Earnings Call Transcript - TCBI Q3 2023

Operator, Operator

Hello, everyone, and welcome to TCBI's Third Quarter 2023 Earnings Call. My name is Lydia, and I will be your operator today. It's my pleasure to now hand you over to your host, Jocelyn Kukulka, Head of Investor Relations. Please proceed when you are ready.

Jocelyn Kukulka, Head of Investor Relations

Good morning, and thank you for joining us for TCBI's third 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, President and CEO

This quarter marks two years since we announced that we would transform Texas Capital into the first full-service financial services firm founded and headquartered in our state. Our work over the last two years has focused on ensuring Texas has a financial partner capable of providing clients the widest possible range of differentiated products and services on parity with those of the largest Wall Street firms, with high-touch, locally based execution from an experienced team of bankers invested in the success of this state's economy and our clients. We are both committed and equipped to serve the best clients in all of our markets throughout the entire country while ensuring our firm is a relevant, trusted partner throughout our clients' corporate and individual life cycles. And we know that the success of our clients will define our firm. With the strategy risk and build risk behind us and all critical roles now filled with top requisite talent, we have a solid and financially resilient foundation from which to execute. Our industry-leading liquidity and capital position afford us a competitive advantage in this unique operating environment. CET1 of 12.7% ranked fourth among the largest banks in the country. TCE of 9.4% ranked first among the largest banks in the country, and liquid assets of 28% allow our bankers to be front-footed in our clients' offices, as we are well prepared to support the diverse and broad needs of our clients in what continues to be a challenging operating environment for all industries. We saw the emerging power of the platform on display again this quarter. In the current environment, which is putting material pressure on the industry's ability to grow net interest income, the firm was again able to deliver financial results through resolution of critical client needs with new products and services purpose built over the last two years. We are no longer a loan-only bank, unable to holistically serve our clients' needs, which by definition makes our capital less of a commodity. Our continued success in supporting clients across our platform has solidified our positioning as a full-service financial services firm. This quarter's financial results, but more importantly, market momentum earned through strong execution, suggest continued progress on the core components of long-term value creation. More than three-quarters of clients to whom we have made credit commitments since we launched our strategy had expanded their engagement with our treasury business or other services. We continue to add clients and operating accounts at a pace consistent with our long-term plan. September was the highest month on record in the last two years for our new treasury business, including new operating accounts, indicative of becoming our clients' trusted financial partner. The treasury business won today will generate balances, payments, and revenues in the next six to eighteen months as the account activity ramps to full potential. Gross segment revenues were up 14% year-over-year, the highest growth since the first quarter of 2022 and a result of realized treasury business awarded in prior quarters. Additionally, as I've detailed in the past, our clients' response to our proprietary onboarding tool, Initio, that provides significantly improved client journeys through faster and automated account opening and onboarding has exceeded expectations. For some specialized client types, we have been able to open several hundred accounts per client per day, including during March, when clients needed expedited onboarding. Our broad platform continues to avail itself to clients in need of alternative cash management solutions. In the current rate environment, clients are actively seeking options for those deposits and excess other daily operating needs. And we remain active in advising them on how to best position their liquidity given their unique circumstances. Our platform can now provide alternatives such as interest-bearing deposits, automated insured suite programs, money market options, or in some instances, liquid investments like treasuries. The firm's constant focus on a financially resilient balance sheet is enabling a consistent market-facing posture, ensuring we can confidently approach clients and prospects based on their needs, not ours. In my many interactions with current and especially new clients, this is frequently cited as a reason why clients are choosing to do more with us or bank with us for the first time. As we continue to build this franchise, we are and will remain materially more focused on ensuring client needs can be met with our offerings than on our own near-term financial outcomes. Clients are also increasingly benefiting from our still emerging investment banking capabilities. Investment banking and trading income had a fourth consecutive record quarter with revenue up 6% quarter-over-quarter to $29.2 million, which is comprised of revenue from all areas of the Investment Bank. Each of the past four quarters had significant contributions from a different part of the platform. This quarter, our capital markets group solved a material financing need outside the bank markets for a marquee client, a need a renowned money center bank attempted to solve, took to market but failed to complete. We successfully arranged a comprehensive financing solution, including serving as sole arranger on the $1.2 billion term loan, which was the largest transaction of its type this year and one of the largest sole managed term loans ever, plus acted as a financial adviser on the $155 million equity follow-on for the same client. This transaction was executed with a global reach and a wide variety of investors, including leading alternative asset managers, energy specialists, insurance companies, and family offices, the majority of whom opened new institutional accounts with Texas Capital Securities if they didn't already have one. These are the types of transactions that create real market momentum, and the amount of opportunity that has created from that institutional growth is and will be significant. It is important to once again note that this was not syndicated in the traditional bank market. As such, we do not hold any part of this financing transaction on our balance sheet. Since we launched the strategy, we acknowledge that revenues 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 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 substantial investments made over the last two years to deliver a higher-quality operating model supporting a defined set of scalable businesses are resulting in the intended outcomes. The entire platform contributed to our now fifth consecutive quarter of positive operating leverage as year-over-year quarterly adjusted PPNR grew 18% in the third quarter. Non-interest income as a percentage of total revenue increased to 16.8% this quarter and stands at 15.7% year-to-date, in line with the bottom end of our full year 2025 goal to generate 15% to 20% of total revenue from fee income sources. As you know, a foundational tenant, the financial resiliency we have established and will preserve is continued focus on tangible book value, which finished the quarter up 12% year-over-year, ending at $57.82 per share, which continues to be near an all-time high for our firm. As we enter the fourth quarter from a position of strength and fully committed to improving financial performance over time, we do recognize that we have made strategic capital decisions that suppress near-term profitability. But as you have heard me say in the past, maximizing near-term returns is not the immediate goal of the transformation. We will drive attractive through-cycle shareholder returns with both higher quality earnings and a lower cost of capital, as we 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 quarter's results.

Matt Scurlock, CFO

Thanks, Rob, and good morning. Starting on Slide 5. Progress against our 2021 strategic performance drivers continued this quarter, with the revenue base increasingly balanced toward non-interest income targets and capital and liquidity in excess of both medium and longer-term guidance. Year-to-date, non-interest income to total revenue was 15.7%, in line with our long-term target of 15% to 20% and reflective of our increased ability to support a broad range of clients' financial needs. Treasury product fees increased 5% quarter-over-quarter as client onboarding continues to accelerate. Near-term pull-through to earnings from sustained momentum in our cash management and payment businesses is being offset by increased deposit compensation at this point in the rate cycle. We remain less focused on current quarterly fluctuations in revenue from this offering and we are ensuring we are adding primary banking relationships consistent with our long-term plan. Wealth management income decreased 3% year-over-year, in large part due to continued client preference from 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 in revenue contribution. Year-over-year growth in assets under management and total clients of 22% and 16%, respectively, is on pace with plan. This connectivity between private wealth and commercial banking continues to mature. Investment banking and trading income of $29.2 million increased 6% linked quarter, which was our fourth consecutive record quarter since launching the investment banking business last year. Rob described the one marquee transaction that occurred during the quarter. However, we continue to see early success across the breadth of that platform, both in transactions executed year-to-date and in the broad and granular medium-term pipeline. Fee income from our areas of focus more than doubled year-over-year as each individual offering continues to advance against our expectations and their collective benefit further differentiates our value proposition in the market. Total revenue increased modestly linked quarter to $278.9 million as both net interest income and non-interest revenue improved slightly over previous year-to-date highs experienced last quarter. As expected, further net interest income expansion was pressured by industry-wide trends related to rising deposit costs and slowing credit demand. Total revenue increased $14.5 million or 5% when compared to Q3 2022 with year-over-year results benefiting from an 85% increase in non-interest income, coupled with disciplined balance sheet repositioning into higher earning assets associated with our long-term strategy. Total non-interest expenses declined 1% linked quarter after a 6.4% reduction during the second quarter, as structural efficiencies associated with our go-forward operating model are improving near-term financial performance while enabling select investments associated with long-term capability build. Taken together, quarterly adjusted PPNR increased 18% year-over-year to $99.1 million, the high point since we began this transformation in Q1 of 2021. This quarter's provision expense of $18 million resulted primarily from continued resolution of select legacy problem credits and a modest increase in criticized loans. Net income to common was $57.4 million, an increase of 15% from Q3 of last year when adjusted for the divestiture of our insurance premium finance business. Our balance sheet metrics remain exceptionally strong. Cash balances grew $1.3 billion this quarter as clients deposit growth broadly outpaced credit needs. Ending period gross LHI balances declined by approximately $700 million or 3% linked quarter, driven predominantly by predictable seasonality in the mortgage finance business, whereby average balances grew, but end-of-period balances declined, reflecting the end of the summer home buying season. Deposit balances increased 2% or $560 million in the quarter, resulting in period-end loan-to-deposit ratio of 86%, down from 91% at the end of the second quarter. Finally, the nearly 50 basis point increase in five-year treasury yields during the quarter resulted in AOCI decline of $66 million, which is nearly offset by net income of common and resulted in tangible book value per share of $57.82. Total LHI, excluding mortgage finance, decreased $43 million for the quarter, but remains up $1 billion or 6.5% for the year. During the quarter, we executed a $164 million pooled sale of non-strategic C&I loans sold at par. $36 million was delivered in September and a related $127 million were moved to held for sale and subsequently sold in early October. Both our market-facing posture and capital priorities remain unchanged as we continue our 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. Commercial loan balances continue to moderate this quarter, declining $94 million or about 1%, which while marginally unfavorable to near-term earnings expansion obscures continued strong underlying momentum in the commercial business. New relationships onboarded year-to-date are up nearly 10% relative to elevated 2022 levels, with a portion of new activity that includes more than just the loan product remaining over 95% for the first nine months of the year. The noted progress on winning clients' treasury business is highly correlated with the increasing percentage of commercial relationships in which we are the lead bank. For commercial syndicated transactions that meet the definition of a shared national credit, the portion we agent has increased to 30% from 12% in Q3 of last year. For other syndicated loans on our balance sheet, we now act as agent on over two-thirds of existing credit facilities, which is consistent with our desired value proposition and stated balance sheet priorities. This manifests in the fee income trends Rob noted in his commentary, as we are increasingly the primary operating bank providing value in multiple ways for those clients for whom we choose to extend balance sheet. Period-end real estate balances increased $50 million or 1% in the quarter. We continue to experience the expected, but still material slowdown in payoff rates of recent record highs. Despite a modest increase in the third quarter, we are positioned for continuation of year-to-date payoff trends in the medium term. Our clients' new origination volume also remains 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. Approximately 36% of the real estate portfolio has a maturity date in 2023 or 2024, while over 64% of the portfolio matures in 2025 or later. Our office exposure is $459 million or approximately 9% of the total commercial real estate book. The office portfolio has solid underwriting with the current average LTV of 57% and 90% recourse, as well as strong market characteristics as over 73% is Class A properties and over 71% located in Texas. Average mortgage finance loans increased $321 million or 7% in the quarter, as the seasonality associated with summer home buying partially offset rate-driven pressures that continue to drive down estimates of next 12 to 24-month activity. Year-over-year, the industry has contracted from $3.4 trillion to $1.5 trillion in trailing 12-month originations. Overall, market and volume estimates from professional forecasters suggest total originations to decrease approximately 20% in the fourth quarter, with full year expectations showing a decline of nearly 35% in total origination volume. As you know, Q4 and Q1 are the seasonally weakest origination quarters from a home buying perspective, and we expect the next six months to be amongst the toughest the industry has seen in the last 15 years. Total ending period deposits increased 2% quarter-over-quarter with changes in the underlying mix reflected on both the continued funding transition in a tightening rate environment, coupled with predictable seasonality and a sustained focus on leveraging our cash management platform into deeper client relationships. Total non-interest-bearing deposits remained stable quarter-over-quarter with a portion to total deposits decreasing modestly to 39% from 42% at year-end. Mortgage finance non-interest-bearing deposit balances increased $363 million or 7% quarter-over-quarter as we remain focused on holistic relationships with top-tier clients in the industry. Average mortgage finance deposits were 128% of average mortgage finance loans, at the high end of our guidance and up from 108% last year, due to both continued success in capturing more of our clients' treasury business and the impacts of system-wide contraction in mortgage origination volume on their short-term credit needs. As a reminder, Q4 is a seasonally weak quarter for mortgage finance deposits as escrow balances related to tax payments are remitted beginning in late November and run through January. However, given the previously mentioned client-level trends, we expect the ratio of the average mortgage finance deposits to average mortgage finance loans to increase in the fourth quarter, further pressuring the firm's net interest margin. As expected, other non-interest-bearing deposits declined $440 million or 11% this quarter. As previously described trends, whereby select clients shifted excess balances to interest-bearing deposits or to other cash management options on our platform, have slowed. Non-interest-bearing deposits, excluding mortgage finance, is now 15% of total deposits, down from 18% last quarter and 26% in Q3 of last year. Our expectation remains that the portion of our total deposits comprised of non-interest-bearing excluding mortgage finance will continue to decline but at a decelerating pace in the near term. Our repositioning away from reliance on index deposit sources is complete, as balances are now aligned to clients consistent with our strategy and paired with bankers equipped to effectively serve their specific needs. At 7% of total deposits, well inside our published 2025 threshold of 15%, we now consider these relationships as part of the target client base and we'll report them as interest-bearing deposits moving forward. Broker deposits declined $86 million during the quarter, as growth in client-focused deposits consistent with our long-term strategy remains sufficient to satisfy the desired near-term balance sheet positioning. We maintain ample brokered capacity and while always evaluating future liquidity composition consistent with established balance sheet management priorities, do anticipate that brokered CDs will decline during the fourth quarter as $124 million will mature without replacement. As expected, our modeled earnings at risk was relatively flat quarter-over-quarter at 3% or $29 million in a plus 100 basis point shock scenario and negative 4.3% or $42 million in a down 100 basis point shock scenario. Proactive measures taken earlier in the year to achieve a more neutral posture at this stage of the rate cycle, coupled with an increase in quarterly cash balances have produced the intended outcome. There were no new securities purchases in the quarter, and we continue to believe the current levels to be an efficient and prudent portion of our liquid asset composition at this time. The core component of our naturally asset-sensitive profile remains the large portion of our earning asset mix that reprices with changes in short-term rates. 93% of the total LHI portfolio, excluding MFLs, is variable rate with approximately 90% of these loans tied to either prime or a one-month index. Net interest margin decreased 16 basis points this quarter and net interest income was flat at $232.1 million, predominantly as a function of the deposit mix shift into interest-bearing deposits and higher quarter-over-quarter deposit costs, partially offset by improved loan yield and increased cash balances. Our multi-year business model transformation and associated platform build is directly intended to lessen our dependence on these inevitable fluctuations and rate-driven earnings. Sustained execution on non-interest income initiatives will, over time, enable revenue stability even as near-term net interest income expansion moderates. Further, 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. We expect to see another contraction in quarterly year-over-year non-interest expense, which when coupled with maturing revenue generation capabilities, enables the foundation for future earnings expansion despite the market backdrop. Criticized loans increased $58.1 million or 9% in the quarter to $677.4 million or 3.3% of total LHI. As increases in special mention of both commercial loans and real estate loans were only partially offset by a $17.9 million reduction in non-accrual loans as a result of both realized net charge-offs of $8.9 million in selected payoffs and upgrades. Non-performing assets are at 0.21% of total assets, which continues to be near all-time industry lows. As in prior quarters, the composition of criticized loans is weighted towards commercial clients with dependencies on consumer discretionary income plus a handful of well-structured commercial real estate loans supported by strong sponsors. We continue to believe our client selection and underwriting guidelines provide adequate protection against realized loss. Preparation for an inevitable normalization in asset quality began early 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. Total allowance for credit loss, including off-balance sheet reserves increased $9 million on a linked-quarter basis to $291 million or 1.41% of total LHI at quarter end, up nearly $35 million or 11 basis points year-over-year in anticipation of a more challenging economic environment, while our ACL to non-accrual loans improved to 4.6 times. We have previously commented on the portion of legacy loans still on the balance sheet and consistent with current client selection or underwriting principles. That will be resolved in maturities, workouts or select charge-offs. During the quarter, we recognized gross charge-offs of $7.5 million against this identified portfolio and exposure to this client set is now approximately $60 million of book balance. As Rob described in his commentary, capital levels remain at or near the top of the industry. Total regulatory capital remains exceptionally strong relative to the peer group and our internally assessed risk profile. CET1 finished the quarter at 12.7%, a 50 basis point increase from the prior quarter. Intangible common equity to tangible assets finished the quarter at 9.4%, which ranks first relative to second quarter results for all large US banks and in the top quartile of the peer group. We remain focused on managing the hard-earned capital base in a disciplined and analytically rigorous manner focused on driving long-term shareholder value. Our guidance accounts for the market-based forward rate curve, which assumes Fed funds of $550 through the remainder of the year. The recognition of system-wide funding cost increases has resulted in net interest income pressure as we anticipated earlier this year. Our outlook for low double-digit percent full-year revenue growth remains unchanged as recognized fee income year-to-date has partially offset net interest income pressure associated with both market events and chosen balance sheet positioning. As detailed above, the significant investments made over the last two years are yielding expected operating and financial efficiencies that will continue contributing to profitability of the firm. Our non-interest expense guidance remains unchanged, and we believe that current consensus expense estimates are achievable with flat total non-interest expense in Q4 before accounting for an FDIC special assessment. The same commitment to our long-term strategy, coupled with a historically challenging environment for our mortgage clients, resulted in us lowering PPNR expectations in Q4 to below Q4 2022 levels. Finally, we remain committed to maintaining our strong liquidity and capital positions, and our intent remains to hold greater than 20% of our total assets in cash and securities and to exit the year with CET1 ratio of greater than 12%. And now I'll turn the call back over to Rob for closing remarks.

Rob Holmes, President and CEO

Operator, you wanted to have questions?

Operator, Operator

Yeah, absolutely. Our first question today comes from Michael Rose of Raymond James. Your line is open.

Michael Rose, Analyst

Good morning, everyone. Thank you for your questions. Let's begin by discussing the increase in CET1 levels in your guidance for the intermediate term. A recurring question over the past year has been how you plan to meet the 2025 targets, especially considering potential pressure on margins and challenges in the warehouse sector. Matt, your comments about PPNR levels being somewhat lower year-on-year in the fourth quarter raise significant concerns. Despite your ongoing commitment to these targets, consensus seems to indicate generally lower expectations. Could you help clarify how you intend to bridge this gap as we move closer to the deadline? Thank you.

Matt Scurlock, CFO

Appreciate the question, Michael. Capital priorities remain the same for us. So we said since September 1, '21 that we wanted to run the place based on our principle of financial resilience, which for us means the ability to access markets for clients and serve communities through any cycle, and we do that as a competitive advantage always, and certainly one right now. Rob mentioned in his comments that our market-facing posture remains the exact same, which is having a clear benefit in terms of new client acquisitions, mentioned in my comments that we've onboarded 10% more new C&I relationships than new C&I relationships last year and other coming with materially more new business. Those are, in our view, the things that drive long-term value. We're going to continue to bias the capital base in that direction.

Rob Holmes, President and CEO

I would like to give you an example of how we see capital as crucial for new client acquisition and client retention. We onboarded a new client in February of last year who chose our platform primarily for our treasury services and technology. We do not lend to this client, but they are an impressive company with great people. Once fully ramped, they will process over $1 billion in payments through our bank annually. I met with their CEO and team last month, and afterward, the CFO sent me a note explaining the importance of our financial structure and stability. They conducted thorough due diligence on our capital and resilience before choosing us over their previous super regional bank. The caliber of our technology, service, and financial stability reassured them to continue working with us. This partnership will have over 30 lockboxes and is projected to bring nearly $2 billion in payments through our system, which is extremely valuable.

Michael Rose, Analyst

Can you help us understand how to reach our targets now that capital levels are increasing? That's the key question. Additionally, on a related note, the investment bank and trading segment have continued to grow this quarter. While it’s difficult to predict, it seems we are gaining more confidence in the sustainability of the business model. Can you summarize these points, as I believe this is what most investors are inquiring about? Thank you.

Matt Scurlock, CFO

Michael, so keeping our average assets north of $130 million for 1.3% for the second straight quarter, we got to get that to $165 million to $170 million, which on the same size balance sheet is $20 million to $25 million of additional PPNR per quarter. There is a multitude of levers that will be dependent on the environment, which we find ourselves in '24 and '25, as we continue to warehouse liquidity that's certainly an available lever. If you simply move the loan-to-deposit ratio back to 90% through repositioning of cash into loans, that's going to drive another $7 million or so of quarterly PPNR. And then to your comment, fee-generating businesses, while we've seen material progress this year, they're in their infancy, they're brand new. So, for example, we got a pretty robust at this point M&A offering. The M&A bankers landed in the second quarter. So they had over 80 conversations with clients this quarter. So 80 conversations in the last 90 days about prospective M&A transactions over the next two years. But those are brand-new businesses. So if we were to look into the crystal ball and look forward, you would continue to prospect the recycling capital from low-return relationships and to those where we can be more relevant, drive higher risk-adjusted return on the allocated capital, start to reduce some of the excess liquidity as the deposit base continues to improve. That provides that $6 million, $7 million to support the PPNR right there. And then the expense outlook and probably too early to go detailed into 2024, but we continue to run the same playbook that we have on a non-interest expense stage, where we're focused on making technology investments that lead to structural improvements in how we show up for our clients, while reducing risk and increasing efficiency.

Michael Rose, Analyst

That's really helpful. Thanks. Thanks for that, Matt. Thanks for taking my question guys. Appreciate it.

Rob Holmes, President and CEO

See you, Michael.

Operator, Operator

Our next question today comes from Matt Olney of Stephens. Matt, your line is open.

Matt Olney, Analyst

Hey, thanks. Good morning, everybody. On the mortgage finance, great to see those balances of loans and deposits outperform in a difficult backdrop in the third quarter. Any more colors on that outperformance that we just saw? And then, Matt, you mentioned industry expectations for originations, down 20% in the fourth quarter. Can you just talk about the ability or potential to outperform that? Thanks.

Matt Scurlock, CFO

The mortgage market is facing serious challenges over the next six months, possibly the toughest we've seen in 15 years. Recently, home affordability has reached a 25-year low, coinciding with 30-year fixed-rate mortgages hitting a 25-year high, which is impacting overall industry originations. Forecasts now indicate that originations may drop by around 35% across the industry this year, suggesting our own decline will be about 25%, leading to a full-year average balance in the low-4s, down from a 5.3 balance last year. We are effectively executing our strategy of targeting stronger, larger clients, similar to our approach in the commercial sector, by offering a variety of products and services. We're successfully capturing more of the treasury and deposit wallets. Generally, we've operated at a 100% to 120% self-funding ratio, even in a slower fourth quarter, and we expect this to rise to about 150%, which may negatively impact net interest income and margins in the short term. However, we are introducing significant new capabilities for our clients that we believe will enhance returns on capital over time, despite the immediate pressures as we continue to build these initiatives.

Matt Olney, Analyst

Okay. That's great, Matt. Thanks for the color around that. And then just as a follow-up on the positive operating leverage in the near term, I appreciate the updated guidance around the challenges of achieving, kind of, your goals in the fourth quarter. Can you speak just more broadly about operating leverage in 2024, what are the just the puts and takes around the challenge of achieving the operating leverage in '24 versus '23? Thanks.

Matt Scurlock, CFO

The update to the guidance reflects seasonal aspects related to the mortgage business in the fourth and first quarters. It’s also important to highlight our ongoing efforts in capital recycling, which has been a fundamental part of our strategy since Rob arrived. We executed a loan sale at par that involved consumer-focused C&I credits, resulting in a $160 million decrease in balances. Additionally, we exceeded our expectations in reducing capital tied to relationships where we don’t foresee future relevance. This quarter, we reduced C&I loan balances by about $300 million and converted that into cash, preparing for opportunities to redeploy at significantly better risk-adjusted returns as we move into 2024. We are highly committed to achieving our 2025 targets and have numerous ways to reach them, including maintaining non-interest expenses, meeting fee income goals, and exploring repositioning within our asset base. While I appreciate your question, we aren’t ready to provide detailed guidance for 2024 yet, but this reflects our current approach to balance sheet positioning as we approach our 2025 objectives.

Matt Olney, Analyst

Okay, that's helpful, guys. Thank you.

Matt Scurlock, CFO

You bet.

Operator, Operator

Our next question comes from Zachary Westerlind of UBS. Please go ahead.

Zachary Westerlind, Analyst

Good morning. It's Zach on for Brody. Just had a couple of quick ones. On the consumer-dependent commercial loans that got moved to criticized and classified, are those oriented towards sub-prime consumers or just any color you could provide on what's driving the move into criticized, classified for those?

Matt Scurlock, CFO

They are not focused on subprime consumers, Zach. We indicated in last year's call that we anticipated some downgrades in both commercial and industrial loans and in commercial real estate as we entered the middle of this year. Those downgrades have mostly occurred as we expected. The consumer-dependent commercial and industrial credits don't have enough unique characteristics to detail further. There is some franchise finance included, but there is nothing systemic in the portfolio that requires additional explanation beyond what we have shared. Overall, we are quite pleased with the credit progression this quarter. When Rob came on board, we identified about $200 million in legacy problem credits that needed to be addressed. That figure has now decreased to $60 million, with a reduction of $40 million this quarter. This included $20 million from sales or payoffs, approximately $10 million that was restructured and upgraded, and a $10 million charge-off, which contributes to the $17.9 million reduction in non-accruals. We are now at $63 million in non-accruals, down from the mid-90s earlier this year. We feel we are making significant progress on the most concerning credits.

Zachary Westerlind, Analyst

Understood and appreciate that. And then just on the, on the shared national credits. Apologies if I missed this, what percentage of the loan portfolio is our snicks? And then of that, what amount are you guys the lead underwriter on?

Matt Scurlock, CFO

Yeah. Great question. 23% of the total loans, we lead 30% of that, Zach. It's not all syndicated credits or SNCs. So there's certain criteria that classify as syndicated credit as SNC, north of $100 million, three or more banks. We lead a large portion of syndicated credits across the middle market, so we were the ninth ranked middle market book runner through the first two quarters of this year, which means we originated and distributed more middle market credit than all, but eight banks in the country. So we noted in the comments that across syndications that are not SNCs for the lead on north of two-thirds of those relationships, which is a critical part of our strategy and a key driver of why we're driving increased fee income, which obviously improves return on equity or return on allocated balance sheet.

Zachary Westerlind, Analyst

Got it. Thanks for that. That's very helpful. Sorry.

Matt Scurlock, CFO

We've stated since Rob joined that our strategy for participating in any credit facility, whether it's an SNC or not, is guided by the same client selection and underwriting principles we apply when it's a bilateral relationship or when we lead. Often, if we identify a target client with a management team we trust and that aligns with our strategy, we are open to entering a credit facility to enhance our engagement or capture a larger share of their business. In response to Matt's question, we are beginning to move away from some of these relationships where we don't see a way to become more relevant to the client. It's crucial to underline that this approach is entirely consistent with the messages we've been conveying over the past few years.

Zachary Westerlind, Analyst

Got it. Appreciate that. And then if I could just sneak one more quick one in. The office portfolio, are you able to share what the reserve is on that?

Matt Scurlock, CFO

No, we generally don't disclose. I mean we have $460 million of office and we've got $4.2 billion of cash, 2% of total loans. So generally we don't describe the asset class or property type-specific reserve.

Zachary Westerlind, Analyst

Understood. Thanks for taking my questions.

Matt Scurlock, CFO

You got it.

Operator, Operator

And our next question is from Brady Gailey of KBW. Please go ahead.

Brady Gailey, Analyst

Hey, thanks. Good morning, guys.

Matt Scurlock, CFO

Good morning.

Brady Gailey, Analyst

I think one of the most challenging aspects to forecast is the investment banking line. It's been very strong recently, with $29 million this quarter, up from just $8 million a year ago. While I recognize that it's volatile and hard to predict, should we expect the trend to continue to drift higher from this third-quarter base? Or do you feel you've reached a target level, as you mentioned aiming for about 10% of revenue, which seems close. Should we consider this level as a solid run rate for the next few years?

Rob Holmes, President and CEO

Let me just comment on the business, then Matt can comment on guidance, if that's okay, Brady. I think it's a great question and obviously, a very fair question. As you know, I think we've had this conversation before. When Matt and I were coming up with the strategy I told Matt, that when we say we're going to start an investment bank, everybody is going to think we're crazy. Then we're going to do it. We're going to be successful. We're going to have great revenues and a great practice and then everybody is going to complain about the ability to model go-forward earnings and I think that will be a great problem to have. So first of all, I am glad we are having a conversation and I’m proud of the business, of the team and the broader business because remember, we're not doing investment banking business with other clients. They're clients of our commercial bank and corporate bank and real estate banking franchise. So it's one firm, which I think is really, really important. The big transaction this week that we talked about, this quarter, is a great example of how the platform works. So we went in, committed on 3% of a credit facility to a big public company and started hammering them with advice. And we lost, they went with another money center bank to address ‘24 maturities that they had to address as a strategic imperative. And they took it to the market, they failed to get it done, they called us back, asked us if we could get it done. So our strategy, we said yes. Remember, the bank market has substantially closed. Not everybody has our capital or liquidity. They are calling on their clients right now like we are. So we went to a market that was non-bank, like I said in my remarks, it was a global investor base, energy specialists, alternative asset managers, insurance companies, family offices, et cetera. When you do that and you get a transaction that's the largest sole-managed transaction in the country year-to-date, then everybody in that industry and frankly other industries wants to talk to you about the market and market receptivity. And so that opens doors and credibility for new business. The principle of the company is part of the private wealth business. And then when you distribute the allocations to these different investors, we had over 30, I forget the exact number, but well over 30 investors that opened accounts with our sales and trading floor that we weren't doing business with before. So that helps sales and trading, helps private wealth, and helps further dialogue with other clients. And then when you allocate the right amount of demand to that investor, it creates an unwritten IOU with that investor. And so that's another way of generating more business. And then when somebody wants to trade the debt, they come to us because they know we know where the debt is. So then you have secondary trading. So it's very granular and broad like Matt talked about, the go forward pipeline in investment banking. And I just wanted you to kind of know how it works. A lot of people that follow us haven't followed investment banks in the past. And so I thought that was an important note. But Matt, why don't you talk about the guidance?

Matt Scurlock, CFO

Yes, back-to-back quarters of landmark transactions, Brady. Near-term pipeline is materially more granular. We suggested to you and the rest of the investor base to model this as trailing four-quarter average. We point to that guidance and suggest that some quarters we’re going to be in excess, the last two quarters being examples of that, and some quarters we’re going to be below. And our current outlook would suggest we'll be below a four-quarter trailing average in its fourth quarter. As we think about the long-term prospects for that business, we need to sustainably hit 10% total revenue, which is the guide until we alter that guide. I think that the platform to date has proven to be one that clients certainly value and one that we're quite optimistic is going to be able to achieve the growth targets that we've set out as we move into ‘24, ‘25.

Brady Gailey, Analyst

Okay. And sorry, if I missed it, but did you guys quantify the fee from that marquee big transaction?

Matt Scurlock, CFO

No, but the quarter would have been good without it. It was a solid performance.

Brady Gailey, Analyst

Okay. And then my last question is, if you compare Texas Capital today to before Rob, the capital is significantly higher, the liquidity is much greater, and the credit is much cleaner, making it a much stronger institution. However, the stock still trades at around one times tangible book value. I understand you have engaged in buybacks previously, but given the current uncertainty, when do you think you might more seriously consider increasing involvement in share buybacks?

Rob Holmes, President and CEO

We consider getting involved every day. We have a disciplined capital allocation framework and have demonstrated our ability to repurchase shares responsibly and efficiently. We believe that those are key priorities for us. We remain committed to our clients and stakeholders on this front. We still consider ourselves to be in the growth phase, bringing on clients at a pace we are pleased with, and our pipelines continue to be robust. Our client base is responding positively to our strategy. Many banks are currently struggling, making organic growth a more promising return for our business in the long run. However, we acknowledge that buybacks will need to be taken into account, and while we do consider them, they are not our first choice.

Brady Gailey, Analyst

Understood. Thanks, Rob.

Rob Holmes, President and CEO

Thank you, Brady.

Operator, Operator

We have no further questions at this time. So, I will turn the call back over to Rob for any closing remarks.

Rob Holmes, President and CEO

Just thanks everybody for their interest in the firm and look forward to talking to you next quarter.

Operator, Operator

This concludes today's call. Thank you for joining. You may now disconnect your lines.