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Texas Capital Bancshares, Inc. (NASDAQ:TCBI)

Q2 2008 Earnings Call

July16, 2008 5:00 pm ET

Executives

Mryna Vance – Director of Investor Relations

George Jones – President and Chief Executive Officer

Peter Bartholow – Chief Financial Officer

Analysts

Erika Penala – Merrill Lynch

John Pancari – JP Morgan

Brent Christ – Fox-Pitt

Andrea Jao – Lehman Brothers

Brad Milsaps – Sandler O’Neil

Bain Slack – KBW

Michael Rose – Raymond James

Operator

Welcome to the Texas Capital Bancshares Q2 earnings conference call. (Operator Instructions) Now, I would like to turn the conference over to Mryna Vance.

Mryna Vance

As always, if you have any follow-up questions, give me a call at 214-932-6646.

Now before we get into our discussion today, let me read the following statement. Certain matters discussed on this call may contain forward-looking statements, which are subject to risks and uncertainties. A number of factors, many of which are beyond Texas Capital Bancshares' control, could cause actual results to differ materially from future results expressed or implied by such forward-looking statements. These risks and uncertainties include the risk of adverse impacts from general economic conditions, competition, interest rate sensitivity, and exposure to regulatory and legislative changes.

These and other factors that could cause results to differ materially from those described in the forward-looking statements can be found in our Annual Report on Form 10-K for the year ended December 31, 2007, and other filings made by Texas Capital Bancshares with the Securities and Exchange Commission.

Now, let's begin our discussion. With me on the call today are George Jones, our President and CEO; and Peter Bartholow, our CFO. As Amy said, after a few prepared remarks, she will facilitate a Q&A session.

Let me turn the call over to George.

George Jones

Texas Capital Banc had another good quarter of growth. You’ll see that in just a few moments, when we reveal the specific numbers for Q2. Our margin stabilized during the quarter, and we did not see any deterioration from Q1 2008. We are, though, modestly adjusting guidance for annual net income to a range of $30 million to $33 million, and we’re confident about the remainder of 2008.

The Texas economy is certainly the bright spot in the economy today. While we don’t have all the numbers in for the second quarter, we can see that our economy continues to show resilience. The markets where we’re located continue to outperform national averages. The unemployment rate is below the national average in May for 4 out of our 5 markets, and equal to the national average in the Dallas/Fort Worth area. The annual job growth rate was better in each of our markets than the national average. Houston, as an example, added more jobs in the trailing 12 months ending March 31 than any other city in the nation. New housing inventory, May 2008 over May 2007 in all our markets, declined significantly, and we believe that Texas is beginning to show that market absorption of excess inventory is beginning to take place.

Peter will cover Q2 results in more depth, but let me touch on some of the numbers briefly. Net income in Q2 was $5.8 million, or $0.22 per share. It decreased 27% compared to Q1 2008, and a 29% decrease compared to Q2 2007. The major contributing factor to the decrease was our provision for loan losses, which I’ll discuss in much more depth in just a few moments.

We had excellent growth in total loans, 5% link quarter, a 22% increase compared to Q2 2007. I’m particularly pleased with our demand deposit growth, on a link quarter basis of 9%, a 12% increase compared to Q2 2007. Another positive element of core operating results was our net interest margin remaining stable at 365, compared to Q1. As I mentioned before, we provided $8 million to our loan loss reserve in Q2 2008, supporting growth and risk rate changes in our loan portfolio. I will discuss charge-offs, EPS and ORE in some detail after Peter reviews our financial performance.

I’ll turn it over to Peter.

Peter Bartholow

Talking about the performance drivers in the second quarter that produced a net income of $5.8 million, reflecting what we believe is very good performance, especially in core earning power, and especially, also, in light of industry conditions. We did experience 28% decrease in earning per share, for the reasons George has already mentioned, but the stable net interest margin – and I’ll comment more on this in a moment – we did see improvement again in net operating leverage, a reversal of the Q4 to Q1 situation when we experienced a reduction in net increase margin.

The modest change in guidance obviously reflects changes in the industry since January of this year. While net interest margin was stable in Q2, the rapid change in short term rates was not anticipated when we gave guidance. I think we commented earlier that the pace and level of change was greater than we had anticipated. We are experiencing some impact, obviously, of the factors affecting the entire industry – only to a much more moderate degree. Provision through Q2 is clearly larger than anticipated, and guidance about which George will comment in much more detail.

Due to the strong growth we experienced, we may have maintained guidance if only one of the two factors had changed – either net interest margin, or provision, but not both. The wider range we have provided, we believe is appropriate due the uncertainty in the market today, and industry conditions.

I would like to emphasize, while it’s not reflected on the slide, that we had really good growth in stockholders’ equity, strong equity position we have to support growth, and we have no intangibles that are foregoing, have become, and may become a bigger issue in our industry. If you’ll forgive us, we have apparently, construction taking place on the floor above us as we speak.

Turning to the next slide, as I said, good core earnings power reflected in net revenue growth, link quarter growth 4.3% and year over year of 10.9%. Loan growth, link quarter of 5% and 22% over the previous year, obviously were major factors in the growth and net interest income. Reversing the position from Q4 to Q1, where we, for the first time, had actually seen net decrease in net interest income. Non-interest income growth was good at 4.3%, and that was due primarily to significant improvements in service charges and mortgage warehouse fees. Expense growth of 3.7% in the link quarter, and 7.3% in the year over year periods show that we are making progress in the ratio of non-interest expense turning assets, and more modestly on the efficiency ratio compared to prior years. The core operating expense growth was less than 2%. Professional and other expenses contributed to most of the link quarter increase of just over $1 million.

Provision expense of $8 million was the obvious variance from which we anticipated in the guidance originally given. We saw in the quarter, significant contributions of the mortgage warehouse group, strong growth, meaningful yield improvement, and an ability to increase these in this market.

Turning to slide 9, the strong growth is obviously evident in the balances on average basis for loans held for investment and loans held for sale. Link quarter growth of 5%, or just under $200 million, year over year growth of almost $700 million, or 22%. As stated in earlier calls, this does reflect much improvement in the productivity of REMs, something that’s been planned for 2007 and 2008. The link quarter growth in loans held for investment is consistent with our view that growth rates in 2008 would be less than those for 2004 to 2007, but still very strong compared to industry and Texas peers. We have higher return threshold built into the models today, and we are imposing much tighter credit standards than in previous years.

The loans held for sale category is up sharply due to our position in that industry, and things that are driving business our way. Obviously the continued shift in earning asset composition is important to us, and is driven by strong loan growth, with loans to earning asset now in excess of 90%.

Total deposits, we mentioned, up 3% link quarter and 6% year over year. DDA growth was exceptional, link quarter up 9% - and actually most of that occurred in the last half of the quarter. EDA growth year over year of 12%.

The next slide – June 30 loans held for investment were $3.7 billion, obviously a record for us at quarter end. An increase of -- that reflects actually an increase of 3% from the average levels of Q2 2008, again implies an annualized growth rate, on that basis, of 24%. I will say that Q2 has been historically very strong in terms of loan growth.

Total loss peaked at $4 billion for the first time. Loan link quarter increase of over $300 million. The strongest contributors to loans held for investment were Energy and Dallas Corporate, and had strong support also from Houston, San Antonio and Austin. We also saw deposits grow at a record level. Q2 is, again, historically a strong period for deposit growth. With DDA, though, reaching $610 million, it was really extraordinary. The link quarter increase of 21% and a year over year increase of 23% is something that, I think, is really remarkable in light of an all organic growth business model.

Total deposits at quarter end – $3.6 billion, an increase of $438 million, again a record. We believe that our performance reflects some weaknesses in the large competitors that operate in our market. Strongest contributors on deposit growth are Dallas – in various lines of business, Austin, San Antonio.

The next slide we’re back to margin. The 365, same as Q1 2008, and obviously a major contributor, was the strength of DDA balance growth. We also have had good re-pricing of interest bearing liabilities and all interest bearing liabilities – interest bearing deposits and all liabilities, essentially the same as loans. We saw a spread improvement due to greater pricing flexibility now evident in our marketplace, and we also benefited from the spread between LIBOR and Fed Funds, a contribution that was greater than that during Q1 of this year.

The NEM contribution of Mortgage Warehouse was also important. Historically, that category of lending has been among the lowest yielding in our portfolio. The conditions in that marketplace have seen spreads widen significantly, and we have also been able to increase fees in that business. As indicated, the company is much less asset sensitive than in years past, but growth will constrain that interest margin. Stability of rates, as demonstrated, is obviously very helpful, and the DDA contribution going forward, depending on the growth rate in DDA, will obviously have a significant effect at the margin. Rising rates, obviously, will be helpful, even if asset sensitivity, as I said, isn’t as big a factor.

Also contributing to net interest margin, earning asset composition with strong loan growth, and with continued run-off at securities, and obviously fixed rate earning assets are having a bigger impact today. We have seen, as I commented earlier, such a steep decrease in the speed and the level of Fed Funds, that it has had an effect on our margin expectations this year. Also, the private pricing, especially if a bank is growing, have become more significant to us and to the industry because, we think, primarily of a global demand for liquidity given the problems in our industry.

Turning to the next slide, I’ll say simply that we think, again, this is a very strong growth model, and one that supports the view and the commitments we’ve made. A very strong core earnings power reflected on that slide. Conditions did not change in our view of that business model, and I will comment that, while we have higher than normal provisions so far this year, historically, credit costs have been maintained at very low levels compared to the industry and to our peers, and have been more than offset by the growth advantage of our business model and the focus on organic growth and not acquisitions.

Slide 13 – The taggers for DDA and total deposits have actually increased from the earlier periods. Strong growth in the recent past has been, obviously, a big contributor. No change in the tagger for the loans held for investment. Again, the growth model is confirmed and we believe the market opportunity remains very strong today.

And, with that, I’ll turn it back to George for more comments about credit.

George Jones

You’ll see a new slide in the presentation – the loan portfolio statistics. Let me make a couple quick changes before we discuss it. The residential real estate market risk is 7%, rather than 10%. The commercial real estate market risk is 20%, and our business assets are 32%. We had a transposition of a couple of numbers there and I want to clarify that before we discuss. We’ll send a new slide out for your use.

We classify our portfolio a number of ways, but this way is shown by loan collateral type, which will give you a slice of what our portfolio looks like. We classify as C&I loans the business asset segment, the energy segment, a portion of the highly liquid assets – those loans secured by cash, marketable securities, those kinds of things – other assets, and unsecured, for approximately 55% of the portfolio we deem to be C&I exposure. Our mortgage warehouse totals about 8%, and is included in the liquid asset category. We classify as real estate, as you see here, commercial real estate, market risk real estate non-residential at 20%, owner occupied at 10%, and residential market risk at 7%.

If you move to the next slide, we show our non-pass, or classified grade loans, by type. This includes the non-performing loans also, and is broken down as follows, as you can see: 71% being the C&I portfolio – again, this category includes corporate credit, business assets, energy leasing, and other lines of business. Our residential related exposure here is 24% related to single family, market risk – these are builders and lot developers. The third category, commercial real estate, at 5% includes every type of commercial, market-risk real estate other than residential. And as we’ve said before, and we’ll say again, you can tell that the commercial real estate portfolio is performing extremely well.

If you turn to the next slide, we’ll talk about our credit in specifics. Our credit experience remains good. Net charge-offs were $3.6 million in Q2 2008, and $6.1 million year to date. 53%, or $3.2 million of the year to date charge-offs of $6.1 million was one credit, Home Solutions, that we identified and reserved in Q4 2007. 48% or $1.7 million of the Q2 2008 charge-off – again, that same credit – was in that total. 89% of Q2 charge-offs were represented by just 2 credits. As we mentioned earlier, the charge-offs related to specific problems were substantially covered with allocated reserves in 2007.

Net charge-offs represent 40 basis points for the quarter, 35 basis points year to date, and 25 for the last 12 months. We have seen an increase in non-performing loan levels that we believe are not excessive, but require – and are receiving – intense focus from management. Overall, we are seeing risk grade increases, and increases from non-accruals, but we do not currently foresee significant charge-offs in the second half of the year.

As mentioned previously, of great help to us, frankly, in reducing charge-off potential in Q3 and Q4 is the disposition of 3 problem credits that were resolved in Q2. The largest problem loan over the last 3 quarters has been related to the Home Solutions credit. We received payment for the outstanding balance of that loan earlier this month, July. That loan represented approximately $5 million in charge-offs of the total $8.6 million charge-offs over the last 3 quarters. The exposure in that loan was substantially reserved for in Q4 2007. The remaining exposure was covered by provision in Q1 2008 as the borrower’s restructuring plan was developed.

The second problem loan was a C&I loan for which a substantial reserve was applied at year end 2007. That was covered all but approximately $250,000. We were able to sell that loan, and we did not provide any financing to accomplish that transaction, at a discount of $1,450,000. The sale of that loan eliminated the need for a protracted work out that really would have increased expense and exposure to additional loss.

Third, one additional loan in Houston, which we’ve discussed before, had a substantial reserve that had been allocated at year end 2007, was charged off in the amount of $1.5 million dollars. The balance of that loan was repaid.

Let me take a moment to give a little more transparency and color, as it relates to our non-performing loans, our ORE, and our 90 day past dues. Non-approval loans and ORE are up from $17 million in Q1 to $22 million in Q2. The larger, non-accrual loans that make up, really, over 85% of that total, are the ones I’ll talk about right now. Home solutions at $2 million – that was paid in early July, and as I mentioned, we took a charge-off of $1.7 million. Again, that has been reserved in Q1. Secondly, residential mortgage loans of $4 million that have been marked to market and allocated with proper reserves. Third, there was a lot development loan in the amount of $8.8 million dollars, with a current appraisal supporting our collateral value. But, in addition, we have also put additional reserves behind this particular loan. We have a number of prospects today for sale of this property.

This particular loan is really a good example, frankly, of the need for cash equity upfront on a real estate development loan. We had 35% hard cash equity invested by the owners upfront, and made a 65% loan to cost ratio on the project. While this really doesn’t guarantee the value of the collateral will fully liquidate the loan, the loan balance carried on our books today is supported by an appraisal. Even in a down market, the value of cash equity is very important.

ORE totals have moved up to $5.6 million in Q2, from $3.1 million in Q1, and one half of that amount is represented by a commercial site near Houston that we’ve talked about before. We have a current appraisal supporting our carrying value today, and we’re actively marketing the property with some success. The other one half of our ORE portfolio is represented by single family product and a small office building, all in Texas. We have 12 homes and 10 lots today, and we’ve sold 3 homes and 4 lots as of 06/30/08. We’ve got 9 of the 10 remaining lots under contract for sale, and 1 house is under contract for sale. This is all cash. No financing required to accomplish these transactions. We believe that all of our ORE portfolio is properly valued on our books today. Also, I will mention that in the sales of those particular properties we have not recognized any loss.

In looking at our loans over 90 days past due – that total is $23 million – the increase of $16 million from Q1 really represents 2 loans. Frankly, one is a non-criticized $5.9 million real estate loan to a good customer that carries an above average credit grade, and that loan has already been renewed in early July – absolutely no problem, but did slip into the 90 day past due category. Secondly, a C&I loan of $9.6 million that is criticized, but has not been placed on non-accrual today because the company and the guarantors can still service the loan. It was being held past due to help in our restructure process. We believe the loan has the proper amount of reserves allocated to it at this time. The balance of the 90 day past due category we’ve really talked about before – premium finance loans of $1.8 million that are not problems, but represent cancelled insurance policies waiting for returned premiums to pay the loans, C&I loans of $1 million are waiting to be paid or renewed that are not criticized, and then we do have $3 million of real estate loans that are less than past credits, but again believe they are properly reserved.

As we’ve mentioned, Peter’s mentioned and I have, we made up a loss provision of $8 million in Q2 08. This provision increased our loan loss reserve balance to $38.5 million, or 1.04% of loans held for investment. The provision was ahead of our guidance because, as we’ve said before, based on our methodology we’ve applied all loans, especially MPAs; our reserve balance should always be increased by more than our expected loss exposure at that time. When we identify a weakness in a loan and we downgrade it, or classify it, even if we cannot identify any amount of loss at that time, our formula drives a certain precautionary percentage that can be increased or decreased over time as loss exposure is recognized.

We certainly believe that conditions today in our industry continue to warrant intense focus and further tightening of standards. We’ve done this across our different lines of business so we’re always evaluating what we need to strengthen underwriting.

If you move to the next slide, it graphs net charge-offs to average loans. As mentioned before, year to date charge-offs are 35 basis points, and our loan loss reserve to average loans held for investment is 1.04%. As you can see, that percentage is as large as it’s been since 2004, but frankly today’s environment dictate higher reserves. We believe that 45 basis points of non-accrual loans are slightly higher than we’d like to see, but we also believe that most all banks are going to see this ratio climb while the financial community is dealing in this economic environment.

So let me close the credit discussion -- I'd like to summarize with 4 or 5 bullet points: Non-performing assets now represent less than 1% of total loans, or 86 basis points, today; Provision is driven by consistent application of the methodology – that’s growth, and that’s change in grade; Losses have historically been substantially below allocated resources; Our charge-off potential for Q3 and Q4 has been reduced with the disposition of the 3 problem loans I discussed in Q2; Real estate exposure is more than 90% in the Texas market.

I’d like to make a few closing comments before I open the call for questions. We believe that we had another good quarter of growth and operating. We’ve increased our loan loss provision above our previous guidance, but we believe that’s prudent and really necessary in this economy. We continue to be cautious about the near term future for the economy, but we do believe that Texas, and the markets within Texas where we’re located, will perform better than the rest of the country. We have changed the guidance to a range of $30 to $33 million, or approximately 10% below guidance given earlier this year. We’re continually, and are continuing, our intense focus on maintaining good credit quality. And frankly, something we have not discussed today, we want to exploit our market opportunities that we see today for people and customers. We believe that banks with good credit quality, adequate capital, and good people can certainly take advantage of opportunities that will arise in extremely difficult economic times – we plan to do just that.

Thanks again for your support, and be assured that Texas Capital will be working hard to be the bank of choice in the Texas market. Now we’ll take a few moments for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question comes from Erika Penala from Merrill Lynch.

Erika Penala – Merrill Lynch

Are the C&I losses that you’re taking concentrated in any one sector, and are you seeing any weakness in the lender finance arena?

George Jones

No, and no, would be the answers to those questions. We really don’t see it concentrated in any one or two industries. It’s more broad based than that, and we have not seen issues and problems in the lender finance area.

Erika Penala – Merrill Lynch

The $8.8 million lot development loan is this -- does it have a structure on top of the dirt? And what is the bid-ask spread, so to speak, between the interested parties in a secondary market transaction, and what your expectations are –

George Jones

Right, we’re involved in negotiations right now, and it probably wouldn’t be the thing to do to talk about specifics of transactions that we’re talking about. But, I mentioned, I believe, that we have a recent appraisal – within 12 months – that supports the value that we have on the books today. And we did have significant cash equity injected upfront on that particular loan. Back to your first question, yes, they are fully developed lots ready to be delivered to the builder, and we have additional property for future expansion pledged on the credit also.

Erika Penala – Merrill Lynch

Do you mind giving us more color on that $9.6 million C&I loan that’s 90 days past due, in terms of the industry or –

George Jones

Well, let’s see, it’s a credit we’ve had for some time. We know the principals quite well. They are experiencing a downturn in this particular industry and product. They are very good folks and we expect to be able to work out of that problem, so to speak, over a reasonable period of time – probably 18 months to 2 years.

Erika Penala – Merrill Lynch

Would you remind us what your average C&I loan size is?

George Jones

Well, our average C&I loan is probably a little bit over $1 million, but we have a number of smaller loans. Our sweet spot, Erika, is between the $2 million and $10 million, so if you really look at what we would consider real average loans it’s in that category as opposed to the $1 million. It’s a little bit larger than that we believe – probably in the $2 million to $2.5 million range.

Operator

Our next question comes from John Pancari from JP Morgan.

John Pancari – JP Morgan

Just to get more color on the pay down that you cited in your comments and in the presentation. Can you just give us -- what total to that pay down -- I back into it and I get to about $7.5 million, I guess. I’m just trying to understand what that pay down was. Was it that non-criticized $5.9 million credit that was renewed in early July, plus some of the Home Solutions? If you could just give us some detail.

George Jones

It was the $5.9 million – a real estate loan that we had on a very wealthy gentleman, and he was in the process of selling the real estate. We kept it past due too long thinking it was going to sell or move. We have subsequently renewed it, and he’s made other payments on other relationships at the bank. The other was the home solutions credit, which was about $2 million that we have -- we have that done.

John Pancari – JP Morgan

In terms of your watch list, if you could just give us a little bit more color in terms of how that’s changed this quarter, and your expectation for non performers going forward here in the near term.

George Jones

Well, that’s a little bit difficult to do. We believe that we’ve got things properly reserved at this point, and properly classified at this point – whether it’s a non performer or not. We continually review the portfolio. We have a third party, outside loan review company that comes in and reviews about 65% of the portfolio annually. They assist us in the loan review process, and are continually helping us stay on top of the portfolio in an economic time like we’re dealing with today. We’ve seen a lot of movement within those portfolios today. Some of the criticized portfolio has gone down. But, it’s a very fluid process right now in an economy in which we’re dealing today. What I’d like to be sure, and translate to everyone, is that we are absolutely on top of the process – the credit process and the review process – and are making the right classifications when it is appropriate, with the right allocated reserves to the credits.

John Pancari – JP Morgan

Can you just give us a little but more granularity in terms of where you’re really seeing the good loan demand by product there in your market?

George Jones

It’s still in the C&I portfolio primarily. Real estate has certainly slowed down, both on the residential and on the commercial side of the real estate business. But, frankly, it’s really been good across most industries that we see today. The Texas market is still pretty darn good, and we still see a lot of good companies seeking credit, or seeking to move their credit. One thing that I mentioned briefly in my comments is that we think there is a real opportunity, even in a down cycle like what everyone’s looking at today – primarily in the national market – to take advantage of the ability to find really good people and really great credit relationships. A lot of that’s happened in our marketplace. We’ve been able to up price to a certain extent, we’ve been able to get better structure today, and we believe that’s going to continue for some period of time.

Operator

Our next question comes from Brent Christ at Fox-Pitt.

Brent Christ – Fox-Pitt

Obviously with the really strong balance sheet growth that you guys had this quarter, it looks like your capital levels came down a little bit – your total risk based capital is about 10.3% now, just above that well capitalized threshold. And I’m just kind of curious how you’re thinking about capital on a go forward basis, and how that could potentially impact your future balance sheet growth expectations.

George Jones

Texas Capital can manage, frankly, through 2009 with our existing resources. We really took steps in 2007 to provide for future needs when the capital markets really were becoming difficult. The trust preferred markets went away, so we did some other things. Obviously, market conditions are going to drive growth rates below those that we’ve enjoyed historically. But, frankly, if that should change, we think the market will provide capital to those banks, even though it’s probably difficult today, like Texas Capital, who can perform well even in difficult circumstances. If we see a different opportunity, or changing circumstances, we’ll react accordingly.

I think also, an interesting point about capital, when we do raise capital, we really have somewhat more flexibility than many other banks because if you look at our capital structure, our tier 1 capital is strong and we can choose to raise only tier 2 capital if that’s what’s necessary. So we feel pretty good about our capital levels and we feel pretty good about our ability to take advantage of the marketplace and some of the opportunities that could arise.

Brent Christ – Fox-Pitt

With the larger 90 days past due C&I loan, was that a syndicated credit and, if so, are you guys still the lead on it or are you participating with somebody else?

George Jones

Nope, nope. That’s one credit. It comes out of our Fort Worth area, again, as I mentioned to you, by two good friends of the bank that, frankly, just had a downturn in their particular business and, you know, we properly reserved it, we think we properly classified it, and we think that we have very little loss potential in that particular credit, and it’s just going to take a little time for it to write itself.

Brent Christ – Fox-Pitt

And then, with respect to the $8.8 million lot development loan, what’s the geography of that particular relationship? Where’s that loan based out of, the lot development.

George Jones

The $8.8?

Brent Christ – Fox-Pitt

Yes.

Peter Bartholow

Because it’s, we’re planning discussions about sale -- it might make sense not to get into that.

Brent Christ – Fox-Pitt

You did mention that about 10% or something less than 10% of your real estate exposure was outside of Texas. Could you give us a sense of, geographically, where that may be?

George Jones

Yes, if you look at residential product, we’ve probably got about 96% of our residential product in Texas. For our commercial properties, it’s about 90%. We would tell you, one, it’s diversified and, secondly, we have less than 2% in any one particular market. So, it’s very little outside of the state of Texas, and no concentration in any one market outside of the state of Texas.

Brent Christ – Fox-Pitt

You’ve mentioned on a couple of these real estate related loans getting updated appraisals. I’m just curious where those are coming in, in terms of the type of price declines you’re seeing since the last time they were appraised – you know, just broadly, not specific to any one loan.

George Jones

We’re really pretty pleased where we see the appraisals coming in. We think that, again, is a hot button today, certainly with the regulators, and we are very much interested in updating our appraisals where necessary. And, frankly, we feel pretty good about where we see them coming in.

Operator

Our next question comes from Andrea Jao at Lehman Brothers.

Andrea Jao – Lehman Brothers

Once again you’ve posted good long growth and pretty good deposit growth, but loans continue to outpace deposits, and your loan to deposit ratio has inched higher over the quarter, since now it’s 114%. At what level do you start being uncomfortable with the level of loans to deposits, and where do you want that to be?

Peter Bartholow

You know, Andrea, a lot of it has a lot to do with what we’re seeing in the held for sale category. With that level reaching $300 million or so, and given the fact that, in today’s environment that turn on that – meaning the through foot is less than 10 or 12 days. So, it’s a very, very liquid market, and we obviously feel comfortable carrying that kind of asset with something other than customer deposits.

You saw the growths by the end of the quarter were substantially reduced today in other borrowing categories. Equity, despite provision levels, especially because we don’t have intangibles cluttering up our ability to support growth, our equity is actually dedicated heavily to the financing of our loan portfolio. So, I think if you take out something that we would consider the especially high level of held for sale, and given that loan growth typically proceeds deposit growth, as it has in the last couple quarters, 105% to 110% would not surprise us. 100% to 105% or 110%.

Andrea Jao – Lehman Brothers

Now, please remind us the composition of your investment securities portfolio, and if you could put any color on the markets -- just want to check in if there are any Fan or Freddie securities in there.

George Jones

No, we own no GSE stock. We own only agency kinds of mortgage-backs. We haven’t purchased a security since year end 2004, so as I think we’ve said, we missed out on the opportunity to buy a lot of securities that today are giving the industry a lot of heartburn. The slight market value erosion link quarter is strictly bond market. It has nothing to do with any issue within our portfolio.

Andrea Jao – Lehman Brothers

Do you have the numbers for the OCI?

George Jones

We have zero, other than temporarily impaired.

Operator

Our next question comes from Brad Milsaps at Sandler O’Neil.

Brad Milsaps – Sandler O’Neil

But, just curious on the operating expense numbers. Sometimes when you guys have had weaker quarters than you’re expected you’ll go a long way to maybe cut the incentive comp and maybe drop a little bit more of the bottom line. Didn’t seem to be the case this quarter. I know you had some, maybe, outside legal expenses, but just kind of curious if your guidance includes maybe some reduction in the run rate on the incentive comp, or how to kind of think about that going forward.

George Jones

Effectively it does. The incentive comp accrual is based on full year performance. We are reducing, obviously, the guidance as indicated, so that will have an effect on the incentive accrual.

Brad Milsaps – Sandler O’Neil

But it didn’t this quarter?

George Jones

Nothing of any consequence because, again, we focus on the full year basis.

Brad Milsaps – Sandler O’Neil

So, if you come in this guidance you should be in that range in terms of where you think you’re going to be in terms of incentive comp.

George Jones

That’s correct.

Operator

Our next question comes from Bain Slack at KBW

Bain Slack - KBW

What time of the year does your safe and sound interview typically occur?

George Jones

In today’s world, Bain, we’re examined basically throughout the year on one thing or another, so targeted exams – we don’t really get into examination watches.

Bain Slack - KBW

With regard to the demand deposit growth that you all saw, if I heard correctly, the bulk of it sounded like it was at the end of the quarter –

George Jones

The last half of the quarter was quite a bit stronger than the growth rate on a link quarter basis.

Bain Slack - KBW

I was just wondering, was there anything lumpy in there, such as a specific deposit from one customer?

George Jones

No, you know, we really looked hard at that, and it’s very well spread across our customer base. We saw energy being a nice component, we saw our business banking group with nice component, and really across our commercial customers we saw good DDA growth.

Operator

Our next question comes from Michael Rose at Raymond James.

Michael Rose – Raymond Jones

I wanted to ask about how the dislocations have translated into, maybe, your hiring plans for the year, if you guys are looking at adding additional lenders given some of the weakness we’ve seen out of some of your competitors.

George Jones

As we’ve always said in the past, we’ll be opportunistic, and I think we’ve had, in a couple of our markets outside of Dallas we’ve seen some really good opportunities, and we’ve hired a few people. I think it’s going to continue, and we’re going to see opportunities in business banking, private client, and treasury management. It’s an opportunity that we want to take advantage of when the time is right. And we think we can make some hay in this marketplace.

Michael Rose – Raymond Jones

What kind of opportunities are you seeing in the energy lending practice, given the rise in oil prices?

George Jones

We’re seeing good opportunities. We’ve seen good growth in our energy lending portfolio, you know, we’re lending on proved reserves. We’re an EMP lender, we don’t lend on steel, and equipment, and tubular. We’re lending on cash flow, and it’s been pretty darn good.

We’re seeing a lot of people drill today and we’re providing capital to help continue to develop reserves. It’s production based, using a drill bit. We don’t see -- we're not financing acquisitions for our customers in today’s environment. We’re seeing them use the drill bit and develop reserves that they own.

Operator

Our next question comes from Erika Panela from Merrill Lynch.

Erika Panela – Merrill Lynch

With the deposit balances, I noticed that there was an increase – a significant quarterly increase – in average time deposit balances, and a similar decrease in foreign deposits over the same time period. Was there anything going on there?

George Jones

No, we had -- I think we commented at end of Q1. We had a transaction specific, primarily one transaction specific outflow at the end of Q1. It’s staying basically stable since then.

Operator

We show no further questions at this time.

George Jones

Well, thank you. We appreciate your attendance on the call. We want you to know that Texas Capital Banc, again, will be working very hard for the interest of the shareholders, and we appreciate all your support. Thank you very much.

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Source: Texas Capital Bancshares, Inc. Q2 2008 Earnings Call Transcript
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