when evaluating qualitative loss factors. Additionally, the Allowance for Loan Loss Committee adjusts qualitative factors to account for the potential impact of external economic factors, including the unemployment rate, vacancy and capitalization rates and other pertinent economic data specific to our primary market area and lending portfolios.
For the specific component, the allowance for loan losses includes loans where management has concerns about the borrower's ability to repay and on individually analyzed loans found to be impaired. Management evaluates current information and events regarding a borrower's ability to repay its obligations and considers a loan to be impaired when the ultimate collectability of amounts due, according to the contractual terms of the loan agreement, is in doubt. If an impaired loan is collateral-dependent, the fair value of the collateral, less the estimated cost to sell, is used to determine the amount of impairment. If an impaired loan is not collateral-dependent, the impairment amount is determined using the negative difference, if any, between the estimated discounted cash flows and the loan amount due. For impaired loans, the amount of the impairment can be adjusted, based on current data, until such time as the actual basis is established by acquisition of the collateral or until the basis is collected. Impairment losses are reflected in the allowance for loan losses through a charge to the provision for credit losses. Subsequent recoveries are credited to the allowance for loan losses. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement. Cash receipts on impaired loans for which the accrual of interest has been discontinued are applied first to principal.

16
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Large groups of smaller-balance homogeneous loans are collectively evaluated for impairment. As a result, the Company does not separately identify consumer real estate loans less than $417 or individual consumer non-real estate secured loans for impairment disclosures. The Company considers these loans to be homogeneous in nature due to the smaller dollar amount and the similar underwriting criteria.
Changes in the allowance for off-balance sheet credit losses on lending-related commitments and guarantees on credit card debt, included in "accrued expenses and other liabilities" on the consolidated balance sheets, are summarized in the following table. Please see Note 10 - Commitments and Contingent Liabilities for more information.
 
Three Months Ended March 31, 2017
Balance at beginning of period
$
1,573

Charge-offs on lending-related commitments
—

Provision for credit losses on lending-related commitments
(399
)
Balance at end of period
$
1,174

Impaired loans at March 31, 2017 and December 31, 2016, were as follows 1:
March 31, 2017
 
Unpaid
Contractual Principal
Balance
 
Recorded
Investment With No Allowance
 
Recorded
Investment With Allowance
 
Total Recorded Investment
 
Related
Allowance
Commercial real estate
 
$
4,474

 
$
4,336

 
$
—

 
$
4,336

 
$
—

Commercial and industrial
 
105,152

 
61,727

 
32,767

 
94,494

 
9,336

Construction and land
 
311

 
310

 
—

 
310

 
—

Consumer real estate
 
3,282

 
2,681

 
102

 
2,783

 
15

Other consumer
 
1,002

 
29

 
944

 
973

 
349

Total
 
$
114,221

 
$
69,083

 
$
33,813

 
$
102,896

 
$
9,700

December 31, 2016
 
 
 
 
 
 
 
 
 
 
Commercial real estate
 
$
5,388

 
$
4,429

 
$
766

 
$
5,195

 
$
272

Commercial and industrial
 
87,756

 
73,377

 
13,287

 
86,664

 
4,519

Construction and land
 
11,384

 
11,385

 
—

 
11,385

 
—

Consumer real estate
 
3,766

 
3,290

 
10

 
3,300

 
10

Other consumer
 
107

 
33

 
42

 
75

 
30

Total
 
$
108,401

 
$
92,514

 
$
14,105

 
$
106,619

 
$
4,831

1 
No Warehouse Purchase Program loans were impaired at March 31, 2017 or December 31, 2016. Loans reported do not include PCI loans.

17
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Income on impaired loans at March 31, 2017 and 2016, was as follows1:
March 31, 2017
 
 Average
Recorded
Investment
 
Interest
Income
Recognized
Commercial real estate
 
$
4,966

 
$
2

Commercial and industrial
 
88,076

 
—

Construction and land
 
7,388

 
—

Consumer real estate
 
3,042

 
3

Other consumer
 
297

 
1

Total
 
$
103,769

 
$
6

March 31, 2016
 
 
 
 
Commercial real estate
 
$
9,204

 
$
2

Commercial and industrial
 
21,063

 
1

Construction and land
 
32

 
—

Consumer real estate
 
5,935

 
4

Other consumer
 
112

 
1

Total
 
$
36,346

 
$
8

1 
Loans reported do not include PCI loans.
Past due status is based on the contractual terms of the loan. Loans that are past due 30 days are considered delinquent. Interest income on loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Non-mortgage consumer loans are typically charged off no later than 120 days past due. In all cases, loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and larger individually classified impaired loans.
All interest accrued but not received for loans placed on nonaccrual status is reversed against interest income. Subsequent receipts on non-accrual loans are recorded as a reduction of principal, and interest income is recorded only after principal recovery is reasonably assured. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.
No loans past due over 90 days were still accruing interest at March 31, 2017. At December 31, 2016, $141 of loans past due over 90 days were still accruing interest, which consisted entirely of PCI loans. At March 31, 2017, no PCI loans were considered non-performing loans. No Warehouse Purchase Program loans were non-performing at March 31, 2017 or December 31, 2016. Non-performing (nonaccrual) loans were as follows:
 
March 31, 2017
 
December 31, 2016
Commercial real estate
$
4,337

 
$
5,195

Commercial and industrial
94,503

 
86,664

Construction and land
310

 
11,385

Consumer real estate
7,193

 
7,987

Other consumer
1,061

 
158

Total
$
107,404

 
$
111,389

A loan that has been modified is considered a troubled debt restructuring (“TDR”) when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made for the borrower's benefit that would not otherwise be considered for a borrower or transaction with similar credit risk characteristics. Modifications to loan terms may include a modification of the contractual interest rate to a below-market rate (even if the modified rate is higher than the original rate), forgiveness of accrued interest, forgiveness of a portion of principal, an extended repayment period or a deed in lieu of foreclosure or other transfer of assets other than cash to fully or partially satisfy a debt. The Company's policy is to place all

18
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

TDRs on nonaccrual for a minimum period of six months. Loans qualify for return to accrual status once they have demonstrated performance with the restructured terms of the loan agreement for a minimum of six months and the collection of principal and interest under the revised terms is deemed probable. All TDRs are considered to be impaired loans.
The outstanding balances of TDRs are shown below:
 
March 31, 2017
 
December 31, 2016
Nonaccrual TDRs(1)
$
25,034

 
$
11,701

Performing TDRs (2)
446

 
454

Total
$
25,480

 
$
12,155

Specific reserves on TDRs
$
2,749

 
$
1,686

Outstanding commitments to lend additional funds to borrowers with TDR loans
—

 
—

1 
Nonaccrual TDR loans are included in the nonaccrual loan totals.
2 
Performing TDR loans are loans that have been performing under the restructured terms for at least six months and the Company is accruing interest on these loans.
The following tables provide the recorded balances of loans modified as a TDR during the three months ended March 31, 2017 and 2016.
 
Three Months Ended March 31, 2017
 
Principal Deferrals (1)
 
Combination of Rate Reduction and Principal Deferral
 
Other
 
Total
Commercial and industrial
$
—

 
$
—

 
$
14,592

(2) 
$
14,592

 
Three Months Ended March 31, 2016
Commercial and industrial
$
9

 
$
—

 
$
7,225

(2) 
$
7,234

Consumer real estate
67

 
83

 
—

 
150

Other consumer
—

 
—

 
3

 
3

Total
$
76

 
$
83

 
$
7,228

 
$
7,387

1 
Principal deferrals include Chapter 7 bankruptcy loans for which the court has discharged the borrower's obligation and the borrower has not reaffirmed the debt. Such loans are placed on non-accrual status.
2 
Reserve-based energy relationships where the primary modifications consisted of suspension of required borrowing base payments.
Loans modified as a TDR during the three months ended March 31, 2017 or 2016 which experienced a subsequent payment default during the periods are shown below. A payment default is defined as a loan that was 90 days or more past due.
 
Three Months Ended March 31,
 
2017
 
2016
Consumer real estate
$
—

 
$
36

Loans acquired with evidence of credit quality deterioration at acquisition, for which it was probable that the Company would not be able to collect all contractual amounts due, were accounted for as PCI loans. The carrying amount of PCI loans included in the consolidated balance sheets and the related outstanding balances at March 31, 2017 and December 31, 2016 are set forth in the table below. The outstanding balance represents the total amount owed, including accrued but unpaid interest, and any amounts previously charged off.
 
March 31, 2017
 
December 31, 2016
Carrying amount 1
$
6,672

 
$
6,793

Outstanding balance
7,465

 
7,597

1 
The carrying amounts are reported net of allowance for loan losses of $225 and $180 as of March 31, 2017 and December 31, 2016.

19
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Changes in the accretable yield for PCI loans for the three months ended March 31, 2017 and 2016 are as follows:
 
Three Months Ended March 31,
 
2017
 
2016
Beginning balance
$
2,515

 
$
3,356

Reclassifications from nonaccretable
198

 
237

Disposals
—

 
(268
)
Accretion
(186
)
 
(269
)
Balance at end of period
$
2,527

 
$
3,056

Below is an analysis of the age of recorded investment in loans that were past due at March 31, 2017 and December 31, 2016. No Warehouse Purchase Program loans were delinquent at March 31, 2017 or December 31, 2016 and therefore are not included in the following table.
March 31, 2017
30-59 Days Past Due
 
60-89 Days Past Due
 
90 Days and Greater Past Due
 
Total Loans Past Due
 
Current Loans 1
 
Total Loans
Commercial real estate
$
241

 
$
2,516

 
$
43

 
$
2,800

 
$
2,783,677

 
$
2,786,477

Commercial and industrial
2,573

 
1,345

 
7,598

 
11,516

 
2,016,831

 
2,028,347

Construction and land
142

 
—

 
310

 
452

 
289,806

 
290,258

Consumer real estate
15,765

 
1,307

 
428

 
17,500

 
1,091,959

 
1,109,459

Other consumer
536

 
14

 
916

 
1,466

 
49,256

 
50,722

Total
$
19,257

 
$
5,182

 
$
9,295

 
$
33,734

 
$
6,231,529

 
$
6,265,263

December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
1,829

 
$
72

 
$
766

 
$
2,667

 
$
2,667,788

 
$
2,670,455

Commercial and industrial
20,910

 
495

 
46

 
21,451

 
1,949,709

 
1,971,160

Construction and land
19,517

 
283

 
—

 
19,800

 
275,094

 
294,894

Consumer real estate
10,487

 
1,916

 
1,199

 
13,602

 
1,061,321

 
1,074,923

Other consumer
1,523

 
31

 
6

 
1,560

 
52,431

 
53,991

Total
$
54,266

 
$
2,797

 
$
2,017

 
$
59,080

 
$
6,006,343

 
$
6,065,423

1 
Includes acquired PCI loans with a total carrying value of $6,840 and $6,729 at March 31, 2017 and December 31, 2016, respectively.
For loans collateralized by real property and commercial and industrial loans, credit exposure is monitored by internally assigned grades used for classification of loans. A loan is considered “special mention” when management has determined that there is a potential weakness that deserves management's close attention. Loans rated as "special mention" are not adversely classified according to regulatory classifications and do not expose the Company to sufficient risk to warrant adverse classification. A loan is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged, if any. “Substandard” loans include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected, and the loan may or may not meet the criteria for impairment. Loans classified as “doubtful” have all of the weaknesses of those classified as “substandard” with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions and values, “highly questionable and improbable.” All other loans that do not fall into the above mentioned categories are considered “pass” loans. Updates to internally assigned grades are made monthly and/or upon significant developments.
For other consumer loans (non-real estate), credit exposure is monitored by payment history of the loans. Non-performing other consumer loans are on nonaccrual status and are generally greater than 90 days past due.

20
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

The recorded investment in loans by credit quality indicators at March 31, 2017 and December 31, 2016, was as follows.
Real Estate and Commercial and Industrial Credit Exposure
Credit Risk Profile by Internally Assigned Grade
March 31, 2017
 
Commercial Real Estate
 
Commercial and Industrial
 
Construction and Land
 
Consumer Real Estate
Grade: 1
 
 
 
 
 
 
 
 
Pass
 
$
2,765,852

 
$
1,833,111

 
$
289,864

 
$
1,098,546

Special Mention
 
7,906

 
93,216

 
—

 
1,511

Substandard
 
12,719

 
101,865

 
394

 
7,443

Doubtful
 
—

 
155

 
—

 
1,959

Total
 
$
2,786,477

 
$
2,028,347

 
$
290,258

 
$
1,109,459

December 31, 2016
 
 
 
 
 
 
 
 
Grade: 1
 
 
 
 
 
 
 
 
Pass
 
$
2,648,842

 
$
1,712,171

 
$
283,423

 
$
1,062,549

Special Mention
 
7,972

 
155,110

 
—

 
2,083

Substandard
 
12,875

 
103,815

 
11,471

 
8,252

Doubtful
 
766

 
64

 
—

 
2,039

Total
 
$
2,670,455

 
$
1,971,160

 
$
294,894

 
$
1,074,923

1 
PCI loans are included in the substandard or doubtful categories. These categories are consistent with the "substandard" and "doubtful" categories as defined by regulatory authorities.
Warehouse Purchase Program Credit Exposure
All Warehouse Purchase Program loans were graded pass as of March 31, 2017 and December 31, 2016.
Other Consumer Credit Exposure
Credit Risk Profile Based on Payment Activity
 
March 31, 2017
 
December 31, 2016
Performing
$
49,661

 
$
53,833

Non-performing
1,061

 
158

Total
$
50,722

 
$
53,991



21
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 6 - FAIR VALUE    
ASC 820, “Fair Value Measurements and Disclosures”, establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Prices or valuation techniques that require inputs that are both significant and unobservable in the market. These instruments are valued using the best information available, some of which is internally developed, and reflects a reporting entity’s own assumptions about the risk premiums that market participants would generally require and the assumptions they would use.
Assets and Liabilities Measured on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are summarized below.
 
 
Fair Value Measurements Using Level 2
 
 
March 31, 2017
 
December 31, 2016
Assets:
 
 
 
 
Agency residential mortgage-backed securities
 
$
215,905

 
$
218,551

Agency commercial mortgage-backed securities
 
9,313

 
9,347

Agency residential collateralized mortgage obligations
 
117,108

 
86,529

US government and agency securities
 
2,110

 
2,251

Municipal bonds
 
37,395

 
37,837

Total securities available for sale
 
$
381,831

 
$
354,515

 
 
 
 
 
Loans held for sale
 
$
19,315

1 
$
21,279

Derivative financial instruments:
 
 
 
 
Interest rate lock commitments
 
551

 
379

Forward mortgage-backed securities trades
 
1

 
36

Loan customer counterparty
 
—

 
—

Financial institution counterparty
 
1,590

 
1,369

Liabilities:
 
 
 
 
Derivative financial instruments:
 
 
 
 
Interest rate lock commitments
 
—

 
—

Forward mortgage-backed securities trades
 
97

 
80

Loan customer counterparty
 
1,590

 
1,369

Financial institution counterparty
 
—

 
—

1 
At March 31, 2017, loans held for sale had an aggregate outstanding principal balance of $18,620. There were no mortgage loans held for sale that were 90 days or greater past due or on non-accrual at March 31, 2017.
The following methodologies were used to measure the fair value of financial assets and liabilities valued on a recurring basis:
Securities available for sale - The fair values of securities available for sale are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs).

22
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Residential mortgage loans held for sale - Mortgage loans held for sale, which are sold on a servicing released basis, are valued using a market approach by utilizing either: (i) the fair value of securities backed by similar mortgage loans, adjusted for certain factors to approximate the fair value of a whole mortgage loan, including the value attributable to mortgage servicing and credit risk, (ii) current commitments to purchase loans or (iii) recent observable market trades for similar loans, adjusted to credit risk and other individual loan characteristics. As these prices are derived from market observable inputs, the Company classifies these valuations as Level 2 in the fair value disclosures. Interest income on mortgage loans held for sale is recognized based on the contractual rates and reflected in interest income on loans held for sale in the consolidated income statement. The Company has no continuing involvement in any residential mortgage loans sold.
Derivative instruments - The Company enters into a variety of derivative instruments as part of its hedging strategy and measures these instruments at fair value on a recurring basis in the balance sheet. The majority of these derivatives are forward mortgage-backed securities and are exchange-traded or traded within highly active dealer markets. In order to determine the fair value of these instruments, the Company utilized the exchange price or dealer market price for the particular derivative contract; therefore these contracts are classified as Level 2. In addition, the Company enters into interest rate lock commitments ("IRLCs") with prospective borrowers. These commitments are carried at fair value based on the fair value of the underlying mortgage loans which are based on observable market data. The Company adjusts the outstanding IRLCs with prospective borrowers based on an expectation that it will be exercised and the loan will be funded. These commitments are classified as Level 2 in the fair value disclosures, as the valuations are based on market observable inputs.
The Company also enters into certain interest rate derivative positions that are not designated as hedging instruments. The estimated fair value of these commercial loan interest rate swaps are obtained from a pricing service that provides the swaps' unwind value (Level 2 inputs). Please see Note 7 — Derivative Financial Instruments for more information.
Assets and Liabilities Measured on a Non-Recurring Basis

Assets measured at fair value on a non-recurring basis are summarized below. There were no liabilities measured at fair value on a non-recurring basis at March 31, 2017 or December 31, 2016.
 
 
Fair Value Measurements Using Level 3
 
 
March 31, 2017
 
December 31, 2016
Assets:
 
 
 
 
Impaired loans
 
$
24,113

 
$
9,274

Foreclosed assets:
 
 
 
 
Commercial real estate
 
10,638

 
10,638

Construction and land
 
3,016

 
194

Foreclosed assets- other
 
—

 
6

Impaired loans that are collateral dependent are measured for impairment using the fair value of the collateral adjusted by additional Level 3 inputs, such as discounts of market value, estimated marketing costs and estimated legal expenses. Impaired loans secured by real estate, receivables or inventory had discounts determined by management on an individual loan basis. Impaired loans that are not collateral dependent are measured for impairment by a discounted cash flow analysis using a net present value calculation that utilizes data from the loan file before and after the modification.
Foreclosed assets are measured at the lower of book or fair value less costs to sell using third party appraisals, listing agreements or sale contracts, which may be adjusted by additional Level 3 inputs, such as discounts of market value, estimated marketing costs and estimated legal expenses. Management may also consider additional adjustments on specific properties due to the age of the appraisal, expected holding period, lack of comparable sales, or if the other real estate owned is a special use property. At March 31, 2017, the Company had $518 in residential mortgage loans in the process of foreclosure.
The Credit Risk Management department evaluates the valuations on impaired loans and foreclosed assets at least quarterly. The valuations on impaired loans are reviewed at least quarterly by the Allowance for Loan Loss Committee and are considered in the calculation of the allowance for loan losses. Unobservable inputs, such as discounts to collateral, are monitored and adjusted if market conditions change.

23
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Fair value of financial instruments not recored at fair value
The carrying amount and fair value information of financial instruments not recorded at fair value in their entirety on a recurring basis on the Company's consolidated balance sheets at March 31, 2017 and at December 31, 2016, were as follows:
 
 
 
 
Fair Value Measurement Using
March 31, 2017
 
Carrying
Amount
 
Level 1
 
Level 2
 
Level 3
Financial assets
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
355,028

 
$
355,028

 
$
—

 
$
—

Securities held to maturity
 
200,541

 
—

 
203,394

 
—

Loans held for investment, net
 
6,197,429

 
—

 
—

 
6,254,525

Loans held for investment - Warehouse Purchase Program
 
846,973

 
—

 
—

 
846,822

FHLB and other restricted securities, at cost
 
43,156

 
—

 
43,156

 
—

Accrued interest receivable
 
19,222

 
19,222

 
—

 
—

Financial liabilities
 
 
 
 
 
 
 
 
Deposits
 
$
6,379,646

 
$
—

 
$
—

 
$
6,003,152

FHLB advances
 
830,195

 
—

 
—

 
829,463

Repurchase agreements
 
76,880

 
—

 
—

 
74,710

Subordinated debt
 
134,155

 
—

 
—

 
122,996

Accrued interest payable
 
3,961

 
3,961

 
—

 
—

December 31, 2016
 
 
 
 
 
 
 
 
Financial assets
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
289,212

 
$
289,212

 
$
—

 
$
—

Securities held to maturity
 
210,387

 
—

 
212,981

 
—

Loans held for investment, net
 
5,998,596

 
—

 
—

 
6,080,165

Loans held for investment - Warehouse Purchase Program
 
1,055,341

 
—

 
—

 
1,055,219

FHLB and other restricted securities, at cost
 
43,266

 
—

 
43,266

 
—

Accrued interest receivable
 
20,347

 
20,347

 
—

 
—

Financial liabilities
 
 
 
 
 
 
 
 
Deposits
 
$
6,365,476

 
$
—

 
$
—

 
$
5,989,933

FHLB advances
 
833,682

 
—

 
—

 
830,930

Repurchase agreement
 
86,691

 
—

 
—

 
84,265

Subordinated debt
 
134,032

 
—

 
—

 
121,743

Accrued interest payable
 
2,111

 
2,111

 
—

 
—

The following methods and assumptions were used to estimate the fair values of each class of financial instrument presented:
Cash and cash equivalents - Due to their short term nature, the carrying amount approximates the estimated fair value.
Securities held to maturity - The fair values of these securities is determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs).
Loans held for investment (including Warehouse Purchase Program loans) - Fair value is based on discounted cash flows using current market offering rates, estimated life, and applicable credit risk.
FHLB stock and other restricted securities - The fair value on these securities is their cost basis due to restrictions on transferability.

24
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Accrued interest receivable - Due to their short term nature, the carrying amount approximates the estimated fair value.
Deposits - Fair value is calculated using the FHLB advance curve to discount cash flows based on the estimated life of the deposits.
FHLB advances - Fair value is calculated using the FHLB advance curve to discount cash flows based on the contractual repayment schedule.
Repurchase agreement - The fair value is based on discounting the estimated cash flows using the current rate at which similar borrowings would be made with similar terms and remaining maturities.
Subordinated debt - The estimated fair value is based on current market rates on similar debt in the market.
Accrued interest payable - Due to their short term nature, the carrying amount approximates the estimated fair value.
The fair value of off-balance sheet items is based on the current fees or costs that would be charged to enter into or terminate such arrangements and are not considered significant to this presentation.

25
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)


NOTE 7 - DERIVATIVE FINANCIAL INSTRUMENTS

The following table provides the outstanding notional balances and fair values of outstanding derivative positions at March 31, 2017 and December 31, 2016.
 
 
March 31, 2017
 
December 31, 2016
 
 
Outstanding Notional Balance
 
Asset Derivative Fair Value
 
Liability Derivative Fair Value
 
Outstanding Notional Balance
 
Asset Derivative Fair Value
 
Liability Derivative Fair Value
IRLCs
 
$
14,284

 
$
551

 
$
—

 
$
10,952

 
$
379

 
$
—

Forward mortgage-backed securities trades
 
27,034

 
1

 
97

 
18,613

 
36

 
80

Commercial loan interest rate swaps and caps:
 
 
 
 
 
 
 
 
 
  Loan customer counterparty
 
$
116,627

 
$
—

 
$
1,590

 
$
112,294

 
$
—

 
$
1,369

Financial institution counterparty
 
116,627

 
1,590

 
—

 
112,294

 
1,369

 
—

These financial instruments are not designated as hedging instruments and are used for asset and liability management and commercial customers' financing needs. All derivatives are carried at fair value in either other assets or other liabilities.
IRLCs - The Company enters into IRLCs with prospective residential mortgage borrowers whereby the interest rate on the loan is determined prior to funding and the borrowers have locked into that interest rate. The estimated fair values of IRLCs are based on the fair value of the related mortgage loan which is based observable market data. The Company adjusts the outstanding IRLCs based on the expectation that it will be exercised and the loan will be funded.
Forward mortgage-backed securities trades - To manage the price risk associated with IRLCs, the Company enters into forward sales of mortgage-backed securities in an amount similar to the portion of the IRLC expected to close, assuming no change in mortgage interest rates. In addition, to manage the interest rate risk associated with mortgage loans held for sale, the Company enters into forward sales of mortgage-backed securities to deliver mortgage loan inventory to investors. The estimated fair values of forward sales of mortgage-backed securities and forward sale commitments are based on quoted market values.
Interest rate swaps and caps - These derivative positions relate to transactions in which we enter into an interest rate swap or cap with a customer, while at the same time entering into an offsetting interest rate swap or cap with another financial institution. An interest rate swap transaction allows our customer to effectively convert a variable rate loan to a fixed rate. In connection with each swap, we agree to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, we agree to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. In connection with each interest rate cap, we sell a cap to the customer and agree to pay interest if the underlying index exceeds the strike price defined in the cap agreement.  Simultaneously we purchase a cap with matching terms from another financial institution which agrees to pay us if the underlying index exceeds the strike price.

26
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

The commercial loan customer counterparty weighted average received and paid interest rates for interest rate swaps outstanding at March 31, 2017 and December 31, 2016 are presented in the following table.

 
 
Weighted-Average Interest Rate
March 31, 2017
 
December 31, 2016
Received
 
Paid
 
Received
 
Paid
Loan customer counterparty
 
3.25
%
 
2.67
%
 
3.12
%
 
2.36
%

Our credit exposure on interest rate swaps is limited to the net favorable value of all swaps by each counterparty, which was approximately $109 at March 31, 2017. This credit exposure is partly mitigated as transactions with customers are generally secured by the collateral, if any, securing the underlying transaction being hedged. Our credit exposure, net of collateral pledged, relating to interest rate swaps with upstream financial institution counter-parties was approximately $1,556 at March 31, 2017.  A credit support annex is in place and allows the bank to call collateral from upstream financial institution counter-parties. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values. Our cash collateral pledged for interest rate swaps and included in our interest-bearing deposits, which totaled $1,950 at March 31, 2017 and $1,950 at December 31, 2016, is in excess of our credit exposure.
The initial and subsequent changes in the fair value of IRLCs and the forward sales of mortgage-back securities are recorded in net gain on sale of mortgage loans. These gains and losses were not attributable to instrument-specific credit risk. For interest rate swaps and caps, because we act as an intermediary for our customer, changes in the fair value of the underlying derivative contracts substantially offset each other and do not have a material impact on our results of operations. Income (loss) for the three months ended March 31, 2017 and 2016 was as follows:

Derivatives not designated as hedging instruments
Three Months Ended March 31,
 
2017
 
2016
 
IRLC's
$
172

 
$
210

 
Forward mortgage-backed securities trades
(112
)
 
(345
)
 


27
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 8 - SHARE-BASED COMPENSATION
The Company has shareholder approved share-based compensation plans that are accounted for under ASC 718, Compensation - Stock Compensation, which requires companies to record compensation cost for share-based payment transactions with employees in return for employment service. Under the plans, options to purchase 3,370,040 shares of common stock and 1,348,016 restricted shares of common stock were made available. The plans allow for the Company to grant restricted stock, restricted stock units, stock options and stock appreciation rights to directors, advisory directors, officers and other employees. Shares issued in connection with stock compensation awards are issued from available authorized shares.
Compensation cost is recognized for stock options and restricted stock awards based on the fair value of these awards at the date of grant. A Black-Scholes model is utilized to estimate the fair value of stock options, while the market price of the Company’s common stock at the date of grant is used for restricted stock awards. Compensation cost is recognized over the required service period, generally defined as the vesting period. For awards with time-based vesting, compensation cost is recognized on a straight-line basis over the requisite service period for the entire award. For awards with performance-based vesting conditions, compensation cost is recognized when the achievement of the performance condition is considered probable of achievement. If a performance condition is subsequently determined to be improbable of achievement, compensation cost is reversed.

Compensation cost charged to income for share-based compensation is presented below:
 
Three Months Ended March 31,
 
2017
 
2016
Restricted stock
$
868

 
$
448

Stock options
694

 
549

Income tax benefit
547

 
349


A summary of activity in the restricted stock portion of the Company's stock plans is presented below:
 
 
 
Time-Vested Shares
 
Performance-Based Shares
Three Months Ended March 31, 2016
Shares
 
Weighted-Average Grant Date Fair Value per Share 1
 
Shares
 
Weighted-Average Grant Date Fair Value per Share 2
Non-vested at December 31, 2015
246,461

 
$
20.98

 
61,800

 
$
25.02

Vested
(69,266
)
 
21.00

 
(20,600
)
 
25.02

Non-vested at March 31, 2016
177,195

 
$
20.20

 
41,200

 
$
19.15

Three Months Ended March 31, 2017
 
 
 
 
 
 
 
Non-vested at December 31, 2016
200,176

 
$
23.79

 
81,400

 
$
43.06

Granted
19,208

 
38.92

 
12,208

 
39.90

Vested
(68,930
)
 
21.00

 
(20,600
)
 
41.32

Non-vested at March 31, 2017
150,454

 
$
26.86

 
73,008

 
$
39.90

1 
For restricted stock awards with time-based vesting conditions, the grant date fair value is based upon the closing stock price as quoted on the NASDAQ Stock Market on the grant date.
2 
For restricted stock awards with performance-based vesting conditions, the value of the award is based upon the closing stock price as quoted on the NASDAQ Stock Market on the date of vesting. Until the final value is determined on the vesting date, the Company estimates the fair value quarterly based upon the closing stock price as quoted on the NASDAQ Stock Market near the last business day of each calendar quarter end.
As of March 31, 2017, there was $5,103 of total unrecognized compensation expense related to non-vested restricted shares awarded under the Company's stock plans. That expense is expected to be recognized over a weighted-average period of 1.7 years. The total fair value of shares vested during the three months ended March 31, 2017 and 2016, was $2,299 and $1,970, respectively. At March 31, 2017, total restricted shares available for future issuance under the plans totaled 6,389, excluding

28
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

26,204 shares reserved if maximum performance targets are met. 1,440,420 shares have been issued under the plans through March 31, 2017.
Under the terms of the plans, stock options may not be granted with an exercise price less than the fair market value of the Company’s common stock on the date the option is granted and may not be exercised later than ten years after the grant date in the case of incentive stock options, and 15 years after the grant date in the case of non-qualified stock options. The fair market value is the closing stock price as quoted on the NASDAQ Stock Market on the date of grant.
The fair value of each option award is estimated on the date of grant using a closed form option valuation (Black-Scholes) model that uses the assumptions noted in the table below. The risk-free interest rate is the implied yield available on U.S. Treasury zero-coupon issues with a remaining term equal to the expected term of the stock option in effect at the time of the grant. Although the contractual term of the stock options granted is ten years, the expected term of the stock is less because option restrictions do not permit recipients to sell or hedge their options and therefore, we believe, encourage exercise of the options before the end of the contractual term. The expected term of stock options is based on employees' actual vesting behavior and expected volatilities are based on historical volatilities of the Company’s common stock. Expected dividends are the estimated dividend rate over the expected term of the stock options.
The weighted average fair value of stock options granted during three months ended March 31, 2017 and 2016 was $11.44 and $4.51, respectively. The fair value of options granted was determined using the following weighted-average assumptions as of grant date:
 
2017
 
2016
Expected stock price volatility
31.87
%
 
31.58
%
Expected dividends
1.52
%
 
2.88
%
Expected term of stock options (years)
6.2

 
6.3

Risk-free interest rate
2.20
%
 
1.67
%
A summary of activity in the stock option portion of the Company's stock plans as of is presented below:
Three Months Ended March 31, 2016
Shares
 
Weighted-
Average
Exercise Price
per Share
 
Weighted-
Average
Remaining
Contractual Term
 
Aggregate
Intrinsic Value
Outstanding at December 31, 2015
1,865,750

 
$
22.21

 
7.9

 
$
6,401

Granted
10,000

 
19.11

 
10.0

 
—

Forfeited
(18,000
)
 
25.47

 
—

 
—

Outstanding at March 31, 2016
1,857,750

 
22.16

 
7.6

 
1,509

Three Months Ended March 31, 2017
 
 
 
 
 
 
 
Outstanding at December 31, 2016
2,008,080

 
$
23.71

 
7.4

 
$
38,850

Granted
108,800

 
38.92

 
10.0

 
—

Exercised
(44,727
)
 
17.21

 
—

 
1,124

Forfeited
(39,775
)
 
27.29

 
—

 
—

Outstanding at March 31, 2017
2,032,378

 
24.60

 
7.4

 
31,095

Fully vested and expected to vest
2,016,509

 
24.54

 
7.3

 
30,967

Exercisable at March 31, 2017
794,491

 
$
20.74

 
6.1

 
$
15,220

As of March 31, 2017, there was $7,352 of total unrecognized compensation expense related to non-vested stock options. That expense is expected to be recognized over a weighted-average period of 2.4 years. At March 31, 2017, the Company applied an estimated forfeiture rate of 5% based on historical activity. The intrinsic value for stock options is calculated based on the difference between the exercise price of the underlying awards and the market price of our common stock as of the reporting date.

29
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Effective January 1, 2017, the Company changed the accounting for income taxes upon the vesting of stock options and restricted stock to be in accordance with ASC 718, as modified by Accounting Standards Update ("ASU") 2016-09, Improvements to Employee Share-Based Payment Accounting. Prior to the implementation of ASU 2016-09, the tax effects of income tax deductions in excess of compensation cost (windfalls) were recorded in additional paid-in capital, and the tax effects of compensation cost in excess of income tax deductions (shortfalls) were recorded in additional paid-in capital to the extent of previously recognized windfalls, with the remainder recorded in income tax expense. Under ASU 2016-09, all tax effects of windfalls and shortfalls related to share-based payments are recorded through the income statement.
For the three months ended March 31, 2017, we recognized income tax deductions in excess of compensation cost of $2,378 for share-based payment awards, which resulted in a tax benefit of $832 recorded as a reduction of income tax expense. The tax effect of this windfall is treated as a discrete item in this interim reporting period and is not considered in determining the annual estimated effective tax rate. The classification of excess tax benefits on the statement of cash flows will be shown as an operating activity.


30
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 9 - INCOME TAXES
A summary of the net deferred tax assets as of March 31, 2017 and December 31, 2016, is presented below:
 
March 31, 2017
 
December 31, 2016
Net deferred tax assets
$
30,583

 
$
29,231

Estimated annual effective tax rate
34
%
 
 


31
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 10 - COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business, the Company enters into various transactions which, in accordance with US GAAP, are not included in its consolidated balance sheets. The Company enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and standby letters of credit which involve, to varying degrees, elements of credit and interest rate risk. Credit losses up to the face amount of these instruments could occur, although material losses are not anticipated. The Company's credit policies applied to loan originations are also applied to these commitment requests, including obtaining collateral at the exercise of the commitment.
The contractual amounts of financial instruments with off‑balance sheet risk at March 31, 2017 and December 31, 2016, are summarized below. Please see Part I-Item 2-"Off-Balance Sheet Arrangements, Contractual Obligations and Commitments" of this Form 10-Q for information related to commitment maturities.
 
March 31, 2017
 
December 31, 2016
Unused commitments to extend credit
$
1,752,556

 
$
1,642,528

Unused capacity on Warehouse Purchase Program loans
926,042

 
892,659

Standby letters of credit
29,758

 
29,198

Total unused commitments/capacity
$
2,708,356

 
$
2,564,385

Unused commitments to extend credit - The Company enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Since many commitments expire without being drawn upon, the total contractual amount of commitments does not necessarily represent future cash requirements of the Company. Substantially all of the Company's commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of future loan funding.
Unused capacity on Warehouse Purchase Program loans - In regard to unused capacity on Warehouse Purchase Program loans, the Company has established maximum purchase facility amounts, but reserves the right, at any time, to refuse to buy any mortgage loans offered for sale by each customer, for any reason in the Company's sole and absolute discretion.
Standby letters of credit - Standby letters of credit are conditional commitments issued by the Company to guarantee the performance of a customer to a third party. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
In addition to the commitments above, the Company guarantees the credit card debt of certain customers to the merchant bank that issues the credit cards. These guarantees are in place for as long as the guaranteed credit card is open. At March 31, 2017 and December 31, 2016, these credit card guarantees totaled $3,814 and $3,335, respectively. This amount represents the maximum potential amount of future payments under the guarantee, which the Company is responsible for in the event of customer non-payment.
The Company funds an allowance for credit losses on off-balance sheet lending-related commitments and guarantees on credit card debt through a charge to provision for credit losses on the Company's consolidated statement of income. At March 31, 2017 and December 31, 2016, this allowance for credit losses on off-balance sheet lending-related commitments and guarantees on credit card debt, included in "other liabilities" on the Company's consolidated balance sheets, totaled $1,174 and $1,500, respectively.
In addition to the commitments above, the Company had overdraft protection available in the amounts of $85,177 and $85,709 at March 31, 2017 and December 31, 2016, respectively.
The Company, at March 31, 2017 and December 31, 2016, had FHLB letters of credit of $949,043 and $946,338, respectively, pledged to secure public deposits, repurchase agreements, and for other purposes required or permitted by law.
At March 31, 2017 and December 31, 2016, the Company had $1,680 and $2,080, respectively, of unfunded commitments recorded in other liabilities in its consolidated balance sheet related to investments in community development-oriented private equity funds used for Community Reinvestment Act purposes.

32
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 11 - RECENT ACCOUNTING DEVELOPMENTS    
Effect of Newly Issued But Not Yet Effective Accounting Standards
In May 2014, the Financial Accounting Standards Board (the "FASB") issued ASU 2014-09, Revenue from Contracts with Customers. This ASU states that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU affects entities that enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards. In August 2015, the FASB issued ASU 2015-14, "Revenue from Contracts with Customers (Topic 606): Deferral of the Effective Date," which deferred the effective date of ASU 2014-09 for public entities to annual reporting periods beginning after December 15, 2017, including interim reporting periods within that reporting period. Our revenue is comprised of net interest income on financial assets and financial liabilities, which is explicitly excluded from the scope of ASU 2014-09, and non-interest income. ASU 2014-09 could require us to change how we recognize certain recurring revenue streams; however, we do not expect these changes to have a significant impact on our financial statements. We continue to evaluate the impact of ASU 2014-09 on components of non-interest income. We expect to adopt the standard in the first quarter of 2018 with a cumulative effect adjustment to opening retained earnings, if such adjustment is deemed to be significant.
In January 2016, the FASB issued ASU 2016-01, Recognition and Measurements of Financial Assets and Financial Liabilities. This ASU requires that all equity investments be measured at fair value with changes in the fair value recognized through net income (other than those accounted for under the equity method of accounting or those that result in consolidation of the investee). This ASU also requires that an entity present separately in other comprehensive income the portion of the total change in the fair value of a liability resulting from a change in the instrument-specific credit risk when the entity has elected to measure the liability at fair value in accordance with the fair value option for financial instruments. In addition, this ASU eliminates the requirement to disclose the fair value of financial instruments measured at amortized cost for entities that are not public business entities and the requirement to disclose the method(s) and significant assumptions used to estimate the fair value that is required to be disclosed for financial instruments measured at amortized cost on the balance sheet for public business entities. For public business entities, this ASU is effective for annual periods beginning after December 15, 2017, and interim periods therein. The adoption of this ASU is not expected to have a significant impact on the Company's financial statements and disclosures.

In February 2016, the FASB issued ASU 2016-02, Leases. This ASU requires lessees to put most leases on their balance sheets but recognize expenses in the income statement in a manner similar to current accounting treatment. This ASU changes the guidance on sale-leaseback transactions, initial direct costs and lease execution costs, and, for lessors, modifies the classification criteria and the accounting for sales-type and direct financing leases. For public business entities, this ASU is effective for annual periods beginning after December 15, 2018, and interim periods therein. Entities are required to use a modified retrospective approach for leases that exist or are entered into after the beginning of the earliest comparative period in the financial statements. The Company is evaluating the impact of this ASU on its financial statements and disclosures.
In June 2016, the FASB issued ASU 2016-13, Measurement of Credit Losses on Financial Instruments. This ASU removes the thresholds that companies apply to measure credit losses on financial instruments measured at amortized cost, such as loans, receivables, and held-to-maturity debt securities. Under current US GAAP, companies generally recognize credit losses when it is probable that the loss has been incurred. This revised guidance will remove all recognition thresholds and will require companies to recognize an allowance for lifetime expected credit losses. Credit losses will be immediately recognized through net income; the amount recognized will be based on the current estimate of contractual cash flows not expected to be collected over the financial asset’s contractual term. ASU 2016-13 also amends the credit loss measurement guidance for available for sale debt securities. For public business entities, this ASU is effective for financial statements issued for fiscal years and for interim periods within those fiscal years beginning after December 15, 2019. The Company is evaluating the impact of this ASU on its financial statements and disclosures.
In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment. This ASU simplifies the accounting for goodwill impairment for all entities by requiring impairment charges to be based on the first step in today's two-step impairment test. Under the new guidance, if a reporting unit’s carrying amount exceeds its fair value, an entity will record an impairment charge based on that difference. The impairment charge will be limited to the amount of goodwill allocated to that reporting unit. The standard eliminates today’s requirement to calculate a goodwill impairment charge using Step 2, which requires an entity to calculate any impairment charge by comparing the implied fair value of goodwill with its carrying amount. For public business entities, this ASU is effective for annual periods beginning after December 15, 2019, and interim periods

33
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

therein. The adoption of this ASU is not expected to have a significant impact on the Company's financial statements and disclosures.

34
LEGACYTEXAS FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 12 — SUBSEQUENT EVENTS
The Company evaluated events from the date of the consolidated financial statements on March 31, 2017 through the issuance of those consolidated financial statements included in this Quarterly Report on Form 10-Q dated April 25, 2017. No additional events were identified requiring recognition in and/or disclosures in the consolidated financial statements.

35

Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Special Note Regarding Forward-Looking Statements

This document and other filings by Legacy Texas Financial Group, Inc. (the "Company") with the Securities and Exchange Commission (the “SEC”), as well as press releases or other public or stockholder communications released by the Company, may contain forward-looking statements, including, but not limited to, (i) statements regarding our financial condition, results of operations and business, (ii) statements about our plans, objectives, expectations and intentions and other statements that are not historical facts and (iii) other statements identified by the words or phrases "will likely result," "are expected to," "will continue," "is anticipated," "estimate," "project," "intends" or similar expressions that are intended to identify "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on current beliefs and expectations of the Company’s management and are inherently subject to significant business, economic and competitive uncertainties and contingencies, many of which are beyond the Company’s control. In addition, these forward-looking statements are subject to assumptions with respect to future business strategies and decisions that are subject to change.

The following factors, among others, could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements: the expected cost savings, synergies and other financial benefits from acquisition or disposition transactions might not be realized within the expected time frames or at all and costs or difficulties relating to integration matters might be greater than expected; changes in economic conditions; fluctuations in interest rates; the risks of lending and investing activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses; our ability to access cost-effective funding; fluctuations in real estate values and both residential and commercial real estate market conditions; demand for loans and deposits in our market area; fluctuations in the price of oil, natural gas and other commodities; competition; changes in management's business strategies; our ability to successfully integrate any assets, liabilities, customers, systems and management personnel we have acquired or may acquire into our operations and our ability to realize related revenue synergies and cost savings within expected time frames and any goodwill charges related thereto; results of examinations of us by the FRB (as defined below) and our bank subsidiary by the TDOB (as defined below) or other regulatory authorities, including the possibility that any such regulatory authority may, among other things, require us to increase our reserve for loan losses, write-down assets, change our regulatory capital position or affect our ability to borrow funds or maintain or increase deposits, which could adversely affect our liquidity and earnings; legislative or regulatory changes that adversely affect our business including the revenue impact from, and any mitigation actions taken in response, to the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”); changes in regulatory policies and principles, or the interpretation of regulatory capital or other rules; changes in accounting policies and practices, as may be adopted by the financial institution regulatory agencies, the Public Company Accounting Oversight Board or the Financial Accounting Standards Board; and other economic, competitive, governmental, regulatory, and technological factors affecting our operations, pricing, products and services; and the other risks set forth under Risk Factors under Item 1A. of the Company's Form 10-K for the year ended December 31, 2016.

The factors listed above could materially affect our financial performance and could cause our actual results for future periods to differ materially from any opinions or statements expressed with respect to future periods in any current statements.

We do not undertake - and specifically decline any obligation - to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events. When considering forward-looking statements, you should keep in mind these risks and uncertainties. You should not place undue reliance on any forward-looking statement, which speaks only as of the date made. You should refer to our periodic and current reports filed with the SEC for specific risks that could cause actual results to be significantly different from those expressed or implied by any forward-looking statements.

Overview
LegacyTexas Financial Group, Inc. is a Maryland corporation and LegacyTexas Bank is its wholly owned principal operating subsidiary. Unless the context otherwise requires, references in this document to the “Company” refer to LegacyTexas Financial Group, Inc., and references to the “Bank” refer to LegacyTexas Bank. References to “we,” “us,” and “our” mean LegacyTexas Financial Group, Inc. or LegacyTexas Bank, as the context requires.

36

The Bank is regulated by the Texas Department of Banking (“TDOB”) and the Board of Governors of the Federal Reserve System (“FRB”) with back-up oversight by the Federal Deposit Insurance Corporation ("FDIC"). Additionally, the Bank is a Federal Reserve member bank required to have certain reserves and stock set by the FRB and a member of the Federal Home Loan Bank of Dallas, one of the 12 regional banks in the Federal Home Loan Bank System (“FHLB”). The Company is regulated by the FRB.
Business Strategies
Our principal business consists of attracting retail deposits from the general public and the business community and investing those funds, along with borrowed funds, in commercial real estate loans, secured and unsecured commercial and industrial loans, as well as permanent loans secured by first and second mortgages on one-to-four family residences and consumer loans. Additionally, the Warehouse Purchase Program allows mortgage banking company customers to close one-to four-family real estate loans in their own name and manage its cash flow needs until the loans are sold to investors. We also offer title services and brokerage services for the purchase and sale of non-deposit investment and insurance products through a third party brokerage arrangement. Our operating revenues are derived principally from interest earned on interest-earning assets, including loans and investment securities and service charges and fees on deposits and other account services. Our primary sources of funds are deposits, FHLB advances and other borrowings, and payments received on loans and securities. We offer a variety of deposit accounts that provide a wide range of interest rates and terms, generally including savings, money market, term certificate and demand accounts.
Our principal objective is to be an independent, commercially-oriented, customer-focused financial services company, providing outstanding service and innovative products in our primary market area of North Texas. Our Board of Directors has adopted a strategy designed to maintain growth and profitability, a strong capital position and high asset quality.
Performance Highlights

•
Net income of $18.2 million for the first quarter of 2017 included an $11.2 million increase in net interest income, which was offset by a $13.5 million increase in the provision for credit losses, a $2.5 million decrease in non-interest income and a $2.2 million increase in non-interest expense.

•
Gross loans held for investment at March 31, 2017, excluding Warehouse Purchase Program loans, grew $199.8 million, or 3.3%, from December 31, 2016, with $173.2 million of growth in commercial real estate and commercial and industrial loans and $34.5 million of growth in consumer real estate loans.

•
Deposits at March 31, 2017 increased by $14.2 million, or 0.2%, from December 31, 2016, which included $65.7 million of growth in non-interest-bearing demand deposits and $9.5 million of growth in time deposits.

Critical Accounting Estimates
Certain of our accounting estimates are important to the portrayal of our financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances which could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers. Management believes that determining the allowance for loan losses is its most critical accounting estimate. Our accounting policies are discussed in detail in Note 1 of the Notes to Consolidated Financial Statements contained in Item 8 of our 2016 Form 10-K.
Allowance for Loan Loss. The allowance for loan losses and related provision expense are susceptible to change if the credit quality of our loan portfolio changes, which is evidenced by many factors, including but not limited to charge-offs and non-performing loan trends. Generally, consumer real estate lending has a lower risk profile compared to other consumer lending (such as automobile loans). Commercial real estate and commercial and industrial lending, however, can have higher risk profiles than consumer loans due to these loans being larger in amount and more susceptible to fluctuations in industry, market and economic conditions. While management uses available information to recognize losses on loans, changes in economic conditions, the mix and size of the loan portfolio and individual borrower conditions can dramatically impact our level of allowance for loan losses in relatively short periods of time. Management believes that the allowance for loan losses is maintained at a level that represents coverage of our best estimate of credit losses in the loan portfolio as of March 31, 2017.

37

Management evaluates current information and events regarding a borrower's ability to repay its obligations and considers a loan to be impaired when the ultimate collectability of amounts due, according to the contractual terms of the loan agreement, is in doubt. If an impaired loan is collateral-dependent, the fair value of the collateral, less the estimated cost to sell, is used to determine the amount of impairment. If an impaired loan is not collateral-dependent, the impairment amount is determined using the negative difference, if any, between the estimated discounted cash flows and the loan amount due. For impaired loans, the amount of the impairment can be adjusted, based on current data, until such time as the actual basis is established by acquisition of the collateral or until the basis is collected. Impairment losses are reflected in the allowance for loan losses through a charge to the provision for credit losses. Subsequent recoveries are credited to the allowance for loan losses. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement. Cash receipts on impaired loans for which the accrual of interest has been discontinued are applied first to principal.

38

Comparison of Financial Condition at March 31, 2017 and December 31, 2016
General. Total assets increased by $74.3 million, or 0.9%, to $8.44 billion at March 31, 2017 from $8.36 billion at December 31, 2016, primarily due to a $199.8 million, or 3.3%, increase in gross loans held for investment, excluding Warehouse Purchase Program loans, and a $65.8 million, or 22.8%, increase in cash and cash equivalents. The increase in total assets due to loan portfolio growth and increased cash and cash equivalents was partially offset by a $208.4 million, or 19.7%, decrease in Warehouse Purchase Program loans compared to December 31, 2016.
Loans. Gross loans held for investment decreased by $8.5 million, or 0.1%, to $7.11 billion at March 31, 2017 from $7.12 billion at December 31, 2016, while one- to four-family mortgage loans held for sale decreased by $2.0 million, or 9.2%, for the same period.
    
 
March 31, 2017
 
December 31, 2016
 
Dollar
Change
 
Percent
Change
 
(Dollars in thousands)
Commercial real estate
$
2,786,477

 
$
2,670,455

 
$
116,022

 
4.3
 %
Commercial and industrial
2,028,347

 
1,971,160

 
57,187

 
2.9

Construction and land
290,258

 
294,894

 
(4,636
)
 
(1.6
)
Consumer real estate
1,109,459

 
1,074,923

 
34,536

 
3.2

Other consumer
50,722

 
53,991

 
(3,269
)
 
(6.1
)
Gross loans held for investment, excluding Warehouse Purchase Program loans
6,265,263

 
6,065,423

 
199,840

 
3.3

Warehouse Purchase Program loans
846,973

 
1,055,341

 
(208,368
)
 
(19.7
)
Gross loans held for investment
7,112,236

 
7,120,764

 
(8,528
)
 
(0.1
)
Loans held for sale
19,315

 
21,279

 
(1,964
)
 
(9.2
)
Gross loans
$
7,131,551

 
$
7,142,043

 
$
(10,492
)
 
(0.1
)%

Gross loans held for investment at March 31, 2017, excluding Warehouse Purchase Program loans, grew $199.8 million, or 3.3%, from December 31, 2016, which included growth in the commercial real estate, commercial and industrial and consumer real estate portfolios and was partially offset by declines in the construction and land and other consumer portfolios. Commercial real estate and commercial and industrial loans at March 31, 2017 increased by $116.0 million and $57.2 million, respectively, from December 31, 2016. Consumer real estate loans at March 31, 2017 increased by $34.5 million, while construction and land and other consumer loans decreased by $4.6 million and $3.3 million, respectively, from December 31, 2016.
Reserve-based energy loans, which are reported as commercial and industrial loans, totaled $504.0 million at March 31, 2017, down $23.2 million from $527.2 million at December 31, 2016. Substantially all of the reserve-based energy loans are secured by deeds of trust on properties containing proven oil and natural gas reserves. Due to the sensitivity of the energy portfolio to downward movements in oil prices, the Bank has seen migration in the portfolio into criticized classifications. See "Allowance for Loan Losses" for more information.
  
At March 31, 2017, our reserve-based energy portfolio (reported above at $504.0 million) was secured by collateral that consisted of 50% natural gas reserves and 50% crude oil reserves. We encourage, and in some cases even require, borrowers to utilize commodity hedges, in order to stabilize cash flows during volatile commodity price environments.  Hedges are used to guard against falling prices, and the goal is that the duration of the hedge will last long enough for prices to come back from any significant decline.  Hedges will typically include minimum and maximum allowed percentage of production, a minimum and maximum allowed term, and a minimum price.

In addition to the reserve-based energy loans, the Bank has loans categorized as "Midstream and Other," which are typically related to the transmission of oil and natural gas and would only be indirectly impacted from declining commodity prices. At March 31, 2017, "Midstream and Other" loans had a total outstanding balance of $43.1 million, up $4.1 million from $39.0 million at December 31, 2016. Also, at March 31, 2017, we had four relationships in the commercial and industrial loan portfolio (aside from the reserve-based and midstream loans discussed above) that are involved in the energy exploration sector providing front-end service to companies who drill oil and gas wells and whose business could be impacted by the dramatic

39

reduction in drilling activity as a result of the severe drop in the price of oil and gas.  These relationships totaled $2.1 million at March 31, 2017.

Warehouse Purchase Program loans decreased by $208.4 million, or 19.7%, to $847.0 million at March 31, 2017 from $1.06 billion at December 31, 2016, which reflects the seasonal slowdown typically experienced with Warehouse Purchase Program loans during the first quarter of the year. Although not bound by any legally binding commitment, when a purchase decision is made, the Bank purchases a 100% participation interest in the loans originated by our mortgage banking company customers. The mortgage banking company closes mortgage loans consistent with underwriting standards established by approved investors and, once all pertinent documents are received, the participation interest is delivered by the Bank to the investor selected by the originator and approved by us. Loans funded by the Warehouse Purchase Program during the first quarter of 2017 consisted of 41% conforming, 53% government loans and 6% of other loan types, including Jumbo loans.
Allowance for Loan Losses. The allowance for loan losses is maintained to cover losses that are estimated in accordance with US GAAP. It is our estimate of credit losses in our loan portfolio at each balance sheet date. Our methodology for analyzing the allowance for loan losses consists of general and specific components. For more information about the Company's calculation of its allowance for loan losses, please see Item 1 (Financial Statements) - Note 5 - "Loans" under Part 1 of this report.
Acquired loans initially are recorded at fair value, which includes an estimate of credit losses expected to be realized over the remaining lives of the loans, and therefore no corresponding allowance for loan losses is recorded for these loans at acquisition. An allowance will be recorded in later periods if additional losses are subsequently anticipated. Methods utilized to estimate the required allowance for loan losses for acquired loans not deemed credit-impaired at acquisition are similar to originated loans; however, the estimate of loss is limited to the amount that the calculated allowance for loan losses exceeds the remaining purchase discount.
PCI loans are not considered nonperforming loans, and accordingly, are not included in the non-performing loans to total loans ratio as a numerator, but are included in total loans reflected in the denominator. The result is a downward trend in the ratio when compared to prior periods, assuming all other factors stay the same. Similarly, other asset quality ratios, such as the allowance for loan losses to total loans ratio will reflect a downward trend, assuming all other factors stay the same, due to the impact of PCI loans on the denominator with no corresponding impact in the numerator.
Our non-performing loans, which consist of nonaccrual loans, include both smaller balance homogeneous loans that are collectively evaluated for impairment and larger individually evaluated impaired loans. Loans generally are placed on nonaccrual status when the loan becomes 90 days or more delinquent. Non-performing loans include loans that are not contractually past due but have been placed on nonaccrual status due to the loan's designation as a troubled debt restructuring or if there is a distinct possibility that the Company will sustain some loss if deficiencies existing within a loan are not corrected. In all cases, loans are placed on nonaccrual status (or charged-off) at an earlier date when the collection of principal and/or interest becomes doubtful or other factors involving the loan warrant placing the loan on nonaccrual status.
Non-performing loans to total loans held for investment, excluding Warehouse Purchase Program loans, was 1.71% at March 31, 2017 compared to 1.84% at December 31, 2016. Including Warehouse Purchase Program loans, non-performing loans to total loans held for investment was 1.51% at March 31, 2017 compared to 1.56% at December 31, 2016. Non-performing loans decreased by $4.0 million to $107.4 million at March 31, 2017 from $111.4 million at December 31, 2016. This decrease was primarily related to an $11.1 million decline in construction and land non-performing loans from December 31, 2016, due to the resolution of a relationship with a residential home builder. After various lots and homes were liquidated, paying down the credit facility, the Company foreclosed on the majority of the remaining partially completed homes in the first quarter of 2017, which resulted in a net charge-off of $418,000. This decrease in non-performing loans related to construction and land loans was partially offset by a $7.8 million increase in non-performing commercial and industrial loans related to a $7.7 million increase in substandard non-performing energy loans compared to December 31, 2016. For more information about the Company's non-performing loans, please see Note 5 of the Condensed Notes to Unaudited Consolidated Interim Financial Statements contained in Item 1 of this report.
The below table shows criticized energy loans at March 31, 2017, December 31, 2016 and March 31, 2016.




40

 
March 31,
2017
 
December 31,
2016
 
Linked-Quarter
 Change
 
March 31,
2016
 
Year-over-Year
 Change
 
(Dollars in thousands)
Special Mention (all performing)
$
72,026

 
$
141,794

 
$
(69,768
)
 
$
115,199

 
$
(43,173
)
Substandard (performing)
—

 
—

 
—

 
48,088

 
(48,088
)
Substandard (non-performing)
75,284

 
67,576

 
7,708

 
25,171

 
50,113

 
$
147,310

 
$
209,370

 
$
(62,060
)
 
$
188,458

 
$
(41,148
)
The increase in substandard non-performing energy loans on a linked-quarter and year-over-year basis resulted from collateral value declines and borrowers' deteriorating financial conditions due to past pressure on the price of oil and gas. The Company continues to take action to improve the risk profile of the criticized energy loans by instituting monthly commitment reductions, obtaining additional collateral, obtaining additional guarantor support and/or requiring additional equity injections or asset sales. 
Our allowance for loan losses was $70.7 million at March 31, 2017 compared to $64.6 million at December 31, 2016, or 0.99% of total loans held for investment (including Warehouse Purchase Program loans) at March 31, 2017 compared to 0.91% at December 31, 2016. Our allowance for loan losses to non-performing loans was 65.79% at March 31, 2017 compared to 57.97% at December 31, 2016. The increase in the allowance for loan losses from December 31, 2016 was primarily related to increased loan loss reserves allocated to the corporate healthcare finance portfolio, which is reported on the balance sheet as commercial and industrial loans and totaled $59.7 million at March 31, 2017. During the first quarter of 2017, the Company charged-off its $16.4 million interest in a large syndicated credit within the corporate healthcare finance portfolio. The note was sold at a deep discount after the borrower experienced liquidity constraints during the first quarter of 2017 that challenged its ongoing viability. One other relationship in the corporate healthcare finance portfolio totaling $11.4 million was considered to be impaired and rated as substandard (non-performing) at March 31, 2017. At this time, the Company is no longer originating corporate healthcare finance loans. The allowance for loan losses allocated to corporate healthcare finance and energy loans totaled $7.2 million and $18.7 million, respectively, at March 31, 2017. Net charge-offs for the three months ended March 31, 2017 totaled $16.6 million, an increase of $16.4 million from the fourth quarter of 2016 and an increase of $16.2 million from the first quarter of 2016, due to the $16.4 million charge-off recorded on the healthcare finance relationship discussed above.
Classified Assets. Loans and other assets, such as securities and foreclosed assets, that are considered by management to be of lesser quality are classified as "substandard," "doubtful" or "loss." An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses of those classified as "substandard," with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Assets classified as "loss" are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. PCI loans are included in the "substandard" and "doubtful" categories.
We regularly review the assets in our portfolio to determine whether any should be considered as classified. The total amount of classified assets represented 15.5% of our total equity and 1.7% of our total assets at March 31, 2017 compared to 17.0% of our total equity and 1.8% of our total assets at December 31, 2016. The aggregate amount of classified assets at the dates indicated was as follows:







41

 
March 31,
2017
 
December 31,
2016
 
(Dollars in thousands)
Doubtful
$
2,115

 
$
2,880

Substandard
123,730

 
136,815

Total classified loans
125,845

 
139,695

Foreclosed assets
13,654

 
10,838

Total classified assets
$
139,499

 
$
150,533

Substandard loans at March 31, 2017 decreased by $13.1 million from December 31, 2016, which was primarily due to the resolution of the construction and land relationship with a residential home builder discussed above in "Allowance for Loan Losses" that resulted in the builder's remaining partially completed homes being transferred into foreclosed assets in the 2017 period.
The Company also has potential problem loans, considered "other loans of concern," that are currently performing and do not meet the criteria for impairment, but where there is the distinct possibility that we might sustain some loss if credit deficiencies are not corrected. These possible credit problems may result in the future inclusion of these loans in the non-performing asset categories and consisted of $11.5 million in loans that were classified as "substandard," but were still accruing interest and were not considered impaired at March 31, 2017 (excluding PCI loans.) Other loans of concern have been considered in management's analysis of potential loan losses.
Securities. Our securities portfolio increased $17.5 million, or 3.1%, to $582.4 million at March 31, 2017 from $564.9 million at December 31, 2016. During the three months ended March 31, 2017, purchases totaling $794.2 million offset paydowns and maturities of securities totaling $776.6 million.
Deposits. Total deposits increased $14.2 million, or 0.2%, to $6.38 billion at March 31, 2017 from $6.37 billion at December 31, 2016, primarily due to 4.7% growth in non-interest-bearing demand deposits.
 
March 31, 2017
 
December 31, 2016
 
Dollar
Change
 
Percent
Change
 
(Dollars in thousands)
Non-interest-bearing demand
$
1,449,656

 
$
1,383,951

 
$
65,705

 
4.7
 %
Interest-bearing demand
873,085

 
903,314

 
(30,229
)
 
(3.3
)
Savings and money market
2,679,538

 
2,710,307

 
(30,769
)
 
(1.1
)
Time
1,377,367

 
1,367,904

 
9,463

 
0.7

Total deposits
$
6,379,646

 
$
6,365,476

 
$
14,170

 
0.2
 %

Non-interest-bearing demand deposits increased by $65.7 million compared to December 31, 2016, while time deposits increased by $9.5 million for the same period. These increases were partially offset by reductions in savings and money market and interest-bearing demand deposits of $30.8 million and $30.2 million, respectively, compared to December 31, 2016.
Borrowings. FHLB advances decreased $3.5 million, or 0.4%, to $830.2 million at March 31, 2017 from $833.7 million at December 31, 2016. At March 31, 2017, the Company was eligible to borrow an additional $1.81 billion from the FHLB.

42

The table below shows FHLB advances by maturity and weighted average rate at March 31, 2017:
 
Balance
 
Weighted Average Rate
 
(Dollars in thousands)
Less than 90 days
$
3,521

 
4.53
%
90 days to less than one year
612,130

 
0.90

One to three years
211,705

 
1.07

After three to five years
2,065

 
5.50

After five years
792

 
5.48

 
830,213

 
0.97
%
Restructuring prepayment penalty
(18
)
 
 
Total
$
830,195

 
 
Additionally, the Company has eight available federal funds lines of credit with other financial institutions totaling $255.0 million and was eligible to borrow $42.7 million from the Federal Reserve Bank discount window. At March 31, 2017, the Company also had a $25.0 million outstanding structured repurchase agreement with Credit Suisse, as well as $51.9 million in overnight repurchase agreements with depositors. Also, at March 31, 2017, subordinated debt totaled $134.2 million, which included $122.4 million of fixed-to-floating rate subordinated notes (reported net of $2.6 million in debt issuance costs.) $75.0 million of these notes were issued by the Company in November 2015, and $50.0 million additional notes were issued in September 2016 when the Company reopened the offering. The $134.2 million of subordinated debt also included $11.8 million of trust preferred securities that were acquired through the merger with LegacyTexas Group, Inc. All subordinated debt is reported net of purchase accounting fair value adjustments and debt issuance costs.
Accrued Expenses and Other Liabilities. Accrued expenses and other liabilities increased $58.7 million, or 103.0%, to $115.7 million at March 31, 2017 from $57.0 million at December 31, 2016. This increase was primarily due to timing of escrow payments.
Shareholders’ Equity. Total shareholders' equity increased by $14.6 million, or 1.6%, to $899.9 million at March 31, 2017 from $885.4 million at December 31, 2016.
 
March 31, 2017
 
December 31, 2016
 
Dollar
Change
 
Percent
Change
 
(Dollars in thousands)
Common stock
$
479

 
$
479

 
$
—

 
—
 %
Additional paid-in capital
592,159

 
589,408

 
2,751

 
0.5

Retained earnings
321,648

 
310,641

 
11,007

 
3.5

Accumulated other comprehensive income (loss), net
(2,051
)
 
(2,713
)
 
662

 
(24.4
)
Unearned ESOP shares
(12,318
)
 
(12,450
)
 
132

 
(1.1
)
Total shareholders’ equity
$
899,917

 
$
885,365

 
$
14,552

 
1.6
 %
The increase in shareholders' equity at March 31, 2017, compared to December 31, 2016, was primarily due to net income of $18.2 million recognized during the three months ended March 31, 2017, which was partially offset by the payment of quarterly dividends totaling $0.15 per common share, or $7.2 million, during the three months ended March 31, 2017.

43

Comparison of Results of Operations for the Three Months Ended March 31, 2017 and 2016
General. Net income for the three months ended March 31, 2017 was $18.2 million, a decrease of $3.9 million, or 17.6%, from net income of $22.1 million for the three months ended March 31, 2016. The decrease in net income was driven by a $13.5 million increase in the provision for credit losses, a $2.5 million decrease in non-interest income, a $2.2 million increase in non-interest expense and a $3.0 million increase in interest expense on deposits, which was partially offset by a $14.3 million increase in interest income on loans. Basic earnings per share for the three months ended March 31, 2017 was $0.39, a $0.09 decrease from $0.48 for the three months ended March 31, 2016. Diluted earnings per share for the three months ended March 31, 2017 was $0.38, a $0.10 decrease from $0.48 for the three months ended March 31, 2016.
Interest Income. Interest income increased by $14.9 million, or 20.6%, to $87.5 million for the three months ended March 31, 2017 from $72.6 million for the three months ended March 31, 2016.
 
Three Months Ended
March 31,
 
Dollar Change
 
Percent Change
 
2017
 
2016
 
 
 
(Dollars in thousands)
Interest and dividend income
 
 
 
 
 
 
 
Loans, including fees
$
83,103

 
$
68,806

 
$
14,297

 
20.8
 %
Securities
3,317

 
3,086

 
231

 
7.5

Interest-bearing deposits in other financial institutions
732

 
330

 
402

 
121.8

FHLB and Federal Reserve Bank stock and other
384

 
386

 
(2
)
 
(0.5
)
 
$
87,536

 
$
72,608

 
$
14,928

 
20.6
 %
The $14.9 million increase in interest income for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 was primarily due to a $14.3 million increase in interest income on loans, which was driven by increased volume in the commercial real estate, commercial and industrial and consumer real estate portfolios. The average balance of commercial real estate loans increased by $495.5 million from the first quarter of 2016, resulting in a $5.8 million increase in interest income. The average balance of commercial and industrial loans increased by $357.6 million from the first quarter of 2016, resulting in an $8.3 million increase in interest income, which also included the impact of the amortization of a discount recorded in the fourth quarter of 2016 on a purchased energy loan, of which $4.7 million was completely amortized to interest income during the first quarter of 2017. The amortization of this discount positively impacted the yield on commercial and industrial loans for the first quarter of 2017 by 96 basis points. The average balance of consumer real estate loans increased by $141.1 million compared to the first quarter of 2016, which was partially offset by a 23 basis point decline in the average yield earned on that portfolio compared to the prior year period, leading to a $1.1 million increase in interest income. Interest income on loans for the first quarter of 2017 included $943,000 in accretion of purchase accounting fair value adjustments on acquired loans, which includes $385,000 on acquired commercial real estate loans, $157,000 on acquired commercial and industrial loans, $21,000 on acquired construction and land loans and $380,000 on acquired consumer loans.
Interest Expense. Interest expense increased by $3.7 million, or 51.4%, to $11.0 million for the three months ended March 31, 2017 from $7.3 million for the three months ended March 31, 2016.

 
Three Months Ended
March 31,
 
Dollar Change
 
Percent Change
 
2017
 
2016
 
 
 
(Dollars in thousands)
Interest expense
 
 
 
 
 
 
 
Deposits
$
7,110

 
$
4,122

 
$
2,988

 
72.5
 %
FHLB advances
1,632

 
1,673

 
(41
)
 
(2.5
)
Repurchase agreements and other borrowings
2,246

 
1,462

 
784

 
53.6

 
$
10,988

 
$
7,257

 
$
3,731

 
51.4
 %
The increase in interest expense for the three months ended March 31, 2017 compared to the same period in 2016 was primarily due to higher average rates and increased volume in all deposit products compared to the prior year period. The average balance of savings and money market deposits increased by $443.2 million and the average balance of time deposits increased by $264.8 million compared to the first quarter of 2016, while the average rates paid on these deposits increased by

44

22 basis points and 20 basis points, respectively, compared to the prior year period. These increases in volume and rate on savings and money market and time deposits increased interest expense compared to the first quarter of 2016 by $1.7 million and $1.1 million, respectively. A $65.7 million decrease in the average balance of borrowings from the first quarter of 2016 was more than offset by a 37 basis point increase in the average rate, resulting in a $743,000 increase in interest expense on borrowed funds.
Net Interest Income. Net interest income increased by $11.2 million, or 17.1%, to $76.5 million for the three months ended March 31, 2017 from $65.4 million for the three months ended March 31, 2016. The net interest margin for the first quarter of 2017 was 4.00%, a ten basis point increase from the first quarter of 2016. Approximately 24 basis points of the net interest margin for the quarter ended March 31, 2017 was related to the amortization of the purchased loan discount discussed in "Interest Income" above. Accretion of interest resulting from the merger with LegacyTexas Group, Inc. on January 1, 2015, as well as the 2012 Highlands acquisition, contributed five basis points to the net interest margin and average yield on earning assets for the quarter ended March 31, 2017, compared to seven basis points for the quarter ended March 31, 2016. The average yield on earning assets for the first quarter of 2017 was 4.58%, a 25 basis point increase from the first quarter of 2016. The cost of deposits for the first quarter of 2017 was 0.47%, up 15 basis points from the first quarter of 2016.
Provision for Credit Losses. The Company recorded a provision for credit losses of $22.3 million for the quarter ended March 31, 2017, up $13.5 million from $8.8 million for the quarter ended March 31, 2016. During the first quarter of 2017, the Company charged-off its $16.4 million interest in a large syndicated credit within the corporate healthcare finance portfolio. The note was sold at a deep discount after the borrower experienced liquidity constraints during the first quarter of 2017 that challenged its ongoing viability. One other relationship in the corporate healthcare finance portfolio totaling $11.4 million was considered to be impaired and rated as substandard (non-performing) at March 31, 2017. As a result of declining credit quality in the corporate healthcare finance portfolio, the Company increased the loan loss reserves allocated to this loan portfolio and discontinued originating these types of loans during the first quarter of 2017. For more information about the Company's allowance for loan losses, please see "Management's Discussion and Analysis - Comparison of Financial Condition at March 31, 2017 and December 31, 2016 - Allowance for Loan Losses" contained in Item 2 of this report.
Non-interest Income. Non-interest income decreased by $2.5 million, or 17.2%, to $12.1 million for the three months ended March 31, 2017 from $14.7 million for the three months ended March 31, 2016.
 
Three Months Ended
March 31,
 
Dollar Change
 
Percent Change
 
2017
 
2016
 
 
 
(Dollars in thousands)
Non-interest income
 
 
 
 
 
 
 
Service charges and other fees
$
8,431

 
$
8,181

 
$
250

 
3.1
 %
Net gain on sale of mortgage loans held for sale
1,628

 
1,580

 
48

 
3.0

Bank-owned life insurance income
422

 
426

 
(4
)
 
(0.9
)
Net (loss) on securities transactions
(19
)
 
—

 
(19
)
 
N/M1

Gain on sale and disposition of assets
1,399

 
4,072

 
(2,673
)
 
(65.6
)
Other
269

 
396

 
(127
)
 
(32.1
)
 
$
12,130

 
$
14,655

 
$
(2,525
)
 
(17.2
)%
1N/M - not meaningful
The $2.5 million decrease in non-interest income for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 was primarily due to a gain of $3.9 million on the sale of two buildings recorded in the first quarter of 2016 in gain on sale and disposition of assets, compared to a $1.3 million gain recorded in the first quarter of 2017 on the sale of a parcel of land. Service charges and other fees increased by $250,000, which was driven by a $281,000 increase in commercial loan fee income (consisting of syndication, arrangement, non-usage and pre-payment fees). The Company recognized $1.6 million in net gains on the sale of mortgage loans held for sale during the first quarter of 2017, which includes the gain recognized on $39.6 million of one-to four-family mortgage loans that were sold or committed for sale during the first quarter of 2017, fair value changes on mortgage derivatives and mortgage fees collected, compared to $1.6 million in comparable net gains recorded during the first quarter of 2016 on $43.2 million of one-to four-family mortgage loans sold.

45

Non-interest Expense. Non-interest expense increased by $2.2 million, or 5.9%, to $39.8 million for the three months ended March 31, 2017 from $37.5 million for the three months ended March 31, 2016.
 
Three Months Ended
March 31,
 
Dollar Change
 
Percent Change
 
2017
 
2016
 
 
 
(Dollars in thousands)
Non-interest expense
 
 
 
 
 
 
 
Salaries and employee benefits
$
24,444

 
$
22,337

 
$
2,107

 
9.4
 %
Advertising
817

 
1,036

 
(219
)
 
(21.1
)
Occupancy and equipment
3,654

 
3,691

 
(37
)
 
(1.0
)
Outside professional services
1,156

 
816

 
340

 
41.7

Regulatory assessments
985

 
1,133

 
(148
)
 
(13.1
)
Data processing
3,895

 
3,290

 
605

 
18.4

Office operations
2,276

 
2,468

 
(192
)
 
(7.8
)
Other
2,525

 
2,771

 
(246
)
 
(8.9
)
 
$
39,752

 
$
37,542

 
$
2,210

 
5.9
 %
The increase in non-interest expense for the three months ended March 31, 2017 compared to the three months ended March 31, 2016 was primarily due to a $2.1 million increase in salaries and employee benefits expense, which was driven by additional staff and merit increases, as well as increases in performance incentive accruals, payroll taxes and share-based compensation expense. Data processing expense increased by $605,000 compared to the first quarter of 2016, primarily due to increased costs compared to the prior year for system upgrades to enhance customer service and increase operating efficiency, while outside professional services expense increased by $340,000 due to higher legal fees in the 2017 period. These increases were partially offset by a $246,000 decline in other non-interest expense due to lower debit card fraud losses in the 2017 period, as well as a $219,000 decline in advertising costs compared to the first quarter of 2016.
Income Tax Expense. For the three months ended March 31, 2017, we recognized income tax expense of $8.4 million on our pre-tax income, which was an effective tax rate of 31.7%, compared to income tax expense of $11.6 million for the three months ended March 31, 2016, which was an effective tax rate of 34.4%. The decrease in the effective tax rate in the 2017 period primarily resulted from the adoption of ASU 2016-09, Improvements to Employee Share-Based Payment Accounting, in the 2017 period, which changed the tax effect of the difference between the amount of share-based compensation cost recognized for financial reporting purposes and the amount deducted on the Company's tax return for share-based payment awards. Previously, the tax effects of income tax deductions in excess of compensation cost (windfalls) and the tax effects of compensation cost in excess of income tax deductions (shortfalls) were recorded in equity to the extent of previously recognized windfalls, with the remainder recorded in income tax expense.  Under ASU 2016-09, all tax effects of windfalls and shortfalls related to share-based payments are recorded through the income statement. 
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following table presents, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. Also presented are the weighted average yields on interest-earning assets, rates paid on interest-bearing liabilities and the resultant spread. All average balances are daily average balances. Non-accruing loans have been included in the table as loans carrying a zero yield. Yields earned and rates paid are calculated at the portfolio level using the actual number of days in each month over the actual number of days in the year, with the exception of the securities portfolios and the consumer real estate and loans held for sale loan portfolios, which are calculated using 30 days in a month over 360 days in a year.






46



 
 
Three Months Ended March 31,
 
 
2017
 
2016
 
 
Average
Outstanding
Balance
 
Interest
Earned/Paid
 
Yield/
Rate
 
Average
Outstanding
Balance
 
Interest
Earned/Paid
 
Yield/
Rate
 
 
(Dollars in thousands)
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
2,724,167

 
$
33,924

 
5.05
%
 
$
2,228,682

 
$
28,146

 
5.08
%
 
Warehouse Purchase Program
697,316

 
6,025

 
3.50

 
796,832

 
6,674

 
3.37

 
Commercial and industrial
1,969,766

 
26,221

 
5.40

 
1,612,125

 
17,929

 
4.47

 
Construction and land
290,856

 
3,716

 
5.18

 
269,691

 
3,604

 
5.37

 
Consumer real estate
1,090,700

 
12,380

 
4.54

 
949,568

 
11,325

 
4.77

 
Other consumer
52,655

 
715

 
5.51

 
67,055

 
948

 
5.69

 
Loans held for sale
12,667

 
122

 
3.85

 
19,588

 
180

 
3.68

 
Less: deferred fees and allowance for loan loss
(65,904
)
 
—

 
—

 
(49,178
)
 
—

 
—

 
Loans receivable 1
6,772,223

 
83,103

 
4.97

 
5,894,363

 
68,806

 
4.69

 
Agency mortgage-backed securities
326,307

 
1,672

 
2.05

 
344,762

 
1,802

 
2.09

 
Agency collateralized mortgage obligations
143,671

 
859

 
2.39

 
79,299

 
464

 
2.34

 
Investment securities
114,382

 
786

 
2.75

 
123,281

 
820

 
2.66

 
FHLB and FRB stock and other restricted securities
45,006

 
384

 
3.41

 
52,338

 
386

 
2.95

 
Interest-earning deposit accounts
332,664

 
732

 
0.89

 
238,576

 
330

 
0.56

Total interest-earning assets
7,734,253

 
87,536

 
4.58

 
6,732,619

 
72,608

 
4.33

Non-interest-earning assets
437,819

 
 
 
 
 
424,640

 
 
 
 
Total assets
$
8,172,072

 
 
 
 
 
$
7,157,259

 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand
$
855,075

 
1,121

 
0.53

 
$
774,798

 
932

 
0.48

 
Savings and money market
2,652,866

 
3,024

 
0.46

 
2,209,675

 
1,341

 
0.24

 
Time
1,314,607

 
2,965

 
0.91

 
1,049,810

 
1,849

 
0.71

 
Borrowings
1,040,835

 
3,878

 
1.51

 
1,106,577

 
3,135

 
1.14

Total interest-bearing liabilities
5,863,383

 
10,988

 
0.76

 
5,140,860

 
7,257

 
0.57

Non-interest-bearing demand
1,341,315

 
 
 
 
 
1,134,070

 
 
 
 
Non-interest-bearing liabilities
67,256

 
 
 
 
 
63,791

 
 
 
 
Total liabilities
7,271,954

 
 
 
 
 
6,338,721

 
 
 
 
Total shareholders’ equity
900,118

 
 
 
 
 
818,538

 
 
 
 
Total liabilities and shareholders’ equity
$
8,172,072

 
 
 
 
 
$
7,157,259

 
 
 
 
Net interest income and margin
 
 
$
76,548

 
4.00
%
 
 
 
$
65,351

 
3.90
%
Net interest income and margin (tax-equivalent basis) 2
 
 
$
76,812

 
4.01
%
 
 
 
$
65,622

 
3.92
%
Net interest rate spread
 
 
 
 
3.82
%
 
 
 
 
 
3.76
%
Net earning assets
$
1,870,870

 
 
 
 
 
$
1,591,759

 
 
 
 
Average interest-earning assets to average interest-bearing liabilities
131.91
%
 
 
 
 
 
130.96
%
 
 
 
 
1 
Calculated net of deferred fees, loan discounts, loans in process and allowance for loan losses.
2 
In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment has been computed using a federal income tax rate of 35% for 2017 and 2016. Tax-exempt investments and loans had an average balance of $103.8 million and $108.3 million for the three months ended March 31, 2017 and 2016, respectively.



47

Rate/Volume Analysis
The following table presents the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the changes related to outstanding balances and those due to changes in interest rates. The change in interest attributable to rate has been determined by applying the change in rate between periods to average balances outstanding in the earlier period. The change in interest due to volume has been determined by applying the rate from the earlier period to the change in average balances outstanding between periods. Changes attributable to both rate and volume which cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.


 
Three Months Ended March 31,
 
2017 versus 2016
 
Increase (Decrease) Due to
 
Total Increase
 
Volume
 
Rate
 
(Decrease)
 
(Dollars in thousands)
Interest-earning assets:
 
 
 
 
 
Commercial real estate
$
6,175

 
$
(397
)
 
$
5,778

Warehouse Purchase Program
(855
)
 
206

 
(649
)
Commercial and industrial
4,392

 
3,900

 
8,292

Construction and land
275

 
(163
)
 
112

Consumer real estate
1,622

 
(567
)
 
1,055

Other consumer
(197
)
 
(36
)
 
(233
)
Loans held for sale
(66
)
 
8

 
(58
)
Loans receivable
11,346

 
2,951

 
14,297

Agency mortgage-backed securities
(95
)
 
(35
)
 
(130
)
Agency collateralized mortgage obligations
385

 
10

 
395

Investment securities
(61
)
 
27

 
(34
)
FHLB and FRB stock and other restricted securities
(58
)
 
56

 
(2
)
Interest-earning deposit accounts
161

 
241

 
402

Total interest-earning assets
11,678

 
3,250

 
14,928

Interest-bearing liabilities:
 
 
 
 
 
Interest-bearing demand
101

 
88

 
189

Savings and money market
313

 
1,370

 
1,683

Time
528

 
588

 
1,116

Borrowings
(196
)
 
939

 
743

Total interest-bearing liabilities
746

 
2,985

 
3,731

Net interest income
$
10,932

 
$
265

 
$
11,197

 
 
 
 
 
 








48

Liquidity
Management maintains a liquidity position that it believes will adequately provide funding for loan demand and deposit run-off that may occur in the normal course of business. The Company relies on a number of different funding sources in order to meet its potential liquidity demands. The primary funding sources are increases in deposit accounts and cash flows from loan payments and the securities portfolio.
Management also has several secondary sources of funds available to meet potential liquidity demands. At March 31, 2017, the Company had additional borrowing capacity of $1.81 billion with the FHLB and $255.0 million in federal funds lines of credit available with other financial institutions. The Company may also use the discount window at the Federal Reserve Bank as a source of short-term funding. Federal Reserve Bank borrowing capacity varies based upon securities pledged to the discount window line. At March 31, 2017, securities pledged had a collateral value of $42.7 million.
At March 31, 2017, the Company had classified 65.6% of its securities portfolio as available for sale (including pledged securities), providing an additional source of liquidity. Management believes that because active markets exist and our securities portfolio is of high quality, our available for sale securities are marketable. Selling participations in loans we originate, including portions of commercial real estate loans, creates another source of liquidity and allows us to manage borrower concentration risk as well as interest rate risk.
Liquidity management is both a daily and long-term function of business management. Short-term excess liquidity is generally placed in short-term investments, such as overnight deposits at the Federal Reserve Bank and correspondent banks. On a longer term basis, we maintain a strategy of investing in various lending products and investment securities, including mortgage-backed securities.
Planning for the Company's normal business liquidity needs, both expected and unexpected, is done on a daily and short-term basis through the cash management function. On a longer-term basis it is accomplished through the budget and strategic planning functions, with support from internal asset/liability management software model projections.
The Liquidity Committee monitors liquidity positions and projections. Liquidity contingency planning is added to the Committee's process by focusing on possible scenarios that would stress liquidity beyond the Bank's normal business liquidity needs. These scenarios may include macro-economic and bank specific situations focusing on high probability-high impact, high probability-low impact, low probability-high impact, and low probability-low impact stressors.
Management recognizes that the factors and conditions leading up to and occurring during a liquidity stress event cannot be precisely defined or listed. Nevertheless, management believes that liquidity stress events can be categorized into sources and uses of liquidity, and levels of severity, with responses that apply to various situations.
The Company, which is a separate legal entity from the Bank and must provide for its own liquidity, had liquid assets of $21.6 million on an unconsolidated basis at March 31, 2017. In addition to its operating expenses, the Company is responsible for paying any dividends declared to its shareholders, funds paid out for Company stock repurchases, and payments on trust-preferred securities and subordinated debt held at the Company level. The Company has the ability to receive dividends or capital distributions from the Bank, although there are regulatory restrictions on the ability of the Bank to pay dividends. See “How We Are Regulated - Limitations on Dividends and Other Capital Distributions” under Item 1 and Note 16 of the Notes to Consolidated Financial Statements contained in Item 8 of the Company's 2016 Form 10-K.
The Company uses its sources of funds primarily to meet its expenses, pay maturing deposits and fund withdrawals, and to fund loan commitments. Total approved loan commitments (including Warehouse Purchase Program commitments, unused lines of credit and letters of credit) amounted to $2.71 billion and $2.56 billion at March 31, 2017, and December 31, 2016, respectively. It is management's policy to offer deposit rates that are competitive with other local financial institutions. Based on this management strategy, we believe that a majority of maturing deposits will remain with the Company. Certificates of deposit scheduled to mature in one year or less at March 31, 2017 totaled $973.6 million with a weighted average rate of 0.82%.
During the three months ended March 31, 2017, cash and cash equivalents increased by $65.8 million, or 22.8%, to $355.0 million at March 31, 2017 from $289.2 million at December 31, 2016. Operating activities provided cash of $96.6 million, which was partially offset by cash used in investing activities of $25.2 million and cash used in financing activities of $5.5 million. Primary sources of cash for the three months ended March 31, 2017 included proceeds from pay-offs of Warehouse Purchase Program loans totaling $4.47 billion, a $58.5 million increase in other liabilities related to escrow accounts, proceeds from the sale of loans held for sale totaling $43.5 million, and a $14.2 million increase in deposits. Primary

49

uses of cash for the three months ended March 31, 2017 included originations of Warehouse Purchase Program loans totaling $4.26 billion and net fundings of loans held for investment totaling $218.9 million.
Please see Item 1A (Risk Factors) under Part 1 of the Company's 2016 Form 10-K for information regarding liquidity risk.
Off-Balance Sheet Arrangements, Contractual Obligations and Commitments
The following table presents our longer term contractual obligations and commitments to extend credit to our borrowers, in aggregate and by payment due dates (not including any interest amounts). In addition to the commitments below, the Company had overdraft protection available to its depositors in the amount of $85.2 million and credit card guarantees outstanding in the amount of $3.8 million at March 31, 2017.
 
March 31, 2017
 
Less than
One Year
 
One
through
Three Years
 
Four
through
Five Years
 
After Five
Years
 
Total
 
(Dollars in thousands)
Contractual obligations:
 
 
 
 
 
 
 
 
 
Deposits without a stated maturity
$
5,002,279

 
$
—

 
$
—

 
$
—

 
$
5,002,279

Certificates of deposit
973,601

 
319,460

 
80,956

 
3,350

 
1,377,367

FHLB advances 1
615,651

 
211,705

 
2,065

 
792

 
830,213

Repurchase agreements
51,880

 
25,000

 
—

 
—

 
76,880

Subordinated debt 1
—

 
—

 
—

 
140,464

 
140,464

Private equity fund for Community Reinvestment Act purposes
1,680

 
—

 
—

 
—

 
1,680

Operating leases (premises)
6,110

 
9,985

 
8,418

 
18,696

 
43,209

Total contractual obligations
$
6,651,201

 
$
566,150

 
$
91,439

 
$
163,302

 
7,472,092

Off-balance sheet loan commitments: 2
 
 
 
 
 
 
 
 
 
Unused commitments to extend credit
$
832,162

 
$
559,579

 
$
303,494

 
$
57,321

 
1,752,556

Unused capacity on Warehouse Purchase Program loans 3
893,387

 
32,655

 
—

 
—

 
926,042

Standby letters of credit
21,731

 
5,774

 
2,253

 
—

 
29,758

Total loan commitments
$
1,747,280

 
$
598,008

 
$
305,747

 
$
57,321

 
2,708,356

Total contractual obligations and loan commitments
 
 
 
 
 
 
 
 
$
10,180,448

1 FHLB advances and subordinated debt are shown at their contractual amounts.
2 Loans having no stated maturity are reported in the “Less than One Year” category.
3 In regards to unused capacity on Warehouse Purchase Program loans, the Company has established a maximum purchase facility amount, but reserves the right, at any time, to refuse to buy any mortgage loans offered for sale by its mortgage banking company customers for any reason in the Company's sole and absolute discretion.




50

Capital Resources
Consistent with our goal to operate a sound and profitable organization, our policy is for the Company and its subsidiary bank to maintain “well-capitalized” status under the FRB regulations. Based on capital levels at March 31, 2017 and December 31, 2016, the Bank and the Company were considered to be well-capitalized. At March 31, 2017, the Bank's equity totaled $992.6 million. The Company's consolidated equity totaled $899.9 million, or 10.7% of total assets, at March 31, 2017. Warehouse Purchase Program loan volumes can increase significantly on the last day of the month, potentially leading to a significant difference between the ending and average balance of Warehouse Purchase Program loans. At March 31, 2017, Warehouse Purchase Program loans totaled $847.0 million, compared to an average balance of $697.3 million for the three months ended March 31, 2017. Because the capital ratios below are calculated using ending risk-weighted assets and Warehouse Purchase Program loans are risk-weighted at 100%, an end of period increase in these balances can significantly impact the Company's reported capital ratios.
 
Actual
 
Required for Capital Adequacy Purposes
 
To Be Well-Capitalized
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
March 31, 2017
(Dollars in thousands)
Total risk-based capital
 
 
 
 
 
 
 
 
 
 
 
Company
$
929,705

 
11.93
%
 
$
623,528

 
8.00
%
 
$
779,410

 
10.00
%
Bank
888,245

 
11.40

 
623,494

 
8.00

 
779,368

 
10.00

Tier 1 risk-based capital
 
 
 
 
 
 
 
 
 
 
 
Company
735,508

 
9.44

 
467,646

 
6.00

 
467,646

 
6.00

Bank
816,414

 
10.47

 
467,621

 
6.00

 
623,494

 
8.00

Common equity tier 1 risk-based capital
 
 
 
 
 
 
 
 
 
 
Company
723,720

 
9.29

 
350,735

 
4.50

 
n/a 1

 
n/a 1

Bank
816,414

 
10.47

 
350,715

 
4.50

 
506,589

 
6.50

Tier 1 leverage
 
 
 
 
 
 
 
 
 
 
 
Company
735,508

 
9.19

 
320,001

 
4.00

 
n/a 1

 
n/a 1

Bank
816,414

 
10.20

 
320,022

 
4.00

 
400,027

 
5.00

December 31, 2016
 
 
 
 
 
 
 
 
 
 
 
Total risk-based capital
 
 
 
 
 
 
 
 
 
 
 
Company
$
910,040

 
11.71
%
 
$
621,870

 
8.00
%
 
$
777,338

 
10.00
%
Bank
869,523

 
11.19

 
621,840

 
8.00

 
777,300

 
10.00

Tier 1 risk-based capital
 
 
 
 
 
 
 
 
 
 
 
Company
721,600

 
9.28

 
466,403

 
6.00

 
466,403

 
6.00

Bank
803,374

 
10.34

 
466,380

 
6.00

 
621,840

 
8.00

Common equity tier 1 risk-based capital
 
 

 
 
 
 
 
 
 
 
Company
709,858

 
9.13

 
349,802

 
4.50

 
n/a 1

 
n/a 1

Bank
803,374

 
10.34

 
349,785

 
4.50

 
505,245

 
6.50

Tier 1 leverage
 
 
 
 
 
 
 
 
 
 
 
Company
721,600

 
8.73

 
330,782

 
4.00

 
n/a 1

 
n/a 1

Bank
803,374

 
9.71

 
330,873

 
4.00

 
413,591

 
5.00

1 Not applicable
 
 
 
 
 
 
 
 
 
 
 
Pursuant to the capital regulations of the FRB and the other federal banking agencies, the Company and the Bank must maintain a capital conservation buffer consisting of additional common equity tier 1 capital greater than 2.5% of risk-weighted assets above the required minimum levels of risk-based common equity tier 1 capital, tier 1 capital and total capital in order to avoid limitations on paying dividends, repurchasing shares, and paying discretionary bonuses. For our fiscal year ending December 31, 2017, the capital conservation buffer rule requires a buffer of greater than 1.25% of risk-weighted assets, which amount will increase by 0.625% yearly until the requirement is fully phased-in on January 1, 2019, when the buffer must exceed 2.5% of risk-weighted assets. At March 31, 2017, the Company's and the Bank's common equity tier 1 capital exceeded the required capital conservation buffer.

51

Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Asset/Liability Management
Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. However, market rates change over time. Like other financial institutions, our results of operations are impacted by changes in market interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in market interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.
How We Measure Our Risk of Interest Rate Changes. As part of our attempt to manage our exposure to changes in market interest rates and comply with applicable regulations, we calculate and monitor our interest rate risk. In doing so, we analyze and manage assets and liabilities based on their interest rates and contractual cash flows, timing of maturities, prepayment potential, repricing opportunities, and sensitivity to actual or potential changes in market interest rates.
The Company is subject to interest rate risk to the extent that its interest-bearing liabilities, primarily deposits, FHLB advances and other borrowings, reprice more rapidly or slowly, or at different rates (basis risk) than its interest-earning assets, primarily loans and investment securities.
The Bank calculates interest rate risk by entering relevant contractual and projected information into its asset/liability management software simulation model. Data required by the model includes balance, rate, pay down schedule, and maturity. For items that contractually reprice, the repricing index, spread, and frequency are entered, including any initial, periodic, and lifetime interest rate caps and floors.
The Bank has adopted an asset and liability management policy. This policy sets the foundation for monitoring and managing the potential for adverse effects of material prolonged increases or decreases in interest rates on our results of operations. The Board of Directors sets the asset and liability policy for the Bank, which is implemented by the Asset/Liability Management Committee.
The purpose of the Asset/Liability Management Committee is to monitor, communicate, coordinate, and direct asset/liability management consistent with our business plan and board-approved policies. The Committee directs and monitors the volume and mix of assets and funding sources, taking into account relative costs and spreads, interest rate sensitivity and liquidity needs. The objectives are to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, interest rate risk, growth, and profitability goals.
The Committee meets on a quarterly basis to, among other things, protect capital through earnings stability over the interest rate cycle, maintain our well-capitalized status, and provide a reasonable return on investment. The Committee recommends appropriate strategy changes based on this review. The Committee is responsible for reviewing and reporting the effects of policy implementation and strategies to the Board of Directors at least quarterly. Senior managers oversee the process on a daily basis.
A key element of the Bank’s asset/liability management strategy is to protect earnings by managing the inherent maturity and repricing mismatches between its interest-earning assets and interest-bearing liabilities. The Bank generally manages such earnings exposure through the addition of loans, investment securities and deposits with risk mitigating characteristics and by entering into appropriate term FHLB advance agreements.
As part of its efforts to monitor and manage interest rate risk, the Bank uses the economic value of equity (“EVE”) methodology adopted by the Federal Financial Institutions Examination Council ("FFIEC") as part of its capital regulations. In essence, the EVE approach calculates the difference between the present value of expected cash flows from assets and liabilities. In addition to monitoring selected measures of EVE, management also calculates and monitors potential effects on net interest income resulting from increases or decreases in market interest rates. This approach uses the earnings at risk (“EAR”) methodology adopted by the Joint Agency Policy Statement on Interest Rate Risk as part of its capital regulations. EAR calculates estimated net interest income using a flat balance sheet approach over a twelve month time horizon. The EAR process is used in conjunction with EVE measures to identify interest rate risk on both a global and account level basis. Management and the Board of Directors review EVE and EAR measurements at least quarterly to review historical trends, projected measurements, and to determine whether the Bank's interest rate exposure is within the limits established by the Board of Directors.

52

The Bank's asset/liability management strategy sets acceptable limits for the percentage change in EVE and EAR given changes in interest rates. For instantaneous, parallel, and sustained interest rate increases or decreases of 100 basis points, the Bank's policy indicates that change in EVE should not decrease by more than 5.00%, and for increases of 200, 300, and 400 basis points, the change in EVE should not exceed a 10.00%, 12.50% and 15.00% decrease, respectively. For an instantaneous, parallel, and sustained interest rate increase or decrease of 100 basis points, the Bank's policy indicates that the change in EAR should not exceed a 7% decrease, and for increases of 200, 300, and 400 basis points, the change in EAR should not exceed decreases of 10%, 13%, and 15%, respectively.
As illustrated in the tables below, the Bank was within policy limits for all scenarios tested. The tables presented below, as of March 31, 2017, and December 31, 2016, are internal analyses of our interest rate risk as measured by changes in EVE and EAR for instantaneous, parallel, and sustained shifts for all market rates and yield curves, in 100 basis point increments, up 400 basis points and down 100 basis points.
As illustrated in the tables below, our EVE would be negatively impacted by a parallel, instantaneous, and sustained increase in market rates. Such an increase in rates would negatively impact EVE as a result of the duration of assets, including loans and investments, being longer than the duration of liabilities, primarily deposit accounts and FHLB borrowings. In rising rate environments, deposits are more beneficial to the Bank’s EVE than comparable wholesale funding. As illustrated in the table below, at March 31, 2017, our EAR would be positively impacted by a parallel, instantaneous, and sustained increase in market rates. Our EVE and EAR would also be negatively impacted by a 100 basis point decline in market rates.
March 31, 2017
Change in Interest Rates in Basis Points
 
Economic Value of Equity
 
Earnings at Risk (12 months)
 
Estimated EVE
 
Estimated Increase / (Decrease) in EVE
 
 EVE Ratio %
 
Estimated Net Interest Income
 
Increase / (Decrease) in Estimated Net Interest Income
 
 
$ Amount
 
$ Change
 
% Change
 
 
 
$ Amount
 
$ Change
 
% Change
 
 
(Dollars in thousands)
400

 
1,118,540

 
(134,709
)
 
(10.75
)
 
14.43
 
320,518

 
3,626

 
1.14

300

 
1,161,112

 
(92,137
)
 
(7.35
)
 
14.71
 
319,752

 
2,860

 
0.90

200

 
1,198,234

 
(55,015
)
 
(4.39
)
 
14.91
 
318,871

 
1,979

 
0.62

100

 
1,231,997

 
(21,252
)
 
(1.70
)
 
15.06
 
317,888

 
996

 
0.31

—

 
1,253,249

 
—

 
—

 
15.07
 
316,892

 
—

 
—

(100
)
 
1,214,045

 
(39,204
)
 
(3.13
)
 
14.36
 
304,042

 
(12,850
)
 
(4.06
)
December 31, 2016
Change in Interest Rates in Basis Points
 
Economic Value of Equity
 
Earnings at Risk (12 months)
 
Estimated EVE
 
Estimated Increase / (Decrease) in EVE
 
 EVE Ratio %
 
Estimated Net Interest Income
 
Increase / (Decrease) in Estimated Net Interest Income
 
 
$ Amount
 
$ Change
 
% Change
 
 
 
$ Amount
 
$ Change
 
% Change
 
 
(Dollars in thousands)
400

 
1,137,560

 
(127,508
)
 
(10.08
)
 
14.74
 
312,457

 
1,807

 
0.58

300

 
1,180,103

 
(84,965
)
 
(6.72
)
 
15.02
 
312,109

 
1,459

 
0.47

200

 
1,216,125

 
(48,943
)
 
(3.87
)
 
15.21
 
311,549

 
899

 
0.29

100

 
1,248,129

 
(16,939
)
 
(1.34
)
 
15.34
 
310,953

 
303

 
0.10

—

 
1,265,068

 
—

 
—

 
15.30
 
310,650

 
—

 
—

(100
)
 
1,230,570

 
(34,498
)
 
(2.73
)
 
14.64
 
297,726

 
(12,924
)
 
(4.16
)

The Bank's EVE was $1.25 billion, or 15.07%, of the market value of portfolio assets as of March 31, 2017, an $11.8 million decrease from $1.27 billion, or 15.30%, of the market value of portfolio assets as of December 31, 2016. Based upon

53

the assumptions utilized, an immediate 200 basis point increase in market interest rates would result in a $55.0 million decrease in our EVE at March 31, 2017 compared to a $48.9 million decrease at December 31, 2016, and would result in a 16 basis point decrease in our EVE ratio to 14.91% at March 31, 2017 compared to a nine basis point decrease to 15.21% at December 31, 2016. An immediate 100 basis point decrease in market interest rates would result in a $39.2 million decrease in our EVE at March 31, 2017 compared to a $34.5 million decrease at December 31, 2016, and would result in a 71 basis point decrease in our EVE ratio to 14.36% at March 31, 2017, as compared to a 66 basis point decrease in our EVE ratio to 14.64% at December 31, 2016.
The Bank's projected EAR for the twelve months ending March 31, 2018 is $316.9 million, compared to $310.7 million for the twelve months ending December 31, 2017. Based on the assumptions utilized, an immediate 200 basis point increase in market rates would result in a $2.0 million, or 0.62%, increase in net interest income for the twelve months ending March 31, 2018 compared to a $899,000, or 0.29%, increase for the twelve months ending December 31, 2017. An immediate 100 basis point decrease in market rates would result in a $12.9 million decrease in net interest income for the twelve months ending March 31, 2018 compared to a $12.9 million decrease for the twelve months ending December 31, 2017.
We have implemented a strategic plan to mitigate interest rate risk. This plan includes the ongoing review of our current and projected mix of fixed rate versus variable rate loans, investments, deposits, and borrowings. When available and appropriate, high quality adjustable rate assets are purchased or originated. These assets generally may reduce our sensitivity to upward interest rate shocks. On the liability side of the balance sheet, borrowings are added as appropriate. These borrowings will be of a size and term so as to mitigate the impact of duration mismatches, reducing our sensitivity to upward interest rate shocks. These strategies are implemented as needed and as opportunities arise to mitigate interest rate risk without materially sacrificing earnings.
In managing our mix of assets and liabilities, while considering the relationship between long and short term interest rates, market conditions, and consumer preferences, we may place somewhat greater emphasis on maintaining or increasing the Bank’s net interest margin than on strictly matching the interest rate sensitivity of its assets and liabilities.
Management also believes that at times the increased net income which may result from a mismatch in the actual maturity, repricing, or duration of its asset and liability portfolios can provide sufficient returns to justify the increased exposure to sudden and unexpected increases or decreases in interest rates which may result from such a mismatch. Management believes that the Bank’s level of interest rate risk is acceptable under this approach.
In evaluating the Bank’s exposure to market interest rate movements, certain shortcomings inherent in the method of analysis presented in the foregoing table must be considered. For example, although certain assets and liabilities may have similar maturities or repricing characteristics, their interest rate drivers may react in different degrees to changes in market interest rates (basis risk). Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market interest rates. Additionally, certain assets, such as adjustable rate mortgages, have features which restrict changes in interest rates over the life of the asset (time to initial interest rate reset; interest rate reset frequency; initial, periodic, and lifetime caps and floors). Further, in the event of a significant change in market interest rates, loan and securities prepayment and time deposit early withdrawal levels may deviate significantly from those assumed in the table above. Assets with prepayment options and liabilities with early withdrawal options are being monitored, with assumptions stress tested on a regular basis. Current market rates and customer behavior are being considered in the management of interest rate risk. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. The Bank considers all of these factors in monitoring its exposure to interest rate risk. Of note, the current historically low interest rate environment has resulted in asymmetrical interest rate risk. The interest rates on certain repricing assets and liabilities cannot be fully shocked downward.
The Board of Directors and management believe that the Bank’s ability to successfully manage and mitigate its exposure to interest rate risk is strengthened by several key factors. For example, the Bank manages its balance sheet duration and overall interest rate risk by placing a preference on originating and retaining adjustable rate loans. In addition, the Bank borrows at various maturities from the FHLB to mitigate mismatches between the asset and liability portfolios. Furthermore, the investment securities portfolio is used as a primary interest rate risk management tool through the duration and repricing targeting of purchases and sales.

54

Item 4.
Controls and Procedures
An evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of March 31, 2017. Based on that evaluation, the Company's Chief Executive Officer and Chief Financial Officer concluded that the Company's disclosure controls and procedures were effective as of the end of the period covered by this quarterly report. There has been no change in the Company's internal controls over financial reporting during the quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
While the Company believes the present design of its disclosure controls and procedures is effective to achieve its goals, future events affecting its business may cause the Company to modify its disclosure controls and procedures. The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all error and fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns in controls or procedures can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual actions of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.


55

PART II - OTHER INFORMATION

Item 1.
Legal Proceedings
We are involved from time to time as plaintiff or defendant in various legal actions arising in the normal course of our businesses. While the ultimate outcome of pending proceedings cannot be predicted with certainty, it is the opinion of management, after consultation with counsel representing us in such proceedings, that the resolution of these proceedings should not have a material adverse effect on our consolidated financial position or results of operations.
Item 1A.
Risk Factors

There have been no material changes to the risk factors previously disclosed in the Company's 2016 Form 10-K.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
The Company did not repurchase any of its common stock during the quarter ended March 31, 2017.
Item 3.
Defaults upon Senior Securities
Not applicable.

Item 4.
Mine Safety Disclosures
Not applicable.
Item 5.
Other Information
Not applicable.

56


Item 6.
 
Exhibits
Exhibit
 
 
Number
 
Description
 
 
 
2.1

 
Agreement and Plan of Merger, dated as of November 25, 2013, by and between the Registrant and LegacyTexas Group, Inc. (incorporated herein by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on November 25, 2013 (File No. 001-34737))
 
 
 
2.2

 
Amendment No. One to the Agreement and Plan of Merger, dated as of February 19, 2014, by and between the Registrant and LegacyTexas Group, Inc. (incorporated herein by reference to Exhibit 2.3 of the Registrant’s Annual Report on Form 10-K filed with the SEC on February 26, 2014 (File No. 001-34737))
 
 
 
2.3

 
Amendment No. Two to the Agreement and Plan of Merger, dated as of August 29, 2014, by and between the Registrant and LegacyTexas Group, Inc. (incorporated herein by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on August 29, 2014 (File No. 001-34737))
 
 
 
3.1

 
Charter of the Registrant (incorporated herein by reference to Exhibit 3.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on January 6, 2015 (File No. 001-34737))
 
 
 
3.2

 
Bylaws of the Registrant (incorporated herein by reference to Exhibit 3.2 of the Registrant’s Current Report on Form 8-K filed with the SEC on January 6, 2015 (File No. 001-34737))
 
 
 
4.1

 
Certificate of Registrant’s Common Stock (incorporated herein by reference to Exhibit 4.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on January 6, 2015 (File No. 001-34737))
 
 
 
4.2

 
The Registrant hereby agrees to furnish to the Commission, upon request, the instruments defining the rights of the holders of each issue of long-term debt of the Registrant and its consolidated subsidiaries.
 
 
 
10.1

 
ViewPoint Bank Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.7 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 0-24566-01))
 
 
 
10.2

 
Amended and Restated ViewPoint Bank Supplemental Executive Retirement Plan (incorporated herein by reference to Exhibit 10.8 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 0-24566-01))
 
 
 
10.3

 
2017 Executive Annual Incentive Plan (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on March 3, 2017 (File No. 001-34737))
 
 
 
10.4

 
Change in Control and Severance Benefits Agreement entered into between the Registrant and Mays Davenport (incorporated herein by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the SEC on November 25, 2013 (File No. 001-34737)).
 
 
 
10.5

 
Form of Change In Control and Severance Benefits Agreement entered into between the Registrant and the following executive officers: Scott A. Almy, Charles D. Eikenberg, Thomas S. Swiley, and Mark L. Williamson (incorporated herein by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the SEC on December 2, 2013 (File No. 001-34737)).
 
 
 
10.6

 
Amended and Restated Executive Employment Agreement entered into by the Registrant on December 2, 2013 with Kevin J. Hanigan (incorporated herein by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K filed with the SEC on December 2, 2013 (File No. 001-34737)).
 
 
 
10.7

 
Registrant's 2007 Equity Incentive Plan (incorporated herein by reference to Appendix A to the proxy statement filed with the SEC on March 30, 2007 (File No. 001-32992))
 
 
 

57

10.8

 
Registrant's 2012 Equity Incentive Plan (incorporated herein by reference to Appendix A to the Registrant's proxy statement filed with the SEC on April 4, 2012 (File No. 001-34737))
 
 
 
10.9

 
Forms of Incentive Stock Option, Non-Qualified Stock Option, and Restricted Stock (time and performance-based) Agreements under the 2012 Equity Incentive Plan (incorporated herein by reference to the Exhibits to the Registrant's Registration Statement on Form S-8 filed with the SEC on June 14, 2012 (File No. 333-182122))
 
 
 
10.10

 
Form of 2012 Equity Incentive Plan Restricted Stock Award and Non-Solicitation Agreement (incorporated herein by reference to Exhibit 10.10 to the Registrant's Quarterly Report on Form 10-Q filed with the SEC on July 26, 2016 (File No. 001-34737))
 
 
 
10.11

 
Form of 2012 Equity Incentive Plan Non-Employee Restricted Stock Award Agreement (incorporated herein by reference to Exhibit 10.11 to the Registrant's Quarterly Report on Form 10-Q filed with the SEC on July 26, 2016 (File No. 001-34737))
 
 
 
11

 
Statement regarding computation of per share earnings (See Note 3 of the Condensed Notes to Unaudited Consolidated Interim Financial Statements included in this Form 10-Q).
 
 
 
31.1

 
Rule 13a — 14(a)/15d — 14(a) Certification (Chief Executive Officer)
 
 
 
31.2

 
Rule 13a — 14(a)/15d — 14(a) Certification (Chief Financial Officer)
 
 
 
32

 
Section 1350 Certifications
 
 
 
101

 
Financial statements from Quarterly Report on Form 10-Q of the Registrant for the quarter ended March 31, 2017, formatted in eXtensible Business Reporting Language (XBRL): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Condensed Notes to Unaudited Consolidated Interim Financial Statements.
 
 
 


58


SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
LegacyTexas Financial Group, Inc.
(Registrant)

Date:
April 25, 2017
 
By:
/s/ Kevin J. Hanigan
 
 
 
 
Kevin J. Hanigan,
 
 
 
 
President and Chief Executive Officer
 
 
 
 
(Duly Authorized Officer)
 
 
 
 
 
Date:
April 25, 2017
 
By:
/s/ J. Mays Davenport
 
 
 
 
J. Mays Davenport
 
 
 
 
Executive Vice President and Chief Financial Officer
 
 
 
 
(Principal Financial and Accounting Officer)


59


EXHIBIT INDEX
Exhibits:

31.1
Certification of the Chief Executive Officer
31.2
Certification of the Chief Financial Officer
32.0
Section 1350 Certifications
101
Financial statements from Quarterly Report on Form 10-Q of the Registrant for the quarter ended March 31, 2017, formatted in eXtensible Business Reporting Language (XBRL): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders' Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Condensed Notes to Unaudited Consolidated Interim Financial Statements.



60

LegacyTexas Financial Group, Inc. Reports