ITEM 1. BUSINESS
Company Overview
Cadence Bancorporation is a financial holding company and a Delaware corporation headquartered in Houston, Texas, and is the parent company of Cadence Bank, National Association (“Cadence Bank”). Formed in 2009 by banking industry veterans, we secured $1.0 billion of capital commitments in 2010 and built our franchise on the foundation established from three successful acquisitions: Cadence Bank, in March 2011, the franchise of Superior Bank in April 2011, and Encore Bank, N.A. in July 2012. On January 1, 2019, we completed our merger with State Bank Financial Corporation (“State Bank”), the holding company for State Bank and Trust Company. Today, we are a middle-market focused commercial relationship bank providing a broad range of banking and wealth management services to businesses, high net worth individuals, business owners and retail customers through a network of 98 branches in Alabama, Florida, Georgia, Texas, Mississippi, and Tennessee. We completed our initial public offering and listing on the NYSE in April 2017 with the ticker “CADE.”
As of December 31, 2019, we had $17.8 billion of assets, $13.0 billion of gross loans, $14.8 billion in deposits and $2.5 billion in shareholders’ equity. We generated $202.0 million and $166.3 million of net income for the years ended December 31, 2019 and 2018, respectively.
Our Strategy
Our strategy is to build a premier commercial bank primarily through organically growing our client base, using mergers and acquisitions as an opportunistic complement to our strategy. We focus on middle-market commercial lending (generally characterized as lending to businesses with annual revenues of $10 million to $500 million) and provide a broad range of banking services to businesses, high net worth individuals, business owners and retail customers. Through our experienced and motivated team of commercial relationship managers and our integrated, client-centric approach to banking, we have successfully grown our businesses. Our management team and experienced relationship managers have long-standing client relationships and operating experience in the markets we serve, and we believe these attributes will continue to position us to build market share. Further, we believe our franchise is positioned for continued growth as a result of (i) our attractive geographic footprint, (ii) our focus and ability to provide differentiated, personalized service to a wide variety of industries and clients, (iii) our stable and customer-driven deposit funding base, (iv) our veteran board of directors, management team and relationship managers, (v) our ability to realize economies of scale, (vi) our capital position and (vii) our credit and risk management processes.
Leverage our Relationships and Service Capabilities to Drive Organic Growth
We have previously demonstrated meaningful loan growth in our markets, driven by our client relationships and client development efforts. We believe our loan growth has been a direct result of our people and our strategy, which focuses on a client-centered, service-oriented approach. Further, we believe our relationship managers’ entrepreneurial spirit, decision-making autonomy, flexibility and market expertise offer us unique growth opportunities not available to many of our peers. We intend to leverage the quality of our team, our existing relationships and our institutional approach to building tailored banking solutions to drive deeper relationships and increase penetration in our markets. Additionally, we are dedicated to investing in our team to ensure they continue to meet our high standard of excellence, while attracting and developing early career talent that embodies our entrepreneurial spirit and drives incremental relationships and loan growth.
Grow our Core Deposit Franchise
The strength of our deposit franchise is derived from the relationships we have with our clients and the strong ties we have to the markets we serve. Our deposit footprint has provided, and we believe will continue to provide, primary support for our loan growth. Deposits comprise over 98% of our total funding as of December 31, 2019. Our deposit growth and funding opportunities to support our loan growth come from our commercial and public-sector relationships, in addition to our retail deposit base. An additional part of our strategy is to continue to enhance our funding sources by expanding the ways in which we serve our customers, including ongoing optimization of our product offerings, treasury management services and client service capabilities, and increased adoption of mobile and digital platforms.
Prudently Invest in our Business to Drive Operating Leverage and Support our Risk Management Framework
We believe it is critical to prudently invest in our business in order to provide the best possible customer experience and build a scalable infrastructure that can support our growth while driving operating leverage. We have a history of making successful investments, starting with the acquisition and integration of our four predecessor banks. Our past investments have yielded significant benefits to our business, and we believe a focus on investing in our people, our technology and our processes will allow us to continue to support operational efficiencies.
Build our Fee-Based Business through New Business Initiatives and Existing Customer Relationships
We have built a successful base of fee businesses-in both our Banking segment and our Financial Services segment-that provide complementary products and services to our core banking business. Each of our fee-based businesses is run by an experienced team and has infrastructure to support additional growth. We believe our integrated approach to our commercial relationships, along with our growing market position and the expertise and knowledge of our team, will provide ongoing new business opportunities.
Engage in Opportunistic Mergers and Acquisitions
We prioritize organic growth but may evaluate acquisition opportunities that we believe could produce attractive returns for our shareholders. We may consider acquisition opportunities that can improve our market position in geographies with attractive demographics and business growth trends (including Texas and the southeast United States), expand our branch network in existing markets, increase our earnings power and/or enhance our suite of products. We believe our acquisition and integration experience provides an advantage in identifying and executing on strategically and financially compelling opportunities that could supplement our organic growth strategy. We have been, and will continue to be, highly selective on acquisitions.
Products and Services
Lending Activities
Our primary strategic objective is to engage in commercial lending to middle-market customers (generally characterized as businesses with annual revenues of $10 million to $500 million) and provide a full array of commercial loans to middle-market commercial businesses, high net worth individuals and business owners. We believe we have a strong team of consumer and commercial bankers to execute on a client-centered, relationship-driven banking model. Our Commercial Banking team focuses on middle-market businesses with an advisory approach that emphasizes understanding the client’s business and offering a broad suite of loan, deposit and treasury management products and services. Within Commercial, our bankers focused on specialized industries have deep expertise and relationships in the sectors served, including the energy, franchise restaurant, healthcare and technology industries.
Our Consumer Banking team consists of experienced professionals that focus on knowing individual clients in order to best meet their financial needs, offering a full complement of loan, deposit and online banking solutions. Our consumer bankers do most of their new lending in the areas served by our branches, which are also where our marketing is focused.
Our loan portfolio includes commercial and industrial loans, residential real estate loans, commercial real estate loans and other consumer loans. The principal risk associated with each category of loans we make is the creditworthiness of the borrower. Borrower creditworthiness is affected by general economic conditions and the attributes of the borrower and the borrower’s market or industry. Attributes of the relevant business market or industry include the competitive environment, customer and supplier availability, the threat of substitutes and barriers to entry and exit.
Commercial and Industrial Loans (“C&I”). As of December 31, 2019, $6.9 billion or 53% of our total bank loan portfolio consisted of C&I loans. Our C&I loans, which are generally made to middle-market businesses, include lines of credit, acquisition finance credit facilities and other types of commercial credit, and typically have maturities of five years or less. At December 31, 2019, an additional $734 million or 6% of our total bank loan portfolio consisted of loans to small businesses, including those loans made through programs administered by the Small Business Administration.
Commercial Real Estate Loans. As of December 31, 2019, $2.8 billion or 21% of our bank loan portfolio consisted of commercial real estate loans. We offer construction financing, acquisition or refinancing of properties primarily located in our markets in Texas and the southeast United States.
Residential Real Estate Loans. As of December 31, 2019, $2.6 billion or 20% of our bank loan portfolio consisted of residential real estate loans. We provide one-to-four family residential real estate loans with terms ranging from 10 to 30 years; however, our portfolio is heavily weighted to the 30-year term. We offer both fixed and adjustable interest rates. We do not originate subprime loans. Loans are typically closed-end first lien loans for purposes of purchasing property, or for refinancing existing loans with or without cash out. Our loans are primarily owner occupied, full documentation loans.
Other Consumer Loans. As of December 31, 2019, $93 million or 1% of our bank loan portfolio consisted of other types of consumer loans. We offer consumer loans to our customers for personal, family and household purposes, auto, boat and personal installment loans.
Shared National Credits (“SNC”). The federal banking agencies define a SNC as any loan(s) extended to a borrower by a supervised institution or any of its subsidiaries and affiliates which aggregates $100 million or more and is shared by three or more institutions under a formal lending agreement or a portion of which is sold to two or more institutions, with the purchasing institutions assuming its pro rata share of the credit risk. As a commercial focused relationship bank, we may participate in syndicated loan offerings as a result of the size of the customers and nature of industries we serve. As of December 31, 2019, we have $2.6 billion of outstanding SNCs, representing 20% of our total loans outstanding.
Our SNC loans are spread across our commercial products with many falling within our specialized industries and are focused on customers where we have ancillary business or believe we can develop such business. Our management team, relationship managers and credit risk management team have extensive experience in the underwriting, due diligence and monitoring of SNC credits. We evaluate SNC loans using the same credit standards we apply in underwriting all our loans.
Deposit Products and Other Funding Sources
We offer our customers a variety of deposit products, including checking accounts, savings accounts, money market accounts, time deposits, and other deposit accounts through multiple channels, including our extensive network of full-service branches, drive-through branches, ATMs, ITMs, and our online, mobile and telephone banking platforms. See “-Marketing and Distribution.” As of December 31, 2019, our deposit portfolio was comprised of 26% noninterest-bearing deposits and 74% interest bearing deposits. We intend to continue our efforts to provide funding for our business from customer relationship deposits.
Deposit flows are significantly influenced by general and local economic conditions, changes in prevailing interest rates, internal pricing decisions and competition. Our deposits are primarily obtained from depositors located in our footprint, and we believe that we have attractive opportunities to capture additional retail and commercial deposits in our markets. In order to attract and retain deposits, we rely on providing quality service, offering a suite of retail and commercial products and services at competitive prices, and introducing new products and services that meet our customers’ needs as they evolve.
Wealth Management
Through our Linscomb & Williams and Cadence Trust brands, we offer wealth management and other fiduciary and private banking services targeted to affluent clients, including individuals, business owners, families and professional service companies. In addition to fiduciary and investment management fee income, we believe these services enable us to build new relationships and expand existing relationships to grow our deposits and loans. Through our wealth management line of business, we offer financial planning, retirement services and trust and investment management by a team of seasoned advisors, providing access, for affluent clients as well as mass market clients, to a wide range of certificates of deposits, mutual funds, annuities, individual retirement accounts, money market accounts and other financial products. Although we do not limit our customers to affluent clients and business owners, the focus of our wealth management line of business is on the “mass affluent” ($500,000 to $2 million in investible assets) and “highly affluent” ($2 million to $5 million in investible assets) markets.
Insurance
Under our Cadence Investment Services brand, we offer, directly and through licensed financial consultants, financial advisors and third-party partners a variety of personal insurance products to retail and commercial customers, including life insurance, disability insurance, long-term care insurance, and buy-sell agreements. Our individual customers purchase our insurance products for income replacement, wealth transfer, estate planning and tax planning purposes.
Correspondent Banking
In 2018, the Company began offering correspondent banking products to financial institutions. In 2019, with the State Bank acquisition, we have expanded our correspondent banking services. Services include white-label treasury management services, liquidity management, Fed Funds accommodations, and commercial real estate participations.
Payroll Services
In January 2019, we acquired Altera Payroll and Insurance (“Altera”) as part of the acquisition of State Bank. This acquisition diversified our revenue beyond existing business lines and complements our other treasury management services. Altera operates as a subsidiary of Cadence Bank, and in partnership with treasury management services, provides payroll services, human resources services, payroll cards and employee health insurance. Altera also offers employer liability insurance, and worker’s compensation through licensed insurance agents.
Financial Products and Services
In addition to traditional banking activities and the other products and services specified above, we provide a broad array of financial services to our customers, including: debit and credit card products, treasury management services, merchant services, employee and payroll benefits solutions (including payroll cards and bank-at-work benefits) automated clearing house services, lock-box services, remote deposit capture services, foreign exchange services, and other treasury services.
Our Markets
We define our markets broadly as Texas and the southeast United States. Our active banking operations are located principally in six states, which we refer to as our geographic footprint (our “footprint”), where we operate 98 branches as of December 31, 2019 throughout Texas, Alabama, Florida, Georgia, Mississippi, and Tennessee. We focus on serving these regional markets, although we also serve specialized industries clients both within our geographic footprint and throughout the United States, as many of our clients in these industries have operations nationwide.
While we are focused on driving growth across all our markets and products, we believe our Texas presence will be the largest contributor to near term asset growth, followed by Georgia, with funding support from our deposit base in Texas and the southeast United States.
Technology Systems
We continue to make significant investments in our information technology systems for our banking, lending, and cash management activities. We believe this is necessary investment in order to offer new products and enhance our overall customer experiences, as well as to provide scale for future growth. Our technology investments include investment in the foundational layer of our infrastructure (including security, data and voice network, storage, and business continuity).
Additionally, our technology investments include investment in the application layer of our technology. We have built a robust technology core for the Treasury Management product suite, including “Allegro,” our single sign on portal for our business customers to access our Treasury Management products. Supported by this technology core, our Treasury Management product suite is competitive with small community banks as well as large regional and money center banks. Additionally, we operate the “Fluent by Cadence” platform, our online, mobile and other digital banking solution for consumer and small business banking. By leveraging the same platform as “Allegro,” we can centrally service and manage all digital banking activities and provide a seamless experience to our customers as they migrate from a small business to one that leverages our Treasury Management services.
We have also invested in video teller capabilities which enable our customers to interact with tellers outside of regular banking hours through interactive drive-throughs.
Credit Policy and Procedures
General. Our credit policy requires that key risks be identified and measured, documented and mitigated, to the extent possible, to seek to ensure the soundness of our loan portfolio. We require various levels of internal approvals based on the characteristics of our loans, including the size of the exposure. We also have specialized underwriting guidelines for loans in our specialized industries that we believe reflect the unique characteristics of these industries. Our credit policy also provides guidelines for the underwriting of loans to individuals along with the regulatory requirements to ensure that all loan applications are evaluated subject to our fair lending policy. We believe that the guidelines required by our credit policies enhance internal responsibility and accountability for underwriting decisions and permit us to monitor the performance of credit decision-making.
Credit Risk Management. Using our dual credit risk rating (“DCRR”) system, it is our policy to assign risk ratings to all commercial loan exposures using our internal credit risk rating system. The assignment of loan risk ratings is the primary responsibility of the lending officer concurrent with approval from the credit officer reviewing and recommending approval of the credit. The assignment of commercial risk ratings is done on a transactional basis using scorecards. We use a total of nine different scorecards that accommodate various areas of lending. Each scorecard contains two main components: probability of default (“PD”) and loss given default (“LGD”). Each component is assessed using a multitude of both qualitative and quantitative scoring elements, which will generate a percentage for each component. The key elements assessed in the scorecard for PD are financial performance and trends as well as qualitative measures. The key elements for LGD are collateral quality and the structure of the loan. The PD percentage and LGD percentage are converted into PD and LGD risk ratings for each loan. The PD rating is used as our grade of record, while the LGD rating is utilized in both our allowance estimate as well as pricing model. Loans with PD ratings of 1 through 8 are loans that we rate internally as “Pass.” Loans with PD ratings of 9 through 13 are rated internally as “Criticized” and represent loans for which one or more potential or defined weaknesses exists. Loans with PD ratings of 10 through 13 are also considered “Classified” and represent loans for which one or more defined weaknesses exist. These classifications are consistent with regulatory guidelines. Consumer purpose loan risk classification is done in accordance with the Uniform Retail Credit Classification, based on delinquency and accrual status.
Our credit risk management is overseen by our Board of Directors, including its Risk Management Committee, and our Senior Credit Risk Management Committee. Our Senior Credit Risk Management Committee has seven standing members, including the Chief Executive Officers of Cadence Bancorporation and Cadence Bank, Cadence Bank’s President, our Chief Credit Administration Executive, who serves as chairman of the committee, our Enterprise Risk Management Executive, our Chief Risk Officer, and our Chief Credit Underwriting Executive, who serves as vice chairman of the committee. The committee is responsible for reviewing our credit portfolio management information, including asset quality trends, concentration reports, policy, financial and documentation exceptions, delinquencies, charge-offs, and nonperforming assets. The approval of the Senior Credit Risk Management Committee is required for changes to our credit policy as well as lending and wire authority.
Concentration Limits. Our policies establish concentration limits for various industries within the commercial portfolio as well as commercial real estate, leveraged lending and other regulatory categories. Concentration limits are monitored and reassessed on a periodic basis and approved by the Board of Directors on an annual basis.
Credit Approval Process. The approval of our Senior Loan Committee is generally required for relationships in an amount greater than $5.0 million. The Senior Loan Committee has seven standing voting members, including five members of the Senior Credit Risk Management Committee. Two “no” votes will result in declining a credit request.
For loans in an amount greater than $5 million that are risk rated 10 or worse, approval of the Credit Transition Committee is generally required. The Credit Transition Committee has six standing members, including our Director of Special Assets Group, who serves as chairman of the committee, our Chief Credit Administration Executive, and our Chief Credit Underwriting Executive, who serves as vice chairmen. Two “no” votes will result in declining a credit application. There is a credit executive assigned to each line of business who holds the primary responsibility for the approval process outside of the loan approval committees.
Portfolio Monitoring and Reporting. We believe that an important part of our assessment of client risk is the ongoing completion of periodic risk rating reviews. As part of these reviews, we seek to review the risk ratings of each facility within a customer relationship and may recommend an upgrade or downgrade to the risk ratings. Our policy is to review two times per year all customer relationships with an aggregate exposure of $10 million or greater as well as all SNC’s. Additionally, all customer relationships with an aggregate exposure of $2.5 million to $10.0 million are reviewed annually. Further, customer relationships with an aggregate exposure of $1.0 million and greater with pass watch or criticized risk ratings are reviewed quarterly. Certain relationships are exempt from review, such as relationships where our exposure is cash-secured. An updated risk rating scorecard is required during each risk review as well as with any credit event that requires credit approval.
Marketing and Distribution
As of December 31, 2019, we conduct our banking business through 98 branches located in Texas and five states in the southeast United States. Our distribution network also includes ATMs, ITMs, fully integrated online banking and a telephone banking service. In addition, our customers have free access to Publix Presto! ATMs located throughout Alabama, Florida, North Carolina, South Carolina and Tennessee and Allpoint ATMs worldwide. Our ATMs are enabled for several networks, including Visa, Discover, MasterCard, NYCE, Plus, Cirrus, Pulse, American Express and Quest.
We target growing companies and middle-market businesses, as well as individual consumers throughout Texas and the southeast United States. In order to market our deposit products and financial services, we use local print advertising and direct mail and provide sales incentives for our employees. We market our lending products through our experienced relationship managers, who rely on robust calling efforts and relationship banking to develop relationships with customers that result in business growth and product sales. Our compensation plans for our relationship managers include incentives based on achievement of certain loan, deposit, fee, income and profitability metrics that are established as individual performance goals that support our business plan each year.
Competition
The financial services industry in general and in our markets in Texas and the southeast United States are highly competitive. We compete actively with national, regional and local financial services providers, including banks, thrifts, credit unions, mortgage bankers and finance companies, money market mutual funds and other financial institutions, some of which are not subject to the same degree of regulation and restrictions imposed upon us. See “Risk Factors-Risks Relating to Our Business-We face significant competition to attract and retain customers and clients, which could adversely affect our growth and profitability.”
Competition among providers of financial products and services continues to increase, with consumers having the opportunity to select from a growing variety of traditional and non-traditional alternatives. The primary factors driving commercial and consumer competition for loans and deposits are the interest rates, the fees charged, the levels of customer service and the range of products and services offered. In addition, other competitive factors include the location and hours of our branches and ATMs.
In addition to the terms of loans and deposits, we compete with other financial institutions with respect to the terms of swaps and letters of credit that we offer our customers and the fraud prevention products and other technological aspects of customers’ accounts that we provide, including compatibility with our commercial customers’ accounting systems.
Supervision and Regulation
Banking is a complex, highly regulated industry. Consequently, our growth and earnings performance can be affected, not only by management decisions and general and local economic conditions, but also by the statutes administered by, and the regulations and policies of, various governmental regulatory authorities. These authorities include, but are not limited to, the Federal Reserve Board (“Federal Reserve”), the Office of the Comptroller of the Currency (“OCC”), the Federal Deposit
Insurance Corporation (“FDIC”), Consumer Financial Protection Bureau (“CFPB”), various state banking regulators, the Internal Revenue Service (“IRS”) and state taxing authorities. The effect of these statutes, regulations and policies and any changes to any of them can be significant and cannot be predicted.
The primary goals of the bank regulatory structure are to maintain a safe and sound banking system and to facilitate the conduct of sound monetary policy. In furtherance of those goals, the U.S. Congress and the individual states have created numerous regulatory agencies and enacted numerous laws, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”), that govern banks and the banking industry. The system of supervision and regulation applicable to the Company establishes a comprehensive framework for our operations and is intended primarily for the protection of the Deposit Insurance Fund (“DIF”), our depositors and the public, rather than our shareholders and creditors.
The Dodd-Frank Act and its implementing regulations impose additional supervisory obligations on banking organizations with $10.0 billion or more in total consolidated assets. The Economic Growth, Regulatory Relief, and Consumer Protection Act (the “EGRRCPA”), enacted into law on May 24, 2018, modified several requirements of the Dodd-Frank Act. After September 30, 2018, which was the fourth consecutive quarter in which total average consolidated assets exceeded $10.0 billion, we and Cadence Bank are, among other requirements:
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required to calculate our FDIC deposit insurance assessment using the large bank pricing rule;
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subject to the restrictions on proprietary trading and investment in mutual or hedge funds under the Volcker Rule;
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subject to more frequent regulatory examinations; and
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subject to examination for compliance with federal consumer protection laws by the CFPB.
In addition, after June 30, 2018, Cadence and Cadence Bank became subject to the Durbin Amendment to the Dodd-Frank Act regarding limits on debit card interchange fees. The Durbin Amendment gave the Federal Reserve the authority to establish rules regarding interchange fees charged for electronic debit transactions by a payment card issuer that, together with its affiliates, has assets of $10.0 billion or more and to enforce a statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. The Federal Reserve has adopted rules under this provision that limit the swipe fees that a debit card issuer can charge a merchant for a transaction to the sum of 21 cents and five basis points times the value of the transaction, plus up to one cent for fraud prevention costs.
New regulations and statutes are regularly proposed that contain wide-ranging proposals for altering the structures, regulations and competitive relationships of financial institutions operating in the United States. The federal banking agencies have issued several significant new regulations as a result of the Dodd-Frank Act and a number of additional regulations are pending or may be proposed as a result of the EGRRCPA. We cannot predict whether or in what form any proposed regulation or statute will be adopted or the extent to which any of our businesses may be affected by any new regulation or statute.
The following is an attempt to summarize some of the relevant laws, rules and regulations governing banks and bank holding companies, but does not purport to be a complete summary of all applicable laws, rules and regulations governing banks. The descriptions are qualified in their entirety by reference to the specific statutes and regulations discussed.
Bank Holding Company Regulation
The Company is a financial holding company registered under the Bank Holding Company Act of 1956 (the “BHC Act”) and is subject to supervision and regulation by the Federal Reserve. Federal laws subject financial holding companies to restrictions on the types of activities in which they may engage and to a range of supervisory requirements and activities, including regulatory enforcement actions, for violation of laws and policies.
Activities Closely Related to Banking
The BHC Act prohibits a bank holding company, with certain limited exceptions, from acquiring direct or indirect ownership or control of any voting shares of any company that is not a bank or from engaging in any activities other than those of banking, managing or controlling banks and certain other subsidiaries or furnishing services to or performing services for its subsidiaries. Bank holding companies also may engage in or acquire interests in companies that engage in a limited set of activities that are closely related to banking or managing or controlling banks.
If a company has elected to become a financial holding company (an “FHC”), it may engage in a broader set of activities, including insurance underwriting and broker-dealer services, as well as activities that are jointly determined by the Federal Reserve and the Treasury Department to be financial in nature or incidental to such financial activity. FHCs may also engage in activities that are determined by the Federal Reserve to be complementary to financial activities. To qualify as an FHC, the bank holding company and all subsidiary depository institutions must be well managed and well capitalized. Additionally, each subsidiary depository institution of the bank holding company must have received at least a “Satisfactory” rating on its most recent Community Reinvestment Act of 1977 (“CRA”) examination. Failure to meet any of these requirements may result in limitations on activities and acquisitions.
Safe and Sound Banking Practices
Bank holding companies are not permitted to engage in unsafe and unsound banking practices. The Federal Reserve may order a bank holding company to terminate an activity or control of a non-bank subsidiary if such activity or control constitutes a significant risk to the financial safety, soundness or stability of a subsidiary bank and is inconsistent with sound banking principles. Regulation Y and capital rules also require a holding company to receive the prior approval of the Federal Reserve for certain redemption or repurchase of its own equity securities.
Consistent with the Dodd-Frank Act codification of the Federal Reserve’s policy that bank holding companies must serve as a source of financial strength for their subsidiary banks, the Federal Reserve has stated that, as a matter of prudence, a bank holding company generally should not maintain a rate of distributions to shareholders unless its available net income has been sufficient to fully fund the distributions, and the prospective rate of earnings retention appears consistent with a bank holding company’s capital needs, asset quality and overall financial condition.
In addition, the Federal Reserve Supervisory Letter SR 09-4 provides guidance on the declaration and payment of dividends, capital redemptions and capital repurchases by a bank holding company. Supervisory Letter SR 09-4 provides that, as a general matter, a bank holding company should eliminate, defer or significantly reduce its dividends if: (i) the bank holding company’s net income available to shareholders for the past four quarters, net of dividends previously paid during that period, is not sufficient to fully fund the dividends, (ii) the bank holding company’s prospective rate of earnings retention is not consistent with the bank holding company’s capital needs and overall current and prospective financial condition, or (iii) the bank holding company will not meet, or is in danger of not meeting, its minimum regulatory capital adequacy ratios. Failure to do so could result in a supervisory finding that the bank holding company is operating in an unsafe and unsound manner.
Limitations on the Bank paying dividends could, in turn, affect our ability to pay dividends to our shareholders. For more information concerning the Bank’s ability to pay dividends, see below.
The Federal Reserve has broad authority to prohibit activities of bank holding companies and their non-banking subsidiaries that represent unsafe and unsound banking practices or which constitute violations of laws or regulations. Notably, the Financial Institutions Reform, Recovery and Enforcement Act of 1989 (“FIRREA”) provides that the Federal Reserve can assess civil money penalties for such practices or violations which can be as high as $1.0 million per day. FIRREA contains expansive provisions regarding the scope of individuals and entities against which such penalties may be assessed.
Annual Reporting and Examinations
The Company is required to file annual and quarterly reports with the Federal Reserve and such additional information as the Federal Reserve may require pursuant to the BHC Act. The Federal Reserve may examine a bank holding company or any of its subsidiaries and charge the company for the cost of such an examination.
Volcker Rule
Section 619 of the Dodd-Frank Act, known as the Volcker Rule, prohibits any bank, bank holding company, or affiliate (referred to collectively as “banking entities”) from engaging in two types of activities: “proprietary trading” and the ownership or sponsorship of private equity or hedge funds that are referred to as “covered funds.” In December 2013, the federal banking agencies, the SEC, and the Commodities Futures Trading Commission, finalized a regulation to implement the Volcker Rule. After the enactment of the EGRRCPA in May 2018, Volcker Rule limitations apply to banking entities with $10.0 billion or more in total consolidated assets. Under the Volcker Rule implementing regulations, banking entities have two years to conform its investments and implement the required compliance plan.
Regulatory Capital
Cadence and Cadence Bank are each required to comply with applicable capital adequacy standards established by the federal banking agencies. In 2013, the federal bank regulators approved the final Basel III Rules implementing the Basel III framework as well as certain provisions of the Dodd-Frank Act. The Basel III Rules, among other things, (i) introduced a new capital measure called Common Equity Tier 1 (“CET1”), (ii) specified that Tier 1 capital consists of CET1 and “Additional Tier 1 capital” instruments meeting certain revised requirements, (iii) defined CET1 narrowly by requiring that most deductions/ adjustments to regulatory capital measures be made to CET1 and not to the other components of capital, and (iv) expanded the scope of the deductions/adjustments to capital as compared to previously existing regulations. For more information, see the “Regulatory Capital” section of Item 7. “Management’s Discussion and Analysis of Financial Condition and Results of Operations” of this Annual Report on Form 10-K.
FHCs and banks are also required to comply with minimum leverage capital requirements. These requirements provide for a minimum of Tier 1 capital to total consolidated average tangible assets (as defined for regulatory purposes), called the “leverage ratio,” of 4.0% for all bank holding companies.
Imposition of Liability for Undercapitalized Subsidiaries
The Federal Deposit Insurance Corporation Improvement Act of 1991 (“FDICIA”) required each federal banking agency to revise its risk-based capital standards to ensure that those standards take adequate account of interest rate risk, concentration of credit risk and the risks of non-traditional activities.
As discussed above, in accordance with the law, each federal banking agency has specified, by regulation, the levels at which an insured institution would be considered well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. As of December 31, 2019, the Bank exceeded the capital levels required to be deemed well capitalized.
Additionally, FDICIA requires bank regulators to take prompt corrective action to resolve problems associated with insured depository institutions.
Under these prompt corrective action provisions of FDICIA, if a controlled bank is undercapitalized, then the regulators could require the bank to submit a capital restoration plan. If an institution becomes significantly undercapitalized or critically undercapitalized, additional and significant limitations are placed on the institution. The capital restoration plan of an undercapitalized institution will not be accepted by the regulators unless each company having control of the undercapitalized institution guarantees the subsidiary’s compliance with the capital restoration plan until it becomes adequately capitalized. The Company has control of the bank for the purpose of this statute.
Further, by statute and regulation, a bank holding company must serve as a source of financial and managerial strength to each bank that it controls and, under appropriate circumstances, may be required to commit resources to support each such controlled bank. This support may be required at times when the bank holding company may not have the resources to provide the support. In addition, if the Federal Reserve believes that a bank holding company’s activities, assets or affiliates represent a significant risk to the financial safety, soundness or stability of a controlled bank, then the Federal Reserve could require the bank holding company to terminate the activities, liquidate the assets or divest the affiliates. The regulators may require these and other actions in support of controlled banks even if such actions are not in the best interests of the bank holding company or its shareholders.
Acquisitions by Bank Holding Companies
The BHC Act requires every bank holding company to obtain the prior approval of the Federal Reserve before (1) acquiring more than 5% of any class of voting stock of any bank or other bank holding company, (2) acquiring all or substantially all of the assets of any bank or bank holding company, or (3) merging or consolidating with any other bank holding company. Additionally, the BHC Act provides that the Federal Reserve may not approve any of these transactions if it would result in or tend to create a monopoly or substantially lessen competition or otherwise function as a restraint of trade, unless the anti-competitive effects of the proposed transaction are clearly outweighed by the public interest in meeting the convenience and needs of the community to be served. The Federal Reserve is also required to consider the financial and managerial resources and prospects of the bank holding companies and banks concerned and the convenience and needs of the community to be served. The Federal Reserve’s consideration of financial resources generally focuses on capital adequacy. As a result of the USA PATRIOT Act of 2001, which is discussed below, the Federal Reserve is required to consider the record of a bank holding company and its subsidiary bank(s) in combating money laundering activities in its evaluation of bank holding company merger or acquisition transactions. The Dodd-Frank Act also amended the BHC Act to require consideration of the extent to which a proposed acquisition, merger or consolidation would result in greater or more concentrated risks to the stability of the U.S. banking or financial system.
Control Acquisitions
Subject to various exceptions, the BHC Act and the Change in Bank Control Act of 1978, together with related regulations, require Federal Reserve approval prior to any person or company acquiring “control” of a bank holding company, such as the Company. Control is conclusively presumed to exist if a person or company acquires 25% or more of any class of voting securities of the bank holding company. Control is rebuttably presumed to exist if a person or entity acquires 10% or more, but less than 25%, of any class of voting securities and that person or entity, by such acquisition, becomes the single largest holder of that class of voting securities.
Interstate Acquisitions
Under the Riegle-Neal Interstate Banking and Branching Efficiency Act of 1994 (the “Riegle-Neal Act”), a bank holding company may acquire banks in states other than its home state, subject to any state requirement that the bank has been organized and operating for a minimum period of time, not to exceed five years, and the requirement that the bank holding company not control, prior to or following the proposed acquisition, more than 10% of the total amount of deposits of insured depository institutions nationwide or, unless the acquisition is the bank holding company’s initial entry into the state, more than 30% of such deposits in the state (or such lesser or greater amount set by the state). The Riegle-Neal Act also authorizes banks to merge across state lines, thereby creating interstate branches. The Dodd-Frank Act permits a national or state bank, with the approval of its regulator, to open a branch in any state if the law of the state in which the branch is located would permit the establishment of the branch if the bank were a bank chartered in that state. National banks may provide trust services in any state to the same extent as a trust company chartered by that state.
Anti-tying Restrictions
Bank holding companies and their affiliates are prohibited from tying the provision of certain services, such as extensions of credit, to other non-deposit services offered by a holding company or its affiliates.
Bank Regulation
Cadence Bank
Cadence Bank is a national banking association, which is subject to regulation and supervision primarily by the OCC and secondarily by the Federal Reserve and the FDIC. Cadence Bank is subject to requirements and restrictions under federal law, including requirements to maintain reserves against deposits, restrictions on the types and amounts of loans that may be granted and the interest that may be charged thereon and limitations on the types of investments that may be made and the types of services that may be offered. Various consumer laws and regulations also affect the operations of the Bank.
The OCC regularly examines the Bank. The FDIC may also periodically examine and evaluate insured banks.
Standards for Safety and Soundness
As part of FDICIA’s efforts to promote the safety and soundness of depository institutions and their holding companies, the federal banking regulators are required to have in place regulations specifying operational and management standards (addressing internal controls, loan documentation, credit underwriting and interest rate risk), asset quality and earnings. As discussed above, the Federal Reserve, the OCC, and the FDIC have extensive authority to police unsafe or unsound practices and violations of applicable laws and regulations by depository institutions and their holding companies. For example, the FDIC may terminate the deposit insurance of any institution that it determines has engaged in an unsafe or unsound practice. The agencies can also assess civil money penalties of up to $1.0 million per day, issue cease-and-desist or removal orders, seek injunctions and publicly disclose such actions.
The OCC also has restrictions on the payment of dividends by national banks. Cadence Bank may not, without the prior approval of the OCC, declare a dividend if the total amount of dividends declared by it in the current year, including the proposed dividend, exceeds certain levels of net and retained income. In addition, under the National Bank Act, Cadence Bank may not declare a dividend in excess of its “undivided profits.” See below for additional discussion regarding the Bank’s ability to pay dividends.
The present and future dividend policy of Cadence Bank is subject to the discretion of its Board of Directors. In determining whether to pay dividends to the Company and, if made, the amount of the dividends, the board of directors of Cadence Bank considers many of the same factors discussed above. Cadence Bank cannot guarantee that it will have the financial ability to pay dividends to the Company, or if dividends are paid, that they will be sufficient for Cadence to make distributions to shareholders. Cadence Bank is not obligated to pay dividends.
Restrictions on Transactions with Affiliates
Section 23A of the Federal Reserve Act imposes quantitative and qualitative limits on transactions between a bank and any affiliate and requires certain levels of collateral for extensions of credit to affiliates and certain other transactions involving affiliates. It also limits the amount of advances to third parties that are collateralized by the securities or obligations of the Company. Section 23B requires that certain transactions between the Bank and its affiliates must be on terms substantially the same, or at least as favorable, as those prevailing at the time for comparable transactions with or involving other nonaffiliated companies. In the absence of such comparable transactions, any transaction between the banks and their affiliates must be on terms and under circumstances, including credit standards, which in good faith would be offered to or would apply to nonaffiliated companies.
Capital Adequacy
In addition to the capital rules applicable to both banks and bank holding companies discussed above, under the prompt corrective action regulations, the federal bank regulators are required and authorized to take supervisory actions against undercapitalized banks. For this purpose, a bank is placed in one of five categories based on the bank’s capital (as of the new capital rules discussed above): well capitalized, adequately capitalized, undercapitalized, significantly undercapitalized and critically undercapitalized. Currently, the quantitative requirements for the categories are:
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well-capitalized (at least 5% leverage capital, 6.5% common equity Tier 1 capital, 8% Tier 1 capital and 10% total capital);
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adequately capitalized (at least 4% leverage capital, 4.5% common equity Tier 1 capital, 6% Tier 1 capital and 8% total capital);
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undercapitalized (less than 4% leverage capital, 4.5% common equity Tier 1 capital, 6% Tier 1 capital and 8% total capital);
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significantly undercapitalized (less than 3% leverage capital, 3% common equity Tier 1 capital, 4% Tier 1 capital and 6% total capital); and
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critically undercapitalized (less than 2% tangible capital).
Federal banking regulators are required to take various mandatory supervisory actions and are authorized to take other discretionary actions with respect to institutions in the three undercapitalized categories. The severity of the action depends upon the capital category in which the institution is placed. Generally, subject to a narrow exception, banking regulators must appoint a receiver or conservator for an institution that is “critically undercapitalized.” The federal banking agencies have specified by regulation the relevant capital level for each category. An institution that is categorized as “undercapitalized,” “significantly undercapitalized,” or “critically undercapitalized” is required to submit an acceptable capital restoration plan to its appropriate federal banking agency, which, for the Bank, is the OCC.
Failure to meet capital guidelines could subject the Bank to a variety of enforcement remedies, including issuance of a capital directive, the termination of deposit insurance by the FDIC, a prohibition on accepting brokered deposits and other restrictions on our business.
Deposit Insurance
The FDIC insures the deposits of federally insured banks up to prescribed statutory limits for each depositor, through the DIF and safeguards the safety and soundness of the banking and thrift industries. The Dodd-Frank Act permanently raised the standard maximum deposit insurance amount to $250,000.
Cadence Bank pays deposit insurance assessments to the FDIC based on an assessment rate established by the FDIC. FDIC assessment rates for large institutions with more than $10.0 billion in assets, such as Cadence Bank, are calculated on a scorecard methodology that seeks to capture both the probability that an individual institution will fail and the magnitude of the impact on the DIF if such a failure occurs. Cadence Bank became subject to the scorecard methodology in the third quarter of 2018. The FDIC has the authority to make discretionary adjustments to the total score, up or down, based upon significant risk factors that are not adequately captured in the scorecard. For large institutions, including Cadence Bank, the initial base assessment rate ranges from 3 basis points to 30 basis points on an annualized basis. After the effect of the potential base rate adjustments, the total base assessment rate could range from 1.5 basis points to 40 basis points on an annualized basis. The deposit insurance assessment base is calculated based upon the average of total assets less the average tangible equity of the insured depository institution during the assessment period, less allowable deductions.
The Federal Deposit Insurance Act establishes a minimum ratio of the DIF to estimated insured deposits of 1.15% prior to September 30, 2020 and 1.35% thereafter. Additionally, beginning July 1, 2016, the FDIC imposed a surcharge on the quarterly assessments of insured depository institutions with total consolidated assets of $10.0 billion or more, such as Cadence Bank (the surcharge only applied to Cadence Bank for the quarter ended September 30, 2018). The surcharge applied until the DIF first reaches or exceeds 1.35%, which occurred at September 30, 2018 and thus, the surcharge no longer applies.
Consumer Financial Protection Bureau (“CFPB”)
The Dodd-Frank Act created the CFPB, which is granted broad rulemaking, supervisory and enforcement powers under various federal consumer financial protection laws, including the Equal Credit Opportunity Act, Truth in Lending Act, Real Estate Settlement Procedures Act, Fair Credit Reporting Act, Fair Debt Collection Practices Act, the Consumer Financial Privacy provisions of the Gramm-Leach-Bliley Act and certain other statutes. The CFPB has examination and primary enforcement authority with respect to depository institutions with $10.0 billion or more in assets. The CFPB has authority to prevent unfair, deceptive or abusive practices in connection with the offering of consumer financial products. As noted above, the Company and Cadence Bank exceeded $10.0 billion in total consolidated assets for four consecutive quarters as of September 30, 2018 and are now subject to examination by the CFPB.
The CFPB has issued several regulations related to the origination of mortgages, foreclosures, and overdrafts, as well as many other consumer issues. Additionally, the CFPB has proposed, or will be proposing, additional regulations or modifying existing regulations that directly relate to our business. Although it is difficult to predict at this time the extent to which the CFPB’s final rules impact the operations and financial condition of the bank, such rules may have a material impact on the bank’s compliance costs, compliance risk and fee income.
Financial Privacy and Cybersecurity
Under the Right to Financial Privacy Act of 1978, which imposes a duty to maintain confidentiality of consumer financial records and prescribes procedures for complying with administrative subpoenas of financial records, financial institutions are required to disclose their policies for collecting and protecting confidential information. Customers generally may prevent financial institutions from sharing personal financial information with nonaffiliated third parties except for third parties that market the institutions’ own products and services. Additionally, financial institutions generally may not disclose consumer account numbers to any nonaffiliated third party for use in telemarketing, direct mail marketing or other marketing through electronic mail to consumers.
The federal banking regulators regularly issue guidance regarding cybersecurity intended to enhance cyber risk management standards among financial institutions. A financial institution is expected to establish multiple lines of defense and to ensure their risk management processes address the risk posed by potential threats to the institution. A financial institution’s management is expected to maintain sufficient processes to effectively respond and recover the institution’s operations after a cyber-attack. A financial institution is also expected to develop appropriate processes to enable recovery of data and business operations if a critical service provider of the institution falls victim to this type of cyber-attack. The Cadence Information Security Program reflects the requirements of this guidance.
PATRIOT Act, International Money Laundering Abatement and Financial Anti-Terrorism Act and Bank Secrecy Act
A major focus of governmental policy on financial institutions has been aimed at combating money laundering and terrorist financing. The PATRIOT Act and the International Money Laundering and Financial Anti-Terrorism Act of 2001 substantially broadened the scope of U.S. anti-money-laundering laws and penalties, specifically related to the Bank Secrecy Act, and expanded the extra-territorial jurisdiction of the United States. The U.S. Treasury Department has issued a number of implementing regulations which apply various requirements of the PATRIOT Act to financial institutions such as Cadence Bank. These regulations impose obligations on financial institutions to maintain appropriate policies, procedures and controls to detect, prevent and report money laundering and terrorist financing and to verify the identity of their customers.
Failure of a financial institution and its holding company to maintain and implement adequate programs to combat money laundering and terrorist financing, or to comply with relevant laws and regulations, could have serious legal, reputational and financial consequences for the institution. Because of the significance of regulatory emphasis on these requirements, Cadence Bank will continue to expend significant staffing, technology and financial resources to maintain programs designed to ensure compliance with applicable laws and regulations and an effective audit function for testing of the banks’ compliance with the Bank Secrecy Act on an ongoing basis.
Community Reinvestment Act
The CRA requires that, in connection with examinations of financial institutions within its jurisdiction, the OCC evaluates the record of each financial institution in meeting the credit needs of its local community, including low and moderate-income neighborhoods. The performance of a financial institution in meeting the credit needs of its community is a factor that must be taken into consideration when the federal banking agencies evaluate applications related to mergers and acquisitions, as well as branch openings and relocations. Additionally, financial institutions must publicly disclose the terms of various CRA-related agreements.
Failure to adequately meet the credit needs of our community in accordance with the CRA could prevent us from pursuing our business strategy. Any CRA rating below “Satisfactory” for the Bank could restrict the Company’s ability to undertake certain activities, including any merger or acquisition that our management and Board of Directors may otherwise desire to pursue, and may prevent or materially delay the consummation of future mergers or acquisitions or the opening of new branch locations, until the Bank’s rating improves. In addition, as described above, an FHC faces limitations on activities and acquisitions if its subsidiary depository institutions do not have at least a “Satisfactory” CRA rating. Our latest CRA rating assessment period was January 1, 2015 through December 31, 2018, for which our public CRA rating was “Satisfactory”.
On December 13, 2019, the FDIC and the OCC issued a joint Notice of Proposed Rulemaking (“NPR”) to comprehensively amend the CRA’s implementing regulations. The rules were last substantially updated nearly 25 years ago. The proposed revisions would seek to modernize and update CRA regulations to better achieve the law’s underlying purpose of encouraging banks to serve their communities. Specifically, the NPR seeks to modernize the CRA regulations by:
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Clarifying and expanding what qualifies for CRA credit;
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Expanding where CRA activity counts by creating additional “assessment areas’ tied to where deposits originate;
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Providing a more objective method to measure CRA performance by establishing activity thresholds as a percentage of domestic deposits; and
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Revising data collection, recordkeeping, and reporting requirements.
Comments on the NPR are due to the FDIC on or before 60 days after publication in the Federal Register. The OCC recently extended the comment period for another 30 days.
Other Regulations
Interest and other charges that the Bank collects or contracts for are subject to state usury laws and federal laws concerning interest rates. The Bank’s loan operations also are subject to federal laws applicable to credit transactions, such as:
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the Truth in Lending Act, governing disclosures of credit terms to consumer borrowers;
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the Home Mortgage Disclosure Act, requiring financial institutions to provide information to enable the public and public officials to determine whether a financial institution is fulfilling its obligation to help meet the housing needs of the community it serves;
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the Equal Credit Opportunity Act, prohibiting discrimination on the basis of race, creed or other prohibited factors in extending credit;
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the Fair Credit Reporting Act, governing the use and provision of information to credit reporting agencies;
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the Fair Debt Collection Practices Act, governing the manner in which consumer debts may be collected by collection agencies; and
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the rules and regulations of the various governmental agencies charged with the responsibility of implementing these federal laws.
In addition, the Bank’s deposit operations are subject to the Electronic Funds Transfer Act and Regulation E issued by the Federal Reserve to implement that act, which govern automatic deposits to and withdrawals from deposit accounts and customers’ rights and liabilities arising from the use of ATMs and other electronic banking services.
Concentrated Commercial Real Estate Lending Regulations
The Federal Reserve and other federal banking regulatory agencies promulgated guidance governing financial institutions with concentrations in commercial real estate lending. The guidance provides that a bank has a concentration in commercial real estate lending if (i) total reported loans for construction, land development and other land represent 100% or more of total capital or (ii) total reported loans secured by multifamily and non-farm residential properties and loans for construction, land development and other land represent 300% or more of total capital and the bank’s commercial real estate loan portfolio has increased 50% or more during the prior 36 months. If a concentration is present, management must employ heightened risk management practices including board and management oversight and strategic planning, development of underwriting standards, risk assessment and monitoring through market analysis and stress testing and increasing capital requirements.
Compliance with the above laws and regulations add significantly to the cost of operating the Company and the Bank and thus have a negative impact on profitability. We would also note that there has been a tremendous expansion experienced in recent
years by certain financial service providers that are not subject to the same rules and regulations as the Company and the Bank. These institutions, because they are not so highly regulated, have a competitive advantage over us and the Bank and may continue to draw large amounts of funds away from traditional banking institutions, with a continuing adverse effect on the banking industry in general.
Effect of Governmental Monetary Policies
The commercial banking business is affected not only by general economic conditions but also by both U.S. fiscal policy and the monetary policies of the Federal Reserve. Some of the instruments of fiscal and monetary policy available to the Federal Reserve include changes in the discount rate on member bank borrowings, the fluctuating availability of borrowings at the “discount window,” open market operations, the imposition of and changes in reserve requirements against member banks’ deposits and assets of foreign branches, the imposition of and changes in reserve requirements against certain borrowings by banks and their affiliates, and the placing of limits on interest rates that member banks may pay on time and savings deposits. Such policies influence to a significant extent the overall growth of bank loans, investments, and deposits and the interest rates charged on loans or paid on time and savings deposits. We cannot predict the nature of future fiscal and monetary policies and the effect of such policies on the future business and our earnings.
Employees
As of December 31, 2019, Cadence had 1,849 full-time equivalent employees. None of our employees is represented by any collective bargaining unit or is a party to a collective bargaining agreement. We believe that our relations with our employees are good.
Availability of Information
Our investor website can be accessed at www.cadencebancorporation.com under “Investor Relations.” Our Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to those reports filed or furnished to the Securities and Exchange Commission (the “SEC”) pursuant to Section 13(a) or Section 15(d) of the Securities Exchange Act of 1934, as amended, are available free of charge on our investor website under the caption “SEC Filings” as soon as reasonably practicable after we electronically file such materials with, or furnish such materials to, the SEC. No information contained on any of our websites is intended to be included as part of, or incorporated by reference into, this Annual Report on Form 10-K. Documents filed with the SEC are also available free of charge on the SEC’s website at www.sec.gov.
ITEM 1A.
ITEM 1A. RISK FACTORS
There are risks, many beyond our control, which could cause our results to differ significantly from management’s expectations. Some of these risk factors are described below. Any factor described in this Annual Report on Form 10-K (“Annual Report”) could, by itself or together with one or more other factors, adversely affect our business, results of operations and/or financial condition. Additional risks and uncertainties not currently known to us or that we currently consider to not be material also may materially and adversely affect us. In assessing these risks, you should also refer to other information disclosed in our SEC filings, including the financial statements and notes thereto.
Risks Relating to Our Business
As a business operating in the financial services industry, our business and operations may be adversely affected in numerous and complex ways by economic conditions.
Our businesses and operations, which primarily consist of commercial banking activities, including offering financial products and services to middle-market commercial business, high net worth individuals and business owners, are sensitive to business and economic conditions in the United States generally and in Texas and the southeast United States, the principal markets where we conduct business. The economic conditions in these local markets may be different from the economic conditions in the United States as a whole. If the U.S. economy or the economy in any of our principal markets weaken, our growth and profitability from our lending, deposit and investment operations could be constrained. Uncertainty about the federal fiscal policy-making process, the medium- and long-term fiscal outlook of the federal government, and future tax rates and tax policies is a concern for businesses, consumers and investors in the United States, including our customers. In addition, economic conditions in foreign countries, could affect the stability of global financial markets, which could hinder U.S. economic growth. Weak economic conditions are characterized by deflation, fluctuations in debt and equity capital markets, a lack of liquidity and/or depressed prices in the secondary market for mortgage loans, increased delinquencies on mortgage, consumer and commercial
loans, residential and commercial real estate price declines, and lower home sales and commercial activity. All of these factors are detrimental to our business, and the interplay between these factors can be complex and unpredictable. Unfavorable market conditions can result in a deterioration in the credit quality of our borrowers and the demand for our products and services, an increase in the number of loan delinquencies, defaults and charge-offs, additional provisions for credit losses, adverse asset values, and an overall material adverse effect on the quality of our loan portfolio.
Our business is also significantly affected by monetary and related policies of the U.S. federal government and its agencies. Changes in any of these policies are influenced by macroeconomic conditions and other factors that are beyond our control. Adverse economic conditions and government policy responses to such conditions could have a material adverse effect on our business, financial condition and results of operations.
Our success will depend in significant part upon our ability to maintain a sufficient interest margin between the rates of interest we receive on loans and other investments and the rates we pay on deposits and other liabilities. The monetary and economic factors listed above, and the need to pay rates sufficient to attract deposits, may adversely affect our ability to maintain an interest margin sufficient to result in operating profits.
Our business depends on our ability to successfully manage credit risk.
Our business depends on our ability to successfully measure and manage credit risk. As a lender, we are exposed to the risk that the principal of, or interest on, a loan will not be repaid timely or at all or that the value of any collateral supporting a loan will be insufficient to cover our outstanding exposure. In addition, we are exposed to risks with respect to the period of time over which the loan may be repaid, risks relating to proper loan underwriting, risks resulting from changes in economic and industry conditions, and risks inherent in dealing with individual loans and borrowers. The creditworthiness of a borrower is affected by many factors including local market conditions and general economic conditions. If the overall economic climate in the United States, generally, or our market areas, specifically, experiences material disruption, our borrowers may experience difficulties in repaying their loans, the collateral we hold may decrease in value or become illiquid, and the level of nonperforming loans, charge-offs and delinquencies could rise and require significant additional provisions for credit losses. Additional factors related to the credit quality of commercial loans include the quality of the management of the business and the borrower’s ability both to properly evaluate changes in the supply and demand characteristics affecting their market for products and services and to effectively respond to those changes. Additional factors related to the credit quality of commercial real estate loans include tenant vacancy rates and the quality of management of the property.
Our risk management practices, such as monitoring the concentration of our loans within specific industries and our credit approval, review and administrative practices, may not adequately reduce credit risk, and our credit administration personnel, policies and procedures may not adequately adapt to changes in economic or any other conditions affecting customers and the quality of the loan portfolio. Many of our loans are made to small and medium-sized businesses that are less able to withstand competitive, economic and financial pressures than larger borrowers. Consequently, we may have significant exposure if any of these borrowers becomes unable to pay their loan obligations as a result of economic or market conditions, or personal circumstances, such as divorce or death. In addition, we are a middle-market lender, as such, the relative size of individual credits in our commercial portfolio increases the potential impact from singular credit events. A failure to effectively measure and limit the credit risk associated with our loan portfolio may result in loan defaults, foreclosures and additional charge-offs, and may necessitate that we significantly increase our allowance for credit losses (“ACL”), each of which could adversely affect our net income. As a result, our inability to successfully manage credit risk could have a material adverse effect on our business, financial condition and results of operations.
Our ACL may prove to be insufficient to absorb potential losses in our loan portfolio, which may adversely affect our business, financial condition and results of operations.
As a lender, we are exposed to the risk that our customers will be unable to repay their loans in accordance with their terms and that any collateral securing the payment of their loans may not be sufficient to assure repayment. Credit losses are inherent in the business of making loans and could have a material adverse effect on our operating results. We have established our ACL and maintain it at a level considered adequate by management to absorb probable credit losses based on our analysis of the quality of our loan portfolio, market environment and other factors we deem to be relevant to this analysis. The ACL represents our estimate of probable losses in the portfolio at each balance sheet date and is based upon relevant information available to us. The allowance contains provisions for probable losses that have been identified relating to specific borrowing relationships, as well as probable losses inherent in the loan portfolio and credit undertakings that are not specifically identified. Additions to the ACL, which are charged to earnings through the provision for credit losses, are determined based on a variety of factors, including an analysis of the loan portfolio, historical loss experience and an evaluation of current economic conditions in our market areas. The determination of the appropriate level of the ACL inherently involves a high degree of subjectivity and requires us to make significant estimates of current credit risks and future trends, all of which may undergo material changes. Although our
management has established an ACL it believes is adequate to absorb probable and reasonably estimable losses in our loan portfolio, the allowance may not be adequate. We could sustain credit losses that are significantly higher than the amount of our ACL. Higher credit losses could arise for a variety of reasons, including changes in economic, operating and other conditions within our markets, as well as changes in the financial condition, cash flows, and operations of our borrowers.
As of December 31, 2019, our ACL as a percentage of total loans was 0.92% and as a percentage of total nonperforming loans was 100.1%. Additional credit losses will likely occur in the future and may occur at a rate greater than we have previously experienced. We may be required to take additional provisions for credit losses in the future to further supplement the ACL, either due to management’s decision to do so or requirements by our banking regulators. In addition, bank regulatory agencies will periodically review our ACL, the policies and procedures we use to determine the level of the allowance and the value attributed to nonperforming loans or to real estate acquired through foreclosure. Such regulatory agencies may require us to recognize future charge-offs. In addition, in June 2016, the Financial Accounting Standards Board issued a new accounting standard, Current Expected Credit Losses (“CECL”), that will replace the current approach under generally accepted accounting principles (GAAP) for establishing allowances for credit losses, which generally considers only past event and current conditions. CECL is a forward-looking methodology that reflects the expected credit losses over the lives of financial assets, starting when such assets are first acquired. Under the revised methodology, credit losses will be measured based on past events, current conditions and reasonable and supportable forecasts that affect the collectability of financial assets. The standard is expected to result in increases to allowance levels generally and will require the application of the revised methodology to existing financial assets through a one-time adjustment to retained earnings upon initial effectiveness. We will adopt this standard on January 1, 2020. See “Notes to Consolidated Financial Statements-Note 1-Summary of Accounting Policies-Pending Accounting Pronouncements” for additional information about the standard. Substantial increases in the ACL could have a material adverse effect on our business, financial condition and results of operations.
The security interest that we have in our clients’ assets may not be sufficient to protect us from a partial or complete loss if we are required to foreclose.
Lending is a substantial part of our business, and each loan carries a certain risk that it will not be repaid in accordance with its terms. Our loans are often secured by a lien on specified collateral of our clients. However, the collateral may not protect us from suffering a partial or complete loss if we move to foreclose on the collateral. Factors that could reduce the value of the collateral that we have a security interest in including, among other things:
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changes in general economic and industry conditions;
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changes in the real estate markets in which we lend;
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inherent uncertainties in the future value of the collateral;
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the financial condition and/or cash flows of the borrower and/or the project being financed; and
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any representation by the borrower of, or failure to keep adequate records related to, important information concerning the collateral.
Any one or more of the preceding factors could materially impair our ability to collect on specified collateral of our clients in the event loans we have made to such clients are not repaid in accordance with their terms, which could have a material adverse effect on our business, financial condition and results of operations.
Liquidity risk could impair our ability to fund operations and meet our obligations as they become due and could jeopardize our financial condition.
Liquidity is essential to our business. Liquidity risk is the potential that we will be unable to meet our obligations as they become due because of an inability to liquidate assets or obtain adequate funding. We require sufficient liquidity to meet customer loan requests, customer deposit maturities and withdrawals, payments on our debt obligations as they come due and other cash commitments under both normal operating conditions and other unpredictable circumstances, including events causing industry or general financial market stress. Our access to deposits may be affected by the liquidity needs of our depositors. We depend on deposit account balances and other forms of customer deposits as our primary source of funding for our lending activities. A key part of our liquidity plan and funding strategy is to increase our deposit base as a source of funds. We might have difficulty replacing such funds in the future, especially if a large number of our depositors seek to withdraw their accounts, regardless of the reason. Liquidity risk can increase due to a number of factors, including an over-reliance on a particular source of funding or market-wide phenomena such as market dislocation and major disasters. Our inability to raise funds through deposits, borrowings, the sale of loans or securities, and other sources could have a substantial negative effect on liquidity. Our access to funding sources in amounts adequate to finance our activities or on acceptable terms could be impaired by factors that affect our organization specifically or the financial services industry or economy in general. We rely on brokered deposits as a source of liquidity and generally target a brokered deposit to total deposit ratio of less than 15% to 20%. Brokered deposits may have a higher deposit cost compared to our core deposits. Factors that could detrimentally impact access to liquidity sources include, but are not limited to, a
decrease in the level of our business activity as a result of a downturn in the markets in which our loans are concentrated (including a downturn resulting from natural disasters affecting those markets) or adverse regulatory actions against us or changes in the liquidity needs of our depositors. Market conditions or other events could also negatively affect the level or cost of funding, affecting our ongoing ability to accommodate liability maturities and deposit withdrawals, meet contractual obligations (including any unfunded credit commitments), and fund asset growth and new business transactions at a reasonable cost, in a timely manner, and without adverse consequences.
A failure to maintain adequate liquidity or any substantial, unexpected, and/or prolonged change in the level or cost of liquidity could impair our ability to fund operations and meet our obligations as they become due and could have a material adverse effect on our business, financial condition and results of operations.
The borrowing needs of our clients may increase, especially during a challenging economic environment, which could result in increased borrowing against our contractual obligations to extend credit.
A commitment to extend credit is a formal agreement to lend funds to a client as long as there is no violation of any condition established under the agreement. The actual borrowing needs of our clients under these credit commitments have historically been lower than the contractual amount of the commitments. A significant portion of these commitments expire without being drawn upon. Because of the credit profile of our clients, we typically have a substantial amount of total unfunded credit commitments, which is not reflected on our balance sheet. As of December 31, 2019, we had $5.0 billion in unfunded credit commitments to our clients. Actual borrowing needs of our clients may exceed our expectations, including due to unexpected impacts from a natural disaster, but especially during a challenging economic environment when our clients’ companies may be more dependent on our credit commitments due to the lack of available credit elsewhere, the increasing costs of credit, or the limited availability of financings from venture firms. This could adversely affect our liquidity, which could impair our ability to fund operations and meet obligations as they become due and could have a material adverse effect on our business, financial condition and results of operations. See “Risk Factors-Risks Relating to Our Business-Liquidity risk could impair our ability to fund operations and meet our obligations as they become due and could jeopardize our financial condition.”
We are subject to interest rate risk, which could adversely affect our financial condition and profitability.
The majority of our banking assets are subject to changes in interest rates. For example, as of December 31, 2019, 67% of our loan portfolio consisted of floating and adjustable interest rate loans. Like most financial institutions, our earnings significantly depend on our net interest income, the principal component of our earnings, which is the difference between interest earned by us from our interest-earning assets, such as loans and investment securities, and interest paid by us on our interest-bearing liabilities, such as deposits and borrowings. We expect that we will periodically experience “gaps” in the interest rate sensitivities of our assets and liabilities, meaning that either our interest-bearing liabilities will be more sensitive to changes in market interest rates than our interest-earning assets, or vice versa. In either event, if market interest rates should move contrary to our position, this “gap” will negatively impact our earnings. Many factors beyond our control impact interest rates, including economic conditions, governmental monetary policies, inflation, recession, changes in unemployment, the money supply, and disorder and instability in domestic and foreign financial markets. Changes in monetary policies of the various government agencies could influence not only the interest we receive on loans and securities and the interest we pay on deposits and borrowings, but such changes could also affect our ability to originate loans and obtain deposits, the fair value of our financial assets and liabilities, and the average duration of our assets and liabilities.
In any future declining interest rate environment, there may be an increase in prepayments on loans as borrowers refinance their loans at lower rates. Interest rate increases often result in larger payment requirements for our floating interest rate borrowers, which increases the potential for default. At the same time, the marketability of the property securing a loan may be adversely affected by any reduced demand resulting from higher interest rates. An increase (or decrease) in interest rates may also require us to increase (or decrease) the interest rates that we pay on our deposits.
Changes in interest rates also can affect the value of loans, securities and other assets. An increase in interest rates that adversely affects the ability of borrowers to pay the principal or interest on loans may lead to increases in nonperforming assets, charge-offs and delinquencies, further increases to the ACL, and a reduction of income recognized, among others, which could have a material adverse effect on our results of operations and cash flows. Further, when we place a loan on non-accrual status, we reverse any accrued but unpaid interest receivable, which decreases interest income. At the same time, we continue to have a cost to fund the loan, which is reflected as interest expense, without any interest income to offset the associated funding expense. Thus, an increase in the amount of nonperforming assets could have a material adverse impact on our net interest income.
Additionally, an increase in interest rates may not increase our net interest income to the same extent we currently anticipate based on our modeling estimates and the assumptions underlying such modeling. Our failure to benefit from an increased interest
rate environment to the extent we currently estimate, to the same extent as our competitors or at all could have a material adverse effect on our business, financial condition and results of operations.
If short-term interest rates remain at their current levels for a prolonged period, and assuming longer term interest rates fall, we could experience net interest margin compression as our rates on our interest earning assets would decline while rates on our interest-bearing liabilities could fail to decline in tandem. Similarly, if short-term interest rates increase and long-term interest rates do not increase, or increase but at a slower rate, we could experience net interest margin compression as our rates on interest earning assets decline measured relative to rates on our interest-bearing liabilities. Any such occurrence could have a material adverse effect on our net interest income and on our business, financial condition and results of operations. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Quantitative and Qualitative Disclosures about Market Risk.”
The geographic concentration of our markets in Houston, Atlanta, other parts of Texas, and the southeast United States makes our business susceptible to downturns in the local economies and depressed banking markets, including the downturns in the energy industry, effects of natural disasters in the region and decreases in oil prices. These factors as well as other geography-specific risks could materially and adversely affect us.
Unlike larger financial institutions that are nationally diversified, we are a regional banking franchise concentrated in Texas and the southeast United States. As of December 31, 2019, 43% of our total loans were in Texas, 20% were in Georgia, 8% were in Alabama, and 7% were in Florida. A deterioration in local economic conditions in the loan market or in the residential or commercial real estate markets could have a material adverse effect on the quality of our portfolio, the demand for our products and services, the ability of borrowers to timely repay loans, and the value of the collateral securing loans. If the population, employment or income growth in one of our markets is negative or slower than projected, income levels, deposits and real estate development could be adversely impacted.
The effects of adverse weather events may negatively affect our local economies or disrupt our operations, which would have an adverse effect on our business or results of operations.
Like other coastal areas, our geographic markets in Texas and the southeast United States are susceptible to severe weather, including hurricanes, flooding, tornadoes, droughts, wildfires, and hailstorms and damaging winds. In August 2017, Hurricane Harvey made landfall near Corpus Christi, Texas and struck the Houston area and parts of eastern Texas and Louisiana, causing record flooding, power outages, significant damage to impacted residential and commercial properties and disruptions to normal economic activity in certain of our market areas. Additionally, in September 2017, Hurricane Irma made landfall near Naples, Florida in southwest Florida, with impacts throughout much of south, central and eastern Florida, including flooding, power outages and various degrees of wind damage to certain residential and commercial properties. Finally, in October 2018, Hurricane Michael made landfall near Mexico Beach and Panama City, Florida, with impacts across the Florida panhandle area, including flooding, power outages and significant wind damage. The credit impact of Hurricanes Harvey, Irma, and Michael were minimal to Cadence Bank. In addition, the occurrence of other adverse weather and natural or man-made disasters in the future could destroy, or cause a decline in the value of, mortgaged properties, crops or other assets that serve as our collateral and increase the risk of delinquencies, defaults, foreclosures and losses on our loans, damage our banking facilities and offices, negatively impact regional economic conditions, result in a decline in local loan demand, loan originations and deposit availability and negatively impact the implementation of our growth strategy. Any one or more of these developments could have a material adverse effect on our business, financial condition and results of operations.
The effects of widespread public health emergencies may negatively affect our local economies or disrupt our operations, which would have an adverse effect on our business or results of operations.
Widespread health emergencies, such as the recent coronavirus outbreak in China and other countries, can disrupt our operations through their impact on our employees, customers and their businesses, and the communities in which we operate. Disruptions to our customers could result in increased risk of delinquencies, defaults, foreclosures and losses on our loans, negatively impact regional economic conditions, result in a decline in local loan demand, loan originations and deposit availability and negatively impact the implementation of our growth strategy. Any one or more of these developments could have a material adverse effect on our business, financial condition and results of operations.
Sustained low oil prices, volatility in oil prices and downturns in the energy industry, including in Texas, could materially and adversely affect us.
As of December 31, 2019, energy lending comprised approximately 11% of our loan portfolio. The economy in Texas has dependence on the energy industry. A downturn or lack of growth in the energy industry and energy-related business, including sustained low oil prices or the failure of oil prices to rise in the future, could adversely affect our results of operations and financial
condition. Prolonged pricing pressure on oil and gas could lead to increased credit stress in our energy portfolio, increased losses associated with our energy portfolio, increased utilization of our contractual obligations to extend credit and weaker demand for energy lending. Such a decline or general uncertainty resulting from continued volatility could have other adverse impacts such as job losses in industries tied to energy, increased spending habits, lower borrowing needs, higher transaction deposit balances or a number of other effects that are difficult to isolate or quantify, particularly in states with significant dependence on the energy industry such as Texas, all of which could have a material adverse effect on our business, financial condition and results of operations.
We May Be Adversely Impacted by The Transition from LIBOR as a Reference Rate
In 2017, the United Kingdom’s Financial Conduct Authority announced that after 2021 it would no longer compel banks to submit the rates required to calculate the London Interbank Offered Rate (“LIBOR”). This announcement indicates that the continuation of LIBOR on the current basis cannot and will not be guaranteed after 2021. Consequently, at this time, it is not possible to predict whether and to what extent banks will continue to provide submissions for the calculation of LIBOR. Similarly, it is not possible to predict whether LIBOR will continue to be viewed as an acceptable market benchmark, what rate or rates may become accepted alternatives to LIBOR, or what the effect of any such changes in views or alternatives may be on the markets for LIBOR-indexed financial instruments.
In particular, regulators, industry groups and certain committees (e.g., the Alternative Reference Rates Committee) have, among other things, published recommended fall-back language for LIBOR-linked financial instruments, identified recommended alternatives for certain LIBOR rates (e.g., the Secured Overnight Financing Rate as the recommended alternative to U.S. Dollar LIBOR), and proposed implementations of the recommended alternatives in floating rate instruments. At this time, it is not possible to predict whether these specific recommendations and proposals will be broadly accepted, whether they will continue to evolve, and what the effect of their implementation may be on the markets for floating-rate financial instruments.
We have a significant number of loans, derivative contracts, borrowings and other financial instruments with attributes that are either directly or indirectly dependent on LIBOR. The transition from LIBOR could create considerable costs and additional risk. Since proposed alternative rates are calculated differently, payments under contracts referencing new rates will differ from those referencing LIBOR. The transition will change our market risk profiles, requiring changes to risk and pricing models, valuation tools, product design and hedging strategies. Furthermore, failure to adequately manage this transition process with our customers could adversely impact our reputation. Although we are currently unable to assess what the ultimate impact of the transition from LIBOR will be, failure to adequately manage the transition could have a material adverse effect on our business, financial condition and results of operations.
We have formed a cross-functional project team to manage the assessment, identification, and resolution of risks and potential issues related to the transition from LIBOR to a replacement index. This team reports to the Asset Liability Committee (“ALCO”) and Enterprise Risk Management Committee, who will provide regular reports to the Board of Directors.
A failure in or breach of our operational or security systems or infrastructure, or those of our third-party providers, could result in financial losses to us and/or in the disclosure or misuse of confidential or proprietary information, including client information, each of which could adversely affect our financial condition, damage our reputation and subject us to litigation.
As a financial institution, we may be the target of fraudulent activity that may result in financial losses to us or our clients, privacy breaches against our clients or damage to our reputation. Such fraudulent activity may take many forms, including check fraud, electronic fraud, wire fraud, phishing, unauthorized intrusion into or use of our systems, and other dishonest acts. We provide our clients with the ability to bank remotely, including over the Internet and over the telephone. The secure transmission of confidential information over the Internet and other remote channels is a critical element of remote banking.
Additionally, our customers and employees have been, and will continue to be, targeted by parties using fraudulent e-mails and other communications in attempts to misappropriate passwords, bank account information or other personal information or to introduce viruses or other malware through “Trojan horse” programs to our information systems and/or our customers’ computers. Information security risks for financial institutions related to these types of attacks have generally increased in recent years in part because of the proliferation of new technologies, the use of the Internet and telecommunications technologies to conduct financial transactions, and the increased sophistication and activities of organized crime, hackers, terrorists, activists, and other external parties, including foreign state-sponsored parties. Though we endeavor to mitigate these threats through product improvements, use of encryption and authentication technology and customer and employee education, such cyberattacks against us or our merchants and our third-party service providers remain a serious issue.
Our operations are dependent upon our ability to protect the computer systems and network infrastructure utilized by us, including our Internet, telephone and other remote channel banking activities, our debit and credit card payment processing
activities, and our customer relationship management, general ledger, deposit, loans and other systems, against damage from physical break-ins, cybersecurity breaches and other disruptive problems caused by the Internet or other users. Such computer break-ins and other disruptions would jeopardize the security of information stored in and transmitted through our computer systems and network infrastructure, which may result in significant liability, damage our reputation and inhibit current and potential customers from using our Internet banking services. While we maintain security measures to mitigate the risk of cybersecurity breaches, it is possible that we may not be able to anticipate, detect or recognize threats to its systems or to implement effective preventive measures against all security breaches of these types, especially because the techniques used change frequently or are not recognized until launched, and because cyberattacks can originate from a wide variety of sources, including third parties. Controls employed by our information technology department and cloud vendors could prove inadequate. These risks may increase in the future as we continue to increase our Internet-based product offerings and expand our internal usage of web-based products and applications. In addition, maintaining our security measures to seek to protect against the latest types of threats entails significant costs and creates risks associated with implementing new systems and integrating them with existing ones.
A breach of our security that results in unauthorized access to our data could expose us to a disruption or challenges relating to our daily operations, as well as to data loss, litigation, damages, fines and penalties, significant increases in compliance costs (such as repairing systems or adding new personnel or protection technologies), and reputational damage (including customer dissatisfaction), any of which could have a material adverse effect on our business, financial condition and results of operations.
We depend on third parties for many of our information technology and telecommunications solutions, and any systems failures, interruptions, or data breaches involving these systems could adversely affect our operations and financial condition.
Our business depends on the successful and uninterrupted functioning of our information technology and telecommunications systems, third-party servicers and financial intermediaries. We outsource many of our major systems, such as data processing, loan servicing and deposit processing systems. The failure of these systems, or the termination of a third-party software license or service agreement on which any of these systems is based, could interrupt our operations, and we could experience difficulty in implementing replacement solutions. In many cases, our operations rely heavily on the secure processing, storage and transmission of information and the monitoring of a large number of transactions on a minute-by-minute basis, and even a short interruption in service could have significant consequences. In addition, we interact with and rely on financial counterparties, regulators and retailers for whom we process transactions. Each of these third parties may be targets of the same types of fraudulent activity, computer break-ins and other cybersecurity breaches described in the immediately preceding risk factor, and the cybersecurity measures that they maintain to mitigate the risk of such activity may be different than our own.
Because our information technology and telecommunications systems interface with and depend on third-party systems, we could experience service denials if demand for such services exceeds capacity or such third-party systems fail or experience interruptions. If significant, sustained or repeated, a system failure or service denial could compromise our ability to operate effectively, damage our reputation, result in a loss of customer business, and subject us to additional regulatory scrutiny and possible financial liability, any of which could have a material adverse effect on our business, financial condition and results of operations. In addition, failure of third parties to comply with applicable laws and regulations, or fraud or misconduct on the part of employees of any of these third parties could disrupt our operations or adversely affect our reputation. We may also incur costs as a result of data or security breaches of third parties with whom we do not have a significant direct relationship. For example, various retailers and companies processing payments on their behalf have reported that they were victims of cyberattacks in which large amounts of their customers’ data, including debit and credit card information, was obtained. In these situations, we generally incur costs to replace compromised cards and address fraudulent transaction activity affecting our customers.
As a result of financial entities and technology systems becoming more interdependent and complex, a cyber incident, information breach or loss, or technology failure that compromises the systems or data of one or more financial entities could have a material impact on counterparties or other market participants, including ourselves. For example, security breaches such as the Equifax incident made public in September 2017 may result in our customers requesting to freeze their credit accounts, which may impact the speed at which we can open or our ability to open new accounts. We have taken measures to implement backup systems and other safeguards, such as third party risk management due diligence and ongoing monitoring, disaster recovery testing with key providers, key service level agreements, and strategic planning/exit strategy, to support our operations, but our ability to conduct business may be adversely affected by any significant disruptions to us or to third parties with whom we interact.
We are subject to laws regarding the privacy, information security and protection of personal information and any violation of these laws or another incident involving personal, confidential or proprietary information of individuals could damage our reputation and otherwise adversely affect our operations and financial condition.
Our business requires the collection and retention of large volumes of customer data, including personally identifiable information in various information systems that we maintain and in those maintained by third parties with whom we contract to
provide data services. We also maintain important internal company data such as personally identifiable information about our employees and information relating to our operations. We are subject to complex and evolving laws and regulations governing the privacy and protection of personal information of individuals (including customers, employees, suppliers and other third parties). For example, our business is subject to the Gramm-Leach-Bliley Act which, among other things: (i) imposes certain limitations on our ability to share nonpublic personal information about our customers with nonaffiliated third parties; (ii) requires that we provide certain disclosures to customers about our information collection, sharing and security practices and afford customers the right to “opt out” of any information sharing by us with nonaffiliated third parties (with certain exceptions); and (iii) requires that we develop, implement and maintain a written comprehensive information security program containing appropriate safeguards based on our size and complexity, the nature and scope of our activities, and the sensitivity of customer information we process, as well as plans for responding to data security breaches. Various state and federal banking regulators and states have also enacted data security breach notification requirements with varying levels of individual, consumer, regulatory or law enforcement notification in certain circumstances in the event of a security breach. Ensuring that our collection, use, transfer and storage of personal information complies with all applicable laws and regulations can increase our costs. Furthermore, we may not be able to ensure that all of our clients, suppliers, counterparties and other third parties have appropriate controls in place to protect the confidentiality of the information that they exchange with us, particularly where such information is transmitted by electronic means. If personal, confidential or proprietary information of customers or others were to be mishandled or misused (in situations where, for example, such information was erroneously provided to parties who are not permitted to have the information, or where such information was intercepted or otherwise compromised by third parties), we could be exposed to litigation or regulatory sanctions under personal information laws and regulations. Concerns regarding the effectiveness of our measures to safeguard personal information, or even the perception that such measures are inadequate, could cause us to lose customers or potential customers for our products and services and thereby reduce our revenues. Accordingly, any failure or perceived failure to comply with applicable privacy or data protection laws and regulations may subject us to inquiries, examinations and investigations that could result in requirements to modify or cease certain operations or practices or in significant liabilities, fines or penalties, and could damage our reputation and otherwise adversely affect our operations and financial condition.
We continually encounter technological change.
The financial services industry is continually undergoing rapid technological change with frequent introductions of new technology-driven products and services. The effective use of technology increases efficiency and enables financial institutions to better serve customers and to reduce costs. Our future success depends, in part, upon our ability to address the needs of our customers by using technology to provide products and services that will satisfy customer demands, as well as to create additional efficiencies in our operations. Many of our competitors have substantially greater resources to invest in technological improvements than we do. As a result, they may be able to offer additional or superior products to those that we will be able to provide, which would put us at a competitive disadvantage. We may not be able to effectively implement new technology-driven products and services or be successful in marketing these products and services to our customers. In addition, the implementation of technological changes and upgrades to maintain current systems and integrate new ones may also cause service interruptions, transaction processing errors and system conversion delays, may cause us to fail to comply with applicable laws, and may cause us to incur additional expenses, which may be substantial. Failure to successfully keep pace with technological change affecting the financial services industry and avoid interruptions, errors and delays could have a material adverse effect on our business, financial condition or results of operations.
We expect that new technologies and business processes applicable to the consumer credit industry will continue to emerge and these new technologies and business processes may be better than those we currently use. Because the pace of technological change is high, and our industry is intensely competitive, we may not be able to sustain our investment in new technology as critical systems and applications become obsolete or as better ones become available. A failure to maintain current technology and business processes could cause disruptions in our operations or cause our products and services to be less competitive, all of which could have a material adverse effect on our business, financial condition or results of operations.
We rely heavily on our management team and could be adversely affected by the unexpected loss of key personnel.
We are led by an experienced management team with substantial experience in the markets that we serve, and our operating strategy focuses on providing products and services through long-term relationship managers. Accordingly, our success depends in large part on the performance of our key personnel, as well as on our ability to attract, motivate and retain highly qualified senior and middle management. Competition for employees is intense, and we may be unsuccessful in locating key personnel with the combination of skills and attributes required to execute our business plan. The cost of hiring, incentivizing, and retaining skilled personnel may continue to increase. We may not be successful in retaining our key employees, and the unexpected loss of services of one or more of our key personnel, including our relationship managers, could also have a material adverse effect on our business because of their skills, knowledge of our market, years of industry experience, relationship-centric banking model, and the difficulty of promptly finding qualified replacement personnel. If the services of any of our key personnel should become
unavailable for any reason, we may not be able to identify and hire qualified persons on terms acceptable to us, which could have a material effect on our business, financial condition and results of operations.
Our indebtedness could affect our ability to meet our obligations and may otherwise restrict our activities.
As of December 31, 2019, the Company and its subsidiaries had approximately $387.6 million of gross indebtedness on a consolidated basis ($50.6 million of which represents junior subordinated debt before purchase accounting adjustment). Total interest expense on all outstanding indebtedness was $20.8 million on a pre-tax basis for 2019. An increase in interest rates would increase our interest expense. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Quantitative and Qualitative Disclosures about Market Risk.”
Our indebtedness could have important consequences. For example, it could limit our ability to borrow money for our working capital, capital expenditures, debt service requirements or other corporate purposes; require us to dedicate a substantial portion of our cash flow to payments on our indebtedness, which would reduce the amount of cash flow available to fund working capital, capital expenditures, product development and other corporate requirements; increase our vulnerability to general adverse economic and industry conditions; and limit our ability to respond to business opportunities, including growing our business through acquisitions. In addition, the instruments governing our indebtedness contain certain restrictive covenants including with respect to consolidating or merging the Company or the Bank into another entity or transferring substantially all of their respective assets or properties. Certain of the Company’s debt also contains restrictions on the Company’s ability to assign or grant a security interest in or otherwise dispose of any shares of the voting stock of the Bank. Failure to meet any of these covenants could result in an event of default under these agreements. If an event of default occurs under these agreements, the lenders could elect to declare all amounts outstanding under these agreements to be immediately due and payable.
Our principal source of funds for interest and repayment of principal upon the maturity of our debt is dividends received directly from our subsidiaries, including the Bank. Federal and state statutes and regulations limit the amount of dividends that the Bank may pay to us, with or without regulatory approval. We may not receive dividends sufficient to fund our debt obligations. In addition, we may not be able to refinance our indebtedness on substantially similar terms, or at all, at or prior to the time that it comes due.
We rely on customer deposits as a significant source of funding, and our deposits may decrease in the future.
We rely on customer deposits as a significant source of funding. Competition among U.S. banks and non-banks for customer deposits is intense and may increase the cost of deposits or prevent new deposits and may otherwise negatively affect our ability to grow our deposit base. Our deposit accounts may decrease in the future, and any such decrease could have an adverse impact on our sources of funding, which impact could be material. Any changes we make to the rates offered on our deposit products to remain competitive with other financial institutions may adversely affect our profitability and liquidity. The demand for our deposit products may also be reduced due to a variety of factors such as demographic patterns, changes in customer preferences, reductions in consumers’ disposable income, regulatory actions that decrease customer access to particular products or the availability of competing products. In addition, a portion of our deposits are brokered deposits. The levels of these types of deposits that we hold may be more volatile during changing economic conditions.
We face significant competition to attract and retain customers and clients, which could adversely affect our growth and profitability.
We operate in the highly competitive banking industry and face significant competition in originating loans, attracting deposits and providing other financial services for customers from bank and non-bank competitors, particularly regional and nationwide institutions, including U.S. banks, mortgage banking companies, consumer finance companies, credit unions, insurance companies, and other institutional lenders and purchasers of loans. Many of our competitors are significantly larger and have significantly more resources, greater name recognition, larger market share, and more extensive and established branch networks than we do. Because of their scale, many of these competitors can be more aggressive than we can on loan and deposit pricing. Also, many of our non-bank competitors have fewer regulatory constraints and may have lower cost structures. In addition, they may maintain a wider range of product offerings than we do, including more technology-based banking tools. We expect competition to continue to intensify due to financial institution consolidation; legislative, regulatory and technological changes; and the emergence of alternative banking sources.
Our ability to compete successfully will depend on a number of factors, including, among other things:
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our ability to build and maintain long-term customer relationships while ensuring high ethical standards and safe and sound banking practices;
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our ability to leverage existing client relationships;
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our ability to build ancillary business through participation in SNC’s;
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the success of our focused calling efforts;
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our ability to attract and retain qualified employees to operate our business effectively;
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our ability to expand our market position;
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the scope, relevance and pricing of products and services that we offer;
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customer satisfaction with our products and services;
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industry and general economic trends; and
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our ability to keep pace with technological advances and to invest in new technology.
Customer and client loyalty can also be influenced by a competitor’s new products, especially offerings that could provide cost savings or a higher return to the customer. Increased competition could require us to increase the rates that we pay on deposits or lower the rates that we offer on loans, which could reduce our profitability. Our failure to compete effectively in our markets could restrain our growth or cause us to lose market share, which could have a material adverse effect on our business, financial condition and results of operations. We may also face a competitive disadvantage as a result of our concentration in Texas and the southeast United States and will be unable, as compared to our more geographically diversified peers, to spread our operating costs across a broader market.
If we are not able to continue the historical levels of growth in our loan and deposit levels and market share, we may not be able to maintain our historical earnings trends.
Since our formation in 2009, we have consummated four major acquisitions, including our merger with State Bank which closed on January 1, 2019, which have significantly contributed to growth in our loan and deposit levels and market share. While supported by these acquisitions, we are pursuing an organic growth strategy focused on growing market share. This strategy may not sustain our historical rate of growth or our ability to grow at all. Our ability to execute our growth strategy, including by opening new branches, depends on a variety of factors such as economic conditions, competition, and regulatory approval, which are beyond our control, and access to capital and liquidity to fund such growth. We may not be able to obtain the financing necessary to fund internal growth and we may not pursue growth through new acquisitions. Sustainable growth requires that we manage our risks by following prudent underwriting standards, balancing loan and deposit growth without increasing interest rate risk or compressing our net interest margin, maintaining more than adequate capital at all times, hiring and retaining qualified employees, and successfully implementing strategic projects and initiatives. Our growth strategy may also change from time to time as a result of various internal and external factors. For example, natural disasters and other events beyond our control may also adversely affect our growth. If we are not able to continue our historical levels of growth, we may not be able to maintain these historical earnings trends. The absence of these growth opportunities or our ability to manage our growth successfully, could have a material adverse effect on our business, financial condition and results of operations.
We may not be able to manage our growth effectively, which could adversely affect our business profitability and financial condition.
We may face a variety of risks and difficulties in pursuing our organic growth strategy and managing our growth, including, among other things:
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maintaining organic loan growth;
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maintaining asset quality;
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finding suitable markets for expansion;
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attracting funding to support additional growth;
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managing execution risks;
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attracting and retaining qualified management;
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maintaining adequate regulatory capital;
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managing a growing number of client relationships;
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scaling technology platforms; and
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achieving expected additional capacity of our relationship managers.
To manage our growth and maintain adequate information and reporting systems within our organization, we must identify, hire and retain qualified associates, particularly in the accounting and operational areas of our business. We must also successfully implement improvements to, or integrate, our management information and control systems, procedures and processes in an efficient or timely manner and identify deficiencies in existing systems and controls. In particular, our controls and procedures must be able to accommodate an increase in loan volume in various markets and the infrastructure that comes with expanding operations, including new branches. Our growth strategy may divert management from our existing franchises and may require us to incur additional expenditures to expand our administrative and operational infrastructure. If we are unable to effectively manage and grow our banking franchise, we may experience compliance and operational problems, have to slow the pace of growth, or have to incur additional expenditures beyond current projections to support such growth, any one of which could materially and adversely affect our business, financial condition, results of operations and future prospects.
We depend on the accuracy and completeness of information provided to us by our borrowers and counterparties and any misrepresented information could adversely affect our business, results of operations and financial condition.
In deciding whether to approve loans or to enter into other transactions with borrowers and counterparties, we rely on information furnished to us by, or on behalf of, borrowers and counterparties, including financial statements, credit reports and other financial information. We also rely on representations of borrowers and counterparties as to the accuracy and completeness of that information and, with respect to financial statements, on reports of independent auditors. If any of this information is intentionally or negligently misrepresented and such misrepresentation is not detected prior to loan funding, the value of the loan may be significantly lower than expected and we may be subject to regulatory action. Whether a misrepresentation is made by the loan applicant, another third party, or one of our employees, we generally bear the risk of loss associated with the misrepresentation. Our controls and processes may not have detected, or may not detect all, misrepresented information in our loan originations or from our business clients. Any such misrepresented information could adversely affect our business, financial condition and results of operations.
We may not be able to raise additional capital in the future.
In the future, should we need additional capital to implement our business plan, support our business, expand our operations, or meet applicable capital requirements, we may not be able to raise additional funds in the form of additional debt or equity. Our ability to raise additional capital, if needed, will depend on, among other things, conditions in the capital markets at that time, and our financial condition, results of operations and prospects. Economic conditions and a loss of confidence in financial institutions may increase our cost of funding and limit access to certain customary sources of capital, including inter-bank borrowings, repurchase agreements and borrowings from the discount window of the Federal Reserve System.
Such capital may not be available on acceptable terms, or at all. Any occurrence that may limit our access to the capital markets, such as a decline in the confidence of debt purchasers, depositors of our bank or counterparties participating in the capital markets or other disruption in the capital markets, may adversely affect our capital costs and our ability to raise capital and, in turn, our liquidity. Further, if we need to raise capital in the future, we may have to do so when many other financial institutions are also seeking to raise capital and would then have to compete with those institutions for investors. An inability to raise additional capital on acceptable terms when needed could have a material adverse effect on our business, financial condition or results of operations.
As a public company, we are required to meet periodic reporting requirements under the rules and regulations of the Securities and Exchange Commission (the “SEC”). Complying with federal securities laws as a public company is expensive.
As a publicly traded company, we are required to file periodic reports containing our consolidated financial statements with the SEC within a specified time following the completion of quarterly and annual periods. Any failure by us to file our periodic reports with the SEC in a timely manner could harm our reputation and cause investors and potential investors to lose confidence in us and reduce the market price of our Class A common stock.
The current economic environment poses significant challenges and could adversely affect our financial condition and results of operations.
We are operating in a challenging and uncertain economic environment. Financial institutions continue to be affected by uncertainty in the real estate market, the credit markets, and the national financial market generally. We retain direct exposure to the commercial and, to a lesser extent, residential, real estate markets, and we are affected by events in these markets. The uncertainty in economic conditions has subjected us and other financial institutions to increased regulatory scrutiny. In addition, deterioration in local economic conditions in our markets could result in losses beyond that provided for in our ACL and result in increased loan delinquencies, problem assets, and foreclosures. This may also result in declining
demand for products and services, decreased deposits and increased borrowings under our current contractual obligations to extend credit, all of which would adversely impact our liquidity positions, and declining values for loan collateral, which in turn would reduce customers’ borrowing power and the value of assets and collateral associated with our existing loans.
Continued uncertainty regarding, and potential deterioration in, the fiscal position of the U.S. federal government and possible downgrades in U.S. Treasury and federal agency securities could adversely affect us and our banking operations.
The long-term outlook for the fiscal position of the U.S. federal government is uncertain, as illustrated by the 2011 downgrade by certain rating agencies of the credit rating of the U.S. government and federal agencies. In addition to causing economic and financial market disruptions, uncertainty regarding the fiscal position of the U.S. federal government (which could lead to, among other things, a future credit ratings downgrade of the U.S. government and federal agencies, failure to raise the U.S. statutory debt limit, or deterioration in the fiscal outlook of the U.S. federal government), could adversely affect the market value of the U.S. and other government and governmental agency securities that we hold, the availability of those securities as collateral for borrowing and our ability to access capital markets on favorable terms. In particular, it could increase interest rates and disrupt payment systems, money markets, and long-term or short-term fixed income markets, adversely affecting the cost and availability of funding, which could negatively affect our profitability. Also, the adverse consequences of this uncertainty could extend to those to whom we extend credit and could adversely affect their ability to repay their loans. Any of these developments could have a material adverse effect on our business, financial condition and results of operations.
We may be adversely affected by the soundness of other financial institutions.
Our ability to engage in routine funding transactions could be adversely affected by the actions and commercial soundness of other financial institutions. Financial services companies are interrelated as a result of trading, clearing, counterparty, and other relationships. We have exposure to different industries and counterparties including through transactions with counterparties in the financial services industry, including brokers and dealers, commercial banks, investment banks and other institutional clients. As a result, defaults by, or even rumors or questions about the soundness of, one or more financial services companies, or the financial services industry generally, have historically led to market-wide liquidity problems and could lead to losses or defaults by us or by other institutions. These losses or defaults could have a material effect on our business, financial condition and results of operations.
We have a significant deferred tax asset that may not be fully realized in the future.
Our net deferred tax liability totaled $25.0 million as of December 31, 2019, which is net of $79.2 million in deferred tax assets. Included in deferred tax assets is $11.5 million attributable to federal and state net operating loss carryforwards. The ultimate realization of a deferred tax asset is generally dependent upon the generation of future taxable income during the period prior to the expiration of the applicable net operating losses. In addition, a portion of our net operating losses are currently subject to the limitations of Section 382 of the Internal Revenue Code, which may limit our ability to offset future taxable income. As of December 31, 2019, $48.2 million of our net operating loss carryforward was limited to $4.1 million per year through 2030, $1.4 million in 2031, $1.0 million in 2032, and $0.2 million in 2033. We will be required to generate taxable income equal to or greater than the amount of the annual limitation to fully realize the deferred tax asset. The value of our deferred tax asset is also derived in part from estimates and assumptions regarding our expected future tax liability. If our estimates and assumptions about future taxable income or our future tax liability are not accurate, including the application of the Tax Cuts and Jobs Act or any changes to tax laws and regulations applicable to us, the value of our deferred tax asset may not be recoverable, in whole or in part, and we may be required to record a valuation allowance that would negatively impact our earnings.
Many of our loans are to commercial borrowers, which have unique risks compared to other types of loans.
As of December 31, 2019, we had approximately $9.6 billion of commercial loans comprised of $6.9 billion in commercial and industrial and $2.8 billion in commercial real estate, representing approximately 74% of our total loan portfolio. Because payments on these loans are often dependent on the successful operation or development of the property or business involved, their repayment is sensitive to adverse conditions in the real estate market and the general economy. Accordingly, downturns in the real estate market and economy increase the risk related to commercial loans, particularly commercial real estate loans. Commercial loans are also subject to loan specific risks, including risks associated with construction, cost overruns, project completion risk, general contractor credit risk and risks associated with the ultimate sale or use of the completed construction. If a decline in economic conditions, natural disasters affecting commercial development or other issues cause difficulties for our borrowers of these types of business loans, if we fail to evaluate the credit of these loans accurately when we underwrite them or if we do not continue to monitor adequately the performance of these loans, our lending portfolio could experience delinquencies, defaults and credit losses that could have a material adverse effect on our business, financial condition or results of operations.
Our loan portfolio has significant concentration in energy and our specialized industries.
Much of our lending activity is concentrated in energy and our specialized industries. As of December 31, 2019, we had a total of $1.5 billion of loans, or 11.2% of our total loans, to companies operating in the restaurant and healthcare industries, and $1.4 billion, or 10.9%, to companies operating in the energy sector. These industries and businesses are sensitive to economic conditions and complex factors (such as supply chain factors), which may expose us to the risk of economic downturns and other risks unique to these industries. Oil prices can fluctuate widely on a month-to-month basis in response to a variety of factors that are beyond our control. Factors that contribute to price fluctuations include instability in oil-producing regions, worldwide economic conditions, weather conditions, the supply and price of domestic and foreign oil, natural gas and natural gas liquids, consumer demand, the price and availability of alternative fuels, the proximity to, and capacity of, transportation facilities and the effect of worldwide energy conservation measures. Adverse economic conditions or business conditions relating to these industries could negatively impact our operating results more than if our loan portfolio was not concentrated in these industries.
A significant portion of our loan portfolio is comprised of loan participations and SNC’s, which could have a material adverse effect on our ability to monitor the lending relationships and lead to an increased risk of loss.
We achieved a significant portion of our loan growth in our initial years of operation by participating in loans originated by other institutions and by participating in SNC’s, broadly defined as loans to larger institutions by a group of participating lenders where the client’s needs are larger than any individual lender can prudently provide, and in which other lenders serve as the agent bank. Additionally, our specialized industries lending includes larger, national companies that tend to be served through SNC’s. As of December 31, 2019, $2.6 billion, or approximately 20% of our total loans, consisted of participations or SNC’s. For the vast majority of SNC’s, we are not the lead bank. Our reduced control over the monitoring and management of these relationships, particularly participations in large bank groups, could lead to increased risk of loss, which could have a material adverse effect on our business, financial condition, results of operations and future prospects.
The amount of nonperforming and criticized assets may increase significantly, resulting in additional losses, and costs and expenses that will negatively affect our operations and financial condition.
At December 31, 2019, we had a total of approximately $125.5 million of nonperforming assets or approximately 0.71% of total assets. Total criticized assets as of December 31, 2019 were approximately $605.1 million or approximately 3.4% of total assets.
Should the amount of nonperforming assets and criticized assets increase in the future, we may incur losses, and the costs and expenses to maintain such assets likewise can be expected to increase and potentially negatively affect earnings. Any additional increase in losses due to such assets could have a material adverse effect on our business, financial condition and results of operations. Such effects may be particularly pronounced in a market of reduced real estate values and excess inventory.
Nonperforming assets take significant time and resources to resolve and adversely affect our results of operations and financial condition.
Nonperforming assets adversely affect our net income in various ways. We generally do not record interest income on nonperforming loans or OREO, thereby adversely affecting our income and increasing loan administration costs. When we take collateral in foreclosures and similar proceedings, we are required to mark the related asset to the then fair market value of the collateral, which may ultimately result in a loss. An increase in the level of nonperforming assets increases our risk profile and may impact the capital levels regulators believe are appropriate in light of the ensuing risk profile. While we seek to reduce problem assets through loan workouts, restructurings, and otherwise, decreases in the value of the underlying collateral, or in these borrowers’ performance or financial condition, whether or not due to economic and market conditions beyond our control, could have a material effect on our business, financial condition and results of operations. In addition, the resolution of nonperforming assets requires significant commitments of time from management, which may materially and adversely impact their ability to perform their other responsibilities. We may not experience future increases in the value of nonperforming assets.
By engaging in derivative transactions, we are exposed to credit and market risk, which could adversely affect our profitability and financial condition.
We manage interest rate risk by, among other things, utilizing derivative instruments to minimize significant unplanned fluctuations in earnings that are caused by interest rate volatility. Hedging interest rate risk is a complex process, requiring sophisticated models and constant monitoring, and is not a perfect science. Due to interest rate fluctuations, hedged assets and liabilities will appreciate or depreciate in market value. The effect of this unrealized appreciation or depreciation will generally be offset by income or loss on the derivative instruments that are linked to the hedged assets and liabilities. By engaging in derivative transactions, we are exposed to credit and market risk. If the counterparty fails to perform, credit risk exists to the extent of the fair
value gain in the derivative. Market risk exists to the extent that interest rates change in ways that are significantly different from what we expected when we entered into the derivative transaction. The existence of credit and market risk associated with our derivative instruments could adversely affect our net interest income and, therefore, could have a material effect on our business, financial condition and results of operations. Failure to manage interest rate risk could have a material adverse effect on our business. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations-Quantitative and Qualitative Disclosures about Market Risk.”
The fair value of our investment securities may decline.
As of December 31, 2019, the fair value of our investment securities portfolio was approximately $2.4 billion. Factors beyond our control can significantly influence the fair value of securities in our portfolio and can cause potential adverse changes to the fair value of these securities. These factors include, but are not limited to, rating agency actions in respect of the securities, defaults by, or other adverse events affecting, the issuer or with respect to the underlying securities, and changes in market interest rates and continued instability in the capital markets. Any of these factors, among others, could cause other-than-temporary impairments and realized and/or unrealized losses in future periods and declines in other comprehensive income, which could have a material effect on our business, financial condition and results of operations. The process for determining whether impairment of a security is other-than-temporary usually requires complex, subjective judgments about the future financial performance and liquidity of the issuer and any collateral underlying the security to assess the probability of receiving all contractual principal and interest payments on the security.
Future acquisitions will subject us to a variety of risks, including execution risks, failure to realize anticipated transaction benefits, and failure to overcome integration risks, which could adversely affect our growth and profitability.
We regularly consider potential acquisition opportunities, such as State Bank, that we believe would support our businesses and enhance our profitability. If we do pursue acquisitions, we may have difficulty executing on acquisitions and may not realize the anticipated benefits of any transaction we complete. Any of the foregoing matters could materially and adversely affect us.
Generally, any acquisition of financial institutions, branches or other banking assets by us will require approval by, and cooperation from, federal and state banking regulatory agencies. Such regulators could deny our application, which would restrict our growth, or the regulatory approvals may not be granted on terms that are acceptable to us. For example, we could be required to sell branches as a condition to receiving regulatory approvals, and such a condition may not be acceptable to us or may reduce the benefit of an acquisition.
As to any acquisition that we complete, we may fail to realize some or all of the anticipated transaction benefits if the integration process takes longer or is more costly than expected or otherwise fails to meet our expectations.
In addition, acquisition activities could be material to our business and involve several risks, including the following:
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incurring time and expense associated with identifying and evaluating potential acquisitions and negotiating potential transactions, resulting in our attention being diverted from the operation of our existing business;
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using inaccurate estimates and judgments to evaluate credit, operations, management and market risks with respect to the target institution or assets;
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projected results may vary significantly from actual results;
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intense competition from other banking organizations and other inquirers for acquisitions;
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potential exposure to unknown or contingent liabilities of banks and businesses we acquire;
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unexpected asset quality problems;
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the time and expense required to integrate the operations and personnel of the combined businesses;
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experiencing higher operating expenses relative to operating income from the new operations;
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creating an adverse short-term effect on our results of operations;
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losing key employees and customers as a result of an acquisition that is poorly received;
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significant problems relating to the conversion of the financial and customer data of the entity;
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integration of acquired customers into our financial and customer product systems;
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risk of assuming businesses with internal control deficiencies; or
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risks of impairment to goodwill or other than temporary impairment of investment securities.
Depending on the condition of any institution or assets or liabilities that we may acquire, that acquisition may, at least in the near term, adversely affect our capital and earnings and, if not successfully integrated with our organization, may continue to have such effects over a longer period. We may not be successful in overcoming these risks or any other problems encountered in connection with potential acquisitions, and any acquisition we may consider will be subject to prior regulatory approval. Also, acquisitions may involve the payment of a premium over book and market values and, therefore, some dilution of our tangible book value and net income per common share may occur in connection with any future transaction. Our inability to overcome these risks could have a material adverse effect on our profitability, return on equity and return on assets, our ability to implement our business strategy and enhance shareholder value, which, in turn, could have a material adverse effect on our business, financial condition and results of operations. Additionally, our inability to overcome these risks could materially and adversely affect the market price of our Class A common stock, which could make it difficult to sell your shares at the volume, price or time desired.
If the goodwill that we record in connection with a business acquisition becomes impaired, it could require charges to earnings, which would have a negative impact on our financial condition and results of operations.
Goodwill represents the amount by which the purchase price exceeds the fair value of net assets we acquire in a business combination. We review goodwill for impairment at least annually, or more frequently if events or changes in circumstances indicate the carrying value of the asset might be impaired.
We evaluate for potential impairment by comparing the estimated fair value with the carrying amount of each reporting unit. If the carrying amount of the reporting unit exceeds the estimated fair value of that reporting unit, an impairment loss is recognized in an amount equal to the excess of the carrying value of goodwill over the implied fair value of the goodwill. Factors that could cause an impairment charge include adverse changes to macroeconomic conditions, declines in the profitability of the reporting unit or declines in the tangible book value of the reporting unit. At December 31, 2019, our goodwill totaled $485.3 million. Although we have not recorded any impairment charges since we initially recorded the goodwill, our future evaluations of goodwill may result in findings of impairment and related impairment losses, which could have a material adverse effect on our business, financial condition and results of operations.
We are required to make significant estimates and assumptions in the preparation of our financial statements. These estimates and assumptions may not be accurate and are subject to change.
The preparation of our consolidated financial statements in conformity with GAAP requires our management to make significant estimates and assumptions that affect the reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the consolidated financial statements, and the reported amounts of income and expense during the reporting periods. Critical estimates are made by management in determining, among other things, the accounting for business combinations, estimates of fair value, ACL, accounting for acquired loans and other real estate owned, and valuation of deferred tax assets. If our underlying estimates and assumptions prove to be incorrect or if events occur that require us to revise our previous estimates or assumptions, our financial condition and results of operations may be materially adversely affected.
We are subject to certain operational risks, including, but not limited to, employee or customer fraud, the obligation to repurchase sold loans in the event of a documentation error, and data processing system failures and errors.
Employee errors and employee and customer misconduct could subject us to financial losses or regulatory sanctions and seriously harm our reputation. Misconduct by our employees could include, among other things, improper use of confidential information or engaging in unauthorized activities on behalf of our customers. It is not always possible to prevent such employee errors and misconduct or documentation errors, and the precautions we take to prevent and detect this activity may not be effective in all cases. Employee errors and misconduct could also subject us to financial claims for negligence.
While we maintain a system of internal controls and insurance coverage to mitigate against operational risks, if our internal controls fail to prevent or detect an occurrence, or if any resulting loss is not insured or exceeds applicable insurance limits, it could have a material adverse effect on our business, financial condition and results of operations.
In addition, we rely heavily upon information supplied by third parties, including the information contained in credit applications, property appraisals, title information, equipment pricing and valuation and employment and income documentation, in deciding which loans we will originate, as well as the terms of those loans. If any of the information upon which we rely is misrepresented, either fraudulently or inadvertently, and the misrepresentation is not detected prior to asset funding, the value of the asset may be significantly lower than expected, or we may fund a loan that we would not have funded or on terms we would
not have extended. Whether a misrepresentation is made by the applicant or another third party, we generally bear the risk of loss associated with such misrepresentation. A loan subject to a material misrepresentation is typically unsellable or subject to repurchase if it is sold prior to detection of the misrepresentation. The sources of the misrepresentations are often difficult to identify, and it is often difficult to recover any of the monetary losses we may suffer.
We are subject to environmental liability risk associated with our lending activities.
We own certain of our properties, and, in the course of our business, we may purchase real estate, or we may foreclose on and take title to real estate. As a result, we could be subject to environmental liabilities with respect to these properties. We may be held liable to a governmental entity or to third parties for property damage, personal injury, investigation and clean-up costs incurred by these parties in connection with environmental contamination or may be required to investigate or clean up hazardous or toxic substances or chemical releases at a property. The costs associated with investigation or remediation activities could be substantial and could exceed the value of the underlying properties. In addition, if we are the owner or former owner of a contaminated site, we may be subject to common law claims by third parties based on damages and costs resulting from environmental contamination emanating from the property. Any significant environmental liabilities could have a material adverse effect on our business, financial condition and results of operations.
We offer third-party products including mutual funds, annuities, life insurance, individual securities and other wealth management products which could experience significant declines in value subjecting us to reputational damage and litigation risk.
We offer third-party products including mutual funds, annuities, life insurance, individual securities and other wealth management products. If these products do not generate competitive risk-adjusted returns that satisfy clients in a variety of asset classes, we will have difficulty maintaining existing business and attracting new business. Additionally, our wealth management business involves the risk that clients or others may sue us, claiming that we have failed to perform under a contract or otherwise failed to carry out a duty owed to them. This risk may be heightened during periods when credit, equity or other financial markets are deteriorating in value or are particularly volatile, or when clients or investors are experiencing losses. Significant declines in the performance of these third-party products could subject us to reputational damage and litigation risk.
We are subject to litigation, which could result in substantial judgment or settlement costs.
We are regularly involved in litigation matters in the ordinary course of business. While we believe that these litigation matters should not have a material adverse effect on our business, financial condition, results of operations or future prospects, we may be unable to successfully defend or resolve any current or future litigation matters, in which case those litigation matters could have a material adverse effect on our business, financial condition and results of operations.
Acts or threats of terrorism and political or military actions taken by the United States or other governments could adversely affect general economic or industry conditions.
Geopolitical conditions may affect our earnings. Acts or threats of terrorism and political or military actions taken by the United States or other governments, including in response to terrorism or similar activity, could have a material adverse effect on our business, financial condition and results of operations.
Risks Relating to the Regulation of Our Industry
Our business, financial condition, results of operations and prospects could be adversely affected by the highly regulated environment in which we operate.
As a financial holding company, we are subject to federal supervision and regulation. Federal regulation of the banking industry, along with tax and accounting laws, regulations, rules and standards, may limit our operations significantly and control the methods by which we conduct business, just as they limit those of other banking organizations. In addition, compliance with laws and regulations can be difficult and costly, and changes to laws and regulations can impose additional compliance costs. The Dodd-Frank Act, which imposes significant regulatory and compliance changes on financial institutions, is an example of this type of federal regulation. Many of these regulations are intended to protect depositors, customers, the public, the banking system as a whole or the FDIC insurance funds, not shareholders. Regulatory requirements and discretion affect our lending practices, capital structure, investment practices, dividend policy and many other aspects of our business. There are laws and regulations which restrict transactions between us and our subsidiaries. These requirements may constrain our operations, and the adoption of new laws and changes to or repeal of existing laws may have a further impact on our business, financial condition, results of operations and future prospects. Also, the burden imposed by those federal and state regulations may place banks in general, including our Bank in particular, at a competitive disadvantage compared to their non-bank competitors. We are also subject to requirements
with respect to the confidentiality of information obtained from clients concerning their identities, business and personal financial information, employment, and other matters. We require our personnel to agree to keep all such information confidential and we monitor compliance. Failure to comply with confidentiality requirements could result in material liability and adversely affect our business, financial condition, results of operations and future prospects.
Bank holding companies and financial institutions are extensively regulated and currently face an uncertain regulatory environment. Applicable laws, regulations, interpretations, enforcement policies and accounting principles have been subject to significant changes in recent years and may be subject to significant future changes. Future changes may have a material adverse effect on our business, financial condition and results of operations.
Federal and state regulatory agencies may adopt changes to their regulations or change the manner in which existing regulations are applied. We cannot predict the substance or effect of pending or future legislation or regulation or the application of laws and regulations to our Company. Compliance with current and potential regulation, as well as regulatory scrutiny, may significantly increase our costs, impede the efficiency of our internal business processes, require us to increase our regulatory capital, and limit our ability to pursue business opportunities in an efficient manner by requiring us to expend significant time, effort and resources to ensure compliance and respond to any regulatory inquiries or investigations. In addition, press coverage and other public statements that assert some form of wrongdoing by financial services companies (including press coverage and public statements that do not involve us) may result in regulatory inquiries or investigations, which, independent of the outcome, may be time-consuming and expensive and may divert time, effort and resources from our business. Evolving regulations and guidance concerning executive compensation may also impose limitations on us that affect our ability to compete successfully for executive and management talent.
In addition, given the current economic and financial environment, regulators may elect to alter standards or the interpretation of the standards used to measure regulatory compliance or to determine the adequacy of liquidity, certain risk management or other operational practices for financial services companies in a manner that impacts our ability to implement our strategy and could affect us in substantial and unpredictable ways, and could have a material adverse effect on our business, financial condition and results of operations. Furthermore, the regulatory agencies have extremely broad discretion in their interpretation of the regulations and laws and their interpretation of the quality of our loan portfolio, securities portfolio and other assets. If any regulatory agency’s assessment of the quality of our assets, operations, lending practices, investment practices, capital structure or other aspects of our business differs from our assessment, we may be required to take additional charges or undertake or refrain from taking actions that would have the effect of materially reducing our earnings, capital ratios and share price.
Because our total assets exceed $10 billion, we are subject to additional regulatory requirements, which could have an adverse effect on our financial condition or results of operations.
Various federal banking laws and regulations, including rules adopted by the Federal Reserve pursuant to the requirements of the Dodd-Frank Act, impose heightened requirements on certain large banks and bank holding companies. Most of these rules apply primarily to bank holding companies with at least $50 billion in total consolidated assets, but certain rules also apply to banks and bank holding companies with at least $10 billion in total consolidated assets. The Economic Growth, Regulatory Relief, and Consumer Protection Act (“EGRRCPA”) was enacted on May 24, 2018 and provides certain limited amendments to the Dodd-Frank Act as well as other modifications to certain post-crisis regulatory requirements. The EGRRCPA will likely decrease the overall regulatory burden on institutions like Cadence; however, the ultimate impact is uncertain at this time and will depend on the implementation of the law by the federal banking agencies.
As a result of reaching $10 billion in total assets for four consecutive quarters, we and Cadence Bank are, among other requirements:
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required to establish a dedicated risk committee of our Board of Directors responsible for overseeing our enterprise-risk management policies, commensurate with our capital structure, risk profile, complexity, size and other risk-related factors, and including as a member at least one risk management expert;
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required to calculate our FDIC deposit insurance assessment using the large bank pricing rule;
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subject to more frequent regulatory examinations; and
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subject to examination for compliance with federal consumer protection laws by the CFPB.
In addition, Cadence and Cadence Bank are affected by the Durbin Amendment to the Dodd-Frank Act regarding limits on debit card interchange fees. The Durbin Amendment gave the Federal Reserve Board the authority to establish rules regarding
interchange fees charged for electronic debit transactions by a payment card issuer that, together with its affiliates, has assets of $10 billion or more and to enforce a new statutory requirement that such fees be reasonable and proportional to the actual cost of a transaction to the issuer. The Federal Reserve Board has adopted rules under this provision that limit the swipe fees that a debit card issuer can charge a merchant for a transaction to the sum of 21 cents and five basis points times the value of the transaction, plus up to one cent for fraud prevention costs. The ultimate impact of the heightened scrutiny to which we are subject is uncertain, but we may be adversely affected and may incur increased costs related to regulatory oversight.
Legislative and regulatory actions taken now or in the future may increase our costs and impact our business, governance structure, financial condition or results of operations. Proposed legislative and regulatory actions, including changes to financial regulation, may not occur on the timeframe that is expected, or at all, which could result in additional uncertainly for our business.
We and our subsidiaries are subject to extensive regulation by multiple regulatory bodies. These regulations may affect the manner and terms of delivery of our services. If we do not comply with governmental regulations, we may be subject to fines, penalties, lawsuits or material restrictions on our businesses in the jurisdiction where the violation occurred, which may adversely affect our business operations. Changes in these regulations can significantly affect the services that we provide as well as our costs of compliance with such regulations. In addition, adverse publicity and damage to our reputation arising from the failure or perceived failure to comply with legal, regulatory or contractual requirements could affect our ability to attract and retain customers.
Current and recent-past economic conditions, particularly in the financial markets, have resulted in government regulatory agencies and political bodies placing increased focus and scrutiny on the financial services industry. The Dodd-Frank Act significantly changed the regulation of financial institutions and the financial services industry. The Dodd-Frank Act and the regulations thereunder affect large and small financial institutions, including several provisions that will affect how community banks, thrifts and small bank and thrift holding companies will be regulated in the future.
New proposals for legislation continue to be introduced in the U.S. Congress that could further substantially increase regulation of the financial services industry, impose restrictions on the operations and general ability of firms within the industry to conduct business consistent with historical practices, including in the areas of compensation, interest rates, financial product offerings and disclosures, and have an effect on bankruptcy proceedings with respect to consumer residential real estate mortgages, among other things. Federal and state regulatory agencies also frequently adopt changes to their regulations or change the manner in which existing regulations are applied. In addition, President Donald Trump has issued an executive order directing the review of existing financial regulations. It is not clear when, or if, changes to existing statutory or regulatory requirements may be implemented.
Certain aspects of current or proposed regulatory or legislative changes, including to laws applicable to the financial industry, if enacted or adopted, may impact the profitability of our business activities, require more oversight or change certain of our business practices, including the ability to offer new products, obtain financing, attract deposits, make loans and achieve satisfactory interest spreads, and could expose us to additional costs, including increased compliance costs. These changes also may require us to invest significant management attention and resources to make any necessary changes to operations to comply and could have a material adverse effect on our business, financial condition and results of operations. In addition, any proposed legislative or regulatory changes, including those that could benefit our business, financial condition and results of operations, may not occur on the timeframe that is proposed, or at all, which could result in additional uncertainty for our business.
Regulatory initiatives regarding bank capital requirements may require heightened capital.
Regulatory capital rules, adopted in July 2013, implement higher minimum capital requirements for bank holding companies and banks. Additionally, bank holding companies and banks are also required to hold a capital conservation buffer of Common Equity Tier 1 capital of 2.5% to avoid limitations on capital distributions and discretionary executive compensation payments.
In December 2017, the Basel Committee on Banking Supervision published standards that it described as the finalization of the Basel III regulatory framework (commonly referred to as Basel IV). Among other things, these standards revise the Basel Committee’s standardized approach for credit risk and provide a new standardized approach for operational risk capital. Under the Basel framework, these standards will generally be effective on January 1, 2022, with an aggregate output floor phasing in through January 1, 2027. Under the current U.S. capital rules, operational risk capital requirements and a capital floor apply only to advanced approaches institutions, and not to the Company or the Bank. The impact of Basel IV on us will depend on the manner in which it is implemented by the federal bank regulators.
The Federal Reserve may also set higher capital requirements for holding companies whose circumstances warrant it. For example, holding companies experiencing internal growth or making acquisitions are expected to maintain strong capital positions
substantially above the minimum supervisory levels, without significant reliance on intangible assets. At this time, the bank regulatory agencies are more inclined to impose higher capital requirements to meet well-capitalized standards, and future regulatory change could impose higher capital standards as a routine matter.
Any new standards may require the Company or the Bank to maintain materially more capital, with common equity as a more predominant component, or manage the configuration of our assets and liabilities to comply with formulaic liquidity requirements. Our ability to raise additional capital depends on conditions in the capital markets, economic conditions and a number of other factors, including investor perceptions regarding the banking industry, market conditions and governmental activities, and on our financial condition and performance. Accordingly, we may not be able to raise additional capital if needed or on terms acceptable to us. Failure to maintain capital to meet current or future regulatory requirements could significantly impact our return on equity, financial condition, operations, capital position and ability to pursue business opportunities which could have a material adverse effect on our business, financial condition and results of operations.
Regulators periodically examine our business and we may be required to remediate adverse examination findings.
The Federal Reserve, the FDIC, the OCC, and the CFPB periodically examine our business, including our compliance with laws and regulations, and we may become subject to other regulatory agency examinations in the future. If, as a result of an examination, a federal banking agency were to determine that our financial condition, capital resources, asset quality, earnings prospects, management, liquidity, or other aspects of any of our operations had become unsatisfactory, or that we were in violation of any law or regulation, it may require us to take a number of different remedial actions as it deems appropriate. These actions include the power to enjoin “unsafe or unsound” practices, to require affirmative action to correct any conditions resulting from any violation or practice, to issue an administrative order that can be judicially enforced, to direct an increase in our capital, to restrict our growth by preventing us from acquiring other financial institutions or limiting our ability to expand our business by engaging in new activities, to change the asset composition of our portfolio or balance sheet, to assess civil monetary penalties against our officers or directors, to remove officers and directors and, if it is concluded that such conditions cannot be corrected or there is an imminent risk of loss to depositors, to terminate our deposit insurance and place us into receivership or conservatorship. Any regulatory action against us could have a material adverse effect on our business, financial condition and results of operations.
Our FDIC deposit insurance premiums and assessments may increase.
The deposits of the Bank are insured by the FDIC up to legal limits and, accordingly, subject to the Bank’s payment of FDIC deposit insurance assessments. The Bank’s regular assessments are calculated under the large bank pricing rule using its average consolidated total assets minus average tangible equity as well as by risk classification, which includes regulatory capital levels. To maintain a strong funding position and restore the reserve ratios of the Deposit Insurance Fund (“DIF”), the FDIC increased deposit insurance assessment rates and charged a special assessment to all FDIC-insured financial institutions. The FDIC also imposed a temporary surcharge on insured depository institutions with assets of at least $10 billion. Further increases in assessment rates or special assessments may occur in the future, especially if there are significant additional financial institution failures. Any future special assessments, increases in assessment rates, or required prepayments in FDIC insurance premiums could reduce our profitability or limit our ability to pursue certain business opportunities, which could have a material adverse effect on our business, financial condition and results of operations.
The Federal Reserve may require us to commit capital resources to support Cadence Bank.
As a matter of policy, the Federal Reserve expects a bank holding company to act as a source of financial and managerial strength to a subsidiary bank and to commit resources to support such subsidiary bank. The Dodd-Frank Act codified the Federal Reserve’s policy on serving as a source of financial strength. Under the “source of strength” doctrine, the Federal Reserve may require a bank holding company to make capital injections into a troubled subsidiary bank and may charge the bank holding company with engaging in unsafe and unsound practices for failure to commit resources to a subsidiary bank. A capital injection may be required at times when the holding company may not have the resources to provide it and therefore may be required to borrow the funds or raise capital. Any loans by a holding company to its subsidiary banks are subordinate in right of payment to deposits and to certain other indebtedness of such subsidiary bank. In the event of a bank holding company’s bankruptcy, the bankruptcy trustee will assume any commitment by the holding company to a federal bank regulatory agency to maintain the capital of a subsidiary bank. Moreover, bankruptcy law provides that claims based on any such commitment will be entitled to a priority of payment over the claims of the institution’s general unsecured creditors, including the holders of its note obligations. Thus, any borrowing that must be done by the bank holding company to make the required capital injection becomes more difficult and expensive and could have a material adverse effect on our business, financial condition and results of operations.
Future consumer legislation or actions could harm our competitive position.
In addition to the enactment of the Dodd-Frank Act, various legislative bodies have also recently been considering altering the existing framework governing creditors’ rights, including legislation that would result in, or allow, loan modifications of various sorts. Such legislation may change banking statutes and the operating environment in substantial and unpredictable ways. If enacted, such legislation could increase the cost of doing business; limit permissible activities; or affect the competitive balance among banks, savings associations, credit unions, and other financial institutions. We cannot predict whether new legislation will be enacted, and if enacted, the effect that it or any regulations would have on our activities, financial condition, or results of operations.
We are subject to numerous laws designed to protect consumers, including the CRA and fair lending laws, and failure to comply with these laws could lead to a wide variety of sanctions.
The CRA, the Equal Credit Opportunity Act, the Fair Housing Act and other fair lending laws and regulations impose non-discriminatory lending requirements on financial institutions. The Department of Justice and other federal agencies, including the CFPB, are responsible for enforcing these laws and regulations. A successful regulatory challenge to an institution’s performance under the CRA or fair lending laws and regulations could result in a wide variety of sanctions, including damages and civil money penalties, injunctive relief, restrictions on mergers and acquisitions activity, restrictions on expansion, and restrictions on entering new business lines. In the case of the CRA, the performance of a financial institution in meeting the credit needs of its community and its overall CRA rating are factors that will be taken into consideration when the federal banking agencies evaluate applications related to mergers and acquisitions, as well as branch opening and relocations. Private parties may also have the ability to challenge an institution’s performance under fair lending laws in private class action litigation. Such actions could have a material adverse effect on our business, financial condition and results of operations.
Federal, state and local consumer lending laws may restrict our ability to originate certain mortgage loans or increase our risk of liability with respect to such loans and could increase our cost of doing business.
Federal, state and local laws have been adopted that are intended to eliminate certain lending practices considered “predatory.” These laws prohibit practices such as steering borrowers away from more affordable products, selling unnecessary insurance to borrowers, repeatedly refinancing loans and making loans without a reasonable expectation that the borrowers will be able to repay the loans irrespective of the value of the underlying property. It is our policy not to make predatory loans, but these laws create the potential for liability with respect to our lending and loan investment activities. They increase our cost of doing business and, ultimately, may prevent us from making certain loans and cause us to reduce the average percentage rate or the points and fees on loans that we do make.
The expanding body of federal, state and local regulations and/or the licensing of loan servicing, collections or other aspects of our business and our sales of loans to third parties may increase the cost of compliance and the risks of noncompliance and subject us to litigation.
We service some of our own loans, and loan servicing is subject to extensive regulation by federal, state and local governmental authorities as well as to various laws and judicial and administrative decisions imposing requirements and restrictions on those activities. The volume of new or modified laws and regulations has increased in recent years and, in addition, some individual municipalities have begun to enact laws that restrict loan servicing activities including delaying or temporarily preventing foreclosures or forcing the modification of certain mortgages. If regulators impose new or more restrictive requirements, we may incur additional significant costs to comply with such requirements which may further adversely affect us. In addition, were we to be subject to regulatory investigation or regulatory action regarding our loan modification and foreclosure practices, our financial condition and results of operation could be adversely affected.
In addition, we and our legacy companies have sold loans to third parties. In connection with these sales, we or certain of our subsidiaries or legacy companies make or have made various representations and warranties, breaches of which may result in a requirement that we repurchase the loans, or otherwise make whole or provide other remedies to counterparties. These aspects of our business or our failure to comply with applicable laws and regulations could possibly lead to: civil and criminal liability; loss of licensure; damage to our reputation in the industry; fines and penalties and litigation, including class action lawsuits; and administrative enforcement actions. Any of these outcomes could materially and adversely affect us.
Potential limitations on incentive compensation contained in proposed federal agency rulemaking may adversely affect our ability to attract and retain our highest performing employees.
In April 2011 and May 2016, the Federal Reserve, other federal banking agencies and the SEC jointly published proposed rules designed to implement provisions of the Dodd-Frank Act prohibiting incentive compensation arrangements that would
encourage inappropriate risk taking at covered financial institutions, which includes a bank or bank holding company with $1 billion or more in assets, such as Cadence Bank. It cannot be determined at this time whether or when a final rule will be adopted and whether compliance with such a final rule will substantially affect the manner in which we structure compensation for our executives and other employees. Depending on the nature and application of the final rules, we may not be able to successfully compete with certain financial institutions and other companies that are not subject to some or all of the rules to retain and attract executives and other high performing employees. If this were to occur, relationships that we have established with our clients may be impaired and our business, financial condition and results of operations could be adversely affected, perhaps materially.
Failure to comply with economic and trade sanctions or with applicable anti-corruption laws could have a material adverse effect on our business, financial condition and results of operations.
The Office of Foreign Assets Control administers and enforces economic and trade sanctions against targeted foreign countries and regimes, under authority of various laws, including designated foreign countries, nationals and others. We are responsible for, among other things, blocking accounts of, and transactions with, such persons and countries, prohibiting unlicensed trade and financial transactions with them and reporting blocked transactions after their occurrence. Through our company and the Bank, and our agents and employees, we are subject to the Foreign Corrupt Practices Act (“FCPA”), which prohibits offering, promising, giving, or authorizing others to give anything of value, either directly or indirectly, to a non-U.S. government official in order to influence official action or otherwise gain an unfair business advantage. The Company is also subject to applicable anti-corruption laws in the jurisdictions in which it may operate. The Company has implemented policies, procedures, and internal controls that are designed to comply with economic and trade sanctions or with applicable anti-corruption laws, including the FCPA. Failure to comply with economic and trade sanctions or with applicable anti-corruption laws, including the FCPA, could have serious legal and reputational consequences for us.
Risks Relating to an Investment in Our Class A Common Stock
The market price of our Class A common stock may be subject to substantial fluctuations, which may make it difficult to sell shares at the volume, prices and times desired.
The market price of our Class A common stock may be highly volatile, which may make it difficult to sell shares at the volume, prices and times desired. There are many factors that may impact the market price and trading volume of our Class A common stock, including, without limitation:
•
actual or anticipated fluctuations in our operating results, financial condition or asset quality;
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changes in economic or business conditions;
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failure to meet market predictions of our earnings;
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the effects of, and changes in, trade, monetary and fiscal policies, including the interest rate policies of the Federal Reserve;
•
publication of research reports about us, our competitors, or the financial services industry generally, or changes in, or failure to meet, estimates made by securities analysts or ratings agencies of our financial and operating performance, or lack of research reports by industry analysts or ceasing of coverage;
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operating and stock price performance of companies that investors deemed comparable to us;
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future issuances of our Class A common stock or other securities;
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additions or departures of key personnel;
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proposed or adopted changes in laws, regulations or policies affecting us;
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perceptions in the marketplace regarding our competitors and/or us;
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changes in accounting principles, policies and guidelines;
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rapidly changing technology;
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significant acquisitions or business combinations, strategic partnerships, joint ventures or capital commitments by or involving our competitors or us;
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other economic, competitive, governmental, regulatory and technological factors affecting our operations, pricing, products and services; and
•
other news, announcements or disclosures (whether by us or others) related to us, our competitors, our markets or the financial services industry.
The stock market and the market for financial institution stocks, have experienced substantial fluctuations in recent years, which in many cases have been unrelated to the operating performance and prospects of particular companies. In addition, significant fluctuations in the trading volume in our Class A common stock may cause significant price variations to occur. Increased market volatility may materially and adversely affect the market price of our Class A common stock, which could make it difficult to sell your shares at the volume, prices and times desired.
There are substantial regulatory limitations on changes of control of bank holding companies that may discourage investors from purchasing shares of our Class A common stock.
With certain limited exceptions, federal regulations prohibit a person or company or a group of persons deemed to be “acting in concert” from, directly or indirectly, acquiring more than 10% (5% if the acquirer is a bank holding company) of any class of our voting stock or obtaining the ability to control in any manner the election of a majority of our directors or otherwise direct the management or policies of our company without prior notice or application to, and the approval of, the Federal Reserve. Companies investing in banks and bank holding companies receive additional review and may be required to become bank holding companies, subject to regulatory supervision. Accordingly, prospective investors must be aware of and comply with these requirements, if applicable, in connection with any purchase of shares of our Class A common stock. These provisions could discourage third parties from seeking to acquire significant interests in us or in attempting to acquire control of us, which, in turn, could adversely affect the market price of our Class A common stock.
Securities analysts may not continue coverage on our Class A common stock, which could adversely affect the market for our Class A common stock.
The trading market for our Class A common stock depends in part on the research and reports that securities analysts publish about us and our business. We do not have any control over these securities analysts, and they may not cover our Class A common stock. If securities analysts do not continue to cover our Class A common stock, the lack of research coverage may adversely affect our market price. If our Class A common stock is the subject of an unfavorable report, the price of our Class A common stock may decline. If one or more of these analysts cease to cover us or fail to publish regular reports on us, we could lose visibility in the financial markets, which could cause the price or trading volume of our Class A common stock to decline.
As a public company, we incur significant legal, accounting, insurance, compliance and other expenses. Any deficiencies in our financial reporting or internal controls could materially and adversely affect us, including resulting in material misstatements in our financial statements, and the market price of our Class A common stock.
As a public company, we incur significant legal, accounting, insurance and other expenses. These costs and compliance with the rules of the SEC and the rules of the applicable stock exchange may further increase our legal and financial compliance costs and make some activities more time consuming and costly. Beginning with our 2018 Annual Report on Form 10-K, SEC rules require that our Chief Executive Officer and Chief Financial Officer periodically certify the existence and effectiveness of our internal control over financial reporting and our independent registered public accounting firm will be required to attest to our assessment of our internal control over financial reporting. This process will require significant documentation of policies, procedures and systems, review of that documentation by our internal auditing and accounting staff and our outside independent registered public accounting firm and testing of our internal control over financial reporting by our internal auditing and accounting staff and our outside independent registered public accounting firm. This process will involve considerable time and attention from management, which could prevent us from successfully implementing our business initiatives and improving our business, results of operations and financial condition, may strain our internal resources, and will increase our operating costs. We may experience higher than anticipated operating expenses and outside auditor fees during the implementation of these changes and thereafter.
During our testing, we may identify deficiencies that would have to be remediated to satisfy the SEC rules for certification of our internal control over financial reporting. A material weakness is defined by the standards issued by the Public Company Accounting Oversight Board as a deficiency, or combination of deficiencies, in internal control over financial reporting that results in a reasonable possibility that a material misstatement of our annual or interim financial statements will not be prevented or detected on a timely basis. Therefore, we would have to disclose in periodic reports we file with the SEC any material weakness in our internal control over financial reporting. The existence of a material weakness would preclude management from concluding that our internal control over financial reporting is effective and would preclude our independent auditors from attesting to our assessment of the effectiveness of our internal control over financial reporting is effective. In addition, disclosures of deficiencies of this type in our SEC reports could cause investors to lose confidence in our financial reporting, may negatively affect the market price of our Class A common stock, and could result in the delisting of our securities from the securities exchanges on which they trade. Moreover, effective internal controls are necessary to produce reliable financial reports and to prevent fraud. If we have deficiencies in our disclosure controls and procedures or internal control over financial reporting, it may materially and adversely affect us.
Material weaknesses in our financial reporting or internal controls could adversely affect our business.
A material weakness is a deficiency, or a combination of deficiencies, in internal control over financial reporting, such that there is a reasonable possibility that a material misstatement of the company’s annual or interim financial statements will not be prevented or detected on a timely basis. The identification of any material weakness could also result in investors losing confidence in our internal controls and questioning our reported financial information, which, among other things, could have a negative impact on the trading price of our Class A common stock. Additionally, we could become subject to increased regulatory scrutiny and a higher risk of shareholder litigation, which could result in significant additional expenses and require additional financial and management resources.
Shares of our Class A common stock are subject to dilution.
Actual or anticipated issuances or sales of substantial amounts of our Class A common stock could cause the market price of our Class A common stock to decline significantly and make it more difficult for us to sell equity or equity-related securities in the future at a time and on terms that we deem appropriate. The issuance of any shares of our Class A common stock in the future also would, and equity-related securities could, dilute the percentage ownership interest held by shareholders prior to such issuance. We may issue all these shares without any action or approval by our shareholders, and these shares, once issued (including upon exercise of outstanding options), will be available for sale into the public market, subject to the restrictions described below, if applicable, for affiliate holders.
We may issue shares of Class B non-voting common stock or shares of preferred stock that would adversely affect the rights of our Class A common shareholders.
Our authorized capital stock includes 300,000,000 shares of Class B non-voting common stock, $0.01 par value per share and 50,000,000 shares of preferred stock, $0.01 par value per share. As of the date of this Annual Report, we have no issued and outstanding shares of either our Class B non-voting common stock or our preferred stock. Our Board of Directors, in their sole discretion, may issue Class B non-voting common stock and one or more series of preferred stock. Subject to limitations imposed by our articles of incorporation, our Board of Directors is empowered to determine, among other items, the number of shares for each series, the dividend rate for each series, the terms and conditions of any voting, conversion or exchange rights for each series, and the preferences and the relative rights for each series.
Our future ability to pay dividends is subject to restrictions.
We currently conduct substantially all our operations through our subsidiaries, and a significant part of our income is attributable to dividends from the Bank and we principally rely on the profitability of the Bank to conduct operations and satisfy obligations. Our principal source of funds to pay dividends on our common and preferred stock and service any of our obligations are dividends received directly from our subsidiaries, including Cadence Bank. As is the case with all financial institutions, the profitability of the Bank is subject to the fluctuating cost and availability of money, changes in interest rates, and in economic conditions in general. In addition, various federal and state statutes and regulations limit the amount of dividends that the Bank may pay to us, with or without regulatory approval.
Holders of our Class A common stock are entitled to receive only such cash dividends as our Board of Directors may declare out of funds legally available for such payments. Any declaration and payment of dividends on Class A common stock will depend upon our earnings and financial condition, liquidity and capital requirements, the general economic and regulatory climate, our ability to service any equity or debt obligations senior to the Class A common stock, and other factors deemed relevant by the board of directors. Furthermore, consistent with our business plans, growth initiatives, capital availability, projected liquidity
needs, and other factors, we have made, and will continue to make, capital management decisions and policies that could adversely impact the amount of dividends, if any, paid to our common shareholders.
Our articles of incorporation and bylaws include provisions that could impede a takeover of the Company.
Certain provisions of our articles of incorporation and bylaws could delay, defer, or prevent a third party from acquiring control of our organization or conduct a proxy contest, even if those events were perceived by many of our shareholders as beneficial to their interests. These provisions:
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enable our Board of Directors to issue additional shares of authorized, but unissued capital stock;
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enable our Board of Directors to issue “blank check” preferred stock with such designations, rights and preferences as may be determined from time to time by the board;
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enable our Board of Directors to increase the size of the board and fill the vacancies created by the increase;
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enable our Board of Directors to serve for three-year terms;
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may prohibit large shareholders, in particular those owning 15% or more of our outstanding voting stock, from merging or combining with us for a certain period of time;
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provide for a plurality voting standard in the election of directors;
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do not provide for cumulative voting in the election of directors;
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enable our Board of Directors to amend our bylaws without shareholder approval;
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do not allow for the removal of directors without cause;
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limit the right of shareholders to call a special meeting;
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require advance notice for director nominations and other shareholder proposals; and
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require prior regulatory application and approval of any transaction involving control of our organization.
These provisions may discourage potential acquisition proposals and could delay or prevent a change in control, including when our shareholders might otherwise receive a premium over the market price of our shares. At the 2020 Annual Shareholders Meeting, certain amendments to the Company’s Articles of Incorporation and By-Laws are subject to shareholder vote. These amendments: (a) declassify the Board of Directors beginning in 2021, at which time each director on the ballot for election would be elected to a one-year term following the expiration of such director’s existing term and (b) eliminate the requirement for a supermajority vote in order to amend the By-Laws and replace the requirement with a majority vote standard.
Shares of our Class A common stock are not deposits insured by the FDIC and are subject to risk of loss.
Shares of our Class A common stock are not deposit accounts and are not insured the FDIC or any other government agency and are subject to investment risk, including the possible loss of your investment.
The return on investment in our common stock is uncertain.
An investor in our Class A common stock may not realize a substantial return on his or her investment or may not realize any return at all. Further, as a result of the uncertainty and risks associated with our operations, many of which are described in this “Risk Factors” section, it is possible that an investor could lose his or her entire investment.
ITEM 1B.
ITEM 1B. UNRESOLVED STAFF COMMENTS
None.
ITEM 2.
ITEM 2. PROPERTIES
Our main office is located at 2800 Post Oak Boulevard, Suite 3800, Houston, Texas 77056. In addition to our main office, which is leased, as of December 31, 2019, we operate from 98 branch offices located in Texas, Alabama, Florida, Georgia, Mississippi, and Tennessee, of which 31 are leased, 79 are in free standing facilities, 79 provide for drive-up access, and most are equipped with ATMs. Additionally, throughout our footprint, we operate three operations centers (one leased, two owned), leased trust offices, leased mortgage offices, leased Linscomb & Williams offices, and leased lending offices with most of these located within our branch offices.
ITEM 3.
ITEM 3. LEGAL PROCEEDINGS
The Company and its subsidiaries are from time to time subject to claims and litigation arising in the ordinary course of business. At this time, in the opinion of management, the likelihood is remote that the impact of such proceedings, either individually or in the aggregate, would have a material adverse effect on our consolidated results of operations, financial condition or cash flows. However, one or more unfavorable outcomes in any claim or litigation against us could have a material adverse effect for the period in which they are resolved. In addition, regardless of their merits or their ultimate outcomes, such matters are costly, divert management’s attention and may materially adversely affect our reputation, even if resolved in our favor.
Cadence Securities Class Action Litigation. On September 16, 2019, a Cadence Bancorporation shareholder filed a putative class action complaint against Cadence Bancorporation and certain senior officers. Following consolidation of a related matter and appointment of lead plaintiffs, the lead plaintiffs filed an amended complaint on January 31, 2020, which asserted claims under Sections 10(b) and 20 of the Securities Exchange Act on behalf of a putative class of persons and entities that purchased or otherwise acquired Cadence Bancorporation securities between July 23, 2018, and January 23, 2020, inclusive. The amended complaint alleges that Cadence Bancorporation and the individual defendants made materially misleading statements about the credit quality of Cadence Bancorporation’s loan portfolio, did not timely charge off bad debt or record sufficient loss provisions to reserve against the risk of loss, and maintained an inadequate allowance for credit losses. The consolidated case is captioned Frank Miller et al. v. Cadence Bancorporation et al., Case No. H-19-3492-LNH, in the United States District Court for the Southern District of Texas. Cadence Bancorporation and the individual defendants intend to file a motion to dismiss and to mount a vigorous defense. The case is in its preliminary stages, discovery has not yet commenced, and it is not possible at this time to estimate the likelihood or amount of any potential damages exposure.
ITEM 4.
ITEM 4. MINE SAFETY DISCLOSURES
Not applicable.
PART II
ITEM 5.
ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES
Common Stock Market Prices
Our Class A common stock has been listed on the New York Stock Exchange (“NYSE”) under the symbol “CADE” since April 13, 2017. The NYSE is the principal U.S. market where our Class A common stock is traded.
Dividend Policy
During 2019, we declared four quarterly dividends of $0.175 per share of our Class A common stock for an annual total of $0.70. On February 4, 2020, our Board of Directors declared a quarterly dividend of $0.175 per share of outstanding common stock, payable on February 25, 2020 to shareholders of record on the close of business on February 18, 2020.
Although we currently expect to continue to pay quarterly dividends, any future determination relating to our dividend policy will be made by our Board of Directors and will depend on a number of factors, including: (1) our historic and projected financial condition, liquidity and results of operations, (2) our capital levels and needs, (3) tax considerations, (4) any acquisitions or potential acquisitions that we may examine, (5) statutory and regulatory prohibitions and other limitations, (6) the terms of any credit agreements or other borrowing arrangements that restrict our ability to pay cash dividends, (7) general economic conditions and (8) other factors deemed relevant by our Board of Directors. We are not obligated to pay dividends on our common stock and are subject to restrictions on paying dividends on our common stock.
As a Delaware corporation, we are subject to certain restrictions on dividends under the Delaware General Corporation Law (the “DGCL”). Generally, a Delaware corporation may only pay dividends either out of “surplus” or out of the current or the immediately preceding year’s net profits. Surplus is defined as the excess, if any, at any given time, of the total assets of a corporation over its total liabilities and statutory capital. The value of a corporation’s assets can be measured in a number of ways and may not necessarily equal their book value.
In addition, we are subject to certain restrictions on the payment of cash dividends as a result of banking laws, regulations and policies. See “Supervision and Regulation-Bank Holding Company Regulation-Safe and Sound Banking Practices.”
Because we are a financial holding company and do not engage directly in business activities of a material nature, our ability to pay dividends to our shareholders depends, in large part, upon our receipt of dividends from Cadence Bank, which is also subject to numerous limitations on the payment of dividends under federal banking laws, regulations and policies. See “Supervision and Regulation-Bank Regulation-Standards for Safety and Soundness.”
Recent Sales of Unregistered Securities
None.
Securities Authorized for Issuance under Equity Compensation Plans
The information required by this Item is incorporated herein by reference to the information under the caption “Equity Compensation Plan Information” in our Proxy Statement for the 2020 Annual Meeting of Shareholders (“2020 Proxy Statement”).
Issuer Purchases of Equity Securities
In October 2018, the Company’s Board of Directors authorized a share repurchase program in an amount of up to $50 million as part of the Company’s overall capital management strategies. On December 21, 2018, the Board approved an amendment to the repurchase program providing for the purchase of up to 4,310,000 shares not to exceed an aggregate purchase of $81 million, subject to receipt of required regulatory approvals. In July 2019, the Board authorized a new share repurchase program in an amount of up to $50 million. As of December 31, 2019, the Company had repurchased approximately 5.4 million shares of common stock at a cost of $101.1 million.
The following table presents information related to issuer purchases of equity securities during the fourth quarter of 2019:
Performance Graph
The performance graph below compares the cumulative total shareholder return on Cadence Bancorporation Class A common stock with the cumulative total return on the equity securities of companies included in the Standard & Poor’s 500 Stock Index and the KBW NASDAQ Regional Bank Index, measured at the last trading day of each period shown. The graph assumes an investment of $100 on April 13, 2017 and reinvestment of dividends on the date of payment without commissions. The performance graph represents past performance and should not be considered to be an indication of future performance.
ITEM 6.
ITEM 6. SELECTED CONSOLIDATED FINANCIAL DATA
The following table summarizes certain selected consolidated financial data for the years presented. The selected historical financial data as of and for each of the years in the period ended December 31, 2019 have been derived from our audited consolidated financial statements. The historical consolidated financial information presented below contains financial measures that are not presented in accordance with generally accepted accounting principles (“GAAP”) in effect in the United States and which have not been audited. See “Non-GAAP Financial Measures.”
You should read the following information, together with “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” and our consolidated financial statements and notes thereto included elsewhere in this Annual Report.
(1)
Considered a non-GAAP financial measure. See “Non-GAAP Financial Measures” for a reconciliation of our non-GAAP measures to the most directly comparable GAAP financial measure.
NON-GAAP fINANCIAL mEASURES
We identify “efficiency ratio,” “adjusted efficiency ratio,” “adjusted noninterest expense,” “adjusted noninterest income,” “adjusted operating revenue,” “tangible common equity,” “tangible common equity ratio,” “return on average tangible common equity,” “adjusted return on average tangible common equity,” “tangible book value per share,” “adjusted return on average assets,” “adjusted net income,” “adjusted net income allocated to common stock,” “tangible net income,” “adjusted tangible net income,” “adjusted diluted earnings per share” and “adjusted pre-tax pre-provision net earnings” as “non-GAAP financial measures.” In accordance with the SEC’s rules, we identify certain financial measures as non-GAAP financial measures if such financial measures exclude or include amounts in the most directly comparable measures calculated and presented in accordance with generally accepted accounting principles (“GAAP”) in effect in the United States in our statements of income, balance sheet or statements of cash flows. Non-GAAP financial measures do not include operating and other statistical measures, ratios or statistical measures calculated using exclusively financial measures calculated in accordance with GAAP.
The non-GAAP financial measures that we discuss herein should not be considered in isolation or as a substitute for the most directly comparable or other financial measures calculated in accordance with GAAP. Moreover, the manner in which we calculate these non-GAAP financial measures may differ from that of other companies reporting measures with similar names, and, therefore, may not be comparable to our non-GAAP financial measures.
Efficiency ratio is defined as noninterest expenses divided by operating revenue, which is equal to net interest income plus noninterest income. Adjusted efficiency ratio is defined as adjusted noninterest expenses divided by adjusted operating revenue, which is equal to net interest income plus noninterest income, excluding certain non-routine income and expenses. We believe that these measures are important to many investors in the marketplace who wish to assess our performance versus that of our peers.
Our adjusted noninterest expenses represent total noninterest expenses net of any merger, restructuring, branch closing costs or other non-routine expense items. Our adjusted operating revenue is equal to net interest income plus noninterest income excluding gains and losses on sales of securities and other non-routine revenue items. In our judgment, the adjustments made to noninterest expense and operating revenue allow management and investors to better assess our performance by removing the volatility that is associated with certain other discrete items that are unrelated to our core business.
Tangible common equity is defined as total shareholders’ equity, excluding preferred stock, less goodwill and other intangible assets. We believe that this measure is important to many investors in the marketplace who are interested in changes from period to period in common shareholders’ equity exclusive of changes in intangible assets. Goodwill, an intangible asset that is recorded in a purchase business combination, has the effect of increasing both common equity and assets while not increasing our tangible common equity or tangible assets.
The tangible common equity ratio is defined as the ratio of tangible common equity divided by total assets less goodwill and other intangible assets. We believe that this measure is important to many investors in the marketplace who are interested in relative changes from period to period in common equity and total assets, each exclusive of changes in intangible assets. We believe that the most directly comparable GAAP financial measure is total shareholders’ equity to total assets.
Return on average tangible common equity is defined as tangible net income divided by average tangible common equity. Adjusted return on average tangible common equity is defined as adjusted tangible net income divided by average tangible common equity. We believe the most directly comparable GAAP financial measure is the return on average common equity.
Tangible net income is defined as net income plus intangible asset amortization, net of tax. Adjusted tangible net income is defined as net income plus intangible asset amortization, net of tax, plus non-routine item, net of tax. Non-routine items include merger related expenses, gain on acquired loans, net securities gains, pension plan termination expense, reevaluation of receivables from sale of insurance assets, and other non-routine expenses.
Adjusted net income is defined as net income plus or minus total non-routine items, net of tax. Non-routine items include merger related expenses, gain on acquired loans, net securities gains, pension plan termination expense, reevaluation of receivables from sale of insurance assets, and other non-routine income and expenses. We believe the most directly comparable GAAP financial measure is net income.
Tangible book value per share is defined as book value, excluding the impact of goodwill and other intangible assets, if any, divided by shares of our common stock outstanding.
Adjusted return on average assets is defined as adjusted net income divided by average assets. We believe the most directly comparable GAAP financial measure is the return on average assets.
Adjusted net income allocated to common stock is defined as net income allocated to common stock plus total non-routine items. We believe the most directly comparable GAAP financial measure is net income allocated to common stock.
Adjusted pre-tax, pre-provision net earnings is defined as income before taxes, provision for credit losses and non-routine items. We believe the most directly comparable GAAP financial measure is income before taxes.
The following table is a reconciliation of our Non-GAAP measures to the most directly comparable GAAP financial measure:
(1)
Other non-routine expenses for 2018 included expenses related to the sale of the assets of our insurance company and legal costs associated with litigation related to a pre-acquisition matter of a legacy acquired bank that has been resolved. 2017 non-routine expenses represent additional expenses for the aforementioned legal matter. 2016 and 2015 non-routine expenses represent amounts related to branch closures.
(1) Other non-routine expenses for 2018 included expenses related to the sale of the assets of our insurance company and legal costs associated with litigation related to a pre-acquisition matter of a legacy acquired bank that has been resolved. 2017 non-routine expenses represent additional expenses for the aforementioned legal matter. 2016 and 2015 non-routine expenses represent amounts related to branch closures.
ITEM 7.
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
General
The following discussion and analysis presents our results of operations and financial condition on a consolidated basis. This discussion should be read in conjunction with the consolidated financial statements, accompanying notes and supplemental financial data included herein. Because we conduct our material business operations through our bank subsidiary, Cadence Bank, N.A., the discussion and analysis relate to activities primarily conducted by the Bank. We generate most of our revenue from interest on loans and investments and fee-based revenues. Our primary source of funding for our loans is deposits. Our largest expenses are interest on these deposits and salaries and related employee benefits. We measure our performance primarily through our net income, pre-tax and pre-loan provision earnings, net interest margin, efficiency ratio, ratio of allowance for credit losses to total loans, return on average assets and return on average equity, among other metrics, while maintaining appropriate regulatory capital ratios.
This Report on Form 10-K (“Annual Report”) contains forward-looking statements. These forward-looking statements reflect our current views with respect to, among other things, future events and our results of operations, financial condition and financial performance. These statements are often, but not always, made through the use of words or phrases such as “may,” “should,” “could,” “predict,” “potential,” “believe,” “will likely result,” “expect,” “continue,” “will,” “anticipate,” “seek,” “estimate,” “intend,” “plan,” “projection,” “would” and “outlook,” or the negative version of those words or other comparable words of a future or forward-looking nature. These forward-looking statements are not historical facts, and are based on current expectations, estimates and projections about our industry, management’s beliefs and certain assumptions made by management, many of which, by their nature, are inherently uncertain and beyond our control. Accordingly, we caution you that any such forward-looking statements are not guarantees of future performance and are subject to risks, assumptions and uncertainties that are difficult to predict. Although we believe that the expectations reflected in these forward-looking statements are reasonable as of the date made, actual results may prove to be materially different from the results expressed or implied by the forward-looking statements.
There are or will be important factors that could cause our actual results to differ materially from those indicated in these forward-looking statements, including, but not limited to, the following:
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business and economic conditions generally and in the financial services industry, nationally and within our current and future geographic market areas;
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economic, market, operational, liquidity, credit and interest rate risks associated with our business;
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deteriorating asset quality and higher loan charge-offs;
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the laws and regulations applicable to our business;
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our ability to achieve organic loan and deposit growth and the composition of such growth;
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increased competition in the financial services industry;
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our ability to maintain our historical earnings trends;
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our ability to raise additional capital to implement our business plan;
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material weaknesses in our internal control over financial reporting;
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systems failures or interruptions involving our information technology and telecommunications systems or third-party servicers;
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the composition of our management team and our ability to attract and retain key personnel;
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our ability to monitor our lending relationships;
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the composition of our loan portfolio, including the identity of our borrowers and the concentration of loans in energy-related industries and in our specialized industries;
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the portion of our loan portfolio that is comprised of participations and shared national credits;
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the amount of nonperforming and criticized assets we hold;
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our ability to identify potential candidates for, consummate, and achieve synergies resulting from, potential future acquisitions;
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any interruption or breach of security resulting in failures or disruptions in customer account management, general ledger, deposit, loan, or other systems;
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environmental liability associated with our lending activities;
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the geographic concentration of our markets in Texas and the southeast United States;
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the commencement and outcome of litigation and other legal proceedings against us or to which we may become subject;
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changes in legislation, regulation, policies, or administrative practices, whether by judicial, governmental, or legislative action, including, but not limited to, the Dodd-Frank Wall Street Reform and Consumer Protection Act (“Dodd-Frank Act”), and other changes pertaining to banking, securities, taxation, rent regulation and housing, financial accounting and reporting, environmental protection, and the ability to comply with such changes in a timely manner;
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changes in the monetary and fiscal policies of the U.S. Government, including policies of the U.S. Department of the Treasury and the Federal Reserve Board;
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requirements to remediate adverse examination findings;
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changes in the scope and cost of FDIC deposit insurance premiums;
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implementation of regulatory initiatives regarding regulatory capital requirements that may require heightened capital;
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changes in accounting principles, policies, practices, or guidelines;
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our success at managing the risks involved in the foregoing items;
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our modeling estimates related to an increased interest rate environment;
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natural disasters, war, or terrorist activities; and
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other economic, competitive, governmental, regulatory, technological, and geopolitical factors affecting our operations, pricing, and services.
The foregoing factors should not be construed as exhaustive and should be read together with the other cautionary statements included in this Report. If one or more events related to these or other risks or uncertainties materialize, or if our underlying assumptions prove to be incorrect, actual results may differ materially from what we anticipate. Accordingly, you should not place undue reliance on any such forward-looking statements. Any forward-looking statement speaks only as of the date on which it is made, and we do not undertake any obligation to publicly update or review any forward-looking statement, whether as a result of new information, future developments or otherwise. New factors emerge from time to time, and it is not possible for us to predict which will arise. In addition, we cannot assess the impact of each factor on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
Overview
Cadence Bancorporation is a financial holding company and a Delaware corporation headquartered in Houston, Texas, and is the parent company of Cadence Bank, National Association. With $17.8 billion in assets, $13.0 billion in total loans (net of unearned discounts and fees), $14.7 billion in deposits and $2.5 billion in shareholders’ equity as of December 31, 2019, we operate a network of 98 branch locations across Texas, Alabama, Florida, Georgia, Mississippi, and Tennessee. We focus on middle-market commercial lending, complemented by retail banking and wealth management services, and provide a broad range of banking services to businesses, high net worth individuals and business owners.
On January 1, 2019, we acquired all the outstanding stock of State Bank Financial Corporation (“State Bank”), headquartered in Atlanta, Georgia, the bank holding company for State Bank and Trust Company. State Bank shareholders received 1.271 shares of the Company’s Class A common stock in exchange for each share of State Bank common stock, resulting in the issuance of 49.2 million shares of our Class A common stock resulting in a total purchase price of $826.4 million. The primary reasons for the transaction were to expand our market presence into Georgia, create a more diverse business mix, enhance our funding base and leverage operating costs through economies of scale. The acquisition added $3.5 billion in loans and $4.1 billion in deposits as well as 32 branch locations throughout Georgia to our portfolio (see “Note 2 - Business Combinations” to the Consolidated Financial Statements).
On July 1, 2019, the Bank’s wholly owned subsidiary, Linscomb & Williams, Inc., acquired certain assets and assumed certain liabilities of Wealth and Pension Services Group, Inc., a fee-based investment advisory firm with its principal office in Atlanta, Georgia. The total purchase consideration paid was $8.0 million. During the third quarter of 2019, we recorded provisional identifiable intangible assets with an estimated fair value of $5.1 million, comprised primarily of customer relationships and noncompete agreements and goodwill of $2.6 million (see “Note 2 - Business Combination” to the Consolidated Financial Statements).
We operate Cadence Bancorporation through three operating segments: Banking, Financial Services and Corporate. Our Banking Segment, which represented approximately 97% of our total revenues for the three years in the period ended December 31, 2019, consists of our Commercial Banking, Retail Banking and Private Banking lines of business. Our Commercial Banking activities focus on commercial and industrial (“C&I”), community banking, business banking and commercial real estate lending and treasury management services. Within our Commercial Banking line of business, we focus on select industries, which we refer to as our “specialized industries,” in which we believe we have specialized experience and service capabilities. These industries include franchise restaurant, healthcare, and technology. Energy lending is also an important part of our business as energy production and energy related industries are meaningful contributors to the economy in our primary markets. In our Retail Banking business line, we offer a broad range of banking services through our branch network to serve the needs of consumers and small businesses. In our Private Banking business line, we offer banking services, such as deposit services and residential mortgage lending, to affluent clients and business owners. Our Financial Services Segment includes our Trust, Retail Brokerage and Investment Services. These businesses offer products independently to their own customers as well as to Banking Segment clients. Investment Services operates through the “Linscomb & Williams” name. The products offered by the businesses in our Financial Services Segment primarily generate non-banking service fee income. Our Corporate Segment reflects parent-only activities, including debt and capital raising, and intercompany eliminations.
We are focused on organic growth and expanding our position in our markets. We believe that our franchise is positioned for continued growth as a result of prudent lending in our markets through experienced relationship managers and a client-centered, relationship-driven banking model, and our focus and capabilities in serving specialized industries. We believe our continued growth is supported by (i) our attractive geographic footprint, (ii) the stable and cost-efficient deposit funding provided by our acquired franchises (each of which was a long-standing institution with an established customer network), (iii) our veteran board of directors and management team, (iv) our capital position, and (v) our credit quality and risk management processes.
Key Factors Affecting Our Business and Financial Statements
We believe our business and results of operations will be impacted in the future by various trends and conditions, including the following:
Interest rates: Based on our asset sensitivity over the past few years, our interest income has increased incrementally more than interest expense required to maintain and grow our deposits and funding sources. Recently, our balance sheet has become slightly liability sensitive. While historical trends in rising and falling rate environments can be used as a potential indicator for the necessity and pace of asset and deposit repricing, asset and deposit repricing may vary from historical trends and result in unexpected speeds than would have been experienced historically.
Banking laws and regulations: The banking industry continues to experience intense regulatory focus, and continual revision of rules and regulations. We anticipate that this environment of heightened scrutiny will continue for the industry and for Cadence Bank specifically, since we exceeded $10.0 billion in assets during the quarter ended September 30, 2017, which is included in the “mid-sized” bank category for supervision purposes. Above $10.0 billion in assets, Cadence Bank is subject to additional regulations, including regulation by the CFPB and being subject to the Durbin Amendment.
Asset quality: As our originated loan portfolio has grown and seasoned, our asset quality indicators have matured, including some recent negative trending within certain segments of our portfolio. We believe our underwriting practices are prudent and we strive to maintain long-term credit quality metrics that are favorable to peers.
Cost efficiency: Since 2011, we have invested significantly in our infrastructure, including our management, lending teams, systems and integration. As a result, our ratio of expenses to revenue was historically greater than that experienced by many of our peer financial institutions. The pace of normalized expense growth has increased at a slower rate than our revenue growth, which resulted in a meaningful declining trend in our efficiency ratio (as defined in “Non-GAAP Financial Measures”) since 2013. Given costs associated with the company’s growth trends and ongoing technology spend, this declining ratio trend may be slowed, reversed or not continue over a longer term.
Competition: The industry and businesses in which we operate are highly competitive, and as the economy continues to show strength, we anticipate that competition will continue to remain robust and potentially increase. We may see increased
competition in different areas including market rates, underwriting, products and structure. While we seek to maintain an appropriate risk-adjusted spread on our business, we anticipate that we may experience continued pressure on our net interest margins as we operate in this competitive environment.
Acquired loan accretion and costs: As a result of our acquisitions, we have recognized accretion in our interest income as a result of the accretable difference on our acquired credit-impaired (“ACI”) loan portfolio. Total scheduled accretion reflected in interest income was approximately $30 million, $20 million and $23 million for the years ended December 31, 2019, 2018 and 2017, respectively. The increase in 2019 is related to the merger with State Bank. As these acquired portfolios are reduced through payoffs, paydowns, foreclosures or charge-offs, the scheduled accretion declines. (In addition to scheduled accretion, a portion of our accretion recognized in a period represents recovery income on non-pooled loans from higher cash flows received than were expected or received sooner than expected. These cash flows vary and are difficult to estimate.) Accordingly, we expect the proportion of our revenues attributable to scheduled accretion to continue to decline as the related assets are reduced and for the recovery income to trend downward in addition to the effects of the adoption on January 1, 2020 of ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (referred to as “CECL”). Conversely, we expect the proportion of our revenues attributable to our organically originated portfolio will continue to increase. Total of credit loss provision related to the acquired loan portfolios (both ACI and ANCI) was $8.0 million in the year ended December 31, 2019 with a reversal of $(1.4) million and $(1.8) million for the years ended December 31, 2018 and 2017, respectively.
CECL: In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (referred to as “CECL”). The effective date for CECL is January 1, 2020 and it will replace the current incurred loss accounting model with an expected loss approach and requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts. The ASU also eliminates existing guidance for ACI loans and requires recognition of the nonaccretable difference as an increase to the allowance for expected credit losses on financial assets purchased with more than insignificant credit deterioration since origination, which will be offset by an increase in the amortized cost of the related loans. For ACI loans accounted for under ASC 310-30 prior to adoption, the guidance in this amendment for purchase credit deteriorated assets will be prospectively applied. (see “Note 1 - Summary of Accounting Policies - Pending Accounting Policies” to the Consolidated Financial Statements).
We formed a cross-functional CECL implementation team that consists of representatives from finance, credit, and risk management. The team has progressed through its detailed project plan and timeline that has included limited parallel CECL runs in 2019. We are in the last stages of finalizing our key accounting policies, credit loss models, processes and the associated data requirements needed to meet the standard. We completed validation of the credit loss models in 2019.
We expect that the allowance related to our loans and commitments will increase as it is an estimate of credit losses over the full remaining expected life of the portfolio. Cadence intends to estimate losses through various models that include selected forecasted macroeconomic variables produced in a baseline macroeconomic scenario forecast provided by an external party. Based on current expectations of future economic conditions and the results from our models, we believe our allowance for credit losses on loans will increase up to 65% from our allowance for credit losses as of December 31, 2019, as disclosed in our consolidated financial statements. Approximately 68% of this increase is attributable to our originated portfolios with C&I and CRE at 38% and consumer at 30%. Our ACI and ANCI portfolios comprise approximately 32% of the increase.
The initial impact to regulatory capital is expected to be minimal; we plan to elect the transition provisions provided by the banking agencies and will phase-in the “Day One” regulatory capital effects resulting from adoption of CECL over the three-year period beginning January 1, 2020. The final impact depends on the characteristics of the portfolio as well as the macroeconomic conditions and forecasts upon adoption and other management judgments.
Capital
We manage capital to comply with our internal planning targets and regulatory capital standards. We monitor capital levels on an ongoing basis, perform periodic evaluations under stress scenarios and project capital levels in connection with our growth plans to ensure appropriate capital levels. We evaluate several capital ratios, including Tier 1 capital to total adjusted assets (the leverage ratio), Tier 1 capital and Common Equity Tier 1 capital to risk-weighted assets, and our tangible common equity ratio.
Summary of Results of Operations
Net income for 2019 totaled $202.0 million, a $35.7 million or 21.5% increase compared to $166.3 million for 2018. The primary drivers of the net increase included a $263.4 million increase in net interest income offset by a $98.3 million increase in provision expense and a $150.5 million increase in noninterest expense. The resulting earnings per diluted common share for 2019 was $1.56 compared to $1.97 for 2018.
The years 2019 and 2018 included non-routine revenues and expenses, primarily consisting of merger related expenses, specially designated bonuses, secondary offering expenses, gains and losses on sales of certain loans, insurance assets, and securities, and other items. These non-routine revenues and expenses resulted in adjusted net income(1) of $222.4 million for 2019, and $174.7 million for 2018. Adjusted diluted earnings per share(1) was $1.72 for 2019 and $2.07 for 2018.
Returns on average assets, common equity and tangible common equity(1) for 2019 were 1.14%, 8.51%, and 12.40%, respectively, compared to 1.45%, 12.07%, and 15.93%(1), respectively, for 2018. Adjusted returns(1) on average assets, common equity, and tangible common equity for 2019 were 1.26%, 9.40%, and 13.60%, respectively, and exclude the impact of the non-routine items noted above.
Net interest income was $651.2 million for 2019, a $263.4 million, or 67.9%, increase compared to 2018. Our net interest spread increased to 3.48% for 2019 compared to 3.17% for 2018, and the net interest margin increased 39 basis points to 4.00% from 3.61%. The increase in net interest margin primarily resulted from an increase in our earning assets from the merger with State Bank combined with changes in our balance sheet mix, derivative activities, funding costs, and accretion income.
Provision for credit losses increased $98.3 million to $111.0 million in 2019, compared to $12.7 million in 2018 (see “-Provision for Credit Losses” and “-Asset Quality”). The increase resulted primarily from increased charge-offs and adverse credit migration. Net charge-offs were 0.63% and 0.06% of average loans during 2019 and 2018, respectively.
Noninterest expense for 2019 increased $150.5 million or 58.3% to $408.8 million compared to $258.3 million during 2018. The increase from 2018 was largely due to the merger with State Bank. The majority of the increase were salaries and employee benefits, merger related expenses, premises and equipment, and intangible asset amortization. Noninterest expense in 2019 also included non-routine expenses of $28.5 million in merger related expenses and $1.2 million in pension plan termination expense. Noninterest expense in 2018 included $20.8 million in non-routine expenses including a specially designated bonus of $9.8 million, secondary offering expenses of $4.6 million, legal costs of $2.3 million related to a legacy bank litigation settlement, $1.1 million in expenses related to the sale of the assets of our insurance company, and $3.0 million in merger related expenses.
Our efficiency ratio(1) was 52.27% for 2019, an improvement over the 53.55% efficiency ratio for 2018. Our adjusted efficiency ratio(1) was 48.64% for 2019, an improvement over the 49.56% adjusted efficiency ratio for 2018. Adjusted efficiency ratios exclude the impact of the non-routine items.
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(1)
Considered a non-GAAP financial measure. See “Non-GAAP Financial Measures” for a reconciliation of our non-GAAP financial measures to the most directly comparable GAAP financial measure.
Summary of Financial Condition
Our total loans, net of unearned income, increased $2.9 billion or 29.1% from December 31, 2018 to $13.0 billion at December 31, 2019, which was driven by the merger with State Bank adding $3.3 billion. The increase from the merger was offset by a decrease of $387.3 million in loans.
Total nonperforming assets (“NPAs”) as a percent of total loans, OREO and other NPAs increased to 0.97% compared to 0.82% as of December 31, 2018. NPAs totaled $125.5 million and $82.4 million as of December 31, 2019 and 2018, respectively. Our allowance for credit losses increased $25.3 million or 26.8%, to $119.6 million at December 31, 2019 and represented approximately 0.92% and 0.94% of total loans at December 31, 2019 and 2018, respectively.
Total deposits increased $4.0 billion or 37.7% to $14.7 billion at December 31, 2019. Over the same period, noninterest-bearing deposits increased $1.4 billion or 56.2% and comprised 26.0% and 22.9% of total deposits at December 31, 2019 and 2018, respectively. Interest-bearing deposits increased $2.7 billion or 32.2% and comprised 74.0% and 77.1% of total deposits at December 31, 2019 and 2018, respectively. There was a decrease of $842.3 million in brokered deposits from December 31, 2018.
Our Tier 1 leverage ratio increased 26 basis points, total risk-based capital ratio increased 193 basis points and Tier 1 risk-based capital ratio increased 138 basis points from December 31, 2018. We met all capital adequacy requirements and both
Cadence and the Bank exceeded the requirements to be considered well-capitalized under regulatory guidelines as of December 31, 2019.
Business Segments
We operate Cadence Bancorporation through three operating segments: Banking, Financial Services and Corporate.
Our Banking Segment includes our Commercial Banking, Retail Banking and Private Banking lines of business. Our Commercial Banking line of business includes a general business services component primarily focusing on commercial and industrial (“C&I”), community banking, business banking and commercial real estate lending and treasury management services to clients in our geographic footprint in Texas and the southeast United States. In addition, our Commercial Banking line of business includes within C&I a separate component that focuses on select industries (which we refer to as our “specialized industries”) in which we believe we have specialized experience and service capabilities, including restaurant industry, healthcare and technology. We serve clients in these specialized industries both within our geographic footprint and throughout the United States as a result of the national orientation of many of these businesses. Energy lending is also an important part of our business as energy production and energy related industries are meaningful contributors to the economy in certain of our primary markets. Our Retail Banking line of business offers a broad range of retail banking services including mortgage services through our branch network to serve the needs of consumer and small businesses in our geographic footprint. Our Private Banking line of business offers banking services and loan products tailored to the needs of our high-net worth clients in our geographic footprint.
Our Financial Services Segment includes our Trust, Retail Brokerage, and Investment Services. These businesses offer products independently to their own customers as well as to Banking Segment clients. Investment Services operates through the “Linscomb & Williams” name. The products offered by the businesses in our Financial Services Segment primarily generate non-banking service fee income. Our Corporate Segment reflects parent-only activities, including debt and capital raising, and intercompany eliminations.
While this section reviews financial performance from a business segment perspective, it should be read in conjunction with the discussion of Results of Operations, and our consolidated financial statements and notes thereto for a full understanding of our consolidated financial performance.
Business segment results are determined based upon our management reporting process, which assigns balance sheet and income statement items to each of the business segments. The process is based on our organizational and management structure and, accordingly, the results derived are not necessarily comparable with similar information published by other financial institutions and the results are not necessarily prepared in accordance with generally accepted accounting principles.
The following table presents the operating results of our segments for the periods presented:
Banking Segment
Our Banking Segment is our largest business segment and generates most of our net income. Net income for the Banking Segment was $219.0 million, $174.3 million, and $103.9 million for the years ended December 31, 2019, 2018, and 2017, respectively.
Our Banking Segment’s net income is composed of net interest earned on our loan and investment portfolios, in addition to service fees and revenue from our deposit and loan customers. The Banking Segment expense includes all interest expense on our deposit accounts and other bank liabilities, operational and administrative expenses related to the business conducted in this segment, and the provision for credit losses on our loan portfolio. All these income and expense components, including noninterest expense, are discussed in greater detail elsewhere in this section.
Financial Services Segment
Our Financial Services Segment primarily generates non-banking fee revenue from trust services, insurance, investment and retail brokerage services. Net income for the Financial Services Segment was $4.4 million, $4.8 million and $8.4 million for the years ended December 31, 2019, 2018 and 2017, respectively. The decline in net income from 2017 to 2018 is related to the sale of the assets of our insurance subsidiary in the second quarter of 2018. For additional discussion, please see “-Noninterest income” and “-Noninterest expense.”
Corporate Segment
The loss in our Corporate Segment is primarily driven by the interest expense on our corporate senior and subordinated debt. Net loss for the Corporate Segment was $21.5 million, $12.8 million, and $10.0 million for the years ended December 31, 2019, 2018 and 2017, respectively. For additional discussion, please refer to “-Net interest income” and “-Borrowing.”
Results of Operations
Earnings
Our net income for 2019 totaled $202.0 million compared to $166.3 million and $102.4 million for 2018 and 2017, respectively.
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Excluding non-routine items, adjusted net income(2) was $223.1 million for 2019, up $48.3 million or 27.6% from $174.8 million for 2018.
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Net income per diluted share was $1.56 for 2019, a decrease of $0.41 per share or 20.8% as compared to $1.97 per share in the prior year. Adjusted diluted earnings per share(2) for 2019 was $1.72 per share, a decrease of $0.35 per share or 16.9% as compared to $2.07 per share in the prior year.
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Returns on average assets, common equity and tangible common equity(2) for 2019 were 1.14%, 8.51% and 12.40%, respectively, as compared to 1.45%, 12.07% and 15.93%, respectively, for the prior year. Excluding total non-routine items, returns on average assets and average tangible common equity(2) were 1.26%(2) and 13.60%(2), respectively, for 2019.
The following table presents key earnings data for the periods indicated:
Table 1 - Key Earnings Data
(1)
Includes common stock equivalents of 103,637, 813,180, and 532,070 for 2019, 2018, and 2017, respectively.
(2)
Considered a non-GAAP financial measure. See “Non-GAAP Financial Measures” for a reconciliation of our non-GAAP measures to the most directly comparable GAAP financial measure.
Net Interest Income
The largest component of our net income is net interest income, which is the difference between the income earned on interest earning assets and interest paid on deposits and borrowings. We manage our interest-earning assets and funding sources to maximize our net interest margin. (See “-Quantitative and Qualitative Disclosures about Market Risk” for a discussion regarding our interest rate risk). Net interest income is determined by the rates earned on our interest-earning assets, rates paid on our interest-bearing liabilities, the relative amounts of interest-earning assets and interest-bearing liabilities, the degree of mismatch and the maturity and re-pricing characteristics of our interest-earning assets and interest-bearing liabilities. Net interest income divided by average interest-earning assets represents our net interest margin. The yield on our net earning assets less the yield on our interest-bearing liabilities represents our net interest spread.
Interest earned on our loan portfolio is the largest component of our interest income. Our originated and acquired non-credit impaired loans (“ANCI”) portfolios are presented at the principal amount outstanding net of deferred origination fees and unamortized discounts and premiums. Interest income is recognized based on the principal balance outstanding and the stated rate of the loan. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield on the related loan. ANCI loans acquired through our acquisitions are initially recorded at fair value. Discounts or premiums created when the loans were recorded at their estimated fair values at acquisition are being accreted or amortized over the remaining term of the loan as an adjustment to the related loan’s yield (see “Note 2-Business Combinations” to our consolidated financial statements for additional information related to the State Bank acquisition).
The performance of loans within our ACI portfolio impacts interest income as the remaining discounts and proceeds received in excess of expected cash flow are realized in interest income when these loans are closed through payoff, charge off, workout, sale or foreclosure. At acquisition, the expected shortfall in future cash flows on our ACI portfolio, as compared to the contractual amount due, was recognized as a non-accretable discount. Any excess of expected cash flows over the acquisition date fair value is known as the accretable discount and is recognized as accretion income over the life of each pool or individual ACI loan. Expected cash flows over the acquisition date fair value are re-estimated quarterly utilizing the same cash flow methodology used at the time of acquisition. Any subsequent decreases to the expected cash flows will generally result in a provision for credit losses charge in the consolidated statements of income. Conversely, subsequent increases in expected cash flows result in a transfer from the non-accretable discount to the accretable discount, which has a positive impact on accretion income prospectively.
The following table summarizes the amount of interest income related to our ACI portfolio for the periods presented:
Table 2 - ACI Interest Income
As of December 31, 2019, the weighted average contractual interest rate on the remaining active ACI portfolio loans was approximately 5.35%.
The following table is a rollforward of the accretable difference on our ACI portfolio for the periods indicated:
Table 3 - Accretable Difference Rollforward
(1)
See “Note 2-Business Combinations” to our consolidated financial statements for additional information related to the State Bank acquisition.
Years Ended December 31, 2019 and 2018
Our net interest income, fully-tax equivalent (“FTE”), for 2019 and 2018 was $652.9 million and $390.3 million, respectively, an increase of $262.6 million. Our net interest margin for 2019 and 2018 was 4.00% and 3.61%, respectively, an increase of 39 basis points. The yield on our total loan portfolio increased 65 basis points to 5.81% for 2019 compared to 5.16% for 2018 due to an increase in the rate and volume. The following table sets forth the components of our FTE net interest income with the effect that the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in net interest income for 2019 and 2018.
Table 4 - Rate/Volume Analysis
(1)
The change in interest income due to both rate and volume has been allocated to rate and volume changes in proportion to the relationship of the absolute dollar amounts of the changes in each.
(2)
Interest income is presented on a tax equivalent basis using the Federal tax rate of 21% on our state, county and municipal investment portfolios.
Our FTE total interest income for 2019 totaled $861.8 million compared to $515.2 million for 2018. This increase is primarily the result of the loans acquired in the State Bank acquisition resulting in increased volume of interest income and accretion of purchase accounting discounts. Additionally, we experienced an increase in the average volume and yield of our originated loans as well, which reflects the impact of LIBOR and other index rates on our loan portfolio during the periods, partially mitigated by the effect of our February 2019 purchase of a $4.0 billion notional interest rate collar. The lower FTE yield on our tax-exempt securities reflects the decrease in average tax-exempt securities which began during the second quarter of 2018. This was offset by a higher volume of average investments in taxable securities.
The yield on our ACI portfolio fluctuates due to the volume and timing of cash flows received or expected to be received. The yield on our ACI portfolio for 2019 was 12.62% compared to 9.44% for 2018. During 2019, interest income on the ACI portfolio included $4.6 million in discount and recovery income compared to $2.2 million for 2018. These amounts were realized on certain individual loans that were settled before expected, or where we received amounts above our estimates. Excluding these amounts, the yield on our ACI loans would have been 10.93% for 2019 compared to 8.47% for 2018. Our total loan yield, excluding this recovery income, would have been 5.77% and 5.13% for 2019 and 2018, respectively.
Our interest expense for 2019 and 2018 was $208.9 million and $124.9 million, respectively, an increase of $84.0 million. This increase is primarily related to the increased volume in interest-bearing deposits assumed in the State Bank acquisition as well as organic growth in 2019. The increased expense also reflected the impact of higher index rates on our interest-bearing demand accounts and time deposits. Our cost of interest-bearing deposits increased to 1.68% for 2019 compared to 1.38% for 2018. Our cost of borrowings increased to 4.76% from 4.33% reflecting an increase in interest rates from the prior period but was more than offset by a net decrease of 22.7% in average borrowings. We were able to decrease average borrowings and brokered deposits through increased levels of average non-brokered deposits which included an increase of average demand deposits to 23.5% of total deposits compared to 22.7% in 2018.
The following table presents our average balance sheet and our average FTE yields on assets and average costs of liabilities for the years presented. Average FTE yields are calculated by dividing income or expense by the average balance of the corresponding assets or liabilities. Average balances have been calculated on a daily basis, except for ACI loans, which is a monthly average.
Table 5 - Average Balances, Net Interest Income and Interest Yields/Rates
(1)
Nonaccrual loans are included in loans, net of unearned income. No adjustment has been made for these loans in the calculation of yields.
(2)
Interest income and yields are presented on an FTE basis using the Federal tax rate of 21% on our state, county, and municipal investment portfolios.
Years Ended December 31, 2018 and 2017
Our FTE net interest income for 2018 and 2017 was $390.3 million and $333.4 million, respectively, an increase of $56.9 million. Our net interest margin for 2018 and 2017 was 3.61% and 3.57%, respectively, an increase of 4 basis points. The yield on our total loan portfolio increased 57 basis points to 5.16% for 2018 compared to 4.59% for 2017 due to an increase in the rate and volume of our originated portfolio. The following table sets forth the components of our FTE net interest income with the effect that the varying levels of interest-earning assets and interest-bearing liabilities and the applicable rates have had on changes in FTE net interest income for 2018 and 2017:
(1)
The change in interest income due to both rate and volume has been allocated to rate and volume changes in proportion to the relationship of the absolute dollar amounts of the changes in each.
(2)
Interest income is presented on an FTE basis using Federal tax rates of 21% and 35% for 2018 and 2017, respectively, on our state, county and municipal investment portfolios.
Our total FTE interest income for 2018 totaled $515.2 million compared to $404.1 million in 2017. This increase is primarily the result of an increase in the volume and yield of our originated loans. The yield on our originated loan portfolio reflects an increase in LIBOR and other index rates used in our loan portfolio. The lower FTE yield on our tax-exempts securities reflects the lower income tax rate of 21% in 2018 compared to 35% in 2017. In addition, the volume of our securities decreased during 2018 compared to 2017 due to the rebalancing of the municipal securities portfolio which occurred in the second quarter of 2018.
The yield on our ACI portfolio fluctuates due to the volume and timing of cash flows received or expected to be received. The yield on our ACI portfolio for 2018 was 9.44% compared to 10.82% for 2017. During 2018, interest income on the ACI portfolio included $2.2 million in discount and recovery income, compared to $8.1 million for 2017. These amounts were realized on certain individual loans that were settled before expected, or where we received amounts above our estimates. Excluding these recovery income amounts, the yield on our ACI loans would have been 8.47% for 2018 compared to 8.02% for 2017. Our total loan yield excluding these amounts would have been 5.13 % and 4.49% for 2018 and 2017.
Our interest expense for 2018 and 2017 was $124.9 million and $70.7 million, respectively, an increase of $54.3 million. This increase is primarily related to higher market rates on our interest-bearing demand accounts and time deposits. Our cost of interest-bearing deposits increased to 1.38% for 2018 compared to 0.80% for 2017. Our cost of borrowings increased to 4.33% from 4.25% reflecting an increase in interest rates from the prior year and a higher volume of short-term FHLB advances.
The following table presents our average balance sheet and our average FTE yields on assets and average costs of liabilities for the years presented. Average FTE yields are calculated by dividing income or expense by the average balance of the corresponding assets or liabilities. Average balances have been calculated on a daily basis, except for ACI loans, which is a monthly average.
(1)
Nonaccrual loans are included in loans, net of unearned income. No adjustment has been made for these loans in the calculation of yields.
(2)
Interest income and yields are presented on an FTE basis using Federal tax rates of 21% and 35% for 2018 and 2017, respectively, on our state, county, and municipal investment portfolios.
Provision for Credit Losses
The provision for credit losses is based on management’s quarterly assessment of the adequacy of our ACL which, in turn, is based on such factors as the composition of our loan portfolio and its inherent risk characteristics, the level of nonperforming loans and net charge-offs, historical loss data, local economic and credit conditions, the direction of collateral values, and regulatory guidelines. The provision for credit losses is charged against earnings in order to maintain our ACL, which reflects management’s best estimate of probable losses inherent in our loan portfolio at the balance sheet dates (see “-Allowance for Credit Losses”).
Under accounting standards for business combinations, acquired loans are recorded at fair value with no credit loss allowance on the date of acquisition. A provision for credit losses is recorded in periods after the date of acquisition for the emergence of new probable and estimable losses on ANCI loans. A provision for credit losses is recognized on our ACI loans after the date of acquisition based on the re-estimation of expected cash flows. See “-Asset Quality” and “-Critical Accounting Policies and Estimates.”
The provision for credit losses totaled $111.0 million for 2019 compared to $12.7 million and $9.7 million for 2018 and 2017, respectively. Approximately 77.2% of the 2019 provision related to loans incurring a charge-off during the year. Net charge-offs were $85.8 million or 0.63% of average loans for 2019 compared to $5.9 million or 0.06% for 2018. The 2019 charge-offs included: $44.0 million related to six General C&I non-SNC credits, $21.0 million related to five Restaurant credits; and $13.0 million related to three Energy credits.
The following is a summary of our provision for credit losses for the periods indicated presented by originated, ANCI and ACI portfolios:
Table 7 - Provision for Credit Losses
Our originated and ANCI loan portfolios are divided into commercial and consumer segments. The commercial allowance estimate is driven by loan level risk ratings. The consumer allowance estimate uses pool level historical loss rates based on certain credit attributes. The primary driver of the ACL is the underlying credit quality of the loans, which have seen certain credit risk migration trends in 2019. The 2019 provision includes a $103.0 million provision related to the originated portfolio and $4.4 million related to the ANCI portfolio. Compared to 2018, the 2019 provision included increases in the commercial segments primarily in the General C&I, Restaurant and Energy portfolios.
Currently, Restaurant and certain leveraged loans in our commercial portfolios have elevated risk. However, we have taken steps to attempt to manage our risk in these categories. Our exposure to leveraged loans without moderators and to the Restaurant portfolio have declined since 2018. Our Energy portfolio is predominantly Midstream and we believe the risks in this segment of the portfolio are lower than other Energy segments. Our E&P portfolio underwritten post-2014 has also performed well and our Energy impaired loans are approximately $11.0 million.
The increase in criticized and classified assets may have slowed relative to the increases we had in the third quarter of 2019. We also believe that criticized and classified loans may have the opportunity to decline during 2020 with potential credit upgrades due to operating performance as well as potential pay downs from refinancing exceeding new migration into the criticized and classified loan categories. However, these reductions may be offset by any future negative migration of current pass rated loans.
We recognized $12.7 million in provision during 2018, which included $14.1 million provision related to the originated portfolio. The originated loan provision for 2018 is primarily attributable to robust loan growth, some credit migration within the General C&I and Restaurant portfolios, as well as some changes seen in the qualitative factors related to economic conditions such as oil prices and market volatility.
We recognized $9.7 million in provision during 2017, which included $11.5 million provision related to the originated portfolio. The originated loan provision for 2017 is primarily attributable to loan growth within the originated Specialty Lending and CRE portfolios, as well as some credit migration within the General C&I and Consumer portfolios as these loans become more seasoned.
The provision for credit losses (impairment reversal) on our ACI portfolio was $4.4 million for 2019 compared to $(0.8) million for 2018 and $(2.2) million for 2017. The 2019 provision resulted primarily from two commercial credits where there were reductions in estimated expected cash flows or cash received in settlement of the debt. The provision reversals in prior years are primarily related to changes in credit quality and payments received in excess of expected cash flows in the commercial real estate portfolio in 2018 and the residential real estate portfolio in 2017.
Noninterest Income
Noninterest income is a component of our revenue and is comprised primarily of income generated from the services we provide our customers.
Year Ended December 31, 2019 Compared to December 31, 2018
Noninterest income totaled $130.9 million for 2019 compared to $94.6 million for 2018. This increase in revenue is primarily attributable to the State Bank merger which provided additional markets for our products and services as well as two new revenue sources, SBA income and payroll processing revenue.
The following table compares noninterest income for 2019 and 2018:
Table 8 - Noninterest Income
NM-not meaningful.
Investment Advisory Revenue. Our investment advisory revenue is comprised largely of investment management and financial planning revenues generated through our subsidiary L&W. Investment advisory revenue grew 16.6% during 2019 primarily due to an increase of 28.2% in assets under management supplemented by the July 2019 acquisition of a fee-based investments advisory firm based in Atlanta, Georgia.
Trust Services Revenue. We earn fees from our customers for trust services. Trust fees for 2019 were essentially unchanged from 2018.
Service Charges on Deposit Accounts. We earn fees from our customers for deposit-related services. For 2019, service charges and fees increased by $5.1 million. This 32.9% increase was largely due to the increased number of deposit accounts and customers resulting from the State Bank merger.
Credit-Related Fees. Our credit-related fees include fees related to credit advisory services, unfunded commitment fees, asset-based lending and letter of credit fees. For 2019, credit-related fees increased by 31.9% primarily from loan arrangement and other credit advisory fees due to increased volume, asset-based lending fees which is a new line of business resulting from the State Bank acquisition, and to the recognition of the purchase accounting mark related to unfunded commitments when those commitments expire without being drawn upon.
Bankcard Fees. Our bankcard fees are comprised of automated teller machine (“ATM”) network fees and debit card revenue. Our bankcard fees of $8.5 million for 2019 increased 42.6% compared to 2018 primarily due to the State Bank acquisition. This increase was partially mitigated by the limit on interchange fees imposed by the Durbin Amendment which became effective for us in the third quarter of 2018.
Payroll Processing Revenue. Payroll processing revenue represents a new source of revenue for us which we acquired in the State Bank acquisition.
SBA Income. Small Business Administration (“SBA”) income also represents a new source of revenue for us through the State Bank acquisition. This revenue consists of gains on sales of SBA loans, servicing fees, and other miscellaneous fees.
Other Service Fees. Our other service fees include retail services fees. For 2019 and 2018, other service fees totaled $7.4 million and $5.3 million, respectively. The 2019 increase resulted primarily from additional foreign exchange fees due to increased trading volume. Other fees increased across the board due to the State Bank acquisition.
Other Noninterest Income. Other noninterest income increased by $1.4 million in 2019 primarily as a result of increased volume resulting from the State Bank acquisition. We also experienced increases in mortgage banking income, income from bank-owned life insurance, and gains on sales of commercial loans. These increases were partially offset by decreased insurance revenue from the sale of the insurance subsidiary assets in second quarter 2018 and the revaluation of the receivable related to that sale.
Year Ended December 31, 2018 Compared to December 31, 2017
Noninterest income totaled $94.6 million for 2018 compared to $99.9 million for 2017. This decrease in revenue is attributable to insurance revenue and bankcard fees.
The following table compares noninterest income for 2018 and 2017:
NM-not meaningful.
Investment Advisory Revenue. Our investment advisory revenue is comprised largely of investment management and financial planning revenues generated through our subsidiary L&W. Investment advisory revenue increased 4% for 2018 primarily due to growth in assets under management due to both new customer origination and portfolio/market improvements.
Trust Services Revenue. During 2018, trust fees declined by 7.8% primarily due to the transfer of certain deposit relationships from trust to treasury management. Additionally, the volatility in the equity markets and estate tax reform slowed the pace of personal trust growth.
Credit-Related Fees. Our credit-related fees primarily include fees related to credit advisory services and unfunded commitment fees. For 2018, credit-related fees increased by 32.5% primarily as a result of an increase in unfunded commitment and letter of credit fees resulting from growth in our commercial lending.
Insurance Revenue. The decrease of 63.7% in insurance revenue is the result of the sale of the assets of Cadence Insurance in the second quarter of 2018.
Bankcard Fees. Our bankcard fees are comprised of ATM network fees and debit card revenue. Our bankcard fees of $6.0 million for 2018 decreased 18.6% compared to 2017 primarily due to decreased interchange fee rates resulting from the imposition of the Durbin Amendment which limits these fees. The Durbin Amendment became effective for us in the third quarter of 2018 as a result of regulations associated with exceeding $10 billion in total assets.
Noninterest Expenses
Year Ended December 31, 2019 Compared to December 31, 2018
Noninterest expense was $408.8 million for 2019 compared to $258.3 million for 2018. The increase of $150.5 million or 58.3% for 2019 was driven by increases in salaries and benefits, merger related expenses, intangible asset amortizable, and other expenses related to organic growth of our business and growth from the State Bank merger.
The following table compares noninterest expense for 2019 and 2018:
Table 9 - Noninterest Expense
Salaries and Employee Benefits. Salaries and employee benefit costs are the largest component of noninterest expense and include employee salaries and commissions, incentive compensation, health insurance, benefit plans, and payroll taxes. Salaries and employee benefits increased $59.0 million or 38.1% for 2019, compared to 2018, largely due to the acquisition of State Bank and the resulting 58% increase in full-time equivalent employees. This increase in salaries and benefits was partially offset by lower incentive compensation impacted by lower results from performance targets in 2019. The following table provides additional detail of our salaries and employee benefits expense for the periods presented:
Premises and Equipment. Rent expense, depreciation, and maintenance costs comprise most of this expense. The 2019 increase of 46.5% resulted from additional facilities and equipment from the acquisition of State Bank.
Merger Related Expenses. In 2019, the Company incurred acquisition costs related to the acquisition of State Bank and the acquisition of W&P. Merger related expenses were related to salaries and employee benefits, consulting and professional fees, and other expenses.
Intangible Asset Amortization. In connection with the acquisition of State Bank, we recorded core deposit and other intangible assets of approximately $117.0 million which are being amortized over a ten-year period for the core deposit intangibles and a ten to twenty-year period for the other intangibles. The third quarter 2019 acquisition of W&P resulted in additional other intangible assets of $5.1 million.
Data Processing. Data processing expense for our operating systems totaled $13.0 million for 2019, an increase of 48.3%. The increase reflects growth in our business as well as implementations and enhancement of various technologies.
Consulting and Professional Services. For 2019, our consulting and professional services decreased $3.0 million or 22.5% compared to 2018. In 2019, merger related expenses included consulting and professional fees of $4.8 million.
FDIC Insurance. The FDIC insurance expense increased 16.1% due to the acquisition of State Bank and resulting increase to our balance sheet and risk profile under the Large Bank Pricing Rule. During the third and fourth quarters of 2019 we received total credits of $3.5 million from the FDIC related to assessments paid prior to reaching $10 billion in total assets which partially mitigated this increase. The FDIC assessment will vary between reporting periods as it is determined on various risk factors including credit, liquidity, composition of balance sheet, loan concentration, and regulatory ratings.
Communications. Communications expenses include all forms of communications such as telecommunications, as well as data communications. The 84.5% increase in 2019 resulted primarily from increased data communications costs due to our expanded footprint and facilities from the State Bank acquisition.
Advertising and Public Relations. Advertising and public relations expenses include costs to create marketing campaigns, purchase the various media space or time, conduct market research, and various sponsorships in our expanded markets. The acquisition of State Bank expanded Cadence into several of the largest Georgia markets which resulted in the 2019 increase of 98.8%.
Legal Expenses. Our legal expenses include fees paid to outside counsel related to general legal matters as well as loan resolutions. Legal expenses decreased 56.9% due to 2018 fees of $2.2 million associated with litigation related to a pre-acquisition matter of a legacy acquired bank. This matter was fully resolved in the first quarter of 2018.
Other Noninterest Expenses. These expenses include costs for insurance, supplies, travel education and training, and other operational expenses. Other noninterest expenses increased 86.5% with the increase occurring across all categories due to the acquisition of State Bank and the resulting costs of managing a larger company in a larger footprint.
Year Ended December 31, 2018 Compared to December 31, 2017
Noninterest expense was $258.3 million for 2018 compared to $233.4 million for 2017. The increase of $24.9 million or 10.7% for 2017 compared to 2016 reflects increases in our growth while maintaining our broad efforts to manage expenses.
The following table compares noninterest expense for 2018 and 2017:
Salaries and Employee Benefits. Salaries and employee benefit costs are the largest component of noninterest expense and include employee payroll expense, incentive compensation, health insurance, benefit plans and payroll taxes. Salaries and employee benefits increased $15.8 million or 11.3% for 2018 compared to 2017, largely due to short and long-term incentive costs as salary expense remained relatively level. The increase in long-term incentive costs is related to achieving higher levels of performance targets and higher corporate valuation; the short-term incentive is related to business growth. The $9.8 million specially designated bonuses were granted by the Board of Directors after the Compensation Committee consulted with an independent compensation consultant who identified a strategy for a normalized approach to performance pay programs in comparison to peers and to enhance retention and continuity of senior management. Further, the specially designated bonuses recognized the multi-year performance of management and addressed a design feature of the 2016 performance stock unit awards that caused the awards to not vest despite management’s achievement of performance objectives underlying the awards. The following table provides additional detail of our salaries and employee benefits expense for the periods presented:
Merger Related Expenses. In 2018, the Company incurred acquisition costs related to the then-pending merger with State Bank.
Premises and Equipment. Rent, depreciation and maintenance costs comprise most of the occupancy and equipment expenses, which increased 5.4% for 2018.
Intangible Asset Amortization. In connection with our acquisitions, we recorded core deposit and other customer intangible assets of approximately $66.0 million, which are being amortized on an accelerated basis over a seven- to ten-year period.
Data Processing. Data processing expense for our operating systems totaled $8.8 million for 2018, an increase of 15.6%. The increase reflect growth in our business as well as implementations and enhancement of various technologies.
Consulting and Professional Services. For 2018, our consulting and professional services increased by $4.2 million or 46.1%, compared to 2017 as a result of the costs of secondary stock offerings and the engagement of outside consultants related to regulatory compliance and additional costs of being a public company.
FDIC Insurance. For 2018 and 2017, FDIC insurance expense totaled $4.6 million and $4.3, respectively. In the third quarter of 2018, we became subject to the Large Bank Pricing Rule for calculation of our insurance assessments due to reaching $10 billion in total assets.
Other Noninterest Expenses. Other noninterest expense categories remained consistent with modest increases in loan related expenses, advertising and public relations, offset by decreases in software amortization and legal expenses.
Income Tax Expense
Income tax expense for 2019 was $60.3 million compared to $45.1 million and $80.6 million for 2018 and 2017, respectively.
The effective tax rate was 23.0% for 2019 compared to 21.3% and 44.1% for 2018 and 2017, respectively. The increase in the effective tax rate for 2019 compared to 2018 was due to an increase in state tax expense, a decrease in tax exempt interest, and a one-time bad debt deduction on a legacy loan portfolio that occurred in 2018. The decrease in the effective tax rate for 2018 compared to 2017 was due to the decrease in the U.S. federal statutory income tax rate from 35% to 21% which became effective January 1, 2018, as a result of the Tax Cut and Jobs Act (“Tax Reform”) enacted on December 22, 2017. See Note 12 to the Consolidated Financial Statements and “- Critical Accounting Policies and Estimates” for additional disclosures and discussion regarding income taxes.
Our effective tax rate is impacted by pre-tax income, tax-exempt income, and the increase in the cash surrender value of bank-owned life insurance. The effective tax rate is also affected by discrete items that may occur in any given period, but are not consistent from period to period, which may impact the comparability of the effective tax rate between periods.
At December 31, 2019, we had a net deferred income tax liability of $25.0 million compared to a net deferred asset of $33.2 million at December 31, 2018. The decrease in the net deferred asset was primarily due to certain purchase accounting adjustments recorded during the State Bank acquisition, changes in market conditions that impacted the mark to market deferred tax adjustments on securities available-for-sale and on cash flow hedges including the interest rate collar.
Financial Condition
The following table summarizes selected components of our balance sheet as of the periods indicated. Our acquisition of State Bank on January 1, 2019 had a significant impact on our balance sheet. See “Note 2-Business Combinations” to our consolidated financial statements for additional information related to the State Bank acquisition.
Table 10 - Financial Condition
Investment Portfolio
Our securities available-for-sale portfolio increased by $1.2 billion or 99.5% during 2019. Approximately $393.7 million of securities available-for-sale were sold during 2019 and $352.5 million of securities matured or paid down. We purchased $1.2 billion in securities during 2019 with $800.0 million in the fourth quarter as a result of strong deposit growth combined with lower loan balances. Additionally, during 2019 we acquired $667.9 million in securities from the State Bank acquisition. At December 31, 2019, our securities portfolio was 14.6% of our total interest-earning assets and produced an average taxable equivalent yield of 2.84% for 2019 compared to 3.04% and 3.34% for 2018 and 2017, respectively.
The following table sets forth the fair value of the securities available-for-sale at the dates indicated:
Table 11 - Securities Available-for-Sale Portfolio
See “-Maturity Distribution of Investment Securities,” for information regarding the contractual maturities and duration of our investment securities portfolio.
The following table summarizes the investment securities with unrealized losses determined to be temporarily impaired at December 31, 2019 by aggregated major security type and length of time in a continuous unrealized loss position:
Table 12 - Investment Securities with Unrealized Losses
None of the unrealized losses relate to the marketability of the securities or the issuer’s ability to honor redemption of the obligations. We have adequate liquidity, no plans to sell securities and the ability and intent to hold securities to maturity resulting in full recovery of the indicated impairment. Accordingly, the unrealized losses on these securities have been determined to be temporary.
Loan Portfolio
We originate commercial and industrial loans, commercial real estate loans (including construction loans), residential mortgages and other consumer loans. A strong emphasis is placed on the commercial portfolio, consisting of commercial and industrial and commercial real estate loan types, with 74% and 75% of the portfolio residing in these loan types as of December 31, 2019 and 2018, respectively. Our commercial portfolio is further diversified by industry concentration and includes loans to clients in specialized industries, including restaurant, healthcare and technology. Additional commercial lending activities include energy, construction, general corporate loans, business banking and community banking loans. Also, with the acquisition of State Bank, we have added asset-based lending, lender finance, and Small Business Administration (“SBA”) lending. Mortgage, wealth management and retail make up the majority of the consumer portfolio.
Total loans increased $3.0 billion or 29.4% from December 31, 2018. The merger with State Bank added approximately $3.3 billion in held for investment loan balances. The increase from the merger was primarily offset by a decrease in our specialized lending. See “Note 2-Business Combinations” to our audited consolidated financial statements for additional information related to the State Bank acquisition.
The following table presents total loans outstanding by portfolio segment and class of financing receivable. Total loan balances include originated loans, ANCI loans, and ACI loans. The State Bank merger significantly increased the ANCI portfolio balances and to a lesser degree, the ACI portfolio. The subsequent tables present the ANCI and ACI loans separately.
Table 13 - Loan Portfolio
Commercial and Industrial. Total C&I loans increased by $675.4 million or 10.9% during 2019 and represented 52.6% of the total loan portfolio at December 31, 2019, compared to 61.4% of total loans at December 31, 2018. The increase resulted from our merger with State Bank.
General C&I. As of December 31, 2019, our general C&I category included loans to the following industries: finance and insurance, professional services, durable manufacturing, commodities excluding energy, contractors, consumer services, and other. Generally, C&I loans typically provide working capital, equipment financing, and financing for expansion and are generally secured by assignments of corporate assets including accounts receivable, inventory, and/or equipment.
Energy. Our energy team is comprised of experienced lenders with significant product expertise and long-standing relationships. Additionally, energy production and energy related industries are substantial contributors to the economies in the Houston metropolitan area and the state of Texas. We strive for a rigorous and thorough approach to energy underwriting and credit monitoring. The allowance for credit losses was $12.7 million for our energy loans or 0.89% of the energy portfolio as of December 31, 2019 compared to $7.3 million or 0.57% as of December 31, 2018 (see “-Provision for Credit Losses” and “-Allowance for Credit Losses”). As of December 31, 2019, we had $9.8 million of nonperforming energy credits compared to $20.7 million of nonperforming energy credits as of December 31, 2018. In addition, 6.7% of the energy portfolio was criticized as of December 31, 2019 compared to 2.5% at December 31, 2018. As presented in the following table, our energy lending business is comprised of three areas: Exploration and Production (“E&P”), Midstream, and Energy Services.
Table 14 - Energy Loan Portfolio
E&P loans outstanding comprised approximately 25.1% of outstanding energy loans as of December 31, 2019 compared to 28.5% of outstanding energy loans as of December 31, 2018. E&P customers are primarily businesses that derive a majority of their revenues from the sale of oil and gas and whose credit needs require technical evaluation of oil and gas reserves. Emphasis for E&P is on high quality, independent producers with proven track records. Our E&P credit underwriting includes a combination of well-by-well analyses, frequent updates to our pricing decks and engaging energy engineers to actively monitor the portfolio and provide credit redeterminations, at a minimum, every six months. At least quarterly, and potentially more frequent during periods of higher commodity price volatility, we adjust the base and sensitivity price decks on which we value our clients’ oil and gas reserves. Generally, we seek to follow the shape of the NYMEX strips for oil and natural gas but at a discount to the strip. In periods of higher commodity prices, our discount from the strip is higher whereas in lower price periods our discount is lower. Borrowing base redeterminations occur every spring and fall, with the spring redeterminations completed prior to the end of the second quarter and fall determinations completed prior to the end of the fourth quarter.
Midstream loans outstanding comprised 62.1% of outstanding energy loans as of December 31, 2019 compared to 57.4% of outstanding energy loans as of December 31, 2018. Midstream lending is generally to customers who handle the gathering, treating and processing, storage or transportation of oil and gas. These customers’ businesses are generally less price sensitive than other energy segments given the nature of their fee-based revenue streams. Underwriting guidelines for the Midstream portfolio generally require a first lien on all assets as collateral.
Energy Services loans outstanding comprised 12.8% of outstanding energy loans as of December 31, 2019 compared to 14.0% of outstanding energy loans as of December 31, 2018. Energy Services lending targets oilfield service companies that provide equipment and services used in the exploration for and extraction of oil and natural gas. Customers consist of a wide variety of businesses, including production equipment manufacturers, chemical sales, water transfer, rig equipment, and other early and late stage services companies.
Specialized Lending. The following table presents our originated specialized lending portfolio by category.
Table 15 - Originated Specialized Lending Portfolio
Restaurant, healthcare, and technology are the components of our specialized lending. For these industries, we focus on larger corporate clients who are typically well-known within the industry. The client coverage for these components is national in scope, given the size and capital needs of the majority of the clients. Given these customer profiles, we frequently participate in such credits with two or more banks through syndication.
Restaurant loans outstanding decreased by 12.1% compared to December 31, 2018. In the restaurant sector, we focus on major franchisees and the operating companies of “branded” restaurant concepts. Our restaurant group focuses on top tier operators in restaurant operating companies and franchisee restaurants in nationwide markets. The Restaurant sector has experienced increases in nonperforming loans and charge-offs during 2019 as certain customers have faced difficulties dealing with market pressures on employee compensation and increased competition among other issues.
Healthcare loans outstanding decreased by 16.3% and comprised 25.3% of total specialized lending at December 31, 2019 compared to 25.7% at December 31, 2018. Our healthcare portfolio focuses on middle market healthcare providers generally with a diversified payer mix.
Technology loans outstanding decreased by 19.7% and comprised 20.7% of total specialized lending at December 31, 2019 compared to 21.9% at December 31, 2018. Our technology portfolio focuses on the technology sub-segments of software and services, network and communications infrastructure, and internet and mobility applications.
Commercial Real Estate. Commercial real estate (“CRE”) loans increased by $1.4 billion or 108.4% since December 31, 2018. CRE loans represented 21.2% of our total loan portfolio at December 31, 2019, compared to 13.2% of total loans at December 31, 2018. The increase resulted from our merger with State Bank. Income Producing CRE includes non-owner occupied loans secured by commercial real estate, regardless of the phase of the loan (construction versus completed). Commercial construction loans are primarily included in Income Producing CRE. Additionally, all real estate investment trust and income producing loans are included in the Income Producing CRE segment. Land, lots, and homebuilder loans are included in the land and development segment. All owner occupied CRE loans reside in the various C&I segments in which the underlying risk exists. Our CRE lending team is a group of experienced relationship managers focusing on construction and income producing property lending which generally have property or sponsors located in our geographic footprint. CRE loans are secured by a variety of property types, including multi-family dwellings, office buildings, industrial properties, and retail facilities.
Consumer. Consumer loans increased by $383.2 million or 16.7% since December 31, 2018 with a significant portion of the increase attributable to the merger with State Bank. Consumer loans represent 20.5% of total loans at December 31, 2019, compared to 22.7% of total loans at December 31, 2018. We originate residential real estate mortgages that are held for investment as well as held for sale in the secondary market. Approximately 19.1% of the consumer portfolio relates to acquired portfolios, compared to 17.6% a year ago. Our originated consumer loan portfolio totaled $2.2 billion as of December 31, 2019, an increase of $274.2 million from year end 2018.
Small Business. Small business loans increased by $468.0 million or 175.7% since December 31, 2018. The majority of the increase is attributable to the merger with State Bank. Small business loans represent 5.6% of the total loan portfolio at December 31, 2019, compared to 2.6% of total loans at December 31, 2018. The small business category is defined as all commercial loans with a transactional exposure of $1.5 million or less and relationship exposure of $2.0 million or less that were underwritten in our centralized loan center. Additionally, it includes any acquired loans that we believe would have been underwritten in our centralized loan center had they been part of Cadence at origination. These loans are primarily centrally underwritten using defined underwriting standards that are applied consistently throughout the category.
Concentrations of Credit. We closely and consistently monitor our concentrations of credit. Individual concentration limits are assessed and established, as needed, on a quarterly basis and measured as a percentage of risk-based capital. All concentrations greater than 25% of risk-based capital require a concentration limit, which is monitored and reported to the Board of Directors on at least a quarterly basis. In addition to the specialized industries, energy, and CRE segments in the loan portfolio, we manage concentration limits for other loans, such as, construction, multifamily, office building, leveraged loans, technology loans, specialty chemical, and non-specialized enterprise value loans. We evaluate the appropriateness of our underwriting standards in response to changes in national and regional economic conditions, including energy prices, interest rates, real estate values, and employment levels. Underwriting standards and credit monitoring activities are assessed and enhanced in response to changes in these conditions.
Shared National Credits. The federal banking agencies define a shared national credit (“SNC”) as any loan(s) extended to a borrower by a supervised institution or any of its subsidiaries and affiliates which aggregates $100 million or more and is shared by three or more institutions under a formal lending agreement or a portion of which is sold to two or more institutions, with the purchasing institutions assuming its pro rata share of the credit risk. As a commercial focused relationship bank, we often participate in syndicated loan offerings as a result of the size of the customers and nature of industries we serve.
Our SNC loans are spread across our commercial products with many falling within our specialized industries and are focused on customers where we have ancillary business or believe we can develop such business. Our management team, relationship managers, and credit risk management team have extensive experience in the underwriting, due diligence, and monitoring of SNC credits. We evaluate SNC loans using the same credit standards we apply in underwriting all our loans.
The following table presents our SNC portfolio by portfolio segment and class of financing receivable.
Asset Quality
We focus on asset quality strength through robust underwriting, proactive monitoring and reporting of the loan portfolio and collaboration between the lines of business, credit risk and enterprise risk management.
Credit risk is governed and reported up through the Board of Directors primarily through our Senior Credit Risk Management Committee (“SCRMC”). The SCRMC reviews credit portfolio management information such as problem loans, delinquencies, concentrations of credit, asset quality trends, portfolio analysis, exception management, policy updates and changes, and other relevant information. Further, both the Senior Loan Committee and Credit Transition Committee, the primary channels for credit approvals, report up through SCRMC. The Senior Loan Committee generally approves all loans with relationship exposure greater than $5 million. Dual signature authority between the business unit and the credit officer is utilized for loan approvals below the $5 million threshold. Additionally, the Credit Transition Committee manages all material credit actions for classified credits greater than $5 million. Our Board of Directors receives information concerning asset quality measurements and trends on at least a quarterly basis if not more frequently.
Credit policies have been established for each type of lending activity in which we engage, with a particular focus given to the commercial side of the Bank. Policies are evaluated and updated as needed based on changes in guidance and regulations as well as business needs of the Bank.
Each loan’s creditworthiness is assessed and assigned a risk rating, based on both the borrower strength (probability of default) as well as the collateral protection of the loan (loss given default). Risk rating accuracy and reporting are critical tools for monitoring the portfolio as well as determining the allowance for credit losses. Assigned risk ratings are periodically reviewed for accuracy and adjusted as appropriate for all relationships greater than $2.5 million and Pass rated. Relationships rated Pass, Watch, or worse and $1 million or more are reviewed quarterly.
Acquired Loans
Loans acquired in acquisitions are initially recorded at fair value with no carryover of the related ACL. The fair value of the loans is determined using market participant assumptions in estimating the amount and timing of principal and interest cash flows initially expected to be collected on the loans and discounting those cash flows at an appropriate market rate of interest.
Under the accounting model for ACI loans, the excess of cash flows expected to be collected over the carrying amount of the loans, referred to as the “accretable yield,” is accreted into interest income over the life of the loans using the effective yield method. Accordingly, ACI loans are not subject to classification as nonaccrual in the same manner as originated loans. Rather, acquired loans are considered to be accruing loans because their interest income relates to the accretable yield recognized and not to contractual interest payments. However, if the timing or amount of the expected cash flows cannot be reasonably estimated an ACI loan may be placed in nonaccruing status. The excess of an ACI loan’s contractually required payments over the cash flows expected to be collected is the nonaccretable difference. As such, charge-offs on ACI loans are first applied to the nonaccretable difference and then to any related ACL recognized subsequent to the acquisition. A decrease in expected cash flows in subsequent periods may indicate that the ACI loan pool or specifically reviewed loan is impaired, which would require the establishment of an allowance for credit losses by a charge to the provision for credit losses.
Select asset quality metrics presented below distinguish between the originated, ANCI and ACI portfolios.
Nonperforming Assets
Nonperforming assets (“NPA”) primarily consist of nonperforming loans (“NPL”) and other assets acquired through any means in full or partial satisfaction of a debt previously contracted. The following table presents all nonperforming assets and additional asset quality data for the dates indicated.
Table 16 - Nonperforming Assets
Nonperforming Loans. Commercial loans, including small business loans, are generally placed on nonaccrual status when principal or interest is past due 90 days or more unless the loan is well secured and in the process of collection, or when the loan is specifically determined to be impaired. When a commercial loan is placed on nonaccrual status, interest accrued but not received is generally reversed against interest income.
Consumer loans, including residential first and second lien loans secured by real estate, are generally placed on nonaccrual status when they are 120 or more days past due. When a consumer loan is placed on nonaccrual status, interest accrued but not received is generally reversed against interest income.
Generally, cash receipts on nonperforming loans are used to reduce principal rather than recorded as interest income. Past due status is determined based upon contractual terms. A nonaccrual loan may be returned to accrual status when repayment is reasonably assured under the terms of the loan or, if applicable, under the terms of the restructured loan. Approximately $16.3 million, $8.5 million, and $7.3 million of contractual interest accrued on nonperforming loans was not recognized in earnings during the years ended December 31, 2019, 2018, and 2017, respectively. For the year ended December 31, 2019, an immaterial amount of contractual interest paid was recognized on the cash basis compared to $1.7 million and $1.5 million for the same periods in 2018 and 2017, respectively.
Our nonperforming loans have increased to 0.92% of our loan portfolio as of December 31, 2019 compared to 0.74% of our loan portfolio as of December 31, 2018, with the increase primarily due to six credits in the General C&I segment, five credits in the Restaurant segment, and one credit each in the Healthcare and E&P segments within our originated portfolio.
The following table includes our originated nonperforming assets for the periods presented.
Table 17 - Originated Nonperforming Assets
Other Real Estate Owned. Other real estate owned consists of properties acquired through foreclosure and unutilized bank-owned properties. These properties, as held for sale properties, are initially recorded at fair value, less estimated costs to sell, on the date of foreclosure (establishing a new cost basis for the property). Subsequent to the foreclosure date, the OREO is maintained at the lower of cost or fair value. Any write-down to fair value required at the time of foreclosure is charged to the allowance for credit losses. Subsequent gains or losses on other real estate owned resulting from either the sale of the property or additional valuation allowances required due to further declines in fair value are reported in other noninterest expense.
The balance of foreclosed OREO was $1.6 million as of December 31, 2019 and consisted of eight properties compared to $2.4 million and 19 properties as of December 31, 2018, with approximately 96% related to foreclosures resulting from our ACI loan portfolio. There were no additions to OREO resulting from foreclosure or repossession from a shared national credit during the three years ended December 31, 2019. In 2016, we received net profits interests (“NPIs”) in certain oil and gas reserves related to two energy credit bankruptcies that were charged-off in 2016. We recorded the NPIs at estimated fair value using a discounted cash flow analysis applied to the expected cash flows from the producing developed wells. We sold one NPI during 2018. The remaining NPI balance was $4.3 million as of December 31, 2019 compared to $5.8 million as of December 31, 2018.
The following tables provide additional detail of our OREO and other nonperforming assets. The first table presents total balances including OREO related to foreclosures resulting from originated loans, ANCI loans, and ACI loans. The subsequent table presents the ACI OREO separately.
Table 18 - OREO and Other Nonperforming Assets
Past Due 90 Days and Accruing. We classify certain loans with principal or interest past due 90 days or more as accruing loans if those loans are well secured and in the process of collection or are specifically determined to be impaired as accruing loans. The bulk of the accruing 90 days or more past due loans reside in the ACI portfolio. These loans are monitored on a monthly basis by both the lines of business and credit administration. As of December 31, 2019, there was one SNC that is an ACI loan with a balance of $11.7 million that was 90 days or more past due and accruing.
Troubled Debt Restructuring. We attempt to work with borrowers when necessary to extend or modify loan terms to better align with the borrower’s ability to repay. Extensions and modifications to loans are made in accordance with internal policies and guidelines which conform to regulatory guidance. Each occurrence is unique to the borrower and is evaluated separately. The Bank considers regulatory guidelines when restructuring loans to ensure that prudent lending practices are followed. Qualifying criteria and payment terms are structured by the borrower’s current and prospective ability to comply with the modified terms of the loan.
A modification is classified as a troubled debt restructuring (“TDR”) if the borrower is experiencing financial difficulty and it is determined that we have granted a concession to the borrower. We may determine that a borrower is experiencing financial difficulty if the borrower is currently in default on any of its debt, or if it is probable that a borrower may default in the foreseeable future without the modification. Concessions could include reductions of interest rates at a rate lower than the current market rate for a new loan with similar risk, extension of the maturity date, reduction of accrued interest, principal forgiveness, forbearance, or other concessions. The assessments of whether a borrower is experiencing or will likely experience financial difficulty and whether a concession has been granted is highly subjective in nature, and management’s judgment is required when determining whether a modification is classified as a TDR.
All TDRs are reported as impaired. An impaired classification may be removed if the borrower demonstrates compliance with the modified terms and the restructuring agreement specifies an interest rate equal to that which would be provided to a borrower with similar credit at the time of restructuring. Nonperforming loans and impaired loans have unique definitions. Some loans may be included in both categories, whereas other loans may only be included in one category. As of December 31, 2019, there were SNCs totaling $7.7 million designated as TDRs compared to $24.7 million as of December 31, 2018.
Originated and ANCI Loans Modified into TDRs. The following table provides information regarding loans that were modified into TDRs in the originated and ANCI portfolios for the periods indicated.
Table 19 - Originated and ANCI Loans Modified into TDRs
During the year ended December 31, 2019, approximately $49.7 million in charge-offs were taken related to commercial and industrial loans that were modified into TDRs during the same 12-month period. For the year ended December 31, 2018, there was one commercial specialized lending customer with a combined recorded investment of $11.8 million which experienced payment default in the year of modification. There were no TDRs modified during 2017 and 2016 that experienced payment default during the year of modification. For the year ended December 31, 2015, there were two small business lending loans with a combined recorded investment of $0.5 million which experienced payment default during the year of modification. Default is defined as the earlier of the troubled debt restructuring being placed on non-accrual status or obtaining 90 day past due status with respect to principal and/or interest payments.
ACI Loans Modified into TDRs. There was one ACI loan modified into a TDR during the year ended December 31, 2019 with a recorded investment of $1.5 million that was sold prior to year-end. There were no ACI loans modified into a TDR during the years ended December 31, 2018 and 2017. During the year ended December 31, 2016, there was one ACI loan modified into a TDR with a recorded investment of $1.0 million in income producing commercial real estate. During the year ended December 31, 2015, there was one ACI loan modified into a TDR with a recorded investment of $0.6 million in income producing commercial real estate. There were no ACI TDRs modified during the three years ended December 31, 2019 that experienced payment default during the year of modification.
Potential Problem Loans. Potential problem loans represent loans that are currently performing, but for which available information about possible credit problems of the related borrowers causes management to have doubts as to the ability of such borrowers to comply with the repayment terms in the future and which may result in the classification of such loans as nonperforming at some time in the future. These loans are not included in the amounts of nonaccrual or restructured loans presented above. We cannot predict the extent to which economic conditions or other factors may impact borrowers and the potential problem loans. Accordingly, there can be no assurance that other loans will not become 90 days or more past due, be placed on nonaccrual status, become restructured, or require increased allowance coverage and provision for credit losses. We have identified $47 million in credits as potential problem loans at December 31, 2019 with the majority of the balances in E&P ($18 million), General C&I ($12 million), Restaurant ($10 million) and CRE ($4 million). Of the $47 million, approximately $29 million is in our originated portfolio and $18 million in the acquired portfolio. Any potential problem loans would be assessed for loss exposure consistent with the methods described in Notes 1 and 4 to our Consolidated Financial Statements.
We expect the levels of nonperforming assets and potential problem loans to fluctuate in response to changing economic and market conditions, and the relative sizes of the respective loan portfolios, along with our degree of success in resolving problem assets. We seek to take a proactive approach with respect to the identification and resolution of problem loans.
Allowance for Credit Losses
The allowance for credit losses (“ACL”) is maintained at a level that management believes is adequate to absorb all probable losses on loans inherent in the loan portfolio as of the reporting date. Events that are not within the Company’s control, such as changes in economic factors, could change subsequent to the reporting date and could cause increases or decreases to the ACL. The amount of the allowance is affected by loan charge-offs, which decrease the allowance; recoveries on loans previously charged off, which increase the allowance; and the provision for credit losses charged to earnings, which increases the allowance. In determining the provision for credit losses, management monitors fluctuations in the ACL resulting from actual charge-offs and recoveries and reviews the size and composition of the loan portfolio in light of current and anticipated economic conditions (see Notes 1 and 4 to the Consolidated Financial Statements). This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as events change.
Total ACL as of December 31, 2019 was $119.6 million or 0.92% of total loans (net of unearned discounts and fees) of $13.0 billion. This compares with $94.4 million on loans of $10.1 billion or 0.94% at December 31, 2018. The following tables present the allocation of the allowance for credit losses and the percentage of these loans to total loans. The allocation below is neither indicative of the specific amounts or the loan categories in which future charge-offs may occur, nor is it an indicator of any future loss trends. The allocation of the allowance to each category does not restrict the use of the allowance to absorb any losses in any category.
Table 20 - Allocation of Allowance for Credit Losses
Originated ACL. The ACL on our originated loan portfolio totaled $108.9 million or 1.09% on loans of $10.0 billion as of December 31, 2019 compared to $85.4 million or 0.90% on loans of $9.5 billion as of December 31, 2018. The primary driver of the originated ACL is the net new loan growth as well as the underlying credit quality of the loans. Our originated and ANCI loan portfolios are divided into commercial and consumer segments for allowance estimation purposes. The commercial allowance estimate is driven by loan level risk ratings. The consumer allowance estimate uses pool level historical loss rates assigned based on certain credit attributes.
As of December 31, 2019, $82.7 million or 75.9% of our originated ACL is attributable to our C&I loan segment compared to $66.0 million or 77.2% as of December 31, 2018. The ACL as a percentage of the C&I portfolio was 1.39% as of December 31, 2019 compared to 1.08% as of December 31, 2018. This increase in the level of ACL on the C&I portfolio as of December 31, 2019 from December 31, 2018 includes additional provision of approximately $84 million on specific credits primarily within the Energy, Restaurant and General C&I segments, offset by charge-offs of approximately $78 million, as well as credit migration (see “-Provision for Credit Losses”).
The level of criticized loans in the originated C&I portfolio is presented in the following tables.
Table 21 - Originated Criticized C&I Loans
The increase in the General C&I criticized and classified assets does not represent any specific industry within General C&I. Energy criticized and classified loans includes one E&P credit totaling $18 million and four Midstream credits totaling $66 million. The Restaurant criticized assets include eight credits totaling $99 million of which approximately $90 million are in the Quick Service (QSR) sector, while Healthcare includes three credits totaling $26 million.
As of December 31, 2019, $11.9 million or 10.9% of our originated ACL is attributable to the CRE loan segment compared to $8.8 million or 10.3% as of December 31, 2018. The ACL as a percentage of the CRE portfolio has increased to 0.78% as of December 31, 2019 from 0.70% as of December 31, 2018 due to growth in the portfolio as well as a slight increase in criticized credits.
In addition to quantitative elements, certain qualitative and environmental factors are also considered at management’s discretion, which are generally based on a combination of internal and external factors and trends. At December 31, 2019, these factors totaled $16.7 million and accounted for approximately 15.3% of the originated ACL compared to $19.7 million or 23.1% as of December 31, 2018. The factors related to higher criticized loan levels and certain macroeconomic trends accounted for the highest portion of these factors as of December 31, 2019. At December 31, 2019, the qualitative factors were allocated to various segments of the portfolio as follows: approximately $1.7 million to CRE, $10.4 million to C&I, and $4.6 million to Consumer.
As of December 31, 2019, approximately $32.0 million or 29.4% of the total originated ACL was attributable to SNC loans compared to $21.1 million or 24.7% as of December 31, 2018. During 2019, we recorded gross charge-offs of $22.7 million on five SNC credits within the Energy and Restaurant portfolios. During 2018, we recorded gross charge-offs of a single Energy portfolio SNC credit totaling $6.2 million. The ACL is estimated based on the underlying credit quality of the loan, primarily based on its probability of default and loss given default. This methodology is consistent whether or not a loan is a SNC.
The following table includes the charge-off and recoveries on our originated portfolio for the periods presented.
Table 22 - Originated Charge-offs and Recoveries
ANCI ACL. The ACL on our ANCI loan portfolio totaled $1.4 million or 0.05% on loans of $2.9 billion at December 31, 2019 compared to $1.1 million or 0.30% on $349.3 million in loans at December 31, 2018. ANCI loans were recorded at fair value at the date of each acquisition and are pooled for ACL assessment based on risk segment. The State Bank merger added approximately $3.2 billion in loan balances to the ANCI portfolio (see Table 13). Any net deficiency of credit mark indicates the need for an allowance on that segment of loans with certain loans individually reviewed for specific impairment.
ACI ACL. The ACL on our ACI loan portfolio totaled $9.4 million or 4.09% on loans of $228.6 million at December 31, 2019 compared to $7.9 million or 3.90% on $203.3 million in loans at December 31, 2018. At the time of our acquisitions, we estimated the fair value of the total ACI loan portfolio by segregating the portfolio into loan pools with similar characteristics and certain specifically reviewed non-homogeneous loans. Our recent merger with State Bank added approximately $78 million in ACI loans to our portfolio (see “Note 2 - Business Combinations” to the audited consolidated financial statements).
Expected cash flows are re-estimated quarterly utilizing the same cash flow methodology used at the time of each acquisition. Any subsequent decreases to the expected cash flows generally result in a provision for credit losses. Conversely, subsequent increases in expected cash flows result first in the reversal of any impairment, then in a transfer from the non-accretable discount to the accretable discount, which would have a positive impact on accretion income prospectively. These cash flow evaluations are inherently subjective, as they require material estimates, all of which may be susceptible to significant change.
The largest component of our ACI ACL is attributable to our consumer category, primarily first and second-lien residential loans, that represents 64.9% of the ACI ACL at December 31, 2019 compared to 78.6% at December 31, 2018. This component of the ACL has remained relatively stable at $6.1 million compared to $6.2 million at December 31, 2018.
The commercial real estate component comprises 22.6% of the ACI ACL at December 31, 2019 compared to 20.7% at December 31, 2018. This component of the ACL has increased $0.5 million to $2.1 million since December 31, 2018 due to revised cash flow estimates. The commercial and industrial component comprises 12.5% of the ACI ACL at December 31, 2019.
The following table summarizes certain information with respect to our ACL on the total loan portfolio and the composition of charge-offs and recoveries for the periods indicated. Subsequent tables present this information separately for the originated, ANCI, and ACI loan portfolios.
Table 23 - Allowance for Credit Losses Rollforward
Deposits. Deposits at December 31, 2019 totaled $14.7 billion as compared to $10.7 billion and $9.0 billion at December 31, 2018 and 2017, respectively. The increase in deposits is primarily due to $4.1 billion of deposits acquired from State Bank. Excluding State Bank, core deposits (total deposits less brokered deposits) increased $779.7 million, or 8.1% from December 31, 2018, while brokered deposits decreased $842.3 million, or 81.2%. We categorize deposits as brokered and non-brokered consistent with the banking industry. Our strategy is to fund asset growth primarily with customer deposits in order to maintain a stable liquidity profile and a more competitive cost of funds. All customer deposits are non-brokered. The following table illustrates the growth in our deposits during the periods indicated:
Table 24 - Deposits
Domestic time deposits of $250,000 and over were $644.1 million and $491.3 million at December 31, 2019 and 2018, respectively. These amounts represented 4.4% and 4.6% of total deposits at December 31, 2019 and 2018, respectively.
The following table sets forth our average deposits and the average rates expensed for the periods indicated:
Borrowings
The following is a summary of our borrowings for the periods indicated:
Table 25 - Borrowings
At December 31, 2019, the outstanding advance from the FHLB was a long-term convertible advance. At December 31, 2019, we had borrowing availability of $1.5 billion from the FHLB.
In June 2014, we completed a $245 million unregistered multi-tranche debt transaction, and in March 2015, we completed an unregistered $50 million debt transaction ($10 million senior; $40 million subordinated). In June 2019, we completed a registered public offering of $85 million aggregate principal amount of 4.75% fixed to floating rate subordinated notes due 2029, the net proceeds of which, along with holding company cash, were used to redeem our 4.875% senior notes due June 28, 2019. These transactions enhanced our liquidity and the Bank’s regulatory capital levels to support balance sheet growth. Details of the debt transactions are as follows (in thousands):
Table 26 - Senior and Subordinated Debt
The senior transactions were structured with four- and seven-year maturities to provide holding company liquidity and to stagger our debt maturity profile. The $35 million and $25 million subordinated debt transactions were structured with a fifteen-year maturity, ten-year call options, and fixed-to-floating interest rates. The $85 million subordinated debt transaction was structured with a ten-year maturity, a five-year call option, and a fixed-to-floating interest rate. The $40 million subordinated debt transaction has a five-year call option. These subordinated debt structures were designed to achieve full Tier 2 capital treatment for 10 years.
On March 29, 2019, we entered into a credit agreement for a revolving loan facility in the amount of $100 million with a maturity date of March 29, 2020. The proceeds of the revolving line of credit can be used to finance general corporate purposes. There were no amounts outstanding under this line of credit at December 31, 2019. Although the credit facility is unsecured, we agreed not to sell, pledge or transfer any part of our right, title or interest in our subsidiary bank while the agreement is in place.
In conjunction with our acquisitions of Cadence and Encore, we assumed certain junior subordinated debentures, which were marked to their fair value as of the acquisition dates. The related mark is being amortized over the remaining terms. The following is a list of our junior subordinated debt as of the dates indicated:
Table 27 - Junior Subordinated Debentures
Shareholders’ Equity
As of December 31, 2019, our ratio of shareholders’ equity to total assets was 13.82%, as compared to 11.30% and 12.41% as of December 31, 2018 and 2017, respectively, and we had tangible equity ratios of 10.9% and 9.1%, respectively. Our shareholders’ equity increased by $1.0 billion in 2019 primarily as a result of issuance of common stock of $826.1 million related to the merger with State Bank, $202.0 million in net income, and an increase of $157.6 million in accumulated other comprehensive income primarily related to an interest rate collar hedge entered into during 2019. These increases to shareholders’ equity were offset by cash dividends on common stock of $90.1 million along with repurchases of 4.3 million common shares totaling $79.1 million pursuant to share repurchase programs authorized by the Board of Directors in July 2019 and in December 2018.
Regulatory Capital. We are required to comply with regulatory capital requirements established by federal banking agencies. These regulatory capital requirements involve quantitative measures of the Company's assets, liabilities and selected off-balance sheet items, and qualitative judgments by the regulators. Failure to meet minimum capital requirements can subject us to a series of increasingly restrictive regulatory actions. Failure to meet well capitalized capital levels (as defined) can result in restrictions on our operations.
Additionally, the regulatory capital requirements impose a capital conservation buffer designed to absorb losses during periods of economic stress. The capital conservation buffer is on top of minimum risk-weighted asset ratios and is equal to the lowest difference between the three risk-based capital ratios less the applicable minimum required ratio. As of January 1, 2019, the capital conservation buffer was fully phased in and is 2.5% of common equity Tier 1 capital to risk-weighted assets. Banking institutions with ratios that are above the minimum but below the combined capital conservation buffer face constraints on dividends, equity repurchases, and compensation based on the amount of the shortfall and the institution’s eligible retained income (“ERI”). ERI is compiled using the past four quarter trailing net income, net of distributions and tax effects not reflected in net income.
Our regulatory capital amounts and ratios at December 31, 2019 and 2018 are presented in the following tables:
Table 28 - Regulatory Capital Amounts and Ratios
Liquidity
Overview
We measure and seek to manage liquidity risk by a variety of processes, including monitoring the composition of our funding mix; monitoring financial ratios specifically designed to measure liquidity risk; maintaining a minimum liquidity cushion; and performing forward cash flow gap forecasts in various liquidity stress testing scenarios designed to simulate possible stressed liquidity environments. We attempt to limit our liquidity risk by setting board-approved concentration limits on sources of funds and limits on liquidity ratios used to measure liquidity risk and maintaining adequate levels of on-hand liquidity. We use the following ratios to monitor and analyze our liquidity:
•
Total Loans to Total Deposits-the ratio of our outstanding loans to total deposits.
•
Non-Brokered Deposits to Total Deposits-the ratio of our deposits that are organically originated through commercial and branch activity to total deposits.
•
Brokered Deposits to Total Deposits-the ratio of our deposits generated through wholesale sources to total deposits.
•
Highly Liquid Assets to Uninsured Large Depositors-the ratio of cash and highly liquid assets to uninsured deposits with a current depository relationship greater than $10 million.
•
Wholesale Funds Usage-the ratio of our current borrowings and brokered deposits to all available wholesale sources with potential maturities greater than one day.
•
Wholesale Funds to Total Assets-the ratio of current outstanding wholesale funding to assets.
As of December 31, 2019, all our liquidity measures were within our established guidelines.
The goal of liquidity management is to ensure that we maintain adequate funds to meet changes in loan demand or any deposit withdrawals. Additionally, we strive to maximize our earnings by investing our excess funds in securities and other assets. To meet our short-term liquidity needs, we seek to maintain a targeted cash position and have borrowing capacity through many wholesale sources including the FHLB, correspondent banks, and the Federal Reserve Bank. To meet long-term liquidity needs, we additionally depend on the repayment of loans, sales of loans, term wholesale borrowings, brokered deposits, and the maturity or sale of investment securities. See “-Maturity Distribution of Investment Securities” and “-Selected Loan Maturity and Interest Rate Sensitivity.”
Maturity Distribution of Investment Securities
The following table shows the scheduled contractual maturities and average book yields (not tax-equivalent) of our investment securities held at December 31, 2019. Within our investment securities portfolio, expected maturities will differ from contractual maturities because issuers have the right to call or prepay obligations without call or prepayment penalties in certain instances. During the year ended December 31, 2019, we received cash proceeds from calls/maturities and paydowns on our investment securities portfolio totaling approximately $352.5 million.
Table 29 - Contractual Maturity of Investment Securities
Selected Loan Maturity
Loan repayments are a source of long-term liquidity for us. The following table sets forth our loans by category maturing within specified intervals as of December 31, 2019. The information presented is based on the contractual maturities of the individual loans, including loans that may be subject to renewal at their contractual maturity. Renewal of such loans is subject to review and credit approval, as well as modification of terms upon their maturity. Consequently, management believes this treatment presents fairly the maturity and re-pricing of the loan portfolio.
Table 30 - Contractual Maturity of Loans
Maturities of Time Deposits
The aggregate amount of time deposits in denominations of $100,000 or more as of December 31, 2019, 2018, and 2017 was $1.59 billion, $1.24 billion, and $1.05 billion, respectively.
At December 31, 2019, the scheduled maturities of time deposits greater than $100,000 were as follows:
Table 31 - Contractual Maturity of Time Deposits Greater than $100,000
Cash Flow Analysis
Cash and cash equivalents
At December 31, 2019, we had $988.8 million of cash and cash equivalents on hand, an increase of 26.9% over our cash and cash equivalents of $779.3 million at December 31, 2018. At December 31, 2019, our cash and cash equivalents comprised 5.6% of total assets compared to 6.1% at December 31, 2018. We monitor our liquidity position and increase or decrease our short-term liquid assets as necessary. The higher balance in cash and cash equivalents at December 31, 2019 is due the acquisition of State Bank, strong organic deposits growth, and moderate loan growth.
Year Ended December 31, 2019 Compared to December 31, 2018
As shown in the Consolidated Statements of Cash Flows, operating activities provided $306.1 million for 2019 compared to $191.2 million for 2018. The increase in operating funds during 2019 was due primarily to an increase in net income, a decrease in origination of loans held for sale, and an increase in proceeds from sales of loans held for sale. The increases were offset by the purchase of the interest rate collar.
Investing activities during 2019 provided $265.4 million of net funds, compared to a net use of $1.8 billion for 2018. The 2019 activity resulted from cash received in acquisitions of $409.1 million, proceeds from sales and maturities of securities available-for-sale of $746.2 million, and a net decrease in loans of $287.6 million. These items were mitigated by purchases of securities available-for-sale of $1.2 billion.
Financing activities during 2019 used net funds of $362.0 million, due to a decrease of $150.0 million in short-term borrowings partially offset by a net increase of $48.6 million in long-term borrowings which included the pay-off of $134.9 million in senior debt and issuance of $83.5 million in subordinated debt. Net financing activities also included the repurchase of common stock of $79.1 million and cash dividends of $90.1 million. This compares to financing activities during 2018 providing net funds of $1.6 billion, resulting from an increase in deposits of $1.7 billion.
Year Ended December 31, 2018 Compared to December 31, 2017
As shown in the Consolidated Statements of Cash Flows, operating activities provided $191.2 million in 2018 compared to $144.7 million in 2017. The increase in operating funds during 2018 was due primarily to an increase in net income and an increase in proceeds from sales of loans held for sale.
Investing activities during 2018 used $1.8 billion of net funds, due to net loan funding of $1.8 billion and the purchase of available-for-sale securities as compared to investing activities during 2017 using $951.1 million of net funds, due to net loan funding of $847.4 million.
Financing activities during 2018 provided net funds of $1.6 billion, due to an increase of $1.7 billion in deposits. This compares to financing activities during 2017 providing net funds of $1.3 billion, resulting from an increase of $994.8 million in deposits and an increase of $150.0 million in advances from the FHLB.
Contractual Cash Obligations
We have entered into certain contractual obligations and commercial commitments in the normal course of business that involve elements of credit risk, interest rate risk and liquidity risk.
The following tables summarize these relationships as of December 31, 2019 by contractual cash obligations and commercial commitments:
Table 32 - Contractual Cash Obligations
(1)
See Note 8 to our 2019 Consolidated Financial Statements. The above includes rent and other costs due under the lease such as property taxes.
(2)
Includes remaining capital commitments to certain limited partnership investments.
The following table includes our commitments to extend credit including home equity lines, overdraft protection lines, and letters of credit as of December 31, 2019.
Table 33 - Commitments to Extend Credit
Such financial instruments are recorded when they are funded and not on the date of entry into the obligation to extend credit. Commitments to extend credit and letters of credit include some exposure to credit loss in the event of default by the customer and exposure to liquidity risk during economic downturns. See “Risk Factors-Risks Relating to Our Business.” The borrowing needs of our clients may increase, especially during a challenging economic environment, which could result in increased borrowing against our contractual obligations to extend credit. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The credit policies and procedures for such commitments are the same as those used for lending activities. Because these instruments have fixed maturity dates and because a number expire without being drawn upon, they generally do not present significant liquidity risk in a normal operating environment. No significant losses on commitments were incurred during the three years in the period ended December 31, 2019. We do not currently anticipate any significant future losses as a result of these transactions.
Quantitative and Qualitative Disclosures about Market Risk
Market risk is the exposure to unanticipated changes in net interest earnings or changes in the fair value of financial instruments due to fluctuations in interest rates, exchange rates and equity prices. Our primary market risk is interest rate risk (“IRR”).
IRR is the risk that changing market interest rates may lead to an unexpected decline in our earnings or capital. The main causes of IRR are the differing structural characteristics of our assets, liabilities and off-balance sheet obligations and their cumulative net reaction to changing interest rates. These structural characteristics include timing differences in maturity or repricing and the effect of embedded options such as loan prepayments, securities prepayments and calls, interest rate caps, floors, collars, and deposit withdrawal options. In addition to these sources of IRR, basis risk results from differences in the spreads between various market interest rates and changes in the slope of the yield curve which can contribute to additional IRR.
We evaluate IRR and develop guidelines regarding balance sheet composition and re-pricing, funding sources and pricing, and off-balance sheet commitments that aim to moderate IRR. We use financial simulation models that reflect various interest rate scenarios and the related impact on net interest income over specified periods of time. We refer to this process as asset/liability management (“ALM”).
The primary objective of ALM is to manage interest rate risk and desired risk tolerance for potential fluctuations in net interest income (“NII”) and economic value of equity (“EVE”) throughout interest rate cycles, which we aim to achieve by maintaining a balance of interest rate sensitive earning assets and liabilities. In general, we seek to maintain a desired risk tolerance with asset and liability balances within maturity and repricing characteristics to limit our exposure to earnings volatility and changes in the value of assets and liabilities as interest rates fluctuate over time. Adjustments to maturity categories can be accomplished either by lengthening or shortening the duration of either an individual asset or liability category, or externally with interest rate contracts, such as interest rate swaps, caps, collars, and floors. See “-Interest Rate Exposures” for a more detailed discussion of our various derivative positions.
Our ALM strategy is formulated and monitored by our Asset/Liability Management Committee (“ALCO”) in accordance with policies approved by the Board of Directors. The ALCO meets regularly to review, among other things, the sensitivity of our assets and liabilities to interest rate changes, the book and market values of assets and liabilities, unrealized gains and losses, recent purchase and sale activity, maturities of securities and borrowings, and projected future transactions. The ALCO also establishes and approves pricing and funding strategies with respect to overall asset and liability composition. The ALCO reports regularly to our Board of Directors.
Financial simulation models are the primary tools we use to measure IRR exposures. By examining a range of hypothetical deterministic interest rate scenarios, these models provide management with information regarding the potential impact on NII and EVE caused by changes in interest rates.
The models simulate the cash flows and accounting accruals generated by the financial instruments on our balance sheet, as well as the cash flows generated by the new business we anticipate over a 60-month forecast horizon. Numerous assumptions are made in the modeling process, including balance sheet composition, the pricing, re-pricing and maturity characteristics of existing business, and new business. Additionally, loan and investment prepayments, administered rate account elasticity, and other option risks are considered as well as the uncertainty surrounding future customer behavior. Because of the limitations inherent in any approach used to measure interest rate risk and because our loan portfolio will be actively managed in the event of a change in interest rates, simulation results, including those discussed in “-Interest Rate Exposures” immediately below, are not intended as a forecast of the actual effect of a change in market interest rates on our NII or EVE or indicative of management’s expectations of actual results in the event of a fluctuation in market interest rates, however, these results are used to help measure the potential risks related to IRR.
LIBOR Transition
One additional emerging risk related to IRR is the transition of the market from LIBOR to an alternative benchmark index. We have formed a cross-functional project team to manage the assessment, identification, and resolution of risks and potential issues related to the transition from LIBOR to a replacement index. This team reports to the ALCO and Enterprise Risk Management Committee, who will provide regular reports to the Board of Directors. See “Risk Factors-We May Be Adversely Impacted by The Transition from LIBOR as a Reference Rate.”
Interest Rate Exposures
Based upon the current interest rate environment as of December 31, 2019, our net interest income simulation model projects our sensitivity to an instantaneous increase or decrease in interest rates was as follows:
Table 34 - Interest Rate Sensitivity
Based upon the current interest rate environment as of December 31, 2019, the following table reflects our sensitivity to a gradual increase or decrease in interest rates over a twelve-month period:
Both the NII and EVE simulations include assumptions regarding balances, asset prepayment speeds, deposit repricing and runoff and interest rate relationships among balances that management believes to be reasonable for the various interest rate environments. Differences in actual occurrences from these assumptions may change our market risk exposure.
Derivative Positions
Overview. Our Board of Directors has authorized the ALCO to utilize financial futures, forward sales, options, interest rate swaps, caps, collars, and floors, and other instruments to the extent appropriate, in accordance with regulations and our internal policy. We expect to use interest rate swaps, caps, collars, and floors as macro hedges against inherent rate sensitivity in our assets and our liabilities.
Positions for hedging purposes are undertaken primarily as a mitigation of three main areas of risk exposure: (1) mismatches between assets and liabilities; (2) prepayment and other option-type risks embedded in our assets, liabilities and off-balance sheet instruments; and (3) the mismatched commitments for mortgages and funding sources.
We currently intend to engage in only the following types of hedges: (1) those which synthetically alter the maturities or re-pricing characteristics of assets or liabilities to reduce imbalances; (2) those which enable us to transfer the interest rate risk exposure involved in our daily business activities; and (3) those which serve to alter the market risk inherent in our investment portfolio, mortgage pipeline, or liabilities and thus help us to match the effective maturities of the assets and liabilities.
The following is a discussion of our primary derivative positions.
Interest Rate Lock Commitments. We enter into certain commitments with customers in connection with the origination of residential mortgage loans which will be sold in the secondary market. Such commitments are considered derivatives under current accounting guidance and are required to be recorded at fair value. The change in fair value of these instruments is reflected currently in earnings in mortgage banking revenue.
Forward Sales Commitments. To mitigate the effect of the interest rate risk inherent in providing interest rate lock commitments to customers, we enter into forward sales commitments of mortgage-backed securities (“MBS”) with investors. During the period from commitment date to closing date, we are subject to the risk that market rates of interest may change. To mitigate such risk, we may establish forward delivery sales commitments under which we agree to deliver certain MBS. These commitments are non-hedging derivatives in accordance with current accounting guidance and recorded at fair value, with changes in fair value reflected currently in earnings in mortgage banking revenue.
Forward Purchase Commitments. If we determine that the amount of our forward sales commitments exceeds the amount necessary to mitigate the interest rate risk in the rate lock commitments, we will seek to enter into forward purchase commitments to purchase MBS on an agreed-upon date and price similar to the terms of forward sales commitments. These commitments are non-hedging derivatives in accordance with current accounting guidance and recorded at fair value, with changes in fair value reflected currently in earnings in mortgage banking revenue.
Interest Rate Swaps/Floor/Cap/Collar Agreements not Designated as Hedging Derivatives. To attempt to meet the financing needs and interest rate risk management needs of our customers, we enter into interest rate swap, floor, collar, or cap agreements related to commercial loans with customers while at the same time entering into offsetting interest rate agreements with other financial institution in order to minimize IRR. These interest rate swap agreements are non-hedging derivatives and are recorded at fair value with changes in fair value reflected in earnings in other noninterest income. The fair value of these derivatives is recorded on the consolidated balance sheet in other assets and other liabilities.
Cash Flow Hedges. Cash flow hedge relationships mitigate exposure to the variability of future cash flows or other forecasted transactions. The Company uses interest rate swaps, caps, floors, and collars to manage overall cash flow changes related to interest rate risk exposure on benchmark interest rate loans (1-Month LIBOR).
In February 2019, the Company entered into a $4.0 billion notional interest rate collar with a five-year term. The interest rate collar has a purchased cap strike of 4.70%, a sold cap strike of 3.50%, a sold floor strike of 0.00%, and a purchased floor strike of 3.00%. The purchased option price was $127.8 million when executed and the current estimated fair value at December 31, 2019 is $239.2 million. The purchased option will amortize as contra interest income over the five-year term. The purchased option proceeds will change with one-month LIBOR and we may collect more or less than the original price which will result in interest income or contra interest income, respectively.
In June 2015 and March 2016, the Company entered into interest rate swap agreements with notional values totaling $982 million and $350 million, respectively, to manage overall cash flow changes related to interest rate risk exposure on the 1-Month LIBOR rate indexed loans. In 2019, 2018, and 2017, interest rate swap agreements matured with notional amounts totaling $300 million, $382 million and $300 million, respectively. At December 31, 2019, the Company has outstanding the following interest rate swap agreements:
The following summarizes all derivative positions as of December 31, 2019 and 2018:
Table 35 - Derivatives
Counterparty Credit Risk
Derivative contracts involve the risk of dealing with both bank customers and institutional derivative counterparties and their ability to meet contractual terms. Our policies require that institutional counterparties be approved by our ALCO and all positions over and above the minimum transfer amounts are secured by marketable securities or cash.
Critical Accounting Policies and Estimates
Our consolidated financial statements are prepared in accordance with GAAP. Application of these principles requires management to make complex and subjective estimates and judgments that affect the amounts reported in the consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions that we believe to be reasonable under current circumstances.
These assumptions form the basis for our judgments about the carrying values of assets and liabilities that are not readily available from independent, objective sources. We evaluate our estimates on an ongoing basis. Use of alternative assumptions may have resulted in significantly different estimates. Actual results may differ from these estimates.
Accounting policies are an integral part of our financial statements. A thorough understanding of these accounting policies is essential when reviewing our reported results of operations and our financial position. The critical accounting policies and estimates discussed below involve additional management judgment due to the complexity and sensitivity of the methods and assumptions used.
Business Combinations
We account for transactions that meet the definition of a purchase business combination by recording the assets acquired and liabilities assumed at their fair value upon acquisition. Intangible assets, indemnification contracts and contingent consideration are identified and recognized individually. If the fair value of the assets acquired exceeds the purchase price plus the fair value of the
liabilities assumed, a bargain purchase gain is recognized. Conversely, if the purchase price plus the fair value of the liabilities assumed exceeds the fair value of the assets acquired, goodwill is recognized.
Goodwill and Other Intangible Assets
Goodwill is accounted for in accordance with FASB Accounting Standards Codification (“ASC”) Topic 350, and accordingly is not amortized but is evaluated for impairment at least annually, in the fourth quarter or between annual tests if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
Under ASC 350-20, a company is required to assign and then test goodwill for impairment at the reporting unit level. A reporting unit is defined as an operating segment or a component of that operating segment, as defined in ASC 280. Reporting units may vary, depending on the level at which performance of the segment is reviewed. No impairment has been identified in any period presented.
Our other identifiable intangible assets consist primarily of the core deposit premiums and customer relationships arising from our acquisitions. These intangibles were established using the discounted cash flow approach and are being amortized using an accelerated method over the estimated remaining life of each intangible recorded at acquisition. These finite-lived intangible assets are reviewed for impairment when events or changes in circumstances indicate that the asset’s carrying amount may not be recoverable from undiscounted future cash flows or that it may exceed its fair value. No impairment has been identified in any period presented.
Fair Value Measurement
We use estimates of fair value in applying various accounting standards for our consolidated financial statements. Fair value measurements are used in one of four ways: (1) in the consolidated balance sheet with changes in fair value recorded in the consolidated statements of income and other comprehensive income (loss); (2) in the consolidated balance sheet for instruments carried at the lower of cost or fair value with impairment charges recorded in the consolidated statements of income and other comprehensive income (loss); and (3) in the notes to our consolidated financial statements.
Fair value is defined as the price at which an asset may be sold, or a liability may be transferred in an orderly transaction between willing and able market participants. In general, our policy in estimating fair values is to first look at observable market prices for identical assets and liabilities in active markets, where available. When these are not available, other inputs are used to model fair value such as prices of similar instruments, yield curves, volatilities, prepayment speeds, default rates and credit spreads (including for our liabilities).
Depending on the availability of observable inputs and prices, different valuation models could produce materially different fair value estimates. The values presented may not represent future fair values and may not be realizable.
Allowance for Credit Losses
The ACL represents management’s estimate of probable credit losses inherent in our loan portfolio and the difference between the recorded investment and the present values of our most recent estimates of expected cash flows for purchased impaired loans where we have identified additional impairment subsequent to the date of acquisition. Determining the amount of the ACL is considered a critical accounting estimate because it requires significant judgment and the use of estimates related to the amount and timing of expected future cash flows on impaired loans, estimated losses based on risk characteristics of loans and consideration of other qualitative factors, all of which may be susceptible to significant change.
The ACL is maintained at a level that management believes is adequate to absorb all probable losses on loans inherent in the loan portfolio as of the reporting date. Events that are not within our control, such as changes in economic factors, could change subsequent to the reporting date and could cause the ACL to be overstated or understated. The amount of the ACL is affected by loan charge-offs, which decrease the ACL; recoveries on loans previously charged off, which increase the ACL; and the provision for credit losses charged to earnings, which increases the ACL. In determining the provision for credit losses, management monitors fluctuations in the ACL resulting from actual charge-offs and recoveries and reviews the size and composition of the loan portfolio in light of current and anticipated economic conditions. See Notes 1 and 4 to the Consolidated Financial Statements for additional disclosure regarding our ACL.
Accounting for Acquired Loans
We account for our acquisitions using the acquisition method of accounting. All identifiable assets acquired, including loans, are recorded at fair value as of their respective acquisition dates. No allowance for credit losses related to the acquired loans is recorded on the acquisition date, as the fair value of the loans acquired incorporates assumptions regarding credit risk. Loans acquired are recorded at fair value, exclusive of the impact of guarantees under any applicable loss sharing agreements with the FDIC. The fair value estimates associated with the loans include estimates related to expected prepayments and the amount and timing of undiscounted expected principal, interest and other cash flows.
Loans acquired in a transfer, including business combinations, with respect to which there is evidence of credit deterioration since origination and it is probable at the date of acquisition that we will not collect all contractually required principal and interest payments, are accounted for under accounting guidance for ACI loans. We have applied this guidance to each of our acquisitions; including our FDIC-assisted acquisition of the Superior franchise and our open market acquisitions of Cadence, Encore and State Bank. For each acquisition, we have aggregated the ACI loans into pools of loans with common risk characteristics. Over the life of these acquired loans, we continue to estimate cash flows expected to be collected on individual loans or on pools of loans sharing common risk characteristics. For each pool of loans, we estimate cash flows expected to be collected over the remaining life of the pool’s loans, based on assumptions about yields, prepayments and magnitude and timing of credit losses, and discount those cash flows to present value using effective interest rates to calculate the carrying value. The difference between our carrying value in the loans and our estimates of cumulative lifetime undiscounted expected cash flows represents the accretable yield. The accretable yield represents the amount we expect to recognize as interest income over the remaining life of the loans. The difference between the cash flows that our customers legally owe us under the contractual terms of their loan agreements and our cumulative lifetime expected cash flows represents the nonaccretable difference. The nonaccretable difference of a pool is a measure of the expected credit loss, prepayments and other factors affecting expected cash flows for that pool.
Each quarter, we estimate the expected cash flows for each pool or specifically reviewed loan and evaluate whether the present value of future expected cash flows for each pool or loan has decreased below its carrying value and, if so, we recognize a provision for credit loss in our consolidated statement of income for that pool or loan and appropriately adjust the amount of accretable yield. The expected cash flows are estimated based on factors which include loan grades established in our ongoing credit review program, past due status, likelihood of default based on observations of specific loans during the credit review process as well as applicable industry data, loss severity based on updated evaluation of cash flow from available collateral, and the contractual terms of the underlying loan agreement. For any pool or loan where the present value of our most recent estimate of future cumulative lifetime cash flows has increased above its recorded investment, we transfer appropriate estimated cash flows from non-accretable difference to accretable yield, which is then recognized in income first in the reversal of any impairment, then on a prospective basis through an increase in the pool’s or individual loan yield over its remaining life. For further discussion of our acquisitions and loan accounting, see Notes 1 and 4 to our consolidated financial statements.
Deferred Tax Asset
ASC 740-30-25 provides accounting guidance for determining when a company is required to record a valuation allowance on its deferred tax assets. A valuation allowance is required for deferred tax assets if, based on available evidence, it is more likely than not that all or some portion of the asset may not be realized due to the inability to generate sufficient taxable income in the period and/or of the character necessary to utilize the benefit of the deferred tax asset. In making this assessment, all sources of future taxable income must be considered, including taxable income in prior carryback years, future reversals of existing taxable temporary differences, tax planning strategies, and future taxable income exclusive of reversing taxable temporary differences and carryforwards.
Management assesses the valuation allowance recorded against deferred tax assets at each reporting period. The determination of whether a valuation allowance for deferred tax assets is appropriate is subject to considerable judgment and requires an evaluation of all positive and negative evidence. Management concluded, based on the assessment of all of the positive and negative evidence, it was more likely than not that its deferred tax asset at December 31, 2019 and 2018 will be realized. This conclusion was based primarily on projections of future taxable income and the expected reversal of existing deferred tax liabilities. See Note 12 to our consolidated financial statements.
Management’s estimate of future taxable income is based on internal projections, various internal assumptions, as well as certain external data all of which management believes to be reasonable although inherently subject to significant judgment. Projected future taxable income is expected to be generated through loan growth at the bank, revenue growth due to cross selling initiatives, the development of new business, and the reduction of expenses through economies of scale all in the context of a macro-economic environment that continues to trend favorably. If actual results differ significantly from the current estimates of future taxable income, even if caused by adverse macroeconomic conditions, a valuation allowance may need to be recorded for some or all our deferred tax asset. Such an increase to the deferred tax asset valuation allowance could have a material adverse effect on our financial condition and results of operations.
Recently Adopted and Pending Accounting Standards
See Note 1-Summary of Accounting Policies to the consolidated financial statements for information regarding recently adopted or pending accounting standards.
ITEM 7A.
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
We manage our market risk, which is primarily interest rate risk, through its Asset Liability Management Committee. See the “Management Discussion and Analysis of Financial Condition and Results of Operations - Financial Condition - Quantitative and Qualitative Disclosures about Market Risk.”
ITEM 8.
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
Management Report On Internal Control Over Financial Reporting
Report of Independent Registered Public Accounting Firm
Consolidated Financial Statements
Consolidated Balance Sheets at December 31, 2019 and 2018
Consolidated Statements of Income for each of the three years in the period ended December 31, 2019
Consolidated Statements of Comprehensive Income for each of the three years in the period ended December 31, 2019
Consolidated Statements of Changes in Shareholders’ Equity for each of the three years in the period ended December 31, 2019
Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2019
Notes to Consolidated Financial Statements
Management Report On Internal Control Over Financial Reporting
To the Board of Directors of Cadence Bancorporation
The management of Cadence Bancorporation (the “Company”) is responsible for establishing and maintaining effective internal control over financial reporting. The Company’s internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of the Company’s financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Internal control over financial reporting includes self-monitoring mechanisms, and actions are taken to correct deficiencies as they are identified.
All internal control systems, no matter how well designed, have inherent limitations and may not prevent or detect misstatements in the Company’s financial statements, including the possibility of circumvention or overriding of controls. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of a change in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
The Company’s management assessed the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019. In making this assessment, it used the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission (COSO) in Internal Control-Integrated Framework (2013 Framework). Based on its assessment, management believes that, as of December 31, 2019, the Company’s internal control over financial reporting is effective based on those criteria.
The Company’s independent registered public accounting firm has also issued an attestation report on the effectiveness of the Company’s internal control over financial reporting as of December 31, 2019.
/s/ Paul B. Murphy, Jr.
/s/ Valerie C. Toalson
Paul B. Murphy, Jr.
Valerie C. Toalson
Chairman and Chief Executive Officer
Executive Vice President and Chief Financial Officer
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Cadence Bancorporation
Opinion on Internal Control Over Financial Reporting
We have audited Cadence Bancorporation and subsidiaries’ internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework) (the COSO criteria). In our opinion, Cadence Bancorporation and subsidiaries (the Company) maintained, in all material respects, effective internal control over financial reporting as of December 31, 2019, based on the COSO criteria.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the consolidated balance sheets of Cadence Bancorporation and subsidiaries as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2019, and the related notes and our report dated February 28, 2020 expressed an unqualified opinion thereon.
Basis for Opinion
The Company’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting included in the accompanying Management Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects.
Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, testing and evaluating the design and operating effectiveness of internal control based on the assessed risk, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
Definition and Limitations of Internal Control Over Financial Reporting
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
/s/ Ernst & Young LLP
Birmingham, Alabama
February 28, 2020
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Cadence Bancorporation
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Cadence Bancorporation and subsidiaries (the Company) as of December 31, 2019 and 2018, the related consolidated statements of income, comprehensive income, shareholders’ equity and cash flows for each of the three years in the period ended December 31, 2019 and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2019 and 2018, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2019, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company's internal control over financial reporting as of December 31, 2019, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway (2013 framework) and our report dated February 28, 2020 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relate to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing separate opinions on the critical audit matters or on the accounts or disclosures to which they relate.
Business Combinations
Description of the Matter
During 2019, the Company completed its acquisition of State Bank Financial Corporation (“State Bank”) for net consideration of $826.4 million, as disclosed in Note 2 to the consolidated financial statements. The transaction was accounted for as a business combination.
Auditing the Company’s accounting for its acquisition of State Bank was complex due to the estimation required by management to determine the fair values of acquired loans and a deposit-related intangible asset of $3.5 billion and $111.9 million, respectively. The significant estimation was primarily due to the sensitivity of the respective fair values to the significant underlying assumptions. The significant assumptions for acquired loans included the discount rate and loan loss assumptions. The significant assumptions for the deposit-related intangible asset were the attrition rate of the deposit base and net maintenance cost. These significant assumptions are forward looking and could be affected by future economic and market conditions.
How We Addressed the Matter in Our Audit
We obtained an understanding, evaluated the design, and tested the operating effectiveness of the Company’s controls over its accounting for the acquisition, including controls over the estimation process supporting the recognition and measurement of the fair values of acquired loans and the deposit-related intangible asset. This included testing management’s review controls over the judgments applied and evaluation of underlying assumptions used in the valuation methodologies.
To test the estimated fair values of the acquired loans and the deposit-related intangible asset, our audit procedures included, among others, evaluating the Company's selection of the valuation methodologies, evaluating the methods and significant assumptions used by the Company's valuation specialist, and evaluating the completeness and accuracy of the underlying data supporting the significant assumptions and estimates. We involved our valuation specialists to assist with our evaluation of the methodologies used by the Company and significant assumptions included in the fair value estimates. For example, we compared loan loss assumptions and attrition rate of the deposit base assumptions to industry data and performed sensitivity analyses of the significant assumptions to evaluate the changes in estimated fair values that would result from changes in the assumptions.
Description of the Matter
Valuation of Goodwill
At December 31, 2019, the Company's goodwill was $485.3 million. As discussed in Note 1 to the consolidated financial statements, the Company's goodwill is initially assigned to its reporting units as of the acquisition date and is evaluated for impairment at least annually in the fourth quarter or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount.
Auditing management's annual goodwill impairment test was complex and judgmental due to the degree of estimation required to determine the fair values of the Company’s reporting units. Specifically, the fair value estimates were sensitive to significant factors and assumptions, such as macroeconomic and market conditions and the profitability of the reporting units.
How We Addressed the Matter in Our Audit
We obtained an understanding, evaluated the design, and tested the operating effectiveness of controls over the Company’s goodwill impairment testing process, including controls over management’s review of the significant assumptions described above used in determining the reporting unit fair values.
To test the estimated fair values of the Company’s reporting units, our audit procedures included, among others, assessing management’s determination of reporting units, assessing the valuation methodologies used, and testing the significant assumptions used in determining the fair value of the reporting units as well as the underlying data used by the Company in its analysis and the mathematical accuracy of the calculations. We compared the significant assumptions used by management to current industry and economic trends and other relevant factors. We performed sensitivity analyses of significant assumptions to evaluate the changes in the fair values of the reporting units that would result from changes in the assumptions, including management’s business forecasts and other market valuation inputs. We involved our valuation specialists to assist in our evaluation of the significant assumptions used to develop the fair value estimates. We also tested management’s reconciliation of the fair values of the reporting units to the market capitalization of the Company.
Allowance for Credit Losses
Description of the Matter
The Company’s loan portfolio totaled $13.0 billion as of December 31, 2019, and the allowance for credit losses (ACL) was $119.6 million. As discussed in Note 1 and Note 4 to the consolidated financial statements, the ACL represents management’s estimate of credit losses inherent in the loan portfolio at December 31, 2019. The ACL is comprised of four components: specific reserves on loans individually reviewed for impairment based on the present value of expected future cash flows, the loan’s observable market price, or the fair value of the collateral if the loan is collateral dependent; for loans not considered to be impaired, a general reserve for each loan segment based on external loss data; qualitative adjustment factors applicable to the general reserve; and a reserve for unfunded commitments. As outlined in Note 1 to the consolidated financial statements, examples of qualitative adjustment factors that may affect credit losses in the loan portfolio include changes in national and service market business conditions, changes in the nature, size, or concentrations of the portfolio, changes in portfolio collateral values, and the volume and/or severity of past due and classified credits, among others.
Auditing the ACL was complex due to the subjectivity involved in management’s estimate of specific reserves on impaired loans as well as management’s identification and estimate of qualitative adjustment factors applicable to the general reserve component of the ACL. These estimates are highly judgmental and could have a significant effect on the ACL.
How We Addressed the Matter in Our Audit
We obtained an understanding, evaluated the design, and tested the operating effectiveness of the Company’s controls over the ACL process. This included testing controls over management’s review and approval of analyses supporting specific reserves on impaired loans as well as testing controls over management’s assessment of the qualitative adjustment factors and management’s review and approval of the ACL, including the data inputs and outputs of the analyses supporting the ACL and their consistent application to the estimates.
For specific reserves on impaired loans, our audit procedures included inquiring of the responsible loan and credit officers to corroborate management judgments and considerations, testing the clerical accuracy of data and calculations used by management in the reserve estimate, agreeing key estimate inputs to supporting documents such as borrower financial statements or valuation reports, searching
for and evaluating information that corroborates or contradicts the Company’s inputs or assumptions about the expected future cash flows or the fair value of the collateral, and testing the completeness and accuracy of the Company’s recognition of charge-offs.
For the qualitative adjustment factors applicable to the general reserve component of the ACL, our audit procedures included, among others, evaluating the consistency in application of the Company’s qualitative adjustment factor framework methodology. Additionally, we tested of the clerical accuracy of the formulas utilized in the calculations and the completeness and accuracy of inputs used in estimating the qualitative adjustment factors. These procedures included comparing the inputs to data from the Company’s information systems or other reports subject to internal controls and macroeconomic and other information from third-party sources. We also evaluated changes in the qualitative factor adjustments relative to changes in the Company’s loan portfolio, factors impacting the Company’s business, and the credit environment.
We evaluated the overall ACL amount, including specific reserves for impaired loans and qualitative adjustment factors applicable to the general reserve, and whether the amount recorded appropriately reflects losses incurred in the loan portfolio as of the consolidated balance sheet date. We reviewed subsequent events and transactions and considered whether they corroborate or contradict the Company’s measurement of the ACL as of December 31, 2019.
/s/ Ernst & Young LLP
We have served as the Company’s auditor since 2016.
Birmingham, Alabama
February 28, 2020
CADENCE BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
See accompanying notes to the consolidated financial statements.
CADENCE BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
See accompanying notes to the consolidated financial statements.
CADENCE BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
See accompanying notes to the consolidated financial statements.
CADENCE BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CHANGES IN SHAREHOLDERS’ EQUITY
See accompanying notes to the consolidated financial statements.
CADENCE BANCORPORATION AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
See accompanying notes to the consolidated financial statements.
CADENCE BANCORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Cadence Bancorporation (the “Company”) is a Delaware corporation and a financial holding company whose primary asset is its investment in its wholly owned subsidiary bank, Cadence Bank, National Association (the “Bank”).
Note 1-Summary of Accounting Policies
Basis of Presentation and Consolidation
The Company and its subsidiaries follow accounting principles generally accepted in the United States of America, including, where applicable, general practices within the banking industry. The consolidated financial statements include the accounts of the Company and its subsidiaries. Significant intercompany accounts and transactions have been eliminated in consolidation. The assessment of whether or not the Company has a controlling interest (i.e., the primary beneficiary) in a variable-interest entity (“VIE”) is performed on an on-going basis. All equity investments in non-consolidated VIEs are included in “other assets” in the Company’s consolidated balance sheets (Note 21).
Certain amounts reported in prior years have been reclassified to conform to the 2019 presentation. These reclassifications did not materially impact the Company’s consolidated balance sheets or consolidated statements of income.
In accordance with the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 855, Subsequent Events, the Company’s management has evaluated subsequent events for potential recognition or disclosure in the consolidated financial statements through the date of the issuance of these consolidated financial statements. No subsequent events were identified that would have required a change to the consolidated financial statements or disclosure in the notes to the consolidated financial statements.
Nature of Operations
The Company’s primary subsidiary is the Bank.
The Bank operates under a national bank charter and is subject to regulation by the Office of the Comptroller of the Currency (“OCC”). The Bank provides full banking services in six southern states: Alabama, Florida, Georgia, Mississippi, Tennessee, and Texas.
The Bank’s subsidiaries include:
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Linscomb & Williams, Inc. - financial advisory firm;
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Cadence Investment Services, Inc. - provides investment and insurance products; and
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Altera Payroll and Insurance, Inc. - provides payroll processing services and the sale of certain insurance products.
The Company and the Bank also have certain other non-operating and immaterial subsidiaries.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Material estimates that are susceptible to significant change in the near term are the allowance for credit losses, valuation of and accounting for acquired credit impaired loans, valuation of goodwill, intangible assets and deferred income taxes.
Business Combinations
Assets and liabilities acquired in business combinations are accounted for under the acquisition method of accounting and, accordingly, are recorded at their estimated fair values on the acquisition date. The Company generally records provisional amounts at the time of acquisition based on the information available. These provisional estimates of fair values may be adjusted for a period of up to one year from the acquisition date if new information is obtained about facts and circumstances that existed as of the acquisition date that, if known, would have affected the measurement of the amounts recognized as of that date. Adjustments recorded during this period are recognized in the current reporting period. The excess cost over fair value of net assets acquired is recorded as goodwill. On January 1, 2019, we completed our merger with State Bank Financial Corporation and on July 1, 2019, we completed our acquisition of Wealth and Pension Services Group, Inc. (see Note 2).
Sale of Subsidiary
On May 31, 2018, the Company completed the sale of the assets of its subsidiary Cadence Capital, Inc. (formerly known as Town & Country Insurance Agency, Inc.) to an unrelated third party, selling $11.1 million in net assets, including $10.9 million in goodwill and intangibles. This transaction resulted in a pre-tax gain of $4.9 million recorded in noninterest income, offset by $1.1 million in sale related expenses recorded in noninterest expenses during the second quarter of 2018.
Securities
Securities are accounted for as follows:
Securities Available-for-Sale
Securities classified as available-for-sale are those debt securities that are intended to be held for an indefinite period of time, but not necessarily to maturity. Any decision to sell a security classified as available-for-sale would be based on various factors, including movements in interest rates, liquidity needs, security risk assessments, changes in the mix of assets and liabilities and other similar factors. These securities are carried at their estimated fair value, and the net unrealized gain or loss is reported as accumulated other comprehensive income, net of tax, until realized. Premiums and discounts are recognized in interest income using the effective interest method.
Realized gains and losses on the sale of securities available-for-sale are determined by specific identification using the adjusted cost on a trade date basis and are included in securities gains (losses), net.
Securities Held-to-Maturity
Securities classified as held-to-maturity are those debt securities for which there is a positive intent and ability to hold to maturity. These securities are carried at cost, adjusted for amortization of premium and accretion of discount, computed by the effective interest method. The Company had no securities held-to-maturity at December 31, 2019 or 2018.
Trading Account Securities
Trading account securities are securities that are held for the purpose of selling them at a profit. The Company had no trading account securities as of December 31, 2019 or 2018.
FHLB and FRB Stock
The Company has ownership in Federal Home Loan Bank of Atlanta (“FHLB”) and Federal Reserve Bank (“FRB”) stock which do not have readily determinable fair values and no quoted market values, as ownership is restricted to member institutions, and all transactions take place at par value with the FHLB or FRB as the only purchaser. Therefore, the Company accounts for these investments as long-term assets and carries them at cost. Management’s determination as to whether these investments are impaired is based on management’s assessment of the ultimate recoverability of the par value (cost) rather than recognizing temporary declines in fair value. In order to become a member of the Federal Reserve System, regulations require that the Company hold a certain amount of FRB capital stock. Additionally, investment in FHLB stock is required for membership in the FHLB system and in relation to the level of FHLB advances.
Derivative Financial Instruments and Hedging Activities
Derivative instruments are accounted for under the requirements of ASC Topic 815, Derivatives and Hedging. ASC 815 requires companies to recognize all of their derivative instruments as either assets or liabilities in the consolidated balance sheets at fair value.
The fair value of derivative positions outstanding is included in other assets and other liabilities in the accompanying consolidated balance sheets and in the net change in each of these financial statement line items in the accompanying consolidated statements of cash flows. The Company does not speculate using derivative instruments.
Interest Rate Lock Commitments
In the ordinary course of business, the Company enters into certain commitments with customers in connection with residential mortgage loan applications for loans the Company intends to sell. Such commitments are considered derivatives under current accounting guidance and are required to be recorded at fair value. The change in fair value of these instruments is reflected currently in the mortgage banking revenue of the consolidated statements of income. The fair value of these derivatives is recorded on the consolidated balance sheets in other assets and other liabilities.
Forward Sales Commitments
The Company enters into forward sales commitments of mortgage-backed securities (“MBS”) with investors to mitigate the effect of the interest rate risk inherent in providing interest rate lock commitments to customers. During the period from commitment date to closing date, the Company is subject to the risk that market rates of interest may change. In an effort to mitigate such risk, forward delivery sales commitments, under which the Company agrees to deliver certain MBS, are established. These commitments are non-hedging derivatives in accordance with current accounting guidance and recorded at fair value, with changes in fair value reflected currently in the mortgage banking revenue of the consolidated statements of income. The fair value of these derivatives is recorded on the consolidated balance sheets in other assets and other liabilities.
Interest Rate Swap, Floor, Cap, and Collar Agreements Not Designated as Hedging Derivatives
The Company enters into interest rate swap, floor, cap and collar agreements on commercial loans with customers to meet the financing needs and interest rate risk management needs of its customers. At the same time, the Company enters into offsetting interest rate swap agreements with a financial institution in order to minimize the Company’s interest rate risk. These interest rate agreements are non-hedging derivatives and are recorded at fair value with changes in fair value reflected in noninterest income. The fair value of these derivatives is recorded on the consolidated balance sheets in other assets and other liabilities.
Interest Rate Swap, Floor, Cap, and Collar Agreements Designated as Cash Flow Hedges
Cash flow hedge relationships mitigate exposure to the variability of future cash flows or other forecasted transactions. The Company uses interest rate swaps, caps, collars, and floors to manage overall cash flow changes related to interest rate risk exposure on benchmark interest rate loans. The entire change in the fair value related to the derivative instrument is recognized as a component of other comprehensive income and subsequently reclassified into interest income when the forecasted transaction affects income. The Company assesses the effectiveness of hedging derivatives during the initial period with a quantitative test such as statistical regression on a prospective and retrospective basis. For subsequent periods, the effectiveness of hedging derivatives is assessed qualitatively by assuring the notional amounts of the respective derivative instruments are equal to or less than the current balance of the hedged items.
Foreign Currency Contracts
The Company enters into certain foreign currency exchange contracts on behalf of its clients to facilitate their risk management strategies, while at the same time entering into offsetting foreign currency exchange contracts in order to minimize the Company’s foreign currency exchange risk. The contracts are short term in nature, and any gain or loss incurred at settlement is recorded as other noninterest income or other noninterest expense. The fair value of these contracts is reported in other assets and other liabilities. The Company does not apply hedge accounting to these contracts.
Counterparty Credit Risk
Derivative contracts involve the risk of dealing with both bank customers and institutional derivative counterparties and their ability to meet contractual terms. Under Company policy, institutional counterparties must be approved by the Company’s Asset/Liability Management Committee. The Company’s credit exposure on derivatives is limited to the net fair value for each counterparty.
Refer to Note 7 for further discussion and details of derivative financial instruments and hedging activities.
Transfers of Financial Assets
Transfers of financials assets are accounted for as sales when control over the transferred assets is surrendered. Control is generally considered to have been surrendered when 1) the transferred assets are legally isolated from the Company or its consolidated affiliates, even in bankruptcy or other receivership, 2) the transferee has the right to pledge or exchange the assets with no conditions that constrain the transferee and provide more than a trivial benefit to the Company, and 3) the Company does not maintain the obligation or unilateral ability to reclaim or repurchase the assets. If these sale criteria are met, the transferred assets are removed from the Company’s balance sheet and a gain or loss on sale is recognized. If not met, the transfer is recorded as a secured borrowing, and the assets remain on the Company’s balance sheet, the proceeds from the transaction are recognized as a liability, and gain or loss on sale is deferred until the sale criterion are achieved. All transfers of financial assets in the reported periods have qualified and been recorded as sales.
Loans Held-for-Sale
Mortgage Loans Held-for-Sale
Mortgage loans originated and intended for sale in the secondary market are carried at the lower of cost or estimated fair value in the aggregate. The Company also transfers certain mortgage loans to held-for-sale when management has the intent to sell the loan or a portion of the loan in the near term. These held-for-sale loans are recorded at the lower of cost or estimated fair value. At the time of transfer, write-downs on the loans are recorded as charge-offs and a new cost basis is established. Generally, loans in this category are sold within thirty days. These loans are primarily sold with the mortgage servicing rights released. Fees on mortgage loans sold individually in the secondary market, including origination fees, service release premiums, processing and administrative fees, and application fees, are recognized as mortgage banking revenue in the period in which the loans are sold. These loans are underwritten to the standards of upstream correspondents and are held on the Company’s consolidated balance sheets until the loans are sold. Buyers generally have recourse to return a purchased loan to the Company under limited circumstances. Recourse conditions may include early payment default, breach of representations or warranties, and documentation deficiencies. During 2019, 2018, and 2017, an insignificant number of loans were returned to the Company.
Commercial Loans Held-for-Sale
The Company originates certain commercial loans for which a portion is intended for sale. The Company also transfers certain commercial loans to held-for-sale when management has the intent to sell the loan or a portion of the loan in the near term. These held-for-sale loans are recorded at the lower of cost or estimated fair value. At the time of transfer, write-downs on the loans are recorded as charge-offs and a new cost basis is established. Any subsequent lower of cost or market adjustment is determined on an individual loan basis and is recognized as a valuation allowance with any charges included in other noninterest expense. Gains and losses on the sale of these loans are included in other noninterest income when realized.
Loans (Excluding Acquired Credit Impaired Loans)
Loans include loans that are originated by the Company and acquired loans that are not considered impaired at acquisition. Loans originated by the Company are carried at the principal amount outstanding adjusted for the allowance for credit losses, net of deferred origination fees, and unamortized discounts and premiums. Interest income is recognized based on the principal balance outstanding and the stated rate of the loan. Loan origination fees and certain direct origination costs are capitalized and recognized as an adjustment of the yield on the related loan. Loans acquired through acquisition are initially recorded at fair value. Discounts and premiums created when the loans were recorded at their estimated fair values at acquisition are accreted over the remaining term of the loan as an adjustment to the related loan’s yield.
Commercial loans, including small business loans, are generally placed on nonaccrual status when principal or interest is past due ninety days or more unless the loan is well secured and in the process of collection, or when the loan is specifically determined to be impaired. Consumer loans, including residential first and second lien loans secured by real estate, are generally placed on nonaccrual status when they are 120 or more days past due.
The accrual of interest, as well as the amortization/accretion of any remaining unamortized net deferred fees or costs and discount or premium, is generally discontinued at the time the loan is placed on nonaccrual status. All accrued but uncollected interest for loans that are placed on nonaccrual status is reversed through interest income. Cash receipts received on nonaccrual loans are generally applied against principal until the loan has been collected in full, after which time any additional cash receipts are recognized as interest income (i.e., cost recovery method). However, interest may be accounted for under the cash-basis method as long as the remaining recorded investment in the loan is deemed fully collectible.
Loans are evaluated for potential charge-off in accordance with the parameters discussed below or when the loan is placed on non-accrual status, whichever is earlier. Loans within the commercial portfolio are generally evaluated for charge-off at 90 days past due, unless both well-secured and in the process of collection. Closed and open-end residential mortgage and consumer loans are evaluated for charge-off no later than 120 days past due. Any outstanding loan balance in excess of the fair value of the collateral less costs to sell is charged-off no later than 180 days past due for loans secured by real estate. For non-real estate secured loans, in lieu of charging off the entire loan balance, loans may be written down to the fair value of the collateral less costs to sell if repossession of collateral is assured and in process.
A loan is considered to be impaired when it appears probable that the entire amount contractually due will not be collected in accordance with the terms of the loan agreement. Factors considered in determining impairment include payment status, collateral values, and the probability of collecting scheduled payments of principal and interest when due. The measurement of impaired loans is based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the loan’s observable market price or based on the fair value of the collateral less disposal costs if the loan is collateral dependent.
Included in impaired loans are loans considered troubled debt restructurings (“TDRs”). The Company attempts to work with borrowers when necessary to extend or modify loan terms to better align with the borrower’s ability to repay. Extensions and modifications to loans are made in accordance with internal policies and guidelines which conform to regulatory guidance. A modification is classified as a TDR if the borrower is experiencing financial difficulty and it is determined that the Company has granted a concession to the borrower. The Company may determine that a borrower is experiencing financial difficulty if the borrower is currently in default on any of its debt, or if it is probable that a borrower may default in the foreseeable future without the modification. Concessions could include reductions of interest rates at a rate lower than current market rate for a new loan with similar risk, extension of the maturity date, reduction of accrued interest, principal forgiveness, forbearance, or other concessions. The assessments of whether a borrower is experiencing or will likely experience financial difficulty and whether a concession has been granted can be subjective in nature, and management’s judgment is required when determining whether a modification is classified as a TDR.
Allowance for Credit Losses
The allowance for credit losses (“ACL”) is established through charges to income in the form of a provision for credit losses. The ACL is maintained at a level that management believes is adequate to absorb all probable losses inherent in the loan portfolio which are incurred as of the reporting date. Events that are not within the Company’s control, such as changes in economic factors, could change subsequent to the reporting date and could cause the ACL to be overstated or understated. The amount of the ACL is affected by loan charge-offs, which decrease the ACL; recoveries on loans previously charged off, which increase the ACL; and the provision for credit losses charged to income, which increases the ACL. In determining the provision for credit losses, management monitors fluctuations in the ACL resulting from actual charge-offs and recoveries and reviews the size and composition of the loan portfolio in light of current and anticipated economic conditions.
The ACL is comprised of the following four components:
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Specific reserves are recorded on loans reviewed individually for impairment. Generally, all loans that are individually identified as impaired are reviewed on a quarterly basis in order to determine whether a specific reserve is required. A loan is considered impaired when, based on current information, it is probable that we will not receive all amounts due in accordance with the contractual terms of the loan agreement. Once a loan has been identified as impaired, management measures impairment in accordance with ASC Topic 310, Receivables. The measurement of impaired loans is based on the present value of expected future cash flows discounted at the loan’s effective interest rate or the loan’s observable market price or based on the fair value of the collateral if the loan is collateral dependent. When management’s measured value of the impaired loan is less than the recorded investment in the loan, the amount of the impairment is recorded as a specific reserve. These specific reserves are determined on an individual loan basis based on management’s current evaluation of the loss exposure for each credit, given the payment status, the financial condition of the borrower and any guarantors and the value of any underlying collateral. Loans that are individually identified as impaired are excluded from the general reserve calculation described below. Changes in specific reserves from period to period are the result of changes in the circumstances of individual loans such as charge-offs, payments received, changes in collateral values or other factors.
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For loans not considered to be impaired, a general reserve is maintained for each loan segment in the loan portfolio. Due to the growth of the credit portfolio into new geographic areas and into new commercial segmentations and the lack of seasoning of the portfolio, the Company recognizes there is limited historical loss information to adequately estimate loss rates based primarily on historical loss data. Therefore, external loss data is utilized from a nationally recognized risk rating agency to assist in determining the loss rates within the ACL model until sufficient loss history can be accumulated from the Company’s loss experience in these segments. These loss rates are calibrated to the Cadence customer risk profile and portfolio mix. The Company monitors actual loss experience for each loan segment for potential adjustments required to the loss rates utilized.
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In assessing the overall risk of the credit portfolio, the ACL Committee also considers the following qualitative factors that may affect credit losses within the current credit portfolio. Management discretion dictates how these factors should affect certain segments (or the entire portfolio) according to a number of basis points to be added to (or subtracted from) loan loss rates. By their nature, qualitative adjustments attempt to quantify and standardize factors that serve as “leading indicators” of credit deterioration or improvement. These primary adjustment factors include, but are not limited to the following:
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Lending policies, procedures, practices or philosophy, including underwriting standards and collection, charge-off and recovery practices
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Changes in national and service market economic and business conditions that could affect the level of default rates or the level of losses once a default has occurred within the Bank’s existing loan portfolio
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Changes in the nature or size of the portfolio
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Changes in portfolio collateral values
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Changes in the experience, ability, and depth of lending management and other relevant staff
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Volume and/or severity of past due and classified credits or trends in the volume of losses, non-accrual credits, impaired credits and other credit modifications
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Quality of the institution’s credit review system and processes and the degree of oversight by bank management and the board of directors
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Concentrations of credit such as industry and lines of business
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Competition and legal and regulatory requirements or other external factors
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In connection with acquisitions (see Accounting for Acquired Loans), the Company acquired certain loans considered impaired and accounts for these loans under the provisions of ASC Topic 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality, which require the initial recognition of these loans at the present value of amounts expected to be received. The ACL previously associated with these loans does not carry over to the books of the acquiring entity. Any decreases in expected cash flows subsequent to acquisition are recorded in the ACL. For any increases in cash flows expected to be collected, the Company adjusts the amount of accretable yield recognized on a prospective basis over the loan’s or pool’s remaining life.
Management presents the quarterly review of the ACL to the Board of Directors. This evaluation is inherently subjective as it requires estimates that are susceptible to significant revision as more information becomes available or as events change.
The reserve for unfunded commitments is determined by assessing three distinct components: unfunded commitment volatility in the portfolio (excluding commitments related to letters of credit and commitment letters), adverse letters of credit, and adverse lines of credit. Unfunded commitment volatility is calculated on a trailing eight quarter basis; the resulting expected funding amount is then reserved for based on the current combined reserve rate of the pass-rated originated and ANCI loans. Adverse lines and letters of credit are assessed individually based on funding and loss expectations as of the period end. The reserve for unfunded commitments is recorded in other liabilities and other noninterest expense separate from the allowance and provision for credit losses. As of December 31, 2019 and 2018, the reserve for unfunded commitments totaled $1.7 million and $0.6 million, respectively.
Accounting for Acquired Loans
Acquired Loans
The Company accounts for its acquisitions under ASC 805 which requires the use of the acquisition method of accounting. All identifiable assets acquired, including loans, are recorded at fair value. No ACL related to the acquired loans is recorded on the acquisition date as the fair value of the loans acquired incorporates assumptions regarding credit risk. Loans acquired are recorded at fair value in accordance with the fair value methodology prescribed in ASC 820. The Company estimated the fair value of loans by utilizing the discounted cash flow method applied to pools of loans aggregated by product categories and interest rate type. In addition, certain cash flows were estimated on an individual loan basis based on current performance and collateral value, if the loan is collateral dependent. Contractual principal and interest cash flows were projected based on the payment type (i.e., amortizing or interest only), interest rate type (i.e., fixed or adjustable), interest rate index, weighted average maturity, weighted average interest rate, weighted average spread, and weighted average interest rate floor of each loan pool. The expected cash flows for each category were determined by estimating future credit losses using probabilities of default (PD), loss given default (LGD) and the rate of prepayments. Projected monthly cash flows were then discounted to present value based on discount rates developed from various sources including newly originated loans, a buildup approach and market data.
The Company accounts for and evaluates acquired credit impaired (“ACI”) loans in accordance with the provisions of ASC 310-30. When ACI loans exhibit evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all principal and interest payments in accordance with the terms of the loan agreement, the expected shortfall in future cash flows, as compared to the contractual amount due, is recognized as a non-accretable discount. Any excess of expected cash flows over the acquisition date fair value is known as the accretable discount and is recognized as accretion income over the life of each pool or individual loan. ACI loans that meet the criteria for non-accrual of interest at the time of acquisition may be considered performing upon acquisition, regardless of whether the customer is contractually delinquent, if the timing and expected cash flows on such loans can be reasonably estimated and if collection of the new carrying value of such loans is expected. However, if the timing or amount of the expected cash flows cannot be reasonably estimated an ACI loan may be placed in non-accruing status. Expected cash flows over the acquisition date fair value are periodically re-estimated utilizing the same cash flow methodology used at the time of acquisition and subsequent decreases to the expected cash flows will generally result in a provision for loan losses charge to the Company’s consolidated statements of income. Conversely, subsequent increases in expected cash flows result in a transfer from the non-accretable discount to the accretable discount, which would have a positive impact on accretion income prospectively. These cash flow evaluations are inherently subjective as they require material estimates, all of which may be susceptible to significant change.
Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and amortization. Depreciation and amortization are determined using the straight-line method at rates calculated to depreciate or amortize the cost of assets over their estimated useful lives.
Maintenance and repairs of property and equipment are charged to expense, and major improvements that extend the useful life of the asset are capitalized. Upon retirement, sale, or other disposition of property and equipment, the cost and accumulated depreciation are eliminated from the accounts, and any gains or losses are included in income.
Leases
The Bank leases various premises and equipment. At the inception of the contract the Bank determines if an arrangement is or contains a lease and will recognize on the balance sheet a lease asset for its right to use the underlying asset (“ROU”) and a lease liability for the corresponding lease obligation for contracts longer than a year. Both the asset and liability are initially measured at the present value of the future minimum lease payments over the lease term. In determining the present value of lease payments, the Bank uses our incremental borrowing rate as the discount rate for the leases.
The Bank has defined a separate accounting policy for real estate and non-real estate leases to account for non-lease components from a lessee perspective. For non-real estate leases, the Bank elected the practical expedient to not separate non-lease components from lease components and instead to account for both as a single lease component as it relates to this class type. The election was made to separate the non-lease components from the lease components in real estate leases due to the volume of real estate leases that are structured as triple net leases, where many of these expenses are already excluded from the lease. The Bank’s lease agreements do not contain any residual value guarantees.
The Bank elected to apply the short-term lease exception to existing leases that meet the definition of a short-term lease, considering the lease term from the commencement date, not the remaining term at the date of adoption. The Bank includes all renewal options in the lease term, unless we have determined we will not renew a particular lease, in determination of the capitalization period and lease liability and ROU asset.
See Recently Adopted Accounting Pronouncements below for more information.
Other Real Estate Owned
Other real estate owned (“OREO”) consists of properties acquired through foreclosure and unutilized bank-owned properties. OREO totaled $1.6 million and $2.4 million as of December 31, 2019 and 2018, respectively. These properties, as held-for-sale properties, are recorded at fair value, less estimated costs to sell, on the date of foreclosure establishing a new cost basis for the property. Subsequent to the foreclosure date the OREO is maintained at the lower of cost or fair value. Any write-down to fair value required at the time of foreclosure is charged to the ACL. Subsequent gains or losses resulting from the sale of the property or additional valuation allowances required due to further declines in fair value are reported in other noninterest expense.
Cash Surrender Value of Life Insurance
The Company invests in bank-owned life insurance (“BOLI”), which involves the purchasing of life insurance on selected employees. The Company is the owner of the policies and, accordingly, the cash surrender value of the policies is included in total assets and increases in cash surrender values are reported as income in the consolidated statements of income. The cash value accumulation on BOLI is permanently tax deferred if the policy is held to the insured person’s death and certain other conditions are met.
Goodwill and Other Intangible Assets
Goodwill is accounted for in accordance with ASC 350, and accordingly is not amortized but is evaluated for impairment at least annually in the fourth quarter or more frequently if an event occurs or circumstances change that would more likely than not reduce the fair value of a reporting unit below its carrying amount. As part of its testing, the Company may elect to first assess qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If the results of the qualitative assessment indicate that more likely than not a reporting unit’s fair value is less than its carrying amount, the Company determines the fair value of the respective reporting unit (through the application of various quantitative valuation methodologies) relative to its carrying amount to determine whether quantitative indicators of potential impairment are present (i.e., Step 1). The Company may also elect to bypass the qualitative assessment and begin with Step 1. If the results of Step 1 indicate that the fair value of the reporting unit may be below its carrying amount, the Company determines the fair value of the reporting unit’s assets and liabilities, considering deferred taxes, and then measures impairment loss by comparing the implied fair value of goodwill with the carrying amount of that goodwill (i.e., Step 2).
A reporting unit is defined as an operating segment or a component of that operating segment, as defined in ASC 280. Reporting units may vary, depending on the level at which performance of the segment is reviewed. No impairment was identified in any reporting unit in 2019, 2018 or 2017.
Other identifiable intangible assets consist primarily of the core deposit premiums and customer relationships arising from acquisitions. These intangibles were established using the discounted cash flow approach and are being amortized using an accelerated method over the estimated remaining life of each intangible recorded at acquisition. These finite-lived intangible assets are reviewed for impairment when events or changes in circumstances indicate that the asset’s carrying amount may not be recoverable from undiscounted future cash flows or that it may exceed its fair value.
Variable Interest Entities and Other Investments
Under ASC 810-10-65, the Company is deemed to be the primary beneficiary and required to consolidate a variable interest entity (“VIE”) if it has a variable interest in the VIE that provides it with a controlling financial interest. For such purposes, the determination of whether a controlling financial interest exists is based on whether a single party has both the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and the obligation to absorb the losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. ASC 810-10-65, as amended, requires continual reconsideration of conclusions reached regarding which interest holder is a VIE’s primary beneficiary.
The Company invests in certain affordable housing projects as a limited partner and accounts for these investments and the related tax credits using either the effective yield method or the proportional amortization method, depending upon the date of the investment. Under the effective yield method, the Company recognizes the tax credits as they are allocated and amortizes the initial costs of the investments to provide a constant effective yield over the period that the tax credits are allocated. Under the proportional amortization method, the Company amortizes the cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense.
Equity securities with readily determinable fair values not held for trading consist of marketable equity securities which are carried at fair value with changes in fair value reported in net income.
For other investments in limited partnerships without readily determinable fair values, the Company has elected to account for these investments using the practical expedient of the fair value of underlying net asset value. For investments in other limited partnerships without readily determinable fair values that do not qualify for the practical expedient, these investments are accounted for at their cost minus impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. Any changes in fair value are reported in net income.
See Note 21 for more information about our equity investments.
Income Taxes
The Company and its significant subsidiaries are subject to income taxes in federal, state and local jurisdictions, and such corporations account for income taxes under the asset and liability method in accordance with ASC 740. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and net operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted tax rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled.
The recognition of a deferred tax asset is dependent upon a “more likely than not” expectation of realization of the deferred tax asset, based upon the analysis of available evidence. The deferred tax asset recoverability is calculated using a consistent approach, which considers the relative impact of negative and positive evidence, including review of historical financial performance, and all sources of future taxable income, such as projections of future taxable income exclusive of future reversals of temporary differences and carryforwards, tax planning strategies, and any carryback availability. A valuation allowance is required to sufficiently reduce the deferred tax asset to the amount that is expected to be realized on a “more likely than not” basis. Changes in the valuation allowance are generally recorded through income.
Treasury Stock and Share Repurchases
The Company purchases shares of its Class A common stock pursuant to share repurchase programs authorized by its Board of Directors. The purchase of the Company’s common stock is recorded at cost. At the date of repurchase, shareholders’ equity is reduced by the repurchase price. Upon retirement, or upon purchase for constructive retirement, treasury stock would be reduced by the cost of such stock with the excess of repurchase price over par or stated value recorded in additional paid-in capital. If the Company subsequently reissues treasury shares, treasury stock is reduced by the cost of such stock with differences recorded in additional paid-in capital or retained earnings, as applicable.
Revenue Recognition
Service Charges on Deposit Accounts
Service charges on deposit accounts consist of non-sufficient funds fees, account analysis fees, and other service charges on deposits which consist primarily of monthly account fees. Non-sufficient funds fees are recognized at the time the account overdraft occurs in accordance with regulatory guidelines. Account analysis fees consist of fees charged to certain commercial demand deposit accounts based upon account activity (and reduced by a credit which is based upon cash levels in the account).
Assets Under Administration and Asset Management Fees
The Company does not include assets held in fiduciary or agency capacities in the consolidated balance sheets, as such items are not assets of the Company. Fees from asset management activities are recorded on an accrual basis, over the period in which the service is provided. Fees are a function of the market value of assets administered and managed, the volume of transactions, and fees for other services rendered, as set forth in the underlying client agreement. This revenue recognition involves the use of estimates and assumptions, including components that are calculated based on estimated asset valuations and transaction volumes.
Credit Related Fees
Credit related fees primarily include fees assessed on the unused portion of commercial lines of credit (“unused commitment fees”) and syndication agent fees. Unused commitment fees are recognized when earned. Syndication agent fees are earned to act as an agent for a period of time, usually one year. Arranger fees are earned to arrange a syndicate of lenders and are generally recognized when the transaction is closed.
Bankcard Fees
Bankcard fees include primarily bankcard interchange revenue, which is recorded when services are provided.
Payroll Processing Revenue
Payroll processing revenue represents a new source of revenue for us which we acquired in the State Bank transaction. Payroll processing revenue consists principally of payroll processing fees, property and casualty brokerage and employee benefits brokerage. Payroll processing fees are charged as the services are provided and the Company satisfied its performance obligation simultaneously. Property and casualty includes the brokerage of both personal and commercial coverages. The placement of the policy is completion of the Company's performance obligation and revenue is recognized at that time. The Company's commission is a percentage of the premium. Employee benefits brokerage consists of assisting companies in designing and managing comprehensive employee benefit programs. The services provided by the Company are collectively benefit management services which are considered a bundle of services that are highly interrelated. Each of the underlying services are activities to fulfill the benefit management service and are not distinct and separate performance obligations. Revenue is recognized over the contract term as services are rendered on a monthly basis. Customer payments are usually received on a monthly basis.
SBA Income
Small Business Administration (“SBA”) income also represents a new source of revenue for us through the State Bank transaction. This revenue consists of gains on sales of SBA loans, servicing fees, changes in the fair value of servicing rights, and other miscellaneous fees. Servicing fee income is recorded for fees earned for servicing SBA loans. The fees are based on a contractual percentage of the outstanding principal or a fixed amount per loan and are recorded as income when earned.
Basic and Diluted Earnings Per Share
Basic earnings per share is calculated using the two-class method to determine income attributable to common shareholders. Unvested share-based payment awards that contain nonforfeitable rights to dividends are considered participating securities under the two-class method. Net income attributable to common shareholders is then divided by the weighted average number of common shares outstanding for the period. Diluted earnings per share reflects the potential dilution that could occur if securities or other contracts to issue common stock were exercised or converted into common stock or resulted in the issuance of common stock that then shared on the net income of the Company. Diluted earnings per share is calculated by dividing net income available to common shareholders by the total of the weighted average number of common shares outstanding during the period, plus the dilutive effect of outstanding share-based compensation awards.
Comprehensive Income
Accounting principles generally require that recognized revenue, expenses, gains, and losses be included in net income. Although certain changes in assets and liabilities, such as unrealized gains and losses on available for sale securities, pension liability and cash flow hedges, are reported as a separate component of the shareholders’ equity section of the consolidated balance sheets, such items, along with net income, are components of comprehensive income.
Employee Benefits
The Company offers a 401(k) defined contribution benefit plan to its employees. The plan provides for a 100% match of employee contributions up to five percent of employee compensation. All contributions and related earnings are 100% vested.
Employees of the legacy Cadence Bank hired prior to January 1, 2001 participate in a noncontributory defined benefit pension plan. The plan calls for benefits to be paid to eligible employees at retirement based primarily upon years of service and compensation. Contributions to the plan reflect benefits attributed to employees’ services to date, as well as services expected to be provided in the future. The annual pension cost charged to expense is actuarially determined in accordance with the provisions of ASC Topic 715, Compensation-Retirement Benefits. The plan was amended effective January 1, 2001, to close participation in the plan, and employees hired subsequent to December 31, 2000, are not eligible to participate. The pension plan was terminated in 2019.
The Company has a supplemental retirement plan that originated from an acquired bank for certain directors and officers of that acquired bank. The annual cost charged to expense and the estimated present values of the projected payments are actuarially determined in accordance with the provisions of ASC 715.
As a result of the prior acquisitions, the Company has various legacy unqualified supplemental retirement plans. The plans allow for fixed payment amounts to begin on a monthly basis at a specified age. The annual cost charged to expense and the estimated present value of the projected payments was determined in accordance with the provisions of ASC 715. The present value of projected payments is recorded as a liability, in accordance with ASC 710-30, in the Company’s consolidated balance sheets.
The Company provides a voluntary deferred compensation plan for certain of its executive and senior officers. Under this plan, the participants may defer up to 25% of their base compensation and 100% of certain incentive compensation. The Company may, but is not obligated to, contribute to the plan. Amounts contributed to this plan are credited to a separate account for each participant and are subject to a risk of loss in the event of the Company’s insolvency. The Company made no contributions to this plan in 2019, 2018 or 2017.
Equity-Based Compensation and Equity Incentive Plan
The Company maintains an equity incentive plan that provides for the granting of various forms of incentive equity-based compensation. The Company values these units at the grant date fair value and recognizes expense over the requisite service period. The Company’s equity-based compensation costs are recorded as a component of salaries and employee benefits in the consolidated statements of income. See Note 23 for additional information.
Cash Based Long Term Incentive Plan
Prior to 2018, the Bank granted long-term incentive awards to certain employees that provide for cash compensation, half of which are based on the quoted market price of the Company’s common stock, as determined on at least a quarterly basis. The awards are generally subject to a 36-month vesting period and the attainment of certain three-year profitability levels. The Company adjusts the accrual related to this plan on at least a quarterly basis, based on the phantom shares awarded, and the fair value of Cadence Bancorp, LLC’s or Company’s stock. Expense under this plan was $2.1 million, $6.0 million and $7.3 million in December 31, 2019, 2018 and 2017, respectively.
Employee Stock Purchase Plan
The Company provides an employee stock purchase plan whereby employees may purchase the Company’s Class A common stock at a discount of 15% of the fair market value of a share of common stock, defined as the closing price of the common stock on the stock exchange for the first and last day of the purchase period (as defined). The Company records an expense for the 15% discount which is included in salaries and employee benefits in the consolidated statements of income. See Note 23 for additional information.
Cash Flows
For purposes of reporting cash flows, cash and cash equivalents include cash on hand and amounts due from banks, interest-bearing deposits with banks, and federal funds sold. Generally, federal funds are sold for one to seven day periods.
Cash flows from loans, either originated or acquired, are classified at the time according to management’s intent to either sell or hold the loan for the foreseeable future. When management’s intent is to hold the loan for the foreseeable future, the cash flows of that loan are presented as investing cash flows.
Off-Balance Sheet Financial Instruments
In the ordinary course of business, the Company enters into off-balance sheet financial instruments consisting of commitments to extend credit, credit card lines, standby letters of credit and commitments to purchase securities. Such financial instruments are recorded in the consolidated financial statements when they are exercised.
Fair Value of Financial Instruments
Fair value estimates are made at a specific point in time, based on relevant market information and other information about the financial instrument. These estimates do not reflect any premium or discount that could result from offering for sale, at one time, the entire holdings of a particular financial instrument. Because no market exists for a portion of the financial instruments, fair value estimates are also based on judgments regarding estimated cash flows, current economic conditions, risk characteristics of various financial instruments, and other factors. These estimates are subjective in nature and involve uncertainties and matters of significant judgment and, therefore, cannot be determined with precision. Changes in assumptions could significantly affect the estimates.
Management employs independent third-party pricing services to provide fair value estimates for the Company’s financial instruments. Management uses various validation procedures to validate the prices received from pricing services and quotations received from dealers are reasonable for each relevant financial instrument, including reference to relevant broker/dealer quotes or other market quotes and a review of valuations and trade activity of comparable securities. Consideration is given to the nature of the quotes (e.g., indicative or firm) and the relationship of recently evidenced market activity to the prices provided by the third-party pricing service.
Understanding the third-party pricing service’s valuation methods, assumptions and inputs used by the firm is an important part of the process of determining that reasonable and reliable fair values are being obtained. Management evaluates quantitative and qualitative information provided by the third-party pricing services to assess whether they continue to exhibit the high level of expertise and internal controls that management relies upon.
Fair value estimates are based on existing financial instruments on the consolidated balance sheets, without attempting to estimate the value of anticipated future business and the value of assets and liabilities that are not considered financial instruments. Significant assets and liabilities that are not considered financial instruments include deferred income taxes, premises and equipment, goodwill and other intangible assets. In addition, the income tax ramifications related to the realization of the unrealized gains and losses on available for sale investment securities can have a significant effect on fair value estimates and have not been considered in any of the estimates.
For further information about fair value measurements, see Note 20.
Recently Adopted Accounting Pronouncements
In February 2016, the FASB issued Accounting Standards Update (“ASU”) No. 2016-02, Leases (Topic 842). This ASU requires lessees to recognize lease assets and lease liabilities generated by contracts longer than a year on their balance sheets. Accordingly, a lessee recognizes a lease asset for its right to use the underlying asset and a lease liability for the corresponding lease obligation. Both the asset and liability are initially measured at the present value of the future minimum lease payments over the lease term. The ASU also requires lessees to provide additional qualitative and quantitative information about the amount, timing, and uncertainty for the payments they make for the lease agreements.
In July 2018, the FASB issued ASU No. 2018-10, Codification Improvements to Topic 842, Leases, and ASU No. 2018-11, Leases (Topic 842): Targeted Improvements. ASU 2018-10 provides improvements related to ASU 2016-02 to increase stakeholders’ awareness of the amendments and to expedite the improvements. The amendments affect narrow aspects of the guidance issued in ASU 2016-02. ASU 2018-11 allows entities adopting ASU 2016-02 to choose an additional (and optional) transition method, under which an entity initially applies the new leases standard at the adoption date and recognizes a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption. ASU 2018-11 also allows lessors to not separate non-lease components from the associated lease component if certain conditions are met. The amendments in these updates became effective for annual periods and interim periods within those annual periods beginning after December 15, 2018.
In December 2018, the FASB issued ASU 2018-20, Leases (Topic 842) Narrow-Scope Improvements for Lessors. The amendments in this guidance allow lessors as accounting policy election to not evaluate whether certain sales taxes and other similar taxes are lessor costs or lessee costs. The amendments in ASU 2018-20 affect the amendments in ASU 2016-02 and have the same effective date and transition requirements.
In March 2019, the FASB issued ASU No. 2019-01, Leases (Topic 842): Codification Improvements. ASU 2019-01 updates codification improvements related to ASU 2016-02 to increase stakeholders’ awareness of the amendments and to expedite the improvements. The amendments in ASU 2019-01 address three topics which include 1) determining the fair value of the underlying asset by lessors that are not manufacturers or dealers (Issue 1); 2) presentation on the statement of cash flows-sales-type and direct financing leases (Issue 2); and 3) transition disclosures related to ASC 250, Accounting Changes and Error Corrections (Issue 3). ASU 2019-01 will be effective for fiscal years beginning after December 15, 2019, and interim periods within those fiscal years for public business entities. An entity is permitted to early adopt. However, an entity should apply the amendments as of the date that it first applied ASC 842. The transition and effective date provisions apply to Issue 1 and Issue 2. The Company adopted ASU 2019-01 at January 1, 2019 and it did not have a material impact on the Company’s financial condition, results of operations, or cash flows.
The Company adopted ASU 2016-02 and related ASUs on January 1, 2019 using the optional modified retrospective transition approach which resulted in a right-of-use (“ROU”) asset of approximately $80.0 million and lease liability of $92.3 million. The Company elected to adopt the package of practical expedients permitted under ASC 842 which, among other things, does not require reassessment of lease classification. See Note 8 for more information.
In March 2017, the FASB issued ASU No. 2017-08, Receivables-Nonrefundable Fees and Other Costs (Subtopic 310-20): Premium Amortization on Purchased Callable Debt Securities, which shortens the amortization period for callable debt securities held at a premium to the earliest call date instead of the maturity date. The amendments do not require an accounting change for securities held at a discount, which continue to be amortized to the maturity date. ASU 2017-08 became effective for annual reporting periods beginning after December 15, 2018, including interim reporting periods within those fiscal years. The amendments should be applied using a modified-retrospective transition method as of the beginning of the period of adoption. The adoption of ASU 2017-08 at January 1, 2019 did not have a material impact on the Company’s financial condition, results of operations, or cash flows.
In October 2018, the FASB issued ASU No. 2018-16, Derivatives and Hedging (Topic 815): Inclusion of the Secured Overnight Financing Rate (SOFR) Overnight Index Swap (OIS) Rate as a Benchmark Interest Rate for Hedge Accounting Purposes. The amendments in ASU 2018-16 permit the use of the OIS rate based on SOFR as a U.S. benchmark interest rate for hedge accounting purposes under ASC 815. The amendments should be adopted on a prospective basis for qualifying new or redesignated hedging relationships entered into on or after the date of the adoption. For public business entities that have already adopted ASU 2017-12, the amendments were effective for fiscal years beginning after December 15, 2018, and interim periods within those fiscal years. The adoption of ASU 2018-16 at January 1, 2019 did not have an impact on the Company’s financial condition, results of operations, or cash flows as the Company does not have any instruments tied to the OIS rate.
Pending Accounting Pronouncements
In June 2016, the FASB issued ASU No. 2016-13, Financial Instruments-Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (referred to as “CECL”).
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Replaces the current incurred loss accounting model with an expected loss approach and requires the measurement of all expected credit losses for financial assets held at the reporting date based on historical experience, current conditions, and reasonable and supportable forecasts.
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Eliminates existing guidance for acquired credit impaired (“ACI”) loans and requires recognition of the nonaccretable difference as an increase to the allowance for expected credit losses on financial assets purchased with more than insignificant credit deterioration since origination, which will be offset by an increase in the amortized cost of the related loans. For ACI loans accounted for under ASC 310-30 prior to adoption, the guidance in this amendment for purchase credit deteriorated assets will be prospectively applied.
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Requires inclusion of expected recoveries, limited to the cumulative amount of prior write-offs, when estimating the allowance for credit losses for in-scope financial assets (including collateral dependent assets).
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Amends existing impairment guidance for available-for-sale securities to incorporate an allowance, which will allow for reversals of credit impairments if the credit of an issuer improves. The Company expects no material allowance impact to available-for-sale securities.
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Requires enhanced disclosures to help investors and other financial statement users better understand significant estimates and judgments used in estimating credit losses, as well as the credit quality and underwriting standards of an organization’s portfolio.
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Required effective date: January 1, 2020.
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Upon adoption, Cadence will record a cumulative-effect adjustment to retained earnings as of the beginning of the reporting period of adoption.
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The allowance related to loans and commitments will increase as it will relate to credit losses over the full remaining expected life of the portfolio. Cadence intends to estimate losses through various models that include selected forecasted macroeconomic variables produced in a baseline macroeconomic scenario forecast provided by an external party.
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Based on current expectations of future economic conditions and the results from our models, Cadence believes its allowance for credit losses on loans will increase up to 65% from its allowance for credit losses as of December 31, 2019, as disclosed herein. The initial impact to regulatory capital is expected to be minimal; Cadence plans to elect the transition provisions provided by the banking agencies and will phase-in the “Day One” regulatory capital effects resulting from adoption of CECL over the three-year period beginning January 1, 2020. The final impact depends on the characteristics of the portfolio as well as the macroeconomic conditions and forecasts upon adoption and other management judgments.
In January 2017, the FASB issued ASU No. 2017-04, Intangibles-Goodwill and Other (Topic 350): Simplifying the Test for Goodwill Impairment, which simplifies how an entity is required to test goodwill for impairment by eliminating Step 2 from the goodwill impairment test. Therefore, any carrying amount which exceeds the reporting unit’s fair value (up to the amount of goodwill recorded) will be recognized as an impairment loss. ASU 2017-04 will be effective for annual reporting periods beginning after December 15, 2019, including interim reporting periods within those annual periods. The amendments will be applied prospectively on or after the effective date. Based on recent goodwill impairment tests, which did not require the application of Step 2, the Company does not expect the adoption of this ASU to have an immediate impact.
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement (Topic 820): Disclosure Framework-Changes to the Disclosure Requirements for Fair Value Measurement. ASU 2018-13 amends the disclosure requirements of ASC 820 to remove disclosure of transfers between Level 1 and Level 2 of the fair value hierarchy and the valuation process for Level 3 fair value measurements, among other amendments, and to include disclosure of the range and weighted average used in Level 3 fair value measurements, among other amendments. Amendments should be applied retrospectively to all periods presented, except for certain amendments, which should be applied prospectively. ASU 2018-13 will be effective for annual reporting periods beginning after December 15, 2019, including interim periods within those annual periods. The Company does not expect the adoption of this guidance to have an impact on its consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-14, Compensation-Retirement Benefits-Defined Benefit Plans-General (Subtopic 715-20): Disclosure Framework-Changes to the Disclosure Requirements for Defined Benefit Plans. This ASU makes minor changes to the disclosure requirements for employers that sponsor defined benefit pension and/or other postretirement benefit plans. ASU 2018-14 is effective for fiscal years ending after December 15, 2020; early adoption is permitted. The Company does not expect the adoption of this guidance to have an impact on the its consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-15, Intangibles-Goodwill and Other-Internal-Use Software (Subtopic 350-40): Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (a consensus of the FASB Emerging Issues Task Force). This standard aligns the requirements for capitalizing implementation costs in a hosting arrangement service contract with the existing guidance for capitalizing implementation costs incurred for an internal-use software license. This standard also requires capitalizing or expensing implementation costs based on the nature of the costs and the project stage during which they are incurred and establishes additional disclosure requirements. This standard will be effective for annual periods beginning after December 15, 2019, including interim periods within that reporting period. The Company plans to adopt the standard prospectively and does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.
In October 2018, the FASB issued ASU No. 2018-17, Consolidation (Topic 810): Targeted Improvements to Related Party Guidance for Variable Interest Entities. This ASU amends ASC 810 guidance on how all reporting entities evaluate indirect interests held through related parties in common control arrangements when determining whether fees paid to decision makers and service providers are variable interests. ASU 2018-17 is effective for fiscal years beginning after December 15, 2019, including interim periods within those annual periods. The adoption of this guidance will not have a material impact on the Company’s consolidated financial statements.
In April 2019, the FASB issued ASU No. 2019-04, Codification Improvements to Topic 326, Financial Instruments-Credit Losses, Topic 815, Derivatives and Hedging, and Topic 825, Financial Instruments, that clarifies and improves areas of guidance related to the recently issued standards on credit losses, hedging activities, and recognition and measurement. The amendments clarify the scope of the credit losses standard and address issues related to accrued interest receivable balances, recoveries, variable interest rates, and prepayments, among other things. With respect to hedge accounting, the amendments address partial-term fair value hedges, fair value hedge basis adjustments, application by not-for-profit entities and private companies, and certain transition requirements, among other things. On recognizing and measuring financial instruments, they address the scope of the guidance, the requirement for remeasurement under ASC 820 when using the measurement alternative, certain disclosure requirements and which equity securities must be remeasured at historical exchange rates.
The credit losses and hedging amendments have the same effective dates as the respective standards, unless an entity has already adopted the standards. The pending adoption of the credit losses standard, or CECL, is discussed above. Since the Company early adopted the guidance in ASU No. 2017-12, Derivatives and Hedging (Topic 815): Targeted Improvements to Accounting for Hedging Activities, in 2018, the amended hedge accounting guidance in ASU 2019-04 will be effective as of the beginning of the first annual reporting period beginning after April 25, 2019 with early adoption permitted on any date after the issuance of this ASU and is not expected to have a material impact on the consolidated financial statements. The amendments related to recognizing and measuring financial instruments are effective for fiscal years beginning after December 15, 2019, including interim periods within those fiscal years. The Company currently does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.
In December 2019, the FASB issued ASU No. 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. The ASU eliminates certain exceptions to the guidance in ASC 740 related to the approach for intraperiod tax allocation, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. The new guidance also simplifies aspects of the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill. The guidance is effective for fiscal years beginning after December 15, 2020, and interim periods within those fiscal years. Early adoption is permitted in interim or annual periods for which entities have not yet issued financial statements. Entities that elect to early adopt the amendments in an interim period should reflect any adjustments as of the beginning of the annual period that includes that interim period. Additionally, entities that elect early adoption must adopt all the amendments in the same period. Entities will apply the guidance prospectively, except for certain amendments. The Company is evaluating the impact this guidance may have on its consolidated financial statements.
Note 2-Business Combinations
State Bank
On January 1, 2019, the Company acquired all the outstanding stock of State Bank Financial Corporation (“State Bank”), of Atlanta, Georgia, the bank holding company for State Bank and Trust Company, in a stock transaction. State Bank shareholders received 1.271 shares of the Company’s Class A common stock in exchange for each share of State Bank common stock resulting in the Company issuing 49.2 million shares of its Class A common stock. In total, the purchase price for State Bank was $826.4 million, including $826.1 million in the Company’s common stock and $0.3 million representing the fair value of unexercised warrants. The Company’s strategic rationale for the transaction was to expand our market presence into Georgia, create a more diverse business mix as well as an attractive funding base and leverage operating costs through economies of scale. The acquisition added $3.5 billion in loans and $4.1 billion in deposits as well as 32 branch locations across Georgia.
The State Bank transaction was accounted for using the acquisition method of accounting. Accordingly, the results of operations of the acquired company have been included in the Company’s results of operations since the date of acquisition. Under this method of accounting, assets acquired, liabilities assumed, and consideration paid were recorded at their estimated fair values on the acquisition date. The fair values of securities, loans, OREO, premises and equipment, core deposit intangibles, other assets and deposits were determined with the assistance of appraisals, third-party valuations and advisors. The excess cost over fair value of net assets acquired is recorded as goodwill. As the consideration paid for State Bank exceeded the net assets acquired, goodwill of $175.7 million was recorded from the acquisition and allocated to the Banking segment. Goodwill recorded in the transaction, which reflects the new Georgia market and synergies expected from the combined operations, is not deductible for income tax purposes.
The following table provides the purchase price calculation as of the acquisition date and the identifiable assets acquired and the liabilities assumed at their fair values. These fair value measurements are based on internal and third-party valuations.
Measurement Period Adjustments. The Company estimated the fair value of loans by utilizing the discounted cash flow method applied to pools of loans aggregated by product categories and interest rate type. In addition, certain cash flows were estimated on an individual loan basis based on current performance and collateral value, if the loan is collateral dependent. Contractual principal and interest cash flows were projected based on the payment type (i.e., amortizing or interest only), interest rate type (i.e., fixed or adjustable), interest rate index, weighted average maturity, weighted average interest rate, weighted average spread, and weighted average interest rate floor of each loan pool. The expected cash flows for each category were determined by estimating future credit losses using probabilities of default (PD), loss given default (LGD) and the rate of prepayments. Projected monthly cash flows were then discounted to present value based on discount rates developed from various sources including an analysis of State Bank’s newly originated loans, a buildup approach and market data. There was no carryover of State Bank’s ACL associated with the loans acquired.
The initial valuation of the acquired loans was not final due to the complexity and time involved in valuing loans. An estimate was recorded during the first quarter of 2019 based on the results of a valuation exercise conducted as of December 31, 2018, and applied to the January 1, 2019, balance of loans acquired from State Bank. During the remainder of 2019, we continued to analyze the valuations assigned to the acquired assets and assumed liabilities and our third-party valuation firm provided updated valuation assumptions for loans. These updated assumptions impacted the January 1, 2019, valuation estimates for the acquired loans. In addition, adjustments were made to deferred taxes and accrued expense balances based on new information resulting in the revised fair values displayed below. We updated our estimated fair values of these items within our Consolidated Balance Sheet with a corresponding adjustment to goodwill. These changes are gross of taxes and reflected in the following table:
The impact on the income statement resulting from the changes to the estimated fair values was insignificant. We completed our analysis of the assumptions and related valuation results associated with the acquired loans, and accordingly, the valuation of the loans is final as of December 31, 2019.
On January 1, 2019, the estimated fair value of the acquired non-credit impaired (“ANCI”) loans acquired in the State Bank transaction was $3.2 billion, which is net of a $83.8 million discount. The gross contractual amounts receivable of the ANCI loans at acquisition was $3.9 billion, of which $0.2 billion is the amount of contractual cash flows not expected to be collected.
The Company accounts for and evaluates acquired credit impaired (“ACI”) loans in accordance with the provisions of ASC Topic 310-30. When ACI loans exhibit evidence of credit deterioration since origination and it is probable at the date of acquisition that the Company will not collect all principal and interest payments in accordance with the terms of the loan agreement, the expected shortfall in future cash flows, as compared to the contractual amount due, is recognized as a non-accretable discount. Any excess of expected cash flows over the acquisition date fair value is known as the accretable discount and is recognized as accretion income over the life of each pool or individual loan. Information about the ACI loans acquired in the State Bank merger as of the acquisition date is as follows:
Intangible assets consisted of the core deposit intangible and the customer relationship intangible of a subsidiary. The core deposit intangible asset recognized of $111.9 million is being amortized over its estimated useful life of ten years utilizing an accelerated method. The benefit of the deposit base is equal to the difference in cash flows between maintaining the existing deposits and obtaining alternative funds over the life of the deposit base. The difference was tax effected and discounted to present value at a risk-adjusted discount rate. The valuation of the core deposit base includes estimates of the attrition rates for each deposit type based on historical attrition data and market participant information, in addition to estimates of total costs including interest cost, net maintenance cost, cost of reserves, and cost of float. The customer relationship and trademark intangible recognized of $3.7 million and $1.4 million are being amortized over estimated useful lives of ten and twenty years, respectively, using an accelerated method.
Goodwill of $175.7 million was recorded as a result of the transaction and is not amortized for financial statement purposes. All the goodwill was assigned to the Banking segment. The goodwill recorded is not deductible for income tax purposes
Certificates of deposit, including IRAs, were valued by projecting out the expected cash flows based on the contractual terms of the certificates of deposit. The fair values of savings and transaction deposit accounts were assumed to approximate the carrying value as these accounts have no stated maturity and are payable on demand. These cash flows were discounted using the interest rates on fixed maturity deposits offered by Cadence and State Bank as of January 1, 2019 resulting in a $3.4 million discount amortized over a twelve-month period.
Unfunded commitments are contractual obligations by a financial institution for future funding as it relates to closed end or revolving lines of credit. The Company valued these unfunded commitments at $26.8 million and recorded a liability using the “Netback” method. Because the borrower can draw upon their credit anytime until maturity, the lender must increase its capital on hand to meet funding requirements. Therefore, the undrawn portion is considered a liability (or asset if the loan is valued above par) and is netted back against the asset or the drawn portion. Generally, amortization for revolving lines occurs straight-line over the life of the loan and for closed end loans using the effective yield method over the remaining life of the loan when the loan funds.
The following table presents certain unaudited pro forma information for the results of operations for the years ended December 31, 2019 and 2018, as if State Bank had been acquired on January 1, 2018. The pro forma results combine the historical results of State Bank into the Company’s consolidated income statements including the impact of certain acquisition accounting adjustments including loan discount accretion, investment securities discount accretion, intangible assets amortization and deposit premium accretion. The pro forma results have been prepared for comparative purposes only and are not necessarily indicative of what would have occurred had the acquisition taken place on January 1, 2018. No assumptions have been applied to the pro forma results of operations regarding possible revenue enhancements, provision for credit losses, expense efficiencies or asset dispositions. Merger-related costs of $28.0 million recorded in 2019 and $3.0 million recorded by Cadence and $29.9 million recorded by State Bank in 2018 are not included in the pro forma statements below.
Revenues and earnings of the acquired company since the acquisition date have not been disclosed as it is not practicable as State Bank was merged into the Company and separate financial information is not available.
Merger-related expenses of $28.0 million incurred during 2019 are recorded in the consolidated income statement and include incremental costs related to the closing of the transaction, including legal, accounting and auditing, investment banker fees, certain employment related costs, travel, printing, supplies, and other costs. The data processing systems conversion occurred in February 2019.
Wealth & Pension
On July 1, 2019, the Company’s wholly owned subsidiary, Linscomb & Williams, Inc., acquired certain assets and assumed certain liabilities of Wealth and Pension Services Group, Inc. (“W&P”), a fee-based investment advisory firm with its principal office in Atlanta, Georgia. The total purchase consideration paid of $8.0 million included an initial cash payment of $5.2 million and future cash payments totaling approximately $2.1 million to be paid in installments over a five-year period pursuant to the Asset Purchase Agreement. W&P is also eligible for future earn-out payments pursuant to the Asset Purchase Agreement based on achieving certain levels of earnings growth over a three- and five-year period. The acquisition is accounted for as a business combination. During the third quarter of 2019, the Company recognized provisional identifiable intangible assets with an estimated fair value of $5.1 million, comprised primarily of customer relationships and noncompete agreements. We also recognized provisional goodwill of $2.6 million in connection with the acquisition. These fair value estimates represent our best estimate of fair value and are expected to be finalized over a period of up to one year from the acquisition date. Merger-related expenses of $0.5 million incurred in 2019 are recorded in the consolidated income statement.
Note 3-Securities
A summary of amortized cost and estimated fair value of securities available-for-sale at December 31, 2019 and 2018 is as follows:
The scheduled contractual maturities of securities available-for-sale at December 31, 2019 were as follows:
Proceeds from sales, gross gains, and gross losses on sales of securities available-for-sale for the years ended December 31, 2019, 2018, and 2017 are presented below. There were no other-than-temporary impairment charges included in gross realized losses for the years ended December 31, 2019, 2018, and 2017. The specific identification method is used to reclassify gains and losses out of other comprehensive income at the time of sale.
Securities with a carrying value of $629.4 million and $711.2 million at December 31, 2019 and 2018, respectively, were pledged to secure public deposits, FHLB borrowings, repurchase agreements and for other purposes as required or permitted by law.
Information pertaining to securities available-for-sale with gross unrealized losses aggregated by category and length of time the securities have been in a continuous loss position was as follows:
As of December 31, 2019 and 2018, approximately 35% and 84%, respectively, of the fair value of securities in the investment portfolio reflected an unrealized loss. As of December 31, 2019, there were 23 securities that had been in a loss position for more than twelve months, and 61 securities that had been in a loss position for less than twelve months. None of the unrealized losses relate to the marketability of the securities or the issuer’s ability to honor redemption of the obligations. The Company has adequate liquidity and, therefore, does not plan to sell and, more likely than not, will not be required to sell these securities before recovery of the indicated impairment. Accordingly, the unrealized losses on these securities have been determined to be temporary.
Note 4-Loans Held-for-Sale, Loans and Allowance for Credit Losses
Loans Held-for-Sale
The following table presents a summary of the loans held-for-sale by portfolio segment as of December 31, 2019 and 2018:
Loans
The following table presents total loans outstanding by portfolio segment and class of financing receivable as of December 31, 2019 and 2018. Outstanding balances include originated loans, Acquired Noncredit Impaired (“ANCI”) loans and Acquired Credit Impaired (“ACI”) loans. Additional information about ACI loans is presented separately in the “Acquired Credit-Impaired Loans” section of this Note.
During 2018, the Company purchased $214 million of consumer residential real estate loans, at a premium of approximately 6.0%. These loans were evaluated and determined not to be credit impaired before purchase and were classified as ANCI as of December 31, 2018. The Company did not purchase any loans during 2019 other than those acquired as part of the State Bank merger on January 1, 2019 (see Note 2).
Allowance for Credit Losses (“ACL”)
The ACL is management’s estimate of credit losses inherent in the loan portfolio at the balance sheet date. The Company has an established process to determine the adequacy of the ACL that assesses the losses inherent in our portfolio. While management attributes portions of the ACL to specific portfolio segments, the entire ACL is available to absorb credit losses inherent in the total loan portfolio.
The ACL process involves procedures that appropriately consider the unique risk characteristics of the loan portfolio segments based on management’s assessment of the underlying risks and cash flows. For each portfolio segment, losses are estimated collectively for groups of loans with similar characteristics, individually for impaired loans or, for ACI loans, based on the changes in cash flows expected to be collected on a pool or individual basis.
The level of the ACL is influenced by loan volumes, risk rating migration, historic loss experience influencing loss factors, and other conditions influencing loss expectations, such as economic conditions. The primary indicator of credit quality for the portfolio segments is its internal risk ratings. The assignment of loan risk ratings is the primary responsibility of the lending officer concurrent with approval from the credit officer reviewing and recommending approval of the credit. Additionally, there is independent review by internal credit review, which also performs ongoing, independent review of the risk management process. The risk management process includes underwriting, documentation and collateral control. Credit review is centralized and independent of the lending function. The credit review results are reported to senior management and the Board of Directors.
The following is a summary description of the risk ratings. Tables summarizing the amount of loans by criticized or classified risk rating in each loan portfolio segment is included in the sections “Credit Exposure in the Originated and ANCI Loan Portfolios” and “Credit Exposure in the ACI Portfolio.”
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Pass-For loans within this risk rating, the condition of the borrower and the performance of the loan is satisfactory or better.
•
Special Mention-A special mention loan has identified potential weaknesses that are of sufficient materiality to require management’s close attention. If left uncorrected, these potential weaknesses may result in deterioration of the repayment prospects for the loan or in the Bank’s credit position at some future date. Special mention assets contain greater than acceptable risk to warrant increases in credit exposure and are thus considered non-pass rated credits.
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Substandard-A substandard loan is inadequately protected by the current net worth and paying capacity of the obligor or the collateral pledged, if any. Loans classified as substandard possess well-defined weaknesses that are expected to jeopardize their liquidation. Loans in this category may be either on accrual status or nonaccrual status.
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Doubtful-Loans classified as doubtful possess all of the weaknesses inherent in loans classified as substandard with the added characteristic that the weaknesses make collection or liquidation in full highly questionable or improbable based on currently existing facts, conditions, and values. Loans rated as doubtful are not rated as loss because certain events may occur that could salvage the debt. Loans in this category are required to be on nonaccrual.
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Loss-Loans classified loss are considered uncollectible and of such little value that their continuance as bankable assets is not warranted. This classification does not mean that the asset has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this worthless loan even though partial recovery may be affected in the future. Loans may reside in this classification for administrative purposes for a period not to exceed the earlier of thirty (30) days or calendar quarter-end.
A summary of the activity in the ACL for each of the three years in the period ended December 31, 2019 is as follows:
Impaired Originated and ANCI Loans Including Troubled Debt Restructurings (“TDRs”)
The following tables include certain key information about individually impaired originated and ANCI loans.
(1)
The recorded investment of a loan also includes any interest receivable, net unearned discount or fees, and unamortized premium or discount.
The related amount of interest income recognized for impaired loans was $0.4 million for the year ended December 31, 2019, compared to $0.3 million and $1.6 million for the same periods in 2018 and 2017, respectively.
Generally, cash receipts on nonperforming loans are used to reduce principal rather than recorded as interest income. Past due status is determined based upon contractual terms. A nonaccrual loan may be returned to accrual status when repayment is reasonably assured and there has been demonstrated performance under the terms of the loan or, if applicable, under the terms of the restructured loan. For the year ended December 31, 2019, an immaterial amount of contractual interest paid was recognized on the cash basis, compared to $1.7 million and $1.5 million for the same periods in 2018 and 2017, respectively.
Average Recorded Investment in Impaired Originated and ANCI Loans
The following table presents the average recorded investment in individually impaired originated and ANCI loans.
Originated and ANCI Loans Modified into TDRs
Included in impaired loans are loans considered to be TDRs. The Company attempts to work with borrowers when necessary to extend or modify loan terms to better align with the borrower’s ability to repay. Extensions and modifications to loans are made in accordance with internal policies and guidelines which conform to regulatory guidance. Each occurrence is unique to the borrower and is evaluated separately. The Bank considers regulatory guidelines when restructuring loans to ensure that prudent lending practices are followed. Qualifying criteria and payment terms are structured by the borrower’s current and prospective ability to comply with the modified terms of the loan.
A modification is classified as a TDR if the borrower is experiencing financial difficulty and it is determined that the Company has granted a concession to the borrower. The Company may determine that a borrower is experiencing financial difficulty if the borrower is currently in default on any of its debt, or if it is probable that a borrower may default in the foreseeable future without the modification. Concessions could include reductions of interest rates at a rate lower than current market rate for a new loan with similar risk, extension of the maturity date, reduction of accrued interest, principal forgiveness, forbearance, or other concessions. The assessments of whether a borrower is experiencing or will likely experience financial difficulty and whether a concession has been granted is highly subjective in nature, and management’s judgment is required when determining whether a modification is classified as a TDR.
All TDRs are reported as impaired. Impaired classification may be removed if the borrower demonstrates compliance with the modified terms and the restructuring agreement specifies an interest rate equal to that which would be provided to a borrower with similar credit at the time of restructuring. The majority of TDRs are classified as impaired loans for the remaining life of the loan. Nonperforming loans and impaired loans are defined differently. Some loans may be included in both categories, whereas other loans may only be included in one category.
The following table provides information regarding loans that were modified into TDRs in the originated and ANCI portfolios during the periods indicated.
During the year ended December 31, 2019, approximately $49.7 million in charge-offs were taken related to commercial and industrial loans that were modified into TDRs during the same 12-month period. For the year ended December 31, 2018, there was one commercial specialized lending customer with a combined recorded investment of $11.8 million which experienced payment default in the year of modification. There were no TDRs modified during 2017 that experienced payment default during the year of modification. Default is defined as the earlier of the troubled debt restructuring being placed on non-accrual status or obtaining 90 days past due status with respect to principal and/or interest payments.
The following table provides information regarding the types of loan modifications that were modified into TDRs in the originated and ANCI portfolios during the periods indicated.
Residential Mortgage Loans in Process of Foreclosure
﻿Included in loans are $4.4 million and $3.8 million of consumer loans secured by single family residential real estate that are in process of foreclosure at December 31, 2019 and 2018, respectively. Loans in process of foreclosure include those for which formal foreclosure proceedings are in process according to local requirements of the applicable jurisdiction. In addition to the single family residential real estate loans in process of foreclosure, the Company also held $0.2 million and $1.0 million of foreclosed single-family residential properties in other real estate owned as of December 31, 2019 and 2018, respectively.
Credit Exposure in the Originated and ANCI Loan Portfolios
The following tables provide information regarding the credit exposure by portfolio segment and class of receivable.
Aging of Past due Originated and ANCI Loans
The following tables provide an aging of past due loans by portfolio segment and class of receivable.
Acquired Credit Impaired (“ACI”) Loans
The following table presents total ACI loans outstanding by portfolio segment and class of financing receivable. See Note 2 for more information regarding our merger with State Bank.
The excess of cash flows expected to be collected over the carrying value of ACI loans is referred to as the accretable yield and is recognized in interest income using an effective yield method over the remaining life of the loan, or pools of loans. The accretable yield is affected by:
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Changes in interest rate indices for variable rate ACI loans-Expected future cash flows are based on the variable rates in effect at the time of the regular evaluations of cash flows expected to be collected;
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Changes in prepayment assumptions-Prepayments affect the estimated life of ACI loans which may change the amount of interest income, and possibly principal, expected to be collected; and
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Changes in the expected principal and interest payments over the estimated life-Updates to expected cash flows are driven by the credit outlook and actions taken with borrowers.
Changes in Accretable Yield on ACI Loans
Changes in the amount of accretable discount for ACI loans for each of the three years in the period ended December 31, 2019 were as follows:
Impaired ACI Loans and Pools Including TDRs
The following tables include certain key information about individually impaired and pooled ACI loans.
(1)
The recorded investment of a loan also includes any interest receivable, net unearned discount or fees, and unamortized premium or discount.
ACI Loans Modified into TDRs
There was one ACI loan modified into a TDR during the year ended December 31, 2019 with a recorded investment of $1.5 million that was sold prior to year-end. There were no ACI loans modified into a TDR during the years ended December 31, 2018 and 2017. There were no ACI TDRs modified during the three years ended December 31, 2019 that experienced payment default during the year of modification. Default is defined as the earlier of the troubled debt restructuring being placed on nonaccrual status or obtaining 90 days past due status with respect to principal and interest payments.
Credit Exposure in the ACI Portfolio
The following table provides information regarding the credit exposure by portfolio segment and class of receivable.
The following table provides an aging of ACI consumer loans by past due status.
Note 5-Premises and Equipment
Premises and equipment are stated at cost, less accumulated depreciation and amortization, as follows:
(1)
Leasehold improvements are depreciated over the lesser of the estimated useful life or the lease term.
Depreciation expense was $11.7 million, $7.6 million and $7.1 million for 2019, 2018 and 2017, respectively.
Included in other assets is net software cost totaling $6.5 million and $4.0 million as of December 31, 2019 and 2018, respectively. Software amortization expense was $3.4 million, $1.7 million, and $1.9 million for the years ended December 31, 2019, 2018, and 2017, respectively.
Note 6-Goodwill and Other Intangible Assets
The following table summarizes the Company’s goodwill and other intangible assets at December 31, 2019 and 2018:
The increase in goodwill and other intangible assets is primarily related to the acquisition of State Bank on January 1, 2019, as well as an insignificant amount that resulted from the net asset acquisition from Wealth & Pension Services Group, Inc. on July 1, 2019 by the Bank’s subsidiary, Linscomb & Williams, Inc. (see Note 2).
The following table represents changes to the carrying amount of goodwill by segment for the period reported.
The estimated aggregate amortization expense for core deposit intangibles, customer relationships, and other intangible assets is estimated as follows:
Note 7-Derivatives
The Company primarily uses derivatives to manage exposure to market risk, including interest rate risk, credit risk and foreign currency risk, and to assist customers with their risk management objectives. Management will designate certain derivatives as hedging instruments in a qualifying hedge accounting relationship. The Company’s remaining derivatives consist of economic hedges that do not qualify for hedge accounting and derivatives held for customer accommodation, or other purposes.
The fair value of derivative positions outstanding is included in other assets and other liabilities in the accompanying consolidated balance sheets and in the net change in each of these financial statement line items in the accompanying consolidated statements of cash flows. For derivatives not designated as hedging instruments, gains and losses due to changes in fair value are included in noninterest income and the operating section of the consolidated statement of cash flows. For derivatives designated as hedging instruments, the entire change in the fair value related to the derivative instrument is recognized as a component of other comprehensive income and subsequently reclassified into interest income when the forecasted transaction affects income. The notional amounts and estimated fair values as of December 31, 2019 and 2018 were as follows:
The Company is party to collateral support agreements with certain derivative counterparties. Such agreements require that the Company maintain collateral based on the fair values of derivative transactions. In the event of default by the Company, the counterparty would be entitled to the collateral. At December 31, 2019 and 2018, the Company was required to post $10.6 million and $25.3 million, respectively, in cash or securities as collateral for its derivative transactions, which are included in “interest-bearing deposits in banks” on the Company’s consolidated balance sheets. In addition, the Company had recorded the obligation to return cash collateral provided by a counterparty of $240.9 million as of December 31, 2019 within deposits on the Company’s consolidated balance sheet. The Company’s master agreements represent written, legally enforceable bilateral agreements that (1) create a single legal obligation for all individual transactions covered by the master agreement and (2) in the event of default, provide the non-defaulting counterparty the right to accelerate, terminate, and close-out on a net basis all transactions under the agreement and to promptly liquidate or set-off collateral posted by the defaulting counterparty. As permitted by U.S. GAAP, the Company does not offset fair value amounts for the right to reclaim cash collateral or the obligation to return cash collateral against fair value amounts of derivatives executed with the same counterparty under the master agreement.
Pre-tax gain (loss) included in the consolidated statements of income related to derivative instruments for each of the three years ended December 31:
Cash Flow Hedges
Cash flow hedge relationships mitigate exposure to the variability of future cash flows or other forecasted transactions. The Company uses interest rate swaps to manage overall cash flow changes related to interest rate risk exposure on benchmark interest rate loans (1-Month LIBOR).
In February 2019, the Company entered into a $4.0 billion notional interest rate collar with a five-year term. The interest rate collar has a purchased cap strike of 4.70%, a sold cap strike of 3.50%, a sold floor strike of 0.00%, and a purchased floor strike of 3.00%. The purchased option price was $127.8 million.
At December 31, 2019, the Company has outstanding the following interest rate swap agreements to manage overall cash flow changes related to interest rate risk exposure on benchmark interest rate loans.
Based on our current interest rate forecast, $27.0 million of deferred net gain on derivatives in OCI at December 31, 2019 is estimated to be reclassified into net interest income during the next twelve months due to the receipt of interest. Future changes to interest rates may significantly change actual amounts reclassified to income. There were no reclassifications into income during 2019, 2018 or 2017 as a result of any discontinuance of cash flow hedges because the forecasted transaction was no longer probable. The maximum length of time over which the Company is hedging a portion of its exposure to the variability in future cash flows for forecasted transactions is approximately 6.2 years as of December 31, 2019.
Interest Rate Agreements not designated as hedging derivatives
The Company enters into certain interest rate swap, floor, cap and collar agreements on commercial loans that are not designated as hedging instruments. These derivative contracts relate to transactions in which the Company enters into an interest agreement with a loan customer while at the same time entering into an offsetting interest rate agreement with another financial institution. In connection with each swap transaction, the Company agrees 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, the Company agrees 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 interest rate swap transaction allows the Company’s customer to effectively convert a variable rate loan to a fixed rate. The interest rate cap transaction allows the Company’s customer to minimize interest rate risk exposure to rising interest rates. Because the Company acts as an intermediary for its customer, changes in the fair value of the underlying derivative contracts for the most part offset each other and do not significantly impact the Company’s consolidated statements of income. The Company is exposed to credit loss in the event of nonperformance by the parties to the interest rate agreements. However, the Company does not anticipate nonperformance by the counterparties. The estimated fair value has been recorded as an asset and a corresponding liability in the accompanying consolidated balance sheets as of December 31, 2019 and 2018.
Note 8-Leases
On January 1, 2019, the Company adopted ASU No. 2016-02, Leases (Topic 842). This ASU requires lessees to recognize right-of-use (“ROU”) assets and related lease liabilities on their consolidated balance sheets for all arrangements with terms longer than 12 months. Operating ROU assets represent a right to use an underlying asset for the contractual lease term. Operating lease liabilities represent an obligation to make lease payments arising from the lease. ROU assets and related liabilities are recognized at commencement date based upon the present value of lease payments over the lease term.
The Company elected to adopt the optional modified retrospective transition approach, which resulted in the following initial recognition amounts on January 1, 2019:
The Company’s operating ROU assets represent both real estate and non-real estate leases. These leases have varying terms, with most containing renewal or first-right-of-refusal options for multi-year periods and annual increases in base rates. The Company leases various premises and equipment under operating leases. The leases have varying terms, with most containing renewal or first-right-of-refusal options for multi-year periods and annual increases in base rates.
The following is a schedule by year of future minimum lease payments under operating leases, as of December 31, 2019:
Rental expense for premises and equipment, net of rental income, for the years ended December 31, 2019, 2018 and 2017, was $17.4 million, $12.1 million, and $11.2 million, respectively. The major portion of equipment rental expense is related to office equipment and is paid on a month-to-month basis.
The components of lease cost for the year ended December 31, 2019 were as follows:
The Company elected to exempt the short-term lease from the recognition requirements as permitted under ASU No. 2016-02. The lease cost was recognized on a straight-line basis. As of December 31, 2019, a right-of-use asset of $66.1 million and an operating lease liability of $77.4 million were included as part of “other assets” and “other liabilities,” respectively, on the consolidated balance sheets. Supplemental balance sheet information related to operating leases at December 31, 2019 was as follows:
The following table presents a maturity analysis of the Company’s operating lease liabilities as of December 31, 2019:
Note 9-Deposits
Domestic time deposits $250,000 and over were $644.1 million and $491.3 million at December 31, 2019 and 2018, respectively. There were no foreign time deposits at either December 31, 2019 or 2018.
At December 31, 2019, the scheduled maturities of time deposits included in interest-bearing deposits were as follows:
Note 10-Borrowed Funds
Repurchase Agreements
Securities sold under agreements to repurchase generally mature within one to seven days from the transaction date. Securities underlying the repurchase agreements remain under the control of the Company. Repurchase agreements are treated as collateralized financing obligations and are reflected as a liability in the consolidated balance sheets. The carrying value of investment securities collateralizing repurchase agreements was $0 million and $3.3 million at December 31, 2019 and 2018, respectively.
Information concerning the Company’s securities sold under agreements to repurchase as of December 31, 2019 and 2018 is summarized as follows:
Senior and Subordinated Debt
In June 2019, the Company completed a registered public offering of $85 million aggregate principal amount of 4.75% fixed to floating rate subordinated notes due 2029, the net proceeds of which were used to redeem our 4.875% senior notes due June 28, 2019. In June 2014, the Company and the Bank completed an unregistered $245 million multi-tranche debt transaction and in March 2015, the Company completed an unregistered $50 million debt transaction. These transactions enhanced our liquidity and regulatory capital levels to support balance sheet growth. Details of the debt transactions are as follows:
The senior transactions were structured with four and seven year maturities to provide holding company liquidity and to stagger the Company’s debt maturity profile. The $35 million and $25 million subordinated debt transactions were structured with a fifteen year maturity, ten year call options, and fixed-to-floating interest rates. The $85 million subordinated debt transaction was structured with a ten-year maturity, a five-year call option, and a fixed-to-floating interest rate. The $40 million subordinated debt transaction has a five-year call option. These subordinated debt structures were designed to achieve full Tier 2 capital treatment for 10 years.
The Company’s outstanding senior note is unsecured, unsubordinated obligations and is equal in right of payment to all the Company’s other unsecured debt. The Company’s subordinated notes are unsecured obligations and will be subordinated in right of payment to all the Company’s senior indebtedness and general creditors and to depositors at the Bank. The Company’s senior notes and subordinated notes are not guaranteed by any subsidiary of the Company, including the Bank.
The Bank’s subordinated notes are unsecured obligations and are subordinated in right of payment to all the Bank’s senior indebtedness and general creditors and to depositors of the Bank. The Bank’s subordinated notes are not guaranteed by the Company or any subsidiary of the Bank.
Payment of principal on the Company’s and Bank’s subordinated notes may be accelerated by holders of such subordinated notes only in the case of certain insolvency events. There is no right of acceleration under the subordinated notes in the case of default. The Company and/or the Bank may be required to obtain the prior written approval of the Federal Reserve, and, in the case of the Bank, the OCC, before it may repay the subordinated notes issued thereby upon acceleration or otherwise.
Junior Subordinated Debentures
In conjunction with the Company’s acquisition of Cadence Financial Corporation and Encore Bank, N.A., the junior subordinated debentures were marked to fair value as of their respective acquisition dates. The related mark is being amortized over the remaining term of the junior subordinated debentures. The following is a list of junior subordinated debt:
Advances from FHLB and Borrowings from FRB
Outstanding FHLB advances were $100.0 million and $150.0 million at December 31, 2019 and 2018, respectively. At December 31, 2019, the outstanding advance was a long-term convertible advance. Advances are collateralized by $2.0 billion of commercial and residential real estate loans pledged under a blanket lien arrangement as of December 31, 2019, which provides $1.5 billion of borrowing availability.
As of December 31, 2019, and 2018, the FHLB has issued for the benefit of the Bank irrevocable letters of credit totaling $391.0 million and $590.0 million, respectively. Included in the FHLB letters of credit is a $35.0 million irrevocable letter of credit in favor of the State of Alabama SAFE Program to secure certain deposits of the State of Alabama. This letter of credit expires September 28, 2020 upon 45 days’ prior notice of non-renewal; otherwise it automatically extends for a successive one-year term. The Bank also has a $350.0 million variable letter of credit to secure a large public fund treasury management deposit. This letter of credit will expire March 16, 2020 upon 45 days’ prior notice of non-renewal; otherwise it automatically extends for a successive one-year term. Approximately $6.0 million in letters of credit are used to secure municipal deposits which expire on July 20, 2020.
There were no borrowings from the FRB discount window as of December 31, 2019 and 2018. Any borrowings from the FRB will be collateralized by $684.5 million in commercial loans pledged under a borrower-in-custody arrangement.
Notes Payable
On July 1, 2019, the Company’s wholly owned subsidiary, Linscomb & Williams, Inc., acquired certain assets and assumed certain liabilities of Wealth and Pension Services Group, Inc. (“W&P”). At December 31, 2019, a note payable of $2.1 million was outstanding in connection with this acquisition (see Note 2).
On March 29, 2019, the Company entered into a credit agreement for a revolving loan facility in the amount of $100 million with a maturity date of March 29, 2020. The proceeds of the revolving loan are used to finance general corporate purposes. There were no amounts outstanding under this line of credit at December 31, 2019. Although the credit facility is unsecured, we agreed not to sell, pledge, or transfer any part of our right, title, or interest in our subsidiary bank while the agreement is in place.
Note 11-Other Noninterest Income and Other Noninterest Expense
The detail of the other noninterest income and other noninterest expense captions presented in the consolidated statements of income is as follows:
Note 12-Income Taxes
The components of the consolidated income tax expense are as follows:
Income tax expense as shown in the consolidated statements of income differed from the amounts computed by applying the U.S. federal income tax statutory rate to income before income taxes. The statutory rate is 21% for 2019 and 2018 and 35% for 2017. A reconciliation of the differences is presented below:
As a result of the Tax Cuts and Jobs Act (“Tax Reform”) enacted on December 22, 2017, deferred taxes are based on the newly enacted U.S. federal statutory income tax rate of 21%. In 2017, the provisional amount recorded related to the remeasurement of the Company’s deferred tax asset was $19.0 million, which was recorded as income tax expense. The Company completed its analysis of the remeasurement of the Company’s deferred tax asset within the measurement period and the amount was not materially different from the provisional amount recorded in 2017.
The significant components of the Company’s deferred tax assets and liabilities as of December 31, 2019 and 2018 are as follows:
At December 31, 2019, we had a net deferred income tax liability of $25.0 million compared to a net deferred asset of $33.2 million at December 31, 2018. The decrease in the net deferred asset was primarily due to certain purchase accounting adjustments recorded during the State Bank acquisition, changes in market conditions that impacted the mark to market deferred tax adjustments on securities available-for-sale and on cash flow hedges including the interest rate collar.
ASC Topic 740, Income Taxes, requires that deferred tax assets be reduced if it is more likely than not that some portion or all the deferred tax asset will not be realized. Management’s determination of the realizability of deferred tax assets is based on its evaluation of all available evidence both positive and negative, and its expectation regarding various future events, including the reversal of deferred tax liabilities, projected future taxable income and tax planning strategies. Positive evidence supporting the realization of the Company’s deferred tax assets at December 31, 2019, includes generation of taxable income since 2012, the Company’s strong capital position, as well as sufficient amounts of projected future taxable income, of the appropriate character, to support the realization of the $79.2 million at December 31, 2019. Based on the assessment of all positive and negative evidence at December 31, 2019 and 2018, management has concluded that it is more likely than not that the results of future operations will generate sufficient taxable income to realize the deferred tax assets.
Management’s estimate of future taxable income is based on internal projections, various internal assumptions, as well as certain external data all of which management believes to be reasonable although inherently subject to significant judgment. Projected future taxable income is primarily expected to be generated through loan growth at the bank, investment strategies and revenue from successful cross initiatives and the control of expenses through operating effectiveness, all in the context of a macro-economic environment that continues to trend favorably. If actual results differ significantly from the current estimates of future taxable income, a valuation allowance may need to be recorded for some portion or all the net deferred tax asset. Such an increase to the deferred tax asset valuation allowance could have a material adverse effect on the Company’s consolidated balance sheets and consolidated statements of income.
The acquisitions of Cadence Financial Corporation, Encore Bancshares, Inc., and State Bank resulted in an “ownership change” as defined for U.S. federal income tax purposes under Section 382 of the Internal Revenue Code. The acquisition of Superior Bank was an asset acquisition and is not subject to the limitations of Section 382. As a result of the operation of Section 382, the Company is not able to fully utilize a portion of our U.S. federal and state tax net operating losses and certain built-in losses that have not been recognized for tax purposes. An ownership change under Section 382 generally occurs when a change in the aggregate percentage ownership of the stock of the corporation held by 5% stockholders increases by more than 50% over a rolling three-year period. A corporation experiencing an ownership change generally is subject to an annual limitation on its utilization of pre-change losses and certain post-change recognized built-in losses equal to the value of the stock of the corporation immediately before the ownership change, multiplied by the long-term tax-exempt rate (subject to certain adjustments). The annual limitation is increased each year to the extent that there is an unused limitation in a prior year. Since U.S. federal net operating losses generally may be carried forward for up to 20 years, the annual limitation also effectively provides a cap on the cumulative amount of pre-change losses and certain post-change recognized built-in losses that may be utilized. Pre-change losses and certain post-change recognized built-in losses in excess of the cap are effectively unable to be used to reduce future taxable income. The Company has estimated the amount of pre-change losses and certain post-change losses that are not expected to be utilized and has reduced the deferred tax asset at the acquisition date to reflect this limitation.
As of December 31, 2019, the Company has federal net operating loss carryforwards of $48.2 million which will begin to expire in 2031. The Company has state net operating loss carryforwards of $31.9 million which will begin to expire in 2024. In addition, the Company has an AMT credit carryforward of $0.5 million as of December 31, 2019, which has no expiration.
The Company and its subsidiaries are subject to U.S. federal income tax as well as various state and local income taxes. With certain limited exceptions, the Company has concluded all U.S. federal and state income tax matters for years before 2015. The Company applies the guidance in ASC 740-10, Accounting for Uncertainty in Income Taxes. ASC 740-10 provides guidance for how uncertain tax positions should be recognized, measured, presented, and disclosed in the financial statements. ASC 740-10 requires the evaluation of tax positions taken or expected to be taken in the course of preparing the Company’s tax returns to determine whether the tax positions are “more likely than not” to be sustained by the applicable tax authority based on technical merits of the position. Tax benefits from tax positions not deemed to meet the “more likely than not” threshold should not be recognized in the year of determination.
A reconciliation of the beginning and ending amount of unrecognized income tax benefits is as follows (unrecognized state income tax benefits are not adjusted for the federal income tax impact):
As of December 31, 2019, and 2018, the balance of unrecognized tax benefits, if recognized, that would reduce the effective tax rate is $1.0 million. The Company does not anticipate a significant change to the total amount of unrecognized tax benefits with the next 12 months.
The Company classifies interest and penalties on uncertain tax positions as a component of noninterest expense. During the years ended December 31, 2019 and 2018, the Company recognized approximately $123,000 and $57,000 in interest and penalties. The Company’s accrued interest and penalties on unrecognized tax benefits was $259,000 and $137,000 as of December 31, 2019 and 2018, respectively. Accrued interest and penalties are included in other liabilities.
Note 13-Earnings Per Common Share
The following table displays a reconciliation of the information used in calculating basic and diluted net income per common share for each of the years in the period ended December 31, 2019.
The effect from the assumed exercise of 1,393,783 stock options and restricted stock units for the year ended December 31, 2019 was not included in the above computations of diluted earnings per share because such amounts would have had an antidilutive effect on earnings per common share. There were 67,384 antidilutive restricted stock units for the year ended December 31, 2018. There were no antidilutive stock options and restricted stock units for the year ended December 31, 2017.
Note 14-Employee Benefits
Defined Benefit Pension Plan
The Company accounts for its defined benefit pension plan in accordance with ASC Topic 715. This guidance requires companies to recognize the funded status of a defined benefit plan (measured as the difference between the fair value of plan assets and the projected benefit obligation) on the balance sheets and to recognize in other comprehensive income any gains or losses and prior service costs or benefits not included as components of periodic benefit cost.
Participation in the defined benefit pension plan was frozen effective April 30, 2011. In 2019, the Company terminated its defined benefit pension plan. Lump sum payments of accrued benefits were offered to plan participants. For those participants who did not elect the lump sum payment, an annuity contract was purchased.
The following table sets forth the defined benefit pension plan’s funded status as of December 31, 2019 and 2018 and amounts recognized in the Company’s consolidated financial statements for each of the years in the period ended December 31, 2019:
Due to the termination of the defined benefit pension plan in 2019, there are no future retiree benefit payments.
In determining the expected return on plan assets, the Company considers the relative weighting of plan assets, the historical performance of total plan assets, individual asset classes, and economic and other indicators of future performance. In addition, the Company may consult with and consider the opinions of financial and other professionals in developing appropriate return benchmarks.
The Company’s defined benefit pension plan fair values and weighted-average asset allocations at December 31, 2019 and 2018, by asset category, were as follows:
The primary investment objective of the Company’s defined benefit pension plan has been to maximize total return while accepting and managing a moderate to average degree of risk. The assets are invested based upon a moderate growth asset allocation model, which seeks to provide long-term growth of capital with a moderate level of current income and a somewhat higher level of principal volatility. For 2019, the assets were allocated in a target mix of fixed income, equity, and other funds.
The investments were managed by the Trust Division of the Company within the established guidelines. It is the intent of management to give the investment managers flexibility within the overall parameters designated in the investment model selected by the Bank’s Trust Company Investment Committee for the plan.
The fair values of all plan assets as of December 31, 2019 and 2018, were measured using quoted prices in active markets for identical assets and liabilities (Level 1 inputs, as defined by ASC 820).
The Company does not have a minimum cash contribution for 2020. The Company did not contribute in 2019 or 2018. The Company contributed $1.3 million for the year ended December 31, 2017.
Other Plans
Contributions to the 401(k) plan totaled $7.4 million and $3.8 million in 2019 and 2018, respectively.
The Company has certain nonqualified postretirement benefit plans assumed from legacy banks. The accrued liabilities for these plans totaled $5.7 million and $4.9 million at December 31, 2019 and 2018, respectively. The Company recognized expense for these plans totaling $2.0 million, $(0.3) million, and $0.8 million for the years ended December 31, 2019, 2018, and 2017, respectively.
Projected benefit payments under these plans are anticipated to be paid as follows:
Note 15-Related Party Transactions
In the normal course of business, loans are made to directors and executive officers and to companies in which they have a significant ownership interest. In the opinion of management, these loans are made on substantially the same terms, including interest rates and collateral, as those prevailing at the time for comparable transactions with other parties, are consistent with sound banking practices, and are within applicable regulatory and lending limitations. The aggregate balances of related party deposits are insignificant as of December 31, 2019. As of December 31, 2018, the aggregate balances of related party deposits were approximately $571 million. This was primarily due to a deposit account of approximately $311 million by State Bank and one large deposit account by a related third party. The aggregate balances of related party loans as of December 31, 2019 and 2018 were insignificant.
Note 16-Regulatory Matters
Cadence and Cadence Bank are each required to comply with regulatory capital requirements established by federal and state banking agencies. Failure to meet minimum capital requirements can subject the Company and the Bank to certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. These regulatory capital requirements involve quantitative measures of the Company’s assets, liabilities and certain off-balance sheet items, and qualitative judgments by the regulators.
Quantitative measures established by regulation to ensure capital adequacy require institutions to maintain minimum ratios of common equity Tier 1, Tier 1, and total capital (as defined in the regulations) to risk-weighted assets (as defined), and of Tier 1 capital to average tangible assets (the “Leverage” ratio).
The actual capital amounts and ratios for the Company and the Bank as of December 31, 2019 and 2018 are presented in the following tables and as shown, are above the thresholds necessary to be considered “well-capitalized.” Management believes that no events or changes have occurred after December 31, 2019 that would change this designation.
Under regulations controlling national banks, the payment of any dividends by a bank without prior approval of the OCC is limited to the current year’s net profits (as defined by the OCC) and retained net profits of the two preceding years. The Federal Reserve, as primary regulator for bank holding companies, has also stated that all common stock dividends should be paid out of current income. As the Company does not generate income on a stand-alone basis, it does not have the capability to pay common stock dividends without receiving dividends from the Bank.
The Bank is required to maintain average reserve balances in the form of cash or deposits with the Federal Reserve Bank. The reserve balance varies depending upon the types and amounts of deposits. At December 31, 2019 and 2018, the required reserve balance with the Federal Reserve Bank was approximately $246.0 million and $91.5 million, respectively.
Note 17-Commitments and Contingent Liabilities
The consolidated financial statements do not reflect various commitments and contingent liabilities which arise in the normal course of banking business and which involve elements of credit risk, interest rate risk, and liquidity risk. The commitments and contingent liabilities are commitments to extend credit, home equity lines, overdraft protection lines, and standby and commercial letters of credit. Such financial instruments are recorded when they are funded. A summary of commitments and contingent liabilities is as follows:
Commitments to extend credit and letters of credit include some exposure to credit loss in the event of nonperformance of the customer. Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. In addition, the Company has entered certain contingent commitments to grant loans. Standby letters of credit are conditional commitments issued to guarantee the performance of a customer to a third party. The credit policies and procedures for such commitments are the same as those used for lending activities. Because these instruments have fixed maturity dates and because a number expire without being drawn upon, they generally do not present any significant liquidity risk. No significant losses on commitments were incurred during the years ended December 31, 2019 and 2018.
The Company makes investments in limited partnerships, including certain low-income housing partnerships for which tax credits are received. As of December 31, 2019 and 2018, unfunded capital commitments totaled $44.9 million and $37.5 million, respectively (Note 21).
The Company and the Bank are defendants in various pending and threatened legal actions arising in the normal course of business. In the opinion of management, based upon the advice of legal counsel, the ultimate disposition of all pending and threatened legal action will not have a material effect on the Company’s consolidated financial statements. On September 16, 2019, a Company shareholder filed a putative class action complaint against Cadence Bancorporation and certain senior officers. Following consolidation of a related matter and appointment of lead plaintiffs, the lead plaintiffs filed an amended complaint on January 31, 2020, which asserted claims under Sections 10(b) and 20 of the Securities Exchange Act on behalf of a putative class of persons and entities that purchased or otherwise acquired the Company’s securities between July 23, 2018, and January 23, 2020, inclusive. The amended complaint alleges that the Company and the individual defendants made materially misleading statements about the credit quality of the Company’s loan portfolio, did not timely charge off bad debt or record sufficient loss provisions to reserve against the risk of loss, and maintained an inadequate allowance for credit losses. The consolidated case is captioned Frank Miller et al. v. Cadence Bancorporation et al., Case No. H-19-3492-LNH, in the United States District Court for the Southern District of Texas. The Company and the individual defendants intend to file a motion to dismiss and to mount a vigorous defense. The case is in its preliminary stages, discovery has not yet commenced, and it is not possible at this time to estimate the likelihood or amount of any potential damages exposure.
Note 18-Concentrations of Credit
Most of the loans, commitments and letters of credit involve customers or sponsors in the Company’s market areas. Investments in state and municipal securities also involve governmental entities within the Company’s market areas. General concentrations of credit by type of loan are set forth in Note 4 of these consolidated financial statements. The distribution of commitments to extend credit approximates the distribution of loans outstanding. Letters of credit were granted primarily to commercial borrowers.
Note 19-Supplemental Cash Flow Information
Note 20-Disclosure About Fair Values of Financial Instruments
The Company groups its assets and liabilities measured at fair value in three levels, based on the markets in which the assets and liabilities are traded, and the reliability of the assumptions used to determine fair value. This hierarchy requires the Company to maximize the use of observable market data, when available, and to minimize the use of unobservable inputs when determining fair value. Each fair value measurement is placed into the proper level based on the lowest level of significant input. These levels are:
•
Level 1-Valuation is based upon quoted prices for identical instruments traded in active markets.
•
Level 2-Valuation is based upon quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.
•
Level 3-Valuation is generated from model-based techniques that use significant assumptions not observable in the market. These unobservable assumptions reflect management’s estimates of assumptions that market participants would use in pricing the asset or liability. Valuation techniques include use of option pricing models, discounted cash flow models, and similar techniques.
Transfers between fair value levels are recognized at the end of the fiscal quarter in which the associated change in inputs occurs.
Assets and Liabilities Recorded at Fair Value on a Recurring Basis
The table below presents the Company’s assets and liabilities measured at fair value on a recurring basis categorized by the level of inputs used in the valuation of each asset and liability at December 31, 2019 and 2018:
There were no transfers between the Level 1 and Level 2 fair value categories during the years ended December 31, 2019 and 2018.
Changes in Level 3 Fair Value Measurements Recorded on a Recurring Basis
The table below includes a roll-forward of the consolidated balance sheet amounts for each of the years in the period ended December 31, 2019 for changes in the fair value of financial instruments within Level 3 of the valuation hierarchy that are recorded on a recurring basis. Level 3 financial instruments typically include unobservable components but may also include some observable components that may be validated to external sources. The gains or (losses) in the following table (which are reported in Other Noninterest Income in the consolidated income statements) may include changes to fair value due in part to observable factors that may be part of the valuation methodology.
Level 3 Assets Measured at Fair Value on a Recurring Basis
The fair value of the net profit interests in oil and gas reserves was estimated using discounted cash flow analyses applied to the expected cash flows from producing developed wells. Expected cash flows are derived from reports prepared by consulting engineers under established professional standards for the industry. These expected cash flow projections contain significant unobservable inputs regarding the net recoverable oil and gas reserves and forward-looking commodity prices discounted at a rate of 10%. Therefore, the fair value is subject to change based on these commodity markets. An increase of 5% in the discount rate will not produce a material change in the fair value of the net profits interest.
The fair value of certain investments in limited partnerships was estimated using the practical expedient of net asset value. For other investments in limited partnerships that do not qualify for the practical expedient, we use a measurement alternative which measures these investments at cost, less any impairment, plus or minus any changes resulting from observable price changes in orderly transactions for identical or similar investments of the same issuer.
The fair value of the SBA servicing assets was estimated using the gross coupon less an assumed contractual servicing cost (CSC) of 40 basis points for Section 7a loans and 12.5 basis points for USDA loans.
Assets Recorded at Fair Value on a Nonrecurring Basis
From time to time, the Company may be required to measure certain other financial assets at fair value on a nonrecurring basis in accordance with GAAP. These adjustments to fair value usually result from the application of lower of cost or fair value accounting or write-downs of individual assets. For assets measured at fair value on a nonrecurring basis which were still held on the balance sheets at December 31, 2019 and 2018, the following tables provide the level of valuation assumptions used to determine each adjustment and the related carrying value:
The fair value of collateral-dependent impaired loans and OREO and the related fair value adjustments are generally based on unadjusted third-party appraisals. Appraisals that are not based on observable inputs or that require significant adjustments or fair value measurements that are not based on third-party appraisals are considered to be based on significant unobservable inputs.
Significant unobservable inputs used in Level 3 fair value measurements for financial assets measured at fair value on a nonrecurring basis are summarized below:
Determination of Fair Values
In accordance with ASC 820-10-35, fair values are based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The following describes the assumptions and methodologies used to estimate the fair value of financial instruments recorded at fair value in the consolidated balance sheets and for estimating the fair value of financial instruments for which fair value is disclosed under ASC 825-10-50.
Investment Securities. When quoted prices are available in an active market, securities are classified as Level 1. For securities reported at fair value utilizing Level 2 inputs, the Company obtains fair value measurements from an independent pricing service. These fair value measurements consider observable market data that may include benchmark yield curves, reported trades, broker/dealer quotes, issuer spreads and credit information, among other inputs.
Loans Held for Sale. Loans held for sale are recorded at the lower of aggregate cost or fair value. Fair value is generally based on quoted market prices of similar loans and is considered to be Level 2.
Net Loans. Loans are valued on an individual basis, with consideration given to the loans’ underlying characteristics, including account types, remaining terms, annual interest rates or coupons, interest types, accrual basis, timing of principal and interest payments, current market rates, and remaining balances. A discounted cash flow model is used to estimate the fair value of the loans using assumptions for prepayments speeds, projected default probabilities by risk grade, and estimates of prevailing discount rates. The discounted cash flow approach models the projected cash flows, applying various assumptions regarding interest and payment risks for the loans based on the loan types, payment types and fixed or variable interest rate classifications. Estimated fair values are disclosed through the application of the exit price notion. The assumptions used to estimate fair value are intended to approximate those that a market participant would use in an orderly transaction on the measurement date.
Derivative Financial Instruments. Derivative financial instruments are measured at fair value based on modeling that utilizes observable market inputs for various interest rates published by leading third-party financial news and data providers. This is observable data that represents the rates used by market participants for instruments entered into at that date; however, they are not based on actual transactions, so they are classified as Level 2.
Deposits. The fair values disclosed for demand deposits are, by definition, equal to the amount payable on demand at the reporting date (that is, their carrying amounts). Fair values for time deposits are estimated using a discounted cash flow calculation that uses recent issuance rates over the prior three months and a market rate analysis of recent offering rates for retail products. For wholesale products, brokered pricing offering rates were used.
FHLB Advances. The fair value of the FHLB advance approximates its book value.
Security Sold Under Agreements to Repurchase. The carrying amount of security repurchase agreements approximates their fair values.
Senior Debt. The fair value of senior debt was estimated using a discounted cash flow calculation that uses recent issuance rates for similar debt offerings for similar sized issuers.
Subordinated Debt. The fair value of subordinated debentures was estimated using a discounted cash flow calculation that uses recent issuance rates for similar debt offerings for similar sized issuers.
Junior Subordinated Debentures. The fair value of junior subordinated debentures was estimated using a discounted cash flow calculation that uses recent issuance rates for similar debt offerings for similar sized issuers.
Notes Payable. The carrying amount of notes payable approximates the fair value.
Limitations. The following fair value estimates are determined as of a specific point in time utilizing various assumptions and estimates. The use of assumptions and various valuation techniques, as well as the absence of secondary markets for certain financial instruments, will likely reduce the comparability of fair value disclosures between financial institutions. The fair values for loans involve the use of various assumptions due to market-illiquidity as of December 31, 2019 and 2018. These assumptions are considered to reflect inputs that market participants would use in transactions involving these instruments as of the measurement date. This table only includes financial instruments of the Company, and, accordingly, the total of the fair value amounts does not represent, and should not be construed to represent, the underlying value of the Company.
The estimated fair values of the Company’s financial instruments are as follows:
Note 21-Variable Interest Entities and Other Investments
Under ASC 810-10-65, the Company is deemed to be the primary beneficiary and required to consolidate a variable interest entity (“VIE”) if it has a variable interest in the VIE that provides it with a controlling financial interest. For such purposes, the determination of whether a controlling financial interest exists is based on whether a single party has both the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance and the obligation to absorb the losses of the VIE or the right to receive benefits from the VIE that could potentially be significant to the VIE. ASC 810-10-65, as amended, requires continual reconsideration of conclusions reached regarding which interest holder is a VIE’s primary beneficiary.
The Bank has invested in several affordable housing projects as a limited partner. The partnerships have qualified to receive annual affordable housing federal tax credits that are recognized as a reduction of current tax expense. The Company has determined that these structures meet the definition of VIE’s under ASC 810 but that consolidation is not required, as the Bank is not the primary beneficiary. At December 31, 2019 and 2018, the Bank’s maximum exposure to loss associated with these limited partnerships was limited to the Bank’s investment. The Company accounts for these investments and the related tax credits using either the effective yield method or the proportional amortization method, depending upon the date of the investment. Under the effective yield method, the Bank recognizes the tax credits as they are allocated and amortizes the initial costs of the investments to provide a constant effective yield over the period that the tax credits are allocated. Under the proportional amortization method, the Bank amortizes the cost of the investment in proportion to the tax credits and other tax benefits received and recognizes the net investment performance in the income statement as a component of income tax expense. At December 31, 2019 and 2018, the Company had recorded investments in other assets on its consolidated balance sheets of approximately $28.2 million and $7.8 million, respectively related to these investments.
Additionally, the Company invests in other certain limited partnerships accounted for under the fair value practical expedient of net asset value (“NAV”) totaling $18.7 million and $11.2 million as of December 31, 2019 and 2018, respectively. The Company recognized gains of $2.8 million and $2.5 million for the years ended December 31, 2019 and 2018, respectively, related to these assets recorded at fair value through net income. Other limited partnerships without readily determinable fair values that do not qualify for the practical expedient are accounted for at their cost minus impairment, plus or minus changes resulting from observable price changes in orderly transactions for the identical or a similar investment of the same issuer. These investments totaled $8.7 million as of December 31, 2019 and 2018. Other limited partnerships are accounted for under the equity method totaled $9.0 million and $9.2 million as of December 31, 2019 and 2018, respectively.
The following table presents a summary of the Company’s investments in limited partnerships as of December 31, 2019 and 2018:
Equity investments with readily determinable fair values not held for trading are recorded at fair value with changes in fair value reported in net income. Cadence elected a measurement alternative to fair value for certain equity investments without a readily determinable fair value. During 2019 and 2018, there were no adjustments to these investments for impairments or price changes from observable transactions. The carrying amount of equity investments measured under the measurement alternative are as follows:
Cadence’s investment in certain marketable equity securities are carried at fair value and are reported in other assets in the consolidated balance sheets. Total marketable equity securities were $1.9 million and $5.8 million at December 31, 2019 and 2018, respectively.
During 2016, the Bank received net profits interests in oil and gas reserves, in connection with the reorganization under bankruptcy of two loan customers (one of these was sold during 2018). The Company has determined that these contracts meet the definition of VIE’s under Topic ASC 810, but that consolidation is not required as the Bank is not the primary beneficiary. The net profits interests are financial instruments and recorded at estimated fair value, which was $4.3 million and $5.8 million at December 31, 2019 and 2018, respectively, representing the maximum exposure to loss as of that date.
The Company has established a rabbi trust related to the deferred compensation plan offered to certain of its employees. The Company contributes employee cash compensation deferrals to the trust. The assets of the trust are available to creditors of the Company only in the event the Company becomes insolvent. This trust is considered a VIE because either there is no equity at risk in the trust or because the Company provided the equity interest to its employees in exchange for services rendered. The Company is considered the primary beneficiary of the rabbi trust as it has the ability to select the underlying investments made by the trust, the activities that most significantly impact the economic performance of the rabbi trust. The Company includes the assets of the rabbi trust as a component of other assets and a corresponding liability for the associated benefit obligation in other liabilities in its consolidated balance sheets. The amount of rabbi trust assets and benefit obligation was $3.7 million and $3.6 million at December 31, 2019 and 2018, respectively.
Note 22-Segment Reporting
The Company determines reportable segments based on the services offered, the significance of the services offered, the significance of those services to the Company’s financial condition and operating results and management’s regular review of the operating results of those services. The Company operates through three operating segments: Banking, Financial Services and Corporate.
The Banking Segment includes the Commercial Banking, Retail Banking and Private Banking lines of business. The Commercial Banking line of business includes a general business services component primarily focusing on commercial & industrial (C&I), community banking, business banking and commercial real estate lending to clients in the geographic footprint in Texas and the southeast United States. In addition, the Commercial Banking line of business includes within C&I a separate component that focuses on select industries (which is referred to as the “specialized industries”) in which the Company believes it has specialized experience and service capabilities, including energy, healthcare, restaurant industry, and technology. The
Company serves clients in these specialized industries both within the geographic footprint and throughout the United States as a result of the national orientation of many of these businesses. The Retail Banking line of business offers a broad range of retail banking services including mortgage services through the branch network to serve the needs of consumer and small businesses in the geographic footprint. The Private Banking line of business offers banking services and loan products tailored to the needs of the high-net worth clients in the geographic footprint.
The Financial Services Segment includes the Trust, Retail Brokerage, and Investment Services lines of business. These businesses offer products independently to their own customers as well as to Banking Segment clients. Investment Services operates through the “Linscomb & Williams” name. The products offered by the businesses in the Financial Services Segment primarily generate non-banking service fee income. The Corporate Segment reflects parent-only activities and intercompany eliminations.
Business segment results are determined based upon the management reporting system, which assigns balance sheet and income statement items to each of the business segments. The process is designed around the organizational and management structure and, accordingly, the results derived are not necessarily comparable with similar information published by other financial institutions or in accordance with generally accepted accounting principles.
The Company evaluates performance and allocates resources based on profit or loss from operations. There are no material inter-segment sales or transfers. The accounting policies used by each reportable segment are the same as those discussed in Note 1. All costs, except corporate administration and income taxes, have been allocated to the reportable segments. Therefore, combined amounts agree to the consolidated totals.
The following tables present the operating results of the segments as of and for the years ended December 31, 2019, 2018 and 2017:
Note 23-Equity-based Compensation
The Company administers a long-term incentive compensation plan that permits the granting of incentive awards in the form of stock options, restricted stock, restricted stock units, performance units, stock appreciation rights, or other stock-based awards. The terms of all awards issued under these plans are determined by the Compensation Committee of the Board of Directors.
The Amended and Restated 2015 Omnibus Incentive Plan (the “Plan”) permits the Company to grant to employees and directors various forms of incentive compensation. The principal purposes of this plan are to focus directors, officers, and other employees and consultants on business performance that creates shareholder value, to encourage innovative approaches to the business of the Company, and to encourage ownership of the Company’s stock. The Plan authorizes 7.5 million common share equivalents available for grant, where grants of full value awards (e.g., shares of restricted stock, restricted stock units and performance stock units) count as one share equivalent. The number of remaining share equivalents available for future issuance under the Plan was 4.1 million at December 31, 2019.
Restricted Stock Units
During 2019, the Company granted shares of stock-based awards in the form of restricted stock units pursuant to and subject to the provisions of the Plan. The following table summarizes the activity related to restricted stock unit awards:
The restricted stock units granted include both time and performance-based components. Of the time-based restricted stock units granted and remaining at December 31, 2019:
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85,804 units will vest in annual installments ending in the first quarter of 2021;
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2,116 units will vest in annual installments ending in the third quarter of 2021;
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311,961 units will vest in quarterly installments ending in the first quarter of 2022;
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53,219 units will cliff-vest in the first quarter of 2022;
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72,840 units will vest in annual installments ending in the first quarter of 2022;
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249,651 units will vest in annual installments ending in the first quarter of 2023;
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2,000 units will vest in quarterly installments ending in the second quarter of 2020;
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6,998 units will vest in annual installments ending in the second quarter of 2023; and
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9,901 units will vest in annual installments ending in the third quarter of 2023.
While the grants specify a stated target number of units, the determination of the actual settlement in shares will be based in part on the achievement of certain financial performance measures of the Company. For the performance-based restricted stock units granted, these performance conditions will determine the actual units vesting and can be in the range of 25% to 200% of the units granted. These grants include rights as a shareholder in the form of dividend equivalents. Dividend equivalents for time vested restricted stock units will be paid on each dividend payment date for the Company; dividend equivalents for the performance vesting restricted stock will be accrued and paid on the vested number of shares once the performance is achieved and the shares are issued. The fair value of the restricted stock units was estimated based upon the fair value of the underlying shares on the date of the grant.
The Company recorded $6.4 million of equity-based compensation expense for the outstanding restricted stock units for the year ended December 31, 2019, compared to $3.7 million and $1.7 million for 2018 and 2017, respectively. The remaining expense related to unvested restricted stock units is $18.2 million as of December 31, 2019 and will be recognized over service periods ranging from 15 months to 45 months.
Stock Options
During the year ended December 31, 2019, the Company granted 1,602,848 stock options to certain executive officers. The options were granted at an exercise price equal to a 15% premium to the fair value of the common stock at the date of grant with a weighted-average exercise price of $20.43. The options vest over a three-year period and expire at the end of seven years. The remaining expense related to non-vested stock option grants is $2.5 million at December 31, 2019 and will be recognized over the next 25 months.
The Company uses the Black-Scholes option pricing model to estimate the fair value of the stock options. The following weighted-average assumptions were used for stock option awards issued during the year ended December 31, 2019:
Employee Stock Purchase Plan
On June 1, 2018, the Company commenced the 2018 Employee Stock Purchase Plan (“ESPP”) whereby employees may purchase the Company’s Class A common stock at a discount of 15% of the fair market value of a share of Class A common stock, defined as the closing price of Class A common stock on the NYSE for the first and last days of the purchase period (as defined in the ESPP). The total amount of the Company’s Class A common stock on which options may be granted under the ESPP shall not exceed 500,000 shares. Shares of Class A common stock subject to any unexercised portion of a terminated, canceled or expired option granted under the ESPP may again be used for options under the ESPP. No participating employee shall have any rights as a shareholder until the issuance of a stock certificate to the employee. There have been 109,020 shares and 40,598 shares of Class A common stock purchased in the open market by the ESPP in 2019 and 2018, respectively, which resulted in compensation expense of $301 thousand and $205 thousand for the years ended December 31, 2019 and 2018, respectively.
Note 24-Condensed Financial Information of Cadence Bancorporation (Parent Only)
Condensed Balance Sheets
December 31, 2019 and 2018
Condensed Statements of Income
For the Years Ended December 31, 2019, 2018, and 2017
Condensed Statements of Cash Flows
For the Years Ended December 31, 2019, 2018, and 2017
Note 25-Accumulated Other Comprehensive Income (Loss)
Activity within the balances in accumulated other comprehensive income (loss) is shown in the following tables for each of the years in the period ended December 31, 2019.
Note 26-Quarterly Results of Operations (Unaudited)
The following is a summary of the quarterly results of operations for the years ended December 31, 2019 and 2018:
(1)
Includes net securities gains (losses) of $317 thousand, $775 thousand, $938 thousand and $(12) thousand during the fourth, third, second and first quarters of 2019, respectively.
(2)
Includes net securities gains (losses) of $(54) thousand, $2 thousand, $(1.8) million and $12 thousand during the fourth, third, second and first quarters of 2018, respectively.
Note 27-Subsequent Events
On February 18, 2020, the Company announced that its Board of Directors authorized an increase to its share repurchase program of its Class A common stock by an additional $100 million. The Company previously announced a $50 million share repurchase authorization on July 26, 2019. In January and February of 2020, the Company repurchased approximately 1.8 million shares of common stock at a cost of $29.9 million.
The Company expects to fund the program with cash on hand and cash generated from operations. The repurchase authorization may be modified, suspended or discontinued at any time at our discretion and does not obligate us to acquire any particular amount of Class A common stock. The actual timing, number and value of the shares to be purchased under the program will be determined by management at its discretion.
The Company’s Class A common stock repurchase program will be subject to various factors, including our capital position, liquidity, financial performance and alternate uses of capital, stock trading price, general market and other conditions, and applicable legal requirements. The Class A common stock repurchases may be accomplished through open market purchases or privately negotiated transactions.
On January 31, 2020, the lead plaintiffs filed an amended complaint in the consolidated case captioned Frank Miller et al. v. Cadence Bancorporation et al., Case No. H-19-3492-LNH, in the United States District Court for the Southern District of Texas. See Note 17 for additional detail.
ITEM 9.
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE
Not applicable.
ITEM 9A.
ITEM 9A. CONTROLS AND PROCEDURES
Evaluation of Disclosure Controls and Procedures: As of the end of the period covered by this Annual Report on Form 10-K, our management, including the Chief Executive Officer and Chief Financial Officer have evaluated our disclosure controls and procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based upon that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that our disclosure controls and procedures were effective in ensuring that information required to be disclosed is recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms and are also designed to ensure that the information required to be disclosed in the reports filed or submitted under the Exchange Act is accumulated and communicated to management, including the Chief Executive Officer and Chief Financial Officer, to allow timely decisions regarding required disclosures.
Management's Report on Internal Control Over Financial Reporting. The Report of Management on Internal Control Over Financial Reporting and the attestation report on our internal control over financial reporting issued by Ernst & Young LLP, the independent registered public accounting firm that audited our consolidated financial statements, are included in Item 8 of this Annual Report on Form 10-K.
Changes in Internal Control Over Financial Reporting. No change in our internal control over financial reporting occurred during the fourth fiscal quarter ended December 31, 2019 covered by this Annual Report that materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
ITEM 9B.
ITEM 9B. OTHER INFORMATION
None.
PART III
ITEM 10.
ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE
The information required by this Item is incorporated herein by reference to the information under the captions “Directors and Executive Officers” and “Board of Directors, Committees and Governance” in our Proxy Statement for the Annual Meeting of Shareholders to be held on May 7, 2020 (the “2020 Proxy Statement”), to be filed with the Commission pursuant to Regulation 14A under the Exchange Act within 120 days of our fiscal year end.
ITEM 11.
ITEM 11. EXECUTIVE COMPENSATION
The information required by this Item is incorporated herein by reference to the information under the caption “Executive and Director Compensation” in the 2020 Proxy Statement.
ITEM 12.
ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED SHAREHOLDER MATTERS
The information required by this Item is incorporated herein by reference to the information under the caption “Security Ownership of Certain Beneficial Owners, Directors and Management” in the 2020 Proxy Statement.
ITEM 13.
ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE
The information required by this Item is incorporated herein by reference to the information under the caption “Certain Related Party Transactions” in the 2020 Proxy Statement.
ITEM 14.
ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES
The information required by this Item is incorporated herein by reference to the information under the caption “Principal Accountant Fees” in the 2020 Proxy Statement.
PART IV
ITEM 15.
ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES
(a) Financial Statements and Financial Schedules.
(l)
The consolidated financial statements of the Company and its subsidiaries filed as a part of this Annual Report on Form 10-K are listed in Item 8 of this Annual Report on Form 10-K, which is hereby incorporated by reference herein.
(2)
All schedules to the consolidated financial statements of the Company and its subsidiaries have been omitted because they are not required under the related instructions or are inapplicable, or because the required information has been provided in the consolidated financial statements or the notes thereto.
(b) Exhibits.
The exhibits to this Annual Report on Form 10-K listed below have been included only with the copy of this report filed with the Securities and Exchange Commission. The Company will furnish a copy of any exhibit to shareholders upon written request to the Company and payment of a reasonable fee not to exceed the Company’s reasonable expense.
EXHIBIT INDEX
NUMBER
DESCRIPTION
2.1
Agreement and Plan of Merger, dated as of May 11, 2018, by and between Cadence Bancorporation and State Bank Financial Corporation (incorporated herein by reference to Exhibit 2.1 to the Current Report on Form 8-K of Cadence Bancorporation, filed with the Securities and Exchange Commission on May 14, 2018).
3.1
Second Amended and Restated Certificate of Incorporation of Cadence Bancorporation (incorporated by reference to Exhibit 3.1 to the Registration Statement on Form S-1 of Cadence Bancorporation (Registration No. 333-216809), filed with the Securities and Exchange Commission on March 17, 2017).
3.2
Amended and Restated Bylaws of Cadence Bancorporation (incorporated by reference to Exhibit 3.2 to the Registration Statement on Form S-1 of Cadence Bancorporation (Registration No. 333-216809), filed with the Securities and Exchange Commission on March 17, 2017).
4.1
Form of common stock certificate of Cadence Bancorporation (incorporated by reference to Exhibit 4.1 to the Registration Statement on Form S-1 of Cadence Bancorporation (Registration No. 333-216809), filed with the Securities and Exchange Commission on March 17, 2017).
4.2
Certain instruments defining the rights of holders of long-term debt securities of the Company and its subsidiaries are omitted pursuant to Item 601(b)(4)(iii)(A) of Regulation S-K. The Company hereby agrees to furnish copies of these instruments to the SEC upon request.
10.1
Credit Agreement, dated as of March 29, 2019, by and between Cadence Bancorporation and U.S. Bank National Association (incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K of Cadence Bancorporation, filed with the Securities and Exchange Commission on April 2, 2019).
10.2†
Employment Agreement, dated February 1, 2015, by and between Cadence Bancorporation and Paul B. Murphy, Jr (incorporated by reference to Exhibit 10.1 to the Registration Statement on Form S-1 of Cadence Bancorporation (Registration No. 333-216809), filed with the Securities and Exchange Commission on March 17, 2017).
10.3†
Amended and Restated Employment Agreement, dated March 14, 2017, by and between Cadence Bancorporation and Samuel M. Tortorici (incorporated by reference to Exhibit 10.2 to the Registration Statement on Form S-1 of Cadence Bancorporation (Registration No. 333-216809), filed with the Securities and Exchange Commission on March 17, 2017).
10.4†
Amended and Restated Employment Agreement, dated March 14, 2017, by and between Cadence Bancorporation and R.H. “Hank” Holmes, IV (incorporated by reference to Exhibit 10.3 to the Registration Statement on Form S-1 of Cadence Bancorporation (Registration No. 333-216809), filed with the Securities and Exchange Commission on March 17, 2017).
10.5†
Amended and Restated Employment Agreement, dated March 14, 2017, by and between Cadence Bancorporation and Valerie C. Toalson.
10.6†
Amended and Restated Employment Agreement, dated March 14, 2017, by and between Cadence Bancorporation and Jack R. Schultz (incorporated by reference to Exhibit 10.5 to the Registration Statement on Form S-1 of Cadence Bancorporation (Registration No. 333-216809), filed with the Securities and Exchange Commission on March 17, 2017).
10.7†
Cadence Bank 2013 Long-Term Incentive Plan (incorporated by reference to (incorporated by reference to Exhibit 10.8 to the Registration Statement on Form S-1 of Cadence Bancorporation (Registration No. 333-216809), filed with the Securities and Exchange Commission on March 17, 2017).
10.8†
Form of Cadence Bank Long-Term Incentive Award Agreement under the Cadence Bank 2013 Long-Term Incentive Plan (incorporated by reference to Exhibit 10.9 to the Registration Statement on Form S-1 of Cadence Bancorporation (Registration No. 333-216809), filed with the Securities and Exchange Commission on March 17, 2017).
10.9†
Amended and Restated Cadence Bancorporation 2015 Omnibus Incentive Plan (incorporated by reference to Exhibit 10.1 to the Registration Statement on Form S-8 of Cadence Bancorporation (Registration No. 333-217316), filed with the Securities and Exchange Commission on April 14, 2017).
10.10†
Form of Performance-Based Restricted Stock Unit Agreement under the Amended and Restated Cadence Bancorporation 2015 Omnibus Incentive Plan (incorporated by reference to Exhibit 10.11 to the Registration Statement on Form S-1 of Cadence Bancorporation (Registration No. 333-216809), filed with the Securities and Exchange Commission on March 17, 2017).
NUMBER
DESCRIPTION
10.11†
Cadence Bancorporation Executive Bonus Plan (incorporated by reference to Exhibit 10.12 to the Registration Statement on Form S-1 of Cadence Bancorporation (Registration No. 333-216809), filed with the Securities and Exchange Commission on March 17, 2017).
10.12†
Cadence Bancorporation Deferred Compensation Plan (incorporated by reference to Exhibit 10.13 to the Registration Statement on Form S-1 of Cadence Bancorporation (Registration No. 333-216809), filed with the Securities and Exchange Commission on March 17, 2017).
10.13†
Form of Indemnification Agreement (incorporated by reference to Exhibit 10.14 to the Registration Statement on Form S-1 of Cadence Bancorporation (Registration No. 333-216809), filed with the Securities and Exchange Commission on March 17, 2017).
10.14†
Cadence Bancorporation 2018 Employee Stock Purchase Plan (incorporated by reference to Exhibit A to the Revised Definitive Proxy Statement of Cadence Bancorporation for its 2018 Annual Meeting of Stockholders, filed with the Securities and Exchange Commission on March 30, 2018).
10.15†
Services and Covenant Agreement, dated as of June 11, 2018, by and between Cadence Bancorporation and Joseph W. Evans (incorporated herein by reference to Exhibit 10.1 to the Current Report on Form 8-K of Cadence Bancorporation, filed with the Securities and Exchange Commission on January 2, 2019).
10.16†
Services and Covenant Agreement, dated as of June 11, 2018, by and between Cadence Bancorporation and J. Thomas Wiley, Jr. (incorporated herein by reference to Exhibit 10.2 to the Current Report on Form 8-K of Cadence Bancorporation, filed with the Securities and Exchange Commission on January 2, 2019).
21.1
Subsidiaries of Cadence Bancorporation.
23.1
Consent of Ernst & Young LLP.
31.1
Certification of the Chief Executive Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
31.2
Certification of the Chief Financial Officer pursuant to Section 302 of Sarbanes-Oxley Act of 2002
32.1
Certification of the Chief Executive Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002
32.2
Certification of the Chief Financial Officer pursuant to Section 906 of Sarbanes-Oxley Act of 2002
101.INS
Inline XBRL Instance Document - the instance document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL document.
101.SCH
Inline XBRL Taxonomy Extension Schema Document.
101.CAL
Inline XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF
Inline XBRL Taxonomy Extension Definition Linkbase Document
101.LAB
Inline XBRL Taxonomy Extension Label Linkbase Document
101.PRE
Inline XBRL Taxonomy Extension Presentation Linkbase Document
The cover page for the Company’s Annual Report on Form 10-K for the year ended December 31, 2019, has been formatted in Inline XBRL
†
Indicates a management contract or compensatory plan.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Annual Report to be signed on its behalf by the undersigned, thereunto duly authorized in Houston, Texas on the 28th day of February 2020.
Pursuant to the requirements of the Securities Exchange Act of 1934, as amended, this Annual Report has been signed by the following persons in the capacities and on the dates indicated.