Texas Capital Bancshares, Inc. — Q3 2020 Form 10-Q
Reporting period: Three and nine months ended September 30, 2020. Amounts are in U.S. dollars; financial statement amounts are in millions unless otherwise noted. The company operates Texas Capital Bank, serving commercial businesses and professionals, with mortgage finance and other specialized lending businesses.
Financial performance and position
- Q3 earnings: Net income was $57.1 million, down from $88.1 million a year earlier. Income available to common shareholders was $54.7 million, or $1.08 per diluted share, versus $85.6 million, or $1.70 per share.
- First nine months: Net income was $6.1 million and common shareholders incurred a $1.2 million loss, compared with net income of $247.6 million and common income of $240.3 million in 2019. Diluted EPS was a loss of $0.02 versus earnings of $4.77.
- Net interest income and margin: Q3 net interest income was $207.6 million versus $252.2 million; nine-month income was $645.8 million versus $731.3 million. Net interest margin fell to 2.22% from 3.16% for Q3 and to 2.42% from 3.41% for the nine-month period. Lower asset yields and a shift toward liquidity assets pressured results, partly offset by lower funding costs.
- Credit costs: Provision for credit losses was $30.0 million in Q3 versus $11.0 million; the nine-month provision was $226.0 million versus $58.0 million. Q3 net charge-offs were $1.6 million, compared with $74.1 million in Q2 2020 and $36.9 million in Q3 2019. The allowance for loan losses was $290.2 million; total allowance, including off-balance-sheet exposures, was $305.4 million.
- Other income and expenses: Q3 non-interest income increased to $60.3 million from $20.3 million, primarily reflecting loan-sale gains of $25.2 million versus a $6.0 million loss and higher brokered-loan fees. Non-interest expense was $165.7 million versus $149.4 million. Nine-month non-interest expense rose to $553.5 million from $432.7 million, including software costs, severance and merger-related expenses.
- Balance sheet and liquidity: Total assets were $38.4 billion, up from $32.5 billion at year-end 2019. Deposits were $32.0 billion versus $26.5 billion. Cash and cash equivalents were $10.6 billion; interest-bearing deposits in other banks were $10.5 billion. Loans held for investment, net, were $24.9 billion. Shareholders’ equity was $2.8 billion.
- Borrowings and capital: Other borrowings were $2.7 billion, principally FHLB borrowings; subordinated notes and trust preferred debentures totaled about $395.8 million. At September 30, the company’s CET1, total risk-based capital and Tier 1 leverage ratios were 9.05%, 11.84% and 7.58%, respectively. Management said the company and bank met applicable capital adequacy requirements; the bank met the ratios to be considered well capitalized.
- Cash flow: For the first nine months, operating activities provided $2.17 billion, investing activities used $1.79 billion and financing activities provided $5.84 billion. Cash and cash equivalents increased $6.22 billion to $10.65 billion.
Material changes and notable items
- Criticized loans rose to $1.1 billion from $584.1 million at December 31, 2019, with management citing COVID-19 impacts and vulnerable borrower categories. Non-performing assets were $161.9 million, down from $225.4 million at year-end but above $120.7 million a year earlier. Potential problem loans increased to $129.5 million from $46.6 million at year-end.
- Energy loans declined to $969.0 million from $1.4 billion at year-end. Energy reserves were $112.9 million, or 12% of energy loans; non-accrual energy loans were $73.8 million. The company reported $100.2 million in energy loan charge-offs for the first nine months.
- The company adopted CECL on January 1, 2020. Adoption increased the loan allowance by $8.6 million and the off-balance-sheet allowance by $0.6 million, with a $7.2 million after-tax reduction to retained earnings and no initial income-statement impact.
- Mortgage servicing rights were $95.3 million net of a $26.7 million valuation allowance. The company recorded $20.9 million of MSR impairment in the first nine months, attributed to lower mortgage rates and faster expected prepayments.
- The proposed all-stock merger with Independent Bank Group was mutually terminated on May 22, 2020; neither party paid a termination fee. Nine-month results included $17.8 million in merger expenses, $42.1 million in non-recurring software expenses (including $36.2 million of write-offs and $5.9 million of PPP technology expense), $18.0 million in severance accruals and $20.9 million in MSR impairment.
- The filing says previously reported 2019 figures were revised for identified immaterial accounting errors, including a $30.9 million year-end 2019 liability/equity adjustment. Management concluded the errors were not material to prior periods, but revised comparative financial information.
Outlook, management commentary and risks
- Management said it intends to maintain above-average liquidity amid economic uncertainty and sees opportunities to improve core earnings through lower-cost funding and a better earning-asset mix. Workforce reductions and expense actions were expected to lower run-rate expenses, with meaningful reductions beginning in Q4 2020; the full effects were expected in the first half of 2021. Further software write-offs were not expected in Q4.
- The company had funded $717.5 million of Paycheck Protection Program loans, with $715.0 million outstanding at September 30. It had granted temporary payment modifications on 483 loans totaling $1.3 billion; 73 loans totaling $166.2 million remained on deferral.
- Management stated the pandemic had materially adversely affected the company and customers, and that the duration and financial effects could not be reliably estimated. Risks highlighted include further credit deterioration, oil and gas volatility, commercial real estate and other stressed industries, interest-rate and mortgage-servicing exposure, liquidity and funding needs, cybersecurity and operational risks, and the LIBOR transition.
- No specific earnings or financial guidance was provided. The company reported no common dividends declared or paid during the first nine months and said it had no plans to pay common dividends in the foreseeable future.
- Interest-rate simulations estimated next-12-month net interest income increases of $52.3 million under a 100-basis-point rise and $121.5 million under a 200-basis-point rise. Management cautioned that the model relies on uncertain assumptions and actual results may differ materially.
Key facts for investors to verify
- Whether criticized loans, non-performing assets and potential problem loans stabilize or worsen, particularly in energy, commercial real estate and other COVID-affected sectors.
- Whether the $305.4 million total credit-loss allowance proves adequate as economic forecasts and borrower performance evolve under CECL.
- Whether lower net interest margin is offset by reduced funding costs, changes in asset mix and growth in fee income.
- Whether expected expense savings materialize, and how recurring technology, servicing and MSR valuation costs develop.
- Liquidity, deposit composition, reliance on brokered funding and the company’s ability to maintain capital ratios as mortgage finance balances fluctuate.
- The effects of the accounting revisions, MSR valuation assumptions, and eventual LIBOR transition on reported results and risk exposure.