TEXAS CAPITAL BANCSHARES INC quarterly report, Q3 FY2014

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Texas Capital Bancshares, Inc. — Q3 2014 Form 10-Q

Business context and period. Texas Capital Bancshares is a Texas-focused commercial bank serving businesses, professionals and entrepreneurs, with additional regional and national lending activities. This unaudited filing covers the quarter and nine months ended September 30, 2014; balance-sheet comparisons are primarily with December 31, 2013.

Financial performance

  • Q3 earnings: Net income was $36.8 million, versus $33.5 million in Q3 2013. Net income available to common shareholders was $34.4 million; diluted EPS was $0.78, up from $0.74.
  • Nine-month earnings: Net income was $98.5 million, versus $90.7 million in 2013. Common-shareholder income was $91.2 million and diluted EPS was $2.09, versus $85.7 million and $2.05.
  • Interest income and margin: Q3 net interest income was $125.7 million, up from $108.8 million; nine-month net interest income was $349.4 million, versus $308.0 million. Net interest margin declined to 3.77% from 4.21% in Q3 and to 3.87% from 4.22% for the nine-month period.
  • Other income and expenses: Q3 non-interest income was $10.4 million, essentially unchanged year over year; non-interest expense rose 16% to $71.9 million. For nine months, non-interest income declined to $31.3 million from $32.8 million, while expense rose 13% to $211.0 million.
  • Credit costs: Q3 provision for credit losses was $6.5 million, versus $5.0 million a year earlier. Nine-month provision was $15.5 million, versus $14.0 million. Nine-month net charge-offs were $5.2 million, compared with $3.6 million in 2013.
  • Cash flow: For nine months, operating cash flow was $111.8 million, investing cash flow was negative $2.18 billion, and financing cash flow was positive $2.45 billion. Cash and cash equivalents ended at $529.7 million, up $375.8 million from year-end. Investing cash flow chiefly reflects mortgage-finance loan activity and growth in other loans.

Financial position and material changes

  • Total assets were $14.27 billion, up from $11.71 billion at year-end 2013. Net loans held for investment grew to $13.36 billion from $11.18 billion. Mortgage-finance loans increased to $3.77 billion from $2.78 billion; these interests are generally held for 10–20 days.
  • Total deposits were $11.72 billion, up from $9.26 billion. The company reported $9.89 billion of core-customer deposits and $1.82 billion of relationship-brokered deposits at quarter-end; it had no traditional brokered CDs outstanding.
  • Borrowings included $285.7 million of federal funds purchased and repurchase agreements, $450.0 million of FHLB borrowings, $286.0 million of subordinated notes and $113.4 million of trust-preferred debentures. The Bank issued $175 million of 5.25% subordinated notes in January 2014, maturing in 2026. A January common-stock offering raised $106.5 million net.
  • Stockholders’ equity was $1.30 billion, versus $1.10 billion at year-end. Company capital ratios at September 30 were 8.83% Tier 1, 11.31% total risk-based and 10.17% leverage. Management said the Bank met the ratios to be considered well capitalized; the Company’s ratios exceeded the regulatory definition of adequately capitalized.
  • Q3 return on average assets was 1.07% and return on average common equity was 12.11%, down from 1.25% and 13.74%, respectively. Management cited lower loan yields, more liquidity assets, and the cost of the new subordinated notes; common equity issuance also reduced ROE.

Outlook, risks and unusual items

  • No specific earnings or growth guidance was provided. Management said growth depends on continued loan and deposit relationships and access to capital, and noted that competition could constrain non-interest income growth.
  • Management attributed higher expenses chiefly to business growth and infrastructure investment. Nine-month expense comparisons also reflected $7.7 million of non-recurring CEO-succession-related expense in the prior-year period. Q3 2013 included a one-time $3.0 million FDIC assessment related to amended historical call reports and mortgage-finance risk weighting.
  • Credit risks include rapid loan growth, the Texas concentration in most non-mortgage lending, commercial real estate and construction exposure, and uncertainty in collateral values and borrower information. Non-accrual loans rose to $37.7 million from $32.4 million at year-end; they were $35.7 million at September 2013. Non-performing assets totaled $38.4 million. Management said the allowance was adequate but acknowledged estimates could prove insufficient.
  • Unfunded commitments to extend credit were $5.00 billion and standby letters of credit were $164.1 million. These contractual amounts are not necessarily expected cash outflows but represent potential credit exposure.
  • Interest-rate sensitivity modeling estimated next-12-month net interest income increases of $56.1 million under a 100-basis-point rate increase and $122.9 million under a 200-basis-point increase versus the company’s most-likely scenario. Management cautioned that actual results may differ materially because the model depends on assumptions about rates, balances, repricing and customer behavior.
  • The company disclosed a prior cash-flow classification error for mortgage-finance loan transactions: 2013 nine-month operating cash flow was reduced by $913.2 million and investing cash flow increased correspondingly. Management concluded the reclassification did not affect earnings or materially misstate prior financial statements.
  • Residual discontinued-mortgage operations include $288,000 of loans held for sale and possible repurchase claims from investors. Management said market conditions could create further loss exposure and extend the time to resolve these matters. Ordinary-course legal matters were not expected to have a material adverse effect.
  • Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter. No material risk-factor changes from the 2013 Form 10-K were reported.

Investor verification points

  • Assess whether loan and deposit growth can sustain earnings as net interest margin compresses and operating expenses rise.
  • Review asset quality trends, especially rising commercial non-accrual loans, charge-offs, criticized credits and reserve adequacy relative to rapid portfolio growth.
  • Evaluate the concentration and liquidity implications of mortgage-finance warehouse lending, including its short holding period and reliance on investor and originator performance.
  • Confirm capital and funding capacity under applicable Basel III rules, including the maturity of the $100 million unused credit line in December 2014 and the company’s reliance on deposits and wholesale funding.
  • Track potential mortgage repurchase exposure, off-balance-sheet commitments, and the assumptions underlying interest-rate sensitivity estimates.