Independent Bank 10Q 2017 Q1 Quarterly report

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q(Mark One)



ý	Quarterly Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934.

For the quarterly period ended March 31, 2017.



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

For the transition period from to .

Commission file number 001-35854

Independent Bank Group, Inc.

(Exact name of registrant as specified in its charter)



Texas		13-4219346
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

1600 Redbud Boulevard, Suite 400 McKinney, Texas		75069-3257
(Address of principal executive offices)		(Zip Code)

(972) 562-9004

(Registrant’s telephone number, including area code)

Not applicable

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

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or such shorter periods that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ý No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes ý No ¨

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



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

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards pursuant to Section 13(a) of the Exchange Act. ý

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

Applicable Only to Corporate Issuers

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practical date.

Common Stock, Par Value $0.01 Per Share – 27,780,224 shares as of April 26, 2017.

INDEPENDENT BANK GROUP, INC. AND SUBSIDIARIES

Form 10-Q

March 31, 2017



PART I.	Financial Information

Item 1.	Financial Statements
	Consolidated Balance Sheets-Unaudited	1
	Consolidated Statements of Income-Unaudited	2
	Consolidated Statements of Comprehensive Income-Unaudited	3
	Consolidated Statements of Changes in Stockholders’ Equity-Unaudited	4
	Consolidated Statements of Cash Flows-Unaudited	5
	Notes to Consolidated Financial Statements-Unaudited	6

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	30

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	44

Item 4.	Controls and Procedures	45

PART II.	Other Information

Item 1.	Legal Proceedings	46

Item 1A.	Risk Factors	46

Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	46

Item 3.	Defaults Upon Senior Securities	46

Item 4.	Mine Safety Disclosures	46

Item 5.	Other Information	46

Item 6.	Exhibits	47

Signatures

***

Independent Bank Group, Inc. and Subsidiaries

Consolidated Balance Sheets

March 31, 2017 (unaudited) and December 31, 2016

(Dollars in thousands, except share information)



	March 31,		December 31,
Assets	2017		2016

Cash and due from banks	$	162,985	$	158,686
Interest-bearing deposits in other banks	342,138		336,341
Federal funds sold	10,000		10,000
Cash and cash equivalents	515,123		505,027
Certificates of deposit held in other banks	5,892		2,707
Securities available for sale, at fair value	350,409		316,435
Loans held for sale	5,081		9,795
Loans, net	4,666,653		4,539,063
Premises and equipment, net	88,286		89,898
Other real estate owned	2,896		1,972
Federal Home Loan Bank (FHLB) of Dallas stock and other restricted stock	26,672		26,536
Bank-owned life insurance (BOLI)	57,608		57,209
Deferred tax asset	7,950		9,631
Goodwill	258,319		258,319
Core deposit intangible, net	13,685		14,177
Other assets	24,040		22,032
Total assets	$	6,022,614	$	5,852,801

Liabilities and Stockholders’ Equity
Deposits:
Noninterest-bearing	$	1,126,113	$	1,117,927
Interest-bearing	3,596,090		3,459,182
Total deposits	4,722,203		4,577,109

FHLB advances	460,727		460,746
Other borrowings	107,388		107,299
Junior subordinated debentures	18,147		18,147
Other liabilities	25,680		17,135
Total liabilities	5,334,145		5,180,436
Commitments and contingencies
Stockholders’ equity:
Preferred stock (0 and 0 shares outstanding, respectively)	—		—
Common stock (18,925,182 and 18,870,312 shares outstanding, respectively)	189		189
Additional paid-in capital	556,350		555,325
Retained earnings	131,730		117,951
Accumulated other comprehensive income (loss)	200		(1,100		)
Total stockholders’ equity	688,469		672,365
Total liabilities and stockholders’ equity	$	6,022,614	$	5,852,801

See Notes to Consolidated Financial Statements

Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Income

Three Months Ended March 31, 2017 and 2016 (unaudited)

(Dollars in thousands, except per share information)



	Three Months Ended March 31,
	2017		2016
Interest income:
Interest and fees on loans	$	53,744	$	49,910
Interest on taxable securities	764		730
Interest on nontaxable securities	541		451
Interest on interest-bearing deposits and other	890		373
Total interest income	55,939		51,464
Interest expense:
Interest on deposits	5,029		3,651
Interest on FHLB advances	1,171		1,001
Interest on repurchase agreements and other borrowings	1,705		1,003
Interest on junior subordinated debentures	167		149
Total interest expense	8,072		5,804
Net interest income	47,867		45,660
Provision for loan losses	2,023		2,997
Net interest income after provision for loan losses	45,844		42,663
Noninterest income:
Service charges on deposit accounts	1,927		1,695
Mortgage fee income	1,267		1,376
Gain on sale of other real estate	—		43
Gain on sale of premises and equipment	5		38
Increase in cash surrender value of BOLI	399		265
Other	985		1,053
Total noninterest income	4,583		4,470
Noninterest expense:
Salaries and employee benefits	16,837		16,774
Occupancy	3,872		4,040
Data processing	1,288		1,182
FDIC assessment	878		726
Advertising and public relations	297		295
Communications	475		535
Net other real estate owned expenses (including taxes)	37		33
Other real estate impairment	—		55
Core deposit intangible amortization	492		488
Professional fees	773		660
Acquisition expense, including legal	146		639
Other	2,933		3,092
Total noninterest expense	28,028		28,519
Income before taxes	22,399		18,614
Income tax expense	6,728		6,162
Net income	$	15,671	$	12,452
Basic earnings per share	$	0.83	$	0.67
Diluted earnings per share	$	0.82	$	0.67

See Notes to Consolidated Financial Statements

Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

Three Months Ended March 31, 2017 and 2016 (unaudited)

(Dollars in thousands)



	Three Months Ended March 31,
	2017		2016
Net income	$	15,671	$	12,452
Other comprehensive income before tax:
Change in net unrealized gains on available for sale securities during the year	2,000		1,205
Reclassification adjustment for gain on sale of securities available for sale included in net income	—		—
Other comprehensive income before tax	2,000		1,205
Income tax expense	700		422
Other comprehensive income, net of tax	1,300		783
Comprehensive income	$	16,971	$	13,235

See Notes to Consolidated Financial Statements

Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

Three Months Ended March 31, 2017 and 2016 (unaudited)

(Dollars in thousands, except for par value, share and per share information)



	Preferred Stock $.01 Par Value 10 million shares authorized		Common Stock $.01 Par Value 100 million shares authorized				Additional Paid in Capital			Retained Earnings			Accumulated Other Comprehensive Income (loss)			Total
	Preferred Stock $.01 Par Value 10 million shares authorized		Shares		Amount		Additional Paid in Capital			Retained Earnings			Accumulated Other Comprehensive Income (loss)			Total
Balance, December 31, 2016	$	—	18,870,312		$	189	$	555,325		$	117,951		$	(1,100	)	$	672,365
Net income	—		—		—		—			15,671			—			15,671
Other comprehensive income, net of tax	—		—		—		—			—			1,300			1,300
Restricted stock granted	—		51,667		—		—			—			—			—
Stock based compensation expense	—		—		—		970			—			—			970
Exercise of warrants	—		3,203		—		55			—			—			55
Cash dividends ($0.10 per share)	—		—		—		—			(1,892		)	—			(1,892		)
Balance, March 31, 2017	$	—	18,925,182		$	189	$	556,350		$	131,730		$	200		$	688,469

Balance, December 31, 2015	$	—	18,399,194		$	184	$	530,107		$	70,698		$	2,382		$	603,371
Net income	—		—		—		—			12,452			—			12,452
Other comprehensive income, net of tax	—		—		—		—			—			783			783
Restricted stock forfeited	—		(5,534	)	—		—			—			—			—
Restricted stock granted	—		67,820		1		(1		)	—			—			—
Income tax deficiency on restricted stock vested	—		—		—		(83		)	—			—			(83		)
Stock based compensation expense	—		—		—		1,220			—			—			1,220
Preferred stock dividends	—		—		—		—			(8		)	—			(8		)
Cash dividends ($0.08 per share)	—		—		—		—			(1,477		)	—			(1,477		)
Balance, March 31, 2016	$	—	18,461,480		$	185	$	531,243		$	81,665		$	3,165		$	616,258

See Notes to Consolidated Financial Statements

Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Three Months Ended March 31, 2017 and 2016 (unaudited)

(Dollars in thousands)



	Three Months Ended March 31,
	2017			2016
Cash flows from operating activities:
Net income	$	15,671		$	12,452
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense	1,763			1,639
Accretion income recognized on acquired loans	(480		)	(2,217		)
Amortization of core deposit intangibles	492			488
Amortization of premium on securities, net	721			377
Amortization of discount and origination costs on other borrowings	89			32
Stock based compensation expense	970			1,220
Excess tax benefit on restricted stock vested	(724		)	—
FHLB stock dividends	(88		)	(36		)
Gain on sale of premises and equipment	(5		)	(38		)
Gain recognized on other real estate transactions	—			(43		)
Impairment of other real estate	—			55
Deferred tax expense	981			594
Provision for loan losses	2,023			2,997
Increase in cash surrender value of life insurance	(399		)	(265		)
Loans originated for sale	(51,631		)	(49,481		)
Proceeds from sale of loans	56,345			53,265
Net change in other assets	(2,008		)	1,294
Net change in other liabilities	3,201			780
Net cash provided by operating activities	26,921			23,113
Cash flows from investing activities:
Proceeds from maturities, calls and pay downs of securities available for sale	17,241			16,479
Purchases of securities available for sale	(43,868		)	(44,838		)
Purchases of certificates held in other banks	(3,185		)	—
Maturities of certificates held in other banks	—			22,412
Net purchases of FHLB stock	(48		)	(8,108		)
Net loans originated	(129,883		)	(137,809		)
Additions to premises and equipment	(155		)	(1,269		)
Proceeds from sale of premises and equipment	9			84
Proceeds from sale of other real estate owned	—			411
Capitalized additions to other real estate owned	(174		)	—
Net cash used in investing activities	(160,063		)	(152,638		)
Cash flows from financing activities:
Net increase in demand deposits, NOW and savings accounts	141,116			163,847
Net increase (decrease) in time deposits	3,978			(40,862		)
Proceeds from FHLB advances	—			225,000
Repayments of FHLB advances	(19		)	(132,520		)
Net change in repurchase agreements	—			8,528
Repayments of other borrowings	—			(5,798		)
Proceeds from exercise of common stock warrants	55			—
Redemption of preferred stock	—			(23,938		)
Dividends paid	(1,892		)	(1,485		)
Net cash provided by financing activities	143,238			192,772
Net change in cash and cash equivalents	10,096			63,247
Cash and cash equivalents at beginning of year	505,027			293,279
Cash and cash equivalents at end of period	$	515,123		$	356,526

See Notes to Consolidated Financial Statements

Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

(Dollars in thousands, except for share and per share information)

Note 1. Summary of Significant Accounting Policies

Nature of Operations: Independent Bank Group, Inc. (IBG) through its subsidiary, Independent Bank, a Texas state banking corporation (Bank) (collectively known as the Company), provides a full range of banking services to individual and corporate customers in the North Texas, Central Texas and Houston areas through its various branch locations in those areas. The Company is engaged in traditional community banking activities, which include commercial and retail lending, deposit gathering, investment and liquidity management activities. The Company’s primary deposit products are demand deposits, money market accounts and certificates of deposit, and its primary lending products are commercial business and real estate, real estate mortgage and consumer loans.

Basis of Presentation: The accompanying consolidated financial statements include the accounts of IBG, its wholly-owned subsidiaries, the Bank and IBG Adriatica Holdings, Inc. (Adriatica) and the Bank’s wholly-owned subsidiaries, IBG Real Estate Holdings, Inc., IBG Aircraft Company III, Preston Grand, Inc, and McKinney Avenue Holdings, Inc. and its wholly owned subsidiary, McKinney Avenue SPE 1, Inc. Adriatica, McKinney Avenue Holdings, Inc. and its subsidiary are currently not active entities. All material intercompany transactions and balances have been eliminated in consolidation. In addition, the Company wholly-owns IB Trust I (Trust I), IB Trust II (Trust II), IB Trust III (Trust III), IB Centex Trust I (Centex Trust I) and Community Group Statutory Trust I (CGI Trust I). The Trusts were formed to issue trust preferred securities and do not meet the criteria for consolidation.

The consolidated interim financial statements are unaudited, but include all adjustments, which, in the opinion of management, are necessary for a fair presentation of the results of the periods presented. All such adjustments were of a normal and recurring nature. These financial statements should be read in conjunction with the financial statements and the notes thereto in the Company's Annual Report of Form10-K for the year ended December 31, 2016. The consolidated statement of condition at December 31, 2016 had been derived from the audited financial statements as of that date, but does not include all of the information and footnotes required by accounting principles generally accepted in the United States of America for complete financial statements.

Segment Reporting: The Company has one reportable segment. The Company’s chief operating decision-maker uses consolidated results to make operating and strategic decisions.

Reclassifications: Certain prior period financial statement amounts have been reclassified to conform to current period presentation. The reclassifications have no effect on net income or stockholders' equity as previously reported.

New Accounting Pronouncement: ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting was effective for the Company on January 1, 2017. ASU 2016-09 requires that all income tax effects related to vestings of share-based payment awards be reported in earnings as an increase (or decrease) to income tax expense. Previously, excess income tax benefits of a vested award were reported as an increase (or decrease) to additional paid-in capital to the extent that those benefits were greater than (or less than) the income tax benefits recognized in earnings during the award's vesting period. The requirement to report those income tax effects in earnings has been applied to vestings occurring on or after January 1, 2017 and resulted in recording a $724 thousand tax benefit for the period ended March 31, 2017. ASU 2016-09 also requires that all income tax-related cash flows resulting from share-based payments be reported as operating activities in the statement of cash flows. We have elected to apply that change in cash flow classification on a prospective basis. The impact of this change and that of the remaining provisions of ASU 2016-09 did not have significant impact on our financial statements.

Subsequent events: Companies are required to evaluate events and transactions that occur after the balance sheet date but before the date the financial statements are issued. They must recognize in the financial statements the effect of all events or transactions that provide additional evidence of conditions that existed at the balance sheet date, including the estimates inherent in the financial statement preparation process. Entities shall not recognize the impact of events or transactions that provide evidence about conditions that did not exist at the balance sheet date but arose after that date. The Company has evaluated subsequent events through the date of filing these financial statements with the Securities and Exchange Commission (SEC) and noted no subsequent events requiring financial statement recognition or disclosure, except as disclosed in Note 10.

Earnings per share: Basic earnings per common share are net income available to common shareholders divided by the weighted average number of common shares outstanding during the period. The unvested share-based payment awards that contain rights to non forfeitable dividends are considered participating securities for this calculation. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under stock warrants. The participating nonvested common stock was not included in dilutive shares as it was anti-dilutive for the three months ended March 31, 2017. Proceeds from the assumed exercise of dilutive stock warrants are assumed to be used to repurchase common stock at the average market price.

The following table presents a reconciliation of net income available to common shareholders and the number of shares used in the calculation of basic and diluted earnings per common share.



	Three Months Ended March 31,
	2017		2016
Basic earnings per share:
Net income	$	15,671	$	12,452
Less: Preferred stock dividends	—		(8		)
Net income after preferred stock dividends	15,671		12,444
Less:
Undistributed earnings allocated to participating securities	176		211
Dividends paid on participating securities	24		28
Net income available to common shareholders	$	15,471	$	12,205
Weighted-average basic shares outstanding	18,667,274		18,089,853
Basic earnings per share	$	0.83	$	0.67
Diluted earnings per share:
Net income available to common shareholders	$	15,471	$	12,205
Total weighted-average basic shares outstanding	18,667,274		18,089,853
Add dilutive stock warrants	107,132		61,492
Add dilutive participating securities	—		22,255
Total weighted-average diluted shares outstanding	18,774,406		18,173,600
Diluted earnings per share	$	0.82	$	0.67
Anti-dilutive participating securities	126,847		—

Note 2. Statement of Cash Flows

As allowed by the accounting standards, the Company has chosen to report on a net basis its cash receipts and cash payments for time deposits accepted and repayments of those deposits, and loans made to customers and principal collections on those loans. The Company uses the indirect method to present cash flows from operating activities. Other supplemental cash flow information is presented below:



	Three Months Ended March 31,
	2017		2016
Cash transactions:
Interest expense paid	$	9,694	$	6,823
Income taxes paid	$	—	$	760
Noncash transactions:
Transfers of loans to other real estate owned	$	750	$	—
Securities purchased, not yet settled	$	6,068	$	—
Excess tax deficiency on restricted stock vested	$	—	$	(83	)
Transfer of repurchase agreements to deposits	$	—	$	20,688

The supplemental schedule of noncash investing activities from Company acquisition activity includes the following measurement-period adjustments made during the period:



	Three Months Ended March 31,
	2017		2016
Assets acquired:
Loans	$	—	$	735
Goodwill	—		(324		)
Core deposit intangibles	—		(216		)
Deferred tax asset	—		(175		)
Total assets	$	—	$	20
Liabilities assumed:
Other liabilities	—		20
Total liabilities	$	—	$	20

Note 3. Securities Available for Sale

Securities available for sale have been classified in the consolidated balance sheets according to management’s intent. The amortized cost of securities and their approximate fair values at March 31, 2017 and December 31, 2016, are as follows:



	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses			Fair Value
Securities Available for Sale
March 31, 2017
U. S. treasuries	$	3,196	$	—	$	(38	)	$	3,158
Government agency securities	136,621		165		(1,078		)	135,708
Obligations of state and municipal subdivisions	103,554		1,259		(1,447		)	103,366
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC	107,643		1,085		(551		)	108,177
	$	351,014	$	2,509	$	(3,114	)	$	350,409
December 31, 2016
U.S. treasuries	$	3,208	$	—	$	(61	)	$	3,147
Government agency securities	123,605		141		(1,479		)	122,267
Obligations of state and municipal subdivisions	88,358		920		(2,022		)	87,256
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC	103,869		928		(1,032		)	103,765
	$	319,040	$	1,989	$	(4,594	)	$	316,435

Securities with a carrying amount of approximately $169,770 and $176,457 at March 31, 2017 and December 31, 2016, respectively, were pledged to secure public fund deposits and repurchase agreements.

There were no sales of securities during the three months ended March 31, 2017 and 2016.

The amortized cost and estimated fair value of securities available for sale at March 31, 2017, by contractual maturity, are shown below. Maturities of pass-through certificates will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.



	March 31, 2017
	Securities Available for Sale
	Amortized Cost		Fair Value
Due in one year or less	$	31,149	$	31,132
Due from one year to five years	113,221		112,685
Due from five to ten years	37,014		36,601
Thereafter	61,987		61,814
	243,371		242,232
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC	107,643		108,177
	$	351,014	$	350,409

The number of securities, unrealized losses and fair value, aggregated by investment category and length of time that individual securities have been in a continuous unrealized loss position, as of March 31, 2017 and December 31, 2016, are summarized as follows:



	Less Than 12 Months						Greater Than 12 Months						Total
Description of Securities	Number of Securities	Estimated Fair Value		Unrealized Losses			Number of Securities	Estimated Fair Value		Unrealized Losses			Estimated Fair Value		Unrealized Losses
Securities Available for Sale
March 31, 2017
U.S. treasuries	1	$	3,158	$	(38	)	—	$	—	$	—		$	3,158	$	(38	)
Government agency securities	45	104,389		(1,072		)	1	995		(6		)	105,384		(1,078		)
Obligations of state and municipal subdivisions	76	38,076		(1,418		)	5	2,185		(29		)	40,261		(1,447		)
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC	28	70,714		(551		)	—	—		—			70,714		(551		)
	150	$	216,337	$	(3,079	)	6	$	3,180	$	(35	)	$	219,517	$	(3,114	)
December 31, 2016
U.S. treasuries	1	$	3,147	$	(61	)	—	$	—	$	—		$	3,147	$	(61	)
Government agency securities	43	102,044		(1,472		)	1	993		(7		)	103,037		(1,479		)
Obligations of state and municipal subdivisions	100	46,186		(2,011		)	4	1,549		(11		)	47,735		(2,022		)
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC	30	67,868		(1,032		)	—	—		—			67,868		(1,032		)
	174	$	219,245	$	(4,576	)	5	$	2,542	$	(18	)	$	221,787	$	(4,594	)

Unrealized losses are generally due to changes in interest rates. The Company has the intent to hold these securities until maturity or a forecasted recovery, and it is more likely than not that the Company will not have to sell the securities before the recovery of their cost basis. As such, the losses are deemed to be temporary.

Note 4. Loans, Net and Allowance for Loan Losses

Loans, net, at March 31, 2017 and December 31, 2016, consisted of the following:



	March 31,			December 31,
	2017			2016
Commercial	$	601,985		$	630,805
Real estate:
Commercial	2,562,743			2,459,221
Commercial construction, land and land development	573,623			531,481
Residential	647,569			634,545
Single family interim construction	237,740			235,475
Agricultural	52,515			53,548
Consumer	26,224			27,530
Other	112			166
	4,702,511			4,572,771
Deferred loan fees	(2,427		)	(2,117		)
Allowance for loan losses	(33,431		)	(31,591		)
	$	4,666,653		$	4,539,063

The Company has certain lending policies and procedures in place that are designed to maximize loan income within an acceptable level of risk. Management reviews and approves these policies and procedures on a regular basis. A reporting system supplements the review process by providing management with frequent reports related to loan production, loan quality, concentrations of credit, loan delinquencies and non-performing and potential problem loans.

Commercial loans are underwritten after evaluating and understanding the borrower’s ability to operate profitably and prudently expand its business. The Company’s management examines current and projected cash flows to determine the ability of the borrower to repay their obligations as agreed. Commercial loans are primarily made based on the identified cash flows of the borrower and secondarily on the underlying collateral provided by the borrower. These cash flows, however, may not be as expected and the value of collateral securing the loans may fluctuate. Most commercial loans are secured by the assets being financed or other business assets such as accounts receivable or inventory and may incorporate a personal guarantee; however, some short term loans may be made on an unsecured basis. Additionally, our commercial loan portfolio includes loans made to customers in the energy industry, which is a complex, technical and cyclical industry. Experienced bankers with specialized energy lending experience originate our energy loans. Companies in this industry produce, extract, develop, exploit and explore for oil and natural gas. Loans are primarily collateralized with proven producing oil and gas reserves based on a technical evaluation of these reserves. At March 31, 2017 and December 31, 2016, there were approximately $97.2 million and $115.3 million of exploration and production (E&P) energy loans outstanding, respectively.

Commercial real estate loans are subject to underwriting standards and processes similar to commercial loans. These loans are viewed primarily as cash flow loans and secondarily as loans secured by real estate. Commercial real estate lending typically involves higher loan principal amounts, and the repayment of these loans is generally largely dependent on the successful operation of the property or the business conducted on the property securing the loan. Commercial real estate loans may be more adversely affected by conditions in the real estate markets or in the general economy. The properties securing the Company’s commercial real estate portfolio are diverse in terms of type and geographic location. Management monitors the diversification of the portfolio on a quarterly basis by type and geographic location. Management also tracks the level of owner occupied property versus non owner occupied property.

Land and commercial land development loans are underwritten using feasibility studies, independent appraisal reviews and financial analysis of the developers or property owners. Generally, borrowers must have a proven track record of success. Commercial construction loans are generally based upon estimates of cost and value of the completed project. These estimates may not be accurate. Commercial construction loans often involve the disbursement of substantial funds with the repayment dependent on the success of the ultimate project. Sources of repayment for these loans may be pre-committed permanent financing or sale of the developed property. The loans in this portfolio are geographically diverse and due to the increased risk are monitored closely by management and the board of directors on a quarterly basis.

Residential real estate and single family interim construction loans are underwritten primarily based on borrowers’ credit scores, documented income and minimum collateral values. Relatively small loan amounts are spread across many individual borrowers, which minimizes risk in the residential portfolio. In addition, management evaluates trends in past dues and current economic factors on a regular basis.

Agricultural loans are collateralized by real estate and/or agricultural-related assets. Agricultural real estate loans are primarily comprised of loans for the purchase of farmland. Loan-to-value ratios on loans secured by farmland generally do not exceed 80% and have amortization periods limited to twenty years. Agricultural non-real estate loans are generally comprised of term loans to fund the purchase of equipment, livestock and seasonal operating lines to grain farmers to plant and harvest corn and soybeans. Specific underwriting standards have been established for agricultural-related loans, including the establishment of projections for each operating year based on industry developed estimates of farm input costs and expected commodity yields and prices. Operating lines are typically written for one year and secured by the crop and other farm assets as considered necessary.

Agricultural loans carry significant credit risks as they involve larger balances concentrated with single borrowers or groups of related borrowers. In addition, repayment of such loans depends on the successful operation or management of the farm property securing the loan or for which an operating loan is utilized. Farming operations may be affected by adverse weather conditions such as drought, hail or floods that can severely limit crop yields.

Consumer loans represent less than 1% of the outstanding total loan portfolio. Collateral consists primarily of automobiles and other personal assets. Credit score analysis is used to supplement the underwriting process.

Most of the Company’s lending activity occurs within the State of Texas, primarily in the north, central and southeast Texas regions. A large percentage of the Company’s portfolio consists of commercial and residential real estate loans. As of March 31, 2017 and December 31, 2016, there were no concentrations of loans related to a single industry in excess of 10% of total loans.

The allowance for loan losses is an amount that management believes will be adequate to absorb estimated losses relating to specifically identified loans, as well as probable credit losses inherent in the balance of the loan portfolio.

The allowance is derived from the following two components: 1) allowances established on individual impaired loans, which are based on a review of the individual characteristics of each loan, including the customer’s ability to repay the loan, the underlying collateral values, and the industry in which the customer operates, and 2) allowances based on actual historical loss experience for the last three years for similar types of loans in the Company’s loan portfolio adjusted for primarily changes in the lending policies and procedures; collection, charge-off and recovery practices; nature and volume of the loan portfolio; change in value of underlying collateral; volume and severity of nonperforming loans; existence and effect of any concentrations of credit and the level of such concentrations and current, national and local economic and business conditions. This second component also includes an unallocated allowance to cover uncertainties that could affect management’s estimate of probable losses. The unallocated allowance reflects the imprecision inherent in the underlying assumptions used in the methodologies for estimating this component.

The Company’s management continually evaluates the allowance for loan losses determined from the allowances established on individual loans and the amounts determined from historical loss percentages adjusted for the qualitative factors above. Should any of the factors considered by management change, the Company’s estimate of loan losses could also change and would affect the level of future provision expense. While the calculation of the allowance for loan losses utilizes management’s best judgment and all the information available, the adequacy of the allowance for loan losses is dependent on a variety of factors beyond the Company’s control, including, among other things, the performance of the entire loan portfolio, the economy, changes in interest rates and the view of regulatory authorities towards loan classifications.

In addition, regulatory agencies, as an integral part of their examination process, periodically review the Bank’s allowance for loan losses, and may require the Bank to make additions to the allowance based on their judgment about information available to them at the time of their examinations.

Loans requiring an allocated loan loss provision are generally identified at the servicing officer level based on review of weekly past due reports and/or the loan officer’s communication with borrowers. In addition, past due loans are discussed at weekly officer loan committee meetings to determine if classification is warranted. The Company’s credit department has implemented an internal risk based loan review process to identity potential internally classified loans that supplements the annual independent external loan review. The external review generally covers all loans greater than $2.9 million annually. These reviews include analysis of borrower’s financial condition, payment histories and collateral values to determine if a loan should be internally classified. Generally, once classified, an impaired loan analysis is completed by the credit department to determine if the loan is impaired and the amount of allocated allowance required.

The Texas economy, specifically the Company’s lending area of north, central and southeast Texas, has generally performed better than certain other parts of the country. The risk of loss associated with all segments of the portfolio could increase due to this impact. During the first quarter of 2016, the Company increased its reserves in the energy portfolio in response to the risk associated with volatility in oil prices. Due to the stabilization of commodity prices and reductions to the energy portfolio during the second half of 2016, the Company has not made any additional allocations during 2017 and believes economic factors indicate improvement in the energy sector and that the economy in our lending areas, including Houston, will continue to grow.

The economy and other risk factors are minimized by the Company’s underwriting standards, which include the following principles: 1) financial strength of the borrower including strong earnings, high net worth, significant liquidity and acceptable debt to worth ratio, 2) managerial business competence, 3) ability to repay, 4) loan to value, 5) projected cash flow and 6) guarantor financial statements as applicable. The following is a summary of the activity in the allowance for loan losses by loan class for the three months ended March 31, 2017 and 2016:



	Commercial			Commercial Real Estate, Land and Land Development			Residential Real Estate		Single-Family Interim Construction			Agricultural			Consumer			Other			Unallocated			Total
Three months ended March 31, 2017
Balance at the beginning of period	$	8,593		$	18,399		$	2,760	$	1,301		$	207		$	242		$	29		$	60		$	31,591
Provision for loan losses	(590		)	2,048			67		235			(6		)	64			23			182			2,023
Charge-offs	—			—			—		(134		)	—			(56		)	(22		)	—			(212		)
Recoveries	2			20			1		—			—			2			4			—			29
Balance at end of period	$	8,005		$	20,467		$	2,828	$	1,402		$	201		$	252		$	34		$	242		$	33,431

Three months ended March 31, 2016
Balance at the beginning of period	$	10,573		$	13,007		$	2,339	$	769		$	215		$	164		$	8		$	(32	)	$	27,043
Provision for loan losses	1,592			1,046			133		220			(28		)	(3		)	22			15			2,997
Charge-offs	—			(54		)	—		—			—			(1		)	(23		)	—			(78		)
Recoveries	8			2			1		—			—			2			9			—			22
Balance at end of period	$	12,173		$	14,001		$	2,473	$	989		$	187		$	162		$	16		$	(17	)	$	29,984

The following table details the amount of the allowance for loan losses and recorded investment in loans by class as of March 31, 2017 and December 31, 2016:



	Commercial		Commercial Real Estate, Land and Land Development		Residential Real Estate		Single-Family Interim Construction		Agricultural		Consumer		Other		Unallocated		Total
March 31, 2017
Allowance for losses:
Individually evaluated for impairment	$	500	$	4	$	—	$	—	$	—	$	94	$	—	$	—	$	598
Collectively evaluated for impairment	7,505		20,463		2,828		1,402		201		158		34		242		32,833
Loans acquired with deteriorated credit quality	—		—		—		—		—		—		—		—		—
Ending balance	$	8,005	$	20,467	$	2,828	$	1,402	$	201	$	252	$	34	$	242	$	33,431

Loans:
Individually evaluated for impairment	$	8,196	$	2,843	$	2,039	$	—	$	—	$	264	$	—	$	—	$	13,342
Collectively evaluated for impairment	591,823		3,103,643		643,455		237,740		52,515		25,951		112		—		4,655,239
Acquired with deteriorated credit quality	1,966		29,880		2,075		—		—		9		—		—		33,930
Ending balance	$	601,985	$	3,136,366	$	647,569	$	237,740	$	52,515	$	26,224	$	112	$	—	$	4,702,511

December 31, 2016
Allowance for losses:
Individually evaluated for impairment	$	3	$	4	$	—	$	84	$	—	$	94	$	—	$	—	$	185
Collectively evaluated for impairment	8,590		18,395		2,760		1,217		207		148		29		60		31,406
Loans acquired with deteriorated credit quality	—		—		—		—		—		—		—		—		—
Ending balance	$	8,593	$	18,399	$	2,760	$	1,301	$	207	$	242	$	29	$	60	$	31,591

Loans:
Individually evaluated for impairment	$	7,720	$	7,089	$	1,889	$	884	$	—	$	279	$	—	$	—	$	17,861
Collectively evaluated for impairment	620,665		2,953,333		630,689		234,591		53,548		27,240		166		—		4,520,232
Acquired with deteriorated credit quality	2,420		30,280		1,967		—		—		11		—		—		34,678
Ending balance	$	630,805	$	2,990,702	$	634,545	$	235,475	$	53,548	$	27,530	$	166	$	—	$	4,572,771

Nonperforming loans by loan class at March 31, 2017 and December 31, 2016, are summarized as follows:



	Commercial		Commercial Real Estate, Land and Land Development		Residential Real Estate		Single-Family Interim Construction		Agricultural		Consumer		Other		Total
March 31, 2017
Nonaccrual loans	$	8,196	$	1,666	$	1,031	$	—	$	—	$	264	$	—	$	11,157
Loans past due 90 days and still accruing	—		—		—		—		—		—		—		—
Troubled debt restructurings (not included in nonaccrual or loans past due and still accruing)	—		1,177		1,008		—		—		—		—		2,185
	$	8,196	$	2,843	$	2,039	$	—	$	—	$	264	$	—	$	13,342
December 31, 2016
Nonaccrual loans	$	7,718	$	5,885	$	866	$	884	$	—	$	273	$	—	$	15,626
Loans past due 90 days and still accruing	—		—		—		—		—		—		—		—
Troubled debt restructurings (not included in nonaccrual or loans past due and still accruing)	1		1,204		1,011		—		—		—		—		2,216
	$	7,719	$	7,089	$	1,877	$	884	$	—	$	273	$	—	$	17,842

The accrual of interest is discontinued on a loan when management believes after considering collection efforts and other factors that the borrower's financial condition is such that collection of interest is doubtful. All interest accrued but not collected for loans that are placed on nonaccrual status or charged-off is reversed against interest income. Cash collections on nonaccrual loans are generally credited to the loan receivable balance, and no interest income is recognized on those loans until the principal balance has been collected. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Impaired loans are those loans where it is probable that all amounts due will not be collected according to contractual terms of the loan agreement. The Company has identified these loans through its normal loan review procedures. Impaired loans are measured based on 1) the present value of expected future cash flows discounted at the loans effective interest rate; 2) the loan's observable market price; or 3) the fair value of collateral if the loan is collateral dependent. Substantially all of the Company’s impaired loans are measured at the fair value of the collateral. In limited cases, the Company may use the other methods to determine the level of impairment of a loan if such loan is not collateral dependent.

All commercial, real estate, agricultural loans and troubled debt restructurings are considered for individual impairment analysis. Smaller balance consumer loans are collectively evaluated for impairment.

Impaired loans by loan class at March 31, 2017 and December 31, 2016, are summarized as follows:



	Commercial		Commercial Real Estate, Land and Land Development		Residential Real Estate		Single-Family Interim Construction		Agricultural		Consumer		Other		Total
March 31, 2017
Recorded investment in impaired loans:
Impaired loans with an allowance for loan losses	$	3,635	$	77	$	—	$	—	$	—	$	204	$	—	$	3,916
Impaired loans with no allowance for loan losses	4,561		2,766		2,039		—		—		60		—		9,426
Total	$	8,196	$	2,843	$	2,039	$	—	$	—	$	264	$	—	$	13,342
Unpaid principal balance of impaired loans	$	11,319	$	2,860	$	2,249	$	—	$	—	$	275	$	—	$	16,703
Allowance for loan losses on impaired loans	$	500	$	4	$	—	$	—	$	—	$	94	$	—	$	598
December 31, 2016
Recorded investment in impaired loans:
Impaired loans with an allowance for loan losses	$	8	$	78	$	—	$	168	$	—	$	209	$	—	$	463
Impaired loans with no allowance for loan losses	7,712		7,011		1,889		716		—		70		—		17,398
Total	$	7,720	$	7,089	$	1,889	$	884	$	—	$	279	$	—	$	17,861
Unpaid principal balance of impaired loans	$	10,844	$	7,133	$	2,087	$	884	$	—	$	291	$	—	$	21,239
Allowance for loan losses on impaired loans	$	3	$	4	$	—	$	84	$	—	$	94	$	—	$	185
For the three months ended March 31, 2017
Average recorded investment in impaired loans	$	7,958	$	4,966	$	1,964	$	442	$	—	$	272	$	—	$	15,602
Interest income recognized on impaired loans	$	2	$	397	$	12	$	—	$	—	$	1	$	—	$	412
For the three months ended March 31, 2016
Average recorded investment in impaired loans	$	15,677	$	3,429	$	3,157	$	—	$	85	$	94	$	—	$	22,442
Interest income recognized on impaired loans	$	366	$	36	$	40	$	—	$	—	$	—	$	—	$	442

Certain impaired loans have adequate collateral and do not require a related allowance for loan loss.

The Company will charge off that portion of any loan which management considers a loss. Commercial and real estate loans are generally considered for charge-off when exposure beyond collateral coverage is apparent and when no further collection of the loss portion is anticipated based on the borrower’s financial condition.

The restructuring of a loan is considered a “troubled debt restructuring” if both 1) the borrower is experiencing financial difficulties and 2) the creditor has granted a concession. Concessions may include interest rate reductions or below market interest rates, principal forgiveness, extending amortization and other actions intended to minimize potential losses.

A “troubled debt restructured” loan is identified as impaired and measured for credit impairment as of each reporting period in accordance with the guidance in Accounting Standards Codification (ASC) 310-10-35. Modifications primarily relate to extending the amortization periods of the loans and interest rate concessions. The majority of these loans were identified as impaired prior to restructuring; therefore, the modifications did not materially impact the Company’s determination of the allowance for loan losses. The recorded investment in troubled debt restructurings, including those on nonaccrual, was $2,389 and $2,425 as of March 31, 2017 and December 31, 2016.

There were no loans modified under troubled debt restructurings during the three months ended March 31, 2017 and 2016..

At March 31, 2017 and 2016, there were no loans modified under troubled debt restructurings during the previous twelve month period that subsequently defaulted during the three months ended March 31, 2017 and 2016, respectively. At March 31, 2017 and 2016, the Company had no commitments to lend additional funds to any borrowers with loans whose terms have been modified under troubled debt restructurings.

Loans are considered past due if the required principal and interest payments have not been received as of the date such payments were due. The following table presents information regarding the aging of past due loans by loan class as of March 31, 2017 and December 31, 2016:



	Loans 30-89 Days Past Due		Loans 90 or More Past Due		Total Past Due Loans		Current Loans		Total Loans
March 31, 2017
Commercial	$	182	$	8,196	$	8,378	$	593,607	$	601,985
Commercial real estate, land and land development	1,631		1,631		3,262		3,133,104		3,136,366
Residential real estate	2,955		556		3,511		644,058		647,569
Single-family interim construction	—		—		—		237,740		237,740
Agricultural	—		—		—		52,515		52,515
Consumer	36		36		72		26,152		26,224
Other	—		—		—		112		112
	$	4,804	$	10,419	$	15,223	$	4,687,288	$	4,702,511
December 31, 2016
Commercial	$	226	$	7,711	$	7,937	$	622,868	$	630,805
Commercial real estate, land and land development	151		6,752		6,903		2,983,799		2,990,702
Residential real estate	846		561		1,407		633,138		634,545
Single-family interim construction	1,062		—		1,062		234,413		235,475
Agricultural	10		—		10		53,538		53,548
Consumer	154		52		206		27,324		27,530
Other	—		—		—		166		166
	$	2,449	$	15,076	$	17,525	$	4,555,246	$	4,572,771

The Company’s internal classified report is segregated into the following categories: 1) Pass/Watch, 2) Special Mention, 3) Substandard and 4) Doubtful. The loans placed in the Pass/Watch category reflect the Company’s opinion that the loans reflect potential weakness that requires monitoring on a more frequent basis. The loans in the Special Mention category reflect the Company’s opinion that the credit contains weaknesses which represent a greater degree of risk and warrant extra attention. These loans are reviewed monthly by officers and senior management to determine if a change in category is warranted. The loans placed in the Substandard category are considered to be potentially inadequately protected by the current debt service capacity of the borrower and/or the pledged collateral. These credits, even if apparently protected by collateral value, have shown weakness related to adverse financial, managerial, economic, market or political conditions, which may jeopardize repayment of principal and interest. There is possibility that some future loss could be sustained by the Company if such weakness is not corrected. The Doubtful category includes loans that are in default or principal exposure is probable. Substandard and Doubtful loans are individually evaluated to determine if they should be classified as impaired and an allowance is allocated if deemed necessary under ASC 310-10.

The loans that are not impaired are included with the remaining “pass” credits in determining the portion of the allowance for loan loss based on historical loss experience and other qualitative factors. The portfolio is segmented into categories including: commercial loans, consumer loans, commercial real estate loans, residential real estate loans and agricultural loans. The adjusted historical loss percentage is applied to each category. Each category is then added together to determine the allowance allocated under ASC 450-20.

A summary of loans by credit quality indicator by class as of March 31, 2017 and December 31, 2016, is as follows:



	Pass		Pass/ Watch		Special Mention		Substandard		Doubtful		Total
March 31, 2017
Commercial	$	525,014	$	34,378	$	15,563	$	27,030	$	—	$	601,985
Commercial real estate, construction, land and land development	3,122,652		5,699		4,942		3,073		—		3,136,366
Residential real estate	640,467		3,292		490		3,320		—		647,569
Single-family interim construction	236,803		937		—		—		—		237,740
Agricultural	39,190		13,100		225		—		—		52,515
Consumer	25,931		17		2		274		—		26,224
Other	112		—		—		—		—		112
	$	4,590,169	$	57,423	$	21,222	$	33,697	$	—	$	4,702,511
December 31, 2016
Commercial	$	555,342	$	31,954	$	16,734	$	26,775	$	—	$	630,805
Commercial real estate, construction, land and land development	2,972,732		5,426		5,148		7,396		—		2,990,702
Residential real estate	629,081		1,897		370		3,197		—		634,545
Single-family interim construction	233,800		791		—		884		—		235,475
Agricultural	52,724		569		255		—		—		53,548
Consumer	27,215		12		3		300		—		27,530
Other	166		—		—		—		—		166
	$	4,471,060	$	40,649	$	22,510	$	38,552	$	—	$	4,572,771

The Company has acquired certain loans which experienced credit deterioration since origination (purchased credit impaired (PCI) loans). Accretion on PCI loans is based on estimated future cash flows, regardless of contractual maturity. No additional PCI loans were acquired during the three months ended March 31, 2017 and the year ended December 31, 2016.

The carrying amount of all acquired PCI loans included in the consolidated balance sheet and the related outstanding balance at March 31, 2017 and December 31, 2016 were as follows:



	March 31, 2017		December 31, 2016
Outstanding balance	$	38,380	$	39,442
Carrying amount	33,930		34,678

There was no allocation established in the allowance for loan losses relating to PCI loans at March 31, 2017 or December 31, 2016.

The changes in accretable yield during the three months ended March 31, 2017 and 2016 in regard to loans transferred at acquisition for which it was probable that all contractually required payments would not be collected are presented in the table below.



	For the Three Months Ended March 31,
	2017			2016
Balance at January 1,	$	1,526		$	2,380
Additions	—			—
Accretion	(225		)	(302		)
Transfers from nonaccretable	270			—
Balance at March 31,	$	1,571		$	2,078

Note 5. Commitments and Contingencies

Financial Instruments with Off-Balance Sheet Risk

The Company is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. The commitments involve, to varying degrees, elements of credit and interest rate risk in excess of the amount recognized in the balance sheet.

The Company’s exposure to credit loss in the event of nonperformance by the other party to the financial instrument for commitments to extend credit is represented by the contractual amount of this instrument. The Company uses the same credit policies in making commitments and conditional obligations as it does for on-balance sheet instruments. At March 31, 2017 and December 31, 2016, the approximate amounts of these financial instruments were as follows:



	March 31,		December 31,
	2017		2016
Commitments to extend credit	$	873,962	$	865,668
Standby letters of credit	7,623		10,562
	$	881,585	$	876,230

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments are expected to expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Company evaluates each customer’s credit worthiness on a case-by-case basis. The amount of collateral obtained if deemed necessary by the Company upon extension of credit is based on management’s credit evaluation of the counterparty. Collateral held varies but may include accounts receivable, inventory, farm crops, property, plant and equipment and income-producing commercial properties.

Letters of credit are written conditional commitments used by the Company to guarantee the performance of a customer to a third party. The Company’s policies generally require that letter of credit arrangements contain security and debt covenants similar to those contained in loan arrangements. In the event the customer does not perform in accordance with the terms of the agreement with the third party, the Company would be required to fund the commitment. The maximum potential amount of future payments the Company could be required to make is represented by the contractual amount shown in the table above. If the commitment is funded, the Company would be entitled to seek recovery from the customer. As of March 31, 2017 and December 31, 2016, no amounts have been recorded as liabilities for the Company’s potential obligations under these guarantees.

Litigation

The Company is involved in certain legal actions arising from normal business activities. Management believes that the outcome of such proceedings will not materially affect the financial position, results of operations or cash flows of the Company.

Independent Bank is a party to a legal proceeding inherited in connection with its acquisition of BOH Holdings, Inc. and its subsidiary, Bank of Houston. Please see Part II, Item 1. for more details on this lawsuit.

Lease Commitments

The Company leases certain branch facilities and other facilities. Rent expense related to these leases amounted to $681 and $675 for the three months ended March 31, 2017 and 2016, respectively.

Note 6. Income Taxes

Income tax expense for the three months ended March 31, 2017 and 2016 was as follows:



	Three Months Ended March 31,
	2017			2016
Income tax expense for the period	$	6,728		$	6,162
Effective tax rate	30.0		%	33.1		%

The effective tax rates differ from the statutory federal tax rate of 35% largely due to tax exempt interest income earned on certain investment securities and loans and the nontaxable earnings on bank owned life insurance. In addition, the effective tax rate differs for the period ended March 31, 2017 due to the excess tax benefit on restricted stock, which was recognized in income tax expense as a result of adopting ASU 2016-09, which became effective for the Company on January 1, 2017.

Note 7. Fair Value Measurements

The fair value of an asset or liability is the price that would be received to sell that asset or paid to transfer that liability in an orderly transaction occurring in the principal market (or most advantageous market in the absence of a principal market) for such asset or liability. In estimating fair value, the Company utilizes valuation techniques that are consistent with the market approach, the income approach and/or the cost approach. Such valuation techniques are consistently applied. Inputs to valuation techniques include the assumptions that market participants would use in pricing an asset or liability. ASC Topic 820, Fair Value Measurements and Disclosures, establishes a fair value hierarchy for valuation inputs that gives the highest priority to quoted prices in active markets for identical assets or liabilities and the lowest priority to unobservable inputs. The fair value hierarchy is as follows:

Level 1 Inputs – Unadjusted quoted prices in active markets for identical assets or liabilities that the reporting entity has the ability to access at the measurement date.

Level 2 Inputs – Inputs other than quoted prices included in Level 1 that are observable for the asset or liability, either directly or indirectly. These might include quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in markets that are not active, inputs other than quoted prices that are observable for the asset or liability (such as interest rates, volatilities, prepayment speeds, credit risks, etc.) or inputs that are derived principally from or corroborated by market data by correlation or other means.

Level 3 Inputs – Unobservable inputs for determining the fair values of assets or liabilities that reflect an entity’s own assumptions about the assumptions that market participants would use in pricing the assets or liabilities.

The following table represents assets reported on the consolidated balance sheets at their fair value on a recurring basis as of March 31, 2017 and December 31, 2016 by level within the ASC Topic 820 fair value measurement hierarchy:



			Fair Value Measurements at Reporting Date Using
	Assets/ Liabilities Measured at Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
March 31, 2017
Measured on a recurring basis:
Assets:
Investment securities available for sale:
U.S. treasuries	$	3,158	$	—	$	3,158	$	—
Government agency securities	135,708		—		135,708		—
Obligations of state and municipal subdivisions	103,366		—		103,366		—
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC	108,177		—		108,177		—
December 31, 2016
Measured on a recurring basis:
Assets:
Investment securities available for sale:
U.S. treasuries	$	3,147	$	—	$	3,147	$	—
Government agency securities	122,267		—		122,267		—
Obligations of state and municipal subdivisions	87,256		—		87,256		—
Residential pass-through securities guaranteed by FNMA, GNMA and FHLMC	103,765		—		103,765		—

There were no transfers between level categorizations and no changes in valuation methodologies for the periods presented.

A description of the valuation methodologies used for instruments measured at fair value, as well as the general classification of such instruments pursuant to the valuation hierarchy, is set forth below.

Securities classified as available for sale are reported at fair value utilizing Level 2 inputs. For these securities, the Company obtains fair value measurements from an independent pricing service. The fair value measurements consider observable data that may include dealer quotes, market spreads, cash flows, the U.S. Treasury and other yield curves, live trading levels, trade execution data, market consensus prepayment speeds, credit information and the security’s terms and conditions, among other things.

In accordance with ASC Topic 820, certain assets and liabilities are measured at fair value on a nonrecurring basis; that is, the assets and liabilities are not measured at fair value on an ongoing basis but are subject to fair value adjustments in certain circumstances (for example, when there is evidence of impairment). The following table presents the assets carried on the consolidated balance sheet by caption and by level in the fair value hierarchy at March 31, 2017 and December 31, 2016, for which a nonrecurring change in fair value has been recorded:



			Fair Value Measurements at Reporting Date Using
	Assets Measured at Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Period Ended Total Losses
March 31, 2017
Measured on a nonrecurring basis:
Assets:
Impaired loans	$	3,135	$	—	$	—	$	3,135	$	500
Other real estate	—		—		—		—		—

December 31, 2016
Measured on a nonrecurring basis:
Assets:
Impaired loans	$	968	$	—	$	—	$	968	$	708
Other real estate	340		—		—		340		52

Impaired loans (loans which are not expected to repay all principal and interest amounts due in accordance with the original contractual terms) are measured at an observable market price (if available) or at the fair value of the loan’s collateral (if collateral dependent). Fair value of the loan’s collateral is determined by appraisals or independent valuation, which is then adjusted for the estimated costs related to liquidation of the collateral. Management’s ongoing review of appraisal information may result in additional discounts or adjustments to valuation based upon more recent market sales activity or more current appraisal information derived from properties of similar type and/or locale. Therefore, the Company has categorized its impaired loans as Level 3.

Other real estate is measured at fair value on a nonrecurring basis (upon initial recognition or subsequent impairment). Other real estate is classified within Level 3 of the valuation hierarchy. When transferred from the loan portfolio, other real estate is adjusted to fair value less estimated selling costs and is subsequently carried at the lower of carrying value or fair value less estimated selling costs. The fair value is determined using an external appraisal process, discounted based on internal criteria.

In addition, mortgage loans held for sale are required to be measured at the lower of cost or fair value. The fair value of mortgage loans held for sale is based upon binding quotes or bids from third party investors. As of March 31, 2017 and December 31, 2016, all mortgage loans held for sale were recorded at cost.

The methods and assumptions used by the Company in estimating fair values of financial instruments as disclosed herein in accordance with ASC Topic 825, Financial Instruments, other than for those measured at fair value on a recurring and nonrecurring basis discussed above, are as follows:

Cash and cash equivalents: The carrying amounts of cash and cash equivalents approximate their fair value.

Certificates of deposit held in other banks: The fair value of certificates of deposit held in other banks is based upon current

rates in the market.

Loans and loans held for sale: For variable-rate loans that reprice frequently and have no significant changes in credit risk, fair values are based on carrying values. Fair values for certain mortgage loans (for example, one-to-four family residential), commercial real estate and commercial loans are estimated using discounted cash flow analyses, using interest rates currently being offered for loans with similar terms to borrowers of similar credit quality.

Federal Home Loan Bank of Dallas and other restricted stock: The carrying value of restricted securities such as stock in the Federal Home Loan Bank of Dallas and Independent Bankers Financial Corporation approximates fair value.

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). The carrying amounts of variable-rate certificates of deposit (CDs) approximate their fair values at the reporting date. Fair values for fixed-rate CDs are estimated using a discounted cash flow calculation that applies interest rates currently being offered on certificates to a schedule of aggregated expected monthly maturities on time deposits.

Federal Home Loan Bank advances, line of credit and federal funds purchased: The fair value of advances maturing within 90 days approximates carrying value. Fair value of other advances is based on the Company’s current borrowing rate for similar arrangements.

Other borrowings: The fair value of private subordinated debentures are based upon prevailing rates on similar debt in the market place. The subordinated debentures that are publicly traded are valued based on indicative bid prices based upon market pricing observations in the current market.

Junior subordinated debentures: The fair value of junior subordinated debentures is estimated using discounted cash flow analyses based on the Company’s current incremental borrowing rates for similar types of borrowing arrangements.

Accrued interest: The carrying amounts of accrued interest approximate their fair values.

Off-balance sheet instruments: Fair values for off-balance sheet, credit-related financial instruments are based on fees currently charged to enter into similar agreements, taking into account the remaining terms of the agreements and the counterparties' credit standing. The fair value of commitments is not material.

The carrying amount, estimated fair value and the level of the fair value hierarchy of the Company’s financial instruments were as follows at March 31, 2017 and December 31, 2016:



					Fair Value Measurements at Reporting Date Using
	Carrying Amount		Estimated Fair Value		Quoted Prices in Active Markets for Identical Assets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
March 31, 2017
Financial assets:
Cash and cash equivalents	$	515,123	$	515,123	$	515,123	$	—	$	—
Certificates of deposit held in other banks	5,892		5,943		—		5,943		—
Securities available for sale	350,409		350,409		—		350,409		—
Loans held for sale	5,081		5,081		—		5,081		—
Loans, net	4,666,653		4,636,219		—		4,632,901		3,318
FHLB of Dallas stock and other restricted stock	26,672		26,672		—		26,672		—
Accrued interest receivable	11,410		11,410		—		11,410		—
Financial liabilities:
Deposits	4,722,203		4,726,879		—		4,726,879		—
Accrued interest payable	2,398		2,398		—		2,398		—
FHLB advances	460,727		469,430		—		469,430		—
Other borrowings	107,388		110,550		—		110,550		—
Junior subordinated debentures	18,147		18,140		—		18,140		—
Off-balance sheet assets (liabilities):
Commitments to extend credit	—		—		—		—		—
Standby letters of credit	—		—		—		—		—
December 31, 2016
Financial assets:
Cash and cash equivalents	$	505,027	$	505,027	$	505,027	$	—	$	—
Certificates of deposit held in other banks	2,707		2,733		—		2,733		—
Securities available for sale	316,435		316,435		—		316,435		—
Loans held for sale	9,795		9,795		—		9,795		—
Loans, net	4,539,063		4,532,364		—		4,532,086		278
FHLB of Dallas stock and other restricted stock	26,536		26,536		—		26,536		—
Accrued interest receivable	12,331		12,331		—		12,331		—
Financial liabilities:
Deposits	4,577,109		4,581,866		—		4,581,866		—
Accrued interest payable	4,020		4,020		—		4,020		—
FHLB advances	460,746		459,436		—		459,436		—
Other borrowings	107,299		110,000		—		110,000		—
Junior subordinated debentures	18,147		18,131		—		18,131		—
Off-balance sheet assets (liabilities):
Commitments to extend credit	—		—		—		—		—
Standby letters of credit	—		—		—		—		—

Note 8. Stock Awards and Stock Warrants

The Company grants common stock awards to certain employees of the Company. The common stock issued prior to 2013 vests five years from the date the award is granted and the related compensation expense is recognized over the vesting period. In connection with the initial public offering in April 2013, the Board of Directors adopted a new 2013 Equity Incentive Plan. Under this plan, the Compensation Committee may grant awards in the form of restricted stock, restricted stock rights, restricted stock units, qualified and nonqualified stock options, performance-based share awards and other equity-based awards. The Plan reserved 800,000 shares of common stock to be awarded by the Company’s compensation committee. The shares currently issued under the 2013 Plan are restricted and will vest evenly over the required employment period, generally ranging from three to five years. Shares granted under a previous plan prior to 2012 and those in and subsequent to 2013 under the 2013 Equity Incentive Plan were issued at the date of grant and receive dividends. Shares issued under a revised plan in 2012 are not outstanding shares of the Company until they vest and do not receive dividends. During the three months ended March 31, 2017, 11,040 shares that were issued under the 2012 Plan vested during the period.

The following table summarizes the activity in nonvested shares for the three months ended March 31, 2017 and 2016:



	Number of Shares		Weighted Average Grant Date Fair Value
Nonvested shares, December 31, 2016	280,524		$	36.88
Granted during the period	40,627		62.37
Vested during the period	(65,668	)	31.23
Forfeited during the period	—		—
Nonvested shares, March 31, 2017	255,483		$	42.38

Nonvested shares, December 31, 2015	373,572		$	40.29
Granted during the period	66,220		29.91
Vested during the period	(44,220	)	32.61
Forfeited during the period	(6,334	)	42.25
Nonvested shares, March 31, 2016	389,238		$	39.20

Compensation expense related to these awards is recorded based on the fair value of the award at the date of grant and totaled $970 and $1,220 for the three months ended March 31, 2017 and 2016, respectively. Compensation expense is recorded in salaries and employee benefits in the accompanying consolidated statements of income. At March 31, 2017, future compensation expense is estimated to be $8,015 and will be recognized over a remaining weighted average period of 2.76 years.

The fair value of common stock awards that vested during the three months ended March 31, 2017 and 2016 was $4,119 and $1,306, respectively. The Company has recorded $724 in excess tax benefits on vested restricted stock to income tax expense for the three months ended March 31, 2017 as a result of adopting ASU 2016-09. The Company recorded $(83) to additional paid in capital, which represents the income tax deficiency recognized on the vested shares for the three months ended March 31, 2016.

At March 31, 2017, the future vesting schedule of the nonvested shares is as follows:



First year		124,575
Second year		79,482
Third year		41,526
Fourth year		6,050
Fifth year		3,850
Total nonvested shares		255,483

The Company has warrants outstanding representing the right to purchase 147,341 shares of Company stock at $17.19 per share to certain Company directors and shareholders. The warrants were issued in return for the shareholders' agreement to repurchase the subordinated debt outstanding to an unaffiliated bank in the event of Company default. The warrants were recorded as equity awards at fair value and were being amortized over the term of the debt. The subordinated debt was paid off by the Company in 2013. The warrants expire in December 2018. During the three months ended March 31, 2017, warrants to purchase 3,203 shares of common stock were exercised and have been issued by the Company.

Note 9. Regulatory Matters

Under banking law, there are legal restrictions limiting the amount of dividends the Bank can declare. Approval of the regulatory authorities is required if the effect of dividends declared would cause the regulatory capital of the Bank to fall below specified minimum levels. For state banks, subject to regulatory capital requirements, payment of dividends is generally allowed to the extent of net profits.

The Company (on a consolidated basis) and the Bank are subject to various regulatory capital requirements administered by federal and state banking agencies. Failure to meet minimum capital requirements can initiate certain mandatory and possibly additional discretionary actions by regulators that, if undertaken, could have a direct material effect on the Company’s consolidated financial statements. Under capital adequacy guidelines and the regulatory framework for prompt corrective action, the Company and the Bank must meet specific capital guidelines that involve quantitative measures of assets, liabilities and certain off-balance sheet items as calculated under regulatory accounting practices. The capital amounts and classification are also subject to qualitative judgments by the regulators about components, risk weightings and other factors.

The Company is subject to the Basel III regulatory capital framework (the "Basel III Capital Rules"). Starting in January 2016, the implementation of the capital conservation buffer was effective for the Company starting at the 0.625% level and increasing 0.625% each year thereafter, until it reaches 2.5% on January 1, 2019. The capital conservation buffer is designed to absorb losses during periods of economic stress and requires increased capital levels for the purpose of capital distributions and other payments. Failure to meet the full amount of the buffer will result in restrictions on the Company's ability to make capital distributions, including dividend payments and stock repurchases and to pay discretionary bonuses to executive officers.

Quantitative measures established by regulation to ensure capital adequacy require the Company and the Bank to maintain minimum amounts and ratios (set forth in the table below) of total, CET1 and Tier 1 capital (as defined in the regulations) to risk weighted assets (as defined), and of Tier 1 capital (as defined) to average assets (as defined). Management believes, as of March 31, 2017 and December 31, 2016, the Company and the Bank meet all capital adequacy requirements to which they are subject, including the capital buffer requirement.

As of March 31, 2017 and December 31, 2016, the Bank’s capital ratios exceeded those levels necessary to be categorized as “well capitalized” under the regulatory framework for prompt corrective action. To be categorized as “well capitalized," the Bank must maintain minimum total risk based, CET1, Tier 1 risk based and Tier 1 leverage ratios as set forth in the table. There are no conditions or events since that notification that management believes have changed the Bank’s category.

The actual capital amounts and ratios of the Company and Bank as of March 31, 2017 and December 31, 2016, are presented in the following table:



	Actual				Minimum for Capital Adequacy Purposes				To Be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
March 31, 2017
Total capital to risk weighted assets:
Consolidated	$	583,864	11.44	%	$	408,474	8.00	%	N/A		N/A
Bank	572,757		11.22		408,247		8.00		$	510,309	10.00	%
Tier 1 capital to risk weighted assets:
Consolidated	440,433		8.63		306,356		6.00		N/A		N/A
Bank	539,326		10.57		306,185		6.00		408,247		8.00
Common equity tier 1 to risk weighted assets
Consolidated	422,833		8.28		229,767		4.50		N/A		N/A
Bank	539,326		10.57		229,639		4.50		331,701		6.50
Tier 1 capital to average assets:
Consolidated	440,433		7.84		224,601		4.00		N/A		N/A
Bank	539,326		9.61		224,491		4.00		280,614		5.00

December 31, 2016
Total capital to risk weighted assets:
Consolidated	$	568,808	11.38	%	$	399,698	8.00	%	N/A		N/A
Bank	558,551		11.19		399,497		8.00		$	499,371	10.00	%
Tier 1 capital to risk weighted assets:
Consolidated	427,217		8.55		299,774		6.00		N/A		N/A
Bank	526,960		10.55		299,623		6.00		399,497		8.00
Common equity tier 1 to risk weighted assets
Consolidated	409,617		8.20		224,830		4.50		N/A		N/A
Bank	526,960		10.55		224,717		4.50		324,591		6.50
Tier 1 capital to average assets:
Consolidated	427,217		7.82		218,612		4.00		N/A		N/A
Bank	526,960		9.65		218,517		4.00		273,146		5.00

Note 10. Subsequent Event

Carlile Bancshares, Inc.

On April 1, 2017, the Company acquired 100% of the outstanding stock of Carlile Bancshares, Inc. ("CBI"). and its subsidiary, Northstar Bank, Denton, Texas. This transaction gives the Company 24 branches in the DFW Metroplex and Austin area as well as 18 branches in Colorado. The Company issued 8,804,699 shares of Company stock and paid $17,463 in cash for the outstanding shares of CBI common stock.

The Company has recognized a provisional amount of goodwill of $362,922 which is calculated as the excess of both the consideration exchanged and liabilities assumed compared to the fair market value of identifiable assets acquired. The goodwill in this acquisition resulted from a combination of expected synergies and entrance into desirable Texas and Colorado markets. None of the goodwill recognized is expected to be deductible for income tax purposes.

The Company has incurred expenses related to the acquisition of approximately $146 for the three months ended March 31, 2017, which is included in acquisition expenses in the consolidated statements of income. The Company incurred expenses of $659 during the year ended December 31, 2016. Provisional estimates for loans, premises and equipment, goodwill, core deposit intangible and deposits have been recorded for the acquisition as final valuations are not yet available. The Company does not expect any significant differences from estimated values upon completion of the valuations. The Company is still evaluating the loan portfolio for credit-impaired and non-credit-impaired loan estimations, therefore, the amounts are not available for disclosure.

Estimated fair values of the assets acquired and liabilities assumed in this transaction as of the closing date are as follows:



Assets of acquired bank:
Cash and cash equivalents	$	159,469
Securities available for sale	336,506
Loans	1,396,169
Premises and equipment	63,581
Other real estate owned	10,666
Goodwill	362,922
Core deposit intangible	15,623
Other assets	92,696
Total assets acquired	$	2,437,632

Liabilities of acquired bank:
Deposits	$	1,834,655
Junior subordinated debentures	12,566
Other liabilities	20,893
Total liabilities assumed	$	1,868,114
Common stock issued at $62.70 per share	$	552,055
Cash paid	$	17,463

To determine pro forma information, the Company adjusted its 2017 and 2016 historical results to include the historical results for CBI for the three months ended March 31, 2017 and 2016 and the year ended December 31, 2016. Pro forma net income for the three months ended March 31, 2017 and 2016 was $23,763 and $17,985, respectively, and pro forma revenue was $88,564 and $84,853, respectively, had the transaction occurred as of January 1, 2016. Pro forma net income for the year ended December 31, 2016 was $69,391 and pro forma revenue was $350,067 had the transaction occurred on January 1, 2016. Nonrecurring adjustments directly attributable to the acquisition included in the pro forma revenues and net income were expenses related to professional fees, integration costs, as well as change of control and noncompete agreements. For the three months ended March 31, 2017 and 2016 and the year ended December 31, 2016, these expenses totaled $16,339, $0, and $659, respectively.

Declaration of Dividends

On April 26, 2017, the Company declared a quarterly cash dividend in the amount of $0.10 per share of common stock to the stockholders of record on May 8, 2017. The dividend will be paid on May 18, 2017.

ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Cautionary Note Regarding Forward Looking Statements

This Quarterly Report on Form 10-Q, our other filings with the SEC, and other press releases, documents, reports and announcements that we make, issue or publish may contain statements that we believe are “forward-looking statements” within the meaning of the Private Securities Litigation Reform Act of 1995. These forward-looking statements are statements or projections with respect to matters such as our future results of operations, including our future revenues, income, expenses, provision for taxes, effective tax rate, earnings per share and cash flows, our future capital expenditures and dividends, our future financial condition and changes therein, including changes in our loan portfolio and allowance for loan losses, our future capital structure or changes therein, the plan and objectives of management for future operations, our future or proposed acquisitions and the integration thereof, the future or expected effect of acquisitions on our operations, results of operations and financial condition, our future economic performance and the statements of the assumptions underlying any such statement. Such statements are typically identified by the use in the statements of words or phrases such as “aim,” “anticipate,” “estimate,” “expect,” “goal,” “guidance,” “intend,” “is anticipated,” “is estimated,” “is expected,” “is intended,” “objective,” “plan,” “projected,” “projection,” “will affect,” “will be,” “will continue,” “will decrease,” “will grow,” “will impact,” “will increase,” “will incur,” “will reduce,” “will remain,” “will result,” “would be,” variations of such words or phrases (including where the word “could”, “may” or “would” is used rather than the word “will” in a phrase) and similar words and phrases indicating that the statement addresses some future result, occurrence, plan or objective. The forward-looking statements that we make are based on the Company’s current expectations and assumptions regarding its business, the economy, and other future conditions. Because forward-looking statements relate to future results and occurrences, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. The Company’s actual results may differ materially from those contemplated by the forward-looking statements, which are neither statements of historical fact nor guarantees or assurances of future performance. Many possible events or factors could affect the future financial results and performance of the Company and could cause such results or performance to differ materially from those expressed in forward-looking statements. These factors include, but are not limited to, the following:


•	worsening business and economic conditions nationally, regionally and in our target markets, particularly in Texas and the geographic areas in which we operate;


•	our dependence on our management team and our ability to attract, motivate and retain qualified personnel;


•	the concentration of our business within our geographic areas of operation in Texas;


•	deteriorating asset quality and higher loan charge-offs;


•	concentration of our loan portfolio in commercial and residential real estate loans and changes in the prices, values and sales volumes of commercial and residential real estate;


•	inaccuracy of the assumptions and estimates we make in establishing reserves for probable loan losses and other estimates;


•	lack of liquidity, including as a result of a reduction in the amount of sources of liquidity we currently have;


•	material decreases in the amount of deposits we hold;


•	regulatory requirements to maintain minimum capital levels or maintenance of capital at levels sufficient to support our anticipated growth;


•	changes in market interest rates that affect the pricing of our loans and deposits and our net interest income;


•	fluctuations in the market value and liquidity of the securities we hold for sale;


•	effects of competition from a wide variety of local, regional, national and other providers of financial, investment and insurance services;


•	changes in economic and market conditions that affect the amount of assets we have under administration;


•	the institution and outcome of litigation and other legal proceeding against us or to which we become subject;


•	the occurrence of market conditions adversely affecting the financial industry generally;


•	the impact of recent and future legislative and regulatory changes, including changes in banking, securities and tax laws and regulations and their application by our regulators, such as the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act;


•	changes in accounting policies and practices, as may be adopted by the bank regulatory agencies, the Financial Accounting Standards Board, the SEC and the Public Company Accounting Oversight Board;


•	governmental monetary and fiscal policies;


•	changes in the scope and cost of FDIC insurance and other coverage;


•	the effects of war or other conflicts, acts of terrorism (including cyber attacks) or other catastrophic events, including storms, droughts, tornadoes and flooding, that may affect general economic conditions;


•	our actual cost savings resulting from previous or future acquisitions are less than expected, we are unable to realize those cost savings as soon as expected, or we incur additional or unexpected costs;


•	our revenues after previous or future acquisitions are less than expected;


•	deposit attrition, operating costs, customer loss and business disruption before and after our completed acquisitions, including, without limitation, difficulties in maintaining relationships with employees, may be greater than we expected;


•	the risk that the businesses of the Company, and financial institutions that it has or will acquire, will not be integrated successfully, or such integrations may be more difficult, time-consuming or costly than expected;


•	the quality of the assets acquired from other organizations being lower than determined in our due diligence investigation and related exposure to unrecoverable losses on loans acquired;


•	general business and economic conditions in our markets change or are less favorable than expected;


•	changes occur in business conditions and inflation;


•	personal or commercial customers’ bankruptcies increase;


•	technology-related changes are harder to make or are more expensive than expected; and


•	the other factors that are described or referenced in Part II, Item 1A. of this Quarterly Report on Form 10-Q under the caption “Risk Factors.”

We urge you to consider all of these risks, uncertainties and other factors carefully in evaluating all such forward-looking statements that we may make. As a result of these and other matters, including changes in facts and assumptions not being realized, the actual results relating to the subject matter of any forward-looking statement may differ materially from the anticipated results expressed or implied in that forward-looking statement. Any forward-looking statement made by the Company in any report, filing, press release, document, report or announcement speaks only as of the date on which it is made. The Company undertakes no obligation to update any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.

A forward looking-statement may include a statement of the assumptions or bases underlying the forward-looking statement. The Company believes it has chosen these assumptions or bases in good faith and they are reasonable. However, the Company cautions you that assumptions or bases almost always vary from actual results, and the differences between assumptions or bases and actual results can be material. The Company undertakes no obligation to publicly update or otherwise revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as required by law.

Overview

This Management’s Discussion and Analysis of Financial Condition and Results of Operations analyzes the major elements of the Company’s financial condition and results of operation as reflected in the interim consolidated financial statements and accompanying notes appearing in this Quarterly Report on Form 10-Q. This section should be read in conjunction with the Company’s interim consolidated financial statements and accompanying notes included elsewhere in this report and with the consolidated financial statements included in the Annual Report on Form 10-K for the year ended December 31, 2016.

The Company was organized as a bank holding company in 2002. On January 1, 2009, the Company was merged with Independent Bank Group Central Texas, Inc., and, since that time, has pursued a strategy to create long-term shareholder value through organic growth of our community banking franchise in our market areas and through selective acquisitions of complementary banking institutions with operations in our market areas. On April 8, 2013, the Company consummated the initial public offering, or IPO, of its common stock which is traded on the Nasdaq Global Select Market.

During the three months ended March 31, 2017, the Company operated 41 full service banking locations, with 23 located in the Dallas/North Texas region, seven located in the Austin/Central Texas region and 11 in the Houston region. See subsequent event footnote in the financial statements for recent acquisition, which resulted in additional branch locations. The Company’s headquarters are located at 1600 Redbud, Suite 400, McKinney, Texas 75069, and its telephone number is (972) 562-9004. The Company’s website address is www.ibtx.com. Information contained on the Company’s website is not incorporated by reference into this Quarterly Report on Form 10-Q and is not part of this or any other report.

Our principal business is lending to and accepting deposits from businesses, professionals and individuals. We conduct all of our banking operations through Independent Bank, which is a Texas state banking corporation and our principal subsidiary (the Bank). We derive our income principally from interest earned on loans and, to a lesser extent, income from securities available for sale. We also derive income from non-interest sources, such as fees received in connection with various deposit services and mortgage brokerage operations. From time to time, we also realize gains on the sale of assets. Our principal expenses include interest expense on interest-bearing customer deposits, advances from the Federal Home Loan Bank of Dallas, or the FHLB, and other borrowings, operating expenses, such as salaries, employee benefits, occupancy costs, data processing and communication costs, expenses associated with other real estate owned, other administrative expenses, provisions for loan losses and our assessment for FDIC deposit insurance.

Discussion and Analysis of Results of Operations for the Three Months Ended March 31, 2017 and 2016

The following discussion and analysis of our results of operations compares our results of operations for the three months ended March 31, 2017 with the three months ended March 31, 2016. The results of operations for the three months ended March 31, 2017 are not necessarily indicative of the results of operations that may be expected for all of the year ending December 31, 2017.

Results of Operations

For the three months ended March 31, 2017, net income was $15.7 million ($0.82 per common share on a diluted basis) compared with net income after preferred stock dividends of $12.4 million ($0.67 per common share on a diluted basis) for the three months ended March 31, 2016. The Company posted annualized returns on average common equity of 9.33% and 8.10%, returns on average assets of 1.08% and 0.95% and efficiency ratios of 53.44% and 56.89% for the three months ended March 31, 2017 and 2016, respectively. The efficiency ratio is calculated by dividing total noninterest expense (which does not include the provision for loan losses) by net interest income plus noninterest income.

Net Interest Income

The Company’s net interest income is its interest income, net of interest expenses. Changes in the balances of the Company’s earning assets and its deposits, FHLB advances and other borrowings, as well as changes in the market interest rates, affect the Company’s net interest income. The difference between the Company’s average yield on earning assets and its average rate paid for interest-bearing liabilities is its net interest spread. Noninterest-bearing sources of funds, such as demand deposits and stockholders’ equity, also support the Company’s earning assets. The impact of the noninterest-bearing sources of funds is reflected in the Company’s net interest margin, which is calculated as annualized net interest income divided by average earning assets.

Net interest income was $47.9 million for the three months ended March 31, 2017, an increase of $2.2 million, or 4.8%, from $45.7 million for the three months ended March 31, 2016. This increase is due primarily to a $794 million increase, or 17.6%, in average interest earning assets to $5.3 billion for the three months ended March 31, 2017 compared to $4.5 billion for the three months ended March 31, 2016. The increases in interest-earning assets and interest-bearing deposits is primarily due to strong organic growth. The average yield on interest earning assets decreased 32 basis points from 4.60% for the three months ended March 31, 2016 to 4.28% for the three months ended March 31, 2017 primarily due to a decrease in the loan yield from 4.98% for the three months ended March 31, 2016 to 4.71% for the three months ended March 31, 2017. The decrease is primarily related to lower accretion income on acquired loans during the period, which resulted in an 11 basis point decrease, but is also reflective of lower loan yields due to a flattened yield curve and a shift to a higher mix of variable rate loans in the second half of 2016. The average cost of interest-bearing liabilities increased 15 basis points to 0.80% for the three months ended March 31, 2017 compared to 0.65% for the three months ended March 31, 2016. This change was primarily due to an increase in the cost of other borrowings due to the issuance of subordinated debt in 2016 and higher rates paid on our deposit products, primarily our public fund and variable rate brokered deposit accounts. The aforementioned changes resulted in a 41 basis point decrease in the net interest margin for the three months ended March 31, 2017 to 3.67% compared to 4.08% for the three months ended March 31, 2016.

Average Balance Sheet Amounts, Interest Earned and Yield Analysis. The following table presents average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the three months ended March 31, 2017 and 2016. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances.



	Three Months Ended March 31,
	2017						2016
	Average Outstanding Balance		Interest		Yield/ Rate ⁽³⁾		Average Outstanding Balance		Interest		Yield/ Rate ⁽³⁾
(dollars in thousands)
Interest-earning assets:
Loans ⁽¹⁾	$	4,631,918	$	53,744	4.71	%	$	4,031,322	$	49,910	4.98	%
Taxable securities	242,822		764		1.28		208,740		730		1.41
Nontaxable securities	81,773		541		2.68		74,609		451		2.43
Interest-bearing deposits and other	338,034		890		1.07		185,855		373		0.81
Total interest-earning assets	5,294,547		$	55,939	4.28		4,500,526		$	51,464	4.60
Noninterest-earning assets	585,926						741,763
Total assets	$	5,880,473					$	5,242,289
Interest-bearing liabilities:
Checking accounts	$	1,938,628	$	2,166	0.45		$	1,593,295	$	1,745	0.44
Savings accounts	168,328		66		0.16		144,315		64		0.18
Money market accounts	566,833		1,056		0.76		504,616		459		0.37
Certificates of deposit	846,610		1,741		0.83		825,353		1,383		0.67
Total deposits	3,520,399		5,029		0.58		3,067,579		3,651		0.48
FHLB advances	460,733		1,171		1.03		435,730		1,001		0.92
Repurchase agreements and other borrowings	107,356		1,705		6.44		72,297		1,003		5.58
Junior subordinated debentures	18,147		167		3.73		18,147		149		3.30
Total interest-bearing liabilities	4,106,635		8,072		0.80		3,593,753		5,804		0.65
Noninterest-bearing checking accounts	1,073,703						1,016,032
Noninterest-bearing liabilities	18,701						11,026
Stockholders’ equity	681,434						621,478
Total liabilities and equity	$	5,880,473					$	5,242,289
Net interest income			$	47,867					$	45,660
Interest rate spread					3.48	%					3.95	%
Net interest margin ⁽²⁾					3.67						4.08
Average interest earning assets to interest bearing liabilities					128.93						125.23


(1)	Average loan balances include nonaccrual loans.


(2)	Net interest margins for the periods presented represent: (i) the difference between interest income on interest-earning assets and the interest expense on interest-bearing liabilities, divided by (ii) average interest-earning assets for the period.


(3)	Yield and rates for the three month periods are annualized.

Provision for Loan Losses

Management actively monitors the Company’s asset quality and provides specific loss provisions when necessary. Provisions for loan losses are charged to income to bring the total allowance for loan losses to a level deemed appropriate by management based on such factors as historical loss experience, trends in classified loans and past dues, the volume, concentrations, and growth in the loan portfolio, current economic conditions and the value of collateral.

Loans are charged off against the allowance for loan losses when determined appropriate. Although management believes it uses the best information available to make determinations with respect to the provision for loan losses, future adjustments may be necessary if economic conditions differ from the assumptions used in making the determination.

The Company recorded a $2.0 million provision for loan losses for the three months ended March 31, 2017 compared to $3.0 million for the comparable period in 2016. Provision expense is directly related to organic loan growth and net charge-offs during the respective periods. The increased provision for first quarter 2016 also reflected increased reserve allocations related to the risks associated with the energy portfolio due to commodity price volatility during the majority of 2016. Net charge-offs were $183 thousand and $56 thousand for the three months ended March 31, 2017 and 2016, respectively.

Noninterest Income

The following table sets forth the components of noninterest income for the three months ended March 31, 2017 and 2016 and the period-over-period variations in such categories of noninterest income:



	Three Months Ended March 31,				Variance
(dollars in thousands)	2017		2016		2017 v. 2016
Noninterest Income
Service charges on deposit accounts	$	1,927	$	1,695	$	232
Mortgage fee income	1,267		1,376		(109		)
Gain on sale of other real estate	—		43		(43		)
Gain on sale of premises and equipment	5		38		(33		)
Increase in cash surrender value of bank owned life insurance	399		265		134
All other noninterest income	985		1,053		(68		)
Total noninterest income	$	4,583	$	4,470	$	113

Total noninterest income increased $113 thousand, or 2.5% for the three ended March 31, 2017 over same period in 2016. Significant changes in the components of noninterest income are discussed below.

Service charges on deposit accounts. Service charges on deposit accounts increased $232 thousand, or 13.7% for the three months ended March 31, 2017, as compared to the same period in 2016. The increase in services charges is due to a new deposit fee schedule implemented in third quarter 2016 in addition to organic deposit growth.

Mortgage fee income. Mortgage fee income for the three ended March 31, 2017 decreased $109 thousand, or 7.9% compared to the same period in 2016. This decrease is due to a drop in market activity related to seasonality and an increase in interest rates.

Increase in cash surrender value of bank owned life insurance (BOLI). BOLI income increased $134 thousand, or 50.6% for the three months ended March 31, 2017, as compared to the same period in 2016. The increase is a result of $15 million in policies purchased at the end of second quarter 2016.

Noninterest Expense

Noninterest expense decreased $491 thousand, or 1.7% for the three months ended March 31, 2017 as compared to the same period in 2016. The following table sets forth the components of the Company’s noninterest expense for the three months ended March 31, 2017 and 2016 and the period-over-period variations in such categories of noninterest expense:



	Three Months Ended March 31,				Variance
(dollars in thousands)	2017		2016		2017 v. 2016
Noninterest Expense
Salaries and employee benefits	$	16,837	$	16,774	$	63
Occupancy	3,872		4,040		(168		)
Data processing	1,288		1,182		106
FDIC assessment	878		726		152
Advertising and public relations	297		295		2
Communications	475		535		(60		)
Other real estate owned expense, net	37		33		4
Impairment of other real estate	—		55		(55		)
Core deposit intangible amortization	492		488		4
Professional fees	773		660		113
Acquisition expense, including legal	146		639		(493		)
Other	2,933		3,092		(159		)
Total noninterest expense	$	28,028	$	28,519	$	(491	)

FDIC Assessment. FDIC assessment expense increased $152 thousand, or 20.9% for the three months ended March 31, 2017 compared to the same period in 2016. The higher assessment is associated with an increase in deposit accounts due to organic growth.

Acquisition Expenses. Acquisition expenses decreased $493 thousand, or 77.2% for the three months ended March 31, 2017 compared to the same period in 2016. The decrease in acquisition expenses over the prior year is due to elevated fees incurred during first quarter 2016 relating to the core conversion of Grand Bank.

Occupancy and Other. Occupancy and other noninterest expense decreased by $168 thousand and $159 thousand, or 4.2% and 5.1%, respectively, for the three months ended March 31, 2017 compared to the same period in 2016. The majority of the decrease in these categories from prior year is generally due to increased operational efficiency as a result of the Grand Bank conversion in first quarter 2016 in addition to decreased operational costs related to efficiencies implemented in 2016.

Income Tax Expense

Income tax expense was $6.7 million and $6.2 million for the three months ended March 31, 2017 and 2016, respectively. The effective tax rates were 30.0% and 33.1% for the three months ended March 31, 2017 and 2016, respectively. The lower tax rate in the first quarter 2017 was due to the adoption of ASU 2016-09, Compensation - Stock Compensation (Topic 718): Improvements to Employee Share-Based Payment Accounting, which resulted in recording $724 thousand in tax benefits related to restricted stock vesting into income tax expense during first quarter 2017.

Discussion and Analysis of Financial Condition

The following discussion and analysis of the Company’s financial condition discusses and analyzes the financial condition of the Company as of March 31, 2017 and December 31, 2016.

Assets

The Company’s total assets increased by $169.8 million, or 2.9%, to $6.0 billion as of March 31, 2017 from $5.9 billion at December 31, 2016.

Loan Portfolio

The following table presents the balance and associated percentage of each major category in our loan portfolio as of March 31, 2017 and December 31, 2016:




(dollars in thousands)	March 31, 2017					December 31, 2016
Commercial	$	601,985		12.7	%	$	630,805		13.7	%
Real estate:
Commercial	2,562,743			54.4		2,459,221			53.7
Commercial construction, land and land development	573,623			12.2		531,481			11.6
Residential⁽¹⁾	652,650			13.9		644,340			14.1
Single family interim construction	237,740			5.1		235,475			5.1
Agricultural	52,515			1.1		53,548			1.2
Consumer	26,224			0.6		27,530			0.6
Other	112			—		166			—
	4,707,592			100.0	%	4,582,566			100.0	%
Deferred loan fees	(2,427		)			(2,117		)
Allowance for loan losses	(33,431		)			(31,591		)
Total loans, net	$	4,671,734				$	4,548,858

⁽¹⁾Includes mortgage loans held for sale as of March 31, 2017 and December 31, 2016 of $5.1 million and $9.8 million, respectively.

Our loan portfolio is the largest category of our earning assets. As of March 31, 2017 and December 31, 2016, loans, net of allowance for loan losses, totaled $4.672 billion and $4.549 billion, respectively, which is an increase of 2.7% between the two dates.

Asset Quality

Nonperforming Assets. The Company has established procedures to assist the Company in maintaining the overall quality of the Company’s loan portfolio. In addition, the Company has adopted underwriting guidelines to be followed by the Company’s lending officers and which require significant senior management review of proposed extensions of credit exceeding certain thresholds. When delinquencies exist, the Company rigorously monitors the levels of such delinquencies for any negative or adverse trends. The Company’s loan review procedures include approval of lending policies and underwriting guidelines by Independent Bank’s board of directors, an annual independent loan review, approval of large credit relationships by Independent Bank’s Executive Loan Committee and loan quality documentation procedures. The Company, like other financial institutions, is subject to the risk that its loan portfolio will be subject to increasing pressures from deteriorating borrower credit due to general economic conditions.

The Company discontinues accruing interest on a loan when management of the Company believes, after considering the Company’s collection efforts and other factors, that the borrower’s financial condition is such that collection of interest of that loan is doubtful. Loans are placed on nonaccrual status or charged-off at an earlier date if collection of principal or interest is considered doubtful. All interest accrued but not collected for loans, including troubled debt restructurings, that are placed on nonaccrual status or charged off is reversed against interest income. The interest on these loans is accounted for on the cash-basis or cost-recovery method, until qualifying for return to accrual. Loans are returned to accrual status when all the principal and interest amounts contractually due are brought current and future payments are reasonably assured.

Real estate we have acquired as a result of foreclosure or by deed-in-lieu-of foreclosure is classified as other real estate owned until sold. The Bank’s policy is to initially record other real estate at fair value less estimated costs to sell at the date of foreclosure. After foreclosure, other real estate is carried at the lower of the initial carrying amount (fair value less estimated costs to sell or lease), or at the value determined by subsequent appraisals of other real estate.

The Company periodically modifies loans to extend the term or make other concessions to help a borrower with a deteriorating financial condition stay current on their loan and to avoid foreclosure. The Company generally does not forgive principal or interest on loans or modify the interest rates on loans to rates that are below market rates. Under applicable accounting standards, such loan modifications are generally classified as troubled debt restructurings.

The following table sets forth the allocation of the Company’s nonperforming assets among the Company’s different asset categories as of the dates indicated. The Company classifies nonperforming loans as nonaccrual loans, loans past due 90 days or more and still accruing interest or loans modified under restructurings as a result of the borrower experiencing financial difficulties. The balances of nonperforming loans reflect the net investment in these assets, including deductions for purchase discounts.



(dollars in thousands)	March 31, 2017			December 31, 2016
Nonaccrual loans
Commercial	$	8,196		$	7,718
Real estate:
Commercial real estate, construction, land and land development	1,666			5,885
Residential real estate	1,031			866
Single family interim construction	—			884
Consumer	264			273
Total nonaccrual loans ⁽¹⁾	11,157			15,626
Loans delinquent 90 days or more and still accruing
Total loans delinquent 90 days or more and still accruing	—			—
Troubled debt restructurings, not included in nonaccrual loans
Commercial	—			1
Real estate:
Commercial real estate, construction, land and land development	1,177			1,204
Residential real estate	1,008			1,011
Total troubled debt restructurings, not included in nonaccrual loans	2,185			2,216
Total nonperforming loans	13,342			17,842
Other real estate owned and other repossessed assets:
Commercial real estate, construction, land and land development	783			783
Residential Real Estate	1,189			1,189
Single family interim construction	924			—
Consumer	—			4
Total other real estate owned and other repossessed assets	2,896			1,976
Total nonperforming assets	$	16,238		$	19,818
Ratio of nonperforming loans to total loans	0.28		%	0.39		%
Ratio of nonperforming assets to total assets	0.27			0.34


⁽¹⁾	Nonaccrual loans include troubled debt restructurings of $204 thousand and $209 thousand as of March 31, 2017 and December 31, 2016, respectively.

Nonaccrual loans decreased to $11.2 million at March 31, 2017 from $15.6 million as of December 31, 2016. Troubled debt restructurings that were not on nonaccrual status totaled $2.2 million at both March 31, 2017 and December 31, 2016. The decrease in nonaccruals was primarily due to the payoffs of two commercial real estate loans totaling $5.8 million and the foreclosure of a single-family interim construction property totaling $884 thousand offset by four loans totaling $2.7 million that were placed on nonaccrual during the current quarter. The net increase in other real estate owned and repossessed assets is due to the addition of the single-family interim construction property foreclosure discussed above.

As of March 31, 2017, the Company had a total of 54 substandard loans with an aggregate principal balance of $20.7 million that were not currently impaired loans, nonaccrual loans, 90 days past due loans or troubled debt restructurings, but where the Company had information about possible credit problems of the borrowers that caused the Company’s management to have

serious concerns as to the ability of the borrowers to comply with present loan repayment terms and that could result in those loans becoming nonaccrual loans, 90 days past due loans or troubled debt restructurings in the future.

The Company generally continues to use the classification of acquired loans classified nonaccrual or 90 days and accruing as of the acquisition date. The Company does not classify acquired loans as troubled debt restructurings, or TDRs, unless the Company modifies an acquired loan subsequent to acquisition that meets the TDR criteria. Reported delinquency of the Company’s purchased loan portfolio is based upon the contractual terms of the loans.

Allowance for Loan Losses. The allowance for loan losses is established through charges to earnings in the form of a provision for loan losses. The Company’s allowance for loan losses represents the Company’s estimate of probable and reasonably estimable loan losses inherent in loans held for investment as of the respective balance sheet date. The Company’s methodology for assessing the adequacy of the allowance for loan losses includes a general allowance for performing loans, which are grouped based on similar characteristics, and an allocated allowance for individual impaired loans. Actual credit losses or recoveries are charged or credited directly to the allowance. As of March 31, 2017, the allowance for loan losses amounted to $33.4 million, or 0.71% of total loans, compared with $31.6 million, or 0.69% of total loans as of December 31, 2016. The increase in the allowance is primarily due to general reserves for organic loan growth.

The allowance for loan losses to nonperforming loans has increased from 177.06% at December 31, 2016 to 250.57% at March 31, 2017. Nonperforming loans have decreased to $13.3 million at March 31, 2017 compared to $17.8 million at December 31, 2016 primarily due to the payoff of two commercial real estate loans and the foreclosure of single-family interim construction property as discussed above.

Securities Available for Sale

The Company’s investment strategy aims to maximize earnings while maintaining liquidity in securities with minimal credit, interest rate and duration risk. The types and maturities of securities purchased are primarily based on the Company’s current and projected liquidity and interest rate sensitivity positions.

There were no sales of securities for the three months ended March 31, 2017 and 2016. Securities represented 5.8% and 5.4% of the Company’s total assets at March 31, 2017 and December 31, 2016, respectively.

Management evaluates securities for other-than-temporary impairment (OTTI) on at least a quarterly basis and more frequently when economic of market conditions warrant such an evaluation. Management does not intend to sell any debt securities it holds and believes the Company more likely than not will not be required to sell any debt securities it holds before their anticipated recovery, at which time the Company will receive full value for the securities. Management has the ability and intent to hold the securities classified as available for sale that were in a loss position as of March 31, 2017 for a period of time sufficient for an entire recovery of the cost basis of the securities. For those securities that are impaired, the unrealized losses are largely due to interest rate changes. The fair value is expected to recover as the securities approach their maturity date. Management believes any impairment in the Company’s securities at March 31, 2017 is temporary and no other-than-temporary impairment has been realized in the Company’s consolidated financial statements.

Capital Resources and Regulatory Capital Requirements

Total stockholder’s equity was $688.5 million at March 31, 2017 compared with $672.4 million at December 31, 2016, an increase of approximately $16.1 million. The increase was due primarily to net income of $15.7 million earned by the Company during the three months ended March 31, 2017 as well as stock based compensation of $970 thousand and an increase of $1.3 million in unrealized gain on available for sale securities offset by dividends paid of $1.9 million.

As of March 31, 2017, the Company exceeded all capital ratio requirements under prompt corrective action and other regulatory requirements, as detailed in the table below:



	As of March 31, 2017
	Actual		Required to be considered well capitalized	Required to be considered adequately capitalized
	Ratio		Ratio	Ratio
Tier 1 capital to average assets ratio	7.84	%	≥5.00%	4.00-5.00%
Common equity tier 1 capital to risk-weighted assets ratio	8.28		≥6.50	4.50-6.50
Tier 1 capital to risk-weighted assets ratio	8.63		≥8.00	6.00-8.00
Total capital to risk-weighted assets ratio	11.44		≥10.00	8.00-10.00

Liquidity Management

The Company continuously monitors the Company’s liquidity position to ensure that assets and liabilities are managed in a manner that will meet all of the Company’s short-term and long-term cash requirements. The Company manages the Company’s liquidity position to meet the daily cash flow needs of customers, while maintaining an appropriate balance between assets and liabilities to meet the return on investment objectives of the Company’s shareholders. The Company also monitors its liquidity requirements in light of interest rate trends, changes in the economy, and the scheduled maturity and interest rate sensitivity of the investment and loan portfolios and deposits.

Liquidity risk management is an important element in the Company’s asset/liability management process. The Company’s short-term and long-term liquidity requirements are primarily to fund on-going operations, including payment of interest on deposits and debt, extensions of credit to borrowers, capital expenditures and shareholder dividends. These liquidity requirements are met primarily through cash flow from operations, redeployment of pre-paid and maturing balances in the Company’s loan and investment portfolios, debt financing and increases in customer deposits. The Company’s liquidity position is supported by management of liquid assets and liabilities and access to alternative sources of funds. Liquid assets include cash, interest-bearing deposits in banks, federal funds sold, securities available for sale and maturing or prepaying balances in the Company’s investment and loan portfolios. Liquid liabilities include core deposits, brokered deposits, federal funds purchased, securities sold under repurchase agreements and other borrowings. Other sources of liquidity include the sale of loans, the ability to acquire additional national market non core deposits, the issuance of additional collateralized borrowings such as FHLB advances, the issuance of debt securities, borrowings through the Federal Reserve’s discount window and the issuance of equity securities. For additional information regarding the Company’s operating, investing and financing cash flows, see the Consolidated Statements of Cash Flows provided in the Company’s consolidated financial statements.

In addition to the liquidity provided by the sources described above, Independent Bank maintains correspondent relationships with other banks in order to sell loans or purchase overnight funds should additional liquidity be needed. As of March 31, 2017, the Bank had established federal funds lines of credit with nine unaffiliated banks totaling $225.0 million with no amounts advanced against those lines at that time. The Company also participates with an exchange that provides direct overnight borrowings with other financial institutions with a borrowing capacity of $75 million and none outstanding as of March 31, 2017. The Company has an unsecured line of credit totaling $50.0 million at two unaffiliated commercial banks. Based on the values of stock, securities, and loans pledged as collateral, as of March 31, 2017, the Company had additional borrowing capacity with the FHLB of $905.7 million. In addition, the Company maintains a secured line of credit with the Federal Reserve Bank with an availability to borrow $372.4 million.

Contractual Obligations

In the ordinary course of the Company’s operations, the Company enters into certain contractual obligations, such as obligations for operating leases and other arrangements with respect to deposit liabilities, FHLB advances and other borrowed funds. The Company believes that it will be able to meet its contractual obligations as they come due through the maintenance of adequate cash levels. The Company expects to maintain adequate cash levels through profitability, loan and securities

repayment and maturity activity and continued deposit gathering activities. The Company has in place various borrowing mechanisms for both short-term and long-term liquidity needs.

Other than normal changes in the ordinary course of business, there have been no significant changes in the types of contractual obligations or amounts due since December 31, 2016.

Off-Balance Sheet Arrangements

In the normal course of business, the Company enters into various transactions, which, in accordance with accounting principles generally accepted in the United States, are not included in the Company’s consolidated balance sheets. However, the Company has only limited off-balance sheet arrangements that have, or are reasonably likely to have, a current or future material effect on the Company’s financial condition, revenues, expenses, results of operations, liquidity, capital expenditures or capital resources. Independent Bank enters into these transactions to meet the financing needs of the Company’s customers. These transactions include commitments to extend credit and issue standby letters of credit, which involve, to varying degrees, elements of credit risk and interest rate risk in excess of the amounts recognized in the consolidated balance sheets.

Commitments to Extend Credit. Independent Bank enters into contractual commitments to extend credit, normally with fixed expiration dates or termination clauses, at specified rates and for specific purposes. Substantially all of Independent Bank’s commitments to extend credit are contingent upon customers maintaining specific credit standards at the time of loan funding. Independent Bank minimizes its exposure to loss under these commitments by subjecting them to credit approval and monitoring procedures.

Standby Letters of Credit. Standby letters of credit are written conditional commitments that Independent Bank issues to guarantee the performance of a customer to a third party. In the event the customer does not perform in accordance with the terms of the agreement with the third party, Independent Bank would be required to fund the commitment. The maximum potential amount of future payments Independent Bank could be required to make is represented by the contractual amount of the commitment. If the commitment is funded, the customer is obligated to reimburse Independent Bank for the amount paid under this standby letter of credit.

Independent Bank’s commitments to extend credit and outstanding standby letters of credit were $874.0 million and $7.6 million, respectively, as of March 31, 2017. Since commitments associated with letters of credit and commitments to extend credit may expire unused, the amounts shown do not necessarily reflect the actual future cash funding requirements. The Company manages the Company’s liquidity in light of the aggregate amounts of commitments to extend credit and outstanding standby letters of credit in effect from time to time to ensure that the Company will have adequate sources of liquidity to fund such commitments and honor drafts under such letters of credit.

Critical Accounting Policies and Estimates

The preparation of the Company’s consolidated financial statements in accordance with U.S. generally accepted accounting principles, or GAAP, requires the Company to make estimates and judgments that affect the Company’s reported amounts of assets, liabilities, income and expenses and related disclosure of contingent assets and liabilities. The Company bases its estimates on historical experience and on various other assumptions that are believed to be reasonable under current circumstances, results of which form the basis for making judgments about the carrying value of certain assets and liabilities that are not readily available from other sources. The Company evaluates the Company’s estimates on an ongoing basis. Actual results may differ from these estimates under different assumptions or conditions.

Accounting policies, as described in detail in the notes to the Company’s consolidated financial statements, are an integral part of the Company’s financial statements. A thorough understanding of these accounting policies is essential when reviewing the Company’s reported results of operations and the Company’s financial position. The Company believes that the critical accounting policies and estimates discussed below require the Company to make difficult, subjective or complex judgments about matters that are inherently uncertain. Changes in these estimates, that are likely to occur from period to period, or the use of different estimates that the Company could have reasonably used in the current period, would have a material impact on the Company’s financial position, results of operations or liquidity.

Acquired Loans. The Company’s accounting policies require that the Company evaluates all acquired loans for evidence of deterioration in credit quality since origination and to evaluate whether it is probable that the Company will collect all contractually required payments from the borrower.

Acquired loans from the transactions accounted for as a business combination include both loans with evidence of credit deterioration since their origination date and performing loans. The Company accounts for performing loans under ASC Paragraph 310-20, Nonrefundable Fees and Other Costs, with the related discount being adjusted for over the life of the loan and recognized as interest income. The Company accounts for the loans acquired in accordance with ASC Paragraph 310-30, Loans and Debt Securities Acquired with Deteriorated Credit Quality. At the date of the acquisition, acquired loans are recorded at their fair value.

The Company recognizes the difference between the undiscounted cash flows the Company expects (at the time the Company acquires the loan) to be collected and the investment in the loan, or the “accretable yield,” as interest income using the interest method over the life of the loan. The Company does not recognize contractually required payments for interest and principal that exceed undiscounted cash flows expected at acquisition, or the “nonaccretable difference,” as a yield adjustment, loss accrual or valuation allowance. Increases in the expected cash flows subsequent to the initial investment are recognized prospectively through adjustment of the yield on the loan over the loan’s remaining life, while decreases in expected cash flows are recognized as impairment. Valuation allowances on these impaired loans reflect only losses incurred after the acquisition.

Upon an acquisition, the Company generally continues to use the classification of acquired loans classified nonaccrual or 90 days and accruing. The Company does not classify acquired loans as TDRs unless the Company modifies an acquired loan subsequent to acquisition that meets the TDR criteria. Reported delinquency of the Company’s purchased loan portfolio is based upon the contractual terms of the loans.

Allowance for Loan Losses. The allowance for loan losses represents management’s estimate of probable and reasonably estimable credit losses inherent in the loan portfolio. In determining the allowance, the Company estimates losses on individual impaired loans, or groups of loans which are not impaired, where the probable loss can be identified and reasonably estimated. On a quarterly basis, the Company assesses the risk inherent in the Company’s loan portfolio based on qualitative and quantitative trends in the portfolio, including the internal risk classification of loans, historical loss rates, changes in the nature and volume of the loan portfolio, industry or borrower concentrations, delinquency trends, detailed reviews of significant loans with identified weaknesses and the impacts of local, regional and national economic factors on the quality of the loan portfolio. Based on this analysis, the Company records a provision for loan losses in order to maintain the allowance at appropriate levels.

Determining the amount of the allowance is considered a critical accounting estimate, as it requires significant judgment and the use of subjective measurements, including management’s assessment of overall portfolio quality. The Company maintains the allowance at an amount the Company believes is sufficient to provide for estimated losses inherent in the Company’s loan portfolio at each balance sheet date, and fluctuations in the provision for loan losses may result from management’s assessment of the adequacy of the allowance. Changes in these estimates and assumptions are possible and may have a material impact on the Company’s allowance, and therefore the Company’s financial position, liquidity or results of operations.

Goodwill and Core Deposit Intangible. The excess purchase price over the fair value of net assets from acquisitions, or goodwill, is evaluated for impairment at least annually and on an interim basis if an event or circumstance indicates that it is likely an impairment has occurred. Under current accounting standards, the Company has the option to first assess qualitative factors to determine whether the existence of events or circumstances leads to a determination that it is more likely than not that the fair value of a reporting unit is less than its carrying amount. If, after assessing the totality of events or circumstances, the Company determines it is not more likely than not that the fair value of a reporting unit is less than its carrying amount, no further testing is necessary. If the Company concludes otherwise, then it is required to perform the first step of the two step impairment test by calculating the fair value of the reporting unit and comparing the fair value with the carrying amount of the reporting unit. The Company performs its impairment test annually as of December 31. There have been no circumstances since December 31, 2016 that would indicate any impairment has occurred, therefore, management does not believe goodwill is impaired as of March 31, 2017.

Core deposit intangibles are acquired customer relationships that lack physical substance but can be distinguished from goodwill because of contractual or other legal rights or because the asset is capable of being sold or exchanged either on its own or in combination with a related contract, asset, or liability. Core deposit intangibles are being amortized on a straight-line basis over their estimated useful lives of ten years. Core deposit intangibles are tested for impairment whenever events or changes in circumstances indicate the carrying amount of the assets may not be recoverable from future undiscounted cash flows. If impaired, the assets are recorded at fair value.

Recent Acquisition

On November 21, 2016, the Company entered into a definitive reorganization agreement to acquire Carlile Bancshares, Inc., a Texas corporation ("CBI") and its subsidiary, Northstar Bank, Denton, Texas, a Texas state chartered bank. The Company completed this acquisition on April 1, 2017. Pursuant to the reorganization agreement, CBI was merged with and into the Company, with the Company continuing as the surviving company, such merger being referred to as the “Carlile acquisition.” At the effective time of the Carlile acquisition, CBI ceased to exist. Immediately following the Carlile acquisition, Northstar Bank was merged with and into Independent Bank, with Independent Bank being the surviving bank. The existing locations of Northstar Bank became banking centers of Independent Bank. Under the terms of the Carlile acquisition, the Company acquired all of the outstanding shares of CBI's common stock and outstanding securities convertible into CBI common in exchange for the Company’s issuance of 8,804,699 shares of its common stock and approximately $17.4 million in cash.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

The principal objective of the Company’s asset and liability management function is to evaluate the interest rate risk within the balance sheet and pursue a controlled assumption of interest rate risk while maximizing net income and preserving adequate levels of liquidity and capital. The Investment Committee of the Bank’s Board of Directors has oversight of our asset and liability management function, which is managed by our Treasurer. Our Treasurer meets with our Chief Financial Officer and senior executive management team regularly to review, among other things, the sensitivity of the Company’s assets and liabilities to market interest rate changes, local and national market conditions and market interest rates. That group also reviews the liquidity, capital, deposit mix, loan mix and investment positions of our Company.

Our management and our Board of Directors are responsible for managing interest rate risk and employing risk management policies that monitor and limit our exposure to interest rate risk. Interest rate risk is measured using net interest income simulations and market value of portfolio equity analyses. These analyses use various assumptions, including the nature and timing of interest rate changes, yield curve shape, prepayments on loans, securities and deposits, deposit decay rates, pricing decisions on loans and deposits, reinvestment/replacement of asset and liability cash flows.

Instantaneous parallel rate shift scenarios are modeled and utilized to evaluate risk and establish exposure limits for acceptable changes in net interest margin. These scenarios, known as rate shocks, simulate an instantaneous change in interest rates and use various assumptions, including, but not limited to, prepayments on loans and securities, deposit decay rates, pricing decisions on loans and deposits, reinvestment and replacement of asset and liability cash flows.

We also analyze the economic value of equity as a secondary measure of interest rate risk. This is a complementary measure to net interest income where the calculated value is the result of the market value of assets less the market value of liabilities. The economic value of equity is a longer term view of interest rate risk because it measures the present value of the future cash flows. The impact of changes in interest rates on this calculation is analyzed for the risk to our future earnings and is used in conjunction with the analyses on net interest income.

We conduct periodic analyses of our sensitivity to interest rate risks through the use of a third-party proprietary interest-rate sensitivity model. That model has been customized to our specifications on an installment level basis. The analyses conducted by use of that model are based on current information regarding our actual interest-earnings assets, interest-bearing liabilities, capital and other financial information that we supply. The third party uses that information in the model to estimate our sensitivity to interest rate risk.

Our interest rate risk model indicated that we were in a balanced rate sensitive position as of March 31, 2017. The table below illustrates the impact of an immediate and sustained 200 and 100 basis point increase and a 100 basis point decrease in interest rates on net interest income based on the interest rate risk model as of March 31, 2017:



Hypothetical Shift in Interest Rates (in bps)	% Change in Projected Net Interest Income
200	(1.28)%
100	(0.59)%
(100)	2.48%

These are good faith estimates and assume that the composition of our interest sensitive assets and liabilities existing at each period-end and is based on future maturities and market pricing over the relevant twelve month measurement period and that changes in market interest rates are instantaneous and sustained across the yield curve regardless of duration of pricing characteristics of specific assets or liabilities. Also, this analysis does not contemplate any actions that we might undertake in response to changes in market interest rates. We believe these estimates are not necessarily indicative of what actually could occur in the event of immediate interest rate increases or decreases of this magnitude. As interest-bearing assets and liabilities re-price in different time frames and proportions to market interest rate movements, various assumptions must be made based on historical relationships of these variables in reaching any conclusion. Since these correlations are based on competitive and market conditions, we anticipate that our future results will likely be different from the foregoing estimates, and such differences could be material.

ITEM 4. CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures. An evaluation of the effectiveness of the design and operation of our disclosure controls and procedures as of the end of the period covered by this Quarterly Report on Form 10-Q was performed under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that our disclosure controls and procedures are effective to provide reasonable assurance that information required to be disclosed by the Company in the reports that it files or submits under the Securities Exchange Act of 1934, as amended, is accumulated and communicated to management, including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions regarding required disclosure and are effective to provide reasonable assurance that such information is recorded, processed, summarized and reported within the time periods specified by the SEC's rules and forms.

Changes in internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting during the three months ended March 31, 2017 that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

PART II

Item 1. LEGAL PROCEEDINGS

In the normal course of business, the Company and Independent Bank are named as defendants in various lawsuits. Management of the Company and Independent Bank, following consultation with legal counsel, do not expect the ultimate disposition of any, or a combination, of these matters to have a material adverse effect on the business of the Company or Independent Bank. A legal proceeding that the Company believes could become material is described below.

Independent Bank is a party to a legal proceeding inherited by Independent Bank in connection with the Company's acquisition of BOH Holdings, Inc. and its subsidiary, Bank of Houston, or BOH, that was completed on April 15, 2014. Several entities related to R. A. Stanford, or the Stanford Entities, including Stanford International Bank, Ltd., or SIBL, had deposit accounts at BOH. Certain individuals who had purchased certificates of deposit from SIBL filed a class action lawsuit against several banks, including BOH, on November 11, 2009 in the U.S. District Court Northern District of Texas, Dallas Division, alleging, among other things, that the plaintiffs were victims of fraud by SIBL and other Stanford Entities and seeking to recover damages and alleged fraudulent transfers by the defendant banks.

On May 1, 2015, the plaintiffs filed a motion requesting permission to file a Second Amended Class Action Complaint in this case, which motion was subsequently granted. The Second Amended Class Action Complaint asserted previously unasserted claims, including aiding and abetting or participation in a fraudulent scheme based upon the large amount of deposits that the Stanford Entities held at BOH and the alleged knowledge of certain BOH officers. Given the new allegations, Independent Bank notified its insurance carriers of the claims made in the Second Amended Class Action Complaint. The insurance carriers have initially indicated that a “loss” has not yet occurred or that the claims are not covered by the policies. However, Independent Bank is continuing to pursue insurance coverage for these claims, as well as for the reimbursement of defense costs, through the initiation of litigation and other means.

Independent Bank believes that the claims made in this lawsuit are without merit and is vigorously defending this lawsuit. This is complex litigation involving a number of procedural matters and issues. As such, Independent Bank is unable to predict when this matter may be resolved and, given the uncertainty of litigation, the ultimate outcome of, or potential costs or damages arising from, this case.

Item 1A. RISK FACTORS

In evaluating an investment in our securities, investors should consider carefully, among other things, the risk factors previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2016, in the information contained in this Quarterly Report on Form 10-Q and our other reports and registrations statements, and, with respect to our 5.875% Subordinated Notes due August 1, 2024, in the Prospectus Supplement filed pursuant to Rule 424(b)(5) on June 23, 2016, in each case as filed with the SEC.

Item 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

None

Item 3. DEFAULTS UPON SENIOR SECURITIES

None

Item 4. MINE SAFETY DISCLOSURES

Not applicable

Item 5. OTHER INFORMATION

None

Item 6. EXHIBITS

The following documents are filed as exhibits to this Quarterly Report on Form 10-Q:




Exhibit 3.1		Amended and Restated Certificate of Formation of Independent Bank Group, Inc., which is incorporated herein by reference to Exhibit 3.1 to Registration Statement on Form S-1 of Independent Bank Group, Inc. filed with the SEC on February 27, 2013 (the "S-1 Registration Statement").

Exhibit 3.2		Certificate of Amendment to Amended and Restated Certificate of Formation of Independent Bank Group, Inc., which is incorporated herein by reference to Exhibit 3.3 to Amendment No. 2 to the S-1 Registration Statement filed with the SEC on April 1, 2013.

Exhibit 3.3		Third Amended and Restated Bylaws of Independent Bank Group, Inc., which are incorporated herein by reference to Exhibit 3.2 to Amendment No. 1 to the S-1 Registration Statement filed with the SEC on March 18, 2013.

Exhibit 3.4		Statement of Designations of Senior Non-Cumulative Perpetual Preferred Stock, Series A of Independent Bank Group, Inc., as filed with the Office of the Secretary of State of the State of Texas on April 15, 2014, which is incorporated herein by reference to Exhibit 3.1 to the Current Report on Form 8-K of Independent Bank Group, Inc. filed with the SEC on April 17, 2014.

Exhibit 3.5		Certificate of Merger, dated January 2, 2014, of Live Oak Financial Corp. with and into Independent Bank Group, Inc., which is incorporated herein by reference to Exhibit 3.5 to Amendment No. 1 to the Registrant’s Registration Statement on Form S-3 (Registration No. 333-196627) filed with the SEC on June 25, 2014 (the “S-3 Registration Statement”)

Exhibit 3.6		Certificate of Merger, dated April 15, 2014, of BOH Holdings, Inc. with and into Independent Bank Group, Inc., which is incorporated herein by reference to Exhibit 3.6 to Amendment No. 1 to the S-3 Registration Statement filed with the SEC on June 25, 2014

Exhibit 3.7		Certificate of Merger, dated September 30, 2014, of Houston City Bancshares, Inc. with and into Independent Bank Group, Inc., which are incorporated by reference to Exhibit 3.7 to the Registrant’s Quarterly Report on Form 10-Q, dated July 31, 2015

Exhibit 3.8		Certificate of Merger, dated March 31, 2017, of Carlile Bancshares, Inc. with and into Independent Bank Group, Inc.*

Exhibit 4.1		Form of certificate representing shares of the Registrant’s common stock, which is incorporated herein by reference to Exhibit 4.1 to Amendment No. 1 to the Form S-1 Registration Statement filed with the SEC on March 18, 2013

Exhibit 4.2		Form of Common Stock Purchase Warrant, with schedules of differences, which is incorporated herein by reference to Exhibit 4.2 to the Form S-1 Registration Statement

Exhibit 4.3		Form of certificate representing shares of the Registrant’s Series A preferred stock, which is incorporated herein by reference to Exhibit 4.3 to the S-3 Registration Statement

Exhibit 4.4		Subordinated Debt Indenture, dated as of June 25, 2014, between Independent Bank Group, Inc. and Wells Fargo Bank, National Association, in its capacity as Indenture Trustee, which is incorporated herein by reference to Exhibit 4.6 to the Registrant’s Amendment No. 1 to the S-3 Registration Statement filed with the SEC on June 25, 2014

Exhibit 4.5		First Supplemental Indenture, dated as of July 17, 2014, between Independent Bank Group, Inc. and Wells Fargo Bank Shareowner Services, in its capacity as Indenture Trustee, which is incorporated herein by reference to Exhibit 4.2 to the Registrant’s Current Report on Form 8-K, dated July 17, 2014.

Exhibit 4.6		Form of Global Note to represent the 5.875% Subordinated Notes due August 1, 2024, of the Registrant, which is incorporated herein by reference to Exhibit 4.3 to the Registrant’s Current Report on Form 8-K, dated July 17, 2014.

Exhibit 4.7		Form of Global Note to represent the 5.875% Subordinated Notes due August 1, 2024, of the Registrant, which is incorporated herein by reference to Exhibit 4.1 to the Registrant’s Current Report on Form 8-K, dated June 22, 2016.



Exhibit 4.8		Independent Bank 401(k) Profit Sharing Plan, including related Adoption Agreement, which is incorporated herein by reference to Exhibit 4.9 to the Registrant’s Registration Statement on Form S-8 filed with the SEC on August 29, 2014.

The other instruments defining the rights of holders of the long-term debt securities of the Registrant and its subsidiaries are omitted pursuant to section (b)(4)(iii)(A) of Item 601 of Regulation S-K. The Registrant hereby agrees to furnish copies of these instruments to the SEC upon request.
Exhibit 10.1		CBI Nominee Agreement, dated March 28, 2017, by and among the Registrant and Tom C. Nichols, which is incorporated by reference to Exhibit 10.1 to the Current Report on Form 8-K of Independent Bank Group, Inc. filed with the SEC on April 14, 2017.

Exhibit 10.2		CBI Nominee Agreement, dated as of March 28, 2017, by and among the Registrant and Trident IV PF Depository Holdings, LLC and Trident IV Depository Holdings, LLC, which is incorporated by reference to Exhibit 10.2 to the Current Report on Form 8-K of Independent Bank Group, Inc. filed with the SEC on April 14, 2017.

Exhibit 10.3		CBI Nominee Agreement, dated March 28, 2017, by and among the Registrant and LEP Carlile Holdings, LLC, which is incorporated by reference to Exhibit 10.3 to the Current Report on Form 8-K of Independent Bank Group, Inc. filed with the SEC on April 14, 2017.

Exhibit 31.1*		Chief Executive Officer Section 302 Certification

Exhibit 31.2*		Chief Financial Officer Section 302 Certification

Exhibit 32.1**		Chief Executive Officer Section 906 Certification

Exhibit 32.2**		Chief Financial Officer Section 906 Certification

Exhibit 101.INS *		XBRL Instance Document

Exhibit 101.SCH *		XBRL Taxonomy Extension Schema Document

Exhibit 101.CAL *		XBRL Taxonomy Extension Calculation Linkbase Document

Exhibit 101.DEF *		XBRL Taxonomy Extension Definition Linkbase Document

Exhibit 101.LAB *		XBRL Taxonomy Extension Label Linkbase Document

Exhibit 101.PRE *		XBRL Taxonomy Extension Presentation Linkbase Document



*	Filed herewith as an Exhibit.



**	Furnished herewith as an Exhibit.

Signatures

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.



		Independent Bank Group, Inc.

Date: April 27, 2017		By: /s/ David R. Brooks

		David R. Brooks
		Chairman, Chief Executive Officer and President



Date: April 27, 2017		By: /s/ Michelle S. Hickox

		Michelle S. Hickox
		Executive Vice President
		Chief Financial Officer

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Independent Bank (IBTX) 10-Q2017 Q1 Quarterly report

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