Texas Capital Bancshares Inc (TCBIO) 2006 Q1 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the first quarter 2006 Texas Capital BancShares Inc. earnings conference call.

My name is Erik and I will be your coordinator for today.

At this time, all participants are in a listen-only mode.

We will conduct a question-and-answer session towards the end of the conference.

If at any time during the call you require assistance, please key star, followed by zero, and a coordinator will be happy to assist you.

As a reminder, this conference is being recorded for replay purposes.

I would like to now turn the call over to Ms. Myrna Vance, Director of Investor Relations.

Please proceed, Madam.

Thank you, Erik, and good afternoon to all of you.

We’re glad you could join us today on our first quarter conference call to discuss the results that we just reported.

To check any follow-up questions after the call, please call me at 214-932-6646.

Now, before we begin our formal discussion, I'd like to read the following statement.

Certain matters discussed on this call may contain forward-looking statements which are subject to risks and uncertainties.

A number of factors, many of which are beyond Texas Capital BancShares' control, could cause actual results to differ materially from future results, expressed or implied by such forward-looking statements.

These risks and uncertainties include the risks of adverse impact from general economic conditions, 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 can be found in our annual report on Form 10-K for the year ended December 31st, 2005, and other filings made by Texas Capital BancShares with the Securities and Exchange Commission.

With that done, let's begin our discussion.

With me on the call today are Jody Grant, Chairman and CEO;

George Jones, President of Texas Capital Bank; and Peter Bartholow, our CFO.

After our prepared remarks, our coordinator Erik will facilitate a Q&A session.

At this point, let me turn the call over to Jody.

Thanks, Myrna.

Good afternoon, everybody.

Let me just say on behalf of the crew here at Texas Capital how much we appreciate your being with us this afternoon, and your ongoing interest in our story.

We feel like the story continues to get better with the progression of each quarter.

The big news this quarter is growth in our loan portfolio in particular, but it’s a continued story of growth since the inception of our company about seven-and-a-half years ago.

Much of this has been fuelled by a much stronger-than-expected Texas economy, but of course that goes together with a lot of hard work on the part of our people and a continued focus on executing our business plan.

Looking back on expectations for 2005, it developed that Texas created about 100,000 more jobs than had been expected.

Every sector of the economy is expanding except for one; that’s telecommunications, which continues to receive some modest contraction, and fortunately, we’re not involved in that segment of the economy.

I’m please to say that all the indicators are pointing strongly upward.

Industrial production was at an all-time high in February, and contrary to past periods, that’s now being fuelled by the manufacturing sector, which had been in a protracted weakness since the recession of 2001.

Likewise, the index leading indicators for Texas are at a six-year high, and the unemployment rate in our five major cities -- Dallas, Fort Worth, Austin, San Antonio and Houston -- are all below five percent, except for Houston, which is a little above five percent, and that’s due primarily to an influx of people from Louisiana following Katrina.

The drivers in our major markets are what they have been in the past.

In Dallas, it’s just general services, the health industry, high tech with Texas Instruments and other smaller companies doing very, very well.

Dallas is a centre of commerce for North Texas, and we continue to prosper as a result of that.

The whole state, of course, is being benefited by the activity in the oil and gas sector.

High prices of both oil and gas have helped create a tremendous amount of wealth in Texas, and there is of course the ongoing activity in the Barnett Shale, of which we are a principal beneficiary.

The Houston and Fort Worth economies are benefiting in particular from the activity in the oil industry.

Turning to San Antonio, there are a number of things going on there, not the least of which is the completion of the Toyota plant and the merger of AT&T and Southwestern Bell, or SBC.

Many, many families are being moved to San Antonio by AT&T, and that’s a strong motivator in that economy.

Austin just continues to benefit from continued solid growth, very low unemployment rate -- it's the lowest in the state -- and in our case, it is a huge generator of deposits, and we continue to benefit from our presence in Austin.

Turning to the financial highlights, I’m just going to hit a few of them because Peter Bartholow is going to cover these in more detail.

Our earnings for the quarter were $6.6 million versus $5.3 million the year before.

On an EPS basis, we were up 25% from the previous year.

On an adjusted basis, that is, if you went back and adjusted the last quarter of last year for 123R, earnings on a per-share basis rose 32%.

Again, turning to our loans, which I mentioned at the outset are the real story for the quarter, loans were up in total $206 million.

On a link-quarter basis, our loans held for sale were up $187 million -- that’s 9%.

And loans -- I’m sorry, loans held for investment were up $187 million, which is 9% on a link-quarter basis, and loans held for sale were up 17%, or $19 million.

This pretty well evidences growth across the board and in all of our lines of business.

Houston in particular accounted for about 25% of the growth in the first quarter, and Dallas accounted for a very large percentage.

All of these results continue to validate the business strategy that we adopted seven-and-a-half years ago when we focused on the middle market business segment, as well as affluent individuals, and decided that we wouldn’t attempt to compete for retail banking business.

I’m pleased to report that these results do continue to support the guidance that we gave at the beginning of the year.

Our pipeline is very strong.

Momentum seems to be continuing.

All the lines of business are benefiting, and all the geographies are strong as well.

We do continue to spend heavily to build out our new lines of business and those include heavy investments in our insurance business, TexCap Insurance, in residential mortgage lending, Bank-Direct Capital Finance, which is the premium finance company that we bought last June, and which I might just say has done very, very well.

That’s been a splendid acquisition for us.

In addition, we continue to spend heavily on Lender Finance, which is a business that’s been with us now for about 18 months and has done exceedingly well.

That’s a business that lends money to small finance companies, as well as [captive] finance companies of smaller companies.

And last but not least, you know, we believe that Houston still offers tremendous potential for us.

We continue to see consolidation in that market, the most recent being with the take out of Republic by Trustmark, and we continue to benefit from that consolidation.

Just a word about asset and liability management, which brings us to net interest margin.

Year over year, we were up 48 basis points.

We did have a slight decline quarter to quarter.

I might just elucidate a little bit and say that we are executing a strategy at this point in time which we telegraphed to you in previous calls, and that is that when we felt that rates were beginning to approach a normal range, we would begin to take action to lock in longer [securities] -- that is, make more fixed-rate loans as opposed to, relatively speaking, adjustable rate loans.

And in that context, 77% of the new loans that we made in the quarter were floating rate versus 23% which were fixed rate.

Obviously, we’re attempting to take advantage of again a more normal rate with a more normal environment of interest rates and taking actions to protect ourselves for future declines in interest rates.

Our securities portfolio was down about $31 million over the quarter.

We continue to expect it to run off.

We’re not sure it will be at the rate of $10 million a month, which it was in the first quarter, but nonetheless, we don’t see any opportunities at the present time to purchase securities at margins that we would deem acceptable.

All in all, it was a splendid first quarter and with this, I’ll turn it over to Peter Bartholow to discuss the financials in more depth.

Peter.

Jody, thank you very much.

Jody reported net income at $6.6 million, or $0.25 a share -- 25% above last year.

Driving that was very strong net revenue growth, 35% up from a year ago due to loan growth and the margin expansion that Jody mentioned of 48 basis points.

We saw just a 1% increase on a link-quarter basis, due entirely to the reasons that we’ve enumerated in the past and for which we will provide additional detail.

Expense growth has also been very high, again due in large part of Q4 to Q1 conditions, and to the extent to which the company is committed to its growth strategy.

We have in the first quarter the full first quarter impact of the expansion undertaken in Q4, TexCap, etc., more expense related to TCB’s new growth and people that we’ve brought on since year-end.

Additions in several areas where we continue to build out, and the expense in Q1 related solely to the build-out of those areas, exceeds $500,000 when compared to Q4.

We saw a net recovery on a last 12 months basis, and favorable reserve coverage of non-performing assets again required no provision.

Afterwards, we’ll provide additional details relating to credit quality.

The expense ratio levels in Q1 are directly affected by the conditions specific to Q4 to Q1 trend and the continuation of build-out.

On the next slide, I think it depicts how we did on an ad-adjusted basis, and provide additional details about the factors that were linked to Q1 versus Q4 performance.

All of the items that we are listing here relate to things in the ordinary course of business.

There are no special investments.

The impact of the items, specifically FICA and employment taxes that are heavily weighted to the first quarter; the difference in days -- we are a very asset-sensitive bank and the two-day difference compared to the fourth quarter results in $638,000 less than Q4 net interest income.

FAS 123R Jody mentioned was $426,000.

We had a small restricted stock vesting, which we had reported earlier, at about 128, bringing the total to $1.9 million, or $0.047 a share.

You can see also that these had a pronounced effect on ROE, ROA and efficiency ratios.

When you factor in those elements, we had essentially the same levels, and improved levels from prior quarters, that we experienced in Q4.

All ratios are again affected by those things.

They are also affected, we don’t include that by substantial amount of build-out expense of Q1 versus Q4.

Jody mentioned a slight decline in margin.

It is directly the result of the exceptional loan growth.

Total loan growth of 8% on an average basis from Q4 and 36% from a year ago.

We have substantially improved earning asset composition, a very favorable shift with an increase to 78% loans to earning assets compared to 76% just one quarter ago, and 67% a year ago.

At month-end, we reached 80%.

With rates rising in the quarter, we know that all fixed-rate assets, of which we were able to increase, experienced some spread compression.

It’s the cost of building a base that will enhance our margins in the future.

Loans at 78% of average earning assets -- again, markedly higher.

That means, of course, securities are still declining and will remain declining for the foreseeable future.

We saw the loan deposit ratio, an increase to 97%.

That’s relatively high for us.

It has to do with the seasonal weakness we encounter in deposit growth.

History indicates that growth in deposits, however, has followed the growth in loans.

An example specifically in Q4, 2005, where DDA represented 38% of average loan growth.

We’ve seen many quarters where deposit growth has actually exceeded loan growth, and I would point to the Q3 and Q4 of 2005.

With the relative weakness in demand deposits, which didn’t cost us very much in terms of margin, we saw a shift, of course, to interest rearing funds.

Coupled with the contraction of the securities and of course the reduction in liquidity investments relative to Q4.

Without the extent of growth that we had, we would have seen some margin expansion, despite the compression of spreads on securities and fixed-rate assets.

We think this is a clear and very favorable effect of strong growth, and I would say that a 4 basis point reduction in margin is a small price to pay for linked quarter growth of 9% in loans.

Next slide is [date-stamped] with financial information.

Jody mentioned, we grew loans at $206 million from year-end, perhaps the best quarter ever.

Large contributions to loan growth and several lines of business and regions, which George will discuss. [Core imbalance] of 9% above a very high level at year-end 2005.

Recent growth is also very pronounced.

March 31 loans total 5% above Q1 2006 averages -- again, a predictor of very strong growth.

Late quarter growth in loans held for sale is also very strong.

We’re seeing seasonal pick-up and activity in that business.

We saw and we’ll see on the average balance sheet in the next slide, that there’s not much growth there that occurred during the quarter.

The growth occurred at the end of the quarter.

Customer deposits were stronger than the total suggests.

We saw a $50 million reduction maturity of broker deposits which were not replaced.

The decrease in the deposit growth rate is also exaggerated by the exceptional growth that we had throughout the first half of 2005.

And so what we saw in DDA, for example, a 19% increase year over year, despite the reduction that occurred in the first quarter.

Seasonal contraction in demand deposits I mentioned had a very minor affect on margin, as again, history indicates that we will see substantial growth in deposits following periods of heavy or significant growth in loans. [inaudible] remain very favorable on all accounts.

The next slides shows average balances.

Again, loans held for investment growth was exceptional, especially for Q1, with an increase of 36%.

DDA increase 22% over last year.

The slight decrease in DDA is a reflection in large part of the growth that we had in the fourth quarter and, of course, the seasonal activity that we experience as a bank focused on the commercial market.

Total deposit growth of 36%, and total deposit growth in Q1 of 3% after the maturity of $50 million in broker deposits.

Next slide shows that there are many variables that have an impact on net interest margin.

The small contraction in margin primarily, as I said, related to what we would regard as counter-seasonal growth in loans.

Historically, we’ve seen relatively weak Q4 to Q1 growth in loans this period, at 206 total and 164 on an average basis is remarkable.

We saw loan yields increase by 31 basis points.

We know the spread compression related to those loans that are fixed rate, and the expansion of leasing assets, which had grown, had an affect on net interest margin.

We’ve seen leasing assets grow on the financing lease side, as well as the operating lease side.

Operating lease income netted depreciation on those assets is not included in the net interest margin, but the funding cost related to support of those leasing activities is included in margins.

We have some compression from that increased activity as well.

The spread on securities is also compressed.

We saw some reduction in average balances of [inaudible].

Those had been very favorably -- they had very favorable costs.

They still do, but at a lesser balance.

And so we’ve had to replace those with funds that at the margin are essentially at the fed funds level.

Again, brokerage CT reduction of $50 million also had an affect on the shift in funding composition.

The next slide you’ve seen many times, focused on our interest sensitivity.

Jody mentioned we have an increase in fixed rate loans, leases, operating leases which have extended very slightly, earning asset duration.

The growth in these loans in largely offset by the decrease that we’ve had in securities.

We’ve had a significant yield pick-up in converting those securities into lending activities, lending and leasing activities, and we have things like premium finance loans which, while are fixed rate, are very short duration, repricing about 50% of that portfolio every three months.

So we remain in a very good interest sensitive position.

Jody mentioned we selectively begin increasing fixed rate lending activity.

With that, I’ll ask George to comment on the growth regions and the activities in the banks.

Thanks, Peter.

If you’ll turn to slide 13, as you’ve seen this before, it shows growth relating to demand deposits, total deposits, and loans held for investment.

As we’ve said before, historically, the first quarter has typically been a slower growth quarter in both loans and deposits, and our deposits reflected some of that trend.

However, again, as we’ve said, loan growth reversed that trend and showed at very, very good growth.

As mentioned before, average total deposits improved 3% on link quarter basis, and was up 30% over Q1, 2005.

I believe Peter mentioned that we let $50 million of broker deposits roll off in the first quarter, so customer deposits actually grew more than the 3%, closer to 5%.

Demand deposits were seasonally down about 3% on a link quarter basis, but they showed 22% growth over Q1 2005.

CDs and Euros represented most of that growth.

If you look at our lines of business, business banking, the Austin region, and private banking were really responsible for the majority of that deposit growth in the first quarter.

Again, we’ll reiterate.

We expect demand and overall deposit growth to show traditional seasonal strength for the rest of the year and see deposit growth maintaining pace with our loan growth.

Average loans held for investment, as has been said before, grew about $165 million, or 8% on a link quarter basis.

Period end loans were up $187 million from 12/31/05, or 9.2%.

Actually, total loans were up $206 million.

And this came after an unusually large pay down of energy loans in the first quarter.

The strongest loan growth came from the Dallas Corporate Banking Group of about $55 million; the Houston region, $54 million; the Dallas Private Client Group of about $25 million; and our Fort Worth region, of $21 million.

But, as has been said before, almost all of our lines of business showed very good growth.

If you’ll turn to slide 14, we won’t spend much time on this as Peter’s talked about it, but our growth shows all areas of income and also our growth in non-interest expense.

We show a nice increase in all forms of income, and our expense side continues to grow, as been said before, so it’ll all just [re-continue] to build out our company, and it’s primarily represented with salary and benefit expense.

Again, some of those expenses related to build out businesses or leasing, Lender Finance, TexCap Insurance, Bank Direct, Capital Finance, and Houston, just to name a few.

If you’ll go to the next slide, 15, again, this is repetitive quarter after quarter, but it doesn’t get much better than this.

Credit quality remains strong.

Growth in loans -- our loan portfolio has been very good and our credit quality remains very good also.

Net recoveries of $12,000 in Q1 2006.

Frankly, we’ve had net recovery for the trailing 12 months and charge-offs for the last two years are now only $40,000.

Since the inception of our company, as we’ve said before, we’ve had less than 10 basis points of losses.

Reserve remains adequate and high as a multiple of all measures, net charge-offs, non-performing loans, etc., and our non-accrual loans remain very low at 27 basis points.

If you go to the next slide, 16, it actually just shows what I’ve been talking about, but one thing I’ll point out.

You’ll notice that non-performing loans to loans is 39 basis points.

That includes 12 basis points for loans past due over 90 days.

Virtually all of that number, or $2.5 million, relates to our premium finance line of business.

These loans are secured by return premiums from large insurance companies, and it’s very common to have a number of these loans that represent cancelled policies past due over 90 days.

We expect very few if any losses in that number, and about $1.1 million of that number is in the process of being collected and should be paid off quite soon.

Excellent credit quality for the quarter, and we’re very pleased.

Jody.

Thanks, George.

Just to close on a note regarding guidance.

I think the most important thing about this quarter, in addition to the strong results, is that we ended the quarter with a tremendous amount of momentum, which we believe will carry forward into the year, and give us an increased confidence in confirming the guidance for 2006.

We’re not sure that there’s a lot of consistency among the analysts in terms of treating 123R, in terms of their projections, so we’re going to give you guidance both without 123R and with 123R.

The original guidance we gave, $32 million to $35 million, excluded the impact from 123R.

If you adjust the range based on what we know today, that guidance would be about $30.5 million to $33 million.

We are about to roll out a new equity package to our key employees at Texas Capital Bank, and this will have some impact on expense in the remaining nine months of this year.

Of the assumptions with regard to the guidance we’re giving, obviously are significant improvements in ROA and ROE, as we experienced last year through the progression of the year.

Superior growth in loans and deposits, margin expansion, but again, a cautionary note: that margin expansion will be more modest going forward because we are attempting to make modestly more fixed rate loans, and that trend will continue as rates continue to increase, if in fact we see the fed funds going to 5, and even possibly to 5.25.

Our yield curve obviously is flat, remains flat.

We don’t have any opportunities to buy securities, and unless that changes and changes materially, I think we’ll continue to see the securities portfolio roll off, and that is a negative in so far as margin expansion in the cost of carrying those securities is higher.

On the other hand, as we’re able to replace those securities with loans, that changes the mix of the assets and helps offset any negative impact from the shrinking margin on the securities portfolio.

Again, we expect increased profits from all lines of business.

We think the new lines of business are positioned to do very, very well as we continue the year, and we believe that the strong pace that we see now, again fuelled largely by the Texas economy plus the continued execution of our very focused business strategy, should put us in good shape for the year.

With that, we will conclude our formal remarks and be glad to entertain questions.

(Operator Instructions) The first question comes from the line of Andrew Collins with Piper Jaffray.

Please proceed, sir.

Good afternoon.

My question really is on the funding side.

We saw kind of a 6% decline in non-interest deposits link quarter.

I know you guys have said that it wasn’t much of an impact on your margin.

I just want to make sure that that impact won’t be felt further here in the second quarter, and perhaps in the third quarter a little bit, on margin.

Or do you think that that’s going to be completely offset by other sources of funds, if you will?

Well, Andy, you know, we did indicate that the first quarter is a seasonal low in terms of deposits, so we would anticipate deposits improving.

Peter also mentioned, and I think maybe George reiterated the fact that we had a $50 million run-off in brokered CDs during the quarter.

If you adjust for all that, it changes the deposit picture a little bit.

But you know, we’ll be disappointed if we don’t see a return to more normal trends as the year progresses.

All right, so it wasn’t just like a single client or something like that.

It was mostly just seasonal?

There was no single client involved at all.

You know, we scrub and look at these things very, very carefully to try to determine any trends or aberrations, and you know, we really don’t see any other than just general seasonal factors.

Okay.

Just another question.

I was wondering if you could kind of indicate how much of your time is being spent on building out some of the non-bank businesses versus the bank businesses at this point, Jody?

Well, in terms of my time, you know, other than the fund, which we’ve talked about before, I am devoting some time to that, but that’s what I’m paid to do, and that is to create new opportunities for Texas Capital Bank’s various shareholders.

We have very, very competent managers who are running all these lines of business for them.

They report in to George, Keith Cargill, primarily.

You know, that’s part of their day-to-day business, and I don’t think they’re being distracted from that in any way at all.

So you know, I think we’re on -- not automatic pilot, but we certainly have adequate control of the business.

We have a lot of confidence in our business managers and I think we continue to be very, very focused on what we’re doing, which has accounted for, in my way of thinking, a large degree of the success that we’ve enjoyed today.

Great, thank you.

Thank you.

Our next question comes from the line of Brent Christ with Fox-Pitt.

Please proceed, sir.

Hey, guys, a couple of quick questions.

First, you mentioned layering on a little bit more in terms of fixed rate loans as opposed to the variable rate loans.

Is there anything else that you’re doing to potentially combat the feds stop raising rates?

No, I would just say the other action that we can take, and maybe have some control over, is the maturity of our CD portfolio, and that is keeping it rather short so that the cost of funds declines as rates decline.

And we really haven’t begun to pull that lever yet, because we don’t feel that we’re at the peak in interest rates.

But on the assets side, taking a more laddered approach to layering in some fixed rate loans seem prudent.

You know, you just can’t turn on a dime.

These things have to be done and done gradually, so we think we’re doing the prudent thing we should be doing in terms of asset liability management at this point in time.

In terms of the deposit flows, have you noticed any pick-up, either near the end of the quarter or since the end of the quarter that would lead you to believe that the seasonality issues are kind of behind you and you’re going to see deposits pretty much mirror loans over the near term?

Yes, I think in my comments I said that, again, the first quarter, as we’ve mentioned, has seasonally been slow, down somewhat from the 4th quarter, but that we expect deposits to track loan growth on a go-forward basis.

We have seen that in the month of April, and in fact our total deposits are up nicely, [about 8 points on the 18th], significantly so.

Under that scenario, would you expect that the margin trajectory to turn back and head higher from first quarter levels?

I believe that, you know, our margin experience is going to continue to be better than that of either the universe of our peer banks or the general universe of banks, and that relates to the continued asset sensitivity that we enjoy.

We told you in the past that about 90%+ of our loans have been variable rate loans.

That’s now down to about 89%, and we’ll continue to bring that down gradually over time, but I think we’re on the right side of the momentum as it relates to the potential increase in interest rates going forward.

Once the fed does decide to pause, we believe that they’ll pause for some considerable period of time until other trends are evident, such as increasing inflation or, on the other hand, a slow-down in the economy.

So you know, we’re going to be watching what the fed does very carefully, and we’re going to be taking our keys from what we perceive to be general trends in the economy plus actions on the part of the federal reserve.

And I might mention also, Brent, that in the last half of 2005, deposits outgrew loans by $140 million.

And actually, that has occurred I think three of the last -- or four of the last six quarters I believe we’ve had deposit growth in excess of loan growth.

There has been variability.

We have an exceptionally strong loan growth quarter, and then it follows by deposit growth quarter.

And the margin contraction, again, if we had not had $168 million on an average basis growth in the portfolio, and we had not taken some steps that Jody mentioned and increased our involvement in such things as leasing, we would not have had contraction in margin.

Do you anticipate that that impact from leasing is going to be more evident going forward?

It’s still relatively small, but we’re describing the large number of variables that have an affect on that interest margin -- composition of funding is one, composition of earning assets, the spread issues that we’ve talked about, and -- you know, there’s just no way to say one thing is going to happen.

That’s one of the reasons, given our business model, that we are very reluctant to provide quarterly guidance on margins and things like that.

If I might just elaborate one more issue as it relates to the margin contraction, because of the $206 million increase in loans and the trends in deposits, we financed that growth largely with borrowed money, and the cost of that borrowed money was approximately 20 basis points higher than the cost of our quarter deposits.

So that played a big factor in this, and you know, we don’t expect that trend to continue.

We do expect deposits to pick up.

We hope certainly our loans will continue to grow as they have in the past and have indicated that, you know, based upon the pipeline and early returns in April, it looks like momentum is continuing.

Okay, thanks a lot, guys.

The next question comes from the line of Kerstin Ramstorm.

Please proceed, Madam.

Hi, everyone.

A couple quick questions, perhaps.

Could you provide any other caller on where all the loan growth came from this quarter?

In terms of regional or mix of loans?

Mix of loans.

Mix of loans?

It’s primarily related to CNI, Kerstin.

I can’t give you the exact percentage, but for the last couple of quarters, we’ve seen CNI growth really outpace the other types of lending.

We’re always going to have decent real estate, decent energy growth, but CNI, from the last at least six months, has certainly outpaced any other category of loan.

This happens from the last quarter in the corporate banking and the private banking area.

Okay.

I think, Kerstin, it’s also an indication or a reflection of the Texas economy.

You know, we’re finally beginning to see the manufacturing sector take hold and some real solid growth in terms of durable good manufacturing, for example.

And that’s impacting the whole economy, hence the CNI demand for loans in particular.

Got it.

And then in terms of RML, what are some of the trends you’re seeing in that business?

Obviously gain on sale of loans is down.

What’s driving that?

Is that spreads?

Is that volume?

It’s a combination of a couple of things.

It’s the activity levels in the first quarter on average are low.

It’s rate related.

The yield I mentioned earlier, the yield there is a little lower because it’s not getting the throughput and the fees that are a part of the margin computation.

It’s also a function of the mix of asset that come from what we call the net branches versus retail.

And net branches now are significantly larger than the retail.

And on that, we get lower spreads, lower gain on sale because we’re sharing the gain on sale essentially with the producer. [multiple speakers]…the commission dollars dropped in the quarter as well, again reflecting the reduction in mortgage activity generally.

Okay.

I might just add, Kerstin, that based upon again what we’re seeing in early April, it looks like the volume in activity in residential is picking up, so you know, we’re looking for a better result in the second quarter.

Okay.

Typically, we see also from the December timeframe to March is typically a seasonal weak mortgage business.

Right, but when you look at year over year, it’s still down versus year over year, so I figured there had to be something else driving that.

Okay.

Thank you.

Thank you.

Our next question comes from the line of Andrea Jao with Lehman Brothers.

Please proceed, Madam.

Good afternoon, gentlemen.

On the balance sheet, how much elbow room do you have on your securities, you know, on a quarterly basis?

Is the decrease or the run-off in first quarter a good guide to use?

It should be.

We know, you know, it can vary a little bit based on pre-payments in the market place, over which we have no control.

It’s a little less this quarter than last quarter, but not significantly so.

So for a rough guess would be $10 million a month.

Okay.

Do deposits stabilize in the second quarter, or have you already seen a pick-up in what category?

Yeah, what we have seen, as I mentioned a minute ago, in April, a nice pick-up in deposits, primarily in the interest bearing category, but we’ve also seen a firming of some of the other categories also.

It’s up nicely through the 18th of April.

Okay.

Last question: as you look in the coming quarters, and I understand it’s important to invest in the franchise, but how do you think about operating leverage?

Efficiency ratio for us I think is one of the key measures, obviously.

We have spent a lot of money in the last three quarters on expanding the business, and we’ve done so, Andrea, in businesses that by their nature are going to have not good efficiency ratios.

High volume, high margin, meaning not only high ROA, potentially high ROE, but not good in terms of efficiency ratio.

They are heavily non-interest income focused and non-interest expense focused as opposed to net interest margin, where you’re getting leverage out of the earning asset base.

And essentially, you’re going to see, relative to where we are today, let’s say 66% is adjusted, if you don’t add business that produces a 50% profit margin, you’re going to see erosion in that number, and the profit margin associated with gain on sale, those kinds of activities -- excuse me, operating [activities] are obviously nowhere near 50%.

So the trends are okay.

They reflect the extent of the build-out.

And obviously we need to see that the build-out produces the returns, growth and profitability that we predict.

Great details.

Thank you very much.

The next question comes from the line of Jennifer Demba with SouthTrust Robinson & Humphrey.

Please proceed, Madam.

Were you acquired by SouthTrust?

Hi again.

A couple of questions.

Number one, you had a pretty healthy increase from the fourth quarter in occupancy expense.

Can you give us some color on that?

Yes, Jennifer.

It’s two elements, the smaller of which is the expansion of the offices in Fort Worth.

The other one is that it’s the lump-all of where least depreciation occur is booked.

So it’s not our lease expense or our fixtures -- it’s the depreciation on operating leases where we’re the leaser.

And that increase was link quarter in excess of $200,000.

And expanding the Fort Worth offices, what did you do there?

Actually, we moved from one office to another office, and we expanded our space from about 5,000 square feet to 13,000, in anticipation of greater growth there and taking advantage of the opportunity that the Fort Worth economy offers.

As you know, Fort Worth sits right on top of the Barnett Shale, and the level of activity over there is really frenetic in terms of housing, in terms of wealth creation, and it’s having a domino effect on the whole economy.

So you know, we’re actively looking to expand our workforce, particularly RM’s in Fort Worth.

We’ve been working hard to do that and we think we’re have success in doing it.

Quite frankly, we have built out space in Fort Worth in anticipation of and leading the booking of business, but we feel very confident about the action we’ve taken there, even though it’s going to cost us some money in the short run.

So that occupancy first quarter run rate you feel like it’s pretty good going forward?

Well, the bank premises occupancy, yes.

The component related to operating lease activity will be a function of that activity.

Okay.

In that level, we reached just under $15 million in that during the first quarter.

Okay.

Secondly, in your earnings guidance for this year, does that include loan loss provisioning throughout the rest of the year?

It includes… it’s back to what we said before.

Loan loss provisioning actually in excess of the average of the earnings models that we’ve seen.

Okay.

The earnings models I think had about $4 million of loan loss reserves in them.

We’ve burned one quarter off of that, to give you further guidance.

Okay.

And the final question is can you give us some detail on the private client group you hired in Houston?

We hired three people in Houston out of another well-known bank there.

They’re very high production people.

We’ve been working on this for a year-and-a-half.

It took a merger and divesting of all these peoples’ securities in order to enable us to move them and move them in a manner that was cost-effective, but we’re very high on their capabilities and think they’re going to bring a lot to our Houston franchise, which is doing very, very well, I might add.

Okay, thanks.

Thank you.

The next question comes from the line of John Martinez with Cohen Brothers and Company.

Please proceed, sir.

Hi, Jody, hi, Peter, thanks for taking my questions.

Thanks again for the breakout as far as expenses related to 123R, and kind of looking at your guidance that’s been updated, as well as the piece that you broke out earlier in your slides, would it be fair to look at that first quarter activity and that level as a reasonable run rate, given the adjusted guidance?

No, the adjusted guidance, the 426 is a pre-tax number, and as Jody mentioned, there’s a rollout of a new program that will affect part of the second quarter, and then of course all of the remainder of the year.

And we would expect in the ordinary course of our hiring that we would see some increase in the last half of the year, just from new people.

Gotcha.

And could you maybe share with us a little bit of what’s changing about this program versus what you might have had in place before?

Yes, and it’s all driven by 123R.

Heretofore we had as part of our equity program, basically it was a stock-option program.

There was a limited use of restricted stock.

In the new program, we’re moving to stock appreciation provides SARs, and the reason we’re doing that is because the dilution impact is about two-thirds less than normal stock options.

We’re also mixing in some restricted stock units.

And we’re not going to know exactly what the cost is going to be until this program’s rolled out and the recipients have an opportunity to make an election.

And that election consists of choosing between SARs and restricted stock.

And you know, we’ll be able to give you greater guidance on that at the end of the second quarter.

That probably is a confusing answer, because this is a complicated program, one we’ve been working on now for about a year-and-a-half.

And we think we’re, in terms of it’s efficiency and effectiveness, way ahead of the power curve here.

Gotcha.

Thank you.

Another question then, looking into your Houston market with the new ads that you had here during the first quarter, do you expect it to continue to try to add during the second quarter to either your lending team, or bringing in an additional teams, or are you kind of happy with where you’re at and looking to maybe just lever that as people capital better?

We’re never happy with where we are, and we do continue to be in the market, not only in Houston, aggressively looking for really high-class, first-rate RM’s, but in the other markets as well.

You know, I’ve think we’ve had extraordinary success over the last year.

We added six RM’s in the first quarter.

And you know, we’re optimistic that we will continue to be very, very successful, but we will continue to be very aggressive on that front, looking for the best possible people we can find.

Gotcha.

And then just a last question, from the non-interest income side, the insurance commission, that line item, is there anything [trusting] about that level of volume and why it was broken up this quarter, or should we expect to be able to see that going forward?

Yeah, you should be able to see that going forward.

I guess to expand that answer, we did make a significant investment in TexCap Insurance in the fourth quarter of last year.

This first quarter is the full first time we felt the full impact of the expense, or the income, from that activity.

And we expanded it also during this quarter.

Yeah, and we have expanded it during this quarter as well.

About how many people did you add there, during the quarter?

Was it 18?

About 18 during the fourth quarter of last year, another 4 this quarter.

Okay, guys, thanks for the answers.

Thanks very much, John.

We have no more questions at this time.

I will now turn the call back over to management.

In conclusion, you know, we feel like we’ve concluded a very, very good quarter.

Normally one that has a lot of seasonal lows in it, particularly on the loan side.

We did experience that on the deposit side.

We do view that as being a seasonal aberration.

We’re very optimistic as we look to the rest of the year, particularly on the asset side of the balance sheet, exclusive of course to securities.

We’ve got a lot of people working very hard to make things happen for our shareholders and we appreciate those of you who have expressed such great interest in our stock and the analysts who write about us.

That concludes this particular quarter, but I encourage you to call any of us any time, and particularly direct those calls to Myrna Vance, who will be happy to answer any questions that you may have.

So on behalf of everybody, thanks again and I also thank the great people of Texas Capital BancShares for their contribution during the quarter.

Thank you for your participation in today’s conference.

This concludes the presentation.

You may now disconnect.

Good day.