Earnings Call Transcript - TCBI Q2 2023

Operator, Operator

Hello and welcome to today's conference call titled Texas Capital Bancshares Q2 2023 Earnings Call. My name is Ellen and I'll be coordinating the call for today. I will now hand over to Jocelyn Kukulka to begin. Jocelyn, please go ahead when you are ready.

Jocelyn Kukulka, Head of Investor Relations

Good morning, and thank you for joining us for TCBI's second quarter 2023 earnings conference call. I'm Jocelyn Kukulka, Head of Investor Relations. Before we begin, please be aware that 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, 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. 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. And now, I'll turn the call over to Rob for opening remarks.

Rob Holmes, President and CEO

Thank you for joining us today. The firm's sustained progress against our well-documented strategy was evident again this quarter as the people, products, services and infrastructure implemented over the past 2.5 years delivered another quarter marked by notable improvements in financial performance. I am proud of the foundation we have built and acknowledge that the early successes of our strategy are due entirely to the material efforts of the employees across the firm and the trust placed in us by our clients who believe in what and how we are building. We are resolute in our mission to realize the unique opportunity to create something differentiated for our clients and steadfast in our commitment to building something of lasting value. The financial resiliency of this firm continues to be a strategic advantage. A goal since our arrival was to build a firm characterized by the strength of its balance sheet and the breadth of its platform, a firm that is resilient through market and interest rate cycles. Maintaining sector-leading capital and liquidity continues to enable our bankers to focus on growing the firm by both serving the broader needs of existing clients and confidently engaging identified prospects with an increasingly mature and compelling offering. The pace of client acquisition over the first two years of the transformation was marked largely by aggressive balance sheet reallocation to focus our capital on defined industry end market segments, where we believe clients will benefit from the material investments made in our treasury solutions, private wealth, and investment banking offerings. Our view was that as capabilities and culture evolve, we would become more relevant to our clients and in turn, begin to generate structurally higher returns on that allocated capital. Both this quarter's financial results and client behaviors suggest sustained progress towards this objective. We continue to add operating accounts at a pace consistent with our long-term plan. Gross payment revenues increased for the second straight quarter and were up 12% year-over-year, as our multiyear focus and material investments in proprietary applications like our commercial onboarding solution Initio are enabling us to win the operating business indicative of becoming our client's primary bank, which improves long-term earnings capacity and enhances the quality and resiliency of our transforming deposit base. Over 90% of our commercial client onboardings now occur digitally. And during the second quarter, new business client onboarding increased over 30% compared to the prior quarter. Given the current rate environment, clients with deposits greater than necessary for daily operating needs are utilizing other cash management options on our platform, including interest-bearing deposits or, in some instances, short-term liquid investments like treasuries. We remain materially focused on ensuring client needs can be met with our offerings rather than on our own near-term financial outcomes. The full rebuild of the private wealth business that I detailed in prior calls is nearing completion, resulting in a front, middle, and back-office structure built for superior client experience and significant scale. The pace of year-over-year client acquisition was 13% this quarter and continues to indicate both future earnings potential and further connectivity across our services. Clients are increasingly benefiting from our still-emerging investment banking capabilities. Investment banking and trading income had a third consecutive record quarter with revenue up $8.7 million or 47% quarter-over-quarter to $27.5 million, with contributions from all components of our newly built platform. We continue to achieve milestones in our product and services road maps and will focus future investments on an offering capable of delivering at least 10% of total revenue targeted by 2025. Since its launch in December 2021, our investment banking business has built an impressive array of capabilities to help clients solve a broad set of needs. Our capital solutions offering enables our clients to manage their interest rate risk via strategies of varying complexities and sophistication, such as swaps, collars, corridors, and FX hedging. Our capital markets group has been actively assessing and executing alternative financing strategies for clients, including securitizations, high yield, follow-on, and initial public offerings, with our first convertible bond trade occurring this quarter. Additional trades in the last six quarters have included TBA trades, specified MBS pool trades, corporate bond trades, corporate loan trades, and equity trades. Sales and trading has now completed over $35 billion in notional flat trades since the first trade last May. Our M&A advisory team has assisted clients in realizing long-term strategic objectives through its first buy-side advisory mandate and the closing of its first sell-side engagement. Finally, our newly created ETF and funds management team successfully launched the Texas Capital Texas Equity ETF, now trading under the ticker TXS on the NYSE. At Texas Capital, we recognize that Texas' diverse, business-friendly climate and vibrant economy are critical to our growth and success. I am excited to announce that last week, we launched the Texas Capital Texas Equity Index exchange-traded fund as the first investment offering created by Texas Capital's newly founded ETF and Funds Management business. With this launch, we entered one of the fastest-growing spaces in the asset management industry, further progressing against our objective to be the flagship financial services firm in the State of Texas and marking a significant expansion of our asset management capabilities. The substantial and transformative investments made over the last 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 fourth consecutive quarter of positive operating leverage as year-over-year quarterly PPNR grew 43% in Q2. Noninterest income as a percentage of total revenue increased to 16.6% this quarter, standing at 15.1% year-to-date, already in line with the bottom end of our full year 2025 goal to generate 15% to 20% of total revenue from fee income sources. Importantly, these diverse and complementary revenue streams were all built in the last two years. It will take time to deliver both at the magnitude and with the consistency we expect. That said, we are pleased with our progress to date and have proven that each of our areas of focus will be key contributors to earnings going forward. Before concluding, a foundational tenet of the financial resiliency we established and consistently communicate will preserve its continued focus on tangible book value, which finished the quarter up 7% year-over-year, ending at $57.93 per share, a near all-time high for our firm. As you have heard me say in the past, while we are fully committed to improving financial performance over time, maximizing near-term returns is not the primary goal. Instead, we are focused on responsibly scaling high-value businesses through increased client adoption, improved client journeys, and realized operational efficiencies. Doing so will enable both higher quality earnings and a lower cost of capital, resulting in attractive through-cycle shareholder returns. 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. Good morning. Strong balance sheet positioning built over the last two years continues to be exemplified by top-tier capital and liquidity levels. At quarter end, on-hand cash liquidity totaled $2.8 billion or 10% of total assets compared to the 5% median in our peer group. On insured deposits as a percentage of total deposits further decreased this quarter to 40%, and deposit coverage ratios remained extremely strong, both in absolute and relative terms, with cash plus contingent funding to uninsured deposits of 165%. Capital levels remain at or near the top of the industry. CET1 finished the quarter at 12.2% and tangible common equity to tangible assets finished the quarter at 9.6%, which ranks first relative to first-quarter results for all large U.S. banks. Notable progress in our fee-generating businesses continued again this quarter. Our year-to-date noninterest income to total revenue was over 15%, in line with our long-term target of 15% to 20%. This was driven in part by our quarterly investment banking and trading income of $27.5 million, which increased nearly 150% from the second quarter of last year and is up 47% linked quarter. Notably, this is our third consecutive record quarter since launching the investment banking business last year. Treasury product fees increased 1% quarter-over-quarter. The pull-through to earnings from sustained momentum in our cash management and payment businesses is being offset at this stage of the rate cycle by increased deposit compensation. We are less focused on quarterly fluctuations in revenue from this offering than we are in ensuring we are adding primary banking relationships consistent with our long-term plan. Wealth management income increased 8% quarter-over-quarter, as assets under management grew 6%, resulting from market changes, net new inflows, and some additional rotation from existing commercial and private wealth clients and manage liquidity options. Managed liquidity now represents approximately 25% of AUM, up from less than 5% a year ago. Taken together, fee income from our areas of focus increased by approximately $16 million or 70% year-over-year, representing the early stages of client adoption across the set of capabilities tailored for our clients' evolving needs. Total revenue increased $5 million linked quarter, as the $3.3 million decline in net interest income was more than offset by improving noninterest revenue. As expected, despite seasonally strong warehouse loan growth, net interest income was pressured by industry-wide increases in overall deposit costs. Total revenue increased $46.2 million or 20% compared to Q2 2022, with year-over-year results benefiting from a 76% increase in noninterest income, coupled with disciplined balance sheet repositioning into higher-earning assets. Total noninterest expenses declined 6.4% linked quarter, as structural efficiencies associated with our go-forward operating model began to reflect in the income statement. Taken together, quarterly PPNR increased 43% year-over-year to $96.4 million, the high point since we began this transformation in Q1 of 2021. Net income to common was $64.3 million for the quarter, up $34.5 million year-over-year, while earnings per share increased $0.74, marking the highest level in two years, adjusted for our divestiture. Preparation for an inevitable normalization in asset quality began in 2022, as we steadily built the reserve necessary to address both known legacy concerns and align balance sheet metrics with our foundational objective of financial resilience. We recognized $8.3 million in net charge-offs during the quarter, reducing nonaccrual loans to 28 basis points of total assets. This quarter's provision expense of $7 million accounts for the modest increase in criticized loans, as well as quarterly loan growth predominantly related to mortgage finance, which garners proportionately lower reserve rates. Quarterly performance metrics continued their steady progression towards target financial outcomes, with quarterly return on assets and return on tangible common equity of 0.95% and 9.17%, respectively, both more than double the levels observed in the second quarter of last year. Our balance sheet metrics remain strong, with the end-of-period profile reflective of continued execution of our set of core objectives. Gross LHI balances increased by $1.3 billion or 6% linked quarter, driven by predictable seasonality in the mortgage finance business and modest increases in commercial real estate, which is experiencing lower levels of prepayment activity. Deposit balances increased 5% or $1.1 billion in the quarter. Consistent with previous guidance, deposit and loan growth were likely to more closely mirror each other in the near term after significant loan growth in Q1. As a result, the period-end loan-to-deposit ratio remained flat linked quarter at 91%, and down from 95% in the second quarter of last year. Cash balances moderated to 10% of total assets as outstanding FHLB borrowings declined by $750 million, now below historically observed levels representing one component of our ample contingent liquidity. As we detailed on the January earnings call, we have rebuilt nearly every process and procedure across the firm. As a result, in the second quarter, changes were made to certain estimates used in the Company's CECL model. The most significant of which are more granular estimates of historical loss rates to incorporate probability of default, loss severities, and allocations of expected losses to outstanding loan balances and off-balance sheet financial instruments. These changes resulted in adjustments to the Company's portfolio segments, including the introduction of the consumer category and a reallocation of the allowance for credit losses between loan portfolio segments and the allowance balances allocated to off-balance sheet financial instruments. The changes to estimates used in the Company's CECL model result in a higher allocation of losses to off-balance sheet financial instruments as reflected in the $24 million decline in the ACL loans. On a combined basis, however, total ACL inclusive of off-balance sheet reserves remained relatively flat compared to the prior quarter. Finally, the increase in interest rates resulted in an AOCI decline of $65 million, which is nearly offset by net income to common and resulted in tangible book value share of $57.93. Total LHI, excluding mortgage finance, increased $213 million or 1.43% for the quarter and is now up $1 billion or 6.8% for the year. After expanding 8% in Q1, commercial loan growth moderated this quarter, declining $126 million or 1%, as both clients and the industry reset expectations for capital costs and its impact on credit demand. Commercial loan growth over the past four quarters has added $1.4 billion of client balances consistent with our strategy, an increase of $0.15 when adjusted for divested loans. This capital previously attributed to loan-only relationships and the insurance brand finance business continues to be recycled into a client base that benefits from a broadening platform of available product solutions delivered within an enhanced client journey. Overall, requests for capital extensions continue to come primarily from new and expanded relationships, as utilization rates remain constant quarter-over-quarter at 51%. Our balance sheet committee trends indicate that while volume has declined from the year-ago period, the proportion of new activity that includes more than just the out has increased substantially over the last two years to over 95% for the first six months of the year. This is further evidence of our ability to bring increasingly comprehensive solutions to our clients in any economic environment, throughout their corporate life cycle. Period-end real estate balances increased $358 million or 7% in the quarter. We continue to experience the expected but still material slowdown in payoff rates off recent record highs. Our clients' new origination volume also slowed in recent quarters but remains focused on multifamily, reflecting both our deep experience in the space and observed performance through credit and interest rate cycles. Only 12% of the real estate portfolio had a maturity date in 2023, while over 58% of the portfolio matures in 2025 or later. Our exposure to at-risk asset classes is limited, with office exposure of $460 million, approximately 9% of the total commercial real estate portfolio. The office book has solid underwriting with a current average LTV of 57% and 89% recourse, as well as strong market characteristics, with over 75% being Class A properties and over 71% located in Texas. Average mortgage finance loans increased $1.1 billion or 33% in the quarter, as the seasonality associated with spring homebuying 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 $1.6 trillion in trailing 12-month originations. Overall, market and volume estimates from professional forecasters suggest total market originations to decrease modestly in the third quarter, with full-year expectations still showing a decline of more than 30% in origination volume. Consistent with historical performance, we expect to maintain our outperformance margin of about 25% as we remain confident in our ability to successfully serve this industry. In line with expectations communicated last quarter, total ending period deposits increased 5% quarter-over-quarter, with changes in the underlying mix reflective of both a continued funding transition and a tightening rate environment, coupled with market-driven trends and predictable seasonality. Total noninterest-bearing deposits remained stable quarter-over-quarter, with the proportion of total deposits decreasing modestly to 40% from 42% at year-end. The underlying composition, however, continues to shift. As expected, mortgage finance noninterest-bearing deposits increased $884 million or 20% quarter-over-quarter, alongside higher loan balances as we remain focused on holistic relationships with top-tier clients in the industry. Average mortgage finance deposits were 120% of average mortgage finance loans at the high end of our guidance of between 100% and 120% due to the impacts of decreased mortgage originations. Other noninterest-bearing deposits declined $955 million or 19%, in part due to the previously described trends whereby select clients shifted excess operating account balances to interest-bearing deposits, including insured cash sweep or to other cash management options on our platform. While the pace of rotation is slowing, we do expect a portion of our total deposits comprised of noninterest-bearing, excluding mortgage finance, to continue to decline in the near term. These behaviors, coupled with the continued realization of additional interest-bearing deposits through business channels aligned with our strategy, resulted in a 10% linked quarter increase in total interest-bearing deposits. The pace of our proactive repositioning away from index deposit sources has slowed as balances are now aligned to clients consistent with our strategy and at 6% of total deposits, well inside our published 2025 threshold of 15%. Including the $195 million reduction experienced this quarter, these balances are now down over $8.5 billion since year-end 2020. During the quarter, we began prefunding a portion of the $499 million of brokerage CDs maturing during the third quarter. We maintain ample broker capacity and while always evaluating future liquidity composition consistent with established balance sheet management priorities, we anticipate that brokerage CDs will remain relatively flat during the third quarter. Our expectation remains that we will be able to grow client deposits by a continued elevated marginal cost, given the material change in market conditions experienced over the last four months. As expected, our earnings at risk decreased this quarter to 2.6% or $26 million in a plus 100 basis point shock scenario, and minus 3.8% or $39 million in a down 100 basis point shock scenario, as a result of both increased funding costs and proactive measures taken earlier in the year to achieve a more neutral posture at this stage of the rate cycle. There were no new security purchases in the quarter, as we continue to believe holding levels equivalent to 15% of total assets is an efficient and prudent portion of our liquidity asset composition at this time. The core component of our naturally asset-sensitive profile remains the large portion of our earning asset mix that reprices with changes in short-term rates. 93% of the total LHI portfolio, excluding MFLs, is variable rate, with 91% of these loans tied to either prime or one-month index. Net interest margin decreased by 4 basis points this quarter and net interest income declined $3.3 million, predominantly due to a decline in interest-earning assets and higher quarter-over-quarter deposit costs, partially offset by increased average loan balances and improved loan yields. Our multi-quarter business model transformation and associated platform build is directly intended to lessen our dependence on these inevitable fluctuations in rate-driven earnings. Sustained execution on noninterest income initiatives will enable revenue stability even should near-term net interest income expansion moderate. Further, the systemic realignment of our expense base with strategic priorities is beginning to deliver the expected efficiencies associated with a rebuilt and more scalable operating model. We expect to see continued contraction in quarterly noninterest expense over the remainder of the year, which when coupled with revenue stability resulting from strong execution on behalf of our clients will enable core earnings expansion despite the market backdrop. Criticized loans increased $58.2 million or 10% in the quarter to $619.3 million or 2.9% of total LHI, as increases in special mention real estate loans offset a $22 million reduction in criticized commercial loan credits. The composition of criticized loans continues to be weighted toward commercial clients reliant specifically on consumer discretionary income, plus a handful of well-structured commercial real estate loans supported by strong Texas-based sponsors. We've previously communicated that we anticipated manageable real estate migration beginning in the middle of this year. And based on our economic outlook, we believe our client selection and underwriting guidelines provide adequate protection against realized loss. Detailed credit reviews, a credit risk practice implemented during the pandemic, continued to occur quarterly, whereby the line of business leads and their credit partners conduct a series of reviews on a name-by-name basis. Additionally, during the second quarter, executive management hosted enhanced credit review sessions in middle market and corporate, resulting in a review of over 50% of the commitments in these verticals. Since late March, specific reviews have also been conducted on asset classes or industries, including office, multifamily, homebuilder, contractors, beverage distributors, and Software as a Service. The results of these reviews are reflected in the migration trends, both inflows and outflows, in special mention and substandard loans this quarter. We have previously commented on the portion of legacy loans still on the balance sheet, consistent with current client selection and our underwriting principles, that will be resolved through maturities, workouts, or select charge-offs. During the quarter, we recognized net charge-offs of $8.2 million against this identity portfolio and have now reduced total exposures by over 55% to approximately $100 million of book balances since early 2022. These actions, coupled with negligible new inflows into the category, supported a $12.9 million reduction in nonperforming assets during the quarter and an improvement in our ACL coverage to 3.5 times. The total allowance for credit loss, including off-balance sheet reserves, was relatively flat on a linked-quarter basis at $282 million or 1.32% of total LHI at quarter end, up over $35 million or 29 basis points year-over-year in anticipation of a more challenging economic environment. Total regulatory capital remains exceptionally strong relative to the peer group and in our internally assessed risk profile. During the quarter, $75 million of the original $275 million mortgage warehouse-related credit-linked notes were partially paid down, as mortgage industry volumes and related credit protection eligible balances have declined significantly since the note was issued in early 2021. This reduction in note balance was neutral to CET1, and at current interest rate levels saved the firm $0.02 of interest expense in the second quarter or $7.9 million on an annualized basis. We remain focused on managing the hard-earned capital base in a disciplined and analytical manner, focused on driving long-term shareholder value. Our guidance accounts for the market-based forward rate curve, which now assumes Fed fund reaches 5.5% this quarter and remains there through year-end. Changes in anticipated system-wide funding costs and slower net interest income expansion were specifically cited in our revenue guidance update last quarter. Our outlook for low double-digit percent full-year revenue growth remains unchanged. As evidenced by this quarter's results, the significant investments made over the last two years are yielding expected operating and financial efficiencies that will continue contributing to profitability in the second half of the year. Our noninterest expense guidance also remains unchanged, and we believe the current consensus expense estimates are achievable. Together, these expectations should result in the maintenance of operating leverage, defined as year-over-year quarterly PPNR growth. Finally, we are committed to maintaining our strong liquidity and capital positions, and our intent remains to hold greater than 20% of our total assets in cash and securities and to exit the year with a CET1 ratio of at least 12%. I'll hand the call back over to Rob for closing remarks.

Rob Holmes, President and CEO

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

Operator, Operator

Our first question comes from Michael Rose from Raymond James. Michael, please go ahead. Your line is now open.

Michael Rose, Analyst

Maybe we can begin with expenses. You just mentioned it, Matt. I understand there have been some changes regarding headcount and related aspects. Could you provide an update on your staffing expectations and highlight areas where you would like to add personnel opportunistically? I know some details are in the slide deck, but I would appreciate some overarching insights.

Matt Scurlock, CFO

Yes. You bet, Michael. So the quarter-over-quarter noninterest expense was down 6% after normalizing for the $7.5 million in seasonal expenses in the first quarter, moving to about a 3% linked quarter decline. You'll recall that the structural efficiencies we announced on the April call had been enacted in the weeks just prior. So we made certain to note that it would take until the third quarter before we see the full run rate reductions flow through salaries and benefits. The only items that I would flag that could potentially increase salaries and benefits of that run rate would be remaining items on our near-term investment banking road map, which now that we have the infrastructure built out, should deliver revenue in excess of any marginal cost inside approximately 12 months. For all other noninterest expenses, our expectation is still that remains between $65 million and $70 million. The higher end of that range continues to be potentially driven by increased spend associated with deposit gathering, which we would more than offset with higher revenues.

Rob Holmes, President and CEO

Now I just add, Michael, a subjective comment actually a factual comment that what I'm most excited about, maybe more than anything else at this point of the build is that we have high-quality people in place. Everything is built. We have stability. For the first time, we have the entire team on the field. We may add, like Matt said, one or two different capabilities, which require more, but the build is complete, the seats are filled, and we're really, really happy with who's here.

Michael Rose, Analyst

That's very helpful. If we step back for a moment, Rob, I recall that this goes back a couple of years when you established the initial targets. Considering the progress you're making, it seems there is increased confidence in meeting and possibly exceeding those targets. Given the changes in the world and the different businesses you're involved in now compared to when you set those targets, can you clarify if those targets are still valid and if the timeline aligns with your original expectations?

Rob Holmes, President and CEO

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

Michael Rose, Analyst

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

Rob Holmes, President and CEO

Yes. Look, the answer is the same. We have a very, very complex decision tree on which we determine distribution policy. Right now, a dollar investment in business generates a much greater return than buying back shares even at book value for future benefit of our shareholders. If that changes, we have plenty of capital liquidity to where we could buy back. But right now, we're just so pleased with the plan and our progress that that's the best use of capital.

Operator, Operator

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

Brett Rabatin, Analyst

Appreciate the questions. I wanted to first talk about Investment Banking. And last quarter was obviously a good quarter for investment banking, and this quarter was even better. So I just wanted to hear what the pipeline looks like from an investment banking perspective. Do you expect continued momentum in the back half of the year related to that line item?

Rob Holmes, President and CEO

Yes, Brett, thanks for the question. Look, we're really excited about the platform that we built. The flywheel is just starting to take hold. The investment bank and the connectivity with the rest of the platform has been exceptional. The cross coordination with clients in private wealth, commercial banking, corporate banking, and mortgage business has greatly improved. We're further along in our maturity than I could have hoped for. The pipeline is broad, diverse, and granular. It's literally coming from all components of the investment bank, whether it's sales and trading, M&A advisory, capital markets, or capital solutions. We're very encouraged and look forward to continued solid performance in the third and fourth quarter.

Matt Scurlock, CFO

Brett, the only thing I'd add to Rob's comment in his script, which I think is worth reviewing in detail, is that the capabilities on that platform are enabling us to solve different problems for our clients at various points in the market rate cycle. In Q1, the revenue was largely driven by syndication revenue as we helped clients access markets via running their credit facilities. In the second quarter, a lot of that revenue shifted to more capital solutions as we help clients hedge their own rate risk and deliver advisory services. The contributors to that income, to Rob's point on the pipeline, are very much going to change from quarter to quarter. However, it enables us to deliver exceptional outcomes for our clients, regardless of what the need is.

Brett Rabatin, Analyst

Okay. That's really helpful. And then I want to just talk about funding for a second. And I think one of the challenges the banks face has been declining DDA as clients move funds to interest-bearing sources. You could make a case that maybe your DDA is finally bottoming here with operational accounts. Would that be a fair assessment, do you think? Or maybe there's some additional migration in that bucket?

Rob Holmes, President and CEO

Brett, let me just make one quick comment that I think is really important, and I'll let Matt answer your question specifically. We are totally agnostic to where the client is on our balance sheet, whether they're in a DDA account or they move to AUM to manage liquidity because they may be moving out of the DDA, but they're staying on our platform. They're not leaving the firm. And so, we're here to solve client needs, and over time, both we and the client will benefit. It's important to point out that nobody is leaving the firm; they're just relocating to different products and services. Sorry, Matt, go ahead.

Matt Scurlock, CFO

No. Thanks for calling that out. We're obviously quite pleased to have a suite of cash management products and infrastructure to support that client rotation at this point. Our view embedded in the guidance is that the rotation does start to slow. We're modeling commercial noninterest-bearing to end just south of 15% as we exit the year. We think it's extremely important to balance any sort of near-term impact on financial performance, as we are in the middle of a multi-year transformation of the deposit base. The activities today, like the 12% growth in year-over-year gross payment revenue or the fact that our treasury pipelines in the third quarter are up 50% relative to the second quarter, indicate how today's activities are driving financial outcomes in '24 and '25.

Operator, Operator

Thank you. We'll now take our next question from Stephen Scouten from Piper Sandler. Stephen, your line is now open. Please go ahead.

Stephen Scouten, Analyst

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

Rob Holmes, President and CEO

Yes. A lot of that is from the treasury onboarding, and 90% of that is now done digitally through our new Initio platform, which I take is market receptor leading, providing a super simplistic way to onboard a commercial client. The client journey is much improved and more efficient. I'm really excited to have that up and running. That's for new clients and also clients expanding their relationships with us on the platform, which is new to this quarter as well. I think it's broad-based. We've had new clients on the platform in capital markets, which has become increasingly busy. The capital solutions, treasury, and private credit are all areas driving new clientele. It's very broad and not confined to one segment or product.

Stephen Scouten, Analyst

Okay. Great. Very helpful. And then I appreciate the commentary about being somewhat agnostic about where the customer sits on the balance sheet. But that presents a pretty significant near-term profitability headwind. So, I'm curious about the 110 ROA target. It's pretty ambitious and will take a lot of heavy lifting. How do you get there near-term in light of that specific headwind and its impact on profitability?

Matt Scurlock, CFO

We're at a little bit of a hard time here, Stephen. So if I answered the wrong question, please feel free to rephrase. We believe a normalized through-cycle provision of about 40 basis points of loans, excluding mortgage finance, would require us to push PPNR to average assets from the $133 million delivered this quarter to closer to $165 million to $170 million. That's around $20 million or so of PPNR each quarter on the same size balance sheet to start to bring that 1/1 into sight. To Rob's earlier comments, we think the breadth of our platform gives us a variety of paths to get there, which would include continued expansion of fee income, continued realization of structural efficiencies enacted in April, and we'll get more specific on the relevant components driving that outcome next year.

Stephen Scouten, Analyst

Okay. Great. That's helpful. And maybe just one last thing for me. Any update on approximately $130 million in legacy loans that maybe weren't as high quality as what you put on over the last few years? Did that drive any increase in the criticized assets?

Matt Scurlock, CFO

Yes, great question. When we started the journey, the number was just north of $200 million. It's now down to $100 million. About $30 million of that has been driven through charge-offs, including the charge this quarter. The remainder has been driven by maturity, restructure, and refinance out of there. That did not drive the pickup in special mention credits this quarter. That was largely driven by C&I commercial real estate clients consistent with our go-forward strategy. As we mentioned in our commentary, we expected early-stage migration in commercial real estate to begin in the middle of this year. We're not surprised to see that, and we are confident in our client selection as well as the underwriting characteristics that support those credits.

Operator, Operator

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

Brady Gailey, Analyst

Good morning, guys. I wanted to ask again about investment banking and trading. As I look at that line item, the growth has been incredible over the last few quarters; it went from $8 million to $12 million to $19 million, now over $27 million in the second quarter. When you step back and look at that business, what do you think is the right goal for annualized revenue? If you annualize Q2, you hit over $100 million in revenue there. What's the potential for that business over time?

Rob Holmes, President and CEO

Yes, look, I think the guidance was 10%. We'll stick with that guidance for now, but I'll just expand a little on why we're so confident in that business. First, this quarter was another great quarter, with firsts across various areas including our first IPO, our first convertible bond trade, and the closing of our first sell-side M&A advisory fee. We launched our TS and the funds management vertical, originated our first warehouse to securitization facility, onboarded our first gestation balances, and settled the first pool trade. There's just a lot of firsts coming out of the ground for a platform where we have already incurred the expense. A couple of years ago, we had a small TF client, and we weren't the primary bank. We eventually won the primary banking relationship through a loan from a lending-centered bank. That middle market banker referred that principle to the private wealth business and then a little later, the private wealth banker referred them to our M&A team, resulting in the first M&A sell-side engagement we just did. That's the power of this platform. TF, full wallet, commercial bank, middle market banking client leading to private wealth, and then the business sale. That’s why we're confident we'll hit our targets and maintain them.

Operator, Operator

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

Matt Olney, Analyst

I just want to stick with that same discussion on the investment banking line. I'm trying to understand how lumpy this item can be in the future. Any color on the granularity within this line for some specific events? Just trying to gauge the potential for volatility in that line as you continue to ramp this up?

Rob Holmes, President and CEO

I appreciate the question because Matt and I were alone in this board room talking about the strategy. I told Matt that when we say we're going to start investment banking, people are going to think we're crazy. They won't think it will work, then it will work, and they'll complain about the inconsistent earnings of it. Here we are. So the real answer here is that it's granular. It's driven by all components of the investment bank. To Matt's point, the mix will shift quarter to quarter based on the economic environment. Remember, we're outperforming and doing really well right now, despite minimal issuance by any corporate company. The breadth of our platform means the mix can shift so clients never have to leave us to get what they need done. The sophistication of the advice we provide clients demands that premium for other products and services. Therefore, if we discuss a swap or a sell-side engagement, and they don’t proceed with that, they generally reward us over time with treasury or another type of business. It's not just the fee that the investment bank earns; it's the connection between the rest of the firm and the investment bank. And by the way, it works both ways; the Investment Bank is acquiring business because our commercial bankers have credibility with their clients over time.

Matt Olney, Analyst

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

Matt Scurlock, CFO

Yes. I’d see the high end of that range largely staying intact, Matt. We really like the industry. We've invested in expanded product offerings. We feel we're banking top-tier clients in the space, and they want a place to move their treasury and their deposits, and we're pleased to provide that. We’re still looking at a declining trend in the industry, which we projected at about 30%. If we were $5.3 million last year on full-year average warehouse balances, you can look for that to be somewhere in the low 4s. So, I think you'll see that phenomenon play out through the back half of the year. There are components of those balances that are compensated for the mortgage warehouse yield, so as loan volumes decrease, the yield may also decline while deposits remain flat or grow. So that's a consideration we're modeling out.

Operator, Operator

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

Zach Westerlind, Analyst

It's Zach on for Brady. I just wanted to get your outlook for loan growth, if that's possible? And what are some key drivers?

Rob Holmes, President and CEO

I'm sorry, operator. We can barely hear for some reason. Would you mind repeating? Loan growth, so look, I'll touch on it. Loan growth was materially less this quarter, as Matt said. As I've always said since we started the journey two-plus years ago, this is not a loan growth story. Remember, a primary focus of ours is recycling capital while resolving complex solutions or needs for our clients. Even with low loan growth, remember a 30% increase in new clients. We are active in various ways, whether we engage through loans, treasury, capital solutions, private wealth, mortgage finance, or wherever they may end up on our platform. I do think loan growth across the entirety of the economy is down; we are no exception. People are a little more cautious today than they were in the past, and I believe the spending on CapEx has also slowed due to cost and confidence, which is why the strength of our platform is increasingly crucial. Great. Operator, thank you very much to everybody for dialing in and your continued interest in Texas Capital and our transformation story. We look forward to talking to you next quarter.

Operator, Operator

This concludes the conference call. Thank you very much for joining. You may now disconnect your lines. Have a lovely rest of your day.