Texas Capital Bancshares - 10-Q quarterly report FY

(Exact Name of Registrant as Specified in Its Charter)

214/932-6600
(Registrant’s telephone number,
including area code)

N/A
(Former Name, Former Address and Former Fiscal Year, if Changed Since Last Report)

     Indicate by checkmark whether the issuer (1) has filed all reports required to be filed by Section 13 or 15(d) of the Exchange Act during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes þ No £

     Indicate by checkmark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes þ No £

     Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o No þ

     On October 31, 2005, the number of shares set forth below was outstanding with respect to each of the issuer’s classes of common stock:

Common Stock                                                                                                                             25,690,049

Texas Capital Bancshares, Inc.
Form 10-Q
Quarter Ended September 30, 2005

Index

CONSOLIDATED STATEMENTS OF OPERATIONS — UNAUDITED
(In thousands except share data)

CONSOLIDATED BALANCE SHEETS
(In thousands except share data)

CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
(In thousands except share data)

CONSOLIDATED STATEMENTS OF CASH FLOWS — UNAUDITED
(In thousands)

The accounting and reporting policies of Texas Capital Bancshares, Inc. conform to accounting principles generally accepted in the United States and to generally accepted practices within the banking industry. Our Consolidated Financial Statements include the accounts of Texas Capital Bancshares, Inc. and its subsidiary, Texas Capital Bank, National Association (the “Bank”). Certain prior period balances have been reclassified to conform with the current period presentation.

The consolidated interim financial statements have been prepared without audit. Certain information and footnote disclosures presented in accordance with accounting principles generally accepted in the United States have been condensed or omitted. In the opinion of management, the interim financial statements include all normal and recurring adjustments and the disclosures made are adequate to make interim financial information not misleading. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions to Form 10-Q adopted by the Securities and Exchange Commission (SEC). Accordingly, the financial statements do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements and should be read in conjunction with our consolidated financial statements, and notes thereto, for the year ended December 31, 2004, included in our Annual Report on Form 10-K filed with the SEC on March 15, 2005 (the “2004 Form 10-K”).

At September 30, 2005, we had a stock-based employee compensation plan. We account for the plan under the recognition and measurement principles of APB Opinion No. 25, Accounting for Stock Issued to Employees, and related interpretations. No stock-based employee compensation cost for options is reflected in net income, as all options granted under the plan had an exercise price equal to the market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and earnings per share if we had applied the fair value recognition provisions of FASB Statement No. 123, Accounting for Stock-Based Compensation, to stock-based employee compensation.

The fair value of these options was estimated at the date of grant using a Black-Scholes value option pricing model with the following weighted average assumptions used for 2005 and 2004, respectively: a risk free interest rate of 3.81% and 3.63%, a dividend yield of 0%, a volatility factor of .293 and .288, and an estimated life of five years.

The Black-Scholes option valuation model was developed for use in estimating the fair value of traded options which have no vesting restrictions and are fully transferable. In addition, option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because our employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not necessarily provide a reliable single measure of the fair value of its employee stock options.

In December 2004, the Financial Accounting Standards Board (FASB) issued SFAS No. 123 (revised 2004), “Share-Based Payment,” which revises SFAS No. 123, “Accounting for Stock-Based Compensation,” and supersedes APB Opinion No. 25, “Accounting for Stock Issued to Employees.” This Statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. This Statement requires an entity to recognize the cost of employee services received in share-based payment transactions and measure the cost on a grant-date fair value of the award. That cost will be recognized over the period during which an employee is required to provide service in exchange for the award. The provisions of SFAS No. 123 (revised 2004) will be effective for the financial statements issued for years beginning after June 15, 2005. We anticipate adopting the provisions of this statement January 1, 2006. The methodology has not yet been determined, but we anticipate that the results will not vary materially from the proforma fair value numbers that have been presented in the table above.

The following table presents the computation of basic and diluted earnings per share (dollars in thousands except share and per share data):

The Bank is a party to financial instruments with off-balance sheet risk in the normal course of business to meet the financing needs of its customers. These financial instruments include commitments to extend credit and standby letters of credit which involve varying degrees of credit risk in excess of the amount recognized in the consolidated balance sheets. Our exposure to credit loss in the event of non-performance by the other party to the financial instrument for commitments to extend credit and standby letters of credit is represented by the contractual amount of these instruments. We use the same credit policies in making commitments and conditional obligations as we do for on-balance sheet instruments. The amount of collateral obtained, if deemed necessary, is based on management’s credit evaluation of the borrower.

Commitments to extend credit are agreements to lend to a customer as long as there is no violation of any condition established in the contract. Commitments generally have fixed expiration dates or other termination clauses and may require payment of a fee. Since many of the commitments may expire without being drawn upon, the total commitment amounts do not necessarily represent future cash requirements. The Bank evaluates each customer’s credit-worthiness on a case-by-case basis.

Standby letters of credit are conditional commitments we issue to guarantee the performance of a customer to a third party. Those guarantees are primarily issued to support public and private borrowing arrangements. The credit risk involved in issuing letters of credit is essentially the same as that involved in extending loan facilities to customers.

During the second quarter of 2005, we announced the formation of BankDirect Capital Finance (BDCF), a new line of business focused on premium finance and other services for insurance agencies and their customers. We paid $5.1 million for the purchase of 100% of the stock of a sales and marketing company. The purchase agreement allows for additional payments of up to $4.0 million over 3 years which are contingent upon meeting certain production targets. Additionally, in July 2005, $1.6 million was paid for the customer base intangible related to a purchased portfolio and loan account services of premium finance loans totaling $80 million.

As of September 30, 2005, we have recorded $5.1 million of goodwill that will not be amortized and $1.6 million of a customer intangible that will be amortized over 10 years. The third quarter of 2005 includes $33,000 of amortization related to the intangible.

QUARTERLY FINANCIAL SUMMARY — UNAUDITED
Consolidated Daily Average Balances, Average Yields and Rates
(Dollars in thousands except per share data)

QUARTERLY FINANCIAL SUMMARY — UNAUDITED
Consolidated Daily Average Balances, Average Yields and Rates
(Dollars in thousands except per share data)

Statements and financial analysis contained in this document that are not historical facts are forward looking statements made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward looking statements describe our future plans, strategies and expectations and are based on certain assumptions. As a result, these forward looking statements involve substantial risks and uncertainties, many of which are beyond our control. The important factors that could cause actual results to differ materially from the forward looking statements include the following:

We have no obligation to update or revise any forward looking statements as a result of new information or future events. In light of these assumptions, risks and uncertainties, the events discussed in any forward looking statements in this quarterly report might not occur.

We recorded net income of $7.6 million, or $.28 per diluted common share, for the third quarter of 2005 compared to $5.2 million, or $.20 per diluted common share, for the third quarter of 2004. Return on average equity was 14.41% and return on average assets was 1.04% for the third quarter of 2005 compared to 11.25% and .85%, respectively, for the third quarter of 2004.

The increase in net income and improvement in return on assets in 2005 are attributed to growth in net interest income, which came from continued earning asset growth, as well as an improvement in net interest margin. Net interest income for the third quarter of 2005 increased by $7.6 million, or 39%, from $19.4 million to $27.0 million over the third quarter of 2005. The increase in net interest income was due to an increase in average earning assets of $425.2 million, or 18.6%, with a 59 basis point increase in net interest margin.

Non-interest income increased $2.3 million, or 67%, compared to the third quarter of 2004. We benefited from growth in fees related to wealth management and gain on sale of mortgage loans, which is related to our residential mortgage lending division that was started in the third quarter of 2003. Additionally, brokered loan fee income, which includes third party fees on mortgage warehouse and premium finance loans, increased $721,000 in the third quarter of 2005 as compared to the third quarter of 2004.

Non-interest expense increased $6.6 million, or 46%, compared to the third quarter of 2004. The increase is primarily related to a $4.6 million increase in salaries and employee benefits to $13.5 million from $8.9 million. The increase in salaries and employee benefits resulted from an increase in the total number of employees related to general business growth, additional staffing for the Houston office, addition of the premium finance business, the continued expansion of the residential mortgage lending division, and increased incentive compensation reflective of our performance.

Net interest income was $27.0 million for the third quarter of 2005, compared to $19.4 million for the third quarter of 2004. The increase was due to an increase in average earning assets of $425.2 million as compared to the third quarter of 2004 and a 59 basis point increase in net interest margin. The increase in average earning assets included a $451.3 million increase in average loans held for investment and an increase of $50.5 million in loans held for sale offset by a $109.2 million decrease in average securities. For the quarter ended September 30, 2005, average net loans and securities represented 73% and 25%, respectively, of average earning assets compared to 65% and 35% in the same quarter of 2004.

Average interest bearing liabilities increased $298.5 million from the third quarter of 2004, which included a $411.2 million increase in interest bearing deposits offset by a $112.7 million decrease in other borrowings. The average cost of interest bearing liabilities increased from 1.97% for the quarter ended September 30, 2004 to 3.21% for the same period of 2005, reflecting rising market interest rates.

Net interest income was $73.1 million for the first nine months of 2005, compared to $53.3 million for the same period of 2004. The increase was due to an increase in average earning assets of $406.9 million as compared to 2004 and a 53 basis point increase in net interest margin. The increase in average earning assets included a $402.4 million increase in average loans held for investment offset by a $41.0 million decrease in average securities. For the nine months ended September 30, 2005, average net loans and securities represented 71% and 28%, respectively, of average earning assets compared to 64% and 36% in the same period of 2004.

Average interest bearing liabilities increased $289.6 million compared to the first nine months of 2004, which included a $365.8 million increase in interest bearing deposits offset by a $76.1 million decrease in other borrowings. The average cost of interest bearing liabilities increased from 1.81% for the nine months ended September 30, 2004 to 2.84% for the same period of 2005, reflecting the rising market interest rates.

TABLE 1 — VOLUME/RATE ANALYSIS
(In thousands)

Net interest margin, the ratio of net interest income to average earning assets, was 3.82% for the first nine months of 2005 compared to 3.29% for the same period of 2004. The improvement in net interest margin resulted primarily from a 135 basis point increase in the yield on earning assets offset by a 103 basis point increase in the cost of interest bearing liabilities from the same period of the prior year.

Non-interest income increased $2.3 million in the third quarter of 2005 compared to the same quarter of 2004. The increase is primarily related to a $1.1 million increase in gains on sale of mortgage loans to $2.2 million from $1.1 million. Additionally, brokered loan fee income, which includes third party fees on mortgage warehouse and premium finance loans, increased $721,000 in the third quarter of 2005 as compared to the third quarter of 2004. Trust fee income increased $296,000 due to continued growth of trust assets.

Non-interest income increased $4.8 million during the nine months ended September 30, 2005 to $14.7 million compared to $9.9 million during the same period of 2004. The increase is primarily related to a $3.6 million increase in gains on sale of mortgage loans to $5.9 million from $2.3 million. Brokered loan fee income increased $828,000 to $1.6 million for the nine months ended September 30, 2005, as compared to $753,000 for the same period of 2004. Trust fee income increased $606,000 due to continued growth of trust assets. Offsetting these increases were decreases in cash processing fees and service charges. Cash processing fees were $587,000 lower in the first nine months of 2005 compared to the same period of 2004. These fees were related to a special project that occurred in the first quarter of 2002, 2003 and 2004. Service charges decreased by $183,000 due to the overall increase in market interest rates, which raises the earnings credit rate for analysis customers, which account for the majority of our deposit customers.

While management expects continued growth in non-interest income, the future rate of growth could be affected by increased competition from nationwide and regional financial institutions. In order to achieve continued growth in non-interest income, we may need to introduce new products or enter into new markets. Any new product introduction or new market entry would likely place additional demands on capital and managerial resources.

TABLE 2 — NON-INTEREST INCOME
(In thousands)

Non-interest expense for the third quarter of 2005 increased $6.6 million, or 46%, to $21.2 million from $14.6 million, and is primarily related to a $4.6 million increase in salaries and employee benefits to $13.5 million from $8.9 million. The increase in salaries and employee benefits resulted from an increase in the total number of employees related to general business growth, additions to staffing for the Houston office, addition of the premium finance business, continued expansion of the residential mortgage lending division and increased incentive compensation reflective of our performance. Of the increase, approximately $971,000 is related to commissions in the residential mortgage lending division and represents a variable component of compensation expense directly related to residential loan productions, sales and gains on the sale of mortgage loans reflected in non-interest income.

Net occupancy expense for the three months ended September 30, 2005 increased by $494,000, or 34%, compared to the same quarter in 2004 and is related to our continued general growth and expansion of the residential mortgage lending division.

Marketing expense increased $152,000, or 23%. Marketing expense for the three months ended September 30, 2005 included $139,000 of direct marketing and promotions and $360,000 for business development compared to direct marketing and promotions of $107,000 and business development of $301,000 during the same period for 2004. Marketing expense for the three months ended September 30, 2005 also included $322,000 for the purchase of miles related to the American Airlines AAdvantage® program, compared to $261,000 for the same period for 2004. Our direct marketing expense may increase as we seek to further develop our brand, reach more of our target customers and expand in our target markets.

Legal and professional expense for the three months ended September 30, 2005 increased $428,000, or 57%, compared to the same quarter in 2004 mainly related to growth and increased cost of compliance with laws and regulations. Communications and data processing expense for the three months ended September 30, 2005 decreased $106,000, or 14%, compared to the same quarter in 2004 primarily related to the efficiencies of the deposit system, which we converted to in mid-2004.

Non-interest expense for the first nine months of 2005 increased $16.9 million, or 41%, to $58.3 million from $41.4 million during the same period in 2004, and is primarily related to an $11.8 million increase in salaries and employee benefits to $36.9 million from $25.0 million. The increase in salaries and employee benefits resulted from an increase in the total number of employees related to general business growth, additional staffing for the Houston office, addition of the premium finance business, the continued expansion of the residential mortgage lending division, and increased incentive compensation reflective of our performance. Of the increase, approximately $3.0 million is related to commissions in the residential mortgage lending division and represents a variable component of compensation expense directly related to residential loan productions, sales and gains on the sale of mortgage loans reflected in non-interest income.

Net occupancy expense for the nine months ended September 30, 2005 increased by $1.4 million, or 33%, compared to the same period in 2004 and is related to our continued general growth and expansion of the residential mortgage lending division.

Marketing expense increased $670,000, or 38% compared to the first nine months of 2004. Marketing expense for the nine months ended September 30, 2005 included $368,000 of direct marketing and promotions and $1.1 million for business development compared to direct marketing and promotions of $172,000 and business development of $817,000 during the same period for 2004. Marketing expense for the nine months ended September 30, 2005 also included $957,000 for the purchase of miles related to the American Airlines AAdvantage® program, compared to $782,000 for the same period for 2004.

Legal and professional expense for the nine months ended September 30, 2005 increased $1.1 million, or 45%, compared to the same period in 2004 mainly related to growth and increased cost of compliance with laws and regulations. Communications and data processing expense for the nine months ended September 30, 2005 decreased $391,000, or 15%, compared to the same period in 2004 primarily related to the efficiencies of the deposit system, which we converted to in mid-2004.

TABLE 3 — NON-INTEREST EXPENSE
(In thousands)

The aggregate loan portfolio at September 30, 2005 increased $374.0 million from December 31, 2004 to $2.1 billion. Commercial loans increased $271.3 million and real estate loans increased $62.8 million. Construction loans, consumer loans and leases increased $36.0 million, $3.8 million and $773,000, respectively. Loans held for sale decreased $608,000.

TABLE 4 — LOANS
(In thousands)

We continue to lend primarily in Texas. As of September 30, 2005, a substantial majority of the principal amount of the loans in our portfolio was to businesses and individuals in Texas. This geographic concentration subjects the loan portfolio to the general economic conditions within this area. We originate substantially all of the loans in our portfolio, except in certain instances we have purchased individual leases and loan and lease

pools (primarily commercial and industrial equipment and vehicles), as well as selected loan participations and USDA government guaranteed loans.

The reserve for loan losses, which is available to absorb losses inherent in the loan portfolio, totaled $18.9 million at September 30, 2005, $18.7 million at December 31, 2004 and $18.7 million at September 30, 2004. This represents 0.98%, 1.20% and 1.26% of loans held for investment (net of unearned income) at September 30, 2005, December 31, 2004 and September 30, 2004, respectively.

The provision for loan losses is a charge to earnings to maintain the reserve for loan losses at a level consistent with management’s assessment of the loan portfolio in light of current economic conditions and market trends. Due to continued improvement in key measures of credit quality, such as net charge-offs and non-performing loans, we did not record a provision for possible loan losses during the third quarter of 2005, consistent with the second quarter of 2005 and down from $375,000 in the third quarter of 2004.

The reserve for loan losses is comprised of specific reserves for impaired loans and an estimate of losses inherent in the portfolio at the balance sheet date, but not yet identified with specified loans. We regularly evaluate our reserve for loan losses to maintain an adequate level to absorb estimated loan losses inherent in the loan portfolio. Factors contributing to the determination of specific reserves include the credit worthiness of the borrower, changes in the value of pledged collateral, and general economic conditions. All loan commitments rated substandard or worse and greater than $1,000,000 are specifically reviewed and a specific allocation is assigned based on the losses expected to be realized from those loans. For purposes of determining the general reserve, the portfolio is segregated by product types to recognize differing risk profiles among categories, and then further segregated by credit grades. Credit grades are assigned to all loans greater than $50,000. Each credit grade is assigned a risk factor, or reserve allocation percentage. These risk factors are multiplied by the outstanding principal balance and risk-weighted by product type to calculate the required reserve. A similar process is employed to calculate that portion of the required reserve assigned to unfunded loan commitments.

The reserve allocation percentages assigned to each credit grade have been developed based on an analysis of our historical loss rates and historical loss rates at selected peer banks, adjusted for certain qualitative factors. Qualitative adjustments for such things as general economic conditions, changes in credit policies and lending standards, and changes in the trend and severity of problem loans, can cause the estimation of future losses to differ from past experience. The unallocated portion of the general reserve serves to compensate for additional areas of uncertainty and considers industry trends. In addition, the reserve considers the results of reviews performed by independent third party reviewers as reflected in their confirmations of assigned credit grades within the portfolio.

The methodology used in the periodic review of reserve adequacy, which is performed at least quarterly, is designed to be dynamic and responsive to changes in portfolio credit quality and anticipated future credit losses. The changes are reflected in the general reserve and in specific reserves as the collectibility of larger classified loans is evaluated with new information. As our portfolio matures, historical loss ratios are being closely monitored, and our reserve adequacy will rely primarily on our loss history. Currently, the review of reserve adequacy is performed by executive management and presented to our board of directors for their review, consideration and ratification on a quarterly basis.

(In thousands)