Primis Financial Corp. Q1 FY2024 Earnings Call

Thank you for joining us. My name is John, and I will be your conference operator today. I would like to welcome everyone to the Primis Financial Corp. First Quarter Earnings Conference Call. I will now hand the call over to Matt Switzer, Chief Financial Officer. Please proceed.

Good morning, and thank you for joining us for Primis Financial Corp.'s 2024 First Quarter Webcast and 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. How a non-GAAP measure relates to the most comparable GAAP measure will be discussed when the non-GAAP measure is used if not readily apparent. I will now turn the call over to our President and Chief Executive Officer, Dennis Zember.

Thank you, Matt. I appreciate that and everyone who joined our call today. I want to begin by saying that we have made significant changes to our company over the past year, and it is gratifying to see how these changes have contributed to considerable improvement. When I adjust for the cost of consulting services, which was a one-time expense this quarter, I see that we have improved pretax pre-provision by approximately $3.2 million compared to last year. This is a significant improvement given the serious challenges facing the industry. Let me provide more detail on where these improvements originated. First, the core bank's performance is exceptional. Last year, the bank reduced its branch infrastructure by 25% while retaining around 95% of its deposits. Our core margin, which excludes the effects of the third-party portfolio, stands at 3.03%. This is slightly lower than the fourth quarter, yet remains above the 3% mark. A key driver of these results is our core bank's deposit franchise, which reported a cost of interest-bearing deposits of only 2.56% when excluding the impact of the national deposit franchise. This cost is between 50 and 150 basis points lower than most regional peers, highlighting the quality of our customer base and our franchise. We are heavily focused on building our deposit sales pipeline, leveraging our advantages with V1BE and other technologies to establish significant relationships. Secondly, Panacea generated about $1.6 million pretax this quarter, a notable improvement from just $22,000 during the same quarter a year ago. Their loan and deposit growth over the past year has been impressive, particularly in terms of deposits, which now fund about 30% of their total balance sheet. Their deposit growth pipeline is much stronger than their loan pipeline, a result of the technology enhancements enabled by their capital raise. We still have around $16 million after-tax of market value intangible book that we have yet to recognize, but we expect to do so once we deconsolidate Panacea Financial Holdings and see that improvement reflected in book value. Our mortgage division made strides last year by building capabilities in technology and secondary markets. Throughout this process, they have adjusted their operating expenses, which led to earning about $850,000 pretax in the first quarter, compared to a loss of $250,000 in the same quarter last year. This is an excellent result given the current industry conditions, particularly with 30-year rates at or above 8%. I plan to continue recruiting in this division, focusing on steady growth to prepare for declining rates and the expected revenue increase when rates eventually fall. Lastly, our Premium Finance division concluded the quarter with pretax income of about $1.3 million, up from around $850,000 in the same period last year. This improvement is driven by impressively low operating expenses while managing the sector's fastest, most digitally-focused processes for facilitators and customers. This business is entirely cash-secured, with current production yields exceeding those of CRE by at least 100 basis points. It demonstrates the strength of our company that we emerged from this past year even stronger. Our multifaceted strategy has undoubtedly contributed to our success, as we are not solely reliant on one region or concept for our results. At a consolidated level, we are not seeking to add more strategies or complexities. Instead, we aim to fine-tune and enhance our existing operations to take advantage of the improved results that follow. With that, I will hand it back to you, Matt.

Thank you, Dennis. I will now provide an overview of our results before we turn to Q&A. But as a reminder, the financial information we will discuss is preliminary, pending our previously disclosed SEC preclearance process. These results incorporate consistent accounting methodologies as previous quarters for comparison purposes. As in previous quarters, these results include various adjustments related to a third-party managed portfolio that net across different line items. In the first quarter, $1.31 million related to this portfolio is included in interest income with an offsetting amount included in noninterest expense. In addition, $6.28 million of the provision for credit losses related to this portfolio with an offsetting amount included in noninterest income. In the following discussion, references to core items will exclude these amounts. In addition, our results this quarter continue to include the consolidation of Panacea Financial Holdings, or PFH. PFH's pretax loss included in consolidated pretax income was $2 million. This is comprised of approximately $78,000 of noninterest income and $2.1 million of noninterest expense that's included in our consolidated financial results. Results will be discussed excluding these amounts and relative to common share, unless otherwise noted. With that, earnings available to common and earnings per diluted share for the first quarter were $6.3 million or $0.26 per diluted share, respectively. Adjusting for PFH and certain one-time items, core earnings were $7.2 million or $0.29 per share and up substantially from $0.23 in the year-ago period. Total assets were $3.9 billion at March 31, up slightly versus December 31. Excluding PPP loans and loans held for sale, loan balances increased approximately 1% annualized after selling roughly $11 million of Panacea loans in the quarter. Deposits were $3.3 billion in Q1, up slightly from the fourth quarter and net of approximately $70 million of deposits off-balance sheet in the sweep program at March 31. Noninterest-bearing deposits declined approximately 2% in the quarter to $463 million. Core net interest income, excluding accounting adjustments from the third-party managed portfolio decreased $0.7 million to $27.0 million in Q1 due to one less calendar day and with increased loan yields only partially offsetting increased funding costs. Core net interest margin decreased 6 basis points to 3.03% in Q1. Core yield on loans held for income increased 9 basis points to 6.10%, while core yield on earning assets increased 5 basis points to 5.84%. Cost of deposits increased 13 basis points to 2.82%, while cost of funds increased 12 basis points to 2.97%. Excluding accounting adjustments, noninterest income was $8.3 million in Q1 versus $6.1 million in Q4, largely due to increased mortgage activity. Noninterest income this quarter also included $336,000 of gain on sale revenue from the Panacea loan sale. Noninterest expense was $26.5 million, excluding PFH. Mortgage expenses included a net number of $5.1 million this quarter, up from $4.8 million last quarter on higher volume. Unfunded commitment reserve expense was $75,000 in the first quarter versus $299,000 last quarter. Core noninterest expense, excluding accounting adjustments and nonrecurring items, was $19.4 million in Q1 versus $18.7 million for the previous quarter and in line with expectations. More importantly, core noninterest expense was lower by approximately 10% this quarter versus the year-ago period, demonstrating the substantial strides we have made rightsizing the expense base while executing on our growth strategies. The core provision for credit losses was $1.6 million in Q1 versus a much smaller core provision of $100,000 approximately in Q4. Core net charge-offs were $900,000, down from $1.9 million last quarter. The net reserve build in Q1 versus Q4 was influenced by a softer forward economic forecast when modeling our allowance under CECL, particularly for projected unemployment. Lastly, operating return on average assets was 75 basis points in Q1. Mortgage was nicely profitable in the first quarter with a roughly $2 million pretax swing versus the fourth quarter, offsetting an increase in the core provision. Core pretax pre-provision earnings were $10.7 million in the first quarter, up 7% linked quarter and 44% versus the year-ago period. Core profitability remains solid even in this difficult operating environment, and we are optimistic we can continue improving core returns from here. 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.

First of all, I'll just ask, is there any update on the timing for when you might be able to deconsolidate Panacea?

I can't say definitively that it would be in the second quarter, Casey. We're hopeful it's possible in the third quarter.

I appreciate that. Can you walk us through the deposit growth this quarter? Please break down how much you have in digital deposits, whether you're seeing core deposit growth, and how the noninterest bearing accounts are performing. Just give us an overview of the deposits this quarter.

The core deposits remained mostly stable. In fact, we removed some from the balance sheet, and the total amount we reduced declined during the quarter. The average deposits were approximately $2.5 million, down by about $20 million to $30 million in the core bank compared to the last quarter, but not significantly. Additionally, there was an increase in balance sheet activity on the digital platform. The cost of our digital deposits has been fairly steady; this quarter, the average cost of interest-bearing deposits in digital was 504, compared to 503 last quarter. Core bank deposits saw a slight increase, and we're observing similar trends among our peers. However, the overall cost of total deposits in the core bank rose by about 15 basis points during the quarter.

Are you starting to see that kind of pace of deposit cost increases start to slow, at least in March or so far this month?

Yes, to some extent. As we head into the second quarter, I don't think we will be as optimistic about significant margin expansion during this period. I'm expecting it to be more stable, with hopes for increased margin expansion in the latter part of the year, even if there are no rate cuts.

Yes, Casey, I would add that margin compression could occur if we become more reliant on securing deposits. However, I don't see that happening. Each week, we are successfully opening between 50 and 100 new accounts on our digital platform, without any advertising. These accounts are coming in with an average balance of about $25,000, and their pricing is likely just below 5%. This alleviates a lot of pressure on our core banking operations, which is a key reason why we believe in the strength of our core bank's cost of deposits and the overall value of our franchise. Therefore, I don't foresee any urgency to adjust rates for funding this coming quarter, even considering the loan demand and pipeline.

You threw a lot of numbers out there, Matt, but it sounds like from a core expense run rate, from core fees, core margin, you're sort of where you had hoped to be or somewhat near there and that your sort of outlook for 2024 hasn't meaningfully adjusted. Would that be accurate?

Yes.

Okay. And I'll just ask one more. I recognize that nonaccruals are coming off of a very low level. But did you see any sort of credit migration this quarter or any major increases in classified assets or anything you want to address there?

We did not see any significant changes. Our risk-rated special mention increased by approximately $4.5 million this quarter, but it remains at a relatively low level, around $19.5 million compared to $15 million last quarter, which is within normal activity ranges. Additionally, substandard loans actually decreased from 17.2 to 14.9 since last quarter. Overall, there was some movement in and out of categories, but no significant directional changes.

The next question comes from the line of Christopher Marinac from Janney Montgomery Scott.

I'm going to pick up where Casey left off on the credit question. So the reserve build we saw this quarter, was that sort of out of an abundance of caution, do you think you'll have higher losses, or is it just because it was prudent at this structure?

The core reserve build included some provision for charge-offs, and the rest amounted to around $600,000 in core reserve build. Half of that was an increase in specific reserves for individual credits, roughly $300,000, which isn’t a large amount. The other half, also about $300,000, was driven by our CECL model. This quarter, we noticed that the front end of the Moody's forecast was weaker on average compared to recent trends, and that influenced our model. While other banks have been releasing reserves, our methodology and those forecasts led to a slight reserve build, which wasn’t substantial, just not a release.

Perfectly fine. And I guess, if we look at the core charge-offs we saw this quarter outside of the third party, is that a good run rate for the near term? Would you expect that to be a little higher over the course of the cycle?

I think that's probably a good run rate. Hopefully, it will be down from there.

Got it. And then last question just has to do with kind of just new deposits at the margin. What does it cost to get new money in the door? And do you think that, that sort of incremental rate may back off a little bit as this next quarter develops?

Dennis, do you want to address that or should I take it? I'll take it. It depends on the approach we're taking, Chris. On the digital platform, the additional cost of funds is likely still around 5 or low 5s. In the core bank, it varies; most of our focus in local markets is driven by commercial efforts. I believe Dennis mentioned that we've had significant success using some of our technology offerings, particularly in attracting corporate customers. We can acquire those customers even when they are opening an interest-bearing business account at 4, sometimes even below 4. So, our weighted average for raising funds is probably in the low to mid-4s on an incremental basis. We're consistently working to maximize our resources to bring in those funds.

Yes, I apologize for speaking while muted. To reinforce what Matt mentioned, on the digital front, we are generating revenue in the low to mid-4s. Without any marketing efforts, we can likely achieve $30 million to $60 million each quarter from that. Regarding the core banking side, Matt is correct; it's not as costly, but we have technologies like V1BE, which is consistently bringing in around $20 million a quarter from checking accounts. Given the current rates, this helps reduce our overall cost of deposits and our total expenses for the bank. In response to Casey’s question about margins, Matt and I agree that our initiatives are not negatively impacting our 3% margin. Our additional costs of funds and lending are supportive of that margin. There may be isolated impacts, particularly from repricing, but overall, I believe we are in a strong position.

Great. That's all very helpful. And that the pace that you're talking about in the digital channel is a function of kind of the groundwork you've laid in the past couple of years. So over time, is it possible that, that number could be a little bit bigger?

Yes, absolutely. We do have restrictions on the number of deposits we will open, primarily because we're focused on maintaining customer service, ensuring that each digital customer has a banker to contact. Consequently, we're limiting the number of customers who can open accounts. The next phase involves introducing offerings that attract deposits with a focus on checking accounts, which tend to have lower long-term costs. To your point, Chris, we are not actively marketing this digital platform. We have approximately 16,000 customers and around 18,000 accounts opened, largely through referrals from existing customers. Additionally, increased name recognition is beneficial. It’s unrealistic to expect a large influx of customers opening accounts at a bank they are unfamiliar with. However, as we continue this effort and improve our visibility, we anticipate more account activity.

The last question comes from the line of Russell Gunther from Stephens.

I wanted to ask about your loan growth expectations for the year. If you could talk about this volume and mix and then how your gain on sale strategy factors in?

Yes, I'll begin. I believe the core bank has identified some loan opportunities, primarily with existing customers. However, the industry's caution and the hesitance of real estate investors regarding commercial real estate may limit the growth we can achieve in our balance sheet from the core bank. As for Life Premium Finance, there are no boundaries to its potential. While we are attempting to temper the growth levels somewhat, we are not making significant reductions. We could be aiming for total loan growth in the high single digits, combining Life Premium Finance and Panacea, which appears to have similar loan volumes. Matt?

Yes. I think last quarter, we said high single digits to maybe low double digits, 10-ish percent net loan growth, net of sales, and I think still imminently doable.

Okay. I appreciate it, guys. And then just a couple of follow-ups. I hear you on the potential timing of your ability to deconsolidate Panacea. Can you just remind us in terms of use of capital, balancing that kind of high single-digit, maybe low double-digit loan growth with the potential for buyback activity?

Well, when we get that gain, we will definitely evaluate the best use for that capital, be it growth or buybacks. I mean if we continue to trade at a meaningful discount to tangible book value, buybacks obviously become much more attractive.

Probably the buyback would probably move way up the list of strategic ideas.

Okay. Very good. And then last one for me. Matt, you touched on in response to a question, just overall '24 outlook given the start to the year hasn't materially adjusted. So as we fold all of this together, can you just remind us of your timeline to achieving that 1% ROA target on a sustainable basis?

We still believe that achieving our goal by the end of this year is feasible. We've consistently mentioned the latter half of 2024 as the timeframe to reach that target, though it could be in the third or fourth quarter, which depends somewhat on the margin environment. However, we are still confident that we can reach that level.

As there are no further questions at this time. I would like to turn the call over to Dennis Zember for closing remarks.

Okay. Thanks again for everyone that joined the call and expressed some interest. Matt and I are available the rest of the day, really any time. So call us if you have any more questions, otherwise, I hope you have a good weekend. We'll talk to you soon.

This concludes today's conference call. Thank you for your participation. You may now disconnect.