Texas Capital Bancshares, Inc. (TCBI) Q2 2018 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Texas Capital Bancshares Second Quarter 2018 Earnings Conference Call. All participants will be in a listen-only mode during the presentation. Please note this event is being recorded. [Operator Instructions] At this time, I will turn the call over to Heather Worley, Director of Investor Relations. Please go ahead.

Thank you for joining us for the TCBI second quarter 2018 earnings conference call. I’m Heather Worley, Director of Investor Relations. Before we begin our call, please be aware it 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 assume 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 in subsequent filings with the SEC. Our speakers for the call today are Keith Cargill, President and CEO and Julie Anderson, CFO. At the conclusion of our prepared remarks, our operator, Brian, will facilitate a Q&A session. And now, I will turn the call over to Keith who will begin on slide three of the webcast. Keith?

Thank you, Heather. I have a few opening comments, after which Julie will offer her review of the quarter. Then I will close and open the call for Q&A. On slide 3, certain highlights wanted a bit of color. The LHI growth in Q2 was strong, especially considering the somewhat depleted loan pipeline at the beginning of Q2 after the very strong Q1 LHI loan results. Mortgage finance recorded an excellent Q2 in outstandings, following a much improved Q1, 2018 against Q1, 2017. We showed an 8% linked quarter increase in Q2 for total deposits. The competitive environment we and most banks face in growing deposits requires greater focus across the bank. Importantly, our treasury management team and technology team continues to innovate. We are currently marketing and are fully operational on one of eight prospective cash rich industry verticals. Further, we are in beta testing on three additional verticals. By Q1 2019, we should be engaged with marketing and operating three new deposit verticals that didn't exist in 2018, and we will be beta testing four additional deposit verticals in the first half of 2019. Each of these eight potential, new cash rich industry verticals has the opportunity to deliver favorably priced deposits, totaling $500 million to $2 billion within three to four years, that’s each vertical. Net revenue growth continues at a robust 8% from Q1 and 23% year-over-year from Q2, 2017. While we experienced an unusual loan loss scenario in Q2, involving approximately 14 million of energy losses and 24 million in charge-offs on three C&I loans, our underlying credit metrics on the loan portfolio are actually very good. Slide 4 updates you on our energy and healthcare exposures. We are pleased with the quality growth our energy business is again achieving. Non-accrual energy loans have decreased approximately 60% since Q2, 2017, while criticized energy loans are down approximately 50% year-over-year. While we experienced an unusual outsized loan loss in the second quarter from two healthcare loans, overall criticized healthcare loans total only 3% at Q2 2018, with over half of the 3% relating to the two loans charged down in Q2. The large majority of our healthcare loans totaling almost 70% of the portfolio relates to senior housing as opposed to leverage lending. Only $9 million of senior housing loans are criticized as of Q2, 2018. Slide 5 describes the geographic diversification of our loans and deposits. Also, we update you on the top right quadrant on the unemployment rates in each Texas Metro area in which we operate. The economy in Texas remains very strong. In fact, Texas was again named CNBC's top state in America for business. In the 12 years CNBC has named the top state for business, Texas is the only four time winner. We have added more than 350,000 jobs in the past year. 39 companies in the S&P 500 index are based in Texas and some of the nation's largest privately-owned companies call Texas home, including HEB Supermarkets, Neiman Marcus and Hunt Oil. The score for Texas in the ten categories of competitiveness in this survey included top 10 finishes in workforce. We came in number 7 out of 50 states. Infrastructure, came in number 1. Technology and innovation, we were number 9. Access to capital, we were number 3; and finally the economy, number 1. We’re fortunate to be based in such a dynamic economy. Julie?

Thanks, Keith. My comments will cover slides 6 through 12. Our reported NIM increased by 22 basis points from the first quarter. The change in earning asset mix accounted for a portion of the increase. The decrease of almost 900 million in average liquidity assets since the first quarter accounted for approximately 15 basis points of the improvement and that was offset by the seasonality impact from mortgage finance, which was negative to NIM by about 14 basis points. So net 11 basis points of positive impact to the NIM from earning asset shifts with the remainder coming from improvement in earning asset margins. Our traditional LHI yields were up 33 basis points from the first quarter, reflecting continued impact of moves in LIBOR and a good strong loan fee quarter. As we noted in the first quarter, we benefit as one month LIBOR has increased relative to Fed funds rate. Recently LIBOR spread to Fed fund seems to be slowing some. Our asset betas continued to be as expected. Our continued loan growth can mute rate impact somewhat as new loans may not be coming on at the same effective rate as the overall portfolio yields, but that can vary some by loan type. We experienced continued improvement in yield on mortgage finance loans in the second quarter with LIBOR moving up, but that industry remains competitive and we will evaluate relationships as needed. We had a slight linked quarter increase in average deposits from the first quarter. Our overall deposit cost increased by 15 basis points from 66 basis points in Q1 to 81 basis points in Q2. The increase was expected as Q1 numbers only included a few days of the March Fed funds move on index deposits, similarly Q2 only includes a few days of the June move. Additionally, we continue to see a pickup in magnitude of rate change request, but not more than expected. We have a continued solid deposit topline, but as we've said in the past, it can involve a long sales cycle, so difficult to forecast exact timing, it can be lumpy in how it comes on and most of it is interest bearing. During the second quarter, we chose to layer in approximately $1 billion of traditional brokered CDs as we were able to lock in 6 and 12 month maturities at a cost slightly less than our index deposits. While use of the brokered CDs makes sense from a balance sheet management perspective, we don't plan to use an outsized amount of brokered CDs going forward. Floored loans are now around 110 million and it's fairly irrelevant at this point, because there's no significant difference in rates on floored and un-floored loans. As a reminder, approximately 70% of our floating rate loans are tied to LIBOR and over 80% of that tied to 30-day LIBOR. As Keith commented, we had a continued good traditional LHI growth in the quarter and actually a little higher than expected. Year to date, it remains consistent with our annual guidance. Traditional LHI average balances grew 3% from the first quarter and up 16% from this year -- from this time last year. Strong growth in June with ending balance above average provides a good start for the second half of 2018. The level of payoffs continues to be high, primarily in CRE and no sign that that will flow. Continued strong average total mortgage finance balances were impacted favorably by seasonality, but also were up from last year at this time by almost 38%. Q3 volumes are expected to be good, but less than Q2 and followed by a seasonally lower Q4. There was some pickup in linked quarter average total deposits with all of that growth coming in interest bearing. As we continue to say, we do expect most and probably all of the 2018 growth to come from interest bearing categories, but still at reasonable overall effective cost. As I noted earlier, we chose to add some traditional brokered CDs during the second quarter. They have 6 and 12 month maturities and pricing is very favorable as compared to our index deposits. Primarily, interest bearing deposits in the top line, but we're also working hard on maintaining and growing existing relationships. Again, asset betas are an important part of the story for us and why we feel good about our balance sheet positioning going forward. We have seen our asset betas perform as expected. We're continuing to react to specific customer situations, evaluating them on a total relationship basis and just to note that our index deposit categories still total approximately 5 billion in balances. Moving on to non-interest expense and looking at changes in linked quarter non-interest expense, we are effectively slowing our core expenses, but there are a few items of note that require some additional commentary. I'll start with the salaries and employee benefits line as that’s obviously the major driver of our non-interest expense as it’s over 50% of the total and we think we're doing a good job of managing this with a lower level of FTE additions year to date. There's an increase in non-LTI and annual incentive pool from first quarter levels and that's driven by the annual incentive accrual, which generally continues to ramp throughout the year, based on overall financial performance. Very little fluctuation in FAS 123R expense in the second quarter compared to the first quarter and no -- as there were no major fluctuations in stock price. As a reminder, total FAS 123R expense in 2017 of 22 million versus our planned 123R expense of 24 million in 2018. Q1 and Q2 FAS 123R expense was 5.6 million. Legal and other professional was abnormally high in the second quarter with some nonrecurring expenses, but expected to return to a more normalized level in Q3. There was about 2.5 million in Q2 that's not normal run rate and we wouldn't expect to see that in Q3 and Q4. We discussed a new variable component added during Q1 that is directly related to deposit services and that accounted for a little over 1 million of the increase for from Q1 to Q2. We would expect to see the same 1 million to 1.5 million increase in each of the next two quarters, but on a base excluding the 2.5 million that I mentioned. A portion of the marketing category is variable in nature and is tied to growth in deposit balances as well as increases in rate. The trend in marketing over the last year or so is representative of the increase in run rate expected throughout the rest of 2018. We continue to be targeted about expense growth and heading into 2019 planning season, that will be even more evident. No new outsized build out plans for ’19, but rather a focus on improving returns in all lines of business. Our efficiency ratio for Q2 was 53%, slightly improved from first quarter of 54% and compares favorably to last year at this time of 55%. Obviously, seasonality for mortgage finance positively impacts our efficiency ratio in the second quarter. Moving on to asset quality, despite the outsized provision and charge-offs, asset quality continues to be good. Non-accrual levels are at an acceptable rate of 37 basis points of total LHI. As we've discussed previously, the additional provision and charge-offs were related to four larger C&I credit. One energy, two leveraged healthcare and one general C&I with a unique situation. None of the four give us a reason to believe that there's a more systemic issue within the portfolio. As you know, we take credit very seriously and are as focused as ever on maintaining our standards of credit quality. Expect Q3 and Q4 provision levels to be more normalized, but it is important to note that as we've grown, we're doing larger deals and when we see migration, it can cause lumpiness in provision levels from quarter to quarter. The provision of 27 million for Q2 compares to 12 million in Q1 and 13 million in Q2 of last year. Of the 27 million, about 7 million of the provision this quarter was related to new loan growth and that was a little higher than we expected as we had strong growth late in the quarter. Charge-offs for the quarter totaled 38 million and included 14 million related to energy. And looking at net revenue, we continue to have good growth linked quarter. Strong traditional LHI growth year-to-date and the entire portfolio has benefited from improved margins as a result of the continued move in LIBOR. We continue to take market share away in mortgage finance as well. ROE and ROA levels were penalized in the second quarter as a result of the higher level of provisioning. The expectation is that ROE will continue to improve through the remainder of 2018. The benefit from interest rate moves continues to be evident in net interest income and positively impacting ROE and ROA. Current lower liquidity levels have been beneficial for ROA, but we're comfortable with holding higher liquidity levels and we would expect balanced increases over the next two quarters, as mortgage finance moves into the seasonally weaker part of the year. Last, I’ll talk about the 2018 outlook and any changes. We have no change in our outlook for traditional LHI growth of low to mid-teens percent growth. There's a slight change in our outlook for mortgage finance growth of mid-single digit percent growth. Additionally, a slight change in MCA guidance to 1.2 billion for average outstandings for 2018, despite the fact that that market continues to be highly competitive. In total deposits, we have a slight change as we think growth will be in low teens, the low teens percent growth. We still expect to see more growth in interest bearing categories and continued shift from non-interest bearing to interest bearing. We're comfortable funding seasonally higher mortgage finance balances with short term borrowings, which is perfectly match funded. The deposit growth can be lumpy, which can mean that liquidity levels can vary from quarter to quarter. For NIM, we're improving our outlook to 3.6% to 3.7% to include the impact from the June rate move. The guidance is still assuming no additional rate increases in 2018. We're also taking into consideration that our deposit growth is coming in interest bearing and that also assumes that we have liquidity levels higher than the second quarter level. Improved outlook for net revenue to mid to high teens percent growth to reflect the impact from the rate move in Q2, no change in our provision guidance at low to mid $60 million level, the second quarter was outsized as a result of the four deals and we expect the more normalized levels in Q3 and Q4. We're updating the guidance for non-interest expense to low teens percent growth, primarily related to some of the variable cost I’ve previously discussed. No change in guidance for efficiency ratio, it's still remained in low-50s. Keith?

Thank you, Julie. I'll close with slide 13. Despite the outsized loan loss provision in Q2, we delivered strong earnings and have set ourselves up for a strong start to Q3 with the excellent loan growth in Q2. We continue to benefit greatly from our high asset beta, allowing us to improve NIM guidance for the remainder of 2018. The impact of one quarter of slippage on credit costs clearly keeps us focused on credit quality, despite the good credit metrics currently. For all of 2018, we continue to believe the loan loss provision will remain in the upper range we provided in guidance back in January. We are committed to the targeted approach in slowing non-interest expense growth, while also modestly and efficiently investing in new and better deposit generation capabilities, including new cash rich industry verticals, new products, and always the finest possible client service. At this time, we will open the lines for Q&A.

[Operator Instructions] And our first question today comes from Brady Gailey with KBW.

So the billion of brokered CDs that was brought on balance sheet 6- to 12-month maturities, what was the average rate paid for those?

It was more attractive than going out, Brady and generating the incremental deposits. The 6 and 12-month, this was too attractive to pass up on the pricing out, do you have that --?

Yeah. I mean, I don’t know – I don’t think we’re going to – I don’t that we are wanting to go into exact costs, it’s less free, it’s at a rate less than our index deposits.

Okay. And is that something you expect to potentially do more of on down the line, bring on more brokered CDs?

No. We just thought it was a good time in the market to do that, relative to the alternative, and it’s proved to be the case since we made that purchase.

Yeah. The timing was right. It was earlier in the quarter before the June rate move and it just – yeah, we were just trying to be opportunistic from a balance sheet management perspective.

All right. And then Keith, I know you mentioned the 8 new kind of cash rich industry verticals that should produce some nice deposit growth. I think you said you've launched one of them. And I mean, the other seven that are coming the rest of this year and into next year, do you expect any sort of notable expense build surrounding those new deposits verticals?

They should really be modest expense builds. It’s the key there Brady, and I think we've mentioned this a time or two when we first started explaining, our R&D project has been underway for two years to develop these targeted cash rich industries. The key is hiring the right people. Now, we do some additional product development, but it is not out of sight, very expensive to do that. Again, what we've done over the years and had good success at is identifying niches, talking to quality prospects, and a few of the clients that we may have attracted already and having them assist us in final design of the product. And so that collaborative effort has really helped us deliver something uniquely tailored to these different industries, but it is not an expensive undertaking like you would expect on a build out of a typical business that would involve credit as well.

Okay. And then last for me, there was about a $2.5 million swing in other fees, just wondering if you all could give a little color there?

No, I don't remember anything of mention that we would talk about. It has to do what most of it's going to have to do, because what primarily in other is some of the MCA stuff, gain on sale, so there were some losses and it had to do with our transfer of the – the servicing book, so not recurring.

The next question today comes from Jon Arfstrom with RBC Capital Markets.

Just on the loans, Keith, you talked about a little bit lower pipeline coming out of Q1, but obviously you had a great loan growth quarter, and now you have period end higher than average. Can you talk a little bit about what if anything changed during the quarter? And kind of the key drivers of the LHI growth?

I can't say Jon that we're seeing a significant shift in the psychology of the clients, but it is getting some more positive, in spite of all the chaos about trade wars and things of this sort. I know there are some that are on the sidelines, but generally, and our clients are really prospering. They're having good success in their businesses and we just got some good traction intra-quarter that we didn't expect we could build that quickly and it was quite broad. So it wasn’t a particular area. In fact, some areas that have typically been good boost in a given quarter when we have this kind of growth would be CRE, and CRE actually was pretty modest. We had quite a lot of paydowns in CRE. So it was largely C&I, and also our premium finance business did extremely well. Now, you would expect a little of that in the second quarter. There is some seasonality in that business, but they really did far better than just the typical seasonality. So it was a combination of, across the board, our team has really doing a good job even though we started with a pretty lean pipeline right at the beginning of the quarter.

And then maybe Julie for you on the NIM guidance versus the number that you put up this quarter, is there anything you would call out in that 393 margin number and how do you want us to think about some of the near term puts and takes on the margin as we look into Q3?

The things that -- we try to -- we do the roll forward and the things that I would call out are the ones that I called out, there was some pickup from the shift in earning assets, but the 11 net that was still improvement, I mean, that's improvement, that’s based on the earning assets. The loan yield is going up, there were some -- a good quarter of loan fees, but that's not – that’s something that we have regularly. So, no, nothing in particular that we’ll call out. I mean, our deposit increased. We're pretty much what we expected. So I don't think anything – anything that we weren't expecting.

We're going to have to watch that LIBOR lead relative to other rates, because as Julie mentioned, it's not leading as much as it was the case earlier in the quarter. So we're watching that.

Next question comes from Peter Winter with Wedbush Securities.

I was wondering, can you give a little bit more color on some of the deposit initiatives. I know it's early stages, but I'm just wondering if you can give some broad color on some of the initiatives?

Peter, we really can't do that because we’d just be telegraphing to competitors these areas that we’ve spent a lot of time and energy and invested some R&D money in researching the last couple of years, and now that we're in beta and build out. Until we get out there and establish on our balance sheet some meaningful deposit growth, which I think we’ll really create over the next two or three years, until we get some of that traction and get established, if someone is quite good in that specialty niche, we're not going to telegraph that early. When we were a smaller bank and just an ankle biter, people didn’t really pay a lot of attention to some of our innovation. We've created this organically and our people have come forward with ideas mostly from clients to give us those ideas for 20 years. This is our 20th year of creating an organic growth company. What we know now is we can't be too proud and talk early about these ideas until we get the market traction that we expect we’ll accomplish, but I’ll try to give you a little more color than what I had in the previous quarters about the relative impact these could have over time, over the next three to four years. We think each of these 8, if we ultimately execute 8, again, we're going to have 4 that are out and operating by Q1. I feel very confident now. But of these other four that will be in beta the first half of the year, not all will make it necessarily out into the market, but let's say, at least two of those four make it to the market. Our beta test goes very well, then we would have six new businesses that only one of which we launched this year and I'm very proud of our team across the company and we've worked together to develop these new opportunities I wish I could share more, but I just can't. I hope you understand that.

I do. Can I ask about the -- you maintain the guidance for the average loans held for investment, but if I look at the first half of the year, you're tracking slightly above the guidance. And so I guess I'm just wondering what the outlook is for the second half.

The outlook for the second half is good, but it’s – Q2, it’s less than Q2 levels. I mean, both in Q3 and Q4, we would expect good growth, but less than what we saw in Q2.

And what would be the reason behind that?

Well, the main reason behind that is like most banks, we're pivoting some on the time that we want our bankers to spend on deposit growth with our treasury team members and we're rolling out some of these new products and opportunities. So we're going to have to be a bit more balanced at how we allocate our time and I think that's really a wise investment. We have a lot of opportunity to create more core deposit growth with our existing customer base even before these new verticals get rolled out, but it does take time. In fact, deposit generation takes more time off than loan generation. So we're just trying to be realistic, be sure our bankers know that loan growth is still important, but it's balanced growth in the environment we're going to be in the next three to five years. It's very important to achieve our sustainably higher ROE objectives.

Our next question comes from Michael Rose with Raymond James.

Maybe to start with the energy loan growth, this quarter was pretty strong. Can you give us a flavor for the types of energy credits you’re putting on the books today? Are they what they have been historically, more of the club credits, bigger credits, or bigger pieces of larger SNCs [ph], just a flavor of what the environment looks like now?

This particular quarter, it was just good solid E&P. Not concentrated at all on SNCs, although SNC does have a fair amount of energy included in it. E&P made up about, well, close to 100 million of the growth this quarter and then we had some very modest increase in midstream water disposal with some of the increase and then we had a little compressor financing that kind of falls outside the true E&P category and falls more on our business loans, which you'll notice a differential between our pie chart on the energy loans and our 7% we talk about on our energy subsection and that difference of things like compressor financing, we don't do near the wellhead, energy service financing, as you well know. Thank goodness going through the last cycle. But we do some of these ancillary types of oilfield service, not near the wellhead like compressor financing. So that was a piece of it as well.

And then maybe just one more broadly speaking, the efficiency ratio, low 50% expected for this year, that’s unchanged. But as we move to next year, you guys have built up a bunch of businesses over the past few years and I think a lot of people are really counting on the operating leverage to come through to drive that efficiency ratio lower. I know it's probably a little early to comment on next year, but would the expectations be that generally, assuming rates continue to grind higher, we get a couple of more rate hikes to see that efficiency actually improve next year?

Yes. We should. We certainly should. We are continuing as we refine our tactical plan and constantly work on our strategic plan, it involves quarter-by-quarter. We really work at this year round now. We're going to have more and more emphasis on those key areas where we can be number one, number two kinds of players and optimize returns, risk adjusted returns. And that will help us be more focused on how we allocate our people, our human capital as well as our overall financial capital and that will contribute to more efficiency as well.

And then just one quick one for Julie, how much were the non-recurring legal fees this quarter, pretax, just the dollar amount?

Roughly about 2.5 million.

Next question comes from Dave Rochester with Deutsche Bank.

So on the deposit growth, are you guys assuming that the brokered CDs actually stay with the bank? Are you planning on rolling those off at some point as they come due over the next year?

I mean they would roll off. Some are 6-month maturity, some are one-year maturities.

Yeah. So you’re not planning on replacing those. Got you.

We have these verticals coming on, but it takes a little time to get out in the market and actually generate that new lower cost funding and in the meantime, to go in to the market as competitive as it is, this was a better financial alternative.

I know you mentioned seeing a greater incidence of price and request this quarter, but it sounded like that was within your expectations. I was just wondering how the competitive backdrop has changed at all this quarter versus last quarter and if you've seen any standard pricing changes in the market post the June hike?

No. So far, steady as it goes.

And then on the NIM, just comparing where the NIM guide is now versus the reported NIM for 2Q, you're looking for a pretty big decline in the NIM in the second half. Is that all just liquidity declining or liquidity increasing and funding pricing going up?

Because we assume no more rate increases, so in that, we would assume that there's a little bit of compression on the loan yields that deposit costs tick up a little bit more and that yes, that there's some build in liquidity.

Remember the fourth quarter warehouse that Dave is always a seasonally softer quarter. So that will lift liquidity.

Right. But you should still see some benefit from the lift in LIBOR this quarter from the June hike, right?

Yes. There would still be some.

Yeah. That’s true.

Yeah. In July though -- earlier in July, we’re starting to see it, it narrowed a little bit, but that’s been factored into the right guidance.

Okay. But it’s just you're looking to go from 3.93 to something that’s 20 bps or more lower, so I was just trying to figure out, are you looking for a big liquidity build in the back half of the year. I know the dynamics around the warehouse, but –

Yeah. But not huge, but a much bigger liquidity build, it would be more liquidity than we had in the second quarter.

Got it. And then I know you mentioned the loan fees were a little bit higher this quarter, about how much higher were they versus last quarter, just to try to get a sense?

I mean that can vary from a couple of basis points from quarter to quarter.

So it's not that big of a swing factor?

No. It can vary a couple of basis points from quarter to quarter.

Okay. And then you're assuming the DDA, I guess, remains stable through the end of this year, as a part of your guidance or continues to run off?

We're not assuming growth in DDA. I’ll tell you that.

And then just one last one on expenses, there was great color on all the new verticals, appreciated that. And I know you just said that you weren't expecting any other big build outs next year. So I was just wondering if you're thinking that low double digit expense growth pace should be good for next year as well.

It's early, but that’s certainly what we would be targeting.

Yeah. I got another crown from Julie. That happens about every other quarter.

Next question comes from Jennifer Demba with SunTrust.

Your legal fees that were higher this quarter, what was that attributable to?

We are not going to get in to the specifics. I mean, it’s regulatory compliance type other professional expenses. Nothing that is indicative of a problem or just some lumpiness there.

Okay. And your other fee income that was a loss this quarter, should that return to the more normalized levels in the third quarter?

Yeah. It should return to a more normalized.

And you just guide at this point about 83 million in non-performing loans. Can you just talk about the granularity of those non-accruals? Maybe what the larger loan sizes are in that bucket?

I don't have that really handy, Jennifer, but I don't remember anything outsized. By that, I mean we don't have any $50 million kinds of issues in that portfolio of non-accruals. It’s going to be -- the high end of that might be a 20 or a 22-ish or even more modest. So 15-ish, mid-teens to high-teens would be the high end of anything in that balance.

We give you what the energy portion of it is, the total for the remaining energy in that.

Our next question comes from Brett Rabatin with Piper Jaffray.

Wanted to go back to just thinking about the margin and the loan yields, your LHI loan yield was up 33 basis points this quarter and you got the June rate hike. I just want to make sure, are you saying Julie that there is a lot of stability to pass along, maybe some of the LIBOR increase from June. I just wanted to make sure I understood your commentary around the implications of that hike specifically?

Yeah. Not all of the loans. They don't all reprice at the same time. So depending on how quickly something reprices, there can still be some pickup in Q3 from that Q2 move.

Well, so what I was going to ask is, it would seem like there'd still be a pretty northward trajectory on that, but I realized that new loan production is also a headwind if I understand correctly. Can you maybe comment on that relative to the current yield?

Yes. So new loan demand, some of it is coming on at a rate less than our portfolio yield. Now, that can vary by type, by type of new loans. So –

Brett, you really have to factor in that liquidity build where we go from a strong third quarter on warehouse to a much softer fourth quarter and when we flip the assets to liquidity, I mean, we give up a lot of yield. And so that's really what is driving most of that change.

And then wanted to ask on MCA, just want to make sure I understood the related fee income this quarter, what happened there and kind of what that might mean for the back half of the year?

I mean, we don't need to get into the details, I mean I don't even have all the details in front of me. It’s just kind of a nonrecurring, it had to do with some losses, some mark to markets, but I don't even remember the details, but it’s non-recurring and it shouldn't -- it's not a trend that you should see repeating going forward.

And then maybe one last one if I could. I realized that the two healthcare credits, the leverage ones were a little bit unusual, relative to the rest of the book, but I was just curious if you've done kind of a deep dive on the rest of the healthcare book to make sure there's not reimbursement rate risk with the rest of the portfolio and just kind of thinking about the remaining healthcare and how it's different than the ones you obviously had to address in 2Q?

Yeah. We really feel good about the book other than these two deals of course. I mean, when you look at that whole book, only having 3% criticized and then half of that is the existing non-accruals that we reported on. We feel very good about the book.

Next question comes from Geoffrey Elliott with Autonomous Research.

On capital, the CET1 came down a bit, I guess, because of the strong loan growth to 8.3. Can you give us your thinking there on where you're looking to run and how you are approaching potentially coming back and raising some equity.

So, in the second quarter, that’s the seasonally strong for warehouse. So our CET1 will generally run a little lower in Q2, but that's kind of a peak at the end of Q2 for the mortgage warehouse. So we will continue to build capital, our internal generated capital is, as you know, is adding pretty quickly. So we have no plans to raise capital and we're comfortable at the levels that we're adding, you'll see those continue to pick up.

And then just following up on something you said earlier on the legal and professional fees. I think you said there was about 1.5 million related to some of the deposit gathering initiatives. Was the message that it's kind of 1.5 million growth each quarter sequentially from here or was it message that 1.5 million is in the run rate and it stays in the run rate?

There was -- from Q1 to Q2, there was about a little over 1 million. That increase that was related to that and what I said was that we would expect to see another 1 million to 1.5 million in each quarter added to that. So an additional 1 million to 1.5 million each quarter related to that, that specific item.

That is in the guidance.

Next question comes from Chris Gamaitoni with Compass Point.

Assuming you’re successful with these new deposit verticals, do you have any sense of kind of the cadence of ramping up to the market opportunity that you’ve disclosed?

It will really vary by the sector. Some sectors -- some of these verticals will have a potential of $1.5 billion over three or four years. Others could be $1.5 billion to $2 billion opportunity. So the timing of when those actually roll into the market matters, but also they’re new businesses. And that's all we've done is put new businesses here, we never bought a bank in 20 years. So we know enough to be careful about having expectations set until we actually get out of the market for six or twelve months. So we're going to be a little careful about where we guide you on that, Chris, but we think the potential, if we get -- which we launch six of these that five of which didn't even get a launch this year, we only launched one so far this year and we were able to launch, I'm projecting, six of these remaining eight, five of these remaining 7 rather, I think, we're going to have a phenomenal booster rocket attached to our core deposit growth, which again still offers a lot of opportunity for us. It’s just better mining of deposits with our existing client base. We've done a lot of work on that too, not just focused on these new cash rich industry verticals and we've bought some new tools for our bankers to better understand the opportunities, to see the data and I really am quite optimistic a year from now, we’ll be showing some much better deposit growth, even in a tough market.

And then moving over to mortgage finance, is there -- right now is probably the most difficult gain on sale environment I’ve seen for your client base in the mortgage finance vertical. Is there any concerns about profitability challenges, tripping kind of profitability covenants or anything in that business?

We think we're moving up the food chain a bit. We now are able to generate a better opportunity than we were six or twelve months ago on the buy side. Yes, it's then -- I mean, you ending up with a loss on sale in some cases, but if you have extremely aggressive buyers in a given quarter, you may recall, last third quarter a year ago, wealth was just kind of above the market and we just weren't going to go with those kind of prices and so we really backed off on our outstandings and what we were buying. So we just have to stay true to what we think the right targets are on return, but you can't realize the full return until we get some normalizing. I'm not sure we'll ever see it normalize back the next few years to the 75 to 100 basis point gain on sale and that was there 3.5 years ago, it's just not anymore. And if we can get back to consistently 25 to 50 basis point gain on sale, it would really help us lift the ROE. So we’re delivering an ROE, we’re pleased with. This is not a top decile ROE that we had hoped for when we launched it 2.5 years ago. It's still a top 50 percentile ROE though.

My question was just related to the health of your clients in the warehouse business, if there's any concern there. I know you're generally focused on larger lenders, but just wondering if there is any operational costs that may come in with difficulty for lender clients.

No. We’re doing well. I am very thankful we moved up the food chain with our client targets because I do think the small operators are really having a hard time to have two successive years, they cumulatively will be close to 25% percent lower volume than two years ago and that's really tough, even if you're a strong upper mid-sized company that we bank, it's not easy, but if you're on the smaller end of that food chain, it's really hard today, but again, we see our clients being able to pick up top producers from some of those weaker smaller ones without having to buy and do M&A and we think that will help our clients move through this tough period.

Our next question comes from Brock Vandervliet with UBS.

In terms of the energy portfolio, I know the credit that encountered counter problems this quarter, that was a coal methane company I believe. Are there other credits tied to that area in the portfolio?

We have two other coal methane deals, each rather modest sized deals, neither of which have the same engineering burst if you will that we encountered on this one. That’s the worst as you know of all scenarios in an energy deal, an E&P deal is you just missed the reserves. So we had some other challenges with that credit too, but the fact that we had one of the top firms in the country that provided us a reserve report and our engineers looked at it, reviewed it, but we didn't catch it on our side either. Prices certainly haven't helped you -- helped us over the borrower like they have on the oil side over the last couple of years. So you combine all of those things, and this was a different scenario than the other two we're dealing with. We think the risks are okay on the other two at this point.

And just stepping back, I'm sure you've all spend a ton of time on credit in general here in the last quarter and what would be some of your puts and takes on the process? Are you doing anything differently? Do you look at syndication differently? And any sorts of changes that you may have made to your credit process?

We really haven't. We are very disciplined on credit. We have told the market for years that because we do larger average sized deals, not having a retail component to our business, we’re fully focused on commercial, that if we have a few of our credits hit and go sit out in the same quarter or same half of the year, it can be tough, it can be lumpy. But if you look at us and we have emphasized this as well, on an annual basis, we consistently deliver very low credit costs, relative to peers. And I think we'll do the same this year although it's been a bumpy quarter, but we don't have a systemic fundamental problem. Absolutely, we're looking more carefully at credit, because when you have one, it's just another wake-up call, Brock, that no matter how good you think you are, you've got to be better. And as you get deeper into the cycle, closer to the next downturn, we have to be better than we've ever been over the last nine, ten years. So our bankers and our credit team are certainly looking more carefully at the portfolio. We've not found any systemic issues nor are we changing at this point anything strategically about how we buy syndications and the like.

Next question comes from Matt Olney with Stephens.

Just wanted to clarify the guidance around 2018 revenue growth. I am a little surprised that revenue guidance is a little higher than the mid to high teens. If I just assume that 2Q revenue of $250 million continues into 3Q and 4Q, sort of no growth at the back half of the year, then the full year ’18 revenue growth would be about 17%, which is essentially where the guidance is today. So I'm trying to understand the full year revenue guidance. Is there a chance that revenue could actually decrease or is that guidance just conservative?

We always hope that we're conservative with guidance. But we also are coming off of a seasonally strong mortgage warehouse quarter. So yes, we would expect revenue to continue to pick up, but you have to remember Q4 is generally seasonally weaker for mortgage warehouse.

If we have a third quarter like I hope and think we might, we can give you some better updates at the end of that third quarter, even with the softening that we’ll experience in the fourth quarter. But at this point, we're just going to be on the conservative side and I grant you that's a pretty conservative number, but we wanted to be more solid than just halfway through the year after that big boost we get in the second quarter.

Okay. That's helpful. And then can you guys also disclose what the – in the mortgage warehouse, what percent [indiscernible].

I think refi is in the high-20s.

At this time, this will conclude our question-and-answer session for today. I will turn the conference back over to the President and CEO, Keith Cargill, for any closing remarks.

We appreciate your time and your interest in Texas Capital Bancshares. Good evening.

Thank you for your participation in TCBI’s second quarter 2018 earnings conference call. Please direct any requests for follow-up questions to Heather Worley at heather.worley@texascapitalbank.com. At this time, you may now disconnect. Thank you for joining.