ServisFirst Bancshares, Inc. Q2 FY2022 Earnings Call

Greetings. Welcome to the ServisFirst Bancshares’ Second Quarter Earnings Call. Please note, this conference is being recorded. I will now turn the conference over to your host, Davis Mange, Head of Investor Relations. Thank you. You may begin.

Good afternoon and welcome to our second 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 will 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 and thank you for joining us on our second quarter call. Before Bud talks about the numbers, I am going to give a few highlights of the quarter. On the loan side, obviously, the loan growth was extremely strong in the quarter; excluding PPP loans, loans grew by $803 million in the quarter. One factor is there were really no payoffs in the quarter. We expect those to accelerate in the third and fourth quarters, which will moderate the loan growth. We still see a strong pipeline of loans, but we do expect to be more offset with payoffs in the third and fourth quarters. On the deposit side, we did see some runoff in the correspondent deposits that are making loans and buying securities, just like we are. Our customers are experiencing very strong profitability, and tax payments were up a good bit in March and April, above normal, which affected deposit levels as well. I think we will probably be back to more typical patterns of deposits; pre-pandemic for most of the bank’s history would see deposits decline in the first quarter, kind of be flat in the second quarter, and then grow in the third and fourth quarter of the year. Let’s talk for a minute about loan quality. That seems to be on everybody’s mind, and we talk about it at our Board meetings and management meetings often. With the prospect of a possible recession ahead, we are often asked about what we are seeing. First, Henry Abbott will talk in a minute about our loan quality, but our loan quality metrics are the best we’ve ever had as far as I can remember. We have been very proactive in loss recognition; we certainly won’t be proactive if we are facing a recession. We want to be proactive in loan loss recognition as quickly as possible. In terms of loan underwriting, some investors have asked if we changed our underwriting, and the answer is no. We want to be consistent year in and year out. Good banks are very consistent in underwriting; they don’t change. When times are good and times are bad, they underwrite exactly the same way. We stress test every loan that we make, and I think we have a pretty good system and a good track record of performance over the years. We are a disciplined growth company that sets high standards for performance. I can assure you our credit team is looking for cracks in the economy. Henry and his group are constantly monitoring. On the C&I side, any issues we see are due to people that just aren’t good business people; it’s not really because of any meltdown in one economic area or type of business. On the CRE side, the big question is whether cap rates will move up; as of now, they really haven’t. Investors are looking for yield on high-quality REIT-type products. What really gives me the ability to sleep well at night to an extent is that we see strong migration continue into the southeast, which I think will offset some of the recessionary forces if we do experience a recession. Frankly, I don’t think a little bit of a slowdown would be all that bad for the economy. I got a bit spoiled the last couple of years when traveling, as all the nicer hotels were quite inexpensive, and now that’s not the case anymore. I am back in the less expensive hotels, so I miss that. We have a few hospitality operators as customers, and they are reporting very strong occupancy and high rates. That wouldn’t be all bad to have a little bit of a slowdown there. In terms of talent, we added the most new bankers in a quarter that we have ever added, 15 in the quarter. We think we brought in some top talent into our company. If I had to identify one of the strengths of our company, it is that we have not had any turnover in senior leadership in our banks and regions over the last 17 years. We have had a few retirements, but we have not had any turnover, and we have a very loyal executive team. We want to be the best place for a commercial banker to be, and I think the absence of bureaucracy at our company is attractive to many bankers as well. I will stop there and let Bud cover some of the financial aspects.

Thanks, Tom. Good afternoon. Liquidity; we will continue to evaluate our monthly investment purchase plan based on the bank’s excess funds. Net investment security growth in the second quarter was $172 million. In mid-June, we decided to suspend investment purchases based on our strong loan growth. Net interest margin, as Tom mentioned, the loan growth exclusive of PPP forgiveness was $803 million for the second quarter. Average loans, exclusive of PPP, increased by $650 million. Average PPP loans decreased by $108 million, resulting in net average loan growth of $542 million in the second quarter. PPP fees and interest income were $2.9 million in the second quarter compared to $10.2 million in the second quarter of 2021, and the remaining PPP fees are $513,000. Net loans grew by $97 million in the last few days of the quarter, which increased our loan loss provision, but we will not receive the positive net interest income impact until next quarter. Deposits decreased by $637 million in the second quarter, with $532 million of this decrease related to correspondent banks. Fed funds purchases decreased by $250 million in the second quarter. Our margin has gradually improved each month; starting in January it was 2.84%, increasing to 2.91%, then to 2.97%, 3.04%, and 3.28% in May, and then June was 3.43%. The bank received a positive net interest margin impact from the Fed rate increases in May and June. For future Fed rate increases, correspondent interest-bearing accounts will have a 100% beta, which is just part of the business. For the remaining interest-bearing DDAs, we anticipate a deposit beta of 30% to 35%. Loan loss provision; our provision increased by $4.2 million in the second quarter as our loan production, excluding PPP, increased by $314 million from the first quarter. Non-interest income; credit card income continues to grow. It was $2.7 million in the second quarter versus $1.9 million in the second quarter of 2021. Spend was $264 million in 2022 versus $226 million in 2021. We recorded a write-up in value of $2.1 million for the quarter on a LIBOR cap we purchased in 2020. Non-interest expenses; first, salaries and benefits, as a result of our market expansions, total salaries increased by $732,000 in the second quarter and by $1.9 million year-over-year. Total salaries and benefits increased by $2.4 million during the second quarter and by $6.6 million year-over-year. Second quarter 2022 incentive expense was $6.2 million versus $4.5 million for the first quarter of 2022. The increase reflects loan growth, strong core relationship growth, and entry into new markets. Tax credits; year-to-date investment write-down related to tax credits was $5 million in 2022 versus $173,000 in 2021. This increase was more than offset by an income tax reduction of $6.6 million. Correspondent banks; the year-to-date correspondent bank service charges increased by $3 million. The number of settlement banks increased from 111 in June of 2021 to 164 in June of 2022. That concludes my remarks, and I’ll turn it over to Henry.

Thank you, Bud. The bank saw record loan growth in the second quarter of 29% annualized, as Tom and Bud previously mentioned. The loan growth was strong in each of our regional banks, and the bulk of this growth was centered around commercial real estate. With this loan growth, our credit quality continues to be incredibly strong and in line with prior trends in the post-COVID PPP environment. I’m pleased to say that annualized net charge-offs and OREO expense for the quarter were only 2 basis points, which is down from the first quarter of 2022 at 11 basis points and the fourth quarter of 2021 at 3 basis points. Of the roughly $1.8 million in charge-offs, around 60% of the expense was related to one specific credit that we had previously impaired. The net credit expense figure was aided by roughly $1.2 million in recoveries, primarily driven by one credit we aggressively wrote down last quarter but had significantly better-than-expected results in liquidating the remaining assets of the operating company. We continue to be well-positioned with our loan loss reserve at 1.21%, which is consistent with the prior quarter and slightly down from 1.22% that we had in the fourth quarter of 2021. From a dollar perspective, we did grow our loan loss reserve by $8.9 million in the second quarter. This increase was not related to a reserve on any one specific credit but rather the growth of our loan portfolio as a whole. Past due to total loans were 10 basis points, which is in line with the first quarter of 2022 and continues to be near record lows. As I mentioned on the call last quarter, I don’t expect ServisFirst or banks in general to maintain the record-setting pristine credit quality we have seen over the past year forever, but we have yet to see a rise in key credit metrics. Past due loans are a simple but good early warning indicator, and they continue to be very minimal. Nonperforming assets were $16.7 million for the quarter versus $21.4 million for the prior quarter. This figure equates to 15 basis points of NPLs to total loans, which is a 25% decrease from the prior quarter as well as the same period a year ago when we had 20 basis points of NPLs to total loans for each of those quarters respectively. In the face of rising interest rates and inflation, the loan portfolio continues to perform very well, and I’m pleased with the second quarter results. With that, I’ll pass it back to Tom.

Thank you, Henry. For the remainder of the year, we’re going to focus on growing core relationships in the bank. In the past two years after the pandemic hit, we did experience a large deposit surge and loan growth was pretty minimal during that period. We did book some transactional loans during the pandemic, just like we did in the 2009 to 2011 period when we had large deposit inflows and loan demand was very weak. We did some transactional loans that we probably won’t do going forward. So we will look for deposits where we have significant deposit relationships as well as loans for the remainder of the year. With that, we will be happy to answer any questions you might have about the quarter.

Thank you. Our first question comes from the line of Brad Milsaps with Piper Sandler. Please proceed with your question.

Hey, good afternoon.

Good afternoon, Brad.

Tom, maybe I wanted to start with loan growth. Obviously, another really strong quarter. It sounds like 15 new lending hires, which is certainly a plus. Maybe on the negative side, you’ve talked about some pay-downs that you expect to come. I think at the beginning of the year, you set out a goal of growing about $1.2 billion. You’re already there. Can you just kind of talk a little bit more about sort of what a pullback looks like in your eyes? I mean, you’ve got some of the best growth metrics out there. Just kind of wanted to understand if we could frame that a little bit better, sort of what a pullback in growth for you guys might mean.

It’s sort of hard to give a very accurate answer, Brad, rather than we are going to be very selective in what we book. Obviously, $150,000 a month is probably—I think we will look at something north of $150,000 a month on average in terms of where we’re going, net growth. I wouldn’t change that estimate yet. The $150,000 a month, I think, is a good number net of paydowns. We still, like I said, we do have some construction paydowns that we know are coming over the next two quarters. So I can’t really get a whole lot more accurate than that.

Sure. No, that’s helpful. And maybe just kind of as a follow-up to Bud, as you think about the size of the balance sheet, I know you talked about stopping the securities purchases. It’s tough to gauge. But do you have a sense where your deposit balances might sort of floor out? Just wanted to think better about the liquidity that you have remaining? How that might be deployed as you move through the back half of the year?

So you’re asking how much we think will grow deposits each month, is that right, the first part of?

Yes. Or just if you’re thinking about the correspondent book, you had some runoff this quarter. I think average liquidity was down about $1.2 billion or so just kind of thinking about where that number is headed as you move through the year. It sounds like you stopped buying bonds. Tom has talked about the loan growth. Just curious if you could think about a floor for the liquidity?

Well, from a regulatory standpoint, we have to ensure that excess funds are above 5% of total assets. That’s about $750 million now. We’re not going to get to that point, but that’s kind of what we look at and have to shoot for to be well above that. We’re about $1.4 billion today. With a big drop over the second quarter, since we wouldn’t buy any more securities. You’ll have the paydowns available as liquidity during the month. Correspondent, I don’t know, have you…

Brad, this is Rodney Rushing. In the second and third quarters of last year, we had unbelievable growth, a balloon of new correspondent deposits. Their liquidity was coming in like ours. When you have over 300 community banks that have accounts with you, we were taking that liquidity. At the end of the second quarter of 2021, total correspondent balances, including Fed Funds, DDA, everything, were $2.4 billion. In one quarter, we went to $3.6 billion. Then by year-end, it grew another $300 million to $3.9 billion. We’ve seen that run down about $800 million this year, and there has been a tremendous slowdown. In the same period, we grew the number of correspondent banks from 316 to just shy of 350. If you look at the past year-end, total balances have increased by almost $600 million in correspondent banking. That shows how much the balloon in liquidity from all the banks provided. That was from the stimulus money, and some of it was from us adding seven banks. We do a lot of things in correspondent banks, like credit products and agent credit card programs. If a community bank uses us as their settlement point, we’re helping with their cash position, and we consider them our primary correspondent. We’ve increased settlement banks. For the year, it was over 50—53 banks, I think. These provided increased deposits in the DDA account using the compensating balance to pay their Fed bill. I hope that answers your question. If I confused you, I will try to clarify that. Did that help?

No, no. Yes, that’s very helpful. Thank you guys very much. I will hop back in the queue.

Thanks, Brad.

Our next question comes from the line of Kevin Fitzsimmons with D.A. Davidson. Please proceed with your question.

Hey. Good afternoon, guys. How are you?

Fine, Kevin.

Maybe we could shift gears and talk about expenses. There are a lot of moving parts in there, and thank you for all the detail; that’s very helpful. When we look at a run rate, I think it’s like $39.8 million this quarter. How should we think of that going forward? Now, I recognize that we have new markets to go into and all the new lenders, and expenses come from day one with that while the resulting revenues will come over time. You also talked about processing revenues. I want to clarify that the additional processing expenses you are referring to are temporary due to the preparation for the conversion, resulting in some duplicate kind of expenses. Maybe remind us when some of that will go away. I want to distinguish that from what I believe last quarter, you talked about like $874,000 in expenses, which I treated as kind of a one-time expense because that seemed to be not core, but related to the actual de-conversion. That’s a lot of different details but all related to expenses; take it however you like, Tom and Bud. Thanks.

Yes. Hi, Ken. One, we made the additional incentive accrual of $1.8 million in the second quarter. Right now, we wouldn’t anticipate doing anything additional in the third quarter, and we will see how that shakes out in the fourth quarter. So, you can really take the $1.8 million out. That was an adjustment in the second quarter. For the core conversion that will take place in February of 2023, TSYS will convert in September of this year except for purchase cards.

September.

Of this year. Then the remainder will be in 2023. We might have some smaller de-conversion expenses. I don’t see anything major that would really impact the quarter going forward. But the biggest factor is taking out the additional incentive accrual from the second-quarter numbers. Hopefully, that helps. I think I covered all of it.

Yes. That’s very helpful. Tom, maybe we could talk about new markets. In the last few months, you guys have entered Metro Charlotte, Tallahassee, and most recently, Nashville was announced. I wonder if you can give us a sense of what inning you are in on those. ASCO would be very, very early. But in terms of expansion, are there prospects for new markets? Do you look at what you have now and say, 'Alright, that’s good for a while, let those season,' or is it based solely on availability of folks? Thanks.

Yes. A lot of it is about availability, but we can go three years without adding a new reach. We’ve done that before because we just can’t find good people. It’s rare to find this many good people at one time. I would say that Tallahassee is fairly well staffed. That’s a good-sized group. Nashville is not going to have a huge team; we are still staffing in the Piedmont region, Greater Charlotte area, which we call the Piedmont region. But we will be selective in the people we look for everywhere. It’s hard to provide a good answer, but just all these mergers have led to an unusual supply of people looking for new opportunities, which is a good thing. The more mergers there are—the mergers we all know slowed down this year, I think. So, I would anticipate it would tail off for a while, Kevin. But we are always looking for the right people to have core relationships and are not transactional lenders, also having deposit customers.

Okay. Great. Thanks very much.

Thank you.

Our next question comes from the line of David Bishop with Hovde Group. Please proceed with your question.

Yes. Good evening, gentlemen.

Hi, Dave. Good evening.

Tom, just curious; you noted the nice margin expansion and obviously, loans as a percent of earning assets creeping up. But I am curious: with the Fed aggressively raising rates, are you able to pass—what’s your success rate, I guess, in terms of how much of that climb in interest rates you can pass on to the borrower? Are you seeing risk premiums adjust? Are you getting paid for potentially higher risk within the market if we enter a recession, be it mild or strong? Just curious what you are seeing in terms of loan pricing across your markets.

I think we have seen, up until the last 60 days, some irrational loan pricing out in the market. I think that’s much more rational today in terms of what we are seeing from our competitors. They are doing a little bit better in terms of what they are doing. However, we have to do what we have to do; we don’t try to pay attention to what our competitors are doing. When you have strong loan growth, we are much better positioned to pick and choose our customers. We would rather be in a position where we have stronger loan demand than deposit demand, right. It’s the best position for a bank to be in, and to increase margin and improve profitability. I don’t know—Bud, do you want to elaborate on interest rate sensitivity?

You asked about interest rate sensitivity, Dave. Was that part of the question?

Yes. Just curious, in terms of spread, I heard in the preamble that you expect some second half deposit growth; it sounds like there has been some seasonality, but you expect some back half funding growth on the deposit side.

Yes, we do. We will focus more on the second half of the year. We have been focused on it for 2.25 years; we will focus on it now.

Got it. Appreciate the color.

Thank you, Dave.

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session. This does conclude today’s conference. You may disconnect your lines at this time. We thank you for your participation.