Texas Capital Bancshares, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. The company is a Texas-focused commercial bank and lender, with additional regional and national commercial lending and mortgage finance businesses. Financial statements are unaudited.
Financial performance and position
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net interest income | $166.7 million | $142.0 million | $468.6 million | $414.3 million |
| Provision for credit losses | $22.0 million | $13.8 million | $68.0 million | $39.3 million |
| Non-interest income | $16.7 million | $11.4 million | $41.9 million | $36.4 million |
| Non-interest expense | $94.8 million | $81.7 million | $275.9 million | $239.5 million |
| Net income | $42.7 million | $37.1 million | $106.7 million | $110.1 million |
| Net income available to common stockholders | $40.3 million | $34.7 million | $99.4 million | $102.8 million |
| Diluted earnings per common share | $0.87 | $0.75 | $2.14 | $2.21 |
| Net interest margin | 3.14% | 3.12% | 3.15% | 3.18% |
At September 30, 2016, total assets were $22.2 billion, deposits $18.1 billion, net loans held for investment $17.4 billion, and stockholders’ equity $1.73 billion. Compared with December 31, 2015, assets increased $3.31 billion, deposits increased $3.06 billion, and net loans held for investment increased $872 million. Other borrowings were $1.67 billion; subordinated notes and trust preferred debentures totaled about $394 million.
Cash and cash equivalents were $3.59 billion at quarter-end. For the first nine months, operating activities used $427 million, investing activities used $936 million, and financing activities provided $3.16 billion. The filing attributes significant operating cash-flow activity to mortgage loans purchased and sold through the correspondent mortgage business; cash flow should be viewed in that context. Total liquidity assets were $3.47 billion, or 20.8% of deposits.
Company regulatory capital ratios at quarter-end were 7.55% CET1, 8.80% Tier 1, 11.09% total capital, and 8.38% Tier 1 leverage. Management stated the Bank met the capital ratios to be considered well capitalized; the company’s ratios exceeded adequately capitalized levels.
Material changes and credit quality
- Q3 net income rose 15% year over year, as higher net interest income and non-interest income more than offset higher credit provision, operating costs, and taxes. For the nine-month period, net income declined 3%, primarily due to the $28.8 million increase in credit provision and $36.4 million increase in non-interest expense.
- Net interest income grew with higher average earning assets, including loan growth and increased liquidity. Funding costs also rose: the cost of interest-bearing liabilities was 0.57% in Q3 versus 0.46% a year earlier. Nine-month net interest margin eased to 3.15% from 3.18%.
- Credit costs increased amid deterioration in energy lending, loan growth, and higher criticized loans. Nine-month net charge-offs were $26.8 million versus $9.1 million a year earlier. The allowance for loan losses was $180.4 million, up from $141.1 million at year-end 2015.
- Non-accrual loans were $169.1 million and total non-performing assets were $188.1 million at September 30. Energy non-performing assets were $150.0 million, compared with $36.9 million a year earlier. The company also reported $26.3 million of potential problem loans not included in non-accrual or past-due categories.
- OREO increased to $19.0 million from $278,000 at year-end, primarily following foreclosure of three commercial properties. The allowance for loan losses was 1.02% of loans held for investment, or 1.42% excluding mortgage finance loans; management considered the allowance appropriate.
- Non-interest expense growth reflected business expansion and investment in staff, technology and IT security, as well as higher FDIC assessments. Mortgage correspondent activity expanded: loans held for sale were $648.7 million versus $86.1 million at year-end, while the servicing portfolio grew to $1.3 billion from $39 million.
Outlook, risks and contingencies
The filing gives no formal earnings or revenue guidance. Management said it expects growth organically through earnings and additional loan and deposit relationships, and expects continued growth in some non-interest income components, while noting competition and the resource demands of new products or business lines. The company said it had no plans to pay common dividends in the foreseeable future.
Management highlighted continued low and volatile oil and gas prices as a risk to energy borrowers, collateral values, credit quality, and loan-loss estimates. Other disclosed risks include Texas and broader economic conditions, real-estate values, funding and liquidity, interest-rate exposure, regulatory requirements, competition, mortgage market and servicing risks, cybersecurity, third-party performance, and legal or operational risks. Management did not expect current commodity-price conditions to materially adversely affect financial position, but continued to monitor the exposure.
The mortgage business carries repurchase, indemnification, and make-whole obligations for loans sold. Estimated exposure was $621,000 at quarter-end, based on industry loss data because the program lacked sufficient company loss history; no related losses were reported for the period. The company reported ordinary-course legal claims and did not expect their disposition to have a material adverse financial impact. Management reported effective disclosure controls and no material changes in internal control over financial reporting.
The company’s interest-rate model estimated that a parallel 100- or 200-basis-point rate increase would raise net interest income by $117.1 million or $241.4 million, respectively, over the next 12 months versus its “most likely” scenario. These are model estimates, depend on uncertain assumptions, and are not company guidance.
Important facts for investors to verify
- Whether energy-sector credit deterioration, criticized loans, charge-offs, and non-performing assets continue to rise, and whether the allowance adequately reflects potential losses.
- The composition and collateral support of the $150.0 million in energy non-performing assets and the $26.3 million in potential problem loans.
- Whether mortgage correspondent volumes, loan-sale margins, servicing-rights valuations, and repurchase exposures remain manageable as the business scales.
- The sustainability and cost of deposit growth, liquidity levels, and borrowings, including the $1.65 billion of FHLB borrowings and the line of credit that matured in December 2016.
- Whether operating expenses and credit provisions grow faster than net interest income, and how that affects returns and capital.
- The assumptions behind interest-rate sensitivity estimates, especially deposit pricing, loan repricing, and prepayment behavior.