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Texas Capital Bancshares Inc
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Good afternoon and welcome to the TCBI Fourth Quarter 2018 Earnings Conference Call. All participants today will be in a listen-only mode during the presentation. Please note this event is being recorded. [Operator Instructions]
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 fourth quarter 2018 earnings conference call. I'm Heather Worley, Director of Investor Relations.
Before we begin, please be aware this call will include forward-looking statements that are based on our current expectations of future results or events. Forward-looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from these statements.
Our forward-looking statements are as of the date of this call and we do not assume any obligation to update or revise them. Statements made on this call should be considered together with the cautionary statements and other information contained in today’s earnings release, our most recent Annual Report on Form 10-K, and in subsequent filings with the SEC.
Speakers for the call today are Keith Cargill, President and CEO; and Julie Anderson, CFO. At the conclusion of our prepared remarks, our operator, Brian, will facilitate a Q&A session.
And now, I will turn the call over to Keith who will begin on slide three of the webcast. Keith?
Thank you, Heather. After I open, Julie will provide her review of the quarter and our guidance for 2019, and then I will close and open the call for Q&A
On slide three, we present a timeline showing highlights of key events over our 20-year history and a related chart depicting our purely organic asset growth. Preceding our 20th anniversary in December, we launched a company-wide strategic initiative named Inflection Point.
This initiative involves our full commitment to create an even more differentiated premier client experience. We are refining our organization, processes, and products to develop more comprehensive and strategic client relationships, leading to improved efficiency and revenue growth. Further, Inflection Point will enhance our ability to deliver business insights as we improve response time and data analytics within the bank and for our clients.
Let's move to slide four. We showed good loan growth in Q4 and year-over-year in both average LHI and in mortgage finance loans. Average deposits increased 1% in Q4 and 2% year-over-year.
Net revenue was up 19% and non-interest expense increased 13% for the year resulting in a strong improvement in full year operating leverage. We posted a higher than planned loan loss provision due to migration and charge-offs on a small number of previously identified energy and C&I loans, primarily leveraged C&I.
The net charge-offs to total LHI were 0.37% for the full year and included some energy charge-offs as well. Non-accrual loans to total LHI was 0.36% at year-end versus 0.49% at Q3, 2018. Net income for 2018 increased more than $100 million from 2017 and earnings per share increased 53%.
On slide five, we highlight the energy portfolio and the C&I leveraged portfolio. Non-accrual loans were down in both categories from year-end 2017. Allocated reserves are 2% for energy and 5% for C&I leveraged. Energy remains primarily exploration and production. C&I leveraged is broadly diversified with manufacturing the largest subset at 23%. In the C&I leveraged portfolio, senior leveraged greater than 3x and total leveraged greater than 4x, totaled slightly over 50% of the portfolio. We've had a small number of loans in the C&I leverage book. It merges [ph] increasing problems in the second, third, and fourth quarters contributing to the larger than planned fourth quarter provision. Some additional migration is expected, but we are actively addressing go forward credit in C&I leveraged. We anticipate 30%-plus portfolio run-off in 2019.
Slide 6 describes one of our premier businesses, mortgage finance. As you can see, it continues to be one of our most efficient businesses. Likewise, the earnings and combined yield remains strong despite the competitive environment in 2018. The historically low credit risk is consistent with our focus on building an even stronger balance sheet as the economic expansion stretches historical norms. Julie?
Thanks, Keith. My comments will cover slides 7 through 15. I'll start with the NIM review. Our reported NIM increased 8 basis points from the third quarter. We had a slight decrease in average liquidity assets, which had a minimal impact on NIM.
Traditional LHI yields were up 24 basis points from the third quarter which included the catch-up from the late LIBOR move in Q3. Traditional LHI betas continued to be as expected. The slower LIBOR move in the third quarter came through in fourth quarter yields and we would expect a positive impact in the first quarter from the slow move of 30-day LIBOR in the fourth quarter.
Ending December rate on LIBOR loans was about 25 basis points higher than the rate on loans at the end of September. These were back to normalized levels in the fourth quarter as opposed to the lower level in the third quarter and higher than normal in the second quarter, which accounts for about six basis points of the core LHI yield increase in the fourth quarter.
Mortgage finance yields ticked up 10 basis points on a linked-quarter basis. As we mentioned during the third quarter call, we thought we were close to the bottom and believe that's true for now. With lower probability of rate increases in 2019, there should be less movement in this yield. Because of the multiple offerings that we provide, we have more flexibility in evaluating overall relationship pricing and making adjustments as needed to retain and grow market share.
We had a linked-quarter increase in average interest-bearing deposits. Overall deposit cost increased by 18 basis points from 99 basis points in the third quarter to 117 basis points in the fourth quarter. The increase was expected as Q3 numbers only included a few days of the September Fed fund move on the index deposit. Similarly, Q4 only includes a few days of the December move. Overall increase of 18 basis points is comparable to the 18 basis points increase we experienced from second quarter to third quarter and is consistent with our expectations. If the Fed slows, we would expect to see less change in deposit costs from quarter-to-quarter later in 2019. We have a continued solid deposit pipeline with verticals getting traction. We're also seeing very positive behaviors in the front line with focus on deposit.
During the fourth quarter, we chose to replace approximately $600 million of traditional brokered CDs that were maturing, but nothing additional that remains still about $1.5 billion in total.
As of the end of the year, 75% of our floating rate loans are tied to LIBOR and over 80% of that is 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. Annual growth of 14% is in line with our guidance for the year. Traditional LHI average balances grew 2% from the third quarter and up 11% from the fourth quarter of last year. The level of payoff continues to be high, primarily in CRE and some C&I leveraged.
First quarter pipeline looks positive, and I'll cover 2019 guidance shortly We continue to see strong average total mortgage finance balances including MCA that benefited from stronger than expected fourth quarter which can be seasonally weak and they're up overall 14% from fourth quarter last year. Obviously, we would expect first quarter volumes to be seasonally lower.
As I mentioned earlier, we did see some pick up in linked quarter average total deposits with all of that growth in interest-bearing, primarily interest bearing in the pipeline but we're also working hard on maintaining and growing existing relationships. We're not seeing any pickup in the individual request for rate concessions.
I'll now move on to non-interest expenses. In looking at the changes in the annual expense trends, we are effectively slowing growth in our core expenses, which is primarily salary expenses. Annual salaries and employee benefits adjusted for stock price fluctuation and severance is up about 11% from 2017.
Year-over-year fourth quarter comparison is in mid-single digits. We're managing with a lower level of FTE additions. We did have a small amount of severance this quarter less than $1 million compared to $2.8 million in the third quarter. The fluctuation in FAS 123R expense in the fourth quarter compared to third quarter primarily related to a sizable drop in our stock price. The increase in other professional expense includes about $1 million related to deposit services, the remaining amount due to other operating expenses.
For 2019, we would expect to see quarterly levels consistent with the $11 million range we saw in second and third quarter. A portion of the marketing category is variable in nature and is tied to growth in deposit balances and will continue in 2019, but is expected to be at a slower rate than what we've experienced the last two years.
Lastly, efficiency ratio for the fourth quarter was 50.7%, which was improved from the third quarter of 53.6%. Full year of 52.9% is better than our prior year of 55%, and we would expect further improvement in 2019.
Moving on to asset quality, we continue to feel good about overall credit quality despite the fact we experienced another quarter of larger provisioning and charge-offs. The charge-offs related deals that were previously identified, some of which had earlier charge-offs in the second quarter.
As we review the year, it's important to understand how limited the scope of credit issues have been as they've been primarily in leveraged, which as you know we’re very focused on. And more specifically, it's been just a handful of deals.
The fourth quarter charge-offs included additional charges for three of the four loans we discussed in the second quarter and then the two non-accruals discussed in the third quarter.
Of the total $78 million in charge-offs for the year, about 60% were related to four leverage lending deals; the two healthcare that we discussed in the second quarter and two quick-serve restaurant deals that went to non-accrual in the third quarter.
Additionally, there was a C&I ideal that was part of this Q2 discussion that was a fraud, which is something that happens from time to time, but is certainly not indicative of a broader portfolio issue. Lastly, we had a couple of energy charge-offs during the year, which were part of legacy nonperforming and had been and work out for a long time.
With the charge-offs we took in the fourth quarter, non-accrual levels decreased at a low level of 36 basis points of total LHI. We did experience an uptick in total criticized levels in the fourth quarter, primarily as a result of the deeper look at the leverage portfolio that Keith mentioned the last quarter. However, our criticized as a percentage of total LHI remains low at less than 2% which compares very favorably to industry level.
As you know from our history, we're always focused on being proactive with grading and especially late cycle. The $35 million in fourth quarter provision is made up primarily of additional charges on the five deals that were previously identified some of which had higher charge-offs in the second quarter as well as additional reserves related to the risk migration.
As I'll discuss shortly, we've assumed some additional migration in the leverage book in our 2019 guidance for provision. As we look at net revenue, we saw a continued strength in length quarter net revenue and 2018 net revenue was up 19% from prior year. We've experienced strong traditional LHI growth in 2018 and the portfolio has benefited from improved margins as a result of the continued move in LIBOR. Some volatility in non-interest income during the year related primarily to MCA items.
Gain or loss on sales can be affected by how long we hold production. In the fourth quarter, we chose to sell less so hedging cost for rolling net production were higher, but more than offset by the higher interest carry included in interest income. [Indiscernible] in the warehouse in MCA, we have the ability to optimize overall profit by altering hold times and timing of loan sales. So, in seasonally slower quarters, it may be optimal to hold longer.
When we look at non-interest expenses, we continue to improve run rate on core operating expense items, specifically salaries and a focus on improving efficiency while enhancing client experience. Full year 2018 was a 13% increase in NIE compared to last year and compared to 19% of net revenue growth.
On a PP&R basis, the earnings power has accelerated significantly with this year's increased about 25% over 2017 levels. More importantly, we will continue to have meaningful growth in PP&R in 2019 even with the slower asset growth because of the slower NIE growth that we’re positioned for.
ROE and ROA levels were lower in the fourth quarter as a result of the higher provision. We made significant improvement in 2018 compared to 2017. Our current lower liquidity levels have been beneficial for ROA, but we're comfortable holding slightly higher liquidity levels during quarters when mortgage finance is seasonally weaker. We will continue to monitor capital level and take appropriate actions based on our growth outlook.
Now I'd like to move to our 2019 guidance. Our outlook for average traditional LHI growth is high single-digit percent growth. Consistent with our messaging for the last several months, we think this is a risk appropriate level consistent with the areas that we expect to see growth potential, limiting and in some cases expecting net runoff in other areas that we believe are overheated at this point.
Our outlook for average mortgage finance growth is low single-digit percent growth compared to an NBA forecast, which is currently forecasting down slightly year-over-year. This is representative of the benefit of our approach to a full relationship which maximizes profitability and the ability to capture volume. MCA guidance of 1.9 billion for average outstandings for 2019 signals are continuing to see pickup in market share.
Our outlook for average total deposits is mid to high single-digit percent growth. With an expectation that net growth would be all interest-bearing, we expect some traction from 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 deposit trend.
Our outlook for NIM is 375 to 385. The guidance is assuming no additional rate increases in 2019. Our outlook for net revenue is high single-digit percent growth. Our outlook for provision expense guidance is mid to high $80 million level. The higher provisioning as we ensure our balance sheet is positioned for three cycles. We expect some great migration as part of this effort.
The outlook for noninterest expense is mid-single digit percent growth. Certainly this is a level not achieved in the past, but we believe we're positioned ourselves during 2018 to leverage existing capabilities and limit growth and headcount. Our outlook for guidance on efficiency ratio is low 50s.
Lastly I want to spend a few minutes discussing a longer-term outlook for average key metrics. As we move to our long-term outlet -- outlook as part of our 3-year planning horizon with improved returns we make a few assumptions. First, we assume state of the economy continuing as it is currently which enables us to fully capitalize on our Inflection Point of growing our higher return businesses.
We've also assumed the potential for continued volatility in our provision as we are positioning the portfolio. Net charge-offs of 20 to 25 basis points of average LHI. While we never decide higher credit costs, we have the earnings power to sustain the volatility, while still executing on our objectives.
Mortgage finance continues to be an important part of our business. We continue to leverage our investment to yield efficiency, thus lowering noninterest expense growth rate over the horizon. An important part of maximizing return levels will be an efficient use of shareholder capital which we are committed to.
Overall we believe our outlook for the future is extremely positive and we already have the initiatives underway to accomplish our return objective. Successful execution will result in an increasingly attractive and sustainable return profile with ROA above 13%, ROE greater than 15% and efficiency ratio of less than 50%. Keith?
Thank you, Julie. In closing, the Inflection Point initiative and the continued rollout of new deposit rich industry verticals will contribute to further improving the premier client experience, we've long been known for, while also improving our efficiency, revenue growth deposit base and deposit costs.
The Texas economy remains vibrant. Unemployment in each Texas Metro market in which we operate is low and population growth continues to outpace all other states by a wide margin. Low taxes, cost of living and a growing workforce keep Texas jobs growth strong.
We're optimistic that the initial deposit verticals launched in 2018, will continue to grow and diversify our deposits. In 2019 we are launching yet another six deposit verticals to further drive deposit growth at lower marginal costs.
The enhanced core treasury management products position us well for deepening existing client relationships in 2019 as well. We are proactively addressing risks in our loan portfolio, as we did with energy prior to and early after the price down cycle in 2013. Building loan reserves and allowing loans offered loans subject to higher down cycle risks before slowdown produces credit losses through cycle.
The targeted approach we are deploying and slowing non-interest expense growth improves efficiencies as we refine processes and technology. 2018 was a strong year of earnings growth and we have strong momentum to continue growth in earnings in 2019.
Texas Capital Bank enjoyed a record-setting first 20 years as of December 2018 and is positioned to become an even more premier client experience bank as we begin the next 20 years in 2019, with our clients referring most of our new clients to Texas Capital.
At this time, let's please open the call for Q&A.
We will now begin the question-and-answer session. (Operator Instructions) The first question will be from Peter Winter with Wedbush Securities. Please go ahead.
Good afternoon.
Hello, Peter.
I was going to start with credit quality. Just wondering why not be more aggressive now on writing down some of the leveraged loan book?
Really there's not more to write-down right now. The building of the reserves, I think we really addressed, not just the charge downs that needed to be taken because of further deteriorating migration on those few credits that started to pop up in the second quarter, Peter. But also during the deeper look and scrub of the leverage portfolio.
You may recall back in the energy downturn a couple of years ago, we were one of the first to move our reserve meaningfully from about 2% up to 5% and it was a bit of angst about, why did you move it up so much? And then a quarter or two later as others followed, we were glad we did and it actually served us well to motivate everyone in our company to appropriately exit risk where we can and be sure we don't create new risk in that category.
So as you can tell from my comments, we are now at 5% reserves on the leverage lending book and that's after taking these charge downs from those deals that began to surface that were worst, worst to deal with over the last few [ph] quarters. So the go forward provisioning really is just we think a conservative, but best guess on potential other migration that might occur not just in leveraged, but because we've had some of these issues in leveraged that could occur, but we feel very well and appropriately reserved on that book as we sit today.
I guess then outside of the leveraged lending, is there any other portfolios that you might be watching more carefully? Or you're seeing any type of deterioration?
Generally, we're just watching a couple of segments that are not just industries that we finance in leveraged lending. But to answer your question more specifically, no. We feel very good about the quality of our book in CRE, the quality of our book in billing finance.
I could go down the list, premium finance, lender finance, and on and on. Energy, we've been able to book a really high-quality that just wasn't available late in the energy cycle before the downturn. So this is the one category, as we began to see it raise its ugly head back in the second quarter that we think it is not unique to us, it's just a higher risk category, because of the high multiples these private companies have been selling at. Increasingly high multiples over the last four or five years, and therefore the need for the sponsors to attract more leverage, and then as that needs come around, there's massive amounts of capital on the lending side that’s come into play in this space and ratcheted up the leverage generally on the M&A on sponsored finance and leveraged deals.
And while we've played, we think, much more conservatively than those we compete against overall in the market, we've been affected some, simply by the higher prices for these companies being sold and also the added competition coming in from BDCs and other lenders.
So again, as we look at our book, the one that gives us some pause, that we've addressed, again, the last few quarters and really attacked, I would say, is leveraged lending. Before we get to the down cycle, we just need to be sure we're ahead of it, and that's what we've attempted to do.
Thanks Keith
Next question will be from Ebrahim Poonawala with Bank of America Merrill Lynch. Please go ahead.
Hey, guys. Good afternoon.
Hi, Ebrahim.
I just wanted to follow up on that. In terms of, Keith, I think I heard you say that you expect 36% run off in the leveraged lending book in 2019. Is that right?
30-plus percent. Yes, it could be as high as mid-30s. We're trying to estimate as best we can. The velocity of sale of these companies has picked up much as I've talked about on other asset classes like CRE, where we've had these accelerating higher payoffs the last year or so, Ebrahim.
It's happening in businesses being sold too and we all know these sponsors, they don't necessarily – they can't necessarily hold these deals in their portfolio much beyond five years, so they begin to dilute [ph] the returns to their investors.
So I think it's an indicator on the sale of assets generally that we're seeing in paydowns in CRE and paydowns in our businesses like sponsored finance. We're nearing a peak in the cycle and the sellers, want to begin to exit and maximize their values, so that's why I expect this run off to be as high as it is.
And are we done doing leverage lending? Are we doing more new loan? Because it seems like second quarter into third, third into fourth, we've been a little blindsided by the loss content of these loans that you identified. And I'm just wondering, are we at a point where the goal is to essentially exit this book over the next few years?
If you can help me think through, because I feel like you guys have historically done a great job managing credit tight and I went back and read Julie's comments from the third quarter call. And it feels like we sensed it in the third quarter, but turned out to be worse than expected, which makes it harder from the outside to reconcile the provisioning guidance for next year around how much of that is being conservative and how much of that may get just eaten up because of things popping up.
Let me try to answer that question. It had a couple of parts to it, Ebrahim. First of all, no, we're not exiting the business. Secondly, we are exiting taking on any new sponsor finance to our leveraged lending until the cycle runs its course that is on the high end of what we might have done before on leverage. And if it happens to be in industries that we generally want to stay away from because, we just don't have the expertise, okay? So we wouldn't do new sponsor finance lending or brand-new sponsors in an industry that were outside or if that leverage is higher than our typically 3x that we want to underwrite to going in on senior debt.
If some of these that we got into over the course of the last couple of years with these high prices being paid and some new sponsors that we began to finance that we've had some of this deterioration without the sponsor stepping up and recapitalizing as we should normally see happen with an established longtime sponsor.
So it is time for us to be sure that the sponsors we are doing new business with and go-forward business with are solid and reliable sponsors. And that's the case with most of those we financed, but we're going to be more selective, not just on deals, but on who in fact is the sponsor.
And then also we're tightening up how we’re going to do this lending both in terms of micros with the most expertise as well as underwriters with the most expertise and credit approval senior people as well. So we're taking all the steps you should take and it's not unique. We've done this in CRE over the years during cycle issues. We've done it energy over the years. And so we're doing it again in leverage lending. But we will still be in the business. It's not a business that we see growing though over the next year or two.
Got it. And just one quick if I missed it, did you lay out the timeline for the long-term ROE, ROE targets and when you expected those?
Ebrahim, that's part of our three-year planning cycle. So at the end of the -- I mean during the three years, but towards the end.
Understood. Thanks for taking my questions.
Next question will be from Steve Alexopolous with JPMorgan. Please go ahead.
Hi everybody. Not to be the dead horse of credit, but I'm trying to understand this. So if you look at the credit that you added to NPL in 2018, right, the two loans in healthcare in 2Q and then two loans restaurant 3Q. At year-end what's the remaining balance of these four credits still on the books? And what are the reserves on those?
Yes, we don't usually get into talking about individual credits, but I will tell you there -- they've been written down to the amount that we think we're going to be able to resolve that. So like the healthcare -- the two healthcare, we took some charge-offs in the second quarter on those and then the fourth quarter. So we do believe those are written down to the levels that they need to be worked down.
By the way Steve, a little more color on your question, you didn't ask it specifically, but perhaps this helps. On healthcare, there is virtually nothing left in the leverage book in that category. So we have not been great at healthcare financing. And so we're not going to decide we will be great anytime soon. And so that exposure is down to almost nothing in the leverage book.
On the quick service retail category of the problems we've had, none of them have been under the new lead and team that we recruited two and a half, three years ago to come in and make that a specialized line of business. And so of that portfolio overall, it has evolved from being 100% generated again, I guess bankers, but not experts at Texas Capital to now two-thirds of that portfolio that we have overall in the company has been generated by this new team and they're doing an outstanding job very much synced up with credit and doing an excellent job in that space.
Okay. That's helpful. Just a follow-up. So if you look at the criticized loans, which did pickup in the quarter, could you give color – it sounds like that was leverage lending also. What drove that?
I – we haven't changed our methodology. I need to be sure and make that clear about how we go about reserving. But as we get late in the cycle, as we all know there is some amount of qualitative assessment or judgment used and whether a credit is a six or a seven or a seven or an eight. It is not absolutely quantitative in how you arrived at that.
We certainly have our guidelines, but as we get later in the cycle, Steve, we're going to lean towards being more conservative and tend to lean into the lower grade. And as we did that on a deeper scrub, more comprehensive scrub of this portfolio, it did elevate some of those reserves.
And we think appropriately so because of the risk we see in this portfolio relative to the strong quality we have in the rest of the bank portfolios.
Okay. Keith, are you saying that's what drove the elevated criticized loans in the quarter?
Well, that drove some of the criticized loans, but also the reserve why is 5% on that book even though we took these charge downs. That's 5% still remaining.
But it is – there was risk migration in what several loans in the leverage book and that was part of the – Keith talked about on the third call – third quarter call that we were doing a deep look at that. And so some of those downgrades came from the more scrutiny of that book.
Got it. Okay. And then just at the margin that should benefit from the December hike, assuming the feds on hold, how do you think the margin progresses beyond 1Q? Can you hold it relatively stable without the help from the fed?
Yeah. And we've given – our guidance, that’s what our guidance consist it will be stable to up a little bit for the year. Now we can have some fluctuation from quarter-to-quarter based on warehouse balances if they're down and we have more in liquidity assets that can cause some volatility. But for the full year, yes, that's what we got to do is stable and maybe up a little bit.
But we do have that mix shift, Steve as Julie alluded to that can create quarter-to-quarter some changes.
Okay, great. Thanks for taking my questions.
Thanks.
Next question will be from Michael Rose with Raymond James. Please go ahead.
Hey, guys, I think I'll step away from credit and maybe talk about expenses. So I appreciate the expense guide. One of the bigger components has been FAS 123R, the stock option expense. Can you talk about how much of that is layered into the guidance and then what are some of the push and pull areas? And I assume it's less investment given all the investments you've made really over the past five years, but what are the areas of growth? And what are the areas you're ratcheting back? Thanks.
Of course. It's primarily, Michael significantly reducing the pace of new hires and as we work on our Inflection Point initiative and continue to work on that initiative, we're looking at our structures and refine some of those. And that's benefited us to get more efficient and not have to had as many new people and still be able to grow the client base.
Also we have taken a hard look at when we have some turnover be sure that we're thinking of hiring somebody with a skill set that might be able to do 1.5 jobs. Not just the same skill set as somebody that might have left us.
And so that really is beginning to help us to hire fewer new people. But overall, we have added so many new people and as you can see from the trajectory of our growth rate on that front chart and how we've gone from crossing $10 billion just about six years ago to now $28 billion. We've hired an enormous amount of new people each year and so with the Inflection Point we're really trying to focus on how we can become more efficient and at the same time improve response time, client quality service, and get a little smarter about how we staff going forward, where there is select turnover.
Michael on your FAS 123R we've assumed in the guidance a more normalized stock price not the one that we're at right now. I don't remember specifically what we used, but it was something – it is something higher than what we are right now.
Okay. That's helpful. And then as I think about that expense guidance relative to the loan growth outlook which is still very healthy on the health for investment side high-single-digit growth year-on-year. I mean, I think the way you get to the longer-term targets you would have to keep expense growth kind of low to mid-single digits and still kind of get similar types of held for investment growth, is that the right way to think about it? Or are there other levers that will get you to those longer-term targets? Thanks.
That's 98% of it.
Yes.
What you just said, there really isn't anything nearly as material as doing exactly as you described.
Okay. So there’s been – as you described the paradigm shift and kind of the way you're running the company hiring less people to get more out of it –
We've grown – at the rate we've grown, particularly the last 5.5 years Michael you do create some inefficiencies. You actually do things because you're moving so fast where you're just replacing someone that leaves, but maybe the same skill set or a lesser skill set than the one that you – that might have left the company and we're very much thinking about how do we get it more effective and efficient order structure. Look at processes that we have added over the years. We've added different bells and whistles to how can we streamline these processes to create quicker response time and not have so many hands touching papers especially and integrate these technology tools. As you know, we've invested heavily the last 2.5 years on rebuilding our technology infrastructure and by the end of this year we will have accomplished rebuilding about 80% of it. And that gives us a lot more ability to be more agile in adding new products that we can almost plug-and-play on this more up-to-date infrastructure. We don't have the legacy technology system infrastructure that a lot of our competitors are still going to have to navigate and reinvest and rebuild So that should contribute to not just this year, but going forward thus being able to hold these expense increases at a much more modest level.
Okay. That's very helpful. Thanks for the color, guys.
You’re welcome.
Next question will be from Jon Arfstrom with RBC Capital Markets. Please go ahead.
Hey, thanks. Good afternoon.
Hello, Jon.
A couple of questions here. In terms of your LHI growth you talked a bit about the leverage rundown, but can you talk a little bit about where you expect to see strength in LHI in 2019?
Yes. It's going to be primarily in core C&I and it's going to be highly diversified. We will have still some energy growth, but it will be more modest than what we saw this year. We do expect to see again some growth even though MBA as they have now three years in a row is projecting for mortgage volumes to be down. As you know we've overcome that each year and we expect we will again this next year. So, we're expecting that sum as well.
And then MCA has grown very significantly this year. We expect it to grow yet again next year. But the real answer is that we see an ability to replace with high-quality CRE rundown that continues to be quite high as a lot of our clients are selling their assets and selling them earlier at very high prices and then on the leverage lending, we do see that actually having some modest run down.
Okay, good, good. That helps. And then very big picture here. On your 2019 versus 2018 guidance, when I plugged the numbers and I kind of get back to where I was and obviously I think we're all questioning the credit line in terms of credit expenses, but can you just talk a little bit about confidence level in this 2019 outlook? And maybe the biggest potential variables in your mind or the toughest part to hit on the 2019 outlook?
Well, I feel confident we can do what we're telling you if we don't have an unexpected recession Even if we sustain the slowdown that most are talking about now, we believe that that's baked in our guidance and we can deliver.
But if we were to have a recession or some unexpected event throws us a curve ball on the economy and confidence generally then that could change. So, it's not baked in the recession. We think with the Texas economy being as vibrant as it is that our core business being based here in Texas that helps us.
But again recessions are restricted to just one part of the country. They tend to be a psychological thing too and there's more and more talk about it and that gives me some pause and we've not baked in a full recession.
The other thing that you would expect me to be thinking about is what about energy prices? We had a pretty good dip here over the last few months. And we've run all our numbers at a 40 straight-line for three years -- $40 straight-line for three years and feel good about where we sit.
Now, if energy goes to 30 and straight-lines for three years that would be another situation, but to give you a little context the lowest 12 months we had and the three year price drop we had in energy starting back in 2013, the lowest 12-month average on WTI was 41.50. So, I think our 40 assumption not just for 12 months but for three years is quite conservative and so we feel good about that.
Okay And the big picture message on credit in terms of the guidance. You're saying you've identified what the issues are, but you just -- you're really not seeing anything new in terms of credit issues?
Again, we've got a really, really strong portfolio. The area that seems to be that at area that's got a little more outsized risk and I think that's true across all financial institutions banks and non-banks and average lending, it's that category
And John I think I've said in my commentary I mean we've given the guidance assuming that we will have some additional risk migration, that we will have some additional downgrades that we need to deal with.
And so that will happen, but already have a 5% reserve against that book and have taken these charge downs. We feel pretty good about where we sit on that risk overall risk in the loan portfolio
Okay. I hear you load and clear. Thank you.
Welcome.
Next question will be from Brady Gailey with KBW. Please go ahead.
Hi, good afternoon guys.
Hi, Brady.
So, I mean, Keith, your stock trades around 1.25 times tangible book value. I think if you look back in 4Q, it traded as low as a little under 1.10 times tangible. So, I want to ask about the buyback. I don't think I ever remember you guys doing a buyback. But I mean, as your organic growth rate slows, you have more capital potentially to repurchase stock. Is that something you all have considered? Or you think you will consider with the stock trade now is trading?
Well with the rate at which we are accumulating capital, yes, we just never Brady had a high enough ROE because of our high growth rate and how that suppresses near term ROEs. And of course, when you grow at 20% a year on lending and you suppress your ROE and it's running high single-digits or maybe 10, you're constantly faced with when do we go back? Not if we go back to the capital markets and raise equity. And going through that period with energy prices causing everyone to sell banks that had any energy portfolio and the punishment we took on our bank stock price I was just so grateful that we had raise capital before that occurred.
But I realized we should never put ourself in a position where we have to go to the market in order to sustain healthy growth. And we always are going to be a growth company relative to that peers I think that's important. We just don't see late in the cycle, it's been very wise to be a mid-teens or a high-teens growth company and expect to have good through cycle credit cost. So yes, we're looking at all options as we accumulate capital. This next year faster than we anticipate we'll grow loans.
One of those options is buyback, but we're a growth company and when we finally now have the luxury of actually accumulating a little dry powder and capital, we're going to be looking at some opportunities where we might add product, where we might add really outstanding teams or we might even do a select fee-weighted type niche business, so we complement what we're doing today. You won't see us use incremental capital to go do traditional bank M&A. That's not in our DNA and we have such a strong organic growth model that wouldn't be very proactive. But anything we can do to enhance ROE long run and add complementary products to take better care of clients that's on the table. And then of course stock buyback is as well. We don't see stock buyback as necessarily our best option considering our growth capability.
All right. And then, I noticed in the press release when you all broke out the fee income you added a new line item which is the loss on the sale of loans held for sale, which I think its first time you all disclosed that. I was surprised to see that number bounce around as much as it did. I mean, it was down a little over $8 million in the fourth quarter. How should we think about that number going forward? And what are the components that drive that?
So, I said a little bit to that in my commentary that's all related to MCA and how long we decide to hold loans. So, this quarter or the fourth quarter, we decided to hold some of the loans longer. We didn't sell them as quickly as we thought we would originally. So, when you roll those hedges, it results in a loss. So -- but that's more than offset by the additional interest carry that we get. So when we're looking at that business, we look at the overall economics. So there will -- I would say that the fourth quarter was a little bit more dramatic than we would normally see. But there can be some fluctuations there depending on how long we decide to hold loans before selling them.
So I would say that if - third quarter, third, second third quarter will probably be more representative of what you'll see going forward. But we will be opportunistic from time to time if we think it's more profitable to hold the book a little bit longer.
All right, Julie. I didn't see it on the slide, but I know last year you all guided to an effective tax rate of around 22%. Should that be the same for 2019?
That's fair. That's a fair estimate for it. We don’t talk much situation in that.
Next question will be from Dave Rochester with Deutsche Bank. Please go ahead.
Hey, good afternoon guys.
Hey Dave.
Hey, on expenses I hear you on the slower trajectory there. It's good to hear. I'm just wondering as you look out to 2020 and I know we're not giving guidance on that today, but are you guys concerned at all about the growth potentially slowing in terms of the balance sheet growth if you pause in hires this year. I mean is there any concern that you just don't have that production momentum continuing into the next year?
No, we picked up some significant efficiencies and some of the odd changes that we made and some of the things that we're doing now, actually free up right making time and capacity for our top bankers. So -- by the way, we are very opportunistic always about top talents and teams of talent that would fit us even late in the cycle, if they have the right again highly diversified C&I book, they were after growing and also quite good at cross-selling treasury.
And so we are always in the market Dave for the right talent. And I think this is going to be an opportune time next year too. But we really believe that we can achieve unless it's just a particularly large team that we brought on. We still believe we can achieve these expense numbers even bringing on some meaningful new team members.
Yes, okay. Are you guys -- sorry go ahead.
Dave, I wouldn't -- I guess, I wouldn't [indiscernible]. I would characterize this as more targeted hiring.
Got you.
We're not talking about not adding new hires. We're just not going to add….
Got you.
That trajectory that’s been so steep every year should flatten quite a bit as we get more targeted as Julie suggest.
Are you guys thinking about any headcount reductions in certain areas or office consolidation? Anything like that?
No, no. Again we just have the luxury of being a growth company. And so, that luxury means we can really achieve a lot more efficiencies by slowing new hires. And then we do have turnover and we would hate to have turnover in 90% of the cases, but if we do have turnover we'd be really wise about who we bring in and the kind of talents that they have. And we're doing a much better job as we think about anyone coming in to replace someone as well.
Great. And just switching to mortgage. Anything materially change their in the competitive landscape because it seemed like the yield trend on the warehouse book performed better than you would had expected earlier last quarter. So just wondering, it sounds like you've got more increased baked into your expectations, any color on that front?
Well, we've not brought the big boys to their knees, but I do think we have fended off that outsized competitive attack that we experienced. And I think I prepared all of this, because we weren't sure either that it might be the end of the first quarter even the second quarter before we saw this actually picked up on yield, and we've frankly seen it already in the fourth.
So we're optimistic that it's solidifying and that will be somewhat better over the course of next year.
Great. And then just one quick one on credit if I could. Are you guys at all tightening underwriting standards in any of your other segments of the loan book at this point
Well, that's been going on and just an ongoing process. As we get late in the cycle that's just part of how we have to operate so that we can justify being a higher growth company.
Yeah.
And by the way the reason we want to still accumulate some capital is we want to be well prepared for when we get past this slow down, because we could see and we expect to see growth in the double-digits again probably not a 20%, but certainly something higher than high single-digits that we were targeting in 2018.
And how much of that provision are you guys expecting this range here actually is allocated to the leveraged loan book at this point?
I feel pretty good about where we sit today with the 5% reserve, satisfied on the loan book. But at the same time, as Julie alluded to, we expect some migration.
Right.
And we think we've lifted in bud. I think we're proactively acting on it. So that migration will really slow and will exit some of these credits and there’s a lot of capital still looking for this ample of opportunity, a lot of it non-bank capital. Many of the deals we have financed, again, we financed two years or three years ago and those multiples on company selling today are even higher EBITDA multiples, seeking even higher leverage.
So we think naturally some of the book will get refinanced and some of them will actually run off as these companies sell. So we think we're in good shape today. We can't say specifically how much of that forward-looking provision will go to leverage lending, but we feel good about where we sit today.
Okay. Great. Thanks, guys.
You’re welcome.
Next question will be from Brett Rabatin with Piper Jaffray. Please go ahead.
Hey, good afternoon everyone.
Hello, Brett.
Hey, Brett.
Wanted to talk about deposits for a second. And you mentioned the six new lines of platforms or platforms that are going to be new this year. DDAs obviously have been kind of the struggle. Can you give us some color around the guidance that you're giving in 2019 on deposits? And just what you're anticipating might be the mix of the new businesses that you're adding? And if that has able to flatten out the DDA trends or any additional color around deposits will be great?
We've been extremely conservative in our guidance about what we think the new verticals will do. We think there's quite a lot that we can harvest with existing clients where we don't have full treasury management licenseships, and so that alone we think will help us backfill some of this ongoing migration from DDA to interest-bearing, that's going to continue for some time.
We do think though that the new verticals have the potential of really contributing to a lower overall cost of funds over time. But because we haven't had enough time with them, it would be overly optimistic, Brett, for us to project if that was going to happen in 2018. So we're essentially saying that most of what they're going to generate for us will end up in time money. We expect something better than that, but we're not willing to put that in guidance at this point.
Okay. Fair enough. And then wanted to just go back to the leveraged book and I was hoping for some additional color if you could, just around what that portfolio may have looked like in the past? And then just, how much of the portfolio you guys are relayed on?
Well, the portfolio, let me just give you this. Maybe this helps answer part of your question. I'm not exactly sure what you mean by what the portfolio looked like in the past. It has meaningfully changed in the mix of industry, but the underwriting has been for us at 3x to no more than a 3.25 senior debt typically on new deals that we've done over the last few years.
As time goes by, some of those that aren't performing as well, that number changes. And so that's why we have the mix we presented today that has some of that credit having migrated to 4x and above 4x on overall senior debt. But the OCC actually helped us for a while. Helped all of us I think in the banks, with some parameters that they suggested and gave us guidance around this 3x and 4 total debt coverage. And we were abiding by that, but losing more and more business for years before OCC came out with it.
So that was really helpful, but then over the last year or two, I've just seen a lot of other non-banks begin to play in this space. And it makes it harder and harder to find new opportunities where we can underwrite and book new business. So the deals have not changed radically, we're the lead in 24% of that book and that's been something that I think important over time, that we improve the overall lead relationship percentages.
Okay. And then maybe just to be more clear, Keith. Just trying to figure out, is this a portfolio that's been flat for a few years, maybe just give us -- if you could give a general idea of the loan balances over time.
Yes. It's been flat for the last year. It used to be a portfolio that we had expertise. Most of our competitors in our size, companies we target, sponsors we target, just didn't have the know-how. So we grew this after The Great Recession at a really nice rate for a few years. And then the market began to really change and a lot of capital and other banks come into the space. And that's why we've had to really flatten it out and not grow it this last year. And for 2019 we'll actually see it likely decline some, as much as I would.
I'm sorry. So it sounds to me like you grew it and then like maybe the past years or so it's been flat than you obviously – you said 30%.
Much like you may recall in energy, we've stopped growing the energy book two years before we saw the price decline, because of the advance rates on the collateral and the hedging – the structure just really made no sense. So we had 10% of our loans in energy two years before the price decline and 7% of our loans in energy when we finally experienced the price decline. We want to see the same type of thing happen by being proactive and really risk of ours, so we stopped growing this book a year ago and was actually experience some rundown this next year again to just further diversify our risk and mitigate the risk in that category.
Okay. I appreciate all the color on that. Thanks so much.
Next question will be from Jennifer Demba with SunTrust. Please go ahead.
Thank you. Good evening. Question for you. There was a question earlier about FAS 123R expense, just wondering Julie what that expense was in 2018?
Let me break that out. I can get it for you. I didn't include it in my commentaries this time. I forgot what it was last quarter and this quarter it was less than $2 million the actual FAS 123R. So if you take what I gave you last quarter and then $2 million this year I mean this quarter.
Okay, thank you so much.
It was down, it was down Jennifer. I want to say it was down $3 million late quarter. Last quarter was $4 million and change and this quarter was $1 million and change.
Okay, thank you.
Next question is from Brad Milsaps with Sandler O'Neill. Please go ahead.
Hey, good evening.
Hello Brad.
Julie, I wanted to follow up on Brady's question regarding the MCA business. The guidance I think for this year is around $1.9 billion; you’re above that for the quarter as you point out you earn probably $7 million more in interest income by retaining more of the production. Is the guide of $1.9 billion in 2019 is that a function of market share gains? Or are you assuming you're going to hold maybe for longer it does seem more accessible to whatever happens with the hedge in rates during the given quarter? Just trying to get a sense of how much volatility there could be around some of the fee income pieces that you guys started disclosing this quarter?
So it's definitely market share. It's definitely increased market share, but they have built in there that there certain quarters. If it's a seasonally weaker quarter they may hold the volume a little bit longer. So they built that in. But mostly we're continuing to take market share there.
So to be more specific that would naturally be Brad the first quarter and the fourth quarter.
Correct.
Right, okay, so that was my follow-up. And so -- but you're saying with a result this quarter with the $8 million or so mark that is and the high side of kind of what you typically expect?
Absolutely.
Got it, and obviously the impact of rates the way the tenure moved to the quarter that was kind of the big driver?
So for the -- well what happens is when you decide you're going to hold it longer then you have to roll the hedges and there's a cost to that which runs through the base line item.
Okay, all right.
It really wasn't -- there was actually some positive impact with the mark on the rates.
Yeah I think with rates down, it would have been a positive move. So I'm just trying to understand.
But that was offset when we rolled the hedges, when we decided to hold the portfolio a little bit longer.
Understood. Okay, thank you.
Next question will be from Chris Gamaitoni with Compass Point. Please go ahead.
Most of my questions have been asked. I just want to ask one on demand deposits something about deposits. Period end was up 4% quarter-over-quarter and the average was down 6%. Wondering if that's just kind of seasonality and normal volatility or if you're seeing any type of increased momentum towards the end of the year?
So I generally tell people to look at the averages. The averages are more representative. We have several businesses that can fluctuate at period and period end. So I think generally the averages are more representative.
But seasonally we do have a bill in the fourth quarter towards the end of the quarter. So that did contribute to this.
That's all I have. Thank you.
You’re welcome.
Next question will be from Geoffrey Elliott with Autonomous Research. Please go ahead.
Hello. Thanks for taking the question. I guess it might seem very basic, but I'm still a little bit confused. When you think about the loans that were charged-off during the fourth quarter what actually changed in 4Q relative to your expectations back in October? What was it that was different about how those companies were performing that maybe needed to charge-off those loans and take those provisions which you haven't been expecting?
Well, half of those we've already taken charge-offs on and all of them we identified earlier Geoff. But they deteriorated three of those really deteriorated in the fourth quarter and then further as we took a look at the whole book, we wanted that reserve and needed that reserve to be higher that's we ended the quarter with the 5% allocated reserve against that book. So that combination of things that contributed to that higher provision.
And the deterioration was that kind of tied to the tougher market environment kind of left leveraged loan activity going on left demand from non-banks making it harder for those banks – for those companies to get credit? Was it kind of tied to what was going on in the market side? Or was it more idiosyncratic to the three companies?
It was unique to the three companies. Some management issues decisions that played out poorly that the sponsors believe even replacing management that would ride the ship even with subsequent additional capital and some of those cases. It was not enough to turn quick enough the market problem they were experiencing. So it was really unique to each of those companies. But it costs us to really look more carefully at the whole leverage portfolio. Again, we've just watched this for the last couple of years especially and found that the structures to get more aggressive and that's why we flat lined growth last year and we wanted to take a deeper dive that did cause some incremental classifications, when we scrubbed the portfolio and that's part of the increase in provision related to increasing those reserves.
And how does the yield on the loans that you're going to be running down compared with the yield on the overall C&I book? Is that kind of a headwind to the NIM as you go into 2019?
It's slightly higher. It depends on the deal. But it would be slightly higher and we bake that in to our guidance.
Got it. Thanks very much.
Welcome.
And tonight's last question will be from Brock Vandervliet with UBS. Please go ahead.
Thanks for squeezing me in here. Just kind of a top of the house question on mortgage financing. You've done well at I think gaining share in a market that's been under pressure. Do you worry there are longer-term secular headwinds in this business that could for example shortening dwell times or some other issue that could cause pressure in the business longer-term?
Well, definitely headwinds and we've really invested heavily, Brock, to be sure we're ahead of that and actually take advantage ourselves against competition. So even where we sit today with our incremental technology investment, we could do approximately four times the volume we're doing today on the existing platform, it was really almost no new fixed costs and very marginal variable cost increases.
And I think that's the kind of position you have to be thoughtful about if you're in this business for the next few years, because you're right with the notes over time and generally improved efficiencies by the companies that we do business with, we have to be one of the very best in the industry to sustain this position we've enjoyed.
Okay. Thank you.
You're welcome.
At this time, this will conclude today's question-and-answer session. I'll turn the call back over to President and CEO, Keith Cargill for any closing remarks.
We appreciate your time and interest in our company and look forward to this next year and thanks for your interest. Good night.
Thank you for your participation in TCBI's Q4 2018 earnings conference call. Please direct request for follow-up questions to Heather Worley at heather.worley@texascapitalbank.com. You may now disconnect.