UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
þ
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2014
OR
o
 
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 001-34737
VIEWPOINT FINANCIAL GROUP, INC.
(Exact name of registrant as specified in its charter)
Maryland
 
6021
 
27-2176993
(State or other jurisdiction of incorporation or organization)
 
(Primary Standard Industrial Classification Code Number)
 
(I.R.S. Employer Identification No.)
 
 
 
 
 
1309 W. 15 th   Street, Plano, Texas
 
 
 
75075
(Address of Principal Executive Offices)
 
 
 
(Zip Code)
Registrant’s telephone number, including area code: (972) 578-5000
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports) and (2) has been subject to such filing requirements for the past 90 days. Yes x No o
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 x No o
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. (Check one):
    
Large accelerated filer x
 
Accelerated filer o
 
 
 
Non-accelerated filer o
 
Smaller reporting company o
(Do not check if a smaller reporting company)
 
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes o No x
Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date.
Class: Common Stock
 
Shares Outstanding as of July 28 , 2014:
 
 
39,995,920



VIEWPOINT FINANCIAL GROUP, INC.
FORM 10-Q
June 30, 2014
INDEX
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 





PART 1 - FINANCIAL INFORMATION        Item 1. Financial Statements
VIEWPOINT FINANCIAL GROUP, INC.
CONSOLIDATED BALANCE SHEETS
(Dollars in thousands, except per share data)
 
June 30,
 
December 31,
 
2014
 
2013
ASSETS
(unaudited)
 
 
Cash and due from financial institutions
$
35,276

 
$
30,012

Short-term interest-bearing deposits in other financial institutions
130,632

 
57,962

Total cash and cash equivalents
165,908

 
87,974

Securities available for sale, at fair value
224,184

 
248,012

Securities held to maturity (fair value: June 30, 2014 — $277,913, December 31, 2013— $301,739)
267,614

 
294,583

Loans held for investment:
 
 
 
Loans held for investment (net of allowance for loan losses of $20,440 at June 30, 2014 and $19,358 at December 31, 2013)
2,327,370

 
2,029,277

Loans held for investment - Warehouse Purchase Program
769,566

 
673,470

Total loans held for investment
3,096,936

 
2,702,747

FHLB and Federal Reserve Bank stock, at cost
44,532

 
34,883

Bank-owned life insurance
35,863

 
35,565

Premises and equipment, net
51,955

 
53,272

Goodwill
29,650

 
29,650

Other assets
34,602

 
38,546

Total assets
$
3,951,244

 
$
3,525,232

LIABILITIES AND SHAREHOLDERS’ EQUITY
 
 
 
Deposits
 
 
 
Non-interest-bearing demand
$
433,194

 
$
410,933

Interest-bearing demand
476,203

 
474,515

Savings and money market
1,032,496

 
904,576

Time
493,833

 
474,615

Total deposits
2,435,726

 
2,264,639

FHLB advances
874,866

 
639,096

Repurchase agreement
25,000

 
25,000

Other liabilities
58,240

 
52,037

Total liabilities
3,393,832

 
2,980,772

Commitments and contingent liabilities
—

 
—

Shareholders’ equity
 
 
 
Preferred stock, $.01 par value; 10,000,000 shares authorized; 0 shares issued — June 30, 2014 and December 31, 2013
—

 
—

Common stock, $.01 par value; 90,000,000 shares authorized; 39,995,720 shares issued — June 30, 2014 and 39,938,816 shares issued — December 31, 2013
400

 
399

Additional paid-in capital
381,808

 
377,657

Retained earnings
190,150

 
183,236

Accumulated other comprehensive income (loss), net
770

 
(383
)
Unearned Employee Stock Ownership Plan (ESOP) shares; 1,641,748 shares at June 30, 2014 and 1,733,845 shares at December 31, 2013
(15,716
)
 
(16,449
)
Total shareholders’ equity
557,412

 
544,460

Total liabilities and shareholders’ equity
$
3,951,244

 
$
3,525,232

 
 
 
 
See accompanying notes to consolidated financial statements.

3

VIEWPOINT FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF INCOME
(unaudited)
(Dollars in thousands, except per share data)
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Interest and dividend income
 
 
 
 
 
 
 
Loans, including fees
$
33,888

 
$
32,151

 
$
64,276

 
$
62,529

Taxable securities
2,453

 
2,457

 
5,018

 
4,860

Nontaxable securities
561

 
529

 
1,125

 
1,003

Interest-bearing deposits in other financial institutions
71

 
25

 
128

 
56

FHLB and Federal Reserve Bank stock
136

 
134

 
266

 
267

 
37,109

 
35,296

 
70,813

 
68,715

Interest expense
 
 
 
 
 
 
 
Deposits
2,035

 
2,450

 
4,026

 
4,882

FHLB advances
1,948

 
2,205

 
3,875

 
4,466

Repurchase agreement
204

 
203

 
405

 
404

 
4,187

 
4,858

 
8,306

 
9,752

Net interest income
32,922

 
30,438

 
62,507

 
58,963

Provision for loan losses
1,197

 
1,858

 
1,573

 
2,741

Net interest income after provision for loan losses
31,725

 
28,580

 
60,934

 
56,222

Non-interest income
 
 
 
 
 
 
 
Service charges and fees
4,874

 
4,768

 
9,172

 
9,059

Other charges and fees
239

 
179

 
449

 
391

Bank-owned life insurance income
145

 
153

 
298

 
315

Loss on sale of available-for-sale securities (reclassified from accumulated other comprehensive income for unrealized losses on available-for-sale securities)
—

 
—

 
—

 
(177
)
Gain on sale and disposition of assets
727

 
444

 
728

 
674

Other
(556
)
 
199

 
(256
)
 
1,340

 
5,429

 
5,743

 
10,391

 
11,602

Non-interest expense
 
 
 
 
 
 
 
Salaries and employee benefits
14,127

 
12,528

 
28,259

 
25,443

Merger and acquisition costs
652

 
—

 
821

 
—

Advertising
493

 
751

 
848

 
1,264

Occupancy and equipment
1,819

 
1,938

 
3,711

 
3,728

Outside professional services
486

 
570

 
1,011

 
1,254

Regulatory assessments
687

 
650

 
1,315

 
1,229

Data processing
1,708

 
1,729

 
3,370

 
3,247

Office operations
1,717

 
1,751

 
3,397

 
3,399

Other
1,661

 
1,786

 
2,773

 
3,012

 
23,350

 
21,703

 
45,505

 
42,576

Income before income tax expense
13,804

 
12,620

 
25,820

 
25,248

Income tax expense (items reclassified from accumulated other comprehensive income include an income tax benefit of $62 for the six months ended June 30, 2013)
4,986

 
4,446

 
9,320

 
9,016

Net income
$
8,818

 
$
8,174

 
$
16,500

 
$
16,232

Earnings per share:
 
 
 
 
 
 
 
Basic
$
0.23

 
$
0.21

 
$
0.43

 
$
0.43

Diluted
$
0.23

 
$
0.21

 
$
0.43

 
$
0.43

Dividends declared per share 1
$
0.12

 
$
0.10

 
$
0.24

 
$
0.10

 
 
 
 
 
 
 
 
See accompanying notes to consolidated financial statements.
1 In 2012, the Company prepaid the quarterly dividend for the first quarter of 2013 in December 2012, distributing an additional $0.10 per common share.

4

VIEWPOINT FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(unaudited)
(Dollars in thousands)
 
Three Months Ended
 
Six Months Ended
 
June 30,
 
June 30,
 
2014
 
2013
 
2014
 
2013
Net income
$
8,818

 
$
8,174

 
$
16,500

 
$
16,232

Change in unrealized gains (losses) on securities available for sale
1,065

 
(3,031
)
 
1,775

 
(2,705
)
Reclassification of amount realized through sale of securities
—

 
—

 
—

 
177

Tax effect
(373
)
 
1,063

 
(622
)
 
904

Other comprehensive income (loss), net of tax
692

 
(1,968
)
 
1,153

 
(1,624
)
Comprehensive income
$
9,510

 
$
6,206

 
$
17,653

 
$
14,608

 
 
 
 
 
 
 
 
See accompanying notes to consolidated financial statements.


5

 
VIEWPOINT FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
(unaudited)
(Dollars in thousands, except per share data)
For the six months ended June 30, 2013
Common
Stock
 
Additional
Paid-In
Capital
 
Retained
Earnings
 
Accumulated
Other
Comprehensive
Income, Net
 
Unearned
ESOP Shares
 
Total
Shareholders’
Equity
Balance at January 1, 2013
$
396

 
$
372,168

 
$
164,328

 
$
1,895

 
$
(17,916
)
 
$
520,871

Net income
—

 
—

 
16,232

 
—

 
—

 
16,232

Other comprehensive income (loss), net of tax
—

 
—

 
—

 
(1,624
)
 
—

 
(1,624
)
Share repurchase (83,800 shares)
(1
)
 
(1,553
)
 
—

 
—

 
—

 
(1,554
)
Dividends declared ($0.10 per share)
—

 
—

 
(3,991
)
 
—

 
—

 
(3,991
)
ESOP shares earned (92,097 shares)
—

 
1,124

 
—

 
—

 
733

 
1,857

Share-based compensation expense
—

 
1,422

 
—

 
—

 
—

 
1,422

Net issuance of common stock under employee stock plans (397,605 shares)
4

 
217

 
—

 
—

 
—

 
221

Balance at June 30, 2013
$
399

 
$
373,378

 
$
176,569

 
$
271

 
$
(17,183
)
 
$
533,434

For the six months ended June 30, 2014
 
 
 
 
 
 
 
 
 
 
 
Balance at January 1, 2014
$
399

 
$
377,657

 
$
183,236

 
$
(383
)
 
$
(16,449
)
 
$
544,460

Net income
—

 
—

 
16,500

 
—

 
—

 
16,500

Other comprehensive income, net of tax
—

 
—

 
—

 
1,153

 
—

 
1,153

Dividends declared ($0.24 per share)
—

 
—

 
(9,586
)
 
—

 
—

 
(9,586
)
ESOP shares earned (92,097 shares)
—

 
1,664

 
—

 
—

 
733

 
2,397

Share-based compensation expense
—

 
1,835

 
—

 
—

 
—

 
1,835

Net issuance of common stock under employee stock plans (56,904 shares)
1

 
652

 
—

 
—

 
—

 
653

Balance at June 30, 2014
$
400

 
$
381,808

 
$
190,150

 
$
770

 
$
(15,716
)
 
$
557,412


See accompanying notes to consolidated financial statements.

6

VIEWPOINT FINANCIAL GROUP, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(unaudited)
(Dollars in thousands)
 
Six Months Ended June 30,
 
2014
 
2013
Cash flows from operating activities
 
 
 
Net income
$
16,500

 
$
16,232

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Provision for loan losses
1,573

 
2,741

Depreciation and amortization
2,211

 
2,270

Deferred tax expense
1,043

 
188

Premium amortization and accretion of securities, net
1,803

 
3,356

Accretion related to acquired loans
(869
)
 
(1,705
)
Loss on sale of available for sale securities
—

 
177

ESOP compensation expense
2,397

 
1,857

Share-based compensation expense
1,835

 
1,422

FHLB stock dividends
(42
)
 
(60
)
Bank-owned life insurance (BOLI) income
(298
)
 
(315
)
Gain (loss) on sale and disposition of assets
49

 
(674
)
Net change in deferred loan fees
432

 
371

Net change in accrued interest receivable
(716
)
 
(199
)
Net change in other assets
3,295

 
10,230

Net change in other liabilities
5,580

 
393

Net cash provided by operating activities
34,793

 
36,284

Cash flows from investing activities
 
 
 
Available-for-sale securities:
 
 
 
Maturities, prepayments and calls
305,686

 
500,103

Purchases
(281,000
)
 
(515,941
)
Proceeds from sale of AFS securities
—

 
10,614

Held-to-maturity securities:
 
 
 
Maturities, prepayments and calls
32,003

 
59,917

Purchases
(5,919
)
 
(31,969
)
Originations of Warehouse Purchase Program loans
(5,377,239
)
 
(7,710,481
)
Proceeds from pay-offs of Warehouse Purchase Program loans
5,281,143

 
7,866,973

Net change in loans held for investment, excluding Warehouse Purchase Program loans
(299,638
)
 
(145,566
)
Redemption (purchase) of FHLB and Federal Reserve Bank stock
(9,607
)
 
3,610

Purchases of premises and equipment
(744
)
 
(1,755
)
Proceeds from sale of assets
532

 
3,249

Net cash provided by (used in) investing activities
(354,783
)
 
38,754


7

Cash flows from financing activities
 
 
 
Net change in deposits
171,087

 
11,374

Proceeds from FHLB advances
691,000

 
600,000

Repayments on FHLB advances
(455,230
)
 
(692,000
)
Share repurchase
—

 
(1,554
)
Payment of dividends
(9,586
)
 
(3,991
)
Proceeds from stock option exercises
653

 
221

Net cash provided by (used in) financing activities
397,924

 
(85,950
)
Net change in cash and cash equivalents
77,934

 
(10,912
)
Beginning cash and cash equivalents
87,974

 
68,696

Ending cash and cash equivalents
$
165,908

 
$
57,784

Supplemental cash flow information:
 
 
 
Interest paid
$
8,297

 
$
9,817

Income taxes paid
6,128

 
5,007

Supplemental noncash disclosures:
 
 
 
Transfers from loans to other real estate owned
409

 
1,338

See accompanying notes to consolidated financial statements.


8
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)


NOTE 1 - BASIS OF FINANCIAL STATEMENT PRESENTATION

The accompanying consolidated financial statements of ViewPoint Financial Group, Inc. (the “Company”) have been prepared in accordance with U.S. generally accepted accounting principles ("US GAAP") and with the rules and regulations of the Securities and Exchange Commission for interim financial reporting. Accordingly, they do not include all of the information and footnotes required for complete financial statements. In the opinion of management, all normal and recurring adjustments which are considered necessary to fairly present the results for the interim periods presented have been included. Certain items in prior periods were reclassified to conform to the current presentation. These statements should be read in conjunction with the consolidated financial statements and notes thereto included in the Company's Annual Report on Form 10-K for the year ended December 31, 2013 (“2013 Form 10-K”). Interim results are not necessarily indicative of results for a full year.
In preparing the financial statements, management is required to make estimates and assumptions that affect the recorded amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses for the period. Actual results could differ from those estimates. For further information with respect to significant accounting policies followed by the Company in preparation of its consolidated financial statements, refer to the 2013 Form 10-K.
The accompanying Unaudited Consolidated Interim Financial Statements include the accounts of the Company, whose business primarily consists of the operations of its wholly owned subsidiary, ViewPoint Bank, N.A. (the “Bank”). All significant intercompany transactions and balances are eliminated in consolidation.

9
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 2 - ADJUSTMENTS TO FINANCIAL STATEMENTS
Prior to the December 31, 2013 reporting period, the Company reported Warehouse Purchase Program loans as held for sale as we believed that was the most meaningful presentation to our financial statement users given that the collection of the loan was based upon the sale of the loan. Effective December 31, 2013, the Company concluded that, under US GAAP, these loans should be accounted for as held for investment. This correction changed the accounting for Warehouse Purchase Program loans from a lower-of-cost-or-market accounting method to accounting for the loans under Accounting Standards Codification ("ASC") 310, with any credit losses incurred as of the balance sheet date recognized in the allowance for loan losses. As we had not reported any valuation decreases below cost in prior periods, and we have experienced no credit losses on these loans, this correction had no impact on net income, comprehensive income, earnings per share or income taxes. Additionally, total assets and shareholders' equity remained unchanged. However, this correction did impact the statement of cash flows by moving cash flows associated with the Warehouse Purchase Program from operating cash flows to investing cash flows.

The table below illustrates the impact of this change on the Company's Consolidated Statement of Cash Flows for the six months ended June 30, 2013 . There was no impact to the Company's Consolidated Statements of Income for the three or six months ended June 30, 2013 .

Impact to the Consolidated Statement of Cash Flows
 
 
Six Months Ended June 30, 2013
 
 
As Originally Presented
 
As Adjusted
Cash flows from operating activities
 
 
 
 
Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
 
Loans originated or purchased for sale
 
$
(7,710,481
)
 
$
—

Proceeds from sale of loans held for sale
 
7,866,973

 
—

Net cash provided by operating activities
 
192,776

 
36,284

Cash flows from investing activities
 
 
 
 
Originations of Warehouse Purchase Program loans
 
N/A

1  
(7,710,481
)
Proceeds from pay-offs of Warehouse Purchase Program loans
 
N/A

1  
7,866,973

Net change in loans held for investment, excluding Warehouse Purchase Program loans
 
(145,566
)
 
(145,566
)
Net cash provided by (used in) investing activities
 
(117,738
)
 
38,754

Cash flows from financing activities
 
 
 
 
Net cash used in financing activities
 
(85,950
)
 
(85,950
)
Net change in cash and cash equivalents
 
(10,912
)
 
(10,912
)
Beginning cash and cash equivalents
 
68,696

 
68,696

Ending cash and cash equivalents
 
$
57,784

 
$
57,784

1 Not applicable

10
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 3 - EARNINGS PER COMMON SHARE
Basic earnings per common share is computed by dividing net income (which has been adjusted for distributed and undistributed earnings to participating securities) by the weighted-average number of common shares outstanding for the period, reduced for average unallocated ESOP shares and average unvested restricted stock awards. Unvested share-based awards that contain nonforfeitable rights to dividends or dividend equivalents (whether paid or unpaid) are participating securities and shall be included in the computation of earnings per share pursuant to the two-class method described in ASC 260-10-45-60B. Diluted earnings per common share reflects the potential dilution that could occur if securities or other contracts to issue common stock (such as stock awards and options) were exercised or converted to common stock, or resulted in the issuance of common stock that then shared in the Company’s earnings. Diluted earnings per common share is computed by dividing net income by the weighted-average number of common shares outstanding for the period increased for the dilutive effect of unexercised stock options and unvested restricted stock awards. The dilutive effect of the unexercised stock options and unvested restricted stock awards is calculated under the treasury stock method utilizing the average market value of the Company’s stock for the period. A reconciliation of the numerator and denominator of the basic and diluted earnings per common share computation for the three and six months ended June 30, 2014 and 2013 is as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Basic earnings per share:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Net income
$
8,818

 
$
8,174

 
$
16,500

 
$
16,232

Distributed and undistributed earnings to participating securities
(97
)
 
(116
)
 
(187
)
 
(180
)
Income available to common shareholders
$
8,721

 
$
8,058

 
$
16,313

 
$
16,052

Denominator:
 
 
 
 
 
 
 
Weighted average common shares outstanding
39,966,568

 
39,940,712

 
39,954,509

 
39,837,010

Less: Average unallocated ESOP shares
(1,671,941
)
 
(1,856,135
)
 
(1,694,835
)
 
(1,879,030
)
  Average unvested restricted stock awards
(420,956
)
 
(539,527
)
 
(434,729
)
 
(420,517
)
Average shares for basic earnings per share
37,873,671

 
37,545,050

 
37,824,945

 
37,537,463

Basic earnings per common share
$
0.23

 
$
0.21

 
$
0.43

 
$
0.43

Diluted earnings per share:
 
 
 
 
 
 
 
Numerator:
 
 
 
 
 
 
 
Income available to common shareholders
$
8,721

 
$
8,058

 
$
16,313

 
$
16,052

Denominator:
 
 
 
 
 
 
 
Average shares for basic earnings per share
37,873,671

 
37,545,050

 
37,824,945

 
37,537,463

Dilutive effect of share-based compensation plan
247,703

 
147,463

 
247,786

 
147,231

Average shares for diluted earnings per share
38,121,374

 
37,692,513

 
38,072,731

 
37,684,694

Diluted earnings per common share
$
0.23

 
$
0.21

 
$
0.43

 
0.43

Share awards excluded in the computation of diluted earnings per share because the exercise price was greater than the common stock average market price and were therefore antidilutive
86,910

 
1,212,900

 
134,790

 
1,235,050




11
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 4 - SECURITIES
The fair value of available-for-sale securities and the related gross unrealized gains and losses recognized in accumulated other comprehensive income (loss) were as follows:
 
Amortized
 
Gross
Unrealized
 
Gross
Unrealized
 
 
June 30, 2014
Cost
 
Gains
 
Losses
 
Fair Value
Agency residential mortgage-backed securities 1
$
160,143

 
$
1,666

 
$
812

 
$
160,997

Agency residential collateralized mortgage obligations 2
60,524

 
338

 
65

 
60,797

SBA pools
2,332

 
58

 
—

 
2,390

Total securities
$
222,999

 
$
2,062

 
$
877

 
$
224,184

 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
Agency residential mortgage-backed securities 1
$
175,693

 
$
1,322

 
$
2,306

 
$
174,709

Agency residential collateralized mortgage obligations 2
70,257

 
423

 
105

 
70,575

SBA pools
2,652

 
76

 
—

 
2,728

Total securities
$
248,602

 
$
1,821

 
$
2,411

 
$
248,012

1 Residential mortgage-backed securities issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
2 Collateralized mortgage obligations issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
The carrying amount, unrecognized gains and losses, and fair value of securities held to maturity were as follows:
 
Amortized
 
Gross
Unrealized
 
Gross
Unrealized
 
 
June 30, 2014
Cost
 
Gains
 
Losses
 
Fair Value
Agency residential mortgage-backed securities 1
$
72,740

 
$
3,731

 
$
28

 
$
76,443

Agency commercial mortgage-backed securities 2
25,518

 
991

 
119

 
26,390

Agency residential collateralized mortgage obligations 3
102,297

 
2,635

 
37

 
104,895

Municipal bonds
67,059

 
3,537

 
411

 
70,185

Total securities
$
267,614

 
$
10,894

 
$
595

 
$
277,913

 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
Agency residential mortgage-backed securities 1
$
83,177

 
$
3,523

 
$
130

 
$
86,570

Agency commercial mortgage-backed securities 2
24,828

 
523

 
310

 
25,041

Agency residential collateralized mortgage obligations 3
118,757

 
2,772

 
107

 
121,422

Municipal bonds
67,821

 
2,292

 
1,407

 
68,706

Total securities
$
294,583

 
$
9,110

 
$
1,954

 
$
301,739

1 Residential mortgage-backed securities issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
2 Commercial mortgage-backed securities issued and /or guaranteed by U.S. government agencies or government-sponsored enterprises.
3 Collateralized mortgage obligations issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.


12
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

The carrying amount and fair value of held to maturity debt securities and the fair value of available for sale debt securities at June 30, 2014 by contractual maturity were as follows. Securities with contractual payments not due at a single maturity date, including mortgage backed securities and collateralized mortgage obligations, are shown separately.
 
 
 
Available
 
Held to maturity
 
for sale
 
Carrying
Amount
 
Fair Value
 
Fair Value
Due in one year or less
$
145

 
$
148

 
$
—

Due after one to five years
7,659

 
8,124

 
2,390

Due after five to ten years
28,464

 
30,570

 
—

Due after ten years
30,791

 
31,343

 
—

Agency residential mortgage-backed securities 1
72,740

 
76,443

 
160,997

Agency commercial mortgage-backed securities 2
25,518

 
26,390

 
—

Agency residential collateralized mortgage obligations 3
102,297

 
104,895

 
60,797

Total
$
267,614

 
$
277,913

 
$
224,184

1 Residential mortgage-backed securities issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
2 Commercial mortgage-backed securities issued and /or guaranteed by U.S. government agencies or government-sponsored enterprises.
3 Collateralized mortgage obligations issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
Information regarding pledged securities is summarized below:
 
June 30, 2014
 
December 31, 2013
Public fund certificates of deposit
$
148,310

 
$
156,731

Public fund demand deposit accounts
13,781

 
15,068

Commercial demand deposit accounts
3,058

 
4,439

Repurchase agreements
25,000

 
25,000

Federal Reserve Bank primary credit - collateral value
60,016

 
68,686

Carrying value of securities pledged on above funds
281,005

 
308,652

Sales activity of securities for the three and six months ended June 30, 2014 and 2013, was as follows. All securities sold were classified as available for sale.
    
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Proceeds
$
—

 
$
—

 
$
—

 
$
10,614

Gross losses
—

 
—

 
—

 
177


Gains and losses on the sale of securities classified as available for sale are recorded on the trade date using the specific-identification method.
    

13
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Securities with unrealized losses at June 30, 2014 and December 31, 2013 , aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, were as follows:
AFS
Less than 12 Months
 
12 Months or More
 
Total
June 30, 2014
Fair Value
 
Unrealized Loss
 
Number
 
Fair Value
 
Unrealized Loss
 
Number
 
Fair Value
 
Unrealized Loss
 
Number
Agency residential mortgage-backed securities 1
$
4,929

 
$
6

 
3

 
$
58,392

 
$
806

 
10

 
$
63,321

 
$
812

 
13

Agency residential collateralized mortgage obligations 2
5,360

 
5

 
2

 
6,568

 
60

 
5

 
11,928

 
65

 
7

Total temporarily impaired
$
10,289

 
$
11

 
5

 
$
64,960

 
$
866

 
15

 
$
75,249

 
$
877

 
20

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency residential mortgage-backed securities 1
$
83,461

 
$
2,306

 
19

 
$
—

 
$
—

 
—

 
$
83,461

 
$
2,306

 
19

Agency residential collateralized mortgage obligations 2
13,975

 
50

 
6

 
6,780

 
55

 
5

 
20,755

 
105

 
11

Total temporarily impaired
$
97,436

 
$
2,356

 
25

 
$
6,780

 
$
55

 
5

 
$
104,216

 
$
2,411

 
30

1 Residential mortgage-backed securities issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
2 Collateralized mortgage obligations issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
HTM
Less than 12 Months
 
12 Months or More
 
Total
June 30, 2014
Fair Value
 
Unrealized Loss
 
Number
 
Fair Value
 
Unrealized Loss
 
Number
 
Fair Value
 
Unrealized Loss
 
Number
Agency residential mortgage-backed securities 1
$
—

 
$
—

 
—

 
$
3,556

 
$
28

 
1

 
$
3,556

 
$
28

 
1

Agency commercial mortgage-backed securities  2
—

 
—

 
—

 
3,860

 
119

 
1

 
3,860

 
119

 
1

Agency residential collateralized mortgage obligations 3
—

 
—

 
—

 
5,905

 
37

 
3

 
5,905

 
37

 
3

Municipal bonds
6,546

 
58

 
11

 
11,895

 
353

 
17

 
18,441

 
411

 
28

Total temporarily impaired
$
6,546


$
58


11

 
$
25,216

 
$
537

 
22

 
$
31,762


$
595

 
33

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Agency residential mortgage-backed securities 1
$
5,779

 
$
130

 
2

 
$
—

 
$
—

 
—

 
$
5,779

 
$
130

 
2

Agency commercial mortgage-backed securities  2
4,940

 
310

 
2

 
—

 
—

 
—

 
4,940

 
310

 
2

Agency residential collateralized mortgage obligations 3
10,453

 
91

 
2

 
1,679

 
16

 
3

 
12,132

 
107

 
5

Municipal bonds
17,784

 
1,406

 
29

 
280

 
1

 
1

 
18,064

 
1,407

 
30

Total temporarily impaired
$
38,956

 
$
1,937

 
35

 
$
1,959

 
$
17

 
4

 
$
40,915

 
$
1,954

 
39

1 Residential mortgage-backed securities issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
2 Commercial mortgage-backed securities issued and /or guaranteed by U.S. government agencies or government-sponsored enterprises.
3 Collateralized mortgage obligations issued and/or guaranteed by U.S. government agencies or U.S. government-sponsored enterprises.
Other-than-Temporary Impairment
In determining other-than-temporary impairment for debt securities, management considers many factors, including: (1) the length of time and the extent to which the fair value has been less than amortized cost, (2) the financial condition and near-term prospects of the issuer, (3) whether the market decline was affected by macroeconomic conditions, and (4) whether the Company has the intent and ability to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. The Company does not believe these unrealized losses are other-than-temporary. All principal and interest payments are being received on time and in full.
   


14
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 5 - LOANS
Loans consist of the following:
 
June 30, 2014
 
December 31, 2013
Commercial real estate
$
1,162,035

 
$
1,091,200

Commercial and industrial loans:
 
 
 
Commercial
579,561

 
425,030

Warehouse lines of credit
31,426

 
14,400

Total commercial and industrial loans
610,987

 
439,430

Construction and land loans
 
 
 
Commercial construction and land
28,496

 
27,619

Consumer construction and land
3,445

 
2,628

Total construction and land loans
31,941

 
30,247

Consumer:
 
 
 
Consumer real estate
501,328

 
441,226

Other consumer loans
43,218

 
47,799

Total consumer
544,546

 
489,025

Gross loans held for investment, excluding Warehouse Purchase Program
2,349,509

 
2,049,902

Net of:
 
 
 
Deferred fees and discounts, net
(1,699
)
 
(1,267
)
Allowance for loan losses
(20,440
)
 
(19,358
)
Net loans held for investment, excluding Warehouse Purchase Program
2,327,370

 
2,029,277

Warehouse Purchase Program
769,566

 
673,470

Total loans held for investment
$
3,096,936

 
$
2,702,747


15
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Activity in the allowance for loan losses for the three and six months ended June 30, 2014 and 2013 , segregated by portfolio segment and evaluation for impairment, was as follows. All Warehouse Purchase Program loans are collectively evaluated for impairment and are purchased under several contractual requirements, providing safeguards to the Company. These safeguards include the requirement that our mortgage company customers have a takeout commitment for each loan and multiple investors identified for purchases. To date, the Company has never experienced a loss on these loans and no allowance for loan losses has been allocated to them. At June 30, 2014 and 2013 , $272 and $228 , respectively, of the allowance for loan losses individually evaluated for impairment was allocated to purchased credit impaired ("PCI") loans.
For the three months ended June 30, 2014
Commercial Real Estate
 
Commercial and Industrial
 
Construction and Land
 
Consumer Real Estate
 
Other Consumer
 
Total
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance - April 1, 2014
$
10,668

 
$
4,802

 
$
243

 
$
3,327

 
$
362

 
$
19,402

Charge-offs
—

 
(92
)
 
—

 
(74
)
 
(128
)
 
(294
)
Recoveries
—

 
39

 
—

 
20

 
76

 
135

Provision expense (benefit)
518

 
536

 
9

 
66

 
68

 
1,197

Ending balance - June 30, 2014
$
11,186

 
$
5,285

 
$
252

 
$
3,339

 
$
378

 
$
20,440

For the six months ended June 30, 2014
Commercial Real Estate
 
Commercial and Industrial
 
Construction and Land
 
Consumer Real Estate
 
Other Consumer
 
Total
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance - January 1, 2014
$
10,944

 
$
4,536

 
$
212

 
$
3,280

 
$
386

 
$
19,358

Charge-offs
—

 
(302
)
 
—

 
(156
)
 
(307
)
 
(765
)
Recoveries
—

 
57

 
—

 
25

 
192

 
274

Provision expense (benefit)
242

 
994

 
40

 
190

 
107

 
1,573

Ending balance - June 30, 2014
$
11,186

 
$
5,285

 
$
252

 
$
3,339

 
$
378

 
$
20,440

Allowance ending balance:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
$
964

 
$
1,535

 
$
—

 
$
189

 
$
1

 
$
2,689

Collectively evaluated for impairment
10,222

 
3,750

 
252

 
3,150

 
377

 
17,751

Loans:
 
 
 
 
 
 
 
 
 
 
 
Individually evaluated for impairment
8,052

 
6,407

 
52

 
5,152

 
453

 
20,116

Collectively evaluated for impairment
1,149,741

 
604,396

 
31,889

 
495,083

 
42,597

 
2,323,706

PCI loans
4,242

 
184

 
—

 
1,093

 
168

 
5,687

Ending balance
$
1,162,035

 
$
610,987

 
$
31,941

 
$
501,328

 
$
43,218

 
$
2,349,509

For the three months ended June 30, 2013
Commercial Real Estate
 
Commercial and Industrial
 
Construction and Land
 
Consumer Real Estate
 
Other Consumer
 
Total
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance - April 1, 2013
$
10,824

 
$
3,568

 
$
114

 
$
3,566

 
$
570

 
$
18,642

Charge-offs
(716
)
 
(124
)
 
—

 
(326
)
 
(228
)
 
(1,394
)
Recoveries
—

 
60

 
—

 
6

 
105

 
171

Provision expense (benefit)
417

 
1,235

 
5

 
217

 
(16
)
 
1,858

Ending balance - June 30, 2013
$
10,525

 
$
4,739

 
$
119

 
$
3,463

 
$
431

 
$
19,277


16
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

For the six months ended June 30, 2013
Commercial Real Estate
 
Commercial and Industrial
 
Construction and Land
 
Consumer Real Estate
 
Other Consumer
 
Total
Allowance for loan losses:
 
 
 
 
 
 
 
 
 
 
 
Beginning balance - January 1, 2013
$
11,182

 
$
2,574

 
$
149

 
$
3,528

 
$
618

 
$
18,051

Charge-offs
(772
)
 
(334
)
 
(31
)
 
(355
)
 
(378
)
 
(1,870
)
Recoveries
—

 
98

 
—

 
12

 
245

 
355

Provision expense (benefit)
115

 
2,401

 
1

 
278

 
(54
)
 
2,741

Ending balance - June 30, 2013
$
10,525

 
$
4,739

 
$
119

 
$
3,463

 
$
431

 
$
19,277

Allowance ending balance:
 
 
 
 
 
 
 
 
 
 

Individually evaluated for impairment
$
1,313

 
$
1,736

 
$
—

 
$
1,043

 
$
32

 
$
4,124

Collectively evaluated for impairment
9,212

 
3,003

 
119

 
2,420

 
399

 
15,153

Loans:
 
 
 
 
 
 
 
 
 
 

Individually evaluated for impairment
8,625

 
7,045

 
4

 
8,657

 
466

 
24,797

Collectively evaluated for impairment
977,407

 
304,916

 
18,836

 
449,279

 
51,727

 
1,802,165

PCI loans
4,195

 
1,070

 
1,631

 
1,140

 
189

 
8,225

Ending balance
$
990,227

 
$
313,031

 
$
20,471

 
$
459,076

 
$
52,382

 
$
1,835,187


The allowance for loan losses and related provision expense are susceptible to change if the credit quality of our loan portfolio changes, which is evidenced by many factors, including but not limited to charge-offs and non-performing loan trends. Generally, consumer real estate lending has a lower credit risk profile compared to other consumer lending (such as automobile loans). Commercial real estate and commercial and industrial lending, however, can have higher risk profiles than consumer loans due to these loans being larger in amount and non-homogeneous in structure and term. Changes in economic conditions, the mix and size of the loan portfolio, and individual borrower conditions can dramatically impact our level of allowance for loan losses in relatively short periods of time.
The allowance for loan losses is maintained to cover losses that are estimated in accordance with US GAAP. It is our estimate of credit losses inherent in our loan portfolio at each balance sheet date. Our methodology for analyzing the allowance for loan losses consists of general and specific components. For the general component, we stratify the loan portfolio into homogeneous groups of loans that possess similar loss potential characteristics and apply a loss ratio to these groups of loans to estimate the credit losses in the loan portfolio. We use both historical loss ratios and qualitative loss factors assigned to major loan collateral types to establish general component loss allocations. Qualitative loss factors are based on management's judgment of company, market, industry or business specific data and external economic indicators, which may not yet be reflected in the historical loss ratios, and that could impact the Company's specific loan portfolios. The Allowance for Loan Loss Committee sets and adjusts qualitative loss factors by regularly reviewing changes in underlying loan composition and the seasonality of specific portfolios. The Allowance for Loan Loss Committee also considers credit quality and trends relating to delinquency, non-performing and/or classified loans and bankruptcy within the Company's loan portfolio when evaluating qualitative loss factors. Additionally, the Allowance for Loan Loss Committee adjusts qualitative factors to account for the potential impact of external economic factors, including the unemployment rate, housing price, vacancy rates and inventory levels specific to our primary market area.
Management evaluates current information and events regarding a borrower's ability to repay its obligations and considers a loan to be impaired when the ultimate collectability of amounts due, according to the contractual terms of the loan agreement, is in doubt. If an impaired loan is collateral-dependent, the fair value of the collateral, less the estimated cost to sell, is used to determine the amount of impairment. If an impaired loan is not collateral-dependent, the impairment amount is determined using the negative difference, if any, between the estimated discounted cash flows and the loan amount due. For impaired loans, the amount of the impairment can be adjusted, based on current data, until such time as the actual basis is established by acquisition of the collateral or until the basis is collected. Impairment losses are reflected in the allowance for loan losses through a charge to the provision for loan losses. Subsequent recoveries are credited to the allowance for loan losses. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement. Cash receipts on impaired loans for which the accrual of interest has been discontinued are applied first to principal.
For the specific component, the allowance for loan losses includes loans where management has concerns about the borrower's ability to repay and on individually analyzed loans found to be impaired by definition. For example, all troubled debt restructurings are considered to be impaired. Loss estimates include the negative difference, if any, between the estimated

17
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

discounted cash flows of the loan, or if the loan is collateral dependent the current fair value of the collateral, and the loan amount due.
Impaired loans at June 30, 2014 , and December 31, 2013 , were as follows 1 :
June 30, 2014
 
Unpaid
Contractual Principal
Balance
 
Recorded
Investment With No Allowance
 
Recorded
Investment With Allowance
 
Total Recorded Investment
 
Related
Allowance
Commercial real estate
 
$
8,911

 
$
4,755

 
$
3,297

 
$
8,052

 
$
793

Commercial and industrial
 
7,380

 
3,152

 
3,255

 
6,407

 
1,461

Construction and land
 
52

 
52

 
—

 
52

 
—

Consumer:
 
 
 
 
 
 
 
 
 
 
Consumer real estate
 
5,436

 
4,027

 
1,125

 
5,152

 
163

Other consumer
 
501

 
453

 
—

 
453

 
—

Total
 
$
22,280

 
$
12,439

 
$
7,677

 
$
20,116

 
$
2,417

December 31, 2013
 
 
 
 
 
 
 
 
 
 
Commercial real estate
 
$
8,328

 
$
3,619

 
$
3,986

 
$
7,605

 
$
2,016

Commercial and industrial
 
6,058

 
539

 
4,786

 
5,325

 
550

Construction and land
 
2

 
2

 
—

 
2

 
—

Consumer:
 
 
 
 
 
 
 
 
 
 
Consumer real estate
 
5,050

 
3,725

 
1,087

 
4,812

 
155

Other consumer
 
579

 
550

 
—

 
550

 
—

Total
 
$
20,017

 
$
8,435

 
$
9,859

 
$
18,294

 
$
2,721

1 No Warehouse Purchase Program loans were impaired at June 30, 2014 or December 31, 2013 . Loans reported do not include PCI loans.


18
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Income on impaired loans at June 30, 2014 and 2013 was as follows 1 :
June 30, 2014
 
Current Quarter Average
Recorded
Investment
 
Year-to-Date Average
Recorded
Investment
 
Current Quarter Interest
Income
Recognized
 
Year-to-Date Interest
Income
Recognized
Commercial real estate
 
$
8,067

 
$
8,021

 
$
3

 
$
3

Commercial and industrial
 
6,163

 
5,973

 
3

 
6

Construction and land
 
13

 
9

 
—

 
—

Consumer:
 
 
 
 
 
 

 
 

Consumer real estate
 
4,759

 
4,675

 
11

 
23

Other consumer
 
482

 
510

 
1

 
2

Total
 
$
19,484

 
$
19,188

 
$
18

 
$
34

June 30, 2013
 
 
 
 
 
 
 
 
Commercial real estate
 
$
13,340

 
$
14,740

 
$
62

 
$
124

Commercial and industrial
 
6,924

 
6,366

 
3

 
6

Construction and land
 
4

 
79

 
—

 
—

Consumer:
 
 

 
 
 
 

 
 
Consumer real estate
 
8,513

 
8,502

 
19

 
33

Other consumer
 
433

 
406

 
—

 
—

Total
 
$
29,214

 
$
30,093

 
$
84

 
$
163

1 Loans reported do not include PCI loans.

Past due status is based on the contractual terms of the loan. Loans that are past due 30 days are considered delinquent. A loan is moved to nonaccrual status in accordance with the Company's policy, typically after 90 days of non-payment. Interest income on loans is discontinued at the time the loan is 90 days delinquent unless the loan is well-secured and in process of collection. Non-mortgage consumer loans are typically charged off no later than 120 days past due. In all cases, loans are placed on nonaccrual or charged-off at an earlier date if collection of principal or interest is considered doubtful. Nonaccrual loans include both smaller balance homogeneous loans that are collectively evaluated for impairment and larger individually classified impaired loans.
All interest accrued but not received for loans placed on nonaccrual status is reversed against interest income. Interest received on such loans is accounted for on the cash-basis or cost recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

19
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Loans past due over 90 days that were still accruing interest totaled $981 at June 30, 2014 and $266 at December 31, 2013 , which consisted entirely of PCI loans. At June 30, 2014 and December 31, 2013 , no PCI loans were considered non-performing loans. Purchased performing loans that were non-performing as of June 30, 2014 and December 31, 2013 totaled $3,335 and $4,201 , respectively. Those loans included $1,358 and $1,698 at June 30, 2014 and December 31, 2013 , respectively, of commercial lines of credit that did not qualify for PCI accounting due to their revolving nature. No Warehouse Purchase Program loans were non-performing at June 30, 2014 or December 31, 2013 . Non-performing (nonaccrual) loans were as follows:
 
June 30, 2014
 
December 31, 2013
Commercial real estate
$
7,386

 
$
7,604

Commercial and industrial
6,245

 
5,141

Construction and land
213

 
—

Consumer:
 
 
 
Consumer real estate
9,304

 
8,812

Other consumer
457

 
567

Total
$
23,605

 
$
22,124


A modified loan is considered a troubled debt restructuring (“TDR”) when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made for the borrower's benefit that would not otherwise be considered for a borrower or transaction with similar credit risk characteristics. Modifications to loan terms may include a modification of the contractual interest rate to a below-market rate (even if the modified rate is higher than the original rate), forgiveness of accrued interest, forgiveness of a portion of principal, an extended repayment period or a deed in lieu of foreclosure or other transfer of assets other than cash to fully or partially satisfy a debt. The Company's policy is to place all TDRs on nonaccrual for a minimum period of six months . Loans qualify for return to accrual status once they have demonstrated performance with the restructured terms of the loan agreement for a minimum of six months and the collection of principal and interest under the revised terms is deemed probable. All TDRs are considered to be impaired loans.

Large groups of smaller-balance homogeneous loans are collectively evaluated for impairment. As a result, the Company does not separately identify consumer real estate loans less than $417 or individual consumer non-real estate secured loans for impairment disclosures.

20
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

The outstanding balances of troubled debt restructurings ("TDRs") are shown below:
 
June 30, 2014
 
December 31, 2013
Nonaccrual TDRs (1)
$
12,498

 
$
11,368

Performing TDRs (2)
1,600

 
971

Total
$
14,098

 
$
12,339

Specific reserves on TDRs
$
1,048

 
$
1,191

Outstanding commitments to lend additional funds to borrowers with TDR loans
—

 
—

1 Nonaccrual TDR loans are included in the nonaccrual loan totals.
2 Performing TDR loans are loans that have been performing under the restructured terms for at least six months and the Company is accruing interest on these loans.
The following tables provide the recorded balances of loans modified as a TDR during the three and six months ended June 30, 2014 and 2013 .
 
 
Three Months Ended June 30, 2014
 
Six Months Ended June 30, 2014
 
 
Principal Deferrals (1)
 
Combination of Rate Reduction and Principal Deferral
 
Other
 
Total
 
Principal Deferrals (1)
 
Combination of Rate Reduction and Principal Deferral
 
Other
 
Total
Commercial and industrial
 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
1,913

 
$
1,913

Consumer real estate
 
130

 
—

 
113

 
243

 
130

 
269

 
113

 
512

Other consumer
 
—

 
—

 
—

 
—

 
13

 
6

 
—

 
19

Total
 
$
130

 
$
—

 
$
113

 
$
243

 
$
143

 
$
275

 
$
2,026

 
$
2,444

 
 
Three Months Ended June 30, 2013
 
Six Months Ended June 30, 2013
 
 
Principal Deferrals (1)
 
Combination of Rate Reduction and Principal Deferral
 
Other
 
Total
 
Principal Deferrals (1)
 
Combination of Rate Reduction and Principal Deferral
 
Other
 
Total
Commercial real estate
 
$
62

 
$
47

 
$
—

 
$
109

 
$
752

 
$
47

 
$
—

 
$
799

Commercial and industrial
 
—

 
—

 
—

 
—

 
8

 
31

 
—

 
39

Consumer real estate
 
41

 
73

 
223

 
337

 
41

 
73

 
223

 
337

Other consumer
 
71

 
68

 
—

 
139

 
130

 
68

 
—

 
198

Total
 
$
174

 
$
188

 
$
223

 
$
585

 
$
931

 
$
219

 
$
223

 
$
1,373

1 Principal deferrals include Chapter 7 bankruptcy loans for which the court has discharged the borrower's obligation and the borrower has not reaffirmed the debt. Such loans are placed on non-accrual status.

TDRs modified during the three and six months ended June 30, 2014 and 2013 which experienced a subsequent default during the periods are shown below. A payment default is defined as a loan that was 90 days or more past due.
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
 
2014
 
2013
 
2014
 
2013
Commercial and industrial
 
$
66

 
$
—

 
$
66

 
$
—

Consumer real estate
 
210

 
359

 
210

 
584

Total
 
$
276

 
$
359

 
$
276

 
$
584


    

21
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Below is an analysis of the age of recorded investment in loans that were past due at June 30, 2014 and December 31, 2013 . No Warehouse Purchase Program loans were delinquent at June 30, 2014 or December 31, 2013 .
June 30, 2014
 
30-59 Days Past Due
 
60-89 Days Past Due
 
90 Days and Greater Past Due
 
Total Loans Past Due
 
Current Loans 1
 
Total Loans
Commercial real estate
 
$
2,731

 
$
—

 
$
1,342

 
$
4,073

 
$
1,157,962

 
$
1,162,035

Commercial and industrial
 
142

 
2,632

 
875

 
3,649

 
607,338

 
610,987

Construction and land
 
—

 
—

 
213

 
213

 
31,728

 
31,941

Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
 
Consumer real estate
 
481

 
2,149

 
4,268

 
6,898

 
494,430

 
501,328

Other consumer
 
161

 
102

 
27

 
290

 
42,928

 
43,218

Total
 
$
3,515

 
$
4,883

 
$
6,725

 
$
15,123

 
$
2,334,386

 
$
2,349,509

December 31, 2013
 
30-59 Days Past Due
 
60-89 Days Past Due
 
90 Days and Greater Past Due
 
Total Loans Past Due
 
Current Loans 1
 
Total Loans
Commercial real estate
 
$
552

 
$
1,315

 
$
57

 
$
1,924

 
$
1,089,276

 
$
1,091,200

Commercial and industrial
 
4,518

 
129

 
2,835

 
7,482

 
431,948

 
439,430

Construction and land
 
152

 
—

 
—

 
152

 
30,095

 
30,247

Consumer loans:
 
 
 
 
 
 
 
 
 
 
 
 
Consumer real estate
 
6,579

 
3,295

 
3,651

 
13,525

 
427,701

 
441,226

Other consumer
 
460

 
106

 
53

 
619

 
47,180

 
47,799

Total
 
$
12,261

 
$
4,845

 
$
6,596

 
$
23,702

 
$
2,026,200

 
$
2,049,902

1 Includes acquired PCI loans with a total carrying value of $2,295 and $5,218 at June 30, 2014 and December 31, 2013 , respectively.
For loans collateralized by real property and commercial and industrial loans, credit exposure is monitored by internally assigned grades used for classification of loans. A loan is considered “special mention” when management has determined that there is a potential weakness that deserves management's close attention. Loans rated as "special mention" are not adversely classified according to regulatory classifications and do not expose the Company to sufficient risk to warrant adverse classification. A loan is considered “substandard” if it is inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged, if any. “Substandard” loans include those characterized by the “distinct possibility” that the insured institution will sustain “some loss” if the deficiencies are not corrected, and the loan may or may not meet the criteria for impairment. Loans classified as “doubtful” have all of the weaknesses of those classified as “substandard”, with the added characteristic that the weaknesses present make “collection or liquidation in full,” on the basis of currently existing facts, conditions and values, “highly questionable and improbable.” All other loans that do not fall into the above mentioned categories are considered “pass” loans. Updates to internally assigned grades are made monthly and/or upon significant developments.
For consumer loans, credit exposure is monitored by payment history of the loans. Non-performing consumer loans are on nonaccrual and are generally greater than 90 days past due.

22
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

The recorded investment in loans by credit quality indicators at June 30, 2014 and December 31, 2013 , was as follows.
Real Estate and Commercial and Industrial Credit Exposure
Credit Risk Profile by Internally Assigned Grade
June 30, 2014
 
Commercial Real Estate
 
Commercial and Industrial
 
Construction and Land
 
Consumer Real Estate
Grade: 1
 
 
 
 
 
 
 
 
Pass
 
$
1,133,080

 
$
596,508

 
$
31,430

 
$
484,590

Special Mention
 
10,542

 
5,223

 
163

 
4,125

Substandard
 
17,574

 
9,191

 
348

 
8,911

Doubtful
 
839

 
65

 
—

 
3,702

Total
 
$
1,162,035

 
$
610,987

 
$
31,941

 
$
501,328

December 31, 2013
 
Commercial Real Estate
 
Commercial and Industrial
 
Construction and Land
 
Consumer Real Estate
Grade: 1
 
 
 
 
 
 
 
 
Pass
 
$
1,055,872

 
$
424,110

 
$
28,146

 
$
424,174

Special Mention
 
16,030

 
1,672

 
161

 
3,661

Substandard
 
18,444

 
13,492

 
1,940

 
9,110

Doubtful
 
854

 
156

 
—

 
4,281

Total
 
$
1,091,200

 
$
439,430

 
$
30,247

 
$
441,226

1 PCI loans are included in the substandard or doubtful categories. These categories are consistent with the "substandard" and "doubtful" categories as defined by regulatory authorities.

Warehouse Purchase Program Credit Exposure
All Warehouse Purchase Program loans were graded pass as of June 30, 2014 and December 31, 2013 .
Consumer Other Credit Exposure
Credit Risk Profile Based on Payment Activity
 
June 30, 2014
 
December 31, 2013
Performing
$
42,761

 
$
47,232

Non-performing
457

 
567

Total
$
43,218

 
$
47,799



23
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 6 - FAIR VALUE     
ASC 820, “Fair Value Measurements and Disclosures”, establishes a fair value hierarchy which requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The standard describes three levels of inputs that may be used to measure fair value:
Level 1: Quoted prices (unadjusted) for identical assets or liabilities in active markets that the entity has the ability to access as of the measurement date.
Level 2: Significant other observable inputs other than Level 1 prices such as quoted prices for similar assets or liabilities; quoted prices in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.
Level 3: Prices or valuation techniques that require inputs that are both significant and unobservable in the market. These instruments are valued using the best information available, some of which is internally developed, and reflects a reporting entity’s own assumptions about the risk premiums that market participants would generally require and the assumptions they would use.
The fair values of securities available for sale are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs).
The estimated fair value of interest rate swaps are obtained from a pricing service that provides the swaps' unwind value (Level 2 inputs). In September 2013, we entered into certain interest rate derivative positions that are not designated as hedging instruments. The fair value of these derivative positions outstanding are included in other assets and other liabilities in the accompanying consolidated balance sheets. Please see Note 7 - Derivative Financial Instruments for more information.

24
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

Assets and Liabilities Measured on a Recurring Basis
Assets and liabilities measured at fair value on a recurring basis are summarized below.
June 30, 2014
 
Fair Value Measurements Using Significant Other Observable Inputs (Level 2)
Assets:
 
 
Agency residential mortgage-backed securities
 
$
160,997

Agency residential collateralized mortgage obligations
 
60,797

SBA pools
 
2,390

Total securities available for sale
 
$
224,184

Derivative asset 1
 
$
79

Derivative liability 1
 
$
79

December 31, 2013
 
 
Assets:
 
 
Agency residential mortgage-backed securities
 
$
174,709

Agency residential collateralized mortgage obligations
 
70,575

SBA pools
 
2,728

Total securities available for sale
 
$
248,012

Derivative asset 1
 
$
33

Derivative liability 1
 
$
33

1 Derivative assets and liabilities are measured at fair value on a recurring basis, generally quarterly. Please see Note 7 - Derivative Financial Instruments for more information.
Assets and Liabilities Measured on a Non-Recurring Basis

Assets measured at fair value on a non-recurring basis are summarized below. There were no liabilities measured at fair value on a non-recurring basis at June 30, 2014 or December 31, 2013 .

June 30, 2014
 
Fair Value Measurements Using Significant Unobservable
Inputs (Level 3)
Assets:
 
 
Impaired loans
 
$
5,260

Foreclosed assets
 
240

December 31, 2013
 
 
Assets:
 
 
Impaired loans
 
$
7,138

Foreclosed assets
 
480


Impaired loans that are collateral dependent are measured for impairment using the fair value of the collateral adjusted by additional Level 3 inputs, such as discounts of market value, estimated marketing costs and estimated legal expenses. At June 30, 2014 , impaired loans secured by real estate had an average discount of 5% applied to the appraised value of the collateral, and impaired loans secured by receivables or inventory had discounts determined by management on an individual loan basis. Impaired loans that are not collateral dependent are measured for impairment by a discounted cash flow analysis using a net present value calculation that utilizes data from the loan file before and after the modification.
Foreclosed assets are measured at the lower of book or fair value less costs to sell using third party appraisals, listing

25
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

agreements or sale contracts, which may be adjusted by additional Level 3 inputs, such as discounts of market value, estimated marketing costs and estimated legal expenses. Management may also consider additional adjustments on specific properties due to the age of the appraisal, expected holding period, lack of comparable sales, or if the other real estate owned is a special use property. The market value discounts on foreclosed assets at June 30, 2014 , ranged from 0% to 77% , with an average of 19% .
The Credit Administration department evaluates the valuations on impaired loans and foreclosed assets at least quarterly. The valuations on impaired loans are reviewed at least quarterly by the Allowance for Loan Loss Committee and are considered in the calculation of the allowance for loan losses. Unobservable inputs, such as discounts to collateral, are monitored and adjusted if market conditions change.
The carrying amount and fair value information of financial instruments not recorded at fair value in their entirety on a recurring basis on the Company's consolidated balance sheets at June 30, 2014 and at December 31, 2013 , were as follows:
 
 
 
 
Fair Value
June 30, 2014
 
Carrying
Amount
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Financial assets
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
165,908

 
$
165,908

 
$
—

 
$
—

Securities held to maturity
 
267,614

 
—

 
277,913

 
—

Loans held for investment, net
 
2,327,370

 
—

 
—

 
2,345,041

Loans held for investment - Warehouse Purchase Program
 
769,566

 
—

 
—

 
769,877

FHLB and Federal Reserve Bank stock
 
44,532

 
—

 
44,532

 
—

Accrued interest receivable
 
10,620

 
10,620

 
—

 
—

Financial liabilities
 
 
 
 
 
 
 
 
Deposits
 
$
2,435,726

 
$
—

 
$
—

 
$
2,307,105

FHLB advances
 
874,866

 
—

 
—

 
884,707

Repurchase agreement
 
25,000

 
—

 
—

 
27,149

Accrued interest payable
 
1,075

 
1,075

 
—

 
—


26
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

 
 
 
 
Fair Value
December 31, 2013
 
Carrying
Amount
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
Financial assets
 
 
 
 
 
 
 
 
Cash and cash equivalents
 
$
87,974

 
$
87,974

 
$
—

 
$
—

Securities held to maturity
 
294,583

 
—

 
301,739

 
—

Loans held for investment, net
 
2,029,277

 
—

 
—

 
2,054,460

Loans held for investment - Warehouse Purchase Program
 
673,470

 
—

 
—

 
673,785

FHLB and Federal Reserve Bank stock
 
34,883

 
—

 
34,883

 
—

Accrued interest receivable
 
9,904

 
9,904

 
—

 
—

Financial liabilities
 
 
 
 
 
 
 
 
Deposits
 
$
2,264,639

 
$
—

 
$
—

 
$
2,123,846

FHLB advances
 
639,096

 
—

 
—

 
650,976

Repurchase agreement
 
25,000

 
—

 
—

 
27,430

Accrued interest payable
 
1,066

 
1,066

 
—

 
—

The methods and assumptions used to estimate fair value are described as follows:
Estimated fair value is the carrying amount for cash and cash equivalents and accrued interest receivable and payable. The fair values of securities held to maturity are determined by matrix pricing, which is a mathematical technique widely used in the industry to value debt securities without relying exclusively on quoted prices for the specific securities but rather by relying on the securities' relationship to other benchmark quoted securities (Level 2 inputs). For loans held for investment, fair value is based on discounted cash flows using current market offering rates, estimated life, and applicable credit risk. For deposits and FHLB advances, fair value is calculated using the FHLB advance curve to discount cash flows for the estimated life for deposits and according to the contractual repayment schedule for FHLB advances. Fair value of the repurchase agreement is based on discounting the estimated cash flows using the current rate at which similar borrowings would be made with similar terms and remaining maturities. It is not practicable to determine the fair value of FHLB and Federal Reserve Bank stock due to restrictions on its transferability. The fair value of off-balance sheet items is based on the current fees or costs that would be charged to enter into or terminate such arrangements and are not considered significant to this presentation.


27
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 7 - DERIVATIVE FINANCIAL INSTRUMENTS

In September 2013, we entered into certain interest rate derivative positions that are not designated as hedging instruments. These derivative positions related to transactions in which we entered into an interest rate swap with a customer, while at the same time entering into an offsetting interest rate swap with another financial institution. In connection with each swap transaction, we agree to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, we agree to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount. The transaction allows our customer to effectively convert a variable rate loan to a fixed rate. Because we act as an intermediary for our customer, changes in the fair value of the underlying derivative contracts substantially offset each other and do not have a material impact on our results of operations. The Company presents derivative instruments at fair value in other assets and other liabilities in the accompanying consolidated balance sheets.

The notional amounts and estimated fair values of interest rate derivative positions outstanding and weighted-average receive and pay interest rates at June 30, 2014 and December 31, 2013 are presented in the following table.

 
 
Outstanding
Notional Amount
 
Estimated Fair Value
 
Weighted-Average Interest Rate
Non-hedging interest rate contracts - commercial loan interest rate swaps:
 
 
 
Received
 
Paid
June 30, 2014
 
 
 
 
 
 
 
 
Loan customer counterparty
 
$
6,304

 
$
79

 
4.38
%
 
2.90
%
Financial institution counterparty
 
(6,304
)
 
(79
)
 
2.90

 
4.38

 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
 
Loan customer counterparty
 
$
6,406

 
$
33

 
4.38
%
 
2.92
%
Financial institution counterparty
 
(6,406
)
 
(33
)
 
2.92

 
4.38


Our credit exposure on interest rate swaps is limited to the net favorable value of all swaps by each counterparty. In some cases, collateral may be required from the counterparties involved if the net value of the swaps exceed a nominal amount considered to be immaterial. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values. At June 30, 2014 , our cash collateral pledged for these derivatives totaled $150 , which was in excess of our credit exposure. This collateral is reported in our interest-bearing deposits in other financial institutions in the accompanying consolidated balance sheets.



28
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 8 - SHARE-BASED COMPENSATION

Compensation cost charged to income for share-based compensation is presented below:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
2014
 
2013
 
2014
 
2013
Restricted stock
$
640

 
$
595

 
$
1,295

 
$
1,025

Stock options
276

 
255

 
540

 
397

Income tax benefit
320

 
298

 
642

 
498


A summary of activity in the restricted stock portion of the Company's stock plans is presented below:
 
Six Months Ended June 30, 2014
 
Time-Vested Shares
 
Performance-Based Shares
 
Shares
 
Weighted-Average Grant Date Fair Value 1
 
Shares
 
Weighted-Average Grant Date Fair Value 2
Non-vested at December 31, 2013
381,402

 
$
20.39

 
82,400

 
$
27.45

Granted
20,000

 
24.69

 
—

 
—

Vested
(63,000
)
 
21.61

 
—

 
—

Forfeited
—

 
—

 
—

 
—

Non-vested at June 30, 2014
338,402

 
$
20.57

 
82,400

 
$
27.06

1 For restricted stock awards with time-based vesting conditions, the grant date fair value is based on the closing stock price as quoted on the NASDAQ Stock Market on the grant date.
2 For restricted stock awards with performance-based vesting conditions, the value of the award is based upon the closing stock price as quoted on the NASDAQ Stock Market on the date of vesting. Until the final value is determined on the vesting date, the Company estimates the fair value quarterly based upon the closing stock price as quoted on the NASDAQ Stock Market near the last business day of each calendar quarter end.

As of June 30, 2014 , there was $7,924 of total unrecognized compensation expense related to non-vested shares awarded under the restricted stock plans. That expense is expected to be recognized over a weighted-average period of 2.77 years .

A summary of activity in the stock option portion of the Company's stock plans as of June 30, 2014 , is presented below:
    
 
 
 
Weighted-
Average
Exercise Price
 
Weighted-
Average
Remaining
Contractual Term
 
Aggregate
Intrinsic Value
 
Shares
 
Outstanding at December 31, 2013
1,173,618

 
$
18.16

 
8.4
 
$
10,903

Granted
8,500

 
28.51

 
10.0
 
—

Exercised
(36,904
)
 
13.30

 
0.0
 
421

Forfeited
(21,420
)
 
16.74

 
0.0
 
—

Outstanding at June 30, 2014
1,123,794

 
18.42

 
8.1
 
9,549

Fully vested and expected to vest
1,116,799

 
18.42

 
8.1
 
9,497

Exercisable at June 30, 2014
342,458

 
$
16.19

 
7.0
 
$
3,671


As of June 30, 2014 , there was $3,886 of total unrecognized compensation expense related to non-vested stock options. That expense is expected to be recognized over a weighted-average period of 3.50 years .

29
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 9 - INCOME TAXES    
A summary of the net deferred tax assets as of June 30, 2014 and December 31, 2013 , is presented below:
 
June 30, 2014
 
December 31, 2013
Net deferred tax assets
$
10,656

 
$
12,320

Estimated annual effective tax rate
36
%
 
 



30
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 10 - COMMITMENTS AND CONTINGENT LIABILITIES
In the normal course of business, the Company enters into various transactions which, in accordance with US GAAP, are not included in its consolidated balance sheets. The Company enters into these transactions to meet the financing needs of its customers. These transactions include commitments to extend credit and standby letters of credit which involve, to varying degrees, elements of credit and interest rate risk. Credit losses up to the face amount of these instruments could occur, although material losses are not anticipated. The Company's credit policies applied to loan originations are also applied to these commitment requests, including obtaining collateral at the exercise of the commitment.
The Company enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Since many commitments expire without being drawn upon, the total contractual amount of commitments does not necessarily represent future cash requirements of the Company. Substantially all of the Company's commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of future loan funding. Standby letters of credit are written conditional commitments issued by the Company to guarantee the performance of a customer to a third party. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. The maximum potential amount of future payments the Company could be required to make is represented by the contractual amount of the commitment. If the commitment were funded, the Company would seek payment from the customer under pre-arranged terms. The Company's policies generally require that standby letter of credit arrangements contain security and debt covenants similar to those contained in loan agreements.
The contractual amounts of financial instruments with off‑balance sheet risk at June 30, 2014 and December 31, 2013 , are summarized below. Please see Part I-Item 2-"Off-Balance Sheet Arrangements, Contractual Obligation and Commitments" of this Form 10-Q for information related to commitment maturities.
    
 
June 30, 2014
 
December 31, 2013
Unused commitments to extend credit
$
399,229

 
$
425,324

Unused capacity on Warehouse Purchase Program loans
344,434

 
562,030

Standby letters of credit
1,192

 
1,354

Total unused commitments/capacity
$
744,855

 
$
988,708

In addition to the commitments above, the Company guarantees the credit card debt of certain customers to the merchant bank that issues the credit cards. These guarantees are in place for as long as the guaranteed credit card is open. At June 30, 2014 and December 31, 2013, these credit card guarantees totaled $1,099 and $1,307 , respectively. This amount represents the maximum potential amount of future payments under the guarantee. At June 30, 2014 , the Company had set aside a reserve of $28 for its credit card guarantees.
    Also, the Company had overdraft protection available in the amounts of $74,608 and $87,772 for June 30, 2014 and December 31, 2013, respectively.
In regards to unused capacity on Warehouse Purchase Program loans, the Company has established maximum purchase facility amounts, but reserves the right, at any time, to refuse to buy any mortgage loans offered for sale with each customer, for any reason in the Company's sole and absolute discretion.
At June 30, 2014 , the Company had $3,480 of unfunded commitments recorded in other liabilities in its consolidated balance sheet related to investments in community development -oriented private equity funds used for Community Reinvestment Act purposes.

31
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 11 - RECENT ACCOUNTING DEVELOPMENTS    
In January 2014, the FASB issued ASU 2014-01, Accounting for Investments in Qualified Affordable Housing Projects. This ASU permits reporting entities to make an accounting policy election to account for their investments in qualified affordable housing projects using the proportional amortization method if certain conditions are met. For public entities, the amendments are effective, with retrospective application, for annual periods, and interim periods within those years, beginning after December 15, 2014. Early adoption is permitted. The adoption of this ASU is not expected to have a significant impact on the Company's financial statements.
In January 2014, the FASB issued ASU 2014-04, Reclassification of Residential Real Estate Collateralized Consumer Mortgage Loans upon Foreclosure. This ASU is intended to clarify when a creditor should be considered to have received physical possession of residential real estate property collateralizing a consumer mortgage loan such that the loan should be derecognized and the real estate recognized. For public entities, the amendments are effective for annual periods, and interim periods within those years, beginning after December 15, 2014. An entity can elect to adopt the amendments in this update using either a modified retrospective transition method or a prospective transition method. Early adoption is permitted. The adoption of this ASU is not expected to have a significant impact on the Company's financial statements.    
In April 2014, the FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity . This ASU states that only disposals representing a strategic shift in operations should be presented as discontinued operations. Those strategic shifts should have a major effect on the organization's operations and financial results. In addition, this ASU requires expanded disclosures about discontinued operations and disclosure of the pre-tax income attributable to a disposal of a significant part of an organization that does not qualify for discontinued operations reporting. For public entities, the amendments are effective prospectively for annual periods, and interim periods within those years, beginning on or after December 15, 2014. Early adoption is permitted, but only for disposals that have not been reported in financial statements previously issued. The adoption of this ASU is not expected to have a significant impact on the Company's financial statements.    
In May 2014, the FASB issued ASU 2014-09, Revenue from Contracts with Customers . This ASU states that an entity should recognize revenue to depict the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. This ASU affects entities that enter into contracts with customers to transfer goods or services or enter into contracts for the transfer of nonfinancial assets, unless those contracts are within the scope of other standards. For public entities, the amendments are effective for annual reporting periods, and interim periods within those years, beginning after December 15, 2016. Early adoption is not permitted. The adoption of this ASU is not expected to have a significant impact on the Company's financial statements.
In June 2014, the FASB issued ASU 2014-11, Repurchase-to-Maturity Transactions, Repurchase Financings, and Disclosures . This ASU aligns the accounting for repurchase-to-maturity transactions and repurchase agreements executed as a repurchase financing with the accounting for other typical repurchase agreements by accounting for these transactions as secured borrowings. This ASU also requires a new disclosure for transactions economically similar to repurchase agreements in which the transferor retains substantially all of the exposure to the economic return of the transferred financial assets throughout the term of the transaction. For public entities, the amendments are effective for annual periods, and interim periods within those years, beginning after December 15, 2014. Early adoption is not permitted. The adoption of this ASU is not expected to have a significant impact on the Company's financial statements.
In June 2014, the FASB issued ASU 2014-12, A ccounting for Share-Based Payments When the Terms of an Award Provide that a Performance Target Could Be Achieved after the Requisite Service Period . This ASU requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. The amendments are effective for annual periods, and interim periods within those years, beginning after December 15, 2015. Early adoption is permitted. The adoption of this ASU is not expected to have a significant impact on the Company's financial statements.
  
     
  
    

32
VIEWPOINT FINANCIAL GROUP, INC.
CONDENSED NOTES TO UNAUDITED CONSOLIDATED INTERIM FINANCIAL STATEMENTS
(Dollars in thousands, except per share data)

NOTE 12 — SUBSEQUENT EVENTS
The Company evaluated events from the date of the consolidated financial statements on June 30, 2014 , through the issuance of those consolidated financial statements included in this Quarterly Report on Form 10-Q dated July 29, 2014. No additional events were identified requiring recognition in and/or disclosures in the consolidated financial statements.

33

Item 2.
Management's Discussion and Analysis of Financial Condition and Results of Operations
Private Securities Litigation Reform Act Safe Harbor Statement
When used in filings by ViewPoint Financial Group, Inc. (“ViewPoint”) with the Securities and Exchange Commission (the “SEC”), in ViewPoint’s press releases or other public or shareholder communications, and in oral statements made with the approval of an authorized executive officer, the words or phrases “will likely result,” “are expected to,” “will continue,” “is anticipated,” “estimate,” “project,” “intends” or similar expressions are intended to identify “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to certain risks and uncertainties that could cause actual results to differ materially from historical earnings and those presently anticipated or projected, including, among other things: the expected cost savings, synergies and other financial benefits from the ViewPoint-LegacyTexas merger (the “Merger”) might not be realized within the expected time frames or at all and costs or difficulties relating to integration matters might be greater than expected; the requisite regulatory approvals might not be obtained or other conditions to completion of the merger set forth in the merger agreement might not be satisfied or waived; changes in economic conditions; legislative changes; changes in policies by regulatory agencies; fluctuations in interest rates; the risks of lending and investing activities, including changes in the level and direction of loan delinquencies and write-offs and changes in estimates of the adequacy of the allowance for loan losses; ViewPoint’s ability to access cost-effective funding; fluctuations in real estate values and both residential and commercial real estate market conditions; demand for loans and deposits in ViewPoint’s market area; the industry-wide decline in mortgage production; competition; changes in management’s business strategies and other factors set forth in ViewPoint’s filings with the SEC.

ViewPoint does not undertake - and specifically declines any obligation - to publicly release the result of any revisions which may be made to any forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events.
Overview
The Company, a Maryland corporation, is a full stock holding company for its wholly owned subsidiary, ViewPoint Bank, N.A. (the “Bank”). Unless the context otherwise requires, references in this document to the “Company” refer to ViewPoint Financial Group, Inc. and references to the “Bank” refer to ViewPoint Bank, N.A. References to “we,” “us,” and “our” means ViewPoint Financial Group, Inc. or ViewPoint Bank, N.A. , as the context requires. The Company is regulated by the Board of Governors of the Federal Reserve System ("FRB") and the Bank is regulated by the Office of the Comptroller of the Currency (“OCC”) with certain back-up oversight by the Federal Deposit Insurance Corporation (“FDIC”). The Bank is required to have certain reserves and stock set by the FRB and is a member of the Federal Home Loan Bank of Dallas, which is one of the 12 regional banks in the Federal Home Loan Bank (“FHLB”) System.
On November 25, 2013, the Company and LegacyTexas Group, Inc. (“LegacyTexas”) announced that they had entered into a definitive merger agreement whereby LegacyTexas will merge into the Company and, immediately thereafter, the Bank will merge into LegacyTexas’ subsidiary bank, LegacyTexas Bank. The merger was approved by LegacyTexas' shareholders on May 19, 2014, and will result in one of the largest independent banks in the state of Texas, with 51 branches and pro forma assets of over $5 billion. On June 17, 2014, the Company and LegacyTexas announced that additional time will be required to obtain regulatory approvals and to satisfy customary closing conditions necessary to complete the merger, and have jointly extended the agreement to August 31, 2014, pursuant to its terms.

Our principal business consists of attracting retail deposits from the general public and the business community and investing those funds, along with borrowed funds, in commercial real estate loans, secured and unsecured commercial and industrial loans, as well as permanent loans secured by first and second mortgages on owner-occupied, one- to four-family residences and consumer loans. Additionally, the Warehouse Purchase Program allows mortgage banking company customers to close one- to four-family real estate loans in their own name and manage its cash flow needs until the loans are sold to investors. We also offer brokerage services for the purchase and sale of non-deposit investment and insurance products through a third party brokerage arrangement. Our operating revenues are derived principally from interest earned on interest-earning assets including loans and investment securities and service charges and fees on deposits and other account services. Our primary sources of funds are deposits, FHLB advances and other borrowings, and payments received on loans and securities. We offer a variety of deposit accounts that provide a wide range of interest rates and terms, generally including savings, money market, term certificate and demand accounts. Our principal objective is to remain an independent, community-oriented financial institution, providing outstanding service and innovative products to customers in our primary market area.


34

Performance Highlights
•
Loans held for investment, excluding Warehouse Purchase Program loans, grew $299.6 million , or 14.6% , from December 31, 2013, with commercial loans increasing by $243.3 million, or 15.6%, to $1.80 billion at June 30, 2014.

•
Warehouse Purchase Program loans increased by $96.1 million , or 14.3% , from December 31, 2013, to $769.6 million at June 30, 2014.

•
The $644,000 , or 7.9% , increase in net income for the quarter ended June 30, 2014, compared to the quarter ended June 30, 2013, was driven by a $1.7 million , or 5.4% , increase in interest income on loans and a $671,000 , or 13.8% , decrease in interest expense.

•
Deposits increased by $171.1 million , or 7.6% , from December 31, 2013.

•
Net interest margin for the quarter ended June 30, 2014, was 3.76% , a four basis point increase from the quarter ended June 30, 2013.
Critical Accounting Estimates
Certain of our accounting estimates are important to the portrayal of our financial condition, since they require management to make difficult, complex or subjective judgments, some of which may relate to matters that are inherently uncertain. Estimates are susceptible to material changes as a result of changes in facts and circumstances. Facts and circumstances which could affect these judgments include, but are not limited to, changes in interest rates, changes in the performance of the economy and changes in the financial condition of borrowers. Management believes that its critical accounting estimates include determining the allowance for loan losses and other-than-temporary impairments in our securities portfolio. Our accounting policies are discussed in detail in Note 1 of the Notes to Consolidated Financial Statements contained in Item 8 of our 2013 Form 10-K.
Allowance for Loan Loss. The allowance for loan losses and related provision expense are susceptible to change if the credit quality of our loan portfolio changes, which is evidenced by many factors, including but not limited to charge-offs and non-performing loan trends. Generally, consumer real estate lending has a lower risk profile compared to other consumer lending (such as automobile loans). Commercial real estate and commercial and industrial lending, however, can have higher risk profiles than consumer loans due to these loans being larger in amount and more susceptible to fluctuations in industry, market and economic conditions. While management uses available information to recognize losses on loans, changes, in economic conditions, the mix and size of the loan portfolio and individual borrower conditions can dramatically impact our level of allowance for loan losses in relatively short periods of time. Management believes that the allowance for loan losses is maintained at a level that represents coverage of our best estimate of inherent credit losses in the loan portfolio as of June 30, 2014.

Management evaluates current information and events regarding a borrower's ability to repay its obligations and considers a loan to be impaired when the ultimate collectability of amounts due, according to the contractual terms of the loan agreement, is in doubt. If an impaired loan is collateral-dependent, the fair value of the collateral, less the estimated cost to sell, is used to determine the amount of impairment. If an impaired loan is not collateral-dependent, the impairment amount is determined using the negative difference, if any, between the estimated discounted cash flows and the loan amount due. For impaired loans, the amount of the impairment can be adjusted, based on current data, until such time as the actual basis is established by acquisition of the collateral or until the basis is collected. Impairment losses are reflected in the allowance for loan losses through a charge to the provision for loan losses. Subsequent recoveries are credited to the allowance for loan losses. Cash receipts for accruing loans are applied to principal and interest under the contractual terms of the loan agreement. Cash receipts on impaired loans for which the accrual of interest has been discontinued are applied first to principal.
Other-than-Temporary Impairments. The Company evaluates securities for other-than-temporary impairment on at least a quarterly basis and more frequently when economic, market, or security specific concerns warrant such evaluation. Consideration is given to the length of time and the extent to which the fair value has been less than amortized cost, the financial condition and near-term prospects of the issuer, adverse conditions specifically related to the security, issuer, or geographic area, and the intent and ability of the Company to retain its investment in the issuer for a period of time sufficient to allow for any anticipated recovery in fair value. In analyzing an issuer’s financial condition, the Company may consider whether the securities are issued by the federal government or its agencies, whether downgrades by bond rating agencies have occurred, and the results of reviews of the issuer’s financial condition. The Company conducts regular reviews of the bond agency ratings of securities and considers whether the securities were issued by or have principal and interest payments

35

guaranteed by the federal government or its agencies. These reviews focus on the underlying rating of the issuer and also include the insurance or guarantee rating of securities that have an insurance or guarantee component. The ratings and financial condition of the issuers are monitored, as well as the financial condition and ratings of the insurers and guarantors.
Comparison of Financial Condition at June 30, 2014 and December 31, 2013
General . Total assets increased by $426.0 million , or 12.1% , to $3.95 billion at June 30, 2014 , from $3.53 billion at December 31, 2013 , primarily due to an increase of $171.6 million , or 39.0% , in commercial and industrial loans, a $70.8 million , or 6.5% , increase in commercial real estate loans, a $60.1 million , or 13.6% , increase in consumer real estate loans and a $96.1 million , or 14.3% , increase in Warehouse Purchase Program loans. These increases were partially offset by a $50.8 million , or 9.4% , decrease in the securities portfolio.
Loans. Gross loans increased by $395.7 million , or 14.5% , to $3.12 billion at June 30, 2014 , from $2.72 billion at December 31, 2013.
 
June 30, 2014
 
December 31, 2013
 
Dollar
Change
 
Percent
Change
 
(Dollars in thousands)
Commercial real estate
$
1,162,035

 
$
1,091,200

 
$
70,835

 
6.5
 %
Commercial and industrial loans:
 
 
 
 
 
 
 
Commercial
579,561

 
425,030

 
154,531

 
36.4

Warehouse lines of credit
31,426

 
14,400

 
17,026

 
118.2

Total commercial and industrial loans
610,987

 
439,430

 
171,557

 
39.0

Construction and land loans
 
 
 
 
 
 
 
Commercial construction and land
28,496

 
27,619

 
877

 
3.2

Consumer construction and land
3,445

 
2,628

 
817

 
31.1

Total construction and land loans
31,941

 
30,247

 
1,694

 
5.6

Consumer:
 
 
 
 
 
 
 
Consumer real estate
501,328

 
441,226

 
60,102

 
13.6

Other consumer
43,218

 
47,799

 
(4,581
)
 
(9.6
)
Total consumer loans
544,546

 
489,025

 
55,521

 
11.4

Gross loans held for investment, excluding Warehouse Purchase Program loans
2,349,509

 
2,049,902

 
299,607

 
14.6

Warehouse Purchase Program loans
769,566

 
673,470

 
96,096

 
14.3

Gross loans
$
3,119,075

 
$
2,723,372

 
$
395,703

 
14.5
 %

During the six months ended June 30, 2014, the increase in gross loans, excluding Warehouse Purchase Program loans, was primarily driven by growth in our commercial lending portfolio, as commercial loans (essentially commercial real estate and commercial and industrial loans) increased a combined $243.3 million , or 15.6% , from December 31, 2013 . Our commercial real estate portfolio consists almost exclusively of loans secured by well-established, multi-tenanted commercial real estate properties. Approximately 91% of our commercial real estate loan balances are secured by properties located in Texas.

The Company has historically participated in several energy loan transactions, but to further develop this line of business, in May 2013, the Company announced the formation of a new energy lending group. The Energy Finance group focuses on providing loans to private and public oil and gas companies throughout the United States, with an emphasis on reserve-based transactions for development drilling, capital expenditures to enhance oil and gas reserves, and acquisitions of oil and gas reserves. The group's offerings also include the Bank's full array of commercial services, including Treasury Management and letters of credit. Energy loans, which are reported as commercial and industrial loans, totaled $222.2 million at June 30, 2014 , up $55.7 million from $166.5 million at December 31, 2013.

Warehouse Purchase Program loans increased by $96.1 million , or 14.3% , to $769.6 million at June 30, 2014 , from $673.5 million at December 31, 2013 . The Company purchases a 100% participation interest in the loans originated by our mortgage banking company customers, which are then held as one- to four- family mortgage loans. The mortgage banking company has no obligation to offer to sell to us and we have no obligation to purchase participation interests in these loans. The

36

mortgage banking company closes mortgage loans consistent with underwriting standards established by approved investors and once the loan closes, the participation interest is delivered by the Company to the investor selected by the originator and approved by the Company. Loans funded by the Warehouse Purchase Program during the second quarter of 2014 consisted of 57% conforming, 42% government and 1% Home Affordable Refinance Program (HARP) loans.
Prior to the December 31, 2013 reporting period, the Company reported Warehouse Purchase Program loans as held for sale, as the Company believed that was the most meaningful presentation to our financial statement users given that the collection of the loan was based upon the sale of the loan. Effective December 31, 2013, the Company concluded that, under US GAAP, these loans should be accounted for as held for investment. This correction changed the accounting for Warehouse Purchase Program loans from a lower of cost or market accounting method to accounting for the loans under ASC 310, with any credit losses incurred as of the balance sheet date recognized in the allowance for loan losses. As we had not reported any valuation decreases below cost in prior periods and we have experienced no credit losses on these loans, this correction had no impact on net income, comprehensive income, earnings per share or income taxes. Additionally, total assets and shareholders' equity remained unchanged. However, this correction did impact the statement of cash flows by moving cash flows associated with the Warehouse Purchase Program from operating cash flows to investing cash flows.
Consumer real estate loans increased by $60.1 million , or 13.6% , to $501.3 million at June 30, 2014 , from $441.2 million at December 31, 2013 . The Company does not originate one- to four- family real estate loans but does periodically purchase these loans from correspondents on both a servicing retained and servicing released basis. Also, the Company originates consumer home equity and home improvement loans.
Mortgage reform rules mandated by the Dodd-Frank Act became effective in January 2014, requiring lenders to make a reasonable, good faith determination of a borrower’s ability to repay any consumer closed-end credit transaction secured by a dwelling and to limit prepayment penalties. Increased risks of legal challenge, private right of action and regulatory enforcement are presented by these rules. The Company originates and purchases loans that do not meet the definition of a “qualified mortgage” (“QM”). At June 30, 2014, the Company had $25.2 million in non-QM loans, consisting of home equity and home improvement loans totaling $18.1 million and residential mortgage loans totaling $7.1 million. To mitigate the risks involved with non-QM loans, the Company has implemented systems, processes, procedural and product changes, and maintains its underwriting standards, to ensure that the “ability-to-repay” requirements of the new rules are adequately addressed.
Allowance for Loan Losses . The allowance for loan losses is maintained to cover losses that are estimated in accordance with US GAAP. It is our estimate of credit losses in our loan portfolio at each balance sheet date. Our methodology for analyzing the allowance for loan losses consists of general and specific components.
For the general component, we stratify the loan portfolio into homogeneous groups of loans that possess similar loss potential characteristics and apply a loss ratio to these groups of loans to estimate the credit losses in the loan portfolio. We use both historical loss ratios and qualitative loss factors assigned to major loan collateral types to establish loss allocations. Qualitative loss factors are based on management's judgment of company, market, industry or business specific data and external economic indicators which may not yet be reflective in the historical loss ratios and that could impact the Company's specific loan portfolios. The Allowance for Loan Loss Committee sets and adjusts qualitative loss factors by reviewing changes in loan composition and the seasonality of specific portfolios. The Allowance for Loan Loss Committee also considers credit quality and trends relating to delinquency, non-performing and/or classified loans and bankruptcy within the Company's loan portfolio when evaluating qualitative loss factors. Additionally, the Allowance for Loan Loss Committee adjusts qualitative factors periodically to account for the potential impact of external economic factors, including the unemployment rate, housing price, vacancy rates and inventory levels specific to our primary market area.
For the specific component, the allowance for loan losses includes loans where management has concerns about the borrower's ability to repay and on individually analyzed loans found to be impaired by definition. For example, all troubled debt restructurings are considered to be impaired, regardless of collateral type or note amount. This impairment analysis includes all loans secured by commercial real estate and all commercial and industrial loans, as well as certain residential real estate loans. Loss estimates include the negative difference, if any, between the current fair value of the collateral, or the estimated discounted cash flows, and the loan amount due.
Acquired loans are initially recorded at fair value, which includes an estimate of credit losses expected to be realized over the remaining lives of the loans, and therefore no corresponding allowance for loan losses is recorded for these loans at acquisition. Methods utilized to estimate the required allowance for loan losses for acquired loans not deemed credit−impaired at acquisition are similar to originated loans; however, the estimate of loss is based on the unpaid principal balance less the remaining purchase discount.

37

Purchased credit impaired (PCI) loans are not considered nonperforming loans, and accordingly, are not included in the non-performing loans to total loans ratio as a numerator, but are included in total loans reflected in the denominator. The result is a downward trend in the ratio when compared to prior periods, assuming all other factors stay the same. Similarly, other asset quality ratios, such as the allowance for loan losses to total loans ratio will reflect a downward trend, assuming all other factors stay the same, due to the impact of PCI loans on the denominator with no corresponding impact in the numerator.
Our non-performing loans, which consist of nonaccrual loans, include both smaller balance homogeneous loans that are collectively evaluated for impairment and larger individually classified impaired loans. Loans are placed on nonaccrual status when the collection of principal and/or interest becomes doubtful or other factors involving the loan warrant placing the loan on nonaccrual status.
A modified loan is considered a troubled debt restructuring (“TDR”) when two conditions are met: 1) the borrower is experiencing financial difficulty and 2) concessions are made for the borrower's benefit that would not otherwise be considered for a borrower or transaction with similar credit risk characteristics. Modifications to loan terms may include a modification of the contractual interest rate to a below-market rate (even if the modified rate is higher than the original rate), forgiveness of accrued interest, forgiveness of a portion of principal, an extended repayment period or a deed in lieu of foreclosure or other transfer of assets other than cash to fully or partially satisfy a debt. The Company's policy is to place all TDRs on nonaccrual for a minimum period of six months. Loans qualify for a return to accrual status once they have demonstrated performance with the restructured terms of the loan agreement for a minimum of six months and the collection of principal and interest under the revised terms is deemed probable. All TDRs are considered to be impaired loans. At June 30, 2014 , of our $14.1 million in TDRs, $1.6 million were accruing interest and $12.5 million were classified as nonaccrual. Nonaccrual TDRs included $6.7 million attributable to four commercial real estate loans, $6.6 million of which were performing in accordance with their restructured terms at June 30, 2014 .
Non-performing loans to total loans held for investment, excluding Warehouse Purchase Program loans, was 1.00% at June 30, 2014 , compared to 1.08% at December 31, 2013. Including Warehouse Purchase Program loans, non-performing loans to total loans held for investment was 0.76% at June 30, 2014 , compared to 0.81% at December 31, 2013 . Non-performing loans increased by $1.5 million to $23.6 million at June 30, 2014 , from $22.1 million at December 31, 2013 . This increase was primarily attributable to a commercial and industrial loan totaling $1.9 million that was placed on nonaccrual status in 2014. The $1.9 million commercial and industrial loan, which was not past due at June 30, 2014, was placed on nonaccrual solely due to its designation as a troubled debt restructuring. Also, non-performing consumer real estate loans increased by $492,000 during the six months ended June 30, 2014, primarily due to a $606,000 loan that was past due and rated as Substandard at June 30, 2014.
Our allowance for loan losses was $20.4 million at June 30, 2014 , compared to $19.4 million at December 31, 2013, or 0.66% of total loans held for investment (including Warehouse Purchase Program loans) at June 30, 2014 , compared to 0.71% at December 31, 2013 . Our allowance for loan losses to non-performing loans was 86.59% at June 30, 2014 , compared to 87.50% at December 31, 2013 .
Classified Assets. Loans and other assets, such as securities and foreclosed assets that are considered by management to be of lesser quality, are classified as "substandard," "doubtful" or "loss." An asset is considered "substandard" if it is inadequately protected by the current net worth and paying capacity of the obligor or of the collateral pledged, if any. "Substandard" assets include those characterized by the distinct possibility that the Company will sustain some loss if the deficiencies are not corrected. Assets classified as "doubtful" have all of the weaknesses of those classified as "substandard," with the added characteristic that the weaknesses present make collection or liquidation in full, on the basis of currently existing facts, conditions and values, highly questionable and improbable. Assets classified as "loss" are those considered uncollectible and of such little value that their continuance as assets without the establishment of a specific loss reserve is not warranted. Purchased credit impaired loans are included in the "substandard" and "doubtful" categories.
We regularly review the assets in our portfolio to determine whether any should be considered as classified. The total amount of classified assets represented 7.5% of our total equity and 1.1% of our total assets at June 30, 2014 , compared to 9.1% of our total equity and 1.4% of our total assets at December 31, 2013 . The aggregate amount of classified assets at the dates indicated was as follows:

38

 
June 30, 2014
 
December 31, 2013
 
(Dollars in thousands)
Doubtful
$
4,611

 
$
5,307

Substandard
36,711

 
43,827

Total classified loans
41,322

 
49,134

Foreclosed assets
240

 
480

Total classified assets
$
41,562

 
$
49,614

The Company has potential problem loans, considered "other loans of concern," that are currently performing and do not meet the criteria for impairment, but where there is the distinct possibility that we could sustain some loss if credit deficiencies are not corrected. These possible credit problems may result in the future inclusion of these loans in the non-performing asset categories and consisted of $11.7 million in loans that were classified as "substandard" but were still accruing interest and were not considered impaired at June 30, 2014 . These loans have been considered in management's analysis of potential loan losses.
Securities . Our securities portfolio decreased by $50.8 million , or 9.4% , to $491.8 million at June 30, 2014 , from $542.6 million at December 31, 2013 . The decrease in our securities portfolio primarily resulted from paydowns and maturities totaling $337.7 million , which were partially offset by purchases totaling $286.9 million . The majority of these purchases were done for tax strategy purposes. A portion of these proceeds from the securities paydowns were maintained in cash accounts to build liquidity in preparation for the cash payment portion of the pending merger with LegacyTexas.
Deposits. Total deposits increased by $171.1 million , or 7.6% , to $2.44 billion at June 30, 2014 , from $2.26 billion at December 31, 2013 .
 
June 30, 2014
 
December 31, 2013
 
Dollar
Change
 
Percent
Change
 
(Dollars in thousands)
Non-interest-bearing demand
$
433,194

 
$
410,933

 
$
22,261

 
5.4
%
Interest-bearing demand
476,203

 
474,515

 
1,688

 
0.4

Savings and money market
1,032,496

 
904,576

 
127,920

 
14.1

Time
493,833

 
474,615

 
19,218

 
4.0

Total deposits
$
2,435,726

 
$
2,264,639

 
$
171,087

 
7.6
%

The increase in deposits from December 31, 2013 , was primarily due to a $127.9 million , or 14.1% , increase in savings and money market deposits. In the second quarter of 2014, the Company began offering a savings deposit account to other financial institutions and added $71.8 million in deposits to this product, which drove the increase in savings and money market deposit balances. Non-interest-bearing demand deposits increased by $22.3 million , or 5.4% , to $433.2 million at June 30, 2014 , which was driven by higher balances in commercial checking products, while time deposits increased by $19.2 million , or 4.0% .
Borrowings . FHLB advances, net of a $1.7 million restructuring prepayment penalty, increased by $235.8 million , or 36.9% , to $ 874.9 million at June 30, 2014 , from $639.1 million at December 31, 2013 . The outstanding balance of FHLB advances increased due to higher Warehouse Purchase Program balances at June 30, 2014 , of which a portion had been strategically funded with short-term advances. At June 30, 2014 , the Company was eligible to borrow an additional $146.7 million from the FHLB. Additionally, the Company has five available federal funds lines of credit with other financial institutions totaling $125.0 million and was eligible to borrow $60.0 million from the Federal Reserve Bank discount window. In addition to FHLB advances, at June 30, 2014 , the Company had a $25.0 million outstanding repurchase agreement with Credit Suisse.
The below table shows FHLB advances by maturity and weighted average rate at June 30, 2014 :

39

 
Balance
 
Weighted Average Rate
 
(Dollars in thousands)
Less than 90 days
$
695,415

 
0.15
%
90 days to less than one year
38,000

 
2.46

One to three years
116,421

 
3.17

After three to five years
21,928

 
4.42

After five years
4,765

 
5.49

 
876,529

 
0.79
%
Restructuring prepayment penalty
(1,663
)
 
 
Total
$
874,866

 
 
Shareholders’ Equity . Total shareholders' equity increased by $13.0 million , or 2.4% , to $557.4 million at June 30, 2014 , from $544.5 million at December 31, 2013 .
 
June 30, 2014
 
December 31, 2013
 
Dollar
Change
 
Percent
Change
 
(Dollars in thousands)
Common stock
$
400

 
$
399

 
$
1

 
0.3
 %
Additional paid-in capital
381,808

 
377,657

 
4,151

 
1.1

Retained earnings
190,150

 
183,236

 
6,914

 
3.8

Accumulated other comprehensive income (loss), net
770

 
(383
)
 
1,153

 
N/M 1

Unearned ESOP shares
(15,716
)
 
(16,449
)
 
733

 
(4.5
)
Total shareholders’ equity
$
557,412

 
$
544,460

 
$
12,952

 
2.4
 %
1 N/M - not meaningful
Retained earnings were increased by net income of $16.5 million recognized during the six months ended June 30, 2014 . The increase due to net income was partially offset by the payment of two quarterly dividends totaling $0.24 per common share, or $9.6 million , during the six months ended June 30, 2014.
Comparison of Results of Operation for the Three Months Ended June 30, 2014 and 2013
    
General. Net income for the three months ended June 30, 2014 , was $8.8 million , an increase of $644,000 , or 7.9% , from net income of $8.2 million for the three months ended June 30, 2013 . The increase in net income was driven by a $2.5 million increase in net interest income and a $661,000 decrease in the provision for loan losses, partially offset by a decrease in non-interest income of $314,000 and a $1.6 million increase in non-interest expense. Basic and diluted earnings per share for the three months ended June 30, 2014 , was $0.23 , a $0.02 increase from $0.21 for the three months ended June 30, 2013 .
  
Interest Income. Interest income increased by $1.8 million , or 5.1% , to $37.1 million for the three months ended June 30, 2014 , from $35.3 million for the three months ended June 30, 2013 .
 
Three Months Ended June 30,
 
Dollar
 
Percent
 
2014
 
2013
 
Change
 
Change
 
(Dollars in thousands)
Interest and dividend income
 
 
 
 
 
 
 
Loans, including fees
$
33,888

 
$
32,151

 
$
1,737

 
5.4
%
Securities
3,014

 
2,986

 
28

 
0.9

Interest-bearing deposits in other financial institutions
71

 
25

 
46

 
184.0

FHLB and Federal Reserve Bank stock
136

 
134

 
2

 
1.5

 
$
37,109

 
$
35,296

 
$
1,813

 
5.1
%


40

The increase in interest income for the three months ended June 30, 2014 , compared to the same period in 2013 , was primarily due to a $1.7 million , or 5.4% , increase in interest income on loans, which was driven by higher commercial loan volume. For the three months ended June 30, 2014 , the average balance of commercial and industrial loans increased by $274.2 million, or 86.7%, compared to the three months ended June 30, 2013 , which resulted in a $2.3 million increase in interest income. Additionally, the average balance of commercial real estate loans increased by $207.9 million, or 21.6%, for the three months ended June 30, 2014 , compared to the same period in 2013 , contributing $1.9 million of the increase in interest income. The increases in interest income related to commercial loan volume were partially offset by a $183.7 million, or 24.3%, decrease in the average balance of Warehouse Purchase Program loans for the three months ended June 30, 2014 , compared to the same period in 2013 , as well as reductions in yields on all commercial and real estate loan portfolios. The average yield on earning assets for the three months ended June 30, 2014 was 4.24% , a decrease of eight basis points from 4.32% for the three months ended June 30, 2013 .

     Interest Expense. Interest expense decreased by $671,000 , or 13.8% , to $4.2 million for the three months ended June 30, 2014 , from $4.9 million for the three months ended June 30, 2013 .

 
Three Months Ended June 30,
 
Dollar
 
Percent
 
2014
 
2013
 
Change
 
Change
 
(Dollars in thousands)
Interest expense
 
 
 
 
 
 
 
Deposits
$
2,035

 
$
2,450

 
$
(415
)
 
(16.9
)%
FHLB advances
1,948

 
2,205

 
(257
)
 
(11.7
)
Repurchase agreement
204

 
203

 
1

 
0.5

 
$
4,187

 
$
4,858

 
$
(671
)
 
(13.8
)%

The decrease in interest expense for the three months ended June 30, 2014 , compared to the same period in 2013 , was primarily due to a $415,000 , or 16.9% , decrease in interest expense on deposits, as well as a $257,000 , or 11.7% , decrease in interest expense on FHLB advances. While volume was up in all deposit categories, a 54 basis point reduction in the average rate paid on time deposits, as well as a four basis point decline in the average rate paid on interest-bearing demand deposits, drove the decrease in interest expense on deposits for the three months ended June 30, 2014 , compared to the three months ended June 30, 2013 . The average rate paid on borrowings decreased by 15 basis points for the three months ended June 30, 2014 , compared to the same period in 2013 , while volume remained relatively flat. The average cost of interest-bearing liabilities decreased by 16 basis points to 0.63% for the three months ended June 30, 2014 , compared to 0.79% for the same period in 2013.

Net Interest Income. Net interest income increased by $2.5 million , or 8.2% , to $32.9 million for the three months ended June 30, 2014 , from $30.4 million for the three months ended June 30, 2013 . The net interest margin increased by four basis points to 3.76% for the three months ended June 30, 2014 , from 3.72% for the same period last year. The net interest rate spread increased by eight basis points to 3.61% for the three months ended June 30, 2014 , from 3.53% for the same period last year. The increases in the net interest margin and spread were primarily attributable to changes in the earning asset mix, as we increased volume in higher-yielding commercial loans, as well as lowered time and interest-bearing demand deposit rates. Accretion of interest related to the 2012 Highlands acquisition contributed four basis points to the net interest margin for the three months ended June 30, 2014 , compared to nine basis points for the three months ended June 30, 2013 .

Provision for Loan Losses. The provision for loan losses was $1.2 million for the three months ended June 30, 2014 , a decrease of $661,000 , or 35.6% , from $1.9 million for the three months ended June 30, 2013 . Non-performing loans totaled $23.6 million at June 30, 2014 , compared to $23.8 million at June 30, 2013 . Net charge-offs totaled $159,000 for the three months ended June 30, 2014 , compared to $1.2 million for the three months ended June 30, 2013 .
 

41

Non-interest Income. Non-interest income decreased by $314,000 , or 5.5% , to $5.4 million for the three months ended June 30, 2014 , from $5.7 million for the three months ended June 30, 2013 .
 
Three Months Ended June 30,
 
Dollar
 
Percent
 
2014
 
2013
 
Change
 
Change
 
(Dollars in thousands)
Non-interest income
 
 
 
 
 
 
 
Service charges and fees
$
4,874

 
$
4,768

 
$
106

 
2.2
 %
Other charges and fees
239

 
179

 
60

 
33.5

Bank-owned life insurance income
145

 
153

 
(8
)
 
(5.2
)
Gain on sale and disposition of assets
727

 
444

 
283

 
63.7

Other
(556
)
 
199

 
(755
)
 
N/M 1

 
$
5,429

 
$
5,743

 
$
(314
)
 
(5.5
)%
1 N/M - not meaningful

The $314,000 decrease in non-interest income from the three months ended June 30, 2013 , was primarily attributable to a $755,000 decrease in other non-interest income, caused by the $610,000 net decrease in the value of an investment in a community development-oriented private equity fund used for Community Reinvestment Act purposes recognized in the second quarter of 2014, compared to no value change recognized in the second quarter of 2013. This decrease was partially offset by a $283,000 , or 63.7% , increase in the gain on sale and disposition of assets, which was primarily attributable to $777,000 in gains recognized on payoffs of purchased credit impaired loans during the second quarter of 2014, compared to $331,000 in similar gains recognized during the second quarter of 2013.
Non-interest Expense. Non-interest expense increased by $1.6 million , or 7.6% , to $23.4 million for the three months ended June 30, 2014 , from $21.7 million for the three months ended June 30, 2013 .
 
Three Months Ended June 30,
 
Dollar
 
Percent
 
2014
 
2013
 
Change
 
Change
 
(Dollars in thousands)
Non-interest expense
 
 
 
 
 
 
 
Salaries and employee benefits
$
14,127

 
$
12,528

 
$
1,599

 
12.8
 %
Merger and acquisition costs
652

 
—

 
652

 
N/M 1

Advertising
493

 
751

 
(258
)
 
(34.4
)
Occupancy and equipment
1,819

 
1,938

 
(119
)
 
(6.1
)
Outside professional services
486

 
570

 
(84
)
 
(14.7
)
Regulatory assessments
687

 
650

 
37

 
5.7

Data processing
1,708

 
1,729

 
(21
)
 
(1.2
)
Office operations
1,717

 
1,751

 
(34
)
 
(1.9
)
Other
1,661

 
1,786

 
(125
)
 
(7.0
)
 
$
23,350

 
$
21,703

 
$
1,647

 
7.6
 %
1 N/M - not meaningful

The increase in non-interest expense from the three months ended June 30, 2013 was primarily attributable to a $1.6 million , or 12.8% , increase in salaries and employee benefits expense, resulting from increased performance-based incentive accruals due to higher loan production, as well as increased ESOP and share-based compensation expense due to the rise in the Company's stock price. Also contributing to the $1.6 million increase in salaries and employee benefits expense was a $247,000 increase in health care costs for the three months ended June 30, 2014 , compared to the three months ended June 30, 2013 . The Company incurred merger and acquisition costs related to the pending merger with LegacyTexas totaling $652,000 during the three months ended June 30, 2014 , with no comparable costs recognized during the three months ended June 30, 2013 . Reductions in advertising, occupancy and equipment and other non-interest expense for the three months ended June 30, 2014 , compared to the same period in 2013, partially offset these increases in non-interest expense.

42

Income Tax Expense. For the three months ended June 30, 2014 , we recognized income tax expense of $5.0 million on our pre-tax income, which was an effective tax rate of 36.1% , compared to income tax expense of $4.4 million for the three months ended June 30, 2013 , which was an effective tax rate of 35.2% . The difference in the effective tax rate was primarily due to permanent book-tax differences.

Comparison of Results of Operation for the Six Months Ended June 30, 2014 and 2013
    
General. Net income for the six months ended June 30, 2014 , was $16.5 million , an increase of $268,000 , or 1.7% , from net income of $16.2 million for the six months ended June 30, 2013 . The increase in net income was driven by a $3.5 million increase in net interest income and a $1.2 million decrease in the provision for loan losses, partially offset by a decrease in non-interest income of $1.2 million and a $2.9 million increase in non-interest expense. Basic and diluted earnings per share for the six months ended June 30, 2014 , was $0.43 , unchanged from the six months ended June 30, 2013 .
  
Interest Income. Interest income increased by $2.1 million , or 3.1% , to $70.8 million for the six months ended June 30, 2014 , from $68.7 million for the six months ended June 30, 2013 .
 
Six Months Ended June 30,
 
Dollar
 
Percent
 
2014
 
2013
 
Change
 
Change
 
(Dollars in thousands)
Interest and dividend income
 
 
 
 
 
 
 
Loans, including fees
$
64,276

 
$
62,529

 
$
1,747

 
2.8
 %
Securities
6,143

 
5,863

 
280

 
4.8

Interest-bearing deposits in other financial institutions
128

 
56

 
72

 
128.6

FHLB and Federal Reserve Bank stock
266

 
267

 
(1
)
 
(0.4
)
 
$
70,813

 
$
68,715

 
$
2,098

 
3.1
 %

The increase in interest income for the six months ended June 30, 2014 , compared to the same period in 2013 , was primarily due to a $1.7 million , or 2.8% , increase in interest income on loans, which was driven by higher commercial loan volume. For the six months ended June 30, 2014 , the average balance of commercial and industrial loans increased by $229.5 million, or 76.5%, compared to the six months ended June 30, 2013 , which resulted in a $4.0 million increase in interest income. Additionally, the average balance of commercial real estate loans increased by $249.3 million , or 27.7%, for the six months ended June 30, 2014 , compared to the same period in 2013 , contributing $4.8 million of the increase in interest income. The increases in interest income related to commercial loan volume were partially offset by a $237.2 million , or 31.8%, decrease in the average balance of Warehouse Purchase Program loans for the six months ended June 30, 2014 , compared to the same period in 2013 , as well as reductions in yields on all commercial and real estate loan portfolios.

The $280,000 increase in interest income on securities for the six months ended June 30, 2014 , compared to the same period in 2013 , was primarily due to a 93 basis point increase in the average yield earned on agency collateralized mortgage obligations, which increased to 2.22% for the six months ended June 30, 2014 , from 1.29% for the six months ended June 30, 2013 . The average yield on earning assets for the six months ended June 30, 2014 was 4.25% , a decrease of four basis points from 4.29% for the six months ended June 30, 2013 .
  
     Interest Expense. Interest expense decreased by $1.4 million , or 14.8% , to $8.3 million for the six months ended June 30, 2014 , from $9.8 million for the six months ended June 30, 2013 .


43

 
Six Months Ended June 30,
 
Dollar
 
Percent
 
2014
 
2013
 
Change
 
Change
 
(Dollars in thousands)
Interest expense
 
 
 
 
 
 
 
Deposits
$
4,026

 
$
4,882

 
$
(856
)
 
(17.5
)%
FHLB advances
3,875

 
4,466

 
(591
)
 
(13.2
)
Repurchase agreement
405

 
404

 
1

 
0.2

 
$
8,306

 
$
9,752

 
$
(1,446
)
 
(14.8
)%
    
The decrease in interest expense for the six months ended June 30, 2014 , compared to the same period in 2013 , was primarily due to a $856,000 , or 17.5% , decrease in interest expense on deposits, as well as a $591,000 , or 13.2% , decrease in interest expense on FHLB advances. While volume was up in all deposit categories, a 50 basis point reduction in the average rate paid on time deposits, as well as a three basis point decline in the average rate paid on interest-bearing demand deposits, drove the decrease in interest expense on deposits for the six months ended June 30, 2014 , compared to the six months ended June 30, 2013 . The average balance of borrowings decreased by $62.9 million for the six months ended June 30, 2014 , compared to the same period in 2013 , due to lower average Warehouse Purchase Program balances, of which a portion had been strategically funded with short-term advances. The average cost of interest-bearing liabilities decreased by 13 basis points to 0.67% for the six months ended June 30, 2014 , compared to 0.80% for the same period in 2013.
  
Net Interest Income. Net interest income increased by $3.5 million , or 6.0% , to $62.5 million for the six months ended June 30, 2014 , from $59.0 million for the six months ended June 30, 2013 . The net interest margin increased by seven basis points to 3.75% for the six months ended June 30, 2014 , from 3.68% for the same period last year. The net interest rate spread increased by nine basis points to 3.58% for the six months ended June 30, 2014 , from 3.49% for the same period last year. The increases in the net interest margin and spread were primarily attributable to changes in the earning asset mix, as we increased volume in higher-yielding commercial loans, as well as lowered time and interest-bearing demand deposit rates.

Provision for Loan Losses. The provision for loan losses was $1.6 million for the six months ended June 30, 2014 , a decrease of $1.2 million , or 42.6% , from $2.7 million for the six months ended June 30, 2013 . Non-performing loans totaled $23.6 million at June 30, 2014 , compared to $23.8 million at June 30, 2013. Net charge-offs totaled $491,000 for the six months ended June 30, 2014 , compared to $1.5 million for the six months ended June 30, 2013 .
 
Non-interest Income. Non-interest income decreased by $1.2 million , or 10.4% , to $10.4 million for the six months ended June 30, 2014 , from $11.6 million for the six months ended June 30, 2013 .
 
Six Months Ended June 30,
 
Dollar
 
Percent
 
2014
 
2013
 
Change
 
Change
 
(Dollars in thousands)
Non-interest income
 
 
 
 
 
 
 
Service charges and fees
$
9,172

 
$
9,059

 
$
113

 
1.2
 %
Other charges and fees
449

 
391

 
58

 
14.8

Bank-owned life insurance income
298

 
315

 
(17
)
 
(5.4
)
Loss on sale of available for sale securities
—

 
(177
)
 
177

 
(100.0
)
Gain on sale and disposition of assets
728

 
674

 
54

 
8.0

Other
(256
)
 
1,340

 
(1,596
)
 
N/M 1

 
$
10,391

 
$
11,602

 
$
(1,211
)
 
(10.4
)%
1 N/M - not meaningful

The $1.2 million decrease in non-interest income from the six months ended June 30, 2013 , was primarily attributable to a $1.6 million decrease in other non-interest income, caused by the $571,000 net decrease in the value of an investment in a community development-oriented private equity fund used for Community Reinvestment Act purposes recognized during the six months ended June 30, 2014 , compared to a $784,000 net increase recognized on this investment during the six months

44

ended June 30, 2013 . This decrease was partially offset by a $177,000 loss on the sale of available-for-sale securities recorded in the 2013 period with no comparable loss recorded in the 2014 period.
Non-interest Expense. Non-interest expense increased by $2.9 million , or 6.9% , to $45.5 million for the six months ended June 30, 2014 , from $42.6 million for the six months ended June 30, 2013 .
 
Six Months Ended June 30,
 
Dollar
 
Percent
 
2014
 
2013
 
Change
 
Change
 
(Dollars in thousands)
Non-interest expense
 
 
 
 
 
 
 
Salaries and employee benefits
$
28,259

 
$
25,443

 
$
2,816

 
11.1
 %
Merger and acquisition costs
821

 
—

 
821

 
N/M 1

Advertising
848

 
1,264

 
(416
)
 
(32.9
)
Occupancy and equipment
3,711

 
3,728

 
(17
)
 
(0.5
)
Outside professional services
1,011

 
1,254

 
(243
)
 
(19.4
)
Regulatory assessments
1,315

 
1,229

 
86

 
7.0

Data processing
3,370

 
3,247

 
123

 
3.8

Office operations
3,397

 
3,399

 
(2
)
 
(0.1
)
Other
2,773

 
3,012

 
(239
)
 
(7.9
)
 
$
45,505

 
$
42,576

 
$
2,929

 
6.9
 %
1 N/M - not meaningful

The increase in non-interest expense from the six months ended June 30, 2013 was primarily attributable to a $2.8 million , or 11.1% , increase in salaries and employee benefits expense, resulting from increased performance-based incentive accruals due to higher loan production, as well as increased ESOP and share-based compensation expense due to the rise in the Company's stock price. Also contributing to the $2.8 million increase in salaries and employee benefits expense was a $374,000 increase in health care costs for the six months ended June 30, 2014 , compared to the six months ended June 30, 2013 . The Company incurred merger and acquisition costs related to the pending merger with LegacyTexas totaling $821,000 during the six months ended June 30, 2014 , with no comparable costs recognized during the six months ended June 30, 2013 . Reductions in advertising, outside professional services and other non-interest expense for the six months ended June 30, 2014 , compared to the same period in 2013, partially offset these increases in non-interest expense.
Income Tax Expense. For the six months ended June 30, 2014 , we recognized income tax expense of $9.3 million on our pre-tax income, which was an effective tax rate of 36.1% , compared to income tax expense of $9.0 million for the six months ended June 30, 2013 , which was an effective tax rate of 35.7% . The difference in the effective tax rate was primarily due to permanent book-tax differences.
Average Balances, Net Interest Income, Yields Earned and Rates Paid
The following tables present, for the periods indicated, the total dollar amount of interest income from average interest-earning assets and the resultant yields, as well as the interest expense on average interest-bearing liabilities, expressed both in dollars and rates. Also presented are the weighted average yields on interest-earning assets, rates paid on interest-bearing liabilities and the resultant spread. All average balances are daily average balances. Non-accruing loans have been included in the table as loans carrying a zero yield.


45

 
 
Three Months Ended June 30,
 
 
2014
 
2013
 
 
Average
Outstanding
Balance
 
Interest
Earned/Paid
 
Yield/
Rate
 
Average
Outstanding
Balance
 
Interest
Earned/Paid
 
Yield/
Rate
 
 
(Dollars in thousands)
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
1,169,484

 
$
15,989

 
5.47
%
 
$
961,631

 
$
14,074

 
5.85
%
 
Warehouse Purchase Program
571,922

 
5,094

 
3.56

 
755,577

 
7,307

 
3.87

 
Commercial and industrial
590,353

 
6,168

 
4.18

 
316,151

 
3,829

 
4.84

 
Consumer real estate
480,512

 
5,967

 
4.97

 
476,226

 
6,143

 
5.16

 
Other consumer
44,162

 
670

 
6.07

 
53,759

 
798

 
5.94

 
Less: deferred fees and allowance for loan loss
(21,683
)
 
—

 
—

 
(18,649
)
 
—

 
—

 
Loans receivable 1
2,834,750

 
33,888

 
4.78

 
2,544,695

 
32,151

 
5.05

 
Agency mortgage-backed securities
267,218

 
1,493

 
2.23

 
321,548

 
1,565

 
1.95

 
Agency collateralized mortgage obligations
171,330

 
943

 
2.20

 
253,741

 
872

 
1.37

 
Investment securities
69,582

 
578

 
3.32

 
67,925

 
549

 
3.23

 
FHLB and FRB stock
37,814

 
136

 
1.44

 
37,717

 
134

 
1.42

 
Interest-earning deposit accounts
118,529

 
71

 
0.24

 
45,810

 
25

 
0.22

Total interest-earning assets
3,499,223

 
37,109

 
4.24

 
3,271,436

 
35,296

 
4.32

Non-interest-earning assets
183,819

 
 
 
 
 
182,263

 
 
 
 
Total assets
$
3,683,042

 
 
 
 
 
$
3,453,699

 
 
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
 
 
 
 
Interest-bearing demand
$
468,283

 
428

 
0.37

 
$
459,433

 
466

 
0.41

 
Savings and money market
1,000,243

 
738

 
0.30

 
883,507

 
601

 
0.27

 
Time
503,035

 
869

 
0.69

 
451,110

 
1,383

 
1.23

 
Borrowings
678,817

 
2,152

 
1.27

 
679,693

 
2,408

 
1.42

Total interest-bearing liabilities
2,650,378

 
4,187

 
0.63

 
2,473,743

 
4,858

 
0.79

Non-interest-bearing demand
414,746

 
 
 
 
 
393,815

 
 
 
 
Non-interest-bearing liabilities
63,417

 
 
 
 
 
53,244

 
 
 
 
Total liabilities
3,128,541

 
 
 
 
 
2,920,802

 
 
 
 
Total shareholders’ equity
554,501

 
 
 
 
 
532,897

 
 
 
 
Total liabilities and shareholders’ equity
$
3,683,042

 
 
 
 
 
$
3,453,699

 
 
 
 
Net interest income and margin
 
 
$
32,922

 
3.76
%
 
 
 
$
30,438

 
3.72
%
Net interest income and margin (tax-equivalent basis) 2
 
 
$
33,120

 
3.79
%
 
 
 
$
30,628

 
3.74
%
Net interest rate spread
 
 
 
 
3.61
%
 
 
 
 
 
3.53
%
Net earning assets
$
848,845

 
 
 
 
 
$
797,693

 
 
 
 
Average interest-earning assets to average interest-bearing liabilities
132.03
%
 
 
 
 
 
132.25
%
 
 
 
 
1  
Calculated net of deferred fees, loan discounts, loans in process and allowance for loan losses.
2  
In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment has been computed using a federal income tax rate of 35% for 2014 and 2013. Tax-exempt investments and loans had an average balance of $67.5 million and $62.0 million for the three months ended June 30, 2014 and 2013, respectively.


46

 
 
Six Months Ended June 30,
 
 
2014
 
2013
 
 
Average
Outstanding
Balance
 
Interest
Earned/Paid
 
Yield/
Rate
 
Average
Outstanding
Balance
 
Interest
Earned/Paid
 
Yield/
Rate
 
 
(Dollars in thousands)
Interest-earning assets:
 
 
 
 
 
 
 
 
 
 
 
 
Commercial real estate
$
1,150,004

 
$
31,203

 
5.43
%
 
$
900,732

 
$
26,410

 
5.86
%
 
Warehouse Purchase Program
509,773

 
9,156

 
3.59

 
746,954

 
14,549

 
3.90

 
Commercial and industrial
529,441

 
11,099

 
4.19

 
299,939

 
7,102

 
4.74

 
Consumer real estate
460,698

 
11,457

 
4.97

 
490,516

 
12,835

 
5.23

 
Other consumer
45,301

 
1,361

 
6.01

 
55,452

 
1,633

 
5.89

 
Less: deferred fees and allowance for loan loss
(21,228
)
 
—

 
—

 
(17,949
)
 
—

 
—

 
Loans receivable 1
2,673,989

 
64,276

 
4.81

 
2,475,644

 
62,529

 
5.05

 
Agency mortgage-backed securities
271,368

 
3,012

 
2.22

 
308,345

 
3,066

 
1.99

 
Agency collateralized mortgage obligations
177,751

 
1,972

 
2.22

 
271,252

 
1,752

 
1.29

 
Investment securities
71,449

 
1,159

 
3.24

 
61,561

 
1,045

 
3.40

 
FHLB and FRB stock
33,661

 
266

 
1.58

 
36,381

 
267

 
1.47

 
Interest-earning deposit accounts
107,472

 
128

 
0.24

 
49,930

 
56

 
0.22

Total interest-earning assets
3,335,690

 
70,813

 
4.25

 
3,203,113

 
68,715

 
4.29

Non-interest-earning assets
184,072

 
 
 
 
 
185,548

 
  
 
 
Total assets
$
3,519,762

 
 
 
 
 
$
3,388,661

 
  
 
 
Interest-bearing liabilities:
 
 
 
 
 
 
 
 
  
 
 
 
Interest-bearing demand
$
464,535

 
850

 
0.37

 
$
462,393

 
936

 
0.40

 
Savings and money market
959,665

 
1,387

 
0.29

 
880,614

 
1,189

 
0.27

 
Time
498,142

 
1,789

 
0.72

 
450,594

 
2,757

 
1.22

 
Borrowings
572,362

 
4,280

 
1.50

 
635,212

 
4,870

 
1.53

Total interest-bearing liabilities
2,494,704

 
8,306

 
0.67

 
2,428,813

 
9,752

 
0.80

Non-interest-bearing demand
414,832

 
 
 
 
 
380,589

 
  
 
 
Non-interest-bearing liabilities
59,355

 
 
 
 
 
48,817

 
  
 
 
Total liabilities
2,968,891

 
 
 
 
 
2,858,219

 
  
 
 
Total shareholders’ equity
550,871

 
 
 
 
 
530,442

 
  
 
 
Total liabilities and shareholders’ equity
$
3,519,762

 
 
 
 
 
$
3,388,661

 
 
 
 
Net interest income and margin
 
 
$
62,507

 
3.75
%
 
 
 
$
58,963

 
3.68
%
Net interest income and margin (tax-equivalent basis) 2
 
 
$
62,904

 
3.77
%
 
 
 
$
59,322

 
3.70
%
Net interest rate spread
 
 
 
 
3.58
%
 
 
 
 
 
3.49
%
Net earning assets
$
840,986

 
 
 
 
 
$
774,300

 
 
 
 
Average interest-earning assets to average interest-bearing liabilities
133.71
%
 
 
 
 
 
131.88
%
 
 
 
 
1  
Calculated net of deferred fees, loan discounts, loans in process and allowance for loan losses.
2  
In order to make pretax income and resultant yields on tax-exempt investments and loans comparable to those on taxable investments and loans, a tax-equivalent adjustment has been computed using a federal income tax rate of 35% for 2014 and 2013. Tax-exempt investments and loans had an average balance of $67.8 million and $56.9 million for the six months ended June 30, 2014 and 2013, respectively.



47

Rate/Volume Analysis
The following tables present the dollar amount of changes in interest income and interest expense for major components of interest-earning assets and interest-bearing liabilities. It distinguishes between the changes related to outstanding balances and those due to changes in interest rates. The change in interest attributable to rate has been determined by applying the change in rate between periods to average balances outstanding in the earlier period. The change in interest due to volume has been determined by applying the rate from the earlier period to the change in average balances outstanding between periods. Changes attributable to both rate and volume which cannot be segregated have been allocated proportionately based on the changes due to rate and the changes due to volume.
 
Three Months Ended June 30,
 
2014 versus 2013
 
Increase (Decrease) Due to
 
Total Increase
 
Volume
 
Rate
 
(Decrease)
 
(Dollars in thousands)
Interest-earning assets:
 
 
 
 
 
Commercial real estate
$
2,889

 
$
(974
)
 
$
1,915

Warehouse Purchase Program
(1,670
)
 
(543
)
 
(2,213
)
Commercial and industrial
2,927

 
(588
)
 
2,339

Consumer real estate
55

 
(231
)
 
(176
)
Other consumer
(145
)
 
17

 
(128
)
Loans receivable
4,056

 
(2,319
)
 
1,737

Agency mortgage-backed securities
(285
)
 
213

 
(72
)
Agency collateralized mortgage obligations
(343
)
 
414

 
71

Investment securities
14

 
15

 
29

FHLB and FRB stock
—

 
2

 
2

Interest-earning deposit accounts
43

 
3

 
46

Total interest-earning assets
3,485

 
(1,672
)
 
1,813

Interest-bearing liabilities:
 
 
 
 
 
Interest-bearing demand
9

 
(47
)
 
(38
)
Savings and money market
84

 
53

 
137

Time
145

 
(659
)
 
(514
)
Borrowings
(3
)
 
(253
)
 
(256
)
Total interest-bearing liabilities
235

 
(906
)
 
(671
)
Net interest income
$
3,250

 
$
(766
)
 
$
2,484





48

 
Six Months Ended June 30,
 
2014 versus 2013
 
Increase (Decrease) Due to
 
Total Increase
 
Volume
 
Rate
 
(Decrease)
 
(Dollars in thousands)
Interest-earning assets:
 
 
 
 
 
Commercial real estate
$
6,879

 
$
(2,086
)
 
$
4,793

Warehouse Purchase Program
(4,331
)
 
(1,062
)
 
(5,393
)
Commercial and industrial
4,892

 
(895
)
 
3,997

Consumer real estate
(759
)
 
(619
)
 
(1,378
)
Other consumer
(304
)
 
32

 
(272
)
Loans receivable
6,377

 
(4,630
)
 
1,747

Agency mortgage-backed securities
(389
)
 
335

 
(54
)
Agency collateralized mortgage obligations
(745
)
 
965

 
220

Investment securities
162

 
(48
)
 
114

FHLB and FRB stock
(21
)
 
20

 
(1
)
Interest-earning deposit accounts
68

 
4

 
72

Total interest-earning assets
5,452

 
(3,354
)
 
2,098

Interest-bearing liabilities:
 
 
 
 
 
Interest-bearing demand
4

 
(90
)
 
(86
)
Savings and money market
111

 
87

 
198

Time
266

 
(1,234
)
 
(968
)
Borrowings
(472
)
 
(118
)
 
(590
)
Total interest-bearing liabilities
(91
)
 
(1,355
)
 
(1,446
)
Net interest income
$
5,543

 
$
(1,999
)
 
$
3,544


Liquidity
Management maintains a liquidity position that it believes will adequately provide funding for loan demand and deposit run-off that may occur in the normal course of business. The Company relies on a number of different sources in order to meet its potential liquidity demands. The primary sources are increases in deposit accounts and cash flows from loan payments and the securities portfolio.
Planning for the Company's normal business liquidity needs, both expected and unexpected, is done on a daily and short-term basis through the cash management function. On a longer-term basis it is accomplished through the budget and strategic planning functions, with support from internal asset/liability management software model projections.
The Liquidity Committee monitors liquidity positions and projections, and adds liquidity contingency planning to the process by focusing on possible scenarios that would stress liquidity beyond the Bank's normal business liquidity needs. These scenarios may include macro-economic and bank specific situations focusing on high probability-high impact, high probability-low impact, low probability-high impact, and low probability-low impact stressors.
Management recognizes that the events and their severity of liquidity stress leading up to and occurring during a liquidity stress event cannot be precisely defined or listed. Nevertheless, management believes that liquidity stress events can be categorized into sources and uses of liquidity, and levels of severity, with responses that apply to various situations.
In addition to the primary sources of funds, management has several secondary sources available to meet potential funding requirements. At June 30, 2014 , the Company had an additional borrowing capacity of $146.7 million with the FHLB. Also, at June 30, 2014 , the Company had $125.0 million in federal funds lines of credit available with other financial institutions. The Company may also use the discount window at the Federal Reserve Bank as a source of short-term funding. Federal Reserve Bank borrowing capacity varies based upon securities pledged to the discount window line. At June 30, 2014 ,

49

securities pledged had a collateral value of $60.0 million .
At June 30, 2014 , the Company had classified 45.6% of its securities portfolio as available for sale (including pledged securities), providing an additional source of liquidity. Management believes that because active markets exist and our securities portfolio is of high quality, our available for sale securities are marketable. Participations in loans we originate, including portions of commercial real estate loans, are sold to create another source of liquidity and to manage borrower concentration risk as well as interest rate risk.
Liquidity management is both a daily and long-term function of business management. Short term excess liquidity is generally placed in short-term investments, such as overnight deposits at the Federal Reserve Bank and correspondent banks. On a longer term basis, we maintain a strategy of investing in various lending products and investment securities, including mortgage-backed securities.
The Company is a separate legal entity from the Bank and must provide for its own liquidity. In addition to its operating expenses, the Company is responsible for paying any dividends declared to its shareholders. We also have the ability to receive dividends or capital distributions from the Bank, although there are regulatory restrictions on the ability of the Bank to pay dividends. At June 30, 2014 , the Company (on an unconsolidated basis) had liquid assets of $47.3 million.
On November 25, 2013, the Company and LegacyTexas announced that they had entered into a definitive merger agreement whereby LegacyTexas will merge into the Company and, immediately thereafter, the Bank will merge into LegacyTexas’ subsidiary bank, LegacyTexas Bank. Under the terms of the agreement, the Company will issue 7.85 million shares of the Company's common stock plus approximately $115 million in cash for all the outstanding stock of LegacyTexas. In anticipation of the merger with LegacyTexas, the Company is strategically increasing its cash position in order to accommodate the approximate $115 million cash merger consideration. LegacyTexas' shareholders approved the merger on May 19, 2014, and on June 17, 2014, the Company and LegacyTexas announced that additional time will be required to obtain regulatory approvals and to satisfy customary closing conditions necessary to complete the merger, and have jointly extended the agreement to August 31, 2014, pursuant to its terms.
The Company uses its sources of funds primarily to meet its expenses, pay maturing deposits and fund withdrawals, and to fund loan commitments. Total approved loan commitments (including Warehouse Purchase Program commitments, unused lines of credit and letters of credit) amounted to $744.9 million and $988.7 million at June 30, 2014 , and December 31, 2013 , respectively. It is management's policy to offer deposit rates that are competitive with other local financial institutions. Based on this management strategy, we believe that a majority of maturing deposits will remain with the Company. Certificates of deposit scheduled to mature in one year or less at June 30, 2014 totaled $287.9 million with a weighted average rate of 0.54%.
During the six months ended June 30, 2014 , cash and cash equivalents increased by $77.9 million , or 88.6% , to $165.9 million at June 30, 2014 , from $88.0 million at December 31, 2013 . Operating activities provided cash of $34.8 million and financing activities provided cash of $397.9 million , which was partially offset by cash used in investing activities of $354.8 million . Primary sources of cash for the six months ended June 30, 2014 included pay-offs of Warehouse Purchase Program loans totaling $5.3 billion , proceeds from FHLB advances of $691.0 million and maturities, prepayments and calls of available-for-sale securities of $305.7 million . Primary uses of cash for the six months ended June 30, 2014 , included originations of Warehouse Purchase Program loans totaling $5.4 billion , repayments on FHLB advances of $455.2 million and purchases of available-for-sale securities of $281.0 million .
Please see Item 1A (Risk Factors) under Part 1 of the Company's 2013 Form 10-K for information regarding liquidity risk.

50

Off-Balance Sheet Arrangements, Contractual Obligations and Commitments

The following table presents our longer term, non-deposit related, contractual obligations and commitments to extend credit to our borrowers, in aggregate and by payment due dates (not including any interest amounts). In addition to the commitments below, the Company had overdraft protection available to its depositors in the amount of $74.6 million and credit card guarantees outstanding in the amount of $1.1 million at June 30, 2014 .
 
June 30, 2014
 
Less than
One Year
 
One
through
Three Years
 
Four
through
Five Years
 
After Five
Years
 
Total
 
(Dollars in thousands)
Contractual obligations:
 
 
 
 
 
 
 
 
 
Deposits without a stated maturity
$
1,941,893

 
$
—

 
$
—

 
$
—

 
$
1,941,893

Certificates of deposit
287,855

 
192,125

 
11,921

 
1,932

 
493,833

FHLB advances (gross of restructuring prepayment penalty of $1,663)
733,415

 
116,421

 
21,928

 
4,765

 
876,529

Repurchase agreement
—

 
—

 
25,000

 
—

 
25,000

Private equity fund for Community Reinvestment Act purposes
3,480

 
—

 
—

 
—

 
3,480

Operating leases (premises)
2,455

 
4,267

 
1,809

 
4,826

 
13,357

Total contractual obligations
$
2,969,098

 
$
312,813

 
$
60,658

 
$
11,523

 
3,354,092

Off-balance sheet loan commitments: 1
 
 
 
 
 
 
 
 
 
Unused commitments to extend credit
$
133,769

 
$
111,256

 
$
123,492

 
$
30,712

 
399,229

Unused capacity on Warehouse Purchase Program loans
344,434

 
—

 
—

 
—

 
344,434

Standby letters of credit
901

 
51

 
—

 
240

 
1,192

Total loan commitments
$
479,104

 
$
111,307

 
$
123,492

 
$
30,952

 
744,855

Total contractual obligations and loan commitments
 
 
 
 
 
 
 
 
$
4,098,947

1   Loans having no stated maturity are reported in the “Less than One Year” category.
 
 



51

Capital Resources

The Bank and the Company are subject to minimum capital requirements imposed by the OCC and the FRB. Consistent with our goal to operate a sound and profitable organization, our policy is for the Bank and the Company to maintain “well-capitalized” status under the capital categories of the OCC and the FRB. Based on capital levels at June 30, 2014 , and December 31, 2013 , the Bank and the Company were considered to be well-capitalized.

At June 30, 2014 , the Bank's equity totaled $454.4 million . The Company's consolidated equity totaled $557.4 million , or 14.1% of total assets, at June 30, 2014 .
 
Actual
 
Required for Capital Adequacy Purposes
 
To Be Well-Capitalized Under Prompt Corrective Action Regulations
 
Amount
 
Ratio
 
Amount
 
Ratio
 
Amount
 
Ratio
June 30, 2014
(Dollars in Thousands)
Total risk-based capital
 
 
 
 
 
 
 
 
 
 
 
the Company
$
546,458

 
17.06
%
 
$
256,298

 
8.00
%
 
$
320,372

 
10.00
%
the Bank
443,412

 
13.84

 
256,246

 
8.00

 
320,308

 
10.00

Tier 1 risk-based capital
 
 
 
 
 
 
 
 
 
 
 
the Company
526,018

 
16.42

 
128,149

 
4.00

 
192,223

 
6.00

the Bank
422,972

 
13.21

 
128,123

 
4.00

 
192,185

 
6.00

Tier 1 leverage
 
 
 
 
 
 
 
 
 
 
 
the Company
526,018

 
14.43

 
145,811

 
4.00

 
182,264

 
5.00

the Bank
422,972

 
11.61

 
145,750

 
4.00

 
182,188

 
5.00

 
 
 
 
 
 
 
 
 
 
 
 
December 31, 2013
 
 
 
 
 
 
 
 
 
 
 
Total risk-based capital
 
 
 
 
 
 
 
 
 
 
 
the Company
$
533,266

 
18.85
%
 
$
226,316

 
8.00
%
 
$
282,895

 
10.00
%
the Bank
431,442

 
15.26

 
226,181

 
8.00

 
282,727

 
10.00

Tier 1 risk-based capital
 
 
 
 
 
 
 
 
 
 
 
the Company
513,908

 
18.17

 
113,158

 
4.00

 
169,737

 
6.00

the Bank
412,084

 
14.58

 
113,091

 
4.00

 
169,636

 
6.00

Tier 1 leverage
 
 
 
 
 
 
 
 
 
 
 
the Company
513,908

 
15.67

 
131,197

 
4.00

 
163,996

 
5.00

the Bank
412,084

 
12.56

 
131,217

 
4.00

 
164,021

 
5.00


52

Item 3.
Quantitative and Qualitative Disclosures about Market Risk
Asset/Liability Management
Our Risk When Interest Rates Change. The rates of interest we earn on assets and pay on liabilities generally are established contractually for a period of time. However, market rates change over time. Like other financial institutions, our results of operations are impacted by changes in market interest rates and the interest rate sensitivity of our assets and liabilities. The risk associated with changes in market interest rates and our ability to adapt to these changes is known as interest rate risk and is our most significant market risk.
How We Measure Our Risk of Interest Rate Changes. As part of our attempt to manage our exposure to changes in market interest rates and comply with applicable regulations, we calculate and monitor our interest rate risk. In doing so, we analyze and manage assets and liabilities based on their interest rates and contractual cash flows, timing of maturities, prepayment potential, repricing opportunities, and sensitivity to actual or potential changes in market interest rates.
The Company is subject to interest rate risk to the extent that its interest bearing liabilities, primarily deposits, FHLB advances and other borrowings, reprice more rapidly or slowly, or at different rates (basis risk) than its interest earning assets, primarily loans and investment securities.
The Bank calculates interest rate risk by entering relevant contractual and projected information into the asset/liability management software simulation model. Data required by the model includes balance, rate, pay down schedule, and maturity. For items that contractually reprice, the repricing index, spread, and frequency are entered, including any initial, periodic, and lifetime interest rate caps and floors.
The Bank has adopted an asset and liability management policy. This policy sets the foundation for monitoring and managing the potential for adverse effects of material prolonged increases or decreases in interest rates on our results of operations. The Board of Directors sets the asset and liability policy for the Bank, which is implemented by the Asset/Liability Management Committee.
The purpose of the Asset/Liability Management Committee is to monitor, communicate, coordinate, and direct asset/liability management consistent with our business plan and board-approved policies. The committee directs and monitors the volume and mix of assets and funding sources, taking into account relative costs and spreads, interest rate sensitivity and liquidity needs. The objectives are to manage assets and funding sources to produce results that are consistent with liquidity, capital adequacy, interest rate risk, growth, and profitability goals.
The Committee meets on a bimonthly basis to, among other things, protect capital through earnings stability over the interest rate cycle; maintain our well-capitalized status; and provide a reasonable return on investment. The Committee recommends appropriate strategy changes based on this review. The Committee is responsible for reviewing and reporting the effects of policy implementation and strategies to the Board of Directors at least quarterly. In addition, two outside members of the Board of Directors are on the Asset/Liability Management Committee. Senior managers oversee the process on a daily basis.
A key element of the Bank’s asset/liability management strategy is to protect earnings by managing the inherent maturity and repricing mismatches between its interest earning assets and interest bearing liabilities. The Bank generally manages such earnings exposure through the addition of loans, investment securities and deposits with risk mitigating characteristics and by entering into appropriate term FHLB advance agreements.
As part of its efforts to monitor and manage interest rate risk, the Bank uses the economic value of equity (“EVE”) methodology adopted by the OCC as part of its capital regulations. In essence, the EVE approach calculates the difference between the present value of expected cash flows from assets and liabilities. In addition to monitoring selected measures of EVE, management also calculates and monitors potential effects on net interest income resulting from increases or decreases in market interest rates. This approach uses the earnings at risk (“EAR”) methodology adopted by the OCC as part of its capital regulations. EAR calculates estimated net interest income using a flat balance sheet approach over a twelve month time horizon. The EAR process is used in conjunction with EVE measures to identify interest rate risk on both a global and account level basis. Management and the Board of Directors review EVE and EAR measurements at least quarterly to review historical trends, projected measurements, and to determine whether the Bank's interest rate exposure is within the limits established by the Board of Directors.

53

The Bank's asset/liability management strategy sets acceptable limits for the percentage change in EVE and EAR given changes in interest rates. For an instantaneous, parallel, and sustained interest rate increase or decrease of 100 basis points, the Bank's policy indicates that the EVE ratio should not fall below 7.00%, and for increases of 200, 300 and 400 basis points, the EVE ratio should not fall below 6.00%, 5.25% and 5.00%, respectively. For an instantaneous, parallel, and sustained interest rate increase or decrease of 100 basis points, the Bank's policy indicates that EAR should not decrease by more than 7%, and for increases of 200, 300, and 400 basis points, EAR should not decrease by more than 10%, 13%, and 15%, respectively.
As illustrated in the tables below, the Bank was within policy limits for all scenarios tested. The tables presented below, as of June 30, 2014 , and December 31, 2013 , are internal analyses of our interest rate risk as measured by changes in EVE and EAR for instantaneous, parallel, and sustained shifts for all market rates and yield curves, in 100 basis point increments, up 400 basis points and down 100 basis points.
As illustrated in the tables below, our EVE would be negatively impacted by a parallel, instantaneous, and sustained increase in market rates. Such an increase in rates would negatively impact EVE as a result of the duration of assets, including loans and investments, being longer than the duration of liabilities, primarily deposit accounts and FHLB borrowings. As illustrated in the table below at June 30, 2014 , our EAR would be positively impacted by a parallel, instantaneous, and sustained increase in market rates of 200, 300, or 400 basis points. As market interest rates rise and variable loan rates move above their floors, the interest rate repricing of variable rate and maturing loans and securities increases net interest income.
June 30, 2014
Change in Interest Rates in Basis Points
 
Economic Value of Equity
 
Earnings at Risk (12 months)
 
Estimated EVE
 
Estimated Increase / (Decrease) in EVE
 
 EVE Ratio %
 
Estimated Net Interest Income
 
Increase / (Decrease) in Estimated Net Interest Income
 
 
$ Amount
 
$ Change
 
% Change
 
 
 
$ Amount
 
$ Change
 
% Change
 
 
(Dollars in thousands)
400

 
548,067

 
(51,116
)
 
(8.53
)
 
14.86
 
152,958

 
16,905

 
12.43

300

 
566,681

 
(32,502
)
 
(5.42
)
 
15.06
 
147,080

 
11,027

 
8.10

200

 
576,779

 
(22,404
)
 
(3.74
)
 
15.06
 
141,252

 
5,199

 
3.82

100

 
589,211

 
(9,972
)
 
(1.66
)
 
15.09
 
135,302

 
(751
)
 
(0.55
)
—

 
599,183

 
—

 
—

 
15.06
 
136,053

 
—

 
—

(100
)
 
613,013

 
13,830

 
2.31

 
15.08
 
133,689

 
(2,364
)
 
(1.74
)

December 31, 2013
Change in Interest Rates in Basis Points
 
Economic Value of Equity
 
Earnings at Risk (12 months)
 
Estimated EVE
 
Estimated Increase / (Decrease) in EVE
 
 EVE Ratio %
 
Estimated Net Interest Income
 
Increase / (Decrease) in Estimated Net Interest Income
 
 
$ Amount
 
$ Change
 
% Change
 
 
 
$ Amount
 
$ Change
 
% Change
 
 
(Dollars in thousands)
400

 
549,795

 
(51,978
)
 
(8.64
)
 
16.73
 
133,556

 
11,026

 
9.00

300

 
567,418

 
(34,355
)
 
(5.71
)
 
16.92
 
129,170

 
6,640

 
5.42

200

 
580,197

 
(21,576
)
 
(3.59
)
 
16.96
 
124,779

 
2,249

 
1.84

100

 
592,724

 
(9,049
)
 
(1.50
)
 
16.99
 
120,245

 
(2,285
)
 
(1.86
)
—

 
601,773

 
—

 
—

 
16.92
 
122,530

 
—

 
—

(100
)
 
604,473

 
2,700

 
0.45

 
16.67
 
120,556

 
(1,974
)
 
(1.61
)

The Bank's EVE was $599.2 million , or 15.06% , of the market value of portfolio assets as of June 30, 2014 , a $2.6 million decrease from $601.8 million , or 16.92% , of the market value of portfolio assets as of December 31, 2013 . Based upon

54

the assumptions utilized, an immediate 200 basis point increase in market interest rates would result in a $22.4 million decrease in our EVE at June 30, 2014 , compared to a $21.6 million decrease at December 31, 2013 , and would result in no change in our EVE ratio at June 30, 2014 , as compared to a four basis point increase to 16.96% at December 31, 2013 . An immediate 100 basis point decrease in market interest rates would result in a $13.8 million increase in our EVE at June 30, 2014 , compared to a $2.7 million increase at December 31, 2013 , and would result in a two basis point increase in our EVE ratio to 15.08% at June 30, 2014 , as compared to a 25 basis point decrease in our EVE ratio to 16.67% at December 31, 2013 .
The Bank's projected EAR for the twelve months ending June 30, 2015 is measured at $136.1 million , compared to $122.5 million for the twelve months ending December 31, 2014. Based on the assumptions utilized, an immediate 200 basis point increase in market rates would result in a $5.2 million , or 3.82% , increase in net interest income for the twelve months ending June 30, 2015, compared to a $2.2 million , or 1.84% , increase for the twelve months ending December 31, 2014. An immediate 100 basis point decrease in market rates would result in a $2.4 million decrease in net interest income for the twelve months ending June 30, 2015, compared to a $2.0 million decrease for the twelve months ending December 31, 2014.
We have implemented a strategic plan to mitigate interest rate risk. This plan includes the ongoing review of our current and projected mix of fixed rate versus variable rate loans, investments, deposits, and borrowings. When available and appropriate, high quality adjustable rate assets are purchased or originated. These assets generally may reduce our sensitivity to upward interest rate shocks. On the liability side of the balance sheet, borrowings are added as appropriate. These borrowings will be of a size and term so as to mitigate the impact of duration mismatches, reducing our sensitivity to upward interest rate shocks. These strategies are implemented as needed and as opportunities arise to mitigate interest rate risk without materially sacrificing earnings.
In managing our mix of assets and liabilities, while considering the relationship between long and short term interest rates, market conditions, and consumer preferences, we may place somewhat greater emphasis on maintaining or increasing the Bank’s net interest margin than on strictly matching the interest rate sensitivity of its assets and liabilities.
Management also believes that at times the increased net income which may result from a mismatch in the actual maturity, repricing, or duration of its asset and liability portfolios can provide sufficient returns to justify the increased exposure to sudden and unexpected increases or decreases in interest rates which may result from such a mismatch. Management believes that the Bank’s level of interest rate risk is acceptable under this approach.
In evaluating the Bank’s exposure to market interest rate movements, certain shortcomings inherent in the method of analysis presented in the foregoing table must be considered. For example, although certain assets and liabilities may have similar maturities or repricing characteristics, their interest rate drivers may react in different degrees to changes in market interest rates (basis risk). Also, the interest rates on certain types of assets and liabilities may fluctuate in advance of changes in market interest rates, while interest rates on other types may lag behind changes in market interest rates. Additionally, certain assets, such as adjustable rate mortgages, have features which restrict changes in interest rates over the life of the asset (time to initial interest rate reset; interest rate reset frequency; initial, periodic, and lifetime caps and floors). Further, in the event of a significant change in market interest rates, loan and securities prepayment and time deposit early withdrawal levels may deviate significantly from those assumed in the table above. Assets with prepayment options and liabilities with early withdrawal options are being monitored, with assumptions stress tested on a regular basis. Current market rates and customer behavior are being considered in the management of interest rate risk. Finally, the ability of many borrowers to service their debt may decrease in the event of an interest rate increase. The Bank considers all of these factors in monitoring its exposure to interest rate risk. Of note, the current historically low interest rate environment has resulted in asymmetrical interest rate risk. The interest rates on certain repricing assets and liabilities cannot be fully shocked downward.
The Board of Directors and management believe that the Bank’s ability to successfully manage and mitigate its exposure to interest rate risk is strengthened by several key factors. For example, the Bank manages its balance sheet duration and overall interest rate risk by placing a preference on originating and retaining adjustable rate loans. In addition, the Bank borrows at various maturities from the FHLB to mitigate mismatches between the asset and liability portfolios. Furthermore, the investment securities portfolio is used as a primary interest rate risk management tool through the duration and repricing targeting of purchases and sales.

55

Item 4.
Controls and Procedures

An evaluation was performed under the supervision and with the participation of the Company's management, including the Chief Executive Officer and Principal Financial Officer, of the effectiveness of the design and operation of the Company's disclosure controls and procedures (as defined in Rule 13a-15(e) promulgated under the Securities and Exchange Act of 1934, as amended) as of June 30, 2014 . Based on that evaluation, the Company's Chief Executive Officer and Principal Financial Officer concluded that the Company's disclosure controls and procedures were effective as of the end of the period covered by this quarterly report. There has been no change in the Company's internal controls over financial reporting during the quarter that has materially affected, or is reasonably likely to materially affect, the Company's internal control over financial reporting.
While the Company believes the present design of its disclosure controls and procedures is effective to achieve its goals, future events affecting its business may cause the Company to modify its disclosure controls and procedures. The Company does not expect that its disclosure controls and procedures and internal control over financial reporting will prevent all error and fraud. A control procedure, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control procedure are met. Because of the inherent limitations in all control procedures, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the Company have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty, and that breakdowns in controls or procedures can occur because of simple error or mistake. Additionally, controls can be circumvented by the individual actions of some persons, by collusion of two or more people, or by management override of the control. The design of any control procedure is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions; over time, controls become inadequate because of changes in conditions, or the degree of compliance with the policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control procedure, misstatements due to error or fraud may occur and not be detected.     


56

PART II - OTHER INFORMATION

Item 1.
Legal Proceedings
We are involved from time to time as plaintiff or defendant in various legal actions arising in the normal course of our businesses. While the ultimate outcome of pending proceedings cannot be predicted with certainty, it is the opinion of management, after consultation with counsel representing us in such proceedings, that the resolution of these proceedings should not have a material adverse effect on our consolidated financial position or results of operations.
Item 1A.
Risk Factors

Set forth below is an updated risk factor related to our business. This risk factor should be read in conjunction with the Company's risk factors disclosed in our Annual Report on Form 10-K for the year ended December 31, 2013.

New rules issued by the Consumer Financial Protection Bureau (the “CFPB”) may have a negative impact on our residential loan origination process and foreclosure proceedings, which could adversely affect our business, operating results, and financial condition.
The CFPB issued a rule effective in January 2014 to implement the “qualified mortgage” provisions of the Dodd-Frank Act requiring that mortgage lenders consider consumers’ ability to repay home loans before extending them credit. This new rule describes certain minimum requirements for lenders making so-called “ability-to-repay” determinations, but does not dictate that they follow particular underwriting models. Loans that meet the terms of the “qualified mortgage” provisions under the rule will be presumed to have complied with the new ability-to-repay standard. Loans that do not meet the ability-to-repay standard can be challenged in court by borrowers who default and the absence of ability-to-repay status can be used against a lender in foreclosure proceedings. The CFPB’s rule on “qualified mortgages” could limit our ability or desire to make certain types of loans or loans to certain borrowers, or could make it more expensive/and or time consuming to make these loans, which could limit our growth or profitability. In addition, any loans that we make outside of the “qualified mortgage” criteria could expose us to an increased risk of liability and reduce or delay our ability to foreclose on the underlying property. It is difficult to predict how the CFPB’s “qualified mortgage” rule will impact us, but any decreases in loan origination volume or increases in compliance and foreclosure costs caused by the rule could negatively affect our business, operating results and financial condition.

Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
The Company did not repurchase any of its common stock during the quarter ended June 30, 2014 .

Item 3.
Defaults upon Senior Securities
Not applicable.

Item 4.
Mine Safety Disclosures
Not applicable.

Item 5.
Other Information
Not applicable.

57


Item 6.
 
Exhibits
Exhibit
 
 
Number
 
Description
 
 
 
2.1

 
Agreement and Plan of Merger by and between the Registrant and Highlands Bancshares, Inc. (incorporated herein by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on December 9, 2011 (File No. 001-34737))
 
 
 
2.2

 
Agreement and Plan of Merger, dated as of November 25, 2013, by and between the Registrant and LegacyTexas Group, Inc. (incorporated herein by reference to Exhibit 2.1 of the Registrant’s Current Report on Form 8-K filed with the SEC on November 25, 2013 (File No. 001-34737))
 
 
 
2.3

 
Amendment No. One to the Agreement and Plan of Merger, dated as of February 19, 2014, by and between the Registrant and LegacyTexas Group, Inc. (incorporated herein by reference to Exhibit 2.3 of the Registrant’s Annual Report on Form 10-K filed with the SEC on February 26, 2014 (File No. 001-34737))
 
 
 
3.1

 
Charter of the Registrant (incorporated herein by reference to Exhibit 3.1 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-165509))
 
 
 
3.2

 
Bylaws of the Registrant (incorporated herein by reference to Exhibit 3.2 to the Registrant’s Registration Statement on Form S-1 (File No. 333-165509))
 
 
 
4.0

 
Certificate of Registrant’s Common Stock (incorporated herein by reference to Exhibit 4.0 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 333-165509))
 
 
 
10.1

 
ViewPoint Bank Deferred Compensation Plan (incorporated herein by reference to Exhibit 10.7 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 0-24566-01))
 
 
 
10.2

 
Amended and Restated ViewPoint Bank Supplemental Executive Retirement Plan (incorporated herein by reference to Exhibit 10.8 to the Registrant’s Registration Statement on Form S-1, as amended (File No. 0-24566-01))
 
 
 
10.3

 
2013 Executive Annual Incentive Plan (incorporated herein by reference to Exhibit 10.1 to the Registrant’s Current Report on Form 8-K filed with the SEC on March 6, 2013 (File No. 001-34737))
 
 
 
10.4

 
Form of Director's Agreement between the Registrant and James B. McCarley (incorporated herein by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K filed with the SEC on March 6, 2013 (File No. 001-34737))
 
 
 
10.5

 
Form of Director's Agreement between the Registrant and Gary D. Basham (incorporated herein by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K filed with the SEC on March 6, 2013 (File No. 001-34737))
 
 
 
10.6

 
Form of Director's Agreement between the Registrant and Jack D. Ersman (incorporated herein by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K filed with the SEC on March 6, 2013 (File No. 001-34737))
 
 
 
10.7

 
Form of Director's Agreement between the Registrant and V. Keith Sockwell (incorporated herein by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K filed with the SEC on March 6, 2013 (File No. 001-34737))
 
 
 
10.8

 
Resignation, Release and Consulting Agreement between the Registrant and Pathie E. McKee (incorporated herein by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the SEC on July 3, 2013 (File No. 001-34737))
 
 
 
10.9

 
Change in Control and Severance Benefits Agreement entered into between the Registrant and Mays Davenport (incorporated herein by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the SEC on November 25, 2013 (File No. 001-34737)).
 
 
 

58

10.10

 
Form of Change In Control and Severance Benefits Agreement entered into between the Registrant and the following executive officers: Scott A. Almy, Charles D. Eikenberg, Thomas S. Swiley, and Mark L. Williamson (incorporated herein by reference to Exhibit 10.1 to the Registrant's Current Report on Form 8-K filed with the SEC on December 2, 2013 (File No. 001-34737)).
 
 
 
10.11

 
Amended and Restated Executive Employment Agreement entered into by the Registrant on December 2, 2013 with Kevin J. Hanigan (incorporated herein by reference to Exhibit 10.2 to the Registrant's Current Report on Form 8-K filed with the SEC on December 2, 2013 (File No. 001-34737)).
 
 
 
11

 
Statement regarding computation of per share earnings (See Note 3 of the Condensed Notes to Unaudited Consolidated Interim Financial Statements included in this Form 10-Q).
 
 
 
31.1

 
Rule 13a — 14(a)/15d — 14(a) Certification (Chief Executive Officer)
 
 
 
31.2

 
Rule 13a — 14(a)/15d — 14(a) Certification (Principal Financial Officer)
 
 
 
32

 
Section 1350 Certifications
 
 
 
101*

 
Financial statements from Quarterly Report on Form 10-Q of the Registrant for the quarter ended June 30, 2014, formatted in eXtensible Business Reporting Language (XBRL): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders’ Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Condensed Notes to Unaudited Consolidated Interim Financial Statements.
 
 
 
 
 
*This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934. As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.


59




SIGNATURES
In accordance with the requirements of the Exchange Act, the Registrant caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
ViewPoint Financial Group, Inc.
(Registrant)

Date:
July 29, 2014
 
By:
/s/ Kevin J. Hanigan
 
 
 
 
Kevin J. Hanigan,
 
 
 
 
President and Chief Executive Officer
 
 
 
 
(Duly Authorized Officer)
 
 
 
 
 
Date:
July 29, 2014
 
By:
/s/ Kari J. Anderson
 
 
 
 
Kari J. Anderson,
 
 
 
 
Chief Accounting Officer
 
 
 
 
(Interim Principal Financial Officer)


60

EXHIBIT INDEX
Exhibits:

31.1
Certification of the Chief Executive Officer
31.2
Certification of the Principal Financial Officer
32.0
Section 1350 Certifications
101*
Financial statements from Quarterly Report on Form 10-Q of the Registrant for the quarter ended June 30, 2014, formatted in eXtensible Business Reporting Language (XBRL): (i) the Consolidated Balance Sheets, (ii) the Consolidated Statements of Income, (iii) the Consolidated Statements of Comprehensive Income, (iv) the Consolidated Statements of Changes in Shareholders' Equity, (v) the Consolidated Statements of Cash Flows and (vi) the Condensed Notes to Unaudited Consolidated Interim Financial Statements.*
 
* This exhibit shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that section, and shall not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934. As provided in Rule 406T of Regulation S-T, this information is furnished and not filed for purposes of Sections 11 and 12 of the Securities Act of 1933 and Section 18 of the Securities Exchange Act of 1934.



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