Primis Financial Corp.

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.

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.

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.