LegacyTexas Financial Group Inc. (NASDAQ:LTXB)
Q2 2016 Results Earnings Conference Call
July 20, 2016, 09:00 AM ET
Scott Almy - EVP and COO
Kevin Hanigan - President and CEO
Mays Davenport - CFO
Michael Yang - SunTrust Robinson Humphrey
Michael Ross - Raymond James
Frank Barlow - KBW
Brett Rabatin - Piper Jaffray
Brad Milsaps - Sandler O'Neill
Matt Olney - Stephens
Christopher Nolan - FBR and Company
Scott Valentin - Compass Point Research & Trading
Gary Tenner - D.A. Davidson
Good morning, and welcome to the LegacyTexas Second Quarter 2016 Earnings Conference Call and Webcast. [Operator Instructions] Please note this event is being recorded.
I would now like to turn the conference over to Mr. Scott Almy, EVP and COO of LegacyTexas. Please go ahead.
Thanks, and good morning everyone. Welcome to the LegacyTexas Financial Group's second quarter 2016 earnings call. Before getting started, I would like to remind you that this presentation may include forward-looking statements. Those statements are subject to risks and uncertainties that could cause actual and anticipated results to differ. The company undertakes no obligation to publicly revise any forward-looking statement. At this time, if you're logged into our webcast, please refer to the slide presentation available online, including our Safe Harbor statement on Slide 2. For those of you joined by phone, please note that the Safe Harbor statement and presentation are available on our website at legacytexasfinancialgroup.com. All comments made during today's call are subject to that Safe Harbor statement.
I'm joined this morning by LegacyTexas President and CEO, Kevin Hanigan and Chief Financial Officer, Mays Davenport. After the presentation we'll be happy to address questions that you may have as time permits.
And with that I’ll turn it over to Kevin.
Thank you, Scott and thank you all for joining us on the call this morning. Mays and I will work aside through the slide deck and then time permitting we'll open up the call for questions.
In short, we had a very, very good quarter. We made $0.50 a share an all-time record for the company. And this was a high quality $0.50 a share. We reported record earnings while continuing to build our energy loan loss reserves.
Looking at Page 4 of the slide deck, we highlighted our $23.2 million of earnings or $0.50 a share, an ROE of 1.2%, really impressive loan growth of $424 million or 8% on a linked-quarter basis and our all time best efficiency ratio of 48.2%.
Our continued growth has been balanced with discipline underwriting as evidenced by our NPAs to total loans in OREO of 99 basis points and net charge offs to loans of a scant one basis point. Our TCE now stands at 8.4% and Tier 1 common risk based capital is at 9.28%.
I won't spend much time on Page 5 where we highlighted our impressive market share statistics, particularly in the highly affluent Collin County. The DFW is a fantastic market and is headquarters to 21 Fortune 500 companies and it's also very diverse in terms of its employment base.
On Page 6, I'll point out our 29.5% year-over-year loan growth, our year-over-year deposit growth of 24.2% and our core EPS is up 16.3% over last quarter and 13.6% over last year. Let's get forward and focus on Pages 8 to 11.
On Slide 8, we highlight our energy portfolio which consists of 49% crude oil reserves and 51% natural gas reserves. Importantly 59% of our energy loans are backed by private equity firms with significant capital invested and additional capital commitments available to our customers. We also break out the concentration of reserves by basin or region. About 57% of the reserves are in the Permian, Ark-La-Tex, and Mid-Con basins.
On Page 9, we remind you that we are almost exclusively a first lien vendor in our reserve base portfolio. We have no public company or unsecured exposures, and by design we only have $3.3 million of loans to front-end oil field service companies.
You can also see that a significant level of the reserves we financed are hedged and importantly hedging volumes have increased from where they were at March, 31. At June 30, we had 60% of our oil reserves hedged for the rest of this year at weighted average prices of $63.33. For 2017 we have 48% of our oil reserves hedged at weighted average prices of $56.19.
On the gas side, we have 78% of the reserves hedged for the remainder of 2016 at $3.31 and fully 86% of our gas reserves hedge for 2017 at weighted average prices of $3.9.
Slide 10, concludes our energy slides and shows some continued energy loan migration into the substandard category as we continue to use a $40 price deck and a $28 minimum price deck during the full spring borrowing base season.
Our loan loss reserve related energy loans totaled $21.9 million at June 30, up $4.5 million from March, 31. And these reserves now represent 4% of our energy loans.
Turning to Slide 11, we take a look at our Houston real estate exposure, which totals $466 million, $75 million of which is in the energy corridor. As a reminder we financed stabilized [BNC] [ph] properties at low 60% LTVs and high yields on debt. We have no construction exposure in Houston. The Houston CRE portfolio has a very strong weighted average debt service rate coverage ratio of 1.79% and the yield on debt of 11.91%.
Looking at just the energy corridor, the debt service coverage's average 1.71 times which is actually up from 1.58 times last quarter. Yield on debt remains strong at 11.16 and we can report that our customers are having surprisingly good success in renewing maturing leases.
Let me now turn the call over to Mays who will pick up on Slide 12.
Thanks Kevin. Turning to Page 12 you will see we grew our deposits $319.8 million in the second quarter and $1.09 billion or 24.2% year-over-year. Non-interest bearing deposit ended the quarter at 22% of total deposits, down from the 22.2% of total deposits at March, 2016. Our cost of deposits including non-interest bearing demand deposits increased slightly to 33 basis points in 2016, up from the 29 basis points in 2015.
Slide 13, shows the significant growth in net interest income as a result of the strong organic loan growth. Net interest income for the second quarter was $69.4 million. This was 4 million higher than linked-quarter and $9.5 million higher than second quarter 2015. That's a 15.9% year-over-year growth rate in net interest income.
Net interest margin ended at 379 compared to 388 linked-quarter and 406 for the same quarter last year. 1.1 million in accretion of interest related to the LegacyTexas and Highland's acquisitions contributed 7 basis points to the net interest margin.
Net interest margin excluding accretion of purchase accounting fair value adjustments on acquired loans was 3.72% for the quarter ended June 30, 2016 down 9 basis points from the 3.81% for the linked-quarter and down 14 basis points from the 3.86% for the quarter ended June 30, 2015.
Slide 14 shows the components of our efficiency ratio. Net interest income was $69.4 million in core non-interest income which excludes one-time gains and losses on securities and other assets was $12.7 million for the quarter. Non-interest expense was $39.6 million for the quarter. These amounts resulted in an efficiency ratio for Q2 '16 of 48.2% down from 49% linked-quarter and 51.6% for Q2 of '15.
Salary expense was impacted by an increase in performance based incentive accruals and commissions related to higher loan production, as well as an increase in share based compensation expense due to increase in our average stock price during the second quarter.
Turning to Slide 15, you will see that credit quality remains strong with non-performing assets down 647,000 from last quarter, to $56.2 million. We had net charge-offs of only 90,000 and booked a $6.8 million loan loss provision for Q2 '16. Our allowance for loan loss grew to $62.2 million at June 30, 2016 compared to $47.1 million at December 31, 2015.
We ended the quarter with the allowance for loan loss equal to 1.26% of total loans held for investment excluding acquired and warehouse purchase program loans. $4.5 million of the provision and $21.9 million of the allowance are specifically related to energy loans.
Slide 16 shows our strong capital position at June 30, 2016. I will highlight here that our Basel-III Tier 1 common ratio is estimated at 9.3%. We ended the quarter with 8.4% TCE to total assets and an 8.9% Tier 1 leverage ratio. All of our regulatory capital levels remained in excess of well capitalized levels.
Before I turn it back over to Kevin, I want to give some explanation to the much higher effective tax rate, as this will not be a trend going forward. The increase in the effective tax rate to 36.7% in the second quarter as compared to 34.4% for the three months ended March 31, 2016 was due to the sale of the insurance company. The assets of our insurance company that were sold during the quarter were subject to purchase accounting rules upon the merger with LegacyTexas Group Inc. on January 1, 2015.
Approximately $2.2 million were allocated to goodwill most of which were now deductible for tax. Upon the sale the tax gain was higher than the book gain by that amount of non-deductible goodwill and resulted in approximately 1.1 million of tax expense on the 1.2 million book gain. I expect the effective tax rate for Q3 and Q4 to be inline with the first quarter.
With that I'll turn it back over to Kevin.
Thanks Mays. Let me wrap up with this. For about the last 2.5 years we have been talking about our medium-term goals of growing our franchise to $8 billion focused in the highly attractive DFW marketplace of achieving a 1.25% ROE and efficiency ratio of under 50%, while getting to a $2 run rate for EPS.
We continue to execute on this plan. We passed the $8 billion asset mark in the second quarter. We reported our second consecutive quarter of sub 50% efficiency ratios and made $0.50 a share. While our ROE this quarter of 1.2 falls a bit shy of our targeted 1.25%, it was clearly impacted by the continued add to our reserves for the energy loans. In short, this team of some 800 plus people continues to execute on our plans.
With that let's open up the call for questions.
[Operator Instructions] And our first question comes from Michael Yang of SunTrust Robinson Humphrey. Please go ahead.
Hi, good morning. Congrats on the second quarter first of all. I wanted to ask just a little more on sort of your credit outlook from here, maybe specifically as it relates to provisioning. Should we expect additional sort of qualitative reserve build from here within the energy or have we kind of peaked in, maybe if you could sort of characterize the increase in the sub standards within the energy book this quarter?
Yes, we certainly can but who knows where energy prices go for here. Our gut sense and our gut feel is there they are more likely to stabilize and/or go up even what's happening to U.S. production. But then in the event it does stabilize or go up from here. I don’t think you will see growth in few factors and things of that nature.
As we just look at the credit quality of the portfolio, obviously there was little bleed into the substandard category in the quarter and little bleed into the OAM category in the quarter. Again we use the lower price deck, the lowest price deck we've been using throughout this cycle $40 for 2016 on a base case in 28, on a stress case across the entire portfolio.
You could expect I think that most of us have increased our price stacks so when we go into the fall over determination, less price is dropped from where we are now. Our price decks will be higher and that will obviously help across the board.
One of the things that's - it's kind of an inside baseball, it really low price deck, once the well becomes economic, let's say at our $40 price deck, even if in future years it becomes economic again because where you are out relative to the strip, it doesn’t get to come back into the borrowing bases. So once it’s out it always out.
So one of the things that will happen of the higher price deck is some wells that were uneconomic at 40, are going to enter back in the equation and stay in the equation for the full run of the cash flows that we do.
So we are probably at the peak. As I just look at the portfolio in general. I think our criticizing classifieds were $188 million at the end of Q1 which is 36% of the portfolio and if we roll back to what we are talking about last quarter, we said we had $55 million of SNIC deals that we rated past that we had rated worse than past.
We didn’t upgrade any of those this quarter as we went through the spring borrowing base redeterminations season. Our [litmus test] [ph] was not what the regulators having equated at. It's how we feel about the credit and our standard was and had to be materially better than it was the last time we looked at it, or we wanted to upgrade it.
And some are more a little better but not material enough for us to upgrade it. I prefer not to have out of volatility in these upgrades and downgrades. We’ll keep an eye on those and if they are suitable for an upgrade of higher price deck in Q3, we will do it then and obviously that will be a good guy.
As we roll forward to Q2, that criticizing classified group of $188 million to $214 million, so a couple of credits level little harder, okay, little harsher and that now represented about 36% of our portfolio of 39.
Now I am going to link two other concepts together here, Michael. Our loan growth of $424 million was staggeringly good. Way better than any anticipation we had and way better than any other quarter we had. But what happen is, we had about $70 million worth of pay-offs that were slated to occur at June 30, it did not occur.
June 30 is - especially when that comes late in the week, I think it was a Thursday. You lose a lot of people heading out for 4th of July weekend and some deals swift in terms of closing into the next quarter and that's what happened here.
So we had about $70 million worth of pay-offs occur early in the quarter which will be a headwind for growth this year - this quarter. So, last quarter was probably more realistically like a $355 million growth quarter without these deals. Importantly, out of that 70, there was a $36 million pay down to zero of our ever criticized energy credit.
Right, so it didn’t make it into the quarter. But had it made it into the quarter, our OEM and sub standards would have led down to 33% from 36%. So rather than going up 3%, it would have come down 3%. The bank just doesn't run on the time clock of the public markets and something slip. So I'd say the portfolio feels to us better across the board, balance sheets are getting restored either through better cash flows and then not putting it into drilling yet and or private equity coming in.
On the pay down I’m talking about of $36 million that occurred right after quarter end. That was $147 million outstanding syndicated credit, and that raised well over that in new equities. So bankrupt got paid to zero, and they're still a client, they still have a big borrowing base capacity and they will use that money to drill and/or for M&A going forward.
So the $36 million payoff is now a very high pass credit because of the new equity injection. It just happens to be funded at zero for the time being. But we do anticipate them funding up over the course of the rest of the year and in the next year.
Okay, great. There was a lot of good color. And just wanted to ask on the margin side obviously some compression there, they got some mix shift with the mortgage business. But we also saw, the warehouse, yields come in a little bit as well as C&I just any color you can provide there in kind of what drove some of those declines.
Yes, let me talk about warehouse first. We kind of held our own where most of the market has gone the lower pricing. We're holding our own - mid 330s kind of weighted average coupons in that portfolio where I think the markets drifted probably and I don’t have all the stats that you guys have but probably closer to less than 3.
So we've done that by letting go of some clients that that really put pressure on pricing or replacing them with clients that we're more willing to pay for - for our services and our money. We got hit by the competitive pressures on some big deals in the quarter and that dragged down the weighted average coupons in that portfolio and also hurt our NIM.
We're constantly looking at that line of business and it’s a really great line of business for us. In terms of the risk return relative to all the other opportunities in the bank and obviously as we manage our growth rates which are strong, we have really good growth opportunities in C&I commercial real estate in some of our lines of business.
So we keep an eye on that margin. It was clearly impacted by - I think we gave up 9 basis points across the board on weighted average coupon warehouse that - that was a big factor in the overall decline in margin.
Okay, great. Any color on the C&I yields?
C&I has gotten – it's always been competitive, it gets continuing competitive. There’s been much written about regulatory pressure on some banks are over the 100 and 300 in commercial real estate to the extent that's true you did you can expect that there will be some non C&I lenders, becoming C&I lenders and giving up the cost of C&I lenders and being aggressive to say C&I deals and we’ve seen some of that. I can tell you we lost a deal, we don’t lose many deals.
I think it was probably the first deal we have lost in a couple of years to very competitive pricing pressure across - and structured pressure across the board. I can tell you we had to deal with prime plus a half I think with owner guarantees and a very tight borrowing base.
As we look at what they were offered by another institution, the pricing was sub 3%. They gave up on the guarantees and had more aggressive advance rates against the collateral. My guys came to me and said, hi you know this guy you want to try to save this relationship and I said not a bad structure.
So, the competitive pressure is every now and then you get something really wacky like that. And congrats to the company for giving a really great deal, that’s just - that’s way too cheap for the risk of that deal.
Okay, great. And one last one if I can sneak it in, just on the mortgage warehouse volumes, the period and balances were down actually quarter-over-quarter. Just curious was that more of a proactive capital management action or…
It was, and as we just look at all the other opportunities we had and obviously we’re looking at staggeringly high loan growth and it could have been even higher than that, where we did have a few things that slipped in terms of fundings as well.
And we were looking at just the proactive management of our growth and we work with some of our clients for more muted volumes at quarter end and that worked out very well for us. You know Michael at the end of May, the month end balances were close to $1.3 billion I think. So it was just a management of a line of business where spreads are compressing and we have to think about risk return and that was just part of our process during the month of June with a couple of clients.
Okay, great. Thanks.
Our next question comes from Michael Ross of Raymond James. Please go ahead.
Hi, good morning guys, how are you? Just wanted to touch on the two markets Dallas and Houston first. You know Houston, Kevin any kind of commentary you can provide, just updates on what's going on there in the portfolio, looks like balances were up a little bit and then on Dallas just want to see how much of the growth is maybe coming from some of the newer lenders you may have hired and maybe how many did you hire kind of this year and what's the pipeline like for lending hires at this point given in this location in the Dallas market? Thanks.
Yes, in the quarter we hired three. We hired a new energy guy, believe it or not but we have lost one. We hired somebody in our new insurance lending division and that’s been a very active group as they migrate clients from another bank over to us so that's been part of our growth. And then we added somebody in mortgage warehouse business kind of focus maybe on the smaller end mortgage warehouse plans that are a little more or little less price sensitive.
So there were three hires, they will add to our volume going forward. They fit in all of the boxes that we look for as we bring somebody on, do they do our kind of deals, do they fit in our culture, do we really believe they can migrate significant amounts of credit of their existing portfolio over to us in all three cases that was true.
So they added to the volume a bit in Q2, my expectation is they will add more in Q3.
Okay. And then any commentary on Houston generally speaking?
Houston, if there was a surprising stat to me on Houston is our debt service coverage ratios in the energy quarter actually went up and while there is a lot going on down there on balance it's extremely positive. The biggest lease we have in the portfolio was up for renewal and it was a pretty significant lease in a over 200,000 square foot building, 13,000, 15000 square foot lease. I talked about that lease before and are worried about that one, they actually renewed it at $3 of foot higher than their prior lease.
So that was in a wild moment and as we sat around and talked about that, I think what really happened in Houston is these leases that are coming up now were put on five years ago. So they were put on in 11 or 12 kind of timeframe. And the market back then was lower and raised up through 13, 14, 15 to higher levels but as it migrated back down from the highs of 2015 if you will to where we are today but still above where we were in '11 when we were signing these leases.
So that’s what's driving believe it or not an increase in the debt service coverage ratios there. So that’s probably the best news story. The biggest lease is renewed for another five years on really favorable terms and you know that was a worry point. I think the worst news there is we had one not nearly as big of a lease, I think it was 6,000 square feet they renewed but with lesser space, they were downsizing a bit, so but still at a very attractive rate. So I think that was the worst of the news out there.
But on balance what we are seeing is slightly higher renewal rates on leases than the existing rates. Hence that service coverage ratio is going up there.
Okay, that’s helpful. And just one from me Kevin, you got it to kind of mid teens longer upgrade X the warehouse last quarter, you’re tracking about 10 percentage points above that through the first half obviously understand the commentary and payoffs but should we expect higher levels of growth in what you had got into last quarter?
Yes, I won’t get too jiggy about the 32% growth rate of this quarter again because we had some payoffs and now we’ve got the headwinds of dealing with payoffs. So, but we do recognize we’re well above of our mid-teens guidance.
So we’re probably more likely to be on the higher end of that guidance or maybe into the higher teens, Michael, for the year. The third quarter could be new just to bet as we work through the payoffs that occurred early in the quarter. And by the way, those payoffs don’t bother me one bit, if somebody says you’re going to grow slower and you can get out of a $37 million OEM energy credit. I will take that trade all day long and explain to you guys why we’re growing a little slower in the third quarter. But that’s a good guide on balance for the company.
Okay. Thanks for taking my questions.
Our next question comes from Frank Barlow of KBW. Please go ahead.
Good morning and congrats on the record quarter. My first question is on the energy portfolio, how committed are you all to potentially growing our portfolio and do you have any appetite for purchasing loans from any of your competitors?
No, we don’t – that’s really not our way to go about the business. We are committed to the business. I don’t anticipate to go into 15% of our overall portfolio. It will be in the 10 to 11% range of our overall portfolio. We did some new deals in the quarter. I think we did four new deals in the quarter.
And I could tell you the characteristics of the new deals is really good, probably some of the best structures I have seen in a really long time in the oil and gas business, really big levels of private equity backing management teams to buy assets or to expand assets.
Pricing that is 75 to 125 basis points higher across the grid. The standard has become 4 or 5 years’ worth of hedging very significant volumes, call it 75 to 90% of volumes being hedged out for 4 or 5 years. And relatively low advance rates against PW9 values. I would say on average it was probably 50% or just slightly below 50% initial advance rates versus everybody’s policy is more like 65 so -- and tons of liquidity.
So they are really much better deals and again all of these were into written – at a $40 price stack and $28 million - or $28 minimum price stack either abate in the first quarter and funded in the second quarter or we did do a couple deals we approved in the second quarter that actually funded in the second quarter. So we will take that improvement across the board and stay committed to the business.
Q – Frank Barlow
Okay. That's great color. And then another question, just given the pace that you are growing I mean you could cross the $10 billion mark in one to two years it seems. You know, what’s your desire to cross that mark, how have you all prepared to do that and can you give us an update on your thoughts on potentially partnering with another institution to do that?
Yes, so I concluded our remarks of, we’ve been talking for years about what we intended to do here. We intended to turn this into an $8 billion single market franchise with size, scale and density which we think creates values and drives down cost.
We intended to do that very profitably, be good allocators of capital and drive a 125 ROA and I believe with that one quarter that was 128, if the provisioning for energy abates there is no doubt we will be back to above 125 again. And as the sub 50% efficiency ratio and while there -- I said last quarter let’s not get too excited about us being here. We could drift between 49 and 51 I think we’re now forever below 50.
So we’ve hit all of those goals but we’ve also said when we did that we’re going to hit a crossroad of what do we do next. And we sit down with our Board once a year in August and talk about all those kind of things.
So we have a day planned and in not too distant future and the past are too full. Okay. Either the franchise is very valuable to somebody, all right, and we can go down that path or it seems we could do a merger of equals or do something to leap frog the tan and get into the 12 to $15 million range. And I won’t think that should be a surprise to anybody because I’ve been talking about that for about two years as well but we operated M&A out of three buckets.
The smaller end market guys we would buy to get to 8 billion while there's - you know, that’s not part of our strategy anymore. Makes no sense for us to go buy a $0.5 billion bank when we are growing almost $0.5 billion in a quarter and as we get closure to $10 million.
The middle bucket was the MOE bucket and then the far bucket is who wants to come to Texas so, we really focused on the buckets two and buckets three at this stage of the game and it's my job to create opportunities in both of those buckets to the maximized value for our shareholders and that’s exactly what we intend to do.
Q – Frank Barlow
It's great color. Thank you.
Our next question comes from Brett Rabatin of Piper Jaffray. Please go ahead.
Hi, Kevin good morning. Congrats on the loan growth you didn’t talked too much about deposit generation which was really strong as well. Can you may be just talk some about that and your goals for the efficiency or for the loans to deposit ratio kind of going forward and new thoughts on growing deposits, the various lines of business.
Yes, one of the new lines of business we started was this insurance lending group and it’s a very deposit rich business which is why we are - the big reasons why we are getting into it. I will tell you obviously we started off in the whole with payoffs and our deposit generating capacity is continued very strong into the month of July.
So I think some of the strategies that we are employing to manage the loan to deposit ratio more efficiently are working for us. I'm not quite ready to say we’re going to outgrow our loans with deposits this quarter but I think this is a really good chance that we might.
The strategies are working I think - I think it will be evident as we go forward. I think our loan to deposit ratios are hovering right around 100%, there is a board policy of 110. We have more than adequate sources of availability through the flub. I think we have over $1 billion of availability Mays.
So, it's not like we can’t fund loans at relatively keep prices obviously we prefer to drive the deposit franchise because that’s more valuable in terms of building franchise value.
Okay. And then I guess the other thing I was curious about was kind of thinking about the expense run rate, with the incentive comp in this quarter is 2Q levels kind of a good run rate going forward, any thoughts anything that might impact that in the near term.
Brett, it's Mays. I think we should be able to bring that down a little bit. We had couple of things that came into the quarter, one was as you mentioned – it has been mentioned that compensation with higher loan production during the quarter, we had to case up a little bit on bonus accruals, as well as we had some extraordinary kind of consulting fees, I think you probably saw from the release.
We actually spend some money on [DFW] [ph] just a little bit of get ready, I think we've signaled that we are going to be doing that. We spend a little money on that, some high key consulting. So, one thing I have been working real hard on is keeping the expenses below $39 million for the quarter, so I’m continuing to work on that.
One thing I do want to kind of throughout there is, you guys start updating your models is with the sale of the insurance agency, that non-interest income and non-interest expense will go away. So, there was quarter to-date non-interest income of about 642,000 for the insurance agency and about - income and about 604,000 of expenses.
So, I mean just pulling those expenses out we would have been below $39 million but I think on a - just if you’re looking at that quarter and what would be run rate, I think it will be simply similar I think we can probably come down beside the insurance - agency come down, may be close to 600,000 from there.
Yes, I kind of think with this headwinds to tailwinds. Headwinds are as stock prices goes up and we continue to produce loans we might have either share based compensation move up because the stock price or bonus pool accretion as we build into the bonus pool, those are good news events. Right, I don't take those as bad news events.
And in terms of tailwinds we still have a couple of branches to close that we have been talking about. We've said we’re going to close for this year, we’ve got a couple left to close and I think beginning in August our costs of - cost goes down, goes down a couple 100 brand a year and then the final tailwind would be - we talked about this a couple of times these debit card fraud losses.
We were hit by the windy situation and one of the things we found out to windy situation is 35% of our consumer clients event windy, so it was - we probably took an outsize hit in terms of debit card fraud losses which we are running about 350,000 grand a month.
I think we've got all of those 12,000 cards replaced and almost done with a chip embedded card re-issuance that’s been going on for couple of months. Both of those things are going to help on the fraud loss side. How much I don’t know, but I think we can cut what we had closely in half. So we do have some tailwinds on the expense side.
Okay. That's great color. Thanks.
Our next question comes from Brad Milsaps of Sandler O'Neill. Please go ahead.
Hi Kevin, Mays. Hi Kevin, just curious if you kind of give some color on kind of new and renewed loan yields that you saw during the quarter. Just trying to get a sense of - I know the warehouse had a bit impact on the margin this quarter, but just trying to get a sense or maybe potential how you are going to think about maybe further compression in the back half for the year?
Yes, competitive in C&I while competitive in oil and gas it's at higher rates so that portfolio is going through a re-pricing at somewhere higher than where it was, which will be helpful. We get a couple of bigger deals in CRE that we are normally a 5% vendor in the CRE bucket. We did some 450s and 475, so this quarter was probably one of the rare quarter where we are below 5%.
As I look at the pipeline surprisingly we got some deals in there well above 5%. We got some 575 and 576 in the pipeline, whether that means we are able to hold 5% for Q3 now it’s too early for me to say. But I was more worried about it when we had 10 year dancing around at 138 than we are dancing around today haven’t seen where we are this morning 150, 160 allows us a little more leeway.
But if the tenure does drop down into much lower levels that will hurt that product line and that commercial real estate product lines are big category for us. So that's what we are watching probably more closely than anything. Tell me where the tenure is going to go and I can probably tell you where that line of business is going to go.
That’s where we are getting really good deals. And you all know because you follow the company or mostly know because you follow the company really long time. We are not an asset sensitive play, we are actually in the static basis we are slightly liability sensitive. And on a more dynamic basis, we are probably neutral, so we are not a big - we were never a big play for rate rises. That said the flattening of the curve is not good for our business.
So would it be safe to say so actually what's going at the warehouse that sort of the magnitude of pressure, you saw this quarter will be less over the back half of the year similar tenure going to stay where it is?
Yes. Similar to less spread, does that mean we are at 375 to 380 NIMs I think that's probably - Mays I think it’s probably pretty close to what we are thinking. New information comes into us every day as we look at the pipeline and we are managing for yield. If clients are willing to pace enough and we have to grow it at mid teens rather than high teens, we will grow it mid teens. We are not afraid to walk away. We have shown that in the past in businesses and they gotten way too cheap.
Q – Brad Milsaps
Sure. I know that’s great color. And just a follow up on the energy loan that you resolve in July to the bankruptcy proceedings, do you anticipate using the entire specific reserve to clean that up just kind of curious any additional color there on how balance difference than others would be great?
Yes, that was another one that swift. We use the entire reserve and if we add some legal fees for the last minute annually on that thing it’s going to be slightly - very slightly higher than what we had in terms of the impairment charge, but it has been resolved. The deal has done, we financed the new buyer coming out of it. That was one of those deals that swift from a June 28 closing to whatever the first business day in July was closed.
So that NPA is off. Like our NPAs we’re 26 million in oil and gas Mays, and they are down by 12 million.
Okay, great. And that was roughly maybe 25%, 30% of your reserve - your energy reserve right?
It was 6.5 out of the - what is now 21.
Okay, great. Thank you.
Our next question comes from Matt Olney of Stephens. Please go ahead.
Hi, thanks. Good morning, guys. Just going back to the mortgage warehouse obviously there is a nice strength in 2Q. As you look into 3Q so far can you maintain these volumes on average or you can grow this and would you expect the seasonal pressures in the fourth quarter and first quarter still?
No, I think the clients we worked with to moderate the month end balances were quickly sending us files the very next business day, so I think the third quarter does look pretty strong. It may not be as strong as the second quarter for the industry but it maybe stronger in our case because if we have more muted loan growth in the rest of the business, there will be more room for us to do some things with our warehouse clients. It’s just a balancing act. I think on balance for us it’s probably going to be as good or better quarter in Q3.
And any kind of breakout you can give us as far as re-fi versus new purchase Kevin.
A – Kevin Hanigan
Yes, it was exactly 70-30 purchase versus re-fi and if I think about last quarter and I don’t have the stat in front of me but I am pretty sure it was 62-38 last quarter so it was skewed towards purchase but we are in the purchase season. The volumes we’re seeing so far this quarter are matching that 70-30 kind of mix.
Interestingly now that everybody is getting more used to TRID the gestation period in that portfolio when from 17 days to 16 days this quarter. What else could I tell you about it? It’s a pretty high average FICO scores, LPVs are right at 80%, FICO scores running 720, the average cut size deal in the portfolio is about 276,000 so it’s a lot of small loans.
I am sorry the average deal…?
Average 286, my glasses are bad. 286,000 is the average size deal.
Did you add any customers during the quarter?
We did. We had at the end of Q1 we had 41 clients. The new person we brought on has migrated to couple of clients over. We ended the quarter at 44 but one of those clients was officially on our books but hadn’t been funding yet.
Okay, that’s great. And then just one more housekeeping question. It looked like service chargers were pretty strong on the fee income line. Any color behind service charge strength?
I wouldn’t say so. It can be lumpy but as we - there is usually a lag. As we continue our success in middle market and corporate banking you fund their loans a lot quicker than you move over their deposits. Treasury management business is, it takes a while to move over and for our customers to retrain their clients as to how they pay things or how they are to pay our client, switching over lock boxes, switching over a whole bunch of wire transfer information all of that, it takes a while to wire that up correctly and believe me that’s one thing you don’t want to mess up. It’s the life blood of our client’s business. The cash flows are getting off of their receivables.
So it tends to lag but we’re having some really good success at treasury management fees across the board with some very nice clients. That was an area a couple of years I think we were probably collecting 15,000 a month in treasury management fees and it’s probably closer to 350,000 a month today and growing every month.
Okay, that's great. Congrats on the quarter.
Our next question comes from Christopher Nolan of FBR and Company. Please go ahead.
Hi guys, good quarter. A quick question, given the capital ratios and your expectations for a margin of roughly 3.8%, it sounds like you might be slowly down overall balance sheet growth in the second half of the year, is that a fair way to look at it?
Well it is, yes, it is because as Michael Rose said we’re 25% so far for the first half of the year and I am guiding towards higher teens and it would have to be slower in the second half than the first half. So that’s not an unfair characterization.
Okay. And then I guess how low are you targeting the TCE ratio to go?
We’ve got room to leverage it. I would say that our constraining factor if there is a constraint and we ended the quarter a bit higher than thought because of some proactive management on the warehouse side. I think we ended the risk based capital rate at 11% Mays.
So that’s where we - we’re a spread bank and we’re a high risk based capital kind of user. That’s the one we really get constrained by over time. I would remind everybody I’ve been clear about this about how we manage that. We manage virtually everything that’s important in this bank at some kind of Broad level trigger and they are all set in our policies. The Board level trigger around risk based capital is 11%. When we add 11% we have a conversation with the Board about where we stand and how quickly we’re consuming capital, how quickly we’re regenerating capital so our earning less the dividends.
What the risk is on the balance sheet and how we feel about the economy and we make decisions about whether we should be thinking about raising higher levels of risk-based capital at that point or not, we generally have not. And then the next trigger for us is at 10.5% where we have a much more serious conversation about where is this going because we don’t ever want to test the 10% threshold.
At some point we may test that threshold. It wasn’t this quarter and if we test it we know we’re pretty aware of where the sub debt market is in terms of pricing, we’re pretty aware of where the sub-debt is in terms of our capacity to issue more predicated on the concept of double leverage which is what the insurance buyers are usually looking at in terms of your maximum capacity and to the extent that our growth and our opportunities are good and we constrain risk-based capital, we’ve got room probably $60 million or $70 million in the sub-debt bucket to support our capital needs. It’s not now and we’ll see how the growth rates go for the rest of the year.
Got it. And then growing core deposits it looks like this quarter your incremental loan growth was funded mostly by time deposits. Should we expect any sort of change in how you are funding incremental loan growth going forward?
No, I think probably the most success we’re having is in the money market account and we’ve got an opportunity to that money market account where we raise the pricing a bit and it’s been successfully executed, if you will, and we’re getting a lot of action in that account. We’re not a market leader by any means in terms of what we’re paying at that upper tier but I think given our credit quality and our name around town and our 60-year history of being in the town as we go out and talk to people that’s where the money flow seem to be coming into.
All right. Thanks for taking my questions Kevin.
Our next question comes from Scott Valentin of Compass Point Research & Trading. Please go ahead.
Good morning guys. Thanks for taking my question. Just quickly on the loan growth, commercial real estate has been kind of in the regulatory grousers lately. You guys grew I think it was $200 million this quarter and commercial real estate is up I think 30% year-over-year. Just wondering one, what types of collateral are you guys focused on, two, and geographies that you are focused on be it Dallas, or Houston or other areas in the market. And third, would be any changes you’ve made to underwriting as a result of increased regulatory scrutiny, not of you guys but of the asset class.
Yes, a really good question because there has been much written and rumored about the subject. And we’re close to the 300% range on the total and we’ll never come anywhere near the 100% range on land and construction, we’re probably at 35% and the vast majority of that is in residential home building.
I think we have a whopping total of 93 million of commercial construction going on and if anything I would expect that number to drip lower between now and the next time we talk. We have a Board policy at 350%, 350% of capital on the total and that’s the one we keep an eye on since we know we’re not construction junkies.
So we have room. We’ve always had the follow-up season procedures in place to be a little more concentrated than your average payer. We don’t feel as though there is anything that would cause us to change that 350%, nothing at all. We have long been good at this product, it’s about a third in terms of what we’ve got in the portfolio call it a third multi-tenant occupied office buildings, a third multi-family and a third retail.
So it’s a pretty well balanced portfolio. It’s primarily in Dallas and maybe some surrounding cities but that I mean, we might have some stuff in Arlington and Erving and folks like - places like that Dalton.
And then we’ve got the $466 million down in Houston but that’s pretty much. We don’t go out of market very often, we might have one or two out of market deals, I think we got a deal over in New Orleans an apartment deal in New Orleans and we did something up in Denver where we followed some really - two of our biggest clients, we followed. So if one like we were taking on - somebody over New Orleans as a new client, it was a Dallas based client doing something in New Orleans.
Low LTVs, the portfolio has got about a 62% LTV across the board and a bit over 12% yield on debt. So it’s generally really high quality stuff. Our tracking and monitoring about product type and geography is outstanding. I think we've gotten comments from many regulators since we’ve had virtually all of them regulate us at one point or other about the quality of our underwriting.
So I don’t know how this is playing out for other people, but our position remains at the board level we can go to 350% and we’ve seen nothing or talked to nobody that would indicate that that is anything but doable.
Okay, thanks. And then just a follow up. You have many changes in terms of monitoring underwriting as a result of any regulatory guidance that’s out there.
No, we stress test the portfolio twice a year. Our trigger there by policy is now that if cap rates were to go up, we stress test more often, probably four times a year. But that's only and again since cap rates have not gone up, we haven’t pulled back trigger. Our policies and procedures have not had a change to any regulatory pressure.
Okay, thanks very much.
[Operator Instructions] Our next question comes from Gary Tenner of D.A. Davidson. Please go ahead.
Thanks, good morning guys. Had a quick question on Houston commercial real estate, you did provide some detail earlier. But it seems like we’ve heard a lot of discussion about leasing in Class A, pricing coming out quite a bit and a lot of sublease pricing even lower. Now, I know you’re going to focus on Class A. But I would have thought there would be some kind of impact to the stuff that you do and in terms of cannibalizing tenants et cetera. But your commentary was very positive, so I wonder if you could talk about some of those dynamics.
Frankly Gary I'm surprised. The debt service coverage ratios went up, if there was a surprising number as we were putting together the slide deck and preparing for this call that was the surprise number - we're sure we got this right somebody go run this math again, that doesn’t seem logical to me.
And I’ve been out talking throughout the quarter and I think I talked last quarter, think of the A market, and Houston is way overbuilt in the A space, way overbuilt in the A space. I think they can see rates are going to 20 before this is over. And they started at 9, and I'd be surprised if they don’t go to 20.
The brand new buildings coming out of the ground need about 40 bucks or 42 bucks to be economic. What's happening in Houston is, there18 million square feet of new buildings that came out of the ground but half of those we’re expecting, think about that is being probably 40% prelease. So you had 60%, a half of that is empty and needs 42 bucks and it needs really big tenants.
Unfortunately, the vast majority of the tenants they're attracting are coming out of other A space, older A space in Houston and leaving behind a shadow space or sublets space. That is generally a $30 market and then we got the B space that we play in which is a $20 market. So 40, 30, 20.
I’ve been saying for the better part of six months that I have expect that that $30 sublease market, A market could present put pressure on our $20 B market rents. And we haven't seen it yet but we were preparing for as low as getting pressed some of our clients getting pressed down in the mid-teens to keep leases, as pressure came from the sublet space.
I think the pressure is coming. I think there's been pressure already, it just hasn't gotten down to the point where it’s caused us to lose tenancy in the buildings we're at. And as I said earlier, as we talked about how did this debt service coverage ratio end up going higher in the energy portal rather than lower, it was - we’re roiling over leases now that we’re put on in 2011 and we were recovering back then from the crisis if you will and lease rates were still pretty low.
We are confident and we know leases kind of win up in 12, 13, 14 and 15 and kind of peaked up and now they're coming back down but they are coming back down but there are still above where they were in the 11 which is driving these higher debt service coverage ratios.
Does that mean it’s over, I don’t think so. I think this is a - this could be a couple of year situation for the Houston A space market. I still, I’m concerned at some point there is pressure put on the sublet market relative to the B space $20 market. And we are telling our clients and we've been telling it for a while go ugly early, don’t lose tenants, we only give up a buck or two and live for another day, you’ve got room. So far it didn't happen, I’m not ruling out it could happen.
All right, that’s great color Kevin. Thanks very much.
This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Kevin Hanigan for any closing remarks.
Thanks you all for joining us. Really great quarter for the company, we’re pleased with it. We know we are in - what we done for me likely business, so we’re going to go back to work, we’ll see you guys when you're on our own. Thank you.
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.