Texas Capital Bancshares Inc (TCBI) 2015 Q3 法說會逐字稿

Good afternoon and welcome to the Texas Capital Bancshares Inc. third quarter 2015 earnings conference call.

(Operator Instructions)

Please note this event is being recorded. I would now like to turn the conference over to Heather Worley, Director of Investor Relations. Please go ahead.

Welcome to the Texas Capital Bancshares third quarter 2015 earnings conference call. I am Heather Worley, Director of Investor Relations. If you have any follow-up questions, please call me at 214-932-6646.

Before we get into our discussion today, I would like to read the following statement. Certain matters discussed within or in connection with these materials may contain forward-looking statements as defined in federal securities laws, which are subject to risks and uncertainties and are based on Texas Capital's current estimates or expectations of future events or future results.

These statements are not historical in nature and can generally be identified by such words as believe, expect, estimate, anticipate, plan, may, will, intend, and similar expressions. A number of factors many of which are beyond Texas Capital's control could cause actual results to differ materially from future results expressed or implied by our forward-looking statements.

These risks and uncertainties include but are not limited to deterioration of credit quality of our loan portfolio, the effects of recent declines in oil and gas prices on our customers, increased defaults in loan officers, the risk of adverse impact from general economic conditions, volatility in the mortgage industry, competition, interest rate sensitivity and exposure to regulatory and legislative changes. These and other factors that could cause results to differ materially from those described in the forward-looking statements, as well as a discussion of the risks and uncertainties that may affect Texas Capital's business can be found in our annual report on form 10-K and other filings made by Texas Capital with the Securities and Exchange Commission.

Forward looking statements speak only as of the date of this presentation. Texas Capital is under no obligation and expressly disclaims any obligation to update, alter or revise its forward-looking statements whether as a result of new information or future events or otherwise.

Joining me on the call today are Keith Cargill, President and CEO, and Peter Bartholow, CFO and COO. After a few prepared remarks our operator, Amy, will facilitate a Q&A session. At this time I'll turn the call over to Keith who will begin on slide 3 of the webcast.

Thank you, Heather. Welcome to our 2015 third-quarter earnings call. After my opening comments on the third quarter Peter Bartholow will offer his review, and I will close our presentation before opening the call for Q&A.

Beginning with slide 3, you will note that we delivered strong growth in traditional LHI balances and total deposits. As expected mortgage finance outstandings showed some seasonal slowdown that is typical in the third quarter as compared to the seasonally strongest second-quarter, but also was affected by the softening in the refi market.

Mortgage finance remained a significant contributor to year-over-year earnings due to the market share gains we have accomplished yet again this past year with growth since the third quarter of 2014 totaling 14%. Despite the continuing buildout of private wealth advisors and in mortgage correspondent aggregation, or MCA, operating leverage remained strong. The organic growth business model at Texas Capital is solid.

It allows us to not only produce healthy growth in our core businesses but also enables us to add complementary higher return lines of business and products as we diversify our income stream. We remain confident that the buildout efforts in 2014 and 2015 will be meaningful contributors to earnings growth in 2016 and beyond, regardless of interest rates. We are strategically building Texas Capital to deliver sustainable higher ROE for our shareholders in a flat rate environment but remain highly asset sensitive if rates rise, and we'll benefit from rate increases at some point.

Credit quality remains sound. We showed stable NPAs for the quarter but recognize the likelihood of some continued weakening in our energy portfolio in the future.

On slides 4 and 5 we update you on our recently launched mortgage correspondent aggregation business, or MCA, as we refer to it. Due to a later than planned launch date in late September, rather than late July, we have less to report in terms of actual results than we would otherwise. We can tell you that we are experiencing some competitive headwinds related to fees.

Because we have started up numerous businesses, we are showing good agility in fine-tuning our positioning to engage prospects and win market share. Whilst the income will be more modest, we remain optimistic about the risk-adjusted capital efficient returns this business should produce.

Due to the late launch and increased pressure on marketing competitive fees we no longer expect MCA to be profitable in Q4. However, MCA should be a meaningful contributor to 2016 earnings and will improve capital efficiency in our mortgage finance services division. We will have considerably more facts and market visibility to offer you on MCA in our year end earnings call in January after having operated the new business for a full quarter.

On slides 6 and 7 we show you quarter end highlights on our energy business. The quarter end balance of energy loans declined slightly from $1.2 billion at Q2 2015 to $1.1 billion for Q3.

The mix within the energy portfolio in relation to total loans remained essentially the same with E&P at 5%, service 1%, and other security 1%. 60% is non-SNC, 40% is SNC with 12% of SNC agented by us. Effectively we lead or agent approximately 65% of our energy portfolio. The oil-weighted borrowers are in an accretive hedged position in 73% of the cases throughout 2016.

Our updated 2015 base case oil and gas price assumptions are $47.50 per barrel of oil, and $2.75 per mcf for gas. Our sensitivity case assumptions are $40 per barrel of oil, and $2.25 per mcf of gas.

Forward-looking price assumptions track the forward strip. Non-accruals in energy are flat linked quarter. We expect continued risk grade migration to the extent this low price cycle persists.

Currently our loan loss reserves related to energy appear appropriate. Our energy team is working diligently with our clients to adjust debt levels as borrowing bases fluctuate, by directing cash flow towards debt reduction as well as adding collateral, reducing debt through asset sales or through new equity injected by investments.

We expect new high-quality energy loan opportunities to pick up in Q4 as some properties change ownership. There is ample equity capital and experienced management talent available to absorb the change in ownership.

Turning to slide 8 we summarize our Houston market risk real estate. The real estate portfolio has modestly increased as we continue to experience no downgrades. The entire Houston market risk real estate portfolio remains graded pass as of December 30 as was the case of June 30, 2015.

Peter?

Thank you, Keith. In 2015 third-quarter the Company produced near record level of net income. Despite the continued buildout of MCA and wealth advisors, we maintained good operating leverage well within guidance.

We saw the impact of growth in liquidity assets on NIM and ROA remain very high. The pace of liquidity asset growth increased linked quarter up more than 20% to $2.8 billion.

We also saw asset sensitivity up very slightly compared to Q2. Since Q2 -- excuse me Q3 of 2014, the impact of net interest income from a change in 100 basis point and 200 basis point change in Fed funds rate has demonstrated the following changes. With 100 basis point shock net interest income shows an increase from $56 million to $87 million. With 200 basis point shock we see an increase from $122 million to $183 million.

We are seeing a year-over-year growth in DDA of $2 billion or 42% and total asset growth of 30%, or $3.4 billion in growth. That produced the growth in liquidity assets of $2.5 billion -- the growth in liquidity assets. NIM declined by 10 basis points linked quarter due almost entirely to the increasingly liquidity assets.

As adjusted for liquidity growth NIM exceeded guidance at 3.7% an increase of two basis points from Q2. We saw a minor weakening in yield on traditional LHI a six basis points offset by two things. A six basis point improvement in yield and a lower composition of mortgage finance loans to total loans.

Yield trends have actually remained very favorable especially given the magnitude of growth and the competitive environment in which we operate. As noticed, we experienced growth of 3.3% on the average balances of traditional held for investment loans. Very solid growth despite what remains to be a high level of paydown activity, and declining contributions to growth rates from CRE and energy.

We did still see growth in builder finance and other CRE totals, but the pace of growth is declining. As Keith mentioned, energy is down $100 million linked quarter. In Q4 in 2016 we expect a further reduction in the rate of growth and the contribution from CRE and builder finance and energy. In excluding the growth in these components, year-to-date average balance growth in traditional held for investment loans is approximately 14% above the full-year average in 2014.

We recognize that the mortgage finance business clearly benefits from our position in this important business sector. Average balances were $4 billion in Q3. Participation program increased to $480 million average balance, to maintain capacity to expand relationships including MCA while limiting the quarter end spike.

Mortgage finance loans represent 26% of total loans for the quarter. That contributed -- that reduction contributed to the NIM increase but to the NII reduction.

Industry trend of reduction and refinancing activity did reduce the total of MFL's to 30% average for the quarter in refinancing compared to approximately 40% in the second quarter. This business has shown to be a source of sustainable contribution and very high risk adjusted returns. On slides 9 through 12 with respect to net interest income, NIM and NII efficiency. Proponents of net interest income and NIM are shown on slide 9.

Net interest income was down slightly from the second quarter due to the reduction in MFL balances, but up 12.8% from the year ago quarter, and year-to-date it is up 18.5%. Mortgage finance loan yield has improved and as expected to yield on the very small MCA balance was 4.2%. Yields on traditional held for investment loans have remained good, an increase in the traditional held for loans composition improved NIM. Lending costs obviously remain highly favorable, and we believe the duration will continue to increase with relatively low deposit data because of the composition of the deposits.

In terms of the components of net interest income -- excuse me, expense, they are shown on slide 12. MCA expense for the quarter was $2.5 million or $0.035 per share reaching $4.8 million for the year-to-date or $0.07 per share. Growth in total NII was less than 1% from Q2 for the reasons shown.

Efficiency ratio did increase by 80 basis points and remained within the previous guidance. Impact of that was lower MFL balances of eight basis points. A reduction in fees on mortgage finance loans and the activity levels and swaps, 47 basis points, a higher non-interest expense due the buildout of MCA, 27 basis points offset in part by a reduction in 123R cost due to the stock price decrease.

MCA is expected to incur a loss in Q4 for the reasons that Keith mentioned. We had minimal income in Q3. Balance build in Q4 will produce a more meaningful income level but not produce a net contribution due to the late launch and the reduction in fee opportunity due to industry conditions.

The outlook for 2016 remains very favorable. As Keith mentioned, we will provide additional guidance in January as we see the impact of the buildup in balances during Q4.

On slide 13 the quarterly highlights are shown. Return on assets is obviously reduced by the very significant impact of liquidity increase. Adjusted ROA still is favorable close to 1%.

Obviously also ROA has been affected by the higher levels of provision and by the reduction in MFL MCA contribution. ROA is just below 10% for the reasons -- same reasons driving ROA.

Slide 14 is the 2015 outlook. On the strength of Q2 growth our outlook for traditional held for investment growth is improved to upper teens despite the increased level of paydown activity, and reduced contributions from builder, CRE and energy. Expected level of MFL balances year-over-year has also increased and certainly does relate to the seasonal weakness and the reduction in refinancing activity.

We do see potential for further market share gain to be managed with participation programs. We see softer industry conditions that will be partly offset by the growth in MCA in Q4.

Deposit growth will continue at a very strong pace, more than 30% year-over-year based primarily on exceptional DDA growth. Because of the difference in growth rates in loans and deposits, we do expect to see continued growth in the level of liquidity assets.

Net interest income, not a major change, but our outlook has been reduced slightly to mid-teens because of the impact of paydowns and reduction in refinancing activity, seasonal factors in MF and the offset to some degree by MCA balance growth. NIM is still focused on 340 to 350 excluding the outsized effect of growth in liquidity assets as I mentioned a moment ago. We are actually above that today.

The guidance for efficiency ratio is also unchanged. No change in guidance for NIE growth, and we remain cautious about predicting improvement until we have a better view of the ability to increase mortgage corresponded aggregation balances.

Net charge-off range was actually reduced to 20 basis points or less. We do see continued uncertainty about provision as reflected in Q3. Our methodology drives quarterly levels which should be generally consistent with Q3 based on exposures already taken into consideration.

Keith?

Thank you, Peter.

Slide 15 provides an update on asset quality. We were pleased to show a decrease in nonperforming assets from $123 million in Q2, to $110 million in Q3. Our ratio of loan loss reserves to nonaccrual total, LHI, is 1.2 times.

Total credit cost in Q3 was lower at $13.8 million versus total credit cost in Q2 of $14.5 million or a $700,000 decrease. Net charge-offs totaled $2.3 million or eight basis points in Q3, down from 14 basis points in Q2. Again, we have no net charge-offs related to energy, and NPAs related to energy were flat Q2 to Q3.

In closing, the strong traditional LHI growth in Q3 affirms our confidence in the guidance for 2015. The lower mortgage finance growth in Q3 also supports full year 2015 guidance. Of course, credit quality is job one in light of the current environment. It is important for us to manage nonaccrual levels, and we were pleased with the results and Q3.

We remain committed to building liquidity despite the NIM compression as it continues to provide a minor benefit to net interest income, and our deposit growth is important to our long-term success and income growth. While MCA was launched late in the third quarter, it should be a meaningful contributor to 2016 earnings. We remain highly asset sensitive and are well-positioned to benefit whenever short-term rates increase.

This concludes our presentation. We will now open it up for Q&A.

(Operator Instructions )

David Rochester, Deutsche Bank.

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

We're really not inclined to go into the weeds and give the details on criticized and classified. We aren't seeing that escalate. We are seeing, at this point, that we've got a reasonably good grip on what we have allocated and what our expectations are near term.

But I will tell you going into the next six months, all banks that are involved in the energy lending business certainly have some concern about what shapes up over the course of the next couple of quarters. And one of the key reasons is the hedges burning off. We are just now entering into the redetermination cycle, and we should be pretty well finished with that, at least 90% finished by the end of November.

But we would anticipate some borrowers, perhaps more than last redetermination that might fall outside the borrowing base parameter. But we've also been working carefully with some of those borrowers, all of those that we see as under the most stress, Dave, to find a path whereby they can either through select asset sales or new equity investor money, supplement the cash flow that they are dedicating to reduce the debt and get back in compliance. It is going to be an interesting couple of quarters. I think that is yet to be determined. If this low price cycle continues, and we expect it will for some time, should create some additional migration in the portfolio. At this point we feel like we are well reserved and in good shape.

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

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

Okay. So I guess you are feeling a little bit more comfortable going forward just given your stable provision guide for Q4 versus Q3, just given all the trend you are seeing?

We think so. We are seeing a little softening in rental rates, as an example, in the Houston market. For instance, on some multifamily we are beginning to see some incentives offered. Like two months incentives if you will sign a 14 month lease, as an example.

But the properties that are finished that are leasing up are leasing up quite nicely. We have a couple that have not finished yet, multifamily, they may experience a little softening. We have such low advanced rates, Dave, today relative to the last downturn. You know we are typically at 60% or 65% of cost. It was not unusual in the last downturn to see projects 75% to 85% of cost.

We really feel quite good about where we are, and so far our portfolio is holding up quite nicely. But Houston, for instance, downtown office as an example is a little bit -- quite a bit different story. They are having some real challenges on space that they are attempting to sublease and the like. Thankfully we don't have downtown Houston office in our portfolio.

All right. Great. Good color. Thanks. Switching to the MCA business. You mentioned the competitive price was impacting your fee expectations. What are you guys now expecting for gain on sale there at this point? I think you mentioned maybe a range of 100 or 200 basis points previously. It sounds like maybe the range is a bit lower now?

We were expecting 100 to 200 total including mortgage servicing rights. But in fact, the gain on sale component of that is virtually gone temporarily in the market. It's going to be a much more modest fee run rate over time.

We should see that recover some, but right now what's happening is mortgage companies are so hungry to gather up mortgage servicing that they are willing to do the transactions without the same kind of fee that we could have enjoyed before. And breaking in as a new player in the market we are going to have to, obviously, meet competitive pricing on the fee side. We will have fees, but that they will not be as rich as we had hoped.

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

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

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

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

Then the $2.5 million of expenses for Q3 for MCA, did that include the capitalized costs as well for the investments that you've been making there?

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

Are you expecting any additional increase in MCA expense in Q4 at this point, or are you pretty much done with the buildout?

I think we're done with the buildout of anything that is a significant expense category.

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

Great. All right, thanks, guys.

You are welcome.

Kevin Fitzsimmons, Hovde Group.

I wonder if I could switch gears to the margin here? We've talked for a number of quarters about the asset sensitivity, and we are probably at a different place today than we were a quarter or two ago of timing of when rising rates were coming.

I'm just curious it seems like you are committed to the asset sensitivity and rate rises will come eventually, but has there been any talk or have you guys explored peeling back any of the asset sensitivity? If not, do you have a lower view of the margin as a result going forward? Thanks.

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

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

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

We don't expect any surprises. I did not mean to suggest in any way that we are anxious about surprises at this point. That is always a possibility in any loan portfolio but not something we are worried about.

What I was referring to is the continued migration and the degree that we experience continued migration, and that's why we would expect to continue to stay at this level of provisioning, Kevin. Until we see some relief on prices, until we see some significant equity begin to come back into this space and again relieve debt on the more stress companies, and the asset sales begin to happen; then I think we should remain conservative and continue to provide at a level comparable to what we have been providing. That is our best view today.

Got it. Okay. Thanks for the color.

You are welcome.

Brady Gailey, KBW.

This is the first time we've seen the warehouse yield pickup in a while. It wasn't a big move. What drove that kind of reversal in the trend there?

Phenomenal bankers. (laughter) Really great team. We really are seeing that stabilize some, the pricing. That was just not the case for the last couple of years, as we all saw, and we are somewhat encouraged that maybe we found a bit of a bottom, but we will have to see. But there is nothing particular other than that, that we would attribute it to.

Okay.

We think it will be more stable going forward. Hopefully, we've seen the bottom, but we will have to monitor that as we go.

And then we have heard from some of the other energy lenders that are involved in the SNC business like Texas Capital and there's going to be kind of a special winter energy focus SNC exam by regulators. Have you all heard anything about that, and could you update us on your SNC balances? I think they were up around $1.7 billion last quarter. Does it change at all in Q3?

Yes it did. It came down a little bit.

We really haven't heard that it was energy focused but that we did expect kind of a six month instead of in prior year's just once a year SNC review. As they look at SNCs, I would not be surprised if they took at a particular look at the energy piece, but we haven't heard that it was particularly focused on energy.

Okay. Great. Thanks, guys.

You are welcome.

Brad Milsaps, Sandler O'Neill.

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

We really do not expect the combination of MCA and mortgage finance to get out above 30% to 32% for the next couple of quarters. I would be surprised if we saw anything stronger than that. For one thing we are in a seasonally slow quarter, in the first quarter always tends to be slow, too, on the core mortgage finance business. While MCA is going to begin to ramp up, it will effectively be filling part of the soft decline that we always experience seasonally in the fourth and first quarters.

We do really like the dynamic of that being a filling capability with a higher yield than the core mortgage finance business, and it gives us some ability we think going forward that we have not had before to manage total volumes and the volatility. We are so early into it though, Brad, I think that tool will be more useful in a year from now in the fourth quarter than necessarily this quarter. It is something we look forward to benefiting from.

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

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

Great. Thank you, guys. Appreciate it.

You are welcome.

Jennifer Demba, SunTrust Robinson Humphrey.

Can you talk about your comfort level in growing loans in Houston in the future?

Jennifer, we cannot hear you very well.

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

Jennifer, could you start over with your question?

Can you talk about your comfort level in growing Houston commercial real estate loans going forward over the next few quarters given we don't know exactly what the energy impact is going to be on the Houston economy ultimately and you [notice] the softness in multifamily and downtown office.

Yes. I sure will, Jennifer. The growth we had experienced is virtually all just advances on projects that we've had under construction and development for some time. In fact, I do not know of any significant projects that we have undertaken that are new in the last six months in Houston. Are we going to find opportunities here and there? Of course.

We actually like disruption in markets, but you have to be extremely careful and be sure that the opportunity you pick, is in fact, a really high-quality opportunity and we will find those from time to time. There have been a couple of small ones in the last six months but nothing significant that is new that we've done in that footprint.

Okay. Thanks so much.

You are welcome.

Emlen Harmon, Jefferies.

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

We still believe it's going to be one of our top most profitable ROE businesses. Having a two month later start in the third quarter than we anticipated means we had very little at all to really contribute on the revenue side. It just started to happen late in September. That throws us off for the balance of the year in terms of volumes and overall profit run rate.

So the give up on the market competition on the fee side, it is not going to be in any way to cause us to be less optimistic overall about what this can do relative to our other businesses. This still should be a top quartile, top decile kind of contributor particularly when you look at the capital efficiency of the business. It's just going to take us an extra quarter to, particularly with the fee competition, to achieve that kind of run rate. But we should have a very nice contribution this next year from the business, and as we wrap up the back half of next year, I'm extremely optimistic about the returns we will see here.

Got it. Thanks. And then on -- from the perspective of capital TCE ratio fell another 20 basis points this quarter. And it is in the range where you have raised capital in the past. Do you feel like you are at a point where you need some more equity on the balance sheet? How are you thinking about capital needs?

Emlen, it remains the same. We are forward-looking, and we believe things are well balanced. We are waiting to see what the impact of MCA growth will be on the total, obviously. That comes at a much improved capital risk rate.

If you take -- if you look at from a risk perspective, if you look at the mortgage finance portfolio at something like a 40% risk rate which is the effective underlying risk rate of that portfolio without regard to the regulatory issues, We're really running over 12% in TCE. So we first assess it based on the underlying risk that we have in the business, and then we address the other attributes.

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

Got it. Thanks for taking the questions. Appreciate it.

You are welcome.

Michael Rose, Raymond James.

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

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

Okay that's great. And one other follow-up. Can you talk about maybe any lending hires in the quarter and kind of what your outlook in your pipeline looks like as we go into 2016. Thanks.

We hired a couple of RMs in the quarter, and we are always on the look for the starting lineup of the All-Star team, as we've been saying for a few quarters now, since that record pace that we put together four quarters in a row. We feel very good about the prospects as we go into the fourth quarter on picking up some talent. And of course we're going to be opportunistic. As some parts of the economy, particularly I think the overall economy in Houston has some softening and some weakening.

We actually may find some really good opportunities on the talent side, too, and we continue to have an advantage, relative to the biggest banks against whom we compete, in terms of just how difficult it is to operate in those biggest banks in this regulatory environment and still take care of your clients. And of course that is our key calling card for the best talent is that they can come to our Company. We are going to run a tight ship. We are always going to be somebody thought well of by regulatory overseers, but at the same time we are not held to quite that high a standard, and therefore they can be more agile and decisive and collaborative with our team and respond to the client. So we do feel good about the next few quarters coming up as more opportunistic on talent.

Great. Thanks for taking my questions.

Brett Rabatin, Piper Jaffray.

I wanted to I guess go back to liquidity and just thinking about where that could go? 16% or so of average in Q3, is there a level where you would start to do something more aggressively? If that number pushed above a certain level to kind of mitigate the impact it has on the margin? Or can you talk about the upper limits of liquidity?

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

And the stickiness.

And the stickiness.

We are trying to build this base rock solid so when be rates do move we have them embedded as a key client and provide a lot of service for that client.

Okay. And the other thing I was just curious about and I was thinking about expenses and I think it was $1.8 million related to 123. When you think about Q4 with MCA building, I mean, does it make sense that expenses are $4 million to $5 million higher, or can you talk about some of the ins and outs that you're looking at as you go into the end of the year?

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

Okay. That's fair enough. I just didn't know if you want to give any more color on that. Thanks.

You are welcome.

Stephen Moss, Evercore ISI.

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

That is really not something I could speculate on. I would only be speculating, and I don't think that would be helpful to you. It is such a specific client by client scenario, really, Steve, that we will just have to see how that plays out.

But again it's not as though is we are going into this redetermination with really high anxiety about surprises we are going to find. These clients that have had the more stressful leverage and have the most exposure on hedges bleeding off, we've been working with them for quarters, since last year.

I wish I could give you a better answer, but the data points will be up and down depending on the particular client. There's really not a generic energy loan I can describe for you.

Okay. I guess one more related to energy. Do have an idea as to what percentage of your borrowers are likely to be divesting properties over the next couple of quarters as you look at the over all portfolio stress?

You know they will have a variety of options and again, it's going to be the borrower that makes those choices. A lot of that really will depend on when the private equity is ready to hit the offering price and also the alternative on inquisitors, that are operating companies, that want to add to their reserves. Public companies are constantly on the lookout for acquisition of reserves too because their balance sheet is so sensitive to you guys, the analyst community and the investor community, and being sure that they are adding reserves at all times and not depleting their reserves.

It's going to be interesting to see how that develops. It's not simply a function of selling assets. There's also an opportunity for some equity to be sold, and also the cash flows -- in some cases they are dedicating increasing amounts of their cash flows towards debt reductions. SO there are three different fields that we will be using. Again it's very hard to predict on an overall basis.

Okay and then with regard to overall loan growth, looking at things from an EOP basis. You seem to indicate a bit of a slowdown in overall loan production going forward. I'm just wondering what you are thinking about in 2016.

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

Okay. Thank you very much.

You are welcome.

Ebrahim Poonawala, Bank of America.

So I have one question, and I'm looking at the slide 13 (technical difficulty) and assuming that interest rates did not do anything meaningful for the next 12-18 months, what should we think is the sustainable ROE or ROE (inaudible) of the Company?

You know I tell you, Ebrahim, that is hard to know. It's going to be so much a function of the loan growth, where we are with liquidity, the model right now is very stable where it is. The growth will reduce margin. Added liquidity will reduce ROA but not to the detriment of NII. We feel good about where we are on credit, despite the uncertainty related to the potential migration so that we are not anticipating any huge surges in credit costs. But if static today with a little improvement from MCA and pulling expenses back and the development expenses back in line we would be up 1% today, adjusted for the effective liquidity build. (multiple speakers)

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

Understood. And just one other -- I'm sorry if I missed it. Did you say what the expectations are in terms of the ramp-up in MCA in the fourth quarter? Just the MCA component?

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

Understood. And one last question in terms of are you seeing any interest (inaudible) from the big banks? How big a driver is the (inaudible) can that be as we look out over the next 6 to 12 months?

There was part of that was garbled, Ebrahim, from the phone. Can you repeat that please?

Sure. I'm just wondering you've talked a lot about during the [salmon] season about the projects coming from the big banks to small and medium cap banks. I'm wondering what your expectations are, if you are seeing the same trend and what your expectations are going on with the next 12 months with regards to deposit [group] coming from the big banks.

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

Understood. Thanks for taking my questions.

You are welcome.

Matthew Keating, Barclays.

With respect to the MCA business could you tell us how many employees currently you have within that unit?

We're approaching 50, Matt.

That is not a [full] sized number, but it's going to be within 10%.

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

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

I believe, substantially all of the senior level people in terms of the professionals as well as the RMs had actually been hired before the end of Q2. Maybe --

Okay, that's helpful.

Could be a minor change from that, but the talent that drove the creation of the systems and all that has been on for much longer.

Great. Thank you.

Brett Rabatin, Piper Jaffray.

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

Good try, Brett, but, no, we really would rather not do that. And we've explained and maybe I should mention it again. We just believe that such a dynamic portfolio -- it is a case by case, client by client business, and energy especially, as much as people want to have a homogeneous kind of template where we could all look at apples to apples relative to different banks. We think actually it can be misleading to put some of that information out.

We feel very confident that we are on top of it, adequately reserved, we don't expect surprises. Again, if you are in our business you get them once in a while, but we don't expect that to occur over the next couple of quarters. What we do know is that the challenging next couple of quarters because of the hedges bleeding off, and the redeterminations will inevitably show some that have fallen out of the borrowing base compliance. But we think we've been working on a path to get them back in compliance, in some cases for six months or nine months with the borrower.

But we would rather not disclose the details. I know some banks have chosen to, but we really don't think it will be helpful and informative because of how dynamic it is.

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

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

Okay. Great. Appreciate the color.

You are welcome.

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

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

We appreciate your interest in our Company, and we always get great questions that are very helpful to us, too. We encourage you anytime to give Heather a call if there's something you want to follow up on, and we will always do our best to be responsive. Thank you very much.

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