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Table of Contents

 

 

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 Exchange Act of 1934.

For the quarterly period ended March 31, 2011

 

¨ Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the transition period from              to             

Commission File Number: 000-53629

 

 

PLAINSCAPITAL CORPORATION

(Exact name of registrant as specified in its charter)

 

Texas   75-2182440

(State or other jurisdiction

of incorporation or organization)

 

(I.R.S. Employer

Identification No.)

2323 Victory Avenue, Suite 1400, Dallas, Texas 75219

(Address of principal executive offices, including zip code)

(214) 252-4000

(Registrant’s telephone number, including area code)

N/A

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or 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 check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ¨    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer   ¨    Accelerated filer   ¨
Non-accelerated filer   x  (Do not check if a smaller reporting company)    Smaller reporting company   ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

As of May 3, 2011, there were 34,108,147 shares of the registrant’s Original Common Stock, $0.001 par value, and no shares of the registrant’s Common Stock, $0.001 par value, outstanding, including 2,473,741 shares that participate in dividends but are not defined as outstanding under generally accepted accounting principles.


Table of Contents

PlainsCapital Corporation

Quarterly Report on Form 10-Q for the period ended March 31, 2011

TABLE OF CONTENTS

 

PART I. FINANCIAL INFORMATION   
Item 1.   Financial Statements   

Unaudited Consolidated Interim Financial Statements

  

Consolidated Balance Sheets, March 31, 2011 and December 31, 2010

     3   

Consolidated Statements of Income, Three Months Ended March 31, 2011 and 2010

     4   

Consolidated Statements of Shareholders’ Equity, Three Months Ended March 31, 2011 and 2010

     5   

Consolidated Statements of Cash Flows, Three Months Ended March 31, 2011 and 2010

     6   

Notes to Consolidated Financial Statements

     7   
Item 2.   Management’s Discussion and Analysis of Financial Condition and Results of Operations      36   
Item 3.   Quantitative and Qualitative Disclosures about Market Risk      55   
Item 4.   Controls and Procedures      58   
PART II. OTHER INFORMATION   
Item 1.   Legal Proceedings      58   
Item 1A.   Risk Factors      59   
Item 2.   Unregistered Sales of Equity Securities and Use of Proceeds      59   
Item 3.   Defaults Upon Senior Securities      59   
Item 4.   (Removed and Reserved)      59   
Item 5.   Other Information      59   
Item 6.   Exhibits      59   
Signatures      60   

 

2


Table of Contents

PART I. FINANCIAL INFORMATION

 

Item 1. Financial Statements

PlainsCapital Corporation and Subsidiaries

Consolidated Balance Sheets

 

     March 31, 2011
(Unaudited)
    December 31,
2010
 
     (in thousands)  

Assets

    

Cash and due from banks

   $ 451,869      $ 332,208   

Federal funds sold and securities purchased under agreements to resell

     69,561        154,501   

Assets segregated for regulatory purposes

     13,000        —     

Loans held for sale

     482,627        477,711   

Securities

    

Held to maturity, fair market value $200,631 and $228,730, respectively

     196,270        232,913   

Available for sale, amortized cost $806,402 and $614,588, respectively

     798,932        613,236   

Trading, at fair market value

     44,636        18,931   
                
     1,039,838        865,080   

Loans, net of unearned income

     2,985,660        3,138,170   

Allowance for loan losses

     (65,940     (65,169
                

Loans, net

     2,919,720        3,073,001   

Broker-dealer and clearing organization receivables

     78,325        45,768   

Fee award receivable

     18,910        19,222   

Investment in unconsolidated subsidiaries

     2,012        2,012   

Premises and equipment, net

     92,994        80,183   

Accrued interest receivable

     15,159        16,615   

Other real estate owned

     18,847        23,968   

Goodwill, net

     35,880        35,880   

Other intangible assets, net

     12,927        13,441   

Other assets

     152,695        177,064   
                

Total assets

   $ 5,404,364      $ 5,316,654   
                

Liabilities and Shareholders’ Equity

    

Deposits

    

Noninterest-bearing

   $ 282,615      $ 256,372   

Interest-bearing

     3,829,575        3,662,087   
                

Total deposits

     4,112,190        3,918,459   

Broker-dealer and clearing organization payables

     107,987        65,632   

Short-term borrowings

     492,927        582,134   

Capital lease obligation

     11,579        11,693   

Notes payable

     62,195        63,776   

Junior subordinated debentures

     67,012        67,012   

Other liabilities

     101,820        160,672   
                

Total liabilities

     4,955,710        4,869,378   

Commitments and contingencies

    

Shareholders’ equity

    

PlainsCapital Corporation shareholders’ equity

    

Preferred stock, $1.00 par value per share, authorized 50,000,000 shares;

    

Series A, 87,631 shares issued

     84,711        84,481   

Series B, 4,382 shares issued

     4,688        4,712   

Original Common Stock, $0.001 par value per share, authorized 50,000,000 shares; 31,866,787 and 31,780,828 shares issued, respectively

     32        32   

Common Stock, $0.001 par value per share, authorized 150,000,000 shares; zero shares issued

     —          —     

Surplus

     153,774        153,289   

Retained earnings

     211,278        206,786   

Accumulated other comprehensive loss

     (4,104     (281
                
     450,379        449,019   

Unearned ESOP shares (232,381 shares)

     (2,528     (2,528
                

Total PlainsCapital Corporation shareholders’ equity

     447,851        446,491   

Noncontrolling interest

     803        785   
                

Total shareholders’ equity

     448,654        447,276   
                

Total liabilities and shareholders’ equity

   $ 5,404,364      $ 5,316,654   
                

See accompanying notes.

 

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Table of Contents

PlainsCapital Corporation and Subsidiaries

Consolidated Statements of Income - Unaudited

(In thousands, except per share amounts)

 

     Three Months Ended March 31,  
     2011      2010  

Interest income:

     

Loans, including fees

   $ 42,204       $ 44,624   

Securities

     

Taxable

     4,606         3,804   

Tax-exempt

     2,387         2,451   

Federal funds sold and securities purchased under agreements to resell

     1,092         9   

Interest-bearing deposits with banks

     314         243   

Other

     1,400         1,177   
                 

Total interest income

     52,003         52,308   

Interest expense

     

Deposits

     7,528         7,144   

Short-term borrowings

     398         778   

Capital lease obligations

     136         141   

Notes payable

     810         881   

Junior subordinated debentures

     621         613   

Other

     85         78   
                 

Total interest expense

     9,578         9,635   
                 

Net interest income

     42,425         42,673   

Provision for loan losses

     6,500         22,955   
                 

Net interest income after provision for loan losses

     35,925         19,718   

Noninterest income

     

Service charges on depositor accounts

     1,842         2,118   

Net realized gains on sale of securities

     —           1,612   

Net gains from sale of loans

     44,334         32,993   

Mortgage loan origination fees

     17,292         14,409   

Trust fees

     1,006         1,073   

Investment advisory fees and commissions

     12,011         15,536   

Securities brokerage fees and commissions

     6,186         5,713   

Other

     2,669         1,978   
                 

Total noninterest income

     85,340         75,432   

Noninterest expense

     

Employees’ compensation and benefits

     66,346         56,795   

Occupancy and equipment, net

     15,398         13,837   

Professional services

     6,046         5,791   

Deposit insurance premiums

     1,856         1,275   

Repossession and foreclosure, net of recoveries

     1,880         1,452   

Other

     17,515         13,610   
                 

Total noninterest expense

     109,041         92,760   
                 

Income before income taxes

     12,224         2,390   

Income tax provision

     4,508         580   
                 

Net income

     7,716         1,810   

Less: Net income attributable to noncontrolling interest

     122         124   
                 

Net income attributable to PlainsCapital Corporation

     7,594         1,686   

Dividends on preferred stock and other

     1,400         1,388   
                 

Income applicable to PlainsCapital Corporation common shareholders

   $ 6,194       $ 298   
                 

Earnings per share

     

Basic

   $ 0.19       $ 0.01   
                 

Diluted

   $ 0.18       $ 0.01   
                 

See accompanying notes.

 

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Table of Contents

PlainsCapital Corporation and Subsidiaries

Consolidated Statements of Shareholders’ Equity - Unaudited

 

          PlainsCapital Corporation Shareholders              
    Comprehensive     Preferred Stock     Common Stock           Retained    

Accumulated

Other

Comprehensive

    Unearned
ESOP
    Noncontrolling        
    Income     Shares     Amount     Shares     Amount     Surplus     Earnings     Income (Loss)     Shares     Interest     Total  
    (Dollars in thousands)  

Balance, January 1, 2010

      92,013      $ 88,400        31,613,010      $ 32      $ 150,626      $ 186,743      $ (300   $ (3,001   $ 1,659      $ 424,159   

Stock option plans’ activity, including compensation expense

      —          —          65,706        —          303        —          —          —          —          303   

Vesting of stock-based compensation

      —          —          75,419        —          —          —          —          —          —          —     

Stock-based compensation expense

      —          —          —          —          217        —          —          —          —          217   

ESOP activity

      —          —          —          —          —          14        —          —          —          14   

Dividends on common stock ($0.05 per share)

      —          —          —          —          —          (1,697     —          —          —          (1,697

Dividends on preferred stock

      —          —          —          —          —          (1,194     —          —          —          (1,194

Preferred stock discount and accretion

      —          193        —          —          —          (193     —          —          —          —     

Cash distributions to noncontrolling interest

      —          —          —          —          —          —          —          —          (78     (78

Comprehensive income:

                     

Net income

  $ 1,810        —          —          —          —          —          1,686        —          —          124        1,810   

Other comprehensive income (loss):

                     

Unrealized gains on securities available for sale, net of tax of $210.4

    391                       

Unrealized gains on securities held in trust for the Supplemental Executive Retirement Plan, net of tax of $82.9

    144                       

Unrealized losses on customer-related cash flow hedges, net of tax of $1.6

    (3                    
                           

Other comprehensive income

    532        —          —          —          —          —          —          532        —          —          532   
                           

Total comprehensive income

  $ 2,342                       
                                                                                       

Balance, March 31, 2010

      92,013      $ 88,593        31,754,135      $ 32      $ 151,146      $ 185,359      $ 232      $ (3,001   $ 1,705      $ 424,066   
                                                                                 

Balance, January 1, 2011

      92,013      $ 89,193        31,780,828      $ 32      $ 153,289      $ 206,786      $ (281   $ (2,528   $ 785      $ 447,276   

Stock option plans’ activity, including compensation expense

      —          —          2,246        —          34        —          —          —          —          34   

Vesting of stock-based compensation

      —          —          83,713        —          —          —          —          —          —          —     

Stock-based compensation expense

      —          —          —          —          451        —          —          —          —          451   

ESOP activity

      —          —          —          —          —          —          —          —          —          —     

Dividends on common stock ($0.05 per share)

      —          —          —          —          —          (1,702     —          —          —          (1,702

Dividends on preferred stock

      —          —          —          —          —          (1,194     —          —          —          (1,194

Preferred stock discount and accretion

      —          206        —          —          —          (206     —          —          —          —     

Cash received from noncontrolling interest

      —          —          —          —          —          —          —          —          49        49   

Cash distributions to noncontrolling interest

      —          —          —          —          —          —          —          —          (153     (153

Comprehensive income:

                     

Net income

  $ 7,716        —          —          —          —          —          7,594        —          —          122        7,716   

Other comprehensive income (loss):

                     

Unrealized losses on securities available for sale, net of tax of $2137.6

    (3,982                    

Unrealized gains on securities held in trust for the Supplemental Executive Retirement Plan, net of tax of $103.5

    193                       
                           

Unrealized losses on customer-related cash flow hedges, net of tax of $17.9

    (34                    
                           

Other comprehensive loss

    (3,823     —          —          —          —          —          —          (3,823     —          —          (3,823
                           

Total comprehensive income

  $ 3,893                       
                                                                                       

Balance, March 31, 2011

      92,013      $ 89,399        31,866,787      $ 32      $ 153,774      $ 211,278      $ (4,104   $ (2,528   $ 803      $ 448,654   
                                                                                 

See accompanying notes.

 

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Table of Contents

PlainsCapital Corporation and Subsidiaries

Consolidated Statements of Cash Flows - Unaudited

(In thousands)

 

     Three Months Ended
March 31,
 
     2011     2010  

Operating Activities

    

Net income

   $ 7,716      $ 1,810   

Adjustments to reconcile net income to net cash used in operating activities

    

Provision for loan losses

     6,500        22,955   

Net losses on other real estate owned

     1,460        712   

Depreciation and amortization

     8,584        2,630   

Stock-based compensation expense

     470        253   

Net realized gains on sale of securities

     —          (1,612

Loss on sale of premises and equipment

     5        18   

Stock dividends received on securities

     (7     (16

Deferred income taxes

     5,176        (366

Changes in prepaid FDIC assessments

     1,566        1,116   

Changes in assets segregated for regulatory purposes

     (13,000     —     

Changes in trading securities

     (25,705     (48,761

Changes in broker-dealer and clearing organization receivables

     (32,557     (47,176

Changes in fee award receivable

     312        320   

Changes in broker-dealer and clearing organization payables

     42,355        100,856   

Changes in other assets

     (5,313     (38,941

Changes in other liabilities

     (59,141     (26,385

Net gains from sale of loans

     (44,334     (32,993

Loans originated for sale

     (1,471,560     (1,152,337

Proceeds from loans sold

     1,536,012        1,128,959   
                

Net cash used in operating activities

     (41,461     (88,958
                

Investing Activities

    

Net decrease in securities purchased under resale agreements

     75,402        —     

Proceeds from maturities and principal reductions of securities held to maturity

     9,083        23,187   

Proceeds from sales, maturities and principal reductions of securities available for sale

     98,256        83,689   

Purchases of securities held to maturity

     (1,031     (4,911

Purchases of securities available for sale

     (265,372     (167,760

Net decrease in loans

     144,451        31,271   

Purchases of premises and equipment and other assets

     (17,471     (4,649

Proceeds from sales of premises and equipment and other real estate owned

     6,258        1,542   

Net cash received (paid) for Federal Home Loan Bank and Federal Reserve Bank stock

     2,164        (326
                

Net cash provided by (used in) investing activities

     51,740        (37,957
                

Financing Activities

    

Net increase in deposits

     193,731        67,678   

Net increase (decrease) in short-term borrowings

     (89,207     122,933   

Proceeds from notes payable

     1,500        1,200   

Payments on notes payable

     (3,081     (2,143

Proceeds from issuance of common stock

     15        267   

Dividends paid

     (2,896     (2,891

Net cash distributions to noncontrolling interest

     (104     (78

Other, net

     (114     (106
                

Net cash provided by financing activities

     99,844        186,860   
                

Net increase in cash and cash equivalents

     110,123        59,945   

Cash and cash equivalents at beginning of period

     359,335        160,367   
                

Cash and cash equivalents at end of period

   $ 469,458      $ 220,312   
                

Supplemental Disclosures of Cash Flow Information

    

Cash paid during the period for:

    

Interest

   $ 11,482      $ 9,355   
                

Income taxes

   $ 1,090      $ 802   
                

Supplemental Schedule of Noncash Activities

    

Conversion of loans to other real estate owned

   $ 2,568      $ 4,115   
                

 

See accompanying notes.

    

 

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Table of Contents

PlainsCapital Corporation and Subsidiaries

Notes to Consolidated Interim Financial Statements – Unaudited

March 31, 2011

1. Summary of Significant Accounting and Reporting Policies

Basis of Presentation

The unaudited consolidated financial statements of PlainsCapital Corporation, a Texas corporation, and its subsidiaries (“we,” “us,” “our,” “our company,” or “PlainsCapital”) for the three month periods ended March 31, 2011 and 2010 have been prepared by us pursuant to the rules and regulations of the Securities and Exchange Commission (the “SEC”).

The consolidated interim financial statements of PlainsCapital and subsidiaries are unaudited, but in the opinion of management, contain all adjustments (consisting primarily of normal recurring accruals) necessary for a fair statement of the results of the interim periods presented. The consolidated interim financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with instructions to Form 10-Q adopted by the SEC. Accordingly, the financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements and should be read in conjunction with the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K filed with the SEC on March 22, 2011. Results for interim periods are not necessarily indicative of results to be expected for a full year or any future period. PlainsCapital has evaluated subsequent events for potential recognition and/or disclosure through the date the unaudited consolidated financial statements included in this Quarterly Report on Form 10-Q were issued.

PlainsCapital is a financial holding company registered under the Bank Holding Company Act of 1956, as amended by the Graham-Leach-Bliley Act of 1999, headquartered in Dallas, Texas, that provides, through its subsidiaries, an array of financial products and services. In addition to traditional banking services, PlainsCapital provides residential mortgage lending, investment banking, public finance advisory, wealth and investment management, treasury management, capital equipment leasing, fixed income sales and trading, asset management and correspondent clearing services.

PlainsCapital owns 100% of the outstanding stock of PlainsCapital Bank (the “Bank”) and 100% of the membership interest in PlainsCapital Equity, LLC. PlainsCapital owns a 69.75% membership interest in Hester Capital Management, LLC (“Hester Capital”). The Bank owns 100% of the outstanding stock of PrimeLending, a PlainsCapital Company (“PrimeLending”), PNB Aero Services, Inc., PCB-ARC, Inc. and Plains Financial Corporation (“PFC”). The Bank has a 100% interest in First Southwest Holdings, LLC (“First Southwest”) and PlainsCapital Securities, LLC, as well as a 51% voting interest in PlainsCapital Insurance Services, LLC.

After the close of business on December 31, 2008, First Southwest Holdings, Inc., a diversified, private investment banking corporation headquartered in Dallas, Texas merged into FSWH Acquisition LLC, a wholly owned subsidiary of the Bank. Following the merger, FSWH Acquisition LLC changed its name to “First Southwest Holdings, LLC.” The principal subsidiaries of First Southwest are First Southwest Company (“FSC”), a broker-dealer registered with the SEC and the Financial Industry Regulatory Authority (“FINRA”) and First Southwest Asset Management, Inc., a registered investment advisor under the Investment Advisors Act of 1940.

The acquisition cost of First Southwest Holdings, Inc. was approximately $62.2 million. In addition, PlainsCapital placed approximately 1.7 million shares of PlainsCapital Original Common Stock, valued at approximately $19.2 million as of December 31, 2008, into escrow. The percentage of shares to be released from escrow and distributed to former First Southwest stockholders will be determined based upon, among other factors, the valuation of certain auction rate bonds held by First Southwest prior to the merger (or repurchased from investors following the closing of the merger) as of the last day of December 2012 or, if applicable, the aggregate sales price of such auction rate bonds prior to such date. Any shares issued out of the escrow will be accounted for as additional acquisition cost.

 

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Table of Contents

1. Summary of Significant Accounting and Reporting Policies (continued)

 

PlainsCapital used a third-party valuation specialist to assist in the determination of the fair value of assets acquired, including intangibles, and liabilities assumed in the acquisition. The purchase price allocation resulted in net assets acquired in excess of consideration paid of approximately $12.8 million. That amount has been recorded in other liabilities until the contingent consideration issue described previously is settled. Upon resolution of the contingent consideration issue the acquisition cost of First Southwest may increase, resulting in a smaller excess of net assets acquired over consideration paid, or in certain circumstances, an excess of consideration paid over net assets acquired that would result in recording goodwill from the transaction. Any remaining excess of net assets acquired over consideration paid will be allocated pro-rata to reduce the carrying value of purchased assets.

The consolidated interim financial statements include the accounts of the above-named entities. All significant intercompany transactions and balances have been eliminated. Noncontrolling interests have been recorded for minority ownership in entities that are not wholly owned and are presented in compliance with the provisions of Noncontrolling Interest in Subsidiary Subsections of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”).

PlainsCapital also owns 100% of the outstanding common stock of PCC Statutory Trusts I, II, III and IV (the “Trusts”), which are not included in the consolidated financial statements pursuant to the requirements of the Variable Interest Entities Subsections of the ASC, because the primary beneficiaries of the Trusts are not within the consolidated group.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the 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. Estimates regarding the allowance for loan losses are particularly subject to change.

Comprehensive Income (Loss)

PlainsCapital’s comprehensive income (loss) consists of its net income and unrealized holding gains (losses) on its available for sale securities, investments held in trust for the Supplemental Executive Retirement Plan and derivative instruments designated as cash flow hedges.

The components of accumulated other comprehensive loss, net of taxes, at March 31, 2011 and December 31, 2010 are shown in the following table (in thousands):

 

       March 31,  
2011
    December 31,
2010
 

Unrealized loss on securities available for sale

   $ (4,859   $ (877

Unrealized gain on securities held in trust for the Supplemental Executive Retirement Plan

     744        551   

Unrealized gain on customer-related cash flow hedges

     11        45   
                
   $ (4,104   $ (281
                

Reclassification

Certain items in the 2010 financial statements have been reclassified to conform to the 2011 presentation.

 

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Table of Contents

2. Securities

The amortized cost and fair value of securities, excluding trading securities, as of March 31, 2011, and December 31, 2010 are summarized as follows (in thousands):

 

     Held to Maturity  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value  

As of March 31, 2011

          

U. S. government agencies

          

Mortgage-backed securities

   $ 8,167       $ 652       $ —        $ 8,819   

Collateralized mortgage obligations

     22,024         433         (256     22,201   

States and political subdivisions

     120,551         3,300         (600     123,251   

Auction rate bonds

     45,528         850         (18     46,360   
                                  

Totals

   $ 196,270       $ 5,235       $ (874   $ 200,631   
                                  

As of December 31, 2010

          

U. S. government agencies

          

Mortgage-backed securities

   $ 10,369       $ 677       $ (8   $ 11,038   

Collateralized mortgage obligations

     28,169         615         (101     28,683   

States and political subdivisions

     120,348         1,758         (2,497     119,609   

Auction rate bonds

     74,027         644         (5,271     69,400   
                                  

Totals

   $ 232,913       $ 3,694       $ (7,877   $ 228,730   
                                     
     Available for Sale  
     Amortized
Cost
     Gross
Unrealized
Gains
     Gross
Unrealized
Losses
    Fair Value  

As of March 31, 2011

          

U. S. government agencies

          

Bonds

   $ 38,250       $ —         $ (144   $ 38,106   

Mortgage-backed securities

     34,463         426         (560     34,329   

Collateralized mortgage obligations

     620,223         2,747         (6,354     616,616   

States and political subdivisions

     61,952         1,901         (347     63,506   

Auction rate bonds

     51,514         —           (5,139     46,375   
                                     

Totals

   $ 806,402       $ 5,074       $ (12,544   $ 798,932   
                                  

As of December 31, 2010

          

U. S. government agencies

          

Bonds

   $ 30,000       $ 5       $ (46   $ 29,959   

Mortgage-backed securities

     18,907         410         (473     18,844   

Collateralized mortgage obligations

     507,536         2,364         (2,131     507,769   

States and political subdivisions

     35,209         43         (1,042     34,210   

Auction rate bonds

     22,936         —           (482     22,454   
                                     

Totals

   $ 614,588       $ 2,822       $ (4,174   $ 613,236   
                                     

 

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Table of Contents

2. Securities (continued)

 

Information regarding securities that were in an unrealized loss position as of March 31, 2011, is shown in the following tables (dollars in thousands):

 

     As of March 31, 2011  
     Number of
Securities
     Fair Value      Unrealized
Losses
 

Held to maturity

        

U. S. government agencies

        

Collateralized mortgage obligations

        

Unrealized loss for less than twelve months

     2       $ 10,732       $ 256   

Unrealized loss for more than twelve months

     —           —           —     
                          
     2         10,732         256   

States and political subdivisions

        

Unrealized loss for less than twelve months

     49         22,622         429   

Unrealized loss for more than twelve months

     12         4,456         171   
                          
     61         27,078         600   

Auction rate bonds

        

Unrealized loss for less than twelve months

     —           —           —     

Unrealized loss for more than twelve months

     2         10,455         18   
                          
     2         10,455         18   

Total held to maturity

        

Unrealized loss for less than twelve months

     51         33,354         685   

Unrealized loss for more than twelve months

     14         14,911         189   
                          
     65       $ 48,265       $ 874   
                          

Available for sale

        

U. S. government agencies

        

Bonds

        

Unrealized loss for less than twelve months

     4       $ 38,106       $ 144   

Unrealized loss for more than twelve months

     —           —           —     
                          
     4         38,106         144   

Mortgage-backed securities

        

Unrealized loss for less than twelve months

     5         15,035         560   

Unrealized loss for more than twelve months

     —           —           —     
                          
     5         15,035         560   

Collateralized mortgage obligations

        

Unrealized loss for less than twelve months

     25         305,027         6,354   

Unrealized loss for more than twelve months

     —           —           —     
                          
     25         305,027         6,354   

States and political subdivisions

        

Unrealized loss for less than twelve months

     11         13,617         340   

Unrealized loss for more than twelve months

     1         609         7   
                          
     12         14,226         347   

Auction rate bonds

        

Unrealized loss for less than twelve months

     —           —           —     

Unrealized loss for more than twelve months

     3         46,375         5,139   
                          
     3         46,375         5,139   

Total available for sale

        

Unrealized loss for less than twelve months

     45         371,785         7,398   

Unrealized loss for more than twelve months

     4         46,984         5,146   
                          
     49       $ 418,769       $ 12,544   
                          

 

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Table of Contents

2. Securities (continued)

 

Management has the intent and ability to hold the securities classified as held to maturity until they mature, at which time the Bank expects to receive full value for the securities. As of March 31, 2011, management does not intend to sell any of the securities classified as available for sale in the previous table, and management believes that it is more likely than not that PlainsCapital will not have to sell any such securities before a recovery of cost. As of March 31, 2011, management believes the impairments detailed in the table are temporary and relate primarily to changes in interest rates and liquidity. Accordingly, no other-than-temporary impairment loss has been recognized in PlainsCapital’s consolidated statements of income.

The amortized cost and fair value of securities, excluding trading securities, as of March 31, 2011, are shown by contractual maturity below (in thousands).

 

     Securities Held to Maturity      Securities Available for Sale  
     Amortized
Cost
     Fair Value      Amortized
Cost
     Fair Value  

Due in one year or less

   $ 3,369       $ 3,412       $ —         $ —     

Due after one year through five years

     2,218         2,254         33,033         32,892   

Due after five years through ten years

     16,479         16,981         670         677   

Due after ten years

     144,013         146,964         118,013         114,418   
                                   
     166,079         169,611         151,716         147,987   

Mortgage-backed securities

     8,167         8,819         34,463         34,329   

Collateralized mortgage obligations

     22,024         22,201         620,223         616,616   
                                   
   $ 196,270       $ 200,631       $ 806,402       $ 798,932   
                                   

The Bank did not sell securities in the three months ended March 31, 2011. For the three months ended March 31, 2010, the Bank received proceeds from the sale of available for sale securities of $54.3 million and recognized gross gains of $1.6 million. The Bank determines the cost of securities sold by specific identification.

FSC realized net gains from its trading operations of $1.0 million and $0.5 million for the three months ended March 31, 2011 and 2010, respectively.

During the first quarter of 2011, auction rate bonds with a net carrying amount of $28.6 million were transferred from held to maturity to available for sale to address a downgrade in credit rating from investment grade to below investment grade. The net carrying amount of the transferred securities included an unrealized loss of $5.1 million that was included in accumulated other comprehensive loss at March 31, 2011, reducing shareholders’ equity. As of March 31, 2011 and December 31, 2010, the unrealized loss on the transferred securities was $5.1 million and $5.0 million, respectively.

Securities with a carrying amount of approximately $585.0 million and $624.4 million (fair value of approximately $585.4 million and $623.6 million) at March 31, 2011 and December 31, 2010, respectively, were pledged to secure public and trust deposits, federal funds purchased and securities sold under agreements to repurchase, and for other purposes as required or permitted by law. In addition, the Bank had secured a letter of credit from the Federal Home Loan Bank (“FHLB”) in the amount of $60.0 million at both March 31, 2011 and December 31, 2010, in lieu of pledging securities to secure certain public deposits.

 

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Table of Contents

3. Loans and Allowance for Loan Losses

Loans summarized by category as of March 31, 2011 and December 31, 2010, are as follows (in thousands):

 

     March 31,
2011
    December 31,
2010
 

Commercial and industrial

    

Commercial

   $ 1,227,439      $ 1,299,654   

Lease financing

     44,606        50,216   

Securities (primarily margin loans)

     232,409        289,351   

Real estate

     1,137,855        1,112,402   

Construction and land development

     302,880        343,920   

Consumer

     40,471        42,627   
                
     2,985,660        3,138,170   

Allowance for loan losses

     (65,940     (65,169
                
   $ 2,919,720      $ 3,073,001   
                

PlainsCapital has lending policies in place with the goal of establishing an asset portfolio that will provide a return on shareholders’ equity in order that we may retain sufficient earnings to maintain capital to assets ratios that meet or exceed established regulatory guidelines. Loans are underwritten with careful consideration of the borrower’s financial condition, the specific purpose of the loan, the primary sources of repayment and any collateral pledged to secure the loan.

Underwriting procedures address financial components based on the size or complexity of the credit. The financial components include but are not limited to current and projected global cash flows, shock analysis and/or stress testing, and trends in appropriate balance sheet and income statement ratios. Collateral analysis includes complete description, values, monitoring requirements, loan to value ratios, concentration risk, appraisal requirements and other information determined to be relevant to the collateral being pledged. Guarantor analysis includes liquidity and global cash flow analysis based on the significance the guarantors are expected to serve as secondary repayment sources. PlainsCapital’s underwriting standards are governed by adherence to the loan policy. The loan policy provides for specific guidelines by portfolio segment, including commercial and industrial, real estate, construction and land development, and consumer loans. Within each individual portfolio segment, permissible and impermissible loan types are explicitly outlined. Within the loan types, minimum requirements for the underwriting factors listed above are provided.

PlainsCapital maintains an independent loan review department that reviews credit risk on an ongoing basis. The loan review process reviews the creditworthiness of borrowers and determines compliance with lending policy. The loan review process compliments and reinforces the risk identification and assessment decisions made by lenders and credit personnel. Results of these reviews are presented to management and the Bank’s Board of Directors.

 

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3. Loans and Allowance for Loan Losses (continued)

 

Impaired loans exhibit a clear indication that the borrower’s cash flow may not be sufficient to meet principal and interest payments as they become due according to the terms of the loan agreement, which is generally when a loan is 90 days past due unless the asset is both well secured and in the process of collection. Impaired loans include non-accrual loans, troubled debt restructurings and partially charged-off loans. Impaired loans as of March 31, 2011 and December 31, 2010 are summarized by class in the following table (in thousands):

 

     Unpaid
Contractual
Principal Balance
     Recorded
Investment  with
No Allowance
     Recorded
Investment  with
Allowance
     Total
Recorded
Investment
     Related
Allowance
     Average
Recorded
Investment
 

As of March 31, 2011

                 

Commercial and industrial

                 

Secured by receivables

   $ 13,780       $ 3,556       $ 4,364       $ 7,920       $ 2,441       $ 11,782   

Secured by equipment

     3,568         1,228         —           1,228         —           1,052   

Unsecured

     7,875         995         2,880         3,875         1,197         1,992   

Lease financing

     5,352         5,352         —           5,352         —           5,690   

All other commercial and industrial

     4,926         254         630         884         256         4,402   

Real estate

                 

Secured by commercial properties

     14,104         14,104         —           14,104         —           15,331   

Secured by residential properties

     9,309         4,261         4,548         8,809         273         9,365   

Construction and land development

                 

Residential construction loans

     196         196         —           196         —           1,014   

Commercial construction loans and land development

     72,136         29,689         28,692         58,381         5,760         57,949   

Consumer

     34         34         —           34         —           35   
                                                     
   $ 131,280       $ 59,669       $ 41,114       $ 100,783       $ 9,927       $ 108,612   
                                                     
     Unpaid
Contractual
Principal Balance
     Recorded
Investment with
No Allowance
     Recorded
Investment with
Allowance
     Total
Recorded
Investment
     Related
Allowance
     Average
Recorded
Investment
 

As of December 31, 2010

                 

Commercial and industrial

                 

Secured by receivables

   $ 24,036       $ 11,301       $ 4,343       $ 15,644       $ 2,089       $ 29,670   

Secured by equipment

     3,290         638         237         875         57         2,783   

Unsecured

     4,148         109         —           109         —           227   

Lease financing

     6,028         6,028         —           6,028         —           5,607   

All other commercial and industrial

     7,920         4,811         3,109         7,920         2,507         13,989   

Real estate

                 

Secured by commercial properties

     19,039         16,427         130         16,557         1         8,417   

Secured by residential properties

     10,420         6,840         3,080         9,920         417         9,472   

Construction and land development

                 

Residential construction loans

     1,831         1,831         —           1,831         —           1,094   

Commercial construction loans and land development

     70,801         36,430         21,087         57,517         3,724         33,728   

Consumer

     35         35         —           35         —           1   
                                                     
   $ 147,548       $ 84,450       $ 31,986       $ 116,436       $ 8,795       $ 104,988   
                                                     

Interest income recorded on impaired loans that were not in non-accrual status at March 31, 2011, was approximately $0.2 million for the three months ended March 31, 2011. Interest income recorded on non-accrual loans for the three months ended March 31, 2011 and 2010 was nominal. At March 31, 2011, PlainsCapital had unadvanced commitments of approximately $0.8 million to borrowers whose loans had been restructured in troubled debt restructurings.

 

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3. Loans and Allowance for Loan Losses (continued)

 

Non-accrual loans as of March 31, 2011 and December 31, 2010 are summarized by class in the following table (in thousands):

 

       March 31,  
2011
     December 31,
2010
 

Commercial and industrial

     

Secured by receivables

   $ 6,089       $ 7,580   

Secured by equipment

     971         875   

Unsecured

     2,938         64   

Lease financing

     5,352         6,028   

All other commercial and industrial

     630         3,740   

Real estate

     

Secured by commercial properties

     4,156         4,426   

Secured by residential properties

     7,953         3,609   

Construction and land development

     

Residential construction loans

     196         199   

Commercial construction loans and land development

     58,132         57,423   

Consumer

     11         27   
                 
   $ 86,428       $ 83,971   
                 

The average aggregate balance of non-accrual loans for the three months ended March 31, 2010 was approximately $79.4 million.

An analysis of the aging of PlainsCapital’s loan portfolio as of March 31, 2011 and December 31, 2010 is shown in the following table (in thousands):

 

     Loans Past Due
30-89 Days
     Loans Past Due
90  Days or More
     Total
Past Due Loans
     Current
Loans
     Total
Loans
     Accruing Loans
Past Due
90 Days or More
 

As of March 31, 2011

                 

Commercial and industrial

                 

Secured by receivables

   $ 6,225       $ 1,417       $ 7,642       $ 585,197       $ 592,839       $ —     

Secured by equipment

     704         918         1,622         121,291         122,913         —     

Unsecured

     193         5         198         90,532         90,730         —     

Lease financing

     10,025         5,347         15,372         29,234         44,606         —     

All other commercial and industrial

     120         —           120         653,246         653,366         —     

Real estate

                 

Secured by commercial properties

     5,746         2,282         8,028         888,169         896,197         —     

Secured by residential properties

     4,228         1,950         6,178         235,480         241,658         —     

Construction and land development

                 

Residential construction loans

     16         —           16         61,833         61,849         —     

Commercial construction loans and land development

     4,353         4,899         9,252         231,779         241,031         —     

Consumer

     122         20         142         40,329         40,471         9   
                                                     
   $ 31,732       $ 16,838       $ 48,570       $ 2,937,090       $ 2,985,660       $ 9   
                                                     

 

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Table of Contents

3. Loans and Allowance for Loan Losses (continued)

 

     Loans Past Due
30-89 Days
     Loans Past Due
90 Days or More
     Total
Past Due  Loans
     Current
Loans
     Total
Loans
     Accruing Loans
Past Due

90 Days or More
 

As of December 31, 2010

                 

Commercial and industrial

                 

Secured by receivables

   $ 3,630       $ 3,655       $ 7,285       $ 648,856       $ 656,141       $ —     

Secured by equipment

     1,092         287         1,379         121,011         122,390         —     

Unsecured

     15         —           15         92,812         92,827         —     

Lease financing

     2,204         5,343         7,547         42,669         50,216         71   

All other commercial and industrial

     265         2,778         3,043         714,604         717,647         —     

Real estate

                 

Secured by commercial properties

     5,834         1,768         7,602         862,521         870,123         395   

Secured by residential properties

     4,017         1,286         5,303         236,976         242,279         —     

Construction and land development

                 

Residential construction loans

     23         —           23         55,414         55,437         —     

Commercial construction loans and land development

     8,492         21,433         29,925         258,558         288,483         —     

Consumer

     149         —           149         42,478         42,627         —     
                                                     
   $ 25,721       $ 36,550       $ 62,271       $ 3,075,899       $ 3,138,170       $ 466   
                                                     

Management tracks credit quality trends on a monthly basis related to: (i) past due levels, (ii) non-performing asset levels, (iii) classified loan levels, (iv) net charge-offs and (v) general economic conditions at state and local levels.

PlainsCapital utilizes a risk grading matrix to assign a risk grade to each of the loans in its portfolio. A risk rating is assigned based on an assessment of the borrower’s management, collateral position, financial capacity, and economic factors. The general characteristics of the various risk grades are described below.

Pass – “Pass” loans present a range of acceptable risks to the bank. Loans that would be considered virtually risk-free are rated Pass – low risk. Loans that exhibit sound standards based on the grading factors above and present a reasonable risk to the Bank are rated Pass – normal risk. Loans that exhibit a minor weakness in one or more of the grading criteria but still present an acceptable risk to the Bank are rated Pass – high risk.

Special Mention – A “Special Mention” asset has potential weaknesses that deserve management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the asset or the Bank’s credit position at some future date. Special Mention assets are not adversely classified and do not expose the Bank to sufficient risk to require adverse classification.

Substandard – “Substandard” loans are inadequately protected by the current sound worth and paying capacity of the obligor or the collateral pledged, if any. Loans so classified must have a well-defined weakness or weaknesses that jeopardize the liquidation of the debt. They are characterized by the distinct possibility that the Bank will sustain some loss if the deficiencies are not corrected. Many substandard loans are considered impaired.

Doubtful – Loans classified “Doubtful” have all the weaknesses inherent in those classified Substandard with the added characteristic that the weaknesses make collection or liquidation in full, on the basis of currently known facts, conditions and values, highly questionable and improbable. All doubtful loans are considered impaired.

Loss – Loans classified “Loss” are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the loan has absolutely no recovery or salvage value. Rather, it is not practical or desirable to defer writing off this basically worthless asset even though partial recovery may occur in the future.

 

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Table of Contents

3. Loans and Allowance for Loan Losses (continued)

 

The following table presents the internal risk grades of loans, as described above, in the portfolio as of March 31, 2011 and December 31, 2010 by class (in thousands):

 

     Pass      Special Mention      Substandard      Total  

As of March 31, 2011

           

Commercial and industrial

           

Secured by receivables

   $ 554,672       $ 12,454       $ 25,713       $ 592,839   

Secured by equipment

     118,550         18         4,345         122,913   

Unsecured

     87,251         8         3,471         90,730   

Lease financing

     38,264         —           6,342         44,606   

All other commercial and industrial

     631,821         1,286         20,259         653,366   

Real estate

           

Secured by commercial properties

     856,116         11,350         28,731         896,197   

Secured by residential properties

     230,211         —           11,447         241,658   

Construction and land development

           

Residential construction loans

     54,746         6,700         403         61,849   

Commercial construction loans and land development

     174,683         2,607         63,741         241,031   

Consumer

     40,403         —           68         40,471   
                                   
   $ 2,786,717       $ 34,423       $ 164,520       $ 2,985,660   
                                   
     Pass      Special Mention      Substandard      Total  

As of December 31, 2010

           

Commercial and industrial

           

Secured by receivables

   $ 628,464       $ 11,636       $ 16,041       $ 656,141   

Secured by equipment

     119,948         321         2,121         122,390   

Unsecured

     91,654         —           1,173         92,827   

Lease financing

     42,285         —           7,931         50,216   

All other commercial and industrial

     697,938         16,223         3,486         717,647   

Real estate

           

Secured by commercial properties

     834,940         13,078         22,105         870,123   

Secured by residential properties

     229,503         897         11,879         242,279   

Construction and land development

           

Residential construction loans

     55,029         209         199         55,437   

Commercial construction loans and land development

     222,046         1,205         65,232         288,483   

Consumer

     42,536         40         51         42,627   
                                   
   $ 2,964,343       $ 43,609       $ 130,218       $ 3,138,170   
                                   

Net investment in lease financing at March 31, 2011 and December 31, 2010 is shown in the following table (in thousands).

 

       March 31,  
2011
    December 31,
2010
 

Future minimum lease payments

   $ 46,865      $ 53,178   

Unguaranteed residual value

     194        139   

Guaranteed residual value

     2,051        2,096   

Initial direct costs, net of amortization

     160        166   

Unearned income

     (4,664     (5,363
                
   $ 44,606      $ 50,216   
                

 

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3. Loans and Allowance for Loan Losses (continued)

 

The allowance for loan losses is a reserve established through a provision for loan losses charged to expense, which represents management’s best estimate of probable losses that have been incurred within the existing portfolio of loans. Management has responsibility for determining the level of the allowance for loan losses, subject to review by the Audit Committee of our Board of Directors and the Directors’ Loan Review Committee of the Bank’s Board of Directors.

It is management’s responsibility at the end of each quarter, or more frequently as deemed necessary, to analyze the level of the allowance for loan losses to ensure that it is appropriate for the estimated credit losses in the portfolio consistent with the Interagency Policy Statement on the Allowance for Loan and Lease Losses and the Receivables and Contingencies Topics of the ASC. Estimated credit losses are the probable current amount of loans that we will be unable to collect given facts and circumstances as of the evaluation date. When management determines that a loan or portion thereof, is uncollectible, the loan, or portion thereof, is charged off against the allowance for loan losses. Any subsequent recovery of charged-off loans is added back to the allowance for loan losses.

We have developed a methodology that seeks to determine an allowance within the scope of the Receivables and Contingencies Topics of the ASC. Each of the loans within the scope of the Receivables Topic has been determined to be impaired and individually evaluated for impairment using one of three impairment measurement methods as of the evaluation date: (1) the present value of expected future discounted cash flows on the loan, (2) the loan’s observable market price, or (3) the fair value of the collateral if the loan is collateral dependent. When loans are determined to be impaired, specific reserves are provided in our estimate of the allowance, as appropriate. Loans within the scope of the Contingencies Topic include all non-impaired loans. Estimates of loss for the Contingencies Topic are calculated based on historical loss experience by loan portfolio segment adjusted for changes in trends, conditions, and other relevant factors that affect repayment of loans as of the evaluation date. While historical loss experience provides a reasonable starting point for the analysis, historical losses, or recent trends in losses, are not the sole basis upon which to determine the appropriate level for the allowance for loan losses. Management considers recent qualitative or environmental factors that are likely to cause estimated credit losses associated with the existing portfolio to differ from historical loss experience, including but not limited to: changes in lending policies and procedures, including changes in underwriting standards and collection, charge-off, and recovery practices not considered elsewhere in estimating credit losses; changes in international, national, regional, and local economic and business conditions and developments that affect the collectibility of the portfolio, including the condition of various market segments; changes in the nature and volume of the portfolio and in the terms of loans; changes in the experience, ability, and depth of lending management and other relevant staff; changes in the volume and severity of past due loans, the volume of nonaccrual loans, and the volume and severity of adversely classified or graded loans; changes in the quality of the institution’s loan review system; changes in the value of underlying collateral for collateral-dependent loans; and the existence and effect of any concentrations of credit, and changes in the level of such concentrations.

We design our loan review program to timely identify and monitor problem loans by maintaining a credit grading process, ensuring that timely and appropriate changes are made to the loans with assigned risk grades and coordinating the timely delivery of the information necessary to assess the appropriateness of the allowance for loan losses. Loans are evaluated for impairment when: (i) payments on the loan are delayed, typically by 90 days or more (unless in the process of collection), (ii) the loan becomes classified, (iii) the loan is being reviewed in the normal course of the loan review scope, or (iv) the loan is identified by the servicing officer as a problem. We review all loan relationships that exhibit probable or observed credit weaknesses, the top 25 loan relationships by dollar amount in each market we serve, and additional relationships necessary to achieve adequate coverage of our various lending markets.

Homogenous loans, such as consumer installment loans, residential mortgage loans and home equity loans, are not individually reviewed and are generally risk graded at the same levels. The risk grade and reserves are established for each homogenous pool of loans based on the expected net charge-offs from a current trend in delinquencies, losses or historical experience and general economic conditions. As of March 31, 2011, we had no material delinquencies in these types of loans.

The allowance is subject to regulatory examinations and determinations as to adequacy, which may take into account such factors as the methodology used to calculate the allowance and the size of the allowance in comparison to peer banks identified by regulatory agencies.

 

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3. Loans and Allowance for Loan Losses (continued)

 

Changes in the allowance for loan losses, distributed by portfolio segment, for the three months ended March 31, 2011 were as follows (in thousands):

 

     Commercial  and
Industrial
    Real Estate     Construction and
Land  Development
    Consumer     Unallocated      Total  

Three Months Ended March 31, 2011

             

Balance at beginning of period

   $ 41,687      $ 11,732      $ 11,227      $ 523      $ —         $ 65,169   

Provision charged to operations

     3,024        (188     3,575        (35     124         6,500   

Loans charged off

     (4,055     (417     (1,571     (63     —           (6,106

Recoveries on charged off loans

     206        149        5        17        —           377   
                                                 

Balance at end of year

   $ 40,862      $ 11,276      $ 13,236      $ 442      $ 124       $ 65,940   
                                                 

Changes in the allowance for loan losses for the three months ended March 31, 2010 were as follows (in thousands):

 

     Three Months Ended
March  31, 2010
 

Balance at beginning of period

   $ 52,092   

Provision charged to operations

     22,955   

Loans charged off

     (25,347

Recoveries on charged off loans

     271   
        

Balance at end of period

   $ 49,971   
        

As of March 31, 2011 and December 31, 2010, the loan portfolio was distributed by portfolio segment and impairment methodology as shown below (in thousands):

 

     Commercial  and
Industrial
     Real Estate      Construction and
Land  Development
     Consumer      Total  

As of March 31, 2011

              

Loans individually evaluated for impairment

   $ 19,259       $ 22,913       $ 58,577       $ 34       $ 100,783   

Loans collectively evaluated for impairment

     1,485,195         1,114,942         244,303         40,437         2,884,877   
                                            
   $ 1,504,454       $ 1,137,855       $ 302,880       $ 40,471       $ 2,985,660   
                                            
     Commercial and
Industrial
     Real Estate      Construction and
Land Development
     Consumer      Total  

As of December 31, 2010

              

Loans individually evaluated for impairment

   $ 30,576       $ 26,477       $ 59,348       $ 35       $ 116,436   

Loans collectively evaluated for impairment

     1,608,645         1,085,925         284,572         42,592         3,021,734   
                                            
   $ 1,639,221       $ 1,112,402       $ 343,920       $ 42,627       $ 3,138,170   
                                            

As of March 31, 2011 and December 31, 2010, the allowance for loan losses was distributed by portfolio segment and impairment methodology as shown below (in thousands):

 

     Commercial  and
Industrial
     Real Estate      Construction and
Land  Development
     Consumer      Unallocated      Total  

As of March 31, 2011

                 

Loans individually evaluated for impairment

   $ 3,894       $ 273       $ 5,760       $ —         $ —         $ 9,927   

Loans collectively evaluated for impairment

     36,968         11,003         7,476         442         124         56,013   
                                                     
   $ 40,862       $ 11,276       $ 13,236       $ 442       $ 124       $ 65,940   
                                                     
     Commercial and
Industrial
     Real Estate      Construction and
Land Development
     Consumer      Unallocated      Total  

As of December 31, 2010

                 

Loans individually evaluated for impairment

   $ 4,654       $ 417       $ 3,724       $ —         $ —         $ 8,795   

Loans collectively evaluated for impairment

     37,033         11,315         7,503         523         —           56,374   
                                                     
   $ 41,687       $ 11,732       $ 11,227       $ 523       $ —         $ 65,169   
                                                     

 

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3. Loans and Allowance for Loan Losses (continued)

 

Net (charge-offs)/recoveries by class for the three months ended March 31, 2011 and 2010 are shown in the following table (in thousands):

 

     Three Months Ended
March 31,
 
           2011                 2010        

Commercial and industrial

    

Secured by receivables

   $ (866   $ (9,394

Secured by equipment

     (267     (1,977

Unsecured

     (14     (562

Lease financing

     (270     (127

All other commercial and industrial

     (2,432     (5,067

Real estate

    

Secured by commercial properties

     39        (7,392

Secured by residential properties

     (307     (304

Construction and land development

    

Residential construction loans

     (23     (98

Commercial construction loans and land development

     (1,543     (92

Consumer

     (46     (63
                
   $ (5,729   $ (25,076
                

4. Deposits

Deposits at March 31, 2011 and December 31, 2010 are summarized as follows (in thousands):

 

        March 31,   
2011
     December 31,
2010
 

Noninterest-bearing demand

   $ 282,615       $ 256,372   

Interest-bearing:

     

NOW accounts

     61,292         61,800   

Money market

     1,565,604         1,416,816   

Brokered - money market

     363,651         374,972   

Demand

     63,277         71,547   

Savings

     165,664         167,398   

In foreign branches

     174,903         132,131   

Time - $100,000 and over

     821,623         817,956   

Time - other

     237,142         218,163   

Brokered - time

     376,419         401,304   
                 
   $ 4,112,190       $ 3,918,459   
                 

 

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5. Short-Term Borrowings

 

Short-term borrowings at March 31, 2011 and December 31, 2010 were as follows (in thousands):

 

       March 31,  
2011
     December 31,
2010
 

Federal funds purchased

   $ 199,625       $ 134,675   

Securities sold under agreements to repurchase

     209,941         304,207   

Federal Home Loan Bank notes

     25,000         100,000   

Treasury tax and loan note option account

     2,611         3,002   

Short-term bank loans

     55,750         40,250   
                 
   $ 492,927       $ 582,134   
                 

Federal funds purchased and securities sold under agreements to repurchase generally mature daily, on demand or on some other short-term basis. The Bank and FSC execute transactions to sell securities under agreements to repurchase with both their customers and broker-dealers. Securities involved in these transactions are held by the Bank, FSC or the dealer. Information concerning federal funds purchased and securities sold under agreements to repurchase is shown in the following table (dollar amounts in thousands):

 

     Three Months Ended March 31,  
     2011     2010  

Average balance during the period

   $ 480,141      $ 237,276   

Average interest rate during the period

     0.23     0.22
     March 31,
2011
    December 31,
2010
 

Average interest rate at end of period

     0.22     0.23

Securities underlying the agreements at end of period

    

Carrying value

   $ 199,869      $ 276,284   

Estimated fair value

   $ 252,349      $ 336,317   

The estimated fair value of securities underlying repurchase agreements above includes approximately $52.5 million of securities owned by FSC customers and pledged to FSC as collateral for margin loans as of March 31, 2011. FSC is permitted to sell or re-pledge customer securities held as collateral for margin loans under the terms of the margin loan agreements between FSC and its customers.

FHLB notes mature over terms not exceeding 365 days and are collateralized by FHLB Dallas stock, nonspecified real estate loans and certain specific commercial real estate loans. Other information regarding FHLB notes is shown in the following table (dollar amounts in thousands).

 

     Three Months Ended March 31,  
     2011     2010  

Average balance during the period

   $ 43,889      $ 331,111   

Average interest rate during the period

     0.42     0.70
     March 31,
2011
    December 31,
2010
 

Average interest rate at end of period

     0.41     0.43

FSC uses short-term bank loans periodically to finance securities owned, customers’ margin accounts, and other short-term operating activities. Interest on the borrowings varies with the federal funds rate. The weighted average interest rate on the borrowings at March 31, 2011 and December 31, 2010 were 1.38% and 1.50%, respectively.

 

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6. Notes Payable

Notes payable at March 31, 2011 and December 31, 2010 consisted of the following (in thousands):

 

       March 31,  
2011
     December 31,
2010
 

Revolving credit line with JPMorgan Chase not to exceed $17.7 million. Facility matures July 31, 2011, with interest payable quarterly.

   $ 17,700       $ 17,700   

Revolving credit line with JPMorgan Chase not to exceed $5.0 million. Facility matures July 31, 2011 with interest payable quarterly.

     2,500         1,000   

Term note with JPMorgan Chase, due July 31, 2011. Principal payments of $1.9 million and interest are payable quarterly.

     3,825         5,738   

Term note with JPMorgan Chase, due July 31, 2011, Principal payments of $0.5 million and interest are payable semi-annually.

     2,500         3,000   

Term note with JPMorgan Chase, due October 27, 2015, Principal payments of $25,000 and interest are payable quarterly.

     500         500   

Subordinated note with JPMorgan Chase, not to exceed $20 million. Facility matures October 27, 2015 with interest payable quarterly.

     20,000         20,000   

First Southwest nonrecourse notes, due January 25, 2035 with interest payable quarterly.

     15,170         15,838   
                 
   $ 62,195       $ 63,776   
                 

The agreements underlying the JPMorgan Chase debt include certain restrictive covenants, including limitations on the ability to incur additional debt, limitations on the disposition of assets and requirements to maintain various financial ratios, including a non-performing asset ratio, at acceptable levels.

In January 2011, PlainsCapital and JPMorgan Chase amended the revolving credit line agreements to, among other things, increase the acceptable non-performing asset ratio for the Bank such that, beginning December 31, 2010, the Bank’s non-performing asset ratio may not exceed 4.50%. At March 31, 2011, the Bank’s non-performing asset ratio, as defined, was 3.43%, which was in compliance with the non-performing asset ratio covenant.

7. Income Taxes

PlainsCapital’s effective tax rate was 36.9% and 24.3% for the three months ended March 31, 2011 and 2010, respectively. Due to the lower amount of pre-tax income, which is taxed at lower marginal rates, the effective tax rate for the three months ended March 31, 2010 was lower compared to the comparable period in 2011.

PlainsCapital files income tax returns in the U.S. federal jurisdiction and several U.S. state jurisdictions. PlainsCapital is no longer subject to U.S. federal income tax examinations by tax authorities for years before 2007.

 

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8. Commitments and Contingencies

The Bank acts as agent on behalf of certain correspondent banks in the purchase and sale of federal funds that aggregated $7.4 million and $0.5 million at March 31, 2011 and December 31, 2010, respectively.

Legal Matters

In November 2006, FSC received subpoenas from the SEC and the United States Department of Justice (the “DOJ”) in connection with an investigation of possible antitrust and securities law violations, including bid-rigging, in the procurement of guaranteed investment contracts and other investment products for the reinvestment of bond proceeds by municipalities. The investigation is industry-wide and includes approximately 30 or more firms, including some of the largest U.S. investment firms.

As a result of these SEC and DOJ investigations into industry-wide practices, FSC was initially named as a co-defendant in cases filed in several different federal courts by various state and local governmental entities suing on behalf of themselves and a purported class of similarly situated governmental entities and a similar set of lawsuits filed by various California local governmental entities suing on behalf of themselves and a purported class of similarly situated governmental entities. All claims asserted against FSC in these purported class actions were subsequently dismissed. However, the plaintiffs in these purported class actions have filed amended complaints against other entities, and FSC is identified in these complaints not as a defendant, but as an alleged co-conspirator with the named defendants.

Additionally, as a result of these SEC and DOJ investigations into industry-wide practices, FSC has been named as a defendant in twenty individual lawsuits (of which three were filed after December 31, 2010). These lawsuits have been brought by several California public entities and two New York non-profit corporations that do not seek to certify a class. The Judicial Panel on Multidistrict Litigation has transferred these cases to the United States District Court, Southern District of New York. The California plaintiffs allege violations of Section 1 of the Sherman Act and the California Cartwright Act. The New York plaintiffs allege violations of Section 1 of the Sherman Act and the New York Donnelly Act. The allegations against FSC are very limited in scope. FSC filed an answer to sixteen lawsuits, will timely answer the four unanswered lawsuits on or before May 31, 2011, and intends to defend itself vigorously in these individual actions. The relief sought is unspecified monetary damages.

On December 8, 2010, PrimeLending entered into a settlement with the DOJ pursuant to a Consent Order with respect to an inquiry by the DOJ into certain lending practices of PrimeLending in prior years. The Consent Order settles a complaint filed by the United States against PrimeLending earlier that day in the United States District Court for the Northern District of Texas, Dallas Division relating to alleged violations by PrimeLending of fair lending laws between 2006 and 2009. In its complaint, the United States sought a finding that PrimeLending violated the Fair Housing Act and the Equal Credit Opportunity Act, to enjoin PrimeLending from discriminating in connection with its mortgage lending business, monetary damages on behalf of alleged victims and a civil penalty. The Consent Order was subsequently approved by the court on January 11, 2011.

PrimeLending denies that it has engaged in any discriminating lending practices and entered into the Consent Order voluntarily to avoid the risks and burdens of litigation. No factual finding or adjudication was made with respect to the United States’ allegations against PrimeLending, and no civil penalty was assessed. Prior to entering into the Consent Order, PrimeLending altered its loan pricing policy to ensure that the price it charges for residential loan products is set in a nondiscriminatory manner consistent with applicable law.

As a part of the Consent Order, PrimeLending agreed to provide a $2.0 million settlement fund, which PrimeLending charged to expense in 2010, for borrowers nationwide who may have suffered as a result of the alleged violations by PrimeLending of fair lending laws. Any moneys not distributed from the settlement fund to individual borrowers will be distributed to qualified organizations to provide credit counseling, financial literacy, and other related educational programs.

PlainsCapital and subsidiaries are defendants in various other legal matters arising in the normal course of business. Management believes that the ultimate liability, if any, arising from these matters will not materially affect the consolidated financial statements.

 

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8. Commitments and Contingencies (continued)

 

Other Contingencies

PlainsCapital and its subsidiaries lease space, primarily for branch facilities and automated teller machines, under noncancelable operating leases with remaining terms, including renewal options, of 1 to 17 years and under capital leases with remaining terms of 11 to 18 years. Future minimum payments under these leases have not changed significantly from the amounts reported at December 31, 2010 in the audited consolidated financial statements and notes thereto included in our Annual Report on Form 10-K filed with the SEC on March 22, 2011. Rental expense under the operating leases was approximately $5.6 million and $5.2 million for the three months ended March 31, 2011 and 2010, respectively.

9. Financial Instruments with Off-Balance Sheet Risk

The Bank is party to financial instruments with off-balance sheet risk that are used 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 that involve varying degrees of credit and interest rate risk in excess of the amount recognized in the consolidated financial statements. Such financial instruments are recorded in the financial statements when they are funded or related fees are incurred or received. The contract amounts of those instruments reflect the extent of involvement (and therefore the exposure to credit loss) the Bank has in particular classes of financial instruments.

Commitments to extend credit are agreements to lend to a customer provided that the terms established in the contract are met. Commitments generally have fixed expiration dates and may require payment of fees. Because certain commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. These 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 commitments to customers.

The Bank had in the aggregate outstanding unused commitments to extend credit of $908.7 million at March 31, 2011. The Bank had outstanding standby letters of credit of $49.0 million at March 31, 2011.

The Bank uses the same credit policies in making commitments and standby letters of credit as they do for on-balance sheet instruments. The amount of collateral obtained, if deemed necessary, upon extension of credit is based on management’s credit evaluation of the borrower. Collateral held varies but may include real estate, accounts receivable, marketable securities, interest-bearing deposit accounts, inventory, and property, plant and equipment.

In the normal course of business, FSC executes, settles and finances various securities transactions that may expose FSC to off-balance sheet risk in the event that a customer or counterparty does not fulfill its contractual obligations. Examples of such transactions include the sale of securities not yet purchased by customers or for the account of FSC, clearing agreements between FSC and various clearinghouses and broker-dealers, secured financing arrangements that involve pledged securities, and when-issued underwriting and purchase commitments.

10. Stock-Based Compensation

PlainsCapital and subsidiaries have four stock option plans (the “Stock Option Plans”) that provide for the granting of stock options to officers and key employees. In addition, PlainsCapital has granted restricted stock to a group of officers and key employees.

In addition, the PlainsCapital Corporation 2010 Long-Term Incentive Plan (the “2010 Plan”) allows for the granting of nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units, performance awards, dividend equivalent rights and other awards to employees of PlainsCapital, its subsidiaries and outside directors of PlainsCapital. In the aggregate, 1.0 million shares of Original Common Stock may be delivered pursuant to awards granted under the 2010 Plan.

 

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10. Stock-Based Compensation (continued)

 

Compensation cost related to the plans was approximately $0.5 million and $0.3 million for the three months ended March 31, 2011 and 2010, respectively.

At March 31, 2011, unrecognized cost related to unvested restricted stock and restricted stock units was $4.8 million and $3.0 million, respectively. The vesting of the unvested restricted stock and restricted stock units will automatically accelerate in full under certain conditions. Upon a change in control of PlainsCapital, the entire unrecognized cost related to both unvested restricted stock and restricted stock units would be recognized in noninterest expense immediately. On the date upon which our common stock is listed and traded on an exchange registered under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), the entire unrecognized cost related to unvested restricted stock would be recognized in noninterest expense immediately.

At March 31, 2011, a total of 187,281 shares were available for grant under the Stock Option Plans and 624,662 shares were available for grant under the 2010 Plan. PlainsCapital typically issues new shares upon exercise of option grants.

PlainsCapital granted 67,059 shares of unvested restricted stock and 294,092 restricted stock units to certain employees effective April 1, 2011. The estimated grant date fair value of the unvested restricted stock and restricted stock units was $0.8 million and $3.3 million, respectively. The grants vest in 5 years and are subject to the accelerated vesting conditions discussed previously.

Information regarding unvested restricted stock and restricted stock units for the three months ended March 31, 2011 is as follows:

 

     2011      2011  
     Unvested
Restricted
Stock
    Weighted
Average Grant
Date Fair Value
     Restricted
Stock Units
     Weighted
Average Grant
Date Fair Value
 

Outstanding, January 1

     535,862      $ 11.48         290,057       $ 12.58   

Granted

     —          —           2,000         11.26   

Vested

     (83,713     11.47         —           —     

Cancellations and expirations

     —          —           —           —     
                      

Outstanding, March 31

     452,149      $ 11.48         292,057       $ 12.57   
                      

Information regarding the Stock Option Plans for the three months ended March 31, 2011 is as follows:

 

     2011  
     Shares     Weighted
Average
Exercise
Price
 

Outstanding, January 1

     725,651      $ 9.62   

Exercised

     (2,246     6.69   

Cancellations and expirations

     (8,700     12.97   
          

Outstanding, March 31

     714,705        9.59   
          

 

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11. Regulatory Matters

The Bank and PlainsCapital are subject to various regulatory capital requirements administered by the federal banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory—and possibly additional discretionary—actions by regulators that, if undertaken, could have a direct, material effect on the consolidated financial statements. The regulations require us to meet specific capital adequacy guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital classifications are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

Quantitative measures established by regulation to ensure capital adequacy require the companies to maintain minimum amounts and ratios (set forth in the table below) of Tier 1 capital (as defined in the regulations) to total average assets (as defined), and minimum ratios of Tier 1 and total capital (as defined) to risk-weighted assets (as defined). A comparison of the Bank’s and PlainsCapital’s actual capital amounts and ratios to the minimum requirements is as follows (dollar amounts in thousands):

 

     At March 31, 2011  
     Required     Actual  
     Amount      Ratio     Amount      Ratio  

PlainsCapital Bank:

          

Tier 1 capital (to average assets)

   $ 213,088         4   $ 488,332         9.17

Tier 1 capital (to risk-weighted assets)

     148,276         4     488,332         13.17

Total capital (to risk-weighted assets)

     296,552         8     534,920         14.43

PlainsCapital Corporation:

          

Tier 1 capital (to average assets)

   $ 214,000         4   $ 468,538         8.76

Tier 1 capital (to risk-weighted assets)

     149,007         4     468,538         12.58

Total capital (to risk-weighted assets)

     298,015         8     531,352         14.26
     At December 31, 2010  
     Required     Actual  
     Amount      Ratio     Amount      Ratio  

PlainsCapital Bank:

    

Tier 1 capital (to average assets)

   $ 206,270         4   $ 485,013         9.41

Tier 1 capital (to risk-weighted assets)

     152,091         4     485,013         12.76

Total capital (to risk-weighted assets)

     304,181         8     532,769         14.01

PlainsCapital Corporation:

          

Tier 1 capital (to average assets)

   $ 206,664         4   $ 462,823         8.96

Tier 1 capital (to risk-weighted assets)

     152,946         4     462,823         12.10

Total capital (to risk-weighted assets)

     305,891         8     526,843         13.78

 

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11. Regulatory Matters (continued)

 

To be considered adequately capitalized (as defined) under the regulatory framework for prompt corrective action, the Bank must maintain minimum Tier 1 capital to total average assets and Tier 1 capital to risk-weighted assets ratios of 4%, and a total capital to risk-weighted assets ratio of 8%. Based on the actual capital amounts and ratios shown in the previous table, the Bank’s ratios place it in the well capitalized (as defined) capital category under the regulatory framework for prompt corrective action. The minimum required capital amounts and ratios for the well capitalized category are summarized as follows (dollar amounts in thousands):

 

     At March 31, 2011  
     Required     Actual  
     Amount      Ratio     Amount      Ratio  

PlainsCapital Bank:

          

Tier 1 capital (to average assets)

   $ 266,360         5   $ 488,332         9.17

Tier 1 capital (to risk-weighted assets)

     222,414         6     488,332         13.17

Total capital (to risk-weighted assets)

     370,690         10     534,920         14.43
     At December 31, 2010  
     Required     Actual  
     Amount      Ratio     Amount      Ratio  

PlainsCapital Bank:

          

Tier 1 capital (to average assets)

   $ 257,838         5   $ 485,013         9.41

Tier 1 capital (to risk-weighted assets)

     228,136         6     485,013         12.76

Total capital (to risk-weighted assets)

     380,227         10     532,769         14.01

Pursuant to the net capital requirements of the Exchange Act, FSC has elected to determine its net capital requirements using the alternative method. Accordingly, FSC is required to maintain minimum net capital, as defined in Rule 15c3-1, equal to the greater of $250,000 or 2% of aggregate debit balances, as defined in Rule 15c3-3. At March 31, 2011, FSC had net capital of $52.2 million; the minimum net capital requirement was $3.3 million; net capital maintained by FSC at March 31, 2011 was 32% of aggregate debits; and net capital in excess of the minimum requirement at March 31, 2011 was $48.9 million.

As a mortgage originator, PrimeLending is subject to minimum net worth requirements established by the United States Department of Housing and Urban Development (“HUD”). PrimeLending determines its compliance with the minimum net worth requirements on an annual basis. As of December 31, 2010, PrimeLending was required to have net worth of $1.0 million. PrimeLending’s adjusted net worth as defined by the Consolidated Audit Guide for Audits of HUD Programs was $54.1 million as of December 31, 2010, resulting in adjusted net worth above the required amount of $53.1 million.

12. Shareholders’ Equity

The Bank is subject to certain restrictions on the amount of dividends it may declare without prior regulatory approval. At March 31, 2011, approximately $41.7 million of retained earnings was available for dividend declaration without prior approval from the Federal Reserve.

13. Assets Segregated for Regulatory Purposes

At March 31, 2011, FSC had segregated $13.0 million of cash and securities in a special reserve account for the benefit of customers under Rule 15c3-3 of the Exchange Act. Assets segregated under the provisions of the Exchange Act are not available for general corporate purposes. FSC was not required to segregate cash and securities at December 31, 2010.

FSC was not required to segregate cash or securities in a special reserve account for the benefit of proprietary accounts of introducing broker-dealers at March 31, 2011 or December 31, 2010.

 

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14. Broker-Dealer and Clearing Organization Receivables and Payables

Broker-dealer and clearing organization receivables and payables at March 31, 2011 and December 31, 2010 consisted of the following (in thousands):

 

       March 31,  
2011
     December 31,
2010
 

Receivables

     

Securities borrowed

   $ 65,265       $ 34,495   

Securities failed to deliver

     4,069         4,287   

Clearing organizations

     8,943         6,926   

Due from dealers

     48         60   
                 
   $ 78,325       $ 45,768   
                 

Payables

     

Securities loaned

   $ 65,576       $ 39,660   

Correspondents

     38,533         24,171   

Securities failed to receive

     3,809         1,140   

Clearing organizations

     69         661   
                 
   $ 107,987       $ 65,632   
                 

15. Fair Value Measurements

Fair Value Measurements and Disclosures

PlainsCapital determines fair values in compliance with the Fair Value Measurements and Disclosures Topic of the ASC (“Fair Value Topic”). The Fair Value Topic defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. The Fair Value Topic defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. The Fair Value Topic assumes that transactions upon which fair value measurements are based occur in the principal market for the asset or liability being measured. Further, fair value measurements made under the Fair Value Topic exclude transaction costs and are not the result of forced transactions.

The Fair Value Topic creates a fair value hierarchy that classifies fair value measurements based upon the inputs used in valuing the assets or liabilities that are the subject of fair value measurements. The fair value hierarchy gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs, as indicated below.

 

   

Level 1 Inputs: Unadjusted quoted prices in active markets for identical assets or liabilities that PlainsCapital can access at the measurement date.

 

   

Level 2 Inputs: Observable inputs other than Level 1 prices. Level 2 inputs include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (e.g. interest rates and credit risks), and inputs that are derived from or corroborated by market data, among others.

 

   

Level 3 Inputs: Unobservable inputs that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities. Level 3 inputs include pricing models and discounted cash flow techniques, among others.

 

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15. Fair Value Measurements (continued)

 

Fair Value Option

PlainsCapital has elected to measure substantially all of PrimeLending’s mortgage loans held for sale and certain time deposits at fair value under the provisions of the Fair Value Option Subsections of the ASC (“Fair Value Option”). PlainsCapital elected to apply the provisions of the Fair Value Option to these items so that it would have the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. PlainsCapital determines the fair value of the financial instruments accounted for under the provisions of the Fair Value Option in compliance with the provisions of the Fair Value Topic discussed above.

At March 31, 2011, the aggregate fair value of PrimeLending loans held for sale accounted for under the Fair Value Option was $481.4 million, while the unpaid principal balance of those loans was $469.7 million. At December 31, 2010, the aggregate fair value of PrimeLending loans held for sale accounted for under the Fair Value Option was $476.4 million, while the unpaid principal balance of those loans was $465.3 million. The fair value excludes interest, which is reported as interest income on loans in the income statement.

PlainsCapital holds a number of financial instruments that are measured at fair value on a recurring basis, either by the application of the Fair Value Option or other authoritative pronouncements. The fair values of those instruments are determined primarily using Level 2 inputs. Those inputs include quotes from mortgage loan investors and derivatives dealers, data from an independent pricing service and rates paid in the brokered certificate of deposit market.

At March 31, 2011, the Bank held auction rate bonds purchased as a result of the First Southwest acquisition. The estimated fair value of the auction rate bonds is determined quarterly by a third-party valuation specialist using Level 3 inputs, primarily due to the lack of observable market data. Inputs for the valuation were developed using terms of the auction rate bonds, market interest rates, asset appropriate credit transition matrices and recovery rates and assumptions regarding the term to maturity of the auction rate bonds. The following table reconciles the beginning and ending balances of assets measured at fair value using Level 3 inputs (in thousands).

 

     Auction
Rate Bonds
    Total  

Balance, January 1, 2011

   $ 22,454      $ 22,454   

Unrealized losses in other comprehensive income, net

     (4,657     (4,657

Transfers from held to maturity

     28,564        28,564   

Premium amortization and discount accretion, net

     14        14   
                

Balance, March 31, 2011

   $ 46,375      $ 46,375   
                

During the first quarter of 2011, auction rate bonds with a net carrying amount of $28.6 million were transferred from held to maturity to available for sale to address a downgrade in credit rating from investment grade to below investment grade. The Bank uses the date of the transfer to determine when the auction rate bonds entered Level 3.

 

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15. Fair Value Measurements (continued)

 

The following tables present information regarding financial assets and liabilities measured at fair value on a recurring basis, including changes in fair value for those instruments that are reported at fair value under an election under the Fair Value Option (in thousands).

 

     At March 31, 2011  
     Level 1
Inputs
     Level 2
Inputs
     Level 3
Inputs
     Total Fair
Value
 

Loans held for sale

   $ —         $ 481,380       $ —         $ 481,380   

Securities available for sale

     —           752,557         46,375         798,932   

Trading securities

     —           44,636         —           44,636   

Derivative assets

     —           4,893         —           4,893   

Time deposits

     —           1,106         —           1,106   

Trading liabilities

     —           7,323         —           7,323   

Derivative liabilities

     —           606         —           606   

 

     Changes in Fair Value for Assets and Liabilities  Reported at Fair Value under Fair Value Option  
     Three Months Ended March 31, 2011     Three Months Ended March 31, 2010  
     Net Gains from
Sale of Loans
     Other
Noninterest
Income
    Total
Changes in
Fair Value
    Net Gains from
Sale of Loans
     Other
Noninterest
Income
    Total
Changes in

Fair Value
 

Loans held for sale

   $ 568       $ —        $ 568      $ 829       $ —        $ 829   

Time deposits

     —           (2     (2     —           (1     (1

PlainsCapital also determines the fair value of assets and liabilities on a non-recurring basis. For example, facts and circumstances may dictate a fair value measurement when there is evidence of impairment. Assets and liabilities measured on a non-recurring basis include the items discussed below.

Impaired Loans – PlainsCapital reports impaired loans at fair value through allocations of the allowance for loan losses. PlainsCapital determines fair value using Level 2 inputs consisting of observable loss experience for similar loans. At March 31, 2011, loans with a carrying amount of $41.1 million had been reduced by allocations of the allowance for loan losses of $9.9 million, resulting in a reported fair value of $31.2 million.

Other Real Estate Owned – PlainsCapital reports other real estate owned at fair value through use of valuation allowances that are charged against the allowance for loan losses when property is initially transferred to other real estate. Subsequent to the initial transfer to other real estate, valuation adjustments are charged against earnings. PlainsCapital determines fair value using Level 2 inputs consisting of independent appraisals. At March 31, 2011, the estimated fair value of other real estate owned was $18.8 million.

The Fair Value of Financial Instruments Subsection of the ASC requires disclosure of the fair value of financial assets and liabilities, including the financial assets and liabilities previously discussed. The methods for determining estimated fair value for financial assets and liabilities is described in detail in Note 21 to the consolidated financial statements included in our Annual Report on Form 10-K filed with the SEC on March 22, 2011.

 

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15. Fair Value Measurements (continued)

 

The estimated fair values of PlainsCapital’s financial instruments are shown below (in thousands):

 

     At March 31, 2011      At December 31, 2010  
     Carrying
Amount
     Estimated
Fair Value
     Carrying
Amount
     Estimated
Fair Value
 

Financial assets

           

Cash and short-term investments

   $ 521,430       $ 521,430       $ 486,709       $ 486,709   

Assets segregated for regulatory purposes

     13,000         13,000         —           —     

Loans held for sale

     482,627         482,627         477,711         477,711   

Securities

     1,039,838         1,044,199         865,080         860,897   

Loans, net

     2,919,720         2,964,446         3,073,001         3,116,532   

Broker-dealer and clearing organization receivables

     78,325         78,325         45,768         45,768   

Fee award receivable

     18,910         18,910         19,222         19,222   

Cash surrender value of life insurance policies

     22,603         22,603         22,410         22,410   

Interest rate swaps, interest rate lock commitments (“IRLCs”) and forward purchase commitments

     4,893         4,893         4,107         4,107   

Accrued interest receivable

     15,159         15,159         16,615         16,615   

Financial liabilities

           

Deposits

     4,112,190         4,117,814         3,918,459         3,924,188   

Broker-dealer and clearing organization payables

     107,987         107,987         65,632         65,632   

Other trading liabilities

     7,323         7,323         4,944         4,944   

Short-term borrowings

     492,927         492,927         582,134         582,134   

Debt

     129,207         129,207         130,788         130,788   

Forward purchase commitments

     606         606         317         317   

Accrued interest payable

     4,045         4,045         5,949         5,949   

16. Derivative Financial Instruments

The Bank and PrimeLending use various derivative financial instruments to mitigate interest rate risk. The Bank’s interest rate risk management strategy involves effectively modifying the re-pricing characteristics of certain assets and liabilities so that changes in interest rates do not adversely affect the net interest margin. PrimeLending has interest rate risk relative to its inventory of mortgage loans held for sale and IRLCs. PrimeLending is exposed to such rate risk from the time an IRLC is made to an applicant to the time the related mortgage loan is sold.

Cash Flow Hedges

The Bank entered into interest rate swap agreements to manage interest rate risk associated with certain customer contracts. The swaps were originally designated as cash flow hedges. The swaps were highly effective in offsetting future cash flow volatility caused by changes in interest rates. The Bank has recorded the fair value of the swaps in other assets and unrealized gains (losses) associated with the swaps in other comprehensive income.

Non-Hedging Derivative Instruments and the Fair Value Option

As discussed in Note 15, PrimeLending elected to measure substantially all mortgage loans held for sale at fair value under the provisions of the Fair Value Option. The election provides PrimeLending the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without applying complex hedge accounting provisions. PrimeLending provides IRLCs to its customers and executes forward purchase commitments to sell mortgage loans. The fair values of both IRLCs and purchase commitments are recorded in other assets or other liabilities, as appropriate. Changes in the fair values of these derivative instruments produced net gains of approximately $0.5 million and $1.6 million for the three months ended March 31, 2011 and 2010, respectively. The net gains were recorded as a component of gain on sale of loans.

 

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16. Derivative Financial Instruments (continued)

 

Derivative positions at March 31, 2011 and December 31, 2010 are presented in the following table (in thousands):

 

     At March 31, 2011      At December 31, 2010  
     Notional
Amount
     Estimated
Fair  Value
     Notional
Amount
     Estimated
Fair Value
 

Non-hedging derivative instruments

           

IRLCs

   $ 613,229       $ 3,219       $ 442,270       $ 274   

Interest rate swaps

     1,969         113         1,969         129   

Forward purchase commitments

     616,644         955         436,241         3,387   

The Bank recorded unrealized gains (losses), net of reclassifications adjustments, on the swaps designated as cash flow hedges in other comprehensive income as shown in the following table (in thousands).

 

     Three Months Ended March 31, 2011     Three Months Ended March 31, 2010  
     Before-Tax
Amount
    Tax Benefit
(Expense)
     After-Tax
Amount
    Before-Tax
Amount
    Tax Benefit
(Expense)
     After-Tax
Amount