Earnings Call Transcript - FRST Q2 2021

Operator, Operator

Good day, and welcome to the Primis Financial Corp. Second Quarter Earnings Conference Call. All participants will be in a listen-only mode. After today's presentation, there will be an opportunity to ask questions. Please note, this event is being recorded. I would now like to turn the conference over to Matt Switzer, Chief Financial Officer. Please go ahead.

Matt Switzer, CFO

Thank you, Sean, and good morning, everyone, and thank you for joining us for our second-quarter earnings 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. These factors are discussed in our recent filings with the Securities and Exchange Commission, including our recently filed earnings release, which has been posted to the Investor Relations section of our corporate site primisbank.com. We undertake no obligation and we specifically disclaim any obligation to update or revise forward-looking statements to reflect change the assumptions, the occurrence of unanticipated events or changes to future operating results over time. In addition, some of the financial measures that we will discuss this morning are non-GAAP financial measures. 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.

Dennis Zember, CEO

Thanks, Matt, and thank you to all of you who have joined our call today. We had a good quarter on several fronts and some really positive items ahead of us. We've also have some challenges that we can discuss here. But even those challenges pale relative to the opportunities that we all believe this franchise has going forward. Matt's going to get into the details about the quarter and the numbers. But at a high level, we earned $0.42 per share this quarter, which was roughly 10% higher than what we earned in the same quarter a year ago. We've grown total assets to about $3.4 billion, mainly through very successful efforts on deposit levels. At the end of the current quarter, total deposits were $2.8 billion, which only included $388 million of CD. In the last year, we have run off about 40% of our CD portfolio, pretty much all of our brokered and national CD and replaced that with about $800 million of growth in transaction accounts. I know the industry is awash in liquidity and that trend has definitely held. But our work on training, sales incentives, new products and services and adding additional staff has had a tremendous impact on our deposit levels. I'm very thankful and very grateful for the team that we have here at Primis for their absolutely drive to be champions and the results that we're getting across the board. The quality of the team here, their results, their early results give me a lot of confidence that the results that we're seeing are sustainable. The success on growing deposits and building our funding base has led to what is currently our biggest challenge. We finished the quarter with about $850 million of very low-yielding short-term assets, which include our PPP portfolio. Deploying that in the current environment has not been easy, but we've started to make some headway and the second half of this year will be noticeably better with respect to loan growth. Our pipelines and our commercial bank are higher and our pipeline at Panacea is building very nicely with their recent move into commercial. We are still recruiting where it's possible. But the growth that we expect in the second half of the year and in 2022 has very little incremental operating expense behind it. So we expect really impressive operating leverage in the coming quarters. Lastly, and really before I turn it back over to Matt, we continue to work towards a fourth-quarter launch of our digital bank offering that's focused on commercial and consumer checking accounts, at least initially. Our team and our partners are very close to the testing phase of the project, and we are still targeting a complete project that we can go live with during the fourth quarter. There are some elements of our work on this digital bank that are actually just a few weeks away from a lab test with elements of our existing customer base. This test will prove in a real-world environment if the features and the hooks, as we like to call them, are actionable, if they're meaningful enough to move business from one competitor bank to Primis, which obviously is our goal. I'd like to take this opportunity to say one more thing about our vision for digital. The biggest misperception is that we are going all digital, and basically going to abandon our effort to build an impressive growth and profitability machine out of this existing franchise. And that's just not true. Everything that it takes to build a legacy franchise with the growth and profitability to earn high multiples, we're going to do. Our digital bank will just complement our core bank, not replace it. It will further augment our future growth and I absolutely unquestionably believe that. Traditional bankers, such as myself, have seemingly dismissed digital bank efforts because they focus too much on interchange income or low-balance millennials like my two young sons. Planning an entry into this space is critical. It's absolutely critical. But it's also terrifying because there are untold millions of fees and service charges in the legacy bank system that we all know cannot materialize in the digital world. The only way to avoid that is to run a parallel brand. You're talking about companies that have decades and centuries of building brand loyalty and bulletproof reputations. Our focus, our vision is to focus elsewhere. We've looked at our core customers, and we've talked to them endlessly. We've gained real insight into what would start to move them from valuing the branch to valuing a digital platform. Because we're looking to augment our core bank, we will only be using one brand, which is Primis, which we believe is very unique in our industry. And let's be honest, everybody operating in this industry believes that future growth in earnings and balances will progressively be left centered on branches built in the traditional fashion. We are confident that our efforts are perfectly timed to drive value in the core bank right now and be ready for where we all know the industry is going into the future. All right. With that, I'll turn it back to Matt for an update on the quarter.

Matt Switzer, CFO

Thank you, Dennis. Earnings for the second quarter were $10.3 million or $0.42 per basic and diluted share versus $9.4 million or $0.39 per basic share and $0.38 per diluted share in the first quarter. Total assets grew to $3.4 billion in the quarter, gross loans declined to $2.29 billion in the second quarter from $2.39 billion in the first quarter due to the decline in PPP balances. Excluding PPP loans, loan balances were essentially flat in the second quarter. Deposits increased 2.3% versus the first quarter to $2.75 billion. As Dennis mentioned, we are proud of the progress we've made on improving our deposit mix and improving our core deposit funding. Non-interest bearing deposits are over 19% and time deposits are now less than 15% of total deposits. Liquidity continues to build and impact our results with cash and equivalents reaching $621 million at quarter end versus $480 million at the end of the first quarter. We've added some to the securities portfolio in the quarter, but do not currently intend to aggressively buy securities in anticipation of loan demand increasing in the coming quarters. As Dennis alluded to, pipelines have grown particularly later in the quarter, which gives us confidence that we will be deploying this cash in the near future. We have $240 million of PPP loans remaining and continue to work through the forgiveness process with customers. We recognized $1.8 million of net PPP in the second quarter versus $4.9 million in the first quarter. As of June 30th, we have $5.2 million of net deferred fees remaining to be recognized. Credit quality remains good with non-accrual stable and OREO balances continuing to decline. Losses remain muted with net recoveries in the quarter of $587,000. COVID-related deferrals declined to $26 million from $113 million at the end of the first quarter as expected, with substantially all of the remaining loans on deferral anticipated to be off by the end of the third quarter. Improvement in the operating environment and reduction in loan deferrals led to a negative provision for the quarter of $4.2 million versus a negative provision of $1.4 million in the first quarter. The allowance for credit losses to loans excluding PPP balances is 1.52% at June 30th versus 1.7% at March 31st. Our reported margin was 2.8% for the second quarter, down 61 basis points from the first quarter. The biggest driver of the change was the decline in PPP fee income in the second quarter. Excluding the effects of PPP, net interest margin declined 22 basis points to 2.77% in the second quarter. Essentially all of this compression was due to higher average cash balances in the quarter. While the level of margin compression we've experienced over the past year has not been fun, we know this liquidity will be put to good use. As noted above, we're excited to see pipelines building and fully appreciate that the operating leverage as we deploy this cash is significant. Non-interest income increased $677,000 in the second quarter, largely due to an increased contribution from our equity investment in Southern Trust Mortgage. Non-interest expense declined $783,000 in the quarter. Excluding the decline in the expense related to the unfunded commitment reserve, non-interest expense declined $220,000 in the second quarter. We closed one branch location in April and will be closing another location in August. We continue to be focused on managing expenses while building the capabilities and resources to manage a much larger bank. I will now turn the call back over to Dennis.

Dennis Zember, CEO

Well, let's turn it back over for questions if we have any.

Operator, Operator

Thank you. We will now begin the question-and-answer session. The first question today will come from Casey Whitman with Piper Sandler. Please go ahead.

Casey Whitman, Analyst

Hey, good morning.

Dennis Zember, CEO

Hi, good morning.

Casey Whitman, Analyst

First, I appreciate you hosting the call this quarter. It's been very helpful. You mentioned that the pipeline is improving, so how should we view the rate of loan growth for the latter half of the year? Are we looking at low, mid, or high single-digit growth? Additionally, do you anticipate Panacea to be a significant contributor this year, or what would be a reasonable growth expectation over the next few years?

Dennis Zember, CEO

Yes, I believe on a consolidated basis, Matt and I reviewed some reconciliations this morning. We might be looking at an annualized loan growth rate in the range of 10% to 15%. I don't think we will reach that by the end of the year, but an annualized pace of around 10% seems attainable. While it may not quickly absorb all the liquidity as we would like, we have spent three to four years without significant loan growth, and we are focusing on helping our team to effectively deploy capital. Regarding Panacea, we initially concentrated on consumer unsecured loans, then shifted to student loan refinancing, which significantly boosted their growth. Now, we've expanded into the commercial sector, which is proving to be highly beneficial for their growth rate. The response from customers has been overwhelmingly positive. I believe we should allow another quarter to see how this develops, as the pipeline has improved significantly, and once we start closing those loans, the narrative regarding total loan growth may change in the near future.

Casey Whitman, Analyst

Okay, okay. Makes sense. All right, so sounds like you're feeling good, though about the talent you have to drive the loan growth. So curious how you're thinking about the second-quarter expense level? Do you think you can hold the expenses at around $17.5 million, or are there, I guess, some incremental expenses related to the opening of the digital bank that we should consider, or is this just a good rate given your growth expectations for expenses?

Matt Switzer, CFO

I think, Casey, this is Matt. $17.5 million is still a pretty good number for the next quarter as well. We have some additional expenses coming in from the digital bank, which will be more pronounced in the fourth quarter than in the third quarter. However, some of the positive incentives we discussed in the last quarter or two will begin to decline, with a smaller decline in the third quarter due to a lag effect, but a more significant decrease in the fourth quarter. This will offset some of the expenses. Therefore, while there may be fluctuations in some line items, overall, $17.5 million plus or minus remains a solid figure.

Casey Whitman, Analyst

Okay. Sounds good. Just one more, sort of, modeling question. What was the – do you have the accretion level that you guys book this quarter, is similar to last quarter’s level? My last…

Matt Switzer, CFO

The accretion is close, at $581,000. Last quarter, it was $481,000.

Casey Whitman, Analyst

Perfect. Perfect. And my last question will be just do you have the amount left in deferred origination fees for the PPP program?

Matt Switzer, CFO

Yes, it's $5.2 million.

Casey Whitman, Analyst

Awesome. Thank you guys for hosting the call. We appreciate it.

Matt Switzer, CFO

All right. Thanks, Casey.

Operator, Operator

The next question today will come from Brody Preston with Stephens Inc. Please go ahead.

Brody Preston, Analyst

Hi. Good morning, everyone.

Matt Switzer, CFO

Good morning.

Brody Preston, Analyst

Yes, I want to circle back to Panacea. So just with the shift in the commercial that you all are executing on right now. Just maybe could you talk a little bit about how quickly you could see that effort kind of ramp, the gentleman you hired from Wells Fargo just thinking about his ability to bring on relationships and anything related to a non-compete. So just how quickly you in that commercial effort to ramp from here?

Dennis Zember, CEO

Yes. He has been with us for about a month, possibly a week or two longer. His pipeline has increased very quickly, and while I don't want to disclose the exact number, the first few items he added to it are set to close in the next couple of weeks. He has likely achieved a 75% success rate on these initial entries. The larger opportunity lies in the fact that he is acquiring customers, building relationships, and establishing referral sources, which are all essential for his growth and success. Additionally, he has the ability to influence other healthcare bankers, particularly those who specialize in niche lending, such as warehouse and equipment lending. He is well-regarded in the industry, and his influence is already contributing to successful bookings. We expect to wrap up the quarter with a couple more healthcare lenders focused on commercial. The commercial sector remains highly relationship-driven, contrasting with the digital focus of other initiatives like Panacea, which relies heavily on social media. Currently, we believe we may have found a significant asset in the first commercial banker we hired.

Matt Switzer, CFO

And Brody, just to clarify, he does not have a non-compete.

Brody Preston, Analyst

Okay, great. Don't want those folks from Wells coming down on you.

Dennis Zember, CEO

We are not going to publish this script.

Brody Preston, Analyst

So you gave the stat just around the penetration on a checking account spent about 45%, which I'm assuming is mostly consumer, at this point just given what the products that were at Panacea since it's been open. But I wanted to get a sense for how that penetration rate might change. You expect to see a similar level of account opening and deposit growth in the commercial side, just trying to get a sense for how the commercial side will shape up from a deposit perspective?

Dennis Zember, CEO

Yes, I would expect Tower to gain traction, but we need to first launch the digital bank. It's unique to focus the digital bank on commercial clients, and having it geared towards commercial products, services, tools, and access is crucial. This will enhance our position to attract deposits in these relationships. While we're approaching them with a somewhat digital framework on the loan side, I believe it won't be too difficult to persuade them about the deposit side. However, I must present them with something that is competitive, convenient, and reliable, which I feel is currently lacking in this space. There are some commercial entities that use digital banking, but those that prefer local banking with branches and personal bankers may not find the current offerings compelling enough to make the shift to a digital environment. We're working to improve that situation.

Brody Preston, Analyst

Okay, I understand. I have one more question regarding the NSE and the digital bank. Although the digital bank hasn't launched yet, Dennis, since your arrival, you've quickly initiated two nationwide programs: the Panacea partnership and the upcoming digital bank launch later this year. Could you share your thoughts on the potential to expand Primis into other nationwide niche verticals?

Dennis Zember, CEO

We see a lot of potential there. If we can expand our focus beyond our current areas, we could selectively invest, though our resources are limited. We can't reach $30 billion with our current capital. We plan to use our funds carefully, targeting niche asset classes and ideas that will enhance market value without diluting it. If I can only focus on healthcare assets in specific regions like Northern Virginia, DC, Southern Maryland, Richmond, and Tidewater, it becomes challenging. That said, we are still mindful of our foundational value. We are not abandoning our legacy businesses or closing branches; we are not turning our backs on our long-term customers. We want to be prepared as banking evolves, particularly towards all-digital models, which I believe are on the horizon, even if they are currently not tailored for low-balance millennials. Additionally, we have around $800 million or $850 million in liquidity and are still seeing deposits grow faster than loans. I anticipate a strong second half of the year for loan growth, but I think deposit growth will outpace loan growth. We will need to explore more verticals and innovative ways to utilize this capital. Our Panacea initiative, where we collaborate with Fintechs to achieve a solid return on equity, is one focus as we consider branching into national verticals. We are cautious and do not feel this is the right moment to make any drastic moves.

Brody Preston, Analyst

Understood. And then maybe just on that traditional lending front, you all had a nice uptick in core CNI loans this quarter; want to get a sense for what drove that and then secondarily ask how the new team that you're hired up in Northern Virginia is doing and how their pipelines are shaping up?

Dennis Zember, CEO

Brody, some of the C&I growth was early wins on that medical front.

Brody Preston, Analyst

Okay.

Dennis Zember, CEO

And the rest of it was just more blocking and tackling in our main footprint.

Brody Preston, Analyst

Got it. And how's the team that you hired out in Northern Virginia doing?

Matt Switzer, CFO

They're coming along, building pipelines; a few of them were subject to non-compete. And so those are burning off here this quarter, and their pipelines and so their pipelines accordingly are building because of that.

Brody Preston, Analyst

Got it. And then last one for me, could it be – could we get a sense for what new loan yields are coming on the book?

Dennis Zember, CEO

Still around 3.5 to 4.

Brody Preston, Analyst

Got it. Thank you very much for taking my questions, everyone.

Dennis Zember, CEO

All right. Next question, please.

Operator, Operator

The next question will come from Christopher Marinac with Janney Montgomery Scott. Please go ahead.

Christopher Marinac, Analyst

Hey, thanks. Good morning, Dennis and Matt. Thanks for all the disclosure and the information you're providing this morning. Want to circle up on the profitability from the slide back? And when we looked at the pre-tax pre-provision returns? Is it fair to expect that that's kind of bottoming here and that as it stabilizes that will start to revert upward over time as you deploy liquidity and continue to grow the company?

Dennis Zember, CEO

No, absolutely no question about it. Now, I will say bottom, I know I think bottoming. I like that word better than bottomed. And I'd say that, because I want to finish a quarter where we're able to actually sort of put some of the money to work and see the results flow to the bottom line. I mean, I know, Chris, where the balances are coming from. And I know that the expenses are already there, the staff is already in place, the systems. So I know that the operating leverage – from I know, we're going to have significant operating leverage from that. I just want to see some of that be put to work. I mean, Matt, and I, I mean, we're used to much higher pre-tax pre-provision ROA. We've let our Board to expect higher; it’s just we're so watered down by, what's approaching a billion dollars of liquidity. And I don't want us to get again, that's – we're in a bank that's transitioning. And we're way down the road. But I mean, we went years without really having meaningful loan growth and kind of mindful of just sort of waking up one day and going from sort of slow growth to really aggressive growth. We don't want to do that, we want to be a little more methodical as we move into something faster-paced.

Christopher Marinac, Analyst

Got it. Makes sense. And just to follow-up on – on the Panacea and Digital Bank build-out, how much of those processes are you using at the core bank, or do you envision applying those to the core bank over time?

Matt Switzer, CFO

The rollout is an excellent question, Chris. We are about to begin beta testing in a lab environment with current customers, and this is based on the existing core system of our bank. We have developed something we believe is quite unique, which we may announce in a quarter or so regarding the platform. It is achievable. The new platform focuses primarily on FinTech and its related partners. We are gradually transitioning the product set to ensure consistency. It's challenging to convey the benefits of having a digital product set that aligns with a legacy bank product set. This similarity allows us to utilize a single brand. Ultimately, we aim to demonstrate that the new modern core can be built exactly to our specifications. Long term, we intend for all our customers to adopt either one core or the other.

Christopher Marinac, Analyst

Got it. But you can continue to customize the experience for both the digital and the legacy bank along the way and keep extracting cost?

Matt Switzer, CFO

I completely agree. It's crucial because I truly believe the industry is progressing towards a more digital approach. The key challenge for the industry is to transition the mainstream and help customers feel more at ease with banking in a digital setting. Therefore, we need to tailor the core system, introduce new technologies, and demonstrate their potential to our customers. This is the focus of our lab test in the upcoming quarter.

Christopher Marinac, Analyst

Great. And last question just has to do with all the consolidation around you both at community banks and large national banks alike, how much of that is going to be a focus for you just to kind of win new business from bankers as well as customers and how much is out there for you in the near term on that?

Matt Switzer, CFO

I believe there is a significant opportunity. Credit is deserved for the community banks in the Mid-Atlantic region that are dedicated to safeguarding their customer base, which is not unexpected. However, disruption is occurring, especially as some of these banks transition to larger institutions, leading to notable changes, including mergers. Our bank serves as an example of this. These changes can distract from our main goals. We recently rebranded, which, while not a merger, was a distraction for us as well. I think we are now emerging from that at an opportune time; our new brand has received positive feedback from customers and the community. As a result, I believe we are well-positioned to capitalize on this situation. Additionally, our digital initiatives will help us stand out and provide compelling reasons for people to choose us.

Christopher Marinac, Analyst

Great, Dennis. Thanks for all the background. We appreciate it. Thank you, Matt, as well.

Dennis Zember, CEO

All right.

Matt Switzer, CFO

You bet.

Operator, Operator

The next question will come from Ross Haberman with RLH. Please go ahead.

Ross Haberman, Analyst

Good morning. Great quarter. Most of my questions have been addressed, but I have a quick question or two for Matt. Matt, you have significant exposure to hospitality and hotels. Can you share your thoughts on how that sector is reemerging? Are you considering reducing that concentration over time? Thank you.

Matt Switzer, CFO

Sure. We had approximately $269 million in hotels at the end of the quarter, with $14 million on deferral, which is about 5% of the portfolio. This involves two hotels that are expected to come off deferral in the third quarter. The key statistics for our hotel portfolio have shown significant improvements since the beginning of the year, making us more positive about it. Regarding concentration, given that hotels are still recovering, there isn't a strong demand to refinance them, so we don't expect many to exit the bank organically. Additionally, we are not planning to expand our hotel portfolio in the short term while the rest of the portfolio is growing.

Ross Haberman, Analyst

And just a quick question for Dennis. Branch-wise, any plans to close or relocate any of the branches given your new sort of digital emphasis? Thank you.

Dennis Zember, CEO

Yes, Ross, that's a good question. We are consistently evaluating our branch network. As I mentioned earlier, we are focused on increasing market and franchise value, which means we need to ensure our branches are operating profitably. I can confidently say that we are not planning to exit any of the communities we currently serve. While we are reviewing the branch footprint, any changes we may consider would be minimal. We are proceeding cautiously. The initiatives we plan to implement in the upcoming quarter or two may help us understand how many customers are interested in our digital services. By the end of the year, we should have a clearer picture. For now, I want to emphasize that we are not looking to make any major changes.

Ross Haberman, Analyst

Okay. Thanks, guys, and best of luck. Appreciate the help.

Dennis Zember, CEO

All right.

Matt Switzer, CFO

Thank you.

Operator, Operator

At this time, there are no further questions, and this will conclude today's question-and-answer session. I would now like to turn the conference back over to Matt Switzer for any closing remarks.

Matt Switzer, CFO

Thank you, everybody, for joining us, and we have some upcoming conferences, we’ll be interacting with investors and look forward to seeing folks in person.

Operator, Operator

The conference has now concluded. Thank you for attending today's presentation and you may now disconnect.