Earnings Call Transcript - SFBS Q4 2020

Operator, Operator

Good day. And welcome to the ServisFirst Bancshares Incorporated Fourth Quarter Earnings Call. All participants will be in a listen-only mode. After today’s presentation, there will be an opportunity to ask questions. Please note this event is being recorded. I would now like to turn the conference over to Mr. Davis Mange. Please go ahead, sir.

Davis Mange, Host

Good afternoon, and welcome to our fourth quarter earnings call. We will have Tom Broughton, our CEO; Bud Foshee, our CFO; and Henry Abbott, our Chief Credit Officer, covering some highlights from the quarter and then we will take your questions.

Tom Broughton, CEO

Thank you, Davis, and good afternoon. Welcome to our year-end earnings call. If you asked me back in March if I thought we would report record earnings for 2020, I certainly would have said that I feel fairly certain we will not report record earnings with a looming pandemic in front of us. So we are very pleased to be able to report record earnings. I think it speaks very well for the quality of our team and our asset quality. Our credit quality has never been stronger. As Henry Abbott, our Chief Credit Officer, will discuss in more detail in a few minutes. Our deposits grew about $2.5 billion in the past year, a 33% increase, a very large deposit surge because of the pandemic. We are beginning to transition to a $10 billion bank, and we have been planning this for several years. The pandemic just sped up the timeline a bit; we do have all the infrastructure in place to make the transition. Our regulators have been very proactive in working with us to ensure a smooth transition, and our Chief Risk Officer, Mark McVay, has done an outstanding job. The pandemic helped us transition quickly to new technology and showed us that we really don’t need as much brick-and-mortar as we have, even in a bank with a branch-like model such as ours. It has also made our clients transition more quickly as well. We are very fortunate to be based entirely in the Southeast, where we have had very few shutdowns and less affected customers than in other parts of the country. Our unemployment rate is a good bit lower. More workers have jobs, and our economy is in much better shape. We are seeing a large migration into our footprint, and we expect it to continue. I have always said that given the choice between a bad bank in a good market or a good bank in a bad market, I would pick the bad bank in a good market, as we can fix a bad bank but we cannot fix a bad market. Talking a little bit about loan growth for the quarter, particularly we did see a 6% annualized growth in the fourth quarter. I thought it would be a bit higher than that. I did not anticipate the fear of higher tax rates; capital gains rates led several customers to sell their companies and other assets to lock in the current rates. We also lost a few loans on writing structure. We continue to emphasize being a disciplined lender.

Henry Abbott, Chief Credit Officer

Thank you, Tom. I am pleased with the bank’s fourth quarter results and how the bank’s loan portfolio performed throughout the pandemic, and I am optimistic about how we are positioned for 2021 and beyond. Our total past dues to loans was 11 basis points, which is roughly $9 million, and that’s on par with the third quarter, which is near historic lows. Non-performing assets were $25.5 million on a total loan portfolio of $8.5 billion. The $25 million in NPAs is an $8 million reduction from the third quarter and an $18.8 million reduction from year-end 2019. These resulted in NPA total assets at 21 basis points, which is an 8 basis point reduction from the third quarter and a 29 basis point reduction, or over half from the same period in the prior year. I am proud to say that past dues to total assets and non-performing assets to total assets have not been this low since 2015. As referenced, asset quality improved, which leads me to be optimistic about our outlook in these uncertain times. We did have roughly $9 million in charge-offs for the quarter, as we have historically referenced; we are proactive in our credit servicing and took appropriate actions as needed on credit in the fourth quarter. The overwhelming majority of these charge-offs we took in the fourth quarter were related to previously impaired loans. Two of the specific charge-offs we took in the fourth quarter were related to borrower misrepresentations on C&I relationships, and these charge-offs accounted for just over half of the charge-offs for the quarter. I’d also note that the charge-offs were down from our third quarter results. We have grown our ALLL by over $11 million in the past year. As of year-end, our ALLL to loans was 1.04%. However, excluding PPP from total loans, our ALLL to total loans was 1.16%, which is higher than we have been at a year-end in roughly 10 years. As we move to the CECL calculation in 2020, the difference between the amount of credit loss allowance required under our incurred loss methodology and the amount required under the CECL methodology resulted in a $2 million reduction, which was shown in our fourth quarter results. With that, I will pass it back to you, Tom.

Tom Broughton, CEO

Thank you, Henry. Thank you for that update. I will now turn it over to Bud Foshee, our Chief Financial Officer, for the financial update.

Bud Foshee, CFO

Thank you, Tom. Good afternoon. Net interest margin for the fourth quarter was 3.27% versus 3.14% in the third quarter. The adjusted margin was 3.23%, excluding the average PPP balances of $1.01 billion and PPP interest and loan fees of $10.1 million. The adjusted margin for the third quarter was 3.25%, the average PPP balances were $1.05 billion, and PPP interest and fees were $6.6 million.

Tom Broughton, CEO

Thank you, Bud. I will cover a couple more things before we take questions. One, I thought you might be interested in an update on COVID. Like all banks, we took all precautions early on and continue to do so. We work remotely in rotation, require masks, and use barriers and plexiglass. We have also had many redundant systems, which have proven to be very beneficial. I checked with our HR last week, and 17% of our employees have tested positive for COVID. A total of 57% have either been sick, have been out due to exposure, or quarantined for other reasons. So we continue to operate the bank even though half of our employees have been out for one reason or another. None of our employees have been hospitalized, and we learned that most of them are not too sick to work remotely, which has been helpful for our operations. We don't think we've had significant internal transmission; it seems to be more related to employees going to lunch together. Most of the stories I hear from my employees are that they attended weddings, social events, or large family gatherings during the holidays. So that's your update on COVID. We are fortunate that we have managed this without any hospitalizations in our office.

Operator, Operator

And our first question will come from Brad Milsaps with Piper Sandler. Please go ahead.

Brad Milsaps, Analyst

Hi, guys.

Tom Broughton, CEO

Hi, Brad.

Henry Abbott, Chief Credit Officer

Hi, Brad.

Brad Milsaps, Analyst

Tom, I appreciate your optimism around loan growth. So I’m just kind of curious, would you expect that with what you have in front of you, you can kind of get back to that sort of low double-digit, maybe even higher growth rate that you guys have experienced in the past? Or do you think that’s more of a second half of '21 and '22 kind of proposition?

Tom Broughton, CEO

That’s a really good question, Brad. It’s the timing of when the rebound in loan demand happens. We think the line utilization will bounce back, but I couldn’t say that it’s going to be evenly over the next four quarters, right? That would be speculative on my part. And the construction loan drawdowns—we have a fair pipeline of construction loan draws that will happen this year that will be additive to our loan growth. So I feel good about that part. Just the line utilization, I don’t know exactly when we will see the rebound that I would expect there, Brad. But the pipelines are generally strong in the first quarter, because we close everything—it’s a year-end incentive for everyone to get their deals closed by the fourth quarter. So the first quarter is always a little on the slim side. I would expect a pickup in the second, third, and fourth quarters, Brad. However, we are in the throes of PPP, and nobody is out doing any prospecting right now; we are trying to make sure all our clients' needs are taken care of first. Also, we are still in a pandemic, and companies are moving their banking to us. They say they will do it, but when we get through the pandemic and the loan forgiveness for existing banks, so moving their bank is not top of mind right now for our customers. So we need a little bit of time, I think, to get this pandemic behind us, perhaps.

Brad Milsaps, Analyst

And Tom, for the growth that you are seeing, what types of rates are you seeing on the new loan originations that are coming on?

Bud Foshee, CFO

Hey, Brad. It’s Bud. We are getting around 4.25% on new deals.

Brad Milsaps, Analyst

Okay. Great. And then maybe just another follow-up, Bud, obviously liquidity continues to be a big headwind for the margin. I’m kind of curious, are you guys going to hold that, kind of wait for the loan growth to come, or would you increase the bond book at all? Just kind of trying to get a sense of how you are thinking about that big liquidity bucket that you have got on the balance sheet right now?

Bud Foshee, CFO

Well, we like to try, but the Fed buys up everything. So there’s really nothing to buy. You are about like if you break even every month, that’s what pays down a mortgage-backed; you can buy. It would be hard to build it up by that much just based on what’s out there from an inventory standpoint right now.

Brad Milsaps, Analyst

Okay. Great. I will hop back in queue.

Tom Broughton, CEO

Thank you.

Operator, Operator

Our next question will come from Kevin Fitzsimmons with D.A. Davidson. Please go ahead.

Kevin Fitzsimmons, Analyst

Hey. Good afternoon, everyone.

Tom Broughton, CEO

Hey, Kevin.

Bud Foshee, CFO

Hey, Kevin.

Kevin Fitzsimmons, Analyst

Just curious, it sounds like everything is going in the right direction in terms of credit, and you guys all feel comfortable. I am wondering what you are seeing in terms of migration into criticized and classified assets, whether any of the big declines we have seen in deferrals have migrated to those categories yet? Thanks.

Henry Abbott, Chief Credit Officer

No. I mean, I think for the year we were up in criticized assets. But for the quarter, we were down in the fourth quarter on our criticized assets. As folks got off of the deferrals, they start making payments again. We haven’t increased TDRs; they are continuing to pay. So for the quarter, we did see a decrease, but as of 12/31/2019, we were in a pandemic, so they are up for the year.

Tom Broughton, CEO

Yeah. I think, Kevin, if I may, very few of our credit problems have anything to do with the pandemic. I mean, there is some, but probably, like, if Henry would agree, 5% or 10% of our problem credits are tied to the pandemic, damage from the pandemic, would that be accurate?

Henry Abbott, Chief Credit Officer

Yeah. I mean from a loss perspective, I can really only harp on one, and that was one we talked about last quarter that was deeply impacted. But other than that, these are existing credits we have just been working through.

Tom Broughton, CEO

That’s really accurate.

Kevin Fitzsimmons, Analyst

Is it fair to say, though, are you taking a more, not more proactive, but are you taking a deliberate approach because of the pandemic to work those through this pipe a little quicker than you might if you didn’t have the pandemic looming out there?

Tom Broughton, CEO

We are, Kevin, it’s just a good time to take a hard look, especially in the fourth quarter. You don’t want to carry something over from year-to-year that has any sort of loss potential in it, right? So you, as a former examiner, would not appreciate us doing that if we were a bank. So we do try to be fairly aggressive these days and looking at everything out there. It’s a good time to go ahead and deal with the problem.

Kevin Fitzsimmons, Analyst

Sounds very reasonable to me. Bud, I appreciate all the information on PPP; some of those details came in rather quickly. How should we view the timing of the forgiveness for what's left on Round One and the recognition of the fees over the next few quarters? Will it all happen in the first quarter, or will it be distributed over the next two quarters? Additionally, regarding Round Two, do you think that will be mostly finalized by the end of this quarter in terms of timing? Thanks.

Bud Foshee, CFO

Yeah. The current PPP is spread throughout the year. I know it’s a little bit elevated more in the, probably in the first half of the year. So we anticipate we had there $17 million left or $17.8 million. So essentially, all of that will play out. We don’t foresee maybe just a small amount left, maybe at the end of 2021, but as far as the fees, I would say it’s more first half weighted. Do you have any additional comments?

Tom Broughton, CEO

I don’t have a feel for that either.

Kevin Fitzsimmons, Analyst

Yeah.

Tom Broughton, CEO

But, I am sorry, it’s too early. We think it will all be paid off in this calendar year, but I can’t tell you the timing though.

Kevin Fitzsimmons, Analyst

To build on Brad's question regarding excess liquidity, you already have a significant excess liquid position. However, is it likely to increase further now that you are receiving cash from the SBA for Round One? Do you anticipate that some of the deposits associated with PPP may decline once the PPP loans are forgiven?

Tom Broughton, CEO

Our assumption is that we will see some deposits migrate out at some point, but we are projecting net deposit growth for this year. Each of our regions is optimistic as they report their numbers; they continue to grow their balance sheet. We need to find some loans.

Kevin Fitzsimmons, Analyst

Right. Understood. All right, guys. Thank you very much.

Tom Broughton, CEO

Thank you, Kevin.

Bud Foshee, CFO

Thank you.

Operator, Operator

Our next question will come from William Wallace with Raymond James. Please go ahead.

William Wallace, Analyst

Thanks. Good evening, guys. So, Tom, in your prepared remarks, you mentioned crossing over $10 billion, which we generally assume comes with elevated costs around the compliance side of the business. You also mentioned that the pandemic helped you learn that the branch network is not as necessary, even for a branch-light network like yours. Can you talk a little bit about the push and pull of the potential cost pressures from going over $10 billion and what relief valves you may have on the branch side or whatever other areas there are? And then maybe just kind of help us think about where we end up the year from an expense perspective?

Tom Broughton, CEO

I will let Bud address most of the question, Wally. We are looking at branch rationalization. As we open new branches, we are going to always be asking where we can be more efficient. We think there are opportunities as leases come up. It takes a little bit of time, but we have got a couple of offices we think we can consolidate. We are consolidating one in the Atlantic region starting in March; it will be closed and that will add to our efficiency a little bit. But it’s going to be a noisy year because we are going through the system conversion and I will let Bud refer to that. In terms of your overall question of expenses on compliance, the regulators have really been working with us for several years on what we would need, so we don’t see an elevated expense from a compliance standpoint. We feel like we are pretty well staffed in that area. Really, on the system conversion, it will take place, and we will phase that in starting in February. So really, you have elevated costs from our current provider, because we are under a short-term agreement with them, and then the costs for the new system will only be there for a couple of months this year. So you will have elevated IT expenses this year, but we will have a lower IT expense next year with the new provider. I mean going back from client management, we are just not a consumer bank; I think that’s where a lot of banks have increased expenses as they crossed $10 billion and that’s something we don’t have to worry about from that side as far as staffing and infrastructure.

Bud Foshee, CFO

On the compliance side, the regulators have been collaborating with us for several years regarding our needs. Therefore, we don’t anticipate significant compliance-related expenses. We believe we have sufficient staffing in that area. As for the system conversion, it will begin in February. Currently, we are incurring higher costs from our existing provider due to a short-term agreement, and the expenses for the new system will only impact us for a couple of months this year. Consequently, there will be increased IT expenses this year, but we expect lower IT costs next year with the new provider. Reflecting on client management, we are not a consumer bank, which is where many banks have seen rising expenses as they surpass the $10 billion mark. This is not a concern for us in terms of staffing and infrastructure.

William Wallace, Analyst

Okay. And maybe just trying to put a bow on this; you did about, I don’t know, it’s like 8% or 9% growth in your expenses in 2020. Do you think that the growth is at that range in 2021 or is it above that, or do you think that you have got opportunities to slow that growth down?

Bud Foshee, CFO

I would say it’s still going to be in that range, mainly because of the elevated IT expenses.

William Wallace, Analyst

Okay. And then just one housekeeping question. I couldn’t find it anywhere else; I mean, it was probably somewhere, but what was the period-end PPP balance?

Bud Foshee, CFO

Oh! One second, $900 million.

William Wallace, Analyst

Okay. Thank you.

Tom Broughton, CEO

The balance, which you asked about, I didn’t hear that.

Bud Foshee, CFO

Yeah. Yeah.

William Wallace, Analyst

Yeah. Yeah. The ending year balance. I got the average. I just didn’t get any. Thank you, guys.

Tom Broughton, CEO

Thanks, Wallace.

Bud Foshee, CFO

Thank you.

Tom Broughton, CEO

Thank you, Wally.

Operator, Operator

This concludes our question-and-answer session, as well as our conference call for today. Thank you for attending today’s presentation. You may now disconnect.