Q4 2023 Third Coast Bancshares Inc Earnings Call

Presentation

Operator

Greetings and welcome to the Third Coast Bank Fourth Quarter and Full Year 2023 earnings conference call.
At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. 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.

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 Callaway, Chairman, President and Chief Executive Officer, John McWhirter, Chief Financial Officer, and Roger 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 dot TCPSSB. dot com. There will also be a telephonic replay available until February second, 2020. For 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. And 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, 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 websites.
Now I would like to turn the call over to our host, Chairman, President and CEO, Mr. Bart Caraway.

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 two 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 two years can 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?

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 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 had 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, and 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 [6360] and receive Fed funds floating, which today is about [533]. This will give us good margin protection in the event that rates are down less than our 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.

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 Serko's loan portfolio has proven to be resilient. This is due to our conservative underwriting, extensive ongoing monitoring and diversity in the loan mix to mitigate segment specific risk.
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 for 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 two years. And 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. So 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 non-owner 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 CRE 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% of the properties are primarily neighborhood centers and are located within our Texas footprint. Multi-family 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 path to watch.
With that, I'll turn the call back to Bart barns.

Thanks, Audrey. Looking ahead to 2024 third, Costa is confident in its ability to refine and execute our strategic plan while building on the success of the past two 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 is approved. We also regularly review our loan portfolio to identify any potential risks 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 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 risks 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 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 product 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?

Question and Answer Session

Operator

(Operator Instructions) Brady Gailey, KBW.

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

Yeah, relatively unchanged on our side, still $300 million to $400 million consistently. What we're looking at, obviously up at the qualifier and what the economy does may affect it 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. (multiple speakers)
So on the positive side, we've been rolling out strategies all last year on deposit growth, and we're actually feeling better about, yes, 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 contingencies of those those skills are those initiatives working, actually.

Yeah, forecasting deposits have 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 in the deposit campaign where we were giving out prices, if you will, for people that produce the most deposits. I mean some even though that has expired. We still have a lot of deposits coming in from that. It's been it's been very promising.

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

Yeah, so last quarter, we had guided to 5% to 10% noninterest expense growth, and we're still pretty comfortable being pretty comfortable with that number. And 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 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 we're talking, you know, kind of net interest income, what 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.

That's great to hear. Thanks for the color, guys.

Operator

Bernard Von-Gizycki,Deutsche Bank

Hi, guys, good morning. Just on expenses, I wanted to dig in there a little bit on you were slightly above the guide. But just wondering on the legal and regulatory expenses, those saw 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?

Yeah, 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 in 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.

Okay. Perfect. And then maybe maybe on the fee income side, there is that nice lift sequentially and 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 are there some sort of seasonality or anything you're seeing kind of on as the year starts and how it pertains to like, say, 1Q on would you expect that to continue or any color you can add there?

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

Okay, great. Thanks for the color.

Operator

Graham Dick, Piper Sandler

So 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, what the customers looked like. Just anything you could do there on to help us understand like the level of granularity or what type of deposits that came on this quarter would be helpful.

Yeah, we talked before about the deposit campaign that we did in the summer. And you know, we were 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. We expect that to continue.

In the community bankers as well, all of our bankers actually, we've changed the incentive plan. And that takes a little while to roll out, but they've all been in 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've bought business on some funds, the loan comes first and it takes a while to onboard the customer for wallet relationship. And what's been nice towards the end of last year was a lot of those deposits finally came on.

Now that definitely make sense and it's helpful. I guess just looking more so at the margin or the NIM guidance, I guess you can kind of back into this given your loan growth outlook as well and with the NIMD., obviously, I guess loan growth 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 some of that missing.

Yeah, 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 non-interest 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 non-interest bearing demand in the year after the liquidity crisis would would still be going down and some of that may come back by the way and then well, that's my train of thought.

And again, just like with 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.

So the other thing that I was going to say sorry about that was the loan to deposit ratio declining from E&O 98% down to 95%. We weren't necessarily expecting that either. So at year end, we had I don't know, it was $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 in 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 Gino, 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.

Okay, good to hear. So really at the end of the day, it's more balanced driven than anything. Our 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 stay seemingly can't go like all that much lower? Do you feel pretty good about? Maybe bounce around the bottom here a little bit, but nothing nothing super meaningful in 2024?

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.

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

Yes, we're buying models. I'll let Audrey jump in. But for us we're not seeing deterioration in our loan portfolio market remains very strong. So we're expecting more or less the provisioning based on the growth in what our model shows more than anything.

Yeah, we've been carrying a up fairly sizable unallocated portion based on the CECL methodology. So when you saw the ACL to total loans go down from $1.7 million to $1.2 million, we did have that $1.5 million charge off. We didn't need to fully provision to cover that charge-off because we already had it in the ACO. So I wish we still have we've kind of whittled down the unallocated some portion that we had, but we're still well within our range on the ACO.

Yeah, it seems like since going public we've always said just 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.

Operator

Jim Mitchell, Raymond James.

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

Yeah, so what I would tell you is it's still rather difficult on the CRE side just because 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 passed approval that meets our criteria just because of the rate environment. But we do think that we'll end up with them, you know, some good customers that we kind of cherry pick on that. Most of our growth is really going to be and 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, too. And John, do you have anything else to add?

As far as yields on new loans getting a primary point. I mean, we're typically new loans are going in the books between 8.50% and 9%.

And then just thinking about loan repricing in 2'4, you guys have a kind of breakdown on what your variable rate loan book is a chunky fixed rate loans that are coming due and there?

Yeah, our floating rate loans are about 60% of the portfolio. I mean we're very evenly matched to, I think the duration on the asset side of our balance sheet is 10 months or something like that for the entire balance sheets or were very short and anything that we might have that's coming up for renewal, say like older CRE loans in other or certainly loans that we were doing in the fours back two to three 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.

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

We don't have a whole lot of 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 weight went up.

Operator

Matt Olney, Stephens.

I was going to pick up on that last line of questioning there. I think you mentioned 60% of loans are floating, but 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 maybe more of a challenge to keep everything neutral on any more color you can provide or help us appreciate how you would be neutral with those dynamics?

Yeah, I mean, the liability side of the balance sheet, too, is it should be just as interest rate sensitive. I mean, most of our deposits are in money market accounts and you know, 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 I don't think it's materially different, but know most of it's going to be in money market and we expect it to come down immediately.

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

There certainly could. And again, back to the competitive nature of it is or if our peers don't lower rate immediately, it makes it harder for us to do it. So so yes, there could be that lag there that if the first cut say, for instance, comes in Maine is 25 basis points. We can't be the only ones to lower our deposit costs 25 basis points. And so so there, yes, there could be some lag there program 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 and most accounts that we're bringing over being that there are no existing accounts at other banks we're paying generally in in oh 4.50% to 5% range.

Okay. On And then thinking about loan growth and kind of capital, I think per your loan growth expectations for the year, how should we think about in this scenario of a kind of a softer landing borrowers on better about them from their point of view, at what level could you grow loans in 24 before we start to pressure capital? And then I guess what's the internal tolerance as far as pressuring capital, would that be acceptable? Or would you have to really slow things down in that scenario?

Yes, we're definitely mindful of the capital side of that in that we're going to grow the bank for the best, our allocation of capital basically. So there is zero 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 you know it, we think the earnings is really going to provide the ability to hit $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.

And if you think about last year's who, if we made $33 million in net income last year and grew loans about [550]. 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.

Operator

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

Thank you, Doug. 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.