ServisFirst Bancshares, Inc. (SFBS) Q3 2023 Earnings Report, Transcript and Summary

Greetings and welcome to the ServisFirst Bancshares Third 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. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce you to our host, Davis Mange, Director of Investor Relations. Thank you, Davis. You may begin.

Good afternoon and welcome to our third quarter earnings call. We'll have Tom Broughton, our CEO; Rodney Rushing, our Chief Operating Officer; Henry Abbott, our Chief Credit Officer; and Bud Foshee, our CFO, covering some highlights from the quarter and then we'll take your questions. 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 us for our calls where we review the third quarter. I thought I'd start by reviewing the current economic outlook. Going back to late spring, the conventional wisdom, which included mine, was that we were pretty much headed for a hard economic landing. A bunch of that outlook was due to -- we'd seen rapid escalation in interest rates, we've seen bank deposits disintermediation for over close to a year at that point. And then we'd see credit tightening by most banks. You know, the demand for goods and services continues to be amazing. The consumer appears to be very resilient. Like, they're sort of hooked on living large, it seems, since the pandemic started. They were buying stuff when they were stuck at home, and now they're consuming stuff. So, it seems like we're in a little bit better spot than we've been in. We have seen a slowdown in demand for credit, both CRE and C&I. It's probably a combination of borrower caution and higher interest rates. I was with a customer last week and, he said the best way I can make $16 million is to pay down $200 million of debt at 0.8%. He said, that's the best way for me to improve my earnings. I'm not going to buy any more capital goods. So I think that's probably a prevailing thought. I know our bank and others are watching for late cycle credit cracks. Henry Abbott will discuss a little bit more in a few minutes on the credit side. We don't run our bank based on any kind of economic forecast, because they're all wrong. But it does appear we are headed for more of a soft landing than we envisioned a few months ago. The recent disinversion of the yield curve will be helpful to us as we move towards a normal yield curve and really the higher for longer rate environment we think benefits us, our future earnings for the bank. So that's sort of a brief overlook of where we are. And I’ll get down into a little more granular information here. Start talking about deposits. We have focused on building core deposits over the last four quarters. We've seen really fantastic results. Our people have done an outstanding job, they've done what we've asked them to do. And very few banks can demonstrate the deposit growth we've seen combined with zero federal home loan bank advances and zero broker deposits. Our municipal clients have received significant COVID funding this year. It'll take a bit of time for that to be spent. The most COVID funds I know have to be committed by the end of 2024 and spent by the end of 2026. But I do have faith that most politicians can spend it more quickly than that. Our deposit pipeline is down a bit from the record level last quarter. We are looking for, it's still strong, we're looking for granular new relationships that are sticky. On the correspondent side, Rodney Rushing will give an update in a few minutes when I finish. Our total new accounts are up 19% year-over-year, while our commercial accounts are up 20% year-over-year. This is indicative of broad-based deposit growth, which is what we wanted. We think our emphasis on deposit growth over current liquidity will set the stage for improved profitability in 2024. We're seeing cash on hand stay consistently at the $2 billion level in October. We are pleased to have built this liquidity of this level during the industry disruption we've seen. While it may reduce the net interest margin, it does not affect net interest income. So, very pleased with the deposit situation. Talk a little bit about loan demand. We did turn the loan [spigot] (ph) back on a few months ago and it started with a trickle as it always does after you shut off the tap. Our loan pipeline today is up 74% over the prior quarter. And though it's not back to levels from early 2022, it is back to late 2022 levels. We have seen increased activity in the past 30 days, and we also -- as loans grew $87 million in the month of September, we are seeing increased confidence by borrowers, both C&I and CRE. Our liquidity position we think gives us a significant competitive advantage in the industry. On the production side, we previously announced we added a great new team of bankers in the Montgomery region, four new bankers there. We had a total of five in the quarter. From a headcount standpoint, we were down three for the quarter. We are focused on adding the right people and right size in our team this year. We think that'll be certainly coming to an end as we go towards the end of the year and we'll have the right group here. We will open our new Lake Norman office in the Piedmont region soon and it'll be a community banking office that's very similar to the offices in Tallahassee, Panama City, and Asheville, North Carolina. These community banking offices do produce good, granular, and sticky deposits and have improved margins. So with that, I'll turn it over to Rodney to discuss the correspondence side.

Thank you, Tom. Correspondent banking had a strong deposit rebound, closing the quarter with total fundings just over $2 billion. Our deposit growth at September 30 was 12.3% for the quarter. Most of that increase came from Tennessee and our new Texas market expansion with just over $275 million in new deposit relationships coming from those markets. I need to also mention or remind you that correspondent balances are not hot or temporary funding sources, as our rates paid are market rates, not rate specials. 70% of all correspondent balances are tied to settlement relationships with these downstream banks. The division is well diversified in both correspondent bank sizes and geographies. Seven new bank relationships were opened during the quarter in five different states. Correspondent participation loans and new relationship pipelines are strong for the remainder of the year and also into 2024. Our Correspondent Agent Bank Credit Card program has 15 new banks in our pipeline that are in various stages of the sales process. There are three new state banking associations reviewing our American Bankers endorsed Agent Credit Card program to determine if they would like to participate. We currently have nine state endorsements at this time. This has expanded our reach and as the existing pipeline includes banks in Connecticut, Virginia, Texas, Georgia, Montana, Missouri, and New York, just an example of how wide that market has grown. Correspondent Deposits and Fundings in summary; correspondent balances stabilized in the early second quarter and we had impressive strong growth, as you can see, for the third quarter. And with that, I'll turn it over to Henry Abbott, our Chief Credit Officer.

Thank you, Rodney. ServisFirst had a very strong third quarter, and we're pleased with the Bank's results. Past due loans to total loans were down to only 8 basis points. This represents 45% reduction from the second quarter and a 50% drop from the first quarter. Our asset quality continues to remain strong. Now, I'm pleased to say, non-performing assets to total assets decreased from 16 basis points in the second quarter to only 15 basis points in the third quarter. With the current economic outlook, the bank felt it appropriate to maintain its ALLL to total loans of 1.31%, which is consistent with the prior quarter. AD&C as a percentage of risk-based capital was 91% at the end of the third quarter and income-producing CRE and AD&C to risk-based capital was 312%. Both of these figures are down from when we started 2023. We had no material downgrades to the watchlist in our CRE portfolio and we continue to focus on and monitor our AD&C bucket. We also review and stress our entire CRE portfolio via both internal and external sources. We use an industry leader in commercial real estate, data, and analytics to help provide stress testing in real-time data on the portfolio. As a reminder, our CRE exposure is primarily in the Southeast, which continues to remain one of the strongest areas and we have no material downtown urban office exposure. Charge-offs for the quarter were 15 basis points when annualized and year-to-date annualized charge-offs were only 11 basis points. Charge-offs for the quarter were not related to income-producing CRE or any SNCs. I know those are items of interest and impacted the charge-offs at some of our peer banks. We continue to feel very good about our diverse and granular loan portfolio and outperformance in the third quarter. With that, I'll hand it over to Bud Foshee.

Thank you, Henry. Good afternoon. We're very pleased with the progress the Bank has made in the third quarter with deposit growth, liquidity, capital, and improving loan pipelines. Our non-interest-bearing deposits were stable in the third quarter with the exception of $100 million in deposit run-off related to COVID times. We were pleased with the total deposit growth of $854 million in the quarter. We saw loans grow in the quarter after several quarters of decline or flat. The key to improving EPS is loan growth and our team is focused on a more balanced approach to loan and deposit growth going forward. We had a goal of $1 billion in liquidity and we have exceeded that goal with $2 billion at quarter end. Our loan repricing initiative will contribute to market expansion later in the year. Examples of our repricing effort; $390 million of loans for the REIT has been restructured, loans paid off early $104 million, we have $188 million pending in loan repricing. Loan repricing is the best opportunity to improve profitability combined with loan growth. Loans that repriced or paid off in the third quarter were $276 million, which combined with loan pay-downs on fixed-rate loans totals to $2 billion on an annualized run rate. Cumulative effects of this repricing will improve margin and EPS over time. Net interest margin stabilized in the third quarter, a $100 million in the third quarter versus $101 million in the second quarter; 89% of our new loans are floating rate and about 41% of total loans are floating rate today. Our adjusted loan-to-deposit ratio at September 30, 2023 was 80.5%. This ratio includes the correspondent fed funds purchase. We saw improvement in core non-interest income in the quarter with improvements in both credit card and mortgage. We expect continued improvement over the balance of the year. As a reminder, the second quarter non-interest income included a death benefit of $890,000. Discussing non-interest expense, we have made an effort to hold the line on expense growth in 2023. We have experienced increases in non-core expenses. Problem credit, which was primarily legal expenses related to credits, check fraud and credit card fraud. And we had one case of $600,000 in credit card fraud. These items increased $1.4 million from the first quarter of 2023. We also experienced an increase in FDIC insurance $825,000 from the first quarter. We have built our staffing and our new offices and do not expect additional head count for any existing offices. Our teams are performing quite well and have grown new accounts 90% year-over-year. We continued our growth in book value per share, our CET1 ratio was 10.69% and our Tier-1 leverage ratio was 9.35%. Our capital continues to be a strength. That concludes my remarks and I'll turn the program back over to Tom.

Thank you, Bud. You know, if we made a list of the 20 most important metrics [indiscernible] buying, we are performing extremely well on almost all of those, except for the one that's the most important, which is earnings per share. We've got to get our earnings back up to where they were, it's going to take a few quarters we think, but we will get there. So, we think our performance in all those other metrics will lead to improved earnings per share in the future. So, we will open it up now for now for questions. I will be glad to see what you have on your mind.

Thank you. We’ll now be conducting a question-and-answer session. [Operator Instructions] Thank you. Our first question comes from Kevin Fitzsimmons with D.A. Davidson. Please proceed with your question.

Hey guys, good afternoon.

Hey, Kevin.

I'm just trying to, I know there's a number of contributors to your -- to the margin, but I'm just trying to unpack. I think when we ran the last conference call, we talked about the NIM may be stabilizing in the third quarter and then beginning to expand in the fourth quarter and there is -- there is -- it looks like there's maybe a couple contributors here and maybe you can kind of go through them in terms of what contributed. So, it looks like on the one hand, you talked about repricing the loans and maybe that's going to help earnings in the future, but it seems like that might have led to less substantial loan growth than you might have had otherwise and then, coupled with pay-downs. On the funding side, you had a very successful quarter growing deposits and building up that liquidity. But I guess it comes at a cost to that ratio. And I know you don't talk about not necessarily managing to that ratio, but - and then the loan to deposit ratio, looks like it came into and -- so, I'm just trying to like weigh all those with the increased funding, was that exceeding that goal of $1 billion to $2 billion, was that more a byproduct of just the movement you saw in the correspondent network and elsewhere, or was it a deliberate aim? Because most banks are talking about, I'm not sure if you guys put it this way, but really loan growth being governed by the pace of deposit growth and in this case, we saw a big, big delta between deposit growth and loan growth. So I know that's a lot. But I just wanted to set up on helping us understand where the margin goes from here. Thanks.

Yeah, I'll probably [indiscernible] Bud will have to give you some actual numbers, but my take on it is that the improvement in loan repricing is been swallowed up by deposit repricing to this point in time. So, that's why you haven't seen the margin improve, yes, because of that. If we think the rate increases are behind us, then it stabilizes from this point forward pretty well as we reprice loans more of that will start to flow into net income instead of flow into repriced deposits. So that's the first thing, I think and, of course, we had no ideal of deposits, we asked our people 15 months ago to focus solely on growing deposits, our incentive plan is skewed almost a 100% of that for the year 2023. So, you probably heard me say people do what you incent them to do, and they've done what we incented them to do. They've grown deposits. So, now we've actually gone back and -- for the last three months of the year, we are putting in a special incentive to grow loans from October 15 to January 15 to have an incentive to grow loans about a fair amount of money to try to get the loan pipeline restarted. But I guess -- but I don't know, obviously, when you add that much in deposits [indiscernible] it does not do anything to help the net interest margin at all. But that wasn't the point. It doesn't hurt the net interest income and that's -- we think showing liquidity today, we will start rationalizing deposit costs as we go forward. We had a call with our regional executives couple of weeks ago and we're starting to try to rationalize some of that call because we're in a pretty good spot. And we think -- again, we think having all this excess liquidity is a significant competitive advantage with our -- in the industry. Well, I probably didn't answer your question, Kevin.

No, that was helpful, Tom. I just -- I guess -- I know there's a lot of moving parts to it. But do you guys feel like that, it sounds like you're overshot -- not overshot, but I mean, it's never -- you can never have too much of it. But is it -- and it's just one quarter, but do you feel --assuming the Fed is mostly done here do you feel we're getting closer to that ratio. stabilizing and then maybe speed up to expand in 2024 is that what you would suspect?

Yes, we mentioned that our municipal clients have had big liquidity and these are existing customers. We're not -- they are core relationships. We're not out bidding out money with municipalities. In fact, we're not bidding on money with municipalities, we're not going to do that. These are core relationships at some reasonable price, it doesn't leave you a lot of profit when you put and get the money to the [indiscernible], but nevertheless, we're not going to tell a good client, we won't take their money, so that's -- that's the bottom line, they're not -- there's not -- again, we don't have any -- we don't have any brokered deposits and we don't have any home loan bank advances. So, we are in really kind of a spot, I don't think most of the industry would trade places with they could.

And Tom, just on loan growth, typically you guys have seen more back half of the year heavy in loan growth if I recall correctly and it's sort of gains momentum over the course of the year. And so, on the one hand you mentioned that a lot of customers are looking to pay down debt, there is the impact of rates, there is the impact of you guys being tightening standards and -- but on the other hand you cited, if I heard it correct, a big increase in the loan pipeline. And last quarter you were -- it seems like much more optimistic on the economy. So, do you feel like loan growth is just going to grind higher at this point, not necessarily in leaps and bounds?

Yeah. We do now. Again, like I said, our loans grew $87 million in the month of September, we've seen a lot of activity just in the last 30 days. It seems like we've seen things really pick-up, borrowers are getting a little bit more confidence in the economy and starting with projects in both C&I and CRE. So -- and again we're being a little bit more creative when trying to find sources of loan demand right now, Kevin, and I think that's what we had to do after 2008, 2009, and 2010 after the -- people weren't buying boats and airplanes during that year at a time, and we had to draw to finance operating equipment for trucking companies and things that we're still growing and doing well. So that's what we're trying to do this time. We just had to be more creative in finding the loan demand out there, than you do when times are really good.

Right. Okay, all right. Well, thank you very much and I'll hop out and let others hop in. Thanks.

Thanks, Kevin.

Thank you. Our next question comes from Steve Moss with Raymond James. Please proceed with your question.

Good afternoon.

Hi, Steve.

Tom, you spoke about the loan pipeline improving here just kind of curious, what is the rate you're seeing these days and kind of hearing you say $87 million of growth in September, it kind of feels like, hey we will see a decent step-up in growth for the fourth quarter on loans?

Go ahead, Bud.

Yes, we think that loans can increase, the rate that new loans went on during September was 8.35%. So, we feel likely to be that or above. And like Tom said, we put in an extra incentive for loans in the fourth quarter. So, we expect loans to increase. I mean, fourth quarter is always our best quarter.

Steve, what I can't project is, what kind of payoffs we're going to pay-up and then when I am looking Henry Abbott, if we've got -- if a multifamily developer is looking at going to permanent financing with Fannie Mae, I mean, their rates going up. But it's still less than what we're charging them. I think they might pay 6 at Fannie, but they're going to pay us -- they're paying us 0.25 -- 8.5, so there is a -- that is what I can't predict, Steve.

Great. And then maybe just curious in terms of the underlying mix in the pipeline. Is that a little more weighted towards CRE and construction these days or is there a healthy C&I component, just kind of curious [Technical Difficulty] business mix is?.

Yeah, I mean I think -- I think it's a mix. I mean, we're seeing a lot of AD&C opportunities, but at the same time, we know we've got a limited bucket. So we're being more selective on those and obviously trying to point our incentive and our folks to go after C&I opportunities and that is certainly what we're looking for and striving for.

Yes. We think we need -- we think we need to, kind of, stay on to that 100% AD&C exposure level that seems to be a bright line with -- it might become more of a bright line with the regulators, we're not sure but that was our though on that.

Okay. And then just in terms of thinking about the liquidity on balance sheet here. You guys achieved the goal of having $1 billion on balance sheet. Curious, let's just say there is a healthy step-up in loan growth, and it is may be sustained for next quarter or two, are you willing to dip below that $1 billion of liquidity or kind of how do we think about funding loan growth, it will be more buy deposits or existing liquidity?

Yeah. We've got $2 billion in cash is fair today and I guess we've got some short-term treasuries that are about $250 million, Bud?

We do.

So, you say, we got [$250 million] (ph), we really think that of that we can put $1.5 billion probably into the loan bucket over time. Now, again, some of these municipal deposits are going. Again they're going to spend it, politicians always find a way to spend money as you know. So, it'll burn a hole in their pocket a bit. Then it will take a couple years to mark some of it off and we will replace it by the end with other -- with other deposits, but right now we feel good about where we are -- we just again are actively looking for the right. We're still being careful on loans. I mean, we're not really talking to -- we're trying to talk to the people we've always done business with rather than somebody that just walked in the door.

Got it. One last one for me here, just on the reserve ratio, you guys have built it up for a number of quarters, this quarter kind of flat. Just curious, was this kind of as high as it can go in terms of what -- maybe the auditors are comfortable with or is there any -- are you guys just more comfortable with credit and hence the reserve ratio is not quite enough of as much.

Well, I think the primary driver as Tom mentioned in his remarks was kind of the economic outlook improved over the past two or three quarters. So I mean, that's where we were able to maintain, where we are. It just depends on kind of the key drivers being unemployment and GDP are going to impact the model and the outlook on those.

Yes. Unfortunately, there's a limit on what you can, -- I think bankers by nature would have a much higher loan loss reserve if we were left to our own desires. We're not. But the CECL models are -- they can switch or change over time as you well know.

Right. Okay. Appreciate all the color and I'll step back. Thanks guys.

Thank you.

Thank you. Our next question comes from Graham Rick with Piper Sandler. Please proceed with your question.

Hey, good evening guys.

Hey, Graham.

I just wanted to circle back with something you just touched on is that $1.5 billion number of deployment into loans. What's sort of the ideal time horizon for achieving that?

[Multiple Speakers] You know, I mean -- at this point, I don't know. I just don't know how quickly we can get the loans on the books and I don't know what will pay off. Our loan pipeline is pretty robust. But it's nothing like $1.5 billion, I can tell you that. So that is a -- that is a $64,000 question which is -- you weren't born when a $64,000 question came about, Graham, but Google it sometime.

Okay, fair enough. Fair enough. Okay. So then I guess, I wanted to just talk a little bit more about deposits as it relates to the pipeline, you mentioned that the pipeline is smaller than it was last quarter now. Can you just provide what the pipeline was heading into 3Q and then also what it was heading into 4Q?

Yes, it's not a scientific number and we don't ever discuss it, but let's see -- probably down -- probably down a couple of hundred million dollars from last quarter, Graham.

Okay.

So we put it on the books, so we got it on the books. So -- and again, we're trying to rationalize deposit costs now, as time starts, improving profitability, we got to be a little bit smarter about it.

Okay. And then on that front with deposit costs, I mean, it seems like most of the growth has been in money market recently. And I guess most of that's probably fully indexed and floating rate. So, as you start to adjust your strategy on the deposit pipeline and pricing perspective, what does that sort of look like for you guys? Is it saying like no more index money market, and just time at a rate below Fed funds or how do you guys kind of approach that from here I guess?

Well, it depends on what as a percent of -- as a percent of Fed funds, what is the rate, you know is it, you know, 100% of Fed fund you are interested in some percentage of Fed fund. So that -- you've got to have some margin and what -- you will at least have some margin what you leave sitting at the Fed, because we got a lot of cash sitting in the Fed right now. Of course, the other question is, when do you start buying securities and we got about securities again someday, but given we've got so much -- we don't -- we want little bit more floating rate assets on the book, so we're hesitant to move into longer term, when I say longer-term, I say two to five-year treasuries. So that's -- you might be smart and start doing it now, but we're not going to be smart, because we're not going to do it now. So we're just waiting on that, but again, we don't have to [indiscernible] it someday.

Yep. Understood. And I guess just one more follow-up on the deposit front and the costs. So, that money market piece, correct me if I am wrong, that's like that's fully floating, right? So, there's not a lot of -- there's no maturities that thing or any, I guess exception pricing within that segment that's going to cause that to have any further catch up. So for example if we get no more rate hikes it's probably going to stick around 4.25% on cost, right.

We think so, Graham.

All right, that's helpful. That's all I had. Thanks guys.

Thank you.

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

Hey, good evening, gentlemen, how are you?

Good, Dave, from Hovde Group.

Yes, thank you for clarifying that. Hey, Tom, you noted the revamp of the incentive plans, obviously they were very successful on the funding side this quarter. From an operating expense standpoint, does that imply maybe an acceleration of operating expenses into the last quarter of the year and how should we think maybe about expense growth into the next year?

Now we've already caught up, we accrued more than the third -- a good bit more in the third quarter, Dave, I don't know the exact number. Bud has got it over there, but we're going to accrue more in the third and the fourth quarter to account for that. So, we've already started doing that, because they have -- we have been wildly successful at raising deposits and they've done -- they done what we asked them to do.

Got it. And then circling back to the liquidity and maybe securities, outlook here and then maybe answer that last question or so, but there's been a lot of chatter and I think you even noted, we're probably higher for longer scenario economic outlook here, interest rate outlook moving forward, is there a potential to potentially restructure the securities portfolio and maybe, I don't know, sell off some of the lower yielding stuff, pay off some of the borrowings to improve the margin and profitability. Just curious how we should think about that?

Hey, Dave, it's Bud. I don't see us selling anything. I think will continue to buy, if we buy, we will buy treasury short-term, six months to a year. It just takes a long time to actually pay it back and earn money, I don't know, just something we don't want to do. We'd rather just hold it to maturity.

And what if rates drop, I mean, problem is my salesman can always show you a Bloomberg run that shows that makes you a lot of money to reposition securities.

Got it. Now understood, understood. And then, a housekeeping question, I guess maybe for Bud, good tax rate to assume moving forward, it looks like there were some lower than trend tax rate this quarter, curious how should we think about next quarter and into 2024?

Yeah, I would say 18% would be a good rate for the fourth quarter.

18%.

18. Yes.

Got it. Great, thank you.

Thank you. There are no further questions at this time. I'd like to turn the floor back over to management for closing comments.

Thanks. I think we're done. Thank you everybody for joining us.

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