Earnings Call Transcript - SFBS Q2 2025

Operator, Operator

Greetings, and welcome to the ServisFirst Bancshares Second Quarter Earnings Conference Call and Webcast. As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to Davis Mange, Director of Investor Relations. Davis, please go ahead.

Davis S. Mange, Director of Investor Relations

Good afternoon, and welcome to our second quarter earnings call. Today's speakers will cover some highlights from the quarter, and then we'll take your questions. We'll have Tom Broughton, our CEO; Jim Harper, our Chief Credit Officer; and David Sparacio, our CFO. Now I'll 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.

Thomas Ashford Broughton, CEO

Thank you, Davis, and thank you for joining our second quarter conference call. I will provide a few highlights followed by a credit update from Jim Harper, and then David Sparacio will share more financial information about the quarter. From a loan perspective, we experienced solid loan growth in the quarter. Net of payoffs, our growth was 11% annualized. We continue to see a very strong loan pipeline. I would describe the loan demand as good, but not great. We are also experiencing elevated payoffs in commercial real estate, which is consistent with what others are reporting. Fortunately, we are primarily a commercial and industrial lending bank, which does not face the same level of payoffs as the CRE side. We are replacing payoffs with new projects, but we now have larger equity requirements than in the past. Our funding will only start once the projects are well underway. On the real estate front, many projects are not feasible at the current higher interest rates. We believe that if we see some rate cuts, demand would improve significantly. Many of the projects we are seeing are focused on tax credits and low-income housing, which are supported by the government and continue to have strong demand. On the deposit side, we have seen some normalization of higher-cost municipal and correspondent deposits this quarter. One significant municipal deposit that has been held for two years while construction projects have started is now running off as anticipated. We are concentrating on opening core deposit accounts with treasury products that align with those. This has always been our bank's primary focus. In new markets, we added seven new producers in the second quarter within our footprint. Furthermore, we have increased our efforts in the merchant area by bringing on a team to enhance our production in that sector. We believe there is significant potential to grow our merchant business. While our producer count only includes commercial bankers, and does not account for many revenue generators, we are confident they will excel in increasing merchant revenue for us. Now, I will turn it over to Jim Harper for a credit update.

Jim Harper, Chief Credit Officer

Thanks, Tom. Good afternoon. As Tom mentioned, we continue to see solid loan growth in the second quarter and through year-to-date '25, with continued solid demand into the third quarter and the second half of the year, supported by active owner and non-owner-occupied CRE and C&I pipelines. Total charges in the second quarter were just under $6.5 million and were driven primarily by a charge of just over $5 million related to one loan. This was a situation where the borrower's performance deteriorated quickly and unexpectedly. Our allowance relative to total loans, which increased by almost $5 million compared to the first quarter, remained flat on a relative basis at 1.28% at quarter-end. On the non-performing asset front, NPAs remained stable on a quarter-over-quarter basis, moving from 40 basis points at March 31 to 42 basis points at June 30, and we continue to aggressively manage our NPAs. As evidence of those efforts, we achieved resolution on a couple of long-term problem credits in the second quarter and expect additional resolutions throughout the second half of this year. In summary, through our granular portfolio review that we execute on a quarterly basis, we haven't identified any systemic issues or concerns, whether by industry or borrower type, including within our income-producing and AD&C portfolios. Of course, there continue to be isolated incidents of credit deterioration, but we're not seeing any broader negative trends from a credit quality perspective. I'll turn it over to David for his financial highlights.

David Sparacio, CFO

Thank you, Jim. Good afternoon, everybody. For the quarter, we reported net income of $61.4 million and diluted earnings per share of $1.12, as well as pre-provision net revenue of $87.9 million. This represented a return on average assets of 1.40% and a return on common equity of 14.56%. Net income grew more than $9 million or 18% from the second quarter of 2024. Compared to the first quarter of 2025, net income was down slightly by about $1.8 million or 3%. During the quarter, we had two significant non-routine transactions. The first was an $8.6 million loss on the restructuring of our bond portfolio. We strategically sold about $70 million of bonds yielding 1.34% at a loss, and reinvested the $62 million of proceeds in new investments with an average yield of 6.28%. The expected payback period on this transaction is 3.8 years. This restructuring will position us for stronger margin performance in future quarters. Secondly, we reversed an interest expense accrual of about $2.3 million that had been building for several quarters. This accrual was related to a legal matter that has been resolved, resulting in a reduction of about 7 basis points in our deposit costs. The reported deposit costs at 3.50% will not sustain in future quarters. We expect it to be similar to the first quarter at about 3.57%. We continue to focus on growing our margin, emphasizing price discipline for both loans and deposits. Our adjusted margin stands at 3.05% for the quarter, which is up 13 basis points from the linked quarter and 26 basis points from the same quarter of last year. We continue to have repricing opportunities and cash flow paydowns on our existing fixed-rate book of loans. We have about $1 billion in variable rate loans maturing in the next 12 months. Lastly, our tangible book value grew by an annualized 12.5% versus last quarter and by nearly 14% from the same quarter a year ago, ending at $31.27 per share. We remain well-capitalized with a common equity Tier 1 capital ratio of 11.38% and a risk-based capital ratio of 12.81% for the quarter. Net interest income for the quarter was $131.7 million as reported and adjusted net interest income totaled $129.4 million. This represents an increase of $5.9 million over the first quarter of 2025 and more than $23 million higher than the second quarter of 2024. We are pleased with the margin improvement, which increased from a normalized spot rate of 3.06% in March to 3.19% in June. If you recall, first quarter margin was affected by excess cash balances, which have now reduced as expected and are more stable. Therefore, we anticipate our margin will continue to increase throughout the year, and it may accelerate if the Fed decides to lower benchmark rates. This quarter witnessed a significant increase in our provision expense, necessary to maintain our allowance for credit losses given the loan growth and notable charge-offs Jim mentioned in the second quarter. Little change was noted in our economic and credit indicators in our CECL model, and as a result, our allowance for credit losses ratio held steady at 1.28%. We expect provision expense to normalize based on the current economic environment and steady loan growth experienced year-to-date. Non-interest income saw a significant decrease due to the bond book restructure discussed earlier. Excluding that loss, adjusted net interest revenue for the quarter was just under $9 million, which is $706,000 better than the first quarter of 2025 and about 1% higher than the second quarter of 2024. We remain committed to non-interest income growth through merchant services, processing, and treasury management services. Tom already mentioned the onboarding of the new merchant team, which continues to focus on cross-selling opportunities. We also increased service charges related to our treasury management services on July 1, the first increase in 20 years. So, while we didn't see those results in the second quarter, we will see them in future quarters. Our non-interest expense was down $1.9 million versus the first quarter, primarily due to the large operational loss recorded in the first quarter. Conversely, we experienced a $1.4 million increase compared to the same quarter of last year, approximately a 3% increase versus the second quarter of 2024, which is modest given the 18% increase in net income. My goal is to limit non-interest expense growth to a fraction of our revenue growth. We remain focused on expense control and are looking for opportunities to reduce our operating costs. This quarter, our largest effort in back-office operations involved a conversion with our core processing system. We successfully unwound a configuration that involved third-party processing of our transactions and switched to a direct relationship with Jack Henry. We expect cost savings in future quarters from this change, but continue to anticipate our non-interest expense to be in the range of $46 million to $46.5 million per quarter. Our non-interest expense this quarter resulted in an efficiency ratio below 34%, and we do not expect drastic changes in our efficiency ratio going forward. Overall, our second quarter 2025 pretax net income was down about $2.5 billion compared to the first quarter and up over $10 million versus the second quarter of 2024. Our adjusted pretax net income was up $3.8 million versus the first quarter and up over $16 million versus the second quarter of 2024. We continue to focus on organic loan and deposit growth priced both competitively and profitably. Finally, we are strategizing on reducing our tax expense and managed to realize a slight decrease in our effective tax rate from the first quarter to the second quarter, which we will continue to focus on going forward. That concludes our prepared comments, and we will turn it over to the operator for questions.

Operator, Operator

Our first question today is coming from Stephen Scouten from Piper Sandler.

Stephen Kendall Scouten, Analyst

I would like to start with the net interest margin and discuss how you expect it to increase from here. What do you see as the starting point excluding that interest reversal, and what are your projections for its trajectory by the end of the year, not considering any Federal Reserve actions?

David Sparacio, CFO

Yes. So Stephen, this is David Sparacio. Our adjusted margin for the quarter is 3.06%, excluding the interest expense item we discussed. We continue to focus on deposit and loan pricing throughout our area. If there are no changes from the Fed, we anticipate it will keep rising each quarter. We are seeing increases of about 10 to 14 basis points quarterly. Based on that, we might see increases of around 10 basis points in both the third and fourth quarters, bringing us to a year-end range of approximately 3.25% to 3.20%.

Stephen Kendall Scouten, Analyst

Okay. Fantastic. Very helpful. And then in terms of deposit growth, I know you mentioned some expected outflows on the municipal side. But how do you view the ability to drive deposit growth in line with the nice loan growth you've had?

David Sparacio, CFO

Yes. So again, it's David. If you recall back in the first quarter, we had hefty deposits. We had excess funding that negatively impacted our margin. We knew some of those municipal deposits were going to run off, and we were okay with that. Some were high yielding. If we pay the right price, we can attract deposits, and we are managing through what we need to fund our loan growth while avoiding any excess funding.

Stephen Kendall Scouten, Analyst

Okay. Great. And then just the last thing for me. I think you noted maybe 23 new FTEs this quarter. I think Tom said 7 of those were new lenders potentially. Can you give us a feel for what markets those new lenders are coming from, any potential new markets you're thinking about moving into? Any additional color on that merchant banking initiative? What the focus is there, whether certain dollar revenue companies, or kind of how we should think about that opportunity?

Thomas Ashford Broughton, CEO

Our HR is very literal in their headcount, so 14 of them are former employees. You can exclude 14 from that list, as they don't count for anything.

David Sparacio, CFO

Yes, there are interns. If you look at the supplemental schedule we shared, we were up 23 and 14 of those, as Tom said, are interns. They are temporary employees. There are new markets, but it mainly adds to our existing staff.

Thomas Ashford Broughton, CEO

The hiring of new tellers in Auburn, Alabama or Memphis, Tennessee is not a significant expense.

Stephen Kendall Scouten, Analyst

And just thinking about the opportunity set in that merchant banking area you mentioned.

Thomas Ashford Broughton, CEO

It's not in merchant banking; it’s merchant card.

David Sparacio, CFO

The focus is on merchant processing for our existing customer base, which has a very low penetration rate. The theory is that we will increase our penetration rate among existing customers.

Thomas Ashford Broughton, CEO

And while it's not big dollars, we have about 1% penetration, and the new team believes we can achieve 8% penetration. This would provide a fairly substantial boost to our non-interest income.

Operator, Operator

Your next question today is coming from Steve Moss from Raymond James.

Thomas Bernard Reid, Analyst

This is Thomas on for Steve. Another strong quarter of loan growth from you guys. I appreciate the commentary you provided. But I want to see what are some of the broad trends that you're seeing today in terms of the demand for commercial credit? I know many are uncertain and pulling back with the tariff uncertainty that was ongoing. Any anecdotal insights you might offer?

Thomas Ashford Broughton, CEO

I think tariffs are a valid excuse. If you're not executing, it’s a convenient excuse. We don’t see much impact from the tariffs. Our construction loan volume increased this quarter, but due to our CECL model, we must keep a higher reserve for construction loans. We experienced a $5 billion increase in our construction loan loss reserve, which is costly. But it's not confined to one area; we see it broadly across various markets including Memphis, Auburn, and Montgomery. It's performing well across different asset classes.

Thomas Bernard Reid, Analyst

Okay. So are we thinking that maybe low double digits is still possible?

Thomas Ashford Broughton, CEO

Yes. I mean, if we had great loan demand, it would certainly be more than that; however we're dealing with payoff headwinds which might lower it below double digits this quarter. Our pipeline looks good, but I can’t project every quarter.

Thomas Bernard Reid, Analyst

Got it. I'm sorry if I missed this in the prepared remarks, but do you have any fixed rate loans repricing over the next 12 months?

David Sparacio, CFO

We have about $1 billion in the next 12 months.

Thomas Ashford Broughton, CEO

The accounting for investment securities is right at $2 billion a year for 12 months, between $1.9 billion, and a little over $1.9 billion.

Thomas Bernard Reid, Analyst

Do you happen to have a yield that they're coming off at or what pickup you might be getting?

David Sparacio, CFO

Give us a minute, and we can get that for you. Yes, we have a weighted average yield of 4.87% right now on $1.5 billion of loans, fixed rate, for the next 12 months.

Operator, Operator

Our next question is coming from Dave Bishop from Hovde.

David Jason Bishop, Analyst

David, maybe during the preamble, you spoke about some of the trends you're seeing in the cost of deposits. I know there were some anomalies this quarter. Could you go over expectations for deposit cost trends?

David Sparacio, CFO

Yes. I think it will normalize more like the first quarter. We had an adjustment this quarter, so if you look at our adjusted cost of deposits, we're at 3.57% as opposed to 3.50%, which is reported. That should be the trend going forward. We are slightly liability sensitive, so assuming there is no Fed rate cut, we will probably hold around 3.50% to 3.57%.

David Jason Bishop, Analyst

Got it. I think Tom or Dave, you noted a change, a late quarter change on the treasury management fees you're charging for services. Can you discuss that from a dollar perspective? Would that significantly impact the run rate moving forward?

David Sparacio, CFO

Yes. As you know, we're not a big non-interest revenue bank. We increased our treasury management fees on July 1, so there will be no impact in the second quarter, but we do expect increases in the third quarter.

Thomas Ashford Broughton, CEO

And we hope they will increase their noninterest-bearing deposits. You won't see a revenue increase, but you'll observe an increase in NIBs.

David Sparacio, CFO

The earnings credit will factor in the increased fee.

David Jason Bishop, Analyst

Got it. And then, Tom, it sounded like the loan pipeline continues to hold strong. You noted the increase in construction loans outstanding. Could you share any commonality in the funded projects? Were they relatively newer credits or did they take a while to fund?

Thomas Ashford Broughton, CEO

Jim, do you want to comment?

Jim Harper, Chief Credit Officer

I'd say both, actually. It was a mix of projects with considerable equity that finally reached the point where they were drawn on lines. There was certainly some aspect of new production as well.

David Jason Bishop, Analyst

Got it. Finally, with regard to the funding noise, what should we expect concerning the loan-to-deposit ratio at that mid-90% range? Is there a comfortable level to allow that to trend to par? Should it come back down to the lower 90s over the year?

Thomas Ashford Broughton, CEO

We include Fed funds purchases, so looking at our adjusted loan-to-deposit ratio, it's closer to 80% than 90%. Would that be correct, Davis?

Davis S. Mange, Director of Investor Relations

Yes, it's in the mid-80s.

Thomas Ashford Broughton, CEO

So we're in good shape from a liquidity and funding standpoint. We prefer to be in a position where we need to generate deposits rather than loans. We have been in a position needing to generate loans for the past couple of years. Ideally, we want to face the challenge of needing deposits instead of loans.

Operator, Operator

We've reached the end of our question-and-answer session. I'd like to turn the floor back over for any further or closing comments.

Davis S. Mange, Director of Investor Relations

There are no further comments. That concludes our call. Thank you all for joining.

Operator, Operator

That does conclude today's teleconference webcast. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.