Primis Financial Corp. (NASDAQ:FRST) Q3 2024 Earnings Call Transcript

Primis Financial Corp. (NASDAQ:FRST) Q3 2024 Earnings Call Transcript October 25, 2024

Operator: Thank you for standing by. My name is Ian, and I will be your conference operator today. At this time, I would like to welcome everyone to the Primis Financial Corp. Third Quarter Earnings Call. [Operator Instructions] I’d like to hand the call over to Matt Switzer, Chief Financial Officer. You may begin your conference.

Matthew Switzer: Good morning, and thank you for joining us for Primis Financial Corp’s. 2024 third quarter webcast and conference call. Before we begin, please note that many of our comments during this call will be forward-looking statements, which involve risk and uncertainty. There are many factors that could cause actual results to differ materially from the anticipated results or other expectations expressed in the forward-looking statements. Further discussion of the company’s risk factors and other important information regarding our forward-looking statements are part of our recent filings with the Securities and Exchange Commission, including our recently filed earnings release, which has also been posted to the Investor Relations section of our corporate site, primisbank.com.

We undertake no obligation to update or revise forward-looking statements to reflect changed assumptions, the occurrence of unanticipated events or changes to future operating results over time. In addition, some of the financial measures that we may discuss this morning are non-GAAP financial measures. How a non-GAAP measure relates to the most comparable GAAP measure will be discussed when the non-GAAP measure is used if not readily apparent. I will now turn the call over to our President and Chief Executive Officer, Dennis Zember.

Dennis Zember: Thank you, Matt. Good morning, and thank you to all of you that have joined our call. Our results this quarter reflect our correction of the accounting error on the consumer loan portfolio and the impacts for accounting for this portfolio using the multiunit accounting method. As Matt will discuss in more detail, this method recognizes credit costs upfront with a full CECL reserve and the impacts of the credit support are not recognized until they are received, which is generally in the second half of the average life of the portfolio. Additionally, not all the revenue is recognized, particularly while the loan is in a promotional period. We are in high gear working to catch up on all of our 10-Qs and targeting to be fully current on our SEC filings by the middle of November.

Lastly, as we’ve stated in our NT filings, we still have an open consultation with the Chief Accountants office at the SEC regarding the accounting for this portfolio. And while we expect some resolution on that in the near future, we cannot predict the outcome. The noise from this consumer portfolio is unfortunate because these loans really only represent 5% to 6% of total loans. And I say unfortunate because outside of this portfolio and our delayed filings, we’ve made a lot of progress on our strategy. A few examples are these: First, the core bank’s contribution to our results continues to improve. The core bank’s cost of deposits, for instance, for the quarter was 2.21% compared to just — compared to 1.97% a year ago. Alongside the recent rate cut, we made the necessary adjustments immediately to keep the margin and net interest income steady.

But coming into the quarter, we have $1.1 billion of deposits that we know are going to adjust further in the quarter. Our current bank — excuse me, our core bank’s cost of deposits is consistently 40 to 50 basis points lower than our community bank peers in the Mid-Atlantic, and that’s because of the lifetime relationships we have with our customer base, the technology that we use like V1BE to deliver noticeable, convenience to the commercial customers and the leverage we have with our digital platform. Secondly, the core bank is building pipelines on new relationships at a very impressive pace. While we do work hard with existing clients and continue to grow with them, the majority of our push and our incentive dollars focused on new relationships to the bank — new commercial relationships to the bank.

The pipeline and pace of new relationships is 3x what it was a year ago and the momentum is almost all in the second half of this year. This leads us to believe that the community bank’s ability to be the noticeable driver in our growth and operating results is finally present. A comment or two about Panacea. When we started the division, this concept was built to just be a loan vertical and really a consumer loan vertical at that. To date, we have continued to tweak the model and built unique digital capabilities that equally focus on deposits as well as commercial loan activity. Tyler’s team this quarter had several, really big wins with continued endorsements from large national medical associations and a flurry of new commercial deposits at the end of the quarter that will probably mean up to $20 million in noninterest-bearing balances once the accounts are fully moved and funded.

The development of all the ancillary financial services that we can sell alongside our loan and deposit relationships are in high gear and the early signs about adoption are good. We experienced real momentum with our mortgage team. Our results this quarter on locked loans, we eclipsed $1 billion of annual production — our run rate is $1 billion of locked loans for the first time. In the quarter, we locked $277 million of mortgage loans, which was up 67% against the same quarter in 2023. While we expect a slower fourth quarter, obviously, than what we had in the second and third quarter, our year-over-year growth rate in production says a lot about, first, recruiting success; and second, momentum in this industry. Right now, we have the best recruiting pipeline that we have had since we launched this platform in 2022.

And combining that with the momentum that the industry is having given us real confidence that we’re going to see expansion in the contribution to our ROA and earnings per share that this division provides. Our announcement about Life Premium Finance is very positive, but bittersweet. It’s very positive for the three gentlemen that we recruited in 2021, who came to us with a lot of ambition, who built a platform and deepened their relationships and reputation in their industry to a really remarkable level. The opportunity in this division is probably bigger than my entire balance sheet, and it just needed a home similar to the one we announced. We’ll sweep off a similar amount of deposits immediately and shrink total assets by probably about 10%.

We expect this move by itself to improve tangible common equity ratio by about 75 basis points and improve our net interest margin immediately by 6 to 7 basis points. We expect another 5 basis points of margin lift over the next several quarters as some of the remaining assets run off. The real lift with our announcement is with regards to mortgage warehouse. We recruited a team from a large bank that was exiting the space alongside an acquisition, and we are sprinting to onboard their client base. Fortunately, we had the software already and had done significant engineering with our small warehouse client base. But what we didn’t have was leadership or a team with the relationships that this team has and their vision. I’m confident that we can replace the entire Life Premium portfolio over the next few quarters.

And the yields we are selling in warehouse right now are 160 basis points higher than our current Life Premium yields. Conservatively, if we assume that only 80% of that pickup holds as we build capacity, we’re talking about almost 20 basis points pickup in the margin and about 13 basis points or so pickup in our return on assets. The baseline OpEx in this division really isn’t materially different than what we had in Life Premium, and we believe credit costs will be similar. This was a very good opportunity for our company and my line of sight to the operating ratios that Matt and I want are much clearer after this move. On credit quality, we finished the quarter with only 25 basis points of nonperforming assets, which is steady really for the last few quarters, but half of what it was in the third quarter of 2023.

We still don’t have any other real estate and have had little migration between the grades. During the quarter, we did conservatively downgrade one commercial real estate property that had been slow to lease up and really affected by vacancies in close or adjacent properties. Our borrower has funded all of the cost overruns, has never missed a payment and pledged additional collateral. But our appraisals cap rate almost doubled from the origination date, and so we booked a provision for the small shortfall in collateral values. I don’t expect a loss on this asset or migration into nonperforming and also believe we might have downgraded this asset right as cap rates on CRE were peaking. All right. With that, Matt, I will turn it over to you for some comments.

Matthew Switzer: Thanks, Dennis. As a reminder, a summary of our financial results can be found in our press release and investor presentation, both of which can be found in our 8-K filed with the SEC last evening and placed on our corporate website. This quarter, instead of repeating information found in those sources, I’m going to attempt to walk through some of the impacts of the recent accounting changes in order to help highlight underlying trends in our results. As Dennis mentioned, our results for the current period and prior periods include the impact of corrected accounting for a third-party originated consumer loan portfolio. As detailed in our recently filed 10-K, these changes require the following: The subset of loans with promotional features don’t accrue interest until the end of the promotional period.

Deferred interest on these loans that exit the promotional phase is largely recognized all at once with a modest discount that is accreted over time. Third-party reimbursement for waived interest under our agreement on promotional loans that pay off early is recorded in fee income instead of interest income. We record a derivative value representing the fair value of expected interest reimbursements mark-to-market each period with changes in that value recognized through noninterest income. And all credit costs are fully recognized, including estimated life-of-loan losses under CECL, while potential credit enhancements from the consumer program are recognized as received. Reported pretax pre-provision earnings can be found in our earnings release and includes the effects of the Panacea Financial Holdings consolidation as in previous periods.

Adjusting for effects of this consolidation and nonrecurring items, core pretax pre-provision earnings were $10 million in the third quarter versus $9.4 million before changes for the change in accounting in the second quarter. Adjustment amounts for both PFH consolidation and nonrecurring items can both be found in our press release and investor presentation. This quarter, the various interest income and expense items for the consumer program we’ve previously discussed contributed a net of $4.5 million to pretax pre-provision earnings in the third quarter versus $3.2 million in the second quarter. Under our previous accounting, contribution from this portfolio would have been $3.8 million or $700,000 less than reported this quarter. Last quarter, that would have been $4.5 million or $1.3 million higher than reported.

Adjusting for these differences, core pretax pre-provision earnings were $9.3 million in the third quarter versus $10.6 million last quarter. A substantial portion of the volatility in reported earnings is due to the timing of interest recognition on promotional loans where we are required to defer to the end of the promotion. We recognized $3 million of interest catch-up in the third quarter for promotional loans that exited the period and began amortizing, up substantially from $0.5 million in the second quarter. As a result, our reported margin was 2.97% in the third quarter, up from 2.72% in the second quarter. Adjusting for the effects of the timing differences, our margin would have been 2.83% in the third quarter, down only 3 basis points from the second quarter.

We also recognized $2.5 million of interest reimbursement from our third-party partner for promotional loans that paid off early in the third quarter, up from $1.5 million last quarter, all of which is reflected in noninterest income and not in interest income or margin. We have $60 million of promotional loans deferring interest at September 30 with $17 million and $21 million reaching the end of their promotional periods in the fourth quarter and first quarter of 2025, respectively. Lastly, I do want to spend a minute on noninterest expense. As we highlighted in our earnings release and investor presentation, reported noninterest expense was $31 million, which included $2.7 million of consolidated PFH expenses or $28.4 million net compared to $27.4 million last quarter.

Mortgage expenses were $6.4 million in the third quarter, up from $6.1 million last quarter on higher volume. Excluding these expenses as well as nonrecurring items, core bank expenses were $19.8 million, down from $20.1 million last quarter and in line with our 5-quarter average. We are laser-focused on controlling expenses and generating operating leverage as we move past our accounting noise and look to grow revenue meaningfully in 2025. With that, operator, we can now open the line for questions.

Operator: [Operator Instructions] Our first question comes from the line of Russell Gunther with Stephens Inc. Your line is open.

Q&A Session

Nicholas Lorenzoni: Hi, this is Nick filling in for Russell Gunther. I just wanted to start off with your core expense outlook. Could you give a little guidance on that given the puts and takes of the Premium Finance sale and new hires around mortgage warehouse?

Matthew Switzer: Should be relatively flat, Nick.

Nicholas Lorenzoni: Okay. And then going on mortgage warehouse, do you plan to break that — those loans out separately from a modeling perspective?

Dennis Zember: Modeling, I think we would — similar to everything else we’ve done, we probably display it kind of like an operating segment. When you say modeling, you mean maybe for loan loss reserving or for interest rate risk…

Matthew Switzer: …or margin?

Nicholas Lorenzoni: Yes, that’s what I mean loan loss reserves.

Matthew Switzer: Yes. I mean it’s going to be not that material in the fourth quarter, depending on how the next couple of weeks ago. But as we move through ’25, we will certainly break out as much information as possible so you can get a sense for the trends.

Nicholas Lorenzoni: Okay. That makes sense. And if I remember correctly, I believe the deck said it will be either in 4Q of ’24 or 1Q of ’25. And I was just curious if there was going to be — if you guys had a good growth rate on those mortgage warehouse loans.

Matthew Switzer: What was — what are you referring to in the fourth quarter or first quarter?

Nicholas Lorenzoni: When you start breaking out and disclosing the mortgage warehouse loans. That’s what I…

Dennis Zember: I would tell you that I think — I mean, we’re sprinting to sort of add their customers. I know the fourth quarter and the first quarter are slower in the mortgage industry generally. So this is really a good time to be contacting the customers. I think they left their former bank with about 215 customers. They’ve been employed here for about three weeks. I think we’re close to 24 customers now. We’re trying to get maybe to 75 by the end of the year. And I think we’ll just sort of sprinting to that. And then maybe as we get into the first part of the year, we continue to add. I mean, again, we’re moving off $375 million or so of Life Premium loans. We think there’s going to be another probably $50 million or so that runs off through the middle of next year.

So really, we’re looking to replace, call it, let’s say, $400 million to $450 million of Life Premium loans with these mortgage warehouse loans. And I think for the — for next year, I think the average mortgage warehouse book, I think I feel comfortable at $400 million for the whole year.

Nicholas Lorenzoni: Okay. Great. That makes sense. And now on to ROA. So you previously laid out a target for a sustainable 1% ROA. Can you walk us or walk me through the glide path to when you think you guys are going to get there?

Matthew Switzer: I think we’ve got a reasonable shot to get there in the second half of 2025 — second half to late 2025. Part of that, Nick, is going to be — we’re going through — we’re either going to get the change in accounting that we’re hoping for and take out some of the volatility. Otherwise, we’re going to be experiencing volatility, but really only for largely a couple more quarters, potentially because most of the volatility is tied to these promotional loans and they bleed off pretty fast in the next two to three quarters. So setting all that aside, we’re moving off a pretty good-sized portfolio, but going to be replacing it almost dollar for dollar by the middle of ’25, and we think at higher rates and incrementally better profitability.

So you combine that with some decent expense save or cost controls, our normal retail mortgage operation, we’re projecting that to do better next year. And we expect the core bank to contribute more next year and to see some margin expansion on the core basis. So I mean I can’t lay out all the basis points of contribution that all those puts and takes are going to add up. But as we look at kind of how all that combines, we think that gets us to at least 1%.

Dennis Zember: I mean you can’t — there are so many moving parts, but I mean, the mortgage — the momentum we have in mortgage, talking about quarter-over-quarter growth in locked loans and in revenues and all that. I mean, if that holds into next year, that’s probably another 7 or 8 to 10 basis points. Life Premium — trading Life Premium for the warehouse opportunity, like we said, is probably 13 basis points. The core bank, no question, rates falling, like I said, with $1 billion of deposits still left to be repriced this quarter. There’s no doubt that the sensitivity to falling rates on our liability side is going to power more margin and more ROA. So again, like I was saying, I mean, the energy and enthusiasm we have for the line of sight to the numbers you’re talking about or better is really good. It’s — anyway, I’ll leave it at that.

Nicholas Lorenzoni: No, that’s perfect. That helps a lot. And that’s it all my questions. Thanks for answering them.

Operator: Your next question comes from the line of Christopher Marinac with Janney Montgomery Scott.

Christopher Marinac: Hi, good morning. Thanks for hosting us. Matt, just a quick housekeeping question. So the numbers we see in the press release and the quarterlies, those are going to — those reflect sort of the new information and that will be kind of verified once the Qs are filed. Do I have that right?

Matthew Switzer: Yes. And those are all the quarters restated for the change in accounting. So it’s all been pushed backwards.

Christopher Marinac: Perfect. That’s what I thought. Okay, great. I just wanted to be 100% sure. The criticized loan numbers were stable this quarter. Do you see any movement from that? And does the way that the consumer portfolio behave impact those at all?

Matthew Switzer: No. Those are not reflected in those. It’s — those loans are typical consumer loans, they get to 90 days and they charge off.

Christopher Marinac: That’s what I thought. Okay. And then the trends on just general coming and goings on commercial criticized and special — or substandard?

Matthew Switzer: I mean, outside of the two credits, the more significant one and a much smaller one in the quarter that went from special mention to substandard, we’re not — still not seeing a whole lot of inflows. And both of these credits, we’ve been watching for a while. So it’s not like this came out of the blue but with some surprise, maybe the valuation that we had to rely on when we put the reserve on the bigger loan was a little bit of a surprise, but we think that’s very, very conservative, and the customers continue to pay. So unfortunately, you still have to use their appraisal when it comes in. But otherwise, I can’t think of any credits that have moved into a problem bucket or started to creep up the risk curve — risk rating curve that we weren’t already aware of or have been watching.

Christopher Marinac: Great. Thank you for that color. And then another question just goes back to the cost of funds. Should that rate that we see this quarter be sort of a peak and then it works itself down? And do you have a thought, I guess, in terms of how betas may play out looking forward the next four to five quarters?

Matthew Switzer: For the first part of your question, yes, I mean, we saw cost of funds ticked down in September. So it basically peaked in August. As to betas, some of it’s going to depend on, I think, what happens with the next Fed cut. It feels like competitors have lower rates, and we have to, particularly in the core bank for the higher rate stuff that have been kind of the upper end of the cost structure. We were pretty aggressive moving some of those down. I think our overall beta for the core bank is probably 20% maybe after the last move. If the Fed doesn’t cut, I think we’ll have an opportunity actually to continue to incrementally keep moving stuff down and get some more beta on the first Fed cut. If they do cut again, we’re still going to cut, but somewhat — some of it is dictated by the competitive environment and what they’re doing with their rates. Not as many people seem to have been aggressive cutting after that first move.

Dennis Zember: Chris, one more thing. Matt and I have been watching our digital deposits, and we did make a few moves on the digital side. But generally, we did not make a lot of adjustments on the digital deposits. There’s $915 million or $920 million there. One, we’re doing a little bit of a — we’re doing a small sort of upgrade/conversion on the customer experience here in about a month. And we think there’s another rate move coming — or if there is another rate move coming, we did not want to be paying them aggressively. So I mean that’s that plus some broker deposits that we have that are coming up in December. I mean, there’s $1 billion of deposits on our balance sheet that never really got moved on this last rate cut that we are going to move this quarter, just want a little more line of sight into what the Fed is going to do and get past our conversion.

So I mean, I know — I mean your question about have we peaked, there’s no question we peaked. I think how much we can get out of that ahead of maybe having an earning asset opportunity with mortgage warehouse, we just want to be smart and cautious there. But no, we’re going to — you’re going to see some noticeable improvement in cost of funds.

Matthew Switzer: And even on the digital bank, and what Dennis is referring to, we were — we’ve been appropriately measured in like how we deal with existing deposits on that, but we did lower rates for new money coming in, and we’re still attracting money at those newer rates. So we’re averaging down the cost of the digital platform even without being real aggressive for existing ones.

Christopher Marinac: Okay. Great. Yes, I was going to ask about the new inflows that you saw, you sort of addressed that. And it sounds like if there is a difference on beta versus digital versus the core bank, it’s hard to really talk about that today, give a few more quarters and sort of circle back on how the experience is.

Matthew Switzer: Yes.

Christopher Marinac: Okay, great. Thanks for all the information today, as always, and I appreciate you hosting the call.

Matthew Switzer: Thanks Chris.

Operator: There are no further questions at this time. I’ll hand things back over to Dennis Zember, CEO, for some final remarks.

Dennis Zember: All right. Thank you again for your participation and your interest. If you have any questions or comments, of course, Matt and I are around all the time. So just give us a call, text or e-mail, and we’ll get back to you. Thank you. Have a great weekend.

Operator: Thank you. This concludes today’s conference call. You may now disconnect.