ServisFirst Bancshares, Inc. (SFBS) Earnings Call Transcript & Summary

Greetings, and welcome to the ServisFirst Bancshares First Quarter Earnings Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Davis Mange, Director of Investor Relations.

Good afternoon, and welcome to our first quarter earnings call. We will 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, and good afternoon to everybody. Thank you for joining us on the call. The year is off to a great start with the first quarter as we'll review for you over the next few minutes, and we have various reports from our various management people. We've always done well in times of stress in the banking industry. We did after the '08-'09 recession, and we certainly did during the pandemic. The bank has experienced significant growth during those periods of time. And we do expect significant opportunities, again, during this time, a little bit of dislocation in the industry. So you're asking why do we do well during times like this? One thing, there are several reasons. First is our business model has changed in over 18 years since we opened 18 years ago. We are well capitalized. We're financially stable and we retain 75% of our net income to fund our growth and increasing capital. We do have an industry-leading efficiency ratio, and we're highly profitable. We have very strong credit quality. Henry is going to talk about this in more detail in a few minutes. We don't have any broker deposits for Federal Home Loan Bank advances like many of our competitors. So in summary, our bank is built for times like this, and we'll demonstrate that to you during the course of the call this afternoon. I was going to talk a few minutes about our most recent expansions in our community banking offices, which are in -- our newest ones were in Nashville, North Carolina, and Panama City and Tallahassee, Florida, all are doing quite well. They're off to a great start. We're also in the process of opening a new office in the Lake Norman area of the Piedmont in North Carolina, which should be another community bank and office, and we are very pleased to start these are off to. We're building up the right way with core customers with -- that our bankers have had a relationship with for many years. Rodney is going to talk in a few minutes about our new correspondent office in Houston that we opened last month. So that's certainly a plus. It became apparent to us in mid-2022 that the Fed tightened cycle would lead to a focus on deposit rather than the lending side of the bank. We do anticipate some economic slowdown based on recent events. And Rodney Rushing is going to give a quick review of our deposit franchise. Rodney?

Thank you, Tom. You noted how we have had virtually no dependence on brokered or wholesale deposits for fundings, and I wanted to provide some understanding and details of our deposit metrics and our bank's deposit base. From our beginnings, our model has always been to bank relationships and not just book transactions. Excluding correspondent banks, 25% of our deposits have a credit relationship with ServisFirst. There are no industry concentrations outside of private households and correspondent banks. For example, commercial banking makes a 4.7% of our deposit base, law firms were 3% and real estate firms were 2% and it goes down from there. As you can see, we are very granular with no concentrations. When it comes to corresponding banking, we have 340-plus correspondent relationships in 28 states and just over 120 are settlement banks. Settlement banks are banks from downstream correspondent banks whose daily cash letters are cleared with us or their Federal Reserve account fees are settled through us, working much like a corporate cash management account. As rates have risen, you will see a shift from compensating DDA balances, which are noninterest bearing, into interest bearing. But because we paid for settlement expenses with the DDA earnings, there is no effect on profitability because of the settlement relationship, we keep the fundings by sweeping into interest-bearing accounts, making these deposits very sticky. In fact, 65% of total correspondent fundings are with these settlement customers. This past month proved how stable these deposits and relationships are. As Tom mentioned, we opened our Texas corresponding office with the addition of Don Dickerson. Don and I worked together previously. And with over 40 years of experience in Texas banking, Don was the perfect choice to expand the Texas market with a large number of relationships developed over the last 40 years. We are looking forward to the growth that this market will provide, growth we should realize in the near future. I just wanted to highlight some of the details, more details are in the slide deck that we provided, about our stable conservative deposit base and where we have plans to grow. With that, I'll turn it over to our Chief Credit Officer, Henry Abbott.

Thank you, Rodney. Bank got off to a strong start in 2023, with continued strong credit quality. I'm pleased to say we ended 2022 with NPAs to total assets of 12 basis points, and we're able to maintain that in the first quarter. With no major changes in NPAs, they continue to be near historic lows. Annualized charge-offs were 5 basis points, well below the same period prior year of 11 basis points and 6 basis points for the fourth quarter of 2022. At the end of the quarter, our [indiscernible] total loans was 1.28% versus 1.25% at the end of 2022. This was not associated with any one loan, but rather conservative steps the bank took in the first quarter. I won't go through each of the bullet points, but you should have access to some additional information in the slide deck about our CRE portfolio, and I can go over any questions you have during the Q&A session. Hitting the highlights, AD&C as a percent of total risk-based capital dropped from 100% at year-end to 93% at the end of the first quarter. Total income-producing commercial real estate also dropped for the quarter and is now 317% of risk-based capital. The vast majority of our commercial real estate projects are in the Sunbelt as we have only had a handful of projects where we followed our customers outside of the Southeast. Office space makes up roughly 3.5% of our total loan portfolio. The average loan size within our income-producing office bucket is $1.5 million. These loans are typically in suburban locations and are more traditional 1- or 2-story office walk-ups. We have very minimal CBD office exposure. Comparable to our office exposure, the bank has never been a big single-family residential development lender, and our raw land and lot exposure is minimal. We have stress and continue to look closely at our CRE portfolio to ensure we are appropriately managing the risks. We continue to be best-in-class within our peer group with our past due management. In the first quarter, ServisFirst switched to a new residential mortgage loan servicing company because of client issues with our prior vendor. We did see an increase in past due loans for the quarter, but they are still near historic lows. And a major component of the increase in past due was related to operational changes that caused delays within our residential mortgage portfolio. The majority of mortgage loans that were showing this past due have now been caught up. A lot of the issues were related to getting ACH set up correctly and where and how to properly make payments with this change in servicing companies. Switching gears towards pricing, of new loans that were originated in the first quarter, more than 80% were variable rate loans. We continue to push to increase yield on both new and existing loans. We've also begun various repricing efforts on existing loans prior to their maturity. Through those efforts, we were able to reprice roughly $130 million in existing debt by an average of 1.4% in the first quarter. We also had over $70 million in fixed rate debt paid down early in the first quarter. These 2 items combined for roughly $200 million in positive movement within our fixed rate loan portfolio. In summary, very pleased with the results in the first quarter, and I'll hand it over to Bud Foshee.

Thank you, Henry. Good afternoon. For earnings, we kicked off 2023 with strong earnings in the first quarter as we continue to build capital and liquidity. Diluted earnings per share increased 7% compared to the first quarter of 2022 when adjusting for income on PPP loans. Our investment portfolio. The portfolio is a small component of our balance sheet, 11% of total assets. The portfolio is managed for liquidity. The components of the portfolio are 45% pass-through mortgage-backed securities, 30% U.S. treasury and agency, 1% municipal and 24% bank and bank holding company sub debt. We have never purchased a CMO. The average life of the total portfolio is 4.2 years. The average life for our peer group is 7.2 years, and that peer group is 33 banks with total assets greater than $10 billion. The average life of our treasury portfolio is 2.8 years, and the average lives of the bank and bank holding company sub debt, is 2.4 years. And the average life of the bank and bank holding company sub debt, is based on the call date. We have the expertise to analyze bank and bank holding company sub debt. Our liquidity excess funds were $732 million in March of 2023. Our goal is to increase this to a $1 billion range. Total balance sheet liquidity in March of 2023 was $1.5 billion, and total available liquidity was $8.4 billion. Margin average loan growth was $166 million for the first quarter. Triple fee fees and interest income were $29,000 in the first quarter of 2023 versus $4.9 million in the first quarter of 2022. Our NIM compression is a result of record rate increases. The Fed funds have increased by 475 basis points since December of 2021. We had 4 consecutive 75 basis point increases during the period from December '21 to March of 2023. Second largest Fed rate increase over a one-year time frame was from February 1994 to February 1995, and that increase was 300 basis points. Only 175 basis point increase occurred during that cycle. We see deposit rates stabilizing and NIM improving as loans are repriced. The average rate for new loans in the first quarter was 7.71%, having a short maturity loan portfolio will improve the margin over time. Our noninterest income, credit card income continues to be impacted by our conversion in September of 2022, [indiscernible] fee income has been impacted by decreased volume and rate increases. We expect improvement in both areas over the course of 2023. Our noninterest expenses as a result of our market expansions, total salaries and benefits increased by $765,000. The investment write-down related to tax credits was $2.7 million in 2023 versus $2.5 million in 2022. Tax credits were $3.9 million in the first quarter of 2023 versus $3.3 million in the first quarter of 2022. Capital. Tier 1 leverage ratio was 9.91% at March of '23 versus 7.79% at December of 2021. The ratio was 9.11% after adjusting for the net unrealized losses of both the available for sale and held to maturity securities. That concludes my remarks. I will turn the program back to Tom.

Thank you, Bud. In summary, we're seeing a record deposit pipeline. Slide deck that we filed this afternoon should give you a lot more information about the bank, and I think it's all very positive. One thing we're excited about. We opened 23% more accounts in the first quarter than we did in the first quarter of last year. So we're very, very pleased with improvement there. We think we're close to the other side of this Fed tightening cycle. We're certainly going to be vigilant on credit quality because we do expect a slowdown, and we'll certainly be watching to make sure we're doing everything correctly to manage our loan portfolio and manage our assets properly. So we are -- in summary, we do like where we are today. Our simple business model is paying dividends, and we'll be happy to answer any questions you might have.

[Operator Instructions] Our first question comes from the line of Brad Milsaps with Piper Sandler.

Tom, maybe I wanted to start on loan growth. I think this is the first quarter, maybe outside of the pandemic, where you didn't grow loans. Just kind of curious, last quarter, you talked about high single-digit loan growth and double-digit deposit growth. I know a lot has changed. Just kind of curious how you would sort of think about those numbers as we sit here today?

We think we had a fair number of payoffs that some of them were unexpected, Brad, but a lot of them were very pleasant surprises because they were low fixed rates that paid off during the quarter. So that was a win-win for us and our customers. So we had a -- I can -- to tailor for you, but it's a pretty substantial amount of payoffs. And we started trying to slow the loan [indiscernible] middle of 2022 when we realized the Fed tighten was going to give the industry issues, treasuries are leading the way on rates going up, and they were going up in lockstep with fair rate increases, it was a concern to us. And we started slowing it down a bit. And the result has showed up in this filing in this first quarter. So we feel like we'll start growing loans again, probably in the back half of the year. You'll see some increased loan growth, Brad. But we sort of -- part of it was unexpected with loan pay-downs [indiscernible] not an unpleasant surprise, a very pleasant surprise. And part of that was because we started slower things down the middle of last summer. So that's a longer answer than you want it probably, Brad.

Yes. I know construction has been a big area of growth for you guys. Obviously, those tend to be some of the higher-yielding assets as well. Would you expect to see a kind of similar decline? I mean, obviously, you want those loans to -- those projects to finish up and move off your books. But would that sort of downward trajectory kind of continue in your mind and you pick up growth in other areas?

We have a pretty good -- a fairly robust pipeline of construction loans. So they're probably -- there's still a positive increase in construction loans on a monthly basis of around $20 million a month. I think Henry's last number we computed [indiscernible].

I think -- more than that, I think maybe closer to $70 million a month, maybe $200 million a quarter in new funded construction loans.

But net of payoffs, it's about $20 million a month or so.

Yes.

Yes, it's still positive there, and we like those projects, Brad. We're not concerned about any of those projects in any way, but I'll stop there and see what your other questions are.

No, that's helpful. Maybe just kind of switching gears, the second to Bud. I think I heard your comments that you expect the NIM to improve from here as loans reprice. Are you expecting improvement as soon as the second quarter? It just seems like that could be a challenge if the Feds continue to move rates up, you guys are sitting right around 100% loan-deposit ratio. Also wanted to kind of square that with your comments around building that liquidity book back up to $1 billion? Or just trying to understand all the moving parts on how you get there and kind of how you think about the NIM?

Sure. Yes, if -- and it looks like if Fed is going to increase rates at the May meeting, that's definitely going to impact us from the second quarter. So if that happens, I think it would -- it might take into the third quarter before you start soon some gradual improvement. We're just -- you just got -- you got about $9 billion in either a total floating rate deposits purchased on the asset side between loans and Fed funds, you're looking at about $5 billion. So we're just -- Fed keeps increasing, it's going to hard for a while. You'll have some compression, put it that way. Fed stock for what you can really say it's going...

Right, right. And maybe a final question to me. It looked like your first quarter expenses were up about 10% year-over-year. I know there's a few adjustments in there. Is that kind of how we should think about a growth rate in '23? Or -- I know your incentives are tied to typically loan growth. I know more so deposit growth this year. But just kind of wanted to think about kind of how to think about expense growth? It did look like professional fees were maybe a little heavier this quarter. Anything to back out of there that you think is worth noting?

Let me think on professional. I don't remember anything unusual. Let me -- I'll look at it and e-mail you after the call, but I e-mail everybody. I'll go back and look at it. I don't have anything highlighted, but let me go back and look...

Both. But then I was just looking at the total -- expenses in totality up about 10%.

Fourth quarter was down because we had a credit commitments, but I'll look at everything just to make sure there's nothing...

Yes. I was more looking at 1Q '23 versus 1Q '22, up about 10% year-over-year. Is that kind of the growth rate to kind of think about as you think about '23 versus '22?

I wish I had more detail in front of me because I know we've had market expansion in different markets. Let me look at it and I'll send something out on that, just to make sure you get a good answer.

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

I appreciate the detail on the correspondent deposits. And maybe I want to ask this in -- maybe a very top-level sort of way, like it's obviously a good business to be in. You guys wouldn't be in it if it wasn't. But with what is going on right now in terms of the pressure on deposits and the mix shift within deposits that's going on. Is the correspondent network helping you in this near term? Or is it really exacerbating this pressure and making it more challenging for you just in that your client banks are probably dealing with the same thing and maybe therefore, you guys reflect some of that on your balance sheet? Just trying to...

Deposit beta, Kevin, or from what respect, interest rate sensitivity, I mean, what do you mean of...

I guess just the pressure on mix shift that's going on and mainly on that mix shift and the pressure to grow deposits in general, I guess.

Well, this is Rodney Rushing. Let me answer it this way and then you can see if I've answered your question. It has been business as usual on the deposit side. We -- what I tried to explain in my comments was we are in the correspondent banking business for the relationship, and we find clearing the settlement relationship what is beneficial to us in the downstream bank. We act as an intermediary between the small community bank and affiliate. And because of that, we get their settlement account and then -- and they keep compensating balance. It sweeps in the Fed funds. And that makes those relationships very sticky. Out of 340-plus relationships, this past month, we may have had, it was less than 10 that moved any material amount of money from us. And it was just a small amount. So those relationships are very sticky. We have looked best place to grow that. In Alabama, Georgia, Tennessee, we have probably all the vast majority of the correspondent relationships we're going to get. In Alabama, we have 90-something banks, and we have 60-plus corresponding accounts in the State of Alabama. That same ratio was true in Georgia, Tennessee. So that's why we look to grow in Texas. Texas was a big corresponding market for me when I was at Compass. And we expect with Don Dickerson, it's going to be an area of growth for the correspondent division through the rest of this year and next year.

Now as Rodney said on the call, this money shift from nonbearing DDA to interest-bearing deposits or the Fed funds purchased, there's no effect on profitability of the bank whatsoever. There's no deterioration in our profitability. So if it moves -- as rates start falling, it moves back to the DDA accounts, it will not improve our profitability. It will be the same. It just will show more money in noninterest-bearing DDA.

That's right. And the simple fact that we pay their Fed deals with those DDA earnings. So you'll see, of course, when expenses go up, when we bring on more settlement accounts. And if -- in rising rates if they have to keep less money with us, then that money, as Tom shifts into interest-bearing accounts, but it doesn't affect profitability. What the settlement relationship does for us is it makes it a true relationship between us and banks that instead of a relationship, it is a transaction where we're just buying liquidity from it.

Just enough to -- I'm not answer to your question, Kevin, but Rodney, why don't you mentioned that during the time a couple of weeks when there's a little stress in the industry that when corresponds wanted to test -- wanted to borrow money, some of our competitors didn't take care of.

We had a number of banks that called and wanted to test their line with us, and they did it. David Jordan is here in the room with us, who manages our correspondent operation. And during that, we learned that they tried to test their loans or draw on their other upstream loans from other correspondents and they were not able to do so. And that's...

Yes. I guess one follow-up on that, I was going to ask was just this -- what's going on in the environment and the focus on deposits and particularly on insured deposits? Does it make it -- is it a better -- like not better, but I guess is it -- is it an easier service to sell in an environment like this to -- for them to have you as your correspondent network as a resource?

I don't know if it's easier. To my knowledge, a bank has not lost money to another bank in Fed funds. So in that counterparty relationship where one bank is selling another bank, overnight funds, I don't -- maybe somebody could correct me, but I don't know of a case where a bank has lost money. Now with that, there is prudency. And the only deposits we lost over that couple of weeks were some downstream community banks who -- we're their primary correspondent, it may be a small $200 million bank and $20 million in capital and they look up and they've got $15 million sold to us. They called Mr. Rodney, we looked at our amount of funds we're selling you. We're going to move some of that to the Fed. So I'm going to leave $8 million with you and $7 million to the Fed. Sure, go ahead. And that happened less than 10 or 12x in that 2-week period. That was the only stress we saw in that deposit base. The rest of it was business as usual. And I don't -- it's all about the relationships, and that's why hiring Don in Texas is so important to us. I hope that answered your question.

Yes. No, that's great. And one, just I guess, a follow-on to Brad's question. So [indiscernible] comment about things stabilizing and getting better. But then is it -- I guess the way I would want to ask you whether the Fed moves or not, when we look at the linked quarter decline in the margin and more importantly, decline in dollars of NII, is it fair to say -- maybe we're not at the bottom because there could be some incremental pressure, but the size of the pressure linked quarter is not going to be -- this is probably the high point. Is that fair to say?

We think we're close to the bottom. And with our short loan and securities portfolio, we're going -- our margin will start moving up. It will take a couple or 3 quarters, but we'll start seeing some pretty good improvement once the Fed achieves their peak rate. Bud, I don't know if you can answer any -- add anything to that?

No, I think that's -- yes, we're just -- it's kind of wait and see on the Fed side. So...

And one last housekeeping thing from me. I noticed the restructuring in the TDR section, seemed like it was blanked out for the first quarter of '23. Is that due to that -- is that just an omission? Or was that due to that change in servicer that you referenced? I was -- just was confused about that.

That was due to an accounting change, and that is something that we no longer -- after a report, there were no material changes within the categories. It was just something we don't have to report any more under new guidance.

Our next question comes from the line of Steve Moss with Raymond James.

Maybe just following up on the margin here. Curious to see where are loans pricing these days? And any color you can give on that front as we think about the repricing aspect of your loan portfolio going forward here?

[indiscernible] the first quarter?

For the first quarter, new loan production was at 7.71%.

80% floating in that.

Yes, we were at, I think, 78% variable rate in the first quarter. So that's definitely improving. We're definitely putting more variable rate loans. It's just process. Yes. I mean that is -- that's going to take a while to improve the margin over time, just...

What surprised me is how quickly we're seeing payoffs and pay-downs on floating rate loans. I mean Henry mentioned some $200 million in the first quarter. Already in the second quarter through what -- and what's already closed this quarter in processes like $85 million in fixed rate loans, either paying off or paying down. So it's moving much more quickly. You don't notice that when rates are flat. You certainly notice that when rates are -- have gone up as much as they have. We see the potential improvement in margin that really is very hard for you to quantify in your model. But -- and of course, the natural cash flow on fixed rate loans is substantial as well, over $1 billion a year, natural paydown.

Right. That's helpful. And then in terms of just -- on the deposit side, just curious on your interest-bearing deposits. If by any chance, you have a spot rate at quarter end, just kind of get a feel for where things shook out.

Yes. Let's see. The cost of total deposits at the end of the quarter was 2.31, interest-bearing DDAs was 3.12 and total interest bear deposits, 3.08.

You got all that?

Great. I got all that. And then in terms of just going back to -- or just thinking about credit overall still remains pristine. Kind of just any updated thoughts as to how you're thinking about the reserve ratio and credit costs going forward here?

The -- we keep as much in the reserve as we can keep in the reserve. The accounts will let us keep, Steve. And it's 1.28% the most we've ever had in our reserves. Going into the '08-'09 recession, we had 1.05% or so in the loan loss reserve. So we're -- we feel like we're in much better shape on loan loss reserve today than we were at that time. So CECL obviously helps a little bit, but we feel good about where we are. And we feel really good. We filed that deck that you probably hadn't had time to look at, but it details our office building exposure and AD&C exposure. You know what, remember, when pandemic [indiscernible] banks -- the industry's retail exposure and how much retail the banks were going to lose on retail and that turned into a nonevent. I mean, yes, some banks lost some money on big malls, but they had earnings and it just sort of got handled. So I think it will this time, too. We don't have any of that exposure. But I think it's just -- some of it's just CNBC headlines they like to put out different loan exposures out there. Bud, just -- I don't know any banks that have a lot of office building exposure. But maybe there are some that are.

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

Quick question. Most of my questions have been answered. I think of the preamble, I think it was maybe Rodney or Bud, you mentioned that you've been able to be opportunistic and maybe repricing or refinancing certain, I think it was variable rate loans. Is that done with a view of getting ahead of potential cash flow pressures on these loans repricing? Or just curious what the impetus was for some of the repricing there, maybe the nature of the loans repriced? And was that sort of a credit-driven decision?

No, no. Those were all fixed rate loans. And we're talking about an average rate of -- Henry, would it be 4%, something like that.

Yes.

So those are the loans, and it's just surprising to us all and somebody will need something to redo them. And it's not necessarily a credit issue or a default issue. They might need to borrow some more money. They might not finish the construction on time of a loan that has a fixed rate on it. So we're seeing repricing opportunities. And again, you can't capture it in your model, except for -- when we have a commercial loan portfolio that has an average maturity of 3.5 years, we're going to have a lot of repricing opportunities on fixed rate loans. Yes, we have a few more fixed rate loans than we'd like to have today in this environment. But one thing when rates start coming down, those fixed rate loans might not look as bad as they do today. But in any event, we are seeing repricing opportunities on a lot of loans. Again, like I said, just what, 17 days of this quarter, over $80 million is in the process of being repriced or paid off. We've had a couple of companies which are always constantly selling or [indiscernible] selling assets. They might have a mini firm, a multifamily project that's going to anybody with any sense is going to any of our developers in any sense or going to the Fannie and Freddie and doing permanent financing as quickly as they can, paying us off. So that's certainly in their best interest.

Got it. And then as we think about the Texas expansion into Houston, I assume you expect to see some of that flow into the balance sheet this year. Just curious if any of that shows up on the current deposit pipeline you mentioned in the slide deck?

It's not in there. We don't have any of that. No, we don't have anything in this pipeline yet, right?

No, we don't. It's not in the pipeline, and we anticipate our growth coming. He's already opened 2 or 3 accounts with new banks. We probably had 10 total Texas accounts before Don came on board. So he's out meeting those current customers. So I would expect in the third and fourth quarter looking for growth from that Texas market.

How many banks from Texas, 400?

It's over 400 community banks in Texas. The numbers, a lot of charters in Houston, Dallas markets, San Antonio, Austin. And again, the State of Alabama, we're down to 90-something from bank charters.

They say everything is bigger in Texas, and that's true. More banks, bigger banks, bigger deposits. Well, I think we have no more questions in the queue. If you all need any further information, I know Bud is going to get out some expense management answers to you and look forward. If you all have any further questions, please let us know. Thanks for joining us today.

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