LOANS AND ALLOWANCE FOR LOAN LOSSES | 5. LOANS AND ALLOWANCE FOR LOAN LOSSES The loan portfolio balances, net of unearned income and fees, consist of various types of loans primarily made to borrowers located within Texas and are classified by major type as follows: September 30, 2020 December 31, 2019 (Dollars in thousands) Commercial and industrial $ 650,634 $ 689,360 Mortgage warehouse — 8,304 Paycheck Protection Program (PPP) 710,234 — Real estate: Commercial real estate (including multi-family residential) 1,971,228 1,873,782 Commercial real estate construction and land development 376,877 410,471 1-4 family residential (including home equity) 716,565 698,957 Residential construction 148,056 192,515 Consumer and other 18,768 41,921 Total loans 4,592,362 3,915,310 Allowance for loan losses (48,698 ) (29,438 ) Loans, net $ 4,543,664 $ 3,885,872 Acquired Loans PCI loans The Company has loans that were acquired and for which there was, at acquisition, evidence of deterioration of credit quality since origination and for which it was probable, at acquisition, that all contractually required payments would not be collected. The carrying amount of PCI loans included in the consolidated balance sheet and the related outstanding balance owed at September 30, 2020 and December 31, 2019 are presented in the table below: As of September 30, 2020 As of December 31, 2019 (Dollars in thousands) Outstanding balance $ 15,195 $ 16,589 Less: Discount (1,970 ) (2,414 ) Less: Allowance (1,381 ) (259 ) Recorded investment $ 11,844 $ 13,916 Acquired loans were recorded through acquisition accounting without an allowance. There was an allocation of $1.4 million in the allowance for loan losses relating to PCI loans at September 30, 2020. Changes in the accretable yield for PCI loans for the three and nine months ended September 30, 2020 and 2019 were deemed immaterial. Nonaccrual and Past Due Loans An aging analysis of the recorded investment, defined as the unpaid principal balance, in past due loans, segregated by class of loans, is as follows: September 30, 2020 Loans Past Due and Still Accruing 30-89 90 or More Total Past Nonaccrual Current Total Days Days Due Loans Loans Loans Loans (Dollars in thousands) Commercial and industrial $ 3,793 $ — $ 3,793 $ 13,171 $ 633,670 $ 650,634 Mortgage warehouse — — — — — — Paycheck Protection Program (PPP) — — — — 710,234 710,234 Real estate: Commercial real estate (including multi-family residential) 2,419 — 2,419 15,849 1,952,960 1,971,228 Commercial real estate construction and land development 1,433 — 1,433 3,085 372,359 376,877 1-4 family residential (including home equity) 8,722 — 8,722 4,263 703,580 716,565 Residential construction 3,150 — 3,150 876 144,030 148,056 Consumer and other 392 — 392 684 17,692 18,768 Total loans $ 19,909 $ — $ 19,909 $ 37,928 $ 4,534,525 $ 4,592,362 December 31, 2019 Loans Past Due and Still Accruing 30-89 90 or More Total Past Nonaccrual Current Total Days Days Due Loans Loans Loans Loans (Dollars in thousands) Commercial and industrial $ 3,098 $ — $ 3,098 $ 8,388 $ 677,874 $ 689,360 Mortgage warehouse — — — — 8,304 8,304 Real estate: Commercial real estate (including multi-family residential) 4,421 — 4,421 6,741 1,862,620 1,873,782 Commercial real estate construction and land development 66 — 66 9,050 401,355 410,471 1-4 family residential (including home equity) 1,598 — 1,598 3,294 694,065 698,957 Residential construction 564 — 564 746 191,205 192,515 Consumer and other 254 — 254 152 41,515 41,921 Total loans $ 10,001 $ — $ 10,001 $ 28,371 $ 3,876,938 $ 3,915,310 Impaired Loans Impaired loans by class of loans are set forth in the following tables. As of September 30, 2020 Unpaid Recorded Principal Related Investment Balance Allowance (Dollars in thousands) With no related allowance recorded: Commercial and industrial $ 5,627 $ 5,771 $ — Mortgage warehouse — — — Paycheck Protection Program (PPP) — — — Real estate: Commercial real estate (including multi-family residential) 12,835 12,835 — Commercial real estate construction and land development 3,085 3,085 — 1-4 family residential (including home equity) 1,623 1,623 — Residential construction 876 1,053 — Consumer and other 53 53 — Total 24,099 24,420 — With an allowance recorded: Commercial and industrial 12,933 13,328 5,428 Mortgage warehouse — — — Paycheck Protection Program (PPP) — — — Real estate: Commercial real estate (including multi-family residential) 13,498 13,498 2,801 Commercial real estate construction and land development 3,342 3,342 216 1-4 family residential (including home equity) 1,834 1,834 124 Residential construction — — — Consumer and other 520 520 276 Total 32,127 32,522 8,845 Total: Commercial and industrial 18,560 19,099 5,428 Mortgage warehouse — — — Paycheck Protection Program (PPP) — — — Real estate: Commercial real estate (including multi-family residential) 26,333 26,333 2,801 Commercial real estate construction and land development 6,427 6,427 216 1-4 family residential (including home equity) 3,457 3,457 124 Residential construction 876 1,053 — Consumer and other 573 573 276 $ 56,226 $ 56,942 $ 8,845 As of December 31, 2019 Unpaid Recorded Principal Related Investment Balance Allowance (Dollars in thousands) With no related allowance recorded: Commercial and industrial $ 5,721 $ 6,136 $ — Mortgage warehouse — — — Real estate: Commercial real estate (including multi-family residential) 19,478 19,558 — Commercial real estate construction and land development — — — 1-4 family residential (including home equity) 2,000 2,000 — Residential construction 208 208 — Consumer and other 38 38 — Total 27,445 27,940 — With an allowance recorded: Commercial and industrial 7,812 7,286 3,480 Mortgage warehouse — — — Real estate: Commercial real estate (including multi-family residential) 5,335 5,335 459 Commercial real estate construction and land development 12,142 12,142 2,085 1-4 family residential (including home equity) — — — Residential construction 537 537 66 Consumer and other 26 26 26 PCI 2,039 2,959 659 Total 27,891 28,285 6,775 Total: Commercial and industrial 13,533 13,422 3,480 Mortgage warehouse — — — Real estate: Commercial real estate (including multi-family residential) 24,813 24,893 459 Commercial real estate construction and land development 12,142 12,142 2,085 1-4 family residential (including home equity) 2,000 2,000 — Residential construction 745 745 66 Consumer and other 64 64 26 PCI 2,039 2,959 659 $ 55,336 $ 56,225 $ 6,775 The following table presents average impaired loans and interest recognized on impaired loans for the three and nine months ended September 30, 2020 and 2019: Three Months Ended September 30, 2020 2019 Average Interest Average Interest Recorded Income Recorded Income Investment Recognized Investment Recognized (Dollars in thousands) Commercial and industrial $ 19,109 $ 128 $ 12,268 $ 94 Mortgage warehouse — — — — Paycheck Protection Program (PPP) — — — — Real estate: Commercial real estate (including multi-family residential) 26,326 63 18,762 86 Commercial real estate construction and land development 6,440 65 12,005 52 1-4 family residential (including home equity) 3,498 — 1,609 — Residential construction 887 — — — Consumer and other 580 2 91 1 Total $ 56,840 $ 258 $ 44,735 $ 233 Nine Months Ended September 30, 2020 2019 Average Interest Average Interest Recorded Income Recorded Income Investment Recognized Investment Recognized (Dollars in thousands) Commercial and industrial $ 19,770 $ 292 $ 12,265 $ 261 Mortgage warehouse — — — — Paycheck Protection Program (PPP) — — — — Real estate: Commercial real estate (including multi-family residential) 26,513 370 19,453 279 Commercial real estate construction and land development 6,308 162 10,263 140 1-4 family residential (including home equity) 3,540 6 1,641 4 Residential construction 811 — — — Consumer and other 590 3 96 — Total $ 57,532 $ 833 $ 43,718 $ 684 Credit Quality Indicators The Company categorizes loans into risk categories based on relevant information about the ability of borrowers to service their debt, including factors such as: current financial information, historical payment experience, credit documentation, public information and current economic trends. The Company analyzes loans individually by classifying the loans by credit risk. As part of the ongoing monitoring of the credit quality of the Company’s loan portfolio and methodology for calculating the allowance for loan losses, management assigns and tracks risk ratings to be used as credit quality indicators. Due to the COVID-19 pandemic, the Company initiated an enhanced customer outreach effort to re-evaluate its loan grades assigned to its commercial loan portfolio during the third quarter of 2020, the results of which are reflected in the disclosures below. Effects as a result of the pandemic may continue, potentially resulting in further downgrades and additional loans being identified. The following is a general description of the risk ratings used: Pass —Loans classified as pass are loans with low to average risk and not otherwise classified as watch, special mention, substandard or doubtful. In addition, the guaranteed portion of SBA loans are considered pass risk rated loans. Watch —Loans classified as watch loans may still be of high quality, but have an element of risk added to the credit such as declining payment history, deteriorating financial position of the borrower or a decrease in collateral value. Special Mention —Loans classified as special mention have a potential weakness that deserves management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or of the institution’s credit position at some future date. They are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Substandard —Loans classified as substandard have well-defined weaknesses on a continuing basis and are inadequately protected by the current net worth and paying capacity of the borrower, impaired or declining collateral values, or a continuing downturn in their industry which is reducing their profits to below zero and having a significantly negative impact on their cash flow. These classified loans are characterized by the distinct possibility that the institution will sustain some loss if the deficiencies are not corrected. Doubtful —Loans classified as doubtful have all the weaknesses inherent in those classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full on the basis of currently existing facts, conditions and values highly questionable and improbable. Based on the most recent analysis performed, the risk category of loans by class of loan at their recorded investment at September 30, 2020 is as follows: Pass Watch Special Mention Substandard Doubtful Total (Dollars in thousands) Commercial and industrial $ 563,375 $ 31,973 $ 23,748 $ 31,395 $ 143 $ 650,634 Mortgage warehouse — — — — — — Paycheck Protection Program (PPP) 710,234 — — — — 710,234 Real estate: Commercial real estate (including multi-family residential) 1,638,276 192,413 78,725 61,814 — 1,971,228 Commercial real estate construction and land development 335,865 32,436 3,108 5,468 — 376,877 1-4 family residential (including home equity) 651,583 36,696 18,444 9,842 — 716,565 Residential construction 141,319 3,614 2,247 876 — 148,056 Consumer and other 17,487 297 281 703 — 18,768 Total loans $ 4,058,139 $ 297,429 $ 126,553 $ 110,098 $ 143 $ 4,592,362 The following table presents the risk category of loans by class of loan at December 31, 2019: Pass Watch Special Mention Substandard Doubtful Total (Dollars in thousands) Commercial and industrial $ 641,696 $ 14,170 $ 9,121 $ 24,295 $ 78 $ 689,360 Mortgage warehouse 8,304 — — — — 8,304 Real estate: Commercial real estate (including multi-family residential) 1,775,789 47,762 9,289 40,942 — 1,873,782 Commercial real estate construction and land development 388,151 9,583 639 12,098 — 410,471 1-4 family residential (including home equity) 669,288 15,798 5,844 8,027 — 698,957 Residential construction 189,209 2,560 — 746 — 192,515 Consumer and other 41,355 6 358 202 — 41,921 Total loans $ 3,713,792 $ 89,879 $ 25,251 $ 86,310 $ 78 $ 3,915,310 Allowance for Loan Losses The following table presents the activity in the allowance for loan losses by portfolio type for the three and nine months ended September 30, 2020 and 2019: Commercial and Mortgage warehouse Paycheck Protection Program (PPP) Commercial real estate (including multi-family residential) Commercial real estate construction and land development 1-4 family residential (including home equity) Residential construction Consumer and other Total (Dollars in thousands) Allowance for loan losses: Three Months Ended Balance June 30, 2020 $ 13,367 $ — $ — $ 20,889 $ 3,865 $ 7,542 $ 1,803 $ 176 $ 47,642 Provision for loan losses (126 ) — — 2,453 (379 ) (349 ) (471 ) 219 1,347 Charge-offs (350 ) — — — (71 ) — — — (421 ) Recoveries 122 — — 8 — — — — 130 Net charge-offs (228 ) — — 8 (71 ) — — — (291 ) Balance September 30, 2020 $ 13,013 $ — $ — $ 23,350 $ 3,415 $ 7,193 $ 1,332 $ 395 $ 48,698 Nine Months Ended Balance December 31, 2019 $ 8,818 $ — $ — $ 11,170 $ 4,421 $ 3,852 $ 1,057 $ 120 $ 29,438 Provision for loan losses 5,256 — — 12,309 1,335 3,556 275 275 23,006 Charge-offs (1,442 ) — — (137 ) (2,341 ) (215 ) — — (4,135 ) Recoveries 381 — — 8 — — — — 389 Net charge-offs (1,061 ) — — (129 ) (2,341 ) (215 ) — — (3,746 ) Balance September 30, 2020 $ 13,013 $ — $ — $ 23,350 $ 3,415 $ 7,193 $ 1,332 $ 395 $ 48,698 Allowance for loan losses: Three Months Ended Balance June 30, 2019 $ 8,255 $ — $ — $ 12,940 $ 2,257 $ 3,376 $ 1,004 $ 108 $ 27,940 Provision for loan losses 1,322 — — 613 (222 ) 608 247 29 2,597 Charge-offs (769 ) — — — (44 ) — — — (813 ) Recoveries 84 — — — — — — — 84 Net charge-offs (685 ) — — — (44 ) — — — (729 ) Balance September 30, 2019 $ 8,892 $ — $ — $ 13,553 $ 1,991 $ 3,984 $ 1,251 $ 137 $ 29,808 Nine Months Ended Balance December 31, 2018 $ 8,351 $ — $ — $ 11,901 $ 2,724 $ 2,242 $ 1,040 $ 73 $ 26,331 Provision for loan losses 1,668 — — 1,729 (689 ) 2,037 211 50 5,006 Charge-offs (1,357 ) — — (80 ) (44 ) (295 ) — (8 ) (1,784 ) Recoveries 230 — — 3 — — — 22 255 Net charge-offs (1,127 ) — — (77 ) (44 ) (295 ) — 14 (1,529 ) Balance September 30, 2019 $ 8,892 $ — $ — $ 13,553 $ 1,991 $ 3,984 $ 1,251 $ 137 $ 29,808 The following table presents the balance of the allowance for loan losses by portfolio type based on the i mpairment method as of September 3 0 , 20 20 and December 31, 201 9 : Commercial and Mortgage warehouse Paycheck Protection Program (PPP) Commercial real estate (including multi-family residential) Commercial real estate construction and land development 1-4 family residential (including home equity) Residential construction Consumer and other Total (Dollars in thousands) Allowance for loan losses related to: September 30, 2020 Individually evaluated for impairment $ 5,428 $ — $ — $ 2,801 $ 216 $ 124 $ — $ 276 $ 8,845 Collectively evaluated for impairment 7,585 — — 20,549 3,199 7,069 1,332 119 39,853 Total allowance for loan losses $ 13,013 $ — $ — $ 23,350 $ 3,415 $ 7,193 $ 1,332 $ 395 $ 48,698 December 31, 2019 Individually evaluated for impairment $ 4,139 $ — $ — $ 459 $ 2,085 $ — $ 66 $ 26 $ 6,775 Collectively evaluated for impairment 4,679 — — 10,711 2,336 3,852 991 94 22,663 Total allowance for loan losses $ 8,818 $ — $ — $ 11,170 $ 4,421 $ 3,852 $ 1,057 $ 120 $ 29,438 The following table presents the recorded investment in loans held for investment by portfolio type based on the impairment method as of September 30, 2020 and December 31, 2019: Commercial and Mortgage warehouse Paycheck Protection Program (PPP) Commercial real estate (including multi-family residential) Commercial real estate construction and land development 1-4 family residential (including home equity) Residential construction Consumer and other Total (Dollars in thousands) Recorded investment in loans: September 30, 2020 Individually evaluated for impairment $ 18,560 $ — $ — $ 26,333 $ 6,427 $ 3,457 $ 876 $ 573 $ 56,226 Collectively evaluated for impairment 632,074 — 710,234 1,944,895 370,450 713,108 147,180 18,195 4,536,136 Total loans evaluated for impairment $ 650,634 $ — $ 710,234 $ 1,971,228 $ 376,877 $ 716,565 $ 148,056 $ 18,768 $ 4,592,362 December 31, 2019 Individually evaluated for impairment $ 15,572 $ — $ — $ 24,813 $ 12,142 $ 2,000 $ 745 $ 64 $ 55,336 Collectively evaluated for impairment 673,788 8,304 — 1,848,969 398,329 696,957 191,770 41,857 3,859,974 Total loans evaluated for impairment $ 689,360 $ 8,304 $ — $ 1,873,782 $ 410,471 $ 698,957 $ 192,515 $ 41,921 $ 3,915,310 Troubled Debt Restructurings As of September 30, 2020 and December 31, 2019, the Company had a recorded investment in troubled debt restructurings of $32.1 million and $28.9 million, respectively. The Company allocated $6.8 million and $3.2 million of specific reserves for troubled debt restructurings at September 30, 2020 and December 31, 2019. The following table presents information regarding loans modified in a troubled debt restructuring during the three and nine months ended September 30, 2020 and 2019: Three Months Ended September 30, 2020 2019 Number of Contracts Pre-Modification of Outstanding Recorded Investment Post Modification of Outstanding Recorded Investment Number of Contracts Pre-Modification of Outstanding Recorded Investment Post Modification of Outstanding Recorded Investment (Dollars in thousands) Troubled Debt Restructurings Commercial and industrial 5 $ 1,133 $ 1,133 4 $ 1,502 $ 1,502 Mortgage warehouse — — — — — — Paycheck Protection Program (PPP) — — — — — — Real estate: Commercial real estate (including multi-family residential) 3 1,983 1,983 — — — Commercial real estate construction and land development — — — — — — 1-4 family residential (including home equity) 1 1,081 1,081 — — — Residential construction — — — — — — Consumer and other — — — — — — Total 9 $ 4,197 $ 4,197 4 $ 1,502 $ 1,502 Nine Months Ended September 30, 2020 2019 Number of Contracts Pre-Modification of Outstanding Recorded Investment Post Modification of Outstanding Recorded Investment Number of Contracts Pre-Modification of Outstanding Recorded Investment Post Modification of Outstanding Recorded Investment (Dollars in thousands) Troubled Debt Restructurings Commercial and industrial 16 $ 3,137 $ 3,137 11 $ 2,069 $ 2,069 Mortgage warehouse — — — — — — Paycheck Protection Program (PPP) — — — — — — Real estate: Commercial real estate (including multi-family residential) 3 1,983 1,983 1 303 303 Commercial real estate construction and land development 1 830 830 — — — 1-4 family residential (including home equity) 4 2,021 2,021 1 396 396 Residential construction — — — — — — Consumer and other 1 30 30 1 38 38 Total 25 $ 8,001 $ 8,001 14 $ 2,806 $ 2,806 Troubled debt restructurings resulted in $632 thousand of charge-offs during the nine months ended September 30, 2020 and $251 thousand of charge-offs during the nine months ended September 30, 2019. There was one loan for $22 thousand modified under a troubled debt restructuring during the previous twelve-month period that subsequently defaulted during the nine months ended September 30, 2020. As of September 30, 2019, seven loans for a total of $4.7 million were modified under a troubled debt restructuring during the previous twelve-month period that subsequently defaulted during the nine months ended September 30, 2019. Default is determined at 90 or more days past due. The modifications primarily related to extending the amortization periods of the loans. The Company did not grant principal reductions on any restructured loans. There were no commitments to lend additional amounts to troubled debt restructured loans for the three and nine months ended September 30, 2020 and 2019. During the nine months ended September 30, 2020, the Company added $8.0 million in new troubled debt restructurings, of which $6.7 million was still outstanding on September 30, 2020. During the nine months ended September 30, 2019, the Company added $2.8 million in new troubled debt restructurings, of which $2.7 million was still outstanding on September 30, 2019. In working with customers adversely affected by the COVID-19 pandemic, the Company implemented a payment deferral program where customers meeting certain conditions were able to request payment deferrals that were not considered troubled debt restructurings. During the nine months ended September 30, 2020, the Company granted 2,007 initial principal and interest deferrals on outstanding loan balances of $1.15 billion at September 30, 2020 with associated accrued interest of $16.1 million. Additionally, upon request and after meeting certain conditions, borrowers could be granted additional payment deferrals subsequent to the first deferral. Of the initial deferrals, 242 loans with outstanding loan balances of $219.6 million with associated accrued interest of $3.4 million, as of September 30, 2020 had been granted additional deferrals. These deferrals were generally no more than 90 days in duration and were not considered troubled debt restructurings. While the modifications themselves did not trigger a downgrade, if the impact of COVID-19 continues, borrower operations do not improve or if other negative events occur, such modified loans could transition to potential problem loans or into problem loans. The following table presents information regarding principal and interest deferrals as of September 30, 2020 associated with loan modifications related to COVID-19: Initial Deferrals Additional Deferrals Remaining Deferrals Outstanding Loan Balance Deferred Loan Balance Percentage of Total Deferrals Deferred Loan Balance Percentage of Total Deferrals Deferred Loan Balance Percentage of Total Deferrals (Dollars in thousands) Commercial and industrial $ 650,634 $ 123,996 10.8 % $ 19,681 9.0 % $ 26,061 11.0 % Mortgage warehouse — — 0.0 % — 0.0 % — 0.0 % Paycheck Protection Program (PPP) 710,234 — 0.0 % — 0.0 % — 0.0 % Real estate: Commercial real estate (including multi-family residential) 1,971,228 791,323 68.7 % 166,509 75.8 % 169,875 71.6 % Commercial real estate construction and land development 376,877 102,537 8.9 % 17,041 7.7 % 22,219 9.4 % 1-4 family residential (including home equity) 716,565 125,063 10.8 % 15,132 6.9 % 17,599 7.4 % Residential construction 148,056 7,654 0.7 % 1,139 0.5 % 1,139 0.5 % Consumer and other 18,768 1,112 0.1 % 140 0.1 % 142 0.1 % Total loans $ 4,592,362 $ 1,151,685 100.0 % $ 219,642 100.0 % $ 237,035 100.0 % |