Greetings, and welcome to Third Coast Bank's second quarter 2022 earnings conference call. At this time, all participants are in listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference call, please press star zero on your telephone keypad. 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's 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.thirdcoast.bank. 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. We closed the second quarter with $3.4 billion in assets, an increase of 34% year-to-date. The second quarter results also included certain one-time charges of $1.2 million. John will walk through the non-recurring 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're 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 two 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 had 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. 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 mid-sized banks. Focus 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 its customers. Additionally, we have committed $5 million to the Castle Creek Launchpad Fund, where I will serve on the Limited Partner 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. 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 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 non-interest-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 this 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-$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 non-interest-bearing and interest-bearing deposits discussed previously, but also resulting from our $82 million subordinated 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 one-time 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 five-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 non-performing 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. Non-performing 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. 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. 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 non-interest income streams. We have entered phase two 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?
Thank you very much, sir. At this time, we will be conducting our question and answer session. If you'd like to ask a question, please press star one on your telephone keypad. The confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. We request you to limit to one question and one follow-up. Your first question from the line of Brad Milsaps with Piper Sandler. Please go ahead.
Hey, good morning, guys.
Morning, Brad.
Thanks for taking my question. John, maybe 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 net expansion with a 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, you know, 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. Just wanted to see if you could give us an update there.
Just a little color on those accounts. It was three accounts, so obviously very few relatively large accounts that went from non-interest bearing to interest bearing, and it was a customer that was not all that rate sensitive until, you know, when rates were close to zero. As rates started moving up, they insisted, if you will, on being paid. We're paying close to Fed funds on those accounts. The full impact wasn't felt in the quarter because they didn't make that change until about the middle of May, roughly. 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. Then of course our subordinated 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. As rates are up yesterday, today, whatever, however you wanna look at it, you know, we do think we're still asset sensitive. We'll have the headwinds from the non-interest-bearing, but the margin we're forecasting to be roughly flat for the next quarter.
Okay, thank you for that. I guess as my follow-up, just on loan yields, I think if I calculated correctly, if I kinda take out the PPP, you know, loan yields are somewhere around 4.70%, 4.69%. Are we close to seeing that sort of, you know, stabilize or are new loans coming on and still diluting that yield that we saw as the average for the quarter?
Yes. I did go in and look at that. For the month of June, which I assume is kinda gonna be the most relevant numbers we have, our average new loan yield for loans booked in June was 4.50. Our fees, you know, that's a little harder to equate to the whole portfolio, but I think our loan fees going forward on the full portfolio are gonna be about 10 basis points a month.
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%.
Okay, great. Thank you. I'll pop back in queue.
Thank you. Your next question from the line of Michael Rose with Raymond James. Please go ahead.
Hey, guys. Thanks for taking my questions. Just wanted to dig into the expenses this quarter, obviously a couple, you know, non-recurring type items. 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, you know, across the space impacting pretty much all banks. Should we think about kind of a higher, you know, run rate as you guys build out some of these new products and services? Thanks.
Yeah, I think definitely. You know, it's hard to put an exact number on that. Some of the projects that we have ongoing are, you know, maybe a little harder to find what the expense is. Then the employees that we're hiring. I mean, we're certainly seeing the wage inflation that you talked about. You know, even though our hiring is materially slower than last year, it is definitely not zero. The people that we're hiring today are either coming to us that are very high performers that are seeing an opportunity, or they're people that we're reaching out to specifically where we have a need. 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 two that we're real excited about that.
You know, it takes time for them to fully pay for themselves. You know, the typical thing about a lender, the most expensive day is day one when you have all their salary and none of their loans. They're people that'll be high performers that we're excited about.
Yeah. If I could echo that with John, that, you know, kind of in big themes, in 2021, it was the big team lift outs, which were truly transformational for us. In 2022, the theme is surgical and opportunistic. Like John said, these are all high value talent. Almost all of them are approaching us, you know, to join us. You know, it's also, you know, folks that, you know, quite frankly, you only get kind of once in a lifetime opportunity probably to get. It is very much a smaller number. We don't have any other large teams that we're looking at. This is all highly productive high value talent that's coming on board.
Yeah, Michael, where I was saying, you know, something between 21% and 22% last quarter, I think it's more between 22% and 23% at this point.
Okay, that's helpful. 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 gonna slow a little bit from where you guys had been. You know, I think that makes sense for a lot of different reasons. You're sitting at a 95% loan-to-deposit ratio. You know, the beta's obviously ramping pretty high. Can you just get an update there? Just maybe if you can put a finer point.
I think last quarter you talked about, you know, getting to a 1% ROA, you know, in relatively short order, you know, looks like next year. If you can just kind of address, you know, just given some of the changes that we've seen in the funding mix, what that could mean for achievement of that ROA. Thanks.
Yeah. Maybe I'll start and let Bart add on. 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. You know, 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. You know, 70%'s 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 in the past, and we hope it'll be less in the future.
The ROA question, with the lower margin, I think that does push out our timeline to getting to a 1% ROA towards 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. I would guide towards the second half of the year.
Yeah. Just to kind of follow up.
Okay.
Oh, go ahead, Michael.
Nope. Go ahead. I'm sorry.
Yeah. I just want to remind everybody a little bit about on the deposit side that, you know, it's really a multi-pronged approach. 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. We are seeing, you know, some nice deposits coming in from the community banking efforts as well as the private bankers. You know, there's a few of them that still are not free of restrictions and have some limitations. By and large, you know, we are getting full wallet relationships. In 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. On the FinTech side, with the partnerships we're looking at, including with Treasury Prime, you know, we are optimistic that those are gonna be some good non-interest-bearing accounts with some fee revenue to them as well. We're looking at this across several platforms and trying to make sure that, you know, we're hitting all of those to bring in the deposits and certainly turn it as core as possible.
All right. Thanks for the color. If I could just maybe slip one more in. The drop in derivative income this quarter, I mean, it's just I know it's lumpy, but is this kind of a run rate we should expect, or do you think it'll bounce back in the third quarter? Thanks.
You know, with rates being so much higher, there are fewer customers that are interested in, you know, fixing their rates at this point. There's a few. I mean, we didn't do zero this quarter, but I would expect that to slow down. The higher rates go, the less likely it is that our customers want to do those transactions.
All right. Thanks for all the color. Appreciate it.
Thank you.
Thank you. We have next question from the lineup, Bernard Von Gizycki with Deutsche Bank. Please go ahead.
Hey, guys. Good morning. My first question. You noted 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? Like, are you hiring for this initiative as well?
Yeah. For the most part, we're trying to handle everything on a contract basis, to where, you know, as things we can always dial back expenses if we want on it. Most of these projects we're working on are focused towards, you know, core deposit growth is what we're looking at. 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. Most of these things can be adjusted if we need it. The focus is on a lot of these initiatives are bringing over core customers or customers that are bringing low cost deposits.
Okay. Thank you.
Thank you. Again, if you have a question, please press star followed by one on your touchtone phone now. We have next question from the line of Matt Olney with Stephens. Please go ahead.
Yeah, good morning. Thanks for taking the question. Wanna 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 pay downs to accelerate? Just any more color you can provide on that. Thanks.
Yeah, I'll be happy to take that. Right now our pipelines are pretty robust. You know, I anticipate, particularly as we get towards the end of the year and first of next year, that the anticipated economic slowdown is gonna take its effect. What we're really thinking about is projecting forward and anticipating, you know, lower volumes and maybe some pay downs 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. I do believe that will slow down just a little bit with the economy. Although, I still feel like it's gonna be robust and one of the fastest growing banks in the country.
We're just, you know, believe it's gonna be towards that lower range of what we initially projected.
Okay. That's helpful. Thank you for that. 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%. I think most banks are talking about deposit betas accelerating in the back half of the year. Would love to hear more about kind of what your expectations are for deposit betas the back half of the year. Thanks.
I think that's likely to be true for us also. You know, six or nine months ago, seems like everyone was drowning 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 get calls 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?" God, six or nine months ago, we just didn't have those calls at all. You know, the deposit betas that we have in the model, you know, it's just hard to say. But I certainly think they will move up just based on what we've seen over the last month.
Okay. 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?
Yeah, 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. 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.
Okay. Thank you.
Thanks, Matt.
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, Bikram. 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 y'all. Ladies and gentlemen.
Thank you.
This 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.