Primis Financial Corp. Q1 FY2023 Earnings Call

Good morning. My name is Audra, and I will be your conference operator today. I would like to welcome everyone to the Primis Financial Corp. First Quarter Earnings Call. Today’s conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. I would like to turn the conference over to Matthew Switzer, Chief Financial Officer. Please go ahead.

Good morning and thank you for joining us. Before we begin, please note that many of our comments during this call will be forward-looking statements, which involve risk and uncertainty. There are many factors that could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements. Further discussion of the company’s risk factors and other important information regarding our forward-looking statements are part of our recent filings with the Securities and Exchange Commission, including our recently filed earnings release, which has also been posted to the Investor Relations section of our corporate site, primisbank.com. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time. In addition, some of the financial measures that we may discuss this morning are non-GAAP financial measures. A reconciliation of the non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. I will now turn the call over to our President and Chief Executive Officer, Dennis Zember.

Thank you, Matt, and thank you to all of you that have joined our first quarter conference call. Matt asked me last night after our Board meeting, what part of the quarter I wanted to address on this call, and I told them, of course, all the good parts. Only one of us had a chuckle about it. He’s still not laughing as much as I thought he would. But seriously, we’re very encouraged about what happened here at the bank in the first quarter. With that said, I’m really mindful of what the industry is experiencing, especially banks, say, our size, maybe even a little larger. But our thesis for this bank and our future has played out very well this quarter and I think maybe for the cycle that we could be close to entering. I’ll cover all of that shortly, but first, I wanted to summarize net income. For the quarter, we’re reporting $5.7 million of net income. The one-time kind of things were about $1 million of negative spread and DP costs associated with the digital success that unquestionably will not replay in the second quarter, about $450,000 of fraud expenses, all of which are at the Core Bank, none of which were individually significant and a mortgage run rate that I think is about $300,000 below our current run rate, even with no additional pickup in volumes or locked pipeline. All of that moves our ROA closer to 75 basis points or 80 basis points, which isn’t good enough, but I think it’s within striking distance, given the momentum I see in several areas of the bank. I’m happy with the performance of the Core Bank this quarter. On the headline, it appears that non-interest-bearing deposits were down significantly, but one chunky deposit associated with a mortgage servicing rights loan of about $54 million left this quarter, and excluding that, non-interest-bearing only dropped 5.8%, which I believe is a good result. Total deposits, even including this departure, were only down 0.2%, just $6 million. Our bankers on both sides of the balance sheet did a great job. Our margin at the Core Bank was at 3.38%, down obviously from the fourth quarter, but up materially in percentage terms from where we were a year ago when we reported 2.96%. In mortgage, we’ve been focused on two seemingly different strategies and without sounding too Southern, it boils down to trimming and recruiting. We’ve been rightsizing support staff, commission rates, incentive plans and everything we can to make our breakeven production levels as low as possible. Given the performance in the last two months, I believe we are somewhere around, say, $40 million to $45 million a month to break even, which is remarkable for our industry. We’ve been recruiting as well, looking for lenders that like our culture, our speed to closing, our nearly nationwide capacity that aren’t looking for 2021 signing bonuses. These combined efforts have moved production to somewhere around $700 million to $800 million a year and positioned us well for when rates fall and volumes return to pre-pandemic levels. In Panacea and Life Premium Finance, we see strong pipeline, and honestly, some resiliency to today’s yields. Both units have very good pipelines and their profitability and efficiency curves are directionally very nice. Panacea, in particular, has benefited from the attractiveness of the credit offering and we are seeing more parties interested in this paper, which signals better non-interest income opportunities and a faster pathway to meaningful profitability. On top of that, Panacea continues to punch above their weight, finding niches with larger and larger organizations and associations that build their brand and the balance sheet affordably. Lastly, Tyler and his partners and the bank continue to tweak and build technology solutions and at the LLC level have considered raising capital to turbocharge things on the technology build. I’m increasingly aware though that their earnings rate alone can fuel all of this investment that we collectively need to absolutely own this medical space in the next couple of years. Lastly, the digital platform and the deposit success. In short, we raised $1 billion nationwide with no more staff, no fraud losses, almost nothing on advertising spend and virtually no impact at the Core Bank. Right now, we have over 12,000 customers on the digital platform. 54% of them came from the nation’s 10 or 12 largest banks, where realistically they were earning close to nothing. Another 21% came from smaller community banks or credit unions, where realistically they appreciate customer service and personal relationships. The average age is just over 50% and the average deposit is a touch over $80,000. Daily we have multiples more in deposits to existing accounts than we have withdrawals or account closures. We are still opening accounts. Last night, we opened about 53 accounts at a rate that’s about 50 basis points below the national sweep rate. And the obvious boost to our company’s safety with liquidity is clear. Our liquidity ratios and our uninsured deposit levels are some of the best in the country. And when the sweep in place, we will have done all of this in a way that doesn’t dent our capital ratios. That’s so important in this environment to be confident on liquidity and capital. But what may be lost on some is the opportunity with this platform. We’re going to have the same success in the near future on checking accounts and lower cost deposits. Our app is more progressive and functional and safe with respect to fraud or bad actors. And as we do that, especially with the sweep in place, I expect incremental spread to the rate we offer with very little impact on our earning asset levels. So, hopefully, in a way that could boost our margins by some amount. There’s no playbook for banks our size, even banks 10 times our size to build a national brand or image. The industry has been so awash in liquidity with really subpar technology and it’s just seemed nonsensical to focus a lot of strategic energy on being a deposit growth leader. Our strategy is to get as many customers on this app at rates that have a positive spread to the swaps, surprise them with customer service and attention, surprise them with humanizing communications, smart technology, accessibility to our executive team, rates that are better than our competition that is stuck with incremental or branch or marketing costs, and over time, build a significant national customer base that can fully fund our lines of business at costs that will push 3% margins or better. I absolutely love connecting with these customers, whether it’s in text or email or telephone calls or honestly even in person as I travel across the country and seeing how pleased they are with the experience that Primis Bank has delivered. It isn’t perfect yet, but we aren’t done tweaking things and making improvements either. Before I turn it back over to Matt, I want to thank our staff. I cannot say it loud enough or too many times. What we’ve rolled out here and succeeded with is not something you both show. We built this. We engineered this solution. We dreamed up everything from the background systems, features on the app security and fraud prevention and the unbelievably affordable and effective marketing of this idea. This is not just fintech relationships that are pouring deposits onto our balance sheet. Beyond just the digital team, I’m so thankful for the rest of our bank that has stepped up this quarter, answering calls and working with customers to make this quarter and this effort successful, and it’s great work for our team. All right, Matt, with that, I will turn it over to you.

Thank you, Dennis. I will provide a brief overview of our results before we turn to Q&A. But as a reminder, a full description of our first quarter results can be found in our earnings release and first quarter earnings presentation, both of which can be found on our website. Operating earnings for the first quarter were $5.8 million or $0.23 per diluted share versus a little less than $1 million or $0.03 per diluted share in the fourth quarter. Total assets were $4.2 billion at March 31 versus $3.6 billion at December 31. Excluding PPP loans and loans held for sale, loan balances grew 13% annualized, and that’s after a $15 million Panacea loan sale in the first quarter. Growth was particularly strong in Life Premium Finance again in the first quarter. Given the current environment, we expect to see continued loan growth with an emphasis on quality. Deposits were up approximately 35% on annualized in Q1, bringing our loan deposit ratio down to 83% at the end of the quarter from 108% at the end of the fourth quarter. As we discussed on last quarter’s call, reducing that ratio was a singular focus in Q1 and the success of our digital offering has been a tremendous boost to our bank. As a result, we had excess cash of approximately $500 million at March 31 and excess average cash of approximately $300 million for the quarter. We’re in the process of implementing a sweep program that will allow excess funds and deposits to be moved off balance sheet and expect that to be live by the end of the second quarter. Excluding accounting adjustments related to a third-party managed portfolio, net interest income was down slightly to $27.5 million from $28.2 million in the fourth quarter. The decrease was largely due to a temporary drag to earnings from building deposits in advance of the last Fed move and which has now abated. Net interest margin was 3.15%, down 52 basis points from 3.67% in the fourth quarter. Approximately 29 basis points of the decrease was due to the excess liquidity described earlier. Excluding accounting adjustments and a one-time gain in the fourth quarter, non-interest income was $6.6 million in the quarter versus $4.8 million last quarter. Mortgage originations were up 43% in the quarter in the face of substantial industry headwinds and on top of normal seasonal lows. The locked pipeline also ended the first quarter at $53 million, up 110% from the last quarter, adjusting strong momentum into the second quarter. Lastly, non-interest income included a gain of $427,000 from a $15 million loan sale from Panacea. Panacea has cultivated a number of relationships with other banks that will lead to increasing gain on sale revenue through the rest of this year. Core non-interest expense, excluding accounting adjustments and non-recurring items, was flat at $26.5 million for the quarter, which includes approximately $5 million related to Primis Mortgage. Of note, marketing costs were down even with the increased deposit raising activity as we were particularly efficient with how we attracted funds to the digital platform. Also of note, fraud losses were higher by $371,000 in the quarter, but none was attributed to the digital platform activity. Digital activity did contribute most of the data processing expense increase of $549,000 due to application volumes, which is expected to subside in the second quarter. The efficiency ratio declined to 69% from 72% in the fourth quarter as our various business lines increased profitability. The provision for credit losses was $5.2 million in the quarter versus $7.9 million last quarter. The vast majority of the provision was due to accounting for a third-party managed portfolio, which is offset by non-interest income gains. Excluding these adjustments, the provision would have been approximately $500,000 for the quarter. Core net charge-offs were $2.1 million and were largely charge-offs of specific reserves established in prior quarters. The allowance for credit losses to gross loans, excluding PPP balances, was flat at 117 basis points for March 31 and December 31. Non-performing assets net of SBA guarantees decreased to $32.8 million in the quarter from $34.9 million last quarter. A little over 80% of our NPAs are comprised of two relationships that we’ve discussed previously, one of which was actually current as of March 31. The assisted living credits that we’ve described previously were impaired and were impaired last quarter are currently being marketed by a receiver with bids expected in the next couple of weeks. We also have no OREO still. Pretax pre-provision operating ROA was 131 basis points in the quarter, up from 99 basis points in Q4. Operating ROA was 60 basis points, up materially from 9 basis points last quarter. Without excess liquidity and the slight earnings drag from raising funds when we did, ROA would have been over 70 basis points in the quarter, as Dennis described. While there are plenty of headwinds facing the industry right now, we see upcoming sweep capabilities, increasing gain on sale revenue, stronger mortgage activity and general improvement in operating performance across our business lines in the Core Bank, all as reasons to believe we will continue driving the ROA higher this year.

We can now open the line for Q&A.

Hi. Good morning.

Hi. Good morning, Casey.

So congrats on the success of the Digital Bank here. I am wondering how should we think about how big on balance sheet you would run the Digital Bank versus, I guess, the Core Bank here or how should we think about the size on balance sheet of that once you implement that sweep function?

So we ended the quarter with about $600 million in cash or rough math as we will probably drive that cash back down to about $100 million. So that would be about $500 million of balance sheet shrinkage in the second quarter. And with that sweep, Casey, we can then manage that cash level at about that level, depending on overall balance sheet growth and any incremental deposits we raise, we can immediately move off. So, net-net, we’ll stay around that $100 million in cash.

Okay. And then sticking with the Digital Bank, I would assume like the back office compliance costs have already been incurred. What about marketing costs from here? Is there any more, I guess, expenses there or are you pretty set with what you’ve got here for expenses?

I don’t see any material increases in marketing expenses from here, I mean, at the margin, maybe, but I think our experience in the first quarter is we have a pretty good playbook for how we think we can grow these Digital deposits without spending tons of dollars. It’s largely digital advertising, which is much more efficient, as you can imagine, than radio and TV ads and other local advertising efforts.

Yeah. Okay. And then just generally, just touching on sort of how you’re thinking about profitability this year next. It seems like you’re on track for a lot of the things we were discussing last quarter. So has, I guess, some of the industry turmoil pushed any of your goals out a bit or are we still, I guess, pretty on track from your standpoint?

I believe we have solid pipelines in both Panacea and Life Premium Finance. Loan demand in the Core Bank seems consistent with the overall industry trend, though it may be slightly lower than before. I still see potential for profitable growth in both divisions, particularly with gains from sales, allowing us to increase net income, although Tyler won't be selling all of that business, which will lead to some growth on the balance sheet. While there are some margin challenges, I believe that, given our liquidity, we won't face as significant headwinds as some of our competitors. However, I do acknowledge there are still some challenges in the market. Assuming there are no credit issues, I want to emphasize that our diversified banking model remains strong. We have around 35% in commercial real estate and we have lines of business that generate good commercial and industrial volumes in a safe and diversified manner. This strategy should enable us to continue growing, albeit not at last year's rate, so I don't anticipate a stagnant balance sheet.

Yeah. Okay. And that one large relationship seemed pretty big for you guys. Are there other like chunky non-interest-bearing you might be, I don’t know, worried about or looking at or was that sort of just a unique situation?

That was a unique situation. We don’t have any other large non-interest-bearing accounts.

Okay. Great. And just for modeling purposes, I guess, what’s like a normal run rate for that credit enhancement fee line? I recognize there’s an offset in the provision, but would like the $5 million be a little large?

The process may seem complicated and a bit noisy. The charge-offs from that portfolio go through our provision and are then reflected in our non-interest income. Additionally, there’s an incremental spread that affects our net interest income, which we account for in our non-interest expense. You can find all of these details in the income statement in our tables in the press release. In the first quarter, we built an allowance for that portfolio due to some changes in modeling, but I don’t anticipate this happening again in the second quarter. The only items impacting the provision and non-interest income related to that portfolio will be losses, which we expect to be lower than the previous quarter’s losses of about $1.9 million. For the second quarter, those losses should decrease. Furthermore, the net interest income and non-interest expense from that portfolio was around $900,000 in the first quarter, which is likely to be a reasonable figure for the second quarter.

Okay. Great. Well, congrats to you guys and thank you.

All right. Thanks, Casey.

Hey. Good morning, guys.

Good morning, Russell.

I want to focus on the balance sheet size a bit due to some changes we've seen. Regarding loan growth, I understand your expectations. Do you have an overall view on organic loan growth? Similarly, on the deposit side, I acknowledge your thoughts on the sweeps, but where do you anticipate balances will trend from here?

I believe we would typically expect a couple of hundred million, possibly a bit more from Tyler’s Group. However, we will likely see around half of that, due to some sales contributions and slightly softer demand. So, maybe about $100 million or $125 million. For Life Premium Finance, we would usually anticipate a couple of hundred million there as well, and we might still reach that figure. As for the Core Bank, given the current demand, I think a growth of about 1% or 2% would be a respectable outcome. Overall for the year, we are probably looking at a growth range of 10% to 13%.

Got it. Okay. Really helpful. And then from a deposit balance perspective, in terms of where you expect that to trend? I’m just trying to triangulate to the margin going forward? I think you mentioned, Dennis, in your remarks, kind of that 3% bogey and an ability to remain kind of at or above that going forward?

I believe that regarding the Digital aspect, we are essentially one bank. All the individuals on the Core side have significantly supported the Digital side. When we consider the Digital Platform, we focus on how national deposits fund our national lines of business. I think we should aim for around a 3% margin in that area. On the Core Bank side, I anticipate it might perform slightly better than that, although I don’t expect the margin to reach 3%. There is definitely some downward pressure, but if we recorded 3.38% in the first quarter, I think a projection of around 3.25% for the Core Bank seems reasonable. Long-term, I believe that 3% for the Digital Platform is appropriate. However, we are likely three to four quarters away from achieving that, given that everything is still new. One factor that may assist us is that we currently have $1 billion on the Digital Platform, and once we start sweeping, we could see positive spreads with effectively no earning assets, which might help increase the margin.

Okay. So…

In terms of the balance sheet, we’re at an 83% loan-to-deposit ratio at the end of the quarter. The sweep reduces cash but also decreases the deposits on the balance sheet. You can expect that the loan-to-deposit ratio will rise back to the mid-90s as we engage new customers through various initiatives. We’ll manage the loan-to-deposit ratio by sweeping excess off the balance sheet. Does that help?

Yeah. That helps a lot. I appreciate it from both of you for the clarification and color there. And then just last one for me. Could you help us with, excuse me, could you help me with the non-interest expense outlook going forward, considering some of the puts and takes around fixed Mortgage variable with improvement in that fee line and just any other franchise investments and potential offsets?

I can imagine that you are likely hearing this frequently due to the challenges with margins. We are dedicating significant time to managing non-interest expenses. In the first quarter, our expenses amounted to approximately $21.5 million, excluding Mortgage costs. This total included some expenditures related to fraud and data processing for various applications, among other items. We aim to reduce that figure to around a $20 million run rate, or possibly even slightly lower, as we continue to learn and make adjustments, as Dennis mentioned earlier.

I would also like to add.

That’s on a core basis. Obviously, Mortgage non-interest expense will fluctuate, I mean, it will be higher the next couple of quarters because their production will be higher. But on a core basis, that’s what I’m referring to.

And Russell, given the current environment, we don't have the energy to increase expenses. All our division leaders understand that this isn't the right time for incremental positive growth. Matt and I want to assure you that we won't be caught off guard if the industry declines; we will have strategies in place. We're already in the process of developing these plans. While we have some positive momentum, I don't believe it’s the right moment to aggressively pursue growth, but we are definitely planning for it, and I can assure you that this is being addressed.

Understood. Thank you, guys, very much for taking my question.

All right.

Thanks, Russell.

Hey. Good morning.

Good morning, Chris.

Dennis and Matt, I just want to circle back on the deposit growth initiative in the checking and NOW accounts going forward. Is that going to pay down some of the savings or is it going to be complementary and therefore, just have a lower blended rate?

It will be complementary. So hopefully average down the cost of those deposits.

And as the Fed plays out over time, whether up or down, do you have to move those savings rates that you’ve established so far?

I think we will. In our offering, there is no set term on the rate we’re providing. Initially, I believed it would only attract Internet rate shoppers, but that's not the case. Over half of the interest came from money center banks that were hardly offering anything. I believe that if we can maintain a rate maybe 10 or 15 basis points below Fed funds, that would be excellent. I am quite confident we can achieve that. Additionally, I think we can retain a lot of the funds through our efforts to humanize our company and build relationships. In a year, it might even improve further.

Great. Thanks for all the background this morning and disclosures.

Thanks, Chris.

And we have no further questions at this time. I’ll turn the conference back over to management for any closing remarks.

Thank you to everyone who joined the call. Matt and I are available for any questions you might have through call, text, or email. Have a good weekend, and we’ll talk to you soon.

And that does conclude today’s conference. Again, thank you for your participation. You may now disconnect.