Primis Financial Corp. (NASDAQ:FRST) Q1 2023 Earnings Call Transcript

Primis Financial Corp. (NASDAQ:FRST) Q1 2023 Earnings Call Transcript April 28, 2023

Primis Financial Corp. misses on earnings expectations. Reported EPS is $0.23 EPS, expectations were $0.29.

Operator: Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the Primis Financial Corp. First Quarter Earnings Call. Today’s conference is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. At this time, I would like to turn the conference over to Matthew Switzer, Chief Financial Officer. Please go ahead.

Matthew Switzer: Good morning and thank you for joining us. Before we begin, please note that many of our comments during this call will be forward-looking statements, which involve risk and uncertainty. There are many factors that could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements. Further discussion of the company’s risk factors and other important information regarding our forward-looking statements are part of our recent filings with the Securities and Exchange Commission, including our recently filed earnings release, which has also been posted to the Investor Relations section of our corporate site, primisbank.com. We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time.

In addition, some of the financial measures that we may discuss this morning are non-GAAP financial measures. A reconciliation of the non-GAAP measures to the most comparable GAAP measures can be found in our earnings release. I will now turn the call over to our President and Chief Executive Officer, Dennis Zember.

Dennis Zember: Thank you, Matt, and thank you to all of you that have joined our first quarter conference call. Matt asked me last night after our Board meeting, what part of the quarter I wanted to address on this call, and I told them, of course, all the good parts. Only one of us had a chuckle about it. He’s still not laughing as much as I thought he would. But seriously, we’re very encouraged about what happened here at the bank in the first quarter. With that said, I’m really mindful of what the industry is experiencing, especially banks, say, our size, maybe even a little larger. But our thesis for this bank and our future has played out very well this quarter and I think maybe for the cycle that we could be close to entering.

I’ll cover all of that shortly, but first, I wanted to summarize net income. For the quarter, we’re reporting $5.7 million of net income. The one-time kind of things were about $1 million of negative spread and DP costs associated with the Digital success that unquestionably will not replay in the second quarter, about $450,000 of fraud expenses, all of which are at the Core Bank, none of which were individually significant and a Mortgage run rate that I think is about $300,000 below our current run rate, even with no additional pickup in volumes or locked pipeline. All of that moves our ROA closer to, say, 75 basis points or 80 basis points, which isn’t good enough, but I think it’s within striking distance, given the momentum I see in several areas of the bank.

I’m happy with the performance of the Core Bank this quarter. On the headline, it appears that non-interest-bearing deposits were down significantly, but one chunky deposit associated with a Mortgage Servicing Rights Loan of about $54 million left this quarter, and excluding that, non-interest-bearing only dropped 5.8%, which I believe is a good result. Total deposits, even including this departure, we’re only down 0.2%, just $6 million. Our bankers on both sides of the balance sheet did a great job. Our margin at the Core Bank was at 3.38%, down obviously from the fourth quarter, but up materially in percentage terms from where we were a year ago when we reported 2.96%. In Mortgage, we’ve been focused on two seemingly different strategies and without sounding to Southern, it boils down to trimming and recruiting.

We’ve been rightsizing support staff, commission rates, incentive plans and everything we can to make our breakeven production levels as low as possible. Given the performance in the last two months, I believe we are somewhere around, say, $40 million to $45 million a month to break even, which is remarkable for our — for this industry. We’ve been recruiting as well, looking for lenders that like our culture, our speed to closing, our nearly nationwide capacity that aren’t looking for 2021 signing bonuses. These combined efforts have moved production to somewhere around $700 million to $800 million a year and positioned us well for when rates fall and volumes return to pre-pandemic levels. In Panacea and Life Premium Finance, we see strong pipeline, and honestly, some resiliency to today’s yields.

Both units have very good pipelines and their profitability and efficiency curves are directionally very nice. Panacea, in particular, has benefited from the attractiveness of the credit offering and we are seeing more parties interested in this paper, which signals better non-interest income opportunities and a faster pathway to meaningful profitability. On top of that, Panacea continues to put way above their weight, finding niches with larger and larger organizations and associations that build their brand and the balance sheet affordably. Lastly, Tyler and his partners and the bank continue to tweak and build technology solutions and at the LLC level have considered raising capital to turbocharge things on the technology build. I’m increasingly aware though that their earnings rate alone can fuel all of this investment that we collectively need to absolutely own this medical space in the next couple of years.

Lastly, the Digital Platform and the deposit success. In short, we raised $1 billion nationwide with no more staff, no fraud losses, almost nothing on advertising spend and virtually no impact at the Core Bank. Right now, we have over 12,000 customers on the Digital Platform. 54% of them came from the nation’s 10 or 12 largest banks, where realistically they were earning close to netting. Another 21% came from smaller community banks or credit unions, where realistically they appreciate customer service and personal relationships. The average age is just over 50% and the average deposit is a touch over $80,000. Daily we have multiples more in deposits to existing accounts than we have withdrawals or account closures. We are still opening accounts.

Last night, we opened about 53 accounts at a rate that’s about 50 basis points below the national sweep rate. And the obvious boost our company’s safety with liquidity is obvious. Our liquidity ratios and our uninsured deposit levels are some of the best in the country. And when the sweep in place will have done all of this in a way that doesn’t dent our capital ratios. That’s so important in this environment to be confident on liquidity and capital. But what may be lost on some is the opportunity with this platform. We’re going to have the same success in the near future on checking accounts and lower cost deposits. Our app is more progressive and functional and safe with respect to fraud or bad actors. And as we do that, especially with the sweep in place, I expect incremental spread to the rate we offer with very little impact on our earning asset levels.

So, hopefully, in a way that could boost our margins by some amount. There’s no playbook for banks our size, even bank 10 times our size to build a national brand or imaging. The industry has been so awash in liquidity with really subpar technology and it’s just seemed nonsensical to focus a lot of strategic energy on being a deposit growth leader. Our strategy is to get as many customers on this app at rates that have positive spread to the swaps, surprised them with customer service and attention, surprise them with humanizing communications, smart technology, accessibility to our executive team, rates that are better than our competition that is stuck with incremental or branch or marketing costs, and over time, build a significant national customer base that can fully fund our lines of business at costs that will push 3% margins or better.

I absolutely love connecting with these customers, whether it’s in text or e-mail or telephone calls or honestly even in person as I travel across the country and seeing how pleased they are with the experience that Primis Bank has delivered. It isn’t perfect yet, but we aren’t doing tweaking things and making improvements either. Before I turn it back over to Matt, I want to thank our staff. I cannot say it loud enough or too many times. What we’ve rolled out here and succeeded with is not something you both show. We built this. We engineered this solution. We dreamed up everything from the background systems, features on the app security and fraud prevention and the unbelievably affordable and effective marketing of this idea. This is not just fintech relationships that are pouring deposits onto our balance sheet.

Beyond just the Digital team, I’m so thankful for the rest of our bank that has stepped up this quarter, answering calls and working with customers to make this quarter and this effort successful and it’s great work for our team. All right, Matt, with that, I will turn it over to you.

Matthew Switzer: Thank you, Dennis. I will provide a brief overview of our results before we turn to Q&A. But as a reminder, a full description of our first quarter results can be found in our earnings release and first quarter earnings presentation, both of which can be found on our website. Operating earnings for the first quarter were $5.8 million or $0.23 per diluted share versus a little less than $1 million or $0.03 per diluted share in the fourth quarter. Total assets were $4.2 billion at March 31 versus $3.6 billion at December 31. Excluding PPP loans and loans held for sale loan balances grew 13% annualized and that’s after a $15 million Panacea loan sale in the first quarter. Growth was particularly strong in Life Premium Finance again in the first quarter.

Given the current environment, we expect to see continued loan growth with an emphasis on quality. Deposits were up approximately 35% on annualized in Q1, bringing our loan deposit ratio down to 83% at the end of the quarter from 108% at the end of the fourth quarter. As we discussed on last quarter’s call, reducing that ratio was a singular focus in Q1 and the success of our Digital offering has been a tremendous boost to our bank. As a result, we had excess cash of approximately $500 million at March 31 and excess average cash of approximately $300 million for the quarter. We’re in the process of implementing a sweep program that will allow excess funds and deposits to be moved off balance sheet and expect that to be live by the end of the second quarter.

Excluding accounting adjustments related to a third-party managed portfolio, net interest income was down slightly to $27.5 million from $28.2 million in the fourth quarter. The decrease was largely due to a temporary drag to earnings from building deposits in advance of the last Fed move and which has now abated. Net interest margin was 3.15%, down 52 basis points from 3.67% in the fourth quarter. Approximately 29 basis points of the decrease was due to the excess liquidity described earlier. Excluding accounting adjustments and a one-time gain in the fourth quarter, non-interest income was $6.6 million in the quarter versus $4.8 million last quarter. Mortgage originations were up 43% in the quarter in the face of substantial industry headwinds and on top of normal seasonal lows.

The locked pipeline also ended the first quarter at $53 million, up 110% from the last quarter, adjusting strong momentum into the second quarter. Lastly, non-interest income included a gain of $427,000 from a $15 million loan sale from Panacea. Panacea has cultivated a number of relationships with other banks that will lead to increasing gain on sale revenue through the rest of this year. Core non-interest expense, excluding accounting adjustments and non-recurring items was flat at $26.5 million for the quarter, which includes approximately $5 million related to Primis Mortgage. Of note, marketing costs were down even with the increased deposit raising activity as we were particularly efficient with how we attracted funds to the Digital Platform.

Also of note, fraud losses were higher by $371,000 in the quarter, but none was attributed to the Digital Platform activity. Digital activity did contribute most of the data processing expense increase of $549,000 due to application volumes, which is expected to subside in the second quarter. The efficiency ratio declined to 69% from 72% in the fourth quarter as our various business lines increased profitability. The provision for credit losses was $5.2 million in the quarter versus $7.9 million last quarter. The vast majority of the provision was due to accounting for a third-party managed portfolio, which is offset by non-interest income gains. Excluding these adjustments, the provision would have been approximately $500,000 for the quarter.

Core net charge-offs were $2.1 million and were largely charge-offs of specific reserves established in prior quarters. The allowance for credit losses to gross loans, excluding PPP balances, was flat at 117 basis points for March 31 and December 31. Non-performing assets net of SBA guarantees decreased to $32.8 million in the quarter from $34.9 million last quarter. A little over 80% of our NPAs are comprised of two relationships that we’ve discussed previously, one of which was actually current as of March 31. The assisted living credits that we’ve described previously were impaired — and were impaired last quarter are currently being marketed by a receiver with bids expected in the next couple of weeks. We also have no OREO still. Pretax pre-provision operating ROA was 131 basis points in the quarter, up from 99 basis points in Q4.

Operating ROA was 60 basis points, up materially from 9 basis points last quarter. Without excess liquidity and the slight earnings drag from raising funds when we did ROA would have been over 70 basis points in the quarter, as Dennis described. While there are plenty of headwinds facing the industry right now, we see upcoming sweep capabilities, increasing gain on sale revenue, stronger Mortgage activity and general improvement in operating performance across our business lines in the Core Bank, all has reasons to believe we will continue driving the ROA higher this year. Operator, we can now open the line for Q&A.

Q&A Session

Operator: Thank you. We’ll take our first question from Casey Whitman at Piper Sandler.

Casey Whitman: Hi. Good morning.

Dennis Zember: Hi. Good morning, Casey.

Casey Whitman: So congrats on the success of the Digital Bank here. I am wondering how should we think about how big on balance sheet you would run the Digital Bank versus I guess, the Core Bank here or how should we think about the size on balance sheet of that once you implement that sweep function?

Dennis Zember: So we ended the quarter with about $600 million in cash or rough math as we will probably drive that cash back down to about $100 million. So that would be about $500 million of balance sheet shrinkage in the second quarter. And with that sweep, Casey, so we can then manage that cash level at about that level, depending on overall balance sheet growth and any incremental deposits we raise, we can immediately move off. So, net-net, we’ll stay around that $100 million in cash.

Casey Whitman: Okay. And then sticking with the Digital Bank, I would assume like the back office compliance costs have already been incurred. What about marketing costs from here? Is there any more, I guess, expenses there or are you pretty set with what you’ve got here for expenses?

Dennis Zember: I don’t see any material increases in marketing expenses from here, I mean, at the margin, maybe, but I think our experience in the first quarter is, we have a pretty good playbook for how we think we can grow these Digital deposits without spending tons of dollars. It’s largely digital advertising, which is much more efficient, as you can imagine, than radio and TV ads and other local advertising efforts.

Casey Whitman: Yeah. Okay. And then just generally, just touching on sort of how you’re thinking about profitability this year next. It seems like you’re on track for a lot of the things we were discussing last quarter. So has, I guess, some of the industry turmoil pushed any of your goals out a bit or are we still, I guess, pretty on track from your standpoint?

Matthew Switzer: I mean, I think, the — I think — I mean, we see like, we see good pipelines in Panacea and Life Premium Finance. I think loan demand in the Core Bank is no different than I think what the industry. I think, Core Bank — I think that’s come in a little. I don’t think there’s not as much demand there. I think we could grow both of those divisions profitably from here, especially with the gain on sale. I think we can grow net income, but still Tyler’s not going to sell all of that business. So there’s going to be some balance sheet growth there. I mean are there margin headwinds? There are. I don’t think there’s going to be, for us, especially when we have this much cash, I don’t think we’re going to have as much margin headwinds as maybe our competition.

So, but I still think there’s a little bit of that out there. I mean I still feel — I mean assuming that there’s — we don’t see anything in credit. I didn’t make this in the — I wrote this, but I didn’t say it in our prepared comments. I think the thesis about our bank being diversified. We’ve got less than, say, 30% — we have about 35% in CRE. We have lines of business that drives C&I, good C&I volumes and a safe, diversified. I think that thesis is going to play out pretty well here. It’s going to allow us to keep growing, not at the pace we did last year, but I don’t think you’ll see us with a stagnant balance sheet.

Casey Whitman: Yeah. Okay. And that one large relationship seemed pretty big for you guys. Are there other like chunky non-interest-bearing you might be, I don’t know, worried about or looking at or was that sort of just a unique situation?

Dennis Zember: That was a unique situation. We don’t have any other large non-interest-bearing accounts.

Casey Whitman: Okay. Great. And just for modeling purposes, I guess, what’s like a normal run rate for that credit enhancement fee line? I recognize there’s an offset in the provision, but would like the $5 million be a little large?

Dennis Zember: So the way it works and I know this is somewhat complicated and noisy. The charge-offs on that portfolio flow through our provision and then we get it back in non-interest income. And then there’s incremental spread that runs through net interest income that we give back in non-interest expense and you can see all those in the income statement on our — in our tables in the press release. But we had an allowance build on that portfolio in the first quarter that was due to some modeling changes. I wouldn’t expect that to occur again in the second quarter. So really the only thing running through the provision in non-interest income related to that portfolio will be losses, which we don’t expect to be as high as they were.

It was about $1.9 million in the first quarter, so that should be lower in the second quarter. And then in the net interest income and non-interest expense pieces, it was about $900,000 in the first quarter, and that’s probably, a reasonable number for the second quarter.

Casey Whitman: Okay. Great. Well, congrats to you guys and thank you.

Dennis Zember: All right. Thanks, Casey.

Operator: We’ll go next to Russell Gunther at Stephens.

Russell Gunther: Hey. Good morning, guys.

Dennis Zember: Good morning, Russell.

Russell Gunther: I want — good morning. I wanted just to stick with some of the balance sheet size a bit just given some of the puts and takes here. So on the loan growth side, I hear you in terms of where you expect it to come from. But from an order of magnitude perspective, do you guys have a view on overall organic loan growth? And then a similar question on the deposit side, I’ll hear you on the sweeps, but kind of where do you think balances go from here?

Matthew Switzer: I think, normally, we would have expected a couple of hundred million, maybe a little more than that from Tyler’s Group. I think we’ll probably end up probably seeing half of that, some from sales and some from a little softer demand. So maybe $100 million or so, $125 million. I think Life Premium Finance, I think, we would have normally seen a couple of hundred million there. I think that might still — we might still hit that number. And then at the Core Bank, I think, just given demand, honestly, I think, maybe just 1% or 2% growth at the Core Bank would be a good result, honestly, I think. So maybe — I think for the whole year, we’re probably looking at, call it, 10%, 12%, 13%.

Russell Gunther: Got it. Okay. Really helpful. And then from a deposit balance perspective, in terms of where you expect that to trend? I’m just trying to triangulate to the margin going forward? I think you mentioned, Dennis, in your remarks, kind of that 3% bogey and an ability to remain kind of at or above that going forward?

Dennis Zember: Yeah. I am — I think on the Digital — what we — we’re just one bank here, and honestly, all of the people, I say, Core Bank and Digital Bank, I try to say Digital Platform. But, I mean, we’re just one bank. And honestly, all of the people on the Core side helped us out tremendously on the Digital side. And I think that when we think about Digital Platform, I mean, we really think about those national deposits funding national lines of business and stuff like that. And it’s that that I think we should be sort of eyeing about a 3% margin. I think when you look at the Core Bank side, I think it could be a little better than that. I do. I don’t think seeing the margin at the Core Bank go to 3%. I don’t think that’s going to happen.

Is there some downward pressure? Absolutely. No question about it. But if we’re at 3.38% in the first quarter, I mean, probably, 3.25%-ish or so at the Core Bank is, I think, a safe number. And then, I think, 3% or so long-term on the Digital Platform is appropriate. I mean I don’t — I think we’re probably three quarter or four quarters from hitting to 3%, just given that everything is brand new. What may help us is that, we’ll have $1 billion — we have $1 billion on the Digital Platform right now. When we start sweeping things, we will be have — we will be getting positive spreads with really no denominator, no earning asset and so that could help boost the margin. As far as what could be on the Digital Platform? I mean if we had the sweep in place right now and we were confident that we weren’t going to see ugly capital ratios.

I mean, I hate to even say a number. But, I mean, I think, right now I think we’re probably doing $30 — probably $50 million a month. I think we could probably triple that.

Matthew Switzer: Russell, just to…

Russell Gunther: Okay. So…

Matthew Switzer: Yeah. So in terms of the balance sheet, we’re at 83% loan-to-deposit ratio at the end of the quarter, that sweep reduces cash, obviously, but it also reduces the deposits on balance sheet. So you can assume that loan-to-deposit ratio goes back up to, call it, mid-90s or something around there in that as we raise — as we track new customers through some of these different initiatives, we’ll be able to kind of manage that loan-to-deposit ratio by sweeping excess off the balance sheet. That helps?

Russell Gunther: Yeah. That helps a lot. I appreciate it from both of you for the clarification and color there. And then just last one for me. Could you help us with, excuse me, could you help me with the non-interest expense outlook going forward, considering some of the puts and takes around fixed Mortgage variable with improvement in that fee line and just any other franchise investments and potential offsets?

Matthew Switzer: Well, I just can imagine given — and you probably are hearing this a lot given the challenges on the margin side. We’re spending a lot of time thinking about non-interest expense and controlling that. I mean we were, call it, $21.5 million ex-Mortgage in the first quarter. That included some expenses related to fraud and data processing with all the applications, a couple of other things, and we would like to see that number closer to $20 million run rate, maybe even a little bit below as we do some learning and trimming, as Dennis talked about earlier.

Dennis Zember: I would also like to add.

Matthew Switzer: That’s on a core basis. Obviously, Mortgage non-interest expense will fluctuate, I mean, it will be higher the next couple of quarters because their production will be higher. But on a core basis, that’s what I’m referring to.

Dennis Zember: And Russell, I mean, there’s no — given the environment, there’s no energy around here to grow expenses anywhere. All of our division leaders know that this just isn’t the time to be thinking incrementally positive growth to that. And we’re also — Matt and I also just assure you, we’re not going to be caught flat-footed if the industry — if things turn worse, we’re not going to be caught flat-footed and stuck on non-interest expense. We’ll have plans. I mean we’re already kind of developing plans. I don’t think right now, given the momentum, some of the things that Matt finished with about the positive momentum here. I don’t know that it’s time to go hard at that, but it is time to have a plan and I can assure you that that’s in the works.

Russell Gunther: Understood. Thank you, guys, very much for taking my question.

Dennis Zember: All right.

Matthew Switzer: Thanks, Russell.

Operator: We’ll go next to Christopher Marinac at Janney Montgomery Scott.

Christopher Marinac: Hey. Good morning. Dennis and Matt, I just want to circle back on the deposit growth initiative in the checking and NOW accounts going forward. Is that going to pay down some of the savings or is it going to be complementary and therefore, just have a lower blended rate?

Dennis Zember: It will be complementary. So hopefully average down the cost of those deposits.

Christopher Marinac: And as the Fed plays out over time, whether up or down, do you have to move those savings rates that you’ve established so far?

Dennis Zember: I suppose — yeah. I suppose we would. We — there’s — in our offering, there’s no term on the rate we’re offering. And I mean, Chris, initially, I would have thought, okay, it’s just going to — I made a comment about this. I would have thought is just all Internet rate shoppers. I mean it turns out that’s exactly what it’s not. Over half of it come from money center banks where I know they weren’t being paid hardly anything. I think long-term, I think, if this could be — could hover say, maybe 10 or 15 below Fed funds, I think that would be excellent. I’m pretty confident we could be there. I think we could probably hold a lot of the funds with some of the other stuff that we’re doing sort of humanizing our company and establishing relationships, I think in a year, it might even be better than that.

That’s what the whole effort around here is. A lot of the concept that you just get Digital customers in here and they use the apps seriously.t90% of them opened an account in 5 minutes — opened and funded an account in 5 minutes and never and just use the app. For us to illustrate that they’re not banking with box, so to speak, is the term we use around here and to humanize our company with e-mail, letters, phone calls, visits from me or the other executives, I mean, it means a lot. And I think over time, the savings that we’re going to get sort of from those qualitative or assertive relationship building things is you’re going to see that in the yield here.

Christopher Marinac: And I know it’s early on the expense side, but your expenses overall are much cheaper than what you doing, because that’s going to blend that whole experience and return as you get further along on this.

Dennis Zember: Correct. Yeah. Exactly.

Christopher Marinac: And then last question just related here is, you mentioned about the fraud experience so far. Is there anything unique, because you’ve built some scratch compared to other deposit systems you’ve worked with in the past, Dennis?

Dennis Zember: There is absolutely no question. Yes. The — I’ll tell you — just anecdotally, I’ll tell you, when we turned this on is what October 1st. We turned this on on October 1st. And we did some light marketing of it sort of in our core markets, like mostly in the D.C. MSA. And every single morning I would look at the balances at the accounts. And I would say four or five accounts and that was — I see the balances come through and I would write personal notes and do all that. And then is it just — it get — it started catching on a little more and you’d see five accounts, 10 accounts, 50 accounts. When we were doing 600 and 700 accounts a day, I mean, we had a moment around here, we’re like, oh my God, is this going to — I mean, are we going to lose the bank, because fraud is so prevalent.

I mean I’ve talked to other bankers, fraud at the Core Bank level is so prevalent and so massive right now. And we just sort of — as we were in the middle of that, Chris, we just went back and looked at all of our fraud measures, what it takes to open account, how we identify who you are, how we know that your — that these are your funds and not somebody else that you’re putting in these accounts, what we do after you put the money in the account. And all of that, we engineered ourselves and it is none of that we bought off the shelf and it has just — it’s worked. It’s worked fantastically. And honestly, it’s protecting our customers as well. And we’ve not figured out exactly how to communicate that back to the customers, but the ones that I’m meeting in person are talking to on telephone recognize that this is a safe way to bank.

Christopher Marinac: Great. Thanks for all the background this morning and disclosures.

Dennis Zember: Thanks, Chris.

Operator: And we have no further questions at this time. I’ll turn the conference back over to management for any closing remarks.

Dennis Zember: All right. Thank you for — again for everybody that — to everybody that’s joined the call. Matt and I are available if you want to call, text or e-mail, we’ll answer any other questions you might have. Okay, have a good weekend. We’ll talk to you soon.

Operator: And that does conclude today’s conference. Again, thank you for your participation. You may now disconnect.