Good afternoon, and welcome to the Texas Capital Bancshares second quarter 2018 earnings conference call. All participants will be in a listen-only mode during the presentation. Please note this event is being recorded. If you do need assistance, please signal a conference specialist by pressing the star key followed by zero. At this time, I will turn the call over to Heather Worley, Director of Investor Relations. Please go ahead.
Thank you for joining us for the TCBI second quarter 2018 earnings conference call. I'm Heather Worley, Director of Investor Relations. Before we begin our call, please be aware it 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-K, and in subsequent filings with 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, Brian, will facilitate a Q&A session. Now I will turn the call over to Keith, who will begin on slide three of the webcast. Keith?
Thank you, Heather. I have a few opening comments, after which Julie will offer her review of the quarter, then I will close and open the call for Q&A. On slide three, certain highlights warrant a bit of color. The LHI growth in Q2 was strong, especially considering the somewhat depleted loan pipeline at the beginning of Q2 after the very strong Q1 LHI loan results. Mortgage finance recorded an excellent Q2 in outstandings, following a much improved Q1 2018 against Q1 2017. We showed an 8% linked quarter increase in Q2 for total deposits. The competitive environment we and most banks face in growing deposits requires greater focus across the bank. Importantly, our treasury management team and technology team continue to innovate. We are currently marketing and are fully operational on one of eight prospective cash-rich industry verticals. Further, we are in beta testing on three additional verticals.
By Q1 2019, we should be engaged with marketing and operating three new deposit verticals that didn't exist in 2018, and we will be beta testing four additional deposit verticals in the first half of 2019. Each of these eight potential new cash-rich industry verticals has the opportunity to deliver favorably priced deposits totaling $500 million to $2 billion within three to four years. That's each vertical. Net revenue growth continues at a robust 8% from Q1 and 23% year-over-year from Q2 2017. While we experienced an unusual loan loss scenario in Q2 involving approximately $14 million of energy losses and $24 million in charge-offs on three C&I loans, our underlying credit metrics on the loan portfolio are actually very good. Slide four updates you on our energy and healthcare exposures. We are pleased with the quality growth our energy business is again achieving.
Non-accrual energy loans have decreased approximately 60% since Q2 2017. While criticized energy loans are down approximately 50% year-over-year. While we experienced an unusual outsized loan loss in the second quarter from two healthcare loans, overall criticized healthcare loans total only 3% at Q2 2018, with over half of the 3% relating to the two loans charged down in Q2. The large majority of our healthcare loans, totaling almost 70% of the portfolio, relates to senior housing as opposed to leveraged lending. Only $9 million of senior housing loans are criticized as of Q2 2018. Slide five describes the geographic diversification of our loans and deposits. We update you in the top right quadrant on the unemployment rates in each Texas metro area in which we operate. The economy in Texas remains very strong. In fact, Texas was again named CNBC's top state in America for business.
In the 12 years CNBC has named the top state for business, Texas is the only four-time winner. We have added more than 350,000 jobs in the past year. 39 companies in the S&P 500 Index are based in Texas, and some of the nation's largest privately owned companies call Texas home, including H-E-B Supermarkets, Neiman Marcus, and Hunt Oil. The score for Texas in the 10 categories of competitiveness in this survey included top 10 finishes in workforce, we came in number 7 out of 50 states. Infrastructure, came in number 1. Technology and innovation, we were number 9. Access to capital, we were number 3. Finally, the economy, number 1. We're fortunate to be based in such a dynamic economy. Julie?
Thanks, Keith. My comments will cover slide six through 12. Our reported NIM increased by 22 basis points from the first quarter. The change in earning asset mix accounted for a portion of the increase. The decrease of almost $900 million in average liquidity assets since the first quarter accounted for approximately 15 basis points of the improvement. That was offset by the seasonality impact from mortgage finance, which was negative to NIM by about 14 basis points. Net 11 basis points, a positive impact to the NIM from earning asset shifts, with the remainder coming from improvement in earning asset margins. Our traditional LHI yields were up 33 basis points from the first quarter, reflecting continued impact of moves in LIBOR and a good strong loan fee quarter. As we noted in the first quarter, we benefit as one-month LIBOR has increased relative to Fed funds rate.
Recently, LIBOR spread to Fed funds seems to be slowing some. Our asset betas continue to be as expected. Our continued loan growth can mute rate impacts somewhat, as new loans may not be coming on at the same effective rate as the overall portfolio yield, but that can vary some by loan type. We experienced continued improvement in yield on mortgage finance loans in the second quarter with LIBOR moving up, but that industry remains competitive, and we will evaluate relationships as needed. We had a slight linked quarter increase in average deposits from the first quarter. Our overall deposit cost increased by 15 basis points from 66 basis points in Q1 to 81 basis points in Q2. The increase was expected as Q1 numbers only included a few days of the March Fed funds move on index deposits.
Similarly, Q2 only includes a few days of the June move. Additionally, we continue to see a pickup in magnitude of rate change requests, but not more than expected. We have a continued solid deposit pipeline, but as we've said in the past, it can involve a long sales cycle, so difficult to forecast exact timing and can be lumpy in how it comes on, and most of it is interest-bearing. During the second quarter, we chose to layer in approximately $1 billion of traditional brokered CDs as we were able to lock in 6 and 12-month maturities at a cost slightly less than our index deposits. While use of the brokered CDs makes sense from a balance sheet management perspective, we don't plan to use an outsized amount of brokered CDs going forward.
Floored loans are now around $110 million, and it's fairly irrelevant at this point because there's no significant difference in rates on floored and unfloored loans. As a reminder, approximately 70% of our floating rate loans are tied to LIBOR, and over 80% of that tied to 30-day LIBOR. As Keith commented, we had a continued good traditional LHI growth in the quarter and actually a little higher than expected. Year to date, it remains consistent with our annual guidance. Traditional LHI average balances grew 3% from the first quarter and up 16% from this time last year. Strong growth in June with ending balance above average provides a good start for the second half of 2018. The level of payoffs continues to be high, primarily in CRE, and no sign that that will slow.
Continued strong average total mortgage finance balances were impacted favorably by seasonality, but also were up from last year at this time by almost 38%. Q3 volumes are expected to be good, but less than Q2 and followed by a seasonally lower Q4. There was some pickup in linked quarter average total deposits, with all of that growth coming in interest-bearing. As we've continued to say, we do expect most and probably all of the 2018 growth to come from interest-bearing categories, but still at reasonable overall effective cost. As I noted earlier, we chose to add some traditional brokered CDs during the second quarter. They have 6 and 12-month maturities, and pricing is very favorable as compared to our index deposits. Primarily interest-bearing deposits in the pipeline, but we're also working hard on maintaining and growing existing relationships.
asset betas are an important part of the story for us and why we feel good about our balance sheet positioning going forward. We have seen our asset betas perform as expected. We're continuing to react to specific customer situations, evaluating them on a total relationship basis. Just to note that our index deposit categories still total approximately $5 billion in balances. Moving on to non-interest expense. In looking at changes in linked quarter non-interest expense, we are effectively slowing our core expenses, but there are a few items of note that require some additional commentary. I'll start with the salaries and employee benefits line, as that's obviously the major driver of our non-interest expense, as it's over 50% of the total, and we think we're doing a good job of managing this with a lower level of FTE additions year-to-date.
There's an increase in non-LTI and annual incentive pool from first quarter levels, that's driven by the annual incentive accrual, which generally continues to ramp throughout the year based on overall financial performance. Very little fluctuation in FAS 123R expense in the second quarter compared to the first quarter, as there were no major fluctuations in stock price. As a reminder, total FAS 123R expense in 2017 of $22 million versus our planned 123R expense of $24 million in 2018. Q1 and Q2 FAS 123R expense was $5.6 million. Legal and other professional was abnormally high in the second quarter with some non-recurring expenses, but expected to return to a more normalized level in Q3. It was about two and a half million in Q2. That's not normal run rate, and we wouldn't expect to see that in Q3 and Q4.
We discussed a new variable component added during Q1 that is directly related to deposit services, that accounted for a little over $1 million of the increase from Q1 to Q2. We would expect to see the same $1 million to one and a half million increase in each of the next two quarters, but on a base excluding the two and a half million that I mentioned. Portion of the marketing category is variable in nature and is tied to growth in deposit balances as well as increases in rates. The trend in marketing over the last year or so is representative of the increase in run rate expected throughout the rest of 2018. We continue to be targeted about expense growth and heading into 2019 planning season, that will be even more evident.
No new outsized build-out planned for 2019, rather a focus on improving returns in all lines of business. Our efficiency ratio for Q2 was 53%, slightly improved from first quarter of 54%, and compares favorably to last year at this time of 55%. Obviously, seasonality for mortgage finance positively impacts our efficiency ratio in the second quarter. Moving on to asset quality. Despite the outsized provision in charge-offs, asset quality continues to be good. Non-accrual levels are at an acceptable rate of 37 basis points of total LHI. As we've discussed previously, the additional provision and charge-offs were related to four larger C&I credits, one energy, two leveraged healthcare, and one general C&I with a unique situation. None of the four give us a reason to believe that there's a more systemic issue within the portfolio.
As you know, we take credit very seriously and are as focused as ever on maintaining our standards of credit quality. Expect Q3 and Q4 provision levels to be more normalized. It is important to note that as we've grown, we are doing larger deals, and when we see migration, it can cause lumpiness in provision levels from quarter to quarter. The provision of $27 million for Q2 compares to $12 million in Q1 and $13 million in Q2 of last year. Of the $27 million, about $7 million of the provision this quarter was related to new loan growth, and that was a little higher than we expected as we had strong growth late in the quarter. Charge-offs for the quarter totaled $38 million and included $14 million related to energy. In looking at net revenue, we continue to have good growth linked quarter.
Strong traditional LHI growth year to date, the entire portfolio has benefited from improved margins as a result of the continued move in LIBOR. We continue to take market share away in mortgage finance as well. ROE and ROA levels were penalized in the second quarter as a result of the higher level of provisioning. The expectation is that ROE will continue to improve through the remainder of 2018. The benefit from interest rate moves continues to be evident in net interest income and positively impacting ROE and ROA. Current lower liquidity levels have been beneficial for ROA, we're comfortable with holding higher liquidity levels, and we would expect balance increases over the next two quarters as mortgage finance moves into the seasonally weaker part of the year. Last, I'll talk about the 2018 outlook and any changes.
We have no change in our outlook for traditional LHI growth of low to mid-teens % growth. There's a slight change in our outlook for mortgage finance growth of mid-single digit % growth. Additionally, a slight change in MCA guidance to $1.2 billion for average outstandings for 2018, despite the fact that that market continues to be highly competitive. In total deposits, we have a slight change as we think growth will be in low teens to low teens % growth. We still expect to see more growth in interest-bearing categories and continued shift from non-interest bearing to interest bearing. We're comfortable funding seasonally higher mortgage finance balances with short-term borrowings, which is perfectly match funded. The deposit growth can be lumpy, which can mean that liquidity levels can vary from quarter to quarter.
For NIM, we're improving our outlook to 3.6%-3.7% to include the impact from the June rate move. The guidance is still assuming no additional rate increases in 2018. We're also taking into consideration that our deposit growth is coming in interest bearing, that also assumes that we have liquidity levels higher than the second quarter level. Improved outlook for net revenue to mid to high teens % growth to reflect the impact from the rate move in Q2. No change in our provision guidance at low to mid $60 million level. The second quarter was outsized as a result of the four deals, we expect the more normalized levels in Q3 and Q4. We're updating the guidance for non-interest expense to low teens % growth, primarily related to some of the variable costs I previously discussed. No change in guidance for efficiency ratio.
It still remains in low 50s. Keith?
Thank you, Julie. I'll close with slide 13. Despite the outsized loan loss provision in Q2, we delivered strong earnings and have set ourselves up for a strong start to Q3 with the excellent loan growth in Q2. We continue to benefit greatly from our high asset beta, allowing us to improve NIM guidance for the remainder of 2018. The impact of one quarter of slippage on credit costs clearly keeps us focused on credit quality, despite the good credit metrics currently. For all of 2018, we continue to believe the loan loss provision will remain in the upper range we provided in guidance back in January. We are committed to the targeted approach in slowing non-interest expense growth, while also modestly and efficiently investing in new and better deposit generation capabilities, including new cash-rich industry verticals, new products, and always the finest possible client service.
At this time, we will open the lines for Q&A.
To ask a question, you may press star, then one on your touchtone phone. We do ask, if you're using a speakerphone, to please pick up the handset before pressing the keys. To withdraw your question, please press star then two. At this time, we'll pause momentarily to assemble the roster. Our first question today comes from Brady Gailey with KBW. Please go ahead.
Hey, good afternoon, guys.
Hello, Brady.
Hey, Brady.
The $1 billion of brokered CDs that was brought on balance sheet, six to 12 month maturities, what was the average rate paid for those?
It was more attractive than going out, Brady, and generating the incremental deposits. The six and 12 months just was too attractive to pass up on the pricing. Do you have that-
Cheaper. Yeah, I don't know that we want to go into the exact cost.
Okay.
It's less free. It's at a rate less than our index deposits.
Is that something you expect to potentially do more of on down the line, bring on more broker CDs?
No, we just thought it was a good time in the market to do that relative to the alternative. It's proved to be the case since we made that purchase.
Yeah, the timing was right. It was earlier in the quarter, before the June rate move, and we were just trying to be opportunistic from a balance sheet management perspective.
All right. Then Keith, I know you mentioned the eight new kind of cash-rich industry verticals that should produce some nice deposit growth. I think you said you've launched one of them. The other seven that are coming the rest of this year and into next year, do you expect any sort of notable expense build surrounding those new deposit verticals?
They should really be modest expense builds. The key there, Brady, and I think we've mentioned this a time or two when we first started explaining our R&D project that's been underway for two years to develop these targeted cash-rich industries, the key is hiring the right people. Now, we do some additional product development, but it is not out of sight, very expensive to do that. Again, what we've done over the years and had good success at is identifying niches, talking to quality prospects, and a few of the clients that we may have attracted already, and having them assist us in final design of the product. So that collaborative effort has really helped us deliver something uniquely tailored to these different industries. It is not an expensive undertaking like you would expect on a build-out of a typical business that would involve credit as well.
Okay. Last for me, there was about a $2.5 million swing in other fees. Just wonder if y'all could give a little color there.
No, I don't remember anything of mention that we would talk about. Most of it's going to have to do, because what is primarily in other is some of the MCA stuff, gain on sale. There were some losses, and it had to do with our transfer of the sale of the servicing book. Not recurring.
Okay. All right, great. Thanks for the color, guys.
Yeah.
Yeah.
The next question today comes from Jon Arfstrom with RBC Capital Markets. Please go ahead.
Hey, thanks. Good afternoon.
Hello, Jon.
Hey. Just on the loans, Keith, you talked about a little bit lower pipeline coming out of Q1, obviously you had a great loan growth quarter, and now you have period end higher than average. Can you talk a little bit about what, if anything, changed during the quarter, and kind of the key drivers of the LHI growth?
I can't say, Jon, that we're seeing a significant shift in the psychology of the clients, it is getting some more positive in spite of all the chaos about trade wars and things of this sort. I know there are some that are on the sidelines. Generally, our clients are really prospering. They're having good success in their businesses, and we just got some good traction intra-quarter that we didn't expect we could build that quickly, and it was quite broad. It wasn't a particular area. In fact, some areas that have typically been good boosts in a given quarter when we have this kind of growth would be CRE actually was pretty modest. We had quite a lot of paydowns in CRE. It was largely C&I. Also, our premium finance business did extremely well.
You would expect a little of that in the second quarter. There is some seasonality in that business. They really did far better than just the typical seasonality. It was a combination of across the board, our team's really done a good job, even though we started with a pretty lean pipeline right at the beginning of the quarter.
Good. That's helpful. Then maybe Julie, for you on the NIM guidance versus the number that you put up this quarter, is there anything you would call out in that 393 margin number? How do you want us to think about some of the near-term puts and takes on the margin as we look into Q3?
The things that we try to. We do the roll forward, the things that I would call out are the ones that I called out. There was some pickup from the shift in earning assets, the 11 net, that was still improvement. That's improvement. That's based on the earning assets, the loan yields going up. There were some. A good quarter of loan fees, that's something that we have regularly. No, nothing in particular that I would call out. Our deposit increase were pretty much what we expected. I don't think anything that we weren't expecting.
We're going to have to watch that LIBOR lead relative to other rates, because as Julie mentioned, it's not leading as much as was the case earlier in the quarter. We're watching that.
Yeah. Okay. Okay, thanks for the help. I appreciate it.
You're welcome.
Next question comes from Peter Winter with Wedbush Securities. Please go ahead.
Hi.
Peter.
Thank you for taking my question. I was wondering, can you give a little bit more color on some of the deposit initiatives? I know it's early stages, but I'm just wondering if you could give some broad color on some of the initiatives.
Peter, we really can't do that because we'd just be telegraphing to competitors these areas that we spent a lot of time and energy and invested some R&D money in researching the last couple of years, and now that we're in beta and build-out. Until we get out there and establish on our balance sheets some meaningful deposit growth which I think we'll really create over the next two or three years, until we get some of that traction and get established as someone that's quite good in that specialty niche, we're not going to telegraph that early. When we were a smaller bank and just an ankle biter, people didn't really pay a lot of attention to some of our innovation. We've created this organically, and our people have come forward with ideas, mostly from clients who give us those ideas for 20 years.
This is our 20th year of creating an organic growth company. What we know now is we can't be too proud and talk early about these ideas until we get the market traction that we expect we'll accomplish. I tried to give you a little more color than what I had in previous quarters about the relative impact these could have over time, over the next three to four years. We think each of these eight, if we ultimately execute eight, again, we're going to have four that are out and operating by Q1. I feel very confident now. Of these other four that'll be in beta the first half of the year, not all will make it necessarily out into the market.
Let's say at least two of those four make it to the market, our beta test goes very well, then we would have six new businesses that only one of which we launched this year. I'm very proud of our team across the company, how we've worked together to develop these new opportunities. I wish I could share more, but I just can't. I hope you understand that.
I do. Can I ask about the? You maintained the guidance for the average loans held for investment. If I look at the first half of the year, you're tracking slightly above the guidance. I guess I'm just wondering what the outlook is for the second half.
The outlook for the second half is good, but it's less than Q2 levels. Both in Q3 and Q4, we would expect good growth, but less than what we saw in Q2.
What would be the reason behind that?
Well, the main reason behind that is, like most banks, we're pivoting some on the time that we want our bankers to spend on deposit growth with our treasury team members. We're rolling out some of these new products and opportunities. We're going to have to be a bit more balanced in how we allocate our time, I think that's really a wise investment. We have a lot of opportunity to create more core deposit growth with our existing customer base, even before these new verticals get rolled out, but it does take time. In fact, deposit generation takes more time often than loan generation.
We're just trying to be realistic, be sure our bankers know that loan growth is still important, but it's balanced growth in the environment we're going to be in the next three to five years that's very important to achieve our sustainably higher ROE objectives.
Okay. Thanks.
You're welcome.
Our next question comes from Michael Rose with Raymond James. Please go ahead.
Hey, good afternoon, guys. Maybe we can start with the energy loan growth this quarter was pretty strong. Can you give us a flavor for the types of energy credits you're putting on the books today? Are they what they've been historically, more of the club credits, bigger credits or bigger pieces of larger SNCs? Just a flavor of what the environment looks like now.
This particular quarter, it was just good solid E&P, not concentrated at all in SNCs, although our SNC book does have a fair amount of energy included in it. E&P made up about close to $100 million of the growth this quarter. We had some very modest increase in midstream. Water disposal was some of the increase. We had a little compressor financing that kind of falls outside the true E&P category and falls more in our business loans, which you'll notice a differential between our pie chart on energy loans and our 7% we talk about on our energy subsection, and that difference are things like compressor financing. We don't do near the wellhead energy service financing, as you well know. Thank goodness, going through the last cycle.
We do some of these ancillary types of oil field service that's not near the wellhead, like compressor financing. That was a piece of it as well.
Okay, that's helpful. Maybe just one more, broadly speaking. The efficiency ratio, low 50% expected for this year. That's unchanged. As we move into next year, you guys have built up a bunch of businesses over the past few years, and I think a lot of people are really counting on the operating leverage to come through to drive that efficiency ratio lower. I know it's probably a little early to comment on next year, but would the expectations be to generally, assuming rates continue to grind higher, we get a couple more rate hikes, to see that efficiency actually improve next year?
Yes, we should. We certainly should. We're continuing as we refine our tactical plan and constantly work on our strategic plan. It evolves quarter by quarter. We really work at this year-round now. We're going to have more and more emphasis on those key areas where we can be number 1, number 2 kinds of players and optimize returns, risk-adjusted returns. That will help us be more focused on how we allocate our people, our human capital, as well as our overall financial capital. That will contribute to more efficiency as well.
Okay. Then just one quick one for Julie. How much were the non-recurring legal fees this quarter, pre-tax? Just a dollar amount.
The professional was roughly about $ two and a half million.
Okay. Thanks for taking my question.
It's just not recurring.
Next question comes from Dave Rochester with Deutsche Bank. Please go ahead.
Hey, good afternoon, guys.
Hello, Dave.
Hey, Dave.
On the deposit growth, are you guys assuming that the brokered CDs actually stay with the bank, or are you planning on rolling those off at some point as they come due over the next year?
They would roll off. Some are six-month maturities, some are one-year maturities.
Yep. You're not planning on replacing those.
They would roll off.
Got you.
We have these new verticals coming on, but it takes a little time
Right
to get out in the market and actually generate that new lower cost funding. In the meantime, to go into the market as competitive as it is, this was a better financial alternative.
Right. Yep. I appreciate that. I know you mentioned seeing a greater incidence of pricing requests this quarter, but it sounded like that was within your expectations. I was just wondering how the competitive backdrop has changed at all this quarter versus last quarter, and if you've seen any standard pricing changes in the market post the June hike.
No. So far, steady as it goes.
Okay, great. Then on the NIM, just comparing where the NIM guide is now versus the reported NIM for 2Q, you're looking for a pretty big decline in the NIM in the second half. Is that all just liquidity declining, or liquidity increasing and funding pricing going up?
We assume no more rate increases. In that, we would assume that there's a little bit of compression on the loan yields, that deposit costs tick up a little bit more, and that, yes, that there's some build in liquidity.
Remember, the fourth quarter warehouse, Dave.
Yep
is always a seasonally softer quarter, that'll lift liquidity, too.
Right. You should still see some benefit from the lift in LIBOR this quarter from the June hike, right?
Yes. There would still be some.
Yeah, that's true.
Yeah. In July, though, earlier in July, we're starting to see it narrow a little bit.
Right.
That's why there'd be a little pickup. That's been factored into the guidance.
Okay. It's just you're looking to go from 393 to something that's 20 basis points or more lower. Was just trying to figure out, are you looking for a big liquidity build in the back half of the year? I know the dynamics around the warehouse.
Yeah. Not huge, but a much bigger liquidity build. It would be more liquidity than we had in the second quarter.
Got it. I know you mentioned the loan fees were a little bit higher this quarter, but how much higher were they versus last quarter?
That can vary from a couple of basis points from quarter to quarter.
It's not that big of a swing factor?
No. It can vary a couple of basis points from quarter to quarter.
Okay. Then you're assuming the DDA, I guess, remains stable through the end of this year as a part of your guidance, or continues to run off?
We're not assuming growth in DDA, I'll tell you that.
Okay. Got you. Okay, great. Then just one last one on expenses. There's great color on all the new verticals. Appreciated that. I know you just said that you weren't expecting any of the big build-outs next year, was just wondering if you're thinking that low double-digit expense growth pace should be good for next year as well.
We think it should.
It's early, but that's certainly what we would be targeting.
Yeah, I got another frown from Julie. You know, that happens about every other quarter.
All right, great.
I spoke out here a little quick.
All right. Well, I appreciate it. Thanks, guys.
You're welcome.
Next question comes from Jennifer Demba with SunTrust. Please go ahead.
Thank you. Good afternoon.
Hello, Jennifer.
Jennifer.
The legal fees that were higher this quarter, what was that attributable to?
Oh, we're not going to get into the specifics. It's regulatory compliance type of other professional expenses.
Nothing that the-
Nothing that is indicative of a problem or just some lumpiness there
Okay. Your other fee income that was a loss this quarter, should that return to the more normalized levels in the third quarter?
Yeah, it should return to more normalized.
Okay.
Had to do with some
You've got at this point about $83 million in non-performing loans. Can you just talk about the granularity of those non-accruals? Maybe what the larger loan sizes are in that bucket.
I don't have that really handy, Jennifer, I don't remember anything outsized. By that I mean, we don't have any $50 million kinds of issues in that portfolio of non-accruals. The high end of that might be a 20 or a 22-ish, or even more modest. 15-ish, mid-teens to high teens would be the high end of anything in that balance.
We give you what the energy portion of it is, the total for the remaining energy in that.
Mm-hmm. Okay. Thank you.
You're welcome.
Our next question comes from Brett Rabatin with Piper Jaffray. Please go ahead.
Hi, good afternoon, everyone.
Hello, Brett.
Wanted to go back to just thinking about the margin and the loan yields. Your LHI loan yield was up 33 basis points this quarter, and you've got the June rate hike. I just want to make sure, are you saying, Julie, that there's less ability to pass along maybe some of the LIBOR increase from June? I just wanted to make sure I understood your commentary around the implications of that hike specifically.
Yeah. Not all of the loans, they don't all reprice at the same time. Depending on how quickly something reprices, there can still be some pickup in Q3 from that Q2 move.
Okay.
Go ahead.
What I was going to ask is it would seem like there'd still be a pretty northward trajectory on that, but I realize that new loan production is also a headwind, if I understand correctly. Can you maybe comment on that relative to the current yield?
Yeah. New loan demand, some of it is coming on at a rate less than our portfolio yield. That can vary by type of new loans.
Brett, you really have to factor in that liquidity build where we go from a strong third quarter on warehouse to a much softer fourth quarter. When we flip the assets to liquidity, we give up a lot of yield. That's really what is driving most of that change.
Okay. Fair enough. Wanted to ask on MCA, just want to make sure I understood the related fee income this quarter, what happened there and kind of what that might mean for the back half of the year.
We don't need to get into the details of it. I don't even have all the details in front of me. It's just kind of a non-recurring. It had to do with some losses, some mark-to-markets, but I don't even remember the details. It's non-recurring, and it's not a trend that you should see repeating going forward.
Okay. Maybe one last one if I could. I realize that the two healthcare credits, the leverage ones, were a little bit unusual relative to the rest of the book, but was just curious if you've done kind of a deep dive on the rest of the healthcare book to make sure there's not reimbursement rate risk with the rest of the portfolio, and just kind of thinking about the remaining healthcare and how it's different than the ones you obviously had to address in 2Q.
Yeah. We really feel good about the book other than these two deals, of course. When you look at that whole book only having 3% criticized, and then half of that is the existing non-accruals that we reported on. We feel very good about the book.
Okay, great. Appreciate all the color.
You're welcome, Brett.
Our next question comes from Geoffrey Elliott with Autonomous Research. Please go ahead.
Hello. Thank you for taking the question. On capital, the CET1 came down a bit, I guess because of the strong loan growth to 8.3%. Can you give us your thinking there on where you're looking to run and how you're approaching potentially coming back and raising some equity?
In the second quarter, that's seasonally strong for warehouse. Our CET1 will generally run a little lower in Q2. That's kind of a peak at the end of Q2 for the mortgage warehouse. We will continue to build capital. Our internal generated capital, as you know, is adding pretty quickly. We have no plans to raise capital, and we're comfortable at the levels that we're at, and you'll see those continue to pick up.
Great. Then just following up on something you said earlier on the legal and professional fees. I think you said there was about $1.5 million related to some of the deposit gathering initiatives. Was the message that it's kind of $1.5 million growth each quarter sequentially from here?
Correct.
Was the message that $1.5 million is in the run rate, and it stays in the run rate?
From Q1 to Q2, there was about a little over $1 million of that increase that was related to that, and what I said was that we would expect to see another $1 million-$1.5 million in each quarter added to that. An additional $1 million-$1.5 million each quarter related to that specific item.
That is in the guidance.
Yeah, it is.
Got it. Thank you very much.
You're welcome, Geoffrey.
Next question comes from Chris Gammon with Compass Point. Please go ahead.
Thanks for taking my call.
Good morning, Chris.
Assuming you're successful at these new deposit verticals, do you have any sense of kind of the cadence of ramping up to the market opportunity that you've disclosed?
It will really vary by the sector. Some sectors, some of these verticals will have a potential of a half billion dollars over three or four years. Others could be a billion and a half, $2 billion opportunity. The timing of when those actually roll into the market matters, but also they're new businesses. That's all we've done is build new businesses here. We've never bought a bank in 20 years. We know enough to be careful about having expectation set until we actually get out into the market for six or 12 months. We're going to be a little careful about where we guide you on that, Chris.
We think the potential, if we launch 6 of these, that 5 of which didn't even get launched this year, we only launched 1 so far this year, and we're able to launch, I'm projecting, 6 of these remaining 8, or 5 of these remaining 7 rather, I think we're going to have a phenomenal booster rocket attached to our core deposit growth, which again, still offers a lot of opportunity for us. It's just better mining of deposits with our existing client base. We've done a lot of work on that too, not just focused on these new cash-rich industry verticals. We've bought some new tools for our bankers to better understand the opportunities, see the data, and I really am quite optimistic a year from now, we'll be showing some much better deposit growth, even in a tough market.
Okay. Moving over to mortgage finance. Right now is probably the most difficult gain on sale environment I've seen for your client base in the mortgage finance vertical. Is there any concerns about profitability challenges, tripping kind of profitability covenants or anything in that business?
We think we're moving up the food chain a bit. We now are able to generate a better opportunity than we were 6 or 12 months ago on the buy side. Yes, it's thin. You're ending up with a loss on sale in some cases. If you have extremely aggressive buyers in a given quarter, you may recall, last third quarter, a year ago, Wells just kind of bought the market and we just weren't going to go with those kind of prices. We really backed off on our outstandings and what we were buying. We just have to stay true to what we think the right targets are on return, but you can't realize the full return until we get some normalizing.
I'm not sure we'll ever see it normalize back the next few years to the [75 to 100] basis point gain on sale, and that was there three and a half years ago. It's just not anymore. If we can get back to consistently 25 to 50 basis point gain on sale, it would really help us lift the ROE. We're delivering an ROE we're pleased with. It's just not a top decile ROE that we had hoped for when we launched it two and a half years ago. It's still a top 50 percentile ROE, though.
My question was just related to the health of your clients in the warehouse business, if there's any concern there. I know you're generally focused on larger lenders, I am just wondering if there's any operational costs that may come in with difficulty for lender clients.
No. We're doing well. I am very thankful we moved up the food chain with our client targets because I do think the small operators are really having a hard time. To have two successive years that cumulatively will be close to 25% lower volume than two years ago, that's really tough. Even if you're a strong upper mid-size company that we bank, it's not easy, if you're on the smaller end of that food chain, it's really hard today. Again, we see our clients being able to pick up top producers from some of those weaker, smaller ones without having to buy and do M&A, and we think that'll help our clients move through this tough period.
Perfect. Thank you so much for taking my questions.
You're welcome.
Our next question comes from Brock Vandervliet with UBS. Please go ahead.
Thanks for taking my question. Good afternoon.
Hi, Brock.
Hey, Brock.
Hi, there. In terms of the energy portfolio, I know the credit that encountered problems this quarter, that was a coal methane company, I believe. Are there other credits tied to that area in the portfolio?
We have two other coal methane deals, each rather modest-sized deals, neither of which have the same engineering bust, if you will, that we encountered on this one. That's the worst, as you know, of all scenarios in an energy deal, a PDP deal, is you just miss the reserves. We had some other challenges with that credit, too, but the fact that we had one of the top firms in the country that provided us a reserve report, and our engineers looked at it, reviewed it, but we didn't catch it on our side either. Prices certainly haven't helped us or the borrower like they have on the oil side over the last couple of years. You combine all those things, and this was a different scenario than the other two we're dealing with. We think the risks are okay on the other two at this point.
Just stepping back, I'm sure you've all spent a ton of time on credit in general here in the last quarter. What would be some of your puts and takes on the process? Are you doing anything differently? Do you look at syndication differently? Any sorts of changes that you may have made to your credit process?
We really haven't. We are very disciplined on credit. We have told the market for years that because we do larger average-sized deals, not having a retail component to our business, we're fully focused on commercial, that if we have a few of our credits hit and go south in the same quarter or same half of the year, it can be tough, it can be lumpy. If you look at us, and we emphasize this as well, on an annual basis, we consistently deliver very low credit costs relative to peers. I think we'll do the same this year, although it's been a bumpy quarter. We don't have a systemic fundamental problem. Absolutely, we're looking more carefully at credit, because when you have one, it's just another wake-up call, Brock, that no matter how good you think you are, you've got to be better.
As you get deeper into this cycle, closer to the next downturn, we have to be better than we've ever been over the last nine, 10 years. Our bankers and our credit team are certainly looking more carefully at the portfolio. We've not found any systemic issues, nor are we changing at this point anything strategically about how we buy syndications and the like.
Okay, understood. Thank you.
You're welcome.
Next question comes from Matt Olney with Stephens. Please go ahead.
Hey, thanks. Good afternoon, guys.
Hello, Matt.
Just wanted to clarify the guidance around 2018 revenue growth. I'm a little surprised the revenue guidance isn't a little higher than the mid to high teens. If I just assume the 2Q revenue of $250 million continues into 3Q and 4Q, in other words, no growth the back half of the year, then the full year 2018 revenue growth would be about 17%, which is essentially where the guidance is today. I'm trying to understand the full year revenue guidance. Is there a chance the revenue could actually decrease, or is that guidance just conservative?
We always hope that we're conservative with guidance. We also are coming off of a seasonally strong mortgage warehouse quarter. Yes, we would expect revenue to continue to pick up, but you have to remember, Q4 is generally seasonally weaker for mortgage warehouse.
If we have a third quarter, like I hope and think we might, we can give you some better updates at the end of that third quarter. Even with the softening that we'll experience in the fourth quarter. At this point, we're just going to be on the conservative side. I'll grant you, that's a pretty conservative number. We want it to be more solid than just halfway through the year after that big boost we get in the second quarter.
Okay. That's helpful. Can you guys also disclose in the mortgage warehouse, what % three, five [inaudible] purchase? Thanks.
It was in the 20s, the high 20s. I think refi is in the high 20s.
Thank you.
You're welcome, Matt.
Sure. Thanks, Matt.
At this time, this will conclude our question and answer session for today. I will turn the conference back over to the President and CEO, Keith Cargill, for any closing remarks.
We appreciate your time and your interest in Texas Capital Bancshares. Good evening.
Thank you for your participation in TCBI's second quarter 2018 earnings conference call. Please direct any requests for follow-up questions to Heather Worley at heather.worley@texascapitalbank.com. At this time, you may now disconnect. Thank you for joining.