Q3 2023 ServisFirst Bancshares Inc Earnings Call
Participants
Davis S. Mange; VP IR Accounting Manager; ServisFirst Bancshares, Inc.
Henry F. Abbott; Senior VP & Chief Credit Officer; ServisFirst Bancshares, Inc.
Rodney Eldon Rushing; Executive VP & COO; ServisFirst Bancshares, Inc.
Thomas Ashford Broughton; Chairman, President & CEO; ServisFirst Bancshares, Inc.
William M. Foshee; Executive VP, CFO, Treasurer & Secretary; ServisFirst Bancshares, Inc.
David Jason Bishop; Director; Hovde Group, LLC, Research Division
Graham Conrad Dick; VP & Research Analyst; Piper Sandler & Co., Research Division
Kevin Patrick Fitzsimmons; MD & Senior Research Analyst; D.A. Davidson & Co., Research Division
Stephen M. Moss; Research Analyst; Raymond James & Associates, Inc., Research Division
Presentation
Operator
Greetings, and welcome to the ServisFirst Bancshares Third Quarter Earnings Call. (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.
Davis S. Mange
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.
Thomas Ashford Broughton
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. Much of that outlook was due to -- we've seen rapid escalation in interest rates. We've seen bank deposit disintermediation for over -- close to a year at that point. And then we see credit tightening by most banks.
The demand for goods and services continues to be amazing. The consumer appears to be very resilient. 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, is 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%] of. 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 [addition -- version] 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 4 quarters. We've seen really fantastic results. Our people have done an outstanding job, and they've done what we've asked them to do. And very few banks can demonstrate the deposit growth we've seen combined with 0 Federal Home Loan Bank advances and 0 brokered 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 were up 19% year-over-year, while our commercial accounts were 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 are seeing cash on hand stay consistently at the $2 billion level in October. We are pleased to have built this liquidity at 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 I'm very pleased with the deposit situation.
Talking a little bit about loan demand. We did turn the loans 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 -- 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, 4 new bankers there. We had a total of 5 in the quarter. From a head count standpoint, we were down 3 for the quarter. We are focused on adding the right people and rightsizing our team. This year, we think that will 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. It will be a community banking officer -- office that's very similar to the offices in Tallahassee, Panama City and Nashville, 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 correspondent side.
Rodney Eldon Rushing
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 was 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. 7 new bank relationships were opened during the quarter in 5 different states. Correspondent participation loans and new relationship pipelines are strong for the remainder of the year and also in the 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 3 new state banking associations reviewing our American Bankers endorsed agent credit card program to determine if they would like to participate.
We currently have 9 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 for an example of how wide that the market has grown. Correspondent deposits and fundings in summary, the 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.
Henry F. Abbott
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 a 45% reduction from the second quarter and a 50% drop from the first quarter.
Our asset quality continues to remain strong, and I'm pleased to say nonperforming 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% and 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 watch list 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 as an industry leader in commercial real estate data and analytics help provide stress testing and 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. And 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 to outperform in the third quarter.
With that, I'll hand it over to Bud Foshee.
William M. Foshee
Thank you, Henry. Good afternoon. We are very pleased with the progress the bank has made in the third quarter with deposit growth, liquidity, capital and improving loan pipelines. Our noninterest-bearing deposits were stable in the third quarter with the exception of $100 million in deposit runoff related to COVID funds. 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. A 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 are our repricing effort, $390 million of loans where the rate 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 are paid off in the third quarter were $276 million, which combined with loan paydowns on fixed rate loans totaled 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, $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 net funds purchase. We saw improvement in core noninterest 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 noninterest income included a debt benefit of $890,000. Discussing noninterest expense, we have made an effort to hold the line on expense growth in 2023. We have experienced increases in noncore expenses. Problem credit, which was primary legal expenses related to credits, check fraud and credit card fraud, and we had 1 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 19% 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.
And that concludes my remarks, and I'll turn the program back over to Tom.
Thomas Ashford Broughton
Thank you, Bud. If we made a list of the 20 most important metrics in managing a bank, 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'll get there. So we think our performance on all those other metrics will lead to improved earnings per share in the future.
So we'll open it up now for questions. I'd be glad to see what you have to -- on your mind.
Question and Answer Session
Operator
(Operator Instructions) Our first question comes from Kevin Fitzsimmons with D.A. Davidson.
Kevin Patrick Fitzsimmons
I'm just trying to -- I know there's a number of contributors into the margin, but I'm just trying to let -- unpack. I think when we were on the last conference call, we talked about the NIM maybe stabilizing in third quarter and then beginning to expand in the fourth quarter. And there's -- looks like there's maybe a couple of 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 paydowns. 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 -- you talked 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. Was 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 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.
Thomas Ashford Broughton
Yes. Probably let me -- Bud will have to give you some actual numbers. But my take on it is that the improvement in loan repricing, it's been swallowed up by deposit repricing to this point in time. So that's why you haven't seen the margin improve yet because of that. If we think the rate increases are behind us, then it stabilizes from this point forward pretty well. And as we reprice loans, more of that starts flowing to net income instead of flowing to reprice deposits.
So that's the first thing, I think. And of course, we had no idea of deposits. We asked our people 15 months ago to focus solely on growing deposits. Our incentive plan is skewed almost 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 have grown deposits.
So now we've actually gone back and for the last 3 months of the year, we're putting a special incentive to grow loans from October 15 to January 15 to have an incentive to grow loans and by a fair amount of money to try to get the loan pipeline restarted. But I guess, Bud, I don't know -- obviously, when you add that much in deposits that's sitting at the Fed, 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 cost as we go forward.
We had a call with our regional executives a couple of weeks ago, and we're starting to try to rationalize some of that cost 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. But I probably didn't answer your question, Kevin.
Kevin Patrick Fitzsimmons
No. No, that was helpful, Tom. I just -- I guess, I know there's a lot of moving parts to it, but are you -- do you guys feel like that -- it sounds like you're over -- not overshot, but I mean it's never -- you can never have too much of it. But is it -- and it's just 1 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 [eat up] to expand in '24? Is that where -- what you suspect?
Thomas Ashford Broughton
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 outbidding on 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 that doesn't leave you a lot of profit when you get the money to the Fed to hold. But nevertheless, we're not going to tell a good client we won't take their money.
So that's the bottom line. They're not -- it's not -- again, we don't have any brokered deposits, and we don't have any home loan bank advances. So we're really kind of a spot. I don't think most of the industry would trade places with us if they could.
Kevin Patrick Fitzsimmons
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 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's the impact of rates. There's the impact of you guys being -- tightened 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 kind of -- it seemed 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?
Thomas Ashford Broughton
Yes, 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 in trying to find sources of loan demand right now, Kevin. And I think that's what we had to do after '08, '09, '10, after the -- people weren't buying boats and airplanes during that period of time, and we had to try 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 have to be a little more creative in finding the loan demand out there than you do when times are really good.
Operator
Our next question comes from Steve Moss with Raymond James.
Stephen M. Moss
Tom, you spoke about the loan pipeline improvement 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 kind of feels like maybe we'll see a decent step-up in growth for the fourth quarter on loans.
Thomas Ashford Broughton
Go ahead, Bud.
William M. Foshee
Yes, we think that loans can increase. The rate that new loans went on during September was 8.35%. So we feel like it would 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.
Thomas Ashford Broughton
Steve, what I can't project is what kind of payoffs we're going to have. And I'm looking at Henry Abbott. If we've got -- if a multifamily developer is looking at going to permanent financing with Fannie Mae, I mean, their rate's going up, but it's still less then what we're charging them. I mean they might pay 6% at Fannie, but they're going to pay us -- they're paying us 8.25%, 8.5%. So there's what I can't predict, Steve.
Stephen M. Moss
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 business mix is.
Henry F. Abbott
Yes. I mean 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 those are certainly what we're looking for and striving for.
Thomas Ashford Broughton
Yes, 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 thought on that.
Stephen M. Moss
Great. 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's a healthy step-up in loan growth and it may be sustained for the next quarter or 2. Are you willing to dip below that $1 billion of liquidity? Or kind of how do we think about funding loan growth? Will it be more by deposits or existing liquidity?
Thomas Ashford Broughton
Yes. We've got $2 billion in cash at the Fed today. And I guess we've got some short-term treasuries that are about $250 million, Bud?
William M. Foshee
We do.
Thomas Ashford Broughton
So you say we got $2.250 billion. We really think that of that, we could put $1.5 billion probably into the loan bucket over time. Now again, some of these municipal deposits are going -- again, the -- 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. They will take a couple of years to burn some of it off, and we'll replace it by the end 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 walks in the door.
Stephen M. Moss
Got you. 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, is 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 climbing up as much or not climbing?
Henry F. Abbott
And I think the primary driver, as Tom mentioned in his remarks, was kind of the economic outlook improved over the past 2 or 3 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.
Thomas Ashford Broughton
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, but we're not. And subject to the CECL, models are -- they can switch -- change all the time as you well know.
Operator
Our next question comes from Graham Dick with Piper Sandler.
Graham Conrad Dick
I just wanted to circle back with something you just touched on, is that $1.5 billion number of deployment in the loans. Do you -- what's sort of the ideal time horizon for achieving that?
Thomas Ashford Broughton
You know why I'm laughing, Graham. I don't know. I mean, at this point, I don't know. I just don't know how quickly we can book -- 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 the $64,000 question, which is -- that was -- you weren't born when the $64,000 question came about, Graham. But Google it some time.
Graham Conrad Dick
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?
Thomas Ashford Broughton
Yes, it's not a scientific number, and we don't ever discuss it, but I -- let me see. Where is the -- I don't have it. Probably down. Probably down a couple of hundred million dollars from the last quarter, Graham. So we put it on the book. So we got it on the book.
So -- and again, we're trying to rationalize deposit costs now. It's time to start improving profitability. So we've got to be a little bit smarter about it.
Graham Conrad Dick
Okay. And then on that front with deposit costs, I mean, it seems like most of the growth has been in money market recently. I guess most of that's probably fully indexed and floating, right? 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 indexed money market and just time at a rate below Fed funds? Or how do you guys kind of approach that from here, I guess?
Thomas Ashford Broughton
Well, it depends on what is -- as a percent of Fed funds, what is the rate. You're not using 100% of Fed funds. You're using some percentage of Fed funds, so -- that -- you got to have some margin in what -- you want at least to have some margin in 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 to buy securities again someday, but given we've got so much -- we don't -- we want a 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 2- to 5-year treasuries. So that's -- you might be smart to start doing it now, but we're not going to be smart because we're not going to do it now. But we're just waiting on that. But again, we will have to all do it someday.
Graham Conrad Dick
Yes. Understood. And I guess just one more follow-up on the deposit front and the costs. So that money market piece, just correct me if I'm wrong, that's like that's fully floating, right? So that -- there's not a lot of -- there's no maturities in 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?
Thomas Ashford Broughton
We think so, Graham.
Operator
Our next question comes from Dave Bishop with Hovde Group.
David Jason Bishop
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?
Thomas Ashford Broughton
No, we've already caught up. We accrued more in the third -- a good bit more in the third quarter, Dave. I don't know the exact number. Bud's 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 in the -- because they have -- we have been wildly successful at raising deposits and they've done what we asked them to do.
David Jason Bishop
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 a higher for longer scenario economic outlook, your 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.
William M. Foshee
Dave, this is Bud. I don't see us selling anything. I think we'll continue to buy. If we buy, we'll buy treasury short term, 6 months to a year. This takes a long time to be actually paid back and earn money. I just -- I don't know, just something I want to do. We'd rather just hold it to maturity.
Thomas Ashford Broughton
And what if rates drop? I mean probably my salesman can always show you a Bloomberg run that shows that makes you a lot of money to reposition securities.
David Jason Bishop
Got it. No, understood. Understood. And then a housekeeping question, I guess, maybe for Bud. Good tax rate system 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?
William M. Foshee
Yes. I would say 18% would be a good rate for the fourth quarter.
David Jason Bishop
18%?
William M. Foshee
18%, yes.
Operator
There are no further questions at this time. I'd like to turn the floor back over to management for closing comments.
Thomas Ashford Broughton
Thanks. I think we're done. Thank you, everybody, for joining us.
Operator
This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.
