Q4 2022 Texas Capital Bancshares Inc Earnings Call
These actions to both provide context for where we are on the journey and share perspective on the opportunity that is in front of us.
As of today, we have addressed every single rebuild reorganization and restructuring that we said we would do at the outset of our plan plus much much more.
When I arrived fee income was limited and loan growth unfocused and represented an uncoordinated series of transactions without a comprehensive strategy as the only products available to serve our clients were basic credit solutions and very simplistic payment rails.
Achieving client relevance and earning our cost of capital was impossible under the prior model and our inability to serve clients in multiple ways led to an overemphasis of a loan product rather than active consideration of the solution best fit for the client's current or prospective need.
In contrast today, we have the tools and resources with a more durable and valued offering for our clients with over 20, New investment banking Treasury management and private wealth related services supporting our stated focus of being relevant to our clients throughout their life cycles.
Fees across these areas of focus are up $32 million or 68% since full year 2020.
And loan portfolio concentrations have been right sized through proactive risk reduction and focused calling efforts on the best in class, Texas based clients.
In early 2021, we made the first of many difficult decisions, we exited correspondent lending and sacrificed revenue to derisk the balance sheet.
Then in 'twenty, two we sold a disconnected national insurance premium finance business.
Sacrificing loan growth in order to refocus our business.
In aggregate. These two portfolio dispositions represented 10% of our starting loan portfolio composition.
C&I loans now comprise 52% of the total portfolio.
An increase of $3 3 billion or 48% since year end 2020.
The implementation of the balance sheet committee into our routines has been an instrumental tool to ensure our capital is increasingly allocated to our target clients.
75% of commitments reviewed by the balance sheet Committee during the last three quarters included treasury or ancillary product opportunities. In addition to credit extension evidenced in our desire to strategy is becoming increasingly ingrained in our daily client facing interactions.
We said, we would fix revenue contributions and build a client focused payments bank.
And we did.
Sustainably earn a return greater than your cost of capital requires a stable and reliable funding base tied to the core clients at the firm exist to serve.
The legacy funding strategy was also broken and characterized by an over reliance on disconnected high cost high beta in national deposit verticals that created headwinds to earnings growth and volatility as interest rates change we.
We knew at the outset transitioning our funding base would be hard.
And take time.
But that sustained emphasis on earning the right to be our clients' primary treasury bank will ultimately be a foundational element of our future success.
Repositioning of the deposit base consistent with our long term strategy began in early 'twenty, one and the many subsequent actions have been directly aligned with this effort.
Our first step was to rationalize a series of national deposit verticals, resulting in a $15 million reduction to annualized noninterest expense, which was reinvested and our focused strategy of supporting core Texas based clients. The proceeds contributed to doubling the number of client facing treasury management professionals.
And a wholesale tech enabled improvement in the treasury product platform.
Overall in 'twenty two a significant portion of total technology projects, Ben was allocated to an improved treasury solutions platform.
Projects, both delivered and currently in flight are on time.
On budget.
And meeting the expectations originally established.
To further enhance the funding structure of the firm the highest cost highest beta and shortest duration institutional index deposits, we're deliberately reduced from 32% to 13% of total deposits from year end 2022 year end 'twenty two.
Coupled with the 15% growth a full year average operating deposits in 'twenty two.
This is a critical input into our stated plans to transition the model to one was structurally less rate sensitivity and improved balance sheet efficiency, both of which are required to deliver against our desired return targets.
By addressing the loan concentrations and the funding base, we are building a balanced company, while establishing and now reinforcing cultural expectations that our success will not be marked by balance sheet growth, but instead by the relevance of our offerings and the quality of our advice.
We said, we'd fix the funding base and as people in financial services well no. This is not easy.
However, the foundation is established and the transformation is well underway.
To round out the balance sheet challenges capital levels were also lower than peers, which both negatively impacted market perception and raised concerns with regulators and rating agencies.
<unk> to this team as foundational commitment to financial resilience.
This excess leverage also created an inability to proactively manage capital to take advantage of market opportunities in a manner consistent with long term value creation.
During my first 15 weeks as CEO , we secured improved outlook from one of our two rating agencies, then recapitalize the firm another decisive action.
Recapitalization added approximately 250 basis points of total risk based capital through a $300 million preferred offering.
$275 million of subordinated debt and a first of its kind mortgage warehouse credit risk transfer.
This demonstrated clear action against our stated commitment to building a business model not reliant on excess leverage for short term returns, but instead operates from a through cycle position of strength.
Core component of how we believe you create sustained long term value build.
Building upon these actions.
During 2022, the firm developed implemented and began executing within a fully rebuilt internal capital planning and allocation framework.
Delivering this analytic framework required addressing weaknesses in a cumbersome and outdated legacy data infrastructure that impacted everything from call centers to expense allocations limiting the usefulness of legacy modeling tools.
These are now rebuilt.
As a result of this disciplined approach and the resulting capital framework further proactive measures during the year led to a higher and increasingly more focused capital position.
Well in excess of both our internally assess our risk profile and our externally communicated medium term targets.
Our capital considerations extend beyond our regulatory ratios and as we've stated are also focus on higher quality tangible book value growth.
Through cycle.
In Q1 'twenty two we took another crucial action, we transferred $1 billion of our lowest coupon longest duration securities to held to maturity.
To appropriately hedged the balance sheet should rates rise.
As of year end this reclassification allowed us to avoid additional unrealized loss positions by approximately $120 million.
Or 4% of TCE contributing to our success in improving TCE ratios and supporting tangible book value. During this volatile market period.
Tangible book value per share has grown over 5% since year end 2020, compared to a decline of nearly 8%.
Amongst the peer set.
This outperformance further confirms our commitment to steadily improving the value of the franchise, even during a two year period, where our focus was weighted more heavily towards building a bank then optimizing for short term financial returns.
In addition to increasing both our absolute and relative capital levels. The firm both implemented and acted upon a wider range of previously unavailable tools to proactively manage the capital base in.
In Q2 of this year, we put in place our first ever share repurchase program and over the course of the year executed $115 3 million of repurchases, reducing total shares by 4% at a weighted average price equal to approximately 100% of the prior months tangible.
Book value.
As of today, we have nearly completed the program and repurchased 5% of the shares since it began in Q2.
Finally in November we closed the well received and highly financially accretive divestiture of our National insurance premium finance business Bank direct capital.
The 8% asset premium pull forward four years of earnings for this business.
Generated approximately $165 million of capital.
Reduced 100% risk weighted assets by over $3 billion.
Which resulted in an approximately 220 basis points of CET one.
And importantly, it was accretive to earnings day one.
We have worked tirelessly to be in this position of strength with solid conservative capital ratios two investment grade ratings. The first time since 2015, and a balanced business model.
We have proven we prioritize a disciplined and professional approach to managing the firms capital.
During 'twenty three we expect to hold north of 12% CET, one with amounts in excess continue to be dynamically reallocated consistent with our well defined strategy and observed risk appetite.
We said, we would fix the capital base and we did.
Before the transformation high leverage was paired with a miss allocated expense base not tied to our strategy for long term scale.
The legacy investment agenda lacked a sustained focus.
Prioritize incompatible infrastructure, an expensive build outs for noncore businesses now.
Now we successfully re underwrote all of our expenses and over the last year steadily reposition the cost base to support consistent advancements in the businesses, where we know we can compete.
And when.
During 2021, we undertook a series of actions to release on productive experts to invest against the strategy stated.
The corresponding lending business has wound down and MSR portfolio sold in the second quarter to both improve through cycle earnings variability and to unlock $70 million of expenses that were directly reinvested into the strategy.
Underused inefficient and redundant software technology assets were written off for a total of $12 million in the third quarter.
Coupled with additional $15 million of deposit vertical rationalization and $40 million of other realized internal opportunities.
In the first year, we repositioned approximately $140 million of run rate expenses, enabling the transformational activities delivered in 2022.
Additional savings through the divestiture of bank direct in late 2022 allows for $36 million of annual expense to directly contribute to improved profitability.
The go forward run rate as a clean expense base directly matched to our strategic goals as we move to a period of more normal investment and improving performance.
<unk> alignment is foundational tenant of future scale, and we expect the proportion of noninterest expense directly attributable to our people technology and operational infrastructure to remain a priority.
We said, we would fix the expense space and we did.
Since the previous operating model offered limited.
Or a poorly functioning product suite and relied on excess leverage to deliver returns.
The historical loan portfolio concentrations were cyclical and overweight.
This outsized risk profile, coupled with poor client selection and energy and leverage lending led to substantial charge offs $273 million during 2019 and 2020.
While large holds led to overexposure in the wrong sectors and sub optimal risk adjusted returns.
We are now providing capital discipline via the balance sheet Committee.
Coupled with a new CEO led enterprise risk culture ensures resources are more prudently directed towards achieving our goal of earning deep long term relationships.
Our entire credit risk management team and platform is rebuilt.
Aligning sector specific credits expertise with a new set of business leaders focused on client selection and adherence to appropriately establish concentration and hold limits.
Loan portfolio diversification has materially improved as our balance sheet is now a vehicle to support our clients' broad financial needs rather than an overemphasize internal growth metric, providing a false sense or short lived success.
New credit disciplines are supported by a complete overhaul of our underlying processes systems and technologies.
After a $7 million of legacy spend associated with unsuccessful attempts to implement a credit onboarding process.
The firm on the other hand delivered its first and a credit loan management system named Allo escape, a significant contributor to reducing operational risk.
This loan management system enables onetime data capture.
Standardized workflows for more efficient processing and improve client and stakeholder visibility, including foundational capabilities for future automation.
Finally, we continue to thoughtfully resolve legacy credit issues, while building a reserve consistent with our objective of being appropriately conservative.
Current reserve levels are now 49 basis points greater than seasonal day one.
In the top 20% of peers as a percent of total loans.
And over five two times nonperforming loans.
We have said before that being appropriately reserved as both a metric and a mindset and with coupled with our strong capital position a competitive advantage heading into this year.
We said, we had fixed loan concentrations and focus on client selection and we did.
Finally, the historical organizational structure of the bank managed with a siloed mindset did not allow for the ability to scale or provide adequate transparency during.
During my first year at the firm, we established organizational routines to ensure resources are effectively allocated against strategic priorities and that decision, making and execution is not hindered by inefficient processes with limited information.
All necessary parties are at the table to achieve our goals.
<unk> leadership also implemented an expectation of clear communication execution transparency and accountability throughout the enterprise.
This was further emphasized firm wide as functions, where centralized and the operating committee restructured to directly align accountability against strategic and financial initiatives.
During 2022, we further reorganized operating model around client delivery to emphasize client experience.
Firm wide every process flow across credit delivery, Onboarding Treasury services and deposits and payments was reconstructed to meet this objective and is now further grounded and solidified risk controls through our risk controls self assessments.
Detailed procedures are also now in place serving to automate manual and error prone processes, while operational reporting dashboards now systematically measure and highlight opportunities driving continuous improvement and reduce operational risk.
The organization is now structured within a more efficient higher quality operating model driving both client and employee satisfaction, while supporting future scale.
We said, we would re imagine the client journey by improving the organization structure and operational infrastructure and.
And we did.
By addressing the legacy challenges of the previous operating model, we built a coverage product and technology required to serve our target clients and are now poised to deliver the next phase of our multi year transformation.
Our business banking middle market and corporate coverage areas are well established and match each client set with the talent products and offerings they need to succeed.
Since I arrived we have grown the number of client facing professionals by one nine times across our defined industry and geographic coverage.
By combining this coverage model with expanded Treasury solutions, a holistic private wealth offering and unique investment banking capabilities. This construct allows us to serve clients through the entirety of their lifecycle with a delivery model and solution set tailored to support them at each step of their journey.
As we seek to be relevant to our clients each day assisting them in addressing their day to day working capital needs in an efficient and secure manner, we meaningfully improved our treasury and payments platforms completely transforming operations technology and products to build a real payments bank.
In 2022, the Treasury solutions group implemented a new enterprise payments platform and launched API connectivity significantly improving the quality and ease of digital banking for our clients.
Said simply our cash management offering from basic wires on an antiquated platform to a best in class Treasury solutions platform.
Our investment banking Division Teck's capital Securities and a Texas based institution offering a full suite of investment banking products and services focused on delivering exceptional outcomes for our clients launched in mid 2022.
Well ahead of schedule.
We are now leveraging our deep knowledge of industry dynamics complemented by our extensive network of capital sources to deliver results that are aligned to our clients' definition of success the.
Sales and trading group now offer significant experience in mortgage securities and corporate fixed income convertible and equity markets.
Leveraging our considerable network of domestic and international institutional relationships. Our team is now providing clients with actionable insight and access to global markets.
And a year since we received FINRA approval, Texas capital Securities has delivered the following first.
Our first swap trade first FX spot trade first TBA trade first specified MBS pool trade first whole loan trade first corporate bond trade first corporate loan trade first equity trade first biocide advisory mandate and close its first sell side advisory success.
<unk>.
We on boarded 150, new clients and traded over $9 billion of mortgage and corporate debt and equity securities.
And finally tax capital Securities partnership with mortgage finance has been critical and evolving the business from a warehouse only platform into a differentiated industry vertical characterized by multiple new products and services.
To meet clients' needs in real time, resulting in incremental treasury and deposit relationships with top tier national mortgage lenders.
The full lifecycle of a client extends beyond our corporate profile and it closed a personal financial wellbeing.
We are rebuilding and significantly enhancing our successful, but subscale private wealth business and are halfway through our project plan, which includes updating our go to market strategy expanding our products improving our back office operations investing in our front end client experience and adding additional quality talent complete.
Completion of this wholesale improvement is targeted by the middle of this year.
In total we have launched over 20, new products and services in the last two years and have detailed and achievable roadmaps to deliver the over 25, new offerings targeted by 2025.
The improvements of our technology and operating platform are also significant we are beginning to see our investments generate efficiencies in operations, while uplifting the client experience through vastly improved Onboarding times.
Straight through processing and reduced meantime to resolve client issues and incidents.
We internally developed and delivered a market leading cloud native software named initio are proprietary account opening and Onboarding solution, which has received praise from our beta clients and we expect that over 50% of all treasury Onboarding requests will be completed digitally by March.
This means that existing and new commercial clients will be able to self serve account opening products and services will be attached automatically and they can use the account same day.
This puts us at or above parity will compared to the most digitally forward banks in the country.
Other transformational technology infrastructure builds include cortex.
<unk> modern API driven services platform.
<unk> hundred 60 across <unk> operations management system, and a completely modernized cloud based data platform.
Underneath these new platforms and applications, we increased transparency and efficiency of operations from front end to back office through a CRM overhaul.
Another legacy challenge relating to $20 million of legacy expense split on something that simply did not work when I arrived the implementation of corporate management information system for cost cutting metrics automation of infrastructure network improvements deployment of new hardware and the implementation of a new cloud based call Center.
Platform I have often said the biggest risk to our strategy was a need to build each pillar of the platform simultaneously.
Which was an acknowledgement of both our opportunity and of the limited infrastructure in place.
Through five quarters of dedication and focused execution by people across the firm. This execution risk has been further mitigated as the businesses were built and the needed capabilities landed on a more scalable platform.
The accomplishments over the last two years resulted in a firm that is poised to begin delivering structurally higher and more stable financial returns for our shareholders over time.
We are heading into 2023 operating from a position of strength.
The expense and capital base are aligned directly to our strategic priorities.
We are recycling capital into new and profitable relationships and improving our relevance with both existing and new clients.
Our balance sheet is the best since the bank's founding.
Portfolio concentrations increasingly match our desired composition.
Liquidity and funding are higher quality.
And our institutional financial reliance is a true strategic advantage positioning us well for the potentially challenging operating environment.
The significant investments and efforts to rebuild a firm are largely in the ground and we are transitioning our focus towards leveraging the full breadth of the new platform to achieving first call status with our best clients and prospects in our markets.
This thoughtfully and deliberately rebuilt client focused business model is designed.
To earn above our cost of capital through cycle and drive structurally higher more sustainable earnings.
It is very important to appreciate that this transformation is a result of the tireless work of each of our 2200 people across the entirety of the firm who truly bought into the strategy accepted that the rebuild is harder than status quo, but believed it was worth it as we work together to build a new.
Company collectively we make up the new Texas capital I would like to express my sincere appreciation for the continued efforts and dedication to our strategy vision goals and our core values. We have so much to look forward to in 2023 as we execute upon what we have established this year I'll now turn the call over.
Matt who will provide the financial details for the fourth quarter.
Thanks, Rob and good morning, as Rob described we are increasingly transitioning the firm's focus from a period of concentrated build to state a purposeful execution as we begin to mature uniquely broad and client centric offering into scaling platform that delivers against our long term objectives today with client coverage build out largely complete and targeted capabilities now in place we are positioned to accelerate <unk>.
Every against our defined financial goals.
Our value proposition continues to resonate and.
C&I loans increased again this quarter, finishing the year up $2 3 billion or 29% relative to the fourth quarter of 2021.
We also delivered notable progress in our fee generating businesses in the quarter, which will over time grow in contribution as we improve our relevance with our now consistently expanding client base treasury product fees are up 27% year over year, reflecting increased adoption of our newly built cash management and payment capabilities wealth management income also rose materially year over year as AUM growth of 11%.
<unk> broad market declines, resulting a 14% increase in wealth management and trust fee income during 2022.
Rounding out our noninterest income areas of focus investment banking and trading income grew 43% this year with the $11 $9 million realized in the fourth quarter setting the high watermark since we launched the business earlier this year.
Taken together fee income from our areas of focus increased by approximately $19 million or 31% year over year, representing steadily improving client receptivity to the completely refreshed operating model and capabilities that Rob described in his comments.
Turning to slide 11, total adjusted revenue was up $12 3 million or 19% annualized linked quarter and increased $51 2 million or 23% when compared to fourth quarter 2021.
Quarterly results benefited from an $8 $5 million increase in net interest income mainly attributable to the continued realized benefits for asset sensitive balance sheet modest improvements in the composition of our asset mix and continued reduction in our highest cost shortest duration deposit sources.
Additionally, investment banking fee income was up by $4 1 million on a linked quarter basis, our syndicated loan fees doubled quarter over quarter and increased 56% year over year. A result of improved capabilities and stated client focus the divestiture of our insurance premium finance business closed in November resulting in the recognition of a nonrecurring $2 to $48 5 million.
Pre tax gain.
We stated clearly that while our long term plans do account for continued investment much of the initial lift to deliver the foundational talent technology products and capabilities was incurred over the past two years and we do expect slowing expense growth in 2023.
Q4 expenses includes several nonrecurring items related to both the divestiture and restructuring reserves associated with the continued implementation of our target operating model.
These items include $13 million in legal and professional expenses related to the divestiture $9 8 million in restructuring expenses and $8 million to fund the newly created Texas Capital Bank Foundation.
Taken together <unk>, excluding nonrecurring items increased 13% linked quarter to $94 4 million, which is a 20% increase relative to the fourth quarter of last year.
As we indicated during our Q3 quarterly call after achieving this important milestone in the last quarter, we do expect to maintain year over year quarterly peeping, our growth moving forward, including throughout 2023.
Of note the divested business unit contributed $8 $3 million of revenue and $2 8 million of expense during the month of October resulting at $5 $9 million PNR contribution during Q4, when applying our observed cost of funds for the month of October .
As Rob mentioned with the proceeds invested into cash we recognized immediate PPE and our accretion.
Adjusted net income to common was $44 3 million for the quarter down 11% compared to the third quarter as a result of the $22 million increase in quarter over quarter provision expense.
Overall credit quality remains historically strong although we continue to prepare for inevitable normalization, which based on external factors appears increasingly likely this year.
We recognized $15 million of net charge offs during the quarter as expected losses on certain legacy credits move closer to resolution.
Compared to net charge offs of $2 7 million in Q3.
We've previously indicated that we closely monitor an identified list of legacy credits and the weighted average origination dates of the charge offs recognized during the quarter was mid 2013.
Criticized loans increased $29 million quarter over quarter to 266% of <unk>, primarily a result of continued migration in a small number of consumer dependent C&I credits.
This quarter's provision expense was impacted by both realized charge offs and observed and expected portfolio trends.
Finally on capital, we repurchased $65 3 million or $1 1 million of common shares during the quarter.
Equal to two 3% of prior quarter shares outstanding at a weighted average price of $57 in 'twenty.
The modest decline in interest rate outlook as of year end resulted in slight improvement in OCI $16 5 million.
Considering the realized gain on divestiture, we ended the year with CET, one of 13% and tangible book value per share of <unk> $56 45.
Quarter to date, we have repurchased approximately 450000 shares of common stock and have nearly completed our inaugural share repurchase program.
Turning to slide 12, C&I loan growth moderated this quarter is the more cautious client sentiment described on the third quarter call resulted in period end C&I loan growth of $143 million.
Even with the reduction in recent volumes sustained loan growth over the past four quarters has driven C&I balances, excluding PPP and insurance premium finance loans, $2 3 billion or 29% higher year over year consistently delivering our improving value proposition to core Texas based businesses is resulting in a balance sheet increasingly comprised of client base the benefits from our <unk>.
<unk> platform of available product solutions delivered within a rebuilt and enhanced client journey.
Growth continues to come primarily from new and expanded relationships.
As utilization rates moved down slightly in the quarter to 51% and remain in line with our pre Covid average of low <unk>.
Moving to real estate period end real estate balances increased $183 million of 4% in the quarter as payoffs slowed supported by modest mix shift toward term over the last 12 months.
This is one of the most mature businesses at the firm and we take it through cycle view grounded in client selection and managed portfolio using established and well tested concentration limits new origination volume slowed in the back half of 2022 and remains focused on multifamily.
Both our deep experience in this space and observed performance through credit and interest rate cycles.
Average mortgage finance loans declined by 19% in the quarter comparing favorably to the estimated 25% or greater levels of broader market contraction as our industry specific product offerings are increasingly compelling and what is and is expected to continue to be historically challenged market environment.
Full year industry originations declined by approximately 50% in 2022 compared to our full year average decrease of 34%.
As a reminder, while distorted by the rising rate environment experienced over the last 12 months outstanding balances in this business reflect the typical seasonality associated with home buying activity rising in the second and third quarter, then falling in the fourth and the first.
Assuming the current rate outlook remains intact expectations are for total market originations to declined by 15% to 20% in the first quarter. We expect the same dynamic in Q1 as seasonality is paired with continued rate and industry specific pressures.
Near term pipelines remain reflective of a more cautious client outlook and are comparable to the levels. We saw at the beginning of Q4.
Moving to slide 13, as Rob discussed through a series of actions over the last two years, we are thoughtfully shifting our balance sheet the businesses, where we believe multiple client touch points will over time result in a higher quality funding base increasingly comprised of our clients' primary operating accounts, while pleased with the observed progress and associated benefits.
Relative to the last tightening cycle, we are realistic on our expectations for achieving target state.
We remain in the early stages of our funding transformation and do anticipate deposit costs and betas to continue increasing as market pricing response to the rapid pace of fed tightening.
Total ending period deposits declined 7% quarter over quarter with changes in the underlying mix reflective of both the continued funding transition in a tightening rate environment and predictable seasonality exacerbated by market driven trends.
Noninterest bearing deposits represented 42% of total deposits at period end and were down 16% linked quarter as mortgage finance deposits experienced seasonal fluctuations associated with tax payments from escrow accounts, coupled with moderate impacts from select client repositioning tax.
Tax related escrow deposits will begin to rebuild in Q1 as I do every year and if market conditions hold we would expect average quarterly mortgage finance deposits to remain between 100% to 120% of average total mortgage finance loans throughout next year.
Average full year commercial operating deposits increased 15%, reflecting our focused strategy to generate and sustain operating account growth.
Our highest cost most rate sensitive deposit sources continue to be de emphasized in favor of more granular and modestly less rate sensitive options, including bask.
Q4, ending period balances and high Beta index deposits contracted $788 million and now represent just 13% of total deposits. These balances are down $3 7 billion or 55% year over year.
Due to our sound current and prospective liquidity position. This quarter. We also had $170 million of brokerage Cds mature without replacement.
Ending period brokerage CD balances of $1 1 billion are expected to continue mature throughout the year with $228 million of one 2% coupon Cds rolling off in the first quarter.
The remaining weighted average portfolio coupons, it's two 5%.
Supported by the proceeds and accompanying flexibility created by the BDC up transaction, we will continue to use our balance sheet to onboard clients, where we believe there are or will be meaningful treasury opportunities.
<unk> reduction in our highest cost deposit sources is likely to persist as improving the quality of our liquidity as a prerequisite to establishing a more efficient balance sheet.
Despite this focus our current outlook anticipate sustained pricing pressure and we do expect continued upward trajectory for interest bearing deposit betas alongside planned fed rate increases.
Turning to NII sensitivity on page 14 as expected after decreasing materially in Q3, our asset sensitivity increase this quarter.
Modestly to 8% or $77 million and a plus 100 basis points shock scenario on a static balance sheet as the underlying composition changed quarter over quarter.
Proceeds from the 61% fixed rate Bcf portfolio were invested in cash and a reduction in our most rate sensitive deposits increased our overall exposure to changing rates.
Model base net interest income depicted on the slide assumes the balance sheet remains constant in terms of size and composition, meaning the expected seasonality of various businesses is not captured nor is the anticipated evolution of our business over the defined time period. This is a potentially useful view for comparing point in time earnings at risk cross firms, but should.
Not be viewed as a forecast.
Following a brief pause in early Q4 subsequent to the closing of the BDC up transaction actions resumed to reduce the amount of future earnings exposed to changes in forward interest rates with the addition of $255 million of securities to the investment portfolio.
Core component of our asset sensitivity profile as a large portion of our earning asset mix that re prices with changes in short term rates exiting the year, 93% of total HIV portfolio. Excluding <unk> is variable rate with 86% of these loans tied to either prime or one month index.
Net interest income produced by our mortgage finance business is not as sensitive as the rest of the portfolio to changes in index rates due to the pricing dynamic of the associate escrow deposits held in non interest bearing accounts, which in some cases receive compensation in the form of interest rate credit.
The asset sensitivity figures depicted on the slide account for the behavior of pricing relative to both mortgage finance loans and deposits.
Moving to slide 15, net interest margin increased by 21 basis points. This quarter, while net interest income rose $8 5 million predominantly as a function of higher loan yields and increased income from significantly larger cash balances from the divestiture proceeds partially offset by an expected increase in funding costs.
Similar to the last several quarters timing associated with the late quarter fed move coupled with quarter end spot rates suggest the full impact of the 125 basis point Q4 rate increase will be more fully realized in Q1.
The investment portfolio grew this quarter as we reinvested $65 million of cash flows and began a multi quarter process of remixing excess cash balances by purchasing $255 million in agency MBS and U S Treasury Securities.
Purchases came on the book at four 7% yield versus those rolling off around one 5%.
As the characteristics of our deposit base continues to improve we will be actively looking to prudently, bringing our excess liquidity levels closer to our published targets. While also taking advantage of market opportunity to more efficiently balance our liquid asset composition with additional securities purchases.
Noninterest expense adjusted for nonrecurring items benefited in Q4 from two months of cost savings associated with the insurance premium finance divestiture and.
In addition to the previously discussed nonrecurring expenses legal and professional expenses rose in part due to noninterest expenses associated with deposit compensation.
This expense is expected to increase in 2023 and is included in our full year noninterest expense guidance.
Year over year, adjusted noninterest expense grew 16% or 13% when compared to the $600 million starting point referenced in our 2022 full year guidance.
<unk> priority established over the last year remains intact and we continue the disciplined process of systematically aligning our expense base with our published strategic priorities.
Turning to page 16.
Criticized loans increased $29 2 million or 6% in the quarter to $513 2 million or $2, 66% <unk>.
As early grade migration in these categories continues to be primarily driven by commercial clients reliant specifically on consumer discretionary income.
While criticized loans are down 12% since year end 2021, we do expect a breadth of industries and client types experiencing grade migration to expand in the coming quarters as the economy slows and.
And are pleased to be entering the year with reserve levels at 131% of total NHI and five two times non accrual loans, both at or near cyclical highs.
Capital levels are also strong and we remain committed to managing the hard earned capital base and a disciplined and analytically rigorous manner focused on driving long term shareholder value.
As Rob mentioned the gain on the insurance premium finance divestiture bolstered our already strong capital position and we ended the year and the best capital position and firm history.
CET, one and total risk based capital finished the quarter at 13% and 17, 7% respectively.
In the top 10% appears in well in excess of both short and longer term targets.
Finally, as we near completion of our inaugural share repurchase program. The board has authorized a new $150 million program. As we did in 2022, we will consider the ramp capital uses as we make capital allocation decisions to enhance long term shareholder value.
Consistent with our previously disclosed framework, our preference remains reinvesting capital into the value accretive growth of our Texas based franchise and we are pleased to be operating with a strong hand heading into a potentially more challenged operating environment.
Looking ahead at 2023, consistent with the methodology disclosed last year to better highlight the impact of a potential financial performance our guidance accounts for the forward rate curve and assumes a peak fed funds rate of five 5% in mid 2023 with a year end exit rate of 475%.
We expect total revenue to increase year over year in the mid teens percent range as full year impacts of the balance sheet transitions are paired with increasing contribution from recently added coverage and capabilities.
As Rob and I, both indicated earlier, a large majority of the expense growth related to the wholesale transformation and infrastructure build is behind us.
We of course have additional investments already in flight, but we expect to begin realizing operating efficiencies as we entered the year executing within our target model.
As a result, we expect full year noninterest expense growth of low double digits.
Together these expectations should result in the maintenance of operating leverage is defined as year over year quarterly PPR growth. This.
This metric is important given the aforementioned seasonality associated with our business, we expect a predictable decline in linked quarter performance moving into the traditionally slower first quarter, which is why measuring PNR relative to the same quarter in the prior year is a more appropriate metric by which to assess progress.
Moving to the balance sheet market expectations call for further decline in mortgage originations during 2023 with full year volumes anticipated to be down by more than 25% from 2022 levels, given our market positioning and expanded products. We do expect to maintain modest outperformance, but remain cautious given the wide range of potential rate and market outcomes.
As we continue to deploy cash proceeds from the divestiture.
We will prioritize actions that reduce our asset sensitivity and help stabilize the earnings power of the bank through cycle over the course of the year, we will look to bring our published sensitivity down to a mid single digit level as measured in an up 100 shock scenario with the pace and levers used ultimately dictated by our strategic progress and market conditions.
At this point in our transformation, we remain committed to holding greater than 20% of our total assets in cash and securities, but do expect the absolute level to come down through the year and the composition to change consistent with our goals to reduce interest rate sensitivity.
When we set forth our strategic plan, we accounted for an economic downturn over our planning horizon and the path to reach our 2025 goals does account for more normalized level of provision.
Lastly, we are committed to conservative capital levels and as Rob mentioned, we maintain our CET one capital ratio of 12% throughout 2023, as we earn the right to operate at a lower level in the future with.
With that I'll hand, the call back over to Rob.
Thanks, Matt.
Available to answer any questions operator.
Thank you if you would like to ask a question today. Please press star followed by one no telephone keypad. If you changed with Hello. A question. Please press star followed by case on the <unk>.
Can I ask a question please enjoy your day.
Lee.
And our first question, we'll go see Brett Robertson.
Robertson of Hovde Group. Please go ahead your line is open.
Hey, good morning, Thanks for taking the questions.
The first.
Rob I'm curious about how you view the environment, where in the past it was really hard to hire talent.
Additive.
Landscape seems like fast east West always curious I'm thinking about the expense growth this year.
We're expecting maybe the acceleration of hires just given the environment with the pullback from some competitors.
On that front.
Sure. Thanks.
Good question.
The broader Texas economy assay.
Manufacturing output decline as it did in the fourth quarter other firms are not hiring as aggressively in the past.
<unk>.
During the summer months.
Employment growth in Texas fell, but not as much as the national average. So I was just kind of the macro.
If you will we as a firm as we start as we stated in our comments the.
The majority of the.
The spend is behind us and the transformation that includes wholesale hiring as well we built the businesses.
They are largely in place and they will grow as they grow organically we do have.
Different.
Opportunities.
To add select talent on a select basis as we move forward, but we feel really really good where we are the good news is.
As you said the hiring across the board has slowed the competition for talent.
I think has peaked.
That's just a coincidence of where we are in the transformation.
<unk>.
I think we're going to slow hiring, but it's not because of the environment necessarily because where we are in the journey.
Okay. That's helpful and then.
Matt a question for you you want to make sure I understood. The balance sheet management going forward, you mentioned buying securities wanted to make sure.
Or do you maybe get a little better color on the magnitude.
Securities purchases, managing our cash position and then just thinking about the overall balance sheet management.
'twenty three in terms of thinking about the liquidity on the balance sheet, maybe you could keep the balance sheet fairly flattish or.
Tend to grow it if the deposits are successful.
Growing from here.
Yes happy to take that Brett it's fairly complex calculus, as you would expect but like everything else. We're doing around here really thinking about our aggregate ability to steal the spear to place to a point, where we can sustainably earn a return in excess of the cost of capital. So we look at the impact of changing rates on the balance sheet and business model, we generally like that guide our.
<unk> just stated in the comments that we would like to take the earnings at risk in an up 100 scenario down into the mid single digits. This year, while keeping liquidity assets above that 20% threshold you will see the mix likely shift from heavier weighting towards cash into securities as we do that but of course, we'll balance securities in <unk>.
<unk> portfolio, depending on where we see forward rates going.
And just to be clear.
They're a targeted cash position you think you would want to get too might end up at.
Yes, I think again, it's pretty dependent on the rate environment.
But if you look at the portion of our total liquidity assets today that sit in cash versus securities.
Ladies scenario, where that could slip in the heavier weighted to securities.
Yeah.
Okay fair enough. Thanks for thanks for the detail.
You bet.
Thank you and the next question guys, Hey, Matt Olney of Stephens. Please go ahead. Your line is open.
Hi, Thanks, good morning.
I wanted to drill down on deposits and specifically on the DDA.
Matt you provided a disclosure around mortgage finance DDA I think as a percent of mortgage finance loans can you just kind of clarify what that disclosure was for the year.
Yes, you bet that in general mortgage finance DDA as youre going to equal about 120% mortgage finance loans and Thats again.
It depends on where you are seasonally there's obviously another year outflow as people pay their taxes and then you start to see that build back up into the first quarter, but generally you can think about is about 100% to 120% deposits relative to loans and mortgage finance.
Got it okay. That's helpful. I appreciate that.
Disclosure.
And then I guess kind of looking at DDA is from non mortgage finance clients I think there were $6 billion year and I know the bank is adding new.
Commercial operating accounts with its higher but on the other hand with higher rates, we're seeing borrowers move deposits into interest bearing accounts. So would love to hear any kind of commentary about expectations of the <unk>.
Non mortgage finance DDA balances from here. Thanks.
Yes.
It doesn't really pleased with success in adding commercial operating accounts over the last few years in.
Average deposits in that space are up 15% year over year.
Expect candidly an acceleration in our ability to add clients some of the balance sheet and income statement impact could be muted by changes in earnings credit rate as rates rise, but both our ability to attract those clients and their deposits along with continued penetration for the new treasury products and services to Rob's comments are right on track.
We expect a continuation of that trend for the duration of this year.
Okay I appreciate that Matt and then just lastly around the strategy good to see you reiterate the guidance around the positive operating leverage and I guess from our perspective, it's clear the bank has a good tailwind right now from from higher rates and the bank's sensitivity to.
To higher rates, but assuming that that takes a pause here in the near term.
There could be some some pressure as you move into the back half of next year or this year on the margin. So just looking for any kind of commentary that you can get us more comfortable with maintaining that positive operating leverage the back half of this year and into next year.
With with rates that may be not as cooperative.
Yes, thanks, Matt for coming out.
Importance of that year over year quarterly P&L are so I just wanted to reemphasize as we didn't have comments the seasonality associated with the balance sheet and ability to ability to generate earnings.
So we said all along that we're trying to build a business model that is less dependent on rates and as we continue to accelerate progress across the new capability build in particular private wealth and notably the investment bank.
Really to generate earnings from sources other than margin is going to improve which does give us confidence that despite the rate outlook will be able to achieve guidance. This year.
Okay. Thanks, guys.
You bet.
Thank you and the next question guys, Hey, Jonathan back over to MS. Jennifer. Please go ahead. Your line is open.
Okay.
Thank you good morning.
Hi, Jennifer.
Hi, curious on on asset quality your higher level of net charge offs. This quarter as you think.
Take some losses on some legacy loans, how much more loss content do you see in this legacy portfolio that maybe you could be realizing in 'twenty three or 'twenty four.
So.
The legacy <unk>.
Issues that we've talked about in the past.
Right.
I think we've been pretty vocal for a while about the amount that we saw has worked its way down.
About $130 million left in the portfolio.
And Thats.
Those are loans and clients that we would like to work.
Off the balance sheet over time.
So a very manageable number.
Okay.
Okay.
Not too much left and is.
Is that $130 million concentrated in any one industry or type of loan.
No.
Yes.
What is the plan.
I'll, let Matt correct me, what I understand is the majority of it is.
As for sponsors.
Across the country without a sponsor relationship.
Thanks, Bob.
The firm had trouble with in the past and we're working our way through those the rest is pretty is pretty distributed.
I think that's entirely accurate Jennifer there there are legacy credits wholly inconsistent with how we underwrite today.
And we comment in the script that the weighted average origination date of those charge offs was 2013.
So we'll continue to work our way through those as we get opportunity for resolution.
And consistent with underwriting since Roger idle.
And what are you seeing in terms of credit trends in the rest of the portfolio.
Other than what you noted in terms of non non accruals being up from from businesses.
More dependent on discretionary on consumer discretionary.
Yes, Jeff I mean, the fed has been on the path now for nearly a year to try to increase unemployment and lower consumer spending.
Over that same period, we've been consistently conservative in our view and our approach to how we manage the reserve, adding nearly 40 basis points over the last 12 months.
So well all the later stage indicators of credit out that actually improved year over year, So criticized down 12% CAGR down 33%.
We are seeing some downgrades in the past rated book, which we would obviously expect so when coupled with our conservative outlook. That's what drove the provision expense. There is no real trend to highlight there other than just we're going to continue to take a conservative approach and be timely in our changes.
Underlying credit grades.
Yes.
Thanks, so much.
Thanks, Jennifer.
Thank you and the next question you guys have Brady Gailey of <unk>. Please go ahead. Your line is open.
Thank you and good morning, guys.
Yes.
Alright, Thanks, I wanted to start with the share buyback if you looked at it.
Yes. Thank you I wanted to start with the share buyback. If you look at last year. So 2022, you repurchased about $115 million of stocks about 4% of the company and despite you doing that your common equity tier one increased from 11% to 13%.
It feels like the buyback could be.
Lot larger in size this year versus last year.
Is that correct and is there any way to help us size, how big the share buyback could be this year.
Yeah. Thanks, Thanks Bree.
I thought you'd be happy with our.
First share repurchase program that you want more.
Okay great.
On a serious note we talked about before we have a highly disciplined framework that we go through on share repurchase as you know much to your frustration and some others.
We look at organic growth.
Other opportunities.
There is a whole metric of framework that we work our way through before we decide on capital actions.
Before.
Two years ago, we weren't in a position to do any capital actions whatsoever. Now as you know we are we're still balancing that against those opportunities.
<unk>.
As you know my preference is to invest in the business and organic growth and progress across the firm.
But the fact of the matter is when you can buy back.
Hundred $50 million of share tangible book.
That's pretty good and you cant ignore that and we could afford to do both at this period of time with very conservative capital liquidity levels, and still and reinvest in the business.
We felt good about it.
We will continue to be disciplined and opportunistic on the buybacks.
As opportunity presents itself.
So to project how much this year, how can you do that.
I can tell you it will.
Alright.
Sorry, Greg go ahead.
Yes.
My follow up question is just kind of a bigger picture question on the ROA.
You have the one one target out there for 2025.
Look at the core ROA for last year was about 50 basis points.
That's down from 65 basis points in 2021, I know you guys are investing a lot.
The revenue producing activities, but when should we expect to start to see the auto really inflect higher.
Do you guys still feel good about the 112025.
We definitely feel good about our ability to achieve the longer term targets Brady.
And you will see material progress down the course of the year.
Seasonal step back in the first quarter, which will include most performance metrics as you have seasonally slow warehouse and then for the duration of the year Youll see a steady build as we continue make progress against those targets.
Guidance, we've given you a lot of components to assess what that progress it looks like this year, including how we're thinking about capital and liquidity levels.
And one of the slides because the comment we've made quite often.
Rich.
Fully realize that this is the year to transition from capability build.
<unk> financial performance and the Companys oriented to go do so.
Okay, Alright, great. Thanks, guys.
See you.
Thank you and our final question guys, Hey, Brad Millsaps of Piper Sandler. Please go ahead. Your line is open.
Hey, good morning, Thanks for taking my question.
Hey, Brad.
Yeah.
Matt I joined a few minutes late but I think I heard you mentioned that the increase in professional fees after making the adjustments. The last couple of quarters, primarily related to maybe ECR cost.
I was wondering if in fact that is correct and then can you give us a sense of.
As we see further rate increases how much more that.
Could go up it would almost seem that.
If you have a roughly $80 million year over year increase in expenses, maybe half of it is coming from that of professional fee sort of hold here, but just wanted to make sure I am understanding.
That relationship correctly as you kind of move forward.
Yeah. Thanks, Brad to just a couple of points to call out. So there's a lot going on with noninterest expense this quarter and this year.
$680 million adjusted noninterest expense is what we're building full year guidance off of and then if youre thinking about run rate for those who may have an interest in building models.
182, three is a pretty good fourth quarter number although the underlying composition is going to shift a bit.
Somewhat unusual or episodic items.
Weighted what we would call sort of other noninterest expense and then <unk>.
Kris some of the salary and benefits expense as we reset accruals. So if you look through that legal and professional lines.
Keep about $2 million of that increase.
And then there will be some sensitivity in that line on the income statement as we see or don't see rates move up.
Closing individual or incremental move is probably not what we're willing to do at this point just given some of the competitive nature of how we compensate folks, but you are right that that will be an area that is going to be sensitive to interest rate changes.
Yeah.
Got it Matt and if I look at it bigger picture, although you've guided to low double digit if I annualize the fourth quarter.
Really only represents maybe 4% to 5% growth over the.
The fourth quarter or is that is that a level that you guys kind of hope to aspire to you going forward I know you've got a lot of investments in a lot of things going on but.
Looking looking at it through that lens. It seems it seems a little better than what double digit might first appear to people.
I appreciate the question Brad.
We then I think pretty clear that the volume of investment is absolutely slowing.
But the number of people the amount of.
Infrastructure build and the capabilities that come along with it that we incurred over 2022 is going to bleed into 2023.
We're highly focused on sustaining expense discipline, which as you know we view as just matching expense directly against the strategy and do you feel good about the implied operating leverage but certainly.
Too early to call, if we're going to be able to come come in inside of our published expense guidance.
Got it okay. Thank you guys.
Beth.
Yeah.
Thank you we have no further questions I'll hand back to Rob for any closing remarks.
Highly appreciative.
The interest by everybody and I'm sure, Jeff will not will make themselves available as long.
As necessary have a great day, thanks for your time.
Thank you. This now concludes today's call. Thank you so much for joining you may now disconnect your lines.
Yeah.
Yes.
Yes.
Okay.