TEXAS CAPITAL BANCSHARES INC quarterly report, Q3 FY2015

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Business context and reporting period

Texas Capital Bancshares, Inc. filed this unaudited Form 10-Q for the quarter ended September 30, 2015. The company serves businesses and professionals, primarily in Texas, and operates commercial lending, mortgage finance and other banking businesses. Unless noted otherwise, financial amounts below are in U.S. dollars.

Financial performance and condition

  • Third-quarter earnings: Net income was $37.1 million, up 0.8% from $36.8 million a year earlier. Net income available to common stockholders was $34.7 million; diluted EPS was $0.75 versus $0.78.
  • Nine-month earnings: Net income was $110.1 million, up 11.8% year over year; diluted EPS was $2.21 versus $2.09.
  • Net interest income and margin: Third-quarter net interest income rose to $142.0 million from $125.7 million, while net interest margin fell to 3.12% from 3.77%. For the first nine months, net interest income was $414.3 million versus $349.4 million and margin was 3.18% versus 3.87%.
  • Credit costs: Third-quarter provision for credit losses increased to $13.8 million from $6.5 million. The nine-month provision was $39.3 million versus $15.5 million.
  • Other income and expenses: Third-quarter non-interest income was $11.4 million, up from $10.4 million, while non-interest expense rose to $81.7 million from $71.9 million. For nine months, these were $36.4 million versus $31.3 million and $239.5 million versus $211.0 million, respectively.
  • Returns: Third-quarter ROA was 0.79% and ROE was 9.69%, compared with 1.07% and 12.11% a year earlier. Nine-month ROA was 0.82% and ROE 9.94%, versus 1.06% and 11.27%. Management attributed weaker returns in part to reduced loan yields, higher average liquidity and increased average equity following the late-2014 share offering.
  • Balance sheet and liquidity: Total assets were $18.67 billion at quarter-end, up from $15.90 billion at December 31, 2014. Deposits were $15.17 billion versus $12.67 billion. Loans held for investment, net, were $15.75 billion versus $14.16 billion. Cash and cash equivalents were $2.45 billion; reported liquidity assets were $2.35 billion.
  • Cash flow, first nine months: Operating activities provided $91.8 million, investing activities used $1.62 billion and financing activities provided $2.65 billion. Cash and cash equivalents increased by $1.12 billion to $2.45 billion.
  • Funding and capital: Other borrowings were $1.25 billion; federal funds purchased and repurchase agreements totaled $103.8 million. Long-term subordinated notes and trust preferred debentures totaled $399.4 million. Company CET1, Tier 1, total capital and leverage ratios were 7.69%, 9.10%, 11.39% and 9.08%, respectively. Management stated the Company met applicable capital adequacy requirements; the Bank met the ratios for “well capitalized.”

Material changes versus comparable periods

  • Loan growth and higher average liquidity drove increased net interest income, but lower loan yields and the larger low-yield liquidity position compressed net interest margin.
  • Credit quality metrics weakened: non-accrual loans rose to $109.7 million from $43.3 million at December 2014 and $37.7 million at September 2014. Non-performing assets were $109.9 million versus $43.9 million at year-end 2014. The allowance for loan losses increased to $130.5 million from $101.0 million; the combined reserve for credit losses was $138.1 million.
  • Management cited increased reserves for energy and other loans, portfolio growth and changes in risk ratings as drivers of higher provision expense. Net charge-offs for the first nine months were $9.1 million, compared with $5.2 million a year earlier; allowance coverage of non-accrual loans declined to 1.2x from 2.3x at year-end.
  • Operating costs rose, led by salaries and benefits, occupancy, technology and FDIC insurance assessments. The assessment increase was attributed to growth in total assets.
  • Customer deposits grew substantially; core customer deposits represented 89.4% of total deposits, compared with 86.0% at December 2014. Liquidity assets also increased materially.

Outlook, commentary and risks

  • The company launched its Mortgage Correspondent Aggregation (MCA) program in the third quarter to purchase residential mortgages and sell them into the secondary market. Nine-month volume was not significant; third-quarter purchases were $4.2 million and sales $3.2 million, with an immaterial gain.
  • Management expected continued growth in certain non-interest income components, but noted competition could affect growth. The filing provides no quantified earnings or revenue guidance.
  • Management identified Texas and broader economic conditions, oil and gas price weakness, real estate values, loan concentrations and the adequacy of credit-loss estimates as risks. Energy prices remained suppressed; management did not expect then-current declines to have a material adverse effect but said energy credits were being monitored.
  • MCA adds mortgage pricing, resale, servicing-rights and hedging risks. Management cautioned that hedging cannot fully eliminate exposure and that non-bank competitors may have pricing advantages.
  • Interest-rate simulations estimated net interest income increases over the next 12 months of $87.0 million under a 100-basis-point rise and $182.7 million under a 200-basis-point rise versus the most-likely scenario. These are model estimates subject to uncertain assumptions, not guidance.
  • The company reported no common-stock dividends and no plans to pay them in the foreseeable future. Management did not expect ordinary-course legal matters to have a material adverse financial impact. Disclosure controls were assessed as effective, with no material change in internal control reported.

Important facts for investors to verify

  1. Whether the sharp increase in non-accrual loans, particularly commercial, energy and construction exposures, leads to further charge-offs or reserve increases.
  2. Whether the allowance and its assumptions adequately reflect Texas economic conditions, energy-sector stress, loan growth and potential collateral or borrower-information weaknesses.
  3. Whether loan growth can support earnings as net interest margin remains compressed by lower yields and high liquidity balances.
  4. How funding costs, liquidity levels, mortgage-finance balances and quarter-end balance-sheet fluctuations affect profitability and regulatory capital ratios.
  5. Whether the MCA program can generate sustainable returns after pricing, servicing-rights, competitive and hedging risks are considered.