Texas Capital Bancshares' CEO Discusses Q1 2014 Earnings Results - Earnings Call Transcript

Apr.24.14 | About: Texas Capital (TCBI)

Texas Capital Bancshares, Inc. (NASDAQ:TCBI)

Q1 2014 Results Earnings Conference Call

April 24, 2014 5:00 pm ET

Executives

Heather Worley – Director of Investor Relations

C. Keith Cargill – President, Chief Executive Officer, Operating Officer, Director & Chief Executive Officer of the Bank.

Peter B. Bartholow – Chief Financial Officer, Director & Chief Operating Officer of the Bank

Analyst

Michael Rose – Raymond James

David Rochester – Deutsche Bank

[Abraham Puthawala] – Merrill Lynch

Brady Gailey – Keefe, Bruyette & Woods

Emlen Harmon – Jefferies & Company

Matthew Clark – Credit Suisse

Brad Milsaps – Sandler O’Neill

Jennifer Demba – SunTrust Robinson Humphrey

John Pancari – Evercore Partners

Brett Rabatin – Sterne Agee & Leach

John Moran – Macquarie Group

Operator

Welcome to the Texas Capital Bancshares’ first quarter 2014 earnings conference call. All participants will be in listen-only mode. (Operator Instructions) Please note that this event is being recorded. I would now like to turn the conference over to Heather Worley, Director of Investor Relations. Please go ahead.

Heather Worley

Thank you for joining us for our first quarter earnings conference call. I’m Heather Worley, Director of Investor Relations. Should you have any follow up questions, please call me at 214-932-6646. Before we get into our discussion today I would like to read the following statement. Certain matters discussed on this call may contain forward-looking statements which are subject to risks and uncertainties and are based on Texas Capital’s current estimates or expectations of future events or future results.

Texas Capital is under no obligation and expressly disclaims such obligation to update, alter, or revise its forward-looking statements whether as a result of new information, future events, or otherwise. A number of factors, many of which are beyond Texas Capital’s 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 impacts from generally 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 the perspective supplement, the annual report on Form 10K, and other filings made by Texas Capital with the Securities & Exchange Commission.

Now, let’s begin the discussion. With me on the call today are Keith Cargill, President and CEO and Peter Bartholow, Chief Operating Officer & CFO. After a few prepared remarks our operator will facilitate a Q&A session. At this time I’d like to turn the call over to Keith.

C. Keith Cargill

Thank you for joining us for the first quarter 2014 call. I’m Keith Cargill, President and CEO of Texas Capital Bancshares. After my opening comments I will hand it off to Peter Bartholow our Chief Operating Officer and Chief Financial Officer and then close with a few comments before opening the call to Q&A.

The first quarter showed continued strong growth in core LHI, deposits and significantly better performance than peer in mortgage finance. Due to our high growth rate and aggressive loan pricing market and the added interest expense from our debit offering, we experienced net interest margin pressure with NIM dropping just below 4% at 3.99%.

Put into perspective our first quarter core LHI growth, the $575 million Q1 average loan growth from Q4 2013 was more than twice as large as our prior record Q1 growth. In fact, the Q1 quarter end balance is 20% above the average for all of 2013. This record setting start to the year positions us well for strong growth in net revenue the balance of the year despite the drag on net interest income due to the sub debt offering in January.

Talent acquisition continued at a steady pace in Q1 adding seven net RMs. We are focused on improving performance across all lines of business before incrementally adding staff. Those business units delivering top performance and offering the greatest high quality revenue growth opportunities continue to win our talent acquisition resources, as always.

Credit quality remains strong. I will cover this topic in more detail a little later. On Slide Four we show the revenue and expense trends since 2009. As you can see from the five year bar chart, we continue to trend favorably on the net interest income and non-interest income with the first quarter of 2014 affected by the short number of days and sub debt cost. Peter will walk you through the key metrics on the financials and I’ll rejoin to cover credit and wrap up with closing remarks.

Peter B. Bartholow

Results in the first quarter clearly demonstrated our ability to generate strong growth in loans, earning assets, also of course net revenue and higher returns. The commercial portfolios of exceptional quality carry a yield of more than 4.4%. Funding costs were stable despite plans to increase liquidity that we described last quarter. The business model is producing high returns on assets in equity. The loan spreads and returns remained high in Q1, greater than 4.2% spread with core funding cost, meaning just deposits and borrowings of just 17 basis points.

We had growth of 7% in traditional held for investment balances from Q4 and 27% from a year ago. As contemplated and as we have said for many quarters, the combination of growth, competition, and [inaudible] periods of low interest rates will apply pressure to yields and NIM. The yields did however, remain very favorable in traditional held for investment categories at 4.61%, a 12 basis point decrease driven primarily by growth, a change in one fee component from Q4 and had a total impact of six basis points and reduction on NIM.

As Keith mentioned, the mortgage finance business clearly demonstrated performance in excess of the industry. The highly profitable business demonstrating the success of our strategy and the favored status it enjoys with its customer base. Q1 was very challenging for the industry with sharp reductions in origination caused by seasonal factors and the weather in many parts of the country. TCB was able to maintain MFL balances above $2 billion with a contraction of just 9% from Q4 2013.

Other industry participants were down by 20% or more from Q4 and more than 40% from the first quarter of last year. Relationship pricing decisions did result in higher utilization at lower spreads. [Inaudible] is down to 19% of total loans on average in Q1 compared to 22% in Q4 and 26% in Q1 of last year. Even with the yield reduction, this business is still generating after tax returns of more than 20% on allocated capital with costs of less than 5% and has a yield above prime it’s a highly liquid asset class with near zero credit exposure generating significant value with low cost deposits and a highly efficient operation.

The change in the composition of mortgage finance loans to total loans actually increased NIM by two basis points but it was offset in NIM by four basis points because of the yield contraction. After maintaining strong balances in Q1, we do now see the opportunity to expand the balances in Q2 and believe that the yield may not be subject to further erosion of any consequence.

We had total loan growth including both traditional held for investment categories and mortgage finance of 3.5% from Q4 and 17% from the prior year. At a spread of 4.24% against 17 basis point cost of core funding, we had excellent results. Total deposit growth, as Keith mentioned, also remained very strong. We did have, as we announced earlier, the strategic objective to increase liquidity with a benefit to long term asset sensitivity.

BDA growth has continued to be especially strong even with Q1 seasonality that had limited growth in previous years. Total deposit growth exceeded total loan growth on an average basis by more than $400 million compared to the year ago quarter. Changes in loan composition and funding profile have increased the level of asset sensitivity in our balance sheet by a substantial factor over the past two years.

Referring to Slide Six, major factors in reduced income and returns in Q1 ’14 are described and many are not indicative of expectations for the full year. Capital initiatives were obviously justified by the opportunity we discussed in January in connection with the offerings of both equity and debt securities. Obviously, we weren’t in a position at the time of the report of year end results to discuss the magnitude of the opportunity that increased held for investment loans, the traditional category, by more than $440 million point-to-point. That’s twice as much as any pervious Q1 record and tied for fourth in all quarters in our history. That’s a pace at a level that dramatically exceeded that of the peer group.

Even with the reduction in mortgage finance loans, total loan growth in Q1 exceeded the amount of capital raised showing effective utilization, leverage, and good returns soon after issuance. We issued common equity of $103 million dollars with the sale of 1.85 million shares. We have good returns already achieved with already most additional leverage. The impact on the EPS and ROE were $0.02 per share and 75 basis points respectively.

The offering of bank sub debt of $175 million increased total interest expense with an impact on NIM of six basis points and not related to changes in core funding costs. It’s a very low capital cost as distinguished from the 17 basis point cost of core funding. It obviously had an impact on the EPS, ROA, ROE, and the efficiency ratio that are depicted on the slide.

Compared to Q4 the reduction in two days of yield accrual represented $2.5 million reduction in net interest income. It’s a bigger impact in TCB than you’d normally expect because of the high concentration of floating rate loans as a percent of total earning assets. As always, in Q1 we experience linked quarter increase in FICA and other employment expenses. Again, larger than prior years due to the growth in the company. The increase in FICA was $1.9 million and there was a total of $2.5 million including FICA and other employment related costs. I will mention that historically FICA expenses fall between 40% and 45% between Q1 and Q2 and then decrease modestly in subsequent quarters.

The impact of the stock pricing increase of $6 per share, and that’s average March versus average December, was much less than we experienced in Q4. It did have the effect of increasing 123R expense by $600,000 not from the Q4 level but we did not benefit from the full $3.6 million reduction in costs from Q4. We are now able to demonstrate more consistent impact of approximately $100,000 of expenses per $1 in stock price change compared to the almost $275,000 per dollar in Q4. Obviously, this had an impact on EPS, ROA, ROE, and the efficiency ratio.

I mentioned our planned increase in liquidity and it’s reflected in the combination of the increase in average balances of liquidity assets and the decrease in the average balance of borrowed funds. Consistent with our strategic objective, we are building low costs deposits that will increase our asset sensitivity and support growth. The increase in these components of liquidity average $170 million compared to Q4 and over $900 million from the first quarter of 2013.

We had a negative impact on NIM of five basis points resulting from the increase in liquidity. With no meaningful change in net interest income or funding costs of 17 bips. The change in profile does not optimize our funding costs. We recognize that. We have mortgage finance loans now paired with a component of interest bearing deposits that replace borrowed funds with a cost differential of 20 to 25 basis points.

The FDIC assessment has increased with assets now above $10 billion. We had a $900,000 increase from Q4 obviously, with an impact in the key metrics of performance. In build out expense we had, as you’ll recall, about a $1.2 million in the fourth quarter. We experienced consistent improvement or increases in the level of salary expenses for the last nine quarters at approximately $900,000 in the quarter. In the first quarter we obviously had the full first quarter impact of recruiting in Q4 and the growth of staffing in Q1. It is offset by a reduction in extended expense from the fourth quarter.

Loan and deposit trends are obviously very favorable. Strong growth in held for investment growth and mortgage finance loans as well. Now, Keith will describe growth and composition of the portfolio.

C. Keith Cargill

Referring to Slide Eight, please note the trends in demand deposit growth, total deposit growth and core LHI growth. We continue to see an opportunity to improve our deposit mix with outside DDA growth and grow total deposits at a faster pace than loans as has been the case for the past four plus years. On the top right quadrant of slide eight, you will see that the total loan portfolio mix remains well diversified with our C&I categories totaling just over 40% followed by the next largest category, mortgage finance at 23%. Combining the market risk real estate loans, that would be CRA as well as residential, that market risk category in total is 26%.

Average DDAs increased 3% link quarter and we were up 34% from Q1 2013. Total deposits grew $2 billion year-over-year compared to total loan growth of $1.5 billion. The following slide breaks down the non-accrual loans by category. None accrual loans as a percentage of core LHI equaled 0.48%. We did show a slight increase in non-accruals due to a new C&I loan that moved to non-accrual totaling approximately $18 million. Real estate non-accruals and OREO both declined since Q4 2013.

Total credit cost was $5.4 million in Q4. A provision of $5 million in Q1 was the same as Q4 versus $2 million in Q1 2013. We experienced net charge offs of $2.1 million or 10 basis points in the first quarter of this year versus six basis points in the fourth quarter of ’13 and seven basis points in Q1 2013. There was no OREO valuation charge in the first quarter of this year. Total OREO now, at quarter end, was $2.4 million in total.

Before closing, I refer you to Slide 10 for our EPS growth bar chart. We delivered a strong five year CAGR on EPS growth at 27%. We see the opportunity in 2014 to build out significant high return complementary businesses and win the critical talent to drive significant earnings growth for years to come and are working harder than ever to exploit these opportunities. Despite significant competition, we are winning core business and market share across business units and remain keenly focused on building high quality growth even at some near term pressure on pricing.

Finally, we continued to improve our asset sensitivity and at some point will benefit in NIM and earnings power whenever rates trend higher. Our organic growth model remains strong and is off to record growth in core loans and deposits. We appreciate your interest in Texas Capital Bancshares and now welcome your questions. Heather I’ll turn it back to you.

Heather Worley

We’ll go ahead and open the line for questions now.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Rose – Raymond James.

Michael Rose – Raymond James

Can you just help walk us through kind of what’s going to stick in the NIM and potentially what could come back in the NIM as we move through the year? I would suspect that core held for investment yield compression would continue and that there’d be further declines also in the yield in the mortgage book just from competition. You might get some relief if rates go back up in the back half of the year but just can you walk us through or help us understand how sticky this level is at 3.99?

C. Keith Cargill

The competition in the mortgage finance business is certainly keen but we don’t see that being as big a pressure point as we go forward. We’ve certainly put some incentives in place that again, motivate our clients to not only consolidate other bank lines and move that usage to us, but we also insist on moving additional demand deposits. It’s just in this environment we’re in those incentives are giving us a little more pressure than the offsetting DDAs but we really believe we’re building a very, very profitable upside with that relationship pricing negotiation we’re doing there. We don’t see continued pressure to the same degree on that side of the business.

On the core LHI business, in C&I in particular it’s just very, very tough competition on pricing. Now I’ll tell you the structure is just as competitive but that’s one of those situations where we try so hard, as I’m sure all banks will tell you, but we try so very hard to avoid getting drawn into the pressure on structure and at the end of the day if we have to make a choice and we’re after picking up quality market share, we’ll make that choice on meeting the pricing competition not the structure. That’s especially true on private equity financing business that has been so good to us over the last several years. It continues to be really cutthroat when it comes to pricing and structure which is put added challenges in actually finding business that we are comfortable with and book in that space. But we do expect continued pressure on core LHI as we go forward in the year. Peter do you have anything to add?

Peter B. Bartholow

Obviously, we issued the sub debt at the end of the quarter so that’s only two of the three months and that number will be higher in dollar terms with no real impact on NIM in the second quarter. We had an unusual fee in Q4. Overall loan fees have been a big contributor in making the yield stickier than even we would have been willing to project. The increase in liquidity, we see that building a little bit but not by the same magnitude that it did in Q1 compared to Q4.

As Keith mentioned, we’re really not looking for significant additional erosion in the mortgage finance yields. Held for investment loan yields, while they were down 12 basis points, that really represented only a two basis point reduction in NIM. So, the core loan yields, the portfolio yields in traditional held for investment categories have held up actually, fairly well. The sub debt, that’s a capital cost not a core funding cost. We’re not looking for any increase in the cost of deposits or borrowed funds.

We start the quarter in very good shape and Q2 historically has been strong for us so we’re expecting good growth in net revenue and improvement in volumes in the mortgage finance business in Q2.

Michael Rose – Raymond James

Okay, but as we kind of think about the margin going forward, given everything you just said, it seems like this is probably a base that we’re going to work off of and potentially, with the added liquidity that you plan to add through the year, even if it’s smaller impact, we could actually see the margin go down? Is that the right way to think about it?

Peter B. Bartholow

I don’t believe today that over the year we will see mortgage finance yields where they are today. They are expected to rise so we’ll get some relief there. What we’re also getting from mortgage finance is growth in deposits which his contrary to the industry trend that is improving their contribution relative to the yield. It’s hard to argue with the central premise when you factor in the effective subordinated note cost in NIM but until, and I think we made this clear, until we see a lift in short term interest rates, there is no fundamental change in the way that we see the model working.

C. Keith Cargill

It makes it a little tricky on the core LHI growth on predicting NIM because of the syndications component which is really more significant now but creates some more lumpiness in the business and in that actual NIM affect as well. But at the end of the day, we would expect some slippage I would think because the growth rate, we see, is still quite strong and with that kind of growth rate in this pricing market even with syndication fees leveling a bit over the course of the balance of the year, on average I would expect a little slippage still in the LHI core NIM.

Operator

Your next question comes from David Rochester – Deutsche Bank.

David Rochester – Deutsche Bank

You talked about getting the DDA from the mortgage finance business, I was just wondering if you could update us on what that balance is this quarter and what the balance was for 4Q?

Peter B. Bartholow

The link quarter average is up a little bit. We’re actually trying not to get into depth on that.

C. Keith Cargill

We also of course seasonally, have a lot of escrow money paid out because of taxes, insurance and so on so that builds back rather quickly but that does have an impact on us in the first quarter.

Peter B. Bartholow

It’s part of the seasonal weakness that I mentioned traditionally we’ve experienced in demand deposit growth in Q1 that was overcome by the growth in other portions of the bank.

C. Keith Cargill

We still see good prospects for growth there as we’ve experienced.

David Rochester – Deutsche Bank

Then just switching to your comment on the RMs, I’m just wondering what the timing was on the hiring for the net seven this quarter? Just in trying to think about the build out around them should we also expect to see a little bit of increase in the comp line or just expenses generally building out that support in Q2 as well as I guess, additional hires that you would have?

Peter B. Bartholow

Most of those came, I think more than half, came in the first month of the quarter so most of the impact is in place. Those additions did not come from changes in the profile of a business that would imply significantly different support costs.

C. Keith Cargill

Two of them though, over the course of the next year and a half, we will have some incremental build out but it’s not going to be needle moving but they are a special niche team. I don’t want to go into a lot of detail on that right now, but nothing as Peter suggests, immediately the next few quarters.

Peter B. Bartholow

Then just getting into some of the nitty gritty on expenses, the FDIC insurance line I know you mentioned that was up because you’re larger, is there anything one time in that that we can pull out?

Peter B. Bartholow

There’s really not. We’re looking basically at a run rate for the year. It obviously, can vary a little bit quarter-by-quarter because it is always in arrears, but that’s the rate fundamentally we’re dealing with this year. Another joy of being over $10 billion.

David Rochester – Deutsche Bank

Then the legal and professional, should we expect to see that trend down a little bit at least in Q2? It seems like it’s been elevated the last couple of quarters?

C. Keith Cargill

Maybe 3Q, but the last half of the year for sure, as sure as you can be, we feel confident that’s going to trend down. Not as sure the second quarter.

Peter B. Bartholow

A lot of that has to do with support and build out of critical technical components of our business so it’s not just traditional legal and professional, it includes contract support for business solutions.

C. Keith Cargill

Some big technology build outs that are really important. As we hire these people, it’s just critical that we leverage them appropriately and be sure and give them the tools to provide really excellent client servicing. Any more you’ve got to match up the talent with the technology.

David Rochester – Deutsche Bank

Just one last one on the credit side, you mentioned the $18 million C&I credit, can you just give a little bit more credit there where this was, what industry this was, and maybe the reserve you have against it right now?

C. Keith Cargill

It’s a long time company long history client of ours for a number of years. They had gotten involved in expanding to a couple of international markets that didn’t work out so well. They’re involved in providing manufacturing of various types of metal bars, poles, and equipment for utility companies. The utility industry has been a little bit of a lager on capital investment the last three or four quarters so they’ve suffered some on pipeline and then they were distracted looking at other than domestic core clients.

We don’t see it as an issue where we have a massive hole. We’ve begun to address the reserve. Of course, when you move something to non-accrual you don’t know as much as you will 30 days later or 60 days later so at this point we think we’re adequately reserved and we have an appropriate reserve. I can’t recall exactly the number Peter but again, it was time to put it on non-accrual and address it.

David Rochester – Deutsche Bank

Was there any interest give out because of that this quarter?

C. Keith Cargill

No, they were current and we just moved it I think, right at the end of the quarter, as I recall.

Operator

Your next question comes from [Abraham Puthawala] – Merrill Lynch.

[Abraham Puthawala] – Merrill Lynch

I guess just in terms of sort of following up on Dave’s question, I guess the expenses move depending on the investments you’re making. Are we still expecting the efficiency ratio to move to the low 50s as we get towards the end of the year? Does that still hold good?

Peter B. Bartholow

Yes, it is. That is based as we see it today. When you factor in the adjustments and relative to the size of the company, we still see that the efficiency ratio will be less than it was for 2013.

[Abraham Puthawala] – Merrill Lynch

Far to say most of that improvement is coming on the revenue side as opposed to the expense side at this point?

Peter B. Bartholow

I think most of it will. Obviously, the subordinated note interest cost is fixed. We’ll benefit from a pickup in days over the rest of the year. That has, as you know, a meaningful impact. Then it’s a combination of growth that we’ve already put on the books and even though the FDIC insurance assessment will remain high, we’ll see a big drop off in FICA and other expenses. The incentive expenses came down sharply linked quarter and they’ll stay down until we demonstrate that we can be on plan again.

C. Keith Cargill

One of the challenges for us is that we’re building a couple of really significant complementary businesses. We talked about private client and wealth management and the importance of that strategically as we address all these business owners that we have brought on in banking their companies for the last 15 years and we’ve never had a really strong complete offering and we didn’t have all the talent we needed on the playing field. That is still a build out process and it will begin to accelerate some I guess towards the last half of this year and into the first of next year. But, we see the build out, the next phase of build out being primarily client facing revenue producing people.

We’ve got the infrastructure talent pretty well on board and are in the process no of finishing the technology upgrade over the course of the next six months so that’s one piece that is a little bit of a moving target on us. But again, as we bring those people on they’ll be bringing revenue, it will just take a few months for that to offset the negative cash flows just like on RMs, it takes a few months before the revenue build that they bring with them overcomes the expense. It’s just our organic model, only on a business that we really like long term because of the fee component and we really want to grow fee income at a faster rate over time than spread income.

[Abraham Puthawala] – Merrill Lynch

I guess the second question, just again following up on Michael’s earlier question on liquidity build, is there a specific target in terms of where you want to get on liquidity or is that going to be essentially a function of deposit growth outstripping loan growth and where the balance falls off in any given quarter?

Peter B. Bartholow

It’s primarily that. We do, as we’ve commented, at the end of Q4 or last quarter, we have a strategic opportunity in certain lines of business to keep the balances high. Obviously, you can’t predict quarter-by-quarter when those will occur but over the course of the year, the rest of the year, we will see some additional liquidity build.

Operator

Your next question comes from Brady Gailey – Keefe, Bruyette & Woods.

Brady Gailey – Keefe, Bruyette & Woods

You mentioned the change in one fee component when you’re doing a loan deal in Q1. It looks like the majority of the decline in the loan yield was driven by this change of the fee component. Can you just describe what that is and is the full impact of that felt in Q1 or will there also be some additional burden felt going forward?

Peter B. Bartholow

No, it was a onetime event in Q4 related to the payoff of a loan where we had the chance to earn a substantial fee. So, it is non-recurring and we’re actually, as we commented earlier, seeing very strong performance in syndication and the other fee components that we see in NIM and that is a onetime occurrence.

Brady Gailey – Keefe, Bruyette & Woods

Where did the share national credit balances go quarter-on-quarter? I think at year end they were around $1.4 billion, where is that at the end of March?

Peter B. Bartholow

They ended up at $1.455, they were up $35 million.

C. Keith Cargill

The agented piece actually grew more than that Peter so the mix improved from 28% agented to 30% quarter-to-quarter. A year ago it was 26% agented and now it’s 30% at the end of the quarter. We may begin to selectively let a few of our new RMs that we brought on last year that were very, very significant lead bankers at other big institutions on some of these syndicated credits, we may begin to allow them to take a piece in a relationship participation to position us, over the course of the next couple of years, to work our way into the co-agent or agent position. It is possible, and again it won’t be buying paper it will be very strategic, that this trend we’ve had now for about five quarters to improve agented mix, it might shift some in the next few quarters but it will be because we think we can significantly move the needle over the next couple of years.

Peter B. Bartholow

Yes, and those are relationship managers that were employed by the agents of the credits that Keith is talking about.

C. Keith Cargill

That’s right.

Peter B. Bartholow

Again, there’s a relationship manager connection with all of our shared national credits.

C. Keith Cargill

So, I don’t want to confuse things this quarter but I just think it’s important you guys have the heads up on going forward and why our strategy should produce even better long term yields as we work our way into agented positions.

Brady Gailey – Keefe, Bruyette & Woods

Then finally, you mentioned the math on for every dollar per share of stock change it’s about $100,000 of comp. Is that both when the stock goes up and when the stock goes down or is that just when the stock goes up?

Peter B. Bartholow

It goes both ways.

Operator

Your next question comes from Emlen Harmon – Jefferies & Company.

Emlen Harmon – Jefferies & Company

I wanted to go back to the NIM within legacy held for investment book. I hear your kind of commentary about the competitive environment out there and it’s been kind of a long grind if you will, but you guys did a pretty good job of kind of holding in the 470s through last year and we did actually kind of see meaningful step down this quarter. Could you give us a sense of whether there’s been a shifting kind of loan pipes or whether there really was a meaningful competitive shift in the first quarter that would drive that?

Peter B. Bartholow

Remember, the decline in the loan fee was a substantial portion of that. The rest of it is, actually as I commented, held up very well. We have seen over the last two years a shift to a LIBOR balance from prime base. So we’ve now just barely moved above 50% of our portfolio is LIBOR based compared to prime base and you get with that some narrowing of spreads as LIBOR has come down but you will also get a much more rapid response and a leading response when there’s any indication that rates will increase so it’s a dual edged sword today. It’s one that can provide us a lift in advance of a Fed funds rate increase but it’s costing us a little right now.

C. Keith Cargill

We’re trying to be more helpful on Slide Five with the chart net interest income and margin trends and I hope it is helpful. But if you look at the purple line there on total loan spread, that still has the piece Peter mentioned in it and if you make some adjustment for that you can see it’s more horizontal than trending down quite as much as some of the overall NIM. Obviously, the overall NIM with the new sub debt and also two less days, we got hit on a couple of those things. We do see pressure, we want to continue to grow and take market share of high quality C&I business and that frees up and gives us more shelf space for other businesses we want to grow but we are so focused on having a good diversified book we’re not willing to let just any business grow at any pace without good C&I growth and today C&I high quality growth is cheaper.

Emlen Harmon – Jefferies & Company

Just hoping back to the expenses as well, you guys did note in your K this year that going over $10 billion comes with additional regulatory expenses this year. Do you feel that regulatory expenses is fully in the run rate, or at least as best as you can tell?

Peter B. Bartholow

There’s a component of it that certainly is. We’ve done some staffing and support in the work to support the stress test and to build the models related to that initiative or that endeavor. There will be a little more. The FDIC expense is part of what we were addressing at the same time.

C. Keith Cargill

When you layer it all together it’s $5 million or $6 million that we didn’t have before this year, Peter wouldn’t you say? So, thankfully our model of strong organic growth I think is going to really help us move through and push through that stair step cost increase. But, it’s real and we’re being sure to be proactive and have the right talent, have the right systems in place to be a bank that’s highly regarded by the regulators in this new mid-size category.

Operator

Your next question comes from Matthew Clark – Credit Suisse.

Matthew Clark – Credit Suisse

Back to the core loan yields, can you give us a sense for the rate on new fundings relative to what’s in that portfolio? I’m just also curious whether or not you’re seeing customers come back to you, those with floors, and trying to renegotiate that if that’s part of the pressure to?

C. Keith Cargill

There’s a little bit of that but overall our floor dollar amount has actually went up. It’s amazing, our people still in this environment, as evidenced by still a 3.99 NIM, we have something of value and our clients pay more than average in the market for what we offer. It’s just that we had a significant premium before we had so much capital pouring into Texas the last couple of years and all focused on C&I. We’re not willing to forego high quality C&I market share growth because again, it inhibits us to grow other businesses that are important to this too and we really want the diversification and credit quality to be strong.

I think we’re seeing no 15 to 25 basis points that’s moved the last six to nine months on these credits and at the high growth rate we’re booking enormous amounts of loan growth each quarter, it begins to really move the needle. But these others things have impacted that NIM as well and we’ve talked a lot about that.

Peter B. Bartholow

It does vary widely by product type or by line of business, but overall it’s still come in at a quarter to half over prime average.

Matthew Clark – Credit Suisse

Then just on the average balances at the warehouse, I think previously and maybe before your latest capital raise you guys talked about the warehouse being down modestly. Any update there based on what you saw in the first quarter and what you’re seeing in 2Q for the year?

C. Keith Cargill

This is a better seasonal quarter and we expect it to reflect that. A really solid quarter is what we think is shaping up.

Matthew Clark – Credit Suisse

Any desire at all for something more for the full year as you look out beyond it?

C. Keith Cargill

It’s difficult. Part of that is just a function of how all the clients and market continue to adjust the QM. That’s certainly having an effect on the market. Just a lot of otherwise qualified borrowers with significant paths of income now get to count none of it. It’s got to be W2 income in order to qualify them and overtime some of these clients are going to begin to get comfortable perhaps doing something outside the box that’s not necessarily what we’re going to be comfortable financing.

We think we’ve got to see how this rolls out. Even in the last two and half month since QM took effect January 10, we’re seeing much better application, [hit] rates and things of that sort with our client base and then you get the seasonal uplift too on house purchases. We still have a much lower than average refi component, it’s about 28% the industry is at about 37% so there is still a little refi that is deflating but again, as we continue to show quarter-by-quarter it’s effecting us less in competition. We think we’ve got a solid quarter shaping up. It’s hard to predict for the year.

The MBA is now estimating a $900 million to $1 trillion year in mortgage volume. That’s about a 30% to 35% drop from last year. We’re really pleased with the kind of numbers we booked in the first quarter and we think we’ll continue to outperform industry and peer. That’s the best I can really give you at this point.

Operator

Your next question comes from Brad Milsaps – Sandler O’Neill.

Brad Milsaps – Sandler O’Neill

You made the comment that you thought the rates on the warehouse would stabilize kind of going forward and maybe you have the potential to rise in ’14. Correct me if I didn’t hear that correctly. I’m just kind of curious what would be driving the increase in those rates as it seems to be there’s a lot of capacity in that industry right now.

Peter B. Bartholow

There is a lot of capacity in the industry. There’s also a lot of turmoil in the prospect of meaningful consolidation. It’s also a function basically of the rates have gotten about as low as they can go. We’re not experiencing the same kind of pressure nor to the same degree and the industry is looking for an increase to something closer to 5% by the end of the year and we’ll get some carry from that as well.

C. Keith Cargill

We’re also seeing some volume pick up and that helps us on the fee component that also contributes to a pickup in yield.

Brad Milsaps – Sandler O’Neill

Just to clarify on your comment about the efficiency ratio being lower in ’14 versus 2013, I guess that means you would probably be somewhere below 52% or so? That would mean that on a quarterly basis you would have to probably dip below 50 to kind of get there?

Peter B. Bartholow

It’s less than ’13, we were above 55 in ’13 for the year.

Operator

Your next question comes from John Pancari – Evercore Partners.

John Pancari – Evercore Partners

Back to the comp expense, given the give and take you gave us and all the color you gave us particularly around the FICA and the other costs that are lumpy about the quarter, if we back out that $2.5 million what is a good run rate to assume for the total comp and benefits line going forward from here through the rest of the year?

C. Keith Cargill

It usually drops 40% to 45% in the second quarter.

Peter B. Bartholow

FICA will drop 40% to 45% in the second quarter. We mentioned earlier you go back nine quarters and we have each quarter about a $900,000 increase in salaries. Obviously, incentive expense is a function of how we’re doing relative to plan and it starts off low and rises as we see how we are measuring up against the plan at the unit level and on a consolidated basis. The big factor last year was, as we’ve talked about many times, the impact of the increase in stock price and a lot of people would have assumed that that $3.46 million in the fourth quarter would come down and it certainly did but December to March there was a six point increase that resulted in a $600,000 cost of the 123R.

C. Keith Cargill

As compared to the fourth quarter where it was a $13 average increase and a $3.6 million impact. As we said in January, the number of units actually finally vested at the end of last year and while there is some volatility with the way we structure our incentives with the cash based [inaudible] type unit program, as Peter suggests, now we can give you a little better metric and that’s for each dollar movement in stock price on average in a quarter. It ran $100,000 this time and it will vary some but it won’t be back up in that 275 kind of range that we experienced in the fourth quarter.

Peter B. Bartholow

The level of build out we expect to be continuing to build out in RMs and support for the year. It’s very hard to predict by quarter. The pipeline is very good.

C. Keith Cargill

Both deposits and loans it looks solid and a gain, after this phenomenal first quarter we may not see the kind of significant bump up from the first quarter because we were twice any record we ever book in the first quarter. But, we still see a really solid second quarter. The reason I say that is when you’re closing loans, like we were in the first quarter, it does have some effect on filing the pipeline for the next quarter but I like putting them in the bag in the first quarter rather than hoping we close them in the second.

Peter B. Bartholow

Then you have carry over from things that could have closed in Q4 but slid into Q1. When I was talking about pipeline I also meant the talent pipeline.

C. Keith Cargill

Yes, exactly talent pipeline is very solid. We’re being disciplined about being sure that we’re getting better talent than ever each year and that we’re really looking at performance across the company too to be sure the talent we brought on we’re developing and getting the results we need from them. But we feel very good about again, a very strong opportunity to build out these businesses including our core businesses.

John Pancari – Evercore Partners

Then on the margin side, I know you gave the mix of the LIBOR and prime base and on that increasing percentage of LIBOR base what is the spread over LIBOR that you’re getting on your new production and then I guess on the prime base as well, just to give us an idea?

C. Keith Cargill

It varies widely on the product type and the company and the credit of that particular deal. We’re seeing extremely aggressive pricing in the market that we’re not matching. Literally, in the 175 over LIBOR range. We’re not going to go to that kind of pricing but we certainly have seen a 15 to 25 basis point slippage over the last couple of quarters in the book of high quality C&I business that we’re after.

Peter B. Bartholow

When I gave the estimate of the quarter to a half over prime, that was to the entire portfolio including the LIBOR based.

C. Keith Cargill

It wouldn’t be unusual for us to see a 225 or 250 over LIBOR today that we might do on a really high quality opportunity and that would have been 15 to 25 basis points richer back midyear last year.

John Pancari – Evercore Partners

Lastly on the loan volume can you just give us a little more granularity on the loan growth in the quarter by your portfolio types? I mean ideally, if you can give us the linked quarter and the period changes in some of the niche portfolios like the energy book, the premium finance book, and then the builder finance book as well?

C. Keith Cargill

We shared with you the mix and we’d like to kind of stay there. The energy business is building nicely. As you can see the residential real estate and also commercial real estate ticked up a little from the prior quarter. It moved about 1% each but the C&I book is solid and still growing at about the overall pace of the loan portfolio which is important to us and the energy book is now seeing some good growth again. We are seeing quite a bit of energy book growth be in syndicated opportunities we’re leading and so we’re not getting all of that growth in just outstandings, we’re also getting a disproportionate growth in fees too from the syndication lead position we’re in.

Peter B. Bartholow

Houston has also been a bit contributor as it has been in the past and it’s fairly broad based C&I. This is in addition to what Keith mentioned in energy.

C. Keith Cargill

But I hope that pie chart is helpful to you to just kind of help us track the mix and we just want everyone to know that diversification is very important to us. We’re going to again, meet pricing pressure to drive the right kind of growth, the right quality diversification. At the end of the day this growth is only as good as the quality. I mean, it really means nothing but bad if you’re growing and not focused on quality first and we will give up 15 to 25 basis points to be sure we’re maintaining quality growth.

Operator

Your next question comes from Brett Rabatin – Sterne Agee & Leach.

Brett Rabatin – Sterne Agee & Leach

I was just hoping to get a little color around loan production size this quarter versus last if you had it or versus the portfolio on average and just maybe thinking about are you increasing the side of the credits that you’re doing in the different businesses or is the mix changing any aspect of the size of the relative credits to the portfolio?

C. Keith Cargill

Overtime we’re growing up our companies, we’re growing with them. I will tell you, not at the pace that we’re growing our equity base, our legal loan limit. We’ve moved very modestly over the last few years on hold positions relative to the growth that has been substantial in our legal loan limit or capital base. But, absolutely over time you to grow up with the customers. We’re not targeting just large syndicated opportunities. What we’re doing now is with that expertise and that team, our bankers are just now able to go attract some of these opportunities that in the past passed right in front of them and they didn’t reach out and engage and pursue because we didn’t have a SWAT team of talent like we have today to go help them win that business.

I want to give lots of credit to our bankers across the company for being alert, aware, and getting us in with our syndication team and that’s really what is happening is we’re getting incremental higher credit grade C&I opportunities as well as some real estate high grade opportunities that we’re leading and we’re able to make some arrangement fees in addition to the yield on the credit. It’s just lumpy and so our pipeline is building really nicely for this quarter and the balance of the year on syndications. We had a good first quarter in syndications but we’re working on a lot of credit that hasn’t closed in the first quarter and we feel very good about the income contribution for the year in syndications.

Brett Rabatin – Sterne Agee & Leach

What would be the average size of maybe your bread and butter business of new clientele you had in the C&I businesses?

C. Keith Cargill

It still varies widely. If you look at actual average it’s going to be lower, by far, than the median. On average you’re going to see something in the $2 million to $2.5 million range. But in fact, our more median type sweet spot deal is still $5 million to $10 million. It now is more frequently that we find opportunities in the $10 million up to $20 million range but it’s not moved the average significantly from what we’ve had over the years. It is growing as we grow but not in a big way.

Operator

Your next question is from John Moran – Macquarie Group.

John Moran – Macquarie Group

Maye just circling back to one that was asked a couple of different ways and there has been folks trying to get at this same thing, just on the FICA if I’m thinking about it right, we drop a million bucks out in the second quarter but we’re adding about a million, round numbers, on average per quarter over the last nine quarters so net-net, and the reason I ask is that I’m just kind of consistently modeling this line wrong, net-net we shouldn’t really be looking for much movement on that salary and employee benefits line in quarter-over-quarter second versus first? I’m reading you right there?

Peter B. Bartholow

You’re probably right and obviously it’s a function of when we are successful in recruiting. Obviously, we recruited well in the first quarter. Most of the RMs, as I said, came in the early part of the quarter so you’re not having a big spill over from Q1 to Q2 although the overall staffing levels have risen consistent with what we described. You do get the benefit of that but along with the increased staffing comes the income from the production that occurred in Q1 for which we only got a partial quarter and going into Q2 where we may see continued significant growth in the traditional held for investment categories and some growth we expect in the mortgage finance group.

John Moran – Macquarie Group

The other one I had is really kind of housekeeping on the brokered loan fees and maybe it circle backs to some of the discussion that was just had on syndications, but if I look at that line that is down kind of 40% from where it peaked last year and understanding of course, that you guys had a participation program going on in the mortgage book, but is the 28 level that we’re at here, all that mortgage participation stuff is scrubbed out at that line at this point or most of it is anyways and we would just kind of grow with production here? Is that fair to say?

C. Keith Cargill

We should because most of the pricing pressure on the fee piece [inaudible] on that. So, as we pick up volume with a seasonally better second quarter we should see that line move linear with that volume pick up.

Peter B. Bartholow

You mention it in connection with syndication. There’s not a meaningful syndication number there, that’s the volume of transactions in the mortgage finance group.

John Moran – Macquarie Group

So that would be expected to be seasonally strong in Q2 and then just kind of going, as that business goes, in the back half of ’14?

Peter B. Bartholow

Yes, and not as exposed as greatly to the competitive pressure.

C. Keith Cargill

Quarter two and quarter three are typically your best quarters on the house buying market, and that’s our core customer not the refi customer.

Operator

(Operator Instructions) Showing no additional questions I would like to turn the conference back over to Heather Worley for any closing remarks.

Heather Worley

If you have any follow up questions, please feel free to call me at 214-932-6646 and I’ll hand over the call to Keith for closing remarks.

C. Keith Cargill

Thank you very much for your interest in Texas Capital Bancshares. We are pleased with the growth we experienced in the first quarter and the pipeline we’re looking at executing on both talent as well as core business in loans and deposits in the second quarter. We see a really great opportunity to continue to take quality market share this year. Thanks again for your time and your interest.

Operator

The conference is now concluded. Thank you for attending today’s presentation you may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!