Primis Financial Corp. Q3 FY2023 Earnings Call

Hello, my name is Krista, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Primis Financial Corporation Third Quarter Earnings Call. Thank you. I will now turn the conference over to Matt Switzer, Chief Financial Officer. You may begin.

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 everyone who has joined our third quarter conference call. I'm thrilled about our quarter and the broad improvement and momentum we see in key areas. I'll highlight a few points and then hand it back to Matt for more details. Joining me on this call are Matt Switzer, our CFO, and Rick Fulk, our newly appointed President of Primis Bank. First and foremost, our net interest margin improved significantly this quarter due to several factors. We began sweeping excess funds off the balance sheet on June 30, and the full impact was felt in the third quarter. Even if we normalize figures for the second quarter, our margin still increased slightly in the third quarter, which is encouraging. Notably, we had a strong September with a margin of 3.05%, and we are increasingly confident in maintaining these levels and continuing to grow. The improvement in our margin is due to various factors, but our successes in community banking are foundational. We opened 2,404 new accounts for new customers, totaling nearly $73 million at a low weighted average cost of $1.80. On an annualized basis, adjusting for movements in existing accounts, this would represent an annual growth rate of 9% in total deposits, aligning closely with our current cost of funds. It's impressive to achieve this level of deposit activity without needing to offer high interest rates. Moreover, despite the size of our national deposit platform, we completed over two-thirds of this new account activity within the Community Bank. For existing customers, we managed a cost of deposits of 1.91%, which only rose slightly from the second quarter of 2023. Retaining deposits has been crucial, especially after consolidating eight branches, which accounted for 25% of our footprint about a quarter ago. However, our outreach efforts and the convenience we provide have resulted in minimal runoff from those branches. In fact, two of the branches set for consolidation have seen increased deposit levels since the announcement. Rick and his team have excelled in achieving these results, and we believe they are sustainable. Looking ahead to the fourth quarter, our pipeline and closed activity appear very promising compared to our third quarter results, and the enthusiasm within the bank is palpable. On the digital front, we spent no money on paid marketing during the third quarter, yet we opened about 1,400 new accounts and saw total accounts on the platform grow by 15% on an annualized basis. Notably, the average cost of these new deposits remained below 5%, with a significant portion coming from referrals by existing customers. In the third quarter, customers opened approximately five new accounts for every account they closed. Our average customer balance is $73,000, and our average depositor is about 49 years old. On the lending side, we are increasingly demonstrating the value of our niches. Between the Community Bank, Panacea, and Life Premium, we achieved new production exceeding $100 million at an average yield of around 7.95%. We booked incremental spreads of 5.18%, effectively neutralizing the dilutive effects of the current interest rate environment. Panacea and Life Premium represent high-quality lending niches with established brands. Throughout the quarter, both divisions focused on building relationships with partners, including other banks and securitization platforms, successfully placing about 25% of their production capacity. As we enter the fourth quarter, we aim to increase this percentage and hope to have the resources in place to operate at full capacity next year. Our mortgage division performed well this quarter, generating about $169 million in volume and pre-tax earnings nearing $700,000, despite challenging conditions for building such a division. These excellent results came from focusing on top-tier lenders and stringent cost controls. Our team is aware of the current environment, and when yields rise and volumes increase, our division's profitability will be impressive, and our discipline will pay off. As I conclude and hand it back to Matt, I want to briefly touch on the balance sheet. We currently have strong liquidity and a solid narrative around our deposits. Our capital levels are robust, and we have very low nonperforming assets, with no significant issues in office commercial real estate. We possess substantial and highly profitable loan and deposit engines that can be adjusted according to our needs. Our earnings are improving as we enhance our margins and manage operating expenses effectively. I am pleased with our position during this uncertain period. Now, I will turn it back 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 third quarter results can be found in our earnings release and third quarter investor presentation, both of which can be found on our website. Operating earnings for the third quarter were $7.7 million or $0.32 per diluted share versus $1 million or $0.04 per diluted share in the second quarter, and up over 50% from the year-ago period. Total assets were $3.8 billion at September 30, flat versus June 30. Excluding PPP loans and loans held for sale, loan balances declined 1% linked quarter. We sold $15 million of Panacea loans and moved another $9 million to held for sale at September 30. We also sold $10 million of participation in Life Premium finance loans in the quarter. If not for those transactions, loans held for investment would have grown slightly in the third quarter. Deposits were down slightly in Q3, as we manage excess liquidity by sweeping off excess deposits. We had approximately $229 million of deposits in the sweep program at the end of the quarter. Impressively, average noninterest-bearing deposits were flat in the third quarter, while ending noninterest-bearing balances increased 2% unannualized from June 30 to September 30. Our core bank is a source of strength in this environment, and the unique products and services we've developed continue to resonate with customers, particularly small businesses. Net interest income increased $1 million to $27.1 million in the third quarter, as funding cost pressures were offset with higher earning asset yields. Net interest margin increased to 3.02% from 3% last quarter, when adjusting for the excess liquidity we carried in Q2. We believe we have a unique advantage due to our two-pronged funding strategy. As a result, in the third quarter, we were able to hold the increase in deposit costs in the core bank to 11 basis points, well below the increase in wholesale options. Excluding accounting adjustments, noninterest income was $7.9 million in the third quarter versus $7.3 million in the second quarter. Mortgage revenue declined slightly in Q3, but was still strong given the environment. Offsetting that decline was an increase in gain on sale income. We sold $15 million of Panacea loans for a $400,000 gain and moved another $9 million to held for sale as they will close shortly. Additional potential sales in the pipeline lead us to have confidence that gain on sale income will be higher in the fourth quarter. Core noninterest expense, excluding accounting adjustments, nonrecurring items and mortgage was $20.5 million for the third quarter versus $23.5 million in the previous quarter. The decline is reflective of the administrative cost saves we announced last quarter, and that were effective midway through the third quarter. We also will consolidate eight branches at the end of October. We continue to be disciplined on the expense side and look for additional saves through attrition while navigating this challenging environment. The provision for credit losses was $1.6 million in the third quarter versus $4.3 million last quarter. $2.1 million of the provision was due to accounting for our third-party managed portfolio, and which is offset by noninterest income gains. Core net charge-offs were $2.3 million, the majority of which was the charge-off of specific reserves tied to the partial resolution of the assisted living problem relationship we have discussed in previous quarters. The final piece of that relationship was resolved in October, bringing pro forma nonperforming assets to $6.5 million or 17 basis points of assets at September 30. The allowance for credit losses to gross loans, excluding PPP balances, was 1.14% at September 30 versus 1.21% last quarter, with the decline largely due to the charge-off of specific reserves and a small reserve release from a lower loan balance and reduced model losses under CECL. Lastly and in summary, operating ROAA improved to 81 basis points in the third quarter, the highest level since the fourth quarter of 2021. We have further expense savings being realized in the fourth quarter, and are confident we can keep grinding net interest income higher with a healthy margin. Combined with additional gain on sale revenue, we believe we can still improve profitability even in this difficult environment, and are optimistic about our prospects in the near term. With that, operator, we can now open the line for Q&A.

Your first question comes from the line of Casey Whitman from Piper Sandler.

Congrats on the quarter. So first, can you walk us through how we should think about the size of the balance sheet from here? Do you see that holding pretty flat, allowing profitability improvement, capital accretion? Could we see some modest growth? What is your outlook there?

I think we'll see modest growth over the next four to five quarters, but not nearly the pace it's been in the last year or two. So probably mid- to high single digits over that time frame.

And really not in a way that moves TCE lower. I mean we want to inch higher on TCE. And I think we're more than comfortable with capital levels where they are right now, especially with nonperformers this low. So with earnings moving where they are, being able to continue growing the balance sheet, but at a slower pace is what we're looking for.

Okay. So then with some balance sheet growth, the margins stable to maybe even up, like do we have pretty high confidence that we've reached the inflection point on NII, and we'll continue to see growth? Maybe not to the same extent this quarter, but the trend will continue to go up.

I think so.

Okay. And Dennis, do you want to maybe talk about your success this quarter with the $50 million in deposits at the Community Bank? Can we expect more of this kind of inflow? I just thought that was a big one.

Yes. About 45 days before we announced the branch closures, Rick and his team mobilized to communicate with every customer who would be impacted. This effort not only mitigated any negative effects from closing branches on outflows, but it also revealed several opportunities, effectively turning the situation into a sales initiative. There were substantial accounts we were working on at the end of September that we didn't close before the quarter ended. This is why we feel confident about replicating the results from the third quarter as we move into the fourth quarter. The restructuring that took place in the second quarter, which enabled Rick to take this position and lead the team, has been beneficial, generating wins and boosting the energy and excitement within the company.

I will add that we're not the only ones with this strategy, but we believe we have advantages with our technology and offerings. We have completely dedicated the core bank to pursuing small business customers. We can attract retail funds through our digital platform from outside the market at a reasonable cost, allowing us to avoid extensive efforts on CD specials or other deposit campaigns locally. Our focus in the core bank and in Virginia and Maryland is on small businesses, which typically have higher balances and lower costs, many of whom are moving away from larger banks, especially Truist. We're also hearing complaints from customers about poor service as those banks cut costs and continue to underpay on interest rates for those balances. Therefore, we see significant opportunities to target these banks and capture some of their business.

Okay. And then can you give us an update as to where you think quarterly expenses will land for the branch consolidations in there? Is it sort of the same range you gave last quarter? Or any change to that?

It won't be fully implemented until next quarter, but I am still quite confident about that range. It might even be significantly higher. I believe we mentioned 18 to 18.5, possibly 18.5 to 19 by the end, but I am still comfortable within that range for next quarter.

And that just excludes the mortgage, right?

Yes, it does. Yes.

Branches closed today.

Is that correct? Are the branches closing at the end of the month or today?

Today.

Okay. Great.

All right. Thank you.

I just wanted to go back to that expense point we were just talking about the $18.5 million to $19 million expense run rate. How much could we see that grow over the course of 2024? Just trying to get a good sense for beyond just next quarter or the next couple of quarters, whether that's low mid-single digits? Or what's your thinking in terms of expenses for next year?

That's a great question. Given the environment, we are fully focused on controlling expenses. Our goal is to stabilize at that level and keep any increases to a minimum. I hope we can aim for low single digits in the end, certainly not exceeding that.

Got it. I think you mentioned this earlier, but what was the spot rate on new deposits at the end of the quarter, and as we are now in late October, has that increased by any significant amount?

I believe the spot rate on deposits is gradually increasing, not dramatically, but we are significantly exceeding that with asset repricing and additional new business. The new business is performing solidly in the 5s. I genuinely think we are generating sufficient new incremental spread just from new business, and asset repricing is the main factor driving the margin higher.

Yes. I think we saw on cost of deposits in July and August. Overall cost of deposits went up about five basis points a month, but it was lower than that in September. And with some of the wins we got late in the month, we're hoping that's less than that to flat in October and November.

Understood. That's helpful. And then the $75 million in brokerage CDs that you have rolling off later this year, do you think you'll put some level of that back on just the supplement funding base? Or do you feel like deposit growth is strong enough at this point that you can potentially let that roll off?

We're going to let that roll off.

Okay. Last question for me. What's your base case for net charge-offs over the next couple of quarters? I mean, obviously, we don't know exactly how everything is going to play out with credit. But should we expect a certain level each quarter and just compare that with where the strong reserve level is today?

I think with the last piece of that assisted living relationship, there's still a little bit of a specific reserve left that will be charged off in the fourth quarter. Absent that, our charge-off has been running about $600,000 a quarter. And we don't see any reason why that would be in the near term.

Understood.

We have no further questions in the queue at this time. I'll turn the call back over to Dennis Zember for closing remarks.

All right. Thank you again for joining our call. I hope you have a good and safe weekend. If you have any questions, we are here in the office, and I'm happy to take the call. All right. Thank you. Have a good day.

And this concludes today's conference call. Thank you for your participation, and you may now disconnect.