Afternoon, everyone, and welcome to the TCBI Q1 2019 Earnings Conference Call. All participants will be in a listen only mode during the presentation. And please note that this event is being recorded. And I would now like to turn the call over to Heather Worley, Director of Investor Relations. Please go ahead.
Good afternoon, and thank you for joining us for the TCBI First Quarter 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 in subsequent filings with the SEC. 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, William, will At the conclusion of our prepared remarks, our operator, William, will facilitate a question and answer session. And now I will turn the call over to Keith, who will begin on Slide 3 of the webcast. Keith?
Thank you, Heather. I will offer opening comments, then Julie Anderson, our CFO, will share her review of Q1. I will then close and open the call for Q and A. On Slide 3, we lead off with the key operating results for Q1. Earnings per share totaled $1.60 in Q1 'nineteen versus $1.38 in Q1 twenty eighteen.
ROE of 13.58 percent is higher than the ROE of 13.39 percent in Q1 'eighteen. Net interest income increased 12% from a year ago as well. Driving the higher EPS and ROE were the net revenue increase of 15% from Q1 'eighteen. Non interest expense increased 11% from Q1 twenty eighteen, but the core NIE expense related to salaries and benefits increased at a lower rate. Julie will speak to this a little later in the call.
Net charge offs were 0.09 percent of LHI as compared to 0.11% in Q1 2018. Non accrual loans to total LHI were 0.57% compared to 0.60% in Q1 'eighteen. Slide 4 highlights our energy loans and C and I leverage loans. Energy loans equal 7% of total loans as was the case in Q1 2018. Non accrual energy loans increased to $76,700,000 from $50,400,000 1 year earlier.
Allocated reserves equal 3 percent of energy loans or 48,600,000 dollars C and I leverage loans equal 5 percent of total loans or $1,200,000,000 versus 6% of total loans or $1,200,000,000 at Q1 'eighteen. Non accrual leverage loans were $30,600,000 at Q1 twenty nineteen versus $54,400,000 atq1 twenty eighteen. Criticized loans increased from $138,000,000 in Q1 twenty eighteen to $219,000,000 in Q1 2019. Allocated reserves for C and I leverage lending totaled 6% or $68,900,000 We have no significant concentration in a particular industry in this portfolio. Over the balance of 2019, we estimate runoff of approximately 30% of the leverage lending loan portfolio.
Let's now move to Slide 5. We strongly believe we have built over 15 years an exceptionally valuable business for our shareholders in mortgage finance. This slide highlights core strengths in the mortgage LHI component of mortgage finance and hopefully better informs our constituents as to the low risk, high return qualities of this business. We did not build mortgage finance LHI or mortgage warehousing as we once called it to simply be a transaction loan business. We chose to invest, hire and grow the business in 2,009, 2010 and since then to be a strategic solution business for our mortgage banking clients.
During the 2,008, 2009 Great Recession, the number of competitor banks in this business dropped from 82 to 11. We were not entangled in the subprime mortgage problems and decided to exploit the opportunity, our top national talent and take quality client market share. We made the largest investment in our history in a specialized line of business technology platform, offering the independent mortgage banking companies coast to coast, the finest expert bankers and best of class technology. We hired top treasury management talent and developed customized treasury management products for their industry. And importantly, we provided much needed capital when they needed a strong bank the most.
Since 2009 through 2011, we've continued to invest in technology and talent in the mortgage finance business, launching the mortgage correspondent aggregation business 3.5 years ago. While this slide focuses on the core business of mortgage finance LHI, our MCA business is growing and delivering strong earnings growth as well. I want to point out that the earnings and combined yield bar chart shows strong earnings and yield, but does not include the strong deposits we've grown and the additional profitability the deposits generate in this business. We have a long history of growing market share and earnings in mortgage finance, despite headwinds affecting mortgage origination volumes, because we are able to outperform competitors and take market share to offset origination slowdowns. We have a truly amazing team of mortgage finance professionals and best of class clients.
It is a great business for us. Julie?
Thanks, Keith.
My comments will cover Slides 6 through 13. Our reported NIM decreased 5 basis points from the 4th quarter with about 2 basis points related to additional liquidity. Our traditional LHI yields were up 10 basis from the Q4, which included catch up from the late LIBOR move in 4th quarter as well as the slight decline in February, but was offset by a lower level of fees this quarter. Traditional LHI betas continue to be as expected, but we could see pressure on spreads as competition remains robust. These were lower in the Q1 as compared to the 4th quarter, which accounts for about 11 basis points.
So basically, our core LHI yields were up 21 basis points. Our anticipated mix of loan growth for the remainder of the year will likely result in lower fee levels than we have experienced in the past. Mortgage finance yields were up 9 basis points on a linked quarter basis and these yields are stable at this point. Additionally, with long term rates dropping, we are seeing additional volumes first evidenced in March. While MCA will also benefit from additional volumes with long term rates dropping, it's important to remember that those loans are tied to the actual mortgage rates, which will have a lower coupon unlike the warehouse loans that are tied to LIBOR.
We had a linked quarter increase in average interest bearing deposits and overall deposit cost increased by 16 basis points from 117 basis points in the 4th quarter to 1 through 33 in Q1. The increase was expected as Q4 numbers only included a few days of the December Fed funds rate move on the index deposits. We saw the full catch up in January and trends in February March have been positive with minimal movement. With the Fed pause, we expect more gradual increases in deposit pricing that's reflective of net growth coming from interest bearing. Continued solid deposit pipeline with verticals getting traction, we would expect to have more to discuss related to some of the verticals in the second half of the year.
In addition, the Frontline is focused on targeted calling efforts. During the Q1, we replaced approximately 500,000,000 dollars of traditional brokered CDs that were maturing at a 25 basis points increase in cost, which was more favorable than some of our higher cost deposits, still about $1,500,000,000 in total. While verticals ramp up, we are very comfortable increasing the level of brokered CDs as needed when pricing is more favorable than some of our higher cost funding. As of the end of March, 75% of our floating rate loans are tied to LIBOR and over 80% of that tied to 30 day LIBOR. The percentage of LIBOR loans in our portfolio continues to increase.
We had growth in average traditional LHI during the quarter consistent with our expectations. Traditional LHI average balances grew 1% from the 4th quarter and up 9% from the Q1 of last year. The level of payoffs continues to be high, primarily in CRE and some C and I leveraged. We would expect payoffs in C and I leverage to pick up during the remainder of the year. Continued strong average total mortgage finance balances, including MCA, benefited from stronger than expected Q1, which is seasonally weaker.
Balances are up from Q1 last year by 33%. With the drop in long term rates, we expect Q2 volumes to be quite strong. We did see some pickup in linked quarter average deposits with all of the growth in interest bearing, primarily interest bearing deposits in the pipeline, but we continue to be vigilant maintaining and growing core existing relationships. Negatives on interest bearing deposits declined slightly in the Q1. We expect more gradual increases in deposit pricing with the Fed pause.
Additionally, slower core loan growth will be beneficial to our marginal cost of funding. We would expect to start to see improvements in funding mix in the second half of the year with more meaningful improvement evident in 2020. Moving to non interest expense. 1st quarter expenses have some noise, but overall, we are pleased with the trends of our core operating cost. Specifically looking at the changes in salary expenses.
1st quarter salaries and employee benefits are up about 7% from the Q1 in 2018. We are managing at a much lower level of FTE additions. Seasonal items of $4,000,000 offset by the normal lower level of incentive accrual in the Q1 as that ramps throughout the year. Fluctuation in FAS 123 are expense in the Q1 compared to Q4 primarily related to a sizable drop in stock price that occurred at the end of the year and has rebounded slightly in the Q1. The deferred comp plan that was started a couple of years ago now has a sizable enough balance that there can be some meaningful mark to market fluctuations and that's generally consistent with moves in the stock market, dollars 2,500,000 flux from 4th quarter to 1st quarter.
However, that's offset in non interest income, so net neutral impact on net income, but rather just a gross up in income and expense. Portion of the marketing category continues to be variable in nature and is tied to growth in deposit balances and is expected to continue to increase throughout the year. Quarterly increase in that category could range from $1,000,000 to $2,500,000 per quarter depending on volumes. Efficiency ratio for the Q1 was 52.8% compared to 55.1% in the Q1 of last year. We expect continued improvement for the remainder of the year.
Now moving to asset quality. We continue to be positive about overall credit quality with lower level of charge offs and provisioning in the Q1. Non accrual levels increased, but still at a relatively low of 0.57 of total LHI. The increase is primarily related to 3 energy deals, 2 of which had been criticized for some time. While each of these credits have unique characteristics, poor development results were common along with other challenges unique to each and not indicative of the remainder of the energy book.
We believe each are adequately reserved at this time. Additionally, we experienced an uptick in total criticized levels in the Q1, predominantly driven by leverage deals. More than 50% of that was in the special mention category and is not surprising as a result of a continued focus on the leverage portfolio or any loans that may be viewed as weaker if we move into a slowdown. Percentage of total LHI remains low at 2.6% and we have rigorous action plans for problem loans. As you know from our history, we are always focused on being proactive with grading and especially late cycle, which can drive higher provisioning and classifications early.
The $20,000,000 in 1st quarter provision is related to the migration that I have discussed and is in line with our annual guidance. As we have mentioned, we would expect a larger portion of provision in the first half of the year. So Q2 provision could be higher than the Q1 level. Generally, that would be the result of any additional migration. Our team is staying very close to all criticized loan situations, but this is the time of year that clients are finishing their audits and if those audits reveal deterioration that internal financials or our ongoing dialogue with clients had not previously downgrades could be possible.
We wouldn't expect that to be significant and believe it is adequately covered in our guidance for the year. $4,600,000 or 9 basis points of charge offs in Q1, all of which was previously reserved. Continue to see strength in our linked quarter net revenue. Core loan growth in the Q1 as well as better than expected volumes in mortgage finance. 1st quarter non interest income includes an $8,500,000 legal settlement, which is obviously nonrecurring.
Continuing to improve run rate on our core operating expense items, specifically salaries and a focus on improving efficiency while enhancing client experience. Year over year, 11% increase in non interest expense compared to prior year Q1 and it's 8% excluding the MSR write down and compared to 15% net revenue growth or 12% if you exclude the non recurring legal settlement. On a PPNR basis, the earnings power continues to improve as we evaluate our year over year comparison. ROE and ROA levels were improved in Q1 as a result of lower provision level. We could see some lift in ROE levels later in the year if provision levels come in lower than guidance.
Now we will move on to the remainder of our outlook for the year. We are decreasing our guidance for average traditional LHI growth slightly to mid to high single digit percent growth from high single digit. That doesn't represent much change in our outlook, but rather fine tuning what we expect to see from a paydown perspective. We have experienced good growth in the Q1, but expect higher runoff in areas that we are focused on running off. We are increasing our guidance for average mortgage finance growth to high teens from low single digit percent growth, additional growth as a result of lower long term rates.
While we assume this is a short term opportunity with lower rates, we will be opportunistic as it's very positive on earnings and it makes sense from a risk perspective while we work on the appropriate runoff in other areas. We are also increasing our MCA guidance to $2,500,000,000 from $1,900,000,000 for average outstandings for 2019. While we continue to see pickup in market share in this space, MCA will also benefit from additional volumes from the drop in rates. We are increasing our guidance for average total deposits to high single digits from mid to high single digit percent growth, still with an expectation that net growth will be interest bearing. We expect some traction with initiatives, but weighted towards the second half of the year.
We also expect to continue to see growth in core clients, which may result in some upside on non interest bearing deposit trends. We are comfortable using well priced brokered CDs as we gain traction in other areas. We are decreasing our guidance for NIM to 3.6 to 3.7 from the previous 3.75 to 3.85. The decrease is primarily related to an earning asset shift as we now expect more meaningful growth in total mortgage finance, which is lower earning assets. While slightly punitive to NIM, the added growth is very positive to net revenue and net income.
The guidance continues to assume no Fed changes in rates for the remainder of 2019. Guidance for net revenue remains at high single digit percent growth, but at the higher end of that high single percent range with the additional revenue expected from mortgage finance. Our guidance from provision expense remains at mid to high $80,000,000 level. While our Q1 provision might indicate slightly lower than annual guidance, it's too early in the year to warrant any adjustment. Guidance for our non interest expense remains at mid single digit percent growth.
We continue to feel good about the slowing of our core operating expenses, primarily related to our very targeted growth in headcount. Guidance for efficiency ratio remains in the low 50s. Lastly, I'd just like to reiterate our long term outlook, which is on Slide 13 and is part of our 3 year planning horizon with no changes to the view we shared last quarter. Keith?
Thank you, Julie. We continue to make the necessary changes in our business to better align our organization structure with full solution product delivery at a strategic level with our clients. We have long been known as a high touch client service company, but we are committed to further differentiate our reputation by becoming the premier client experience bank against all key competitors. This undertaking includes the 3 year rebuild we launched in 2016 to rebuild our technology infrastructure. We're roughly a year away from essentially completing that rebuild.
The up to date technology grid positions us for better agility for the ever evolving client preferences for mobile access and ease of use banking products and services. It also assists us in gaining better insights into our clients' emerging needs. Regarding LHI growth, it was solid in Q1 2019 despite our deliberate efforts to allow runoff and leverage lending and be ever more thorough in booking only high quality new loans across all lines of business in this hyper competitive environment. We want to grow modestly, not rapidly in this later stage of the recovery. Asset prices are continuing to escalate.
We know late cycle loans create higher through cycle risk unless we exert strong discipline and carefully manage down higher risk loan categories. We are fortunate to have the outstanding mortgage finance business to deliver higher growth in earnings with very high credit quality as we optimize our loan mix while still driving earnings and ROE. Our deposit initiatives continue to roll out and grow. The growth in our new deposit verticals will allow us to run off higher cost deposits over time. This will help us show net deposit growth at improved costs in more granular levels.
We believe we have a very clear view of our loan portfolio after much drill down and review last quarter. While criticized loans grew, we expect that to plateau. Finally, the targeted approach to slowing non interest expense is showing good results, more disciplined hiring, organizational changes, new technology and process refinement are all contributing to delivering a more premier client experience and more efficient bank. At this time, I'll turn it over to William to open the lines for Q and A.
Thank And the first questioner today will be Ebrahim Poonawala with Bank of America Merrill Lynch. Please go ahead.
Hey guys, good afternoon.
Hello Ebrahim.
So I just wanted to touch upon criticized loans and credit, Keith. Just trying to understand where we are in terms of putting this behind us. And so I think you mentioned in the prepared remarks, Giulio, you regarding expecting a little more potential for migration in the Q2. Can you give us a sense of like when like 3 months from now when we are on the call, do you think this will be well addressed absent any deterioration in the economy or is this kind of a moving target? Because I feel like there's been a lot of impact to the stock and just concern on the stock around credit and things kind of slipping negatively.
So I would love to get some color around that.
Sure. Well, as we've been describing at each quarter, the last couple of quarters, Ebrahim, we've taken a very deep dive, not just in leverage lending, but really through our entire loan portfolio. And we think that was prudent having seen some of the leverage lending deals begin to pop up Q2 last year and then they continued in the 3rd. And we wanted to be sure, as I mentioned last quarter, that we had not had any kind of leakage into having any kind of breakdown of credit underwriting and problems in other parts of the portfolio. We feel very good about that.
But by taking such a deep dive, we're naturally going to identify more watch credits and special mention and we should. We've really spent a lot of time and energy to get our arms around this early and before the downturn, whenever that might come. And our experience, Ebrahim, has always been if we're proactive and early on addressing things as soon as we see them, then there are pools of capital that are willing to sometimes accept high returns for what they perceive to be still reasonable risk in their world. And they have different objectives our interest often on credits that if we waited all the way into the cycle and the downturn, it wouldn't be the case. So while it is a little bitter to take medicine early, we really believe it's always been in the best interest of our shareholder.
And we don't see this as a continuing upward trend on the criticized volumes. We think we're approaching a plateauing on that. And also we expect quite a few of these to refinance in the special mention as well as in some of those that are what we call classified light, we're being conservative in how we're looking at our credits. And so while we are not overstepping our methodology or our approach, we're definitely being conservative in how we're grading these credits. And that's how you really get action and you get progress made on upgrading the entire portfolio.
So that's a lot of editorial, but I hope I'm answering your question. And I think we're just seeing what we expected we would see with this deep dive and we think we're nearing a crest on criticized.
Understood. So I guess takeaway is we spent a year digging through this. I appreciate getting ahead of the curve given where we are in the cycle. It sounds like the likelihood of you being surprised in any meaningful way from year on on credit should be relatively low?
No, we really haven't been surprised. Of course, we've learned a few things, but we really haven't been surprised. Again, if you look at our growth, the last 5 years, we have almost tripled the company. And so it was very, very important for us to start this tipping down of the growth rate, which we did over a year ago. To be sure, we were all about quality and having the building the strongest balance sheet possible for the next down cycle.
We really believe we earn the right to be a high growth bank as we go through each economic cycle. We don't just inherently have that right to be a high growth bank. So it's entirely appropriate and based on our history and experience, when you get into the late cycle, whether the economy lasts another year or 3 years, we're later in the cycle than we are early. We're seeing a lot of signs of asset values really, really peaking of a lot of clients selling assets, which often is an indicator to that we're nearing the late end of the cycle. Sellers generally have a better feel for the kind of value they want to realize than big pools of capital that want to be deployed and acquire assets.
So we're very thoughtful and watch our client asset sales. That's contributed to some more pay downs, not just in real estate, but overall in C and I too. But rather than chase that and try to overcome those pay downs by booking even more loans and pushing growth, it's a mistake in our view, because through cycle, it will just cost us a lot of credit write offs. So we feel very solid about where we sit. We think we have the best visibility on our portfolio we've had in 3 or 4 years, and we think we're headed in the right direction.
Understood. And if I may just on a separate topic, Julie, just if you could talk about the 3 loan buckets when we think about the yields today with the Fed on the sidelines, what's the expectation on those 3 in terms of should they be relatively flat, drift lower? Just any expectations? Do you expect any of the fees that kind of went away this quarter to come back?
So yes, so we'll start with traditional or poor LHI. As I said in my prepared remarks, we do think that lower fees is going to be something that we're going to have for the rest of the year. I don't think it's going to be lower than what we saw this quarter. So there could be some rebound from that, but we're I'm not going to say it's going to be significant. So I think the levels that we're at right now on core should be flat.
It can fluctuate up or down a couple of basis points, but it should be pretty flat. On mortgage finance, the warehouse piece, we felt that those yields are stable right now, and we would expect that to continue. And then on MCA, that's going to be tied to note rates. So as what's on our books now as that sells and we put on new, it will be tied to the note rate, which will be lower.
Got it. Thank you.
Our next questioner today will be Jon Arfstrom with RBC. Please go ahead.
Thanks. Good afternoon.
Hello, Jon.
Hey, just maybe the other side of Ebrahim's question on deposit costs. Julie, you talked about a little bit of abatement, slight minor, but give us an idea of what you're seeing in terms of less pressure in deposit costs? And then also the second part, you talked a little bit about a better deposit and mix shift later in the year. And I'm just curious what kind of magnitude you're signaling in terms of easing
deposit pricing pressure?
I don't think we are seeing anything specific at this point. We will talk about that as we get more traction with the different verticals. But we do think for now, because we had such a big like 5,500,000,000 dollars in index deposits, we're getting some relief from the Fed pause from that. So we saw all of that reprice in the Q1. And then as I said, we saw that reprice in January, February March.
Our overall costs were pretty stable. We do think there will be some gradual increase just because everything the net growth is coming in interest bearing, but it shouldn't be anything compared to what we've seen in the past.
And John, we seasonally have a softer Q1 in DDA. That's typical because of some of the large commercial accounts we have in a couple of different industries. So that is going to be rebuilding in the second quarter and should hold up better for the next couple of quarters.
Okay. And Julie, the 15 basis points you talked about, you're basically saying a lot of that pressure has gone away at this point?
Right, because a lot of that was from the repricing, the complete a full quarter of the Feb repricing on the index deposit.
Okay. And then back on the provision, 2 parts of it, you talked about potential for an increase in Q2. Curious if you're willing to talk about potential magnitude. And then on the other side of it, you talked about the potential for maybe beating or coming in lower on provision for the full year. Maybe give us an idea of what you're thinking there?
Let us tell you what we can, John. We can't drill down specifically because we're working with a couple of clients that are that's important. But 2 of the 8 credits that we've referred to before, we haven't graded conservatively today, but that's because the sponsors and the businesses, the sponsors are acting responsibly, the businesses are improving. If those things continue to play out on those two deals in particular, I think we have a good chance to come in with better provisioning in the Q2 and perhaps for the year. But we don't know yet.
We're going to have to see another couple of quarters and again, how the sponsor and the underlying business performs.
Okay. And that's the driver of the potential for coming in below for the full year is what you're saying?
Below or coming in with a higher provision in the next quarter.
Yes. And the same thing, John, when we talk about migration, it doesn't mean that we think there's going to be a lot more that moves to criticize. But within that criticize bucket, if we have some that move from special mention to substandard, then obviously that costs more in provision dollars.
And we feel very solid about our annual guidance still on provision. We just think there's a chance we could beat it, but we're another quarter or 2 away on these two deals.
Okay. All right. Thank you.
You're welcome.
And our next questioner today will be Steven Alexopoulos with JPMorgan. Please go ahead.
Hi, everybody.
Hello, Steve. Hello.
To start on credit, Keith, I appreciate the deeper dive into the loan book, but you could could you help me parse through the increase in classified loans this quarter and how much was tied to you just having a more conservative view versus actual deterioration, right? If we look at leverage C and I up $68,000,000 quarter over quarter. If I look at outside of C and I leverage and energy, that was up $74,000,000 Can you help me parse out what's actual credit deterioration in those numbers?
Well, I think actually is what we're telling you, I think most banks though would rotate over the course of 4 quarters as you well appreciate and maybe cover 60%, 65% of their portfolio in a credit review. We do that as well, but we've accelerated that over the last 4 months, actually the last 5 months to do a much deeper dive, Steve. And not just on the leverage lending portfolio, which we initially focused on, but more broadly across our entire loan portfolio. So what I would tell you is, it is what we're presenting, but I think we're giving you a more real time update than most banks could give you, if that makes sense.
Okay. And then that's helpful. On the provision guidance, which I guess implies that 2Q isn't of the largest provision for the year, this is first half loaded. What specifically is happening in 2Q that you'll see the most provision? Are you accelerating loan disposition or something that quarter?
It really relates to these two credits I mentioned, how the sponsors continue to act and they've been responsible in supporting the businesses of late and the businesses are improving. Of course, as you well appreciate, it helps the sponsor be responsible when the business is improving. And so we need to see another quarter or 2 of in fact that continuing and we're encouraged, but we're not ready to declare victory on either of those until we get another quarter or 2 of performance under our belt. But that's the biggest unknown about next quarter and whether we're going to have this initially projected front end loaded, namely a bigger provision next quarter than this. We're hopeful that we could come in if those 2 credits and sponsors keep performing as they are that we could come in more modestly, but we just don't know at this point.
Okay. And then sorry to beat a dead horse on credit, but if we look at the NPAs and the increase there, I know a lot of those in energy, not particular point where we're seeing other banks have an increase in NPAs on energy. Can you give more color on why you're seeing an increase there?
Those 3 are kind of older vintage deals that we really didn't see early on any major issues with, but that's changed. And the type of deals they are, are very out of the fairway, unusual relative to our overall book. As a matter of fact, one of those 2 is a coal methane deal. And because of the costs involved in developing that particular asset and reserves, there was a miss on what the cost run rates were going to be and the prices haven't helped either on the gas. So that's the type of thing when Julie said 2 of the 3 are more vintage deals, only one is something that we booked really in the last 2.5 or 3 years, one of those 3 and that's a different issue.
It's not something that we see as any kind of systemic problem, Steve, in the energy book. But nevertheless, another lesson on don't do things that are not in your fairway.
Right. Okay. And finally, I won't take up any more time. Is this more thorough review now completed of the loan portfolio? Is that why you're confident we won't see class criticized increase further?
Well, again, that's why I mentioned, I think we're plateauing on the increase in criticized and that's what I expect and my team expects. And so I think we're about there. And we should again start to see some of these deals pay off, some refinanced. And over the course of the next couple of quarters, we're optimistic, hopeful that these 2 larger deals that are properly provisioned or reserved today are going to play out better than we're estimating. But we still want to stay with our annual guidance on provision at this point until we have another quarter or 2.
Okay, Terrific. Thanks for answering my questions.
You're welcome.
And the next questioner today will be Brady Gailey with KBW. Please go ahead.
Hey, good afternoon, guys. Hello,
Brady. Hello, Brady.
So if you can, can you give us just a little more color on the 2 credits that you're that could potentially drive a higher 2Q provision? I know they're lever lending, but what sector are these 2 credits out of?
I can tell you this, there are 2 completely different sectors and we have no concentration in the portfolio in either of these two industries. I can't give you more than that, Brady, because again, we're involved in some pretty important discussions and work with these 2 borrowers and the sponsors.
All right. And then, Julie, you've told us a couple of times on the call today that we should expect the MCA yield to decrease from here. I know it has been going up 10 ish basis points a quarter for the last year or so. But I mean with the yield curve that obviously come down. Any idea as to the magnitude we could see that MCA yield decrease from here?
The MCA yield is going to follow mortgage rates. So as we churn what's on the books now and have new purchases, it's going to be based on that. So it's going to follow mortgage rates.
And what's the delay on that? Like I know you all keep some and then you sell it. So it's not it doesn't happen immediately. But by when we're talking 90 days from now, should the new yield curve
be fully reflective in that
MCA yield? That's very close. Yes, that's
to the warehouse and the core, which all of which is more tied to LIBOR.
All right. And then finally for me, just an update. I know we've been talking a lot about these new deposit verticals coming on. Maybe just an update on kind of where you stand on the 2 or 3 that are launched and what the balances are there and kind of how you're thinking about the rest of the year?
They continue to grow, Brady. We're encouraged. We are still in the process of just launching some new ones. And the one that until sometime in Q3, maybe early 4th. But we're very excited about that business.
The teams with us, they're working with our technology team to build out the technology that we think will give us best of class nationally in this niche. But the others are continuing to grow and we're optimistic that we're going to have at least 4 or 5 winners out of those 8. And but it's early. It's just so early that I can't tell you a lot more than the 2 that we launched last year continue to grow.
All right, great. Thanks.
You're welcome.
The next questioner today will be Michael Rose with Raymond James. Please go ahead.
Hey, guys. Maybe I'll move away from credit and talk about the long term outlook, which incorporates a 3.5% Fed Funds target. The futures curve is telling us we're not going to get there. Just wanted to see what the goals look like should rates remain at current levels or perhaps fall a
couple of times over the next year or 2? Thanks.
So the financial goals are based on no rate increase. What we had given was if rates went up. So the over 1.3 percent ROA, the over 15% ROCE and efficiency ratio of under 50, percent, that's all in the existing rate environment.
Okay. So what if rates actually decline 50 basis points or 100 basis points over the next 3 years? What's the productivity, I guess, I'm trying to get at?
We definitely have plan B on how we'll address efficiencies and org structure. It's not what is optimum, but it is something that we're looking at in a slower growth environment. We're not going to ramp up growth this late in the cycle just to generate more revenue growth than we're looking at now. I mean, already, we're on target to grow net interest income around 9% this year, which is, I think, quite healthy. And we're growing it with the best high quality credit mix, I think, of any bank out there by having this great engine of mortgage finance.
So certainly, Michael, we are committed to continuing to get more efficient even with the rate scenario changing perhaps, and we have plans to make that happen.
So just following up on that, what are some of the expense levers that you have because clearly the plans you put into place to kind of change and optimize the expense structure are kind of already in expectations. I guess I'm trying to ask what are the incremental levers that you can pull should the deposit or should the growth rate environment and the interest rate environment go against you? Thanks.
You do more faster. It's I'm not trying to be flipping at all. I'm trying to really answer your question. But the things that we have planned and the technology that we're able to deploy over the next year, I think are going to give us opportunities to enable us to hire fewer and fewer new people and use the people we have with the new technology. Our existing colleagues are going to be able to create more value, be more efficient in how we deliver productivity and deliver even more premier client experience.
So it's not a situation where we have a company that has lots of brick and mortar, we got to go address how are we going to close a lot of this, it's not going to be a big contributor. We don't have that scenario. We have been investing proactively as you well know for 3 years plus to get our technology grid really in top condition. We're well down the path on that. And I think we're going to be able to really leverage our people and continue to drive more efficient net interest expense growth and we can accelerate that.
We have that capability. I'd rather go on the pace we're planning because there is more training and development that's important to accomplish. So if we move faster, we may kid ourselves on how much more true productivity we pick up and it may compromise a little bit as further differentiating premier client experience. And that's really important that we not just do this to optimize our efficiency that we do it to improve the client experience too. But that would be the trade off, Michael.
Hey, Michael, also when you look at our at the current mix of our funding, obviously, we have a significant amount that's index deposits. So if rates start coming down, those would come down if we hadn't onboarded some of these lower costs. So those would start to come down immediately as rates come down. And then the variable components in non interest expense related to deposits that I talk about, those would come down significantly also.
Okay. That's helpful. Thanks for taking my questions.
You're very welcome.
The next questioner today will be Jennifer Demba with SunTrust. Please go ahead.
Good evening. Two questions. Were any of the downgrades in the Q1 prompted by the Shared National Credit Exam?
We didn't have any SNCC downgrades, Jennifer.
Okay.
And any interest in buybacks? I know you were asked about that in the last quarterly earnings call. Just wonder if the interest level has changed at all there?
Again, we won't rule it out, but that is not something we're considering anytime in the near future. I mean, and not something we plan to act on anytime in the near future. We really want to be in the right position on having plenty of equity, but not get to a point where it's putting too much a drag on ROE. So that's the balancing act. We still think we're fine.
We're going to have a very strong second quarter with mortgage finance. And so I think you're going to see a really nice ROE.
Thank you.
You're welcome.
And the next questioner today will be Dave Rochester with Deutsche Bank. Please go ahead.
Hey, good afternoon guys.
Hey Dave.
Hey, just real quick on the deeper dives that you did in the loans outside the leverage lending and energy, any industries pop up more frequently within those credits that went criticized this quarter or any geographic areas?
No, there really haven't been. I mean, we've slashed and diced it every way we could possibly think of to see if there were niches or particular industries that were causing more of the credit issue because of an industry margin squeeze or something systemic. We just haven't found it. I think what we have found is we've grown really, really fast. We've hired a lot of bankers.
We've hired a lot of credit underwriters. We've hired a lot of credit approval people. And it was important that we really, really do what we've been doing the last year and a half, Dave, and slow the pace of growth appropriately late in cycle and dig deeper and manage more carefully what we have on the books and then learn lessons from having grown so fast. So that through cycle, we'll have the strongest balance sheet and the lowest credit costs of other peers. And we really believe we're doing the right things on that.
Great.
And then just switching to the new deposit verticals. I know you mentioned more coming in the second half of the year, but I was just wondering how much lower those costs on those deposits are expected to come in overall versus the book cost at this point? How much of an advantage does that give you?
The big advantage is going to come from the 3rd major vertical that again, as I mentioned earlier, you have a much richer mix of demand deposit and also treasury fees. The first two we launched that are the primary ones we're running and growing currently. Those are largely tied to money market rates. So those are not coming in materially lower, but they're very efficient and they're marginally lower than our top marginal cost of funds. So that's encouraging.
And it's creating more granularity and diversity in the funding as well. So the big needle mover potentially is this one that will really launch late Q3. We are getting off the ground another 4 of these. But again, these are very these are brand new businesses. And so until we've been out there and had a few quarters to expose the capability of our products and our teams that we're hiring to go sell these on a national brand basis.
It's just too early to predict. We are highly confident with all the analysis we've done on these 8 that we'll have 4 or 5 of these that blended are going to deliver a very nice improvement in cost of funds and certainly quite a lot more granularity.
Yes, great. And then I guess just on the NIM guidance, I would assume you're probably not including too much in the way of deposit growth from the new verticals at this point, so probably not a whole lot of DDA growth at this point?
We're including almost none, because again, they're just very early stage. Now we're optimistic that by the end of the year, we'll be over $1,000,000,000 from 2018 having launched our first one early 2018, our second one mid 2018 and then our 3rd major one will launch late in the 3rd quarter. These other 4 that we're just beginning to test and get off the ground are going to be slower growth, but again lower cost and add more granularity. And we feel really good if we create over $1,000,000,000 staggering 3 major new businesses over 2 years with no new brick and mortar and very marginal incremental cost. We think we're doing all the right things strategically to improve our deposit mix and our cost.
But it's just early. I wish I had this third one. I wish we had all our ducks lined up a year earlier because we'd really be crowing about how nice the deposit costs were coming in and it'd be incrementally bigger numbers along with those first two that are more money market.
Yes. I appreciate all the color. I guess just one last one real quick. You upped your warehouse growth expectations, MCA makes a lot of sense. I was just wondering just given the increase that you have in your deposit growth expectations, is that going to be enough to fund that extra growth?
And just bigger picture, do you think you can fund all your loan growth with deposit growth this year? Is that what you guys are assuming at this point?
We do. We think we can. Great. We feel good about our deposit growth guidance. We feel good about our net revenue guidance.
We really still solid on our non interest expense guidance. We made a couple of adjustments, some up, one modestly down. And we're still hopeful on the provision, but we just have to get another quarter or 2 on these two credits I referred to.
All right. Sounds good. Thanks guys.
You're welcome.
Thanks Dave.
And today's next questioner will be Peter Winter with Wedbush Securities. Please go ahead.
Good afternoon. I had a question on asset sensitivity. I was just wondering with the Fed turning more dovish, can you talk about some of the steps maybe you're taking to reduce some of the asset sensitivity?
We have the advantage of this MCA business that we did not really have a meaningful business in back when we had the rate decline environment a few years ago. And that actually is helpful to us. It doesn't set us up for 5 10 year types of duration, but I don't think we'd be convinced yet. We're just not convinced yet that we should be taking that kind of duration risk anyway. If we had a lot of excess liquidity and desire to start investing in longer term assets, I think we'd be very careful.
But incrementally, because of the volume growth we've seen, Peter, in MCA, it does help us some. And we also are seeing some opportunities that have developed with just owner occupied real estate. We're not going out and aggressively seeking merchant long term CRE debt today. We think that's a real opportunity when the market adjusts, but we think the values of real estate that we'd have to loan against the appraised values today, they look a little rich to us to go out and do much of a play there. But on owner occupied, we feel much more comfortable with underlying business generating the cash flow to pay the debt and us not having to look quite as carefully at the fair market value of the real estate.
But there's not a material change in our approach to growing our asset base, but those are a couple of things that actually will help us a bit.
So no plans put on any types of like swaps or hedges?
No. We really don't want to complicate our balance sheet. I think we there are potential positives, but we've learned enough horror stories of those that thought they would become derivative experts on their balance sheet. And we just don't think that's a complexity we think serves us well at this point at least.
Okay. And then just one more question on credit. And I'm sorry if you talked about it, but the increase in non performing assets of 53,000,000 dollars Half came from energy. And I'm just wondering what if you mentioned what the other drivers to the increase in NPAs were?
Yes, it was I think I said in there, it was predominantly energy and there were 3 deals, 2 of which had been criticized for some time.
Well, if I'm right, energy was $26,000,000 right, of the increase Of the $53,000,000 increase?
Yes. And the rest of it was yes, the rest of it was the rest of it was some small things. So the bulk of it the bulk of the bigger deals were energy.
Right. But it's still another $25,000,000
Yes. Yes, nothing else meaningful.
So a
couple of smaller deals. Nothing to call out, I guess, is what I'm telling.
You're saying $3,000,000 to $5,000,000 He's trying to get a feel for?
Yes.
Were they leveraged lending?
They were just it was just kind of a mixture of much smaller deals.
Okay. And
then We took a deep dive on the portfolio, so we don't have as much color on that. But there aren't any big $20,000,000 type deals that make up the balance, Peter.
Okay.
And then can you repeat that? We don't see an industry issue with those dealing. We don't have any industry concentration and flavor to the smaller deals.
Energy went up 40. Yes, there was just nothing else to call out. The 3 energy deals, which was the I think it's $40,000,000 total was the bulk of it.
Instead of $26,000,000 it was $40,000,000
Yes. Because when they went from yes, energy non accruals are $77,000,000 and they were $37,000,000 at the end of the year. The 50 hey, Peter, the 50 you are talking about was last year at this time. Non accruals for energy are 77 and they were 37 at the end of the year.
Got it. Okay. Got it. Thank you. And then just one last housekeeping item.
The net revenue forecast of high single digit, I'm assuming that excludes the $8,500,000 legal settlement claim. Is that right?
No, for the year, it includes it.
It does include
it. For the year.
Got it. Okay. Thanks very much.
You're welcome.
And the next question is
By the
way, it also includes the mortgage servicing rights adjustment that went negative. Yes. So it's offset a chunk of it, but anyway.
And our next questioner today will be Brian Foran with Autonomous Research. Please go ahead.
Hi. I just wanted to make sure I kind of was piecing together the long term deposit vertical opportunity correctly. So I think last year you said 8 planned verticals, each could be a $500,000,000 to $2,000,000,000 opportunity and it would take 3 to 4 years to kind of get there? And then if I heard you right, this time you said you've got 2 live, you've got a big one coming on soon. You feel good that at least 4 or 5, if not more, will kind of really become meaningful over time and you'll be around $1,000,000,000 by year end.
So I mean, if I put that all in a blender, is kind of the punch line that over 4 years, there could be 4 to 8 really successful verticals and obviously the proof will be in the pudding, but maybe this could be like a $10,000,000,000 total deposit opportunity?
I think it's more like 4 to 6. I mean, yes, it would be a real a really great outcome if we did north of 6. I think it's Brian, all 8 of these hitting the median, dollars 1,000,000,000 and that's roughly what you're looking at, I think, is $1,000,000,000 to $1,500,000,000 on maybe all $8,000,000 We've done enough organic growth and innovative new businesses over the last 20 years. We're a little bit conservative and we just don't know on brand new businesses how well they do. I think 4 or 5 of these could well hit the median of $1,000,000,000 to $1,500,000,000 So to me, it's more like a $4,000,000,000 to $6,000,000,000 incremental increase over the next 3 to 4 years.
Got it. And then your mortgage growth, your mortgage warehouse has been better than peers. There's always a quarter to quarter volatility, but you've been better than peers clearly for a long time. And I think from the outside looking in, it's always hard to really whether it's Comerica or customers or BB and T or Wells like they all feel kind of homogeneous when you look from the outside. So I mean if you're a client or if I'm a client of your officer be better, like what do you think are the 2 or 3 kind of real special sauces that enable you to consistently gain share over time?
It really is delivering on all those key pieces that you mentioned, especially the banker talent, especially the technology that it's not just outstanding for us here in creating scalability, but importantly, that it creates a much more user friendly, more productive and efficient technology interface on the client's desk. So that their frontline people love working with us and would prefer to put all their new mortgage finance notes with Texas Capital. And similarly, they love working with our treasury team. They'd much rather work with our treasury people on managing their deposits than another competitor. Almost all of our clients have 5 or 6 banks involved in their mortgage finance business.
So our goal is to be sure that we give them the best client experience all the way across. And that we also are, Brian, being innovative, listening to our clients about new products as the business evolves. And we've been a leader in innovating and creating new product over the last 10 years as well that our clients give us insights to and help us craft and then others tend to follow. But I think we view it as more of a strategic business partner than just purely a bank. And that's why we're able to win market share and overcome headwinds when originations overall get soft.
And there's only 1 quarter in the last 15 years that I remember any of our competitors grew more than we did. And we kind of took our eye off the ball. This was about 2 years ago. And so our competitors came in with a more aggressive offering for 1 quarter and we came back with a vengeance, our team did. And we continue to take market share and it's just a fabulous credit quality addition to our balance sheet too.
And just very quickly, I know it's late, the Slide 5, am I interpreting it right that it's kind of a $200,000,000 ish revenue business and a 13% efficiency ratio, so kind of call it $175,000,000 of annual pretax or am I missing something?
Yes. We don't there are pieces that we don't, right? You can see the interest income is broken out separately. You can see the fee component. And we have said in the past that the fee component of the warehouse, which is a non interest income, basically covers the expenses.
And then again, we're not including the deposits in this chart.
They're in the efficiency.
They're in the efficiency. So there's a way to back into it.
They're in the efficiency, but that's not something that we've typically given. We haven't given we just haven't talked about the balances of that, which is why we present it this way.
Got it. Thank you.
You're welcome.
And the next questioner today will be Brett Rabatin with Piper Jaffray. Please go ahead.
Hey, good afternoon.
Hello, Brett.
Driving up the end here, just wanted to make sure I understood the more you've talked about mortgage quite a bit, but just thinking about 2Q, you've given guidance for high teens percent growth year over year, but just thinking about 2Q versus 1Q where you are at the end of the period end of 1Q versus kind of an average on 2Q, it would seem like this year you might have a more meaningful expansion in the Q2 mortgage. And then also just want to make sure I understood just the guidance around that strong 2Q in mortgage. Is that just mostly a function of the market or are you also onboarding quite a few new clients as well?
It's both. It's us taking market share and the volumes. And the seasonality is meaningful in the second quarter. That's true of our competitors too. They'll see a mass pickup.
But the thing we do differently is we take market share each quarter. And so that is the kind of the added turbocharge to the growth opportunity we have in this business. Our bankers are fabulous and our clients refer us our new clients. It's a great business.
Okay. And then just to go back to the question, could we see 2Q balances up $1,500,000,000 $2,000,000,000 in the second quarter? Can you maybe just give us
I know
you gave year over year guidance, but it's obviously very seasonal. So it's kind
of tough to decide.
I guess, Preston, answer that is Q1 averages were higher than we expected because we started to see some of that come in. So you can do the math, but we would see a pickup in Q2 and Q3 because those the averages in both of those quarters are usually strong. But keeping in mind that our Q1 was stronger than we expected.
Okay. Fair enough. Thanks for all the color. You're welcome.
And the next questioner today will be Chris Gamaitoni with Compass Point. Please go ahead.
Good afternoon. Thanks for taking my call. Good afternoon, Chris.
Thank you.
I want to get a sense of what gives you confidence on the runoff of the leverage loan book of roughly 30%. Is that scheduled maturities or are you expecting a significant portion to be refinanced away?
A great deal of it is just normal runoff. These companies typically when the private equity firm invests in the company, their target, as you well know, is anywhere from 3 to 5 years. Typically, it runs closer to 4 or 5 years on the tenure in the portfolio. So that would just lead you to look at about a 20% a year just natural runoff. And because we're obviously working hard on derisking the portfolio too, we think there'll be opportunities for other pools of capital to refinance us if we have covenant breaches or things that might come up.
And so we think there's a really good likelihood that we're going to see somewhere in that 30% runoff range between the 2.
All right. And then one small one, the loss on loans held for sale quarter over quarter improved significantly. Is that reflective of correspondent margins in the channel or is it something else?
Yes. We talked about last quarter that what we did in the Q4 is we held some of those loans longer. We held some of them longer and so there was some offset, some extended hedging costs that affected that. And so because of the volumes that we've seen that started in the Q1, there is just more churn to it. So that improves the gain piece or it lowers the loss piece.
All right. That makes a lot of sense. Thanks for taking my questions.
Welcome.
And the next questioner today will be Brock Vandelet with UBS. Please go ahead.
Good afternoon. Thanks for the question. I'm aware of the full year guide on the NIM. I was just wondering if you could offer any sort of additional color on the trajectory the remainder of the year as you may get benefit later in the year from some of these new verticals, pressure in the near term, like any color you have on how we should think of shaping that margin trajectory the rest of the year?
A lot of it's just the mix, Brock, with warehouse being stronger than we had originally thought we could generate for the year. And so that's a significant piece of the NIM issue. I'm very happy to take that trade off to have such high credit quality for our net interest income growth and our balance sheet strength, but that is a big piece of it. Julie, is there something on the cost side that's material?
No, no. It's really Brock, the bulk of the change in our guidance is really related to the earning asset shift with more of it coming from more growth coming in both warehouse and MCA, both of which are lower yielding, but very positive for net revenue.
Got it.
Okay. Thanks for the color.
You're welcome.
And this will conclude our question and answer session. I would now like to turn the conference back over to President and CEO, Keith Cargill for any closing remarks.
We appreciate each of you joining us today and your interest in our company, and we're excited about the balance of 'nineteen after a good start in the Q1. Again, thank you for your time. Good night.
Thank you for your participation in TCBI's Q1 2019 earnings conference call. Please direct request for follow-up questions to Heather Worley at heather. Worleytexascapitalbank.com. You may now disconnect and have a great day.