LOANS HELD FOR INVESTMENT AND ALLOWANCE FOR LOAN LOSSES

At September 30, 2015 and December 31, 2014, loans held for investment were as follows (in thousands):



	September 30, 2015			December 31, 2014
Commercial	$	6,553,639		$	5,869,219
Mortgage finance	4,312,790			4,102,125
Construction	1,864,178			1,416,405
Real estate	3,058,574			2,807,127
Consumer	24,757			19,699
Leases	118,644			99,495
Gross loans held for investment	15,932,582			14,314,070
Deferred income (net of direct origination costs)	(56,964		)	(57,058		)
Allowance for loan losses	(130,540		)	(100,954		)
Total loans held for investment	$	15,745,078		$	14,156,058

Commercial Loans and Leases. Our commercial loan and lease portfolio is comprised of lines of credit for working capital and term loans and leases to finance equipment and other business assets. Our energy production loans are generally collateralized with proven reserves based on appropriate valuation standards and take into account the risk of oil and gas price volatility. Our commercial loans and leases are underwritten after carefully evaluating and understanding the borrower’s ability to operate profitably. Our underwriting standards are designed to promote relationship banking rather than to make loans on a transactional basis. 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.

Mortgage Finance Loans. Our mortgage finance loans consist of ownership interests purchased in single-family residential mortgages funded through our mortgage finance group. These interests are typically on our balance sheet for 10 to 20 days. We have agreements with mortgage lenders and purchase interests in individual loans they originate. All loans are underwritten consistent with established programs for permanent financing with financially sound investors. Substantially all loans are conforming loans. Balances as of September 30, 2015 and December 31, 2014 are stated net of $425.0 million and $358.3 million participations sold, respectively.

Construction Loans. Our construction loan portfolio consists primarily of single- and multi-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 equity investment in the borrowers. Loan amounts are derived primarily from the bank's evaluation of expected cash flows available to service debt from stabilized projects under hypothetically stressed conditions. Construction loans are also based in part upon estimates of costs and value associated with the completed project. Sources of repayment for these types of loans may be pre-committed permanent loans from other lenders, sales of developed property or an interim loan commitment from us until permanent financing is obtained. The nature of these loans makes ultimate repayment sensitive to overall economic conditions. Borrowers may not be able to correct conditions of default in loans, increasing risk of exposure to classification, non-performing status, reserve allocation and actual credit loss and foreclosure. These loans typically have floating rates and commitment fees.

Real Estate Loans. A portion of our real estate loan portfolio is comprised of loans secured by properties other than market risk or investment-type real estate. Market risk loans are real estate loans where the primary source of repayment is expected to come from the sale, permanent financing or lease of the real property collateral. We generally provide temporary financing for commercial and residential property. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Our real estate loans generally have maximum 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. Real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. Appraised values may be highly variable due to market conditions, the impact of the inability of potential purchasers and lessees to obtain financing and a lack of transactions at comparable values.

At September 30, 2015 and December 31, 2014, we had a blanket floating lien on certain real estate-secured loans, mortgage finance loans and certain securities used as collateral for Federal Home Loan Bank (“FHLB”) borrowings.

Portfolio Geographic Concentration

As of September 30, 2015, a substantial majority of our loans held for investment, excluding our mortgage finance loans and other national lines of business, were to businesses with headquarters and operations in Texas. This geographic concentration subjects the loan portfolio to the general economic conditions within this area. Additionally, we may make loans to these businesses and individuals secured by assets located outside of Texas. The risks created by this concentration have been considered by management in the determination of the appropriateness of the allowance for loan losses. Management believes the allowance for loan losses is appropriate to cover probable losses inherent in the loan portfolio at each balance sheet date.

Summary of Loan Loss Experience

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 appropriate level to absorb estimated loan losses inherent in the loan portfolio. Factors contributing to the determination of 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 $500,000 are specifically reviewed for loss potential. For loans deemed to be impaired, 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. 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 a reserve assigned to off-balance sheet commitments, specifically unfunded loan commitments and letters of credit, and any needed reserve is recorded in other liabilities. 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.

We have several pass credit grades that are assigned to loans based on varying levels of risk, ranging from credits that are secured by cash or marketable securities, to watch credits which have all the characteristics of an acceptable credit risk but warrant more than the normal level of monitoring. Within our criticized/classified credit grades are special mention, substandard and doubtful. Special mention loans are those that are currently protected by the current sound worth and paying capacity of the borrower, but that are potentially weak and constitute an additional credit risk. The loan has the potential to deteriorate to a substandard grade due to the existence of financial or administrative deficiencies. Substandard loans have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that we will sustain some loss if the deficiencies are not corrected. Some substandard loans are insufficiently protected by the current sound worth and paying capacity of the borrower and of the collateral pledged and may be considered impaired. Substandard loans can be accruing or can be on non-accrual depending on the circumstances of the individual loans. Loans classified as doubtful have all the weaknesses inherent in substandard loans with the added characteristics that the weaknesses make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. The possibility of loss is extremely high. All doubtful loans are on non-accrual.

The reserve allocation percentages assigned to each credit grade have been developed based primarily on an analysis of our historical loss rates. The allocations are adjusted for certain qualitative factors for such things as general economic conditions and changes in credit policies and lending standards. Changes in the trend and severity of problem loans can cause the estimation of losses to differ from past experience. In addition, the reserve reflects the results of reviews performed by the Company's independent Credit Review function as reflected in their confirmations of assigned credit grades within the portfolio. The Credit Review function reports to the Credit Risk Committee of the Company's board of directors with administrative oversight from the Company's Chief Risk Officer. 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. Examples of risks that support the Company's maintaining an unallocated reserve include the possibility of precipitous negative changes in economic conditions and borrowers' submission of financial statements or certifications of collateral value that subsequently prove to be materially inaccurate for reason of either misstatement or omission of critical information. These situations, while not common, do not necessarily correlate well with the general risk profile presented by assigned credit grade and product type categories. We evaluate many factors and conditions in determining the unallocated portion of the allowance, including amount and frequency of losses attributable to issues not specifically addressed or included in the determination and application of the allowance allocation percentages. We consider the allowance to be appropriate, given management’s assessment of probable losses within the portfolio as of the evaluation date, 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 appropriateness, which is performed at least quarterly, is designed to be dynamic and responsive to changes in portfolio credit quality. The changes are reflected in the general reserve and in specific reserves as the collectability of larger classified loans is evaluated with new information. As our portfolio has matured, historical loss ratios have been closely monitored, and our reserve appropriateness relies primarily on our loss history. The review of reserve appropriateness is performed by executive management and presented to a committee of our board of directors for their review. The committee reports to the board as part of the board’s review on a quarterly basis of the Company’s consolidated financial statements.

The following tables summarize the credit risk profile of our loan portfolio by internally assigned grades and non-accrual status as of September 30, 2015 and December 31, 2014 (in thousands):



September 30, 2015
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Grade:
Pass	$	6,244,334	$	4,312,790	$	1,845,094	$	3,014,205	$	24,497	$	110,295	$	15,551,215
Special mention	113,542		—		1,771		23,076		26		2,650		141,065
Substandard-accruing	115,565		—		564		14,265		234		—		130,628
Non-accrual	80,198		—		16,749		7,028		—		5,699		109,674
Total loans held for investment	$	6,553,639	$	4,312,790	$	1,864,178	$	3,058,574	$	24,757	$	118,644	$	15,932,582

December 31, 2014
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Grade:
Pass	$	5,738,474	$	4,102,125	$	1,414,671	$	2,785,804	$	19,579	$	91,044	$	14,151,697
Special mention	53,839		—		1,734		8,723		11		4,363		68,670
Substandard-accruing	43,784		—		—		2,653		47		3,915		50,399
Non-accrual	33,122		—		—		9,947		62		173		43,304
Total loans held for investment	$	5,869,219	$	4,102,125	$	1,416,405	$	2,807,127	$	19,699	$	99,495	$	14,314,070

The following table details activity in the reserve for loan losses by portfolio segment for the nine months ended September 30, 2015 and September 30, 2014. Allocation of a portion of the reserve to one category of loans does not preclude its availability to absorb losses in other categories.



September 30, 2015
(in thousands)	Commercial		Mortgage Finance		Construction			Real Estate			Consumer		Leases			Unallocated			Total
Beginning balance	$	70,654	$	—	$	7,935		$	15,582		$	240	$	1,141		$	5,402		$	100,954
Provision for loan losses	48,689		—		(3,944		)	(4,328		)	154		(221		)	(1,622		)	38,728
Charge-offs	11,278		—		—			346			62		25			—			11,711
Recoveries	2,098		—		397			28			19		27			—			2,569
Net charge-offs (recoveries)	9,180		—		(397		)	318			43		(2		)	—			9,142
Ending balance	$	110,163	$	—	$	4,388		$	10,936		$	351	$	922		$	3,780		$	130,540
Period end amount allocated to:
Loans individually evaluated for impairment	$	9,304	$	—	$	—		$	254		$	—	$	1		$	—		$	9,559
Loans collectively evaluated for impairment	100,859		—		4,388			10,682			351		921			3,780			120,981
Ending balance	$	110,163	$	—	$	4,388		$	10,936		$	351	$	922		$	3,780		$	130,540

September 30, 2014
(in thousands)	Commercial		Mortgage Finance		Construction			Real Estate			Consumer		Leases			Unallocated			Total
Beginning balance	$	39,868	$	—	$	14,553		$	24,210		$	149	$	3,105		$	5,719		$	87,604
Provision for loan losses	20,900		—		(1,611		)	(6,095		)	112		(1,480		)	2,044			13,870
Charge-offs	8,518		—		—			296			101		—			—			8,915
Recoveries	3,480		—		—			45			66		172			—			3,763
Net charge-offs (recoveries)	5,038		—		—			251			35		(172		)	—			5,152
Ending balance	$	55,730	$	—	$	12,942		$	17,864		$	226	$	1,797		$	7,763		$	96,322
Period end amount allocated to:
Loans individually evaluated for impairment	$	5,999	$	—	$	—		$	660		$	—	$	2		$	—		$	6,661
Loans collectively evaluated for impairment	49,731		—		12,942			17,204			226		1,795			7,763			89,661
Ending balance	$	55,730	$	—	$	12,942		$	17,864		$	226	$	1,797		$	7,763		$	96,322

We have traditionally maintained an unallocated reserve component to compensate 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 believe the level of unallocated reserves at September 30, 2015 is warranted due to the continued uncertain economic environment which has produced losses, including those resulting from borrowers' misstatement of financial information or inaccurate certification of collateral values. Such losses are not necessarily correlated with historical loss trends or general economic conditions. Our methodology used to calculate the allowance considers historical losses; however, the historical loss rates for specific product types or credit risk grades may not fully incorporate the effects of continued weakness in the economy.

Our recorded investment in loans as of September 30, 2015, December 31, 2014 and September 30, 2014 related to each balance in the allowance for loan losses by portfolio segment and disaggregated on the basis of our impairment methodology was as follows (in thousands):



September 30, 2015
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Loans individually evaluated for impairment	$	82,050	$	—	$	16,749	$	9,895	$	—	$	5,699	$	114,393
Loans collectively evaluated for impairment	6,471,589		4,312,790		1,847,429		3,048,679		24,757		112,945		15,818,189
Total	$	6,553,639	$	4,312,790	$	1,864,178	$	3,058,574	$	24,757	$	118,644	$	15,932,582

December 31, 2014
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Loans individually evaluated for impairment	$	35,165	$	—	$	—	$	13,880	$	62	$	173	$	49,280
Loans collectively evaluated for impairment	5,834,054		4,102,125		1,416,405		2,793,247		19,637		99,322		14,264,790
Total	$	5,869,219	$	4,102,125	$	1,416,405	$	2,807,127	$	19,699	$	99,495	$	14,314,070

September 30, 2014
	Commercial		Mortgage Finance		Construction		Real Estate		Consumer		Leases		Total
Loans individually evaluated for impairment	$	27,109	$	—	$	—	$	17,904	$	—	$	10	$	45,023
Loans collectively evaluated for impairment	5,594,227		3,774,467		1,640,596		2,344,614		16,502		101,317		13,471,723
Total	$	5,621,336	$	3,774,467	$	1,640,596	$	2,362,518	$	16,502	$	101,327	$	13,516,746

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 collectability is questionable, then cash payments are applied to principal. As of September 30, 2015, $884,000 of our non-accrual loans were earning on a cash basis compared to $310,000 at December 31, 2014. A loan is placed back on accrual status when both principal and interest are current and it is probable that we will be able to collect all amounts due (both principal and interest) according to the terms of the loan agreement.

A loan held for investment 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. In accordance with ASC 310 Receivables ("ASC 310"), we have also included all restructured loans in our impaired loan totals. The following tables detail our impaired loans, by portfolio class, as of September 30, 2015 and December 31, 2014 (in thousands):



September 30, 2015
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial
Business loans	$	16,370	$	24,185	$	—	$	18,211	$	—
Energy	35,304		35,304		—		16,991		28
Construction
Market risk	16,749		16,749		—		7,444		—
Real estate
Market risk	3,591		3,591		—		3,671		—
Commercial	2,909		2,909		—		3,467		16
Secured by 1-4 family	—		—		—		—		—
Consumer	—		—		—		—		—
Leases	5,695		5,695		—		2,777		—
Total impaired loans with no allowance recorded	$	80,618	$	88,433	$	—	$	52,561	$	44
With an allowance recorded:
Commercial
Business loans	$	28,890	$	28,890	$	8,607	$	32,756	$	—
Energy	1,486		1,486		697		699		—
Construction
Market risk	—		—		—		—		—
Real estate
Market risk	1,785		1,785		29		2,421		—
Commercial	—		—		—		408		—
Secured by 1-4 family	1,610		1,610		225		1,710		—
Consumer	—		—		—		14		—
Leases	4		4		1		98		—
Total impaired loans with an allowance recorded	$	33,775	$	33,775	$	9,559	$	38,106	$	—
Combined:
Commercial
Business loans	$	45,260	$	53,075	$	8,607	$	50,967	$	—
Energy	36,790		36,790		697		17,690		28
Construction
Market risk	16,749		16,749		—		7,444		—
Real estate
Market risk	5,376		5,376		29		6,092		—
Commercial	2,909		2,909		—		3,875		16
Secured by 1-4 family	1,610		1,610		225		1,710		—
Consumer	—		—		—		14		—
Leases	5,699		5,699		1		2,875		—
Total impaired loans	$	114,393	$	122,208	$	9,559	$	90,667	$	44



December 31, 2014
	Recorded Investment		Unpaid Principal Balance		Related Allowance		Average Recorded Investment		Interest Income Recognized
With no related allowance recorded:
Commercial
Business loans	$	9,608	$	11,857	$	—	$	7,334	$	—
Energy	—		—		—		375		25
Construction
Market risk	—		—		—		118		—
Real estate
Market risk	3,735		3,735		—		7,970		—
Commercial	3,521		3,521		—		2,795		—
Secured by 1-4 family	—		—		—		1,210		—
Consumer	—		—		—		—		—
Leases	—		—		—		—		—
Total impaired loans with no allowance recorded	$	16,864	$	19,113	$	—	$	19,802	$	25
With an allowance recorded:
Commercial
Business loans	$	24,553	$	25,553	$	7,433	$	17,705	$	—
Energy	1,004		1,004		272		991		—
Construction
Market risk	—		—		—		—		—
Real estate
Market risk	4,203		4,203		317		5,064		—
Commercial	526		526		79		705		—
Secured by 1-4 family	1,895		1,895		240		2,119		—
Consumer	62		62		9		16		—
Leases	173		173		26		41		—
Total impaired loans with an allowance recorded	$	32,416	$	33,416	$	8,376	$	26,641	$	—
Combined:
Commercial
Business loans	$	34,161	$	37,410	$	7,433	$	25,039	$	—
Energy	1,004		1,004		272		1,366		25
Construction
Market risk	—		—		—		118		—
Real estate
Market risk	7,938		7,938		317		13,034		—
Commercial	4,047		4,047		79		3,500		—
Secured by 1-4 family	1,895		1,895		240		3,329		—
Consumer	62		62		9		16		—
Leases	173		173		26		41		—
Total impaired loans	$	49,280	$	52,529	$	8,376	$	46,443	$	25

Average impaired loans outstanding during the nine months ended September 30, 2015 and 2014 totaled $90.7 million and $46.3 million, respectively.

The table below provides an age analysis of our past due loans that are still accruing and non-accrual loans, by portfolio class, as of September 30, 2015 (in thousands):



	30-59 Days Past Due		60-89 Days Past Due		Greater Than 90 Days and Accruing(1)		Total Past Due		Non-accrual		Current		Total
Commercial
Business loans	$	15,004	$	8,919	$	7,556	$	31,479	$	43,409	$	5,452,730	$	5,527,618
Energy	—		—		2		2		36,789		989,230		1,026,021
Mortgage finance loans	—		—		—		—		—		4,312,790		4,312,790
Construction
Market risk	—		—		—		—		16,749		1,831,340		1,848,089
Secured by 1-4 family	928		—		—		928		—		15,161		16,089
Real estate
Market risk	1,046		1,657		—		2,703		3,620		2,366,647		2,372,970
Commercial	—		15,405		—		15,405		2,909		573,353		591,667
Secured by 1-4 family	414		—		—		414		499		93,024		93,937
Consumer	350		—		—		350		—		24,407		24,757
Leases	—		—		—		—		5,699		112,945		118,644
Total loans held for investment	$	17,742	$	25,981	$	7,558	$	51,281	$	109,674	$	15,771,627	$	15,932,582


(1)	Loans past due 90 days and still accruing includes premium finance loans of $6.2 million. These loans are generally secured by obligations of insurance carriers to refund premiums on canceled insurance policies. The refund of premiums from the insurance carriers can take 180 days or longer from the cancellation date.

Restructured loans are loans on which, due to the borrower’s financial difficulties, we have granted a concession that we would not otherwise consider for borrowers of similar credit quality. This may include a transfer of real estate or other assets from the borrower, a modification of loan terms, or a combination of the two. Modifications of terms that could potentially qualify as a restructuring include reduction of the contractual interest rate, extension of the maturity date at a contractual interest rate lower than the current rate for new debt with similar risk, a reduction of the face amount of debt or forgiveness of either principal or accrued interest. As of September 30, 2015 and December 31, 2014, we had $249,000 and $1.8 million, respectively, in loans considered restructured that are not on non-accrual. These loans did not have unfunded commitments at September 30, 2015 or December 31, 2014. Of the non-accrual loans at September 30, 2015 and December 31, 2014, $26.1 million and $12.1 million, respectively, met the criteria for restructured. These loans had no unfunded commitments at their respective balance sheet dates. A loan continues to qualify as restructured until a consistent payment history or change in borrower’s financial condition has been evidenced, generally no less than twelve months. Assuming that the restructuring agreement specifies an interest rate at the time of the restructuring that is greater than or equal to the rate that we are willing to accept for a new extension of credit with comparable risk, then the loan no longer has to be considered a restructuring if it is in compliance with the modified terms in calendar years after the year of the restructure.

The following tables summarize, for the nine months ended September 30, 2015 and 2014, loans that were restructured during 2015 and 2014 (in thousands):



September 30, 2015
	Number of Restructured Loans	Pre-Restructuring Outstanding Recorded Investment		Post-Restructuring Outstanding Recorded Investment
Commercial business loans	5	$	20,459	$	15,438
Total new restructured loans in 2015	5	$	20,459	$	15,438

September 30, 2014
	Number of Restructured Loans	Pre-Restructuring Outstanding Recorded Investment		Post-Restructuring Outstanding Recorded Investment
Real estate—commercial	1	$	1,441	$	1,430
Commercial business loans	1	$	95	$	95
Total new restructured loans in 2014	2	$	1,536	$	1,525

The restructured loans generally include terms to temporarily place loans on interest only, extend the payment terms or reduce the interest rate. We did not forgive any principal on the above loans. The restructuring of the loans did not have a significant impact on our allowance for loan losses at September 30, 2015 or 2014.

The following table provides information on how restructured loans were modified during the nine months ended September 30, 2015 and 2014 (in thousands):



	Nine months ended September 30,
	2015		2014
Extended maturity	$	—	$	1,430
Combination of maturity extension and payment schedule adjustment	15,438		95
Total	$	15,438	$	1,525

As of September 30, 2015 and 2014, we did not have any loans that were restructured within the last 12 months that subsequently defaulted.