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spk02: Greetings and welcome to the Surface First Bank Share Third Quarter Earnings Call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce you to our host, Davis Mays, Director of Investor Relations. Thank you, Davis. You may begin.
spk06: 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 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.
spk07: Thank you, Davis. Good afternoon, and thank you for joining us for our call as we review the third quarter. I thought I'd start by reviewing the current economic outlook. you know, 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, you know, we'd seen rapid escalation in interest rates. We've seen bank deposit disintermediation for over close to a year at that point. And then we'd see credit tightening by most banks. You know, the demand for goods and services continues to be, you know, amazing. The consumer appears to be very resilient. You know, 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, you know, 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. It's probably a combination of our caution and higher interest rates. You know, I was with a customer last week, and, you know, he said the best way I can make $16 million is to pay down $200 million of debt at 0.08%. 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 disinversion 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. That's Sort of a brief overlook of where we are and get down into a little more granular information here. Start talking about deposits. We have focused on building core deposits over the last four quarters. We've seen really fantastic results. Our people have done an outstanding job. They've done what we've asked them to do. And very few banks can demonstrate the deposit growth we've seen combined with zero deposits. federal home loan bank advances, and zero broker deposits. Our municipal clients have received significant COVID funding this year. It'll take a bit of time for that to be spent. 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. It's still strong. We're looking for granular new relationships that are sticky. On the correspondent side, Rodney Rushin will give an update in a few minutes when I finish. Our total new accounts are up 19% year over year. while our commercial accounts are 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're seeing cash on hand stay consistently at the $2 billion level in October. We are pleased to have built this liquidity 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, very pleased with the deposit situation. Talk a little bit about loan demand. We did turn the loan spigot 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 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, four new bankers there. We had a total of five in the quarter. From a headcount standpoint, we were down three for the quarter. We are focused on adding the right people and right size in our team this year. We think that'll 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, and it'll be a community banking office that's very similar to the offices in Tallahassee, Panama City, and Asheville, 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.
spk01: 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 30th was 12.3% for the quarter. Most of that increase came from Tennessee and our new Texas market expansion with 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 geography. Seven new bank relationships were opened during the quarter in five different states. Correspondent participation loans and new relationship pipelines are strong for the remainder of the year and also in 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 three new state banking associations reviewing our American Bankers Endorsed Agent credit card program to determine if they would like to participate. We currently have nine 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 market has grown. Correspondent deposits and fundings in summary. Correspondent balance is 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.
spk04: Thank you, Rodney. Service First 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 eight 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 non-performing 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% 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 use an industry leader in commercial real estate data and analytics to help provide stress testing and real-time data on the portfolio. 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 SNICs. I know those are items of interest and impacted the charge-offs at some of our peer banks. I continue to feel very good about our diverse and granular loan portfolio and how it performed in the third quarter. With that, I'll hand it over to Buck Fossey.
spk05: Thank you, Henry. Good afternoon. We're very pleased with the progress the bank has made in the third quarter with deposit growth, liquidity, capital, and improving loan pipelines. Our non-interest-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 a quarter after several quarters of decline or flat. The 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 efforts. 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 reprice or paid off in the third quarter were 276 million which combined with loan paydowns on fixed-rate loans totals to $2 billion on an annualized run rate. The 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. Eighty-nine percent of our new loans are floating rate, and about 41% of total loans are floating rate today. Our adjusted loans and deposit ratio at September 30th, 2023 was 80.5%. This ratio includes the correspondent that funds purchase. We saw improvement in core non-interest income in the quarter with improvements in both credit cards and mortgage. we expect continued improvement over the balance of the year. As a reminder, the second quarter non-interest income included a death benefit of $890,000. In discussing non-interest expense, we have made an effort to hold the line on expense growth in 2023. We have experienced increases in non-core expenses. Problem credit, which was primary legal expenses related to credits, check fraud, and credit card fraud. And we had one case of $600,000 in credit card fraud. These items increased about $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 headcount 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 CBT-1 ratio was 10.69%, and our Tier 1 leverage ratio was 9.35%. Our capital continues to be a strength. That concludes my remarks, and I'll turn this program back over to Tom.
spk07: Thank you, Bud. You know, 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, you know, a few quarters, we think, but we'll get there. So, we think our performance and all those other metrics will lead to improved earnings per share in the future. So we'll open it up now for questions. I'll be glad to see what you have on your mind.
spk02: Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star key. One moment please while we poll for questions. Thank you. Our first question comes from Kevin Fitzsimmons with DA Davidson. Please proceed with your question.
spk10: Hey, guys. Good afternoon. Hi, Kevin. I'm just trying to – I know there's a number of contributors in here to the margin, but I'm just trying to 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 fourth quarter. And, you know, there's – looks like there's maybe a couple 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 know, 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 talk about not necessarily managing to that ratio. But, you know, 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, you know, I'm not sure if you guys put it this way, but really, you know, loan growth being governed by the pace of deposit growth. And in this case, we saw a big 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. Thanks.
spk07: Yeah, I probably, let me, you know, Bud will have to give you some actual numbers, you know, but my take on it is that the improvement in loan repricing has been swallowed up by deposit repricing to this point in time. So that's why you hadn't seen the margin improve yet because of that. If we think the rate increases are behind us, you know, 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, you know, of course, you know, We had no idea of deposits. We asked our people 15 months ago to focus solely on growing deposits. Our incentive plan has skewed almost 100% of that for year 2023. So you probably heard me say, people do what you incent them to do, and they've done what we've incented them to do. They've grown deposits. So now we've actually gone back and for the last three months of the year, we've put in a special incentive to grow loans from October 15th to January 15th to have an incentive to grow loans about 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, the 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 rate income. 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. Again, we think having all this excess liquidity is a significant competitive advantage in the industry. but I probably didn't answer your question, Ken.
spk10: No, no, that was, that was helpful, Tom. I just, I guess it, you know, I know there's a lot of moving parts to it, but are you, do you guys feel like that? You know, it sounds like you're overshot, not overshot, but I mean, it's never too, you can never have too much of it, but is it, and it's just one quarter, but do you feel, you know, assuming the fed is mostly done here, do you feel we're getting closer to that ratio? stabilizing and then maybe heat up to expand in 24. Is that what you would suspect?
spk07: Yeah, we mentioned that our municipal clients have had big liquidity. These are existing customers. There are core relationships. We're not out bidding 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 and It's some reasonable price that doesn't leave you a lot of profit when you give 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. Again, we don't have any brokered deposits, and we don't have any home loan back 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.
spk10: 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 sort of 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, you know, tightening standards, um, 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, you know, 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?
spk07: Yeah, we do. Now, you know, again, like I say, our loans grew 87 million in the month of September last We've seen a lot of activity just in the last 30 days. It seems like we've seen things really, you know, pick up. Bars are getting a little bit more confidence in the economy and, you know, starting with projects in both CNI and CRE. So, you know, and again, we're being a little bit more creative in trying to find, you know, sources of loan demand right now, Kevin. And I think, you know, 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 were 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.
spk10: Right. Okay. All right. Well, thank you very much, Tom. I'll hop out and let others speak. Thanks, Kevin.
spk02: Thank you. Our next question comes from Steve Moss with Raymond James. Please proceed with your question.
spk11: Good afternoon. Hey, Steve. Tom, you spoke about, you know, the loan pipeline improving here. Just kind of curious, you know, 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?
spk05: Go ahead, Bud. Yeah, we think that loans can increase. The rate that new loans went on during September was 8.35. So we feel like it'd be that or above. 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.
spk07: Steve, what I can't project is what kind of payoffs we're going to have. I'm looking at Henry Abbott. 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 than what we're charging them, you know. I mean, they might pay six at Fannie, but they're going to pay us, you know, they're paying us eight and a quarter, eight and a half. So there's what I can't predict, Steve.
spk11: Right. And then maybe just curious in terms of, you know, the underlying mix in the pipeline, is that a little more weighted towards CRE and construction these days, or, you know, is there a healthy C&I component? Just kind of curious. Business mixes.
spk04: Yeah, 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.
spk07: Yeah, we think we need to kind of stay under that 100% AD&C exposure level that seems to be a bright line with, you know, it might become more of a bright line with the regulators, we're not sure, but that was our thought on that.
spk11: Okay, and then just in terms of thinking about the liquidity on balance sheet here, you guys achieved, you know, the goal of having a 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 two. You know, are you willing to dip below that billion of liquidity, or kind of how do we think about funding loan growth? Will it be more by deposits or existing liquidity?
spk07: Yeah, you know, 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. We do. So you say we've got $2 million, $250 million. You know, we really... think that of that we could put, you know, one and a half billion probably into the loan bucket, you know, over time. Now, you know, again, some of these municipal deposits are going, you know, again, they're going to spend it, you know, politicians always find a way to spend money, as you know, so it'll burn a hole in their pocket a bit. It'll take a couple of years to burn some of it off and we'll replace it by then with other deposits, but You know, right now we feel good about where we are. We just, again, are actively looking for the right, you know, 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 or, you know, rather than somebody that just walks in the door.
spk05: Got it.
spk11: One last one for me here, just on the reserve ratio, you guys had built it up. for a number of quarters, this quarter kind of flat. Just curious, you know, is this kind of as high as it can go in terms of what, you know, maybe the auditors are comfortable with or, you know, is there any ability, are you guys just more comfortable with credit and hence the reserve ratio not climbing up as much or not climbing?
spk04: And I think the primary driver, as Tom mentioned in his remarks, was kind of the economic outlook improved over the past two or three quarters. So, I mean, that's where we were able to maintain where we are. You know, it just depends on kind of the key drivers being unemployment and GDP are going to impact the model and the outlook on those.
spk07: Yeah, unfortunately, you know, there's a limit on what you can, you know – I think bankers by nature would have a much higher loan loss reserve if we were left to our own, you know, desires. But we're not. And these CECL models are, you know, they can switch, change on a dime, as you well know.
spk11: Right. Okay. Well, I appreciate all the color, and I'll step back. Thanks, guys.
spk08: Thank you.
spk02: Thank you. Our next question comes from Graham Dick with Piper Sandler. Please proceed with your question.
spk00: Hey, good evening, guys. Hey, Greg. I just wanted to circle back with something you just touched on, is that 1.5 billion number of deployment into loans. What's sort of the ideal time horizon for achieving that?
spk08: You know why I'm laughing, Graham. I don't know.
spk07: You know, I mean, at this point, you know, I don't know. I just don't know how quickly we can get the loans on the books, and I don't know what will pay off. You know, our loan pipeline is pretty robust, but it's nothing like $1.5 billion, I can tell you that. So that is a $64,000 question. You weren't born when the $64,000 question came about, Graham, but Google it sometime.
spk00: 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?
spk07: Yeah, it's not a scientific number. And we don't ever discuss it. But let me see. Where are the? I don't have it. Probably down a couple hundred million dollars from the last quarter gram. We put it on the book. We got it on the book. Again, we're trying to rationalize deposit costs now. It's time to start improving profitability. We've got to be a little bit smarter about it.
spk00: Then on that front with deposit costs, 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, you know, a rate below Fed funds? How do you guys kind of approach that from here, I guess?
spk07: Well, it depends on, you know, as a percent of Fed funds, what is the rate? You know, you're not interested in 100% of Fed funds. You're interested in some percentage of Fed funds, so... you've got to have some margin. You want to at least have some margin in what you leave sitting at the Fed because we've got a lot of cash sitting at the Fed right now. Of course, the other question is when do you start buying securities? We've got to buy securities again someday, but given we've got so much, we want a little bit more floating rate assets on the books, so we're hesitant to move into longer term. When I say longer term, I say a two to five-year treasuries. 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. We're just waiting on that. But again, we're going to have to all do it someday.
spk00: Yep, 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 fully floating, right? So there's not a lot of – there's no maturities in that thing or any, I guess, exception pricings 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?
spk07: We think so, Graham.
spk00: All right. That's helpful. That's all I had. Thanks, guys.
spk07: All right, buddy. Thank you.
spk02: Thank you. Our next question comes from Dave Bishop with Hard Group. Please proceed with your question.
spk09: Hey, good evening, gentlemen. How are you? Good, Dave, from Hubby Group. Yes. Thank you for clarifying that. Hey, 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?
spk07: No, we've already caught up. We accrued a good bit more in the third quarter, Dave. I don't know the exact number, but I just got it over there. 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 we have been wildly successful at raising deposits, and they've done what we asked them to do.
spk09: 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 in a higher for longer scenario, economic outlook here, interest rate outlook moving forward. Is there 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.
spk05: Hey, Davis, but I don't see us selling anything. I think we'll continue to buy. If we buy, we'll buy Treasury short-term, six months to a year. It just takes a long time to – That's to be paid back and earn money. I just, I don't know, just something I don't want to do. We'd rather just hold it to maturity.
spk07: And what if rates drop? You know, I mean, probably my salesman can always show you a Bloomberg run that shows that makes you a lot of money to reposition securities.
spk09: Got it. No, understood. Understood. And then a housekeeping question, I guess maybe for Bud. Good tax rates this year moving forward. It looks like there was some you know, lower than trend tax rate this quarter. How should we think about next quarter and into 2020?
spk05: Yeah, I would say 18% would be a good rate for fourth quarter. 18, yeah.
spk09: Got it. Great. Thank you.
spk02: Thank you. There are no further questions at this time. I'd like to turn the floor back over to management for closing comments.
spk07: I think we're done. Thank you, everybody, for joining us.
spk02: This concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.
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