Texas Capital Bancshares Inc
NASDAQ:TCBI
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Texas Capital Bancshares Inc
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Good afternoon and welcome to the Texas Capital Bancshares First Quarter 2018 Earnings Conference Call. All participants will be in listen-only mode during the presentation. 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 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, 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%. Fill it in 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 consistently linked quarter even with the seasonal softness in Q1 and grew 28% from Q1 2017 to Q1 2018.
Finally, ROE continued the upward three 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 remain 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 billion at the end of 2017. Our energy reserve remains 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 non-accruals 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 described the significant geographic diversification of our loans and deposits. Also you will note in the upper right hand quadrant that three of our four Texas metro markets shown unemployment under 4%. Fueling continued strong population in migration and robust overall economies. Julie?
Thanks Keith. My comments will cover Slide 6 through 12. Our reported NIM increased of 24 basis points from the fourth quarter. The decrease was 653 million and average liquidity assets of 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 news in LIBOR. First quarter NIM includes full impact from the December fed rate move and some from March move.
However, the LIBOR movement specifically one month LIBOR is really more meaningful for us and has moved in advance of fed funds and moves have been a greater spreads in 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 at the overall portfolio yield. We experienced some 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 in mortgage finance was in line with our expectations and we expect volume 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 number only included a few days of the December fed funds move on the index deposits similarly Q1 only includes a few days of the March news. Additionally, we are seeing a pickup in the magnitude of rate change request. Continued solid deposit top lines but as we've said several times in the past, it can involve a long sales cycle so difficult to forecast exact timing and it can be lumpy and how it comes on, and most it is going to be interest bearing.
The change in loans with floors with the rate move in March were now around the 170 million down almost 400 million from the end of December about fairly a relevant at this point because no significant difference in the rates on floored versus un-floored 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 balances about average by over 316 million provides a good start to the second quarter. The level of payoffs continued to be high and no sign 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 a higher level.
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 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 into 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 two major deposit categories moving in tandem with fed rate that totaled approximately 5 billion in balances.
We move on to non-interest 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 was a decrease of 2.2 million in non-LTI and annual incentive pool expense and that's driven by the million in special incentives we did in -- for the fourth quarter as well as our annual incentive accrual ramps through the year and generally starts out at a lower rate in Q1.
With 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. First quarter expense of 5.6 million compared with fourth quarter of 7 million with stock price impact of slightly less than a million coupled with several other items.
Legal and other professional was abnormally high in the fourth quarter with some non-recurring 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 continued to be profitable in 2018.
And again, we don't have -- we have no new outsized build out plans for this year. Just a few reminders about the more variable part of our noninterest expense, as we 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 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 includes 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 non-accrual levels 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 resolution. First quarter increase in nonaccruals as compared to fourth quarter includes two large C&I credits. Different industries and 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 and 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 costs for the quarter to 14 million.
The OREO charge is on the same property as the write-down in Q4. The valuation allowance taken -- 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 a 100%, almost a 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 were led in the cycle and qualitative factors support for 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 provision levels. 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 digit growth for the year and that’s despite expected industry contraction and origination.
No change in MCA guidance at a 1 billion, 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 non interest bearing to interest bearing. Seasonal declines in the positives 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-50 million to mid-60 million levels. As we’ve said, we’ll try to tighten 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 non-interest expense at high single digit to low-teens percent growth. And finally, our guidance for efficiency ratio is improved to low 50, first quarter results were positive for efficiency ratio, and was also a positive impact on net revenue from the March rate. 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 three 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 to strong 13%.
Our asset betas continued to overcome the shift in deposit composition allowing for continued positive income contribution with future rate increases. Credit metrics remain strong. Our three year focus on lifting ROE, the sustainable mid-teen level is working. We continue to slow the pace of NIE growth, sustainably higher ROE requires that we maintain our strong track record in 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 ROE.
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 of Bank of America Merrill Lynch. Please go ahead.
So I wanted to touch base in terms of -- I think you mentioned about the importance of asset betas and I think that's -- there have been fair amount of concern around your deposit costs in particular and I think it misses the point around the re-pricing that we’ve seen on the asset side. When we look at the re-pricing 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 you look at the March rate hike, we saw about 25 basis points pick up in both those loan buckets like should that continue into second quarter, if we see a similar moment LIBOR in the middle of 2Q and the fed funds impact from March?
We do believe that’s going to be the case, Ebrahim. We don’t build in future rate increases as we mentioned in our guidance, but we do see our asset betas continued to pass us on some expansion as rates increase.
Understood, so the moment we saw on the warehouse that should continue, right, because we saw some adjustment last year when you readjusted prices, but the warehouse will stabilize for a couple of quarters. It looks like we’re back in re-pricing mode and that something that should continue in 2Q and going forward?
I mean that’s what we expect for now but you know 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 look back as needed in that space but…
But we are very much past that for several months when we redeployed our incentive program relationship incentive program and that was about this time last year, and I think that's what's you are alluding to. And so, yes, things are somewhat more stable because we are well positioned, we are continuing to take market share gain, and so we are going to be competitive off course, but we relationship price and that's what really well for us over the years.
Understood, and last quarter I think you two mentioned in terms of, if we get three rate hikes you should see 15 to 20 basis points upside to your NIM guide, I guess if we get two more hikes as 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 actually increase margin as we get future hikes. We can't tell you precisely what will be, but again as you can see from this last quarter we are up about 14 basis points, some of that about for those basis points were relative to the liquidity shift. So, I do think we are 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 for the rest of the year from here?
That right.
Our next question comes from the line of Brett Rabatin of Piper Jaffray. Please go ahead.
Wanted just ask maybe if you can just go back and 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 get back and maybe walkthrough some of the assumptions on liquidity and kind of what you are assuming for deposit betas from here, if they pick up a lot? And just kind of looking to get little more color on margin that margin guidance maybe not been a little more aggressive than it is?
So, Brett, again we don’t assume any additional rate hikes, and in this first quarter, there was a 10 basis points pick up from liquidity -- from the shift and liquidity. And so, as deposits come back that liquidity level could build up, not anything outsize, but it can fluctuate it can cause the NIM to fluctuate from quarter-to-quarter, so…
No, it increases net interest income as you know, Brett. But it could put a little step down on margin, right, if liquidity inflates.
Same thing with just other asset changes in the asset mix as mortgage finance comes into their seasonally stronger quarters. When there is 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 margins and that can cause it to fluctuate from quarter-to-quarter.
And then wanted just to ask on MCA, the guidance for a 1 billion and average outstanding, I'm curious why that's just kind of the number that you are sticking with. Is there a potential for that to be the higher than the 1 billion average? And why it is kind of the 1 billion the number that's you are focused on there?
Well, I think we will be able to do some 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. Please go ahead.
Just back on the warehouse, I know you 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 these new increased guidance numbers of those.
Okay.
So unless the market changes, no, we don't expect to be able to re-trade or re-negotiate that incentive deal.
Okay, and just on your mortgage guidance. So just wondering why you moved the guidance up for the warehouse, but not for MCA? Was it -- we just had a more positive result on the warehouse versus what you originally thought. Just any color there would be great?
Well, I think our guys are sandbagging just a pad on the corresponded business, but 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 a 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 will re-look at it for the balance of the year.
And then on deposit you reiterated the guidance there for low-to mid-teens growth this year, which implies a decent amount of growth from here. So just wondering what you're seeing that gives you guys the confidence there. Have you just talked about areas you think might be good drivers of sources of that growth? And then what the pricing is on that growth that you think you're going to get just x more rate hikes that'll be great?
We feel good about our pipeline and we have a good solid pipeline and even though we haven't really seen any kind of outsize pickup from existing clients coming to us and saying they want to do some significantly 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 about from?
It's really broad of course we're getting a little more growth and energy in 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 CNI industries that we finance.
And Julie you said that it would all or 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?
We're probably not going to get into specifics about pricing but it's -- I mean what we're seeing in the pipeline is still at good rate. It certainly less than we're paying on the index money, so I mean we feel good about that, I don't think 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 were coming in lower than the book yield, which I would imagine is higher than the book yield for 1Q. I was just curious where spreads are on time 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 we're having the cut the pricing. So, it is somewhat more stable than we saw year-over-year, quarter-over-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 the 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. Please go ahead.
So, if you look at loan yields, it sure doesn’t look like anything is getting computed away to the tax reform and loan yields were up 24 to 25 basis points. Keith, I know really 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 really is 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, couple of deals that we were competing on with but what we thought it was just really irrational pricing. But in terms of competitors coming after a client, we’re not going to allow our clients 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, but we faced that. But on new prospects it needs to be rational we’re not willing to go giveaway our new found tax benefit, but when it comes to defending clients we’re absolutely going to defend clients and we’ve had success doing that.
Right, and 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 costs catching up. I mean that’s certainly was not the case this quarter, but do you still think that's the right way to look at your asset sensitivity and maybe when 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, and I think this intellectually -- our logic is still sound that we should see some more catch up more quickly with more of our commercial funding then buyings are going to see catch up with their consumer funding, but it’ll be later. And at some point I think those lines cross and we’re going to be really pleased with our funding costs. So far it's not come as fast and it continues to not come as fast on that catch up as we anticipated three 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 business like.
And then finally from me just any color on any new lender hires and just tell your take on your ability to hire away talent in Texas right now?
We’re more confident then we’ve been in some time. We picked up some really fine bankers over the last four months. And importantly to, we’re having really good success with some of our young people that we’re bringing through our management training program, they are 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. Please go ahead.
Just wanted to get your thoughts on capital levels, as I run my model looks like capital is going to build from here obviously as part because of tax cuts, but how should we think about I mean you guys grown at a good pace for sure, relative to the industry but capital does work to be building here at least on TCE basis. How should we think about your ability to deploy capital and improve your turns on equity overtimes?
Well that will be a new challenge for us as you can appreciate having followed us for so long, Michael, and we welcome that challenge, but it is a new challenge. What I will tell you, this is not the time in the cycle to worry about being cheerfully levered and drove for with every loan we can may. We’re being more selective than we’ve even 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 grown 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 might have a little capital bill, what we've been able to experience over the years is when there is a down cycle, and we done the right thing and then disciplined early and not gotten over excused and try the loan as much as we could late in the cycle than we've been able to deploy quite a lot more capital during the downturn cycle, and some of those industries that are in the ditch with our competitors.
And so, again, I hope we don't have a recession if we have to face up to in the next two or three years, but we're preparing that we're in late innings, 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 to deploy that rather than go back to Wall Street as frequently as we used to.
And that's certainly a better dynamic within. And maybe just a follow-up to that, with tax form how you guys have any sort of targeted ranges for any of the capital levels that you'd like to be in a 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, it's we're kind of early into this phase. And if we all keep our heads and we don't have continued outsized competitive pressure on banks that are only growing at the GDP rate or quite lower and feeling pressure that with their low growth then hopefully we won’t get too much of that way, and we'll be able to continue to realize these mid teams and even raise the mid things run rate we saw this quarter on ROE and that is our goal. And we want to achieve this to Michael before rates peak, we've had this unexpected tax benefit. And so, we thought it might be three years before the rate cycle might peak.
And now off course, it's always uncertain but we are realizing early some of this benefit in ROE from tax cuts, and so we intend to just really on improving fee mix, improving efficiency as we are rebuilding quite a lot of our technology in the last two years and again this year, and improving our processes and client experience. I want to emphasize client experience, so all we are doing around technology and refreshing our offerings to clients, we are listening and talking with them so that it improves client experience and elevates our RMs to have even deeper and more strategic relationships with their clients and continue to have the lowest turnover of appliance in the industry that's very important our model.
So those are the key things actually 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 the liquidity run rate over the course of next year, two years. And in this up rate cycle, we are going to have to see how that mix develops on non-interest bearing and interest bearing, but we are also seeing some other alternatives that will present themselves as other earnings asset opportunities for us as the rate cycles around this course too. So those pieces are little uncertain to address, but I do think we can sustain a higher ROE and the rate increases that come ahead of this are going to be a contributor, but we want to be sure we are delivering on slower NIE growth too.
And, I'd say Michael, I mean we're comfortable with that improving ROE as 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 and maybe just one for me. You guys overtime have developed a lot of very successful deposit strategies and even predating the liquidity build that we've seen in balance sheets across those 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 can give you some color on that but not as much off 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 national footprint industry treasury product set, as we have today. In the previous 20 year of the Company, I remember at the most we would look at two in a given year or two and might do one new industry vertical. And already in the last six months, we are testing to and looking at an incremental potentially six more new industry verticals on the deposit side.
Now, we won't do six more, we are 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 two we're testing is great receptivity to what we are offering, it's early we are not ramping it up, it's still in a pilot mode, and I'm fairly confident we are going to go from two to at least four maybe five, not eight, and that would be again a record setting pace rest offered these new capabilities in a 1.5 year and 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 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 lock some of these -- until they'll become meaningful, obviously, we don't want to 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. Thanks.
No more Voldemort, this is not a complete. I want to encourage you on these new deposit verticals, it’s a very small fraction of what it costs to build out a full new business and as you know we rebuilt three businesses simultaneous to building three brand new businesses that were full credit businesses and deposits, full operational businesses. These are not nearly as costly and it certainly takes time and effort and you got to hire the right talent that knows the industry niche, and you got the right product set to keep it refreshed, but it is a small fraction of what it costs to do a full build out business.
Our next question comes from Peter Winter of Wedbush Securities. Please go ahead.
If I can stick with the margin, you know if I take out the benefit from the decline in excess liquidity so I get 361 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 got the March rate hike?
Right, the changes in asset mix from quarter to quarter, so there was also some pickup in the margins because Q1 is a seasonally lower 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 manage this income, but it can cause some fluctuation 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 a 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 new still come through in traditional and probably in warehouse but it can the asset mix shift can cause some fluctuations in actual in NIM from quarter-to-quarter.
That's fair. On a separate note, I know you're not done with it, but can we just get an update what you're seeing with regard to the spring redetermination in energy?
So far no surprises, I think we're going be a good solid position on the redetermination. So unlike what we faced for two or three springs and falls, things are looking better and we should have net positives as we 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 will have most of it dealt with, and I mean most of it in terms of 80 plus percent of it if not 90 percent of the charge-offs accomplished, but it does take some time to resolve these last ones that are non-accrual, but we think we are very well reserved.
Our next question comes from Jennifer Demba of SunTrust. Please go ahead.
I think most of the questions have been asked, quick question on the increase in non-accruals from the two larger commercial loans. What industries were those in?
We are dealing with a couple of new problems and I’d really want -- don’t want to telegraph the detail there, but it's not healthcare let me tell you that, we’ve had that before. One of the ORE -- the write-down of the ORE which was a subsequent $2 million write-down was a piece of healthcare real estate that we dealt with in the fourth quarter too. But there’re two C&I deals of the size that we 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 if that’s helpful, but that’s about I could say today.
And Jennifer, as I said in my comments, its different industry, the two are not the same industry. So there’s nothing to -- there’s no bigger impact from specific industry that we would expect, these are just two one off deals.
And we’re not seeing migration and these are -- these types businesses, no migration from other categories that are still passed the lesser grade or weakening. So that’s what Julie is alluding to. We are not seeing any kind of pattern. These are just two situations where we’ve had some --clients have had some challenging decisions that might not -- made the best ones in some cases.
Are either the credit -- shared national credits or clubbed deals?
Well, it's 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 helped.
Our next question comes from Geoffrey Elliott of Autonomous Research. Please go ahead.
Another question on the deposits 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 looked to the second quarter, should we kind of think about there being some follow through from what happened in December, positive impacts of March?
If I am understanding your question, yes, there’re -- because of the rate -- the rate move was late in March in Q2, there’ll be the rest of the impact from that. So we have the two categories which are for all intent, purposes index, and they would have only -- Q1 would only reflect of two 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 coming a bit faster now, certainly then they were in the second half of this year. So does that just kind of amplify the effects? The -- I guess the reason I am talking about what happened in the second half of last year is because you only had rate increase late in December but some of the move out in 4Q felt like it was may be triggered by some the competition that was kind set up post the June rate rise. 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 of the 30 day reset. So part of it is just that 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 then to just clarify on something I thought I quote you said, you say said earlier. Did you talked about adding a variable component to comp link to deposit? Did you say that in the prepared remarks, I wasn't quite sure of?
Yes, there was an added fee in legal and other professional, this directly related to some deposits sort of this cost.
Why -- so that's using outside providers to help you find deposit because just if you could explain more what that is?
Yes, for competitive reasons we will get into the specifics about what that is. But yes it's tied just to a couple of category of deposits that we had and services that we provide in those categories. That's something that comes up and that’s why we wanted to go ahead and give a little color on that because it's something that that we will see going forward.
Our next question comes from Brock Vandervliet of UBS. Please go ahead.
I just wanted to clarify first off, if the non-interest expense base that we see in Q1 is kind of a good level base level to start the year?
Yes, I think that’s fair. We try to point the some of the seasonality that occurred in the first quarter and then again that clarifies there's some additional deposit related cost in the couple of categories, but yes I think that’s fair.
And getting to the guide of the non-interest expense guide, high single-digit to low teens, I know you don't want to narrow that at this time. But what should we think of in terms of since that is a pretty wide range? What could keep you toward the bottom that versus pushing through the upper end?
123R has a big effect on it, Brock. And we hope we have some hire expenses related the stock price depreciation, but it's not something we control of course. So that would be one of the factors. Other things that would impact this would be, if something unplanned at this point where to present itself as a real opportunity. And again, we give ourselves 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 of on these things than maybe some companies.
Our next question comes from Jon Arfstrom of RBC Capital Markets. Please go ahead.
Question just on bigger picture loan growth, the LHI excluding mortgage. Curious if you, as Keith Cargill more optimistic and all your clients more optimistic you haven't change the guidance when 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 is what I think today. So we try to stay very close to the clients and my optimism comes from some more confidence that are clients are demonstrating, but again they are 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 full ride off on CapEx and the like. So, we are still wondering and waiting, if that's going to happen and we haven't built that into that guidance, but we are seeing them want to build out their businesses more than they want to do.
They've seen deregulation happen and affect their businesses, they're encouraged by it with all the noise and so on that comes out of Washington then that result of what's actually happened in terms of regulation has been positive, and it's been broad across many industries that we would finance just encouraging for us banks. And off course the tax reform I think is a plus, but that optimism gets offset a bit by new banks or things like the midterm elections or 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 in our overall guidance, and generally I'm more optimistic this economy has legs for some while longer than it was even four or five months ago.
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 a cycle, but do you have any emerging concerns on credit? It sounds like that's not the case, but is there anything maybe you are watching a little more carefully?
We don’t have any emerging concerns other than just being late in the cycle and we've been early to have those concerns. We've been concerned about that for two years and then more and more and more selective on those kinds of assets that we think have been quite hot and continue to perform extra ordinarily well, but are just somewhat concerned just late in the cycle about being sure we are making better quality loans in those categories. So that when things turn, it will 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. Please go ahead.
I just had a question on. I was looking at Slide 5 in your deck that talks about the geographic diversification, if I'm looking at the deposits in the Texas region and look 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 warehouse 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 wondering to see you offered new 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 you know clients leave us without calling and talking about rate, things of the sort that we are then go back and take a look at the relationship and make appropriate adjustments and things of this short, 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 two that the grey chart and the dark grey chart one more expensive than the other.
I would say they're really quite close I mean, there's 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 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 First Quarter 2018 Earnings Conference Call. Please direct any request for follow questions to Heather Worley at 214-932-6646 or heather.worley@texascapitalbank.com. You may now disconnect.