Texas Capital Bancshares, Inc. (TCBI) Q3 2017 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Third Quarter 2017 Texas Capital Bancshares, Incorporated Earnings Conference Call. All participants will be in listen-only mode during the presentation. Please note this event is being recorded. [Operator Instructions] I'd now like to turn the call over to Heather Worley, Director of Investor Relations. Please go ahead.

Thank you for joining us today for the TCBI third 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 the cautionary statements and other information contained in today's earnings release, our most recent Annual Report on Form 10-K, and subsequent filings with the SEC. With me on the call today are Keith Cargill, President and CEO; Julie Anderson, CFO; and Peter Bartholow, COO. At the conclusion of our prepared remarks, our operator, Gary, will facilitate a question-and-answer session. At this time, I will turn the call over to Keith who will begin on Slide 3 of the webcast. Keith?

Thank you, Heather. And thank you all for joining us for our third quarter 2017 earnings call. After my opening comments, Julie will provide more details. Following my closing comments, Julie, Peter, and I will open the call for Q&A. As Heather mentioned, let's begin with Slide 3. We are very pleased with the results for the third quarter. Loan growth and traditional loans held for investment were strong at 4% linked quarter, following a record breaking second quarter. Year-over-year growth in traditional LHI was 17%. On average, linked quarter growth was 5% and year-over-year growth was 15%. Mortgage finance LHI grew on average 27% linked quarter and 4% year-over-year. MCA or loans held for sale grew 19% linked quarter and 134% year-over-year. Our results demonstrate continued market share gains as was the case in the second quarter. On average demand deposits in Q3 increased 11% linked quarter, while total deposits climbed 1.7 billion or 10% in Q3 compared to Q2. Year-over-year total deposits increased 7% on average. Despite our strong loan and deposit growth, we are importantly achieving our growth while also lifting ROE and ROA. Linked quarter ROE improved to 11.2% in the third quarter as compared with 10.08% in the second quarter. The third quarter 2017 ROE was higher at 11.2% than the third quarter of 2016 at 10.2%, despite the new capital raise that occurred in the fourth quarter of 2016. Really we’ve been able to deploy the new capital effectively. Lifting our ROE, we’ve moved Texas Capital Bank toward a state of self sustaining capital alongside our peer leading growth. Slide 4 summarizes the current status of our hurricane Harvey and Irma exposure. While we continue to learn more day-by-day, we consider ourselves and our clients at large fortunate to have sustained relatively minor losses. Since the assessment of loss and loan classification risk will continue for some time, we took prudent to take a modest incremental loan loss provision of $4.5 million this quarter and charged an additional $700,000 in various related expenses as well. The energy loan portfolio continues to improve and now is growing. Outstanding energy loans totaled approximately 6% of our total loans or $1.2 billion, up $100 million from Q2. The loan loss reserve set aside for energy represents 4% of total energy loans and 41% of criticized energy loans net of the $6.3 million in energy charge-offs in Q3. Retail CRE and retail C&I is approximately $787 million. Total criticized is only $4.3 million with no nonperforming loans. Julie?

Thanks, Keith. My comments will cover Slide 6 through 12. We will start with the NIM review. This quarter we reported a NIM increase by 2 basis points from the second quarter. We continue to see asset sensitivity confirmed in our analysis of yields and costs. Traditional LHI yields on balances approaching $15 billion were up 20 basis points from the second quarter and up 58 basis points from last year at this time. Mix shift in the third quarter needed margin expansion with $1.2 billion growth in mortgage finance and MCA and $200 million growth in liquidity assets. We continue to see growth in deposits from the second quarter and interest-bearing as well as DDA. Average DDA growth for the quarter exceeded growth in interest-bearing deposits and growth in traditional LHI. Overall, deposit cost increased by 9 basis points from 38 basis points in Q2 to 47 basis points in Q3. This was less than we had expected. Again, we haven't changed posted rates, but expect fourth quarter deposit growth to be weighted towards interest-bearing deposits with modest migration based on the overall relationship. A good deposit pipeline is in place, but it can involve a long sale cycle, so it's difficult to forecast the exact timing. Pace and change of deposit costs will depend largely on timing and magnitude of changes in future fed rates. A modest change in loans with floor since there was no rate change since our last report. Its currently around a little over $800 million at the end of September. As a reminder, approximately 70% of our floating rate loans are tied to LIBOR and about 80% of that tied to 30 day LIBOR. Continued solid loan growth experienced in the third quarter did reduce the impact from rate increases as new loans are not being put on at the same effective rate as portfolio yield, which is reflected of the rate move. The yield on mortgage financed loans decreased from 352 in the second quarter to 346 in the third quarter, which is reflective of our response to competitive pressures based on relationship pricing. This change in pricing approach that began in mid first quarter has had a dramatic impact on our balances and net revenue. Keith commented earlier, we had continued good traditional LHI growth in the quarter, not at the same pace as the second quarter, but in line with full-year guidance. Our traditional LHI average balances grew by 5% from the second quarter and 15% from the third quarter last year. Strong growth in the final days of the quarter with ending balances above average by $400 million providing a really good start for Q4. We continue to experience high level of payoffs in the third quarter. We continued -- had continued strong mortgage finance balances increasing 27% from second quarter and up 4% from this time last year, as Q3 is typically seasonally strong for these volumes. We experienced linked quarter growth in total deposits including DDA and still expecting continued growth in the fourth quarter. We are always targeting the most cost efficient deposit sources, we do expect most of the future growth to come from interest-bearing categories at a very reasonable effective cost. With rising rates, no change in stated rates before increases, but some migration to interest-bearing from DDA reacting to specific customer situations, evaluated on a total relationship basis. As a reminder, only two major deposit categories move in tandem with fed rates and that’s approximately $4 billion to $4.5 billion in balances. The impacts on deposit pricing from June to June increase was less than anticipated, but we expect more impact from any subsequent increases which as we said in the past is not particularly concerning based on the composition of the asset side of our balance sheet, which is basically 95% floating-rate. Moving on to noninterest expense, the increased linked quarter in noninterest expense was predominantly related to variable items that were anticipated. Incentive accrual ramps as earnings ramp during the year, so generally Q3 accrual will be higher than Q2. More fluctuation in FAS 123R expense in this third quarter compared to Q2, primarily related to the increase in our stock price. $2 million change in expected to full year 2007 total FAS 123R expense of approximately $21 million. That’s up from 19 million in Q2 and compared to a planned level of almost $16 million in 2016. As mentioned in the past, quarterly and annual cost can vary with the change in stock price, but not as variable if viewed with a full-year perspective. The fourth quarter FAS 123R expense is expected to be consistent with the third quarter expense of $6.1 million assuming no significant change in our stock price. FDIC expense fluctuation as Q3 -- as the Q3 level is back to a more normalized level. Q2 was unusually low as a result of lower asset balances earlier in the year. All of our new and expanding lines of business continue to be profitable during the third quarter and contributed to our third quarter loan growth. New lines of business -- new lines of businesses are continuing to provide meaningful contribution on pre-tax, pre-provision basis. Continued normal build out at a more modest pace and nothing is expected to be as significant as what we experienced in 2015 and '16. Servicing related expenses are directly related to servicing revenue, which provides overall about $0.5 million of profit contribution for the quarter. Other categories, including occupancy, technology and marketing costs are all primarily directly related to growth including growth in deposit. With strong warehouse balances and the contribution of the new and expanded LOBs, net revenue increased significantly and the efficiency ratio improved in the third quarter to 51.4%. That level will rise in Q4 with the adverse impact from lower mortgage warehouse balances with some offset from core growth and continued ramp in the contribution of the new and expanded businesses. Moving on to asset quality. Asset quality continues to be good and very strong net of the energy NPA. Nonaccrual level still on an acceptable level of 58 basis points of total loans with more than 65% of that comprised of energy loans which are taking time to resolve. The provision of $20 million for Q3 compared to $13 million in Q2 and $22 million in third quarter last year. Our Q3 provision includes an additional $4.5 million for hurricane related exposures, the strong growth in the quarter drove additional provisioning. And lastly our methodology required covering charge-offs for which previously allocated reserves were not sufficient and the effects of a minor increase in criticized classified loans during the quarter. Charge-offs for the quarter totaled $10.7 million and included $6.3 million related to energy. Quarterly net charge-offs represented 22 basis points of total loans, of which about 60% related to energy. Strong growth with net revenue increasing a 11% and net income increasing 15% from the second quarter with good loan growth both in traditional LHI and total mortgage finance. Positive impact going into the fourth quarter with strong earning asset base and very favorable composition. ROE and ROA levels much improved following impact of the elevated provisions in results from most of 2016, with much improved outlook in '17 which we started to see in Q2 and has continued in Q3 as mortgage finance volumes have benefited from seasonal strength. Our provisioning in Q3 as a result of the additional hurricane related cost of $5.2 million including the $4.5 million provision impacted ROE and ROA. ROE back over 11% related to higher net revenue and despite higher provision level and the impact of the equity raised in Q4 2016. However, seasonally strong mortgage finance contribution has a positive impact on ROE levels in Q3, which will be diminished somewhat in Q4 to 11% is not necessarily a new run rate. Finally, I will finish up with our 2017 outlook. The outlook for traditional LHI is unchanged with our Q3 results. Q3 growth was in line with guidance and we expect good growth in Q4. We expect average balances for total mortgage finance loans including warehouse and MCA for Q4 to be $4.5 billion to $4.9 billion, up from the previously communicated $4.4 billion. Total average for -- for the full-year of '17 will be approximately $4.7 billion which is flat with 2016, despite the benefit of the refinance activity on 2016 numbers. Our Q3 warehouse volumes were better than originally expected and some lift in expectations for warehouse volumes for fourth quarter bringing expected average for Q4 for the warehouse to $3.6 billion to $4 billion. MCA guidance stays the same at $900 million. We are still working to fine-tune optimal whole towns [ph], which can be affected by seasonal trends and the pace of new client on boarding. The balance sheet is managed to optimize earnings results which is especially important in the current environment when gain on sale is basically nonexistent. For total deposits, guidance remained unchanged with continued growth in deposits expected, but we do expect to see more mix shift from non-interest bearing to interest-bearing over the remainder of the year. Seasonally we expect liquidity levels will increase in Q4 as warehouse volumes will be down and we will continue to increase deposits. It will be punitive to NIM in Q4, but still favorable to net interest income. The outlook for core NIM is unchanged, negative impact of mortgage finance growth in Q3 extending to Q4 NIM with a more pronounced impact in Q4 as balances from reduced warehouse activity will shift to liquidity assets. And additionally any mix shift in deposit profile will be negative. The outlook from net revenue has improved with Q3 mortgage finance performance now at mid to high teens percent growth, slightly better than the previous range of mid teens. Servicing income is risen with a partial offset from servicing expenses. Provision -- our provision guidance is unchanged at low to mid $50 million level. We are expecting a slight change in NIE guidance to reflect some of the factors in Q3 like an elevated FAS 123R expense related to stock price and servicing expenses which are offset by increases in income, reviving [ph] to low to mid teens, up from low teens. With changes in both net revenue and NIE, no overall change in efficiency ratio. We are keeping it at low to mid 50s. Keith?

Thank you, Julie. On Slide 13, we summarize the key takeaways for Q3. We delivered strong earnings. Our loan growth in Q3 was strongest in the last half of Q3, thereby setting us up for a strong start in Q4. Deposit growth is improving and should be stronger than loan growth in Q4. Asset sensitivity remains one of the strongest in the industry positioning us well with the expected shift in deposit composition with rising rates. Credit metrics are improving. We remain confident in the adequacy of our energy reserve and improving quality and our growing energy portfolio. The $4.5 million special provision related to the hurricanes prepares us well for any great migration that might occur. The emphasis we placed two years ago on lifting ROE is showing positive results. Better discipline in growing top quartile ROE new and existing lines of business is contributing improved margin in incremental revenue and the effect of slowing NIE growth should help sustain year-over-year improvements in ROE going forward. All in all, we are pleased not only with the results during Q3, but believe these results further reinforce our improving prospects for higher returns for our investors in the years ahead. This concludes our Q3 remarks. Before I open the lines for Q&A, Julie and our executive management team joined me on behalf of all our cohorts at Texas Capital Bank in wishing Peter Bartholow very best upon his approaching retirement at the end of the year. Peter, we will all miss you day-to-day, but hope to see you often as the friends we’ve become. Julie, Heather and I, in particular want to thank you for teaching us so much about the capital markets and investment community over our years together. And we all want you to know that we will sorely miss your sense of humor, intellectual challenge, wisdom and concern for others. Our very best wishes, Peter, for the new chapter that lies ahead.

We will now begin the question-and-answer session. [Operator Instructions] The first question comes from Ebrahim Poonawala with Bank of America Merrill Lynch. Please go ahead.

Good afternoon, guys.

Hi, Ebrahim.

So, I just wanted to touch upon the mortgage finance LHI yields declined from last quarter. I just wanted to get sort of your thought process and obviously we had that big drop-off in the first quarter of this year. We’ve realigned some strategy there. Just want to get a sense of if the fed moves again, let's call it in December, should we expect those loan yields to sort of reprice higher or how are you thinking about the profitability of that business, the deposits that sort of justify having those yields staying flat or going down from here?

Well, they’re LIBOR-based for the most part, Ebrahim. So if we do get a fed lift, we would expect that would benefit our overall yield there.

But do you think that the benefits would be lower today than it was 12 months ago, because of how competitive that business has been in the last nine months or you might have to give up some of that LIBOR move to the clients?

It's been competitive, but as you can see we’ve competed quite well in the last two quarters. I think we -- when all the results come in, we will end up likely best appears for us market share takeaway. Certainly it is more competitive than it was a year-ago. It's hard to predict exactly what that look like -- come early next year. But we are thankfully in a position where we can, we believe scale at the lowest possible incremental cost as we grow that business relative to the competitors. So we are in a very good position to still deliver a really nice ROE even in a competitive environment.

Ebrahim, this is Peter. I would also say that giving up a few basis points which is the way we analyze it. $4 billion in growth linked quarter was certainly the smart decision relative to the marketplace. And secondly, as part of your question, yes, indeed the deposit profile in that business justifies some shaving of rates as part of the relationship pricing that Julie mentioned.

Understood. That’s helpful. And then just sort of taking a step back, Julie mentioned the 11% ROE obviously is seasonally may not be sustainable into fourth quarter. But Keith, I would love to get your thoughts around as we think about '18, absent any sort of rate hikes? Do you think structurally there is room to improve that efficiency ratio from low to mid 50s, or this is kind of where on an ongoing basis the bank should be operating and that’s why you think it would be in '18 without any rate hikes?

Without any rate hikes, we still believe we are well-positioned Ebrahim to improve our efficiency ratio year-over-year in '18 versus '17.

Would you care to quantify by how much?

We are not ready to give guidance yet, but we do believe we can improve on it and we will be prepared to address that in January.

We are in the planning process now. So we will -- more information in January on that.

We give you an A for effort, though.

Yes, good job.

Well, I had to try. And again, Peter, good luck. I agree with everything Keith said, particularly we will miss your sense of humor. So thanks for taking my questions.

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

Hi. Good afternoon, guys.

Hello, Dave.

On the expense side real quick, I know you reiterated the efficiency ratio guidance. Just wonder if you could speak directionally to expenses beyond this quarter? And you mentioned the $700,000 hurricane costs you have that portion of comp that was related to stock price. Are you thinking that expense levels could stabilize here through the end of this year or will that continue to grow from this higher base, even if the warehouse book declines, any thoughts there?

Sure. We try to point out there are some variable components that will grow and that’s when we try to highlight those. We are always going to have a certain amount of build out, but as I said, less than we’ve experienced in '15 and '16. So the core build out expenses you should see us slowing, but there are a few variable pieces and we will just try to keep pointing those out, because those really should be looked at separately than some of the core like salaries and some of the other core expenses.

Okay. So we back out some of these one-time items, call them one-time this quarter and hurricane expense or whatnot, but then we should probably be higher on expenses for 4Q, just generally speaking? Is that what it sounds like overall?

Again, the delivery, the kind of overall LHI, traditional LHI growth we deliver versus all our peers, we are as Julie suggests, always in a certain state of build out. But we're not in that mode, Dave, as you can appreciate building out three brand-new businesses full bore and rebuilding three others, and that that really took an outsized amount of NIE growth. And that should begin to taper next quarter year-over-year.

Got you. Okay.

Okay.

And then on the deposit side, you have some great average non-interest bearing deposit growth this quarter. I was just wondering what the main driver of that was, if that reflected certain business lines, do you saw any benefit from the beginning of the rebuilding Houston? Any color on that will be great.

We are not going to see like perhaps more traditional retail banks, the kind of near-term build up in insurance proceeds that was the case with Katrina and that was something that everyone was projecting might happen after these hurricanes and perhaps banks primarily based in Houston that have the brick-and-mortar footprint unlike our model may see that. We don't expect to see as much effect from that because we have businesses with our clients primarily. So we really saw overall broad growth and it’s coming in the typical areas we’ve seen before in our Texas markets as well as in some of our national treasury market niches that we’re playing in.

Okay. And it sounds like …

Its widespread, but it's all tied to treasury services -- treasury clients instead of widespread in our markets and some of the specialty areas.

Both Texas and also national markets.

Yes.

Okay. It sounds like you expect those balances to grow maybe not the same pace obviously and it sounds like you’re expecting more growth in interest-bearing, but those balances should still grow from here?

We expect to grow, but we also expect some migration from DDA to interest-bearing and then also incremental growth will be higher in interest-bearing. But we still believe we will have ongoing growth in the new market share takeaway in DDA and we're hopeful that that'll hold DDA at a very nice level with maybe some very modest growth, but most of the growth we expect with rising rates will be occurring in the interest-bearing side.

I think we made clear Dave that we’ve long sales cycle on some of those treasury relationships, and they can -- there is fairly significant dollars when they come in and the pipeline as Julie says is very strong.

But it can't be lumpy.

Okay. And then just one on the NIM. On the increase on the cost of interest-bearing deposits, that was up, it looks like about 17 bps in 3Q. So little bit of a bigger move than last quarter, but it doesn’t sound like you changed stated rates and I know you have the correspondent bank deposits, the broker deal the deposits that reprice up automatically, but that’s a smaller piece of that bucket. So just wondering what's driving the rest of that increase in the remainder of an interest-bearing deposit bucket that you saw this quarter?

It was some mix shift. And again we expect that'll continue in a rising rate environment.

And again the last rate increase was at the end of last quarter. So we had a full quarter about this time. And those buckets that move in tandem, it would have only been half a month in last quarter and so it was a full quarter about this time.

In addition, growth is not coming at average for the entire portfolio.

Okay, got it. Okay, great. Well, thank you very much and Peter, of course real pleasure working with you and of course the sense of humor comments resonates here. I don’t know, if Heather is going to miss your sense of humor as much as I will, but I think it will be a miss, though.

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

Hey, good evening, everyone.

Hi, Emlen.

I was just hoping you could hit on the specialty that some of the newer kind of specialty businesses and just kind of what their contribution was to the -- has been to held for investment growth this quarter? I think kind of public finance, ABL, franchise finance, some of those newer businesses?

We don’t historically give specifics on those, but it’s important to know that their contribution both from an income perspective and growth continues to increase each quarter. So we don’t -- we won't, and I think we will get into a pattern of given specifics on any of those lines of businesses, but they’re all continuing to expand their contribution and expand their contribution to loan growth.

Got it. Maybe try and get in a different way, I mean, do you still feel like we’re in early innings for a number of those -- very early innings for a number of those businesses?

We are seeing very nice increases. It's just a -- relative significance is not so great that we feel like it's a material item, we should start disclosing more detail maybe sometime late next year that will change, we will have to see.

We are continuing to see improving ROE and improvement -- in efficiency ratio on all those lines of business. So the trend is what we expected and it should continue.

Got it. Okay. Thanks. And then, just the tax rate looks maybe a little low kind of versus a normalized level. Any unique effects on that this quarter? Was that maybe just an effect because putting away more provision than charge-offs this quarter?

There is two components that affects that now and it can vary a little bit from quarter-to-quarter. One, that’s public finance. Public finance, most of that’s tax exempt, so that has an impact and then the new stock-based compensation rule that can have an impact. So it can just vary a little bit from quarter-to-quarter. But overall the annual year-to-date rate I think is pretty good to consider where it’s going to be going forward.

Got it. So I’m getting something I think at the 34%-ish range year-to-date. It feels about right to you?

Yes, down from 36% previously. Yes, that’s right.

Got it. Got it. Perfect. Thank you. And best of luck to you Peter. It has been a pleasure.

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

Hey. Good afternoon, guys.

Hello, Brady.

So maybe one more just on the funding cost and we’ve had three quarters in a row where we’ve seen basically 25 basis point increase in the fed funds. And here we’ve seen you all's funding cost rise kind of accordingly. I mean, if the fed slows the pace of rate increases going forward, do you think that you'll see a much slower creep higher in your funding costs or do you think competition or maybe your customers asking for higher deposit rates will keep that cost headed higher?

No, a lot of our cost as you know, Brady, is tied to two categories. It drive about $4.5 billion to $5 billion and they really think that with those fed increases. In one case it's synced precisely 100% beta relative to fed increases. The other is close to saying, it maybe 90%, a little bit of a lag on it. So that is primarily what drives the shift. Competition, we are seeing competition, everybody does and we look at it on a case by case relationship basis. But we're not seeing that escalate. In fact, we're not seeing at a level that we anticipated yet. So we will deal with it as the market -- puts us in that position to deal with it, but there is no bank in a better position from an asset sensitivity standpoint to deal with those shifts.

Yes, Brady, I think it's just important to focus on what’s happening on the asset side of the balance sheet. I mean, $15 billion in traditional LHI and we saw 20 basis point increase in net yield for the quarter. And then that will continue to move in tandem with future rate increases.

And even on the mortgage finance, mortgage warehouse, MCA side relative to the securities portfolios, I mean, we definitely have far more asset sensitive assets in that category. So you look at our overall assets out of our balance sheet not just our loans, not again we struggle to find anybody, anymore asset sensitive than we are.

Okay, all right. That’s helpful. And then, Keith, you put in the press release on the front page you’re kind of also remaining cautious as we are late in the recovery cycle. I think you’ve said that a couple times on previous conference calls. Are you seeing anything in the Texas and national economies that start to actually look like projects are slowing or businesses are starting to see some softness? I know in the last couple of years in Texas, you’ve had the energy issue and now you have some hurricane, so there is some noise there. Are you actually starting to see any weakness in the Texas and national economies?

You know we are really not. What that comment really is about is, as you know, we've had quite a conservative point of view about this expansion and economic recovery cycle. And we still believe there's a lot riding on whether we get a tax reform package that’s really meaningful. And if we find that that's going to remain dysfunctional, that effort in Washington for a long period that is what the comment really relates to. I think it will cost companies that today are doing business and growing very modestly. So you think again about how they choose to grow and that could cause enough concern that we could have a slowdown or at some point in the next year or so. Hopefully not a technical recession, but some slowdown. And now we are more conservative. We have been for a couple of years, but we grow faster than any other bank in our peer group, and so it's very important that we would be cautious and thoughtful about the quality of that growth. And so that's the genesis of that comment.

Okay. Maybe [indiscernible] same with Peter, good luck with retirement. You’re definitely going to be missed by all of us.

Thank you, Brady.

The next question come from Casey Haire with Jefferies. Please go ahead.

Hey, thanks. So wanted to touch on the NIM guide as well as the mortgage finance guide. I understand that mortgage finance obviously seasonal weakness in the fourth quarter, but the guide of $4.8 billion in the fourth quarter implies a pretty violent downdraft. I'm just wondering are you guys being conservative? Is there any update you can give us as to where that -- those balances are in late October here or just some color there on the guide on mortgage finance?

Yes. The [technical difficulty] change was the warehouse guidance, which we said will be $3.6 billion to $4 billion in the fourth quarter. And that’s actually up from what we thought it would have been last quarter. So that’s our best estimate right now.

Right. But my point is that those period end balances were 5.6 and it was $4.8 billion on -- in the third quarter average to sort of [technical difficulty]?

The seasonality can -- I mean, we were up a $1 billion. We were up a $1 billion when you look at averages from Q2. From Q1 to Q2 to Q3, you can see that there is some -- there can be some significant fluctuations with seasonality.

Okay.

The quarter end balance, Casey, really has no bearing on what they happened and may be instructive relative to other companies, what's happening in our portfolio compared to others. But it may not be and will not be indicative of the average in the seasonally soft fourth quarter.

Yes, it's just at the end of Q3 -- Q2 and Q3 is just the end balances, the end of period balances are just so artificially high that you can't really base an average on those.

Okay, understood. And then just -- coming out of the mortgage finance pricing another way, what was -- what is today sort of the new money yield on the mortgage finance versus at 3.46 in the third quarter?

Same.

I’m sorry.

Same. Basically there is no change in that number in Q4 until there is a rate increase.

Okay. And then just last one, just sort of switching to credit, obvious you guys -- the first time in a while, I guess, energy loans increasing on the quarter. Can you just give us some updated thoughts on how you guys are feeling about reserve adequacy here on the HFI book at 1.23 is -- with energy above 50. What does -- are you feeling good at that level or is there room to sort of ride that lower?

We feel good at that level. We are going to have to continue to monitor the economy of course and what's going on quarter-by-quarter. And again, we hope to see continued good economic growth and the big question we still have like most of the business community is what happens with tax reform, Casey. But at this point we feel good about where we sit with our overall reserves and our credit quality. If you extract the energy piece from our overall MPAs, we're in very good condition.

Okay, great. Peter good luck in retirement.

Thank you very much, Casey.

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

Hey, good afternoon, guys. How are you?

Hi, Michael.

Hey, I’m just trying to -- I’m not sure if I’m doing the math right, but you guys maintained the full-year margin guidance of 3.35 to 3.45, yet you have two quarters in the upper 3.50s, which implies a pretty steep drop in the fourth quarter. Am I thinking about that right?

It's the shift.

Yes, it’s the shift.

In liquidity.

Yes, from the warehouse that 4.8 going to 3.6 to 4 and that move into liquidity assets.

Okay. Understood. And then …

We’ve also some additional growth in interest-bearing deposits, which could drop the NIM down some.

Got it. Okay. That’s very helpful. And then, just on the noninterest expense guidance, are you guys including the technology charge that you took last quarter or is that excluded when thinking about the guidance?

No, it's in there.

Its full-year.

It's there for the full-year, yes.

Okay. And I know it's a little early to talk about 2018, but you guys have obviously made a lot of investments over the past few years in some of these businesses. I think one of the things I hear most from investors is that you guys have grown expenses pretty commensurate with the revenue growth over the years. I mean, can we actually conceivably see a year, or a couple year period where we actually get some really meaningful operating leverage and noninterest expense growth as below a double-digit rate where it's been historically?

Well, we may depending on if we see some outsized opportunity that we don't see at this moment. We don't intend. Michael, we are not working in our lab on any major new businesses. And so do not take that on when we had 6, that we’ve been building in the last 2.5 years. I think you should see some improved operating performance, operating leverage and we're expecting to deliver that. If we saw an outsized opportunity and we don't -- I don't see one today and could hire several great C&I bankers and really explore the opportunity there, then for a quarter or three you could see that elevate, but again I’m not planning -- we're not planning for that happening, but we are always going to be entrepreneurial and tuned in to the market and look for opportunities.

We are reaching a size where those kinds of decisions don’t have the same kind of impact with the ones that happened in '15 and '16, Michael.

It will just be hard to find enough RMs in any given two quarters successively to make an impact, as Peter suggests. Unless we built that some major new business and that's just not on the drawing board.

Understood. And Peter thanks for everything over the years and we expect some blueberry shipment as we move forward.

To everyone.

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

Hey, good afternoon.

Hello, Brad.

Hey, just one more mortgage warehouse question. I guess, in the first quarter of this year when you saw the seasonal fall off, the liquidity didn't actually build in the first quarter because you had some deposit exit the bank. Do you feel like with the rate concessions you’ve given in the third quarter that dynamic -- it sounds like that dynamic you don’t expect that to play out again in the fourth and into the first, you’re going to hold on to more that which therein lies your margin guidance. Is that kind of the way we should think about it?

That’s how we see it at the moment.

Okay, great. And, Keith, I know you mentioned this in the beginning, but I was writing, quickly do you feel like -- I was just kind of curios how you arrived at the $4.5 billion provision number for the storms? Do you think that kind of captures it all or still kind of too early to tell as you continue to kind of work through all that?

Well, I think in terms of all our accounting trends, it is a very precise scientific number we’ve developed and we think it's absolutely appropriate. But of course it's an estimate because there is information still coming in. We don't think we were overly generous nor do we think we minimized it. We think it's the best estimate we can make in this information -- with information we have today. So we feel comfortable with it, Brad.

Brad, its mostly driven by the risk of great change not identified loss. And the methodology would cause that to be allocated if we see meaningful grade changes that had not come about.

Got it. Great. Thank you. Peter, best of luck with everything. It's been a pleasure.

The next question comes from Jennifer Demba with SunTrust. Please go ahead.

Thank you. Good afternoon. The question -- another question on the hurricane provision. So do you think that any losses or grade changes on these impacted credits, this all probably occurs in the next three to six months or do you think it could drag on any longer than that?

I’d be surprised if it dragged on longer than that, Jennifer. I think we will have a much better fix on it over the next couple of months and then likely deal with most of it, the large majority of it by the end of the first quarter.

Okay. And as far as on this …

I just expect a lot, but we just thought it was imprudent to not set aside some provision, because we don't know everything yet.

Okay. And if I’m missing this earlier, I'm sorry, did you outline any -- did you do any hiring during the third quarter?

We did. We hired three RMs, as I recollect in the third quarter and are continuing to look for the starting lineup of the All-Star team.

Okay, great.

But those kind of as you know too -- those come as they’re ready to join, and not when we press them to join us. And so it's a long recruiting sales cycle the way we approach talent selection. We want to be sure they select us very carefully too. I know enough of our people that when they join us, we are out of the gate strong and that the likelihood of them being disappointed or us being disappointed is much reduced, because we’ve spent enough time and understand what needs to be done.

Okay, great. Peter, thank you very much. Congratulations.

Thank you very much, Jennifer.

Look forward to seeing you later this quarter. Bye.

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

Hey, good afternoon everyone.

Hi, Brett.

Wanted to just kind of go back to the deposit stuff and talking about some of the migration from DDA moving to other categories. Just want to make sure I understood the magnitude of what you're expecting there and then kind of what products that you’re expecting that movement to and what that might mean for the cost of funds from just that perspective alone?

We are just estimating as best we can judge. What we're beginning to see increasing because of more and more talk about further rate increases and we have always said once we got past the first two rate increases, we would start to see more influence thus having to pass-through some of that rate increase into our cost of funds rate payment. And we continue to negotiate it on relationship basis, but it's our best estimate of where we think the trends are headed. And we don't see a massive change, but we just think the trend is going to pickup.

Along with the heavy weighting of interest-bearing in the identified pipeline.

That’s right.

That’s a bigger factor actually than migration.

We've really been working on trying to tie of our treasury relationships even more tightly to us, and some of that incremental money is simply an interest-bearing if we are going to add to the relationship and that's what Peter is alluding to.

Okay. And then post -- obviously some liquidity build with mortgage being lower in the fourth quarter, it would seem like if we get a December hike that your margin should actually end up trading higher than it was this quarter. I guess, I'm curious if you’re hearing any conversations about loan spread, competition affecting the next rate hike and then any thoughts on the magnitude as you see at the December rate hike on your margin in the first quarter next year?

The December rate move if we get it, it will be late. So I just don’t think it will have a huge impact on the fourth quarter margin.

Right. No, I’m sorry, Julie, on the first quarter.

On the first quarter, yes. No, we would absolutely see it in first quarter, but we’re just not going to see much of it in the fourth quarter. Since most of ours are priced on LIBOR, we may see it if LIBOR starts to move while we may see it in advance of that, but it would be -- it would have a bigger impact on Q1, very little on fourth quarter.

It is hard to estimate at this point how much the competition will press in order to achieve some amount of growth. But again we continue to have outsize growth when you look at year-over-year in our more typical quarters. And if you just look at quarter-by-quarter on traditional LHI, we have very, very strong growth. So, yes, we are always in competition, but we're not under the same pressure with some of the competitors find themselves in, that shows some growth. And we will just have to see how that plays out and how much of that rate increase we end up having to compete against.

And again the competition is going to be on growth and new loans. So the existing book would reprice and we would have some benefit from that until that starts to renew, so …

Okay.

It's exactly right.

Okay, great. Thanks for all the color, and best of luck, Peter.

Thank you very much, Brett.

The next question comes from Jon Arfstrom with RBC Capital Markets. Please go ahead. Mr. Arfstrom, your line is open.

Thanks. Good afternoon.

Hi, Jon.

Hi. Just to follow-up on Brad's question, on the deposit pricing in the pipeline, Peter, you talked about just this is the way it happens with -- you have an interest-bearing pipeline, it sounds like. Are these deposits that you expect to come in at above or below your current average deposit rate?

Above the current average rate …

Yes.

… we believe below what we’re earning is the Federal Reserve Bank of Dallas.

Okay. Okay, got it. That helps. And then, Keith, a question for you, back -- way back on the core loan growth. You talked about how it kind of picked up mid quarter and after and the pipelines have pulled through into Q4, anything specifically driving that? And just curious if it's broad-based or there are a few specific businesses that are driving that?

Nothing in particular. We just have our growth. Sometimes it comes a bit lumpy, because we do cater to almost exclusively businesses as opposed to having the more granular retail that sometimes is more predictable. And it just happened to come in more heavily in the last half of the quarter, Jon.

Okay. Okay, good. That’s all I had. Thank you.

You’re welcome.

The next question comes from Scott Blanton with Compass Point Research & Trading. Please go ahead.

Good afternoon, everyone. Thanks for taking my question. Just with regard to servicing, I know you guys said it's about a $0.5 million net positive, but I’m just wondering at what point if I back into a rough number, if I use 1% on the asset yield, about $7 billion of EPB on the servicing. And just wondering -- I know you guys have said you want to get an economic level before you sell it? Just wondering where that is and second part of that will be potential change in regulation on capital treatment for servicing. Wondering if that's impacting your thoughts on when to sell the asset?

You know I think we’re still talking internally about that strategy. I think that you will start to see us make some moves on that sooner rather than later and we will probably talk a little bit more about that in January. The change is -- the potential changes on the regulation, the way I understand it, it's going to change the maximum which I don’t think we’ve ever intended to get to that level anyway. So I think we hope to be able to talk more about our strategy for what percentage we are going to sell, how we’re going to handle that in the near future.

Okay. All right. Thanks. And then, just to clarify a comment, Julie, you made about the loans held for investment in terms of the yield went up, but it was kind of the repricing occurred, but new loans were done at, I guess, below fully in next rate, is that correct? So the overall …

Correct.

Okay.

Correct. The new growth will be coming on at a -- yes, at a rate lower than the portfolio rate.

Okay, all right. And in terms of the hurricane impact, was there any impact on the mortgage warehouse business, or the MCA business, any ongoing impact there in terms of volumes or delays in closings?

Not volumes. There could be some delays in selling and the MCA there could be some delays in selling the loans, but yes it was -- because it's such a small piece of the overall book, yes, nothing that was noticeable, yes.

Okay, all right. Great.

Houston volume represents about 2% of our overall national volume. I mean, we are very spread out coast-to-coast in that business. So it didn’t have as much effect as you might think, Scott.

Okay. I appreciate it. Thanks, Keith and Peter thanks for your help over the years and best of luck in retirement.

Thank you, Scott.

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

Good afternoon.

Hi, Peter.

Just curious with the margin pressure expected in the fourth quarter, would you expect to still see growth in net interest income sequentially?

It's going to be a function of how much seasonality we experienced with the warehouse and it’s going to be meaningful. So that's the -- that will be the big question really. And again when you see that much shift in warehouse volume softening and it goes to instead, liquidity at the Federal Reserve Bank of Dallas, I mean that’s a meaningful change.

The guidance incorporates an assessment.

It does.

That it would increase?

No, that it was -- I mean, the [multiple speakers] effect of mortgage warehouse reduction, offset by the growth and we expect and have been already benefitted from traditional held for investments and then the increasing contribution expected from the six new or expanded businesses.

You are throwing me a little bit because while we have the guidance, I don’t know the dollars of net interest income and I think that’s what you’re asking, but the math is there in our guidance, I just haven't run the math.

Okay. Because the reason you had said that you expect the efficiency ratio to increase in the fourth quarter relative to the third quarter. And I guess that would imply some pretty similar type growth rate in expenses that you saw in the third quarter, in the fourth quarter?

No, it's about the net revenue. It's about the net revenue. So, yes, in the guidance we said that the warehouse is going to be down. So we’ve adjusted for the lost revenue in the fourth quarter on the warehouse compared to third quarter.

Okay. And then …

So also on the core book, we starting with the higher balance also, which will offset some of that.

Got it. And just my last question, with the improvement in the energy portfolio, I would think that there is some opportunities to release reserves tied to energy and can you shift it to support some of the loan growth?

You know we are not ready to talk about that quite yet. I think by January we might be able to talk a bit more. The way we grow, we grow at such a fast pace relative to everyone else. Releasing would mean really just reallocating in most cases, because our provision with our high growth is meaningful on this incremental new pass grade loans that we add every month, every quarter. So I think at some point there will be some reallocating of that money, Peter, but I can't tell you when that’s going to happen and at what speed yet.

Okay, great. Peter, congratulations on your retirement and good luck in the new chapter of your life.

Thank you, Peter.

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

Thank you for joining us for our Q3 2017 earnings call. We appreciate your interest in Texas Capital Bank, and please know our team is working hard to deliver positive results for Q4. Thank you.

Thank you for your participation in TCBI's third quarter 2017 earnings conference call. Investors are encouraged to contact Heather Worley by phone at 214-932-6646 or by email at heather.worley@texascapitalbank.com with any follow-up questions. You may now disconnect.