Primis Financial Corp. (NASDAQ:FRST) Q4 2022 Earnings Conference Call January 27, 2023 10:00 AM ET
Company Participants
Matthew Switzer – Executive Vice President and Chief Financial Officer
Dennis Zember – President and Chief Executive Officer
Conference Call Participants
Casey Whitman – Piper Sandler
Christopher Marinac – Janney Montgomery Scott
Operator
Hello and thank you for standing by. My name is Regina and I will be your conference operator today. At this time, I would like to welcome everyone to Primis Financial Corporation Fourth Quarter Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions]
I would now like to turn today’s conference over to Matt Switzer, Chief Financial Officer. Please go ahead.
Matthew Switzer
Good morning and thank you for joining us for Primis Financial Corps’ 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
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 and 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 win? 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. And 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 and credit administration and 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 a 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 — between — excuse me — between gain on sales and portfolio. The credit here is outstanding. Our commercial book has debt coverages in the — over 2% — or excuse me — over two times. No past dues ever and incremental yields honestly that are close to or exceeding traditional bank CRE.
Like Premium Finance ended with just $200 million, just under $200 million of outstanding loans and about $800 million underwritten. In less in 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 CRE.
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 comp plans, the level of administrative — excuse me — 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 mean, I really believe we’re ideally positioned for this year and this division will improve our earnings and ROA in 2023.
The last thing I’d mentioned — next to last thing I’d mentioned really 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 I think 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 MPA on our books is the first mortgage on the largest state property. We have a 40% or so LTB 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 to the near — and nearly to the top of our peer group. And none of that, actually — none of that excuses our actual results. We finished a 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 — 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 us 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. And 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 reputations relationships. We needed a better brand. And just saying all that leads 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, and 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. And I believe that we’ll see all of this build and start to pay off and I’m determined with Matt’s help to not be distracted with any other — with anything else other than getting the payback on these investments and honestly illustrating how great a value our stock is at these levels.
Alright, Matt, with that, I will turn it back to you.
Matthew Switzer
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 in 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, both was 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 and 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 increase 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 all together, 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 ROA 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% ROA goal.
With that, operator, we can now open the line for Q&A.
Question-and-Answer Session
Operator
[Operator Instructions]
Our first question will come from the line of Casey Whitman with Piper Sandler. Please go ahead.
Casey Whitman
Hey, good morning.
Dennis Zember
Good morning, Casey.
Casey Whitman
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
That’s right.
Casey Whitman
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 and the gain on sale margins in that space, or sort of — 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
Sure. I’ll start it. Dennis can add to it, or correct me where I go wrong. We’re expecting $1 billion dollars 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
Okay. And that’s assuming the same kind of expense level that you had, I guess, in the fourth quarter.
Matthew Switzer
It’ll be lower than in the fourth quarter.
Dennis Zember
The fourth quarter had a considerable amount of sort of in — of draws that didn’t have any associated production with it. Some of that’s because it’s a fourth quarter. Some of that is because people bringing over pipelines. All of those — almost all of those 90% or of them are more expired on 12/31. So, really as we go into the first quarter, for the most part, almost all of our — all of our producers are on commission only. So, I would also say — and one other thing, so just said a little bit differently. So, the $27 million, $28 million, probably closer to $27 million for the first quarter, with mortgage is fair. But remember, as their production increases, that expense line’s going to increase, but their turn — it’s because of commission expense. Right? So that’s — they’re generating revenue on the other side.
Matthew Switzer
You’re saying that the expense side may stay the same, but we expect an extra million five or so revenue. You know what I’m saying, excluding mortgage should — I mean, the expense with mortgage will go up through the year and probably come back down to the fourth quarter as production decline. But I don’t want you to be surprised if in the second and third quarter expenses are a little bit higher, because it’s the peak of the mortgage market. Does that make sense?
Casey Whitman
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 dumb down what’s going on there? Should we be assuming the 350 margin is sort of the better starting point or, the 370 or whatever that you reported, 367 you reported.
Matthew Switzer
The — so we’re going to, as we go forward, continue to kind of strip out some of the noise from that portfolio. So, we have a portfolio of loans that we originated with a third-party. They come on our balance sheet directly, but they’re managed and serviced by third-party. And when it was smaller, we were just booking the net revenue from the portfolio. But now that it’s bigger, the accounting requires us to run more of the adjustments from the portfolio through various line items. So, booking yield at a gross level instead of net booking the charge-offs that are on the portfolio, but that are covered by the third-party. And then there are offsets for all that in non-interest income and non-interest expense. The net profitability that we’re making on these loans is — has not changed. The only thing that’s changed is we have more of the effects from the portfolio running through various lineup. So, it’s really the — where it shows up in our income statement has changed, but the impact on net income has not.
So, from a core basis, I would encourage you to focus on the 351, which is really apples-to-apples versus last quarter, kind of where we — how we think about our margin going forward. This portfolio — the accounting for this portfolio is going to create some margin effects on a reported basis, but we’ll do our best to adjust for all that and keep it apples-to-apples going forward.
Casey Whitman
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 ROA, I guess 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
I would say — well, Matt’s got a slide that sort of — that shows where the improvement’s coming from, some is from obviously Panacea and the Life Premium Finance, growth in the core bank. Little more expense marketing, the digital bank mortgage and I think gets us to right at $1.50 of earnings per share. I mean I would say …
Casey Whitman
Okay.
Dennis Zember
… for 2023. Yeah. We have — the slide he’s referring to builds up pretax, pre-provision, starting with our run rate in the fourth quarter shows the impact of mortgage improvement that we just talked about, the improvement in Panacea and Life Premium Finance and builds us up to a higher run rate or a higher full year pretax, pre-provision for 2023. And if you assume a reasonable level of provision for more moderate loan growth in 2023 and then tax effect that, you could get to $1.50 a share for the year.
That’s about — that’s — that will be — we will be very delighted with that. But really that just sort of shakes out to just over a 1% ROA. And clearly that’s — and that’s not our goal. I mean, we need — I really believe that Panacea, Life Premium Finance and Mortgage will be meaningful contributors to the ROA honestly in 2023. But, but more so in the out years. I think the core community bank, I mean, is hard really to grow that beyond or to improve the profitability there, say beyond — say 1.10% or 1.15%. And so all these other items — all these other businesses are important. I think long-term we’re still sort of believing that we should be in the 1.25% to 1.35% range. Our goal in 2023 is just to be 1% on the bottom line.
Casey Whitman
Okay. Appreciate it. Thanks for all the color. I’ll let someone else jump on.
Operator
[Operator Instructions]
Your next question will come from the line if Christopher Marinac with Janney Montgomery Scott. Please go ahead.
Christopher Marinac
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 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
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 second and third quarter 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
I think probably if I had to — I don’t think we’d be — I mean, fourth quarter obviously is not the best quarter for mortgage. I mean, I think it’ll be accretive to the ROA in the fourth quarter, but I don’t think it’ll be meaningfully accretive to the ROA. I think if you look at the first half of the year, Chris, versus the second, I think we have a few things teed up. I mean, Panacea, like we said in the reports, looking at some loan sales and we’ve got a little bit of momentum there. I’d say the first half probably is closer to 90, and the second half is probably closer to 110, even with mortgage dipping a little in the fourth quarter, I still think second half of the year — probably 110 and maybe the fourth quarter like a 105, probably what I had to guess.
Matthew Switzer
So, again, slide seven is more than aspirational. It’s really kind of what you’re trying to do for this year and it’s just a question of when those — it all falls in place.
Dennis Zember
I wouldn’t — yeah, I wouldn’t call it 10% aspirational. Yeah. I mean, I think some of the stuff that we’re looking — I mean, no, there’s — I think there’s science behind all of this. I mean, the core bank improvements of 2.6, I don’t want to go into that. I know exactly where the 2.6 is and on the mortgage pretax of 4.9, I know how to get to that 4.9 with $700 million of production and I know how to get there with $1 billion of production. So, in Panacea, I know how much in loan sales we’ve got to have and how much we’ve got a portfolio. And so, I don’t think it’s aspirational. I think it’s — and I know you didn’t mean that word sort of in a negative sense. But I kind of go back to my comments at the end of my prepared comments is, I mean, this is what we’ve been working towards. This is really what we’ve been working towards. And — yeah.
Matthew Switzer
I would just say — I mean, you all don’t get to see this obviously, but when we were — when we work on our multi-year projections, when we were working on our projections last year, we had 2022, somewhat basically coming in. There were more moving parts that we experienced this year than we anticipated, but we ended up netting out around where we thought we would be this year with the various investments we were planning. And we anticipated 2023 seeing meaningful improvement in EPS and profitability as a result. That — with that slide seven and that buildup, that’s not inconsistent with what the plan was a year or so ago. And Dennis said, we’re increasingly confident that we can get to those numbers just based on kind of what we’re seeing with the improvement in these business laws.
Christopher Marinac
Great. That’s helpful for both of you. I appreciate that clarity a lot. My only other questions just goes back to deposits. I know you’ve made a lot of progress on deposits as you cited within Panacea specifically, but just as a general kind of question about opening new deposit accounts and that — what do you see organically ahead of you this year? I know it’s a challenging environment with rates, but you want organically focused and so just want to get a sense of what you think is possible on kind of new deposits coming across the company.
Dennis Zember
In the core bank, out of the branches in our markets, I think staying flat’s going to be pretty magnanimous. I mean, in the whole industry — I don’t — I find a CEO, bank CEO that believes they’re going to be able to grow their poor deposits and now you can. But you’re obviously paying up for every new deposit coming in the bank. Our advantage — and we have got to exacerbate this advantage, our advantage is this digital bank that honestly is as good in Phoenix, Arizona, and I always say Minnetonka then as it is in our core footprint. And so, being able to use the digital bank to raise those deposits in places that we aren’t and that won’t affect, are really valuable core deposit franchise. I mean, we have an advantage that not every other bank in the country has, very few banks have disadvantage. And so, we’ve got to exacerbate that, really help us. I mean, because honestly, if it wasn’t for that and we were trying to grow loans like we are, or had all the opportunity, we would basically be faced with sacrificing the real value in our core deposit franchise and making it more rate sensitive. And we don’t have to do that because of the opportunity we have with the digital bank.
And we’re just hitting the stride on the digital bank. Really, we are. And we’ve got some places that we’re about to market that at reasonable prices. And that’s going to work. I mean, in our delta or what we need to be impactful here is, is really not a big number when you consider it’s got a potential national reach. If I was trying to raise this number in Hampton Roads or Richmond, it would be daunting. We would be having a different conversation here. But when I know that I have the whole country, I feel better about it.
Matthew Switzer
The other thing I would add and we’ve talked about this or highlighted it in our investor presentations previously, we’re — with the digital platform, we’ve been growing in the fourth quarter with one hand on our back. It’s only got consumer accounts so far. In the first quarter, business counts will go live. And at the same time, we have an upgrade of the mobile experience for both consumer and business, that will take place. That’s a meaningful improvement, and for business accounts, a meaningfully improved user experience and functionality for small business customers. So, we’re very excited about that. We’re — I mean, our CIO will tell you we are pounding in every day on updates on when we’re going to have all that live because we think that’s — I mean, consumer’s important, because you can market broadly and move the needle with a lot of accounts. But we really need this business piece live, because we can then move the needle with some larger balances and fewer accounts. And we haven’t had that delivered yet.
Christopher Marinac
Good. I follow you there and I thank you for that. And it sounds like the digital bank is going to influence both total deposits as well as core deposits. Just back to kind of the way that you explained it on the slide 20. So, that’s good. Thanks again for taking the question this morning.
Dennis Zember
All right. Thanks Chris.
Operator
I’d now like to hand the conference back over to management for any closing remarks.
End of Q&A
Dennis Zember
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
That will conclude today’s meeting. Thank you all for joining. You may now disconnect.
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