Q2 2019 Earnings Call
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[music] good afternoon, and welcome to the Texas Capital Bancshares second quarter 2019 earnings Conference call.
All participants will be in listen only mode during the presentation.
Please note this event is being recorded.
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At this time I will turn the call over to Heather Worley director of Investor Relations. Please go ahead.
Good afternoon, and thank you for joining us for the TCV, Our second quarter 2019 earnings Conference call.
I'm, Heather Worley director of Investor Relations before we begin please be aware. This call will include forward looking statements that are based on our current expectations of future results or events were looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ material from these statements.
Our forward looking statements are as of the date of this call, we do not assume any obligation to update or revise them.
Statements made on this call should be considered together with the cautionary statements and other information contained in today's earnings release. Our most recent annual report on Form 10-K and in subsequent filings with the SEC.
Our speakers for the call today are Keith Cargill, President and CEO and Julie Anderson CFO .
At the conclusion of our prepared remarks, our operator, Andrew will facilitate a question and answer session now I'll turn the call over to Keith who will begin on slide three of the webcast Keith. Thank you Heather let's begin with slide three.
The extraordinary volume we drove in the mortgage warehouse produced strong net income for Q2, despite the effect on them.
Average mortgage warehouse loans increased 43% from Q1 to Q2.
Average mortgage finance loans, including M.C.A. increased 35% from Q1, 2019 and were up 49% from Q2 2018.
Due to a continued imbalance and risk versus reward, which our bankers are facing in the core LHC market. We're gratified to have such a strong market leading position in mortgage finance, allowing us to generate solid net income with excellent credit supported by strong controls.
The exceptional mortgage finance results also served to offset the continued intentional reduction in leverage lending loans as we focus on strengthening our overall loan portfolio.
Net revenue increased 1% from Q1, 2019 and was up 8% from Q2 2018.
Noninterest expense similarly increased 1% from Q1.
And 7% from Q2 2018.
Net charge offs to average total el <unk> or <unk>, 0.34% from Q2.
Increased from <unk>, 0.09% in Q1, 2019 and decreased from 0.73%.
For Q2 2018.
Non accrual loans to total Elijah <unk>, 0.47% was down from <unk>, 0.57% in Q1, 2019 and increase from <unk>, 0.37% in Q2 2018.
On slide four we summarize the break down of the energy loan portfolio and see in a leveraged loan portfolio.
Energy loans make up approximately 6% of total loans were $1.6 billion as compared to 7% and 1.7 billion respectively. At the end of Q1 2019.
Year over year energy loans did not grow.
Non accrual energy loans were $61.1 million in Q2, 2000 that seen versus $76.7 million in Q1 2019.
Allocated reserves for energy totaled $49.4 million or 3% of outstanding energy loans.
Moving to see in our leverage loans, we saw a decline of $164.2 million or 13% from the end of 2018.
We're on track for an expected 30% reduction for the full year.
Non accruals for leverage loans were $25 million at Q2, 2019, as compared to 30.6 million in Q1 2019.
Allocated reserves of $67.5 million amount to approximately 6% of outstanding see an AD leverage loans.
We have no significant industry concentration in the portfolio.
Also one of the two leverage loans of greatest concern last quarter has markedly improved and we are encouraged that the other loan has improved prospects as the sponsor continues to provide support.
On slide five we present, a profile of our mortgage finance El HR business.
As you can see in the lower left quadrant of the slide the efficiency of this business is outstanding and even more significant and seasonally strong quarters like Q2.
The bottom right quadrant shows the combined yield when including fees.
The returns are higher still wouldn't associated deposits are included.
This business is especially valuable for us at times like the present, when we find ourselves late in the economic cycle with overly aggressive credit and pricing terms being offered for most other L.A. child loan categories.
The scalability and low credit risk for mortgage finance enables us to deliver strong earnings with limited late cycle credit risk.
Julie.
Thanks Keith.
My comments will cover slides six through 13, our reported NIM decreased 32 basis points from the first quarter with 21 basis points related to the earning asset shift.
Ugly mortgage finance and liquidity.
Additional LNG yields were down nine basis points from the first quarter, resulting from the decline in Lahore in anticipation of a fed rate cuts.
Were slightly lower in the second quarter as compared to the first quarter, but only accounted for one basis point of the declines are anticipated mix and pace of loan growth for the remainder of the year will likely result in lower fee levels.
Experienced in the past mortgage warehouse yields were down 19 basis points on a linked quarter basis. The decline is not related to any shift in competitive pressures, but rather resulted from volume pricing that was already in place. The increased volumes are very positive to net revenue, which includes interest spread as well as the non interest income component.
In CA yields were down 40 basis points, which was expected with actual mortgage rates down in excess of 60 basis points.
First of the year.
There is a lag as we generally hold loans 60 to 120 days, which means we will see further decline in the yield with more recent production.
We're very pleased with the linked quarter increase in average total deposits with growth in interest bearing as well as non interest.
Our overall deposit costs decreased by four basis points from a 133 basis points in the first quarter 229 basis points in the second quarter. The decrease resulted from good growth in DTA.
As previously discussed with no rate increases our index deposits remain flat and with the fed decrease that will move down just as they moved up with the.
Continued solid deposit topline with some other verticals getting traction we expect to be able to discuss more details later in the year.
During the second quarter, we did increase traditional brokered Cds by approximately $500 million as part of the expected surge in mortgage finance.
We have a total of approximately 2.1 billion at June Thirtyth.
As we previously communicated well verticals ramp up we're comfortable using brokered Cds as needed when pricing is more favorable than some of our higher cost funding.
We would expect to see a small movement in NIM for the remainder of the year. If the fed moves down 25 basis points in July as you know over 20% of our deposits are linked to fed rate. So that would offset the decreases were already experiencing on the loan side and those have been repricing with Latam is ahead of the fat.
Obviously hallador react after in June July cut have a direct effect on NIM as well as loan yields will move as law for me.
Ill discuss rate impact in more detail later in my comments.
We had a slight reduction in average traditional only charge during the quarter and that was consistent with the run off in our leveraged loan portfolio as well as some decline in energy.
Traditional Elijah average balances down we're down 1% from the first quarter and up 6% from this time last year.
The level of payoffs continues to be high primarily in CRB, where we're continuing to replace runoff with fundings on existing commitments and new originations. In contrast, the CNL leverage runoff is not being backfill, we would expect payoff and CNL leveraged to pickup during the remainder of the year.
We had a very strong average total mortgage finance balances driven by the seasonally strong quarter, which was even stronger with lower mortgage rate average balances are up from the second quarter of last year by 49%. We would expect Q3 volumes to be quite strong with the continued seasonality and low rate.
We're very pleased with the good growth in linked quarter average total deposit with the mix of interest bearing as well not as noninterest.
Our slower core loan growth is and will continue to be beneficial to our marginal cost of funding.
We started to see improvement in deposit mix in the second quarter with some contribution from vertical as well as from existing clients, including mortgage finance escrow account.
We would expect that to continue with meaningful improvement more evident in 2020 as verticals get more traction and we continue to deepen existing relationships.
Moving to noninterest expense, we continue to show positive trends in core operating expenses, specifically looking at the changes in salaries expense the second quarter salaries and employee benefits were up about 6% from Q2 and 2018, we're managing editor at a much lower level of ft ft additions, but ensuring that we're still being very opportunistic in targeted areas.
As a reminder, a portion of the marketing category continues to be variable in nature and is tied to growth in certain deposit balances.
We expect the Q3 and Q4 expense levels to be fairly flat with Q2 Q2 level was consistent with the high end of our previously discussed range from a million to two and a half million increase depending on volumes. Those volumes are expected to be flat for the remainder of the year.
The second quarter includes an MSR impairment of 2.8 million in the first quarter had an MSR impairment of 2.9 million. So total of almost 6 million of non run rate expenses negatively affecting total noninterest expense for the year.
Our efficiency our business efficiency ratio for Q2 was 52.8%, which is consistent with Q1 levels. We expect similar levels for the remainder of the year.
Turning now to asset quality, we continue to be positive about overall credit quality, despite the higher level of charge offs and provisioning in Q2.
Non accrual level are still at a relatively low level of 0.47% of total only job charge off primarily related to two energy deals and both were part of the increase in non accruals discussed in the first quarter.
While each of these credits discussed last quarter had unique characteristics for development results were common along with other challenges unique to each and not necessarily indicative of the rest of the energy book, We believe each were adequately reserved at the end of the first quarter, but additional information on realizable asset values driven by market liquidity worsened our position, which resulted in additional reserve needed. Additionally, we experienced an uptick in total criticized levels in the second quarter, which was not unexpected but was related to only one energy deal downgraded to special mention not classified or substandard.
Important to note that the significant increase and total criticized since the end of the year has been primarily in the special mentioned category.
Our total criticized as a percentage of total alley Jive remains low at 2.6% and we have rigorous action plans for problem loans for all criticized loan relationships, we have ongoing dialogue with borrowers to understand client performance in general no new information was revealed from the receipt of third party audits throughout the quarter that would point to further just deterioration are issues that were not otherwise no.
As you know from our history were always focused on being proactive with grading and especially lifecycle, which can drive higher provisioning and classifications early.
The $27 million in second quarter provision is driven primarily by additional reserves needed for the two energy loans and some limited migration.
$14 million of the $27 million related to those two energy deal.
As we've mentioned we expected a larger portion of provision in the first half of the year. So Q2 provision level is consistent with the overall guidance, but was related to a different loan category than originally expected generally we remain positive that provision for the second half of the year will be in line with guidance.
$20 million or 34 basis points of charge offs in the second quarter with $15 million of that related to the two energy deals.
We continue to see strength in linked quarter net revenue strong volumes in the mortgage finance contributed to that increase the second quarter. Noninterest income also includes six and a half million related to a legal settlement settlement, which is obviously nonrecurring but is consistent with the eight and a half million in the first quarter no future amounts are expected.
We have a loss on sale of loans in noninterest income resulted from holding some in CA in loans longer which increases the hedging cost and is offset in additional spread income.
Our noninterest expenses are continuing to improve the run rate on on core year over year, 7% increase in noninterest expense compared to prior year, Q2, and compared to 8% net revenue growth.
Our R&D and our way levels were lower in the second quarter as a result of the higher provision level and ROI levels were negatively impacted by the higher mortgage finance and liquidity levels, we could see some lift in our OE levels later in the year it provision levels come in lower than guidance, we are constantly evaluating opportunities to improve returns for the long term.
Looking now to our 2019 outlook, we are decreasing our guidance for average traditional alley Jive rose slightly mid single digit growth from the previous mid to high single digit we're being very diligent about growth. We're very open to growing if the opportunities are right. We're listening to our people about what they're seeing in the market related to risk versus reward and are focused on maintaining strong franchise value as we head into what could be a challenging point in the cycle.
Average mortgage finance, we're increasing our guidance to low to mid twentys percent from high teens percent that takes into consideration the additional growth. So far this year and an expected strong Q3.
Obviously this is the lowest risk asset category for us. So we're happy to exploit the opportunities available with lower mortgage rate, even if it means temporary dilution to some of our performance metrics.
No changes to our MCN guidance of two and a half billion for average Outstandings for 19, the MC I will continue to benefit from additional volumes from the lower rate.
We are increasing our guidance for average total deposits to low double digit from high single digit percent growth. That's reflective of the DTA growth that we experienced in the second quarter. We still believe that most of the growth from the year will be from interest bearing but DTA should be flat to slightly up compared to 2018.
We are decreasing our guidance for NIM to 335 to 345 from 360 to 370. The decrease was driven primarily by the earning asset shift we've experienced and will continue to have from total mortgage finance, which is relatively a lower yielding assets, while slightly punitive to NIM. The added growth is very positive to net revenue.
As always our guidance assumes no fed changes in rates for 2019. However, it's important to understand how we believe rate cuts will impact us and we're focused on it in terms of income with a 25 basis point move in July we estimate the impact to income over the next 12 months would be less than 1.5% with little impact for the remainder of 2019.
Assuming 50 basis points with 25 in July and 25 in September that 12 month impact moves to 3% to 5% finally, assuming 50 basis points in July and 25 in September the impact could be closer to 6% to 8% what none of these scenarios take into consideration is the additional volumes in mortgage finance other than those we've already assumed for the remainder of 2019. We also don't take into consideration any stimulus to the economy. This might drive which can change core growth assumptions going forward. Lastly, this doesn't have the full impact of initiatives already underway that better position our funding mix during 2020.
Our guidance for net revenue remained constant at high single digit percent growth.
The same for guidance for provision expense, which remains at high mid to high 80 million dollar level, we're increasing our guidance slightly for noninterest expense to mid single digit to high single digit percent growth from the previous mid single digit percent growth. We continue to feel very good about the slowing of our core operating expenses, but the impact of MSR impairment charges as well as more of the variable marketing cost in the first half of the year driven some upward pressure on that range.
Our guidance for efficiency ratio remains at the low fiftys.
Finally, turning to our longer term outlook. We are committed to these long term goals and will be validating them as part of our three year planning process, which is kicking off in the third quarter. As you know the initiatives. We have in place are focused on repositioning our balance sheet to be more stable through a rate cycle certainly there can be various variability at different points in the cycle, but these are the right targets and were committed to achieving them. We're confident we have the right initiatives underway and historically, we have been very successful repositioning as needed and expect the same success. This time.
Keith.
Thank you Julie.
I'll close with a few comments and then open the call for questions.
Our business model has always been and will continue to be winning and developing exceptionally talented business partners.
Well technically we are employees of Texas capital, we've never recruited colleagues, who thought of themselves as merely an employee.
We placed the highest priority in it and selection of a new colleague.
On whether or not they have a passion for building a premier industry, leading business, then we focus on skills and experience.
The same holds true in our renewed strategic focus on selecting clients, who see the value in the premier strategic banking relationships we offer.
Today, we offer many new products and services through collaborative specialists, who deliver multifaceted client solutions alongside our relationship managers.
We can and do punch above our weight and at $30 billion in assets. We are a force in the Texas market as well as the national markets.
And we are never satisfied, but always pushing to be one of the very few ALLETE banks in the us able to successfully compete in our targeted niches with any bank for decades to come.
The substantial strategic investments we have made in recent years and we will continue to make in the future will position us to be the Premier financial services company over the next next two decades, not merely a bank who moves to slowly the win tomorrow.
Only focused on next quarter's profit or growth.
We understand the importance of growing profits, but also wisely investing a portion of today's profits for sustainably higher profits in the future.
Those banks to set themselves apart as transformational leaders in the industry will win the premier clients, who similarly, our bold and investing in their company's future also.
Texas Capital Bank will continue to be a transformational leader and my colleagues will continue to engage our business owner clients and a business builder business builder relationship.
This is a powerful advantage we intend to further accentuates as we continued to invest in the finest talent technology and strategic initiatives to ensure a bright future for our clients colleagues investors and communities.
The strategic strategic initiatives in flight or building, a stronger deposit base loan portfolio and more efficient premier client experience.
The results will elevate our profit and RMB for years to come.
We are very optimistic that the smart collaborative hard work, we are accomplishing will deliver superior financial performance over the years ahead.
We are preparing to exploit overly aggressive short term competitors as we focus on quality first and building a premier business of the future and every decision we make.
We are fortunate indeed to be Texas based and benefit from the prosperous economy all around us.
We have never had such outstanding talent join our bank as we have experienced this past year.
It is a powerful combination to add such strong new talent to the extraordinary veteran talent developing in the franchise players as we all build the Texas capital Bank of the future.
This time lets open the lines for Q and a.
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At this time, we will pause momentarily to assemble the roster.
And our first question will come from Brady Gailey of KBW. Please go ahead.
Hey, good afternoon guys.
Great great.
But I want to start with energy we saw the couple of credits move into the nonperforming bucket last quarter you took some losses on this quarter now we have another loan that has been classified special mention you I think as we headed into this year, we were all concerned about levered lending, but now.
Most of the noise, you're seeing is really on the energy side.
I've heard you say these are kind of one off deals and not TCV as typical energy loan, but can you just give us some some color on what's happened with these three credits why did why are they problematic and maybe some color specifically on the new special mentioned energy loan.
Well, the new special mention energy loan we're very encouraged.
As a low probability at this point certainly have a further downward migration. So it is one we've identified we're working closely with the client but feel good about the prospects on that holding up on its quality as is.
The other two loans were instances where.
Yeah, our borrowers.
Entered into very aggressive drilling programs and a and a couple of cases they were up.
Trying to prove up some some large prospects.
And rather than only drill in the heart of the prospect.
Properties, they stepped out a little bit.
And as a result, it created some cash flow challenges and.
Well, we we don't typically run into this kind of situation.
You know, we're very alert that with all the.
The activity in this in this industry over the last two and a half years a lot of it being Brady.
Private equity investors, we're going to be just more intense than ever.
Taking a careful look at the operating properties and not simply be.
Convinced that we have a really great borrowing base scenario because the decline curves are so steep on the shale properties, even though.
The good news is you get your capital back very quickly.
On on these quick decline curves you have to be confident that the operator has it has a sound strategy on how to use that money on existing production, we're loaning against.
To backfill and create that ongoing cash flow on future production.
And in these cases that was not the case. So we feel like this these are one off deals, but again as we as we did a year ago I think we have been early.
Identify.
An energy situation I think there are a couple other banks beginning to experience. Some of this this quarter and I think we are ahead of the curve taking a careful look at at our clients are executing on their plans and that their sound plants.
All right and I know when you saw some credit noise in your Levered lending portfolio you decided to.
Shrink that portfolio like like you're doing when you look at energy and this noise.
Maybe just talk about longer term your commitment to the energy lending space and.
If you would feel more comfortable having less energy exposure at TCP longer term.
Well, it's pretty mature to say longer term Brady, but in the near term, we're taking a much more deliberate approach on.
What we're managing today as opposed to having our bankers and our teams.
Actively looking for that next brand the client will pick up new clients here and there, but they are going to be outstanding top quartile kinds of opportunities, which is definitely the case in leverage lending back. We just picked up one of the best leverage loans Weve had in 20 years.
We closed the here in just the last week or so, but it's a very different high quality top tier opportunity and and the same will be the case in this energy category will only look for very very high tier opportunities and we'll let some of the other credit to run off or plateau.
We're not focused on growing categories.
They were not 100% to comfortable with and right now we're just taking a little bit of a more cautious look at energy as we did leverage lending that's paid off for us on leverage lending and we think it will on energy as well, but long term you know we've always been in the energy lending business and we have no plans to not be.
Okay, great. Thanks for the color.
Welcome.
Our next question comes from Brett Robertson of Piper Jaffray. Please go ahead.
Hi, good afternoon, everyone.
Well Brett Brett.
Wanted to talk about the margin for a second and just I want to make sure I understood. The guidance relative to there was commentary about a further decline in yield.
On the warehouse and just wanted to make sure I understood I'm, Julie what the what the guidance is relative to both the dig further decline in the mortgage book and then just you know how you're sort of responding to LIBOR and if you plan on taking additional actions on.
Talked about stemming some of the asset sensitivity.
Sure. So the guidance that we gave lowering the NIM that that's just assuming nothing else changes, that's assuming that there aren't that the fed does and so thats taken into consideration the shift the shift that we've seen and it will can continue to see in Q3 with the outsized volume from mortgage finance.
But then what I tried to do is give you a little bit of color on if the fed moves in July if they do a 25 basis points made in July we'd expect that to affect us for the next 12 month about one and 1.5% decrease in income.
So, but again that doesn't factor in other things. That's just looking at the math as it is right now that doesn't factor in it that could change some of our growth our growth.
Aspirations.
None of that factor. It also does it factor in what we expect to happen later in 2020 related to some of the deposit initiative.
Okay and doing other things right now.
I think at this point, if the economics of doing any kind of hedging doesn't make sense. Certainly there are things like that that we will continue to to actively look at but we don't think at this point that makes that makes any sense.
Okay, and then I wanted to make sure I understood. So the DTA growth in the quarter.
You had a really really nice bounce back there. It didn't sound like you are expecting that to continue can you one talk about the growth in the quarter was that a function of.
Mortgage or other businesses and then I want to make sure I understood you know sort of how you're thinking about de growth from premier and how it relates to the margin guidance. Thanks.
Sure, Yes, the growth in the second quarter. It was it was mainly from existing clients and that did include some some mortgage.
Q3, we think Q3, we think that we could see a little more growth in Q3.
I said for the year, what's changed is now for the year year over year, we think that deviates could be flat to actually up a little bit and thats definitely a change in what we were seeing in January .
Okay.
Do you see as Julie mentioned earlier.
Brett some some contribution to from some of our new verticals and then also just core treasury, where there have been these opportunities we really didnt mine.
He is deeply because we grew the company so rapidly in some cases, we had loans to clients that we had not you know really gone back in and worked as hard on the treasury. So we're we're picking up steam and all those categories, but some of the recent seasonality.
Also was partly due to the mortgage business.
Okay, and then maybe just on on the businesses.
I've asked in the past and I think you gave me number one time on the new business isn't how much. They contributed any update on on that and then just any update on how you're thinking about what they could contribute over the next year.
I think we're poised to have a very significant pickup in their contribution over the next 12 months, we have our three biggest initiatives.
Teed up to launch in the fourth and very early first quarter and the ones that we launched today are are making good progress, but there are just so young.
That in some cases, where we're testing the pricing breath and not interested in just driving volume we're trying to find the sweet spot and this year, we're not only creating diversified funding, but also lower cost funding and early on you know it's an experiment because you want to go get your name known these are national verticals. So you tend to pay a little more and now we're trying to get that just right and.
We're pleased with the progress not all of them are going to be home runs, we knew that and and so that from the beginning but we we're highly confident that we're on the right track in these three coming up will be our three biggest.
Okay. Thanks appreciate all the color.
Welcome.
Our next question comes from Ebrahim Poonawala of Bank of America Merrill Lynch. Please go ahead.
Hey, good afternoon guys.
Well ebrahim.
Okay, just wanted to go back to credit right.
Yes, everything you are saying in terms of being Ali.
But at the same time and when you talk to investors. They did very little confidence that on credit outlook from every quarter after quarter the stocks and that it is with just five years ago from a valuation standpoint 1.1 tangible book. So it is expressing a lack of confidence and I mean are you talking about making high quality loans loans going forward.
As someone who followed the company for long time, I think part of the appeal of owning the stock has been if you guys have been known to be conservative underwriters.
Tom I'm, having a hard time to reconfigure the book that we have today the surprise on the energy front that we are seeing and just your level of confidence that we are getting towards the end of addressing some of these credit issues would love to sort of get your thoughts on this.
Well I think the improvement we're seeing in leverage lending and that's.
The case in our numbers this quarter should be encouraging to you bring him, but I hear you that energy is is yes, we identified a couple of them that we had these larger charge offs and it really contributed to our provision coming in as we guided we just didnt expect it to come from this you know we expected to come from from leverage lending that we're making so much headway on being all over you know managing that leverage lending portfolio and again. The same is true just a couple of quarters later when we identified a couple of these energy deals that I don't believe it's going to turn into something that's prolonged but honestly until we you know post a just a clean as a whistle quarter and I hope that's the third quarter.
I hear you and I think we're on the right track and it's going to be you know solid on the balance of the back half of the year, but you know you and I will be even more confident when we're talking a quarter from now but I can tell you all the indications for my team and I've got the best team around.
Is that a we're all over this energy portfolio and I don't expect.
As to find some systemic very significant issue, we kits surface another deal or two it's possible, but I don't see that at this point in time today.
And just.
You mentioned that you didn't expect charge offs to come from your does that imply that this potential for some upward drift on the provisioning guidance as we look into the back half or do you feel extremely confident in terms of the mid to high $80 million.
Hi, I'm as confident as I can be I'm encouraged that we're not seeing the kind of.
Continued follow through on leverage lending I'd have a lot more concern if I was still seeing the leverage lending not to performing much better Abraham and that I saw some systemic issue.
In the energy portfolio.
I really believe we're de risking the balance sheet early compared to some banks, but you know we've done it because we've had a couple of bad deals in these categories get our attention early but we didnt just assume they were one off deals we look more deeply at how we're running the business. We've got our bankers really focused on being very thorough and how they're they're looking at go forward business plans with our clients in these areas and I believe these are two of the higher risk categories that banks are going to face over the next.
A few quarters and I think we're ahead, but but we'll have to prove it to you and I think we will in the in the very near term.
Understood, Okay, because I think that obviously the view on the fleet. Rick is the expectation is we had some sort of a slippery slope on credit. So as you said I guess, we have to wait for a quarter to see better results before that can be proven or disproven and just separately in terms of the strategic targets I think I heard Julie talk about.
Going into sort of off site.
Could discuss these targets now.
Do we believe that any.
Realistic possibility that you can get below 50% efficiency ratio in a 12 to 18 month timeframe or.
Good good I feel like that on the other side of the cycle. So you have that headwind could deal with going forward. If you can just talk about.
How you see the bank getting to sustainably a sub 50% efficiency ratio and in your sense, what consigned clean we can get there.
Well it will be two things you mentioned the headwind of the REIT scenario.
Again, we were talking about a whole different rate scenario of seven months ago, I think all of US. So these things can ebb and flow and we'll have to see how that plays out.
But if it in fact that turns into a downward.
Two or three two or three ticks that'll be that'll be challenging to get there as soon as you are projecting are asking.
Secondly, it's the pace of investment.
And we have a number of initiatives that are going to deliver extraordinarily improved and sustainably higher profits and better ROI fees, but in the near term.
They are added expense and that's one of the things that they were choosing to do is invest in setting up the company with.
Better more granular and lower cost funding and deposit base. While the economy is is we think in the later innings, but I hope it lasts a long time, we don't see any clouds that are on the horizon give us great heartburn or a lot of positives about our economy, particularly in Texas.
But even nationally however, you know we're just a more conservative about how we are preparing so that we can explore it whatever opportunities pop up in a down cycle or or otherwise.
And this funding getting it right is super important but also the opportunities we see ebrahim.
In some niches in the sea an eye world that we're exploring I think have great opportunity for us.
And we think we can overtime over the next.
Few quarters began to generate some very strong diversified growth with clients that are going to be full full relationship clients and again, that's been part of our shift. This last year is not focusing on a transaction alone only client and that's part of our strategy to again build a stronger long term, earning earning power of the company.
So I think it's going to be a while it is the bottom line unless we see this rate scenario.
You know stabilize sooner than than summer are concerned that it won't.
Theres not an immediate change we can create there, but I will tell you we have a this added advantage and in the right scenario, where we typically get outsized volume in our mortgage finance and it's just great credit quality, when we get it and when we get it in such a large volumes. It does put pressure on them, but it creates an enormous amount of earnings and they are very high quality low credit risk earnings.
So that is a positive and it certainly is as you can tell from one of our exhibits a very efficient business. So that'll help us as we invest in and get set up for the next you know strong growth run we're going to have over the next several years.
And just on that last if I may squeeze in a follow up do you anticipate the mortgage warehouse spreads to widen if the fed cuts and we see one or two cats, we saw obviously spread tightening on the way up.
Just wanted to see what what's your view on that on that.
Well it seems to be stable and we think probably that will be the scenario, but there isn't a lot of room to go anywhere but up.
But I'm not going to predict it will get necessarily wider margins until we can report that to you.
But we are confident that it's going to stay at least stable if not approval.
Got it thanks for taking my questions.
Well.
Our next question comes from Jon Arfstrom RBC capital markets. Please go ahead.
Thanks, Good afternoon.
Okay, one simple one Jewish we do.
When you talk about your fed funds.
[noise] scenarios.
Do you mean net income or net interest income.
Yes.
Net interest income, Okay, I, just want to make sure I heard that correctly.
And then on the NIM guidance, just very big picture.
With the 335 to 345 range and everything we know today.
I think you're saying low 300 thirtys.
In that range for the rest of the year.
But.
A lot of the pressure is really already occurred on the margin is that a fair way to look at it.
Well, what we saw what we saw with the just the mix shift in the second quarter, we expect that to continue in the third quarter fourth quarter.
We would assume that that from that's when kind of seasonality in the state and become seasonally a little bit weaker, but yes, we would expect to see something similar for the next for the rest of the year. Okay, alright, good that helps.
And then Q3, you just I know, there's a lot of focus on leverage lending in energy.
And you talk about this risk reward balance on the core elway, Charlie but I see some run down in leverage and energy as well.
So it seems like maybe there's some decent activity in core which I can you maybe talk about that balancing act and what kind of activity you're seeing there.
Well there is definitely a decent activity its just.
John a couple of years ago, when when we would go to market and in our core Sienna.
The deals we wanted you know we would win a very high you know.
Number of those.
50, plus percent, even even with a lot of competition today, we're taking yourself out of the out of the process fairly early because of the terms.
Just simply don't make sense and ER and so our hit rate is just lower it's not that we couldn't grow those those loans quite a lot faster. It just wouldn't be a very wise move to to book, a such incredibly underpriced risk reward and again, we're seeing credit terms is that just don't make sense to us.
In advance rates that are much too rich and and a weak collateral basis, if any and it used to be a covenant light nuts covenant gone and in so many cases and of course every once after high quality credit as they should be but still high quality credit you got to be sure you're going to win if you win the deal and I think you are losing in a lot of cases because of the return is just so poor and you have very little if any protection. So that's that's the scenario. So our guys are just having to work a lot harder to win deals and they're they're growing modestly there backfilling you know a lot of the pay downs, but normally you know with the effort, we're putting forward and in the best talent, we've ever had on them on the line, we just keep attracting phenomenal new talent.
We should we should be growing much faster, if we had the right risk reward terms.
Okay. That's helpful. Thanks.
Well.
Our next question comes from Peter Winter of Wedbush Securities. Please go ahead.
Good afternoon.
Hello, Peter.
Keith I was wondering if my understanding that there is a internal concentration limits.
Well, you don't want to see mortgage related loans.
Kind of I guess, you wanted to be more in the low thirtys percentage.
And this quarter, it's at 40% if I include the M.C.I. loans.
I'm just wondering if that's what's your thought is on how big you want this portfolio, how big you're willing to let this portfolio cat.
It's a little above the guidance and again, we use you know guidance terms and we feel like because it's just such a great piece of paper still today that we're able to.
To finance and the liquidity.
Yeah. So.
Excellent and this product to putting over every two or three weeks.
That it's just the right place to deploy.
You know our loan our loan growth right now, but no we do not want to see this we're not we're not looking at raising that guidance range that we have of roughly 25% to 35%, we actually pushed it up I think to 38% out here.
About a year ago, and where we're just write it right a little above that but it is not our our plan to expand that over the long run we liked the 25 to 35 range.
But it's just the place we think is the safest and best to generate earnings at the moment.
Okay.
And then if I could just ask one more question on a credit with.
Energy.
So we had a regional bank.
Reports this morning.
That took some charges on energy and they said it was getting tougher.
To liquidate some of these troubled energy loans, just less demand from.
The capital markets. So I'm just wondering.
Are you guys seeing that as well and could it.
Result in some some charges.
Maybe over the next two quarters.
I don't see that as anything about that happened in one of our clients Smith.
They are accurate in their description of the capital markets are not being very fluid for energy. There was there was just a an avalanche of money pouring into this category over the last two and a half years after that the long down trough, we experienced huge amounts of private equity and and even a foreign sovereign fund money coming in to invest in this in this asset play and we don't see that kind of dry powder out there coming after buying buying the assets today. So.
We feel we feel good about overall, the staying power and the ability of our clients to operate.
But they're not going to be able to if they want to sell their assets and get the kind of price that they might have gotten a year or two ago and so they need to be able to operate maintain their cash flow and manage their expenses run their business will.
And over time this will become attractive again, there's just so much concern apparently in the.
With the overall world economy.
That.
Private equity is becoming anxious there also more concerned either about.
Looking at their true cash flow out of the shale plays the money is very very significant when you go drill these horizontals and in these shale plays, particularly the Permian you know you can have four to 10 or 12 layers of.
Pay zones, and when you started stacking you know six or eight horizontal wells and those 1200 50 acres kinds of template.
I mean, you quickly get to you know 60 or 80 million for one layer and you had a quarter of a billion almost for four.
And so it's it's significant money in it it's going to continue to I think.
Track bigger and bigger players and I think that's what we're going to see over the next few years is is some of the very biggest worldwide oil companies are going to become the bigger players over time in the Permian.
Thank you.
Well.
And so you're you're comfortable then where your energy loans or are marked.
If we are we are and we think again at some point some of the bigger players are going to want to.
Our clients are properties and they'll make up a nice profit, but if you have to go to market today and find buyers.
It's a pretty shallow capital market.
Okay. Thanks Keith.
Well.
Our next question comes from Jennifer Demba of Suntrust. Please go ahead.
Thank you good afternoon.
Keith can you just.
Give a little more color.
On why you chose not to raise.
The provision guidance for this year.
And what gives you real confidence that you guys have a handle on that.
And then my second question is on your interest in buybacks your stock still remain.
Much cheaper than your peers. Thanks.
Let's start with your first question.
You know we don't.
We don't take lightly or reaffirming that guidance because it's it is a very significant.
Number relative to how our earnings will come in for the year.
We do believe we have a handle on our energy portfolio and that we don't have.
Significant other problems there and we're very very comfortable.
As we can be at this point, Jennifer you know things can change on a deal or two but they were ahead of the curve on our leverage lending that's performing quite a bit better than we expected.
And so that I would say is kind of the counterpoint.
That causes us to feel like we're still good.
On on provision, but if we.
Do find something new that that's a significant deal in either leverage lending or energy. It could change the game, we just don't see it today and we have a really thorough.
Loan review process, but more importantly, you know we've got the entire line each other our EMS and and there.
Portfolio managers I mean, it's across the company. We're we're all over our loan portfolio and in particular.
Leverage lending and energy, we've been concerned about a slowing economy for longer than.
Probably I want to admit so I think we have a pretty good grip on it and we put any more out there it would just be a guess.
To give you a higher number than what we're giving you.
Okay and your interest in share repurchases.
Well again it is still a tool that we think about.
We also.
We believe we have other opportunities that we should examine on how we use our capital that could be much better for our shareholder and we're looking at.
At different opportunities, both organic growth opportunities, but also a possible fee businesses that may have opportunities for us to take a look at it.
And those are the reasons why we have not yet or is that too.
What kind of fee business opportunities would you be examining.
You know, we mentioned before and that would still be the case today, but something related to.
Private wealth advisory business, that's doing extremely well for us, but the simply grow it organically, it's going to be hard to make it big enough to make as big an impact.
If we don't look at the possibility of some M&A, but we got to be very thoughtful about how we go about that because we are.
As everyone knows we are very bought into organic growth is is really a the most sound way to go but it's one of those opportunities our team is doing so well.
But we think we probably can integrate the right size opportunity and I still have the outstanding culture that pick up some other great talent and make that work. Another one that weve kicked around is something in the capital markets area. Our clients, we're getting to a point where clients have more needs than they did when we were smaller just a few years ago be very rare we'd have a client. They did have a a need other than senior debt or their treasury management, and maybe swaps and things of this sort, but there are other things that we think we may be able to do there and so we've added some talent there and we might even look beyond simply talent, but it's too early to.
To make that call.
Thanks, So much we know we need to continue to move the needle on our mix of income to have more fee income and not be as realized over the next four or five years on just net interest income spread.
Thank you.
Well.
Our next question comes from Steven Alexopoulos of JP Morgan. Please go ahead.
Hi, everybody.
Yeah.
I wanted to start out for Julie regarding the impacts you are providing from rate cuts, which is very helpful. What deposit beta youre assuming in those scenarios.
Yes.
We don't usually talk too much about beta is.
Well I'll give you I'll give you some color on it though you know we index deposits that we have which is about.
20% of our of our book, we would assume that that something close to 100% going down just like it was going up and some of the other areas. I mean, we've made some assumptions that I don't want to talk too much about those obviously as rates moved up we were evaluating relationship and we would do the same thing going down but it could it could vary.
So that's that's probably all that that I'll say on that at this point.
Okay.
When I look at the scenarios they seem to be not as dramatic of a negative impact as what you disclosed in the 10-Q.
What's the difference.
Yes, there you know that we get that question in the 10. The 10-Q, that's a pretty scripted that's a pretty.
It's it's it's a lot more regimented, we what we report as a shock and so we don't we pretty much done at a given point in time and we just we just run the math with this that I've given guidance Weve taken weve taken a harder look at some of the some of the things that I just talked about looking at some of the client relationships the different categories of our deposit what we think some repricing that might happen because of things that were negotiated as the rates went up and things that might happen on them. So we just do a little bit more there's a little more thought put into it and more and more.
So nothing then what's reported in the 10-Q, what's reported in the 10-Q, it's just kind of the quick math if it happened tomorrow everything followed the the rule.
So Steve this is Keith.
We you can fully appreciate this I'm sure you do but we just don't have the category moves that a more retail bank would have on the deposit pricing and that's what gives it a little more complexity, we relationship price and so we might if someone wants a better deposit price fine we need more business and how do we get more profitable business that might be fee business that might be loan business and then we look at the overall or are we in are we getting a deeper share of wallet and so that does add complexity, except for that 20% Julie mentioned that moves and seek 100% pretty much think that with fed funds.
Thank you and then on the loan side, you had a nice reduction in Cnine leverage loans.
Floating nonaccrual and criticized did you guys sell loans in the quarter or were these just normal pay offs.
Well at least were normal pay offs with a little help you know in some cases.
But most of it was just normal portfolio turnover.
And that's how we really built primarily how we built our forecast back in January for the year of about 30% run off is a typical velocity of turns that we have been seeing of late on these private equity portfolio companies plus about 5% as we work a little harder on not being as opened the modifying deals and things of this sort so that we get others to refinance while there is still a refined market.
And that continues to be the case.
Okay, and then one final one if I look at loans ex mortgage the decline seem to be much more pronounced or just the headwind from running OS running off leverage loans.
You more color of why you saw that decline this quarter.
It was mainly the run down of energy and leverage lending.
It was about.
I'm trying to remember about 270 million.
Combined.
So that was you know 80 plus percent of it.
I would say yes.
Is that right ceiling, yes, I mean, if you look at and certainly if you look at the ending balance yeah that was that was that was almost exactly when it was so year over year.
The energy loans were flat, but from the first quarter. They actually came down 100 million yes.
Got it okay. Thanks for the color.
Our next question comes from Casey Haire of Jefferies. Please go ahead.
Yes. Thanks.
Good evening I'm, Julie just one follow up more follow up on the NIM.
The the loan yields I was wondering if you could provide the spot rates, where they were at June thirtyth for dry mortgage finance and MCR.
No.
No I didn't give that and I don't have that many you know that the commentary like educating the general direction. Obviously, it will start within CAMC a newer production that came has come out come on in the last 30 days, that's obviously going to be that's going to be related to what the what overall mortgage rates look like warehouse that that's pretty stable as we said and then on the core Elijio I mean, that's going to Davis as lot more so most of the pricing like we thought it was going up there will be some lag. So there are a few loans. They don't all reprice on the same day takes about 30 days. It can take up to 30 days to nave. So theres could still be some repricing in the core Elie job, but again, it's I don't think it's going to be that there's going to be that significant of a different.
Okay.
So on the M.C.A., specifically like what is new what is the new money yield on that production and the current environment.
I mean, it's it's similar to what whatever that 30 year mortgage rates are.
Okay.
All right and then just four and a quarter range, yes somewhere in there Casey.
Okay.
And then the just I appreciate the expense guide but.
If what is the what's the slowest you could grow expenses and still support your initiatives.
You know if we do get a tougher.
Would you get a more dovish, we got a lot more fed cuts what's sort of the.
Oh, the slowest you could grow expenses going forward.
I mean, I think that where you know I guess I would say what we've talked about is is what we feel comfortable with you know weve, we are being very deliberate about we're not going to sacrifice opportunity.
To save a few.
A few dollars here and there. So certainly we are we're managing the overall hires a lot better, but we're still going to be opportunistic, but I guess I guess I would say that what you've seen what we feel that we've seen so far this year compared to last year and compared to years in the past it's dramatically different. So we will continue to evaluate that.
Again, we're I think I've said, we're about to go into our our planning process that we will certainly look at those again and certainly take all of that into into account of what we expect are going to happen with rates kind of where our initiatives are but I would say that that what weve given guidance is what we feel comfortable with for now.
Great. Thank you.
Welcome.
Our next question comes from Michael Rose of Raymond James. Please go ahead.
Hey, good afternoon.
Just a couple of clarification hi, good afternoon, just a couple of quick clarification questions. So the noninterest expense guidance does that.
Include the MSR impairments that you've seen in the past two quarters.
Does that and then the variable deposit that was really the reason that I know we've expanded the range nothing else on the core we feel good about that but yes. It does include that.
Okay, and then if million dollar yet.
Perfect and then just wanted to get a sense for if there was anything in other fee income this quarter it looks like it jumped up.
About 6 million Bucks and had been running at a rate much lower than that.
Yeah that was the and I called that out in the commentary there was a $6.5 million related to a legal settlement, we had eight and a half in the first quarter six and a half in the second quarter, but there will be no more no more of that that's finished.
Okay. So that comes out of the run rate and then.
Just the.
No its variable from quarter to quarter, but the gain or loss on sale of loans held for sale was up pretty dramatically as Craig again, I know it bounces around but is there a way to think about that or how we should project that on a go forward basis.
No as I tell people, we have all of the information everything all the information and we have trouble.
Of forecasting it exactly like it is I guess all I can tell you is we were constantly evaluating the economics of the individual tranches does it because the spread is the does the does the additional carry outweigh the the additional cost to extend the hedge and so it just can vary from quarter to quarter based on the volumes that we're seeing and based on what the market is doing.
Okay, and then maybe just one final one for me just going back to the to the mortgage warehouse just.
Understand the.
The question earlier about the percentage it stands as a percentage of loans, but as we think about next year if rates. If we do get a couple of fed rate cuts and mortgage rates continue to.
Tick lower I mean would you be comfortable operating above.
Your range so to speak in the near term because historically you guys have had much stronger Altai growth. Obviously, it's a large numbers. This is a good opportunity set as you mentioned earlier it so.
Good risk return at this point in the cycle why one should continue to see.
Average balances grow beyond 2019.
Well, we we want to be sure we're optimizing our return to and so as much as we want to deploy.
Our our.
Alone.
Assets and capital well, we also just have to be really thoughtful about return on capital to Michael and so we will certainly take care of our clients were not going to be out there trying to win a lot of market share in this environment.
And I don't think we'll we'll want to operate above the guidance.
Over the next year or so but.
We'll have to evaluate that kind of quarter by quarter.
Based on returns and just also the overall.
The strength of the balance sheet and our capital position.
We we feel really good about where we are on capital, but it's important that.
We managed that really well so we have these other opportunities we're developing that we can exploit also.
Okay. Thanks for taking my questions.
Welcome.
Our next question comes from Brad Milsaps of Sandler O'neill. Please go ahead.
Hey, good evening.
Hi, Brad Brad.
Just to follow up on Michael's question, Julie about about the loss on the.
On the insured loans I think you mentioned on the fourth quarter call that you typically maybe see a bigger.
Hello, Brad did we lose you.
Yes, we'll move on and he'll call back in.
Operator should we take the next caller I think we lost Mr. Milsaps. So our next question will come from Gary Tenner of da Davidson. Please go ahead.
Well Gary.
It's disconnected.
Gary The line is up in our in our perhaps you're muted on your end.
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Hi, Yvonne.
And our next question will come from Chris Gamaitoni of Compass point. Please go ahead.
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I'm trying to determine the status.
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Okay. We will try to the next question from Brock Vandervliet of EUV, Yes. Please go ahead.
Can you hear me.
[laughter] Oh [laughter] that's great.
Hi, I just blew away the Q in front of me and that's that's amazing [laughter] whatever it takes to get to that question.
[laughter] yeah. It does seem like something wonky, what happened with the call but anyway.
Just on the on the criticized loans.
You know that the increase here from 364 to 629 is it.
Is it that they are just kind of stuck in the pipe and you can't you can't sell them.
Why are they why did they keep building up like this.
You're talking about the total criticized I mean, we're not trying to sell the criticized I mean, they are you talking about just the overall criticized level.
Yeah, and the criticized level and you know.
[laughter] given other.
No pressure in the portfolio I would think you might.
Try and work them down or.
Or take up your your yeah, I am puzzled that the rate of increase and that you can't you can't work those down more quickly.
Well I'll make a couple comments and then Keith can can.
Add some color, but you know one of the comments that dynamic in our commentary was this important just to know that the big increase in criticized from the end of the year to 630. The biggest category. This increase is special mention.
So we're not any special mention mean theres, some identified weakness, but that doesn't necessarily mean that that's something that's going to migrate. So when we this is typical of what we do when we see a weakness in a in a particular category is we maybe get a little harder on our grading and and downgrade things because we want them to get that special attention. So and we're conservative rock on upgrading our credit once we do have a downgrade and so to your point.
There will be movement.
In a number of these but it's just going to take more time, we want to see multiple quarters of improved performance before we say hey, This is fine now and so will grant you there were somewhat conservative on that but its served us well over the years.
Yes, I realize these are at the.
Beginning of the process as they are criticized.
Is there a level.
At which you would.
Consider taking up your provision.
Guidance.
Given the increase or.
You seem to be comfortable where it is.
At present.
Now we're comfortable we just don't see a significant migration.
From that special mention at this point so.
Again, we've identified a number of these credits were watching them carefully.
But we don't see that those are going to move.
To the right and become substandard or right away. If we if we really believe there is going to be more migration, our methodology would address at and how we would provide and it's all built into how we go about coming up with that provision.
Okay, and shifting back to the rate sensitivity.
And there are a couple of different comments earlier in the call about this but.
Relative to the disclosure that we see every quarter in the Q is your.
Is the sensitivity level likely to change.
Much here in the second quarter.
What are you seeing the Q, that's just kind of a regimented calculation, what we what the guidance that I've tried to give you is a more realistic view, where we take into consideration.
More the characteristics that we see in the different components, both on the asset side and the deposit side.
I put that regimen regimented calculation is unlikely to change that much.
Correct.
Disclosure is not going to change that's right. That's just kind of that that's that's a that's a it's based on FCC Guy and we kind of we do the math and it's a shock when it happens.
Just don't put a lot as a lot more qualitative thought into that as we do a one size fits all so we're trying to give you the more custom playlist view yeah. What we think is more realistic and it's taken a little bit more brain power to come up with.
Okay all right. Thank you.
Welcome.
Our next question comes from Ebrahim Poonawala of Bank of America Merrill Lynch. Please go ahead.
Hey, guys just one quick one Keith I think.
You brought up all M&A from a standpoint of acquiring something I was just wondering how the board and how you think about M&A from the standpoint of.
Merging with.
And in market or not of market clearer and do you see that as an avenue to create shareholder value or do you not think that the model like PCB I could work as part of a larger.
Pierre.
Well again, it's my job to be sure that I'm always looking at every option that would optimize shareholder returns ebrahim, but we find it very very challenging to find other.
Im OEE type.
Potential partners.
We found a very challenging that their model, what actually give us a tailwind post merger in terms of.
Higher performance better performance.
One of the Big challenges is we simply think the traditional brick and mortar distribution model.
It is really going to be a headwind models for years and years to come while it has a place and most banks.
Template.
We prefer our business model and the initiatives we have underway on.
On multiple new Treasury verticals, we think are going to set our model appears to be even more.
Model for others to emulate rather than us.
Again, considering getting onboard with with the model that I think is going to have a lot of headwinds.
And so and also the talent acquisition approach that we take is very unique and by organically growing and having this exceedingly high bar on any talent, we bring on and then the talent development once they are here.
We just don't see that as a as a common way to approach.
Talent building and talent acquisition with other with other companies and we think talent and technology are going to be just vitally important to deliver this very premier strategic connection that's going to keep us.
And that leads competitive company.
In fact, we want to be one of those top five right under the Mega five that are the best at the markets. We we cater to these private companies.
So it makes it difficult to see our way on a strategy that would be.
One that would succeed at that that elite level, and we think our model. It has a path we have a path to get there.
That is helpful. Thanks, a lot.
Okay.
This concludes our question and answer session I will turn the conference back over to President and CEO , Keith Cargill for closing remarks.
Well I'm very grateful to all my colleagues and other class for another strong quarter and for the progress, we're making to see great. The Texas capital Bank for the next two decades. Thanks to each of you for your interest in our company and we hope to talk with you say and if you have questions. Please call us. Thank you.
Thank you for your participation and TCB second quarter 2019 earnings conference call.
Please direct requests for follow up questions to Heather Worley at Heather Worley at Texas Capital Bank Dot Com you may now disconnect.
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