Texas Capital Bancshares Q2 2023 Earnings Call Transcript

Quartr
Provided by Quartr
July 20, 2023

There are 11 speakers on the call.

Operator

And thank you for joining today's conference call titled Texas Capital Bancshares Q2 2023 Earnings Call. We're just holding for a moment while we wait for a few more participants to connect. Today's call will be hosted by Rob Holmes and Matt Scurlock and will be getting underway in a minute or During the presentation, if you would like to ask a question, please press star followed by 1 on your telephone keypad. Thank you for your patience. We will get started.

Operator

Hello, and welcome to today's conference call titled My name is Bella, and I'll be coordinating the call for today. During the presentation, if you would like to ask a question, please press star followed by 1 on your telephone keypad to join the question queue. I'll now hand over to Jocelyn Koepelka to begin. Jocelyn, please go ahead whenever you're ready.

Speaker 1

Good morning, and thank you for joining us for TCBI's Q2 2023 earnings conference call. I'm Jocelyn Kokolka, Head of Investor Relations. Before we begin, please be aware that this call will include forward looking statements that are based on our current expectation of future results or events. Forward looking statements are subject to both known and unknown risks and uncertainties that could cause actual results to differ materially from these statements. Our forward looking statements are as of the date of this call, and we do not assume any obligation to update or revise them.

Speaker 1

Statements made on this call should be considered together with the cautionary statements and other information contained in today's earnings release, our most recent annual report on Form 10 ks and subsequent filings with the SEC. We will refer to slides during today's presentation, which can be found along with the press release in the Investor Relations section of our website. Our speakers for the call today are Rob Holmes, President and CEO and Matt Scurlock, CFO. At the conclusion of our prepared remarks, our operator will open up a Q and A session. And now I'll turn the call over to Rob for opening remarks.

Speaker 2

Thank you for joining us today. The firm's sustained progress against our well documented strategy was evident again this quarter as the people, products, services and infrastructure implemented over the past two and a half years delivered another quarter marked by notable improvements in financial performance. I am proud of the foundation we have built And acknowledge the early successes of our strategy are due entirely to the material efforts of the employees across the firm And the trust placed in us by our clients who believe in what and the how we are building. We are resolute in our mission to realize the unique opportunity to create something differentiated for our clients and steadfast in our commitment to building something of lasting value. The financial resiliency of this firm continues to be a strategic advantage.

Speaker 2

A goal since our arrival was to build a firm characterized by the Strength of its balance sheet and the breadth of its platform, affirm that is resilient through market and interest rate cycles. Maintaining sector leading capital and liquidity continues to enable our bankers to focus on growing the firm by both serving the broader needs of existing clients and confidently engaging identified prospects with an increasingly mature and compelling offering. The pace of client acquisition over the 1st 2 years of the transformation was marked largely by aggressive balance sheet reallocation to focus our capital on defined industry end market segments Where we believed clients would benefit from the material investments made in our treasury solutions, private wealth and investment banking offerings. Our view was that as the capabilities and culture evolved, we would become more relevant to our clients and in turn Begin to generate structurally higher returns on that allocated capital. Both this quarter's financial results And client behaviors suggest sustained progress towards this objective.

Speaker 2

We continue to add operating accounts at a pace consistent with our long term plan. Gross payment revenues increased for the 2nd straight quarter And we're up 12% year over year as our multiyear focus and material investments in proprietary applications Like our commercial onboarding solution, Inacio, are enabling us to win the operating business indicative of becoming our client's primary bank, A designation that not only improves long term earnings capacity, but also advances the already strong quality and associated resiliency of a transforming deposit base. Over 90% of our commercial client onboardings Now occurred digitally. And during the Q2, new business client onboarding increased over 30% compared to the prior quarter. Given the current rate environment, clients with deposits greater than necessary for daily operating needs are utilizing other cash management options on our platform, including interest bearing deposits or in some instances, Short term liquid investments like treasuries.

Speaker 2

We are and will remain Materially more focused on ensuring client needs can be met with our offerings than on our own near term financial outcomes. The full rebuild of the Private Wealth business that I have detailed in prior calls is nearing completion, resulting in a front, middle and back office structure built for both superior client experience and significant scale. The pace of year over year client acquisition was 13% this quarter and remains an indication of both future earnings potential And further connectivity across our services. Clients are increasingly benefiting from our still emerging Investment Banking capabilities. Investment Banking and Trading Income had a 3rd consecutive record quarter with revenue up $8,700,000 Or 47% quarter over quarter to $27,500,000 with contributions from all components of our newly built platform.

Speaker 2

We continue to achieve milestones on our product and services roadmaps And will focus future investments in an offering capable of delivering at least the 10% of total revenue targeted by 2025. Since its launch in December 2021, our Investment Banking business has built an impressive array of capabilities to help clients solve a broad set of needs. Our capital solutions offering enables our clients to manage their interest rate risk via strategies of varying complexities And sophistication, such as swaps, collars, corridors and FX hedging. Our Capital Markets Group has been actively assessing and executing alternative financing strategies for clients, Including securitizations, high yield, follow on, initial public offerings and our first convertible bond trade occurring this quarter. Additional trades in the last 6 quarters have included TBA trades, Specified MBS pool trades, corporate bond trades, corporate loan trades and equity trades.

Speaker 2

Sales and trading has now completed over $35,000,000,000 in notional flat trades Since the first trade last May. Our M and A advisory team has assisted clients in realizing the long term strategic objectives through its 1st buy side advisory mandate and the closing of its 1st sell side engagement. Finally, our newly created ETF and funds management team successfully launched The Texas Capital Texas Equity ETF now trading under the ticker TXS on the NYSE. At Texas Capital, we recognize that Texas' diverse business friendly climate and vibrant economy are critical to our growth success. I am excited to announce that last week we launched the aforementioned Texas Capital Texas Equity Index, Exchange traded fund as the first investment offering created by Texas Capital's newly founded ETF and Funds Management Business.

Speaker 2

With this launch, we entered one of the fastest growing spaces in the asset management industry, further progressing Against our objective to be the flagship financial services firm in the State of Texas and marking a significant expansion of our asset management capabilities. The substantial and transformative investments made over the last 2 years to deliver a higher quality operating model, supporting a defined set of scalable businesses is resulting in the intended outcomes. The entire platform contributed to our now 4th consecutive quarter of positive operating leverage As year over year quarterly PP and R grew 43% in Q2. Non interest income as a percentage of total revenue increased to 16.6% this quarter. It stands at 15.1 percent year to date, already in line with the bottom end of our full year 2025 goal to generate 15% to 20% of total revenue from fee income sources.

Speaker 2

Importantly, these diverse and complementary revenue streams were all built in the last 2 years and will take time to deliver both at the magnitude And with the consistency we expect. That said, we are pleased with our progress to date and have proven that each of our areas of focus will be key contributors to earnings Going forward. Before concluding, a foundational tenet of the financial resiliency we have established And consistently communicated and will preserve its continued focus on tangible book value, which finished the quarter up 7% year over year, ending at $57.93 per share, A near all time high for our firm. As you have heard me say in the past, while fully committed to improving financial Over time, maximizing near term returns is not the primary goal. We are instead focused on responsibly scaling High value businesses through increased client adoption, improved client journeys and realized operational efficiencies.

Speaker 2

Doing so will enable both higher quality earnings and a lower cost of capital, which results in attractive through cycle shareholder returns. Thank you

Speaker 3

for your continued interest in and support of our firm. I'll turn it over to Matt to discuss the quarter's results. Thanks, Rob. Good morning. Strong balance sheet positioning built over the last two years continues to be exemplified by top tier capital and liquidity levels.

Speaker 3

Quarter end, on hand cash liquidity totaled $2,800,000,000 or 10% of total assets compared to 5% median in our peer group. Uninsured deposits as a percentage of total deposits further decreased this quarter to 40%, and deposit coverage ratios remained extremely strong, both in absolute and relative terms, with cash plus contingent funding to uninsured deposits of 165%. Capital levels remain at or near the top of the industry. CET1 finished the quarter at 12.2 percent and tangible common equity to tangible assets finished the quarter at 9.6%, which ranks 1st relative to 1st quarter results for all large U. S.

Speaker 3

Banks. Notable progress in our fee generating businesses continued again this quarter. As year to date non interest income to total revenue was over 15%, in line with our long term target of 15% to 20%. This was in part driven by quarterly investment banking and trading income of $27,500,000 which increased nearly 150% from the Q2 of last year and is up 47% linked quarter. Notably, this is our 3rd consecutive record quarter since launching the Investment Banking business last year.

Speaker 3

Treasury product fees increased 1% quarter over quarter. The pull through to earnings from sustained momentum in our cash management and payment businesses is at this point in the rate cycle being offset by increased deposit compensation. We are less focused on quarterly fluctuations in revenue from offering and we are ensuring we are adding primary banking relationships consistent with our long term plan. Wealth Management income increased 8% quarter over quarter As assets under management grew 6%, resulting from market changes, net new inflows and some additional rotation from existing commercial and private wealth clients into managed liquidity options. Managed liquidity now represents approximately 25% of AUM, up from less than 5% a year ago.

Speaker 3

Taken together, fee income from our areas of focus increased by approximately $16,000,000 or 70% year over year, representing the early stages of client adoption across a set of capabilities unique in our markets and custom built for our clients' evolving needs. Total revenue increased $5,000,000 linked quarter The $3,300,000 decline in net interest income was more than offset by improving noninterest revenue. As expected, despite seasonally strong warehouse loan growth, net interest income was pressured by industry wide increases in overall deposit costs. Total revenue increased $46,200,000 or 20% compared to Q2 2022, with year over year results benefiting from a 76% increase in non interest income coupled with disciplined balance sheet repositioning into higher earning assets. Total non interest expenses declined 6.4% linked quarter, as structural efficiencies associated with our go forward operating model began to flow the income statement.

Speaker 3

Taken together, quarterly PPNR increased 43% year over year to 96,400,000 The high point since we began this transformation in Q1 of 2021. Net income to common was $64,300,000 for the quarter, up $34,500,000 year over year, While earnings per share increased $0.74 This is the highest level in 2 years adjusted for our divestiture. Preparation for an inevitable normalization in asset quality began in 2022 as we steadily built the reserve necessary to both address no legacy concerns and aligned balance sheet metrics with our foundational objective of financial resilience. We recognized $8,300,000 in net charge offs during the quarter, reducing non accrual loans 28 basis points of total assets. This quarter's provision expense of $7,000,000 accounts for the modest increase in criticized loans As well as quarterly loan growth predominantly related to mortgage finance, which garners proportionally lower reserve rates.

Speaker 3

Quarterly performance metrics continued their steady progression towards target financial outcomes with quarterly return on assets And return on tangible common equity of 0.95% and 9.17%, respectively, both more than double levels observed in the 2nd quarter of last year. Our balance sheet metrics remain strong with the end of period profile reflective of continued execution on our set of core objectives. Gross LHI balances increased by $1,300,000,000 or 6% linked quarter, driven by predictable seasonality in the mortgage finance business and modest increases in commercial real estate, Which is experiencing lower levels of prepayment activity. Deposit balances increased 5% or $1,100,000,000 in the quarter. Consistent with previous guidance, the deposit and loan growth were likely to more closely mirror each other in the near term after significant loan growth in Q1.

Speaker 3

As a result, the period end loan to deposit ratio remained flat linked quarter at 91% and down from 95% in the Q2 of last year. Cash balances moderated 10% of total assets as outstanding FHLB borrowings declined by $750,000,000 and are now below our historically observed levels representing one component of our ample contingent liquidity. As we detailed on the January earnings call, We have rebuilt nearly every process and procedure across the firm. As a result, in the Q2, changes were made to certain estimates used in the company's CECL model, The most significant of which are more granular estimates of historical loss rates to incorporate probability of default, loss severities And allocations of expected losses to outstanding loan balances and off balance sheet financial instruments. These changes resulted in adjustments to the company's portfolio segments, including the introduction of the consumer category and then a reallocation of the allowance for credit losses between loan portfolio segments and the allowance balances allocated to off balance sheet financial instruments.

Speaker 3

The changes made to estimates used in the company's CECL model result in a higher allocation of losses to Off balance sheet financial instruments as is reflected in the $24,000,000 decline in the ACL on loans. On a combined basis, however, Total ACL inclusive of off balance sheet reserves remained relatively flat as compared to the prior quarter. Finally, the increase in interest rate resulted in an AOCI decline of $65,000,000 which is nearly offset by net income to common and result in tangible book value per share of $57.93 Total LHI excluding mortgage finance increased $213,000,000 or 1.43 percent for the quarter and is now up $1,000,000,000 or 6.8 percent for the year. After expanding 8% in Q1, commercial loan growth moderated this quarter, declining $126,000,000 or 1% as both clients in the industry reset expectations for capital cost and its impact on credit demand. Commercial loan growth over the past 4 quarters has added $1,400,000,000 of client balances consistent with our strategy, an increase of 15% when adjusted for divested loans.

Speaker 3

This capital previously attributed to loan only relationships in the insurance premium finance business Continues to be recycled into a client base that benefits from our broadening platform of available product solutions delivered within an enhanced client journey. Overall, request for capital extensions continue to come primarily from new and expanded relationships as utilization rates were constant quarter over quarter at 51%. Our balance sheet committee trends indicate that while volume has declined from the year ago period, the proportion of new activity that includes more than just the loan product has increased substantially over the last 2 years to over 95% for the 1st 6 months of the year. This is further evidence of our ability to bring Increasingly comprehensive solutions to our clients in any economic environment and through the entirety of their corporate life cycle. Period end real estate balances increased $358,000,000 or 7% in the quarter.

Speaker 3

We continue to experience the expected but Still material slowdown in payoff rates off recent record highs. Our clients' new origination volume also slowed in recent quarters, It remains focused on multifamily, reflecting both our deep experience in the space and observed performance through credit and interest rate cycles. Only 12% of the real estate portfolio has a maturity date in 2023, while over 58% of the portfolio matures in 25% or later. Our exposure to at risk asset classes is limited with office exposure of $460,000,000 approximately 9% of the total commercial real estate portfolio. The office book has solid underwriting with a current average LTV of 57% 89% recourse as well as strong market characteristics is over 75% is Class A properties and over 71% is located in Texas.

Speaker 3

Average mortgage finance loans increased $1,100,000,000 or 33 percent in the quarter as the seasonality associated with spring home buying partially offset Rate driven pressures that continue to drive down estimates of next 12 to 24 month activity. Year over year, the industry has contracted from 3 point $4,000,000,000,000 to $1,600,000,000,000 in trailing 12 month originations. Overall market and volume estimates from our professional forecasters suggest Total market originations to decrease modestly in the 3rd quarter, with full year expectations still showing a decline of more than 30% in origination volume. Consistent with historical performance, we would expect to maintain our outperformance margin of about 25% as we remain confident in our ability successfully served this industry. In line with expectations communicated last quarter, total ending period deposits increased 5% quarter over quarter With changes in the underlying mix reflective of both a continued funding transition and a tightening rate environment, coupled with market driven trends and predictable seasonality.

Speaker 3

Total non interest bearing deposits remained stable quarter over quarter with the proportion to total deposits decreasing modestly to 40% from 42% at year end. The underlying composition, however, does continue to shift. As expected, mortgage finance non interest bearing deposits increased $884,000,000 or 20 percent quarter over quarter alongside higher loan balances as we remain focused on holistic relationships with top tier clients in the Average mortgage finance deposits were 120 percent of average mortgage finance loans, at the high end of our guidance of between 100% 120% due to the impacts of decreased mortgage originations. Other non interest bearing deposits declined $955,000,000 or 19%, In part due to previously described trends whereby select clients shifted excess operating account balances to interest bearing deposits, including insured cash sweep or to other cash management options on our platform. While the pace of rotation is slowing, we do expect the portion of our total deposits comprised of non interest bearing, Business channels aligned with our strategy resulted in a 10% linked quarter increase in total interest bearing deposits.

Speaker 3

The pace of our proactive repositioning away from index deposit sources has slowed as balances are now aligned to clients consistent with our strategy and at 6% Total deposits well inside our published 2025 threshold of 15%. Including the $195,000,000 reduction experienced this quarter, These balances are now down over $8,500,000,000 since year end 2020. During the quarter, we did begin pre funding of the $499,000,000 of brokered CDs maturing during the Q3. We maintain ample broker capacity and we're always evaluating future liquidity Consistent with established balance sheet management priorities, we do anticipate that brokered CDs will remain relatively flat during the Q3. Our expectation remains that we will be able to grow client deposits by a continued elevated marginal cost given the material change in market conditions experienced over the last 4 months.

Speaker 3

As expected, our earnings at risk decreased this quarter to 2.6 percent or $26,000,000 in a +100basispoint shock scenario and minus 3.8 percent or $39,000,000 in a down 100 basis point shock scenario as a result of both increased funding costs And proactive measures taken earlier in the year to achieve a more neutral posture at this stage of the rate cycle. There were no new security purchases in the quarter As we continue to believe holding levels equivalent to 15% of total assets, an efficient and prudent portion of our liquidity asset composition at this time. The core component of our naturally asset sensitive profile remains the large portion of our earning asset mix that reprices with changes in short term rates. 93% of the total LHI portfolio excluding NPLs is variable rate with 91% of these loans tied to either prime or 1 month index. Net interest margin decreased by 4 basis points this quarter and net interest income declined 3,300,000 predominantly as a function of a decline in interest earning assets and higher quarter over quarter deposit costs, partially offset by increased average loan balances and improved loan yields.

Speaker 3

Our multi quarter business model transformation and associated platform build is directly intended to lessen our dependence on these inevitable fluctuations in rate driven earnings. Sustained execution on non interest income initiatives will enable revenue stability even Should near term net interest income expansion moderate. Further, the systemic realignment of our expense base Strategic Priorities is beginning to deliver the expected efficiencies associated with a rebuilt and more scalable operating model. We expect to see continued contraction in quarterly non interest expense over the remainder of the year, which when coupled with revenue stability resulting from strong execution on behalf of our clients will enable core earnings expansion despite the market backdrop. Criticized loans increased $58,200,000 or 10% in the quarter $619,300,000 or 2.9 percent of total LHI as increases in special mention real estate loans Offset a $22,000,000 reduction in criticized commercial loan credits.

Speaker 3

The composition of criticized loans continues to be weighted toward commercial clients reliant Typically on consumer discretionary income, plus a handful of well structured commercial real estate loans supported by strong Texas based sponsors. We've previously communicated that we anticipate a manageable real estate migration beginning in the middle of this year. And based on our economic outlook, believe our client and underwriting guidelines provide adequate protection against realized loss. Detailed credit reviews, Credit risk practice implemented during the pandemic continued to occur quarterly, whereby the line of business leads and their credit partners conduct a series of reviews on a name by name basis. Additionally, during the Q2, executive management hosted enhanced credit review sessions in middle market and corporate, resulting in the review of over 50% of the commitments in these verticals.

Speaker 3

Since late March, specific reviews have also been conducted on asset classes or industries, including office, Multifamily Home Builder, Contractors, Beverage Distributors and Software as a Service. The results of these reviews are represented in the migration trends, Both inflows and outflows and special mention in substandard loans this quarter. We have previously commented on the portion of legacy loans Still on the balance sheet, inconsistent with current client selection or underwriting principles that would be resolved through maturities, workouts or select charge offs. During the quarter, we recognized net charge offs of $8,200,000 against this identified portfolio and have now reduced total exposures by over 55% to approximately $100,000,000 of book balances since early 2022. These actions coupled with negligible new inflows into the category supported a $12,900,000 reduction in non performing assets during the quarter and an improvement in our ACL coverage to 3.5 times.

Speaker 3

Total allowance for credit loss, including off balance sheet reserves, was relatively flat on a linked quarter basis at $282,000,000 or 1.32 percent of total LHI at quarter end, Up over $35,000,000 or 29 basis points year over year in anticipation of a more challenging economic environment. Total regulatory capital remains exceptionally strong relative to the peer group and in our internally assessed risk profile. During the quarter, dollars 75,000,000 of the original $275,000,000 mortgage warehouse related credit linked notes were partially paid down As mortgage industry volumes and related credit protection eligible balances have declined significantly since the note was issued in early 2021. This reduction in note balance was neutral to CET1 and at current interest rate levels saved a firm $0.02 of interest expense in the 2nd quarter were $7,900,000 on an annualized basis. We remain focused on managing the hard earned capital base in a disciplined and analytical manner Focused on driving long term shareholder value.

Speaker 3

Our guidance accounts for the market based forward rate curve, Which now assumes Fed Fund reaches 5.5% this quarter and remains there through year end. Changes in anticipated system wide funding costs And slower net interest income expansion was specifically cited in our revenue guidance update last quarter. Our outlook For low double digit percent full year revenue growth remains unchanged. As evidenced by this quarter's results, the significant investments made over the last 2 years are yielding expected operating and financial efficiencies that will continue contributing to profitability in the second half of the year. Our non interest expense guidance also remains unchanged, and we believe the current consensus expense estimates are achievable.

Speaker 3

Together, these expectations Should result in the maintenance of operating leverage as defined as year over year quarterly PPNR growth. Finally, we are committed to maintaining our strong liquidity and capital positions, And our intent remains to hold greater than 20% of our total assets in cash and securities and to exit the year with a CET1 ratio of at least 12%. I'll hand the call back over to Rob for closing remarks.

Speaker 4

Thank you, Matt. Operator, We're available for any questions.

Operator

Okay, great. We will now enter our Q and A session. Our first question comes from Michael Rose from Raymond James. Michael, please go ahead whenever you're ready. Your line is now open.

Speaker 5

Hey, good morning. Thanks for taking my questions. Maybe we can just start on expenses that you just mentioned at Matt. I know there's been Some kind of moving pieces with headcount and things like that. But can you just give us an update on kind of where your staffing expectations are and Where you still would like to kind of opportunistically add?

Speaker 5

I know some of that's in the slide deck, but just wanted to get some kind of overarching comments there. Thanks.

Speaker 6

Yes, you bet, Michael. Good morning. So the quarter over quarter non interest expense was down 6%. After you normalize for the $7,500,000 in seasonal In the Q1 that moves to about a 3% linked quarter decline. You'll recall that the structural efficiencies that we announced on the April call has been enacted in the weeks just prior.

Speaker 6

So we made certain to note that it would take into the Q3 for us to see the full run rate reductions Slow through salaries and benefits. The only items that I would flag that could potentially increase salaries and benefits off that run rate would be remaining items on our near term Investment banking roadmap, which now that we have infrastructure built out, should deliver revenue in excess of any marginal cost Inside of about 12 months. And then for all other non interest expense, our expectation is still that, that remains between $65,000,000 $70,000,000 The higher end of that range continues to be potentially driven by increased spend associated with deposit gathering, which we would more than offset with higher revenues.

Speaker 4

Yes, I would just add, Michael, a subjective comment, well actually a factual comment Yes. What I'm most excited about, maybe more anything else at this point of the build is that We have high quality people in the equity seat. Everything is built. We have stability. For the first time, we have the entire team on the field.

Speaker 4

We may add, like Matt said, 1 or 2 different capabilities, which require more, but The build was complete. The seats are filled and we're really, really happy with who's here.

Speaker 6

And that's very helpful.

Speaker 5

And then maybe just step yes, maybe just stepping back Rob, I think I know this is going back a couple of years when you laid out the Initial targets, but given the progress that you're making, it seems like maybe there's a little bit more confidence around meeting and potentially exceeding those targets. Can you just give us Yes. Given that the world's changed a little bit here, you have some different businesses that you're not in than you were when you kind of laid out those targets. Just holistically, are Those targets still hold and is the timeline still in line with the original expectations? Thanks.

Speaker 4

I would say that it's been a long time Since we laid out those targets, more importantly, the world has changed dramatically as we all know, And we're more convinced than when we started that this is the right strategy for the current world or any market or rate environment. And we stand by the targets that we set out and we're confident we'll hit them.

Speaker 5

Great. Maybe just finally for me, it doesn't look like you guys repurchased any shares this quarter. I know the focus is organic growth, obviously, but just given that the stock is kind of Trading around tangible book at this point. Just any updated expectations or thoughts on usage of the buyback? Thanks.

Speaker 4

Yes. Look, the answer is the same. We have a very, very complex decision tree on which we do We determine distribution policy. Right now, a dollar investment business generates a much greater return Then buying back shares even at book value for future benefit of our shareholders. If that changes, we have plenty of capital liquidity to where we could buy back.

Speaker 4

So right now, we're just so pleased with the plan and our progress that that's the best use of capital.

Speaker 5

Great. Thanks for taking my questions.

Operator

Thank you. Our next question comes from Brett Rabatin from Mahogany Group. Brett, your line is now open. Please go ahead.

Speaker 7

Hey, good morning. I appreciate the questions. Wanted to 1st, talk about Investment Banking. And last quarter was obviously a good quarter for Investment Banking and this quarter was even better. So we just wanted to hear What the pipeline looks like from an investment banking perspective?

Speaker 7

And then if you expect continued momentum in the back half of the year related to that one item? Thanks.

Speaker 4

Yes, Brett. Thanks for the question. Look, we're really excited about the platform that we built. The flywheel is just starting to take hold. The investment bank and the connectivity With the rest of the platform has been and continues to be exceptional.

Speaker 4

The cross coordination And with clients both in private wealth, commercial banking, corporate banking, commercial banking, Our mortgage business and real estate business, it's just we're further along in our maturity than I would have To the hope for. The pipeline is broad, it's diverse, it's granular, it's literally coming from all components the Investment Bank, whether it's sales and trading, M and A Advisory, Capital Markets, Capital Solutions, it's just the entirety of the platform that's really Performing and so we are very encouraged and look forward to continued Solid performance in the 3rd Q4.

Speaker 7

Okay. Would that mean

Speaker 6

The only thing that

Speaker 7

Go ahead, Matt. I'm sorry.

Speaker 6

Hey, Brett. The only thing I'd add to Rob's comments in his script, So I think are worth reviewing in detail. The capabilities on that platform are enabling us to solve different problems for our clients at different point of market rate cycle. So in Q1, the $18,800,000 was largely driven by syndications revenue as we were helping clients access Markets via running their credit facilities or with the severely inverted curve in the second quarter, a lot of that revenue shifts to more capital solutions as we help clients Patch their own rate risk and deliver advisory services. So I think the contributors to that income to Rob's point on the pipeline Are very much going to change from quarter to quarter, but it enables us to deliver exceptional outcomes for our clients Regardless of what the need is.

Speaker 7

Okay. That's really helpful. And then wanted to just talk about funding for a second. And I think one of the challenges the banks face had is just declining DDA as clients Move funds to interest bearing sources. If you could make a case that maybe your DDA is finally bottoming here With operational accounts, would that be a fair assessment do you think or maybe there's some additional migration in that bucket?

Speaker 4

Hey, Brett, let me just let me make one quick comment that I think is really important. I'll let Matt answer your question specifically. We are totally agnostic to where the client is on our balance sheet, Whether they're in DDA account or they move to AUM to manage liquidity, because they're that they may be rolling out Of the DDA, but they are staying in our on our platform. They are not leaving the firm. And so we're here to solve Client needs and over time will benefit and the client will too.

Speaker 4

But I think it's really, really important to point out that nobody is leaving the firm. They're just rotating the different products and services. Sorry, Matt, go ahead.

Speaker 6

No, thanks for calling that out. I mean, we're obviously quite pleased to have a Suite of cash management products and infrastructure to support that client rotation at this point. Our view embedded in the guidance is that the rotation Does start to slow. We're modeling commercial non interest bearing to end just south of 15% as we exit the year. We, of course, think it's Extremely important to balance any sort of near term impact on financial performance that we're in the middle of a with the fact we're in the middle of a multi year transformation of the deposit base.

Speaker 6

So things that we go into pretty extreme links every quarter to call out for you guys like 12% growth in year over year gross payment revenue Or the fact that our treasury pipelines in the 3rd quarter up 50% relative to the 2nd quarter. Those are specifically to give you an indication, Brett, of How today's activities are going to drive financial outcomes in 2024 and 2025.

Speaker 7

Okay. That's great color. Appreciate it.

Speaker 4

You bet.

Operator

Thank you. We'll now take our next question from Stephen Skelton from Asana Stephan, your line is now open. Please go ahead.

Speaker 4

Thanks a lot.

Speaker 8

I I guess one of the things I wanted to dig into was the new customer growth. I think you said it was maybe up 30% quarter over quarter, which is impressive. Can you give us a feel for where those customers are coming from and maybe what segment of the bank more so is driving that customer growth if you had to pin it somewhere?

Speaker 4

Yes. A lot of that is the treasury onboarding and 90% of that Done now digitally through our new InitiO platform, which I think is market and sector leading, which is Super simplistic way to onboard a commercial client and the client journey is much improved and much more efficient. Really excited to have that up and running. That's both for new and new clients and also clients expand their relationships with us on the platform, which That's new to this quarter as well. I think it's broad based.

Speaker 4

It's we have New clients on the platform in capital markets, which has become increasingly busy, capital solution, Treasury, private credit through our syndications desk. So I think it's very, very broad, but the predominant amount of the new clients is onto the treasury platform. Where they're coming from, it depends on the segment in which we're discussing. The business banking client is generally coming from a different Firm than the middle market or corporate client. So or even sales and trading or our mortgage clients.

Speaker 4

But It's very broad. It's not in one segment or one product.

Speaker 8

Okay, great, very helpful. And then I appreciate the commentary about being somewhat agnostic about where the customer sits on the balance sheet. But obviously, That does present a pretty significant near term profitability headwind. So I'm kind of curious, the 110 ROA target in particular is pretty I don't know if the rest is the right word, but it's going to take a lot of heavy lifting. So how do you get there near term in light of that specific headwind and that Impact of profitability.

Speaker 6

We're having a little bit of a hard time hearing you, Stephen. So if I answer the wrong question, Ask the right question. I'll try to answer that. So we think about with a normalized Through cycle provision of, call it, 40 basis points of loans, excluding mortgage finance. We need to push PPNR to average assets from The $133,000,000 we delivered this quarter to closer to $165,000,000 to $170,000,000 which is another $20,000,000 or so of PP and R each quarter on the same size balance sheet to start to bring that oneone into site.

Speaker 6

To Rob's earlier comments, We think the breadth of our platform gives us a variety of paths to get there, which would include continued expansion of fee income, Continued realization of the structural efficiencies enacted in April of this year. I think as we move into next year, we'll get more specific on The relevant components that should come together to drive that outcome in 2025. I think that's what drives our confidence is that there are A wide range of options supported by sector leading capital and liquidity that can enable us to hit the target.

Speaker 8

Okay, great. That's really helpful. And maybe just last thing for me. Any update on the I think it was around $130,000,000 in legacy loans maybe that We're still hanging around that maybe weren't as high quality as what you've put on over the last few years. And did that drive any of the increase in the criticized assets?

Speaker 6

Yes, great question. So when we started the journey, the number was just north of $200,000,000 now down to $100,000,000 About $30,000,000 of that has been driven through charge offs, including the charge offs realized this quarter. The remainder has been driven by maturity, Restructure, refinance out of here. That did not drive the pickup in special mention credit this quarter. That was largely driven by C and I, of course, real estate clients that are consistent with the go forward strategy.

Speaker 6

And as we mentioned in our commentary, It was likely the Q3 of last year that we started to indicate we expected early stage migration in commercial real estate to begin in the middle of this year. So we're not surprised to see that and we are quite confident both in our client selection as well as the underwriting characteristics That support those credits.

Speaker 8

Got it. Fantastic. Appreciate all the color and congrats on all the continued progress.

Speaker 4

Thank you.

Operator

We'll now take our next question from Brady Gailey from KBW. Brady, your line is now open. Please go ahead.

Speaker 9

Hey, thanks. Good morning, guys. I wanted to ask again about Investment Banking and trading. As I look at that line item, I mean the growth has just been incredible over the last year. It went from Yes, dollars 8,000,000 to $12,000,000 to $19,000,000 Now over $27,000,000 in the second quarter.

Speaker 9

Maybe when you take a step back and you look at that business, what do you think is the right goal when it comes to annualized Revenue. I mean, if you annualize 2Q, you did over $100,000,000 of revenue there. What's the potential For that business over time.

Speaker 4

Yes. Look, I think the guidance was 10%. We'll stick with that guidance for now. But just to kind of talk a little bit about that, Brady, I just want to expand just real Briefly of why we're so confident in that business. First, this quarter was another great quarter at first for the Investment Bank.

Speaker 4

We had our first IPO, Our first convertible bond trade, we closed our first sell side M and A advisory fee. We launched the ETF in the funds management vertical. We were originating our 1st warehouse, the securitization facility. We onboarded our 1st gestation balances and we settled the 1st pool trade. So there's just there continues to be a lot of first coming out of the ground for a platform that we've already incurred the expense on.

Speaker 4

And this is kind of how it works. So a couple of years ago, we had a small TF client And we want the primary bank and then we want the primary banking relationship to a loan from a money center bank And then that middle market banker referred that principal to the private wealth business. And 6 months later or sometime later, the private wealth banker referred them to our M and A team And that was the first M and A sell side that we just did. So that's the power of this platform, TS, full wallet, Commercial Bank, middle market banking client, which is wonderful, then private wealth, then we sell the business And now the proceeds are back into the private wealth. And so it's just that's the power of it, why we're so confident in it And why we know we'll hit our target and maintain it.

Operator

We'll now move on to our next question from Matt Olney from Stephens. Matt, your line is now open. Please go ahead.

Speaker 10

Thanks. Good morning, guys. Just want to stick with that same discussion on the investment banking line. And I'm Trying to appreciate just how lumpy this line item can be in the future. Any color on the granularity Within this line for some specific events.

Speaker 10

Just trying to appreciate potential for volatility in that line as you continue to ramp this up.

Speaker 4

I really appreciate the question because when Matt and I were alone in this boardroom talking about the strategy, I told Matt That when we say we're going to start investment bank, people are going to think we're crazy, that's not going to work, then it's going to work and then they're going to complain about The inconsistent earnings of it and here we are. So the answer, but the real answer and the constructive answer is It's granular. It's all components of the investment bank. To Matt's point, the mix will shift quarter to quarter Based on the economic environment. But remember, we're outperforming and doing really, really well right now with very little issuance By any corporate company.

Speaker 4

So it's great that the platform is so broad That the mix can shift and we can solve all client needs, so the client never has to leave us to go to another firm to get something done. So it's it helps with other things too. I mean the sophistication of the advice that we're able to give clients Demand that premium for other products and services. So if we go out and talk to a client about a swap or a sell side or something else And they don't do that. That's great.

Speaker 4

They generally will reward us over time with treasury for another type of business. And So it's not even just the fee that the investment bank earns. It's the vertex between the rest of the firm and the investment bank. And by the way, it goes the other way too. The investment bank is getting business because our commercial bankers have credibility With their clients, they've been in market with those clients for a long time.

Speaker 4

So it works both ways, period.

Speaker 10

Okay. I appreciate that, Rob. Thanks for the color. And then I guess changing gears, thinking about the DDAs, Matt, within the mortgage finance, I think you mentioned we're at the high end of that 100% or 120% Of the mortgage finance loans, where do you see that move in the back half of the year?

Speaker 6

Yes, I'd see the high end of that range Largely staying intact, Matt. I mean, as you know, we really like the industry. We've invested in expanded product offerings. We feel as though we're banking top tier clients in the space and they want to place to move their treasury and they want to start to move their deposits and we're happy to avail them of that. So I'd look to the high end, I think on actual warehouse and part of that should be my actual warehouse balances.

Speaker 6

So we still you're still looking at a 30% Industry wide decline in 1 to 4 family originations for the year will be about 75% of that decline or as we said in Square up to 25 percent outperformance margin. So if we're at $5,300,000 last year on full year average warehouse balances, you can look for that somewhere in the low 4s. So I think you're going to see that phenomenon play out through the back end of the year. There are a component of those balances, as you know, Matt, that are compensated via mortgage warehouse Yield. So as the loan volumes decrease, the yield will also decrease as deposits remain flat or grow.

Speaker 6

So that's something to consider as you're modeling it out.

Speaker 10

Okay. That's helpful. Thanks guys.

Speaker 4

You bet. Thank you.

Operator

We'll now take our final question from Zach Westenan from UBS. Zack, your line is now open. Please go

Speaker 7

ahead. Hi. It's Zack on for Brody. I just wanted to get Your outlook for loan growth, if that's possible, what some of the key drivers are?

Speaker 4

I'm sorry, operator. We can barely hear up for some reason. Would you mind repeating? Loan growth? What loan growth?

Speaker 4

So, look, I'll touch on it and it's not the right question. I apologize. Loan growth was materially less this quarter, as Matt said. As I've always said, as we've always said, since We started the journey 2 plus years ago. This is not a long growth story.

Speaker 4

Remember, a primary focus of ours is recycling capital And we're solving complex solutions or needs for our clients. Even though we had low loan growth, remember a 30% increase of new clients. So we're doing A lot of different things than just loans. That is not an indication of the activity of the platform whatsoever. And I'm perfectly content whether we bank the best clients in our markets via a loan or treasury or capital solutions or private wealth or mortgage finance Or wherever they may end up on our platform.

Speaker 4

I do think loan growth across the entirety of The economy is down. A lot know it is. We're no different. And People

Speaker 1

are a

Speaker 4

little bit more bearish today than they were in the past. And I think the spend on CapEx and other things has slowed based on cut costs and confidence, Which makes the power of our platform even more important.

Operator

Thank you. Unfortunately, we have lost that questioner, but I'll now hand back to Rob Holmes, CEO, for any closing comments.

Speaker 4

Great. Operator, thank you very much to everybody for dialing in and your continued interest in Texas Capital and Our transformation story. We look forward to talking to you next quarter.

Operator

This concludes today's conference call. Thank you very much for joining. You may now disconnect your line. Have a lovely rest of your

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Earnings Conference Call
Texas Capital Bancshares Q2 2023
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