The accompanying unaudited consolidated financial statements for the Company have been prepared in accordance with instructions to the SEC Form 10-Q and Article 10 of Regulation S-X; therefore, they do not include all information and footnotes necessary for a fair presentation of financial position, results of operations, comprehensive income, and cash flows in conformity with accounting principles generally accepted in the United States of America (“GAAP”). All adjustments consisting of normally recurring accruals that, in the opinion of management, are necessary for a fair presentation of the consolidated financial position and results of operations for the periods covered by this report have been included. These interim financial statements should be read in conjunction with our Annual Report on Form 10-K for the year ended December 31, 2019. Operating results for the period ended March 31, 2020 are not necessarily indicative of the results that may be expected for the year ending December 31, 2020.

The Company and its subsidiaries follow accounting principles generally accepted in the United States of America, including, where applicable, general practices within the banking industry. The unaudited consolidated financial statements include the accounts of the Company and its subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation. The assessment of whether or not the Company has a controlling interest (i.e., the primary beneficiary) in a variable-interest entity (“VIE”) is performed on an on-going basis. All equity investments in non-consolidated VIEs are included in “other assets” in the Company’s consolidated balance sheets (see Note 15).

Certain amounts reported in prior years have been reclassified to conform to the 2020 presentation. These reclassifications did not materially impact the Company’s consolidated balance sheets or consolidated statements of operations.

In accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 855, Subsequent Events, the Company’s management has evaluated subsequent events for potential recognition or disclosure in the consolidated financial statements through the date of the issuance of the consolidated financial statements. No subsequent events were identified that would have required a change to the consolidated financial statements, however, certain matters that occurred after the balance sheet date are included in Note 19 to the consolidated financial statements.

The Bank operates under a national bank charter and is subject to regulation by the Office of the Comptroller of the Currency (“OCC”). The Bank provides full banking services in six southern states: Alabama, Florida, Georgia, Mississippi, Tennessee, and Texas.

The Company and the Bank also have certain other non-operating and immaterial subsidiaries.

The preparation of financial statements in conformity with GAAP 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. Material estimates that are susceptible to significant change in the near term are the allowance for credit losses, valuation of goodwill, intangible assets, and deferred income taxes.

In the normal course of business, loans are made to directors and executive officers and to companies in which they have a significant ownership interest. In the opinion of management, these loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other parties, are consistent with sound banking practices, and are within applicable regulatory and lending limitations. The aggregate balances of related party loans and deposits are insignificant as of March 31, 2020 and December 31, 2019.

In June 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-13, Financial Instruments–Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. During 2018 and 2019, the FASB issued additional guidance providing clarifications and corrections, including: ASU 2018-19, Codification Improvements to Topic 326, Financial Instruments–Credit Losses; ASU 2019-04, Codification Improvements to Topic 326, Financial Instruments–Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments; ASU 2019-05, Financial Instruments–Credit Losses (Topic 326): Targeted Transition Relief; ASU 2019-10, Financial Instruments–Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842): Effective Dates; ASU 2019-11, Codification Improvements to Topic 326, Financial Instruments–Credit Losses (collectively “ASC 326”). ASC 326, better known as Current Expected Credit Losses (“CECL”), among other things:

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Replaces the current incurred loss accounting model with an expected loss approach and requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts.

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Eliminates existing guidance for acquired credit impaired (“ACI”) loans and requires recognition of the nonaccretable difference as an increase to the allowance for expected credit losses on financial assets purchased with more than insignificant credit deterioration since origination, referred to as purchase credit deteriorated (“PCD”) assets, which will be offset by an increase in the amortized cost of the related loans. For ACI loans accounted for under ASC 310-30 prior to adoption, the guidance in this amendment for PCD assets will be prospectively applied.

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Requires inclusion of expected recoveries, limited to the cumulative amount of prior write-offs, when estimating the allowance for credit losses for in-scope financial assets (including collateral dependent assets).

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Amends existing impairment guidance for available-for-sale securities to incorporate an allowance, which will allow for reversals of credit impairments if the credit of an issuer improves.

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Requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio.

The amendments in these updates became effective for annual periods and interim periods within those annual periods beginning after December 15, 2019.

The Company adopted ASC 326 effective January 1, 2020, using the cumulative effect method. As a result of this adoption, the Company recognized an adjustment to retained earnings of $62.8 million, recorded a deferred tax asset of $19.5 million, and reclassed ACL of $6.1 million with respect to PCD loans, formerly ACI loans, as of January 1, 2020. Because the Company adopted ASC 326 with a cumulative effect adjustment as of January 1, 2020, the comparative results as of December 31, 2019, and for the three months ended March 31, 2019, have not been restated and continue to be reported under the incurred loss accounting model.

The Company has elected the transition provisions provided by the banking agencies and will phase in the “Day One” regulatory capital effects resulting from adoption of CECL. See Note 12 for additional disclosure.

Other changes to the Company’s significant accounting policies pertaining to Loans and the ACL as incorporated under ASC 326 are as follows:

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In accordance with ASC 326, the Company uses amortized cost as a basis for determining the ACL; whereas, prior to adopting ASC 326, under the incurred loss accounting model the Company used recorded investment. The components of amortized cost include unpaid principal balance (“UPB”), and unamortized discounts and premiums. As permitted by ASC 326, the Company has elected to not include accrued interest receivable in the determination of amortized cost and measurement of expected credit losses and, instead, has an accounting policy to write off accrued interest deemed uncollectible in a timely manner.

ASC 326 requires entities that purchase certain financial assets (or portfolios of financial assets) with the intention of holding them for investment to determine whether the assets have experienced more-than-insignificant deterioration in credit quality since origination.

More-than-insignificant deterioration will generally be determined by the asset’s delinquency status, risk rating changes, credit rating, accruing status or other indicators of credit deterioration since origination.

An entity initially measures the amortized cost of a PCD asset by adding the acquisition date estimate of expected credit losses to the asset’s purchase price. Because the initial estimate for expected credit losses is added to the purchase price to establish the Day One amortized cost, PCD accounting is commonly referred to as a “gross-up” approach. There is no credit loss expense recognized upon acquisition of a PCD asset; rather the “gross-up” is offset by establishment of the initial allowance.

Interest income for a PCD asset is recognized using the effective interest rate (“EIR”) calculated at initial measurement. This EIR is determined by comparing the amortized cost basis of the instrument to its contractual cash flows, consistent with ASC 310-20. Accordingly, since the PCD gross-up is included in the amortized cost, the purchase discount related to estimated credit losses on acquisition is not accreted into interest income. Only any noncredit-related discount or premium is accreted or amortized, using the EIR that was calculated at the time the asset was acquired.

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Commercial loans are generally placed on nonaccrual status when principal or interest is past due 90 days or more unless the loan is well secured and in the process of collection. Consumer loans, including residential first and second lien loans secured by real estate, are generally placed on nonaccrual status when they are 120 or more days past due. Prior to the adoption of ASC 326, the majority of our current PCD loans were treated as accruing loans as the Company was able to reasonably predict future cash flows at the unit of account or pool level. After adoption, the accruing status of each individual loan will be subject to the nonaccrual polices described above.

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The accrual of interest, as well as the amortization/accretion of any remaining unamortized net deferred fees or costs and discount or premium, is generally discontinued at the time the loan is placed on nonaccrual status. All accrued but uncollected interest for loans that are placed on nonaccrual status is reversed through interest income. Cash receipts received on nonaccrual loans are generally applied against principal until the loan has been collected in full, after which time any additional cash receipts are recognized as interest income (i.e., cost recovery method). However, interest may be accounted for under the cash-basis method as long as the remaining amortized costs in the loan is deemed fully collectible.

The ACL is maintained through charges to income in the form of a provision for credit losses at a level management believes is adequate to absorb an estimate of expected credit losses over the contractual life of the loan portfolio as of the reporting date. Events that are not within the Company’s control, such as changes in economic factors, could change subsequent to the reporting date and could cause the ACL to be overstated or understated. The amount of the ACL is affected by loan charge-offs, which decrease the ACL; recoveries on loans previously charged off, which increase the ACL; and the provision for credit losses charged to income, which increases the ACL.

The following is a description of the Company’s process for estimating the ACL for all loans in its portfolio, including PCD loans:

The C&I loan segment includes loans to clients in specialized industries, including restaurant, healthcare, and technology. Additional commercial lending activities include energy, general corporate loans, business banking and community banking loans. The C&I segment uses loan level through-the-cycle probability-of-default (“PD”) and loss-given-default (“LGD”) ratings generated by Cadence’s scorecards. These PD ratings are conditioned by industry to reflect the effect of certain forecasted macroeconomic variables, such as market value and volatility, interest rate spreads, and unemployment rate.

The CRE loan segment includes loans which are secured by a variety of property types, including multi-family dwellings, office buildings, industrial properties, and retail facilities. The Company offers construction financing, acquisition or refinancing of properties primarily located in our markets in Texas and the southeast United States. The CRE loan segment uses a loss-rate model, where lifetime loss rates are correlated closely with characteristics such as origination LTV, vintage/origination quality, and loan age, as well as with macroeconomic factors, including GDP growth rate, unemployment rate, and CRE market price change.

The consumer loan segment primarily consists of one-to-four family residential real estate loans with terms ranging from 10 to 30 years; however, the portfolio is heavily weighted to the 30-year term. The Company offers both fixed and adjustable interest rates and does not originate subprime loans. These loans are typically closed-end first lien loans for purposes of purchasing property, or for refinancing existing loans with or without cash out. Our loans are primarily owner occupied, full documentation loans. This segment also offers consumer loans to our customers for personal, family and household purposes, auto, boat and personal installment loans, however, these loans are a small percentage of the portfolio. The consumer loan segment uses a loss-rate model. Life-time loss rates capture the effect of credit score, loan age, size, and other loan characteristics and include Cadence’s own assumptions for LGD and the expected life of the loan. The loss rates are also affected by macroeconomic variables such as the unemployment rate, retails sales percent change year-over-year, household employment percent change year-over-year, FHFA home price index, housing affordability index at origination, and median house price.

When foreclosure of collateral securing a loan is probable, ASC 326 requires that the expected credit loss on a loan be measured based on the fair value of the collateral. When management’s measured value of the impaired loan is less than the amortized cost in the loan, the amount of the impairment is recorded as a specific reserve. These specific reserves are determined on an individual loan basis based on management’s current evaluation of the loss exposure for each credit, given the payment status, the financial condition of the borrower and any guarantors and the value of any underlying collateral. Loans that are individually evaluated are excluded from the collective evaluations described above. Changes in specific reserves from period to period are the result of changes in the circumstances of individual loans such as charge-offs, payments received, changes in collateral values or other factors.

For any collateral dependent loan where foreclosure is not probable, but repayment is expected to be provided primarily from the sale or operation of the collateral and the borrower is experiencing financial difficulty, a practical expedient for measuring the credit loss is allowed using the fair value of the collateral. The Company expects to elect this for qualifying credits particularly when there are unique risk characteristics which prohibit them from being collectively evaluated. When repayment will be from the operation of the collateral, generally fair value is estimated on the present value of expected cash flows from the operation of the collateral (an income approach). When repayment is expected from the sale of the collateral, the present value of the costs to sell will be deducted from the fair value of the collateral measured as of the measurement date.

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As described above, loans included in each segment are collectively or individually evaluated to determine an expected credit loss which is allocated to the individual loans. Due to the growth of the credit portfolio into new geographic areas and into new commercial markets and the lack of seasoning of the portfolio, the Company recognizes there is limited historical loss information to adequately estimate loss rates based primarily on the Company’s historical loss data. Therefore, external loss data was acquired from the research arm of a nationally recognized risk rating agency to act as a proxy for loss rates within the ACL models until sufficient loss history can be accumulated from the Company’s loss experience in these segments. These loss rates were developed specifically for the Company’s customer risk profile and portfolio mix.

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ASC 326 acknowledges that, because historical experience may not fully reflect an institution's expectations about the future, the institution should adjust historical loss information, as necessary, to reflect the current conditions and reasonable and supportable forecasts not already reflected in the historical loss information. The quantitative models use baseline macroeconomic scenario forecast data provided by a nationally recognized rating agency for a reasonable and supportable period in estimating the current expected credit losses. The Company has elected an input reversion approach whereby the selected economic forecast for the identified macroeconomic variables revert to their historical trends. As a rule, the forecasts revert to their long-term equilibrium within two to five years or one “business cycle” depending on the segment The Company monitors actual loss experience for each loan segment for adjustments required to the loss rates utilized.

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Additionally, to adjust historical credit loss information for current conditions and reasonable and supportable forecasts, all significant factors relevant to determining the expected collectability of financial assets as of each reporting date should be considered. ASC 326 provides examples of factors an institution may consider. The banking regulatory agencies believe the qualitative or environmental factors identified in the December 2006 Interagency Policy Statement on the Allowance for Loan and Lease Losses should continue to be relevant under CECL and are covered by the examples of factors that may be considered under ASC 326. These factors require judgments that cannot be subjected to exact mathematical calculation. There are no formulas for translating them into a basis-point adjustment to be applied to historical losses. The adjustment must reflect management’s overall estimate of the extent to which expected losses on a segment of loans will differ from historical loss experience. It would include management’s opinion on the effects related to current conditions and reasonable and supportable forecasts, that are not already reflected in the quantitative loss estimate. These adjustments are highly subjective estimates that will be determined each quarter. To facilitate this process, management has developed certain analyses of selected internal and external data to assist management in determining the risk of imprecision. These primary adjustment factors include, but are not limited to the following:

Changes in national and service market economic and business conditions that could affect the level of default rates or the level of losses once a default has occurred within the Bank’s existing loan portfolio

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The reserve for unfunded commitments is determined by assessing three distinct components: unfunded commitment volatility in the portfolio (excluding commitments related to letters of credit and commitment letters), adversely rated letters of credit, and adversely rated lines of credit. Unfunded commitment volatility is calculated on a trailing nine quarter basis; the resulting expected funding amount is then reserved for based on the current combined reserve rate of the funded portfolio. Adverse letters and lines of credit are assessed individually based on funding and loss expectations as of the period end. The reserve for unfunded commitments is recorded in other liabilities and the provision for losses on unfunded commitments is included in the provision for credit losses. Prior to adoption, the provision for losses on unfunded commitments was recorded in other noninterest expense. As of March 31, 2020, and December 31, 2019, the reserve for unfunded commitments totaled $3.2 million and $2.0 million, respectively.

In January 2017, the FASB issued ASU No. 2017-04, Intangibles–Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Therefore, any carrying amount which exceeds the reporting unit’s fair value (up to the amount of goodwill recorded) will be recognized as an impairment loss. ASU 2017-04 became effective for the Company on January 1, 2020. See Note 5, Goodwill and Other Intangible Assets.

In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework–Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 amends the disclosure requirements of ASC 820 to remove disclosure of transfers between Level 1 and Level 2 of the fair value hierarchy and the valuation process for Level 3 fair value measurements, among other amendments, and to include disclosure of the range and weighted average used in Level 3 fair value measurements, among other amendments. Amendments should be applied retrospectively to all periods presented, except for certain amendments, which should be applied prospectively. ASU 2018-13 became effective for the Company on January 1, 2020. The adoption of ASU 2018-13 did not have a significant impact on the Company’s fair value disclosures.

In August 2018, the FASB issued ASU No. 2018-15, Intangibles–Goodwill and Other–Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (a consensus of the FASB Emerging Issues Task Force). This standard aligns the requirements for capitalizing implementation costs in a hosting arrangement service contract with the existing guidance for capitalizing implementation costs incurred for an internal-use software license. This standard also requires capitalizing or expensing implementation costs based on the nature of the costs and the project stage during which they are incurred and establishes additional disclosure requirements. This standard became effective for Cadence on January 1, 2020. The adoption of this guidance had no material impact on the consolidated financial statements.

In October 2018, the FASB issued ASU No. 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities. This ASU amends ASC 810 guidance on how all reporting entities evaluate indirect interests held through related parties in common control arrangements when determining whether fees paid to decision makers and service providers are variable interests. ASU 2018-17 became effective for Cadence on January 1, 2020. The adoption of this guidance had no material impact on the consolidated financial statements.

In April 2019, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments–Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, that clarifies and improves areas of guidance related to the recently issued standards on credit losses, hedging activities, and recognition and measurement. The amendments clarify the scope of the credit losses standard and address issues related to accrued interest receivable balances, recoveries, variable interest rates, and prepayments, among other things. With respect to hedge accounting, the amendments address partial-term fair value hedges, fair value hedge basis adjustments, application by not-for-profit entities and private companies, and certain transition requirements, among other things. On recognizing and measuring financial instruments, they address the scope of the guidance, the requirement for remeasurement under ASC 820 when using the measurement alternative, certain disclosure requirements and which equity securities must be remeasured at historical exchange rates.

The credit losses and hedging amendments have the same effective dates as the respective standards, unless an entity has already adopted the standards. The adoption of the credit loss standard, or CECL, is discussed above. Since the Company early adopted the guidance in ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, in 2018, the amended hedge accounting guidance in ASU 2019-04 became effective as of the beginning of the first annual reporting period beginning after April 25, 2019. The Company adopted this guidance on January 1, 2020, with no material impact.

In February 2020, the FASB issued ASU No. 2020-02, Financial Instruments—Credit Losses (Topic 326) and Leases (Topic 842)—Amendments to SEC Paragraphs Pursuant to SEC Staff Accounting Bulletin No. 119 and Update to SEC Section on Effective Date Related to Accounting Standards Update No. 2016-02, Leases (Topic 842) (SEC Update). The ASU adds and amends SEC paragraphs in the Accounting Standards Codification to reflect the issuance of SEC Staff Accounting Bulletin No. 119 related to the new credit losses standard and comments by the SEC staff related to the revised effective date of the new leases standard. The guidance became effective upon issuance and did not have a material impact.

In March 2020, the FASB issued ASU No. 2020-03, Codification Improvements to Financial Instruments. The ASU makes narrow-scope improvements to various financial instruments topics, including the new credit losses standard. Transition varies, with some of the amendments effective upon issuance for certain entities. The amendments related to ASU 2019-04 and ASU 2016-13 became effective for Cadence on January 1, 2020. Other amendments became effective upon issuance (March 9, 2020). The adoption of this guidance had no material impact on the consolidated financial statements.

In March 2020, the FASB issued ASU No. 2020-04, Reference Rate Reform (Topic 848): Facilitation of the Effects of Reference Rate Reform on Financial Reporting. The ASU provides temporary optional expedients and exceptions to the US GAAP guidance on contract modifications and hedge accounting to ease the financial reporting burdens of the expected market transition from the London Interbank Offered Rate (“LIBOR”) and other interbank offered rates to alternative reference rates, such as the Secured Overnight Financing Rate. Entities can elect not to apply certain modification accounting requirements to contracts affected by what the guidance calls reference rate reform, if certain criteria are met. An entity that makes this election would not have to remeasure the contracts at the modification date or reassess a previous accounting determination. Entities can elect various optional expedients for hedging relationships affected by reference rate reform, if certain criteria are met. Entities can make a one-time election to sell and/or transfer to available-for-sale or trading any held-to-maturity debt securities that refer to an interest rate affected by reference rate reform and were classified as HTM before January 1, 2020. The guidance became effective upon issuance (March 12, 2020). As Cadence has no held-to-maturity debt securities, the adoption of the guidance had no impact.

In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The ASU eliminates certain exceptions to the guidance in ASC 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The new guidance also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The guidance is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted in interim or annual periods for which entities have not yet issued financial statements. Entities that elect to early adopt the amendments in an interim period should reflect any adjustments as of the beginning of the annual period that includes that interim period. Additionally, entities that elect early adoption must adopt all the amendments in the same period. Entities will apply the guidance prospectively, except for certain amendments. The Company is evaluating the impact this guidance may have on its consolidated financial statements.

In January 2020, the FASB issued ASU No. 2020-01, Investments—Equity Securities (Topic 321), Investments—Equity Method and Joint Ventures (Topic 323), and Derivatives and Hedging (Topic 815)—Clarifying the Interactions between Topic 321, Topic 323, and Topic 815 (a consensus of the FASB Emerging Issues Task Force). The guidance clarifies that entities that apply the measurement alternative in ASC 321 should consider observable transactions that result in entities initially applying or discontinuing the use of the equity method of accounting under ASC 323. The guidance also says that certain forward contracts and purchased options on equity securities that are not deemed to be in-substance common stock under ASC 323 or accounted for as derivatives under ASC 815 are in the scope of ASC 321. The guidance is effective for public business entities for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted. The guidance should be applied prospectively. The Company is evaluating the impact this guidance may have on its consolidated financial statements.