Earnings Call Transcript - SFBS Q2 2024

Operator, Operator

Greetings and welcome to the ServisFirst Bancshares Second 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 your host, Davis Mange, Director of Investor Relations. Thank you, Davis, you may begin.

Davis 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 take your questions. We will have Tom Broughton, our CEO; Henry Abbott, our Chief Credit Officer; and Kirk Pressley, 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.

Tom Broughton, CEO

Thank you, Davis, and good afternoon. Thank you for joining our second quarter earnings call. We think we'll have a really nice report that will please our investors today, and I'll start by discussing deposits. We did see a strong deposit growth of 16% annualized for the quarter. This is a bit unusual, as we normally see flat deposits in the quarter due to April tax payments. We did see the usual decline in deposits in April due to tax payments, but we did see solid deposit growth in the last two months of the quarter. Our deposit pipeline is still really solid, though many deposits never make it onto the pipeline; they just show up. So they are not as typically accurate as a loan pipeline would be. So the growth is broad-based throughout our footprint. We also continue to add new correspondent banking relationships with 377 current correspondent bank relationships. The loan growth was very strong for the quarter at 15% annualized. We were pleased with both the level of loan demand and the profile of credit quality. We think many of our customers delayed projects last year after rates had risen a great deal in a short period of time or they decided to make capital expenditures from cash. We are seeing them borrow again, which led to an increase in our C&I loans. And we still see the loan pipeline is very strong. It has increased 10% over last quarter. We added 14 new bankers in the quarter. We added five in Florida, four in the new Auburn-Opelika market, and the rest spread throughout the footprint. We are pleased with a new team in Auburn-Opelika, which is a $4.5 billion deposit market that's pretty well fragmented. So we think it's a great opportunity for us. The Memphis team in Tennessee is all in place. They were all added in the first quarter; they were all on board during the second quarter. They are beginning to show results, and we are optimistic for the balance of the year. With our strong liquidity, we are seeing opportunities to acquire new customers, and we are optimistic about the balance of the year. So with that, I will stop. I'm going to turn it over to Henry Abbott, our Chief Credit Officer.

Henry Abbott, Chief Credit Officer

Thank you, Tom. The bank continued to show strong credit quality in the second quarter of 2024. We achieved solid loan growth of roughly $450 million, which is 15% when annualized. I would also note that while we experienced loan growth, our AD&C as a percent of capital continues to fall. At the end of the second quarter, AD&C as a percent of capital was 86%, which has continued our downward trajectory from a high of 100% at the end of 2022. I'm pleased that in the current environment, non-performing assets are stable quarter-over-quarter. We ended the quarter at NPAs to total assets of 23 basis points, which is 1 basis point higher than the prior quarter end. We did grow our ALLL by roughly $2.2 million during the quarter. ALLL to total loans did decrease from 1.31% at March 31, 2024, to 1.28%, and this was driven primarily by improved collateral values on two of our substandard credits. When looking at the first six months of 2024, annualized net charge-offs were only 8 basis points, which is less than our annual results for 2023 of 10 basis points. Annualized net charge-offs were down from the same period in the prior year. We had 10 basis points in annual charge-offs for the quarter and had 11 basis points in the second quarter of last year. We have managed to sidestep some potholes, one being that we don't have any major metropolitan office exposure. We continue to have a disciplined approach to winning new relationships in our footprint that help provide the bank with both loans and deposits. Loan growth activity should continue at a positive momentum given our recent entrance into new markets in 2024. The bank has a granular and diversified loan portfolio that continues to perform at a high level, and I'm very pleased with our second quarter results. With that, I'm going to hand it over to Kirk.

Kirk Pressley, CFO

Thank you, Henry. Good afternoon. We are very pleased with the progress the bank has made so far this year. I'm going to focus my comments today on linked quarter because the trends are very meaningful and will highlight our momentum in both growing the balance sheet and earnings. Net income is up 17% annualized and margin is up 13%. Margin increased to $106.9 million in the second quarter versus $102.5 million in the first quarter. The margin is increasing from both the growth in the balance sheet and the repricing of our fixed rate loans and securities, along with maintaining the cost of liabilities. Both loans and deposits had strong growth during the second quarter, and the pipelines continue to grow. The net interest margin percentage is up 13 basis points from the first quarter to 2.79%, as the yield on interest-earning assets is up a strong 16 basis points, while the rate paid on interest-bearing liabilities grew modestly. As we noted in the last few quarters, we see the margin increasing throughout the year. We don't anticipate a significant increase in the cost of funds going forward, while we expect the yield on interest-earning assets to continue to increase as we grow loans and fixed rate loans and investments reprice. Opportunities to proactively reprice loans from covenant violations usually occur after taxes are filed and financial statements are received. This started in Q2 but should pick up steam in the third quarter. During the first quarter, we had $139 million of low-rate securities mature at a rate of 2.2%. We had approximately $120 million of maturing securities yielding 2.62% during the second quarter and will have another $25 million yielding 2.93% in the third quarter. Reinvesting these proceeds and cash flows from mortgage-backed securities will improve the margin going forward. We did experience a minor increase in the cost of deposits; this was largely tied to the strong deposit growth. We do expect modest increases in the cost of funds as we grow deposits in the second part of the year. Core noninterest income expanded at a strong pace during the second quarter. When you exclude the infrequent BOLI death benefits of $1.2 million that we realized in Q1, our core noninterest income was up annualized linked quarter by almost 70%, primarily due to strong mortgage fee income, but we also had nice growth in credit card income and deposit fees. Mortgage fee income had a nice combination of a seasonally strong quarter, more favorable market conditions, and increased staffing levels. Credit card spend was seasonally low in the first couple of months of the year but has grown nicely since then, and we expect a good second half of the year as credit card accounts continue to grow and new correspondent banks are added at a nice pace. Non-interest expenses are a little more challenging to explain because of the implementation of Accounting Standards Update 2023-02. This changed the amortization method to the proportional amortization method for historical and new market tax credits, and moved the amortization of the investments from other noninterest expense to tax expense. This new amortization method, which now matches the low income housing tax credit accounting for qualifying investments, will reduce the volatility of our non-interest expenses going forward and better represent our operating and tax expenses by showing the cost of the tax credits along with the benefit in tax expense. We adopted the new accounting standard in the first quarter, but we did not complete the analysis until the second quarter and therefore reflected this in the second quarter financial statements. The new accounting reduced the non-interest expenses by about $3.9 million in the second quarter from what they would have been under the previous accounting, but about half of which related to Q1. In discussing other components of noninterest expense, we continue to watch expenses closely, but our expenses have increased a little more than we expected at the beginning of the year. We continue to invest in producers and the staffing up of the new markets along with the ancillary costs. We have experienced a significant rise in healthcare costs based on poor performance of our plan. We increased the reserve for unfunded commitments by about $340,000 due primarily to the growth in the balances of the unfunded commitments and a small decrease in the utilization rates. We have continued to invest in our IT infrastructure, and we experienced higher commissions related to the strong mortgage activity discussed previously. We continue to invest for our long-term growth. As we discussed on previous calls, we opened a new location in Memphis earlier this year. That location was able to fully staff up quicker than we projected, which we are happy about, and it is fully operational. We have also been hiring for the new Auburn-Opelika location that Tom discussed. Both of those locations come with compensation costs as well as other operational costs. As to the health plan, it is running about $500,000 more per quarter than we had projected, and we expect that to continue throughout the plan year. Our second-quarter noninterest expenses would have been about $44.8 million if the new accounting had been adopted in the first quarter. Our current expectation is that non-interest expenses will grow at a much slower rate for the remainder of 2024. Income tax expenses under the new standard should be less volatile than in the past. The tax rate should be approximately 20% for the remainder of the year. We are pleased with the 13% linked quarter annualized increase in our book value per share and our ability to maintain our strong capital ratios despite the annualized 15% loan growth. As to what we expect going forward, we continue to be optimistic about 2024. The yield on assets is expected to continue to grow, both dollar and percentage, and we think we can manage the increase in the cost of interest-bearing liabilities to a much slower rate than the asset yield growth. We feel very good about the loan growth we experienced during the first half of the year, as well as our pipeline for the second half of the year. Deposit growth lagged the loan growth during the first four months, but it is trending in the right direction. Our capital, liquidity, and contingent liquidity remain strong. In summary, we like how we're positioned.

Davis Mange, Director of Investor Relations

Thanks, Kirk. Let's open the lines for questions.

Operator, Operator

Thank you. We will now be conducting a question-and-answer session. Thank you. Our first question comes from a line of Steven Moss with Raymond James. Please proceed with your questions.

Steven Moss, Analyst

Good morning or good afternoon, guys.

Tom Broughton, CEO

Hey, afternoon, Steve.

Steven Moss, Analyst

We'll just maybe start off on the loan pipeline here. You guys talking about it being up quarter over quarter. Just curious, is it broad-based as like the loan growth we saw this quarter, or is it more concentrated in any particular type of loan classification? And just kind of where you're seeing it geographically as well?

Tom Broughton, CEO

Yes, it's broad-based and encompasses all types. We've been anticipating the rebound in commercial and industrial lending, which we observed this past quarter. For quite some time, we experienced a situation where customers were withdrawing funds from their money market and checking accounts to finance capital expenditures instead of borrowing from us. This created a dual challenge. Now, however, they have returned to borrowing for capital projects. We are optimistic about the increase in organic loan demand from our current customer base, which we have been looking for. There are still numerous commercial real estate projects on hold due to higher interest rates, which is quite evident. We believe this trend is widespread, affecting all our markets and various sectors, from maritime to almost everything, apart from possibly assisted living.

Steven Moss, Analyst

Okay, appreciate that. And in terms of just the margin here, I see you guys are booking new loans just over 8% here. Obviously, funding costs are relatively stable. A nice plus as assets reprice. Just curious as to how you guys are thinking about the cadence of that margin expansion after a pretty good step-up two quarters in a row now?

Tom Broughton, CEO

Well, we don't really want to forecast the NIM percentage as you would, I'm sure, understand. But what we think is, you've got a lot of information on what's going on with the growth of the assets. And you've got some information on quarter-end on where our cost of deposits are going. So they're moving up a little bit as we're growing at a really nice pace. But we expect this tailwind in margin to run for more than a few quarters.

Steven Moss, Analyst

Okay, fair enough. And then in terms of just the correspondent banking business, just kind of curious, what are the business trends you guys are seeing there? Addition of customers and the associated fee income as well.

Rodney Rushing, Correspondent Banking Officer

Yes, this is Rodney Rushing. We're seeing it mainly in some of our newer markets in Texas. We've got over 25 banks there now and we've got a strong pipeline. We saw some change in correspondent providers in the state of Tennessee and Kentucky. We hired a new officer to help cover half of that territory. We already had one in place. Tennessee, Kentucky, and Texas is where the majority of our new relationships are coming from.

Steven Moss, Analyst

Okay, great. I appreciate the color there and I'll step back in the queue.

Tom Broughton, CEO

Thank you, Steve.

Operator, Operator

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

David Bishop, Analyst

Yes, good evening, gentlemen.

Tom Broughton, CEO

Hi, Dave.

David Bishop, Analyst

Hey, Tom, I'm interested to know that not only has growth picked up on the commercial side, but it seems like there's also been a rebound in other commercial real estate, possibly in non-owner-occupied sectors. I’m wondering where you're observing strength? What kinds of projects are showing growth? Are there new yields in that area? I'm curious about the resilience you're seeing in the CRE market.

Tom Broughton, CEO

I'm going to let Henry Abbott respond to the question today, but generally speaking, I believe that banks experiencing liquidity and deposit growth are attracting new customers, as many banks—especially some incumbents—are unable to maintain the liquidity needed to issue new loans. Therefore, when people mention a lack of loan demand, it may be because they cannot adequately fund that demand. We are being very selective about who we lend to and the types of projects we support. Our top priority is always to take care of our existing clients, who have been with us for a long time. Henry, could you add anything to that?

Henry Abbott, Chief Credit Officer

Yes, from specifics on the non-owner occupied segment, where we saw some of the growth, as Tom mentioned, either for existing customers or new customers with significant equity put into projects, whether that's acquiring an existing project or building one. But multifamily and then warehouse were kind of the primary drivers there.

Operator, Operator

Thank you. Our next question comes from the line of Stephen Scouten with Piper Sandler. Please proceed with your question.

Stephen Scouten, Analyst

Hey, good afternoon, everyone. Appreciate the time here. I guess, I did have one question, just maybe a clarifying question around some of the expense commentary. You gave that $44.8 million number, I guess, if that accounting change had been in effect for the previous quarter as well. So is that $44.8 million numbers, is that a better run rate moving forward as we think about the go-forward expense base start now?

Tom Broughton, CEO

Exactly, yes.

Stephen Scouten, Analyst

Okay. And so then it will grow at a slower pace off of that number.

Tom Broughton, CEO

That's correct. And the tax rate should be around 20% going forward.

Stephen Scouten, Analyst

Thank you, that’s very helpful. It seems that if I'm interpreting these numbers correctly, there was a bit more pressure on non-interest bearing deposits at the end of the period this quarter. Is there anything to note about that? It's pretty stable on average, but I'm curious if this could affect average balances in the next quarter based on the end-of-period observation.

Tom Broughton, CEO

Yes, go ahead, Kirk.

Kirk Pressley, CFO

So you hit it on the head with the average balance was just about the same. It went down right at the end of the quarter. We think that's going to come back but obviously we don't know for sure. It might be some house cleaning at the end of the quarter, but you would normally think that at the end of the first quarter too; however, the average balances are almost spot on. So we don't see anything that really is overly concerning to us at this point that it's a new trend or anything like that if that's what you're asking.

Stephen Scouten, Analyst

Yep. Okay. Very helpful. And maybe just a couple other things for me. One, from a new hire perspective, what would you expect kind of the cadence of that to be moving forward? I think you said you had 14 new bankers in the quarter, 20 overall FTE ads. Should we expect that similar cadence throughout the rest of the year or are those opportunities maybe not as prevalent and/or is it not the time you want to be investing in those given the market opportunities that are out there?

Tom Broughton, CEO

I'll answer it this way. We don't have anything in the pipeline at the moment, but I've learned that can change quickly. If we find the right team in the right market, we will hire them all as best as we can. We believe this approach serves the long-term interests of our shareholders rather than just the short-term ones. Therefore, we're committed to making long-term decisions by bringing in talented individuals. Our perspective is that the team with the best talent usually comes out on top. It’s not just about the head coach making clever plays; it's about having the best players. That's what we aim for—those top-tier players.

Stephen Scouten, Analyst

I totally agree. Okay. And then just last thing for me, from a loan to deposit perspective, I mean, you've made a lot of progress year-over-year there. Is this kind of where we should expect you to try to run the bank moving forward in this kind of, I don't know, mid-90s loan to deposit ratio percentage?

Tom Broughton, CEO

Yes, I think that's probably right. And as you know from past conversations, we view a lot of the correspondent almost like deposits that aren't showing up in deposits, especially the settlement accounts. So we feel pretty comfortable running in the mid-90s.

Stephen Scouten, Analyst

Got it. Makes sense. Super helpful guys, appreciate it, and congrats on a really good quarter.

Tom Broughton, CEO

Thank you.

Operator, Operator

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

David Bishop, Analyst

Yes, thanks, guys. Just had a couple of quick follow-ups. Appreciate the color in terms of the CDs rolling off next quarter, just curious what you're seeing, maybe the blended rate or new offering rates on CDs, sort of new CD money coming into the door, how that compares to maybe the average cost?

Tom Broughton, CEO

So, I'd like to give you a really firm answer long term, but we really play with that a lot based on the need and the markets and what they're asking for and what the competition is doing. So, I can't give you a firm answer of where that's going to be six weeks from now.

Henry Abbott, Chief Credit Officer

Well, I would say that we've seen CD rate pressures moderate over the last more than several weeks. I would say it's been the last couple of months. We've seen less active people. We look at the different markets, what the CD offerings are, and it's, in many cases, this is a defensive product for us, not an offensive product. Again, we've never advertised a rate since we were founded 19 years ago. Not in emails, not in print, not in any form. We've never advertised rates at all, because that's not how you win the game. So I just think we have a defensive product out there, price I think is moderating down. I'll be surprised if we don't see continued price moderation in the CD market, Dave.

Tom Broughton, CEO

And as a reminder, that's less than 10% of our interest-bearing liabilities.

David Bishop, Analyst

Yep. Just curious in terms of maybe the markets where you're seeing, rate pressures moderate, are you seeing some of these CD specials or offerings dip below the 5% range, approach the 4.5%, the high 4% range, just curious.

Tom Broughton, CEO

More like the 4.5%, something like that.

David Bishop, Analyst

Got it. And then one final question, just curious on loan repricings over the rest of the year, just curious how much of the loan portfolio we should expect to maybe return or reprice over the second half of the year? Thanks.

Kirk Pressley, CFO

When you're talking about repricings, we usually define repricings as opportunities to reprice a loan that hasn't matured. Is that what you're asking? Are you talking about total maturities and fixed rates?

David Bishop, Analyst

Probably total maturities, including the fixed rate, correct.

Kirk Pressley, CFO

Okay. We think we run around $2 billion a year, so about $1 billion. Now, some of that is dependent on what we call repricings, which are also the opportunity to go in and when we get the financials, if there's some footfall from the loan covenant, we get to readdress the rate on the loan. And that picks up really in earnest in the third quarter. We've had about $190 million of those through the first half of the year. It starts in earnest in the third quarter, but in general, probably in that billion range.

David Bishop, Analyst

And when you say starts in earnest, are those loans with covenant defaults? Just curious, I'm not sure if I understood it.

Kirk Pressley, CFO

It might be a covenant default, typically small ones. We don't view these as signs of significant credit decline, but often there's something when we receive the financials and tax returns, starting in the second quarter and increasing in the third quarter, where we will thoroughly review everything. If we have the chance to reprice a low-rate fixed-rate loan, we will usually take that chance depending on the client.

Tom Broughton, CEO

Henry, how many different ways are there to have a loan repriced opportunity? I mean is it 20 or 30? It's a big number.

Henry Abbott, Chief Credit Officer

It's a big number, and part of it might be the lack of collection of financials. So you were supposed to get them in May and you still haven't gotten them, so now we use that as a repricing event past dues or…

Tom Broughton, CEO

If they were past due, that's an opportunity. There are many factors to consider. They didn't pay the real estate taxes on time, which could present an opportunity. I've been surprised by the various ways people can breach their contracts. In many instances, they claim to have a draw period on the loan and fail to act in time, which leads them to return to us for assistance. We plan to support our borrowers consistently. However, there are far more opportunities than I ever expected when rates began to rise over the last 18 months or so.

David Bishop, Analyst

Yes, with that, and I know it's not clear, but any material change in the classified, criticized trends quarter-over-quarter?

Henry Abbott, Chief Credit Officer

No major changes.

Tom Broughton, CEO

We see more positive results than negative results, Henry, on balance.

Henry Abbott, Chief Credit Officer

Yes, generally, it's kind of stable across those categories.

David Bishop, Analyst

Great, Thank you.

Henry Abbott, Chief Credit Officer

Thanks.

Tom Broughton, CEO

Thank you, Dave.

Operator, Operator

Thank you. There are no further questions at this time. This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.