Third Coast Bancshares, Inc. (TCBX) Earnings Call Transcript & Summary

Greetings, and welcome to the Third Coast Bancshares' Second Quarter 2023 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Natalie Hairston, Senior Vice President, Dennard Lascar, Investor Relations for Third Coast Bancshares. Thank you. You may begin.

Thank you, operator, and good morning, everyone. We appreciate you joining us for Third Coast Bancshares conference call and webcast to review our second quarter 2023 results. With me today is Bart Caraway, Chairman, President and Chief Executive Officer; John McWhorter, Chief Financial Officer; and Audrey Duncan, Chief Credit Officer. First, a few housekeeping items. There will be a replay of today's call, and it will be available by webcast on the Investors section of our website at ir.tcbssb.com. There will also be a telephonic replay available until August 3, 2023, and more information on how to access these replay features was included in yesterday's earnings release. Please note that information reported on this call speaks only as of today, July 27, 2023, and therefore, you are advised that time-sensitive information may no longer be accurate as of the time of any replay listing or transcript reading. In addition, the comments made by management during this conference call may contain forward-looking statements within the meaning of the United States federal securities laws. These forward-looking statements reflect the current views of management. However, various risks, uncertainties and contingencies could cause actual results, performance or achievements to differ materially from those expressed in the statements made by management. The listener or reader is encouraged to read the annual report on Form 10-K that was filed on March 15, 2023, to better understand those risks, uncertainties and contingencies. The comments made today will also include certain non-GAAP financial measures. Additional details and reconciliation to the most directly comparable GAAP financial measures were included in yesterday's earnings release, which can be found on the Third Coast website. Now I would like to turn the call over to Third Coast Chairman, President and CEO, Mr. Bart Caraway. Bart?

Thanks, Natalie, and good morning, everyone. Thank you for joining us today. I'll begin by highlighting the company's performance for the second quarter. John will then provide a more detailed financial review, and Audrey will give a credit update. Then before we take your questions, I'll return to discuss our outlook. As reported in yesterday's press release, our second quarter results demonstrate Third Coast's ability to maintain strong credit quality, faster than peer balance sheet growth and improving margins. Despite macro pressures, nonperforming assets to total assets were 25 basis points, the same as the prior quarter and down from 33 basis points in the second quarter of 2022. Total assets reached $3.96 billion, which was 2.7% more than the first quarter of 2023 and 18% over the prior year quarter. Loans held for investment grew to $3.33 billion, which was 3.8% higher sequentially and 21.3% more than a year ago period. Deposits reached $3.41 billion, 2.6% over the prior quarter and 17.6% more than the same period last year. Finally, net interest margin improved 3 basis points from the prior quarter and 5 basis points from last year to a strong 3.82%. We are also pleased with the increase in tangible book value to $22.82. A positive sign for investors and customers alike. This achievement shows Third Coast's strong financial footing and is well positioned for the current market environment. Third Coast's capital position remains strong with tangible common equity to tangible assets increasing slightly to 7.88%. By prioritizing customer satisfaction and operational confidence, we have established ourselves as a dependable financial institution. The excellent leadership and strong credit quality of the company further reinforces our position in the industry. With that, I'll turn it over to John for a more detailed financial review. John?

Thank you, Bart, and good morning, everyone. We provided the detailed financial tables in yesterday's earnings release. So today, I'll provide some additional color around select balance sheet and profitability metrics from the second quarter. As Bart mentioned, second quarter loans were up 3.8% or $121 million sequentially. Deposits increased $86 million over the first quarter and total assets reached $3.96 billion, a new record for the company. For the same period, our net interest margin improved 3 basis points quarter-over-quarter and 5 basis points year-over-year to 3.82%. This improvement was primarily due to increased loan yields. We remain slightly asset-sensitive with new business being added at lower spreads, resulting in a slight drag on the net interest margin. Going forward, loan growth is expected to offset margin pressures resulting in increases to net interest income. On May 26, we unwound our $200 million pay-fix law, realizing a gain of just over $5 million. This gain will be accreted over 5 years as an offset to interest expense. Based on this quarter's average interest-bearing deposits, the offset is equivalent to 38 basis points. Combined with our 2 previous unwind, we have almost $9 million and gained equivalent to 70 basis points. At quarter end, our uninsured deposits totaled approximately $1 billion or 30%. Our available borrowing lines are approximately $1.7 billion, resulting in a coverage ratio of 1.7:1. Noninterest expense totaled $23.8 million for the second quarter of 2023 compared to $22 million for the first quarter of 2023. As anticipated, increases from new branches, new employees and inflation have resulted in slight increases in noninterest expense. I think for the remainder of 2023, noninterest expense will be in the range of $24 million. Net income available to common shareholders totaled $7.7 million for the second quarter compared to $8.1 million for the first quarter. Diluted earnings per share were $0.53 in the second quarter compared to $0.55 in the first quarter, a slight decrease of 4%. This performance resulted in returns on average assets of 96 basis points and returns on average common equity of 9.44%. Additionally, our pretax pre-provision ROA was approximately 1.35%. That completes the financial review and at this point, I'll pass the call to Audrey for our credit quality review.

Thank you, John, and good morning, everyone. Credit performance for the second quarter was again strong. Nonperforming assets to total assets was 25 basis for the first and second quarters of 2023, down 8 basis points from 33 basis points for the second quarter of 2022. Nonperforming loans to loans held for investment remains low at 30 basis points, which decreased 10 basis points from 40 basis points as of the prior year period. We adopted the CECL methodology beginning January 1, 2023, and under the new methodology, we recorded a loan loss provision of $1.4 million during the current quarter compared to $1.2 million for the first quarter of 2023 and $3.4 million for the second quarter of 2022. During the second quarter of 2023, our ACL increased from $35.9 million to $37.2 million. The ACL to total loans was 1.12% up from 97 basis points for the same period last year. During the 6 months ended June 30, 2023 and 2022, the company recorded net recoveries of $292,000 and $21,000, respectively. With that, I'll turn the call back to Bart. Bart?

Thanks, Audrey. As we progress through the third quarter in the second half of the year, Third Coast remains vigilant about executing on the following internal and external objectives. First, managing the balance sheet in a conservative fashion, growing deposits to fund loan growth and continuing to enhance liquidity. We have been able to take advantage of higher rates in the face of rising deposit costs to stabilize the net interest margin. We feel like our performance towards these objectives has been very solid. Second, pursuing growth amid the current economic climate. Despite fluctuating market conditions, we continue to be optimistic given our strong credit position and our ability to invest with confidence in our growth strategy. Our strong capital position and solid asset quality positions us to endure and perform through the coming market cycles. Third, discipline around expense growth and efficient capital allocation. Management is constantly tasked with improving efficiency. In that regard, we are exiting our Auto Finance division. Direct expense savings will be $500,000 plus and the $40 million in loans will be reallocated to higher earning assets, managing the asset allocations to maximize our balance sheet return. Fourth, our commitment to quality and innovation. By maintaining our strong credit culture and finding innovative ways to build out service and product capabilities is strategically important to stay ahead of our competition. And finally, we understand the importance of customer service and satisfaction. Our success in attracting, retaining and even connecting with customers has been a testament to our commitment to the satisfaction. By continuing to listen to their needs, we can maintain our loyal customer base, we believe in relationship banking and diversified lending. Overall, we are well positioned to face any challenges that may arise and continue to provide value for our shareholders by staying focused on our core beliefs and listening to our customers, we can navigate through any softening in the growth expectations and emerge stronger on the other side. This concludes our prepared remarks, and I'd now like to turn it back over to the operator to begin the question-and-answer session.

[Operator Instructions] Our first question comes from the line of Graham Dick with Piper Sandler.

So I just wanted to start on the loan growth side of things. I think last quarter, we had talked about doing about $300 million to $400 million of loan growth this year. It seems like you guys are a little bit ahead of schedule over the last 2 quarters. Just wanted to get any updates on your all's color around what you're looking at for growth this year on the loan side. And I know you mentioned that you're still pretty confident in your own strategy. So if there's any upside to that initial guidance would be interesting to hear?

Graham, I appreciate that. You actually teed that up for me because I did want to bring that up. So what we're looking for the rest of the year is probably $100 million to $200 million in net growth from now to the end of the year. I think that's probably more accurate with where we're seeing in terms of just the environment that we're in, and we're just being very selective on the loan side. We are seeing a lot of great customers coming to us, but we're also being very selective of what meets our criteria. So I think $100 million to $200 million is probably the best number I can give you in that range that we'll see between now and the end of the year.

Yes. And Graham just to add to that. I think we mentioned last quarter that loan growth has been somewhat limited by what we can raise in deposits so we obviously don't want to outstrip our deposit growth that we think we could be growing even faster if we weren't more disciplined on rate, but there's lots of good business out there. Last couple of months have been pretty strong, but we're going to be mindful of credit and rates and deposit growth, and that will limit the growth a little bit for the rest of the year.

Okay. That's a perfect segue. So I guess, I mean you pretty answered to that, but it sounds like you expect deposit growth in the pipeline you guys have to pretty much match net growth for the rest of the year, I guess. Is that fair to assume?

Correct.

Okay. Great. And then I kind of just -- I wanted to follow up on the swap -- this decision to sell a swap and the impact that's going to have on the margin. Did you say that there's 38 basis points of impact for lower deposit costs going forward from that the amortization of that gain from $5 million and then $70 million from the $9 million in total you guys have?

Correct. Although that is included in the second quarter, that's not additionally to where we are. I mean, that's fully reflected in the second quarter, but that is the net effect. If we did not have those swap gains, we would be that much worse off. So for the second quarter, we only had one full month where we were paid in the swap. We were paid $280,000 for the month of April. And going forward, we will have for that particular trade about $85,000 a month. So we had a little excess -- not exactly accretion, but the swap income for the quarter, but most of the rest of it was baked in.

Okay. I appreciate it. And then the last thing for me, I guess, would be just on the direction of the overall margin. You said you expect a little more pressure here over the next couple of quarters, it sounds like. Do you guys have like I guess, an amount of pressure you are expecting? I know you kind of hit the nail on the head this quarter with your guidance last quarter saying it was going to be up a couple of basis points. So if there's any color you can provide on what you're expecting in terms of pressure in the back half of the year, that would be helpful?

Yes, the market is not making it any easier on us. I mean the fact that rates went up today certainly helps us. We are still asset sensitive. Should rates start coming down, I mean, the swap income that we have is going to be great protection for rates going down. We had mentioned that new deals that we're putting on the books are at slightly lower spreads. So I think for the quarter, we averaged about 7.5%, so that should go up to somewhere between 7.75% and 8%. So a lower spread based on marginal cost of funds. But kind of best guess is this was the max margin for us for this cycle that will probably come down, I don't know, maybe 5 basis points this quarter is kind of a best guess. But I do think that the balance sheet growth will offset that so that our net interest income is actually up versus this quarter. And if you look back over the last year, our net interest income has been up about $1 million every quarter. So over the last 4, we've gone literally $31 million, $32 million, $33 million, $34 million. We probably won't be up $1 million this next quarter, but I do think the growth will offset any decline in margin.

I appreciate it. It's very helpful.

Our next question comes from the line of Bernard Von Gizycki with Deutsche Bank.

You have a nice sequential increase in fees driven by pickup and derivative fees. Can you just talk to the activity you're seeing and any expectations in the second half of the year?

Yes. So those fees Bernie are totally separate from the balance sheet swap that we did. These are customer derivatives and you wouldn't think at this point in the cycle that, that would have as much appeal to customers, but there are still some that worry about rates going up, and those can be very profitable transactions when we do them. I wouldn't necessarily expect any going forward just because we are likely close to the highs in rates, but we do have the occasional customer that decides they want [indiscernible]. We're happy to help them where we can.

Got it. That's helpful. And then maybe just separately, I think you guys had a recent press release, you noted partnering with Mayfair to provide up to $50 million enhanced FDIC insurance on cash accounts. So I believe at [ 3/31 ] you had $932 million in uninsured deposits, which was about 28% of total deposits. I'm just curious, any updates to this and comments on the service you're providing for clients are the costs mostly incurred by clients to get this enhanced insurance? Or is there some sort of sharing between the 2 of you?

Yes. So first of all, I mean, we're very pleased with some of the partnering that we're doing on the technology side. We're going to provide some services that very few banks can do. So we've got some great customers like Mayfair and some others that are joining us and Mayfair is a great example of being able to provide a partnership, where they provide certain services for the market, and we're able to buy the technology behind that. We expect that relationship to continue to grow and prosper over even through the next couple of quarters to grow pretty dramatically. . As far as being able to offer the insurance, we have a couple of different products that are unique in order to offer FDIC insurance through some large accounts and continue to develop that, and that's been a very popular product for us in the last few months from there. John?

Yes. Bernie, last quarter, I think we mentioned [indiscernible] as one of our new customers, as they had sent out a release similar to this one. So we now have 2 customers that have sent out releases about partnering with Third Coast. So for both of those, we are their depository institution, we help with all things, deposits. There's not a lot of card services, virtually none. There's no lending. I mean these are deposit relationships. And the kind of thing that we've been talking about over the last year, partnering with some of these Fintech companies that are still somewhat cash rich, and we're optimistic that these relationships and others can make a significant difference to our deposits over the long term.

Our next question comes from the line of Jordan Ghent with Stephens Inc.

I just wanted to ask a few questions on credit. First, if you could give us your CRE/office exposure. If you could just give us an update, that would be great. And then also, I don't know if I saw it mentioned, but any credit migration from classified and special mention during the quarter?

Sure. Our office exposure nonowner occupied is 2% of total loans. Dollar amount, it's about the same as it was last quarter. Owner occupied is another 2.3% of total loans. And then we have about 1.5% of total loans in medical office. We don't have any -- all of our office, both owner occupied and on nonowner occupied are in Texas with the exception of $1.2 million loan. And we don't have any -- we have one loan in office that's $1.1 million that's classified. But the office is really -- we haven't been doing new office, but it's been holding up well for us, and it's in good markets.

Yes. We're really pleased that we are in the right position for this change in the marketplace. We have very little exposure and most of ours is smaller office sight. So we don't have any large office nor any participations in large office deals, so particularly our nonowner-occupied office is just a miniscule part of our portfolio.

The average loan balance is $1.2 million, and the average LTV on the nonowner occupied is about 53%.

And then with regard to special assets, again, we've been relatively stable. And truthfully, what we're seeing in the market is our portfolio is handling very well the market right now. We're pretty -- see it's been very stable, and we're pretty pleased with the market conditions, how well our portfolio has performed.

Okay. Perfect. And then maybe just one follow-up on that swap. Where is that -- what line item is that flowing through?

So if you're looking at the income statement on the press release, it's going to be interest expense on deposit accounts. The credit to interest expense, and it's running just a tad under $100,000 a month, and will be that for the next 5 years, roughly 5 years.

And Is that straight lined?

Yes, it is.

Our next question comes from the line of Michael Rose with Raymond James.

Just wanted to start on the expense outlook. I think you said flattish. You guys highlighted in the press release, you guys have added some people over the past couple of quarters. Are you trying to signal that hiring is going to slow from here? Or are there other initiatives in place that are going to be offsets to kind of ongoing opportunistic hiring? And if so, what are those initiatives that are going to keep the run rate kind of flattish here?

Yes, Michael, certainly, expenses were a little higher this quarter than we were expecting. But if I think about expenses over a longer period of time rather than just one quarter, so if I go back a full year, our expenses are only up 4.6%. We had several quarters that they were actually down. And this was just a little bit of a catch-up. I mean, it's hard to have an exact science with this stuff. But I mean, we've certainly hired people this year. We've hired people in compliance and operations. Loans were up 20% over the last year and expenses are up less than 5%. So we think we've done a pretty good job managing that, but there -- we have opened a couple of new branches this year, and we have hired people, particularly on the compliance side. So it's going to be $24 million plus is kind of our best estimate of where expenses are going to be, but the storyline is still the same. We think we can grow net interest income faster than we're growing expenses. Certainly that was true over the last year where net interest income was up 23%, and noninterest expense was up less than 5%. That's certainly our goal in that sort of relationship.

And we certainly are internally watching every line of business in every area for expenses. And again, making a decision like exiting the line of business from auto finance is one of the ways in which we've made hard decisions to make sure that we're on the right path to hit those numbers and returns that we expect. So this team isn't afraid to make our decisions and to make sure we scour our P&L to make sure we find ways to remain competitive. And we certainly are going to continue to do that.

Yes. John or Bart, that actually leads the auto finance was actually my next question. Can you just talk about the process that you guys went through to kind of evaluate the risk rewarded, you're not the first one to scale back or get out of that business. So certainly understand the decision-making process, but just wanted to see what yours was? And then is there any other areas or divisions that you or maybe either looking at reducing or getting out of or conversely allocating more resources to?

Yes. So we kind of look at a holistic view point for return on equity. What's the best allocation of assets to return what we're trying to get for the shareholders? And because of that, we constantly internally are reporting or monitoring every line of business down to stack ranking performers on it. So I think we have some really good internal accounting that we're watching everything. And as rates have gone up, obviously, that's put different perspectives on different lines of business for us. And so as we've grown it would just become more obvious that there are ways to allocate our balance sheet to enhance shareholder equity. And so it really came down to a numbers game, whenever you look at it, that there's an obvious way for us to reallocate our assets for higher earning loans. Everything we look at, I think we have a great management team and even the leaders of all the lines of businesses are always looking for ways to enhance performance. So right now, I think that was sort of the obvious internal answer. Everything else that we're working on is just sharpening our pencils to kind of refine the other businesses. But we're pretty pleased with whether the other line of businesses are growing.

Yes. And Michael, along those same lines, as we were looking at the balance sheet over the last quarter and where we can be most efficient, we were looking at investment securities, and there were a lot of distressed sellers of bank sub debt over the last quarter. So we did buy roughly $20 million in bank sub debt, much of -- so the average for the quarter was not where we ended the quarter. We are worried about $90 million now. I think we averaged about $77 million for the quarter. But the new stuff that we were buying had yields above 10%, and these were big, well-known banks, they should be money good and it just seemed like a good opportunity, where it was mostly small pieces, but just to stress sellers trying to get out of that.

Makes sense. And then just -- I think just finally for me, just putting everything together, so you have positive NII growth from balance sheet, relatively flattish expenses, some momentum on the fee side. It seems like you guys could actually be one of the few banks that could actually generate some positive operating leverage next year. Is that the kind of the goal here? And is that your kind of expectation at this point?

Definitely. We believe so. I mean you probably said it fairer than I could. I just think we're putting ourselves in a position to be nimble and have the right balance sheet structure and efficiency to be able to improve on our operating leverage. And I think you'll see a lot more of that happen over the next few quarters. It's not overnight, but it's definitely certainly throughout the rest of this year and into next year, you'll see a lot of the benefits [ to term ] planning that we've been working on for a couple of years now.

Yes, especially if we can continue growing deposits the way we have in the last couple of quarters, it certainly hasn't gotten any easier. I know some of our peers listening to their calls, they maybe had a little more confidence than I do. But the deposit market is tough out there right now. Ours has been up. We've done great the last couple of quarters. And if that -- if we stay the course there, I think we have a lot of opportunities. Even demand, we saw at month end our demand deposits were up, where most people were down and a lot of that actually came out of our specialty finance group of all places, our builder finance group that -- they called hard on their customers and they had a lot of cash and they really had a great quarter there.

Our next question comes from the line of [indiscernible] with KBW.

You all focused on the 1% ROA target for a while now and hit it in the first quarter, a little down this quarter, which is no surprise with all the expenses. Can you kind of frame your commitment in regards to that 1% as you divest that auto finance division and kind of work on -- kind of making the balance sheet more efficient?

Yes. So about a year ago, we were projecting that we would get to a 1% ROA by the third quarter of this year. So we did it much sooner than we expected. So we consider ourselves ahead of schedule. If you look at the year-to-date numbers, we're at 99 basis points year-to-date. So again, quite a bit ahead. And 1% isn't our goal. I mean to be high performing is our goal. And if that means 1.25% or 1.35% or whatever the number is. We're certainly not satisfied with 1% being anything other than just a bare minimum.

This concludes our question-and-answer session. I'll turn the floor back to Mr. Caraway for any final comments.

Thank you, Melissa. I want to thank everybody that called in and participated. We appreciate you, and thank you for your support of Third Coast Bancshares. We look forward to seeing you next quarter. Thank you all.

Thank you. This concludes today's conference call. You may disconnect your lines at this time. Thank you for your participation.