ServisFirst Bancshares, Inc. Q3 FY2022 Earnings Call

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

Good afternoon, and welcome to our third 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'll 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 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 welcome to our third quarter conference call. I am going to review a few highlights of the quarter, before I turn it over to Bud, to go over the numbers in a little bit more detail. Our loan growth continued to be very strong in the quarter, and the payoffs that we had expected were pushed back to later quarters. We are seeing lower pipelines in loans, because we certainly can't keep growing at the torrid pace that we've been growing in the last two quarters. And we also have been more selective in what we're looking at in terms of the loan pipeline. So, we expect the loan growth to moderate in coming quarters towards our historical growth rates. We did see some runoff in the deposits in the correspondent area in the third quarter, while the general bank was stable. Our correspondents are making loans again, and they're buying securities. So that was to be expected to some extent, probably a little bit more than we thought. We do expect to get back to deposit growth in the general bank in the fourth quarter. We have consistently grown deposits and we are putting more focus on it as we did prior to the pandemic. Incentive plans had been heavily weighted to loan growth in 2021 and 2022, and we will put normal emphasis on deposit growth in 2023. Our general bank had year-over-year deposit growth, even though we did not focus on deposit growth until this past quarter. On the loan quality side, Henry Abbott will certainly discuss it in more detail, but we continue to see strong credit metrics in our loan portfolio. I think we had one credit that was a problem in this past quarter that constituted most of what we had on the charge-off list. We just recently completed a credit card conversion, and we are very pleased to get that done. One reason we're pleased is that we have a moratorium on adding new banks for over six months, so we can start adding agent banks again in the covered area. So that's certainly welcome news from an income-fee income standpoint. We did add 13 new bankers in the quarter after adding 15 bankers last quarter, with growth in Piedmont, Northwest Florida, and Nashville regions. We continue to see opportunities and are being very selective, but we are seeing better quality bankers than we've seen in a long time. In fact, we received a call this morning about a team of community bankers in a very nice market. So, we are seeing potential growth still coming in the door. I'll now turn it over to Bud to go over the financials.

Thanks, Tom. Good afternoon. In mid-June, we decided to make investment purchases due to our strong loan growth. During the third quarter, we reinvested $76 million from maturities and mortgage-backed paydowns into higher-yielding loans. Net interest margin and loan growth, excluding PPP forgiveness, reached $677 million for the third quarter. Average loans, excluding PPP, rose by $776 million in the third quarter, while average PPP loans decreased by $45 million, resulting in a net average growth of $731 million. PPP fees and interest income were $432,000 in the third quarter of 2022, compared to $6.4 million in the same quarter of 2021. Net loans increased by $75 million in the final three days of the quarter, which raised our loan loss provision; we expect to see a positive net interest margin in the next quarter. Our margin has been improving each quarter: it was 2.71% in the fourth quarter of 2021, 2.89% in the first quarter of this year, 3.26% in the second quarter, and 3.64% in the third quarter. Deposits fell by $719 million during the third quarter, primarily due to correspondent banks. Fed funds purchases rose by $77 million in the third quarter. The recent Fed rate increase in September will have minimal impact on our margin over a one-month period. Our loan loss provision increased by $9.6 million in the third quarter, mainly due to a rise in the national forecast from a range of 3.9% to 4.3% on June 30, 2022, to a range of 4.4% to 5.8% by September 30, 2022. Credit card income continues to grow, reaching $2.6 million in the third quarter of 2022 compared to $2 million in the same quarter of 2021. Spending was $275 million in 2022 versus $216 million in 2021. In terms of noninterest expenses, we had a preliminary settlement of litigation and a write-down of a private investment during the third quarter, leading to charges of $2.4 million after income taxes, or $0.05 per diluted share. Total salaries increased by $871,000 in the third quarter and by $3.7 million year-over-year due to our market expansions. The incentive expense for the third quarter of 2022 was $4.3 million, down from $6.2 million in the second quarter. The year-to-date investment write-down related to tax credits was $7.5 million in 2022 versus $3.1 million in 2021, but this increase was more than offset by a $6 million reduction in income taxes. The earnings credit rate on correspondent DDA balances rose from 0.4% on September 30, 2021, to 3.25% on September 30, 2022. Lower balances are now required to pay for account analysis expenses due to the sharp increase in interest rates. That concludes my remarks, and I'll turn it over to Henry Abbott.

Thank you, Bud. The bank continued the trend of very strong loan growth for the third quarter. Loans grew by an annualized 25% for the quarter. We continue to want to help high-quality commercial borrowers and prospects within the bank's footprint. At the same time, we continue to be conservative with our underwriting and interest rate sensitivity analysis, given the persistent inflation in the marketplace as well as being more selective on new commercial real estate exposure, which is income-producing versus our core bread and butter of owner-occupied real estate. Past-due loans were a mere $10.8 million on par with the second quarter, and that figure equates to past due to total loans of 10 basis points, which continues to be near historic lows. We have sliced and diced our loan portfolio in Southwest Florida, followed up with borrowers impacted by Hurricane. While the long-term impact to the region is unknown, we feel like our loan portfolio in that area fared very well. The bulk of our loans in the impacted area were more north of where the hurricane made landfall. To date, we've only uncovered three severely impacted commercial borrowers, and we believe they were appropriately insured. We grew our loan loss reserve for the quarter by $12.6 million, which amounts to an ALLL to total loans of 1.25. This is an increase from 1.21 for the second quarter to slightly above the 1.24 for the same period of the prior year. The increase in reserve is not associated with a specific credit or any deterioration, but rather the model is impacted by changes in economic outlook as Bud previously mentioned. While we have not seen any major changes in the loan portfolio and our four key credit metrics continue to be near historic lows, we did feel it prudent to increase our reserves. Nonperforming loans to total loans were a mere 16 basis points of our $19.5 million in NPAs, over $5 million of that figure is under an LOI to be sold in the fourth quarter to a highly qualified buyer. Our loan portfolio continues to perform at an exceptional level. Charge-offs for the quarter were 11 basis points when annualized. Net charge-offs for the quarter were roughly $3 million on a loan portfolio of $11.3 billion. Of the $3 million in charge-offs, roughly $2 million was related to one specific credit. We were proactive in addressing the issue, and the remaining exposure we do have to the borrower is less than $500,000 and is fully impaired. While charge-offs were slightly elevated, when annualized, our year-to-date charge-offs are a mere 7 basis points. As with all large financial institutions, we are in uncharted territory with the CECL model in the current dynamic environment and how it impacts our loan loss reserve. Changes to the reserve aside, I feel very good about how the bank's loan portfolio is positioned in the diversified markets we serve. With that, I'll hand it back to Tom.

Thank you, Henry. And yes, we're glad to get good news after Hurricane Ian down in Florida. So that turned out to be not as bad as we thought it could possibly be. So that's certainly welcome news. Just in general, I mentioned that I've always thought, I think anybody thinks the core deposits are the key to building the value of a banking franchise. We've always focused on building core deposits. We're certainly well positioned compared to many of our competitors in the industry because our balance sheet liability side is funded with core deposits, not federal home loan advances and brokered deposits. Our compound deposit growth rate in the past five years is 14%, and from the inception of the bank, it's 33% since 2005. We do believe we have the best bankers in the industry, which is the key to the success we've enjoyed since 2005. We think we have the best platform for commercial bankers, which is one reason we've attracted a number of bankers in the last 17 years. We think we have more opportunities for growth than any time in our history as of today. We are pleased with the quarter with an outstanding return on equity, return on assets, and efficiency ratio. We'll certainly be glad to answer any questions.

Our first question comes from Brad Milsaps with Piper Sandler. Please proceed.

Hi guys.

Hi Brad.

Tom, Happy third Monday in October to you.

Well, hi, look, if we all win, you can beat Henry Abbott, Georgia bold out, and we win race as we will see in Atlanta. Decent, but how about that?

That's right, that's right. Well, I don't know if I do. We'll see it though. I think this is the first time I've got to call on a winter. So anyway, I thought I take advantage.

It's a good win but every 15 years, I don't blame you. I would do it too.

As opening, we have rocky top queued up for me.

I am here in Alabama with Mike Sheila and Mike Deboer. We took our turn in the box, and it seems that Tennessee is back, that's for sure.

We'll see. We'll see. I wanted to ask, Tom, you talked obviously, another great quarter of loan growth. You're on pace for we already have generated more than $2 billion of growth this year. Can you maybe frame up for us a little bit more kind of what in your mind is sort of in dollars, maybe what a pullback in loan growth would be kind of vis-à-vis all the people you've hired. And I guess the second part of that question is how much does the pressure on funding sort of impact how much you can grow next year? I know you're focused on deposits, but that's obviously a big part of it with your loan-to-deposit ratio now at 102%.

Yes, we're back to our normal loan-to-deposit ratio, which has been stable for most of the past 17 years, aside from the pandemic and the recession of '08 and '09. This is typical for us, and I have full confidence in our team's ability to drive growth. We've recently brought on some exceptional bankers who are joining us, and I believe we can achieve growth around our historic rates. However, I think a 25% annualized growth rate is not feasible. Our target growth for loans and deposits is in the range of 10% to 15% quarterly, and we expect to reach those levels in the coming quarters. In fact, we are already noticing an increase in deposits, with a significantly larger deposit pipeline than we've had in the last two years. We've had some solid successes recently, and we feel positive about our current position.

I'd just be curious, those that deposit pipeline on average, where are those deposits in terms of rates coming on the books, what are you having to pay to bring in sort of the incremental new dollar of deposits?

Well, our net interest margin in September was what Bud?

3.72%.

That was flat. In August it was...

3.55%.

Yes. So if that gives you any idea, we're still holding the line. We say we're a disciplined growth company and we mean that we're going to be disciplined on both sides of the balance sheet, Brad. We try to grow by treasury management rates; rates are not the answer to building a bank balance sheet. That's not the answer. The answer is treasury management service.

Sure. Thank you, guys, I appreciate the color. I'll hop back in queue.

You have the orange glow always. You have it always, Brad.

Thanks, Tom. I appreciate it.

Our next question is from Kevin Fitzsimmons with D.A. Davidson. Please proceed.

Hi, good evening, everyone, or good evening everyone. How are you all doing?

Good evening.

I wanted to follow up on Brad's question. Bud, I noticed the comment on Page 1 of the release regarding the margin remaining relatively stable moving forward. Are you referring to the quarterly margin, which I believe was around 3.64? Or did I just hear you mention that the September margin was 3.72%? Could you please elaborate on that margin outlook? Is your remark about stability influenced by an accelerating deposit beta offsetting or exceeding the impact from rising rates on the asset side? Thank you.

To clarify, we are discussing the impact of one Federal Reserve rate increase to the next. From a loan perspective, we have approximately $2 billion that will reprice whenever there is a change in the index. This amount is comparable to what we have in money markets and Fed funds. Both of these will increase at the same rate. Over the next month, around $1.8 billion in loans will also reprice. Each loan has a different reset date throughout the month, but overall, there will be another $1.8 billion repriced. Additionally, we expect some increases in the money markets over time. So, the $1.8 billion in loans will see a slight adjustment, and on the deposit side, we can expect repricing during this period.

Okay. So just to clarify, is there still potential for margin improvement from the level you reached in the third quarter of '22 based on what you just mentioned, or am I misunderstanding?

Yes. Yes, definitely.

Okay. So your comment in the release is more about just like we're not going to see the kind of linked quarter change you saw this quarter.

To stress just from a Fed increase standpoint with...

Right. Got it. And the comment about earlier, I think Bud in your comments, you talked about the outlook for general bank deposits to grow. But do you expect total deposits to grow? Or is there still going to be some hangover from correspondent deposits running off? And so what's that kind of next quarter or two outlook for total deposits, would you say?

We believe that correspondent is improving now. They have achieved significant wins recently with the addition of major new customers. We feel like we are returning to our core strengths and moving in a positive direction. Additionally, we have introduced year-end incentives for all of our commercial bankers. At the beginning of the year, we didn’t have a strong focus on deposit growth, but we have made adjustments to prioritize that now. The emphasis is on increasing deposits appropriately, avoiding high-rate deposits, as simply raising rates isn’t the solution for building a successful bank.

Got it. Okay. And Tom, I think early in your comments, you mentioned receiving a call today from a new group of bankers. I know you can't go into too much detail, but is that a market you're currently involved in or not?

No, it is a community bank with a community banking team that we have enhanced in recent months. In addition to the Piedmont region, we've established effective community teams in Tallahassee, Panama City, and Asheville, among others. We believe they are capable of generating both deposits and loans, recognizing the need to fund their own loan growth. They understand this.

All right. Okay. I'll hop back in the queue. Thanks very much.

Thank you.

Our next question is from Dave Bishop with Hovde Group. Please proceed.

Hi. Good evening, gentlemen. I'm a Maryland Terrapins college football fan and I'm very jealous of you all down there in the South, that could produce some good football on Saturday. Look at you on with NBA, that's for sure. Maybe someday, that will change.

We thankfully survived that. I saw Seattle took a lick; it was a game since we left the transfer from Alabama. So we certainly are interested in seeing him do well.

Yes, has to reach. Has to do it. Noticed another 13 bankers added this quarter on top of the 15. Despite that, you guys are continuing to do a yeoman's job in terms of holding the line on salaries and employee benefits. Just curious, I saw that decline 5% linked quarter. Was there anything unusual in the second quarter? Remind us that maybe inflated that? Or are you doing anything special to really sort of hold the line in terms of inflation on the compensation line.

Dave, the only thing from a total salary benefit perspective, we had extra incentive accrual. We have our incentive accrual in the second quarter. So that's the biggest thing I remember our salaries and benefit totals.

Yes. It became obvious to us that all of our banks were going to exceed their loan goals for the year, Dave. So we put an extra accrual in. It was about $2 million.

In the second quarter?

Yes.

Got it. And then the bankers you're talking to, just curious the conversation that sort of compels them to jump to ServisFirst. Just curious at the stage in their career, how that conversation goes. Is there a commonality in terms of a theme where they choose you over the current bank or another suitor out there because, obviously, there's a lot of shares moving around down there? Just curious what sort of compels them to use you over some of the other growth your competitors down there?

Well, I think the banks don't have consistent incentive plans. They change the plans. In fact, we've had a number of bankers that joined us that found out that right at the end of the calendar year, the incentive plan was changed, and they didn't like that for that current year. There are a lot of reasons, but I think a lot of people have found that we're a good platform to work from. We support them in every way, and it's not about the management team in Birmingham; it's about the operating people out in the regions, and we do everything we can to empower them. Henry Abbott turns around credit requests as quickly as we can. We don't spend weeks putting people through the ringer; if we're going to turn it down, we turn it down quickly, and that's what customers want to hear. Really, we're just focused on good customer service. It's not sales; it's service. Service is what wins us customers. We feel like we're offering the best service in the industry. Our compliance person was telling me how few complaints we get this morning because we try to work with customers and try to resolve complaints. We don't have the kind of problems. A lot of banks have; as my watching the branches, if I got a problem, we try to fix it. We think that's the differentiator. David, that's been for 17 years for us compared to most commercial banks. So there are a lot of different reasons people leave. It could be as simple as personality conflicts, but it's not usually because people have personality conflicts; it usually has to do with them feeling their current institution is not a good fit.

Understood. Understood. And then continued nice growth or stability in the credit card income. You mentioned the new agent relationships. Do you think this is sort of a new good run rate in this $2.6 million for credit card income?

This is Rodney Rushing. Probably. We have gone through a conversion. In fact, besides our customers, we issue credit cards for 140 other banks, called our agent credit card program. For the last six months, that has been put on hold as far as onboarding any new agent banks because we were going through this conversion. So for the fourth quarter, we'll be ramping back up, adding agent banks and we have somewhere around 6 or 7 in the queue right now. So I hope that answers your question. We expect that growth to continue.

Right. And then maybe a housekeeping question. I noticed that the continued decline in the effective tax rate is the 17% a good number to assume into 2023?

No. I would estimate it to be between 19.5% and 20%. We made some adjustments in the third quarter that are related to our proprietary tax credits, and that was a change we implemented in the third quarter of this year.

Got it, thanks. I'll hop off and get back in queue.

Our next question is a follow-up from Brad Milsaps with Piper Sandler. Please proceed.

Hi, thanks for taking the follow-up. Bud, you mentioned last quarter that you thought $750 million was a baseline for liquidity or Fed funds. It seems like you've gone beyond that. Have you changed your internal policy on how much cash you'd be willing to hold, and if so, what is that level now going forward?

Yes. We did change the policy. Brad, I believe we're 1.5% of assets is what we can go down to before we need to take some action.

Okay. Please continue, I apologize.

Make sure it is 1.5% of assets.

Okay. And just on loan repricing, we've seen 200 or so basis points change in the Fed funds rate over the last year. Your loan yields are up maybe 40 basis points, excluding PPP. Is that the right relationship going forward? I was thinking you had about 35% of your loans that kind of repriced immediately with Fed funds, but that beta is closer to 20. Is there a bigger lag in there? I assume any floors you had, you're probably through? Just trying to get a sense of how to think about the loan book continuing to reprice.

Yes. I'll let go back to the memory bank. I think the first time the Fed increased, we only had like $700 million in loans that were the reprice because you had so many below floors. It took a while for the actual rate to get by the floor rate. So we had a lag at the very beginning of the Fed rate increases.

Do you happen to have maybe kind of where the loan yield was in September?

Just the month of September? No, but I can email it to you, Brad. I don't have to bring a lot of months before, I guess, on that side. No, I can email that to you.

Okay, sounds good. Thank you, guys. I appreciate it.

I'll go back and look at that number of loans that repriced our quarters, but I think we had a very long wait after the first Fed increase.

Well, thank you everyone. I'm sorry. Thank you everyone for being on the call today. We are excited about the outlook in the future. I think we're positioned for future growth, and we're excited about all the new people that have joined our company. So without anything else anybody wants to say or close out, we'll close it out.

Thank you. That will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.