Texas Capital Bancshares Inc
NASDAQ:TCBI
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Texas Capital Bancshares Inc
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Good afternoon, everyone. And welcome to the TCBI Q1 2019 Earnings Conference Call. All participants will be in a listen-only mode during the presentation. And please note that this event is being recorded [Operator Instructions].
And I'd 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 that 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 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, 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 will 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 $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.
Non-interest 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. Non-accrual loans to total LHI were 0.57% compared to 0.60% in Q1 '18.
Slide 4 highlights our energy loans and C&I leverage loans. Energy loans equaled 7% of total loans as was the case in Q1 2018. Non-accrual energy loans increased to $76.7 million from $50.4 million one year earlier. Allocated reserves equal 3% of energy loans or $48 million 600,000. C&I leverage loans equaled 5% of total loans or $1.2 billion versus 6% of total loans or $1.2 billion at Q1 '18. Non-accrual leverage 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 leverage 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 run-off of approximately 30% of the leverage 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 line 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 explode the opportunity and hired top national talent and take quality client market share. We made the largest investment in our history and a specialize 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 three and one half years ago. While this led 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 and mortgage finance despite headlands affecting mortgage origination volumes, because we're able to outperform competitors and take market share to offset origination 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 Slide 6 through 13. Our reported NIM to decreased 5 basis points from the fourth quarter with about 2 basis points related to additional liquidity. Our traditional LHI deals 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 the lower level of fees this quarter.
Traditional LHI betas continue to be as expected but we can see pressure on spread as competition remains robust. Fees were lower in the first quarter as compared to the fourth quarter, which account 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 core increase in average interest bearing deposits, and overall deposit costs increased by 16 basis points from 117 basis points in the fourth quarter to one [through] 33 in Q1. The increase was expected as Q4 numbers only included a few days of the December fed funds rate move on the index deposits. 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 deposits top-line 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 25 basis points 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’s 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 pay-off continues to be high, primarily in CRE and some C&I leverage. We would expect pay-off in C&I leverage 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 pick-up in linked quarter average deposits with all of the growth in interest bearing, primarily interest-bearing deposits in the top line but we continue to be vigilant on maintaining and growing core existing relationships. Interest bearing deposits declined slightly in the first quarter. We expect more gradual increases and 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 non-interest expense. First quarter expenses have some noise but overall, we're pleased with the trends 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 in a much lower level of FTE addition. 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.
A differed comp plan that was started a couple of years ago now has a sizeable 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-plus from fourth quarter to first quarter. However that's offset in non-interest income, so net neutral impact on net income, but rather just to gross up in income and expense. Portion of the marketing category continues to be variable in nature and is tied to growth and 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 volume. 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. Non-accrual levels increased but still at a relatively low of 0.57 of total LHI. The increase is primarily related to three energy deals, two of which have 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 non-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. With the 50% of that was in the special mention category, and is not surprising as a result of a continued focus on the leverage 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 rating and especially life cycle, which can drop higher provisioning and classifications early.
The $20 million in first quarter provision is related to the migration that I have discussed, and is in line with our annual guidance. As we have 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 in the interim financials or our ongoing dialog 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 off 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 non-interest income includes an $8.5 million legal settlement, which is obviously non-recurring; 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 non-interest expense compared to prior year Q1; and is 8% excluding the MSR writes down and compared to 15% net revenue growth are 12% if you exclude the non-recurring legal settlement.
On a PP&R basis, the earnings power continues to improve as we evaluate our year-over-year comparison. ROE and ROI levels were improved in Q1 as a result of lower provision level. We can see some lift in ROE levels later in the year if provision levels come in lower than guidance.
Now, we'll move on to the remainder of 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 run-off 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 its very positive on earnings and it make sense from a risk prospective while we work on the appropriate run-off 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 pick up in market share in this 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 non-interest-bearing deposits trend. 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 expects more meaningful growth in total mortgage finance, which is lower earning assets. While slightly punitive to NIM, the added growth is very positive to net revenue and net income. The guidance containing 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 from 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 warn any adjustment. Guidance for our non-interest expense remains at mid single-digit percent growth. We continue to do 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 longer-term outlook, which is on flat 13% and is part of our three 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 strategic level with our clients. We have long been known as a high fetched client service company but we are committed to further differentiate our reputation of becoming the premier client experience bank against all key competitors. This undertaking includes the three 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 interests into our clients' emerging needs.
Regarding LHI growth, it was solid in Q1 2019 despite our deliberate efforts to allow run off in leverage lending and be ever more thorough in booking only high-quality new loans across all lines of business in this hyper competitive 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 high 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 to 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 rollout and grow. The growth in our new deposit verticals will allow us to run off higher cost deposits overtime. This will help us show net deposit growth at improved cost and 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 non-interest 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 will turn it over to William to open the lines for Q&A.
Thank you [Operator Instructions]. And the first questioner today will be Ebrahim Poonawala with Bank of America Merrill Lynch. Please go ahead.
I just wanted to touch upon criticized loans and credit, Keith. 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 when three 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 a moving target? Because I feel like there's been a lot of impact to the stock, and just concerned on the stock around credit and things slipping negatively. So would love to get some color around that?
Well, as we've been describing at each quarter the last couple of quarters, Ebrahim, we've taken a very deep dive not just in leverage lending, but really through our entire loan portfolio. And we think that was prudent having seen some of the leverage lending deals begin to pop-up second quarter last year, and then they continued in the third. And we wanted to be sure, as I mentioned last quarter that we had not had any leakage into having any 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. Ad 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 in 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 mentioned, as well as in some of those are what we call classified like.
We're being conservative in how we're looking at our credits. And so, while we're not overstepping our methodology and our approach, we're definitely being conservative in 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.
So I guess takeaway is we 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 year-on on credit should be relatively low?
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 years we have almost tripled the Company. And so it was very, very important for us to start this tipping down at the growth rate, which we did over a year ago to be sure we were all about quality and having -- building the strongest balance sheet possible for the next down cycle. We really believe we earned 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 life cycle whether the economy last another year or three years, we're later in the cycle than we're early.
We're seeing a lot of signs of assets values really, really peaking that a lot of clients selling assets, which often is an indicator to; there were nearing the late end the cycle; seller do only have a better field for the value they want to realize; and big pools of capital that what 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 will 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 three or four years and we think we're headed in the right direction.
And if I may just on a separate topic. Julie, just if you could talk about the three loan buckets when we think about the yields today with the fed on the sidelines. What's the expectation on those in terms of, should it be relatively flat, just lower, just any expectations? Do you expect any of the fees that went away this quarter to come back?
So we will start with traditional core LHI. As I 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 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 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 felt that those yields 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 sales and we put on new, it will be tied to the note rate, which will be lower.
And our next questioner today will be Jon Arfstrom with RBC. Please go ahead.
Just maybe the other side of Ebrahim's question on deposit cost. 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 better deposit mix shift later in the year. And I’m just curious what magnitude you're signaling in terms of easing deposit pricing pressure?
I don’t think we're signaling anything specific at this point. We will talk about that as we get more traction with the different verticals. But we view things for now, because we have such a big $5.5 billion in index deposits. We're getting some relief from the fed pause from that. So we saw all that re-price in the first quarter. And then as I said, with all that re-pricing, January, February and March, our overall costs were pretty stable. We do think there'll 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 past.
And Jon, we seasonally have a softer first quarter and DDA, that’s typical because of some of the large commercial accounts we have in a couple different industries. So that is going to be rebuilding in the second quarter and should hold up better for the next couple of quarters.
And Julie, the 15 basis points you talked about, you're basically saying a lot of that pressure has gone away at this point?
Right, because a lot of that was from the re-pricing, a full quarter of the fed re-pricing on the index deposits.
And then back on the provision two parts that 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 drilldown specifically, because we are working with a couple clients that's important. But two of the eight credits that we've referred to before, we have upgraded conservatively today but that's because of sponsors and the businesses. The sponsors are acting responsibly, the businesses are improving. If those things continue to play out on those two deals, in particular, I think we have a get 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.
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.
And the thing that 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 sub-standards and obviously that cost more in provision dollars…
We feel very silent about our annual guidance still on provision. We just think there's a chance we could beat it, but we're another quarter or two away on these two deals.
And our next questioner today will be Steven Alexopoulos with JP Morgan. Please go ahead.
To start on credit, Keith, I appreciate the deeper dive into the loan book. But 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? If we look at leverage C&I up $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 actually is what we're telling you, I think most banks though would rotate over the course of four 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 four months, actually the last five months to do a much deeper dive, Steve and not just on the leverage 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 giving you a more real-time update than most banks could give you, if that make sense.
And then, on the provision guidance, which I guess implies a 2Q has 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?
I really relate to these two credits I mentioned. How those sponsors continue to act and they've been responsible in supporting the businesses off late and the businesses are improving, of course as you well appreciate. It helps the sponsor to be responsible when the business is improving and so, we need to see another quarter or two 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 two of performance under our belt.
But that's the biggest unknown about next quarter and whether we are going to have this initially projected front-end loaded, mainly a bigger provision next quarter than this. We are hopeful that we could come in, if those two 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 of those are in energy, not particular point where we are seeing other banks have an increase in NPAs on energy. Can you give more color on why you're seeing an increase there?
Two of those three 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, one of those two is a coal methane deal. And because of the cost involved in developing that particular asset and reserves, there was a miss on what the cost run rates are going to be and the prices haven't helped either on the gas.
So, that's the type of thing. When Julie said, two of the three are more vintage deals only one is something that we booked early in last two and a half or three years, one of those three and that's a different issue. It's not something that we see any kind of systemic problems Steve in the energy book. But nevertheless, another lesson on don't do things that are not in your fairway.
And finally, I won't take up any more time. Is this far more thorough review now completed of the loan portfolio? Is that why you're confident, we won't see flat criticized increased 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 are about there. We should again start to see some of these deals pay off, some refinance and over the course of the next couple of quarters we are optimistic, hopeful that these two larger deals that are properly provisioned or reserved today are going to play out better than we're estimating but we're still want to stay with our annual guidance on provisions at this point until we have another quarter or two.
And the next questioner today will be Brady Gailey with KBW. Please go ahead.
So, if you can, can you give us just a little more color on the two credits that you're, that could potentially drive a higher 2Q provision, another lever lending, but what sector are these two credits out of?
I can tell you this. They're two completely different sectors. And we have no concentration in the portfolio in either of these two industries. I can't give you more than that Brady, because again, we're involved in some pretty important discussions and work with these two borrowers and their sponsors.
Julie, you told us a couple 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'll obviously come down. Any idea to the magnitude, we can see that MCA yield decrease from here?
The MCA yield is going to follow mortgage rates. So as we turn on the books now and have new purchases, it's going to be based on that. So it's going to follow mortgage rates.
And what's the delay on that? Like I know you all keep something and you sell it. So it's not, it doesn't happen immediately. But by, 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.
Okay.
As opposed to the warehouse and the core which all of which is more times a lot more.
And then finally for me just an update, I know we've been talking a lot about these new deposit verticals coming on and maybe just an update on kind of where you stand on the two or three that are launched and what's the balances are there and 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 teams with us, they're working with our technology team to build out the technology that we think will give us best in class nationally in this niche. But the others are continuing to grow and we're optimistic, that we're going to have at least four or five winners out of those eight. And but it's early, it's just so early that I can't tell you a lot more than the two that we launched last year continue to grow.
The next questioner today will be Michael Rose with Raymond James. Please go ahead.
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 two?
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 is under 50. That's all in the existing rate environment.
So, what if rates actually decline 50 to 100 basis points over the next three years? [Multiple Speakers]
We definitely have plan B and how we'll address efficiencies and/or 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're committed to continue 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 did more faster, I’m not trying to be flipping it 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 on experience.
So it's not a situation where we have a company that has lots of brick and mortar. We got to address how we're 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 three 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 would 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 that might compromise a little bit as 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 -- the current mix of our funding, obviously, we have significant amount that index deposits. So if rates start coming down, those would come down, if we hadn't on-boarded some of these lower costs. So, those would start to come down immediately as rates come down, and then the variable components 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. Please go ahead.
Two questions. Were any of the downgrades in the first quarter prompted by the shared national credit exam?
We didn’t have any SNCE downgrades, Jennifer.
And any interest in buy backs, I know you were asked about that in the last quarterly earnings call. Just wonder, if the interest level has changed at all there?
Again, we won't rule it out, but that is not something we're considering anytime in the near future. I mean not something we plan to act on anytime in the near future. We really want to be in the right position on having plenty of equity, but not yet to the point where it's putting too much of drag on ROE. So, that's the balancing act. We still think we are 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. Please go ahead.
Just real quick on the deeper dives that you did in the loans outside of the leverage lending in energy, any industries pop-up more frequently within those credits that went criticized this quarter or any geographic areas?
There really haven't been. I mean we sliced and diced it every way we could possibly think of to see if there were niches or particularly industries that were causing more of the credit issue because of an industry margin squeeze or something systemic. 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 in the last year and a half 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 will have the strongest balance sheet and the lowest credit cost of other peers, and we really believe we are doing the right things on that.
And then just switching to the new deposit verticals, I know you mentioned more coming in the second half of the year, but I was just wondering. How much lower those cost on those deposits are expected to come in overall versus the book cost at this point? How much of an advantage does that give you?
The big advantage is going to come from the third major vertical and that again as I mentioned earlier. We're going to have a much richer mix of demand deposit and also treasury fees. The first two we launched that are primary ones, we are running and growing currently. Those are largely tied to money market rates. So, those are not coming in materially lower, but they are very efficient and they are 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 four 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 are hiring to go to 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 eight, that we will have four or five of these that blended are going to deliver a very nice improvement in cost of funds and certainly quite a lot more granularity.
And then I guess just on the NIM guidance. I would assume you are probably not including too much in the way of deposit growth from the new verticals at this point, and so probably not whole lot of DDA growth at this point?
We're including almost none because again they're just very early stage but we're optimistic that by the end of the year we will be over a billion dollars from 2018 having launched our first one early '18, our second one mid '18, and our third major one will launch late in the third quarter. These other four we're just beginning to ask to get off the ground are going to be slower growth but again lower cost and add more granularity, and we feel really good that we create over a billion dollars, staggering three major new businesses over two years but no new brick and mortar and very marginal incremental cost.
We think we're doing all of the right things strategically to improve our deposit mix and our cost. But it's just early I wish that had the third one I wish we had all our ducks lined up a year earlier because we really be crowing about how nice the deposit costs are coming in and it'd be incrementally bigger numbers along with those first two that are more money market.
I appreciate all the color. I guess just one last one really quick. You're up to your warehouse growth expectations MCA make a lot of sense. I was just wondering given the increase that you have in your deposit growth expectations. Is that going to be enough to fund that extra growth? And bigger picture, do you think you can fund all of your loan growth to deposit growth this year? Is that what you guys are assuming at this point?
We did. We think we can.
Great.
We feel good about deposit growth guidance. We feel good about our net revenue guidance. We really still solid on our non-interest expense guidance. We made a couple of adjustments some up, one modestly down and we are still hopeful on the provision but we just have to get another quarter or two on this two credits I referred to.
And today's next questioner will be Peter Winter with Wedbush Securities. Please go ahead.
On asset sensitivity, I was just wondering with the Fed turning more dovish. Can you talk about some of the steps may be you’re taking to reduce some of the asset sensitivity?
We have the advantage of this MCA business that we did not really have meaningful business in, back when we had the rate decline environment few years ago. And that actually is helpful to us. It doesn't set us up for five 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 duration risk anyway. If we had a lot of excess liquidity and desire to start you know investing in longer term assets I think we'd be very careful.
But incrementally because of the volume growth we're seeing, 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 are 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 your price 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 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 is not a material change in our approach to growing our asset base. But 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.
Just one more question on credit. And I'm sorry, if you talked about it, but the increase in non-performing 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 NPAs were?
Yes, it was -- I think, I said in there, it was predominantly energy and there were three deals two 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?
And the rest of it was, so yes, the rest of it was, the rest of it was some small thing. So, the bulk of it -- the bulk of the bigger deals were energy.
It's still another 25 million.
Yes, it's nothing else, but nothing else meaningful. There were a couple of smaller deals. Nothing to call out, I guess is what I'm telling.
Did you say $3 million to $5 million, so he's trying to get a feel for it,
Yes.
Where they leverage lending?
There was just, it was just kind of a mixture of much smaller deals.
And then we took a deep dive on the portfolio. So we don't have as much color on that.
Okay.
But again, there aren't any big $20 million type deals that make up the balance, Peter. We don't see an industry issue with those due late we don't have any industry concentration flavor to the smaller deals.
Energy went 40, yes. There was still nothing else to call out. The three energy deals, which was, I think its 40 million total was the bulk of it.
Instead of 26 it was 40?
Yes, because when they went from, yes. Energy non-accruals are 77 and they were 37 at the end of the year. The 50, hey, Peter, the 50 you're talking about was last year at this time. Non-accruals for energy are 77 and they were 37 at the end of the year.
And then just one last housekeeping item. The net revenue forecasts with high-single-digit. I'm assuming that excludes the 8.5 million legal settlement claim, is that right?
For the year it includes it.
It does include it.
For the year.
Okay. Thanks very much.
You're welcome. And in other way, it also includes the mortgage servicing rights, 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. Please go ahead.
I just wanted to make, I just trying to make sure I kind of was putting together the long-term deposit vertical opportunity, correctly? So I think last year you said planned verticals, each could be a 500 million or 2 billion opportunity and it would take three to four years to kind of get there. And then if I heard you right, this time you said you got two live, you've got a big one coming on soon. You feel good that at least four, five, if not more will kind of really become meaningful overtime and you will be around 1 billion by year end. So I mean, if I put that on a blender, it’s kind of the punch line that over four years there could be four to eight 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 really great outcome, if we did north of 6, I think it's possible, but I’m just not counting on Brian all eight of these hitting the median billion dollars and that’s roughly what you're looking at, I think is 1 billion to1.5 billion on maybe eight. We've done enough organic growth and innovative new businesses over the last 20 years. We’re a little bit conservative and we just don’t know what brand new businesses how well they did, how well they will do. I think four or five of these could well get 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 three to four years.
And then your mortgage growth, your mortgage warehouse has been better than peers. There is always a quarter to quarter volatility, but you’ve been better than peers clearly for a long time. And I think from the outside looking in, it’s always hard to really -- whether its Comerica or customers or BB&T or Wells, like, they all feel kind of homogenous when you look from the outside. So if your client -- or if I’m a client of your business, if I’m a mortgage lender -- like what tangibly would I see a quicker turnaround time? Better advance rates? Would the technology to better, would my relationship officer be better? What do you think are the two or three 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, specially the technology that is not just outstanding for us here and 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 frontline 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 your treasury team, they much better work with your treasury people on managing their deposits than another competitor.
Almost all of our clients have five or six 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 listing to our clients about new products as the business evolves and we’ve been a leader in innovating and creating new products over the last 10 years as well. That our clients give us insights too 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 one quarter in the last 15 years that I remember any of our competitors grew more than we did and we kind of figure out the ball, this was about two years ago and so our competitors came in with a more aggressive offering for one quarter and we came back with the 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 you right that, it's kind of a 200 million-ish revenue business and 13% efficiency ratio? So kind of call it 175 million of annual pretax or am I missing something?
Yes, we don’t -- there are pieces that we don’t break. You can see the interest -- the interest income is broken out separately, you can see that the fee component -- and we've said in the past that the fee component of the warehouse which is a non-interest income basically covers the expenses.
And then again we’re not including the deposits in this chart. So, there’s a way to back into it.
In the efficiency, but that's not something that we've typically given. We just haven't talked about the balances of that which is why we presented it this way.
And the next questioner today will be Brett Rabatin with Piper Jaffray. Please go ahead.
Just want to make sure I understood the -- you've talked about mortgage quite a bit, but just thinking about 2Q are you giving guidance for high teen percent growth year-over-year, but just thinking about 2Q versus 1Q where you are at the end of the period end of 1Q versus kind of average on 2Q -- it would seem like this year you might have a more meaningful expansion in the second quarter on mortgage and then also just want to make sure I understood just the guidance around that strong 2Q and mortgage. Is that just mostly a function of the market or are you also on-boarding quite few new clients as well?
It’s both, it’s just taking market share and the volumes, and the seasonality is meaningful in the second quarter. That’s three of our competitors too at CMS pick-up but the thing we do differently as we take market share each quarter and so that is the kind of the added turbo-charge to the growth opportunity we have in this business. Our bankers are fabulous and our clients refer to our new clients. It's a great business.
And then just to go back to the question, could we see 2Q balances were up 1.5 to 2 billion in the second quarter? Maybe could you give us -- I know you gave year-over-year guidance, but it's obviously very seasonal, so it's kind of tough to…
I guess personally I would well into that is, Q1 averages were higher than we expected because we’ve starting to see some of that come in. So, you can do the math, but we would see a pick-up in Q2 and Q3 because those -- the averages both of those quarters are usually strong, but keeping in mind that our first quarter was stronger than we expected.
And the next questioner here will be Chris Gamaitoni with Compass Point. Please go ahead.
I want to get a sense of what gives you confidence on the run-off of the leveraged loan book of roughly 30%. Is that scheduled maturities or you're expecting a significant portion to be refinanced away?
You know great deal of it is, it’s just normal run off. These companies typically -- when the private equity firm invests in the Company their target as well know is anywhere from three to five years. Typically, it runs closer to four or five years on the tenure and the portfolio. So that would just lead you to look at about a 20% a year just natural run-off and because we're obviously working hard on de-risking the portfolio too, we think there will be opportunities for other tools of capital to refinance us if we have covenant breaches or things that might come up. And so, we think there is a really good likelihood that we're going to see somewhere in that 30% run-off range, between the two.
Alright. And then, one small one. The loss on the loans held for sale quarter-over-quarter improved significantly. Is that reflective of correspondent margin in the channel? Or is it something else?
Yes, we talked about last quarter that what we did in the fourth quarter as we held some of those loans longer, we held some of them longer and some of them with some offset, some extended hedging costs that affected that. And so, because of the volumes that we've seen that started in the first quarter -- they're just more churned, so that improves the gain fees or it lowers the loss piece.
And the next questioner today will be Brock Vandervliet with UBS. Please go ahead.
I'm aware the full year guide on the NIM, I was just wondering if you could offer any sort of additional color on the trajectory that 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 there for the rest of the year?
A lot of it just the mix Brock, but with warehouse being stronger than we had originally felt we could generate for the year. And so, that's a significant piece of the NIM issue. I'm very happy to take that trade off that has such high credit quality for 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 with more of it coming in 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 will 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 are 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 request for follow-up questions to Heather Worley at heather.worley@texascapitalbank.com. You may now disconnect and have a great day.