ServisFirst Bancshares, Inc. Q2 FY2023 Earnings Call

Greetings, and welcome to the ServisFirst Bancshares Second Quarter Earnings Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Davis Mange, IR Director. Thank you, David. You may begin.

Good afternoon, and welcome to our Second Quarter Earnings Call. We will have Tom Broughton, our CEO, and Rodney Rushing, our Chief Operating Officer; Henry Abbott, our Chief Credit Officer; and Bud Foshee, our CFO, 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 with the 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. Good afternoon, and thank you for joining us as we review the quarter. We are generally very pleased with the quarterly results. And, of course, we have a saying that we're pleased but never satisfied with the results of the year or the quarter, and that's always true. We're never satisfied, and we believe we can do much better going forward. I'll give an overview of a few things we're going to talk about. One of them is credit quality. Henry Abbott is going to give a review in a minute. We continue to have industry-leading credit quality, as we will discuss in a few minutes, and we really don't see any issues with all the commercial real estate, contrary to what you may read in the headlines. We don't see any issues with our commercial real estate book at this point. Our strong balance sheet does provide us with many opportunities, and we're seeing many opportunities to grow core relationships and core deposits. We do not have any broker deposits or Federal Home Loan Bank advances on our balance sheet. Very few banks can make that claim. If you include our correspondent Fed funds, our adjusted loan-to-deposit ratio stands at 85% to date, and that accounts for the correspondent Fed funds flow back and forth between non-interest bearing and the Fed funds account based on the level of interest rates. So we're very pleased with the decline in our loan-to-deposit ratio at 85%. We saw very good deposit growth in the second quarter, with encouraging growth in core banking relationships. It was a good number, and we're seeing the results of our deposit focus over the past year. Once again, we focus on service and growing core deposits rather than on the rates we pay as the primary driver. The deposit pipeline continues to be very robust to date. We are pleased with our liquidity position; we have our cash in short-term treasuries and approximately $1 billion, which is a good level. We're proud of that. On the loan demand side, we are seeing some slowdown over the last few months as borrowers assess the economy and, again, we've been a little more cautious than normal as we gauge the effect of recent events on the economy. The entire banking industry seems to be acting more cautiously, and borrowers are a bit more cautious as well. However, I think we're starting to see normalization and anticipate normalization in credit demand in the next few months. Our main focus has been on loan repricing efforts, as Bud Foshee will discuss in more detail shortly. We are focused on enhancing the efficiency of our banking team. We are proud of our industry-leading efficiency ratio and have reduced 11 producers on a year-to-date basis. Bud is going to talk more about loan repricing, but we expect to see an improvement in our margin over the next few quarters as loan rate pricing continues. So, I'll turn it over to Rodney Rushing now to give a correspondent update.

Thank you, Tom. Essentially, we're very happy with the correspondent division results, where we had both growth and stabilization during the quarter. Total active correspondent relationships increased to 360 banks during the quarter. Total fundings were at $1.84 billion, with a slight increase in the BDA operating balances. The biggest news from correspondence is that balances remained stable during the last two months of the quarter. New relationships added during the quarter were 11, 4 from Texas and 4 from Kentucky, as we continue making progress in both of those markets. Credit card revenue increased for the quarter, which Bud will elaborate on shortly. During the second quarter, we added six new correspondent agent banks that issue credit cards. Six additional banks are in the pipeline, which should close in the third and fourth quarters of 2023, plus five for the first half of 2024. The Oklahoma Bankers Association added ServisFirst Bank to their list of endorsed vendors, bringing our state association endorsements to nine. New agent banks were added to the card programs in Oklahoma, Kansas, Vermont, Wisconsin, and Minnesota. During the second quarter, just to demonstrate how broad and diverse the state and American Bankers Association endorsements are for us. With that, I'll turn it over to our Chief Credit Officer, Henry Abbott.

Thank you, Rodney. I'm very pleased with the bank's results and continued strong credit quality in the second quarter. The bank grew its ALLL to 1.31% of total loans in the second quarter versus 1.28% in the first quarter of 2023. This increase is not related to any specific credit but rather a continuation of our conservative outlook as we've had a very strong quarter. We continued the trend started in the first quarter where both AD&C and the entire CRE bucket decreased as a percent of capital for the second consecutive quarter. AD&C as a percent of risk-based capital dropped from 93% at the end of the first quarter to 86%. We continue to monitor closely our CRE portfolio to ensure we manage risk appropriately, but year-to-date, we haven't had any significant shifts or deterioration. I can give specifics during the Q&A section, but we have no material office exposure. As I've mentioned previously, we've achieved record low NPAs for the past few years. Past dues to total loans were down to 15 basis points, a 3 basis point decrease from the first quarter. Net charge-offs for the quarter when annualized were 11 basis points, and year-to-date annualized would be 8.5 basis points, which is in line with our charge-offs for 2022, representing near record lows for our bank. Over 90% of the charge-off figure for the second quarter was related to one specific C&I credit. If it weren't for this specific credit, given the recoveries in the quarter, we would have had zero net charge-offs for the quarter. I want to note that the bank has no remaining exposure to this relationship; we've taken our loss and moved on. I continue to feel optimistic about the markets we serve and the diverse and granular lending relationships we have at ServisFirst Bank. Overall, I'm very pleased with the second quarter results, and I'll turn it over to Bud.

Thank you, Henry. Good afternoon. The bank made solid progress in deposit growth, liquidity, and capital growth in the quarter. Our noninterest-bearing deposits were stable in the second quarter, and we were pleased with the deposit growth during the quarter. We set a goal of $1 billion in liquidity, and with the growth of our cash and short-term treasury bills, we reached that goal. We're seeing great momentum in deposit growth. We did see some margin compression in the quarter from 3.15% to 2.93%. We are assuming one more Fed rate increase for 2023. We expect the margin to stabilize and remain flat in the third quarter and begin to improve in the fourth quarter. Our loan repricing initiative is yielding results and will contribute to margin expansion later this year. Regarding our repricing efforts, fixed-rate loans that were paid off early year-to-date amount to $174 million. Loans that have been repriced total $155 million, and we have $173 million pending in loan repricing. We have $1.9 billion on an annualized basis if you include normal cash flow from fixed-rate loans, and through repricing, we expect to enhance the rates of these loans by about 300 basis points; our loan portfolio has a short duration. Approximately 85% of new loans are floating rate, and about 40% of total loans are floating today. We think with one Fed increase of 25 basis points, we are close to neutral today, with an outlook for improvement moving forward. While loan growth has been flat year-to-date, many maturities are being replaced at significantly better rates. We continue to grow our book value per share; our bank Tier 1 leverage ratio improved from 9.91% to 10.25%, and the consolidated CET1 ratio improved from 10.01% to 10.37%. Our capital remains a strength. We also saw improvements in noninterest income during the quarter, particularly with credit cards and mortgages, and we expect continued improvement over the balance of the year. Regarding noninterest expense, we've made an effort to control expense growth in 2023. We have maintained flat headcount on a year-to-date basis. While we have added a few employees in risk management, we have reduced some staffing in other areas. We anticipate a potential FDIC special assessment at some point, though we cannot predict its impact on 2023 results. We've staffed our new offices and do not expect additional headcount for any existing offices. Our teams are performing well, having grown new accounts by 20% year-over-year. Core expenses declined by $1.1 million in the second quarter, and we expect the third quarter run rate to align with the first quarter. That concludes my remarks. I'll turn it back to Tom.

Thank you, Bud. As you can see from all these comments, we continue with business as usual at ServisFirst. We opened our Virginia Beach office this quarter. I visited there last week, and we have a great team on the ground that is doing a fantastic job. We look forward to their great results as we move ahead. So I am truly proud of what our team has delivered this quarter. They consistently produce what our shareholders need. With that, I'm happy to answer any questions you might have.

And our first question will come from Graham Dick with Piper Sandler.

So I just wanted to kind of start on the balance sheet. Obviously, deposit growth was really strong this quarter, and coupling that with loans that are pretty much flat provided a lot more breathing room on the loan to deposit front. Can you just talk a little bit about how you think the balance between loan growth and deposit growth will play out for the rest of the year? I know you mentioned a high single-digit number a few quarters ago, but any update you can provide on the loan growth front and then the level of deposit growth you guys are expecting to produce throughout the rest of the year would be very helpful.

Graham, we have been cautious, and I've stated that clearly. However, with every day and week that goes by, we gain more confidence about our position and the economy. We're, as I said, business as usual. So, we will resume making loans again. There is always loan demand in places like Nashville, Tennessee; Charlotte, North Carolina; Florida — the whole state, where there's always tremendous loan demand. So we can find the loans to make. Thus, we feel good about our deposit pipeline, and we will start resuming business as usual. I cannot give you a specific number, but our team has always been capable of producing what we need. Again, we are better positioned now than we were at the end of the previous quarter and feel more optimistic about the industry today than at that time.

Yes, I can imagine. Framing it differently, would you say it’s safe to assume loan growth matches deposit growth for the rest of the year? Or is there any more detail you can provide?

Yes. I believe that if we bring in $1 of deposits, we will probably make $1 of loans. That would be a fair statement.

Great, that's helpful. No, you did a fine job. I probably asked the question poorly. So then, on noninterest-bearing, those amounts were indeed much stronger than what we’ve seen from other banks this quarter. Any insight into what you are doing that’s driving that versus some of your peers? Additionally, on the correspondent front, I believe those balances were reportedly up quarter-over-quarter. I'd like to get a sense of whether you think that trend can continue in that area.

This is Rodney Rushing, Graham. Yes, noninterest-bearing correspondent balances were up for the quarter, slightly. Total fundings for correspondence were down quarter-over-quarter. The good news is that in the last two months of the quarter for May and June, the total funding in correspondent banking leveled off. My community banks, I think, as I noted with the number of 360 total banks that we have now, their liquidity runoff seems to have stabilized. Their balances with us have remained stable for the last two months. If we can maintain that trend into the third and fourth quarters while opening new accounts in Texas, Kentucky, and other markets, hopefully, that will promote growth.

Regarding the General Bank, Graham, I believe we are a business bank, and hence we hold significant size accounts. We might have one account that fluctuates by up or down $50 million in a quarter, which could be at the end of the quarter, so we could see variability. We held steady this quarter, but next quarter, we could be down $100 million or up $200 million. The nature of our business bank lends to this variability. We also had less to fall than many older banks.

Yes, definitely. My last question pertains to your bond portfolio this quarter. Could you provide some context behind your decision to add to it, as well as the rates at which you bought those bonds and their duration?

Yes, Graham, it's Bud. The primary reason for that was related to pledging.

We didn't necessarily need to pledge anything, but we did it. We decided to go forward with it just in case we required collateral. We added approximately $350 million in 6 months and less in treasuries.

Yes. And the yield was about 5.35% or 5.40%, thereby reducing our average life to 3.2 years for the entire portfolio.

It's a little better yield than what you get at the Fed, so that's the logic behind it. We didn’t need it for pledging, but overall we think it was prudent.

Our next question is from David Bishop with Hovde Group.

Following up on the bond issue, I couldn't help but notice that the end-of-period balances on investments and even deposits were significantly higher than the average balance. Is that due to some of those correspondent relationships coming online later in the quarter? I'm curious if there was any timing aspect in the surge of funding growth.

It was not a late-quarter surge in correspondent balances. We did have a large municipal deposit that came in right toward the end of the quarter. Bud, do you remember exactly when that occurred?

It was not a late-quarter surge in correspondent balances. We did have a large municipal deposit that came in right toward the end of the quarter. Bud, do you remember exactly when that occurred?

It was pretty late in the quarter, and the deposit will be here for a while as it is a municipal one. Much of the federal stimulus money is now being distributed to state and local municipalities. So that impacted our numbers to date.

Okay, got it. Rodney, staying on the topic, I know you don’t typically like to provide insights into the internal workings. The correspondent division usually remains relatively profitable despite rate fluctuations. However, I noticed a decline in third-party service charges — is that a result of your handling more accounts? Or what is driving that decrease compared to the previous quarters in third-party processing fees?

I don't think it was fluctuation from correspondent banks, so we will have to double check that. I didn't observe a significant decline in correspondent service charges, but we'll follow up with you on that.

Okay, please do that offline. Additionally, do you have an update on the commercial real estate book, particularly regarding the office portfolio? Any changes here? I know it's a small part of the overall picture, but public investors are focused on it — any updates you can provide?

This is Henry Abbott. Yes, there are no material changes. As I mentioned, non-owner occupied office remains around 3.5% of our total loan portfolio, making it a small amount. The overall office income-producing real estate is still down. However, it remains non-material.

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

I want to circle back on the margin again. If I heard you correctly, the margin was down 22 basis points this quarter, but you expect it to stabilize in the third quarter and then begin to expand in the fourth. I'm curious if I heard that right — others seem to indicate there could be more margin pressure in the third quarter, but you think your loan repricing, combined with a stable level of noninterest-bearing, is stabilizing your margins earlier than others?

Yes, Kevin, that's correct.

To add to that, if noninterest-bearing is stable and we are repricing loans effectively, our projections show we can maintain margin at this point while beginning to expand in the upcoming months — not significantly at first, but maybe a couple of basis points per month as we go into fourth quarter. We think the intense pressures we've felt are easing.

That's encouraging to hear. One more question, Bud, if I understood you correctly — did you say that the third quarter will be like the first quarter run rate, not the second quarter?

That's correct.

Got it. And, Tom, I think you mentioned in your comments about expenses that you’ve had a pretty limited number of new hires, focusing primarily on risk management. Given some still-existing disruptions, do you foresee opportunities to attract talent away from other banks? If you're feeling better about the economic backdrop, would you consider doing that sooner rather than later?

Yes, we are continually engaging with potential candidates. Fortunately, we've managed to keep our headcount relatively flat year-to-date — maybe an uptick of 1% annualized at best. As you know, we need to hire risk management personnel; regulators don’t rest, so we always have to recruit in that area. However, we strive for efficiency, working hard to find the right balance. We are actively discussing recruitment. New talent, especially from production roles, is always welcome. We aren't in turtle mode, and we're open to bringing on the right team members at any time.

Okay, excellent. Bud, one last question from my end — you've mentioned that your capital is strong, and you added to securities this quarter. Some banks are considering bond transactions to alleviate some losses and potentially put funds to work at higher rates. Is that something on your radar?

No, Kevin. We executed a bit of that cleanup last year, so we do not have any plans to further address that this year.

We believe our bond portfolio is quite short, so we can allow them to mature at par. We recognize others may have more significant challenges, but we face only modest losses in our portfolio, and we do not possess long durations. Thus, we do not see the need for major adjustments. We believe that doing so—given our slight loss—might result in feeling regret as rate conditions change.

Our next question is from Steve Moss with Raymond James.

Circling back to the margin, where are you seeing pricing for new loans these days?

Yes. New loans for June were around 8%. That’s a blended rate, but 85% of that is at favorable rates.

Understood. Regarding the loans, you're a bit more optimistic about loan growth going forward. I noticed you've reduced your construction portfolio. Do you expect to see growth in that area in the next couple of quarters? Or should we consider a higher weighting towards C&I or CRE?

We still have some in our construction bucket that could fund up in the coming quarter or two. It happens to be down recently as we moved some to the permanent bucket and had some pay-offs. Therefore, there is still potential for growth in our construction bucket. We will be focused on C&I customers with strong deposits, but if a good CRE project presents itself with good loan-to-value and pricing, we are willing to consider it. The critical factor remains the availability of deposits to accompany those relationships.

Regarding construction loans, if it's a multifamily deal and they're lease-up, they may want to stay with us long-term to secure future borrowing capabilities from Fannie when they transition to permanent financing. But I wonder how long they'll be willing to pay us 8.25% when they could potentially borrow from Fannie at 5.5%. But we will see. The variable nature of payoffs in this regard is unpredictable. Nonetheless, there remains significant demand for new CRE projects in the Southeast United States. We appreciate everyone joining us on the call today. Thank you for your continued support, and we look forward to what's ahead. We're very excited about the remainder of the year. Thank you very much.