Third Coast Bancshares Inc (TCBX) 2022 Q2 法說會逐字稿

Greetings, and welcome to Third Coast Bank's Second Quarter 2022 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded.

I'd now like to turn the conference over to your host, Natalie Hairston with Dennard Lascar Investor Relations. Please go ahead.

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 2022 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 August 4, 2022, 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, July 28, 2022. 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 company's prospectus or the annual report on Form 10-K that was filed on March 17, 2022, 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 are 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?

Thanks, Natalie, and good morning to everyone. Thank you for joining us today. As stated in the earnings release, Third Coast reported strong loan and deposit growth of about $300 million with $3.4 billion in assets, an increase of 34% year-to-date. The second quarter results also included certain onetime charges of $1.2 million.

John will walk through the nonrecurring items during his prepared remarks. But for now, I'll begin by highlighting significant events in the quarter for our business. 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.

Since this is only our second conference call as a public company, I thought it would help if I shared a brief overview of Third Coast for the benefit of those listening. With over $3.4 billion in total assets, Third Coast is one of the fastest-growing financial institutions in the nation. We have more than 350 employees in 14 branches across the State of Texas, consisting of 7 branches in the greater Houston market, 4 branches in the Dallas-Fort Worth market and 3 branches in the Austin-San Antonio market. Our business lines consist of community banking, corporate banking and specialty finance.

Next, I'll give you an overview of where we are today. Over the past 12 months, due to disruption in community banks across Texas, we've hired 88 exceptional bankers in a variety of roles. We're recruiting and being approached by leading high-performing bankers who view Third Coast as not too large and not too small. These exceptional bankers have both enhanced our loan portfolio and contributed to our loan growth. We believe we are the bank of choice for extraordinary talent across Texas and are well positioned to take full advantage of this market disruption.

In addition to hiring bankers, we recently opened 2 de novo branches to continue to better serve our customers. We opened our new Fort Worth branch during the first quarter of 2022. And in the second quarter, we opened a branch in Georgetown just north of Austin.

As we sit here today, we've identified the following operational objectives. First, the banking industry is constantly evolving. To stay competitive, we must meet the changing needs of our customers by being a nimble and agile bank with the ability to quickly respond to the rapidly evolving business environment. During the second quarter, we announced that we selected Treasury Prime, a leading Banking-as-a-Service company as our strategic partner for our future of banking initiatives. I'll provide you more information about this new relationship later in my prepared remarks. But suffice to say, we expect the platform will provide us with a nimble, scalable, digital platform poised not only to absorb change but to outperform our competitors.

Second, we continue to optimize, digitize, and automate our business processes in order to improve efficiency and responsiveness. Another impactful decision that our organization is excited about is the announcement in early July about joining Alloy Labs, a consortium of community and midsized banks focused on adopting technology more effectively and efficiently by speeding up the pace of innovation of the new fintech products. Third Coast will also have access to Concept Lab, a reverse accelerator program that builds partnerships between banks and startups that provide services outside of traditional banking.

Ultimately, Third Coast technology platform will bring a comprehensive suite of innovative and cost-effective cloud-based fintech products to the market in response to the growing demand from our customers. Additionally, we have committed $5 million to the Castle Creek Launchpad Fund, where I will serve on the limited partners Advisory Committee.

Third, we believe we have the talent, scale, markets and capabilities to meet or exceed our organic growth objectives. Of course, we will always be opportunistic when it comes to considering acquisitions. But for the time being, Third Coast intends to focus on those internal initiatives that best position us for more organic growth and future successes.

Finally, we'll continue to look to the future and not be content with the status quo. Our investments in our future, particularly in research and development, should lead us to some innovative opportunities for Third Coast. We expect these products and customer experience solutions will increase deposits and fee income.

For those who know Third Coast's history, these objectives are a progression of what we have been doing since our inception, including our priorities to diversify our loan portfolio and revenue streams, grow core funding, strengthen our digital capabilities, and improve customer service functionality.

Finally, during the second quarter and to further our ESG initiative, we hosted a free electronic recycling event and launched an e-statements campaign for our customers leading up to the 52nd anniversary of Earth Day. We also worked with a living tribute to plant over 340 trees to recognize each of our employees in honor of Arbor Day.

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 review select balance sheet and profitability metrics for the second quarter of 2022 compared to the prior year and prior quarter.

To recap, we experienced strong loan growth of $301 million to $2.75 billion. This growth was well diversified with commercial loans up $158 million and real estate loans up $117 million. Similarly, if we look at it by line of business, growth was somewhat evenly split between community banking, commercial banking and specialty finance.

Following that trend, deposits grew slightly more than loans at $311 million. We did, however, experience a negative shift from noninterest-bearing deposits to interest-bearing deposits of approximately $400 million. This negatively impacted the net interest margin about 10 basis points and reduced the bank's asset sensitivity. We closed the second quarter with $3.4 billion in assets, up from $2.5 billion at year-end, an increase of almost $900 million.

While we are pleased to have greatly exceeded our growth targets, we do not expect to grow at the same rate for the second half of the year. As of today, we're up about $80 million for the month, and we're targeting near-term growth to be in the range of $75 million to $100 million per month.

Net interest margin was 3.77% for the quarter, a decrease of 32 basis points from the first quarter. Most of this decline was related to the swap between noninterest-bearing and interest-bearing deposits discussed previously, but also resulting from our $82 million sub debt issuance in April and declines in PPP fees at $883,000. Noninterest expense totaled $22.8 million in the second quarter, up from $20.2 million in the first quarter. primarily due to a loss on the sale of other real estate of $350,000 an unexpected onetime legal settlement of $900,000. We also had higher salary expense related to new hires in the first half of the year. Additionally, we're spending approximately $150,000 per month on fintech and Banking-as-a-Service projects.

In early July, to increase our asset sensitivity, we entered into a 5-year swap agreement with a notional amount of $200 million. We will pay fixed at [2.62%] and receive Fed funds floating, which today is about [2.50%].

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

Thank you, John, and good morning, everyone. Asset quality improved during the second quarter of 2022, with nonperforming assets declining by $1.4 million or 11.4% from the first quarter and 15.2% from the second quarter of 2021. The improvement was primarily the result of a decline in restructured loans. Nonperforming assets remained low at 0.33% of total assets from 0.41% in the first quarter and from 0.64% in the prior year quarter. We recorded net recoveries of $4,000 for the second quarter of 2022. Our allowance for loan and lease losses now represents 0.97% of total loans, an increase from 0.95% sequentially and 0.86% in the second quarter of 2021.

That concludes the credit discussion. But before I pass the call back to Bart, I'd like to congratulate him on behalf of every Third Coast employee for being named a finalist for the Entrepreneur of the Year 2022 Central South Award. Entrepreneur of the Year is one of the preeminent competitive business awards for entrepreneurs and leaders of high-growth companies. Bart was selected by a panel of independent judges according to the following criteria: entrepreneurial spirit, purpose, growth and impact, among other core contributions and attributes.

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

Thanks, Audrey, for that. I'm excited to share this very special recognition with our leadership team and dedicated employees, truly humbling. Before we take your questions, I want to expand on something I mentioned earlier that we intend to take advantage of growth opportunities.

Last quarter, we shared that we had formed a fintech committee in 2021 to consider opportunities for Banking-as-a-Service. And in June, we announced our partnership with Treasury Prime. Third Coast through our high-tech suite of treasury management solutions can now provide fintech companies with a supportive and reliable bank partner. Together, Third Coast and Treasury Prime will build a program to enable fintech and enterprise clients to more quickly and easily embed banking services, including bank accounts, payments and cards into their product and service offerings. We believe that embedded finance is critical when delivering personalized day-to-day solutions to clients. Third Coast is prepared to serve today's competitive banking and payments landscape by adding low-cost deposits and diversifying noninterest income streams.

We have entered Phase 2 of the onboarding with Treasury Prime that includes the development of the platform and its integration with our banking systems. We expect to complete the integration late in the third quarter or early in the fourth quarter. Consistent with our fintech strategy, our committee continues to evaluate opportunities as they present themselves.

In closing, while we are cognizant of the anticipated slowdown in the underlying economic activity, we continue to prioritize our investments in our people and leverage our technology to support long-term sustainable growth. We are committed to generating positive operating leverage and remain focused on our strategic growth initiatives as we continue to enhance shareholder value.

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 Instructions) Our first question from the line of Brad Milsaps with Piper Sandler.

John, maybe I wanted to start with the net interest margin. Obviously, a lot of moving parts. I think last quarter, you guided to 19 basis points of core NIM expansion with 100 basis points increase in Fed funds and then about double that with a 200 basis point increase. Obviously, a big change in the funding this quarter. Could you update sort of your outlook there for the margin? I know you've got a lot of variable rate loans coming on. But obviously, we've kind of got a change in the path of how you're going to fund yourself as well. So I just wanted to see if you could give us an update there.

Sure. So just a little color on those accounts. It was 3 accounts. So obviously, very few relatively large accounts that from noninterest-bearing to interest-bearing, and it was a customer that was not all that rate sensitive until when rates were close to 0, but as rates started moving up, they insisted, if you will, on being paid. So we're paying close to Fed funds on those accounts. And the full impact wasn't felt in the quarter because they didn't make that change until about the middle of May, roughly. So to the extent that, that affected the margin maybe 10 basis points in the month, we probably do have a little more next quarter that would affect it.

Other things on the margin, PPP fees were down $883,000 for the quarter. That's something that we're almost through with. We only have $240,000 remaining in PPP. So we won't have the headwind that we had for that in the past. Our all other loan fees were down slightly quarter-over-quarter, not all that material, maybe 5 basis points to the quarter. And then, of course, our sub debt costs, we did not have the prior quarter and we had for the full quarter. And that was probably another 10 basis points also.

Now looking at asset sensitivity going forward, it's hard to fully reflect with all the changes that we've had going on, but the reports at June 30 do still show that we're asset-sensitive, although slightly less so than we were before. So as rates are up yesterday, today, whatever -- however you want to look at it, we do think we're still asset-sensitive. We'll have the headwinds from the noninterest-bearing, but the margin we're forecasting to be roughly flat for the next quarter.

Okay. And I guess, as my follow-up, just on loan yields. I think if I calculated correctly, if I kind of take out the PPP, loan yields were somewhere around 4.70%, 4.69%. Are we close to seeing that sort of stabilize or are new loans coming on and still diluting that yield that we saw as the average for the quarter?

Yes. So I did go in and look at that. And for the month of June, which I assume is kind of going to be the most relevant numbers we have, our average new loan yield for loans booked in June was 4.50%. And our fees, that's a little harder to equate to the whole portfolio. But I think our loan fees going forward on the full portfolio are going to be about 10 basis points a month.

And I assume what you're putting on is mostly variable, so that 4.50% should move up with what happened this week and if we have future rate hikes?

Correct. Our floating rate loans on the entire portfolio were roughly 65%.

We have next question from the line of Michael Rose with Raymond James.

Just wanted to dig into the expenses this quarter. Obviously, a couple of nonrecurring type items. I understand all the investments that you guys are making. I think last quarter, you talked about kind of a $21 million range for the next few quarters, but it seems like it's running kind of at the high end of that range, and we're seeing kind of wage inflation across the states impacting pretty much all banks. Should we think about kind of a higher run rate as you guys build out some of these new products and services?

Yes, I think definitely. So it's hard to put an exact number on that. Some of the projects that we have ongoing are maybe a little harder to define what the expense is. And then the employees that we're hiring, I mean we're certainly seeing the wage inflation that you talked about. And even though our hiring is materially slower than last year, it is definitely not 0. But the people that we're hiring today are either coming to us that are very high performers, that are seeing an opportunity or there are people that we're reaching out to specifically where we have a need. But it's certainly more strategic, more targeted than it was last year, but we've really hired some great people in the last month or 2 that we're really excited about that it takes time for them to fully pay for themselves.

The typical thing about the most expensive day is day 1 when you have all their salary and none of their loans, but there are people that will be high performers that we're excited about.

Yes. If I could echo that with John, is that kind of big themes. In 2021, it was the big team lift outs, which were truly transformational for us. But in 2022, the theme is surgical and opportunistic. And like John said, these are all high-value talent. Almost all of them are approaching us to join us. And it's also folks that quite frankly, you only get kind of once in a lifetime opportunity probably to get. But it is very much a smaller number. We don't have any other large teams that we were looking at. This is all highly productive, high-value talent that's coming on board.

Yes, Michael, we're always saying something between '21 and '22 last quarter, I think is somewhere between '22 and 2030 at this point.

Okay. That's helpful. And then just maybe back to the deposits and kind of following on to Brad's question. Can you just talk about the funding strategy as we move forward? I mean, I understand the rate of loan growth looks like it's going to slow a little bit from where you guys have been. I think that makes sense for a lot of different reasons, but you're sitting at a 95% loan-to-deposit ratio. The beta is obviously ramping pretty high. So can you just give an update there? And just maybe if you can put a finer point, I think last quarter, you talked about getting to a 1% ROA in relatively short order, looks like next year, if you can just kind of address just given some of the changes that we've seen in the funding mix, what that could mean for achievement of that ROA?

Yes. So maybe I'll start and let Bart add on. But for the second quarter, we were roughly 70% wholesale funded, which is certainly higher than we would like to be. I mean that's why we're spending money and time and effort on some of these other projects to get that number down. But we've talked many times in the past about our growth being somewhat lumpy and it's hard to exactly evenly match the funding with our loan growth. And 70% is more than we would like it to be because those deposits are obviously more expensive. It's harder to predict going forward. It's certainly been less than the past, and we hope it will be less in the future.

And then the ROA question, with the lower margin, I think that does push out our time line to get into a 1% ROA to more the second half of next year, where previously, we had thought it would be the first half, and that seems less practical at this margin. So I would guide towards the second half of the year.

Yes. I just want to remind everybody a little bit about on the deposit side. It's really a multipronged approach. And as fast-growing bank as we are, it is a little difficult. But we have a lot of bankers that have good core customers and we get full wallet relationships from. And we are seeing some nice deposits coming in from the community banking efforts as well as the private bankers. There's a few of them that still are not free of restrictions and have some limitations. But by and large, we are getting full wallet relationships. And our treasury platform, again, we're continuing to enhance it, and it has some very robust capabilities that we think we're going to get some momentum on deposits for it. We also have some retail strategies. Those will probably come into play more late fourth quarter, early first quarter before we start seeing some movements on it. And then again, on the fintech side, with the partnerships we're looking at, including with Treasury Prime, we are optimistic that those are going to be some good noninterest-bearing accounts with some fee revenue to them as well. So we'll look at this across several platforms and trying to make sure that we're hitting all of those to bring in the deposits and certainly turn it as core as possible.

All right. And if I could just maybe slip one more in. The drop in derivative income this quarter, I mean is that -- I mean I know it's lumpy, but is this kind of a run rate we should expect? Or do you think it will bounce back in the third quarter?

With rates being so much higher, there are fewer customers that are interested in fixing their rates at this point. There's a few. I mean we didn't do 0 this quarter, but I would expect that to slow down. The higher rates go, just the less likely it is that our customers want to do those transactions.

We have next question from the line of Bernie Von Gizycki with Deutsche Bank.

So my first question, so you noted making -- you're making about $150,000 a month of investments towards the fintech initiatives. And it seems it's a big opportunity for you. I'm just wondering if you could maybe kind of give us a sense like what does this entail? And like are you hiring for this initiative as well?

Yes. So for the most part, we're trying to handle everything on a contract basis to where, as things, we can always dial back expenses if we want on it. And most of these projects we're working on are focused towards core deposit growth is what we're looking at. And there's -- if I could kind of put it in buckets, I would say there's a few in salaries. The most is in consulting and legal. So most of these things can be adjusted if we need it. But the focus is on a lot of these initiatives are bringing over core customers or customers that are bringing low-cost deposits.

(Operator Instructions) We have next question from the line of Matt Olney with Stephens.

I want to circle back on the loan growth discussion. It sounds like you're expecting a bit of a slowdown in the second half of the year versus that first half. Just help us appreciate the slowdown. How much is driven by economic headwinds versus pipelines being a little bit more moderate now versus a few months ago versus do you expect paydowns to accelerate? Just any more color you can provide on that?

Yes, I'll be happy to take that. So right now, our pipelines are pretty robust. But I anticipate, particularly as we get towards the end of the year and first of next year, that the anticipated economic slowdown is going to take its effect. So what we're really thinking about is projecting forward and anticipating lower volumes and maybe some paydowns more than anything. Right now, again, I think our volume is pretty good, mainly because, again, we're moving business from other banks at this point. But I do believe that, that will slow down just a little bit with the economy. Although I still feel like it's going to be robust in one of the fastest-growing banks in the country, we're just believe it's going to be towards that lower range of what we initially projected.

Okay. That's helpful. And then going back to the discussion around the margin and deposits and deposit cost, I'm backing into deposit beta for you guys in 2Q of around 25%. And most banks are talking about deposit betas accelerating in the back half of the year. I would love to hear more about kind of what your expectations are for deposit beta as the back half of the year?

Yes. I think that's likely to be true for us also. 6 or 9 months ago, it seems like everyone was rounding in liquidity and deposits were easy. And they've certainly become more competitive just in the last 30 days or so. I mean, on everything that we're seeing, we could call just every day of customers that are rate shopping saying, "Gee, the bank down the street is paying me x, will you match it to keep the deposits?" 6 or 9 months ago, we just didn't have those calls at all. So the deposit -- the betas that we have in the model, which is hard to say, but I certainly think they will move up just based on what we've seen over the last month.

Okay. And then if I could ask one more question. You talked about the margin being relatively flat, I believe, from 2Q into 3Q and kind of the moving parts around that. Can we take that discussion to the net interest income, the NII, I'm curious how that should look from quarter-to-quarter? I think the NII increased around $2.5 million during 2Q. Is that a good ballpark number for us to think about as far as the improvement from 2Q into 3Q?

Yes. That's a good question. I didn't look at the average balances to see exactly where we stand. I know that the average balances versus period end were up more in the second quarter than the first, but I didn't see exactly where we ended to try to calculate what you're talking about. But generally speaking, yes, the net interest income, we think will be increasing. If the margin is relatively stable, we do still think we'll have enough growth to drive increases in net interest income.

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session. And I'd like to turn the call back to Mr. Caraway for closing remarks. Over to you, sir.

Thank you, Vikram. We appreciate everybody for joining us today on the call and the continued support for Third Coast Bancshares, and we look forward to talking to you next quarter. Thank you all.

Ladies and gentlemen, that concludes the call.

Thank you very much, sir. Ladies and gentlemen, this concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.