Texas Capital Bancshares, Inc. (NASDAQ:TCBI) Q4 2023 Earnings Call Transcript

Texas Capital Bancshares, Inc. (NASDAQ:TCBI) Q4 2023 Earnings Call Transcript January 18, 2024

Texas Capital Bancshares, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello and welcome to the Texas Capital Bancshares, Inc. Q4 2023 Earnings Call. My name is Elliot and I’ll be coordinating your call today. [Operator Instructions] And I’d like to hand over to Jocelyn Kukulka, Head of Investor Relations. The floor is yours. Please go ahead.

Jocelyn Kukulka: Good morning, and thank you for joining us for TCBI’s fourth quarter 2023 earnings conference call. I’m Jocelyn Kukulka, Head of Investor Relations. Before we begin, please be aware this call will include forward-looking statements that are based on our current expectations 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. Statements made on this call should be considered together with the cautionary statements and other information contained in today’s earnings release and our most recent annual report on Form 10-K 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 at texascapitalbank.com. 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&A session. I’ll now turn the call over to Rob for opening remarks.

Rob Holmes: Thank you for joining us today. Our firm materially progressed its transformation in 2023, increasingly translating a now sustained track record of strategic success into financial outcomes consistent with long-term value creation. We are now operating a unique Texas-based platform providing our clients with the widest possible range of differentiated products and services on parity with the largest money center banks. And we are positioned to serve as a relevant, trusted partner for the best clients in all of our markets. We know that the success of our clients will define our firm. A core element of our strategy is maintaining balance sheet positioning sufficient to support our clients through any circumstance.

Our industry leading liquidity and capital afford us a competitive advantage through market end rate cycles. Year-end CET1 a 12.6% ranked fourth amongst the largest banks in the country. Tangible common equity to tangible assets of 10.2% ranked first among the largest banks in the country and an all-time high for the firm. And liquid assets of 26% allows for a consistent and proactive market-facing posture as we are distinctly capable of supporting the diverse and broad needs of our clients in what continues to be a dynamic and challenging operating environment for all industries. We have over the last three years clearly prioritized enhancing the resiliency of both our balance sheet and business model over near-term growth and earnings. The extensive investments made 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 full-year adjusted financial results with fee revenue growth of 60%, PPNR growth of 14%, and EPS growth of 23%. The foundation of our transformation is the deliberate evolution of our Treasury Solutions platform from a series of disparate deposit gathering verticals into a best-in-class payments offering able to successfully compete for win and serve as the primary operating relationship for the best clients in our markets. The volumes flow through our payment system have increased 23% in the last two years, contributing to an 11% improvement in gross payment revenues in 2023 as Treasury business awarded in prior quarters continues to ramp. Our firm now provides faster, more seamless client onboarding than the major money center banks and ongoing frictionless client journeys that match or exceed theirs with high touch, local service and decisioning.

This theme extends to our investment bank as a capability set on par with the top Wall Street banks ensures clients will never outgrow the services we can provide for them. Market affirmation was evident this year as investment banking and trading income increased 146%. With the largest product offerings, syndications, capital markets, capital solutions, M&A and sales and trading each contributing over $10 million in fee-based revenue, a significant milestone for a still-maturing offering. When we launched the strategy, we acknowledged that results generated by the newly formed investment bank would not be linear, and that it would take several years to mature the business with a solid base of consistent and repeatable revenues. Despite broad-based early success, we expect revenue trends to be inconsistent in the near term, the same as all firms, as we work to translate early momentum into a sustainable contributor to future earnings.

The firm has been and remains committed to banking the mortgage finance industry as it weathers the most challenging operating environment in the last 15 years. Over the previous 18 to 24 months, we have refocused client selection and improved the service model as we look not to expand market share, but to instead deepen relationships through improved relevance with the right clients. Of those that started with just a warehouse line, 100% now do some form of Treasury business with Texas Capital and nearly 50% are open with a broker dealer, paving the way for improved utilization of our sales and trading platform and accelerated return on capital. While the rate environment in ’23 did disproportionately impact this client set as evidenced in our financial results for the quarter, which Matt will walk you through, our commitment to effectively serving these clients will, over time, deliver risk-adjusted returns consistent with firm-wide objectives.

A foundational tenor of the financial resiliency we have established and will preserve is continued focus on tangible book value, which finished the year up nearly 9%, ending at $61.34 per share, an all-time high for our firm. While we continue to buy its capital use towards supporting franchise and creative client segments where we are delivering our entire platform, we do recognize that at times of market dislocation, it can be prudent to selectively utilize share repurchases as a tool for creating longer-term shareholder value. During 2023, we repurchased 3.7% of total shares outstanding at a weighted average price equal to the prior month tangible book value and at 86% of tangible book value when adjusting for AOCI impacts. We enter 2024 from a position of unprecedented strength, fully committed to improving financial performance over time.

Intentional decisions made over the last three years have positioned us to deliver attractive through cycle shareholder returns, with both higher quality earnings and a lower cost of capital as we continue to scale high value businesses through increased client adoption, improved client journeys, and realized operational efficiencies. All objectives that we made significant headway on this year. Thank you for your continued interest in and support of our firm. I’ll turn it over to Matt to discuss the financial results.

Matt Scurlock: Thanks, Rob. Good morning. Starting on slide four, which depicts both current quarter and full year progress against our stated 2021 strategic performance drivers. Full year fee income as a percentage of revenue increased to 15% this year, up 60 million or 60% year-over-year, as our multi-year investment in products and services to provide a comprehensive solution set for our clients continues to translate into improved financial outcomes. Treasury product fees were $7.8 million in the quarter, up 10% from the fourth quarter of last year, as we continue to add primary banking relationships at a pace consistent with our long-term plan. We are also increasingly able to solve a wider range of our clients’ cash management needs.

As outside investments in our card, merchant, and FX offerings ensure the firm’s treasury capabilities are on par or superior to peers in a highly competitive market. Wealth management income decreased 7% during the year, in large part due to temporary client preference for managed liquidity options given market rates. Similar to the Treasury offerings, we are at this point more focused on client growth and platform use than on quarterly changes and revenue contribution. Year-over-year growth and asset under management and total clients of 8% and 11% respectively is on pace with plan as we continue to invest in this high potential offering heading into 2024. Investment banking and trading income of 10.7 million decreased from consecutive record levels in the prior four quarters which were marked by a series of marquee transactions on a still emerging platform.

Results are generally representative of an initial baseline level of quarterly revenue. And while there will always be some volatility associated with this specific line item, we expect increasingly broad and granular contributions to overtime at least partially alleviate expected quarterly fluctuations associated with a new business. In all, we are both pleased with the 64% growth in our fee income area as a focus for the year and in our collective ability to further differentiate our value proposition in the market. As expected, total revenue declined linked quarter to 246 million as both net interest income and non-interest revenue pulled back from respective highs experienced in the preceding quarters. Net interest income was pressured primarily by anticipated seasonal and cyclical impacts of mortgage finance.

As peak self-funding levels reduced, net interest income by $18 million, roughly equivalent to the firm’s total quarter decline. Total adjusted revenue increased 99 million or 10% for the full year, benefiting from a 60% increase in noninterest income coupled with disciplined balance sheet repositioning into higher earning assets associated with our long-term strategy. Quarterly total adjusted non-interest expense increased less than 1% linked quarter and is nearly flat relative to adjusted fourth quarter of last year. During the year we have demonstrated our ability to realize structural efficiencies associated with our go-forward operating model which are improving near-term financial performance while also enabling select investments associated with long-term capability build.

Taken together, full year adjusted PPNR increased 14% to 338 million. This quarter’s provision expense of $19 million resulted primarily from an increase in criticized loans as well as resolution of identified problem credits via charge-off. Full-year provision expense totaled $72 million, or 45 basis points of average LHI excluding mortgage finance loans, consistent with communicated expectations. Adjusted net income to common was $31 million for the quarter and $187 million for the year, an increase of 17% over adjusted 2022 levels. This financial progress continues to be supported by a disciplined and proactive capital management program, which also contributed to a 23% increase in year-over-year adjusted earnings per share to $3.85. Our balance sheet metrics continue to be exceptionally strong.

Period-end cash balances remain in excess of 10% of total assets with a $950 million decline this quarter mainly due to anticipated annual tax payments remitted out of mortgage finance deposit accounts. Ending period LHI balances declined by approximately $270 million or 1% linked quarter, driven predominantly by predictable seasonality in the mortgage finance business, whereby both average balances and end-of-period balances declined, reflecting slower nationwide home buying activity in the winter months. Total LHI, excluding mortgage finance, increased to $181 million during the quarter and 8% for the year. Commercial loan balances remained relatively flat during the quarter, increasing $45 million, which fell marginally unfavorable to near-term earnings expansion, obscures continued strong underlying momentum in the commercial businesses.

New relationships onboarded in 2023 were up nearly 10% relative to elevated 2022 levels. With the proportion of new activity that includes more than just a loan product trending over 95%. The noted progress on winning client treasury business is highly correlated with the increasing percentage of commercial relationships in which we are the lead bank. This manifests in the fee income trends noted earlier as we continue to provide value in multiple ways for clients for whom we choose to extend balance sheet. We are nearing the end of a multiyear process of recycling capital into a client base that benefits from our broadening platform of available product solutions delivered within an enhanced client journey. And after consecutive years of capital build, would expect the sustained pace of new client acquisition to result in modest balance sheet releveraging over the next year.

Period end real estate balances increased $142 million or 3% in the quarter, as payoff rates normalized from record highs in the prior year. Despite a modest increase, we are positioned for a continuation of realized payoff trends in the medium term. Our clients’ new origination volume also remained suppressed. With new credit extension largely focused on multifamily, reflecting both our deep experience in the space and observed performance through credit and interest rate cycles. Average mortgage finance loans decreased $751 million or 16% in the quarter to $3.9 billion as the seasonality associated with home buying approaches its annual low moving into Q1. While both fourth quarter and full year average balances were consistent with communicated guidance, we did experience a late quarter increase in client activity as mortgage rates declined by nearly 120 basis points of fourth quarter highs in late October, resulting in an ending balance of approximately 5% higher than expectations beginning the quarter.

As you know, Q4 and Q1 are the seasonally weakest origination quarters from a home buying perspective. And after a difficult fourth quarter for the mortgage space, our expectation remains that the next quarter will be amongst the toughest the industry has seen in the last 15 years. Despite the modest rate pullback, estimates from professional forecasters, suggest total market originations to contract modestly linked quarter. Should the rate outlook remain intact, industry volumes are expected to recover over the duration of the year with the same professional forecasters expecting a full year increase of 15% in total origination volume. Should origination volume recover consistent with market expectations, we would anticipate a comparable increase given our clients’ strong positioning.

Ending period deposits decreased 6% quarter-over-quarter with changes in the underlying mix reflective of both predictable seasonality and continued funding transition in a tightening rate environment. Sustained focus on leveraging our cash management platform into deeper client relationships has driven outperformance relative to the industry with annual deposits just 2% lower year-over-year. When excluding predictable fluctuations in mortgage finance deposits, our deliberate reduction of index deposits and reduced reliance on broker deposits, year-over-year growth of 4% reemphasizes our success in attracting quality funding associated with core offerings during a challenging year. Period end mortgage finance noninterest-bearing deposit balances decreased $1.7 billion quarter-over-quarter as expected.

As escrow balances related to tax payments are remitted beginning in late November and run through January, at which point the balances begin to predictably rebuild over the course of the year. Average mortgage finance deposits were 142% of average mortgage finance loans, consistent with our guidance of up to 150%. As the system-wide contraction and mortgage origination volume weighs on clients’ short-term credit needs. We expect a ratio of average mortgage finance deposits to average mortgage finance loans of approximately 120% in the first quarter, modestly easing pressure on mortgage finance yields as origination volumes begin to recover through the year. As a reminder, this dynamic is driven by client level relationship pricing, resulting in an interest credit rate applied to the mortgage finance noninterest-bearing deposits that is realized through yield.

Average noninterest-bearing deposits, excluding mortgage finance, was $3.6 billion in the quarter, in line with third quarter period end, as previously described trends whereby select clients shifted excess balances to interest-bearing deposits or to other cash management options on our platform continues to slow. Ending period noninterest-bearing deposits, excluding mortgage finance, remains 15% of total deposits, is flat quarter-over-quarter. Our expectation is that this percentage remains relatively stable in the near term. Broker deposits declined $477 million during the quarter as growth in client-focused deposits consistent with our long-term strategy remains sufficient to satisfy desired near-term balance sheet demands. We anticipate additional declines in brokered CDs during the first quarter as $300 million with an average rate of 5.2% is likely to mature without full replacement.

As expected, our modeled earnings at risk evolved consistent with indications at a slowing tightening cycle as the increase in modeled up betas lessened remaining sensitivity to further upward rate pressure as measured in a plus 100 basis point shock scenario from $29 million in Q3 to $14 million in Q4. Downward rate exposure remained relatively flat quarter-over-quarter at 4.4% or $40 million in a down 100 basis point shock scenario. Proactive measures taken earlier in the year to achieve a more neutral position at this stage of the rate cycle had and produced the intended outcome. It is important to note these are measures of net interest income sensitivity and do not include inevitable rate-driven changes in loan volume or fee-based income.

Further, the disclosed downrate deposit betas are higher than what are contemplated in the guidance as we do not expect deposit pricing to immediately adjust should the Fed deliver against market rate expectations. There were no new bond purchases in the quarter, but we are likely to resume cash flow reinvestment in anticipation of a lower rate environment moving into 2024. Net interest margin decreased by 20 basis points this quarter and net interest income declined $17.4 million, predominantly as a function of the previously described impact of relationship pricing on mortgage finance loan yields and increased interest-bearing deposit volume tied to growth in client balances, partially offset by increased income on higher average cash balances.

The systematic realignment of our expense base with strategic priorities continues to deliver the expected efficiencies associated with a rebuilt and more scalable operating model. Even when accounting for the seasonal factors associated with Q1, salaries and benefit expense has declined three consecutive quarters while retaining in excess of two times the number of frontline employees since the transformation began. Preparation for an inevitable normalization in asset quality began in 2022, as we steadily built the reserve necessary to both address known legacy concerns and align balance sheet metrics with our foundational objective of financial resilience. The total allowance for credit loss, including off-balance sheet reserves increased $5 million on a linked quarter basis to $296 million or 1.46% of total LHI at quarter end, up $21 million year-over-year in anticipation of a more challenging economic environment, while our ACL to nonaccrual loans stands at 3.6 times.

For comparison purposes, the total ACL ratio is 24 basis points higher now than during the pandemic peak in third quarter 2020. Criticized loans increased $61 million or 9% in the quarter to $738 million or 4% of total LHI. As increases in special mention of predominantly commercial real estate loans were only partially offset by payoffs and upgrades of commercial loans. As in prior quarters, the composition of criticized loans remains weighted towards commercial clients with dependencies on consumer discretionary income plus well -structured commercial real estate loans supported by strong sponsors. During the quarter, we recognized net charge-offs of $13.8 million, predominantly related to partial charge-offs of two relationships originated in 2018.

A commercial credit dependent on consumer discretionary income and hospitality loan, which has been unable to recover post the pandemic. Capital levels remain at or near the top of the industry and are near all-time highs for Texas Capital. Total regulatory capital remains exceptionally strong relative to the peer group and our internally assessed risk profile. CET1 finished the quarter at 12.65%, five basis point decrease from prior quarter. Tangible common equity to tangible assets finished the quarter at 10.22%. We remain focused on managing the hard-earned capital base in a disciplined and analytically rigorous manner, focused on driving long-term shareholder value. In aggregate, during 2023, we repurchased approximately 1.8 million shares or 3.75% of the shares outstanding at year-end 2022.

For a total of a $105 million at a weighted average price approximately equal to prior month tangible book value. Our guidance accounts for the market-based forward rate curve, which assumes Fed funds of 4.25% exiting the year. For 2024, we anticipate mid-single-digit growth in revenue, supported by continued execution across the income areas of focus and the slowing of multiyear capital recycling efforts. We should increasingly enable our sustained momentum in new client acquisition to manifest into modest risk appropriate balance sheet expansion. This is in part supported by well-signaled intent to move towards an 11% CET1 ratio, which given our risk-weighted asset heavy commercial orientation should still result in sector-leading tangible common equity levels.

We expect multiyear investments in infrastructure, data and process improvements to continue yielding expected operating and financial efficiencies which should enable targeted additional investment in talent and capabilities while limiting full year noninterest expense growth to low-single -digits. Acknowledging near-term headwinds associated with the mortgage industry, we expect resumption of quarterly increases in year-over-year PPNR growth to begin in the second half of the year, accelerating as we enter 2025. Finally, despite recent market sentiment favoring a potential softer landing, we maintain our conservative outlook and believe it’s prudent to consider potential for further downside stress, therefore, elevating our annual provision expense guidance to 50 basis points of LHI, excluding mortgage finance.

Operator, we’d now like to open up the call for questions. Thank you.

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Q&A Session

Operator: Thank you. [Operator Instructions] First question comes from Ben Gerlinger with Citigroup. Your line is open. Please go ahead.

Ben Gerlinger: Hi. Good morning, guys.

Rob Holmes: Good morning, Ben.

Matt Scurlock: Good morning, Ben. Welcome to the group.

Ben Gerlinger: Thank you. I was curious if we could just kind of parse through the revenue guidance a little bit. That’s helpful given the kind of the year-over-year comp on PPNR, but I get that most of the revenue upside here, we should be expecting from fees. But when you think about just the balance sheet itself, I know you referenced that betas are probably limited for the first couple of cuts. But when we exit the year, can you kind of give just your overall or kind of 10,000-foot view on deposit betas after we get that fifth or potentially sixth cut. I think it’s probably limited in the beginning, but towards the end, just any thoughts on that?

Matt Scurlock: Yes, Ben, happy to take that. So I mean, bifurcated between interest-bearing deposit betas and then the cost of funding within the mortgage finance business. So the model down rate scenario for interest-bearing deposit betas and the static balance sheet is 60%. You’re not going to hit 60% over the first five cuts. You probably hit half of that as it builds over the duration of that cut program. We have modeled in our guide expectation that you actually see interest-bearing deposit costs continue to drift up at a pace similar to what we experienced in the last quarter until if and when the Fed actually takes action. A bit of a different scenario as it relates to mortgage finance, which obviously had a significant impact this quarter.

So of that $17 million, $18 million decline in net interest income is a great chart depicted on one of the slides that suggests you could take the entirety of that to mortgage finance. The severity of the impact of this historical rate increase has had on that industry is pretty difficult to overstate. So there’s really no precedent to look back to. There’s certainly no Texas Capital Bank experience in which to pull insights from. So as volumes just evaporated from mortgage originators over the last year, deposits moved to compensated at a pace well in excess of historical experience. That really started to accelerate toward the middle of the year. And the ultimate deposit beta, which flows through relationship pricing on the yield accelerated pretty much consistent with the 80% interest-bearing deposit beta.

So for us, that definitely impacts balance sheet positioning. You could see that as we pause cash flow reinvestment on the bond portfolio and ultimately stop the hedge program. We realized with deposit rates rising faster on that business, we were going to hit neutral, a bit earlier than anticipated in a rising rate environment. But I think importantly, as the Fed is signaling that they may be done raising rates and are more likely to start to cut. We also realized we aren’t going to need as much downside protection because we would expect those mortgage finance deposits to reprice down at a beta consistent with the 80% on the way up.

Ben Gerlinger: Got you. Okay. That’s a lot. It’s helpful color. I definitely have to look at the transcript of [indiscernible] and just make sure I have everything.

Matt Scurlock: Not that I have a first question, Ben.

Ben Gerlinger: Well, yes, I mean, that’s really the million-dollar question at this point, but and that’s not just for you guys, that’s everybody. So when you guys specifically, it seems like this multiyear process. You have all the seats filled with people now is just kind of execution on the plan. It doesn’t sound that the Fed moved pretty dramatically and it could move pretty dramatically again. But when you just think about overall expenses, what else are we spending money on? I guess that the ramp is not nearly as much, but what other investments other than just people as a technology? Or is it really just do you think the revenue could show up so that some of its compensation. Just kind of asking why we still see upside in expenses?

Matt Scurlock: Yes, happy to talk about that, Ben. We’ve been really consistent in describing our objective around noninterest expense, which is to really improve the productivity of the expense base. And it was our view that you don’t show up in a challenging revenue environment and then make the determination you want to invoke expense discipline. We think that instead, you have to make multiyear investments process, infrastructure, technology which enables you over time to a lower risk, improve throughput, make it easier for your clients to do business with you. That makes your business better and then ultimately has a nice byproduct of reducing structural operating expense. You could see that 2023 expense base really near those priorities, where the multiyear build and middle and back office has really enabled us to remove a lot of manual tasks, which improves the employee experience and also enables us to continue to invest in the front line.

So I think in ’24, you’ll see the typical $8 million to $10 million of seasonal comp expense in the first quarter. And then full year, you should see salaries — full year, you’ll see salaries and benefits grow at a pace in excess of the low single-digit total noninterest expense [indiscernible]. For all non-interest expense, called salaries and benefits you can peg that at about $70 million. And then the underlying composition will continue to bias towards lacking comps as we reach our target level of change in big project portfolio this year. Rob, do you want to talk through capabilities?

Rob Holmes: Yes, I would just say that I think Matt said it very well. I think third quarter or third quarter salaries and benefits were down 5% when we’ve doubled the frontline bankers. So that tells you that kind of quantifies Matt’s comments about repositioning the expense base our successes in doing so. But to your point about the expenses already being in the platform, the platform is fully loaded with all the solutions that we wanted for our clients. So we’ve endured all the expense and both from product and services, a new commercial card, a new merchant, new lockbox, new payments platform. We basically have a brand-new bank, state-of-the-art 2023 bank payments bank. And we’re rolling that out to clients at a record pace and onboarding clients at a record pace. ’22 was a record and ’23, and we expect ’24 to do that again. So — the pipelines are full, the expense base is fully loaded and the platform is built.