ServisFirst Bancshares, Inc.

Good afternoon and welcome to the Service First Bancshares second quarter earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing the star key followed by zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on your telephone keypad. To withdraw your question, please press star then two. Please note this event is being recorded. I would now like to turn the conference over to Davis Mange, Vice President of Investor Relations. Please go ahead.

Good afternoon, and welcome to our second quarter earnings call. We will have Tom Broughton, our CEO, Bud Foshee, our CFO, and Henry Abbott, our Chief Credit Officer, covering some highlights from the quarter, and then we'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 the most recent 10-K 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.

Thank you, Davis, and good afternoon. Thank you for joining our call. I'll talk a little bit about, I'll give you a brief overview of the second quarter. It was a historic quarter in many, many aspects, in many regards. The first and most obvious thing that struck me about the financial statement is we ended the quarter with the highest level of liquidity that we've ever had in the company and by far the most improvement in any one quarter with $1.5 billion in new deposits. We did close over $1 billion in Triple P SBA loans to almost 5,000 borrowers. We have seen the market share reports, and among the loans greater than $150,000, ServiceFirst had a number one market share in both out-of-state Alabama and in Birmingham. I usually don't make self-congratulatory statements on this call and let results speak for themselves, but we do think that is a good sign for the future in that we have strong relationships with the owner managed privately held companies in the state of Alabama and the rest of our footprint. So we think there's good opportunity to grow our bank with those opportunities that we see there. Also from a historic standpoint, it was the largest decline in line utilization in any quarter with a decline from 49% to 40% line utilization, which that is the A huge amount of drop. We saw attributed a lot of it to the pay downs from the Triple P facilities loans to the borrower's lines as well as I think people have just been conservative and cautious and paid down their line where they are able. So it shows the strength of our company. That in turn essentially led to a decline in loans of about $275 million. that we would have had additional loan growth in the quarter of $275 million if we had not seen that decline in line utilization. Most of our PPP income in the quarter was offset by one-time expenses, but I'll be talking about that in a few minutes. We did see a good bit of improvement in all of our asset quality metrics in the quarter with reductions of both NPAs and very low past dues. Henry Abbott is going to discuss a good bit more in terms of asset quality in a few minutes. I know that's a topic certainly during the pandemic and the recession we have had over the last few months. Talking about loan deferrals, that's obviously a subject of huge interest today. Our loan deferrals peaked at the end of May at $1.248 billion. Those deferrals as of July 15th have fallen by over 90% to a current level of $127 million. We expect further declines from there over the next several weeks. So we feel good about where we are. Henry Abbott and I as well can address any questions you have about loan deferrals in our future policy. Our 90-day loan pipeline is down about 20% from the first quarter, which is certainly something you would expect to see given the COVID-19. I think a lot of people hit the pause button on projects. We are seeing more moving forward over the last few weeks, so I think it'll improve. Our total pipeline, including loans greater than 90 days, is consistent with a March 31, end of the quarter. So we think we'll see it get back to normal over the next couple of months. We did make additional loan loss provision in the quarter that would pull us in line with our CECL model. So we can talk about that as you additionally, questions that you have. And also of note, there are loan Loan Loss Reserve and Equity exceeded a billion dollars for the first time in our history, for the first time, so we're certainly proud of that to reach that milestone. I was now going to ask Henry Abbott if he'll give us an update on the effects of pandemic on certain industries and general credit quality update. Henry?

Thank you, Tom. The bank's loan portfolio has continued to perform well in the second quarter despite the economic impacts of COVID-19. At the end of the quarter, past dues decreased by $2.8 million from the first quarter and non-performing assets decreased by roughly $12.7 million. Past dues to total loans were 13 basis points and NPAs were 26 basis points for the quarter. This 30% decrease in NPAs was primarily driven by a settlement being reached on our largest non-performing asset. I'm pleased to say we have no more exposure related to that credit Part of our second quarter charge-offs were related to exiting it. As a reminder from prior comments, the bank has a well-diversified loan portfolio in both geography and industry classifications. The portfolio is granular, and we have no major concentrations within industry codes. We initially took a three-month approach to deferrals and are assessing future deferrals proactively to assess the borrower's current financial status. At the end of May, we had roughly 15% of our portfolio in some form of a deferral. By comparison, at July 15th, as Tom mentioned, we were down to $127 million in loans, roughly 75 units. We had some clients in severely COVID-impacted industries who needed additional deferrals, and we have and will continue to underwrite their ability to repay the debt in the current operating environment. To date, we have granted roughly $60 million in second deferrals As documented by this trend, it is our expectation that the overwhelming majority of our clients who had the deferral will or have already returned to normal payments. The slide deck we have posted highlights some of the comments I'm about to make in more detail as laid out on slide four. We're not a large hotel lender as noted by hotels being less than 2% of our loan portfolio. The majority of our hotels are flagged and none are oriented towards conventions or resort style accommodations. Over 83% of our hotel portfolio is not on a deferral and none are currently on the watch list. Restaurant exposure is noted as less than 3% of our portfolio. Retail CRE consists of $270 million in loans or 3.5% of the loan portfolio. The average loan size is less than $2 million in this segment and are to well-established borrowers that we have long-standing relationships with. We continue to proactively assess our loan portfolio in these more COVID-impacted industries as well as others to ensure we're taking appropriate measures as necessary. As referenced by Tom in prior comments, we have seen an uncharacteristic drop in commercial line utilization. It is my speculation this is driven by TPP loans helping provide our borrowers additional liquidity, and this decrease in utilization helps show the continued strength in our commercial loan portfolio. We're continuing to utilize our proven incurred loss methodology for calculating our A-triple-L and delay the CECL implementation. However, with second quarter, we increased our loan loss reserve to support the reserve as provided by our CECL model. It is our intent to continue to run parallel models. As of 6-30, our reserve was 1.10 as is, but when excluding triple P loans, we're actually at a 1.26%.

Thank you, Henry.

Bud Fossey is now going to give a financial update. Bud? Thank you, Tom. Good afternoon. Net interest margin for the second quarter was 3.32% versus 3.58% for the first quarter. Adjusting for the average Triple P loan balances of $886 million, Triple P interest income and $2.6 million and Triple P Loan Fees, the net interest margin was 3.47. Also adjusting for the increase in average Fed Funds sold balance of 358 million in the second quarter, the net interest margin was 3.44%. The remaining net deferred Triple P deferred fees are 28.9 million. That breaks down into fees of 31.1 million and deferred FASB 91 expenses related to the Triple P loans of 2.2 million. As far as future improvement to our interest expense, we have CD maturities for the remainder of 2020 at 247 million. The average rate is 1.67. We expect the majority of these CDs to reprice at .70% or below, and we are also reviewing our special rate DEAs. Another factor, we have 50 million of brokered CDs that mature in August, and the rate on those CDs is 1.67. A reminder, we have no accretion income related to acquisitions. Tom touched on this. Fed funds sold when we started funding the Triple P loans in April was $600 million, and the funds, excess funds, at the end of June were $1.44 billion. For our non-interest income, we added six new banks in the second quarter through the American Bankers Association credit card referral program. Credit card income, the net income was $1.4 million in the second quarter versus $1.7 million in the first quarter. The spend on our purchase cards decreased by $4 million in the second quarter, and the spend on the business credit cards decreased by $9 million. And we think the majority of that's related to the COVID. Merchant services fee income, The income in 2020 so far is $234,000. We expect that to improve because year-to-date 2019 was $249,000, and we have two officers that are dedicated to selling this service. Mortgage banking income, it was up $1 million for the quarter. It was $2.1 million in the second quarter versus $1.1 million in the first quarter. Also, we purchased a LIBOR cap, a one-month LIBOR cap in the second quarter, $300 million notional amount. The marked market adjustment in the second quarter was negative $252,000. The strike price for that cap is 0.50%. A reminder, we do not sell any government-guaranteed loans to generate non-interest income. Non-interest expense. The Triple P expenses for the quarter were $3.2 million. $2.5 million of that was bonuses and overtime. ORE expenses for the quarter increased $703,000, and that had to do with updated appraisals on two credits. Total producers were down a net of six producers year to date. We had 139 at the end of 2019 and 133 at the end of June. Total employees were down four. We had 506 at the end of 2019 and 502 at the end of June. Capital banks tier one leverage ratio was 9.90% at June 30th. And then tax update. Quarter-to-date tax rate for 2020 is 20.95, 21.22 without stock option tax credits, 136,000. Second quarter of 2019, it was 20.74, 21.15 without stock option credits, 186,000. Year-to-date 2020 is 19.95, 21.25 26 without stock option credits of $1.2 million. And then year-to-date 2019, it was $20.15. $21.23 without stock option credits of $958,000. Objective rate for the remainder of this year is 22%. This concludes my comments. I'll turn the program back over to Tom.

But thank you. Just a few things before we take questions. One thing I'd like to comment on is from a standpoint of economic improvement we've seen, it greatly exceeded any, I think almost any economist's expectations. I would agree with most of them that are currently thinking that we're going to need a couple of two or three years to get back to full employment economy. And I do think the community banks in our country will play a major role in helping us get create the jobs necessary to get back to full employment. And I think also, I think the political mood is such that they recognize that the community banks are necessary in our country, whether you're Democrat or Republican. I think they recognize that at this point in time. As I said last quarter, we do see significant opportunity for growth on the other side of this pandemic. You know, from a liquidity standpoint, I was fully expecting that we would need to draw on our Triple P liquidity facility at the Fed by the second or third week of April. Meanwhile, our liquidity has improved by $1.5 billion in the quarter, which my hope was that certainly that the Triple P money would prove to be much like hurricane money for banks that have been affected by hurricanes. I sort of call it hurricane money because of You know, the money comes in, and it might change hands, but it still stays in the banking system, and it hopefully stays in our bank, where our customers might have gotten the money, they paid it to their employees, they paid it to other vendors. Those vendors put the money back in the bank, so we'll continue to enjoy those deposits, at least for the time being. We do think having high liquidity with excellent credit quality will position us well as we go forward the rest of this year and in 2021. We'll be glad to answer any questions you have. Thank you.

We will now begin the question and answer session. To ask a question, you may press star then 1 on your telephone keypad. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star then 2. At this time, we will pause momentarily to assemble our roster. And our first question comes from Kevin Fitzsimmons of DA Davidson. Please go ahead.

Hey, good evening, everyone. Hey, how are you doing? I'm good. I'm good. Listen, I'll probably start out with a very top-level one. On PPP, it's obviously very lumpy, and it affects several different areas in terms of average balances, the origination fees, and Maybe when you touch on that, Bud, I think last quarter you guys had talked about maybe that flowing through the non-interest income line, but it looks like it's flowing through the margin line like the other banks. And then in terms of the impact to the margin, if you're looking out over the next few quarters, how should we be modeling PPP if you were us? Thanks.

Yeah. Final guidance on the accounting for that came out in June. And also we have set it up to be deferred over the term, the 24 month term. So we'll accrete that into income over the 24 month term. So it's 1.3 million a month that we accrete. It would be 1.1 million a month after you net out the Deferral for the deferred FASB expense. Is that what you're looking for, kind of monthly or quarterly totals?

Yeah, that's helpful, I guess, but what would you be expecting in terms of the forgiveness and these fees hitting in a lump sum fashion? It seemed like we were all thinking about a quarter ago that we would wake up in third or fourth quarter and you have these loans getting forgiven and it's coming in a lump sum fashion.

Yeah, I think we're still waiting on final guidance on that from SBA. If I had to take a guess, I would say probably be November, I would think, before all that's settled and we get our funds back from SBA on that. But that's just a guess. Maybe Tom, I don't

Kevin, they don't have the form yet. We couldn't apply for forgiveness today if we wanted to. We do have a positive carry on these loans. Again, we thought our liquidity would be such that we'd be in the Fed window by now, but we haven't touched it and are looking for home for liquidity, trying to find investments to buy instead. You know, let's say that they come out with it in August and we start the forgiveness process and, you know, September we apply. So then they've got 60 days to pay us. It might come, you know, it might come as early as October, but it might come as late as November, December, you know, as well before. And we under oath, you know, The idea behind 100% of our triple P loans is that they would all be forgivable loans. So we may end up with some small amount of money, but I can't imagine it would be more than $20, $30, $40 million of money left out in triple P loans after the forgiveness period. Does that give you a good enough answer, Kevin?

I guess the simplistic way to think about it is that as we're entering 2021, the PPP balances are gone off the balance sheet. The origination fees are mostly realized, depending on how we model that in. And then maybe if you could just touch on the margin. I know last quarter you said you hope the core margin would stay about The level of March, which I think was 360, and I know we have lumpiness from PPP, but I guess the excess liquidity was the big drag there on the 360 versus the 344. Is that how to think of it?

Yeah, yeah, because it's gone up. Well, today, from when we started funding the PPP, the liquidity is up a billion dollars. Well, $1.6 billion today in excess funds, over $600 million when it started.

And, Bud, would the thought process there be that as BBB winds off, that excess liquidity winds off as well, and you see some shrinkage to the balance sheet from that, but your percentage margin would go up in turn?

Yeah, you know, the biggest key is increasing our loan production. We spent a lot of time in the second quarter on the Triple P loans. We know we have to increase loan production, so it really depends on the loan production side more than anything. What happens to liquidity? I would think so, right? I mean, that's kind of what we're hoping for.

Yeah, I mean, when these Triple P loan proceeds that are clearly still in our bank run off is a good question. I certainly don't have the answer, Kevin. It's my first pandemic.

Mine too. All right. I took enough time. Thank you very much. Thank you. Thank you.

Our next question comes from Brad Millsaps of Piper Sandler. Please go ahead.

Hey, good evening, guys. Hey, Brad. Good afternoon. Hey, Tom, you guys had some nice improvement in non-performing loans. Looks like the deferrals are headed in the right direction. Just curious if you guys could talk about maybe criticized or classified loan trends that kind of might be going on in the background. It sounds like you're really pretty encouraged about the credit outlook, as best you could tell, but just any trends there would be helpful.

Yeah, you know, I think we've added one significant credit this quarter. It's not on the list of of credits we highlighted in the slide deck, but it is clearly affected by COVID-19. It's a specialty transportation company that's going to have issues until we get behind the pandemic and get a vaccine. So that's probably the number one credit that we've added. And, Henry, would you add anything else to that statement?

No, I mean, I think, you know, we're assessing the portfolio, but that's been the one big item that's been impacted that's, you know, It's going to take longer to come back.

But there's no big change in the level of criticized and classified loans from June 30, from March 31?

I wouldn't say any. Outside of that one credit, no material figures. Got it.

Got it. Okay. And then, Bud, just kind of wanted to quickly follow up on expenses. You had the $2.5 million in bonuses that were paid in the second quarter that presumed wouldn't be there in the third. But then I just wanted to confirm the FAS 91 cost that you expect, I think $2.2 million going forward, you note $2.4 million in total in the second quarter. Did you get the benefit of all those deferred costs in the second quarter, or is that the piece, the $200,000 or so that's going to accrete in over the 24 months? Just want to make sure I'm kind of clear on the puts and takes of the expense line on this quarter.

Yeah, we took $2.4 million as a credit against salaries and benefits, and then that plus the Fee accretion, all that nets to the interest income. That will go against the margin once that accretes or amortizes back into income over 24 months. In other words, you've got between the two, you had $28.9 million net between the fees and the referral, and that $28.9 would have 22 months left to accrete into income.

But the FAS 91 that you incurred in the second quarter, does that essentially offset the bonus payment? So in other words, in the third quarter, the expense is going to stay relatively flat.

Right. You had that. You had $2.5 million of expense offset by the $2.4 million in the deferral in salaries and benefits.

Okay. Got it.

Does Brad have the net number? The net income number? The income number is $1.4 million off Triple P in the second quarter.

Well, I think what he's talking about is the 2.5 in bonuses and overtime minus what you deferred in FASB. I thought maybe he was trying to arrive at an answer, and I thought I'd help him get there.

Sorry. Yeah, yeah. No, yeah, yeah. That's helpful. And then the difference, I think you said $4.1 million in fees this quarter, right? 2.6 million in fees and 4.1 million in total. The difference would be the coupon and the fees. Is that right?

No way. So we took 2.6 million in fees. So 1.3 million a month is what we'll defer from a fee stamp. Okay.

Got it. All right. I may follow up with you, but thanks very much. I appreciate it.

I'm confused, so you might be as well, Brad.

Yeah, I'll follow up with you offline.

All this bad deferral business is very confusing. I look at it as a very straightforward. We took almost $5 million of the BBB money into income, and then we had expenses that offset it, and we had $1.8 million pre-tax. And you take taxes out, we had $1.4 million net income for the quarter off BBB. Now, this is after we thought we had a clear understanding of how we could take all the triple fee fee income in in the second quarter, but obviously that changed on us. The accountants changed their opinion on where we were, what we thought was their opinion. It's not a typical origination fee. We don't look at it as a – I didn't think it should be characterized as a typical origination fee on loans.

Yeah, I guess the best way, so going forward, you'll have gross $3.3 million a quarter in net defer off the fees and the deferred FASB. So that will come into income each month. Your expense side goes away. All the Triple P expenses were recorded in the second quarter. So going forward, you'll have that $3.3 million that shows up in the margin until those loans pay out.

Got it. Got it. Understood. So about $3.3 million a quarter.

Yeah, $3.3 million a quarter. Yeah, each quarter. Assuming they get to – yeah, I'm with you.

Okay. Thanks, guys. I really appreciate it. Thank you, Brian.

Our next question comes from Arjun Tulecha of Jaroslawski Fraser. Please go ahead.

Good evening, guys.

Hey, RJ. How are you?

Very well, very well. I have a couple of questions. First one is on competition. Are you guys seeing competition pull back, mainly the big banks, which usually tend to, you know, in these times and sometimes those give opportunities for someone like us to grow? Are you seeing that dynamic play out?

Yes, we are in different, you know, especially... Primarily, one thing is on multifamily construction projects that they were pulling back and the pricing has strengthened. In fact, we've seen pricing strengthen across the board during the pandemic in every area. We're not seeing the intense price competition that we saw prior to the pandemic. You still see some. There's some people that haven't gotten a memo yet that the world changed a bit, a few banks, typically smaller banks that haven't gotten a memo yet. on the world has changed. But we are seeing competition pull back. We did a lot of Triple P loans for customers of other banks during the pandemic with the understanding that they would move their bank into us. And we've also had a lot of companies contact us that were unhappy with the bank. They did their Triple P loan through their old bank, but they want to go through the forgiveness period with their old bank before they change banks, which is certainly understandable. I would do that myself. So we do see opportunities there, Arjun.

Okay, okay, that's helpful. And I guess it's good that pricing is getting better because, you know, the Fed rate cuts, I mean, the better pricing can offset that a little bit for a bank to have a good margin. My second question is, on our losses. So, you know, I'm kind of pleasantly surprised, but I'm also a little confused. So help me in understanding this. When I look at your provision line, I don't see a recession in U.S. But when I look at, you know, provisions which other big banks are taking or other peers which we have, they're taking big provisions. So I'm curious, is this our bank specific that, you know, we have a tighter credit? or is it because of the segment of the customer we are in that segment is just stronger? And I'm not talking about just COVID-related losses which are in hotels and restaurants. I'm just talking about losses which happen in a recession which we don't even see today. But a bank will model out and say that if I see myself going through a recession, I expect a certain number of losses. And I don't know which customer will go bankrupt, but I'm just going to provision it right now and keep it there. So it has been understanding, you know, what do we think about that?

You're asking a good question. We certainly don't, you know, I can't speak to other banks and their provision, but, you know, we're not in a lot of the heavily affected industries to a great degree. Certainly we have minimal energy exposure. You know, our restaurant and hotel exposure is certainly we have probably a little bit more than you want right now, but we certainly have, you know, well-managed facilities. exposure in those industries. I've maintained since the pandemic started that the customers that are going to suffer are not necessarily ones in the affected industries. They're going to be the weak customers in every industry. And I think that's playing out as people that are the weak players are not doing well. And as I said last call, am I surprised that JCPenney got in financial trouble? No, because they were I think the peak of their, as a retailer, was when I was in grade school, and I'm 65 years old, so it's been a long time since they've been a viable company. We think we've adequately, we are providing for more than our model calls for. We're matching our CECL model We don't have a lot of consumer exposure. We don't have any energy exposure. And those are certainly two areas where you see some big provisions. But the best I can tell from some of the larger banks, and I look at their financial statements, their quarterly financials, and I don't know, Henry, would you add any, Henry Abbott, our Chief Credit Officer, if you could add anything to that? Clarence Fauci, our Chief Operating Officer.

I'd say that if you look at what we reserved in the second quarter of 2019, roughly $5 million, in this quarter we put in $10 million. So we've doubled from where we were a year ago. So we're certainly reserved. And as Tom mentioned, we put more than our model. And as my comments were earlier, we're excluding PPP. 1.25, 1.26 on a reserve. So we think we're adequately reserved with what we have.

Clarence, would you add anything? I would just say that we're not a leveraged lender. We don't have any leveraged loans. We have a very small position of shared national credits. Those are companies that we know with our footprint that we know leadership and we have a deposit relationship with. It's around $50 million of shared national credits. So a low position there relative to the overall portfolio.

Is that it? Thank you. Yep, that helps. Thank you very much. Thank you.

Our next question comes from William Wallace of Raymond James. Please go ahead.

Thanks. Good evening, guys. Hi, Wallace. Hi. So I was... surprised at how well your deferrals have improved. And if I'm reading the table on slide five correctly, it would appear that the majority of your deferrals are coming off before the deferral period is even over. Am I reading that correctly? Go ahead, Henry.

No, I mean, they're not coming off before the deferral period is over. So, no, I wouldn't agree with that statement. But once If someone is through their three months of no payments, we are then taking them off deferral unless we're in discussions with them regarding a second deferral. The table should show that progression decreasing based on the fact that that next payment due from that borrower would be a full payment, which would be owed.

Oh, okay. Gotcha. Are you in conversation with all these customers that you feel confident that the $1 billion or so in loans that are coming off deferral between now and the middle of August are actually going to pay? Or are those conversations ongoing?

We've had over a billion come off. We're down $127 million. as of July 15th.

That number is a little bit different than the slide deck, Wiley. Yeah.

What's the difference? The slide deck had $140 or $145 million, and that was early draft, and it got out there, but the actual number is not much different. It's $127 million in July 15th, still on deferral. Keep going, Wiley.

Well, I guess I'm looking at the 531 balance of $1.248 billion. which was 45 days from July 15th. So I guess what I'm trying to figure out is how so much has come off. So these guys that are off are all due before 8-15. Give him some white points, Henry.

So for instance, if someone started a deferral, on April 5th, okay? So they didn't make an April 5th payment because they were on deferral. And once again, the vast majority of these were principal only, so they continued to make interest payments. But if someone was on a deferral for April 5th, May 5th, June 5th, and then they make their July 5th payment, they're off deferral. And in reality, they're off deferral after that June 5th payment because it becomes June 6th. Their next payment is a true payment. So they're out of a deferral come June 6th. if their payment was due on June 5th, and we then deferred principal or if it was a full payment deferral.

Yeah. So is it fair to say that then that they came off before they were – they could have not paid the June payment or the July payment, right, if it was a 90-day deferral?

If they were off of this report, that means that their next payment owed is a full payment or deferral.

All of that one whatever billion has made their payment since their deferment period ends. They're officially not going to go to a 180-day.

Overwhelming majority, yes.

I add that a number of customers Fairly significant number got approved for deferral and then continued to make their payments.

Were they counted in these numbers?

They were counted as deferral.

Okay, fair enough. If a loan does go, if a customer does go to a 180-day deferral period, will you have to downgrade that loan? No.

We're certainly, anyone who's asking for a second deferral, it's not an automatic downgrade, but at the same time, it's something we're looking very hard at, and in most cases, it would be downgraded at that point in time, but we're taking it on case-by-case basis and evaluating repayment.

In some cases, they may be asking for a second deferral because liquidity position, you know, like some of the medical providers, that sort of thing that have seen their business fall off. We feel pretty comfortable most of them will resume normal operations here. You can only put off putting in a new HIP so long. We see those returning to normal, Wiley.

Okay, thank you. Then when we had the last conference call, and it seemed like in your prepared remarks, Tom, that the credit has held up better than you would have anticipated. In the last call, I read what you guys were saying as the accelerated loan fees from the PPP would be used to build the reserves to account for the economic environment.

Do you still anticipate that you would

Be building your reserves aggressively over the coming couple of quarters, or given what you're seeing, do you think that that's now you're more likely to book those fees as these loans are forgiven in the income?

You know, I still take the posture today that it'll be, you know, we're probably the vast majority of that I would expect to add a loan loss reserve just for, you know, the unknown in the future, Wally. I don't know exactly how I think it's too early to declare a victory, so when we get that money, we'll probably defer the vast bulk of it into the loan loss reserve.

Okay. Thank you. That's very helpful. So it's been kind of an interesting couple of months to see how the headlines have shifted from all is fine to all is not so fine as it relates to the spread of the disease, and now you're seeing states starting to Slow Down the Reopening Process, and you operate in some markets that are seeing some pretty significant growth in the disease, and some of the states that you operate in are starting to change their opening schedule. I'm curious. It's early, I understand, but I'm curious if you have an early read on how that's impacting your customer base in some of those markets that you operate in that are kind of seeing more severe spread.

My take, I'm going to ask Henry and Clarence to chime in, but I don't see any significant deterioration from the policy reopenings. Most of our companies, if they're manufacturers in the construction business, they never slowed down much. Some of the manufacturers did. Construction never slowed in the south like it did in the northeast. We don't have a lot of exposure to, obviously, and many of the fast food, fast casual are doing quite well. So I don't think there's a significant, you know, hitting the pause button on these states reopening, I don't see a big fall off in economic activity. Henry, do you or Clarence?

No, I mean, I agree with Tom in that they've already had to make their changes to their business model to adapt, and whether they thought things were going to get better quicker or not is a different story, but they've already kind of had to right-size what they were doing at some level, and now while things are changing a little bit, they had already made their changes, and so I think most of the businesses are continuing to perform adequately.

Okay, great. And then just one kind of just to maybe put some dollars to an earlier question around the expense line. So netting out the deferred expense adjustment and the bonuses, it sounds like if we just use the gap number for the expense of $28.8 million, that that's probably a good baseline to work off of in our models. And assuming that that statement is true, what is Service First doing to manage expenses and investments, et cetera, in light of some potential pressures that could be coming down the pipe.

Well, we've already been doing it, Wally. We've been capping salary increases for this year. It won't bear a lot of fruit this year, but it'll bear fruit next year. Certainly, headcount, We're looking hard at everybody and every department trying to cap expenses where possible. Certainly charitable contributions, anything that's controllable, we're trying to control it as closely as we can. Obviously, there's a lot of noise right now with the Triple P expenses. Everybody that we asked, we needed help from on Triple P, our vendors, they saw us coming. and they charged a big price. We think all of our Triple P fee expenses are behind us except for we are a defendant in one class action lawsuit on agent fees. There are a number of them around the country and we're a defendant along with a number of other banks on the case in Pensacola, Florida.

So putting that together, it sounds like you're saying that you think there's probably some room for some improvement on the expense line.

Yeah, we do. And we're proud of our efficiency ratio. We got to 32% this quarter, which we think is probably one of the better in the industry. But as far as absolute, the expenses don't look good after this quarter, obviously, you know what the answer is. Yeah.

Okay, thanks, guys. That's all I had. I appreciate your time.

Our next question comes from Kevin Swanson of Hovde Group. Please go ahead.

Hi, guys.

Thank you.

I think most of the questions were answered. I think we covered quite a bit here. I just wanted a couple of quick follow-ups. With the pandemic results kind of pushing the balance sheet over $10 billion, Post-COVID, where do you kind of see that shaking out in regards to the go-forward basis, and does it change any of kind of your longer-term expansion plans?

Yeah, I was afraid somebody was going to ask that question. You know, the hurricane money, as I call it, you know, is it here to stay? How much of it is here to stay? Will we fall back below, you know, $10 billion? I probably don't think so. We'll come under large bank supervision after two quarters. We really already have. Our examiner teams have been preparing us for over a year now to become a large bank and certainly in the control of how they manage us and how they regulate us. So we think we're getting close to where they need us to be from that standpoint. No, I didn't answer all your questions. I missed something in there, Kevin. What was it?

Did it change any of your longer-term expansion plans?

No. We're still talking to people, but right now during the pandemic, most people aren't looking to make a change. As you might imagine, people are, from an employment standpoint, we don't have a large, we're talking to one group, a pretty good-sized group of production people actively right now, but usually we'll have three or four we're talking to at any given time. Most of them don't work out, but We usually have three or four we're talking to at a time. I would say activity is off a little bit from that standpoint. Of course, the first few weeks of the pandemic, we weren't looking to make any big changes in our business plan or business model. We were focused really on taking care of our clients, A, number one, before we do anything else.

I appreciate M&A has not been on the radar for a while in terms of the priority list, but it seems like your guys' currency has held up quite a bit better than most out there, and maybe there's some banks that aren't surviving through the process as well. Do those conversations heat up at all, or is it still obviously organic first?

Well, we'll be willing to, but we still want to see where the economy is going ourselves. I don't know how Henry could do due diligence on a loan portfolio very well today of another bank. I don't think he would relish the thought of doing that. So probably we need a little bit more time for a little clarity for the dust to settle. Kevin?

Yeah, that makes sense. Yeah, I appreciate it. And then maybe just one final one, I think. Maybe last time we spoke, there was some idea that the PPP loans would be sold off. I think we've seen a few banks take that option. Is that still under consideration, or does it seem like you're going to hold these through kind of the whole period now?

We thought that there would be a forgiveness process. Again, we thought we would be in the Fed liquidity window by the second or third week of April and that we'd be out of money. and have minimal liquidity in the bank instead of record levels of liquidity. We thought that the SBA forgiveness process would be much farther along than it is today. They don't even have a form designed yet. They say they're coming with a form in the next few weeks. We had a timeline where we would have all the loans forgiven and off the books by the end of June. So I guess perhaps I was naive in dealing with the government to think that we would have that sort of an efficient timeline in terms of forgiveness. But, you know, we had a timeline worked out where the loans the customers would have earned, you know, the payroll would have been done. They could have applied for forgiveness. By the second or third week of June, we'd have them tendered. and we've had customers a lot of ask and say, hey, we'd like to get this done. We say, well, you know, there's not a form. Just because they send us the forgiveness form doesn't mean it's forgiven. It's not forgiven until the SBA repays us the money with interest and they have 60 days to do so. So, you know, the companies would like to get it off their balance sheet but no, we still see the vast bulk of these loans but Again, considering the fact that we do have a positive carry every month on these loans, I mean, 1% is not much, but it's better than the 10 bips we're earning at the Fed per annum. So it's 10 times that amount. And we've not been rushing out to buy a lot of new investments right now. We kind of want to see where this liquidity settles, the hurricane money, how much of it sticks, how much of it leaves. There are a lot of unknowns. I think most banks, given a lack of clarity in the economy, keeping large liquidity makes a lot of sense. It presents us with a lot of options on the other side of this in terms of our ability to make acquisitions, to grow. We'll be able to do what we want to do. We think there will be a lot of opportunities for the bank on the other side of this. We're still extremely optimistic. We just don't have the timeline down of when's the pandemic going to be over. I don't have another answer to that question.

I appreciate it. Yeah, I appreciate it. That's great. Thanks a lot for the questions.

Thank you.

This concludes our question and answer session. The conference has now concluded as well. Thank you for attending today's presentation, and you may now disconnect.