ServisFirst Bancshares, Inc. Q1 FY2021 Earnings Call

Good afternoon and welcome to the ServisFirst Bancshares Inc. First Quarter Earnings Conference Call. All participants will be in 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 Ed Woodie, Controller. Please go ahead.

Good afternoon and welcome to our first quarter earnings call. We will 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 will take your questions. Some of the discussion during our 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’ll turn the call over to Tom.

Good afternoon. We are very pleased with our quarter and we are glad you could join us on our call today. We continue to see rapid improvement in the Southeastern United States economy. Supply chains are still not rebuilt, so line utilization has not improved during the first quarter and I think we’ve seen inflation and a lot of our customers are reporting large inflation in their material cost and so that should lead to line utilization improvement as the year goes on. We talked to one diversified manufacturer and wholesaler last week who said everyone is gouging everyone out there and I know that there is a shortage of labor in most every industry today. The unemployment rates in our state were 4.7% in February and we are seeing improvement monthly in that number. I can only recall one first quarter of our 16 years where we had any reasonable loan growth in the first quarter and certainly this year fits the normal pattern of not having. We did have a little bit of growth in the quarter, but one of our largest clients has seasonal pay downs that offset the growth in the non-PPP loan balance. As I have mentioned before, we have not seen the utilization rebound as of yet, but do expect improvement for the rest of the year. Talking about our loan pipeline, our loan pipeline hit record levels at the end of March, beginning of April. Our 90-day pipeline has doubled since January and we do expect significant loan growth in the second quarter. This includes expected fundings, as well as draws on construction loans. While our pipeline is not exact, and you do have unexpected payoffs, this is the highest pipeline in the last 12 quarters at over $300 million. Our goal for the year is to replace our PPP loans with other loans by year-end. Bud Foshee will give a PPP program update in a few minutes after Henry Abbott. I feel confident we will see loan growth this year. We continue to see more opportunity due to mergers, our performance with PPP in attracting new clients, and referrals from PPP. Based on pent-up demand, we see continued improvement in our footprint. On the deposit side, we continue to attract deposits with annualized growth of 24% in the first quarter; the growth has been very broad across the entire company. While the industry has substantial liquidity today, as our bank does, we feel confident core deposits will add value over time. New account openings have steadily improved over the past six months and were very high in the month of March. So with that, I’m going to stop and turn it over to Henry Abbott to talk about credit quality.

Thank you, Tom. I'm extremely pleased with our first quarter results and our bank’s credit quality. Our numbers generally speak for themselves. I’ll give a few key metrics and hit the high points. Non-performing assets were down to under $20 million on a total loan portfolio of $8.5 billion. The $19.9 million in NPAs is a $5.5 million reduction from the fourth quarter and roughly a $21 million reduction from the first quarter of 2020. This results in NPA to total assets of 16 basis points, which is a 5 basis point reduction from Q4 and a 28 basis point reduction from the same period in the prior year. A key driver in our reduction in NPAs was various sales from our OREO portfolio to bring it to its lowest level in more than 10 years. The now $2 million balance in our OREO is a 68% drop from year-end. Our core key credit metrics have not been this low since 2015. Our continued exceptional asset quality and strong balance sheet lead me to be optimistic about our bank’s future. This NPA reduction was not achieved at the expense of the income statement, as we had extremely minimal charge-offs in the first quarter. The $487,000 in net charge-offs for the first quarter on an annualized basis is 2 basis points versus 41 basis points in the fourth quarter and 26 basis points in the first quarter of 2020. On a strict dollar amount, net charge-offs have not been that low since the first quarter of 2016 and at that time the loan portfolio was only $4.3 billion, roughly half of where we are today. Our past due to total loans were 7 basis points, $6 million, a 34% decrease from year-end. We grew our ACL by $7 million in the first quarter. Our ACL to total loans was 1.12%. However, excluding PPP from total loans, our ACL to loans was 1.26%. Government aid and stimulus, the primary example being PPP, has helped soften the blow from COVID. That said, our credit culture, geography, and the diverse nature of our commercial loan portfolio should help us be well-positioned to grow and prosper as the economy fully opens up and expands. With that, I'll turn it over to Bud.

Thank you, Henry, good afternoon. Net interest margin for the first quarter was 3.20% versus 3.27% in the fourth quarter of 2020. The adjusted margin was 3.08%, excluding the average PPP loan balances of $956 million and PPP interest income and loan fees of $11.4 million. Adjusted margin for the fourth quarter was 3.23%, excluding the average PPP loan balances of $1.01 billion and PPP interest income and loan fees of $10.1 million. The adjusted margin was 3.27% excluding the increase in excess funds of $411 million. Fourth quarter adjusted margin was 3.36% excluding the increase in excess funds of $311 million. The remaining net PPP deferred fees at 3/31/2021 are $20.4 million; $9 million relates to Round One and $11.4 million to Round Two. CD maturities for the remainder of 2021 are $452 million, and $171 million for the second quarter. The average rate is 1.11% for the year and 1.08% for the second quarter maturities. We expect the majority of the CDs to reprice at 0.40% or below. The repricing will result in a $1.3 million annual expense reduction or $717,000 for the second quarter maturities. Quarter-to-date cost of interest-bearing deposits has decreased to 0.38% in the first quarter versus 0.44% in the fourth quarter of 2020. Our quarter-end deposit cost, total deposits was 0.25%. Total interest-bearing DDA is 0.25% and our total interest-bearing deposits are 0.36%. We have no accretion income related to acquisitions. And for our PPP recap: Round One had 4,962 approved loans. The total loan amount was $1.09 billion. Total fees $34.4 million. ServisFirst ranked 89th out of 4,839 participating banks. The balance of loans at the end of 2020 was $900 million. Round Two had 2,287 approved loans. Total loan amount of $407 million. Total fees of $16.7 million and ServisFirst ranked 87th out of 4,628 participating banks in Round Two. PPP balance at the end of March 2021 was $968 million. 2021 Round One loan forgiveness was $334 million. Forty-three loans $2 million and above have been submitted for forgiveness. Only one for $2.2 million has been forgiven, and the dollar amount of loans awaiting forgiveness is $130 million. Monthly yield, including PPP fee accretion around the loan will be about 45 basis points; the loan term being five years versus two years for Round One. Liquidity: excess funds were $600 million more started funding PPP loans in April 2020. Excess funds were $2.7 billion at 3/31/2021. Non-interest income: credit card spend amount was $169.8 million in the first quarter versus $168.4 million in the fourth quarter 2020, and the first quarter of 2020 the spend amount was $146.1 million. Credit card net income in the first quarter was $1.2 million, which included an accrual adjustment of $290,000. First quarter net would have been $1.5 million without that accrual adjustment. Fourth quarter of 2020 actual was $913,000, and that included a rebate accrual adjustment of $870,000. First quarter of 2020 net income was $1.8 million. Merchant services fees year-to-date 2021 are $191,000 versus $100,000 for year-to-date 2020, and we have two officers dedicated to selling this service. Mortgage banking income is $2.7 million in the first quarter versus $3.1 million in the fourth quarter, and first quarter 2020 was $1.1 million. A reminder, we do not sell any government guaranteed loans to generate non-interest income. Non-interest expense: total producers at the end of 2020 were 133; March 31, 2021 were 131. Total employees at the end of 2020 were 499 and the same number at the end of March of this year. Total non-interest expenses in the first quarter of 2020 were $27.9 million; first quarter of 2021 $28.9 million. For the increases, first quarter expense for incentives were $3.7 million versus $2.7 million for 2020, and the increase is primarily based on projecting production from the producers. Our unfunded commitment reserve for the first quarter was $600,000. Mortgage commissions increased by $380,000, and FDIC insurance increased by $224,000. For decreases, the net ORE expenses were down $157,000, the PPP FASB 91 deferral was $1.1 million in the first quarter for Round Two loans. And just note that our salary increase year-over-year was only $11,300. Capital: despite a $2.8 billion increase in deposits year-over-year, the bank's tier 1 leverage ratio remains well above the regulatory minimum. Earnings retention year to date is 79%. Tax update: first quarter, the rate was 20.18%. For 2020, that number was 18.76%. The projected rate for 2021 is 22%. And that concludes our presentation.

Our first question today comes from Graham Dick with Piper Sandler.

Hey, guys, good afternoon. So, just starting on credit, I wanted to ask what might have caused the CECL model to require you to build the reserve further this quarter? I was surprised to see this considering credit quality metrics improved and it seems like the economy has done the same since 4Q.

Well Graham, that's a reasonable question. We do feel really good about where we are. We've been through the worst pandemic I have ever experienced. So, we want to be a little cautious in terms of doing anything in the way of a loan loss reserve release at this point in time. It's nice to have a little bit more cushion in the event of something unexpected. We don't know of anything and feel good about it. We're just a little gun-shy because of where we've been for the last year.

Definitely fair. Going forward, do you expect any more reserve build or are you pretty comfortable with this roughly 1.26% level of reserves excluding PPP?

Because of our projected loan growth in the second quarter, we will have a reserve build in dollars, but as a percentage it will not increase and will likely decrease as we go forward. So, we'll add dollars to the loan loss reserve in the second quarter because of the projected higher loan volumes.

Yeah, absolutely, that's perfect. Turning to loan growth, with the record loan pipeline and a load of excess liquidity, how strong do you think loan growth can be this year over the next couple quarters specifically?

As we said earlier, our goal is to replace all the PPP loans that were outstanding at year-end with other non-PPP loans. That's about $900 million and that's the goal for the year. I feel better about that goal today than I did three months ago because we see pretty clear, substantial loan growth. We've already had some good loan growth this quarter in the early part of the quarter and we feel good about the rest of the quarter in terms of substantial loan production. We are not yet seeing line utilization improve. Some customers have increased their lines because costs like steel and lumber are going up; that should lead to improved line utilization over time. The $300 million we lost last year — I don't know when we'll get all of that back, but I hope we get some of it. I expect some of that to happen in the second half of the year.

Okay, great. That's helpful. One quick one: do you have the average loan yield excluding PPP? I'm trying to get a sense for how much pressure there may be on core loan yields, if any.

For the first quarter, the margin was 3.20% and excluding PPP was 3.08%.

He's asking loan yield.

Oh, loan yield — on new production, we referenced the margin figures. I don't have the average loan yield excluding PPP on hand right now. I can email that to you.

Okay, no problem. Thank you, guys. Congrats on a good quarter.

Thank you.

Our next question comes from Will Curtiss with Hovde Group.

Hi, good afternoon, everyone. I appreciate the details on what you have coming up from a deposit repricing. I'm curious if you can size up what the expectations are for the margin when you back out all the noise from PPP over the next couple of quarters as you manage through the liquidity headwinds. How are you thinking about the trajectory of the margin from here?

Good afternoon, Will.

If we can replace the $900 million we had in PPP by the end of the year, it will have a positive impact because new loans are being originated around a 4.25% yield level. The key to margin improvement is generating that much loan production this year. If we have that, the margin tends to take care of itself as PPP loans pay out or get forgiven.

Got it. And the average balance of PPP for the first quarter — did you give that number?

Yes, it was $956 million.

Okay. Last one on expenses — last time you talked about expense growth this year being similar to what we saw last year. Is that still a fair expectation for the 2021 expense base?

Yes, I think so. The biggest increase will be our core conversion, which we budgeted about a $2 million increase for. Excluding that, we plan to keep expenses under control. We're adding people, mainly production people, so they need to produce quickly to pay for themselves.

All right, appreciate the color. Thank you.

Thank you, Will.

Our next question comes from Kevin Fitzsimmons with D.A. Davidson.

Hey, good afternoon, everyone. I was wondering if we can simplify and talk about dollars of NII. With growth in the balance sheet but margin pressure, what's your outlook for dollars of NII going forward? Do you think it stays relatively soft and then picks up as you get more loan production?

You also have to consider the accretion impact from PPP fees. If all Round One loans are forgiven by the end of the year, you get $9 million in additional accretion that will come in and that impacts how you view margins.

You heard us say all the loans except one over $2 million from Round One are hung up for forgiveness. Only one was forgiven on the first day the portal opened and I think that one was forgiven by mistake. All the others are pending and there has been no news from the portal. The timing on those is uncertain.

I've certainly talked to peers and nobody is getting forgiveness on loans greater than $2 million; they all seem to be held up.

Your guess is as good as mine on timing. There's a fee accretion benefit that works in our favor in the meantime, so I'm not completely unhappy about the delay.

On another topic, as the economy reopens, can you talk about new market expansions? I know you opened an office in Florida recently. Are there new markets on the docket? Do you have teams in place or will you be hiring?

We will have some announcements in the next 7 to 10 days, Kevin, that we can't disclose yet. We actually have people on board; they started today. We also have someone coming in Friday from another state to visit. It's a moving time of year and people move between organizations. We feel pretty good about where we are.

One last one on M&A. You've historically focused on organic growth and bringing in teams. Given the recent merger activity and your relatively strong multiple, do you feel differently about pursuing M&A now?

We are open to the right opportunity. Our multiples are a little higher than the industry and the right opportunity would certainly make sense. The challenge is finding a target that is branch-light and a good cultural fit. Those opportunities exist but they are not numerous. We would be willing to consider a target that is not branch-light if the economics and fit made sense, but closing branches is difficult operationally and from a community perception standpoint. Many community banks have branches that are important to their customers, and regulators often push back on closing them. The pandemic has accelerated digital adoption and branch traffic may be a secular trend downward, but branches will decline slowly, not quickly.

All great points. Thanks, Tom.

Thank you, Kevin.

Our next question comes from William Wallace with Raymond James.

Thanks. Good evening, guys. Tom, your remarks earlier were a bit surprising to me relative to your prior comments after your last acquisition suggesting you weren't that interested in mergers. Are there potential partners that fit what you described that exist out there? Are you having conversations or is it more opportunistic if the right thing falls on your lap?

I wouldn't say they're unicorns, but the number of good fits is limited. Many potential targets are doing quite well and have no reason to sell except age issues or succession concerns. It's hard to find situations where the reasons for the seller and the reasons for us to buy align. There are possibilities, but they're not numerous — more in the tens than the hundreds.

Okay, thanks. On utilization, I think last quarter we discussed utilization being down in the 38% range. Are they still down there or have you seen increases?

At the end of 2019 utilization was 48.1%. At the end of 2020 it was 39.5% and it's even lower today at 37.7% because of the PPP Round Two decrease and line utilization being down. We need government support to be out of the way for draws to resume.

On net interest margin and new loan production, are yields on those loans seeing competitive pressure or are they holding in?

There is competition, but we try to be disciplined. We believe banks that remain disciplined will be the winners. Some players may be undisciplined and focused on short-term growth, but we want to be in this business for the long term. We're impressed with how activity has opened up month by month and we're glad to be focused on commercial lending in the Southeast with our asset diversity.

So generally speaking, outside of a couple of irrational players, pricing pressures have stabilized. Fair characterization?

Yes, I think that's fair. Also, there are signs of wage inflation because employers are having trouble hiring in certain industries, which can affect costs across the economy.

On the expense question, was there any deferred PPP-related comp that will bounce back into the run rate or will that be offset by a reduction in incentive accruals?

The PPP FASB 91 deferral was $1.1 million in the first quarter for Round Two loans. Those fees are accreted over the life of the loans.

Forgiveness timing and deferral make the accounting a little confusing. PPP has been very beneficial to all banks, and the delay in forgiveness impacts accretion timing, but overall we believe we can operate successfully without PPP going forward.

I was also curious about the reserve increase in the quarter. Did you adjust Q-factors to be more conservative or was there risk-rating migration that drove the model to require a higher reserve?

There wasn't any significant risk grade migration driving the reserve increase. The model dictated the change. There were small changes in certain Q-factors by industry, but nothing wholesale changed in our model.

Unfunded loan commitment expense went up, which I think should be part of loss provisioning, but it's presented separately as an expense item. Losses were extraordinarily low in the first quarter; an annualized 2 basis points is unusually low based on my experience. Typically banks might operate between 5 and 10 basis points per year, more commonly around 10. So these are exceptionally low loss levels.

Fair enough. Okay, thanks for the time, guys. I'll hop out.

This will conclude our question-and-answer session, as well as today's conference call. Thank you for attending today's presentation. You may now disconnect.