10-K 1 d33577e10vk.htm FORM 10-K e10vk
Table of Contents

 
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, 2005
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 if the issuer is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.  Yes þ     No o
 
Indicate by check mark if the issuer is not required to file reports pursuant to Section 13 or Section 15(d) of the Securities Act.  Yes o     No þ
 
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 a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):
Large accelerated filer  o     Accelerated filer  þ     Non-accelerated filer  o
 
Indicate by check mark whether the issuer is a shell company (as defined in Rule 12b-2 of the Securities Act).  Yes o     No þ
 
As of June 30, 2005, 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 The Nasdaq National Market, was approximately $441,560,000. There were 25,838,616 shares of the registrant’s common stock outstanding on February 28, 2006.
 
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 30, 2006, are incorporated by reference into Part III of this Form 10-K.
 


 

 
TABLE OF CONTENTS
 
             
Part I
  Business   1
  Risk Factors   10
  Properties   16
  Legal Proceedings   16
  Submission of Matters to a Vote of Security Holders   17
 
Part II
  Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities   17
  Selected Consolidated Financial Data   18
  Management’s Discussion and Analysis of Financial Condition and Results of Operations   20
  Quantitative and Qualitative Disclosure About Market Risk   42
  Financial Statements and Supplementary Data   45
  Changes in and Disagreements With Accountants on Accounting and Financial Disclosures   75
  Controls and Procedures   75
  Other Information   77
 
Part III
  Directors and Executive Officers of the Registrant   77
  Executive Compensation   77
  Security Ownership of Certain Beneficial Owners and Management   77
  Certain Relationships and Related Transactions   77
  Principal Accountant Fees and Services   77
 
Part IV
  Exhibits   77
 Subsidiaries
 Consent of Ernst & Young LLP
 Certification of CEO Pursuant to Rule 13a-14(a)
 Certification of CFO Pursuant to Rule 13a-14(a)
 Section 1350 Certification of CEO
 Section 1350 Certification of CFO


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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. In August 2003, we completed our initial public offering, raising $33.9 million.
 
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 2001 through December 2005.
 
                                         
    December 31  
    2005     2004     2003     2002     2001  
    (In thousands)  
 
Loans held for investment
  $ 2,075,961     $ 1,564,578     $ 1,229,773     $ 1,002,557     $ 854,505  
Total loans
    2,187,139       1,684,115       1,310,553       1,118,663       898,269  
Assets
    3,042,225       2,611,163       2,192,875       1,793,282       1,164,779  
Deposits
    2,495,179       1,789,887       1,445,030       1,196,535       886,077  
Stockholders’ equity
    215,523       195,275       171,756       124,976       106,359  
 
The following table provides information about the growth of our loan portfolio by type of loan from December 2001 to December 2005.
 
                                         
    December 31  
    2005     2004     2003     2002     2001  
    (In thousands)  
 
Commercial loans
  $ 1,182,734     $ 818,156     $ 608,542     $ 509,505     $ 402,302  
Total real estate loans
    976,975       844,640       675,983       571,260       442,071  
Construction loans
    387,163       328,074       256,134       172,451       180,115  
Permanent real estate loans
    478,634       397,029       339,069       282,703       218,192  
Loans held for sale
    111,178       119,537       80,780       116,106       43,764  
Equipment leases
    16,337       9,556       13,152       17,546       34,552  
Consumer loans
    19,962       15,562       16,564       24,195       25,054  
 
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 also compete with other providers of financial services, such as savings and loan associations, credit unions, consumer finance companies, securities firms, insurance companies, insurance agencies, commercial finance and leasing companies, full service brokerage firms and discount brokerage firms. 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


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lending expertise in the specific industries found in their market areas and established community ties. We believeour 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.
 
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, 2005, we maintained approximately 20,000 deposit accounts and 4,100 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;


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  •  interest bearing and non-interest bearing checking accounts with optional features such as Visa® debit/ATM cards and overdraft protection;
 
  •  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.
 
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, 2005, funded commercial loans totaled approximately $1.18 billion, approximately 54% of our total funded loans.
 
Permanent Real Estate Loans.  Approximately 49% 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, 2005, funded permanent real estate loans totaled approximately $478.6 million, approximately 22% of our total funded loans; of this total, $375.6 million were loans with floating rates and $103.0 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, 2005, funded construction real estate loans totaled approximately $387.2 million, approximately 18% 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 and mortgage warehouse groups. These loans are typically on our balance sheet less than 30 days. At December 31, 2005, loans held for sale totaled approximately $111.2 million, approximately 5% 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, 2005, our commitments under letters of credit totaled approximately $52.6 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, 2005, funded consumer loans totaled approximately $20.0 million, approximately 1% of our total funded loans. Consumer residential real estate loans consisting primarily of first and second mortgage loans forresidential 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, 2005.
 
                 
    Funded Loans  
    Amount     Percent of Total  
    (Dollars in thousands)  
 
Agriculture
  $ 10,014       0.5 %
Contracting
    345,925       15.8  
Government
    11,697       0.5  
Manufacturing
    120,614       5.5  
Personal/household
    246,639       11.2  
Petrochemical and mining
    264,535       12.0  
Retail
    64,808       3.0  
Services
    753,994       34.3  
Wholesale
    117,837       5.4  
Investors and investment management companies
    259,945       11.8  
                 
Total
  $ 2,196,008       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.
 
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, 2005.
 


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    Funded Loans  
    Amount     Percent of Total  
    (Dollars in thousands)  
 
Business assets
  $ 658,537       30.0  
Energy
    211,571       9.6  
Highly liquid assets
    178,907       8.2  
Real property
    864,838       39.4  
Rolling stock
    27,584       1.3  
U.S. Government guaranty
    50,222       2.3  
Other assets
    49,023       2.2  
Unsecured
    155,326       7.0  
                 
Total
  $ 2,196,008       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 has become less significant to our overall business and funding strategies. As of December 31, 2005, BankDirect has a total of approximately 5,400 existing deposit accounts containing total deposits of approximately $192.4 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 customer 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 now brokers primarily life insurance products to individuals and businesses. A new insurance subsidiary was formed in 2005, TexCap Insurance Services, LP, which brokers corporate and personal property and casualty insurance as well as group benefits to individuals and businesses. Both subsidiaries are subject to regulation by applicable state insurance regulatory agencies.
 
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

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an agented office to facilitate our offering of these products. We opened our Cayman Islands branch in September 2003. As of December 31, 2005, our Cayman Islands deposits totaled $546.8 million.
 
Employees
 
As of December 31, 2005, we had 709 full-time employees, 276 of whom were related to our residential mortgage lending division, of which approximately 67% 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 the 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 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


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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 anyobligation 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 non-traditional 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 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,


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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 10.15% at December 31, 2005 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.
 
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. During 2004, we 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.


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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 extr-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.
 
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.
 
Available Information
 
Under the Securities Exchange Act of 1934, we are required to file annual, quarterly and current reports, proxy statements and other information with the Securities and Exchange Commission (“SEC”). You may read and copy any document in our files with the SEC at the SEC’s Public Reference Room at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC at 1-800-SEC-0330 for further information about the public reference room. The SEC maintains a website at http://www.sec.gov that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC. We file electronically with the SEC.


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We make available, free of charge through our website, our reports on Forms 10-K, 10-Q and 8-K, and amendments to those reports, as soon as reasonably practicable after such reports are filed with or furnished to the SEC. Additionally, we have adopted and posted on our website a code of ethics that applies to our principal executive officer, principal financial officer and principal accounting officer. The address for the Corporation’s website is http://www.texascapitalbank.com. We will provide a printed copy of any of the aforementioned documents to any requesting shareholder.
 
ITEM 1A.   RISK FACTORS
 
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. The risks and uncertainties described below are not the only ones facing us. Additional risks and uncertainties that management is not aware of or focused on or that management currently deems immaterial mayalso impair our business operations. This report is qualified in its entirety by these risk factors.
 
Risk Factors Associated With Our Business
 
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 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 in all categories of our lending, we cannot assure you that such monitoring and approval procedures will reduce these lending risks. We cannot assure you that our credit administration personnel, policies and procedures will adequately adapt to any new geographic markets.
 
Our results of operation and financial condition 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 in all categories of our lending business will become delinquent, and some may only be partially repaid or may never be repaid at all. Our methodology for establishing the adequacy of the allowance for loan losses depends on subjective application of risk grades as indicators of borrowers’ ability to repay. Deterioration in general economic conditions and unforeseen risks affecting customers may have an adverse effect on borrowers’ capacity to honor their obligations before risk grades could reflect those changing conditions. Moreover, in times of improving credit quality, with growth in our loan portfolio, the allowance for loan losses may decrease as a percent of total loans. A decrease in the ratio of the allowance for loan losses to total loans may increase the risk that the allowance would become inadequate if borrowers experience economic and other conditions adverse to their businesses. Maintaining the adequacy of our allowance for loan losses may require that we make significant and unanticipated increases in our provisions for loan losses in the future, which would materially affect our results of operations. Recognizing that many of our loans individually represent a significant percentage of our total allowance for loan losses, which may have decreased as a percent of total loans, adverse collection experience in a relatively small number of loans could require an increase in our allowance. 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 results of operations and financial condition. For additional descriptions of risks in the loan portfolio, the methodology for determining, and information related to, the adequacy of the reserve for loan losses, see the Summary of Loan Loss Experience section in Management’s Discussion and Analysis of Financial Condition and Results of Operations.
 
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


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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.
 
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 results of operation and financial condition, which would likely adversely affect the market price of our common stock. Further, with the exception of our BankDirect customers, which comprised 8% of our total deposits as of December 2005, 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 business is concentrated in Texas and a downturn in the economy of Texas may adversely affect our business.  A substantial majority 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.
 
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 and lines of business;
 
  •  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.


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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.
 
The risks involved in commercial lending may be material.  We generally invest a greater proportion of our assets in commercial loans than other banking institutions of our size, and our business plan calls for continued efforts to increase our assets invested in these loans. Commercial loans generally involve a higher degree of credit risk than some other types of loans due, in part, to their larger average size, the dependency on the cash flow of the borrowers’ businesses to service debt, the sale of assets securing the loans, and disposition of collateral which may not be readily marketable. Losses incurred on a relatively small number of commercial loans could have a materially adverse impact on our results of operations and financial condition.
 
Real estate lending in our core Texas markets involves risks related to a decline in value of commercial and residential real estate.  Our real estate lending activities, and the exposure to fluctuations in real estate values, are significant and expected to increase. The market value of real estate can fluctuate significantlyin a relatively 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 and we may not be able to realize the amount of security that we anticipated at the time of originating the loan.
 
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.
 
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 customers. In addition, we must be able to protect the computer systems and network infrastructure utilized by us against physical damage, security breaches and service disruption 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, will 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.
 
We are subject to extensive government regulation and supervision.  We are subject to extensive federal and state regulation and supervision. Banking regulations are primarily intended to protect depositors’ funds, federal deposit insurance funds and the banking system as a whole, not shareholders. These regulations affect our lending practices, capital structure, investment practices, dividend policy and growth, among other things. Congress and federal regulatory agencies continually review banking laws, regulations and policies for possible changes. Changes to statutes, regulations or regulatory policies, including changes in interpretation or implementation of statutes, regulations or policies, could affect us in substantial and unpredictable ways. Such changes could subject


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us to additional costs, limit the types of financial services and products we may offer and/or increase the ability of non-banks to offer competing financial services and products, among other things. Failure to comply with laws, regulations or policies could result in sanctions by regulatory agencies, civil money penalties and/or reputation damage, which could have a material adverse effect on our business, financial condition and results of operations. While we have policies and procedures designed to prevent any such violations, there can be no assurance that such violations will not occur.
 
Furthermore, the Sarbanes-Oxley Act of 2002, and the related rules and regulations promulgated by the SEC and NASDAQ that are applicable to us, have increased the scope, complexity and cost of corporate governance, reporting and disclosure practices. As a result, we have experienced, and may continue to experience, greater compliance costs.
 
Severe weather, natural disasters, acts of war or terrorism and other external events could significantly impact our business.  Severe weather, natural disasters, acts of war or terrorism and other adverse external events could have a significant impact on our ability to conduct business. Such events could affect the stability of our deposit base, impair the ability of borrowers to repay outstanding loans, impair the value of collateral securing loans, cause significant property damage, result in loss of revenue and/or cause us to incur additional expenses. For example, during 2005, hurricanes Katrina and Rita made landfall and subsequently caused extensive flooding and destruction along the coastal areas of the Gulf of Mexico, including communities where we conduct business. Operations in several of our markets were disrupted by both the evacuation of large portions of the population as well as damage and or lack of access to our banking and operation facilities. While the impact of these hurricanes did not significantly affect us, other severe weather or natural disasters, acts of war or terrorism or other adverse external events may occur in the future. Although management has established disaster recovery policies and procedures, the occurrence of any such event could have a material adverse effect on our business, which, in turn, could have a material adverse effect on the our financial condition and results of operations.
 
Our success in attracting and retaining consumer deposits depends on our ability to offercompetitive rates and services.  As of December 2005, approximately 8% 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.
 
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 acquirer 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


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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.
 
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, and authorize 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. Although we have no present intention to issue any 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.
 
We are subject to claims and litigation pertaining to fiduciary responsibility.  From time to time, customers make claims and take legal action pertaining to our performance of our fiduciary responsibilities. Whether customer claims and legal action related to our performance of its fiduciary responsibilities are founded or unfounded, if such claims and legal actions are not resolved in a manner favorable to us they may result in significant financial liability and/or adversely affect the market perception of us and our products and services as well as impact customer demand for those products and services. Any financial liability or reputation damage could have a material adverse effect on our business, which, in turn, could have a material adverse effect on our financial condition and results of operations.
 
Our controls and procedures may fail or be circumvented.  Management regularly reviews and updates our internal controls, disclosure controls and procedures, and corporate governance policies and procedures. Any system of controls, however well designed and operated, is based in part on certain assumptions and can provide only reasonable, not absolute, assurances that the objectives of the system are met. Any failure or circumvention of our controls and procedures or failure to comply with regulations related to controls and procedures could have a material adverse effect on our business, results of operations and financial condition.
 
Risks Associated With Our Common Stock
 
Our stock price can be volatile.  Stock price volatility may make it more difficult for you to resell your common stock when you want and at prices you find attractive. Our stock price can fluctuate significantly in response to a variety of factors including, among other things:
 
  •  Actual or anticipated variations in quarterly results of operations;
 
  •  Recommendations by securities analysts;
 
  •  Operating and stock price performance of other companies that investors deem comparable to us;
 
  •  News reports relating to trends, concerns and other issues in the financial services industry;
 
  •  Perceptions in the marketplace regarding us and/or our competitors;
 
  •  New technology used, or services offered, by competitors;
 
  •  Significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving us or our competitors;
 
  •  Failure to integrate acquisitions or realize anticipated benefits from acquisitions;
 
  •  Changes in government regulations; and
 
  •  Geopolitical conditions such as acts or threats of terrorism or military conflicts.


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General market fluctuations, industry factors and general economic and political conditions and events, such as economic slowdowns or recessions, interest rate changes or credit loss trends, could also cause our stock price to decrease regardless of operating results.
 
The trading volume in our common stock is less than that of other larger financial services companies.  Although our common stock is listed for trading on the NASDAQ, the trading volume in its common stock is less than that of other larger financial services companies. A public trading market having the desired characteristics of depth, liquidity and orderliness depends on the presence in the marketplace of willing buyers and sellers of our common stock at any given time. This presence depends on the individual decisions of investors and general economic and market conditions over which we have no control. Given the lower trading volume of our common stock, significant sales of our common stock, or the expectation of these sales, could cause the our stock price to fall.
 
An investment in our common stock is not an insured deposit.  Our common stock is not a bank deposit and, therefore, is not insured against loss by the FDIC, any other deposit insurance fund or by any other public or private entity. Investment in our common stock is inherently risky for the reasons described in this “Risk Factors” section and elsewhere in this report and is subject to the same market forces that affect the price of common stock in any company. As a result, if you acquire our common stock, you may lose some or all of your investment.
 
Our certificate of incorporation and bylaws as well as certain Delaware and banking laws may have an anti-takeover effect.  Provisions of our certificate of incorporation and bylaws, as well as Delaware General Corporation Law, and federal banking laws, including regulatory approval requirements, could make it more difficult for a third party to acquire us, even if doing so would be perceived to be beneficial to our shareholders. The combination of these provisions effectively inhibits a non-negotiated merger or other business combination, which, in turn, could adversely affect the market price of tour common stock.
 
Risks Associated With Our Industry
 
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 which our customers may require. 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.
 
The earnings of financial services companies are significantly affected by general business and economic conditions.  Our operations and profitability are impacted by general business and economic conditions in the United States and abroad. These conditions include short-term and long-term interest rates, inflation, moneysupply, political issues, legislative and regulatory changes, fluctuations in both debt and equity capital markets, broad trends in industry and finance and the strength of the U.S. economy and the local economies in which the we operate, all of which are beyond our control. Deterioration in economic conditions could result in an increase in loan delinquencies and non-performing assets, decreases in loan collateral values and a decrease in demand for our products and services, among other things, any of which could have a material adverse impact on our results of operation and financial condition.
 
Financial services companies depend on the accuracy and completeness of information about customers and counterparties.  In deciding whether to extend credit or enter into other transactions, we may rely on information furnished by or on behalf of customers and counterparties, including financial statements, credit reports and other financial information. We may also rely on representations of those customers, counterparties or other third parties, such as independent auditors, as to the accuracy and completeness of that information. Reliance on inaccurate or misleading financial statements, credit reports or other financial information could have a material adverse impact on our business and, in turn, our results of operation and financial condition.
 
Consumers may decide not to use banks to complete their financial transactions.  Technology and other changes are allowing parties to complete financial transactions that historically have involved banks through alternative methods. For example, consumers can now maintain funds that would have historically been held as bank deposits in brokerage accounts or mutual funds. Consumers can also complete transactions such as paying


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bills and/or transferring funds directly without the assistance of banks. The process of eliminating banks as intermediaries could result in the loss of fee income, as well as the loss of customer deposits and the related income generated from those deposits. The loss of these revenue streams and the lower cost deposits as a source of funds could have a material adverse effect on our results of operations and financial condition.
 
ITEM 2.   PROPERTIES
 
As of December 31, 2005, we conducted business at ten 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 June 2015, not including any renewal options that may be available.
 
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
  570 Throckmorton
Fort Worth, Texas 76102
Motor banking location
  400 East Belknap Street
Fort Worth, Texas 76102
Banking location
  114 W. 7th St.
Suite 100
Austin, Texas 78701
Banking location
  745 East Mulberry Street
Suite 350
San Antonio, Texas 78212
Banking location
  7373 Broadway
Suite 100
San Antonio, Texas 78209
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.


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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 2005.
 
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 National 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 1, 2006 there were approximately 494 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 stock would be cash dividends from our bank. The payment of dividends by our bank is subject to certain restrictions 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 National Market for each of the four quarters of 2004 and 2005.
 
                 
    Price per Share  
Quarter Ended
  High     Low  
 
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  
March 31, 2005
    24.80       19.73  
June 30, 2005
    21.71       17.45  
September 30, 2005
    24.32       19.30  
December 31, 2005
    24.68       18.54  
 
Equity Compensation Plan Information
 
                         
    Number of
             
    Securities to be
          Number of
 
    Issued Upon
    Weighted Average
    Securities
 
    Exercise of
    Exercise Price of
    Remaining Available
 
    Outstanding
    Outstanding
    for Future Issuance
 
    Options, Warrants
    Options, Warrants
    Under Equity
 
Plan Category
  and Rights     and Rights     Compensation Plans  
 
Equity compensation plans approved by security holders
    2,652,506     $ 10.22       1,381,000  
Equity compensation plans not approved by security holders(1)
    84,274       6.80        
                         
Total
    2,736,780     $ 10.11       1,381,000  
                         
 
 
(1) Refers to deferred compensation agreement. See further discussion in Note 11 to the Consolidated Financial Statements.
 
In December 2005, we discovered that we had inadvertently sold 16,361 shares of our common stock to our employees pursuant to our 2000 Employee Stock Purchase Plan in excess of the 160,000 shares of common stock authorized to be issued under the 2000 Employee Stock Purchase Plan. The sale of the excess shares took place on June 30, 2005. The 16,361 shares represented less than one-tenth of one percent of the 25,616,829 shares of common stock outstanding at June 30, 2005.


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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  
    2005     2004     2003     2002     2001  
    (In thousands, except per share, average share and percentage data)  
 
Consolidated Operating Data(1)
                                       
Interest income
  $ 167,695     $ 110,878     $ 85,484     $ 70,142     $ 70,594  
Interest expense
    66,124       36,136       32,329       27,896       35,539  
Net interest income
    101,571       74,742       53,155       42,246       35,055  
Provision for loan losses
          1,688       4,025       5,629       5,762  
Net interest income after provision for loan losses
    101,571       73,054       49,130       36,617       29,293  
Non-interest income
    20,649       13,632       10,892       8,625       5,983  
Non-interest expense
    81,029       57,340       48,380       35,370       29,432  
Income before income taxes
    41,191       29,346       11,642       9,872       5,844  
Income tax expense (benefit)
    13,999       9,786       (2,192 )     2,529        
Net income
    27,192       19,560       13,834       7,343       5,844  
Consolidated Balance Sheet Data(1)
                                       
Total assets
    3,042,225       2,611,163       2,192,875       1,793,282       1,164,779  
Loans held for investment
    2,075,961       1,564,578       1,229,773       1,002,557       854,505  
Loans held for sale
    111,178       119,537       80,780       116,106       43,764  
Securities available-for-sale
    630,482       804,544       775,338       553,169       206,365  
Deposits
    2,495,179       1,789,887       1,445,030       1,196,535       886,077  
Federal funds purchased
    103,497       113,478       78,961       83,629       76,699  
Other borrowings
    162,224       481,513       466,793       365,831       86,899  
Long-term debt
    46,394       20,620       20,620       10,000        
Stockholders’ equity
    215,523       195,275       171,756       124,976       106,359  
Other Financial Data
                                       
Income per share:
                                       
Basic
  $ 1.06     $ .77     $ .62     $ .33     $ .31  
Diluted
  $ 1.02     $ .75       .60       .32       .30  
Tangible book value per share(2)
    7.88       7.61       6.81       5.80       5.08  
Book value per share(2)
    8.68       7.57       6.74       5.57       5.18  
Weighted average shares:
                                       
Basic
    25,619,594       25,260,526       21,332,746       19,145,255       18,957,652  
Diluted
    26,645,198       26,234,637       23,118,804       19,344,874       19,177,204  
Selected Financial Ratios:
                                       
Performance Ratios
                                       
Return on average assets
    0.97 %     0.82 %     0.70 %     0.54 %     0.58 %
Return on average equity
    13.29 %     10.74 %     9.71 %     6.27 %     6.44 %
Net interest margin
    3.91 %     3.37 %     2.87 %     3.28 %     3.62 %
Efficiency ratio (excludes securities gains)
    66.30 %     64.88 %     76.33 %     71.46 %     75.20 %
Non-interest expense to average earning assets
    3.09 %     2.57 %     2.43 %     2.59 %     2.90 %
Asset Quality Ratios
                                       
Net charge-offs (recoveries) to average loans(3)
    (0.01 )%     0.05 %     0.08 %     0.40 %     0.27 %
Reserve to loans held for investment(3)
    .91 %     1.20 %     1.44 %     1.45 %     1.47 %
Allowance to non-performing loans
    2.2 x     3.1 x     1.7 x     5.0 x     1.1 x
Non-accrual loans to loans(3)
    .27 %     .37 %     .83 %     .28 %     .71 %
Non-performing loans to loans(3)
    .41 %     .39 %     .83 %     .29 %     .75 %
Capital and Liquidity Ratios
                                       
Total capital ratio
    10.83 %     11.67 %     13.14 %     11.32 %     11.73 %
Tier 1 capital ratio
    10.09 %     10.72 %     12.00 %     10.16 %     10.48 %
Tier 1 leverage ratio
    8.68 %     8.31 %     8.82 %     7.66 %     9.46 %
Average equity/average assets
    7.32 %     7.66 %     7.16 %     8.57 %     8.93 %
Tangible equity/assets
    6.67 %     7.42 %     7.76 %     6.89 %     9.00 %
Average net loans/average deposits
    91.16 %     92.89 %     91.49 %     96.31 %     95.54 %
 
 
(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


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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) 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. Excludes securities gains/losses.
 
(3) Excludes loans held for sale.


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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 resulted in reduced levels of return on equity in prior years.
 
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.
 
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
 
    2005     Rate(1)     2004     Rate(1)     2003     Rate(1)     2002     Rate(1)  
    (In thousands)  
 
Net interest income
  $ 101,571       36%     $ 74,742       41%     $ 53,155       26%     $ 42,246       21%  
Net income
    27,192       39%       19,560       41%       13,834       88%       7,343       26%  
Assets
    3,042,225       17%       2,611,163       19%       2,192,875       22%       1,793,282       54%  
Loans
    2,196,008       30%       1,687,914       28%       1,314,241       17%       1,122,506       24%  
Deposits
    2,495,179       39%       1,789,887       24%       1,445,030       21%       1,196,535       35%  
 
 
(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.
 
Year ended December 31, 2005 compared to year ended December 31, 2004
 
We recorded net income of $27.2 million for the year ended December 31, 2005 compared to $19.6 million for the same period in 2004. Diluted income per common share was $1.02 for 2005 and $0.75 for the same period in 2004. Returns on average assets and average equity were 0.97% and 13.29%, respectively, for the year ended December 31, 2005 compared to 0.82% and 10.74%, respectively, for the same period in 2004.
 
The increase in net income for the year ended December 31, 2005 over the same period of 2004 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 $26.8 million, or 35.9%, to $101.6 million for the year ended December 31, 2005 compared to $74.7 million for the same period in 2004. The increase in net interest income was primarily due to an increase of $391.8 million in average earning assets, coupled with a 54 basis point improvement in the net interest margin.
 
Non-interest income increased by $7.0 million, or 51.5%, during the year ended December 31, 2005 to $20.6 million, compared to $13.6 million during the same period in 2004. The increase was primarily due to an


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increase in gain on sale of mortgage loans relating to our residential mortgage lending division. Gain on sale of mortgage loans increased $4.6 million to $8.0 million during the year ended December 31, 2005 compared to $3.4 million during the same period in 2004. Also, our trust income increased by $807,000 to $2.7 million during the year ended December 31, 2005 compared to $1.9 million for the same period in 2004, due to continued growth in trust assets. Brokered loan fees increased $763,000 to $1.8 million for the year ended December 31, 2005, compared to $996,000 for the same period in 2004. Insurance commission income increased $603,000 to $1.0 million for the year ended December 31, 2005, compared to $444,000 for the same period in 2004 due to increased focus on the insurance business.
 
Non-interest expense increased by $23.7 million, or 41.3%, to $81.0 million during the year ended December 31, 2005 compared to $57.3 million during the same period in 2004. This increase is primarily related to a $15.9 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 Houston office, addition of the premium finance business, the continued expansion of the residential mortgage lending division, increased focus on the insurance business and increased incentive compensation reflective of our performance. Occupancy expense increased by $1.8 million to $7.5 million during the year ended December 31, 2005 compared to the same period in 2004 and is related to our continued growth in the residential mortgage lending division, our Houston office, and the premium finance business. Marketing expense increased $727,000 to $3.3 million during the year ended December 31, 2005 from $2.6 million during the same period in 2004. Legal and professional expense increased $2.0 million to $5.2 million during the year ended December 31, 2005, compared to $3.1 million for the same period in 2004.
 
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.
 
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


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residential mortgage lending division and our Houston office. Marketing expense increased $1.2 million to $2.6 million during the year ended December 31, 2004 from $1.4 million during the same period in 2003.
 
Net Interest Income
 
Net interest income was $101.6 million for the year ended December 31, 2005 compared to $74.7 million for the same period of 2004. The increase in net interest income was primarily due to an increase of $391.8 million in average earning assets, coupled with a 54 basis point improvement in the net interest margin, which resulted from the repricing of our earning assets with rising rates. The increase in average earning assets from 2004 included a $447.0 million increase in average net loans offset by a $72.0 million decrease in average securities. For the year ended December 31, 2005, average net loans and securities represented 72% and 27%, respectively, of average earning assets compared to 65% and 35%, respectively, in 2004.
 
Average interest bearing liabilities increased $278.8 million from the year ended December 31, 2004, which included a $407.9 million increase in interest bearing deposits offset by a $135.1 million decrease in other borrowings. For the same periods, the average balance of demand deposits increased 37.5% to $410.2 million from $298.4 million. The average cost of interest bearing liabilities increased from 1.92% for the year ended December 31, 2004 to 3.05% in 2005, reflecting the rise in market interest rates.
 
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.


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Volume/Rate Analysis
 
                                                 
    Years Ended December 31,  
    2005/2004     2004/2003  
          Change Due to(1)           Change Due to(1)  
    Change     Volume     Yield/Rate     Change     Volume     Yield/Rate  
    (In thousands)  
 
Interest income:
                                               
Securities(2)
  $ (1,013 )   $ (2,726 )   $ 1,713     $ 9,778     $ 5,188     $ 4,590  
Loans
    57,625       24,116       33,509       16,149       12,413       3,736  
Federal funds sold
    546       153       393       (101 )     (105 )     4  
Deposits in other banks
    134       61       73       (1 )     (1 )      
                                                 
      57,292       21,604       35,688       25,825       17,495       8,330  
Interest expense:
                                               
Transaction deposits
    428       78       350       201       216       (15 )
Savings deposits
    9,604       1,220       8,384       1,450       1,624       (174 )
Time deposits
    5,639       854       4,785       (773 )     (749 )     (24 )
Deposits in foreign branches
    11,119       4,910       6,209       1,428       1,085       343  
Borrowed funds
    3,198       (3,186 )     6,384       1,501       1,550       (49 )
                                                 
      29,988       3,876       26,112       3,807       3,726       81  
                                                 
Net interest income
  $ 27,304     $ 17,728     $ 9,576     $ 22,018     $ 13,769     $ 8,249  
                                                 
 
 
(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 3.37% in 2004 to 3.91% in 2005. This increase was due primarily to a 144 basis point increase in the yield on earning assets coupled with a 113 basis point increase in the cost of interest bearing liabilities.
 
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.


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Consolidated Daily Average Balances, Average Yields and Rates
 
                                                                         
    Year Ended December 31,  
    2005     2004     2003  
    Average
    Revenue/
    Yield/
    Average
    Revenue/
    Yield/
    Average
    Revenue/
    Yield/
 
    Balance     Expense(1)     Rate     Balance     Expense(1)     Rate     Balance     Expense(1)     Rate  
    (In thousands)  
 
Assets
                                                                       
Securities — Taxable
  $ 663,723     $ 28,972       4.37 %   $ 758,975     $ 31,343       4.13 %   $ 642,952     $ 22,796       3.55 %
Securities — Non-taxable(2)
    48,685       2,677       5.50 %     25,407       1,319       5.19 %     1,919       88       4.59 %
Federal funds sold
    17,682       611       3.46 %     5,265       65       1.23 %     14,283       166       1.16 %
Deposits in other banks
    5,309       147       2.77 %     931       13       1.40 %     1,026       14       1.36 %
Loans held for sale (3)
    96,995       12,349       12.73 %     73,883       6,569       8.89 %     121,294       6,790       5.60 %
Loans
    1,810,298       123,876       6.84 %     1,385,848       72,031       5.20 %     1,090,623       55,661       5.10 %
Less reserve for loan losses
    18,872                   18,311                   16,512              
                                                                         
Loans, net
    1,888,421       136,225       7.21 %     1,441,420       78,600       5.45 %     1,195,405       62,451       5.22 %
                                                                         
Total earning assets
    2,623,820       168,632       6.43 %     2,231,998       111,340       4.99 %     1,855,585       85,515       4.61 %
Cash and other assets
    169,225                       144,956                       134,644                  
                                                                         
Total assets
  $ 2,793,045                     $ 2,376,954                     $ 1,990,229                  
                                                                         
Liabilities and Stockholders’ Equity
                                                                       
Transaction deposits
  $ 108,459     $ 1,080       1.00 %   $ 96,911     $ 652       .67 %   $ 65,521     $ 451       .69 %
Savings deposits
    647,039       17,295       2.67 %     558,479       7,690       1.38 %     443,098       6,240       1.41 %
Time deposits
    545,603       19,014       3.48 %     512,852       13,375       2.61 %     541,504       14,148       2.61 %
Deposits in foreign branches
    360,142       12,639       3.51 %     85,133       1,520       1.79 %     6,656       92       1.38 %
                                                                         
Total interest bearing deposits
    1,661,243       50,028       3.01 %     1,253,375       23,237       1.85 %     1,056,779       20,931       1.98 %
Other borrowings
    477,180       14,238       2.98 %     612,295       11,803       1.93 %     512,933       10,493       2.05 %
Long-term debt
    26,694       1,858       6.96 %     20,620       1,096       5.32 %     17,824       905       5.08 %
                                                                         
Total interest bearing liabilities
    2,165,117       66,124       3.05 %     1,886,290       36,136       1.92 %     1,587,536       32,329       2.04 %
Demand deposits
    410,213                       298,430                       249,782                  
Other liabilities
    13,178                       10,052                       10,467                  
Stockholders’ equity
    204,537                       182,182                       142,444                  
                                                                         
Total liabilities and stockholders’ equity
  $ 2,793,045                     $ 2,376,954                     $ 1,990,229                  
                                                                         
Net interest income
          $ 102,508                     $ 75,204                     $ 53,186          
Net interest income to earning assets (net interest margin)
                    3.91 %                     3.37 %                     2.87 %
Net interest spread
                    3.38 %                     3.07 %                     2.57 %
 
 
(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.
 
(3) Revenue includes origination fees and other loan fees for our residential mortgage loans that are earned when the loan is sold. This increases our overall yield on these loans since most of the mortgage loans are on our books for less than 30 days.


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Non-interest Income
 
                         
    Year Ended December 31,  
    2005     2004     2003  
    (In thousands)  
 
Service charges on deposit accounts
  $ 3,223     $ 3,370     $ 3,446  
Trust fee income
    2,739       1,932       1,313  
Gains on sale of securities, net
                666  
Cash processing fees
          587       973  
BOLI income
    1,136       1,288       1,619  
Brokered loan fees
    1,759       996       1,524  
Gain on sale of mortgage loans
    7,992       3,420       120  
Insurance commissions
    1,047       444        
Other(1)
    2,753       1,595       1,231  
                         
Total non-interest income
  $ 20,649     $ 13,632     $ 10,892  
                         
 
 
(1) Other income includes such items as letter of credit fees, rental income, investment in subsidiary income, and other general operating income, none of which account for 1% or more of total interest income and non-interest income.
 
Non-interest income increased by $7.0 million, or 51.5%, during the year ended December 31, 2005 to $20.6 million, compared to $13.6 million during the same period in 2004. The increase was primarily due to an increase in gain on sale of mortgage loans relating to our residential mortgage lending division. Gain on sale of mortgage loans increased $4.6 million to $8.0 million during the year ended December 31, 2005 compared to $3.4 million during the same period in 2004. Also, our trust income increased by $807,000 to $2.7 million during the year ended December 31, 2005 compared to $1.9 million for the same period in 2004, due to continued growth in trust assets. Brokered loan fees, which includes third party fees on mortgage warehouse and premium finance loans, increased $763,000 to $1.8 million during the year ended December 31, 2005, compared to $996,000 for the same period in 2004. Additionally, insurance commission income increased $603,000 due to increased focus on the insurance business. Offsetting these increases was a decrease in cash processing fees. Cash processing fees were $587,000 lower in 2005 compared to 2004. These fees were related to a special project that occurred in the first quarter of 2003 and 2004. Also, there was a decrease in BOLI income related to an annual adjustment in earning rates.
 
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.
 
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,  
    2005     2004     2003  
    (In thousands)  
 
Salaries and employee benefits
  $ 50,726     $ 34,794     $ 23,604  
Net occupancy expense
    7,520       5,695       4,987  
Marketing
    3,336       2,609       1,432  
Legal and professional
    5,166       3,141       2,867  
Communications and data processing
    2,900       3,158       3,042  
Franchise taxes
    273       246       124  
Repurchase agreement penalties
                6,262  
Other(1)
    11,108       7,697       6,062  
                         
Total non-interest expense
  $ 81,029     $ 57,340     $ 48,380  
                         
 
 
(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, 2005 increased $23.7 million, or 41.3%, compared to the same period of 2004. This increase is due primarily to an $15.9 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, addition of the premium finance business, the continued expansion of the residential mortgage lending division, increased focus on the insurance business and increased incentive compensation reflective of our performance. Of the increase, approximately $775,000 is related to commissions in the residential mortgage lending division and represents a variable component of compensation expense directly related to residential loan productions, sales and gains on the sale of mortgage loans reflected in non-interest income.
 
Occupancy expense increased by $1.8 million to $7.5 million during the year ended December 31, 2005 compared to the same period in 2004 and is related to our continued growth in the residential mortgage lending division, our Houston office, and the premium finance business.
 
Marketing expense for the year ended December 31, 2005 increased $727,000, or 27.9%, compared to 2004. Marketing expense for the year ended December 31, 2005 included $557,000 of direct marketing and promotions and $1.5 million in business development compared to direct marketing and promotions of $235,000 and business development of $1.2 million during 2004. Marketing expense for the year ended December 31, 2005 also included $1.3 million for the purchase of miles related to the American Airlines AAdvantage® program compared to $1.2 million during 2004. 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 $2.0 million, or 64.5%, mainly related to growth, creation of BankDirect Capital Finance (BDCF) and increased cost of compliance with laws and regulations. Communications and data processing expense for the year ended December 31, 2005 decreased $258,000, or 8.2%.
 
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


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$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. 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.`
 
Income Taxes
 
At December 31, 2005, we had a gross deferred tax asset of $13.7 million, which relates primarily to our allowance for loan losses and our unrealized loss on securities. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized. We recognized income tax expense of $14.0 million, for an effective tax rate of 34.0% for 2005. The effective income tax rate differed from the U.S. statutory rate of 35% during 2005 primarily due to the effect of tax-exempt income from securities and insurance policies, and state income taxes.
 
At December 31, 2004, we had a gross deferred tax asset of $8.8 million, which related primarily to our allowance for loan losses. For 2004, we recognized income tax expense of $9.8 million, for an effective tax rate of 33.3%. The effective income tax rate differed from the U.S. statutory rate of 35% during 2004 primarily due to the effect of tax-exempt income from securities and insurance policies, and state income taxes.
 
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.
 
Consolidated Interim Financial Information (Unaudited)
 
                                 
    2005 Selected Quarterly Financial Data  
    Fourth     Third     Second     First  
    (In thousands except per share data)  
 
Interest income
  $ 49,195     $ 45,146     $ 39,167     $ 34,187  
Interest expense
    20,734       18,188       14,683       12,519  
                                 
Net interest income
    28,461       26,958       24,484       21,668  
Provision for loan losses
                       
                                 
Net interest income after provision for loan losses
    28,461       26,958       24,484       21,668  
Non-interest income
    5,986       5,790       4,694       4,179  
Non-interest expense
    22,736       21,249       19,190       17,854  
                                 
Income before income taxes
    11,711       11,499       9,988       7,993  
Income tax expense
    3,966       3,915       3,401       2,717  
                                 
Net income
  $ 7,745     $ 7,584     $ 6,587     $ 5,276  
                                 
Earnings per share:
                               
Basic
  $ .30     $ .30     $ .26     $ .21  
                                 
Diluted
  $ .29     $ .28     $ .25     $ .20  
                                 
Average shares:
                               
Basic
    25,726,000       25,650,000       25,578,000       25,522,000  
                                 
Diluted
    26,737,000       26,676,000       26,543,000       26,623,000  
                                 


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    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  
                                 
 
Analysis of Financial Condition
 
Loan Portfolio
 
Our loan portfolio has grown at an annual rate of 17.1%, 28.4% and 30.1% in 2003, 2004 and 2005, respectively, reflecting the build-up of our lending operations. Our business plan focuses primarily 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, increasing from 68.6% of total loans at December 31, 2001 to 75.7% of total loans at December 31, 2005. Construction loans have decreased from 19.9% of the portfolio at December 31, 2001 to 17.6% of the portfolio at December 31, 2005. Consumer loans have decreased from 2.8% of the portfolio at December 31, 2001 to 0.91% of the portfolio at December 31, 2005. 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  
    2005     2004     2003     2002     2001  
    (In thousands)  
 
Commercial
  $ 1,182,734     $ 818,156     $ 608,542     $ 509,505     $ 402,302  
Construction
    387,163       328,074       256,134       172,451       180,115  
Real estate
    478,634       397,029       339,069       282,703       218,192  
Consumer
    19,962       15,562       16,564       24,195       25,054  
Equipment leases
    16,337       9,556       13,152       17,546       34,552  
Loans held for sale
    111,178       119,537       80,780       116,106       43,764  
                                         
Total
  $ 2,196,008     $ 1,687,914     $ 1,314,241     $ 1,122,506     $ 903,979  
                                         


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We continue to lend primarily in Texas. As of December 31, 2005, 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 $754.0 million, or 34.3%, of total loans at December 31, 2005. Other notable concentrations include $246.6 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), $345.9 million to the contracting industry, $264.5 million in petrochemical and mining loans and $259.9 million in investors and investment management company 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, 2005
 
                                 
          Remaining Maturities of Selected Loans  
    Total     Within 1 Year     1-5 Years     After 5 Years  
    (In thousands)  
 
Loan maturity:
                               
Commercial
  $ 1,182,734     $ 564,838     $ 511,816     $ 106,080  
Construction
    387,163       173,784       195,262       18,117  
                                 
Total
  $ 1,569,897     $ 738,622     $ 707,078     $ 124,197  
                                 
Interest rate sensitivity for selected loans with:
                               
Predetermined interest rates
  $ 195,203     $ 136,873     $ 41,451     $ 16,879  
Floating or adjustable interest rates
    1,374,694       601,749       665,627       107,318  
                                 
Total
  $ 1,569,897     $ 738,622     $ 707,078     $ 124,197  
                                 
 
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 did not record a provision for the year ended December 31, 2005, but recorded provisions of $1.7 million for 2004 and $4.0 million for 2003. The provision for loan losses necessary to maintain reserve adequacy decreased due to the improvement in indicators of credit quality in 2005 and 2004, such as net charge-offs and the level of non-performing loans.
 
The reserve for loan losses is comprised of specific reserves for impaired loans and an estimate of losses inherent in the portfolio at the balance sheet date, but not yet identified with specified loans. We regularly evaluate our reserve for loan losses to maintain an adequate level to absorb estimated loan losses inherent in the loan portfolio. Factors contributing to the determination of specific reserves include the credit worthiness 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 specifically 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. Even though portions of the allowance may be allocated to specific loans, the entire allowance is available for any credit that, in management’s judgment, should be charged off.
 
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 at selected peer banks, adjusted for certain qualitative factors. Qualitative adjustments for such things as general economic conditions, changes in credit policies and lending


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standards, and changes in the trend and severity of problem loans, can cause the estimation of future losses to differ from past experience. 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 portion of the allowance that is not derived by the allowance allocation percentages compensates for the uncertainty and complexity in estimating loan and lease losses including factors and conditions that may not be fully reflected in the determination and application of the allowance allocation percentages. We evaluate many factors and conditions in determining the unallocated portion of the allowance, including the economic and business conditions affecting key lending areas, credit quality trends and general growth in the portfolio. The Company’s allowance for loan and lease losses exceeds its cumulative historical net charge-off experience for the last five years. The allowance, which has declined as a percent of total loans, is considered adequate and appropriate, given the significant growth in the loan and lease portfolio, current economic conditions in the Company’s market areas and other factors.
 
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 has matured, historical loss ratios have been closely monitored, and our reserve adequacy relies 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 $18.9 million at December 31, 2005 $18.7 million at December 31, 2004 and $17.7 million at December 31, 2003. Despite the increase in the total reserve, due to growth in the portfolio, the reserve had decreased to 0.91% at year-end 2005 from 1.20% and 1.44% of loans held for investment at December 31, 2004 and 2003, respectively.
 
The table below presents a summary of our loan loss experience for the past five years.


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Summary of Loan Loss Experience
 
                                         
    Year Ended December 31  
    2005     2004     2003     2002     2001  
    (In thousands, except percentage and multiple data)  
 
Beginning balance
  $ 18,698     $ 17,727     $ 14,538     $ 12,598     $ 8,910  
Loans charged-off:
                                       
Commercial
    410       258       50       2,096       1,418  
Real estate
    28             402              
Consumer
    93       157       5       11        
Equipment Leases
    66       939       618       1,740       656  
                                         
Total
    597       1,354       1,075       3,847       2,074  
Recoveries:
                                       
Commercial
    569       148       78       42        
Consumer
    2                          
Equipment Leases
    225       489       161       116        
                                         
      796       637       239       158        
                                         
Net charge-offs (recoveries)
    (199 )     717       836       3,689       2,074  
Provision for loan losses
          1,688       4,025       5,629       5,762  
                                         
Ending balance
  $ 18,897     $ 18,698     $ 17,727     $ 14,538     $ 12,598  
                                         
Reserve to loans held for investment(2)
    .91 %     1.20 %     1.44 %     1.45 %     1.47 %
Net charge-offs (recoveries) to average loans(2)
    (.01 )%     .05 %     .08 %     .40 %     .27 %
Provision for loan losses to average loans(2)
    .00 %     .12 %     .37 %     .61 %     .75 %
Recoveries to gross charge-offs
    133.33 %     47.05 %     22.23 %     4.11 %      
Reserve as a multiple of net charge-offs
    N/M       26.1 x     21.2 x     3.9 x     6.1 x
Non-performing and renegotiated loans:
                                       
Non-accrual(1)
  $ 5,657     $ 5,850     $ 10,217     $ 2,776     $ 6,032  
Loans past due (90 days)(3)
    2,795       209       7       135       384  
Renegotiated
                            5,013  
                                         
Total
  $ 8,452     $ 6,059     $ 10,224     $ 2,911     $ 11,429  
                                         
Allowance to non-performing loans
    2.2 x     3.1 x     1.7 x     5.0 x     1.1 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 $121,000, $168,000, $154,000 and $771,000 for the years ended December 31, 2005, 2004, 2003 and 2002, respectively.
 
(2) Excludes loans held for sale.
 
(3) At December 31, 2005, loans past due 90 days and still accruing includes premium finance loans of $2.5 million (89.4% of total). These loans are secured by obligations of insurance carriers to refund premiums on cancelled insurance policies. The refund of premiums from the insurance carriers can take up to 180 days from the cancellation date.


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Loan Loss Reserve Allocation
 
                                                                                 
    December 31  
    2005     2004     2003     2002     2001  
    Reserve     % of Loans     Reserve     % of Loans     Reserve     % of Loans     Reserve     % of Loans     Reserve     % of Loans  
    (In thousands, except percentage data)  
 
Loan category:
                                                                               
Commercial
  $ 9,996       53 %   $ 6,829       48 %   $ 6,376       46 %   $ 4,818       45 %   $ 7,549       45 %
Construction
    2,346       18       2,701       19       2,608       20       2,008       15       1,004       20  
Real estate(1)
    3,095       27       2,136       31       2,113       32       3,193       36       1,738       29  
Consumer
    115       1       371       1       93       1       114       2       116       2  
Equipment Leases
    395       1       457       1       932       1       706       2       623       4  
Unallocated
    2,950             6,204             5,605             3,699             1,568        
                                                                                 
Total
  $ 18,897       100 %   $ 18,698       100 %   $ 17,727       100 %   $ 14,538       100 %   $ 12,598       100 %
                                                                                 
 
 
(1) Includes loans held for sale.
 
During January 2006, payoff of certain criticized loans reduced the allocation of allowance for loan losses by approximately $1.0 million, increasing the unallocated portion of the allowance for loan losses to approximately $4.0 million. Since year-end 2003, the decrease in the unallocated portion of the allowance for loan losses has resulted primarily from application of risk grades to the growing loan portfolio.
 
Non-performing Assets
 
Non-performing assets include non-accrual loans and equipment 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  
    2005     2004     2003  
    (In thousands)  
 
Non-accrual loans:
                       
Commercial
  $ 4,931     $ 687     $ 4,124  
Construction
    61       4,371       3,986  
Real estate
    464       403       951  
Consumer
    51       126       105  
Equipment Leases
    150       263       1,051  
                         
Total non-accrual loans
  $ 5,657     $ 5,850     $ 10,217  
                         
Reserves
  $ 1,116     $ 1,278     $ 2,252  
 
At December 31, 2005, 2004 and 2003, we had $2.8 million, $209,000 and $7,000, respectively, in accruing loans past due 90 days or more. We did not recognize interest income on impaired loans during 2005, compared to $232,000 and $131,000 of interest income on impaired loans in 2004 and 2003, respectively. Additional interest income that would have been recorded if the loans had been current during the years ended December 31, 2005, 2004 and 2003 totaled $121,000, $168,000 and $154,000, respectively. At December 31, 2005 and 2004, we had $156,000 and $180,000, 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, 2005, approximately $46,000 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.


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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.
 
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, 2005, we maintained an average securities portfolio of $712.4 million compared to an average portfolio of $784.4 million for the same period in 2004. The December 31, 2005 portfolio was primarily comprised of mortgage-backed securities. The mortgage-backed securities in our portfolio at December 31, 2005 primarily consisted of government agency mortgage-backed securities.
 
Our unrealized gain on the securities portfolio value decreased from a gain of $4.0 million, which represented .50% of the amortized cost, at December 31, 2004, to a loss of $12.5 million, which represented 1.94% of the amortized cost, at December 31, 2005. 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, 2005 in relation to previous rates in 2004. The Company has not identified any issues related to the ultimate repayment of principal as a result of credit concerns on these securities.
 
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.
 
The average expected life of the mortgage-backed securities was 3.7 years at December 31, 2005 and December 31, 2004. The effect of possible changes in interest rates on our earnings and equity is discussed under “Interest Rate Risk Management.”


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The following presents the amortized cost and fair values of the securities portfolio at December 31, 2005, 2004 and 2003.
 
                                                 
    At December 31  
    2005     2004     2003  
    Amortized
          Amortized
          Amortized
       
    Cost     Fair Value     Cost     Fair Value     Cost     Fair Value  
    (In thousands)  
 
Available-for-sale:
                                               
U.S. Treasuries
  $ 2,589     $ 2,587     $ 1,896     $ 1,895     $ 1,798     $ 1,798  
Mortgage-backed securities
    533,374       522,499       690,775       694,543       698,093       702,532  
Corporate securities
    45,896       45,207       46,272       46,630       46,635       47,352  
Municipals
    48,642       47,846       48,721       48,644       11,449       11,372  
Equity securities(1)
    12,449       12,343       12,891       12,832       12,336       12,284  
                                                 
Total available-for-sale securities
  $ 642,950     $ 630,482     $ 800,555     $ 804,544     $ 770,311     $ 775,338  
                                                 
 
 
(1) Equity securities consist of Federal Reserve Bank stock, Federal Home Loan Bank stock, and Community Reinvestment Act funds.
 
The amortized cost and estimated fair value of securities are presented below by contractual maturity:
 
                                         
    At December 31, 2005  
          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
  $ 2,589     $     $     $     $ 2,589  
Estimated fair value
  $ 2,587     $     $     $     $ 2,587  
Weighted average yield
    3.862 %                       3.862 %
Mortgage-backed securities:(1)
                                       
Amortized cost
    60       73,598       106,980       352,736       533,374  
Estimated fair value
    60       71,493       104,266       346,680       522,499  
Weighted average yield
    6.000 %     3.985 %     4.337 %     4.625 %     4.479 %
Corporate securities:
                                       
Amortized cost
    10,201       30,696       4,999             45,896  
Estimated fair value
    10,073       30,025       5,109             45,207  
Weighted average yield
    3.016 %     3.880 %     7.376 %           4.075 %
Municipals:(2)
                                       
Amortized cost
          6,158       28,285       14,199       48,642  
Estimated fair value
          6,044       27,849       13,953       47,846  
Weighted average yield
          6.415 %     7.985 %     8.766 %     8.017 %
Equity securities:
                                       
Amortized cost
    12,449                         12,449  
Estimated fair value
    12,343                         12,343  
Total available-for-sale securities:
                                       
                                         
Amortized cost
                                  $ 642,950  
                                         
Estimated fair value
                                  $ 630,482  
                                         


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(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, 2005.
 
(2) Yields have been adjusted to a tax equivalent basis assuming a 35% federal tax rate.
 
The following table discloses, as of December 31, 2005 and 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  
 
December 31, 2005
                                               
U.S. Treasuries
  $ 2,587     $ (2 )   $     $     $ 2,587     $ (2 )
Mortgage-backed securities
    280,855       (5,914 )     157,199       (5,888 )     438,054       (11,802 )
Corporate securities
    30,025       (671 )     10,073       (128 )     40,098       (799 )
Municipals
    35,525       (562 )     8,959       (256 )     44,484       (818 )
Equity securities
    999       (7 )     1,401       (99 )     2,400       (106 )
                                                 
    $ 349,991     $ (7,156 )   $ 177,632     $ (6,371 )   $ 527,623     $ (13,527 )
                                                 
December 31, 2004
                                               
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 2005 in relation to previous rates in 2004. 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, 2005 increased $519.7 million compared to the same period of 2004. Average demand deposits, interest bearing transaction accounts, savings, and time deposits increased by $111.8 million, $11.5 million, $88.6 million, and $307.8 million, respectively, during the year ended December 31, 2005 as compared to the same period of 2004. The average cost of deposits increased in 2005 mainly due to higher market interest rates.


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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.
 
Deposit Analysis
 
                         
    Average Balances  
    2005     2004     2003  
    (In thousands)  
 
Non-interest bearing
  $ 410,213     $ 298,430     $ 249,782  
Interest bearing transaction
    108,459       96,911       65,521  
Savings
    647,039       558,479       443,098  
Time deposits
    545,603       512,852       541,504  
Deposits in foreign branches
    360,142       85,133       6,656  
                         
Total average deposits
  $ 2,071,456     $ 1,551,805     $ 1,306,561  
                         
 
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, 2005, approximately 75% of our deposits originated out of our Dallas metropolitan banking centers. Uninsured deposits at December 31, 2005 were 56% of total deposits, compared to 62% of total deposits at December 31, 2004 and 60% of total deposits at December 31, 2003. The presentation for 2005, 2004 and 2003 does reflect combined ownership, but does not reflect all of the account styling that would determine insurance based on FDIC regulations.
 
At December 31, 2005, approximately 5% 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, 2005, we had $545.3 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  
    2005     2004     2003  
    (In thousands)  
 
Months to maturity:
                       
3 or less
  $ 298,134     $ 174,392     $ 214,778  
Over 3 through 6
    24,224       33,229       37,890  
Over 6 through 12
    89,481       56,943       53,678  
Over 12
    96,341       137,325       104,866  
                         
Total
  $ 508,180     $ 401,889     $ 411,212  
                         
 
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, 2004 and 2005, our principal source of funding has been our customer deposits, supplemented


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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) and Federal Home Loan Bank (FHLB) borrowings.
 
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, 2005, comprised $2,388.7 million, or 95.7%, of total deposits, compared to $1,730.7 million, or 95.2%, of total deposits, at December 31, 2004. 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, 2005, brokered retail CDs comprised $106.5 million, or 4.3%, of total deposits. Our dependence on retail brokered CDs is limited by our internal funding guidelines, which as of December 31, 2005, 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 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 FHLB. As of December 31, 2005, our borrowings consisted of a total of $99.7 million of securities sold under repurchase agreements, $103.5 million of downstream federal funds purchased, $8.7 million from customer repurchase agreements and $3.9 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, 2005, $50.0 million of our borrowings consisted of borrowings from the FHLB. Our unused FHLB borrowing capacity at December 31, 2005 was approximately $280.0 million. As of December 31, 2005, we had unused upstream federal fund lines available from commercial banks of approximately $280.5 million. During the year ended December 31, 2005, our average borrowings from these sources were $477.2 million, of which $315.6 million related to securities sold under repurchase agreements. The maximum amount of borrowed funds outstanding at any month-end during the year ended December 31, 2005 was $610.3 million, of which $354.2 million related to securities sold under repurchase agreements.
 
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 andother 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 7.88%. The interest rate on the Subordinated Debentures issued in connection with the 2003 Trust Preferred adjusts every three months and is currently 7.50%. 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


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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.
 
On October 6, 2005, Texas Capital Statutory Trust III issued $25,000,000 of its Fixed/Floating Rate Capital Securities (the “Capital Securities”) in a private offering. Proceeds of the Capital Securities, together with the proceeds from the sale by the Trust of its Common Securities to the Company, were invested in a related series of our Fixed/Floating Rate Junior Subordinated Deferrable Interest Debentures (the “Debentures”). 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.
 
The interest rate on the Debentures issued in connection with the 2005 Trust Preferred is a fixed rate of 6.19% for five years through December 15, 2010. 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 Capital Securities and the Debentures each mature in October 2035; however, the Capital Securities and the Debentures may be redeemed at the option of the Company on fixed quarterly dates beginning on December 15, 2010.
 
The following table presents, as of December 31, 2005, 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.
 
                                                 
    Note
    Within One
    After One But
    After Three But
    After
       
    Reference     Year     Within Three Years     Within Five Years     Five Years     Total  
    (In thousands)  
 
Deposits without a stated maturity(a)
    6     $ 1,352,196     $     $     $     $ 1,352,196  
Time deposits (a)
    6       999,495       44,924       98,387       177       1,142,983  
Federal funds purchased
    7       103,497                         103,497  
Securities sold under repurchase agreements(a)
    7       70,250       29,400                   99,650  
Customer repurchase agreements(a)
    7       8,707                         8,707  
Treasury, tax and loan notes(a)
    7       3,867                         3,867  
FHLB borrowings(a)
    7       50,000                         50,000  
Operating lease obligations
    16       5,230       10,414       6,997       2,975       25,616  
Long-term debt(a)
    7, 8                         46,394       46,394  
                                                 
Total contractual obligations
          $ 2,593,242     $ 84,738     $ 105,384     $ 49,564     $ 2,832,910  
                                                 
 
 
(a) Excludes interest.


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Off-Balance Sheet Arrangements
 
The contractual amount of our financial instruments with off-balance sheet risk expiring by period at December 31, 2005 is presented below:
 
                                         
          After One
    After Three
             
    Within One
    But Within
    But Within
    After Five
       
    Year     Three Years     Five Years     Years     Total  
    (In thousands)  
 
Commitments to extend credit
  $ 476,361     $ 326,239     $ 42,243     $ 6,782     $ 851,625  
Standby and commercial letters of credit
    46,019       6,535                   52,554  
                                         
Total financial instruments with off-balance sheet risk
  $ 522,380     $ 332,774     $ 42,243     $ 6,782     $ 904,179  
                                         
 
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 $204.5 million for the year ended December 31, 2005 as compared to $182.2 million in 2004 and $142.4 million in 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.
 
Our actual and minimum required capital amounts and actual ratios are as follows:
 
                                 
    Regulatory Capital Adequacy  
    December 31,
    December 31,
 
    2005     2004  
    Amount     Ratio     Amount     Ratio  
    (In thousands, except percentage data)  
 
Total capital (to risk-weighted assets):
                               
Company
                               
Actual
  $ 275,695       10.83%     $ 229,658       11.67%  
Minimum required
    203,701       8.00%       157,395       8.00%  
Excess above minimum
    71,994       2.83%       72,263       3.67%  
Bank
                               
Actual
    258,327       10.15%       199,005       10.13%  
To be well-capitalized
    254,431       10.00%       196,494       10.00%  
Minimum required
    203,544       8.00%       157,195       8.00%  
Excess above well-capitalized
    3,896       0.15%       2,511       .13%  
Excess above minimum
    54,783       2.15%       41,810       2.13%  
Tier 1 capital (to risk-weighted assets):
                               
Company
                               
Actual
  $ 256,798       10.09%     $ 210,960       10.72%  
Minimum required
    101,851       4.00%       78,697       4.00%  
Excess above minimum
    154,947       6.09%       132,263       6.72%  


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    Regulatory Capital Adequacy  
    December 31,
    December 31,
 
    2005     2004  
    Amount     Ratio     Amount     Ratio  
    (In thousands, except percentage data)  
 
Bank
                               
Actual
  $ 239,430       9.41%     $ 180,307       9.18%  
To be well-capitalized
    152,658       6.00%       117,896       6.00%  
Minimum required
    101,772       4.00%       78,597       4.00%  
Excess above well-capitalized
    86,772       3.41%       62,411       3.18%  
Excess above minimum
    137,658       5.41%       101,710       5.18%  
Tier 1 capital (to average assets):
                               
Company
                               
Actual
  $ 256,798       8.68%     $ 210,960       8.31%  
Minimum required
    118,296       4.00%       101,500       4.00%  
Excess above minimum
    138,502       4.68%       109,460       4.31%  
Bank
                               
Actual
  $ 239,430       8.10%     $ 180,307       7.11%  
To be well-capitalized
    147,775       5.00%       126,750       5.00%  
Minimum required
    118,220       4.00%       101,400       4.00%  
Excess above well-capitalized
    91,655       3.10%       53,557       2.11%  
Excess above minimum
    121,210       4.10%       78,907       3.11%  
 
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 inthe 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.

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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.” The statement eliminates the ability to account for stock-based compensation using APB 25 and requires that such transactions be recognized as compensation expense in the income statement based on their fair values on the measurement date. We will implement SFAS 123R effective January 1, 2006. We will transition to the fair-value based accounting for stock-based compensation using a modified version of prospective application (“modified prospective application”). Under modified prospective application, SFAS 123R applies to new awards and to awards modified, repurchased, or cancelled after January 1, 2006. Additionally, compensation expense for the portion of awards which the requisite service has not been rendered, generally non-vested awards that are outstanding as of January 1, 2006, must be recognized as the remaining requisite service is rendered during the period after the adoption of SFAS 123R. Compensation expense for those earlier awards will be based on the same method and on the same grant date fair values previously determined for the pro forma disclosures required for companies that did not adopt the fair value accounting method for stock-based employee compensation. Based on stock-based compensation awards outstanding at December 31, 2005 for which the requisite service period is not expected to be fully rendered prior to January 1, 2006, we expect to recognize compensation expense comparable to the amounts previously reported, on a quarterly basis and in this document, on a pro forma basis. Future levels of compensation expense will be impacted by new awards, which can not be estimated at this time.


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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 +/− 5%. 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.
 
Interest Rate Risk Management
 
Our interest rate sensitivity is illustrated in the following table. The table reflects rate-sensitive positions as of December 31, 2005, 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.


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Interest Rate Sensitivity Gap Analysis
 
                                         
    December 31, 2005  
    0-3 mo Balance     4-12 mo Balance     1-3 yr Balance     3+ yr Balance     Total Balance  
    (In thousands)  
 
Securities(1)
  $ 26,592     $ 79,228     $ 180,970     $ 343,692     $ 630,482  
Total Variable Loans
    1,849,899       19,075       803       1,156       1,870,933  
Total Fixed Loans
    111,383       64,117       77,272       72,303       325,075  
                                         
Total Loans(2)
    1,961,282       83,192       78,075       73,459       2,196,008  
Total Interest Sensitive Assets
  $ 1,987,874     $ 162,420     $ 259,045     $ 417,151     $ 2,826,490  
                                         
Liabilities:
                                       
Interest Bearing Customer Deposits
  $ 1,386,678     $     $     $     $ 1,386,678  
CD’s & IRA’s
    264,600       87,663       39,153       98,319       489,735  
Wholesale Deposits
    50,099       50,358       5,770       245       106,472  
                                         
Total Interest-bearing Deposits
  $ 1,701,377     $ 138,021     $ 44,923     $ 98,564     $ 1,982,885  
Repo, FF, FHLB Borrowings
    193,821       42,500       29,400             265,721  
Trust Preferred
                      46,394       46,394  
                                         
Total Borrowing
    193,821       42,500       29,400       46,394       312,115  
Total Interest Sensitive Liabilities
  $ 1,895,198     $ 180,521     $ 74,323     $ 144,958     $ 2,295,000  
                                         
GAP
    92,676       (18,101 )     184,722       272,193        
Cumulative GAP
    92,676       74,575       259,297       531,490       531,490  
Demand Deposits
                                    512,294  
Stockholders’ Equity
                                    215,523  
                                         
Total
                                  $ 727,817  
                                         
 
 
(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, 2005 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 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.


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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 plannedgrowth 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
    200 bp Decrease
    200 bp Increase
    100 bp Decrease(1)
 
    December 31, 2005     December 31, 2005     December 31, 2004     December 31, 2004  
    (In thousands)  
 
Change in net interest income
  $ 6,794     $ (6,700 )   $ 8,363     $ (3,724 )
 
 
(1) Due to interest rate levels at 12/31/04, calculating the change in net interest income with a 200 bp decrease would have yielded information that would have been not meaningful.
 
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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Table of Contents

 
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, 2005 and 2004, and the related consolidated statements of operations, stockholders’ equity, and cash flows for each of the three years in the period ended December 31, 2005. 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 consolidated financial position of Texas Capital Bancshares, Inc. at December 31, 2005 and 2004, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2005, 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, 2005, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated February 28, 2006, expressed an unqualified opinion thereon.
 
/s/  ERNST & YOUNG LLP
 
Dallas, Texas
February 28, 2006


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Table of Contents

Texas Capital Bancshares, Inc.
 
Consolidated Balance Sheets
 
                 
    December 31  
    2005     2004  
    (In thousands except share data)  
 
ASSETS
Cash and due from banks
  $ 137,840     $ 78,490  
Securities, available-for-sale
    630,482       804,544  
Loans held for sale
    111,178       119,537  
Loans held for investment, net
    2,057,064       1,545,880  
Premises and equipment, net
    21,632       4,518  
Accrued interest receivable and other assets
    71,517       56,698  
Goodwill and intangible assets, net
    12,512       1,496  
                 
Total assets
  $ 3,042,225     $ 2,611,163  
                 
                 
                 
 
LIABILITIES AND STOCKHOLDERS’ EQUITY
Deposits:
               
Non-interest bearing
  $ 512,294     $ 397,629  
Interest bearing
    1,436,111       1,234,283  
Interest bearing in foreign branches
    546,774       157,975  
                 
      2,495,179       1,789,887  
Accrued interest payable
    4,778       3,511  
Other liabilities
    14,630       6,879  
Federal funds purchased
    103,497       113,478  
Repurchase agreements
    108,357       478,204  
Other borrowings
    53,867       3,309  
Long-term debt
    46,394       20,620  
                 
Total liabilities
    2,826,702       2,415,888  
Stockholders’ equity:
               
Common stock, $.01 par value:
               
Authorized shares — 100,000,000 Issued shares — 25,771,718 and 25,461,602 at December 31, 2005 and 2004, respectively
    258       255  
Additional paid-in capital
    176,131       172,380  
Retained earnings
    47,239       20,047  
Treasury stock (shares at cost: 84,274 at December 31, 2005 and 2004)
    (573 )     (573 )
Deferred compensation
    573       573  
Accumulated other comprehensive income (loss)
    (8,105 )     2,593  
                 
Total stockholders’ equity
    215,523       195,275  
                 
Total liabilities and stockholders’ equity
  $ 3,042,225     $ 2,611,163  
                 
 
See accompanying notes.
 


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Texas Capital Bancshares, Inc.
 
Consolidated Statements of Operations
 
                         
    Year Ended December 31  
    2005     2004     2003  
    (In thousands except per share data)  
 
Interest income:
                       
Interest and fees on loans
  $ 136,225     $ 78,600     $ 62,451  
Securities
    30,712       32,200       22,853  
Federal funds sold
    611       65       166  
Deposits in other banks
    147       13       14  
                         
Total interest income
    167,695       110,878       85,484  
Interest expense:
                       
Deposits
    50,028       23,237       20,931  
Federal funds purchased
    4,383       1,791       1,550  
Repurchase agreements
    8,978       9,538       8,621  
Other borrowings
    877       474       322  
Long-term debt
    1,858       1,096       905  
                         
Total interest expense
    66,124       36,136       32,329  
                         
Net interest income
    101,571       74,742       53,155  
Provision for loan losses
          1,688       4,025  
                         
Net interest income after provision for loan losses
    101,571       73,054       49,130  
Non-interest income:
                       
Service charges on deposit accounts
    3,223       3,370       3,446  
Trust fee income
    2,739       1,932       1,313  
Gains on sale of securities, net
                666  
Cash processing fees
          587       973  
Bank owned life insurance (BOLI) income
    1,136       1,288       1,619  
Brokered loan fees
    1,759       996       1,524  
Gain on sale of mortgage loans
    7,992       3,420       120  
Insurance commissions
    1,047       444       163  
Other
    2,753       1,595       1,068  
                         
Total non-interest income
    20,649       13,632       10,892  
Non-interest expense:
                       
Salaries and employee benefits
    50,726       34,794       23,604  
Net occupancy expense
    7,520       5,695       4,987  
Marketing
    3,336       2,609       1,432  
Legal and professional
    5,166       3,141       2,867  
Communications and data processing
    2,900       3,158       3,042  
Franchise taxes
    273       246       124  
Repurchase agreement penalties
                6,262  
Other
    11,108       7,697       6,062  
                         
Total non-interest expense
    81,029       57,340       48,380  
                         
Income before income taxes
    41,191       29,346       11,642  
Income tax expense (benefit)
    13,999       9,786       (2,192 )
                         
Net income
    27,192       19,560       13,834  
Preferred stock dividends
                (699 )
                         
Income available to common stockholders
  $ 27,192     $ 19,560     $ 13,135  
                         
Income per share:
                       
Basic
  $ 1.06     $ .77     $ .62  
                         
Diluted
  $ 1.02     $ .75     $ .60  
                         
 
See accompanying notes.
 


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Texas Capital Bancshares, Inc.
 
Consolidated Statements of Changes in Stockholders’ Equity
 
                                                                                                         
                            Series A-1
          Retained
                      Accumulated
       
    Series A Convertible
                Non-Voting
    Additional
    Earnings/
                      Other
       
    Preferred Stock     Common Stock     Common Stock     Paid-in
    (Accumulated
    Treasury Stock     Deferred
    Comprehensive
       
    Shares     Amount     Shares     Amount     Shares     Amount     Capital     Deficit)     Shares     Amount     Compensation     Income (Loss)     Total  
    (In thousands except share data)  
 
Balance at December 31, 2002
    1,057,142     $ 11       18,500,812     $ 185       695,516     $ 7     $ 131,881     $ (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                                     412  
Sale of common stock
                3,698,913       37                   36,167                                       36,204  
Conversion of preferred stock
    (1,057,142 )     (11 )     2,114,284       21                   (10 )                                    
Preferred dividends
                                        (699 )                                   (699 )
Transfers
                401,598       4       (401,598 )     (4 )                                          
Sale of treasury stock
                                                    12,972       95                   95  
                                                                                                         
Balance at December 31, 2003
                24,715,607       247       293,918       3       167,751       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                                     1,411  
Sale of common stock
                452,077       5                   3,218                                     3,223  
Transfers
                293,918       3       (293,918 )     (3 )                                          
                                                                                                         
Balance at December 31, 2004
                25,461,602       255                 $ 172,380       20,047       (84,274 )     (573 )     573       2,593       195,275  
Comprehensive income:
                                                                                                       
Net income
                                              27,192                               27,192  
Change in unrealized gain (loss) on available- for-sale securities, net of taxes of $5,759
                                                                      (10,698 )     (10,698 )
                                                                                                         
Total comprehensive income
                                                                                                    16,494  
Tax benefit related to exercise of stock options
                                        1,424                                     1,424  
Sale of common stock
                310,116       3                   2,327                                     2,330  
                                                                                                         
Balance at December 31, 2005
        $       25,771,718     $ 258           $     $ 176,131     $ 47,239       (84,274 )   $ (573 )   $ 573     $ (8,105 )   $ 215,523  
                                                                                                         
 
See accompanying notes.


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Texas Capital Bancshares, Inc.
 
Consolidated Statements of Cash Flows
 
                         
    Year Ended December 31  
    2005     2004     2003  
    (In thousands)  
 
Operating activities
                       
Net income
  $ 27,192     $ 19,560     $ 13,834  
Adjustments to reconcile net income to net cash provided by (used in) operating activities:
                       
Provision for loan losses
          1,688       4,025  
Deferred tax benefit
    (302 )     (300 )     (7,726 )
Depreciation and amortization
    1,985       1,555       1,420  
Amortization and accretion on securities
    2,340       4,393       9,510  
Bank owned life insurance (BOLI) income
    (1,136 )     (1,251 )     (1,619 )
Gain on sale of securities, net
                (666 )
Gain on sale of mortgage loans
    (7,992 )     (3,420 )     (120 )
Originations of loans held for sale
    (1,830,533 )     (1,618,401 )     (2,295,268 )
Proceeds from sales of loans held for sale
    1,846,884       1,583,284       2,328,464  
Tax benefit from stock option exercises
    1,424       1,411       412  
Impact of reversing tax valuation allowance
                (5,929 )
Changes in operating assets and liabilities:
                       
Accrued interest receivable and other assets
    (12,792 )     (5,737 )     9,051  
Accrued interest payable and other liabilities
    14,778       1,039       (211 )
                         
Net cash provided by (used in) operating activities
    41,848       (16,179 )     55,177  
Investing activities
                       
Purchases of available-for-sale securities
    (17,437 )     (239,067 )     (652,578 )
Proceeds from sales of available-for-sale securities
                62,895  
Maturities and calls of available-for-sale securities
    17,252       14,002       15,218  
Principal payments received on securities
    155,449       190,427       338,463  
Net increase in loans
    (526,205 )     (336,462 )     (226,207 )
Purchase of premises and equipment, net
    (3,724 )     (1,099 )     (2,088 )
Cash paid for acquisitions
    (11,185 )            
                         
Net cash used in investing activities
    (385,850 )     (372,199 )     (464,297 )
Financing activities
                       
Net increase in checking, money market and savings accounts
    245,178       269,325       161,287  
Net increase in certificates of deposit
    460,114       75,532       87,208  
Sale of common stock
    2,330       3,223       36,117  
Issuance of long-term debt
    25,000             10,000  
Net other borrowings
    (319,289 )     14,720       100,962  
Net federal funds purchased
    (9,981 )     34,517       (4,668 )
Dividends paid
                (979 )
                         
Net cash provided by financing activities
    403,352       397,317       389,927  
                         
Net increase (decrease) in cash and cash equivalents
    59,350       8,939       (19,193 )
Cash and cash equivalents, beginning of year
    78,490       69,551       88,744  
                         
Cash and cash equivalents, end of year
  $ 137,840     $ 78,490     $ 69,551  
                         
Supplemental disclosures of cash flow information:
                       
Cash paid during the year for interest
  $ 64,857     $ 36,093     $ 32,687  
Cash paid during the year for income taxes
    12,999       10,250       5,720  
Non-cash transactions:
                       
Transfers from loans/leases to other repossessed assets
    68       418       230  
Transfers from loans/leases to premises and equipment
    126       302       175  
 
See accompanying notes.


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Table of Contents

Texas Capital Bancshares, Inc.
 
 
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.
 
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.
 
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.
 
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.


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
Loans
 
Loans (which include equipment 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 and purchases participations in 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.
 
Repossessed Assets
 
Repossessed assets, which are included in other assets on the balance sheet, 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.


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
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.
 
Goodwill and 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 tests impairment on an annual basis, or an interim basis if an event occurs or circumstances change that would more likely than not reduce the fair value of the underlying unit below its carrying value. See Note 4 — Goodwill and Intangible Assets.
 
Intangible assets are acquired assets that lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability. The Company’s intangible assets relate primarily to customer relationships. Intangible assets with definite useful lives are amortized on an accelerated basis over their estimated life. Intangible assets are tested for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable from future undiscounted cash flows. See Note 4 — Goodwill and Intangible Assets.
 
Segment Reporting
 
The Company has determined that all of its lending divisions and subsidiaries meet the aggregation criteria of SFAS No. 131 “Segment Disclosures and Related Information,” since all offer similar products and services, operate with similar processes, and have similar customers.
 
Stock-based Compensation
 
At December 31, 2005, 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


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

income and earnings per share if the Company had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.
 
                         
    Year Ended December 31  
    2005     2004     2003  
    (In thousands except per share data)  
 
Net income as reported
  $ 27,192     $ 19,560     $ 13,834  
Add: Total stock based employee compensation recorded, net of related tax effect
    576       510       404  
Less: Total stock based employee compensation expense determined under fair value based method for all awards, net of related tax effect
    (1,526 )     (1,274 )     (952 )
                         
Pro forma net income
  $ 26,242     $ 18,796     $ 13,286  
                         
Basic income per share:
                       
As reported
  $ 1.06     $ .77     $ .62  
Pro forma
    1.02       .74       .59  
Diluted income per share:
                       
As reported
  $ 1.02     $ .75     $ .60  
Pro forma
    .98       .71       .57  
 
The fair value of these options was estimated at the date of grant using the Black-Scholes option pricing model with the following weighted-average assumptions:
 
                         
    2005     2004     2003  
 
Risk-free rate
    5.26 %     3.64 %     3.12 %
Dividend yield
    0.00       0.00       0.00  
Market price volatility factor
    .390       .288       .145  
Weighted-average expected life of options
    5 years       5 years       5 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 below for discussion related to SFAS No. 123 (revised 2004), “Share-Based Payment,” (“SFAS 123R”) which revised SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stockissued to Employees,” and the Company’s pending adoption of the provisions of the new standard.
 
Accumulated Other Comprehensive Income (Loss)
 
Unrealized gains or losses on the Company’s available-for-sale securities (after applicable income tax expense or benefit) are included in accumulated other comprehensive income (loss).
 
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


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

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.
 
New Accounting Standard
 
In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS 123R. The statement eliminates the ability to account for stock-based compensation using APB 25 and requires that such transactions be recognized as compensation expense in the income statement based on their fair values on the measurement date. We will implement SFAS 123R effective January 1, 2006. We will transition to the fair-value based accounting for stock-based compensation using a modified version of prospective application (“modified prospective application”). Under modified prospective application, SFAS 123R applies to new awards and to awards modified, repurchased, or cancelled after January 1, 2006. Additionally, compensation expense for the portion of awards which the requisite service has not been rendered, generally non-vested awards that are outstanding as of January 1, 2006, must be recognized as the remaining requisite service is rendered during the period after the adoption of SFAS 123R. Compensation expense for those earlier awards will be based on the same method and on the same grant date fair values previously determined for the pro forma disclosures required for companies that did not adopt the fair value accounting method for stock-based employee compensation. Based on stock-based compensation awards outstanding at December 31, 2005 for which the requisite service period is not expected to be fully rendered prior to January 1, 2006, we expect to recognize compensation expense comparable to the amounts previously reported, on a quarterly basis and in this document, on a pro forma basis. Future levels of compensation expense will be impacted by new awards, which can not be estimated at this time.
 
Reclassification
 
Certain reclassifications have been made to the 2004 and 2003 consolidated financial statements to conform to the 2005 presentation.
 
2.   Securities
 
The following is a summary of securities:
 
                                 
    December 31, 2005  
          Gross
    Gross
    Estimated
 
    Amortized
    Unrealized
    Unrealized
    Fair
 
    Cost     Gains     Losses     Value  
    (In thousands)  
 
Available-for-Sale Securities:
                               
U.S. Treasuries
  $ 2,589     $     $ (2 )   $ 2,587  
Mortgage-backed securities
    533,374       927       (11,802 )     522,499  
Corporate securities
    45,896       110       (799 )     45,207  
Municipals
    48,642       22       (818 )     47,846  
Equity securities
    12,449             (106 )     12,343  
                                 
    $ 642,950     $ 1,059     $ (13,527 )   $ 630,482  
                                 
 


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

                                 
    December 31, 2004  
    Amortized
    Amortized
    Amortized
    Amortized
 
    Cost     Cost     Cost     Cost  
    (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  
                                 

 
The amortized cost and estimated fair value of securities are presented below by contractual maturity:
 
                                         
    At December 31, 2005  
          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
  $ 2,589     $     $     $     $ 2,589  
Estimated fair value
  $ 2,587     $     $     $     $ 2,587  
Weighted average yield
    3.862 %                       3.862 %
Mortgage-backed securities:(1) 
                                       
Amortized cost
    60       73,598       106,980       352,736       533,374  
Estimated fair value
    60       71,493       104,266       346,680       522,499  
Weighted average yield
    6.000 %     3.985 %     4.337 %     4.625 %     4.479 %
Corporate securities:
                                       
Amortized cost
    10,201       30,696       4,999             45,896  
Estimated fair value
    10,073       30,025       5,109             45,207  
Weighted average yield
    3.016 %     3.880 %     7.376 %           4.075 %
Municipals:(2)
                                       
Amortized cost
          6,158       28,285       14,199       48,642  
Estimated fair value
          6,044       27,849       13,953       47,846  
Weighted average yield
          6.415 %     7.985 %     8.766 %     8.017 %
Equity securities:
                                       
Amortized cost
    12,449                         12,449  
Estimated fair value
    12,343                         12,343  
                                         
Total available-for-sale securities:
                                       
Amortized cost
                                  $ 642,950  
                                         
Estimated fair value
                                  $ 630,482  
                                         
 
 
(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.

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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
Securities with carrying values of approximately $327,091,000 and $659,256,000 were pledged to secure certain borrowings and deposits at December 31, 2005 and 2004, respectively. See Note 7 for discussion of securities securing borrowings. Of the pledged securities at December 31, 2005 and 2004, approximately $173,189,000 and $134,998,000, respectively, were pledged for certain deposits.
 
The following tables disclose, as of December 31, 2005 and 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
          Unrealized
          Unrealized
 
    Fair Value     Loss     Fair Value     Loss     Fair Value     Loss  
 
December 31, 2005
                                               
U.S. Treasuries
  $ 2,587     $ (2 )   $     $     $ 2,587     $ (2 )
Mortgage-backed securities
    280,855       (5,914 )     157,199       (5,888 )     438,054       (11,802 )
Corporate securities
    30,025       (671 )     10,073       (128 )     40,098       (799 )
Municipals
    35,525       (562 )     8,959       (256 )     44,484       (818 )
Equity securities
    999       (7 )     1,401       (99 )     2,400       (106 )
                                                 
    $ 349,991     $ (7,156 )   $ 177,632     $ (6,371 )   $ 527,623     $ (13,527 )
                                                 
December 31, 2004
                                               
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 160. 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, 2005 in relation to previous rates in 2004. The Company has not identified any issues related to the ultimate repayment of principal as a result of credit concerns on these securities.


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
3.   Loans and Allowance for Loan Losses
 
Loans are summarized by category as follows (in thousands):
 
                 
    December 31  
    2005     2004  
 
Commercial
  $ 1,182,734     $ 818,156  
Construction
    387,163       328,074  
Real estate
    478,634       397,029  
Consumer
    19,962       15,562  
Equipment Leases
    16,337       9,556  
Loans held for sale
    111,178       119,537  
                 
      2,196,008       1,687,914  
Deferred income (net of direct origination costs)
    (8,869 )     (3,799 )
Allowance for loan losses
    (18,897 )     (18,698 )
                 
Loans, net
  $ 2,168,242     $ 1,665,417  
                 
 
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 $754.0 million or 34.3% of total loans at December 31, 2005. 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 $246.6 million, contracting industry loans of $345.9 million, petrochemical and mining of $264.5 million and $259.9 million in investors and investment management company loans at December 31, 2005. 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.
 
The changes in the allowance for loan losses are summarized as follows (in thousands):
 
                         
    Year Ended December 31  
    2005     2004     2003  
 
Balance, beginning of year
  $ 18,698     $ 17,727     $ 14,538  
Provision for loan losses
          1,688       4,025  
Loans charged off
    (597 )     (1,354 )     (1,075 )
Recoveries
    796       637       239  
                         
Balance, end of year
  $ 18,897     $ 18,698     $ 17,727  
                         
 
The Bank had impaired loans and equipment leases in the amount of $5,657,000, $5,850,000 and $10,217,000 with reserves of $1,116,000, $1,278,000, and $2,252,000 as of December 31, 2005, 2004 and 2003, respectively. The Bank did not recognize interest income on impaired loans during 2005, compared to $232,000 and $131,000 of interest income on impaired loans in 2004 and 2003, respectively. Additional interest income that would have been recorded if the loans had been current during the years ended December 31, 2005, 2004 and 2003 totaled $121,000, $168,000 and $154,000, respectively. Average impaired loans outstanding during the years ended December 31, 2005, 2004 and 2003 totaled $4,726,000, $7,252,000 and $7,899,000, respectively.
 
At December 31, 2005, 2004 and 2003, the Bank had $2.8 million, $209,000 and $7,000, respectively, in accruing loans past due 90 days or more. The $2.8 million balance at December 31, 2005, includes premium finance loans of $2.5 million (89.4% of the total). These loans are secured by obligations of insurance carriers to refund


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

premiums on cancelled insurance policies. The refund of premiums from the insurance carriers can take up to 180 days from the cancellation date.
 
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 $14,069,000 and $5,325,000 at December 31, 2005 and 2004, respectively. During the years ended December 31, 2005 and 2004, total advances were approximately $22,900,000 and $13,766,000 and total paydowns were $14,156,000 and $23,229,000, respectively.
 
4.   Goodwill and Intangible Assets
 
Goodwill totaled $9.3 million (net of $374,000 of accumulated amortization) at December 31, 2005, and $1.5 million (net of $374,000 of accumulated amortization) at December 31, 2004. During the second quarter of 2005, the Company recorded $5.1 million of goodwill related to the purchase of a premium finance marketing company. Additional payments up to $4 million, over 3 years, may increase this goodwill amount. During the fourth quarter of 2005, the Company recorded $2.7 million of goodwill related to the purchase of an insurance agency and insurance books of business.
 
Other intangible assets include $1.6 million related to the July 2005 purchase of the customer base intangible related to a purchased portfolio and loan account services of a premium finance loan customer base, and $1.7 million related to the purchase of insurance customer relationships. Other intangible assets are amortized over their estimated lives which range from 7 to 10 years. Amortization expense related to intangible assets totaled $169,000 in 2005. Accumulated amortization related to the intangible assets is approximately $169,000 at December 31, 2005. Annual amortization will be approximately $567,000 for 2006 and 2007 and $344,000 for 2008 through 2010.
 
5.   Premises and Equipment
 
Premises and equipment at December 31, 2005 and 2004 are summarized as follows:
 
                 
    December 31  
    2005     2004  
    (In thousands)  
 
Premises
  $ 6,049     $ 4,210  
Furniture and equipment
    10,657       8,332  
Rental equipment
    15,304       609  
                 
      32,010       13,151  
Accumulated depreciation
    (10,378 )     (8,633 )
                 
    $ 21,632     $ 4,518  
                 
 
Depreciation expense was approximately $1,816,000, $1,555,000 and $1,420,000 in 2005, 2004 and 2003, respectively.


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
6.   Deposits
 
The scheduled maturities of interest bearing time deposits are as follows at December 31, 2005 (in thousands):
 
         
2006
  $ 999,495  
2007
    26,634  
2008
    18,290  
2009
    82,034  
2010
    16,353  
2011 and after
    177  
         
    $ 1,142,983  
         
 
At December 31, 2005 and 2004, the Bank had approximately $50,000,000 and $45,000,000, respectively, in deposits from related parties, including directors, stockholders, and their related affiliates.
 
At December 31, 2005 and 2004, interest bearing time deposits, including deposits in foreign branches, of $100,000 or more were approximately $1,053,599,000 and $559,863,000, respectively.
 
7.   Borrowing Arrangements
 
Borrowings at December 31, 2005 consist of $99.7 million of securities sold under repurchase agreements with a weighted average rate of 3.20%, $8.7 million of customer repurchase agreements, and $3.9 million of treasury, tax and loan notes. Securities sold under repurchase are with two significant counterparties which are Salomon Smith Barney at $85.4 million and Credit Suisse First Boston at $14.3 million. The weighted average maturities of the Salomon and Suisse repurchase agreements are nine months and two months, respectively. At December 31, 2005, $50.0 million of our borrowings consisted of borrowings from the FHLB. Our unused FHLB borrowing capacity at December 31, 2005 was approximately $280.0 million. There were $153.9 million of securities pledged for customer repurchase agreements and securities sold under repurchase agreements and $4.4 million pledged for treasury, tax and loan notes. During the year ended December 31, 2005, our average borrowings from these sources were $477.2 million, of which $315.6 million related to securities sold under repurchase agreements. The maximum amount of borrowed funds outstanding at any month-end during the year ended December 31, 2005 was $610.3 million, of which $354.2 million related to securities sold under repurchase agreements.
 
The Bank had $103.5 million of downstream federal funds purchased outstanding with a rate of 4.325% at December 31, 2005. The Bank had unused upstream federal fund lines available from commercial banks at December 31, 2005 of approximately $280.5 million. Generally, these federal fund borrowings are overnight, but not to exceed seven days.
 
As of December 31, 2005, 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
  $ 103,497     $     $     $     $ 103,497  
Securities sold under repurchase agreements
    70,250       29,400                   99,650  
Customer repurchase agreements
    8,707                         8,707  
Treasury, tax and loan notes
    3,867                         3,867  
FHLB borrowings
    50,000                         50,000  
Long-term debt
                      46,394       46,394  
                                         
Total borrowings
  $ 236,321     $ 29,400     $     $ 46,394     $ 312,115  
                                         


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
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, of which $458.9 million related to securities sold under repurchase agreements. The maximum amount of borrowed funds outstanding at any month-end during the year ended December 31, 2004 was $653.2 million, of which $478.6 million related to securities sold under repurchase agreements.
 
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.
 
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 $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 $512.9 million, of which $365.5 million related to securities sold under repurchase agreements. The maximum amount of borrowed funds outstanding at any month-end during the year ended December 31, 2003 was $546.3 million, of which $341.9 million related to securities sold under repurchase agreements.
 
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.
 
8.   Long-term Debt
 
On October 6, 2005, Texas Capital Statutory Trust III issued $25,000,000 of its Fixed/Floating Rate Capital Securities (the 2005 Trust Preferred) in a private offering. Proceeds of the 2005 Trust Preferred were invested in Fixed/Floating Rate Junior Subordinated Deferrable Interest Debentures (the 2005 Subordinated Debentures) of the Company. Interest rate on the 2005 Trust Preferred Subordinated Debentures is a fixed rate of 6.19% for five years through December 15, 2010, and a floating rate of interest for the remaining 25 years that resets quarterly to 1.51% above the three month LIBOR rate. 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.


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
The 2005 Trust Preferred and the 2005 Subordinated Debentures each mature in December 2035. If certain conditions are met, the maturity dates of the 2005 Trust Preferred and the 2005 Subordinated Debentures may be shortened to a date not earlier than December 2010. The 2005 Trust Preferred and the 2005 Subordinated Debentures also may be redeemed prior to maturity if certain events occur. The 2005 Trust Preferred is subject to mandatory redemption, in whole or in part, upon repayment of the 2005 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 2005 Subordinated Debentures, which would result in a deferral of dividend payments on the 2005 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 2005 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 Statutory Trust III 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 2005 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 III under the 2005 Trust Preferred.
 
Texas Capital Statutory Trust III is a Delaware business trust created for the purpose of issuing the 2005 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 III.
 
The 2005 Trust Preferred currently meets the regulatory criteria for Tier I capital, subject to Federal Reserve guidelines that limit the amount of the 2005 Trust Preferred and cumulative perpetual preferred stock to an aggregate of 25% of Tier I capital. At December 31, 2005, all of the 2005 Trust Preferred was included in Tier I capital.
 
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 2003 Subordinated Debentures) of the Company. Interest rate on the 2003 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 2003 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 2003 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 2003 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 2003 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 2003 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 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 2003 Subordinated Debentures, the Indenture and the Agreement as to Expenses and Liabilities, entered into in connection with


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Table of Contents

 
Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

the offering of the 2003 Trust Preferred and the 2003 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, 2005, 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 2002 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 2002 Subordinated Debentures are deductible for federal income tax purposes.
 
The 2002 Trust Preferred and the 2002 Subordinated Debentures each mature in November 2032. If certain conditions are met, the maturity dates of the 2002 Trust Preferred and the 2002 Subordinated Debentures may be shortened to a date not earlier than November 19, 2007. The 2002 Trust Preferred and the 2002 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 2002 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 2002 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 2002 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 2002 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 2002 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, 2005, all of the 2002 Trust Preferred was included in Tier I capital.
 
As of December 31, 2005, assuming we were not allowed to include the $45 million in trust preferred securities issued by Texas Capital Bancshares Statutory Trust I, Texas Capital Statutory Trust II and Texas Capital Statutory Trust III in Tier 1 capital, the Company would still exceed the regulatory required minimums for capital adequacy purposes.


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Table of Contents

 
Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
9.   Income Taxes
 
The Company has a gross deferred tax asset of $13.7 million at December 31, 2005, which relates primarily to our allowance for loan losses and our unrealized loss on securities. Although realization is not assured, management believes it is more likely than not that all of the deferred tax assets will be realized. The Company’s net deferred tax asset is included in other assets in the consolidated balance sheet.
 
At December 31, 2004, the Company had a gross deferred tax asset of $8.8 million, which related primarily to our allowance for loan losses.
 
Income tax expense/(benefit) consists of the following for the years ended:
 
                         
    Year Ended December 31  
    2005     2004     2003  
    (In thousands)  
 
Current:
                       
Federal
  $ 14,054     $ 10,086     $ 5,534  
State
    247              
                         
Total
  $ 14,301     $ 10,086     $ 5,534  
                         
Deferred:
                       
Federal
  $ (302 )   $ (300 )   $ (7,726 )
State
                 
                         
Total
  $ (302 )   $ (300 )   $ (7,726 )
                         
Total expense (benefit):
                       
Federal
  $ 13,752     $ 9,786     $ (2,192 )
State
    247              
                         
Total
  $ 13,999     $ 9,786     $ (2,192 )
                         


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Table of Contents

 
Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
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  
    2005     2004  
    (In thousands)  
 
Deferred tax assets:
               
Allowance for loan losses
  $ 6,641     $ 6,544  
Organizational costs/software
    289       108  
Depreciation
          404  
Loan origination fees
    1,957       1,551  
Stock compensation
    177        
Non-accrual interest
    151       116  
Unrealized loss on securities
    4,363        
Other
    150       58  
                 
      13,728       8,781  
Deferred tax liabilities:
               
Loan origination costs
    (677 )     (579 )
FHLB stock dividends
    (250 )     (175 )
Depreciation
    (109 )      
Unrealized gain on securities
          (1,396 )
                 
      (1,036 )     (2,150 )
                 
Net deferred tax asset
  $ 12,692     $ 6,631  
                 
 
The reconciliation of income attributable to continuing operations computed at the U.S. federal statutory tax rates to income tax expense (benefit) is as follows:
 
                         
    Year Ended December 31  
    2005     2004     2003  
 
Tax at U.S. statutory rate
    35 %     35 %     35 %
State taxes
    1 %            
Non-deductible expenses
    1 %     1 %     1 %
Non-taxable income
    (2 )%     (3 )%     (5 )%
Changes in valuation allowance
                (47 )%
Other and tax related reserves
    (1 )%           (3 )%
                         
Total
    34 %     33 %     (19 )%
                         
 
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 cumulative preferred dividends paid.


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
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, 2005 and 2004. 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, 2005 and 2004, 159,478 shares, had been purchased on behalf of the employees. Effective December 30, 2005, the 2000 Employee Stock Purchase Plan was terminated. During January 2006, a new plan (“2006 Employee Stock Purchase Plan”) was adopted that allocated 400,000 shares to the plan. The 2006 Employee Stock Purchase Plan will be submitted to stockholders for approval at the 2006 annual meeting.
 
As of December 31, 2005, the Company has two active stock option plans, the 1999 Stock Omnibus Plan (“1999 Plan”) and the 2005 Long-Term Incentive Plan (“2005 Plan”). The 1999 Plan is no longer available for grants of equity based compensation; however, options to purchase shares previously issued under the plan will remain outstanding and be subject to administration by the Company’s board of directors. Under the 2005 Plan, equity-based compensation grants will be made by the Board of Directors, or its designated committee. Grants under the 2005 Plan will be subject to vesting requirements. Under the 2005 Plan, the Company may grant, among other things, nonqualified stock options, incentive stock options, restricted stock units, stock appreciation rights, or any combination thereof. Total shares which may be issued under the 2005 Plan at December 31, 2005 were 1,500,000. Total shares which may be issued under the 1999 plan at December 31, 2004, were 3,047,700.
 
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.
 
The Company expects to adopt SFAS 123R effective January 1, 2006. See Note 1 for discussion.


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
A summary of the Company’s stock option activity and related information for 2005, 2004 and 2003 is as follows:
 
                                                 
    December 31, 2005     December 31, 2004     December 31, 2003  
          Weighted
          Weighted
          Weighted
 
          Average
          Average
          Average
 
          Exercise
          Exercise
          Exercise
 
    Options     Price     Options     Price     Options     Price  
 
Options outstanding at beginning of year
    2,654,480     $ 9.01       2,686,193     $ 7.85       1,959,828     $ 6.61  
Options granted
    328,250       21.00       309,500       16.38       1,007,955       9.68  
Options exercised
    (240,814 )     7.35       (318,413 )     6.52       (261,550 )     6.07  
Options forfeited
    (112,910 )     14.62       (22,800 )     7.25       (20,040 )     6.99  
                                                 
Options outstanding at year-end
    2,629,006     $ 10.42       2,654,480     $ 9.01       2,686,193     $ 7.85  
                                                 
Options vested at year-end
    1,557,207     $ 7.56       1,256,812     $ 7.23       1,097,516     $ 6.58  
Weighted average fair value of options granted during 2005, 2004 and 2003
  $ 6.93             $ 5.28             $ 2.87          
Weighted average remaining contractual life of options currently outstanding in years:
    6.55               7.11               7.59          
 
The range of grant prices for all stock options was between $18.62 and $24.05 at December 31, 2005, $14.45 and $21.84 at December 31, 2004 and $6.25 and $13.95 at December 31, 2003.
 
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 2005, 2004 and 2003 totaling 67,500, 98,250 and 49,500 shares. In connection with these vestings, a total of 53,930, 98,436 and 25,326 shares were issued in 2005, 2004 and 2003, respectively. The Company expensed approximately $873,000, $765,000 and $430,000 during 2005, 2004 and 2003, 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


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

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  
    2005     2004  
    (In thousands)  
 
Financial instruments whose contract amounts represent credit risk:
               
Commitments to extend credit
  $ 851,625     $ 558,501  
Standby and commercial letters of credit
    52,554       33,549  
 
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 assets (as defined). Management believes, as of December 31, 2005, 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, 2005 and 2004. As of March 31, 2005, 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


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

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
 
          For Capital
    Under Prompt Corrective
 
    Actual     Adequacy Purposes     Action Provisions  
    Amount     Ratio     Amount     Ratio     Amount     Ratio  
    (In thousands except percentage data)  
 
As of December 31, 2005:
                                               
Total capital (to risk-weighted assets):
                                               
Company
  $ 275,695       10.83 %   $ 203,701       8.00 %     N/A       N/A  
Bank
    258,327       10.15 %     203,544       8.00 %   $ 254,431       10.00 %
Tier 1 capital (to risk-weighted assets):
                                               
Company
  $ 256,798       10.09 %   $ 101,851       4.00 %     N/A       N/A  
Bank
    239,430       9.41 %     101,772       4.00 %   $ 152,658       6.00 %
Tier 1 capital (to average assets):
                                               
Company
  $ 256,798       8.68 %   $ 118,296       4.00 %     N/A       N/A  
Bank
    239,430       8.10 %     118,220       4.00 %   $ 147,775       5.00 %
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 %
 
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 2005, 2004 or 2003.
 
The required balance at the Federal Reserve at December 31, 2005 and 2004 was approximately $48,210,000 and $35,590,000, respectively.


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
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  
    2005     2004     2003  
 
Numerator:
                       
Net income
  $ 27,192     $ 19,560     $ 13,834  
Preferred stock dividends
                (699 )
                         
Numerator for basic earnings per share-income available to common stockholders
    27,192       19,560       13,135  
Effect of dilutive securities:
                       
Preferred stock dividends
                699  
                         
Numerator for dilutive earnings per share-income available to common stockholders after assumed conversion
  $ 27,192     $ 19,560     $ 13,834  
                         
Denominator:
                       
Denominator for basic earnings per share-weighted average shares
    25,619,594       25,260,526       21,332,746  
Effect of dilutive securities:
                       
Employee stock options(1)
    1,025,604       974,111       459,562  
Series A convertible preferred stock
                1,326,496  
                         
Dilutive potential common shares
    1,025,604       974,111       1,786,058  
                         
Denominator for dilutive earnings per share-adjusted weighted average shares and assumed conversions
    26,645,198       26,234,637       23,118,804  
                         
Basic earning per share
  $ 1.06     $ .77     $ .62  
                         
Diluted earnings per share
  $ 1.02     $ .75     $ .60  
                         
 
 
(1) Stock options outstanding of 47,500 in 2005 and 30,000 in 2004 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.
 
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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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
A summary of the carrying amounts and estimated fair values of financial instruments is as follows (in thousands):
 
                                 
    December 31, 2005     December 31, 2004  
    Carrying
    Estimated
    Carrying
    Estimated
 
    Amount     Fair Value     Amount     Fair Value  
 
Cash and cash equivalents
  $ 137,840     $ 137,840     $ 78,490     $ 78,490  
Securities, available-for-sale
    630,482       630,482       804,544       804,544  
Loans, net
    2,168,242       2,163,822       1,665,417       1,666,997  
Deposits
    2,495,179       2,495,081       1,789,887       1,793,239  
Federal funds purchased
    103,497       103,497       113,478       113,478  
Borrowings
    162,224       160,544       481,513       480,913  
Long-term debt
    46,394       46,394       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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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
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 $4,153,000, $3,068,000 and $2,796,000 for the years ended December 31, 2005, 2004 and 2003, respectively.
 
Minimum future lease payments under operating leases are as follows:
 
         
Year Ending December 31,
  Minimum Payments  
    (In thousands)  
 
2006
  $ 5,230  
2007
    5,222  
2008
    5,192  
2009
    4,452  
2010
    2,545  
2011 and thereafter
    2,975  
         
    $ 25,616  
         
 
17.   Parent Company Only
 
Summarized financial information for Texas Capital Bancshares, Inc. — Parent Company Only follows:
 
Balance Sheets
 
                 
    December 31  
    2005     2004  
    (In thousands)  
 
Assets
               
Cash and cash equivalents
  $ 12,655     $ 27,372  
Investment in subsidiaries
    244,559       185,242  
Other assets
    5,265       3,715  
                 
Total assets
  $ 262,479     $ 216,329  
                 
 
Liabilities and Stockholders’ Equity
Other liabilities
  $ 513     $ 434  
Long-term debt
    46,394       20,620  
                 
Total liabilities
    46,907       21,054  
Common stock
    258       255  
Additional paid-in capital
    176,131       172,380  
Retained earnings
    47,288       20,047  
Accumulated other comprehensive income (loss)
    (8,105 )     2,593  
                 
Total stockholders’ equity
    215,572       195,275  
                 
Total liabilities and stockholders’ equity
  $ 262,479     $ 216,329  
                 


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
Statements of Earnings
 
                         
    Year Ended December 31  
    2005     2004     2003  
    (In thousands)  
 
Dividend income
  $ 53     $ 30     $ 25  
Other income
    565              
                         
Total income
    618       30       25  
Interest expense
    1,858       1,097       905  
Salaries and employee benefits
    413       463       474  
Legal and professional
    1,023       883       774  
Other non-interest expense
    328       375       184  
                         
Total expense
    3,622       2,818       2,337  
                         
Loss before income taxes and equity in undistributed income of subsidiary
    (3,004 )     (2,788 )     (2,312 )
Income tax benefit
    (1,016 )     (921 )     (748 )
                         
Loss before equity in undistributed income of subsidiary
    (1,988 )     (1,867 )     (1,564 )
Equity in undistributed income of subsidiary
    29,230       21,427       15,398  
                         
Net income
  $ 27,242     $ 19,560     $ 13,834  
                         


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Texas Capital Bancshares, Inc.
 
Notes to Consolidated Financial Statements — (Continued)

 
Statements of Cash Flows
 
                         
    Year Ended December 31  
    2005     2004     2003  
    (In thousands)  
 
Operating Activities
                       
Net income
  $ 27,242     $ 19,560     $ 13,834  
Adjustments to reconcile net income to net cash used in operating activities:
                       
Equity in undistributed income of subsidiary
    (29,795 )     (21,427 )     (15,398 )
(Increase) decrease in other assets
    (1,550 )     (2,483 )     29  
Tax benefit from stock option exercises
    1,424       1,411       412  
Increase in other liabilities
    78       51       30  
                         
Net cash used in operating activities
    (2,601 )     (2,888 )     (1,093 )
Investing Activities
                       
Investment in subsidiaries
    (40,220 )     (7,000 )     (22,864 )
                         
Net cash used in investing activities
    (40,220 )     (7,000 )     (22,864 )
Financing Activities
                       
Subordinated debentures
    25,774             10,310  
Preferred stock dividends
                (979 )
Sale of common stock
    2,330       3,223       36,204  
Sale of treasury stock, net
                95  
                         
Net cash provided by financing activities
    28,104       3,223       45,630  
                         
Net (decrease) increase in cash and cash equivalents
    (14,717 )     (6,665 )     21,673  
Cash and cash equivalents at beginning of year
    27,372       34,037       12,364  
                         
Cash and cash equivalents at end of year
  $ 12,655     $ 27,372     $ 34,037  
                         
 
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.


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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, 2005.
 
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, 2005, 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, 2005, 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, 2005, 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, 2005. 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, 2005, 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, 2005, 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, 2005, 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, 2005, based on the COSO criteria.
 
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the 2005 consolidated financial statements of Texas Capital Bancshares, Inc. and subsidiaries and our report dated February 28, 2006 expressed an unqualified opinion thereon.
 
/s/  ERNST & YOUNG LLP
 
Dallas, Texas
February 28, 2006


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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 16, 2005, which proxy materials will be filed with the SEC no later than April 30, 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 16, 2005, which proxy materials will be filed with the SEC no later than April 30, 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 16, 2005, which proxy materials will be filed with the SEC no later than April 30, 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 16, 2005, which proxy materials will be filed with the SEC no later than April 30, 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 16, 2005, which proxy materials will be filed with the SEC no later than April 30, 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
  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


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  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. 2006 Employee Stock Purchase Plan, which is incorporated by reference to our registration statement on Form S-8 dated February 3, 2006
         
     
  4 .3   Texas Capital Bancshares, Inc. 2005 Long-Term Incentive Plan, which is incorporated by reference to our registration statement on Form S-8 dated June 3, 2005
         
     
  4 .4   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 .5   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 .6   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 .7   Indenture dated November 19, 2002 which is incorporated by reference to our Current Report on Form 8-K dated December 4, 2002
         
     
  4 .8   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 .9   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 .10   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 .11   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 .12   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 .13   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
         
     
  4 .14   Amended and Restated Declaration of Trust for Texas Capital Statutory Trust III by and among Wilmington Trust Company, as Institutional Trustee and Delaware Trustee, Texas Capital Bancshares, Inc. as Sponsor, and the Administrators named therein, dated as of October 6, 2005
         
     
  4 .15   Indenture between Texas Capital Bancshares, Inc., as Issuer, and Wilmington Trust Company, as Trustee, for Fixed/Floating Rate Junior Subordinated Deferrable Interest Debentures, dated as of October 6, 2005.
         
     
  4 .16   Guarantee Agreement between Texas Capital Bancshares, Inc. and Wilmington Trust Company, dated as of October 6, 2005.
         
     
  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+
         

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  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+
         
     
  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*
         
     
  24 .1   Power of Attorney**
         
     
  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
 
** Included on signature page of this Form 10-K

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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 3, 2006
 
             
/s/  JOSEPH M. GRANT
Joseph M. Grant
  Chairman of the Board of Directors and Chief Executive Officer (principal executive officer)   Date: March 3, 2006
         
/s/  PETER BARTHOLOW

Peter Bartholow
  Chief Financial Officer and Director (principal financial officer)   Date: March 3, 2006
         
/s/  JULIE ANDERSON

Julie Anderson
  Controller
(principal accounting officer)
  Date: March 3, 2006
         
/s/  LEO CORRIGAN III

Leo Corrigan III
  Director   Date: March 3, 2006
         
/s/  FREDERICK B. HEGI, JR.

Frederick B. Hegi, Jr.
  Director   Date: March 3, 2006
         
/s/  LARRY L. HELM

Larry L. Helm
  Director   Date: March 3, 2006
         
/s/  JAMES R. HOLLAND, JR.

James R. Holland, Jr.
  Director   Date: March 3, 2006
         
/s/  GEORGE F. JONES, JR.

George F. Jones, Jr.
  Director   Date: March 3, 2006
         
/s/  LARRY A. MAKEL

Larry A. Makel
  Director   Date: March 3, 2006


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/s/  WALTER W. MCALLISTER III

Walter W. McAllister III
  Director   Date: March 3, 2006
         
/s/  LEE ROY MITCHELL

Lee Roy Mitchell
  Director   Date: March 3, 2006
         
/s/  STEVE ROSENBERG

Steve Rosenberg
  Director   Date: March 3, 2006
         
/s/  JOHN C. SNYDER

John C. Snyder
  Director   Date: March 3, 2006
         
/s/  ROBERT W. STALLINGS

Robert W. Stallings
  Director   Date: March 3, 2006
         
/s/  IAN J. TURPIN

Ian J. Turpin
  Director   Date: March 3, 2006

81