FINW - NASDAQ

Greetings. Welcome to FinWise Bancorp's Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note this conference is being recorded. I will now turn the conference over to Nathan Mills, Investor Relations. Thank you. You may begin.

Thank you, operator. Good afternoon, and welcome to FinWise Bancorp's third quarter 2023 conference call. The earnings press release is available on the Investor Relations section of the Company's website at investors.finwisebancorp.com. Note that this conference call is being recorded. I would like to remind you that certain 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 press 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 this call. Additionally, certain non-GAAP financial measures will be discussed on this conference call. Our 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 our filings with the SEC, including our earnings press release issued earlier today at www.sec.gov. Hosting the call today are Mr. Kent Landvatter, CEO and President of the FinWise Bancorp; Mr. Javvis Jacobson, Chief Financial Officer; and Mr. Jim Noone, President of FinWise Bank. With that, I will turn the call over to Mr. Landvatter.

Good afternoon, everyone, and thank you for joining us on our third quarter 2023 earnings conference call. On today's call, we will discuss our third quarter financial results, provide color on how we navigated the turbulence in the macro economy and share progress on our strategic priorities. We delivered yet another quarter of solid results, driven by 16.2% quarter-over-quarter growth in our loans held for investment portfolio, coupled with steady originations in our Strategic Programs line of business. Our third-party-focused business model, along with prudent underwriting, effective portfolio management and exceptional execution in our core competencies have remained sources of strength for us. During the third quarter, FinWise remained profitable and our loan portfolios continue to perform generally as anticipated. Our credit quality remains solid as evidenced in the relatively low charge-offs for the quarter, notwithstanding an expected rise in non-performing loans. These factors, along with our above pure average capital enabled us to continue investing in our core competencies and laying the groundwork for future growth. For the third quarter of 2023, we generated revenue of $22.4 million, led by interest from our growing loan portfolio and loan originations of $1.1 billion. This resulted in net income of $4.8 million or diluted earnings per share of $0.37, with a return on average equity of 12.8%. While we are pleased with these results, we believe that the higher-for-longer interest rate outlook and tight capital markets will continue to weigh on industry-wide loan originations and that this softness may persist throughout the remainder of 2023 and potentially well into 2024. Despite these macro challenges, we continue to actively manage what we can control. Our focus on providing reliable and uninterrupted services with our current third-party relationships remain strong, and we are actively forging new relationships. This is integral to our strategy and is expected to continue to drive our success. Importantly, we have demonstrated our ability to perform well in this current environment and believe we remain well positioned for growth as the economy begins to recover. Turning to capital at the end of the third quarter, the company's tangible book value per common share was $12.04 as compared to $11.59 at the end of the prior quarter. Our bank capital levels remain significantly above well-capitalized guidelines with a bank leverage ratio of 22.1%. While our total shareholders' equity to total assets ratio remains high, it is important to note that since the end of 2022, the ratio has declined as our balance sheet continued to grow and we repurchased our stock. During the third quarter, we repurchased all remaining shares under the Board-approved buyback plan. While management and our Board of Directors are always evaluating our use of capital, our primary focus has been the deployment of capital to support organic growth opportunities to expand the business and to maintain balance sheet flexibility during what is an uncertain economic and geopolitical environment. I will now provide an update on our key objectives as we move through the remainder of 2023 and beyond. Our strategic lending programs have been a key driver of our revenues and our support for existing platforms continued throughout the quarter. Our teams have also been actively working to bring new relationships through due diligence to expand and diversify revenue in this business line. Our SBA 7(a) lending continued to be a key driver of our portfolio growth, and we are pleased with both the growth and performance in the quarter. While our expected increase in non-performing loans in the quarter was primarily attributable to our SBA loans, we are confident in our team's underwriting and collateral management expertise and have historically managed credit performance quite effectively. Expenses remain well managed with the third quarter efficiency ratio of 51.3% compared to 52.7% in the previous quarter and 42.3% in the same period last year. However, it is important to note that the approximate $0.6 million of miscellaneous income recognized upon the resolution of the forbearance agreement related to a previously reported non-accrual SBA loan played a part in the improved efficiency ratio during the quarter. While this level of miscellaneous income is not expected on a recurring basis, it does demonstrate the expertise of our portfolio and collateral management teams and maximizing bank proceeds related to the non-accrual balances. As previously noted, we expect our efficiency ratio to fluctuate and remain elevated as we bring our new initiatives online. We believe this investment is critical to expanding our business relationships and will serve to further diversify and support our revenue in the years ahead. In summary, we continue to be excited about our pipeline of potential lending programs, the growth and performance of our SBA portfolio and the continued progress we've made on the expansion of our Banking-as-a-Service initiative. We remain disciplined and focused on the items that we can control, including risk management, third-party programs, capital management, our underwriting and collateral management and investment for future growth opportunities at the bank. With that, let me turn the call over to Jim Noone, our Bank President, who will provide you with more detail on strategic program initiatives and credit performance.

Thank you, Ken, and good afternoon. I will take a few minutes to walk you through our lending, card and payment initiatives as well as the details of the loan portfolio growth and credit performance. During the quarter, the bank continued to invest in the strategic programs business line by hiring professionals and building on our strengths in the areas of business development, product and marketing along with compliance, third-party risk, operations, change management and IT. Our lending programs pipeline remains strong, and we have been working to potentially launch additional lending programs prior to this calendar year-end. With regard to product rollouts, we are excited about our work on building the card sponsorship business and payments hub, which we expect to be operational in the first half of 2024, and we anticipate that our first customers will be onboarded in the second half of 2024. As we have noted, we believe that integrated Banking-as-a-Service remains an important aspect of our strategy and meeting the needs of the market and in our positioning for the future. Our SBA 7(a) loan originations were strong during the third quarter, and we maintained our strategy of not selling the guaranteed portions of these loans. While the level of front-end inquiries was more tempered than in previous quarters, our SBA pipeline remains stable. The decision to retain substantially all of the guaranteed portions of our SBA 7(a) loans has been the primary factor in the 16.2% increase in our loans held for investment portfolio quarter-over-quarter. We continue to be comfortable with the strategy of holding a higher balance of government guaranteed loans as a way to generate meaningful and recurring growth in our interest income with minimal credit risk, especially while the secondary market premiums remain subdued and the underlying loan interest rates remained elevated. Now turning to credit. The company's provision for credit losses was $3.1 million for the quarter compared to $2.7 million for the second quarter and a provision for loan losses of $4.5 million for the same quarter last year. The increase in provision over the prior quarter was primarily attributable to management's selection to increase the qualitative factor adjustments based primarily on the Q3 growth of special mention, non-accrual and non-performing assets, which related primarily to the Bank's SBA loan portfolio. The improvement in provision over the same quarter last year was primarily due to the continued reduction in the balance of our strategic program loans held for investment. We have discussed the repositioning of the strategic program HFI portfolio, which started roughly 18 months ago, and there was substantially no change to this strategy. During the quarter, net charge-offs were $2.2 million compared to $2.4 million in the second quarter and $3.1 million during the same quarter last year. The decrease compared to the prior quarter was primarily due to a large recovery in the SBA portfolio. The year-over-year decrease was primarily due to lower net charge-offs from strategic programs and a large recovery in the SBA portfolio. The company's net charge-off rate as a percentage of average loans held for investment was 2.8% compared to 3.4% in the second quarter and 5.8% during the same quarter last year. We believe we are well reserved for potential loan losses with an allowance as a percentage of total loans held for investment at 3.8% in the quarter compared to 4.2% last quarter and 5.6% in the same quarter last year. Our decision to retain most of the originated guaranteed portions in our SBA 7(a) loan program, has been the primary factor in the decrease in this ratio from the prior quarter and year. Non-performing loans for the quarter were $10.7 million compared to $1.8 million in the second quarter and none during the same quarter last year. Of the $10.7 million, $4.7 million is guaranteed by the SBA. This compares to $1.1 million in SBA-guaranteed NPL balances in the second quarter and none during the same quarter last year. The increase in NPLs compared to the prior quarter and year was primarily driven by increases in NPLs in our SBA portfolio. As we discussed in prior quarters, our SBA portfolio is comprised of variable rate loans, which adjusts on a calendar quarterly basis. And we had seen some informal and formal stress in this portfolio, resulting from the series of increases in the prime rate over the last 18 months. Consistent with our policies, we moved several loans to non-accrual status during the quarter. When an SBA loan is 90 days past due, or if management determines that the borrower is not expected to repay the principal and interest on the loan from operating cash flow, the loan becomes collateral-dependent is evaluated for charge-down or charge-off and any net balance is placed into non-accrual status. We believe we will continue to see some stress to the extent rates stay elevated and the consumer spending slowdown continues to affect a segment of our small business customers. While the increase in our non-accrual loan balances was expected, our gross charge-offs within the SBA portfolio during the quarter were slightly lower than each of the prior two quarters, and we would point to the additional miscellaneous income recognized from a previously reported non-accrual account as evidence of the expertise of our portfolio and collateral management teams and maximizing bank proceeds related to non-accrual balances. We feel confident in our team's experience managing this portfolio even as the rate environment may continue to stress a segment of our borrowers. Looking ahead, we expect NPLs to trend higher due to the rate increases and associated increases in borrower monthly payments, customary loan seasoning and the general impact of the persistent and ongoing macroeconomic headwinds. Overall, we believe we are well positioned to continue to manage growth and credit performance in our portfolio due to our experienced team, proven underwriting and portfolio management capabilities and significant capital and reserve levels. Now let me turn the call over to Javvis, who will provide more detail on our financial results.

Thank you, and good afternoon. I plan to discuss our financial results for the third quarter relative to the prior quarter and to the third quarter of the prior year. Loan originations totaled $1.1 billion for the third quarter compared to $1.2 billion in the second quarter and $1.5 billion in the prior year. As we expected and communicated last quarter, the decrease in originations relative to the previous quarter was due to a return to more typical origination volumes in our strategic programs from better-than-anticipated performance in the second quarter that was primarily driven by a single strategic platform that benefited from additional funding during the quarter. The decrease from the prior year was primarily due to a continued contraction in capital markets for certain loan assets due to the challenging macro environment and changes in underwriting in our strategic lending program to manage credit risk. Average loan balances comprising held for sale and held for investment loans were up 9.4% to $354.6 million during the quarter from $324.1 million last quarter and up 34.5% from $263.6 million in the prior year. The increase from the previous quarter and the prior year period was primarily driven by continued growth in our SBA 7(a) program. Despite industry-wide liquidity pressure, our balance sheet and liquidity position remained strong during the quarter. Average interest-bearing deposits were $255.8 million compared to $219.1 million in the second quarter and $104.8 million during the prior year period. The sequential quarter increase was driven primarily by an increase in brokered interest-bearing demand deposits and certificates of deposits. The year-over-year increase was due mainly to increases in certificates of deposit and interest-bearing demand deposits. As we have noted previously, non-interest-bearing deposit levels have historically had a high correlation with loan balances held for sale and origination volume from our strategic programs. Our differentiated business model has provided us with a stable and sticky deposit base. Specifically, the origination platforms have been contractually obligated to maintain certain levels of deposits with FinWise, while a significant portion of the uninsured deposits on the bank's balance sheet have been our own capital. Taken together, as of the end of the quarter, approximately 86% of the bank deposits are either insured our own capital or are contractually required in our strategic lending business. Now turning to the income statement. Net income for the quarter was $4.8 million compared to $4.6 million last quarter and $3.7 million in the same quarter last year. The improvement from the prior quarter was primarily due to an increase in net interest income, driven by growth in our loans held for investment portfolio. The increase from the prior year period was primarily due to an increase in net interest income and a decrease in the provision for credit losses, partially offset by higher non-interest expense, lower gain on sale of loans and lower strategic program fees. Net interest income for the quarter grew 5.4% to $14.4 million compared to $13.7 million last quarter and was up 15.1% over the $12.5 million in the same quarter last year. The improvement relative to the prior quarter and year was primarily due to increases in the bank's average balances on the loans held for investment portfolio, partially offset by an increase in the interest expense being paid and average interest-bearing liability balances over the same period. Net interest margin for the quarter was 37 basis points lower at 11.77%, compared to 12.14% last quarter and 316 basis points lower than 14.93% in the prior year period. The decrease from the prior quarter was mainly due to a loan mix shifted towards loans carrying lower yields in the held for investment portfolio and an increase in the volume of certificates of deposits. The decrease from the prior year period was primarily due to a reduction in average balances in our loans held for sale portfolio, along with a shift in our deposit portfolio mix from lower to higher cost in deposits, partially offset by an increase in average balances in our loans held for investment portfolio. Non-interest income was $5.2 million in the quarter compared to $5.3 million in the second quarter and $7.5 million in the same quarter last year. The decrease from the prior quarter was primarily due to the change in the fair value of our investment in BFG along with a decrease in the number of SBA 7(a) loans sold and was partially offset by an increase in other miscellaneous income, primarily related to a $0.6 million gain on the resolution of a forbearance agreement in our SBA lending program. The decrease from the prior year period was mainly due to a reduction in gain on sale of loans, primarily attributable to our increased retention of the guaranteed portion of SBA loans to increase interest income, which resulted in a corresponding decrease in gain on sale income. Lower fees associated with originations of strategic program loans and a decrease in the fair value of our investment in BFG also contributed to the decrease from the prior year period. We expect that the fair value of our investment in BFG will continue to experience quarterly fluctuations. Non-interest expense during the quarter was $10.1 million compared to $10 million in the prior quarter and $8.5 million in the same quarter last year. The increase from the prior quarter was primarily due to an impairment of our SBA servicing asset, partially offset by a reduction in professional services expense, primarily from a reduction in consulting fees. The increase from the prior year period was primarily due to an increase in salaries and employee benefits related to a higher number of employees, an impairment on our SBA servicing asset, which did not occur in the prior year period, and an increase in other operating expenses primarily related to occupancy and equipment expense and was partially offset by a decrease in professional service expense, primarily from a reduction in consulting fees. The company's efficiency ratio was 51.3% for the third quarter compared to 52.7% for the prior quarter and 42.3% for the prior year period. While the third quarter's efficiency ratio certainly benefited from the additional miscellaneous income related to our SBA loan portfolio, as we've noted in past calls, we expect the company's efficiency ratio to remain elevated as we continue to build out our infrastructure to position the company for sustainable long-term growth. With respect to capital levels, with a 22.1% leverage ratio, the bank remains significantly above the 9% well-capitalized requirement. As Kent mentioned, as part of our effort to be good stewards of capital, during the quarter, we bought 230,978 shares for $2.4 million, at a discount to book value and completed the share buyback program announced in August of 2022. We continue to deploy capital to grow our balance sheet responsibly, invest in our business for long-term growth opportunities and maintain flexibility for potential strategic and accretive transactions. The company's effective tax rate was 26.1% for the third and second quarters. This compares to 48.7% for the same quarter last year. With that, we would like to open up the call for Q&A. Operator?

Thank you. [Operator Instructions] Our first question is from Andrew Terrell with Stephens. Please proceed.

Hey, good afternoon.

Hello, Andrew.

Hey, Andrew.

Maybe just to start, I think I might have missed this in the prepared remarks, but the lift in the non-accruals this quarter are about $10 million. How much of that specifically was SBA? And then how much specifically is guaranteed versus non-guaranteed?

Hey, Andrew, this is Jim. So $10.4 million of the $10.7 million is attributable to the SBA portfolio, and then $4.7 million is guaranteed by SBA.

Got it. Okay. Thank you. I appreciate that. And then maybe Jim is sticking with you here. I heard the commentary about the card programs and the payments hub, sounds like rollout first half of 2024. Just wanted to get a sense of as you've kind of progressed and going down this path, just how the effort there is going? Any major roadblocks or kind of early successes you've experienced to date? And then it might be too early to talk about what you might expect for revenue contribution or targets you might be laying out there, but I would love to get any color you have on that point.

Yes, sure. So just like as a reminder, on the product initiatives and kind of why we feel that a comprehensive fast solution is important to the future of the bank. It allows for stickier relationships with our current programs. We can attract more mature programs generally, which means higher overall volumes for each product. It helps diversify revenue and our funding sources. And finally, we're still highly profitable even in the downturn and believe by reinvesting in our strengths now, we're building a leadership position in the market. And then as far as like the update on both the card sponsorship and the payments hub, like we said in the remarks, we'll be operational in the first half of 2024. With the first customers have seen thereafter in the second half of next year, a lot of the work that's occurred has been kind of expanding the third-party risk and program oversight policies and procedures. Scoping and bringing on new vendors through bank due diligence and then risk assessments commensurate with regulatory requirements. The early success is really are in the staffing additions. We've been the recipient of excellent staff additions here at the bank. I think just because of our reputation in the market because of our history in regulatory exams. So both business development, compliance, operations, change management and IT are all departments that have benefited from those additions. The last thing I would just touch on quickly, Andrew, is while cards and the payments hub are kind of the next phase of our growth, we've been working really hard to bring a couple of lending programs through due diligence and potentially launch these by year-end here. And so business development, compliance and operations teams have been heavily involved to launch a couple of new programs by the end of this year, and we still feel really good that we'll be able to accomplish that goal.

Yes, appreciate all the extra added color there. Jim, that's very helpful. Specifically on the point of adding the new partners think could potentially maybe benefit originations. Just wanted to get a sense of relative to kind of the base you have today for the partners that are in the pipeline right now that you're working to get through by year-end. Just how incremental you think that could be in terms of overall dollar of originations and maybe trying to marry that with some of the commentary. It sounds like originations could remain a little pressured throughout the balance of the year and into 2024, just given the backdrop.

Yes. So yes, like on the originations front, we did $1.1 billion this quarter versus $1.2 billion in Q2 and then roughly $900 million in Q1. This quarter was better than expected. We didn't think we'd see the Q2 origination levels again this year, but we were happy to see things rebound from the Q1 levels, which is still a low point. While most of the programs were stable quarter-over-quarter, that delta against Q1 was still from that single partner rather than a broader uptrend across all the programs. And so we continue to point to Q1 origination levels as the most appropriate for the next two to three quarters. As far as the incremental lift from new programs that potentially launched by year-end, you're more likely looking at a lift in the second half of next year from those programs. A lot of that has to do with just getting – even once they're launched in live, there's a scaling up period, there may be seasonality with the underlying program. So we feel pretty good about where we're at with those potential launches. But as far as incremental lift to the topline, it's probably the second half of next year.

Yes. Understood. Okay. And then maybe last one before I hop back in the queue. The loan growth this quarter, I know is SBA-driven. It was maybe a little bit stronger than what I was expecting for the quarter. Anything unusual about the just the production you saw and the opportunity you saw to bring high-quality paper onto the balance sheet within the SBA group? I mean can you just talk about what kind of targets you might have laid out over the next 12 months or so? I mean, your capital is incredibly robust. What kind of balance sheet growth rate targets are you contemplating over the next year?

Yes. So yes, I mean – so the two things. The pipeline to date has been stable, but I would also mention – we mentioned in the remarks some of the kind of front-end inquiries, I'd say, are a little bit more tempered than they were in previous quarters. So this quarter, we originated about $35 million, $36 million in SBA loans during the third quarter. It's about $24 million in Q2, $36 million in Q1 of this year. So the pipeline has been stable. But what I would point you to is it's possible you see SBA originations tick down a little bit over the next few quarters just because there's less confidence in the economy right now, and that generally leads to a swing in the CapEx cycle if you're a business owner, you're less confident, you're less likely to secure financing for expansion. So we still feel really good. But I would just – we're cautious, Andrew.

Yes, totally appreciate that point. And thanks for all the color and I'll step back in the queue.

[Operator Instructions] Okay, we do have a follow-up from Andrew. Andrew, please proceed.

Perfect. Okay. I've got a couple of more. I keep rolling through. On the capital side, just maybe following up on the last question here, your TCEs still definitely very strong at 27%. Can you remind us just the guardrail of where you like to manage that to over time and what you're comfortable with running the bank from a capital perspective? And then – also just any – I saw you completed the buyback this quarter. Obviously, a very advantageous price. Any thoughts on an incremental buyback in the coming quarters?

Sure. So let me just take the first stab and then Javvis, you can maybe answer some of the questions as well. The capital, just we're noting that each quarter, this year, the capital ratio has dropped as the balance sheet continues to grow. And so we can see a trajectory towards that. The question you asked about the buyback is a great question. And I would just say that we continually assess the best uses of the capital. We include additional buybacks as part of that. But we weigh that against other factors such as continued growth of the balance sheet, build out of the infrastructure, flexibility to take advantage of opportunities. And we want to make certain that we have sufficient capital to take us through the growth that we're thinking may come over the next little while. Of course, not certain of how easy it will be able to raise capital next year, what have you if the macroeconomic conditions don't improve. We also don't think it's a bad thing to have higher levels of capital in this current market. But I would say, once again, as we did last time, the Board takes into account all factors, market conditions, and if it is deemed the best option, yes, we would consider another buyback.

And Andrew, as far as the capital ratio, total TCE, what we've talked about in the past really hasn't changed somewhere in the mid to upper teens level for our business model feels right to us.

Got it. Okay. I appreciate it. And then, Javvis, on the expense side, it looks like if I pull the SBA servicing asset impairment aside, it looks like what I would deem kind of core expenses actually ticked down to maybe like a high $9 million range this quarter. Can you just talk about expectation on the operating expense side heading into the fourth quarter? And then just more broadly, how we should think about the cadence of expense growth into 2024, just given some of the reinvestments you guys are doing or making into the franchise? And just maybe netting that together with like the efficiency ratio. It's low 50% right now, would you expect it to creep up from here? Or do you think you can maintain in the low 50s territory?

Yes, Andrew, I think maybe the best place to start is just on the professional services line. You can see we've really come down quite a bit on that line of non-interest expense. This is primarily due, as we mentioned in the prepared remarks, the lack of consulting fees that we talked about a couple of quarters ago, would be coming off by the end of the second quarter. That was what we were expecting. So growth-wise, from here we believe that we're going to continue to build our infrastructure as we've talked about, the pace probably similar to what you've been seeing between the first, second and third quarter in the history as long as the conditions remain similar, we'll likely see that level of continued expense growth. As far as the efficiency ratio, I think you gave pretty good goalposts on the efficiency ratio. We expect to see better efficiency than generally seen in the market. But until we can start having the revenue come in from these new projects and endeavors then, you're going to see some pressure on the efficiency ratio.

Okay. So maybe thinking about it near-term, just modest lift in efficiency from here as you reinvest and then maybe we can step back and reassess as we start talking more about revenue from some of the initiatives?

That's right.

Okay. Great. Well, I appreciate all the time this afternoon.

No problem. Thanks, Andrew.

That will conclude the question-and-answer session. I would like to turn it back over to Kent for closing comments.

Yes. Thank you. And we appreciate everyone joining the call today. It's been a good quarter. We're very excited still about the initiatives that we're launching, we feel we're on track. We've got a great team. And so we really appreciate the support of our investors and look for good things to come.