Good morning. My name is David, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Primis Financial Corp. Second Quarter Earnings Call. Today's conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speaker’s remarks, there will be a question-and-answer session. Thank you, Matthew Switzer, Chief Financial Officer, you may begin your conference.

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 website 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 everyone who has joined our second quarter conference call. I understand this is a challenging quarter, but I want to emphasize my excitement about how we are positioning the bank for the future. The cost savings initiative is tough, but it will make us more efficient and profitable in the short term. The credit charge to address non-performing assets puts us in a strong position for top-tier credit quality with minimal exposure to office or retail commercial real estate. Our digital platform has improved significantly, moving from 50 basis points above wholesale money to about 50 basis points below wholesale money in just six months. Additionally, while many in the industry are making cuts and reducing branches to deal with revenue challenges, I believe we can counteract our issues through our gain-on-sale strategy. Allow me to elaborate on the cost savings initiative. Since I joined in 2020, we have consolidated several branches and focused on enhancing our sales culture. After our current consolidation is complete, we will operate 24 branches with core bank deposits totaling $2.5 billion. Over the past three years, we have increased checking accounts in the core bank by roughly 12% per year and have fully transitioned away from brokered CDs. The quality and value of this Community Bank's deposit portfolio is at an all-time high, especially given the current rate environment. Consolidating this value into fewer branches staffed with the best sales personnel in our region is an exciting development. Matt will provide further details on the cost savings initiative, but I believe this can be a pivotal moment, as I have seen time and again how this discipline leads to greater savings and improved long-term outcomes. Regarding the value of our community bank, our non-performing asset levels were primarily linked to just two relationships, which has impacted our ability to stand out. However, by closing a loan sale this quarter and managing contracts on other loans, we now expect to have only 13 basis points of non-performing assets. We have never pursued long-term, highly competitive commercial real estate in our area and have instead concentrated on profitable owner-occupied and commercial and industrial deals, as well as cash-secured loans in our business lines. We are well-prepared for what lies ahead, and this reduced level of non-performing assets will enable us to realize our value. On the digital platform, we initially questioned whether we could truly unlock value and profitability from our digital customers. We are diligently working to ensure that our value proposition becomes a reality by leveraging our community bank and relationship skills. In just six months, we have managed to shift almost 100 basis points, moving from 50 basis points above to 50 basis points below wholesale money. Furthermore, we have experienced virtually no account attrition since our peak and have rebuilt nearly all our service platforms to enhance our service and customer experience. Turning to our gain-on-sale strategy, our digital platform was designed to fully support life premium financing and Panacea, yielding a margin of 325 basis points. Our loan business aims to alleviate the pressure of needing to book every available commercial real estate deal while also incorporating higher quality credits into our portfolio. We have successfully achieved the latter; however, the inverted yield curve means we are currently obtaining about 200 to 210 basis points of incremental margin on our balance sheet. I acknowledge that this margin is thin for continued leveraging, but I remain confident that the yield curve will eventually improve. Rather than pausing production and having to rebuild our platforms, we have focused on generating interest and commitments to sell these higher quality loans. I believe this strategy can effectively neutralize the net interest income decline we faced this quarter, which is crucial as it indicates that the cost savings Matt will discuss are more focused on the bottom line than merely compensating for temporary revenue shortfalls. In the mortgage sector this quarter, we've made significant strides. We are gradually and carefully adding a few producers who are reasonable regarding signing bonuses and are delivering strong performance in the current environment. We have expanded from a $200 million entity to a $700 million operation and managed to remain profitable throughout all three months of the second quarter. Achieving profitability in this industry, particularly during a growth phase and at lower levels, is quite impressive, and I take great pride in what our team is accomplishing. I eagerly anticipate a return to a normal industry operational environment. All of this leads me to Page 5 in our slide deck, where Matt describes the current quarter's impact from these changes. Notably, our non-branch savings have already been implemented as of this month, meaning a substantial portion will be reflected in our third quarter run rate. However, what Matt has not mentioned is that there will be around $800,000 per quarter in expenses related to bank operations due to adjustments in responsibilities and risk management. We both truly believe that our loan sale strategy has the potential to exceed $1 million. With this loan sale strategy in place, provisioning will decrease, further benefiting our bottom line. Essentially, we are recalibrating the bank to achieve a minimum of 1% return on assets in this environment. Before I hand it over to Matt, I want to address the employee fraud issue. First, I want to assure you that I am confident that the vast majority of this will be covered by our insurance. However, due to the timing of our discovery during the investigation, we did not record that receivable. I anticipate that there will be minimal financial impact from this event in a short timeframe. I want to be clear that I'm not trying to downplay this situation, but the fact that he spent a decade creating fake loans and ceased three years ago underscores the critical importance of robust controls and procedures, along with the need for experts in administrative roles to maintain quality. For the last three years, he essentially managed existing fraudulent loans with previous proceeds until our credit and regional staff spotted unusual activity and investigated. I expect that Matt and our forensic accountant will conclude their work soon. We will file the claim and navigate the recovery process promptly. With that, I’ll turn it back over to Matt.

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 second quarter results can be found in our earnings release and second quarter earnings presentation, both of which can be found on our website. Operating earnings for the second quarter were $1 million or $0.04 per diluted share versus $6 million or $0.24 per diluted share in the first quarter. Total assets were $3.8 billion at June 30 versus $4.2 billion in March 31. The reduction in total assets was due to the sweep program we instituted at the end of the quarter that moved approximately $350 million of excess deposits off the balance sheet at the end of the quarter. Excluding PPP loans and loans held for sale, loan balances grew 17% annualized. Growth was driven by Life Premium Finance and Panacea in the second quarter. We anticipate loan growth to moderate in the near term as we execute on our loan sales strategy, particularly for our higher growth business lines. Deposits were essentially flat in Q2, if you include the funds that were swept off the balance sheet at June 30. We intend to continue growing deposit relationships while managing overall liquidity through the sweep program. Excluding accounting adjustments related to the third-party managed portfolio, net interest income declined to $25.6 million from $27.5 million in Q1, largely due to funding cost pressures and interest margin adjusted for excess cash on the balance sheet in Q2 and Q1 that is now being swept off was 3%, down from 3.38% in the first quarter. A couple of thoughts on margin and net interest income. Pressure on the margin largely occurred earlier in the second quarter with a noticeable slowdown in deposit repricing later in the quarter. As you look at our press release and investor presentation, we detailed the difference in cost between the Community Bank and the Digital Platform. Our Community Bank data has been approximately 23%, which we believe is very strong. Having an ability to raise incremental funds out of market has allowed us to be measured in our local markets without pressuring the entire bank. We also will be launching our new digital business accounts in the third quarter that will allow us to raise incremental funds at a lower rate than consumer and sweep off higher cost deposits still on the balance sheet. Lastly, we entered into an interest rate swap in the middle of the second quarter. If in place for the whole quarter, net interest income would have been approximately $300,000 higher. Combined, we think we have an opportunity to mitigate a lot of the pressure on net interest income in the short term. Excluding accounting adjustments, non-interest income was $7.3 million in the second quarter versus $6.6 million for the first quarter, largely due to an increase in mortgage activity. Mortgage originations were up 50% in the quarter in the face of limited housing supply. The locked pipeline also ended Q2 at $61 million, up 15% from March 31, suggesting strong momentum into the third quarter. Lastly, non-interest income included a gain of $103,000 from a small Panacea loan sale. We expect this activity to increase materially in the second half of 2023. Core non-interest expense, excluding accounting adjustments, non-recurring items and mortgage was $23.5 million for the second quarter versus $21.5 million in the previous quarter. Much of this increase was due to FDIC insurance, data processing expense, and debit card restocking costs that totaled approximately $2 million in the quarter and they were artificially high due to the high volume of accounts opened late in Q1, early Q2. FDIC insurance, in particular, will decline due to the deposit sweep program. Dennis also discussed we brought operational changes that will benefit expenses going forward. We also announced a cost save initiative, including broader administrative reductions and the consolidation of 8 branches that will reduce noninterest expense by approximately $9.4 million annually. Annual administrative saves are approximately $6.5 million with two-thirds of the run rate expected to be in the third quarter and full run rate in the fourth quarter. Annual branch consolidation saves are expected to be $2.9 million and will be effective starting October 31. The provision for credit losses was $4.3 million in the second quarter versus $5.2 million in the first quarter. $1.4 million of that provision was due to the accounting for a third-party managed portfolio, which is offset by non-interest income. Also included in the provision is approximately $2.3 million of impairments related to non-performing loan relationships that we expect to be fully resolved in the third quarter. As Dennis highlighted, including an approximately $8 million non-performing asset resolution in the second quarter, total NPAs would have been less than $6 million and NPAs to assets would have been very low at approximately 13 basis points as of June 30. Core net charge-offs were only $200,000 in the quarter and the allowance for credit losses to gross loans, excluding PPP was 1.21% at June 30 versus 1.18% last quarter, largely due to the specific reserve build for the NPA sale noted above. Lastly, core pretax pre-provision earnings were $5.6 million in the second quarter after a $2 million reduction in net interest income and various expenses that hit this quarter, as discussed above, but that we expect to be lower going forward. As Dennis discussed, we believe our gain-on-sale strategy is on the cusp of producing results and will mitigate this reduction in net interest income and then some. Our cost save initiatives will also begin adding to earnings in Q3 and Q4, and we'll right-size our expense base for the current environment. Combined, we believe we have a much better path to profitability than this quarter would indicate and are optimistic for the future. Operator, we can now open the line for Q&A.

Thank you. We'll take our first question from Casey Whitman with Piper Sandler. Your line is now open.

Hey. Good morning.

Good morning, Casey.

Just starting off with your comments around the gain-on-sale model loan growth, could we see loan balances shrink or are we just talking about slowing the growth here?

They're not going to shrink. I believe that nearly everything Panacea and Life Premium produce will be sold, with the vast majority likely being sold. Panacea is focused on consumer production, which we value, and I don't think we plan to divest from that. I've noticed that activity in the core bank has picked up somewhat. The fact that we can even offer loans sets us apart, and some of the yields we're observing are in the mid 8s and 9s. Therefore, I anticipate concentrating more of our lending efforts there, which will likely result in just single-digit or low-single-digit increases in loans compared to what you saw this quarter.

And I assume you can be pretty nimble there. I mean how quickly can you kind of shut this off if the yield curve changes and you want to portfolio more?

I think very quickly. What we are really discussing is enhancing our float arrangements and agreements. We want to honor that, but Panacea is currently only producing about 40% to 50% of their potential due to how much we've scaled them back. We haven't been bringing in more producers. If we can establish effective flow arrangements, we could hire additional producers, increase production, and fully leverage the reputation they've built. However, the current yield curve and the need for incremental funding has caused us to slow down, as we are mindful of not exhausting our limited capital. This is a much-needed opportunity for Panacea, and they could potentially double their production levels once we start implementing these arrangements.

Okay. But maybe just start out with the $1 million assumption for the gain on sale that you have in your slide deck.

I would probably start with that. We are confident that we can achieve more. However, for this quarter, that seems like a reasonable figure.

Okay. And then just the cost initiatives you're undertaking, it sounds like at least some of that was driven by the rate environment or would you probably have made these moves regardless, but you just kind of have accelerated the efforts or just kind of walk us through sort of how you came to these decisions?

Every day, Matt and I come to work and assess the situation, calibrating our strategy for achieving the profitability levels we desire. It has been many years since the industry experienced a 10% drop in net interest income within a single quarter. I believe this situation will eventually improve, and a year from now, if interest rates remain stable, we may recover some of those losses. However, currently, the industry is facing headwinds regarding net interest income, making growth difficult. It is an appropriate time for us to consolidate branches, something we've needed to do for years. We also see the opportunity to streamline our management team and other roles. While we are not primarily focused on cutting costs and reducing staff, we will take every opportunity to strengthen our teams and enhance our path to profitability. As we move into the second quarter, we recognize that achieving a 1% return on assets may become more challenging if net interest income declines further and we don't address confidence in credit quality, particularly with nonperformers. That is our focus.

No, I completely agree that we are always looking for efficiencies, but in this environment, it is particularly critical as we aim to manage the balance sheet growth more conservatively than we have in the past. You can manage higher expenses if the balance sheet is expanding and you're increasing spread income. However, in this current situation, that is more difficult, and we need to ensure we have the appropriate expense structure that aligns with the balance sheet size we anticipate in the near term.

Yeah. Ultimately, do you think 24 is the right branch network size? Could we see more branch reductions in the future or?

I mean never say never. It's going to depend on a certain extent, the environment and consumer behavior. But I think we feel pretty good with the number of branches we have for right now. Could see incremental over time, but I don't think you'll see another large consolidation like we just did.

I would say we don't discuss this often, but we are adding approximately $25 million each quarter to our delivery service. While some of that comes from our core network, a significant portion does not. We are expanding in areas that are close to us but not directly adjacent. We certainly plan to add more branches in larger markets near locations like Norfolk and Virginia Beach. However, at this moment, that is not a priority for us.

Okay. Maybe can you help us out then in terms of where or give us a kind of quarterly range for where you expect expenses to run when all said and done with the cost saves? It can be a wide range, but just to help us out with modeling.

Yes. I think, I mean, obviously, this won't all be in the run rate until later this year, but probably in the $18 million to $18.5 million, excluding mortgage, which obviously mortgage kind of fluctuates pretty dramatically based on seasonality. But the core run rate would be in that lower $18 million range.

Okay. Thank you for taking my questions. I’ll let someone else jump on.

Next, we'll go to Russell Gunther with Stephens. Your line is now open.

Hey. Good morning, guys.

Good morning.

I wanted to follow up on the gain-on-sale model discussion and just get your thoughts about how you see that maturing as we look into '24 and the 1% ROA bogey? I hear you on the near-term gain on sale expectations, but how do you think that scales as we move forward?

Panacea produced about 45 this quarter. I believe they could provide 45 in commercial loans. There’s no doubt in my mind that they could hire two or three more bankers, which might even double that output. We have quite a few buyers lined up, with several nearing completion. The payment fees for commercial production are essentially in line with prime rates, and these are high-quality loans to medical professionals who have strong credit metrics. Overall, I think there's significant interest in this area.

They originated about $75 million in the quarter, a little less than half of that actually funded in the quarter.

We originated $75 million in the quarter, which is a solid figure. It's a positive challenge to have such strong interest, but currently, it's not something we can pursue even if the conditions were favorable. Tyler, his team, Matt, and I recognize that we lack the balance sheet and capital to take this on. However, I believe this presents a valuable opportunity for us. We have $1 million allocated to it now, but I think it could grow significantly. We're just being cautious for the time being.

And frankly, I mean we talked about this last quarter, we thought there was going to be more gain on sale income in Q2. It's just taking a little bit longer to get to the finish line with some of these buyers, but that's why we think we're pretty confident about the third quarter.

Understood. No, I appreciate that, guys. And then as I just kind of marry that with the balance sheet expectations. I think you said core loan growth in the single digits kind of on an aggregate basis near term, still thinking of what that could look like in '24 again as we let the gain-on-sale model mature, how are you guys thinking about total loan growth going forward?

If we remain in the current environment, we will target low to mid-single-digit loan growth next year as well. However, with these loan sales, it is not necessary to sell everything we produce. If the curve changes, we have the flexibility to hold more and to bring funding back on the balance sheet from the sweep program, allowing us to manage the balance sheet size essentially from quarter to quarter. Therefore, if we find ourselves in 2024 as we are now, our goal will be to manage the balance sheet and maximize the spread as much as possible.

I don't want to overstate this, but it's clear that we are quite unique in our region in having funds to lend. We haven't completely restricted our lending, and we're currently seeing some attractive opportunities on the community bank side. In fact, the difference between the funds we're raising in deposits and what we can offer to quality customers is likely the largest spread we've experienced on the community bank side since I've been here. We're also encountering potential customers we typically wouldn't have access to. However, we're still operating on the national platform while remaining cautious. We're focused on making these customers as integral as possible before we feel fully confident about investing. The sweep program supports us because we are seeing positive spreads across our entire platform. I'm genuinely pleased with the momentum we’re witnessing on both the core bank and community bank sides, and I believe that mid-single-digit growth will be quite beneficial for the bank.

Okay. I appreciate that both of you for the color there. And then just switching gears, a number of steps were taken this quarter to support net interest income and the net interest margin going forward, be it the sweep or the swap. And just hoping you could tie all that together, give us a sense for where you expect the consolidated margin to trend in the back half of the year?

Matt will handle the swap portion. The sweep is important because it allows us to grow significantly without adversely affecting our capital ratios, margins, or other metrics. Every incremental step we take on the digital platform positively contributes to our overall suite. Some of that will ultimately fund the entire platform, making it crucial for us to continue our growth as we have been. With the Fed’s ongoing adjustments, our incremental spread keeps improving. Most of that contributes to noninterest income, except for the part that offsets sweep deposit interest expense, which contributed around 35 basis points to our margin this quarter. Additionally, as we generate funds within the core bank at robust margins that are lower than the national average, we can sweep more expensive money and reduce our deposit costs, which further enhances our margins. What are your thoughts on this?

To clarify, when we sell loans, we can recognize the gain on sale and replace them with higher-yield loans, maintaining our loan portfolio. On the deposit side, we have about $500 million of deposits on our balance sheet at a higher rate, around 5%, which we raised late in the first quarter. For every dollar of deposits we acquire below that 5%, whether from our local markets, new digital business accounts, or checking accounts, we can keep those on our balance sheet and offset the higher-rate deposits without incurring additional costs since the rate we receive through our sweep service is comparable. This allows us to improve our spread on the balance sheet. Our efforts to manage the balance sheet through loan sales and sweeps address both sides. We have the chance to potentially increase loan yields while reducing deposit costs. I’m not suggesting we will completely reverse the net interest income decline we experienced last quarter, but we are optimistic about our ability to leverage these strategies in the coming quarters to alleviate some of the recent pressure. I won’t provide specific guidance on margins due to unpredictability, but the margin compression we observed was mostly in the first half of the quarter, with June showing much lower rates. While I can’t guarantee that we won’t face any pressure in the third quarter, it should be minimal compared to the significant changes we experienced in the first and second quarters. This doesn’t necessarily imply that net interest income will decline again, just a shift in percentage.

Okay. Understood. And then just last one, tying it all together, a lot of proactive steps to improve profitability this quarter. Could you just update us on what you think the glide path is to that 1% return on assets from here?

It's likely to be the first quarter of next year at the earliest because we need to implement all the cost savings from the branch closures and consolidations, and most of the administrative savings are already in place. These adjustments, along with the other reductions in operating costs we discussed, get us most of the way there, and the remaining progress will come from loan sales. While the $1 million from loan sales won't get us completely there, it could potentially bring us closer, possibly moving us from around 70 to 80 basis points to one or above. That seems to be the key factor.

Great. Thank you, both. Thanks for taking my questions.

Next, we'll go to Christopher Marinac with Janney Montgomery Scott. Your line is open.

Thanks. Good morning. Dennis and Matt, just wanted to go through kind of the cost of funds. And should we think of it kind of maybe bottoming here given that you're going to get a benefit from the sweep program and then that kind of covers this last Fed move that we just saw this week. Is that somewhat good way to think about it?

I hope so. I think so. We are actively working on increasing our digital deposits that offer higher rates by replacing them with community bank deposits that have much lower rates. This effort could potentially cap our cost of funds and positively impact our net interest margin.

Correct.

Got it. Okay. And then the other side of that question was really just the ability to continue to push through both loan and earning asset yields and that's not done evolving in your favor?

Correct.

Got it. Okay. And then if we go through the fraud situation, this is not the first time you've seen and dealt with these things, can you kind of just remind us all the things you've done internally since you've been at the bank and kind of where that positions you going forward? And maybe just the costs that you've already put in for some of the systems you've done to kind of avoid future incidents like this legacy problem?

I wish I had prepared better for that so I could be concise.

We appointed a new Chief Credit Officer and established a fully staffed credit administration team while significantly lowering the approval levels for independent analysts and underwriters. We now have a consistent process for loan approvals, meaning we do not simply approve loans randomly. We have a team of experts who thoroughly review and approve loan packages. Although this may sound basic, it's something we had to implement. The enhancements we've made in our loan systems and monitoring are remarkable. We've learned to decline many requests for extensions and renewals. It's important to not feel obligated to say yes to every loan demand because we have other options. We have put formal procedures in place for renewals and extensions, ensuring a thorough review process rather than quick approvals. Since I joined the team, especially with the disruptions caused by COVID and our underperforming hospitality sector, we have committed to a more detailed review and deeper understanding of our transactions.

Chris, I want to keep this brief, but we are very confident that this was an isolated incident. There was an employee who had been engaging in this behavior for some time, taking advantage of his knowledge of our policies and controls, and leveraging his relationships and long tenure at the bank to bypass many of the checks. However, what Dennis mentioned is what ultimately led to this situation falling apart. He had created a fragile system that he managed within the previous policies, but the changes Dennis referred to made it impossible for him to maintain that system, leading to its collapse.

Sure. That's all helpful background. Thank you very much for all that. Just a quick final question for me just on the mortgage business. Does the seasonality both in Q3 and Q4 suggest that you can still make a little bit of pretax income now and then have a small loss in Q4 or do you think it can be better than that?

I believe Q3 will likely resemble Q2, especially considering what Matt mentioned regarding the pipeline. Q3 should mainly look like Q2, possibly a bit better, but I'm uncertain. For Q4, we aim to achieve around $1 million in pretax profit to avoid going into negative results. My hope is to manage the decline in production and pipeline so we can at least break even in the fourth quarter.

Sure. Okay. Very well. Thank you, both. Appreciate all the background.

All right. Thank you, Chris.

And I show that there are no further questions at this time, and I'll now turn the call back over to Dennis Zember for any additional or closing remarks.

Thank you all again for calling. I hope you have a good weekend. If you have any questions or comments or want to discuss anything further, Matt and I are available and happy to get on the phone with you. All right. Thank you, and have a good weekend.

This concludes today's conference call. You may now disconnect.