Earnings Call Transcript - FRST Q4 2022

Operator, Operator

Hello and thank you for being here. My name is Regina, and I will be your conference operator today. I would like to welcome everyone to Primis Financial Corporation's Fourth Quarter Earnings Call. All lines are muted to minimize background noise. After the speakers' comments, there will be a question-and-answer session. I will now hand over the conference to Matt Switzer, Chief Financial Officer. Please proceed.

Matthew Switzer, CFO

Good morning and thank you for joining us for Primis Financial Corp's 2022 fourth 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. 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.

Dennis Zember, CEO

Thank you, Matt, and thank you to all of you that have joined our fourth quarter conference call. When we started 2022, we were determined to grow our new lines of business alongside the community bank to finish the work that we'd started on the digital bank, and to somehow diversify away from just spread income, wanting to build some strength and opportunity in non-interest income, which our company had not really benefited from. Looking back over the last 12 months, we've invested so hard in the bank that we envision. And the question, or one of the questions that we all have is basically, will it pay off and when? I'm going to answer that in a minute, but first, a few items to highlight in the quarter and in the year. First was the loan growth we experienced. I knew Matt was conservatively estimating our growth potential. He's chuckling right now, as we started 2022, and we did come in very strong with about 25% growth in loans when you exclude the effects of PPP. This was from all areas of the bank, just like we had predicted evenly from the community bank, from Panacea, and from Life Premium Finance. For almost five years, really through the middle of last year, our bank had just not grown loans organically, that's we were not known for that. And I think we've turned that around in a really big way, and I'm really proud of the engine that we have built here from scratch. Two of these engines are operating lines of business. Panacea started the year with only about $50 million of loans, all consumer, and about $1.3 million of recurring revenue. We grew our doctor base to about 3000 doctors doing business with us all across the country. We've invested in production, credit administration, customer support, and technology. We spent all this money to build the brand, and as we progressed through the year, results at Panacea progressed nicely. We finished the year with about $7 million of recurring revenue and the prospect of a material boost to that number as we move to start splitting our production between gains and portfolio. The credit here is outstanding. Our commercial book has debt coverages over two times. No past dues ever and incremental yields that are close to or exceeding traditional bank commercial real estate. Life Premium Finance ended with just under $200 million of outstanding loans and about $800 million underwritten. In less than a year, they've built a brand and all the infrastructure and can take this to something much more sizable, with where the only real incremental operating expense is hiring incentive pay for the producers. This division also moved yields higher on loans that are entirely cash secured, and in the fourth quarter, we are getting incremental variable rate yields within 30 to 40 basis points of fixed rate commercial real estate. Another area we invested in was the mortgage business, and our total investment in the Mortgage company, including the losses associated with recruiting the teams, stands at just under $6 million, which is considerably less than our former investment in Southern Trust. Looking at our production teams, our restructured compensation plans, the level of administrative staffing, and the current rate and housing environment, I feel confident that this investment has a payback of about four or five quarters. We are not so heavily invested in this space that we can't maneuver or pivot if conditions worsen or recruit and build if conditions for this space improve. I really believe we're ideally positioned for this year and this division will improve our earnings and return on assets in 2023. The last thing I'd mention before turning this back to Matt is in regards to credit quality. During the quarter, we took a very large provision for a single asset, one that we had put in non-performers in the third quarter. When this loan got wobbly, we got new appraisals and we felt pretty confident in our position, but we reappraised the properties in the fourth quarter and aggressively wrote them down to the 90-day liquidation value and levels that I'm hopeful will move the property as soon as we're able to do so. The other material non-performing asset on our books is the first mortgage on the largest state property. We have about a 40% loan-to-value there, three junior lien holders behind us, and right now that loan is current, but we have left it in non-performers for the time being. So outside of these two credits, we only have about 20 basis points of non-performers, and our credit quality in 2022 would have improved dramatically, almost about 50%, and nearly to the top of our peer group. None of that excuses our actual results. We finished the year with about 119 basis points of non-performers, and I'm just trying to illustrate to you how determined we are to move these two assets out of the bank as fast as we can and restore credit quality that you'd expect from a top-performing bank. That can connect back to how I started about investing in the bank. It is not easy to grow a bank this size organically, especially at the pace that we're trying to grow. It’s gut-wrenching actually. It takes about 18 months to conceive a strategy, build it out, suffer some operating losses that CEOs like to call investments, stay the course while you make small adjustments here and there while you're second-guessed, and then finally come out on the other side with something that drives value. The outset for me here about three years ago, I saw some issues that I thought were standing in the way of us creating long-term shareholder value and we've invested a lot of our dollars and operating results. Honestly, a lot of myself personally, building engines that I know unquestionably drive value in this industry. We needed a safe way to grow loans. We needed reliable sources of non-interest income. We needed more deposit strategies. We needed more expertise in every area of the bank. We needed better regulatory relationships. We needed a better brand. Just saying all that leaves me out of breath. The good news for 2023 is that we don't have a lot left to invest in. What we've done over the last three years, especially in 2022, is enough to produce outsized growth and profitability for some time. In 2023, we need to let all of that come to fruition. I believe that we'll see all of this build and start to pay off, and I am determined with Matt's help to not be distracted with anything else other than getting the payback on these investments and illustrating how great a value our stock is at these levels. Alright, Matt, with that, I will turn it back to you.

Matthew Switzer, CFO

Thanks, Dennis. I will provide a brief overview of our results before we turn to a Q&A. But as a reminder, a full description of our fourth quarter results can be found in our earnings release and fourth quarter earnings presentation, both of which can be found on our website. Earnings from continuing operations for the fourth quarter were $3.1 million or $0.12 per diluted share versus $5.1 million or $0.20 per diluted share in the third quarter. Excluding one-time items, earnings in the fourth quarter were $0.03 per diluted share versus $0.21 in the third quarter. As Dennis mentioned, as I'll discuss further, earnings were impacted by a large provision and mortgage-related losses in the fourth quarter. Total assets were $3.57 billion at December 31 versus $3.36 billion at September 30. Excluding PPP loans and loans held for sale, loan balances grew 32% annualized in the fourth quarter, primarily driven by Panacea and Life Premium Finance again in Q4, but we did see growth in the core bank as well. Given the rate environment, we did not expect this level of loan growth to continue at this pace in 2023. Deposits were up approximately 2% annualized in Q4. Non-interest-bearing deposits declined to 21.4% from 25.4% last quarter as depositors began looking for yield. Our loan-to-deposit ratio increased to 108% in the fourth quarter, which is higher than we prefer, and we are singularly focused on bringing that ratio down in Q1 of this year. Excluding accounting adjustments, net interest income increased to $28.2 million from $27.5 million in Q3. Excluding these same adjustments plus effects of PPP, our margin was 3.51%, down 7 basis points from the third quarter. Adjusted yield on earning assets expanded 35 basis points, while cost of deposits and cost of funds increased 30 basis points and 48 basis points, respectively from Q3. Excluding accounting adjustments and one-time gain, non-interest income was $5 million versus $4.4 million in the third quarter. Large originations were up 36% in Q4 in the face of substantial industry headwinds and on top of normal seasonal lows for mortgage. The additional teams we added late in the third quarter are fully onboarded and building pipelines. We're projecting originations of $1 billion in 2023, including and taking into account the current environment, and up from roughly $300 million in 2022, with meaningful additions to non-interest income and profitability overall. Non-interest expense included a number of items this quarter, including $1.2 million of non-recurring expenses, $36,000 for unfunded commitment reserve, and increased mortgage expenses of roughly $2.2 million from a full quarter of the production team buildout that we started late in Q3. Excluding these items, non-interest expense was $21.2 million, up from $20 million last quarter. While we intend to moderate them in the first quarter, marketing costs remained high in the fourth quarter. Turnover in the organization continues to cause inflationary pressures and salary and benefits. We also had approximately $500,000 of year-end true-ups for various accruals. As we look to the first quarter, we expect cost controls to push expenses down slightly from Q4. Excluding non-recurring accounting adjustments and the impact of mortgage, our operating efficiency was just under 70% in Q4. Mortgage improvement, which is expected to be breakeven in the first quarter, plus increasing operating leverage from Panacea and Life Premium Finance will drive this efficiency ratio lower in 2023. As Dennis alluded to, the provision for credit losses was $7.86 million in the fourth quarter versus $2.89 million in Q3. Excluding accounting-related adjustments, the provision would've been $6 million in the fourth quarter, with the increase largely due to the impairment of the relationship that Dennis discussed earlier. We also had net charge-offs in the fourth quarter of $3.7 million excluding accounting adjustments, again largely tied to the relationship discussed previously and offset partly by $1.3 million of recoveries in the quarter. Taken altogether, the allowance for credit losses to gross loans, excluding PPP, was flat at 117 basis points at December 31. Non-performing assets net of SBA guarantees decreased to $34.9 million in the fourth quarter from $36.1 million last quarter. The relationship we've previously discussed along with the other loan that Dennis mentioned combined are 78% of our non-performing loans. We also now have no OREO as of December 31. Pretax, pre-provision operating return on assets was 78 basis points in Q4, down from 105 basis points in Q3. Excluding the investment in Mortgage, this ratio would've been approximately 110 basis points versus 115 last quarter. Similar to the efficiency ratio discussion above, we expect meaningful contributions from our newest business lines, including Mortgage, Panacea, and Life Premium Finance in 2023 that will materially increase profitability and drive us to our 1% return on assets goal. With that, operator, we can now open the line for Q&A.

Operator, Operator

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

Casey Whitman, Analyst

Hey, good morning.

Dennis Zember, CEO

Good morning, Casey.

Casey Whitman, Analyst

Maybe I thought we'd start just to touch on expenses. So, it sounds like you've got the mortgage work done, and as you go into 2023, do you have your, I guess, starting point per quarterly expenses somewhere around like $27 million, $28 million or am I off there? And then, I think you just answered this, but just safe to say, there are no other chunky sort of investments that might come in over the next few quarters at least that you're expecting at this point. So that's sort of the runway to go off of.

Matthew Switzer, CFO

That's right.

Casey Whitman, Analyst

Okay. Okay. And then just looking at Primis Mortgage, I mean, you talk about the $1 billion in production, is that enough to breakeven there? Are we assuming some pickup in the gain on sale margins in that space, or is it a little too optimistic to think about that in the first quarter? Are you talking more just sort of throughout the year, or maybe just walk us through sort of the evolution to get that towards profitability timeline?

Matthew Switzer, CFO

Sure. I'll start it. Dennis can add to it, or correct me where I go wrong. We're expecting $1 billion of production for the year. That is enough to more than breakeven. We expect mortgage to contribute to profitability for the full year. The comment I was making earlier was, as you know, mortgage is very seasonal. The housing season really starts in the spring. As production ramps in the first quarter, we expect them to be breakeven for the first quarter and then materially more profitable in the second and third quarters. Fourth quarter is usually, again, breakeven, sometimes slight loss depending on seasonality. But taking overall, we're expecting mortgage to contribute $4 million to $5 million after tax in 2023.

Casey Whitman, Analyst

Okay. And that's assuming the same kind of expense level that you had, I guess, in the fourth quarter.

Matthew Switzer, CFO

It'll be lower than in the fourth quarter.

Dennis Zember, CEO

The fourth quarter experienced a significant number of draws that did not correspond with any production. This is partly due to it being the fourth quarter and partly because of the transfer of pipelines. Almost all, about 90%, expired on December 31. As we enter the first quarter, nearly all of our producers will be on a commission-only basis. Additionally, the estimated revenue for the first quarter is likely around $27 million, with mortgage contributing fairly. However, as production increases, expenses will also rise due to commissions, but they will be generating revenue as a result.

Matthew Switzer, CFO

You're indicating that expenses may remain stable, but we anticipate an additional one and a half million in revenue. Excluding mortgage, expenses related to mortgages are expected to rise throughout the year and likely decrease in the fourth quarter as production wanes. However, I want you to be aware that in the second and third quarters, expenses might be slightly higher due to the peak of the mortgage market. Does that make sense?

Casey Whitman, Analyst

That does. There's going to be a piece of the expenses that will be tied to production. Okay. There was a lot of noise around a third-party service portfolio this quarter. I guess, can you just simplify what's going on there? Should we be assuming the 350 margin is sort of the better starting point or the 370 you reported?

Matthew Switzer, CFO

We will continue to eliminate some of the noise from that portfolio moving forward. We have a portfolio of loans that we originated with a third-party. These loans appear on our balance sheet directly but are managed and serviced by the third party. When the portfolio was smaller, we were only booking the net revenue from it. Now that it has grown, the accounting requires us to adjust more of the portfolio through various line items. This means we're now booking yield at a gross level instead of just booking the charge-offs that are on the portfolio but are covered by the third party. There are offsets for all of that in non-interest income and non-interest expense. The net profitability we earn on these loans remains unchanged. The only change is the effects from the portfolio are running through various line items now. So, while the presentation in our income statement has changed, the impact on net income has not. From a core perspective, I suggest focusing on the 351, which is a better apples-to-apples comparison with last quarter as we think about our margin going forward. The accounting treatment for this portfolio will create some margin effects on a reported basis, but we'll strive to adjust for that and maintain an apples-to-apples comparison going forward.

Casey Whitman, Analyst

Okay. I guess, I would just ask one last question. Obviously, a lot of noise this quarter. You guys got a lot of stuff done last year. Just if we think bigger picture about sort of the profitability outlook and how quickly we can build the return on assets, what kind of sort of outlook can you guys give us over the next few quarters into next year to the extent the environment stays somewhat like it is today?

Dennis Zember, CEO

I would say Matt has a slide that illustrates where the improvements are coming from, which includes Panacea, the growth in Life Premium Finance, and the core bank. There has been a bit more expense related to marketing and the digital bank mortgage, and I believe this positions us right at $1.50 in earnings per share.

Casey Whitman, Analyst

Okay.

Dennis Zember, CEO

For 2023, the slide being referenced outlines the pretax, pre-provision earnings starting with our fourth-quarter run rate. It highlights the impact of improvements in mortgage, Panacea, and Life Premium Finance, leading us to a higher run rate and full-year pretax, pre-provision for 2023. Assuming a reasonable provision for moderate loan growth and factoring in taxes, the earnings could reach $1.50 per share for the year, which we would consider very satisfactory. However, this would result in just over a 1% return on assets, which is not our target. I truly believe that Panacea, Life Premium Finance, and mortgage will significantly contribute to the return on assets in 2023 and even more in the following years. It's challenging to grow the core community bank's profitability beyond 1.10% to 1.15%. While these other segments are crucial, we still aim for a long-term return of 1.25% to 1.35%. Our goal for 2023 is to reach a 1% bottom line.

Casey Whitman, Analyst

Okay. Appreciate it. Thanks for all the color. I'll let someone else jump on.

Operator, Operator

Your next question will come from Christopher Marinac with Janney Montgomery Scott. Please proceed.

Christopher Marinac, Analyst

Hey, Dennis. Hey, Matt. Thank you for hosting the call today. I'm just going to follow up on the last point about the pretax, pre-provision kind of run rate that you put out. That slide was very helpful. Do you think that's possible to be at a run rate by the end of 2023? I just want to get a little more background on timing and kind of what's realistic. I think we follow what you're trying to do. Just want to know kind of what the timing we should expect.

Matthew Switzer, CFO

I haven't been trying to think about the ROA on a quarterly basis when we put that together, because that includes mortgage contribution, which is only going to be breakeven in the first quarter, but more meaningful contribution in the second and third quarters, and then you get the ramp for Panacea and Life Premium Finance over time. So, I have a perfect answer to your question there, Chris. We're trying to think of it more on the full year.

Dennis Zember, CEO

I believe the fourth quarter is typically not the strongest for mortgages. While I think it will contribute positively to the return on assets in the fourth quarter, I don't expect it to significantly boost the ROA. Comparing the first half of the year to the second, we have some initiatives in place. Panacea is looking into some loan sales, and we’re starting to see some momentum in that area. I would estimate that the first half of the year is closer to 90, while the second half may reach around 110, despite a slight decline in mortgages during the fourth quarter. Ultimately, I anticipate the second half will likely be around 110, with the fourth quarter closer to 105, based on my expectations.

Matthew Switzer, CFO

So, slide seven represents more than just goals. It truly outlines what you aim to achieve this year; it's merely a matter of timing for everything to align.

Dennis Zember, CEO

The fourth quarter is typically not the strongest for mortgage activity. I believe it will positively contribute to the return on assets in that quarter, but not significantly. Comparing the first half of the year to the second, we have a few opportunities in place. As mentioned in our reports, we are looking at some loan sales and are seeing a bit of momentum developing.

Matthew Switzer, CFO

I would just say that while you may not have seen this, when we were preparing our multi-year projections last year, we planned for 2022. We encountered more variables this year than we had expected, but we ended up aligning closely with our projections for this year given the investments we had in mind. We expect to see significant improvement in earnings per share and profitability in 2023 as a result. The information on slide seven and the buildup aligns with what our plan was about a year ago. Dennis mentioned that we are increasingly confident we can achieve those targets based on the improvements we are observing in these business areas.

Christopher Marinac, Analyst

Great, that's helpful for both of you. I appreciate that clarity a lot. My only other question goes back to deposits. I know you've made significant progress on deposits, especially within Panacea. As a general question about opening new deposit accounts, what do you foresee organically this year? I understand it's a challenging environment with rates, but I'm interested in your organic focus and what you think is possible regarding new deposits across the company.

Dennis Zember, CEO

In the core bank, maintaining our current branch levels seems quite generous. Across the industry, I haven't encountered any bank CEO who believes they can increase their core deposits, yet it appears that we are incentivizing every new deposit we attract. Our strong point lies in our digital bank, which performs exceptionally well not just in Phoenix, Arizona, but also in Minnetonka, as well as throughout our primary market. Leveraging the digital bank to gather deposits from areas outside our main footprint without compromising our valuable core deposit franchise is crucial. We possess a competitive edge that few banks nationwide share, and only a small number face a significant disadvantage. It's essential for us to capitalize on this advantage. If it weren't for the digital bank, attempting to grow our loans would likely force us to compromise the true value of our core deposit franchise by making it more sensitive to rates. Fortunately, we can avoid that due to our digital bank's offerings. We are truly gaining momentum with our digital bank, and we're preparing to market it effectively at reasonable prices soon. The amount we need to be successful here is relatively modest considering the potential for nationwide reach. Raising this amount in specific regions like Hampton Roads or Richmond would feel overwhelming, but knowing that the entire country is accessible gives me more confidence.

Matthew Switzer, CFO

I would like to emphasize that, as we've mentioned in our previous investor presentations, during the fourth quarter, we experienced growth with our digital platform while only having consumer accounts available. In the first quarter, we will launch business accounts. Additionally, we will be upgrading the mobile experience for both consumer and business users, which represents a significant improvement and offers enhanced user experience and functionality for small business customers. We are very excited about these developments. Our Chief Information Officer is consistently updating us on when everything will be operational because we believe it's crucial. While consumer accounts are important for broad marketing and generating volume, having business accounts live is essential as they can drive larger balances with fewer accounts. We are still waiting for that to be delivered.

Christopher Marinac, Analyst

Good. I follow you there and thank you for that. It sounds like the digital bank is going to influence both total deposits as well as core deposits. Just back to the way you explained it on slide 20. So, that's good. Thanks again for taking the question this morning.

Dennis Zember, CEO

Alright. Thanks, Chris.

Operator, Operator

I'd now like to hand the conference back over to management for any closing remarks.

Dennis Zember, CEO

We have no closing remarks, but we are available if you have questions or comments or want to call us directly. Matt and I are both around. Thank you and have a good weekend.

Operator, Operator

That will conclude today's meeting. Thank you all for joining. You may now disconnect.