Texas Capital Bancshares Inc (TCBIO) 2018 Q1 法說會逐字稿

Good afternoon, and welcome to the Texas Capital Bancshares First Quarter 2018 Earnings Conference Call.

(Operator Instructions) Please note this event is being recorded.

(Operator Instructions)

I would now like to turn the call over to Heather Worley, Director of Investor Relations.

Please go ahead.

Thank you for joining us for the TCBI First Quarter 2018 Earnings Conference Call.

I'm Heather Worley, Director of Investor Relations.

Before we begin our call, please remember 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 its 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, Andrea, will facilitate a question-and-answer session.

And now I will turn the call over to Keith, who will begin on Slide 3 of the webcast.

Keith?

Thank you, Heather.

After my opening comments, Julie will provide her review and our updated guidance, and then I will close and open the call for Q&A.

Slide 3 provides the Q1 financial highlights.

Traditional LHI growth from Q4 2017 to Q1 2018 was 2% for period end.

Average linked-quarter growth was 3%.

Period end first quarter 2017 versus first quarter 2018 showed 18% LHI growth.

Average year-over-year growth was 19%.

Mortgage finance loans, including MCA, decreased 9% linked-quarter and increased 36% from Q1 2017 to Q1 2018.

Moving to overall deposits.

Seasonal weakness in DDAs showed a 5% decrease, linked-quarter, and a 4% increase year-over-year.

Total deposits showed a 2% decrease, linked-quarter, and year-over-year growth of 13%.

Net income increased 61%, linked-quarter, and 69% year-over-year.

Earnings per share were up 64% linked quarter and increased 73% year-over-year.

Net revenue was consistent linked-quarter, even with the seasonal softness in Q1 and grew 28% from Q1 2017 to Q1 2018.

Finally, ROE continued the upward 3-year trend, reaching 13.39% for Q1 2018.

We were very pleased with our financial performance across-the-board this quarter.

Julie will add more color in her comments.

Credit metrics remained good with net charge-offs of $5.2 million in Q1 2018, most of which were energy related.

Q1 2018 total credit costs of $14 million compared to $8.1 million in Q4 2017.

Please turn to Slide 4. Energy loans as of Q1 2018 represent 7% of total loans or $1.4 billion versus $1.3 million at the end of 2017.

Our energy reserve remained strong at 3% of total energy loans and 58% of criticized energy loans.

The $5.1 million of energy charge-offs in Q1 2018 were previously reserved.

Energy non-accruals were $50.4 million at Q1 2018 as compared to $92.3 million at Q1 2017.

Energy nonaccrual is now equal a modest 3.6% of total energy loans.

Retail CRE and commercial exposure remains modest at $846 million.

Criticized retail loans totaled $281,000 at March 31, 2018.

On Slide 5, we describe the significant geographic diversification of our loans and deposits.

Also, you will note in the upper hand right quadrant that 3 of our 4 Texas metro markets show unemployment under 4%, fueling continued strong population in migration and robust overall economies.

Julie?

Thanks, Keith.

My comments will cover Slides 6 through 12.

Our reported NIM increased by 24 basis points from the fourth quarter.

The decrease is $653 million and average liquidity assets since the fourth quarter accounted for 10 of the 24 basis point improvement.

Traditional LHI yields were up 25 basis points from the fourth quarter, reflecting the impact of moves in LIBOR.

First quarter NIM includes full impact from the December-February move and some from the March move.

However, the LIBOR movement, specifically 1 month LIBOR, is really more meaningful for us and has moved in advance of Fed funds and moves have been at greater spend than Fed funds, which resulted in very positive impact on NIM.

Continued loan growth will mute rate impact somewhat as new loans are not being put on at the same effective rate as the overall portfolio yield.

We experienced improvement in yield on the mortgage finance loans with LIBOR moving up.

With the first quarter seasonality impact for mortgage finance, the change in mix was positive on NIM.

The seasonality and mortgage finance was in line with our expectations, and we expect volumes to pick up again in seasonally strong second and third quarters.

Linked quarter decline in deposits from the fourth quarter was primarily driven by seasonality.

Our overall deposit cost increased by 13 basis points from 53 basis points in the fourth quarter to 66 basis points in the first quarter.

The increase was expected as Q4 numbers only include a few days of the December Fed funds move on the index deposits.

Similarly, Q1 only includes a few days of the March move.

Additionally, we are seeing a pickup in the magnitude of rate change request; continued solid deposit top line.

But as we've said several times in the past, it can involve a long sales cycle, so difficult to forecast exact timing and can be lumpy in how it comes on and most is going to be interest bearing.

The change in loans with floors with the rate move in March were now around $170 million, down almost $400 million from the end of December, but that's fairly irrelevant at this point because no significant difference in the rates on floored versus unfloored loans.

As a reminder, approximately 70% of our floating rate loans are tied to LIBOR, and about 80% of those are tied to 30-day LIBOR.

As Keith commented, we had good continued traditional LHI growth in the quarter, consistent with our full year guidance.

Traditional LHI average balances grew 3% from the fourth quarter and up 19% from this time last year.

The strong growth later in the quarter with ending balance above average by over $316 million provides a good start to the second quarter.

The level of payoff continue to be high and no sign that, that will slow.

Continued strong average total mortgage finance balances impacted by the first quarter seasonality but they're still significantly proved from this -- improved from this time last year, increasing almost 40% from Q1 2017.

The first quarter seasonal weakness we experienced this year was exactly as expected, and Q2 volumes are expected to return to higher levels.

We experienced a seasonal decline in linked quarter total deposits, primarily in DDA.

Total deposit balances are expected to rebound in Q2, but we could see some of that come back in interest-bearing.

As we've been saying since January, we do expect most of the 2018 deposit growth to come from interest-bearing categories but still at a reasonable overall effective cost.

Primarily interest-bearing deposits in the top line, but we're also working hard on maintaining and growing existing relationships as competition heats up.

We've been pleased to see more discussion in the industry about asset betas and how those should be considered when evaluating deposit betas.

Certainly, that's an important part of the story for us and while we feel good about our balance sheet positioning going forward.

We continue to stick with our normal posted rates but are experiencing migration to enter some migration from interest-bearing -- to interest-bearing from DDA.

We're continuing to react to specific customer situations and evaluating those on a total relationship basis.

We still have the 2 major deposit categories moving in tandem with Fed rates that total approximately $5 billion in balances.

We move on to noninterest expense.

It's important when looking at the decrease in linked-quarter NIE to remember the noise that we experienced in fourth quarter NIE.

First quarter, there was a decrease of $2.2 million in non-LTI and annual incentive pool expense and that's driven by the $1 million in special incentives we did in the fourth quarter as well as our annual incentive accrual ramps through the year and generally starts out at a lower rate in Q1.

There was some fluctuation in FAS 123R expense in the first quarter compared to fourth, primarily related to a slightly lower stock price.

Our total FAS 123R expense in 2017 of $22 million versus planned 123R expense of $24 million in 2018.

The first quarter expense of $5.6 million compared to fourth quarter of $7 million, with stock price impact of slightly less than $1 million, coupled with several other items.

Legal and other professional was abnormally high in the fourth quarter with some nonrecurring expenses and returning to a more normalized level in Q1.

A new variable component added during Q1 that is directly related to deposit services, so ongoing run rate will be slightly higher than the Q1 level.

All of our new and expanding lines of business continue to be profitable in 2018.

And again, we don't -- we have no new outsized build-out plans for this year.

Just a few reminders about the more variable parts of our noninterest expense.

As we've previously noted, servicing-related expenses are directly related to servicing revenue, which provides net profit contribution.

A portion of the marketing category is more variable in nature and is tied to growth in deposit balances as well as increases in rate.

And as noted above, we've now added a variable component to other professional related to deposits.

Other categories including occupancy, technology and FDIC are all directly related to growth but not as variable as some of those noted earlier.

Our efficiency ratio for the first quarter was 54%, slightly improved from the fourth quarter of 55% and compares very favorably to last year's Q1 of 59%.

First quarter efficiency ratio include some items worthy of mention.

Seasonality for mortgage finance always adversely impacts efficiency ratio in the first quarter.

Fewer days in the first quarter is always a drag on net interest income and efficiency.

And finally, the outsized payroll-related expenses in the first quarter each year are always a drag on efficiency ratio.

This year, that was a $5 million fluctuation from fourth quarter levels.

As we look to asset quality, it continues to be good.

Nonaccrual level still at an acceptable level of 0.6% of total loans, with more than 40% still comprised of energy loans where we are continuing to see progress in their resolutions.

The first quarter increase in non-accruals as compared to fourth quarter includes 2 large C&I credits.

Different industries saw no particular trend evolving in the portfolio, and one of the problem credits we were only made aware of very late in the quarter.

Just a reminder that we have large deals, and when we see migration, it can cause lumpiness in provision levels from quarter-to-quarter.

Provision for the first quarter of $12 million compared to $2 million in fourth quarter and $9 million in the first quarter last year.

Additionally, $2 million of OREO valuation allowance was taken in the first quarter, bringing total credit cost for the quarter to $14 million.

The OREO charge is on the same property as the write-down in Q4.

The valuation allowance was taken as marketing of the property continues and we're not sure it will actually be realized, which is why it wasn't booked as a direct write-down.

Charge-offs for the quarter totaled $5.2 million and included $5.1 million related to energy.

Quarterly net charge-offs represented 14 basis points of traditional LHI, of which 100% -- almost 100% related to energy.

Some reallocation of energy reserves and all of the hurricane reserve was noted in Q1.

It was the reallocation to other areas of the portfolio as we're late in the cycle and qualitative factors support the movement.

Our growth in linked-quarter net revenue despite the seasonality of mortgage finance balances was good.

The good traditional LHI growth in Q1 and the entire portfolio continued to benefit from improved margins as a result of rate moves.

ROE and ROA levels continued to improve in the first quarter compared to first quarter of last year, with the impact from lower tax rate as well as improvement in margins and continued normal prevention level.

ROE level without the new tax rate in the first quarter would have continued to be over 11%.

Benefit from interest rate moves is evident in the first quarter net interest income and positively impacts ROE and ROA.

Additionally, the lower liquidity levels in the first quarter was also beneficial for ROA.

Even though first quarter provision level is higher than Q4, it's still at a very normalized level.

Finally, as we look to our guidance for 2018.

There's no change in our outlook for traditional LHI growth of low to mid-teens.

There's a slight positive change in our guidance for mortgage finance loans to be low to mid-single digits growth for the year, and that's despite expected industry contractions and originations.

No change in MCA guidance at $1 billion outstanding for the year.

Again, no change in our outlook for total deposits as we think growth will keep pace with traditional LHI growth of low to mid-teens.

We still expect to see more growth in the interest-bearing categories and to continue to see some shift from noninterest-bearing to interest-bearing.

Seasonal declines in deposits will rebound in Q2, but deposit growth can be lumpy, which can mean that liquidity levels could vary some from quarter-to-quarter.

We're improving our outlook for core NIM to 3.45% to 3.55% to include the impact from the March rate move.

Guidance is still assuming no additional rate increases in the rest of 2018.

We're also taking into consideration that more of our deposit growth will be coming in interest bearing.

We're also improving our outlook for net revenue to mid-teens percent growth to reflect the impact from the rate move in Q1.

No change at this point in provision guidance at mid-$50s to mid-$60 million level.

As we've said, we will try to tap in the range as we go through the year but it's really still too early for that.

There's too much uncertainty at this point regarding economic growth outlook, and the impact on levels can vary when we see migration of deals in any given quarter as we experienced in the first quarter.

No change in our guidance for noninterest expense at high single-digit to low-teens percent growth.

And finally, our guidance for efficiency ratio is improved to low-50s.

The first quarter results were positive for efficiency ratio and was also a positive impact on net revenue from the March rate move.

Keith?

Thank you, Julie.

In closing, Q1 2018 earnings were indeed strong despite the seasonal softness of the first quarter.

Traditional LHI growth in Q1 2018 was the strongest average linked-quarter growth for TCBI in 3 years.

While the expected seasonality from Q4 2017 to Q1 2018 showed a 9% decline in mortgage finance balances, the year-over-year growth was a very strong 36%.

Again, expected Q1 seasonality produced a modest linked-quarter decline in deposits, while year-over-year total deposits increased a strong 13%.

High asset betas continue to overcome the shift in deposit composition, allowing for continued positive income contribution with future rate increases.

Credit metrics remained strong.

Our 3-year focus on lifting ROE to sustainable mid-teens level is working.

We continue to slow the pace of NIE growth, sustainably higher ROE requires that we maintain our strong track record and credit quality, cost-effective deposit growth and new meaningful reduction -- and the new meaningful reduction in our corporate tax rate to near 22% is another advantageous metric versus many peers to help us achieve these elevated ROEs.

At this time, Julie and I are available to answer questions you might have.

So let's open the call for Q&A.

(Operator Instructions) Our first question comes from Ebrahim Poonawala from Bank of America Merrill Lynch.

So I just wanted to touch base in terms of -- I think you mentioned about the importance of asset betas.

And I think that's been -- there have been a fair amount of concern around your deposit costs in particular and I think it misses the point around de-pricing that we've seen on the asset side.

When we look at the repricing on the traditional LHI and the warehouse, Peter -- Keith, do you expect that trend to continue as we look into the second quarter?

I understand LIBOR is more important.

But when we look at the March rate hike, we saw about 25 basis points pickup in both of those loan buckets, like, should that continue into the second quarter if we see a similar move in LIBOR in the middle of 2Q and the Fed funds impact for March?

We do believe that's going to be the case, Ebrahim.

We don't build in future rate increases as we've mentioned in our guidance.

But we do see our asset betas continuing to power us on some expansion as rates increase.

Understood.

So the movements we saw in the warehouse, that should continue, right?

Because we saw some adjustment last year when you readjusted prices, but the warehouse yield stabilized for a couple of quarters.

It looks like we are back in repricing mode and that's something that should continue into 2Q and going forward?

I mean, that's what we expect for now.

But Ebrahim, we've always said that we listen to our clients and we'll -- for now that's fine, but we'll listen to our clients and we will act as needed in that space.

But...

We are very much past that first several months when we redeployed our incentive program, relationship incentive program, and that was about this time last year.

I think that's what you're alluding to.

And so yes, things are somewhat more stable because we're well positioned, we're continuing to take market share again.

And so we're going to be competitive, of course.

But we have relationship price and that's worked really well for us over the years.

Understood.

And last quarter, I think, Keith, you mentioned in terms of you get 3 rate hikes, you should see 15 to 20 basis points upside to your NIM guide.

I guess if you get 2 more hikes, is 10 to 15 basis points upside a fair assumption?

Well, that's going to be up to Ms. Anderson, because I was doing that math in my head, and I think she usually uses a calculator and thinks a little longer about it.

We should see increased margin as we get future hikes, we can't tell you precisely what it will be.

But again, as you can see from this last quarter, we were up about 14 basis points.

Some of that, about 4 of those basis points, were relative to the liquidity shift.

So I do think we're going to continue to see some improvement if we get future rate hikes.

And over the course of the year, I hope it's more than where we sit just after the one hike in the first quarter, Ebrahim.

Understood.

And just very quick question on the efficiency ratio, 1Q last year was sort of the high for the year.

Should we expect the efficiency ratio to trend lower from the rest of the year from here?

That's right.

Our next question comes from Brett Rabatin of Piper Jaffray.

Wanted just to ask -- maybe we could just go back just thinking about the margin and the implied guidance kind of has it, obviously, down quite a bit linked quarter for the rest of the year.

So I just want to go back and maybe walk through some of the assumptions on liquidity and kind of what you're assuming for deposit betas from here as they pick up a lot.

And just kind of looking to get a little more color on that margin guidance, maybe not being a little more aggressive than it is?

So Brett, again, we don't assume any additional rate hikes.

And in the first quarter, there was a 10 basis points pickup from liquidity -- from the shift in liquidity.

And so as deposits come back, that liquidity level could build up, not anything outsized, but it can fluctuate.

It can cause the NIM to fluctuate from quarter-to-quarter.

So...

It increases net interest income, as you know, Brett.

But it could put a little tap down on margin if liquidity inflates.

Same thing with just other assets.

It changes in the asset mix as mortgage finance comes into their seasonally stronger quarters, when there's more growth in those, it can shift the margin down slightly, again, very positive to net interest income.

But there are several factors that go into margin that can cause it to fluctuate from quarter-to-quarter.

Okay.

And then wanted just to ask on MCA, I think the guidance for $1 billion in average outstanding.

I'm curious why that's kind of the number that you're sticking with.

Is there potential for that to be higher than the $1 billion average?

And why is kind of $1 billion the number that you focused on there?

Well, I think we'll be able to do something better than that, and I think by the end of the second quarter, hopefully, we'll be able to give you a little more positive guidance, but it's early in the year.

And we don't want to get out over our skis.

It's really producing some very nice income for us and much better than a year ago.

Our next question comes from Dave Rochester of Deutsche Bank.

Just back on the warehouse, I know you'd mentioned getting into some of those incentive pricing agreements a year ago.

As you're renewing those deals now effectively, is there any chance you can pull back on the good terms there and recapture a bit more on the yield side for that book?

It's a very competitive market.

If we were to do that, I don't think we'd be in a position to hit this new increased guidance numbers on growth.

So unless the market changes, no, we don't expect to be able to retrade or renegotiate that incentive deal.

Okay.

And just on your mortgage guidance, was just wondering why you moved the guidance up to the warehouse but not for MCA.

Was it -- did you just had a more positive result in the warehouse versus what you had originally thought?

Just any color there will be great.

Well, I think our guys are sandbagging just a tad hand on the non-correspondence business.

But...

It's not a bad thing.

It is a little volatile and it's not as material.

And so it's still a much younger business than our warehouse business.

So rather than push for them to give me number or us a number that we think is a real stretch but achievable goal, we're going to see how the second quarter plays out.

And then we'll really look at it for the balance of the year.

Okay.

And then on deposits, you reiterated the guidance there for low to mid-teens growth this year, which implies a decent amount of growth from here.

So was just wondering what you're seeing that gives you guys the confidence there?

Have you just talked about some areas you think might be good drivers or sources of that growth?

And then what the pricing is on that growth that you think you're going to get just ex more rate hikes, that will be great.

We feel good about our pipeline.

We have a good solid pipeline.

And even though we haven't really seen any kind of outsized pickup from existing clients coming to us and saying they wanted to some significant new capital expenditure financing and things of the sort that we hope eventually might materialize later in the year, we're having good success in the market.

And we feel like we can continue to execute and close good quality business that we have in our pipeline.

Any particular sectors or industries that you think you'll get a lot of that from?

It's really broad.

Of course, we're getting a little more growth in energy than some of the sectors.

It's good to have it growing again.

That didn't start until about this time last year, or even the second quarter last year.

So other than energy, no, it's really quite balanced.

We have over 100 different C&I industries that we finance.

And Julie, you said that it would be all are pretty much interest-bearing, which you've been talking about, I guess, for the last quarter or so.

What do you see in terms of pricing?

Yes.

We're probably not going to get into specifics about pricing.

But it's at -- I mean, what we're seeing in the top line is still at good rates.

It's certainly less than we're paying on the index money.

So I mean, we feel good about that.

I don't think we'll -- we don't want to talk specifics about the rates that we're seeing.

But it's still good pricing.

I'll try one more on the rate angle and I'll let you guys answer however you want.

But just in terms of the new loans, you made the comment that those come in lower than the book yield, which I would imagine is higher than the book yield from 1Q.

Was just curious where spreads are on prime or LIBOR, any commentary there as it relates to pricing and just trying to get a sense for where the NIM could be going potentially versus your guide.

It is a competitive market, but we're having good success.

I really can't tell you that we're getting outsized, upside pricing, nor are we having to cut the deep on pricing.

So it's somewhat more stable than we saw year-over-year, quarter-on-quarter, and we hope that continues for a while.

We are occasionally though seeing competitors come in with irrational pricing but it's not regularly.

So there is the beginning of negotiating away some of the tax rate benefit.

But so far, it's quite modest and we feel good about the pricing overall.

Our next question comes from Brady Gailey of KBW.

So if you look at loan yields, it sure doesn't look like anything is getting competed away to the tax reform, and loan yields were up 24, 25 basis points.

Keith, I mean, I know we're only a quarter into it, but any color on just competition and maybe how competitors are thinking about pricing deals just given the tax reform?

Well, it's a little erratic and we don't have a lot of data points yet, Brady.

I can tell you we've had a couple of large banks come at a couple of deals that we were competing on with what we thought was just really irrational pricing.

But in terms of competitors coming after a client, we're not going to allow a client to be picked off if it's a top quality relationship without competing heads up.

And we haven't had a lot of those instances where we face that.

But on new prospects, it needs to be rational.

We're not willing to go giveaway our newfound tax benefit.

But when it comes to defending clients, we're absolutely going to defend clients, and we've had success doing that.

All right.

Then Keith, I think you said last quarter that as rates continue to rise, your margin might not see as much of a benefit as it has seen in the past due to maybe funding cost catching up.

I mean, that certainly was not the case this quarter.

But do you still think that's the right way to look at your asset sensitivity maybe as it starts to dial back as we get further into the rate increases?

You know us, I think, well enough, Brady, over the years that we'd rather under promise and over deliver.

I think just intellectually, our logic is still sound that we should see some more catch up more quickly with more of our commercial funding than banks that are going to see catch up with their consumer funding, but it will be later.

And at some point, I think those lines cross and we're going to be really pleased with our funding cost.

So far, it's not come as fast and it continues to not come as fast on that catch-up as we anticipated 3 quarters ago that it might.

But we do think it's going to come a little quicker with us just because of the fact that we're a business bank.

And then finally for me, just any color on any new lender hires?

And just kind of your take on your ability to hire away talent in Texas right now?

We're more confident than we've been in some time.

We've picked up some really fine bankers over the last 4 months.

And importantly, two, we're having really good success with some of our young people that we're bringing through our management training program, they're developing extremely well.

And we're having some excellent mentorship by some of our really top, more senior relationship managers with some of our younger bankers as well.

So I'm feeling quite good about what we're doing across the company, developing talent not just attracting talent.

Our next question comes from Michael Rose of Raymond James.

Just wanted to get your thoughts on capital levels.

As I've run my model, it looks like capital is going to build from here, obviously, that's partly because of the tax cuts.

But how should we think about, I mean, you guys have grown at a good pace for sure relative to the industry, but capital does look to be building here at least on a TCE basis.

How should we think about your ability to deploy capital and improve your returns on equity over time?

Well, that will be a new challenge for us as you can appreciate having followed us for so long, Michael.

And we welcome that challenged, but it is a new challenge.

What I would tell you is this is not the time in the cycle to worry about make sure we're fully levered and go for -- with every loan we can make.

We're being more selective than we've ever been.

And we just should be and I think all banks are probably trying to do that.

But our credit discipline has always been paramount to our ability to grow faster than our peers at the pace we've gone all these years, and you cannot grow faster like we do unless you're outstanding on credit quality.

So what I'm suggesting is near term, we may have a little capital build.

What we've been able to experience over the years is when there is a down cycle, and we've done the right thing and been disciplined early and not gotten over our skis and tried to loan as much as we could later in the cycle, that we've been able to deploy quite a lot more capital during a downturn cycle in some of those industries that are in the ditch with our competitors.

And so again, I hope we don't have a recession that we have to face up to in the next 2 or 3 years, but we're preparing that we're in the late inning.

So we're going to be more cautious about quality than fully levering this newfound capital benefit we're going to enjoy.

But I do believe over the years, we've been quite effective at deploying new capital.

Often we'd have to go raise it, and I will welcome the chance to build up a little capital and go deploy that rather than go back to Wall Street as frequently as we used to.

Yes, that's certainly a better dynamic to be in.

And maybe just a follow-up to that.

With tax reform, how should -- do you guys have any sort of targeted ranges for any of the capital levels that you'd like to be in the range of?

And then as it relates to profitability, any sort of ranges for ROA, ROE that we should think about longer-term with tax reform?

With tax reform, we're kind of early into this phase.

And if we keep all our heads and we don't have continued outsized competitive pressure on banks that are only growing at the GDP rate or lower and feeling pressure with their low growth, then hopefully, we won't give too much of that away and we'll be able to continue to realize these mid-teens and even raise the mid-teens run rate we saw this quarter on ROE and that is our goal.

And we want to achieve this too, Michael, before rates peak, we've had this unexpected tax benefit.

And so we thought it might be 3 years before the rate cycle might peak.

And now of course, it's always uncertain.

But we're realizing early some of this benefit in ROA from tax cuts.

And so we intend to just really work on improving fee mix, improving efficiency as we are rebuilding quite a lot of our technology the last 2 years and again this year and improving our processes and client experience.

I want to emphasize client experience.

So all we're doing around technology and refreshing our offerings to clients, we're listening, talking with them so that it improves client experience and elevates our RMs to have even deeper, more strategic relationships with our clients and continue to have the lowest turnover of clients in the industry.

That's very important in our model.

So those are the key things I see going forward.

It's too early to call how ROE is going to play out because we got to see how we end up on liquidity run rate over the course of the next year or 2 years.

And in this up rate cycle, we're going to have to see how that mix develops on noninterest-bearing and interest-bearing.

But we're also seeing some other alternatives that will present themselves as other earning asset opportunities for us as the rate cycle runs its course, too.

So those pieces are a little uncertain to address, but I do think we can sustain a higher ROE and the rate increases that come ahead of us are going to be a contributor, but we want to be sure we're delivering slower NIE growth, too.

And I think, Michael, I mean, we're comfortable with that improving ROE at the capital levels that we have now.

We don't think that our capital levels are going to impede that ROE improvement.

Okay, that's very helpful.

Maybe just one more for me.

You guys, over time, have developed a lot of very successful deposit strategies, even predating the liquidity build that we've seen in balance sheets across most banks since the recovery.

Is there anything that you guys are working on, on the deposit side, whether it's an industry vertical or verticals or any strategies in place outside of higher pricing that you could discuss?

Yes.

We could give you some color on that, but not as much, of course, as you would like.

We have never had as many new industry verticals where we believe there are real niche opportunities for us to develop a national footprint industry, treasury product set as we have today.

In the previous 20-year history of the company, I remember, at the most, we would look at 2 in a given year or 2, and might do 1 new industry vertical.

And already in the last 6 months, we're testing 2 and looking at an incremental potentially 6 more new industry verticals on the deposit side.

Now we won't do 6 more, we're very diligent about how we put these through a process and then do some testing and piloting and focus groups with clients and so on.

But the 2 we're testing, there's great receptivity to what we're offering.

It's early, we're not ramping it up, it's still in a pilot mode.

And I'm fairly confident we're going to go from 2 to at least 4, maybe 5, not 8, and that would be, again, a record-setting pace for us to offer these new capabilities in 1.5-year, 2-year period.

So we've been working on this for some time to develop the research and really be ready for rate cycles that we're starting to increase.

We've been working on this for a couple of years and we're getting to a place where we're going to begin to launch some of these.

Until they become meaningful, obviously, we don't want the telegraph what they are.

But we think each of these could be very meaningful for us.

Okay.

As long as there's no more Voldemort, that's all the questions I have.

No more Voldemort?

This is not a...

(inaudible)

I want to encourage you on these note deposit verticals, it's a very small fraction of what it cost to build out a full new business.

And as you know, we rebuilt 3 businesses simultaneous to building 3 brand new businesses that were full credit businesses and deposit, full operational businesses.

These are not nearly as costly and it certainly takes time and effort and you've got to hire the right talent at most of the industry niche.

You got to have the right product set and keep it refreshed.

But it is a small fraction of what it cost to do a full build-out business.

Our next question comes from Peter Winter of Wedbush Securities.

If I can stick with the margin, if I take out the benefit from the decline in excess liquidity -- so I get a [3.61%] for the margin.

And I'm just wondering given that you're still in the early stages of getting that March benefit from the rate hike, can you just go through some of the moving parts why the margin outlook would not be stronger just given that you've got the March rate hike?

Right.

The changes in asset mix from quarter-to-quarter, so there was also some pickup in the margin because Q1 is a seasonally slower quarter for mortgage finance.

And the mortgage finance loans, while at a really good yield, they're lower than the traditional.

So in Q2, you would expect that as that becomes a bigger percentage again in the seasonally strong quarters, that could compress NIM a few basis points.

Very positive to net interest income, but it can cause some fluctuations in the NIM.

And granted there is some added benefit that will flow through to offset some of that, Peter, but again we're expecting the net volume pickup to be so significant at warehouse that there will be a net shrinkage of some small amount.

But you're right in assuming that we would expect to see more of the move still come through in traditional and probably in warehouse.

But it can -- the asset mix shift can cause some fluctuations in actuals in NIM from quarter-to-quarter.

Okay, that's fair.

On a separate note, I know you're not done with it, but can you just give an update what you're seeing with regards to the spring redetermination in energy?

So far, no surprises.

I think we're going to be at good solid position on the redetermination.

So unlike what we faced for 2 or 3 springs and falls, things are looking better.

And we should have net positives as the outcome.

Do you think you're near the end for net charge-offs on the energy portfolio?

We're certainly moving that direction.

I think by the end of the year, we'll have most of it dealt with.

And I mean, most of it in terms of 80-plus percent of it, if not, 90% of the charge-offs accomplished.

But it does take some time to resolve these last ones that are nonaccrual, but we think we're very well preserved.

Our next question comes from Jennifer Demba of SunTrust.

Just I think most of the questions have been asked.

A quick question on the increase in non-accruals from the 2 larger commercial loans, what industries were those in?

We're dealing with a couple of new problems, and I'd really don't want to telegraph the detail there, but it's not health care, let me tell you that.

We've had that before.

One of the OREO, the write-down on OREO, which was a subsequent $2 million write-down, was a piece of health care real estate that we dealt with in the fourth quarter, too.

But there are 2 C&I deals of the size, we've got to get further into negotiating with the borrowers and working through that, Jennifer, before I telegraph the industries.

But it's not a retail business, it's not the kind of sensitized industries that we've all been talking and worried about.

I don't know that, that's helpful, but that's about all I can say today.

Yes.

And Jennifer, as I said in my comments, it's different industries, the 2 are not the same industries.

So there's nothing to -- there's nothing -- there's no bigger impact from a specific industry that we would expect.

These are just 2 one-off deals.

And we're not seeing migration in either of these kinds of businesses.

No migration from other categories that are still past the lesser grade or weakening.

So that's what Julie's alluding to, we're not seeing any kind of pattern.

These are just 2 situations where we've had some -- the clients have had some challenging decisions and they've not made the best ones in some cases.

Are either of the credits, Shared National Credits, are club deals?

Well, there is one that, I believe, is a Shared National Credit.

Actually, it's a club deal.

There's one other participant.

The other one is just one that we hold.

Our next question comes from Geoffrey Elliott of Autonomous Research.

Another question on the deposit side.

In June, you had a rate increase and in 3Q, average interest-bearing deposit costs increased 17 basis points and then another 9 basis points in 4Q.

This time, you had a rate increase in December and then a rate increase in March.

When we look to the second quarter, should we kind of think about there being some follow through from what happened in December plus the impact of March?

So if I'm understanding your question, yes, there are.

Because the rate move was late in March, in Q2, there will be the rest of the impact from that.

So we have the 2 categories, which are, for all intents and purposes, indexed, and they would only be -- Q1 would only reflect 2 weeks of that rate move.

So the rest of that will show up in Q2.

Does that answer your question?

I guess, the question was more the increases are coming a bit faster now suddenly than they were in the second half of this year.

So does that just kind of amplify the effect?

I guess, the reason I'm talking about what happened in the second half of last year is because you only had a rate increase late in December, but some of the move up in 4Q felt like it was maybe triggered by some of the competition that was kind of set off post the June rate rise, or I don't know if that's the right way to think about it or not.

Well, in fact, yes.

Geoffrey, the LIBOR has moved earlier.

And yet the full follow-through because our -- we don't have all of our LIBOR-based loans on a 30-day reset, some are longer.

But I think 80% of our LIBOR-based loans are on the 30-day reset.

So part of it is just the timing.

But if your point is that you see some of that move earlier than the actual Fed rate hike, you're right.

We have seen that.

And there still will be some follow-through.

And then just to clarify on something I thought -- I caught what you said earlier.

Did you talk about adding a variable component to comp linked to deposits?

Did you say that in the prepared remarks?

I wasn't quite sure.

Yes, yes.

There's an added fee in legal and other professional that's directly related to some deposit service cost.

Why -- so that's using outside providers to help you find deposits?

If you can just -- if you could explain more about it.

We're going to -- for competitive reasons, we won't get into the specifics about what that is.

But yes, it's tied to a couple of categories of deposits that we have and services that we provide in those categories.

That's something that's come up and that's why we wanted to go ahead and give a little color on that because it's something that we will see going forward.

Our next question comes from Brock Vandervliet of UBS.

I just wanted to clarify, first off, if the noninterest expense base that we see in Q1 is kind of a good base level to start the year?

Yes, I think that's fair.

We try to explain some of the seasonality that occurs in the first quarter and then again, I clarified that there's some additional deposit-related costs in a couple of categories.

But yes, I think that's fair.

Okay.

And getting to the guide of the noninterest expense guide, high-single digit to low teens, I know you don't want to narrow that at this time.

But what should we kind of think of in terms of since that is a pretty wide range, what could keep it toward the bottom in that versus push it to the upper end?

Well, 123R has a big effect on it, Brock.

And we hope we have some higher expenses related to the stock price appreciation.

But it's not something we control, of course.

So that would be one of the factors.

Other things that would impact us would be if something unplanned at this point were to present itself as a real opportunity and again, we give ourself a little wiggle room.

If we're going to have an opportunity to hire an all-star team of bankers, we're not planning that at this moment, but as you know, having known our company for a while, we are all about exploiting talent, lift out opportunities at their timing, not ours.

And so we recruit for years to line up some of the talent, and we don't know exactly when it will come.

So that's another reason we give a little broader range on these things than maybe some companies.

Our next question comes from Jon Arfstrom of RBC Capital Markets.

Question just on bigger picture loan growth.

The LHI, excluding mortgage, curious if you -- is Keith Cargill more optimistic?

And are your clients more optimistic?

You haven't changed the guidance, but I'm just curious what your view is?

I am some more optimistic.

I don't think that matters nearly as much as what my clients think tomorrow as what I think today.

So we try to stay very close to the clients.

And my optimism comes from some more confidence that our clients are demonstrating.

But again, they're not breaking our door down because of new tax incentives, Jon, to do financing that we hope will eventually materialize with the new incentives on floor write-off of CapEx and the like.

So we're still wondering and waiting if that's going to happen, and we haven't built that into our guidance.

But we're seeing them want to build out their businesses more than they once did.

They've seen deregulations happen and affect their businesses, they're encouraged by it.

With all the noise and so on that comes out in Washington, the net result of what's actually happened in terms of regulation has been positive and it's been broad across many industries that we finance, just encouraging for us banks.

And of course, the tax reform, I think, is a plus.

But that optimism gets offset a bit by new banks over things like the midterm elections and things of that sort.

So we're going to have to see if that really shows up that incremental growth, but again, it's not built into our overall guidance.

And generally, I'm more optimistic this economy has legs for some while longer than it was even 4 or 5 months ago.

Okay, okay.

And then I guess just one follow-up.

You talked about, I think it was Michael Rose's question on being levered and not at this time in the cycle.

But do you have any emerging concerns on credit?

It sounds like that's not the case, but is there anything maybe you're watching a little more carefully?

We don't have any emerging concerns other just being late in the cycle.

And we've been early to have those concerns.

We've been concerned about that for 2 years, and been more and more and more selective on those kinds of assets that we think have been white hot and continue to perform extraordinarily well, but are just somewhat concerned as late in the cycle about being sure we're making better quality loans in those categories.

So that when things turn, we'll be the healthiest bank in those industries and be able to exploit the downturn, not suffer through it.

Our next question comes from Brad Milsaps of Sandler O'Neill.

I've got a question on, I think it's Slide 5 in your deck that talks about the geographic diversification.

If I'm looking at the deposits in the Texas region, it looked like they were down maybe $500 million or so from the end of the year while the national business were up.

I guess, I was thinking that given the influence of the warehousing in the first quarter and maybe the national lines would have been down more, and you wouldn't see as much change in the Texas region.

But just wondered if you can offer any color there on what kind of might be going on with the Texas deposit base?

Nothing really other than seasonality.

I know it looks a little odd but there's really nothing.

We're not seeing clients leave us without calling and talking about rate, things of this sort, that we're -- than go back and take a look at the relationship and make appropriate adjustments and things of this sort.

So no, there's nothing that concerns us other than it is a softer season, and it is a little odd that it impacted the Texas numbers more than the national.

I would agree with that.

Is there a difference in cost between those 2, the gray chart and the dark gray chart?

One more expensive than the other?

I would say they're really quite close.

I mean, they're different distribution and acquisition mechanisms for some of them.

But all-in cost is really quite close.

This concludes our question-and-answer session.

I will turn the conference back over to President and CEO, Keith Cargill, for final remarks.

Thank you.

We appreciate your time and interest in Texas Capital Bank.

We're optimistic about the economy as we've discussed, we're optimistic about our future and are working hard to build the finest business we can possibly build.

Again, thank you, and good evening.

Thank you for your participation in TCBI's first quarter 2018 earnings conference call.

Please direct any request for follow-up questions to Heather Worley at (214) 932-6646 or heather.worley@texascapitalbank.com.

You may now disconnect.