Texas Capital Bancshares, Inc. (TCBI) Q1 2017 Earnings Report, Transcript and Summary

Good afternoon. And welcome to the Texas Capital Bancshares, Incorporated First Quarter 2017 Earnings Conference Call. All participants will be in a listen-only mode [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.

Thank you, Gary. Thank you for joining us today for the Texas Capital Bancshares’ first quarter 2017 earnings conference call. I'm Heather Worley, Director of Investor Relations. Before we begin, please remember this call will include forward-looking statements that are based on our current expectations of future results or events. Forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from these statements. Our forward-looking statements are, as of the date of this call, and we do not obtain any obligation to update or revise them. Statements made on this call should be considered together with cautionary statements and other information contained in today’s earnings release, our most recent Annual Report on Form 10-K and in subsequent filings with SEC. With me on the call today are Keith Cargill, President and CEO and Peter Bartholow, CFO and COO. After a few prepared remarks, our operator Gary will facilitate a Q&A session. Should you have any follow-up questions, please contact me directly by phone at 214-932-6646 or by email at heather.worley@texascapitalbanc. At this time, I will turn the call over to Keith, who will begin on slide three of the webcast. Keith.

Thank you, Heather. Welcome to our first quarter 2017 earnings call. I’m Keith Cargill, President and CEO of Texas Capital Bancshares. We will begin with my comments on the quarter, followed by Peter Bartholow’s review, and then I'll close our presentation before we open the call for Q&A. Let’s get started, total loans in Q1 2017 were up 7% versus Q1 2016, despite the decline in mortgage finance. We achieved 3% linked quarter LHI growth and 9% growth in LHI year-over-year. It is noteworthy that the LHI growth again largely occurred near quarter end, as well as a case in Q4. However, our loan path line appears meaningfully stronger at the end of Q1, than was the case at year end. Hopefully, for tending yet stronger linked quarter growth in Q2. As well as the case with peer competitors, the first quarter was a challenge in the traditional mortgage warehouse category. We were down at least in percentage decline when compared to peers. But despite continued growth in MCA, our combined linked quarter decline was 28% and the year-over-year decline equaled 1%. As Peter will address same the effect of depressed mortgage industry volume in Q1 and the expected headwinds for the remainder of 2017 cause us to revise downward the guidance for full year 2017 in our combined mortgage finance business. We are pleased that the launch of MCA in October 2015 has pretty helpful in blunting the decline in overall mortgage finance income and outstandings. The first quarter showed a strong seasonal dip in DDAs. Although, they appear to be trending up nicely for the second quarter, as was the case last year. Liquid assets on positive Federal Reserve Bank of Dallas increased on average to $3.3 billion in Q1 2017 versus $2.6 billion in Q1 of 2016. On a linked quarter basis, the effect on net income of the declines in overall mortgage finance and seasonal DDAs cannot be fully overcome by several positive income and expense categories. The 12% linked quarter decrease in net income still produced an ROE of 8.6% versus 6.13% in Q1 2016, and an increase of 63% in earnings per share versus Q1 2016 after the effect of the equity raise in November 2016. The lower loan loss provision of $9 million in Q1 2017 compared to $30 million in Q1 2016 was a significant contributor to the improved year-over-year earnings per share and ROE. Again, Peter will cover our positive change in 2017 guidance for loan loss provision due to the improvement we are experiencing in credit quality. Slide four shows highlights of our energy business and our Houston CRE. We are winning high quality of new loan and deposit relationships with energy clients, while improving credit quality in the classified energy book. Similarly, we are experiencing positive loan grade migration in our overall loan portfolio. Houston CRE remains very high quality as evidenced by only $3 million in special mention loans and no sub-standard or non-accrual loans. On slide five, we show the strong geographic diversification across loan and deposit businesses. Also, we have updated unemployment rates for the Texas metro markets where we are based. As you can see these are quite strong. During 2017, we anticipate that our state-wide SBA business will gain traction and began to evolve into a national footprint business. Our public finance business launched in the third quarter of 2016 has very successfully grown into a meaningfully profitable national footprint business in record time. We are also pleased with the profitable growth in our ADL and franchise finance businesses, each which expanded the national markets in 2016. Among our five Texas regions, Houston again, produced the strongest growth in LHI in Q1. Also, delivered the second strongest growth in LHI and the largest percentage increase our five Texas regions. Importantly, Boston again showed the strongest deposit growth of our five Texas markets. We are very pleased with the outstanding results our Houston, Boston, MCA and public finance teams delivered. Peter?

Thank you, Keith. As Keith commented, the Company produced net income of just over $42 million and $0.80 per share after the 6% per share impact of the stock offering in the fourth quarter. These reflect good growth in traditional held for investment with improved spreads. They have very favorable expansion of NIM, as anticipated, with rate increases in Q4 and again, late in the first quarter. As mentioned, the provision was $9 million, the same as Q4 with improved credit metrics and very favorable reserve position for energy exposure. Contraction in total mortgage finance loans, and that includes warehouse and MCA from Q4, was meaningful of course. But it was flat with a year ago. The growth in MCA balances represented strong performance against the industry headwinds; unfortunately, representing only a partial offset to the warehouse loans. Seasonal impact of purchase money financing with added detriment of higher mortgage rates, affecting refinancing volumes, were paramount. We saw significant excess capacity in the industry that had a meaningful impact on average balances with a reduction in dwell times on more than two days. Those steps are in contrast to the first quarters of 2015 and '16 where very low rates created strong refinancing demand. We benefited from meaningful improvement in warehouse and MCA yields. For pre-provision net revenue, we saw the reduction in warehouse was principally responsible from linked quarter contraction by 5% or $9.5 million. It was actually more than $12 million impact from the reduction in mortgage warehouse activity, plus another $3 million from the reduction in DDA balances. Year-over-year growth of 16% reflects general market share expansion plus growth in new and expanded lines of business. Expenses for Q1 were down slightly from Q4 and the growth from Q1 '16 represented a full impact of the build out activity for new and expanded lines of businesses, which were heaviest in the last three quarters of 2016. On slide six is the NIM review. The reported NIM increased by 18 basis points from Q4. Our asset sensitivity was confirmed and the analysis of yields and cost with reduced impact of liquidity assets due to seasonable reduction in DDA balances, but was much more pronounced than seen in prior periods due to the size of the effected balances. The seasonal reduction in DDA had an adverse impact on both net interest income and NIM expansion, resulted in increase in funding cost and moderated positive impact of the two rate hikes, with the total impact just in funding cost of about a nickel a share; the balance is now coming back in DDA and are not a reflection of exposures to rising rates or customer attrition. The increase in rates has reduced loan subject to floors to approximately $1.3 billion, down from $1.7 billion at the end of 2016; yields on traditional LHI volumes increased by 19 basis points from Q4 and 28 basis points from Q1 of 2016. Asset sensitivity for us is heavily influenced not just by deposit funding but by the composition of the asset base in contrast to what the other banks experience. On slide seven, as Keith noted, loan growth was very and consistent with our guidance in Q1. Traditional LHI balances grew by 2.2% from the fourth quarter and 9% from the year ago. Q1 by the way has historically been our seasonally weakest quarter. We saw strong growth in the final days to the quarter with an ending balance above average by $300 million and a much stronger level of growth indicated now for the second quarter. In addition, we experienced very high level of pay-offs for Q1, especially in commercial real-estate categories. Total mortgage finance again that's sum of MCA and warehouse we achieved meaningful improvement in market position in 2016 and in Q1, despite the contraction in warehouse balances. In contrast to industry trends, average totaled mortgage finance was flat year-over-year and down 28% linked quarter compared to industry and peer results of up to 40%. As expected, the market leading expansion of MCA partly offset the seasonal reduction in average warehouse. And in Q1, MCA represented 28% of mortgage loans, total mortgage loans, at a much more favorable risk weight. Warehouse participation program has been very successful and had an average balance in Q1 of just under $400 million compared to just under $1 billion at the end of the fourth quarter, or during fourth quarter. Program to reduce participation balances was begun and will improve volume in future quarter as activity increases. On slide eight seasonal trends drove linked quarter reduction in DDA balances and total deposit balances from Q4, still reflecting very strong growth from year-ago levels. With rising rates, we’ve had no loss or deposit relationships, no meaningful migration to interest bearing from DDA balances with the two increases through year-end. And only two deposit categories in our balance sheet move in tandem with fed rates. The increase in treasury management fees from both Q4 and year-over-year reflect ECR adjustments and the strength of our market position. We see a benefit of seasonal trend in DDA balances already returning to Q2 and the change in composition of balances will be most beneficial with the effective rate increase last month, and any others which should come in future quarters. We can expect with this third rate increase some minor impact on migration of DDA to interest bearing categories. But those will, we believe, lag significantly the movement in market risk and more particularly the rates in our earnings assets. On slide on non-interest expense, is a lot of activity, most of it relates to salary and benefit expense. And I'm going to move a little bit towards a different kind of discussion of what happens through 123R expense with changes in stock price and the source of some volatility and confusion. We looked in 2016 at an planned level of expense of approximately $16 million, we saw a reduction in days and $16 million for 123R expense. Wide swings in stock price plus other factors reduce the actual expense to $13.6 million, just $2 million below plan. Whereby swings in the quarterly accruals went from $2 million in Q3 to $7 million in Q4 and then again $4.6 million in Q1, where those swings are much more pronounced than the impact on the full year results. While the annual cost will vary with changes in stock price, that won’t occur as much using the full year perspective. For Q1, the impact from $6 increase from Q4 resulted in only a minor increase and the total expense of approximately $19 million for the year. We expect that level to hold spread fairly evenly over the quarters, and we will update the effect of those changes against that $19 million as the year progresses. We saw other categories of non-interest expense $7 million – net interest income $7 million impact or $0.07 per share impact on principle $6 million, resulting from the number of days. Restarted the incentive accrual and was offset by FICA expense, resulting from incentive payments. Continued build out in 2015 and 2016 initiatives has been a major factor, peaking in Q4 as the first full quarter of all of those growth initiatives. That resulted in a big NI increase from Q1 of '16 with a moderating impact over course of 2017. All of the new and expanding lines of businesses were profitable for the first time during the first full quarter of 2017. And due to the contraction in warehouse balances and the net revenue reduction, the efficiency rose sharply in Q1 but with a much improved outlook over the remainder of 2017. Quarterly highlights on slide 10, for 2017 again, net revenue contracted from fourth quarter, but it was up by 16% from a year ago, where the current quarter was most affected by the reduction in mortgage warehouse activities. As mentioned early, ROA and ROE were significantly affected. Obviously, ROE further affected by the offering in the fourth quarter. We have experienced meaningful improvement in NIM and will benefit from that increase after the rate change. And we’ve returned some more traditional levels of DDA funding. With respect to 2017 outlook, our outlook for traditional held for investment balances is unchanged with confirmation from Q1 results and early indications in Q2; until the benefits from pro growth changes would come realize, we continue to be cautious about economic trends. High single, low double digit growth is before any potential benefit from the strengthening economy. From the strength of MCA, we expect modest growth in year-over-year balances of total mortgage finance, that does reflect a reduction obviously in total mortgage finance volumes from what we said at the end of the year. We now expect average balances for the remainder of '17 to be $4.4 billion to $4.7 billion with a mix shift to MCA increasing to approximately 25% of the total increasing capital efficiency. Total deposits based on the level of seasonal outflows in Q1, we are modestly adjusting the guidance to low-teens growth. And average balances for liquidity assets will grow more modestly after recovering the $500 million in contraction experienced during Q1. The outlook for core NIM has increased, reflecting the fact that year-to-date performance has exceeded guidance and we will derive additional benefit from the Q1 rate increase. Guidance has increased for both reported and for NIM adjusted for the level of liquidity assets. The outlook for net revenue, NI and the efficiency ratio, have obviously weakened due to sharper than expected contraction in the warehouse balances. We do expect significant growth from Q1 for the remainder of the year, and a full year contribution for key initiatives that were begun in 2015 and '16. We had only a small contribution from MCA in 2016 being much larger in 2017. We expect a mid 50% efficiency ratio for the year. Following, we believe to low 50s by the end of the year or for the fourth quarter. Core bank before the effective reductions in warehouse and seasonal DDA balances has performed extremely well, and should show continued improvement for the rest of the year. We have some meaningful improvement in national economic trends. We remain cautious about, as I said the prospect for weakening economic conditions. With improved credit metrics, the range of the provision has been reduced, but remains appropriately wide we believe at low 50s to low 60s range. This guidance is based on general stability in the energy sector but no meaningful improvement in economic outlook; reflects the probabilities as I said of a weakening economy if the pro growth agenda cannot be realized. Key conditions and metrics improve or remain stable, we couldn’t see improvements from the guidance and we'll provide updates as the year progresses. Keith?

Thanks Peter. On slide 12, you will note net charge-offs declined from $20.8 million in Q4 '16 to $5.7 million in Q1 2017. The non-performing loan ratio was 1.10 percent, excluding mortgage finance, and 0.88% as a percentage of total loans, as compared to Q4 2016 ratios of 1.29% and 0.96% respectively. The dollar reduction in non-performing loans was slightly over $20 million linked quarter from $167 million to $146 million. The loan loss reserve to non-accrual total LHI was 1.2 times as compared to 1.0 times as of Q4 2016. We are pleased with our progress and overall credit quality improvement. We delivered solid core earnings despite the industry wide drop in mortgage volume, affecting our mortgage finance business. The new MCA business last 18 months ago did reduced the net decline in mortgage finance outstandings and offered new profit contribution versus the first quarter of 2016 start-up loss incurred in that new business. MCA also offers a more capital efficient growth category to our overall mortgage finance business. Traditional LHI growth was solid and showed a surge at quarter end. The loan pipeline is meaningfully stronger at the end of Q1 2017 than was the case at Q4 2016. While the market remains highly competitive, we are encouraged by the build in pipeline. The pipeline is largely comprised to new prospects. If and when we see meaningful progress toward tax reform existing class remain optimistic and likely will increase borrowing to grow their businesses, they tell us. An additional rate hike, although never included in our guidance, would be increasingly beneficial as loan floors are dissipating rapidly, allowing a more meaningful pass through to NIM. The energy portfolio is improving in quality and new opportunities are helping to offset pay downs, and contribute to the rebuild of profit run rate. Overall credit quality is improving allowing us to reduce guidance for the 2017 loan loss provision. While total mortgage finance loans declined on average 28% from the fourth quarter of 2016 the growth in MCA less than the decline that peers experienced. We expect MCA to enable us to outperform peers for 2017 in overall mortgage finance outstandings and income. With the continuing growth in the six new and rebuilt businesses and our strategic focus on growing our highest ROE businesses, we again expect to outperform peers and traditional LHI growth and finish 2017 with a strong efficiency ratio and improved ROE. This concludes our prepared remarks. Gary, we are ready for Q&A.

We will now begin the question-and-answer session [Operator Instructions]. Our first question comes from Jennifer Demba with SunTrust. Please go ahead.

Peter, just wondering if you could give a bit more color on the deposit decline; during the quarter, you said of some of its seasonal. But just can you give us some more color on that and your confidence that it’s rebounding in second quarter and beyond?

It is, we believe, all seasonal. We had a similar, but much smaller experience, at the end of Q1 of last year compared to Q4. But the deposit categories that are affected have become so much larger as a result of the growth that we've experienced during the year and really starting from prior years. We know it because we can track it to individual accounts and we see already the increase in balances that have occurred thus far in the month of April.

Separate topic, you said all your newer lines of business were solidly profitable during the first quarter. And I think you mentioned the SBA lending would eventually evolve into a wider business from a geographic standpoint. Can you give us some details on that? And give us any detail you can on the newer business lines franchise finance, public finance, whatever numbers you can give us there?

We’re not going to give the detailed numbers, but I can give you some color, Jennifer; those are such new businesses. We’re breaking into these markets on a national scale and we’re going to give you more information as they become more significant. But right now, our competitors positioning is important, we don’t want to over-telegraph detail. So let me just share with you, everyone of the business had turned -- all six of those had turned profitable in the fourth quarter, but they were cumulatively profitable as of the first quarter; so increasing profitability from each of those. With respect to SBA lending, it is a major build out that we undertook. We did very limited amount of SBA lending, and only took that state wide this past year. And so as we have begun to build out state wide capability in each of our five metro markets, now we’re looking at, beginning to hire business development officers outside of Texas. And we believe by the end of this year, we’ll begin to generate some meaningful national business even outside Texas. But it's very early, and because it is very early even though it’s turned profitable with the build out it’s turned profitable, it’s not at a stage that we were significant enough in those categories to really talk more about detail. But each of these businesses that we’re developing, we’re very pleased with their growth early on and turning profitable as quickly as they have. And then finally, I do want to mention, these are each businesses that we evaluate to be top cortile businesses. So it's not simply a matter of growing new businesses, but importantly, it’s part of our strategy to increase ROE and generate a higher risk, sustainable level of ROE over the next two or three years.

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

I think at the end of the year you guys had $839 million or so in participations outstanding. Just curious if you can reconcile how much you pulled back on for the balance sheet to offset the volume decline? And then if you think this is potentially kind of a new average run rate for the warehouse just given the decline in refi volume? Thanks.

No, we do not expect that the level of Q1 is average for the warehouse at all. We’re expecting with the $1.2 billion in MCA, we’re expecting that -- the warehouse to expand to $3.2 billion to $3.5 billion level average for the last three quarters. So we should see a pickup of $500 million plus per quarter, going forward. We did suspend a portion of the participation program. But given the notice requirements, all of that was not accomplished during, or had no benefit, was available from some of that during the first quarter; so the remainder of that is comeback. And not just in that context, the balance is that our outstanding or average balances in Q1. But they will reflect a much smaller portion of balances that build back as increased activity comes forward in coming quarters.

When I said the first quarter, I meant the guidance for the back half, $3.2 billion to $3.5 billion, is that a new run rate you guys have been running over $4 billion. I'm not sure what the split was between refi and purchase, but I assume the refi is driving the down graph as it has for several of the peers. And then if you could just give that balance as to what the participations were at the end of the year that'd be helpful -- at the end of the quarter.

If you got another question, I'll go ahead and ask that and I'll give it to you right away.

Maybe if you can just talk about the loan growth by geography, I know there's a split in the slide deck between national businesses in Texas. But I guess within Texas and core C&I, what are you guys seeing from a trend perspective?

We're seeing really good growth continue in Houston. As you note on the slide where we give our unemployment rates, Houston of course has our unemployment rate. But consistently, over the last 2.5 years, Houston has been delivering stronger loan growth than any of our other regions. Now when I talk about Houston loan growth, I'm talking about primarily their C&I book. And in Dallas, as an example, the C&I book actually is in three or four different business units. But still as you look at C&I relative to each region Houston is really continuing to drive significant growth. And also importantly, they just want a couple of new bankers that we think are real first rate potential game changing C&I bankers too that will be joining us soon. So we're very encouraged there. We also have some excellent pipeline candidates that we're looking at in Dallas and feel like the talent acquisition opportunity really is good for us over the next quarter or two. It's not going to be outsized in terms of numbers, but we're seeing those absolute pristine all star relationship managers and group heads ready to come build the Company with us. And that's what we’ve been after and very selective the last couple of years; so we're encouraged by what's happening both in Houston and Dallas on talent acquisition; Austin had a very good quarter; we're very pleased with how Austin has performed both on loan growth, as well as continuing deliver really great deposit growth. It’s just hitting on all cylinders in Austin. And then of course public finance and MCA are just doing so well and big contributors to our profit and ROE pick up too.

Michael, at quarter end, participation balance outstanding was $230 million and that's down from $378 million average for the first quarter. The difference of that it’d be an approximation of what came back to the balance sheet from the participation.

I thought you said in the Q that the balance was $839 million, but I’m maybe wrong.

At the end of the last quarter, it was $839 million. It fell to $230 million. Average balance in the fourth quarter was $991 million, so it's coming down at the end of the quarter. And for the average for Q1 was $378 million.

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

So I just wanted to go back to the demand deposits, and I heard what you said Peter. If I look at the end of period demand deposit for the last two quarters, we've gone down from $8.8 billion to $7.9 billion to $7 billion over the front of the last two quarters. As we look into 1Q and what designs you are seeing, should we expect those demand deposits getting closer to $8 billion or higher by the time we get towards the end of second quarter, is that a reasonable way to think about it?

Absolutely.

Okay, and do you have a sense of you talked about some migration of demand deposits into interest bearing deposits. The extent to which that could occur, or is that something that's predictable that you can look at it from an account analysis perspective and figure what's going to move? Or is that uncertain and will depend on how we see future rate hikes?

It's going to depend on how our marketplace reacts to future rate hikes. We saw no impact from the two that occurred through December, nothing that shown up in a meaningful way since the one in March. But all along, we believe we would have little or no impact from the first two. But as rates moved up, we would begin to see it. As we've commented before, we only have two deposit categories that are moving tandem, the rest our customer-by-customer or -- and that's a function of where they are in treasury management, the earnings credit rate, and so forth. So it's what we're -- if you'd seen and I've mentioned on my comments, the increase in deposit fees is a reflection of getting paid more in both balances and fees for the re-pricing of those services.

And just separately, you mentioned a few times about the pro-growth agenda is taking shape I'm just wondering when I look at your LHI growth guidance of '17. Does it assume that we might get any pro-growth policies out of D.C., or do you expect to get to those numbers even in the current economic backdrop?

We’re not projecting that we get to the tax reform and pro growth tangible outcomes that we believe our client are going to wait to see. It may not require, Ebrahim, that the legislation is finalized and approved. But until it's well down the road and our clients are highly confident, it's going to happen. We are not going to see that pick up in borrowing we don’t think. And so no, it is not in our projections.

And our projections contemplate weakening of the economy. What Keith described does not look like it can happen.

The next question comes from Brady Gailey with KBW. Please go ahead.

It seems some banks have some hiccups this quarter with healthcare credits, especially one of your neighbors in Dallas. But can you give us an update on how much healthcare exposure you have, if any?

Less and less, over the last couple of years, we’ve had a couple of those that won't really less than fun experiences in the healthcare space. We have gone very, very slow on healthcare lending over the last five years. Largely because we’ve been just so uncertain about the effect of Obama Care and then what might happen post Obama Care, if there is a change. And so it is one of those areas that we’re well under-represented. In our loan portfolio in healthcare loans Brady versus the economy in Texas, and the importance of healthcare overall in Texas as a business. So we just feel like the risk is so challenging. We have one OREO asset that’s a healthcare problem that we dealt with for the last year and half or so. And we can relate to what -- one of our friends has just encountered. But we have very modest healthcare exposure.

And then the SNC balances, did they changed much linked quarter? I think they were around 2.2 [multiple speakers]

They went up about $55 million. What I am really pleased to report is our altitude is right at $600 million. And if you look a year ago, our agency was $372 million against $1.9 book our $600 million is against the $2.2 billion book. So we’ve moved from about 18% agency to about 7%. So virtually all of the SNC build over the last year has been in agencies by Texas Capital, which is what we really want to have accomplished.

And then lastly for me, Peter you’ve mentioned the two deposit accounts that move in tandem with rates. How much deposit balances are in those two categories?

They vary, but between $4.5 and $5 billion.

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

On your NIM guidance, I know you mentioned having a lower amount of loan subject to floors and you’ve got the DDA coming back this quarter. But then you also mentioned DDA migration interest bearing. So just trying to get a bigger picture idea for what you’re expecting in terms of expansion with the next rate hike beyond March? Because I think we can figure out what you’re thinking for the March hike. And then in addition to that what kind of deposit data that you are thinking would be most appropriate for the March hike and the next one?

For the March hike, the problem we’ve had or the challenge we’ve had on figuring deposit data the way some do is the level of deposits the amount of growth and for Q1 the seasonality. Our view of deposit data is roughly 25% in all of that to-date has come from the deposit categories I mentioned. Those are broker dealer and some similar kinds of accounts and our deposits have come from downstream correspond banks. They’re the only ones that moved in tandem, and not directly in tandem, but the deposit data those might be 85%. The next one, we’ve had $400 million reduction in the loan subject to floors with the last quarter point. And we’ll lose some other substantial balance in the next one and two increases. What we can’t know is whether the amount frees up from floors and the rate improvement on those loans, so that offset the rate in dollars or in rate and in dollars for the deposits that could migrate.

Just switching to the warehouse guidance, do you guys…

And comments further…

Sure.

The issues with our asset sensitivity and I commented briefly on it in the comments. For us it's more about the asset side of the balance sheet compared to any other bank we can identify than it is just to the deposit side. We know that deposits can rise, we unlike others, are not afraid of paying in for strong demand deposits, because we’re confident the yields on the asset side of the balance sheet will move more quickly than the rates on the liability side. And most of the commentary about that comes from banks that might have 20%, 30% or even more percent of their total balances in fixed rate assets, and for us that’s 3% or so.

Just switching to the warehouse real quick guidance, what do you guys assuming for the volume trends in that participation program. Are you effectively assuming that that goes away this quarter? And then what kind of a fee impacts in that broker loan fee line should we expect to see in 2Q versus 1Q?

That component of the broker loan fee line is not significant at all. In fact the return of the balances will be much more impactful to earnings. I don’t think that program will ever go to zero, but you will see not only in today's world, it would come down from today's level sharply. But more importantly, it will not consume balances as they rise in Q2 and subsequent quarters. That’s the more powerful part of the analysis.

And then I guess on the in state business, gain on sale. Was there any this quarter and was that another income?

Yes. We saw most of that still is in yield. Most of the profitability in that business is still in yield.

What was the gain on sale this quarter? Because I think last quarter, wasn’t at a couple million or few million, something like that…

No, it wasn’t and we’re not ready to give that.

And just one last one just on the deposit growth, was some of that drop at DDA related to the mortgage business at all?

Yes.

Could you provide us with maybe a little bit of magnitude there?

No, it happened across different lines of business, and we’re not get into that level of detail for competitive reasons.

The next question comes from Emlen Harmon with JMP Securities. Please go ahead.

So you guys are bringing up again in sale here, but I just think you’re starting to breakout the servicing income and expense in the income statement. How should we think about the operating margin in that business? And then within the expenses, were there any mark-to-market or hedging expenses in there just given the rate volatility we saw through the quarter?

Not in servicing, no. You do see, we have a small profit on the servicing side of the business and that’s just along as we hold them. And we’re building the servicing in anticipation of sales.

The next question comes from Brad Milsap with Sandler O'Neill. Please go ahead.

Just on the warehouse quickly, one of your competitors said today they obviously saw a big drop in volume, but also saw about a 20% loss in some of the average amount of each individual loan of the warehouse. Just curious if you guys saw same, a similar phenomena on what your average mortgage loan size was this quarter versus the average loan size last quarter?

We saw about a 10% drop. So there was in fact a decline in average size, but not quite as heavy as the competitor that saw 20.

And we're talking about 20% drop from low back already…

Yes, but I'm talking about the average size of each note, each loan…

Yes, each note. Like from 300,000 down to 240,000 something like that. I am just kind of curious kind of what you guys saw?

That's right. We did in fact see a decline and we saw it contributes to the challenge on outstandings. But we expect that's going to shift as we get into a more typical season this next quarter.

And then just one more question about the DDA balance decline, Peter I don’t know if you can answer this. But what percentage of the deposits that you lost would be more exact -- maybe legally, you couldn’t charge or you couldn’t pay interest on. Just trying to get a sense of what that number might be that gives you more confidence as you see those come back in that they won't migrate to other areas?

Substantial majority are covered by either treasury management fees or subject to restrictions on paying interest at all.

The substantial portion, okay, I mean as rates move up on the warehouse and in general view. Do you think some of the warehouse customers will have more pricing power as it relates to the funds that they provide you guys, or they do become more interest rate sensitive? Or is that too early to do determine that?

We've been dealing with that for a couple of quarters, so that's going to be part of the equation. But at the end of the day, we’re a relationship pricing organization, that’s true in all of our businesses including mortgage finance. So I think it will have a less of an impact on us overall.

The next question comes from Scott Valentine with Compass Point. Please go ahead.

Just with regard to NPAs, you had a pretty sharp decline in the NPA bucket. Just wondering; one, if that includes the SNC review that was just completed; and two, any broad categories that saw big declines, that was a pretty broad based?

It was really broad based. It was a little more on the energy side, of course. But we’re seeing positive migration of credit quality across the book. So we’re feeling good about our trends overall in the Company, not just energy.

And you mentioned energy I think reserves is still at 6% for the energy portfolio…

But even after the charge offs, we took fourth quarter and first quarter, we kept a really strong reserve against energy at 6% which I believe is the highest relative to criticized classified of any one that’s in energy buying. So we think we’re well pass towards and they were headed toward an improving profit run rate in our energy business. Nevertheless, we want a rock solid balance sheet and we have that reserve.

And I assume means if energy prices hold where they are, that reserve can come down overtime?

Yes, we would expect that would be the case. We’re typically conservative on how we address those things, so as were on building the reserve earlier than many others. But yes that’s what we would expect.

And then just on the commercial real estate portfolio, I know you guys have been cautious on commercial real estate for a while. Just wondering about retail exposure, seen more and more news about vacancy rates going up in certain retail properties. Just wondering what your exposure looks like and what you’re experiencing in terms of vacancy trends and maybe rental rates?

We have very modest retail exposure. The retail we have seems to be not the big box or the big mall type retail, which seems to be getting get the worse. Our sense to be strip center retail, which is more community driven. But we have a very modest overall retail exposure in our CRE book.

The next question comes from Gary Tenner with D. A. Davidson. Please go ahead.

Just wanted to ask, I don’t know if you’ve mentioned this earlier. But as you look at your or you gave us your margin guidance for the remainder of the year, the 325 to 335. What does that contemplate in terms of additional rate hikes for the remainder of the year?

None.

The next question comes from Peter Winter with Wedbush Securities. Please go ahead.

When I look at that you lowered the revenue outlook, are there opportunities to lower the expense guidance, because that didn’t change with the lower revenue outlook.

One of the challenges on the expense side is that we’re seeing the full affect throughout '17 of the significant build out that occurred during '16, and much of that was toward the end of the back half of the year. So until we get at least through the first half of this year, we’re going to stay with this somewhat more conservative guidance. But there is opportunity we think to see how the business develops, how our new process refinement that we're working on and also some new technology that we're rolling out mid to third quarter. What that might do to overall expense run rates? We think it'll help us slow FTE growth and we'll pick up some efficiencies; and therefore, we're indicating we should have a low 50s efficiency ratio as we finish the year.

Peter, most of the reduction comes from the reduced volumes in warehouse, and warehouse doesn't have level of automation, no longer has a high variable expense component. We can't really expect much from there. We look all the time for opportunities, as Keith mentioned, to improve efficiency in operations. But the correlation to expense to mortgage warehouse is not going to be that fruitful.

And just a follow up, can you just give a little bit more color around the revised guidance around the mortgage finance versus January in terms of the outlook. What has changed so much?

What has really changed is the industry is just down substantially. And we're seeing a number of our clients that are, of course, we cater to the independent mortgage companies because many of them are off 40 plus percent. And so where we not growing the MCA business and also really maintaining very strong relationships and therefore getting strong volume from long time clients. We would be showing the 40% overall drop in numbers as many of our peers. In fact we were down on a combined basis 28%. So we're offsetting some of the headwinds that the industry is facing, but until we see a pick-up in overall mortgage industry volumes, we think this guidance is the best we can give you at this point in time.

The next question comes from Brett Robertson with Piper Jaffray. Please go ahead.

I wanted to just go back to the guidance around provisioning, and you talked about the improvement n continued migration on credit. And if energy holds, it would seem like you’ve had continued positive migration with energy. So I guess I'm -- reduced the provision guidance, but it still seems like it could be conservative. Can you maybe talk about what your assumptions are? And you said you're thinking about maybe the economy could be weak in sort of a base case scenario. What exactly are the assumptions around that?

Again, we are somewhat conservative. I think you always will hear that from us, that's a approach we're always going to try to take. We think that's prudent since we grow faster than peers and we are always about credit quality and maintain a very conservative balance sheet, strong balance sheet on reserving so on, Brett. But at the end of the day, we think there could be some disappointment later in the year. If some of these things don't come about that have created optimism near term with mid-sized private companies that we cater to, that we're not seeing them being convinced yet that we’re going to see tax reform that we’re seeing enough de-regulation, and that we’re going to see a solution to healthcare reform so that they actually will pull the trigger. And take that optimism to actually realizing, taking on more debt and growing their companies. And so if we in fact get into the last half of the year and these things continue to get pushed out and little gets accomplished, we're presenting that could happen, and that is conservative but we think it's appropriate.

Then also one conservatism if the DDA is growing it would seem like with the March hike that the margin guidance would be a little conservative. And you discussed some about interest bearing funds and paying on DDA. Can you give us maybe your assumption on what you are assuming happens to deposit cost over the next few quarters?

It's a minor increase if at all in overall deposit cost offset by the benefit of a huge incremental inflow of DDA balances, again…

And also overcoming more floors, which help offset some of that increase inn interest expense we might see.

[Operator Instructions] The next question comes from Geoffrey Elliott with Autonomous Research. Please go ahead.

The 10-K talks about $125 million benefit to NII from 100 basis point parallel shift in rates. I wondered if you could give some of the key assumptions that go into that. And then maybe talk about how things played out versus those assumptions in 1Q, and whether there is anywhere where it would make sense to modify them?

Its 100 basis points shock, meaning it happens all at once. And there is no catch-up and back for the look previous discussion, no catch-up in some amount of payment on demand deposits or other funding cost. So it is the most beneficial way and it's the way we’re required to report it. When you look at quarter point increments, unfortunately, it's not as the easy as saying you’re going to get one fourth of that. But you’re going to get a significant portion of one forth of that per quarter on an annualized basis. The guidance that we provide or the reporting that we’re required to make requires us to evaluate a base case of total assets for the next 12-months. And it goes down to the transaction level detail in deposits and loans. So there are not a lot of, if you want to call, assumptions or fed fund kinds of assumptions about what's happening other than the general view of the size of our balance sheet and composition.

What is the requirement that means you have to report it in that way?

SAC.

This concludes our question-and-answer session. I would like to turn the conference back over to Keith Cargill for any closing remarks.

We appreciate your interest and joining us today for the call, and we look forward to delivering a good strong second quarter. And we’ll talk with you once we complete this next quarter. Thank you very much.

This concludes our call today. Should you have any follow-up questions, please call Heather Worley at 214-932-6646, or email heather.worley@texascapitalbanc.co. Thank you for attending today's presentation. You may now disconnect.