Third Coast Bancshares - Q1 2023

Transcript

John McWhorter (Senior Executive VP and CFO)

Greetings, and welcome to the Third Coast Bancshares First Quarter 2023 Results Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star 0 on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Natalie Hairston with Dennard Lascar Investor Relations. Thank you, Natalie. You may begin.

Natalie Hairston (VP of Investor Relations)

Thank you, operator. Good morning, everyone. We appreciate you joining us for Third Coast Bancshares Conference Call and Webcast to review our First 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 investor section of our website at ir.tcbssb.com. There will also be a telephonic replay available until May 4, 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, April 27, 2023, and therefore you are advised that any time-sensitive information may no longer be accurate as of the time of any replay listening 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 company's prospectus or 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 are included in yesterday's earnings release, which can be found on the Third Coast website. I would like to turn the call over to Third Coast Chairman, President, and CEO, Mr. Bart Caraway. Bart?

Bart Caraway (Chairman, President, and CEO)

Thanks, Natalie. Good morning, everyone. Thank you for joining us today. I'll begin by highlighting the company's performance for the 1st quarter. John will then provide a more detailed financial review, and Audrey will give a credit update. Before we take your questions, I'll return to discuss our outlook. Third Coast continued to build on momentum from the fourth quarter 2022, and our first-quarter results only validated the company's strategic direction and market positioning. Loans grew $106 million to $3.2 billion, or 3% when compared to the fourth quarter of 2022. Deposits were also up 3% over the fourth quarter to $3.32 billion. The bank's leadership responded quickly to market events and implemented a plan that included distributing information about the company's strong liquidity and capital position.

This, coupled with the efforts of our lenders and relationship managers who proactively reached out to depositors, led to an overall increase in deposits of $86 million, with $31 million being non-interest-bearing demand. The leadership team demonstrated a strong commitment to managing the impact of the liquidity crisis on the bank and its stakeholders. This approach helped to increase relationships with the bank's depositors and grow the bank's reputation for stability and trustworthiness during a time of industry volatility. We made significant strides in our business operations for the quarter, with progress being made across virtually every financial measure, such as margin, income, expenses, and earnings per share. We also surpassed our target of 1% return on average assets in the quarter, accomplishing this goal well ahead of our previously stated schedule.

We maintained our strong credit quality and even had net recoveries for the quarter, which Audrey will discuss further in her prepared remarks. By focusing on the company's operations and business strategy, we can approach any obstacle with confidence and strength, inspiring and motivating employees to perform at their best. The positive first quarter results for Third Coast can be attributed to our talented employees, innovative and timely solutions, and our exceptional leadership. I'll turn the call over to John for more detailed financial review. John?

John McWhorter (Senior Executive VP and CFO)

Thank you, Bart, 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 first quarter. As Bart mentioned, we made great progress in the first quarter. Not only were loans up $106 million, but deposits were up $86 million. On an average quarterly basis, we did even better, with deposits up $201 million, while loans were up $129 million. This growth included no broker deposits or public funds. For the same time period, our net interest margin improved 4 basis points to 3.79%. This improvement was primarily due to decreased Federal Home Loan Bank borrowings due to our strong deposit growth.

We continue to be slightly asset sensitive, with new business being put on at lower spreads, resulting in a slight drag. At quarter end, our uninsured deposits totaled approximately $932 million or 28%, well below industry average. Our available borrowing lines are approximately $2 billion, resulting in a two-to-one coverage. Our accumulated other comprehensive income was a negative $2 million at March 31st, or approximately one half of 1% of shareholders' equity. Non-interest expense totaled $22 million for the first quarter of 2023, down from $22.6 million in the fourth quarter of 2022. This was the fourth consecutive quarter that non-interest expenses were down from the previous quarter. It was also likely the last quarter for lower non-interest expenses due to the new branches, new employees, and inflation finally catching up.

I think the next two quarters will be in the range of $23 million for non-interest expense. The efficiency ratio was 63% for the first quarter of 2023, compared to 67% in the fourth quarter and 75% in the first quarter of 2022. This significant improvement resulting from one of our goals over the last year of growing revenues faster than expenses. In fact, over the last year, net interest income has increased 30%, while non-interest expense has increased only 9%. Net income available to common shareholders totaled $8.1 million for the first quarter of 2023, compared to $6.1 million for the fourth quarter. Diluted earnings per share were $0.55 in the first quarter, compared to $0.44 in the fourth quarter, an improvement of 25%.

This performance resulted in returns on average assets of 1.02% and returns on average common equity of 10.28%. Additionally, our pre-tax, pre-provision ROA was approximately 1.40%. In late March, we entered into a five-year swap agreement with a notional amount of $200 million. We will pay fixed at 3.16% and receive Fed funds floating, which today is about 4.83%. This will give us good margin protection in the event that market rates are flat or down slightly. In the event that rates are down materially, we have floors on 58% of our loans, and additionally, 21% of our loans are fixed. While the Texas economy remains strong, we anticipate and are prepared for more difficult conditions. Rising rates, inflation, and economic uncertainty continue to be a concern.

In closing, we continue to manage through this rate cycle and compete for deposits and believe our unique positioning will allow us to be nimble, innovative, and maintaining a focus on safety and soundness. That completes the financial review, and at this point, I'll pass the call to Audrey for our credit quality review.

Audrey Duncan (Senior Executive VP and Chief Credit Officer)

Thank you, John. Good morning, everyone. Once again, credit performance for the quarter was strong, with non-performing assets decreasing by 16% to $10.3 million at the end of the first quarter. Non-performing assets to total assets was 0.27% in the first quarter of 2023, down from 0.32% for the fourth quarter of 2022 and 0.41% from the first quarter of 2022. Non-performing loans to loans held for investment remains low at 0.32%, which decreased from 0.39% as of year-end and from 0.44% as of the prior year period.

On January 1, 2023, we adopted the Current Expected Credit Loss methodology or CECL, recorded an increase of $4 million to the allowance for credit losses for the cumulative effect of adopting ASC 326. The $4 million increase in the allowance was primarily the result of economic projections for US unemployment and GDP. We also recorded a provision for the quarter of $1.2 million, which related to provisioning for new loans. This compared to a $2 million and $4 million loan loss provision during the fourth quarter of 2022 and first quarter of 2022, respectively, under the Incurred Loss methodology. During the first quarter of 2023, our ACL has increased from $30.4 million to $35.9 million.

The ACL to total loans was 1.12%, up from 0.98% in the fourth quarter and from 0.95% in the same period last year. We're especially pleased to report net recoveries in the first quarter. During the three months ended March 31, 2023 and 2022, the company recorded net recoveries of $364,000 and $17,000, respectively. We continue to closely monitor the portfolio for the impact of rising rates and the likelihood of a recession, and we continue to underwrite conservatively. Our asset quality remains strong. Our loan portfolio continues to perform well and remains well diversified. With that, I'll turn the call back to Bart. Bart?

Bart Caraway (Chairman, President, and CEO)

Thank you, Audrey. Moving forward, the goals we've set are still relevant as we progress through the next few quarters of 2023. We remain focused on two key strategic priorities, increasing efficiencies and maintaining a healthy credit culture. We are committed to improving efficiencies across our company through the following bank-wide initiatives. Implementing technology to optimize our internal processes, enhancing our digital capabilities for our customers, and increasing communication and collaboration. We will continue to monitor the loan portfolio to ensure that we maintain strong credit quality while updating the full year 2023 loan growth guidance to a more moderate level at $300 million to $400 million compared to the full year of 2022.

We acknowledge that our achievements to date are largely attributed to the exceptional team of professionals working for our organization, the company's sound business strategy, and the fact we operate in the most favorable markets in Texas. While none of us are entirely immune to becoming headwinds, we are better positioned than most to adapt and capitalize on these core strengths as we navigate the ever-changing landscape of the financial services industry amid continued economic uncertainty. This concludes our prepared remarks. I would like to now turn the call back over to the operator to begin the question-and-answer session. Operator?

Operator (participant)

Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Thomas Wendler with Stephens. Please proceed with your question.

Thomas Wendler (Senior Research Analyst - Consumer Services)

Hey, good morning, everyone.

Bart Caraway (Chairman, President, and CEO)

Good morning.

Thomas Wendler (Senior Research Analyst - Consumer Services)

I just wanted to start out with, non-interest-bearing deposits. We saw a step up in the end of period, and I was just wondering your expectations for the 2Q 2023 levels?

Bart Caraway (Chairman, President, and CEO)

We've had a focus of actually with our treasury products. I think we've mentioned it in a couple of other calls, and we're getting some progress in growing that core, what I call commercial treasury products. These are mostly granular, you know, deposits that are coming through. You know, we actually believe with some of our custom and digital offerings that are kind of enhancements to that treasury product, that we are seeing some more accounts coming on. In fact, we've got one new account that is maybe fairly significant in non-interest-bearing DDAs that has already been opened and will start funding. We think this is going to be a trend that you will see for the next few quarters.

Obviously, it's a volatile market, but we're seeing, quite a bit of progress in selling, commercial treasury products with a good DDA component to it.

Thomas Wendler (Senior Research Analyst - Consumer Services)

That was great color. Thank you. Moving on to loan yields. Loan yields saw a nice step up in 1Q 2023. Was there anything unusual there driving the strong 1Q 2023 increase? Can you give us any color of what we should be thinking about for loan yields moving forward?

Bart Caraway (Chairman, President, and CEO)

No, Tom, most of our loan portfolio, about 80% is floating. As rates go up, I mean, certainly we expect them to go up again, you know, next week, assuming the Fed increases rates. Let's see, for the month of March, it was probably our best spread month that we've had in quite some time. Our average yield on new loans in the month of March was a little over 8%. We had a really good month there. If I could add on to that, you know, we are revising down our projections for loan growth, again, more to that $300-$400 range. Part of that is intentional in that we are just looking more at credit quality and yield.

We're just being more selective on the, on the loan side as well. That's, you know, you're gonna continue to see those same trends going forward.

Thomas Wendler (Senior Research Analyst - Consumer Services)

All right. Thanks for answering my question, guys, and great quarter.

Bart Caraway (Chairman, President, and CEO)

Thank you. Thanks.

Operator (participant)

Thank you. Our next question comes from the line of Bernard von Gizycki with Deutsche Bank. Please proceed with your question.

Bernard von Gizycki (Equity Research Analyst - US SMID Cap Bank)

Hi, good morning. You know, credit held in fairly well for the quarter. You know, non-performing assets declined as noted, and you had some recoveries instead of charge-offs during the quarter. You know, the potentially weaker backdrop, mentioned in the prepared remarks, or at least some uncertainty in the macro, are there any areas in the portfolio that you would expect to see some pickup in charge-offs or have higher reserving against over the next, several quarters?

Bart Caraway (Chairman, President, and CEO)

Not really. I mean, the we monitor the portfolio so closely. I mean, we actually have implemented over the last couple of years, monitoring groups for our verticals. What we are seeing is, a lot of our companies have either canceled or decided not to go forward with some capital expenditures to expand their business. We're seeing some customers that have pipelines where they've worked through their backlog and perhaps their pipelines are smaller than what we've seen in the past. That slowdown is impacting folks, but most of our customers have addressed that with either expense reductions or themselves or just, you know, forecasting, you know, where their business is gonna be and pivoting to the new environment. We're not seeing credit erosion as much as just a general slowdown.

Is that fair to say, Audrey?Bernie, what I was going to say is our comment was more general in nature just because everyone's expecting a recession. It's nothing specific to our portfolio.

Bernard von Gizycki (Equity Research Analyst - US SMID Cap Bank)

No, understood. It was good color. Maybe, John, just as a follow-up, you know, you gave that details on the swap, and I think in the press release, you were talking about expectations that the NIM could rise in 2Q. Just any color, you know, anything that you can provide for the 2Q NIM guide, and what are you assuming for either the Fed hikes and/or cuts?

John McWhorter (Senior Executive VP and CFO)

Yeah. We're assuming we get the 25 basis point increase next week. You know, if that does happen or assuming it happens, we will be in the money on that swap by about 192 basis points. It'll pay probably a significant amount of money for this next quarter. You know, what's a little harder to know is what the offset may be on the bank's portfolio. Now, with that said, with rates going up one more time, we are asset sensitive. I mean, the second quarter may very well be the high watermark for our margin and, you know, I think it'll be up at least 5 basis points. It's hard for me to say any more than that.

Bernard von Gizycki (Equity Research Analyst - US SMID Cap Bank)

Understood. Appreciate it. Thank you.

Operator (participant)

Thank you. Our next question comes from the line of Brad Milsaps with Piper Sandler. Please proceed with your question.

Brad Milsaps (Managing Director, Equity Research)

Hey, good morning.

John McWhorter (Senior Executive VP and CFO)

Hey, Brad. Good morning.

Brad Milsaps (Managing Director, Equity Research)

Appreciate you guys taking my question. You guys have addressed most everything. Bart, you touched on this a little bit on the deposit growth that you saw in the quarter, specific around DDA, and you guys have been talking about a large deposit pipeline for a couple of quarters. I was just curious how big that might be right now relative to your loan growth, you know, aspirations of $300 million to $400 million this year. Just trying to think about how you'll fund that going forward and where the costs may come in to do so?

John McWhorter (Senior Executive VP and CFO)

Hey, Brad, if I could start that and let Bart add on to it. You know, as we were in the fourth quarter, we knew we had an exam coming up in the first quarter. You know, over the previous couple of years, we'd been trying to fund the loan growth kind of just in time funding, but we thought it was important to have more on-balance sheet liquidity. We had a hard push in the fourth quarter and early in the first quarter, really long before there was any liquidity crisis that people were talking about. You know, as you saw, our average balances were up materially and our demand deposits were up materially. You know, the reason was the push that we had started some number of months ago.

You know, since the liquidity crisis mid-March, I mean, we've continued to push hard and, you know, if I had to say now, I would say our deposit growth would exceed our loan growth comfortably over the next couple of quarters, that the pipeline just looks real strong.

Bart Caraway (Chairman, President, and CEO)

If I could just add on to the tail end of that too, is that, you know, we're really looking at growing it as granular as we possibly can. I'm very proud that our retail team has been bringing on, you know, consumer deposits as well as small business deposits. They've been very successful at that. Indeed, in the last quarter, they brought on, you know, a record number of the small business and consumer deposits. Part of that is we've implemented, you know, a program and added talent to that area where we're doing a lot more outreach into our community.

Again, from the treasury side, to mention again, I think all the investments we've made in the past in enhancing their treasury products is paying off and is allowing us to bring on more sophisticated customers. Again, you know, our wealth side and private bankers have also done a great job as well in that the wealth program has been, you know, by and large, a huge success. I think John would agree, both from the income side, what they're contributing, but also bringing on new customers and clients that has allowed us to cross-sell both deposits and loans to them. Even our specialty verticals have, you know, really done some great base hits and brought on some new deposits as well.

It's been across the board, all of our team has had an emphasis on deposits and it isn't just one sector, it's everybody contributing to the deposit growth. I think we'll only get better as we go on.

Brad Milsaps (Managing Director, Equity Research)

Just curious, you know, sticking with deposit costs, I think your total deposit costs were around 2.92% in the first quarter. Just kind of curious maybe where they ended the quarter and did you guys have much in the way of index money that would, you know, automatically sort of roll down if the Fed were to start to go the other way?

John McWhorter (Senior Executive VP and CFO)

We do. We have a significant amount of money that's floating. It's floated up and I think that's why, you know, the margin pressure that we had, you know, a year ago, we were kind of ahead of most other banks.We don't have to worry about that so much now. If rates do start going down, those deposits will immediately float down also.

Brad Milsaps (Managing Director, Equity Research)

Do you have that number by chance, John?

John McWhorter (Senior Executive VP and CFO)

No. As far as levels, I'd have to go look up exactly where we were, but it wasn't, you know, materially different at the end of March. You know, again, we had so much deposit growth over the last six months. You know, I know some banks had the issue of losing deposits and had to borrow from the Home Loan Bank, and it increased their cost of funds, and we just didn't really see that.

Michael Rose (Managing Director - Banking)

Sure. Okay. All right, great. Thank you, guys. I appreciate it.

Bart Caraway (Chairman, President, and CEO)

Thank you.

Operator (participant)

Thank you. As a reminder, ladies and gentlemen, if you would like to ask a question, please press star one on your telephone keypad. Our next question comes from the line of Michael Rose with Raymond James. Please proceed with your question.

Michael Rose (Managing Director - Banking)

Hey, good morning, everyone. Thanks for taking my questions. Just most have been answered, but, just wanted to get an update on the SBA business. Obviously, no gains this quarter, but, you know, looks like there's a seasonal pattern. Just wanted to get a general update on SBA and maybe just more broadly, you know, what efforts do you have ongoing to drive further, fee income growth? Thanks.

Bart Caraway (Chairman, President, and CEO)

Just to remind that from the SBA standpoint, it's an ancillary product to our community banking, meaning that it basically is just another tool. We tend to, in the past, have kept a lot on our books, and sometimes we sell them. We kind of make it on a case-by-case scenario. We're not dependent on that sales income. I mean, we generally make a loan on the SBA side, primarily as an intro for a customer to come in. It's a customer acquisition or it's a tool to where if we wanna bank someone, it gives us some enhanced comfort with it. I view that as just part of our normal community banking business in it.

Because of that, I don't think we quite stretch as far from a credit quality standpoint. They're usually, you know, near bankable or have some sort of, you know, color to it. In general, the SBA program kind of comes in waves, you know, along with the community banking side of it. It's been slower in this last quarter, probably the last 2 quarters. It probably will remain, you know, relatively small and still slower over the next 2 quarters. Overall, I mean, I would say there's really been no change in what we've done. Do you have anything to add, Audrey, on that?

John McWhorter (Senior Executive VP and CFO)

No, I agree. The portfolio as of March 31st is only $70 million.

Bart Caraway (Chairman, President, and CEO)

It's a relatively small part of our entire bank. Key and significant in that it is a nice product where we're able to offer some benefits to a customer, sometimes on amortization or being able to get a deal done. It's a very complementary product.

Michael Rose (Managing Director - Banking)

Helpful. Then the increase in other fee income, I assume some of that has to do with some of the fintech partnerships, but just wanted to see if there was kind of anything, you know, in there and then if we could get an update on the fintech stuff. Thanks, John.

John McWhorter (Senior Executive VP and CFO)

As far as the fees go, there really was no fee income from the fintechs yet. I mean, we are hopeful that that does pan out over time. You know, the other category this month or this quarter, there was just nothing special in it. It was a bunch of smaller miscellaneous stuff, if anything loan related, but, nothing significant to point out.

Bart Caraway (Chairman, President, and CEO)

On the fintech side, so we are pleased that we onboarded our first fintech. I'd like to say that we're kind of focused on quality over quantity, in this line of business, so we're being very selective. We really only want to partner with the best fintechs that are out there. What we're primarily looking for in a partnership is stable deposits, quality customers, an appreciation for compliance on that. For us, again, we're going to be very selective in who we onboard. We expect maybe 1-2 more partners on board over the next two quarters. That kind of gives you an example of how selective we're being.

I will say again on that custom and digital offering with our traditional commercial treasury products, they overlap a little bit. Again, we have 1 significant new customer there. We also have two more customers in the pipeline, 1 that could be, again, more significant core deposits that are coming, and 1 that's more of a revenue generation versus deposit balances. In general, all of these kind of work together some potential positive impact to our deposit mix.

Michael Rose (Managing Director - Banking)

Very helpful. Then maybe just one final one for me on expenses. I think John, you said $23 million, or so per quarter, at least in the near term is the right way to think about it. That implies for the year mid-single to high single-digit expense growth number. If you could just isolate kind of the parts between wage inflation, hiring efforts, and then maybe if there's any cost containment efforts that you have in place? Just trying to map out the puts and the takes. Thanks.

Bart Caraway (Chairman, President, and CEO)

Sure. Over the last year, we've certainly been very mindful of expenses and done everything we can to hold expenses down. You know, we did have layoffs over the course of the year, or people that just left for whatever reason, you know. Our head count has not changed materially over the last 12 months. You know, as much as we've grown in the last year, I mean, there certainly are needs on the operations side in particular. If we find the right salespeople, I mean, we'll hire them too. Most of our bank-wide salary increases were effective here late in the first quarter, so we'll see the effects of that going forward. I don't know exactly what that number works out to be. I mean, 5% or 6% on salary expenses, something like that.

You know, when you can include bonus accruals and health insurance and, you know, kind of all in is kind of what the run rate increase will be in the second quarter, just specific to that. You know, the other expenses, I mean, there's a couple of other branches that we're working to fill out and hire people, you know, branches that we opened late last year that, you know, we didn't see a big increase in expense related to those for the first quarter. I mean, it was there, but it was offset by other cost-saving initiatives that we had. You know, again, that can't happen forever.

Michael Rose (Managing Director - Banking)

Well, I understand. Thanks for all the insights.

Operator (participant)

There are no further questions at this time. I'd like to turn the floor over to Mr. Caraway for closing remarks.

Bart Caraway (Chairman, President, and CEO)

Thank you. Once again, we appreciate the questions that you all have. Thank you for joining us today. We think we had a fantastic first quarter, we do believe that we're gonna continue to improve going forward. This is all again, part of the plan that we started whenever we went public that we're executing on. I wanna thank you for your time today. I very much appreciate you joining us, and we appreciate your support for Third Coast Bancshares. Thank you all, and have a good day.

Operator (participant)

Ladies and gentlemen, this concludes today's call. You may now disconnect your lines and have a wonderful day.