Welcome to the Texas Capital Bancshares Third Quarter 2019 Earnings Conference Call. All participants will be in listen only mode during the presentation. Please note this event is being recorded. I would now like to turn the conference over to Heather Worley, Director of Investor Relations. Please go ahead.
Good afternoon, and thank you for joining us for the TCBI's Q3 2019 earnings conference call. I'm Heather Worley, Director of Investor Relations. Before we begin, please be aware this call will include forward looking statements that are based on our current expectations of future results or events. Forward looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from these statements. Our forward looking statements are as of the date of this call and we do not assume any obligation to update or revise them.
Statements made on this call should be considered together with the cautionary statements and other information contained in today's earnings release, our most recent Annual Report on Form 10 ks and subsequent filings with the SEC. We will refer to slides during today's presentation, which can be found along with the press release in the Investor Relations section of our website at texascapitalbank.com. Our speakers for the call today are Keith Cargill, President and CEO and Julie Anderson, CFO. At the conclusion of our prepared remarks, our operator, Andrea, will facilitate a Q and A session. Now I will turn the call over to Keith, who will begin on Slide 3 of the webcast.
Thank you, Heather. I will open, then Julie will give her assessment for Q3. I will close before opening the lines for Q and A. Let's begin on Slide 3. In summary, we delivered a strong quarter in multiple key areas.
Deposit growth was excellent. Credit improved. Controllable core expenses were up only modestly. Mortgage finance was strong. Core LHI grew on average despite the significant paydowns we accomplished in leveraged loans.
Net revenue grew linked quarter year over year. Earnings per share grew 13% linked quarter and 3% year over year. Outstanding results from an extraordinary effort by our truly talented team across Texas Capital Bank. And these excellent financial results were accomplished through executing our strategic initiatives to drive continued improvement in deposits, fees, efficiency and an even more differentiated premier client experience. I'm a fortunate CEO indeed to work with amazing talent who wake up each morning excited to build the premier business and private bank in America.
It is an aspiration we all own and expect to achieve in time. Julie?
Thanks, Keith. My comments will cover Slide 6 through 13. Net interest income increased $8,600,000 or 3.5 percent from the 2nd quarter and is up $20,000,000 or 8.6 percent from the Q3 last year, continuing to demonstrate the resiliency of our balance sheet and the existing rate environment. Mortgage finance has acted as a very effective hedge in an inverted or close to inverted yield curve scenario. Despite the fact that our NIM decreased on a linked quarter basis, it's important to understand that it was primarily related to the earning asset shift, specifically mortgage finance and liquidity.
Honestly, we don't believe NIM is the best metric to assess relative profitability, our future revenue generation in this rate environment. Traditional LHI yields were down, which is reflective of the continued decline in LIBOR. Fees were slightly higher in the 3rd quarter and are comparable to Q1 levels, but remain at levels meaningfully lower than we experienced in most of 2018. Our mortgage warehouse yields were down on a linked quarter basis and similar to last quarter, the decline is not related to any shift in competitive pressures, but rather resulted from volume pricing that was already in place. And when we refer to volumes, that means loan volumes as well as deposits, both of which are positive for net interest income.
Our MCA yields continue to be pressured, which was expected compared to actual mortgage rates. We continue to have growth in deposits with growth in interest bearing as well as non interest bearing. Overall deposit costs decreased by 8 basis points from 100 and 29 basis points in the 2nd quarter to 121 basis points in the 3rd quarter. The decrease resulted from continued growth in DDAs as well as meaningful in interest bearing deposit costs. Our total funding costs were down 15 basis points with decreased usage of FHLB borrowings.
We continue to have a solid deposit pipeline with some of the verticals getting traction. The launch of our escrow vertical went public to come in the next few months of our other high potential verticals. Recent sensitivity simulations indicate that net interest income would decline approximately 6 percent to 9%, assuming 75 basis points of additional rate cuts over the next 12 months. This assumes that certain floors would kick in as well as assumptions related to continued elevated mortgage finance volumes over the forecast horizon. We had a slight increase in average traditional LHI during the quarter, but balances were down as of period end.
That's consistent with the continued runoff in our leveraged portfolio. Traditional LHI average balances were down 1% from 2nd quarter and up 3% from this time last year. The level of overall payoffs continue to be high primarily in CRE where we're continuing to replace runoff with commitments and some new originations. In contrast, the C and I leverage runoff is not being backfilled. Payoffs in C and I leverage are in line with what we expected and we would expect to see further reductions in the 4th quarter.
Again, we had a strong average total mortgage finance balances, including MCA, driven by the seasonally strong quarter, which similar to the 2nd quarter was even stronger with lower mortgage rates. Average balances are up from this time last year by 54%. We would expect 4th quarter volumes to be strong with the continued loan rate. We continue to experience good growth in linked quarter average total deposits with the mix of interest bearing as well as non interest bearing. Our slower core loan growth is and will continue to be beneficial to our marginal cost of funding.
We continue to see We continue to see
improvements in
deposit mix with some contribution from verticals as well as from existing clients, including mortgage finance escrow We would expect that to continue with meaningful improvement more evident in 2020 as verticals get more traction and we continue to deepen existing relationships. Overall, 8 basis points linked quarter improvement in our deposit cost and 15 basis points improvement in total funding reliance on FHLB borrowings. Our interest bearing deposit costs were down 6 basis points, but excluding CDs, which are mostly brokered CDs, our interest bearing deposits were down 9 basis points on a linked quarter basis. As we've mentioned, index deposits have an assumed 100% beta, while all other interest bearing is assumed to be closer to 65%. Our playbook for stepping down rates was in place prior to the July move.
We're being cautious, but very proactive in applying rate reductions across the board. We expect repricing to remain at a similar level or perhaps faster for the next 1 to 2 Fed moves. As for broker deposits, they remain at $2,100,000,000 With increasingly favorable pricing, the selective use of brokered CDs remains an option to supplement the funding stack as we gain traction in the new deposit focused vertical. We continue to show positive trends in our core operating expenses. Specifically looking at the changes in salaries and employee benefits, which represents over 50% of our total non interest expense.
3rd quarter salaries and employee benefits were up less than 4% from the Q3 last year. And year to date, the increase is a little over 5%, levels that are unprecedented in our history. And we're doing it at a time when we are focused on transformational changes in how we think about efficiency and client experience. We're being very deliberate with revenue generating hires and are continuing to attract exceptional talent as our story continues to be extremely compelling. We've discussed marketing expenses and the variable portion tied to deposits.
About a third of the increase in that category this quarter was related to the variable portion. That expense peaked in Q3 as we're not focused on growth in that category of deposits. The remainder of the increase was normal business development, which can fluctuate from quarter to quarter, but is not a significant part of the total expense. 3rd quarter included an MSR impairment of $2,600,000 and that's compared to $2,800,000 in the 2nd quarter and $2,900,000 in the 1st quarter. So a total of over $8,000,000 of non run rate expenses negatively affecting total non interest expense for the year.
We are in the process of putting instruments in place that will protect us from future downside risk with the MSR portfolio assuming rates continue to fall. Our efficiency ratio for the Q3 was elevated to 54.8% and was really related to a couple of MCA items, all of which are rate related and have been offset in net revenue either this quarter or in prior quarters. The classifications of several of the MCA items as well as the marketing costs related to deposits have been punitive to our efficiency ratio. If servicing costs were netted in non interest income against servicing revenue and the related marketing fees were moved to interest expense, our efficiency would have been consistently in the 50% to 51% range and would show an improvement year to date 2019 compared to 2018. We believe a more representative measure to focus on in evaluating our non interest expense trend is non interest expense to average earning assets, which has improved from 2.15% in the Q3 of 2018 to 1.86% in this quarter.
We are pleased with certain improvements in our credit in the 3rd quarter, namely a lower provision level as well as a decrease in total criticized net of the charge offs. Our non accrual levels are still at a relatively low level of 0.49 percent of total LHI. Net charge offs for the quarter are primarily related to energy and leverage, specifically $17,000,000 in energy $20,000,000 in leverage. Similarly, year to date charge offs of $61,000,000 are comprised of $32,000,000 in energy $24,000,000 in leverage. All of the quarter's charge offs were related to existing problem credits that we've discussed in previous quarters.
Additionally, we experienced a meaningful decrease in total criticized levels in the 3rd quarter and that's directly reflective of the actions taken over the past few quarters in actively managing each of these credits. Our total criticized as a percentage of total LHI remains low and dropped 2.2% this quarter compared to 2.6% in the 2nd quarter. For all criticized loan relationships, we continue to be engaged and are forecasting additional paydowns in the 4th quarter. We had a meaningful drop in provision to 11,000,000 dollars from $27,000,000 in the 2nd quarter. Loans being charged off already had certain reserves allocated.
Earlier in the year, we expected a larger portion of provision in the first half of the year and our actions have translated into achieving that. There will still be resolutions to existing credits and there could be migration within the criticized book, but we do believe there are enough offsets in those forecasted recoveries of provision for us to lower our full year guidance. We continue to be focused on crisp management of the problem credits, primarily in leverage and energy to minimize downside impact. And we're actively monitoring all portfolios in light of macroeconomic factors. Turning to the quarterly highlights.
Our continued strength in linked quarter net revenue despite the punishing rate environment, That's resulting from our strong volumes in mortgage finance, which have continued to contribute in a meaningful way to the increase. 1st quarter and second quarter non interest income had $8,500,000 $6,500,000 related to a legal settlement which was not recurring in the 3rd quarter and that was the main driver of the decrease on a linked quarter basis. We continue to have some noise in the loss on sale of loans line in non interest income, which has primarily resulted from holding MCA loans longer, which increases the hedging cost and is offset in additional spread income. This quarter, that line also included an additional increased reserve component related to a spike in early loan payoffs resulting from refinance activity. We're continuing to improve run rate on core operating expense items.
Year over year 8% increase in noninterest expense compared to prior year Q3, excluding ORE recoveries last year. Excluding the increases in marketing related to deposit cost and the increases in servicing related to impairments, the year over year as well as year to date comparisons are 4% to 5%, which again is unprecedented in our history and represents a significant improvement in managing our core operating expenses. ROE and ROA levels were improved in the Q3 as a result of the lower provision for loan losses. Our ROA levels will continue to be negatively impacted by the higher mortgage finance and liquidity balances. Loan loss provision levels will continue to be key to driving improved ROE.
Now we'll turn to the outlook for the remainder of 2019. We're maintaining our guidance for average traditional LHI growth at mid single digit percent growth. This is reflective of the growth we experienced earlier in the year and incorporates our current focus of positioning our balance sheet to be as strong as possible as we head into what could be a challenging point in the cycle. We're increasing our guidance for average mortgage finance growth to mid to high 30s from lowtomid20s percent. That takes into consideration the additional growth so far this year and an expected strong Q4.
Obviously, this is the lowest risk category for us, so we're happy to exploit the opportunities available with lower mortgage rates, even if it means temporary dilution to some of our performance metrics. No changes to our NCA guidance of $2,500,000,000 for average outstandings. NCA will continue to benefit from the additional volumes with lower rates. We're increasing our guidance for average total deposits to high teens percent growth from low double digit percent growth, reflective of the DDA growth that we experienced in the 2nd and third quarters. Decreasing our guidance for NIM to 3.2 percent to 3.3 percent, that's down from 3.5% to 3.45 Decrease is primarily the decrease is driven primarily by the earning asset shift we've experienced and will continue to have from the total mortgage finance, which is relatively lower yielding asset.
While punitive to NIM, the added growth is very positive to net revenue and offset some of the impact from rate decreases. Our guidance assumes no Fed changes in rates as the probabilities for those continue to move dramatically from week to week. However, it's important understand how we believe rate cuts will affect us and we're focused on it in terms of net interest income, which will be negatively affected future rate decreases. As I noted earlier, the decrease to net interest income could be 6% to 9% over the next 12 months assuming 75 basis points of additional rate cuts. Our guidance for net revenue remains at high single digit percent growth.
Because of the lower level of provision in 3rd quarter, coupled with continued relationship specific strategies on our leverage lending and energy portfolios, we're reducing our guidance for provision expense to high 60s to high 70s and that's down from mid to high 80s. Our guidance for non interest expense remains at mid to single digit mid single digit to high single digit percent growth. As we've noted, we continue to feel very good about the slowing of our core operating but the impact of MSR impairment charges as well as the variable marketing costs have driven upward pressure on the range. Our guidance for efficiency ratio remains in the low 50s. Lastly, we'll turn to our longer term outlook.
These are the right goals and we're committed to achieving them, but the timeline will be more challenging in the existing rate environment. As you know, the initiatives we have in place are focused on repositioning our balance sheet to be more stable through a rate cycle, but certainly there can be variability at different points in that cycle. We are confident that we have the right initiatives underway for the long term. Historically, we have been very successful at repositioning as needed and we expect similar success this time. Keith?
Thank you, Julie. We are committed to delivering an even more premier differentiated client experience to our current business and private clients, while developing new best of class specialized industry verticals, Elevating our client experience delivery and opening new specialized industry businesses will create untapped opportunities to attract clients in a more favorable ROE and self funding categories, helping us overcome with growth some of the shrinkage we continue to experience deliberately in our leverage lending. Mortgage Finance continues to give our company a high performance growth engine with essentially U. S. Government credit risk.
This business allows us to grow net interest income despite late cycle challenges in pricing and structure and other core LHI categories. It also provides significant self funding through the mortgage finance, treasury management deposits. And the fee income from the mortgage finance business covers our cost of operating the business. Beyond the success of the mortgage finance deposit growth, we have seen strong growth in core C and I treasury management deposits as well as early growth in some of our new deposit verticals. In combination, the core treasury deposits and new deposit vertical funding has grown by over $1,000,000,000 so far in 2019.
Our final two deposit verticals launching in the Q1 of 2020 are expected to be the most significant new deposit growth initiatives of all. We are bullish on our deposit growth prospects for the next few years as these verticals mature and our bankers and treasury management partners drive increased core treasury growth as well as cross sell new deposit vertical products. It was most encouraging to see not only loan loss provision decline meaningfully, but also to see a significant decline in criticized classified loans. The credit team, loan review team, relationship managers and their group heads have all worked as one team for the past year to understand the loan portfolio at a deep, granular level and derisk the portfolio before an eventual economic slowdown sometime in the future. Their hard work continues and we expect to deliver an improving trend for several quarters ahead.
We are seeing significant improvement in process efficiencies and the resulting improvement in more responsive client service and lower core operating expense growth. We are working diligently and with confidence to deliver a great long term investment for our shareholders and premier service and products for our clients. Operator, if you would, let's please open the lines for Q and A.
And our first question comes from Ebrahim Poonawala of Bank of America Merrill Lynch. Please go ahead.
Good afternoon, guys. I think the first question, Keith, just based on feedback I've received over the last 1 hour, Would love to get a little more color on credit and how we should read you lowering the provisioning guide. Would love to get in terms of your comfort on migration trends in the leverage lending, the energy book and just the risk of like things again surprising to the downside 3 or 6 months of now, if you could talk to that, that would be helpful.
Well, we're encouraged. It's early to declare victory, but we really believe we have a much deeper understanding, Ebrahim, of our portfolio and not just leverage lending and energy, than certainly we had a year ago. And it's taken a tremendous amount of work by all the groups I mentioned, our loan review team, credit team, our bankers, our group heads, everyone has really pitched in and it is most encouraging to me that we're seeing this trend, this tipping down that's meaningful linked quarter. But we need to put 2 or 3 of these together, and I believe we will. It's taken a while to be confident that we really have our arms around the portfolio, but I believe we are in that kind of situation and things can happen on a given credit in a given 90 days.
So again, I'm not here to declare victory, but I do believe we're on the right path and we're going to see hopefully multiple successive quarters with the right trends, not just one.
Got it. And is it fair to assume that the quarter end included, as other banks have talked about their SNCC exam having an impact, is all of that reflected?
It did include that. In fact, we had no surprises on the SNCC exam. Our team was on top of it, and so that came out just fine for us.
Perfect. And just moving on to in terms of capital, when we look at TCE, it means in the high 7s, just talk to us in terms of how you're thinking about how low can capital ratios go or just your strategy around participation of the mortgage warehouse loans and how CECL, if at all, may impact capital ratios toward the end of the year?
So, we talked about Ebrahim, I think we talked about earlier in the quarter that we're comfortable with taking advantage of what we're getting with the warehouse growth. And so we're comfortable with doing additional participation. We ended the quarter participation commitments were a little over $1,000,000,000 So we're comfortable with that. We want to make sure that we can continue to take good care of our clients. So we're comfortable with that TCE ratio that's comfortable for us.
We're very comfortable with that. CECL, we're not saying too much about CECL. I guess what I would say is what we have said in the past that commercial commercially focused institutions like ourselves, we don't expect material change in our overall provisioning. So I think that we're comfortable with that.
By the way, Ebrahim, that move and what we had in actual funded participations at 2nd quarter end versus 3rd quarter end was close to $500,000,000 So, we could have taken that on balance sheet, but we're being very disciplined to take care of clients without putting it all on balance sheet. And I think that's the right move. Had we put it on balance sheet, it would have been about a 23% growth linked quarter. But I think we're doing the right thing to have a strong business, but also to manage it and not let it
Got it. And if I can sneak in one last question, demand deposit growth was extremely strong. Is that sustainable? Like do you expect to hang on to these balances as we look into the Q4? And have we seen any early results from the 1 or 2 big deposit verticals that are either online or in the process of coming online?
We're very encouraged by what we're doing with our deposit verticals and our core treasury efforts. Our bankers have done just as we ask and really taken their partners, their treasury partners out far more on calls and we're filling in some of the gaps and relationships where we only had loan relationships and that's really contributing along with our new deposit verticals. As I mentioned just this year, in 9 months we're up over $1,000,000,000 in those two categories. We don't want to drill down a lot at this point, but I think you can tell it's there is always seasonality that comes from our mortgage warehouse deposits and we experienced it in the 2nd quarter and again in the 3rd. But I wanted you to also hear about that north of $1,000,000,000 growth that came from verticals and also just core treasury growth, which is awesome to have alongside those seasonal balances.
Hey Ebrahim, typically we can see some seasonality in the some downward impact from seasonality in our deposits in the Q4 and the first quarter.
Got it. Thanks for taking my questions.
Our next question comes from Brady Gailey of KBW. Please go ahead.
Hey, good afternoon, guys.
Hello, Brady. Hey, Brady.
So I mean the mortgage warehouse and MCA combined continue to perform really nicely here. I mean it's up again off a strong 2Q. It feels like we're getting close to the levels where you start hitting concentration limits. I forgot exactly how you all look at it, but I know you have a limit out there. I mean, as MCA and the warehouse continues to be robust and potentially grow from here, will most of those balances move into the participation program you have through other banks?
Or is there still capacity to let the balances grow on Texas Capital's balance sheet?
As we move into the Q4, while the volumes will be very good compared to most seasonally softer 4th quarters, I don't anticipate it being higher. And so I don't believe that's going to impact this Brady in the 4th or 1st quarters. And as we grow the overall balance sheet between now and the Q2 next year, I think we'll be fine and in good shape and not have to lay off all of the growth once we get a couple of quarters down the road.
All right. And then one more on credit. If you look at non performing loans, they were up they're pretty much stable, up a little bit linked quarter. The net charge offs obviously would naturally reduce that. So maybe just talk about any sort of inflows into the NPL bucket in the quarter?
There was one energy deal and that was the bogey that got us slightly over. I think it was like 2,000,000 hires, I recall, from prior quarter overall on NPAs, still quite modest NPAs though.
Our next question comes from Brett Rabatin of Piper Jaffray. Please go ahead.
Hey, good afternoon, everyone.
Hello, Brett. Hi, Brett.
Wanted just to go back
to, Julie, the NII guidance and the 6% to 9% downside for 75 basis points. Can you just talk about how you're modeling that in terms of the verticals for growing deposits, how the mortgage warehouse factors into that as presumably that declines, it would seem like you'd have a net benefit to the margin. Can you just walk through the modeling for how you're doing downside for Fed cuts?
Sure. So we're focused on net interest interest income because you're right, there can be some variability in NIM with mortgage balance. I said we're assuming 100% beta on the index deposits and 65% on the other interest bearing. But that also assumes that mortgage finance growth still continues to be pretty strong, not elevated, but certainly still strong over that 4 quarter horizon.
Okay. And then wanted to talk about the LHI growth for a second. As you overcome the declines in leverage lending, I'm just thinking about like the growth path for the next year or so. I mean, does that improve notably? Or can you give us any additional color on like kind of how you see that trending once you've gotten past running down some of the leverage book and then obviously not growing energy as well?
We're really encouraged about a couple of new corporate verticals that we're looking at that are full blown lending and deposit verticals. So these would be separate from the deposit vertical initiatives we launched a year and a half ago. And we have a team that's close to us announcing that we'll launch the first of those verticals. So we'll be able to talk about that in January. And I'm very optimistic that with that new vertical, with our some new talent we've been able to bring to the company in our overall C and I business, both in Houston and Dallas, that we're going to be able to more than backfill.
It's just too early to give you that guidance for next year, but I'm very encouraged that we'll be even more diversified certainly with lower risk growth than what we experienced the last few years when we were growing leverage lending. So I will have more for you in January, but we have yet another 2 corporate verticals we're contemplating to launch at some point in 2020. And between those three, I believe that we're going to have some good solid diversified appropriate risk growth in our book.
Okay, great. Appreciate all the color.
You're welcome.
Our next question comes from Steven Alexopoulos of JPMorgan. Please go ahead.
Hi, everybody. Hello, Steve. Hi, Steve.
I wanted to start on the new margin guidance. Is my math correct? Because the midpoint of the new guidance seems to imply a NIM in the $2.70 range for the 4th
No, no. So we do expect NIM, I mean, that's why we try to focus on net income obviously, but we do expect NIM with the continued success in mortgage finance. It could tick down, it would tick down in the Q4 compared to the Q3.
And that
would also still that would also factor in the full extent of the September move. So but not that low.
So what is just so we're clear, what is the range that you expect NIM to come down in the final quarter?
The range that we updated was the 3.25 3.20 to 3.30. It's the full year, that's the update for the full year, dollars 3.20 to $3.30
Okay. Just looking where you started 2019, it seems to imply a pretty dramatic reduction in NIM coming again in 4Q. Like do you expect the pressure to be pretty consistent with what you reported this quarter?
I would expect the Q4 to still be in the low 3.
Okay. Got you. Okay. And could you remind me for your mortgage finance loans, they carry a lower yield than peers, which are just in the mortgage warehouse business, right? First Horizon reported 5.3% yield.
Just remind me why your yield is so much lower than just the mortgage warehouse business?
We really focus Steve on the QM business. Now we have a little non QM, but other competitors are more comfortable with non QM than we are. And so that's the primary difference.
Okay. Got you. Okay. And then just finally, I'm trying to make sense of this very strong deposit growth. And I know Ebrahim asked the question.
When we look at non interest bearing and savings deposit growth, why were they both so strong this quarter? I mean, it was really off the charts growth.
It's primarily from existing clients, Some related to mortgage finance and then some related to our core clients. It was primarily there's some there's also some Keith mentioned there were some impact from some of the verticals, but most of it was from existing clients.
Got you. And you We
just had a gap, Steve, we grew so fast the last 5 years. We had some gaps where we did not gather up the treasury relationship. And so we've really been focused on that and it's bearing fruit and it's really helping us along with the new verticals.
Okay. And now that you have this liquidity, do you plan to keep the loan to deposit ratio below 100?
We'll assess the liquidity levels that we have. Obviously, we've had some outsized success in the last couple of quarters in deposit generation. We've reduced what we're borrowing. That still leaves us with quite a bit of liquidity. So we will assess that.
There will also be some seasonality in some of our deposits, primarily in DDA. We'll see some seasonality in the 4th quarter. So we'll take all of that forecasting into assessment on what we're going to do with liquidity levels.
We're really looking any way we can at replacing higher cost funding too, Steve. So like the brokered deposits over time, we're going to be in a better position to take that out and improve our NIM.
Terrific. Thanks for taking my questions.
You're welcome.
Sure. Thank
you. Pardon me. This is the conference operator. If you were currently in the question queue, could you please re queue? I have accidentally cleared the queue.
And our next question will come from Matt Olney of Stephens. Please go ahead.
Hey, thanks for taking my question. I want to stick with the deposit discussion. And Julie, you mentioned downward pressure on deposit balances due to seasonality in the Q4. If I look at the full year guidance, I think it implies that the balances in the Q4 will drop pretty considerably like 9% or 10%. Can you just confirm that I'm thinking about that right for the 4th quarter deposit balance?
We try to be as you know, we try to be conservative with our guidance. So we do expect some seasonality impact on deposits. We would we try to set that guidance so that it is conservative. I guess that's how I would leave it.
And Matt, with the continued strong volume in warehouse along with that, it does help offset the normal seasonality on the deposit side too, because you they're building their mortgage servicing book and so that helps keep it a little higher and more stable. But we also look at historical seasonality and we try to take what we know today along with historical and give you a more conservative guidance.
Got it. Okay. And I think going back to, I think it was Brady's question previously on the migration of loans from criticized into non accrual. I think I see the migration that you mentioned, Keith, on the energy portfolio. But it also looks like there was some negative migration in the leverage lending book.
Non accruals were flat there, but there were still some higher charge offs in the Q3. Any color you can tell us about that book?
Yes. We really have been able to address those charge offs in prior quarters and built that provision, which we all know was pretty hard on us the first half of the year. But we're seeing the overall criticized classified tip down. And then within that, I really think we're seeing improvement in the classified. So it's not simply a matter of the criticized, which we got on the radar in the Q1 with these deep dives we've been taking on our loan portfolio over the last four quarters.
It's also the actual classified component that's very encouraging at this point. So yes, there were a couple right at toward quarter end, but the overall trend on migration we think is favorable going into the 4th.
Got it. Thank you.
You're welcome.
Our next question comes from Michael Rose of Raymond James.
I wanted to go back
to something you said earlier in the call around expenses. Julie, I think you said the way you guys are looking at it now is expenses to average assets. Is that correct? And if so, do you have kind of thoughts it's obviously come down, but do you have thoughts kind of around how we think about that moving forward?
No, I mean, we've been giving guidance on that. That's something that Michael, that's a thoughtful question and we'll certainly think about that. I guess, we just as we struggle with trying to explain how we really are doing a much better job on our core operating, which is non interest expense to average earning assets just seems like a more representative metric of our progress. So we haven't given any guidance on that. I mean, I think we feel comfortable that that's going to continue to improve, but we haven't given any specific guidance on it.
Excuse me, Julie. Sure. I might add, Michael, over time, this gap between efficiency ratio, as Julie has described measuring it and the traditional way we measure it, they will those lines will cross or meet and that will be as we replace some of these marketing expense deposits. Those marketing expenses are what really throw us and make it hard to give you metrics that are comparable to other peers. But again, that's one of the key things we're working on is lowering overall cost of funding, including those marketing expenses.
Okay. That's helpful. And then maybe just going back to the margin, not to beat a dead horse here, but I think the guidance you said doesn't include any future rate cuts this year. It looks like the futures are implying we get 1 month LIBOR is already down 14 basis points this quarter. Is that kind of all at least the drop in LIBOR, is that contemplated in the outlook and why perhaps the range is so big?
And then if we do get a rate cut in October, December, would the dynamics around the stats that you quoted before in terms of the impact on NII, would that shift at all? Thanks.
So what would already be factored into the guidance is where we ended the quarter, right? Those loans, how they had repriced was lower at the end of the quarter, that would be included in the guidance. And then what we've assumed in that the sensitivities that I gave you, what we've assumed is that there's another 75 basis points we've assumed
that there could be
an October move, December and then again in June for that 12 months sensitivity.
Okay. That's Yes.
And then as we've mentioned, of course, you have the 100% beta on the institutional funding. And then we're projecting a 65% beta on our other interest bearing.
Okay. Maybe just one more separate question on energy. I know it's been a topic of a lot of calls so far. You guys spoke last year, last summer that you guys had seen some issues back then and the thought process was you were getting ahead of it and we're going to be perhaps 1st out of the chute. Do you still kind of feel that way?
And maybe just as it relates to energy, why do you think we're seeing the issues that we're seeing now when oil prices are still pretty healthy? Thanks.
I do think we're as ahead of it as anyone. And I say that because the market, the capital market is just kind of locked up right now. And that is causing some of the stress on some of the energy companies that were not geared to be full blown operating energy companies. It was more of a acquisition play when they thought prices were low and new capital came into that space with the intention of proving up some of the unproven property that they acquired with drilling programs. And now they realize they're going to have to be generating drilling programs that are cash flow positive because the capital markets aren't active and so they don't have access to the capital to have robust drilling programs.
So I think it's just in that state where it's difficult to call how long we might be in this mode of them working their way through it. But I do think we're more on top of the portfolio certainly than many banks and we had to be because it's something we've done at Texas Capital our entire history, but most of us are involved in the credit process at the company have done this 35, 40 years. These cycles, every single one is unique and you learn from each one. But you have to be so aggressive in looking at each deal and each operator. We're much more thoughtful now about looking more carefully at drilling plans, Michael, because some of the, again, operating know how with all that capital flowing in was getting pushed to do some outlying drilling to try and elevate the price of the overall property.
And by doing that, they took some more risks than they should have. I think we've identified who those are. And it's more a matter with the rest of the portfolio of just grinding through this period where they have challenging access to capital. And I mean challenging access to any capital because as banks we're looking so carefully at our borrowing bases that we're taking a lot of the cash flow that they had hoped they'd be able to deploy in new drilling activity. But in order to be sure we keep our borrowing bases in line, we're having to capture more of that cash flow on debt pay downs.
So it's not simply a matter of equity capital that's kind of in a wait and see mode, but also debt capital that they're having a challenging time to find it.
Very helpful. Thanks for all the color, Keith.
You're welcome.
Our next question comes from Jon Arfstrom of RBC Capital Markets. Please go ahead.
Hey, thanks. Good afternoon.
Hello, Jon. Hi, Jon.
A couple of near term and then longer term question, but earning assets have been up quite nicely in Q2 and Q3. And I'm just curious if you feel like Q4 earning assets can be up again?
So it depends on warehouse volume. And so we think they'll be good. I don't know that they're going to be up, because Q4 is seasonally a little slower. So I don't see that. I wouldn't say that would be up.
Well, we're still overcoming on the net growth side, John, the bleeding down, the shrinking and de risking of our balance sheet with the leverage lending portfolio. And so actually, we're really quite optimistic that we'll have an even bigger pay down in leverage lending than we had on average the last three quarters. So if that occurs, then you just have to make up that $100 plus 1,000,000 roughly in order to get back to 0. And so I think it will be a modest growth, if any growth in the Q4. But I don't think that's you have to drill down to see if that's good.
I think it may be good because we are derisking our balance sheet.
Okay. That makes sense. It's just another way to think about the margin NII equation. And my assumption would be flat to down and I just want to make sure I'm thinking about that correctly?
I think that's the I
think you are. Yes.
Okay. On the provision, appreciate the fact that that came down, but it's still there's still about a $10,000,000 swing factor in terms of the high and low level of range. Just curious if you're leaning one way or the other. I know that's a lot of this kind of depends on what happens at year end, but how are you feeling about it right now?
Well, I can tell you, I'm leaning more to the low and some of my cohorts a little more to being safe on the high. But I think collectively, we agree on this range. And I'm still hopeful we'll come in, in the high 60s or low 70s. But I think our team feels like we certainly can come in within the range.
There's a small group in the room and it's probably fifty-fifty. So we all agree again, we all agree that we feel comfortable with the rate.
Okay. All right. And then, I hate to go back to this, but the 6% to 9% decline in NII on the 75 basis points. The first part of the question is, what are you assuming in terms of growth? Is this just a static balance sheet?
Are you assuming like a normal course of business to get to that number?
Our normal forecasted 12 month balance sheet. So it would assume that warehouse is still pretty strong because we wouldn't see any reason why it wouldn't stay strong. Again, the leverage, some of the continued pay down in leverage, but as Keith said, in a couple of quarters from some of these new areas of growth, we would expect some growth. So it's our normal 12 month forecast.
And again, even if the market and we anticipate the market next year, John, being somewhat softer than this year. We won't be doing linked quarter laying off of $500,000,000 of the warehouse volume. And so that gives us that shock absorber capability as we manage how much we take on balance sheet, so that if we do see some backing off slightly next year on mortgage warehouse volumes, we still feel good about being able to take market share and grow it slightly.
And on the deposit side, it does include some more deposits from some of the new verticals. A more meaningful than we've seen in the last couple of quarters.
Okay. And then the last thing, maybe this is an obvious question, but I'm assuming that the last cut would take the biggest bite. So for example, if we get only 25 and the Fed is done, that that's not a terrible outcome for you, but when we get to 50 or 75, that's where the biggest bite comes in terms of the NII guide?
I don't necessarily think so. I'm very optimistic about our deposit trends and our new verticals, but also just our core treasury trends. It won't be easy and we're going to have to be better than we've ever been even though we've been really good this year on core expenses. I really feel good about what we can do overall on our expense and efficiency next year. So, yes, on the spread, it won't be easy, but I don't think it will be as challenging as certainly if we hadn't done these initiatives 2 years ago and be into the process now with launching these biggest deposit initiatives in the next quarter or so.
John, something else that's important to remember is what happened with our deposits on the way up. We moved up really fast with a really high beta, which means we have a lot more to come down. So the index deposits alone will continue to come down. And then in addition, as we continue to replace some of the higher cost deposits with some of these new verticals. So we feel like we have a lot more runway on the deposits coming down.
But we're not naive. I mean, it's a meaningful headwind and we're certainly doing our planning around expenses and all accordingly.
Okay. All right. Thank you. You're welcome.
Our next question comes from Brad Milsaps of Sandler O'Neill. Please go ahead.
Hey, good evening.
Hello, Brad. Hey,
Julie, just to follow-up on the warehouse. Just curious of the 26 basis point decline in the yield on the warehouse this quarter, how much of that relates to volume discount versus just the move in LIBOR. I just want to get a sense as volumes may weaken as you move into 20 20 a little bit versus the high this quarter, kind of can you recover any of that lost yield on the warehouse? I
don't know how best to answer that. I mean
Some of it's driven by volume discounts with these top clients. And so they've been coming in with such robust volumes That certainly has contributed, but it's mostly LIBOR.
Okay, that's helpful. And then I'm sorry if I missed this, relatively small numbers, but there was also an uptick in the loans 90 days past due kind of ex the impact of premium finance customers. Just kind of curious any additional color there on kind of what the driver was?
No. Just a couple of bigger deals, but not ones that we feel uncomfortable with, just some documentation things that didn't have that didn't get done. So nothing that of any consequence that we're concerned about migrating to a category.
But we're not happy it didn't get done on the documentation. But we don't have concern about the credits.
Got it. All right. Thank you, guys.
You're welcome.
Our next question comes from Peter Winter of Wedbush Securities. Please go ahead.
Hi. I just want to follow-up on the expense question. I know you're not going to give specific guidance, but can you just talk about big picture, maybe some opportunities to maybe lower the expense growth rate next year?
We're looking at all things that we can leverage including the technology investing we've been doing here for the last 3 years And that is beginning to show some opportunity where we can in fact hire fewer new people. That's been the case this year. I think it will continue to give us opportunity to leverage that technology as we go into the New Year. We're doing some really incredible work around process reengineering and finding again that we can lift the value of our people that have been doing work not as valuable as they are capable of doing by automating some of the things that are more rudimentary. And we're looking at deploying bots to give us 20 fourseven capabilities to do some of that rudimentary work and looking at a number of different opportunities.
So, thankfully, we have worked hard to get our technology grid in good shape up to date over the last 3 years and now we're able to begin to do things that are more of a contributor to really giving tools to our people that will substantially help their productivity. And I'm encouraged we'll be able to take yet another really good step this next year on being able to hire fewer and continue to hire even higher quality people each year. And we've hired the finest quality people we've ever hired this year. So the company is still just an amazing place on the ability to attract great talent. And I think as we give our people more technology tools to use, that's going to improve productivity.
Okay. And then just on this long term outlook, I was just wondering what type of timeframe are you thinking about reaching these goals? And secondly, with the net charge offs of 20 to 25 basis points, is that kind of the average through a cycle?
Yes, absolutely. That's through a cycle. So obviously, year to date this year and last year, those were higher. But if you look at some of our previous years, we had 7 basis points, 8 basis points that they were seemingly low. So that's through a cycle.
Peter, when we put these out in January, we were talking about a 3 year it was under our 3 year planning horizon. I think what has happened with rates was not what we thought in January. So that's why I said, I think it's going to take a little bit longer. And I don't know exactly what that looks like. We're in the midst of our updating our 3 year planning cycle.
And so we'll try to give a little bit more color on that in January when we update our when we do 2020 guidance and kind of update for the 3 years.
And obviously, we'll have some better visibility on this rate situation. Because that's what primarily is driving the timing. Exactly.
Okay. And then just my last question, just you had mentioned Don Cecil, there shouldn't be much of a change given the commercial short term nature of the portfolio. I'm just wondering, does that include, I guess, a fairly positive economic outlook as well?
Yes. One of the things I've said is that I think that while I think commercially focused banks are not going to have dramatically different reserve levels. I think that the introduction of forecasting into that is going to drive more volatility. So I don't know that it's going to be overall higher levels, but certainly that it could drive more volatility on a quarter to quarter and a year to year basis.
But right now you guys still have a fairly positive economic outlook?
We do. Texas is doing quite well. And there are lots of mixed signals, but overall, we're positive on the economy.
Great. Thanks for taking my questions.
You're welcome.
Our next question is from Jennifer Demba of SunTrust. Please go ahead.
Thank you. Keith, do these results include sorry, back to credit for just a second. Do the results you reported include a redetermination period for the E and P loans?
That is underway. And so it is something that takes 60 days or so, Jennifer. So some of that has been incorporated, but it's not been completed. We don't anticipate any significant change, but that has not put to bed.
Okay. All right. And what is you're still contracting your leverage loan book through the end of this year. What does leverage lending look like for TCBI going forward? What will you be doing differently than previously?
Well, we really, before we started this process, talked and had many meetings to talk about the business we want for the long run and the business we want in this space for the long term are what we call our trophy sponsor clients and of course high quality single run enterprises that happen to also fall into that leverage lending bucket. So we're not inclined to take on new sponsors at the pace we did over the last 5 years. We like the sponsors that we've had a history of 10 or 15 deals with over the years, understand how they behave when portfolio companies don't go exactly as due diligence and plans suggest. And so we do like the business. We just believe we were too successful and brought in and took too much market share with some sponsors that we just didn't have the history with.
And some of the hiccups we had on deals were with these newer sponsors we've not had the history with. So that is the approach we're taking. We certainly want to take great care of our long time quality clients here in the PE space and have a great track record. Think like operators, not just financial engineers. And we have a wonderful core client base.
Over the course of the next year or so, we likely will still tip it down some. It won't be at the same pace. We're not shooting for a 30% type runoff in 2020. It might be something closer to 10. But just fine tuning it, we are not ready to give all that detail until January, but that's directionally where we're headed at this point.
Last question, Keith. Did the escrow team have any impact on 3rd quarter results?
I'm sorry, Jennifer. I was reading a note someone gave.
The escrow team.
The escrow team, will they have any major impact? No.
On 3rd quarter results.
No, they haven't. And they won't have their special black box that they've been working with our IT team on for the larger, more complex clients that we'll be bringing on board until the Q1. So they have several clients that we can take on and handle very capably, but those that are in more complex businesses where we need to have the best piece of technology, much like we understood 13 years ago, we needed to build in mortgage finance, mortgage warehouse. We're doing the same type of thing, but we're really listening to their clients and building something that will be a great tool for us and the client in those cases where we have larger more complex clients in escrow. So they'll have some impact in the Q4, but it should be significantly accelerating as we get into next year.
Thank you.
You're welcome.
Our next question comes from Barak Vandervliet of UBS. Please go ahead.
Thanks. I was just wondering if you could kind of clarify the math on the energy credit flows. So energy NPAs $61,000,000 Q2, energy net charge offs $16,500,000 Q3. I would think that would get to therefore NPAs say 46,000,000 dollars Your NPAs at the end of Q3 were $63,000,000 And does that imply a new energy NPA of $17,000,000 or $18,000,000 or no?
That's exactly what it was, Brock.
Yes. We mentioned that earlier on the call that the uptick in total non accrual was 1 energy deal.
Okay. Got it. All right. And has that been reserved or is that a new credit?
Anytime a loan goes to non accrual, there's an impairment analysis done and the appropriate reserve would have been put on it.
Okay. All right. Got it. I understand the math now. Thank you.
You're welcome.
This concludes our question and answer session. I will turn the call back over to President and CEO, Keith Cargill for closing remarks.
I'd like to thank all the call participants for tuning in and we appreciate your interest and your support. Have a good evening.
Thank you for your participation in TCBI's Q3 2019 earnings conference call. Please direct requests for follow-up questions to Heather Worley at heather. Worleytexascapitalbank.com. You may now disconnect.