Texas Capital Bancshares, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; balance-sheet comparisons are to December 31, 2015 unless noted. The company is a Texas-focused commercial bank, with mortgage-finance and other regional or national lending businesses. Amounts below are in U.S. dollars.
Financial performance and condition
- Earnings: Net income was $25.1 million, down 28% from $35.1 million in Q1 2015. Net income available to common shareholders was $22.7 million, or $0.49 per diluted share, versus $32.6 million, or $0.70 per diluted share.
- Interest income and margins: Net interest income rose to $144.8 million from $130.0 million, primarily as average earning assets grew. Net interest margin declined to 3.13% from 3.22%; the cost of interest-bearing liabilities increased to 0.57% from 0.46%.
- Credit provision and expenses: Provision for credit losses increased to $30.0 million from $11.0 million. Non-interest income decreased to $11.3 million from $12.3 million, largely due to lower swap fees. Non-interest expense increased 13% to $86.8 million, including higher personnel, legal and professional, technology, and FDIC assessment costs.
- Returns: Return on average equity was 6.13% versus 9.82%; return on average assets was 0.53% versus 0.84%. Management attributed the declines chiefly to the higher credit-loss provision, with lower loan yields and higher average liquidity also affecting ROA.
- Assets, loans, and deposits: Total assets were $20.21 billion, up from $18.90 billion. Net loans held for investment were $16.88 billion, up from $16.57 billion; gross loans were $17.10 billion. Deposits rose to $16.30 billion from $15.08 billion, including $7.46 billion of non-interest-bearing deposits.
- Credit quality: Non-accrual loans were $173.2 million, compared with $179.8 million at year-end and $68.3 million a year earlier. Non-performing assets totaled $190.7 million, including $17.6 million of other real estate owned (OREO), versus $180.3 million and $68.9 million, respectively. Energy-related non-performing assets were $141.3 million, up from $120.4 million at year-end and $0.3 million a year earlier. Net charge-offs were $7.4 million versus $3.1 million in Q1 2015.
- Reserves: The allowance for loan losses was $162.5 million, or 0.95% of loans held for investment; including the off-balance-sheet allowance, total allowance for credit losses was $172.7 million. The combined allowance was 1.43% of loans excluding mortgage-finance loans. Management said the allowance reflected its assessment of inherent losses, growth, economic conditions, and energy-sector volatility.
- Cash flow and liquidity: Operating cash flow was $22.7 million; investing cash outflow was $353.3 million; financing cash inflow was $1.273 billion. Cash and cash equivalents ended at $2.734 billion, up $942.8 million during the quarter. Liquidity assets were $2.644 billion, and 90.6% of deposits were from core customers.
- Debt and capital: Other borrowings were $1.604 billion, including $1.600 billion of FHLB borrowings; subordinated notes were $280.8 million and trust-preferred debentures $113.4 million. Company CET1, Tier 1, total capital, and leverage ratios were 7.47%, 8.78%, 11.07%, and 9.10%, respectively. Management said the Company met capital adequacy requirements; the Bank met the ratios for well-capitalized status.
Material changes and management commentary
- Management attributed the higher credit provision to deterioration in the energy portfolio, growth in loans excluding mortgage finance, more criticized loans, and changes in applied risk weights. It identified continued low and volatile oil and gas prices as a key concern.
- Average earning assets increased $2.2 billion year over year, while average liquidity assets increased $742.7 million. Higher funding costs and a larger share of liquidity assets contributed to margin compression.
- The mortgage correspondent aggregation business, launched in 2015, purchased and sold residential loans for the secondary market. Loans held for sale were $94.7 million at quarter-end. The company retained servicing rights on some sales; mortgage servicing rights had a fair value of $4.3 million.
- A single commercial-property foreclosure added $17.4 million to OREO during the quarter; the property was identified as a medical building. The filing reported no OREO valuation expense for the quarter.
Outlook, risks, and contingencies
- The filing gives no specific quantitative earnings or revenue guidance. Management said it expects earnings, capital-raising transactions, and new loan and deposit relationships to support organic growth, and expects growth in some non-interest income components, subject to competition and execution risks.
- Management stated it did not currently expect low commodity prices to have a material adverse effect on financial position, while also warning that continued energy weakness could impair borrowers and collateral values and increase losses. This outlook should be considered alongside the sharp increase in energy-related non-performing assets.
- Key disclosed risks include loan-credit deterioration, Texas and broader economic conditions, energy and real-estate exposures, allowance-estimation uncertainty, funding and liquidity needs, interest-rate changes, regulatory requirements, competition, mortgage-market and servicing risks, cybersecurity, and third-party performance.
- Mortgage-loan sales carry potential repurchase, indemnification, or make-whole obligations. Estimated exposure was $178,000 at March 31, 2016; the relatively new business had limited company-specific loss history. Commitments to extend credit were $5.56 billion and standby letters of credit were $191.1 million.
- Management reported disclosure controls were effective and no material change in internal control over financial reporting. It did not expect ordinary-course legal matters to have a material adverse financial impact; no material risk-factor changes from the 2015 Form 10-K were reported.
Important facts for investors to verify
- Whether energy-sector problem loans, criticized credits, non-accrual balances, and charge-offs continue to rise, and whether collateral valuations and reserves remain adequate.
- How the $30.0 million quarterly provision and higher allowance affect subsequent earnings, and whether the Q1 credit costs are a continuing trend.
- Whether deposit growth and the unusually high liquidity balance persist, and how funding costs and asset mix affect net interest margin.
- Capital ratios and liquidity under quarter-end mortgage-finance balance fluctuations, as well as the company’s capacity to fund commitments and borrowings.
- Mortgage correspondent business profitability, servicing-rights valuation assumptions, and actual repurchase or indemnification claims as company-specific loss experience develops.