Texas Capital Bancshares, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter ended September 30, 2018; comparisons are primarily with Q3 2017 and, for balance-sheet items, December 31, 2017. The company is a Texas-based commercial bank with specialized lending businesses serving regional and national customers.
Financial performance and condition
- Profit: Q3 net income was $85.6 million, up from $58.7 million; net income available to common stockholders was $83.1 million, or $1.65 diluted EPS, versus $56.2 million, or $1.12. Nine-month net income was $228.9 million versus $152.3 million, with diluted EPS of $4.41 versus $2.89.
- Interest income and margins: Q3 interest income was $301.8 million versus $237.6 million; net interest income was $232.2 million versus $204.4 million. Tax-equivalent net interest margin increased to 3.70% from 3.59%. The nine-month GAAP net interest income was $674.2 million versus $550.7 million.
- Non-interest income and expense: Q3 non-interest income rose to $25.5 million from $19.0 million, including gains on mortgage loan sales and a $2.0 million OREO property sale gain. Non-interest expense rose 19% to $136.1 million from $114.8 million, reflecting business growth; the OREO sale also prompted a $2.0 million reversal of a prior valuation allowance.
- Credit costs: Q3 provision for credit losses was $13.0 million, down from $20.0 million, which management attributed mainly to improvement in classified loan portfolio composition, including energy loans. For the first nine months, provision was $52.0 million versus $42.0 million. Net charge-offs were $45.1 million for the nine-month period versus $28.9 million a year earlier.
- Balance sheet and lending: Total assets were $27.1 billion, up from $25.1 billion at year-end 2017. Net loans held for investment were $21.9 billion, up from $20.5 billion; total deposits were $20.4 billion, up from $19.1 billion. Loans held for sale were $1.65 billion, versus $1.01 billion at year-end.
- Credit quality: Non-accrual loans were $107.5 million, compared with $101.4 million at year-end and $118.2 million a year earlier. The allowance for loan losses was $190.3 million; combined loan and off-balance-sheet credit-loss allowances were $200.6 million. Non-performing assets totaled $107.6 million.
- Cash flow and liquidity: For nine months, operating cash flow was negative $388.7 million versus positive $141.5 million, affected in part by mortgage loans purchased and originated exceeding proceeds from sales and repayments. Investing cash flow was negative $1.51 billion; financing cash flow was positive $1.77 billion. Cash and cash equivalents ended at $2.79 billion. Reported liquidity assets were $2.62 billion.
- Funding and capital: Period-end borrowings included $3.2 billion of FHLB borrowings and $395.1 million of subordinated notes and trust preferred debentures. The company reported a CET1 ratio of 8.64%, total capital ratio of 11.47%, and Tier 1 leverage ratio of 9.70%; management said the company and bank met applicable capital requirements. Traditional brokered deposits were $1.53 billion, or 7.5% of deposits, versus none at year-end 2017.
- Returns and taxes: Q3 ROE was 14.68% and ROA 1.31%, versus 11.20% and 0.99%. The nine-month effective tax rate was 21%, compared with 34% in 2017, reflecting the lower federal corporate tax rate under the Tax Act.
Material changes and management commentary
- Management attributed stronger earnings chiefly to loan growth, higher loan yields and rates, and lower tax expense. Q3 margin expansion occurred despite materially higher deposit and borrowing costs; the average cost of interest-bearing liabilities rose to 1.78% from 1.06%.
- Average earning assets increased by $2.3 billion in Q3 year over year, while average interest-bearing liabilities increased by $3.0 billion. Management described the decline in demand deposits and higher funding costs as effects of rising rates and deposit migration to interest-bearing accounts.
- Management expects continued growth in certain non-interest income components, but noted competition could affect growth. The filing provides no specific earnings or revenue guidance.
- The company completed a sale of its largest OREO property in Q3, reducing OREO to $79,000 from $11.7 million at year-end. The transaction produced a $2.0 million gain and reversal of a $2.0 million valuation allowance.
Risks, contingencies, and unusual items
- Key risks include loan deterioration, collateral-value declines, Texas and broader economic conditions, oil and gas price volatility, real estate markets, rising-rate effects on borrowers and funding costs, and the adequacy of credit-loss estimates.
- Mortgage banking exposes the company to loan pricing, servicing-rights valuation, prepayment and interest-rate risks, as well as repurchase and indemnification claims. Estimated exposure for loans previously sold was $1.6 million at quarter-end.
- Commitments to extend credit were $7.51 billion and standby letters of credit were $235.5 million. The related off-balance-sheet credit-loss allowance was $10.3 million.
- Management said ordinary-course legal claims were not expected to have a material adverse impact; no material changes to previously disclosed risk factors were reported.
- The company identified adoption of the current expected credit loss standard (CECL), scheduled for January 1, 2020, as an area under evaluation; it could not yet reasonably estimate the impact.
- Interest-rate simulations estimated next-12-month net interest income increases of $107.0 million under a 100-basis-point rise and $214.6 million under a 200-basis-point rise, and a $111.9 million decrease under a 100-basis-point decline. Management cautioned that modeling assumptions are uncertain and actual results may differ.
Important facts for investors to verify
- Whether loan growth and higher yields can continue to offset rising deposit and borrowing costs, including the use and cost of brokered deposits.
- Credit trends behind the rise in nine-month net charge-offs, particularly commercial and energy exposures, and the adequacy of the allowance as the portfolio grows.
- The sustainability and composition of mortgage banking income, mortgage loan sale results, and mortgage servicing rights valuations and repurchase exposure.
- Whether reported liquidity and capital remain adequate under changing funding conditions and quarter-end mortgage finance balance fluctuations.
- The eventual financial impact of CECL adoption and whether the company provides subsequent quantified guidance.