Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934.
For the quarterly period ended March 31, 2003
[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities and
Exchange Act of 1934.
For the transition period from ________________ to ________________
Commission file number 0-30533
TEXAS CAPITAL BANCSHARES, INC.
(Exact Name of Registrant as Specified in Its Charter)
DELAWARE 75-2679109
(State or other jurisdiction of incorporation or (I.R.S. Employer Identification Number)
organization)
2100 MCKINNEY AVENUE, SUITE 900, DALLAS, TEXAS, U.S.A. 75201
(Address of principal executive officers) (Zip Code)
214/932-6600
(Registrant's telephone number,
including area code)
N/A
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last
Report)
Indicate by checkmark 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 [X] No [ ]
Indicate by checkmark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Exchange Act). Yes [X] No [ ]
APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY
PROCEEDINGS DURING THE PRECEDING FIVE YEARS:
Indicate by check whether the issuer has filed all reports required to
be filed by Section 12, 13 or 15(d) of the Securities and Exchange Act of 1934
subsequent to the distribution of securities under a plan confirmed by a court.
Yes [ ] No [ ]
APPLICABLE ONLY TO CORPORATE ISSUERS:
On May 14, 2003, the number of shares set forth below was outstanding
with respect to each of the issuer's classes of common stock:
Common Stock 18,513,084
Series A-1 Non-voting Common Stock 694,672
Texas Capital Bancshares, Inc.
Form 10-Q
Quarter Ended March 31, 2003
Index
Part I. Financial Information
Item 1. Financial Statements
Consolidated Statements of Operations - Unaudited 3
Consolidated Balance Sheets - Unaudited 4
Consolidated Statements of Changes in Stockholders' Equity - Unaudited 5
Consolidated Statements of Cash Flows - Unaudited 6
Notes to Consolidated Financial Statements - Unaudited 7
Financial Summaries - Unaudited 11
Item 2. Management's Assessment of Operations and Financial Condition 12
Item 3. Quantitative and Qualitative Disclosures about Market Risk 19
Item 4. Controls and Procedures 21
Part II. Other Information
Item 6. Exhibits and Reports on Form 8-K 22
2
ITEM 1. FINANCIAL STATEMENTS
TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS - UNAUDITED
(In thousands except per share data)
Three months ended March 31
2003 2002
------------ ------------
INTEREST INCOME
Interest and fees on loans $ 14,696 $ 12,501
Securities 5,356 2,889
Federal funds sold 87 89
Deposits in other banks 1 1
------------ ------------
Total interest income 20,140 15,480
INTEREST EXPENSE
Deposits 5,382 4,907
Federal funds purchased 440 375
Other borrowings 2,445 804
Long-term debt 133 --
------------ ------------
Total interest expense 8,400 6,086
------------ ------------
NET INTEREST INCOME 11,740 9,394
PROVISION FOR LOAN LOSSES 1,250 1,171
------------ ------------
NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 10,490 8,223
NON-INTEREST INCOME
Service charges on deposit accounts 843 629
Trust fee income 281 247
Gain on sale of securities 341 --
Cash processing fees 900 993
Bank owned life insurance (BOLI) income 414 --
Other 550 327
------------ ------------
Total non-interest income 3,329 2,196
NON-INTEREST EXPENSE
Salaries and employee benefits 5,379 4,333
Net occupancy expense 1,187 1,277
Advertising 193 80
Legal and professional 579 684
Communications and data processing 720 722
Franchise taxes 37 14
Other 1,283 1,231
------------ ------------
Total non-interest expense 9,378 8,341
------------ ------------
INCOME BEFORE INCOME TAXES 4,441 2,078
Income tax expense 1,410 520
------------ ------------
NET INCOME 3,031 1,558
Preferred stock dividends (274) (261)
------------ ------------
Income available to common stockholders $ 2,757 $ 1,297
============ ============
EARNINGS PER SHARE:
Basic $ .14 $ .07
Diluted $ .14 $ .07
See accompanying notes to consolidated financial statements.
3
TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED BALANCE SHEETS - UNAUDITED
(In thousands except share data)
March 31, December 31,
2003 2002
------------ ------------
ASSETS
Cash and due from banks $ 56,049 $ 88,744
Federal funds sold 62,210 --
Securities, available-for-sale 620,769 553,169
Loans, net 1,037,121 988,019
Loans held for sale 122,950 116,106
Premises and equipment, net 3,498 3,829
Accrued interest receivable and other assets 44,084 41,919
Goodwill, net 1,496 1,496
------------ ------------
Total assets $ 1,948,177 $ 1,793,282
============ ============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Deposits:
Non-interest bearing $ 272,789 $ 238,873
Interest bearing 1,023,357 957,662
------------ ------------
Total deposits 1,296,146 1,196,535
Accrued interest payable 2,714 3,826
Other liabilities 7,413 8,485
Federal funds purchased 148,729 83,629
Repurchase agreements 352,628 302,083
Other borrowings 2,785 63,748
Long-term debt:
Guaranteed preferred beneficial interests in the Company's
subordinated debentures 10,000 10,000
------------ ------------
Total liabilities 1,820,415 1,668,306
Stockholders' equity:
Series A convertible preferred stock, $.01 par value, 6%:
Authorized shares - 10,000,000
Issued shares - 1,057,142 at March 31, 2003 and
December 31, 2002 11 11
Common stock, $.01 par value:
Authorized shares - 100,000,000
Issued shares - 18,517,656 and 18,500,812 at March 31, 2003
and December 31, 2002, respectively 185 185
Series A-1 non-voting common stock, $.01 par value:
Issued shares - 694,672 and 695,516 at March 31, 2003 and
December 31, 2002, respectively 7 7
Additional paid-in capital 131,707 131,881
Accumulated deficit (10,316) (13,347)
Treasury stock (shares at cost: 97,246 at March 31, 2003 and
December 31, 2002) (668) (668)
Deferred compensation 573 573
Accumulated other comprehensive income 6,263 6,334
------------ ------------
Total stockholders' equity 127,762 124,976
------------ ------------
Total liabilities and stockholders' equity $ 1,948,177 $ 1,793,282
============ ============
See accompanying notes to consolidated financial statements.
4
TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY - UNAUDITED
(In thousands except share data)
Series A Series A-1
Convertible Non-voting
Preferred Stock Common Stock Common Stock
------------------------- ------------------------- --------------------------
Additional
Paid-in
Shares Amount Shares Amount Shares Amount Capital
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 2001 753,301 $ 8 18,400,310 $ 184 741,392 $ 7 $ 127,378
Comprehensive income:
Net income -- -- -- -- -- -- --
Change in unrealized gain
(loss) on
available-for-sale
securities, net of tax
of $3,683, net of
reclassification amount
of $1,375 -- -- -- -- -- -- --
Total comprehensive income
Sale of Series A convertible
preferred stock 303,841 3 -- -- -- -- 5,247
Sale of common stock -- -- 54,626 1 -- -- 350
Preferred dividends -- -- -- -- -- -- (1,097)
Transfers -- -- 45,876 -- (45,876) -- --
Purchase of treasury stock -- -- -- -- -- -- --
Sale of treasury stock -- -- -- -- -- -- 3
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 2002 1,057,142 11 18,500,812 185 695,516 7 131,881
Comprehensive income (loss):
Net income -- -- -- -- -- -- --
Change in unrealized gain
(loss) on
available-for-sale
securities, net of
taxes of $38, net
of reclassification
amount of $341 -- -- -- -- -- -- --
Total comprehensive income
(loss)
Sale of common stock -- -- 16,000 -- -- -- 100
Transfers -- -- 844 -- (844) -- --
Preferred dividend accrued -- -- -- -- -- -- (274)
----------- ----------- ----------- ----------- ----------- ----------- -----------
Balance at March 31, 2003 1,057,142 $ 11 18,517,656 $ 185 694,672 $ 7 $ 131,707
=========== =========== =========== =========== =========== =========== ===========
Accumulated
Treasury Stock Other
-------------------------- Compre-
hensive
Accumulated Deferred Income
Deficit Shares Amount Compensation (Loss) Total
----------- ----------- ----------- ------------ ------------ -----------
Balance at December 31, 2001 $ (20,690) (87,516) $ (594) $ 573 $ (507) $ 106,359
Comprehensive income:
Net income 7,343 -- -- -- -- 7,343
Change in unrealized gain
(loss) on
available-for-sale
securities, net of tax
of $3,683, net of
reclassification amount
of $1,375 -- -- -- -- 6,841 6,841
-----------
Total comprehensive income 14,184
Sale of Series A convertible
preferred stock -- -- -- -- -- 5,250
Sale of common stock -- -- -- -- -- 351
Preferred dividends -- -- -- -- -- (1,097)
Transfers -- -- -- -- -- --
Purchase of treasury stock -- (14,144) (103) -- -- (103)
Sale of treasury stock -- 4,414 29 -- -- 32
----------- ----------- ----------- ----------- ----------- -----------
Balance at December 31, 2002 (13,347) (97,246) (668) 573 6,334 124,976
Comprehensive income (loss):
Net income 3,031 -- -- -- -- 3,031
Change in unrealized gain
(loss) on
available-for-sale
securities, net of
taxes of $38, net
of reclassification
amount of $341 -- -- -- -- (71) (71)
-----------
Total comprehensive income 2,960
(loss)
Sale of common stock -- -- -- -- -- 100
Transfers -- -- -- -- -- --
Preferred dividend accrued -- -- -- -- -- (274)
----------- ----------- ----------- ----------- ----------- -----------
Balance at March 31, 2003 $ (10,316) (97,246) $ (668) $ 573 $ 6,263 $ 127,762
=========== =========== =========== =========== =========== ===========
See accompanying notes to consolidated financial statements.
5
TEXAS CAPITAL BANCSHARES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS - UNAUDITED
(In thousands)
Three months ended March 31
2003 2002
------------ ------------
OPERATING ACTIVITIES
Net income $ 3,031 $ 1,558
Adjustments to reconcile net income to net cash provided by (used
in) operating activities:
Provision for loan losses 1,250 1,171
Depreciation and amortization 366 461
Gain on sale of securities (341) --
Amortization and accretion on securities 1,975 327
Bank owned life insurance (BOLI) income (414) --
Originations of loans held for sale (452,891) (230,012)
Proceeds from sales of loans held for sale 446,047 249,776
Changes in operating assets and liabilities:
Accrued interest receivable and other assets (1,735) (419)
Accrued interest payable and other liabilities (1,867) (3,411)
------------ ------------
Net cash provided by (used in) operating activities (4,579) 19,451
INVESTING ACTIVITIES
Purchases of available-for-sale securities (145,660) (80,534)
Proceeds from sales of available-for-sale securities 10,694 --
Maturities and calls of available-for-sale securities 1,800 1,400
Principal payments received on securities 63,550 17,616
Net (increase) decrease in loans (50,408) 6,904
Purchase of premises and equipment, net 5 (123)
------------ ------------
Net cash used in investing activities (120,019) (54,737)
FINANCING ACTIVITIES
Net increase (decrease) in checking, money market and savings
accounts 65,503 (25,573)
Net increase in certificates of deposit 34,108 76,257
Sale of preferred stock -- 5,250
Sale of common stock 100 --
Net other borrowings (10,418) 5,805
Dividends paid (280) --
Net federal funds purchased 65,100 8,670
Sale of treasury stock, net -- 24
------------ ------------
Net cash provided by financing activities 154,113 70,433
------------ ------------
Net increase in cash and cash equivalents 29,515 35,147
Cash and cash equivalents at beginning of period 88,744 56,620
------------ ------------
Cash and cash equivalents at end of period $ 118,259 $ 91,767
============ ============
Supplemental disclosures of cash flow information:
Cash paid during the period for interest $ 9,380 $ 6,644
Non-cash transactions:
Transfers from loans/leases to other repossessed assets 16 --
Transfers from loans/leases to premises and equipment 40 --
See accompanying notes to consolidated financial statements.
6
TEXAS CAPITAL BANCSHARES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED
(1) ACCOUNTING POLICIES
Basis of Presentation
The accounting and reporting policies of Texas Capital Bancshares, Inc. (the
"Company") conform to accounting principles generally accepted in the United
States and to generally accepted practices within the banking industry. The
Consolidated Financial Statements of the Company include the accounts of the
Company and its subsidiary, Texas Capital Bank, National Association (the
"Bank"). The Company owns all of the outstanding common securities of Texas
Capital Bancshares Statutory Trust I, which is a Connecticut business trust.
Certain prior period balances have been reclassified to conform with the current
period presentation.
New Accounting Standards
In December 2002, the Financial Accounting Standards Board issued FASB Statement
No. 148, Accounting for Stock-Based Compensation - Transition and Disclosure.
Statement 148 amends FASB Statement No. 123, Accounting for Stock-Based
Compensation, to provide alternative methods of transition to Statement 123's
fair value method of accounting for stock-based employee compensation. Statement
148 also amends the disclosure provisions of Statement 123 and APB Opinion No.
28, Interim Financial Reporting, to require disclosure in the summary of
significant accounting policies of the effects of an entity's accounting policy
with respect to stock-based employee compensation on reported net income and
earnings per share in annual and interim financial statements. While the
Statement does not amend Statement 123 to require companies to account for
employee stock options using the fair value method, the disclosure provisions of
Statement 148 are applicable to all companies with stock-based employee
compensation, regardless of whether they account for that compensation using the
fair value method of Statement 123 or the intrinsic value method of Opinion 25.
The Company adopted the disclosure provisions of Statement 148 effective
December 31, 2002.
At March 31, 2003, the Company had a stock-based employee compensation plan. The
Company accounts for the 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 those plans had an exercise price equal to
the market value of the underlying common stock on the date of grant. The
following table illustrates the effect on net income and earnings per share if
the Company had applied the fair value recognition provisions of FASB Statement
No. 123 to stock-based employee compensation.
Three months ended March 31
2003 2002
------------ ------------
Net income as reported $ 3,031 $ 1,558
Deduct: Total stock based employee compensation expense
determined under fair value based method for all awards (188) (101)
------------ ------------
Pro forma net income $ 2,843 $ 1,457
============ ============
Basic income per share:
As reported $ .14 $ .07
Pro forma .13 .06
Diluted income per share:
As reported $ .14 $ .07
Pro forma .13 .06
The fair value of these options was estimated at the date of grant using a
Black-Scholes value option pricing model with the following weighted average
assumptions used for 2003 and 2002, respectively: a risk free interest rate of
2.85% and 4.37%, a dividend yield of 0%, a volatility factor of .228 and .001,
and an estimated life of five years.
7
(1) ACCOUNTING POLICIES (CONTINUED)
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.
(2) EARNINGS PER SHARE
The following table presents the computation of basic and diluted earnings per
share (dollars in thousands except share data):
Three months ended March 31
2003 2002
-------------- --------------
Numerator:
Net income $ 3,031 $ 1,558
Preferred stock dividends (274) (261)
-------------- --------------
Numerator for basic earnings per share-income available to
common shareholders 2,757 1,297
Effect of dilutive securities:
Preferred stock dividends(2) 274 --
-------------- --------------
Numerator for dilutive earnings per share-income available to
common shareholders after assumed conversion $ 3,031 $ 1,297
============== ==============
Denominator:
Denominator for basic earnings per share-weighted average
shares 19,194,023 19,054,114
Effect of dilutive securities:
Employee stock options(1) 207,804 203,298
Convertible preferred stock(2) 2,114,284 --
-------------- --------------
Dilutive potential common shares 2,322,088 203,298
-------------- --------------
Denominator for dilutive earnings per share-adjusted weighted
average shares and assumed conversions 21,516,111 19,257,412
============== ==============
Basic earnings per share $ .14 $ .07
Diluted earnings per share $ .14 $ .07
(1) Excludes employee stock options with exercise price greater than
current market price.
(2) Effects of convertible preferred stock are anti-dilutive and are not
included in March 2002. Effects of convertible preferred stock are
dilutive and are included in March 2003.
8
(3) REPORTABLE SEGMENTS
The Company operates two principal lines of business under the Bank: the
traditional bank and BankDirect, an internet only bank.
BankDirect has been a net provider of funds and the traditional bank has been a
net user of funds. In order to provide a consistent measure of the net interest
margin for BankDirect, a multiple pool funds transfer pricing method was used to
calculate credit for funds provided. This method takes into consideration market
conditions during the reporting period.
TRADITIONAL BANKING
(In thousands)
Three months ended March 31
2003 2002
------------ ------------
Net interest income $ 11,901 $ 9,019
Provision for loan losses 1,250 1,171
Non-interest income 3,286 2,154
Non-interest expense 8,448 7,689
------------ ------------
Net income $ 5,489 $ 2,313
============ ============
BANKDIRECT
(In thousands)
Three months ended March 31
2003 2002
------------ ------------
Net interest income (loss) $ (28) $ 375
Provision for loan losses -- --
Non-interest income 43 42
Non-interest expense 476 518
------------ ------------
Net loss $ (461) $ (101)
============ ============
Reportable segments reconciliations to the Consolidated Financial Statements for
the three months ended March 31, 2003 are as follows (in thousands):
Net Interest Provision for Non-interest Non-interest
Income Loan Losses Income Expense
------------ ------------- ------------ ------------
Total reportable lines of business $ 11,873 $ 1,250 $ 3,329 $ 8,924
Unallocated items:
Holding company (133) -- -- 454
------------ ------------ ------------ ------------
The Company consolidated $ 11,740 $ 1,250 $ 3,329 $ 9,378
============ ============ ============ ============
Reportable segments reconciliations to the Consolidated Financial Statements for
the three months ended March 31, 2002 are as follows (in thousands):
Net Interest Provision for Non-interest Non-interest
Income Loan Losses Income Expense
------------ ------------- ------------ ------------
Total reportable lines of business $ 9,394 $ 1,171 $ 2,196 $ 8,207
Unallocated items:
Holding company -- -- -- 134
------------ ------------ ------------ ------------
The Company consolidated $ 9,394 $ 1,171 $ 2,196 $ 8,341
============ ============ ============ ============
9
(4) FINANCIAL INSTRUMENTS WITH OFF-BALANCE SHEET RISK
The Bank is a party to financial instruments with off-balance sheet risk in the
normal course of business to meet the financing needs of its customers. These
financial instruments include commitments to extend credit and standby letters
of credit which involve varying degrees of credit risk in excess of the amount
recognized in the consolidated balance sheets. The Bank's exposure to credit
loss in the event of non-performance by the other party to the financial
instrument for commitments to extend credit and standby letters of credit is
represented by the contractual amount of these instruments. The Bank uses the
same credit policies in making commitments and conditional obligations as it
does for on-balance sheet instruments. The amount of collateral obtained, if
deemed necessary, is based on management's credit evaluation of the borrower.
Commitments to extend credit are agreements to lend to a customer as long as
there is no violation of any condition established in the contract. Commitments
generally have fixed expiration dates or other termination clauses and may
require payment of a fee. Since many of the commitments may expire without being
drawn upon, the total commitment amounts do not necessarily represent future
cash requirements. The Bank evaluates each customer's credit-worthiness on a
case-by-case basis.
Standby letters of credit are conditional commitments issued by the Bank to
guarantee the performance of a customer to a third party. Those guarantees are
primarily issued to support public and private borrowing arrangements. The
credit risk involved in issuing letters of credit is essentially the same as
that involved in extending loan facilities to customers.
March 31,
(In thousands) 2003
------------
Financial instruments whose contract amounts represent credit risk:
Commitments to extend credit $ 344,098
Standby letters of credit 22,812
(5) SUBSEQUENT EVENTS
Effective April 15, 2003, Raleigh Hortenstine resigned from his positions with
the Company and the Bank. In accordance with the terms of his separation
agreement, the Company incurred additional compensation expense. The amounts are
not expected to materially affect the results of operations for the year 2003.
10
QUARTERLY FINANCIAL SUMMARY - UNAUDITED
Consolidated Daily Average Balances, Average Yields and Rates
(In thousands except per share data)
For the three months ended For the three months ended
March 31, 2003 March 31, 2002
Average Revenue/ Yield/ Average Revenue/ Yield/
Balance(1) Expense Rate Balance(1) Expense Rate
----------- ----------- ----------- ----------- ----------- -----------
ASSETS
Taxable securities $ 546,120 $ 5,356 3.98% $ 214,281 $ 2,889 5.47%
Federal funds sold 29,394 87 1.20% 21,291 89 1.70%
Deposits in other banks 213 1 1.90% 171 1 2.37%
Loans 1,119,684 14,696 5.32% 884,795 12,501 5.73%
Less reserve for loan losses 14,944 -- -- 12,928 -- --
----------- ----------- ----------- ----------- ----------- -----------
Loans, net of reserve 1,104,740 14,696 5.39% 871,867 12,501 5.81%
----------- ----------- ----------- ----------- ----------- -----------
Total earning assets 1,680,467 20,140 4.86% 1,107,610 15,480 5.67%
Cash and other assets 144,661 87,044
----------- -----------
Total assets $ 1,825,128 $ 1,194,654
=========== ===========
LIABILITIES AND STOCKHOLDERS'
EQUITY
Transaction deposits $ 59,584 $ 112 0.76% $ 48,658 $ 125 1.04%
Savings deposits 381,587 1,640 1.74% 342,460 1,519 1.80%
Time deposits 524,622 3,630 2.81% 368,359 3,263 3.59%
----------- ----------- ----------- ----------- ----------- -----------
Total interest-bearing deposits 965,793 5,382 2.26% 759,477 4,907 2.62%
Other borrowings 496,617 2,885 2.36% 185,263 1,179 2.58%
Long-term debt 10,000 133 5.39% -- -- --
----------- ----------- ----------- ----------- ----------- -----------
Total interest-bearing liabilities 1,472,410 8,400 2.31% 944,740 6,086 2.61%
Demand deposits 213,991 130,552
Other liabilities 11,784 7,464
Stockholders' equity 126,943 111,898
----------- -----------
Total liabilities and
stockholders' equity $ 1,825,128 $ 1,194,654
=========== ===========
Net interest income $ 11,740 $ 9,394
Net interest income to earning
assets 2.83% 3.44%
----------- -----------
Provision for loan losses 1,250 1,171
Non-interest income 3,329 2,196
Non-interest expense 9,378 8,341
----------- -----------
INCOME BEFORE TAXES 4,441 2,078
Federal income tax 1,410 520
----------- -----------
NET INCOME $ 3,031 $ 1,558
=========== ===========
EARNINGS PER SHARE:
NET INCOME
Basic $ .14 $ .07
Diluted $ .14 $ .07
Return on average equity 9.68% 5.65%
Return on average assets .67% .53%
Equity to assets 6.96% 9.37%
(1) The loan averages include loans on which the accrual of interest has
been discontinued and are stated net of unearned income.
11
ITEM 2. MANAGEMENT'S ASSESSMENT OF OPERATIONS AND FINANCIAL CONDITION
FORWARD LOOKING STATEMENTS
Statements and financial analysis contained in this document that are not
historical facts are forward looking statements made pursuant to the safe harbor
provisions of the Private Securities Litigation Reform Act of 1995. Forward
looking statements describe our future plans, strategies and expectations and
are based on certain assumptions. As a result, these forward looking statements
involve substantial risks and uncertainties, many of which are beyond our
control. The important factors that could cause actual results to differ
materially from the forward looking statements include the following:
(1) Changes in interest rates
(2) Changes in the levels of loan prepayments, which could affect
the value of our loans
(3) Changes in general economic and business conditions in areas or
markets where we compete
(4) Competition from banks and other financial institutions for
loans and customer deposits
(5) The failure of assumptions underlying the establishment of and
provisions made to the allowance for credit losses
(6) The loss of senior management or operating personnel and the
potential inability to hire qualified personnel at reasonable
compensation levels
(7) Changes in government regulations
We have no obligation to update or revise any forward looking statements as a
result of new information or future events. In light of these assumptions, risks
and uncertainties, the events discussed in any forward looking statements in
this quarterly report might not occur.
RESULTS OF OPERATIONS
SUMMARY OF PERFORMANCE
The Company recorded net income of $3.0 million or $.14 per diluted common share
for the first quarter of 2003 compared to $1.6 million or $.07 per diluted
common share for the first quarter of 2002. Return on average assets was .67%
for the first quarter of 2003 compared to .53% for the first quarter of 2002.
Return on average equity was 9.68% and 5.65%, for the first quarter of 2003 and
2002, respectively.
The increase in net income for the quarter ended March 31, 2003 over the same
period of 2002 was due to an increase in net interest income and an increase in
non-interest income, offset by an increase in non-interest expenses. Net
interest income for the first quarter of 2003 increased by $2.3 million or 25.0%
from $9.4 million to $11.7 million over the first quarter of 2002. The increase
in net interest income was due to an increase in average earning assets of
$572.9 million or 51.7%, which offset a 61 basis point decrease in net interest
margin.
Non-interest income increased $1.1 million or 51.6% compared to the first
quarter of 2002. This increase was due primarily to an increase in service
charge income, BOLI income and an increase in mortgage warehouse fees. The first
quarter of 2003 non-interest income also includes a $341,000 gain on sale of
securities.
Non-interest expense increased $1.0 million or 12.4% compared to the first
quarter of 2002. This increase was primarily due to an increase in salaries and
employee benefits of $1.0 million related to an increase in full-time employees.
Total employees increased from 196 at March 31, 2002 to 224 at March 31, 2003.
12
NET INTEREST INCOME
Net interest income was $11.7 million for the first quarter of 2003 compared to
$9.4 million for the first quarter of 2002. The increase was primarily due to an
increase in average earning assets of $572.9 million as compared to the first
quarter of 2002. The increase in average earning assets from the first quarter
of 2002 included a $232.9 million increase in average net loans which
represented 65.7% of average earning assets for the quarter ended March 31, 2003
compared to 78.7% for the same period of 2002. Average securities in the first
quarter of 2003 increased $331.8 million compared to the same quarter of 2002.
Securities represented 32.5% of average earning assets for the quarter ended
March 31, 2003 compared to 19.3% in the same quarter for 2002. Average interest
bearing liabilities increased $527.7 million from the first quarter of 2002
which included a $206.3 million increase in interest bearing deposits and a
$311.4 million increase in other borrowings. Average other borrowings were 27.2%
of average total assets for the first quarter of 2003 compared to 15.5% in the
same period in 2002. The increase in average other borrowings was primarily
related to an increase in federal funds purchased and securities sold under
repurchase agreements and was used to supplement deposits in funding loan growth
and securities purchases. The average cost of interest bearing liabilities
decreased from 2.61% for the quarter ended March 31, 2002 to 2.31% for the same
period of 2003, reflecting the continuing decline in market interest rates.
TABLE 1 - VOLUME/RATE ANALYSIS
(In thousands)
Three months ended March 31, 2003/2002
-----------------------------------------------
Change Due To
Change Volume Yield/Ratio
------------ ------------ ------------
Interest income
Securities $ 2,467 $ 4,474 $ (2,007)
Loans 2,195 3,319 (1,124)
Federal funds sold (2) 34 (36)
------------ ------------ ------------
Total 4,660 7,827 (3,167)
Interest expense:
Transaction deposits (13) 28 (41)
Savings deposits 121 174 (53)
Time deposits 367 1,384 (1,017)
Borrowed funds 1,706 1,981 (275)
Long-term debt 133 133 --
------------ ------------ ------------
Total 2,314 3,700 (1,386)
------------ ------------ ------------
Net interest income $ 2,346 $ 4,127 $ (1,781)
============ ============ ============
Net interest margin, the ratio of net interest income to average earning assets,
was 2.83% for the first quarter of 2003 compared to 3.44% for the first quarter
of 2002. The decrease in the net interest margin during the first quarter of
2003 was due to a continued overall decline in market interest rates.
NON-INTEREST INCOME
Non-interest income increased $1.1 million compared to the same quarter of 2002.
Service charges on deposit accounts increased $214,000. This increase was due to
the increase in deposits, which resulted in a higher volume of transactions.
Trust fee income increased $34,000, due to continued growth of trust assets in
2003. Other non-interest income increased by $223,000 primarily due to an
increase in mortgage warehouse fees. BOLI income was $414,000. The first quarter
of 2003 non-interest income also includes a $341,000 gain on sale of securities.
Consistent with the first quarter of 2002, non-interest income included cash
processing fees that totaled $900,000. The fees are related to a special project
that will not be recurring in future quarters in 2003. There will be some income
recorded in the second quarter of 2003 as the project extended into the first
few weeks of April.
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 would likely place
additional demands on capital and managerial resources.
13
TABLE 2 - NON-INTEREST INCOME
(In thousands)
Three months ended March 31
2003 2002
------------ ------------
Service charges on deposit accounts $ 843 $ 629
Trust fee income 281 247
Gain on sale of securities 341 --
Cash processing fees 900 993
Bank owned life insurance (BOLI) income 414 --
Other 550 327
------------ ------------
Total non-interest income $ 3,329 $ 2,196
============ ============
NON-INTEREST EXPENSE
Non-interest expense for the first quarter of 2003 increased $1.0 million or
12.4% compared to the first quarter of 2002. Salaries and employee benefits
increased by $1.0 million or 24.1%. The increase in salaries and employee
benefits was due to an increase in full time employees from 196 at March 31,
2002 to 224 at March 31, 2003.
Advertising expense increased $113,000 or 141.3%. Advertising expense for the
three months ended March 31, 2003 included $31,000 of direct marketing and
branding, including print ads for the traditional bank, and $162,000 for the
purchase of miles related to the American Airlines AAdvantage(R) program. We did
not purchase any miles in the first quarter of 2002 because the miles that we
were contractually required to purchase in 2000 were sufficient to cover our
mileage rewards to customers for 2001 and the first part of 2002. In 2003, we
are purchasing miles as we utilize them. Legal and professional expenses
decreased $105,000 or 15.4%, mainly related to legal expenses incurred with our
non-performing loans and leases that were experienced in 2002.
Net occupancy expense for the three months ended March 31, 2003 decreased by
$90,000, or 7.0% compared to the same quarter in 2002, because no additional
facilities have been added, there were minimal capital expenditures and certain
assets are becoming fully depreciated.
TABLE 3 - NON-INTEREST EXPENSE
(In thousands)
Three months ended March 31
2003 2002
------------ ------------
Salaries and employee benefits $ 5,379 $ 4,333
Net occupancy expense 1,187 1,277
Advertising 193 80
Legal and professional 579 684
Communications and data processing 720 722
Franchise taxes 37 14
Other 1,283 1,231
------------ ------------
Total non-interest expense $ 9,378 $ 8,341
============ ============
INCOME TAXES
For the quarter ended March 31, 2003, the provision for income taxes was $1.4
million, which is based on the Company's estimated effective rate for the year
ended December 31, 2003.
14
ANALYSIS OF FINANCIAL CONDITION
The aggregate loan portfolio at March 31, 2003 increased $57.7 million from
December 31, 2002 to $1.18 billion. Commercial loans increased $28.8 million and
real estate loans increased $7.1 million. Construction loans increased $18.0
million and leases and consumer loans decreased $3.1 million.
TABLE 4 - LOANS
(In thousands)
March 31, December 31,
2003 2002
------------ ------------
Commercial $ 538,324 $ 509,505
Construction 190,491 172,451
Real estate 289,823 282,703
Consumer 22,714 24,195
Leases receivable 15,923 17,546
Loans held for sale 122,950 116,106
------------ ------------
Total $ 1,180,225 $ 1,122,506
============ ============
We continue to lend primarily in Texas. As of March 31, 2003, 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 within this area. We originate
substantially all of the loans 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 selected loan participations and
USDA government guaranteed loans.
SUMMARY OF LOAN LOSS EXPERIENCE
The reserve for loans losses, which is available to absorb losses inherent in
the loan portfolio, totaled $15.9 million at March 31, 2003, $14.5 million at
December 31, 2002 and $12.8 million at March 31, 2002. This represents 1.35%,
1.30% and 1.46% of total loans at March 31, 2003, December 31, 2002 and March
31, 2002, respectively.
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. The Company
recorded a provision of $1.3 million for the quarter ended March 2003 and $1.2
million for the same quarter in 2002. These provisions were made to reflect
management's assessment of the risk of loan losses specifically including risk
associated with the continued rapid growth in the loan portfolio and the
unseasoned nature of the current portfolio.
The reserve for loan losses is comprised of specific reserves assigned to
classified loans and general reserves. We continuously 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.
The reserve allocation percentages assigned to each credit grade have been
developed based on an analysis of 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
standards, and changes in the trend and severity of problem loans, can cause the
estimation of future losses to differ from past experience. The unallocated
portion of the general reserve serves to compensate for additional areas of
15
uncertainty and considers industry comparable reserve ratios. In addition, the
reserve considers the results of reviews performed by independent third party
reviewers as reflected in their confirmations of assigned credit grades within
the portfolio.
The methodology used in the periodic review of reserve adequacy, which is
performed at least quarterly, is designed to be dynamic and responsive to
changes in actual credit losses. The changes are reflected in the general
reserve and in specific reserves as the collectibility of larger classified
loans is continuously recalculated with new information. As our portfolio
matures, historical loss ratios are being closely monitored. Eventually our
reserve adequacy analysis will rely more on our loss history and less on the
experience of peer banks. Currently, the review of reserve adequacy is performed
by executive management and presented to the Board of Directors for their
review, consideration and ratification on a quarterly basis.
TABLE 5 - SUMMARY OF LOAN LOSS EXPERIENCE
(In thousands)
Three months Three months Year ended
ended March 31, ended March 31, December 31,
2003 2002 2002
--------------- --------------- ------------
Beginning balance $ 14,538 $ 12,598 $ 12,598
Loans charged-off:
Commercial -- 1,000 2,096
Consumer -- -- 11
Leases 13 -- 1,740
------------ ------------ ------------
Total 13 1,000 3,847
Recoveries:
Commercial 78 -- 116
Consumer -- 1 --
Leases 40 -- 42
------------ ------------ ------------
Total recoveries 118 1 158
------------ ------------ ------------
Net charge-offs (recoveries) (105) 999 3,689
Provision for loan losses 1,250 1,171 5,629
------------ ------------ ------------
Ending balance $ 15,893 $ 12,770 $ 14,538
============ ============ ============
Reserve for loan losses to loans outstanding
at end of period 1.35% 1.46% 1.30%
Net charge-offs to average loans(1) -- .46% .38%
Provision for loan losses to average loans(1) .45% .54% .58%
Recoveries to gross charge-offs 907.69% .10% 4.11%
Reserve as a multiple of net charge-offs -- 12.8x 3.9x
Non-performing and renegotiated loans:
Loans past due (90 days) $ 38 $ 5,312 $ 135
Non-accrual 3,769 4,750 2,776
------------ ------------ ------------
Total $ 3,807 $ 10,062 $ 2,911
============ ============ ============
Reserve as a percent of non-performing
and renegotiated loans 417.47% 126.91% 499.42%
(1) Interim period ratios are annualized.
NON-PERFORMING ASSETS
Non-performing assets include non-accrual loans and leases, accruing loans 90 or
more days past due, restructured loans, and other repossessed assets. We had
non-accrual loans and leases of $3,769,000, $2,776,000 and $4,750,000 at March
31, 2003, December 31, 2002 and March 31, 2002, respectively. At March 31, 2003,
our non-accrual loans and leases consisted of $815,000 in commercial loans,
$1,355,000 in
16
real estate loans, $13,000 in consumer loans and $1,586,000 in leases. At
December 31, 2002, our non-accrual loans and leases consisted of $641,000 in
commercial loans, $1,367,000 in real estate, $26,000 in consumer loans and
$742,000 in leases. At March 31, 2003, we had $38,000 in loans past due 90 days
and still accruing interest. At March 31, 2003, we had $66,000 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.
A loan is considered impaired when, based on current information and events, it
is probable that we will be unable to collect all amounts due (both principal
and interest) according to the terms of the loan agreement. Reserves on impaired
loans are measured based on the present value of the expected future cash flows
discounted at the loan's effective interest rate or the fair value of the
underlying collateral.
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 bank's 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 year ended December 31, 2002 and for the three months ended March 31, 2003,
our principal source of funding has been our customer deposits, supplemented by
our short-term and long-term borrowings, primarily from securities sold under
repurchase agreements and federal funds purchased from our downstream
correspondent bank relationships (which consist of banks that are considered to
be smaller than our bank).
Since early 2002, our liquidity needs have primarily been fulfilled through
growth in our traditional bank customer and stockholder deposits. Our goal is to
obtain as much of our funding as possible from deposits of these customers and
stockholders, which as of March 31, 2003, comprised $893.2 million, or 69%, of
total deposits, compared to $605.2 million, or 65%, of total deposits, at March
31, 2002. These traditional deposits are generated principally through
development of long-term relationships with customers and stockholders.
In addition to deposits from our traditional bank customers and stockholders, we
also have access to incremental consumer deposits through BankDirect and through
brokered retail certificates of deposit, or CDs. As of March 31, 2003,
BankDirect deposits comprised $252.9 million, or 20%, of total deposits, and
brokered retail CDs comprised $150.0 million, or 12%, of total deposits. Our
dependence on internet deposits and retail brokered CDs is limited by our
internal funding guidelines, which as of March 31, 2003, limited borrowing from
these sources to 15-20% and 10-20%, respectively, 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 and from our upstream
correspondent bank relationships (which consist of banks that are larger than
our bank), securities sold under repurchase agreements, treasury, tax and loan
notes, and advances from the Federal Home Loan Bank, or FHLB. As of March 31,
2003, our borrowings consisted of a total of $346.3 million of securities sold
under repurchase agreements, $148.7 million of downstream federal funds
purchased, $6.4 million from customer repurchase agreements and $2.8 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 March 31, 2003, there were no borrowings from the FHLB. Our unused
FHLB borrowing capacity at March 31, 2003 was approximately $290 million. As of
March 31, 2003, we had unused upstream federal fund lines available from
commercial banks of approximately $43 million. During the three months ended
March 31, 2003, our average borrowings from these sources were 27% of average
assets, which is well within our internal funding guidelines, which limit our
dependence on borrowing sources to 25-30% of total assets. In prior periods, our
internal funding guidelines limited our dependence on borrowing sources to
20-25% of total assets. In the current quarter, management's strategy of
increasing the investment securities portfolio funded by term repurchase
agreements to lock in a return required us to increase this internal guideline.
Average borrowed funds were $496.6 million during the three month period ended
March 31, 2003. The maximum amount of borrowed funds outstanding at any
month-end during the first three months of 2003 was $516.2 million, or 27%, of
total assets.
17
As of March 31, 2003, our contractual obligations and commercial commitments,
other than deposit liabilities, were as follows:
After One After Three
Within but Within but Within After
One Year Three Years Five Years Five Years Total
----------- ----------- ----------- ----------- -----------
(In Thousands)
Federal funds purchased $ 148,729 $ -- $ -- $ -- $ 148,729
Securities sold under repurchase
agreements 82,318 263,937 -- -- 346,255
Customer repurchase agreements 6,373 -- -- -- 6,373
Treasury, tax and loan notes 2,785 -- -- -- 2,785
Operating lease obligations 2,544 4,991 4,924 5,398 17,857
Long-term debt -- -- -- 10,000 10,000
----------- ----------- ----------- ----------- -----------
Total contractual obligations $ 242,749 $ 268,928 $ 4,924 $ 15,398 $ 531,999
=========== =========== =========== =========== ===========
The contractual amount of our financial instruments with off-balance sheet risk
expiring by period at March 31, 2003 is presented below:
After One After Three
Within but Within but Within After
One Year Three Years Five Years Five Years Total
----------- ----------- ----------- ----------- -----------
(In Thousands)
Commitments to extend credit $ 226,554 $ 97,216 $ 14,653 $ 5,675 $ 344,098
Standby letters of credit 16,129 6,683 -- -- 22,812
----------- ----------- ----------- ----------- -----------
Total financial instruments with
off-balance sheet risk $ 242,683 $ 103,899 $ 14,653 $ 5,675 $ 366,910
=========== =========== =========== =========== ===========
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 $126.9 million for the three months ended March 31,
2003 as compared to $111.9 million for the same period in 2002. This increase
reflects our retention of net earnings during this period. We have not paid any
cash dividends on our common stock since we commenced operations and have no
plans to do so in the near future.
TABLE 6 - CAPITAL RATIOS
March 31, March 31,
2003 2002
------------ ------------
Risk-based capital:
Tier 1 capital 9.69% 11.13%
Total capital 10.88 12.38
Leverage 7.15 9.38
CRITICAL ACCOUNTING POLICIES
The Securities and Exchange Commission ("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 generally accepted accounting principles. 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.
18
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
creditworthiness of the borrower, and more specifically, changes in the expected
future receipt of principal and interest payments and/or in the value of pledged
collateral. A reserve is recorded when the carrying amount of the loan exceeds
the discounted estimated cash flows using the loan's initial effective interest
rate or the fair value of the collateral for certain collateral dependent loans.
For purposes of determining the general reserve, the portfolio is segregated by
product types in order to recognize differing risk profiles among categories,
and then further segregated by credit grades. See "Summary of Loan Loss
Experience" for further discussion of the risk factors considered by management
in establishing the allowance for loan losses.
Management considers the policies related to income taxes to be critical to the
financial statement presentation. The Company utilizes the liability method in
accounting for income taxes. Under this method, deferred tax assets and
liabilities are determined based upon the difference between the values of the
assets and liabilities as reflected in the financial statements and their
related tax basis using enacted tax rates in effect for the year in which the
differences are expected to be recovered or settled. As changes in tax law or
rates are enacted, deferred tax assets and liabilities are adjusted through the
provision for income taxes. A valuation reserve is provided against deferred tax
assets unless it is more likely than not that such deferred tax assets will be
realized.
The Company has a gross deferred tax asset and the asset is realizable to the
extent it offsets deferred tax liabilities in a given year, creates a loss that
can be carried back and offset against 2002 taxes paid or reduces future taxable
income. The Company has not assumed future income in assessing the
recoverability of the deferred tax assets due to the uncertainty surrounding
current economic conditions and the fact that the Company has a limited
operating history and is in an accumulated deficit position for the most recent
three calendar years. As a result, the Company has provided a valuation
allowance related to deferred taxes unless such assets are certain to turn
around during a period in which losses could be carried back to 2002 or in the
same period as an offsetting deferred tax liability is certain to turn around.
The largest component of the valuation allowance relates to the allowance for
loan losses, as it is not practical to determine the exact period in which a
charge-off would be recorded and sustained as a tax deduction.
At such time as the Company concludes it is appropriate to consider future
taxable income in assessing the recoverability of the deferred tax asset, all or
a portion of the allowance would be reversed resulting in a reduction of tax
expense.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES 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.
The Company is subject to market risk primarily through the effect of changes in
interest rates on its 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 the Company.
The responsibility for managing market risk rests with the BSMC, which operates
under policy guidelines established by the Board of Directors. The negative
acceptable variation in net interest revenue due to a 200 basis point increase
or decrease in interest rates is generally limited by these guidelines to +/-
10%. These guidelines also establish maximum levels for short-term borrowings,
short-term assets, and public and brokered deposits. They also establish minimum
levels for unpledged assets, among other things. Compliance with these
guidelines is the ongoing responsibility of the BSMC, with exceptions reported
to the full Board of Directors on a quarterly basis.
19
INTEREST RATE RISK MANAGEMENT
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 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 30-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 an instantaneous sustained parallel 200
basis point increase or decrease, respectively, in interest rates. As short-term
rates fell below 2.0% by the end of 2002, we could not assume interest rate
changes of 200 basis points as the results in the decreasing rates scenario
would be negative rates. Therefore, we are using 100 basis point variance for
our "shock test" decreasing scenario until short-term rates rise above 2.0%.
Our interest rate risk exposure model incorporates assumptions regarding the
level of interest rate or balance changes on indeterminable maturity deposits
(demand deposits, interest bearing transaction accounts and savings accounts)
for a given level of market rate changes. These assumptions have been developed
through a combination of historical analysis and future expected pricing
behavior. Changes in prepayment behavior of mortgage-backed securities,
residential, and commercial mortgage loans in each rate environment are captured
using industry estimates of prepayment speeds for various coupon segments of the
portfolio. The impact of planned growth and new business activities is factored
into the simulation model.
This modeling indicated interest rate sensitivity is as follows:
TABLE 7 - INTEREST RATE SENSITIVITY
(In thousands)
Anticipated Impact Over the Next Twelve Months
as Compared to Most Likely Scenario
----------------------------------------------
200 bp Increase 100 bp Decrease
March 2003 March 2003
--------------- ---------------
Change in net interest income $ 10,330 $ (6,461)
With the record number of interest rate declines in the past two years, we have
positioned our balance sheet to take advantage of a rising rate environment. The
estimated changes in interest rates on net interest income are not within
guidelines established by our Board of Directors for all interest rate
scenarios. These exceptions are not excessive in the current rate environment
and are being monitored closely. In the declining scenario, the larger
sensitivity is due in large part to the artificial floor created for the
liabilities, due to the overall low market interest rates. In the upward rate
shock, the guideline is exceeded due to the asset sensitive nature of the
balance sheet.
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.
We expect our balance sheet will continue to be asset sensitive over the next
twelve months, which means that we will have more loans repricing than deposits
over this period. This is largely due to the concentration of our
20
assets in variable rate (rather than fixed rate) loans. In the current rate
environment, management may choose to fund investment securities purchased with
term liabilities/deposits to lock in a return. Investment securities are
generally held in the "available for sale" category so that gains and losses can
be realized as appropriate. At certain times, we use the "held to maturity"
category if we are not planning to sell these securities before maturity.
As of March 31, 2003, the Bank sources approximately 20% of its total deposits
from retail consumer internet deposit customers through BankDirect. These retail
consumer deposits may be more interest rate sensitive than our other deposits as
a result of the extremely competitive internet banking market.
ITEM 4. CONTROLS AND PROCEDURES
The Company's chief executive officer and chief financial officer have evaluated
the Company's disclosure controls and procedures as of March 31, 2003 and
concluded that those disclosure controls and procedures are effective. There
have been no changes in the Company's internal controls or in other factors
known to the Company that could significantly affect these controls subsequent
to their evaluation, nor any corrective actions with regard to significant
deficiencies and material weaknesses. While the Company believes that its
existing disclosure controls and procedures have been effective to accomplish
these objectives, the Company intends to continue to examine, refine and
formalize its disclosure controls and procedures and to monitor ongoing
developments in this area.
21
PART II - OTHER INFORMATION
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
99.1 Certification of Chief Executive Officer
99.2 Certification of Chief Financial Officer
(b) Report on Form 8-K
Current report filed on Form 8-K regarding Item 7 (Financial
Statements, Pro Forma Financial Information and Exhibits) and
Item 9 (Other Events) dated March 21, 2003.
22
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 thereunto duly authorized.
TEXAS CAPITAL BANCSHARES, INC.
Date: May 14, 2003 /s/ Gregory B. Hultgren
--------------------------------------------
Gregory B. Hultgren
Chief Financial Officer
(Duly authorized officer and principal
financial officer)
23
CERTIFICATIONS
I, Joseph M. Grant, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Texas Capital
Bancshares, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 14, 2003
/S/ Joseph M. Grant
- ------------------------------------
Joseph M. Grant
Chief Executive Officer
24
I, Gregory B. Hultgren, certify that:
1. I have reviewed this quarterly report on Form 10-Q of Texas Capital
Bancshares, Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officer and I are responsible for
establishing and maintaining disclosure controls and procedures (as defined
in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have:
a) designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within those
entities, particularly during the period in which this quarterly
report is being prepared;
b) evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date of
this quarterly report (the "Evaluation Date"); and
c) presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of the registrant's board of directors (or persons performing the
equivalent function):
a) all significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) any fraud, whether or not material, that involves management or other
employees who have a significant role in the registrant's internal
controls; and
6. The registrant's other certifying officer and I have indicated in this
quarterly report whether or not there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
Date: May 14, 2003
/S/ Gregory B. Hultgren
- ------------------------------------
Gregory B. Hultgren
Chief Financial Officer
25
EXHIBIT INDEX
Exhibit Number
99.1 Certification of Chief Executive Officer
99.2 Certification of Chief Financial Officer
26