ServisFirst Bancshares, Inc. Q3 FY2025 Earnings Call

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

Good afternoon, and welcome to our third quarter earnings call. Today's speakers will cover some highlights from the quarter and then take your questions. We'll have Tom Broughton, our CEO; Jim Harper, our Chief Credit Officer; and David Sparacio, our CFO. 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 third quarter conference call. I'll provide some highlights followed by a credit update from Jim Harper and then David Sparacio with financial updates. Regarding loan growth, it fell short of our expectations for the third quarter. We reviewed the loans booked and the draws versus paydowns over the three quarters of 2025, and loan paydowns increased by $500 million compared to the previous two quarters in the third quarter. This contributed to the lack of significant loan growth. However, we observed a nice increase of over 10% in our loan pipeline in October compared to September. When compared to a year ago, the pipeline is now 40% higher. Additionally, the projected payoffs today represent 30% of the projected pipeline, while a year ago it was 41% of the projected new loans. This indicates a slight decline in the pipeline as a percentage of loan payoffs in relation to the loan pipeline. We do acknowledge that the pipeline is not precise, but we emphasize to our bankers the importance of accuracy. Historically, we have experienced solid loan growth in every fourth quarter, so I expect a strong closing quarter in loans. Not all loan payoffs are negative, as some low fixed-rate loans are paid off due to asset sales, and we have seen several of those this quarter. On the deposit side, we observed a continued reduction in our high-cost municipal deposits in the third quarter, which were balanced by significant inflows from corporate deposits. As David will explain shortly, we are working to manage our total deposit costs as the Federal Reserve lowers the Fed funds rate. In new markets, we hired seven new producers during the quarter across our operational areas, and we are pleased to report that all of our markets are now profitable, which is a first for us since our inception. Now, I will turn it over to Jim Harper for a credit update.

Thanks, Tom. As Tom noted, lending activity softened a bit during the third quarter, but activity as we moved into the fourth quarter has been robust, with activity across our footprint. From a credit metric standpoint, charge-offs totaled just over $9 million in the third quarter, which results in an annualized net charge-off to average loan percentage of 27 basis points, on higher than recent historical periods; the charges were primarily taken on loans that had previously been impaired with one exception of a $3 million charge taken on a loan that had not previously been impaired. From an allowance perspective, the allowance to total loan percentage remains static compared to the second quarter at 1.28% at quarter end. Nonperforming assets were notably higher at September 30, increasing by approximately $96 million during the quarter with the increase driven by our relationship consisting of eight loans with a large merchant developer, rehabilitator of multifamily properties. Properties associated with the loans are in Alabama, Louisiana, and Texas. Despite us placing these loans on nonaccrual during the quarter, the bank was able to successfully obtain additional collateral to bolster our position. Additionally, the borrower is actively selling assets as evidenced by purchase and sale agreements on five properties and eight letters of intent on others as well as pursuing other corporate actions, which are expected to produce meaningful liquidity in the coming quarters. ServisFirst continues to aggressively manage our NPAs, and we expect to have resolutions on several material credits as soon as late in the fourth quarter of this year. I will now turn it over to David to provide his comments on our third quarter financial performance.

Thank you, Jim. Good afternoon, everyone. For the quarter, we reported a net income of $65.6 million and diluted earnings per share of $1.20, with preprovision net revenue of $88.3 million. This represents a return on average assets of 1.47% and a return on common equity of 14.9%. Our net income increased by more than $9 million, or 18%, compared to the same quarter last year. During this quarter, we experienced a few unique transactions. The first was the reversal of about $4.4 million in accrued interest on the credit Jim mentioned. Secondly, we recognized a loss of $7.8 million on the sale of bonds. Finally, we invested in a solar tax credit, resulting in a benefit of approximately $2.4 million in tax provision. Considering these three transactions, we estimate our normalized net income for the quarter to be $73.8 million, or $1.35 earnings per common share. I will discuss these transactions further later on. Additionally, our book value increased by an annualized 14% compared to last quarter and by more than 13% from the same quarter last year, finishing at $32.37 per share. We remain well capitalized, with a common equity Tier 1 capital ratio of 11.5% and a risk-based capital ratio of 12.8% for the quarter. These figures are preliminary. Our net interest income for the quarter was $133.4 million, while the normalized net interest income was $137.8 million. This gives us a net interest margin of 3.09% as reported and, more significantly, 3.19% when adjusted for the previously mentioned interest income reversal. This normalized net interest income is $8.4 million higher than the normalized figure from the second quarter of '25 and over $22.7 million higher than the third quarter of '24. We are pleased with the continued margin expansion, benefiting from the Fed's rate reduction in September, and we anticipate further margin growth in the fourth quarter due to expected additional rate cuts. Regarding provisions, we experienced single-digit loan growth, resulting in a reduction of about $1.8 million in provision expense compared to the second quarter. Our economic and credit indicators in our CECL model remained stable, leading to our allowance ratio holding steady at 1.28%. During the quarter, we recognized, as stated, a $7.8 million loss on restructuring our bond portfolio. As we did in the second quarter, we strategically sold $83.4 million of bonds with a weighted average yield of 1.66% at a loss. We capitalized on market opportunities and reinvested the proceeds into new investments yielding an average of 6.14%, with an expected payback period of about three years. This restructuring positions us for stronger margin performance in upcoming quarters. It has significantly reduced our low-yielding bonds and our accumulated other comprehensive losses, and we do not foresee continued restructuring of our bond portfolio. Excluding the bond losses, our net interest revenue grew by over $1.6 million from the second quarter of '25 to the third quarter. This growth was mainly driven by increased service charges, which began on July 1, and stronger mortgage production. Our focus remains on expanding noninterest income, particularly through credit cards, merchant services, and treasury management products. While our revenue increases, we are effectively managing noninterest expenses, resulting in an improved efficiency ratio. Our top-tier efficiency ratio improved from 36.90% in the third quarter of '24 to 35.22% in the third quarter of '25. Our adjusted efficiency ratio for this quarter is 33.31%, marking a considerable improvement from the same quarter last year. In this quarter, our noninterest expenses increased compared to the second quarter of '25, primarily due to adjusting our incentive accrual in that quarter. Compared to the same quarter last year, noninterest expenses rose by about $2.4 million, more than offset by a $12.6 million revenue increase. I aim to keep noninterest expense growth well below revenue growth rates. We remain committed to controlling expenses and exploring opportunities to lower operating costs. Overall, our pretax net income for the third quarter of '25 was up about $2.2 million compared to the second quarter of '25, and up over $6.4 million compared to the third quarter of '24. We continue to focus on organic loan and deposit growth that is both competitively priced and profitable, while also looking to expand our margins. As mentioned earlier, we invested in a solar tax project, effectively lowering our average tax rate for the year to 18.9%. This is our initial solar investment, and we will keep evaluating other tax improvement opportunities as they arise. This wraps up my remarks, and I will now hand it back to Tom for additional comments.

Thank you, David. I want to address the recent media focus on the rise of fraud involving some regional banks. This mainly pertains to a type of lending known as NDFI, which means nondepository financial institution lending. We have managed to limit our exposure in this area primarily because fraud tends to occur more frequently with NDFI loans, and it’s challenging to completely safeguard your processes. Historically, warehouse lending, asset-based lending, and floor plans have experienced a higher frequency of fraud compared to other loan types. Our total NDFI exposure stands at $71 million, constituting less than 1% of our loan portfolio. As you may know, our correspondent division partners with community banks, and the majority of our exposure comprises holding company lines of credit to these banks. We are quite comfortable with our position in this sector. I want to clarify that a fraud issue should be seen differently from a credit issue. It’s not that the credit has deteriorated when fraud is involved; it’s simply fraud, which tends to be relatively common. It often resembles a Ponzi scheme until the lender discovers the fraud and the individuals involved confess. We steer clear of most high-risk categories and avoid shared national credits. We prefer to lend to borrowers we are familiar with, such as owner-managed companies and real estate developers. While we acknowledge that lenders occasionally make mistakes, our approach of lending to known entities has resulted in significantly lower loan losses and superior credit quality at ServisFirst Bank. We view ourselves as a community bank, with 11 community banks and our correspondent division. We take pride in what we have established over the past 20 years, withstanding various challenges, and we intend to continue this path. This wraps up our prepared remarks, and I'll now hand it over to the operator for questions.

Our first question comes from the line of Steve Moss with Raymond James.

Good afternoon, everyone. I would like to start by asking about the nonperforming loan. Could you provide some insight into what led the borrower to this status and what the loan-to-value is on those loans?

During the quarter, we accepted a significant amount of additional collateral from the borrower, who was anticipating a large payment before the end of the quarter, but that payment did not arrive. Consequently, we had to categorize the loan as nonaccrual, although we hope to return it to accrual status within the next six months. The borrower is a long-term client involved in workforce housing redevelopment, and we maintain our confidence in them. Overall, we feel positive about our exposure. While the loan is not current at this time, we are comfortable with our position.

Could you provide information about the loan-to-cost ratio or your thoughts on how secure this loan is? I understand you plan to return to accrual status soon; could you elaborate on that?

So we think through the forbearance process and all the actions that we were able to execute toward the end of the quarter. We did think there was possibly a little bit of a collateral shortfall, and we were able to work with the borrower to obtain additional collateral across several different fronts, and we think we've shored that up. So our loan to value, while certainly elevated, is still below 1:1 at this point, and we've got adequate security to cover the loans for sure right now.

I appreciate that. Regarding margin, I understand the discussion about the reversal of accrued interest. I'm curious if we'll see the effect of that next week. The underlying margin was 3.19%, and I'm interested in the outlook for margin. Are you still expecting something in the high single digits to low double digits due to rate cuts? Additionally, what are the current loan yields and pricing trends?

Yes, this is David. We remain confident in achieving an improvement of 7 to 10 basis points in margin each quarter, as we have been observing. For September, our normalized spot rate was 3.28%, excluding the net interest accrual reversal, indicating that our margin is in good shape. The Federal Reserve's cut on September 17 allowed us only about two weeks to benefit from it, but we expect to see that impact throughout the fourth quarter and anticipate additional cuts in the October and December meetings. We will continue to see improvements in margin. Regarding loan yields, the going-on rate has decreased slightly; last quarter, it was at 7.07%, and this quarter it stands at 6.87% for loans being issued. However, we are effectively managing the process and experiencing healthy repricings and cash flows. We have around $1.7 billion in cash flows expected over the next 12 months. Additionally, as Tom mentioned in previous calls, we have roughly $300 million a year in covenant bust that will be repriced. Therefore, we are optimistic about margin expansion and believe it will continue for the foreseeable future, provided there are no significant changes from the Fed.

Got you. And just in terms of the cash flows for the next 12 months, it's still in the high 4s in terms of fixed rate loans, cash flow?

Yes. It's still in the high 4s. 4.87% was a number for the second quarter. We don't have an updated number from our external ALM consulting yet for the third quarter. But we can get that to you, but still in the high 4s.

Of course. Okay. And Tom, in terms of the loan pipeline here picking up, just curious where you're seeing the growth and the demand for loans?

I can't give you a definitive answer, Steve. It's quite inconsistent. We would obviously prefer to see more commercial and industrial lending rather than focusing on commercial real estate. However, our acquisition, development, and construction lending is at its lowest point in many years, in terms of percentage. The commercial real estate lending is below 300% of capital; it's different from region to region. For example, Atlanta has performed exceptionally well, and certain areas in our markets are doing quite well. Some nearby markets, which you would assume would perform well, actually are. New markets like Memphis, Auburn, and the Piedmont region have experienced good loan growth this year, which is expected. Overall, I would still characterize loan demand as acceptable. I spoke with a banker recently, and he mentioned loan demand is okay, to which I agreed. It's not great, though, so we need a few more rate cuts to potentially enhance loan demand overall.

Our next question comes from the line of Dave Bishop with Hovde Group.

I'm curious, Tom, about the expenses. It seems that Tom and Dave came in slightly above expectations. It sounds like there was some adjustment on the incentive accruals. Is that correct? Could you also provide some insight on expectations for compensation, salaries, and benefits as we approach the final quarter of the year?

Yes, Dave, the true-up really happened in the second quarter. So when you compare the second quarter to the third quarter, it's really the second quarter that was lower because of the true-up. We did an incentive true-up; it's all in incentive compensation. It's going to depend a lot on loan production. We went back to accruing our normal incentive rate for the third quarter. And so fourth quarter, at this point in time, given the uptick in the pipeline, we expect the fourth quarter to be very similar to the third quarter from an incentive standpoint. So I would expect the noninterest expense to come in at the same level as well. So roughly $48 million. I know it's higher than expected, but I would just guide you back to our efficiency ratio. Our efficiency ratio is still best-in-class in the 130%. The expense increase is a fraction of what our revenue increase is. And as long as we continue on that trajectory, that's what I'm pleased with from the results standpoint.

Got it. Appreciate that color. Then Tom, I think when we had you on the virtual road last month or so, it's still sort of fresh in the news, the opportunities from the MOE in your backyard. Any early signs of success there? Or you're pretty active in terms of recruiting efforts? Any commentary you can provide there in terms of maybe early reads of relationship wins or bank or mergers?

It's not just mergers that create opportunities. We are looking at various announced mergers and exploring opportunities in multiple areas. We are confident in our ability to attract customers and provide them with a more stable foundation than they may have encountered in the market. We believe in the potential for growth and know that it requires engagement with people. Most of our opportunities stem from our current customers; around 80% of our new business results from referrals from existing clients. Therefore, we focus on providing excellent service to our clients, ensuring that they will refer us to their friends and colleagues who they trust and do business with. We believe that the best approach is to prioritize our clients and address their needs, which will lead to more customers like them.

Got it. And then one final maybe housekeeping question. The tax rate, I know the solar tax credit investment bounced around a little bit. Maybe a good expectation for the effective tax rate going forward?

I believe the 18.9% tax rate will remain for the year, at least for 2025. As Tom pointed out, our recent deal has made us more aware of market opportunities. We have strong contacts and relationships and plan to continue developing these prospects. Our goal is to keep the tax rate below 20%. Although we have no specific plans for 2026 yet, we are actively discussing potential opportunities. Therefore, I anticipate the tax rate will stay within the 18% to 19% range for the foreseeable future.

Our next question comes from the line of Stephen Scouten with Piper Sandler.

David, I want to reconcile one number real quick. I think you said maybe a 3.28% margin for the month of September excluding the interest reversal; is that the main difference versus the number listed in the supplemental information?

Yes, that is correct. Yes. It's about 31 basis points on that interest reversal.

Okay. Great. And so you would expect to kind of see that 7 to 10 basis points, the way you would think about it in the fourth quarter would be 7 to 10 basis points potential roughly off of the 3.19% all-in number. Is that the right way to think about it?

Yes, that is correct.

Okay. Great. And then, Tom, maybe kind of following up on that question around dislocation. I like how you said that kind of offering stability in the market and being there for your customers. Are there any kind of new markets maybe on the horizon for you guys, where that level of business quality and stability you don't see being offered today that you'd be interested in, whether that's opened up via M&A or otherwise?

Yes. We have always been interested in finding the right people in Texas, and we are very focused on that. It’s not an easy market. I believe that if you have the right team with a bank base like ours, it could be a great place to do business. Texas has a strong local culture, and people prefer to collaborate with locals rather than individuals from other states. I understand this dynamic, and we are definitely keen on pursuing opportunities in that market. Additionally, regarding interest rates, as the Fed lowers rates, we see it as an opportunity to manage our deposit costs, aiming to reduce them by more than the Fed's cut, which could be around 25 basis points. We view the Fed's rate cuts as a time for us to capitalize on such opportunities.

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