UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 FORM 10-Q [X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934. For the quarterly period ended June 30, 2002 [ ] 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 0-30533 TEXAS CAPITAL BANCSHARES, INC. (Exact Name of Registrant as Specified in Its Charter) <Table> <S> <C> DELAWARE 75-2671109 (State or other jurisdiction of incorporation or organization) (I.R.S. Employer Identification Number) 2100 MCKINNEY AVENUE, SUITE 900, DALLAS, TEXAS, U.S.A. 75201 (Address of principal executive officers) (Zip Code) </Table> 214/932-6600 (Registrant's telephone number, including area code) N/A (Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report) Indicate by check whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ] APPLICABLE ONLY TO ISSUERS INVOLVED IN BANKRUPTCY PROCEEDINGS DURING THE PRECEDING FIVE YEARS: Indicate by check whether the issuer has filed all reports required to be filed by Section 12, 13 or 15(d) of the Securities Exchange Act of 1934 subsequent to the distribution of securities under a plan confirmed by a court. Yes [ ] No [ ] APPLICABLE ONLY TO CORPORATE ISSUERS: Indicate the number of shares outstanding of each of the issuer's classes of common stock, as August 9, 2002, as adjusted for the one-for-one stock dividend, which was declared on July 30, 2002: <Table> <S> <C> Common Stock: Voting 18,450,486 Nonvoting 697,166 </Table> 1
Texas Capital Bancshares, Inc. Form 10-Q Quarter Ended June 30, 2002 Index <Table> <S> <C> Part I. Financial Information Item 1. Financial Statements 3 Consolidated Statements of Operations 3 Consolidated Balance Sheets 4 Consolidated Statements of Changes in Stockholders' Equity 5 Consolidated Statements of Cash Flows 6 Notes to Consolidated Financial Statements - Unaudited 7 Financial Summaries - Unaudited 11 Item 2. Management's Discussion and Analysis of Financial Condition and Results 13 of Operations Item 3. Quantitative and Qualitative Disclosures about Market Risk 22 Part II. Other Information Item 1. Legal Proceedings 24 Item 2. Changes in Securities 24 Item 3. Defaults upon Senior Securities 24 Item 4. Submission of Matters to a Vote of Security Holders 24 Item 5. Other Information 25 Item 6. Exhibits and Reports on Form 8-K 25 Signatures 27 </Table> 2
CONSOLIDATED STATEMENTS OF OPERATIONS (In thousands except share data) <Table> <Caption> Three Months Ended Six Months Ended June 30 June 30 2002 2001 2002 2001 -------- -------- -------- ---------- (Unaudited) (Unaudited) <S> <C> <C> <C> <C> INTEREST INCOME Interest and fees on loans $ 12,825 $ 15,069 $ 25,326 $ 29,694 Securities 3,616 2,520 6,505 5,540 Federal funds sold 90 84 179 446 Deposits in other banks 2 5 3 9 -------- -------- -------- ---------- Total interest income 16,533 17,678 32,013 35,689 INTEREST EXPENSE Deposits 5,126 8,481 10,033 18,224 Federal funds purchased 368 -- 743 -- Other borrowings 825 935 1,629 1,435 -------- -------- -------- ---------- Total interest expense 6,319 9,416 12,405 19,659 -------- -------- -------- ---------- NET INTEREST INCOME 10,214 8,262 19,608 16,030 PROVISION FOR LOAN LOSSES 808 1,292 1,979 2,122 -------- -------- -------- ---------- NET INTEREST INCOME AFTER PROVISION FOR LOAN LOSSES 9,406 6,970 17,629 13,908 NON-INTEREST INCOME Service charges on deposit accounts 716 429 1,345 801 Trust fee income 245 211 492 404 Gain on sale of securities -- 540 -- 981 Cash processing fees -- -- 993 -- Other 499 281 826 529 -------- -------- -------- ---------- Total non-interest income 1,460 1,461 3,656 2,715 NON-INTEREST EXPENSE Salaries and employee benefits 3,996 3,763 8,329 7,991 Net occupancy expense 1,276 1,143 2,553 2,300 Advertising and affinity payments 482 77 562 178 Legal and professional 767 509 1,451 827 Communications and data processing 678 712 1,400 1,445 Franchise taxes 33 38 47 66 Other 1,207 1,023 2,438 2,113 -------- -------- -------- ---------- Total non-interest expense 8,439 7,265 16,780 14,920 -------- -------- -------- ---------- INCOME BEFORE INCOME TAXES 2,427 1,166 4,505 1,703 Income tax expense 608 -- 1,128 -- -------- -------- -------- ---------- NET INCOME 1,819 1,166 3,377 1,703 Preferred stock dividends (276) -- (537) -- -------- -------- -------- ---------- INCOME AVAILABLE TO COMMON STOCKHOLDERS $ 1,543 $ 1,166 $ 2,840 $ 1,703 ======== ======== ======== ========== EARNINGS PER SHARE: Basic $ .08 $ .06 $ .15 $ .09 Diluted $ .08 $ .06 $ .15 $ .09 </Table> See accompanying notes to consolidated financial statements. 3
CONSOLIDATED BALANCE SHEETS (In thousands except share data) <Table> <Caption> June 30, December 31, 2002 2001 ----------- ------------ <S> <C> <C> ASSETS Cash and due from banks $ 45,039 $ 44,260 Federal funds sold 1,320 12,360 Securities available for sale 270,085 206,365 Loans, net 890,539 841,907 Loans held for sale 37,826 43,764 Premises and equipment, net 4,434 4,950 Accrued interest receivable and other assets 10,035 9,677 Goodwill, net 1,496 1,496 ----------- ----------- Total assets $ 1,260,774 $ 1,164,779 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Liabilities: Deposits: Non-interest bearing $ 159,503 $ 136,266 Interest bearing 820,794 749,811 ----------- ----------- Total deposits 980,297 886,077 Accrued interest payable 3,042 2,848 Other liabilities 4,863 5,897 Federal funds purchased 52,087 76,699 Other borrowings 102,442 86,899 ----------- ----------- Total liabilities 1,142,731 1,058,420 Stockholders' equity: Convertible preferred stock, non-voting, $.01 par value, 6%: Authorized shares - 10,000,000 Issued shares - 1,057,142 and 753,301 at June 30, 2002 and December 31, 2001, respectively 11 8 Common stock, $.01 par value: Authorized shares - 100,000,000 Issued shares - 18,461,046 and 18,400,310 at June 30, 2002 and December 31, 2001, respectively 184 184 Series A-1 Nonvoting common stock, $.01 par value: Issued shares - 697,166 and 741,392 at June 30, 2002 and December 31, 2001, respectively 7 7 Additional paid-in capital 132,195 127,378 Accumulated deficit (17,313) (20,690) Treasury stock (shares at cost: 94,834 and 87,516 at June 30, 2002 and December 31, 2001, respectively) (650) (594) Deferred compensation 573 573 Accumulated other comprehensive income (loss) 3,036 (507) ----------- ----------- Total stockholders' equity 118,043 106,359 ----------- ----------- Total liabilities and stockholders' equity $ 1,260,774 $ 1,164,779 =========== =========== </Table> See accompanying notes to consolidated financial statements. 4
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS' EQUITY (In thousands, except share data) <Table> <Caption> Series A-1 Convertible Non-voting Preferred Stock Common Stock Common Stock Additional --------------------- ----------------------- ----------------------- Paid-in Shares Amount Shares Amount Shares Amount Capital ---------- ---------- ---------- ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> <C> <C> Balance at December 31, 2000 -- $ -- 18,303,594 $ 183 812,256 $ 8 $ 113,876 Comprehensive income: Net income -- -- -- -- -- -- -- Change in unrealized gain (loss) on available-for-sale securities, net reclassification amount of $1,902 -- -- -- -- -- -- -- Total comprehensive income Sale of convertible preferred stock 753,301 8 13,175 Sale of common stock -- -- 25,852 -- -- -- 159 Preferred dividends payable -- -- -- -- -- -- (26) Transfers -- -- 70,864 1 (70,864) (1) -- Purchase of treasury stock -- -- -- -- -- -- -- Sale of treasury stock -- -- -- -- -- -- 194 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Balance at December 31, 2001 753,301 $ 8 18,400,310 $ 184 741,392 $ 7 $ 127,378 Comprehensive income: Net income -- -- -- -- -- -- -- Change in unrealized gain (loss) on available-for-sale securities, net of tax of $1,908 -- -- -- -- -- -- -- Total comprehensive income Sale of convertible preferred stock 303,841 3 -- -- -- -- 5,247 Sale of common stock -- -- 16,510 -- -- -- 104 Preferred dividends -- -- -- -- -- -- (537) Transfers -- -- 44,226 -- (44,226) -- -- Purchase of treasury stock -- -- -- -- -- -- -- Sale of treasury stock -- -- -- -- -- -- 3 ---------- ---------- ---------- ---------- ---------- ---------- ---------- Balance at June 30, 2002 1,057,142 $ 11 18,461,046 $ 184 697,166 $ 7 $ 132,195 ========== ========== ========== ========== ========== ========== ========== <Caption> Accumulated Treasury Stock Other Accumulated ------------------------ Deferred Comprehensive Deficit Shares Amount Compensation Income (Loss) Total ----------- --------- --------- ------------ -------------- --------- <S> <C> <C> <C> <C> <C> <C> Balance at December 31, 2000 $ (26,534) (220,828) $ (1,427) $ 573 $ (482) $ 86,197 Comprehensive income: Net income 5,844 -- -- -- -- 5,844 Change in unrealized gain (loss) on available-for-sale securities, net reclassification amount of $1,902 -- -- -- -- (25) (25) --------- Total comprehensive income 5,819 Sale of convertible preferred stock 13,183 Sale of common stock -- -- -- -- -- 159 Preferred dividends payable -- -- -- -- -- (26) Transfers -- -- -- -- -- -- Purchase of treasury stock -- (70,670) (452) -- -- (452) Sale of treasury stock -- 203,982 1,285 -- -- 1,479 --------- --------- --------- --------- --------- --------- Balance at December 31, 2001 $ (20,690) (87,516) $ (594) $ 573 $ (507) $ 106,359 Comprehensive income: Net income 3,377 -- -- -- -- 3,377 Change in unrealized gain (loss) on available-for-sale securities, net of tax of $1,908 -- -- -- -- 3,543 3,543 --------- Total comprehensive income 6,920 Sale of convertible preferred stock -- -- -- -- -- 5,250 Sale of common stock -- -- -- -- -- 104 Preferred dividends -- -- -- -- -- (537) Transfers -- -- -- -- -- -- Purchase of treasury stock -- (11,732) (85) -- -- (85) Sale of treasury stock -- 4,414 29 -- -- 32 --------- --------- --------- --------- --------- Balance at June 30, 2002 $ (17,313) (94,834) $ (650) $ 573 $ 3,036 $ 118,043 ========= ========= ========= ========= ========= ========= </Table> See accompanying notes to consolidated financial statements. 5
CONSOLIDATED STATEMENTS OF CASH FLOWS (In thousands) <Table> <Caption> Six Months Ended June 30 2002 2001 --------- ---------- (Unaudited) <S> <C> <C> OPERATING ACTIVITIES Net income $ 3,377 $ 1,703 Adjustments to reconcile net income to net cash provided by (used in) operating activities: Provision for loan losses 1,979 2,122 Depreciation and amortization 887 937 Gain on sale of securities -- (981) Amortization and accretion on securities 699 7 Originations of loans held for sale (421,442) (201,380) Proceeds from sales of loans held for sale 427,380 183,743 Changes in operating assets and liabilities: Accrued interest receivable and other assets (242) (1,771) Accrued interest payable and other liabilities (2,722) 274 --------- ---------- Net cash provided by (used in) operating activities 9,916 (15,346) INVESTING ACTIVITIES Purchases of available-for-sale securities (91,439) (121,871) Proceeds from sale of available-for-sale securities -- 79,233 Proceeds from maturities and sales of securities 2,900 67,780 Principal payments received on securities 29,628 23,035 Net increase in loans (50,932) (165,344) Purchase of premises and equipment, net (223) (234) --------- ---------- Net cash used in investing activities (110,066) (117,401) FINANCING ACTIVITIES Net increase in checking, money market and savings accounts 9,024 88,901 Net (decrease) increase in certificates of deposit 85,196 (61,668) Issuance of common stock 104 81 Net other borrowings 15,543 32,090 Federal funds purchased (24,612) 45,470 Sale of preferred stock 5,250 -- (Purchase) sale of treasury stock, net (53) 483 Dividends paid (563) -- --------- ---------- Net cash provided by financing activities 89,889 105,357 --------- ---------- Net decrease in cash and cash equivalents (10,261) (27,390) Cash and cash equivalents at beginning of period 56,620 60,291 --------- ---------- Cash and cash equivalents at end of period $ 46,359 $ 32,901 ========= ========== Supplemental disclosures of cash flow information: Cash paid during the period for interest $ 12,211 $ 20,811 Non-cash transactions: Transfers from loans/leases to other repossessed assets 173 -- Transfers from loans/leases to premises and equipment 148 -- </Table> See accompanying notes to consolidated financial statements. 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - UNAUDITED (1) ACCOUNTING POLICIES Basis of Presentation The accounting and reporting policies of Texas Capital Bancshares, Inc. conform to accounting principles generally accepted in the United States and to generally accepted practices within the banking industry. The Consolidated Financial Statements of the Company include the accounts of the Company and its subsidiary, Texas Capital Bank, National Association. Certain prior period balances have been reclassified to conform with the current period presentation. Amounts and disclosures have been adjusted to reflect a one-for-one stock dividend which was declared on July 30, 2002, and which will be paid by September 16, 2002, pursuant to which each stockholder will receive one additional share of common stock for each common stock owned as of July 30, 2002. The condensed consolidated statements of operations, changes in stockholders equity and cash flows for the six months ended June 30, 2002 and the condensed balance sheets as of December 31, 2001 and June 30, 2002 have been derived from our audited financial statements included in our Form S-3 filed with the Securities and Exchange Commission on August 9, 2002. The condensed consolidated interim statements of operations for the six months ended June 30, 2001 and the three month periods ended June 30, 2001 and 2002 and the condensed consolidated interim statements of changes in stockholders equity and cash flow for the six months ended June 30, 2001 have been prepared without audit. Certain information and footnote disclosures presented in accordance with accounting principles generally accepted in the United States have been condensed or omitted. In the opinion of management, the interim financial statements include all normal and recurring adjustments and the disclosures made are adequate to make interim financial information not misleading. (2) EARNINGS PER SHARE The following table presents the computation of basic and diluted earnings per share (dollars in thousands except share data): <Table> <Caption> Three Months Ended June 30 Six Months Ended June 30 2002 2001 2002 2001 ------- -------- ------- ------- <S> <C> <C> <C> <C> Numerator: Net income (loss) $ 1,819 $ 1,166 $ 3,377 $ 1,703 Preferred stock dividends (276) -- (537) -- ------- ------- ------- ------- Numerator for basic earnings (loss) per share-income (loss) available to common stock-holders 1,543 1,166 2,840 1,703 Effective of dilutive securities: Preferred stock dividends(2) -- -- -- -- ------- ------- ------- ------- Numerator for dilutive earnings (loss) per share-income (loss) available to common stockholders and assumed conversion $ 1,543 $ 1,166 $ 2,840 $ 1,703 ======= ======= ======= ======= </Table> 7
(2) EARNINGS PER SHARE (CONTINUED) <Table> <S> <C> <C> <C> <C> Denominator: Denominator for basic earnings per share-weighted average shares 19,133,205 18,918,084 19,135,782 18,909,656 Effective of dilutive securities: Employee stock options(1) 202,952 171,500 203,124 172,198 Convertible preferred stock(2) -- -- -- -- ---------- ---------- ---------- ---------- Dilutive potential common shares 202,952 171,500 203,124 172,198 ---------- ---------- ---------- ---------- Denominator for dilutive earnings per share-adjusted weighted average shares and assumed conversions 19,336,157 19,089,584 19,338,906 19,081,854 ========== ========== ========== ========== Basic earnings (loss) per share $ .08 $ .06 $ .15 $ .09 Diluted earnings (loss) per share $ .08 $ .06 $ .15 $ .09 </Table> (1) Excludes employee stock options with exercise price equal to or greater than the current market price of $7.25. (2) Effects of convertible preferred stock are anti-dilutive in 2002 and are not included. (3) REPORTABLE SEGMENTS The Company operates two principal lines of business under Texas Capital Bank (the "Bank"): the traditional bank and BankDirect, an internet only bank. BankDirect has been a net provider of funds and the traditional bank has been a net user of funds. In order to provide a consistent measure of the net interest margin for BankDirect, a multiple pool funds transfer pricing method was used to calculate credit for funds provided. This method takes into consideration the current market conditions during the reporting period. TRADITIONAL BANKING (In thousands) <Table> <Caption> Three Months Ended June 30 Six Months Ended June 30 2002 2001 2002 2001 ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> Net interest income $ 9,779 $ 8,081 $ 18,798 $ 15,944 Provision for loan losses 808 1,292 1,979 2,122 Non-interest income 1,429 1,375 3,583 2,512 Non-interest expense 7,379 6,155 15,068 12,576 ---------- ---------- ---------- ---------- Net income $ 3,021 $ 2,009 $ 5,334 $ 3,758 ========== ========== ========== ========== Average assets $1,226,759 $ 974,799 $1,210,787 $ 938,770 Total assets 1,260,258 1,106,685 1,260,258 1,106,685 Return on average assets .99% .83% 0.89% 0.81% </Table> BANKDIRECT (In thousands) <Table> <Caption> Three Months Ended June 30 Six Months Ended June 30 2002 2001 2002 2001 ------- -------- ------- ------- <S> <C> <C> <C> <C> Net interest income $ 435 $ 181 $ 810 $ 86 Non-interest income 31 86 73 203 Non-interest expense 771 834 1,289 1,795 ------- ------- ------- ------- Net loss $ (305) $ (567) $ (406) $(1,506) ======= ======= ======= ======= </Table> 8
(3) REPORTABLE SEGMENTS (CONTINUED) Reportable segments reconciliations to the Consolidated Financial Statements for the three month and six month periods ended June 30, 2002 are as follows (in thousands): <Table> <Caption> Three months ended June 30, 2002 --------------------------------------------------------------- Net Interest Provision for Non-interest Non-interest Income Loan Losses Income Expense ------------ ------------- ------------ ------------ <S> <C> <C> <C> <C> Total reportable lines of business $10,214 $ 808 $ 1,460 $ 8,150 Unallocated items: Holding company -- -- -- 289 ------- ------- ------- ------- The Company consolidated $10,214 $ 808 $ 1,460 $ 8,439 ======= ======= ======= ======= </Table> <Table> <Caption> Six months ended June 30, 2002 --------------------------------------------------------------- Net Interest Provision for Non-interest Non-interest Income Loan Losses Income Expense ------------ ------------- ------------ ------------ <S> <C> <C> <C> <C> Total reportable lines of business $19,608 $ 1,979 $ 3,656 $16,357 Unallocated items: Holding company -- -- -- 423 ------- ------- ------- ------- The Company consolidated $19,608 $ 1,979 $ 3,656 $16,780 ======= ======= ======= ======= </Table> Reportable segments reconciliations to the Consolidated Financial Statements for the three month and six month periods ended June 30, 2001 are as follows (in thousands): <Table> <Caption> Three months ended June 30, 2001 ------------------------------------------------------------- Net Interest Provision for Non-interest Non-interest Income Loan Losses Income Expense ------------ ------------- ------------ ------------ <S> <C> <C> <C> <C> Total reportable lines of business $8,262 $1,292 $1,461 $6,989 Unallocated items: Holding company -- -- -- 276 ------ ------ ------ ------ The Company consolidated $8,262 $1,292 $1,461 $7,265 ====== ====== ====== ====== </Table> <Table> <Caption> Six months ended June 30, 2001 --------------------------------------------------------------- Net Interest Provision for Non-interest Non-interest Income Loan Losses Income Expense ------------ ------------- ------------ ------------ <S> <C> <C> <C> <C> Total reportable lines of business $16,030 $ 2,122 $ 2,715 $14,371 Unallocated items: Holding company -- -- -- 549 ------- ------- ------- ------- The Company consolidated $16,030 $ 2,122 $ 2,715 $14,920 ======= ======= ======= ======= </Table> 9
(4) NEW ACCOUNTING STANDARDS In June 2001, the Financial Accounting Standards Board issued Statements of Financial Accounting Standards No. 141, Business Combinations, and No. 142, Goodwill and Other Intangible Assets. Statement 141 requires that the purchase method of accounting be used for all business combinations initiated after June 30, 2001. Statement 141 also includes guidance on the initial recognition and measurement of goodwill and other intangible assets arising from business combinations completed after June 30, 2001. Statement 142 prohibits the amortization of goodwill and intangible assets with indefinite useful lives. Statement 142 requires that these assets be reviewed for impairment at least annually. Intangible assets with finite lives will continue to be amortized over their estimated useful lives. Additionally, Statement 142 requires that goodwill included in the carrying value of equity method investments no longer be amortized. The Company has tested goodwill for impairment using the two-step process prescribed in Statement 142. The first step is a screen for potential impairment, while the second step measures the amount of the impairment, if any. The Company performed the first of the required impairment test of goodwill and indefinite lived intangible assets as of January 1, 2002 in the first quarter of 2002 and no impairment was noted. For disclosure purposes, the prior year results shown below have been adjusted to reflect the impact the change in accounting would have. <Table> <Caption> Three months ended June 30 Six months ended June 30 2002 2001 2002 2001 --------- --------- --------- --------- <S> <C> <C> <C> <C> Net income: As reported $ 1,819 $ 1,166 $ 3,377 $ 1,703 Amortization expense -- 32 -- 63 --------- --------- --------- --------- Net income without amortization expense $ 1,819 $ 1,198 $ 3,377 $ 1,766 ========= ========= ========= ========= Basic income per share: As reported $ .08 $ .06 $ .15 $ .09 Excluding amortization expense .08 .06 .15 .09 Diluted income per share: As reported $ .08 $ .06 $ .15 $ .09 Excluding amortization expense .08 .06 .15 .09 </Table> 10
QUARTERLY FINANCIAL SUMMARY - UNAUDITED Consolidated Daily Average Balances, Average Yields and Rates (In Thousands Except Share) <Table> <Caption> For the three months ended For the three months ended June 30, 2002 June 30, 2001 ------------------------------------------ ----------------------------------------- Average Revenue/ Yield/ Average Revenue/ Yield/ Balance Expense(1) Rate Balance Expense(1) Rate ---------- ---------- ---------- ---------- ---------- ---------- <S> <C> <C> <C> <C> <C> <C> ASSETS Taxable securities $ 267,753 $ 3,616 5.42% $ 161,779 $ 2,520 6.25% Federal funds sold 20,413 90 1.77% 7,816 84 4.31% Deposits in other banks 151 2 5.31% 418 5 4.80% Loans 897,388 12,825 5.73% 768,834 15,069 7.86% Less reserve for loan losses 12,910 -- -- 10,239 -- -- ---------- ---------- ---------- ---------- ---------- ---------- Loans, net of reserve 884,478 12,825 5.82% 758,595 15,069 7.97% ---------- ---------- ---------- ---------- ---------- ---------- Total earning assets 1,172,795 16,533 5.65% 928,608 17,678 7.64% Cash and other assets 53,764 46,203 ---------- ---------- Total assets $1,226,559 $ 974,811 ========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Transaction deposits $ 49,353 $ 118 .96% $ 39,851 $ 251 2.53% Savings deposits 327,184 1,582 1.94% 360,239 3,809 4.24% Time deposits 422,577 3,426 3.25% 296,618 4,421 5.98% ---------- ---------- ---------- ---------- ---------- ---------- Total interest bearing deposits 799,114 5,126 2.57% 696,708 8,481 4.88% Other borrowings 167,988 1,193 2.85% 83,576 935 4.49% ---------- ---------- ---------- ---------- ---------- ---------- Total interest bearing liabilities 967,102 6,319 2.62% 780,284 9,416 4.84% Demand deposits 138,598 98,695 Other liabilities 6,563 7,842 Stockholders' equity 114,296 87,990 ---------- ---------- Total liabilities and stockholders' equity $1,226,559 $ 974,811 ========== ========== Net interest income $ 10,214 $ 8,262 Net interest income to earning assets 3.49% 3.57% ---------- ---------- Provision for loan losses 808 1,292 Non-interest income 1,460 1,461 Non-interest expense 8,439 7,265 ---------- ---------- INCOME (LOSS) BEFORE TAXES 2,427 1,166 Federal and state income tax (608) -- ---------- ---------- NET INCOME (LOSS) $ 1,819 $ 1,166 ========== ========== EARNINGS PER SHARE: NET INCOME (LOSS) Basic $ .08 $ .06 Diluted $ .08 $ .06 Return on average equity 6.38% 5.32% Return on average assets .59% .48% Average equity to average assets 9.32% 9.03% </Table> (1) The loan averages include loans on which the accrual of interest has been discontinued and are stated net of unearned income. 11
QUARTERLY FINANCIAL SUMMARY - UNAUDITED Consolidated Daily Average Balances, Average Yields and Rates (In Thousands Except Share) <Table> <Caption> For the six months ended For the six months ended June 30, 2002 June 30, 2001 --------------------------------------- -------------------------------------- Average Revenue/ Yield/ Average Revenue/ Yield/ Balance Expense(1) Rate Balance Expense(1) Rate ----------- ------------ --------- ---------- ----------- --------- <S> <C> <C> <C> <C> <C> <C> ASSETS Taxable securities $ 241,165 $ 6,505 5.44% $ 173,843 $ 5,540 6.43% Federal funds sold 20,850 179 1.73% 17,062 446 5.27% Deposits in other banks 161 3 3.76% 450 9 4.03% Loans 891,126 25,326 5.73% 713,958 29,694 8.39% Less reserve for loan losses 12,919 -- -- 9,728 -- -- ----------- ------------ --------- ---------- ----------- --------- Loans, net of reserve 878,207 25,326 5.82% 704,230 29,694 8.50% ----------- ------------ --------- ---------- ----------- --------- Total earning assets 1,140,383 32,013 5.66% 895,585 35,689 8.04% Cash and other assets 70,312 43,200 ----------- ---------- Total assets $ 1,210,695 $ 938,785 =========== ========== LIABILITIES AND STOCKHOLDERS' EQUITY Transaction deposits $ 49,007 $ 243 1.00% $ 36,826 $ 466 2.55% Savings deposits 334,780 3,101 1.87% 368,613 8,723 4.77% Time deposits 395,618 6,689 3.41% 290,798 9,035 6.27% ----------- ------------ --------- ---------- ----------- --------- Total interest bearing deposits 779,405 10,033 2.60% 696,237 18,224 5.28% Other borrowings 176,578 2,372 2.71% 59,573 1,435 4.86% ----------- ------------ --------- ---------- ----------- --------- Total interest bearing liabilities 955,983 12,405 2.62% 755,810 19,659 5.25% Demand deposits 134,597 87,001 Other liabilities 7,012 8,102 Stockholders' equity 113,103 87,872 ----------- ---------- Total liabilities and stockholders' equity $ 1,210,695 $ 938,785 =========== ========== Net interest income $ 19,608 $ 16,030 Net interest income to earning assets 3.47% 3.61% --------- --------- Provision for loan losses 1,979 2,122 Non-interest income 3,656 2,715 Non-interest expense 16,780 14,920 ------------ ----------- INCOME (LOSS) BEFORE TAXES 4,505 1,703 Federal and state income tax (1,128) -- ------------ ----------- NET INCOME (LOSS) $ 3,377 $ 1,703 ============ =========== EARNINGS PER SHARE: NET INCOME (LOSS) Basic $ .15 $ .09 Diluted $ .15 $ .09 Return on average equity 6.02% 3.91% Return on average assets .56% .37% Average equity to average assets 9.34% 9.36% </Table> (1) The loan averages include loans on which the accrual of interest has been discontinued and are stated net of unearned income. 12
ITEM 2. MANAGEMENT'S ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS FORWARD LOOKING STATEMENTS Statements and financial analysis contained in this document that are not historical facts are forward looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward looking statements describe our future plans, strategies and expectations and are based on certain assumptions. As a result, these forward looking statements involve substantial risks and uncertainties, many of which are beyond our control. The important factors that could cause actual results to differ materially from the forward looking statements include the following: (1) Changes in interest rates (2) Changes in the levels of loan prepayments, which could affect the value of our loans (3) Changes in general economic and business conditions in areas or markets where we compete (4) Competition from banks and other financial institutions for loans and customer deposits (5) The failure of assumptions underlying the establishment of and provisions made to the allowance for credit losses (6) The loss of senior management or operating personnel and the potential inability to hire qualified personnel at reasonable compensation levels (7) Changes in government regulations We have no obligation to update or revise any forward looking statements as a result of new information or future events. In light of these assumptions, risks and uncertainties, the events discussed in any forward looking statements in this memorandum might not occur. RESULTS OF OPERATIONS SUMMARY OF PERFORMANCE Texas Capital Bancshares, Inc. (the "Company") recorded net income of $1.8 million (net of $608,000 of income tax expense) or $.08 per diluted common share for the second quarter of 2002 compared to $1.2 million or $.06 per diluted common share for the second quarter of 2001. Return on average assets was .59% for the second quarter of 2002 compared to .48% for the second quarter of 2001. Returns on average equity were 6.38% and 5.32% for the second quarter of 2002 and 2001, respectively. The increase in net income for the quarter ended June 30, 2002 over the same period of 2001 was primarily due to an increase in net interest income and a decrease in provision for loan losses, offset by an increase in non-interest expenses. Net interest income for the second quarter of 2002 increased by $1.9 million or 23.6% from $8.3 million to $10.2 million over the second quarter of 2001. The increase in net interest income was due to an increase in average earning assets of $244.2 million or 26.3%, which offset an eight basis point decrease in net interest margin. Non-interest expense increased $1.2 million or 16.2% compared to the second quarter of 2001. This increase was partially due to an increase in salaries and employee benefits of $233,000 and an increase of $133,000 in occupancy expense related to the relocation of our operations center. Advertising expense increased $405,000 from $77,000 during the quarter ended June 30, 2001 to $482,000 during the quarter ended June 30, 2002, 13
which included $218,000 of direct marketing and branding, including print ads for the traditional banking activities of our bank and $264,000 for the purchase of miles related to the American Airlines AAdvantage(R) program. In May 2000, BankDirect entered into the American Airlines AAdvantage(R) travel benefits program and began offering AAdvantage(R) awards to AAdvantage(R) members who opened and maintained accounts with BankDirect. We did not purchase any miles in 2001 because the miles that we were contractually required to purchase in 2000 were sufficient to cover our mile rewards to customers for 2001. Our legal and professional expenses increased $258,000 to $767,000 for the quarter ended June 30, 2002, mainly related to legal expenses incurred in connection with non-performing loans and leases. NET INTEREST INCOME Net interest income was $10.2 million for the second quarter of 2002 compared to $8.3 million for the second quarter of 2001. The increase was primarily due to an increase in average earning assets of $244.2 million as compared to the second quarter of 2001. The increase in average earning assets from the second quarter of 2001 included a $125.9 million increase in average loans which represented 75.4% of average earning assets for the quarter ended June 30, 2002 compared to 81.7% for the same period of 2001. The decrease reflected management's decision to tighten lending standards during the second half of 2001 pending clearer signs of improvement in the U.S. economy. Average interest bearing liabilities increased $186.8 million from the second quarter of 2001 which included a $102.4 million increase in interest bearing deposits and a $84.4 million increase in borrowings. Average borrowings were 13.7% of average total assets for the second quarter of 2002 compared to 8.6% in the same period in 2001. The increase in average borrowings was primarily related to an increase in federal funds purchased and securities sold under repurchase agreements and was used to supplement deposits in funding loan growth and securities purchases. The average cost of interest bearing liabilities decreased from 4.84% for the quarter ended June 30, 2001 to 2.62% for the same period of 2002, reflecting the continuing decline in market interest rates. Net interest income was $19.6 million for the six months ended June 30, 2002 compared to $16.0 million for the same period of 2001. The increase was primarily due to an increase in average earning assets of $244.8 million for the first six months of 2002 as compared to the same period of 2001. The increase in average earning assets from the first six months of 2001 included a $174.0 million increase in average net loans, which represented 77.0% of average earning assets for the six months ended June 30, 2002 compared to 78.6% for the same period of 2001. The decrease reflected management's decision to tighten lending standards during the second half of 2001 pending clearer signs of improvement in the U.S. economy. Average interest bearing liabilities increased $200.2 million in the first six months of 2002 compared to the same period of 2001, due, in part, to an $83.2 million increase in interest bearing deposits and a $117.0 million increase in borrowings. Average borrowings were 14.6% of average total assets for the first six months of 2002 compared to 6.4% in the same period in 2001. The increase in average borrowings was primarily related to an increase in federal funds purchased and securities sold under repurchase agreements, and was used to supplement deposits in funding loan growth and securities purchases. The average cost of interest bearing liabilities decreased from 5.25% for the six months ended June 30, 2001 to 2.62% for the same period of 2002, reflecting the continuing decline in market interest rates. 14
TABLE 1 - VOLUME/RATE ANALYSIS (In thousands) <Table> <Caption> Three months ended Six months ended June 30, 2002/2001 June 30, 2002/2001 --------------------------------------- --------------------------------------- Change Due To Change Due To ------------------------ ------------------------ Change Volume Yield/Rate Change Volume Yield/Rate -------- -------- ---------- -------- -------- ---------- <S> <C> <C> <C> <C> <C> <C> Interest income: Securities $ 1,096 $ 1,651 $ (555) $ 965 $ 2,145 $ (1,180) Loans (2,244) 2,520 (4,764) (4,368) 7,369 (11,737) Federal funds sold 6 135 (129) (267) 99 (366) Deposits in other banks (3) (3) -- (6) (6) -- -------- -------- -------- -------- -------- -------- Total (1,145) 4,303 (5,448) (3,676) 9,607 (13,283) Interest expense: Transaction deposits (133) 60 (193) (223) 154 (377) Savings deposits (2,227) (350) (1,877) (5,622) (801) (4,821) Time deposits (995) 1,877 (2,872) (2,346) 3,257 (5,603) Borrowed funds 258 944 (686) 937 2,818 (1,881) -------- -------- -------- -------- -------- -------- Total (3,097) 2,531 (5,628) (7,254) 5,428 (12,682) -------- -------- -------- -------- -------- -------- Net interest income $ 1,952 $ 1,772 $ 180 $ 3,578 $ 4,179 $ (601) ======== ======== ======== ======== ======== ======== </Table> Net interest margin, the ratio of net interest income to average earning assets, was 3.49% for the second quarter of 2002 compared to 3.57% for the second quarter of 2001. The decrease in net interest margin during the second quarter of 2002 was due to an overall decline in market interest rates. Net interest margin, the ratio of net interest income to average earning assets, was 3.47% for the six months ended June 30, 2002 compared to 3.61% for the same period of 2001. The decrease in the net interest margin during the six months ended June 30, 2002 was due to the overall decline in market interest rates. NON-INTEREST INCOME Non-interest income decreased $1,000 compared to the same quarter of 2001. Service charges on deposit accounts increased $287,000. This increase was due to the increase in deposits, which resulted in a higher volume of transactions. Trust fee income increased $34,000, due to continued growth of trust assets during 2002. Other non-interest income increased by $218,000 due to an increase in mortgage warehouse fees and gain on sale of leases. There were no gains on sales of securities for the second quarter of 2002 compared to $540,000 in the same quarter of 2001. Non-interest income increased $941,000, or 35%, in the first six months of 2002 as compared to the first six months of 2001. Service charges on deposit accounts increased $544,000 for the six month period ended June 30, 2002 as compared to the same period in 2001. This increase was due to the significant increase in deposits, which resulted in a higher volume of transactions. Trust fee income increased $88,000 due to continued growth of trust assets during 2002. Cash processing fees totaled $993,000 for the six month period ended June 30, 2002. These fees were related to a special project that occurred during the first quarter of 2002 and will not be recurring in future quarters in 2002. Other non-interest income increased by $297,000 due to mortgage warehousing fees and gains on sales of leases. 15
TABLE 2 - NON-INTEREST INCOME (In thousands) <Table> <Caption> Three Months Ended June 30 Six Months Ended June 30 2002 2001 2002 2001 ------ ------ ------ ------ <S> <C> <C> <C> <C> Service charges on deposit accounts $ 716 $ 429 $1,345 $ 801 Trust fee income 245 211 492 404 Gain on sale of securities -- 540 -- 981 Cash processing fees -- -- 993 -- Other 499 281 826 529 ------ ------ ------ ------ Total non-interest income $1,460 $1,461 $3,656 $2,715 ====== ====== ====== ====== </Table> NON-INTEREST EXPENSE Non-interest expense for the second quarter of 2002 increased $1.2 million or 16.2% compared to the second quarter of 2001. Salaries and employee benefits increased by $233,000 or 6.2% which accounts for 19.8% of the increase in non-interest expense. Advertising expense increased $405,000 or 526.0% from $77,000 during the quarter ended June 30, 2001 to $482,000 during the quarter ended June 30, 2002, which included $218,000 of direct marketing and branding, including print ads for the traditional banking activities of our bank and $264,000 for the purchase of miles related to the American Airlines AAdvantage(R) program. Legal and professional increased $258,000, or 50.7%, mainly related to legal expenses incurred in connection with non-performing loans and leases. Communications and data processing expense for the quarter ended June 30, 2002 decreased $34,000 or 4.8% due to some increased efficiencies in our communication costs. Non-interest expense for the six months ended June 30, 2002 increased $1.9 million, or 12.5%, compared to the same period of 2001. Salaries and employee benefits increased by $338,000 or 4.2% which accounts for 18.2% of the increase in non-interest expense. Net occupancy expense for the six months ended June 30, 2002 increased by $253,000, or 11.0%, mainly related to the relocation of our operations center in the last quarter of 2001. Advertising expense for the six months ended June 30, 2002 increased $384,000, or 215.7%, compared to the same period of 2001. Advertising expense for the six months ended June 30, 2002 included $289,000 of direct marketing and branding, including print ads for the traditional bank, and $273,000 for the purchase of miles related to the American Airlines AAdvantage(R) program. We did not purchase any miles in 2001 because the miles that we were contractually required to purchase in 2000 were sufficient to cover our mileage rewards to customers for 2001. In 2002, we are purchasing miles as we utilize them. Legal and professional expenses increased $624,000 or 75.5%, mainly related to legal expenses incurred with our non-performing loans and leases. Communications and data processing expense for the six months ended June 30, 2002 decreased $45,000, or 3.1%, due to some increased efficiencies in our communications costs. 16
TABLE 3 -NON-INTEREST EXPENSE (In thousands) <Table> <Caption> Three Months Ended June 30 Six Months Ended June 30 2002 2001 2002 2001 ------- ------- ------- ------- <S> <C> <C> <C> <C> Salaries and employee benefits $ 3,996 $ 3,763 $ 8,329 $ 7,991 Net occupancy expense 1,276 1,143 2,553 2,300 Advertising and affinity payments 482 77 562 178 Legal and professional 767 509 1,451 827 Communications and data processing 678 712 1,400 1,445 Franchise taxes 33 38 47 66 Other expense 1,207 1,023 2,438 2,113 ------- ------- ------- ------- Total non-interest expense $ 8,439 $ 7,265 $16,780 $14,920 ======= ======= ======= ======= </Table> INCOME TAXES The Company utilized net operating loss carryforwards for the first six months of 2002, but has expensed $608,000 of current tax expense during the second quarter based on the expected effective rate for 2002. ANALYSIS OF FINANCIAL CONDITION The aggregate loan portfolio at June 30, 2002 increased $40.8 million from December 31, 2001 to $944.7 million. Commercial loans increased $49.8 million and real estate loans increased $20.7 million. Construction loans decreased $9.8 million and leases decreased $10.4 million. TABLE 4 - LOANS (In thousands) <Table> <Caption> June 30, December 31, 2002 2001 -------- ----------- <S> <C> <C> Commercial $452,133 $402,302 Construction 170,271 180,115 Real estate 238,901 218,192 Consumer 21,436 25,054 Leases receivable 24,164 34,552 Loans held for sale 37,826 43,764 -------- -------- Total $944,731 $903,979 ======== ======== </Table> 17
SUMMARY OF LOAN LOSS EXPERIENCE The reserve for loans losses, which is available to absorb losses inherent in the loan portfolio, totaled $12.1 million at June 30, 2002, $12.6 million at December 31, 2001 and $10.7 million at June 30, 2001. This represents 1.28%, 1.39% and 1.31% of total loans at June 30, 2002, December 31, 2001 and June 30, 2001, respectively. The provision for loan losses is a charge to earnings to maintain the reserve for loan losses at a level consistent with management's assessment of the loan portfolio in light of current economic conditions and market trends. We recorded a provision of $808,000 for the quarter ended June 2002 and $1.3 million for the same quarter in 2001. These provisions were made to reflect management's assessment of the risk of loan losses specifically including risk associated with the continued rapid growth in the loan portfolio and the unseasoned nature of the current portfolio. The reserve for loan losses is comprised of specific reserves assigned to certain classified loans and general reserves. We continuously evaluate our reserve for loan losses to maintain an adequate level to absorb loan losses inherent in the loan portfolio. Factors contributing to the determination of specific reserves include the credit worthiness of the borrower, changes in the expected future receipt of principal and interest payments and/or changes in the value of pledged collateral. All loans rated doubtful and all commitments rated substandard that are at least $1,000,000 are specifically reviewed for impairment as appropriate. A reserve is recorded when the carrying amount of the loan exceeds the discounted cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. For purposes of determining the general reserve, the portfolio is segregated by product types to recognize differing risk profiles among categories, and then further segregated by credit grades. Credit grades are assigned to all loans greater than $50,000. Each credit grade is assigned a risk factor, or reserve allocation percentage. These risk factors are multiplied by the outstanding principal balance and risk-weighted by product type to calculate the required reserve. A similar process is employed to calculate that portion of the required reserve assigned to unfunded loan commitments. The reserve allocation percentages assigned to each credit grade have been developed based on an analysis of historical loss rates at selected peer banks, adjusted for certain qualitative factors and on our management's experience. Qualitative adjustments for such things as general economic conditions, changes in credit policies and lending standards, and changes in the trend and severity of problem loans, can cause the estimation of future losses to differ from past experience. The unallocated portion of the general reserve serves to compensate for additional areas of uncertainty and considers industry comparable reserve ratios. In addition, the reserve considers the results of reviews performed by independent third party reviewers as reflected in their confirmations of assigned credit grades within the portfolio. The methodology used in the periodic review of reserve adequacy, which is performed at least quarterly, is designed to be dynamic and responsive to changes in actual credit losses. The changes are reflected in the general reserve and in specific reserves as the collectibility of larger classified loans is continuously recalculated with new information. As our portfolio matures, historical loss ratios are being closely monitored. Eventually our reserve adequacy analysis will rely more on our loss history and less on the experience of peer banks. Currently, the review of reserve adequacy is performed by executive management and presented to the Board of Directors for their review, consideration and ratification on a quarterly basis. 18
TABLE 5 - SUMMARY OF LOAN LOSS EXPERIENCE (In thousands) <Table> <Caption> Six months Six months Year ended ended June 30, ended June 30, December 31, 2002 2001 2001 -------------- -------------- ------------ <S> <C> <C> <C> Beginning balance $12,598 $ 8,910 $ 8,910 Loans charged-off: Commercial 2,000 -- 1,418 Consumer 6 -- -- Leases 485 353 656 ------- ------- ------- Total 2,491 353 2,074 Recoveries: Consumer 10 -- -- ------- ------- ------- Net chargeoffs 2,481 353 2,074 Provision for loan losses 1,979 2,122 5,762 ------- ------- ------- Ending balance $12,096 $10,679 $12,598 ======= ======= ======= Reserve for loan losses to loans outstanding at end of period 1.28% 1.31% 1.39% Net charge-offs to average loans .56% .10% .26% Provision for loan losses to average loans .45% .60% .73% Recoveries to gross charge-offs .40% -- -- Reserve as a multiple of net chargeoffs 4.9x 30.3x 6.1x Non-performing and renegotiated loans: Loans past due (90 days) $ -- $ 1,661 $ 384 Nonaccrual 6,762 8,424 6,032 Renegotiated -- -- 5,013 ------- ------- ------- Total $ 6,762 $10,085 $11,429 ======= ======= ======= Reserve as a percent of non-performing and renegotiated loans 178.88% 105.89% 110.23% </Table> NON-PERFORMING ASSETS Non-performing assets include non-accrual loans and leases, accruing loans 90 or more days past due, restructured loans, and other repossessed assets. We had non-accrual loans and leases of $6,762,000, $8,424,000 and $6,032,000 at June 30, 2002, June 30, 2001, and December 31, 2001, respectively. At June 30, 2002, one loan relationship represented $3,064,000 of total non-accruals. We have specific reserves of $545,000 related to this relationship. At June 30, 2002, our non-performing loans and leases consisted of $3,209,000 in commercial loans, $1,665,000 in real estate loans, and $1,888,000 in leases. At December 31, 2001, our non-performing loans and leases consisted of $5,767,000 in commercial loans and $265,000 in leases. At June 30, 2002, we had $173,000 in other repossessed assets, which consist of collateral that has been repossessed. 19
LIQUIDITY AND CAPITAL RESOURCES In general terms, liquidity is a measurement of our ability to meet our cash needs. Our objective in managing our liquidity is to maintain our ability to meet loan commitments, purchase securities or repay deposits and other liabilities in accordance with their terms, without an adverse impact on our current or future earnings. Our liquidity strategy is guided by policies, which are formulated and monitored by our senior management and our bank's balance sheet committee, and which take into account the marketability of assets, the sources and stability of funding and the level of unfunded commitments. We regularly evaluate all of our various funding sources with an emphasis on accessibility, stability, reliability and cost-effectiveness. For the year ended December 31, 2001 and for the six months ended June 30, 2002, our principal source of funding has been our customer deposits, supplemented by our short-term and long-term borrowings, primarily from securities sold under repurchase agreements and federal funds purchased from our downstream correspondent bank relationships (which consist of banks that are considered to be smaller than our bank). Since early 2001, our liquidity needs have primarily been fulfilled through growth in our traditional bank customer and stockholder deposits. Our goal is to obtain as much of our funding as possible from deposits of these customers and stockholders, which as of June 30, 2002, comprised $665.4 million, or 68%, of total deposits, compared to $459.6 million, or 56%, of total deposits, at June 30, 2001. These traditional deposits are generated principally through development of long-term relationships with customers and stockholders. In addition to deposits from our traditional bank customers and stockholders, we also have access to incremental consumer deposits through BankDirect, our internet banking facility, and through brokered retail certificates of deposit, or CDs. As of June 30, 2002, BankDirect deposits comprised $219.9 million, or 22%, of total deposits, and brokered retail CDs comprised $95.0 million, or 10%, of total deposits. Our dependence on internet deposits and retail brokered CDs is limited by our internal funding guidelines, which as of June 30, 2002, limited borrowing from these sources to 15-25% and 10-20%, respectively, of total deposits. Additionally, we have borrowing sources available to supplement deposits and meet our funding needs. These borrowing sources include federal funds purchased from our downstream correspondent bank relationships and from our upstream correspondent bank relationships (which consist of banks that are considered to be larger than our bank), securities sold under repurchase agreements, treasury, tax and loan notes, and advances from the Federal Home Loan Bank, or FHLB. As of June 30, 2002, our borrowings consisted of a total of $87.7 million of securities sold under repurchase agreements, $52.1 million of downstream federal funds purchased, $2.4 million from customer repurchase agreements and $12.0 million of treasury, tax and loan notes. Credit availability from the FHLB is based on our bank's financial and operating condition and borrowing collateral we hold with the FHLB. At June 30, 2002, borrowings from the FHLB consisted of approximately $356,000 of term advances bearing interest at 5.28%. Our unused FHLB borrowing capacity at June 30, 2002 was approximately $284.0 million. As of June 30, 2002, none of our borrowings consisted of upstream federal funds purchased, although we had unused upstream federal fund lines available from commercial banks of approximately $45.0 million. During the six months ended June 30, 2002, our average borrowings from these sources were 15% of average assets, which is well within our internal funding guidelines, which limit our dependence on borrowing sources to 15-25% of total assets. In accordance with our current internal guidelines, excess funding capacity is monitored and maintained at a level in excess of 25% of total assets at all times. Average borrowed funds were $176.6 million during the six month period ended June 30, 2002. The maximum amount of borrowed funds outstanding at any month-end during the first six months of 2002 was $218.8 million, or 17.9%, of total assets. 20
As of June 30, 2002, our contractual obligations and commercial commitments, other than deposit liabilities, were as follows: <Table> <Caption> After One After Three Within but Within but Within After One Year Three Years Five Years Five Years Total -------- ----------- ----------- ---------- -------- (In Thousands) <S> <C> <C> <C> <C> <C> Federal funds purchased $ 52,087 $ -- $ -- $ -- $ 52,087 Securities sold under repurchase agreements -- 83,215 4,500 -- 87,715 Customer repurchase agreements 2,400 -- -- -- 2,400 Treasury, tax and loan notes 11,971 -- -- -- 11,971 FHLB borrowings 356 -- -- -- 356 Operating lease obligations 2,489 4,432 4,211 6,463 17,595 -------- -------- -------- -------- -------- Total contractual obligations $ 69,303 $ 87,647 $ 8,711 $ 6,463 $172,124 ======== ======== ======== ======== ======== </Table> The contractual amount of our financial instruments with off-balance sheet risk expiring by period at June 30, 2002 is presented below: <Table> <Caption> After One After Three Within but Within but Within After One Year Three Years Five Years Five Years Total -------- ----------- ----------- ---------- -------- (In Thousands) <S> <C> <C> <C> <C> <C> Commitments to extend credit $209,120 $ 76,519 $ 6,017 $ 6,870 $298,526 Standby letters of credit 25,288 1,006 -- -- 26,294 -------- -------- -------- -------- -------- Total financial instruments with off-balance sheet risk $234,408 $ 77,525 $ 6,017 $ 6,870 $324,820 ======== ======== ======== ======== ======== </Table> Due to the nature of our unfunded loan commitments, including unfunded lines of credit, the amounts presented in the table above do not necessarily represent amounts that we anticipate funding in the periods presented above. Our equity capital averaged $113.1 million for the six months ended June 30, 2002 as compared to $87.9 million for the same period in 2001. This increase reflects our retention of net earnings during this period. We have not paid any cash dividends on our common stock since we commenced operations and have no plans to do so in the future. TABLE 7 - CAPITAL RATIOS <Table> <Caption> June 30, June 30, 2002 2001 -------- -------- <S> <C> <C> Risk-based capital: Tier 1 capital 10.83% 9.16% Total capital 11.99% 10.28% Leverage 9.27% 8.98% </Table> CRITICAL ACCOUNTING POLICIES The Securities and Exchange Commission ("SEC") recently issued guidance for the disclosure of "critical accounting policies." The SEC defines "critical accounting policies" as those that are most important to the presentation of a company's financial condition and results, and require management's most difficult, subjective or complex judgments, often as a result of the need to make estimates about the effect of matters that are inherently uncertain. We follow financial accounting and reporting policies that are in accordance with generally accepted accounting principles. Not all these significant accounting policies require management to make difficult, subjective or complex judgments. However, the policies noted below could be deemed to meet the SEC's definition of critical accounting policies. Management considers the policies related to the allowance for loan losses as the most critical to the financial statement presentation. The total allowance for loan losses includes activity related to allowances calculated in accordance with Statement of Financial Accounting Standards ("SFAS") No. 114, "Accounting by Creditors for Impairment of a Loan" and SFAS No. 5, "Accounting for Contingencies." The allowance for loan losses is established through a provision for loan losses charged to current earnings. The amount maintained in the allowance reflects management's continuing evaluation of the loan losses inherent in the loan portfolio. The allowance for loan losses is comprised of specific reserves assigned to certain classified loans and general reserves. Factors contributing to the determination of specific reserves include the credit-worthiness of the borrower, and more specifically, changes in the expected future receipt of principal and interest payments and/or in the value of pledged collateral. A reserve is recorded when the carrying amount of the loan exceeds the discounted estimated cash flows using the loan's initial effective interest rate or the fair value of the collateral for certain collateral dependent loans. For purposes of determining the general reserve, the portfolio is segregated by product types in order to recognize differing risk profiles among categories, and then further segregated by credit grades. See "Summary of Loan Loss Experience" for further discussion of the risk factors considered by management in establishing the allowance for loans losses. 21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Market risk is a broad term for the risk of economic loss due to adverse changes in the fair value of a financial instrument. These changes may be the result of various factors, including interest rates, foreign exchange rates, commodity prices, or equity prices. We are subject to market risk primarily through the effect of changes in interest rates on our portfolio of assets held for purposes other than trading. The effect of other changes, such as foreign exchange rates, commodity prices, and/or equity prices do not pose significant market risk to us. The responsibility for managing market risk rests with the Balance Sheet Management Committee (BSMC), which operates under policy guidelines established by the Board of Directors. The negative acceptable variation in net interest revenue due to a 200 basis point increase or decrease in interest rates is generally limited by these guidelines to +/- 10%. These guidelines also establish maximum levels for short-term borrowings, short-term assets, and public and brokered deposits. They also establish minimum levels for unpledged assets, among other things. Compliance with these guidelines is the ongoing responsibility of the BSMC, with exceptions reported to the full Board on a quarterly basis. INTEREST RATE RISK MANAGEMENT We perform a sensitivity analysis to identify interest rate risk exposure on net interest income. We quantify and measure interest rate exposure using a model to dynamically simulate the effect of changes in net interest income relative to changes in interest rates over the next twelve months based on three interest rate scenarios. These are a "most likely" rate scenario and two "shock test" scenarios. The "most likely" rate scenario is based on the consensus forecast of future interest rates published by independent sources. These forecasts incorporate future spot rates and relevant spreads of instruments that are actively traded in the open market. The Federal Reserve's Federal Funds target affects short-term borrowing; the prime lending rate and the London Interbank Offering Rate are the basis for most of our variable-rate loan pricing. The 30-year mortgage rate is also monitored because of its effect on prepayment speeds for mortgage-backed securities. These are our primary interest rate exposures. We are currently not using derivatives to manage our interest rate exposure. The two "shock test" scenarios assume a sustained parallel 200 basis point increase or decrease, respectively, in interest rates. As short-term rates fell below 2.0% by the end of 2001, we could not assume interest rate changes of 200 basis points as the results in the decreasing rates scenario would be negative rates. Therefore, we are using 150 basis point variances for our "shock test" scenarios until short-term rates rise above 2.0%. Our interest rate risk exposure model incorporates assumptions regarding the level of interest rate or balance changes on indeterminable maturity deposits (demand deposits, interest bearing transaction accounts and savings accounts) for a given level of market rate changes. These assumptions have been developed through a combination of historical analysis and future expected pricing behavior. Changes in prepayment behavior of mortgage-backed securities, residential, and commercial mortgage loans in each rate environment are captured using industry estimates of prepayment speeds for various coupon segments of the portfolio. The impact of planned growth and new business activities is factored into the simulation model. 22
This modeling indicated interest rate sensitivity is as follows: TABLE 6 - INTEREST RATE SENSITIVITY (In thousands) <Table> <Caption> Anticipated Impact Over the Next Twelve Months as Compared to Most Likely Scenario ---------------------------------------------- 150 bp Increase 150 bp Decrease June 2002 June 2002 --------------- --------------- <S> <C> <C> Change in net interest income $ 4,477 $ (6,250) </Table> The estimated changes in interest rates on net interest income are within guidelines established by our board of directors for all interest rate scenarios. The simulations used to manage market risk are based on numerous assumptions regarding the effect of changes in interest rates on the timing and extent of repricing characteristics, future cash flows, and customer behavior. These assumptions are inherently uncertain and, as a result, the model cannot precisely estimate net interest income or precisely predict the impact of higher or lower interest rates on net interest income. Actual results will differ from simulated results due to timing, magnitude and frequency of interest rate changes as well as changes in market conditions and management strategies, among other factors. We expect our balance sheet will continue to be asset sensitive over the next twelve months, which means that we will have more loans repricing than deposits over this period. This is largely due to the concentration of our assets in variable rate (rather than fixed rate) loans. If, as we expect will occur, interest rates rise in 2003, this asset-sensitivity will tend to result in an increase in our interest margin, all other factors being equal. In the event of a rising rate environment, management may choose to fund investment securities purchased with term liabilities/deposits to lock in a return. Investment securities are generally held in the "available for sale" category so that gains and losses can be realized as appropriate. At certain times, we use the "held to maturity" category if we are not planning to sell these securities before maturity. As of June 30, 2002, the bank sources approximately 22% of its total deposits from retail consumer internet deposit customers through BankDirect, our internet banking facility. These retail consumer deposits may be more interest rate sensitive than our other deposits as a result of the extremely competitive internet banking market. 23
PART II - OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS We are not involved in any pending legal proceedings other than legal proceedings occurring in the ordinary course of business. Management believes that none of these legal proceedings, individually or in the aggregate, will have a material adverse impact on our results of operations or financial condition. ITEM 2. CHANGES IN SECURITIES Not applicable. ITEM 3. DEFAULTS UPON SENIOR SECURITIES Not applicable. ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS On May 21, 2002, the Company held its annual meeting of stockholders (the "Annual Meeting"). At the Annual Meeting, out of 10,272,265 shares of common stock and Series A Preferred Stock (which vote as a class together with the holders of common stock, on an as converted basis) entitled to vote at the meeting, the holders of 6,241,444 shares were present in person or by proxy. At the Annual Meeting, each nominee for director discussed in the Company's Proxy Statement dated April 30, 2002 regarding the Annual Meeting, was elected a director of the Company. The votes received by each nominee for director are set forth below: <Table> <Caption> Votes Votes Nominee Received Withheld ------- -------- -------- <S> <C> <C> Joseph M. Grant ........................................................... 6,241,444 0 Raleigh Hortenstine III ................................................... 6,241,444 0 George F. Jones, Jr. ...................................................... 6,241,444 0 Leo Corrigan III .......................................................... 6,241,444 0 James R. Erwin ............................................................ 6,241,444 0 Frederick B. Hegi, Jr. .................................................... 6,241,444 0 James R. Holland, Jr. ..................................................... 6,241,444 0 David Lawson .............................................................. 6,241,444 0 Larry A. Makel ............................................................ 6,241,444 0 Walter W. McAllister III .................................................. 6,241,444 0 Lee Roy Mitchell .......................................................... 6,241,444 0 Marshall B. Payne ......................................................... 6,241,444 0 Steve Rosenberg ........................................................... 6,241,444 0 John C. Snyder ............................................................ 6,241,444 0 Robert W. Stallings ....................................................... 6,241,444 0 Theodore H. Strauss ....................................................... 6,241,444 0 James Cleo Thompson, Jr. .................................................. 6,241,444 0 Ian J. Turpin ............................................................. 6,241,444 0 Charles David Wood ........................................................ 6,241,444 0 </Table> 24
At the Annual Meeting, a vote was taken by ballot on proposals to increase the authorized capital stock of the Company. Proposal #1 was an Amendment to our Certificate of Incorporation increasing our authorized common stock to 100 million shares. Proposal #2 was an Amendment to our Certificate of Incorporation increasing our authorized preferred stock to 10 million shares. The votes received for proposal are set forth below: <Table> <Caption> For Withheld --------- -------- Proposals to Increase the Authorized Capital Stock <S> <C> <C> Proposal #1 6,214,346 27,098 Proposal #2 6,209,346 32,098 </Table> ITEM 5. OTHER INFORMATION Not applicable. ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits 99.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith) 99.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith) (b) Reports on Form 8-K None. 25
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. TEXAS CAPITAL BANCSHARES, INC. Date: August 14, 2002 /s/ Gregory B. Hultgren -------------------------------------- Gregory B. Hultgren Chief Financial Officer (Duly authorized officer and principal financial officer) 26
INDEX TO EXHIBITS <Table> <Caption> EXHIBIT NUMBER DESCRIPTION - ------- ----------- <S> <C> 99.1 Certification of Chief Executive Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith) 99.2 Certification of Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, as Adopted Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith) </Table>