ServisFirst Bancshares, Inc. Q2 FY2021 Earnings Call

Good day and welcome to the ServisFirst Bancshares Incorporated Second 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, sir.

Good afternoon and welcome to our second quarter earnings call. CEO Tom Broughton will share his thoughts on the quarter; and then we will hear from Henry Abbott, our Chief Credit Officer; and Bud Foshee, Chief Financial Officer for their detailed reviews. We will then 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 to the date they are made and ServisFirst assumes no duty to update them. With that, I’ll turn the call over to Tom.

Thank you, Ed, and thank you for joining our second quarter conference call. We were very pleased with the quarter and before I talk a little bit about our results, I'll give you a little bit of background on the Southeast economy. And again, we in our conference call will not read our press release to you; we assume you can read it yourself. So, if you're new to our call, that’s our practice not to read from the press release. In the Southeast, we continue to see lower unemployment compared to the rest of the country. We hear from all of our customers as employers that they cannot find the needed workers in almost all industries. It is not just fast food; it's almost every industry. Hopefully, as unemployment benefits expire we will see job openings filled. In the Birmingham area, for example, of large metro areas, we have the lowest unemployment rate in the United States at 2.2%. So, we have pretty much a full employment economy in many areas of the Southeast. The economy is robust and continuing to improve greatly. I was talking with a customer last night at an open house in our new office in Fort Walton Beach, Florida and he said, you know, we can't keep boats in inventory. He was wondering, why are people spending so much money? As far as the government says, it's stimulus money, but he said it can't be just a couple of $1,200 stimulus checks. His theory is that after the pandemic people just want to enjoy the things they've always wanted to enjoy. The pandemic made people decide, you know, 'I want to enjoy the things I've always wanted.' So, it'll be interesting to see as we move forward how the economy evolves. Talking about our results, loan growth soared to a record level in the quarter. Line utilization is still well below year-end 2019 levels. Line utilization has not improved, and customers continue to report that supply chains are still disruptive. I've been saying that we thought we would see improvement in line utilization this year. It has not happened yet. From talking with customers, the Fed acts like the supply chains were repaired in just a few months' time, but from talking with customers we don't see that happening. So, it may be toward next year before we see substantial improvement in line utilization. We're glad we had some organic loan growth to help fill the gap. We do expect to see a second-half 2022 tailwind from construction line draws. We have a number of projects underway where we expect substantial draws, and of course we expect line utilization to improve from inflationary effects of higher prices for steel, lumber and many other raw materials. That will be helpful as well. Our loan pipeline is down 10% from April, but it's still 77% higher than it was at year-end 2020 and above typical second-half levels. Our loan growth is broad based and is centered around commercial real estate and commercial and industrial loans. We continue to see deposit inflows though they are at more normal historical growth rates of the mid-teens for our bank rather than the large surge in deposits we saw during the pandemic. Our liquidity continues to build to historic levels despite the record low loan growth earlier in the period. We were very pleased with asset quality. As Henry will talk about in a few minutes, we had negative charge-offs in the quarter. I thought we should have a celebration and Henry just asked that we postpone the celebration until we could see what happens when government stimulus is withdrawn — whether it will lead to some uptick in future losses and some long categories. But personally, I don't see many businesses struggling; some that are poorly managed are having trouble. Now, we'll turn it over to Henry Abbott, our Chief Credit Officer, to give a little bit more detail on my credit outlook. Henry?

Thank you, Tom. Our second quarter results continued the very positive trends started in the first quarter of 2021. In the second quarter we even showed a net recovery, which has not occurred in at least the past five years as far back as I looked, and we continue to show strong asset quality trends across the board. Our numbers generally speak for themselves, so I'll give a few key metrics. Non-performing assets to total assets were 15 basis points versus 16 basis points last quarter, and 26 basis points in the second quarter of 2020. Our OREO was roughly $2 million, near record lows in our bank history, and in line with the first quarter. We had roughly $540,000 in OREO expense for the quarter. I'm pleased to say we posted a net recovery of $112,000 for the quarter. As mentioned, as far back as I looked we have not posted a quarterly recovery. Our past due to total loans were 8 basis points, $6.7 million, a 27% decrease from year-end. While we are optimistic given the bank's financial performance throughout the past 18 months, we also want to be realistic that the unprecedented government aid helped stabilize various businesses, and with PPP round two now complete, those businesses will have to be self-sustaining in this new economic environment. We were pleasantly surprised by the $517 million in loan growth; this is excluding the runoff of PPP loans, which are 0% risk-weighted assets. Primarily because of the loan growth and the above-referenced uncertainty given the end of PPP, we grew our ALLL by $9.7 million in the second quarter. Our ALLL to loans, excluding PPP loans, was 1.30% at quarter-end, up from 1.26% at the end of the first quarter. We have been diligent throughout the pandemic in our credit servicing to monitor for problem loans, but we need to continue to allow more time to pass to fully understand the long-term impact on our clients. Thus, it is appropriate to continue to build our reserve at this time. Our core key credit metrics continue to be exceptional and even improving, which I think can be credited to our high-quality customer base as well as our granular and diversified loan portfolio. With that, I'll hand things over to Bud Foshee, our CFO.

Thank you, Henry. Good afternoon. Net interest margin for the second quarter was 3.06% versus 3.20% in the first quarter. The adjusted margin was 2.96%, excluding the average PPP loan balances of $860 million and PPP interest income and loan fees of $8 million. Adjusted margin for the first quarter was 3.08%, excluding the PPP average loan balances of $956 million and PPP interest income and loan fees of $11.4 million. The adjusted margin also was 3.19% excluding the increase in excess funds of $525 million; the first quarter adjusted margin was 3.27% excluding the increase in excess funds of $411 million. The remaining net PPP deferred fees at June 30 are $16.8 million — $2.2 million relates to Round One and $14.6 million to Round Two. CD maturities for the remainder of 2021 are $365 million, $163 million for the third quarter. Average rate on the CDs is 0.95% for the year, 1.11% for the third quarter maturities. We expect the majority of these CDs to reprice at 0.40% or below. The repricing will result in a $500,000 annual expense reduction, $290,000 for the third quarter maturities. Our quarter-to-date cost of interest-bearing deposits decreased to 0.34% in the second quarter versus 0.38% in the first quarter. Our quarter-end deposit cost for total deposits was 0.24%. Total interest-bearing DDA is 0.24% and total interest-bearing deposits is 0.34%. We have no accretion income related to acquisitions. Our PPP recap: Round One balance at year-end 2020 was $900 million. The balance at June 30, 2021 was $184 million. Fees recognized during the second quarter were $6.8 million and $15.7 million year-to-date, and the remaining net fees are $2.2 million. Round Two balance at June 30 was $411 million. Remaining net fees are $14.6 million. We recognized $1.24 million of fees in the second quarter and $1.45 million year to date. The total PPP balance was $595 million at June 30. Forgiveness for Round One in 2021 was $379 million for the second quarter, $730 million year-to-date, and for Round Two $6.9 million for the quarter and year-to-date. Excess liquidity funds were $600 million when we started funding PPP loans in April 2020; excess funds at the end of June 30, 2021 were $3.1 billion. Non-interest income: credit card spend improved significantly — $197.4 million in the second quarter versus $169.8 million in the first quarter; the second quarter of 2020 spend was $134 million. The credit card net income second quarter was $1.9 million; the first quarter was $1.2 million. We also had an accrual adjustment of $290,000 in the first quarter, which would have made first quarter net $1.5 million, and second quarter 2020 net was $1.4 million. Our merchant services fee income continues to improve: year-to-date 2021 is $480,000 versus 2020 year-to-date of $234,000. Mortgage banking income was $2.7 million in the second quarter and the same amount in the first quarter; second quarter 2020 was $2.1 million. A reminder: we did not sell any government-guaranteed loans to generate non-interest income. Recap of our non-interest expense: total producers at the end of 2020 were 133; we had 134 at June 30, 2021. Total employees at the end of 2020 were 499 and at the end of June 2021 were 534. Our total non-interest expenses in the second quarter of 2021 were $31.3 million and the second quarter of 2020 was $28.8 million. For the increases: the FASB 91 deferral increased $1.7 million. The second quarter of 2020 includes deferrals of $2.4 million related to Round One of PPP. FDIC insurance increased $800,000. Unfunded commitment reserve in the second quarter of 2021 was $500,000. Data processing increased $443,000, and that increased expense is due to our current data processing provider increasing our contract based on converting to a new platform. Salaries increased $326,000 related to new hires in our West Central Florida region in our Fort Walton and Columbus offices. Business mail increased $290,000. Office rent increased $235,000, primarily due to our new lease space for the national office. Decreases: incentives decreased $1.1 million. The second quarter 2020 expense for incentives was $4.9 million versus $3.9 million for 2021; second quarter 2020 included $2.5 million related to PPP incentives. Net OREO expenses decreased $764,000. Operational losses in the second quarter of 2020 included a $500,000 accrual for potential losses. Our capital increased with about $1.6 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 78.7%. The quarter-to-date tax rate for both 2020 and 2021 was 21%. The year-to-date tax rate for 2021 was 20.6% and the year-to-date rate in 2020 was 20%. The projected rate for the remainder of this year is 21%. This concludes my comments, and I'll turn the program back over to Tom.

Thank you, Bud. We are very optimistic about the rest of the year, as you could tell from the timing of what we've had to say here. We've seen loan demand improve. We've seen a bounce back in the economy. There was clearly some pent-up demand for loans that we've enjoyed in the second quarter. So we're very optimistic. Also, you see in the results a couple of things. One is the new bankers we hired a year ago are seeing substantial loan growth this year, and we expect the same next year. We've had a number of key hires this year that will provide good growth in 2022. The second reason we're optimistic is we had a policy last year of not working from home — I don't think any of us missed a day of work last year here in the office. That's resulted in better customer service and better growth rates than the industry average. We expect that to continue. With that, we'll be happy to answer any questions you might have.

And the first question will come from Graham Dick with Piper Sandler. Please go ahead.

Hey, guys, good evening.

Hi, Graham. Graham, we don't expect to have a quarter like that every quarter. I'd rather under-promise and over-deliver if possible. Our goal for the rest of the year is probably around $300 million a quarter in loan growth to get to where we need to be, which would be above the $900 million that we had mentioned we'd like to replace. So, that would be a little above that target, but $500 million a quarter is a little aggressive. The hires earlier this year have not had time to do too much yet. Most of the production this quarter is pretty broad based. The top three regions were West Central Florida and Birmingham. Birmingham is getting growth back. We obviously lost some C&I loans last year as a result of the pandemic and PPP stimulus, not only from line utilization but because people postponed projects. So we saw some pent-up demand this quarter. We think the hires we've made this year will produce more next year than they have yet. Most of what we saw was broad based and net of payoffs, including some payoffs from non-recourse lenders and West Coast lenders coming into our Southeast market in a couple of cases where we had some significant payoffs. We're competing like everybody else: it is a matter of putting on more than you're losing and having good structure and well thought-out, sound credits. Did I answer your question, Graham?

Yeah, absolutely. That's very helpful. And then you guys aren't alone in the liquidity issue that's facing the industry right now. I'm curious to hear how you think this dynamic might evolve over the next few quarters. I know you said deposit inflows have sort of slowed a bit, but how are you thinking about this? And will you add to the securities portfolio over the next couple of quarters similar to how we saw in 1Q or 2Q, or do you think it's settled out and you can focus on moving this into the loan book from here?

Graham, you can sit there and argue with yourself all day whether to wait for higher rates or to buy securities now. I'll say I was speaking to someone several years ago — a man who ran the largest bank in Japan — and he told me he'd been waiting for rates to go up in Japan for ten years. You're not coming back until that happens, so we need to quit waiting. We need to buy some securities now. We can't have a strategy of just waiting for higher rates. We do a little of that, but we aren't going to say we're just waiting. Everything I see says we're going to have inflation, but find me an economist who has gotten rich doing accurate economic forecasts; I don't think such a person exists. The best thing we can do is find more loans — good short-term loans at floating rates or short fixed rates — and buy some securities. When the market normalizes, every security created will yield a little better and you can work through it, but you can't buy some mortgage-backed securities with high yield — short mortgage-backed securities just almost don't exist.

Not a good yield anyway. If you buy seasoned types, you're probably going to get about 80 basis points.

Okay, that's helpful as well. That's for me. I'll hop out of the queue. Thanks and congrats on a great quarter, guys.

Thank you, Graham.

The next question will come from Kevin Fitzsimmons with D.A. Davidson. Please go ahead.

Hey, good afternoon, guys.

Hi, Kevin.

Tom, at the beginning of the call you talked about line utilization and it seems like you're a little less hopeful than you were last quarter about that coming back. What's driving that? You mentioned talking to customers, but what's driving that shift in thinking?

It's the supply chains — they're still broken and companies cannot get inventory. It's the strangest economy I've ever seen. People are buying houses, cars, boats, bicycles — everything is in short supply. The companies are constrained by supply chains. I thought supply chains would improve faster based on what the Fed said, but they clearly don't know much more than we do. Supply chains aren't getting rebuilt very quickly. We're not counting on line utilization improvement in the short term. If I had to guess, I'd say they'd probably improve in the fourth quarter, but I don't see regaining the $300 million in loan volume we lost last year this year. I hope we get half of it back, maybe $150 million. So maybe I'm a little less optimistic on that today than I was last quarter. We've got to count on organic loan growth to get to where we need to be.

Other than line utilization, you characterized the organic growth this quarter as a real acceleration because of pent-up demand and catch-up. You still expect it to be healthy over the balance of the year but not explosive like this quarter. Is that accurate?

Yes. Many companies got PPP stimulus and, with hindsight, some didn't need to sustain operations but thought they needed it. Hopefully that money gets spent — people buy boats and airplanes — and they'll start using lines of credit again. Everything's selling; it's pretty amazing.

Final question: with the economy continuing to reopen and additional growth out there, are you looking at any additional markets or moves to invest in new markets you're not currently in?

Yes, we're talking to teams in a couple of markets. Nothing imminent in the next couple months, but one could be toward the end of the year and one perhaps in the third quarter. We also like bolt-on opportunities in existing regions, which can be very profitable when we add people that support our regional hub. We're talking to a lot of groups right now.

Okay, great. That's all I had. Thanks, Tom and Bud.

Thank you, Kevin.

The next question will come from William Wallace with Raymond James. Please go ahead.

Thanks. Good afternoon, guys. Hope you all are well.

Yes, sir.

I want to circle back on the liquidity question. I see cash is up about a billion, deposits were up about a billion, but Fed funds purchased are up a couple hundred million. With so much liquidity, why are you adding to that line? Does that have something to do with a different line item, or are you worried about deposits?

This is Rodney Rushing. We're not worried. We have over 300 downstream correspondent banks that have accounts with us, and like us they're flush with cash. They're selling us more of the funds. One thing we've done is move as much as we can into DDA so those banks can pay for their Fed charges and other services with an earnings credit. To answer your question, correspondent balances have grown and will probably continue to grow over the next couple of quarters as we add accounts. To us, it is core deposits because it acts like a corporate cash management account. We're acting as the bank's main working deposit account: they pay bills and run business through that DDA account and then it automatically sweeps into the money market where they can borrow fed funds from us if they need it. That's exactly how our correspondent accounts work. We buy fed funds when they're flush and we lend when they need it. That's on our balance sheet, and we perceive it as valuable deposits. I hope that answers your question.

Do you have to carry slightly more liquidity against those deposits given potential volatility?

Right now Bud is selling some excess liquidity to the Fed. We used the opportunity when the Fed increased what they pay on excess reserves from 10 basis points to 15 to not increase on a regular fed funds rate. We could take that money and sell it to the Fed as agent; we could do that in the future if we wanted to. Right now we choose not to, so we're buying it all as principal and it's on our balance sheet.

Okay.

The regulators would love to have more and more liquidity. You cannot have too much liquidity with the regulators.

You highlighted in the press release and prepared remarks that because PPP forgiveness is going away you are building reserves. I still don't understand how PPP forgiveness going away causes you to build reserves; all the metrics look positive economically.

It's not so much PPP forgiveness as PPP ending and the tapering of added stimulus and government support. The credit metrics are generally positive, but we lost some of the support these businesses had. Couple that with $500 million of loan growth and that helped drive an increase in the reserve.

So from here, is it safe to assume you've taken a conservative precaution and built the reserve to a sensible level, and assuming economic metrics remain favorable, you could start to see some release?

Also, Wally, it can take a year to collect on an SBA guarantee; nobody's really tried to collect on PPP loans from the SBA yet. So, we could get complexity even if we expect forgiveness to be clean. The government processes can be messy, and we're just prepared for every eventuality. It's not a large amount — we booked a small reserve for that. We booked $1.5 billion of PPP loans, so on that basis the reserve is not huge, but it's part of the equation.

If I remember correctly, you set aside some reserve early on against PPP loans for potential issues. Looking at reserves excluding PPP loans, have you built that up more?

Wally, no. In the past, we have not had a specific reserve on PPP loans. This quarter we did set aside a small reserve associated with potential fraud; we know of no fraud. We have been successful in our forgiveness applications, but on a billion dollars there might be some issues related to fraud, so we want to be conservative and set aside some funds for that potential. As Tom mentioned, nobody has applied for the SBA to pay on their guarantee versus pay on their forgiveness, so we're just being a little conservative there. It's not a huge factor in our model.

Okay. What is your utilization rate now? I think you mentioned it last quarter but can you give the current number?

We were at 38.77% utilization at the end of the quarter. It was up from 37.67% at the end of the first quarter; at the end of 2020 it was 39.54%. At the end of 2019 it was 48.13%, so we're about 10 percentage points below where we were prior to the pandemic. Regarding PPP and the SBA, historically when one administration takes over from another they sometimes try to undo prior actions, so it pays to be cautious in preparing to deal with the SBA. We have had very good experience with them and no issues at this point, but it's best to be prepared.

One final housekeeping: Bud, I believe you mentioned $8 million of PPP net interest income in the quarter. In the release it says $8 million of net fees. Does that $8 million include interest income, or is it fee acceleration only? Is it total PPP income that was booked as part of NII?

Let me go back to that and confirm.

Okay. Very good. That's all I had. I appreciate you taking the time. Take care.

Thank you.

This will conclude our question-and-answer session. Actually, it seems we have a question that just came in from Mr. Graham Dick with Piper Sandler. Please go ahead.

Hey, guys. Just one follow-up on PPP, mainly as it pertains to expenses. It doesn't look like you did much in the way of PPP originations this quarter, but was there any FASB 91 deferred origination cost incurred this quarter or are you pretty much behind that? Is this $16.9 million salary level something we might see over the next couple of quarters?

No, it was not a significant amount in the second quarter. That was mainly in the first quarter for Round Two. I don't have the exact number on the call but I can send that to you.

No, that's perfect. That's all I wanted. Thanks.

You asked a great question. If there are no more questions, thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.