Third Coast Bancshares - Earnings Call - Q1 2025

Transcript

Operator (participant)

Welcome to the Third Coast Bancshares First Quarter 2025 Earnings 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 zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Natalie Harrison, Investor Relations for Third Coast Bancshares. Thank you. You may begin.

Natalie Hairston (SVP)

Thank you, Operator, and good morning, everyone. We appreciate you joining us for Third Coast Bancshares conference call and webcast to review our first quarter 2025 results. With me today are 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.thirdcoast.bank. There will also be a telephonic replay available until May 1, 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 24, 2025, 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 annual report on Form 10-K that was filed on March 5, 2025, 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.

Bart Caraway (Chairman, President, and CEO)

Good morning, everyone, and thank you, Natalie. I'll start by sharing the key points from our earnings release. Following my remarks, John will discuss the financials, and Audrey will review our credit quality. Finally, I'll provide our outlook for the remainder of 2025. The results of the first quarter showcase the strength of our team and the effectiveness of our strategic planning. This is largely due to our well-defined priorities, which include disciplined loan growth, robust credit management practices, improved operational efficiencies, and the ongoing commitment to increasing shareholder value. First, early in the second quarter, we announced that Third Coast had successfully executed a significant commercial real estate loan securitization. This transaction provides us with increased flexibility in managing our balance sheet and capital ratios and generates fee income that will positively impact our net interest margin in the second quarter.

We believe the securitization transaction exemplifies our forward-thinking approach to capital management by positioning the company to support future loan growth while maintaining a prudent risk profile. By converting a portion of our loan portfolio into marketable securities, we have not only reduced our concentration in commercial real estate, a key focus for regulators and source of potential risk, but also improved our risk-based capital ratios as the securitization allows us to redeploy capital more effectively into new lending opportunities. This proactive step enhances our liquidity and enables us to manage our loan portfolio dynamically, responding to shifts in loan demand or economic conditions without compromising our credit standards. Furthermore, the structure and ongoing management of the securitization ensure that we maintain rigorous oversight of our credit quality as required by regulatory guidance and that we continue to meet the evolving needs of our customers and communities.

Additionally, our proactive asset management strategies focused on reducing non-performing loans and efficiently transitioning selected assets to other real estate owned continue to deliver positive results, as evidenced by the ongoing improvement in our already strong credit quality. While Audrey will provide more specifics, I just want to emphasize our continued confidence in the company's credit risk strategies. We are committed to maintaining a healthy balance sheet while promoting long-term sustainable growth. Another high point is our net interest margin, which improved 9 basis points in the first quarter to 3.80%. While John will provide more detailed financials, I want to underline that our commitment to maximizing returns through informed decision-making, cost awareness, and adaptability. Lastly, but certainly not least, we are committed to prioritizing enhanced shareholder value, which is demonstrated by our continuous rise in book value and tangible book value.

We achieved growth of 4.4% and 4.7% respectively over the prior quarter, and when compared to the same period last year, we achieved growth of 14.3% and 15.2% respectively. Overall, I am very pleased with the results of the first quarter. Our team has continued to show remarkable focus and discipline in executing the company's strategic priorities, which has allowed us to sustain this upward momentum. With our clearly defined objectives and such a talented team, we are well-positioned for future success. I'm confident that we will continue to deliver exceptional value in the upcoming quarters. With that, I'll turn it over to John.

John McWhorter (CFO)

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 first quarter. We reported first quarter net income of $12.4 million, essentially flat versus the fourth quarter of 2024. This resulted in an ROA of 1.17% and a 12.4% return on equity. Net interest income growth was 12.4% for the year, but down slightly from the fourth quarter. The decline from the fourth quarter was primarily due to a decline in Fed funds sold and other interest-earning assets. Non-interest expenses were up 3.2%, or $878,000 in the first quarter, and were up 8.5%, or $2.2 million, from the same quarter last year. Investment securities were up $13.4 million to $397 million, and AOCI improved to a gain of $10.3 million.

Deposits declined $62 million for the quarter, resulting in a loan-to-deposit ratio of 93.9%, but also resulted in a net interest margin which improved 9 basis points to 3.80%. Period-end loan growth was $21.6 million, but quarterly average growth was slightly better at $42.5 million. Payoffs were relatively high for the quarter, resulting in the modest growth. Loan growth has been better in April, with loans up more than $50 million thus far. Additionally, investment securities are up $78 million due to the securitization. The bank collected an origination fee on the securitization, which will benefit second quarter net interest margin by approximately 5 basis points. Non-interest expenses will be somewhat noisy in the second quarter, with headcount up 14, undergoing a core conversion and also incurring extra expense related to the securitization. Lastly, we accreted capital for the quarter and are therefore considering a share buyback program.

That completes the financial review, and at this point, I'll pass the call to Audrey for our credit quality review.

Audrey Duncan (Chief Credit Officer)

Thank you, John, and good morning, everyone. I'm pleased to report that our ongoing efforts towards improving asset quality and maintaining a well-diversified credit portfolio have led to a noticeable improvement in our already strong asset quality ratios. In the first quarter, non-performing loans declined by $9.3 million, resulting in the non-performing loans to total loans ratio improving by 23 basis points from the prior quarter. The decline in non-performing loans was primarily due to the foreclosure and transfer to OREO of three non-performing loans in one relationship totaling $7.3 million, the payoff and paydown of five non-performing loans totaling $1.9 million, and the charge-off of one loan for $810,000. Non-performing assets to total assets declined by two basis points to 0.56%. Net charge-offs also declined, improving by 5 basis points in the first quarter when compared to the prior quarter.

Although we charged off one loan totaling $810,000, recoveries of $412,000 for the quarter resulted in net charge-offs of just $398,000. Our loan portfolio continues to be well-diversified. C&I loans increased to 40% of total loans. Construction, development, and land loans increased slightly to 21%, while owner-occupied declined slightly to 11%, and non-owner-occupied CRE stayed the same at 16% of total loans. Office represented 3.4% of total loans, with approximately 54% being owner-occupied. Medical office was another 1.2% of total loans. As I have stated previously, the office portfolio generally consists of Class B with some owner-occupied C space and is all located in our Texas footprint. The average LTV of our office and medical office portfolio is approximately 60%. Multifamily represented 3.4% of total loans and has an average LTV of less than 65%. Overall, our conservative credit culture has consistently yielded strong results.

We remain disciplined in our credit underwriting approach and foster a culture of prudent credit standards and disciplined practices that align with our strategic vision for sustainable growth. With that, I'll turn the call back to Bart. Bart?

Bart Caraway (Chairman, President, and CEO)

Thank you, Audrey. First, let me start our outlook by expressing my pride in our team's exceptional ability to navigate challenges and capitalize on opportunities with expert-level precision. We consistently execute our strategic plan effectively, concentrating our efforts on initiatives and priorities that align with our company-wide goals. During our last earnings call, we outlined several key priorities. First, efforts to improve our efficiency ratio. We remain optimistic that our ongoing success of our 1% improvement campaign will continue to deliver significant operational efficiencies and cost savings. Second, our loan volumes continue to align with our targets, remaining in the range of $50 million-$100 million per quarter. Notably, we have already surpassed $50 million in gross loan production for April.

While fluctuations may occur month to month, we remain on track to achieve $325 million in loan growth, translating to an 8% annual run rate when compared to the prior year. Third, deposits experienced the typical seasonal decline in the first quarter, and we anticipate some additional seasonal rolloff. Similar to loans, deposits can vary significantly month to month. Lastly, we continue to evaluate additional securitizations as a tool to manage concentrations and support sustainable profitable growth, demonstrating our commitment to robust capital planning and risk management. In conclusion, I'd like to emphasize our thorough pursuit of operational excellence and profitability. With our highly effective strategic plan in place, a strong capital foundation, improved asset quality, and disciplined execution, Third Coast is well-positioned to continue delivering value to our shareholders and to remain competitive in our dynamic Texas markets.

I would now like to turn the call back 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 Woody Lay with KBW. Please proceed with your question.

Woody Lay (Analyst)

Hey, good morning, guys.

John McWhorter (CFO)

Morning, Woody.

Woody Lay (Analyst)

I wanted to start on the securitization impact. Congrats on executing that in April. I think you called out an origination fee that'll flow through the NIM next quarter. Is there also a non-interest impact that we should see in the quarters ahead, or will it all flow through interest?

John McWhorter (CFO)

It'll all flow through the margin. For this next quarter, I think it'll be about 5 basis points tailwind to the margin, and it'll be less than that going forward. We do still have some fees that'll amortize over time, but not as much.

Woody Lay (Analyst)

Got it. You completed this one in April. You said you'll evaluate the potential for additional securitization from here. What's a realistic target? Is it execute on a couple every year, or just how should we think about the opportunity?

John McWhorter (CFO)

Yeah, it's going to be based on demand, so it's really hard to predict when it may be. If our concentration ratios creep up, we're certainly going to be more interested in doing one than not, but it's dependent on the loan demand that we see out there, and our ratios are in good shape today.

Woody Lay (Analyst)

Got it. Maybe last for me, just shifting over to loan growth. It's pretty impressive to hear loans are already up $50 million this month, especially given all the sort of macro uncertainty that's in place. Talking to those borrowers, what gave them the confidence to execute on the loans? Speaking with other deals in the pipeline, does it feel like they're looking to delay deals, or are they open to executing in the near term?

John McWhorter (CFO)

Yeah, maybe I'll start and let Bart add to it. For the things that we have funded up in April, remember, we're a commercial bank, so there's a lot of revolving lines out there. These weren't necessarily new deals that were closed and funded during the month. It's more likely fundings on revolving lines that have been outstanding for a long period of time. Those numbers go up and down every month. For the first quarter, we had a lot of paydowns. We had some paydowns on revolving lines, but we had some big customers that sold out and I think primarily sold out and just paid off completely.

Bart Caraway (Chairman, President, and CEO)

Yeah, I think kind of following up on what John's talking about is our pipeline has been maybe a little bit more moderate in the past, but still pretty strong. It's been the paydowns that have kept our loan volumes from being higher. I think we hope that we're towards the tailwind of that. When I'm talking to the customers, we're in really good markets in Texas. A lot of them are even saying, even if we hit a recession, that it taps the brakes, and that's going to help some people find labor sources and keep costs down. Regardless of whether we hit a little bit of a lull or go forward, our economy, I think, is pretty optimistic. I would say most of our borrowers are cautious but optimistic on where they're going with it.

I'm not seeing anything that is extremely alarming other than the fact that there's just a lot of noise out there. The core businesses that we're seeing, and Audrey's looked through the portfolio, seem to be doing pretty well right now. We're just going to be very selective. We're not going to have the huge loan growth that we've had in past years because we've just tightened up credit quality so much. At the same time, there's a lot of business coming to us, and so much of this is coming from existing customers and other banks that are portable and moving their business to us. We feel pretty good about it right now.

Woody Lay (Analyst)

That's great, color. Thanks for taking my questions.

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 (Analyst)

Hey, guys. Good morning. Just my first question on the fee income. It was really good to the $3.1 million, and I think the biggest driver was in the service charges. Just wanted to know, has there been any pricing changes? Maybe you can just give some color on what drove the increase and if that's mostly a recurring trend from here.

John McWhorter (CFO)

Yeah, Bernie, we probably haven't talked about it in a couple of quarters, but our treasury management division, the fee income from that business, year before last was up 100%. Last year was up 75%. It's coming off a relatively small base, but we've done a great job in moving commercial businesses over that have lots of fee income. Some of the billings on that are quarterly. After any quarter end, you'll see a little bit of a pickup. More, of course, I'm looking at it on a monthly basis, but particularly after year-end, that'll be our largest billing cycle. It wasn't an increase in fees or anything like that. It was more those customers that are on annual billing.

Bernard Von Gizycki (Analyst)

Okay, got it. Thanks for that. John, maybe you mentioned the 14 headcount addition, some of the conversion expenses, and I think some additional expenses to the securitization. Could you just help maybe size expectations for expenses, whether it's 2Q or for the rest of the year?

John McWhorter (CFO)

Yeah, that's a good question. The first quarter, we have all the extra expense related to payroll taxes, and I know everyone has that. Other than that, and the new employees, I mean, I think we did a great job on expenses, holding the line on virtually everything. It doesn't look like the pipeline for hiring new people is material. I think all the payroll tax stuff rolls off. It's maybe replaced with some of the securitization expenses. I mean, kind of my best guess is non-interest expense is pretty flat in the second quarter versus where we were. I think right around that $28 million range is probably what you should expect.

Bernard Von Gizycki (Analyst)

Okay, great. Thanks for taking my question.

Operator (participant)

Thank you. Our next question comes from the line of Michael Rose with Raymond James. Please proceed with your question.

Michael Rose (Analyst)

Hey, good morning, guys. Thanks for taking my question. Just wanted to go back to the puts and takes to the margin. 5 basis point benefit from the securitization. You guys still have a fairly high cost of deposits that I think you can kind of continue to bring down, although you did have a step down in DDA, so would love some color there. Just on the loan side, kind of where new production yields trending, obviously saw the average yield came down, but just trying to get a sense for kind of what the all-in margin could kind of look like, puts and takes with the securitization benefit. How many cuts do you have baked into those expectations? Thanks.

John McWhorter (CFO)

Sure. I think you'll remember last quarter, we said that our margin was somewhat tamped down by all the extra cash that we had. We had some seasonal deposits, and for the most part, we just left that money at Fed. Our spread on that was modest. If I remember right, I said that it was probably 5 basis points to the margin, and instead, we went up 9 basis points. We did do a little bit better than I expected. All things being equal, that kind of 3.75%-3.80% on the margin, I think, is what you should expect. Adding to that is the securitization, which will be 5 basis points or roughly 5 basis points for the second quarter. That will be kind of a one-time shot as we pick up the origination fee income from the loan that we booked.

There is other amortized fee income, but it won't have a material effect on the margin, I wouldn't say. Kind of in that 3.75% range. We've talked before about being pretty well-matched assets versus liabilities and that if rates move, whether it be up or down, we feel well-positioned to take care of it. We do expect rates to come down at least a couple of times this year. If it does, I think the margin will be flat to somewhat better.

Michael Rose (Analyst)

Okay, helpful. I appreciate the color. Just maybe back to the loan growth outlook, if you are expecting a couple rate cuts this year, I'd assume that would kind of ramp up some of the paydown activity on the CRE side. I think, Bart, you said you still kind of expect $325-ish million in growth in the next three quarters. That's about $110 million, $180 million, $109 million a quarter. Does that encompass kind of expectations for rate cuts? Could you maybe actually do a little bit better on the growth side if there's anything else? Thanks.

Bart Caraway (Chairman, President, and CEO)

Yeah. We've been pretty good about the loan growth. We've always been kind of lumpy. Sometimes the third quarter is the biggest, sometimes the first, sometimes the fourth, it moves around. We have a lot of clients that are still going to move over, a lot of opportunities we're seeing with it. I feel like it's just going to be that and what our comfort level is. Actually, sometimes when things slow down like this, when you give good customer service, you're able to move more customers easier. With rates coming down, you probably will see some more payoffs. If rates come down enough, it also will help a little bit on the real estate lending side of it. We might be able to pick up some more deals. There are opportunities all throughout the market if you're looking at it.

That is why I feel confident that this team has a really good core group of customers that is continuing to move over to us, that I just believe the pipeline is strong enough and the customer base is strong enough that we are going to hit somewhere in maybe it is the lower end of that range. It is hard to tell with it, but $325 this year.

Michael Rose (Analyst)

Okay, helpful. Appreciate the color, Bart. Maybe just last one for me, just contemplation on the buyback. I've always thought of you guys as kind of a growth bank. Does that signal anything in your evolution? You also now paying a dividend, right? I mean, does that signal any evolution of the company, or are we still growth-focused at this point? Just trying to better understand the rationale around a buyback other than just where the stock is, right? I mean, you guys have had such strong growth for a period of time. Just trying to better appreciate why you would even consider a buyback at this point. Thanks.

Bart Caraway (Chairman, President, and CEO)

Yeah, we are definitely having discussions around the board. At this price level, I think we're seriously considering that. I'll bump that till next quarter, but I will tell you that where we are now, it is certainly such an attractive stock for the existing shareholders that we're having discussions about it.

John McWhorter (CFO)

Yeah, I agree, Michael. I mean, the accretion of capital and the level of our stock price is what makes it appealing. Certainly, we're somewhat biased, but I don't think we should be trading at less than tangible book value either.

Michael Rose (Analyst)

Yeah, totally get it. It's an interesting environment out there. All right. Thanks for taking my questions, guys. Appreciate it.

John McWhorter (CFO)

Thank you, Michael.

Operator (participant)

Thank you. Our next question comes from the line of Matt Olney with Stephens. Please proceed with your question.

Matt Olney (Analyst)

Yeah, thanks. Good morning. Just a few follow-ups here, and you may have addressed some of these. I'm having a hard time with the phone, so apologies if you already addressed some of these. I guess on the deposit side, John, you mentioned it briefly in your prepared remarks, saw some deposit balance contraction, liquidity levels came down. Just any color on the drivers of that?

John McWhorter (CFO)

No, I mean, we have the seasonal or it's more than one customer, but we do have seasonal deposits that primarily affect December and March. There was still a little bit of that in the March numbers, but the pipeline for deposit growth looks strong in the second quarter. Probably flattish on deposits. I wouldn't expect a big increase because we do have some seasonal deposits yet to roll off that are kind of tax-related that may be gone now or gone in the next week or so. Nothing out of the ordinary. I think if you look back at our prior years, you see the same thing in December and March. I know y'all aren't seeing the monthly numbers, but particularly just right at quarter end, we're getting some pretty big deposits in.

Matt Olney (Analyst)

Okay. Back on the securitization, just a few follow-ups here. I think you mentioned this should obviously help improve the commercial real estate and construction concentration levels. Just any color on that in terms of where we were March 31, and kind of what the pro forma?

John McWhorter (CFO)

Yeah. At December, if I remember right, our construction concentration ratio was 148% or 149% of capital, somewhere thereabouts. It is about 130% today. Low 130s, 132% or somewhere thereabouts over the last couple of weeks. Doing the securitization did free up a lot of room there. Kind of similar story on the 300 bucket that we were, I do not know, 350-ish or something, and it probably took us down 10-25 basis points.

Matt Olney (Analyst)

Okay. Also on the securitization, just trying to appreciate maybe any kind of off-balance sheet exposure here. What type of exposure is there remaining to the bank off that securitization?

John McWhorter (CFO)

We took back an investment security of $78 million that we put in held to maturity that we consider to be investment grade. It's lower yielding, but should be, from a credit perspective, very strong, stronger than the original loan would have been because effectively, we're selling risk in doing a securitization. The assets that we take back, whether we're calling it investment security, we actually contemplated calling it a loan, but it's obviously related to the original loan request. It's just that it doesn't have the same credit risk today. We don't have to put provisions against it, nothing like that.

Matt Olney (Analyst)

John, on the same note, any more color on the underlying assets of the securitization and what type of duration would that security on your balance sheet look like?

John McWhorter (CFO)

Yeah. The loan had a three-year maturity. It is short-term. It is floating rate. The underlying collateral is primarily construction loans.

Matt Olney (Analyst)

I assume single-family construction?

John McWhorter (CFO)

Correct. Yes.

Matt Olney (Analyst)

Okay. Okay. Great. Thanks, guys. Appreciate it.

John McWhorter (CFO)

Thank you.

Operator (participant)

Thank you. As a reminder, ladies and gentlemen, if you'd like to ask a question, please press star one on your telephone keypad. Our next question comes from the line of Dave Storms with Stonegate. Please proceed with your question.

Dave Storms (Analyst)

Good morning, everyone, and thank you for taking my questions. Apologies if these have been asked. I've been having a bit of an issue with the phone. Just want to start, historically, some chop in the market has provided you all with an opportunity to add some key bankers and other employees. Does the current macro environment provide a similar opportunity, or does this one have maybe a different flavor than in the past?

Bart Caraway (Chairman, President, and CEO)

No. I mean, I think we've steadily built up a good reputation of being a talent magnet. And quite frankly, there are probably more people that want to join us than we have room on the payroll right now. We've been selective and added a couple of bankers here and there to fit needs, but I really think we've got a great culture that people want to join. However, we're also very mindful of expenses too. We're just kind of layering in bankers at the right positions when we need them. Certainly, we have, I think, a very desirous culture to be a part of.

Dave Storms (Analyst)

That's very helpful. Just one more on the M&A environment. Just curious as to what you're seeing there, how intently you're focusing on it, if it's all frozen up until we get a couple of rate cuts. Any color you could provide there would be very helpful.

Bart Caraway (Chairman, President, and CEO)

Certainly. I mean, we continue to talk to various people and make sure that we see some deals that are coming through. At this point in time, M&A is very, very difficult to do. At some point, the market will change, and all of the legwork that we've been doing and foundation building, hopefully, something will come to fruition. I just think we have a great bank that we can grow organically and hit the numbers we need to. M&A is not something that we need to have like some other banks do. I think we can continue on hitting our goals and objectives through the normal course of business. Eventually, there probably will be a unicorn out there that could be very interesting to us.

Dave Storms (Analyst)

That's it. Thank you for taking my questions. Good luck in the next quarter.

Bart Caraway (Chairman, President, and CEO)

Thank you, Dave.

Operator (participant)

Thank you. This concludes today's question-and-answer session. I'd like to turn the floor back over to management for closing comments.

Bart Caraway (Chairman, President, and CEO)

Thank you, Devin. Thank you, everybody, for your continued support of Third Coast Bancshares. We look forward to speaking to you next quarter. Thank you.

Operator (participant)

Ladies and gentlemen, thank you for your participation. This does conclude today's teleconference. You may disconnect your lines and have a wonderful day.