Primis Financial Corp. Q4 FY2023 Earnings Call

Hello, and thank you for joining us. My name is Regina, and I will be your conference operator today. I would like to welcome everyone to the Primis Financial Corp. Fourth Quarter Earnings Conference Call. All lines have been muted to reduce background noise. After the remarks from the speakers, we will have a question-and-answer session. I will now turn the conference over to Matt Switzer, Chief Financial Officer. Please proceed.

Good morning, and thank you for joining the conference call. 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. With that, 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 fourth quarter conference call. Before I get into our results for the quarter and the year, I wanted to let the investing public know that our company CIO, Cody Sheflett, passed away suddenly on the afternoon of January 16. Cody was one of the most visionary CIOs I've had the good fortune of being around. Cody could unquestionably outdream me and Matt, but he had all the engineering and technical skills to make all of it come to life. On top of that, he fostered our company staff with love and humble attention that drove the unique culture we aspire to build. Fortunately, Cody mentored his staff incessantly for many years to always be prepared. And while I'm confident in the future, our company is reeling from his departure. Now about our results. For the quarter, what I think is important is that these results include a pretax loss in mortgage of about $730,000, which obviously is timing related and about $1.4 million lower than where we were in the third quarter. And while I don't want to steal all of Matt's good news, which I've been known to do, in the quarter, our margin was up, our expenses were down, NPAs down to very low levels, liquidity and capital strong and getting stronger. Nobody at Primis thinks that we can even see land yet on this journey to top quartile operating ratios, but it's nice to know that we have a lot more wind in our sails. We took advantage of all the chaos in the industry in 2023 and built momentum that can be clearly seen in improving margins, operating expense control that has us close to 2022 levels going into the new year, and impressive growth in core deposits at levels that drive results. Without any noise in the quarter, our margin was up about 10 basis points, resulting from hard management of all the important factors. We control deposit costs, we increased loan yields. Our incremental activity was very accretive. There's more information in Matt's details that are shortly coming. But for the quarter, we opened about $75 million in new deposit accounts, costing only 2.69%. And that funded new loan production of $86 million with yields of $838 million. With this kind of activity, the momentum on margins and net interest income is clearly on our side going into '24, which is critical to continued quarterly improvement in our ratios. Cost controls are equally important, especially in a year when revenue was so pressured, we delivered an impressive second half of '23 with the changes that we made earlier in the year. We've restructured almost every division, consolidated eight branches and leveraged technology to absorb even more of the jobs and tasks that were previously pushing compensation levels. This restructuring mindset continued through the fourth quarter and honestly, into today. And while the improvements we are making are smaller individually, they are large enough to offset growth levels and allow more of the anticipated revenue to make it to the bottom line. In 2023, we grew deposits a touch better than 20% with a substantial amount coming through digital channels. A year later, we still have over 90% of the deposit accounts we opened originally, and with virtually no advertising expense, we continue to open accounts almost solely through referrals from existing customers. We are live with business accounts now and focusing that activity really only on referrals for the time being. But the promise of lower-cost deposits on this platform is starting to take shape. Our core bank has well outperformed in '23, with our retail franchise driving substantial deposit activity amidst our branch consolidation and major industry headwinds. We've taken V1BE to new levels that we didn't think were possible, and we're starting to see customer referrals for new accounts that need the convenience and the technology we're bringing to the table. Over the last two quarters, we've opened 4,400 new non-CD deposit accounts with approximately $147 million of balances, costing a remarkably low 2.25%. I don't want to convey to anybody that we've cracked this nut or that this effort is on autopilot. Moving deposit balances even with noticeably better tools and technology is through sheer force and grit. But the momentum and success that we've had so far builds confidence in our staff, and we're determined to continue this trend. A few other notable and, I think, important factors for our 2023. Our two national divisions, Panacea and Life Premium Finance had outstanding years. Panacea was just named the exclusive banking partner of the American Dental Association and shortly thereafter closed its Series B round, rightly establishing an impressive market value for this concept. Our ownership in Panacea is worth about $20 million, which, of course, at this point is unrealized while that entity is consolidated. We anticipate being able to deconsolidate and recognize this gain in the near future, which would give us substantial flexibility to either ramp up share repurchases or increase our growth rate by a touch across the bank. Life Premium had an amazing year, bringing substantial diversification and quality onto our balance sheet at yields that are substantially better than CRE. On top of that, they've built remarkable technology to drive efficiency and speed, and they operate with one of the lowest expense burdens imaginable. Lastly, despite an expected slowdown in activity and profitability, our mortgage division finished the year profitable, with just $600 million in total production. We have recruited all year without big sign-on bonuses using culture and great technology to build our stable producers. Looking at the current month, January '24, our pipeline is up over 25% from a year ago. And so we feel like the revenue opportunity here is much brighter. Turning this over to Matt, I'm pretty excited about what '24 could bring. Our core bank has never been this strong on expense control or management on core deposit growth and loan quality. Our divisions are past the concept stage and in places where they will drive the boost to operating ratios that we expect, and our capital and liquidity levels give us all the flexibility we need to be nimble with uncertain economic and rate conditions. So with that, Matt, turn it to you.

Thank you, Dennis. I'll provide a brief overview of our results so that we can get to Q&A. But as a reminder, a full description of the fourth quarter results can be found in our earnings release and investor presentation, both of which are on our website and on 8-K with the SEC. As Dennis just discussed, our results this quarter include the consolidation of Panacea Financial Holdings, or PFH. Results will be discussed relative to common shares unless otherwise noted. Operating earnings per share for the fourth quarter were $8.6 million or $0.35 per diluted share versus $7.8 million or $0.32 in the linked quarter and up substantially from $0.03 in the year-ago period. Total assets were $3.9 billion, essentially up a little bit versus September 30. Excluding PPP loans, which are de minimis at this point and loans held for sale, loan balances increased 1.5% linked quarter, and that's after selling roughly $31 million worth of loans in the fourth quarter. Deposits were essentially flat. As we discussed previously, we manage excess liquidity by sweeping off excess deposits, of which we had approximately $113 million swept off the balance sheet at December 31. Impressively and as noted in our press release, average noninterest-bearing deposits were essentially flat for the third quarter in a row, which we think is exciting in the current environment. Net interest income, excluding accounting noise from a third-party managed portfolio increased almost $1 million to $27.7 million in the fourth quarter as funding cost pressures were offset with higher earning asset yields. Core net interest margin, as Dennis alluded to, increased 10 basis points to 3.09% in the fourth quarter. We continue to believe we have a unique advantage due to our two-pronged deposit funding strategy. As a result, in the fourth quarter, the core bank cost of deposits increased only 3 basis points versus the third quarter. Excluding accounting adjustments, noninterest income was $5.9 million in the fourth quarter versus $7.9 million in the third quarter, largely due to reduced mortgage activity, which we think will improve in the first quarter. Core noninterest expense, excluding accounting adjustments, nonrecurring items, and mortgage, was $18.7 million for the fourth quarter versus $20.5 million in the third quarter. As we discussed in the press release, the fourth quarter includes expense reimbursement from Panacea Financial Holdings related to division expenses. But in addition to that, the decline is reflective of administrative cost savings that we announced earlier in the year and the consolidation of eight branches in October. The provision for credit losses was $3.1 million in the fourth quarter versus $1.6 million in the third quarter; $3 million of that was due to accounting for our third-party managed portfolio, which is offset by noninterest income gains. Core net charge-offs were $2 million, the majority of which was charge-off related to specific reserves from credits impaired in previous quarters. Nonperforming assets were down substantially to $7.7 million or 20 basis points of assets at the end of the year. The allowance for credit losses to gross loans was 1.06% at December 31 versus 113 basis points last quarter. Lastly, as Dennis indicated, operating ROA improved to 89 basis points in the fourth quarter, the highest level since the second quarter of 2021. We have rightsized the expense base and are confident we can keep grinding net interest income higher with a healthy margin. Combined with additional mortgage activity that we expect in 2024, we believe we still have an opportunity to improve profitability even in a tough environment and are optimistic about our prospects in the near term. With that, we can now open the line to Q&A.

Our first question will come from Casey Whitman with Piper Sandler. Please go ahead.

Hey, good morning.

Good morning, Casey.

So just looking at that core operating expense burden, which you have in the release, just coming off, I think it's $18.7 million, do you still have room to bring that down a bit in the first quarter just with full cost savings coming off? Or is this a pretty good run rate?

No. I mean, I would say it's a little artificially low, Casey. I think our guidance previously of $19 million to $19.5 million is still the better run rate. That $18.7 million in the fourth quarter does include some excess expense reimbursement from Panacea Holdings that won't be there in the first quarter, even though they will still be reimbursing us for expenses in the division. And it also had some other accrual noise that would offset some of that. So I would say that $19 million to $19.5 million is still the best run rate in the near term.

Okay. That $2.8 million you referenced in the expenses for the effect of consolidating Panacea, that's just the reimbursement cost?

While their expenses are consolidated into ours, the majority of their costs, apart from a few minor items, were related to our expense reimbursement.

Okay. Regarding the Panacea relationship, how does the investment impact your profit and loss in the near term? Will it have any effect now, or can you simplify how it will function?

The profitability from Panacea has been positively impacting our bottom line, with the income from spread minus operating expenses and a slight amount of fee income likely from sales. Moving forward, especially now that we have capital at the parent level, the bottom line will essentially be our operating hurdle rate times their average outstanding balance times their total assets. I would expect around $1.7 million to $1.8 million to consistently contribute to the bottom line, and this amount will increase as assets grow, unlike in the past where it could vary. If there was significant loan growth in a quarter, we could have reported zero due to funding provisions or expenses from recruiting. The expense reimbursement was meant to lower our operating hurdle a bit. However, the operating hurdle will be higher moving forward. The reimbursement Matt mentioned was primarily to align us for 2023. Therefore, our operating results from Panacea will be stronger and more stable in the future.

Okay. Thank you. Please continue.

I understand that this can be quite confusing. Our goal was to present the information as clearly as possible, allowing for an apples-to-apples comparison with the previous quarters. Currently, the consolidation involves only expenses, primarily in the form of expense reimbursements to us. If you look at all the line items aside from noninterest expense, there is essentially no impact from the consolidation in those areas. The items still reflect the Panacea division, which we've included in our run rate for the past three years. The main change is in the noninterest expense category, and a significant portion of that is offset in the non-controlling interest since we own only 19% of it. To make things comparable, focus on the revenue line items and the noninterest expense we just discussed as you look ahead, and this will help you align with our previous performance before the consolidation.

Got it. And the $19 million you referenced would include the effect of Panacea, correct? And then you'd add mortgage on top of it?

It would include the effect of the future level of reimbursement from Panacea, yeah, as if they weren't consolidated.

Okay. Appreciate that. And then just given where capital is today and the potential to keep growing, I guess, just how are you thinking about overall balance sheet going forward? Could you potentially start the portfolio more? Or sort of how should we think about that?

Yes. I know we've talked the last couple of quarters about mid-single digits growth. I think for '24, we're targeting more towards around 10% overall balance sheet growth.

Okay. Thank you. Last thing I'll ask, just appreciate there's some seasonality within mortgage this quarter, but what's a reasonable outlook for those revenues next year to the extent you can share?

We made around $700,000 to $800,000 in the second and third quarter. I believe we might be about 25% higher than that for those quarters. Typically, we wouldn’t have broken even, and I mean to say we lost money in the fourth quarter. I think part of that is influenced by some rate fluctuations and the seasonal trends of the fourth quarter. Overall, I believe we made approximately $300,000 in mortgage revenue throughout the year.

$600 million.

$600 million. And the incremental, I think, would probably could be somewhere $900 million, maybe even $1 billion, and it's going to be incrementally much more profitable, just given the fixed expense burden that is not expected to grow. If we made $300,000 this year, and we were able to increase volume to $900 million, which it looks like we're going to be able to do. Probably $3 million...

Yeah. That's what I was going to say, pretax.

Sounds good. Thank you.

Yeah. Thank you.

Your next question comes from the line of Russell Gunther with Stephens. Please go ahead.

Hey, good morning, guys. Just wanted to start on the loan growth commentary about 10% for 2024. Can you just spend a minute touching on the mix, maybe particularly addressable Life Premium Finance and Panacea as well?

I believe that both Life Premium and Panacea, if fully utilized, could potentially generate sufficient growth to significantly benefit a much larger bank. Therefore, what I'm sharing here may seem understated compared to their actual potential. Tyler has excellent production capabilities and is also focused on flow agreements and loan sale opportunities. I estimate that the impact on our balance sheet from Tyler for Panacea will likely be between $100 million to $150 million. Life Premium finance is likely around $150 million. Life Premium is achieving outstanding yields, and the expense burden is remarkably low. The core bank could achieve similar results as those divisions, although I'm unsure if the market is fully there. In total, I would estimate about $150 million for each division and between $75 million to $100 million for the core bank.

Okay. That’s very helpful.

Yeah, long term, I'll just make sure everybody knows, long term, we would love to be driving more activity through the core bank, and there is the potential there, and we've got the horses. I think we're all just realistic. I don't know that the market or the economy is going to be there for that.

That's really helpful color, Dennis. And then maybe just switching gears to the margin. So again, you guys talked about the success you have with new deposits at a much lower rate than where the loan yields are coming on and we're looking at 10% loan growth. So could you spend a second just thinking through how that core margin trends in 2024, maybe set expectations for us, what you're thinking with regard to Fed funds in that expectation as well?

I’m not sure we have a clear fit. There is a lively discussion happening internally about the passive Fed funds, Russell.

Matt is laughing because he won the bet last year.

I feel confident about our outlook this year. If interest rates remain stable, we anticipate that our margins will continue to improve due to repricing, and we expect to lower deposit costs further. Regarding balance sheet growth, we've already secured $100 million for that purpose. By the end of the year, we expect margins to rise to the mid-3.30s, around 3.35%. A few rate cuts later in the year could potentially reduce our margins by a couple of basis points, which would likely affect the entire industry. Overall, without significant benefits from rate cuts, our margins may settle between 3.25% and 3.30%. It's challenging to predict precisely, but this is our general expectation.

I think overall we are positioned really well. Rates going up or down will not provide any relief from deposit costs. A 5% Federal Funds rate won't help since industry deposit costs are mostly still in the 2% range. I don't expect deposit costs to decrease significantly, and I doubt we will see a strong response to the first couple of rate cuts anyway.

Well, that's helpful, guys. I appreciate just framing that narrative. The follow-up would be that margin guide is relative to that core $3.09 million from this quarter?

Yes. Yeah.

Okay. Great. Thanks for that. And then just last one. It seems like you're getting increased capital flexibility here. I'd just love some comments on buyback expectations and hurdles to getting that done.

Matt and I always participate in these calls, and we are aware of the engines we've built to grow the balance sheet. We are very focused on capital levels and opportunities, especially since the stock has been trading below tangible book value for much of 2023. This situation makes us even more determined to raise our capital levels, but we lack the flexibility to pursue new capital. That said, we feel confident about the direction of our operating ratios, earnings per share, and the upcoming capital build. If we are able to deconsolidate and realize the associated gains while the stock remains at tangible book value, we plan to be quite active with that capital. We believe our story is gaining traction. So while Matt and I see potential for capital to enable further growth, we are also ready to invest more in our own stock if necessary.

Understood. All right, Dennis, thanks for the thoughts. Thank you both for taking my questions.

All right.

Your next question will come from the line of Christopher Marinac with Janney Montgomery Scott. Please go ahead.

Hey, thanks, good morning. Dennis and Matt, you may have kind of partially answered this in previous calls, but I wanted to understand, is the pretax pre-provision that we talk about on an operating basis this quarter, can we further adjust that back for the operating expenses, the $18.7 million that you called out, is the PPNR kind of higher than it appears because of that operating expense change?

It is a bit higher based on what Matt mentioned. You might consider adding between $19 million to $19.5 million, and I would suggest looking at the lower end of that range, although Matt might suggest the higher end. Therefore, you could probably add around $300,000 to $400,000 to that figure, Chris.

Okay. And that's on expenses. Would there be any adjustments on the revenue side to kind of get a true apples and apples?

No.

Because all the third party is netting against each other, so we don't have to be too concerned about that.

On the pretax pre-provision. Well, I take that back. In pretax pre-provision, there is a third-party effect through noninterest income that if you wanted to take all the third-party, I would come out. And there's a line item on customer...

Okay. So you use that to kind of net that, which would therefore be a reduction to get to kind of a run rate?

Yeah. But if you're using the noninterest expense above the line, obviously, that's got the Panacea consolidated expenses in there. So you got to adjust that out as well. So if you use the table for our noninterest expense, that's adjusting out the consolidated expenses from Panacea.

Yep. Understood. Okay. Thank you for walking us through that. And then when we talk about deposit costs, and I appreciate the angles that you've got in the release, what is the most important one that you're focusing on as you manage this business quarter-to-quarter?

On the incremental deposit cost as a whole or...

Correct. Going forward, should we concentrate on that core bank number, or are you considering all three and adjusting each of them?

All three for sure. Coming into this rate cycle and this inverted yield curve, people didn’t recognize Primis as having the strongest core bank deposit portfolio. It’s impressive that we have navigated through this. In our region, we actually have one of the lower core bank deposit costs. This is partly because we aren't as desperate for every single dollar due to the flexibility offered by our digital platform. I recall that for about 30 days, the digital platform seemed like it was associated with costly money, but for the subsequent 11 months, the situation changed. Currently, the strategies we're employing on the platform, after experiencing rapid growth, have brought us into a favorable phase where the growth aligns well with a $4 billion balance sheet. This growth isn't being fueled by extraordinary rates; instead, it's about utilizing technology and referrals. Consequently, the growth appears slightly subdued, allowing the advantages of our core banks to become more pronounced. This is how we achieve such an impressive level of incremental deposit costs.

Got it. And then incrementally, would we expect to just all things being equal that the digital costs would come down quarter-over-quarter again in Q1?

I believe that around 90% of the balances on the digital platform are likely to have a high sensitivity to Fed funds compared to our core bank, which probably has a low sensitivity to the initial rate changes. Therefore, I think that declining rates may impact the digital platform more quickly, which makes sense given the higher costs. The introduction of new incremental products with lower sensitivities to Fed funds or that are noninterest-bearing on the business side will likely result in a decrease in the weighted average cost on the digital platform.

Got it, and that makes sense. Great. Thank you for the taking the questions and all information today.

All right. Thanks, Chris.

Thank you again for joining our call. Matt and I are available all day if you have any more questions or comments. With that, I hope you have a great weekend. Talk to you soon. That will conclude today's meeting. We thank you all for joining, and you may now disconnect.