TEXAS CAPITAL BANCSHARES INC quarterly report, Q2 FY2020

Texas Capital Bancshares, Inc. — Q2 2020 Form 10-Q

Reporting period: Quarter and six months ended June 30, 2020. The company is a Texas-focused commercial bank with national specialty lending businesses, including mortgage finance. Amounts below are rounded.

Financial performance and position

Metric	Q2 2020	Comparable period / change
Net income (loss)	$(34.3) million; common-stockholder loss $(36.8) million; diluted EPS $(0.73)	Q2 2019 net income $77.8 million; diluted EPS $1.50
Net interest income	$209.9 million	$243.6 million in Q2 2019
Net interest margin	2.30%	3.41% in Q2 2019
Provision for credit losses	$100.0 million	$27.0 million in Q2 2019
Non-interest income	$70.5 million	$24.4 million in Q2 2019, including a swing in gains on loan sales
Non-interest expense	$222.4 million	$141.7 million in Q2 2019

For the six months, net loss was $51.0 million, net loss available to common stockholders was $55.9 million, and diluted EPS was $(1.11), versus net income of $159.5 million and diluted EPS of $3.07 in the first half of 2019. Net interest income was $438.2 million versus $479.2 million; net interest margin was 2.53% versus 3.56%; and provision for credit losses was $196.0 million versus $47.0 million.

At June 30, total assets were $36.6 billion, up from $32.5 billion at year-end 2019. Deposits were $30.2 billion versus $26.5 billion; loans held for investment, net, were $25.3 billion versus $24.5 billion; and the allowance for loan losses was $264.7 million versus $195.0 million. Cash and cash equivalents were $9.72 billion, compared with $4.43 billion at year-end. Six-month operating cash flow was $2.25 billion, investing cash outflow $1.02 billion, and financing cash inflow $4.06 billion.

Total liabilities were $33.9 billion and stockholders’ equity $2.73 billion. Borrowings included $2.7 billion of FHLB borrowings, $282.3 million of subordinated notes, and $113.4 million of trust preferred subordinated debentures. The company and bank exceeded applicable capital adequacy minimums; the bank was reported well capitalized. Company CET1 was 8.88% and total capital ratio 11.60% at quarter-end.

Material changes and credit trends

• Net interest margin compressed as lower market rates reduced asset yields and the company held substantially more low-yielding liquidity. Lower funding costs partly offset that pressure. Management reported Q2 average earning assets rose $7.9 billion year over year, including higher liquidity and mortgage finance balances.
• Credit costs rose sharply amid COVID-19 uncertainty and energy-sector weakness. Q2 net charge-offs were $74.1 million, including $62.4 million in energy and $8.1 million in leveraged lending. Criticized loans reached $1.0 billion, compared with $584.1 million at December 31, 2019; nonperforming assets were $174.0 million.
• Energy loans totaled $1.15 billion, down from $1.43 billion at year-end. Energy non-accruals were $103.9 million. Management said approximately 70% of E&P clients were hedged at least 50% for 2020 and approximately 60% for 2021.
• The allowance increased to $264.7 million for loans; total allowance including off-balance-sheet exposures was $277.0 million. The company adopted CECL on January 1, 2020, increasing the allowance by $9.1 million at adoption, with no income-statement impact.

Outlook, management commentary, risks, and unusual items

• The merger agreement with Independent Bank Group was mutually terminated on May 22, 2020; neither party paid a termination fee. Management cited COVID-19’s effects on markets and the parties’ ability to realize expected merger benefits.
• Management said it intended to maintain above-average liquidity, while seeking to improve core earnings by reducing or replacing higher-cost funding and improving earning-asset mix. It began moving some low-yield liquidity into securities in early July. The filing gives no numerical earnings or margin guidance and says the effects of the pandemic for the rest of 2020 cannot be reliably estimated.
• Q2 included $100.0 million of credit-loss provision; $26.6 million of non-recurring software and technology costs, including $20.7 million in software write-offs and $5.9 million related to PPP capabilities; $18.0 million in severance accruals; $10.5 million in final merger costs; and $9.1 million of MSR impairment. Management characterized the non-interest expense items as not expected to recur. Six-month MSR valuation allowance increases were $20.8 million.
• PPP loans funded totaled $717.5 million at June 30. Temporary COVID-19 payment modifications covered 482 loans with $1.2 billion outstanding and deferred $10.8 million in interest payments.
• COVID-19, energy and other industry exposures, criticized-loan migration, CECL forecast assumptions, interest rates, mortgage prepayments and MSR valuations, liquidity/funding, and operational and cybersecurity risks are emphasized. Management stated approximately 90% of its workforce was working virtually with limited effect on operations at the time.
• The company disclosed correction of an immaterial historical accounting error involving certain puttable share-based liabilities, along with other immaterial errors; prior comparative information was revised. It concluded the errors were not material to prior periods, current period, or earnings trends. Disclosure controls were assessed as effective, and management reported no material change in internal control over financial reporting.

Important facts for investors to verify

• Whether credit deterioration, charge-offs, and criticized-loan growth—especially in energy, leveraged lending, and COVID-affected industries—remain within the assumptions behind the allowance.
• How the $1.2 billion of modified loans perform after deferrals, and whether further modifications or additional losses emerge.
• Whether the unusually high liquidity balance can be deployed at adequate yields without increasing funding or interest-rate risk; also monitor deposit mix and borrowing needs.
• Whether loan-sale gains and mortgage servicing economics persist, and whether further MSR impairment or make-whole losses occur as rates and prepayments change.
• The effects of the merger termination, workforce reduction, software write-offs, and accounting revisions on future recurring costs, execution, and reported comparisons.