ServisFirst Bancshares, Inc. Q1 FY2022 Earnings Call

Greetings. Welcome to the ServisFirst Bancshares First Quarter Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to your host, Davis Mange, IR Director. You may begin.

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. 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 and thank you for joining our call today. I’m going to cover a few highlights of the quarter, and then I’ll turn it over to Bud Foshee for a more detailed financial report. Our report today is fairly brief; we don’t read to you, but it’ll be a little more brief than normal, because we don’t really have a lot of problems to explain away. So I’ll first cover our loan growth. We had just under $500 million in loan growth for the quarter. That exceeded our goal of $100 million per month in net loan growth. And of course, this excludes PPP loans when I use that number. The growth was very solid in all regions during the quarter. There was broad based growth in our southeastern footprint. We were pleased to finally see some C&I loan growth during the quarter. This was the first quarterly improvement in C&I line utilization albeit modest that we’ve had since the pandemic started. On our loan pipeline, it’s back up from year end. It dropped a bit at year end, and it’s up 35%, back to what I would say are record levels—the highest we’ve had since last fall. So we’re pleased with our pipeline. We’re seeing a lot of activity today. We’re having a lot of phone calls every day on credits. And regarding our loan growth for the quarter, I liked that we didn’t have any significant payoffs this quarter; it was all small, broad-based loan growth, which is certainly our preference. On the deposit side, deposits were pretty flat for the quarter. We did see a little decline in correspondent balances plus corporate tax payments. Our correspondent banks are beginning to deploy their liquidity in both loans and securities just as we are. My guess is we’ll see modest deposit growth this year due to the stimulus withdrawal and other factors such as the correspondents making loans and buying securities. We did add some new bankers in the quarter, and we’ve made some announcements, with more to come. We’re very pleased with the group we picked up. We have more than usual in the hiring queue today and the interviewing process. So we continue to have the same goal as always: recruiting only the best bankers to have the best efficiency ratio in the industry. We’re very pleased with the upgrade in our team over the last two years. The pandemic has highlighted the best places for bankers to work, and we think we are the best place to work. In addition, the merger activity continues to work in our favor. Consolidation certainly helps us. So, I’ll turn it over to Bud Foshee now, our Chief Financial Officer, for the financial update for the quarter.

Thank you, Tom. Good afternoon. As part of our strategy, in deploying some of our excess liquidity, we’re changing our monthly investment purchase plan. In the future, we’ll purchase a combined total of $75 million in securities: $25 million of that will be 10-year mortgage backed and $50 million will be 2-year treasuries. Net investment security growth in the first quarter was $311 million. We also decided to retain a portion of our mortgage originations. For the first quarter, we sold $4.6 million to investors and retained $41.8 million. Margin, loan growth, exclusive of PPP forgiveness, was $489 million for the first quarter. Average loans, exclusive of PPP, increased by $731 million in the first quarter, while average PPP loans decreased by $143 million. The net average growth for the quarter was $588 million. PPP fees and interest income were $4.9 million in the first quarter, comparing to $11.5 million in the first quarter of 2021. The remaining PPP fees at the end of March were $3.1 million. The net income impact from the March ‘22 Fed rate increase: we had excess funds of $3.4 billion that repriced. On the loan side, we had $717 million that repriced. On the liability side, correspondent had $2 billion in deposits and Fed funds that repriced. The net impact is $4.6 million on an annual basis, or on a per-share basis, that’s $0.08 per share. Noninterest income, credit card income, continues to grow, $2.4 million in the first quarter versus $1.2 million in the first quarter of 2021. The spend was $226.4 million in 2022 versus $169.8 million in 2021. We recorded a write-up in value of $3.4 million for the quarter for the LIBOR cap that we purchased in 2020. Offsetting most of this write-up was a loss of $3.3 million on the sale of $47 million of low-yielding mortgage-backed securities. Noninterest expenses due to our market expansions—total salaries and benefits—increased by $2.8 million. Salaries increased by $786,000 comparing the first quarter of 2022 to 2021. West Central Florida’s increase was $342,000 as we added production staff and opened the Orlando office. We added two producers in the mortgage department for Pensacola and Tampa Bay markets. We also hired an internal audit manager in the fourth quarter of 2021 to decrease our outsourced internal audit expense. We hired 6 new producers in the first quarter. The 2022 incentive expense was $4.5 million versus $3.7 million for 2021. The investment write-down related to tax credits was $2.5 million in 2022 versus $86,000 in 2021. This increase was more than offset by an income tax reduction of $3 million. Correspondent bank service charges increased by $1.4 million. The number of settlement banks increased from 18 in March of 2021 to 52 in March 2022. We paid additional upfront core conversion expenses of $874,000 in the first quarter. The total amount that will be paid to the current core vendor over the remaining contract term was reduced by over $2 million. For 2023, we estimate our annual IT expenses will decrease by about $2.4 million. Unfunded commitment reserve showed a $300,000 charge in the first quarter of 2022, and a $600,000 charge in the first quarter of 2021. That concludes my remarks, and I’ll turn it over to Henry.

Thank you, Bud. The bank got off to a strong start in the first quarter with the loan growth Tom previously mentioned. As discussed on this call in the past, 2021 was a record year for our bank and for most of the financial sector in terms of strong credit quality, given the influx of government stimulus. It is my expectation that 2022 will likely be a return to more normalized results from a credit perspective and more in line with historical performance we saw pre-pandemic. We are well-positioned with our loan loss reserves. At the end of the quarter, our ALLL to total loans was 1.21 compared to 1.22 for the fourth quarter of 2021. From a dollar perspective, we did grow our loan loss reserve by $2.8 million for the quarter, which was needed due to our loan growth. Past due loans were $9.6 million on a total loan portfolio of roughly $10 billion, which equates to 10 basis points, 3 basis points higher than where we were at year-end, but still lower than our peer group. Nonperforming assets were $21.4 million for the quarter, which equates to NPA to total assets of 20 basis points, a decrease from the first quarter of 2021. We have two NPAs under agreement to be sold, which are projected to result in roughly a $4 million reduction in NPAs in the near future. Both sales are scheduled to close in the next 30 days. Annualized net charge-offs and OREO expenses were 11 basis points for the quarter. While this is elevated from Q4 and the first quarter of 2021, 50% of the charge-off credit expense was related to one specific credit that we have no remaining exposure to. The owner of the business had health issues, the business is now closed, and we have liquidated the remaining assets and been aggressive in writing down the debt. If not for this one specific relationship, our charge-off would have been closer to 5 basis points. Overall, I’m very pleased with the bank’s performance in the first quarter. Credit quality continues to be excellent, and our diverse granular loan portfolio remains one of our bank’s biggest strengths. With that, I’ll hand it over to Tom.

Thank you, Henry. I know that I read a lot about expectations for a possible recession, and we just don’t see, at this point in time, any significant threat. I’d be happy to discuss further if you have specific questions, but we just don’t see it. Our borrowers are in better shape than they’ve ever been before. On the C&I side, they’re extremely strong and liquid, very low leveraged. On the commercial real estate side, we’re seeing much greater equity investment on the part of all the projects we’re working on today compared to historical times, certainly much greater equity than we saw prior to the 2008 and 2009 recession. So, we feel good about all of our credit exposure as well as we can. We’d be happy to answer any questions you might have. I’ll turn it over for questions now.

Our first question is from Brad Milsaps with Piper Sandler.

Bud, just curious, what made you guys change your— I mean, I know it’s a subtle change, but still a change, even with rates where they are. What made you guys change the pace of deployment of liquidity in the bond portfolio? Just kind of curious how you’re thinking about that.

Yes, I think mainly we’re looking at whatever, 4, 5 or 6 Fed rate increases, and I guess trying not to get too far out on the purchases, market value; we’re trying to pace our purchases a little bit differently. At some point, it will extend out. I mean, we’re staying short now, but just a little change. We just want to make sure of what rates are going to do before we continue with $100 million in purchases.

Plus loan demand is strong, Brad. So, we’d rather make loans than buy securities any day. We’re seeing strong loan growth.

Right, absolutely. And just on that topic, Tom, I mean, you guys have been targeting $300 million a quarter, but you’ve been easily exceeding that. I think you said your pipeline was back at a record level. I mean, is $300 million kind of a very, very low bar at this point? How should we think about that as we kind of move through the year, based on what you’ve done the last few quarters?

Well, we’ve not had any significant payoffs these last two quarters—no significant payoff trend. This could be a dynamic we have to face. Certainly, as we’ve done more commercial real estate and more real estate construction, we should see heightened payoffs in the future, but probably not anytime soon. That said, it’s a good question. We’d rather be on the conservative side than the aggressive side in our forecast.

Sure. Maybe just a final question for me, but I was writing quickly when you were discussing the repricing of loans and deposits. I think at one point, you told me variable rate loans were about 35% of total loans, without many floors remaining anymore. But can you just update us on your view of loan repricing as the Fed moves higher?

Yes. What repriced in March was $717 million. We did a static balance sheet break shock based on March’s numbers, where the Fed would increase in their May through December meetings. We used a 50% deposit beta except for the correspondent money market accounts, and we used 100% beta on Fed funds purchased. That should give you a better flavor of what happened because the second and third quarters really aren’t impacted; there’s a small decrease, then you have a bigger decrease in the fourth quarter than the first quarter of 2023. So, we go from $717 million repriced in March, and by the last Fed rate increase, you would have over $2 billion. The floors gradually go away and the margin improves, and it's just so much each quarter, it's going to go above the floor rate.

That’s really why we bought that LIBOR cap in 2020, to smooth out any earnings gaps caused by rate floors. However, what we didn’t account for is even though those rates have not kicked in yet, they will soon, but the accounting treatment is to take an immediate gain on the instrument, which is not what we’re interested in; we’re more focused on the cash flow. The gains we expect over the next year have been accelerated into this quarter, and that’s why we offset it with the sale of some low-rate mortgage-backed securities.

Got it. Bud, just remind me, I think you have $4 billion of correspondent bank deposits. Are all those in the money market account, or is some of that encompassed in the Fed funds purchase line?

This is Rodney Rushing. It’s split about half: just over $1.7 billion is in DDA paid for settlement services. There’s about $1.6 billion in Fed funds and another $400 million in money market. So for a total of—at quarter end, it was $3.7 billion. I believe today it’s slightly up from that. But that gives you a breakdown of where the balances are. From year-end, it was only a $157 million decline in correspondent balances, so that’s about 4% of the $3.9 billion we started with. Does that answer your question?

Yes. So, some of it’s in DDA offsetting charges, so that could—rates move up unless you move your charges up; that could start to cost a little bit more?

That’s right. And we have raised our rates. We pay a slight premium over what the Fed is paying. The last two increases have declined—shortened that margin slightly.

I’m going to try asking from a more top-level perspective. I know you gave a lot of great detail on the margin, Bud. I guess, with all the moving parts, we have remaining PPP fees, although likely less than what we’ve had in prior quarters. We have rates going up, and you talked about asset repricing and funding repricing. Lastly, excess liquidity is being put to work as well and loan growth is strong. So, buttoning all that up with future rate increases likely, how should we think about the margin trajectory? Are we basically at 2.89%, effectively at the bottom? To what kind of level should we be thinking about NIM with the current curve? Just a very top-level thought would be great.

Yes, I don’t really have a specific number in mind. My focus is more from the deposit side. We’re planning for deposit rates versus competitors. No matter what the Fed does in May, we’re going to wait and see what we have to do from a rate standpoint. It’s hard to tell you because it’s kind of unknown from the deposit point of view. I’m saying we’re sitting here with over $3 billion in excess funds; it won’t hurt for some of those deposits to roll off if they’re at a higher rate. It’s really driven more from our loan pipeline.

Right. Well, assuming only modest growth in deposits, it seems like that's the message. Now more of that liquidity is being put to work, but there’s still a lot of it. It seems reasonable to assume you’ll be able to lag on taking deposit prices up. Is that fair?

Yes. That’s how we’re standing: rates go up, we always lag.

And I guess—we’ve got 23% of our assets in cash still. That presents a real opportunity for us to put a lot of that cash to work over however many quarters it takes to utilize that excess liquidity.

Understood. We’re all thinking of this, especially in these early stages, but we see the rate cycle being positive for banks. We’re trying to factor in all factors and not get too aggressive on what that margin may do. Maybe it’s more modest, steady expansion than something that’s dramatic.

I would say steady versus dramatic, yes.

That excess liquidity has certainly weighed on our margin heavily. We haven’t seen anything like the levels of excess liquidity we’ve had since the pandemic started, so we really stopped talking about margin traditionally because we traditionally have a 100% loan-to-deposit ratio, not 70%. So, the margin has become not a meaningful number for us, at least when we usually think about it. Does that make sense?

Right, right. I understand. And that’s another factor just with the opportunity to take that loan-to-deposit ratio back up to where it had been historically. Tom, maybe—you referenced at the beginning the entry into Charlotte. Can you provide some insight on how large you see the team in that market and how significant you see that market being for you over time? Also, I think you mentioned some hiring that could happen. Will that include additional new markets that you’re not in right now? Thanks.

Yes, we will have an announcement on that within the next two weeks, Kevin. We’ll have more information on the team we’re assembling there. So, you’ll have more data soon. We also have an announcement on another team joining the bank today, and we’re excited about that. There’s never been a better time to have an organic growth strategy when everyone around you is undergoing merger activity. We’re more optimistic today than we’ve ever been.

Our next question is from David Bishop with Hovde Group.

Maybe staying along the topic Kevin just asked about. Obviously, you’ve got some teams and hiring lined up there. As we think about the inflationary pressure from those hires vis-à-vis the outlook for operating expenses, I think my model had them up about 17% last year, year-over-year. Are you thinking at this point, maybe mid-teens, mid-to-high teens is the right way to think about operating expense growth into 2022?

I’m not sure. I’d be guessing on that, but I’m not confident about how many employees we’re going to add in total for those markets I guess—it’s best to factor out the expansions and just look at what we can control. We don’t anticipate noninterest expenses increasing like that; we see it increasing by maybe 3% for noninterest expenses. It’s influenced mainly by salary increases and the total number of people needed to grow in those markets. I just don’t have a great overall number...

Bud, you’ll send some detailed information out on this because those numbers might be misleading. The percentage increase Dave—we’ll send all the analyst group information on why that could be misleading without getting into the weeds on this call. We did salary deferrals last year for a substantial amount due to the PPP program. I don’t think the true year-over-year increase in cost is anything close to that.

Got it. That’s a good point. And I know in the preamble, you noted that you had seen the first time since the pandemic, some level of uptick in C&I line utilization. Just curious if you’ve had that number. Also, if we were to see a normalization of those line utilizations back to pre-pandemic levels, how would that imply loan balances being translated on the balance sheet?

I didn’t quite understand—what is normal and where are we now? What’s normal, Dave?

From a percentage and an implied balance perspective, if you were to normalize.

Pre-pandemic, we would see 47% to 48%. One reason our number hasn’t gone up is that the denominator has increased a good bit over the course of the pandemic, primarily because of our success with the PPP program, which made our pandemic denominator larger. Hence, that’s suppressed our outstandings a bit. We got as low as 38% utilization and we’re about 41% now, 41.5%. So, reaching 47% to 48% would be normal. We expect it—but we just don’t know; I originally thought we’d see all that back in the second half of last year, and I was mistaken when that would recover because of the stimulus. One reason I said our corporate borrowers are in better shape to withstand a recession than they’ve ever been is that their liquidity is very strong today.

That probably is my final question about that liquidity. I think you or someone else made the comment that cash and liquidity is about 22% of ending assets. Just curious where you see that and if there’s a target level to settle into, as you use that excess liquidity for loans and securities? Thanks.

In a perfect world, it would be about $500 million in cash, Dave. It’s tempting to look at what we can do above what we’re earning at the Fed today and be tempted to buy some securities immediately. We’ve resisted that temptation and decided that over a two-year period starting last fall, we would gradually put that money into securities and hold some single-family mortgages. So, we think over a two-year period we’ll average the market rate because we’re not smart enough to find the peak yields—we’re doing our best to average the market over that time frame.

This concludes today’s conference, and you may disconnect your lines at this time. Thank you for your participation.