Texas Capital Bancshares, Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; balance sheet comparisons are to December 31, 2018. Texas Capital Bancshares is a commercial bank focused on businesses, professionals and entrepreneurs, with mortgage finance and other national lending businesses. Amounts below are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Financial performance and position
- Earnings: Net income was $82.8 million, up from $71.9 million in Q1 2018. Net income available to common stockholders was $80.4 million, or $1.60 per diluted share, versus $69.5 million, or $1.38 per diluted share. Return on average assets was 1.26% and return on average common equity was 13.58%.
- Revenue and margins: Net interest income was $235.6 million, up from $210.3 million. Net interest margin increased to 3.73% from 3.71%; the yield on earning assets rose to 5.15% from 4.48%, while the average cost of interest-bearing liabilities increased to 2.17% from 1.32%. Non-interest income grew to $30.0 million from $19.9 million. Non-interest expense increased to $140.4 million from $127.0 million.
- Credit costs: Provision for credit losses was $20.0 million versus $12.0 million. Net charge-offs were $4.6 million. The allowance for loan losses was $208.6 million, or 0.89% of loans held for investment; the combined allowance, including off-balance-sheet credit losses, was $218.4 million, or 0.93% of loans held for investment.
- Loans and asset quality: Net loans held for investment rose to $23.15 billion from $22.38 billion. Non-accrual loans increased to $133.7 million from $80.4 million at year-end and were $123.5 million in Q1 2018. Potential problem loans were $74.0 million, down from $81.7 million at year-end. The filing attributes the higher Q1 provision primarily to loan growth and describes a refinement of its allowance methodology.
- Cash flow: Operating activities provided $164.2 million, compared with $5.3 million in Q1 2018. Investing activities used $910.0 million, versus providing $231.5 million; financing activities used $2.9 million, versus using $691.3 million. Cash and cash equivalents declined $748.8 million during the quarter to $2.33 billion.
- Liquidity, funding and debt: Deposits totaled $20.65 billion, up slightly from $20.61 billion at year-end. Non-interest-bearing deposits declined to $6.74 billion from $7.32 billion, while interest-bearing deposits increased to $13.91 billion from $13.29 billion. Liquidity assets were $2.15 billion, or 10.4% of deposits, down from $2.87 billion, or 13.9%. Federal funds purchased and repurchase agreements were $897.9 million; FHLB borrowings were $3.60 billion, down from $3.90 billion. Subordinated notes and trust preferred debentures were $281.9 million and $113.4 million, respectively.
- Capital: At March 31, the company’s CET1 ratio was 8.64%, total capital ratio 11.35%, and Tier 1 leverage ratio 10.02%. The Bank’s corresponding ratios were 8.70%, 10.84%, and 9.70%. Management stated the Company and Bank met applicable capital adequacy requirements; the Bank met the ratios for “well capitalized” status.
Material changes and notable items
- Year-over-year earnings growth reflected higher net interest income and non-interest income, partly offset by higher credit provision and operating expenses. The increase in net interest income was driven chiefly by growth in average earning assets and higher loan yields; funding costs also rose materially.
- Other non-interest income included an $8.5 million legal claim settlement. The filing says servicing income fell $2.8 million year over year, principally with a smaller mortgage servicing rights portfolio.
- Mortgage servicing rights had a $2.9 million impairment charge in Q1, associated with lower mortgage rates and changed valuation assumptions. A $331,000 credit-related impairment was recorded on newly acquired credit risk transfer securities.
- The company adopted lease accounting guidance on January 1, 2019, recognizing an operating lease right-of-use asset and liability of $64 million and $74 million, respectively, at adoption. At quarter-end, these balances were $62.2 million and $71.7 million.
- Traditional brokered deposits were $1.56 billion, representing 7.6% of deposits; they were not reported at March 31, 2018. Management describes their use as a funding source for temporary differences in loan and deposit growth.
- The company converted to a new loan servicing system during the quarter for its $17.1 billion loans-held-for-investment portfolio, excluding mortgage finance loans. Testing and additional controls were implemented; management reported no other material changes to internal control over financial reporting.
Outlook, risks and contingencies
- The filing provides no specific earnings or financial guidance. Management noted that future non-interest income growth may be affected by competition and economic conditions.
- Key disclosed risks include deterioration in loan quality or collateral values, Texas and energy-sector economic conditions and commodity-price volatility, interest-rate and deposit-cost changes, funding and liquidity access, mortgage market and servicing volatility, competition, operational and cybersecurity risks, and regulatory or capital changes.
- The company is preparing for the CECL credit-loss standard, scheduled for adoption January 1, 2020. It could not yet reasonably estimate the adoption impact and said the effect will depend on portfolio characteristics and economic conditions.
- Off-balance-sheet commitments to extend credit were $7.85 billion and standby letters of credit were $265.1 million. Management did not expect ordinary-course legal proceedings to have a material adverse effect. The filing reports no material changes to previously disclosed risk factors.
- Interest-rate simulations estimated that, over the next 12 months versus the “most likely” rate scenario, net interest income would increase $102.9 million under a 100-basis-point rise or $206.5 million under a 200-basis-point rise, and decline $116.8 million under a 100-basis-point fall. Management cautions that model assumptions are uncertain and actual results may differ.
Most important facts for investors to verify
- Whether the increase in non-accrual loans—particularly commercial energy loans—and the higher allowance remain adequate as the loan portfolio grows.
- How deposit mix, rising deposit costs, brokered funding and lower liquidity assets affect funding stability and net interest margin.
- Whether the $8.5 million legal settlement and other unusual items affect comparisons with future quarters.
- How mortgage servicing rights values, mortgage finance volumes and secondary-market conditions evolve.
- The eventual CECL adoption impact, and whether the new loan servicing system and related controls operate as intended.