ServisFirst Bancshares, Inc. Q4 FY2023 Earnings Call

Greetings and welcome to the ServisFirst Bancshares Fourth Quarter and Full Year Earnings Call. As a reminder, this conference is being recorded.

Good afternoon, and welcome to our fourth quarter earnings call. Today's speakers will cover some highlights in 2023 and then take your questions. We'll have Tom Broughton, our CEO; Rodney Rushing, our Chief Operating Officer; Henry Abbott, our Chief Credit Officer; Bud Foshee, our CFO; and Kirk Pressley, who will be taking over as CFO after Bud retires later this quarter. 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 our fourth quarter earnings call. 2023 was not what we expected it to be when the year began, but we're pleased with the results of the hard work by our bankers, who I think are the best in the industry, and where we ended up in the year. Bud will go into more detail on, but we were certainly pleased to see the net interest income not only stabilize but improve in the fourth quarter. What I found over the years in banking is that you can cut expenses to improve profitability, but you cannot reach prosperity without the net interest margin reaching acceptable levels. We do expect some tailwinds from the margin in both this year and 2025; we'll hear more about that as we move through our speakers. We are pleased to announce that Joel Smith has joined us as President of the Memphis, Tennessee market, and we'll certainly provide more information on the team and our location there soon. Total deposits in Memphis were $41 billion, and we think we have a great opportunity there. As we have commented in prior calls, once we saw the run-up in treasury rates in mid-'22, we pivoted to deposit gathering, which proved to be great timing given the events of March 2023. Our results in 2023 exceeded expectations with year-over-year deposit growth of 15%. New commercial accounts were up 15% over 2022, and total new accounts, including retail accounts, were up 12% year-over-year. We are one of the few banks our size without brokered deposits or Federal Home Loan advances. This will certainly serve us well if the regulators announce new liquidity standards, as expected. Rodney Rushing will discuss a little bit more about the correspondent division after I finish my remarks. Loans grew slightly in the fourth quarter. We had loan growth in 5 of the last 7 months of the year. C&I line utilization has really not improved since it's been flat since June 30, 2022. Certainly, there were aftereffects of the PPP program. As rates moved higher, that also has reduced borrowings more than you would see otherwise. Most of this reduction on the C&I side was funded with noninterest-bearing deposits, which presents quite a challenge, as we are withdrawing funds from noninterest-bearing accounts to pay down lines of credit. We think most of that is in the rearview mirror at this point. Notably, we had $178 million of loans that paid off early in the quarter at an average rate of 4.3%. These payoffs were beneficial and improved profitability. We are increasingly optimistic that, as activity picks up, we will see more normalized loan growth this year. Our loan pipeline has increased 50% since last quarter end, which has improved substantially from 2023 levels. While we are not at the blistering pace of 2022, that year was way above normal in loan activity and we do not expect a repeat. Our pipeline is very robust at this point and we see loan activity picking up on a weekly basis. Activity in the new market like Memphis will help carry us and give us momentum later in the year. On the production side, we hired 7 new producers in the fourth quarter, yielding a net increase of 3 for a total of 143. Even though we are adding a team in Memphis, we expect to improve the efficiency of some of our other markets over time, potentially leading to a more balanced headcount as we approach the end of the year. Credit quality remains strong. We, like many others in the industry, have been anticipating a recession since 2019. However, we do not see early signs of difficulties emerging, and Henry Abbott will provide more details shortly. Now, I'll turn it over to Rodney to talk about the correspondent division.

Thank you, Tom. Correspondent banking had a strong second half of 2023 and fourth quarter in both deposit growth and new relationships. As I reported last quarter, correspondent balances grew, and they continued expanding with just over $280 million, a 15% increase during the second half of the year. During the fourth quarter, we opened 9 new correspondent banking relationships, bringing the total to 28 for 2023, in addition to 3 new agent bank credit card issuers, which amounted to 14 new issuers for the entire year, and 8 new settlement banks during the fourth quarter, totaling 15 for the year. Most of the new account activity came from our newly expanded Texas market, while the new agent credit card issuers were spread across the U.S. As we look to continue this momentum into 2024, our focus has shifted somewhat from deposit growth to improving liability costs. We are specifically optimistic about this outlook in correspondent banking. If interest rate futures markets are accurate, and we are entering a declining rate environment, correspondent banking should benefit from these falling rates. As rates decline, our correspondent liability costs will decline step-for-step with a beta of one. Simultaneously, we expect funds to migrate from interest-bearing deposits to noninterest-bearing accounts. The only other topic I'd like to mention, Tom, is that we've completed the credit card system conversion and have worked through the changes, enjoying the benefits and additional features it provides both us and our agent banks. Due to this, we are optimistic about credit card revenue contributions in 2024. With that, I'll turn it over to Henry Abbott for comments, who has a short report, I believe. Short usually means good news coming from our Chief Credit Officer. Henry?

Thank you, Rodney. I'm pleased with the bank's performance in 2023, especially in the fourth quarter. The bank's loan portfolio continued to perform exceptionally well in an environment with rising interest rates that we experienced in 2023. While Tom covered pipelines and loan outlook for 2024, I'd like to add that we brought on some strong teams in North Carolina and Virginia in 2023. Throughout the past year, we focused on deposits rather than loans, so we are well-positioned for loan growth in 2024 and beyond as we will benefit from some good tailwinds in these new markets. These bankers are now directing their efforts towards lending. Some of these markets are experiencing disruptions due to bank mergers and other changes, creating an opportunity for ServisFirst to attract and retain high-quality customers. Our asset quality remains strong, and key credit metrics are generally stable or improving. Our charge-offs for the quarter were only 9 basis points on an annualized basis, down from 15 basis points in the third quarter, representing a reduction of roughly 40% quarter-over-quarter in charge-offs. Our ALLL to total loans increased from 1.31% to 1.32% for the quarter. Nonperforming assets decreased in both dollars and as a percentage of total assets, from 15 basis points in the third quarter to only 14 basis points in the fourth quarter. Our asset quality continues to be impressive. Additionally, we began the year with AD&C loans as a percent of risk-based capital at 100%. Over the course of the year, that figure declined to 90%. We don’t see any issues within our portfolio concerning problematic asset classes such as office space. Our commercial real estate portfolio continues to perform at a high level. Overall, we feel optimistic about our loan portfolio and its performance in 2023, as well as our positioning for 2024 and beyond. I'll now turn it over to Bud.

Thank you, Henry. Good afternoon. We are very pleased with the progress the bank has made in the fourth quarter regarding liquidity, credit quality, capital, improving loan pipelines, and a stabilized net interest margin. Our noninterest-bearing deposits remained stable in the fourth quarter. Our total deposits grew by $132 million. As Tom mentioned, we saw net loan growth in 5 of the last 7 months of 2023. The key to improving earnings per share is loan growth, and our team is focused on a balanced approach to loan and deposit growth in 2024. Our 2023 focus on deposits has paid off as our liquidity has remained strong at $2.1 billion. Our adjusted loan-to-deposit ratio at year-end was 80.2%. This includes the correspondent Fed funds purchase. Our loan repricing initiative will contribute positively to net income in 2024 as we do not anticipate an increase in deposit costs. To illustrate our repricing efforts, we have restructured $525 million in loans year-to-date. Loans paid off early totaled $185 million. We have $154 million pending in loan repricing. Loan repricing remains the best opportunity to enhance profitability alongside loan growth. Loans that repriced or were paid off in the fourth quarter totaled $212 million, along with loan paydowns on fixed-rate loans, equating to an annualized run rate of $2 billion. The cumulative effects of this repricing will boost margin and earnings per share over time. We have low-rate investment securities of $347 million maturing in 2024. We expect an $8 million annualized improvement in margin by reinvesting in short-term treasuries or overnight funds. Net interest margin rose in the quarter, with $102 million in the fourth quarter compared to $100 million in the third quarter. Variable rate loan originations constituted 69% of total production in the fourth quarter at a rate of 8.3%, with 82% of these loans having a floor rate. 36% of the production had a floor rate of 5%, and 18% had a floor rate of 5.5%. Currently, around 42% of total loans are floating rate. Deposit costs stabilized in December. We have begun to rationalize higher deposit costs in the first quarter, anticipating a decline in high-cost excess funds, along with seasonal declines in first quarter excess cash. Lastly, credit card income in the fourth quarter was affected by a billing issue with one vendor who did not timely pass through certain expenses. We expect this income to normalize in 2024. Regarding noninterest expenses, we worked to control expense growth in 2023. The incentive payouts for 2023 exceeded our expectations due to our intensive focus on deposit growth over the year. Our 2024 incentive plans will aim to enhance earnings per share. We anticipate that new additions in the Memphis market will be balanced by attrition in production officers throughout 2024. We also have some nonrecurring expenses in the fourth quarter, detailed in the earnings release. Overall, our teams are performing well and have achieved a 12% year-over-year growth in new accounts. We have also seen growth in book value per share. Our CET1 ratio stands at 10.91%, and our Tier 1 capital leverage ratio is 9.12%. Overall, our capital remains a strength. I’m retiring next month, so I will not be here for the first quarter of 2024. Kirk Pressley will be the next CFO, and I will turn the program over to him to discuss 2024.

Thank you, Bud. Tom has provided good insights on the business. I'll focus on the earnings side. I'm optimistic about 2024. As a reminder, like most other banks, Q4 2023 was significantly different than Q1 2023, so I'll highlight the run rates from the fourth quarter versus year-over-year. The positive news is that we feel confident about our future. We expect the margin to grow from here, not only due to loan growth but also from the repricing of fixed-rate loans and securities, as Bud discussed. We believe our deposits repriced quicker than most of our peer banks, so we are likely ahead in overcoming increased funding costs. We think our dollar margin bottomed out in the third quarter of 2023 and will continue to grow from here. We expect Q1 2024 to be higher than Q4 2023, despite there being one less day. We anticipate that margin expansion will accelerate due to both the fixed rate loans and security cash flows, along with growth in the loan portfolio. Noninterest income should perform well this year, but as you know, that is a smaller segment of our business. We do expect growth in low double digits. Noninterest expense presents a slightly bigger challenge to explain; however, we maintain firm control over expenses. The fourth quarter had a lot of unusual noise, primarily due to non-GAAP adjusting items noted in the press release, including the FDIC special assessment, duplicate privilege tax expense, and the termination of our EDP contract. Additionally, we incurred elevated expenses related to historic tax credits. If you remove the unusual items, we believe our fourth quarter core noninterest expense run rate was closer to $44 million. We expect expenses to grow slowly from here. Year-over-year, we anticipate expenses to rise mid-single digits from the 2023 reported figures, nearing closer to 10% after accounting for infrequent and unusual items from Q4. The increases are due to normalized incentives for the full year, investments in the Memphis team and facilities, merit increases, and ongoing investments in technology and back office capabilities. We foresee positive progress in the income statement in the first quarter as well as continued loan growth. We expect EPS for the quarter to modestly improve compared to the adjusted fourth quarter of $0.91. However, the funding of the allowance for credit losses due to loan growth is expected to limit net income and EPS growth. The good news is the added margin from loan growth will benefit the bottom line in subsequent quarters. I'll now turn it back over to Tom for final thoughts.

Thank you, Kirk. We previously announced that Bud is retiring after year-end, marking his last earnings call. Bud joined us at the beginning of the bank's formation in 2005 and has overseen all back-office functions, cash management, HR, and finance duties. When Bud came on board, I said to him, 'Bud, two things. I've hired a head of deposit operations, she’s great. And I bought a phone system.' He replied, ‘I didn’t think the deposit operations person was all that good,’ and indeed, she resigned two weeks before we opened the bank. Bud swiftly replaced the phone system, and afterward, I stopped interfering with his back-office operations. He has done an outstanding job, and while the stock price has been somewhat depressed, it's important to remember we started at $1.66 a share in 2005, and it's now in the $60s. So Bud has clearly excelled in his role. Thank you for everything you’ve done for the company. Now, we will open the floor for questions.

Our first question comes from Graham Dick with Piper Sandler.

I just wanted to start on the loan side of things. I know we talked a little last quarter, you mentioned it a bit just now, but I think things are a little slower than I expected this quarter on the loan growth side. I know you had some payoffs. But we had discussed that $1.5 billion of liquidity you wanted to deploy. Just trying to get a better sense of how much loan growth you expect in 2023, whether that be a dollar amount or a percentage growth number—something to just set the bar at going forward. Additionally, do you think you'll have this elevated liquidity position for a longer period than you anticipated last quarter? How are things looking on that front compared to where you were three months ago?

Graham, this is Tom. We're quite optimistic as I just mentioned in the prepared comments. Loan demand has picked up markedly. Our pipeline has doubled from where it was, and we expect those loans—that's a 90-day pipeline. We’re anticipating some drag, it could take up to 120 days to close the amount in the pipeline. However, I think that funding will contribute to a nice number by the year-end. Internally, we are budgeting for high single digits this year in loan growth.

Okay, that’s helpful. Regarding loan growth, it sounded like the C&I lines are pretty stable. Where do you anticipate the growth will originate within your customer base? What segments are you seeing demand pick up in?

A lot of the growth is coming from commercial real estate. We're seeing a diverse range of opportunities out there—whether it be a marina in Florida or various constructions. Florida is showing strong growth with population inflows. We hope to see some C&I growth as rates potentially ease in the latter half of the year. We are confident that our pipeline includes C&I opportunities. Overall, we believe we can grow across all segments this year.

Got it. Regarding expenses, you mentioned some one-time occurrences. Specifically related to the tax credit accrual—was that a $1.9 million net benefit to the bottom line? In the release, it seemed there was a $4.1 million tax benefit connected to that accrual. Is that how we should interpret it?

You had $4.1 million in tax credit and the related tax expense was $3.3 million. Are you inquiring about something else?

No, that makes sense. I was curious about the $2.15 million referenced in the non-GAAP adjustments.

That figure is entirely different, relating to privilege tax.

Okay. Understood. So the run rate is essentially $44 million, as you said, and you're expecting mid-single digit growth from here?

Yes.

Great. Lastly, on the margin, specifically regarding deposit costs, it seems like at the end of the quarter, the cost of interest-bearing deposits was lower than average. Are you seeing relief in the cost of interest-bearing deposits or is that just stabilization at this point?

We're actively working on improving margins, which require effort. We're aiming to rationalize the higher-cost deposits as we desire to enhance margins. While we recognize our charge-offs won’t remain at 10 basis points indefinitely, we need to secure higher margins to accommodate any potential loan losses. Our focus this year is to raise loan rates while lowering deposit costs, which remains a critical focus for us.

That definitely clarifies things. Bud, congratulations and best of luck in your retirement.

Thank you.

Our next question comes from Steve Moss with Raymond James.

To circle back to loan growth—this quarter had a tilt towards residential. Do you anticipate this will continue for another quarter or two? Are you looking to increase your asset sensitivity? What are the product dynamics there?

We didn’t see significant loan growth in the quarter, particularly not on the residential side. I think we don't have much there, Steve. Could you clarify what you see?

Yes. While 1-to-4 family was indeed a factor in the growth during the third quarter, that's not our primary focus. We will focus on commercial clients for our growth in C&I and commercial CRE, as that is our core strength.

Does that include rent-to-own, or are you referring to just typical family structures?

This is exclusively for families of 1 to 4.

Okay. I apologize for focusing on that segment. What else was on your mind, Steve? Could you elaborate on the second half of your query?

Yes. My question centers around asset sensitivity—potential rate cuts should help you. I was curious what steps you're taking to improve the balance sheet in anticipation of potential rate cuts and how you're currently positioned. What impact will a 25-basis-point move have on your margin?

We are liability-sensitive, but it is not excessive. We're quite close to neutral at this point, and that's the position Tom has consistently sought for this bank. Compared to a year ago, we are much closer to neutral. Therefore, in the event of a nominal increase or decrease in rates, we don't foresee a significant effect—more than a 2%-3% change with a 1% rate change annually. We believe the repricing narrative will be very beneficial for us over the next year, and we feel good about the state of our securities as well.

Thank you for the additional insights. Regarding credit card income, I understand you faced a vendor issue. I’d like to know your expectations for the growth of that business moving forward.

Yes, we had vendor billing issues where we incurred double expenses for the fourth quarter, which negatively impacted credit card income. We've also completed a conversion that I mentioned earlier, and all of that is behind us now. Besides growth with our own commercial customers and fee cards, we are also adding agent banks. In 2023, we welcomed 14 new correspondent banks issuing credit cards and plan to share revenue through the ABA-endorsed program. We're looking forward to a stronger pipeline and growth for new banks in 2024 than we had in 2023.

Bud, best of luck on your retirement.

Thank you.

Our next question comes from Dave Bishop with Hovde Group.

You mentioned a balanced approach between loan and deposit growth for the year. How should we view the funding for loan growth at a high single digit? Will it be entirely from deposits, or will it involve runoff from cash and securities?

Our strategy will be focused on deposits. We are aiming for a balanced approach in dollar terms.

Kirk, could you remind me of the expected cash flow from the securities portfolio this year?

It's about $2 billion in loans.

Got it. And regarding the securities?

That's about $7 million a month in paydowns.

Understood. And what are the new origination yields on loans for this quarter?

The origination rate was 8.34% for the quarter.

Got it. Just a housekeeping item—what tax rate should we model for going forward?

About 17.5%.

Perfect. Tom, you mentioned the new hire in Memphis. Forecasting that market, how big do you believe it could grow in terms of loans and deposits?

We typically will not enter a market unless we believe we can achieve a minimum of $300 million in loans and deposits within a three-year span. This new market will align with that criteria. Our team is focused on building relationships rather than transactional banking, which is our preferred approach. We’re optimistic about our success in Memphis, particularly with the cross-pollination of bankers from various institutions.

Bud, congratulations on your retirement.

Thank you.

Thank you to everyone for joining the call. I appreciate your presence and hope you have a great evening.

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