ServisFirst Bancshares, Inc. Q2 FY2020 Earnings Call

Good afternoon, and welcome to the ServisFirst Bancshares Second Quarter Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Davis Mange, Vice President of Investor Relations. Please go ahead.

Good afternoon, and welcome to our second quarter earnings call. We'll have Tom Broughton, our CEO; Bud Foshee, our CFO; and Henry Abbott, our Chief Credit Officer, covering some highlights from the quarter, and then we'll take your questions. I'll now cover our forward-looking statements disclosure. Some of the discussion in today's earnings call may include forward-looking statements. Actual results may differ from any projections shared today, due to factors described in our most recent 10-K and 10-Q filings. Forward-looking statements speak only as of the date they are made, and ServisFirst assumes no duty to update them. With that, I will turn the call over to Tom.

Thank you, Davis, and good afternoon. Thank you for joining our call. I'll talk a little bit about the second quarter. It was a historic quarter in many aspects, and the first and most obvious thing that struck me about the financial statement is we ended the quarter with the highest level of liquidity that we've ever had in the company, and by far the most improvement in any one quarter with $1.5 billion in e-deposits. We did close over $1 billion in PPP SBA loans for almost 5,000 borrowers. We have seen the market share reports, and among the loans greater than $150,000, ServisFirst had a number one market share in both the State of Alabama and in Birmingham. I usually don't make self-congratulatory statements on this call; I let results speak for themselves, but we do think that is a good sign for the future, and that we have strong relationships with owner-managed privately-held companies in the State of Alabama and the rest of our footprint. So, we think there's good opportunity to grow our bank with those opportunities that we see there. Also, from a historic standpoint, it was the largest decline in line utilization in any quarter with the decline from 49% to 40%. That is a huge amount of drop; we attribute a lot of it to the paydowns from the PPP facilities, loans to the borrowers' lines, as well as, I think, people have just been conservative and cautious to pay down their lines where they are able. So, it shows the strength of our company. That in turn essentially led to a decline in loans of about $275 million, as we would have had additional loan growth in the quarter of $275 million if we were not seeing that decline in line utilization. Most of our PPP income in the quarter was offset by one-time expenses. Bud will be talking about that in a few minutes. We did see a good bit of improvement in all our asset quality metrics in the quarter with reductions of both NPAs and very low past dues. Henry Abbott is going to discuss a good bit more in terms of asset quality in a few minutes. I know that's a topic certainly during the pandemic and the recession we've had over the last few months. Talking about loan deferrals, that's obviously a subject of huge interest today. Our loan deferral peaked at the end of May at $1.248 billion. Those deferrals, as of July 15, have fallen about over 90% to a current level of $127 million. We expect further declines from there over the next several weeks. So, we feel good about where we are. Henry Abbott and I as well can address any questions you have about loan deferrals in our future policy. Our 90-day loan pipeline is down about 20% from the first quarter, which is certainly something you would expect to see, given COVID-19; I think a lot of people hit the pause button on projects. We are seeing more moving forward over the last few weeks. So, I think it'll improve. Our total pipeline, including loans greater than 90 days, is consistent with the March 31 end of the quarter. So, we think we'll see it get back to normal over the next couple of months. We did make an additional loan loss provision in the quarter to pull us in line with our CECL model. So, we can talk about that as additional questions that you have. Also of note, our loan loss reserve in equity exceeded $1 billion for the first time in our history. So, we're certainly proud of that to reach that milestone. I was now going to ask Henry Abbott if he'll give us an update on the effects of the pandemic on certain industries in general, and a credit quality update. Henry?

Thank you, Tom. The Bank's loan portfolio has continued to perform well in the second quarter despite the economic impact of COVID-19. At the end of the quarter, past dues decreased by $2.8 million from the first quarter, and non-performing assets decreased by roughly $12.7 million. Past dues to total loans were 13 basis points, and NPAs were 26 basis points for the quarter. This 30% decrease in NPAs was primarily driven by a settlement being reached on our largest non-performing asset. I'm pleased to say we have no more exposure related to that credit. Part of our second quarter charge-offs were related to exiting it. As a reminder from prior comments, the bank has a well-diversified loan portfolio in both geography and industry classifications. The portfolio is granular, and we have no major concentrations within industry credit codes. We initially took a three-month approach to deferrals and are assessing future deferrals proactively to assess the borrower's current financial status. At the end of May, we had roughly 15% of our portfolio on some form of a deferral. By comparison, as Tom mentioned, we were down to $127 million in loans, roughly 75 units. We had some clients in severely COVID-impacted industries who needed additional deferrals, and we have and will continue to underwrite their ability to repay the debt in the current operating environment. To date, we've granted roughly $60 million in second deferrals. As documented by this trend, it is our expectation that the overwhelming majority of our clients who had the deferral will or have already returned to normal payments. Slide deck we have posted highlights some of the comments I'm about to make in more detail. As laid out on slide four, we're not a large hotel lender, as noted by hotels being less than 2% of our loan portfolio. The majority of our hotels are flagged, and none are oriented towards conventions or resort style accommodations. Over 83% of our hotel portfolio is not on a deferral, and none are currently on the watch list. Restaurant exposure is noted at less than 3% of our portfolio. Retail CRE consists of $270 million in loans, or 3.5% of the loan portfolio, the average loan size is less than $2 million in this segment and is to well-established borrowers with whom we have longstanding relationships. We continue to proactively assess our loan portfolio in these more COVID-impacted industries, as well as others, to ensure we're taking appropriate measures as necessary. As referenced by Tom in prior comments, we've seen an uncharacteristic drop in commercial line utilization. It is my speculation this is driven by PPP loans helping provide our borrowers additional liquidity, and this decreasing utilization helped show the continued strength in our commercial loan portfolio. We're continuing to utilize our proven incurred loss methodology for calculating our ALLL and delaying CECL implementation. However, with the second quarter, we increased our loan loss reserve to support the reserve as provided by our CECL model, and it is our intent to continue running parallel models. As of June 30, our reserve was 1.10; however, when excluding PPP loans, we were actually at a 1.26%.

Thank you, Henry. Bud Foshee is now going to give a financial update. Bud?

Thanks, Tom. Good afternoon. Net interest margin for the second quarter was 3.32% versus 3.58% for the first quarter. Adjusting for the average PPP loan balances of $886 million, PPP interest income, and $2.6 million in PPP loan fees, the net interest margin was 3.47%. Also adjusting for the increase in average Fed funds sold balance of $358 million in the second quarter, the net interest margin was 3.44%. The remaining net deferred PPP deferred fees are $28.9 million. That breaks down into fees of $31.1 million and deferred FASB 91 expenses related to the PPP loans of $2.2 million. As far as future improvement to our interest expense, we have CD maturities for the remainder of 2020 at $247 million. The average rate is 1.67. We expect the majority of these CDs to reprice at 0.7% or below, and we are also reviewing our special rate DAs. Another factor is we have $50 million of brokered CDs that mature in August, and the rate on those CDs is 1.67. A reminder, we have no accretion income related to acquisitions. Liquidity, as Tom touched on this, Fed funds sold when we started funding the triple PPP loans in April was $600 million, and the excess funds at the end of June were $1.44 billion. For our non-interest income, we added six new banks in the second quarter through the American Bankers Association credit card referral program. Credit card net income was $1.4 million in the second quarter versus $1.7 million in the first quarter. The spend on our purchase cards decreased about $4 million in the second quarter, and the spend on the business credit cards decreased by $9 million, and we think the majority of that is related to COVID. Merchant services fee income in 2020 so far is $234,000. We expect that to improve, because year-to-date 2019 was $249,000, and we will have two officers dedicated to selling into service. Mortgage banking income was up $1 million for the quarter, totaling $2.1 million in the second quarter versus $1.1 million in the first quarter. Also, we purchased a LIBOR cap with a $300 million notional amount, the mark-to-market adjusted in the second quarter was negative $252,000. The strike price for that cap is 0.50%. A reminder, we do not sell any government guaranteed loans to generate non-interest income. Non-interest expense; the PPP expenses for the quarter were $3.2 million, with $2.5 million of that being bonuses and overtime. ORE expenses for the quarter increased $703,000, due to the updated appraisals on credits. Total producers were down net of six producers year-to-date, from 139 at the end of 2019 to 133 at the end of June. Total employees were down four, from 506 at the end of 2019 to 502 at the end of June. Capital banks' Tier 1 leverage ratio was 9.90% at June 30, and the tax update, quarter-to-date tax rate for 2020 is 20.95%, 21.22% without stock option tax credits of $136,000. The second quarter of 2019 was 20.74%, 21.15% without stock option credits of $186,000. Year-to-date 2020 is 19.95%, 21.26% without stock option credits of $1.2 million, and year-to-date 2019 was 20.15%, 21.23% without stock option credits of $958,000. The projected rate for the remainder of this year is 22%. This concludes my comments, and I'll turn the program back over to Tom.

Bud, thank you. Just a few things before we take questions, and one thing I'd like to comment on is from a standpoint of economic improvement we've seen it greatly exceeded almost any economist's expectations. I would agree with most of them who currently think that we're going to need a couple of years to get back to a fully employed economy, and I do think the community banks in our country will play a major role in helping us create the jobs necessary to get back to full employment. The political mood is such that they recognize that the community banks are necessary in our country, whether you're Democrat or Republican. I think they recognize that at this point in time. It's actually our last quarter. We do see significant opportunities for growth on the other side of this pandemic. You know, from a liquidity standpoint, I was fully expecting that we would need to draw on our PPP liquidity facility at the Fed by the second or third week of April. Meanwhile, our liquidity has improved by $1.5 million in the quarter. My hope was that certainly the PPP money would prove to be much like hurricane money for banks that have been affected by hurricanes. I call it "hurricane money," because the money comes in, and it might change hands, but still stays in the banking system, and so it hopefully stays in our bank. For one, our customers who got the money paid employees like they did to other vendors; those vendors put the money back in the bank. So, we continue to enjoy those deposits at least for the time being. We do think with high liquidity and excellent credit quality, we will be positioned well as we go forward the rest of this year and in 2021. We're glad to answer any questions you have. Thank you.

And our first question comes from Kevin Fitzsimmons of D.A. Davidson. Please go ahead.

Hey, good evening, everyone.

Hi. How are you, Kevin?

I'm good. I'm good. Listen, I'll probably start out with a very top-level one. On PPP, it's obviously very lumpy and it affects several different areas in terms of average balances, the origination fees, and maybe when you touch on that, Bud, I think last quarter you guys had talked about maybe that flowing through the non-interest income line, but it looks like it's flowing through the margin line like the other banks. In terms of the impact of the margin, just if you're looking out over the next few quarters, how should we be modeling PPP if you were us? Thanks.

Yes, final guidance on the accounting for that came out in June. Also, we have set it up to be deferred over the 24-month term. So, we'll accrete that into income over the 24-month term. It will be $1.3 million a month that we accrete. It would be $1.1 million a month after you net out the deferral for the deferred FASB expense. Is that what you're looking for, kind of a monthly or quarterly totals?

Yes, that's helpful. Bud, what do you expect regarding the forgiveness and the fees being accounted for as a lump sum? It seemed like we anticipated that in the third or fourth quarter, we would see these loans forgiven all at once.

Yes, I think we're still waiting on final guidance on that from SBA. If I had to take a guess, I would say probably November, I would think, before all that settled and we get our funds back from SBA on that, but that's just a guess. Maybe Tom, I don't…

Kevin, I don't have the form yet. We couldn't apply for forgiveness today if we wanted to. We do have a positive carry on these loans, so we're not. Again, we thought our liquidity would be such that we'd be into the Fed window by now, but we haven't touched it, and are looking for a home for liquidity trying to find investments to buy instead. So let's say that they come out with it in August, and we start the forgiveness process; in September, we apply, so then they've got 60 days to pay us. It might come as early as October, it might come as late as November or December as well before, and we underwrote the idea behind 100% of our loans that were PPP loans is that they would all be forgivable loans. So, we may end up with some small amount of money, but I can't imagine it would be more than $20 million, $30 million, or $40 million of money left out in PPP loans after the forgiveness period. Does that give you a good enough answer, Kevin, or…

Yes, I guess the simplistic way to think about it is that as we're entering 2021, the PPP balances are gone off the balance sheet, the origination fees are mostly realized depending on how we model that in. And then maybe if you could just touch on the margin, I know last quarter, you said you hoped the core margin would stay about the level of March, which I think was 3.60, and I know we have lumpiness from PPP, but I guess the excess liquidity was the big drag there on the 3.60 versus the 3.44. Is that how to think about that?

Yes, yes, because it's gone up well today from when we started funding the PPP, the liquidity is up $1 billion, we are $1.6 billion today in excess funds over $600 million when it started.

As the PPP program winds down, will the excess liquidity decrease as well, leading to a reduction in the balance sheet, while your percentage margin potentially increases?

Yes, the most important factor is increasing our loan production. We dedicated a significant amount of time in the second quarter to the PPP loans, and we recognize that we need to boost loan production. Ultimately, it relies more on the loan production aspect than anything else. We are hopeful about how liquidity will be affected.

Yes, when it comes to the PPP loan proceeds, that's a good question. I don’t have the answer, Kevin; this is my first pandemic.

Mine too. I took enough time. Thank you very much.

Thank you.

Thank you.

Our next question comes from Brad Milsaps of Piper Sandler. Please go ahead.

Hi, good evening, guys.

Hey, Brad. Good afternoon.

Hey. Tom, you guys had some nice improvement in non-performing loans, looks like the deferrals are headed in the right direction. Just curious if you guys could talk about maybe criticized or classified loan trends that kind of might be going on in the background. It sounds like you're really pretty encouraged about the credit outlook as best as you can tell, but just any trends there would be helpful?

Yes, I think we've added one significant credit this quarter; it's not on the list of credits we highlighted in the slide deck, but it is clearly affected by COVID-19. It’s a specialty transportation company that is going to have issues until we get behind the pandemic and get a vaccine. So, that's probably the number one credit that we've added. And Henry, would you add anything else to that statement?

No, I mean I think we're assessing the portfolio, but that's been the one big item that's been impacted that can take longer to come back.

But there's no big change in the level of criticized and classified loans from June 30 to March 31?

I wouldn't say any outside of that one credit, no material figures.

Got it, got it, okay. And then, Bud, just kind of wanted to quickly follow up on expenses. You had the $2.5 million in bonuses that were paid in the second quarter; I presume won’t be there in the third. But then I just wanted to confirm the FAS 91 costs that you expect, I think $2.2 million going forward. Did you get the benefit of all those deferred costs in the second quarter, or is that the piece; the $200,000 or so that's going to accrete in over the 24 months? Just want to make sure I'm kind of clear on the puts and takes of the expense line item this quarter.

Yes, I know, we took $2.4 million as a credit, $2.4 million as a credit against salaries and benefits, and then that plus the fee accretion, all that nets to the interest income, but that will go against the margin once that accretes or amortizes backed in income over 24 months.

No, you've got between the two, you had $28.9 million net between the fees and the deferral, and that $28.9 would have 22 months left to accrete into income.

Understood, but the FAS 91 that you incurred in the second quarter that essentially offset the bonus payment, so in other words, in the third quarter you're going to stay relatively flat?

Yes, right, you had that $2.5 million of expense offset by the $2.4 million into deferral in salaries and benefits.

Okay, got it.

Does Brad have a net number? The net income number is $1.4 million of PPP in the second quarter.

I think what he termed that is 2.5 in bonuses and overtime minus what you deferred in FASB, in salaries.

I thought you were trying to arrive at an answer, and I thought I'll help him get there. Sorry.

Yes, yes. That's helpful. And then the difference, I think you said $4.1 million in fees this quarter, or $2.6 million in fees and $4.1 million in total; the difference would be the coupon and the fees, is that right?

No. So, we took $2.6 million in fees. So, $1.3 million a month is what we defer from a fee standpoint.

Okay, got it. All right, I may follow up with you, but thanks very much, I appreciate it.

Okay.

I'm confused. So, you might see a slip, Brad.

Yes, I will follow up with you offline.

I will just tell you, deferral business is very confusing. I look at it as a very straight bar; we took almost $5 million of the PPP money into income, and then we had expenses that offset it. We had $1.8 million pre-tax, and you take taxes out, we had $1.4 million net income for the quarter of PPP. Now this is after we thought we had a clear understanding of how that we could take all the PPP fee income in the second quarter, but obviously that changed on us. We cannot change their opinion on what we thought was their opinion. It's not a typical origination fee. We don't look at it as - I didn't think it should be characterized as a typical origination fee.

Yes, the best way going forward will be to have gross $3.3 million each quarter, and we will net defer the fees and the deferred FASB, which will contribute to income each month. Your expense side will go away since all the PPP expenses were recorded in the second quarter. Therefore, moving forward, you'll see that $3.3 million reflected in the margin until those loans are paid out.

Got it, I understand. So, about $3.3 million each quarter, assuming they reach that. Yes, I'm on the same page. Thank you, everyone. I really appreciate it.

Thank you, Brad.

Our next question comes from Arjun Tuteja of Jarislowsky, Fraser. Please go ahead.

Good evening, guys.

Hi, Arjun. How are you?

Very well, very well. I have a couple of questions. The first one is on competition. Are you guys seeing competition pull back, mainly the big banks which usually tend to in these times, and sometimes those give opportunities for someone like us to grow using that dynamic played out?

Yes, we are different. Especially primarily one thing is multifamily construction projects that they are pulling back, and the pricing has strengthened. In fact, we've seen pricing strengthen across the board during the pandemic in every area. We're not seeing the intense price competition that we saw prior to the pandemic. You still see some, there are some people that hadn't gotten the memo. Yes, the world changed a bit, a few banks, typically smaller banks that haven't gotten the memo; the world has changed. So we're seeing competition pull back, we do see, we did a lot of PPP loans for customers of other banks during the pandemic with an understanding that they would move their bank into us, and we've also had a lot of companies contact us that were unhappy with the bank. They did their PPP loan through their bank, but they want to go through the forgiveness period with their old bank before they change banks, which is certainly understandable. I would do that myself. So, we do see opportunities there, Arjun.

It's good to see that pricing is improving since the Fed rate cuts, as better pricing can help maintain a solid margin. My second question concerns our losses. I'm pleased but a bit confused, so I need some clarification. When I review your provision line, I don’t perceive a recession in the U.S. However, other major banks and peers are taking significant provisions. I'm wondering if this situation is specific to our bank due to tighter credit, or if it relates to the strength of our customer segment. I'm not solely referring to COVID-related losses in sectors like hotels and restaurants; I'm talking about losses typically associated with recessions that we don’t see currently. I'm considering that if we foresee a recession, we might estimate a certain level of losses. However, I can’t predict which customers may face bankruptcy, so I might provision for it now and keep it in mind. Can you clarify our viewpoint on this?

You're asking a good question. I can’t speak for other banks and their provisions, but we're not heavily involved in industries that are significantly affected. We have minimal exposure to energy, and our exposure to restaurants and hotels is managed well. Since the pandemic began, I've maintained that it's not just the customers in the impacted sectors who will suffer, but rather the weaker customers across all industries, and that pattern is becoming evident. The weaker players are struggling, and as I mentioned in the last call, it’s not surprising that J.C. Penney has faced financial difficulties because they have not been a strong company for a long time. We believe we've provided adequately, surpassing what our model requires. We're aligning our provisions with our CECL model. We don’t have significant consumer or energy exposure, which are areas known for larger revisions. As I review some of the larger banks' financial statements, I’m unsure if there’s anything you'd like to add, Henry.

Yes, thank you.

I mean, I'd say that if you look at what we reserved in the second quarter of 2019, we reserved roughly $5 million. In this quarter, we put in $10 million. So, I mean we've doubled from where we were a year ago. So, we're certainly reserving, and as Tom mentioned, we put more than our model, and as my comments were earlier, we could be around 1.25 or 1.26 on a reserve, so we think we're adequately reserved before we have.

Thank you. Yes, that helps. Thank you very much.

Thank you.

Our next question comes from William Wallace of Raymond James. Please go ahead.

Thanks. Good evening, guys.

Hi, Wally.

Hi. So, I was surprised at how well your deferrals have improved, and if I'm reading the table on slide five correctly, it would appear that the majority of your deferrals are coming off before the deferral period is even over. Am I reading that correctly?

Go ahead, Henry.

No, I mean, they're not coming off before the deferral period is over. So, I wouldn't agree with that statement, but once someone has gone through their three months of no payments, we are then taking them off deferral unless we're in discussions with them regarding the second deferral. So, the table should show that progression decreasing based on the fact that that next payment due from that borrower would be a full payment, which would be owed.

Oh, okay, got you. So, are you in conversation with all these customers that you feel confident that the $1 billion or so in loans that are coming off deferral between now and the middle of August are actually going to pay. Are those conversations ongoing?

We've had over a billion come off.

Come off.

So yes, what's the difference?

Give him some wide points, Henry.

So, for instance, if someone started deferral on April 5, okay, so they didn't make an April 5 payment because they were on deferral. Once again, the vast majority of these were principal only, so they continue to make interest payments. But if someone was on a deferral for April 5, May 5, June 5, and then they make their July 5 payments, they're off deferral. In reality, they're off deferral after that June 5.

Yes, okay.

Payment becomes due on June 6; their net payment is a true payment. So they're off deferral become June 6 if their payment was due on June 5, and we then deferred principal only or if it was a full payment deferral.

Yes. So, is it fair to say then they came off before they could have not paid the June payment or the July payment, right. This was a 90-day deferral?

If they are not covered by this report, it indicates that their next payment due is either the full payment or the interest, whichever it was.

Yes, go ahead, Wallace.

All of those who deferred their payments have made their payments since the deferral period ended. They will not be receiving the 180-day extension.

Overwhelming majority, yes.

I would add that a number of customers, fairly significant number got approved for deferral and then continued to make their payments.

Were they counted into these numbers?

They will count as deferral.

If a customer enters a 180-day deferral period, will that loan need to be downgraded?

We're certainly considering any requests for a second deferral. It's not an automatic downgrade, but we are evaluating each case carefully. In most situations, a downgrade would likely occur at that time, but we are reviewing repayment on an individual basis.

Okay.

In some cases, they might be asking for a second deferral because of liquidity position. Some of the medical providers and that sort of thing that have claimed their business fall off, but we feel pretty comfortable most of them will resume normal operations here, and you can only put off-putting in a deferral for so long. So we say, those returning to normal, Wally.

Okay, thank you. And then, when we had the last conference call, and it seems like in your prepared remarks, Tom, that the credit has held up better than you would have anticipated. In the last call, I read what you guys were saying as the accelerated loan fees from the PPP would be used to build the reserves to account for the economic environment. Do you still anticipate that you would be building your reserves aggressively over the coming couple of quarters? Or given what you're seeing, do you think that's now you're more likely to book those fees as these ones are forgetting into?

I still believe that we will likely add to our loan loss reserve due to uncertainty about the future. While I can't say for certain how this will unfold, I think it's premature to claim success. Once we receive that money, we will probably set aside most of it for the loan loss reserve.

Okay, thank you. That's very helpful. So, it's been kind of an interesting couple of months to see how the headlines have shifted from all is fine to all is not so fine as it relates to the spread of the disease, and now you're seeing states starting to slow down the reopening process. You operate in some markets that are seeing some pretty significant growth in the disease, and some of the states that you operate in are starting to change their opening schedule. I'm curious, it's early, I understand. But I'm curious if you have an early read on how that's impacting your customer base in some of those markets that are kind of seeing more severe spread.

Henry?

No, I mean I agree with Tom, and that they've already had to make their changes to their business model to adapt, and whether they thought things were going to get better quicker or not is a different story, but they've already kind of had to right-size what they were doing at some level, and you know, now, well, things are changing a little bit, they had already made their changes until I think most of the businesses are continuing to perform adequately.

Okay, great. And then just one kind of just to maybe put some dollars to an earlier question around the expense line, so netting out the deferred expense adjustment and the bonuses, it sounds like if we just use the GAAP number for the expense of $28.8 million, that's probably a good baseline. So, to work off of in our models, and assuming that statement is true, what is ServisFirst doing to manage expenses and investments, etc., in light of some potential pressures that could be coming down the pipe?

Well, we've already been doing it, Wally. We have been capping salary increases for this year. It won't bear a lot of fruit this year, but it'll bear fruit next year. Certainly, headcount control, we're looking hard at everybody and every department trying to cap expenses where possible. Certainly, terrible contributions, anything that's controllable, we're trying to control as closely as we can. Obviously there is a lot of noise right now with the PPP expenses, and everybody that we asked to, we needed help from PPP or vendors, they saw us coming and charged a big price. We think all of our PPP expenses are behind us, except for we are dependent in one class action lawsuit of agent fees or a number of them around the country, and we're dependent along with a number of banks on the case of Pensacola, Florida.

Yes. So, putting that together, it sounds like you're saying that you think there is probably some room for some improvement on the expense line?

Yes, we are proud that our efficiency ratio reached 32% this quarter, which we believe is among the best in the industry. However, the expenses do not look favorable after this quarter, and the reasons for that are clear.

Yes. Okay. Thanks, guys. That's all I had. I appreciate your time.

Our next question comes from Kevin Swanson of Hovde Group. Please go ahead.

Hi, guys.

Hi, Kevin.

I think most of the questions are answered, and we've covered quite a bit here, but I wanted to ask a couple quick follow-ups. The pandemic has pushed the balance sheet over $10 billion; post-COVID, where do you see that settling in terms of your future plans? And does it impact any of your longer-term expansion strategies?

Yes, I was thinking someone was going to ask that question. The hurricane money, as I call it, you know, is it here to stay, how much of it here to stay? Well, if we fall back below $10 billion, I probably don't think so. We'll come under large bank supervision after two quarters of what we really already have. Our examiner teams have been preparing us for over a year now to become a large bank, and certainly in the control of how they manage us, and how they regulate us. So, we think we're getting close to where they need us to be from that standpoint, but I know I didn't answer all your questions. I missed something in there, Kevin; what was it?

Oh, does it change any of your longer-term expansion plans?

No. We're still in conversations with people, but during the pandemic, most individuals are looking to make a change. From a performance perspective, we currently have a sizable group of production people we are engaged with. Typically, we talk to three or four groups at a time, although most of these discussions do not lead anywhere. So, I would say our activity has decreased somewhat. Additionally, in the initial weeks of the pandemic, we did not seek to make any significant changes to our business plan or model; our priority was to take care of our clients first and foremost before shifting our focus elsewhere.

Thanks. I appreciate it. M&A has not been on the radar for a while in terms of, I guess, the priority list, but it seems like your currency has held up quite a bit better than most out there, and maybe there are some banks that aren't surviving through the process as well. Did those conversations heat up at all, or is it still obviously organic first?

We are open to understanding where the economy is headed. Our sales performance is currently strong, and I believe Henry might find the due diligence on another bank's loan portfolio challenging. It's likely that we will need more time for the situation to clear up, Kevin.

Yes, that makes sense. Yes, appreciate it. And then maybe just one final one. I think maybe last time we spoke there was some idea that the PPP loans would be sold off, and I think we've seen a few banks do that, take that option. Is it still under consideration, or does it seem like you're going to hold these through kind of the whole period now?

We expected there to be a forgiveness process. Initially, we anticipated utilizing the Fed liquidity window by the second or third week of April, after which we would run low on funds and have minimal liquidity in the bank instead of record levels. Additionally, we believed that the SBA forgiveness process would be further along than it is currently. As of now, they have not even designed a form yet, but they mention a form will be available in the upcoming weeks. We had planned for all the loans to be forgiven and removed from our books by the end of June. Looking back, I may have been overly optimistic in expecting a patient timeline from the government regarding forgiveness. Our timeline suggested that by the second or third week of June, once customers had completed payroll, they could apply for forgiveness, and we would have everything tendered. Many customers have expressed urgency in getting this resolved, but we explain that the absence of a form means forgiveness isn't processed. It only becomes official when the SBA reimburses us with interest, and they have 60 days to do that. While companies are eager to clear these loans from their balance sheets, we still see the majority of them remaining. However, it is worth noting that we earn a positive carry on these loans every month. Although the yield is only 1%, it's better than the 10 basis points we earned at the Fed annually. We haven't been rushing into new investments; instead, we want to see how this liquidity stabilizes and assess factors like the hurricane relief funds and their potential impact. With many variables at play, I believe most banks find it reasonable to maintain significant liquidity during this period of economic uncertainty, as it provides various options for future growth and acquisitions. We remain very optimistic about the opportunities ahead, despite not knowing when the pandemic will conclude. I am unable to provide a definitive answer to that question.

I appreciate it. Yes, I appreciate it. That's great. Thanks a lot for the questions.

Thank you.

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