ServisFirst Bancshares, Inc. Q3 FY2021 Earnings Call

Good day, and welcome to the ServisFirst Bancshares Incorporated Third 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, Director of Investor Relations. Please go ahead, sir.

Good afternoon, and welcome to our third 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 will 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'll turn the call over to Tom.

Thank you, Davis, and good afternoon, thank you for joining us on our call. I'll talk a few minutes about our loan growth for the quarter. We had three hundred and sixty-nine million dollars of net loan growth for the quarter, which is an annualized growth rate of eighteen percent. Our goal has been to have a monthly loan growth goal of one hundred million dollars a month and we've exceeded that goal over the last three quarters, and certainly, we're pleased to see that. We had thought that we would see line utilization improve in the second half of the year, but we saw no improvement in this past quarter. We do not know when we will see an improvement in line utilization, given the continued low inventories at our customers and supply chain issues that continue, but we certainly expect it to be a tailwind for us at some point in the future. So that's certainly something we look forward to. We did see net pay downs in commercial and industrial loan balances in the quarter excluding PPP loans. This is both the result of the second round of PPP stimulus, as well as, we are seeing very strong profitability in our customer base in the commercial and industrial companies. Loan growth for the quarter was highest in the West Central Florida, Charleston, Dothan and Northwest Florida regions. Looking at our loan pipeline, it is about ten percent above last quarter and is back at historically high levels. We've looked back at our pre-pandemic pipelines, and our pipelines today are roughly double where we were prior to the pandemic. On the deposit side, we do continue to see deposit growth — most of the growth was in our correspondent division this quarter. Other regions are seeing a flattening in growth during the quarter. Most of the correspondent division growth is attributed to new account growth in the South Florida market with the addition of a key banker in South Florida. Our non-interest bearing accounts doubled in the quarter in correspondent from five hundred million dollars to one billion dollars. A few minutes to talk about capital. When we started the pandemic eighteen months ago we were under ten billion dollars in assets, and I remember analysts and investors were asking us what our plans were to do with all our excess capital. Our answer was, it's nice to have excess capital on hand to fund future growth. Eighteen months later we are at fifteen billion dollars in assets. So we are quite happy to have the capital to support a bigger balance sheet. The question now is how much of the deposit growth is transitory, if any? I don't think any of us know the answer to that question, but what certainly seems logical is that as the massive fiscal stimulus wears off, our deposits will flatten or decline slightly over the next couple of years. As of this morning, we're sitting on four point six billion dollars in cash at the Fed and we do have a negative carry on that four point six billion dollars. I did see an analyst report recently saying we're in the top ten for cash as a percentage of assets. Bud will go over our plans in a few minutes to invest those funds over time. On the hiring front, we continue to have many conversations, more than in the past few years, again, as more merger activity has led to more discussions with more teams. Early in the pandemic we took a very conservative approach and did not really tell everybody that we talked to that we really wanted to hire anybody or do anything during the early part of the pandemic; we wanted to see. We just thought the best thing to do was to be conservative, and that actually was the best thing to do — in the banking business it is almost always to be conservative. That's something we'll continue to look at and we see many opportunities and our goal is to only bring in a small number of very high quality bankers. So now I'd like to turn it over to Henry Abbott, our Chief Credit Officer to talk about our credit situation.

Thank you, Tom. Very pleased with the bank's performance in the third quarter and the loan portfolio continues to perform well in the current economic environment. I'll give a brief overview of the key ratios for the quarter. We continue to see strong asset quality, which can be attributed to ServisFirst’s strong client selection, credit servicing and the vitality of the markets in our footprint. Non-performing assets to total assets were down to eleven basis points versus fifteen basis points last quarter, and twenty-nine basis points in the third quarter of 2020. For the quarter, NPAs were down to sixteen point five million dollars; this is a fifteen percent reduction from the prior quarter and a fifty percent reduction from the third quarter of 2020. This drop is attributed to OREO continuing to be at near record lows in line with the prior quarter and a two point seven million dollar reduction in non-performing loans. Our past due to total loans were eight basis points, six point eight million dollars, on par with last quarter and a twenty-seven percent reduction from the end of the third quarter in 2020. Charge offs and OREO expenses for the quarter were one point eight million dollars, an eighty-five percent reduction from the eleven point five million dollars in the third quarter of 2020. Our net credit expense annualized for the third quarter would be eight basis points, and I'm proud to say that year to date, net credit expenses when annualized are four basis points versus credit expenses for 2020 for the whole year of thirty-eight basis points. In the face of strong competition, loans grew by three seventy million dollars excluding PPP payoffs. Including PPP payoffs our loan outstanding still grew by one hundred and sixty-three million dollars. Primarily due to loan growth, we grew our ALLL by four point two million dollars in the third quarter versus roughly nine point seven million dollars last quarter. Our ALLL to loans, excluding PPP loans from total loans, is 1.29 percent. Even as we put some of the more dramatic COVID economic impact in the rearview mirror, given the bank’s continued strong loan growth and unprecedented government aid still helping borrowers, we felt it’s appropriate to continue to grow our loan loss reserve. 2021 continues to be a very strong year for the bank and our core key credit metrics continue to improve and charge offs continue to be near historic lows. With that, I'll hand it over to Bud.

Thank you, Henry, good afternoon. Liquidity, as Tom mentioned, we have a plan to invest a portion of our excess funds. Our initial goals are to purchase 15-year mortgage-backed securities and five- and seven-year treasuries. The net monthly investment security growth will be about one hundred million dollars and we will increase these monthly purchases over time. Current yield on mortgage-backed securities is approximately 1.30 percent, current yield on five-year treasuries is approximately 1.08 percent and 1.38 percent for 30-year treasuries. We also decided to retain a portion of our mortgage originations. For the third quarter we sold thirty-three million dollars to investors and retained fifty-three million dollars. Net interest margin: average loans, exclusive of PPP, increased by 424 million dollars in the third quarter. Average PPP loans decreased by 387 million dollars for net average growth of thirty-seven million dollars. PPP fees and interest income were six point four million in the third quarter compared to ten point two million dollars in the second quarter. Also, an increase of 971 million dollars in average excess funds decreased the margin by twenty basis points in the third quarter. On non-interest expenses, salaries increased eight hundred and fifty-two thousand dollars comparing the third quarter 2021 to 2020. The majority of this increase was in West Central Florida as we added production staff and opened the Orlando office. West Central Florida had the highest year-over-year loan growth. We've also hired fifteen new producers in 2021. We increased the incentive accrual in the third quarter by 1.1 million dollars based on the high dollar volume of loan production this year. Also, we invested in new markets tax credits during the quarter. The investment write-down increased non-interest expenses by 2.8 million dollars for the quarter, but was more than offset by an income tax reduction of 3.3 million dollars. Non-interest income, credit card income continues to grow; it’s 2.04 million dollars in the third quarter versus 1.8 million dollars in the third quarter of 2020. Third quarter card spend was 216 million dollars in 2021 versus 151 million dollars in 2020. And that concludes my remarks and I’ll turn the program back over to Tom.

Thanks, Bud. We do continue to be optimistic about our future growth due to strong pipelines and conversations with clients regarding their future plans. So, all in all, we were pleased with the quarter, we’re pleased with the outlook, and we'll be more than happy to answer any questions you might have.

Thank you. Let's open the floor for questions.

We’ll now begin the question-and-answer session. The first question will come from Brad Milsaps with Piper Sandler. Please go ahead.

Hey, good afternoon, guys.

Hey, Brad.

Hey, Brad.

Tom, I was just curious — obviously, another great quarter of loan growth. If you could give us a sense of kind of where your new loans are coming on the books kind of relative to the current book yield?

Brad, it’s Bud. At the pace we're still putting loans on at 4.15 percent to 4.20 percent, right?

Okay, great. And based on your comments, I just want to make sure I got you correctly, you thought that the pace of securities purchases would be right around one hundred million dollars a month, so about three hundred million dollars a quarter, is that correct?

Right. Yes. We're going to watch rates. Five- and seven-year treasuries have been turning up. We'll watch it and I'm sure we'll look at increasing that purchase amount over time, but one hundred million dollars a month and three hundred million a quarter is our current goal.

Yes. So, all else equal, you might get the security portfolio up to two billion dollars or so by the end of next year?

Yes. That’s right, yes.

Got it. And obviously Bud, none of us has a crystal ball, but just kind of curious, if we got fifty basis points or seventy-five starting late next year, aside from the obvious — your cash balances would get a higher rate. What do you think the impact would be for you guys? How would you want to express it in terms of NIM? Just kind of curious, what the impact would be on loan yields with higher Fed funds and taking into account anything you might add sitting at floors, etc.?

I don't know if I have a good answer just right off the top of my head, especially when you go into the loan side. I really have to look at it.

How much cash we're going to have on deposit in the Fed matters.

Yes. That's an important factor. The amount of cash we hold will influence the net benefit.

Yes. Well, maybe ask differently, can you just remind us of your kind of split between sort of prime or LIBOR-based loans versus fixed rate?

The mix? Let me think. We're at sixty-something percent on fixed. Brad, I think we're probably sixty percent to sixty-five percent on fixed. I know that's been shrinking, but I just don't have the exact number right here. I can email it to you.

Okay. No problem. All right, great. Well, I’ll hop back in the queue and let some other folks hop in. Thank you, guys.

All the cash is floating rate — the four point six billion is floating rate, Brad.

Sure. Absolutely. Yes. Got it. Thank you.

That's the biggest floating rate asset we have — that's cash.

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

Hey, good afternoon, guys.

Good afternoon.

Just digging into the loan growth a little bit. Tom, you mentioned in the release about the economic recovery, you also had cited just a few minutes ago the line utilization really hasn't picked up like you would have hoped. Where would you attribute this growth to — pure economic expansion versus the effect of your hiring efforts in bringing folks over, and that probably dovetails with the deals that are going on. Maybe it's not just from hiring, but you're getting some loan opportunities because of some of the consolidation that's going on in your markets. Can you point to what are the main driving forces for that loan growth?

Kevin, I don't really know that precisely. I'm giving you a guess, but I think it's probably half and half — probably half in new hires and half is projects from existing customers. People put projects on hold during the pandemic, and we didn't want to do anything, and they didn't want to do anything. Now they're moving forward with new projects — a lot of commercial real estate. Loan demand is not that strong in the commercial and industrial sector; our C&I loans declined in the last quarter just because of strong profitability and continued stimulus and strong corporate profitability. Supply chain constraints affect hiring and operations. I'm just giving you a guess, Kevin. We haven't broken it down.

You've mentioned that supply chain disruption and employee shortages are big issues for everyone. When you're looking at that, is that something that in your mind is just preventing a more healthy pace of C&I growth, and/or is it something that is starting to get on your radar in terms of credit — getting concerned and watching things like that more carefully?

We don't have any credit concerns at this time, but yes, we think that if the supply chain ever does get fixed, which we don't think will be anytime soon, that certainly will lead to more inventory build and could be a tailwind for us. There is a tremendous lack of supply and unprecedented demand that we are seeing today. We hear it from every customer that we have. We're getting a little pickup in demand in areas like steel prices rising; for example, customers in steel fabrication have had to increase inventories and some scrap dealers are borrowing a little bit more. But it has not been an overwhelming change yet.

Okay, great. One last one for me: you mentioned capital and how you moved from having a lot of excess capital to putting it to use. How do you feel about your capital levels now? If you have this kind of loan growth going forward and we don't have a major change in the balance sheet, is it something that you might look at for getting more capital?

Kevin, we've talked to our regulators; our Tier 1 leverage was 8.25 percent in the quarter. We'll reassess in the fourth quarter, but I think that eight percent is the key number and we would have some leeway. The thing that really has driven it down is that we grew over one billion dollars in deposits in the third quarter — spikes like that cause the issue. I think the regulators understand that. So I think we could probably get by without doing a capital raise or subordinated debt as long as that's a short-term issue.

We think we will be fine based on projections and we think we have more than adequate capital, Kevin. Also, the risk weighting on the four point six billion dollars at the Fed is zero, so we don't have a risk-weighted capital issue with that much cash on the Federal Reserve. We think we're in good shape — absolutely no problems, and we're glad we have that extra capital.

Yes, and part of the reason I asked is you're also sitting with a very strong currency. That's another variable to weigh when thinking about whether to raise capital or not. That was my point. Okay, thanks very much, guys.

Thank you.

Thank you.

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

Hey, good afternoon, guys. Maybe following along with Kevin's line of questioning. The liquidity from a capital perspective — you've said it's liquidity pressure, not a loan growth perspective, but your liquidity has been building since really pre-COVID. Four point six billion dollars is massive liquidity. One, Tom, I might have missed if you gave the timeframe, but I believe you said your correspondent channel balances have doubled from five hundred million dollars to one billion dollars. Is that correct, and was that year-over-year or in the quarter?

Go ahead, Rodney.

Yes, you heard him correctly. Since year-end, our correspondent DDA balances went from just over four hundred million dollars to over one billion dollars. Total correspondent balances were just shy of two billion dollars at the beginning of the year and are at three point six billion dollars now. What makes that up is the DDA balances where our downstream correspondent banks keep money on the DDA to meet compensating balance requirements with a settlement point at the Fed for cash flow. Anything over that, we sweep into Fed funds or money market accounts. Right now our largest category by far is DDA balances, but that growth has come from new correspondent relationships, mainly in Florida. Last month alone we opened over twenty-something correspondent accounts in the State of Florida. This month we opened another six correspondent accounts. In addition to those new accounts, our downstream correspondent liquidity is higher than it's ever been; they have a lot more cash just like we did. We are taking this year as a spike; I didn't predict it and I don't think it will continue. But that's where it came from.

We are seeing a flattening, Wally, in deposit growth in most regions. The question is whether you do a capital raise to support cash in the Federal Reserve where you have a negative carry. I don't think so. You figure out some other solutions. There are solutions to offload some deposits in a third-party arrangement if we need to. That would probably be the solution rather than a capital raise.

William, we do have the ability to manage those funds. Right now funds that go into DDA are deposits. What we purchase as Fed funds, we are purchasing as principal. If we want to, we can sell that money off to another bank or we can place it at the Fed in an agent relationship, which we have the capability to do. We just have chosen not to do that up until now as we've been buying these principals. We'll see if we can put it to work.

Okay. So are we at the point where you are starting to make those decisions? I'm assuming the answer is yes, if you start putting one hundred million dollars to work a month in securities and trying to figure out other ways to turn it into a positive carry. That's where we are today?

That's more a question for Bud and Tom, but we have the capability and the tools to manage it if we decide to take different actions.

We want the correspondent channel to grow because there are other aspects: long participations that we purchase, we make direct loans, and we're growing our credit card outstandings through the correspondent credit card agent program. There are a lot of other revenue elements from our correspondent relationships. We think we have a good chance to capture market share in the Southeast United States and we're seeing a national credit card program to date.

Okay. Thank you. Bud, it looks like you moved about two sixty million dollars into held to maturity this quarter. Can you give a brief overview of the nature of those securities?

Yes, that was all mortgage-backed securities that we moved. The net unrealized gain was about 5.6 million dollars and that will be amortized over the remaining life. We get to keep that 5.6 million dollars in our unrealized gain total. I think a lot of banks are looking at doing this — you don't have a negative impact down the road if rates go up. It helps your book value by moving those securities to held to maturity.

What's the duration on those on average?

About five years.

On credit, you highlighted in the prepared remarks how strong credit is overall, yet you decided to increase the reserves and the reserves to loans. If you take PPP out of the equation, it's really kind of holding flat on a reserve to loan basis. At what point do you in your models make the qualitative adjustments that would bring the reserves back down, or do you think you're where you need to be?

We look at it on a quarterly basis. That two basis points of charge-offs on a year-to-date basis is not normal. I've been a bank president for thirty-six years and I've never seen losses as low in my career as this on a one-off basis. We know losses exist somewhere in a portfolio; we just don't know where. Historically, in good times, charge-offs might be ten to fifteen basis points and during bad times they might be twenty-five to thirty. We want to be prepared for when losses normalize. We're in the banking business; there will be charge-offs. We need to be prepared.

Thanks. And my last question: you've got your one hundred million dollar monthly loan production target that you have been exceeding. Has production itself been accelerating, or are payoffs also declining? Are you getting a double benefit?

Payoffs are lumpy; it's hard to answer precisely. Production was lower in the third quarter than the second quarter, and we didn't have significant payoffs. People who wanted to sell properties or companies in anticipation of potential capital gains tax increases already did so last year, so payoffs can be very timing-dependent. It's hard to predict, but usually the fourth quarter is a good production time for us; it's typically the highest of the year.

Okay. Thank you very much for answering my questions. I appreciate it, guys.

Thank you, Wally.

The next question will come from Dave Bishop with Seaport Global Securities. Please go ahead.

Good evening, gentlemen. How are you?

Hi, Dave.

Most of my questions have been asked and answered, but how should we think about operating expenses here? You mentioned the new markets tax initiative. Should we think about this as sort of a good run-rate, conversely the tax rate sort of remaining around that eighteen percent moving forward with the tax credit investments?

Maybe a little bit higher, somewhere in the nineteen percent to twenty percent range. The new markets tax credits and investments — at the end of the period, if you have a capital gain or loss, the new market investments can be used to offset it. That is really why some of these tax credit deals come into play; you want to match as much as possible on capital gains or losses. That definitely impacted our non-interest expense for the quarter.

Got it. So that's a good run rate moving forward, maybe one million or two million dollars heading into the fourth quarter?

The write-down will still be there — it's about 2.8 million dollars in the quarter for the write-down, but you'll have a 3.3 million dollar tax reduction, so that's essentially the net dynamic.

Got it. Okay, great. That's all I had.

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