Texas Capital Bancshares, Inc. (TCBI) Q2 2012 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2012 Texas Capital BancShares Inc. Earnings Conference Call. [Operator Instructions] And now I have the pleasure in turning the conference over to Ms. Myrna Vance. Director of Investor Relations. Please proceed.

[Audio Gap] please call me at (214) 932-6646. Now before we get into our discussion today, let me read the following statement. Certain matters discussed on this call may contain forward-looking statements, which are subject to risks and uncertainties and are based on Texas Capital's current estimates or expectations of future events or future results. Texas Capital is under no obligation and expressly disclaims such obligation, to update, alter or revise its forward-looking statements, whether as a result of new information, future events or otherwise. A number of factors, many of which are beyond Texas Capital's control, could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. These risks and uncertainties include the risk of adverse impacts from general economic conditions, competition, interest rate sensitivity and exposure to regulatory and legislative changes. These and other factors that could cause results to differ materially from those described in the forward-looking statements can be found in prospectus supplement relating to the offering and the annual report on Form 10-K and other filings made by Texas Capital with the Securities and Exchange Commission. We are currently undertaking a public offering of 1.75 million shares of our common stock. The Securities laws preclude us from commenting on that offering or taking any questions relating to that offering. Now let's begin the discussion. With me on the call today are George Jones, our CEO; and Peter Bartholow, our CFO. After a few prepared remarks, our operator, Zinia, will facilitate a Q&A session. Now let me turn the call over to George.

Thank you, Myrna. Good afternoon, everyone, and welcome to our second quarter call. Well, this has been another outstanding quarter for Texas Capital Bancshares. In addition to achieving dramatic improvements in ROA and ROE, we experienced excellent growth in total loans, deposits and earnings. We have a very strong pipeline in place to continue this trend. This growth opportunity is the basis for our separately announced common equity offering. This offering is consistent with objectives for taking advantage of what we believe is a significant opportunity to enhance our market share and competitive position. As mentioned a moment ago, we have had continued strong growth in loans. Loan sale for investment grew 5% linked quarter and 22% from Q2 2011. Our deposit base, 7% linked quarter and 19% from Q2 2011. And our earnings per share, 9% linked quarter and 73% year-over-year. Return on assets and equity have reached record levels at Q2 of 1.4% and 18.1%. We have continued to see our credit costs and nonperforming asset ratios come down in Q2. Nonperforming asset ratio of nonperforming assets to loans plus ORE was 1.35%, down from 1.42% in Q1 2012. I mentioned our strong growth in loan sale for investment, and we continue to have a good pipeline of transactions remaining for that segment of our business. Loans held for sale, our mortgage warehouse line of business, continues to grow. We are adding a number of new relationships and have been taking advantage of the market demand for this product that should extend through this period of low rates. I'll be back in a moment, but let me turn the financial review over to Peter.

Thank you, George. Beginning in Slides 4 and 5 for the financial review. Net revenue, net income and EPS were all very strong linked quarter and year-over-year. This resulted from very favorable performance, building on the -- during the seasonally strong quarter on the great growth we had at the end of Q1. In terms of quarter earnings power and NIM, this is exceptional performance again, resulting from superior operating leverage and the improvement in credit costs. Net revenue growth was driven by obviously growth in loans with a relatively stable net interest margin. Our solid NIM results from the strong growth in both LHI, loans held for investment, and loans held for sale and has provided for us a much improved composition of earning assets and the growth in net interest income. I will have more to say later on the net interest margin. We had good growth in noninterest income, primarily in the mortgage warehouse, also with loan swap fees and a gain of $400,000 from the sale of ORE. In terms of expense management, we've seen a significant reduction in legal, professional, problem asset recovery and ORE credit [ph] costs with the improvement in credit quality metrics. Loan growth showed strength across a wide range of lines of businesses and regions, reaching $6.2 billion at quarter end. That's near record growth for us of $442 million or 7.6% from the very high level at the end of the first quarter. Loan held for sale balances remained very high, with a small increase from Q1, net of $100 million in average participation sold during the quarter. Obviously, we've designed our business to build a larger customer base while managing the balance sheet concentration. With growth to $2.4 billion at quarter end, net of $245 million in participations sold,…

Thanks, Peter. If you look at Page 14, this page really should be familiar to you. I'm sure the pie chart showing loan collateral by type of the credit quality overview on the right side of the page. Our loans held for investment, or approximately 72% of our loan book, grew $290 million in Q2 on an average basis. As Peter said from period end Q1 2012 to period end Q2, loans held for investment actually grew $443 million net, giving us a great tailwind going into Q3. If you look at Page 15. As mentioned previously, credit trends continue to improve. Total credit cost of $4.1 million for Q2 compared to $5.7 million in Q1 and almost $9 million in Q2 of 2011. Our provision this quarter of $1 million was a third of the provision for Q1, with net charge-offs of $533,000 or only 4 basis points. We took on ORE valuation charge this quarter of $3.1 million. That's down from Q1. And as Peter mentioned earlier, we realized a $400,000 gain on sale of real estate, for a net charge of $2.7 million. Our nonperforming assets continue to decline as a percentage of loans, but they were up slightly in absolute dollars. This represented one loan that we have well reserved. Our ratio is 1.35% compared to 2.03% in Q2 2011. We have also achieved a reduction in related credit cost that are consistent with the improvements we've discussed in the credit metrics. Page 18 simply graphs the last 5 years of net charge-offs to average loans. As you can see, we're returning to our historical level of charge-offs, and our coverage ratios are quite strong. I'd like to close the prepared remarks with the following thoughts. We have strong core earnings, and the growth in those earnings and the growth in the assets should continue well through 2012 and beyond. As mentioned earlier, we closed Q2 with strong loan growth that will give us a good start for Q3, improving capital position with our common equity offering to support respective growth as reflected in the release. Credit cost improvements have been exceptional, and all metrics reflect good improvement. We have a strong loan held for investment pipeline that presents an opportunity for growth potential, certainly in the near term and beyond. Loans held for sale balances could grow modestly, with increased market share and benefits of the participation program we've briefly described. We believe that our strong acquisition of relationships will continue and the business model has produced and should continue to produce industry-leading results. Well, thanks very much. That's the end of our prepared remarks. We'll pause, and we'll let you have an opportunity for the Q&A.

[Operator Instructions] And your first question comes from the line of Brady Gailey with KBW.

Could you, I guess to start off, could you update us on where the participation balance is at the end of the second quarter?

Yes. As I mentioned, Brady, it was at $245 million at the end of the quarter.

We have commitments for more than that.

I'm sorry, but this -- the SNC book is what I'm talking about.

[indiscernible]

Yes. So it was 9 54 at the end of March.

Relatively flat. We're getting that number for you right now.

Okay. But not much growth there. And then back to the warehouse participation program, so you went from $72 million to $245 million. What were the fees associated with that program in the second quarter? And where did those show up? Did those show up in the...

The brokered loan fee line. There are other file fees related to the warehouse. They weren't material. Most of the volume in the participations sold occurred near the end of the quarter.

Okay. Okay. And then new loan yields, where do -- where are those? Where did those come in the second quarter?

Say it again?

The yields on new loans. Where are those running nowadays?

Loan spreads are still pretty good. We're able to renew still with floors in the majority of the loans. Obviously, we don't make new loans. All new loans have a spread of 4 50. But we really have no significant erosion.

Okay. And then lastly on the capital raised. Obviously its growth capital you guys are growing like crazy. But if you could just expand on why you're raising capital. Is it -- we've seen the new NPRs out. We've seen a little more clarification on Basel III. I mean, does any of that come into play in, I mean, your stock prices at an all-time high. Does any of that come in to the decision to raise capital today?

No, not really. It's growth opportunity. The NPR, the Basel III looks to have like a less than 40-basis-point impact on the total capital ratio. So less than $30 million. So it's only indirectly related because of the bias of the capital rigs for equity instead of debt. Not directly related. By the way, Brady?

Yes?

$987 million at the end of the quarter in syndicated loans.

And your next question comes from the line of John Pancari with Evercore Partners.

Back on the capital raised, can you just talk a little bit more around your decision to raise common versus debt? Is it just given where your stock is here? And then also how you came up with the amount of the raise, the size, just given what you're doing with the balance sheet?

I think you're going to have to return to the prospectus supplement that will be out. Obviously, we're growing fast. Equity pricing is favorable to us, making advantage of the markets.

Okay. And then...

About 5% is all we're talking about. So it's not an exceptionally large raise.

Okay. All right. And then in terms of the growth in the warehouse, just what your -- you can talk a little bit about what you expect for that -- for the held for sale balances in coming quarters. Do you think that can remain flattish given that you are now stepping up the participations? Can you just give us color on that?

Yes; this is George. Our goal really with the participation product is to rightsize the concentration on our balance sheet. The business, we're able to develop a lot of business in the warehouse. But we manage everything by concentration limits. We want to continue to grow our business but we want to limit the amount that we keep on our balance sheet. It's just risk management. So we've created the participation program. It will continue to grow as we continue to grow, in terms of relationships. I will tell you that we are adding relationships every month. We are growing our outstandings. As you can see, we ended the year at $2.4 billion and we had $245 million participated. So you can see, you can back end to that number in terms of what really could be outstanding. All that's to say, we like the business. We want to continue to grow the relationships. We're going to manage it in that 25% to 30% ratio that we're talking about on our balance sheet. And be a real participant in this business.

Okay. So based on that, we could expect probably some continued growth in the warehouse held for sale balance in the coming quarters, but also some growth in the broker loan fees as you step out the participations?

That's right. But again, we are still in the process of approving participants and selling participations. So while we are growing, we might not be growing a heck of a lot on our balance sheet, if you understand what I'm talking about. This really does help us on a go-forward basis as, we've said before, when rates do rise and volumes in this business begin to come down. The more relationships we have, the more customers we have, the more we're able to stabilize that income strength. So that's our goal, and I think we've said that before.

And your next question comes from line of Jennifer Demba with SunTrust Robinson.

Two questions. One, can you just describe the nature of the loan growth, the held for investment growth you had this quarter? And two, can you give us an idea of what your total relationship manager force looks like today versus a year ago, and what the hiring opportunities are going forward?

I'll take the first one first. Where is the loan growth coming from? It's coming on a broad basis from really most all our regions and line of business. The leader -- let's talk about loans held for investment instead of throwing loans held for sale in there. Energy, it leads the pack. healthcare, builder finance , which is our construction group we hired about 18 months ago to take advantage of regional builder needs. Lender finance, which is more of a national business or regional business. They loan money to privately-owned finance company operations. And then our premium finance group has grown well. We've taken on some larger insurance agencies that have larger customers. And we do see that business in the PNC side firming a little bit. Not a lot, but a little bit. So that's kind of a broad-based approach, but that's where we're seeing most of it coming from. Our REMs, as we said before, we had a -- are real bold so to speak in hiring a couple of years ago. Those people are becoming very productive today, and we're seeing them take a reasonable amount of market share away from the competitors. We're still not seeing a real resurgence of organic internal growth. It's beginning to show up, but we're not seeing it. We're still taking business away. Over a -- gosh, I guess a year's period of time, we're up 11 in REMs. We're developing a stronger than normal pipeline of REM recruits. We're out in the marketplace continuing to try and hire the best. I wouldn't say it's a heck of a lot of harder to hire, but it is a little bit harder to hire. Some of the other banks have firmed up and aren't in the shape that they were 2 years ago. But we still don't have a heck of a lot of trouble of hiring about who we want to hire. Did I miss something? What else where you asking?

That was it. That was it. That's all very helpful.

And your next question comes from the line of Brad Milsaps with Sandler O'Neill.

Peter, just maybe another question on the warehouse. Could you give me the mix kind of refi versus purchase money?And then the yield on that book maybe held up better than I thought. Is that just really a timing thing as rates move down through the quarter? And just kind of curious, so if you can maybe give a little more color on where that might head for the third quarter?

We've seen them fairly flat, but over the course of the quarter even though they were down from the prior quarter. We're running close to 58% refi, and that's down from 68.3%.

Brad, our emphasis too in onboarding some of our new customers are customers that don't go after the refi business necessarily. We're trying to build our book of new customers with people that have a great pipeline for the traditional mortgage origination, not the refi. A lot of these companies that are 90% refi are going to go away when rates go up and the refi business goes down. So we're building our book with people that don't necessarily depend on the refi business to survive.

Okay. And then just another question, on the loan loss provision. I know you mentioned last quarter that the majority of the $3 million provision was related in new loan growth. This quarter, only a $1 million loan growth. It was a little bit stronger. Just kind of curious if you could kind of give me a little more color there and kind of how you feel about that going forward, considering the improvement you've had in credit.

It's a little more complicated. But the simple -- the simplest answer, Brad, is that the improvement in the credit quality within the portfolio freed up more reserves than was needed for the growth.

Okay. Nothing really different in the mix, though, in terms of the loan growth between the 2 quarters?

No.

And your next question comes from the line of Scott Valentin with FBR Capital Markets.

Just with regard to deposit growth, as you mentioned, it was quite strong. I'm just wondering -- I know you focused on general management. I was wondering if it's more due to large relationships or anything special during the quarter that occurred. And then just a corollary to that, deposit fees didn't increase that much compared to deposit growth. Just wondering maybe deposit growth occurred more towards quarter end.

On the deposit growth side, we, nothing really unusual, but we have seen continued growth in the warehouse. The warehouse balances in that particular area are well over 400 million now, about 70% of that is DDA. And we had very good growth there. We have also seen an expansion of our niche of broker-dealer deposit generation. Remember, we've talked a lot about non-borrowing cash-rich lines of business that we target. Our broker-dealer arena has expanded fairly dramatically over the last 6 months. And we've been able to onboard a number of deposits in that niche. Those are just 2 areas that if you look at more of the traditional lines of business, it's Treasury continues to bring in good deposits. Energy, our correspondent division through correspondent banks. So it's really fairly broad-based. But the DDA component, a large part of that was warehouse because these are escrow deposits.

Okay. And then that -- I guess, just a correlation with the fees, the fees have increased as much quarter-over-quarter?

The fees -- the costs are covered by balances for us more than they are fees.

Okay. So compensating balances also the fees, I guess?

Correct. That's what people are doing today, with all the liquidity that they have. Rather than paying fees, they're putting balances in the bank.

Okay, okay. And then just a final question. I'll get back in the queue. Large [ph] expense, if we exclude the OREO-related expenses, is that a good run rate going forward? I know professional expense was down, but it sounds like that's kind of a permanent level given the improvement in credit?

It can vary widely, unfortunately. But the only other issue is we build the incentive expense based on the performance. And with performance high, that number goes up.

Okay. So I guess quarter-to-quarter can be some volatility, but overall it should end up being net-net?

There are no fundamental out-of-control expense categories. General business growth and incentives.

Your next question comes from line of Brett Rabatin with Sterne Agee.

I wanted to get a little more clarity, if I could, around thinking about the margin as we head into 2013. And just you obviously commented that you would have more of the growth and the held for sale portfolio, the off-balance sheet so to speak. I'm curious to hearing thoughts around if a mixed shift change towards held for investment might keep the margin from declining much. Or kind of how you think about that?

We've got to be obviously very careful about that. Not to provide guidance, but the math works fundamentally the way you just described it.

Okay. And then just also wanted to get a little more color around -- you commented some about loan pricing, and it's obviously a competitive market, but things are -- it sounds like holding out pretty well. When you say floor protection, I guess I'm curious to understand if you're building new loans of floors or your existing floors are holding out pretty good. Or what you meant when you were talking about floor protection?

Well, if you look at our floating rate portfolio, we've said about 60% to 65% of our floating rate has a floor. We've maintained reasonably the same amount, the same number of -- or same percentage of the portfolio that we had before. But obviously, the rates are down. So we're in the 4 75, 4 80 range of floors today, where at one time, we were well over 5. We've kept the floors on most of our existing relationships, albeit lowering them somewhat. We are still able to get floors on some new credits, but it is getting quite competitive out there and is more and more difficult to do that. But we've been able to get some. I'd say maybe 25%, something like that.

Okay. And then just one last question around the offering. In the past, you've done an ATM and done it sparingly. I'm curious, was that just not going to be meaningful enough in your opinion to proceed with that or was there some other reason why you chose to go the other route?

Nothing in particular. What we had left is going to have be refreshed. It was only $27 million. So you would have had to do that and had to -- we would have chosen to do that and something else, and this is just less complicated.

And your next question comes from line of Michael Rose with Raymond James.

I'm just trying to understand why the yields in the securities portfolio went up. And then if you could comment on the size of the securities portfolio going forward.

Again, we're not going to give any guidance, but you can expect to see the securities portfolio continue to run down. Maybe that it was a due 30-day [ph] months has an impact on that yield.

We -- Michael, as you recall and have heard us say, we're not adding to the security portfolio, have not added to the portfolio in a number of years.

In Q1, we had a repo that we used to secure a letter of credit or some other transaction that bought that yield down to -- and that went away.

Okay. I'm sorry if I missed that. And then secondarily, can you give some color on your loan pipelines, kind of where they end at the quarter, utilization rates and if there's any kind of geographic skew to the loan pipeline.

Well, utilization rates. I think I've said before, we are a bank that does not give lines of credit if we don't expect them to be used and used fairly fully. And so our utilization is always going to be higher than a number of others in the marketplace. We don't do backup lines. We don't do those kinds of things. So we're going to have a higher utilization than most. And your other question was? I'm sorry.

It's okay. Loan pipelines, where they entered the quarter versus last quarter. And sorry if I missed it. And then if there's any geographic concentration.

Realistically, the pipelines are good. As I said, the market share movement has continued, that our relationship managers have continued to move significant amounts of market share. It's not specifically tied to any one region or any one line of business. If you exclude the warehouse, again, you're looking at -- energy has had a really good quarter, healthcare, a really good quarter. But no specific geographic regions have outperformed on a great basis.

And your next question comes from line of Matt Olney with Stephens.

George, you've already addressed the new commercial lenders you've hired in recent years. But it seems like in the past, you provided some kind of aggregate capacity of those lenders and how much market share you think they can move over at Texas Capital. Did you have an aggregate number that you can provide for us?

It's really difficult to put a number on something like that. It differs with the line of business you're talking about. It differs with the person. I will tell you that it's all in the hiring process. I mean if you pick the right individual or group, they're going to outperform your expectations. Those kind of people have brought much more than we anticipated they could bring. It's really amazing. We surprised ourselves. We started the company and had this philosophy of moving the best over with us. We saw a tremendous amount of business just absolutely move with the individual. We built, as I've said before, Matt, some capacity into the company because we want to be prepared and ready to compete heads up when the economy does heal itself. And we have a reasonable amount of capacity in the company today. But the REM -- the REMs we hire must have strong enough relationships to move business and then produce new clients. So it's all in the hiring process, getting the right people, putting them in the right place and moving it over. But we've got a reasonable amount of capacity today by design.

And your next question comes from the line of Gary Tenner with D.A. Davidson.

Just couple of questions. In terms of the loan loss allowance, pre-credit crisis, you guys were well under 1% in some period of time. It's written down that it's about -- at 1.16% right now. Where do you think reasonably in this environment you guys could take that down to?

Well, first of all, that 1.16%, I think you're probably throwing in the mortgage warehouse. This I'm not sure if you are not. But we've been around 1.25%, something like that, 1.30%. And it all gets to the methodology. And we've just done an interesting exercise. We have looked at the adequacy of the loan loss reserve through the most difficult times we could possibly imagine. And that's been of the last 5 years, see if in effect the provisioning and the level reserve was adequate and if we're identifying the problems and reserving them properly. And that survey came back absolutely yes. So what it tells us is the methodology we've been using for the last 13 years, i.e. sometimes it takes it higher. Sometimes it takes it lower. But it has been accurate. And that's how we managed the reserve process. We live and die by that methodology, and the research we've done in the last 2 or 3 months have proved that. That's the way to do it.

In response to your question also [indiscernible] that the economy is still not strong, so there are qualitative factors that go into the methodology that are likely to keep it from ever going as low as it did during the 2004-2005 period.

Okay. In terms of the mortgage warehouse business, can you kind of give us a sense or talk about the profitability of that business as a standalone entity if you will, maybe put, ROE would be on a fully loaded basis?

Because of the offering, we need to avoid that. What we have said in the past is that it's obviously very profitable. When it's growing rapidly, it provides good operating leverage, and the fees should cover -- at high volumes, the fees cover our direct operating expense, not overhead, not space systems development and the general requirement to support the corporation. It is obviously much better than owning securities.

Okay, great. And then just one last question. In terms of just the timing of the offerings, is that -- do you -- comment on that at all, in terms of when expect that to appraise?

I think we need to encourage you to look for the prospectus supplement for that. We apologize, but I think that's the case.

[indiscernible] don't talk right now.

[Operator Instructions] And your next question comes from line of David Bishop with Stifel, Nicolaus.

Most of my questions were answered. But I just wonder if we could get some color in regards to the NPL inflow. You mentioned it sounds like that was one larger credit?

Yes. It was one particular credit that we've been watching for some time. We had walked it down the credit scale. It had been at a level that was just one particular level above where we put it today. So the system worked right. And we are anticipating a recovery of that credit. We are not anticipating a liquidation or a severe problem, but we do have what we believe is very, very adequately reserved. But they just hit some bumps in the road, and we think hopefully it's fixable.

And there are no further questions. I now would like to hand the conference back over to Myrna Vance. Please proceed with any closing remarks.

Thank you very much, Zinia. Let me let George make any remarks he'd like, and then we'll end the call. And any further questions, please let me know.

Great. Thanks, Myrna. We want to thank you for taking your time to sit and listen and give us the questions that were very good. We appreciate all your interests. We work hard at Texas Capital to return to our investors the level of income they deserve, and we'll continue to do that. So thanks again, and we'll talk later.

Ladies and gentlemen, that concludes the conference. You may now disconnect. Have a wonderful day.