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spk00: Good day and welcome to today's Hermes Financial Corporation third 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. If you would like to ask a question during this time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press the star one. Thank you. I would now like to turn today's conference over to Matt Switzer, Chief Financial Officer. Please go ahead, sir.
spk02: 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. For 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, www.primsbank.com. We undertake no obligation to update or revise forward-looking statements to reflect change 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 Ember. Thank you, Matt, and thank you to all of you that have joined our third quarter conference call. I want to take a few moments and talk about some of the trends that we referenced in the press release and then talk about how this is driving our core earnings performance in the current quarter and what we expect out into 2023. The most notable item in the quarter is the investment in mortgages. We recruited very well this quarter and landed two very strong teams and some other strong producers. We bought this group with about 250 to 300 million of production capacity, but we ended the quarter very close to our $1 billion goal. To illustrate the progress, we took about 178 applications in August before we recruited anybody. And in October so far, the first full month with just one of the two teams, we have taken about 430 applications. The other team is being onboarded now. And at full capacity, we expect to end the quarter with about 550 to 600 applications per month, which should translate into about $75 to $85 million per month of volume. We pay small signing bonuses, and we buy out the team's existing pipelines. And this accounted for about 80% of the group's operating loss. While we recruited the team in the quarter and paid the cost to onboard them, the team booked no loans, just built pipelines. And so a lot of the revenue or all of the revenue that we expect from these teams will happen in the fourth quarter and beyond. The new level of production that we've built the mortgage company to is about what we expected. While we would like to continue to grow, we don't expect to continue adding costs like this into next year. We think the new level of production should produce EPS of about 24 cents per share and increase our return on assets by about 20 basis points. We also began marketing the digital bank in a more pronounced fashion. For the quarter, we spent about $500,000 promoting the offerings in our core bank. In the first month, we had traction on all of the accounts. And while it's small, I believe we could get to about $10 million in new customer dollars in just the first month. And I believe in a couple of quarters, the digital bank will be one of our largest branches. In the presentation that Matt put out last night, we list some of the novel features of our product set, which is the first time I think we put that in one place together. When you combine those features with the progressive look and feel of the app and the delivery capabilities from Vibe, we have a hyper-competitive offering that unquestionably is going to grow our franchise and our core markets. Speaking of Vibe this quarter, we spent about $300,000 to $400,000 extra staffing up and investing in Vibe for two reasons. We wanted to be in a position to expand the reach of the service and the hours we operate. And secondly, we wanted to be in a position to offer the service to other banks. Five, the service costs a fraction, maybe 15% of what a full-service branch costs. Right now, there are community banks out there that want to expand to neighboring markets but can't stomach a two-year period to break even. There are some that need to close branches but can't risk inconvenience in customers and losing hard-fought or deposit customers in this day when liquidity is drying up. To date, we've done over 8,000 deliveries, generally inside of 30 minutes, and we're on pace to do more than 1,000 per month. In my opinion, we need to be in a position to export this to new markets where we estimate the break-even to be only about $1.5 million in new deposits. Bringing other banks into the concept will only help us with that strategy. These items cost us about $1.6 million in the current quarter. And even with that extra investment in these areas, we posted the highest pre-tax, pre-provision earnings we've had in several years. For the current quarter of 2022, we're reporting pre-tax, pre-provision income of $9.9 million, or about a 1.2% ROA. This is up substantially from a year ago when we reported $8.5 million and an associated ROA of only 72 basis points. Driving that higher was growth in revenue of about 46% over last year, excluding PPP fees, and an improvement in the margin from 287 to 3.57 in the current quarter. Both of which resulted from the needed improvement in earning asset mix as well as a very low and controllable deposit beta. So I'm pleased with all of the progress we're making there, and I'm pleased with the move in revenue and pre-tax, pre-provision. But the fact is we have to move the reported ROA higher, and I see a clear pathway to do that. The mortgage team I know will move to profitable very quickly. Panacea will continue to move up the ladder with its returns. Our provision for loan losses associated with growth will moderate. We're not going to have provisions for model changes. much longer. Nothing is a slam dunk these days in this industry, but I feel very confident that all of these strategies are gelling and will produce the higher returns we want. Last thing before I turn it back to Matt, I want to comment on the loan to deposit ratio and where I see that headed. We've spent the last two years being flush with liquidity and benefiting from an absolutely wonderful growth in deposits. At the same time, We were building new strategies in five and with the digital bank that could position us to grow deposits when the easy money disappeared. I know we finished the quarter at 101% loan-to-deposit, but I feel our deposit strategies have just as much or more, honestly, more potential than our loan strategies. And given the rate and liquidity environment the industry is facing, I believe these are coming online at just the right moment. We expect the digital bank will continue to grow alongside the core bank and I don't expect loan-to-deposit ratios over 100% for much longer. Okay, with that, I will turn it over to Matt for some comment on the numbers. Thank you, Dennis. As a reminder, a full description of our third quarter results can be found in our earnings release and third quarter earnings presentation, both of which can be found on our website. Earnings from continuing operations for the third quarter were 5.1 million or 20 cents per diluted share versus 5 million or 20 cents per diluted share in the second quarter. Excluding one-time items, earnings in the third quarter were 5.3 million or 21 cents per diluted share versus 6 million or 24 cents in the second quarter. Total assets were 3.36 billion at September 30, up slightly from June 30. Excluding PPP loans and loans held for sale, loan balances grew 18% annualized in the quarter. Growth was primarily driven by panacea and life premium finance in Q3. We expect growth in the fourth quarter in the loan portfolio, albeit at a seasonally slower pace. Deposits were up almost 4% annualized in Q3, while the mix continued to improve. Non-interest-bearing deposits are 25.4%, which is a record for our bank. As we look out the next few quarters, we are confident we have the ability to keep growing deposits in the face of industry pressures. As Dennis alluded to, we have branches in strong markets enhanced by our Vibe service, a digital platform with unique deposit account features, and a nationwide brand in Panacea, all of which we plan to leverage for funding. Net interest income saw strong growth in the quarter, increasing to $27.5 million from $24.6 million in Q2, or 11.6% linked quarter growth. Our reported margin was 3.57% for the third quarter, or 3.58%, excluding the effects of PPP, up 24 basis points and 23 basis points, respectively, from the second quarter. Yield on earning assets expanded 42 basis points, while cost of deposits and cost of funds increased 13 basis points and 18 basis points, respectively, from Q2. Our deposit beta this year remains low at only 4% cycle to date. Non-interest income increased to $5.6 million for a $2.6 million link quarter, largely due to a full quarter of premise mortgage. The premise mortgage management team has done an incredible job recruiting to the platform with two substantial teams in particular added, largely in the third quarter. With these additions, we are projecting originations of over $1 billion next year, up from roughly $300 million this year, with meaningful additions to non-interest income and overall profitability. Non-interest income also included a gain this quarter for an increase in a credit indemnification asset of approximately $1.2 million tied to a segment of our loan portfolio. Non-interest expense included a number of items this quarter, including $308,000 in branch closure costs, a $311,000 expense for unfunded commitment reserve, and a full quarter of mortgage expenses, which included the build-out of origination teams, as Dennis discussed previously. Excluding these items and recovery, or expense for unfunded commitments, non-interest expense was $20 million, up from $18.5 million last quarter. The increase was driven by lower deferred costs from lower commercial lending volumes in Q3, which was roughly $500,000 impact, an increase in fraud losses of roughly $250,000, increased marketing and advertising for the new digital platform and Vibe, and customer mailing, which combined was roughly $300,000, increased professional costs of roughly $250,000, plus additional investments in our lines of business. Many of these expenses will be lower going forward. We will also start to benefit by approximately $500,000 starting in the fourth quarter from the renegotiation of our main data processing contract. The provision for credit losses was $2.89 million in Q3 versus $408,000 in Q2. The provision was driven by three things, loan growth we experienced in the quarter, weakening economic forecasts included in our CECL models, and an increase in specific reserves tied to one non-accrual loan. We also had net charge-offs in Q3 of $1.1 million, largely tied to one credit that had already specific reserves established against it in previous quarters. As a result, our allowance for credit losses to gross loans excluding PPP increased slightly to 1.17% at September 30 versus 1.16% at June 30. Non-performing assets net of SBA guarantees increased $17.3 million in Q3 primarily due to one relationship largely comprised of three assisted living facilities. This relationship was rated special mention last quarter and was downgraded and placed on non-accrual in Q3. We are working with the borrower to dispose of the properties, and current appraisals indicate we are fully collateralized. Our operating efficiency ratio was approximately 71% in the third quarter, essentially flat from Q2. Excluding the impact of mortgage, our operating efficiency ratio would have been approximately 65% in Q3. We consolidated two branches in Q3, bringing the total for the year to 8%. With the data processing savings highlighted above, plus additional efficiency improvements we are pursuing, we continue to believe we can drive the operating efficiency on a combined basis below 65% as we finish 2022. As Dennis mentioned, pre-tax pre-provision operating ROA was 120 basis points in Q3, up from 100 basis points in Q2. Excluding the investment in mortgage, this ratio would have been approximately 10 basis points higher in the quarter. Our various business lines continue to ramp profitability quickly. Similar to the efficiency ratio discussion, we are confident pre-tax, pre-provision ROA, and return on assets will continue to see meaningful improvement in the near future. With that, operator, we can now open the line to questions.
spk00: At this time, I would like to remind everyone, in order to ask a question, press the star, then the number one on your telephone keypad. We'll pause for just a moment to compile the Q&A roster. Your first question comes from the line of Betty Strickland with Jannie Montgomery Scott. Your line is open.
spk01: Hey, good morning. Morning.
spk03: Just wanted to start with deposit trends. I know you guys gave a little bit of color with the digital bank, but we're just curious, you know, in terms of new deposit trends and funding new accounts, do you have visibility into new core funding going into next year?
spk01: And how much of that comes from the digital bank versus kind of regular bank operations? That's a great question, Freddie.
spk02: So the digital bank, as you'll recall, went live to the broader public at the very end of July, and then we were slow to advertise it heavily while we made sure all the final books were worked out of it. So we really didn't start advertising the digital bank and those products until kind of midway through the third, mid to late in the third quarter. As we sit here today, I think we're at approximately $8 million in deposits in that platform already. So we feel pretty good that the platform Products that we've got there, some of the novel features combined with Bob and how we've set up those accounts, that we're going to see some pretty good growth in the digital platform in the fourth quarter and then into next year. And centered on checking accounts. Yes. And I would point out, right now the only products live are consumer accounts. So we don't even have business live yet. So that $8 million is all consumer funding. Business should be live early next year. I think, to your question too, I think the core banks got, let's just say, almost $3 billion of deposits, a little under that. I think in a normal year, given our exposure in Richmond, in Northern Virginia, D.C., Southern Maryland, out the Hampton Roads area, I feel those are good markets. I feel like in a normal year, you'd expect us to grow, call it, looking at Matt, probably $7 billion. to 8%, 9% without being too aggressive and without being centered on rates. I think the industry is probably facing a 10% attraction in deposits, so the core bank, it might be hard for the core bank to grow. I think all core banks are going to struggle growing. I think you've seen that this quarter. The digital bank, I think, is different. I think, really, I believe, I don't want to, sit here and be a sage and I don't want to declare victory early, but I think it's the one thing that's going to change the tenor of what we do next year on the liability side. I know it's only approaching $10 million, but if you look at the cost of funds in the new customers, in the digital bank against where we're loaning money, we're pushing net interest margins that are higher than what we reported this quarter. The whole strategy itself is incremental to our margins. It's going to increase our growth rate in deposits. I think it's going to make a big difference. Freddie, one last comment on that when we're talking about deposits. I highlighted it a little bit in my remarks, but Panacea. So Panacea's got a little over 13 million deposits at the end of the third quarter. Deposit gathering. They push for deposits, especially with commercial customers. I think they have almost 100% penetration with a deposit account with their commercial customers. But it has not been as great of a focus as building out their business in other areas to date. However, they've got a massive built-in customer base and eyeballs that they can market to. And we intend to leverage that more aggressively here in short order.
spk03: Got it. No, that's really helpful. Appreciate all the colors. And just switching gears to expenses, Does the expense growth we saw in the third quarter continue, or do we see sort of a slowdown on that line from here? I know you guided towards 65%, I think you said, in the fourth quarter. I was just also curious where you think efficiency can go in the longer term, just as, you know, revenues start to rise as well.
spk01: I guess two parts to that. So, yes, you
spk02: not only should we not see growth in the fourth quarter, we're expecting to bring expenses down the fourth quarter because the number of those items were not technically non-recurring but should not be showing up on a regular basis in our financials. Longer term, we have a stated goal of being below 60, mid-50s in the core bank, excluding mortgage. Mortgage, by definition, is a higher efficiency business additive to ROA because it's not heavy on assets, but higher efficiency. So stripping that out, we're driving the community bank and the rest of our business lines to low to mid-50s. Panacea should be below 50. Life premium finance should be well below 50. And then kind of a standard community bank efficiency ratio of mid-50s combined puts us at the bottom of that range.
spk01: Got it. That's helpful.
spk03: And speaking of mortgage, I know you provided a little bit of guidance on what you think you're going to see there. Do you see opportunities there just as other banks are retreating from the space to pick up good produce? I mean, it sounds like you have. You did this past quarter. Is there more of that out there just given kind of a downturn in mortgage? And I was just curious if you can also explain – how mortgage expands just absent an external market shift in rates and whatnot?
spk02: There's a lot of opportunity to, to grow mortgage. I honestly, I think we've got a great team. I think we've got good leadership. I think we've got good infrastructure that's on its way to being great infrastructure and systems. Um, I love the mortgage industry. I don't know how much we can stomach, though. And I think we picked up two dynamite teams in great markets. I feel like we could probably do that seven or eight more times probably before June of next year. But I don't think we should. I think what we need to do is sort of incubate these two teams, get them to profitability, sort of let it drive, let us get the results that we expected and make a good name for ourselves and then sort of start building from there. I mean, if we were further along in the digital bank and further along with Panacea and further along with some other profitability ideas, I think we might invest harder here, but I just don't think it's, I don't think we ought to keep investing before we start putting up some returns. I mean, the industry is just retracting or contracting. And, you know, good teams that, I mean, a year ago, I think either of these teams we just recruited, it would have taken a couple million dollars. I don't even know that you could have moved them. You would have taken a couple million dollar signing bonuses plus on top of what we paid. And, you know, today mortgage companies especially the independents, are slashing backrooms, slashing marketing. You know, they have no ability to portfolio anything. And so a lot of these teams are available right now. I mean, the nation's best mortgage companies right now started in 2008. And so this is what happens. In the pullback, the best mortgage teams look for good homes. And I think that's what we're benefiting from. At least answer the phone. Exactly. Exactly.
spk03: Got it. No, that makes sense. That makes sense. And kind of along that same line, can you talk a little bit about what you see on the interplay of profitability over time further out in 2023, 2024 within the various subsidiaries, whether it's Panacea, the premium finance division, Mortgage Obviously, mortgage is a little – we more or less talked about mortgage. It's a little harder to forecast, not knowing exactly what the Fed's going to do. But we're just curious what – across the different segments, what's the different level of opportunity that you see?
spk02: I think the core bank, as it is in a normal credit environment, should probably do – we'll do probably about a 1 to 115 ROA. I think premium finance, our premium finance folks will do a 150 to 175 ROA. Matt said below 50% efficiency ratio. I was like, you know, I mean, they're going to probably run a 20% efficiency ratio. I think they could get to a billion dollars outstanding with, you know, seven or eight people. Panacea probably is 125 to 150 ROA. We may be longer getting there because what we want to do is invest in their deposit infrastructure. I think Panacea long-term is probably going to look like really the nation's first full-service digital bank, both sides of the balance sheet. to doctors, vets, and dentists, maybe expanding that to medical staff, but at least for the deposit side. I mean, mortgage, I think, would probably produce pre-tax somewhere in the 75 to 80 basis points on production. So I think if we do a billion dollars of production, I think we should do seven and a half million of pre-tax. I think if you take mortgage from $1 billion to $3 billion, I think you probably can get closer to the higher end of that because you can do more things with servicing and MSRs and secondary, adding a little bit here and there to profitability. But I think for us next year, $1 billion should produce somewhere in the 75 basis point pre-tax range.
spk01: I think the digital bank is mostly deposit-focused.
spk02: I think it's going to produce a lot of deposits that probably have a cost of funds that might be a touch ahead of an established core bank, but it will have no infrastructure. or have very, very low op-ex associated with it.
spk01: And so I think the bottom line impact from that will be significant. I don't know if that was... No, that's exactly what I was looking for, so I appreciate it.
spk03: And just last question for me, just kind of more broadly speaking, Can you speak a little bit to customer sentiment on economic outlook? Have you seen any incremental change just in talking with customers or customer behavior with all the talk over session? I was just curious if you've seen, you know, any customers that might be looking at doing an expansion, not doing expansion or just even any discussion, just anything there.
spk01: I mean,
spk02: I think right now I'm thinking of a couple customers that I've spoken to in the last few weeks. I think they're probably more just sort of hyper aware of what might be coming. I mean, I don't think, I think this is investors and bankers and we're all kind of in the same boat. I think we are afraid of a recession, but we haven't seen all the signs yet. We're afraid of credit. slow down, but we've not seen anything yet. You know, we were in our board meeting this last week. We were talking about, you know, a credit that we resolved in the third quarter that, you know, quit paying. We foreclosed. We sold it. We got out of the loan 100%. That's That's not what everybody's afraid of. Everybody's afraid of being underwater 10%, 20% on credit. That's not happened yet. That's just not happened yet. Customers are afraid, I think, because they've heard stuff on the news, but I don't think they see anything...
spk01: They don't see anything anecdotal to sort of guard against. But yeah, they are aware.
spk02: And they are, I think, we've seen some good investors that are commercial real estate investors and customers from private equity, venture capital people that we bank that are just sort of on the sideline. They don't know if valuations are coming down. But
spk01: I don't know if that answers your question. It's a little rambling, you guys think. No, I think that answers it.
spk03: I was just kind of looking for like a broad overview because that's similar to what I've heard of other banks, which is just that it sounds like everyone's aware and they're hearing what's going on in the news, but they're not necessarily seeing anything going on down the street. That sounds like that's what you said in a nutshell, right?
spk01: Right.
spk03: Got it. Well, thanks for taking all my questions. I really appreciate it. Thank you. Thanks, Freddie. Thanks, Freddie.
spk00: There are no further questions at this time. I'd like to turn the call back over to Dennis Zember.
spk02: I appreciate everybody's attendance today. If you have any questions or comments, Matt and I will be available. just reach out, email, or telephone, and we'll do what we can. Thank you, and have a good weekend.
spk00: This concludes today's conference call. You may now disconnect.
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