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Texas Capital BancSharesInc.(NASDAQ:TCBI)

Q3 2007 Earnings Call

October 17, 2007 5:00 pm ET

Executives

Jody Grant - Chairman and CEO

George Jones - President

Peter Bartholow - CFO

Myrna Vance, Director of InvestorRelation

Analysts

John Pancari - J.P. Morgan

Erika Penala - Merrill Lynch

Brad Milsaps - Sandler O'Neill

Jennifer Demba - SunTrust

Brent Christ - Fox-Pitt

Neil Kasaty - Morgan

Andrea Jao - Lehman Brothers

Operator

Good day, ladies and gentlemen.Thank you very much for your patience and welcome to the Third Quarter 2007Texas Capital Bancshares Incorporated Earnings Call. My name is Bill and I'llbe your conference coordinator for today. At this time, all participants are inlisten-only mode. We will be conducting a question-and-answer session towardsthe end of today's presentation. (Operator Instructions) As a reminder today’sconference is being recorded for replay purposes.

I would now like to turn thepresentation over to your host for today’s conference call Ms. Myrna Vance,Director of Investor Relations. Please proceed.

Myrna Vance

Thank you, Bill, and goodafternoon to all of you. We are glad you could join us today to hear theresults of our third quarter. As Bill said, I am Myrna Vance, Director ofInvestor Relations, and I invite you to call me if you have any follow-upquestions, you can reach me at 214-932-6646.

Now, before we begin ourdiscussion today, I need to read the following statement. Certain mattersdiscussed on this call may contain forward-looking statements, which aresubject to risks and uncertainty. A number of factors, many of which are beyondTexas Capital Bancshares' control, could cause actual results to differmaterially from future results expressedor implied by such forward-looking statements.

These risks and uncertaintiesinclude the risk of adverse impacts from general economic conditions,competition, interest rate sensitivity, and exposure to regulatory andlegislative changes. These and other factors that could cause results to differmaterially from those described in the forward-looking statements can be foundin our annual report on Form 10-K for the year ended December 31st, 2006, andother filings made by Texas Capital Bancshares with the Securities and ExchangeCommission.

Okay. Now, let's begin ourdiscussion of the quarter. With me on the call today are Jody Grant, ourChairman and CEO; George Jones, President; and Peter Bartholow, our CFO. Andafter our prepared remarks, our conference coordinator Bill, will facilitate aQ&A session. At this time I'd like to turn the call over to Jody.

Jody Grant

Hi everyone and welcome to thecall. We had another record in nearly every aspect of our business. Some of themost important aspects of our business, net income was up $8.8 million,earnings per share were up $0.33, and both of those were up 10%.

Our loan growth was a bestquarter in the Company's history, and we measure that by loans held forinvestment beating the second best quarter, which happened coincidentally to bethe second quarter of this year. Just to give you some numbers, average loansheld for investment were up $231 million, that's 29% year-over-year or 8% on alinked quarter basis, and at period end the growth was $204 million that's 30%year-over-year and 7% linked quarter. Year-to-date we've made $0.93 per share,which compares to $0.80 last year, which is an increase of 16%.

Before turning it over to PeterBartholow and George Jones to talk about the numbers, let me make a few words,make a few remarks about the economy in that, suddenly the economy, nationallyis receiving a lot of attention these days, a lot of it negative, and I ampleased to report that the local economy is strong. Texas seems to be bucking the trends,employment hit an all-time high at August in spite of the fact that we do haveweakness in single-family housing.

We created 280,000 jobs in thelast 12 months, and interesting that includes 31,000 in July and August of thisyear versus 43,000 in the same period in 2006. So we are still performing well.The Dallas, Fort Worth area was number one in the nation,in job creation in the last 12 months with 90,000 jobs. Houston was the second in the nation lastyear creating 82,000 jobs.

In particular we had strength inprofessional and business services, leisure and hospitality and oil and gas,and all of you are aware of the Barnett Shale and the continued activity there,and needless to say with oil at over $88 a barrel that helps us as well. As aconsequence, we have the highest rig count in the State of Texas since August of 1984.

Even construction employment wasup by approximately 20,000 jobs in the latest period with weakness insingle-family being offset by strength in multi-family, commercial and thepublic sector, that period being year-over-year. While we are concerned aboutthe weakness in the single-family housing sector and watching it carefully, andGeorge will comment more on that in a few minutes. And just to highlight thattotal residential permits in August were about 31% below the same period in2006. On the other hand multi-permit, multi-family permits were up 54% fromlast year, and in the latest four months were up 65%. People have to have someplace to live and what we are experiencing is an increase in multi-familyconstruction versus single-family construction.

And even though new homepurchases drive a lot of personal expenditures, total construction employmentcomprises only about 6% of total employment in the state. And our unemploymentin the sate at 4.2% is significantly better than that in the nation as a whole.In Austin, andin the other major cities that we operate, we are experiencing very, very lowunemployment rates. Austin is 3.4%, Dallas 3.9%, Houston 4%, San Antonio 3.8% and Fort Worth 3.9%. These were all as of August this year.

Our results this year, thisquarter also reflects our increased focuses on our core business. We also spenta lot of time on expense control; I don't believe we really fully comprehendedthe drain on the company that was created by our residential mortgage andlending business. Fortunately as you know, we exited that business, and we'lltell you more about that in a few minutes as well.

Linked quarter net revenue, justto highlight expense control, was up 4.1%, and we were able to holdnon-interest expenses to 1.9% increase on linked quarter basis. And thatcompares to the second quarter, when we experienced linked quarter growth inrevenue of 8% and linked quarter growth in net-interest expenses of 5.5%. Wecontinue to focus on return on equity, organic growth and credit quality. Ourreturn on equity in the quarter was 12.7% which is one basis point above thesecond quarter, but less than the 13.8% in the third quarter of ’06. Thedifference is totally accounted for by the provision that we took in thisquarter of $2 million versus $750,000 last year.

The growth story continues to bestrong year-over-year. Again, our loans held for investment were up 30%, totaldeposits up 19%, year-to-date net income up 17% and earnings per share up 16%.

With that, let me turn it over toPeter, who will go into more depth on the numbers. Peter?

Peter Bartholow

Jody, thank you. As Jodycommented a minute ago, net income for the quarter was $8.8 million, linkedquarter growth of 5.5%, and a year-over-year increase of 10%. The very strongperformance driven primarily by loan growth and improvements in the coststructure produced continued improvement in operating leverage with 4% growthin net revenue driven by 6.6% growth in net-interest income. We did seesignificant weakness in non-interest income due to our mortgage warehousegroup. That group is experiencing difficulties in the -- that are associatedwith the mortgage industry, and while it is profitable in Q3 its reduction innet income contribution compared to Q2 was right at $0.02 per share. As Jodymentioned, our operating leverage is reflected in the comparison of the growthrate in net revenue to that for a non-interest expense. We picked up 220 basispoints in difference between those growth rates in this quarter.

Obviously important to us was aexpansion of the net interest margin by 3 basis points, which I'll discuss inmore detail compared to the second quarter of this year. Credit quality costswere well contained as it relates to the effects of nonperforming assets and tocharge-offs.

We will turn into the next slideon page seven. Again, net interest margin increased, and it was obviously dueto important growth, and it produced important growth and improvement in keyperformance measures. We had an improvement in the efficiency ratio by a 140basis points despite the effect of the mortgage warehouse group which Imentioned a moment ago, which caused us to have flat ROA and ROE compared tothe linked quarter. Without the effects of that, we would have had someexpansion in both of those key measures of profitability.

Loan growth has produced veryobviously a change in the earning asset and funding composition. And we nowhave with the decrease in the Fed Funds rate we have now income contributionsfrom securities portfolio and improved contributions from the fixed rateearning assets, LIBOR priced loans and the leasing activities.

Operating leverage again was avery important factor in producing these results. Jody mentioned the increase inthe provision for loan loss of 33% on a linked quarter basis and 167% anddespite those dramatic increases we've produced very strong growth. The growthin the provision was driven essentially entirely by the growth in the portfoliowith net charge offs of only 59,000 in the quarter leaving us within a $300,000net recovery position for the year-to-date.

Turning to slide 8, Jodymentioned some of the remarkable growth here, record loan growth this quarteron an average basis of $230 million. Loans held for investment up 7.8% linkedquarter, and 29% over the prior year quarter. We did as I mentioned to haveissues in loans held of sale, a much more stringent underwriting, and theindustry conditions that caused significant reductions in that portfolio.

We still ended up with totalloans up 6% linked quarter and 27% year-over-year. With the growth in loans, wenow have loans representing 88% of earnings assets, a much more favorableposition relative to net interest margin and continued growth.

Deposit growth was very strongthis quarter, growth resume this quarter after what we -- as we said that itwould in the prior quarter. Deposit growth is our customer base and grew $245million on an average basis, 8% linked quarter and grew much more than the $230million in loans held for investment and $60 million more than the growth intotal loans.

We did see again some increase inDDA, a 2.5% growth rate or $12 million. And that funding category is obviouslyimportant to margin and again, I think with that it probably be an industrytrend and an indication obviously that DDA is hard to produce in thisenvironment. So then growth in loans held for investment continue to the end ofthe quarter and Q4 begins 3% higher than the average of Q3.

So, I cannot comment a little bitmore about the net interest margin mentioned earlier. We had three basis pointincrease. This expansion was especially significant in light of the growth. Theeffect of that growth on funding composition, the reduction in the fed fundsrate and the flat yield curve. But reduction in the fed funds rate of 50 basispoints did occur only in the last half of the quarter, so its effect for thefull quarter was not substantial, but it did have an impact the one that wasprobably less than had been anticipated.

The exceptional loan growth, as Imentioned, had a favorable impact on earning asset composition. Overall earningasset yields were essentially flat despite the reduction in the fed funds rate.Securities, fixed credit loans, LIBOR priced loans, leasing and othercategories saw improved contributions from them into net interest income. DDAgrowth was an important element, and despite the growth and impact on thefunding composition, total interest funding costs were actually reduced by fivebasis points.

We saw a meaningful success inreducing the deposit cost in key categories, really unrelated, or really partlyrelated to the decrease in the fed funds rate. The company definitely remainsasset sensitive, but the impact of that sensitivity is much less than at a timewhen rates began to rise.

I want to make sure everybodyunderstands there has been no meaningful change in net-interest margin from thetime fed funds rose above 4% in the fourth quarter of 2005. Growth in loans hasproduced a change in funding composition as a principle driver of that change.The composition of funding does affect and limits or constraints net-interestmargin, but liabilities now reprise much more rapidly.

Net floating rate assets fundedby fixed rate or zero cost liabilities have decreased substantially, as apercent of earning assets, since rates began to increase. I’ll share onecharacteristic event. DDA plus equity is now just under 20% of total earningassets, compared to just under 25%, just two years ago, a full 500 basis pointshift.

As I commented earlier, we aregetting now for the first time, and for quite sometime an actual earningscontribution out of our securities portfolio. The yield curve for us and forthe rest of the industry obviously continues to represent on opportunity cost.We really have no opportunity to have meaningful amount of free income from thesecurities portfolio.

And then the other contributor iswhat we have described is the efficiency of our balance sheet. With a lack ofintangible, the lack of fixed capital on the assets, we now have earning assetsto total assets in excess of 95%.

And with that I will ask Georgeto comment on growth and credit quality.

George Jones

Thanks Peter. I'll talk a littlebit more about our loan and deposit growth again, with a little bit moretransparency. Again, our demand deposit growth on slide eleven, our rate overthe last five years is 15%. Our average demand deposit as Peter mentionedincreased $12 million or 3% in Q3 on a linked quarter basis.

Total deposit growth is 24% andon a linked quarter basis Q3 deposits as mentioned before outgrew loans, whichwe're very pleased to see. It increased $244 million or 8% on a linked quarterbasis. Most of that growth in the deposit area however was in money marketdeposit, CDs and Euro-Dollar deposits. As all of us know, it's difficult toraise demand deposits in this environment today.

Our Business Banking group inDallas and our Dallas Corporate Banking Group accounted for most of thatdeposit growth. Loan growth over the past five years grew to compounded rate of28%. Loans held for investment growth in Q3 as mentioned before, established anew all-time record for quarterly average loan growth, $231 million or 8% on alinked quarter basis.

Commercial loans seen in ourportfolio made up approximately 75% of the loan growth in Q3, with real estatealso comprising the balance. Loans held for sale, our mortgage warehouse groupis down 22% on an average basis. Our private banking and energy groups in Dallas contributed 44% of the growth, and the regionsoutside of Dallascontributed 31% of the overall growth in Q3. As previously noted, both by Peterand Jody, our loans held for sale, the mortgage warehouse line of business wasdown significantly in Q3, by design, I might add reflecting the credit issuesand residential housing nationwide, it was declining from Q2 averages of a 192million to Q3 averages of a 150 million or about 22% decline. Currently, thetotal period in Q3 was a 118 million, and could possibly decline further in thefuture.

Our significant changes to moreconservative underwriting standards and investor selections in addition to theissues in the marketplace have contributed mildly for this decline. Volumesfees and mark-to-market in the warehouse have caused our non-interest incomeline to decline from Q2 to Q3, and as Peter stated amounts to roughly $0.02 ashare.

We believe that these revisionsin underwriting standards that now basically reflect Fannie and Freddie agencyguideline, plus our stringent review of existing customers, and their prominentinvestors cause us to have a product that can be sold in the market today.

You turn to slide 12, our revenuegrowth numbers remain very good. As previously mentioned our non-income line isdown somewhat because of the mortgage warehouse area, but we are especiallypleased with our reductions on a linked quarter basis of our non-interestexpense growth, as Jody mentioned, the increase for Q3 was only 1.9%, basicallywith our closure of our retail mortgage unit and other expense reductionefforts.

We stated previously on thesecalls that expense growth reduction was a priority in 2007, and we were reallyseeing that kind of about in Q2 and Q3. We turn to slide 13, credit quality inthe third quarter remained strong, no question about it. Net charge-offs werereflected at $59,000 and we saw the year-to-date 2007 a $300,000 net recoveryfor the year.

Our net charge-offs for the past12-month period are two basis points, and we only show three basis points incharge-offs over the last two years. Our general outlook for credit remainsfavorable and we remain cautiously optimistic, but believe that the near-termcredit environment could present all of this in the banking industry challengesfor the next few quarters.

You turn to slide 14, again, thisshows graphically our net charge-offs to average loans, and really displays thegood credit history for Texas Capital Bank that we've shown you in the past.

Okay. I'll turn it to you Jody?

Jody Grant

Thanks, George. Just a couple ofclosing remarks. The growth story does continue to be good, and that's in theface of the moderating economy certainly in the nation, and we are seeing somesigns of that in Texas as well as we peel the layers of the onion back and lookat certain segments of the economy, off course, the most prominent one beingsingle-family housing.

We are confirming our guidancethat we gave at the close of the quarter when we had the last conference call;that was $33 million to $34 million, which is roughly about a $1.26 to $1.28 ofshare.

With that let me turn it backover to the operator for Q&A.

Question-and-Answer Session

Operator

Thank you very much sir.(Operator Instructions). Our first question comes from the line John Pancari ofJ.P. Morgan. Please proceed.

John Pancari - J.P. Morgan

Good evening

Jody Grant

Hi.

John Pancari - J.P. Morgan

I want to just see if you cangive us some color on the increase in the loans in 90 days and more past due.Just give us some color on the types of loans we do on and any outlook on towhat's happening there?

Jody Grant

George is going to comment onthat, John.

George Jones

Yeah. Hi John. We had a slightincrease. Some of that was our mortgage warehouse portfolio that moved into the90-day plus past due area and the other area that was increased was our premiumfinance group. As you know we've said before, we continually have a portion ofthat portfolio that's in the 90 day plus past due.

We don’t believe there is much ofany loss in that past due category, but the nature of the business actuallypromotes that amount of past dues. The balance primarily is the normal courseof business as far as we are concerned we haven't seen a lot of change in that.We have a real estate loan or two, that is in non-accrual category but we thinkwe're properly reserved for those and done what we needed to do to protectourselves.

John Pancari - J.P. Morgan

Okay. So with the bulk of theincreased clients from the mortgage warehouse, what's your expectations aroundloss of content. Are there any risk, given that increase because it's just apretty sizeable jump.

George Jones

Sure. Well again, we properlyreserve. We believe every category within that 90 day category passed due andwe have what we believe proper reserves today. Behind that portfolio that ineffect are held for investment portfolio. We would never say that there wouldnever be any additional loss in that portfolio, but we do believe to date basedon our visibility that we have it properly reserved.

John Pancari - J.P. Morgan

Okay.

George Jones

Along with the mark-to-market.

John Pancari - J.P. Morgan

Okay. All right and thensecondly, if I could just touch on loan growth. You indicated that C&I loangrowths accounted for about 75% of the growth was that on a linked quarterbasis?

George Jones

Yes.

John Pancari - J.P. Morgan

Okay. And could you just a littlebit of color around the types of credit there and the trends that you areseeing in terms of pure commercial demand in your markets?

George Jones

Sure. Demand has been pretty goodand we are in a very competitive market obviously. But our demand has beenpretty good. We actively attack the market in terms of trying to bring businessto the company. These are our typical middle market customers that we've beentrying to attract since the inception of the Company. They are companiesbasically that are privately owned who have top-line revenues of $5 million to$150 million typically that need operating lines of credit, expansion capitalfor facilities, warehouses.

On the commercial side or on thecommercial real estate side, they would narrow the middle market area on thecommercial side too. They look like middle market customers, but the commercialside is basically just that.

John Pancari - JP Morgan

Okay. And then the on the depositside, just one question there, the nature of the deposit moved on the balancesheet in the quarter, Myrna mentioned they are largely money markets and CDsand etcetera, I mean, do you have any feel of the stickiness of these types ofdeposits, just given that we’ve seen quite a bit of volatility in your depositnumbers lately because of some larger relationships, just want to get an ideaif you have some sense or some color around what moved on to the balance sheetthis quarter?

George Jones

No, as Peter mentioned, they areall basically customer deposits, we don't believe there is a lot of hot moneywithin those totals. We’ve significantly reduced in our deposits reliance onwholesale funding. We deal with a lot of larger customers that keep largedeposits and actively use our euro branching. But again, we feel very goodabout our deposit growth in Q3.

Jody Grant

John, some of the volatility thatyou referred to, I assume, relates back to the second quarter, and in thesecond quarter we had the tax date and we had some large customers who hadlarge tax payments. So, this is something that was out of the norm or notanticipated, and I think what we’ve seen since then is just a resumption of kindof the normal growth in deposits.

John Pancari - JP Morgan

Okay. All right. Thank you.

Operator

Thank you very much, sir. Ladiesand gentlemen your next question comes from the line of Erika Penala of MerrillLynch. Please proceed.

Erika Penala - Merrill Lynch

Good afternoon.

Jody Grant

Hello.

Erika Penala - Merrill Lynch

I just wanted to get some clarityon the guidance. In last quarter’s guidance, you had said that margin would beessentially flat except for the second strong growth on funding in DDA. Doesthat take into account any reduction in Fed funds?

Peter Bartholow

The guidance we gave didanticipate a reduction in Fed funds. We couldn't have predicted withreliability that it would go from 5 in the quarter to 475. We saw the effect ofthat, Erika, for the just the last half of September but with a dramaticimprovement in earning asset composition. We also said that the guidance -- themargin would be heavily dependent on ability to grow DDA, which did occur inthe quarter. So it's a combination of composition of funding DDA growth, as theworld knows there has been now some widening of the spread between LIBOR andFed fund’s rate because 20% roughly of our floating right portfolio is LIBORrelated; we’ve benefited from that.

Erika Penala - Merrill Lynch

And as the improvement in theearning assets composition enough to stave off any pressure from floating orre-pricing in the fourth quarter, did you mention the effect of a reduction inFed funds is only for some part of the third quarter?

Peter Bartholow

Right. We have a very substantialportion of the loan portfolio does re-price effective date of change, but aswe've grown and we’ve emphasized over and over again the liability structurehas changed dramatically as well. So that it re-prices much more rapidly thenit did two years ago as the fed funds rate came off up the 4% level.

Erika Penala - Merrill Lynch

Okay. And I also have a follow-upquestion. It was mentioned a couple of times during the call that you areseeing weakness in single-family. Is that translating into concerns in yourconstruction portfolio or do you remain -- is everything fine there?

George Jones

No, at the end of the thirdquarter, we feel very good of about our construction portfolio. We have veryfew problems in the construction portfolio today either in the single familyportfolio or in the commercial real estate portfolio. But we are reflectingreally our thoughts as it relates to more of a national housing market and whatkind of effects are we going to see in the State of Texas from some of those reverberations.

Again we feel very good aboutwhat's going on today. We see a lot of movement nationally and some locally inthe starter home market, where we see a lot of those problems happening. Wehave a very small starter home portfolio. It's less than 1% of the entire loanportfolio in the company. And we have virtually no problems in that particularportfolio. So we feel, today we feel pretty good about our constructionportfolio.

Erika Penala - Merrill Lynch

Okay.

Jody Grant

And its also estimated that inthe single-family residential arena the inventory in Texas is about 6.5% versusabout 10% for the rest of the country and with the decline that we've seen inpermits and starts, hopefully we will be approaching equilibrium between supplyand demand sometime late this year or early next year, at least in Texas.

Erika Penala - Merrill Lynch

Okay. Thank you so much fortaking my call.

Operator

Thank you very much ma'am. Ladiesand gentlemen your next question comes from the line of Brad Milsaps of SandlerO'Neill. Please proceed.

Brad Milsaps - Sandler O'Neill

Hey good afternoon. Good quarter.

Jody Grant

Hi Brad and thank you.

Myrna Vance

Hi.

Brad Milsaps - Sandler O'Neill

Just kind of refresh my memoryfor a moment. You guys may have gone over this and I missed it but when willthe discontinued or earnings from discontinued ops begin to fall off. Can youjust give me an update on the divesture of the mortgage company, kind of whenwill we see those that fall off your income statement?

Peter Bartholow

Brad, this is Peter. I think whenthat happened and I am focused now on the March deal. We set out witheverything that we thought could hit us. What we didn't anticipate was thecollapse in the overall mortgage market and that has resulted in weakness inour ability to get rid the few remaining loans that had been there.

You may have seen all kinds ofcirculars about accounting guidelines that forced mark-to-market of loans thatare held for those kinds of loans that were in the discontinued portfolio. Sothat has increased. I can't say that we won't have some hangover effect, but webelieve after this quarter, it will be nominal and not certainly important tothe results.

Brad Milsaps - Sandler O'Neill

Okay. But if I’m picking up theright number on the balance sheet, you’ve got about $863,000 of those loansleft?

Peter Bartholow

That's correct.

Brad Milsaps - Sandler O'Neill

Okay. And in terms of themortgage warehouse, I know it’s -- I don't want to put words in your mouth, butjust curious, if you wanted to power down that division, can you give me anindication of what the EPS, it might be and sort of what kind of how you thinkthrough that, you’ve shown in the last year, so you guys have been prettyaggressive in jet setting off this. Is that either taking up too much time orjust don't make (inaudible) kind of make sense for your long-term strategy?

George Jones

Yeah, I will address thatquickly. We’ve been in the warehouse business for the last six, six and a halfyears and we’ve made a lot of money and had a lot of success in that business.And we don't believe it’s a business that we should exit at this point in time.As I mentioned, we’ve not talked about it before, it’s certainly down fromwhere it was, I think in our peak we were roughly 250 million in average loans,it's a 118 today, and I mentioned it probably can go lower.

Hopefully it can be rectified ina reasonable period of time, but we think long range that's the business theway we do it. It’s a business we want to stay in, but we can adjust our costsin various ways in that particular area, and we can do that, but we don't havea desire today to in effect, as you say jettison that business, we think it’sone we want to continue to be in. But again, underwrite it properly, make thechanges that the market demands today, and that's what we think we’ve done.

As I mentioned before, the way weunderwrite today on a go-forward basis, it’s basically Freddie and Fannie that todaywe believe is still very saleable in the marketplace. I hope that answers yourquestion, Brad.

Brad Milsaps - Sandler O'Neill

No, no. Fair enough, I mean, yournear-term, are there steps you can take, it sounds like you feel like on theexpense side, you've got some maybe rubbers you can pull that sort of make thehit, maybe not as severe as -- not that it was real severe this quarter, butmaybe not as severe it was?

Jody Grant

Yeah. There is probably some wayswe can, again, we can do that. It's not a big number on our income statement asit relates to expense of running this business right now. So we'll certainlytake a look at that, and it will depend, again, on how low the averageoutstanding go on these kinds of business, and we'll certainly make adjustmentsthe way we feel we should.

Peter Bartholow

Brad. This is Peter. It's abusiness that if you've seen in that line item doesn't produce very strongspreads. We get additional benefit from transactional volume which has beendown according, off course, but their core business today is profitable.

And finally, Brad, we did lowerdown the amount of loans that we've had in the warehouse by making the criteriafor approval much, much stringent than it was. So, any new loans coming in thewarehouse should be in very, very good shape.

Brad Milsaps - Sandler O'Neill

And Jody, if I recall, you guysuse a third-party to do a lot of verification there?

Jody Grant

Yes.

Brad Milsaps - Sandler O'Neill

Okay. Fair enough.

Operator

Thank you very much, sir. Ladiesand gentlemen your next question comes from the line of Jennifer Demba of SunTrust.Please proceed.

Jody Grant

Hi, Jennifer.

Jennifer Demba - SunTrust

Hello. Question for you? When doyou think you've had incredibly strong loan growth this year, when do you thinkthat might start to taper off a little bit, given you have slowed down yourhiring over the last few quarters?

George Jones

As you can tell at the end ofthird quarter we certainly haven't experienced that yet. As we told you earlierwe for a number of reason are going to use up some of the capacity we have inthe Company. We still believe we have capacity in the company to continuecertainly for the near-term and generate good growth in the portfolio. I thinkone of the bigger questions in terms of loan growth today is just the market.What will the market give us in terms of loan growth or what is -- the creditissues impact the market to a certain extend, not necessarily impact us, butjust the market itself.

And as we become a little bitmore conservative in terms of how we underwrite and how we look at things theremight be some slowing in the growth, but I would tell you its my firm beliefthat we will significantly outperform our peer group in terms of growth for theforcible future in the loan portfolio, regardless of those conditions we justtalked about.

Jennifer Demba - SunTrust

Are you seeing you competitorspull back a little bit and be more conservative with their underwriting, givenwhat's happened in the last 60 days or so?

George Jones

You know it’s hard to tell. 60days is really not an accurate measurement, so to speak it's little early tomake that determination. It would not surprise me to see that happen somewhere,but it's really a little too soon to make a judgment on that.

Jody Grant

There are occasional discussionsthat suggest that people are pulling back or not forcing the issue in terms ofmarket share in Texasthat will be beneficial to the group, our group in any case.

George Jones

Yeah that's right. Jennifer,really we look at this to a certain extent as an opportunity. If it wins, someof this happens with our competitors and they begin to slow down somewhat andmay be pull in their horns a little bit. We think there is going to be sometalented bankers out there that who would want to make a change and we areopportunistic and we look forward to having an opportunity to attract some ofthose bankers.

Jennifer Demba - SunTrust

Okay thanks.

Operator

Thank you very much ma'am. Ladiesand gentlemen, your next question comes from the line of Brent Christ of Fox-Pitt. Please proceed.

Brent Christ - Fox-Pitt

Goodafternoon.

Jody Grant

Hello.

Brent Christ - Fox-Pitt

Just acouple of follow ups on a few topics you guys already touched on. First, interms of the margin and the impact from the Fed rate cut. Obviously it was latein the quarter. Has there been any internal analysis that you guys have done,that you could share with us, in terms of what your near-term expectations arefor the impact of the Fed cut on your margin and then may be any offsettingfactors whether it be lower mortgage warehouse balances or continued reductionin deposit costs?

Peter Bartholow

Brentit's never occurred to us to do any analysis.

Brent Christ - Fox-Pitt

My guessis that you already did and you could share with us.

Jody Grant

Now thatyou've suggested, we'll get right on that. Of course we have and as I said weget very rapid repricing now on both liabilities and assets. So while theeffect on the full quarter was not great. The last half of September producesevidence that's constructive. As we've told you in the past we are not going tobe good about giving guidance on quarterly margins. There are lot morevariables at play. DDA is very important one obviously. Composition, obviouslyand, and the effect for the first time now in the year of seeing aprofit margin improvement in our fixed rate loans, our LIBOR loans and oursecurities portfolio and leases. So, we have a lot of things going force inthat regard, and as I commented a minute ago on the call, you look back to Q4of '05 and our margin is 3 basis points higher than it was then and at thattime the Fed Funds rate was 4.

Jody Grant

Just to elaborate little bitBrad, just on the securities portfolio, we’ve gone from a negative 35 basispoints on the carry to a little better than breakeven.

Brent Christ - Fox-Pitt

And is there a thought there nowthat it is contributing a little bit, that the plan is still to continue to runthat down or is there any thoughts in terms of reinvesting?

Jody Grant

Still let it run down to letssomething dramatic happens it would change the spreads that are available, andI doubt that's going to happen not in the near term.

Brent Christ - Fox-Pitt

Got you. And then just afollow-up on the credit question, my guess, your comment about the softeningeconomy seem to be speaking about the national economy, as well as, Texas alittle bit, but is there anything in your portfolio that outside of some loansin the mortgage warehouse that you are overly concerned about at this point oryou seeing any adverse internal risk grading migration with?

Jody Grant

I think the answer to thatquestion is no. There are always risks in the portfolio and we monitor those ona daily, weekly, monthly and quarterly basis. We are fortunate to be in Texas. Texas is performing well with the exceptionof the one sector that is getting all the attention, and that’s single-familyhousing. And I think the whole nations and sort of uncharted waters, as itrelates to that because we never had a recession or a major decline inbusiness, its being driven by the housing market. So, I think all of theeconomists in the country that I have looked at are, they are looking for abouta 2% GDP growth next year. And if that's true Texas should do a little bit better thanthat.

Brent Christ - Fox-Pitt

Got you.

George Jones

You know, where I would certainlywatching we are not immune to what's going on nationally in the single-family,in the lot development portfolio we certainly watch that as one of the points,the interest from our concern as Jody mentioned, the nice thing about ourresidential portfolio, both single-family construction and lot developmentsabout 95% of that product is Texasreal estate. So, if we have issues based on what we see in the economy we thinkthe issues will be somewhat less than maybe other parts of the country.

Peter Bartholow

And Brent, to put it inperspective we built the guidance and the plan for 2007 around the fact that wewould have some losses. Losses don't surprise us, losses don't scare us. We'veobviously benefited from a remarkable success in credit policy and having a netrecovery for the year-to-date of 300,000, but nobody is building plans andexpectations about around those kinds of numbers.

Brent Christ - Fox-Pitt

Sure. Okay thanks a lot guys.

Operator

Thank you very much sir. Ladiesand gentlemen your next question comes from the line of Neil Kasaty of Morgan.Please proceed.

Neil Kasaty - Morgan

Hi guys. Great quarter.

Jody Grant

Thank you.

Neil Kasaty - Morgan

I just wanted to ask a question.Do you have a large line of credit percentage for a company called HomeSolutions? And what amount seems to exceed the annual allowance for bad debt?Can you just tell me how much expose you have to that loan? It seems there arein violation with some of the loan covenants?

Jody Grant

Home Solutions is public companyand we can't comment on our customers and I think you'd have to go to them forany answers like that.

Neil Kasaty - Morgan

For how much exposure you havewith them, I have to go to them?

Jody Grant

I think you would. I mean we arenot at liberty to be able to divulge that information without their permission.

Neil Kasaty - Morgan

Okay. Thanks for answering thequestion.

Operator

Thank you very much sir.(Operator Instructions) Our next question comes from the line of Andrea Jao of LehmanBrothers. Please proceed.

Andrea Jao - Lehman Brothers

Good afternoon everyone.

Myrna Vance

Good afternoon, Andrea.

Jody Grant

Good afternoon.

Andrea Jao - Lehman Brothers

Just want to drill down on thefunding side. You showed good deposit growth this quarter in contrast to someyour peers and we are able decrease borrowed funds, do you think that continuesinto the fourth quarter into 2008?

Peter Bartholow

Andrea we expect to have gooddeposit growth. The nature of our business is driving that. As Georgecommented, it can be a little lumpy because of the nature of our business, butovertime we've proven that we can grow the deposits very well. Q2, youremember, we had transaction specific maturities and a tax payment that Jodymentioned, that force shift the borrowings which were more (inaudible) intoday's market would be more expensive than the deposits. As George commented100% of the deposits were customer based. We are now down to insignificantnumber in terms of anything that looks like hot money or non-customer orwholesale money.

Andrea Jao - Lehman Brothers

Great. Now focusing on deposits couldyou give us a little bit more detail on are you seeing customer migration tohigher cost categories? What kind of seasonal effects should we expect in thefourth quarter and then in the first?

Peter Bartholow

Q4 has historically has been avery good quarter in both demand deposits in total. The market has gottentougher as we've said many times on demand, but we had a good quarter in thatcomparatively to peers, I'm sure. In Q3 we have seen very good growth of coursein the Euro-Dollar accounts, but in those accounts we have been very effectivefor lack of a better term rationalizing pricing, based on the customerutilization of those funds and we've seen a consistent improvement in the rateson that portfolio each quarter.

Andrea Jao - Lehman Brothers

Okay great. Thank you so much.

George Jones

Thanks Andrea.

Operator

Thank you very much ma'am andladies and gentlemen you've no further questions in queue.

Jody Grant

If that's the case, let me justthank everybody for being with us this afternoon. We appreciate your questionsand remind you to call Myrna Vance, if you have any further questions. We lookforward to a good quarter in the fourth quarter. We reaffirmed our guidance andwe will look forward to talking to you either between now and then or at thenext conference call.

So that concludes the call andthank you again very much.

Operator

Thank you, very much sir andthank you, ladies and gentlemen for your participation in today's conferencecall. This concludes your presentation for today, and you may now disconnect.Have a good day.

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Source: Texas Capital BancShares Q3 2007 Earnings Call Transcript
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