Third Coast Bancshares Inc

NASDAQ:TCBX

Earnings Call Analysis

Earnings Call Transcript 2024-Q2

[Operator]

Greetings, and welcome to the Third Coast Bank's Second Quarter Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Ken Dennard.

[Ken Dennard, executive]

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 2024 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 the website and that's ir.thirdcoast.bank. There'll also be a telephonic replay available until August 1 and more information on how to access these replay features was included in yesterday's earnings release.

Please note that the information reported on this call speaks only as of today, July 25, 2024 and therefore, you are advised that 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 7, 2024, 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'd like to turn the call over to the Third Coast Chairman, President and CEO, Mr. Bart Caraway. Bart?

[Bart Caraway, executive]

Good morning, everyone, and thank you, Ken. Welcome to the TCBX second quarter earnings call. I'll start by outlining a few performance highlights followed by John's financial review and Audrey's credit quality review. Then I will discuss our outlook for the third quarter and the rest of the year.

To start, I'd like to highlight the great strides the company has made in improving profitability. Since our first quarter as a public company, which was the fourth quarter of 2021, I'd like to note some of the progress. First, we have grown quarterly net interest income from $24.6 million to $38.9 million, a dramatic increase of 57.8%.

Also, we have decreased noninterest expenses for 3 consecutive quarters, resulting in a noninterest expense to average earning asset ratio of just 2.39%.

We have also improved our efficiency ratio since the fourth quarter of 2021 from 75.3% to 61.4%. And we have also doubled our allowance for credit losses from $19.3 million to $38.2 million. The net result has been an increase of tangible book value of $4.90 or 23.7% to $25.60. Additionally, we have successfully opened new branch locations in Austin, Texas and the Woodlands, Texas, expanding our presence in the Texas Triangle region to 18 branches. Although we are proud of what we have accomplished, we think our best days are ahead.

With that, I'll turn it over to John. John?

[John McWhorter, executive]

Thank you, Bart, and good morning, everyone. In yesterday's earnings release, detailed financial tables were provided. So today, I'll offer further insight into specific financial results for the second quarter. And our second quarter net income was $10.8 million, resulting in 10.5% return on equity, a record diluted earnings per share of $0.63 and a return on average assets of 97 basis points. Net interest income was up 8.2% on an annualized basis despite modest loan growth for the quarter.

Loans grew by $12 million for the quarter, coming in under initial projections, mainly because of higher-than-expected paydowns. Specifically, we chose not to bid on new bond anticipation notes due to lower spreads. Bond anticipation notes are classified as tax-free municipal loans on the balance sheet. They paid down $40 million in the second quarter and approximately $40 million more in paydowns for the third quarter will take us down to 0. They were among the lowest yielding loans on the books at approximately 5.5%.

Overall, loan pipelines for the third and fourth quarters appear strong and in the $50 million to $100 million range. Noninterest expenses were down slightly for the third consecutive quarter and we continue to target a base in the $26 million range. Investment securities were up $40 million for the quarter and AOCI improved from $2.9 million to $4.2 million. With rates at current levels, it is unlikely that we will add to the portfolio in the third quarter.

Tax expense for the quarter was $3.4 million for an effective rate of 24%. This increase was due to the roll-off of tax-free loans previously mentioned and finalization of our year-end accruals. We expect our effective rate to be approximately 22.5% in the third quarter. Regarding asset liability management in anticipation of lower rates, we have moved from 1.4% asset sensitive to 0.9% liability sensitive, a change of almost 2.3%.

As we highlighted last quarter, deposit growth in the first quarter exhibited seasonal patterns and as anticipated, deposits decreased for the second quarter. We did improve the overall deposit mix by adding more noninterest-bearing deposits. Our loan-to-deposit ratio was 97%, aligning closely with the projected range of 95% to 98%, expected to be maintained throughout the remainder of the year. Since we are capital accretive for the quarter, the bank dividended $10 million to the holding company to both maintain cash reserves and pay down $7 million in debt, which we had at a rate of 7.85%. That completes the financial review.

And at this point, I'll pass the call to Audrey for our credit quality review.

[Audrey Duncan, executive]

Thank you, John, and good morning, everyone. Our loan portfolio remained strong during the quarter and I'd like to add some color to the numbers shared in yesterday's earnings release. Classified assets declined $20 million or 33.4% during the second quarter. The decline was primarily the result of the payoff in full of a $14.6 million substandard loan. Nonperforming loans to total loans increased slightly to 0.65% from 0.58% the previous quarter, primarily due to one relationship totaling $7.9 million that was placed on nonaccrual.

The combined LTV is 69% based upon 2024 appraisals and we do not anticipate a loss. Net charge-offs for the quarter totaled $1.8 million, which was primarily due to the $1.2 million charge-off of a Main Street Lending Program loan. The bank originated 6 Main Street loans, of which 2 remain in both our current. Combined gross fee income from the Main Street loans was $1.7 million.

The loan portfolio mix remained well balanced with percentages similar to the previous quarter. C&I loans represented 36% of total loans, construction development and land loans increased slightly to 20%, while owner-occupied and non-owner-occupied CRE represented 13% and 16% of total loans respectively.

Office represented 3.8% of total loans with a little over half being owner-occupied. Medical office was another 1.3% of total loans. Consistent with previous quarters, 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 portfolio is approximately 60% and the average LTV for medical office is approximately 55%. Multifamily represents 3.3% of total loans and has an average LTV of 59%.

And with that, I'll turn the call back to Bart. Bart?

[Bart Caraway, executive]

Thank you, Audrey. Before delving into discussions regarding our third quarter expectations and the outlook for the remainder of the year, I wish to extend my heartfelt appreciation to our dedicated team of employees. In the wake of Hurricane Beryl's impact on the Texas Coast in several of our markets a few weeks ago, our team faced unprecedented challenges, including prolonged power outages and disrupted communication services.

Despite such adversities, our team's resilience and dedication shone through as they rally together to support one another and serve our customers and communities with an unwavering commitment during this trying time. I am profoundly grateful for their exceptional efforts. As we plan for our operations in the third quarter, our primary focus remains on promoting sustainable growth through operational excellence. Although the full extent of the hurricane's impact on our expenses is still uncertain, we are dedicated to prudently managing our expenses.

We will continue to promote our 1% improvement initiative where we foster a culture of continuous improvement across the organization by empowering employees to bring creative ideas and utilize technology to enhance our operations and increase efficiency. We are committed to cultivating enduring valuable customer relationships by empowering our bankers to deliver exceptional service and products.

Regarding the loan pipelines, they still remain robust. We therefore continue to expect growth of $50 million to $100 million per quarter. This should drive net interest income growth to exceed 10%. Coupled with noninterest expense growth of less than 5%, we believe the company will gain more operating leverage over the next few quarters.

Our team's dedication to adaptability, innovation and strategic planning positions us to overcome challenges and capitalize on the opportunities as we progress through the year. We are making headway in driving quality growth, enhancing the customer experience and building excellence in our operations. This concludes our prepared remarks.

I would now like to turn it back over to the operator to begin the question-and-answer session. Operator?

[Operator]

[Operator Instructions] Your first question comes from Michael Rose with Raymond James.

[Michael Rose, analyst]

We're going to ask on the loan outlook. I know you said the municipal loans are going to kind of run off. Is that -- as we think about the third quarter, should we think about that $50 million to $100 million net of that or inclusive or excluding that?

[John McWhorter, executive]

Really talking about net? Yes. We've often said for last couple of years that loan is going to be lumpy and I wish I could give you all exact projections. But we do see quite a bit of business. Obviously, we've been even more selective this year with it, but we still see a nice pipeline. It's just going to be a little choppy as far as whenever it falls.

[Michael Rose, analyst]

Got it. And Bart, if you can just kind of expand on kind of what you're hearing from customers? I mean, I assume most of the growth is still kind of client acquisition, new clients coming on. I saw you opened 2 new branches, I assume that will kind of help as well. But we have heard from some other banks, maybe some larger ones, but customers are being a little bit more cautious here even in Texas, just given some of the near-term uncertainty with the election coming up, things like that. But what are you generally hearing from your lenders and then your customers out there just as it relates to their growth plans and things like that?

[Bart Caraway, executive]

Yes. It still seems like the economy despite the headwinds is doing well in our markets. But what I would call it is prudence from our customers where they're being more selective in their business as well being judicious about using their own capital and lower-cost funds of their own versus drawing down on lines and just managing their businesses even more carefully with it.

But I haven't seen any kind of dramatic swings in the market. For the most part, the customers that are coming to us are relationships where the banker has had a very long-term relationship, more than likely has already been through a downturn with that customer before. So they're kind of prepared and maybe they had to pivot a little bit with their business, but they've already sort of made that pivot now and are just waiting for some of the economic factors to turn. But I would almost call it business as usual with a little bit more caution.

[Michael Rose, analyst]

Very helpful. Maybe just one more for me. Just on fees. Really nice momentum again this quarter. I know last quarter, you guys talked about something just north of $2 million a quarter, obviously above that this quarter. Can you talk about just some of the puts and takes? Like I think last quarter, you announced the benefits from monetizing the swap. I know that's about [ $275,000 ] a quarter. But just can you discuss some of the drivers of the performance and expectations going forward?

[John McWhorter, executive]

Yes, Michael, this is John. So we did have some excess SBIC fees for the quarter. And when I say excess, I mean, just more than they had been running in recent quarters. But so far in July, loan fees look really strong that they may make up whatever that excess was. So I still -- I feel pretty good about the $2.5 million sort of range for fee income.

So we had about $600,000 in SBIC and that's hard to predict what it may be. It may be 0 next quarter, maybe a couple of hundred thousand. It's not going to be $600,000 again, but the loan fees, I think, will make up the difference. We'll be kind of in that $2.5 million range.

[Operator]

Next question, [ Woody ] Lay with KBW.

[Wood Lay, analyst]

So I think in your opening comments, you made a comment about how you all's screen is liability sensitive right now just modestly. What sort of drove that change in the sensitivity to rates in the quarter?

[John McWhorter, executive]

Yes. It's hard to change the balance sheet much from quarter-to-quarter. But if you remember back to last quarter, we had a lot more cash on the balance sheet, which is going to make us more asset-sensitive. So increasing our loan-to-deposit ratio, having less cash. We bought a lot of investment securities that were fixed rate.

If next quarter, our cash balances jump back up, I mean, it may take us closer to 0. But we kind of did everything that we could within reason. Fixing loans at this point is not an easy thing to do. The customers obviously don't want to do that. But we're trying to be as proactive as we can. And I don't see big changes in that. But we at least feel like we're well positioned for changes in rates.

[Bart Caraway, executive]

Yes. And I guess to kind of hone in on that is that this was all intentional. Obviously, after we went public, we felt like we needed to be asset-sensitive and did a fantastic job of moving the balance sheet to be an asset-sensitive. And now we just feel like with potentially the rate drops that we want to prepare our balance sheet to be at least neutral, if not biased towards site reliability since it would be nothing. John has done a great job of positioning us to do that.

[Wood Lay, analyst]

Yes, that makes sense. And then the noninterest-bearing deposit trends were encouraging in the quarter. Do you think there's momentum in the back half of the year where that segment can continue to grow from here?

[Bart Caraway, executive]

Well, I'll say that we're making a lot of efforts in it. Again, this is one of the most challenging times to grow that, but there's a lot of initiatives internally in the bank. And I'm optimistic that we're going to make some headway. Hard to tell what that's going to look like as far as the end of the year with it. But I do believe that our noninterest-bearing number of accounts are growing and we're trying to work very hard in growing the actual balances on it.

[Wood Lay, analyst]

And then maybe just last for me. You had the 2 branch openings in the quarter. Any more planned branch openings for the back half of the year?

[Bart Caraway, executive]

Yes. So these were actually in the work for a while that are basically based on some teams and strategies that we've had. We have one more location that is on the drawing board potentially for approval. And then after that, we don't have any other in the works.

[Operator]

Next question comes from Bernard Von Gizycki with Deutsche Bank.

[Bernard Von Gizycki, analyst]

So just wanted to discuss some of the drivers of the NIM. The NIM was better than expected and increased to 2 basis points. You had a nice pickup in the loan yields of 11 basis points sequentially. I know, John, you mentioned the runoff of the low-yielding munis helped there. And that offset the 9 basis points pickup in total interest-bearing liabilities. Could you just provide some color on those pricing dynamics and just expectations on the NIM for 3Q?

[John McWhorter, executive]

Yes. So it was a little bit better in the second quarter than I had expected. I mean, that $360 million range is kind of what we're targeting with where we are. There's not a lot to reprice on the balance sheet. So the improvement that we saw this time had more to do with mix than anything else.

And we're not going to be driving big changes to the mix quarter-over-quarter. It was a little bit easier this time, but kind of in that $360 million range, I think whether rates stay where they are or if the Fed finally does decide to start cutting our rates, I just don't see a big change in that number. It should be about the $360 million.

[Bernard Von Gizycki, analyst]

Okay. Got it. And then maybe just moving to expenses. Obviously, you talked about it a little bit, but it came in lower than expected. A few lines I was hoping to get some color on. In the release, you noted the decline in salary and benefits resulted from the operating efficiencies and the continued cost reduction measures that you guys have been talking about. I was just wondering if you can just provide some color on maybe some of the details that drove that down for the quarter?

[John McWhorter, executive]

Yes. So we've done a particularly good job on head count over the last year or 18 months. We have essentially the same number of employees that we did 18 months ago. And we're just real happy with where we are with the numbers of people and the employees that we have. Now after I make my comments, I was thinking about the third quarter does have 1 extra day and we do accrue salary expense on a daily basis.

So that's probably several hundred thousand dollars extra for the third quarter just by itself. So we'll kind of be in that $26 million to $26.5 million range. There are a couple of support people that we've hired recently. There's a couple of lenders that we're looking at and talking to the branches that we open, there's a couple of employees there.

So it's unlikely -- we've been super happy that we have cut expenses 3 quarters in a row. That's unlikely to happen again, but we don't see substantial growth either. It's going to be modest growth going forward. And I don't know what the percentages work out to be, it maybe 2% or 3%, but kind of in -- I think less than $26.5 million would be my best guess.

[Operator]

Next question, Jordan Ghent with Stephens.

[Jordan Ghent, analyst]

Most of them have been answered, but I just wanted to touch on the interest-bearing deposit costs. It looks like it ticked up a little bit, but I was just wondering if you guys could give any additional color on what you guys are seeing and maybe like a month-to-month basis?

[John McWhorter, executive]

Yes, good question. I mean, that really has more to do with mix than anything else. We had so many deposits roll off for the quarter and some of them were relatively inexpensive. It's not that we're putting on new deposits at higher rates.

Our marginal cost of our bigger wholesale deposits has basically been Fed funds and moving accounts over, it seems like they're typically in the 4.5% to 5% range. And we've talked about it before that whatever we don't do on a core basis, we're making up for on a wholesale basis and it's hard to predict what that might be from quarter-to-quarter.

But if the core stuff is going on the books at 4%, 4.5% and the wholesale stuff is going on at 5.25% and the mix from there is just harder to say. But there wasn't any. I know the cost of funds was up, but it wasn't anything different than we were doing.

[Operator]

Next question, Dave Storms with Stonegate.

[David Storms, analyst]

Just wanted to touch on -- given the conversation on expenses that you just had, is there any avenue to getting the efficiency ratio to a sub-60% number? I don't know if is there any sort of time line or the goal to get to that number?

[John McWhorter, executive]

Yes, Dave, good question. Big round numbers are always nice easy goals, 60%. I mean, we certainly want to be better than that, but our goal is to be the best we can be. Once we get to 60%, I'm sure our next goal is going to be 58% or 56% and lower and lower from there. As the bank continues to grow, I think it will be below 60%.

The timing is harder to predict. If we grow loans, $50 million, $75 million in the third quarter and expenses are relatively flat, maybe a little bit of growth, I mean that may be enough right there to take us below. If not third quarter, probably fourth quarter, but this concept of additional operating leverage, where we're growing top line faster than expenses, we think is intact. We think that will continue on for many quarters.

[Bart Caraway, executive]

And if I could add on to that. I mean, it is a consistent topic with the management team. We talk about it every time that we get together. So it's at the forefront of getting this operating leverage. And we're going to get there. It's just going to be a matter of time and growth that we need in order to get to be closer to a high performing. And it's just -- I think this team has got a lot of experience and has found a lot of ways to cut costs. And indeed, on our internal plan, the team is ahead of what I projected us to be. And we've got some nice momentum.

Again, as John said, a little growth will help a lot in just some time, we have some other avenues to be able to make this even more efficient. So again, we want to be a high-performing bank all across the board. It's just a matter of time when we get there.

[David Storms, analyst]

Understood. That's very helpful. And then just one more for me. With the head count being in such a good position, are there any retention policies or anything like that to highlight to help keep the team operating at such a high level?

[John McWhorter, executive]

Well, we basically talk about the hiring process around the management team, they are very judicious. So we're keeping track of the number of assets to employees. And I think we all watch that monthly. And we're also very judicious about where we add and looking even bigger picture of what could be handled with software and scalable versus adding head count.

So I think just there's a lot of conversations about it. Our goal, we know is to improve the efficiency ratio. With that, I think that's helped guide everybody on HR decisions. And I think that's just going to be continued the case.

So I think it's the momentum we have is going to continue in through the next few quarters for progress. And I think it's become almost a cultural shift now because it's kind of this efficiency has become part of our lexicon, part of what we talk about culturally. And I think we're just going to get better at what we're doing.

[Operator]

There are no further questions. I would like to turn the floor over to Bart Caraway for closing remarks.

[Bart Caraway, executive]

Thank you, Stacy. I just appreciate everybody for joining us on the call and your continued support of Third Coast Bancshares and we look forward to speaking to you next quarter. Thank you, all.

[Operator]

This concludes today's teleconference. You may disconnect your lines at this time and thank you for your participation.