Third Coast Bancshares Q2 2024 Earnings Call Transcript

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July 25, 2024

There are 9 speakers on the call.

Operator

Greetings, and welcome to the Third Coast Bank Second Quarter 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. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Ken Dennard.

Speaker 1

Thank you, operator, and good morning, everyone. We appreciate you joining us for Third Coast Bancshares conference call and webcast to review our Q2 2024 results. With me today is Bart Carraway, 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.

Speaker 1

3rdcoast. Bank. There will 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.

Speaker 1

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 ks 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.

Speaker 1

Now I'd like to turn the call over to the Third Coast Chairman, President and CEO, Mr. Bart Carraway. Bart?

Speaker 2

Good morning, everyone, and thank you, Ken. Welcome to the TCBX 2nd 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 Q3 and the rest of the year. To start, I'd like to highlight the great strides the company has made in improving profitability.

Speaker 2

Since our Q1 as a public company, which was the Q4 of 2021, I'd like to note some of the progress. First, we have grown quarterly net interest income from $24,600,000 to $38,900,000 a dramatic increase of 57.8%. Also, we have decreased non interest expenses for 3 consecutive quarters resulting in a non interest expense to average earning asset ratio of just 2.39%. We have also improved our efficiency ratio since the Q4 of 2021 from 75.3% to 61.4 percent, and we have also doubled our allowance for credit losses from 19,300,000 to 38,200,000. The net result has been an increase of tangible book value of $4.90 or 23.7 percent 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.

Speaker 2

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? Thank you, Bart, and good morning, everyone. In yesterday's earnings release, detailed financial tables were provided.

Speaker 2

So today, I'll offer further insight into specific financial results for the Q2. Our 2nd quarter net income was 10,800,000 dollars resulting in 10.5 percent 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 $12,000,000 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.

Speaker 2

Bond anticipation notes are classified as tax free municipal loans on the balance sheet. They paid down $40,000,000 in the 2nd quarter and approximately $40,000,000 more in pay downs for the 3rd quarter will take us down to 0. They were among the lowest yielding loans on the books at approximately 5.5%. Overall loan pipeline for the 3rd and 4th quarters appear strong and in the $50,000,000 to $100,000,000 range. Non interest expenses were down slightly for the 3rd consecutive quarter and we continue to target a base in the $26,000,000 range.

Speaker 2

Investment securities were up $40,000,000 for the quarter and AOCI improved from $2,900,000 to 4,200,000 dollars With rates at current levels, it is unlikely that we will add to the portfolio in the Q3. Tax expense for the quarter was 3,400,000 dollars 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 3rd 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%.

Speaker 2

As we highlighted last quarter, deposit growth in the Q1 exhibited seasonal patterns and as anticipated deposits decreased for the Q2. We did improve the overall deposit mix by adding more non interest bearing deposits. Our loan to deposit ratio was 97% aligning closely with the projected range of 95% to 98 percent expected to be maintained throughout the remainder of the year. Since we were capital accretive for the quarter, the bank dividended 10,000,000 to the holding company to both maintain cash reserves and pay down $7,000,000 in debt, which we had at a rate of 7.85%. That completes the financial review.

Speaker 2

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

Speaker 3

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 $20,000,000 or 33.4 percent during the Q2. The decline was primarily the result of the payoff in full of a $14,600,000 substandard loan. Nonperforming loans to total loans increased slightly to 0.65 percent from 0.58 percent the previous quarter, primarily due to one relationship totaling $7,900,000 that was placed on non accrual.

Speaker 3

The combined LTV is 69% based upon 2024 appraisals and we do not anticipate a loss. Net charge offs for the quarter totaled $1,800,000 which was primarily due to the $1,200,000 charge off of a Main Street Lending Program loan. The bank originated 6 Main Street loans, of which 2 remain and both are current. Combined gross fee income from the Main Street loans was $1,700,000 The loan portfolio mix remained well balanced with percentages similar to the previous quarter. C and I loans represented 36% of total loans.

Speaker 3

Construction, development and land loans increased slightly to 20%, while owner occupied and non owner occupied CRE represented 13% 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 percent 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%.

Speaker 3

Multifamily represents 3.3 percent of total loans and has an average LTV of 59%. And with that, I'll turn the call back to Bart. Bart?

Speaker 2

Thank you, Audrey. Before delving into discussions regarding our Q3 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 Barryl'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 rallied 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.

Speaker 2

As we plan for our operations in the Q3, 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.

Speaker 2

We therefore continue to expect growth of $50,000,000 to $100,000,000 per quarter. This should drive net interest income growth to exceed 10%. Coupled with non interest 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 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.

Speaker 2

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

Thank you. We will now be conducting a question and answer session. Your first question comes from Michael Rose with Raymond James. Please go ahead.

Speaker 4

Hey, good morning guys. Thanks for taking my questions. 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 Q3, should we think about that $50,000,000 to $100,000,000 net of that or includes excluding that?

Speaker 2

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.

Speaker 4

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 open 2 new branches. I assume that will kind of help as well.

Speaker 4

But we have heard from some other banks, maybe some larger ones that 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? Thanks.

Speaker 2

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.

Speaker 2

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.

Speaker 4

Very helpful. Thanks, Bart. 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 $2,000,000 a quarter, obviously above that this quarter.

Speaker 4

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 it's about $275 a quarter, but just can you discuss some of the drivers of the performance and expectations going forward? Thanks.

Speaker 2

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 $2,500,000 sort of range for fee income.

Speaker 2

So we had about $600,000 in SBIC and that's hard to predict what it may be, it may be 0 next quarter, it may be a couple of 100,000. It's not going to be 600 again, but loan fees I think will make up the difference will be kind of in that $2,500,000 range.

Speaker 4

Very helpful. I'll step back. Thanks guys.

Speaker 2

Thank you.

Operator

Next question, Woody Lai with KBW. Please go ahead.

Speaker 5

Hey, good morning guys.

Speaker 2

Good morning, Woody.

Speaker 5

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

Speaker 2

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 balance is jump back up.

Speaker 2

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.

Speaker 2

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 slightly liability since it's been, I think, John has done a great job of positioning us to do that.

Speaker 5

Yes, that makes sense. And then the non interest 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?

Speaker 2

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 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 non interest bearing number of accounts are growing and we're trying to work very hard in growing that the actual balances on it.

Speaker 5

Yes. 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?

Speaker 2

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.

Speaker 5

All right. Makes sense. Thanks for taking my questions.

Speaker 2

Thank you.

Operator

Next question comes from Bernard Von Gazzicchi with Deutsche Bank. Please go ahead.

Speaker 6

Hey, guys. Good morning. 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 the nice pickup in the loan yields of the 11 basis points sequentially.

Speaker 6

I know, John, you mentioned the runoff of the low yielding munis help 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?

Speaker 2

Yes. So it was a little bit better in the Q2 than I had expected. I mean that 360 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.

Speaker 2

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 3.60 range, I think whether rates stay where they are or if the Fed finally just does decide to start cutting rates. I just don't see a big change in that number. It should be about the 360.

Speaker 6

Okay. Got it. And then maybe just moving to expenses. Obviously, you talked about it a little bit, but came in lower than expected. A few lines I was hoping to get some color on.

Speaker 6

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 could just provide some color on maybe some of the details that drove that down for the quarter?

Speaker 2

Yes. So we've done a particularly good job on headcount 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 made my comments, I was thinking about the Q3 does have one extra day and we do accrue salary expense on a daily basis. So that's probably several $100,000 extra for the Q3 just by itself.

Speaker 2

So we'll kind of be in that 26 dollars to $26,500,000 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. To the branches that we open. There's a couple of employees there.

Speaker 2

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. I don't know what the percentages work out to be maybe 2% or 3%, but kind of in I think less than 20 $6,500,000 would be my best guess.

Speaker 6

Okay, great. Thanks for taking my questions.

Speaker 2

Thank you.

Operator

Next question, Jordan Jeng with Stephens. Please go ahead.

Speaker 7

Hey, good morning. Thanks for taking my question. Most of them have been answered, but I just wanted to touch on the interest bearing deposit costs. 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 seeing and maybe like a month to month basis?

Speaker 2

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.

Speaker 2

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 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 that we were doing.

Speaker 7

Perfect. Thanks for answering my question.

Operator

Next question, Dave Storms with Stonegate. Please go ahead.

Speaker 8

Good morning. 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-sixty number? And if there is, is there any sort of timeline or goal to get to that number?

Speaker 2

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% lower and lower from there. As the bank continues to grow, I think it will be below $60,000,000 The timing is harder to predict.

Speaker 2

If we grow loans $50,000,000 $75,000,000 in the 3rd 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 Q3 probably Q4 but this concept of additional operating leverage where we're growing top lines faster than expenses, we think is intact. We think that will continue on for many quarters. Yes. And if I could add on to that, I mean, it is a consistent topic with the management team.

Speaker 2

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's ahead of what I projected us to be.

Speaker 2

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 us 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.

Speaker 8

Understood. That's very helpful. Thank you. And then just one more for me. With the headcount 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?

Speaker 2

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 headcount. So I think just there's a lot of conversations about it. Our goal, we know, is to improve the efficiency ratio.

Speaker 2

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 what the momentum we have is just 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.

Speaker 8

Understood. That's very helpful. Thank you for taking my questions and good luck in the next quarter.

Speaker 2

Thank you. Thanks.

Operator

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

Speaker 2

Thank you, Stacy. Just appreciate everybody for joining us on the call and your continued support of 3rd 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.

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Third Coast Bancshares Q2 2024
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