FINW - NASDAQ

Greetings, and welcome to the FinWise Bancorp First Quarter 2024 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Juan Arias, Corporate Development & Investor Relations. Thank you, sir. You may begin.

Good afternoon, and thank you for joining us today for FinWise Bancorp's First Quarter 2024 Earnings Conference Call. Earlier today, we filed our earnings release and posted it to our investor website at investors.finwisebancorp.com. Today's conference call is being recorded and webcast on the company's website, investors.finwisebancorp.com. On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ from those discussed today. Forward-looking statements represent management's current estimates, expectations and beliefs, and FinWise Bancorp assumes no obligation to update any forward-looking statements in the future. We encourage listeners to review the more detailed discussions related to these forward-looking statements contained in the company's earnings press release and filings with the Securities and Exchange Commission. Hosting the call today are Kent Landvatter, CEO; Jim Noone, President; and Bob Wahlman, CFO. With that, I will turn the call over to Kent.

Good afternoon, everyone. FinWise is off to a good start in 2024, with first quarter results that was supported by robust originations of nearly $1.1 billion and encouraging credit quality performance, evidenced by relatively flat net charge-offs and a modest drop in our NPL balances versus prior quarter. We also remain laser-focused on executing on our strategic initiatives and to date, everything is coming together according to plan. We announced new program agreements during the quarter and are in the process of expanding our product offerings with certain of our existing relationships. We have also deepened our executive bench. Importantly, the resiliency of our business model was demonstrated as we accomplished all of this while remaining profitable in a challenging macro backdrop for the past few quarters. Turning to capital. We ended the quarter with a bank leverage ratio significantly above well-capitalized regulatory guidelines and our tangible book value per common share once again grew, ending the quarter at $12.70. Furthermore, our strong capital position and consistent profitability recently allowed us to initiate a new share repurchase program to buy up to 5% of our outstanding shares while continuing to invest for additional growth. At our stock's current price relative to tangible book value, we believe a share buyback is a very accretive use of capital that benefits all shareholders. I'm also happy to welcome Bob Wahlman to the FinWise team. As you may recall, we recently announced Bob's appointment as our new CFO, and we are very excited to have him. He succeeds Javvis Jacobson, who will remain with the company in the role of Treasurer. Bob joins FinWise to help us execute on our next phase of growth, including the expansion of our fintech banking solution products. He has over 35 years of total experience in the banking industry, including most recently at a bank with credit and prepaid card businesses. He also brings nearly 20 years of experience as a Chief Financial Officer in both private and publicly listed bank holding companies. As we look ahead, we remain on track to deliver our goal to further diversify our business model, which will further enhance the company's long-term growth. We are also confident that our compliance-first culture, along with our strict onboarding process for new products and strategic relationships, provides us with a strong competitive edge and increases the moat around our fintech banking offerings. With that, let me turn the call over to Jim Noone, our President.

Thank you, Kent. I will now provide a bit more detail on originations, credit quality and then discuss some updates on our business initiatives. As Kent mentioned, we are very pleased with another quarter of strong originations of nearly $1.1 billion. Additionally, during the quarter, originations were more evenly distributed amongst our partners and did not include any volume from the program agreements we announced in recent months. While the macro and capital markets environment could change, we are optimistic about the outlook for originations. Through the first 4 weeks of April, originations are tracking at roughly the same rate as the first quarter of 2024. Importantly, the new programs we have recently announced are not expected to start contributing materially to originations until later this year as there is typically a lag of several quarters between when agreements are signed and when we start to see new volume. There is also a lag as the volume moves through the piloting stage before becoming more substantial. Our SBA 7(a) loan originations during the first quarter were lower on a sequential quarter basis, primarily due to reduced application demand for the types of transactions we generally finance as well as our continued adherence to disciplined underwriting. We expect this lower SBA origination environment to continue in the near term as rates remain elevated and small business owners remain cautious. However, the decrease in SBA originations has been partially offset by early success with some of our newer products, including equipment leasing and owner-occupied commercial real estate loans. Moving to our portfolio. We continued to retain the guaranteed portion of our SBA loans. On a sequential quarter basis, the 7.6% increase in guaranteed balances of our SBA loans was the primary driver of the 5% growth in total loans held for investment. Turning to credit quality. The provision for credit losses was $3.2 million in the first quarter compared to $3.3 million in the prior quarter. The provision for the current quarter was driven primarily by relatively flat net charge-offs as compared to the prior quarter and a drop in NPL balances to $26 million from $27.1 million in the prior quarter. The net charge-off rate as a percentage of average loans held for investment declined to 3.5% in the first quarter from 3.8% in the prior quarter. Our strict collateral policies in our SBA portfolio continue to help mitigate net charge-offs and overall credit risk. And currently, we are not seeing any broad-based negative trends within our portfolio. That said, we could see sporadic increases in NPL balances while rates remain elevated. We continue to be well reserved for potential losses with a 3.2% allowance as a percentage of total loans held for investment, particularly given the positive credit mix shift in the portfolio, which we have been managing too over the last 2 years. Specifically, SBA guaranteed and strategic program loans held for sale, both of which carry lower credit risk, made up nearly 44% of our total portfolio. Our strategic program HFI balances were down slightly quarter-over-quarter and almost all of our commercial real estate loan exposure is specific to owner-occupied properties. Overall, while one quarter does not make a trend, we are encouraged by our credit quality performance this quarter. In terms of new partnerships, we are pleased with the meaningful progress we have made so far in 2024, which highlights our intense focus to expand and diversify our lending and payment programs. We have announced new partnerships with Hank Payments and Earnest and are in final stages with another potential new partner. We are also in the process of expanding our relationship with one of our existing lending partners and expect to provide you with more detail on this over the next few weeks. To give you a bit more detail on the new agreements we announced during the first quarter. The Hank relationship gradually moves FinWise into payment processing and helps us expand and diversify sources of recurring fee revenue. Importantly, we also expect it to help diversify our deposit composition and over time, similar relationships will support the goal of reducing our cost of funds through relationship banking. We also remain excited about the mutual growth opportunities from our announced partnership with Earnest, which supports their growing portfolio of private student loan products. Finally, we are very pleased with the continued progress we have made in our payments hub and BIN Sponsorship platforms and remain on track to being operational later this year. We look forward to providing details to help you understand the financial aspects of these opportunities as we move through the year. Now let me turn the call over to our CFO, Bob Wahlman, to provide more detail on our financial results.

Thank you, Jim. Good afternoon, everyone, and thank you, Kent, and the entire FinWise team for the warm welcome I have received. I'm excited to join FinWise at this pivotal moment in the company's growth plans, and I look forward to working with you all as we achieve our corporate objectives. I will briefly review some key financial metrics and provide insight as appropriate. In the first quarter, we generated net income of $3.3 million or $0.25 per diluted common share. We also posted solid profitability, with a return on average assets of 2.2% and a return on average equity of 8.4%. Average loan balances, including both held for sale and held for investment loans, were $429.8 million during the quarter compared to $396.2 million in the prior quarter. This increase was primarily driven by continued growth in our SBA 7(a) and commercial lease programs. Average interest-bearing deposits were $310.7 million compared to $303.4 million in the prior quarter. The sequential quarter increase was driven primarily by an increase in demand deposits and brokered CDs. Now turning to the income statement. Net interest income for the quarter was $14 million compared to last quarter's $14.4 million. Net interest margin was 10.12% this quarter compared to 10.61% last quarter. This decline was mainly due to our strategy to use our balance sheet in a lower risk manner through a pilot product offering, where we provided an extended held for sale option for an established fintech, but the rates we earn on these loans are lower. This action positively impacted gross interest income through higher loan balances, but negatively impacted the net interest margin. We are very excited about this strategy. It is in line with what we have communicated in the past to find ways to utilize our balance sheet in a manner that increases earnings without introducing outsized credit risk. Other items that partially drove the net interest margin decline this quarter were continued loan mix shift towards lower risk loans carrying lower yields in both the held for investment and the held for sale portfolios as well as the impact of nonperforming loan balances. Noninterest income was $5.5 million in the quarter compared to $6 million in the prior quarter. The change from the prior quarter was due primarily to slightly lower strategic program fees as well as a decrease in the fair value of the company's investment in Business Funding Group, LLC, or BFG. Noninterest expense in the first quarter was $11.8 million, up modestly from $11.4 million in the prior quarter. The sequential quarter change was primarily due to slightly higher salary and employee benefits and other operating expenses due to additional investments in our strategic initiatives and the supporting business infrastructure. Within the professional services expense category, roughly $200,000 will not recur on a go-forward basis. Although we don't provide formal guidance, let me give you a bit of perspective on expenses for the remainder of 2024. We expect a material pickup in expenses in Q2 over Q1, followed by a decelerating rate of growth in expenses in the second half of the year as we finish the build-out of our new initiatives and of the bank infrastructure to appropriately support our business. Also by the end of the year and going forward, we expect incremental head count-related expenses to be more correlated to production increases. Finally, our effective tax rate was 26.5% for Q1 compared to 28.5% in the prior quarter. As of now, we expect Q1's effective tax rate to be a reasonable assumption for the remaining quarters of 2024. With that, we would like to open the call for the Q&A. Operator?

[Operator Instructions] Our first question comes from the line of Andrew Liesch with Piper Sandler.

Just a question on this latest announcement today on the extended held for sale option for this fintech. How much of the balance in held for sale loans did this generate? And I guess what's the outlook going forward? How large could this be from one quarter to the next in production?

Sure. So in the last few quarters, as you know, we've talked about using our balance sheet to prudently drive lower risk asset growth and interest income. And this is one of the things we were thinking of, basically provided an extended held for sale option for an established fintech. As Bob said, the rates we earn are lower, but so is the risk. And I just want to be clear, this is not a warehouse line, rather we are holding the originated loans for a longer period. So it does compress NIM some from our historical levels, but we believe it provides higher interest income on lower risk balances. And so we're excited about the incremental growth that these kind of pilots can do for us. But I do want to underscore that it is a pilot. This specific program will drive some incremental pressure to the overall NIM in Q2, then its impact starts to become muted after Q2 because the balances in the program stabilize to our pilot levels. So what we -- we really don't disclose the amount of balances on this because they are sensitive to the partner itself, but specific to the partner itself. But we do say that probably -- well, a large part of the NIM compression is from this strategy. If it works out, we'll extend it further.

Got it. All right. That's really helpful. So you think -- I mean bringing on more growth -- I mean -- and more production would be the second half of the year where we can see net interest income start to rise following some more pressure here this quarter. Just with the production you're hearing -- you're seeing from other products, do you think we've now seen a stabilization or maybe a floor in net interest income that you can see it grow from here? Or is this $14 million number decent here for the second quarter?

This brings in a couple of different things. It also brings in expenses. So from a revenue perspective, I think that we'll continue to see -- our expectation is that as the balances increase, our total net interest income dollar amount will continue to increase. On the expense side, as it relates to expenses, we anticipate that, as noted, I used the word material, but we would anticipate additional expenses somewhat in line with what we experienced during the first quarter in terms of growth.

Got it. Similar increase than the first quarter and then trailing off in the second half of the year.

Yes.

Our next question comes from the line of Andrew Terrell with Stephens.

Bob, if I could just go back and maybe square some of that expense commentary really quick. For 2Q expenses, you would expect a similar lift is what we saw in the first quarter relative to 4Q. Was that the right way to think about it?

Yes.

Okay. Got it. And then maybe just a bigger picture question. It feels like we've seen maybe a pickup in the amount of kind of regulatory or consent orders for BaaS banks over the past kind of 6 -- 3, 6 months. I guess more of a two-pronged question for me. I guess, one, have any of these announcements changed how you guys view the regulatory landscape of BaaS or changed specifically how you're investing from a regulatory perspective on a go-forward basis? And then question, two, have you seen this translate to incremental pipeline for new fintech partners that could be kind of a source of either balance sheet or fee income growth for FinWise moving forward?

Yes. Those are great questions. First off, we don't currently see anything on the horizon that would negatively impact us or slow down any of our initiatives. But that being said, you're spot on, Andrew. We feel that the pipeline that we have right now looks stronger and more robust. And I think that maybe some fallout from some of the fintechs out in the space looking for banks that do it well, and we feel we're one of those banks. Just we've always thought that we have ultimate responsibility for these products. And so this perspective, I think, is what's driving our investments in people and compliance and infrastructure for years, which is keeping us square with the fintechs and the regulators.

Great. I appreciate it, Kent. If I could go back to some of the maybe commentary around SBA that you guys put less on the balance sheet, sold a bit less this quarter. It sounds like the expectation is for kind of similarly lower levels on the SBA front. But I wanted to go back to the commentary on some of the leasing business and commercial real estate. I guess on a go-forward basis, at least in kind of the short run, should we expect that CRE and then the leasing business drive more proportion-wise of the incremental loan growth moving forward?

Andrew, this is Jim. I would say if you're talking about kind of like near-term modeling, I would say, looking at the trend over the course of the last year, I'm not sure I would point to one quarter in particular as a reversal of kind of a, call it, like a 1-year trend. And if you're putting in an order of priority, I would be looking at SBA loans and the guaranteed portion being the primary driver of loan portfolio growth followed by capital leases, followed by owner-occupied commercial real estate lending.

Got it. Okay. Can you maybe compare and contrast the yields across those 3 different buckets that you're getting for incremental originations right now?

Yes. So generally, I think we've talked before about in the SBA portfolio, kind of across the board, you're looking at prime plus 250, prime plus 225, somewhere in that neighborhood. On the capital leases -- or I'm sorry, the equipment leases and owner occupied commercial real estate is going to be lower than that. Generally, the difference is also in the repricing. You guys are familiar with the calendar quarterly repricing that happens based on the underlying prime rate in the SBA portfolio. In the equipment leasing and owner-occupied commercial real estate, first, it's a lower overall yield, but it is a 5-year fixed rate typically.

Yes. Okay. Understood. Okay. That's it for me. I appreciate the questions this afternoon.

At this time, we have no further questions over the phone. I'd like to turn the line back over to Juan Arias.

Thank you, operator. We do have a couple of questions that came in via e-mail, as we now allow shareholders to do that. The first question is on the buyback. Why did you do a buyback? And are you still able to invest for growth?

Yes. Considering the current stock price relative to our tangible book value, we think it's an accretive decision for shareholders. Importantly, it doesn't impede our growth prospects. And so we think it's the right thing to do.

And the other question is on expenses. In terms of your outlook for expenses for the rest of 2024, can you provide a breakout of expenses by salaries and benefits and other?

Certainly, as we mentioned, we still have some nonproduction-related hires that we're expecting to make this year. So it's fair to assume that the biggest component of the expense pickup will be in the salaries and expenses category. In the other expenses category, which captures most everything else, it's fair to assume that we'll be relatively constant to first quarter 2024 or maybe only a slight increase throughout the year. Most of our expense growth will be in that compensation line.

We have no further questions. Thank you.