ServisFirst Bancshares Q3 2024 Earnings Call Transcript

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October 21, 2024

There are 8 speakers on the call.

Operator

presentation. As a reminder, this conference is being recorded. It is now my pleasure to introduce you to your host, Davis Meads, Director of Investor Relations.

Operator

Thank you, Davis. You may begin.

Speaker 1

Good afternoon and welcome to our Q3 earnings call. Today's speakers will cover some highlights from the quarter and then take your questions. We'll have Tom Broughton, our CEO Henry Abbott, our Chief Credit Officer Kirk Presley, our CFO and Ed Woody, our Controller. I'll now cover our forward looking statements disclosure. Some of the discussion in today's earnings call may include forward looking statements.

Speaker 1

Actual results may differ from any projections shared today due to factors described in our most recent 10 ks and 10 Q filings. Forward looking statements speak only as of the date they are made and Service First assumes no duty to update them. With that, I'll turn the call over to Tom.

Speaker 2

Thank you, Davis. Good afternoon and thank you for joining our Q3 earnings call. We were very pleased with the quarter's metrics and we're pleased with outlook for the future. And I'll start by talking about loans and sort of outlook there. Our pipeline is very strong and we had great loan growth in the Q2 and not in the Q3.

Speaker 2

We are here in the line waiting till after the election more than I would have expected. Though our loan balances did not grow in the quarter, we had early payoffs on $126,000,000 of loans at an average rate of 4.89 percent. So that was good news for the shareholders. In addition, we had re pricing on $105,000,000 of loans in the quarter of low rate fixed rate loans. This will contribute to improved margins going forward as Kurt will discuss in more detail in a few minutes and he'll explain our positive balance sheet outlook.

Speaker 2

Loan demand is very robust in one segment, hospitality, but that's certainly a segment where we have limits on our exposure to the industry. We do typically see very strong loan growth at year end and I'm assuming we'll see rebound in closings in the 4th quarter. The election delay is typical, but after a strong second quarter, I thought that we would not see that issue this year, but we did. It could also be at some customers waiting to see if we have more Fed rate cuts come after the one and it was in the very end of Q3. We got nothing as you all know, until the very end of Q3.

Speaker 2

Also think some borrowers want to see more certainty on rate cuts as some projects do not pencil out at current rates in many cases and demand for new product on many segments of commercial real estate is suppressed just due to overbuilding in the last couple of years in some segments. On the deposit side, we did have 1 larger municipal outflow, 1 municipal account outflow in the Q3, but we expect it to return in the 4th quarter. We are trying to be disciplined on loan pricing and we do have great options whether we have, as you know, no broker deposits or federal home loan advances on our balance sheet. We do continue to see more pricing discipline from our major competitors. So that is a very good thing.

Speaker 2

As Henry will discuss, loan losses continue to be quite benign and we still do not have not seen any normalization as they referred to these days. The bottom line is economy continues to be quite good. Having said that, we have said for a long while that we need to see higher margins because we expect higher loan losses at some point in the future. Loan losses are often lumpy and we can see large increases in a quarter. Nothing expected today, but it's always best to expect the unexpected.

Speaker 2

The rate cuts will help some of our developers have been pinched by the rate increases. A good example is one of our larger relationships is a workforce housing real estate developer that experienced tight cash flows in the last year as their interest rate hedges have expired. Due to Hurricane Helene, their payments were delayed past month end, past quarter end and there's a bunch of caution we've downgraded all their 9 projects, especially mentioned. One of those projects was paid off after quarter end of a $10,000,000 loan. They have one project that has permitting delays that will require them to do a capital call with their investments.

Speaker 2

The customer does have a very solid balance sheet, net worth, he and his spouse personally guarantee the debt. So this is example of how rate cuts will help some customers whose cash flow is impacted by higher rates. I'm surprised not seeing more of this in our customer base, but many customers have been able to pass on interest rate increases through their customers in the form of higher prices, including in the form of higher rents on apartment complexes and other properties, warehouses. So in any event, we are pleased with where we are from credit quality standpoint. We expect loan demand rebound in the 4th quarter and to some extent at least and pleased with our pipeline in the future.

Speaker 2

So from a standpoint of where we are with our teams, we have we did add 4 new bankers in the quarter. We have a total of 155 frontline bankers today. Those are all commercial and private bankers. We are very pleased with our new markets. Memphis and Auburn are the newest markets and they are really neither one of them have a permanent office yet, but they're both making great progress on that front.

Speaker 2

So I'll turn it over to Henry now to talk in more detail about credit quality.

Speaker 3

Thank you, Tom. I'm pleased with our credit quality and how the loan portfolio performed in the 3rd quarter. We saw minimal charge offs and increased our ALLL. Our annualized net charge offs to total average loans was only 9 basis points for the quarter, and that was down from 10 basis points in the 2nd quarter and a 40% reduction from the 15 basis points we experienced in the Q3 of 2023. We grew our loan loss reserve by $4,000,000 for the quarter and the loan loss reserve to total loans increased to 1.31%, which is the same percentage we had in the Q1 of the year and same time prior period in 2023.

Speaker 3

We did create a special Hurricane Salina reserve of $2,700,000 We continue to get our arms around the impact of Hurricane Salina and now Milton. Some of our clients operate businesses that are dependent on tourism. As infrastructure in the affected areas is restored, our clients will be positioned to help repair and rebuild the impacted areas in both Florida and North Carolina. Our NPAs to total assets were only 25 basis points in the 3rd quarter, and as always, we continually monitor all segments of the loan portfolio. I'm also pleased to say our AD and C as a percent of capital dropped to 80 percent, which is the lowest that has been in more than 3 years.

Speaker 3

As Tom mentioned, the Federal Reserve's 50 basis point decrease was a welcome sign to our customers and various projects with decreased debt service. I'm pleased with the results of the Q3 and our positive momentum as we continue to build in new markets and continue to grow our core markets. With that, I'll hand it over to Curt.

Speaker 4

Thank you, Henry. Good afternoon. We are very pleased with the progress the bank has made so far this year. We continue to make great progress on the margin. As usual, I'm going to focus my comments today on linked quarter because the trends are very meaningful and it will highlight our momentum.

Speaker 4

Net income is up approximately 15% from the 2nd quarter, diluted EPS about the same. Margin is up an impressive 9%. We did benefit from the timing of some tax credit investments and positive return to accrual adjustments that reduced the tax rate for the quarter by a few percent. Even excluding these tax benefits, we had great growth in net income and EPS. That growth was led by the net interest margin.

Speaker 4

Margin increased to $115,000,000 in the 3rd quarter versus $106,000,000 in the 2nd quarter. The margin is increasing from the continued repricing of our fixed rate loans and securities and from the strong loan growth during the 2nd quarter, along with doing a good job at managing the cost of liabilities. The yield on interest earning assets increased by 11 basis points, while the rate paid on interest bearing liabilities only increased by 3 basis points. The net interest margin percentage increased by 5 basis points over the prior quarter, while holding on average about $600,000,000 more in cash, which negatively impacts the NIM percentage calculation. As we have noted in the past, we are slightly liability sensitive.

Speaker 4

We realize much of the benefit of a rate decrease in the 1st few months. We benefit from the rate decline in general, but even more early on as about 45% of the variable rate loans reprice over a 30 day period. The Fed rate change in September had a modest positive impact on the quarter. We'll continue to benefit from the rate drop, but that benefit will decline over time as assets reprice at the current lower rates. As you know, liability sensitive means that liabilities move faster, but the asset repricing will eventually catch up.

Speaker 4

We try and structure the balance sheet to be neutral. We aren't making rate bets. Our strong margin tailwind from the repricing of fixed rate loans and securities will continue over the next few years within the current projected rates. Obviously, the lower the rates, the less the benefit from the repricing and as time goes on, more of the repriced assets will be from more recent higher rate instruments. Of course, our cost of funds will be dropping too.

Speaker 4

In other words, we continue to be happy with the tailwind and we think we have a few years left of that benefit. Before we get to the other parts of the income statement, I'd like to take a second to discuss the 8 ks that we filed today about my resignation. I'm resigning from the bank for personal reasons. I would like to say that this is an amazing bank, which has been proven over many years in many different operating environments. The bank has great employees and it is positioned for a great future.

Speaker 4

Tom, Rodney and Henry are consistent and proven leaders who have built this amazing bank into what it is today. Ed Woody, who has been the long time Controller of the bank, has been named as the Interim CFO. Ed is an incredibly talented individual and will do a fantastic job. I'd like to turn it over to Ed now to go through the rest of the income statement.

Speaker 5

Thank you, Kirk, and good afternoon, everyone. Non interest income performed well again in the Q3. Deposit fees have increased each quarter this year. We experienced another quarter of higher mortgage fee income in the 3rd quarter and we expect the trend to continue through the Q4 indicated by strong loss volumes during the past few weeks. We see most of our originations in secondary market loans and in purchase money loans.

Speaker 5

Credit card net revenue decreased modestly in the quarter, but we expect it to return to more normal levels in the 4th quarter. On non interest expenses, as usual, we controlled expenses and the efficiency ratio fell below 37%. As a reminder, during the Q2 call, we discussed implementing a new accounting treatment for qualifying tax credits. This resulted in some noise in non interest expenses and income tax. We said our core run rate for expenses for the Q2 was $44,800,000 The 3rd quarter was 1.8% above the core second quarter amount, a little more than we expected, but it did include some one time EDP costs to exit contracts for services we no longer need.

Speaker 5

Also salary and benefit expenses increased modestly due to our new Auburn, Alabama staff being in place for a full quarter. As Curt just mentioned, we did realize some income tax benefits during the quarter. Our 2nd quarter rate was higher due to the implementation of the new accounting for tax credits. Our rate for the first half of twenty twenty four was 19.7% compared to the rate in the Q3 of 17.2%. This rate differential was primarily due to positive adjustments related to filing our 2023 tax returns and adjustments related to some tax credit investments.

Speaker 5

We believe our tax rate for the 4th quarter will be around 19%. And with that, I'll turn the call back over to Tom.

Speaker 2

Thank you, Ed. I will comment one thing. We have $45,000,000 a quarter of core expenses. I was thinking back 19 years ago, we opened the bank with 19 employees. And if you told me in 19 years later that we would have $45,000,000 of expenses in the quarter, I would not believe I knew the bank could grow, but I didn't know we would grow to the extent that it's hard for me to think now that we could operate a bank with 19 employees with all it seems like we need now to operate.

Speaker 2

So in any event, we're very pleased with the quarter. I do want to thank Kirk for his contributions. He joined us in June of last year. He came in sort of a critical time because we had some back office turnover and he did a fantastic job of helping get all that fixed, get the back office in order and he did a great job with that. And then when

Speaker 5

of course, when

Speaker 2

both Fauci retired, he took over as CFO, has done a fantastic job and has helped us professionalize the bank in many cases. His view from coming from a larger bank has been very helpful to us and helping, especially from standpoint of making sure we're ready for growth in the future. So we want to thank Kurt. Kurt, we appreciate your contributions and wish you well. And we'll be ready to take any questions you have now.

Speaker 2

Thank you.

Operator

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

Speaker 6

Good afternoon.

Speaker 2

Hi, Steve.

Speaker 5

Hey, Tom. Just want to go

Speaker 7

a little further on loan the loan pipeline here. You talked about the pipeline being very strong. Just kind of curious, do you think like for the Q4, we'll probably see something similar to what we saw in the Q2? And just kind of like how you're thinking about maybe the early look into 2025?

Speaker 2

Steve, it's real. You're asking a hard question. If I told you, I thought it was going to be as good as the Q2. The Q2 was outstanding and that was probably more than I would hope for in the Q4 that was possible. You tend to get a lot of closings before companies buy and sell in the 4th quarter, assets buy and sell.

Speaker 2

We did like I said, we did see a lot of assets sell, I think, prior to the election in the Q3. We saw some people probably concerned about tax rates going up and sold some companies and businesses. So I think we're I just think the opportunity is always there in the Q4 because of the year end. We've always had a good Q4. So I expect to have at least a decent closing amount and the pipeline is there.

Speaker 2

So of course, we got like everybody, we've got some payoffs coming too, Steve, when people go into into permanent market and in a few cases, we're trying to hold on to some loans that are that could go to Fannie and Freddie and we're trying to talk to them about staying with us for a bit longer on some of those projects. So I'm not giving you very good answer on those, Steve.

Speaker 7

That's okay, Tom. I get it. And then just in terms of just loan pricing here, kind of curious as to what you guys are seeing for the rate on new loans. Obviously, we've had volatility in the 5 year treasury here. So curious as to how you're thinking there?

Speaker 4

Well,

Speaker 2

I It's consistent with where we've been in prior quarters. I would think it's close to right at 8%.

Speaker 4

Right. It came down a little bit this quarter, but that's because the mix has changed a little bit. We've done probably a little more fixed this quarter, I think, than yes, sorry, just looking. So but it's held up really well. I don't see a pricing issue going forward.

Speaker 4

Obviously, I'm saying that we didn't have a whole lot of new loan volume this quarter, but the pricing has been holding up very well.

Speaker 2

And again, remember, we're happy that we had 100 and $26,000,000 or so of loans pay off that was a low fixed rate amount. So that's a win for the shareholders there.

Speaker 4

Yes. I mean, that's a great point. Obviously, we benefited in the 3rd quarter from the great loan growth in the 2nd quarter. But even more than that was the repricing, the maturities and the cash flows of the fixed rate. I mean for us to go up $9,000,000 in the quarter, we've got some really good stuff going on.

Speaker 2

Right. Okay.

Speaker 7

Definitely hear you on that. And then just in terms of the Tom, you mentioned a large borrower you placed on special mention. Just kind of curious how large is that borrower and kind of like what's the total criticized and classified loans for you guys?

Speaker 2

Go ahead, Deane.

Speaker 3

So the total relationship for that borrower is currently, as Tom mentioned, we had a $10,000,000 payoff after quarter end. The relationship size for them is at $97,000,000 and it's all granular. It's divided up now into 8 different projects. So the numbers on individual projects are much smaller, dollars 6,000,000 $10,000,000 large one being $20,000,000

Speaker 2

Yes, they're special mentioned, not substandard. That's correct.

Speaker 7

Right. And just kind of curious on, is there any beyond that one, is there any significant change to your total special mention and sub standards?

Speaker 3

No, that was the Vegas measure.

Speaker 7

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

Speaker 2

Thank you, Steve.

Operator

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

Speaker 6

Hey, thanks. Good afternoon, everyone. Hi,

Speaker 5

Stephen. I guess just sticking

Speaker 6

to those special mention increase there, I assume at this time you don't really expect any significant loss content there given the movement in the reserve and keeping that kind of flat quarter over quarter. Is that fair to say based on how you're thinking about and looking at this, Brent?

Speaker 2

Yes. We there's no reserve on any of those. They only have one project, as I mentioned, as I said in my remarks, they only have one project that is a problem and it's a problem because they had construction delays for a year with the city, it's a city in Alabama, North Alabama, an excellent city, but they had problems with the city. So that's they've gotten that straightened out and they'll get back relevant with that project. And again, this is workforce housing rehab.

Speaker 2

So we like the asset class and we like the borrower. We think they're just they just had some short term because of the hurricane, they had some payment delays and we felt we need to downgrade it as abundance of caution.

Speaker 6

Yes, sounds like a lot of conservatism, so that's great to hear. Perfect. On the loan growth trends, I know you mentioned 4 new hires in the quarter. Are those in Auburn, Memphis, the newer markets? Or is there any particular focus on expansion in any other markets to drive that incremental loan growth or kind of a resumption of

Speaker 2

the loan growth next quarter? I think one of those or 2 of those were in Auburn of LICA market and the other 2, I forget, maybe 1 in Nashville and one in Florida. So we're continuing to hire and we expect the contribution from the new hires, which were many for us this year. We've hired a large number of new people and it takes them about 6 months to start making a contribution. So we expect to start seeing that.

Speaker 2

We just now we're seeing a great contribution. Our team we hired in Montgomery last year. We hired a 4 person team from another bank last year. So we're just now seeing the contribution from that team. So I don't say just now seeing it, but it takes a while for the to start moving things.

Speaker 2

And so we're optimistic that we've got with all the new producers we have, like I said, they're pretty large teams in both Memphis and the Auburn Opelika market. So we feel good about the future there. Got it. That's helpful, Tom.

Speaker 6

And then I guess maybe last thing for me. The loan yields, I know you touched on those briefly, did move up much more significantly this quarter. Was there anything kind of one time in nature or unusual about that, especially with the $126,000,000 in early payoffs you mentioned? I'm just kind of wondering if there's prepayment penalties or anything in that jump in loan yields that might kind of reverse back out next quarter in any way?

Speaker 4

There's nothing that I would say was a one time. I mean this is the recurring theme. We've been signaling for a long time. We expected the velocity to pick up on the margin increase. I think you saw it this quarter.

Speaker 4

Now remember, the 2nd quarter loan growth helped a lot too.

Speaker 2

We are right.

Speaker 6

It came later in the quarter.

Speaker 2

It came later in the quarter. National deposit price. And then I think that's we finally are seeing that, Stephen, I think in terms of, of course, everybody says this to other person that's paying up too much. I mean, I'm painfully aware of that. So I say that with all humility of not trying to blame everybody else.

Speaker 2

We're doing everything right, they're doing everything wrong. I'm not saying that, but we are seeing more rational pricing industry wide.

Speaker 6

Yes. And maybe just touching on that one last question for me. What are you guys seeing on new pricing for CDs currently?

Speaker 2

It's down pretty quickly. I mean, it seemed like if I'm making this up 45 days ago, people were playing 5% on the 6th month and now they're paying 4.25%. And I think that's sort of the trend we're seeing right now is they're moving down pretty quickly. They're below treasury a bit in terms of CD yields. And so that's there.

Speaker 2

Of course, you still have some of the small community banks that are underperforming outliers as you might imagine. But for major operators, we're seeing much more rational CD pricing. And we don't have large CD, I think in the Q4, we have $300,000,000 plus in CDs maturing at a rate in the high fours. So $480,000,000 at $4.90 yield. 4.85.

Speaker 2

4.85 to add to be precise. So there's room there to pick up here and there adds up the real money after a while. Definitely. Great. Thanks for all the color.

Speaker 2

Appreciate the time. Thank you.

Operator

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

Speaker 2

Yes. Good evening, gentlemen. How are you doing? Hey, Thomas, you noticed or noted in the preamble, some build and short term liquidity cash maybe drove the margin down a little bit. Just curious what sort of drove that increase?

Speaker 2

Was that related to maybe customer flows? Just curious what drove that increase in cash?

Speaker 4

So I'm going to jump in here for a second. So the cash really didn't go up that much during the quarter. It did during the quarter and came back out with 1 municipal outflow. What I was saying was, if you look at the average balance of cash in the 2nd quarter and the 3rd quarter, was about $600,000,000 higher in the 3rd quarter with about the same loans at the end of the quarter. So the cash, the calculation, the NIM calculation

Operator

had a

Speaker 4

lot more cash at kind of a breakeven on it. It doesn't hurt the NIM dollars as you can see based on the run up in it. But the percentage, if you kind of normalize for that extra cash, it would have been even higher. Does that make sense?

Speaker 2

Yes. Then maybe just talk about puts and takes there from a funding perspective, should we see that sort of come down as you expect to fund loans this quarter?

Speaker 4

Yes. And that's one reason why it was higher in the Q3 versus the 2nd. Tom has always run the bank where he tries to build the liquidity ahead of time and that's why you don't have FHLB advances and that's why you don't have broker deposits.

Speaker 2

The deposit that flowed out, it was a high rate municipal deposit day. That's why we weren't too terribly upset about it. It's not accretive to income at all. It's a slight negative. So it's hard to we think it'll we may not take it all back when it's all if and when it's offered back to us too.

Speaker 2

Got it. Maybe outlook for core operating expenses from here?

Speaker 5

Yes, Dave, this is Ed Woody. We said in the Q2, we're operating about $44,800,000 We think that's probably still realistic. We think with we may have some adjustments in our annual incentive accrual for the 4th quarter. So we think that number is still realistic, certainly no more than 45,000,000

Speaker 2

dollars Got it. And it my line broke up a little bit, Tom, in the beginning you said the loan the low yielding loans paid off. What was that average rate that was paid off? 4.89.

Speaker 3

4.89?

Speaker 2

Yes. Got it. Perfect. I'll hop off and let someone else ask some questions. Thanks.

Speaker 2

Thank you. Yes, we'll be done. If there are no further questions, that will close the call. Thank you all. Thank you, everybody.

Operator

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

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ServisFirst Bancshares Q3 2024
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