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Texas Capital Bancshares Inc. (TCBI - Analyst Report) has reported second quarter 2011 operating earnings of 44 cents per share, which came in well ahead of the Zacks Consensus Estimate of 36 cents. The results were, however, well above the prior-year quarter’s earnings of 22 cents per share.

Quarterly results benefited from an increase in net interest income. However, lower non-interest income and higher expenses were the dampeners.

Behind the Headline Numbers

Texas Capital’s net interest income was $71.1 million, up 23% from the year-ago quarter. The increase stemmed from a spike of $496.2 million in average earning assets over the year-ago level. Total loans increased 15% while deposits were 10% more than the prior-year period.

Net interest margin increased 40 basis points (bps) sequentially and 54 bps year over year to 4.86%. Growth in loans and a reduction in funding costs led to the sequential as well as year-over-year growth in interest margin. This was also supported by an improvement in loan spreads.

However, Texas Capital’s non-interest income was $8.0 million, down 1% year over year. The decline stemmed from lesser equipment rental income due to the continued decrease in the leased equipment portfolio, partially offset by an increase in brokered loan fees and small increases in various categories.

Additionally, Texas Capital’s non-interest expense increased 16% year over year to $45.3 million. The growth reflects higher salaries and employee benefit expenses primarily due to business expansion.

Moreover, the company reported higher allowance and other carrying costs pertaining to real estate owned assets, and an increase in expenses for marketing activities, legal and professional activities as well as for communications and technology from the prior-year quarter.

Credit Quality

Credit metrics were mixed during the quarter at Texas Capital. Net charge-offs increased to $10.5 million from $9.0 million in the prior quarter but fell from $12.6 million in the year-ago quarter.

Net charge-offs as a percentage of average loans on a trailing 12-month basis were 1.06%, down 5 bps sequentially but up 33 bps year over year. Provisions for credit losses were $8.0 million, slightly up from $7.5 million in the prior quarter but down from $14.5 million in the year-ago quarter.

However, non-accrual loans at Texas Capital were $77.9 million or 1.51% of loans held for investment at the end of the reported quarter, down from $116.5 million or 2.47% at the end of the prior quarter and $138.2 million or 3.10% at the end of the year-ago quarter.

Non-performing assets reported both sequential and year-over-year decline and equaled 2.03% of the loan portfolio plus other real estate owned assets, reflecting 98 bps sequential and 197 bps year-over-year drops.

Capital Ratios

Capital ratios were mixed in the quarter. While Texas Capital’s Tier 1 capital ratio was 10.2%, down 100 bps sequentially, leverage ratio was 10.5%, up 20 bps sequentially.

Our Take

For Texas Capital, which has peers such as First Financial Bankshares Inc. (FFIN - Snapshot Report) and Cullen/Frost Bankers Inc. (CFR - Analyst Report), the business model remains a key driver for growth. Additionally, the gain in market share from its competitors and organic growth augur well.

However, Texas Capital continues to experience an increase in expenses. Though the company’s efforts to hire experienced bankers and expand its presence are encouraging, the resultant expenses, which continue to grow nearly as fast as revenues, negate the incremental effects of business expansion. While credit quality metrics showed some improvement in the quarter, we believe a significant turnaround will remain elusive in the near term.

Texas Capital shares retain a Zacks #2 Rank, which translates into a short-term Buy recommendation.

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