Q3 2019 Earnings Call
Welcome to the Texas Capital Bancshares third quarter 2019 earnings Conference call.
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I'd now like to turn the conference a further Heather Worley director of Investor Relations. Please go ahead.
After <unk>. Thank you for joining us <unk> third quarter 2019 earnings conference call I'm, Heather Worley director of Investor Relations.
Please be aware this call will include forward looking statements are based on our current expectations of future results were event.
We're looking statements are subject to that.
Risks and uncertainties that could cause actual results to differ material from the state.
Forward looking statements our assets today this call and we do not see any obligation to update.
Statements made on this call.
Together with the cautionary statements and other information contained in today's earnings release, our most recent annual report on Form 10-K and stuff.
This capital myself [laughter], our speakers for the call today, our Keith Cargill, President and CEO and usually Anderson CFS.
In conclusion of our prepared remarks, operator area will facilitate thank you and I said now we'll turn the call over to keep it will begin on slide three.
Like you have there I will open then Julie will give her assessment for Q3.
I will close before opening the lines for Q.
Let's begin on slide three.
In summary, we delivered a strong quarter in multiple key areas.
Deposit growth was excellent credit improved controller controllable core expenses were up only modestly.
Mortgage finance with strong core LHC group on average despite the significant pay downs.
We accomplished and leverage loans.
Net revenue grew linked quarter and year over year.
Earnings per share grew 13% linked quarter and 3% year over year.
Outstanding results from an extraordinary effort by our truly talented team across Texas capital buying.
And these excellent financial results were accomplished through executing our strategic initiatives to drive continued improvement in deposits these efficiency and an even more differentiated premier client experience.
I'm unfortunate CEO and need to work with amazing talent to wake up each morning excited to build a premier business and private bank in America.
It is an aspiration, we all alone and expect to achieve in time, usually [noise]. Thanks Keith.
My comments will cover slide 16 13.
Net interest income increased 8.6 million or 3.5% from the second quarter and is up 20 million [laughter], 8.6% from the third quarter last year continuing to demonstrate the resiliency.
She did the existing rate environment.
Mortgage financing I could isn't very effective hedge inverted or close to inverted yield curves scenario.
The fact that our NIM decreased on a linked quarter basis, it's important to understand that it was primarily related to the earning assets shifts specifically mortgage finance and liquidity.
Well, we don't believe now that's the best metric to assess relative profitability, our future revenue generation in this.
For additional L. HR yields were down which is reflective of the continued decline in Lahore. These were slightly higher in the third quarter and all comparable to Q1 levels remain at levels meaningfully lower than we experienced in most of 2018.
Mortgage warehouse yields were down on a linked quarter basis and similar to last quarter. The decline is not related to any shifts in competitive pressures, but rather resulted from volume pricing that was already in place and when we refer to volumes that means longer wells deposit, which all positive for net interest income.
Our India yields continue to be pressured which was expected compared to actual mortgage REIT.
We continue to have broken deposits with growth in interest bearing as well as non interest bearing overall deposit costs decreased by eight basis points from 129 basis points in the second quarter 221 basis points in the third quarter. The decrease resulted from continued growth in D.A. as well as meaningful decreases in it.
Sparing deposit costs.
Our total funding costs were down 15 basis points with decreased usage of FHLB borrowings.
We continue to how solid deposit top line with some of the verticals getting traction the launch of our escrow vertical went public during the quarter and more to come in the next few months other hop attention part.
Resets sensitivity simulation indicate that net interest income would decline approximately 6% to 9% assuming 75 basis points of additional rate cut over the next 12 months.
Sounds that certain floors with kick in as well as assumptions related to continued elevated mortgage finance volumes over the forecast horizon.
We had a slight increase in average traditional Ali tried during the quarter balances were down as a period. There that are consistent with the continued run off in our leverage portfolio.
For additional l. each on average balances were down 1% from second quarter and up 3% from this time last year levels overall pay off continued to be hot on the early NCR. He works, we're continuing to replace run off with funding on existing commitments and some new origination.
In contrast to see and I'll ever tried all is not being backfield I often see I'm leveraged our along with what we expected and we would expect to see further reductions in the fourth quarter.
Yeah, we had a strong average total mortgage finance balances, including M.C.J., driven by the seasonally strong quarter, which similar to the second quarter was even stronger with lower mortgage rates average balances are up from this time last year about 54%.
We would expect fourth quarter volumes to be strong with the continued low right.
We continue to experience good growth in linked quarter average total deposits with a mix of interest bearing as well as non interest bearing are slower core loan growth is and will continue to be beneficial to our marginal cost of funding.
We continue to see improvements in deposit mix with some contribution from vertical as well as from existing clients in clean, including mortgage finance escrow account, we would expect that to continue with meaningful improvement more evident in 2020 at verticals get more traction and we continue to deepen existing relationship.
Overall 80 basis points linked quarter improvement in our deposit costs and 15 basis points improvement in total funding costs less relies on FHLB borrowings.
Our interest bearing deposit costs were down six basis points, but excluding Cds, which are mostly brokered Cds are interest bearing deposits were down nine basis points on a linked quarter basis. As we've mentioned index deposits haven't assumed hotter person fade out well all other interest bearing it's the is assumed to be closer to 65%.
A playbook for stepping down rates went in place prior to the July .
We're being cautious, but very proactive and applying rate reductions across the board, we expect free pricing to remain at a similar level or perhaps faster for the next one to two bad news.
As for broker deposits. They remain at 2.1 billion with increasingly favorable pricing the selective use the brokered Cds remains an option to supplement the funding status as we gain traction in the new deposit focused vertical.
We continue to show positive trends in our core operating expenses.
Typically looking at the changes in salaries and employee benefit which represents over 50% of our total non interest expense third quarter salaries and employee benefits for up less than 4% from the third quarter last year and year to date. The increase is a little over 5% levels that are unprecedented in our history and we're doing another.
Tom we're focused on transformational changes in how we think about efficiency and client experience.
We're being very deliberate with revenue generating hires and are continuing to attract exceptional talent as our story continues to be extremely compelling.
We've discussed marketing expenses and the variable portion Todd to deposit about a third of the increase in that category. This quarter was related to the variable portion that expense peaked in Q3 as we're not focused on growth in that category deposits.
The remainder of the increase was normal business development, which can fluctuate from quarter to quarter, but it's not a significant part of the total access.
Our core included an MSR impairment at 2.6 million and that's compared to 2.8 million in the second quarter 2.9 in the first quarter when totaling over 8 million up non run rate expenses negatively affecting total noninterest expense for the year.
We were in the process of putting instruments in place that will protect us from future downside risk with the MSR portfolio assuming rates continue to fall.
Our efficiency ratio for the third quarter was elevated to 54.8% and was really related to a couple of MCR and see a on all of which are rate related and have been offset in net revenue either this quarter are in prior quarters. The classification several of the Mt items as well as the marketing cost related to the positive harvest.
I've been punitive to our efficiency ratio is servicing costs were noted in noninterest income against servicing revenue and the related marketing. These were moved to interest expense our efficiency would have been consistently in the 50 to 51 range, 50% to 51% range and would show an improvement year to date 2019 compared to 2018.
We believe a more representative measure to focus on in evaluating our noninterest expense trend is non interest expense to average, earning assets, which has improved from 2.15% in the third quarter of 2018% to 1.86% in this quarter.
We're pleased with our improvements in our credit in the third quarter, namely our provision level as well as a decrease in total criticized the charge off.
Our non accrual levels are still at a relatively low level <unk>, 0.49% of total allied shop.
No it's hard for the quarter, primarily related to energy and leverage specifically 17 million energy and 20 million unleveraged. Similarly year to date charge off 61 million are comprised of 32 million in energy and 24 million in leverage over the course charge offs were related to existing problem credits.
We discussed in previous quarters. Additionally, we experienced a meaningful decrease in total criticized levels in the third quarter and that's directly reflected the actions taken over the past few quarters actively managing each of these.
Our total criticized as a percentage of tell the only child remains low and dropped to 2.2% this quarter compared to 2.6 and the second quarter.
All criticized loan relationship we continue to be engaged and our forecasting additional paydowns in the fourth quarter.
Had a meaningful dropping provision to 11 million from 27 million in the second quarter loans being charged off already had certain reserves allocated.
Earlier in the year, we expected a larger portion of provision in the first half of the here and our actions have translated into achieving that there will still be run allusions to existing credit and there could be migration within the criticized book, but we do believe there are enough offsets in those forecasts and recoveries of provision for us to lower our full year God.
We continue to be focused on Christmas management of the problem credits, primarily in leveraged and energy to minimize the downside impact and we're actively monitoring all portfolios and lot of macroeconomic factors.
Turning to the quarterly highlights our continued strength and linked quarter net revenue the spot the punishing rate environment and that's that's resulting from our strong volumes in mortgage finance, which have continued to contribute meaningful way to the increase.
First quarter on second quarter, non interest income had eight and a half million and six and a half million related to a legal settlement, which was not recurring in the third quarter and that was the main driver of the decrease on a linked quarter basis. We continue to have some noise in the law on cell phones line in noninterest income.
Which is primarily resulted from holding and see a loans longer which increases the hedging costs and it's all said and additional spread income. This quarter that line also included an additional increased reserve component related to a spike in early pay offs, resulting from refinance activity.
We're continuing to improve run rate on core operating expense.
Year over year, 8% increase in non it non interest expense compared to prior year Q3, excluding I worry recoveries last year.
Excluding the increases in marketing related to the public cost and the increases in servicing related to impairment the year over year as well as year to date comparisons are 4% to 5%, which again is unprecedented in our history and reference it represents a significant improvement in managing our core operating it.
Are we in our way levels were improved in the third quarter as a result at the lower provision for loan losses.
Our our away levels will continue to be negatively impacted by the higher mortgage finance and liquidity balances.
Well most provision levels will continue to be key to driving improved are we.
No it's hard to the outlook for the remainder of 2019, we're maintaining our guidance for average traditional Elie chalk rose at mid single digit percent growth. This is reflective of the growth we experienced earlier in the year and incorporate our current focus of positioning our balance sheet to be as strong as possible as we head into what could be a challenging.
In the cycle.
We're increasing our guidance for average mortgage finance growth to mid to high Thirtys from low to mid twenties per se that takes into consideration the additional growth. So far this year and an expected strong Q4.
Obviously this is the lowest risk category for us. So we're happy to explore the opportunities available with lower mortgage rate, even if it means temporary dilution to some of our performance metric.
No changes to our and see a guidance of two and a half billion for average outstanding in C. I will continue to benefit from the additional volumes with lower right.
We're increasing our batting average total deposits the high teens percent growth from low double digit percentage growth reflective of the DTA growth that we experienced in the second and third quarters.
Decreasing our guidance for them to 3.2% to 3.3% that's down from 3.5 to 3.4 or five.
Decreases problem era. The decrease was driven primarily by the earning asset shipped we've experienced and we'll continue to have from the total mortgage finance, which is relatively lower yielding asset Wap units shipped an m. The added growth is very positive to net revenue offset some of the impact from rate decrease.
Our guidance assumes no fed changes in right. That's the probabilities for those continue to move dramatically from week to week. However, it's important to understand how we believe rate cuts will affect us and we're focused on it in terms of net interest income which will be negatively affected.
Future rate decreases as I noted earlier the decrease to net interest income could be 6% to 9% over the next 12 months, assuming 75 basis points of additional rate cut.
Our GAAP net revenue remains at high single digit percent growth.
Because of the lower level of provision in third quarter, coupled with continued relationship specific strategies, our leverage lending and energy portfolios, we're reducing our guidance for provision expense to high 16 to high Seventys and that's down from mid to high 80.
Our guidance from non interest expense remains at mid to single digit mid single digit to high single digit percent growth. As we've noted we continue to feel very good about the slowing of our core operating expenses, but the impact of MSR impairment charges as well as the variable marketing costs have driven upward pressure on the range.
Got it was for efficiency ratio remained in the low fiftys.
Lastly, I will turn to our longer term outlook. These are the right gold and we're committed to achieving them. That's how long will be more challenging in the existing rate environment. As you know the initiatives. We haven't place are focused on repositioning our balance sheet to be more stable through rate cycle, but certainly there can be variability at different points in that cycle.
We are confident the we have a lot initiatives underway for the long term historically, we have been very successful repositioning as needed and we expect similar success. This time here I.
Thank you Julie.
We're committed to delivering and even more premier differentiated client experience, our current business and private clients, while developing new best of class specialized industry verticals.
During our client experience delivery and opening new specialized industry businesses will create untapped opportunities to attract clients and a more favorable or are we in self funding categories, helping us overcome with growth some of the shrinkage, we continued to experience deliberately and.
Leverage lending.
Mortgage finance continues to give our company a high performance growth engine with essentially U.S. government credit risk.
This business allows us to grow net interest income despite late cycle challenges and pricing and structure and other core l. HR categories.
It also provides significant self funding through the mortgage finance Treasury management deposits.
And the fee income from the mortgage finance business covers our cost of operating the business.
Beyond the success of the mortgage finance deposit growth, we've seen strong growth in core see enough Treasury management deposits as well as early growth in some of our new deposit verticals in combination the core treasury deposits and new deposit vertical funding has grown by over $1 billion. So far in 2000.
And that team.
Our final two deposit verticals launching in the first quarter of 2020 are expected to be the most significant new deposit growth initiatives of all.
We're bullish on our deposit growth prospects for the next few years as these verticals mature and our bankers and Treasury management partners drive increased core treasury growth as well as cross sell new deposit vertical products.
It was most encouraging.
As to see not only loan loss provision decline meaningfully, but also to see a significant decline in criticized classified loans.
The credit theme loan review team relationship managers and their group pets have all worked as one team for the past year to understand the loan portfolio at deep granular level and de risk the portfolio before an eventual economic slowdown sometime in the future.
Their hard work continues and we expect to deliver an improving trend for several quarters ahead.
We are seeing significant improvement in process efficiencies and the resulting improvement and more responsive client service and lower core operating expense growth, we're working diligently and with confidence to deliver a great long term investment for our shareholders and Premier service and products for arc.
Once.
Operator, if you would that's please open the lines for Tonight.
[noise] to ask a question press Star then one on your Touchtone phone.
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At this time, we will pause momentarily to assemble the roster.
And our first question comes from Ebrahim Poonawala of Bank of America Merrill Lynch. Please go ahead.
Good afternoon guys.
I think first question Keith just based on feedback I've received Oh, the last one or.
We would love to get anymore color on credit and how we should read Oh, you loading the provisioning guide Oh would love to get in terms of your comfort on migration Canton de leveraged lending the energy book and just done this call think things again surprising to the downside three or six months of now if we could talk to that that would be helpful.
Well we're encouraged.
It's a it's early to declare victory.
But we really believe we have a much deeper understanding ebrahim.
Our portfolio and not just leverage lending and energy. A then certainly we had a year ago and it's taken a tremendous amount of work work by all the groups I mentioned, our loan review team credit team, our bankers or group pads, everyone is really pitch then and it is most encouraging to me.
Okay that we're seeing this this tremendous dipping down that's meaningful linked quarter, but we need to put two or three of these together and I believe we will its.
It's taken a well to a to be confident that you know, we really have our arms around the portfolio, but hopefully I believe we are and that kind of situation.
Things can happen you know on a given credit and given that he days, so again I'm I'm not here to.
Declare victory, but I do believe we're on the right path, we're gonna see hopefully multiple successive quarters with the right trends not just want.
Got it and is it fair to assume that the quarter and included.
Other banks have talked about their snick exam, having an impact is all of that reflected the did it did include that in fact, we have no surprises on the snick exam. Our team was was on top of it and and so that came out just fine for us.
Okay, and just moving on to in terms of capital. When you look at the C means into high Sevens, just talk to us and gold Hill.
How you're thinking about how low can capital ratios goal or.
Just your started yet on participation of the mortgage warehouse.
Loans and how all season, if at all main backed up capital ratios toward the end of the or.
So you know we talked about Ebrahim I think we talked about earlier in the quarter that we're comfortable taking advantage of what were getting with the warehouse growth and so we're comfortable with the with doing additional participation. We ended the quarter participation that kind of participation from that.
It's we're a little over a billion dollars, we're comfortable with that and want to make sure that we can continue to take good care of our client. So we're comfortable you know we've been that's easy that's easy ratio that that's comfortable for us we're very comfortable with that Cecil you know we were not in too much about they still I guess what else.
I would say is what we've said in the past that for commercial commercial commercially focused institutions like ourselves, we don't expect a material change in our overall, our overall provisioning Oh I said, we're comfortable with that by the way Ebrahim that's it.
It is and what we had in actual funded participations at second quarter in versus third quarter end was close to half billion dollars. So.
You know, we could have taken that on balance sheet, but we're being very disciplined.
Take care of class without putting it all on balance sheet and I think that's that's right move had we put it on balance sheet. It would've been about a 23% gross linked quarter, but I think we're doing the right thing to have a strong business, but also to manage it a and not let it oh grow on balance sheet.
Got it and things sneak in one last question demand deposit growth was extremely strong is that sustainable I do expect to hang onto these buttons as if we look into the fourth quarter and have you seen anybody that though from the one or two big imported what to do that are either online or in the process of coming online.
Yeah, we're very encouraged about what we're doing with our deposit verticals and our core treasury efforts our bankers it.
Don just as we ask a and really.
Taken there is there a partners there treasury partners.
Far more on calls and we're filling in some of the gaps and relationships, where we only had loan relationships and that's really contributing along with our new deposit verticals as I mentioned, just this year and nine months were up over a billion dollars and those two categories. We don't.
I want to drill down a lot at this point, but but I think you can still it's a there is always seasonality that comes from our mortgage warehouse deposits and we experienced it in the second quarter and again in the third but I wanted you to also here about that in the north of a billion dollars growth.
That came from verticals and also just core treasury growth, which is awesome I have alongside those a seasonal balances Abraham you know typically we can see some seasonality in the sense so downward.
Impact from seasonality in our deposits in the fourth quarter and the first.
Got it thanks for taking my question.
Our next question comes from Brady Gailey of KBW. Please go ahead.
Hey, good afternoon guys.
Oh, Great Hey, Brady.
No I mean, the mortgage warehouse and Mcs combined [noise] continue to perform really nicely here I mean, it's up again off a strong to Q.
Yes, it feels like we're getting close to the levels, where you started hitting concentration limits I forgot exactly how youre kind of it I know you have a women out there I mean, it as if the CIA and the warehouse continues to be robust and potentially grow from here well most of those balances move into the a.
Patient program you have your other bags or is there still capacity to let let the balances grow on Texas capital its balance sheet.
Well as we move into the fourth quarter, well, but volumes will be very good compared to most seasonally softer fourth quarters I don't anticipate it being higher and so I don't believe that's going to impact this brady in the fourth or first quarters and as we grow the overall balance sheet between now and the second quarter next year.
I think we'll be fine and then good shape and not have to lay off all of the growth once we get a couple of quarters down the road.
Alright, and then one more on credit if you look at nonperforming loans. They were up there are pretty much stable up a little bit linked quarter.
The net charge offs, obviously wouldn't actually reduce that so maybe just talk about any sort of inflows into the NPL bucket in the quarter.
There was one energy deal.
And that that's the it was the bogey that got a slightly over I think it was like 2 million.
<unk> as I recall from prior quarter overall on Npis still quite modest npis, though.
Great. Thank you guys.
Welcome.
Our next question comes from Brett Robinson of Piper Jaffray. Please go ahead.
Hey, good afternoon, everyone.
Right.
Wanted just to go back to enjoy the NII guidance and the 6% to 9% downside for 75 basis point can you just talk about how you're modeling that in terms of the verticals for for growing deposits you know how mortgage the mortgage warehouse factors into that as the as presumably.
Finds it would it would seem like you'd have an that benefited the margin can use walked through the modeling for how you're doing a downside that touch.
Sure So well no net interest income because you're right I mean, some variability in them with mortgage Allison you know I said, we're assuming 100% a beta on the index deposit 65 person on the other interest bearing but that also listen.
That mortgage finance growth still can continues to be pretty strong I'm not not not elevated but certainly still strong over that that four quarter horizon.
Okay, and then wanted to talk about the El <unk> for a second you know I I did you overcome that you know that.
The declines in leverage lending I'm, just thinking about like the the growth path for the for the next year. So let me just does not improve notably or can you give us any additional color on like.
Got you see that trending.
Once you've gotten pass you know running down some of the leverage block and then obviously not growing energy as well.
You know were brilliant really encouraged about a couple of new corporate verticals that we're looking at that are full blown lending and deposit verticals. So these would be separate from the the deposit vertical initiatives, we launched the here and a half ago.
And we have a team that's a that's close to us announcing.
That will launch the first of those verticals. So we'll be able to talk about that in January and I'm very optimistic that with that new vertical with our some new talent, we've been able to bring to the company in our overall see in a business both in Houston, and Dallas that we're going to be able to.
More than backfill, it's just too early to give you that guidance for next year, but I'm very encouraged there will be a even more diversified certainly with lower risk gross than what we experienced a the last few years when we were a.
Growing leverage lending so oh.
I will have more for you in January but.
We haven't yet another two corporate verticals were contemplating a it's a lots at some point and 2020.
In between those three I believe that we're going to have some good solid diversified you know appropriate risk.
Growth in in our book.
Okay, great for telecom.
Okay.
Our next question comes from Steven Alexopoulos of JP Morgan. Please go ahead.
Hi, everybody.
Let's see.
Let's start on that then new margin guidance is my math correct, because the midpoint of the new guidance seems to imply in NIM in the 270 range for the fourth.
[laughter], we no no we do expect NIM I mean, that's always try to focus on net interest income, obviously, but but we do expect now with the continued success in mortgage finance it could take down it would take down in the fourth quarter compared to the third quarter on in that would also still it doesn't also factor in that don't fully.
Dan or the September do so, but not that love.
So what is just so we're clear what is the range are you expecting them to come down in the final quarter.
The range that we updated with the with the 325.
Right 20 to 330, if it's the full year, that's the update for the full year free 23.
Okay, just looking where you started 29 feet it seems to imply a pretty dramatic reduction in NIM coming again Fourq you like do you expect the pressure to be pretty consistent with what you reported this quarter.
I think I mean, I wouldnt expect the fourth quarter to to still being below threex.
Okay all right.
Okay.
It could you remind me for your mortgage finance loans, they carry lower yield than peers, which are just in the mortgage warehouse business right first rising reported 5.3% yield just right why your yield is so much lower but just the mortgage warehouse business.
We really a focus Steve on the Q EM business.
We have a little nonqm, but other other competitors are more comfortable.
Non QM then we are.
And so that's that's the primary difference.
Got it Okay, and then just finally I'm trying to make sense, it's very strong deposit growth and I know you bring him asked the question, we look at noninterest bearing in savings deposit growth.
Why were they both so strong this quarter I mean, it was really off the charts.
It's primarily from existing clients summit, some related to mortgage finance them in some related just our core client. It was primarily there's some theres also some you know Keith mentioned there was some impact from some of the vertical but most of it went from existing clients.
I do and you said absolutely we grew so fast the last five years, we had some gaps where we did not gather up the treasury relationship and so we've really been focused on that in and it's bearing fruit and it's really helping us along with the new verticals.
Now that you have this liquidity do you plan to keep the loan to deposit ratio below 100.
Oh, yeah well.
Well assess the additional liquidity levels that we have obviously we've had some some some outsized success in the last couple of quarters in deposit generation, we've reduced what we're borrowing that's still leaves us with quite a bit of liquidity. So we will.
Yes that there's no will also be so seasonality and some of our deposits primarily diego people seasonality as well.
We'll take all of that forecasting into assessment I'm on what we're going to deal with liquidity levels.
And we're really looking anyway, we can it replacing higher cost funding to save so like the brokered deposits over time, you know, we're going to be in a better position to take that out and improve our NIM.
Right.
Terrific. Thanks for taking my questions well thank you.
Pardon me.
Thanks, Operator, if you work currently in the question Q could you. Please re queue accidently cleared the Q. If you would like to ask a question. Please press Star then one at this time and we will pause for a brief moment to reassemble that roster.
And our next question will come from not only of Stephens. Please go ahead.
Hi, Thanks for taking my question, though I want to stick with the deposit discussion and Julie you mentioned downward pressure on deposit balances due to seasonality the fourth quarter.
Hey, if I look at a for your guidance I think it implies that the balances in the fourth quarter will drop pretty considerably like nine or 10% can you just confirm that I'm thinking about that right for the fourth quarter deposit balance.
No we try to be as you know we try to be conservative with our guy. So we do expect some seasonality impact I'm on the positive.
We would we try to set that guidance. So that it is conservative I guess, that's I would leave it and met with the continued strong volume and warehouse you know along with that it does help offset the normal seasonality on the deposit side too because you did they're building their mortgage servicing book in and so that.
That helps keep it a little little higher and more stable but.
We also look at historical seasonality and we try to take what we know today, along with historical and give you a more conservative guidance.
Got it okay.
I think going back to act with Bradys question previously on the migration of loans from criticized into non accrual.
I think I see that migration that you mentioned Keith on the energy portfolio, but it also looks like there was some negative migration in the leverage lending book Nonaccruals were flat there, but there were still from higher charge offs and the third quarter any color you can you could tell us about that book.
Yeah, we really have.
Been able to address those charge offs in prior quarters, and and built that provision which we.
We all know was pretty hard on us a the first half of the year, but.
We're seeing the overall criticized classified tip down and then within that.
I really think where we're seeing improvement and the classified so it's not simply a matter of the criticized which we got on the radar and the first quarter with these deep dives, we've been taking on our loan portfolio over the last four quarters.
It's it's also that the actual classified component that's very encouraging at this point. So yes, there were a couple right it towards quarter end, but the overall trend on migration, we think is favorable going into the fourth.
Got it thank you.
Welcome.
Our next question question comes from Michael Rose of Raymond James. Please go ahead.
Hey, Thanks for taking my questions I wanted to go back to something you said earlier in the call around expenses. Julie I think you said the way you guys are looking at it now is expenses to average assets is that correct and if so.
You have kind of thoughts you know, it's obviously come down, but your thoughts kind of around.
We should think about that moving forward.
No I'm really giving guidance on that and that's something that that that Michael that's a thoughtful question. We'll certainly think about that I guess, we just you know as Ed we struggle with trying to explain how we really argument a much better job on a core operation.
Noninterest expense average, earning assets just just seems like a more representative metric of our progress.
So.
We haven't given any guidance on that I mean, I think we still we feel comfortable that that's going to continue to improve now that we've been giving a specific eyes on excuse me Julie I might add Michael overtime.
This this gap between the efficiency ratio as julie's describe measuring it and the traditional way we measure it.
They will those lines will cross or meat and that will be as we replace some of these marketing expense deposits.
Those marketing expenses or what really throw us and make it hard to give you metrics that are comparable to other peers, but again, that's one of the key things. We're working on is lowering overall cost of funding, including those marketing expenses.
Okay. That's helpful. And then maybe just going back to the margin not to beat a dead horse here a bit.
You know I think the guidance you said doesn't include any future rate cuts. This year looks like the futures are implying we'd get one one month LIBOR is already down 14 basis points. You know this quarter is that kind of ball <unk> leased the drop in my boards that contemplated.
In the outlook and why that perhaps the ranges. So big and then you know if we do get a breakout in October December .
You know would the dynamics around me.
The the stats that you quoted before in terms the impact on and I would that ship at all thanks.
So what what would already be factored into the guidance is where we ended the quarter right. The money how they had reprices lousy ended the quarter that.
In the Guy that and then what we've assumed in that does sensitivities that I gave you. What we've assumed that then is that there was another 25 basis points, we seemed a bit that could be on it that could be in October is December and then again adjusting for that 12 month that 12 month.
No. That's oh, yeah that and then as we mentioned of course, you have 100% beta on the institutional funding and then where we're projecting a 65% beta on or other interest bearing.
Okay, maybe just one more separate question on on energy I know, it's been a top bought it calls.
So far you guys spoke last year last summer that a you know you guys seem some issues back then and the thought process was you were getting ahead of it.
And we're gonna be perhaps first out of the shoot you still kind of feel that way and maybe just as it relates to energy.
Why do you think we're seeing the issues that we're seeing now when oil prices are still pretty healthy. Thanks.
You know I do think whereas ahead of it does anyone know and I say that because the market no capital market is just kind of locked up right now and that is causing some of the stress on some of the energy companies that were not geared to be full blown operating energy companies. It was more of a have a a acquisition play.
When they thought prices were low and new capital came into that space.
With the intention of proving up or some of the unproven property that they acquired with a drilling programs and now they realize they're gonna have to be generating drilling programs that are cash flow positive because the capital markets aren't aren't active and and so they don't have access to the capsule that have robust drilling.
Programs. So I think it's just in that state, where it's it's difficult to call you know how long we might be in this mode of them working their way through it but I do think were more on top of the portfolio.
Certainly than many banks and Oh, we had to be because Oh, you know, it's it's something we've done a Texas capital our entire history, but most of US involved in the credit process at the company have done. This 30 540 years. These cycles every single one is unique and.
And you learn from each one but you have to be so aggressive in looking at each deal and each operator, we're much more thoughtful now about looking more carefully a drilling plans Michael I'm because some of the again operating no with all that capital flowing in.
Is getting pushed to do some outlying drilling to try and elevate the price of the overall property and Oh and by doing that they said some more risks and they should have I think we've identified who those are and it's more a matter with the rest of portfolio just grinding through this period, where they have.
Challenging access to capital and I mean challenging access to any capital because as banks were looking so carefully at a at our borrowing bases that we're taking a lot of the cash flow that they had hoped they'd be able to deploy a in new drilling activity, but in order to be sure we keep our borrowing base.
It is in line.
Having the captured more that cash flow on debt pay downs. So it's not simply a matter of equity capital that's kind of in a wait and see mode, but also debt capital that they're having a challenging time to FID.
Very helpful. Thanks for all the color Q.
[laughter].
Our next question comes from Jon Arfstrom of RBC capital markets. Please go ahead.
Thanks, Good afternoon.
Hi, John .
Couple of near term and then longer term question, but.
Earning assets a bit up.
Quite nicely in Q2 in Q3 and I'm just curious if you feel like Q4, earning assets.
Kim can be up again.
Well it.
It depends on on warehouse bomb and so we think there will be they'll be good I don't know that they're gonna be oh, because fourth quarter. It is seasonally a little slower so I I don't see that when I when I wouldn't say there would be up well we were still overcoming.
On the net gross said.
John the the bleeding down the shrinking and de risking of our balance sheet with to leverage lending portfolio and so actually.
We're really quite optimistic that will have an even bigger pay down.
And leverage lending.
And we had Oh, you know that on average the last three quarters. So if that occurs then you just have to make up 200 plus million roughly.
In order to get back to zero and so I think it'll be a modest growth if any growth in the fourth quarter, but I don't think that's you have to drill down to see if that's good I think it may be good because we are de risking our balance sheet.
Okay. Okay that makes sense, it's just another way to think about.
The margin <unk> and I equation and I you know my assumption would be flat to down I, just want to make sure I'm thinking about that correctly.
Thank you are yeah okay.
I'm a provision.
Appreciate the fact that that came down but it's still you know there's still about a $10 million swing factor in terms of a high and low levels range. Just curious if you're leaning one way or the other I know that's a a lot of this kind of depends on what happens at year end, but how are you feeling about right now.
Well I can tell you I'm leaning more towards the low [laughter] some of my cohorts little more to being safe on the high but I'm [laughter] I think collectively we agree on this range and Oh I'm still hopeful we'll come in in the high sixtys or low seventies, but I think our team feels like we certainly can come in with.
In the right [laughter] small group no Raymond it's probably 50 [laughter]. So we've already again, we all agree that we feel comfortable with the right.
Okay, Alright, and then I hate to go back to this but the this 6% to 9% decline and I on the 75 basis points.
The first part of the question is what are you assuming in terms of growth is this just a static balance sheet are you assuming like in normal course of business to get to that number.
Our normal forecasted 12 month balance sheet. So it wasn't it would have seen warehouse, it's still pretty strong seeing a reason why it's from I again, you know the leverage some of the continued pay down in leveraged but as Keith said, a couple of quarters from somebody new area areas of growth, we would expect some growth.
Well, it's our normal well my forecast and again, even even if the market and we anticipate the market next year, John being somewhat softer than this year.
We won't be doing linked quarter laying off about half a billion of the warehouse. While you are and so that gives us that shock absorber capability as we manage you know how much we take on balance sheet. So that if we do see some some backing off slightly next year on mortgage warehouse volumes, we still feel good about being.
Able to take market share in and grow at slightly and and on the deposit side. It does include some some more deposits from some of any vertical.
More meaningful more meaningful then thing in the last couple of quarters.
Okay and then the last thing maybe this is an obvious question but.
I'm assuming that the last.
Caught would take the biggest body. So for example, if we get only 25 and the fed as Dom.
But that's not a terrible outcome for you, but when we get to 50 or 75.
But that's where the biggest bite comes in terms of the yard.
Oh, I don't necessarily think so I'm very optimistic about our deposit trends and our new verticals, but also just started core treasury trends.
It won't be easy and we're gonna have to be better than we've ever been even though we've been really good. This year on core expenses, you know I really feel good about what we can do overall on our expense inefficiency next year.
So.
Yes on the spread it wont be easy, but I don't think it'll be is.
Is challenging is certainly if we hadn't done these initiatives two years ago and be into the process now with launching these biggest deposit initiatives in the next quarter. So John something else. It's important to remember is what happened with our deposit on the way up we moved up really fast with a really hard data, which.
And we have a lot more to come down so the index deposits alone will continue to come down and then in <unk>. In addition, we continue to replace some of the hard cost deposits society vertical we feel like we have a lot more runway on the deposit.
But we're not naive I mean, it's it's a meaningful headwind and where we're certainly doing our planning around expenses and no accordingly.
Okay alright, thank you.
You're welcome.
Our next question comes from Brad Milsaps, Oh Sandler O'neil. Please go ahead.
Hey, good evening.
Brent right.
Hey, a Julie just you a follow up on the warehouse I'm just curious of the 26 basis point decline.
Yield on the warehouses score how much of that relates to volume discount versus.
Just to move in LIBOR or I, just want to get a sense you know as you know as volumes May you know we can you know as you move into you know 2020, a little bit you know versus the high. This quarter. You know kind of can you recover any of that a lost a lost yield on on the warehouse.
Oh hi.
Uh huh.
I mean, some of its driven by volume discounts you know what these top clients.
And so they've been coming in with such robust volumes. That's certainly has contributed but it's mostly lateral.
Okay. That's helpful and then I'm, sorry, I missed its relatively small numbers, but there was also an uptick in the Oh loans 90 days past due you kind of ex the impact of a premium finance or customers that just kind of curious to me any additional color. There on my kind of what the driver was.
No just it's just a couple of a bigger deals done, but not one that we feel uncomfortable with some documentation things things that didn't get done so nothing that I didn't contemplate that were concerned about migrating to love to Oh.
Okay.
But we're not happy they didn't get done that's correct on the documentation, but we don't have concerns about the credits.
Alright, Thank you guys.
You're welcome.
Our next question comes from Peter Winter of Wedbush Securities. Please go ahead.
Hi.
Just a follow up on the expense question I know, you're not going to give specific guidance, but.
Can you just talked about big picture, maybe some opportunities to maybe lower expense growth rate next year.
We're looking at all things that we can leverage including the technology investing we've been doing your for the last three years.
And that is beginning to show.
Show some opportunity where we can in fact card fewer new people. That's been the case. This year I think it'll continue to give us opportunity to leverage that technology as we go onto the new year, we're doing some really incredible work around process reengineering.
And that finding again it weekend lifts the value of our people that had been doing work or not as valuable payable is they are capable of doing.
ER automating some of the things that are more rudimentary and we're looking at deploying bots. They give us 24 seven capabilities to do some of that rudimentary work and are looking at a number of different opportunities. So you had a thankfully we have worked hard to get our technology grid.
Good shape up today over the last three years and now we're able to begin to do things that are or or more.
I have a contributor to really giving tools to our people settled substantially help their productivity and a I'm encouraged we'll be able to take yet another really good step this next year.
On being able to our fewer ER and continue to higher even higher quality people each year and we've hired the finest quality people we've ever hard this year. So the company is is still just an amazing place on the ability to attract great talent and I think as we give our people more more technology.
Tools to use that's going to improve productivity.
Okay, and then just on this long term outlook.
Just wondering what type of timeframe or are you thinking about reaching these goals and.
Secondly, with that net charge offs of 20 to 25 basis points is that kind of the average through a range through a cycle.
Yeah, absolutely that's that through a cycle. So obviously you know year to date this year and last year those were higher but if you look at some of our previous years seven basis.
They were seasonally low so that through a cycle you know Peter when we when we put these on in January we were talking about a three year. It was it was under our three year horizon I think what is happening with rate, which was not what was not what we thought in January .
That's why I said I think it does take a little bit longer you know and I don't I don't I don't know exactly what that looks like when it's in a in the midst at our other updating our three year for your planning cycle, and we will try to give a little bit more little bit more color on that in January when we update our woman do 2020 guidance and kinda kind of update for that.
Three years, and obviously, we'll have some better visibility on this right.
Because that's what primarily driving that lately.
Okay and then just my last question just.
Had mentioned on C., so there shouldn't be much of a change given the.
Commercial short term nature of the portfolio I'm just I'm just wondering does that include.
It's a fairly positive economic outlook as well.
Yeah, you know one other things I've I've said is that I think that well I think commercial bank commercially focused thing are not going to have dramatically different reserve level I think that the introduction.
Forecasting into that it's going to drive more volatility well I don't know that it's going to be overall higher level, but that's certainly they drive more volatility on a quarter to quarter anyway.
But right now you guys don't have a fairly positive out economic outlook.
We do you know, Texas is doing quite well.
And.
You know there's lots of mixed signals, but overall, we're positive on the economy.
Great. Thanks for taking my questions.
Welcome.
Our next question is from Jennifer Demba of Suntrust. Please go ahead.
Thank you.
These results include a sorry back to credit for just a second do do the results you reported include a redetermination.
Period for the.
That is underway and so it it is something that takes you know 60 days or so Jennifer so some of that has been incorporated but it's not been completed or we don't anticipate any significant change.
But that is not put to bed.
Okay, and what did you are still contracting your leverage loan book.
Through the end of this year, what is leverage lending look like for TV I going forward, what will you be doing differently.
Then previously.
Well, we really before we started this process.
I talked a and had many meetings to talk about.
The business, we want for the long run into business, we want and this space for the long term or what we call. Our trophy sponsor clients and of course, a high quality you know a single run enterprises that happened to also fall into that leverage lending buckets.
So we're not.
Inclined to take on new sponsors at the pace, we did over the last five years, we liked the sponsors that we've had a history of 10 or 15 deals with over the years understand how they behave like portfolio companies don't go exactly is due diligence and plans Oh suggest.
And so oh.
We do like the business. We just believe we were a two successful and brought in and took too much market share with some sponsors that we just didn't have the history with in some of the hiccups we had on deals.
We're with these these newer sponsors we've not had the history with so that is the approach. We're taking we certainly want to take great care of our long time.
Quality class or in the P. space and have a great track record think think lack operators not just financial engineers and we'd have a wonderful.
Core client base over the course of the next year. So we likely will still if it down so it won't be at the same pace, we're not shooting for a 30% type run off in 2020, it might be something closer to 10, but just fine tuning. It we're not ready to give all that detail until January but that's directionally.
Where we're headed at this point.
Last question did the escrow team have any impact on third quarter results.
I'm, sorry, Jennifer I was reading and no someone good.
The escrow thing will they have any.
Do they have any major impact no third quarter results.
They haven't and they won't have their special black box that they've been working with our team on a for the larger more complex clients. They will be oh, bringing onboard until the first quarter. So they they have several clients that weekend.
Take on and have a very capably, but those that are in more complex businesses, where we need that have the best piece of technology much like we understood 13 years ago, we needed to build in mortgage finance mortgage warehouse. We're doing the same type thing, where we're really listening to their clients and and buildings.
Something that'll be a great tool for us and the Cline in those cases, where we have larger more complex clients in escrow. So they'll have some impact in the fourth quarter, but it should be significantly accelerating.
As we get into next year.
Thank you.
Well.
Our next question comes from Brock Vandervliet.
Yes. Please go ahead.
Oh thanks.
Just wondering if you could kind of clarify that the math on the energy credit flows. So energy N. P is 61 million Q2.
Energy net charge off 60, now half Q3 I.
I would think that would get to their four and ph say 46 million.
Your NPL is at the end of Q3 were 63.
And does that it does that imply I knew you know a new energy M.P. Vijay of 17 or 18 million or no.
That's exactly what it was brought yeah. We mentioned that early on the call that could be I can tell accrual with with one hand deal.
Okay got it all right and it has that been reserved or is that a new new credit.
Got it goes to any kind of any kind of lung goes to nonaccrual, there's no impairment analysis done and the appropriate reserve would have been put on it.
Okay, Alright got to understand the mass now thank you.
[noise]. This concludes our question and answer session I will turn.
Back over to President and CEO , Keith Cargill for closing remarks.
I'd like to thank all the call participants for tuning yeah, and we appreciate your interest and your support.
I have a good evening.
Thank you for your participation in PCB.
Quarter 2019 earnings conference call.
These direct request for follow up questions to Heather Worley, Heather Worley, Texas Capital Bank Dot Com you may now disconnect.