Southern First Bancshares: Deposit Repricing Drives Margin Inflection Amid Scale Constraints (NASDAQ:SFST) - SFST Stock Research Report

## Executive Summary / Key Takeaways * Southern First Bancshares is experiencing a clear net interest margin inflection, with NIM expanding 54 basis points to 2.62% in Q3 2025 as deposit costs fall faster than asset yields, driving efficiency ratio improvement from 75.9% to 66.2%. * The ClientFIRST relationship banking model generates a stable core deposit base (84.6% of funding), providing a lower-cost, more reliable funding source than wholesale-dependent regional peers and creating a durable competitive moat in the Southeast. * Scale remains the central constraint: at $4.35 billion in assets, SFST lacks the technology infrastructure and diversification of larger competitors, limiting absolute growth and leaving it vulnerable to deposit flight and fintech disruption. * Commercial real estate concentration (83% of loans) and uninsured deposits (38.1% of total) create asymmetric downside risk if regional economic conditions deteriorate or liquidity pressures emerge. * Valuation at 16.9x earnings and 1.26x book appears reasonable for a relationship-driven bank, but ROE of 7.66% significantly trails regional peers (9-14%), reflecting the profitability drag from smaller scale and limited fee income diversification. ## Setting the Scene: Relationship Banking in the Southeast Southern First Bancshares, incorporated in 1999 and headquartered in Greenville, South Carolina, operates a pure-play relationship banking model across the high-growth Southeast. The company serves the Upstate, Midlands, and Lowcountry regions of South Carolina, the Triangle, Triad, and Charlotte markets of North Carolina, and Atlanta, Georgia. This geographic footprint positions SFST in some of the nation's fastest-growing metropolitan areas, yet its $4.35 billion asset base makes it a fraction of the size of regional competitors like SouthState Corporation (TICKER:SSB) ($20+ billion) or Synovus Financial Corp. (TICKER:SNV) ($30+ billion). The ClientFIRST strategy assigns each customer a dedicated relationship team rather than routing them through call centers or digital-only interfaces. This structure drives deeper deposit relationships and provides a consistent service experience that management believes offers a "distinct competitive advantage." In practice, this translates to a funding profile dominated by retail deposits (84.6% of total deposits) and minimal reliance on wholesale funding. While larger competitors chase scale through acquisitions and digital transformation, SFST has methodically built a franchise that prioritizes deposit stability over growth velocity. The Southeast banking landscape has consolidated rapidly, with 2023's failures creating both opportunity and risk. SFST maintained capital ratios well above regulatory minimums throughout the crisis and preserved a $15 million holding company line of credit that remains untapped. The company now faces a dual environment: falling interest rates that support loan demand but eventually compress asset yields, and persistent concerns about commercial real estate valuations that could pressure credit quality. SFST's response has been to refine its risk management, transitioning in Q1 2025 to a discounted cash flow approach for estimating credit losses that reduces reliance on qualitative factors and incorporates economic forecasts. ## Financial Performance: The Margin Inflection Story Q3 2025 results reveal a bank hitting its stride on the liability side of the balance sheet. Net interest margin expanded 54 basis points year-over-year to 2.62%, driven by a 59 basis point decline in the cost of interest-bearing liabilities to 3.43%. This improvement reflects the Federal Reserve's 125 basis point rate cuts over the preceding twelve months, but more importantly, it demonstrates SFST's ability to reprice deposits faster than its larger competitors. The rate on interest-bearing deposits fell 65 basis points to 3.36%, while the loan yield increased 14 basis points to 5.35%. This asymmetric repricing is the hallmark of a core deposit franchise with pricing power. The efficiency ratio improved dramatically from 75.9% to 66.2%, a 9.7 percentage point decline that management attributes primarily to net interest income growth. Noninterest expense rose a modest 5% year-over-year, with compensation costs up 4.7% and technology spending (outside services and data processing) up 11.8%. These increases were partially offset by lower occupancy costs as depreciation rolled off. The result is a bank generating operating leverage: revenue growth of 13.4% in noninterest income and 8.9% in net interest income far outpaced expense growth.

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Loan growth remains steady but unspectacular at 4.33% annualized through the first nine months of 2025, reaching $3.79 billion. The portfolio is heavily weighted toward commercial real estate (83% of total loans), with commercial owner-occupied loans growing $53.8 million and consumer real estate loans increasing $71.1 million. This concentration in property-backed lending generates higher yields but creates vulnerability if regional real estate markets soften. The provision for credit losses returned to $850,000 in Q3 after zero expense in the prior year, driven by qualitative factor adjustments for past-due loans and risk migration in commercial business and non-owner occupied portfolios. Noninterest income growth of 13.4% was led by mortgage banking revenue, which increased 10.4% to $1.6 million, and service fees on deposit accounts, which surged 37.4% to $625,000 on higher commercial credit card and wire transfer activity. These fee streams remain modest in absolute terms, representing less than 10% of total revenue, and pale in comparison to larger competitors with diversified wealth management and capital markets businesses.

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## Competitive Positioning: Moats and Scale Gaps SFST's primary competitive advantage lies in its deposit franchise. The 84.6% retail deposit ratio provides a stable, low-cost funding base that insulates the bank from wholesale funding volatility. When rates fall, SFST can reduce deposit costs more aggressively than competitors like Synovus (TICKER:SNV) or Ameris Bancorp (TICKER:ABCB), which rely more heavily on brokered CDs and institutional funding. This advantage is evident in the net interest margin: SFST's 2.62% compares favorably to the implied lower blended margins of larger peers who must compete for deposits across multiple states. The relationship model also drives customer stickiness. While national banks and fintechs compete on digital features and price, SFST's embedded position with local businesses and high-net-worth families creates switching costs that preserve deposit share. This is particularly valuable in the Upstate South Carolina market, where SFST ranks among the top 15 deposit holders and maintains deeper community ties than out-of-state acquirers like SouthState (TICKER:SSB). However, scale creates structural disadvantages. SFST operates just 12 offices across three states, limiting its ability to capture deposit share in faster-growing markets like Charlotte and Atlanta where larger competitors have dozens of branches. Technology spending of $228,000 in Q3 represents a fraction of what SouthState (TICKER:SSB) or Synovus (TICKER:SNV) invest in digital platforms, leaving SFST vulnerable to customer attrition as younger demographics demand mobile-first banking. The bank's internal guideline limiting brokered CDs to 30% of deposits is prudent but also constrains growth when wholesale funding is attractively priced. In commercial lending, SFST's $2.33 billion commercial portfolio competes directly with SSB's $3.4 billion quarterly loan production and SNV's corporate banking capabilities. While SFST can offer faster local decisions, it lacks the treasury management services and industry specialization that win larger corporate relationships. The result is a niche position in smaller commercial credits and owner-occupied real estate, profitable but limited in scale. ## Risks and Asymmetries: Where the Thesis Breaks The most material risk is commercial real estate concentration. At 83% of loans, SFST's portfolio is among the most property-heavy in its peer group, with exposure to both owner-occupied and investor-owned properties. While management describes Southeastern markets as "healthy and resilient," the Fed's own risk assessments highlight persistent concerns about CRE valuations and refinancing risks. A regional economic slowdown or spike in vacancy rates could drive credit losses well above the current $850,000 quarterly provision, particularly given the $2.3 million year-to-date expense already exceeds 2024 levels by sevenfold. Uninsured deposits represent another asymmetric risk. At 38.1% of total deposits ($1.4 billion), SFST faces potential liquidity pressure if large depositors lose confidence. The bank maintains $128.5 million in federal funds lines, $189.8 million in Fed Discount Window capacity, and $828.9 million in FHLB borrowing availability, but these contingent sources are no substitute for core deposit stability. In a crisis of confidence, SFST's smaller scale and limited brand recognition could accelerate outflows compared to larger, better-capitalized peers. Technology underinvestment creates a long-term competitive vulnerability. While SFST's $228,000 quarterly spend on outside services represents 11.8% growth, it is orders of magnitude below the millions invested by SSB and SNV in digital onboarding, AI-driven underwriting, and mobile banking. This gap will only widen as fintechs and national banks capture younger customers, potentially eroding SFST's deposit franchise over time. The bank's recent share repurchase authorization of $5 million, with zero executed as of September, suggests capital allocation priorities remain conservative rather than growth-oriented. On the positive side, the margin inflection has room to run. If the Fed continues cutting rates, SFST's deposit beta (the pace at which deposit costs fall) could exceed asset repricing for several more quarters, expanding NIM toward 3%. The efficiency ratio could compress further toward 60% if management holds expense growth below 5% while net interest income rises. These scenarios would drive ROE toward 10%, narrowing the gap with peers. ## Valuation Context: Paying for Quality, Not Growth At $55.01 per share, SFST trades at 16.9x trailing earnings and 1.26x book value, a modest premium to the 1.07x-1.40x range of its larger peers. The price-to-free-cash-flow ratio of 14.9x and price-to-operating-cash-flow of 14.7x appear reasonable for a profitable bank, but the 7.66% return on equity significantly trails the 9.32% at SouthState (TICKER:SSB), 14.23% at Synovus (TICKER:SNV), and 10.35% at Ameris Bancorp (TICKER:ABCB). This ROE gap reflects SFST's lower asset turnover (0.61% ROA vs. 1.24-1.49% for peers) and limited fee income diversification.

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The valuation metrics suggest investors are paying for deposit franchise quality and margin expansion potential rather than absolute growth. SFST's 4.33% loan growth and 13.4% noninterest income growth are solid but far below the 20%+ revenue gains posted by peers expanding through acquisition. The absence of a dividend, with a 0% payout ratio, contrasts with SSB's 2.52% yield and SNV's 2.96% yield, forcing investors to rely entirely on capital appreciation. Enterprise value of $456 million at 4.09x revenue aligns with smaller regional bank multiples, but the premium to book value reflects market confidence in the relationship model's durability. The key valuation question is whether SFST can leverage its margin expansion to drive ROE above 10% without sacrificing credit quality or core deposit funding. If management can achieve this, the current multiples would appear attractive; if scale constraints persist, the stock may trade sideways as larger competitors compound at higher rates. ## Conclusion Southern First Bancshares has engineered a textbook margin inflection by leveraging its core deposit franchise in a falling rate environment, delivering 54 basis points of NIM expansion and a 9.7 point improvement in efficiency. The ClientFIRST relationship model provides a durable moat that larger competitors cannot easily replicate, generating stable funding and pricing power in local markets. However, scale remains the binding constraint, limiting technology investment, absolute growth, and diversification while exposing the bank to CRE concentration and uninsured deposit risks. The investment thesis hinges on whether SFST can convert margin gains into sustainable ROE improvement above 10% without sacrificing credit quality. If management can maintain deposit betas, control expense growth, and navigate CRE risks, the stock's reasonable valuation could support solid returns. But if regional economic conditions deteriorate or technology gaps widen, SFST's smaller scale leaves it vulnerable to both credit losses and competitive displacement. For investors, the critical variables are deposit stability, CRE credit quality, and the pace of technology investment—factors that will determine whether this margin inflection story delivers lasting value or proves to be a temporary cyclical tailwind.