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Texas Capital Bancshares, Inc. (NASDAQ:TCBI)

Q4 2008 Earnings Call

January 28, 2009 5:00 pm ET

Executives

Myrna Vance – Head of Investor Relations

George F. Jones, Jr. – President, Chief Executive Officer, Director & President and CEO of Texas Capital Bank

Peter B. Bartholow – Chief Financial Officer & Director

Analysts

John Pancari – J. P. Morgan

Erika Penala – BAS-ML

Jennifer Demba – Suntrust Robinson Humphrey

Brad Milsaps – Sandler O’Neill & Partners, LP

Louis Feldman – Wells Capital Management

Kyle Kavanaugh – Palisade Capital

Edward Timmons – Sterne, Agee & Leach

Operator

Welcome to the Texas Capital Bancshares fourth quarter earnings release conference call. All participants will be in listen only mode. There will be an opportunity for you to ask questions at the end of today’s presentation. (Operator Instructions) Please note this conference is being recorded. Now, I’d like to turn the conference over to Myrna Vance.

Myrna Vance

For those of you I don’t know, I’m Myrna Vance, I head of Investor Relations and should you have any follow up questions please call me at 214-932-6646. Before we get in to our discussions, I’d like to read the following statement. Certain matters discussed on this call may contain forward-looking statements which are subject to risks and uncertainties. A number of factors, many of which are beyond Texas Capital Bancshares control could cause actual results to differ materially from future results expressed or implied by such forward-looking statements.

These risks and uncertainties include the risk of adverse impact from general economic conditions, competition, interest rate sensitivity and exposure to regulatory and legislative changes. These and other factors that could cause results to differ materially from those described in the forward-looking statements can be found in our annual report on Form 10K for the year ended December 31, 2007 and other filings made by Texas Capital Bancshares with the Securities & Exchange Commission.

Now, with that done let’s begin our discussion. With me on the call today are George Jones, our CEO and Peter Bartholow, our CFO. After a few prepared remarks our operator will facilitate our Q&A session. Now, at this time I’d like to turn the call over to George.

George F. Jones, Jr.

Welcome to our fourth quarter earnings call. Well, 2008 has been an incredible year particularly on a national and international scale with the US Treasury, the Federal Reserve and the FDIC playing a tremendous role in the global financial markets trying to bring stability and increase liquidity in the financial system as you all know.

Texas has not been immune to the economic downturn but it does seem to be weathering the storm better than most parts of the US. Because of the economic environment, we will not be giving specific earnings guidance for 2009 but we will take a few minutes and discuss core earning capabilities with you. I’m going to make a few opening remarks and then I’m going to ask our CFO Peter Bartholow to discuss the financials and then I’ll return to have a more detailed discussion relating to credit and some things that we see for 2009 for Texas Capital Bancshares.

As most of you remember, because of our successful equity capital raise in September of $55 million and our participation in the Treasury’s Capital Purchase program of $75 million in January we have really very strong capital ratios. If you recall Texas Capital was approved for $130 million in capital but because of our strong capital position and that recent equity raise that I discussed, the $75 million gives us an additional cushion to support what we think are a longer term strategic plan activities and to take advantage of some near term opportunities that we see in all our markets across the state.

After that capital injection in the company, our leverage ratio is 11.8%, our tier-1 to risk weighted assets is 11.5% and our tier-1 and tier-2 capital to risk weighted assets, a strong 12.5%. This gives us really an incredibly strong balance sheet to enter 2009 with. We saw another good quarter of loan growth despite the economy. On a linked quarter average basis we grew 3% and 16% on a year-over-year basis. Our business model is intact and positioned for future opportunities that we’ll discuss in a minute with plenty of dry powder to extend our growth strategy in the Texas market.

We did provide a larger than normal provision in Q4 because our fourth quarter loan growth and the increase in our non-performing assets. In today’s difficult environment, credit is absolutely the watch word and we continue to maintain a very intense focus on credit quality. Now, I’ll turn it over to Peter and we’ll talk about financials for a moment.

Peter B. Bartholow

We are going to leave a lot more time at the end so my comments will be fairly brief. On Slide Four, net income of $24.9 million for the year obviously, not consistent with our longer term objectives but in the context of what we’re dealing with in the national economy and particularly for Texas Capital, the margin compression that comes from very low interest rates, we consider this a very good result.

We see economic pressures obviously driving provisions for losses much higher. That’s a consequence of things that for the most part are out of our control but, as George said they’re being addressed aggressively at Texas Capital. We’ve had exceptional growth, loans held for investments substantially about plan reflecting a total of 20% year-over-year, the growth with loans held for sale up 22%. For the fourth quarter we saw growth reach in loans held for investment just over $4 billion providing an excellent start for 2009.

We saw DDA growth, another highlight at 14%, total deposit growth at 5.4% but even stronger in the fourth quarter. As George mentioned, we do enter 2009 with a very strong capital position. We did on a preemptive basis raise $55 million in September and have augmented that with the capital purchase program of the Treasury with $75 million both totaling the amount we applied for and were approved for at $130 million. We have, as we have commented before no intangibles. That’s taken on increased significance as the industry experiences what looks like a tidal wave of write offs reflecting poorly deployed capital with a huge and permanent cost to shareholders, something that we’ve been able to avoid.

Turning to the next Slide, we have despite the effect of provision and the net interest margin and compression from low rates, we’re seeing very good improvement in operating leverage. We saw net interest income growth of 9% after a 7% reduction in net interest margin. We see net revenue increase by 8.6% for the year and 3.5% for the fourth quarter demonstrates the ability to produce core operating growth under very difficult rate and economic conditions.

The growth of non-interest income of 9% year-over-year and 21% linked quarter reflects the strength of the mortgage warehouse activities. The reduction in the ratio of non-interest expense to earning assets of 14 basis points for the year and level for the linked quarter shows our commitment to improving this key ratio. Assuming a stable net interest margin the efficiency ratio would have been less than 59% for the year and just over 57% for the fourth quarter.

The increase of problem assets and the cost associated with increases in problem assets prevented even great improvement. As well talk about shortly, the provision nearly doubled from 2007 to $26.8 million. We saw a significant growth in income contribution from the mortgage warehouse group representing a significant growth opportunity as rates, pricing and fees were all very favorable, especially during the last half of the year and the fourth quarter.

Turning to Slide Six I’ll comment briefly that it’s obviously that industry conditions have an impact on rate levels and net interest margin for us despite that performance is good. The full year ROA of 55 basis points and ROE of 7.5% is certainly not consistent with our long term objectives but in light of net interest margin impact and credit costs not a weak result.

Turning to the next Slide Seven, we have again, exceptional growth in loan with balances of loans held for investment and loans held for sales way above plan. We gave guidance at the beginning of 2008 saying that our growth might be half of the historical rate of 25% to 26%, instead we were up 20% for loans held for investment and 22% for total loans. Loans held for investment up 2% from Q3 and 16% over the year ago quarter.

We saw a surge in growth at the end of the quarter that didn’t get reflected fully in the average balances again, starting off in an excellent position in 2009 and with the loans held for investment at year end 3.9% higher than the average for the fourth quarter represents an implied growth rate of more than 30% which we certainly don’t plan to see in 2009. Remarkable growth in DDA, 14% year-over-year and 17% compared to the year ago quarter. The growth in total deposits was only 5.4%. It’s limited by the fourth quarter effect of borrowed funds to reduce total funding costs in support of the dramatic increase in total loans.

On Slide Eight again, just shows the level of growth balance substantially ahead of plan with held for investment at period end of over $4 billion. Loans held for sale were up $150 million or 45% from Q3 reflecting again what we see as a real opportunity in the mortgage industry. Growth in total deposits I said reflects a preference for borrowings to support the very rapid growth that we saw really in the last one third, the last month of the fourth quarter. Total DDA growth at $587 million represents 11% year-over-year.

Slide Nine, net interest margin of 3.41% is only a six basis point reduction from the prior quarter but it’s 41 basis points or substantially down from the fourth quarter of ’07 and for the full year of ’07. We will benefit significantly from liability maturities in Q1 and could, we hope and we believe that Q1 will represent the low point for 2009 net interest margin. We are experiencing and we will see more spread improvement from pricing and lower funding costs as the year progresses.

The spread of LIBOR to Fed Funds reflecting 25% of total floating rate loans is somewhat lower but will be mitigated by pricing improvement and the imposition of floors in substantially all credit decisions. Funding costs, strong growth again I mentioned in DDA and equity obviously benefited total funding costs, just not nearly as much in a low rate environment. In terms of net interest margin, at very low interest rates DDA and equity just don’t provide the impact on net interest margin that we saw at more typical levels of 3.5% and 4.5% from the Fed Funds rate.

We are in a position where funding costs simply cannot fall as quickly as the rates on earning assets. By earning asset and funding composition Texas Capital is less sensitive but when rates are very low the costs of certain funding components simply cannot fall far enough or fast enough to offset the decrease in earning asset raise. Prolonged period of low interest rates are obviously negative but we are working through pricing and other decisions to improve that condition.

Slide Nine is really clearly strong growth in terms of core earnings power. With the [cager] of net revenue higher than growth in expense by 400 basis points. The [cager] of net interest income higher by 500 basis points. I’m not going to have no real comment on deposit and loan growth since they are obvious in our business model. I’ll turn it back to George.

George F. Jones, Jr.

Take a look at Slide 12 and 13 if you will. I will call your attention to the top of Slide 12, that date should be December 31, 2008 instead of September and we’ll send a clean copy out to you. But, Slide 12 reviews loan portfolio statistics. The pie chart on your left describes our loan portfolio by collateral type and the right side of the page outlines our non-performing assets.

Non-accrual loans totaled $47 million as you can see with real estate loans comprising $29 million or approximately 62%. Other real estate of $26 million brings our total NPAs to $73 million or 1.81% of loans and ORE. Real estate loans and ORE comprise roughly 75% of all our non-performing assets. ORE, other real estate has grown from $6 million to $26 million basically with the addition of three properties. If you remember, all of these three properties have been identified as problems in the previous quarters but actually we foreclosed on them in Q4.

I’ll refresh your memory, there are three. There is $7.7 million in single family completed homes and lots in Houston. We discussed that in Q3. We foreclosed and charged down $1 million in Q4. We sold approximately $850,000 of those homes and lots from that portfolio in Q4 with very little additional write down. The second property is $7.5 million shopping center tract in Austin, Texas previously identified. We did charge that down $2 million in Q4 to the new appraised value.

There’s a $5 million townhouse development we also have discussed previously and that’s carried in ORE at appraised value with no write down needed at this time. We were also successful in disposing of about $4 million of ORE in Q4. With $24 million moving from the non-performing loans to other real estate, Q4 saw an increase in non-performing loans of approximately $28 million. $17 million of that related to real estate loans and $11 million are C&I loans, all we believe to be properly reserved at this time.

Charge offs of $5.2 million in Q4 were basically real estate related also. There were three significant pieces that made up the $5.2: one, was $1 million charge off for those homes foreclosed in Houston that I just mentioned; $2 million for the shopping center tract in Austin; and $1 million charged down on old mortgage warehouse loans generated back in 2007 before underwriting had changed. Remember, we moved some of those in to the held for investment portfolio and had them properly reserved but, we took the charge down in Q4.

Total charge offs year to date were $12.7 million representing 35 basis points for the year. Important to note though that these losses related again to identified problems which were substantially covered with allocated reserves in prior quarters. The increase in non-performing loans in Q4 was not unexpected due to the changing economic conditions. But, we continue, as I’ve mentioned before to increase our focus on resolving these issues.

Our non-performing loans were 1.28% of our loans held for investment. Our loan loss reserve balance increased after very strong growth in the last half of Q4 to 1.16% at year end and it was 1.21% of average outstanding loans held for investment in Q4. As Peter mentioned, we provided $11 million in provision and that was driven as we said before, by our methodology not necessarily by our expectation of loss. We covered our annual loss by over two times with this annual provision.

If you’ll turn now to Slide 14, this graphs our net charge offs to average loans. Our NPAs are up as you would expect in this environment but certainly in our opinion, very manageable and properly reserved. In closing, I’d like to again mention our good loan growth despite the current economic conditions and to reinforce the message that our company has an intense focus on maintaining credit quality.

We believe that $130 million of new capital positions us well to take advantage of the opportunities related to people and customers in all our Texas markets. For most US banks the declining economy and increases in NPAs and loan losses create a high degree of uncertainty for projected earnings in 2009. As the Texas economy continues to suffer with the rest of the country, even if it’s been less severe than most other regions, Texas Capital is not totally immune.

However, excluding the impact of potential loan losses, our base revenue generation appears excellent and intact. We exited, as Peter mentioned, 2008 with strong loan growth, with our earning asset base in 2009 about 14% higher than average for 2008 even if there’s no loan growth in 2009 although we do expect modest loan growth of up to 10% this year. Peter also mentioned that spreads should improve and that’s true. We put various initiatives in place like higher rates and loan rate floors on most of our credits on a go forward basis.

As a result of the aggressive actions of the Fed to improve liquidity in the banking system, our cost of funds will come down and as we’ve already discussed while the amount of loan losses and deterioration in loan quality remains difficult to determine for 2009 our strong credit process will make the levels of non-performing assets manageable.

That is all of our prepared remarks today. We will take a moment and take questions.

Operator

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from John Pancari – J. P. Morgan.

John Pancari – J. P. Morgan

Can you talk a little bit about the inflows in to non-performing loans? I know you mentioned I think $28 million there that $17 million was real estate and $11 million was C&I. Can you give us a little more granularity on that like what types of real estate credits and the same thing on the C&I.

George F. Jones, Jr.

It’s primarily in the market risk real estate side John. It relates to commercial real estate. The C&I portfolio is really pretty much broad based. There’s no one particularly industry or no one particular region, just a general weakening in a few commercial credits that you would expect to see in this environment. As I mentioned before 75% of our existing non-performers are real estate related and we still see that kind of ratio and moving in to the NPA category we still think it will be more heavily weighted to the real estate side, the commercial side.

We have lowered our exposure to the residential real estate market, that’s moved down somewhat in the last quarter in terms of outstanding credit and we haven’t seen a lot of movement from the residential real estate side in to the NPAs, it’s been more of the commercial tracts, possibly small office category or something like that.

John Pancari – J. P. Morgan

Can you talk about your provisioning around your oil and gas exposure? Have you upped your loss provisioning around that at all? Can you just comment in general on your expectations?

George F. Jones, Jr.

No, we have not because we have not needed to. In the last 30 days we’ve done two extensive energy loan reviews and we came away very, very pleased with what we saw. The portfolio is holding up extremely well. Why is that? Really, our long term projections for oil never really exceed $60 a barrel and gas at that $6.50 range at the highest point. We’re not booking transactions at those very high prices.

100% of the credits that showed any sensitivity to prices, oil particularly at $50 or below we’re required to hedge. Any properties with short economic lives or high concentrations we’re also required to hedge. The 2010 futures today, the average price is higher than our recommend base case. Any client today really can enter a hedge that will lock in prices in excess of those pricing assumptions today.

When we see indications of stress in the borrowing base in energy for our clients, there are a number of things that we can do and that we have done. We can either reduce the borrowing base by removing line availability, we can have the client pledge additional properties if they have them. If there’s a gap we’ll have them amortize it over a few short months or have the clients hedge the product in the future. Most of the client that we’ve talked to on this basis have chosen one or more of those options.

It really depends today on how you underwrote the credit six months, a year, two years ago and if you were relatively conservative and understood that $140 oil is not going to always be the norm, you’re in pretty good shape. As we’ve mentioned before we focused, as you know, on production loans and we’ve avoided basically all service business. We’re not in to the iron financing, rig financing, equipment financing, it’s basically financing the commodity coming out of the ground, the cash flow.

So, we’re very pleased with our portfolio and think it’s looking very good. That’s a long answer to a short question but, it’s an important one today.

John Pancari – J. P. Morgan

Then I just have one more follow up there, on the deposit side you saw the out flow there on the foreign deposits, if you could just give me a little color there? Then lastly, what your strategy is to grow deposits particularly given where your loan deposit ratio is?

Peter B. Bartholow

John we have seen going back from early first quarter of last year one large customer redeploy assets out of the [Cayman’s] branch Euro dollar deposits. Since then it’s not been the most attractive source. Pricing driven by global demand for liquidity has made that price not as effective as borrowing costs. When we see the kind of growth that we’ve had, you can’t ramp up deposits to meet that growth. The alternative, which is driven by costs and short term availability is going to be the borrowing base or the borrowed funds category.

So, that’s been an emphasis and certain deposit categories we’ve seen run down because of the global demand for liquidity and pricing.

Operator

Your next question comes from Erika Penala – BAS-ML.

Erika Penala – BAS-ML

Can I follow up to one of John’s question, the $17 million in real estate NPLs, is that construction or term commercial real estate?

George F. Jones, Jr.

Erika that’s basically term real estate, a little bit of construction development but more of the completed real estate projects and some land in there.

Erika Penala – BAS-ML

And of the income producing component of that $17 million, what is the underlying real estate type? Is it retail, is it office?

George F. Jones, Jr.

It’s retail, lot development type property.

Erika Penala – BAS-ML

Are these located primarily in the Dallas MSA?

George F. Jones, Jr.

As we’ve mentioned before, 90% plus of all real estate we finance is in the state of Texas but most of it would be in the Dallas, Fort Worth, Houston area. A few in our other two locations in Austin, I mentioned the shopping center tract in Austin but most of it is in the larger cities.

Erika Penala – BAS-ML

My last question is on expenses, given the uncertainty in term of earnings power because of credit for all banks in ’09, is there room to rationalize expenses in order to protect some of that earnings power?

Peter B. Bartholow

Yes but, there are no categories Erika that lend themselves to sharp reductions. The relationship manager base on the lending side is 75 or 80 people. We have another 25 or 30 relationship managers that are on treasury management, fee producing areas so they are relatively small work forces in a population of a total of only 500 people. We don’t have branches that we can close effectively and we don’t do any advertising to speak of. We do placements in some publications but in terms of significant media type advertising we simply don’t do it.

We are obviously watching very carefully compensation increases. We have an incentive plan that’s driven by pre-tax income so that to the extent we can’t maintain an appropriate level will come down and it has in the past come down quite sharply. So, that would be the principle variable.

Operator

Your next question comes from Jennifer Demba – Suntrust Robinson Humphrey.

Jennifer Demba – Suntrust Robinson Humphrey

Two questions, to kind of follow up on Erika, you did have a reduction in personnel costs in the fourth quarter sequentially. Was that incentive reversals?

Peter B. Bartholow

It’s a little bit of everything but incentive reversals were a portion of that.

Jennifer Demba – Suntrust Robinson Humphrey

A question on your residential builder portfolio, you said you reduced that. How big is that now and how much of it is criticized or on non-accrual status?

George F. Jones, Jr.

It’s down from what we’ve told you in the past. We showed it at over 7%, almost 7.5%. That includes lot development and single family construction and that’s down close to 1%. It’s about $146 million.

Jennifer Demba – Suntrust Robinson Humphrey

And how much of it is on non-accrual and problem credit right now?

George F. Jones, Jr.

Let’s see, I’d have to figure that for you but it is not a large, large amount. We have one lot development that we mentioned before, we got the shopping center lot that I just mentioned to you, we’ve got those homes in Houston and there’s not a lot more of it. I don’t have that specific percentage for you right now but we can get it.

Operator

Your next question comes from Brad Milsaps – Sandler O’Neill & Partners, LP.

Brad Milsaps – Sandler O’Neill & Partners, LP

The mortgage warehouse, the loans held for sale moved up quite a bit. I’m just curious what your appetite is there going forward? I know there are some great opportunities out there and what kind of affect that can have as those balances move higher on earnings in 2009?

George F. Jones, Jr.

Brad, we think it’s actually one of those opportunities that we mentioned earlier to take advantage of. We think we have a good program. We’ve got years and years of management experience in that business. We do it a little bit differently and I believe a little bit more cautiously than some but we’ve seen that grow, you’re right, fairly dramatically about half of our loan growth in Q4 was the warehouse.

What were some of those reason? The refi activity is beginning to pick up with rates coming down. Seasonability, large increase in FHA loan closings due to rule changes and really finally and one of the largest and most important reasons is the lack of funding capability by many of our competitors. We frankly had the opportunity not only to grow but to grow with quality. I would tell you today that our customer base in the mortgage warehouse group today is not only larger but stronger than it’s ever been.

Our ability to pick and chose the right customer is really important to us. The other important thing is that we’re able to increase the pricing, we’re able to increase fees and these loans turn today in about eight to nine days. Another thing that we’re doing that a lot of other warehouse lenders aren’t doing is we’re asking for and getting deposits. Our relationships with these customers basically we tell them the need to bring their deposits with them also.

So, we have grown deposits in that line of business significantly in the fourth quarter. We’re very pleased with that. We manage by concentrations, we’re not going to get to a level where it is larger than we’d like to have it but at this point in time it really can be one of our more profitable lines of business.

Brad Milsaps – Sandler O’Neill & Partners, LP

So if it grows from here you guys are comfortable with that?

George F. Jones, Jr.

We’ve got a little more room to grow, yes.

Brad Milsaps – Sandler O’Neill & Partners, LP

Any update, I know you had a little bit of a fraud last quarter that cost you, any update there or is that still kind of pending?

George F. Jones, Jr.

We have taken what we believe is our exposure on that fraud. I believe we did that in Q3.

Peter B. Bartholow

Nothing new.

George F. Jones, Jr.

No, nothing new.

Brad Milsaps – Sandler O’Neill & Partners, LP

Then just two more questions, you mentioned last quarter on that Dallas condo you thought that you had maybe a couple of interested buyers obviously that didn’t transpire. Any other interest in that project? Then I was just going to see if you could give us the 30 to 89 day past due numbers?

George F. Jones, Jr.

We do not have a signed buyer for that project today. We do have some interest that is still there but we haven’t gotten a signed transaction yet. They put that in to bankruptcy and has delayed the process until we were able to foreclose it. Your other question on the 90 day past dues, we’re about $4.1 million and remember in that 90 day past due category is our premium finance numbers and that’s about $2 million which are no problems at all. That typically historically runs about $2 million every quarter and we have very little or any loss anticipated in that particular category.

Brad Milsaps – Sandler O’Neill & Partners, LP

The 30 to 89 day or however you guys classify that?

George F. Jones, Jr.

Well, we do a 60 to 89 category and that’s $12 million well distributed across the C&I portfolio and the market risk real estate loans also. The 30 to 59 day bucket we have is $22 million.

Operator

Your next question comes from Louis Feldman – Wells Capital Management.

Louis Feldman – Wells Capital Management

Two questions for you, one in terms of the floors that you’re putting in place, how solid do you feel those are? How willing are you to trade the floor for a business relationship?

George F. Jones, Jr.

Every floor that you put on a credit is negotiated so there is no hard and fast rule for exactly what that floor will be and you absolutely do have to take in relationship, deposit balances, fee income, a number of things when you set that floor. We use a profitability model that is return on equity driven and when you put all of the profitability factors in that model and it spits out a number, we price to that number to get to a certain number. So, it’s not a hard and fast number, it’s a negotiated number based on profitability model.

Louis Feldman – Wells Capital Management

So there are more than likely to respect it and now whine and say, “I’m going to take my business down the block.”

George F. Jones, Jr.

I think that’s a fair statement. You’re not going to make everyone exceedingly happy but I think we have a good story.

Louis Feldman – Wells Capital Management

Second off, in terms of your ORE, how recent are the appraisals on that in terms of say the retail center in Austin.

George F. Jones, Jr.

Very recent. The retail site in Austin, the ink is probably not dry on it yet. That’s one reason why we wrote down the amount we did, we had a new appraisal come in. Actually, we had two appraisals done on the property just to be as sure as we could what we felt the value was at this point in time. The appraisals are fresh.

Operator

Your next question comes from Kyle Kavanaugh – Palisade Capital.

Kyle Kavanaugh – Palisade Capital

I just was wondering if you could clarify a little bit your statement about the provision was driven by the methodology rather than expectations? However, you know the methodology is there and in place for a certain reason, I would imagine to capture further weaknesses that are starting to become evident within the portfolio so how come that’s not as translatable in to expectations per say?

Peter B. Bartholow

Of actual loss you mean?

Kyle Kavanaugh – Palisade Capital

Of future losses and just in general.

Peter B. Bartholow

Our history tells us that the actual loss experience on the portfolio is substantially less than the amount that has been reserved.

George F. Jones, Jr.

Part of the methodology, part of the model that we built takes in to consideration loss history from our company and from peer bank companies also in addition to a number of other factors like economic conditions and other issues to build a model. Typically, our methodology drives provision certainly well ahead of losses. As I mentioned in my comments, the methodology is not necessarily an expectation of loss but it is to support the company in terms of preserved and evident weakness in certain credits.

If you look again at our charge off history and the way we’ve underwritten credit typically our provisioning is much more than we’ve experienced in losses.

Kyle Kavanaugh – Palisade Capital

So internally as you do your modeling when you’re going out further is your provisioning, can you come up with – not to give it like an [inaudible] but if you could give me just the general trends? Is your provisioning showing a gradual increase going forward, is it lumpy like the actual experience in the past year and a half?

Because, as I look at the trends, it’s been difficult for me to see any trend in the past year and a half. Last year you were at an outsized provision, it increased in the first three quarters of this year and then in the fourth quarter of this year it’s a very high provision again which I don’t think is fully expected. So, I’m just trying to get a sense of internally how does it –

George F. Jones, Jr.

As we’ve said in the past to you is our model, our commercial banking model is going to be lumpy in terms of provisioning. We’re not a retail bank, we do not have retail exposure so it’s very hard to get an even smooth trend and graph it as it relates to consumer losses, car loans, whatever relates to a more retail bank. I think if you look at other commercial banks, typically that can be the case also.

It will be lumpy, it will not be a smooth trend. Obviously, the annual expense is very important and we believe on a long term basis we’ll outperform our peer group. 35 basis points of losses in 2008 while more than certainly than we would like, in the economic environment in which we’re operating is not a high number.

Peter B. Bartholow

I might add, basically we’ve completed the 10 year anniversary in December and since inception, the charge offs are just over $23 million. There’s a lot of movement in and out of classifications or non-performings but the asset test is what has actually been charged off over a 10 year period.

Kyle Kavanaugh – Palisade Capital

Then just one other question related to that, your loan growth has been substantially above average versus the industry not only in these more difficult times but even when times were a little bit better than the other banks. Does that also come in to play with the more lumpy provisioning? Does the rapid loan growth affect the credit quality in any way?

George F. Jones, Jr.

We don’t believe so. We’ve had strong loan growth since inception of the company, from years. If you look at when we started the company in 1998/99, we’ve had for the last five years our loan growth has been 25% plus percent over the last five years and we’ve had extremely good loan loss history. Again, I think it is a function of the market in which we live today, the economic environment.

Fortunately, we live in Texas. We’re in a much better spot than most of the rest of the company to be in the business that we’re in today so we’re blessed to be in Texas and we’re blessed that 90% plus of our business is in the state of Texas.

Peter B. Bartholow

It is true that growth drives provision because every new loan gets based on its loan grade an allocation of today’s reserve. So, $400 million of growth in the fourth quarter certainly was a meaningful component of the $11 million provision.

Kyle Kavanaugh – Palisade Capital

I guess also just one last question, understandably your charge offs are very low at 35 basis points and they come off of even lower levels of below 10 basis points a year ago. The trend is upwards and I guess kind of the question, you being a newer bank, how far can that trend go is kind of the question that I think about a lot as I look at your company.

George F. Jones, Jr.

Well, that’s right and there’s some – we’ve got to look at the market, we’ve got to see how the market heals itself over a period of time. I will tell you though that we are pleased that we don’t have a lot of the instruments and credit that have costs banks so much money over the last 12 to 18 months. Our investment portfolio has no problem, there is no impairment, there is nothing there. In fact, there’s a slight gain in the portfolio in the fourth quarter.

No derivative exposure. We’re pleased to have no consumer credit exposure. We think that could be some issues that banks are going to have to deal with next, everything from credit cards to consumer business, we have none of that. We do live with lumpiness of being a commercial bank and with commercial business. But again, I will tell you that it is our expectation that we will perform as well or better than our peer group.

Operator

Your next question comes from Erika Penala – BAS-ML.

Erika Penala – BAS-ML

I know that you gave some color on this during your prepared remarks but can you give us a little bit more detail on how you’re seeing margin trends play out for the remainder of the year? I know you said that the first quarter would represent a trough and it should improve from there?

Peter B. Bartholow

That’s correct. Just the rapid decrease that occurred in the fourth quarter getting to essentially zero on December the 10th or whatever date that was, that’s about a hostile condition as we could have with our balance sheet. Then we’ve had, in the fourth quarter we saw on an average basis the spread between LIBOR and Fed Funds remained fairly strong and that’s down today. It’s adequate given the way we price portfolios, the way we fund ourselves but it is down from what it was in the fourth quarter.

So, as that stabilizes, as deposit mature and we replace with lower costs instruments we are going to see improvement over the course of the remainder of the year. Once we get to the point where rates actually with increase we’ll get a substantial benefit.

Erika Penala – BAS-ML

Just to clarify from I think you answered one of the analysts questions, your bias is towards not replacing the maturing deposits because the rates are so competitive it’s just much cheaper to fund loan growth with borrowings at this point?

Peter B. Bartholow

No, that’s in a short term sense. Today, the deposit costs are substantially lower than they were average for the fourth quarter.

Operator

Your next question comes from Edward Timmons – Sterne, Agee & Leach.

Edward Timmons – Sterne, Agee & Leach

Just a couple quick housekeeping items, the FDIC premium going up, what’s the difference in ’09 versus ’08?

Peter B. Bartholow

It’s currently about $100,000 and it’s going up by almost $200,000 a month.

George F. Jones, Jr.

It’s expensive.

Edward Timmons – Sterne, Agee & Leach

Now, on the TARP, the $75 million what is the amount of the warrant discount there?

Peter B. Bartholow

We’re working on that really as we speak. It’s going to be approximately 1.5% or a little less per year for the five years so all in just under 6.5%.

Edward Timmons – Sterne, Agee & Leach

6.5% or 7.5?

Peter B. Bartholow

6.5% in that vicinity.

Edward Timmons – Sterne, Agee & Leach

Then the $22 million that’s currently in construction non-performing, do you have a split between residential and commercial there? Then, can you give us an idea of kind of what type of projects, where they are located?

George F. Jones, Jr.

I can’t give you that specific right now, let us get back to you there. We have a lot of that information but let us get back to you.

Edward Timmons – Sterne, Agee & Leach

Then lastly, can you maybe just touch on the competition, especially in Dallas with some of your competitors recently going away, how hast that improved and where do you see that going through 2009?

George F. Jones, Jr.

Ed, that’s part of our discussion when we talk about opportunity and one of the reasons we wanted to be sure we had plenty of capital in place to take advantage of what we perceive to be good move opportunities out there. We think that while a lot of our competitors are turning inward, looking at issues, dealing with the things that we’ve been talking about, there’s great opportunity to hire great new people and great new people can bring great new relationships.

That’s what we’ve done since we opened our doors in December of 1998. It’s no different but there’s a tremendous opportunity now in the next 12 to 18 months, we believe in all our markets. Not just in Dallas, not just in Houston but in all our markets. The market pricing on loans is improving, floors are common, our spreads are going to be better and we want the capital and the funding to be able to take advantage of that and we think particularly in the Dallas and Houston areas we’re going to see great new opportunities like that.

While it is somewhat competitive with a few banks, the landscape has really changed and the banks like ours with plenty of dry powder and the right people to attack the market place I think will do very well and quite frankly out of chaos comes opportunity and we plan to take advantage of that opportunity.

Operator

We show no further question at this time. I would like to turn the conference back over to Ms. Vance for any closing remarks.

Myrna Vance

Actually, I’ll turn it over to our CEO George.

George F. Jones, Jr.

Thank you everyone for calling in. They were very good questions. This is a challenging time in the marketplace but as I mentioned before I think it is a very opportunistic time also. We think the future for Texas Capital Bancshares is great and we are going to continue to work hard for our shareholders. So, thank you for your interest and we hope to see you soon.

Operator

The conference is now concluded. We thank you for attending today’s presentation. You may now disconnect.

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Source: Texas Capital Bancshares, Inc. Q4 2008 Earnings Call Transcript
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