Participants

Davis Mange; Investor Relations; ServisFirst Bancshares Inc

Thomas Broughton; Chairman of the Board, President, Chief Executive Officer; ServisFirst Bancshares Inc

Henry Abbott; Senior Vice President, Chief Credit Officer; ServisFirst Bancshares Inc

Kirk Pressley; Chief Financial Officer; ServisFirst Bancshares Inc

Edison Woodie; Senior Vice President, Controller; ServisFirst Bancshares Inc

Stephen Moss; Analyst; Raymond James

Stephen Scouten; Analyst; Piper Sandler

David Bishop; Analyst; Hovde Group

Presentation

Operator

Greetings, and welcome to the ServisFirst Bancshares third-quarter earnings call. (Operator Instructions)
As a reminder, this conference is being recorded.
It is now my pleasure to introduce you to your host, Davis Mange, Director of Investor Relations. Thank you, Davis. You may begin.

Davis Mange

Good afternoon, and welcome to our third-quarter earnings call. Today's speakers will cover some highlights from the quarter and then take your questions. We'll have Tom Broughton, our CEO; Henry Abbott, our Chief Credit Officer; Kirk Pressley, our CFO; and Ed Woodie, our Controller.
I'll now cover our forward-looking statements disclosure. Some of the discussion in today's earnings call may include forward-looking statements. Actual results may differ from any projections shared today due to factors described in our most recent 10-K and 10-Q filings. Forward-looking statements speak only as of the date they are made, and ServisFirst assumes no duty to update them.
With that, I'll turn the call over to Tom.

Thomas Broughton

Thank you, David. Good afternoon, and thank you for joining our third-quarter earnings call. We were very pleased with the quarter's metrics, and we're pleased with the outlook for the future. And I'll start by talking about loans and sort of outlook there.
Our pipeline is very strong, and we had great loan growth in the second quarter and not in the third quarter. We are here in the line waiting until after the election more than I would have expected. Though our loan balances did not grow in the quarter, we had early payoffs on $126 million of loans at an average rate of 4.89%. So that was good news for the shareholders.
In addition, we had repricing on $105 million of loans in the quarter of low rate fixed rate loans. This will contribute to improved margin going forward, as Kirk will discuss in more detail in a few minutes. And we'll explain our -- he will also explain our positive balance sheet outlook.
Loan demand is very robust in one segment, Hospitality, but that's certainly a segment where we have limits on our exposure to the industry. We typically see very strong loan growth at year-end, and I'm assuming we'll see a rebound in closings in the fourth quarter.
The election delay is typical. But after a strong second quarter, I thought that we would not see that issue this year, but we did. It could also be some customers wanting to see we have more Fed rate cuts come after the one that was at the very end of the third quarter. We got nothing, as you all know, until the very end of the third quarter.
Also I think some borrowers want to see more certainty on rate cuts. If some projects do not pencil out at current rates in many cases and demand for new product on many segments of commercial real estate is suppressed just to overbuilding in the last couple of years in some segments.
On the deposit side, we did have one larger municipal outflow, on municipal account outflow in the third quarter. And we expect it to return in the fourth quarter. We are trying to be disciplined on loan pricing, and we do have great options when we had, as you know, no broker deposits or federal home loan advances on our balance sheet. We do continue to see more pricing discipline from our major competitors. So that is a very good thing.
As Henry will discuss loan losses continue to be quite benign and we still do not have not seen any normalization as they referred to these days, the bottom line is economy continues to be quite good. Having said that, we have said for a long while that we need to see higher margins because we expect higher loan losses at some point in the future.
Loan losses are often lumpy, and we can see large increases in the quarter. Nothing expected today, but it's always best to expect the unexpected. The rate cuts will help some of our developers have been pinched by the rate increases.
A good example is one of our larger relationships as a workforce housing real estate developer that experienced tight cash flows in the last year as their interest rate hedges have expired. Due to Hurricane Helene, their payments were delayed past monthly and past quarter end, and it's a bunch of caution we've downgraded all their nine projects to special mission.
But one of those projects was paid off after quarter end of a $10 million loan they have one project that has permitting delays that will require them to do a capital call with their investments. The customer does have a very solid balance sheet net worth either personally guarantee the debt.
So this is an example of how rate cuts will help some customers whose cash flow is impacted by higher rates. I'm surprised not seeing more of this in our customer base, but many customers have been able to pass on interest rate increases to the customers in the form of higher prices, including in the form of higher rents on the apartment complexes and other properties, warehouses.
So in any event, we are pleased with where we are from a credit quality standpoint. We expect loan demand to rebound in the fourth quarter and to some extent at least, and pleased with our pipeline in the future. So from a standpoint of where we are with our teams, we have -- we did add four new bankers in the quarter. We have a total of 155 frontline bankers today. Those are all commercial and private bankers.
We are very pleased with our new markets, Memphis and Auburn in the newest markets, and they are really -- neither one of them have a permanent office yet, but they're both making great progress on that front.
So I'll turn it over to Henry now to talk in more detail about credit quality.

Henry Abbott

Thank you, Tom. I'm pleased with our credit quality and how the loan portfolio performed in the third quarter. We saw minimal charge-offs and increased our ALLL. Our annualized net charge-offs to total average loans was only 9 basis points for the quarter. And that was down from 10 basis points in the second quarter and a 40% reduction from the 15 basis points we experienced in the third quarter of 2023.
We grew our loan loss reserve by $4 million for the quarter and the loan loss reserve to total loans increased to 1.31%, which is the same percentage we had at the first quarter of the year and same time prior period in 2023. We did create a special Hurricane Celina reserve of $2.7 million. We continue to get our arms around the impact of Hurricane Celina and now Milton.
Some of our clients operate businesses that are dependent on tourism. As the infrastructure in the affected areas is restored, our clients will be positioned to help repair and rebuild the impacted areas in both Florida and North Carolina.
Our NPAs to total assets were only 25 basis points in the third quarter. And as always, we continually monitor all segments of the loan portfolio. I'm also pleased to say our AD&C as a percent of capital dropped to 80%, which is the lowest that has been in more than three years. As Tom mentioned, the Federal Reserve 50 basis point decrease was a welcome sign to our customers and various projects with decreased debt service. I'm pleased with the results of the third quarter and our positive momentum as we continue to build in new markets and continue to grow our core markets.
With that, I'll hand it over to Kirk.

Kirk Pressley

Thank you, Henry. Good afternoon. We are very pleased with the progress the bank has made so far this year. We continue to make great progress on the margin. As usual, I'm going to focus my comments today on linked quarter because the trends are very meaningful and it will highlight our momentum.
Net income was up approximately 15% from the second quarter; diluted EPS about the same. Margin is up an impressive 9%. We did benefit from the timing of some tax credit investments and positive return to accrual adjustments to reduce the tax rate for the quarter by a few percent. Even excluding these tax benefits, we had great growth in net income and EPS.
That growth was led by the net interest margin. Margin increased to $115 million in the third quarter versus $106 million in the second quarter. The margin is increasing from the continued repricing of our fixed rate loans and securities and from the strong loan growth during the second quarter, along with doing a good job at managing the cost of liabilities. The yield on interest-earning assets increased by 11 basis points, while the rate paid on interest-bearing liabilities only increased by 3 basis points.
The net interest margin percentage increased by 5 basis points over the prior quarter while holding on average about $600 million more in cash, which negatively impacts the NIM percentage calculation. As we have noted in the past, we are slightly liability sensitive. We realized much of the benefit of a rate decrease in the first few months.
We benefit from the rate decline in general, but even more early on as about 45% of the variable rate loans repriced over a 30-day period. The Fed rate change in September had a modest positive impact on the quarter. We'll continue to benefit from the rate drop, but that benefit will decline over time as assets reprice at the current lower rates. As you know, liability sensitive means that liabilities move faster, but the asset repricing will eventually catch up.
We try and structure the balance sheet to be neutral. We aren't making rate bets. Our strong margin tailwind from the repricing of fixed rate loans and securities will continue over the next few years within the current projected rates. Obviously, the lower the rates, the less the benefit from the repricing. And as time goes on, more of the repriced assets will be from more recent higher rate instruments. Of course, our cost of funds will be dropping to. In other words, we continue to be happy with the tailwind, and we think we have a few years left of that benefit.
Before we get to the other parts of the income statement, I'd like to take a second to discuss the 8-K that we filed today about my resignation. I'm resigning from the bank for personal reasons. I would like to say that this is an amazing bank, which has been proven over many years in many different operating environments. The bank has great employees, and it is positioned for a great future.
Tom Rodney and Henry are consistent and proven leaders who have built this amazing bank into what it is today. Ed Woodie, who has been the long-time Controller of the bank, has been named as the interim CFO. Ed is an incredibly talented individual and will do a fantastic job. I'd like to turn it over to Ed now to go through the rest of the income statement.

Edison Woodie

Thank you, Kirk, and good afternoon, everyone. Noninterest income performed well again in the third quarter. Deposit fees have increased each quarter this year. We experienced another quarter of higher mortgage fee income in the third quarter and we expect the trend to continue through the fourth quarter, indicated by strong loss volumes during the past few weeks.
We see most of our originations and secondary market loans and in purchase money loans. Credit card net revenue decreased modestly in the quarter, but we expect it to return to more normal levels in the fourth quarter. On noninterest expenses, as usual, we controlled expenses and the efficiency ratio fell below 37%.
As a reminder, during the second quarter call, we discussed implementing a new accounting treatment for qualifying tax credits. This resulted in some noise in noninterest expenses and income tax. We said our core run rate for expenses for the second quarter was $44.8 million. The third quarter was 1.8% above the core second quarter amount, a little more than we expected, but it did include some onetime EDP costs to exit contracts for services we no longer need.
Also, salary and benefit expenses increased modestly due to our new Auburn, Alabama staff being in place for a full quarter. As Kirk just mentioned, we did realize some income tax benefits during the quarter. Our second quarter rate was higher due to the implementation of the new accounting for tax credits. Our rate for the first half of 2024 was 19.7% compared to the rate in the third quarter of 17.2%. This rate differential was primarily due to positive adjustments related to filing our 2023 tax returns and adjustments related to some tax credit investments. We believe our tax rate for the fourth quarter will be around 19%.
And with that, I'll turn the call back over to Tom.

Thomas Broughton

Thank you, Ed. I will comment one thing, we have $45 million a quarter of core expenses. I was thinking about 19 years ago when we opened the bank with 19 employees. And if you told me 19 years later that we would have $45 million of expenses in the quarter, I would not have believe you. I knew the bank could grow, but I didn't know we would grow to extent that it's hard for me to think now that we could operate a bank with 19 employees with all it seems like we need now to operate.
So in any event, we're very pleased with the quarter. I do want to thank Kirk for his contributions. He joined us in June of last year. He came at sort of a critical time because we had some back office turnover and he did a fantastic job of helping get all that fixed, get the back office in order. And he did a great job with that. And then of course, when both folks retired, he took over as CFO, who's done a fantastic job and it has helped us professionalize the bank in many cases. His view from -- coming from a larger bank has been very helpful to us and helping -- especially from a standpoint of making sure we're ready for growth in the future. So we want to thank Kirk. Kirk, we appreciate the contributions and wish you well.
And we'll be ready to take any questions you have now. Thank you.

Question and Answer Session

Operator

(Operator Instructions)
Steve Moss, Raymond James.

Stephen Moss

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

Thomas Broughton

Steve, it's really asking a hard question. If I told you I thought it was going to be as good as the second quarter. Second quarter was outstanding, and that was probably more than I would hope for in the fourth quarter, though, as possible. You tend to get a lot of closings. People -- companies buy and sell in the fourth quarter, assets buy and sell.
Like I said, we did see a lot of asset sales. I think prior to the election in the third quarter, we saw some people probably concerned about tax rates going up and so some companies and businesses. So I think we're -- I just think the opportunity is always there in the fourth quarter because of the year-end. We've always had a good fourth quarter. So I expect to have at least a decent closing amount and the pipeline is there.
So we've got -- like everybody, we've got some payoffs coming to, Steve, when people go in to permanent market. And in a few cases, we're trying to hold on to some loans that are -- that could go to Fannie and Freddie, and we're trying to talk to them about staying with us for a bit longer on some of those projects. So I'm not giving you a very good answer, I know, Steve.

Stephen Moss

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

Thomas Broughton

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

Edison Woodie

It came down a little bit this quarter, but that's because the mix has changed a little bit. We've done probably a little more fixed this quarter, I think, than -- yes. Sorry, you're just looking -- so -- but it's held up really well. I don't see a pricing issue going forward. Obviously, I'm saying that we didn't have a whole lot of new loan volume this quarter, but the pricing has been holding up very well.

Thomas Broughton

Again, remember, we're happy that we had $126 million or so of loans pay off. That was a low fixed rate amount. So that's a win for the shareholders there.

Edison Woodie

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

Stephen Moss

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

Thomas Broughton

Go ahead, Henry.

Henry Abbott

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

Thomas Broughton

Yes, there's special mention, not substandard. That's correct.

Stephen Moss

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

Henry Abbott

No, that was the biggest misser.

Operator

Stephen Scouten, Piper Sandler.

Stephen Scouten

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

Thomas Broughton

Yes. There's no reserve on any of those. They only have one project, as I mentioned, as I said in my remarks, they only have one project that is a problem. And it's a problem because they had construction delays for a year with the city. It's a city in Alabama and North Alabama, an excellent city, but they had problems with the city.
So they've got that traded out, they'll get back relevant with that project. And again, this is this is workforce housing rehab. So we like the asset class and we like the borrower. We think they're just they just had some short term -- because of the hurricane, they had some payment delays when we felt we needed to downgrade it as abundance of caution.

Stephen Scouten

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

Thomas Broughton

I think one of those or two of those were in Auburn of [Lyca] market and the other two, I forget, maybe one in Nashville and one in Florida. So we're continuing to hire and we expect the contribution from the new hires were many for us this year.
We hired a large number of new people, and it takes them about six months to start making a contribution. So we expect to start seeing that. We just now -- we're seeing a great contribution to our team we hired in Montgomery last year. We hired a four-person team from another bank last year. So we're just now seeing the contribution from that team.
So I don't say just now seeing it, but it takes a while for -- to start moving things. And so we we're optimistic that we've got with all the new producers we have. Like I said, they're pretty large things in both Memphis and Auburn of the Lyca market. So we feel good about the future there.

Stephen Scouten

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

Kirk Pressley

There's nothing that I would say was a onetime. I mean this is the recurring theme. We've been signaling for a long time. We expected the velocity to pick up on the margin increase, and I think you saw it this quarter. Now remember, the second quarter loan growth helped a lot, too.

Stephen Scouten

It came later in the quarter, sure.

Thomas Broughton

On deposit pricing and I think that's -- we finally are seeing that, Stephen, I think, in terms of -- of course, everybody says is the other person is paying up too much. I'm painfully aware of that. So I say that with all humility of not trying to blame everybody else. We're doing everything right; they're doing everything wrong. I'm not saying that, but we are seeing more rational pricing industry-wide.

Stephen Scouten

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

Thomas Broughton

Been down pretty quickly. I mean, it seems like if I'm making this up 45 days ago, people were paying 5% on a 6 months and now they're paying 4.25%. And I think that's sort of the trend we're seeing right now is they're moving down pretty quickly. They're below treasury a bit in terms of CD yields.
So that you still have some of the small community banks that are underperforming outliers, as you might imagine. But for major operators, we're seeing much more rational CD price. And then we don't have a large CD. I think in the fourth quarter, we have $300 million plus in CDs maturing at a rate in the high 4s. So [4.80%] at [4.90%] yield, [4.85%] to be precise. So there's room there to pick up here and there; it adds up to real money after a while.

Operator

David Bishop, Hovde Group.

David Bishop

Good evening, gentlemen. Tom, you noticed or noted in the preamble, some build and short-term liquidity cash, maybe drove the margin down a little bit. Just curious what sort of drove that increase. Was that related to maybe customer flows? Just curious what drove that increase in cash.

Kirk Pressley

So I'll jump in here for a second. So the cash really didn't did go up that much during the quarter. It did during the quarter and came back out with one municipal outflow. What I was saying was if you look at the average balance of cash in the second quarter and the third quarter was about $600 million higher in the third quarter with about the same loans at the end of the quarter.
So the cash, the calculation, the NIM calculation had a lot more cash at kind of a breakeven on it. It doesn't hurt the NIM dollars, as you can see, based on the run-up in it. But the percentage, if you kind of normalize for that extra cash, it would have been even higher. Does that make sense?

David Bishop

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

Kirk Pressley

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

Thomas Broughton

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

David Bishop

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

Edison Woodie

Yes, Dave. This is Ed Woodie. We said in the second quarter, we're operating about $44.8 million. We think that's probably still a realistic. We think with -- we may have some adjustments in our annual incentive accrual for the fourth quarter. So we think that number is still realistic. Certainly, no more than $45 million.

David Bishop

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

Kirk Pressley

4.89%.

Thomas Broughton

If there are no further questions, that will close the call. Thank you all.

Henry Abbott

Thank you, everybody.

Operator

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