Third Coast Bancshares Inc

NASDAQ:TCBX

Earnings Call Analysis

Earnings Call Transcript 2023-Q4

[Operator]

Greetings, and welcome to the Third Coast Bank Fourth Quarter and Full Year 2023 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host, Natalie Hairston, Investor Relations. Thank you. You may begin.

[Natalie Hairston]

Thank you, operator, and good morning, everyone. We appreciate you joining us for Third Coast Bancshares' conference call and webcast to review our fourth quarter and full year 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 February 2, 2024. 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, January 26, 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 15, 2023, to better understand those risks, uncertainties and contingencies.

The comments made today will also include certain non-GAAP financial measures. Additional details and reconciliation to the most directly comparable GAAP financial measures were included in yesterday's earnings release which can be found on the Third Coast website.

Now I would like to turn the call over to Third Coast Chairman, President and CEO, Mr. Bart Caraway. Bart?

[Bart Caraway, executive]

Thanks, Natalie, and good morning, everyone. Thank you for joining us today.

As we wrap up the fourth quarter, we reflected on our journey since going public 2 years ago. In November 2021, we launched our IPO as a $2 billion bank, aware that we still had to grow into our overhead with a return on assets of just 0.55%. However, today, we're proud to report that we have over $4.4 billion in assets, an impressive growth rate of over 100%, and we almost doubled our return on assets at 0.90%.

Our success over the past 2 years could be attributed to our focus on strategic priorities, including reinforcing shareholder value by improving efficiencies and maintaining our strong credit culture.

In 2023, we introduced several new technologies to streamline our daily work and lay the foundation for flexible and scalable for future growth. These include a credit delivery platform to efficiently process loans for corporate and community banking, an integrated risk and issue management software package and an account origination solution for quick and efficient account opening for personal and business accounts, both digitally and in branch.

We also took proactive, decisive actions to reduce our operating expenses and other overhead costs, resulting in a 5% reduction in workforce and the winding down of our Auto Finance division. This allowed us to streamline our operations and improve our bottom line, so that we now have approximately $12 million in assets per employee.

Our loan growth in 2023 continued to outperform our peers, with a well-balanced loan mix of C&I and CRE. We achieved this by focusing on diversification and adding credit talent to our team.

Looking back over the past year, we're immensely proud of our team and their hard work. We wholeheartedly believe that we have the best bankers working with the best customers in the best markets, driving long-term shareholder value and achieving success.

With that, I'll turn the call over to John for a more detailed financial review. John?

[John McWhorter, executive]

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 fourth quarter.

We reported a record fourth quarter net income of $9.7 million, resulting in a 10% return on equity and record diluted earnings per share of $0.57. Net interest income growth was 19.8% for the year, but on an annualized basis, was 23.2% in the fourth quarter, due to strong quarterly loan growth.

Noninterest expenses were down 4% or $1.1 million in the fourth quarter and were up only 13% or $11.5 million for the year, resulting in better than peer operating leverage.

Investment securities are relatively immaterial at $178 million, but significantly, $75 million was purchased early in the fourth quarter. Our timing was good, and we have material gains on these new purchases.

The current yield on the portfolio was 6.42%, and we have a gain of $933,000 in accumulated other comprehensive income.

Deposit growth for the quarter was $156 million, double our loan growth of $78 million. This resulted in a loan-to-deposit ratio of 95.7%, but also resulted in a net interest margin, which declined 10 basis points.

In mid-December, the bank entered into a 5-year swap with a notional amount of $200 million. We will pay fixed at 360 and received Fed funds floating, which today is about [ 5.33% ]. This will give us good margin protection in the event that rates are down, less than current market expectations.

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

[Audrey Duncan, executive]

Thank you, John, and good morning, everyone. Given the current economic climate, we understand that investors are focused more than ever on credit quality.

Despite the difficulties presented by 2023, Third Coast loan portfolio has proven to be resilient and strong. This is due to our conservative underwriting, extensive ongoing monitoring and diversity in the loan mix to mitigate segment-specific risks.

Nonperforming assets to total assets remained at 39 basis points. Net charge-offs of $1.5 million for the quarter were primarily the result of the charge-off of one C&I revolving line of credit. The line originated in 2019. The loan to the same borrower with a 75% SBA guarantee remains on the books.

Additionally, charge-offs have remained low at 4 basis points for the past 2 years.

Provisions for credit losses totaled $1.1 million in the fourth quarter and related to provisioning for new loans and commitments.

The ACL represents 1.02% and remains at the high end of the range.

The loan portfolio mix is well balanced, with commercial and industrial loans accounting for 35% of total loans, construction, development and land loans at 19%, non-owner occupied CRE at 14% and owner occupied CRE at 16%. Non-owner occupied office represents 1.8% of the loan portfolio, with nonowner-occupied medical office accounting for another 1.3%, while owner-occupied office and medical office totaled 2.3% of total loans.

The office portfolio generally consists of Class B, with some owner-occupied [ C ] space, and is all located within our Texas footprint.

Nonowner-occupied retail accounts for 3.5% of total loans and owner-occupied real estate, another 0.5%. The properties are primarily neighborhood centers and are located within our Texas footprint.

Multifamily consists of 3% of total loans, Hospitality represents less than 1% of the portfolio and restaurants represent 1%.

During fourth quarter 2023, Gateway Asset Management conducted our annual loan review. They reviewed 40% of the total loan portfolio, with a concentration in CRE, C&I and construction and development loans. Out of the 145 loans reviewed, there was only one recommended downgrade from pass to launch.

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

[Bart Caraway, executive]

Thanks, Audrey. Looking ahead to 2024, Third Coast is confident in its ability to refine and execute our strategic plan, while building on the success of the past 2 years. Our primary objective is to continuously increase efficiencies, while maintaining excellence in our commitment to serve our customers, communities and shareholders through the execution of our key goals this year.

To achieve our goals, we have identified several key priorities for the coming year: first, maintaining pristine credit quality is paramount. We prioritize credit quality and risk management to ensure the long-term success of our business. Our team of experienced underwriters, credit officers and bankers work diligently to ensure that each loan is evaluated thoroughly before it is approved. We also regularly review our loan portfolio to identify any potential risk and take proactive measures to mitigate them.

Our focus on credit quality has helped us build a strong reputation among our customers and investors. Second, our strong capital position. We expect that future earnings will support 100% of our asset growth going forward. Having said that, maintaining a robust capital position is not just about supporting growth, but is also vital to ensuring stability in times of economic uncertainty. We have implemented a risk management framework that enables us to identify, measure and mitigate risk that could impact our capital position. By prioritizing our capital position, we are able to provide our investors with a strong return on their investment.

Third, our commitment to relationship banking. Our focus on relationship banking means that we place a premium on understanding our clients' needs and providing them with a range of financial products that meet those needs. We aim to become our clients' primary financial institution, offering them everything from checking the savings accounts to loans and investment options. We are confident that our deposit strategies will continue to yield positive results, which, in turn, will lead to strengthening our relationships with our clients.

Finally, balancing future growth with minimizing unnecessary expenses. We are committed to investing in our growth, while being mindful of expenses. Our team is dedicated to reviewing our processes and identifying areas where we can optimize our spending. We prioritize investments that will generate long-term value for our company and our customers, while also seeking out cost-saving measures that don't compromise the quality of our products or services.

In closing, Third Coast is dedicated to building on our past successes and improving every day. Our ultimate goal is to remain relevant and add value to our employees, customers, communities and shareholders in 2024 and beyond. We are confident in our strategy and believe it will help us navigate any challenges or opportunities that come our way.

This concludes our prepared remarks. I would now like to turn the call back over to the operator to begin the question-and-answer session. Operator?

[Operator]

[Operator Instructions] Our first question comes from the line of Brady Gailey with KBW.

[Brady Gailey, analyst]

I know last quarter, we talked about expectations for loan growth in '24 of roughly $300 million to $400 million. Maybe just an update on how you guys are thinking about loan growth in '24 and on the flip side, deposit growth as well?

[Bart Caraway, executive]

Yes, relatively unchanged on our side, still $300 million to $400 million, consistently what we're looking at. Obviously, I put the qualifier end of what the economy does may affect it and as well as the timing. But we still see some pipeline of demand. And so we're going to remain with our estimate of $300 million to $400 million.

[Brady Gailey, analyst]

And do you think [ it's positive ]?

[Bart Caraway, executive]

Yes. So on the deposit side, we've been rolling out strategies all last year on deposit growth, and we're actually feeling better about deposit growth, matching the loan growth. So our goal is not just loan growth but to remix the deposit portfolio for better cost of funds. And we're seeing some signs of some tendencies of those skill or those initiatives working actually.

[John McWhorter, executive]

Yes, forecasting deposits has certainly been harder. We weren't expecting the fourth quarter deposit growth to be double the loan growth. It's hard to forecast that going forward.

But I would say the fourth quarter was probably the easiest quarter of the year for us, that a lot of the initiatives that we had started earlier in the year continue to pay off, even the deposit campaign where we were giving out prices, if you will, for people that produce the most deposits.

I mean some of -- even though that has expired, we still have a lot of deposits coming in from that. It's been very promising.

[Brady Gailey, analyst]

All right. And then on the expense side, I heard one of the priorities on the expense side is investing in growth, but at the same time, being mindful of expenses and looking for ways to optimize the expense base. How should we think about expense creep in '24?

[John McWhorter, executive]

Yes. So last quarter, we had guided to 5% to 10% noninterest expense growth, and we're still pretty comfortable with that number. Most of our staff received salary increases in the first quarter, so we'll see a lot of that immediately.

I would say that December was probably our best month for noninterest expense, if you will, in the fourth quarter, and it was because of the risk that we had done late in the third quarter that was kind of fully realized in the fourth quarter.

Kind of net interest income, while we're talking about it. We still think that net interest income is going to grow more in the 10% to 15% range and expenses in the 5% to 10% range. So we still expect that positive operating leverage.

[Brady Gailey, analyst]

That's great to hear.

[Operator]

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

[Bernard Von Gizycki, analyst]

Just on expenses, I wanted to dig in there a little bit. You're slightly above the guide, but just wondering, on the legal and regulatory expenses, those saw a big sequential uptick. Was that mostly like a year-end cleanup? Just anything, how we can think about that and how that could trend in 1Q?

[John McWhorter, executive]

Yes. Those are actually the two line items that I expect the most improvement in the first quarter. We did have some kind of unusual one-off expenses in the fourth quarter that should not be recurring. And those two line items combined probably in the, I don't know, $300,000 to $500,000 range that was excess expense that we won't see going forward, at least specific to those things.

[Bernard Von Gizycki, analyst]

Okay. Perfect. And then maybe on the fee income side, there was that nice lift sequentially in part due to the derivative fee income you guys called out. Just for activity purposes, was that just much better at year-end or some sort of seasonality or anything you're seeing kind of as the year starts and how it pertains to like, say, 1Q, would you expect that to continue? Any color you can add there?

[John McWhorter, executive]

Yes. I mean, a year ago, I thought that we would not have much derivative income for 2023, just because everyone thought that rates would be going up. But we did. We continued selling swaps to our customers.

And with the expectation now if rates dropping, I wouldn't think that would be a very good market for this year. I would expect fee income to be relatively flat for the next quarter or two. There's nothing special that we expect, and we'll probably have some pressure on things like derivatives and SBA sales, because both of those lines of business are just a little bit slow right now.

[Bernard Von Gizycki, analyst]

Okay. Great.

[Operator]

Our next question comes from the line of Graham Dick with Piper Sandler.

[Graham Dick, analyst]

I just wanted to circle back to the deposit growth you saw this quarter and get a little more color and idea of what kind of deposits these were or what the customers look like? Just anything you could do there to help us understand like the level of granularity or type of deposits that came on this quarter would be helpful.

[John McWhorter, executive]

Yes. We talked before about the deposit campaign that we did in the summer, and we were incenting particularly the retail staff to be salespeople to ask for deposits and it has worked exceedingly well, better than I would have expected. They've done a fantastic job for us. I mean, they're taking money from -- for the most part, it's existing customers that have money at multiple banks and they're bringing -- consolidating more of their money with us. So it's really been a bright spot. And we expect that to continue.

[Bart Caraway, executive]

And the community bankers as well, all of our bankers actually, we've changed up the incentive plan, and that takes a little while to roll out, but they've all been hunting for deposits. And so that, along with Treasury has had a more outward-bound sales focus that's been bringing on more commercial accounts.

And some of this, too, is just as we bought business on, sometimes the loan comes first, and it takes a while to onboard the customer for a full-wallet relationship. And what's been nice towards the end of last year was a lot of those deposits finally came on.

[Graham Dick, analyst]

No, that definitely makes sense and it's helpful. And I guess just looking more so at the margin, I heard the NII guidance, and I guess you can kind of back into this, given your loan growth outlook as well.

But with the NIM, obviously, I guess, loan growth is probably coming on at a dilutive margin relative to where it is today. Where do you see the margin, I guess, sort of bottoming out or settling out in 2024? And then assuming we get no rate cuts, where would it go?

And then I guess the second part of the question would be, if we do get rate cuts, what's sort of the initial reaction? I know you guys are very neutral on the balance sheet side, but I just want to know if there's something that I might be missing there?

[John McWhorter, executive]

Yes. So new loan growth has a slightly lower spread than our margin. So we have some pressure there. And then specifically, in the fourth quarter, we saw noninterest-bearing demand deposits decline, which was a little bit of a drag on the margin.

And again, kind of one of those hard things to predict, I wouldn't have thought noninterest-bearing demand year after the liquidity crisis would still be going down, and some of that may come back, by the way.

And then -- I lost my train of thought. Yes, the NIM, just quite went flat versus going down. I think we are pretty well neutrally positioned. I think we all agree that there may be some impact, but it's not that material.

Yes. Yes. So the other thing that I was going to say -- sorry about that -- was the loan-to-deposit ratio declining from 98% down to 95%. We weren't necessarily expecting that either. So at year-end, we had -- I don't know those $350 million in cash or somewhere thereabouts, and it was just basically in Fed funds. So our spread on that was virtually nothing. So it was the decline in demand, the change in mix of the loan-to-deposit ratio went down, that probably affected the margin.

But you're right, we are evenly matched. Our December numbers are going to show that we're very evenly matched again. We will have a little bit of a tailwind from this swap for the first quarter, and we do have a gain in that transaction right now and at least as of today, it looks to be a good trade that all our modeling shows that as long as we don't have a dramatic more than 200 basis point decline in rates, that we should be better off in virtually every interest rate scenario.

[Graham Dick, analyst]

Okay. Good to hear. So really, at the end of the day, it's more balance driven than anything or a balance sheet mix at this point rather than rate.

And then I guess you mentioned on noninterest-bearing deposits there at the end, they declined a bit. I mean, they seemingly can't go to like all that much lower. Do you feel pretty good about maybe bounce around the bottom here a little bit, but nothing super meaningful in 2024?

[Bart Caraway, executive]

Yes. We think that's a good accurate description. You have folks paying property taxes and other expenses and some tax management at the end of the year that's fairly common that we see, because we have such a lot of commercial accounts. So there's nothing really irregular there.

[Graham Dick, analyst]

Okay. Okay. Good to hear. And then if I could just sneak one more in on credit and more specifically the provision. I heard you say that the loan loss reserve or allowance for credit losses is above your longer-term target, what does that imply for provisioning cost this year in terms of your [ all ] need if, say, the economy, there's uncertainty persisted, but not a huge credit cycle?

[Bart Caraway, executive]

Yes, with buyer models, I'll let Audrey jump in. But for us, we're not seeing deterioration in our loan portfolio. As a matter of fact, it remains very strong. So we're expecting more or less the provisioning based on the growth and what our model shows more than anything.

[Audrey Duncan, executive]

Yes. We've been carrying a fairly sizable unallocated portion based on the CECL methodology. So when you saw the ACL, the total loans go down from [ $107 million to $102 million ], we did have that $1.5 million charge-off. We didn't need to fully provisioned to cover that charge-off because we already had it in the ACL.

So we still have a -- we've kind of whittled down the unallocated portion that we had, but we're still well within our range on the ACL.

[Bart Caraway, executive]

Yes. It seems like since going public, we've always said just count 10 basis points, but we've never really come close to the 10 basis points on it, and I don't see any difference this year.

[Graham Dick, analyst]

Okay. Good to hear.

[Operator]

Our next question comes from the line of Tim Mitchell with Raymond James.

[Timothy Mitchell, analyst]

I just want to start out. You guys mentioned the loan pipeline still looks strong. I was just wondering if you could give us any color on where you're seeing that? And then what kind of rate are you putting new loans on in the fourth quarter?

[Bart Caraway, executive]

Yes. So what I would tell you is it's still rather difficult on the CRE side, just because as with rates have gone high enough, I'm sure all the other banks are seeing it, too. It's much more difficult to find a CRE loan that gets past approval, meets our criteria, just because of the rate environment. But we do think that we'll end up with some good customers that we kind of cherry pick on that.

Most of our growth is really going to be on the C&I side and then some on our specialty finance side of it. But overall, I think we've just had been very fortunate we have a really strong customer base that as we're cherry picking the rest of their business coming over, is providing most of the growth to us on it.

So John, do you have anything else to add?

[John McWhorter, executive]

For yield on new loans, probably 8.5%. I mean, we're typically new loans are going in the books between 8.50% and 9%.

[Timothy Mitchell, analyst]

Yes. Awesome. Very helpful. And then when we think about like loan repricing in '24, do you guys have any kind of breakdown on what your variable rate loan book is and chunky fixed rate loans that are coming due in the year?

[John McWhorter, executive]

Yes. Our floating rate loans are about 60% of the portfolio. I mean we're very evenly matched. I think the duration on the asset side of our balance sheet is 10 months or something like that for the entire balance sheet. So we're very short.

And anything that we might have that's coming up for renewals, say, like older CRE loans, there are certainly loans that we were doing in the 4s back 2 to 3 years ago. As those come up for renewal, they're going to be priced higher, but that's probably not going to have a big effect on the margin.

[Timothy Mitchell, analyst]

Awesome. Very helpful. And then just one last one on deposit betas, kind of as we think about those on the way down. Do you have a percentage of your book that's indexed or anything else to call out on that front, kind of your expectations related to beta?

[John McWhorter, executive]

We don't have a whole lot to indexed, but we fully expect them to go down just as fast as they went up. That, that's certainly the plan. I know our competitors can sometimes make that a little bit harder, but our intent is to mimic the betas for the way it went up.

[Timothy Mitchell, analyst]

Okay. Very helpful.

[Operator]

[Operator Instructions] Our next question comes from the line of Matt Olney with Stephens.

[Matt Olney, analyst]

I was going to pick up on that last line of questioning there. I think you mentioned 60% of loans are floating bit on the liability side, not a whole lot is indexed and you obviously want to reprice deposits lower. Just help me appreciate, being industry neutral with that setup. It sounds like that'd be more of a challenge to keep everything neutral. Any more color you can provide or help us appreciate how you would be neutral with those dynamics?

[John McWhorter, executive]

Yes. I mean the liability side of the balance sheet is -- it should be just as interest rate sensitive. I mean most of our deposits are in money market accounts, and we fully expect to lower those as rates come down.

We may have a little higher percentage in CDs today than we did a year ago, but I'd have to go back and look what the percentages are. I don't think it's materially different. But most of it is going to be in money market, and we expect it to come down immediately.

[Matt Olney, analyst]

John, what about any kind of lag? I mean is the commentary about being more rate neutral? I assume that would be more of a full cycle over a year or 2 time frame. Could there be an initial lag, where the margin could be negatively impacted as loans reset lower faster than the liabilities could reset from repricing lower?

[John McWhorter, executive]

There certainly could. And again, back to the competitive nature of it, if our peers don't lower rates immediately, it makes it harder for us to do it.

So yes, there could be that lag there that if the first cut, say, for instance, comes in May and is 25 basis points, we can't be the only ones to lower our deposit costs 25 basis points. So there -- yes, there could be some lag there.

[Matt Olney, analyst]

Okay. And you disclosed kind of what the newer loan yields are at in the fourth quarter. Any color on incremental funding of those new loans more recently?

[John McWhorter, executive]

Yes. Most accounts that we're bringing over, being that they're existing accounts at other banks, were paying generally in 4.50% to 5% range.

[Matt Olney, analyst]

Okay. And then thinking about loan growth and kind of capital, I think I heard your loan growth expectations for the year. Help me think about in this scenario of kind of a softer landing, borrowers feeling better about from their point of view.

At what level could you grow loans in '24, before it would start to pressure capital. And then I guess, what's the internal tolerance as far as pressuring capital? Would that be acceptable? Or do you have to really slow things down in that scenario?

[Bart Caraway, executive]

Yes. We're definitely mindful of the capital side of it and that we're going to grow the bank for the best allocation of capital, basically. So there is 0 chance that we'd be interested in raising capital or supplementing. What we're going to do is basically grow loans as prudently as possible to fill out the operating leverage.

But we think the earnings is really going to provide the ability to hit to $300 million to $400 million in loans pretty easily. So I don't see that, that capital is going to be an issue for this year or next, because I think we're going to be able to fully sustain our own growth going forward.

[John McWhorter, executive]

Yes. And if you think about last year, if we made $33 million in net income last year and grew loans about [ 5.50% ]. We used capital doing that. But this year, we're expecting to earn more and grow less. So I think it's very likely that we'll be capital accretive this year.

[Matt Olney, analyst]

All right, guys. That's all for me.

[Operator]

There are no further questions in the queue. I'd like to hand the call back to Mr. Caraway for closing remarks.

[Bart Caraway, executive]

Thank you, [ Doug. ] I appreciate very much. Well done, and thank you all for joining us on the call and for your support of Third Coast Bancshares. We look forward to speaking with you next quarter.

[Operator]

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time, and have a wonderful day.