Texas Capital Bancshares, Inc. (TCBI) Q2 2015 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Texas Capital Bancshares Second Quarter 2015 Earnings Conference Call. All participants will be in listen-only mode. [Operator Instructions] After today's presentation, there will be an opportunity to ask questions. [Operator Instructions] Please note that this event is being recorded. I would now like to turn the conference over to Heather Worley, Director of Investor Relations. Please go ahead.

Welcome to the Texas Capital Bancshares' second quarter 2015 earnings conference call. I am Heather Worley, Director of Investor Relations. Should you have any follow-up questions, please call me directly at 214-932-6646. Before we get into our discussion today, I would like to read the following statement. Certain matters discussed on this call may contain forward-looking statements as defined in federal securities laws, which statements are subject to risks and uncertainties and are based on Texas Capital's current estimates or expectations of future events or future results. These statements are not historical in nature and can generally be identified by such words as believe, expect, estimate, anticipate, plan, may, will, intend and similar expressions. 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 our forward-looking statements. These risks and uncertainties include the risks of adverse impacts from general economic conditions, the effects of recent declines in oil and gas prices on our customers, competition, changes in interest rates 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, as well as the discussion of the risks and uncertainties that may affect Texas Capital's business, can be found in our Annual Report on Form 10-K and other filings made by Texas Capital with the Securities and Exchange Commission. Forward-looking statements speak only as of the date of this call. Texas Capital is under no obligation and expressly disclaims any obligation to update, alter or revise its forward-looking statements, whether as a result of new information, future events or otherwise. Joining me on the call today are Keith Cargill, President and CEO, and Peter Bartholow, CFO and COO. After our prepared remarks, our operator Casio will facilitate a Q&A session. At this time, I would like to turn the call over to Keith, who will begin on Slide 3 of the webcast.

Thank you, Heather. Following my opening comments Peter Bartholow will review his assessment of the quarter and I will offer closing comments before opening the call for Q&A. Let's begin with Slide 3, again, our bankers and credit team put some impressive loan growth numbers on the board. Traditional LHI grew 4.2% on average outstandings from Q1 to Q2. Mortgage finance loans grew 22% linked-quarter on average outstandings with the quarter end balance down due to efforts to manage the quarter-end surge. Demand deposits grew 22% linked-quarter on average as well. Liquidity assets were 4.2% higher on average from Q1 to Q2. Growth in loans and deposits was across virtually all regions in lines of business with leading growth in Houston, Dallas real estate, builder finance, premium finance, and mortgage finance. Asset sensitivity continues to increase as demand deposits and our floating rate asset mix each continue to grow. Net interest margin was flat on a linked-quarter basis despite our continued liquidity build. This is encouraging and we hope marks affirming in NIM. Now let's review our credit metrics; NPAs increased $55 million from Q1. SNC energy relationships made up more than half of the dollar increase. Net charge offs for Q2 were 14 basis points and no charge offs were energy related. Although loan loss provision represents a high coverage ratio relative to charge offs, we believe our loan loss methodology is sound and the provision is appropriate. On Slide 4, we describe the launch of our previously unnamed business. The mortgage corresponded aggregation or MCA business. Not only will MCA complement our current offerings in the national mortgage market, it also will increase our capital efficiency since purchased hold loans carry a risk weight of 20% or 50% as compared to the current 100% risk weight on existing mortgage finance products. As we described on Slide 4, the MCA business will buy hold mortgage loans from existing and new mortgage banking clients, then hold the loans for a short period before selling and securitizing. By launching MCA, Texas Capital will offer a full range of products and services under the mortgage finance group including mortgage warehousing, MCA, treasury management, and other business lending to our mortgage banking clients such as Mortgage Servicing Rights financing. It was important to inform you that we were building a new business as we began to invest increasing dollars in the diligence and risk assessment of the MCA business. Since 2014, Texas Capital has expensed more than $3.5 million on MCA in order to build a meaningful risk appropriate ROE business for our shareholders and mortgage finance clients. It has been important to us that we hired top national talent and designed processes and technology that in combination will effectively minimize the incremental risk of put back exposure and provide a client friendly interface to improve efficiency and quality assurance for both our clients and Texas Capital. Because Texas Capital has established a premier reputation in the national mortgage finance industry and achieved a strong market share position. We believe the time and opportunities are right for our launch of MCA next month. As we prepare to launch the MCA business, we are quite encouraged by the early reaction from existing and prospective mortgage banking clients, having gained the approvals of Fannie Mae, Freddie Mac, and Ginnie Mae, we believe Texas Capital is well positioned to exploit the market opportunity. You will likely find Peter's comments related to forecasted profitability of MCA most interesting. We should acknowledge the truly outstanding team work and commitment demonstrated by the MCA team, this management team, finance team, and technology team to build what we believe would be one of the most significant businesses ever launched in Texas Capital. Peter?

Thank you, Keith. As Keith mentioned, the company produced record level of net income of $39 million during the quarter. We saw net interest income and net revenue both increase 9% from the first quarter, both also up 23% from the year ago quarter. Despite the continued build out, we achieved improvement in operating leverage compared both to the first quarter of this year and more especially to the second quarter of last year. Lending costs were stable with exceptional growth and demand deposits, the impact of growth and liquidity assets on NIM and ROA of course remains very high. The pace of linked quarter growth and DDA increased to reach a record level of $6.8 billion, an increase of more than $1.2 billion just from the first quarter of this year. The shift in deposit composition from interest bearing to DDA balances had a significant impact on our asset sensitivity. Since the second quarter of last year, the impact on net interest income from a change in 100 basis point and 200 basis point increases in the Fed funds rate has increased sharply. The 100 basis point shock, net interest income shows an increase from $54 million to $84 million over the course of one year. The 200 basis point shock net interest income shows an increase from $119 million to $178 million. Linked-quarter growth in liquidity assets from the first quarter was more manageable this time as the funds were effectively deployed in mortgage finance loans and certainly helped with the stability of our net interest margin. Year-over-year growth in DDA was $3.2 billion or almost 88%, while liquidity assets increased by $2.1 billion, more than 10x the level in the second quarter of 2014. Net interest margin remains stable as Keith mentioned with Q1 at 3.2%, no weakening of yield and traditional held for investment loans was noted, actually a 1 basis point increase, yield trends have actually remained favorable considering the stiff competition, the magnitude of the growth in our balance sheet. We saw a yield reduction in mortgage finance of just 3 basis points. As the end of the quarter, we saw strengthening of pricing in that sector. Compared to full year 2014, the NIM impact liquidity build has been almost 40 basis points, obviously a very modest benefit for net interest income. As noted, we experienced growth of 4.2% in traditional held for investment balances from the first quarter and 22% from a year ago. This growth reflected and compensated for a substantial increase in paydown activity over the course of the second quarter compared to Q1 -- a paydown activity almost equal the record level experience in the second quarter of last year. Net loan growth was just $220 million point to point, it represents solid growth despite the level of paydown activity and the declining contribution we see in both CRE and energy lending. Over the remainder of 2015, we expect a further reduction in the benefit from growth in CRE, builder finance, and energy. We did experience growth in each category in Q1 and as I commented in Q1, this quarter excluding the growth in those components for year-to-date average balances growth rate has been 13% versus the 2014 full year average balance of traditional held for investment loans. As Keith mentioned mortgage finance business is clearly benefiting from Texas Capital's position in this business. Average balances were over $4.5 billion in Q2 22% above the first quarter average and 62% growth from the prior year. To maintain capacity to expand relationships, manage concentration and limit quarter in spike we have ramped up the participation program and excluding the quarter end balance – quarter end building balances, the average balance remain consistent with our mix objective at 29% of total loans. This business has been shown to be a source of sustainable contribution and very high risk adjusted returns. We think the expansion of MCA will amplify our presence, but this higher levels of profit contribution and returns was a significant benefit of reducing risk weight of total mortgage finance asset class. Net income fees, deposits and very negligible credit or related exposures are evident in this very high – highly liquid asset class. Turning to Slide 6, the components of net interest income and NIM are shown. Net interest income and net revenue were both up 9% from the prior year – from the immediate past quarter and 23% from the prior year. The yields on traditional held for investment remain good as I commented especially given the significance of the competitive activity and the amount of growth that we have experienced. Lending cost have obviously remained very stable given the improved deposit composition. We saw components of growth in net interest income that are reflected on Slide – non-interest expense on Slide 9, 6% growth from the first quarter for the reason shown and I will explain that core growth of 3.8% when you exclude the $1.9 million impact of the movement in stock price over the quarter. I will point the $1.9 million comes from a credit that we benefited from in Q1 reduction in expense with a $1 million increase in expense in Q2 for $1.9 million linked-quarter impact. I mentioned earlier the operating leverage improved from Q1 with net revenue growth of 9% and the low level of core expense growth reducing the efficiency ratio of 52.4%. We saw our build out expense increase to $1.6 million combination for MCA, wealth advisory and general growth compared to $800,000 in the first quarter. As Keith mentioned since MCA began for the second quarter of 2015, we've incurred a total build out cost of approximately $3.5 million or nickel a share. MCA is expected to incur a very minor loss in Q3 and recover all cash operating expenses for 2015 during Q4. Slide 8, the quarterly highlights, obviously, ROA has been reduced by the significant impact of the liquidity asset increases, adjusted ROA allowing for the effect of that increase was still above 1%. Obviously, the elevated levels of provision have had an impact on the year-over-year comparisons. ROE returned to the 10-plus level with more effective utilization of capital, offsetting the increase in the provision and the efficiency ratio with noted improvement due to high productivity in mortgage finance and throughout the rest of the organization. On Slide 9, the outlook for the remainder of 2015, from the strength of the first half growth, our outlook for traditional held for investment growth has improved to the mid to upper teens again that's in contrast with the 13% level of total LHI growth year-to-date excluding CRE builder finance and energy versus the full year balance in 2014. We expect to see the level of mortgage finance loans increase also. The uncertainty for the last half of 2015 does relate to raising rates and the seasonal weaknesses the industry experiences in Q4 given our higher level of purchase financing in our portfolio. Seasonal weakness in Q4 may also be compounded by the change in regulation set to start October 1. Potential for further market share gain was managed with participations which do affect obviously the average balances. Software industry conditions may also be offset by MCA in evaluating total mortgage finance group performance because we will see over time a shifting balance in our total mortgage finance portfolio between traditional warehouse balances at 100% risk weight and the MCA balances which today given our current profile would have a average risk weight of less then 40%. On loan categories, again, there is no change in our view that we will see muted growth in CRE builder and energy. Those outlooks have been unchanged. On net interest income, our outlook has improved to mid to high teens growth from 2014. NIM is still focused on 340 to 350 excluding the outsized effective growth liquidity assets compared to 2014. I mentioned earlier Q2 is approximately 3.6% before the impact of liquidity build. Improvement in the Q2 efficiency ratio, there is certainly a positive and our guidance has improved. We remain cautious about predicting more significant improvement due to plan build out further of MCA before a meaningful contribution is expected in the Q4, a ramp up of expenses really began near the end of Q2 so there would be a carry over effect along with continued growth in Q3. We do expect as I mentioned a significant contribution in Q4 that has the potential for eliminating recovering all cash operating expense for 2015. Net charge offs are still expected to be less than 25 basis points. There is uncertainty about provision this reflected in our Q2 results. Our methodology drives quarterly levels which could be consistent with Q2 based on exposures already taken into consideration without significant change in our credit outlook. Net interest expense growth is still expected in the low to mid teens before the impact of increase in stock buys which grew at a rate of over 14% in Q2. Net pay should slow in Q4 after its ramp up of MCA cost in Q3. Keith?

Thank you, Peter. Slide 12 summarizes our asset quality metrics. I will now retrace my opening comments on asset quality. I will point out that the net charge offs had 14 basis points increase from 12 basis points in Q1 and only 7 basis points in 2014. Thus far in 2015, we have had no charge offs related to energy. In fact in the entire history of Texas Capital, we continue to have only experienced one-charge off in energy totaling $300,000 several years ago. We hope that track record will continue. My closing comments are outlined on Slide 14, we are confident in our LHI guidance for the full year of 2015, despite our efforts to limit CRE and builder finance growth and the uncertain energy environment. The ever diligent focus on our credit quality and effective problem loan management continues. Special attention to managing quarter end spikes and mortgage finance volumes resulted in moderating period end outstandings without depressing strong average outstandings growth from Q1. Despite a continued build in liquidity, NIM was stable in Q2 as compared to Q1. Asset sensitivity remained strong and increasing. And finally, the long awaited launch of our new MCA business is eminent and we believe will be well received by the mortgage banking market. Our new MCA business should contribute to strong earnings growth and improved returns for our shareholders. This concludes our comments and we now will gladly attempt to answer your questions. Heather?

Casio go ahead and queue up the first question please.

Thank you. We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Brady Gailey at KBW. Please go ahead.

Hey, good afternoon, guys.

Hi, Brady.

Congrats on launching MCA, you are almost launching MCA.

Thank you.

So do you care to give any comments on what the increased profitability or accretion could be coming from MCA next year, and you are kind of indirectly hinting that you're going to earn back the $0.05 that you've spent already you're going to earn that back in 4Q, so if you analyze that that would be $0.20 a share. But any shot at what this new business line could offer in increased earnings next year?

Brady, first of all, let me, and Keith can supplement this. The $0.05 a share began in Q1 of 2014, the full year impact of that in 2015 is less than $0.05 that we've expanded so far. That makes sense.

What we're saying Brady is accumulative from first quarter 2014 through the second quarter was $0.05.

Yes.

So that's over an 18 month period. And then we've got a much more ramp with all the hiring late in the second quarter expense run rate that we'll get in the third quarter related to this business. But in spite of that, we expect that really began to hit our stride on growth in the fourth quarter on the revenue side – this sufficient degree that cover all of the expense – cash operating expense in actual calendar year 2015.

Okay. And any --

But it's a little bit convoluted because we're trying to give you a cumulative impact of the $0.05 over a year and a half period. And really why we wanted to talk about that is, as we've talked for some time about the business we were building, and we just wanted to give you some order of magnitude of what kind of expenses we're building and the reason we had to talk about our business that was being built up.

We've given no further guidance on what it could mean to 2016 other than we have been quoted saying that it could be – it should be, may be not as early as all of 2016, but one of the top decile businesses in our portfolio in terms of ROE.

And will the hold time’s change as you switch from the traditional warehouse into this by the loan and securitize, will the hold times gap out at all or will those remain pretty consistent?

It will be a bifurcated business. We'll continue to run the mortgage finance business seamless as we've been able to execute in the past. This will be an incremental business, and to some extent over time, it will make up some increased mix, but our mortgage finance business is a growing market share business, we intent for it to continue to be. The hold times on the new MCA business, yes, will vary. Initially, they will be a bit longer because you need to accumulate a sufficient pool of notes to have a good economic securitization, but as time passes and as we ramp up volume, the hold times would be more muted.

Total portfolio will still fit our general profile, but the composition will shift between the day all mortgage warehouse loans to a combination of mortgage warehouse and MCA.

Okay.

You may remember there is a lot of discussion with our investors about the appeal we made relative to 100% risk-based capital on the mortgage finance business. It’s taken us some time to figure out how to appropriately deal with that, and we think this mix improvement on incremental MCA growth, up to 20% to 50% risk-based capital level, is going to help overall ROE with this business.

We also as we have referenced in the materials do have greater flexibility on the timing of sales, and therefore, the impact on quarter imbalances, that's to be developed as the business matures. That is an additional level of flexibility that we will gain.

Okay. And then lastly, so the time in between when you buy the hold loan and when you securitize it, will that -- will you hedge away the risk of rates moving and you all selling those loans for a price different than you bought -- will you hedge that risk away?

Absolutely, that's a really critical piece of the talent we recruited, the processes we put in place and the technology to ensure that we're real-time on top of that, rest to be sure and we mitigate than a straight risk, very important.

Okay. Great, thanks guys.

You're welcome.

The next question comes from Dave Rochester of Deutsche Bank. Please go ahead.

Hey, good afternoon, guys.

Hi, Dave.

I was just wondering as this business matures, what kind of revenue split are you expecting fees versus NII and then when you're talking about top decile ROEs, I would imagine those would have to be double-digit, what -- if you could just frame how good those could be for us will be great?

Very good, Dave, because it is a new business, obviously, we've run every scenario we can imagine and believe it will be one of our very best ROE businesses and also believe that we put the right risk mitigation as steps and technology and people in place to deliver a really outsized risk reward return for our shareholder. But at this point, yes, it's a little premature for us to talk about I think the range, but again, we think it will be in the top 10% of all of the businesses we run today, one of the top two businesses that we run in the company over the course of – it's certainly by early 2017. That's our best estimate today, and so that's the reason this has been important to us is to really focus on the ROE enhancement, it gives our shareholders and we think the outsize percentage growth it will offer also.

In today's market Dave, the yield would be a significant yield pick up versus our traditional mortgage finance portfolio along with the fee component from both sale of -- gain on sale of the asset and the sale of mortgage servicing rights.

Got you thanks for that. And then just switching to credit, you had mentioned the reserve methodology and may be some changes there. Can you just talk about that and how much of the provision was due to that change and then how much was due to energy this quarter?

That was not what I intended to communicate. There was no change in our methodology. I referred to the provision being higher in terms of coverage of charge offs, but that we believe it was appropriate because our methodology we think is quite sound. It served us well for – through the last downturn through the ups and downs in the economy, we have high confidence in the methodology we use to develop our provisioning and appropriate reserve levels. That was the intended message Dave.

Okay. I thought that you had mentioned in the release something about a change in applied risk weights that was based on historical experience or something like that. So there was really no material change to what you guys are doing?

No, no.

Okay. And then the portion of that that was related to energy and then just as a follow-up in terms of your guidance for the second half of provision in line with the second quarter if you could just talk about what's driving that and migration that you're expecting and where you're expecting to see it?

It's our best estimate, but it is only an estimate. We believe that from the indications we've got in the last three quarters that we'll still have some down grade risk with the energy book that's continued to be the case. And that does drive some higher provisioning. You may recall a year ago virtually all of the provisioning we did was related to growth in the portfolio. We still are growing at a very healthy pace, so there is a significant piece of provisioning from us every quarter that relates to just growth. But, now that we are seeing some migration of credit from one grade down to the next grade, you have that compounding in the methodology along with the growth factor. And we expect that will continue for the balance of the year to some degree. It's our best estimate we don't see anything systemic that would cause that to deviate one way or another in a big way. And we just would rather stay the course at this point not seeing anything significant improving in the economy or in the energy business. We think this is a conservative appropriate approach on guidance.

And so I think at the end of last quarter, you said you were 90% of the way through your redetermination process, I would imagine you have completed that at this point?

We have. We have and we feel again like we have our arms around it and we have had clients over the course of the last quarter, some clients choose to put additional hedges in place obviously at a much lower hedge price than what they had a year or a year and a half ago. But, we think that our clients are managing their business well relative to the environment and we are on top of those relationships and yet it is a commodity business and until we something fundamental shift to improve the prospects of the energy business. We think we should stay with a more conservative estimate of provisioning.

Great. And one last one, can you just talk about the growth trend in the energy book this quarter as well as the share national credit book that would be great.

Dave, this is Peter. We actually had a very small increase in average balance outstanding in energy less than 1%. I don't have the exact number in front of me. And in shared national credits we actually have a small reduction.

On a end of period basis, were they both down?

The end of period balance was down very slightly.

Great. All right. Thanks guys.

You're welcome.

The next question comes from Ebrahim Poonawala of Merrill Lynch. Please go ahead.

Good afternoon guys.

Hello, how are you Ebrahim?

I'm very well. Thank you. Just a follow up on the provisioning guidance for second half, Peter, it means, and then Keith, you have gone through the energy book. I'm just trying to understand that given the SNC review, given the spring redetermination, what's the incremental sort of driver, I mean I know a lot of things can go wrong but I'm just trying to understand if it's lower oil or you still concerned about a set of real borrowers whose financial condition could deteriorate in the back half of the year which could drive a higher provisioning?

Well, as you can tell, we have had some increases in non-performing assets; some of those have been C&I loans. A couple of those have deteriorated some. We don't see anything on the horizon that gives us great concern when you consider that the energy business is still in transition and we don't see anything systemic or that would be a domino effect of this impacting C&I. But, we have had a couple of C&I issues. We think it's prudent both for energy downgrade trend and for the overall economy to estimate our provisioning of this size for the balance of the year. It could change. We could have something develop that are more clearly to the positive. We just don't want to be overly optimistic at this point because of the trend we have seen.

And what the C&I, the rest of the 50% of the increase in non-accruals were those connected to the energy industry or just completely independent?

Completely independent, no connection whatsoever in either of those credits.

And can you disclose what the reserve was for the energy book at the end of the quarter or not?

Was up – hang on just a second, I think it was still right about $1 billion maybe just under.

I meant the reserve that we hold against that portfolio?

Reserve, we know a lot of people do that but the real point of that is what's the reserve against those where you actually have exposure as opposed to the total level. Just to clarify we have credits which there is realistically no exposure. So given the weight of those in our portfolio the real question is what you have against what could be – what could be exposed. You also have the issue that we talked about before which is as a credit rate changes, you pick up additional burden and when that goes to criticize in sub-standard, you pick up an automatic increase in the case of criticize 5% or so and 4-plus-percent and about 15% on sub-standard when it's not realistic in our view that you would actually lose 5% or 15% on those loans. So again, it's really based on – must be based on specific loan terms and identification of what our exposure is not as a percent of the total portfolio.

Understood. And just on a separate topic Peter, you mentioned earlier the LHI X mortgage yields held up pretty nicely this quarter. Was there any one-off that helped the yield, or are we unlikely to see the kind of impact we saw in the first quarter of this year and the fourth quarter of last year in terms of where the yields might be going on that book?

Well, just, we think we had – I mentioned high level of paydowns that appears that a lot of the paydowns may have come in lower yielding categories. There are no linked-quarter trends in fees that had a significant impact. We have more work to do to understand if there are – other any – any other dynamics associated with the change or lack of change.

Understood. And just one last question on MCA, I guess if I understand the balance sheet impact correctly, you are going to be within that 25% to 30% of average loans but it's going to be split between the warehouse and the MCA balance going forward, is that correct?

It's correct. Now, as it matures the composition will change more significantly that you will begin to see that really probably at the end of the fourth quarter.

And the MCA book will have a higher yield?

Yes.

Yes. The MCA book – the yield today on that – on the product we are financing in mortgage finance today would be a point or so higher than the current yield.

That's very helpful. Thank you very much for taking my questions.

Welcome.

The next question comes from Jennifer Demba of SunTrust Robinson Humphrey. Please go ahead.

Hi. Thank you. Peter could you just give a little more color around your net interest margin outlook as it relates to the reported margin versus your reported margin of 322 in the second quarter?

Yes. It's just an adjustment for the level of liquidity assets on average year-to-date or through the course of the balance of the year today that level would be about – between 350 and 360. And we are allowing for the fact that we will have additional liquidity asset growth because DDA balances and total deposit balances will continue to outstrip the loan balances over the course of the remainder of 2015.

Okay. And I think I couldn't hear you clearly I think in your monologue, how many loans were down downgraded in the energy book in the SNC? I think you said the number one.

Well, there were three loans that were downgraded Jennifer.

Okay.

That were energy loans.

Okay. Totaling around $36 million?

That's right.

Okay. Thank you.

You're welcome.

The next question comes from Michael Rose of Raymond James. Please go ahead.

Hey, good afternoon guys. How are you?

Good, Michael.

Hey, just a follow up on that margin question from Jennifer. Maybe ask in another way if mortgage warehouse balances are going to come down in the back half of the year potentially from lower volumes usually has a net positive impact to the margin, can you maybe kind of walk us through what thing could be and I think your longer term guidance is the warehouse to be somewhere in the $2.5 billion to $3 billion range on average? Thanks.

Our longer term view as it can stay between 25% and 30% of total loans. In the last half of the year you do have some issues with the level of purchase financing in our portfolio. The October 1 stated deadline for changing rules that is going to have an effect on the industry, but at the same time we have systematically over the last couple of years had meaningful improvements in market share that have offset then also with beginning of MCA we'll see increased balances in that portion of the portfolio based on today's rates the yields that are higher.

Okay. That's helpful. And then as it relates the risk weighted assets from the MCA business. Can you -- I don't know if you have -- told us your capital ratios in the preamble, but if you could that will be helpful and then what positive impact this may have on capital levels in your eyes going forward? Thanks.

Today's mortgage finance portfolio is comprised of about 45% our FHA/VA loans but today would have, if we were at whole loans at 20% risk rate the balance of the portfolio is essentially 50% risk weighed so on average of less than 40%, 47%, 38% and that's the way we analyze capital needs provided that we don't have issues with respect to well capitalized levels. In other words, our assessment begins with what we think as a detailed analysis of the actual risk characteristics of that asset not the regulatory risk weight. The combination of the two tells us over the course of the remainder of the year we will not have a capital issue if we see things change we made it very clear we believe that we can have sustained levels of average balances growth, average balanced growth way in excess of the, or significantly in excess of the ROE then we will address it, but that is not today's outlook.

Okay. So what were your risk-based capital levels at the end of the quarter?

The CET-1 was between 740 and 750 and the other ones are capital of more than 10% obviously in total capital ratio. Tier-1 capital at 882 and there is about 100 basis point pick up if you assess the mortgage finance portfolio using the actual risk weight of the underlying asset.

Okay. That's very helpful. And then just one final question for me –

More than 100 basis point pick up.

Okay. Just one final question for me on the energy growth this quarter, can you characterize there was more draw down on existing lines or was it actually new client acquisition one of your peer banks actually did some new client acquisition this quarter? Thanks.

Its new client acquisition, I think we've explained, people don't get to draw down on alliance unless there is a borrowing base enhancement that permits that. There are essentially lines our guidance lines based on the amount of borrowing base that's available to us and I think we've made clear. It's under appreciated aspect of that business that the banks have enormous flexibility in determining that borrowing phase.

Well, some of that occurred in the first quarter on the first redetermination Michael. It began to decelerate in the second quarter. So it was a new client acquisition.

That's what I wanted to get. Okay. Thanks a lot guys. I appreciate it.

Welcome.

The next question comes from Brad Milsaps of Sandler O'Neill. Please go ahead.

Hi, good evening.

Hello, Brad.

Keith, just curious you could may be speak to kind of the health of the energy market as you guys have gone through your book we're hearing a lot of evidence of different private equity funds looking to take advantage of distressed assets. Have you guys experienced that and just kind of curious to what degree you're seeing money step up to may be a borrowers that you have either helps throw up some of the credits?

Of course, yes, it's quite a lot of activity, again, some time ago about six moths or so ago and its picked up, our borrowers are most significantly impacted on the upper end of the size of borrowers but we have private equity investment happening on our case by case basis at all levels. But that -- there is no question, the private equity flow has really helped the health of the overall energy business in Texas over the last year and there is really quite an optimistic longer view about private equity that it's a buying opportunity and there will be good returns if they have a operator that they trust and can invest to it.

Some of the credits that you down graded this quarter, I mean do you view those as a sum that could be helped out in that market, or how did those sort of write themselves in your eyes?

One of them we expect to be refinanced very soon it appears to be largely if not completely a debt refinance at a higher amount, amount then we're at but its not banks that are putting the financing together. So that -- not only you have in private equity flow into the sector, but some non-bank lenders too are finding it opportunistic as the regulators are a bit more conservative with the banks and so at the end of the day there is quite a lot of capital flowing into the sector and that's been helpful.

Great. And Peter, I'm sorry if I missed this in your comments, but what was the mix in the warehouse in terms of purchasing refi?

Just over 30% at the end of the quarter.

Okay.

The refi.

Brad, I should mention too, there is quite a lot of undrawn equity that a lot of our borrowers had before the downturn really got underway. So not only if you had new interested private equity, but you have the existing committed equity that's also further cushioned some of the companies. Hello?

The next question comes from Emlen Harmon of Jefferies. Please go ahead.

Hey, good evening everyone.

Hi, Emlen.

Just a quick follow-up on the question about the capital impact and then your risk weightings. Peter you mentioned there could be 100 or greater than 100 basis point pick up in the regulatory ratios if treated according to the mortgage weights. Is that to say that the entirety of the existing mortgage warehouse portfolio could be treated under that regime or is there some portion that's going to continue to maintain the 100% risk weight?

No, today's mortgage finance portfolio we would expect we'll always have the full 100% risk weight.

Okay.

What I meant to say if it wasn't clear is that when you look at the risk the actual risk of the asset class, the first thing we do is take out the effect of the quarter end spike. And just for example CET-1 goes from just over 740 to just almost 760 on that basis. And then we take another look and we say all right looking at the underlying risk characteristics of the asset, if it were rated at that level of just 40% risk weight, the CET-1 would go to 8.82%. It's all hypothetical but the character or the asset we will take an MCA we would say would look more like the asset we have today, but it will be hold loans and would be subject to the risk weight. You might add that, it's also subject to availability of financing at the federal home loan bank -- any issue about liquidity management.

Got you. So then I -- the natural follow-on to that would be what portion of the existing mortgage warehouse could theoretically find its way into the MCA business going forward once you get that --

No way to give a projection on that. If we do know that the customer response from our existing customer base has been very favorable and we obviously then have access to balances that are on our balance sheet today. Not every asset will meet criteria, but we will have the ability to screen and evaluate from those portfolios and then obviously our customers have the option placing with us or going elsewhere. Ideally won't be offering a service level and then an efficiency that will make us an attractive way to go.

Got it. All right, perfect. Thank you. And then follow-up on the held for investment loan growth guide, if I look at the 2Q average loan growth balance, it's about 18% higher than the 2014 average. I think Keith, you commented that X CRE construction and energy that other buckets of the loan book had grown about 13% year-to-date. Would you expect -- are you expecting any slowing in those buckets, or should they be a net contributor to overall loan growth through the rest of the year?

We think we are going to see comparable loan growth in the C&I component to what we have seen over the last four quarters actually. I think that's what Peter alluded to. And he is looking back over four quarters. If you take those other three buckets out, we are growing about 13%

If you take those buckets out because you are not expecting them to grow year-over-year in a significant way. They have grown and continue to grow through Q2 more modestly if you take those out, the remaining balance has grown – the year-to-date average balance is more than – is 13% greater than the full year average balance in 2014 for all of the traditional held for investment balances including those that are not expected to grow during -- much during 2015.

Got it. So even versus that kind of 18% growth so far year-to-date, there is potential – it sounds like potential for a little bit of continued growth on the average balance?

We would – at the end of first quarter we said that number was 10%. So we went from the number that I have just described. That number went from 10% to 13% over the additional one quarter, so we are on a pace obviously depending on competition and other factors in our marketplace.

I wouldn't expect it to pick up like it did from first to second Emlen because we just expected it will be somewhat more modest back half of the year. That's all built into those real guidance for the year.

Got it. Okay. Thank you.

You are welcome.

The next question comes from John Moran of Macquarie Capital. Please go ahead.

Hey, guys. Thanks for taking the question. Real quick kind of follow-up on the energy side. Do you guys disclosed or have you disclosed what the percentage of classified and criticized is in that book today versus where maybe it was at the peak of the last cycle?

No. We haven't. We haven't chosen to disclose that. It's a slippery slope to start with more detail on something like that. It's still a dynamic category. So just gives us some pause honestly John to make those statements. We feel like we have got our arms around it as evidenced by no charge offs for several years and we continue to experience some downgrades. But, it's not something we want to really disclose in that much detail today.

Okay. Then a second one for me. I think in your prepared remarks, you mentioned that Houston was real strong, could you give us a little bit of color about what you guys are seeing down there, I know you got some folks that rolled off with non-competes and a couple of really good teams that you have hired out of banks down there. Any kind of look that you could provide in terms of what you are seeing down there?

Yes. It's really continuing to be a quite healthy market as I believe we talked about early in the year. That we expected another half percentage growth here from Houston and then probably any of our other four regions and that is in fact what's happening. It's primarily C&I growth. And C&I growth that is not in the oil service category despite the fact that everywhere you are looking you are still in there – there is a lot of oil service business and some of it is still healthy and doing well. But it's an area that we have avoided for many years and we are planning good opportunities in non-oil service areas of C&I.

Great. And then I think Peter, I may have missed this but how much is participated out today we are at quarter end on the mortgage finance business. And then it sounds like you guys are just going to use participation just kind of manage the mix with the addition of the MCA business?

I think that's a good way to look at it. We ended the quarter at $540 million in participation sold.

How is that compared to the first quarter?

First quarter, end of quarter was 450.

Thanks very much for taking the questions guys.

You are welcome, John.

The next question comes from Steve Moss of Evercore ISI. Please go ahead.

Good afternoon.

Good afternoon.

I was wondering if you could give a little color around the construction loan or loans that went NPA this quarter?

We had one construction loan in our San Antonio region. And that was to the extent of it.

Okay. You guys have been cautious on construction for a little while now, are you guys seen adverse credit migration in terms of criticizing sub-standard?

Because really aren't Steve. We know we are early relative to what appears to be still a very healthy market really in all categories. Our single family is healthy as I have ever seen it in three decades. It's quite strong in Texas. Our multi-family is still extremely strong. We are – even in our Houston market where we have some projects that are six or eight months ago I had some concern about CRE construction projects. They are holding up quite nicely and as they complete they seem to be hitting pro forma rates or better. And so we hope that continues. But the reality is, we just had such great success attracting top-notch clients in all the different categories, industrial, multi-family and single family. That we have been outgrowing as a percentage of those businesses relative to C&I. And we just believe strongly that you can have too much of a good thing in terms of concentration risk. And while today it's – they are three of the healthiest businesses we have in a down cycle in a recession they have more cyclical risk. And that's the only reason that we are tamping down the growth rate everything looks quite good today. In fact the credit in San Antonio was downgraded actually it's a owner occupied not a C&D.

Okay. And just wanted to go back to the mortgage warehouse yield commentary. Was I correct in hearing that mortgage warehouse loan yields could increase in the third quarter, just given the mix in underlying loans?

That business begins to seasonally taper the back half of the third quarter and then losses some momentum as it goes into fourth seasonally because we are more heavily purchase mix then most companies we have even less refi mix than others. That seasonality affects us a bit more. So as we open up the spigot on the new MCA business, the work will come on really quite slowly in the last half of this quarter. We are anticipating it out going next month. And as you would expect on a new business, we want to start slow and be sure everything is working absolutely optimum. So the impact of pick-up in outstandings on the MCA component of mortgage finance really won't be noticed in a big way until the fourth quarter.

Okay. Thank you very much.

You are welcome.

The next question comes from Gary Tenner of DA Davidson. Please go ahead.

Thanks. Good afternoon. I also had a follow-up regarding the MCA business. I think I have two questions, first, if I understand correctly based of the combination of MCA in the traditional mortgage warehouse business, you think will continue to make up 25% to 35% of total loans, is that correct?

That's correct.

That's correct.

So over time given the more efficient use of capital and higher yields, it would be more optimal to have a lion share of that total exposure in the MCA, is that how you are kind of thinking about it over time?

Not necessarily. Again, the core business, the mortgage finance warehousing business has been a phenomenal business and continues to be for us. Over time, we would anticipate that more of our participation program will in fact be in that business allowing us more shelf space if you will and mix benefit from the MCA business. But in no way that we intend to stop taking market share and growing the core mortgage finance business. It also feeds the MCA business.

Okay. And then the -- I guess the other question then if some amount of existing mortgage finance balances is, I guess essentially converted to MCA balances like a better of way of putting it. Does it do anything to your ability to use that portfolio [as from the fact] [ph] liquidity portfolio?

Not really. But it is still you contain financing in increments of two weeks if the federal home loan bank with very high advance rates just as we now have access through our traditional mortgage warehouse portfolio to that incrementally the 96% advance rate. It's not a liquidity issue at all. It's a capital management tool in terms of the ability first to see how the portfolio migrates or evolves the two components and the ability to manage asset sales at the end of quarters or whenever we choose.

Okay. That's helpful. Thank you.

You are welcome.

The next question comes from Dave Bishop of Drexel Hamilton. Please go ahead.

Yes. Good morning or afternoon. I'm sorry. I was wondering if you could go over the change in asset sensitivity again inter quarter sort of missed those numbers during the preamble.

Not so much intra-quarter, it's just the change since the year ago quarter. Since the number we will include in the 10-Q for tomorrow that number versus the year ago same number or a 100 basis points shock seen in NII increase from $54 million to $84 million. And on the 200 basis point shock, the NII shows an increase from $119 million to $178 million. And what we have seen over the course of really the last two years is very quarter that number increases because basically if the growth in demand deposits and obviously the growth in the floating rate earning assets.

Got it. Thanks.

Welcome.

Next a follow-up question from Jennifer Demba of SunTrust Robinson Humphrey. Please go ahead.

Hi. Thanks. Just wondering if you have the peak non-performing assets in the energy portfolio from the last energy price downturn, if you are disclosing that information.

I really can't answer that. I'm not sure Jennifer. We will need to follow-up on that. And we can talk about it I guess in our next conference. But, I don't know the answer.

Okay. Thank you.

We believe it's substantially lower because they are really – the portfolio is obviously much smaller. But, as a percentage, I don't think it was bigger.

They can follow up with you on that after the call.

Okay. Thanks.

The next question comes from Matthew Keating of Barclays. Please go ahead.

Good afternoon. Thank you. I understand that it's your objective to not or to keep the mortgage – total mortgage finance loans between 25% and 30% of your overall loan portfolio. I guess if you look at this year though you look at the [MBAs] [ph] mortgage finance forecast have and mortgage relation is growing 20% year-over-year as we look out to 2016, we have mortgage relations down 7%. Just wondering for that total book you still expect growth in those balances if it takes share, or do you think the industry dynamic will actually lead to declining balances as we look out to 2016? Thanks.

We expect to have some modest growth. We typically each year been able to outperform the industry projections and actual industry results. And we don't anticipate that changing so even with the headwinds Matt, we think, we would likely have some modest growth. We are not really prepared to give any guidance on 2016.

I mean we were starting from zero on MCA, so every dollar is an increase to some degree in market share. But, it will be – it needs to be looked at as the sum of the two over time and how the mix shifts between the two over time as the new business matures.

Right. And I guess on that front, I know it's really hard to forecast for the MCA business even if its still gets off the ground. But in your business plans because obviously done a lot of planning over the last 18 months, do you have any like expectations or goals for what's the MCA balance is to look like over the next couple of years? Thanks.

No. Yes. We have projections, but we are not prepared to describe those today.

That's fair enough. I mean just the final question. I understand that you don't view sort of the reserves on the energy book as [affected] [ph] meaningful metric. But, if you wouldn't mind sharing that with us, it would be helpful as we try to look at TCBI's reserve vis-à-vis some of the competitors have disclosed that that would be great. Thanks.

We just don't believe it's an apples-to-apples comparison is our problem with it Matt.

We know banks that have larger concentrations in larger loans that have a significant mezz debt piece that puts and creates issues. That's not the case with us. Character of every portfolio is the only thing that can really be assessed and all we can say is our reserves or we believe very conservative relative to actual exposure for the reasons that I have mentioned. You think about 15% reserve for a sub-standard loan sub-standard for a liquidity reason or it's out of borrowing base not for solvency or value of collateral reason.

Very well. Thanks very much for the color. I appreciate it.

You are welcome. Thank you.

This concludes our question-and-answer session. Should you have any follow-up questions, please call Heather Worley at 214-932-6646 or email Heather at heather.worley@texascapitalbank.com. I would now like to turn the conference back over to President and CEO, Keith Cargill for any closing remarks. Please go ahead.

Appreciate your attention and your interest in our company. We are quite optimistic about our new business but also our core business. And we appreciate your time. Thank you.