Texas Capital Bancshares, Inc. (TCBI) Q3 2015 Earnings Report, Transcript and Summary

Good afternoon, and welcome to the Texas Capital Bancshares, Inc. Third 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 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 third quarter 2015 earnings conference call. I am Heather Worley, Director of Investor Relations. If you have any follow-up questions, please call me at 214-932-6646. Before we get into our discussion today, I’d like to read the following statements. Certain matters discussed within or in connection with these materials may contain forward-looking statements as defined in federal securities laws, which 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, but are not limited to, deterioration of credit quality of our loan portfolio, the effects of recent declines in oil and gas prices on our customers, increased defaults and loan losses, the risk of adverse impacts from general economic conditions, volatility in the mortgage industry, 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, as well as a 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 in other filings made by Texas Capital with the Securities and Exchange Commission. Forward-looking statements speak only as of the date of this presentation. 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 a few prepared remarks, our operator Amy will facilitate a Q&A session. At this time, I would turn the call over to Keith, who will begin on Slide three of the webcast. Keith?

Thank you, Heather. Welcome to our 2015 third quarter earnings call. After my opening comments on the third quarter Peter Bartholow will offer his review and I will close our presentation before opening the call for Q&A. Beginning with Slide 3, you will note that we delivered strong growth and traditional LHI balances in total deposits. As expected, mortgage finance outstandings showed some seasonal slowdown that is typical in the third quarter, as compared to the seasonally strongest second quarter, but also was affected by the softening in the refi market. Mortgage finance remained a significant contributor to year-over-year earnings, due to the market share gains we have accomplished yet again this past year, with growth since the third quarter of 2014 totaling 14%. Despite the continuing build out in private wealth advisors and in Mortgage Correspondent Aggregation or MCA, operating leverage remained strong. The organic growth business model at Texas Capital is solid. It allows us to not only produce healthy growth in our core businesses, but also enables us to add complementary higher recurring lines of business in products as we diversify our income stream. We remain confident that the build out efforts in 2014 and 2015 will be meaningful contributors to our earnings growth in 2016 and beyond, regardless of interest rates. We are strategically building Texas Capital to deliver sustainable higher ROE for our shareholders in a flat rate environment that remain highly asset sensitive, if rates rise and will benefit from rate increases at some point. Credit quality remained sound. We showed stable NPAs for the quarter, but recognized the likelihood of some continued weakening in our energy portfolio in the future. On Slides 4 and 5, we update you on our recently launched Mortgage Correspondent Aggregation or MCA as we refer to it. Due to our later than planned launch in late September rather than late July, we have less to report in terms of actual results than we would otherwise. We can tell you that we are experiencing some competitive headwinds related to fees. Because we have started up numerous businesses, we’re showing good agility and fine tuning our positioning to engage prospects and win market share. While fee income will be more modest, we remain optimistic about the risk adjusted capital efficient returns this business should produce. Due the late launch, an increased pressure on market competitive fees, we no longer expect MCA to be profitable in Q4. However, MCA should be a meaningful contributor to 2016 earnings and will improve capital efficiency in our mortgage finance services division. We will have considerably more facts on market visibility to offer you on MCA in our year-end earnings call in January, after having operated the new business for a full quarter. On Slides 6 and 7, we show you quarter end highlights on our Energy business. The quarter end balance of energy loans declined slightly from $1.2 billion at Q2 2015 to $1.1 billion for Q3. The mix within the energy portfolio in relation to total loans remained essentially the same with E&P at 5%, Service 1% and other secured at 1%. 60% is non-SNC, 40% is SNC with 12% of SNC’s agented by us. Effectively we lead our agent approximately 65% at our energy portfolio. The oil-weighted borrowers are in an accretive hedge position in 73% of the cases throughout 2016. Our updated 2015 base case oil and gas price assumptions are $47.50 per barrel of oil and $2.75 per Mcf for gas. Our sensitivity case assumptions are $40 per barrel of oil and $2.25 per Mcf of gas. Forward looking price assumptions track the forward strip. Non-accruals and energy are flat linked quarter. We expect continued risk rate migration to the extent this low price cycle persists. Currently our loan loss reserves related energy appear appropriate. Our energy team is working diligently with our clients to adjust debt levels as borrowing bases fluctuate, our directing cash flow to our debt reduction as well as adding collateral, reducing debt through asset sales or through new equity injected by investors. We expect new high quality energy loan opportunities to pick up in Q4 as some properties change ownership. There is ample equity capital and experience management talent available to absorb the change in ownership. Turning to Slide 8, we’ve summarize our Houston market risk real estate. The real estate portfolio has modestly increased as we continue to experience no downgrades. The entire Houston market risk real estate portfolio remains graded pass as of September 30 as was the case at June 30, 2015. Peter?

Thank you, Keith. In 2015 third quarter, the Company produced near record level of net income. Besides the continued build out of MCA and wealth advisors, we maintained good operating leverage, well within guidance. We saw the impact of growth in liquidity assets on NIM and ROA remain very hot. Pace of liquidity asset growth increased linked quarter, up more than 20% to $2.8 billion. We also saw asset sensitivity up very slightly, compared to Q2. Since Q3 of 2014, the impact of net interest income from a change in a 100 basis point and 200 basis point change in the Fed funds rate has demonstrated the following changes. For the 100 basis points shock, net interest income shows an increase from $56 million to $87 million, and with 200 basis points shock, we see an increase from $122 million to $183 million; seeing year-over-year growth in DDA of $2 billion or 42%, and total asset growth of 30%or $3.4 billion in growth. That produced a growth in liquidity assets of $2.5 billion, the growth in liquidity assets. NIM declined by 10 basis points linked quarter, due to almost entirely to the increase in liquidity assets. And as adjusted for liquidity growth, NIM exceeded guidance at 3.7%, an increase of 2 basis points from Q2. We saw a liner weakening in yields on traditional LHI of six basis points, offset by two things; the six basis point improvement in yield, and a lower composition of mortgage finance loans to total loans. Yield trends have actually remained very favorable, especially given the magnitude of growth and the competitive environment in which we operate. As noticed, we experienced growth to 3.3% in the average balances of traditional health for investment loans. Very solid growth despite, what remains to be a high level of pay down activity, and declining contributions to growth rates from CRE and energy. We did still see growth in builder finance and other CRE totals, but the pace of growth is declining. And as Keith mentioned, energy is down $100 million linked quarter. Q4 and into 2016 we expect a further reduction in the rate of growth, and the contribution from CRE builder finance and energy. And excluding the growth in these components, year-to-date average balance growth in traditional held for investment loans is approximately 14% above the full year average in 2014. We recognize that mortgage finance business truly benefits from our position in this important business sector. Average balances were $4 billion in Q3. Participation program increase to $480 million average balance to maintain capacity to expand relationships including MCA while limiting the quarter end spike. Mortgage finance loans represent 26% of total loans for the quarter, and that contributed, and that reduction contributed to the NIM increase but for the NII reduction. Industry trend reduction and refinancing activity did reduce the total of MFLs with 30% average for the quarter in refinancing to compare to approximately 40% in the second quarter. This business is shown to be a source of sustainable contribution and very high risk adjusted returns. On Slides 9, through 12 with respect to net interest income, NIM, NII and efficiency. Components of net interest income in NIM are shown on slide nine. Net interest income was down slightly from the second quarter due to the reduction in MFL balances, but up 12.8% from the year ago quarter and year-to-date its up 18.5%. Mortgage finance loan yield has improved and as expected the yield on the very small MCA balance was 4.2%. The yields on traditional held for investment loans have remained good and the increase in the traditional healthier loan composition improved NIM. Earning cost obviously remains highly favorable and we believe the duration will continue to increase with relatively low deposit data because of the composition of the deposits. In terms of the components of net interest expense that are shown on Slide 12. MCA expense for the quarter was $2.5 million, or 0.035 per share reaching $4.8 million for the year-to-date or $0.07 a share. Growth in total NIE was less than 1% from Q2 for the reason shown. Efficiency ratio did increase by 80 basis points and remained within the previous guidance. Impact of that was lower MFL balances of 8 basis points, a reduction in fees on mortgage finance loans and the activity levels in swaps, 47 basis points, a higher non-interest expense due to the build out of MCA, 27 basis points, offset in part by a reduction in 123 art cost due to the stock price decrease. MCA is expected to incur a loss in Q4 for the reasons of Keith mentioned. We had minimal income in Q3. Balance billed in Q4 will produce a more meaningful income level, but not produce in net contribution due to the late launch reduction and a reduction in fee opportunity due to industry conditions. The outlook for 2016 remains very favorable. As Keith mentioned, we'll provide additional guidance in January as we see the impact of the buildup in balances during Q4. On Slide 13, the quarterly highlights are shown. Return on assets has obviously reduced by the very significant impact of liquidity increase. Adjusted ROA still is favorable, close of 1%. Obviously also ROA is been affected by higher levels of provision and by the reduction in MFL MCA contribution. ROE is just below 10%, due to same reasons driving ROA. Slide 14 is the 2015 outlook. On the strength of 2Q growth, our outlook for traditional held for investment growth has improved to upper teens, despite the increased level of pay down activity and reduced contributions from builder, CRE and energy. Expected level of MFL balances year-over-year has also increased and certainly does relate to the seasonal weaknesses and the reduction in refinancing activity. We do see potential for further market share gain to be managed with participation programs. We see softer industry conditions that will be partially offset by the growth in MCA in Q4. Deposit growth will continue at very strong phase, more than 30% year-over-year based primarily on exceptional DDA growth. Because of the difference in growth rates in loans and deposits, we do expect to see continued growth in the level of liquidity assets. Net interest income, not a major change but our outlook has been reduced slightly to mid-teens, because of the impact of pay downs, a reduction in refinancing activity, seasonal factors in in NIM, and the offset to some degree by MCA balance growth. NIM is still focused on 340 to 350, excluding the outsized effective growth and liquidity assets as I mentioned a moment ago. We're actually above that today. The guidance for efficiency ratio is also unchanged, no change in guidance for NIE growth, and we remain cautious about predicting improvement until we have a better view of visibility to increased mortgage correspondent aggregation balances. Net charge off range was actually reduced 20 basis point or less. We do see continued uncertainty by provision as reflected in Q3, a methodology drives quarterly levels which should be generally consistent with Q3 based on exposures already taken into consideration. Keith?

Thank you Peter. Slide 15 provides an update on asset quality. We were pleased to show a decrease in non-performing assets from $123 million in Q2 to $110 million in Q3. Our ratio of loan loss reserves to nonaccrual total LHI is 1.2 times. Total credit cost in Q3 was lower at $13.8 million versus total credit cost in Q2 of 14.5 million or a $700,000 decrease. Net charge offs totaled $2.3 million or 8 basis points in Q3, down from 14 basis points in Q2. Again, we had no net charge offs related to energy and NPAs related to energy were flat Q2 to Q3. In closing, the strong traditional LHI growth in Q3 affirms our confidence in the guidance for 2015. The lower mortgage finance growth in Q3 also supports full year 2015 guidance. Of course credit quality is job 1 in light of the current environment. It is important for us to manage nonaccrual levels and we were pleased with results in Q3. We remain committed to building liquidity, despite the NIM compression as it continues to provide a minor benefit in net interest income, and our deposit growth is important to our long term success and income growth. While MCA was launched late in the third quarter, it should be a meaningful contributor to 2016 earnings. We highly remain highly asset sensitive and are well-positioned to benefit whenever short-term rates increase. This concludes our presentation. We’ll now open it up for Q&A.

We’ll now begin the question-and-answer session. [Operator Instructions]. Our first question comes from David Rochester of Deutsche Bank.

On the topic of energy, it sounds like migration was a bit better than last quarter. Can you just talk about the levels of criticized and classified assets in that segment today, if the growth actually did slow in those? And then could you update us on any migration and the $1 billion in C&I you've got in Houston?

We’re really not the inclined to go into the weeds and give the details on criticized and classified. We aren't seeing that escalate. We’re seeing at this point that we've got a reasonably good grip upon on what we have allocated and what our expectations are near term, but I will tell you going into the next six months, all banks that are involved in the energy lending business certainly have some concern about just what shakes up over the course the next couple of quarters and one of the reasons is the hedges burning off. We’re just now entering in to the redetermination cycle and we should be we pretty well finished with that, at least 90% finished by the end of November. But we would anticipate some borrowers perhaps more than last redetermination, that might fall outside the borrowing base parameter, but we also have been working carefully with some of those borrowers, all those that we see as under the most stress Dave, to find a path whereby they can, either through some select asset sales or some new equity investor money, supplement the cash flow that they're dedicating to reduce the debt and get back in compliance. It's going to be an interesting couple of quarters. I think that’s yet to be determined at this low price cycle if it continues, and we expect it will for some time, should create some additional migration in the portfolio. But at this point we feel like we're well reserved and in a good shape.

And then you were saying that all your CRE in Houston is pass rated. Is the C&I as well at this point or have you seen some migration there?

Actually we’re really solid Dave. Market risk real estate in the Houston footprint is all pass grade. We have a very, very small a component of C&I that would be criticized.

Okay. And then so I guess, you're feeling maybe a little bit more comfortable going forward, just given your stable provision guide for 4Q versus 3Q, just given all the trends you're seeing?

We think so. We’re seeing a little softening. In rental rates, as an example in the Houston market for instance, on some multifamily, we’re beginning to see some incentives offered, like two months' incentives, if you'll sign a 14-month lease as an example. But the properties that are finished, that are leasing up are leasing up quite nicely. We have a couple that have not finished yet, multifamily, that may experience a little softening. We have such low advance rates Dave today relative to the last downturn. We’re typically at 60% - 65% of cost and it was not unusual in the last downturn to see projects 75% 85% of cost. So we really feel quite good about where we are. And so far our portfolio is holding up quite nicely, but Houston, for instance Down Town office as an example is a quite a bit different story. They're having some real challenges on space that they're attempting to sublease and the like. Thankfully we don't have Down Town Houston office in our portfolio.

And then just switching to the MCA business, you mentioned the competitive pressures impacting your fee expectations. What are you guys now expecting for gain on sale there at this point? I think you had mentioned your range of 100 or 200 basis points previously. It sounds like maybe the range is a bit lower now?

We were expecting 100 to 200 total, including mortgage servicing rights. But in fact the gain on sale component of that is virtually gone, temporarily in the market. So it's going to be a much more modest fee run rate over time. We should see that recover some, but right now what's happening is mortgage companies are so hungry to gather up mortgage servicing, that they're willing to really do the transactions without the same kind of fee that we could have enjoyed before. And so breaking in as a new player in the market, we’re going to have to obviously meet competitive pricing on the fee side. So we’ll have fees but they won't be as rich as rick we hoped at least.

Maybe you ramp up the balances a little bit faster to potentially offset. Is that the thought at this point?

That’s precisely right. The key right now is we're a new market entrant. We want to be sure and get some good traction and get our volumes up. And as we do that we’ll be in a better position to have some pricing power.

Great. And are you still thinking at this point that a good portion your existing customers in the legacy mortgage finance business will do business with MCA?

We have no reason to think not, but we also are really early into it. And I wish we had more data points for you, but we will the next call.

And then the $2.5 million an expenses for 3Q for MCA; did that include the capitalized costs as well for the investments that you’ve been making there?

Yes, it did. The amortization of the capitalized cost. It did.

Okay. And so are you expecting any additional increase in MCA expense in 4Q at this point, or are you pretty much done with build out?

I think we’re done with the build out of anything that's of significant expense category.

And as we get more volume, we’ll add incrementally some people, but that will be after we get well into our volume run rate.

The next question comes from Kevin Fitzsimmons at Hovde Group.

I wonder if I could switch gears to the margin here. We’ve talked for a number of quarters about the asset sensitivity and we’re probably at a different place today then we were a quarter or two ago and timing of when rising rates were coming. So just curious, it seems like you're committed to the asset sensitivity and rate rises will come eventually, but has there been any talk or have you guys explored pealing back any of the asset sensitivity and if not, do you have a lower view of the margin as a result going forward? Thanks.

We've said many times. We’re in early stages -- relatively early stages of the strategic emphasis on building low costs deposits. Now we are very really reluctant to quit that game at the end of the second quarter. So those balances will continue to build. We remain equally reluctant to extend duration on the asset side. There is nothing out there that offers much opportunity at a reasonable capital risk rate to give us much juice. So…

There will come today Kevin, where we believe this liquidity bill is going to be a nice incremental income opportunity, but not in the right environment we see today.

Got it. And one follow-up. I wanted to gauge -- I believe I heard you say before, you thought the provision would be stable third, the fourth quarter and I just wanted to gauge your conviction on that, because it seems like with energy it's very fluid obviously. So it’s hard to predict. But it seems like what you’re saying Keith is that you’re going to a lot more in the next few quarters and this redetermination process is going to finish up in November. So do you feel like you really have a lot of conviction to say the provision will be stable in fourth quarter or could a lot of things change depending on this process you’re going through that it comes in much differently than you expect? Thanks.

We don’t expect any surprises. I didn’t mean to suggest in any way that we’re anxious about surprises at this point. That’s always a possibility in any loan portfolio, but not something we’re worried about. What I was referring to is just the continued migration and the degree that we experience continued migration. And that’s why we would expect to continue to stay at this level of provisioning, Kevin. Until we see some relief on prices, until we see some significant equity begin to comeback into the space and again relieve debt on the more stressed companies and the asset sales begin to happen, then I think we should remain conservative and continue to provide at a level comparable to what we’ve been providing. That’s our best view today.

Our next question is from Brady Gailey, KBW.

So it’s the first time we’ve seen the warehouse yield pickup in a while. It won the big move. What drove the kind of reversal in the trend there?

Phenomenal bankers. Really great team. We really are seeing that stabilize the pricing. That was just not the case for the last couple of years as we all saw. And we are somewhat encouraged that maybe we found a bit of a bottom, but we’ll have to see. But there is nothing particular other than that, that we would attribute it to. We think it will be more stable going forward. Hopefully we’ve seen bottom, but we’ll have to monitor that as we go.

And then we've heard from some of the other energy lenders that are involved in the SNC business like Texas Capital is that there is going to be kind of a special winner energy focus SNC exam by regulators. Have you all heard anything about that and can you update us on your SNC balances? I think they are around 1.7 billion last quarter. Did those change at all in 3Q?

Best idea is they came down a little bit.

We really haven't heard that it was energy focused, but that we did expect kind of a six month, instead of the -- in prior years, just once a year SNC review. So as they look at SNCs, I wouldn’t be surprised that they particular look at the energy piece, but we haven't heard that it was particularly focused on energy.

The next question is from Brad Milsaps at Sandler O'Neill.

Just to kind of follow-up on the discussion on MCA, just kind of wanted to get a sense of -- you mentioned maybe ramping balances. Could you give us some color on kind of where you think those could go maybe in the first part of the year in terms of maybe the mix. I know you mentioned still 25% to 35% of the balance sheet, but just trying to get a sense of kind of the mix between the two as you get out of the gate here?

We really don't expect the combination of MCA and mortgage finance to get out above 30%, 32% for the next couple of quarters. I’d be surprised that we saw anything stronger than that. For one thing we’re in a seasonally slow quarter, and the first quarter always tends to be slow too on the core mortgage finance business. So while MCA is going to begin to ramp-up, it will expectedly be filling part of the soft decline that we always experience seasonally in the fourth and first quarters. We do really like the dynamic of that being a filling capability with a higher yield than the core mortgage finance business, and it gives us some ability we think going forward that we've not have before to manage total loan, total volumes in the volatility. So we're so early into it though Brad, I think that tool will be more useful a year from now in the fourth quarter than necessarily this quarter, but it's something we look forward to benefiting from.

Okay. And then just switching gears on loan yields, you guys had held the line pretty well for a couple of quarters. Maybe they slipped 6 basis points this quarter. Can you comment there on pricing and kind of your outlook for stabilization or maybe additional pressure there absent, any help from rates.

We really feel like we shouldn’t have a lot of slippage there going forward. Again we feel like much of the erosion we’ve taken over the last couple of years, but being a high growth LHI company does create some amount of a challenge on NIM. This core NIM, its almost all growth that is causing our erosion and I think that's a good thing.

Our next question is from Jennifer Demba of SunTrust Robinson Humphrey.

Okay. I’m sorry. Just can you talk about your comfort level in growing loans in Houston in the future…

Jennifer, we can’t hear you very well.

…certainty around what the energy decline will ultimately do to the Houston economy. I saw you grew about 50 million in CRE loans this quarter?

Jennifer, we’re having a hard time hearing you. Could you start over with your question?

Can you hear me better now?

Now we can, yes.

Okay I’m sorry. Can you just talk about your comfort level in growing Houston commercial real estate loans going forward over the next few quarters given we don't know exactly what the energy impact is going to be on the Houston economy ultimately and you know this is softness multifamily in downtown office?

Yes, I sure will Jennifer. The growth we've experience is virtually all just advances on projects that we’ve had under construction and development for some time. In fact, I don't know if any significant projects that we’ve undertaken that are new in the last six months in Houston. So are we going to find opportunities here and there? Of course. We actually like disruption in markets but you to be extremely careful and be sure that the opportunity you pick is in fact a really high quality opportunity. And we’ll find those from time to time and there have been a couple of small ones the last six months but nothing significant that's new that we’ve done in that footprint.

Our next question is from Emlen Harmon of Jefferies.

Keith, in the past you’ve talked about the MCA business and being kind of the top couple of businesses for you guys in terms of profitability. Does the change in the fee outlook for that business kind of change where that falls on the stack of the different business that you are in?

We still believe it's going to be one of our top most profitable ROE business. We're having two-month later start in the third quarter than we anticipated. It means we had very little at all that really contributed on the revenue side. It just started to happen at late in September. And that throws us off for the balance of the year in terms of volumes and overall profit run rate. So the give up on the market competition on the fee side, it's not going to be in any way to cause us to be less optimistic overall about what this can do relative to our other businesses. This still should be a top quartile, top decile kind of contributor, particularly when you look at the capital efficiency of this business. But it's just going to take us an extra quarter to -- particularly with fee competition to achieve that kind of run rate. But we should have a very nice contribution this next year for the business, and as we wrap up the back half of next year I'm extremely optimistic about the returns we'll see here.

Got it, thanks. And then just on -- from a perspective of capital, Q3 ratio fell another kind of 20 basis points this quarter. And it is in the range or you guys have raised capital in the past. Do you feel like you are at a point where you need some more equity on the balance sheet and just kind of how are you thinking about capital needs?

Emlen, it remains the same. We are forward looking and we believe things are well balanced. We are waiting to see what the impact of MCA growth would be on the total, obviously. That comes in a much improved capital risk way. If you look at from a risk perspective, if you look at the mortgage finance portfolio, at something like a 40% risk weight, which is the effective underlying risk weight of that portfolio in that regard to the regulatory issues, we're really running over 12% in TCE. We first assess it based on the underlying risk that we have in the business and then we address the other attributes.

And Of course we're going into the softer fourth and first quarters on that business too; and while MCA will begin to kick in and provide some funding, part of that softness Emlen, it's at a more capital efficient run rate.

Our next question is from Michael Rose of Raymond James.

Just one quick follow up on energy. Do you have any second lean exposure; and if you do, can you quantify it?

We really don’t. That's not a product where we played.

Okay it's great. And then just one other follow up. Can you talk about maybe any lending hires in the quarter and kind of what's your outlook, your pipeline looks like as we move into 2016? Thanks.

We hired a couple of RMs in the quarter and we're always on the look for the starting lineup of the all-star team as we've been saying for a few quarters now, since that record pace that we put together, four quarters in a row. We feel very good about the prospects, as we go into the fourth quarter on picking up some talent, and off course we're going to be opportunistic. As some parts of the economy, particularly I think the overall economy in Houston as some softening and some weakening, we actually may find some really good opportunities on the talent side too, and we continue to have an advantage relative to the biggest banks to whom we compete in terms of just how difficult it is to operate in those biggest banks in this regulatory environment and still take care of your clients. And off course that's our key calling card for the best talent, is that they can come to our Company. We're going to run a tight ship. We're going to always be somebody thought well about our regulatory overseers, but at the same time we're just not held to quite that high standard and therefore they can be more agile, more decisive, collaborative with our team and respond the client. So we do feel good about the next few quarters coming up as one opportunistic on talent.

The next question is from Brett Robertson of Piper Jaffray.

I wanted to I guess go back to liquidity and just thinking about where that could go. At 16% or so of average in 3Q; is there a level where you would start to do something more aggressively if that number pushed above a certain level to kind of mitigate the impact it has on the margin or can you talk maybe about the upper limits of its liquidity?

I think we'd first focus, Brett, on calling anything that looked and out of line with respect to our longer term growth expectations. In other words, we won't be offering anything that looks like frankly favorable pricing from the depositor perspective. It's be very focused on the lowest cost elements.

And the stickiness, we are trying to build this base rock solid, so that when rates do begin to move, we have them embedded as a key client and provide a lot of service for that client, Peter.

Okay. And then the other thing I was just curious about, I was thinking about expenses. And I know you have -- I think it was 1.8 million related to 123 [ph]-- and we think about 4Q with MCA building. Does it make sense that expenses are sort of $4 million to $5 million higher or can you talk maybe about some of the ins and outs that you're looking at as you go into the end of the year?

We're just not prepared to give a specific Q4 number on that, Brett. We're still with the guidance on net interest expenses growth and efficiency. And more than right now, it's just a little too early to say because of where we are with MCA.

The next question is from Steven Moss at Evercore ISI.

I was wondering if you could discuss by what percentage you expect to reduce borrowing business by during the fall redetermination period?

That’s really a not something I could speculate on -- I would only be speculating. I don’t think that would be helpful to you. It's such a specific client by client scenario, really see that -- we'll just have to see how it plays out. But again it's not as though we're going into this redetermination with a really high anxiety about surprises we're going to find these. These clients that have had more the stressful leverage and who have the most exposure on hedges bleeding off, we've been working with them for quarters since last year. So I wish I could give you a better answer, but the data points will be up and down depending on the particular client. There is really not a generic energy loan I could describe for you.

Okay and then I guess one more related to energy, kind of have an idea as to what percentage of your borrowers are likely to beat divesting properties over the next couple of quarters as you kind of look at the overall portfolio stress?

They will have a variety of options, and again it's going to be the borrower that makes those choices. So a lot of that really will depend on when the private equity is ready to hit the offering price, and also the alternative on aquisitors that are operating companies that want to add to their reserves. Public companies are constantly on the lookout for acquisition reserves too because their balance sheet is so sensitive to you guys, the analyst community and the investor community, being sure that they are adding reserves at all times and not depleting their reserves. So it's going to be interesting to see how that develops but it's not simply a function of selling assets. There is also an opportunity for some equity to be sold and also the cash flows. In some cases, they are dedicating increasing amounts of their cash flows to toward debt reduction. So there are three different tools that they will be using, but again it's very hard to predict on an overall basis.

Okay, and then with regard to overall long growth, just looking at things from an ELP basis, it seems to indicate a bit of a slowdown in overall loan production going forward. Just kind of wondering what you're thinking about 2016?

I think we will have a good 2016. We are early on actually giving guidance. It will be prepared of -- with our bottom-up planning process that we really believe in. We'll have that accomplished by the January call and we'll be able to give you some good idea what of we really expect for the year, but I think we're optimistic about '16.

The next question is from Ebrahim Poonawala at Bank of America.

Just to add one question. In terms of -- I'm looking at the slide 13. The outlook for the Texas [indiscernible] where it is, and assuming that interest rates don’t do anything meaningful over the next 12 to 18 months, what should we think is the sustainable ROA or ROE profile of the company?

Ebrahim, that’s hard to know. It's going to be so much a function of loan growth, where we are in liquidity. The model right now is very stable where it is. A growth will reduce margin. Added liquidity will reduce ROA, but not to the detriment of NII. We feel good about where we are on credit, despite the uncertainty related to the potential migration so that we're not anticipating in huge surges in credit cost. But if static today, with a little improvement from MCA and pulling expenses back in development expenses for that back in line, we'd be at 1% today, adjusting for the effect of liquidity build.

Understood that --

We are growing the fee components of the company which are modest today, but growing them at a much faster rate than the overall loan portfolio. And then with the MCA, with overall yield, not just the feed fees, but the overall yield, and the capital efficiency being so much more attractive, we think we’re on a good solid trajectory. It's going to take time, but we believe we can achieve a higher more sustainable ROE with this discipline we have. But it's not going to happen in a quarter or two. This is a longer process, particularly with rates flat. So we’re building the company to improve ROE with flat rates. We can't control rates, we can't control certain other things about our income stream and returns.

Understood. And just one quick follow-up. I'm sorry if I missed it. Did you see what the expectations are in terms of the ramp up in the MCE in the fourth quarter; just the MCE component?

It's just a little too early to say. We are building it now. So a little too early based on -- for the reasons that Keith mentioned to predict what that average balance will be. We do know it will at least partially offset what we would expect to see is the seasonal reduction in the mortgage warehouse business.

And one last question in terms of, are you seeing any interest on deposit from the big banks. Like how big a driver of the deposit growth combat the -- as we look out over the six to 12 months?

I think there was part of that that was garbled Ebrahim on the phone. Can you repeat that please?

I was just wondering, we've talked a lot about the earnings season, about deposit growth coming from the big banks to some of the mid and small cap banks. I'm wondering what your expectations are, if you assume the same trend; and what your expectations are going out over the next 12 months with regards to deposit growth coming from the big banks?

We have seen some select opportunities that are coming from the big banks. It's not a massive amount, because again we want to be sure on any of these new relationships that it's really an embedded -- a good long-term deposit relationship. But in fact we have picked up some that we think are excellent long-term deposit relationships, and we expect to see more. But I wouldn't say it's the predominant amount of the growth we’re saying at all. I would say it's modest but it's steady and increasing.

The next question comes from Matt Keating of Barclays.

Just with respect to the MCA business, can you tell us how many employees you currently have within that unit?

We’re approaching 50 Matt. That is not a [indiscernible] number but it's going to be within 10%.

So I guess in September you put out a press release and there was an application to hire around 100 mortgage professionals over the next year in that businesses. Is that still an accurate assessment in terms of the build out plan, given the changes in the industry structure, et cetera?

The incremental employees that we’ll be hiring, as you would expect will be more related to the volumes and handling those increasing volumes. So we've hired many of the most expert specialists. Those all had to be on board and then our key -- our interims that are actually soliciting the business and so on. We pretty well hired out that group. So yes, it will be incremental people, but only as the volumes dictate, so that we can maintain top level service.

Matt, I believe substantially all of the senior-level people in terms of the professionals as well as the RMs had actually been hired before the end of Q2. Maybe -- could be a minor change from that. But the talent that drove the creation of the systems and all that has been on for much longer.

Our next question is from Brett Robertson of Piper Jaffray.

I just had a follow-up on energy. I know you guys don't want to give out the criticized-classified number, but you kind of talked about reserves being pretty strong. I didn't know if you wanted to potentially disclose overall the overall reserves, kind of given your confidence in those vis-à-vis the industry?

Good try Brett, but no. We really would rather not do that. And we've explained, and maybe I should mention it again. We just believe that such a dynamic portfolio, it is a case-by-case–client-by-client business in Energy especially, as much as people want to have a homogeneous template where we could all look at apples and apples relative to different banks. We think actually it can be misleading they put some of that information out. We feel very confident that we’re on top of it, adequately reserved. We don't expect surprises. If you're in our business, you get them once in a while, but we don't expect that to occur over the next couple of quarters. What we do know is it's a challenging next couple of quarters because of the hedges bleeding off and the redeterminations will inevitably show some that have falling out of the borrowing base compliance, but we think we've been working on a path to get them back in compliance in some cases for six to nine months with the borrower. But we would rather not disclose the details. I know some banks have chosen too, but we really don’t think it will be helpful and informative, because of how dynamic it is.

So many structural differences in what different banks do and how their portfolios are comprised. If you’re talking about very large credits that have subordinated capital of one type or another, obviously the service component of the portfolio is a huge driver of exposure and provision in this cycle, and I guess in some cases charge offs. So we have to look at those differentiating factors first, and then try to dig into it, and unfortunately the broad measures are not going to be indicative of actual exposure?

I think we can’t say this Peter. I think you may regret that I am. But of those that have disclosed, we feel very comfortable where we are relative to the numbers they've been disclosing. But we can’t be completely comfortable, because they have a different client base in some cases. So we think we’re doing a very good job managing that portfolio and we have a client basis really working with our bankers. And we think we’ll make it through the cycle as long as it’s been and however long and takes with better performance in most peers.

This concludes our question-and-answer session. I’d like to turn the conference back to Heather Worley for closing remarks.

As a reminder, if you have any follow-up question please feel free to call me at 214-932-6646. At this time, I’ll turn the call to Keith Cargill for closing remarks.

We appreciate your interest in our company and we always get the right questions that are very helpful to us too. We encourage you any time to give Heather call if there's something that you want to follow-up on, and we’ll always do our best to be responsive. Thank you very much.

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.