ServisFirst Bancshares, Inc.

Good afternoon and welcome to the Service First Bancshares, Inc. first quarter earnings conference call. All participants will be in 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 touchtone phone. 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 Ed Woodie, Controller. Please go ahead.

Good afternoon, and welcome to our first 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 will take your questions. Some of the discussions during our calls 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 Service First assumes no duty to update them. With that, I'll turn the call over to Tom.

Good afternoon. We're very pleased with our quarter and we're glad you could join us on our call today. We do continue to see rapid improvement in the Southeastern United States economy. Supply chains are still not rebuilt, so line utilization has not improved during the first quarter. And I think we're seeing inflation, and a lot of our customers are reporting large inflation in their material cost, and so that should lead to line utilization improvement as the year goes on. I've talked to one diversified manufacturer wholesaler last week who said everyone is gouging everyone out there and I know that there's a shortage of labor in most every industry today. The unemployment rates in our state are averaging 4.7% in February and we are seeing improvement monthly in that number. And I can only recall one first quarter of any of our 16 years where we had any We did have a little bit of growth in the quarter, but one of our largest clients had seasonal pay downs that offset the growth in the non-PPP loan balance. As I've mentioned before, we have not seen the line utilization rebound as of yet, but do expect improvement through the rest of the year. And talking about our loan pipeline, our loan pipeline hit record levels at the end of March, beginning of April. Our 90-day pipeline has doubled since January, and we do expect significant loan growth in the second quarter. This includes expected fundings as well as draws on construction loans. And while our pipeline is not exact and you do have unexpected payoffs, This is the highest pipeline in the last 12 quarters, over $300 million. Our goal for the year is to replace our Triple P loans with other loans by year end. Bud Foshew will give a Triple P program update in a few minutes after Henry Abbott. So I do feel confident we will see loan growth this year. We do continue to see more opportunity due to mergers. Our performance with Triple P in attracting new clients and incumbent banks' poor performance with Triple P. Based on pinup demand, we do see continued improvement in our footprint. On the deposit side, we do continue to attract deposits with annualized growth of 24% in the first quarter. The growth has been very broad across the entire company. You know, while the industry does have substantial liquidity today, as our bank does, we do feel confident core deposits will add value over time. New account openness has steadily improved over the past six months, and we're very, very high in the month of March. So now I'm going to stop and turn it over to Henry Abbott to talk about credit quality.

Thank you, Tom. I'm extremely pleased with our first quarter results and our bank's credit quality. Our numbers generally speak for themselves. So I'll give a few key metrics and hit the high points. Non-performing assets were down to under $20 million on a total loan portfolio of $8.5 billion. The $19.9 million in NPAs is a $5.5 million reduction from the fourth quarter and roughly a $21 million reduction from the first quarter of 2020. This results in NPAs to total assets of 16 basis points, which is a 5 basis point reduction from Q4 and a 28 basis point reduction from the same period in the prior year. A key driver in our reduction in NPAs was various sales from our Oreo portfolio to bring it to its lowest level in more than 10 years. The now $2 million balance in our Oreo is a 68% drop from year end. Our core key credit metrics have not been this low since 2015. As referenced, our continued exceptional asset quality and strong balance sheet lead me to be optimistic about our bank's future. This NPA reduction was not achieved at the expense of the income statement as we had extremely minimal charge-offs in the first quarter. The $487,000 in net charge-off to average loans for the first quarter on an annualized basis were two basis points versus 41 basis points in the fourth quarter and 26 basis points in the first quarter of 2020. On strictly a dollar amount, net charge-offs have not been that low since the first quarter of 2016, and at that time, the loan portfolio was only $4.3 billion, which is roughly half of where we are today. Our past dues to total loans were seven basis points, $6 million A 34% decrease from year-end. We grew our ALLL by $7 million in the first quarter. Our ALLL to total loans was 1.12. However, excluding PPP from total loans, our ALLL to loans was 1.26. Government aid and stimulus, the primary example being PPP, have helped soften the blow from COVID. That said, our credit culture, geography, and diverse nature of our commercial loan portfolio should help us be well positioned to grow and prosper as the economy fully opens up and expands. With that, I'll turn it over to Bud.

Thank you, Henry. Good afternoon. Net interest margin for the first quarter was 3.20 versus 3.27 in the fourth quarter of 2020. The adjusted margin was 3.08. excluding the average PPP loan balances of $956 million and PPP interest income and loan fees of $11.4 million. Adjusted margin for the fourth quarter was $3.23 excluding the average PPP loan balances of $1.01 billion and PPP interest income and loan fees of $10.1 million. The adjusted margin was 3.27, excluding the increase in excess funds of 411 million. Fourth quarter adjusted margin was 3.36, excluding the increase in excess funds of 311 million. The remaining net Triple P deferred fees at 331.21 are 20.4 million. 9 million relates to round one and 11.4 million. The repricing will result in a 1.3 million annual expense reduction or 717,000 for the second quarter maturities. Quarter-to-day cost of interest-bearing deposits has decreased 0.38 in the first quarter versus 0.44 in the fourth quarter of 2020. Our quarter-end deposit costs, total deposits was 0.25, total interest-bearing DDAs 0.25, and our total interest-bearing deposits 0.36. Reminder, we have no accretion income related acquisitions. And for a triple P recap, round one, 4,962 approved loans. The total loan amount was 1.09 billion. Total fees, 34.4 million. And Service First ranked 89th out of 4,839 participating banks. The balance of those loans at the end of 2020 was $900 million. Round two, 2,287 approved loans, total loan amount of $407 million, total fees of $16.7 million. And Service First ranked 87th out of 4,628 participating banks in round two. Triple P balance at the end of March 2021 was $968 million. 2021 Round 1 loan forgiveness is $334 million. 43 loans, $2 million and above, have been submitted for forgiveness. Only one for $2.2 million has been forgiven. And the dollar amount of loans awaiting forgiveness is $130 million. Monthly yield including Triple P fee accretion on Round 2 loans will be about 45 basis points lower due to the loan term being five years versus two years for Round 1. Liquidity excess funds were $600 million when we started funding Triple P loans in April 2020. Excess funds were $2.7 billion at 331.21. Non-interest income, credit card spend amount, $169.8 million in the first quarter is $168.4 million in the fourth quarter of 2020. And the first quarter of 2020, the spend amount was $146.1 million. Credit card net income, first quarter was $1.2 million, which included an accrual adjustment of $290,000. First quarter net would have been $1.5 million without the accrual adjustment. Fourth quarter of 2020, the actual was $913,000, and that included a rebate accrual adjustment of $870,000. First quarter of 2020, net income was $1.8 million. Merchant services fees, year-to-date, $21 million. is $191,000 versus $100,000 for year-to-date 2020. And we have two officers dedicated to selling this service. Mortgage banking income is $2.7 million in the first quarter versus $3.1 million in the fourth quarter. And first quarter of 2020 was $1.1 million. A reminder, we do not sell any government-guaranteed loans to generate non-interest income. Non-interest expense, total producers at the end of 2020 were 133. March 31st, 21, 131. Total employees at the end of 2020 were 499 and same number at the end of March of this year. Total non-interest expenses in the first quarter of 2020 were 27.9 million. First quarter of 2021, $28.9 million. So for the increases, first quarter expense for incentives was $3.7 million versus $2.7 million for 2020. And the increase is primarily based on projected production from new producers. Our unfunded commitment reserve for the first quarter was $600,000. Mortgage commissions increased by $308,000 and FDIC insurance increased by $224,000. For decreases, the net ORA expenses were $157,000. The Triple P FASB 91 deferral was $1.1 million in the first quarter for Round 2 loans. and just note that our salary increase year over year was only $11,300. Capital, despite a $2.8 billion increase in deposits year over year, the bank's Tier 1 leverage ratio remains well above the regulatory minimum. Earnings retention year to date is 79%. Tax update, First quarter, the rate was 20.18%. For 2020, that number was 18.76%. And the projected rate for 2021 is 22%. And that concludes our presentation.

We will now begin the question and answer session. To ask a question, you may press star then one on your touchtone phone. If you are using a speakerphone, please pick up your handset before pressing the keys. To withdraw your question, please press star, then two. Our first question today comes from Graham Dick with Piper Sandler. Hey, guys. Good afternoon.

Hi, Graham.

Good afternoon. So just starting on credit, just wanted to ask what might have caused the CECL model to require you guys to build the reserve further this quarter? I was just kind of surprised to see this considering credit quality metrics improved and seems like the economy has done the same since 4Q.

Well, Graham, that's a reasonable question, a very reasonable question, I would say. But I think that, you know, we do feel really good about where we are, but, you know, it's just we've been through the worst pandemic and, you know, that I've ever experienced and you've ever experienced. So we just want to be a little bit cautious in terms of, you know, doing anything in the way of a, you know, loan loss reserve release at this point in time. So, you know, it's nice just to have a little bit more dry powder there in the event of something unexpected. We don't know of anything and don't feel good about it. But it's just, you know, we're just a little bit gunshot because of where we've been for the last year.

Definitely, definitely fair. So I guess just kind of going forward, do you expect any more reserve build or are you pretty comfortable with this like 126 level of reserves of XPPP?

Yeah, I think, well, I think because of our projected loan growth in the second quarter, we will have reserve build. but not, you know, as percentage, it will not increase. It certainly will decrease as we go forward. So we'll add dollars to the loan loss reserve in the second quarter because of the projected higher loan volumes. If that makes any sense. Did I answer your question, Graham?

Yeah, absolutely. It's perfect. And then I guess turning to loan growth, with you guys sitting on that record loan pipeline and a load of excess liquidity, how strong do you think

Well, you know, we said that year-end our goal is to replace all the Triple P loans that were outstanding at year-end with other loans, obviously non-Triple P loans. So that's some $900 million. That's our goal of what we'd like to replace for the year. And, you know, I feel better about that goal today than I did when we said that three months ago, right? So just because we see pretty clear, pretty substantial lung growth. Actually, we've already had some pretty good lung growth this quarter in the first two-thirds of the quarter here. And we feel good about the rest of the quarter in terms of some substantial lung production. And we're not yet seeing the line utilization improve, Graham. The real question to me is, you know, we have had some customers come in and increase their lines just because they said the cost of steel is going up, the cost of lumber is going up, or whatever else they keep in inventory. That should lead to improvement in line utilization in time. But just, you know, the good old-fashioned, you know, the $300 million we lost last year, I don't know when we're going to get that back, and I can only hope that We get some of that, you know, that's just a natural lift you get without having to do a whole lot of hard work, right? So I'm looking for that. And hopefully that'll happen. Some of that will happen in the second half of the year. Graham.

Okay, great. That's helpful. And I guess just lastly, a quick one here. Do you guys have the loan yield excluding PPP loans? The release just says the total loan yield and I'm just trying to Get a sense for how much more pressure there may be on core loan yields, if any at all.

Yeah, for the first core, so the margin was 320, excluding Triple T, it was 308.

No, he's asking loan yields.

Oh, loan yields. Just new production?

More particularly on just I don't have that one. No, I can email it to you. Yeah, I just pulled the margin. I don't remember the actual loan yield. Okay.

Yeah, no problem. Thank you, guys. Congrats on a good quarter. Thank you.

And our next question comes from Will Curtis with Hovde Group.

Hey, good afternoon, everyone. Good afternoon, Will. I appreciate the details on kind of what you have coming up from a deposit repricing. I'm just curious, you know, if you can kind of size up what the expectations are for the margin when you back out, you know, all the noise from PPP that, you know, maybe over the next couple quarters and you kind of manage through the liquidity headwinds. Just curious how you're thinking about the trajectory of the margin from here.

Yeah, you know, well, like Tom was talking about, if we can replace the $900 million we had in Triple T by the end of the year, it definitely has a positive impact because new loans are going on around the $425 million yield level. So we expect, the key to the whole margin of improvement is having that much in new loan production this year. So if we have that, margin context care of itself as these PPP loans get forgiven.

Got it. Okay. And then I think, Bud, I may have missed this. You may have provided it, but the average balance of PPP for the first quarter, did you give that number?

Yeah, $956 million. Okay.

Got it. All right. And then just the last one here on the I think last time you guys talked about expense growth this year being sort of similar to kind of what we saw last year. So I'm just curious if that was still kind of a fair expectation as we think about the 2021 expense base.

Yeah, I think so. Like we talked about, the biggest increase will be our core conversion. We budgeted a $2 million increase related to that, so we still think excluding that will We can definitely keep our expenses under control. And I think we talked about the fourth quarter call that, you know, we're adding people. It's mainly production people. So they've got to come in and produce pretty quickly to pay for themselves.

All right. I appreciate the caller. Thank you. Thank you, Will.

And again, if you have a question, you can press star then one. Our next question comes from Kevin Fitzsimmons with DA Davidson.

Hey, good afternoon, everyone. I was wondering if maybe we can, you know, we've talked about loan growth and we've talked about margin. Maybe just if we can simplify it and talk about dollars of NII, because a lot of times we're dealing this quarter with growth in the balance sheet, but the margin gets hit. But what's your outlook for dollars of NII going forward? Do you think it stays Soft or, you know, relatively soft to positive, but then picks up over the course of the year as you get more production and loans.

Let me think on that. So you're saying, so even though we're going to replace, you kind of want to know what we're going to add on new loans versus what's rolling off or given?

Yeah, I mean, it's a lot of moving parts, obviously, with you guys are trying to replace PPP with new loans, and then the elevated liquidity is, you know, that's uncertain, right, as far as when and how that rolls off, and just wondering, you know, how smooth of a trajectory that would be.

Yeah, and what also complicates it, you have $9 million in fees relating to round one, and If all those loans are forgiven, Round 1 loans are forgiven by the end of the year, you've got $9 million in additional accretion that will come in. So that definitely impacts how you're looking at the margins of the year.

Right, right. You heard us say all the loans except one over $2 million of Triple P from Round 1 are hung up. They have been zero forgiveness. There was one forgiven on the first day. The portal opened. I think that was forgiven by mistake. So all the other 43 out of 44 are still, and there's no word at all from the, nor do I think any of our competitors have had any forgiveness there either.

Yeah, I've certainly talked to peers, and nobody is getting forgiveness on $2 million or greater loans. I mean, they all seem to be held up at this time.

And your guess is as good as mine on that. What's weird, you know, We're earning 1% on those loans instead of 10 bips at the Fed, so I'm not completely unhappy about it. I like it. It suits me fine. I know our customers want forgiveness, and they want to get it out off their plate, and I don't blame them a bit, but in the meantime, it's okay.

How about if we're expecting the economy to continue to reopen and growth to materialize, can you talk about... New market expansions. I know you opened an office in Florida fairly recently. And just the state of are there any new markets on the docket as you look forward? Are there new teams that you would like to go out and hire? Or do you have the team in place right now for everything you see coming?

Yeah, we will have some announcements in the next week. You know, week 10 days, Kevin, on that. We just can't do it just yet. We actually have some people in hand and we're working on a press release on a new market that's imminent. Actually, they're on board. They started today. So we just can't talk about it yet. But we will have them and we also have a group coming in Friday from another state to visit. So we have some potential This is moving time of year, as you know. For people that were an asset for us and have become a liability, it's time for them to leave and it's time for new people to join us. It's moving time right now. We feel pretty good about where we are.

One last one, Tom. We always ask from time to time about M&A and that's never really been Your focus, you guys really focus exclusively on organic growth and bringing in teams or producers, although there's been a lot of merger activity we've seen recently and with larger banks, and now you guys have even more of a commanding multiple that you could use if you chose to use it. Do you feel any differently on that front, or are you just consistent with how you've looked at it over the years?

Yeah, I think we would certainly, obviously, you know, our multiple's a little bit higher than the industry as a whole and, you know, the right opportunity, we're always interested and we're always willing to talk. It's just, you know, finding something that's branch-like and is a good cultural fit, you know, there just aren't many of those out there, you know, which you well know. So we're more than willing to talk and we understand the, you know, potential You mentioned that you'd want a target to be branch-light.

Is it possible to get a target that's not branch light but you make it branch light over time or is that too much of a hurdle with regulators or how do you look at that?

I think it's a hurdle. I think there are a lot of people who would like to lighten the branch load right now and there are a lot of reasons they can't do it. We've got a couple of offices we need to close and we can't get our own people on board to close them. You know, and we're only a 16-year-old bank. So it's, you know, it's a lot of our internal people, you know, that's a branch where I go cash my checks. I don't want to close that branch. I mean, that's, you know, it gets out of things like that, Kevin. I mean, you'd think it wouldn't, but it does. And so it's, in a bank that's, you know, been around 30, 40 years and they've had these branches and you've certainly got key issues with regulators and closing branches and You know, it just feels like the bank has failed in some fashion when you start closing branches. That's the biggest problem in closing branches. It's like, well, what's wrong? Why is my bank having to close these offices? Is my bank in trouble? I mean, you know, what's the problem? And, you know, you try to explain it to people, and there's just not a good explanation out there. It's just not a whole lot of fun for anybody. But certainly, I think the pandemic, we'll see, but I don't think branch traffic is going to pick up in the industry permanently. You know, post-pandemic, you know, did people quit coming because of the pandemic? They might have initially, but now I think they found additional channels, you know, so I don't think we're going to see, I think it's a secular trend that's going to continue for branches to continue to wither away. But they're, you know, they're not going to die a quick death, they're going to die a slow death, and it's going to be a, you know, it's going to be a drip, drip, drip of losses in the retail branch front, you know, for years they are.

Yeah, all great points. Thanks, Tom.

Thank you, Kim.

Our next question comes from William Wallace with Raymond James.

Thanks. Good evening, guys. Hey, Wally.

Hey, so, Tom, that was your answer to the question just now. Actually, to me, it was a little bit surprising. I kind of felt after your last acquisition that you weren't really that interested in mergers. Are there partners that fit what you just sort of described as a potential kind of attractive partnership that exists out there? And are you having conversations or is this, you know, if the right thing just happens to fall in your lap, you'd take a look?

Yeah, you know, I won't say they're unicorns, Wally. But, you know, most of the people that would fit it are doing quite well on their own. So why would they want to, you know, do anything different? You know, short of age issues, and you know, that's what we see sometimes is we'll see some people that are, you know, I had a friend in, you know, actually in Texas said, hey, there's a bank, you need to buy it. And I said, well, you know, the CEO of 76, who's his backup management, said he doesn't have any, you know, you'd have to send somebody. And I said, well, you don't send people to Texas, you know, they're not accepted. So I don't care if we're from Georgia, Alabama, Mississippi, they're not accepted in Texas. So, you know, we certainly weren't interested in buying that bank. So it makes it hard to find a fit where there are reasons for the bank to sell and reasons for us to want to buy it and they all match up. I mean, I think you're, it's a little, they're not unicorns, Wally, but they are not numerous, let's put it that way. We have some friends in the Midwest that buy banks and they They told us how many potential bank targets they had. It was in the hundreds. Ours are certainly not in the hundreds. It's more like in the tens than hundreds.

Okay. All right. Thanks. That's helpful. I apologize if you gave this in the very beginning, but I believe last quarter you were talking about utilization rates down in the 38, 38.5% range. Are they still down there or have you seen some usage increase?

I didn't give it, Wally. At 1231, let me go back. At the end of 19, it was 48.1. The end of 20, 39.5. And it's even lower today at 37.7 because of the Triple T Round 2 decreased line utilizations again. We've got to get all the government cheese spent and out of the way so we can start getting some draws back on these lines.

Okay. All right. Yeah. Wow. And then another follow-up on the net interest margin conversation. If you look at new loan production, are the yields on those loans, are you seeing competitive pressures or are they holding in? Or are you actually seeing relief?

You know, we... You know, it's competitive. I won't say that, but we try to be disciplined, Wally. We think the bikes that are disciplined are going to be the winners. You know, we think we'll get the finish line, you know. I see some people that aren't disciplined, but I don't think, I think they're living for today. You know, they maybe want to show an analyst, you know, some growth today and, you know, they're not worried about tomorrow because they're going to plan on being, they're planning on being retired to their beach house in Florida tomorrow at some point, right? So, We want to be in this long term and for the long game, so we are certainly trying to be as disciplined as we possibly can from a pricing standpoint. We see some pretty good opportunities right now. We've been impressed with how things have opened up month by month each of the last three months. We're thrilled to be in the southeast United States. Again, I say that every quarter, but You know, and we're thrilled not to be in the retail banking business. You know, I think we're, I like, I like, I like our space of where we have the bankers position and I like our markets. I like our asset diversity and feel good about where we are. Don't leave anything out.

All right. So, so, so, so generally speaking, the, the, Thank you for joining us.

You know, especially, you know, the restaurant workers are still, you know, they're getting more than, you know, than they were working. So they have no incentive to go back to work.

Yeah. Okay. But on the expense question, are there any, like, was there any deferred comp related to the PPP Part 2 that will be bouncing back into the run rate or? or does that get offset by a reduction in the incentive accruals? Just kind of want to make sure we don't get surprised by anything.

It was $1.1 million in the first quarter, Wiley, but it was part of that net number that I gave. So net fees and FASB deferral was $11.4 million at the end of March for round two. So we'll give a net number. Okay. So if we're back over the... over the life of the loan, yes.

Yeah, so there's going to be $1.1 million that comes back into the run rate in the second quarter, is that correct?

Well, the loans are over five years, so round two is five years, so it just factors in over the life of the loan. Right, yeah, right.

So if we get forgiveness, they come in more quickly. So, yeah, good question, Wally. The deferrals are a little bit misleading here. You know, that Triple P has been a wonderful narcotic for all the banks. The problem is we're just going to have to live without it until 2022. And we won't be prepared to live without it and be successful without it and, you know, continue to grow earnings.

Yeah. Okay. And then just one last question. I, too, was kind of... I'm curious to see your reserves increase just one quarter after you took them down when you adopted CECL. So I'm curious if you adjusted your Q factors to be more aggressive or if there was some risk rating migration or something in the model that caused the reserve requirement to increase. I'm just kind of curious. It just seemed like a pretty quick shift one quarter after adopting it.

There wasn't any risk-grade migration to necessarily drive that, you know, but rather just kind of what the model dictated in general. You know, so no major shift. I mean, there were some small changes in certain Q factors in certain industries, but nothing wholesale changed in our model.

Unfunded loan commitment expense went up, right, which is not in the loan loss reserve, but It should be. To me, I don't know why that's a separate line item on expense factors. It doesn't make any sense. But, you know, we just feel like, you know, losses were extraordinarily low in the first quarter. Don't count on that run rate for very long, Wally, a two basis point per annum. I have not been associated with a bank that had two basis points of losses per annum. in the history of my career. I think, you know, typically I've seen, I've had banks that operated between five and ten basis points a year charge-offs, but usually around ten, but not that low.

Okay. It's just a little common sense.

You know, we've actually had a little bit of common sense there, Wally.

Fair enough.

Okay. Thanks for the time, guys. I'll hop out.

This will conclude our question and answer session as well as today's conference call. Thank you for attending today's presentation. You may now disconnect.