TEXAS CAPITAL BANCSHARES INC/TX (TCBI) FY 2021 MD&A

ITEM 7.     MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis of our financial condition and results of operations for the years ended December 31, 2021 and 2020 should be read in conjunction with our audited consolidated financial statements and the related notes to the consolidated financial statements included in this Annual Report on Form 10-K. Certain risks, uncertainties and other factors, including those set forth under “Risk Factors” in Part I, Item 1A, and elsewhere in this Annual Report on Form 10-K may cause actual results to differ materially from the results discussed in the forward-looking statements appearing in this discussion and analysis. Refer to “Management's Discussion and Analysis of Financial Condition and Results of Operations” in our 2020 Annual Report on Form 10K filed with the SEC on February 9, 2021, for discussion of our results of operations for the years ended December 31, 2020 and 2019.

Forward-Looking Statements

Certain statements and financial analysis contained in this report that are not historical facts may constitute “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are based on our beliefs, assumptions and expectations of our future performance taking into account all information available to us at the time such statements are made. Forward-looking statements may often be identified by the use of words such as “expects,” “estimates,” “anticipates,” “plans,” “goals,” “objectives,” “intends,” “seeks,” “likely,” “should,” “may,” “could” and other similar expressions.

Forward-looking statements may include, among other things and without limitation, statements about the credit quality of our loan portfolio, our liquidity, general economic conditions in the United States and in our markets, including with respect to interest rates and the market generally, the continued impact on our customers from volatility in oil and gas prices, the material risks and uncertainties for the U.S. and world economies, and for our business, resulting from the COVID-19 pandemic, expectations regarding rates of default and loan losses, volatility in the mortgage industry, our business strategies (including new lines of business, products and services) and our expectations about future financial performance, future growth and earnings, the appropriateness of our allowance for credit losses and provision for credit losses, the impact of changing regulatory requirements and legislative changes on our business, increased competition, and technologies (including new technologies and information security risks).

Forward-looking statements are subject to various risks and uncertainties, which change over time, are based on management’s expectations and assumptions at the time the statements are made and are not guarantees of future results. Important factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements include, but are not limited to, the following:

•Deterioration of the credit quality of our loan portfolio or declines in the value of collateral due to external factors or otherwise.

•The unpredictability of economic and business conditions that may impact us or our customers.

•The COVID-19 pandemic on us and our customers, employees and third-party service providers. It is not possible to accurately predict the extent, severity or duration of the COVID-19 pandemic or to what level and when normal economic and operational conditions will return and remain. This includes related costs and liabilities associated with legal and regulatory proceedings, investigations, inquiries and related matters with respect to the financial services industry, including those directly involving us or our Bank and arising from our participation in government stimulus programs responding to the economic impact of the COVID-19 pandemic.

•Our ability to effectively manage our liquidity risk and any growth plans and the availability of capital and funding to us.

•Our ability to effectively manage our information technology systems (including external vendors), on which we are highly dependent. This also includes our ability to, among other things, manage such risks and to prevent cyber-incidents against us, our customers or our third-party vendors, or to manage risks from failures, disruptions or security breaches affecting us, our customers or our third-party vendors.

•The costs and effects of cyber-incidents or other failures, disruptions or security breaches of our systems or those of our third-party providers.

•Changes in interest rates.

•Changes in the method of determining LIBOR, or the replacement of LIBOR with an alternative reference rate.

•Adverse or unexpected economic or market conditions and other factors in Texas, the United States or internationally that could affect the credit quality of our loan portfolio, our operating performance or our ability to access the capital markets or other sources of funding to become less advantageous.

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•The failure to effectively balance our funding sources with cash demands by depositors and borrowers, the failure to maintain capital ratios as a result of adverse changes in our operating performance or financial condition or changes in applicable regulations or interpretations of regulations that impact our business or the characterization or risk weight of our assets.

•Material failures of our accounting estimates and risk management processes based on management judgment, or the supporting assumptions or models.

•The failure to effectively manage our interest rate risk.

•The failure of our enterprise risk management framework (including our risk management strategies and procedures and related controls), our compliance program, or our corporate governance and supervisory oversight functions to timely identify and address emerging risks adequately.

•Uncertainty regarding the upcoming transition away from the London Interbank Offered Rate, or LIBOR, toward new interest rate benchmarks and our ability to successfully implement any new interest rate benchmarks.

•Our ability to comply with applicable governmental regulations, including legislative and regulatory changes that may impose further restrictions and costs on our business, any regulatory enforcement actions that may be brought against us and the effect of changes in laws, regulations, policies and guidelines (including, among others, those concerning taxes, banking, accounting, securities and monetary and fiscal policies) with which we must generally comply.

•Risks related to the U.S. federal government actions impacting us, such as a participating lender in the Small Business Administration’s PPP and the impact of the Tax Cuts and Jobs Act on us and our customers.

•Claims and litigation that may arise in the ordinary course of business, including those that may not be covered by our insurers.

•The failure to successfully execute our business strategy, which may include expanding into new markets, developing and launching new lines of business or new products and services, completing planned transactions or to successfully manage the risks related to certain aspects of our business strategy.

•The failure to identify, attract and retain key personnel.

•Increased or more effective competition from banks and other financial service providers in our markets.

•The susceptibility of fraud on our business.

•The failure to maintain adequate regulatory capital to support our business.

•Environmental liability associated with properties related to our lending activities.

•Severe weather, natural disasters, acts of war or terrorism and other external events.

•Risks relating to our securities, including the volatility of our stock price, trading volume, rights of holders of our indebtedness and preferred stock, our decision to not currently pay dividends on our common stock, and other related factors.

Actual outcomes and results may differ materially from what is expressed in our forward-looking statements and from our historical financial results due to the factors discussed elsewhere in this report or disclosed in our other SEC filings. Forward-looking statements included herein speak only as of the date hereof and should not be relied upon as representing our expectations or beliefs as of any date subsequent to the date of this report. Except as required by law, we undertake no obligation to revise any forward-looking statements contained in this report, whether as a result of new information, future events or otherwise. The factors discussed herein are not intended to be a complete summary of all risks and uncertainties that may affect our businesses. Though we strive to monitor and mitigate risk, we cannot anticipate all potential economic, operational and financial developments that may adversely impact our operations and our financial results. Forward-looking statements should not be viewed as predictions and should not be the primary basis upon which investors evaluate an investment in our securities.

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Overview of Our Business Operations

We commenced our banking operations in December 1998. An important aspect of our growth strategy has been our ability to effectively service and manage a large number of loans and deposit accounts in multiple markets in Texas, as well as several lines of business serving a regional or national clientele of commercial borrowers. Early in 2021, we embarked on an enterprise-wide transformation which included detailed reviews of all of our business lines, our operating model, our investment spend and our overall strategy, which resulted in the September 1, 2021 announcement by management of our new long-term strategy. This new long-term strategy is intended to ensure that we are best positioned to serve clients and capitalize on business opportunities going forward. This new plan includes focusing on building an operating model organized around client delivery and investing in technology. To achieve these goals we are pursuing an aggressive hiring plan to significantly increase the number of client-facing professionals by 2025, and we are also investing in new technologies and lines of business to become a full-service financial services firm for our clients, with the goal of improving client relationships and fee income. We are investing in treasury solutions product and service offerings, building on our existing private wealth business and expanding the scope of our investment banking product and service offerings.

In May 2021 the Bank applied to the Texas Department of Banking to convert from a national association to a Texas state-chartered bank. The application was approved during the third quarter and the conversion was effective at open of business on September 15, 2021. Effective as of the date of conversion, the Texas Department of Banking is the Bank’s primary regulator, the Federal Deposit Insurance Corporation is the Bank’s primary federal regulator and the Federal Reserve will continue to be the Company’s primary federal regulator.

In December 2021, the Company received approval from the SEC and FINRA for registration and FINRA membership of TCBI Securities, a wholly owned non-bank subsidiary of the Bank. TCBI Securities will provide investment banking products and services to our customers.

Significant transactions affecting our financial statements during the year ended December 31, 2021 included:

•Issuance of 5.75% fixed rate non-cumulative perpetual preferred stock, Series B and issuance and sale of 12,000,000 depositary shares, each representing a 1/40th interest in a share of the Series B Preferred Stock. Net proceeds from the sale totaled $289.7 million. The additional equity is being used for general corporate purposes, including funding regulatory capital infusions into the Bank, and was used to redeem our 6.5% non-cumulative perpetual preferred stock Series A, par value $0.01 per share, in accordance with its terms;

•Issuance of $275.0 million in senior unsecured credit-linked notes that mature on September 30, 2024. The net proceeds of the offering are being used to expand the Bank's warehouse lending program and better serve our clients in all market environments;

•Sale of our portfolio of MSRs and transition of the MCA program to a third-party. For additional information, see Note 5 - Certain Transfers of Financial Assets in the accompanying notes to the consolidated financial statements included elsewhere in this report;

•Issuance and sale of $375.0 million of 4.00% fixed-to-fixed rate subordinated notes due 2031. For additional information, see Note 11 - Long-Term Debt in the accompanying notes to the consolidated financial statements included elsewhere in this report;

•Redemption of our 6.50% non-cumulative perpetual preferred stock, Series A. For additional information, see Note 20 - Material Transactions Affecting Stockholders' Equity in the accompanying notes to the consolidated financial statements included elsewhere in this report;

•Redemption of our 6.50% subordinated notes due 2042. For additional information, see Note 11 - Long-Term Debt in the accompanying notes to the consolidated financial statements included elsewhere in this report;

•Negative provision for credit losses of $30.0 million for full year 2021, primarily reflecting improvements in the economic outlook as the economy recovered from the impacts of the COVID-19 pandemic during 2021 combined with a decrease in criticized loans; and

•Write-off of $12.0 million of certain software assets to reposition our capitalized technology investment to align with the long-term strategy as announced by management in the third quarter of 2021.

Impact of COVID-19 Pandemic

The COVID-19 pandemic has had, and continues to have, a significant impact on the global community. The related restrictive measures taken by governments, businesses and individuals have caused and continue to cause uncertainty, volatility and disruption in financial markets and in governmental, commercial and consumer activity in the United States and globally, including the markets that we serve. As the restrictive measures began to be eased during 2021, the U.S. economy has begun to

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improve from 2020, and with the availability and distribution of COVID-19 vaccines, we anticipate continued improvements in commercial and consumer activity and the U.S. economy.

Effective June 1, 2021, we returned to pre-pandemic business operations and brought 100% of our workforce back into the office. Our branch locations are currently open and operating during normal business hours. We continue to take additional precautions within our branch locations, including enhanced cleaning procedures, to ensure the safety of our customers and our employees.

We have taken deliberative actions toward our goal of ensuring that we have the balance sheet strength to serve our clients and communities, including by seeking to increase our liquidity and manage our assets and liabilities in order to maintain a strong capital position; however, future economic conditions are subject to significant uncertainty. Uncertainties associated with the COVID-19 pandemic include the duration of any COVID-19 outbreaks and any related variants, the availability and effectiveness of COVID-19 vaccines, the impact to our customers, employees and vendors and the impact to the economy as a whole. COVID-19 had a significant adverse impact on our business, financial position and operating results for the year ended December 31, 2020. While the economy began to recover in 2021, uncertainty still exists, but we believe we are well-positioned to operate effectively through the present economic environment.

Results of Operations

Year ended December 31, 2021 compared to year ended December 31, 2020

Selected income statement data and key performance indicators are presented in the table below:

(1)    Non-interest expense divided by the sum of net interest income and non-interest income.

We reported net income of $253.9 million and net income available to common stockholders of $235.2 million, or $4.60 per diluted common share, for the year ended December 31, 2021, compared to net income of $66.3 million and net income available to common stockholders of $56.5 million, or $1.12 per diluted common share, for 2020. Return on average common equity (“ROE”) was 8.35% and return on average assets (“ROA”) was 0.67% for the year ended December 31, 2021, compared to 2.10% and 0.18%, respectively, for 2020. The increase in net income, ROE and ROA for the year ended December 31, 2021 resulted primarily from a $288.0 million decrease in the provision for credit losses and a $105.3 million decrease in non-interest expense, partially offset by decreases of $82.5 million and $64.8 million in net interest income and non-interest income, respectively, and a $58.5 million increase in income tax expense.

Details of the changes in the various components of net income are discussed in detail below.

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Consolidated Daily Average Balances, Taxable-Equivalent Net Interest Income, and Yields/Rates

(1)Average balances include non-accrual loans which are stated net of unearned income. Loan interest income includes loan fees totaling $47.8 million, $43.8 million and $46.6 million for the years ended December 31, 2021, 2020 and 2019, respectively.

(2)Taxable equivalent rates used where applicable.

(3)Includes federal funds purchased, repurchase agreements and FHLB borrowings. For additional details see Note 10 - Short-Term and Other Borrowings in the accompanying notes to the consolidated financial statements included elsewhere in this report.

(4)Yield on loans, net of reserves, less funding cost including all deposits and borrowed funds.

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Volume/Rate Analysis

The following table presents the changes in taxable-equivalent net interest income and identifies the changes due to differences in the average volume of earning assets and interest-bearing liabilities and the changes due to differences in the average interest rate on those assets and liabilities.

(1)Yield/rate and volume variances are allocated to yield/rate.

(2)Taxable equivalent rates used where applicable assuming a 21% tax rate.

Net Interest Income

Net interest income was $768.8 million for the year ended December 31, 2021 compared to $851.3 million for 2020. The decrease was primarily due to decreases in total average loans and earning asset yields, partially offset by an increase in average investment securities as well as declining cost of funds.

Average earning assets for the year ended December 31, 2021 increased by $717.1 million compared to the same period in 2020, and included a $2.7 billion increase in average total investment securities, reflecting the deployment of excess liquidity into higher-yielding investment securities, and an $894.5 million increase in average interest-bearing deposits in other banks, partially offset by a $2.8 billion decrease in average total loans. Throughout 2020, management took deliberate actions to increase the balance of interest-bearing deposits in other banks to ensure we had the balance sheet strength to serve our clients during the COVID-19 pandemic. In 2021, balances remained elevated, although began to run off in the later part of the year as we purchased investment securities and proactively exited certain high-cost indexed deposit products. The decrease in average loans held for sale resulted from the transition of the MCA program to a third-party in 2021. Average interest-bearing liabilities decreased $3.3 billion for the year ended December 31, 2021 compared to the same period in 2020, primarily due to a $3.0 billion decrease in average interest-bearing deposits and a $716.1 million decrease in other borrowings, partially offset by a $406.4 million increase in average long-term debt. Average demand deposits for the year ended December 31, 2021 increased to $15.2 billion from $11.6 billion for 2020.

Net interest margin for the year ended December 31, 2021 was 2.07% compared to 2.34% for 2020. The decrease was primarily due to the effect of declining interest rates on earning asset yields and a shift in earning asset composition, primarily increases in lower-yielding investment securities and interest-bearing deposits in other banks, partially offset by lower funding costs compared to 2020.

The yield on total loans held for investment, net, decreased to 3.56% for the year ended December 31, 2021 compared to 3.88% for 2020 and the yield on earning assets decreased to 2.36% for the year ended December 31, 2021 compared to 2.86% for 2020. The average cost of total deposits decreased to 0.21% for 2021 from 0.47% for 2020 and total funding costs, including all deposits, long-term debt and stockholders' equity decreased to 0.28% for 2021 compared to 0.51% for 2020.

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Non-interest Income

Non-interest income decreased by $64.8 million during the year ended December 31, 2021 to $138.2 million, compared to $203.0 million for 2020. This decrease was primarily due to decreases in net gain/(loss) on sale of loans held for sale, brokered loan fees and servicing income, all resulting from the 2021 sale of our MSR portfolio and transition of the MCA program to a third-party. Offsetting these decreases were increases in service charges, related to a change in fee structure for our deposits on analysis, wealth management and trust fee income, related to increases in assets under management and market values, and in other non-interest income, primarily related to a gain on the sale of a foreclosed asset.

Non-interest Expense

Non-interest expense for the year ended December 31, 2021 decreased $105.3 million compared to 2020. The decrease was primarily due to decreases in marketing, legal, communication and technology expenses, servicing-related expenses and merger-related expenses, partially offset by an increase in salaries and employee benefits, resulting primarily from increased headcount in 2021. The decrease in servicing-related expenses resulted from the 2021 sale of our MSR portfolio and transition of the MCA program to a third-party. Communications and technology expense for the year ended December 31, 2021 included a $12.0 million write-off of certain software assets, as is discussed above, compared to $36.0 million included in the same period of 2020.

Analysis of Financial Condition

Loans Held for Investment

The following table summarizes our loans held for investment on a gross basis by portfolio segment. See Note 1 - Operations and Summary of Significant Accounting Policies in the accompanying notes to the consolidated financial statements included elsewhere in this report for details of these portfolio segments.

Gross loans held for investment were $22.9 billion at December 31, 2021, a decline of $1.6 billion from 2020, primarily due to declines in mortgage finance and real estate loans, partially offset by an increase in commercial loans. Mortgage finance loans

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relate to our mortgage warehouse lending operations in which we purchase mortgage loan ownership interests that are typically sold within 10 to 20 days and represent 33% of total loans held for investment at December 31, 2021 compared to 37% at December 31, 2020. Volumes fluctuate based on the level of market demand for the product and the number of days between purchase and sale of the loans, which can be affected by changes in overall market interest rates, and tend to peak at the end of each month. Despite the decline in 2021, balances in this portfolio remain elevated related to increases in volumes driven by continued lower long-term interest rates. The decline in the real estate loan portfolio was primarily due to above-average payoffs during 2021.

We originate a substantial majority of all loans held for investment. We also participate in syndicated loan relationships, both as a participant and as an agent. As of December 31, 2021, we had $2.5 billion in syndicated loans, $688.2 million of which we administer as agent. All syndicated loans, whether we act as agent or participant, are underwritten to the same standards as all other loans we originate. As of December 31, 2021, $9.6 million of our syndicated loans were on non-accrual.

Portfolio Concentrations

Although more than 50% of our total loan exposure is outside of Texas and more than 50% of our deposits are sourced outside of Texas, our Texas concentration remains significant. As of December 31, 2021, a majority of our loans held for investment, excluding mortgage finance loans and other national lines of business, were to businesses with headquarters or operations in Texas. This geographic concentration subjects our loan portfolio to the general economic conditions within this state. The risks created by this concentration have been considered by management in the determination of the appropriateness of the allowance for credit losses.

The table below summarizes the industry concentrations of our loans held for investment on a gross basis at December 31, 2021:

(1)Includes premium finance loans that are generally secured by obligations of insurance carriers.

Our largest concentration of commercial loans held for investment in any single industry is in financials excluding banks. Loans extended to borrowers in the financials excluding banks category are comprised largely of loans to companies who loan money to businesses and consumers for various purposes including, but not limited to, insurance, consumer goods and real estate. This category also includes loans to companies involved in investment management and securities and commodities trading. The next largest industry concentration of commercial loans held for investment is to commercial borrowers providing services to the real estate industry. Loans in this category are not secured by real property and are generally made to commercial borrowers that operate within the real estate industry, which include developers, contractors, professional service providers (such as architectural and interior design services), leasing, management, and other support type services.

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We believe the loans we originate are appropriately collateralized under our credit standards. Approximately 96% of our loans held for investment are secured by collateral. The table below sets forth information regarding the distribution of our loans held for investment on a gross basis among various types of collateral at December 31, 2021:

As noted in the tables above, approximately 21% of our loans held for investment as of December 31, 2021 are real estate loans that are generally secured by real property. This portfolio primarily includes market risk real estate loans, consisting of commercial real estate loans and loans made to residential builders and developers. Loan amounts are determined in part from an analysis of pro forma cash flows. Loans are also underwritten to comply with product-type specific advance rates against both cost and market value. We extend commercial real estate loans, including both construction/development financing and limited term financing, to professional real estate developers and owners/managers of commercial real estate projects and properties who have a demonstrated record of past success with similar properties. Collateral properties generally include office buildings, warehouse/distribution buildings, shopping centers, hotels/motels, senior living, apartment buildings and residential and commercial tract development. The primary source of repayment on these loans is expected to come from the sale, permanent financing or lease of the real property collateral. Loans to residential builders are typically in the form of uncommitted guidance lines and are for the purpose of developing lots into single-family homes, while loans to developers are typically in the form of borrowing base lines extended for the purpose of acquiring and developing raw land into lots that can be further sold to home builders. The table below summarizes our total real estate loan portfolio, which includes real estate loans and construction loans, as segregated by the type of property securing the credit. Property type concentrations are stated as a percentage of year-end total real estate loans as of December 31, 2021:

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The table below summarizes our market risk real estate portfolio at December 31, 2021 as segregated by the geographic region in which the property is located. Approximately 56% of the market risk real estate collateral is located in Texas.

The determination of collateral value is critically important when financing real estate. As a result, obtaining current and objectively prepared appraisals is a major part of our underwriting and monitoring processes. We engage a variety of professional firms to supply appraisals, market studies and feasibility reports, environmental assessments and project site inspections to complement our internal resources to underwrite and monitor these credit exposures. Generally, our policy requires a new appraisal every three years. However, in periods of economic uncertainty where real estate market conditions may change rapidly, more current appraisals are obtained when warranted by conditions such as a borrower’s deteriorating financial condition, their possible inability to perform on the loan or other indicators of increasing risk of reliance on collateral value as the sole source of repayment of the loan. Annual appraisals are generally obtained for loans graded substandard or worse where real estate is a material portion of the collateral value and/or the income from the real estate or sale of the real estate is the primary source of debt service.

Appraisals are, in substantially all cases, reviewed by a third party to determine the reasonableness of the appraised value. The third party reviewer will challenge whether or not the data used is appropriate and relevant, form an opinion as to the appropriateness of the appraisal methods and techniques used, and determine if overall the analysis and conclusions of the appraiser can be relied upon. Additionally, the third party reviewer provides a detailed report of that analysis. Further review may be conducted by our credit officers, as well as by the Bank’s managed asset committee as conditions warrant. These additional steps of review are undertaken to confirm that the underlying appraisal and the third party analysis can be relied upon. If we have differences, we address those with the reviewer and determine an appropriate resolution. Both the appraisal process and the appraisal review process can be less reliable in establishing accurate collateral values during and following periods of economic weakness due to the lack of comparable sales and the limited availability of financing to support an active market of potential purchasers.

Large Credit Relationships

We originate and maintain large credit relationships with numerous customers in the ordinary course of business. The legal lending limit of our Bank is approximately $536.7 million. We employ much lower house limits which vary by assigned risk grade, product and collateral type. Such house limits, which generally range from $20 million to $60 million, may be exceeded with appropriate authorization for exceptionally strong borrowers and otherwise where business opportunity and assessed credit risk warrant a somewhat larger investment. We consider large credit relationships to be those with commitments equal to or in excess of $20.0 million. The following table provides additional information on our large held for investment credit relationships, excluding mortgage finance, outstanding at year-end:

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Growth in period-end outstanding balances related to large credit relationships primarily resulted from an increase in the number of commitments. The following table summarizes the average committed and outstanding loan balances per relationship related to our large held for investment credit relationships, excluding mortgage finance, at year-end:

Loan Maturities and Interest Rate Sensitivity

Interest Reserve Loans

As of December 31, 2021 and December 31, 2020, we had $456.1 million and $549.1 million, respectively, in loans held for investment that included interest reserve arrangements, representing approximately 25% and 23%, respectively, of outstanding construction loans, which are a component of real estate loans. Interest reserve provisions are common in construction loans. The use of interest reserves is carefully controlled by our underwriting standards, which consider the feasibility of the project, the creditworthiness of the borrower and guarantors and the loan-to-value coverage of the collateral. The interest reserve allows the borrower to draw loan funds to pay interest charges on the outstanding balance of the loan when financial conditions precedent are met. When drawn, the interest is capitalized and added to the loan balance, subject to conditions specified during the initial underwriting and at the time the credit is approved. We have ongoing controls for monitoring compliance with loan covenants, advancing funds and determining default conditions.

When we finance land on which improvements will be constructed, construction funds are generally not advanced until the borrower has received lease or purchase commitments which will meet cash flow coverage requirements and/or our analysis of market conditions and project feasibility indicates to our satisfaction that such lease or purchase commitments are forthcoming or other sources of repayment have been identified to repay the loan. It is our general policy to require a substantial equity investment by the borrower to complement the Bank's credit commitment. Any such required borrower investment is first contributed and invested in the project before any draws are allowed under the Bank's credit commitment. We require current financial statements of the borrowing entity and guarantors, as well as conduct periodic inspections of the project and analysis of whether the project is on schedule or delayed. Updated appraisals are ordered when necessary to validate the collateral values to support advances, including reserve interest. Advances of interest reserves are discontinued if collateral values do not support the advances or if the borrower does not comply with other terms and conditions in the loan agreements. In addition, most of our construction lending is performed in Texas and our lenders are very familiar with trends in local real estate. If at any time we believe that our collateral position is jeopardized, we retain the right to stop the use of interest reserves. As of December 31, 2021 and December 31, 2020, none of our loans with interest reserves were on non-accrual.

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Non-performing Assets

Non-performing assets include non-accrual loans and leases and repossessed assets. The table below summarizes our non-accrual loans by type and by type of property securing the credit. We did not have repossessed assets balances at December 31, 2021 or 2020.

(1)As of December 31, 2021 and 2020, non-accrual loans held for investment included $19.4 million and $45.4 million, respectively, in loans that met the criteria for restructured.

(2)At December 31, 2021 and 2020, loans past due 90 days and still accruing includes premium finance loans of $3.3 million and $6.4 million, respectively.

(3)Includes one non-accrual loan previously reported in loans held for investment that was transferred to loans held for sale as of December 31, 2020 and subsequently sold at carrying value.

(4)Includes loans guaranteed by U.S. government agencies that were repurchased out of Ginnie Mae securities. Loans are recorded as loans held for sale and carried at fair value on the balance sheet. Interest on these past due loans accrues at the debenture rate guaranteed by the U.S. government. Balances as of December 31, 2020 also include loans that, pursuant to Ginnie Mae servicing guidelines, we have the unilateral right, but not the obligation, to repurchase if defined delinquent loan criteria are met and therefore must record as loans held for sale on our balance sheet regardless of whether the repurchase option has been exercised.

Total non-accrual loans at December 31, 2021 decreased $49.5 million from December 31, 2020. The decrease during 2021 primarily related to declines in energy and real estate non-accrual loans.

Summary of Credit Loss Experience

The provision for credit losses, comprised of a provision for loans and off-balance sheet credit losses, is a charge to earnings to maintain the allowance for credit losses at a level consistent with management’s assessment of expected losses in the loan portfolio at the balance sheet date. Below is a discussion of provision for credit losses on loans. See Note 12 - Financial Instruments with Off-Balance Sheet Risk in the accompanying notes to the consolidated financial statements included elsewhere in this report for presentation of the activity in the allowance for credit losses for off-balance asset credit losses.

We recorded a negative $29.8 million provision for credit losses on loans for the year ended December 31, 2021 compared to a $249.8 million provision for the year ended December 31, 2020. The year-over-year decrease resulted primarily from decreases in net charge-offs and criticized loans, as well as improvements in the economic outlook as the economy recovered from the impacts of the COVID-19 pandemic during 2021. We recorded $12.9 million in net charge-offs during the year ended December 31, 2021 compared to $198.8 million during 2020. Criticized loans totaled $582.9 million at December 31, 2021, compared to $918.4 million at December 31, 2020.

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The table below presents a summary of our credit loss experience on loans for the past two years:

(1)    Includes negative provision for off-balance sheet credit losses of $169,000 and provision for off-balance sheet credit losses of $8.2 million for the year ended December 31, 2021 and 2020, respectively.

(2)    Includes allowance for off-balance sheet credit losses of $17.3 million and $17.4 million at December 31, 2021 and 2020, respectively.

The allowance for credit losses on loans totaled $211.9 million at December 31, 2021 and $254.6 million at December 31, 2020. The allowance for credit losses on loans as a percentage of loans held for investment decreased to 0.93% at December 31, 2021 from 1.04% at December 31, 2020. The decrease in the allowance for credit losses on loans as a percentage of loans held for investment at December 31, 2021, compared to December 31, 2020, is due primarily to a decrease in the allowance for credit losses on loans, resulting primarily from decreases in net charge-offs and criticized loans, as well as improvements in the economic outlook as the economy recovered from the impacts of the COVID-19 pandemic during 2021.

The following table presents a summary of our allowance for credit losses on loans by portfolio segment for the past two years:

The overall decrease in the allowance for credit losses on loans at December 31, 2021 compared to 2020 resulted primarily from an overall decrease in loans held for investment balances, coupled with reserve releases related to the improved credit quality and economic factors discussed above.

See Note 1 - Operations and Summary of Significant Accounting Policies and Note 4 - Loans Held for Investment and Allowance for Credit Losses on Loans in the accompanying notes to the consolidated financial statements included elsewhere in this report for details of the allowance for credit losses on loans.

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Loans Held for Sale

On April 20, 2021, we entered into an agreement to sell our portfolio of MSRs and to transition the MCA program to a third-party. The sale was completed on June 1, 2021 and the transfer of servicing on the underlying mortgage loans was completed on August 1, 2021. Transition activities began immediately following the execution of the agreement and were complete prior to December 31, 2021. We sold the remaining MSR balance of $1.2 million, which represented MSRs from loans sold after the cut-off date for the initial sale mentioned above. The sale of this MSR portfolio and the transfer of servicing on the underlying mortgage loans were completed on October 1, 2021, at which time all remaining MSR hedge positions were closed. At December 31, 2021, we have $8.1 million in loans held for sale remaining on our balance sheet. For additional information on our loans held for sale portfolio, see Note 1 - Operations and Summary of Significant Accounting Policies and Note 5 - Certain Transfers of Financial Assets in the accompanying notes to the consolidated financial statements included elsewhere in this report.

Deposits

We compete for deposits by offering a broad range of products and services to our customers. While this includes offering competitive interest rates and fees, the primary means of competing for deposits is convenience and service to our customers, tailored to our strategy of maintaining a branch-lite network. Our Bank offers banking centers, courier services and online and mobile banking. BankDirect and Bask Bank, our online banking divisions, serve customers on a 24 hours-a-day, 7 days-a-week basis solely through online banking.

Average total deposits for the year ended December 31, 2021 increased $659.0 million compared to 2020. Average demand deposits for the year ended December 31, 2021 increased $3.6 billion compared to 2020 and average interest-bearing deposits decreased $3.0 billion. The average cost of total deposits decreased to 0.21% in 2021 from 0.47% in 2020 as we proactively exited certain high-cost indexed deposit products in 2021.

The following table discloses our average deposits and weighted-average cost of deposits by type:

Estimated uninsured deposits at December 31, 2021 were $16.1 billion (56% of total deposits), compared to $16.2 billion (52% of total deposits) at December 31, 2020. The insured deposit data for 2021 and 2020 reflect the deposit insurance impact of “combined ownership segregation” of escrow and other accounts at an aggregate level but do not reflect an evaluation of all of the account styling distinctions that would determine the availability of deposit insurance to individual accounts based on FDIC regulations.

The following table shows scheduled maturities of time deposits greater than $250,000:

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Liquidity and Capital Resources

Liquidity

In general terms, liquidity is a measurement of our ability to meet our cash needs. Our objectives in managing our liquidity are to maintain our ability to meet loan commitments, repurchase investment securities and repay deposits and other liabilities in accordance with their terms, without an adverse impact on our current or future earnings. Our liquidity strategy is guided by policies, formulated and monitored by our senior management and our Asset and Liability Management Committee (“ALCO”), which take into account the demonstrated marketability of our assets, the sources and stability of our funding and the level of unfunded commitments. We regularly evaluate all of our various funding sources with an emphasis on accessibility, stability, reliability and cost-effectiveness. Our principal source of funding is customer deposits, supplemented by short-term and long-term borrowings, primarily from federal funds purchased and FHLB borrowings, which are generally used to fund mortgage finance assets. We also rely on the availability of the mortgage secondary market provided by Ginnie Mae and the GSEs to support the liquidity of our mortgage finance assets.

Throughout 2020 we significantly increased our interest-bearing deposits in other banks to ensure that we have the balance sheet strength to serve our clients during the COVID-19 pandemic. These balances have remained elevated during 2021, although they are beginning to run off as we have purchased investment securities and proactively exited certain high-cost indexed deposit products. The following table summarizes these balances:

Our liquidity needs to support growth in loans held for investment have been fulfilled primarily through growth in our core customer deposits. Our goal is to obtain as much of our funding for loans held for investment and other earning assets as possible from deposits of these core customers. These deposits are generated principally through development of long-term customer relationships, with a significant focus on treasury management products. In addition to deposits from our core customers, we also have access to deposits through brokered customer relationships.

We also have access to incremental deposits through brokered retail certificates of deposit, or CDs. These traditional brokered deposits are generally of short maturities and are used to fund temporary differences in the growth in loan balances as compared to customer deposits. The following table summarizes our period-end and average core customer deposits, relationship brokered deposits and traditional brokered deposits:

We have access to sources of traditional brokered deposits that we estimate to be $7.5 billion. Based on our internal guidelines, we have chosen to limit our use of these sources to a lesser amount.

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We have short-term borrowing sources available to supplement deposits and meet our funding needs. Such borrowings are generally used to fund our mortgage finance loans, due to their liquidity, short duration and interest spreads available. These borrowing sources include federal funds purchased from our downstream correspondent bank relationships (which consist of banks that are smaller than our Bank) and from our upstream correspondent bank relationships (which consist of banks that are larger than our Bank), customer repurchase agreements and advances from the FHLB and the Federal Reserve. The following table summarizes our short-term and other borrowings, all of which mature within one year:

For additional information on our short-term borrowings, see Note 10 - Short-Term and Other Borrowings in the accompanying notes to the consolidated financial statements included elsewhere in this report.

We also have long-term debt outstanding of $928.7 million as of December 31, 2021, comprised of trust preferred securities, subordinated notes and senior unsecured credit linked notes with maturity dates ranging from September 2024 to December 2036. See Note 11 - Long-Term Debt in the accompanying notes to the consolidated financial statements included elsewhere in this report for additional information. The Company may consider raising additional capital, if needed, in public or private offerings of debt or equity securities to supplement deposits and meet our long-term funding needs.

As the Company is a holding company and is a separate operating entity from our subsidiary bank, our primary sources of liquidity are dividends received from the Bank and borrowings from outside sources. Banking regulations may limit the amount of dividends that may be paid by the Bank. See Note 13 - Regulatory Restrictions in the accompanying notes to the consolidated financial statements included elsewhere in this report for additional information regarding dividend restrictions and “Liquidity Risks” included in Part I, Item 1A of this report.

As of December 31, 2021, management is not aware of any events that are reasonably likely to have a material adverse effect on our liquidity, capital resources or operations. In addition, management is not aware of any regulatory recommendations regarding liquidity that would have a material adverse effect on us.

Capital Resources

Our equity capital averaged $3.1 billion for the year ended December 31, 2021 compared to $2.8 billion in 2020. We have not paid any cash dividends on our common stock since we commenced operations and have no plans to do so in the foreseeable future.

For additional information on our capital and stockholders’ equity, Note 13 - Regulatory Restrictions and Note 20 - Material Transactions Affecting Stockholders’ Equity, respectively, in the accompanying notes to the consolidated financial statements included elsewhere in this report.

Critical Accounting Estimates

SEC guidance requires disclosure of “critical accounting estimates.” The SEC defines “critical accounting estimates” as those estimates made in accordance with generally accepted accounting principles that involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on the financial condition or results of operations of the registrant.

We follow financial accounting and reporting policies that are in accordance with accounting principles generally accepted in the United States. The more significant of these policies are summarized in Note 1 - Operations and Summary of Significant Accounting Policies in the notes to the consolidated financial statements included elsewhere in this report. Not all significant accounting policies require management to make difficult, subjective or complex judgments. However, the policy noted below could be deemed to meet the SEC’s definition of a critical accounting policy.

Allowance for Credit Losses

Management considers the policies related to the allowance for credit losses as the most critical to the financial statement presentation. The total allowance for credit losses includes activity related to allowances calculated in accordance with Accounting Standards Codification 326, Credit Losses. The allowance for credit losses is established through a provision for credit losses charged to current earnings. The amount maintained in the allowance reflects management’s continuing evaluation of the credit losses expected to be recognized over the life of the loans in our portfolio. The allowance for credit losses on loans is a valuation account that is deducted from the loans' amortized cost basis to present the net amount expected to be collected on

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the loans. For purposes of determining the allowance for credit losses, the loan portfolio is segregated by product types in order to recognize differing risk profiles among categories, and then further segregated by credit grades. Loans that do not share risk characteristics are evaluated on an individual basis and are not included in the collective evaluation. Management estimates the allowance balance using relevant available information from internal and external sources relating to past events, current conditions and reasonable and supportable forecasts. Adjustments to historical loss information are made to incorporate our reasonable and supportable forecast of future losses at the portfolio segment level, as well as any necessary qualitative adjustments using a Portfolio Level Qualitative Factor (“PLQF”) and/or a Portfolio Segment Level Qualitative Factor (“SLQF”). The PLQF and SLQF are utilized to address factors that are not present in historical loss rates and are otherwise unaccounted for in the quantitative process. A reserve is recorded upon origination or purchase of a loan. See “Summary of Credit Loss Experience” above and Note 4 - Loans Held for Investment and Allowance for Credit Losses on Loans in the accompanying notes to the consolidated financial statements included elsewhere in this report for further discussion of the risk factors considered by management in establishing the allowance for credit losses.