FINW - NASDAQ

Greetings, and welcome to the FinWise Bancorp First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brad Caimi, [ph] Investor Relations. Thank you, Brad. You may begin.

Thank you, operator. Good afternoon, and welcome to FinWise Bancorp's First Quarter 2023 Conference Call. The earnings press release is available on the Investor Relations section of the company's website at investors.bancorp.com. Note that this conference call is being recorded. I would like to remind you that statements made in the course of this call are not based on historical information and may constitute forward-looking statements covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on management's current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the company's filings made with the SEC, including its earnings release issued earlier today for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. The company undertakes no duty to update any forward-looking statements that may be made during the course of the call. Additionally, certain non-GAAP financial measures will be discussed on this conference call. A presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliation of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through the company's filings with the SEC, including its earnings release issued earlier today at www.sec.gov. Hosting the call today are Mr. Kent Landvatter, CEO and President of FinWise Bancorp; Mr. Javvis Jacobson, Chief Financial Officer; and Mr. James Noone, President of FinWise Bank. With that, I will turn the call over to Mr. Landvetter. Kent?

Good afternoon, everyone, and thank you for joining us on our first quarter 2023 earnings conference call. On today's call, we will provide an update on our first quarter financial results, discuss the impact of the macroeconomic environment on the company and the continued evolution of our business model. Despite the challenging macroeconomic backdrop, our business remains resilient. Our differentiated and diverse business model coupled with strong execution allowed us to navigate these macro headwinds successfully during the quarter. As a result, our business remained profitable. Credit quality was in line with our expectations, and we are investing in the business for future expansion and to grow capital for our shareholders. In addition, following the recent bank liquidity crisis, we are pleased to report that our balance sheet and liquidity positions remain strong. Deposits continue to grow and exposure to interest rate risk on our investment securities remained minimal. For the first quarter of 2023, despite ongoing contraction in capital markets for certain loan assets, we generated revenue of $18 million, led by loan originations of $0.9 billion, net income of $3.9 million and diluted earnings per share of $0.29. While general credit tightening has impacted our loan growth in the quarter, we believe that the trade-off between credit and growth is appropriate in this environment. Despite these factors, we produced a return on average equity of 11.1% during the quarter, maintaining our profitability. Furthermore, we continue to manage our capital prudently by investing in our business to fuel future growth and repurchasing our stock below tangible book value. At the end of the first quarter, the company's tangible value per common share was $11.26 as compared to $10.95 per share at the end of the prior quarter. As we communicated on our 2022 year-end call, we had anticipated that pressures from the economy would persist throughout 2023. However, what was not as clear was how abrupt the change in industry-wide originations would be in the first quarter. As we look ahead, we believe that we are prepared to deal with similarly challenging economic headwinds should they persist over the next few quarters. While it remains our intent to continue to invest and build on our past success to further diversify our income and funding streams, this will take time. That said, we continue to focus on producing diversified, sustainable and profitable growth as the environment evolves over time. In short, even with the challenging start to the year, our long-term strategy and focus remain intact. Let me provide an update on our key objectives as we move through 2023. We remain committed to securing additional revenue growth opportunities and continued execution in our existing business lines. Focusing for a few minutes on our strategic programs business. The effort to support our current platforms remain strong, and we continue to work to forge new relationships and bring new platforms on board. As we look to the future, the importance of securing new strategic programs to drive and diversified growth for FinWise remains a key priority. However, as we have discussed previously, it can be a multiyear process to build a relationship that contributes meaningfully to our revenue. Specifically, based on past experience, in any given year, it can take 1 to 2 quarters to launch a strategic program. And beyond that, it can take many more quarters before we would see originations related to a new program contribute significantly. Thus, in line with our long-term strategy, we continue to pursue new opportunities to engage with new platforms. Another area of focus is the further expansion of our footprint in the Banking-as-a-Service ecosystem, where we see strategic growth opportunities. In support of this focus, we have made key personnel hires during the quarter, including Robert Kyle as our Chief Fintech Officer, along with 2 additional well-established banking-as-a-service sales professionals. During the quarter, despite recent increases in market interest rates, SBA 7(a) loan originations remained strong. None of the guaranteed portions of these loans were sold during the quarter, which meaningfully impacted our SBA gain on sale revenue compared to prior periods. However, we continue to believe that over the longer term, this shift will result in stronger held-for-investment loan growth and support incremental growth to our net interest income. In addition, as part of our strategy to diversify revenue streams, we are working to further grow and expand our legacy commercial leasing business, which started over 10 years ago. As anticipated, our efficiency ratio rose in the quarter. This was due primarily to our decision to focus on positioning the company for future growth opportunities. This meant the continued investment in people and infrastructure, including administrative support, technology, systems and the expansion of our Banking as a Service product line. An important and exciting development that we believe further strengthens the leadership team is the first quarter promotion of Jim Noone to President of the bank. We believe that Jim's vast industry experience, vision and past contributions will serve FinWise well and speaks to our effort to develop a strong team of leaders to support our growth. Beyond investing in the team, we expect to continue to make investments to deepen relationships with our current customers, pursue new customers and be positioned to take advantage of growth opportunities, particularly as the macro economy improves. As part of our ongoing efforts to effectively navigate the environment with reduced loan originations, we are seeking to identify additional ways to utilize our balance sheet, including prudently adding credit risk as we discussed on prior calls. One area we remain extremely vigilant in is underwriting and maintaining our disciplined approach to growth. We believe we have demonstrated strong risk management efforts that have enabled us to sustain sound credit quality through varying credit cycles. In the first quarter, as anticipated, the overall credit performance of our portfolio has remained strong with no significant deteriorations beyond the ongoing industry-wide normalization of credit to pre-pandemic levels. However, as we have discussed in the past, we remain committed to ensuring our credit quality remains a core focus. While this thoughtful approach could hinder the rate of growth, we know it is critical to stay disciplined. This is our conscious decision to operate in this manner given the uncertain macro environment. We know that some of our loan origination platforms have seen larger declines in others as a percentage of total originations. As we look at year-over-year comparison, this dispersion continued to evolve, reducing our reliance on the originations of any one platform. As we look ahead, while macro uncertainties remain, we believe that our long-term business fundamentals remain intact, and we are well positioned to navigate the current environment and for long-term growth of our business. We are committed to maximizing long-term shareholder value by positioning the business to capitalize on growth opportunities that may emerge when the market stabilizes and the industry returns to grow. With that, let me turn the call over to Javvis Jacobson, our CFO, who will provide you with more detail on our financial results.

Thank you, and good afternoon. As Kent mentioned, we are pleased with our first quarter results despite the industry-wide headwinds. I plan to discuss our financial results for the first quarter relative to the prior quarter and the first quarter of the prior year, provide color on the transition to CECL accounting and discuss credit quality. Loan originations totaled $0.9 billion for the first quarter compared to $1.2 billion in Q4 '22 and $2.5 billion in Q1 '22. The change from the previous quarter and prior year period was primarily due to a continued contraction in capital markets for certain loan assets as a result of the challenging macro environment and our conservative underwriting to manage credit. In addition, loan origination activity has historically followed seasonal industry patterns. Loan originations in balances tend to decelerate in the first and second quarters of the year and rebound in the third and fourth quarters of the year, primarily due to seasonality of income tax refunds and borrower spending patterns. Looking forward, given the challenging macro backdrop, we believe that the industry-wide slowdown in originations could persist as we move through 2023 until macro conditions improve, possibly overriding the traditional seasonal industry patterns. Average loan balances comprising held for sale and held for investment loans were $290.4 million during Q1, an increase of 11% from $261.4 million in Q4 '22 and a 2% decrease from $296.7 million in '22. The change over Q4 in the prior period is primarily driven by continued growth in our SBA 7(a) program, partially offset by decreases in our strategic loan programs. Despite industry-wide liquidity pressure resulting from the failure of certain banks in recent weeks, we are pleased that we grew deposits and our balance sheet and that our liquidity position remains strong during Q1. Average interest-bearing deposits were $165.2 million during Q1 compared to $126.1 million during the prior quarter and $132.5 million during Q1 '22. The sequential increase from Q4 was driven mainly by an increase in certificates of deposit, partially offset by reductions in money market deposits and interest-bearing demand deposits. The year-over-year increase from Q1 '22 was driven mainly by increases in interest-bearing demand deposits and certificates of deposits, partly offset by a reduction in money market deposits. As we have noted previously, noninterest-bearing deposit levels have historically had a high correlation with origination volume from our strategic programs. In addition to our insured deposits from traditional sources, our business model is differentiated in that it contractually obligates loan origination platforms to maintain certain levels of deposits with FinWise. Importantly, this has provided another reliable source of funding that many traditional banks do not possess, and this can be useful in times of funding uncertainty. In addition, a significant portion of the uninsured deposits on the bank's balance sheet is our own capital. Taken together, our deposit base remains sticky and continue to grow despite the challenging recent events in the banking industry. Now turning to the income statement. Net income for Q1 was $3.9 million compared to $6.5 million in Q4 '22 and $9.4 million in Q1 '22. The change from the previous quarter and prior year period was primarily due to lower gain on sale, lower strategic program fees and increased interest expense on deposits, partially offset by a reduction in noninterest expense and lower provision for income taxes. Net interest income for Q1 was $12.1 million compared to $12.6 million in Q4 '22 and $13 million in Q1 '22. The change relative to the prior quarter and the prior year period was primarily due to an increase in the bank's deposit rates being paid to customers and lower average loan held-for-sale balances, partially offset by a shift in our mix of loans held for sale to those yielding higher rates, an increase in rates on our variable rate loans and an increase in interest rates being paid on our cash balances at the Federal Reserve. Net interest margin for Q1 was 12.51%, 176 basis points lower than 14.27% in Q4 '22 and 86 basis points lower than 13.37% in Q1 '22. The change from the prior quarter and the prior year period was primarily due to a reduction in average balances in the loans held for sale portfolio, along with the shifting of the deposit portfolio mix from lower cost deposits to higher cost certificates of deposit, partially offset by an increase in average balances in the loans held for investment portfolio. Noninterest income was $4.5 million in Q1 compared to $9.8 million in Q4 '22 and $11.7 million in Q1 '22. The change from prior quarter and the prior year period was due primarily to a reduction in gain on sale of loans due to the company not having any sales of SBA loans in Q1 '23 and lower strategic program fees as well as a decrease in fair value of the company's investment in business funding Group LLC, EFG. We expect the fair value of our investment in BFG will continue to experience quarterly fluctuations partially driven by general market movements. Noninterest expense during Q1 was $8.7 million compared to $10.2 million in Q4 '22 and $9 million during Q1 '22. The change from the prior quarter was primarily due to a recovery on our SBA servicing asset during T1 23 and reduced accruals for performance bonuses. The improvement over the prior year period was primarily due to the cessation in June 22 of commission accruals related to the company's strategic lending program and reduced accruals for performance bonuses, partially offset by an increase in consulting fees. The company's efficiency ratio was 52.5% during Q1 versus 45.6% during Q4 '22 and 36.7% in Q1 '22. As we've noted in past calls, we expect the company's efficiency ratio to increase as we continue to build out our infrastructure to position the company for sustainable long-term growth. We will strive to be prudent with expenses in light of the tougher macro environment. Credit quality performed in line with our expectations with nonperforming total loans of 0.2% at the end of Q1 compared to 0.1% for the previous quarter and 0.2% for Q1 '22. The company's provision for credit losses was $2.7 million for Q1 compared to a provision for loan losses of $3.2 million for Q4 '22 and $2.9 million for Q1 '22. The modest change in the provision was primarily due to a decrease in strategic program loans held for investment and lower net charge-offs. On January 1 this year, we implemented CECL credit accounting requiring us to provision estimated lifetime credit losses based on historical loan performance and prevailing macro trends, which resulted in a CECL adoption as Joan to retained earnings of approximately $0.3 million $0.2 million net of the deferred tax impact. During Q1, net charge-offs were $2.9 million compared to $3.2 million during Q4 '22 and $2.8 million during Q1 '22. The company's net charge-off rate as a percentage of average loans for Q1 was 4% compared to 4.9% during Q4 '22 and 3.8% for Q1 '22. The change in net charge-offs compared to the prior quarter was primarily due to lower net charge-offs related to strategic programs. The change in net charge-offs compared to the first quarter of '22 was primarily due to higher net charge-offs related to SBA loans. We continue to be well reserved with an allowance as a percentage of total loans of 4% for Q1 compared to 4.6% for Q4 '22 and 3.7% for Q1 '22. Given our team's experience and the data advantages of our business model, we have been exposed to credit across a wide range of different quality tranches and segments, which has enhanced our ability to price risk appropriately and create value through our disciplined underwriting process. Overall, we remain prudent and expect to maintain our already tight underwriting standards. With respect to capital levels with a 24% leverage ratio, the bank remains significantly above the 9% well-capitalized requirement. The company's effective tax rate was 26.1% for the first quarter compared to 27.3% for Q4 '22 and 25.4% for Q1 '22. As part of our effort to be good stewards of capital in Q1 '23, we bought back a total of 23,573 shares for approximately $0.2 million. With that, I would like to open up the call for Q&A. Operator?

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from Andrew Liesch is with Piper Sandler.

It's Michael on for Andrew. I wanted to start off, what's the tone you're getting from your strategic programs on origination volume? And is there kind of a natural floor to that level of originations per quarter kind of absent economic headwinds?

Michael, this is Jim. So originations were under pressure in the first quarter, and we foresee a continuation of this throughout 23 what originations look like in aggregate dollar terms at the end of the year is not clear. But we, not unlike others, don't anticipate a return in 2022 origination levels in the near term. I believe that the origination levels in Q1 could be the high point for the year. But while originations are down, we feel comfortable with how we've positioned the bank for today's environment. We continue to invest in the business and focus on opportunities to extend the franchise long term.

Got it. And then kind of switching gears over to the SBA growth. It was pretty impressive this quarter. How is that production trending? Does it follow any seasonal patterns throughout the year? And is this pace repeatable from here on out?

Sure. There's no seasonal patterns through the year in the what you see for the market generally is there is growth going on like in aggregate, but I wouldn't say that, that's necessarily indicative of FinWise. Lots of times, what you'll see new banks get into the market that weren't in previously that has a tendency to increase the market size like in aggregate. You'll also see banks use the product historically may have shied away from it. So I guess, the simplest answer is, there is some lagging -- some lagging volume from the pipeline that closed and funded in Q1, I would say that as rates rose, the demand in that product will continue to be soft.

Got it. And then some puts and takes on expenses would be helpful. I mean it sounds like there's some ongoing hiring within some growth avenues that you're pursuing this year. Should the trend kind of be a little bit higher from this point? Or any color on the cadence of those investments, whether it's the banking of a service or additional headcount would be helpful.

This is Javvis. The change from the quarter-over-quarter, I think what you're seeing mainly there is the decrease in the bonus accruals, the performance bonus accruals. So that's just a factor of the overall profitability of the company. So as long as that trend continues, I think that's what you would look at as our historical trends there. As far as our build-out, you're right, we've continued to hire additional professionals, specifically in the Banking as a Service area during the first quarter. And we build a group of those individuals and then we'll just work through the launch of it.

Yes. Let me just add to that. This is in line with the evolution of our business strategy. And we really -- that we've been describing for a while, and we really haven't seen anything that makes us want to rethink the strategy. We're still very committed to doing things right and everything, but want to be positioned. So when the market returns, we're in a very strong marketing position and not playing catch up.

Understood. That makes sense. And then I guess, what like related to that Banking as a Service strategy. Can you provide any color at this point of what that might look like for FinWise in the future? And how like how can we expect this build out it? Will it take some time to materialize? Or is there opportunities that we can expect in the near term?

Yes, that's a great question. There's -- to kind of give you a sense of what we're talking about. We're talking about some first strike opportunities of providing some of these services to some of our existing partners. So some of that may be lower-hanging fruit. I don't see a ton this year coming from that. But if you think about things such as payments or debit cards or things like that, that would be helpful to our partners, that's probably where we would start. But there's a lot of opportunity in this area that we think that we can take advantage of.

Got it. And then one last question on the CECL adoption format here. Can you provide any additional color on what some of the important drivers of the CECL model are for you specifically? I mean the balance sheet and the loan growth is a little bit different than other banks who do CECL as well. So any color there would be helpful.

Yes. Michael, lots of times, I think people will ask about like the -- on the economic statistics or releases that come out with our model, what's more impactful, if you remember how we reserve specifically for our SPHFI portfolio, which is a big part of the reserve is based on the high watermark for each individual program. So there's 5 total programs in that SP HFI portfolio, 3 of which are active, 2 of which are inactive, use the high watermark methodology for each of those programs is much more impactful than, let's say, like the unemployment forecast or things like that. So those economic data releases are part of our qualitative factors, but I would point you more towards the high watermark used for each of those programs in our HFI portfolio as being more impactful.

Our next question comes from Andrew Terrell with Stephens.

First, Jim, congrats on the promotion, very well deserved. Yes. Maybe just following up with the last one, the CECL adoption of methodology. Are you able to disclose what type of -- what's the high watermark on a blended basis for the strategic program loans? And then what type of watermark assumptions used on the SBA portfolio as well? Just trying to think of the constituents of the blended reserve.

Sure. So I don't have the blended. So just to be clear, on the SP HFI portfolio, which we refer to in the methodology is like the Vintage portfolio, that is where the high watermarks are being used. The SBA portfolio is part of, let's just call it, like the traditional bank, which includes local lending, retail, leasing, high watermarks are not being used in that traditional bank portfolio. It's just the SP HFI portfolio where those high watermarks are used. As far as what the blend is, I don't have that offhand. What I can tell you is that we've pointed to some of our partners that have public information out there as far as either securitization data or they have shares publicly traded and they've got like 10-Ks and prospectus that have been filed. Those are somewhat indicative is probably the best way to put it because lots of times, they'll use like an annual cohort instead of the monthly, and you get a lot more variance in the monthly cohort, meaning like we will have typically a higher high watermark than what you will see in the annual cohort data in those filings. There's not a good way to kind of estimate offhand what that blend is, but I don't have it for you right now. I can tell you that we did have -- give me one second. We did have one program established a new high watermark during the quarter or material high watermark during the quarter. That program, if you look at it as a percent of the total bank loan portfolio, though, is like less than 3%. So while we are reserving fairly conservatively within each of those retention portfolios, any one of them individually is a fairly small component of the total loan portfolio with the bank.

Okay. I appreciate that's all super helpful color, Jim. If I can move over and just follow up on the question around the originations. I guess I'd be curious of the $908 million in originations in the first quarter, what percentage of that was comprised of your largest partner? I guess, like I'm trying to think about the relative split here. Like how much of the $908 is driven by one larger partner versus the remainder of your strategic partners?

So we haven't disclosed it. But what I can tell you is that what we have disclosed is that the securitization markets or larger partners are more sensitive to the securitization markets. And that's where we have seen more of a decrease in total originations. So I think it's a fair conclusion from that, that of the $900 million in originations, you see more diversification amongst all of our partners than you saw a year ago.

Right. Yes. Okay. Yes, as I was trying to get to is just a greater diversification today. On the deposit front, I guess it's pretty impressive to see some noninterest-bearing growth this quarter. Can you maybe talk about some of the drivers behind just noninterest-bearing deposit flows in the quarter? And then separately, on the deposit front, are you able to quantify how much of the time deposit growth this quarter was brokered in nature? And then did HSA contribute to any deposit growth you guys saw this quarter?

Andrew, there's quite a bit packed in there. Let me start with this. As of the end of March, approximately 85% of our deposits are either insured by the FDIC, our own capital, we are contractually required in our strategic lending businesses. Another 6% is spread across operating accounts owned by 9 separate strategic lending programs and the remaining uninsured deposits representing approximately 9% of total deposits are held by a diverse group of commercial and consumer depositors on the retail side of our business. So as far as what percentage of our deposits are broker deposits. We haven't disclosed that in the most recent earnings release. It's not an insignificant part of our funding stack. We've talked in the past about what that funding stack is. We continue to raise a meaningful portion of our deposits from our retail branch in San to Utah. And then we have a significant source of deposits coming from our strategic lending program where the platforms are required to maintain certain reserves with us. And we had that account with lively that sources HSA deposits. We launched that last year in 2022. And then we've got the wholesale deposits continuing to represent a significant source of reliable deposits for the bank. If you look at our growth in CDs on the chart that we published in the earnings release, you could see a pretty significant increase in time certificates of deposit. You'll see in the call report that gets filed this week, a significant portion of those new deposits are short term in nature. I think that answers most of your questions. I think you asked about noninterest-bearing demand deposits. We saw growth, the end of the period, we were up $1 million. But if you look at the average table on noninterest-bearing deposits, you can see that our average for the quarter is actually down, and that is a direct correlation with our volume on the strategic business. Did I check all the boxes for you there, Andrew?

Yes. No, I think so. Yes, I think that's it. I appreciate it. On the time deposit specifically, I guess I've got -- I'm looking at about 50% of total deposits are comprised of time certificates right now. I guess within your ALCO framework or guardrails, do you have any internal governors on the relative mix of time deposits versus those source from other types of accounts? Or I guess is there a hard stop when you hit a certain threshold on time deposits?

There isn't.

Okay. Got it. Okay. And do you have the weighted average price for the repurchases made this quarter? And then can you talk about the appetite for incremental buyback? I mean you guys still have a really strong capital position.

We haven't disclosed the average price, but we did show that the dollar amount is roughly 0.2 million, so $200,000, and I think we gave the number of shares as well in the earnings release. It's 23,573 -- so -- and then as far as our appetite goes, we continue to purchase those shares below book value as the liquidity opportunity is available to us.

Okay. And then on the expense front, taking with you, Javvis. I know you talked about a few hires made this quarter, but it looks like comp was down. I'm not sure what the 1Q seasonality is like. But can you talk about maybe the puts and takes on the expense run rate into the second quarter and how we should think about the progression of expenses through the year?

Yes. I think as we mentioned earlier in the call, the main difference between last quarter and this quarter in salaries and employee benefits has to do with accruals of bonuses or performance-based bonuses. So to the extent that the company's performance stays the same, you'll likely see no change in that or no significant change in that category aside from what we've talked about already, the building infrastructure, the continued building of our bench here at the bank with seasoned professionals.

Okay. So maybe just think about it as like kind of modest continued growth in the expense run rate as you invest?

Yes, that sounds right.

Okay. And then last for me, just a modeling question on the just expected tax rate moving forward.

Yes. We talked a little bit about that. As soon as our nondeductible comp drops off, it's likely to revert to the levels we've seen in the past.

Okay. And that is, can you just remind me when that occurs?

It's happening in Q2.

There are no further questions in the queue.

Okay. Well, thank you, everyone. With there being no further questions, we'll call to a close here, but I wanted to thank you for your interest and ongoing support of our bank. And we're very excited about the future despite some of the headwinds we have right now. We're still feeling the resilience of our business model and investing in it, and we're excited about the future.