LegacyTexas Financial Group, Inc. (NASDAQ:LTXB)
Q3 2016 Earnings Conference Call
October 19, 2016, 09:00 ET
Kevin Hanigan - President & CEO
Mays Davenport - EVP & CFO
Scott Almy - EVP, Chief Risk Officer, COO and General Counsel
Michael Young - SunTrust Robinson Humphrey
Brady Gailey - KBW
Matt Olney - Stephens Inc.
Gary Tenner - D.A. Davidson
Scott Valentin - Compass Point Research & Trading
Brett Rabatin - Piper Jaffray
Michael Rose - Raymond James & Associates
Brad Milsaps - Sandler O'Neill & Partners
Christopher Nolan - FBR & Co.
Welcome to the LegacyTexas Financial Group Third Quarter 2016 Earnings Conference Call. [Operator Instructions]. I would now like to turn the conference over to Scott Almy, Chief Operating Officer. Please go ahead.
Thanks and good morning, everyone. Welcome to the LegacyTexas Financial Group third quarter 2016 earnings call. Before getting started, I would like to remind you that today's 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 are logged into our webcast, please refer to the slide presentation available online, including our Safe Harbor statement on slide 2. For those joining 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 am joined this morning by LegacyTexas President and CEO, Kevin Hanigan and Chief Financial Officer, Mays Davenport. After the presentation, we will be happy to address questions that you may have as time permits and with that, I will turn it over to Kevin.
Thanks, Scott and thank you all for joining us on the call this morning. As we usually do, I will make some brief comments on the quarter and covered the first few pages of the slide deck and then turn the call over to Mays to finish out the debt. Thereafter, we would be happy to entertain your questions. What a great quarter we had; all-time best in several respects. All-time best in earnings, $27.2 million, GAAP EPS of $0.59 and core EPS of $0.61. Our core ROA of 1.38% represents an all-time high and our core efficiency ratio stood at 45.9%, also an all-time best. We will start our prepared remarks on page 4 of the slide deck. We grew our deposits by $505 million in the quarter and we now ranked number one in deposit market share in Collin County, ahead of JPM and BofA. We have steadily moved up from third to second to first in this very attractive market.
As I mentioned, GAAP EPS was $0.59 and core was $0.61, far surpassing our record earnings of last quarter. After loan growth of $424 million last quarter, our loan growth this quarter was impacted by expected and some unexpected payoffs or paydowns in our loan portfolio and totaled $64.2 million in net loan growth. Our NPAs to loans plus OREO remained solid at 94 basis points and our net charge-offs totaled 51 basis points. TCE, the total assets, stood at 8.3% and our Tier 1 comment risk-based capital ratio was 8.91%.
Looking at page 5, I would highlight our year-over-year loan and deposit growth of 22.8% and 28.5%, respectively. Our core EPS is up 22% over last quarter and 56.4% over last year.
On slide 6, we illustrate our strong loan growth since 2011 and the commercially oriented nature of our loans. Let me spend a moment on our somewhat muted loan growth of $64 million for the quarter. To put this in context, we grew loans $424 million last quarter and as I said on the last earnings call, the $424 million was outsized and resulted from about $120 million of paydowns we were anticipating by the end of June that just did not occur. We suggested we all think about last quarter's loan growth as actually being more like $300 million as we expected the $120 million in payoffs to occur in early July. In fact, all of those payoffs and paydowns occurred by July 12.
In addition to those paydowns, we had about another $100 million more in quarterly paydowns than we normally have. These payoffs were spread throughout the portfolio with $85 million occurring in the oil and gas portfolio, including a $35 million criticized credit, about $110 million in CRE split evenly between sales of property and refinancings, about $70 million in our middle market and corporate banking groups and, finally, the sale of about $35 million in FHA home loan mortgages which we elected to sell to reduce future servicing and compliance costs.
On the oil and gas criticized payoff which came from private equity being injected in the Company, we continue to have a $35 million commitment to the Company but with a zero in fundings. We do anticipate fundings in the future as this Company expands organically or through acquisition.
In our middle market portfolio, we had about $35 million in paydowns between two customers who either sold assets or did a securitization. Again, in the case of these two clients, we expect fundings to increase in the future.
So, to summarize, we have about $120 million in payoffs that split from Q2 to Q3 and about $100 million more in additional payoffs over what we normally get in any given quarter.
On slides 7, 8 and 9, we provide information on our energy loan portfolio. Our portfolio consists of 44 reserve base borrowers and four midstream borrowers. The portfolio balances declined by $57 million in the quarter and now stand at $487 million. As I mentioned earlier, we had about $85 million in payoffs in the quarter and about $28 million in new originations.
On page 9, you can see we had a slight improvement in our substandard and substandard nonaccrual categories and our loan loss reserve now stands at 3.3% of the energy portfolio.
On page 10, we take a closer look at our Houston and Houston energy corridor statistics. As a reminder, we have no CRE construction loans in Houston and only 92 in total CRE land and construction in the entire portfolio and we're a low LTV, Class B property lender. The Houston real estate portfolio, as well as the energy corridor subset of the portfolio, is about the same size as it was last quarter.
At the end of the third quarter, our debt service coverage ratios remained quite strong at 1.77 times for the entire portfolio and 1.65 times in the energy quarter. At this stage of the Houston CRE market cycle, we remain very pleased with the resiliency of our portfolio and the statistics regarding the portfolio.
With that, let me turn the call over to Mays.
Thanks, Kevin. Turning to page 11, you will see what Kevin talked about earlier which was a great quarter for deposit growth with deposits growing $505.4 million in the third quarter and $1.36 billion or 28.5% year over year. Non-interest-bearing deposits ended the quarter at 22.5% of total deposits, up from 22% of total deposits at June 2016. Our costs of deposits, including non-interest-bearing demand deposits, increased to 39 basis points in 2016, up from 29 basis points in 2015.
Slide 12 shows the significant growth in net interest income as a result of the organic loan growth and strong warehouse volumes. Net interest income for the third quarter was $73.5 million. This was $4.1 million higher than linked quarter and $12.3 million higher than third quarter 2015. That is a 20.1% year-over-year growth rate in net interest income. Net interest margin remains stable, ending at 3.80% compared to 3.79% linked quarter and 4.00% for the same quarter last year.
Accretion of interest related to LegacyTexas and Highlands acquisitions contributed 6 basis points to the net interest margins. Net interest margin, excluding accretion of purchase accounting fair value adjustments on acquired loans, was 3.74% for the quarter ended September 30, 2016, up 2 basis points from the 3.72% for the linked quarter and down 14 basis points from the 3.88% for the quarter ended September 31, 2015.
Slide 13 shows the components of our efficiency ratio. Net interest income was $73.5 million and core noninterest income which excludes one-time gains and losses on securities and other assets, was $12.7 million for the quarter. Noninterest expense was $39.7 million for the quarter. These amounts resulted in a core efficiency ratio for Q3 2016 of 46%, down from 48.2% linked quarter and 51.9% for Q3 2015. Salary expense was impacted by an increase in share-based compensation expense due to the increase in our average stock price during the third quarter, as well as higher health insurance costs.
With the complete reissuance of EMV chip cards, we're finally seeing a significant decrease in debit card losses and expect that trend to continue.
Turning to slide 14, you will see that credit quality remains strong with nonperforming assets down $1.9 million from last quarter to $54.3 million. We had net charge-offs of $7.2 million which includes a loss of $6.9 million on the energy loan that we had specifically reserved at the end of Q2. We booked a $3.5 million provision for credit losses for Q3 2016.
Our allowance for loan losses grew to $57.3 million at September 31, 2016, compared to $47.1 million at December 31, 2015. We ended the quarter with the allowance for loan loss equal to 1.12% of total loans held for investment, excluding acquired and warehouse purchase program loans. $16.1 million of the allowance is specifically related to energy loans.
Slide 15 shows our capital position at September 31. I will highlight here that our Basel III Tier 1 common ratio is estimated at 8.9%. We ended the quarter with 8.3% TCE to total assets and at 8.7% Tier 1 leverage ratio. While these ratios were significantly impacted by the spike in warehouse loans at quarter end, all of our regulatory capital levels remain in excess of well-capitalized levels.
I will now turn it back over to Kevin.
Thanks, Mays. Needless to say, we're pleased with how well we're executing on our strategy.
With that, let's open up the call for questions.
[Operator Instructions]. Today's first question comes from Brady Gailey of KBW. Please go ahead.
Maybe just to start with loan growth, thanks for laying out the moving parts there and that makes sense. I think in the past you all have guided to loan growth going forward of somewhere in the midteens range. Is that still the right way to think about loan growth going forward?
Yes. We think it is, Brady. As we started the year, we said midteens and midteens off the base, at the start of the year, would have been roughly $180 million to $200 million a quarter in loan growth. So, as we think about it, we were right on that number. I think we did $203 million in Q1. We had a way outsized second quarter at $424 million and again, a lot of payoffs that we thought were going to recur just didn't happen on June 30. That was a Friday, going into a Fourth of July weekend and a lot of folks just cut out of town a couple of days early and deals just didn't get across the finish line. And obviously, a muted loan growth quarter here at $64 million.
Part of that we elected to sell the FHA portfolio. We didn't think twice about whether we were going to report $64 million versus $100 million when we were selling that portfolio. And my guess is in the fourth quarter we returned to something close to what we have been talking about all year which is, if we do another $200 million, we end up the year at a 17.6% loan growth for the entire year.
And I have no reason to believe at this stage of the game, the fourth quarter will be any different than what we see now. We have kind of looked at what is in the pipeline, what is scheduled to close, what is upcoming for loan committee, the payoffs we're aware of. We can always get surprised by a higher level of payoffs, but at this point we don't see it. So I think we will end up doing midteens and maybe slightly better than midteens for the year.
Okay. All right. That is helpful. And then, if you look at your asset base, it is up roughly from $8 billion to $8.5 billion and some of that is warehouse related and can go away. But you are kind of inching up toward $10 billion. I know you have kind of talked about what to do at the Company. Last quarter, you talked about the off-site board meeting where you guys are going to talk about it. Can you just give us an update on how you are thinking about $10 billion? Will you cross it or will you not?
Well, it depends on what happens between now and getting there, right? Things change between June 30 and July 12. We had $120 million worth of loan payoffs and started in a deep hole in just a scant six or seven business days. So we think about it in three different ways. There are very few acquisitions that would make sense to us, but there are a couple. There are a handful of MOEs that would make sense to us. We understand how hard those are to pull off. It doesn't prevent us from trying to pull one off, as well as the acquisitions that we think would be attractive.
And then, there is a handful of folks that I believe would like to get to Texas or have announced they would like to get to Texas and the timing of those folks coming to Texas is somewhat dependent upon have they done a deal recently or are they on the sidelines. There is a whole bunch of timing aspects to that last bucket. And then, the last thing we talked about is -- what I told the board at the planning session was, look, if we can't find something that makes infinite sense to us, in terms of the risk it brings to our balance sheet and whether we want to manage that level of risk for different asset classes that are put on our balance sheet that we don't have today if we do an MOE, versus going through it alone which isn't the most appealing thing in the world, but it is not a disaster, either.
The way we figure it, at a 13.0% kind of ROA perspective, to crash through it on our own, would take about $575 million worth of new loans which is a couple of quarters worth of loan growth for us. And then, we would be at $10,575,000,000, right? And our ROE would drop from 13.0% to a 12.4% at whatever quarter that occurred in and our efficiency ratio might go from 45% to a 46.5%. We're still one of the top performing banks in the country, even if we go through it alone.
So I don't feel stressed about doing anything. I always like to do something and I think rather than just kind of waddle through it and we're going to try to do something. But if something doesn't happen, it is not like a disaster. We still will be running one of the best performing banks in the country for our size with a 12.5% ROA and a sub 50% efficiency ratio.
So, at the end of it, what we just concluded was to keep operating the business like we're operating, try to make something happen and be prepared to go through $10 billion on our own whether that is with a partner or without a partner, just get prepared for DFAST and everything else. And we had been preparing for that, really, for the last nine or 10 months and we will be totally compliant for DFAST by July of next year, well in advance of us getting the $10 billion.
Our next question comes from Michael Young of SunTrust Robinson Humphrey. Please go ahead.
Just had a quick one, first, on asset quality. Obviously, you had the $35 million larger loan in the energy book that cured this quarter, but I didn't notice a material step down in NPAs in some of the related categories. Was there backfill from maybe the SNC exam review or some other movement in the book that kind of offset that?
Yes. First of all, thanks for the question. There was backfill and really a surprising backfill, from my perspective and I think the other banks and the bank group. There was a SNC exam downgrade of a credit. We have about $36 million of the credit. I don't want to say too much about it, other than I can tell you we're really, really, really comfortable with that credit. It is probably our best sponsor -- not probably. It is our best sponsor in the entire portfolio. So senior funded debt to EBITDA -- is less than one time. We just renewed this credit last Thursday. Cash flows are really strong.
They have 100% of production hedged through 2020 and in 2021 they have 38% of their production hedged. So not only are the cash flows strong, they are assured by the hedging and it is backed by a great sponsor. There is not a single policy violation in that loan. It is every single one of our oil and gas policy parameters in terms of half-lives and cash flows and concentrations and everything else. I think it is a 45% advance against PW9 which is really low.
So there is nothing in that credit that makes me think that it should be graded adversely, but it is and we will deal with it. Again, it is not a credit -- and as we look at the credit, what do you do to improve it? I mean, we don't want them to hedge 120% of their production. So it is really a credit we're not at all concerned about and I should probably stop there before I get myself in trouble.
So it is kind of a total more of a total leverage issue that kind of drove the downgrade?
And the total leverage is sub-4. So, it is that 4 parameter that is being used and as we look think about how somebody might have viewed it differently, maybe if you are in the sub debt, you might have viewed it differently. Because there is, obviously almost 3 times worth of leverage in the sub debt piece alone. But the sponsor also has kind of a back up credit facility and it is a possibility for the bank group and I guess if you lump in the sponsors deeply, deeply subordinated credit facility which is largely undrawn, you could get it above 4, that is the only way you could get it above 4.
So I expect somebody looked at it and maybe put all those things together. We don't know what they looked at. I can tell you, we looked really closely at the credit last Thursday. It was scheduled for its normal borrowing base redetermination and it is a really strong credit in our minds, from a senior debt perspective.
And maybe just switching gears, Mays, on the expense side, you usually give us kind of an outlook going forward. I know you have been trying to stay below the $39,000. Obviously, the kind of increase in the stock price this quarter drove some expense inflation. But going into fourth quarter with lower mortgage warehouse balances, should we expect to be that closer to the $39,000 number or--?
No. I hate to say we're going to be [indiscernible] as we continue to grow, we have got to add people to support that growth and the lenders production. So going from $39,000 to $39,000, so basically noninterest expense was flat with a significant increase in net interest income and total revenues. So I feel pretty good about where our expenses wound up. I think some of you have heard us talk, we don't see a lot of headwinds going into the fourth quarter. I don't see anything major that is going to pop up and some of the tailwind that we see for the fourth quarter are about two-thirds of our ESOP shares that we have been allocating expensing were paid off.
The loan to support those was paid off at the end of the third quarter. So we won't see that going forward. That is $200,000 a month. As I mentioned earlier, the debit card losses are coming down. They were not fully down in the third quarter and we actually had some very outsized processing -- debit card processing charges for the quarter as we had the expense of purchasing the plastic and the mailing of reissuance because we reissued every single household that we had. So that was a significant number of cards. So we should be pretty much done with that reissuance.
So, when you look at expenses going into the fourth quarter, we have got those tailwinds helping. Again, I don't want to try to pin down a specific number, but I still feel real comfortable with our expense numbers and don't see anything that would derail the efficiency ratio we're looking at or our total expenses.
I would say the last tailwind, but it doesn't occur until the end of this quarter, is we have two more facilities that we're shutting down. The last two that we have been talking about. One is a full scale and relatively expensive branch and the other one is a drive-through that is a couple of miles from that branch. And I think the cost save on those which would largely be to flow into Q1 of next year is about -- it is about a run rate of $1 million between the two of them.
Our next question comes from Brad Milsaps of Sandler O'Neill. Please go ahead.
Kevin or Mays, you guys did a good job holding onto the margin this quarter. Just wondering if you could give any additional color there, maybe around loan pricing and also deposit costs. It looks like they ticked up a bit, too, but, obviously, able to more than offset that with some better loan pricing. So any additional color there would be helpful.
Yes. We were pretty pleased with the margins we ended up with for the quarter. As you look at the loans that we have done -- I know Kevin talked about it -- in Houston, there is a little bit of Houston premium. We have come off or are getting to the floors on our warehouse. So I think we're pretty comfortable with -- I think last time we said mid 3.80s% or mid-3.75%, somewhere in there. We're actually above that. Don't see anything much changed in the way of accretion that we will recognize in the fourth quarter. So the 3.75% to 3.80% range, I think, is probably pretty comfortable.
And Mays, you mentioned a few things on the expense side that you thought would help you. On the flip side, on fees I know there are a couple of heavier maybe fees you recognize this quarter. Is some of that stuff sustainable or would you -- or some of that stuff you wouldn't consider run rate?
Yes. For the third quarter, there were. There were some -- maybe some deferred loan fees that were recognized of some of those larger payoffs that we had during the quarter. Some prepayment penalties and some of the real estate deals. So we did have that.
But looking into the fourth quarter, I know we have got some swap fees that we're looking at that would most likely offset those. So I don't see any significant falloff in the noninterest income in the fourth quarter.
And in addition to the swap fees that we have got slated, I think we have got a -- we're working through the syndicate -- we're the lead syndicate of a deal and we have got some syndication fees that will be -- provided the deal closes when we think it does, we will have some syndication fees that will flow in in the fourth quarter as well.
All that Kevin is talking about is lumpy and it is. But at our size, you get just a certain amount of that just goes on every quarter. So we don't see a lot of movement in that.
Our next question comes from Michael Rose of Raymond James. Please go ahead.
Just wanted to dig into the warehouse a little bit. Obviously, this quarter really strong on an average kind of period end basis. I know you guys have added some customers over the past year or two. How should we think about kind of a normal run rate? What percentage of the warehouse line this quarter was purchased versus refi and could we expect kind of a higher run rate going forward in the market share gains and maybe client adds?
In terms of stats for the portfolio, believe it or not, we peeked out in 2000 -- I guess, earlier this year at 43 clients. I know we peeked out at 44 clients early this year. We ended the third quarter with 42 clients, so we have lost or fired two clients. At certain stage of pricing, we just walk away and say we can't make enough money to justify the banking anymore. You are just too good for us. It is not us, it is you. Between purchase and refi, it was 60/40. Last quarter it was 70/30, so it was a little more skewed, but a few more refis this quarter than last. Gestation periods remain the same at 16 days.
We do have a couple of new clients teed up which should help volumes, I think, in the fourth quarter. They might be a little greater because of these two new clients than they might otherwise have been. So I think because of the new clients, maybe the fourth quarter, we do a little better than we would have normally done in the fourth quarter because they are both pretty good-sized clients. I think commitments between the two of them are a bit over $100 million and we would expect 60% to 70% usage of that. So we will have a decent fourth quarter in the warehouse and if I had to guess, maybe we end up -- the guys that are in the room here, they hate when I do this -- but we will probably end up $1.2 billion, $1.25 billion, maybe as high as $1.3 billion.
And that is on an average balance basis?
No, that is at the end of the year. So the average will be slightly down from what it was this quarter.
Secondarily, just going back to expenses, we have heard that there has been some lenders floating around in Dallas. What do your hiring plans entail and have you hired any lenders from any dislocated competitors and just kind of maybe where you stand with all that? Thanks.
No new hires, Michael, in the third quarter. I think we hired an analyst in one of our groups. We had done some hiring to start this year, to start the healthcare finance group and the insurance group and we would expect some nice volume out of those two groups in the fourth quarter as they are starting to hit their strides. We haven't closed an insurance deal yet, but we have several [indiscernible] proposing in the fourth quarter.
So we're always looking for good people. We're looking for them now. If we find them, we will hire them and if our expenses are a little higher, in any given quarter for hiring some people, it is only because we think they are going to produce and drive significant returns for us going forward. So it can be lumpy. We just didn't have any in the third quarter.
Okay. And then, maybe just one final one for me and it is actually not an energy question. This may be the first time I ever haven't asked an energy question in a couple of years. But just, Kevin, can you comment on the CRE concentration issue? What you are hearing from regulators? Obviously, you guys have raised some sub debt. Obviously, some of it is for growth and to pay down some higher cost borrowings. But how should we -- where are you in terms of your CRE concentration at the end of the quarter and have regulators said anything to you guys? Thanks.
Yes. Look, we have had a regulatory exam that was a discussion during the exam. We're not worried at all about growing our CRE book. As long as we can find good deals, we're going to continue to do them, even if that takes us above 300%. So we're not under any restriction in terms of going above 300%. We have an internal policy not to go above 350% in total and I think, as you all know, we're just not much of a land and construction lender and the land and construction that we have on our balance sheet is mostly centered in residential. We ended the quarter, Michael, at 35% on the 100 and at 29.3% on the 300. We were slightly elevated, I think, last quarter on that.
We were maybe 302 and 36%-ish at the end of Q2. The sub debt really had nothing to do with trying to get under 300. That was just an added benefit, if you will. I guess we could take us off of screens at least for a quarter. It was all about growth and timing. As we looked into -- and we're into the budgeting process for next year -- as we just looked into our capital plans going out over the next 15 months through next year end. Because of the growth we're anticipating, we thought it was good timing to go get the sub debt. We did it probably a little earlier than we needed to, but we did it in advance of any Fed moves or move up in rates. We got it done in pretty favorable terms and we think it puts us in great shape going into 2017.
Our next question comes from Brett Rabatin of Piper Jaffray. Please go ahead.
Want to just talk about the deposit growth in the quarter and maybe, Kevin or Mays, if you can discuss kind of business line, where all that came from? Obviously, really solid growth and then do you have any goals where you want to get core funding to over the next year and does that help you kind of -- let you reduce the borrowings that you guys have on your balance sheet?
Yes, I will make a comment or two and then Mays has probably got more detail behind it. But it was broad based. It was across every product category, including non-interest-bearing demand which I think is probably $100 million plus of that -- $120 million or $130 million of that. And, obviously, I think we have found a pricing point in the market where we could bring in very large amount of deposits.
We have found that pricing point, so part of that was pricing related, some upper-level tiers in our money market account. So if somebody brings us a particularly big deposit, by big, I mean $5 million or more and usually not to exceed $25 million so it doesn't get too lumpy. But across the board, in every category, we had great success. Mays, do you have--?
Yes, I don't have too much other than to add you talked about reducing borrowings. Typically, we use the borrowings at the federal home loan bank to support the warehouse. Because of the outside deposit growth we had, we did pay down the federal home loan bank some during the quarter. We had some terms funding out there that won't come due until this month.
So, as opposed to paying a penalty to go ahead and paying that off, we just left it out there. So, as you look at that federal home loan [indiscernible] borrowing, depending on what loan growth other than the warehouse does for this quarter, it may go down from where it is. But I don't see that borrowing as something that I can really focus on because it really is specifically related to the warehouse.
And, again, by way of policy, I think we have a policy limit on loan to deposit of 110%. This level of deposit generation which, look, we have been working on this for a while and it was good to see it really pull through in a material way. It now gets our loan to deposit ratio below 95%. So we're in a really comfortable spot in terms of where we sit on our deposit gathering efforts.
And what we did is, we just looked at the amount of dollars we could raise at particular rates and it really didn't affect our NIM that much. And so we went ahead and tried to get that loan to deposit ratio below 100%. And as we talked about earlier, clients don't necessarily work when we want to, so the process of bringing in deposits doesn't happen overnight. So some of those relationships we were cultivating during the second quarter actually pulled through in the third quarter and we see those balances sticking around. These are not balances that are going in and out. Most of these are longer term relationships that will be here for the long term.
And then, Kevin, the other thing I wanted to ask -- because you mentioned earlier in the call the different paths you can take and I guess I am curious if the path ends up being, you are just going to grow through $10 million. Does that come with geographic expansion at some point or how do you think about where you might be two years from now on sort of a standalone basis?
It would not be geographic expansion, if it is going it alone. We like the size, scale and density concept as we sit here today. So, if we're going it alone, we're going to stay right here. We've got plenty to do in this market. It is a really vibrant market and continues to be a really vibrant market, particularly where we're located. That said, if we expand through acquisition and/or through an MOE, it is very likely it is going to take us to a different geography, but probably not outside of Texas.
Our next question comes from Matt Olney of Stephens Inc. Please go ahead.
Kevin, I wanted to ask you about the energy lending. I think the press release mentioned slow originations in the energy book. Any more color on this? I think you mentioned a few minutes ago that there could be some higher syndication fees in Q4. I am curious if this is energy related.
Not on the energy side, I don't think. The syndications we're looking at are middle market or corporate banking syndications. In the quarter, we originated a couple of new energy deals. They didn't fund a whole lot. I think total fundings on those new deals might have been $28 million, slightly offsetting the $85 million in paydowns we had. And the paydowns we had, again, it was a $35 million criticized credit, who is still a customer and the rest of the paydowns were passed credits. They were people who just said, we're taking our money off the table. We had enough of scare looking at $26 oil once and we're done.
So we had a couple of good credits to pay off along the way as well. In terms of loan growth going forward, we're active in the energy space. We're actively looking at deals. If we were looking at, in the third quarter, that may pull through here in terms of fundings in the fourth quarter, we will see how all those play out. But we have seen quite a few deals in loan committee during the end of the third quarter that should be helpful going forward. So I think it is an aberration that the balances dropped down. And, as we just think about the energy portfolio and reserves around the energy portfolio -- and I know there are some questions about whether we released reserves or that propped up earnings and even though nobody has asked, I need to try to dispel that for everybody who thinks that way.
And look, you are entitled to think any way you think, but I would encourage you to think like I am thinking. We ended the last quarter at a 4% energy reserve and we had a very specific slide deck about that energy reserve. It was page 10 of the second quarter slide deck. That 4% was exactly $21.9 million to support $544 million worth of total energy allowance. That was reserve based in the midstream portfolio. The anatomy of that was $6.9 million of the $21.9 million was a specific reserve for the problem credit we have been talking about now for almost 18 months that got resolved. It was supposed to get resolved June 30. It didn't quite close through the bankruptcy court. On June 30, it closed the very first business day of July and the specific reserve we had up against -- $6.9 million was sufficient.
It is exactly about how much we lost on that credit. But if you think about what was remaining, taking out that specific reserve, we had $15 million of reserves to support the other $532 million worth of loans in the energy portfolio. That is 2.8%. Now, we might have had that deal closed June 30. Back then, we might have been talking about how low our energy reserve was instead of the 4% on the second quarter call. But it has actually grown from 2.8%, despite the shrinking portfolio, to 3.3% reserves today. So we actually increased our energy reserves.
Part of that is, when you suffer a loss, that loss goes into your factors in terms of determining your ALLL against a specific asset class. And the rest of it was Q factors. And out of what we have remaining in there today, very little of it is impairment related. I think we might have one or two impairments of $100,000 or $200,000, but the portfolio is in really good shape.
We feel comfortable with the 3.3% number. But at 3.3%, we actually built reserves. Q factor reserves as opposed to specific reserves into the portfolio. So whether we choose to call that a release or not, I don't think of it as a release. I think that we built energy reserves, just not specific reserves because the credit related to the specific reserves which was a $12 million credit, is gone, thankfully.
And on that note, how are you thinking about incremental provision expense from energy credits from these levels? I mean, what are the scenarios where there could actually be higher incremental provision expense for energy credits?
You know, we haven't bought our Q factors down yet. We haven't even talked about bringing our Q factors down yet. Oil feels a whole lot better to us at $50 or $51. We would like to see a lot more stability of $50 or $51 or higher numbers before we probably even consider lower levels of queue factors. By the very nature of the loss that occurred, that is going to stick with this for a couple of years in terms of factors against the portfolio and we're really much more comfortable -- I mean, nobody talks about it much, but gas above $3 is a big deal because that is half of our portfolio and when gas is $1.80 -- and, as many of you know, I have talked about I am more worried about gas longer term than I am oil, it is really good for us to see gas up in the $3-plus range and getting our clients to be hedging at these levels of gas.
It is going to be meaningful. So I think there will be -- for every new deal that comes, there will still be elevated provisioning for those new deals, even if they are really good credits because of the high Q factors until we reel the Q factors in. That said, I think the executive team and the board -- we're all way more comfortable running this Company at a 110 or 115 ALLL to loans which is where we've kind of been operating for a period of time. And there is always another rainy day out there. So I guess that is why I think -- if people think we're going to bleed reserves out of energy, it is really not our intention to do that anytime soon.
And then, just lastly for me, Mays, you mentioned the margin outlook at 3.75% to 3.80% in the near term. But, as you look into 2017, can you talk about the pushes and pulls on that margin? I am just trying to get an idea if there will be incremental pressure on the margin beyond the fourth quarter.
You know, I guess when you think about changes in that, I mean, we have about $8.4 million of accretion left to be recognized on the portfolio. So you have a declining curve, if you will, on that accretion recognition. So I would assume that you would have a little bit of pressure coming in from a reduced accretion during 2017. Sitting in loan committee, what I have heard is we have been able to maintain our rates. We're not -- what we do is different than what everybody else does. We tend to win on execution and timing and ease of completion of the transaction. So, as Kevin talked about on some of the warehouse clients, we will let them walk away if the rates don't pay fairly for what we feel we're providing. So just continue competition, maybe in the C&I, Kevin, area might, but I don't see anything.
Yes. I mean, the only thing I -- look, we have had a period of elevated pricing in oil and gas which has helped offset the increased deposit pricing costs. It has been a big factor for us. We're basically 100 basis points better off across the grid in oil and gas lending. It was slow for the industry to get risk return more in line during this period of time. I fear now that all the lenders are kind of -- or most of the lenders are returning to this space. We will all act like kids at a party and let that pricing benefit we have had go away at some point and I fear it could happen to same.
It hasn't happened yet, but I worry about that as an asset class that would -- and it is not a huge asset class for us. It is $500 million, $550 million. I worry about giving away some of that extra 100 basis points at some point next year if the market gets a little too heated up which it could in certain segments. We're seeing things that, in the Permian, the stack and the scoop, things that are -- those are really hot areas and a lot of money being poured in those areas and I think credit facilities there are in demand. We all would like to do them because they are pretty well structured. I am not calling for pricing to come down. I just worry about it.
Our next question comes from Scott Valentin of Compass Point. Please go ahead.
Just a quick question on the loan that charged off this quarter, if I am doing numbers correctly, it was a $12 million credit and had about $7 million of associated charge-off with it. So the severity right there is about 60%. Is that fair when you look at it?
Yes, that is not how we look at it, though, but that math I cannot argue with. I mean, obviously, that is the math of that particular credit. The history on this one, Scott, is that it was a $36 million relationship, all the same reserves, slightly different ownership in the $24 million credit versus the $12 million credit. But exactly the same reserves and we treated it as one relationship with the same guy running both companies and the same executive team and operators and everything else throughout the Company. We resolved the first $24 million with no loss.
We collected all principal interest, attorneys fees, everything else related to that $24 million, right at the end of the year and we had pushed this other one into bankruptcy to prove how serious we were about resolving it. So the bankruptcy of this $12 million piece dragged out for a while with operators not -- with certain vendors not getting paid and mechanic liens being filed and a lot of legal fees and a bunch of other stuff. So we think of it as a $7 million loss relative to a $36 million relationship.
Okay. That is a fair way to look at it. And then, just -- you mentioned -- I know you gave us the stats on your Houston portfolio. Things look healthy there. But what are you seeing in terms of -- for, I guess, commercial we have heard vacancy rates are up again and you are seeing additional pressure on -- with [indiscernible] space coming online, as well as multifamily, hearing a lot more about giving one or two months away free rent as incentives. Are you seeing any pressure on values in Houston from multifamily or commercial real estate?
You know, we don't track the A markets since we don't play in it at all. So I guess we track it a little bit in terms of vacancies and I have been calling for higher levels of vacancies in Houston. Earlier this year I said, they went from nine to 13 and were going to 20 or 21 and I believe we will head to 20 or 21 Class A vacancy. I think there is some over 10 million of sublet A space out in the marketplace available today. That is just a staggering number for Houston. The B space has not been affected yet in terms of what we're seeing our clients get in terms of rents. They are still getting $17 to $21 on rents.
I have been saying I expect that to change. It hasn't changed yet. I talked last quarter about the largest tenant of any of the buildings we have down there which is about a 15,000 square foot tenant, actually renewed their lease for another five years at a higher rate than the ongoing rate. So our debt service coverage ratios got better last quarter and held about the same this quarter in all of Houston and the corridor. I am not ruling out at some point, though, that Class A sublet market could put pressure on some of the B lease rates in Houston before this is all said and done.
Do I think it will impact our portfolio to where we have problems? Probably not because with those levels of debt service coverage ratios at $19 and $20 rents, all of our customers could go down a lot lower than $19 or $20 and still service debt. Now, their value proposition in terms of the equity value of those properties is going to go down, but the debt is probably still in good shape all the way down to $14 or $15 rents, probably and I just don't see the sublet market going down that low. I mean, you're getting awfully close to cash on cash negative if they go that low, so I just don't see that happening.
Okay. And then, any color on multifamily? I don't know if you guys are heavily involved in that space or not, but--?
We're, but most of the multifamily we do is B and, in some cases, C properties and those properties are really, probably in terms of yield on debt, some of the strongest ones we have in the portfolio. And we're talking about properties that they are getting $0.95 to $1 rents. So we're nowhere near that A space. And suffice it to say, that is just not a space we play in or ever intend to play in.
Our next question comes from Gary Tenner of D. A. Davidson. Please go ahead.
My question is largely asked and answered, but I wondered if you could just remind us what the dollar amount and rate on that term funding that comes due later this year month was?
I don't have the exact amount on that. We have got a couple of -- some that are 30 days. Those were ones that the rate wasn't really high. It was just we didn't need -- I mentioned it because we could have paid it off and paid down borrowings, so that wasn't significant. We do have some that are probably in the 2% range that have been on the books four or five years that will be coming due, but that is not significant. Maybe $100 million, $150 million. So it is nothing that is too significant, but it will have a little bit of impact.
Okay. And then, just one quick follow-up on the deposit piece. I know there were a lot of questions on that already. But you mentioned, Kevin, that you've kind of found a sweet spot where you could bring in deposits. Where is that rate where you are bringing in deposits kind of relative to the market today?
Yes. Look, it depends on whose market. You have got some of the really big banks that are paying 15 basis points on a money market account. And what we have done is, we have set a very upper tier of the money market account that you have got to put at least -- the threshold is usually $5 million and we will pay 75 basis points. And that is the financial institutions that have got money parked at the Fed and that is very competitive with what other, if you will, corresponding banks are paying for banks to place money with them.
It is just in competition with whatever they are earning at the Fed and then that also pertains to that upper level of money market account. On an exception basis, I think we have gone -- that has got to come to me or Mays to approve anything that is an exception above that and any other banker would tell you this. Once you make an exception to come to the CEO's office to get something done, whether that is a new hire or a rate assess, nobody does it. They don't want to show up in my office with that because I just -- as you all know, it doesn't take much to irritate me and that would irritate me.
Our next question comes from Christopher Nolan of FBR & Co. Please go ahead.
What is the oil and gas prices that you are currently using for credit assessments of your energy business?
Base case $40 minimum price debt for oil. And on gas it might be $2.75 and I can't remember what the minimum is on gas. I have all that stuff loaded up and I just failed to walk that in with me. But base case is below, obviously, where we're and in the out years, we generally try to be 8% to 10% below the strip. And that is, for all of us -- quite honestly, that is a lesser cushion than we have historically been at relative to the strip. But that is just where the market has been for the most part. And so we just try to stay well enough below the strip that we have some kind of margin. Not the margin we had two and three and five years ago or for a long period of history. So it is just how it has evolved.
And, Kevin, on the discussion on the loan loss reserves, you were talking about ideally you want to be, I guess, between 1% and 1.15%. How soon do you want to get there in terms of--?
Well, I think we were at 1.15% last quarter, right?
And we think of it in terms of excluding the acquired loans and the warehouse loans.
And we have had some say your provision is -- your analysis is 70 basis -- well, we don't book anything on the warehouse and then we also don't include the acquired. So that is where our provision was at 1.12% and that is the way we think of it.
Yes. So I really don't feel like we need to build it. If it came across us, we feel like we're going to be building it up. That is probably the wrong impression. So thanks for the question so we could clarify.
Okay. And then, the final question is, given the growth in time deposits and savings and you're getting some traction in terms of your pricing structure, are these commercial relationships and you are really looking to convert them to C&I loans as well [indiscernible]? What sort of success are you seeing in terms of conversions of these deposit relationships into something broader?
Yes. For all of our C&I clients and I think now all of our clients, we did used to really -- previous management really didn't press for deposits from our commercial real estate group, but now we do. So all of our clients. But, on the commercial side, that is driving primarily the DDA growth. So when a retail client comes in and opens up a $5,000 or $10,000 non-interest-bearing account -- there is just not enough Johnny lunch buckets to add up to a whole lot of dollars on the retail side.
In the money market accounts, where the money is above $5 million -- again, that is banks, that is family offices, that is not-for-profit institutions -- they are sitting on relatively large amounts of cash and looking for yield. So it is not related to our commercial effort really in any of those cases, I don't think. It is really related to family offices, not-for-profit institutions, banks and wealthy individuals.
Final question is, all this stuff happening at Wells, do you anticipate that it is going to have any sort of blowback on the industry in general and could it reflect in higher technology investments required by legacy or higher compliance costs?
It is a really good question. Let me talk about in general first and then us specifically. I do think it is going to have blowback. It can't be good from regulatory sense for any of us. And in terms of people who -- how do I say this -- pay by units rather than pay by profitability, i.e., if you open up a unit, a checking account is a unit, a money market account is a unit, a debit card is a unit and not by volume or profitability, I think they are all going to have to change their comp plans. I think there is a possibility that branch banking structures become more geared towards base pay and less towards incentives which means the fixed cost, if you will, of running a branch and the employees in that branch could go up by the increase in base salaries.
So, hey, we're just going to pay your base salary. Forget about the incentives. You will see some of that go on and while we don't pay by unit and we, like every other bank in the country, should have and probably have, we have reviewed all of our pay plans. We have had them looked at and scrubbed and reported to the board at the very first board meeting after the Wells announcement came out. Our plans are all based upon profitability goals, so you better keep the clients you have, you better put them in the right products so you can keep them and you just need more of them. That is how you make money here. But because of the broader industry feeling towards this, if we do migrate towards higher base salaries and less incentives for branch people, we may all have to go there to compete for branch people. So, indirectly, that could impact us.
We will see how it plays out, but I think regulatorily it is bad and I think in terms of how we incent people and how we pay people going forward, it could change and regardless of whether we didn't or did have those kind of practices, you may end up paying the price for it.
And, ladies and gentlemen, this concludes our question and answer session. I would like to turn the conference back over to the management team for any closing remarks they may have.
Great. Thank you all for participating. Again, we think we had a really great quarter. I know loan growth was disappointing for you all and maybe I shouldn't say, but I am going to. While we report on a 90-day cycle, we don't run the business on a 90-day cycle and our clients certainly don't worry about our 90-day cycle.
They close deals when they want to close them and I really think this was a case of slightly elevated payoffs, but really a big second quarter that bled into the loan growth in the third quarter. My guess is you will see us back to where we normally are going forward from here. So, with that, we look forward to seeing you as we get out on the road. And if anybody has any further questions, follow-up questions, feel free to call Mays or myself. Thank you all.
And thank you, sir. Today's conference has now concluded and we thank you all for attending today's presentation. You may now disconnect your lines and have a wonderful day.
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