ServisFirst Bancshares, Inc. Q3 FY2023 Earnings Call

Greetings and welcome to the ServisFirst Bancshares Third Quarter Earnings Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce you to our host, Davis Mange, Director of Investor Relations. Thank you, Davis. You may begin.

Good afternoon and welcome to our third quarter earnings call. We'll have Tom Broughton, our CEO; 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 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. Good afternoon, and thank you for joining us for our calls where we review the third quarter. I thought I'd start by reviewing the current economic outlook. Going back to late spring, the conventional wisdom, which included mine, was that we were pretty much headed for a hard economic landing. A bunch of that outlook was due to – we had seen rapid escalation in interest rates, we've seen bank deposits disintermediation for close to a year at that point. And then we’d see credit tightening by most banks. You know, the demand for goods and services continues to be amazing. The consumer appears to be very resilient. They seem to be somewhat hooked on living large since the pandemic started. They were buying items while they were stuck at home, and now they're consuming them. So, it seems like we're in a little bit better spot than we've been. We have seen a slowdown in demand for credit, both CRE and C&I. It's probably a combination of borrower caution and higher interest rates. I was with a customer last week, and he said the best way I can make $16 million is to pay down $200 million of debt at 0.8%. He said, that's the best way for me to improve my earnings. I'm not going to buy any more capital goods. So I think that's probably a prevailing thought. I know our bank and others are watching for late-cycle credit cracks. Henry Abbott will discuss a little more on the credit side in a few minutes. We don't run our bank based on any kind of economic forecast, because they're all wrong. But it does appear we are headed for more of a soft landing than we envisioned a few months ago. The recent disinversion of the yield curve will be helpful to us as we move towards a normal yield curve and really the higher for longer rate environment we think benefits us; our future earnings for the bank. So, that's sort of a brief overlook of where we are. And I’ll get down into a little more granular information here. Start talking about deposits. We have focused on building core deposits over the last four quarters. We've seen very fantastic results. Our people have done an outstanding job, they've done what we've asked them to do. And very few banks can demonstrate the deposit growth we've seen combined with zero federal home loan bank advances and zero broker deposits. Our municipal clients have received significant COVID funding this year. It'll take a bit of time for that to be spent. The most COVID funds I know have to be committed by the end of 2024 and spent by the end of 2026. But I do have faith that most politicians can spend it more quickly than that. Our deposit pipeline is down a bit from the record level last quarter. We are looking for, it's still strong; we're looking for granular new relationships that are sticky. On the correspondent side, Rodney Rushing will give an update in a few minutes when I finish. Our total new accounts are up 19% year-over-year, while our commercial accounts are up 20% year-over-year. This is indicative of broad-based deposit growth, which is what we wanted. We think our emphasis on deposit growth over current liquidity will set the stage for improved profitability in 2024. We're seeing cash on hand stay consistently at the $2 billion level in October. We are pleased to have built this liquidity at this level during the industry disruption we've seen. While it may reduce the net interest margin, it does not affect net interest income. So, very pleased with the deposit situation. Talk a little bit about loan demand. We did turn the loan spigot back on a few months ago and it started with a trickle as it always does after you shut off the tap. Our loan pipeline today is up 74% over the prior quarter. And though it's not back to levels from early 2022, it is back to late 2022 levels. We have seen increased activity in the past 30 days, and we saw loans grow by $87 million in the month of September. We are seeing increased confidence from borrowers, both C&I and CRE. Our liquidity position we think gives us a significant competitive advantage in the industry. On the production side, we previously announced we added a great new team of bankers in the Montgomery region, four new bankers there. We had a total of five in the quarter. From a headcount standpoint, we were down three for the quarter. We are focused on adding the right people and the right size in our team this year. We think that will certainly come to an end as we go towards the end of the year and we'll have the right group here. We will open our new Lake Norman office in the Piedmont region soon and it'll be a community banking office that's very similar to the offices in Tallahassee, Panama City, and Asheville, North Carolina. These community banking offices do produce good, granular, and sticky deposits and have improved margins. So with that, I'll turn it over to Rodney to discuss the correspondence side.

Thank you, Tom. Correspondent banking had a strong deposit rebound, closing the quarter with total fundings just over $2 billion. Our deposit growth at September 30 was 12.3% for the quarter. Most of that increase came from Tennessee and our new Texas market expansion, with just over $275 million in new deposit relationships coming from those markets. I need to also mention or remind you that correspondent balances are not hot or temporary funding sources, as our rates paid are market rates, not rate specials. Seventy percent of all correspondent balances are tied to settlement relationships with these downstream banks. The division is well diversified in both correspondent bank sizes and geographies. Seven new bank relationships were opened during the quarter in five different states. Correspondent participation loans and new relationship pipelines are strong for the remainder of the year and also into 2024. Our Correspondent Agent Bank Credit Card program has 15 new banks in our pipeline that are in various stages of the sales process. There are three new state banking associations reviewing our American Bankers endorsed Agent Credit Card program to determine if they would like to participate. We currently have nine state endorsements at this time. This has expanded our reach and as the existing pipeline includes banks in Connecticut, Virginia, Texas, Georgia, Montana, Missouri, and New York just as an example of how wide that market has grown. Correspondent Deposits and Fundings in summary; correspondent balances stabilized in the early second quarter, and we had impressive strong growth, as you can see, for the third quarter. And with that, I'll turn it over to Henry Abbott, our Chief Credit Officer.

Thank you, Rodney. ServisFirst had a very strong third quarter, and we're pleased with the Bank's results. Past due loans to total loans were down to only 8 basis points. This represents a 45% reduction from the second quarter and a 50% drop from the first quarter. Our asset quality continues to remain strong. Now, I'm pleased to say non-performing assets to total assets decreased from 16 basis points in the second quarter to only 15 basis points in the third quarter. With the current economic outlook, the bank felt it appropriate to maintain its ALLL to total loans of 1.31%, which is consistent with the prior quarter. AD&C as a percentage of risk-based capital was 91% at the end of the third quarter, and income-producing CRE and AD&C to risk-based capital was 312%. Both of these figures are down from when we started 2023. We had no material downgrades to the watchlist in our CRE portfolio, and we continue to focus on and monitor our AD&C bucket. We also review and stress our entire CRE portfolio via both internal and external sources. We use an industry leader in commercial real estate data and analytics to help provide stress testing in real-time data on the portfolio. As a reminder, our CRE exposure is primarily in the Southeast, which continues to remain one of the strongest areas, and we have no material downtown urban office exposure. Charge-offs for the quarter were 15 basis points when annualized, and year-to-date annualized charge-offs were only 11 basis points. Charge-offs for the quarter were not related to income-producing CRE or any SNCs. I know those are items of interest and have impacted the charge-offs at some of our peer banks. We continue to feel very good about our diverse and granular loan portfolio and outperformance in the third quarter. With that, I'll hand it over to Bud Foshee.

Thank you, Henry. Good afternoon. We're very pleased with the progress the Bank has made in the third quarter with deposit growth, liquidity, capital, and improving loan pipelines. Our non-interest-bearing deposits were stable in the third quarter with the exception of $100 million in deposit run-off related to COVID times. We were pleased with the total deposit growth of $854 million in the quarter. We saw loans grow in the quarter after several quarters of decline or flat. The key to improving EPS is loan growth, and our team is focused on a more balanced approach to loan and deposit growth going forward. We had a goal of $1 billion in liquidity, and we have exceeded that goal with $2 billion at quarter end. Our loan repricing initiative will contribute to market expansion later in the year. Examples of our repricing effort; $390 million of loans for the REIT have been restructured, loans paid off early totaled $104 million, we have $188 million pending in loan repricing. Loan repricing is the best opportunity to improve profitability combined with loan growth. Loans that repriced or were paid off in the third quarter totaled $276 million, which combined with loan pay-downs on fixed-rate loans totals to $2 billion on an annualized run rate. The cumulative effects of this repricing will improve margin and EPS over time. Net interest margin stabilized in the third quarter, a $100 million in the third quarter versus $101 million in the second quarter; 89% of our new loans are floating rate, and about 41% of total loans are floating rate today. Our adjusted loan-to-deposit ratio at September 30, 2023, was 80.5%. This ratio includes the correspondent fed funds purchase. We saw improvement in core non-interest income in the quarter with improvements in both credit card and mortgage. We expect continued improvement over the balance of the year. As a reminder, the second quarter non-interest income included a death benefit of $890,000. Discussing non-interest expense, we have made an effort to hold the line on expense growth in 2023. We have experienced increases in non-core expenses. Problem credit, which was primarily legal expenses related to credits, check fraud, and credit card fraud. And we had one case of $600,000 in credit card fraud. These items increased by $1.4 million from the first quarter of 2023. We also experienced an increase in FDIC insurance of $825,000 from the first quarter. We have built our staffing and our new offices and do not expect additional headcount for any existing offices. Our teams are performing quite well and have grown new accounts by 90% year-over-year. We continued our growth in book value per share; our CET1 ratio was 10.69%, and our Tier-1 leverage ratio was 9.35%. Our capital continues to be a strength. That concludes my remarks and I'll turn the program back over to Tom.

Thank you, Bud. You know, if we made a list of the 20 most important metrics regarding buying, we are performing extremely well on almost all of those, except for the one that's the most important, which is earnings per share. We've got to get our earnings back up to where they were; it's going to take a few quarters we think, but we will get there. So, we think our performance in all those other metrics will lead to improved earnings per share in the future. So, we will open it up now for now for questions. I will be glad to see what you have on your mind.

Thank you. We’ll now be conducting a question-and-answer session. Thank you. Our first question comes from Kevin Fitzsimmons with D.A. Davidson. Please proceed with your question.

Hey guys, good afternoon.

Hey, Kevin.

I'm trying to understand the factors impacting your margin. From the last conference call, we discussed that the net interest margin might stabilize in the third quarter and start to expand in the fourth quarter. It seems there are a couple of contributors, so could you explain what they are? You mentioned repricing loans, which might help with earnings in the future, but it seems like it could have resulted in lower loan growth than expected, along with some pay-downs. On the funding side, you had a successful quarter in growing deposits and increasing liquidity, but this might have affected your ratios. I know you don't strictly manage to that ratio, but the loan-to-deposit ratio has shifted. I'm trying to assess how the increased funding relates to your goal of $1 billion to $2 billion. Was this mainly due to movements in the correspondent network or was it a targeted strategy? Many banks are indicating that loan growth is primarily influenced by deposit growth, but here we have a significant gap between the two. I realize this is a lot to unpack, but I wanted to clarify where you see the margin heading from here. Thank you.

Bud will provide you with specific numbers, but my perspective is that the gains from loan repricing have been offset by deposit repricing up to this point. That's why the margin hasn't improved. If we assume the rate increases are finished, then we expect stability moving forward. As we reprice loans, more of that will contribute to net income instead of being absorbed by repriced deposits. Initially, we focused on increasing deposits, and our incentive plan for 2023 was primarily aimed at that. As I've mentioned, people respond to incentives, and our team successfully grew deposits. Recently, we've introduced a special incentive to boost loan growth from October 15 to January 15 to rejuvenate our loan pipeline. However, I acknowledge that adding substantial deposits doesn’t enhance the net interest margin. The objective wasn’t to improve that metric; rather, we believe that demonstrating liquidity provides us with a significant competitive edge in the industry. I may not have completely addressed your question, Kevin.

No, that was helpful, Tom. I know there are many moving parts to it. Do you feel like you might have overshot? It's not really a negative thing since you can never have too much of it. Given that it's just one quarter, assuming the Fed is mostly done, do you think we're getting closer to stabilizing that ratio and possibly expanding in 2024? Is that what you would expect?

Yes, we noted that our municipal clients have significant liquidity and these are existing customers. They represent core relationships for us. We are not actively seeking new funding from municipalities. In fact, we will not pursue funding from municipalities; we are committed to these core relationships at a fair price. This approach may not yield substantial profits when we manage funds for municipalities, but we will not refuse to accept their business. That's the key point. Moreover, we do not have any brokered deposits or home loan bank advances. Therefore, we find ourselves in a unique situation, and I doubt many in the industry would want to swap places with us if given the choice.

And Tom, just on loan growth, typically you guys have seen more back half of the year heavy in loan growth if I recall correctly, and it’s sort of gains momentum over the course of the year. And so, on the one hand, you mentioned that a lot of customers are looking to pay down debt. There’s the impact of rates, there’s the impact of you guys tightening standards, but on the other hand you cited, if I heard it correct, a big increase in the loan pipeline. And last quarter you were – it seems like much more optimistic about the economy. So, do you feel like loan growth is just going to grind higher at this point, not necessarily in leaps and bounds?

Yes, we do. As I mentioned, our loans increased by $87 million in September. We've experienced a lot of activity in the past 30 days, and it seems that borrowers are gaining more confidence in the economy and starting new projects in both commercial and industrial sectors as well as commercial real estate. We are also becoming more innovative in seeking out sources of loan demand. This approach is similar to what we had to do after 2008, 2009, and 2010 when people weren't making big purchases like boats and airplanes. We focused on financing operational equipment for trucking companies and other growth areas. So, this time we need to be more inventive in finding loan demand compared to when the economy is doing well.

Right. Okay, all right. Well, thank you very much and I'll hop out and let others hop in. Thanks.

Thanks, Kevin.

Thank you. Our next question comes from Steve Moss with Raymond James. Please proceed with your question.

Good afternoon.

Hi, Steve.

Tom, you spoke about the loan pipeline improving here. I'm kind of curious, what is the rate you're seeing these days? Hearing you say $87 million of growth in September, it kind of feels like we will see a decent step-up in growth for the fourth quarter on loans?

Go ahead, Bud.

Yes, we think that loans can increase; the rate that new loans went on during September was 8.35%. So, we feel likely to be that or above. And like Tom said, we put in an extra incentive for loans in the fourth quarter. So, we expect loans to increase; I mean, the fourth quarter is always our best quarter.

Steve, what I can't project is what kind of payoffs we're going to see. If a multifamily developer is looking at going to permanent financing with Fannie Mae, I mean, their rates are going up. But it's still less than what we're charging them. I think they might pay 6 with Fannie, but they're going to pay us – they're paying us 8.5, so that is what I can't predict, Steve.

Great. And then maybe just curious in terms of the underlying mix in the pipeline. Is that a little more weighted towards CRE and construction these days, or is there a healthy C&I component? Just kind of curious what the business mix is?

Yeah, I mean I think it's a mix. We're seeing a lot of AD&C opportunities, but at the same time, we know we've got a limited bucket. So we're being more selective on those and obviously trying to point our incentive and our folks to go after C&I opportunities, and that is certainly what we're looking for and striving for.

Yes. We think we need to kind of stay on to that 100% AD&C exposure level that seems to be a bright line with – it might become more of a bright line with the regulators — we're not sure but that was our thought on that.

Okay. And then just in terms of thinking about the liquidity on balance sheet here. You guys achieved the goal of having $1 billion on balance sheet. Curious, let's just say there is a healthy step-up in loan growth, and it is maybe sustained for the next quarter or two, are you willing to dip below that $1 billion of liquidity or kind of how do we think about funding loan growth? Will it be more buy deposits or existing liquidity?

Yeah. We've got $2 billion in cash as fair today, and I guess we've got some short-term treasuries that are about $250 million, Bud?

We do.

So, you say we have $250 million; we really think that we can put $1.5 billion probably into the loan bucket over time. Now, again, some of these municipal deposits are going. Again they're going to spend it, politicians always find a way to spend money as you know. So, it'll burn a hole in their pocket a bit. Then it will take a couple of years to mark some of it off, and we will replace it with other deposits. But right now we feel good about where we are. We just again are actively looking for the right – we're still being careful on loans. I mean, we're not really talking to – we're trying to talk to the people we've always done business with rather than somebody that just walked in the door.

Got it. One last one for me here, just on the reserve ratio; you guys have built it up for a number of quarters, this quarter kind of flat. Just curious, was this kind of as high as it can go in terms of what maybe the auditors are comfortable with or is there any – are you guys just more comfortable with credit, and hence the reserve ratio is not quite enough of as much?

Well, I think the primary driver, as Tom mentioned in his remarks, was kind of the economic outlook improved over the past two or three quarters. So, I mean, that’s where we were able to maintain our current ratio. It just depends on kind of the key drivers being unemployment and GDP that are going to impact the model and the outlook on those.

Yes. Unfortunately, there's a limit on what you can do. I think bankers by nature would have a much higher loan loss reserve if we were left to our own desires; we're not. But the CECL models can switch or change over time as you well know.

Right. Okay. Appreciate all the color, and I'll step back. Thanks, guys.

Thank you.

Thank you. Our next question comes from Graham Rick with Piper Sandler. Please proceed with your question.

Hey, good evening, guys.

Hey, Graham.

I just wanted to circle back with something you just touched on is that $1.5 billion number of deployment into loans. What's sort of the ideal time horizon for achieving that?

At this point, I don't know how quickly we can get the loans on the books, and I'm uncertain about what will pay off. Our loan pipeline is strong, but it’s not at $1.5 billion, I can assure you. That is a significant question, which you may not be familiar with, Graham, but you can look it up.

Okay, fair enough. Fair enough. Okay. So then I guess I wanted to just talk a little bit more about deposits as it relates to the pipeline. You mentioned that the pipeline is smaller than it was last quarter. Now, can you just provide what the pipeline was heading into Q3 and then also what it was heading into Q4?

Yes, it's not a precise figure and we typically don't discuss it, but it seems to be down a couple of hundred million dollars from last quarter, Graham.

Okay.

We recorded it, so it's now on our books. We need to evaluate deposit costs as we work towards improving profitability, and we have to be more strategic about it.

Okay. And then on that front with deposit costs, I mean, it seems like most of the growth has been in money markets recently. And I guess most of that's probably fully indexed and floating rate. So, as you start to adjust your strategy on the deposit pipeline and pricing perspective, what does that sort of look like for you guys? Is it saying like no more index money market and just time at a rate below Fed funds, or how do you guys kind of approach that from here?

It depends on the percentage of Fed funds you're interested in. You need to maintain some margin on what you keep at the Fed, especially since we have a significant amount of cash there right now. The other consideration is when we'll begin purchasing securities again. We will eventually look into buying securities, but since we have a lot of cash, we prefer having more floating rate assets in our portfolio. Therefore, we are cautious about investing in long-term treasuries, which I define as those with maturities between two to five years. While it may be wise to start investing now, we have decided against it at this moment and will continue to wait for the right time.

I understand your question. Just to clarify on the deposits and costs, the money market portion is fully floating, correct? There aren't any maturities or exceptional pricing issues in that area that would lead to any additional catch-up. For instance, if there are no more rate hikes, the cost might stay around 4.25%.

We think so, Graham.

All right, that's helpful. That's all I had. Thanks, guys.

Thank you.

Thank you. Our next question comes from Dave Bishop with Hovde Group. Please proceed with your question.

Hey, good evening, gentlemen, how are you?

Good, Dave, from Hovde Group.

Yes, thank you for clarifying that. Hey, Tom, you noted the revamp of the incentive plans; obviously, they were very successful on the funding side this quarter. From an operating expense standpoint, does that imply maybe an acceleration of operating expenses into the last quarter of the year, and how should we think maybe about expense growth into next year?

We have already caught up; we accrued significantly more in the third quarter, Dave, although I don't have the exact figure. Bud has the details, but we plan to accrue more in both the third and fourth quarters to address this. We have already begun this process because of our significant success in raising deposits, and our team has effectively executed our requests.

Got it. And then circling back to the liquidity and maybe securities, outlook here, and then maybe answer that last question or so, but there's been a lot of chatter and I think you even noted, we're probably in a higher-for-longer scenario economic outlook here — interest rate outlook moving forward. Is there a potential to restructure the securities portfolio and maybe, I don't know, sell off some of the lower yielding stuff, pay off some of the borrowings to improve the margin and profitability? Just curious how we should think about that?

Hey, Dave, it's Bud. I don't see us selling anything. I think we will continue to buy. If we buy, we will buy treasury short-term, six months to a year. It just takes a long time to actually pay it back and earn money. I don’t know, just something we don't want to do. We'd rather just hold it to maturity.

And what if rates drop? I mean, the problem is my salesman can always show you a Bloomberg run that shows that makes you a lot of money to reposition securities.

Got it. Now understood, understood. And then, a housekeeping question I guess maybe for Bud, good tax rate to assume moving forward; it looks like there were some lower than trend tax rate this quarter, curious how should we think about next quarter and into 2024?

Yeah, I would say 18% would be a good rate for the fourth quarter.

18%.

18%.

Got it. Great, thank you.

Thank you. There are no further questions at this time. I'd like to turn the floor back over to management for closing comments.

Thanks. I think we're done. Thank you, everybody for joining us.

This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.