ServisFirst Bancshares, Inc. (SFBS) Q2 2022 Earnings Report, Transcript and Summary

Greetings. Welcome to the ServisFirst Bancshares’ Second Quarter Earnings Call. [Operator Instructions] Please note, this conference is being recorded. I will now turn the conference over to your host, Davis Mange, Head of Investor Relations. Thank you. You may begin.

Good afternoon and welcome to our second 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. I will 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 will turn the call over to Tom.

Thank you, Davis and good afternoon and thank you for joining us on our second quarter call, I am going to – before Bud talks about the numbers, I am going to give a few highlights of the quarter. On the loan side, obviously, the loan growth was extremely strong in the quarter, excluding PPP loans, loans grew by $803 million in the quarter. One factor is there were really no payoffs in the quarter. And we expect those to accelerate in the third and fourth quarters, which will moderate the loan growth. We still see a strong pipeline of loans, but we do expect to be more offset with payoffs in the third and the fourth quarters. On the deposit side, we did see some runoff in the correspondent deposits that are making loans and buying securities, just like we are. And as well, our customers are experiencing very strong profitability. So they are – tax payments were up a good bit in March and April, above normal. So, that affected deposit levels as well. I think we will probably be back to more typical patterns of deposits, pre-pandemic for most of the bank’s history would see deposits decline in the first quarter, kind of be flat in the second quarter and then grow in the third and the fourth quarter of the year. Let’s go talk for a minute about loan quality. That seems to be absolutely that’s on everybody’s mind and we talk about it at our Board meetings and our management meetings, often, of course. With the prospect of a possible recession ahead, we are often asked about what we are seeing. First, Henry Abbott will talk in a minute about our loan quality, but our loan quality metrics are the best we’ve ever had as far as I can remember. So, we have been very – hopefully, we’ve been very proactive in loss recognition. We certainly won’t be proactive if we are facing a recession we want to be proactive in loan – loss recognition as quickly as possible. In terms of loan underwriting, I have had investors say if you changed your underwriting and the answer is no. We want to be consistent year in and year out. Good banks are very consistent on underwriting. They don’t change. They don’t blow with a win. When times are good and times are bad, they underwrite exactly the same way. And certainly, we stress test every loan that we make, we certainly do a stress test on it. And I think we have a good – a pretty good system and have a good track record of performance over the years. We do say we are a disciplined growth company that sets high standards for performance. I can assure you our credit team is looking for cracks on the economy. Henry and his group are constantly looking. On the C&I side, any of the problems that we see are people that just aren’t good business people. It’s not really because of any meltdown in one economic area, one type of business or the other. On the CRE side, the big question there is will cap rates move up as of now, but they really haven’t. The investors are looking for yield on high quality REIT-type products. I call it CD replacement investments in multifamily industrial and residential rental products. What really gives me ability to sleep well at night to an extent as we see strong migration continue into the southeast and I think it will offset some of the recessionary forces if we do experience a recession. Frankly, I don’t think a little bit of a slowdown would be all that bad for the economy. I got kind of spoiled the last couple of years when we are traveling and all the nicer hotels were pretty inexpensive. And now that’s not the case anymore. I am back in the less expensive hotels. So, I am kind of missing that. So we have a few hospitality operators, there are customers and they are reporting very strong occupancy and very high rates. So that wouldn’t be all bad to have a little bit of a slowdown there. In terms of talent, we added the most new bankers in a quarter we have ever added, 15 in the quarter. We think we brought in some top talent into our company. If I had to say what I think is one of the strengths of our company is that we have not had any turnover in senior leadership in our banks in our regions over the last 17 years. We have had a few retirements, but we have not had any turnover and we have had very loyal executive team in the bank. We do want to be the best place for a commercial banker to be. I think an absence of bureaucracy at our company is attractive to many bankers as well. So, I will stop there and let Bud cover some of the financial aspects. Bud?

Thanks, Tom. Good afternoon. Liquidity, we will continue to evaluate our monthly investment purchase plan based on the bank’s excess funds. Net investment security growth in the second quarter was $172 million. In mid-June, we decided to suspend investment purchases based on our strong loan growth. Net interest margin, as Tom mentioned, loan growth, exclusive of PPP forgiveness was $803 million for the second quarter. Average loans, exclusive of PPP, increased by $650 million. Average PPP loans decreased by $108 million. So, we had net average loan growth of $542 million in the second quarter. PPP fees and interest income were $2.9 million in the second quarter compared to $10.2 million in the second quarter of 2021 and the remaining PPP fees are $513,000. Net loans grew by $97 million the last few days of the quarter. This increased our loan loss provision, but we will not receive the positive net interest income impact until next quarter. Deposits decreased by $637 million in the second quarter, $532 million of this decrease related to correspondent banks. Fed funds purchase decreased by $250 million in the second quarter. Our margin has gradually improved each month. Starting in January, it was 2.84%, increased to 2.91%, increased to 2.97% and 3.04% and 3.28% in May, and then June was 3.43%. The bank received a positive net interest margin impact from the Fed rate increases in May and June. For future Fed rate increases, correspondent interest-bearing accounts will have a 100% beta, which is just part of the business. For the remaining interest-bearing DDAs, we anticipate a deposit beta of 30% to 35%. Loan loss provision, our provision increased by $4.2 million in the second quarter as our loan production, excluding PPP, increased by $314 million for the first quarter. Non-interest income, credit card income continues to grow. It was $2.7 million in the second quarter versus $1.9 million in the second quarter of 2021. Spend was $264 million in 2022 versus $226 million in ‘21. We recorded a write-up in value of $2.1 million for the quarter on a LIBOR cap we purchased in 2020. Non-interest expenses. First, salaries and benefits, as a result of our market expansions, total salaries increased by $732,000 in the second quarter and by $1.9 million year-over-year. Total salaries and benefits increased $2.4 million during the second quarter and by $6.6 million year-over-year. Second quarter 2022 incentive expense was $6.2 million versus $4.5 million for the first quarter of 2022. The increase reflects loan growth, strong core relationship growth and entry into new markets. Tax credits. Year-to-date investment write-down related to tax credits was $5 million in 2022 versus $173,000 in 2021. This increase was more than offset by an income tax reduction of $6.6 million. Correspondent banks, the year-to-date correspondent bank service charges increased by $3 million. The number of settlement banks increased from 111 in June of ‘21 to 164 June of 2022. That concludes my remarks, and I’ll turn it over to Henry.

Thank you, Bud. The bank saw record loan growth in the second quarter of 29% annualized as Tom and Bud previously mentioned. The loan growth was strong in each of our regional banks and the bulk of this growth was centered around commercial real estate. With this loan growth, our credit quality continues to be incredibly strong and in line with prior trends in the post-COVID PPP environment. I’m pleased to say that annualized net charge-offs and OREO expense for the quarter were only 2 basis points, which is down from the first quarter of 2022 at 11 basis points and the fourth quarter of 2021 at 3 basis points. Of the roughly $1.8 million in charge-offs, around 60% of the expense was related to one specific credit that we had previously impaired. The net credit expense figure was aided by roughly $1.2 million in recoveries which was primarily driven by one credit we aggressively wrote down last quarter but had significantly better-than-expected results in liquidating the remaining assets of the operating company. We continue to be well-positioned with our loan loss reserve of 1.21%, which is consistent with the prior quarter and slightly down from 1.22% that we had in the fourth quarter of 2021. From a dollar perspective, we did grow our loan loss reserve by $8.9 million in the second quarter. This increase was not related to a reserve on any one specific credit but rather the growth of our loan portfolio as a whole. Past due to total loans were 10 basis points, which is in line with the first quarter of 2022 and continues to be near record lows. As I mentioned on the call last quarter, I don’t expect ServisFirst or banks in general to be able to maintain the record-setting pristine credit quality we have seen over the past year forever, but we have yet to see a rise in key credit metrics. Past due loans are a very simple but good early warning indicator and they continue to be very minimal. Nonperforming assets were $16.7 million for the quarter versus $21.4 million for the prior quarter. This figure equates to 15 basis points of NPLs to total loans, which is a 25% decrease from the prior quarter as well as the same period a year ago when we had 20 basis points of NPLs to total loans for each of those quarters, respectively. In the face of rising interest rates, rising inflation, the loan portfolio continues to perform very well, and I’m pleased with the second quarter results. With that, I’ll pass it back to Tom.

Thank you, Henry. For the remainder of the year, we’re going to focus on growing core relationships in the bank. In the past 2 years, after the pandemic hit, we did – we obviously experienced a large deposit surge and loan growth was pretty minimal during that period, and we did book some transactional loans during the pandemic just like we did in the 2009 to 2011 period when we had large – back then, we had large deposit inflows and loan demand was very weak. So we did some transactional loans that we probably won’t do going forward. So we will look for deposits where we have significant deposit relationships as well as loans for the remainder of the year. So with that, we will be happy to answer any questions you might have about the quarter.

Thank you. [Operator Instructions] Our first question comes from the line of Brad Milsaps with Piper Sandler. Please proceed with your question.

Hey, good afternoon.

Good afternoon, Brad.

Tom, maybe I wanted to start with loan growth. Obviously, another really strong quarter. It sounds like 15 new lending hires, which is certainly a plus. Maybe on the negative side, you’ve got some – you talked about some pay-downs that you expect to come. I think at the beginning of the year, you set out a goal of growing about $1.2 billion. You’re already there. Can you just kind of talk a little bit more about sort of what a pullback looks like in your eyes? I mean, you’ve got some of the best growth metrics out there. Just kind of wanted to understand if we could frame that a little bit better, sort of kind of what a pullback in growth for you guys might mean.

It’s sort of hard to give a good answer – a very accurate answer, Brad, rather than we are going to be very selective in what we book. But obviously, $150,000 a month is probably – we will probably look at something north of $150,000 a month on average in terms of where we’re going, net growth. So I wouldn’t change that estimate yet. The $150,000 a month, I think, is a good number net of pay down. We still – like I said, we do have some construction paydowns that we know are coming over the next two quarters. So I can’t really get a whole lot more accurate than that. I don’t think, Brad.

Sure. No, that’s helpful. And maybe just kind of as a follow-up to Bud, as you kind of think about the size of the balance sheet, I know you talked about stopping the securities purchases. I know it’s tough to gauge. But do you have a sense where your deposit balances might sort of floor out? Just wanted to kind of think about or how to think better about the liquidity that you have remaining? And how best to think about that – how that might be deployed as you move through the back half of the year?

So you’re asking what you think will grow deposits by each month. Is that right, the first part of?

Yes. Or just if you’re thinking about the correspondent book, you had some runoff this quarter. I think average liquidity was down about $1.2 billion or so just kind of thinking about kind of where that number is headed as you move through the year? It sounds like you stopped buying bonds. Thomas talked about the loan growth. Just kind of curious if you could think about a floor for the liquidity?

Well, from a regulatory standpoint, we have – the excess funds has to be above 5% of total assets. So that’s about $750 million now. We’re not going to get to that point, but that’s kind of what we look at, what we have to shoot for to be well above that. We’re about $1.4 billion today. So just with a big drop over the second quarter with side, we wouldn’t buy any more securities. You’ll have the paydowns that you’ll have as liquidity during the month. Correspondent, I don’t know it’s – Rod, have you got...

Brad, this is Rodney Rushing. And in the second and third quarters of last year, we had just unbelievable growth. I mean there was a balloon of new correspondent deposits. Their liquidity was coming in like ours. And when you have over 300 community banks that have accounts with you, we were taking that liquidity. End of the second quarter of ‘21, total correspondent balances, that’s all Fed Funds, DDA, everything was $2.4 billion. In one quarter, we went to $3.6 billion. And then by year-end, it grew another $300 million to $3.9 billion. And we’ve seen that run down about $800 million this year and that has slowed tremendously. In that same period of time, we grew the number of correspondent banks from 316 to just shy of 350, I think it was 344. And if you look back a year, the end of the second quarter of ‘21 to today, correspondent balances are up $580 million. So, if you look at the past year, balance is up almost $600 million in correspondent banking. That shows how much that balloon in that liquidity from all the banks provided. And that was from the stainless money, and some of it was from us adding seven banks. We do a lot of things in correspondent banks, credit products, agent credit card program. But we consider if a community bank, if we are their settlement point, if they are settling their cash ladder through us at the Fed, we are helping with their cash position, and we consider them a – we are their primary correspondent then. We grew settlement banks. So far – for the year, it was over 50, I think it was 53 banks. So, those provided some increased deposits in the DDA account using compensating balance to pay their Fed bill. So, I hope that answers your question. If I confuse you, I will try to correct that. Did that help?

No, no. Yes, that’s very helpful. Thank you guys very much. I will hop back in the queue.

Thanks Brad.

Our next question comes from the line of Kevin Fitzsimmons with D.A. Davidson. Please proceed with your question.

Hey. Good afternoon guys. How are you?

Fine Kevin.

Maybe we could shift gears and talk about expenses. A lot of moving parts in there and thank you for all the detail. That’s very helpful. So, when we – maybe like a very top-level way of asking it is like if we look at a run rate, I think it’s like $39.8 million this quarter. How to think of that going forward? Now, I recognize that we have new markets going into and all the new lenders and the expenses come day one with that and the resulting revenues will come over time. You also talked about the processing revenues. And I just want to – on this issue, I just want to distinguish the additional processing expenses you are referring to is really just because you are getting ready for the conversion. So, you are kind of dual or duplicate kind of expenses and some – maybe remind us when some of that will go away. But I want to distinguish that from I believe last quarter, you talked about like $874,000 in expenses, which I treated as like kind of one-timer because that seemed like it was not core, but related to the actual de-conversion, I believe, is what you use. So, that’s a lot of different details, but all related to expenses and take it, however, you would like to Tom and Bud. Thanks.

Yes. Hi Ken. So, one, we made the additional incentive accrual of $1.8 million in the second quarter. Right now, we wouldn’t anticipate doing anything additional in the third quarter and what is – we will see how that shakes out in the fourth quarter. So, right, you can really take the $1.8 million out. That was an adjustment in the second quarter. For the core conversion that will take place in February of ‘23 TSYS except for purchase cards will convert in, September?

September.

Of this year. And then the remainder will be in 2023. We might have some smaller de-conversion expenses. I don’t see anything major that would really impact the quarter going forward. But I guess the biggest thing is taking out the additional incentive accrual in the second quarter numbers. Hopefully that helps. I think I had all of it covered.

Yes. That’s very helpful. And then, Tom, maybe we could talk about new markets. So, just in the last number of months, you guys have entered Metro Charlotte, Tallahassee and now most recently, Nashville got announced. And wondering if you can just give us a sense on what innings you are in on those. Obviously, ASCO would be very, very, very early. But like what inning in the expansion, you are? And then what are the prospects of new markets? Do you look at that number of markets and say, alright, that’s good for a while, let those season, or is it totally based on availability of folks? Thanks.

Yes. A lot of it’s availability, but we will go 3 years without adding a new reach. We have done that before because we just can’t find good people. And so it’s rare to find this many good people at one time. Very, very unusual to find. So, I would think that the Tallahassee is fairly well staffed. That’s a pretty good-sized group there. Nashville is not going to be huge. It’s not going to be a huge group. We are still staffing in the Piedmont region, Greater Charlotte area. We call it the Piedmont region. So – but we are going to be selective in the people we look for everywhere. So, it’s hard to give you a good answer, but just all these mergers have led to unusual supply of people looking for a new home and that is a good thing. And so the more mergers there are – I think mergers we all know kind of slowed down this year, right. So, things that it slowed down a bit perhaps going forward. So, I would anticipate it would tail off for a while, Kevin. But we are always looking for the right people to have core relationships and are not transactional lenders and have deposit customers as well as loan customers.

Okay. Great. Thanks very much.

Thank you.

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

Yes. Good evening gentlemen.

Hi Dave. Good evening.

Tom, just curious, you noted the nice margin expansion, obviously, loans as a percent of earning assets to creep up. But I am curious with the Fed aggressively raising rates here. Are you able to pass – what’s your success rate I guess, in terms of how much of that climb in interest rates are you able to pass on to the bar, or are you seeing risk premiums adjust? I guess are you getting paid for potentially higher risk within the market if we do enter a recession, be it mild or strong? Just curious what you are seeing in terms of loan pricing across your markets.

I think we have seen up until the last 60 days, perhaps we have seen some irrational loan pricing out in the market. I think that’s much more rational today in terms of what we are seeing from our competitors. They are doing a little bit better in terms of what they are doing. But we have to do what we have to do, and we don’t try to pay attention to what other – our competitors are doing in terms. But certainly, when you have strong loan growth, we are lot much better positioned to pick and choose sort of our – the customers we choose to do business with today. So, we would rather be in a position where we have stronger loan demand than deposit demand, right. It’s the best position for a bank to be in. It’s the best position to increase margin and improve profitability. So, I don’t know – go ahead, Bud. Bud do you want to – you ask about interest rate sensitivity, Dave. Was that part of the question or no?

Yes. Just curious, I mean in terms of what you have seen just in terms of spread and then maybe an additional question. I think I heard in the preamble, you do expect some second half deposit growth. It sounds like there has been some seasonality, but you do expect some back half funding growth on the deposit side.

Yes, we do. We will focus more on the second half of the year. We have been focused on it for 2.25 years. We will focus on it now.

Got it. Appreciate the color.

Thank you, Dave.

Thank you. Ladies and gentlemen, we have reached the end of the question-and-answer session. This does conclude today’s conference, and you may disconnect your lines at this time. We thank you for your participation.