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Texas Capital Bancshares, Inc. (NASDAQ:TCBI)

February 12, 2013 4:00 pm ET

Executives

George F. Jones - Chief Executive Officer, President, Director and Chief Executive Officer of Texas Capital Bank

Peter B. Bartholow - Chief Financial Officer, Secretary, Director and Chief Financial Officer of Texas Capital Bank

Analysts

Matthew Clark - Crédit Suisse AG, Research Division

Matthew Clark - Crédit Suisse AG, Research Division

Okay. Next up, we have Texas Capital BancShares. I'm sure most of you know the story here, but a relatively young franchise, still very much in growth mode. Founded in 1998, with about $80 million in private equity. In 2003, the company went public at about $11 a share. After, they approached about $2 billion in assets and raised another $45 million of capital along the way.

The original strategy is still in place today, seasoned commercial lenders targeting middle-market private companies, using a customized delivery in a low-cost, small-branch network. Niche -- they also have some niche business offerings, along the lines of the mortgage warehouse, the premium finance business and some SNC lending, that's complemented their more traditional commercial segment, to post a 15% to 20% asset growth and 13% to 18% ROEs more recently.

Very happy to have here, CEO, George Jones; CFO, Peter Bartholow; and EVP-Controller, Julie Anderson. Let me turn it over to George.

George F. Jones

Thank you, Matt. A young franchise, but old management. That's the way they -- the way we should put it here. Greetings, everyone, glad you're here, all 2 of you or 3 of you. No, I'm just kidding. For those of you that don't know Texas Capital, I'll just go over some of the basics and then we'll get into some of the specific numbers.

Texas Capital is a business bank. We're operating principally in the 5 largest MSAs in Texas. And all 5 markets are in the top 10% among all MSAs, in terms of creating, sustaining job and economic growth in 2011. Our borrowers, our customers need borrowings of $2 million to $15 million, middle-market businesses, high net-worth entrepreneurs. And we're a growth story, organic growth. We've never made a bank acquisition. We might be the only bank to be able to say that, I think. We grow loan and deposit base by hiring great, experienced relationship managers from our competition. And they have us bring their established relationships with them.

Our growth opportunities, they reside in the 5 Texas markets. We plan to stay there. We don't have plans to go outside of those 5 markets. And we have an incredibly strong credit culture, low net charge-offs since inception and better asset quality than most of our peers.

I'll talk for a minute about net income and EPS. Great growth in 2012. We achieved record earnings. We had reduction in credit costs and improvement in our nonperforming assets, with strong growth in loan sale for investment and deposits in 2012 with great growth in DDA. Our loans held for sale, which are mortgage warehouse, as Matt mentioned earlier, these levels remained high in 2012. We did take advantage of market demand.

Again, mentioned, we had 2012 exceptional growth in net income. It increased 59% over 2011; ROA, 1.37%; ROE, 17%; 16% in Q4 after the effects of a small equity offering we had in July. If you look at the growth in net revenue, it grew 17% in Q4 and 6% from Q3 2012.

We did have an unusual $4 million charge in the fourth quarter, for settling an Oklahoma lawsuit that we've been embroiled in for the last 2 years, and that $4 million is well within the coverage of our fraud insurance policy. So we expect to vigorously go after that $4 million net number from our insurance company.

Again, strong growth in loans. Our NIM reduction, due to growth and the impact of our debt offering that we'll talk about in just a moment, that was 7 basis points. We had reduced credit costs, with a reduction in our NPAs to 1.06% from 1.58% and an exceptionally low charge-off level of 10 basis points.

Capital, I mentioned earlier, we had a successful addition of almost $200 million in the regulatory capital, $87 million from an equity offering, I mentioned, in July, $111 million at 6.5% 30-year subordinated debt. We believe that capital will hold us for a significant period of time.

Again, loan growth is good. Average has increased 6% from Q3 2012. Quarter end balance, 10% above our 2012 average in total. Our loans held for sale, we were up 9% from Q3 and 27% from Q4 of 2011.

If you look at our funding profile for a moment, our funding is still strong and we had excellent DDA and total deposit growth. Average DDAs increased 17% from Q3 and 42% from Q4 2011.

Our loans held for sale, match-funded with borrowings and deposits, producing great spreads, highly liquid short-duration earning assets. As a matter of information, we received a new [ph] funding source from the Federal Home Loan Bank of -- Home Loan Bank in Dallas, for our loans held for sale portfolio. They'll loan, up to 75% of face value. This gave us over $1 billion of additional funding, certainly for this portfolio.

Credit costs, $5.5 million, Q4. Provision of $4.5 million compared to $3 million in Q3. And again, it was primarily related to growth, not credit problems. We had a favorable trend in NPA ratios, and we expect credit costs to continue to go down.

I promise I won't read numbers to you, but I'll point out a couple of things. If we look at the income statement, on a quarterly basis, the net revenue line, obviously Q4 2011, at $97 million progressed to $114 million, fourth quarter of 2012. Our diluted EPS, $0.67 to $0.76. That $0.76 was after the settlement of the lawsuit. On an operating basis, that number is $0.82, and our efficiency ratio at a little over 48%.

The income statement, on an annual basis, reflects really much of the same thing, $174 million to $420 million in net revenue with EPS at $3.01. Again, $3.07 on an operating basis. Our NIM held in there pretty good at 4.41%. ROA, ROE, very nice numbers, and our efficiency was a little bit below 50%.

Our quarter-to-date average balances, yields and rates. Again, I'll point you to the loans held for sale and the loans held for investment. A highly asset-sensitive balance sheet, our loan yields, again, held up exceedingly well. Loan yields declined just 2 basis points in the loans held for investment, and we put on $360 million worth of growth. The loans held for sale, the yield was down 4 basis points, again with good growth. We did have good growth in DDA and total deposits, and we improved our ability to use borrowed funds, as mentioned before, for our loans held for sale portfolio, again, reducing the funding costs, which protects our net interest margin.

On our quarter-to-date averages. Again, loans held for investment were above industry averages. We were ahead of expectations. Growth was 6% linked quarter, and 22%, year-over-year. If you look at DDA and total deposit growth, again exceptionally strong, 17% linked quarter, 42% year-over-year.

Our year-to-date averages. Again, on the balance sheet, year-to-date averages, really, growth has been excellent. Our securities, you'll notice, continue to decline and are replaced with loans held for sale, creating much less asset-repricing risk. We actually look at our mortgage warehouse portfolio as a replacement for our securities portfolio. We think it has much more liquidity, less risk, both from a credit standpoint and from a repricing standpoint. And that's what we're going to continue to use in terms of liquidity.

Period end, again, they track the quarterly and the year-over-year averages on the previous page. Revenue and income growth. Our CAGR in net revenue and net income, again, especially high, 22% and 31%. Our 5-year EPS CAGR, 21%. Deposit and loan growth, EPS growth that we showed you on the previous slide, driven obviously by growth in loans and deposits. And you can see the significant growth there over a 6-year period of time.

I'll turn for a moment to credit quality. Loan portfolio statistics, the pie chart on the left is our loan collateral by type at the end of the year. One thing you'll notice, if you've seen this chart before, the loans held for sale were at 32%, which is probably about as high as they have been. And that's -- but that's month end. They averaged about 28%, and our goal is to keep it between 25% and 30% average of our earning assets. This number gives us the flexibility and the liquidity that we need on a go-forward basis.

The list on the right shows you our nonaccrual portfolio. Our nonaccrual loans, again, down as I mentioned before, $56 million in loans, and again, $16 million in ORE. That number is down fairly dramatically in the second half of the year, from about $30 million to about $15 million. So we've had good results and our nonaccrual ratio is 1.06.

Improved credit trends. Total credit costs of $5.5 million for Q4 compared to $3 million in Q3, and $7 million in Q4 2011. Charge-offs, as I mentioned before, 10 basis points, $3.5 million, 21 basis points in Q4 compared to 25 basis points in Q4 2011. NPAs, down again 1.06, 1.16, and 1.58 in Q4 2011.

This chart simply charts our net charge-offs to average loans. And you'll see that 2010 was the worst year we had, but still would compare favorably on our peer scale, and we've come down to 2012 at 10 basis points. And if you look at our coverage ratios, they all look pretty good.

Let me make 4 quick closing comments to leave you with. One, as you can see, we've had strong core earnings and growth that will continue in 2013. Our credit costs, again, are expected to be slightly lower than we saw them in 2012. We've got a great pipeline in loans held for investment, and these new commitments present a very strong opportunity for growth. Our loan held for sale balances should stay high and can grow modestly with increased market share and our participation program that we discussed earlier today.

With that, that is the end of our -- my prepared remarks, and Matt, do we take a few questions or...

Question-and-Answer Session

Matthew Clark - Crédit Suisse AG, Research Division

Yes, I think we have some polling questions maybe, we'll start with first, if that's all right?

George F. Jones

Sure. And I've got my army up here to help me.

Matthew Clark - Crédit Suisse AG, Research Division

Here we go. Okay. How do you -- the question for the audience here and you guys all have your clickers there. How do you view management's 2013 guidance that calls for loans held for investment growth of mid double-digit to high teens and flat to modest growth in the mortgage warehouse, which is the loans held for sale? Would you view that as being conservative, realistic, in line with expectations, aggressive or unsure. Obviously, for those that may not know the story, it's new to you but...

George F. Jones

That's number 5.

[Voting]

Matthew Clark - Crédit Suisse AG, Research Division

Okay, fairly in line. Next question. What P/E multiple would you assign to Texas Capital's mortgage warehouse business? A bank multiple? I would actually say maybe even 12x to 15x for you guys. 10x to 12x, 8x to 10x, 6x to 8x, or other?

[Voting]

Kind of what I expected. 8x to 10x seems to be common. Trades [ph] with 6x to 8x, those are a little bit more conservative. Okay. Next question, what is the main reason why you would or already own TCBI shares. Is it for the above-average growth prospects, the highly profitable and potentially sustainable mortgage warehouse, scarcity of value in Texas, valuation or other?

[Voting]

Matthew Clark - Crédit Suisse AG, Research Division

Everybody looking for that TO [ph], too. Okay. And what is most often misunderstood about TCBI? Is it the sustainability of growth, the source of growth, the margin outlook, valuation or other?

[Voting]

Matthew Clark - Crédit Suisse AG, Research Division

Okay. All growth oriented. Good stuff. I think that's it for the polling.

George F. Jones

That is interesting.

Matthew Clark - Crédit Suisse AG, Research Division

Okay. So we'll go to Q&A. For those that have any questions, feel free to raise your hand, we'll get a mic to you. Maybe I can start off. I think coming out of the quarter, one of the questions that at least I had, and I think many probably were thinking about, was the guidance around the mortgage warehouse as being kind of flat to maybe modestly higher this year. A couple of competitors, large competitors, have backed away from the mortgage warehouse business, and maybe dipping a toe back into it. Just curious as to -- knowing that you want to keep that portfolio coming in that 25% to 30% range, knowing that the held for investment portfolio is going to be growing a hell of a lot faster, just curious as to why you think you can't do a little bit better than just modest -- flat to modest growth there?

George F. Jones

Peter, why don't you take that one?

Peter B. Bartholow

I think it reflects, first of all, just the uncertainty of what's happening in that business. For us, we feel very confident with how we're managing the business, using the participation program to act as a buffer when we get the spikes, and is providing a buffer when the industry finally begins to tail off. Do we know what it will be like? Obviously, not. But given where we ended the fourth quarter, an average balance, including participation sold, of about $3 billion compared to the $2.3 billion average outstanding in 2012, it gives us a little comfort and cushion against what the mortgage industry says, originations can be down as much as 25%. We know we're not nearly as exposed in a volatility sense to the origination business, but we also can't know what's going to happen with mortgage rates and the impact of reductions and refinancings.

Matthew Clark - Crédit Suisse AG, Research Division

Okay. Also knowing that you don't have much in the way of -- you're operating at kind of near-optimal efficiency, your credit costs are benign. Obviously, growth in margin is what's most important for you guys. Maybe, can you talk through a little on the margin front, the resilience that you've had on loan yields, why that is, what your outlook is there? Because I think on the funding side, you've also kind of run your course, at least from a deposit and [indiscernible]...

Peter B. Bartholow

Funding costs is about as low as they can get. The only improvement we could see is, in the relative sense, the growth in demand deposits is going to provide us a great source -- or resource, when we finally see rates rise. But on the growth side...

George F. Jones

Yes, the margin has held in there pretty well. As you can tell, we've had slight reductions. One of the reasons, there's a couple of reasons, but one of the reasons is we have floors on all our mortgage warehouse lines. So we're able to collect a little bit more on the spread income than we typically would because of using the coupon rate as the rate today. Secondly, we have floors on about 60% of our loans held for investment floating rate portfolio, too, which has helped us, again. Even though they've come down and been renegotiated down with the competition, we've still been able to hold those floors in place and we work hard at that. And the ones that we can't hold in place, for competitive reasons, we improve -- we try hard to improve the spread of the margin. So if the loan was prime plus 2%, with a floor of 5, if we have to give that floor up or reduce it materially, we try to take that LIBOR plus 2% to LIBOR plus 2.5%, pick up an additional few basis points. It's helped us keep the yields up.

Unknown Analyst

I was just wondering where you see your optimism in Texas, as sort of, do you see it -- a lot of new business is coming into the state. I mean, we're seeing it where we are, but as far as are you seeing -- I mean, what types of businesses are you expecting coming into Dallas and so forth?

George F. Jones

The Texas economy is slowly improving, probably faster than the rest of the country for various reasons, but it's still not robust. The various industries we see -- well, first of all, our growth comes from 2 sources: one, market takeaway, which is -- really during the downturn, had been a lot heavier than originating or organic growth. And it still is more than 50-50 in terms of hiring the teams and bringing the business with us. But opportunities in Texas oil and gas, healthcare, Dallas and Houston are -- they're both developing tremendous healthcare capabilities. The growth in healthcare, the growth in hospitals, the growth in managed care is phenomenal. And I think over the next 10 years, we'll rival New York for healthcare dominance, as we see it today. Builder finance, where the residential business in Texas has picked up fairly dramatically. We're loaning money to regional builders to build that first and second -- or step-up home. We see that as being quite good for 2013. And we see some selected commercial real estate projects. The multifamily has been good. We're stepping back a little from that today, because when it gets really good, it's time to step back and let someone else do it. So those are the things we see that we think we can do in 2013, in the way that we should.

Unknown Analyst

On the held for investment growth, in the quarter, I think it slowed down a bit, but part of it was a paydown in the energy, right, of $150 million?

Peter B. Bartholow

Correct.

Unknown Analyst

So when you kind of think about where we are now and kind of going forward for the year, do you think -- is the growth progressing as it was kind of the prior quarter to that?

George F. Jones

Yes. And I'll let Peter and Julie address that in more detail. But we believe the energy credit will come back also. The typical developer in the energy business will sell his production now, either for tax reasons, which basically, that was a lot of the selling prior to year end, but even selling production just to take something off the table, get their money, turn around within a year and put it back in the ground. So we believe that, that energy business will come back pretty much the way it was previously. Secondly, the growth, the first quarter has always been a little bit slower for us. But we see great pipeline in the loans held for investment. We think the growth is coming back the way it should, and we should have a very good 3 quarters in a go-forward basis for 2013. Peter, you want to add anything?

Peter B. Bartholow

No, I just -- you mentioned the seasonality in the first quarter. We tend to see that a little softer coming off of the ramp-up that occurs, not necessarily at quarter end, but over the course of the fourth quarter. So we -- as George mentioned in the presentation, we start off 2013 10% above the average for the full year 2012 in held for investment. It makes us feel, along with the unfunded commitments, quite good.

George F. Jones

We're comfortable that we can achieve what we've been talking about in terms of high teens growth in loans held for investment.

Unknown Analyst

And one more real quick, on the growth over the past few years, and a lot of it has been driven by you guys, acquiring good producers, and that's sort of been, sort of part of the growth. But if you get into a little bit better environment -- do you have any statistics on what capacity those people are running at or anything? If you can kind of -- numbers we can base around how much additional growth there, potentially is there?

George F. Jones

We don't have the specific capacity numbers, but I will tell you, and what I've said before, is that in a competitive environment like Texas where you're competing against the big boys, you have to have a lot of capacity in your staff. You cannot run the good producers right up to 100% of full, so to speak, and then go hire another one. So that's why we use the opportunistic approach to bring in people and teams whenever they're ready. And that's always -- a secondary approach is to keep enough capacity in your team. So I would say we've got, and again this is off the top of my head, but almost 50% capacity in most of our top producers. It really relates to, again, the "who has that capacity". What you want, really, is your top producers with the capacity to go bring business in. And if you can move it downstream, maybe to some of the teammates, once you get it on board, you can leave that high producer with more capacity to bring in the business. That's been our game plan.

Peter B. Bartholow

Comfortably, we have more than the anticipated growth for 2013.

George F. Jones

Yes, that's right.

Peter B. Bartholow

Substantially more.

George F. Jones

We've used up a little of that capacity because our hiring has not been that strong in the last quarter or 2. But it's not because we have decided not to, it's just timing in terms of when people are ready to make a move. And we work with -- it's a line of business. We work with people 2, 3, 4 years sometimes, before they're ready to make a move.

Unknown Analyst

For those new with the company, if you could give us a sense of your credit underwriting culture and what differentiates you in how you underwrite, such that you had the strong performance over the last cycle. And then as you've been hiring from competitors that may not have had your same culture, how do you reinforce it with all the hiring that you're doing?

George F. Jones

Good question. First of all, I'll say that our marketing people, our relationship managers, have virtually no credit authority. It all rests -- and it gets back to the culture that we're talking about. Our credit underwriting process is centralized. It's all managed from the top by one individual and his team. So we have about 10 or 15 people in the company that have real credit authority. The rest of the 100, so to speak, relationship managers that are making loans, have about $250,000 in terms of ability to make loans without credit policy.

Peter B. Bartholow

Secured.

George F. Jones

Yes, secured. You got to be secured on the $250,000. But we think that really works and helps protect the credit process that we want in our company. Sometimes it is hard when you hire a high volume RM from Chase that says, "By God, I had $10 million when I was at Chase." Well, guess what, you got $250,000 here. And if that doesn't work, then probably this is not the right place for you. We clear most of that up certainly before they join us. I don't know whether we have said this to you before, we have -- we ask all our relationship managers to complete a 2-year plan. It's an income plan, it's not a growth plan. And we'll help them with it, and after they complete it, if we agree with it, then we hand it back to them and say, "This is what you've told us you'll do for the next 2 years, and this is how you're going to get paid. And if you accomplish it, by the way, you can do the same thing that we did with you. You can go out and hire 2 people, 3 people, 4 people, just like you." And it works because most of the people we want have that entrepreneurial, build-the-business spirit that we want in our company. But back to your credit underwriting, it is all centralized. The relationship managers don't have any authority to speak of and the way -- the only way something like that works is if you have the delivery system so slick, that it's transparent. And we work really hard at that. Our credit people understand they have to make -- we have to make loans, or they don't have a job. So it's not a draconian approach at all. It is a partnership approach that really, really works. And they have separate incentive plans, they're managed by separate people, and I give our people credit for developing a system like this that really works. Long answer, short question.

Matthew Clark - Crédit Suisse AG, Research Division

Maybe a question on -- one that seems to be fairly topical these days is the SNC lending. I think third quarter, there were some, not concern, but just it drew some attention, how much growth came from SNCs in the third quarter. In the fourth quarter, the SNCs were flat, and you showed some pretty good HFI growth x SNCs. And I'm just curious as to your outlook on mid double-digit, high teen, loan HFI growth for 2013. I guess, does that include some SNC or related activity? Or is that above and beyond -- will that come on top of that? And just, can you -- and on another -- a follow-up on that, can you just talk about how you view SNCs and how -- and why you think it's more of a relationship-type business?

George F. Jones

Matt, to be honest with you, when we make a loan, we don't really think about is it a SNC or is it a loan. I mean, it's a loan that we would make in our company, fully underwritten by us, and in many times, it's our customer or it's someone that we know or have a relationship with. And we agent about 1/3 of our SNCs credits. Take energy for instance. Some loans get to be a SNC very quickly that don't start out to be a SNC. Oil and gas, you drill a well 7 or 8 years ago, you can drill it for $500,000. Today, it's $5 million. So loans in energy get big real quick. So you might be financing a $20 million oil and gas customer, and all of a sudden, it's $200 million. And that's obviously more than you will carry on your balance sheet. So we use our syndication desk and we go out and place it, primarily with people we know and we've done business with before. And that happens a lot from the SNC comparison. So that's where some of the SNC growth comes from. And it's not just oil and gas, but it's other credits that typically start with us, start smaller and grow bigger than what we want to keep on our balance sheet. So we'll bring a bank or 2 in, and sometimes we give up the agency just because it gets so big, we can't place it without one of the larger banks taking the agency. But we want to stay in because it's a previous customer, somebody we like. We don't go to PNC or Bank of America, or anybody's syndication desk and say, "Would you please sell us 5 credits at $20 million a piece just so we can fill our boat?" That doesn't happen. It's always a reason to do it. And I can tell you, virtually every credit in our SNC portfolio has a reason like that behind it. So it's something to talk about, but it's not an issue with us. We have no nonperformers in our SNC portfolio today. The only one we had previously, was a large credit that we originated and...

Peter B. Bartholow

It's been fixed.

George F. Jones

And it's been fixed, and it probably shouldn't have been there in the first place. But...

Peter B. Bartholow

I'll comment also, every -- whether it's a SNC or any other kind of relationship, there's a relationship manager involved in the transaction. We do not have a syndicate desk that feeds off of somebody else's production. We do -- we have a syndicate group that is responsible for placing credit, and we do expect to see our share of agented credit increase over the next couple of years. But it is included, in general, [indiscernible] to our outlook for the year, but it is not going to be an outsized portion out of growth.

Matthew Clark - Crédit Suisse AG, Research Division

Okay, that's great. Management is going to be in a breakout session after this in the presentation room, but we also have Franklin Resources up next here in this room. Thanks.

George F. Jones

Thank you, everyone.

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Source: Texas Capital BancShares Inc. Presents at 2013 Credit Suisse Financial Services Forum, Feb-12-2013 04:00 PM
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