ibtx-20200930

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)


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

For the quarterly period ended September 30, 2020.


☐			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.)

7777 Henneman Way
McKinney,
Texas						75070-1711
(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)

Securities registered pursuant to Section 12(b) of the Act:

Title of Each Class

Trading Symbol(s)

Name of Exchange on Which Registered

Common Stock, par value $0.01 per share

IBTX

NASDAQ Global Select Market

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 ☒ 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 ☒ 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

☐

Non-Accelerated Filer

☐

(Do not check if a smaller reporting company)

Smaller Reporting Company

☐

Emerging Growth Company

☐

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. ☐

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

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 – 43,248,297 shares as of October 27, 2020.

INDEPENDENT BANK GROUP, INC. AND SUBSIDIARIES

Form 10-Q

September 30, 2020


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	6
	Notes to Consolidated Financial Statements-Unaudited	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	39

Item 3.	Quantitative and Qualitative Disclosures about Market Risk	61

Item 4.	Controls and Procedures	62

PART II.	Other Information

Item 1.	Legal Proceedings	62

Item 1A.	Risk Factors	63

Item 2	Unregistered Sales of Equity Securities and Use of Proceeds	63

Item 3.	Defaults Upon Senior Securities	63

Item 4.	Mine Safety Disclosures	64

Item 5.	Other Information	64

Item 6.	Exhibits	65

Signatures

***

Table of Contents

PART I

ITEM 1. CONSOLIDATED FINANCIAL STATEMENTS

Independent Bank Group, Inc. and Subsidiaries

Consolidated Balance Sheets

September 30, 2020 (unaudited) and December 31, 2019

(Dollars in thousands, except share information)


	September 30,		December 31,
Assets	2020		2019
Cash and due from banks	$	171,029	$	186,299
Interest-bearing deposits in other banks	1,277,704		378,871
Federal funds sold	5,000		—
Cash and cash equivalents	1,453,733		565,170
Certificates of deposit held in other banks	4,481		5,719
Securities available for sale, at fair value	1,076,619		1,085,936
Loans held for sale (includes $81,476 and $29,204 carried at fair value, respectively)	87,406		35,645
Loans, net	12,770,681		11,562,814
Premises and equipment, net	242,720		242,874
Other real estate owned	1,642		4,819
Federal Home Loan Bank (FHLB) of Dallas stock and other restricted stock	26,504		30,052
Bank-owned life insurance (BOLI)	219,088		215,081
Deferred tax asset	4,196		6,943
Goodwill	994,021		994,021
Other intangible assets, net	91,215		100,741
Other assets	144,701		108,392
Total assets	$	17,117,007	$	14,958,207

Liabilities and Stockholders’ Equity
Deposits:
Noninterest-bearing	$	4,187,150	$	3,240,185
Interest-bearing	9,610,410		8,701,151
Total deposits	13,797,560		11,941,336
FHLB advances	375,000		325,000

Other borrowings	305,529		202,251

Junior subordinated debentures	53,973		53,824
Other liabilities	108,572		96,023
Total liabilities	14,640,634		12,618,434
Commitments and contingencies	—		—
Stockholders’ equity:
Preferred stock (0 and 0 shares outstanding, respectively)	—		—
Common stock (43,244,797 and 42,950,228 shares outstanding, respectively)	432		430
Additional paid-in capital	1,932,690		1,926,359
Retained earnings	504,135		393,674

Accumulated other comprehensive income	39,116		19,310
Total stockholders’ equity	2,476,373		2,339,773
Total liabilities and stockholders’ equity	$	17,117,007	$	14,958,207

See Notes to Consolidated Financial Statements

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Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Income

Three and Nine Months Ended September 30, 2020 and 2019 (unaudited)

(Dollars in thousands, except per share information)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Interest income:
Interest and fees on loans	$	144,138	$	154,664	$	434,648	$	457,626
Interest on taxable securities	4,507		5,374		14,499		16,101
Interest on nontaxable securities	2,126		2,074		6,359		6,426
Interest on interest-bearing deposits and other	1,027		3,195		3,938		8,393
Total interest income	151,798		165,307		459,444		488,546
Interest expense:
Interest on deposits	15,679		33,386		62,077		92,550
Interest on FHLB advances	714		2,730		3,629		8,324
Interest on other borrowings	2,928		3,036		8,408		8,674
Interest on junior subordinated debentures	470		762		1,710		2,310
Total interest expense	19,791		39,914		75,824		111,858
Net interest income	132,007		125,393		383,620		376,688
Provision for loan losses	7,620		5,233		39,122		13,196
Net interest income after provision for loan losses	124,387		120,160		344,498		363,492
Noninterest income:
Service charges on deposit accounts	2,173		2,805		6,881		9,247
Investment management and trust	1,924		2,497		5,556		7,238
Mortgage banking revenue	14,722		4,824		27,726		11,619
Gain on sale of loans	—		6,779		647		6,779
Gain on sale of branch	—		1,549		—		1,549

Gain on sale of other real estate	—		539		37		851

Gain on sale of securities available for sale	—		—		382		265
Gain (loss) on sale and disposal of premises and equipment	34		(315)		311		(585)
Increase in cash surrender value of BOLI	1,335		1,402		4,007		4,135
Other	4,977		7,244		19,604		18,849
Total noninterest income	25,165		27,324		65,151		59,947
Noninterest expense:
Salaries and employee benefits	42,253		37,645		115,341		120,557
Occupancy	9,717		9,402		29,132		27,978
Communications and technology	5,716		5,758		17,193		16,598
FDIC assessment (credit)	1,597		(2,139)		5,338		71
Advertising and public relations	492		467		1,965		1,942
Other real estate owned expenses, net	43		152		459		302
Impairment of other real estate	46		—		784		1,424
Amortization of other intangible assets	3,175		3,235		9,526		9,705
Professional fees	2,871		2,057		9,266		4,771
Acquisition expense, including legal	47		9,465		16,225		28,175
Other	7,452		10,906		25,678		29,998
Total noninterest expense	73,409		76,948		230,907		241,521
Income before taxes	76,143		70,536		178,742		181,918
Income tax expense	16,068		14,903		35,807		39,418
Net income	$	60,075	$	55,633	$	142,935	$	142,500
Basic earnings per share	$	1.39	$	1.30	$	3.32	$	3.29
Diluted earnings per share	$	1.39	$	1.30	$	3.31	$	3.29

See Notes to Consolidated Financial Statements

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Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Comprehensive Income

Three and Nine Months Ended September 30, 2020 and 2019 (unaudited)

(Dollars in thousands)


	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Net income	$	60,075	$	55,633	$	142,935	$	142,500
Other comprehensive income before tax:
Change in net unrealized gains on available for sale securities during the year	235		3,624		25,063		36,420
Reclassification for amount realized through sales of securities available for sale included in net income	—		—		(382)		(265)
Other comprehensive income before tax	235		3,624		24,681		36,155
Income tax expense	49		807		4,875		7,910
Other comprehensive income, net of tax	186		2,817		19,806		28,245
Comprehensive income	$	60,261	$	58,450	$	162,741	$	170,745

See Notes to Consolidated Financial Statements

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Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity

Three Months Ended September 30, 2020 and 2019 (unaudited)

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


	Preferred Stock $0.01 Par Value		Common Stock $0.01 Par Value			Additional Paid in Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Total
	10 million shares authorized		100 million shares authorized
			Shares	Amount
Three Months Ended





















Balance, June 30, 2020	$	—	43,041,119	$	430	$	1,930,722	$	454,878	$	38,930	$	2,424,960
Net income	—		—	—		—		60,075		—		60,075
Other comprehensive income, net of tax	—		—	—		—		—		186		186
Common stock repurchased	—		(291)	—		—		(13)		—		(13)
Restricted stock forfeited	—		(6,644)	—		—		—		—		—
Restricted stock granted	—		210,613	2		(2)		—		—		—
Stock based compensation expense	—		—	—		1,970		—		—		1,970
Cash dividends ($0.25 per share)	—		—	—		—		(10,805)		—		(10,805)
Balance, September 30, 2020	$	—	43,244,797	$	432	$	1,932,690	$	504,135	$	39,116	$	2,476,373


























Balance, June 30, 2019	$	—	42,953,818	$	430	$	1,922,475	$	309,314	$	17,123	$	2,249,342
Net income	—		—	—		—		55,633		—		55,633
Other comprehensive income, net of tax	—		—	—		—		—		2,817		2,817
Common stock repurchased	—		(776)	—		—		(41)		—		(41)
Restricted stock forfeited	—		(5,397)	—		—		—		—		—
Restricted stock granted	—		4,997	—		—		—		—		—
Stock based compensation expense	—		—	—		1,910		—		—		1,910

Cash dividends ($0.25 per share)	—		—	—		—		(10,729)		—		(10,729)
Balance, September 30, 2019	$	—	42,952,642	$	430	$	1,924,385	$	354,177	$	19,940	$	2,298,932

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Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Changes in Stockholders’ Equity (Continued)

Nine Months Ended September 30, 2020 and 2019 (unaudited)

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


	Preferred Stock $0.01 Par Value		Common Stock $0.01 Par Value			Additional Paid in Capital		Retained Earnings		Accumulated Other Comprehensive Income (Loss)		Total
	10 million shares authorized		100 million shares authorized
			Shares	Amount
Nine Months Ended
Balance, December 31, 2019	$	—	42,950,228	$	430	$	1,926,359	$	393,674	$	19,310	$	2,339,773

Net income	—		—	—		—		142,935		—		142,935
Other comprehensive income, net of tax	—		—	—		—		—		19,806		19,806

Common stock repurchased	—		(2,951)	—		—		(159)		—		(159)
Restricted stock forfeited	—		(7,270)	—		—		—		—		—
Restricted stock granted	—		304,790	2		(2)		—		—		—
Stock based compensation expense	—		—	—		6,333		—		—		6,333
Cash dividends ($0.75 per share)	—		—	—		—		(32,315)		—		(32,315)
Balance, September 30, 2020	$	—	43,244,797	$	432	$	1,932,690	$	504,135	$	39,116	$	2,476,373


Balance, December 31, 2018	$	—	30,600,582	$	306	$	1,317,616	$	296,816	$	(8,305)	$	1,606,433
Cumulative effect of change in accounting principles	—		—	—		—		(926)		—		(926)
Adjusted balance, December 31, 2018	—		30,600,582	306		1,317,616		295,890		(8,305)		1,605,507
Net income	—		—	—		—		142,500		—		142,500
Other comprehensive income, net of tax	—		—	—		—		—		28,245		28,245
Stock issued for acquisition of bank, net of offering costs of $804	—		13,179,748	132		600,936		—		—		601,068
Common stock repurchased	—		(952,681)	(9)		—		(51,642)		—		(51,651)
Restricted stock forfeited	—		(13,615)	—		—		—		—		—
Restricted stock granted	—		138,608	1		(1)		—		—		—
Stock based compensation expense	—		—	—		5,834		—		—		5,834

Cash dividends ($0.75 per share)	—		—	—		—		(32,571)		—		(32,571)
Balance, September 30, 2019	$	—	42,952,642	$	430	$	1,924,385	$	354,177	$	19,940	$	2,298,932

See Notes to Consolidated Financial Statements

Table of Contents

Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows

Nine Months Ended September 30, 2020 and 2019 (unaudited)

(Dollars in thousands)


	Nine Months Ended September 30,
	2020		2019
Cash flows from operating activities:
Net income	$	142,935	$	142,500
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation expense	9,504		8,679
Accretion of income recognized on acquired loans	(23,534)		(35,228)
Amortization of other intangibles assets	9,526		9,705
Amortization of premium on securities, net	2,028		2,053
Amortization of discount and origination costs on borrowings	497		475
Stock based compensation expense	6,333		5,834
Excess tax expense on restricted stock vested	246		21
FHLB stock dividends	(547)		(645)
Gain on sale of securities available for sale	(382)		(265)
(Gain) loss on sale and disposal of premises and equipment	(311)		585
Gain on sale of loans	(647)		(6,779)
Gain on sale of branch	—		(1,549)

Gain on sale of other real estate owned	(37)		(851)

Impairment of other real estate	784		1,424
Impairment of other assets	462		1,173
Deferred tax (benefit) expense	(2,636)		11,615
Provision for loan losses	39,122		13,196
Increase in cash surrender value of BOLI	(4,007)		(4,135)
Net gain on mortgage loans held for sale	(26,636)		(10,970)
Originations of loans held for sale	(620,635)		(301,869)
Proceeds from sale of loans held for sale	595,510		312,637
Net change in other assets	(35,879)		(17,988)
Net change in other liabilities	(5,587)		9,271
Net cash provided by operating activities	86,109		138,889
Cash flows from investing activities:
Proceeds from maturities, calls and pay downs of securities available for sale	5,452,309		5,328,060
Proceeds from sale of securities available for sale	13,862		189,704
Purchases of securities available for sale	(5,416,037)		(5,321,693)
Purchases of certificates of deposit held in other banks	—		(5,701)
Proceeds from maturities of certificates of deposit held in other banks	1,238		1,473
Proceeds from surrender of bank owned life insurance contracts	—		387

Purchases of FHLB stock and other restricted stock	(27,037)		(9,397)
Proceeds from redemptions of FHLB stock and other restricted stock	31,049		34,788
Proceeds from sale of loans	13,097		90,025
Net loans originated held for investment	(707,884)		(486,692)
Originations of mortgage warehouse purchase loans	(17,217,285)		(8,430,885)
Proceeds from pay-offs of mortgage warehouse purchase loans	16,685,589		7,940,525
Additions to premises and equipment	(11,127)		(26,693)
Proceeds from sale of premises and equipment	1,895		2,100
Proceeds from sale of other real estate owned	6,105		6,987



Cash acquired in connection with acquisition	—		39,913
Cash paid in connection with acquisition	—		(9)
Selling costs paid in connection with branch sale	—		(144)
Net cash transferred in branch sale	—		(25,163)

Net cash used in investing activities	(1,174,226)		(672,415)

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Independent Bank Group, Inc. and Subsidiaries

Consolidated Statements of Cash Flows (Continued)

Nine Months Ended September 30, 2020 and 2019 (unaudited)

(Dollars in thousands)


	Nine Months Ended September 30,
	2020		2019
Cash flows from financing activities:
Net increase in demand deposits, money market and savings accounts	2,165,544		615,655
Net (decrease) increase in time deposits	(309,320)		284,872
Proceeds from FHLB advances	1,600,000		1,600,000
Repayments of FHLB advances	(1,550,000)		(1,477,653)

Proceeds from other borrowings	150,016		56,000
Repayments of other borrowings	(47,086)		(21,000)


Repurchase of common stock	(159)		(51,651)

Offering costs paid in connection with acquired bank	—		(804)
Dividends paid	(32,315)		(32,571)
Net cash provided by financing activities	1,976,680		972,848
Net change in cash and cash equivalents	888,563		439,322
Cash and cash equivalents at beginning of period	565,170		130,779
Cash and cash equivalents at end of period	$	1,453,733	$	570,101

See Notes to Consolidated Financial Statements

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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, Central and Southeast, Texas areas and along the Colorado Front Range, 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 and all other entities in which IBG has controlling financial interest. All material intercompany transactions and balances have been eliminated in consolidation. In addition, the Company wholly-owns nine statutory business trusts that were formed for the purpose of issuing 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 on Form 10-K, as amended, for the year ended December 31, 2019. The consolidated balance sheet at December 31, 2019 has 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.

Accounting standards codification: The Financial Accounting Standards Board's (FASB) Accounting Standards Codification (ASC) is the officially recognized source of authoritative U.S. generally accepted accounting principles (GAAP) applicable to all public and non-public non-governmental entities. Rules and interpretive releases of the SEC under the authority of federal securities laws are also sources of authoritative GAAP for SEC registrants. All other accounting literature is considered non-authoritative. Citing particular content in the ASC involves specifying the unique numeric path to the content through the Topic, Subtopic, Section and Paragraph structure.

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.

Use of estimates: The preparation of financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates and assumptions that affect certain reported amounts of assets and liabilities and disclosures of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenue and expenses during the reporting period. Accordingly, actual results could differ from those estimates. The material estimates included in the financial statements relate to the allowance for loan losses, the valuation of goodwill and valuation of assets and liabilities acquired in business combinations.

Delayed implementation of new accounting standard: ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments. ASU 2016-13 requires a new credit loss methodology, the current expected credit loss (CECL) model, which requires the recognition of an allowance for lifetime expected credit losses on loans, held-to-maturity debt securities and other receivables measured at amortized cost at the time the financial asset is originated or acquired. Credit losses will be immediately recognized through net income; the amount recognized will be based on the current estimate of contractual cash flows not expected to be collected over the financial asset’s contractual term. ASU 2016-13 became effective for the Company on January 1, 2020.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed by the President of the United States that included an option for financial institutions to delay the implementation of ASU 2016-13 until the earlier of the termination date of the national emergency declaration by the President or December 31, 2020. Due to the uncertainty of the economic forecast resulting from the coronavirus (COVID-19) pandemic and the potential impact of the government economic stimulus measures, the Company determined to delay its implementation of ASU 2016-13 and has calculated and recorded its provision for loan losses under the incurred loss model that existed prior to ASU 2016-13.

Upon adoption of ASU 2016-13 with an effective retrospective implementation date of January 1, 2020, the Company expects to increase its combined allowance for loan losses and reserves for unfunded commitments by approximately $80,000, of which $22,000 is attributable to purchase credit deteriorated loans. The Company will apply the standard's provisions as a cumulative-effect adjustment to retained earnings. The expected increase in the allowance for loan losses is a result of changing from an incurred loss model, which encompasses allowances for current known and inherent losses within the portfolio, to a CECL model, which encompasses allowances for losses expected to be incurred over the life of the portfolio. The majority of the increase is attributable to applying the CECL model to the Company's acquired loans, which, under prior guidance, were recorded at fair value without an allowance at acquisition date. Furthermore, ASU 2016-13 necessitates that the Company establish an allowance for expected credit losses for certain debt securities and other financial assets; however, such allowances, if any, are not expected to be significant.

Goodwill assessment: The Company's policy is to test goodwill for impairment annually on December 31 or on an interim basis if an event triggering impairment may have occurred. On January 1, 2020, ASU 2017-04, Intangibles - Goodwill and Other (Topic 350) - Simplifying the Test for Goodwill Impairment became effective for the Company. This ASU simplifies the accounting for goodwill impairment for all entities. Under the new guidance, if a reporting unit’s carrying amount exceeds its fair value, an entity will record an impairment charge based on that difference. During the period ended March 31, 2020, the economic turmoil and market volatility resulting from the COVID-19 crisis resulted in a substantial decrease in the Company's stock price and market capitalization. Management believed such decrease was a triggering indicator requiring an interim goodwill impairment quantitative analysis. Under the new simplified guidance, the Company's estimated fair value to a market participant as of March 31, 2020, exceeded its carrying amount resulting in no impairment charge for the period. Over subsequent periods, the Company's stock price and market capitalization has continued to increase and management's future projections have not materially changed. Management believes there has been no further decline in its fair value as of September 30, 2020. Management will continue to evaluate the economic conditions at future reporting periods for applicable changes.

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 12.

Stock repurchase program: The Company established stock repurchase programs in prior years which would allow the Company to purchase its common stock in the open market or in privately negotiated transactions. In general, stock repurchase programs allow the Company to proactively manage its capital position and return excess capital to shareholders. In October 2018, the Company announced the reestablishment of its stock repurchase program. The program authorizes the Company to repurchase up to $75,000 of its common stock through October 1, 2019. In October 2019, the stock repurchase program was renewed and extended through December 31, 2020. There were no repurchases for the nine months ended September 30, 2020 and 897,738 shares at a total cost of $49,048 purchased during the nine months ended September 30, 2019. Shares of Company stock repurchased to settle employee tax withholding related to vesting of stock awards totaled 2,951 and 54,943 shares at a total cost of $159 and $2,603 for the nine months ended September 30, 2020 and 2019, respectively, and were not included under this program. Subsequent to September 30, 2020, the stock repurchase program was renewed prior to its expiration date, as disclosed in Note 12.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

Earnings per share: Basic earnings per common share is calculated as 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 nonforfeitable dividends are considered participating securities for this calculation. Diluted earnings per common share include the dilutive effect of additional potential common shares issuable under participating nonvested restricted stock awards. The participating nonvested common stock was not included in dilutive shares as it was anti-dilutive for the three months ended September 30, 2020 and the three and nine months ended September 30, 2019. For the nine months ended September 30, 2020, proceeds from the assumed exercise of dilutive participating nonvested restricted stock awards 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 September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Basic earnings per share:
Net income	$	60,075	$	55,633	$	142,935	$	142,500
Less:
Undistributed earnings allocated to participating securities	512		329		849		731
Dividends paid on participating securities	112		79		248		216
Net income available to common shareholders	$	59,451	$	55,225	$	141,838	$	141,553
Weighted average basic shares outstanding	42,785,485		42,636,030		42,765,685		43,056,441
Basic earnings per share	$	1.39	$	1.30	$	3.32	$	3.29
Diluted earnings per share:
Net income available to common shareholders	$	59,451	$	55,225	$	141,838	$	141,553
Total weighted average basic shares outstanding	42,785,485		42,636,030		42,765,685		43,056,441

Add dilutive participating securities	—		—		24,391		—
Total weighted average diluted shares outstanding	42,785,485		42,636,030		42,790,076		43,056,441
Diluted earnings per share	$	1.39	$	1.30	$	3.31	$	3.29
Anti-dilutive participating securities	113,291		46,223		—		60,001

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

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:


	Nine Months Ended September 30,
	2020		2019
Cash transactions:
Interest expense paid	$	80,462	$	110,059
Income taxes paid	$	35,538	$	26,684
Noncash transactions:


Transfers of loans to other real estate owned	$	5,239	$	544
Transfers of loans held for investment to loans held for sale	$	—	$	83,526

Loans to facilitate the sale of other real estate owned	$	1,564	$	517

Securities purchased, not yet settled	$	17,782	$	—
Right-of-use assets obtained in exchange for lease liabilities	$	108	$	35,491



Transfer of bank premises to other real estate	$	—	$	7,896
Transfer of repurchase agreements to deposits	$	—	$	8,475

Supplemental schedule of noncash investing activities from branch sale is as follows:


	Nine Months Ended September 30,
	2020		2019
Noncash assets transferred:
Loans, including accrued interest	$	—	$	796
Premises and equipment	—		$	94

Other assets	—		$	1
Total assets	$	—	$	891
Noncash liabilities transferred:
Deposits, including accrued interest	$	—	$	27,721
Other liabilities	—		$	27
Total liabilities	$	—	$	27,748
Cash and cash equivalents transferred in branch sale	$	—	$	206
Deposit premium received	$	—	$	1,386
Cash paid to buyer, net of deposit premium	$	—	$	24,957

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

Supplemental schedule of noncash investing activities from acquisitions is as follows:


	Nine Months Ended September 30,
	2020		2019
Noncash assets acquired
Certificates of deposit held in other banks	$	—	$	262
Securities available for sale	—		561,052
Restricted stock	—		27,794
Loans	—		2,789,868
Premises and equipment	—		65,786
Other real estate owned	—		1,829
Goodwill	—		272,224
Other intangible assets	—		71,518
Bank owned life insurance	—		80,837
Other assets	—		31,987
Total assets acquired	$	—	$	3,903,157
Noncash liabilities assumed:
Deposits	$	—	$	3,108,810
Repurchase agreements	—		8,475
FHLB advances	—		142,653
Other borrowings	—		40,000
Junior subordinated debentures	—		25,774
Other liabilities	—		15,477
Total liabilities assumed	$	—	$	3,341,189
Cash and cash equivalents acquired from acquisitions	$	—	$	39,913
Cash paid to shareholders of acquired banks	$	—	$	9

Fair value of common stock issued to shareholders of acquired banks	$	—	$	601,872

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

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 September 30, 2020 and December 31, 2019 are as follows:


	Amortized Cost		Gross Unrealized Gains		Gross Unrealized Losses		Fair Value
Securities Available for Sale
September 30, 2020
U.S. treasuries	$	48,060	$	1,905	$	—	$	49,965
Government agency securities	200,317		3,892		(106)		204,103
Obligations of state and municipal subdivisions	356,521		18,665		(5)		375,181
Corporate bonds	18,497		415		—		18,912
Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA	403,261		23,997		—		427,258
Other securities	1,200		—		—		1,200
	$	1,027,856	$	48,874	$	(111)	$	1,076,619
December 31, 2019
U.S. treasuries	$	48,060	$	743	$	(7)	$	48,796
Government agency securities	178,953		926		(583)		179,296
Obligations of state and municipal subdivisions	332,715		11,150		(6)		343,859
Corporate bonds	7,011		207		—		7,218
Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA	493,915		11,981		(329)		505,567
Other securities	1,200		—		—		1,200
	$	1,061,854	$	25,007	$	(925)	$	1,085,936

Securities with a carrying amount of approximately $720,235 and $571,843 at September 30, 2020 and December 31, 2019, respectively, were pledged primarily to secure deposits.

Proceeds from sale of securities available for sale and gross gains and gross losses for the three and nine months ended September 30, 2020 and 2019 were as follows:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Proceeds from sale	$	—	$	—	$	13,862	$	189,704
Gross gains	$	—	$	—	$	385	$	293
Gross losses	$	—	$	—	$	3	$	28

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

The amortized cost and estimated fair value of securities available for sale at September 30, 2020, by contractual maturity, are shown below. Maturities of mortgage-backed securities will differ from contractual maturities because borrowers may have the right to call or prepay obligations with or without call or prepayment penalties.


	September 30, 2020
	Securities Available for Sale
	Amortized Cost		Fair Value
Due in one year or less	$	34,454	$	34,740
Due from one year to five years	134,362		141,141
Due from five to ten years	188,205		195,200
Thereafter	267,574		278,280
	624,595		649,361
Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA	403,261		427,258
	$	1,027,856	$	1,076,619

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 September 30, 2020 and December 31, 2019, 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
September 30, 2020

Government agency securities	6	$	34,892	$	(106)	—	$	—	$	—	$	34,892	$	(106)
Obligations of state and municipal subdivisions	2	1,531		(5)		—	—		—		1,531		(5)


	8	$	36,423	$	(111)	—	$	—	$	—	$	36,423	$	(111)
December 31, 2019
U.S. treasuries	—	$	—	$	—	2	$	8,097	$	(7)	$	8,097	$	(7)
Government agency securities	13	52,790		(495)		6	15,911		(88)		68,701		(583)
Obligations of state and municipal subdivisions	5	2,793		(1)		1	423		(5)		3,216		(6)
Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA	13	46,512		(317)		1	1,193		(12)		47,705		(329)

	31	$	102,095	$	(813)	10	$	25,624	$	(112)	$	127,719	$	(925)

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.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

Note 4. Loans, Net and Allowance for Loan Losses

Loans, net, at September 30, 2020 and December 31, 2019, consisted of the following:


	September 30,		December 31,
	2020		2019
Commercial	$	3,677,220	$	2,482,356
Real estate:
Commercial	6,056,583		5,872,653
Commercial construction, land and land development	1,261,913		1,236,623
Residential	1,409,189		1,515,227
Single-family interim construction	320,387		378,120
Agricultural	86,049		97,767
Consumer	59,146		32,603
Other	381		621
Total loans	12,870,868		11,615,970
Deferred loan fees, net	(12,696)		(1,695)
Allowance for loan losses	(87,491)		(51,461)
Total loans, net	$	12,770,681	$	11,562,814

Loans with carrying amounts of $6,674,750 and $6,244,438 at September 30, 2020 and December 31, 2019, respectively, were pledged to secure Federal Home Loan Bank borrowing capacity and Federal Reserve Bank discount window borrowing capacity.

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 nonperforming 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 September 30, 2020 and December 31, 2019, there were approximately $219,726 and $189,781 of energy related loans outstanding, respectively. The Company has a mortgage warehouse purchase program providing mortgage inventory financing for residential mortgage loans originated by mortgage banker clients across a broad geographic scale. Proceeds from the sale of mortgages is the primary source of repayment for warehouse inventory financing via approved investor takeout commitments. These loans typically have a very short duration ranging between a few days to 15 days. In some cases, loans to larger mortgage originators may be financed for up to 60 days. These loans are reported as commercial loans since the loans are secured by notes receivable, not real estate. As of September 30, 2020 and December 31, 2019, mortgage warehouse purchase loans outstanding totaled $1,219,013 and $687,317, respectively.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

With the passage of the CARES Act Paycheck Protection Program (PPP), administered by the Small Business Administration (SBA), the Company has participated in originating loans to its customers through the program. PPP loans have terms of two to five years and earn interest at 1%. At September 30, 2020, there were approximately $825,966 in PPP loans outstanding included in the commercial loan portfolio. In addition, the Company has recorded net deferred fees associated with PPP loans of $14,006 as of September 30, 2020. Based on published program guidelines, these loans funded through the PPP are fully guaranteed by the U.S. government. Management believes that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program.

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. At September 30, 2020, the portfolio consisted of approximately 30% of 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 and the State of Colorado, specifically along the Front Range area. As of September 30, 2020, loans in the Colorado region represented about 27% of the total portfolio. A large percentage of the Company’s portfolio consists of commercial and residential real estate loans. As of September 30, 2020 and December 31, 2019, there were no concentrations of loans related to a single industry in excess of 10% of total loans.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

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 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, the status of past due loans are routinely discussed within each lending region as well as credit committee meetings to determine if classification is warranted. The Company’s internal loan review department has implemented an internal risk based loan review process to identify potential internally classified loans that supplements the independent external loan review. External loan reviews cover a wide range of the loan portfolio, including large lending relationships and recently acquired loan portfolios. As such, the external loan review generally covers loans exceeding $3,500. 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 in the Company’s lending areas of north, central and southeast Texas, and the Colorado economy started to show improvement by the end of the second quarter of 2020 following unprecedented declines caused by the pandemic and volatile energy prices. During the third quarter, Texas had increased COVID-19 infections that disrupted the budding economic recovery and is the biggest risk to the near-term outlook. The Colorado economy continued to strengthen during the quarter. Activity in the manufacturing and financial sectors continued to expand while the service sector activity declined overall in July but resumed its nascent recovery by the end of the quarter. Energy activity remained depressed. Retail spending stabilized, however, activity remained below pre-pandemic levels. Loan volume increased over the period, driven by a sharp rise in residential real estate lending. Loan pricing fell further, and credit standards and terms continue to tighten with expectations for future loan demand turning slightly negative. Outlooks are increasingly uncertain, with concerns over surging COVID-19 cases and the possible disruption to business and overall economic recovery. The pandemic crisis has been impactful and the timing and magnitude of recovery cannot be predicted. The risk of loss associated with all segments of the portfolio could increase due to these factors.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

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 and nine months ended September 30, 2020 and 2019:


	Commercial		Commercial Real Estate, Construction, Land and Land Development		Residential Real Estate		Single-Family Interim Construction		Agricultural		Consumer		Other		Unallocated		Total
Three months ended September 30, 2020
Balance at beginning of period	$	25,498	$	45,876	$	5,911	$	1,998	$	379	$	291	$	140	$	(38)	$	80,055

Provision for loan losses	476		5,829		532		(152)		(31)		92		119		755		7,620

Charge-offs	(117)		—		—		—		—		(13)		(93)		—		(223)
Recoveries	16		4		—		—		—		5		14		—		39
Balance at end of period	$	25,873	$	51,709	$	6,443	$	1,846	$	348	$	375	$	180	$	717	$	87,491

Nine months ended September 30, 2020
Balance at beginning of period	$	12,844	$	33,085	$	3,678	$	1,606	$	332	$	226	$	5	$	(315)	$	51,461
Provision for loan losses	15,111		19,355		2,765		322		16		150		371		1,032		39,122
Charge-offs	(2,170)		(735)		—		(82)		—		(35)		(271)		—		(3,293)
Recoveries	88		4		—		—		—		34		75		—		201
Balance at end of period	$	25,873	$	51,709	$	6,443	$	1,846	$	348	$	375	$	180	$	717	$	87,491

Three months ended September 30, 2019
Balance at beginning of period	$	15,677	$	29,662	$	3,696	$	1,511	$	343	$	252	$	6	$	(72)	$	51,075
Provision for loan losses	3,151		2,318		(50)		54		(6)		15		108		(357)		5,233
Charge-offs	(5,698)		—		(47)		—		—		(31)		(124)		—		(5,900)
Recoveries	16		—		—		—		—		8		15		—		39
Balance at end of period	$	13,146	$	31,980	$	3,599	$	1,565	$	337	$	244	$	5	$	(429)	$	50,447

Nine months ended September 30, 2019
Balance at beginning of period	$	11,793	$	27,795	$	3,320	$	1,402	$	241	$	186	$	3	$	62	$	44,802
Provision for loan losses	8,507		4,185		419		166		96		68		246		(491)		13,196
Charge-offs	(7,221)		(3)		(140)		(3)		—		(51)		(303)		—		(7,721)
Recoveries	67		3		—		—		—		41		59		—		170
Balance at end of period	$	13,146	$	31,980	$	3,599	$	1,565	$	337	$	244	$	5	$	(429)	$	50,447

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

The following table details the amount of the allowance for loan losses and recorded investment in loans by class as of September 30, 2020 and December 31, 2019:


	Commercial		Commercial Real Estate, Construction, Land and Land Development		Residential Real Estate		Single-Family Interim Construction		Agricultural		Consumer		Other		Unallocated		Total
September 30, 2020
Allowance for losses:
Individually evaluated for impairment	$	9,230	$	—	$	—	$	—	$	—	$	7	$	—	$	—	$	9,237
Collectively evaluated for impairment	16,449		51,709		6,443		1,846		348		368		180		717		78,060
Loans acquired with deteriorated credit quality	194		—		—		—		—		—		—		—		194
Ending balance	$	25,873	$	51,709	$	6,443	$	1,846	$	348	$	375	$	180	$	717	$	87,491

Loans:
Individually evaluated for impairment	$	30,054	$	6,082	$	2,342	$	—	$	680	$	43	$	—	$	—	$	39,201
Collectively evaluated for impairment	3,606,126		7,133,350		1,400,880		320,387		84,649		59,087		381		—		12,604,860
Acquired with deteriorated credit quality	41,040		179,064		5,967		—		720		16		—		—		226,807
Ending balance	$	3,677,220	$	7,318,496	$	1,409,189	$	320,387	$	86,049	$	59,146	$	381	$	—	$	12,870,868

December 31, 2019
Allowance for losses:
Individually evaluated for impairment	$	357	$	—	$	—	$	—	$	—	$	1	$	—	$	—	$	358
Collectively evaluated for impairment	12,108		32,615		3,678		1,606		332		225		5		(315)		50,254
Loans acquired with deteriorated credit quality	379		470		—		—		—		—		—		—		849
Ending balance	$	12,844	$	33,085	$	3,678	$	1,606	$	332	$	226	$	5	$	(315)	$	51,461

Loans:
Individually evaluated for impairment	$	3,130	$	6,813	$	2,008	$	—	$	114	$	22	$	—	$	—	$	12,087
Collectively evaluated for impairment	2,416,569		6,883,639		1,505,896		378,120		93,837		32,556		621		—		11,311,238
Acquired with deteriorated credit quality	62,657		218,824		7,323		—		3,816		25		—		—		292,645
Ending balance	$	2,482,356	$	7,109,276	$	1,515,227	$	378,120	$	97,767	$	32,603	$	621	$	—	$	11,615,970

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

Nonperforming loans by loan class (excluding loans acquired with deteriorated credit quality) at September 30, 2020 and December 31, 2019, are summarized as follows:


	Commercial		Commercial Real Estate, Construction, Land and Land Development		Residential Real Estate		Single-Family Interim Construction		Agricultural		Consumer		Other		Total
September 30, 2020
Nonaccrual loans	$	16,279	$	4,257	$	2,161	$	—	$	680	$	43	$	—	$	23,420
Loans past due 90 days and still accruing	296		15,719		—		—		—		—		—		16,015
Troubled debt restructurings (not included in nonaccrual or loans past due and still accruing)	—		1,825		181		—		—		—		—		2,006
	$	16,575	$	21,801	$	2,342	$	—	$	680	$	43	$	—	$	41,441
December 31, 2019
Nonaccrual loans	$	3,130	$	6,461	$	1,820	$	—	$	114	$	22	$	—	$	11,547
Loans past due 90 days and still accruing	14,529		—		—		—		—		—		—		14,529
Troubled debt restructurings (not included in nonaccrual or loans past due and still accruing)	—		352		188		—		—		—		—		540
	$	17,659	$	6,813	$	2,008	$	—	$	114	$	22	$	—	$	26,616

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 according to contractual terms of the loan agreement will not be collected. 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 loan's 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 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.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

Impaired loans by loan class (excluding loans acquired with deteriorated credit quality) at September 30, 2020 and December 31, 2019, are summarized as follows:


	Commercial		Commercial Real Estate, Construction, Land and Land Development		Residential Real Estate		Single-Family Interim Construction		Agricultural		Consumer		Other		Total
September 30, 2020
Recorded investment in impaired loans:
Impaired loans with an allowance for loan losses	$	29,278	$	—	$	—	$	—	$	—	$	21	$	—	$	29,299
Impaired loans with no allowance for loan losses	776		6,082		2,342		—		680		22		—		9,902
Total	$	30,054	$	6,082	$	2,342	$	—	$	680	$	43	$	—	$	39,201
Unpaid principal balance of impaired loans	$	38,429	$	6,690	$	2,506	$	—	$	707	$	45	$	—	$	48,377
Allowance for loan losses on impaired loans	$	9,230	$	—	$	—	$	—	$	—	$	7	$	—	$	9,237
December 31, 2019
Recorded investment in impaired loans:
Impaired loans with an allowance for loan losses	$	1,580	$	—	$	—	$	—	$	—	$	1	$	—	$	1,581
Impaired loans with no allowance for loan losses	1,550		6,813		2,008		—		114		21		—		10,506
Total	$	3,130	$	6,813	$	2,008	$	—	$	114	$	22	$	—	$	12,087
Unpaid principal balance of impaired loans	$	8,580	$	6,967	$	2,197	$	—	$	123	$	24	$	—	$	17,891
Allowance for loan losses on impaired loans	$	357	$	—	$	—	$	—	$	—	$	1	$	—	$	358
For the three months ended September 30, 2020
Average recorded investment in impaired loans	$	21,790	$	6,264	$	2,417	$	—	$	495	$	28	$	—	$	30,994
Interest income recognized on impaired loans	$	14	$	57	$	164	$	—	$	—	$	—	$	—	$	235
For the nine months ended September 30, 2020
Average recorded investment in impaired loans	$	17,125	$	6,402	$	2,315	$	—	$	400	$	27	$	—	$	26,269
Interest income recognized on impaired loans	$	16	$	110	$	202	$	—	$	—	$	—	$	—	$	328
For the three months ended September 30, 2019
Average recorded investment in impaired loans	$	6,971	$	3,782	$	1,593	$	—	$	58	$	33	$	—	$	12,437
Interest income recognized on impaired loans	$	4	$	6	$	3	$	—	$	—	$	—	$	—	$	13
For the nine months ended September 30, 2019
Average recorded investment in impaired loans	$	7,050	$	3,270	$	1,681	$	895	$	43	$	33	$	—	$	12,972
Interest income recognized on impaired loans	$	25	$	34	$	35	$	114	$	—	$	5	$	—	$	213

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.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

The restructuring of a loan is considered a “troubled debt restructuring” (TDR) 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 TDR 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 $2,607 and $1,208 as of September 30, 2020 and December 31, 2019, respectively.

Following is a summary of loans modified under troubled debt restructurings during the three and nine months ended September 30, 2020 and 2019:



	Commercial		Commercial Real Estate, Construction, Land and Land Development		Residential Real Estate		Single-Family Interim Construction		Agricultural		Consumer		Other		Total
Troubled debt restructurings during the three months ended September 30, 2020
Number of contracts	—		—		—		—		—		—		—		—
Pre-restructuring outstanding recorded investment	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—
Post-restructuring outstanding recorded investment	$	—	$	—	$	—	$	—	$	—	$	—	$	—	$	—

Troubled debt restructurings during the nine months ended September 30, 2020
Number of contracts	—		1		—		—		—		—		—		1
Pre-restructuring outstanding recorded investment	$	—	$	1,517	$	—	$	—	$	—	$	—	$	—	$	1,517
Post-restructuring outstanding recorded investment	$	—	$	1,517	$	—	$	—	$	—	$	—	$	—	$	1,517

Troubled debt restructurings during the three months ended September 30, 2019
Number of contracts	—		—		1		—		—		—		—		1
Pre-restructuring outstanding recorded investment	$	—	$	—	$	29	$	—	$	—	$	—	$	—	$	29
Post-restructuring outstanding recorded investment	$	—	$	—	$	29	$	—	$	—	$	—	$	—	$	29

Troubled debt restructurings during the nine months ended September 30, 2019
Number of contracts	—		—		1		—		—		—		—		1
Pre-restructuring outstanding recorded investment	$	—	$	—	$	29	$	—	$	—	$	—	$	—	$	29
Post-restructuring outstanding recorded investment	$	—	$	—	$	29	$	—	$	—	$	—	$	—	$	29

At September 30, 2020 and 2019, there were no loans modified under troubled debt restructurings during the previous twelve month period that subsequently defaulted during the three and nine months ended September 30, 2020 and 2019, respectively.

At September 30, 2020 and 2019, the Company had no commitments to lend additional funds to any borrowers with loans whose terms have been modified under troubled debt restructurings.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

Under ASC Subtopic 310-40 and federal banking agencies interagency guidance, certain short-term loan modifications made on a good faith basis in response to COVID-19 (as defined by the guidance) are not considered TDRs. Additionally, under section 4013 of the CARES Act, banks may elect to suspend the requirement for certain loan modifications to be categorized as a TDR. In response to the COVID-19 pandemic, the Company has implemented prudent modifications allowing for primarily short-term payment deferrals or other payment relief to borrowers with pandemic-related economic hardships, where appropriate, that complies with the above guidance. As such, the Company's TDR loans noted above do not include loans that are modifications to borrowers impacted by COVID-19. Deferred payments along with any interest accrued during the deferral period are due and payable on the maturity date. As of September 30, 2020, the Company has 1,389 loans with outstanding deferred accrued interest of $24,605 on balances of $1,821,003.

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 September 30, 2020 and December 31, 2019:


	Loans 30-89 Days Past Due		Loans 90 Days or More Past Due		Total Past Due Loans		Current Loans		Total Loans
September 30, 2020
Commercial	$	11,454	$	16,533	$	27,987	$	3,608,193	$	3,636,180
Commercial real estate, construction, land and land development	2,080		19,358		21,438		7,117,994		7,139,432
Residential real estate	1,541		894		2,435		1,400,787		1,403,222
Single-family interim construction	106		—		106		320,281		320,387
Agricultural	1,200		9		1,209		84,120		85,329
Consumer	92		43		135		58,995		59,130
Other	—		—		—		381		381
	16,473		36,837		53,310		12,590,751		12,644,061
Acquired with deteriorated credit quality	2,568		4,381		6,949		219,858		226,807
	$	19,041	$	41,218	$	60,259	$	12,810,609	$	12,870,868
December 31, 2019
Commercial	$	4,512	$	17,656	$	22,168	$	2,397,531	$	2,419,699
Commercial real estate, construction, land and land development	9,153		2,905		12,058		6,878,394		6,890,452
Residential real estate	3,242		642		3,884		1,504,020		1,507,904
Single-family interim construction	2,836		—		2,836		375,284		378,120
Agricultural	22		114		136		93,815		93,951
Consumer	167		22		189		32,389		32,578
Other	—		—		—		621		621
	19,932		21,339		41,271		11,282,054		11,323,325
Acquired with deteriorated credit quality	2,556		6,766		9,322		283,323		292,645
	$	22,488	$	28,105	$	50,593	$	11,565,377	$	11,615,970

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

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 a 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 September 30, 2020 and December 31, 2019, is as follows:


	Pass		Pass/ Watch		Special Mention		Substandard		Doubtful		Total
September 30, 2020
Commercial	$	3,474,238	$	74,512	$	55,812	$	72,658	$	—	$	3,677,220
Commercial real estate, construction, land and land development	6,622,679		430,250		156,815		108,752		—		7,318,496
Residential real estate	1,393,667		6,420		1,767		7,335		—		1,409,189
Single-family interim construction	317,930		2,457		—		—		—		320,387
Agricultural	78,380		5,549		1,437		683		—		86,049
Consumer	59,042		11		—		93		—		59,146
Other	381		—		—		—		—		381
	$	11,946,317	$	519,199	$	215,831	$	189,521	$	—	$	12,870,868
December 31, 2019
Commercial	$	2,332,611	$	71,642	$	37,739	$	40,364	$	—	$	2,482,356
Commercial real estate, construction, land and land development	6,814,780		184,720		46,889		62,887		—		7,109,276
Residential real estate	1,501,019		4,850		994		8,364		—		1,515,227
Single-family interim construction	376,887		1,233		—		—		—		378,120
Agricultural	88,044		5,287		1,864		2,572		—		97,767
Consumer	32,459		33		2		109		—		32,603
Other	621		—		—		—		—		621
	$	11,146,421	$	267,765	$	87,488	$	114,296	$	—	$	11,615,970

The Company has acquired certain loans which experienced credit deterioration since origination (purchased credit impaired (PCI) loans).

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

The Company has included PCI loans in the above grading tables. The following provides additional detail on the grades applied to those loans at September 30, 2020 and December 31, 2019:


	Pass		Pass/ Watch		Special Mention		Substandard		Doubtful		Total
September 30, 2020	$	146,433	$	29,894	$	30,655	$	19,825	$	—	$	226,807
December 31, 2019	232,095		21,284		4,502		34,764		—		292,645

PCI loans may remain on accrual status to the extent the company can reasonably estimate the amount and timing of expected future cash flows. At September 30, 2020 and December 31, 2019, nonaccrual PCI loans were $6,991 and $10,850, respectively.

Accretion on PCI loans is based on estimated future cash flows, regardless of contractual maturity. The following table summarizes the outstanding balance and related carrying amount of PCI loans by acquired bank as of the acquisition date for the acquisition occurring in 2019:


	Acquisition Date
	January 1, 2019
	Guaranty Bancorp
Outstanding balance	$	341,645
Nonaccretable difference	(16,622)
Accretable yield	(13,299)
Carrying amount	$	311,724

The carrying amount of all acquired PCI loans included in the consolidated balance sheet and the related outstanding balance at September 30, 2020 and December 31, 2019 were as follows:


	September 30, 2020		December 31, 2019
Outstanding balance	$	251,263	$	326,077
Carrying amount	226,807		292,645

There was an allocation of $194 and $849 established in the allowance for loan losses relating to PCI loans at September 30, 2020 and December 31, 2019, respectively.

The changes in accretable yield during the nine months ended September 30, 2020 and 2019 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 Nine Months Ended September 30,
	2020		2019
Balance at January 1,	$	8,905	$	1,436
Additions	—		13,299
Accretion	(2,656)		(4,076)
Transfers from nonaccretable	—		—
Balance at September 30,	$	6,249	$	10,659

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

Note 5. Other Borrowings

Other borrowings totaled $305,529 and $202,251 at September 30, 2020 and December 31, 2019, respectively.

In September 2020, the Company issued unsecured fixed-to-floating subordinated notes in the amount of $130,000 in aggregate principal. The notes were sold at par, resulting in proceeds of $127,451, net of origination costs of $2,549. Interest payments initially of 4.00% fixed rate payable semiannually in arrears through September 15, 2025. Thereafter, floating rate payments of 3 month Secured Overnight Financing Rate (SOFR) plus 3.885% payable quarterly in arrears. The maturity date is September 15, 2030 with an optional redemption at September 15, 2025. The notes meet the criteria to be recognized as Tier 2 capital for regulatory purposes.

There were no borrowings as of September 30, 2020 and $24,500 as of December 31, 2019 against the Company's revolving line of credit with an unrelated commercial bank.

Note 6. 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 September 30, 2020 and December 31, 2019, the approximate amounts of these financial instruments were as follows:


	September 30,		December 31,
	2020		2019
Commitments to extend credit	$	2,251,682	$	2,337,385
Standby letters of credit	24,991		23,406
	$	2,276,673	$	2,360,791

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 September 30, 2020 and December 31, 2019, no amounts have been recorded as liabilities for the Company’s potential obligations under these guarantees.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

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. 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 its acquisition of BOH Holdings, Inc. and its subsidiary, Bank of Houston (BOH). The plaintiffs in the case are alleging that Independent Bank aided and abetted or participated in a fraudulent scheme. Independent Bank is pursuing insurance coverage for these claims, including reimbursement for defense costs. The Company believes the claims made in this lawsuit are without merit and is vigorously defending the lawsuit. The Company is unable to predict when the matter will be resolved, the ultimate outcome or potential costs or damages to be incurred.

Note 7. Income Taxes

Income tax expense for the three and nine months ended September 30, 2020 and 2019 was as follows:


	Three Months Ended September 30,						Nine Months Ended September 30,
	2020			2019			2020			2019


Income tax expense for the period	$	16,068		$	14,903		$	35,807		$	39,418
Effective tax rate	21.1		%	21.1		%	20.0		%	21.7		%

The effective tax rates for 2020 and 2019 differ from the statutory federal tax rate of 21% largely due to tax exempt interest income earned on certain investment securities and loans, the nontaxable earnings on bank owned life insurance, nondeductible compensation, acquisition related expenses, and state income tax. In addition, the lower effective tax rate for the nine months ended September 30, 2020 is a result of a tax benefit recorded due to the net operating loss carryback provision allowed through the enactment of the CARES Act.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

Note 8. 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 Company elected the fair value option for certain residential mortgage loans held for sale in accordance with ASC 825, Financial Instruments. This election allows for a more effective offset of the changes in fair values of the loans and the derivative instruments used to economically hedge them without the burden of complying with the requirements for hedge accounting under ASC 815, Derivatives and Hedging. The Company has not elected the fair value option for other residential mortgage loans held for sale primarily because they are not economically hedged using derivative instruments. See below and Note 9, Derivative Financial Instruments, for additional information.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

Assets and Liabilities Measured on a Recurring Basis

The following table represents assets and liabilities reported on the consolidated balance sheets at their fair value on a recurring basis as of September 30, 2020 and December 31, 2019 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)
September 30, 2020
Assets:
Investment securities available for sale:
U.S. treasuries	$	49,965	$	—	$	49,965	$	—
Government agency securities	204,103		—		204,103		—
Obligations of state and municipal subdivisions	375,181		—		375,181		—
Corporate bonds	18,912		—		18,912		—
Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA	427,258		—		427,258		—
Other securities	1,200		—		1,200		—
Loans held for sale, fair value option elected (1)	81,476		—		81,476		—
Derivative financial instruments:
Interest rate lock commitments	5,109		—		5,109		—
Forward mortgage-backed securities trades	18		—		18		—
Loan customer counterparty	22,415		—		22,415		—

Liabilities:
Derivative financial instruments:

Forward mortgage-backed securities trades	330		—		330		—

Financial institution counterparty	23,813		—		23,813		—
December 31, 2019
Assets:
Investment securities available for sale:
U.S. treasuries	$	48,796	$	—	$	48,796	$	—
Government agency securities	179,296		—		179,296		—
Obligations of state and municipal subdivisions	343,859		—		343,859		—
Corporate bonds	7,218		—		7,218		—
Mortgage-backed securities guaranteed by FHLMC, FNMA and GNMA	505,567		—		505,567		—
Other securities	1,200		—		1,200		—
Loans held for sale, fair value option elected (1)	29,204		—		29,204		—
Derivative financial instruments:
Interest rate lock commitments	847		—		847		—
Forward mortgage-backed securities trades	6		—		6		—
Loan customer counterparty	6,104		—		6,104		—

Liabilities:
Derivative financial instruments:
Forward mortgage-backed securities trades	69		—		69		—

Financial institution counterparty	6,566		—		6,566		—

____________

(1) At September 30, 2020 and December 31, 2019, loans held for sale for which the fair value option was elected had an aggregate outstanding principal balance of $77,185 and $28,166, respectively. There were no mortgage loans held for sale under the fair value option that were 90 days or greater past due or on nonaccrual at September 30, 2020.

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.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

Investment securities

Securities classified as available for sale are reported at fair value utilizing Level 1 and Level 2 inputs. Securities are classified within Level 1 when quoted market prices are available in an active market. Inputs include securities that have quoted prices in active markets for identical assets. For securities utilizing Level 2 inputs, 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.

Loans held for sale

Certain mortgage loans held for sale are measured at fair value on a recurring basis due to the Company's election to adopt fair value accounting treatment for those loans originated for which the Company has entered into certain derivative financial instruments as part of its mortgage banking and related risk management activities. These instruments include interest rate lock commitments and mandatory forward commitments to sell these loans to investors known as forward mortgage-backed securities trades. This election allows for a more effective offset of the changes in fair values of the assets and the mortgage related derivative instruments used to economically hedge them without the burden of complying with the requirements for hedge accounting under ASC 815, Derivatives and Hedging. Mortgage loans held for sale, for which the fair value option was elected, which are sold on a servicing released basis, are valued using a market approach by utilizing either: (i) the fair value of securities backed by similar mortgage loans, adjusted for certain factors to approximate the fair value of a whole mortgage loan, including the value attributable to mortgage servicing and credit risk, (ii) current commitments to purchase loans or (iii) recent observable market trades for similar loans, adjusted to credit risk and other individual loan characteristics. As these prices are derived from market observable inputs, the Company classifies these valuations as Level 2 in the fair value disclosures. For mortgage loans held for sale for which the fair value option was elected, the earned current contractual interest payment is recognized in interest income, loan origination costs and fees on fair value option loans are recognized in earnings as incurred and not deferred. The Company has no continuing involvement in any residential mortgage loans sold.

Derivatives

The estimated fair values of interest rate lock commitments utilize current secondary market prices for underlying loans and estimated servicing value with similar coupons, maturity and credit quality, subject to the anticipated loan funding probability (pull-through rate). The fair value of interest rate lock commitments is subject to change primarily due to changes in interest rates and the estimated pull-through rate. These commitments are classified as Level 2 in the fair value disclosures, as the valuations are based on observable market inputs.

Forward mortgage-backed securities trades are exchange-traded or traded within highly active dealer markets. In order to determine the fair value of these instruments, the Company utilized the exchange price or dealer market price for the particular derivative contract; therefore these contracts are classified as Level 2. The estimated fair values are subject to change primarily due to changes in interest rates.

The Company also enters into certain interest rate derivative positions that are not designated as hedging instruments. The estimated fair value of these commercial loan interest rate swaps are obtained from a pricing service that provides the swaps' unwind value (Level 2 inputs). See Note 9, Derivative Financial Instruments, for more information.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

Assets and Liabilities Measured on a Nonrecurring Basis

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 September 30, 2020 and December 31, 2019, 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
September 30, 2020
Assets:
Impaired loans	$	20,522	$	—	$	—	$	20,522	$	10,253
Other real estate owned	966		—		—		966		607

December 31, 2019
Assets:
Impaired loans	$	2,276	$	—	$	—	$	2,276	$	1,806
Other real estate owned	4,618		—		—		4,618		749

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. Therefore, the Company has categorized its other real estate as Level 3.

In addition, mortgage loans held for sale not recorded under the fair value option are required to be measured at the lower of cost or fair value. The fair value of these loans is based upon binding quotes or bids from third party investors. As of September 30, 2020 and December 31, 2019, all mortgage loans held for sale not recorded under the fair value option were recorded at cost.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

Fair Value of Financial Instruments not Recorded at Fair Value

The carrying amount, estimated fair value and the level of the fair value hierarchy of the Company’s financial instruments that are reported at amortized cost on the Company's consolidated balance sheets were as follows at September 30, 2020 and December 31, 2019:


					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)
September 30, 2020
Financial assets:
Cash and cash equivalents	$	1,453,733	$	1,453,733	$	1,453,733	$	—	$	—
Certificates of deposit held in other banks	4,481		4,620		—		4,620		—
Loans held for sale, at cost	5,930		6,036		—		6,036		—
Loans, net	12,770,681		12,870,541		—		—		12,870,541
FHLB of Dallas stock and other restricted stock	26,504		26,504		—		26,504		—
Accrued interest receivable	59,921		59,921		—		59,921		—
Financial liabilities:
Deposits	13,797,560		13,808,521		—		13,808,521		—
Accrued interest payable	4,945		4,945		—		4,945		—
FHLB advances	375,000		369,954		—		369,954		—

Other borrowings	305,529		319,250		—		319,250		—
Junior subordinated debentures	53,973		38,343		—		38,343		—
Off-balance sheet assets (liabilities):
Commitments to extend credit	—		—		—		—		—
Standby letters of credit	—		—		—		—		—
December 31, 2019
Financial assets:
Cash and cash equivalents	$	565,170	$	565,170	$	565,170	$	—	$	—
Certificates of deposit held in other banks	5,719		5,951		—		5,951		—
Loans held for sale, at cost	6,441		6,554		—		6,554		—
Loans, net	11,562,814		11,689,672		—		—		11,689,672
FHLB of Dallas stock and other restricted stock	30,052		30,052		—		30,052		—
Accrued interest receivable	35,860		35,860		—		35,860		—
Financial liabilities:
Deposits	11,941,336		11,958,939		—		11,958,939		—
Accrued interest payable	9,583		9,583		—		9,583		—
FHLB advances	325,000		325,210		—		325,210		—

Other borrowings	202,251		209,050		—		209,050		—
Junior subordinated debentures	53,824		48,879		—		48,879		—
Off-balance sheet assets (liabilities):
Commitments to extend credit	—		—		—		—		—
Standby letters of credit	—		—		—		—		—

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

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 market rates.

Loans held for sale, at cost: The fair value of loans held for sale is determined based upon commitments on hand from investors.

Loans: A discounted cash flow model is used to estimate the fair value of the loans. The discounted cash flow approach models the credit losses directly in the projected cash flows, applying various assumptions regarding credit, interest and prepayment risks for the loans based on loan types, payment types and fixed or variable classifications.

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 published Bloomberg US Financials BB rated corporate bond index yield.

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.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

Note 9. Derivative Financial Instruments

The Company enters into certain derivative financial instruments as part of its hedging strategy. These financial instruments are not designated as hedging instruments and are used for asset and liability management related to the Company's mortgage banking activities and commercial customers' financing needs. All derivatives are carried at fair value in either other assets or other liabilities.

Through the normal course of business, the Company enters into interest rate lock commitments with consumers to originate mortgage loans at a specified interest rate. These commitments, which contain fixed expiration dates, offer the borrower an interest rate guarantee provided the loan meets underwriting guidelines and closes within the timeframe established by the Company.

The Company manages the changes in fair value associated with changes in interest rates related to interest rate lock commitments by using forward sold commitments known as forward mortgage-backed securities trades. These instruments are typically entered into at the time the interest rate lock commitment is made.

The Company also offers certain derivatives products, primarily interest rate swaps, directly to qualified commercial banking customers to facilitate their risk management strategies. The interest rate swap derivative positions relate to transactions in which the Company enters into an interest rate swap with a customer, while at the same time entering into an offsetting interest rate swap with another financial institution. An interest rate swap transaction allows customers to effectively convert a variable rate loan to a fixed rate. In connection with each swap, the Company agrees to pay interest to the customer on a notional amount at a variable interest rate and receive interest from the customer on a similar notional amount at a fixed interest rate. At the same time, the Company agrees to pay another financial institution the same fixed interest rate on the same notional amount and receive the same variable interest rate on the same notional amount.

The following table provides the outstanding notional balances and fair values of outstanding derivative positions at September 30, 2020 and December 31, 2019:



	Outstanding Notional Balance		Asset Derivative Fair Value		Liability Derivative Fair Value
September 30, 2020
Interest rate lock commitments	$	157,006	$	5,109	$	—
Forward mortgage-backed securities trades	144,000		18		330
Commercial loan interest rate swaps:
Loan customer counterparty	339,616		22,415		—
Financial institution counterparty	339,616		—		23,813

December 31, 2019
Interest rate lock commitments	$	28,434	$	847	$	—
Forward mortgage-backed securities trades	42,500		6		69
Commercial loan interest rate swaps:
Loan customer counterparty	280,751		6,104		—
Financial institution counterparty	280,751		—		6,566

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

The commercial loan customer counterparty weighted average received and paid interest rates for interest rate swaps outstanding were as follows:


	Weighted Average Interest Rate
	September 30, 2020				December 31, 2019
	Received		Paid		Received		Paid
Loan customer counterparty	4.10	%	2.27	%	4.23	%	3.77	%

The credit exposure related to interest rate swaps is limited to the net favorable value of all swaps by each counterparty, which was approximately $22,415 at September 30, 2020. In some cases collateral may be required from the counterparties involved if the net value of the derivative instruments exceeds a nominal amount. Collateral levels are monitored and adjusted on a regular basis for changes in interest rate swap values. At September 30, 2020, cash of $23,745 and securities of $6,603 were pledged as collateral for these derivatives.

During the current year, the Company has entered into credit risk participation agreements with financial institution counterparties for interest rate swaps related to loans in which the Company is either a participant or a lead bank. Risk participation agreements entered into as a participant bank provide credit protection to the financial institution counterparty should the borrower fail to perform on its interest rate derivative contract with that financial institution. The Company is party to one risk participation agreement as a participant bank having a notional amount of $5,683 at September 30, 2020. Risk participation agreements entered into as the lead bank provide credit protection to the Company should the borrower fail to perform on its interest rate derivative contract. The Company is party to one risk participation agreement as the lead bank having a notional amount of $9,668 at September 30, 2020.

The changes in the fair value of interest rate lock commitments and the forward sales of mortgage-back securities are recorded in mortgage banking revenue. These gains and losses were not attributable to instrument-specific credit risk. For interest rate swaps, because the Company acts as an intermediary for our customer, changes in the fair value of the underlying derivative contracts substantially offset each other and do not have a material impact on the results of operations.

Income (loss) for the three and nine months ended September 30, 2020 and 2019 was as follows:


	Three Months Ended September 30,				Nine Months Ended September 30,
	2020		2019		2020		2019
Derivatives not designated as hedging instruments
Interest rate lock commitments	$	1,517	$	126	$	4,262	$	682
Forward mortgage-backed securities trades	192		98		(249)		193

Note 10. Stock Awards

The Company grants common stock awards to certain employees of the Company. In connection with the Company's initial public offering in April 2013, the Board of Directors adopted the 2013 Equity Incentive Plan. Under this plan, the Compensation Committee may grant awards to certain employees of the Company 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. All stock awards issued under expired plans prior to 2013 are fully vested. The Plan, as amended, has 2,300,000 reserved shares of common stock to be awarded by the Company’s compensation committee. As of September 30, 2020, there were 1,152,472 shares remaining available for grant for future awards. The shares currently issued under the 2013 Plan are restricted stock awards and will vest evenly over the required employment period, generally ranging from three to five years. As defined in the plan, outstanding awards may immediately vest upon a change-in-control in the Company. Shares granted under the 2013 Equity Incentive Plan were issued at the date of grant and receive dividends.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

In connection with the January 1, 2019 acquisition of Guaranty Bancorp (Guaranty), unvested awards of restricted Guaranty common stock granted under Guaranty’s 2015 Long-Term Incentive Plan (Guaranty 2015 RSA), as amended, that were outstanding as of the acquisition date, were converted into awards of restricted shares of Independent common stock (Replacement RSA) with the same terms and conditions as were applicable under such Guaranty 2015 RSA, except with respect to any performance-vesting Guaranty 2015 RSA, which became a service-vesting RSA only. The Replacement RSA will vest over the remaining service period, which is through May 2021, and do not receive dividends.

The following table summarizes the activity in nonvested shares for the nine months ended September 30, 2020 and 2019:


	Number of Shares	Weighted Average Grant Date Fair Value
Nonvested shares, December 31, 2019	284,861	$	58.63

Granted during the period	304,790	43.38
Vested during the period	(112,914)	58.28
Forfeited during the period	(7,270)	51.97
Nonvested shares, September 30, 2020	469,467	$	48.91

Nonvested shares, December 31, 2018	252,903	$	62.81
Acquired awards replaced during the period	70,248	45.77
Granted during the period	138,608	51.14
Vested during the period	(143,516)	54.66
Forfeited during the period	(13,615)	46.55
Nonvested shares, September 30, 2019	304,628	$	58.14

Compensation expense related to these awards is recorded based on the fair value of the award at the date of grant and totaled $1,970 and $6,333 for the three and nine months ended September 30, 2020, respectively, and $1,910 and $5,834 for the three and nine months ended September 30, 2019, respectively. Compensation expense is recorded in salaries and employee benefits in the accompanying consolidated statements of income. At September 30, 2020, future compensation expense is estimated to be $17,802 and will be recognized over a remaining weighted average period of 2.73 years.

The fair value of common stock awards that vested during the nine months ended September 30, 2020 and 2019 was $5,469 and $7,752, respectively. The Company recorded $44 and $246 in excess tax expense on vested restricted stock to income tax expense for the three and nine months ended September 30, 2020, respectively, and $11 and $21 for the three and nine months ended September 30, 2019, respectively.

There were no modifications of stock agreements during the nine months ended September 30, 2020 and 2019 that resulted in significant additional incremental compensation costs.

At September 30, 2020, the future vesting schedule of the nonvested shares is as follows:


First year						178,463
Second year						139,138
Third year						98,760
Fourth year						52,906
Fifth year						200
Total nonvested shares						469,467

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

Note 11. 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. Tier 2 capital for the Company includes permissible portions of the Company's subordinated notes. The permissible portion of qualified subordinated notes decreases 20% per year during the final five years of the term of the notes.

The Company is subject to the Basel III regulatory capital framework (the Basel III Capital Rules). The Basel III Capital Rules require that the Company maintain a 2.5% capital conservation buffer above the minimum risk-based capital adequacy requirements. 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, Common Equity Tier 1 (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 September 30, 2020 and December 31, 2019, the Company and the Bank meet all capital adequacy requirements to which they are subject, including the capital buffer requirement.

As of September 30, 2020 and December 31, 2019, the Bank’s capital ratios exceeded those levels necessary to be categorized as “well capitalized” under the regulatory framework for prompt corrective action, as amended to reflect the changes under the Basel III Capital Rules. 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 that management believes have changed the Bank’s category.

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Independent Bank Group, Inc. and Subsidiaries

Notes to Consolidated Financial Statements (unaudited)

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

The following table presents actual capital amounts and required ratios under Basel III Capital Rules for the Company and Bank as of September 30, 2020 and December 31, 2019.


	Actual				Minimum for Capital Required - Basel III				To be Well Capitalized Under Prompt Corrective Action Provisions
	Amount		Ratio		Amount		Ratio		Amount		Ratio
September 30, 2020
Total capital to risk weighted assets:
Consolidated	$	1,781,095	13.29	%	$	1,406,672	10.50	%	N/A		N/A
Bank	1,797,610		13.42		1,406,149		10.50		$	1,339,190	10.00	%
Tier 1 capital to risk weighted assets:
Consolidated	1,427,604		10.66		1,138,734		8.50		N/A		N/A
Bank	1,710,119		12.77		1,138,311		8.50		1,071,352		8.00
Common equity tier 1 to risk weighted assets:
Consolidated	1,372,004		10.24		937,781		7.00		N/A		N/A
Bank	1,710,119		12.77		937,433		7.00		870,473		6.50
Tier 1 capital to average assets:
Consolidated	1,427,604		9.15		623,929		4.00		N/A		N/A
Bank	1,710,119		10.97		623,754		4.00		779,692		5.00

December 31, 2019
Total capital to risk weighted assets:
Consolidated	$	1,513,209	11.83	%	$	1,343,114	10.50	%	N/A		N/A
Bank	1,548,103		12.11		1,342,595		10.50		$	1,278,662	10.00	%
Tier 1 capital to risk weighted assets:
Consolidated	1,303,748		10.19		1,087,282		8.50		N/A		N/A
Bank	1,496,642		11.70		1,086,863		8.50		1,022,930		8.00
Common equity tier 1 to risk weighted assets:
Consolidated	1,248,148		9.76		895,409		7.00		N/A		N/A
Bank	1,496,642		11.70		895,064		7.00		831,130		6.50
Tier 1 capital to average assets:
Consolidated	1,303,748		9.32		559,758		4.00		N/A		N/A
Bank	1,496,642		10.70		559,584		4.00		699,480		5.00

Note 12. Subsequent Events

Declaration of Dividends

On October 22, 2020, the Company declared a quarterly cash dividend in the amount of $0.30 per share of common stock to the stockholders of record on November 6, 2020. The dividend will be paid on November 19, 2020.

Stock Repurchase Program

On October 22, 2020, the Company's Board of Directors approved the renewal of its stock repurchase program prior to its expiration date, with an increased maximum authorization limit of $150 million of common stock available for repurchase through October 31, 2021.

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

Cautionary Note Regarding Forward Looking Statements

The Quarterly Report on Form 10-Q, our other filing 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 that are subject to risks and uncertainties and are made pursuant to the safe harbor provisions of Section 27A of the Securities Act, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended, and other related federal security laws. These forward-looking statements include information about our possible or assumed 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, 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, but not exclusively, 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 our 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 our future financial results and performance and could cause those results or performance to differ materially from those expressed in the forward-looking statements. These possible events or factors include, but are not limited to:

•the disruption to local, regional, national and global economic activity caused by infectious disease outbreaks, including the recent outbreak of coronavirus, or COVID-19, and the significant impact that such outbreak has had and may have on our growth, operations, earnings and asset quality;

•our ability to sustain our current internal growth rate and total growth rate;

•changes in geopolitical, business and economic events, occurrences and conditions, including changes in rates of inflation or deflation, nationally, regionally and in our target markets, particularly in Texas and Colorado;

•worsening business and economic conditions nationally, regionally and in our target markets, particularly in Texas and Colorado, and the geographic areas in those states 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 and Colorado;

•changes in asset quality, including increases in default rates on loans and higher levels of nonperforming loans and loan charge-offs generally, and specifically resulting from the economic dislocation caused by the COVID-19 pandemic;

•concentration of the loan portfolio of Independent Bank, before and after the completion of acquisitions of financial institutions, in commercial and residential real estate loans and changes in the prices, values and sales volumes of commercial and residential real estate;

•the ability of Independent Bank to make loans with acceptable net interest margins and levels of risk of repayment and to otherwise invest in assets at acceptable yields and presenting acceptable investment risks;

•inaccuracy of the assumptions and estimates that the managements of our Company and the financial institutions that we acquire make in establishing reserves for probable loan losses and other estimates generally, and specifically as a result of the effect of the COVID-19 pandemic;

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

•material increases or decreases in the amount of deposits held by Independent Bank or other financial institutions that we acquire and the cost of those deposits;

•our access to the debt and equity markets and the overall cost of funding our operations;

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•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 the loans and deposits of each of Independent Bank and the financial institutions that we acquire and that affect the net interest income, other future cash flows, or the market value of the assets of each of Independent Bank and the financial institutions that we acquire, including investment securities;

•fluctuations in the market value and liquidity of the securities we hold for sale, including as a result of changes in market interest rates;

•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, including the economic dislocation resulting from the COVID-19 pandemic, that affect the amount and value of the assets of Independent Bank and of financial institutions that we acquire;

•the institution and outcome of, and costs associated with, litigation and other legal proceedings against one of more of the Company, Independent Bank and financial institutions that we acquire or to which any of such entities is subject;

•the occurrence of market conditions adversely affecting the financial industry generally, including the economic dislocation resulting from the COVID-19 pandemic;

•the impact of recent and future legislative regulatory changes, including changes in banking, securities, and tax laws and regulations and their application by the Company’s regulators, and changes in federal government policies, as well as regulatory requirements applicable to, and resulting from regulatory supervision of, the Company and Independent Bank as a financial institution with total assets greater than $10 billion;

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

•governmental monetary and fiscal policies, including changes resulting from the implementation of the new Current Expected Credit Loss accounting standard;

•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 natural disasters such as storms, droughts, tornadoes, hurricanes 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;

•the liquidity of, and changes in the amounts and sources of liquidity available to, us, before and after the acquisition of any financial institutions that we acquire;

•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 effects of the combination of the operations of financial institutions that we have acquired in the recent past or may acquire in the future with our operations and the operations of Independent Bank, the effects of the integration of such operations being unsuccessful, and the effects of such integration being more difficult, time consuming, or costly than expected or not yielding the cost savings we expect;

•the impact of investments that the Company or Independent Bank may have made or may make and the changes in the value of those investments;

•the quality of the assets of financial institutions and companies that we have acquired in the recent past or may acquire in the future being different than we determined or determine in our due diligence investigation in connection with the acquisition of such financial institutions and any inadequacy of loan loss reserves relating to, and exposure to unrecoverable losses on, loans acquired;

•our ability to continue to identify acquisition targets and successfully acquire desirable financial institutions to sustain our growth, to expand our presence in our markets and to enter new markets;

•general business and economic conditions in our markets change or are less favorable than expected generally, and specifically as a result of the COVID-19 pandemic;

•changes occur in business conditions and inflation generally, and specifically as a result of the COVID-19 pandemic;

•an increase in the rate of personal or commercial customers’ bankruptcies generally, and specifically as a result of the COVID-19 pandemic;

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

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•attacks on the security of, and breaches of, the Company's and Independent Bank's digital information systems, the costs we or Independent Bank incur to provide security against such attacks and any costs and liability the Company or Independent Bank incurs in connection with any breach of those systems;

•the potential impact of technology and “FinTech” entities on the banking industry generally;

•the other factors that are described or referenced in Part I, Item 1A, of the Company’s Annual Report on Form 10-K filed with the SEC on March 2, 2020, as amended by the Company’s Annual Report on Form 10-K/A filed with the SEC on March 6, 2020, the Company’s Quarterly Reports on Form 10-Q, in each case under the caption “Risk Factors”; and

•other economic, competitive, governmental, regulatory, technological and geopolitical factors affecting the Company’s operations, pricing and services.

We urge you to consider all of these risks, uncertainties and other factors carefully in evaluating all such forward-looking statements made by us. As a result of these and other matters, including changes in facts, assumptions not being realized or other factors, 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 in this prospectus or made by us in any report, filing, document or information incorporated by reference in this prospectus, speaks only as of the date on which it is made. We undertake no obligation to update any such 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. We believe that these assumptions or bases have been chosen in good faith and that they are reasonable. However, we caution you that assumptions as to future occurrences or results almost always vary from actual future occurrences or results, and the differences between assumptions and actual occurrences and results can be material. Therefore, we caution you not to place undue reliance on the forward-looking statements contained in this prospectus or incorporated by reference herein.

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Overview

This Management’s Discussion and Analysis (MD&A) 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, as amended, for the year ended December 31, 2019.

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 the Company’s market areas or in new 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.

As of September 30, 2020, the Company operated 93 full service banking locations in north, central and southeast Texas regions, and along the Colorado Front Range region, with 61 Texas locations and 32 Colorado locations.

The Company’s headquarters are located at 7777 Henneman Way, McKinney, Texas 75070 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.

The Company’s principal business is lending to and accepting deposits from businesses, professionals and individuals. The Company conducts all of the Company’s banking operations through Independent Bank, which is a Texas state banking corporation and the Company's principal subsidiary (the Bank). The Company derives its income principally from interest earned on loans and, to a lesser extent, income from securities available for sale. The Company also derives income from non-interest sources, such as fees received in connection with various deposit services, mortgage banking operations and investment advisory services. From time to time, the Company also realizes gains on the sale of assets. The Company’s principal expenses include interest expense on interest-bearing customer deposits, advances from the Federal Home Loan Bank of Dallas (FHLB) and other borrowings, operating expenses such as salaries, employee benefits, occupancy costs, communication and technology costs, expenses associated with other real estate owned, other administrative expenses, amortization of intangibles, acquisition expenses, provisions for loan losses and the Company’s assessment for FDIC deposit insurance.

Recent Developments: COVID-19

In March 2020, the outbreak of the Coronavirus Disease 2019 (COVID-19) was recognized as a pandemic by the World Health Organization. The spread of COVID-19 has caused economic and social disruption resulting in unprecedented uncertainty, volatility and disruption in financial markets, and has placed significant health, economic and other major pressures throughout the communities we serve, the United States and globally. While some industries have been impacted more severely than others, all businesses have been impacted to some degree This disruption has resulted in the shuttering of businesses across the country, significant job loss, material decreases in oil and gas prices and in business valuations, changes in consumer behavior related to pandemic fears, and aggressive measures by the federal government. Towards the end of second quarter 2020, many of the more restrictive government orders eased on a national level and more specifically in the Company's markets of Texas and Colorado, allowing businesses to reopen at varying capacity levels, which has boosted commercial and consumer activity during the third quarter 2020. However, the risk of a resurgence in infections and possible reimplementation of restrictions remains significant.

The CARES Act and Other Regulations

On March 27, 2020, the Coronavirus Aid, Relief, and Economic Security Act (CARES Act) was signed into law. It contains substantial tax and spending provisions intended to address the impact of the COVID-19 pandemic. The goal of the CARES Act is to prevent a severe economic downturn through various measures, including direct financial aid to American families and economic stimulus to significantly impacted industry sectors through programs like the Paycheck Protection Program (PPP). The CARES Act also includes a range of other provisions designed to support the U.S. economy and mitigate the impact of COVID-19 on financial institutions and their customers, including through the authorization of various programs and measures that the U.S. Department of the Treasury, the Small Business Administration, the Federal Reserve Board, and other federal

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banking agencies may or are required to implement. Further, in response to the COVID-19 outbreak, the Federal Reserve Board has implemented or announced a number of facilities to provide emergency liquidity to various segments of the U.S. economy and financial market.

Under the CARES Act, financial institutions are permitted to delay the implementation of ASU 2016-13, Financial Instruments - Credit Losses (CECL) until the earlier of the termination date of the national emergency declaration by the President or by December 31, 2020. The Company has elected such provision and will defer the adoption of CECL until such time has occurred with an effective retrospective implementation date of January 1, 2020. Refer to Note 1, Summary of Significant Accounting Policies, to the Company's consolidated financial statements included elsewhere in this report. Additionally, in a related action to the CARES Act, the joint federal bank regulatory agencies issued an interim final rule effective March 31, 2020, that allows banking organizations that implement CECL this year to elect to mitigate the effects of the CECL accounting standard on their regulatory capital for two years. This two-year delay is in addition to the three-year transition period that the agencies had already made available. Upon such point of adoption of CECL during 2020, the Company will elect to defer the regulatory capital effects of CECL in accordance with the interim final rule.

The CARES Act also includes a provision that permits a financial institution to elect to suspend temporarily troubled debt restructuring accounting under ASC Subtopic 310-40 in certain circumstances (section 4013). To be eligible under section 4013, a loan modification must be (1) related to COVID-19; (2) executed on a loan that was not more than 30 days past due as of December 31, 2019; and (3) executed between March 1, 2020, and the earlier of (A) 60 days after the date of termination of the National Emergency or (B) December 31, 2020. In response to this section of the CARES Act, the federal banking agencies issued a revised interagency statement on April 7, 2020 that, in consultation with the Financial Accounting Standards Board, confirmed that for loans not subject to section 4013, short-term modifications made on a good faith basis in response to COVID-19 to borrowers who were current prior to any relief are not troubled debt restructurings under ASC Subtopic 310-40. This includes short-term (e.g., up to six months) modifications such as payment deferrals, fee waivers, extensions of repayment terms, or delays in payment that are insignificant. Borrowers considered current are those that are less than 30 days past due on their contractual payments at the time a modification program is implemented.

The company continues to monitor developments related to the pandemic and its impact on the Company's business, customers, employees, counterparties, vendors, and service providers. During the nine months ended September 30, 2020, the most notable financial impact to the Company's results of operations include a higher provision for loan losses primarily as a result of deterioration in macroeconomic variables, as well as lower service charge income and deposit and loan related expenses, as more fully discussed throughout this MD&A.

In response to the COVID-19 pandemic, the Company has taken several actions to offer various forms of support to our employees, customers, and communities that have experienced impacts during this unprecedented time. In addition, the Company continues to take deliberate actions to ensure the continued health and strength of its balance sheet in order to serve its clients and communities.

Employees, Customers and Communities

•The Company is supporting the health and safety of its employees and customers, and complying with government directives, through responsible operations administered under its board approved business continuity plan and protocols resulting in minimal impacts to operations:

◦All branches are currently open and operating under reduced hours. Branch lobbies have been adjusted to encourage social distancing, surfaces are regularly sanitized and employees are required to wear face coverings when interacting with customers.

◦The Company increased customer education regarding mobile banking applications and developed a COVID-19 Resource Center accessible on the Company's website.

◦Since early March 2020, the Company has restricted employee travel and implemented work-from-home measures at minimal cost and with limited disruption to operations and customer experience.

•The Company has participated in the CARES Act (PPP). As of September 30, 2020, the Company has originated $826.0 million to 6,383 customers. Management believes that the majority of these loans will ultimately be forgiven by the SBA in accordance with the terms of the program.

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•The Company continues to actively work with its borrowers on an individual, one-on-one basis to assess and understand the impact of pandemic-related economic hardships and provide prudent modifications allowing for payment deferrals or payment relief where appropriate. Through September 30, 2020, the Company has granted temporary COVID-19 modifications on over 2,100 loans totaling approximately $2.6 billion. The number of loans on active payment deferral has significantly declined since the beginning of the pandemic, and the vast majority of borrowers who were provided temporary payment relief have returned to paying as originally agreed. As of September 30, 2020, 322 loans with a total outstanding balance of $683.4 million remain in deferral status, of which $353.0 million are on second deferrals. Under the guidance noted above, such modifications are currently exempt from the accounting guidance for TDRs (Refer to Note 4, Loans, Net and Allowance for Loan Losses, to the Company's consolidated financial statements included elsewhere in this report). As of October 16, 2020, the amount of loans with active deferrals declined to $548.0 million across 239 accounts, which represents 4.5% of the Company’s outstanding total loans held for investment balances, excluding PPP loans, as of third quarter end and 1.2% of the Company’s outstanding total loan accounts at third quarter end. The $548.0 million in active deferrals, of which $329.7 million are second deferrals, include $204.1 million, or 37.2%, in hotel and motel; $87.3 million, or 15.9%, in retail; $18.3 million, or 3.3%, in office; $154.2 million, or 28.1%, in other commercial real estate (CRE) and construction and development (C&D); and $72.3 million, or 13.2% in general C&I, with the remainder spread throughout other portfolios.

•The Company has made donations totaling over $100,000 to support food banks across its footprint to provide 355,000 meals to those most vulnerable during the crisis.

Capital and Liquidity

•Capital remains strong, with ratios of the Company, and its subsidiary bank, well above the standards to be considered well-capitalized under regulatory requirements.

•Liquidity remains strong and continues to reflect excess balances, with cash and securities representing approximately 14.8% of total assets as of September 30, 2020. The Company maintains the ability to access considerable sources of contingent liquidity at the Federal Home Loan Bank and the Federal Reserve. Management considers the Company's current liquidity position to be adequate to meet short-term and long-term liquidity needs. Refer to the section captioned "Liquidity Management" elsewhere in this discussion for additional information.

Credit and Asset Quality

•As noted above, the Company elected to defer the adoption of the CECL accounting standard and has continued its consistent application of the incurred loss method for estimating the allowance for loan losses and applicable provision. Due to the macroeconomic environment brought on by the pandemic and energy price volatility, the Company recorded $23.1 million and $7.6 million in provision for loan losses during second and third quarter 2020, respectively, increasing the allowance for loan losses to $87.5 million at September 30, 2020. Management believes that the allowance adequately supports inherent credit losses within the loan portfolio. Refer to the section captioned "Provision" and "Allowance for Loan Loss" elsewhere in this discussion for additional information.

•During third quarter 2020, the Company adjusted the risk grades of several of its loans as the pandemic’s impacts on borrowers became clearer. Classified loans have increased year to date by $75.2 million to $189.5 million, or 1.6% of loans held for investment, net of mortgage warehouse purchase loans, as of September 30, 2020. Loans on special mention also increased by $128.3 million during the year. These increases are mainly reflective of the migration of several hotel loans as well as a few loans in the office and senior living portfolios. This prudent adjustment of risk grades is reflective of the Company's longstanding credit culture with a lender focus to continue to facilitate constructive engagement with borrowers through these challenging times. Overall, asset quality remains solid, reflecting the Company's disciplined underwriting and conservative lending philosophy which has supported strong credit performance during prior financial crises. Refer to Note 4, Loans, Net and Allowance for Loan Losses, to the Company's consolidated financial statements included elsewhere in this report and to the section captioned "Asset Quality" elsewhere in this discussion for additional information.

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•While all industries could experience adverse impacts as a result of the COVID-19 pandemic, the Company has an increased level of COVID-19 industry exposure risk in the following loan categories as of September 30, 2020:

◦Commercial real estate (CRE) loans were $6.1 billion with an average loan size in the CRE portfolio is $1.2 million.

◦Construction and Development (C&D) loans were $1.6 billion. The average loan size in the C&D portfolio was $661.2 thousand and the average loan-to-value was 57.8%. Construction activity continues across Texas and Colorado, and 98.4% of the Company’s C&D loans are located within these states. Of the Company’s C&D loans, 39.3% are for owner-occupied properties.

◦The Company's Retail CRE loans were approximately $1.7 billion, with the average loan size of $1.7 million. The mix of the portfolio consists of loans secured by 72.6% in strip centers properties, 15.2% in free standing/single tenant properties, 10.4% in mixed use properties, and 1.8% in big box properties.

◦The Company has approximately $444.3 million of loans secured by hotel and motel properties, with the average loan size of $5.6 million and the average loan-to-value of 52.7%. The mix of the portfolio consists of 64.0% of loans secured by limited service properties, 14.7% secured by full-service properties, 13.4% secured by extended stay properties, and 7.9% secured by boutique/independent properties.

◦Energy loans were $219.7 million, or 1.9% of total loans held for investment, excluding mortgage warehouse purchase loans. Energy loans are secured 90.5% by exploration and production of oil and gas, and 9.5% by energy services companies. Energy allowance for loan losses represents 6.1% of the total energy loan portfolio.

This pandemic crisis has been impactful and the timing and magnitude of recovery cannot be predicted. The Company continues to closely monitor the impact of COVID-19 on its customers and the communities it serves; however, the extent to which the pandemic will impact operations and financial results during the remainder of 2020 is uncertain.

Certain Events Affect Year-over-Year Comparability

The Company completed the acquisition of Guaranty Bancorp, a Colorado corporation and its subsidiary, Guaranty Bank and Trust Company (Guaranty), on January 1, 2019. As a result of the acquisition, the Company added 32 full service banking locations along the Colorado Front Range including locations throughout the Denver metropolitan area and along I-25 to Fort Collins, expanding the Company's footprint in Colorado. This acquisition increased total assets by $3.9 billion, gross loans by $2.8 billion and deposits by $3.1 billion.

During 2019, the Company completed a rebalancing of its retail footprint by consolidating branches in Texas and Colorado. This consolidation process resulted in the reduction of seven branches in Colorado and four branches in Texas during second quarter 2019 and one Colorado reduction as well as a branch sale during third quarter of 2019. In addition, during fourth quarter of 2019, the Company sold the trust business acquired in the Guaranty acquisition.

The comparability of the Company's results of operations for the three and nine months ended September 30, 2020 and 2019 is affected by these transactions.

Termination of proposed merger with Texas Capital Bancshares, Inc.: The Company and Texas Capital Bancshares, Inc. (TCBI) and its subsidiary, Texas Capital Bank, had entered into an Agreement and Plan of Merger (Merger Agreement), dated as of December 9, 2019, providing for the merger of TCBI with and into the Company. On May 22, 2020, the Company and TCBI entered into a mutual agreement (Agreement) to terminate the Merger Agreement.

Discussion and Analysis of Results of Operations for the Three and Nine Months Ended September 30, 2020 and 2019

The following discussion and analysis of the Company's results of operations compares the operations for the three and nine months ended September 30, 2020 with the three and nine months ended September 30, 2019. The results of operations for the three and nine months ended September 30, 2020 are not necessarily indicative of the results of operations that may be expected for all of the year ending December 31, 2020.

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Results of Operations

For the three months ended September 30, 2020, net income was $60.1 million ($1.39 per common share on a diluted basis) compared with net income of $55.6 million ($1.30 per common share on a diluted basis) for the three months ended September 30, 2019. The Company posted annualized returns on average equity of 9.73% and 9.68%, returns on average assets of 1.43% and 1.50% and efficiency ratios of 44.69 and 48.27% for the three months ended September 30, 2020 and 2019, respectively. The efficiency ratio is calculated by dividing total noninterest expense (which excludes the provision for loan losses and the amortization of other intangible assets) by net interest income plus noninterest income.

For the nine months ended September 30, 2020, net income was $142.9 million ($3.31 per common share on a diluted basis) compared with $142.5 million ($3.29 per common share on a diluted basis) for the nine months ended September 30, 2019. The Company posted annualized returns on average equity of 7.91% and 8.48%, returns on average assets of 1.19% and 1.33% and efficiency ratios of 49.33% and 53.09% for the nine months ended September 30, 2020 and 2019, respectively.

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.

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Net interest income was $132.0 million for the three months ended September 30, 2020, an increase of $6.6 million, or 5.3%, from $125.4 million for the three months ended September 30, 2019. This increase in net interest income is due to decreased funding costs due to a declining rate environment during the year over year period. Average interest earning assets increased $2.0 billion or 15.2%, to $14.9 billion for the three months ended September 30, 2020 compared to $13.0 billion for the three months ended September 30, 2019. The increase is primarily related to increased average loan balances including Paycheck Protection Program (PPP) loans and mortgage warehouse loans, as well as increased average interest-bearing deposits with correspondent banks. The yield on average interest earning assets decreased 102 basis points from 5.06% for the three months ended September 30, 2019 to 4.04% for the three months ended September 30, 2020. The decrease is due primarily to lower rates on interest-earning assets due to decreases in the Fed Funds rate over the period coupled with increased volume of average interest-bearing deposits, in addition to decreased loan yields as a result of decreased loan accretion and the addition of lower yielding PPP loans to the portfolio. The average cost of interest-bearing liabilities decreased 95 basis points to 0.77% for the three months ended September 30, 2020 compared to 1.72% for the three months ended September 30, 2019. The decrease is primarily due to lower rates offered on our deposit products, primarily promotional certificate of deposit products and money market accounts, as well as rate decreases on short-term FHLB advances and our other debt. The aforementioned changes resulted in a 32 basis point decrease in the net interest margin for the three months ended September 30, 2020 at 3.52% compared to 3.84% for the three months ended September 30, 2019. The decrease was primarily due to lower asset yields, increased liquidity and a decrease in loan accretion income offset by the lower cost of funds of interest bearing liabilities.

Net interest income was $383.6 million for the nine months ended September 30, 2020, an increase of $6.9 million, or 1.8%, from $376.7 million for the nine months ended September 30, 2019. The increase is due to a $1.7 billion increase, or 13.2%, in average interest-earning assets to $14.3 billion for the nine months ended September 30, 2020 compared to $12.6 billion for nine months ended September 30, 2019, as well as decreased funding costs due to a declining rate environment during the year over year period. The increase in average interest-earning assets is primarily related to increased average loan balances including Paycheck Protection Program (PPP) loans and mortgage warehouse loans, as well an increase in average interest-bearing deposits with correspondent banks due to significant deposit growth during 2020. The average yield on interest earning assets decreased 88 basis points from 5.18% for the nine months ended September 30, 2019 to 4.30% for the nine months ended September 30, 2020 while the average rate paid on interest bearing liabilities decreased 65 basis points from 1.67% to 1.02% over the same period. The decrease from the prior year was primarily due to overall lower rates on interest-earning assets and liabilities due to decreases in the Fed Funds rate for the year over year period. The primary driver for decreased average yield on interest earning assets was lower loan yields as a result of decreased loan accretion and the addition of lower yielding PPP loans to the portfolio, coupled with increased volume of average interest-bearing deposits earning at lower rates. The decrease in the cost of interest-bearing liabilities is due to the lower rates offered on deposit products, primarily checking, promotional certificate of deposit products and money market accounts as well as lower rates paid on short-term FHLB advances and junior subordinated debt. The net interest margin for the nine months ended September 30, 2020 decreased 41 basis points to 3.59% compared to 4.00% for the nine months ended September 30, 2019.

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Average Balance Sheet Amounts, Interest Earned and Yield Analysis. The following table present average balance sheet information, interest income, interest expense and the corresponding average yields earned and rates paid for the three and nine months ended September 30, 2020 and 2019. The average balances are principally daily averages and, for loans, include both performing and nonperforming balances.


	Three Months Ended September 30,
	2020						2019
(dollars in thousands)	Average Outstanding Balance		Interest		Yield/ Rate (4)		Average Outstanding Balance		Interest		Yield/ Rate (4)
Interest-earning assets:
Loans (1)	$	12,586,647	$	144,138	4.56	%	$	11,341,768	$	154,664	5.41	%
Taxable securities	705,918		4,507		2.54		777,494		5,374		2.74
Nontaxable securities	351,759		2,126		2.40		329,989		2,074		2.49
Interest bearing deposits and other	1,287,320		1,027		0.32		513,524		3,195		2.47
Total interest-earning assets	14,931,644		151,798		4.04		12,962,775		165,307		5.06
Noninterest-earning assets	1,782,251						1,779,843
Total assets	$	16,713,895					$	14,742,618
Interest-bearing liabilities:
Checking accounts	$	4,619,454	$	5,512	0.47	%	$	3,950,978	$	12,088	1.21	%
Savings accounts	631,862		270		0.17		564,480		348		0.24
Money market accounts	2,471,550		4,361		0.70		2,101,064		10,923		2.06
Certificates of deposit	1,590,734		5,536		1.38		1,863,935		10,027		2.13
Total deposits	9,313,600		15,679		0.67		8,480,457		33,386		1.56
FHLB advances	594,022		714		0.48		453,370		2,730		2.39
Other borrowings	209,532		2,928		5.56		212,824		3,036		5.66
Junior subordinated debentures	53,955		470		3.47		53,757		762		5.62
Total interest-bearing liabilities	10,171,109		19,791		0.77		9,200,408		39,914		1.72
Noninterest-bearing checking accounts	3,991,014						3,160,832
Noninterest-bearing liabilities	94,349						101,500
Stockholders’ equity	2,457,423						2,279,878
Total liabilities and equity	$	16,713,895					$	14,742,618
Net interest income			$	132,007					$	125,393
Interest rate spread					3.27	%					3.34	%
Net interest margin (2)					3.52						3.84
Net interest income and margin (tax equivalent basis) (3)			$	132,978	3.54				$	126,308	3.87
Average interest-earning assets to interest-bearing liabilities					146.80						140.89

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	Nine Months Ended September 30,
	2020						2019
(dollars in thousands)	Average Outstanding Balance		Interest		Yield/ Rate (4)		Average Outstanding Balance		Interest		Yield/ Rate (4)
Interest-earning assets:
Loans (1)	$	12,142,159	$	434,648	4.78	%	$	11,048,706	$	457,626	5.54	%
Taxable securities	740,252		14,499		2.62		775,732		16,101		2.78
Nontaxable securities	343,233		6,359		2.47		332,487		6,426		2.58
Interest bearing deposits and other	1,041,217		3,938		0.51		447,041		8,393		2.51
Total interest-earning assets	14,266,861		459,444		4.30		12,603,966		488,546		5.18
Noninterest-earning assets	1,790,569						1,770,708
Total assets	$	16,057,430					$	14,374,674
Interest-bearing liabilities:
Checking accounts	$	4,434,686	$	22,529	0.68	%	$	3,902,517	$	32,839	1.13	%
Savings accounts	593,646		795		0.18		531,552		1,004		0.25
Money market accounts	2,276,036		16,714		0.98		2,025,704		31,575		2.08
Certificates of deposit	1,704,720		22,039		1.73		1,768,956		27,132		2.05
Total deposits	9,009,088		62,077		0.92		8,228,729		92,550		1.50
FHLB advances	693,248		3,629		0.70		466,603		8,324		2.39
Other borrowings	196,305		8,408		5.72		200,115		8,674		5.80
Junior subordinated debentures	53,906		1,710		4.24		53,708		2,310		5.75
Total interest-bearing liabilities	9,952,547		75,824		1.02		8,949,155		111,858		1.67
Noninterest-bearing checking accounts	3,597,192						3,093,390
Noninterest-bearing liabilities	92,646						84,933
Stockholders’ equity	2,415,045						2,247,196
Total liabilities and equity	$	16,057,430					$	14,374,674
Net interest income			$	383,620					$	376,688
Interest rate spread					3.28	%					3.51	%
Net interest margin (2)					3.59						4.00
Net interest income and margin (tax equivalent basis) (3)			$	386,476	3.62				$	379,440	4.03
Average interest-earning assets to interest-bearing liabilities					143.35						140.84

____________

(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) A tax-equivalent adjustment has been computed using a federal income tax rate of 21% for the three and nine months ended September 30, 2020 and 2019.

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

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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 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 $7.6 million provision for loan losses for the three months ended September 30, 2020 compared to $5.2 million for the comparable period in 2019. Provision expense for the nine months ended September 30, 2020 was $39.1 million compared to $13.2 million for the same period in 2019. Provision expense is generally reflective of organic loan growth as well as charge-offs or specific reserves taken during the respective period. The increase from prior year is primarily due to general provision expense incurred during 2020 due to economic factors related to the COVID-19 and energy price volatility. The increase is also reflective of an $8.9 million net increase in specific reserves for the nine months ending September 30, 2020, including specific reserve allocations of $1.4 million on a commercial loan and $6.9 million on an energy credit. Net charge-offs were $184 thousand and $5.9 million for the three months ended September 30, 2020 and 2019, respectively, and $3.1 million and $7.6 million for the nine months ended September 30, 2020 and 2019, respectively. Net charge-offs for the nine months ended September 30, 2020 were elevated primarily due to second quarter 2020 charge-offs on a $1.1 million commercial loan, $735 thousand commercial real estate loan and $563 thousand energy credit. Net charge-offs for the nine months ended September 30, 2019 were elevated primarily due to third quarter 2019 charge-offs on two commercial credits totaling $5.6 million and first quarter 2019 commercial loan charge-offs of $1.5 million.

Noninterest Income

The following table sets forth the components of noninterest income for the three and nine months ended September 30, 2020 and 2019 and the period-over-period variations in such categories of noninterest income:


	Three Months Ended September 30,				Variance		Nine Months Ended September 30,				Variance
(dollars in thousands)	2020		2019		2020 v. 2019		2020		2019		2020 v. 2019
Noninterest Income
Service charges on deposit accounts	$	2,173	$	2,805	$	(632)	(22.5)	%	$	6,881	$	9,247	$	(2,366)	(25.6)	%
Investment management and trust	1,924		2,497		(573)		(22.9)	%	5,556		7,238		(1,682)		(23.2)	%
Mortgage banking revenue	14,722		4,824		9,898		205.2	%	27,726		11,619		16,107		138.6	%
Gain on sale of loans	—		6,779		(6,779)		N/M		647		6,779		(6,132)		N/M
Gain on sale of branch	—		1,549		(1,549)		N/M		—		1,549		(1,549)		N/M

Gain on sale of other real estate	—		539		(539)		N/M		37		851		(814)		N/M
Gain on sale of securities available for sale	—		—		—		N/M		382		265		117		N/M
Gain (loss) on sale and disposal of premises and equipment	34		(315)		349		N/M		311		(585)		896		N/M
Increase in cash surrender value of BOLI	1,335		1,402		(67)		(4.8)	%	4,007		4,135		(128)		(3.1)	%
Other	4,977		7,244		(2,267)		(31.3)	%	19,604		18,849		755		4.0	%
Total noninterest income	$	25,165	$	27,324	$	(2,159)	(7.9)	%	$	65,151	$	59,947	$	5,204	8.7	%

____________

N/M - not meaningful

Total noninterest income decreased $2.2 million, or 7.9% and increased $5.2 million, or 8.7% for the three and nine months ended September 30, 2020 over same periods in 2019, respectively. Significant changes in the components of noninterest income are discussed below.

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Service charges on deposit accounts. Service charges on deposit accounts decreased $632 thousand, or 22.5% and $2.4 million, or 25.6%, for the three and nine months ended September 30, 2020, respectively, as compared to the same periods in 2019. Service charge income related to transaction volumes such as non-sufficient funds and service charge fees have been adversely impacted by the pandemic during 2020.

Investment management and trust. Investment management and trust decreased $573 thousand, or 22.9%, and $1.7 million, or 23.2%, for the three and nine months ended September 30, 2020, respectively, as compared to the same periods in 2019. The decrease is primarily a result of the sale of the trust business in fourth quarter 2019 coupled with a decline in assets under management, resulting from the market decline during 2020.

Mortgage banking revenue. Mortgage banking revenue increased $9.9 million, or 205.2% and increased $16.1 million, or 138.6% for the three and nine months ended September 30, 2020, respectively, as compared to the same periods in 2019. The increase was primarily reflective of increased mortgage origination and refinance activity resulting from the low interest rate environment during 2020. Revenue was also positively impacted by the favorable market conditions during 2020, which resulted in fair value gains on our derivative hedging instruments of $982 thousand and $2.7 million for the three and nine months ended September 30, 2020, respectively, compared to a gain of $106 thousand and a loss of $519 thousand for the same periods in 2019, respectively.

Other. Other noninterest income decreased $2.3 million, or 31.3% and increased $755 thousand, or 4.0% for the three and nine months ended September 30, 2020, respectively, as compared to the same periods in 2019. The decrease from the prior year three month period is primarily due to decreases of $1.9 million in interchange income as a result of the Durbin amendment becoming effective for the Company starting third quarter 2020, as well as, a decrease of $1.2 million in swap dealer income, offset by an increase of $810 thousand in mortgage warehouse fees. The change for the year over year nine month period is due to the recovery of a $3.5 million contingency reserve on an acquired SBA loan participation sold in addition to higher mortgage warehouse fees offset by $2.4 million in interchange income as well as a decrease in swap dealer income.

Noninterest Expense

Noninterest expense decreased $3.5 million, or 4.6% and decreased $10.6 million, or 4.4% for the three and nine months ended September 30, 2020, respectively, as compared to the same periods in 2019. The following table sets forth the components of the Company’s noninterest expense for the three and nine months ended September 30, 2020 and 2019 and the period-over-period variations in such categories of noninterest expense:


	Three Months Ended September 30,				Variance				Nine Months Ended September 30,						Variance
(dollars in thousands)	2020		2019		2020 v. 2019				2020			2019			2020 v. 2019
Noninterest Expense
Salaries and employee benefits	$	42,253	$	37,645	$	4,608	12.2	%		$	115,341		$	120,557		$	(5,216)	(4.3)	%
Occupancy	9,717		9,402		315		3.4			29,132			27,978			1,154		4.1
Communications and technology	5,716		5,758		(42)		(0.7)			17,193			16,598			595		3.6
FDIC assessment (credit)	1,597		(2,139)		3,736		N/M			5,338			71			5,267		N/M
Advertising and public relations	492		467		25		5.4			1,965			1,942			23		1.2
Other real estate owned expenses, net	43		152		(109)		(71.7)			459			302			157		52.0

Impairment of other real estate	46		—		46		N/M			784			1,424			(640)		(44.9)
Amortization of other intangible assets	3,175		3,235		(60)		(1.9)			9,526			9,705			(179)		(1.8)
Professional fees	2,871		2,057		814		39.6			9,266			4,771			4,495		94.2
Acquisition expense, including legal	47		9,465		(9,418)		(99.5)			16,225			28,175			(11,950)		(42.4)
Other	7,452		10,906		(3,454)		(31.7)			25,678			29,998			(4,320)		(14.4)
Total noninterest expense	$	73,409	$	76,948	$	(3,539)	(4.6)	%		$	230,907		$	241,521		$	(10,614)	(4.4)	%

____________

N/M - not meaningful

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Salaries and employee benefits. Salaries and employee benefits increased $4.6 million, or 12.2% and decreased $5.2 million, or 4.3% for the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019. The increase in third quarter 2020 as compared to third quarter 2019 is primarily due to higher salaries and accrued bonus expense due to higher headcount for the year over year period, partially offset by $911 thousand of conversion bonuses and severance and retention expenses related to the Guaranty transaction and a branch restructuring completed in third quarter 2019. In addition, third quarter 2020 increase is reflective of $1.1 million in elevated commission expense due to significantly increased mortgage production during the quarter. The decrease in salaries and benefits expense for the nine months ended September 30, 2020 compared to the same period in 2019 is primarily due to deferred salaries costs of $10.3 million related to the originations of the PPP loans and other COVID-related loan modifications/deferrals during second quarter 2020, as well as elevated severance and retention expense incurred in 2019 totaling $5.4 million related to employees not retained from the Guaranty acquisition and the 2019 branch restructuring. In addition, the relative change in salaries and benefits expense for the nine months ended September 30, 2020 compared to the same period in 2019 is reflective of $3.4 million in elevated commission expense, as well as 2020 increases of $2.8 million in severance expense and accelerated stock grant amortization related to departmental and business line restructurings, $1.4 million of bonuses and overtime related to PPP loan activity and increases for pandemic related special circumstance pay.

FDIC assessment. FDIC assessment increased $3.7 million and $5.3 million for the three and nine months ended September 30, 2020, respectively, as compared to the same periods in 2019. The increase in the FDIC assessment from the comparable year over year periods was impacted by a $3.2 million Small Bank Assessment Credit recorded in third quarter 2019. In addition, the FDIC assessment was impacted by the Company becoming a large institution under regulatory guidelines, effective January 1, 2020, which resulted in higher assessment costs from the year over year periods.

Professional fees. Professional fees increased $814 thousand, or 39.6%, and $4.5 million, or 94.2%, for the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019. Professional fees increased due to higher legal expenses related to ongoing acquired litigation, and increased consulting expenses related to a compliance project and new system implementations.

Acquisition expenses. Acquisition expenses decreased $9.4 million and $12.0 million for the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019. Acquisition expense decreased compared to the same periods in prior year primarily due to elevated expenses in 2019 related to the Guaranty transaction including $8.7 million in change in control payments to Guaranty executives as well as an increase in professional fees, conversion-related expenses, and contract termination fees, including $6.9 million related to Guaranty's debit card provider expensed in third quarter of 2019. Off-setting these decreases are elevated expenses in 2020 related to the terminated merger including $8.8 million in integration costs and $6.0 million in legal and advisory fees.

Other noninterest expense. Other noninterest expense decreased $3.5 million, or 31.7% and decreased $4.3 million, or 14.4% for the three and nine months ended September 30, 2020, respectively, compared to the same periods in 2019. The decrease in other noninterest expense for both the three and nine month periods is primarily due to lower deposit-related expenses and auto and travel expenses due to the pandemic disruption in 2020, while the decline for the quarter to quarter period also reflects lower loan expenses and impairment charges. In addition, the decrease in the nine month period is reflective of an operations loss recognized in second quarter 2019 which was partially recovered in second quarter 2020, resulting in a net total loss of $974 thousand for the year over year period.

Income Tax Expense

Income tax expense was $16.1 million and $35.8 million for the three and nine months ended September 30, 2020, respectively, and $14.9 million and $39.4 million for the same periods in 2019. The effective tax rates were 21.1% and 20.0% for the three and nine months ended September 30, 2020, respectively, compared to 21.1% and 21.7% for the same periods in 2019. The lower effective tax rate for the nine months ended September 30, 2020 is primarily a result of the 2019 provision to return adjustment related to state income tax and an adjustment to the Company's estimated 2020 state income tax rates recorded in second quarter 2020, as well as an $856 thousand tax benefit recorded in first quarter 2020 due to the net operating loss carryback provision allowed through the enactment of the CARES Act. In addition, the change for the nine month comparable periods is reflective of a higher effective tax rate in 2019 due to $1.4 million in deductibility limitations related to the change in control payments made to Guaranty employees and nondeductible acquisition expenses in addition to increased state income tax expense for the period.

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Discussion and Analysis of Financial Condition

The following is a discussion and analysis of the Company’s financial condition as of September 30, 2020 and December 31, 2019.

Assets

The Company’s total assets increased by $2.2 billion, or 14.4%, to $17.1 billion as of September 30, 2020 from $15.0 billion at December 31, 2019. The increase is due primarily to organic growth in addition to loan and deposit growth related to the PPP program.

Loan Portfolio

The Company’s loan portfolio is the largest category of the Company’s earning assets. The following table presents the balance and associated percentage of each major category in the Company's loan portfolio as of September 30, 2020 and December 31, 2019:


(dollars in thousands)	September 30, 2020				December 31, 2019
Commercial (1)(2)	$	3,677,220	28.4	%	$	2,482,356	21.3	%
Real estate:
Commercial	6,056,583		46.7		5,872,653		50.4
Commercial construction, land and land development	1,261,913		9.7		1,236,623		10.6
Residential (3)	1,496,595		11.5		1,550,872		13.3
Single-family interim construction	320,387		2.5		378,120		3.2
Agricultural	86,049		0.7		97,767		0.9
Consumer	59,146		0.5		32,603		0.3
Other	381		—		621		—
Total loans	12,958,274		100.0	%	11,651,615		100.0	%
Deferred loan fees (2)	(12,696)				(1,695)
Allowance for loan losses	(87,491)				(51,461)
Total loans, net	$	12,858,087			$	11,598,459

____________

(1) Includes mortgage warehouse purchase loans of $1.2 billion and $687.3 million at September 30, 2020 and December 31, 2019, respectively.

(2) Includes SBA PPP loans of $826.0 million with net deferred loan fees of $14.0 million at September 30, 2020.

(3) Includes loans held for sale of $87.4 million and $35.6 million at September 30, 2020 and December 31, 2019, respectively.

As of September 30, 2020 and December 31, 2019, total loans, net of allowance for loan losses and deferred fees, totaled $12.9 billion and $11.6 billion, respectively, which is an increase of 10.9% between the two dates. The increase is primarily due to $826.0 million of net PPP loans funded during 2020 as well as increases in the mortgage loans held for sale and mortgage warehouse purchase loans volumes during 2020 due to the low mortgage rate environment.

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 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.

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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. 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.

Placing a loan on nonaccrual status has a two-fold impact on net interest earnings. First, it may cause a charge against earnings for the interest which had been accrued in the current year but not yet collected on the loan. Second, it eliminates future interest income with respect to that particular loan from the Company’s revenues. Interest on such loans are not recognized until the entire principal is collected or until the loan is returned to performing status.

Real estate the Company has acquired as a result of foreclosure or by deed-in-lieu-of foreclosure is classified as other real estate owned until sold. The Company's policy is to initially record other real estate owned 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 or internal valuations of the other real estate.

The Company obtains appraisals of real property that secure loans and may update such appraisals of real property securing loans categorized as nonperforming loans and potential problem loans, in each case as required by regulatory guidelines. In instances where updated appraisals reflect reduced collateral values, an evaluation of the borrower’s overall financial condition is made to determine the need, if any, for possible write-downs or appropriate additions to the allowance for loan losses.

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.

As a result of the current economic environment caused by the COVID-19 outbreak, the Company has worked with its borrowers on an individual, one-on-one basis to assess and understand the impact of pandemic-related economic hardship on the borrowers and provide prudent modifications allowing for short-term payment deferrals or other payment relief where appropriate. The deferred payments along with interest accrued during the deferral period are due and payable on the maturity date. Under applicable accounting and regulatory guidance, such modifications are not considered troubled debt restructurings. It is possible that the Company’s asset quality measures could worsen at future measurement periods if the effects of COVID-19 are prolonged.

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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 (excluding loans acquired with deteriorated credit quality) 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)	September 30, 2020			December 31, 2019
Nonaccrual loans
Commercial	$	16,279		$	3,130
Real estate:
Commercial real estate, construction, land and land development	4,257			6,461
Residential real estate	2,161			1,820

Agricultural	680			114
Consumer	43			22

Total nonaccrual loans (1)	23,420			11,547
Loans delinquent 90 days or more and still accruing
Commercial	296			14,529
Real estate:
Commercial real estate, construction, land and land development	15,719			—





Total loans delinquent 90 days or more and still accruing	16,015			14,529
Troubled debt restructurings, not included in nonaccrual loans

Real estate:
Commercial real estate, construction, land and land development	1,825			352
Residential real estate	181			188




Total troubled debt restructurings, not included in nonaccrual loans	2,006			540
Total nonperforming loans	41,441			26,616
Other real estate owned and other repossessed assets:

Real estate:
Commercial real estate, construction, land and land development	1,167			4,819

Single family interim construction	475			—

Consumer	114			114
Total other real estate owned and other repossessed assets	1,756			4,933
Total nonperforming assets	$	43,197		$	31,549
Ratio of nonperforming loans to total loans held for investment (2)	0.36		%	0.24		%
Ratio of nonperforming assets to total assets	0.25			0.21

____________

(1) Nonaccrual loans include troubled debt restructurings of $601 thousand and $668 thousand at September 30, 2020 and December 31, 2019, respectively and excludes loans acquired with deteriorated credit quality of $7.0 million and $10.9 million as of September 30, 2020 and December 31, 2019, respectively.

(2) Excluding mortgage warehouse purchase loans of $1.2 billion and $687.3 million as of September 30, 2020 and December 31, 2019, respectively.

Nonaccrual loans increased to $23.4 million at September 30, 2020 from $11.5 million as of December 31, 2019. Troubled debt restructurings that were not on nonaccrual status totaled $2.0 million at September 30, 2020, increasing from $540 thousand at December 31, 2019. The increase in nonaccrual loans was primarily due to a $13.8 million commercial energy loan, reflected in loans 90 days past due and still accruing as of December 31, 2019, as well as a $1.7 million commercial loan placed on nonaccrual, offset by a $1.1 million energy credit paydown and partial charge-off, a $1.1 million commercial loan charge-off and a $1.9 million single family construction loan placed in foreclosure during the nine months ended September 30, 2020. The increase in troubled debt restructurings was primarily due to a $1.5 million commercial real estate loan modified during first quarter 2020. Total loans delinquent 90 days or more and still accruing is elevated as of September 30, 2020 due to a $15.7 million commercial real estate loan which has matured and is pending workout at the end of third quarter.

The net decrease in other real estate owned and repossessed assets is primarily due to the sale of three properties totaling $3.0 million.

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As of September 30, 2020, the Company had a total of 96 substandard and doubtful loans with an aggregate principal balance of $116.7 million that were not currently impaired loans or purchase credit 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 as 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. As permitted under the CARES Act, the Company elected to defer the adoption of the current expected credit loss (CECL) accounting standard and has continued its consistent application of the incurred loss method for estimating the allowance for loan losses and applicable provision. 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 September 30, 2020, the allowance for loan losses amounted to $87.5 million, or 0.75% of total loans held for investment, excluding mortgage warehouse purchase loans, compared with $51.5 million, or 0.47% as of December 31, 2019. The dollar and percentage increases from year end is primarily due to added reserves for economic concerns related to the pandemic, as well as $2.4 million in charge-offs and specific reserve increases of $6.9 million and $1.4 million placed on an energy and commercial credit, respectively.

The allowance for loan losses to nonperforming loans has increased from 193.35% at December 31, 2019 to 211.12% at September 30, 2020. Nonperforming loans have increased from $26.6 million at December 31, 2019 to $41.4 million at September 30, 2020.

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.

The Company recognized a net gain of $0 and $382 thousand on the sale of securities for the three and nine months ended September 30, 2020, respectively, and a net gain of $0 and $265 thousand on the sale of securities for the three and nine month ended September 30, 2019, respectively. Securities represented 6.3% and 7.3% of the Company’s total assets at September 30, 2020 and December 31, 2019, respectively.

Certain investment securities are valued at less than their historical cost. Management evaluates securities for other-than-temporary impairment (OTTI) on at least a quarterly basis and more frequently when economic or 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 September 30, 2020 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 September 30, 2020, is temporary and no other-than-temporary impairment has been realized in the Company’s consolidated financial statements.

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Capital Resources and Regulatory Capital Requirements

Total stockholder’s equity was $2.5 billion at September 30, 2020 compared to $2.3 billion at December 31, 2019, an increase of approximately $136.6 million. The increase was primarily due to net income of $142.9 million earned by the Company during the nine months ended September 30, 2020, stock based compensation of $6.3 million and an increase of $19.8 million in unrealized gain on available for sale securities offset by dividends paid of $32.3 million.

As of September 30, 2020, the Company and the Bank exceeded the Basel III capital ratio requirements under prompt corrective action and other regulatory requirements, as detailed in the table below:


	As of September 30, 2020
	Actual Consolidated		Actual Bank		Required minimum capital - Basel III		Required to be considered well capitalized (Bank only)
	Ratio		Ratio		Ratio		Ratio
Tier 1 capital to average assets ratio	9.15	%	10.97	%	4.00	%	≥5.00%
Common equity tier 1 capital to risk weighted assets ratio	10.24		12.77		7.00		≥6.50
Tier 1 capital to risk weighted assets ratio	10.66		12.77		8.50		≥8.00
Total capital to risk weighted assets ratio	13.29		13.42		10.50		≥10.00

Stock Repurchase Program. The Company established share repurchase programs in prior years which would allow the Company to purchase its common stock in the open market or in privately negotiated transactions. In general, stock repurchase programs allow the Company to proactively manage its capital position and return excess capital to shareholders. In October 2018, the Company announced the reestablishment of its stock repurchase program. The program authorized the Company to repurchase up to $75.0 million of its common stock through October 1, 2019. In October 2019, the stock repurchase program was renewed and extended through December 31, 2020. As of December 31, 2019, the Company repurchased a total of 897,738 shares of Company stock at a total cost of $49.0 million under this program. No repurchases were made during the nine month period ended September 30, 2020. On October 22, 2020, the Company's Board of Directors approved the renewal of its stock repurchase program prior to its expiration date, with an increased maximum limit of $150.0 million of common stock available to repurchase through October 31, 2021.

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.

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In addition to the liquidity provided by the sources described above, the Company maintains correspondent relationships with other banks in order to sell loans or purchase overnight funds should additional liquidity be needed. As of September 30, 2020, the Company had established federal funds lines of credit with nine unaffiliated banks totaling $365.0 million with no borrowings against the lines at that time. The Company also participates in an exchange that provides direct overnight borrowings with other financial institutions with a borrowing capacity of $664.0 million with none outstanding as of September 30, 2020. The Company has an unsecured line of credit totaling $100.0 million with an unrelated commercial bank. There were no borrowings against the line as of September 30, 2020. Based on the values of stock, securities, and loans pledged as collateral, as of September 30, 2020, the Company had additional borrowing capacity with the FHLB of $4.1 billion. In addition, the Company maintains a secured line of credit with the Federal Reserve Bank with availability to borrow $746.8 million at September 30, 2020.

In April 2020, the Company began originating loans to qualified small businesses under the CARES Act PPP administered by the SBA. As of September 30, 2020, the Company has 6,383 loans outstanding totaling $826.0 million. During April 2020, the Company borrowed a $300.0 million advance from the FHLB that provided supplemental funding for the PPP loan originations. The short-term, full-recourse advance bore interest at an annualized rate of 0.35% and expired on July 15, 2020. During second quarter 2020, the Company participated in the Federal Reserve's PPP Facility, which, through September 30, 2020, extended loans to banks who were loaning money to small businesses under the PPP. The amounts borrowed under the facility during second quarter 2020 totaled $7.6 million, bore interest at a rate of 0.35% and matured at the same time as the maturity date of the PPP loan pledged to secure the borrowing. As of September 30, 2020, the Company had repaid all borrowings under the PPP Facility. Federal bank regulatory agencies issued an interim final rule that permits banks to neutralize the regulatory capital effects of participating in the PPP and the PPP Facility. Specifically, all PPP loans have a zero percent risk weight under applicable risk-based capital rules. Additionally, a bank may exclude all PPP loans pledged as collateral to the PPP Facility from its average total consolidated assets for the purposes of calculating its leverage ratio, while PPP loans that are not pledged as collateral to the PPP Facility will be included.

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.

In September 2020, the Company completed the issuance and sale of $130.0 million in aggregate principal of unsecured 4.00% fixed-to-floating subordinated debentures. Refer to Note 5, Other Borrowings, to the Company's consolidated financial statements included elsewhere in this report.

Other than the debt issuance noted above and 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, 2019.

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.

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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 $2.3 billion and $25.0 million, respectively, as of September 30, 2020. 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 its 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 difference in the initial fair value and unpaid principal balance (the discount) recognized as interest income on a level yield basis over the life of the loan. The Company accounts for the nonperforming 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 with no valuation allowance.

For purchase credit impaired loans, 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 still 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.

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Allowance for Loan Losses. ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which requires a new credit loss methodology, the current expected credit loss (CECL) model, became effective for the Company on January 1, 2020. As provided to financial institutions under the CARES Act, the Company elected to defer the adoption of the CECL accounting standard and has continued its consistent application of the incurred loss method. Refer to Note 1, Summary of Significant Accounting Policies, in the notes to the Company's consolidated financial statements included elsewhere in this report for additional information.

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 Other Intangible Assets. 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. The Company first assesses 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, then performing a quantitative impairment test is unnecessary. If the Company concludes otherwise, then it is required to perform an 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. During the period ended March 31, 2020, the economic turmoil and market volatility resulting from the coronavirus (COVID-19) pandemic crisis resulted in a substantial decrease in the Company's stock price and market capitalization. Management believed such decrease was a triggering indicator requiring an interim goodwill impairment quantitative analysis which resulted in no impairment charge for the period ended March 31, 2020. Subsequently, the Company's stock price and market capitalization has seen continued improvement through September 30, 2020. Refer to Note 1, Summary of Significant Accounting Policies, in the notes to the Company's consolidated financial statements included elsewhere in this report for additional information.

Core deposit intangibles and other acquired customer relationship intangibles 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. Other intangible assets are being amortized on a straight-line basis over their estimated useful lives ranging from ten to thirteen years. Other intangible assets 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.

Recently Issued Accounting Pronouncements

The Company has evaluated new accounting pronouncements that have recently been issued and have determined that there are no new accounting pronouncements that should be described in this section that will materially impact the Company’s operations, financial condition or liquidity in future periods. Refer to Note 1, Summary of Significant Accounting Policies, of the Company’s consolidated financial statements for a discussion of recent accounting pronouncements that have been adopted by the Company or that will require enhanced disclosures in the Company’s financial statements in future periods.

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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 Independent Bank's asset and liability management function, which is managed by the Company's Treasurer. The 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 the Company.

The Company's management and the Board of Directors are responsible for managing interest rate risk and employing risk management policies that monitor and limit the Company's 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 and 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.

The Company also analyzes 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 the Company's future earnings and is used in conjunction with the analyses on net interest income.

The Company conducts periodic analyses of its sensitivity to interest rate risks through the use of a third-party proprietary interest-rate sensitivity model. That model has been customized to the Company's specifications. The analyses conducted by use of that model are based on current information regarding the Company's actual interest-earnings assets, interest-bearing liabilities, capital and other financial information that it supplies. The Company uses the information in the model to estimate the its sensitivity to interest rate risk.

The Company's interest rate risk model indicated that it was in an asset sensitive position in terms of interest rate sensitivity as of September 30, 2020. 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 September 30, 2020:


Hypothetical Shift in Interest Rates (in bps)			% Change in Projected Net Interest Income
200			5.44%
100			2.77
(100)			(3.57)

These are good faith estimates and assume that the composition of the Company's 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 the Company might undertake in response to changes in market interest rates. The Company believes 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, the Company anticipates that our future results will likely be different from the foregoing estimates, and such differences could be material.

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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 its Chief Executive Officer and Chief Financial Officer. Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that the Company's 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.

All internal control systems, no matter how well designed, have inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation.

Changes in internal control over financial reporting. There were no changes in the Company’s internal control over financial reporting during the period covered by this report 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, in a case styled Peggy Roif Rotstain, et al. on behalf of themselves and all others similarly situated, v. Trustmark National Bank, et al., Civil Action No. 3:09-CV-02384-N-BG. The suit alleges, among other things, that the plaintiffs were victims of fraud by SIBL and other Stanford Entities and seeks 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 presents 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. The plaintiffs seek recovery from Independent Bank and other defendants for their losses. The case was inactive due to a court-ordered discovery stay issued March 2, 2015 pending the Court’s ruling on plaintiff’s motion for class certification and designation of class representatives and counsel. On November 7, 2017, the Court issued an order denying the plaintiff’s motion. In addition, the Court lifted the previously ordered discovery stay. On January 11, 2018, the Court entered a scheduling order providing that the case be ready for trial on January 27, 2020. Due to agreed upon extensions of discovery on July 25, 2019, the Court amended the scheduling order to provide that the case be ready for trial on January 11, 2021. In light of additional agreed upon extensions of discovery deadlines, the Court entered a new scheduling order on March 9, 2020, which now provides that the case be ready for trial March 15, 2021. In light of delays in discovery associated with the COVID-19 pandemic, the parties agreed to amend the scheduling order with new ready for trial date of May 6, 2021. The Company has experienced an increase in legal fees associated with the defense of this claim and anticipates further increases in legal fees as the case proceeds to trial.

Independent Bank notified its insurance carriers of the claims made in the Second Amended Complaint. The insurance carriers have initially indicated that the claims are not covered by the policies or that a “loss” has not yet occurred. Independent Bank pursued insurance coverage as well as reimbursement of defense costs through the initiation of litigation and other means. On November 6, 2018, the Company settled claims under its Financial Institutions Select Policy pursuant to which the Company received payment of an amount which is not material to the operations of the Company. The Company did not settle any claims under its Financial Institution Bond Policy.

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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 the Company's common stock, 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, as amended, for the year ended December 31, 2019,and Part II, Item 1A of the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2020, and in the information contained in this Quarterly Report on Form 10-Q and our other reports and registrations statements.

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

Purchases of Equity Securities by the Issuer and Affiliated Purchasers

Share Repurchase Program The Company established a share repurchase program which allows the Company to purchase its common stock in the open market or in privately negotiated transactions. In general, the share repurchase program allows the Company to proactively manage its capital position and return excess capital to shareholders. Shares of Company stock repurchased to settle employee tax withholding related to vestings of stock awards are not included under this program. Refer to Note 1, Summary of Significant Accounting Policies, to the Company's consolidated financial statements included elsewhere in this report for additional information.

The following table summarizes the Corporation's repurchase activity during the three months ended September 30, 2020.


	Total Number of Shares Purchased (1)	Average Price Paid Per Share		Total Number of Shares Purchased as Part of Publicly Announced Repurchase Plan	Maximum Dollar Value of Shares that May Yet Be Purchased Under the Plan (thousands)



Total first quarter 2020	2,629	$	55.35	—	$	25,952



Total second quarter 2020	31	27.99		—	25,952
July 2020	—	—		—	25,952
August 2020	291	43.91		—	25,952
September 2020	—	—		—	25,952
Total third quarter 2020	291	43.91		—	25,952




Total 2020 year-to-date	2,951	$	53.93	—	$	25,952

____________

(1) Includes 2,951 shares purchased in connection with the vesting of restricted stock replacement awards acquired with the Guaranty merger. These transactions are not considered part of the Corporation's repurchase program.

Item 3. DEFAULTS UPON SENIOR SECURITIES

None

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Item 4. MINE SAFETY DISCLOSURES

Not applicable

Item 5. OTHER INFORMATION

None

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Item 6. EXHIBITS

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


Exhibit 10.1*						Form of Performance Restricted Stock Unit Agreement for performance based restricted stock units granted to executive officers on July 3, 2020, as more fully described in Schedule 14A filed by the Company on July 27, 2020

Exhibit 10.2*						Form of Restricted Stock Agreement for restricted stock grants with ratable vesting over a four-year period granted to executive officers on July 3, 2020, as more fully described in Schedule 14A filed by the Company of July 27, 2020

Exhibit 10.3						Underwriting Agreement, dated as of September 10, 2020, by and among Independent Bank Group, Inc., Keefe, Bruyette & Woods, Inc. and Piper Sandler & Co., which is incorporated by reference to Exhibit 1.1 to the Company’s Current Report on Form 8-K dated September 15, 2020

Exhibit 10.4						Third Supplemental Indenture, dated as of September 15, 2020, between Independent Bank Group, Inc. and Wells Fargo Bank, National Association, as trustee, which is incorporated by reference to Exhibit 4.2 to the Company’s Current Report on Form 8-K dated September 15, 2020

Exhibit 10.5						Form of 4.00% Fixed-to-Floating Rate Subordinated Notes due 2030, which is incorporated by reference to Exhibit 4.3 (included in exhibit 4.2) to the Company’s Current Report on Form 8-K dated September 15, 2020

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-the XBRL Instance Document does not appear in the Interactive Data File because its XBRL tags are embedded within the Inline XBRL 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.


**			Furnished herewith (such certification shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, except to the extent that the Company specifically incorporates it by reference)

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:	October 29, 2020	By: /s/ David R. Brooks

		David R. Brooks
		Chairman, Chief Executive Officer and President


Date:	October 29, 2020	By: /s/ Michelle S. Hickox

		Michelle S. Hickox
		Executive Vice President
		Chief Financial Officer