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Texas Capital Bancshares, Inc.

TCBI US

Texas Capital Bancshares, Inc.United States Composite

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Q2 2017 · Earnings Call Transcript

Jul 19, 2017

Executives

Heather Worley - Director, IR Keith Cargill - President and CEO Peter Bartholow - COO Julie Anderson - CFO

Analysts

Brady Gailey - KBW Ebrahim Poonawala - Bank of America Merrill Lynch Michael Rose - Raymond James Jennifer Demba - SunTrust Brett Robertson - Piper Jaffray Peter Winter - Wedbush Securities Geoffrey Elliott - Autonomous Research Scott Valentin - Compass Point Research & Trading LLC Emlen Harmon - JMP Securities Matt Olney - Stephens Inc.

Operator

Good afternoon and welcome to the Second Quarter 2017 Texas Capital Bancshares, Inc. Earnings Conference Call.

All participants will be in listen-only mode during the presentation. Please note this event is being recorded.

[Operator Instructions] I would now like to turn the call over to Heather Worley, Director of Investor Relations. Please go ahead.

Heather Worley

Thank you for joining us today for TCBI second quarter 2017 Earnings Conference Call. I'm Heather Worley, Director of Investor Relations.

Before we begin, please remember, 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 obtain 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, our most recent Annual Report on Form 10-K, and subsequent filings with the SEC.

With me on the call today are Keith Cargill, President and CEO; our newly promoted CFO, Julie Anderson; and Peter Bartholow, COO. After the conclusion of our prepared remarks, our operator, Austin, will facilitate question-and-answer session.

At this time, I will turn the call over to Keith who will begin on slide three of the webcast. Keith?

Keith Cargill

Thank you, Heather. And thank you all for joining us for our second quarter 2017 earnings call.

Allow me a few minutes to open our call before Peter and Julie provide more details on our results. We coined the term a couple of years ago and used it in marketing our bank as well as in describing the business culture and optimism we enjoy in Texas as a whole.

The term is Texas Capitalism. We believe Texas Capitalism describes an attitude and culture larger than our bank and greater than the great State of Texas.

In fact, throughout America, Texas Capitalism exists and only needs nurturing to create outstanding growth and prosperity. The results in the second quarter of 2017 were outstanding for Texas Capital Bank.

And speak to the success, our team members, strategic partners, and clients realize with an attitude of collaboration, serving each other and creating synergies that are real, not imagined, to realize greater prosperity for all. The business climate in Texas certainly gives us wind our back, but the results my colleague, clients, and strategic partners produce rank near if not at the top of our Texas peers and national peers.

The resilience and prosperity in Texas demonstrated through the challenging oil cycle over the past three years continues to motivate out-of-state competitors to disproportionately invest resources in Texas in hopes of participating in such a strong and resilient economy. We do not complain about the constant influx of new competitors, but rather embrace it.

Competition makes us stronger, sharper, and more energized to win with our cornerstone principles since inception of quality first and organic growth. And the always competitive environment in Texas, Texas export, our market approach with clients and other national markets enabling us to grow our deposits, loans, and fee income coast-to-coast.

So, with that short offering of context for our Q2 results and optimism for our future results, let's focus on a few highlights. In Q2, we significantly exceeded prior record loan growth linked quarter and the loan growth was very broad as well.

We achieved this record growth at the time when the industry is struggling to grow. We expect that our performance will exceed our Texas peers yet to report and thus far is the strongest important growth to-date.

Q2 net income and earnings per share were at record levels. This result is even more impressive considering our decision to take the $5.3 million write-off of technology that will be replaced by significantly more efficient alternatives.

Credit quality, net of energy, continues to perform at record levels and energy NPLs continued to fall, while our energy reserves remain over 5%. As a side note, Q2 recorded $100 million of high quality growth in our energy portfolio.

Thus far, our mortgage warehouse appears to have outperformed our peers by a meaningful percentage and the business may in fact generate the highest risk-adjusted returns in commercial banking. In our mortgage warehousing business, fees cover our operating expense while the assets are of impeccable credit quality.

Also the warehousing business produces very cost effective funding. While the mortgage warehousing business does experience earnings surges when volumes are seasonally high and pressures when seasonal volumes are softened, those swings did not diminish the significant value of our strong position in the industry year-after-year.

Finally, the Q1 reduction in deposits caused us to focus on each deposit category and better balance costs with reliability, resulting in good Q2 deposit growth and more effective management of liquidity. Peter, I'll hand the baton to you.

Peter Bartholow

Thank you, Keith. I'll give a brief summary before turning it over to Julie.

As Keith mentioned, we had an outstanding quarter. Operating results was $51 million in net income and $0.97 per share, driven by strong net revenue growth, a function of the expansion of NIM with increased -- NIM with increased yields in all LHI and LHS categories, coupled with very modest increase in the cost of deposits.

We had exceptional growth in loans, as Keith mentioned. We have strong growth in non-interest income as the warehouse group ramped up again.

Non-interest expense growth was well contained and we believe the pace of growth is leveling. We did have a special charge as Keith mentioned of $5.3 million or $0.07 per share, producing an adjusted EPS of $1.04.

We charged off the balance of technology investment due to the decision to replace the support system with solutions that could reduce cost over the next several years. We believe that it would more efficient and cost-effective solution that simply wasn't feasible earlier and should provide reasonable payback.

We saw improved operating leverage with the reduction and efficiency ratio and much additional improvement in leverage before the impact of the technology charge. We also experienced strong improvement in return on assets, just over 1% before the technology charge.

And the ROE expanded with more effective use of capital raised in Q4 of last year. Based on our outlook for growth in the traditional held for investment loans, we could be nearing position of capital equilibrium by the end of this year.

Back to the balance sheet, we saw record total earning asset growth at much improved yields. Record traditional held for investment growth from Q1 to Q2 with balances that were still increasing in June.

We experienced strong growth early in Q2 adding to the bills that occurred in late Q1 of this year. Importantly, we start Q3 in a very strong position.

Growth has been achieved despite elevated level of loan pay down activity. So, our record increase in total mortgage finance balances and this is the resurgence producing results are clearly outperformed market trends.

And as expected, we finished the quarter with average balances in June, substantially greater than the quarterly average, reflecting continued build into 2000 -- into Q3. The reduction in participation commitments implemented during Q1 permitted retention of increased volumes that otherwise would have been shared with participants.

We experienced a reduction in average liquidity assets that was a significant source of the funding for the growth in total LHI categories. The yield, given up on the reduced investment and liquidity assets, happen to be equal to the incremental cost of borrowings and similar to the incremental cost of available deposit categories.

Since we don't expect quarterly growth and total loans to match Q2 and for the remainder of the year, we had no need to fund the replacement of liquidity assets in Q2 simply by increasing deposits. Even with the improved yields in all loan categories, the NIM expansion was somewhat constrained by the growth in TLHI and the substantial growth in mortgage finance loans that have yields below traditional held for investment loan levels.

Deposit growth, as Keith mentioned, resumed in Q2 with average balances up sharply from Q1 in DDA balances and growing again rapidly into June. We expect the growth in the last half but a more balanced position relative to loan growth.

So, the average balance of liquidity asset should increase at a much more modest pace for the rest of the year, especially as mortgage finance balances declined in the last quarter. Now, my pleasure to introduce Julie Anderson as the newly elected CFO of Texas Capital Bancshares.

Julie has a long history of Texas Capital. She was almost a Founder; she missed it barely by two months and promptly took control.

Julie and I met a little over 14 years ago and we might have been both a little terrified. Not sure how the fit would work for either one of us.

It worked out perfectly for me, but I'm not completely sure what she might say. Julie is the ultimate go-to person in every aspect of our business, taking an ever-increasing responsibilities from start-up phase to becoming CFO of Texas Capital Bank as part of our succession planning process.

She has a great working relationship with everyone throughout the company because she truly makes us all more effective in everything we do. She's steady, firm and committed, best seen in times of challenge.

She never flinches. She's also incredibly personable and pretty damn funny.

She is immensely talented person is simply the most effective financial executive with whom I've ever worked. Julie is in fact the real deal.

Texas Capital, our investors, and especially I, are extremely fortunate to have Julie as our CFO. She will now complete the financial review.

No pressure, Julie. Good luck.

Julie Anderson

Thanks Peter. I'm sure that review was probably a little more glowing than it needed to be but, well jumping to the details now.

I'll start with slide six. We reported net interest margin that increased by 28 basis points from the first quarter.

We continue to see asset sensitivity confirmed in our analysis of yields and costs. More efficient use of excess liquidity and funding the seasonally strong mortgage finance volumes, which had a significant impact on our NIM and net interest income.

The seasonal reduction in DDA that we experienced in the first quarter has come back some, but we've also learned some additional factors at work in the first quarter, including some significant asset sales by customers which take some time to rebuild. While average DDA has not returned to Q4 levels, ending [Indiscernible] balance is very comparable to year-end balance.

We continue to see deposit growth in DDA in interest-bearing. With the rate move in June, we still have not changed our stated rate and are only reacting to individual customer request and then evaluating based on overall relationship.

After the most recent increase, the pace of change will be greater than what was experienced in Q1 and Q2, but funding cost should continue to lag in both rate and timing. We have seen overall deposit cost increased by only six basis points from 32 basis points in the first quarter to 38 basis points in Q2.

The increased rate has also reduced the loans subject to floors to slightly less than $1 billion at the end of June, that's down from $1.4 billion at the end of March and $1.8 billion at the end of the year, and $2.4 billion at this time last year. The yields on traditional LHI have increased by 19 basis points from Q1 and up 37 basis points from this time last year.

Traditional LHI yields are tracking very closely with changes in 30-day LIBOR since the end of the year. As a reminder, approximately 70% of our floating rate loans are tied to LIBOR and about 80% of that total is tied to 30-day LIBOR.

Significant loan growth experienced in the second quarter did reduce the impact from rate increases as new loans are not being put on at the same effective rate as the portfolio yield which has reflected a great mix. Yield on our total mortgage finance loans increased from 3.46% in the first quarter to 3.59% in the second quarter.

Move on to slide seven, as Keith and Peter both noted, we have record traditional LHI growth in the quarter, but certainly that's a new quarterly run rate. Traditional LHI average balances grew by 7% from the first quarter and up 14% from this time last year.

We saw strong growth in the final days of the quarter with ending balance above average by $560 million. We're continuing to fill the high levels of pay off the second quarter.

Total mortgage finance, we saw a strong rebound in mortgage finance balances, which increased 42% from first quarter and up 10% from this time last year. As we talked about in the past, the second quarter is typically seasonally strong for the volume and with the lower levels in Q1 from the seasonal trends and lower refinance activity, we continue the reduction in our participation commitments from slightly over $600 million at the end of the first quarter to approximately $350 million at the end of this quarter.

Our period end outstanding participation balances are consistent at the end of Q1 and Q2 at around $230 million with the average of 3.78% in the first quarter and 2.83% in the second quarter. There was very little change for participation levels from Q1 volume increases, but it was very beneficial to our future growth that commitment levels were reduced prior to the start of Q2.

Move on to slide eight, we experienced a good linked quarter improvement in DDA and we're still expecting continued growth for the remainder of 2017. The rising rates we've seen no change in stated rate to the four increases, but have seen some migration to interest-bearing from DDA balances, reacting to specific customer situations and generally in response to competitive pressure.

We continue to have only two major deposit categories moving in tandem with Fed rates and that's approximately $4 billion to $4.5 billion in balances. We do expect some impact from the June and any subsequent increases, which as we've said in the past, is not particularly concerning based on the composition of the asset of our balance sheet, which is basically 95% float.

On to slide nine, we talk about non-interest expense. Excluding the $5.3 million technology write-off, non-interest expense was flat compared to Q1 levels.

In Q2 -- in Q1, we were starting an incentive accrual, so it always resulted in increase in Q2 as the accrual ramps throughout the year. But the increase from Q1 to Q2 was less than offsetting decrease from the seasonal payroll items like FICA experienced in Q1.

In the quarter, we saw minimal changes in FAS 123R expense compared to Q1, with no changes in the overall expected 2017 expense for FAS 123R of approximately $19 million compared to a planned level of about $16 million last year. As we talked about last quarter, quarterly and annual cost can still vary with the change in stock price, but is not as variable as viewed with the full year perspective.

Continued buildout of 2015 and 2016 initiatives have been a major factor on our non-interest expense. The growth levels peaked in the fourth quarter of 2016 as that was the full -- first full quarter of all growth initiatives, reflective and significant non-interest expense increases from Q2 2016, but moderating over the remainder of 2017.

All of our new and expanding lines of business continue to be profitable during Q2 and contributed to the Q2 loan growth. With our strong warehouse balances and net revenue impact, the efficiency ratio improved in the second quarter to 55.4% and it was 52.8%, excluding the technology write-off.

On to slide 10, a few comments. Strong growth with net revenue increasing 12% and net income increasing 20% from the first quarter with significant loan growth both in traditional LHI and total mortgage finance.

The positive impact went into the third quarter was strong earnings asset base and favorable comp position. The impact of elevated provision on ROE and ROA was a principal factor in the result for most of 2016 with a much improved outlook in 2017, which we're starting to see in Q2 as mortgage finance volumes have rebounded from seasonal lows in Q1.

Our provisioning in Q2 as a result of the significant traditional LHI growth also impacted ROE. ROE was back over 10% related to our higher net revenue and reasonable provision levels and was 10.79% before the impact of the technology write-off.

Last point that I'll cover is slide 11 and we'll talk about guidance. We've made some updates.

The outlook for traditional LHI has improved with the Q2 results, but Q2 again is not representative of a new quarterly run rate. Until the benefits from our pro-growth economic policies become realized, we continue to be cautious about economic trends, but no signs of anything negative at this point.

Guidance has increased to low double-digit and that's before any potential benefit from the strengthening of economy. We still expect the average balance for total mortgage loans for the remainder of 2017 to be close to $4.4 billion, but we have had some shift between mortgage finance, the warehouse, and MCA.

Q2 warehouse levels were better than originally expected and some lift and expectations for the remainder of the year bringing that average for the year to $3.6 billion to $3.8 billion. We previously guided MCA growth to $1.2 billion average balance for 2017, but are reviving that to $900 million as a result of shorter hold times.

The income and balance sheet are managed to optimize results and that suggest reduced hold periods in average balances that will not adversely affect the total expected profitability for the year. With the introduction of MCA, we'll see total mortgage loans above 2016 levels compared to significantly negative industry trend.

For total deposits, we've decreased from a low teens growth in held total deposits to mid-single-digits. We expect continued growth in deposit slightly less than originally forecasted based on the additional information about the composition of some of our Q1 declines and our plan to manage relative to loan growth for a more balanced position.

We could see some mix shift from non-interest bearing to interest bearing over the remainder of the year. While liquidity levels will increase not as dramatic -- will not be as dramatic of an increase, will be favorable to NIM and to non-interest income with the increase in total loans.

The outlook for core NIM has increased reflecting the fact that the year-to-date performance have exceeded our guidance and will derive additional benefit from the June increase. We expect the impact of liquidity assets to be less significant going forward; we deleted the additional NIM referenced to -- excluding liquidity.

We are increasing the guidance for reported NIM to a new range of 3.35% to 3.45%, that's up from 3.25% to 3.35% previously. The outlook for net revenue has improved with the improvement in volume and NIM.

We're now at mid-teen percent growth, slightly better than the previous range of low to mid-teens. Based on the actual provision expense we've had year-to-date, we are revising full year guidance to low to mid $50 million level.

We're still cautious about the economy which could affect provision levels later in the year and guidance is assumed to -- we've assumed a continued general stability in energy sector, but no meaningful change in economic outlook. The changes in non-interest expense, the levels maintained in Q2 are consistent with our previous guidance.

We do expect some slight improvement in efficiency ratio, and we're updating low to mid 50, improved from mid 50s and that's as a result of the expected improvements in net revenue. Keith, I'll turn it back to you.

Keith Cargill

Thank you, Julie. To summarize Q2, we recorded record earnings and return to double-digit returns on equity.

Loan growth in Q2 was a new quarterly record and deposit growth returned after the Q1 decline. The improved deployment of liquidity contributed to lifting net income, NIM, ROE, and ROA.

The energy reserve remains strong at 5% net of charge-offs and the return of higher quality loan growth in our energy portfolio continues to improve the overall credit quality mix in our energy book. Provision continues to be guided by our pace of loan growth and the high credit quality of our non-energy loan portfolio.

We are encouraged that the strategic emphasis we initiated two years ago on lifting ROE with a more disciplined capital allocation, the higher risk-adjusted return businesses is beginning to deliver improved ROE results. The focus on ROE has not caused our growth to decline below double-digits despite peer growth continuing to vary between GDP growth and mid-single-digits.

Finally, the Texas Capital Bank organic growth story continues in terms of talent acquisition, market share gain, loans, deposits, fees, and now ROE. Before we open up the call for Q&A, I do want to acknowledge what an outstanding job Peter and Julie have just demonstrated over the last several years in accomplishing something that I believe creates enormous value for our current and future shareholders and that's a successful leadership succession and I complement each of them.

However, a few ideas to share on our October call about the great business partnerships Mr. Bartholow and I have enjoyed and today is about Julie Anderson and we're so pleased to have her as our new CFO.

This time, we'll open it up for Q&A.

Operator

We will now begin the question-and-answer session. [Operator Instructions] And our first question comes from Brad Gailey with KBW.

Please go ahead.

Brady Gailey

Hey, it's Brady. Good afternoon guys.

Keith Cargill

Hello Brady.

Brady Gailey

Hey, congrats on a really nice quarter. I wanted to start maybe with deposit cost.

They were up six basis points that was a little less than 10 basis points last quarter. As we get further along in the rate hikes, how are you all thinking about deposit betas going forward?

Julie Anderson

We haven’t -- as we've talked about in the past, we've got the $4 billion, $4.5 billion that move in tandem with rate, but everything else is just on individual evaluation. As I may have comment, we are seeing some shift from DDA to interest bearing on some individual customer situation and so we'll address those.

We actually spent some time looking at our betas over the last couple of quarters and there's been very little shift and we still think they are very -- our betas are low. I don't know that we've ever give in a range of what we think what our beta is, but we don't see a significant change in that.

Keith Cargill

As rates continue to increase, as we've always said, we will see some additional move, but we see that move on cost of funds lagging the pickup that we have with such a strong assets since the balance sheet.

Brady Gailey

Okay. All right.

That's helpful. And then I mean if you look bigger picture, I know over the last two or three years, you all are growing deposits more than you were growing loans, so the loan-to-deposit ratio is kind of trending down.

If you look at the last few quarters, that's kind of reversed and now you have the loan-to-deposit ratios kind of starting the trend up. I was just wondering how comfortable would you feel seeing that loan-to-deposit ratio kind of continue drifting, what's the max level that you feel comfortable with there?

Peter Bartholow

Brady I think it could -- in terms of our comfort levels, it could be a lot higher, but that's not our outlook. Our outlook is that they will come back in line over the last half of the year.

As Julie mentioned we certainly don't expect Q3 and Q4 loan growth to be anything like what we had in Q2 and we do see a meaningful resumption in deposit growth, as in my comments, even into June, and some very good prospects for the last half of the year. So, my guess is loan deposit ratio will be 70 to 75; it could be 75 to 80, but something that's very comfortable for us.

Brady Gailey

Okay. And then finally, you all continue to build up the servicing asset, one day you will sell for gain, any color on when that will happen?

Keith Cargill

We don't have a point in time. I will tell you that it's something we consider regularly.

We keep monitoring the position and whether or not we can, in our view, maximize economics on a trade at the amount of servicing that we're accumulating and at this point, we're not quite ready, but we're watching the market and the position we're building and feel comfortable where we are today.

Brady Gailey

Okay, great. Thanks guys.

Keith Cargill

Welcome.

Operator

Our next question is from Ebrahim Poonawala with Bank of America Merrill Lynch. Please go ahead.

Ebrahim Poonawala

Good afternoon guys.

Keith Cargill

Hello Ebrahim.

Ebrahim Poonawala

So, just following up on that, if I understand that correctly, you do expect deposit growth to outstrip loan growth in the back half of the year and I appreciate, Peter, in terms of I guess, we are looking at loan-to-deposit ratio on LHI ex-mortgage versus deposit, but I'm sort of thinking through in terms of looking at just the total loan book versus deposits, you're probably north of 20%. And I'm just trying to -- like is that not how you or how when you talk to regulators, think about it at all or like how should we think about the overall loan book relative to deposits and is it safe to assume the deposit growth will outstrip loan growth in the back half of the year?

Peter Bartholow

We believe that deposit growth will outstrip loan growth in the last half of the year. Yes, and definitively, we're focused on traditional held for investment loans to deposits.

The mortgage warehouse asset and MCA are both eligible at very high advanced rates at the federal home loan bank and you can fundamentally match maturities relative to the warehouse with two one-week and maybe part of the third-week at the federal home loan bank as very cost effective. So, it's a nature of that asset that allows us to look at rates, including net asset of loans-to-deposit above 90%.

You might not have been covering us at the time when that we went to 120%. We're actually sort of optimized in terms of overall liquidity management by having funded too much of the warehouse balance with deposits.

Ebrahim Poonawala

Very clear. And just on terms of your MCA business and sort of the outlook, I get the shorter duration and that's impacting the balances, but I'm just wondering sort of -- to me it feels like it’s a secular growth business and we have sort of taking down growth expectations.

Is -- what's the right size -- like how do we think about that growth beyond just quarter-to-quarter change in business dynamics in terms of how big that portfolio can get 12 months from now?

Peter Bartholow

It is still in a ramp mode, Ebrahim. We're just saying what could it be over the course of the year recognizing that we -- in that category as well as others, we would have Q4 kinds of headwinds, not counting the average balances.

But in total activity levels, we've been significantly outgrowing headwinds and taking market share. So, the decision about average balances is strictly one of maximizing the overall profitability and capital commitment to that business.

Keith Cargill

Our volumes are going up in that business, Ebrahim. We just chose to not continue to hold the assets as long as we were early in the process of building our book of business, because we were incurring those additional hedging costs for those longer hold periods, too.

So, as we've gotten better at throughput and in capturing market, it makes more sense in our overall returns for the company to have higher velocity than we had in the first quarter as an example.

Ebrahim Poonawala

Understood. And if I could sneak one last one in, Keith.

I think as we think about the ROE, ROA, ex-tech write on this quarter, absent any sort of change in the rate backdrop. Like do you see any sort of operating leverage in the businesses that you built which can take us clearly like maybe closer to 50% over the next 12 to 18 months, which can drive growth higher without the benefit from higher interest rates from here?

Keith Cargill

We believe we have a definite shot at it over the next 12 to 18 months even without hiring.

Ebrahim Poonawala

And what do you think this achievable ROE, let's call it by the end of next year?

Keith Cargill

I can't get a strong fix on that because we still got to see as these next hikes, if we see any more hikes. What that really is going to do to the cost of funds left, too, Ebrahim, because that's going to have a lot of to do with it.

But as far as overall efficiency of the company and what that's going to do to ROE, I think that's going to be a nice lift and that will ultimately help the efficiency as well.

Ebrahim Poonawala

Understood. Thanks for taking my questions.

And Julie congratulations again.

Julie Anderson

Thanks Ebrahim.

Operator

Our next question is from Michael Rose with Raymond James. Please go ahead.

Michael Rose

Hey everyone. Good afternoon.

Keith Cargill

Hello Michael.

Michael Rose

Hi. Just wanted to ask about the NIM guidance for the year.

It looks like it implies that the NIM would actually decline in the back half of the year, I just want to get some color there. I assume it has to do with the fluctuation in liquidity assets, but if you could just give some color, that would be great.

Thanks.

Julie Anderson

That's exactly what it had to do. It has to do with -- we expect that liquidity asset there to be some build in that over the next couple of quarters.

That's exactly what we factored in.

Keith Cargill

Okay. That's what we drive deposits with our loans.

Julie Anderson

Yes.

Michael Rose

Yes. And with no additional rates.

Julie Anderson

That's right.

Keith Cargill

And as you know, Michael, we have a softer seasonal fourth quarter in warehouse, so that also contributes.

Michael Rose

Correct. Okay, great.

Can you give an update on where the participation balances stood at the end of the quarter, obviously a big drawdown last quarter, I just want to see if those can rebuild given this quarter's strong warehouse volumes.

Julie Anderson

We reduced those commitments. So, Michael, at the end of the period, both Q1 and Q2, there were -- it was consistent with that $230 million.

In Q1, we had an average of 3.78% and in Q2, it was 2.83%.

Michael Rose

Okay. And then--

Peter Bartholow

Key there Michael is what didn’t go out as participations.

Julie Anderson

Yes, the key is that the commitments were reduced prior to Q2. So, as we saw volumes ramp worked, the participations weren't ramping at the same rate.

Michael Rose

Got it. Okay, that's clear.

And then just on the charge you guys took this quarter, is there going to be any incremental costs related to implementing a new system and is that in the run rate? Just any color there.

Keith Cargill

I think very modest. And I think as Peter mentioned in his comments, we see a very strong probability of a payback that all our shareholders would be very pleased with recouping through the efficiencies with the new system that we have decided to go with, Michael.

And -- but until we actually deploy it and are up and running, these are our best forecasts.

Michael Rose

Okay. And then maybe just finally from me.

So, obviously, LHI growth was really strong this quarter, was there any sort of geographic or category flare to what drove the growth this quarter. I'm sorry if I missed in the prepared remarks.

Keith Cargill

More than any quarter. We had more consistent broader growth the last several quarters than we experienced two or three years ago, more than any quarter I've seen in the last five years.

This was broad. And the C&I I was just extraordinary, but it was every market, every specialty business that's C&I-oriented, including energy had some growth and that's been some time.

So, we were very pleased with the breadth of the growth.

Michael Rose

Well, I would definitely attribute the growth to your lame duck CFO. Just kidding people.

Congratulations. Congrats Julie on the promotion.

Keith Cargill

[Indiscernible] Julie on such a booming quarter. If you had guess, I think was kidding Julie about this.

Now what are your going to do for your encore now that you're finally CFO?

Julie Anderson

You're taking full credit for this quarter's performance.

Michael Rose

I bet he is. Well, congrats again Julie on the promotion.

And thanks again for taking my questions.

Operator

Our next question comes from Jennifer Demba with SunTrust. Please go ahead.

Jennifer Demba

Thank you. Good afternoon.

Could you just update us on kind of recent hiring trend year-to-date and what you're seeing in the pipeline?

Julie Anderson

Jennifer we're having a hard time hearing you.

Keith Cargill

I think I got the gist of it, our recent hiring trends and the direction.

Jennifer Demba

Yes.

Keith Cargill

We, as I reported last quarter, had a very good quarter in the first quarter hiring new bankers. We, in fact, again, have hired a couple of new bankers that were very high on.

And we have several prospects in the pipeline we're working now. I just want to give tremendous praise to our team that we've had many of them with us for 10 years, 12 years, 15-plus years and what a great job they've done in highly competitive market to go find very, very high-quality business and continue to take market share.

The new bankers we've hired certainly give us a shot [Indiscernible] for the next few years, but it does take some time for them to get their sea lags [ph] and understand our credit processes and culture, but we're very, very pleased with the talent we've been able to attract first and second quarter, Jennifer.

Jennifer Demba

Thank you.

Keith Cargill

You're welcome.

Operator

Our next question comes from Brett Rabatin from Piper Jaffray. Please go ahead.

Brett Rabatin

Hi, good afternoon everyone.

Keith Cargill

Hey Brett.

Brett Rabatin

Wanted just to first just go back to talk about the efficiency ratio and just kind of a broad range, low to mid-50s. I guess a better way to maybe think about is -- and even though your margin is not going to be a strong liquidity, I'm just curious, is it feasible to have the efficiency ratio kind of at a lower pace than 2Q or below 50%, is that generally in your mindset?

Peter Bartholow

It's certainly going to be lower in the last half of the year even ex the effect of the technology charge. We're not prepared to say that we have a forehand all by the time by any means, but the NIM compression, as Julie mentioned earlier, will come only from the built and liquidity assets, not from a change in pace of net interest income levels.

Keith Cargill

And I want to just mention, too, Peter. Fourth quarter seasonal softness in the warehouse always dampens efficiency to a degree.

And so I think we are, as Peter suggesting, and have an improved back half on efficiency, but with the kind of quarter we had, with everything hitting on all cylinders, was quite a jumpstart and I think we could sustain that. Importantly too, so many of our new businesses we've been building the last two, two and a half years should begin to plateau more on staff adds, approaching, if not already, at full staff levels and have capacity and generate quite a lot of productivity before they need to increase staff.

So, that will help us even against, Peter, that's after fourth quarter in warehouse. Do you agree?

Peter Bartholow

Yes.

Brett Rabatin

Okay. Thanks for the color.

And the other related thing I wanted to ask is just around the charge off $5.3 million, was that the core processing system? Was it mortgage related?

Any color on that and how much you're talking about?

Keith Cargill

A support system. Nothing related to long-term investment, mortgage assets--

Brett Rabatin

Okay. And then the way I interpreted or understood your thought around the new system was you beginning efficiencies from that in order that to start to happen early next year or any color around that?

Keith Cargill

Well, I think we'll see some efficiencies I think early next year is a good estimate, through the first half. Every company, every bank and every one of our clients, if they're not looking at how to invest wisely in new more efficient technologies and in some cases, even write-off other technologies that have been more effective than the generation before, I just don't think they're moving quick enough to have a business in the future that really can deliver efficiency and response times that clients want.

So, this was a supportive technology, but I think it's really important for us to look at ways as technology continues to improve to upgrade and if we achieve a quick payback on any kind of write-off, we're just making a mistake not to do that. So, this was an instance where we found one of those situations.

I would expect that and other banks are going to find more of them over the next two years or you're just not looking and paying attention.

Brett Rabatin

Okay, great. Congrats on your results, Julie, this quarter and thanks for the color.

Keith Cargill

Thanks Brett. You meant Peter I think, but Julie will take credit.

Brett Rabatin

I'm giving Julie full credit this quarter.

Operator

And our next question comes from Peter Winter with Wedbush Securities. Please go ahead.

Peter Winter

Thanks. Good afternoon.

Keith Cargill

Hello Peter.

Peter Winter

Question around energy, I guess you guys will go through with the Shared National Credit exam this fall. Do you see the opportunity to possibly upgrade the credits and then maybe accelerate reserve releases on energy and just shift it to support the loan growth?

Keith Cargill

We don't expect any kind of major adjustments to the borrowing base reviews this fall, nor do we -- as we've taken this position for quite some time, nor do we expect to do any releasing, per se of the reserve. But your assumption or presumption, Peter, is accurate, that as the process runs its course, they're resolving criticized class slide issues, NPLs still involved in energy.

That reserve, at 5% looks quite conservative, very high. And we believe we will at some point be able to reallocate rather than release, reallocate some of those reserves as we work through the remaining NPLs.

And we're very encouraged. We're making good progress.

We always wish it would be faster, but we want the most efficient and best outcome for the shareholder, so it's not just about speed and I think we're making good progress.

PeterWinter

Right. And then, if I could just -- if you could just elaborate on something that you said in the opening remarks about the pace of expense growth leveling.

What exactly does that mean?

Keith Cargill

Sure. We rebuilt three businesses, beginning two years ago and actually initiated three new businesses over the last 12 to 18 months.

And so when you are literally creating new businesses, as we've done, or rebuilding and enhancing the business, there is quite a lot of front-end cost, of course before the revenue, incremental revenue really overcomes that cost and that's all I'm speaking to. Now these businesses, in most cases, have been up and running for at least a year, in some cases a year and a half and so the ramp up in personnel as well as software technology that we need in order to deliver a higher level creates a new business capability, that should begin to plateau and not have as steep a curve on adds to staff or other investment.

Peter Winter

So, would that imply -- and so that would imply then, for 2018 just directionally, that this non-interest expense growth of low-teen percent would be essentially much lower. Is that fair?

Keith Cargill

We would hope so.

Peter Winter

So do I. Great.

Thank you. Great quarter.

Keith Cargill

It certainly will grow this year with all our investors and we believe we can certainly show improvement in the run rate.

Peter Winter

That's great. Thanks.

Great quarter.

Keith Cargill

Thank you.

Operator

Our next question comes from Geoffrey Elliott with Autonomous Research. Please go ahead.

Geoffrey Elliott

Hello. Thank you for taking question.

The loan growth, I understand that it's broad in terms of market, in terms of industry. Can you give us a sense of what your customers are borrowing for?

Is it CapEx? Is it M&A?

Is it growing down on working capital lines? Can you give us a sense of whether any of those areas have been responsible for the really strong loan growth this quarter?

Keith Cargill

It is all of those that you mentioned, but importantly for us, we continue to also generate more than half of our new growth out of market share takeaway. And so I think that's a key difference maker, while many of our peers in both locally, regionally and nationally, in our midsize bank range are seeing GDP type growth in loans or less, in the case of a couple of peers here in Texas, they are not seeing the kind of opportunities we've seen for years, even in a highly competitive market, to take away quality market share.

And so we are not seeing yet -- and this may be part of what you're asking in the question, we have not seen yet that significant lift in our existing clients wanting to lever up and really add a lot of new FTEs and plant capacity and so on, because Washington is still a big unknown, relative to tax reform, in the biggest issue with our clients. And so there is, we believe, still quite a lot of pent-up demand if some tax reform that's meaningful should come about, whenever that might happen.

But we did see continued good market share takeaway and existing clients still growing their businesses, just not at the pace that we would expect with this low leverage as they had. This is the lowest levered plant base I've ever seen in my career.

They really have not been at all aggressive borrowers. While a lot of public companies have been aggressive borrowers in terms of public debt over the last several years, at the low rates that that offered, our clients, being privately owned companies, have been very risk averse and very conservative and actually delevered their balance sheets.

Geoffrey Elliott

That's very helpful. And then on the market share gains, clearly you're benefiting on the loan side, but recently, it feels like it's been a bit harder to gain share on the deposit side.

Why do you think there's that disparity between the two?

Keith Cargill

Well, it has to do with competition but also it has a lot to do with us paying a lot of attention the last few quarters, to how we might better deploy our liquidity and ROE really creating value to continue to build the liquidity. And our conclusion was that's probably not the case if there are some areas of our deposit base that are not as reliable as we'd like them to be.

In that case, we don't want to continue to pay up in any way for that deposit funding. And secondly, it made no sense for us to even necessarily meet competition on the interest-bearing side, because we had so much liquidity to deploy.

So, I'm not saying the competition is not intense, I think it always is, but we don't have our foot on the accelerator to the floor to raise deposits as much as we're looking more carefully at those deposits we have and be sure the pricing and stability and reliability is rock solid.

Geoffrey Elliott

Great. Thank you very much.

Keith Cargill

You're welcome.

Operator

Our next question comes from Scott Valentin with Compass Point Research & Trading LLC. Please go ahead.

Scott Valentin

Good evening. And thanks for taking my question.

Just on compensation, I mean it was pretty much dead flat linked quarter, which is impressive, but you had substantial loan growth. Just wondering if at some point we don't see that trickle through the compensation line.

Keith Cargill

Actually, we made some slight adjustment and it still came in flat. But Julie, you might want to speak to the seasonality.

We did not have the seasonal drop because we are building out these businesses.

Julie Anderson

Yes and one of the things that run through non-interest expense is a couple of incentive line items, one FAS 123R, which can fluctuate, but that was pretty flat. We didn't have any significant changes in the price, let's ignore that.

The other is just our normal buildup of our annual accrual and that gets bigger as the year goes on, so there was some pick up there. But it just wasn't -- it was less than the decrease from the seasonal items we saw in Q1.

So, nothing that -- the two are not directly related. Loan growth can be a lot lumpier during the year and these accruals are a little bit more -- they're fixed on a little bit more -- they're more calculated through the year.

So, they're not -- you won't see a direct correlation between an increase in compensation in quarters that we had exceptional loan growth. It's more of an annualized thing, just like the FAS 123R.

Keith Cargill

So, Scott, were we expecting another $900 million increase in traditional LHI and another enormous increase that we saw in warehouse? Yes, you would have seen a bigger pick up, but because we're forecasting still good loan growth, but not at the same pace, as a Julie suggests, we're just looking out through for the full year and we had some pick up, but not as much as it might indicate in the quarter itself.

Scott Valentin

Okay. Appreciate.

Very helpful. I appreciate that.

And you mentioned increasing liquid assets in the back half of the year. I'm just wondering, is there a target level, is there a percent of assets, or how do you guys look at the what should be an appropriate level of liquid assets?

Peter Bartholow

In dollar terms on the balance sheet today, with some growth, we average $2.4 billion during the quarter, I'd say, somewhere between $2.5 billion and $3 billion feels about right, could be a little higher, a little lower. As Keith mentioned, we have the seasonal runoff in the warehouse in the fourth quarter, so that would -- you could expect it to be higher than that then.

Julie Anderson

It's not an exact science, so there -- it can vary from quarter-to-quarter.

Keith Cargill

Particularly with our focus on being sure that the quality of the funding and the stability our clients on the funding side is as solid before rates continue to push up the price. We didn't want to just continue to follow rates alone and keep building liquidity.

It was a good time to get more effective and efficient.

Scott Valentin

All right. And then just one final question.

I think you referred to the kind of dynamic between MCA and the mortgage finance business. Just wondering is there any -- aside from both being mortgage related, but is there any direct dynamic there, where one were to increase, you dial the other one back or do you just, given the faster turn times in MCA, you're able to grow mortgage finance a little higher and still keep -- as a percent, I think you guys have a cap on as a percent of either equity or assets?

Is that what's driving that kind of correlation?

Keith Cargill

Yes, we look at overall concentration on the balance sheet, the combined two categories. So, -- because we had the kind of first seasonal bleed off that the industry has seen in three years with refis off, we're very comfortable with that pick-up we saw in the second quarter, and still showing more growth in the third.

So, we want to grow correspondent at the pace that the market allows for the kind of quality we're after in return and the same with the warehouse. We have plenty of headroom.

Scott Valentin

Okay. Thanks very much.

Keith Cargill

Welcome.

Operator

Our next question comes from Emlen Harmon with JMP Securities. Please go ahead.

Emlen Harmon

Hey, evening everyone.

Keith Cargill

Hello Emlen.

Emlen Harmon

Peter, in your prepared comments, you mentioned the potential reaching capital equilibrium later in the year. Are you effectively saying that you think you can self-fund growth from this point forward?

Peter Bartholow

Absent growth in the warehouse, it can be up and down, in reference to the core traditional held for investment growth, we're growing that 100% risk weighted assets at 10% to 12%, the 10% to 12% ROE is essentially self-funding that from a CapEx standpoint.

Emlen Harmon

Got it. So, that was my follow on.

So, what are you assuming in terms of longer term balance sheet growth? So, that's kind of a 10% to 12%.

Got it. And then Keith [Indiscernible]--

Keith Cargill

I know environment, that's right, but things change. Opportunities come up, we might rethink it, but only if they were in extremely strong, risk-adjusted return opportunity.

Sustainable.

Emlen Harmon

Got it. Okay.

And then Keith, in the past your guidance for the second half was actually anticipated an economic slowdown -- or, guidance is anticipated in the economic slowdown in the second half of the year. Anything at all you're seeing that would point to that later this year?

You're starting to push some of that caution out into later years?

Keith Cargill

Well, I mean, I think generally things have played out better than most all of us would have thought a year ago. I think there was a considerable concern, not just on our part, but many with 1% GDP growth for the first half of a presidential election year, that we might be in a recession by now, and that's obviously not the case.

But we continue to be a bit more conservative about what things might trigger sustainably higher GDP growth. And so we still believe the economic environment is adequate and our numbers make sense for us through the end of the year on growth.

But we're just not seeing, as we feared we might not, some of the things happened as early, particularly tax reform, as all of us hoped and so that is the concern we have. And just listening carefully to our clients, we don't see clients getting particularly anxious about near-term recession.

Whatever industry they're in, they're generally, except I would say, for the few retail clients we have, most of our clients are pretty optimistic. And I think we might have a year and a half or so yet to go.

But of course none of us know and we remain more conservative than most banks, but I feel like the rest of the year should be okay.

Emlen Harmon

Thank you.

Keith Cargill

Welcome.

Operator

Our next question comes from Gary Tenner with D. A.

Davidson. Please go ahead.

Hello, Mr. Tenner, your line is live, you may proceed with your question.

Our next question comes from Matt Olney with Stephens. Please go ahead.

Matt Olney

Great. Thanks for taking my question.

Just want to circle back on the margin. I appreciate the guidance on the margin on how to liquidity will impact that, but if we exclude the liquidity, what are your expectations for the core margin in the back half year?

Peter Bartholow

Matt, we haven't given that guidance, where it can only give -- the guidance we've given includes the effect of liquidity. I mean, it's the reported NIM.

So, you could back into something that looks like a slight improvement in what exists today and then make an assumption about deposit growth, the liquidity asset levels that would weaken that. So, I couldn't tell you that this.

Matt Olney

Okay. So, I understand that the NIM and the revenue guidance does not assume additional Fed increases, but I assume the guidance does consider the Fed hike back in June as already announced?

Peter Bartholow

Yes.

Matt Olney

Okay, great. Thank you.

Keith Cargill

You're welcome.

Operator

This concludes our question-and-answer session. I would like to turn the conference back over to President and CEO, Keith Cargill for his final remarks.

Keith Cargill

I just want to thank each of you for investing some time and hearing about our results in Q2. We feel like we have some strong numbers that we reported, but importantly too, we have some good momentum strategically and we hope to report to you in future quarters, continued follow through on those strategic initiatives.

Thanks again for your interest in Texas Capital. Bye, bye.

Operator

Thank you for your participation in TCBI's second quarter 2017 earnings conference call. Investors are encouraged to contact Heather Worley by phone at 214-932-6646 or by e-mail at [email protected] with any follow-up questions.

You may now disconnect your lines.

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