Texas Capital Bancshares Inc (TCBIO) 2019 Q1 法說會逐字稿

Good afternoon, everyone, and welcome to the TCBI Q1 2019 Earnings Conference Call.

(Operator Instructions) And please note that this event is being recorded.

(Operator Instructions) And I would now like to turn the call over to Heather Worley, Director of Investor Relations.

Please go ahead.

Good afternoon, and thank you for joining us for the TCBI First Quarter 2019 Earnings Conference Call.

I'm Heather Worley, Director of Investor Relations.

Before we begin, please be aware this call will include forward-looking statements that are based on our current expectations of future results or events.

Forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from these statements.

Our forward-looking statements are as of the date of this call, and we do not 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 earning release, our most recent annual report on Form 10-K and in subsequent filings with the SEC.

Our speakers for the call today are Keith Cargill, President and CEO; and Julie Anderson, CFO.

At the conclusion of our prepared remarks, our operator, William, 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.

I will offer opening comments.

Then Julie Anderson, our CFO, will share her review of Q1.

I'll then close and open the call for Q&A.

On Slide 3, we lead off with the key operating results for Q1.

Earnings per share totaled $1.60 in Q1 '19 versus $1.38 in Q1 2018.

ROE of 13.58% is higher than the ROE of 13.39% in Q1 '18.

Net interest income increased 12% from a year ago as well.

Driving the higher EPS and ROE were the net revenue increase of 15% from Q1 '18.

Noninterest expense increased 11% from Q1 2018, but the core NIE expense related to salaries and benefits increased at a lower rate.

Julie will speak to this a little later in the call.

Net charge-offs were 0.09% of LHI as compared to 0.11% in Q1 2018.

Nonaccrual loans to total LHI were 0.57% compared to 0.60% in Q1 '18.

Slide 4 highlights our energy loans and C&I leveraged loans.

Energy loans equal 7% of total loans, as was the case in Q1 2018.

Nonaccrual energy loans increased to $76.7 million from $50.4 million 1 year earlier.

Allocated reserves equal 3% of energy loans or $48.6 million.

C&I leveraged loans equal 5% of total loans or $1.2 billion versus 6% of total loans or $1.2 billion at Q1 '18.

Nonaccrual leveraged loans were $30.6 million at Q1 2019 versus $54.4 million at Q1 2018.

Criticized loans increased from $138 million in Q1 '18 to $219 million in Q1 2019.

Allocated reserves for C&I leveraged lending totaled 6% or $68.9 million.

We have no significant concentration in a particular industry in this portfolio.

Over the balance of 2019, we estimate runoff of approximately 30% of the leveraged lending loan portfolio.

Let's now move to Slide 5. We strongly believe we have built over 15 years an exceptionally valuable business for our shareholders in mortgage finance.

This slide highlights core strengths in the mortgage LHI component of mortgage finance and hopefully better informs our constituents as to the low risk, high return qualities of this business.

We did not build mortgage finance LHI or mortgage warehousing as we once called it to simply be a transaction loan business.

We chose to invest, hire and grow the business in 2009, 2010 and since then, to be a strategic solution business for our mortgage banking clients.

During the 2008-2009 Great Recession, the number of competitor banks in this business dropped from 82 to 11.

We were not entangled in the subprime mortgage problems and decided to exploit the opportunity, our top national talent and take quality client market share.

We made the largest investment in our history in a specialized line of business technology platform offering the independent mortgage banking companies coast to coast the finest expert bankers and best-of-class technology.

We hired top treasury management talent and developed customized treasury management products for their industry.

And importantly, we provided much needed capital when they needed a strong bank the most.

Since 2009 through 2011, we've continued to invest in technology and talent in the mortgage finance business launching the mortgage correspondent aggregation business 3.5 years ago.

While this slide focuses on the core business of mortgage finance LHI, our MCA business is growing and delivering strong earnings growth as well.

I want to point out that the earnings and combined yield bar chart shows strong earnings and yield but does not include the strong deposits we've grown and the additional profitability the deposits generate in this business.

We have a long history of growing market share and earnings in mortgage finance despite headwinds affecting mortgage origination volumes because we are able to outperform competitors and take market share to offset originations slowdowns.

We have a truly amazing team of mortgage finance professionals and best-of-class clients.

It is a great business for us.

Julie?

Thanks, Keith.

My comments will cover Slides 6 through 13.

Our reported NIM decreased 5 basis points from the fourth quarter with about 2 basis points related to additional liquidity.

Our traditional LHI yields were up 10 basis points from the fourth quarter, which included catch up from the late LIBOR move in fourth quarter as well as the slight decline in February but was offset by a lower level of fees this quarter.

Traditional LHI betas continue to be as expected, but we could see pressure on spreads as competition remains robust.

These were lower in the first quarter as compared to the fourth quarter, which accounts for about 11 basis points.

So basically, our core LHI yields were up 21 basis points.

Our anticipated mix of loan growth for the remainder of the year will likely result in lower fee levels than we've experienced in the past.

Mortgage finance yields were up 9 basis points on a linked quarter basis, and these yields are stable at this point.

Additionally, with long-term rates dropping, we're seeing additional volumes first evidenced in March.

While MCA will also benefit from additional volumes with long-term rates dropping, it's important to remember that those loans are tied to the actual mortgage rates, which will have a lower coupon unlike the warehouse loans that are tied to LIBOR.

We had a linked quarter increase in average interest-bearing deposits and overall deposit costs increased by 16 basis points from 117 basis points in the fourth quarter to 133 in Q1.

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

We saw the full catch up in January, and trends in February and March have been positive with minimal movement.

With the Fed pause, we expect more gradual increases in deposit pricing that's reflective of net growth coming from interest bearing.

Continued solid deposit pipeline with verticals getting traction, we would expect to have more to discuss related to some of the verticals in the second half of the year.

In addition, the front line is focused on targeted calling efforts.

During the first quarter, we replaced approximately $500 million of traditional brokered CDs that were maturing at a 25 basis point increase in cost, which was more favorable than some of our higher-cost deposits, so about $1.5 billion in total.

While verticals ramp up, we're very comfortable increasing the level of brokered CDs as needed when pricing is more favorable than some of our higher-cost funding.

As of the end of March, 75% of our floating rate loans are tied to LIBOR and over 80% of that tied to 30-day LIBOR.

The percentage of LIBOR loans in our portfolio continues to increase.

We had growth in average traditional LHI during the quarter consistent with our expectations.

Traditional LHI average balances grew 1% from the fourth quarter and up 9% from the first quarter of last year.

The level of payoff continues to be high primarily in CRE and some C&I leveraged.

We would expect payoffs in C&I leveraged to pick up during the remainder of the year.

Continued strong average total mortgage finance balances, including MCA, benefited from stronger-than-expected first quarter, which is seasonally weaker.

Balances are up from first quarter last year by 33%.

With the drop in long-term rates, we expect Q2 volumes to be quite strong.

We did see some pickup in linked quarter average deposits with all of the growth in interest bearing, primarily interest-bearing deposits in the pipeline, but we continue to be vigilant on maintaining and growing core existing relationships.

Betas on interest-bearing deposits declined slightly in the first quarter.

We expect more gradual increases in deposit pricing with the Fed pause.

Additionally, slower core loan growth will be beneficial to our marginal cost of funding.

We would expect to start to see improvements in funding mix in the second half of the year with more meaningful improvement evident in 2020.

Moving to noninterest expense.

First quarter expenses have some noise, but overall, we're pleased with the trend of our core operating cost, specifically looking at the changes in salary expenses.

First quarter salaries and employee benefits are up about 7% from the first quarter in 2018.

We're managing at a much lower level of FTE additions.

Seasonal items of $4 million offset by the normal lower level of incentive accrual in the first quarter as that ramps throughout the year.

Fluctuation in FAS 123R expense in the first quarter compared to Q4 primarily related to a sizeable drop in stock price that occurred at the end of the year and has rebounded slightly in the first quarter.

The deferred comp plan that was started a couple of years ago now has a sizable enough balance that there can be some meaningful mark-to-market fluctuations, and that's generally consistent with moves in the stock market, $2.5 million flux from fourth quarter to first quarter.

However, that's offset in noninterest income so net neutral impact on net income but rather just a gross up in income and expense.

Portion of the marketing category continues to be variable in nature and is tied to growth in deposit balances and is expected to continue to increase throughout the year.

Quarterly increase in that category could range from $1 million to $2.5 million per quarter depending on volumes.

Efficiency ratio for the first quarter was 52.8% compared to 55.1% in the first quarter of last year.

We expect continued improvement for the remainder of the year.

Now moving to asset quality.

We continue to be positive about overall credit quality with lower level of charge-offs and provisioning in the first quarter.

Nonaccrual levels increased but still at a relatively low of 0.57 of total LHI.

The increase was primarily related to 3 energy deals, 2 of which had been criticized for some time.

While each of these credits have unique characteristics, poor development results were common along with other challenges unique to each and not indicative of the remainder of the energy book.

We believe each are adequately reserved at this time.

Additionally, we experienced an uptick in total criticized levels in the first quarter predominantly driven by leverage deal.

More than 50% of that was in the special mention category and is not surprising as a result of a continued focus on the leveraged portfolio or any loans that may be viewed as weaker if we move into a slowdown.

Total criticized as a percentage of total LHI remains low at 2.6% and we have rigorous action plans for problem loans.

As you know from our history, we're always focused on being proactive with grading and especially late cycle, which can drop higher provisioning and classifications early.

The $20 million in first quarter provision is related to the migration that I've discussed and is in line with our annual guidance.

As we've mentioned, we would expect a larger portion of provision in the first half of the year, so Q2 provision could be higher than the Q1 levels.

Generally, that would be the result of any additional migration.

Our team is staying very close to all criticized loans situations, but this is the time of year that clients are finishing their audits.

And if those audits reveal deterioration that internal financials or our ongoing dialogue with clients had not previously indicated, some additional downgrades could be possible.

We wouldn't expect that to be significant and believe it is adequately covered in our guidance for the year, $4.6 million or 9 basis points of charge-offs in Q1, all of which was previously reserved.

We continue to see strength in our linked quarter net revenue, core loan growth in the first quarter as well as better than expected volumes in mortgage finance.

First quarter noninterest income includes an $8.5 million legal settlement, which is obviously nonrecurring.

Continuing to improve run rate on our core operating expense items, specifically salaries and a focus on improving efficiency while enhancing client experience.

Year-over-year 11% increase in noninterest expense compared to prior year Q1 and is 8% excluding the MSR write-down and compared to 15% net revenue growth or 12% if you exclude the nonrecurring legal settlement.

On a PPNR basis, the earnings power continues to improve as we evaluate our year-over-year comparison.

ROE and ROA levels were improved in Q1 as a result of lower provision level.

We could see some lift in ROE levels later in the year if provision levels come in lower than guidance.

Now we'll move onto our -- to the remainder of the -- our outlook for the year.

We're decreasing our guidance for average traditional LHI growth slightly to mid- to high single-digit percent growth from high single-digit.

That doesn't represent much change in our outlook but rather fine tuning what we expect to see from a pay down perspective.

We've experienced good growth in the first quarter but expect higher runoff in areas that we're focused on running off.

We're increasing our guidance for average mortgage finance growth to high teens from low single-digit percent growth, additional growth as a result of lower long-term rates.

While we assume this is a short-term opportunity with lower rates, we will be opportunistic as it's very positive on earnings and it makes sense from a risk perspective while we work on the appropriate runoff in other areas.

We're also increasing our MCA guidance to $2.5 billion from $1.9 billion for average outstandings for 2019.

While we continue to see pickup in market share in the space, MCA will also benefit from additional volumes from the drop in rate.

We're increasing our guidance for average total deposits to high single digits from mid- to high single-digit percent growth, still with an expectation that net growth will be interest bearing.

We expect some traction with initiatives but weighted towards the second half of the year.

We also expect to continue to see growth in core clients, which may result in some upside on noninterest-bearing deposit trends.

We are comfortable using well-priced brokered CDs as we gain traction in other areas.

We're decreasing our guidance for NIM to 3.6% to 3.7% from the previous 3.75% to 3.85%.

The decrease is primarily related to an earning asset shift as we now expect more meaningful growth in total mortgage finance, which is lower earning asset.

While slightly punitive to NIM, the added growth is very positive to net revenue and net income.

The guidance continues to assume no Fed changes in rates for the remainder of 2019.

Our guidance for net revenue remains at high single-digit percent growth but at the higher end of that high single percent range with the additional revenue expected from mortgage finance.

Our guidance for provision expense remains at mid- to high $80 million level.

While our first quarter provision might indicate slightly lower than annual guidance, it's too early in the year to warrant any adjustment.

Guidance for our noninterest expense remains at mid-single-digit percent growth.

We continue to feel good about the slowing of our core operating expenses primarily related to our very targeted growth in headcount.

Guidance for efficiency ratio remains in the low 50s.

Lastly, I just like to reiterate our long-term outlook, which is on Slide 13 and is part of our 3-year planning horizon with no changes to the view we shared last quarter.

Keith?

Thank you, Julie.

We continue to make the necessary changes in our business to better align our organization structure with full solution product delivery at a strategic level with our clients.

We have long been known as a high-touch client service company, but we are committed to further differentiate our reputation by becoming the premier client experience bank against all key competitors.

This undertaking includes the 3-year rebuild we launched in 2016 to rebuild our technology infrastructure.

We're roughly a year away from essentially completing that rebuild.

The up-to-date technology grid positions us for better agility for the ever evolving client preferences for mobile access and ease-of-use banking products and services.

It also assists us in gaining better insights into our clients' emerging needs.

Regarding LHI growth, it was solid in Q1 2019 despite our deliberate efforts to allow runoff in leveraged lending and be ever more thorough in booking only high-quality new loans across all lines of business in this hypercompetitive environment.

We want to grow modestly, not rapidly, in this later stage of the recovery.

Asset prices are continuing to escalate.

We know late cycle loans create higher through cycle risk unless we exert strong discipline and carefully manage down higher risk loan categories.

We are fortunate to have the outstanding mortgage finance business that deliver higher growth in earnings with very high credit quality as we optimize our loan mix while still driving earnings and ROE.

Our deposit initiatives continue to roll out and grow.

The growth in our new deposit verticals will allow us to run off higher cost deposits over time.

This will help us show net deposit growth at improved costs in more granular levels.

We believe we have a very clear view of our loan portfolio after much drill down and review last quarter.

While criticized loans grew, we expect that to plateau.

Finally, the targeted approach to slowing noninterest expense is showing good results.

More disciplined hiring, organizational changes, new technology and process refinement are all contributing to delivering a more premier client experience and more efficient bank.

At this time, I'll turn it over to William to open the lines for Q&A.

(Operator Instructions) And the first questioner today will be Ebrahim Poonawala with Bank of America Merrill Lynch.

So I just wanted to touch upon the criticized loans and credit, Keith.

Now just trying to understand where we are in terms of putting this behind us.

And so I think you mentioned in the prepared remarks, Julie or you, regarding expecting a little more potential for migration in the second quarter.

Can you give us a sense of like when, like 3 months from now when we are on the call, do you think this will be well addressed absent any deterioration in the economy?

Or is this kind of a moving target?

Because I feel like we -- there's been a lot of impact to the stock and just concern on the stock around credit and things kind of slipping negatively.

So I would love to get some color on that.

Sure.

Well, as we've been describing at each quarter the last couple of quarters, Ebrahim, we've taken a very deep dive not just on leveraged lending but really through our entire loan portfolio.

And we think that was prudent, having seen some of the leveraged lending deals begin to pop up second quarter last year and then they've continued in the third.

And we wanted to be sure, as I mentioned, last quarter, that we had not had any kind of leakage into having any kind of breakdown of credit underwriting and problems in other parts of the portfolio.

We feel very good about that.

But by taking such a deep dive, we're naturally going to identify more watch credits and special mention and we should.

We've really spent a lot of time and energy to get our arms around this early and before the downturn, whenever that might come.

And our experience, Ebrahim, has always been, if we're proactive and early on addressing things as soon as we see them, then there are pools of capital that are willing to sometimes accept high returns for what they perceive to be still reasonable risk in their world and they have different objectives and necessarily regulated banks.

So we have the opportunity to recover our loan capital and our interest often on credits that if we waited all the way into the cycle and the downturn, it wouldn't be the case.

So while it is a little bitter to take medicine early, we really believe it's always been in the best interest of our shareholder.

And we don't see this as a continuing upward trend on the criticized volumes.

We think we're approaching a plateauing on that.

And also, we expect quite a few of these to refinance in the special mention as well as in some of those that are -- what we call classified light.

We're being conservative on how we're looking at our credits.

And so while we're not overstepping our methodology or our approach, we're definitely being conservative on how we're grading these credits.

And that's how you really get action and you get progress made on upgrading the entire portfolio.

So that's a lot of editorial, but I hope I'm answering your question.

And I think we're just seeing what we expected we would see with this deep dive, and we think we're nearing a crest on criticized.

Understood.

So I guess takeaway is you spend a year digging through this.

I appreciate getting ahead of the curve given where we are in the cycle.

It sounds like the likelihood of you being surprised in any meaningful way from here on, on credit should be relatively low.

No, we really haven't been surprised.

Of course, we've learned a few things but we really haven't been surprised.

Again, if you look at our growth the last 5 years, we have almost tripled the company.

And so it was very, very important for us to start this tipping down of the growth rate, which we did over a year ago to be sure we were all about quality and having the -- building the strongest balance sheet possible for the next down cycle.

Now we really believe we earn the right to be a high growth bank as we go through each economic cycle.

We don't just inherently have that right to be a high growth bank.

So it's entirely appropriate and based on our history and experience.

When you get into the late cycle, whether the economy lasts another year or 3 years, we're later in the cycle than we are early.

We're seeing a lot of signs of asset values really, really peaking and a lot of clients selling assets, which often is an indicator too that we're nearing the late end of the cycle.

Sellers generally have a better feel for the kind of value they want to realize, then big pools of capital that want to be deployed and acquire assets.

So we're very thoughtful and watch our client asset sales.

That's contributed to some more pay downs, not just in real estate but overall in C&I too.

But rather than chase that and try to overcome those pay downs by booking even more loans and pushing growth, it's a mistake, in our view, because through cycle it'll just cost us a lot of credit write-offs.

So we feel very solid about where we sit.

We think we have the best visibility on our portfolio we've had in 3 or 4 years.

And we think we're headed in the right direction.

Understood.

And if I may just on a separate topic, Julie, just if you could talk about the 3 loan buckets when we think about the yields today with the Fed on the sidelines.

What's the expectation on those 3 in terms of should they be relatively flat, just lower -- just any expectations?

Do you expect any of the fees that kind of went away this quarter to come back?

So yes.

So we'll start with traditional core LHI.

We've -- as I've said in my prepared remarks, we do think that lower fees is going to be something that we're going to have for the rest of the year.

I don't think it's going to be lower than what we saw this quarter.

So there could be some rebound from that, but we're -- I'm not going to say it's going to be significant.

So I think the levels that we're at right now on core is -- should be flat.

It can fluctuate up or down a couple of basis points, but it should be pretty flat.

On mortgage finance, the warehouse piece, we'd note that those deals are stable right now and we would expect that to continue.

And then on MCA, that's going to be tied to note rates.

So as what's on our books now as that sells and we put on new, it will be tied to the note rate, which could be -- which will be lower.

And our next questioner today will be Jon Arfstrom with RBC.

Just maybe the other side of Ebrahim's question on deposit costs.

Julie, you talked about a little bit of abatement, slight, minor, but give us an idea of what you're seeing in terms of less pressure in deposit costs.

And then also, the second part, you talked a little bit about a better deposit mix shift later in the year, and I'm just curious what kind of magnitude you're signaling in terms of easing deposit pricing pressure.

I think we're being -- I don't think we're signaling anything specific at this point.

We'll talk about that as we get more traction in the -- with the different verticals.

But we do think for now, because we have such a big, like $5.5 billion in index deposits, we're getting some relief from the Fed pause from that.

So we saw all that reprice in the first quarter, and then as I said, with all that reprice in January, February and March, our overall costs were pretty stable.

We do think there will be some gradual increase just because everything -- the net growth is coming in interest bearing, but it shouldn't be anything compared to what we've seen in the past.

And Jon, we seasonally have a softer first quarter in DDA.

That's typical because of some of the large commercial accounts we have in a couple of different industries.

So that is going to be rebuilding in the second quarter and should hold up better for the next couple quarters.

Okay.

And Julie, the 15 basis points you talked about, you're basically saying that a lot of that pressure has gone away at this point.

Right, because a lot of that was from the repricing of the complete -- a full quarter of the Fed repricing on the index deposits.

Okay.

Okay.

And then back on the provision, 2 parts.

You talked about potential for an increase in Q2.

Curious if you're willing to talk about potential magnitude.

And then on the other side of it, you talked about the potential for maybe beating or coming in lower on provision for the full year.

Maybe give us an idea of what you're thinking there.

Let us tell you what we can, Jon.

We can't drill down too specifically because we're working with a couple of clients that are -- that's important.

But 2 of the 8 credits that we've referred to before, we haven't graded conservatively today, but that's because the sponsors and the businesses -- the sponsors are acting responsibly.

The businesses are improving.

If those things continue to play out on those 2 deals in particular, I think we have a good chance to come in with better provisioning in the second quarter and perhaps for the year.

But we don't know yet.

We're going to have to see another couple of quarters and again, how the sponsor and the underlying business performs.

Okay.

And that's the driver of the potential for coming in below for the full year is what you're saying.

Below or coming in with a higher provision in the next quarter.

Yes, and the same thing, Jon, when we talk about migration, it doesn't mean that we think there's going to be a lot more that moves to criticized.

But within that criticized bucket, if we have some that move from special mention to substandard, then obviously that costs more in provision dollars.

And we feel very solid about our annual guidance still on provision.

Absolutely.

We just think there's a chance we could beat it, but we're another quarter or 2 away on these 2 deals.

And our next questioner today will be Steven Alexopoulos with JP Morgan.

To start on credit, Keith, I appreciate the deeper dive into the loan book.

But you -- could you help me parse through the increase in classified loans this quarter and how much was tied to you just having a more conservative view versus actual deterioration, right, if we look at leveraged C&I of $68 million quarter-over-quarter?

If I look at outside of C&I leverage and energy, that was up $74 million.

Can you help me parse out what's actual credit deterioration in those numbers?

Well, I think actual is what we're telling you.

I think most banks, though, would rotate over the course of 4 quarters as you well appreciate and maybe cover 60%, 65% of their portfolio in a credit review.

We do that as well, but we've accelerated that over the last 4 months -- actually, the last 5 months to do a much deeper dive, Steve, and not just on the leveraged lending portfolio, which we initially focused on but more broadly across our entire loan portfolio.

So what I would tell you is it is what we're presenting, but I think we're getting you a more real-time update than most banks could give you if that makes sense.

Okay.

And then -- that's helpful.

On the provision guidance, which, I guess implies that Q2 is going to have the largest provision for the year.

This is first half loaded.

What specifically is happening in 2Q that you'll see the most provision?

Are you accelerating loan disposition or something that quarter?

It really relates to these 2 credits I mentioned, how the sponsors continue to act and they've been responsible in supporting the businesses of late and the businesses are improving.

Of course, as you well appreciate, it helps the sponsor be responsible when the business is improving.

And so we need to see another quarter or 2 of in fact that continuing.

And we're encouraged but we're not ready to declare victory on either of those until we get another quarter or 2 of performance under our belt.

But that's the biggest unknown about next quarter and whether we're going to have this initially projected front end loaded, namely a bigger provision next quarter than this.

We're hopeful that we could come in if those 2 credits and sponsors keep performing as they are that we could come in more modestly.

But we just don't know at this point.

Okay.

And then sorry to beat a dead horse on credit.

But if we look at the NPAs and the increase there, I know a lot goes in energy, not particular point where we're seeing other banks have an increase on NPAs on energy.

Can you give more color on why you're seeing an increase there?

2 of those 3 are kind of older vintage deals that we really didn't see early on any major issues with.

But that's changed and the type of deals they are, are very out of the fairway, unusual relative to our overall book.

As a matter of fact, 1 of those 2 is a coal methane deal.

And because of the costs involved in developing that particular asset and reserves, there was a miss of what the cost run rates were going to be and the prices haven't helped either on the gas.

So that's the type of thing when Julie said 2 of the 3 are more vintage deals, only 1 is something that we booked really in the last 2.5 or 3 years, 1 of those 3, and that's a different issue.

It's not something that we see as any kind of systemic problem, Steve, in the energy book but nevertheless, another lesson on don't do things that are not in your fairway.

Right.

Okay.

And finally, I won't take up any more time.

Is this more thorough review now completed of the loan portfolio?

Is that why you're confident we won't see criticized increase further?

Well, again, that's why I mentioned I think we're plateauing on the increase in criticized and that's what I expect and my team expects.

And so I think we're about there.

And we should again start to see some of these deals pay off, some refinanced.

And over the course of the next couple of quarters, we're optimistic, hopeful that these 2 larger deals that are properly provisioned or reserved today are going to play out better than we're estimating.

But we still want to stay with our annual guidance on provision at this point till we have another quarter or 2.

And the next questioner today will be Brady Gailey with KBW.

So if you can, can you give us just a little more color on the 2 credits that you're -- that could potentially drive a higher 2Q provisioning?

I know they're levered lending, but what sector are these 2 credits out of?

I can tell you this, they're 2 completely different sectors and we have no concentration in the portfolio in either of these 2 industries.

I can't give you more than that, Brady, because, again, we're involved in some pretty important discussions and work with these 2 borrowers and the sponsors.

All right.

And then, Julie, you told us a couple of times on the call today that we should expect the MCA yield to decrease from here.

I know it has been going up 10-ish basis points a quarter for the last year or so, but I mean with the yield curve, that will obviously come down.

Any idea to the magnitude we could see that MCA yield decrease from here?

MCA -- the MCA yield is going to follow mortgage rate.

So as we churn what's on the books now and have new purchases, it's going to be based on that.

So it's going to follow the mortgage rate.

And what's the delay on that?

Like I know you all keep some and then you sell it.

So it's not -- it doesn't happen immediately but by -- when we're talking 90 days from now, should the new yield curve be fully reflective in that MCA yield?

That's very close.

Yes, that would be correct as opposed to the warehouse and the core, which -- all of which is more tied to LIBOR.

All right.

And then finally for me, just an update.

I know you've been talking a lot about these new deposit verticals coming on.

Maybe just an update on kind of where you stand on the 2 or 3 that are launched and what the balances are there, kind of how you're thinking about the rest of the year.

They continue to grow, Brady.

We're encouraged.

We are still in the process of just launching some new ones.

And the one that could be a needle mover really won't be -- get fully launched until sometime in the third quarter, maybe early fourth, but we're very excited about that business.

The team's with us.

They're working with our technology team to build out the technology that we think will give us best of class nationally in this niche.

But the others are continuing to grow, and we're optimistic that we're going to have at least 4, 5 winners out of those 8. And -- but it's early.

It's just so early that I can't tell you a lot more than the 2 that we launched last year continue to grow.

The next questioner today will be Michael Rose with Raymond James.

Maybe I'll move away from credit and talk about the long-term outlook, which incorporates a 3.5% Fed funds target.

The futures curve is telling us we're not going to get there.

Just wanted to see what the goals look like should rates remain at current levels or perhaps fall a couple times over the next year or 2.

The financial goals are based on no rate increase.

What we had given was if rates went up.

So the over 1.3% ROA, the over 15% ROCE and efficiency ratio of under 50%, that's all in the existing rate environment.

Okay.

So what if rates actually decline 50 to 100 basis points over the next 3 years?

What's the sensitivity, I guess is what I'm trying to get at?

We definitely have plan B on how we'll address efficiencies and work structure.

It's not what is optimum, but it is something that we're looking at in a slower growth environment.

We're not going to ramp up growth this late in the cycle just to generate more revenue growth than we're looking at now.

I mean already, we're on target to grow net interest income around 9% this year, which is I think quite healthy.

And we're growing it with the best high-quality credit mix I think of any bank out there by having this great engine of mortgage finance.

So certainly, Michael, we are committed to continuing to get more efficient even with the rate scenario changing perhaps, and we have plans to make that happen.

So just following up on that.

What are some of the expense levers that you have?

Because clearly, the plans you put into place to kind of change and optimize the expense structure are kind of already in expectation.

I guess I'm trying to ask what are the incremental levers that you can pull should the deposit -- or should the growth rate environment and the interest rate environment go against you?

You do more faster.

It's -- I'm not trying to be flippant at all.

I'm trying to really answer your question.

But the things that we have planned and the technology that we're able to deploy over the next year I think are going to give us opportunities to enable us to hire fewer and fewer new people and use the people we have with the new technology.

Our existing colleagues are going to be able to create more value, be more efficient in how we deliver productivity and deliver even more premier client line experience.

So it's not a situation where we have a company that has lots of brick and mortar, we got to go address how are we going to close a lot of this.

It's not going to be a big contributor.

We don't have that scenario.

We have been investing proactively, as you well know, for 3 years plus to get our technology grid really in top condition.

We're well down the path on that.

And I think we're going to be able to really leverage our people and continue to drive more efficient net interest expense growth, and we can accelerate that.

We have that capability.

I'd rather go on the pace we're planning because there is more training and development that's important to accomplish.

So if we move faster, we may kid ourselves on how much more true productivity we pick up, and it may compromise a little bit.

That's further differentiating premier client experience.

And that's really important that we not just do this to optimize our efficiency, that we do it to improve the client experience too.

But that would be the trade-off, Michael.

And Michael, also, when you look at our -- at the current mix of our funding, obviously, we have a significant amount of index deposits, so if the rates start coming down, those would come down if we hadn't onboarded some of these lower costs.

So those would start to come down immediately as rates come down, and then the variable component in noninterest expense related to deposits that I talk about, those would come down significantly also.

The next questioner today will be Jennifer Demba with SunTrust.

Two questions.

Were any of the downgrades in the first quarter prompted by the Shared National Credit exam?

We didn't have any SNC downgrades, Jennifer.

Okay.

And any interest in buybacks?

I know you were asked about that in the last quarterly earnings call.

Just wondered if the interest level has changed at all there.

Again, we won't rule it out, but that is not something we're considering any time in the near future.

I mean, and not something we plan to act on any time in the near future.

We really want to be in the right position on having plenty of equity but not get to a point where it's putting too much drag on ROE.

So that's the balancing act.

We still think we're fine.

We're going to have a very strong second quarter with mortgage finance, and so I think you're going to see a really nice ROE.

And the next questioner today will be Dave Rochester with Deutsche Bank.

Just real quick on the deeper dive that you did in the loans outside the leveraged lending and energy.

Any industries pop up more frequently within those credits that went criticized this quarter?

Or any geographic areas?

No, there really haven't been.

I mean we've sliced and diced it every way we could possibly think of to see if there were niches or particular industries that were causing more of the credit issue because of an industry margin squeeze or something systemically.

We just haven't found it.

I think what we have found is we've grown really, really fast.

We've hired a lot of bankers.

We've hired a lot of credit underwriters.

We've hired a lot of credit approval people, and it was important that we really, really do what we've been doing the last 1.5 years, Dave, and slow the pace of growth appropriately late in cycle and dig deeper and manage more carefully what we have on the books and then learn lessons from having grown so fast so that through cycle we'll have the strongest balance sheet and the lowest credit costs of other peers.

And we really believe we're doing the right things on that.

Great.

And then just switching to the new deposit verticals.

I know you mentioned more coming in the second half of the year but was just wondering how much lower those costs on those deposits are expected to come in overall versus the book costs at this point.

How much of an advantage does that give you?

The big advantage is going to come from the third major vertical that, again, I mentioned earlier, going to have a much richer mix of demand deposit and also treasury fees.

The first 2 we launched that are the primary ones we're running and growing currently, those are largely tied to money market rates.

So those are not coming in materially lower, but they're very efficient and they're marginally lower than our top marginal cost of funds.

So that's encouraging.

And it's creating more granularity and diversity in the funding as well.

So the big needle mover potentially is this -- this one that will really launch late third quarter.

We are getting off the ground another 4 of these, but again, these are very -- these are brand-new businesses.

And so until we've been out there and had a few quarters to expose the capability of our products and our teams that we're hiring to go sell these on a national brand basis, it's just too early to predict.

We are highly confident with all the analysis we've done on these 8 that we'll have 4 or 5 of these that blended are going to deliver a very nice improvement in cost of funds and certainly, quite a lot more granularity.

Yes, great.

And then I guess just on the NIM guidance.

I would assume you're probably not including too much in the way of deposit growth from the new verticals at this point, so probably not a whole lot of DDA growth at this point?

We're including almost none because, again, they're just very early stage.

We're optimistic that by the end of the year we'll be over $1 billion from 2018 having launched our first 1 early '18.

Our second one mid-'18 and our third major one will launch late in the third quarter.

These other 4 that we're just beginning to test and get off the ground are going to be slower growth, but again, lower cost and add more granularity.

And we feel really good if we create over $1 billion, staggering 3 major new businesses over 2 years with no new brick and mortar and very marginal incremental cost.

We think we're doing all the right things strategically to improve our deposit mix and our cost.

But it's just early.

I wish I had -- this third one, I wish we had all our ducks lined up a year earlier because we'd really be crowing about how nice the deposit costs were coming in, and it'd be incrementally bigger numbers along with those first 2 that are more money market.

Yes.

No, I appreciate all the color.

I guess just one last one real quick.

You upped your warehouse growth expectation, MCA, makes a lot of sense.

Was just wondering just given the increase that you have in your deposit growth expectations is that going to be enough to fund that extra growth.

And just bigger picture, do you think you can fund all your loan growth with deposit growth this year?

Is that what you guys are assuming at this point?

We do.

We think we can.

We feel good about our deposit growth guidance.

We feel good about our net revenue guidance.

We're really still solid on our noninterest expense guidance.

We made a couple of adjustments, some up, one modestly down.

And we're still hopeful on the provision, but we just have to get another quarter or 2 on these 2 credits I referred to.

And today's next questioner will be Peter Winter with Wedbush Securities.

I had a question on asset sensitivity.

I was just wondering, with the Fed turning more dovish, can you talk about some of the steps maybe you're taking to reduce some of the asset sensitivity?

We have the advantage of this MCA business that we did not really have a meaningful business in back when we had the rate decline environment a few years ago.

And that actually is helpful to us.

It doesn't set us up for 5- and 10-year types of duration, but I don't think we'd be convinced yet.

We're just not convinced yet that we should be taking that kind of direction risk anyway.

If we had a lot of excess liquidity and desire to start investing in longer-term assets, I think we'd be very careful.

But incrementally, because of the volume growth we've seen, Peter, in MCA, it does help us some.

And we also are seeing some opportunities that have developed with just owner occupied real estate.

We're not going out and aggressively seeking merchant long-term CRE debt today.

We think that's a real opportunity when the market adjusts, but we think the values of real estate that we'd have to loan against, the appraised values today, they look a little rich to us to go out and do much of a play there.

But on owner occupied, we feel much more comfortable with the underlying business generating the cash flow to pay the debt and us not having to look quite as carefully at the fair market value of the real estate.

But there's not a material change in our approach to growing our asset base.

Those are a couple of things that actually will help us a bit.

So no plans to put on any types like swaps or hedges?

No, we really don't want to complicate our balance sheet.

I think we -- there are potential positives, but we've learned enough horror stories of those that thought they would become derivative experts on their balance sheet, and we just don't think that's a complexity we think serves us well at this point at least.

Okay.

And then just one more question on credit and I'm sorry if you talked about it.

But the increase in nonperforming assets of $53 million, half came from energy, and I'm just wondering what -- if you mentioned what the other drivers to the increase in the NPAs were.

Yes, it was -- I think I said in there it was predominantly energy.

And there were 3 deals, 2 of which had been criticized for some time.

Well, if I'm right, energy was $26 million, right, of the increase, of the $53 million increase?

Yes, and the rest of it was -- yes, the rest of it was some small things.

So the bulk of it -- the bulk of the bigger deals were energy.

Right, but it's still another $25 million.

Yes.

We have nothing else that -- nothing else meaningful, so a couple of smaller deals.

Nothing to call out, I guess, is what I'm telling you.

I think he's saying $3 million to $5 million.

He's trying to get a feel for...

Yes.

Were they leveraged lending?

They were just -- it was just kind of a mixture of much smaller deal.

Okay.

And then...

We took a deep dive on the portfolio, so we don't have as much color on that.

But there aren't any big $20 million type deals that make up the balance, Peter.

We don't see an industry issue with those, Julie.

We don't have any industry concentration or flavor to the smaller deals.

Yes, right.

Energy went up $40 million, yes.

Yes, there was nothing else to call out.

The 3 energy deals, which was -- I think it's $40 million total was the bulk of it.

So instead of $26 million, it was $40 million.

Yes, because they went from -- yes, energy nonaccruals are $77 million and they were $37 million at the end of the year.

So $50 million -- Peter, the $50 million you're talking about was last year at this time.

Nonaccruals for energy are $77 million, and they were $37 million at the end of the year.

Got it.

Okay.

Got it.

And then just one last housekeeping item.

The net revenue forecast of high single digit, I'm assuming that excludes the $8.5 million legal settlement claim.

Is that right?

No, for the year it includes it.

It does include it.

For the year.

By the way, it also includes the NIM, mortgage servicing right adjustment that went negative, so it's offset of chunk of it but anyway.

And our next questioner today will be Brian Foran with Autonomous Research.

I just wanted to make sure I kind of was piecing together the long-term deposit vertical opportunity correctly.

So I think last year, you said 8 planned verticals.

Each could be a $500 million or $2 billion opportunity, and it would take 3 to 4 years to kind of get there.

And then if I heard you right this time, you said you got 2 live, got a big one coming on soon.

You feel good that at least 4 or 5, if not, more will kind of really become meaningful over time, and you'll be around $1 billion by year-end.

So I mean if I put that on a blender, it's kind of the punchline that, over 4 years, there could be 4 to 8 really successful verticals and obviously, the proof will be in the pudding but maybe this could be like a $10 billion total deposit opportunity.

I think it's more like $4 billion to $6 billion.

Yes, it would be a real -- a really great outcome if we did north of $6 billion.

I think it's possible.

But I'm just not counting on, Brian, all 8 of these hitting the median of $1 billion, and that's roughly what you're looking at I think is $1 billion to $1.5 billion on maybe all 8. We've done enough organic growth and innovative new businesses over the last 20 years that we're a little bit conservative and we just don't know on brand-new businesses, how well they do.

I think 4 or 5 of these could well hit the median of $1 billion to $1.5 billion.

So to me, it's more like a $4 billion to $6 billion incremental increase over the next 3 to 4 years.

Got it.

And then your mortgage growth, your mortgage warehouse has been better than peers.

There's always a quarter-to-quarter volatility but even better than peers clearly for a long time.

And I think from the outside looking in, it's always hard to really -- whether it's Comerica or customers or BB&T or Wells, like they all feel kind of homogenous when you look from the outside.

So I mean if you're a client -- or if I'm a client of your business, if I'm a mortgage lender, like what tangibly -- would I see quicker turnaround time, better advanced rates?

Would the technology be better?

Would my relationship officer be better?

Like what do you think are the 2 or 3 kind of real special sauces that enable you to consistently gain share over time?

It really is delivering on all those key pieces that you mentioned, especially the banker talent, especially the technology, that it's not just outstanding for us here in creating scalability but importantly, that it creates a much more user-friendly, more productive and efficient technology interface on the client's desk so that their front line people love working with us and would prefer to put all their new mortgage finance notes with Texas Capital.

And similarly, they love working with our treasury team.

They'd much rather work with our treasury people on managing their deposits than another competitor.

Almost all of our clients have 5 or 6 banks involved in their mortgage finance business.

So our goal is to be sure that we give them the best client experience all the way across and that we also are, Brian, being innovative, listening to our clients about new products as the business evolves.

And we've been a leader in innovating and creating new product over the last 10 years as well that our clients give us insights to and help us craft and then others tend to follow.

But I think we view it as more of a strategic business partner than just purely a bank.

And that's why we're able to win market share and overcome headwinds when originations overall get soft.

And there's only 1 quarter in the last 15 years that I remember any of our competitors grew more than we did.

And we kind of took our eye off the ball.

This was about 2 years ago.

And so our competitors came in with a more aggressive offering for 1 quarter.

And we came back with a vengeance, our team did, and we continue to take market share.

And it's just a fabulous credit quality addition to our balance sheet too.

And just very quickly, I know it's late, the Slide 5, am I interpreting it right that it's kind of a $200 million-ish revenue business and a 13% efficiency ratio, so kind of call it $175 million of annual pretax?

Or am I missing something?

Yes, the -- yes, we don't -- there are pieces that we don't -- you can see the interest income's broken out separately.

You can see the fee component.

And we've said in the past that the fee component of the warehouse, which is a noninterest income, basically covers the expenses.

And then, again, we're not including the deposits in this chart so.

They're in the efficiencies.

They're in the efficiency, so there's a way to back into it.

There's the impact from [defaults] in the efficiency, but that's not something that we've typically given.

We haven't given -- we just haven't talked about the balances of that, which is why we present it this way.

And the next questioner today will be Brett Rabatin with Piper Jaffray.

Jogging up the end here.

Just want to make sure I understood the -- you've talked about mortgage quite a bit but just thinking about 2Q.

You've given guidance for high teens percent growth year-over-year, but just thinking about 2Q versus 1Q, where you were at the end of the period -- end of 1Q versus kind of an average on 2Q.

It would seem like this year you might have a more meaningful expansion in the second quarter mortgage.

And then also just want to make sure I understood just the guidance around that strong 2Q in mortgage.

Is that just mostly a function of the market?

Or are you also onboarding quite a few new clients as well?

It's both.

It's us taking market share and the volumes.

And the seasonality is meaningful in the second quarter.

That's true of our competitors, too, they'll see a nice pickup.

But the thing we do differently is we take market share each quarter.

And so that is the -- kind of the added turbocharge to the growth opportunity we have in this business.

Our bankers are fabulous and our clients refer us our new clients.

It's a great business.

Okay.

And then just to go back to the question, could we see 2Q balances up $1.5 billion, $2 billion in the second quarter?

Can you maybe just give us -- I know you give year-over-year guidance, but it's obviously very seasonal so it's kind of tough to decide what second...

I guess the way I would answer that is Q1 averages were higher than we expected because we started to see some of that come in.

So you can do the math.

But we would see a pickup in Q2 and Q3 because those -- the averages in both of those quarters are usually strong but keeping in mind that our first quarter was stronger than we expected.

And the next questioner today will be Chris Gamaitoni with Compass Point.

I wanted to get a sense of what gives you confidence on the runoff of the leveraged loan book of roughly 30%.

Is that scheduled maturities?

Or are you expecting a significant portion to be refinanced away?

A great deal of it is just normal runoff.

These companies typically -- when the private equity firm invests in the company, their target, as you well know, is anywhere from 3 to 5 years.

Typically, it runs closer to 4, 5 years on the tenure in the portfolio.

So that would just lead you to look at about a 20% a year just natural runoff.

And because we're obviously working hard on derisking the portfolio too, we think there will be opportunities for other pools of capital to refinance us if we have covenant breaches or things that might come up.

And so we think there's a really good likelihood that we're going to see somewhere in that 30% runoff range between the 2.

All right.

And then one small one.

The loss on loans held for sale quarter-over-quarter improved significantly.

Is that reflective of correspondent margins in the channel?

Or is it something else?

Yes, we talked about last quarter that what we did in the fourth quarter is we held some of those loans longer; held some of them longer and so there were some offsets, some extended hedging costs that affected that.

And so because of the volumes that we've seen and that started in the first quarter, there's just more churn to it, so that improves the gain piece -- or the -- it lowers the loss piece.

And the next questioner today will be Brock Vandervliet with UBS.

I'm aware of the full year guide on the NIM.

I was just wondering if you could offer any sort of additional color on the trajectory the remainder of the year as you may get benefit later in the year from some of these new verticals pressure in the near term.

Like any color you have on how we should think of shaping that margin trajectory the rest of the year?

A lot if it is just the mix, Brock, with warehouse being stronger than we had originally thought we could generate for the year.

And so that's a significant piece of the NIM issue.

I'm very happy to take that tradeoff to have such high credit quality to our net interest income growth and our balance sheet strength, but that is a big piece of it.

Julie, is there something on the cost side that's material?

No.

No, it's really, Brock, the bulk of the change in our guidance is really related to the earning asset [shift] with more of it coming from -- more growth coming in both warehouse and MCA, both of which are lower yielding but very positive for net revenue.

And this will conclude our question-and-answer session.

I would now like to turn the conference back over to President and CEO, Keith Cargill, for any closing remarks.

We appreciate each of you joining us today and your interest in our company, and we're excited about the balance of '19 after a good start in the first quarter.

Again, thank you for your time.

Good night.

Thank you for your participation in TCBI's Q1 2019 Earnings Conference Call.

Please direct requests for follow-up questions to Heather Worley at heather.worley@texascapitalbank.com.

You may now disconnect, and have a great day.