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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
þ | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 | |
For the fiscal year ended December 31, 2004 | ||
o | TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES AND EXCHANGE ACT OF 1934 | |
For the transition period from to (No fee required) |
TEXAS CAPITAL BANCSHARES, INC.
(Exact Name of Registrant as Specified in Its Charter)
Delaware | 000-30533 | 75-2679109 | ||
(State or other jurisdiction of incorporation or organization) | (Commission File Number) | (I.R.S. Employer Identification Number) |
2100 McKinney Avenue, Suite 900, Dallas, Texas, U.S.A.
(Address of principal executive officers)
75201
(Zip Code)
214-932-6600
(Registrant’s telephone number, including area code)
Securities registered under Section 12(b) of the Exchange Act:
None
Securities registered under Section 12(g) of the Exchange Act:
Common stock, par value $0.01 per share
(Title of class)
Indicate by check mark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act 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 þ No o
Indicate by check mark if there is no disclosure of delinquent filers in response to Item 405 of Regulation S-K contained in this form, and no disclosure will be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. o
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No o
As of June 30, 2004, the last business day of the registrant’s most recently completed second fiscal quarter, the aggregate market value of the shares of common stock held by non-affiliates, based upon the closing price per share of the registrant’s common stock as reported on NASDAQ, was approximately $364,531,000. There were 25,543,296 shares of the registrant’s common stock outstanding on February 28, 2005.
Documents Incorporated by Reference
Portions of the registrant’s Proxy Statement relating to the 2005 Annual Meeting of Stockholders, which will be filed no later than April 28, 2005, are incorporated by reference into Part III of this Form 10-K.
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ITEM 1. | BUSINESS |
Background
We were organized in March 1998 to serve as the holding company for Texas Capital Bank, National Association, an independent bank managed by Texans and oriented to the needs of the Texas marketplace. We decided that the most efficient method of building an independent bank was to acquire an existing bank and substantially increase the equity capitalization of that bank through private equity financing. The acquisition of an existing bank was attractive because it enabled us to avoid the substantial delay involved in chartering a new national or state bank. Our predecessor bank, Resource Bank, N.A., headquartered in Dallas, Texas, had completed the chartering process and commenced operations in October 1997. We acquired Resource Bank in December 1998.
We also concluded that substantial equity capital was needed to enable us to compete effectively with the subsidiary banks of nationwide banking and financial services organizations that operate in the Texas market. Accordingly, in June 1998, we commenced a private offering of our common stock and were successful in raising approximately $80.0 million upon completion of the offering.
Growth History
We have grown substantially in both size and profitability since our formation. The table below sets forth data regarding the growth of key areas of our business from December 2000 through December 2004.
December 31 | ||||||||||||||||||||
2004 | 2003 | 2002 | 2001 | 2000 | ||||||||||||||||
(In thousands) | ||||||||||||||||||||
Loans held for investment | $ | 1,564,578 | $ | 1,229,773 | $ | 1,002,557 | $ | 854,505 | $ | 624,514 | ||||||||||
Total loans | 1,684,115 | 1,310,553 | 1,118,663 | 898,269 | 625,860 | |||||||||||||||
Assets | 2,611,163 | 2,192,875 | 1,793,282 | 1,164,779 | 908,428 | |||||||||||||||
Deposits | 1,789,887 | 1,445,030 | 1,196,535 | 886,077 | 794,857 | |||||||||||||||
Stockholders’ equity | 195,275 | 171,756 | 124,976 | 106,359 | 86,197 |
The following table provides information about the growth of our loan portfolio by type of loan from December 2000 to December 2004.
December 31 | |||||||||||||||||||||
2004 | 2003 | 2002 | 2001 | 2000 | |||||||||||||||||
(In thousands) | |||||||||||||||||||||
Commercial loans | $ | 818,156 | $ | 608,542 | $ | 509,505 | $ | 402,302 | $ | 325,774 | |||||||||||
Total real estate loans | 844,640 | 675,983 | 571,260 | 442,071 | 250,150 | ||||||||||||||||
Construction loans | 328,074 | 256,134 | 172,451 | 180,115 | 83,931 | ||||||||||||||||
Permanent real estate loans | 397,029 | 339,069 | 282,703 | 218,192 | 164,873 | ||||||||||||||||
Loans held for sale | 119,537 | 80,780 | 116,106 | 43,764 | 1,346 | ||||||||||||||||
Equipment leases | 9,556 | 13,152 | 17,546 | 34,552 | 17,093 | ||||||||||||||||
Consumer loans | 15,562 | 16,564 | 24,195 | 25,054 | 36,092 |
The Texas Market
The Texas market for banking services is highly competitive. Texas’ largest banking organizations are headquartered outside of Texas and are controlled by out-of-state organizations. We believe that many middle market companies and high net worth individuals are interested in banking with a company headquartered in, and with decision-making authority based in, Texas and with established Texas bankers who have the expertise to act as trusted advisors to the customer with regard to its banking needs. Our banking centers in our target markets are served by experienced bankers with lending expertise in the specific industries found in their market areas and established community ties. We believe our bank can offer customers more responsive and personalized service. We believe that, if we service these customers properly, we will be able to establish long-term relationships and provide multiple products to our customers, thereby enhancing our profitability.
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Business Strategy
Utilizing the business and community ties of our management and their banking experience, our strategy is to build an independent bank that focuses primarily on middle market business customers and high net worth individuals in each of the major metropolitan markets of Texas. To achieve this, we seek to implement the following strategies:
• | Target middle market businesses and high net worth individuals; | |
• | Focus our business development efforts on the key major metropolitan markets in Texas; | |
• | Grow our loan and deposit base in our existing markets by hiring additional experienced Texas bankers and opening select, strategically-located banking centers; | |
• | Continue the emphasis on credit policy to provide for credit quality consistent with long-term objectives; | |
• | Improve our financial performance through the efficient management of our infrastructure and capital base, which includes: |
• | leveraging our existing infrastructure to support a larger volume of business; | |
• | maintaining tight internal approval processes for capital and operating expenses; and | |
• | extensive use of outsourcing to provide cost-effective operational support with service levels consistent with large-bank operations; |
• | Continue to use BankDirect to complement funding strategies and serve as a brand extension for other banking services; and | |
• | Extend our reach within target markets through service innovation and service excellence. |
Products and Services
We offer a variety of loan, deposit account and other financial products and services to our customers. At December 31, 2004, we maintained approximately 19,700 deposit accounts and 3,700 loan accounts.
Business Customers. We offer a full range of products and services oriented to the needs of our business customers, including:
• | commercial loans for working capital and to finance internal growth, acquisitions and leveraged buyouts; | |
• | permanent real estate and construction loans; | |
• | equipment leasing; | |
• | cash management services; | |
• | trust and escrow services; | |
• | letters of credit; and | |
• | business insurance products. |
Individual Customers. We also provide complete banking services for our individual customers, including:
• | personal trust and wealth management services; | |
• | certificates of deposit; | |
• | interest bearing and non-interest bearing checking accounts with optional features such as Visa® debit/ ATM cards and overdraft protection; |
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• | traditional savings accounts; | |
• | consumer loans, both secured and unsecured; | |
• | mortgages; | |
• | branded Visa® credit card accounts, including gold-status accounts; and | |
• | personal insurance products. |
Lending Activities
Credit Policy. We target our lending to middle market businesses and high net worth individuals that meet our credit standards. The credit standards are set by our standing Credit Policy Committee with the assistance of our Chief Credit Officer, who is charged with ensuring that credit standards are met by loans in our portfolio. Our Credit Policy Committee is comprised of senior bank officers including the President of our bank, our Chief Lending Officer and our Chief Credit Officer. We maintain a diversified loan portfolio. Credit policies and underwriting guidelines are tailored to address the unique risks associated with each industry represented in the portfolio. Our credit standards for commercial borrowers reference numerous criteria with respect to the borrower, including historical and projected financial information, strength of management, acceptable collateral and associated advance rates, and market conditions and trends in the borrower’s industry. In addition, prospective loans are also analyzed based on current industry concentrations in our loan portfolio to prevent an unacceptable concentration of loans in any particular industry. We believe our credit standards are consistent with achieving business objectives in the markets we serve and will generally mitigate risks. We believe that we differentiate our bank from its competitors by focusing on and aggressively marketing to our core customers and accommodating, to the extent permitted by our credit standards, their individual needs.
We generally extend variable rate loans in which the interest rate fluctuates with a predetermined indicator such as the United States prime rate or the London Inter-Bank Offered Rate (LIBOR). Our use of variable rate loans is designed to protect us from risks associated with interest rate fluctuations since the rates of interest earned will automatically reflect such fluctuations. As of December 31, 2004, approximately 91% of the loans in our portfolio were variable rate loans.
Commercial Loans. Our commercial loan portfolio is comprised of lines of credit for working capital and term loans to finance equipment and other business assets. Our energy production loans are generally collateralized with proven reserves based on appropriate valuation standards. Our lines of credit typically are limited to a percentage of the value of the assets securing the line. Lines of credit and term loans typically are reviewed annually and are supported by accounts receivable, inventory, equipment and other assets of our clients’ businesses. At December 31, 2004, funded commercial loans totaled approximately $818.2 million, approximately 48.5% of our total funded loans.
Permanent Real Estate Loans. Approximately 47% of our permanent real estate loan portfolio is comprised of loans secured by commercial properties occupied by the borrower. We also provide temporary financing for commercial and residential property. Our permanent real estate loans generally have terms of five to seven years, and we provide loans with both floating and fixed rates. We generally avoid long-term loans for commercial real estate held for investment. At December 31, 2004, funded permanent real estate loans totaled approximately $397.0 million, approximately 23.5% of our total funded loans; of this total, $314.7 million were loans with floating rates and $82.3 million with fixed rates.
Construction Loans. Our construction loan portfolio consists primarily of single-family residential properties and commercial projects used in manufacturing, warehousing, service or retail businesses. Our construction loans generally have terms of one to three years. We typically make construction loans to developers, builders and contractors that have an established record of successful project completion and loan repayment and have a substantial investment of the borrowers’ equity. These loans typically have floating rates and commitment fees. At December 31, 2004, funded construction real estate loans totaled approximately $328.1 million, approximately 19.4% of our total funded loans.
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Loans Held for Sale. Our loans held for sale portfolio consists primarily of single-family residential mortgages funded through our residential mortgage lending group and mortgage warehouse group. These loans are typically on our balance sheet less than 30 days. At December 31, 2004, loans held for sale totaled approximately $119.5 million, approximately 7.1% of our total funded loans.
Letters of Credit. We issue standby and commercial letters of credit, and can service the international needs of our clients through correspondent banks. At December 31, 2004, our commitments under letters of credit totaled approximately $33.5 million.
Consumer Loans. Our consumer loan portfolio consists of personal lines of credit and loans to acquire personal assets such as automobiles and boats. Our personal lines of credit generally have terms of one year and our term loans generally have terms of three to five years. Our lines of credit typically have floating interest rates. At December 31, 2004, funded consumer loans totaled approximately $15.6 million, approximately .92% of our total funded loans. Consumer residential real estate loans consisting primarily of first and second mortgage loans for residential properties are made very selectively as part of our private client service offerings. We generally do not retain long-term, fixed rate residential real estate loans in our portfolio.
The table below sets forth information regarding the distribution of our funded loans among various industries at December 31, 2004.
Funded Loans | ||||||||
Percent | ||||||||
Amount | of Total | |||||||
(Dollars in thousands) | ||||||||
Agriculture | $ | 11,570 | 0.7 | % | ||||
Contracting | 244,701 | 14.5 | ||||||
Government | 13,629 | 0.8 | ||||||
Manufacturing | 112,918 | 6.7 | ||||||
Personal/household | 223,114 | 13.2 | ||||||
Petrochemical and mining | 189,668 | 11.2 | ||||||
Retail | 40,532 | 2.4 | ||||||
Services | 605,378 | 35.9 | ||||||
Wholesale | 97,699 | 5.8 | ||||||
Investors and investment management companies | 148,705 | 8.8 | ||||||
Total | $ | 1,687,914 | 100.0 | % | ||||
Loans extended to borrowers within the contracting industry are composed largely of loans to land developers and to both heavy construction and general commercial contractors. Many of these loans are secured by real estate properties, the development of which is being funded by our bank’s financing. Loans extended to borrowers within the petrochemical and mining industries are predominantly loans to finance the exploration and production of petroleum and natural gas. These loans are generally secured by proven petroleum and natural gas reserves. Personal/household loans include loans to certain high net worth individuals for commercial purposes and mortgage loans held for sale, in addition to consumer loans. Loans extended to borrowers within the services industries include loans to finance working capital and equipment, as well as loans to finance investment and owner-occupied real estate. Significant trade categories represented within the services industries include, but are not limited to, real estate services, financial services, leasing companies, transportation and communication, and hospitality services. Borrowers represented within the real estate services category are largely owners and managers of both residential and non-residential commercial real estate properties.
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We make loans that are appropriately collateralized under our credit standards. Over 90% of our funded loans are secured by collateral. The table below sets forth information regarding the distribution of our funded loans among various types of collateral at December 31, 2004.
Funded Loans | ||||||||
Percent | ||||||||
Amount | of Total | |||||||
(Dollars in thousands) | ||||||||
Business assets | $ | 382,366 | 22.7 | |||||
Energy | 158,778 | 9.4 | ||||||
Highly liquid assets | 185,497 | 11.0 | ||||||
Real property | 716,220 | 42.4 | ||||||
Rolling stock | 21,312 | 1.3 | ||||||
U.S. Government guaranty | 59,711 | 3.5 | ||||||
Other assets | 50,302 | 3.0 | ||||||
Unsecured | 113,728 | 6.7 | ||||||
Total | $ | 1,687,914 | 100.0 | % | ||||
Deposit Products
We offer a variety of deposit products to our core customers at interest rates that are competitive with other banks. Our business deposit products include commercial checking accounts, lockbox accounts, cash concentration accounts, and other cash management products. Our consumer deposit products include checking accounts, savings accounts, money market accounts and certificates of deposit. We also allow our consumer deposit customers to access their accounts, transfer funds, pay bills and perform other account functions over the Internet and through ATM machines.
BankDirect
BankDirect operates as a division of our bank to complement funding strategies and offer services to retail customers. Over the past two years, BankDirect has evolved primarily into an internet-based funding and services channel for us and become less significant to our overall business and funding strategies. As of December 31, 2004, BankDirect had a total of approximately 6,300 existing deposit accounts containing total deposits of approximately $233.8 million.
Trust and Asset Management
Our trust services include investment management, personal trust and estate services, custodial services, retirement accounts and related services. Our investment management professionals work with our clients to define objectives, goals and strategies for their investment portfolios. We assist the client with the selection of an investment manager and work with the client to tailor the investment program accordingly. We also offer retirement products such as individual retirement accounts and administrative services for retirement vehicles such as pension and profit sharing plans.
Insurance and Investment Services
Texas Capital Bank Wealth Management Services, Inc. was formed as a wholly owned subsidiary of our bank in April 2002. Texas Capital Bank Wealth Management Services brokers corporate and personal property and casualty insurance as well as group health and life insurance products to individuals and businesses. We anticipate that it will also seek to offer limited securities brokerage services in the future. Texas Capital Bank Wealth Management Services is subject to regulation by applicable state insurance regulatory agencies.
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Cayman Islands Branch
In June 2003, we received authorization from the Cayman Islands Monetary Authority to establish a branch of our bank in the Cayman Islands. We believe that a Cayman Islands branch of our bank enables us to offer more competitive cash management and deposit products to our core customers. Our Cayman Islands branch consists of an agented office to facilitate our offering of these products. We opened our Cayman Islands branch in September 2003. As of December 31, 2004, our Cayman Islands deposits totaled $158.0 million.
Employees
As of December 31, 2004, we had 510 full-time employees, 188 of whom were related to our residential mortgage lending division, of which approximately 64% are commission-based. None of our employees is represented by a collective bargaining agreement and we consider our relations with our employees to be good.
Regulation and Supervision
Current banking laws contain numerous provisions affecting various aspects of our business. Our bank is subject to federal banking laws and regulations that impose specific requirements on and provide regulatory oversight of virtually all aspects of our operations. These laws and regulations are generally intended for the protection of depositors, the deposit insurance funds of the Federal Deposit Insurance Corporation or FDIC, and the banking system as a whole, rather than for the protection of our stockholders. Banking regulators have broad enforcement powers over financial holding companies and banks and their affiliates, including the power to impose large fines and other penalties for violations of laws and regulations. The following is a brief summary of laws and regulations to which we are subject.
National banks such as our bank are subject to examination by the Office of the Comptroller of the Currency, or the OCC. The OCC and the FDIC regulate or monitor all areas of a national bank’s operations, including security devices and procedures, adequacy of capitalization and loss reserves, loans, investments, borrowings, deposits, mergers, issuances of securities, payment of dividends, interest rate risk management, establishment of branches, corporate reorganizations, maintenance of books and records, and adequacy of staff training to carry on safe lending and deposit gathering practices. The OCC requires national banks to maintain capital ratios and imposes limitations on its aggregate investment in real estate, bank premises and furniture and fixtures. National banks are currently required by the OCC to prepare quarterly reports on their financial condition and to conduct an annual audit of their financial affairs in compliance with minimum standards and procedures prescribed by the OCC.
Restrictions on Dividends. Our source of funding to pay dividends is our bank. Our bank is subject to the dividend restrictions set forth by the OCC. Under such restrictions, national banks may not, without the prior approval of the OCC, declare dividends in excess of the sum of the current year’s net profits plus the retained net profits from the prior two years, less any required transfers to surplus. In addition, under the Federal Deposit Insurance Corporation Improvement Act of 1991, our bank may not pay any dividend if payment would cause it to become undercapitalized or in the event it is undercapitalized.
It is the policy of the Federal Reserve, which regulates financial holding companies such as ours, that financial holding companies should pay cash dividends on common stock only out of income available over the past year and only if prospective earnings retention is consistent with the organization’s expected future needs and financial condition. The policy provides that financial holding companies should not maintain a level of cash dividends that undermines the financial holding company’s ability to serve as a source of strength to its banking subsidiaries.
If, in the opinion of the applicable federal bank regulatory authority, a depository institution or holding company is engaged in or is about to engage in an unsound practice (which could include the payment of dividends), such authority may require, generally after notice and hearing, that such institution or holding company cease and desist such practice. The federal banking agencies have indicated that paying dividends that deplete a depository institution’s or holding company’s capital base to an inadequate level would be such an unsafe banking practice. Moreover, the Federal Reserve and the FDIC have issued policy statements
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providing that financial holding companies and insured depository institutions generally should only pay dividends out of current operating earnings.
Supervision by the Federal Reserve. We operate as a financial holding company registered under the Bank Holding Company Act, and, as such, we are subject to supervision, regulation and examination by the Federal Reserve. The Bank Holding Company Act and other Federal laws subject financial holding companies to particular restrictions on the types of activities in which they may engage, and to a range of supervisory requirements and activities, including regulatory enforcement actions for violations of laws and regulations.
Because we are a legal entity separate and distinct from our bank, our right to participate in the distribution of assets of any subsidiary upon the subsidiary’s liquidation or reorganization will be subject to the prior claims of the subsidiary’s creditors. In the event of a liquidation or other resolution of a subsidiary, the claims of depositors and other general or subordinated creditors are entitled to a priority of payment over the claims of holders of any obligation of the institution to its stockholders, including any financial holding company (such as ours) or any stockholder or creditor thereof.
Support of Subsidiary Banks. Under Federal Reserve policy, a financial holding company is expected to act as a source of financial strength to each of its banking subsidiaries and commit resources to their support. Such support may be required at times when, absent this Federal Reserve policy, a holding company may not be inclined to provide it. As discussed below, a financial holding company in certain circumstances could be required to guarantee the capital plan of an undercapitalized banking subsidiary in order for it to be accepted by the regulators.
In the event of a financial holding company’s bankruptcy under Chapter 11 of the U.S. Bankruptcy Code, the bankruptcy trustee will be deemed to have assumed and is required to cure immediately any deficit under any commitment by the debtor holding company to any of the federal banking agencies to maintain the capital of an insured depository institution, and any claim for breach of such obligation will generally have priority over most other unsecured claims.
Capital Adequacy Requirements. The bank regulators have adopted a system using risk-based capital guidelines to evaluate the capital adequacy of banking organizations. Under the guidelines, specific categories of assets and off-balance sheet assets such as letters of credit are assigned different risk weights, based generally on the perceived credit risk of the asset. These risk weights are multiplied by corresponding asset balances to determine a “risk weighted” asset base. The guidelines require a minimum total risk-based capital ratio of 8% (of which at least 4% is required to consist of Tier 1 capital elements).
In addition to the risk-based capital guidelines, the Federal Reserve uses a leverage ratio as an additional tool to evaluate the capital adequacy of banking organizations. The leverage ratio is a company’s Tier 1 capital divided by its average total consolidated assets. Banking organizations must maintain a minimum leverage ratio of at least 3%, although most organizations are expected to maintain leverage ratios that are at least 100 to 200 basis points above this minimum ratio.
The federal banking agencies’ risk-based and leverage ratios are minimum supervisory ratios generally applicable to banking organizations that meet specified criteria, assuming that they have the highest regulatory rating. Banking organizations not meeting these criteria are expected to operate with capital positions well above the minimum ratios. The federal bank regulatory agencies may set capital requirements for a particular banking organization that are higher than the minimum ratios when circumstances warrant. Federal Reserve guidelines also provide that banking organizations experiencing significant internal growth or making acquisitions will be expected to maintain strong capital positions substantially above the minimum supervisory levels, without significant reliance on intangible assets. In addition, the regulations of the bank regulators provide that concentration of credit risks arising from nontraditional activities, as well as an institution’s ability to manage these risks, are important factors to be taken into account by regulatory agencies in assessing an organization’s overall capital adequacy.
Transactions with Affiliates and Insiders. Our bank is subject to Section 23A of the Federal Reserve Act which places limits on the amount of loans or extensions of credit to, or investments in, or other transactions with, affiliates that it may make. In addition, extensions of credit must be collateralized by
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Treasury securities or other collateral in prescribed amounts. Most of these loans and other transactions must be secured in prescribed amounts. It also limits the amount of advances to third parties which are collateralized by our securities or obligations or the securities or obligations of any of our non-banking subsidiaries.
Our bank also is subject to Section 23B of the Federal Reserve Act, which, among other things, prohibits an institution from engaging in transactions with affiliates unless the transactions are on terms substantially the same, or at least as favorable to such institution or its subsidiaries, as those prevailing at the time for comparable transactions with non-affiliates. We are subject to restrictions on extensions of credit to executive officers, directors, principal stockholders, and their related interests. These restrictions contained in the Federal Reserve Act and Federal Reserve Regulation O apply to all insured institutions and their subsidiaries and holding companies. These restrictions include limits on loans to one borrower and conditions that must be met before such a loan can be made. There is also an aggregate limitation on all loans to insiders and their related interests. These loans cannot exceed the institution’s total unimpaired capital and surplus, and the FDIC may determine that a lesser amount is appropriate. Insiders are subject to enforcement actions for knowingly accepting loans in violation of applicable restrictions.
Corrective Measures for Capital Deficiencies. The Federal Deposit Insurance Corporation Improvement Act imposes a regulatory matrix which requires the federal banking agencies, which include the FDIC, the OCC and the Federal Reserve, to take “prompt corrective action” with respect to capital deficient institutions. The prompt corrective action provisions subject undercapitalized institutions to an increasingly stringent array of restrictions, requirements and prohibitions as their capital levels deteriorate and supervisory problems mount. Should these corrective measures prove unsuccessful in recapitalizing the institution and correcting its problems, the Federal Deposit Insurance Corporation Improvement Act mandates that the institution be placed in receivership.
Pursuant to regulations promulgated under the Federal Deposit Insurance Corporation Improvement Act, the corrective actions that the banking agencies either must or may take are tied primarily to an institution’s capital levels. In accordance with the framework adopted by the Federal Deposit Insurance Corporation Improvement Act, the banking agencies have developed a classification system, pursuant to which all banks and thrifts will be placed into one of five categories. Agency regulations define, for each capital category, the levels at which institutions are “well capitalized”, “adequately capitalized”, “undercapitalized”, “significantly undercapitalized” and “critically undercapitalized.” A well capitalized bank has a total risk-based capital ratio (total capital to risk-weighted assets) of 10% or higher; a Tier 1 risk-based capital ratio (Tier 1 capital to risk-weighted assets) of 6% or higher; a leverage ratio (Tier 1 capital to total adjusted assets) of 5% or higher; and is not subject to any written agreement, order or directive requiring it to maintain a specific capital level for any capital measure. An institution is critically undercapitalized if it has a tangible equity to total assets ratio that is equal to or less than 2%. Our bank’s total risk-based capital ratio was 10.13% at December 31, 2004 and, as a result, it is currently classified as “well capitalized” for purposes of the FDIC’s prompt corrective action regulations.
In addition to requiring undercapitalized institutions to submit a capital restoration plan which must be guaranteed by its holding company (up to specified limits) in order to be accepted by the bank regulators, agency regulations contain broad restrictions on activities of undercapitalized institutions including asset growth, acquisitions, branch establishment and expansion into new lines of business. With some exceptions, an insured depository institution is prohibited from making capital distributions, including dividends, and is prohibited from paying management fees to control persons if the institution would be undercapitalized after any such distribution or payment.
As an institution’s capital decreases, the FDIC’s enforcement powers become more severe. A significantly undercapitalized institution is subject to mandated capital raising activities, restrictions on interest rates paid and transactions with affiliates, removal of management and other restrictions. The FDIC has only very limited discretion in dealing with a critically undercapitalized institution and is virtually required to appoint a receiver or conservator if the capital deficiency is not corrected promptly.
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Banks with risk-based capital and leverage ratios below the required minimums may also be subject to certain administrative actions, including the termination of deposit insurance upon notice and hearing, or a temporary suspension of insurance without a hearing in the event the institution has no tangible capital.
Sarbanes-Oxley Act of 2002. The Sarbanes-Oxley Act of 2002 (Sarbanes-Oxley) contains important new requirements for public companies in the area of financial disclosure and corporate governance. In accordance with Section 302(a) of Sarbanes-Oxley, written certifications by our chief executive officer and chief financial officer are required. These certifications attest that our quarterly and annual reports do not contain any untrue statement of a material fact. We have also implemented a program designed to comply with Section 404 of Sarbanes-Oxley, which includes the identification of significant processes and accounts, documentation of the design of control effectiveness over processes and entity level controls, and testing of the operating effectiveness of key controls.
Financial Modernization Act of 1999. The Gramm-Leach-Bliley Financial Modernization Act of 1999 (the Modernization Act):
• | allows bank holding companies meeting management, capital and Community Reinvestment Act standards to engage in a substantially broader range of non-banking activities than was permissible prior to enactment, including insurance underwriting and making merchant banking investments in commercial and financial companies; | |
• | allows insurers and other financial services companies to acquire banks; | |
• | removes various restrictions that applied to bank holding company ownership of securities firms and mutual fund advisory companies; and establishes the overall regulatory structure applicable to bank holding companies that also engage in insurance and securities operations. |
The Modernization Act also modifies other current financial laws, including laws related to financial privacy. The financial privacy provisions generally prohibit financial institutions, including us, from disclosing non-public personal financial information to non-affiliated third parties unless customers have the opportunity to “opt out” of the disclosure.
Community Reinvestment Act. The Community Reinvestment Act of 1977 (CRA) requires depository institutions to assist in meeting the credit needs of their market areas consistent with safe and sound banking practice. Under the CRA, each depository institution is required to help meet the credit needs of its market areas by, among other things, providing credit to low- and moderate-income individuals and communities. Depository institutions are periodically examined for compliance with the CRA and are assigned ratings. In order for a financial holding company to commence new activity permitted by the Bank Holding Company Act, each insured depository institution subsidiary of the financial holding company must have received a rating of at least “satisfactory” in its most recent examination under the CRA.
The USA Patriot Act and the International Money Laundering Abatement and Financial Anti-Terrorism Act. A major focus of governmental policy on financial institutions in recent years has been aimed at combating money laundering and terrorist financing. The USA Patriot Act of 2001 and the International Money Laundering Abatement and Financial Anti-Terrorism Act of 2001 substantially broadened the scope of United States anti-money laundering laws and penalties and expanded the extra-territorial jurisdiction of the United States. The United States Treasury Department has issued a number of implementing regulations which apply various requirements of the USA Patriot Act to financial institutions such as our bank. These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers. Failure of a financial institution to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with all of the relevant laws or regulations, could have serious legal and reputational consequences for the institution.
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Forward Looking Statements
This report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. All statements other than historical or current facts, including, without limitation, statements about our business, financial condition, business strategy, plans and objectives of management and our future prospects, are forward-looking statements. Such forward-looking statements are subject to risks and uncertainties that could cause actual results to differ materially from these expectations.
Investment Considerations
An investment in our common stock involves certain risks. You should consider carefully the following risks and other information in this report, including our financial information and related notes, before investing in our common stock.
Our business faces unpredictable economic conditions. General economic conditions impact the banking industry. The credit quality of our loan portfolio necessarily reflects, among other things, the general economic conditions in the areas in which we conduct our business. Our continued financial success depends somewhat on factors beyond our control, including:
• | national and local economic conditions; | |
• | the supply and demand for investable funds; | |
• | interest rates; and | |
• | federal, state and local laws affecting these matters. |
Any substantial deterioration in any of the foregoing conditions could have a material adverse effect on our financial condition and results of operations, which would likely adversely affect the market price of our common stock. Further, with the exception of our BankDirect customers which comprised 13% of our total deposits as of December 2004, our bank’s customer base is primarily commercial in nature, and our bank does not have a significant branch network or retail deposit base. In periods of economic downturn, business and commercial deposits may tend to be more volatile than traditional retail consumer deposits and, therefore, during these periods our financial condition and results of operations could be adversely affected to a greater degree than our competitors that have a larger retail customer base.
We are dependent upon key personnel. Our success depends to a significant extent upon the performance of certain key employees, the loss of whom could have an adverse effect on our business. Although we have entered into employment agreements with certain employees, we cannot assure you that we will be successful in retaining key employees.
Our operations are significantly affected by interest rate levels. Our profitability is dependent to a large extent on our net interest income, which is the difference between interest income we earn as a result of interest paid to us on loans and investments and interest we pay to third parties such as our depositors and those from whom we borrow funds. Like most financial institutions, we are affected by changes in general interest rate levels, which are currently at relatively low levels, and by other economic factors beyond our control. Interest rate risk can result from mismatches between the dollar amount of repricing or maturing assets and liabilities and from mismatches in the timing and rate at which our assets and liabilities reprice. Although we have implemented strategies which we believe reduce the potential effects of changes in interest rates on our results of operations, these strategies may not always be successful. In addition, any substantial and prolonged increase in market interest rates could reduce our customers’ desire to borrow money from us or adversely affect their ability to repay their outstanding loans by increasing their credit costs since most of our loans have adjustable interest rates that reset periodically. Any of these events could adversely affect our results of operations or financial condition.
We must effectively manage our credit risk. There are risks inherent in making any loan, including risks with respect to the period of time over which the loan may be repaid, risks resulting from changes in economic
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and industry conditions, risks inherent in dealing with individual borrowers and risks resulting from uncertainties as to the future value of collateral. The risk of non-payment of loans is inherent in commercial banking. Although we attempt to minimize our credit risk by carefully monitoring the concentration of our loans within specific industries and through prudent loan application approval procedures, we cannot assure you that such monitoring and approval procedures will reduce these lending risks. Moreover, as we expand our operations into new geographic markets, our credit administration and loan underwriting policies will need to be adapted to the local lending and economic environments of these new markets. We cannot assure you that our credit administration personnel, policies and procedures will adequately adapt to any new geographic markets.
Our financial condition and results of operations would be adversely affected if our allowance for loan losses is not sufficient to absorb actual losses. Experience in the banking industry indicates that a portion of our loans will become delinquent, some of which may only be partially repaid or may never be repaid at all. Despite our underwriting criteria, we experience losses for reasons beyond our control, such as general economic conditions. Although we believe that our allowance for loan losses is maintained at a level adequate to absorb any inherent losses in our loan portfolio, these estimates of loan losses are inherently subjective and their accuracy depends on the outcome of future events. We may need to make significant and unanticipated increases in our loss allowances in the future, which would materially affect our results of operations in that period. Federal regulators, as an integral part of their respective supervisory functions, periodically review our allowance for loan losses. The regulatory agencies may require us to increase our provision for loan losses or to recognize further loan charge-offs based upon their judgments, which may be different from ours. Any increase in the allowance for loan losses required by these regulatory agencies could have a negative effect on our financial condition and results of operations.
There are material risks involved in commercial lending that could adversely affect our business. We generally invest a greater proportion of our assets in commercial loans than other banking institutions of our size, which typically invest a greater proportion of their assets in loans secured by single-family residences. Commercial loans generally involve a higher degree of credit risk than residential mortgage loans due, in part, to their larger average size and generally less readily-marketable collateral. Due to their size and the nature of their collateral, losses incurred on a small number of commercial loans could have a material adverse impact on our financial condition and results of operations. In addition, unlike residential mortgage loans, commercial loans generally depend on the cash flow of the borrower’s business to service the debt. Furthermore, a significant portion of our loans is dependent for repayment largely on the liquidation of assets securing the loan, such as inventory and accounts receivable. These loans carry incrementally higher risk, since their repayment is often dependent solely on the financial performance of the borrower’s business. Our business plan calls for continued efforts to increase our assets invested in commercial loans. An increase in non-performing loans could cause operating losses, impaired liquidity and the erosion of our capital, and could have a material adverse effect on our business, financial condition or results of operations.
If the value of real estate in our core Texas markets were to decline materially, a significant portion of our loan portfolio could become under-collateralized, which would have a material adverse effect on us. The market value of real estate, particularly real estate held for investment, can fluctuate significantly in a short period of time as a result of market conditions in the geographic area in which the real estate is located. If the value of the real estate serving as collateral for our loan portfolio were to decline materially, a significant part of our loan portfolio could become under-collateralized. If the loans that are collateralized by real estate become troubled during a time when market conditions are declining or have declined, then we may not be able to realize the amount of security that we anticipated at the time of originating the loan, which could have a material adverse effect on our provision for loan losses and our operating results and financial condition.
Our business is concentrated in Texas and a downturn in the economy of Texas may adversely affect our business. Substantially all of our business is located in Texas. As a result, our financial condition and results of operations may be affected by changes in the Texas economy. A prolonged period of economic recession or other adverse economic conditions in Texas may result in an increase in non-payment of loans and a decrease in collateral value.
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Our business strategy includes significant growth plans and, if we fail to manage our growth effectively as we pursue our expansion strategy, it could negatively affect our operations. We intend to develop our business by pursuing a significant growth strategy. Our prospects must be considered in light of the risks, expenses and difficulties frequently encountered by companies in significant growth stages of development. In order to execute our growth strategy successfully, we must, among other things:
• | identify and expand into suitable markets; | |
• | build our customer base; | |
• | maintain credit quality; | |
• | attract sufficient deposits to fund our anticipated loan growth; | |
• | attract and retain qualified bank management in each of our targeted markets; | |
• | identify and pursue suitable opportunities for opening new banking locations; and | |
• | maintain adequate regulatory capital. |
Failure to manage our growth effectively could have a material adverse effect on our business, future prospects, financial condition or results of operations, and could adversely affect our ability to successfully implement our business strategy.
We compete with many larger financial institutions which have substantially greater financial resources than we have. Competition among financial institutions in Texas is intense. We compete with other financial and bank holding companies, state and national commercial banks, savings and loan associations, consumer finance companies, credit unions, securities brokerages, insurance companies, mortgage banking companies, money market mutual funds, asset-based non-bank lenders and other financial institutions. Many of these competitors have substantially greater financial resources, lending limits and larger branch networks than we do, and are able to offer a broader range of products and services than we can. Failure to compete effectively for deposit, loan and other banking customers in our markets could cause us to lose market share, slow our growth rate and may have an adverse effect on our financial condition and results of operations.
Our future profitability depends, to a significant extent, upon revenue we receive from our middle market business customers and their ability to meet their loan obligations. We expect that our future profitability will depend, to a significant extent, upon revenue we receive from middle market business customers, and their ability to continue to meet existing loan obligations. As a result, adverse economic conditions or other factors adversely affecting this market segment may have a greater adverse effect on us than on other financial institutions that have a more diversified customer base.
We compete in an industry that continually experiences technological change, and we may have fewer resources than many of our competitors to continue to invest in technological improvements. The financial services industry is undergoing rapid technological changes, with frequent introductions of new technology-driven products and services. In addition to improving the ability to serve customers, the effective use of technology increases efficiency and enables financial institutions to reduce costs. Our future success will depend, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands for convenience, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers.
System failure or breaches of our network security could subject us to increased operating costs as well as litigation and other liabilities. The computer systems and network infrastructure we use could be vulnerable to unforeseen problems. Our operations are dependent upon our ability to protect our computer equipment against damage from fire, power loss, telecommunications failure or a similar catastrophic event. Any damage or failure that causes an interruption in our operations could have an adverse effect on our financial condition and results of operations. In addition, our operations are dependent upon our ability to protect the computer systems and network infrastructure utilized by us against damage from physical breakins, security breaches
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and other disruptive problems caused by the Internet or other users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability to us and deter potential customers. Although we, with the help of third-party service providers, intend to continue to implement security technology and establish operational procedures to prevent such damage, there can be no assurance that these security measures will be successful. In addition, advances in computer capabilities, new discoveries in the field of cryptography or other developments could result in a compromise or breach of the algorithms we and our third-party service providers use to protect customer transaction data. A failure of such security measures could have an adverse effect on our financial condition and results of operations.
Our success in the Internet banking market will largely depend on our ability to implement services competitive with similar services offered by other financial institutions. The success of our Internet banking products and services will depend in large part on our ability to implement and maintain the appropriate technology. This includes our ability to provide services competitive with banks that are already using the Internet. If we are unable to implement and maintain the appropriate technology efficiently, it could affect our results of operations and our ability to compete with other financial institutions.
Our success in attracting and retaining consumer deposits depends on our ability to offer competitive rates and services. As of December 2004, approximately 13% of our total deposits came from retail consumer customers through BankDirect, our Internet banking division. The market for Internet banking is extremely competitive and allows retail consumer customers to access financial products and compare interest rates from numerous financial institutions located across the U.S. As a result, Internet retail consumers are more sensitive to interest rate levels than retail consumers who bank at a branch office. Our future success in retaining and attracting retail consumer customers depends, in part, on our ability to offer competitive rates and services.
We could be adversely affected by changes in the regulation of the Internet. Our ability to conduct, and the cost of conducting, business may also be adversely affected by a number of legislative and regulatory proposals concerning the Internet, which are currently under consideration by federal, state, local and foreign governmental organizations. The adoption of new laws or the application of existing laws could decrease the growth in the use of the Internet, which could in turn decrease the demand for our services, increase our cost of doing business or otherwise have an adverse effect on our business, financial condition and results of operations. Furthermore, government restrictions on Internet content could slow the growth of Internet use and decrease acceptance of the Internet as a communications and commercial medium and thereby have an adverse effect on our financial condition and results of operations.
Our management maintains significant control over us. Our current executive officers and directors beneficially own approximately 13% of the outstanding shares of our common stock. Accordingly, our current executive officers and directors are able to influence, to a significant extent, the outcome of all matters required to be submitted to our stockholders for approval (including decisions relating to the election of directors), the determination of day-to-day corporate and management policies and other significant corporate activities.
Anti-takeover provisions of our certificate of incorporation, bylaws and Delaware law may make it more difficult for you to receive a change in control premium. Certain provisions of our certificate of incorporation and bylaws could make a merger, tender offer or proxy contest more difficult, even if such events were perceived by many of our stockholders as beneficial to their interests. These provisions include advance notice for nominations of directors and stockholders’ proposals. In addition, our certificate of incorporation authorizes the issuance of “blank check” preferred stock with such designations, rights and preferences as may be determined from time to time by our board of directors. Accordingly, our board of directors is empowered, without stockholder approval (unless otherwise required by the rules of any stock exchange on which our common stock is then listed), to issue preferred stock with dividend, liquidation, conversion, voting or other rights which could adversely affect the voting power or other rights of the holders of our common stock. In the event of such issuance, the preferred stock could be utilized, under certain circumstances, as a method of discouraging, delaying or preventing a change in control. Although we have no present intention to issue any
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shares of our preferred stock, there can be no assurance that we will not do so in the future. In addition, as a Delaware corporation, we are subject to Section 203 of the Delaware General Corporation Law which, in general, prevents an interested stockholder, defined generally as a person owning 15% or more of a corporation’s outstanding voting stock, from engaging in a business combination with our company for three years following the date that person became an interested stockholder unless certain specified conditions are satisfied.
There are substantial regulatory limitations on changes of control. With certain limited exceptions, federal regulations prohibit a person or company or a group of persons deemed to be “acting in concert” from, directly or indirectly, acquiring more than 10% (5% if the acquiror is a bank holding company) of any class of our voting stock or obtaining the ability to control in any manner the election of a majority of our directors or otherwise direct the management or policies of our company without prior notice or application to and the approval of the Federal Reserve. Accordingly, prospective investors need to be aware of and comply with these requirements, if applicable, in connection with any purchase of shares of our common stock.
ITEM 2. | PROPERTIES |
As of December 31, 2004, we conducted business at nine full service banking locations and one operations center. Our operations center houses our loan and deposit operations and the BankDirect call center. We lease the space in which our banking centers and the operations call center are located. These leases expire between May 2006 and March 2013, not including any renewal options that may be available.
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The following table sets forth the location of our executive offices, operations center and each of our banking centers.
Type of Location | Address | |||
Executive offices, banking location | 2100 McKinney Avenue Suite 900 Dallas, Texas 75201 | |||
Operations center | 6060 North Central Expressway Suite 800 Dallas, Texas 75206 | |||
Banking location | 4230 Lyndon B. Johnson Freeway Suite 100 Dallas, Texas 75244 | |||
Banking location | 5910 North Central Expressway Suite 150 Dallas, Texas 75206 | |||
Banking location | 5800 Granite Parkway Suite 150 Plano, Texas 75024 | |||
Banking location | 1600 West 7thStreet Suite 200 Fort Worth, Texas 76102 | |||
Motor banking location | 400 East Belknap Street Fort Worth, Texas 76102 | |||
Banking location | 114 W. 7thSt. Suite 100 Austin, Texas 78701 | |||
Banking location | 745 East Mulberry Street Suite 350 San Antonio, Texas 78212 | |||
Banking location | One Riverway Suite 150 Houston, Texas 77056 |
ITEM 3. | LEGAL PROCEEDINGS |
We are not involved in any pending legal proceedings other than legal proceedings occurring in the ordinary course of business. Management believes that none of these legal proceedings, individually or in the aggregate, will have a material adverse impact on our results of operations or financial condition.
ITEM 4. | SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS |
No matters were submitted to a vote of security holders during the fourth quarter of 2004.
ITEM 5. | MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES |
Our common stock began trading on the NASDAQ Stock Market on August 13, 2003, and is traded under the symbol “TCBI”. Our common stock was not publicly traded, nor was there an established market therefore, prior to August 13, 2003. On March 4, 2005 there were approximately 550 holders of record of our common stock.
No cash dividends have ever been paid by us on our common stock, and we do not anticipate paying any cash dividends in the foreseeable future. Our principal source of funds to pay cash dividends on our common
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stock would be cash dividends from our bank. The payment of dividends by our bank is subject to certain restriction imposed by federal and state banking laws, regulations and authorities.
The following table presents the range of high and low bid prices reported on the NASDAQ Stock Market for the period from August 13, 2003 through the end of the third quarter of 2003, the fourth quarter of 2003, and each of the four quarters of 2004.
Price per Share | ||||||||
Quarter Ended | High | Low | ||||||
September 30, 2003 | $ | 12.95 | $ | 11.80 | ||||
December 31, 2003 | 14.68 | 12.20 | ||||||
March 31, 2004 | 17.55 | 14.15 | ||||||
June 30, 2004 | 17.33 | 14.08 | ||||||
September 30, 2004 | 18.41 | 15.37 | ||||||
December 31, 2004 | 22.60 | 17.70 |
Equity Compensation Plan Information
Number of Securities | Weighted Average | Number of Securities | ||||||||||
to be Issued upon | Exercise Price of | Remaining Available | ||||||||||
Exercise of | Outstanding | for Future Issuance | ||||||||||
Outstanding Options, | Options, Warrants | Under Equity | ||||||||||
Plan Category | Warrants and Rights | and Rights | Compensation Plans | |||||||||
Equity compensation plans approved by security holders | 2,789,480 | $ | 8.98 | 563,220 | ||||||||
Equity compensation plans not approved by security holders(1) | 84,274 | 6.80 | — | |||||||||
Total | 2,873,754 | $ | 8.92 | 563,220 | ||||||||
(1) | Refers to deferred compensation agreement. See further discussion in Note 11 to the Consolidated Financial Statements. |
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ITEM 6. | SELECTED CONSOLIDATED FINANCIAL DATA |
You should read the selected financial data presented below in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the related notes appearing elsewhere in this Form 10-K.
At or For the Year Ended December 31 | ||||||||||||||||||||||
2004 | 2003 | 2002 | 2001 | 2000 | ||||||||||||||||||
(In thousands, except per share, average share and percentage data) | ||||||||||||||||||||||
Consolidated Operating Data(1) | ||||||||||||||||||||||
Interest income | $ | 110,878 | $ | 85,484 | $ | 70,142 | $ | 70,594 | $ | 55,769 | ||||||||||||
Interest expense | 36,136 | 32,329 | 27,896 | 35,539 | 32,930 | |||||||||||||||||
Net interest income | 74,742 | 53,155 | 42,246 | 35,055 | 22,839 | |||||||||||||||||
Provision for loan losses | 1,688 | 4,025 | 5,629 | 5,762 | 6,135 | |||||||||||||||||
Net interest income after provision for loan losses | 73,054 | 49,130 | 36,617 | 29,293 | 16,704 | |||||||||||||||||
Non-interest income | 13,632 | 10,892 | 8,625 | 5,983 | 1,957 | |||||||||||||||||
Non-interest expense | 57,340 | 48,380 | 35,370 | 29,432 | 35,158 | |||||||||||||||||
Income (loss) before income taxes | 29,346 | 11,642 | 9,872 | 5,844 | (16,497 | ) | ||||||||||||||||
Income tax expense (benefit) | 9,786 | (2,192 | ) | 2,529 | — | — | ||||||||||||||||
Net income (loss)(2) | 19,560 | 13,834 | 7,343 | 5,844 | (16,497 | ) | ||||||||||||||||
Consolidated Balance Sheet Data(1) | ||||||||||||||||||||||
Total assets | 2,611,163 | 2,192,875 | 1,793,282 | 1,164,779 | 908,428 | |||||||||||||||||
Loans held for investment | 1,564,578 | 1,229,773 | 1,002,557 | 854,505 | 624,514 | |||||||||||||||||
Loans held for sale | 119,537 | 80,780 | 116,106 | 43,764 | 1,346 | |||||||||||||||||
Securities available-for-sale | 804,544 | 775,338 | 553,169 | 206,365 | 184,952 | |||||||||||||||||
Securities held-to-maturity | — | — | — | — | 28,366 | |||||||||||||||||
Deposits | 1,789,887 | 1,445,030 | 1,196,535 | 886,077 | 794,857 | |||||||||||||||||
Federal funds purchased | 113,478 | 78,961 | 83,629 | 76,699 | 11,525 | |||||||||||||||||
Other borrowings | 481,513 | 466,793 | 365,831 | 86,899 | 7,061 | |||||||||||||||||
Long-term debt | 20,620 | 20,620 | 10,000 | — | — | |||||||||||||||||
Stockholders’ equity | 195,275 | 171,756 | 124,976 | 106,359 | 86,197 | |||||||||||||||||
Other Financial Data | ||||||||||||||||||||||
Income (loss) per share: | ||||||||||||||||||||||
Basic(2) | $ | .77 | $ | .62 | $ | .33 | $ | .31 | $ | (.95 | ) | |||||||||||
Diluted(2) | $ | .75 | .60 | .32 | .30 | (.95 | ) | |||||||||||||||
Tangible book value per share(3) | 7.61 | 6.81 | 5.80 | 5.08 | 4.46 | |||||||||||||||||
Book value per share(3) | 7.67 | 6.87 | 5.87 | 5.15 | 4.54 | |||||||||||||||||
Weighted average shares: | ||||||||||||||||||||||
Basic | 25,260,526 | 21,332,746 | 19,145,255 | 18,957,652 | 17,436,628 | |||||||||||||||||
Diluted | 26,234,637 | 23,118,804 | 19,344,874 | 19,177,204 | 17,436,628 |
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At or For the Year Ended December 31 | |||||||||||||||||||||
2004 | 2003 | 2002 | 2001 | 2000 | |||||||||||||||||
(In thousands, except per share, average share and percentage data) | |||||||||||||||||||||
Selected Financial Ratios: | |||||||||||||||||||||
Performance Ratios | |||||||||||||||||||||
Return on average assets | 0.82 | % | 0.70 | % | 0.54 | % | 0.58 | % | (2.42 | %) | |||||||||||
Return on average equity | 10.74 | % | 9.71 | % | 6.27 | % | 6.44 | % | (20.02 | %) | |||||||||||
Net interest margin | 3.37 | % | 2.87 | % | 3.28 | % | 3.62 | % | 3.51 | % | |||||||||||
Efficiency ratio (excludes securities gains)(4) | 64.88 | % | 76.33 | % | 71.46 | % | 75.20 | % | 141.90 | % | |||||||||||
Non-interest expense to average earning assets(5) | 2.57 | % | 2.43 | % | 2.59 | % | 2.90 | % | 5.15 | % | |||||||||||
Asset Quality Ratios | |||||||||||||||||||||
Net charge-offs to average loans(6) | 0.05 | % | 0.08 | % | 0.40 | % | 0.27 | % | — | ||||||||||||
Reserve to loans held for investment(6) | 1.20 | % | 1.44 | % | 1.45 | % | 1.47 | % | 1.43 | % | |||||||||||
Allowance to non-performing loans | 308.60 | % | 173.39 | % | 499.42 | % | 110.23 | % | — | ||||||||||||
Non-performing loans to loans(6) | .39 | % | .83 | % | .29 | % | .75 | % | — | ||||||||||||
Capital and Liquidity Ratios | |||||||||||||||||||||
Total capital ratio | 11.67 | % | 13.14 | % | 11.32 | % | 11.73 | % | 10.98 | % | |||||||||||
Tier 1 capital ratio | 10.72 | % | 12.00 | % | 10.16 | % | 10.48 | % | 9.94 | % | |||||||||||
Tier 1 leverage ratio | 8.31 | % | 8.82 | % | 7.66 | % | 9.46 | % | 9.62 | % | |||||||||||
Average equity/average assets | 7.66 | % | 7.16 | % | 8.57 | % | 8.93 | % | 12.07 | % | |||||||||||
Tangible equity/assets | 7.42 | % | 7.76 | % | 6.89 | % | 9.00 | % | 9.31 | % | |||||||||||
Average net loans/average deposits | 92.89 | % | 91.49 | % | 96.31 | % | 95.54 | % | 72.92 | % |
(1) | The consolidated statement of operating data and consolidated balance sheet data presented above for the five most recent fiscal years ended December 31 have been derived from our audited consolidated financial statements, which have been audited by Ernst & Young LLP, our independent registered public accounting firm. The historical results are not necessarily indicative of the results to be expected in any future period. |
(2) | During the year ended December 31, 2003, net income included the impact of reversing our deferred tax asset valuation allowance of $5.9 million, $6.3 million in penalties related to unwinding repurchase agreements prior to maturity and approximately $250,000 in separation expense related to the resignation of a senior officer. For the year ended December 31, 2003, income per share excluding the impact of reversing the valuation allowance, unwinding penalties and separation expense would have been $0.54, on a basic basis, and $0.53, on a diluted basis. During the year ended December 31, 2002, net income included $1.2 million in IPO expenses recognized as our offering was postponed. For the year ended December 31, 2002, income per share excluding these IPO expenses would have been $0.37, on a basic basis, and $0.36, on a diluted basis. Income per share excluding the impact of reversing the valuation allowance, unwinding penalties and separation expense for the year ended December 31, 2003 and income per share excluding IPO expenses for the year ended December 31, 2002 are non-GAAP financial measures. See below for an explanation why we believe these non-GAAP financial measures are useful to management and investors and a reconciliation of these non-GAAP financial measures to income per share, which is the most directly comparable financial measure presented in accordance with GAAP. |
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(3) | Amounts for December 31, 2001 are adjusted to reflect the conversion of 753,301 shares of preferred stock outstanding on such date into 1,506,602 shares of common stock, assuming automatic conversion of the preferred stock. Amounts for December 31, 2002 are adjusted to reflect the conversion of 1,057,142 shares of preferred stock outstanding on such date into 2,114,284 shares of common stock, assuming automatic conversion of the preferred stock. |
(4) | Represents non-interest expense divided by the sum of net interest income and non-interest income for the periods shown. During the year ended December 31, 2003, non-interest expense included $6.3 million in penalties related to unwinding repurchase agreements prior to maturity and approximately $250,000 in separation expense related to the resignation of a senior officer. For the year ended December 31, 2003, the efficiency ratio excluding the unwinding penalties and separation expense would have been 66.06%. During the year ended December 31, 2002, non-interest expense included $1.2 million in IPO expenses recognized as our offering was postponed. For the year ended December 31, 2002, the efficiency ratio excluding the IPO expenses would have been 69.06%. The efficiency ratio excluding unwinding penalties and separation expense for the year ended December 31, 2003 and the efficiency ratio excluding IPO expenses for the year ended December 31, 2002 are non-GAAP financial measures. See below for an explanation why we believe these non-GAAP financial measures are useful to management and investors and a reconciliation of these non-GAAP financial measures to income per share, which is the most directly comparable financial measure presented in accordance with GAAP. |
(5) | During the year ended December 31, 2003, the ratio of non-interest expense to average earning assets ratio included $6.3 million in penalties related to unwinding repurchase agreements prior to maturity and approximately $250,000 in separation expense related to the resignation of a senior officer. For the year ended December 31, 2003, the ratio of non-interest expense to average assets excluding the unwinding penalties and separation expense would have been 2.10%. During the year ended December 31, 2002, the ratio of non-interest expense to average assets ratio included $1.2 million in IPO expenses recognized as our offering was postponed. For the year ended December 31, 2002, the ratio of non-interest expense to average assets excluding the IPO expenses would have been 2.50%. The ratio of non-interest expense to average assets excluding unwinding penalties and separation expense for the year ended December 31, 2003 and the ratio of non-interest expense to average assets excluding IPO expenses for the year ended December 31, 2002 are non-GAAP financial measures. See below for an explanation why we believe these non-GAAP financial measures are useful to management and investors and a reconciliation of these non-GAAP financial measures to income per share, which is the most directly comparable financial measure presented in accordance with GAAP. |
(6) | Excludes loans held for sale. |
Non-GAAP Financial Measures
The footnotes to the Summary Consolidated Financial Information presented above and portions of “Management’s Discussion and Analysis of Financial Condition and Results of Operations” include non-GAAP financial measures. These non-GAAP financial measures are:
• | for the year ended December 31, 2003: |
• | income per share (basic and diluted) excluding the impact of reversing the valuation allowance, unwinding penalties and separation expense; | |
• | efficiency ratio excluding unwinding penalties and separation expense; and | |
• | ratio of non-interest expense to average assets excluding unwinding penalties and separation expense; |
• | for the year ended December 31, 2002: |
• | income per share (basic and diluted) excluding IPO expenses; | |
• | efficiency ratio excluding IPO expenses; and | |
• | ratio of non-interest expense to average assets excluding IPO expenses. |
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The valuation reversal reflects the reversal of our deferred tax asset valuation allowance of $5.9 million. The unwinding penalties reflect $6.3 million in penalties related to unwinding repurchase agreements prior to maturity. The separation expense reflects approximately $250,000 in separation expense related to the resignation of a senior officer. The IPO expenses reflect $1.2 million in IPO expenses recognized as our offering was postponed.
Management believes that these non-GAAP financial measures are useful to investors and to management because they provide additional information that more closely reflects our intrinsic operating performance and growth. Reversal of the entire valuation allowance was based on our assessment of our ability to generate earnings to allow the deferred tax assets to be realized which is supported by our current earnings trends. We unwound certain repurchase agreements, incurring the unwinding penalties, in order to take advantage of historical lows in interest rates, which had decreased on similar repurchase agreements by approximately 1.4% since the time we entered into the original repurchase agreements. Although we have experienced employee separations in the past, this was the first separation with an executive who had entered into an employment agreement with us. We currently have only four other employees with employment agreements. Since we have not had any reversals of valuation allowances, unwinding penalties or separation expenses related to employees who have employment agreements in our operating history, and because expenses related to the initial public offering will not recur since the offering was completed, we believe that these non-GAAP financial measures are useful to investors and to management to understand the development of our income per share results, efficiency ratio and ratio of non-interest expense to average assets since our founding and to help in comparing our intrinsic operating performance in different periods. Management also uses these measures internally to evaluate our performance and manage our operations. These measurements should not be regarded as a replacement for corresponding GAAP measures.
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The following tables reconcile each of the non-GAAP financial measures described above to the most directly comparable financial measure presented in accordance with GAAP.
Reconciliation of GAAP to income per share, excluding the impact of reversing the valuation allowance, unwinding penalties, separation expense and to income per share excluding IPO expenses.
Year Ended | Year Ended | |||||||
December 31, | December 31, | |||||||
2003 | 2002 | |||||||
(In thousands except share | ||||||||
data) | ||||||||
Net income | $ | 13,834 | $ | 7,343 | ||||
Repurchase agreement penalties | 6,262 | — | ||||||
Executive separation | 250 | — | ||||||
Tax effect of repurchase agreement unwinding penalties and separation costs | (2,120 | ) | — | |||||
Impact of reversing deferred tax asset valuation allowance | (5,929 | ) | — | |||||
IPO expenses | — | 1,190 | ||||||
Tax effect of IPO expenses | — | (417 | ) | |||||
Income excluding the impact of reversing the valuation allowance, unwinding penalties, and separation expense (for year ended December 31, 2003) and income excluding IPO expenses (for year ended December 31, 2002) | 12,297 | 8,116 | ||||||
Preferred stock dividends | (699 | ) | (1,097 | ) | ||||
Numerator used to calculate basic income per share excluding the impact of reversing the valuation allowance, unwinding penalties, and separation expense (for year ended December 31, 2003) and numerator for basic income per share excluding IPO expenses (for year ended December 31, 2002) | 11,598 | 7,019 | ||||||
Effect of dilutive securities * | 699 | — | ||||||
Numerator used to calculate diluted income per share excluding the impact of reversing the valuation allowance, unwinding penalties, and separation expense (for year ended December 31, 2003) and numerator for diluted income per share excluding IPO expenses (for year ended December 31, 2002) | $ | 12,297 | $ | 7,019 | ||||
Denominator used for GAAP and basic income per share excluding the impact of reversing the valuation allowance, unwinding penalties, and separation expense (for year ended December 31, 2003) and denominator for GAAP and basic income per share excluding IPO expenses (for year ended December 31, 2002) | 21,332,746 | 19,145,255 | ||||||
Denominator used for GAAP and diluted income per share excluding the impact of reversing the valuation allowance, unwinding penalties, and separation expense (for year ended December 31, 2003) and denominator for GAAP and diluted income per share excluding IPO expenses (for year ended December 31, 2002) | 23,118,804 | 19,344,874 | ||||||
Basic income per share excluding the impact of reversing the valuation allowance, unwinding penalties, and separation expense (for year ended December 31, 2003) and basic income per share excluding IPO expenses (for year ended December 31, 2002) | $ | .54 | $ | .37 | ||||
Diluted income per share excluding the impact of reversing the valuation allowance, unwinding penalties, and separation expense (for year ended December 31, 2003) and diluted income per share excluding IPO expenses (for year ended December 31, 2002) | $ | .53 | $ | .36 |
* | Effects of Series A convertible preferred stock are anti-dilutive in 2002 and are not included. |
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Reconciliation of GAAP to non-interest expense, excluding penalties related to unwinding penalties, separation expense and IPO expenses.
Year Ended | Year Ended | ||||||||
December 31, | December 31, | ||||||||
2003 | 2002 | ||||||||
(In thousands) | |||||||||
Non-interest expense | $ | 48,380 | $ | 35,370 | |||||
Repurchase agreement unwinding penalties | (6,262 | ) | — | ||||||
Executive separation | (250 | ) | — | ||||||
IPO expenses | — | (1,190 | ) | ||||||
Numerator used to calculate efficiency ratio excluding unwinding penalties, and separation expense (for year ended December 31, 2003) and numerator for efficiency ratio excluding IPO expenses (for year ended December 31, 2002) | $ | 41,868 | $ | 34,180 | |||||
Denominator used for GAAP and efficiency ratio excluding unwinding penalties, and separation expense (for year ended December 31, 2003) and denominator for efficiency ratio excluding IPO expenses (for year ended December 31, 2002) | |||||||||
Net interest income | $ | 53,155 | $ | 42,246 | |||||
Non-interest income | 10,892 | 8,625 | |||||||
Less gain on sale of securities | 666 | 1,375 | |||||||
$ | 63,381 | $ | 49,496 | ||||||
Efficiency ratio excluding unwinding penalties, and separation expense (for year ended December 31, 2003) and efficiency ratio excluding IPO expenses (for year ended December 31, 2002) | 66.06 | % | 69.06 | % | |||||
Denominator used for GAAP and ratio of non-interest expense to average assets ratio excluding unwinding penalties and separation expense (for year ended December 31, 2003) and denominator for ratio of non-interest expense to average assets excluding IPO expenses (for year ended December 31, 2002) | |||||||||
Average assets | $ | 1,990,229 | $ | 1,365,722 | |||||
Ratio of non-interest expense to assets excluding unwinding penalties and separation expense (for year ended December 31, 2003) and ratio of non-interest expense to assets excluding IPO expenses (for year ended December 31, 2002) | 2.10 | % | 2.50 | % |
ITEM 7. | MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS |
Overview of Our Operating Results
Our bank was formed through the acquisition of Resource Bank, N.A., which was organized in 1997. Upon completion of our $80 million private equity offering and the acquisition of Resource Bank, we commenced operations in December 1998. The amount of capital we raised, which we believe is the largest amount of start-up capital ever raised for a national bank at that time, was intended to support a significant level of near-term growth and permit us to originate and retain loans of a size and type that our targeted customers, middle market businesses and high net worth individuals, would find attractive. Our large initial capitalization has resulted in reduced levels of return on equity to date. However, as we build our loan and investment portfolio we expect our return on equity to increase to normalized levels.
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An important aspect of our growth strategy is the ability to service and effectively manage a large number of loans and deposit accounts in multiple markets in Texas. Accordingly, we created an operations infrastructure sufficient to support state-wide lending and banking operations. We believe that our existing infrastructure will allow us to grow our business over the next two to three years both geographically and with respect to the size and number of loan and deposit accounts without substantial additional capital expenditures.
Our historical financial results reflect the development of our company in its early stages, notably in connection with initial start-up costs and the raising and retention of excess capital to fund our planned growth. In 1999 and 2000, we incurred significant non-interest expenses for the start-up and infrastructure costs described above, while revenue items gradually increased as we began to source and originate loans and other earning assets. Beginning in 2001, we achieved improved levels of profitability as these costs have been spread over a larger asset base.
Our operating results have improved significantly over the past several years as we moved into full operations. The table below shows the annual growth rate of our net interest income, net income, assets, loans and deposits:
At or for the | At or for the | At or for the | At or for the | |||||||||||||||||||||||||||||
Year Ended | Annual | Year Ended | Annual | Year Ended | Annual | Year Ended | Annual | |||||||||||||||||||||||||
December 31, | Growth | December 31, | Growth | December 31, | Growth | December 31, | Growth | |||||||||||||||||||||||||
2004 | Rate(1) | 2003 | Rate(1) | 2002 | Rate(1) | 2001 | Rate(1) | |||||||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||||||||||
Net interest income | $ | 74,742 | 41% | $ | 53,155 | 26% | $ | 42,246 | 21% | $ | 35,055 | 53% | ||||||||||||||||||||
Net income | 19,560 | 41% | 13,834 | 88% | 7,343 | 26% | 5,844 | 135% | ||||||||||||||||||||||||
Assets | 2,611,163 | 19% | 2,192,875 | 22% | 1,793,282 | 54% | 1,164,779 | 28% | ||||||||||||||||||||||||
Loans | 1,687,914 | 28% | 1,314,241 | 17% | 1,122,506 | 24% | 903,979 | 44% | ||||||||||||||||||||||||
Deposits | 1,789,887 | 24% | 1,445,030 | 21% | 1,196,535 | 35% | 886,077 | 11% |
(1) | The annual growth rate with respect to period data is the percentage growth of the item in the period shown compared to the most recently completed prior period. |
The growth in our profitability is based on several key factors:
• | we have successfully grown our asset base significantly each year; | |
• | we have been able to maintain stable and diverse funding sources, resulting in increased net interest income from 2000 onward, despite a falling interest rate environment and the fact that most of our loans have floating interest rates; and | |
• | the growth in our asset base has resulted in annual growth of 53%, 21%, 26%, and 41% in our principal earnings source, net interest income, in 2001, 2002, 2003, and 2004, respectively. |
Year ended December 31, 2004 compared to year ended December 31, 2003
We recorded net income of $19.6 million for the year ended December 31, 2004 compared to $13.8 million for the same period in 2003. Diluted income per common share was $0.75 for 2004 and $0.60 for the same period in 2003. Returns on average assets and average equity were 0.82% and 10.74%, respectively, for the year ended December 31, 2004 compared to 0.70% and 9.71%, respectively, for the same period in 2003.
The increase in net income for the year ended December 31, 2004 over the same period of 2003 was primarily due to an increase in net interest income and non-interest income, offset by an increase in non-interest expense. Net interest income increased by $21.6 million, or 40.6%, to $74.7 million for the year ended December 31, 2004 compared to $53.2 million for the same period in 2003. The increase in net interest income was primarily due to an increase of $376.4 million in average earning assets, coupled with a 50 basis point improvement in the net interest margin.
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Non-interest income increased by $2.7 million, or 25.2%, during the year ended December 31, 2004 to $13.6 million, compared to $10.9 million during the same period in 2003. The increase was primarily due to an increase in gain on sale of mortgage loans relating to our residential mortgage lending division that was started in the third quarter of 2003. Gain on sale of mortgage loans increased $3.3 million to $3.4 million during the year ended December 31, 2004 compared to $120,000 during the same period in 2003. Also, our trust income increased by $619,000 to $1.9 million during the year ended December 31, 2004 compared to $1.3 million for the same period in 2003, due to continued growth in trust assets. Offsetting these increases was a decrease in mortgage warehouse fees. Mortgage warehouse fees totaled $996,000 for the year ended December 31, 2004, compared to $1.5 million for the same period in 2003. Non-interest income for the year ended December 31, 2003 included a gain on sale of securities of $666,000. We did not recognize any similar gains of this nature in 2004. Also, there was a decrease in bank owned life insurance (BOLI) income in 2004 related to an annual adjustment in earning rates.
Non-interest expense increased by $9.0 million, or 18.5%, to $57.3 million during the year ended December 31, 2004 compared to $48.4 million during the same period in 2003. This increase is primarily related to an $11.2 million increase in salaries and employee benefits. The increase in salaries and employee benefits resulted from an increase in the total number of employees related to general business growth, additional staffing for the new Houston office, the significant expansion of the residential mortgage lending division, and increased incentive compensation reflective of our performance. Occupancy expense increased by $708,000 to $5.7 million during the year ended December 31, 2004 compared to the same period in 2003 and is related to our continued growth in the residential mortgage lending division and our Houston office. Marketing expense increased $1.2 to $2.6 million during the year ended December 31, 2004 from $1.4 million during the same period in 2003.
Year ended December 31, 2003 compared to year ended December 31, 2002
We recorded net income of $13.8 million for the year ended December 31, 2003 compared to $7.3 million for the same period in 2002. Diluted income per common share was $0.60 for 2003 and $0.32 for the same period in 2002. Returns on average assets and average equity were 0.70% and 9.71%, respectively, for the year ended December 31, 2003 compared to 0.54% and 6.27%, respectively, for the same period in 2002.
The increase in net income for the year ended December 31, 2003 over the same period of 2002 was primarily due to an increase in net interest income and non-interest income and the impact of reversing the deferred tax valuation allowance of $5.9 million, offset by an increase in non-interest expense. Net interest income increased by $10.9 million, or 25.8%, to $53.2 million for the year ended December 31, 2003 compared to $42.3 million for the same period in 2002. The increase in net interest income was primarily due to an increase of $567.6 million in average earning assets, offset by a 41 basis point decrease in the net interest margin. Non-interest expense for the year ended December 31, 2003 included approximately $250,000 in separation expense related to the resignation of a senior officer and $6.3 million in penalties related to unwinding repurchase agreements in June 2003 prior to maturity to lower funding costs. We unwound approximately $139 million of repurchase agreements and entered into new repurchase agreements with respect to a significant portion of that amount, with the remainder replaced with overnight funds. A significant portion of these overnight funds were replaced with deposits when we completed our acquisition of the outstanding deposit accounts of Bluebonnet Savings Bank FSB, which occurred on August 8, 2003.
Excluding the impact of reversing the valuation allowance, unwinding penalties and separation expense, diluted income per share would have been $0.53. Income per share excluding the impact of reversing the valuation allowance, unwinding penalties and separation expense is a non-GAAP financial measure. Please see the discussion of non-GAAP financial measures beginning on page 18 for an explanation of why we believe this non-GAAP financial measure is useful to management and investors and the table beginning on page 20 for a reconciliation of diluted income per share excluding impact of reversing the valuation allowance, unwinding penalties and separation expense to diluted income per share, which is the most directly comparable financial measure presented in accordance with GAAP.
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Non-interest income increased by $2.3 million, or 26.3%, during the year ended December 31, 2003 to $10.9 million, compared to $8.6 million during the same period in 2002. The increase was in part due to an overall increase in non-interest bearing deposits for 2003, which resulted in more service charges on deposit accounts. Also, our trust income increased by $326,000 to $1.3 million during the year ended December 31, 2003 compared to $987,000 for the same period in 2002, due to continued growth in trust assets. During the year ended December 31, 2003, we had a gain on sale of securities of $666,000 compared to $1.4 million in 2002 due to our ability to realize substantial profits from sales of fixed-rate debt securities as a result of rapid declines in overall interest rates. Mortgage warehouse fees increased by $831,000 to $1.5 million during the year ended December 31, 2003 from $693,000 in the same period in 2002. Also, we had bank owned life insurance (BOLI) income of $1.6 million during the year ended December 31, 2003 compared to $735,000 in 2002. Our BOLI investment originated in August 2002.
Non-interest expense increased by $13.0 million, or 36.8%, to $48.4 million during the year ended December 31, 2003 compared to $35.4 million during the same period in 2002. This increase is partially due to the incurrence of $6.3 million in penalties related to unwinding repurchase agreements prior to maturity in order to take advantage of historical lows in interest rates, which had decreased on similar repurchase agreements by approximately 1.4% since the time we entered into the original repurchase agreements. Salaries and employee benefits increased by $6.8 million due in part to an increase in total staffing at December 31, 2003 as compared to December 31, 2002. The increase in salaries and employee benefits also included separation expenses of approximately $250,000 related to the resignation of a senior officer. In addition, we experienced losses related to forged checks of approximately $300,000 during 2003. We have taken steps to reduce these types of losses in the future. Occupancy expense decreased by $14,000 to $5.0 million during the year ended December 31, 2003 compared to the same period in 2002 primarily related to a decrease in depreciation as many of our fixed assets are becoming fully depreciated. Marketing expense decreased $234,000 to $1.4 million during the year ended December 31, 2003 from $1.7 million during the same period in 2002.
Net Interest Income
Net interest income was $74.7 million for the year ended December 31, 2004 compared to $53.2 million for the same period of 2003. The increase in net interest income was primarily due to an increase of $376.4 million in average earning assets, coupled with a 50 basis point improvement in the net interest margin. The increase in average earning assets from 2003 included a $246.0 million increase in average net loans and a $139.5 million increase in average securities. For the year ended December 31, 2004, average net loans and securities represented 65% and 35%, respectively, of average earning assets compared to 64% and 35%, respectively, in 2003.
Average interest bearing liabilities increased $298.8 million from the year ended December 31, 2003, which included a $196.6 million increase in interest bearing deposits and a $99.4 million increase in other borrowings. The increase in average borrowings was primarily related to funding of the increase in investment securities. The average cost of interest bearing liabilities decreased from 2.04% for the year ended December 31, 2003 to 1.92% in 2004, reflecting the reduction in market interest rates.
Net interest income was $53.2 million for the year ended December 31, 2003 compared to $42.3 million for the same period of 2002. The increase was primarily due to an increase in average earning assets of $567.6 million for 2003 as compared to 2002, offset by a 41 basis point decrease in net interest margin. The increase in average earning assets from 2002 included a $241.7 million increase in average net loans and a $326.0 million increase in average securities. For the year ended December 31, 2003, average net loans and securities represented 64% and 35%, respectively, of average earning assets compared to 74% and 25%, respectively, in 2002. The decrease in loan percentage reflects management’s decision to tighten lending standards beginning in 2001 and continuing during 2002 pending clearer signs of improvement in the U.S. economy. Our securities percentage increased in 2003 as we used additional securities to increase our earnings and improve our return on equity by taking advantage of market spreads.
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Average interest bearing liabilities increased $502.3 million from the year ended December 31, 2002, which included a $221.8 million increase in interest bearing deposits and a $263.9 million increase in other borrowings. The increase in interest bearing deposits includes the purchase of deposit accounts from Bluebonnet Savings Bank, FSB in August 2003. The increase in average borrowings was primarily related to an increase in federal funds purchased and securities sold under repurchase agreements, and was used to supplement deposits in funding loan growth and securities purchases. The average cost of interest bearing liabilities decreased from 2.57% for the year ended December 31, 2002 to 2.04% in 2003, reflecting the reduction in market interest rates.
Volume/ Rate Analysis
Years Ended December 31, | |||||||||||||||||||||||||||||||||||||
2004/2003 | 2003/2002 | 2002/2001 | |||||||||||||||||||||||||||||||||||
Change Due to(1) | Change Due to(1) | Change Due to(1) | |||||||||||||||||||||||||||||||||||
Change | Volume | Yield/Rate | Change | Volume | Yield/Rate | Change | Volume | Yield/Rate | |||||||||||||||||||||||||||||
(In thousands) | |||||||||||||||||||||||||||||||||||||
Interest income: | |||||||||||||||||||||||||||||||||||||
Securities(2) | $ | 9,778 | $ | 5,188 | $ | 4,590 | $ | 7,400 | $ | 15,826 | $ | (8,426 | ) | $ | 4,724 | $ | 8,740 | $ | (4,016 | ) | |||||||||||||||||
Loans | 16,149 | 12,413 | 3,736 | 8,064 | 14,581 | (6,517 | ) | (4,849 | ) | 13,464 | (18,313 | ) | |||||||||||||||||||||||||
Federal funds sold | (101 | ) | (105 | ) | 4 | (77 | ) | (10 | ) | (67 | ) | (337 | ) | 7 | (344 | ) | |||||||||||||||||||||
Deposits in other banks | (1 | ) | (1 | ) | — | (14 | ) | 23 | (37 | ) | 10 | 11 | (1 | ) | |||||||||||||||||||||||
25,825 | 17,495 | 8,330 | 15,373 | 30,420 | (15,047 | ) | (452 | ) | 22,222 | (22,674 | ) | ||||||||||||||||||||||||||
Interest expense: | |||||||||||||||||||||||||||||||||||||
Transaction deposits | 201 | 216 | (15 | ) | (40 | ) | 126 | (166 | ) | (414 | ) | 255 | (669 | ) | |||||||||||||||||||||||
Savings deposits | 1,450 | 1,624 | (174 | ) | (431 | ) | 1,796 | (2,227 | ) | (7,214 | ) | (452 | ) | (6,762 | ) | ||||||||||||||||||||||
Time deposits | 655 | 1,294 | (639 | ) | 179 | 3,710 | (3,531 | ) | (2,908 | ) | 6,558 | (9,466 | ) | ||||||||||||||||||||||||
Borrowed funds | 1,501 | 1,550 | (49 | ) | 4,725 | 7,412 | (2,687 | ) | 2,893 | 5,416 | (2,523 | ) | |||||||||||||||||||||||||
3,807 | 4,684 | (877 | ) | 4,433 | 13,044 | (8,611 | ) | (7,643 | ) | 11,777 | (19,420 | ) | |||||||||||||||||||||||||
Net interest income | $ | 22,018 | $ | 12,811 | $ | 9,207 | $ | 10,940 | $ | 17,376 | $ | (6,436 | ) | $ | 7,191 | $ | 10,445 | $ | (3,254 | ) | |||||||||||||||||
(1) | Changes attributable to both volume and yield/rate are allocated to both volume and yield/rate on an equal basis. |
(2) | Taxable equivalent rates used where applicable. |
Net interest margin, the ratio of net interest income to average earning assets, increased from 2.87% in 2003 to 3.37% in 2004. This increase was due primarily to a 38 basis point increase in the yield on earning assets coupled with a 12 basis point decrease in the cost of interest bearing liabilities.
Net interest margin decreased from 3.28% in 2002 to 2.87% in 2003. This decrease was due primarily to the falling rate environment in which our balance sheet was asset sensitive, largely due to the concentration of assets in variable rate loans. In addition, a larger portion of our assets was invested in securities, which generally have a lower yield than loans. The cost of interest bearing liabilities decreased by 53 basis points in 2003, primarily due to overall lower market interest rates.
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Consolidated Daily Average Balances, Average Yields and Rates
Year Ended December 31 | ||||||||||||||||||||||||||||||||||||||
2004 | 2003 | 2002 | ||||||||||||||||||||||||||||||||||||
Average | Revenue/ | Yield/ | Average | Revenue/ | Yield/ | Average | Revenue/ | Yield/ | ||||||||||||||||||||||||||||||
Balance | Expense(1)(2) | Rate | Balance | Expense(1)(2) | Rate | Balance | Expense(1) | Rate | ||||||||||||||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||||||||||||||||
Assets | ||||||||||||||||||||||||||||||||||||||
Securities — Taxable | $ | 758,975 | $ | 31,343 | 4.13 | % | $ | 642,952 | $ | 22,796 | 3.55 | % | $ | 318,864 | $ | 15,484 | 4.86 | % | ||||||||||||||||||||
Securities — Non-taxable | 25,407 | 1,319 | 5.19 | % | 1,919 | 88 | 4.59 | % | — | — | — | |||||||||||||||||||||||||||
Federal funds sold | 5,265 | 65 | 1.23 | % | 14,283 | 166 | 1.16 | % | 14,874 | 243 | 1.63 | % | ||||||||||||||||||||||||||
Deposits in other banks | 931 | 13 | 1.40 | % | 1,026 | 14 | 1.36 | % | 558 | 28 | 5.02 | % | ||||||||||||||||||||||||||
Loans held for sale | 73,883 | 6,569 | 8.89 | % | 121,294 | 6,790 | 5.60 | % | 51,393 | 3,578 | 6.96 | % | ||||||||||||||||||||||||||
Loans | 1,385,848 | 72,031 | 5.20 | % | 1,090,623 | 55,661 | 5.10 | % | 915,571 | 50,809 | 5.55 | % | ||||||||||||||||||||||||||
Less reserve for loan losses | 18,311 | — | — | 16,512 | — | — | 13,226 | — | — | |||||||||||||||||||||||||||||
Loans, net | 1,441,420 | 78,600 | 5.45 | % | 1,195,405 | 62,451 | 5.22 | % | 953,738 | 54,387 | 5.70 | % | ||||||||||||||||||||||||||
Total earning assets | 2,231,998 | 111,340 | 4.99 | % | 1,855,585 | 85,515 | 4.61 | % | 1,288,034 | 70,142 | 5.45 | % | ||||||||||||||||||||||||||
Cash and other assets | 144,956 | 134,644 | 77,688 | |||||||||||||||||||||||||||||||||||
Total assets | $ | 2,376,954 | $ | 1,990,229 | $ | 1,365,722 | ||||||||||||||||||||||||||||||||
Liabilities and stockholders’ equity | ||||||||||||||||||||||||||||||||||||||
Transaction deposits | $ | 96,911 | $ | 652 | .67 | % | $ | 65,521 | $ | 451 | .69 | % | $ | 52,155 | $ | 491 | 0.94 | % | ||||||||||||||||||||
Savings deposits | 558,479 | 7,690 | 1.38 | % | 443,098 | 6,240 | 1.41 | % | 349,128 | 6,671 | 1.91 | % | ||||||||||||||||||||||||||
Time deposits | 597,985 | 14,895 | 2.49 | % | 548,160 | 14,240 | 2.60 | % | 433,731 | 14,061 | 3.24 | % | ||||||||||||||||||||||||||
Total interest bearing deposits | 1,253,375 | 23,237 | 1.85 | % | 1,056,779 | 20,931 | 1.98 | % | 835,014 | 21,223 | 2.54 | % | ||||||||||||||||||||||||||
Other borrowings | 612,295 | 11,803 | 1.93 | % | 512,933 | 10,493 | 2.05 | % | 249,000 | 6,608 | 2.65 | % | ||||||||||||||||||||||||||
Long-term debt | 20,620 | 1,096 | 5.32 | % | 17,824 | 905 | 5.08 | % | 1,178 | 65 | 5.52 | % | ||||||||||||||||||||||||||
Total interest bearing liabilities | 1,886,290 | 36,136 | 1.92 | % | 1,587,536 | 32,329 | 2.04 | % | 1,085,192 | 27,896 | 2.57 | % | ||||||||||||||||||||||||||
Demand deposits | 298,430 | 249,782 | 155,298 | |||||||||||||||||||||||||||||||||||
Other liabilities | 10,052 | 10,467 | 8,138 | |||||||||||||||||||||||||||||||||||
Stockholders’ equity | 182,182 | 142,444 | 117,094 | |||||||||||||||||||||||||||||||||||
Total liabilities and stockholders’ equity | $ | 2,376,954 | $ | 1,990,229 | $ | 1,365,722 | ||||||||||||||||||||||||||||||||
Net interest income | $ | 75,204 | $ | 53,186 | $ | 42,246 | ||||||||||||||||||||||||||||||||
Net interest income to earning assets (net interest margin) | 3.37 | % | 2.87 | % | 3.28 | % | ||||||||||||||||||||||||||||||||
Net interest spread | 3.07 | % | 2.57 | % | 2.88 | % |
(1) | The loan averages include loans on which the accrual of interest has been discontinued and are stated net of unearned income. |
(2) | Taxable equivalent rates used where applicable. |
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Non-interest Income
Year Ended December 31 | ||||||||||||
2004 | 2003 | 2002 | ||||||||||
(In thousands) | ||||||||||||
Service charges on deposit accounts | $ | 3,370 | $ | 3,446 | $ | 2,772 | ||||||
Trust fee income | 1,932 | 1,313 | 987 | |||||||||
Gains on sale of securities, net | — | 666 | 1,375 | |||||||||
Cash processing fees | 587 | 973 | 993 | |||||||||
BOLI income | 1,288 | 1,619 | 735 | |||||||||
Mortgage warehouse fees | 996 | 1,524 | 693 | |||||||||
Gain on sale of mortgage loans | 3,420 | 120 | — | |||||||||
Other | 2,039 | 1,231 | 1,070 | |||||||||
Total non-interest income | $ | 13,632 | $ | 10,892 | $ | 8,625 | ||||||
Non-interest income increased by $2.7 million, or 25.2%, during the year ended December 31, 2004 to $13.6 million, compared to $10.9 million during the same period in 2003. The increase was primarily due to an increase in gain on sale of mortgage loans relating to our residential mortgage lending division that was started in the third quarter of 2003. Gain on sale of mortgage loans increased $3.3 million to $3.4 million during the year ended December 31, 2004 compared to $120,000 during the same period in 2003. Also, our trust income increased by $619,000 to $1.9 million during the year ended December 31, 2004 compared to $1.3 million for the same period in 2003, due to continued growth in trust assets. Offsetting these increases were decreases in cash processing fees, mortgage warehouse fees, and gains on sale of securities. Cash processing fees were $386,000 lower in 2004 compared to 2003. These fees were related to a special project that occurred in the first quarter of 2002, 2003, and 2004. Fees are lower in 2004 as compared to 2003 due to smaller participation and more competitive pricing. Mortgage warehouse fees totaled $996,000 for the year ended December 31, 2004, compared to $1.5 million for the same period in 2003. The decrease was due to more normalized production levels in 2004 as compared to peak production during the second and third quarters of 2003 as overall refinancings reached record levels. Non-interest income for the year ended December 31, 2003 included a gain on sale of securities of $666,000. We did not have any sales of securities in 2004. Also, there was a decrease in BOLI income related to an annual adjustment in earning rates. The current policy provides life insurance for 25 executives, naming us as beneficiary.
Non-interest income increased $2.3 million, or 26.3%, in the year ended December 31, 2003 as compared to 2002. Service charges on deposit accounts increased $674,000 for the year ended December 31, 2003 as compared to 2002. The increase was due to the significant increase in non-interest deposits, which resulted in a higher volume of transactions. Trust fee income increased $326,000 due to continued growth of trust assets during 2003. Cash processing fees totaled $973,000 for the year ended December 31, 2003 which is comparable to the 2002 fees. These fees were related to a special project that occurred during the first quarter of 2003. Mortgage warehouse fees increased by $831,000 to $1.5 million during the year ended December 31, 2003 from $693,000 in 2002 as a result of favorable mortgage rates and growth in our customer base. BOLI income totaled $1.6 million during 2003 compared to $735,000 in 2002. Our BOLI investment originated in August 2002.
While management expects continued growth in non-interest income, the future rate of growth could be affected by increased competition from nationwide and regional financial institutions. In order to achieve continued growth in non-interest income, we may need to introduce new products or enter into new markets. Any new product introduction or new market entry could place additional demands on capital and managerial resources.
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Non-interest Expense
Year Ended December 31 | ||||||||||||
2004 | 2003 | 2002 | ||||||||||
(In thousands) | ||||||||||||
Salaries and employee benefits | $ | 34,794 | $ | 23,604 | $ | 16,757 | ||||||
Net occupancy expense | 5,695 | 4,987 | 5,001 | |||||||||
Marketing | 2,609 | 1,432 | 1,666 | |||||||||
Legal and professional | 3,141 | 2,867 | 3,038 | |||||||||
Communications and data processing | 3,158 | 3,042 | 2,839 | |||||||||
Franchise taxes | 246 | 124 | 108 | |||||||||
Repurchase agreement penalties | — | 6,262 | — | |||||||||
IPO expenses | — | — | 1,190 | |||||||||
Other(1) | 7,697 | 6,062 | 4,771 | |||||||||
Total non-interest expense | $ | 57,340 | $ | 48,380 | $ | 35,370 | ||||||
(1) | Other expense includes such items as courier expenses, regulatory assessments, due from bank charges, and other general operating expenses, none of which account for 1% or more of total interest income and non-interest income. |
Non-interest expense for the year ended December 31, 2004 increased $9.0 million, or 18.5%, compared to the same period of 2003. This increase is due primarily to an $11.2 million increase in salaries and employee benefits. The increase in salaries and employee benefits resulted from an increase in the total number of employees related to general business growth, additional staffing for the new Houston office, the significant expansion of the residential mortgage lending division, and increased incentive compensation reflective of our performance.
Occupancy expense increased by $708,000 to $5.7 million during the year ended December 31, 2004 compared to the same period in 2003 and is related to our continued business growth and our new Houston office.
Marketing expense for the year ended December 31, 2004 increased $1.2 million, or 82.1%, compared to 2003. Marketing expense for the year ended December 31, 2004 included $235,000 of direct marketing and promotions and $1.2 million in business development compared to direct marketing and promotions of $122,000 and business development of $593,000 during 2003. Marketing expense for the year ended December 31, 2004 also included $1.2 million for the purchase of miles related to the American Airlines AAdvantage® program compared to $717,000 during 2003. Our direct marketing may increase as we seek to further develop our brand, reach more of our target customers and expand in our target markets. Legal and professional expenses increased $274,000 or 9.6%, mainly related to growth and increased cost of compliance with laws and regulations. Communications and data processing expense for the year ended December 31, 2004 increased $116,000, or 3.8%, due to growth in our loan and deposit base and increased staff.
Non-interest expense for the year ended December 31, 2003 increased $13.0 million, or 36.8%, compared to the same period of 2002. This increase included $6.3 million in penalties related to our restructuring of the maturities and pricing of our repurchase agreements in June 2003 in order to take advantage of historical lows in interest rates, which had decreased on similar repurchase agreements by approximately 1.4% since the time we entered into the original repurchase agreements. We unwound approximately $139 million in repurchase agreements prior to their maturities and entered into new repurchase agreements with respect to a significant portion of that amount, with the remainder replaced with overnight funds. A significant portion of these overnight funds were replaced with deposits when we completed our acquisition of the outstanding deposit accounts of Bluebonnet Savings Bank FSB in August 2003. Salaries and employee benefits increased by $6.8 million or 40.9%. Total full time employees increased from 215 at December 31, 2002 to 305 at December 31, 2003. Also included in salaries and benefits for the year ended December 31, 2003, is $250,000
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in separation costs related to the resignation of a senior officer. In addition, we experienced fraud losses related to check theft of approximately $300,000 during 2003. We have taken steps to reduce these types of fraud losses in the future.
Marketing expense for the year ended December 31, 2003 decreased $234,000, or 14.0%, compared to 2002. Marketing expense for the year ended December 31, 2003 included $122,000 of direct marketing and promotions and business development of $593,000 compared to direct marketing and promotions of $609,000 and business development of $427,000 during 2002. Marketing expense for the year ended December 31, 2003 also included $717,000 for the purchase of miles related to the American Airlines AAdvantage® program compared to $630,000 during 2002. Our direct marketing may increase as we seek to further develop our brand, reach more of our target customers and expand in our target markets. Legal and professional expenses decreased $171,000 or 5.6%, mainly related to legal expenses incurred with our non-performing loans and leases. Communications and data processing expense for the year ended December 31, 2003 increased $203,000, or 7.2%, due to growth in our loan and deposit base and increased staff.
Income Taxes
We had a gross deferred tax asset of $8.8 million at December 31, 2004, which relates primarily to our allowance for loan losses. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized.
At December 31, 2003, we had a gross deferred tax asset of $8.4 million. In 2003, as a result of our reassessment of our ability to generate sufficient earnings to allow the utilization of our deferred tax assets, we believed it was more likely than not that the deferred tax assets would be realized. Accordingly in compliance with Statement of Financial Accounting Standards No. 109, we reversed the valuation allowance and certain related tax reserves during the year.
At December 31, 2002, we had a net deferred tax asset of $2.2 million and a valuation allowance of $5.4 million. In assessing the need for a valuation allowance at December 31, 2002, we did not assume future taxable income would be generated due to our limited operating history and uncertainty regarding the timing of certain future deductions. The effective tax rate in 2002 reflected the use of certain net operating loss carryforwards from prior years.
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Consolidated Interim Financial Information (Unaudited)
2004 Selected Quarterly Financial Data | |||||||||||||||||
Fourth | Third | Second | First | ||||||||||||||
(In thousands except per share data) | |||||||||||||||||
Interest income | $ | 32,529 | $ | 29,019 | $ | 25,056 | $ | 24,274 | |||||||||
Interest expense | 11,069 | 9,633 | 7,804 | 7,630 | |||||||||||||
Net interest income | 21,460 | 19,386 | 17,252 | 16,644 | |||||||||||||
Provision for loan losses | 200 | 375 | 363 | 750 | |||||||||||||
Net interest income after provision for loan losses | 21,260 | 19,011 | 16,889 | 15,894 | |||||||||||||
Non-interest income | 3,738 | 3,463 | 3,116 | 3,315 | |||||||||||||
Non-interest expense | 15,917 | 14,595 | 13,496 | 13,332 | |||||||||||||
Income before income taxes | 9,081 | 7,879 | 6,509 | 5,877 | |||||||||||||
Income tax expense | 3,054 | 2,643 | 2,149 | 1,940 | |||||||||||||
Net income | $ | 6,027 | $ | 5,236 | $ | 4,360 | $ | 3,937 | |||||||||
Earnings per share: | |||||||||||||||||
Basic | $ | .24 | $ | .21 | $ | .17 | $ | .16 | |||||||||
Diluted | $ | .23 | $ | .20 | $ | .17 | $ | .15 | |||||||||
Average shares: | |||||||||||||||||
Basic | 25,386,000 | 25,302,000 | 25,245,000 | 25,109,000 | |||||||||||||
Diluted | 26,457,000 | 26,264,000 | 26,140,000 | 26,076,000 | |||||||||||||
2003 Selected Quarterly Financial Data | |||||||||||||||||
Fourth | Third | Second | First | ||||||||||||||
(In thousands except per share data) | |||||||||||||||||
Interest income | $ | 22,998 | $ | 20,977 | $ | 21,363 | $ | 20,146 | |||||||||
Interest expense | 7,600 | 7,626 | 8,699 | 8,404 | |||||||||||||
Net interest income | 15,398 | 13,351 | 12,664 | 11,742 | |||||||||||||
Provision for loan losses | 700 | 475 | 1,600 | 1,250 | |||||||||||||
Net interest income after provision for loan losses | 14,698 | 12,876 | 11,064 | 10,492 | |||||||||||||
Non-interest income | 2,255 | 2,512 | 2,473 | 2,986 | |||||||||||||
Securities gains, net | (20 | ) | — | 345 | 341 | ||||||||||||
Non-interest expense | 11,618 | 10,483 | 16,901 | 9,378 | |||||||||||||
Income before income taxes | 5,315 | 4,905 | (3,019 | ) | 4,441 | ||||||||||||
Income tax expense | 1,701 | 1,573 | (6,876 | ) | 1,410 | ||||||||||||
Net income | 3,614 | 3,332 | 3,857 | 3,031 | |||||||||||||
Preferred stock dividends | — | (149 | ) | (276 | ) | (274 | ) | ||||||||||
Income available to common stockholders | $ | 3,614 | $ | 3,183 | $ | 3,581 | $ | 2,757 | |||||||||
Earnings per share: | |||||||||||||||||
Basic | $ | .14 | $ | .15 | $ | .19 | $ | .14 | |||||||||
Diluted | $ | .14 | $ | .14 | $ | .18 | $ | .14 | |||||||||
Average shares: | |||||||||||||||||
Basic | 24,931,000 | 21,925,000 | 19,211,000 | 19,194,000 | |||||||||||||
Diluted | 25,808,000 | 23,671,000 | 21,509,000 | 21,433,000 | |||||||||||||
Analysis of Financial Condition
Loan Portfolio. Our loan portfolio has grown at an annual rate of 24.2%, 17.1% and 28.4% in 2002, 2003 and 2004, respectively, reflecting the build-up of our lending operations. Our business plan focuses primarily
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on lending to middle market businesses and high net worth individuals, and accordingly, commercial and real estate loans have comprised a majority of our loan portfolio since we commenced operations, decreasing slightly from 78.0% of total loans at December 31, 2000 to 72.0% of total loans at December 31, 2004. Construction loans have increased from 13.3% of the portfolio at December 31, 2000 to 19.4% of the portfolio at December 31, 2004. Consumer loans have decreased from 5.7% of the portfolio at December 31, 2000 to 0.92% of the portfolio at December 31, 2004. Loans held for sale, which are principally residential mortgage loans being warehoused for sale (typically within 30 days), fluctuate based on the level of market demand in the product.
We originate substantially all of the loans held in our portfolio, except in certain instances we have purchased individual leases and lease pools (primarily commercial and industrial equipment and vehicles), as well as select loan participations and USDA government guaranteed loans.
The following summarizes our loan portfolios by major category as of the dates indicated:
December 31 | ||||||||||||||||||||
2004 | 2003 | 2002 | 2001 | 2000 | ||||||||||||||||
(In thousands) | ||||||||||||||||||||
Commercial | $ | 818,156 | $ | 608,542 | $ | 509,505 | $ | 402,302 | $ | 325,774 | ||||||||||
Construction | 328,074 | 256,134 | 172,451 | 180,115 | 83,931 | |||||||||||||||
Real estate | 397,029 | 339,069 | 282,703 | 218,192 | 164,873 | |||||||||||||||
Consumer | 15,562 | 16,564 | 24,195 | 25,054 | 36,092 | |||||||||||||||
Leases | 9,556 | 13,152 | 17,546 | 34,552 | 17,093 | |||||||||||||||
Loans held for sale | 119,537 | 80,780 | 116,106 | 43,764 | 1,346 | |||||||||||||||
Total | $ | 1,687,914 | $ | 1,314,241 | $ | 1,122,506 | $ | 903,979 | $ | 629,109 | ||||||||||
We continue to lend primarily in Texas. As of December 31, 2004, a substantial majority of the principal amount of the loans in our portfolio was to businesses and individuals in Texas. This geographic concentration subjects the loan portfolio to the general economic conditions in Texas. Within the loan portfolio, loans to the services industry were $605.4 million, or 35.9%, of total loans at December 31, 2004. Other notable concentrations include $223.1 million in personal/household loans (which includes loans to certain high net worth individuals for commercial purposes and mortgage loans held for sale, in addition to consumer loans), $244.7 million to the contracting industry and $189.7 million in petrochemical and mining loans. The risks created by these concentrations have been considered by management in the determination of the adequacy of the allowance for loan losses. Management believes the allowance for loan losses is adequate to cover estimated losses on loans at each balance sheet date.
Loan Maturity and Interest Rate Sensitivity on December 31, 2004
Remaining Maturities of Selected Loans | |||||||||||||||||
Total | Within 1 Year | 1-5 Years | After 5 Years | ||||||||||||||
(In thousands) | |||||||||||||||||
Loan maturity: | |||||||||||||||||
Commercial | $ | 818,156 | $ | 388,877 | $ | 352,786 | $ | 76,493 | |||||||||
Construction | 328,074 | 153,785 | 159,932 | 14,357 | |||||||||||||
Total | $ | 1,146,230 | $ | 542,662 | $ | 512,718 | $ | 90,850 | |||||||||
Interest rate sensitivity for selected loans with: | |||||||||||||||||
Predetermined interest rates | $ | 49,990 | $ | 14,039 | $ | 22,165 | $ | 13,786 | |||||||||
Floating or adjustable interest rates | 1,096,240 | 528,623 | 490,553 | 77,064 | |||||||||||||
Total | $ | 1,146,230 | $ | 542,662 | $ | 512,718 | $ | 90,850 | |||||||||
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Summary of Loan Loss Experience
The provision for loan losses is a charge to earnings to maintain the reserve for loan losses at a level consistent with management’s assessment of the loan portfolio in light of current economic conditions and market trends. We recorded a provision of $1.7 million for the year ended December 31, 2004, $4.0 million for 2003 and $5.6 million for 2002. The provision for losses necessary to maintain reserve adequacy decreased due to the improvement in indicators of credit quality in 2004, such as net charge-offs and non-performing loans.
The reserve for loan losses is comprised of allocated reserves for impaired loans and an estimate of losses inherent in the portfolio at the balance sheet date, but not yet identified with specific loans. We regularly evaluate our reserve for loan losses to maintain an adequate level to absorb loan losses inherent in the loan portfolio. Factors contributing to the determination of allocated reserves include the creditworthiness of the borrower, changes in the value of pledged collateral, and general economic conditions. All loan commitments rated substandard or worse and greater than $1,000,000 are reviewed and a specific allocation is assigned based on the losses expected to be realized from those loans. For purposes of determining the general reserve, the portfolio is segregated by product types to recognize differing risk profiles among categories, and then further segregated by credit grades. Credit grades are assigned to all loans greater than $50,000. Each credit grade is assigned a risk factor, or reserve allocation percentage. These risk factors are multiplied by the outstanding principal balance and risk-weighted by product type to calculate the required reserve. A similar process is employed to calculate that portion of the required reserve assigned to unfunded loan commitments.
The reserve allocation percentages assigned to each credit grade have been developed based on an analysis of our historical loss rates and historical loss rates within the banking industry and our markets, adjusted for certain qualitative factors. Qualitative adjustments for such things as general economic conditions, changes in credit policies and lending standards, and changes in the trend and severity of problem loans, can cause the estimation of future losses to differ from past experience. The unallocated portion of the general reserve serves to compensate for additional areas of uncertainty and considers industry trends. In addition, the reserve considers the results of reviews performed by independent third party reviewers as reflected in their confirmations of assigned credit grades within the portfolio.
The methodology used in the periodic review of reserve adequacy, which is performed at least quarterly, is designed to be dynamic and responsive to changes in portfolio credit quality and anticipated future credit losses. The changes are reflected in the general reserve and in specific reserves as the collectibility of larger classified loans is evaluated with new information. As our portfolio matures, historical loss ratios are being closely monitored, and our reserve adequacy will rely primarily on our loss history. Currently, the review of reserve adequacy is performed by executive management and presented to our board of directors for their review, consideration and ratification on a quarterly basis.
The reserve for loan losses, which is available to absorb losses inherent in the loan portfolio, totaled $18.7 million at December 31, 2004, $17.7 million at December 31, 2003 and $14.5 million at December 31, 2002. This represents 1.20%, 1.44% and 1.45% of loans held for investment at December 31, 2004, 2003 and 2002, respectively.
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The table below presents a summary of our loan loss experience for the past five years.
Summary of Loan Loss Experience
Year Ended December 31 | |||||||||||||||||||||
2004 | 2003 | 2002 | 2001 | 2000 | |||||||||||||||||
(In thousands, except percentage and multiple data) | |||||||||||||||||||||
Beginning balance | $ | 17,727 | $ | 14,538 | $ | 12,598 | $ | 8,910 | $ | 2,775 | |||||||||||
Loans charged-off: | |||||||||||||||||||||
Commercial | 258 | 50 | 2,096 | 1,418 | — | ||||||||||||||||
Real estate | — | 402 | — | — | — | ||||||||||||||||
Consumer | 157 | 5 | 11 | — | — | ||||||||||||||||
Leases | 939 | 618 | 1,740 | 656 | — | ||||||||||||||||
Total | 1,354 | 1,075 | 3,847 | 2,074 | — | ||||||||||||||||
Recoveries: | |||||||||||||||||||||
Commercial | 148 | 78 | 42 | — | — | ||||||||||||||||
Leases | 489 | 161 | 116 | — | — | ||||||||||||||||
637 | 239 | 158 | — | — | |||||||||||||||||
Net charge-offs | 717 | 836 | 3,689 | 2,074 | — | ||||||||||||||||
Provision for loan losses | 1,688 | 4,025 | 5,629 | 5,762 | 6,135 | ||||||||||||||||
Ending balance | $ | 18,698 | $ | 17,727 | $ | 14,538 | $ | 12,598 | $ | 8,910 | |||||||||||
Reserve to loans held for investment(2) | 1.20 | % | 1.44 | % | 1.45 | % | 1.47 | % | 1.43 | % | |||||||||||
Net charge-offs to average loans(2) | .05 | % | .08 | % | .40 | % | .27 | % | — | ||||||||||||
Provision for loan losses to average loans(2) | .12 | % | .37 | % | .61 | % | .75 | % | 1.44 | % | |||||||||||
Recoveries to gross charge-offs | 47.05 | % | 22.23 | % | 4.11 | % | — | — | |||||||||||||
Reserve as a multiple of net charge-offs | 26.1 | x | 21.2 | x | 3.9 | x | 6.1 | x | — | ||||||||||||
Non-performing and renegotiated loans: | |||||||||||||||||||||
Loans past due (90 days) | $ | 209 | $ | 7 | $ | 135 | $ | 384 | $ | — | |||||||||||
Non-accrual(1) | 5,850 | 10,217 | 2,776 | 6,032 | 572 | ||||||||||||||||
Renegotiated | — | — | — | 5,013 | — | ||||||||||||||||
Total | $ | 6,059 | $ | 10,224 | $ | 2,911 | $ | 11,429 | $ | 572 | |||||||||||
Allowance to non-performing loans | 3.1 | x | 1.7 | x | 5.0 | x | 1.1 | x | 15.6 | x |
(1) | The accrual of interest on loans is discontinued when there is a clear indication that the borrower’s cash flow may not be sufficient to meet payments as they become due, which is generally when a loan is 90 days past due. When a loan is placed on non-accrual status, all previously accrued and unpaid interest is reversed. Interest income is subsequently recognized on a cash basis as long as the remaining unpaid principal amount of the loan is deemed to be fully collectible. If collectibility is questionable, then cash payments are applied to principal. If these loans had been current throughout their terms, interest and fees on loans would have increased by approximately $168,000, $154,000 and $771,000 for the years ended December 31, 2004, 2003 and 2002, respectively. |
(2) | Excludes loans held for sale. |
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Loan Loss Reserve Allocation
December 31 | |||||||||||||||||||||||||||||||||||||||||
2004 | 2003 | 2002 | 2001 | 2000 | |||||||||||||||||||||||||||||||||||||
Reserve | % of Loans | Reserve | % of Loans | Reserve | % of Loans | Reserve | % of Loans | Reserve | % of Loans | ||||||||||||||||||||||||||||||||
(In thousands, except percentage data) | |||||||||||||||||||||||||||||||||||||||||
Loan category: | |||||||||||||||||||||||||||||||||||||||||
Commercial | $ | 6,829 | 48 | % | $ | 6,376 | 46 | % | $ | 4,818 | 45 | % | $ | 7,549 | 45 | % | $ | 3,136 | 52 | % | |||||||||||||||||||||
Construction | 2,701 | 19 | 2,608 | 20 | 2,008 | 15 | 1,004 | 20 | 498 | 13 | |||||||||||||||||||||||||||||||
Real estate(1) | 2,136 | 31 | 2,113 | 32 | 3,193 | 36 | 1,738 | 29 | 2,250 | 26 | |||||||||||||||||||||||||||||||
Consumer | 371 | 1 | 93 | 1 | 114 | 2 | 116 | 2 | 144 | 6 | |||||||||||||||||||||||||||||||
Leases | 457 | 1 | 932 | 1 | 706 | 2 | 623 | 4 | 384 | 3 | |||||||||||||||||||||||||||||||
Unallocated | 6,204 | — | 5,605 | — | 3,699 | — | 1,568 | — | 2,498 | — | |||||||||||||||||||||||||||||||
Total | $ | 18,698 | 100 | % | $ | 17,727 | 100 | % | $ | 14,538 | 100 | % | $ | 12,598 | 100 | % | $ | 8,910 | 100 | % | |||||||||||||||||||||
(1) | Includes loans held for sale. |
Non-performing Assets
Non-performing assets include non-accrual loans and leases, accruing loans 90 or more days past due, restructured loans, and other repossessed assets. The table below summarizes our non-accrual loans by type:
Year Ended December 31 | |||||||||||||
2004 | 2003 | 2002 | |||||||||||
(In thousands) | |||||||||||||
Non-accrual loans: | |||||||||||||
Commercial | $ | 687 | $ | 4,124 | $ | 641 | |||||||
Construction | 4,371 | 3,986 | — | ||||||||||
Real estate | 403 | 951 | 1,367 | ||||||||||
Consumer | 126 | 105 | 26 | ||||||||||
Leases | 263 | 1,051 | 742 | ||||||||||
Total non-accrual loans | $ | 5,850 | $ | 10,217 | $ | 2,776 | |||||||
Reserves | $ | 1,278 | $ | 2,252 | $ | 832 |
At December 31, 2004, 2003 and 2002, we had $209,000, $7,000 and $135,000, respectively, in accruing loans past due 90 days or more. Interest income recorded on impaired loans during the years ended December 31, 2004, 2003 and 2002 was approximately $232,000, $131,000 and $64,000, respectively. Additional interest income that would have been recorded if the loans had been current during the years ended December 31, 2004, 2003 and 2002 totaled $168,000, $154,000 and $771,000, respectively. At December 31, 2004 and 2003, we had $180,000 and $64,000, respectively, in other repossessed assets.
Generally, we place loans on non-accrual when there is a clear indication that the borrower’s cash flow may not be sufficient to meet payments as they become due, which is generally when a loan is 90 days past due. When a loan is placed on non-accrual status, all previously accrued and unpaid interest is reversed. Interest income is subsequently recognized on a cash basis as long as the remaining unpaid principal amount of the loan is deemed to be fully collectible. If collectibility is questionable, then cash payments are applied to principal. As of December 31, 2004, approximately $4.0 million of our non-accrual loans were earning on a cash basis.
A loan is considered impaired when, based on current information and events, it is probable that we will be unable to collect all amounts due (both principal and interest) according to the terms of the loan agreement. Reserves on impaired loans are measured based on the present value of the expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral.
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Securities Portfolio
Securities are identified as either held-to-maturity or available-for-sale based upon various factors, including asset/liability management strategies, liquidity and profitability objectives, and regulatory requirements. Held-to-maturity securities are carried at cost, adjusted for amortization of premiums or accretion of discounts. Available-for-sale securities are securities that may be sold prior to maturity based upon asset/liability management decisions. Securities identified as available-for-sale are carried at fair value. Unrealized gains or losses on available-for-sale securities are recorded as accumulated other comprehensive income in stockholders’ equity. Amortization of premiums or accretion of discounts on mortgage-backed securities is periodically adjusted for estimated prepayments.
During the year ended December 31, 2004, we maintained an average securities portfolio of $784.4 million compared to an average portfolio of $644.9 million for the same period in 2003. We used additional securities in 2004 to increase our earnings by taking advantage of market spreads between returns on assets and the cost of funding these assets. The December 31, 2004 portfolio was primarily comprised of mortgage-backed securities. The mortgage-backed securities in our portfolio at December 31, 2004 primarily consisted of government agency mortgage-backed securities.
Our unrealized gain on the securities portfolio value decreased from a gain of $5.0 million, which represented .65% of the amortized cost, at December 31, 2003, to a gain of $4.0 million, which represented .50% of the amortized cost, at December 31, 2004.
During the year ended December 31, 2003, we maintained an average securities portfolio of $644.9 million compared to an average portfolio of $318.9 million for the same period in 2002. We used additional securities in 2003 to increase our earnings by taking advantage of market spreads between returns on assets and the cost of funding these assets. The December 31, 2003 portfolio was primarily comprised of mortgage-backed securities. The mortgage-backed securities in our portfolio at December 31, 2003 primarily consisted of government agency mortgage-backed securities.
Our unrealized gain on the securities portfolio value decreased from a gain of $10.0 million, which represented 1.8% of the amortized cost, at December 31, 2002, to a gain of $5.0 million, which represented .65% of the amortized cost, at December 31, 2003.
The average expected life of the mortgage-backed securities was 3.7 years at December 31, 2004 and 3.9 years at December 31, 2003. The effect of possible changes in interest rates on our earnings and equity is discussed under “Interest Rate Risk Management.”
The following presents the amortized cost and fair values of the securities portfolio at December 31, 2004, 2003 and 2002.
At December 31 | |||||||||||||||||||||||||
2004 | 2003 | 2002 | |||||||||||||||||||||||
Amortized | Amortized | Amortized | |||||||||||||||||||||||
Cost | Fair Value | Cost | Fair Value | Cost | Fair Value | ||||||||||||||||||||
(In thousands) | |||||||||||||||||||||||||
Available-for-sale: | |||||||||||||||||||||||||
U.S. Treasuries | $ | 1,896 | $ | 1,895 | $ | 1,798 | $ | 1,798 | $ | 3,291 | $ | 3,291 | |||||||||||||
Mortgage-backed securities | 690,775 | 694,543 | 698,093 | 702,532 | 530,271 | 540,280 | |||||||||||||||||||
Corporate securities | 46,272 | 46,630 | 46,635 | 47,352 | — | — | |||||||||||||||||||
Municipals | 48,721 | 48,644 | 11,449 | 11,372 | — | — | |||||||||||||||||||
Equity securities(1) | 12,891 | 12,832 | 12,336 | 12,284 | 9,590 | 9,598 | |||||||||||||||||||
Total available-for-sale securities | $ | 800,555 | $ | 804,544 | $ | 770,311 | $ | 775,338 | $ | 543,152 | $ | 553,169 | |||||||||||||
(1) | Equity securities consist of Federal Reserve Bank stock, Federal Home Loan Bank stock, and Community Reinvestment Act funds. |
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The amortized cost and estimated fair value of securities are presented below by contractual maturity:
At December 31, 2004 | ||||||||||||||||||||||
After Five | ||||||||||||||||||||||
After One | Through | |||||||||||||||||||||
Less than | Through | Ten | After Ten | |||||||||||||||||||
One Year | Five Years | Years | Years | Total | ||||||||||||||||||
(In thousands, except percentage data) | ||||||||||||||||||||||
Available-for-sale: | ||||||||||||||||||||||
U.S. Treasuries: | ||||||||||||||||||||||
Amortized cost | $ | 1,896 | $ | — | $ | — | $ | — | $ | 1,896 | ||||||||||||
Estimated fair value | $ | 1,895 | $ | — | $ | — | $ | — | $ | 1,895 | ||||||||||||
Weighted average yield | 2.070 | % | — | — | — | 2.070 | % | |||||||||||||||
Mortgage-backed securities:(1) | ||||||||||||||||||||||
Amortized cost | — | 3,264 | 220,940 | 466,571 | 690,775 | |||||||||||||||||
Estimated fair value | — | 3,336 | 221,470 | 469,737 | 694,543 | |||||||||||||||||
Weighted average yield | — | 6.000 | % | 4.148 | % | 4.630 | % | 4.482 | % | |||||||||||||
Corporate securities: | ||||||||||||||||||||||
Amortized cost | — | 41,274 | 4,998 | — | 46,272 | |||||||||||||||||
Estimated fair value | — | 41,403 | 5,227 | — | 46,630 | |||||||||||||||||
Weighted average yield | — | 3.667 | % | 7.380 | % | — | 4.076 | % | ||||||||||||||
Municipals:(2) | ||||||||||||||||||||||
Amortized cost | — | 4,145 | 22,919 | 21,657 | 48,721 | |||||||||||||||||
Estimated fair value | — | 4,134 | 23,008 | 21,502 | 48,644 | |||||||||||||||||
Weighted average yield | — | 4.174 | % | 5.414 | % | 5.845 | % | 5.500 | % | |||||||||||||
Equity securities: | ||||||||||||||||||||||
Amortized cost | 12,891 | — | — | — | 12,891 | |||||||||||||||||
Estimated fair value | 12,832 | — | — | — | 12,832 | |||||||||||||||||
Total available-for-sale securities: | ||||||||||||||||||||||
Amortized cost | $ | 800,555 | ||||||||||||||||||||
Estimated fair value | $ | 804,544 | ||||||||||||||||||||
(1) | Actual maturities may differ significantly from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties. The average expected life of the mortgage-backed securities was 3.7 years at December 31, 2004. |
(2) | Yields have been adjusted to a tax equivalent basis assuming a 35% federal tax rate. |
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The following table discloses, as of December 31, 2004, our investment securities that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 or more months (in thousands):
Less than 12 Months | 12 Months or Longer | Total | ||||||||||||||||||||||
Unrealized | Unrealized | Unrealized | ||||||||||||||||||||||
Fair Value | Loss | Fair Value | Loss | Fair Value | Loss | |||||||||||||||||||
U.S. Treasuries | $ | 1,895 | $ | (1 | ) | $ | — | $ | — | $ | 1,895 | $ | (1 | ) | ||||||||||
Mortgage-backed securities | 191,433 | (1,174 | ) | 66,114 | (1,309 | ) | 257,547 | (2,483 | ) | |||||||||||||||
Corporate securities | 10,400 | (69 | ) | — | — | 10,400 | (69 | ) | ||||||||||||||||
Municipals | 27,521 | (272 | ) | — | — | 27,521 | (272 | ) | ||||||||||||||||
Equity securities | — | — | 1,440 | (60 | ) | 1,440 | (60 | ) | ||||||||||||||||
$ | 231,249 | $ | (1,516 | ) | $ | 67,554 | $ | (1,369 | ) | $ | 298,803 | $ | (2,885 | ) | ||||||||||
We believe the investment securities in the table above are within ranges customary for the banking industry. The number of investment positions in this unrealized loss position totals 30. We do not believe these unrealized losses are “other than temporary” as (1) we have the ability and intent to hold the investments to maturity, or a period of time sufficient to allow for a recovery in market value; (2) it is not probable that we will be unable to collect the amounts contractually due; and (3) no decision to dispose of the investments were made prior to the balance sheet date. The unrealized losses noted are interest rate related due to rising rates in 2004 in relation to previous rates in mid-2003. We have not identified any issues related to the ultimate repayment of principal as a result of credit concerns on these securities.
Deposits
We compete for deposits by offering a broad range of products and services to our customers. While this includes offering competitive interest rates and fees, the primary means of competing for deposits is convenience and service to our customers. However, our strategy to provide service and convenience to customers does not include a large branch network. Our bank offers nine banking centers, courier services, and online banking. BankDirect, the Internet division of our bank, serves its customers on a 24 hours-a-day/7 days-a-week basis solely through Internet banking.
Average deposits for the year ended December 31, 2004 increased $245.2 million compared to the same period of 2003. Average demand deposits, interest bearing transaction accounts, savings, and time deposits increased by $48.6 million, $31.4 million, $115.4 million, and $49.8 million, respectively, during the year ended December 31, 2004 as compared to the same period of 2003. The average cost of deposits decreased in 2004 mainly due to lower market interest rates.
Average deposits for the year ended December 31, 2003 increased $316.2 million compared to the same period of 2002. Average demand deposits, interest bearing transaction accounts, savings, and time deposits increased by $94.5 million, $13.4 million, $94.0 million, and $114.4 million, respectively, during the year ended December 31, 2003 as compared to the same period of 2002. The average cost of deposits decreased in 2003 mainly due to lower market interest rates.
Deposit Analysis
Average Balances | ||||||||||||
2004 | 2003 | 2002 | ||||||||||
(In thousands) | ||||||||||||
Non-interest bearing | $ | 298,430 | $ | 249,782 | $ | 155,298 | ||||||
Interest bearing transaction | 96,911 | 65,521 | 52,155 | |||||||||
Savings | 558,479 | 443,098 | 349,128 | |||||||||
Time deposits | 597,985 | 548,160 | 433,731 | |||||||||
Total average deposits | $ | 1,551,805 | $ | 1,306,561 | $ | 990,312 | ||||||
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As with our loan portfolio, most of our deposits are from businesses and individuals in Texas, particularly the Dallas metropolitan area. As of December 31, 2004, approximately 75% of our deposits originated out of our Dallas metropolitan banking centers. Uninsured deposits at December 31, 2004 were 62% of total deposits, compared to 60% of total deposits at December 31, 2003 and 57% of total deposits at December 31, 2002. The presentation for 2004, 2003 and 2002 does reflect combined ownership, but does not reflect all of the account styling that would determine insurance based on FDIC regulations.
At December 31, 2004, approximately 7% of our total deposits were comprised of a number of short-term maturity deposits from a single municipal entity. We use these funds to increase our net interest income from excess securities that we pledge as collateral for these deposits.
At December 31, 2004, we had $158.0 million in interest bearing time deposits of $100,000 or more in foreign branches related to our Cayman Islands branch.
Maturity of Domestic CDs and Other Time Deposits in Amounts of $100,000 or More
December 31 | |||||||||||||
2004 | 2003 | 2002 | |||||||||||
(In thousands) | |||||||||||||
Months to maturity: | |||||||||||||
3 or less | $ | 174,392 | $ | 214,778 | $ | 174,518 | |||||||
Over 3 through 6 | 33,229 | 37,890 | 47,041 | ||||||||||
Over 6 through 12 | 56,943 | 53,678 | 28,905 | ||||||||||
Over 12 | 137,325 | 104,866 | 174,715 | ||||||||||
Total | $ | 401,889 | $ | 411,212 | $ | 425,179 | |||||||
Liquidity and Capital Resources
In general terms, liquidity is a measurement of our ability to meet our cash needs. Our objective in managing our liquidity is to maintain our ability to meet loan commitments, purchase securities or repay deposits and other liabilities in accordance with their terms, without an adverse impact on our current or future earnings. Our liquidity strategy is guided by policies, which are formulated and monitored by our senior management and our Balance Sheet Management Committee (BSMC), and which take into account the marketability of assets, the sources and stability of funding and the level of unfunded commitments. We regularly evaluate all of our various funding sources with an emphasis on accessibility, stability, reliability and cost-effectiveness. For the years ended December 31, 2003 and 2004, our principal source of funding has been our customer deposits, supplemented by our short-term and long-term borrowings, primarily from securities sold under repurchase agreements and federal funds purchased from our downstream correspondent bank relationships (which consist of banks that are considered to be smaller than our bank).
Since early 2001, our liquidity needs have primarily been fulfilled through growth in our core customer deposits. Our goal is to obtain as much of our funding as possible from deposits of these core customers, which as of December 31, 2004, comprised $1,730.7 million, or 95.2%, of total deposits, compared to $1,310.1 mil lion, or 90.7%, of total deposits, at December 31, 2003. These deposits are generated principally through development of long-term relationships with customers and stockholders and our retail network which is mainly through BankDirect.
In addition to deposits from our core customers, we also have access to incremental deposits through brokered retail certificates of deposit, or CDs. As of December 31, 2004, brokered retail CDs comprised $59.2 million, or 3.3%, of total deposits. Our dependence on retail brokered CDs is limited by our internal funding guidelines, which as of December 31, 2004, limited borrowing from these sources to 15% of total deposits.
Additionally, we have borrowing sources available to supplement deposits and meet our funding needs. These borrowing sources include federal funds purchased from our downstream correspondent bank
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relationships (which consist of banks that are smaller than our bank) and from our upstream correspondent bank relationships (which consist of banks that are larger than our bank), securities sold under repurchase agreements, treasury, tax and loan notes, and advances from the Federal Home Loan Bank, or FHLB. As of December 31, 2004, our borrowings consisted of a total of $463.9 million of securities sold under repurchase agreements, $113.5 million of downstream federal funds purchased, $14.3 million from customer repurchase agreements, and $3.3 million of treasury, tax and loan notes. Credit availability from the FHLB is based on our bank’s financial and operating condition and borrowing collateral we hold with the FHLB. At December 31, 2004, none of our borrowings consisted of borrowings from the FHLB. Our unused FHLB borrowing capacity at December 31, 2004 was approximately $245.0 million. As of December 31, 2004, we had unused upstream federal fund lines available from commercial banks of approximately $138.6 million. During the year ended December 31, 2004, our average borrowings from these sources were $612.3 million, or 28.3% of average total fundings, which is well within our internal funding guidelines, which limit our dependence on borrowing sources to 35% of total fundings. The maximum amount of borrowed funds outstanding at any month-end during the year ended December 31, 2004 was $653.2 million, or 28.8% of total fundings.
On November 19, 2002, Texas Capital Bancshares Statutory Trust I issued $10,000,000 of its Floating Rate Capital Securities Cumulative Trust Preferred Securities (the 2002 Trust Preferred) in a private offering. On April 10, 2003, Texas Capital Statutory Trust II issued $10,000,000 of its Floating Rate Capital Securities Cumulative Trust Preferred Securities (the 2003 Trust Preferred) in a private offering. Proceeds of the 2002 Trust Preferred and the 2003 Trust Preferred were invested in a related series of our Floating Rate Junior Subordinated Deferrable Interest Securities (the Subordinated Debentures). After deducting underwriter’s compensation and other expenses of the offerings, the net proceeds were available to us to increase capital and for general corporate purposes, including use in investment and lending activities.
The interest rate on the Subordinated Debentures issued in connection with the 2002 Trust Preferred adjusts every three months and is currently 5.91%. The interest rate on the Subordinated Debentures issued in connection with the 2003 Trust Preferred adjusts every three months and is currently 5.41%. Interest payments on the Subordinated Debentures are deductible for federal income tax purposes. The payment by us of the principal and interest on the Subordinated Debentures is subordinated and junior in light of payment to the prior payment in full of all of our senior indebtedness, whether outstanding at this time or incurred in the future.
The 2002 Trust Preferred and related Subordinated Debentures mature in November 2032 and the 2003 Trust Preferred and related Subordinated Debentures mature in April 2033. The 2002 Trust Preferred, the 2003 Trust Preferred and the related Subordinated Debentures also may be redeemed prior to maturity if certain events occur.
On August 18, 2003, we completed an initial public offering of 3,376,533 shares of our common stock resulting in proceeds of $33.9 million after deducting underwriting fees and expenses, all of which is intended for general corporate and working capital purposes. A portion of the proceeds was also used for the opening of our Houston banking center in September 2003. We may also use a portion of the proceeds for acquisitions or the opening of other select banking locations. However, we have no present intentions or definitive plans relating to any specific acquisitions or openings of any other banking locations.
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The following table presents, as of December 31, 2004, significant fixed and determinable contractual obligations to third parties by payment date. Further discussion of the nature of each obligation is included in the referenced note to the consolidated financial statements.
After One | After Three | |||||||||||||||||||||||
Note | Within One | but Within | but Within | After Five | ||||||||||||||||||||
Reference | Year | Three Years | Five Years | Years | Total | |||||||||||||||||||
(In thousands) | ||||||||||||||||||||||||
Deposits without a stated maturity(a) | 6 | $ | 1,107,018 | $ | — | $ | — | $ | — | $ | 1,107,018 | |||||||||||||
Time deposits(a) | 6 | 516,885 | 70,837 | 95,090 | 57 | 682,869 | ||||||||||||||||||
Federal funds purchased | 7 | 113,478 | — | — | — | 113,478 | ||||||||||||||||||
Securities sold under repurchase agreements(a) | 7 | 377,735 | 86,150 | — | — | 463,885 | ||||||||||||||||||
Customer repurchase agreements(a) | 7 | 14,319 | — | — | — | 14,319 | ||||||||||||||||||
Treasury, tax and loan notes(a) | 7 | 3,309 | — | — | — | 3,309 | ||||||||||||||||||
FHLB borrowings(a) | 7 | — | — | — | — | — | ||||||||||||||||||
Operating lease obligations | 16 | 4,092 | 7,885 | 7,169 | 2,771 | 21,917 | ||||||||||||||||||
Long-term debt(a) | 7,8 | — | — | — | 20,620 | 20,620 | ||||||||||||||||||
Total contractual obligations | $ | 2,136,836 | $ | 164,872 | $ | 102,259 | $ | 23,448 | $ | 2,427,415 | ||||||||||||||
(a) | Excludes interest. |
The contractual amount of our financial instruments with off-balance sheet risk expiring by period at December 31, 2004 is presented below:
After One | ||||||||||||||||||||
but Within | After Three | |||||||||||||||||||
Within One | Three | but Within | After Five | |||||||||||||||||
Year | Years | Five Years | Years | Total | ||||||||||||||||
(In thousands) | ||||||||||||||||||||
Commitments to extend credit | $ | 334,280 | $ | 186,635 | $ | 27,440 | $ | 10,146 | $ | 558,501 | ||||||||||
Standby letters of credit | 28,893 | 4,427 | 229 | — | 33,549 | |||||||||||||||
Total financial instruments with off-balance sheet risk | $ | 363,173 | $ | 191,062 | $ | 27,669 | $ | 10,146 | $ | 592,050 | ||||||||||
Due to the nature of our unfunded loan commitments, including unfunded lines of credit, the amounts presented in the table above do not necessarily represent amounts that we anticipate funding in the periods presented above.
Our equity capital averaged $182.2 million for the year ended December 31, 2004 as compared to $142.4 million in 2003 and $117.1 million in 2002. These increases reflect our retention of net earnings during these periods and the proceeds from the initial public offering of our common stock which was consummated in August 2003. We have not paid any cash dividends on our common stock since we commenced operations and have no plans to do so in the future.
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Our actual and minimum required capital amounts and actual ratios are as follows:
Regulatory Capital Adequacy | |||||||||||||||||||||||||
December 31, 2004 | December 31, 2003 | December 31, 2002 | |||||||||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | ||||||||||||||||||||
(In thousands, except percentage data) | |||||||||||||||||||||||||
Total capital (to risk-weighted assets): | |||||||||||||||||||||||||
Company | |||||||||||||||||||||||||
Actual | $ | 229,658 | 11.67 | % | $ | 204,352 | 13.14 | % | $ | 141,688 | 11.32 | % | |||||||||||||
Minimum required | 157,395 | 8.00 | % | 124,385 | 8.00 | % | 100,160 | 8.00 | % | ||||||||||||||||
Excess above minimum | 72,263 | 3.67 | % | 79,967 | 5.14 | % | 41,528 | 3.32 | % | ||||||||||||||||
Bank | |||||||||||||||||||||||||
Actual | 199,005 | 10.13 | % | $ | 169,466 | 10.91 | % | $ | 128,696 | 10.29 | % | ||||||||||||||
To be well-capitalized | 196,494 | 10.00 | % | 155,297 | 10.00 | % | 125,111 | 10.00 | % | ||||||||||||||||
Minimum required | 157,195 | 8.00 | % | 124,237 | 8.00 | % | 100,089 | 8.00 | % | ||||||||||||||||
Excess above well-capitalized | 2,511 | .13 | % | 14,169 | .91 | % | 3,585 | .29 | % | ||||||||||||||||
Excess above minimum | 41,810 | 2.13 | % | 45,229 | 2.91 | % | 28,607 | 2.29 | % | ||||||||||||||||
Tier 1 capital (to risk-weighted assets): | |||||||||||||||||||||||||
Company | |||||||||||||||||||||||||
Actual | $ | 210,960 | 10.72 | % | $ | 186,625 | 12.00 | % | $ | 127,146 | 10.16 | % | |||||||||||||
Minimum required | 78,697 | 4.00 | % | 62,193 | 4.00 | % | 50,080 | 4.00 | % | ||||||||||||||||
Excess above minimum | 132,263 | 6.72 | % | 124,432 | 8.00 | % | 77,066 | 6.16 | % | ||||||||||||||||
Bank | |||||||||||||||||||||||||
Actual | $ | 180,307 | 9.18 | % | $ | 151,739 | 9.77 | % | $ | 114,154 | 9.12 | % | |||||||||||||
To be well-capitalized | 117,896 | 6.00 | % | 93,178 | 6.00 | % | 75,066 | 6.00 | % | ||||||||||||||||
Minimum required | 78,597 | 4.00 | % | 62,119 | 4.00 | % | 50,044 | 4.00 | % | ||||||||||||||||
Excess above well-capitalized | 62,411 | 3.18 | % | 58,561 | 3.77 | % | 39,088 | 3.12 | % | ||||||||||||||||
Excess above minimum | 101,710 | 5.18 | % | 89,620 | 5.77 | % | 64,110 | 5.12 | % | ||||||||||||||||
Tier 1 capital (to average assets): | |||||||||||||||||||||||||
Company | |||||||||||||||||||||||||
Actual | $ | 210,960 | 8.31 | % | $ | 186,625 | 8.82 | % | $ | 127,146 | 7.66 | % | |||||||||||||
Minimum required | 101,500 | 4.00 | % | 84,681 | 4.00 | % | 66,400 | 4.00 | % | ||||||||||||||||
Excess above minimum | 109,460 | 4.31 | % | 101,944 | 4.82 | % | 60,746 | 3.66 | % | ||||||||||||||||
Bank | |||||||||||||||||||||||||
Actual | $ | 180,307 | 7.11 | % | $ | 151,739 | 7.17 | % | $ | 114,154 | 6.88 | % | |||||||||||||
To be well-capitalized | 126,750 | 5.00 | % | 105,759 | 5.00 | % | 82,949 | 5.00 | % | ||||||||||||||||
Minimum required | 101,400 | 4.00 | % | 84,607 | 4.00 | % | 66,359 | 4.00 | % | ||||||||||||||||
Excess above well-capitalized | 53,557 | 2.11 | % | 45,980 | 2.17 | % | 31,205 | 1.88 | % | ||||||||||||||||
Excess above minimum | 78,907 | 3.11 | % | 67,132 | 3.17 | % | 47,795 | 2.88 | % |
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Critical Accounting Policies
The SEC recently issued guidance for the disclosure of “critical accounting policies.” The SEC defines “critical accounting policies” as those that are most important to the presentation of a company’s financial condition and results, and require management’s most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain.
We follow financial accounting and reporting policies that are in accordance with accounting principles generally accepted in the United States. The more significant of these policies are summarized in Note 1 to the consolidated financial statements. Not all these significant accounting policies require management to make difficult, subjective, or complex judgments. However, the policies noted below could be deemed to meet the SEC’s definition of critical accounting policies.
Management considers the policies related to the allowance for loan losses as the most critical to the financial statement presentation. The total allowance for loan losses includes activity related to allowances calculated in accordance with Statement of Financial Accounting Standards (SFAS) No. 114,Accounting by Creditors for Impairment of a Loan, and SFAS No. 5,Accounting for Contingencies. The allowance for loan losses is established through a provision for loan losses charged to current earnings. The amount maintained in the allowance reflects management’s continuing evaluation of the loan losses inherent in the loan portfolio. The allowance for loan losses is comprised of specific reserves assigned to certain classified loans and general reserves. Factors contributing to the determination of specific reserves include the credit-worthiness of the borrower, and more specifically, changes in the expected future receipt of principal and interest payments and/or in the value of pledged collateral. A reserve is recorded when the carrying amount of the loan exceeds the discounted estimated cash flows using the loan’s initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. For purposes of determining the general reserve, the portfolio is segregated by product types in order to recognize differing risk profiles among categories, and then further segregated by credit grades. See “Summary of Loan Loss Experience” for further discussion of the risk factors considered by management in establishing the allowance for loan losses.
Management considers the policies related to income taxes to be critical to the financial statement presentation. We utilize the liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based upon the difference between the values of the assets and liabilities as reflected in the financial statements and their related tax basis using enacted tax rates in effect for the year in which the differences are expected to be recovered or settled. As changes in tax law or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. A valuation reserve is provided against deferred tax assets unless it is more likely than not that such deferred tax assets will be realized. In 2003, as a result of a reassessment of our ability to generate sufficient earnings to allow the utilization of our deferred tax assets, we believed it was more likely than not that the deferred tax assets will be realized. Accordingly, in compliance with SFAS No. 109, we reversed the valuation allowance and certain related tax reserves during the period.
We have a gross deferred tax asset of $8.8 million at December 31, 2004, which relates primarily to our allowance for loan losses. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized.
At December 31, 2003, we had a gross deferred tax asset of $8.4 million. In 2003, as a result of our reassessment of our ability to generate sufficient earnings to allow the utilization of our deferred tax assets, we believed it was more likely than not that the deferred tax assets would be realized. Accordingly, in compliance with Statement of Financial Accounting Standards No. 109, we reversed the valuation allowance and certain related tax reserves during the year.
New Accounting Standard
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which revises SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” This Statement focuses
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primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement requires an entity to recognize the cost of employee services received in share-based payment transactions and measure the cost on a grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. The provisions of SFAS No. 123 (revised 2004) will be effective for the financial statements issued for periods beginning after June 15, 2005. We anticipate adopting the provisions of this statement July 1, 2005. The methodology has not yet been determined, but we anticipate that the results will not vary materially from the proforma fair value numbers that have been presented in Note 1.
ITEM 7A. | QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK |
Market risk is a broad term for the risk of economic loss due to adverse changes in the fair value of a financial instrument. These changes may be the result of various factors, including interest rates, foreign exchange rates, commodity prices, or equity prices. Additionally, the financial instruments subject to market risk can be classified either as held for trading purposes or held for other than trading.
We are subject to market risk primarily through the effect of changes in interest rates on our portfolio of assets held for purposes other than trading. The effect of other changes, such as foreign exchange rates, commodity prices, and/or equity prices do not pose significant market risk to us.
The responsibility for managing market risk rests with the BSMC, which operates under policy guidelines established by our board of directors. The negative acceptable variation in net interest revenue due to a 200 basis point increase or decrease in interest rates is generally limited by these guidelines to +/-10%. These guidelines also establish maximum levels for short-term borrowings, short-term assets, and public and brokered deposits. They also establish minimum levels for unpledged assets, among other things. Compliance with these guidelines is the ongoing responsibility of the BSMC, with exceptions reported to our board of directors on a quarterly basis.
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Interest Rate Risk Management
The Company’s interest rate sensitivity is illustrated in the following table. The table reflects rate-sensitive positions as of December 31, 2004, and is not necessarily indicative of positions on other dates. The balances of interest rate sensitive assets and liabilities are presented in the periods in which they next reprice to market rates or mature and are aggregated to show the interest rate sensitivity gap. The mismatch between repricings or maturities within a time period is commonly referred to as the “gap” for that period. A positive gap (asset sensitive), where interest rate sensitive assets exceed interest rate sensitive liabilities, generally will result in the net interest margin increasing in a rising rate environment and decreasing in a falling rate environment. A negative gap (liability sensitive) will generally have the opposite results on the net interest margin. To reflect anticipated prepayments, certain asset and liability categories are shown in the table using estimated cash flows rather than contractual cash flows.
Interest Rate Sensitivity Gap Analysis
December 31, 2004
0-3 Mo | 4-12 Mo | 1-3 Yr | 3+ Yr | Total | ||||||||||||||||||
Balance | Balance | Balance | Balance | Balance | ||||||||||||||||||
(In thousands) | ||||||||||||||||||||||
Securities(1) | $ | 40,193 | $ | 120,644 | $ | 240,973 | $ | 402,734 | $ | 804,544 | ||||||||||||
Total Variable Loans | 1,531,133 | 3,960 | 1,222 | — | 1,536,315 | |||||||||||||||||
Total Fixed Loans | 19,636 | 24,683 | 61,190 | 46,090 | 151,599 | |||||||||||||||||
Total Loans(2) | 1,550,769 | 28,643 | 62,412 | 46,090 | 1,687,914 | |||||||||||||||||
Total Interest Sensitive Assets | $ | 1,590,962 | $ | 149,287 | $ | 303,385 | $ | 448,824 | $ | 2,492,458 | ||||||||||||
Liabilities: | ||||||||||||||||||||||
Interest Bearing Customer Deposits | $ | 867,364 | $ | — | $ | — | $ | — | $ | 867,364 | ||||||||||||
CD’s & IRA’s | 190,991 | 115,473 | 69,562 | 89,704 | 465,730 | |||||||||||||||||
Wholesale Deposits | 12,460 | 39,992 | 1,275 | 5,437 | 59,164 | |||||||||||||||||
Total Interest-bearing Deposits | 1,070,815 | 155,465 | 70,837 | 95,141 | 1,392,258 | |||||||||||||||||
Repo, FF, FHLB Borrowings | 328,286 | 180,555 | 86,150 | — | 594,991 | |||||||||||||||||
Trust Preferred | — | — | — | 20,620 | 20,620 | |||||||||||||||||
Total Borrowing | 328,286 | 180,555 | 86,150 | 20,620 | 615,611 | |||||||||||||||||
Total Interest Sensitive Liabilities | $ | 1,399,101 | $ | 336,020 | $ | 156,987 | $ | 115,761 | $ | 2,007,869 | ||||||||||||
GAP | 191,861 | (186,733 | ) | 146,398 | 333,063 | — | ||||||||||||||||
Cumulative GAP | 191,861 | 5,128 | 151,526 | 484,589 | 484,589 | |||||||||||||||||
Demand Deposits | 397,629 | |||||||||||||||||||||
Stockholders’ Equity | 195,275 | |||||||||||||||||||||
Total | $ | 592,904 | ||||||||||||||||||||
(1) | Securities based on fair market value. |
(2) | Loans include loans held for sale and are stated at gross. |
The table above sets forth the balances as of December 31, 2004 for interest bearing assets, interest bearing liabilities, and the total of non-interest bearing deposits and stockholders’ equity. While a gap interest table is useful in analyzing interest rate sensitivity, an interest rate sensitivity simulation provides a better illustration of the sensitivity of earnings to changes in interest rates. Earnings are also affected by the effects of changing interest rates on the value of funding derived from demand deposits and stockholders’ equity. We perform a sensitivity analysis to identify interest rate risk exposure on net interest income. We quantify and
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measure interest rate risk exposure using a model to dynamically simulate the effect of changes in net interest income relative to changes in interest rates and account balances over the next twelve months based on three interest rate scenarios. These are a “most likely” rate scenario and two “shock test” scenarios.
The “most likely” rate scenario is based on the consensus forecast of future interest rates published by independent sources. These forecasts incorporate future spot rates and relevant spreads of instruments that are actively traded in the open market. The Federal Reserve’s Federal Funds target affects short-term borrowing; the prime lending rate and the London Interbank Offering Rate are the basis for most of our variable-rate loan pricing. The 10-year mortgage rate is also monitored because of its effect on prepayment speeds for mortgage-backed securities. These are our primary interest rate exposures. We are currently not using derivatives to manage our interest rate exposure.
The two “shock test” scenarios assume a sustained parallel 200 basis point increase or decrease, respectively, in interest rates. As short-term rates continued to fall since 2001 we could not assume interest rate changes of 200 basis points as the results of the decreasing rates scenario would be negative rates. Therefore, our “shock test” scenarios with respect to decreases in rates now assume a decrease of 100 basis points in the current interest rate environment. We will continue to evaluate these scenarios as interest rates change, until short term rates rise above 3.0%.
Our interest rate risk exposure model incorporates assumptions regarding the level of interest rate or balance changes on indeterminable maturity deposits (demand deposits, interest bearing transaction accounts and savings accounts) for a given level of market rate changes. These assumptions have been developed through a combination of historical analysis and future expected pricing behavior. Changes in prepayment behavior of mortgage-backed securities, residential, and commercial mortgage loans in each rate environment are captured using industry estimates of prepayment speeds for various coupon segments of the portfolio. The impact of planned growth and new business activities is factored into the simulation model. This modeling indicated interest rate sensitivity as follows:
Anticipated Impact Over the Next Twelve Months | ||||||||||||||||
as Compared to Most Likely Scenario | ||||||||||||||||
200 bp Increase | 100 bp Decrease | 200 bp Increase | 100 bp Decrease | |||||||||||||
December 31, 2004 | December 31, 2004 | December 31, 2003 | December 31, 2003 | |||||||||||||
(In thousands) | ||||||||||||||||
Change in net interest income | $ | 8,363 | $ | (3,724 | ) | $ | 9,259 | $ | (5,048 | ) |
The simulations used to manage market risk are based on numerous assumptions regarding the effect of changes in interest rates on the timing and extent of repricing characteristics, future cash flows, and customer behavior. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and management strategies, among other factors.
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ITEM 8. | FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA |
Index to Consolidated Financial Statements
Page | ||||
Reference | ||||
48 | ||||
49 | ||||
50 | ||||
51 | ||||
52 | ||||
53 | ||||
Supplementary Data — Included elsewhere in this Form 10-K |
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
Texas Capital Bancshares, Inc.
We have audited the accompanying consolidated balance sheets of Texas Capital Bancshares, Inc. as of December 31, 2004 and 2003, and the related consolidated statements of operations, changes in stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in all material respects, the financial position of Texas Capital Bancshares, Inc. at December 31, 2004 and 2003, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of Texas Capital Bancshares, Inc.’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 8, 2005, expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Dallas, Texas
March 8, 2005
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Texas Capital Bancshares, Inc.
Consolidated Balance Sheets
December 31 | ||||||||||
2004 | 2003 | |||||||||
(In thousands except share | ||||||||||
data) | ||||||||||
ASSETS | ||||||||||
Cash and due from banks | $ | 78,490 | $ | 69,551 | ||||||
Securities, available-for-sale | 804,544 | 775,338 | ||||||||
Loans held for investment, net | 1,545,880 | 1,212,046 | ||||||||
Loans held for sale | 119,537 | 80,780 | ||||||||
Premises and equipment, net | 4,518 | 4,672 | ||||||||
Accrued interest receivable and other assets | 56,698 | 48,992 | ||||||||
Goodwill, net | 1,496 | 1,496 | ||||||||
Total assets | $ | 2,611,163 | $ | 2,192,875 | ||||||
LIABILITIES AND STOCKHOLDERS’ EQUITY | ||||||||||
Deposits: | ||||||||||
Non-interest bearing | $ | 397,629 | $ | 301,886 | ||||||
Interest bearing | 1,234,283 | 1,094,534 | ||||||||
Interest bearing in foreign branches | 157,975 | 48,610 | ||||||||
1,789,887 | 1,445,030 | |||||||||
Accrued interest payable | 3,511 | 3,468 | ||||||||
Other liabilities | 6,879 | 6,247 | ||||||||
Federal funds purchased | 113,478 | 78,961 | ||||||||
Repurchase agreements | 478,204 | 432,255 | ||||||||
Other borrowings | 3,309 | 34,538 | ||||||||
Long-term debt | 20,620 | 20,620 | ||||||||
Total liabilities | 2,415,888 | 2,021,119 | ||||||||
Stockholders’ equity: | ||||||||||
Common stock, $.01 par value: | ||||||||||
Authorized shares — 100,000,000 Issued shares — 25,461,602 and 24,715,607 at December 31, 2004 and 2003, respectively | 255 | 247 | ||||||||
Series A-1 non-voting common stock, $.01 par value: | ||||||||||
Issued shares — 293,918 at December 31, 2003 | — | 3 | ||||||||
Additional paid-in capital | 172,380 | 167,751 | ||||||||
Retained earnings | 20,047 | 487 | ||||||||
Treasury stock (shares at cost: 84,274 at December 31, 2004 and 2003) | (573 | ) | (573 | ) | ||||||
Deferred compensation | 573 | 573 | ||||||||
Accumulated other comprehensive income | 2,593 | 3,268 | ||||||||
Total stockholders’ equity | 195,275 | 171,756 | ||||||||
Total liabilities and stockholders’ equity | $ | 2,611,163 | $ | 2,192,875 | ||||||
See accompanying notes.
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Texas Capital Bancshares, Inc.
Consolidated Statements of Operations
Year Ended December 31 | |||||||||||||
2004 | 2003 | 2002 | |||||||||||
(In thousands except per share | |||||||||||||
data) | |||||||||||||
Interest income: | |||||||||||||
Interest and fees on loans | $ | 78,600 | $ | 62,451 | $ | 54,387 | |||||||
Securities | 32,200 | 22,853 | 15,484 | ||||||||||
Federal funds sold | 65 | 166 | 243 | ||||||||||
Deposits in other banks | 13 | 14 | 28 | ||||||||||
Total interest income | 110,878 | 85,484 | 70,142 | ||||||||||
Interest expense: | |||||||||||||
Deposits | 23,237 | 20,931 | 21,223 | ||||||||||
Federal funds purchased | 1,791 | 1,550 | 1,540 | ||||||||||
Other borrowings | 10,012 | 8,943 | 5,068 | ||||||||||
Long-term debt | 1,096 | 905 | 65 | ||||||||||
Total interest expense | 36,136 | 32,329 | 27,896 | ||||||||||
Net interest income | 74,742 | 53,155 | 42,246 | ||||||||||
Provision for loan losses | 1,688 | 4,025 | 5,629 | ||||||||||
Net interest income after provision for loan losses | 73,054 | 49,130 | 36,617 | ||||||||||
Non-interest income: | |||||||||||||
Service charges on deposit accounts | 3,370 | 3,446 | 2,772 | ||||||||||
Trust fee income | 1,932 | 1,313 | 987 | ||||||||||
Gains on sale of securities, net | — | 666 | 1,375 | ||||||||||
Cash processing fees | 587 | 973 | 993 | ||||||||||
Bank owned life insurance (BOLI) income | 1,288 | 1,619 | 735 | ||||||||||
Mortgage warehouse fees | 996 | 1,524 | 693 | ||||||||||
Gain on sale of mortgage loans | 3,420 | 120 | — | ||||||||||
Other | 2,039 | 1,231 | 1,070 | ||||||||||
Total non-interest income | 13,632 | 10,892 | 8,625 | ||||||||||
Non-interest expense: | |||||||||||||
Salaries and employee benefits | 34,794 | 23,604 | 16,757 | ||||||||||
Net occupancy expense | 5,695 | 4,987 | 5,001 | ||||||||||
Marketing | 2,609 | 1,432 | 1,666 | ||||||||||
Legal and professional | 3,141 | 2,867 | 3,038 | ||||||||||
Communications and data processing | 3,158 | 3,042 | 2,839 | ||||||||||
Franchise taxes | 246 | 124 | 108 | ||||||||||
Repurchase agreement penalties | — | 6,262 | — | ||||||||||
IPO expenses | — | — | 1,190 | ||||||||||
Other | 7,697 | 6,062 | 4,771 | ||||||||||
Total non-interest expense | 57,340 | 48,380 | 35,370 | ||||||||||
Income before income taxes | 29,346 | 11,642 | 9,872 | ||||||||||
Income tax expense (benefit) | 9,786 | (2,192 | ) | 2,529 | |||||||||
Net income | 19,560 | 13,834 | 7,343 | ||||||||||
Preferred stock dividends | — | (699 | ) | (1,097 | ) | ||||||||
Income available to common stockholders | $ | 19,560 | $ | 13,135 | $ | 6,246 | |||||||
Income per share: | |||||||||||||
Basic | $ | .77 | $ | .62 | $ | .33 | |||||||
Diluted | $ | .75 | $ | .60 | $ | .32 | |||||||
See accompanying notes.
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Texas Capital Bancshares, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
Series A-1 | |||||||||||||||||||||||||||||
Series A Convertible | Non-Voting | ||||||||||||||||||||||||||||
Preferred Stock | Common Stock | Common Stock | Additional | ||||||||||||||||||||||||||
Paid-In | |||||||||||||||||||||||||||||
Shares | Amount | Shares | Amount | Shares | Amount | Capital | |||||||||||||||||||||||
(In thousands except share data) | |||||||||||||||||||||||||||||
Balance at December 31, 2001 | 753,301 | $ | 8 | 18,400,310 | $ | 184 | 741,392 | $ | 7 | $ | 127,378 | ||||||||||||||||||
Comprehensive income: | |||||||||||||||||||||||||||||
Net income | — | — | — | — | — | — | — | ||||||||||||||||||||||
Change in unrealized gain/(loss) on available-for-sale securities, net of taxes of $3,683, net of reclassification amount of $1,375 | — | — | — | — | — | — | — | ||||||||||||||||||||||
Total comprehensive income | |||||||||||||||||||||||||||||
Sale of Series A convertible preferred stock | 303,841 | 3 | — | — | — | — | 5,247 | ||||||||||||||||||||||
Sale of common stock | — | — | 54,626 | 1 | — | 350 | |||||||||||||||||||||||
Preferred dividends payable | — | — | — | — | — | — | (1,097 | ) | |||||||||||||||||||||
Transfers | — | — | 45,876 | — | (45,876 | ) | — | — | |||||||||||||||||||||
Purchase of treasury stock | — | — | — | — | — | — | — | ||||||||||||||||||||||
Sale of treasury stock | — | — | — | — | — | — | 3 | ||||||||||||||||||||||
Balance at December 31, 2002 | 1,057,142 | 11 | 18,500,812 | 185 | 695,516 | 7 | 131,881 | ||||||||||||||||||||||
Comprehensive income: | |||||||||||||||||||||||||||||
Net income | — | — | — | — | — | — | — | ||||||||||||||||||||||
Change in unrealized gain on available-for-sale securities, net of taxes of $1,760, net of reclassification amount of $666 | — | — | — | — | — | — | — | ||||||||||||||||||||||
Total comprehensive income | |||||||||||||||||||||||||||||
Tax benefit related to exercise of stock options | — | — | — | — | — | — | 412 | ||||||||||||||||||||||
Sale of common stock | — | — | 3,698,913 | 37 | — | — | 36,167 | ||||||||||||||||||||||
Conversion of preferred stock | (1,057,142 | ) | (11 | ) | 2,114,284 | 21 | — | — | (10 | ) | |||||||||||||||||||
Preferred dividends | — | — | — | — | — | — | (699 | ) | |||||||||||||||||||||
Transfers | — | — | 401,598 | 4 | (401,598 | ) | (4 | ) | — | ||||||||||||||||||||
Sale of treasury stock | — | — | — | — | — | — | — | ||||||||||||||||||||||
Balance at December 31, 2003 | — | — | 24,715,607 | 247 | 293,918 | 3 | 167,751 | ||||||||||||||||||||||
Comprehensive income: | |||||||||||||||||||||||||||||
Net income | — | — | — | — | — | — | — | ||||||||||||||||||||||
Change in unrealized gain on available-for-sale securities, net of taxes of $363 | — | — | — | — | — | — | — | ||||||||||||||||||||||
Total comprehensive income | |||||||||||||||||||||||||||||
Tax benefit related to exercise of stock options | — | — | — | — | — | — | 1,411 | ||||||||||||||||||||||
Sale of common stock | — | — | 452,077 | 5 | — | — | 3,218 | ||||||||||||||||||||||
Transfers | — | — | 293,918 | 3 | (293,918 | ) | (3 | ) | — | ||||||||||||||||||||
Balance at December 31, 2004 | — | $ | — | 25,461,602 | $ | 255 | — | $ | — | $ | 172,380 | ||||||||||||||||||
[Additional columns below]
[Continued from above table, first column(s) repeated]
Retained | Accumulated | ||||||||||||||||||||||||
Earnings/ | Treasury Stock | Other | |||||||||||||||||||||||
(Accumulated | Deferred | Comprehensive | |||||||||||||||||||||||
Deficit) | Shares | Amount | Compensation | Income | Total | ||||||||||||||||||||
(In thousands except share data) | |||||||||||||||||||||||||
Balance at December 31, 2001 | $ | (20,690 | ) | (87,516 | ) | $ | (594 | ) | $ | 573 | $ | (507 | ) | $ | 106,359 | ||||||||||
Comprehensive income: | |||||||||||||||||||||||||
Net income | 7,343 | — | — | — | — | 7,343 | |||||||||||||||||||
Change in unrealized gain/(loss) on available-for-sale securities, net of taxes of $3,683, net of reclassification amount of $1,375 | — | — | — | — | 6,841 | 6,841 | |||||||||||||||||||
Total comprehensive income | 14,184 | ||||||||||||||||||||||||
Sale of Series A convertible preferred stock | — | — | — | — | — | 5,250 | |||||||||||||||||||
Sale of common stock | 351 | ||||||||||||||||||||||||
Preferred dividends payable | — | — | — | — | — | (1,097 | ) | ||||||||||||||||||
Transfers | — | — | — | — | — | — | |||||||||||||||||||
Purchase of treasury stock | — | (14,144 | ) | (103 | ) | — | — | (103 | ) | ||||||||||||||||
Sale of treasury stock | — | 4,414 | 29 | — | — | 32 | |||||||||||||||||||
Balance at December 31, 2002 | (13,347 | ) | (97,246 | ) | (668 | ) | 573 | 6,334 | 124,976 | ||||||||||||||||
Comprehensive income: | |||||||||||||||||||||||||
Net income | 13,834 | — | — | — | — | 13,834 | |||||||||||||||||||
Change in unrealized gain on available-for-sale securities, net of taxes of $1,760, net of reclassification amount of $666 | — | — | — | — | (3,066 | ) | (3,066 | ) | |||||||||||||||||
Total comprehensive income | 10,768 | ||||||||||||||||||||||||
Tax benefit related to exercise of stock options | — | — | — | — | — | 412 | |||||||||||||||||||
Sale of common stock | — | — | — | — | 36,204 | ||||||||||||||||||||
Conversion of preferred stock | — | — | — | — | — | — | |||||||||||||||||||
Preferred dividends | — | — | — | — | — | (699 | ) | ||||||||||||||||||
Transfers | — | — | — | — | — | — | |||||||||||||||||||
Sale of treasury stock | — | 12,972 | 95 | — | — | 95 | |||||||||||||||||||
Balance at December 31, 2003 | 487 | (84,274 | ) | (573 | ) | 573 | 3,268 | 171,756 | |||||||||||||||||
Comprehensive income: | |||||||||||||||||||||||||
Net income | 19,560 | — | — | — | — | 19,560 | |||||||||||||||||||
Change in unrealized gain on available-for-sale securities, net of taxes of $363 | — | — | — | — | (675 | ) | (675 | ) | |||||||||||||||||
Total comprehensive income | 18,885 | ||||||||||||||||||||||||
Tax benefit related to exercise of stock options | — | — | — | — | — | 1,411 | |||||||||||||||||||
Sale of common stock | — | — | — | — | — | 3,223 | |||||||||||||||||||
Transfers | — | — | — | — | — | — | |||||||||||||||||||
Balance at December 31, 2004 | $ | 20,047 | (84,274 | ) | $ | (573 | ) | $ | 573 | $ | 2,593 | $ | 195,275 | ||||||||||||
See accompanying notes.
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Texas Capital Bancshares, Inc.
Consolidated Statements of Cash Flows
Year Ended December 31 | |||||||||||||||
2004 | 2003 | 2002 | |||||||||||||
(In thousands) | |||||||||||||||
Operating activities | |||||||||||||||
Net income | $ | 19,560 | $ | 13,834 | $ | 7,343 | |||||||||
Adjustments to reconcile net income to net cash provided by (used in) operating activities: | |||||||||||||||
Provision for loan losses | 1,688 | 4,025 | 5,629 | ||||||||||||
Deferred tax expense | (300 | ) | (7,726 | ) | — | ||||||||||
Depreciation and amortization | 1,555 | 1,420 | 1,721 | ||||||||||||
Amortization and accretion on securities | 4,393 | 9,510 | 2,696 | ||||||||||||
Bank owned life insurance (BOLI) income | (1,251 | ) | (1,619 | ) | (660 | ) | |||||||||
Gain on sale of securities, net | — | (666 | ) | (1,375 | ) | ||||||||||
Gain on sale of mortgage loans | (3,420 | ) | (120 | ) | — | ||||||||||
Originations of loans held for sale | (1,618,401 | ) | (2,295,268 | ) | (1,192,981 | ) | |||||||||
Proceeds from sales of loans held for sale | 1,583,284 | 2,328,464 | 1,120,639 | ||||||||||||
Tax benefit from stock option exercises | 1,411 | 412 | — | ||||||||||||
Impact of reversing tax valuation allowance | — | (5,929 | ) | — | |||||||||||
Changes in operating assets and liabilities: | |||||||||||||||
Accrued interest receivable and other assets | (5,737 | ) | 9,051 | (6,067 | ) | ||||||||||
Accrued interest payable and other liabilities | 1,039 | (211 | ) | (371 | ) | ||||||||||
Net cash provided by (used in) operating activities | (16,179 | ) | 55,177 | (63,426 | ) | ||||||||||
Investing activities | |||||||||||||||
Purchases of available-for-sale securities | (239,067 | ) | (652,578 | ) | (485,930 | ) | |||||||||
Proceeds from sales of available-for-sale securities | — | 62,895 | 41,471 | ||||||||||||
Maturities and calls of available-for-sale securities | 14,002 | 15,218 | 6,500 | ||||||||||||
Principal payments received on securities | 190,427 | 338,463 | 100,357 | ||||||||||||
Net increase in loans | (336,462 | ) | (226,207 | ) | (152,613 | ) | |||||||||
Purchase of premises and equipment, net | (1,099 | ) | (2,088 | ) | (242 | ) | |||||||||
Purchase of BOLI | — | — | (25,000 | ) | |||||||||||
Net cash used in investing activities | (372,199 | ) | (464,297 | ) | (515,457 | ) | |||||||||
Financing activities | |||||||||||||||
Net increase in checking, money market and savings accounts | 269,325 | 161,287 | 128,609 | ||||||||||||
Net increase in certificates of deposit | 75,532 | 87,208 | 181,849 | ||||||||||||
Sale of common stock | 3,223 | 36,117 | 351 | ||||||||||||
Issuance of long-term debt | — | 10,000 | 10,000 | ||||||||||||
Net other borrowings | 14,720 | 100,962 | 278,932 | ||||||||||||
Net federal funds purchased | 34,517 | (4,668 | ) | 6,930 | |||||||||||
Sale of preferred stock | — | — | 5,250 | ||||||||||||
Purchase of treasury stock, net | — | — | (71 | ) | |||||||||||
Dividends paid | — | (979 | ) | (843 | ) | ||||||||||
Net cash provided by financing activities | 397,317 | 389,927 | 611,007 | ||||||||||||
Net increase (decrease) in cash and cash equivalents | 8,939 | (19,193 | ) | 32,124 | |||||||||||
Cash and cash equivalents, beginning of year | 69,551 | 88,744 | 56,620 | ||||||||||||
Cash and cash equivalents, end of year | $ | 78,490 | $ | 69,551 | $ | 88,744 | |||||||||
Supplemental disclosures of cash flow information: | |||||||||||||||
Cash paid during the year for interest | $ | 36,093 | $ | 32,687 | $ | 26,918 | |||||||||
Cash paid during the year for income taxes | 10,250 | 5,720 | 1,450 | ||||||||||||
Non-cash transactions: | |||||||||||||||
Transfers from loans/leases to other repossessed assets | 418 | 230 | 515 | ||||||||||||
Transfers from loans/leases to premises and equipment | 302 | 175 | 358 |
See accompanying notes.
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1. | Operations and Summary of Significant Accounting Policies |
Organization and Nature of Business
Texas Capital Bancshares, Inc. (Texas Capital Bancshares or the Company), a Delaware bank holding company, was incorporated in November 1996 and commenced operations in March 1998. The consolidated financial statements of the Company include the accounts of Texas Capital Bancshares, Inc. and its wholly owned subsidiary, Texas Capital Bank, National Association (the Bank). The Bank was formed on December 18, 1998 through the acquisition of Resource Bank, National Association (Resource Bank). All significant intercompany accounts and transactions have been eliminated upon consolidation.
In prior periods, the consolidated financial statements of the Company included Texas Capital Bancshares Statutory Trust I, a Connecticut business trust, and Texas Capital Statutory Trust II, a Delaware statutory trust. As of December 31, 2003, we adopted Revised FIN 46 and have deconsolidated both trusts. The deconsolidation did not have a material effect on our consolidated balance sheet or our consolidated statement of operations.
All business is conducted through the Bank. BankDirect, a division of the Bank, provides online banking services through the Internet. The Bank currently provides commercial banking services to its customers in Texas. The Bank concentrates on middle market commercial and high net worth customers, while BankDirect provides basic consumer banking services to Internet users.
Amounts and disclosures have been adjusted to reflect a one-for-one stock dividend, accounted for as a stock split, which was declared on July 30, 2002, and which was paid by September 16, 2002, pursuant to which each stockholder received one additional share of common stock for each share of common stock owned as of July 30, 2002.
Use of Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates.
Cash and Cash Equivalents
Cash equivalents include amounts due from banks and federal funds sold.
Securities
Securities are classified as trading, available-for-sale or held-to-maturity. Management classifies securities at the time of purchase and re-assesses such designation at each balance sheet date; however, transfers between categories from this re-assessment are rare.
Trading Account |
Securities acquired for resale in anticipation of short-term market movements are classified as trading, with realized and unrealized gains and losses recognized in income. To date, the Company has not had any activity in its trading account.
Held-to-Maturity and Available-for-Sale |
Debt securities are classified as held-to-maturity when the Company has the positive intent and ability to hold the securities to maturity. Held-to-maturity securities are stated at amortized cost. Debt securities not classified as held-to-maturity or trading and marketable equity securities not classified as trading are classified as available-for-sale.
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Available-for-sale securities are stated at fair value, with the unrealized gains and losses reported in a separate component of accumulated other comprehensive income, net of tax. The amortized cost of debt securities is adjusted for amortization of premiums and accretion of discounts to maturity, or in the case of mortgage-backed securities, over the estimated life of the security. Such amortization and accretion is included in interest income from securities. Realized gains and losses and declines in value judged to be other-than-temporary are included in gain (loss) on sale of securities. The cost of securities sold is based on the specific identification method.
Loans
Loans (which include financing leases) are either secured or unsecured based on the type of loan and the financial condition of the borrower. Repayment is generally expected from cash flows of borrowers. The Company is exposed to risk of loss on loans which may arise from any number of factors including problems within the respective industry of the borrower or from local economic conditions. Access to collateral, in the event of borrower default, is reasonably assured through adherence to applicable lending laws and through sound lending standards and credit review procedures.
Loans are stated at the amount of unpaid principal reduced by deferred income (net of costs) and an allowance for loan losses. Interest on loans is recognized using the simple-interest method on the daily balances of the principal amounts outstanding. Loan origination fees, net of direct loan origination costs, and commitment fees, are deferred and amortized as an adjustment to yield over the life of the loan, or over the commitment period, as applicable.
A loan is considered impaired when, based on current information and events, it is probable that the Bank will be unable to collect all amounts due (both principal and interest) according to the terms of the loan agreement. Reserves on impaired loans are measured based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the fair value of the underlying collateral.
The accrual of interest on loans is discontinued when it is considered impaired and/or there is a clear indication that the borrower’s cash flow may not be sufficient to meet payments as they become due, which is generally when a loan is 90 days past due. When a loan is placed on non-accrual status, all previously accrued and unpaid interest is reversed. Interest income is subsequently recognized on a cash basis as long as the remaining book balance of the asset is deemed to be collectible. If collectibility is questionable, then cash payments are applied to principal. A loan is placed back on accrual status when both principal and interest are current and it is probable that the Bank will be able to collect all amounts due (both principal and interest) according to the terms of the loan agreement.
The Company originates mortgage loans primarily for sale in the secondary market. Accordingly, these loans are classified as held for sale and are carried at the lower of cost or fair value, determined on an aggregate basis.
Allowance for Loan Losses
The allowance for loan losses is established through a provision for loan losses charged against income. The allowance for loan losses includes specific reserves for impaired loans and an estimate of losses inherent in the loan portfolio at the balance sheet date, but not yet identified with specific loans. Loans deemed to be uncollectible are charged against the allowance when management believes that the collectibility of the principal is unlikely and subsequent recoveries, if any, are credited to the allowance. Management’s periodic evaluation of the adequacy of the allowance is based on an assessment of the current loan portfolio, including known inherent risks, adverse situations that may affect the borrowers’ ability to repay, the estimated value of any underlying collateral and current economic conditions.
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Repossessed Assets
Repossessed assets consist of collateral that has been repossessed. Collateral that has been repossessed is recorded at the lower of fair value less selling costs or the book value of the loan or lease prior to repossession. Writedowns are provided for subsequent declines in value and are recorded in other non-interest expense.
Premises and Equipment
Premises and equipment are stated at cost less accumulated depreciation. Depreciation is computed using the straight-line method over the estimated useful lives of the assets, which range from three to ten years. Gains or losses on disposals of premises and equipment are included in results of operations.
Marketing, Website Development Costs, and Software
Marketing costs are expensed as incurred. Costs incurred in connection with the initial website development are capitalized and amortized over a period not to exceed three years. Ongoing maintenance and enhancements of websites are expensed as incurred. Costs incurred in connection with development or purchase of internal use software are capitalized and amortized over a period not to exceed five years. Both website development and internal use software costs are included in other assets in the consolidated financial statements.
Intangible Assets
As of January 1, 2002, the Company ceased amortizing goodwill in connection with the adoption of Statements of Financial Accounting Standards No. 141,Business Combinations(Statement 141), and No. 142,Goodwill and Other Intangible Assets(Statement 142). Statement 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. Statement 142 requires that these assets be reviewed for impairment at least annually. Intangible assets with finite lives will continue to be amortized over their estimated useful lives. Additionally, Statement 142 requires that goodwill included in the carrying value of equity method investments no longer be amortized. The Company has tested goodwill for impairment using the two-step process prescribed in Statement 142. The first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. The Company performed the first of the required impairment tests of goodwill and indefinite lived intangible assets as of January 1, 2002 in the first quarter of 2002 and annual assessments as of October 2002, 2003 and 2004, and, in each case, no impairment was indicated.
Stock-based Compensation
At December 31, 2004, the Company had a stock-based employee compensation plan, which is described more fully in Note 11. The Company accounts for this plan under the recognition and measurement principles of APB Opinion No. 25,Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost is reflected in net income, as all options granted under this plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if the Company had applied the fair value
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recognition provisions of FASB Statement No. 123,Accounting for Stock-Based Compensation, to stock-based employee compensation.
Year Ended December 31 | |||||||||||||
2004 | 2003 | 2002 | |||||||||||
(In thousands except per share | |||||||||||||
data) | |||||||||||||
Net income as reported | $ | 19,560 | $ | 13,834 | $ | 7,343 | |||||||
Add: Total stock based employee compensation recorded, net of related tax effect | 510 | 404 | 111 | ||||||||||
Deduct: Total stock based employee compensation expense determined under fair value based method for all awards, net of related tax effect | (1,274 | ) | (952 | ) | (802 | ) | |||||||
Pro forma net income | $ | 18,796 | $ | 13,286 | $ | 6,652 | |||||||
Basic income per share: | |||||||||||||
As reported | $ | .77 | $ | .62 | $ | .33 | |||||||
Pro forma | .74 | .59 | .29 | ||||||||||
Diluted income per share: | |||||||||||||
As reported | $ | .75 | $ | .60 | $ | .32 | |||||||
Pro forma | .71 | .57 | .29 |
The fair value of these options was estimated at the date of grant using a Black-Scholes value option pricing model with the following weighted average assumptions used for 2004, 2003 and 2002, respectively: a risk free interest rate of 3.64% 3.12% and 4.46%, a dividend yield of 0%, a volatility factor of .288, .145 and .001, and an estimated life of five years.
The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.
�� See New Accounting Standard and Note 11 for additional disclosures regarding stock-based compensation.
Accumulated Other Comprehensive Income
Unrealized gains or losses on the Company’s available-for-sale securities are included in accumulated other comprehensive income.
Income Taxes
The Company and its subsidiary file a consolidated federal income tax return. The Company utilizes the liability method in accounting for income taxes. Under this method, deferred tax assets and liabilities are determined based upon the difference between the values of the assets and liabilities as reflected in the financial statements and their related tax basis using enacted tax rates in effect for the year in which the differences are expected to be recovered or settled. As changes in tax law or rates are enacted, deferred tax assets and liabilities are adjusted through the provision for income taxes. A valuation reserve is provided against deferred tax assets unless it is more likely than not that such deferred tax assets will be realized.
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New Accounting Standard
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which revises SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement requires an entity to recognize the cost of employee services received in share-based payment transactions and measure the cost on a grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. The provisions of SFAS No. 123 (revised 2004) will be effective for the Company’s financial statements issued for periods beginning after June 15, 2005. We anticipate adopting the provisions of this statement in the third quarter of 2005. The methodology has not yet been determined, but we anticipate that the results will not vary materially from the proforma fair value numbers that have been presented in the stock-based compensation section above.
Reclassification
Certain reclassifications have been made to the 2003 and 2002 consolidated financial statements to conform to the 2004 presentation.
2. | Securities |
The following is a summary of securities:
December 31, 2004 | |||||||||||||||||
Gross | Gross | ||||||||||||||||
Amortized | Unrealized | Unrealized | Estimated | ||||||||||||||
Cost | Gains | Losses | Fair Value | ||||||||||||||
(In thousands) | |||||||||||||||||
Available-for-Sale Securities: | |||||||||||||||||
U.S. Treasuries | $ | 1,896 | $ | — | $ | (1 | ) | $ | 1,895 | ||||||||
Mortgage-backed securities | 690,775 | 6,251 | (2,483 | ) | 694,543 | ||||||||||||
Corporate securities | 46,272 | 427 | (69 | ) | 46,630 | ||||||||||||
Municipals | 48,721 | 195 | (272 | ) | 48,644 | ||||||||||||
Equity securities | 12,891 | 1 | (60 | ) | 12,832 | ||||||||||||
$ | 800,555 | $ | 6,874 | $ | (2,885 | ) | $ | 804,544 | |||||||||
December 31, 2003 | |||||||||||||||||
Gross | Gross | ||||||||||||||||
Amortized | Unrealized | Unrealized | Estimated | ||||||||||||||
Cost | Gains | Losses | Fair Value | ||||||||||||||
(In thousands) | |||||||||||||||||
Available-for-Sale Securities: | |||||||||||||||||
U.S. Treasuries | $ | 1,798 | $ | — | $ | — | $ | 1,798 | |||||||||
Mortgage-backed securities | 698,093 | 6,794 | (2,355 | ) | 702,532 | ||||||||||||
Corporate securities | 46,635 | 726 | (9 | ) | 47,352 | ||||||||||||
Municipals | 11,449 | 26 | (103 | ) | 11,372 | ||||||||||||
Equity securities | 12,336 | — | (52 | ) | 12,284 | ||||||||||||
$ | 770,311 | $ | 7,546 | $ | (2,519 | ) | $ | 775,338 | |||||||||
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The amortized cost and estimated fair value of securities are presented below by contractual maturity:
At December 31, 2004 | ||||||||||||||||||||||
After One | After Five | |||||||||||||||||||||
Less than | Through | Through | After Ten | |||||||||||||||||||
One Year | Five Years | Ten Years | Years | Total | ||||||||||||||||||
(In thousands, except percentage data) | ||||||||||||||||||||||
Available-for-sale: | ||||||||||||||||||||||
U.S. Treasuries: | ||||||||||||||||||||||
Amortized cost | $ | 1,896 | $ | — | $ | — | $ | — | $ | 1,896 | ||||||||||||
Estimated fair value | $ | 1,895 | $ | — | $ | — | $ | — | $ | 1,895 | ||||||||||||
Weighted average yield | 2.070 | % | — | — | — | 2.070 | % | |||||||||||||||
Mortgage-backed securities:(1) | ||||||||||||||||||||||
Amortized cost | — | 3,264 | 220,940 | 466,571 | 690,775 | |||||||||||||||||
Estimated fair value | — | 3,336 | 221,470 | 469,737 | 694,543 | |||||||||||||||||
Weighted average yield | — | 6.000 | % | 4.148 | % | 4.630 | % | 4.482 | % | |||||||||||||
Corporate securities: | ||||||||||||||||||||||
Amortized cost | — | 41,274 | 4,998 | — | 46,272 | |||||||||||||||||
Estimated fair value | — | 41,403 | 5,227 | — | 46,630 | |||||||||||||||||
Weighted average yield | — | 3.667 | % | 7.380 | % | — | 4.076 | % | ||||||||||||||
Municipals:(2) | ||||||||||||||||||||||
Amortized cost | — | 4,145 | 22,919 | 21,657 | 48,721 | |||||||||||||||||
Estimated fair value | — | 4,134 | 23,008 | 21,502 | 48,644 | |||||||||||||||||
Weighted average yield | — | 4.174 | % | 5.414 | % | 5.845 | % | 5.500 | % | |||||||||||||
Equity securities: | ||||||||||||||||||||||
Amortized cost | 12,891 | — | — | — | 12,891 | |||||||||||||||||
Estimated fair value | 12,832 | — | — | — | 12,832 | |||||||||||||||||
Total available-for-sale securities: | ||||||||||||||||||||||
Amortized cost | $ | 800,555 | ||||||||||||||||||||
Estimated fair value | $ | 804,544 | ||||||||||||||||||||
(1) | Actual maturities may differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without prepayment penalties. |
(2) | Yields have been adjusted to a tax equivalent basis assuming a 35% federal tax rate. |
Securities with carrying values of approximately $659,256,000 and $628,069,000 were pledged to secure certain borrowings and deposits at December 31, 2004 and 2003, respectively. See Note 7 for discussion of securities securing borrowings. Of the pledged securities at December 31, 2004 and 2003, approximately $134,998,000 and $133,759,000, respectively, were pledged for certain deposits.
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The following table discloses, as of December 31, 2004, the Company’s investment securities that have been in a continuous unrealized loss position for less than 12 months and those that have been in a continuous unrealized loss position for 12 or more months (in thousands):
Less than 12 Months | 12 Months or Longer | Total | ||||||||||||||||||||||
Unrealized | Fair | Unrealized | Unrealized | |||||||||||||||||||||
Fair Value | Loss | Value | Loss | Fair Value | Loss | |||||||||||||||||||
U.S. Treasuries | $ | 1,895 | $ | (1 | ) | $ | — | $ | — | $ | 1,895 | $ | (1 | ) | ||||||||||
Mortgage-backed securities | 191,433 | (1,174 | ) | 66,114 | (1,309 | ) | 257,547 | (2,483 | ) | |||||||||||||||
Corporate securities | 10,400 | (69 | ) | — | — | 10,400 | (69 | ) | ||||||||||||||||
Municipals | 27,521 | (272 | ) | — | — | 27,521 | (272 | ) | ||||||||||||||||
Equity securities | — | — | 1,440 | �� | (60 | ) | 1,440 | (60 | ) | |||||||||||||||
$ | 231,249 | $ | (1,516 | ) | $ | 67,554 | $ | (1,369 | ) | $ | 298,803 | $ | (2,885 | ) | ||||||||||
The Company believes the investment securities in the table above are within ranges customary for the banking industry. The number of investment positions in this unrealized loss position totals 30. The Company does not believe these unrealized losses are “other than temporary” as (1) the Company has the ability and intent to hold the investments to maturity, or a period of time sufficient to allow for a recovery in market value; (2) it is not probable that the Company will be unable to collect the amounts contractually due; and (3) no decision to dispose of the investments were made prior to the balance sheet date. The unrealized losses noted are interest rate related due to rising rates at December 31, 2004 in relation to previous rates in mid-2003. The Company has not identified any issues related to the ultimate repayment of principal as a result of credit concerns on these securities.
3. | Loans and Allowance for Loan Losses |
Loans are summarized by category as follows (in thousands):
December 31 | ||||||||
2004 | 2003 | |||||||
Commercial | $ | 818,156 | $ | 608,542 | ||||
Construction | 328,074 | 256,134 | ||||||
Real estate | 397,029 | 339,069 | ||||||
Consumer | 15,562 | 16,564 | ||||||
Leases | 9,556 | 13,152 | ||||||
Loans held for sale | 119,537 | 80,780 | ||||||
1,687,914 | 1,314,241 | |||||||
Deferred income (net of direct origination costs) | (3,799 | ) | (3,688 | ) | ||||
Allowance for loan losses | (18,698 | ) | (17,727 | ) | ||||
Loans, net | $ | 1,665,417 | $ | 1,292,826 | ||||
The majority of the loan portfolio is comprised of loans to businesses and individuals in Texas. This geographic concentration subjects the loan portfolio to the general economic conditions within this area. Within the loan portfolio, loans to the services industry were $605.4 million or 35.9% of total loans at December 31, 2004. Other notable segments include personal/household (which includes loans to certain high net worth individuals for commercial purposes and mortgage loans held for sale, in addition to consumer loans) of $223.1 million, contracting industry loans of $244.7 million and petrochemical and mining of $189.7 million at December 31, 2004. The risks created by these concentrations have been considered by management in the determination of the adequacy of the allowance for loan losses. Management believes the allowance for loan losses is adequate to cover estimated losses on loans at each balance sheet date.
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The changes in the allowance for loan losses are summarized as follows (in thousands):
Year Ended December 31 | ||||||||||||
2004 | 2003 | 2002 | ||||||||||
Balance, beginning of year | $ | 17,727 | $ | 14,538 | $ | 12,598 | ||||||
Provision for loan losses | 1,688 | 4,025 | 5,629 | |||||||||
Loans charged off | (1,354 | ) | (1,075 | ) | (3,847 | ) | ||||||
Recoveries | 637 | 239 | 158 | |||||||||
Balance, end of year | $ | 18,698 | $ | 17,727 | $ | 14,538 | ||||||
The Bank had impaired loans and leases in the amount of $5,850,000, $10,217,000 and $2,776,000 with reserves of $1,278,000, $2,252,000, and $832,000 as of December 31, 2004, 2003 and 2002, respectively. Interest income recorded on impaired loans during 2004 was approximately $232,000, $131,000 for 2003 and $64,000 for 2002. Additional interest income that would have been recorded if the loans had been current during the years ended December 31, 2004, 2003 and 2002 totaled $168,000, $154,000 and $771,000, respectively. Average impaired loans outstanding during the years ended December 31, 2004, 2003 and 2002 totaled $7,252,000, $7,899,000 and $5,563,000, respectively.
During the normal course of business, the Company and subsidiary may enter into transactions with related parties, including their officers, employees, directors, significant stockholders and their related affiliates. It is the Company’s policy that all such transactions are on substantially the same terms as those prevailing at the time for comparable transactions with third parties. Loans to related parties, including officers and directors, were approximately $5,325,000 and $14,788,000 at December 31, 2004 and 2003, respectively. During the years ended December 31, 2004 and 2003, total advances were approximately $13,766,000 and $20,560,000 and total paydowns were $23,229,000 and $21,735,000, respectively.
4. | Goodwill |
Prior to the adoption of FAS 142, goodwill acquired in the acquisition of Resource Bank in December 1998 was being amortized over 15 years. Accumulated amortization related to goodwill totaled approximately $374,000 at December 31, 2004 and 2003.
5. | Premises and Equipment |
Premises and equipment at December 31, 2004 and 2003 are summarized as follows:
December 31 | ||||||||
2004 | 2003 | |||||||
(In thousands) | ||||||||
Premises | $ | 4,210 | $ | 3,949 | ||||
Furniture and equipment | 8,941 | 7,801 | ||||||
13,151 | 11,750 | |||||||
Accumulated depreciation | (8,633 | ) | (7,078 | ) | ||||
$ | 4,518 | $ | 4,672 | |||||
Depreciation expense was approximately $1,555,000, $1,420,000 and $1,721,000 in 2004, 2003 and 2002, respectively.
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6. | Deposits |
The scheduled maturities of interest bearing time deposits are as follows at December 31, 2004 (in thousands):
2005 | $ | 516,885 | ||
2006 | 50,741 | |||
2007 | 20,096 | |||
2008 | 16,763 | |||
2009 and after | 78,384 | |||
$ | 682,869 | |||
At December 31, 2004 and 2003, the Bank had approximately $45,000,000 and $26,000,000, respectively, in deposits from related parties, including directors, stockholders, and their related affiliates.
At December 31, 2004 and 2003, interest bearing time deposits of $100,000 or more were approximately $559,863,000 and $459,697,000, respectively.
7. | Borrowing Arrangements |
Borrowings at December 31, 2004 consist of $463.9 million of securities sold under repurchase agreements with a weighted average rate of 2.33%, $14.3 million of customer repurchase agreements, and $3.3 million of treasury, tax and loan notes. Securities sold under repurchase are with two significant counterparties which are Salomon Smith Barney at $435.4 million and Credit Suisse First Boston at $28.5 million. The weighted average maturities of the Salomon and Suisse repurchase agreements are seven months and eight months, respectively. At December 31, 2004, none of our borrowings consisted of borrowings from the FHLB. Our unused FHLB borrowing capacity at December 31, 2004 was approximately $245.0 million. There were $524.3 million of securities pledged for customer repurchase agreements and securities sold under repurchase agreements and $3.4 million pledged for treasury, tax and loan notes. During the year ended December 31, 2004, our average borrowings from these sources were $612.3 million, or 28.3% of average total fundings. The maximum amount of borrowed funds outstanding at any month-end during the year ended December 31, 2004 was $653.2 million or 28.8% of total fundings.
The Bank had $113.5 million of downstream federal funds purchased outstanding with a rate of 2.325% at December 31, 2004. The Bank had unused upstream federal fund lines available from commercial banks at December 31, 2004 of approximately $138.6 million. Generally, these federal fund borrowings are overnight, but not to exceed seven days.
As of December 31, 2004, our borrowings were as follows (in thousands)
After One | After Three | |||||||||||||||||||
Within | but Within | but Within | After Five | |||||||||||||||||
One Year | Three Years | Five Years | Years | Total | ||||||||||||||||
Federal funds purchased | $ | 113,478 | $ | — | $ | — | $ | — | $ | 113,478 | ||||||||||
Securities sold under repurchase agreements | 377,735 | 86,150 | — | — | 463,885 | |||||||||||||||
Customer repurchase agreements | 14,319 | — | — | — | 14,319 | |||||||||||||||
Treasury, tax and loan notes | 3,309 | — | — | — | 3,309 | |||||||||||||||
Long-term debt | — | — | — | 20,620 | 20,620 | |||||||||||||||
Total borrowings | $ | 508,841 | $ | 86,150 | $ | — | $ | 20,620 | $ | 615,611 | ||||||||||
Borrowings at December 31, 2003 consist of $422.3 million of securities sold under repurchase agreements with a weighted average rate of 1.94%, $10.0 million of customer repurchase agreements, and $4.5 million of treasury, tax and loan notes. Securities sold under repurchase are with four significant counterparties which are Salomon Smith Barney at $350.1 million, Morgan Stanley Dean Witter at
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$3.7 million, Bank of America at $40.0 million and Credit Suisse First Boston at $28.5 million. The weighted average maturities of the Salomon, Morgan, Bank of America and Suisse repurchase agreements are 14 months, 5 months, 1 month and 20 months, respectively. Other borrowings also include $30.0 million of FHLB overnight advances bearing interest of 1.05%. Based on the loans that could be pledged and securities that were not already pledged for other purposes, the Bank had an additional $270.0 million of FHLB borrowings available at December 31, 2003. There were $482.9 million of securities pledged for customer repurchase agreements and securities sold under repurchase agreements and $5.5 million pledged for treasury, tax and loan notes. During the year ended December 31, 2003, our average borrowings from these sources were 25.8% of average assets. The maximum amount of borrowed funds outstanding at any month-end during the year ended December 31, 2003 was $546.3 million or 26.8% of total assets.
The Bank had $79.0 million of downstream federal funds purchased outstanding with a rate of 1.075% at December 31, 2003. The Bank had unused upstream federal fund lines available from commercial banks at December 31, 2003 of approximately $72.6 million. Generally, these federal fund borrowings are overnight, but not to exceed seven days.
Borrowings at December 31, 2002 consist of $292.0 million of securities sold under repurchase agreements with a weighted average rate of 2.95%, $10.1 million of customer repurchase agreements, and $14.2 million of treasury, tax and loan notes. Securities sold under repurchase are with three significant counterparties which are Salomon Smith Barney at $240.7 million, Morgan Stanley Dean Witter at $24.9 million and Bank of America at $26.4 million. The weighted average maturities of the Salomon, Morgan and Bank of America repurchase agreements are 25 months, 20 months and 1 month, respectively. Other borrowings also include $49.5 million of FHLB overnight advances bearing interest of 1.4%. Based on the loans that could be pledged and securities that were not already pledged for other purposes, the Bank had an additional $245.0 million of FHLB borrowings available at December 31, 2002. There were $336.4 million of securities pledged for customer repurchase agreements and securities sold under repurchase agreements and $14.5 million pledged for treasury, tax and loan notes. During the year, our average borrowings from these sources were 18.3% of average assets. The maximum amount of borrowed funds outstanding at any month-end during the year ended December 31, 2002 was $449.5 million or 25.1% of total assets.
The Bank had $83.6 million of downstream federal funds purchased outstanding with a rate of 1.39% at December 31, 2002. The Bank had unused upstream federal fund lines available from commercial banks at December 31, 2002 of approximately $37.5 million. Generally, these federal fund borrowings are overnight, but not to exceed seven days.
8. | Long-term Debt |
On April 10, 2003, Texas Capital Statutory Trust II issued $10,000,000 of its Floating Rate Capital Securities Cumulative Trust Preferred Securities (the 2003 Trust Preferred) in a private offering. Proceeds of the 2003 Trust Preferred were invested in the Floating Rate Junior Subordinated Deferrable Interest Securities (the Subordinated Debentures) of the Company. Interest rate on the Trust Preferred Subordinated Debentures is three month LIBOR plus 3.25%. After deducting underwriter’s compensation and other expenses of the offering, the net proceeds were available to the Company to increase capital and for general corporate purposes, including use in investment and lending activities. Interest payments on the Subordinated Debentures are deductible for federal income tax purposes.
The 2003 Trust Preferred and the Subordinated Debentures each mature in April 2033. If certain conditions are met, the maturity dates of the 2003 Trust Preferred and the Subordinated Debentures may be shortened to a date not earlier than April 10, 2008. The 2003 Trust Preferred and the Subordinated Debentures also may be redeemed prior to maturity if certain events occur. The 2003 Trust Preferred is subject to mandatory redemption, in whole or in part, upon repayment of the Subordinated Debentures at maturity or their earlier redemption. The Company also has the right, if certain conditions are met, to defer payment of interest on the Subordinated Debentures, which would result in a deferral of dividend payments on the 2003 Trust Preferred, at any time or from time to time for a period not to exceed 20 consecutive quarters in a deferral period. The payment by the Company of the principal and interest on the Subordinated
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Debentures is subordinated and junior in right of payment to the prior payment in full of all senior indebtedness of the Company, whether outstanding at this time or incurred in the future.
The Company and Texas Capital Statutory Trust II believe that, taken together, the obligations of the Company under the Trust Preferred Guarantee Agreement, the Amended and Restated Trust Agreement, the Subordinated Debentures, the Indenture and the Agreement as to Expenses and Liabilities, entered into in connection with the offering of the 2003 Trust Preferred and the Subordinated Debentures, in the aggregate constitute a full and unconditional guarantee by the Company of the obligations of Texas Capital Statutory Trust II under the 2003 Trust Preferred.
Texas Capital Statutory Trust II is a Connecticut business trust created for the purpose of issuing the 2003 Trust Preferred and purchasing the Subordinated Debentures, which are its sole assets. The Company owns all of the outstanding common securities, liquidation value $1,000 per share of Texas Capital Statutory Trust II.
The 2003 Trust Preferred currently meets the regulatory criteria for Tier I capital, subject to Federal Reserve guidelines that limit the amount of the 2003 Trust Preferred and cumulative perpetual preferred stock to an aggregate of 25% of Tier I capital. At December 31, 2004, all of the 2003 Trust Preferred was included in Tier I capital.
On November 19, 2002, Texas Capital Bancshares Statutory Trust I issued $10,000,000 of its Floating Rate Capital Securities Cumulative Trust Preferred Securities (the 2002 Trust Preferred) in a private offering. Proceeds of the 2002 Trust Preferred were invested in the Floating Rate Junior Subordinated Deferrable Interest Securities (the Subordinated Debentures) of the Company. Interest rate on the 2002 Trust Preferred Subordinated Debentures is three month LIBOR plus 3.35%. After deducting underwriter’s compensation and other expenses of the offering, the net proceeds were available to the Company to increase capital and for general corporate purposes, including use in investment and lending activities. Interest payments on the Subordinated Debentures are deductible for federal income tax purposes.
The 2002 Trust Preferred and the Subordinated Debentures each mature in November 2032. If certain conditions are met, the maturity dates of the 2002 Trust Preferred and the Subordinated Debentures may be shortened to a date not earlier than November 19, 2007. The 2002 Trust Preferred and the Subordinated Debentures also may be redeemed prior to maturity if certain events occur. The 2002 Trust Preferred is subject to mandatory redemption, in whole or in part, upon repayment of the Subordinated Debentures at maturity or their earlier redemption. The Company also has the right, if certain conditions are met, to defer payment of interest on the Subordinated Debentures, which would result in a deferral of dividend payments on the 2002 Trust Preferred, at any time or from time to time for a period not to exceed 20 consecutive quarters in a deferral period. The payment by the Company of the principal and interest on the Subordinated Debentures is subordinated and junior in right of payment to the prior payment in full of all senior indebtedness of the Company, whether outstanding at this time or incurred in the future.
The Company and Texas Capital Bancshares Statutory Trust I believe that, taken together, the obligations of the Company under the Trust Preferred Guarantee Agreement, the Amended and Restated Trust Agreement, the Subordinated Debentures, the Indenture and the Agreement as to Expenses and Liabilities, entered into in connection with the offering of the 2002 Trust Preferred and the Subordinated Debentures, in the aggregate constitute a full and unconditional guarantee by the Company of the obligations of Texas Capital Bancshares Statutory Trust I under the 2002 Trust Preferred.
Texas Capital Bancshares Statutory Trust I is a Connecticut business trust created for the purpose of issuing the 2002 Trust Preferred and purchasing the Subordinated Debentures, which are its sole assets. The Company owns all of the outstanding common securities, liquidation value $1,000 per share of Texas Capital Bancshares Statutory Trust I.
The 2002 Trust Preferred currently meets the regulatory criteria for Tier I capital, subject to Federal Reserve guidelines that limit the amount of the Trust Preferred and cumulative perpetual preferred stock to an aggregate of 25% of Tier I capital. At December 31, 2004, all of the 2002 Trust Preferred was included in Tier I capital.
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As of December 31, 2004, assuming we were not allowed to include the $20 million in trust preferred securities issued by Texas Capital Bancshares Statutory Trust I and Texas Capital Statutory Trust II in Tier 1 capital, the Company would still exceed the regulatory required minimums for capital adequacy purposes.
9. | Income Taxes |
The Company has a gross deferred tax asset of $8.8 million at December 31, 2004, which relates primarily to our allowance for loan losses. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized.
At December 31, 2003, the Company had a gross deferred tax asset of $8.4 million. In 2003, as a result of our reassessment of our ability to generate sufficient earnings to allow the utilization of our deferred tax assets, the Company believed it was more likely than not that the deferred tax assets would be realized.
Accordingly, in compliance with Statement of Financial Accounting Standards No. 109, the Company reversed the valuation allowance and certain related tax reserves during the year.
The provision for income taxes consists of the following for years ended:
Year Ended December 31 | |||||||||||||
2004 | 2003 | 2002 | |||||||||||
(In thousands) | |||||||||||||
Current: | |||||||||||||
Federal | $ | 10,086 | $ | 5,534 | $ | 2,529 | |||||||
State | — | — | — | ||||||||||
Total | $ | 10,086 | $ | 5,534 | $ | 2,529 | |||||||
Deferred: | |||||||||||||
Federal | $ | (300 | ) | $ | (7,726 | ) | $ | — | |||||
State | — | — | — | ||||||||||
Total | $ | (300 | ) | $ | (7,726 | ) | $ | — | |||||
Total expense (benefit): | |||||||||||||
Federal | $ | 9,786 | $ | (2,192 | ) | $ | 2,529 | ||||||
State | — | — | — | ||||||||||
Total | $ | 9,786 | $ | (2,192 | ) | $ | 2,529 | ||||||
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Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes. Significant components of deferred tax assets and liabilities are as follows:
December 31 | |||||||||
2004 | 2003 | ||||||||
(In thousands) | |||||||||
Deferred tax assets: | |||||||||
Allowance for loan losses | $ | 6,544 | $ | 6,205 | |||||
Organizational costs/software | 108 | 12 | |||||||
Depreciation | 404 | 462 | |||||||
Loan origination fees | 1,551 | 1,309 | |||||||
Non-accrual interest | 116 | 150 | |||||||
Other | 58 | 217 | |||||||
8,781 | 8,355 | ||||||||
Deferred tax liabilities: | |||||||||
Loan origination costs | (579 | ) | (501 | ) | |||||
FHLB stock dividends | (175 | ) | (127 | ) | |||||
Unrealized gain on securities | (1,396 | ) | (1,760 | ) | |||||
(2,150 | ) | (2,388 | ) | ||||||
Net deferred tax asset | $ | 6,631 | $ | 5,967 | |||||
The reconciliation of income attributable to continuing operations computed at the U.S. federal statutory tax rates to income tax expense is as follows:
Year Ended December 31 | ||||||||||||
2004 | 2003 | 2002 | ||||||||||
Tax at U.S. statutory rate | 35 | % | 35 | % | 34 | % | ||||||
Non-deductible expenses | 1 | % | 1 | % | 1 | % | ||||||
Non-taxable income | (3 | )% | (5 | )% | (2 | )% | ||||||
Changes in valuation allowance | — | (47 | )% | (9 | )% | |||||||
Other and tax related reserves | — | (3 | )% | 2 | % | |||||||
Total | 33 | % | (19 | )% | 26 | % | ||||||
10. | Series A Convertible Preferred Stock |
In December 2001 and January 2002, the Company issued 753,301 and 303,841 shares, respectively, of Series A Convertible Preferred Stock at $17.50 per share. Dividends were at an annual rate of 6.0% and were payable quarterly. Each share was convertible into two shares of common stock.
In connection with the Company’s IPO in August 2003, all preferred shares were converted to common shares.
Additional paid-in capital at December 31, 2003 is net of $1,822,000 of dividends paid.
11. | Employee Benefits |
The Company has a qualified retirement plan, with a salary deferral feature designed to qualify under Section 401 of the Internal Revenue Code (the 401(k) Plan). The 401(k) Plan permits the employees of the Company to defer a portion of their compensation. Matching contributions may be made in amounts and at times determined by the Company. The Company made no such contributions for the years ended December 31, 2004 and 2003. Amounts contributed by the Company for a participant will vest over six years
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and will be held in trust until distributed pursuant to the terms of the 401(k) Plan. Employees of the Company are eligible to participate in the 401(k) Plan when they meet certain requirements concerning minimum age and period of credited service. All contributions to the 401(k) Plan are invested in accordance with participant elections among certain investment options.
During 2000, the Company implemented an Employee Stock Purchase Plan (ESPP). Employees are eligible for the plan when they have met certain requirements concerning period of credited service and minimum hours worked. Eligible employees may contribute a minimum of 1% to a maximum of 10% of eligible compensation up to the Section 423 of the Internal Revenue Code limit of $25,000. The Company has allocated 160,000 shares to the plan. As of December 31, 2004 and 2003, 159,478 and 124,250 shares, respectively, had been purchased on behalf of the employees.
The Company has a stock option plan. The number of options awarded and the employees to receive the options are determined by the Board of Directors, or its designated committee. Options awarded under this plan are subject to vesting requirements. Generally, one fifth of the options awarded vest annually and expire 10 years after date of grant. Total options available under the plan at December 31, 2004 and 2003, were 3,047,700 and 2,851,120, respectively. During 2004 and 2003, 309,500 and 1,007,955 options were awarded at average exercise prices of $16.38 and $9.68, respectively.
The Company follows SFAS No. 123,Accounting for Stock Based Compensation. The statement allows the continued use of Accounting Principles Board Opinion No. 25,Accounting for Stock Issued to Employees(APB 25), and related interpretations. Under APB 25, no compensation expense is recognized at the date of grant for the options where the exercise price of the stock options equals the market price of the underlying stock on the date of grant. The Company’s election to continue the use of APB 25 requires pro forma disclosures of net income as if the fair value based method of accounting had been applied. See Note 1 for those disclosures.
A summary of the Company’s stock option activity and related information for 2004, 2003 and 2002 is as follows:
December 31, 2004 | December 31, 2003 | December 31, 2002 | ||||||||||||||||||||||
Weighted | Weighted | Weighted | ||||||||||||||||||||||
Average | Average | Average | ||||||||||||||||||||||
Exercise | Exercise | Exercise | ||||||||||||||||||||||
Options | Price | Options | Price | Options | Price | |||||||||||||||||||
Options outstanding at beginning of year | 2,686,193 | $ | 7.85 | 1,959,828 | $ | 6.61 | 1,502,648 | $ | 6.44 | |||||||||||||||
Options granted | 309,500 | 16.38 | 1,007,955 | 9.68 | 553,500 | 7.25 | ||||||||||||||||||
Options exercised | (318,413 | ) | 6.52 | (261,550 | ) | 6.07 | (17,800 | ) | 6.96 | |||||||||||||||
Options forfeited | (22,800 | ) | 7.25 | (20,040 | ) | 6.99 | (78,520 | ) | 6.66 | |||||||||||||||
Options outstanding at year-end | 2,654,480 | $ | 9.01 | 2,686,193 | $ | 7.85 | 1,959,828 | $ | 6.61 | |||||||||||||||
Options vested at year-end | 1,256,812 | $ | 7.23 | 1,097,516 | $ | 6.58 | 851,615 | $ | 6.30 | |||||||||||||||
Weighted average fair value of options granted during 2004, 2003 and 2002 | $ | 5.28 | $ | 2.87 | $ | 1.42 | ||||||||||||||||||
Weighted average remaining contractual life of options currently outstanding in years: | 7.11 | 7.59 | 7.19 |
The range of grant prices for all stock options was between $14.45 and $21.84 at December 31, 2004, $6.25 and $13.95 at December 31, 2003 and $5.55 and $7.25 at December 31, 2002.
In September 2002, the Company granted restricted stock awards to three of its executive officers totaling 220,000 shares and in October 2003 granted 53,750 shares to a fourth executive. The shares vest as certain stock price targets are met. If the targets are not met, the shares will cliff vest at the end of six years. Vestings occurred in 2003 and 2004 totaling 49,500 and 98,250 shares. In connection with these vestings, a total of
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25,326 and 98,436 shares were issued in 2003 and 2004, respectively. The Company expensed approximately $765,000, $430,000 and $91,000 during 2004, 2003 and 2002, respectively, related to these stock awards.
In 1999, the Company entered into a deferred compensation agreement with one of its executive officers. The agreement allows the employee to elect to defer up to 100% of his compensation on an annual basis. All deferred compensation is invested in the Company’s common stock held in a rabbi trust. The stock is held in the name of the trustee, and the principal and earnings of the trust are held separate and apart from other funds of the Company, and are used exclusively for the uses and purposes of the deferred compensation agreement. The accounts of the trust have been consolidated with the accounts of the Company.
12. | Financial Instruments with Off-Balance Sheet Risk |
The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit which involve varying degrees of credit risk in excess of the amount recognized in the consolidated balance sheets. The Bank’s exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. The Bank uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the borrower.
Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s credit-worthiness on a case-by-case basis.
Standby letters of credit are conditional commitments issued by the Bank to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.
December 31 | |||||||||
2004 | 2003 | ||||||||
(In thousands) | |||||||||
Financial instruments whose contract amounts represent credit risk: | |||||||||
Commitments to extend credit | $ | 558,501 | $ | 420,639 | |||||
Standby letters of credit | 33,549 | 18,801 |
13. | Regulatory Restrictions |
The Company and the Bank are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory (and possibly additional discretionary) actions by regulators that, if undertaken, could have a direct material effect on the Company’s and the Bank’s financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of the Company’s and the Bank’s assets, liabilities, and certain off-balance sheet items as calculated under regulatory accounting practices. The Company’s and the Bank’s capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.
Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total and Tier I capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier I capital (as defined) to average
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assets (as defined). Management believes, as of December 31, 2004, that the Company and the Bank meet all capital adequacy requirements to which they are subject.
Financial institutions are categorized as well capitalized or adequately capitalized, based on minimum total risk-based, Tier I risk-based, and Tier I leverage ratios as set forth in the tables below. As shown below, the Bank’s capital ratios exceed the regulatory definition of well capitalized as of December 31, 2004 and 2003. As of June 30, 2004, the most recent notification from the OCC categorized the Bank as well capitalized under the regulatory framework for prompt corrective action. There have been no conditions or events since the notification that management believes have changed the Bank’s category. Based upon the information in its most recently filed call report, the Bank continues to meet the capital ratios necessary to be well capitalized under the regulatory framework for prompt corrective action.
To be Well | ||||||||||||||||||||||||
Capitalized Under | ||||||||||||||||||||||||
For Capital | Prompt Corrective | |||||||||||||||||||||||
Actual | Adequacy Purposes | Action Provisions | ||||||||||||||||||||||
Amount | Ratio | Amount | Ratio | Amount | Ratio | |||||||||||||||||||
(In thousands except percentage data) | ||||||||||||||||||||||||
As of December 31, 2004: | ||||||||||||||||||||||||
Total capital (to risk-weighted assets): | ||||||||||||||||||||||||
Company | $ | 229,658 | 11.67% | $ | 157,395 | 8.00% | N/A | N/A | ||||||||||||||||
Bank | 199,005 | 10.13% | 157,195 | 8.00% | $ | 196,494 | 10.00 | % | ||||||||||||||||
Tier 1 capital (to risk-weighted assets): | ||||||||||||||||||||||||
Company | $ | 210,960 | 10.72% | $ | 78,697 | 4.00% | N/A | N/A | ||||||||||||||||
Bank | 180,307 | 9.18% | 78,597 | 4.00% | $ | 117,896 | 6.00 | % | ||||||||||||||||
Tier 1 capital (to average assets): | ||||||||||||||||||||||||
Company | $ | 210,960 | 8.31% | $ | 101,500 | 4.00% | N/A | N/A | ||||||||||||||||
Bank | 180,307 | 7.11% | 101,400 | 4.00% | $ | 126,750 | 5.00 | % | ||||||||||||||||
As of December 31, 2003: | ||||||||||||||||||||||||
Total capital (to risk-weighted assets): | ||||||||||||||||||||||||
Company | $ | 204,352 | 13.14% | $ | 124,385 | 8.00% | N/A | N/A | ||||||||||||||||
Bank | 169,466 | 10.91% | 124,237 | 8.00% | $ | 155,297 | 10.00 | % | ||||||||||||||||
Tier 1 capital (to risk-weighted assets): | ||||||||||||||||||||||||
Company | $ | 186,625 | 12.00% | $ | 62,193 | 4.00% | N/A | N/A | ||||||||||||||||
Bank | 151,739 | 9.77% | 62,119 | 4.00% | $ | 93,178 | 6.00 | % | ||||||||||||||||
Tier 1 capital (to average assets): | ||||||||||||||||||||||||
Company | $ | 186,625 | 8.82% | $ | 84,681 | 4.00% | N/A | N/A | ||||||||||||||||
Bank | 151,739 | 7.17% | 84,607 | 4.00% | $ | 105,759 | 5.00 | % |
Dividends that may be paid by subsidiary banks are routinely restricted by various regulatory authorities. The amount that can be paid in any calendar year without prior approval of the Bank’s regulatory agencies cannot exceed the lesser of net profits (as defined) for that year plus the net profits for the preceding two calendar years, or retained earnings. No dividends were declared or paid during 2004, 2003 or 2002.
The required balance at the Federal Reserve at December 31, 2004 and 2003 was approximately $35,590,000 and $34,699,000, respectively.
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14. | Earnings Per Share |
The following table presents the computation of basic and diluted earnings per share (in thousands except share data):
Year Ended December 31 | ||||||||||||||
2004 | 2003 | 2002 | ||||||||||||
Numerator: | ||||||||||||||
Net income | $ | 19,560 | $ | 13,834 | $ | 7,343 | ||||||||
Preferred stock dividends | — | (699 | ) | (1,097 | ) | |||||||||
Numerator for basic earnings per share-income available to common stockholders | 19,560 | 13,135 | 6,246 | |||||||||||
Effect of dilutive securities: | ||||||||||||||
Preferred stock dividends(2) | — | 699 | — | |||||||||||
Numerator for dilutive earnings per share-income available to common stockholders after assumed conversion | $ | 19,560 | $ | 13,834 | $ | 6,246 | ||||||||
Denominator: | ||||||||||||||
Denominator for basic earnings per share-weighted average shares | 25,260,526 | 21,332,746 | 19,145,255 | |||||||||||
Effect of dilutive securities: | ||||||||||||||
Employee stock options(1) | 974,111 | 459,562 | 199,619 | |||||||||||
Series A convertible preferred stock(2) | — | 1,326,496 | — | |||||||||||
Dilutive potential common shares | 974,111 | 1,786,058 | 199,619 | |||||||||||
Denominator for dilutive earnings per share-adjusted weighted average shares and assumed conversions | 26,234,637 | 23,118,804 | 19,344,874 | |||||||||||
Basic earning per share | $ | .77 | $ | .62 | $ | .33 | ||||||||
Diluted earnings per share | $ | .75 | $ | .60 | $ | .32 | ||||||||
(1) | Stock options outstanding of 30,000 in 2004 and 330,956 in 2003 have not been included in diluted earnings per share because to do so would have been antidilutive for the periods presented. Stock options are antidilutive when the exercise price is higher than the current market price of the Company’s common stock. |
(2) | Effects of Series A convertible preferred stock are anti-dilutive in 2002 and are not included. |
15. | Fair Values of Financial Instruments |
Generally accepted accounting principles require disclosure of fair value information about financial instruments, whether or not recognized on the balance sheet, for which it is practical to estimate that value. In cases where quoted market prices are not available, fair values are based on estimates using present value or other valuation techniques. Those techniques are significantly affected by the assumptions used, including the discount rate and estimates of future cash flows. This disclosure does not and is not intended to represent the fair value of the Company.
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A summary of the carrying amounts and estimated fair values of financial instruments is as follows (in thousands):
December 31, 2004 | December 31, 2003 | |||||||||||||||
Carrying | Estimated | Carrying | Estimated | |||||||||||||
Amount | Fair Value | Amount | Fair Value | |||||||||||||
Cash and cash equivalents | $ | 78,490 | $ | 78,490 | $ | 69,551 | $ | 69,551 | ||||||||
Securities, available-for-sale | 804,544 | 804,544 | 775,338 | 775,338 | ||||||||||||
Loans, net | 1,665,417 | 1,666,997 | 1,292,826 | 1,297,756 | ||||||||||||
Deposits | 1,789,887 | 1,793,239 | 1,445,030 | 1,447,003 | ||||||||||||
Federal funds purchased | 113,478 | 113,478 | 78,961 | 78,961 | ||||||||||||
Borrowings | 481,513 | 480,913 | 466,793 | 467,917 | ||||||||||||
Long-term debt | 20,620 | 20,620 | 20,620 | 20,620 |
The following methods and assumptions were used by the Company in estimating its fair value disclosures for financial instruments:
Cash and cash equivalents
The carrying amounts reported in the consolidated balance sheet for cash and cash equivalents approximate their fair value.
Securities
The fair value of investment securities is based on prices obtained from independent pricing services which are based on quoted market prices for the same or similar securities.
Loans
For variable-rate loans that reprice frequently with no significant change in credit risk, fair values are generally based on carrying values. The fair value for other loans is estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality. The carrying amount of accrued interest approximates its fair value. The carrying amount of loans held for sale approximates fair value.
Deposits
The carrying amounts for variable-rate money market accounts approximate their fair value. Fixed-term certificates of deposit fair values are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities.
Federal funds purchased, other borrowings and long-term debt
The carrying value reported in the consolidated balance sheet for federal funds purchased and short-term borrowings approximates their fair value. The fair value of term borrowings and long-term debt is estimated using a discounted cash flow calculation that applies interest rates currently being offered on similar borrowings.
Off-balance sheet instruments
Fair values for the Company’s off-balance sheet instruments which consist of lending commitments and standby letters of credit are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties’ credit standing. Management believes that the fair value of these off-balance sheet instruments is not significant.
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16. | Commitments and Contingencies |
The Company leases various premises under operating leases with various expiration dates. Rent expense incurred under operating leases amounted to approximately $3,068,000, $2,796,000 and $2,654,000 for the years ended December 31, 2004, 2003 and 2002, respectively.
Minimum future lease payments under operating leases are as follows:
Minimum | ||||
Year Ending December 31, | Payments | |||
(In thousands) | ||||
2005 | $ | 4,092 | ||
2006 | 3,986 | |||
2007 | 3,899 | |||
2008 | 3,864 | |||
2009 and thereafter | 6,076 | |||
$ | 21,917 | |||
17. | Parent Company Only |
Summarized financial information for Texas Capital Bancshares, Inc. — Parent Company Only follows:
Balance Sheets
December 31 | ||||||||
2004 | 2003 | |||||||
(In thousands) | ||||||||
Assets | ||||||||
Cash and cash equivalents | $ | 27,372 | $ | 34,037 | ||||
Investment in subsidiaries | 185,242 | 157,490 | ||||||
Other assets | 3,715 | 1,232 | ||||||
Total assets | $ | 216,329 | $ | 192,759 | ||||
Liabilities and Stockholders’ Equity | ||||||||
Other liabilities | $ | 434 | $ | 383 | ||||
Long-term debt | 20,620 | 20,620 | ||||||
Total liabilities | 21,054 | 21,003 | ||||||
Common stock | 255 | 250 | ||||||
Additional paid-in capital | 172,380 | 167,751 | ||||||
Retained earnings | 20,047 | 487 | ||||||
Accumulated other comprehensive income | 2,593 | 3,268 | ||||||
Total stockholders’ equity | 195,275 | 171,756 | ||||||
Total liabilities and stockholders’ equity | $ | 216,329 | $ | 192,759 | ||||
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Statements of Earnings
Year Ended December 31 | ||||||||||||
2004 | 2003 | 2002 | ||||||||||
(In thousands) | ||||||||||||
Dividend income | $ | 30 | $ | 25 | $ | 2 | ||||||
Total income | 30 | 25 | 2 | |||||||||
Interest expense | 1,097 | 905 | 67 | |||||||||
Salaries and employee benefits | 463 | 474 | 440 | |||||||||
Legal and professional | 883 | 774 | 614 | |||||||||
IPO expense | — | — | 1,190 | |||||||||
Other non-interest expense | 375 | 184 | 145 | |||||||||
Total expense | 2,818 | 2,337 | 2,456 | |||||||||
Loss before income taxes and equity in undistributed income of subsidiary | (2,788 | ) | (2,312 | ) | (2,454 | ) | ||||||
Income tax benefit | (921 | ) | (748 | ) | (644 | ) | ||||||
Loss before equity in undistributed income of subsidiary | (1,867 | ) | (1,564 | ) | (1,810 | ) | ||||||
Equity in undistributed income of subsidiary | 21,427 | 15,398 | 9,153 | |||||||||
Net income | $ | 19,560 | $ | 13,834 | $ | 7,343 | ||||||
Statements of Cash Flows
Year Ended December 31 | |||||||||||||
2004 | 2003 | 2002 | |||||||||||
(In thousands) | |||||||||||||
Operating Activities | |||||||||||||
Net income | $ | 19,560 | $ | 13,834 | $ | 7,343 | |||||||
Adjustments to reconcile net income to net cash used in operating activities: | |||||||||||||
Equity in undistributed income of subsidiary | (21,427 | ) | (15,398 | ) | (9,153 | ) | |||||||
(Increase) decrease in other assets | (1,072 | ) | 441 | (745 | ) | ||||||||
Increase in other liabilities | 51 | 30 | 135 | ||||||||||
Net cash used in operating activities | (2,888 | ) | (1,093 | ) | (2,420 | ) | |||||||
Investing Activities | |||||||||||||
Investment in subsidiaries | (7,000 | ) | (22,864 | ) | (3,310 | ) | |||||||
Investment in non-marketable equity securities | — | — | (500 | ) | |||||||||
Net cash used in investing activities | (7,000 | ) | (22,864 | ) | (3,810 | ) | |||||||
Financing Activities | |||||||||||||
Subordinated debentures | — | 10,310 | 10,310 | ||||||||||
Sale of preferred stock | — | — | 5,250 | ||||||||||
Preferred stock dividends | — | (979 | ) | (843 | ) | ||||||||
Sale of common stock | 3,223 | 36,204 | 351 | ||||||||||
(Purchase) sale of treasury stock, net | — | 95 | (71 | ) | |||||||||
Net cash provided by financing activities | 3,223 | 45,630 | 14,997 | ||||||||||
Net (decrease) increase in cash and cash equivalents | (6,665 | ) | 21,673 | 8,767 | |||||||||
Cash and cash equivalents at beginning of year | 34,037 | 12,364 | 3,597 | ||||||||||
Cash and cash equivalents at end of year | $ | 27,372 | $ | 34,037 | $ | 12,364 | |||||||
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18. | Related Party Transactions |
Certain members of our board of directors provide legal and consulting services to the Company.
See Notes 3 and 6 for a description of loans and deposits with related parties.
ITEM 9. | CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE |
None.
ITEM 9A. | CONTROLS AND PROCEDURES |
We have established and maintain disclosure controls and other procedures that are designed to ensure that material information relating to us and our subsidiaries required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 is recorded, processed, summarized, and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure. For the period covered in this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation of these disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures were effective as of December 31, 2004.
The Chief Executive Officer and Chief Financial Officer have also concluded that there were no changes in our internal control over financial reporting identified in connection with the evaluation described in the preceding paragraph that occurred during the fiscal quarter ended December 31, 2004, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
Management’s Report on Internal Control Over Financial Reporting
The management of the Company is responsible for establishing and maintaining adequate internal control over financial reporting. Our internal control over financial reporting is a process designed under the supervision of our Chief Executive Officer and Chief Financial Officer to provide reasonable assurance regarding the reliability of financial reporting and the preparation of our financial statements for external purposes in accordance with generally accepted accounting principles.
As of December 31, 2004, management assessed the effectiveness of the Company’s internal control over financial reporting based on the criteria for effective internal control over financial reporting established in “Internal Control — Integrated Framework,” issued by the Committee of Sponsoring Organizations (COSO) of the Treadway Commission. Based on the assessment, management determined that the Company maintained effective internal control over financial reporting as of December 31, 2004, based on those criteria.
Ernst & Young LLP, the independent registered public accounting firm that audited the consolidated financial statements of the Company included in this Annual Report on Form 10-K, has issued an attestation report on management’s assessment of the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004. The report, which expresses unqualified opinions on management’s assessment and on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2004, is included in this Item under the heading “Report of Independent Registered Public Accounting Firm.”
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Report of Independent Registered Public Accounting Firm
The Board of Directors and Shareholders of
Texas Capital Bancshares, Inc.
We have audited management’s assessment, included in the accompanying Management’s Report on Internal Control Over Financial Reporting, that Texas Capital Bancshares, Inc. maintained effective internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control — Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Texas Capital Bancshares, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our responsibility is to express an opinion on management’s assessment and an opinion on the effectiveness of the company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, management’s assessment that Texas Capital Bancshares, Inc. maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, Texas Capital Bancshares, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the 2004 financial statements of Texas Capital Bancshares, Inc. and our report dated March 8, 2005 expressed an unqualified opinion thereon.
/s/ ERNST & YOUNG LLP
Dallas, Texas
March 8, 2005
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ITEM 9B. | OTHER INFORMATION |
None.
ITEM 10. | DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT |
Information required by this item is set forth in our definitive proxy materials regarding our annual meeting of stockholders to be held May 17, 2005, which proxy materials will be filed with the SEC no later than April 28, 2005.
ITEM 11. | EXECUTIVE COMPENSATION |
Information required by this item is set forth in our definitive proxy materials regarding our annual meeting of stockholders to be held May 17, 2005, which proxy materials will be filed with the SEC no later than April 28, 2005.
ITEM 12. | SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT |
Information required by this item is set forth in our definitive proxy materials regarding our annual meeting of stockholders to be held May 17, 2005, which proxy materials will be filed with the SEC no later than April 28, 2005.
ITEM 13. | CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS |
Information required by this item is set forth in our definitive proxy materials regarding our annual meeting of stockholders to be held May 17, 2005, which proxy materials will be filed with the SEC no later than April 28, 2005.
ITEM 14. | PRINCIPAL ACCOUNTANT FEES AND SERVICES |
Information required by this item is set forth in our definitive proxy materials regarding our annual meeting of stockholders to be held May 17, 2005, which proxy materials will be filed with the SEC no later than April 28, 2005.
ITEM 15. | EXHIBITS |
(a) Documents filed as part of this report
(1) All financial statements
Independent Registered Public Accounting Firms’ Report of Ernst & Young LLP |
(2) All financial statements required by Item 8
Independent Registered Public Accounting Firms’ Report of Ernst & Young LLP |
(3) Exhibits
2 | .1 | Agreement and Plan to Consolidate Texas Capital Bank with and into Resource Bank, National Association and under the Title of “Texas Capital Bank, National Association,” which is incorporated by reference to Exhibit 2.1 to our registration statement on Form 10 dated August 24, 2001 | ||
2 | .2 | Amendment to Agreement and Plan to Consolidate, which is incorporated by reference to Exhibit 2.2 to our registration statement on Form 10 dated August 24, 2001 | ||
3 | .1 | Certificate of Incorporation, which is incorporated by reference to Exhibit 3.1 to our registration statement on Form 10 dated August 24, 2001 | ||
3 | .2 | Certificate of Amendment of Certificate of Incorporation, which is incorporated by reference to Exhibit 3.2 to our registration statement on Form 10 dated August 24, 2001 | ||
3 | .3 | Certificate of Amendment of Certificate of Incorporation, which is incorporated by reference to Exhibit 3.3 to our registration statement on Form 10 dated August 24, 2001 |
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3 | .4 | Certificate of Amendment of Certificate of Incorporation, which is incorporated by reference to Exhibit 3.4 to our registration statement on Form 10 dated August 24, 2001 | ||
3 | .5 | Amended and Restated Bylaws of Texas Capital Bancshares, Inc. which is incorporated by reference to Exhibit 3.5 to our registration statement on Form 10 dated August 24, 2001 | ||
4 | .1 | Texas Capital Bancshares, Inc. 1999 Omnibus Stock Plan, which is incorporated by reference to Exhibit 4.1 to our registration statement on Form 10 dated August 24, 2001 | ||
4 | .2 | Texas Capital Bancshares, Inc. 2001 Employee Stock Purchase Plan, which is incorporated by reference to Exhibit 4.2 to our registration statement on Form 10 date August 24, 2001 | ||
4 | .3 | Placement Agreement by and among by and among Texas Capital Bancshares Statutory Trust I and SunTrust Capital Markets, Inc., which is incorporated by reference to our Current Report on Form 8-K dated December 4, 2002 | ||
4 | .4 | Certificate of Trust of Texas Capital Bancshares Statutory Trust I, dated November 12, 2002 which is incorporated by reference to our Current Report on Form 8-K dated December 4, 2002 | ||
4 | .5 | Amended and Restated Declaration of Trust by and among State Street Bank and Trust Company of Connecticut, National Association, Texas Capital Bancshares, Inc. and Joseph M. Grant, Raleigh Hortenstine III and Gregory B. Hultgren, dated November 19, 2002 which is incorporated by reference to our Current Report on Form 8-K dated December 4, 2002 | ||
4 | .6 | Indenture dated November 19, 2002 which is incorporated by reference to our Current Report on Form 8-K dated December 4, 2002 | ||
4 | .7 | Guarantee Agreement between Texas Capital Bancshares, Inc. and State Street Bank and Trust of Connecticut, National Association dated November 19, 2002, which is incorporated by reference to our Current Report on Form 8-K dated December 4, 2002 | ||
4 | .8 | Placement Agreement by and among Texas Capital Bancshares, Inc., Texas Capital Statutory Trust II and Sandler O’Neill & Partners, L.P., which is incorporated by reference to our Current Report Form 8-K dated June 11, 2003 | ||
4 | .9 | Certificate of Trust of Texas Capital Statutory Trust II, which is incorporated by reference to our Current Report on Form 8-K dated June 11, 2003 | ||
4 | .10 | Amended and Restated Declaration of Trust by and among Wilmington Trust Company, Texas Capital Bancshares, Inc., and Joseph M. Grant and Gregory B. Hultgren, dated April 10, 2003, which is incorporated by reference to our Current Report on Form 8-K dated June 11, 2003 | ||
4 | .11 | Indenture between Texas Capital Bancshares, Inc. and Wilmington Trust Company, dated April 10, 2003, which is incorporated by reference to our Current Report on Form 8-K dated June 11, 2003 | ||
4 | .12 | Guarantee Agreement between Texas Capital Bancshares, Inc. and Wilmington Trust Company, dated April 10, 2003, which is incorporated by reference to our Current Report on Form 8-K dated June 11, 2003 | ||
10 | .1 | Deferred Compensation Agreement, which is incorporated by reference to Exhibit 10.2 to our registration statement on Form 10 dated August 24, 2001† | ||
10 | .2 | Amended and Restated Deferred Compensation Agreement Irrevocable Trust*† | ||
10 | .3 | Executive Employment Agreement between Joseph M. Grant and Texas Capital Bancshares, Inc. dated October 8, 2002, which is incorporated by reference to Exhibit 10.3 of our Annual Report on Form 10-K dated March 26, 2003† | ||
10 | .4 | Executive Employment Agreement between George F. Jones, Jr. and Texas Capital Bancshares, Inc. dated October 8, 2002, which is incorporated by reference to Exhibit 10.5 of our Annual Report on Form 10-K dated March 26, 2003† | ||
10 | .5 | Executive Employment Agreement between C. Keith Cargill and Texas Capital Bancshares, Inc. dated October 8, 2002, which is incorporated by reference to Exhibit 10.6 of our Annual Report on Form 10-K dated March 26, 2003† | ||
10 | .6 | Executive Employment Agreement between Peter Bartholow and Texas Capital Bancshares, Inc. dated October 6, 2003, which is incorporated by reference to Exhibit 10.7 of our Annual Report on Form 10-K dated March 15, 2004† |
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10 | .7 | Executive Employment Agreement dated December 20, 2004, by and between Texas Capital Bancshares, Inc. and Joseph M. Grant, which is incorporated by reference to our Current Report on Form 8-K dated December 23, 2004† | ||
10 | .8 | Executive Employment Agreement dated December 20, 2004, by and between Texas Capital Bancshares, Inc. and George F. Jones, Jr., which is incorporated by reference to our Current Report on Form 8-K dated December 23, 2004† | ||
10 | .9 | Executive Employment Agreement dated December 20, 2004, by and between Texas Capital Bancshares, Inc. and C. Keith Cargill, which is incorporated by reference to our Current Report on Form 8-K dated December 23, 2004† | ||
10 | .10 | Executive Employment Agreement dated December 20, 2004, by and between Texas Capital Bancshares, Inc. and Peter B. Bartholow, which is incorporated by reference to our Current Report on Form 8-K dated December 23, 2004† | ||
10 | .11 | Officer Indemnity Agreement dated December 20, 2004, by and between Texas Capital Bancshares, Inc. and Joseph M. Grant, which is incorporated by reference to our Current Report on Form 8-K dated December 23, 2004† | ||
10 | .12 | Officer Indemnity Agreement dated December 20, 2004, by and between Texas Capital Bancshares, Inc. and George F. Jones, Jr., which is incorporated by reference to our Current Report on Form 8-K dated December 23, 2004† | ||
10 | .13 | Officer Indemnity Agreement dated December 20, 2004, by and between Texas Capital Bancshares, Inc. and C. Keith Cargill, which is incorporated by reference to our Current Report on Form 8-K dated December 23, 2004† | ||
10 | .14 | Officer Indemnity Agreement dated December 20, 2004, by and between Texas Capital Bancshares, Inc. and Peter B. Bartholow, which is incorporated by reference to our Current Report on Form 8-K dated December 23, 2004† | ||
21 | Subsidiaries of the Registrant* | |||
23 | .1 | Consent of Ernst & Young LLP* | ||
31 | .1 | Certification of Chief Executive Officer pursuant to Rule 13a-14(a) of the Exchange Act* | ||
31 | .2 | Certification of Chief Financial Officer pursuant to Rule 13a-14(a) of the Exchange Act* | ||
32 | .1 | Section 1350 Certification of Chief Executive Officer* | ||
32 | .2 | Section 1350 Certification of Chief Financial Officer* |
* | Filed herewith |
† | Management contract or compensatory plan arrangement. |
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SIGNATURES
Pursuant to the requirements of the Securities and Exchange Act of 1934, the Registrant has duly caused this report to be signed on its behalf by the undersigned hereunto duly authorized.
TEXAS CAPITAL BANCSHARES, INC. |
By: | /s/ JOSEPH M. GRANT |
Joseph M. Grant | |
Chairman of the Board of Directors and | |
Chief Executive Officer |
Date: March 14, 2005
/s/ JOSEPH M. GRANT |
Joseph M. Grant | |
Chairman of the Board of Directors and Chief | |
Executive Officer (principal executive officer) |
Date: March 14, 2005
/s/ PETER BARTHOLOW |
Peter Bartholow | |
Chief Financial Officer and Director | |
(principal financial officer) |
Date: March 14, 2005
/s/ JULIE ANDERSON |
Julie Anderson | |
Controller | |
(principal accounting officer) |
Date: March 14, 2005
/s/ LEO CORRIGAN III |
Leo Corrigan III | |
Director |
Date: March 14, 2005
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/s/ JAMES R. ERWIN |
James R. Erwin | |
Director |
Date: March 14, 2005
/s/ FREDERICK B. HEGI, JR. |
Frederick B. Hegi, Jr. | |
Director |
Date: March 14, 2005
/s/ JAMES R. HOLLAND, JR. |
James R. Holland, Jr. | |
Director |
Date: March 14, 2005
/s/ GEORGE F. JONES, JR. |
George F. Jones, Jr. | |
Director |
Date: March 14, 2005
/s/ LARRY A. MAKEL |
Larry A. Makel | |
Director |
Date: March 14, 2005
/s/ WALTER W. MCALLISTER III |
Walter W. McAllister III | |
Director |
Date: March 14, 2005
/s/ LEE ROY MITCHELL |
Lee Roy Mitchell | |
Director |
Date: March 14, 2005
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/s/ STEVE ROSENBERG |
Steve Rosenberg | |
Director |
Date: March 14, 2005
/s/ JOHN C. SNYDER |
John C. Snyder | |
Director |
Date: March 14, 2005
/s/ ROBERT W. STALLINGS |
Robert W. Stallings | |
Director |
Date: March 14, 2005
/s/ JAMES CLEO THOMPSON, JR. |
James Cleo Thompson, Jr. | |
Director |
Date: March 14, 2005
/s/ IAN J. TURPIN |
Ian J. Turpin | |
Director |
Date: March 14, 2005
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