Third Coast Bancshares, Inc. Q1 FY2023 Earnings Call

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 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 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 reconciliations to the most directly comparable GAAP financial measures are included in yesterday's earnings release, which can be found on the Third Coast website.

Thanks, Natalie, and good morning, everyone. Thank you for joining us today. I'll begin by highlighting the company's performance for the first 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. 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. And 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 in noninterest-bearing demand. The leadership team demonstrated a strong commitment to managing the impact of a 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. With that, I'll turn the call 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 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 2:1 coverage. Additionally, our accumulated other comprehensive income was a negative $2 million at March 31, or approximately 1/2 of 1% of shareholders' equity. Noninterest 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 noninterest expenses were down from the previous quarter. It was also likely the last quarter for lower noninterest expenses due to the new branches, new employees, and inflation finally catching up. And I think the next 2 quarters will be in the range of $23 million for noninterest 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 noninterest 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 5-year swap agreement with a notional amount of $200 million. We will pay fixed at 316 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 fixed on 58% of our loans and additionally, 21% of our loans are fixed. While the Texas economy remained 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 maintain 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.

Thank you, John, and good morning, everyone. Once again, credit performance for the quarter was strong, with nonperforming assets decreasing by 16% to $10.3 million at the end of the first quarter. Nonperforming assets to total assets was 0.27% in the first quarter 2023, down from 0.32% for the fourth quarter of 2022 and 0.41% from the first quarter of 2022. Nonperforming loans to loans held for investment remain 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, and 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 U.S. 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 loan 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 3 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.

Thank you, Audrey. Moving forward, the goals we've set are still relevant as we progress through the next few quarters of 2023. We’ve remain focused on 2 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. And while none of us are entirely immune to becoming headwinds, we're 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.

Our first question comes from Thomas Wendler with Stephens.

I just wanted to start out with noninterest-bearing deposits. We saw a step up in the end of period. And I was just wondering your expectations for the 2Q '23 levels.

So we've had a focus on actually growing our treasury products. I think we've mentioned it in a couple of other calls, and we're seeing some progress in growing that core, what I call commercial treasury products. So these are mostly granular deposits that are coming through. And we actually believe with some of our custom and digital offerings that are enhancements to that treasury product, that we're seeing more accounts coming on. In fact, we've got one new account that is fairly significant in noninterest-bearing DDAs that has already been opened and will start funding. So 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.

And then moving on to loan yields. Loan you saw a nice step up in 1Q '23. Was there anything unusual there driving the strong 1Q 23 increase? And then can you give us any color on what we should be thinking about for loan yields moving forward?

No. I mean, Tom, most of our loan portfolio, about 80% is floating. So as rates go up, I mean, certainly, we expect them to go up again next week, assuming the Fed increases rates. But 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%. So we had a really good month there.

We are adjusting our expectations for loan growth to the range of 300 to 400. This decision stems from a focus on credit quality and yield, leading us to be more selective in our lending approach. You can expect to observe these trends continuing in the future.

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

Credit held in fairly well for the quarter. Nonperforming assets declined as noted, and you had some recoveries in set of charge-offs during the quarter. With a potentially weaker backdrop I 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?

Not really. I mean we monitor the portfolio so closely. I mean we actually have implemented over the last couple of years, monitoring groups for our verticals. And so 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 work through their backlog and perhaps their pipelines are smaller than what we've seen in the past. So that slowdown is impacting folds, but most of our customers have addressed that with either expense reductions or just forecasting where their business is going to be and pivoting to the new environment. So we're not seeing credit erosion as much as just a general slowdown. Is that fair to say, Audrey?

Yes.

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

No, understood. It was good information. Maybe, John, as a follow-up, could you provide details on the swap? In the press release, you mentioned expectations that the NIM could rise in the second quarter. Can you share any guidance or assumptions regarding the second quarter NIM and what you expect for future Fed hikes or cuts?

Yes. So we're assuming we get the 25 basis point increase next week. And if that does happen or assuming it happens, we will be in the money on that swap by about 192 basis points. So it pays probably a significant amount of money for this next quarter. What's a little harder to know was what the offset may be on the bank's portfolio. Now with that said, with the 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 I think it will be up at least 5 basis points. It's hard for me to say any more than that.

Our next question comes from Brad Milsaps with Piper Sandler.

You guys have addressed most everything. Bart, you touched on this a little bit on the deposit growth that you saw in the quarter, specifically 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 sort of relative to your loan growth aspirations of $300 million to $400 million this year? Just trying to think about how you'll fund that going forward and sort of where the cost may come in to do so.

Brad, if I could start that and let Bart add on to it. So as we were in the fourth quarter, we knew we had an exam coming up in the first quarter. And over the previous couple of years, we've 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. So 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. So as you saw, our average balances were up materially and our demand deposits were up materially. And the reason was the push that we had started some number of months ago. And since the liquidity crisis mid-March, I mean we've continued to push hard. And 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.

We are focused on growing as much as we can at a granular level. I am very proud of our retail team for successfully bringing in both consumer and small business deposits, achieving a record number of these deposits last quarter. This success is partly due to a program we've implemented and additional talent we've added to reach out more to our community. On the treasury side, our investments in enhancing treasury products are paying off, enabling us to attract more sophisticated customers. Our wealth management and private banking teams have also excelled, contributing significantly to income and helping to acquire new clients, allowing us to cross-sell deposits and loans. Additionally, our specialty verticals have made impressive contributions by bringing in new deposits. Overall, every team has focused on deposit growth, and I believe we will continue to improve moving forward.

So just curious, 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 do you guys have much in the way of index money that would automatically sort of roll down if the Fed were to start to go the other way?

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

Do you have that number about a chance, John?

No. As far as levels, I'd have to go look up exactly where we were, but it wasn't materially different at the end of March. Again, we had so much deposit growth over the last 6 months. I know some banks had the issue of losing deposits and had to borrow from the home loan bank and they increased their cost of funds, and we just didn't really see that.

Our next question comes from Michael Rose with Raymond James.

I wanted to get an update on the SBA business. We didn't see any gains this quarter, but there seems to be a seasonal pattern. Could you provide a general update on SBA and any ongoing efforts to drive further growth in fee income?

From the SBA perspective, it's an additional product for our community banking, which means it's just another tool we use. In the past, we've kept a lot of these loans on our books and occasionally sell them based on individual circumstances, but we don't rely on that sales income. Generally, we make SBA loans as a way to bring in customers or as a tool to provide us with increased confidence. I see this as part of our standard community banking operations. Because of this, we haven't pushed too far on credit quality; the loans are typically near bankable or have some reliability. The SBA program tends to fluctuate with our community banking efforts, and it's been slower in the last quarter, as well as the previous ones. It will likely remain modest and continue to be slow in the upcoming quarters. Overall, I would say there hasn't been any significant change in our approach. Audrey, do you have anything to add?

I'm agreeing. The portfolio as of March 31 is only $70 million.

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

Helpful. And then the increase in other fee income, I assume some of that has to do with some of the fintech partnerships, but I just want to see if there's kind of anything in there? And then if we could get an update on the fintech stuff.

Yes. 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. But 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.

Yes. And 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. And what we're primarily looking for in a partnership is stable deposits, quality customers and an appreciation for compliance on that. And so for us, again, we're going to be very selective in who we onboard. We expect maybe 1 to 2 more partners on board over the next 2 quarters. So that kind of gives you some sort of an example of how selective we're being. I will say, again, on that custom and digital offering with our traditional commercial charter products that kind of overlap a little bit. But again, we have one significant new customer there. We also have 2 more customers in the pipeline, one that could be, again, more significant core deposits that are coming and one that's more of a revenue generation versus deposit balances. But in general, all of these kind of work together that we believe we're going to bring in and aggregate some potential positive impact to our deposit mix.

Very helpful. And 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 kind of implies for the year kind of a mid-single to high single-digit expense growth number. If you could just kind of isolate kind of the parts between wage inflation and hiring efforts? And then maybe if there's any cost containment efforts that you have in place, just trying to kind of map out the puts and the takes.

So over the last year, we've certainly been very mindful of expenses and then everything we can to hold expenses down, and we did have layoffs over the course of the year, people that just left for whatever reason, our head count has not changed materially over the last 12 months. But as much as we've grown in the last year, I mean, there certainly are needs on the operations side in particular. And if we find the right salespeople, I mean, we'll hire them, too. But 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. And I don't know exactly what that number works out to be, I mean, 5% or 6% on salary expenses, something like that. When you can include bonus accruals and health insurance and kind of all in is kind of what the run rate increase will be in the second quarter, just specific to that. The other expenses, I mean, there's a couple of other branches that we're working to fill out and hire people, branches that we opened late last year that 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. But again, that can't happen forever.

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

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

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