Good day, and welcome to the ServisFirst Bancshares Incorporated Third Quarter Earnings Conference Call. [Operator Instructions] Please note this event is being recorded.

I would now like to turn the conference over to Davis Mange, Director of Investor Relations. Please go ahead, sir.

Davis Mange - Director of Investor Relations

Good afternoon, and welcome to our third quarter earnings call. We'll 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 our most recent 10-K and 10-Q filings. Forward-looking statements speak only as of the date they are made and ServisFirst assumes no duty to update them.

With that, I'll turn the call over to Tom.

Thomas Ashford Broughton III - President, Chief Executive Officer

Thank you, Davis, and good afternoon. Thank you for joining us on our call. I'll talk a few minutes about our loan growth for the quarter. We had $369 million of net loan growth for the quarter, which is an annualized growth rate of 18%. Our goal has been to have a monthly loan growth goal of $100 million a month, and we've exceeded that goal over the last three quarters, and certainly we're pleased to see.

We had thought that we would see line utilization improve in the second half of the year, but we saw no improvement in this past quarter. We do not know when we will see an improvement in line utilization, given the continued low inventories at our customers and supply chain issues that continue, but we certainly expect it to be a tailwind for us at some point in the future. So that's certainly something look forward to.

We did see net pay downs and commercial industrial loan balances in the quarter, excluding PPP loans. Well, this is both the result of the second round of PPP's stimulus as well as we're seeing very strong profitability in our customer base in the commercial industrial companies. Our loan growth for the quarter was highest in the West Central Florida, Charleston, Dothan and Northwest Florida regions. And looking at our - our loan pipeline is about 10% above last quarter and is back at historically high levels.

We look back at our pre-pandemic pipelines, and our pipelines today are roughly double where we were prior to the pandemic.

On the deposit side, we do continue to see deposit growth. Though most of the growth was in our correspondent division this quarter, other regions are seeing a flattening in growth during the quarter. Most of the correspondent division growth is attributed to new account growth in South Florida market with an addition of a key banker in South Florida. Our noninterest-bearing accounts doubled in the quarter in correspondent from $500 million to $1 billion.

A few minutes to talk about capital. When we started the pandemic 18 months ago, we were under $10 billion in assets, and I remember analysts and investors were asking us what our plans to do with all our excess capital? And our answer was it's nice to have excess capital on hand to fund future growth. 18 months later, we are all at $15 billion in assets. So we are quite happy we had the capital support of bigger balance sheet.

The question now is how much of the deposit growth is transitory, if any. I don't think any of us know the answer to that question, but what certainly seems logical is that as the massive stimulus, fiscal stimulus wears off, our deposits will flatten or decline slightly over the next couple of years.

As of this morning, we're sitting on $4.6 billion in cash at the fed, and we do have a negative carry on that $4.6 billion. Our digitally announced report recently saying we're in the top-10 for cash as a percentage of assets, and Bud will go over our plans in a few minutes to invest those funds over time.

So on the hiring front, we continue to have many conversations more than in the past few years, again as more merger activity has led to more discussions with more teams. Early in the pandemic, we took a very conservative approach and did not really told everybody that we talked to that we really didn't want to hire anybody or do anything during the early part of the pandemic, and wanted to see - we just thought the best thing to do was to be conservative, and that's usually the best thing to do in the banking business is almost always to be conservative.

So that's something we'll continue to look at and we see many opportunities and we're - our goal is to only bring in a small number of very high-quality bankers.

So now I'd like to turn it over to Henry Abbott, our Chief Credit Officer to talk about our credit situation.

Henry Abbott - Senior Vice President, Correspondent Banking

Thank you, Tom. I'm very pleased with the Bank's performance in the third quarter and the loan portfolio continues to perform well in the current economic environment. I will give a brief overview of the key ratios for the quarter, we continue to see strong asset quality, which can be attributed to ServisFirst's strong client selection, credit servicing and the vitality of the markets in our footprint.

Non-performing assets to total assets were down to 11 basis points versus 15 basis points last quarter, and 29 basis points in the third quarter of 2020. For the quarter, NPAs were down to $16.5 million. This is a 15% reduction from the prior quarter and a 50% reduction from the third quarter of 2020. This drop is attributed to OREO continuing to be at near-record lows in line with the prior quarter, and a $2.7 million reduction in non-performing loans.

Our past due to total loans were 8 basis points, $6.8 million, on par with last quarter and a 27% reduction from the end of the third quarter in 2020.

Charge-offs and OREO expenses for the quarter were $1.8 million, an 85% reduction from the $11.5 million in the third quarter of 2020. Our net credit expense annualized for the third quarter would be 8 basis points, and I'm proud to say that year-to-date net credit expenses when annualized would be 4 basis points versus credit expenses for 2020 for the whole year of 38 basis points.

In the face of strong competition, loans grew by $370 million, excluding PPP payoffs. Including PPP payoffs, our loan outstanding still grew by $163 million. Primarily due to loan growth, we grew our ALLL by $4.2 million in the third quarter versus roughly $9.7 million last quarter. Our ALLL to loans excluding PPP loans from total loans is 1.29%. Even as we put some of the more dramatic COVID economic impact in the rearview mirror, given the bank continued strong loan growth and the unprecedented government aid still helping bars, we felt it appropriate to continue to grow our loan loss reserve.

2021 continues to be a very strong year for the bank and our core key credit metrics continue to improve and charge-offs continue to be near historic lows.

With that, I'll hand it over to Bud.

William M. Foshee - Executive Vice President, Chief Financial Officer, Treasurer and Secretary

Thank you, Henry. Good afternoon. Liquidity, Tom mentioned we have a plan to invest a portion of our excess funds. Our initial goals are to purchase 15-year mortgage banks and five and seven-year treasuries. The net monthly investment, security growth will be about $100 million, and we will increase these monthly purchases over time. The current yield on mortgage banks is approximately 1.30%. Current yield on a five-year treasuries is approximately 1.08% and 1.38% for seven-year treasuries. We also decided to retain a portion of our mortgage originations. For the third quarter, we sold $33 million to investors and retained $53 million.

Net interest margin, average loans exclusive of PPP, increased by $424 million in the third quarter. Average PPP loans decreased by $387 million for net average growth of $37 million. PPP fees and interest income were $6.4 million in the third quarter compared to $10.2 million in the second quarter. Also an increase of $971 million in average excess funds decreased margin by 20 basis points in the third quarter.

Non-interest expenses, salaries increased $852,000 compared to third quarter 2021 to 2020. The majority of this increase was in West Central Florida as we added production staff and opened the Orlando office. Western Florida had the highest year-over-year loan growth.

We've also hired 15 new producers in 2021. We increased the incentive accrual in the third quarter by $1.1 million based on high dollar volume of loan production this year. Also, we invested in a new market tax credit during the quarter. The investment write down increased non-interest expenses by $2.8 million for the quarter, but was more than offset by income tax reduction of $3.3 million.

Non-interest income, credit card income continues to grow. It's $2.04 million in the third quarter versus $1.8 million in the third quarter 2020 and third quarter spend was $216 million in 2021 versus $151 million in 2020.

And that concludes my remarks, and I'll turn the program back over to Tom.

Thomas Ashford Broughton III - President, Chief Executive Officer

Thanks, Bud. We do continue to be optimistic about our future growth due to strong pipelines and conversations with clients regarding their future plans. So all in all, we were pleased with the quarter. We're pleased with the outlook and we'll be more than happy to answer any questions you might have.

Davis Mange - Director of Investor Relations

Thank you. Let's open the floor for questions.

Question & Answers

Operator

[Operator Instructions] And the first question will come from Brad Milsaps with Piper Sandler. Please go ahead.

Brad Milsaps - Piper Sandler - Analyst

Hey, good afternoon, guys.

Thomas Ashford Broughton III - President, Chief Executive Officer

Hi, Brad.

William M. Foshee - Executive Vice President, Chief Financial Officer, Treasurer and Secretary

Hi, Brad.

Brad Milsaps - Piper Sandler - Analyst

Tom, I was just curious, obviously another great quarter loan growth. If you could give us a sense of kind of where your new loans are coming on the books, kind of relative to the current book yield?

Thomas Ashford Broughton III - President, Chief Executive Officer

Yes, Brad, but the - with the phase, we're still putting loans on at 4.15% to 4.20%, right?

Brad Milsaps - Piper Sandler - Analyst

Okay, great. And, but based on your comments, I wanted to make sure I heard you correctly. You thought that the pace of securities purchases would be right around $100 million a month, so about $300 million quarter. Is that correct?

Thomas Ashford Broughton III - President, Chief Executive Officer

Right. Yes, we're going to watch right, I know five and seven-year treasuries have been trending up. So, we'll watch it - I'm sure we'll look at increasing that purchase amount over time, but that's $100 million a month and $300 million a quarter is our current go.

Brad Milsaps - Piper Sandler - Analyst

Yes. So all else equal, you might get that securities portfolio up to $2 billion or so by the end of next year?

Thomas Ashford Broughton III - President, Chief Executive Officer

Yes. That's right. Yes.

Brad Milsaps - Piper Sandler - Analyst

Got it. And obviously, but no one has a crystal ball, but just kind of curious if we got 50 basis points or 75 starting late next year. Aside from the obvious, your cash balances would get a higher rate. What do you think the impact would be for you guys, however you want to express it in terms of NIM, just kind of curious what the impact could be on loan yields with higher Fed funds and taking account anything you might have sitting at floors, etc.?

Thomas Ashford Broughton III - President, Chief Executive Officer

I don't know if I have a good answer, just right off top of my head especially when we go onto the loan side. I really have to look at it.

William M. Foshee - Executive Vice President, Chief Financial Officer, Treasurer and Secretary

How much cash we're going to have to deposit in Fed?

Thomas Ashford Broughton III - President, Chief Executive Officer

Yes. [Speech Overlap]

William M. Foshee - Executive Vice President, Chief Financial Officer, Treasurer and Secretary

$1 billion or $3 billion.

Brad Milsaps - Piper Sandler - Analyst

Well, maybe asked differently, can you just remind us of your kind of split between sort of prime or your LIBOR-based loans versus fixed rate?

Thomas Ashford Broughton III - President, Chief Executive Officer

What now, the mix?

Brad Milsaps - Piper Sandler - Analyst

Yes.

Thomas Ashford Broughton III - President, Chief Executive Officer

Okay. Let me think. We're 60 something percent on fixed. Let me look, that one, I think we are probably 60% to 65% fixed. I know that's been shrinking. But I just don't have it right here. And I didn't bring that. I don't have that in my notes, I don't think, so sorry. I can e-mail it to you.

Brad Milsaps - Piper Sandler - Analyst

Okay. No problem. All right, great. Well, I'll hop back in queue, and let some other folks hop in. Thank you, guys.

Thomas Ashford Broughton III - President, Chief Executive Officer

All the cash is floating rate. All the $4.6 billion in a floating rate, Brad.

Brad Milsaps - Piper Sandler - Analyst

Sure, absolutely. Yes. Got it.

Thomas Ashford Broughton III - President, Chief Executive Officer

That's the biggest floating rate asset we have - the cash.

Brad Milsaps - Piper Sandler - Analyst

Yes, understood.

Operator

The next question will come from Kevin Fitzsimmons with D.A. Davidson. Please go ahead.

Kevin Fitzsimmons - D.A. Davidson - Analyst

Hey. Good afternoon, guys.

Thomas Ashford Broughton III - President, Chief Executive Officer

Good afternoon.

William M. Foshee - Executive Vice President, Chief Financial Officer, Treasurer and Secretary

Good afternoon

Kevin Fitzsimmons - D.A. Davidson - Analyst

Just digging into the loan growth a little bit. Tom, you mentioned in the release about the economy, the economic recovery. You also had cited just a few minutes ago, the line utilization really hasn't picked up like you would have hoped. But where, if you would really to attribute this growth to just pure economic expansion versus the effective, your hiring efforts and bringing folks over, and that probably dovetails with the deals that are going on. So maybe it's not just from hiring, but you're getting some loan opportunities because of some of the consolidation that's going on in your markets. If you can just sort of point to what are the main driving forces for that loan growth?

Thomas Ashford Broughton III - President, Chief Executive Officer

I don't really know that. I'm giving you a guess. But I think it's probably half and half, probably half in new hires and half is projects from existing customers and that people put projects on hold obviously during the pandemic, and we didn't want to do anything, and they didn't want to anything. So now they're moving forward with new projects, lot of commercial real estate. I mean the loan demand is not that good in the commercial-industrial sector. I mean, our loans declined in the last quarter and the C&I book just because of strong profitability and continued stimulus, unprecedented stimulus and strong corporate profitability. So and the supply chain lows and hiring issue. So - but I'm just giving you a guess, Kevin. I haven't broken - we haven't broken it down.

Kevin Fitzsimmons - D.A. Davidson - Analyst

Yes. What's your - you've mentioned that a few times, and offset is a big issue for everyone that supply chain disruption, the employee shortages that are out there affecting different companies. Is that - when you're looking at that, is that something that in your mind is just preventing a more healthy pace of C&I growth and/or is it something that is starting to get on your radar in terms of credit, in terms of getting concerned and getting watching things like that more carefully? Thanks.

Thomas Ashford Broughton III - President, Chief Executive Officer

Yes, we don't have any credit concerns, but yes, we think that supply chains getting, if they ever do get fixed, which we don't think it's going to be anytime soon. That certainly will see more inventory, higher inventories. There is a tremendous lack of supply and there is unprecedented demand that we're seeing today. So we hear from every customer that we have. And all those places we get little pickup in demand, steel prices have gone up and our customer ended up, for example, in the steel fabrication business, they've had to increase inventories and some of our scrap dealers are borrow a little bit more money today. But it is not have been an overwhelming change in the numbers there.

Kevin Fitzsimmons - D.A. Davidson - Analyst

Okay, great. And one last one for me is just that you mentioned capital, how you went from this position of having a lot of excess capital. Good thing to have, and you put it to use and where you sit now though, there's a lot of uncertainty in terms of what happens to this excess funds. But how do you feel about your capital levels now? And if you have this kind of loan growth still going forward and we don't have a major change in the balance sheet, is it something that you might look at to getting more capital? Thanks

William M. Foshee - Executive Vice President, Chief Financial Officer, Treasurer and Secretary

Yes. Kevin, we've talked to our regulators where our Tier 1 leverage was 8.25% in the quarter, would just reassess it in the fourth quarter and see. But I think that 8% is the magical number, but I think we would have leeway in that, and it would be monitored.

The thing that really has driven down like we grew over a $1 billion in deposits in the third quarter. Spikes like that really cause the issues, and I think the regulators understand that. So I think, we could probably get by with - without doing a capital raise or sub debt or something like that as long as that's a short term issue.

Henry Abbott - Senior Vice President, Correspondent Banking

And we think we will. I mean, projections, and we think we're fine there - we think we have more than adequate capital, Kevin. And also, again when the risk weighting on the $4.6 billion at the Fed is zero, right. So we don't have a risk weighted capital issue with that much cash on the Fed reserve. So we think we're just absolutely no problems at all, but we're glad we have an extra capital.

Kevin Fitzsimmons - D.A. Davidson - Analyst

Yes, I know. And definitely, and I guess part of the reason I asked the question is you're also sitting with a very strong currency. So I guess that's a variable too, to look at where you're at in the market and your willingness to, if there is capital to be had whether weighing all those different variables about whether you should do it or wait. That was my point. Okay. Thanks very much, guys.

Thomas Ashford Broughton III - President, Chief Executive Officer

Thank you.

William M. Foshee - Executive Vice President, Chief Financial Officer, Treasurer and Secretary

Thank you.

Operator

The next question will come from William Wallace with Raymond James. Please go ahead.

William Wallace - Raymond James - Analyst

Hey. Good afternoon, guys. So maybe just kind of following along with Kevin's kind of line of question. I mean, the liquidity from a capital perspective, you're saying it's the liquidity pressure, not a loan growth perspective, but you're liquidity has been building now for since really pre-COVID, I think, and $4.6 billion is massive liquidity. One, Tom, I guess during your prepared remarks, I might have missed, if you gave the timeframe. But I believe you said your correspondent channel balances have doubled from $500 million to a $1 billion. Did I get that correct? And is that year-over-year, or was that in the quarter?

Thomas Ashford Broughton III - President, Chief Executive Officer

No, you go ahead, Rodney.

Rodney Rushing - Executive Vice President and Chief Operating Officer

Yes, this is Rodney Rushing. You heard incorrect. From since year-end, our correspondent DDA balances went from just over $400 million to over a $1 billion. Total correspondent balances were just shy of $2 billion at the beginning of the year and at $3.6 billion. So what makes that up are the DDA balances where our downstream correspondent banks keep money on the DDA to pay their compensating balances were in a settlement point at the fed form for the cash flow. We then - anything over that. we sweep into Fed funds or money market account.

So right now, our largest category is by far are DDA balances, but that growth has come from new correspondent relationships, mainly in Florida. Last month alone we opened over 20 something correspondent accounts, and so forth. This month we opened, another six correspondent accounts.

In addition to those new account, our downstream correspondent liquidity is higher than it's ever been. They have a lot more cash, just like we did and it's we are taking this year like a spike, I didn't predict and I don't think it will continue. But that's where it came from.

Thomas Ashford Broughton III - President, Chief Executive Officer

Yes, we think, we're seeing a flattening. And as I mentioned, we're seeing a flattening, Wally and all the regions for the most part in deposit growth. And I don't know where your question is leading, but you do a capital raise to support cash in the Federal Reserve where you have a negative carry, I don't think so. You figure out some other solution to the problem we could, there are solutions to the problem that we have a way to offload some deposits in a third-party arrangement if we need to. So that would probably be the solution rather than a capital raise well, and you might not be going there though.

William Wallace - Raymond James - Analyst

No, that's precisely where I was going is, we've seen the channel grow. You've added a few billion dollars of liquidity from that channel alone over the past couple of years. And I'm just wondering at what point do you start to maybe try to figure out ways to sweep some of that liquidity off the balance sheet. So you don't have to answer questions from the regulators about leverage ratio sub 8% etc. Are you there?

Rodney Rushing - Executive Vice President and Chief Operating Officer

Yes, this is Rodney again. And what Tom alluded to was we do have that ability. Right now we're buying all these funds, obviously what goes into DDA as a deposit. What we purchase as fed funds, we are purchasing as principal.

If we want to, we can sell that money off to another bank or we can actually place it at the Fed, we would have to do that in an agent relationship, which we have the capability. We just chosen not to do that. Up until now, we buying all these principal and we'll see if we can put it to work.

William Wallace - Raymond James - Analyst

Okay. So are we - I guess are we at the point where you are starting to make those decisions? I'm assuming the answer is yes, if you start putting $100 million to work a month in securities and trying to figure out other ways to turn it into a positive carry. That's where we are today?

Rodney Rushing - Executive Vice President and Chief Operating Officer

Well, that's more of a question for Bud and Tom. This is Rodney, again. But I'll let them chime in, but -

William M. Foshee - Executive Vice President, Chief Financial Officer, Treasurer and Secretary

I've said it's leveled off. You know, we want the correspondent channel to grow because there are other aspects, you know, either long participations that we purchased. We make them direct loans. And also we're growing our credit card outstanding's through the correspondent credit card agent program. So there are lot of other things, other than just deposits that lead to profits through our correspondent relationships, and we think we have a pretty good chance to be a reasonably good market share in the Southeast United States and as well, we're a national credit card program to date.

William Wallace - Raymond James - Analyst

Okay. Thank you. And then, Bud it looks like you moved about $260 million into held to maturity this quarter. Can you just give us a kind of brief overview of the nature of those securities?

William M. Foshee - Executive Vice President, Chief Financial Officer, Treasurer and Secretary

Yes, that was all mortgage-backed securities that we moved. Net realized, unrealized gain was about $5.6 million and that will just be amortized over the remaining life. So we get to keep that $5.6 million in our unrealized gain total. Really that's still, I think a lot of banks are looking to doing this, really you don't have a negative impact from that $253 million down the road if rates go up 300 basis points, I guess. So it helps your book value by moving that to held maturity.

William Wallace - Raymond James - Analyst

Yes, exactly. And what's the duration on those average?

William M. Foshee - Executive Vice President, Chief Financial Officer, Treasurer and Secretary

About five years.

William Wallace - Raymond James - Analyst

Okay. And then on credit, you highlighted in the prepared remarks really just how strong credit is overall, yet you decided to increase the reserves and the reserves to loans. I guess if you take PPP out of equations, it's really just kind of holding flat on a reserve to loan basis. At what point do you in your models, make the qualitative adjustments that would bringing the reserves back down, or do you think you're where you need to be?

Thomas Ashford Broughton III - President, Chief Executive Officer

I guess we - this is Tom. While we look at it on a quarterly basis, I mean that 2 basis points of charge-offs on year-to-date basis is not reality. You and I both know that. I mean, there is a lot of somewhere in our portfolio we just don't know where it is and you know it, I've been a President of Bank for 36 years, you know I've never seen losses as low in my career than one-off basis, but never as low as 2.

So good buying, you and I both know. Good commercial buying during good times of charge-offs for 10 to 15 basis points and during bad times are probably 25-30, and a little bit higher, if you're not what you credit quality is not where it should be.

So we just want to be prepared for when that happens, while, that we think that we'll see some charge-offs. We're in the banking business. They're going to be charge-offs. That's where we had to be prepared and unprepared for that.

William Wallace - Raymond James - Analyst

I appreciate that. And then my last question, just you got your $100 million monthly loan production target that you have been exceeding. Has production itself accelerating, or are payoffs also declining? So, you kind of getting a double benefit.

Thomas Ashford Broughton III - President, Chief Executive Officer

We didn't have a - payoffs are so lumpy. I can't even answer the question. Well, there were no significant - the production was lower in the third quarter than the second quarter. And, but we didn't have any significant payoffs. I think a lot of the people that wanted to sell their properties or companies and worried about increase in potential capital gains, taxes and other taxes have already done so.

People started doing it last year. We had customer selling assets last year to be prepared for higher tax rate. So it's just hard - it's very hard to predict, Wally but usually fourth quarter is a good production time for us. We usually, it's the highest of the year typically.

William Wallace - Raymond James - Analyst

Okay. Thank you very much for answering my question. I appreciate it, guys.

Thomas Ashford Broughton III - President, Chief Executive Officer

Thank you, Wally.

Operator

The next question will come from Dave Bishop with Seaport Global Securities. Please go ahead.

Dave Bishop - Seaport Global Securities - Analyst

Yes. Good evening, gentlemen. How are you?

Thomas Ashford Broughton III - President, Chief Executive Officer

Hi, Dave.

William M. Foshee - Executive Vice President, Chief Financial Officer, Treasurer and Secretary

Hi, Dave.

Dave Bishop - Seaport Global Securities - Analyst

Most of my questions have been asked and answered, but how should we think about operating expenses here? You mentioned the new market tax initiative. Should we think about this is sort of a good run rate conversely, the tax rates are remaining around that 18% moving forward with the tax credit investments?

William M. Foshee - Executive Vice President, Chief Financial Officer, Treasurer and Secretary

Yes, maybe a little bit higher, but somewhere in the 19% to 20% range. Yes, and the new markets, you know the tax credits, all you actually look at the end of the period you have a capital gain or capital loss, the new market that we purchased in the third quarter was there to offset it. It will have a capital loss, also capital gain. So that's really where some of these tax credit deals come into play, because you want to make sure that you're matched off as well as you can on the capital gains or losses, but that definitely impacted our non-interest expense for the quarter.

Dave Bishop - Seaport Global Securities - Analyst

Got it. So it seems like that could be a little bit of a give back moving forward here probably maybe 1 million or 2 million, heading into the fourth quarter?

William M. Foshee - Executive Vice President, Chief Financial Officer, Treasurer and Secretary

Tom you still have the write down, will still be there, so that's - it's about 900 and well - whatever $2.8 million each quarter we'll have been write down, but you'll have a $3.3 million in tax reductions. Is that what you mean?

Dave Bishop - Seaport Global Securities - Analyst

Okay. But - yeah, so that's a good run rate moving forward.

William M. Foshee - Executive Vice President, Chief Financial Officer, Treasurer and Secretary

Yes, yes.

Dave Bishop - Seaport Global Securities - Analyst

Got it. Okay, great. That's all I had. Thank you.

Operator

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SERVISFIRST BANCSHARES INC

Q3 2021

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