FINW - NASDAQ

Good afternoon and thank you for joining us today for FinWise Bancorp's Second 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 continued its strong momentum in the second quarter, building on the positive results we achieved in the first quarter. Our performance this quarter was supported by continued growth in loan originations to nearly $1.2 billion, solid revenue, and stable credit quality. Importantly, our profitable results were achieved without any contribution from the recently announced new strategic programs and other initiatives, highlighting the strength and resiliency of our existing business. In addition to our solid quarterly performance, it's worth mentioning the significant progress we have made since our November 2021 IPO in strengthening and diversifying our business. Our compliance and risk management first culture has positioned FinWise as a strong competitor in the FinTech lending space. We've also enhanced our product offerings and improved our strategic program lending diversification as the percentage of originations from the top three FinTech programs has declined substantially in the past two years, leading to a more diversified revenue mix. Furthermore, our credit quality has performed relatively well, which is a testament to our rigorous underwriting and risk management practices and has led to a diversified and lower-risk loan portfolio. Turning to our Payments Hub initiative, we remain on track to become operational later this year, which should position us well for future growth and revenue diversification. Our capital position remains strong, with our bank leverage ratio significantly above well-capitalized regulatory requirements and the peer average. We also continue to execute on our share repurchase program announced last quarter, acquiring 44,608 shares for roughly $460,000 in the second quarter. Looking ahead, we remain confident in the strength of our business model and our ability to further expand and diversify our product offerings and revenue streams to enhance long-term growth. We will also continue our efforts to generate operating leverage in 2025 as the significant level of incremental investments we have made in the business to drive future growth start to decelerate. Overall, we remain firmly committed to executing our strategic goals to further enhance long-term value for our shareholders. With that, let me turn the call over to Jim Noon, our President.

Thank you, Kent. I will now provide a bit more detail on originations and credit quality, and then we'll provide an update on our business initiatives. As Kent mentioned, we're very pleased with another quarter of solid performance in the existing business. Importantly, these results do not include contribution from the recently announced strategic program agreements. We are also pleased with the level of originations we are seeing, and although the lending environment could change inter-quarter, through the first three weeks of July, originations are tracking at roughly the same rate as the second quarter of 2024. Our SBA 7A loan originations were modestly lower this quarter versus last quarter, and this is the result of a more cautious approach by small business borrowers, as widely expected during this period of elevated interest rates. While we were successful in continuing to grow our SBA portfolio, our newer products, including equipment leasing and owner-occupied commercial real estate loans, continued to gain traction and helped to diversify our origination mix during the quarter. Turning to our portfolio, we continued to retain substantially all the guaranteed portion of our SBA loans. On a sequential quarter basis, these guaranteed balances increased 4.3%, and were a primary driver of the 6% growth in total loans held for investment. As of the end of Q2, our SBA guaranteed balances and our strategic program loans held for sale, both of which carry lower credit risk, made up 44.6% of our total portfolio, including HFS loans. Moving to credit quality, we are pleased that our disciplined approach continued to serve us well. The provision for credit losses was $2.4 million in the second quarter, compared to $3.2 million in the first quarter. The change was driven by continued improvement in net charge-offs compared to the prior quarter. The bank's loss rate in our SBA portfolio has been more than 70% lower than that of the SBA 7A industry as a whole. This is based on loan performance data from the federal government for the period since the bank began its SBA program in 2014. The net charge-off rate as a percentage of average loans held for investment improved to 1.9% in the second quarter, from 3.5% in the first quarter. Importantly, our lowered net charge-offs are the result of the decisions we made and began implementing two years ago to purposefully reduce our SP-HFI balances in certain categories while simultaneously growing the overall portfolio with lower yielding and safer assets. We continue to feel comfortable with this positioning. NPL balances picked up modestly this quarter to $27.9 million versus $26 million in the prior quarter, which was driven by two new relatively small SBA accounts. Importantly, of the $27.9 million, $15.8 million is guaranteed by the federal government. Overall, this is in line with our prior commentary regarding the potential for sporadic additions to our NPL balances while we remain in a higher interest rate environment. We remain confident in our portfolio, and we are not currently seeing any broad-based negative trends. Our allowance for credit losses as a percentage of total loans held for investment remains stable at 3.2%. Our reserve position, the continued positive shift in credit mix, the strong collateral in our SBA loans, and our consistent and prudent underwriting standards have all contributed to our solid credit quality, particularly during macro uncertainties. Turning to an update on our business initiatives, we are happy to announce that we have delivered ahead of schedule on multiple fintech banking initiatives that we outlined late last year. These include our first payments program, the start of our credit enhanced balance sheet program, and now the launch of our first card product. As you may recall, our first payments program was announced with Hank Payments at the end of Q1, and we are excited that we have already started to gradually process incoming payments. This is a new source of lower cost deposits and fee income for FinWise. Additionally, during Q2, we announced a strategic relationship with Plannery, and with it, the start of our credit enhanced balance sheet program. As we mentioned in our first quarter earnings call, we have deepened our relationship with one of our existing strategic lending programs, Upstart, through a new auto loan product. And subsequent to quarter end, we also expanded our collaboration with another existing strategic program through the successful launch of our first card program. We have not yet formally announced this program as it is still in its piloting stage, but anticipate providing more details later this year. Finally, we remain on schedule to be operational with our payments hub later this year. All of these initiatives represent significant opportunities for FinWise to deepen relationships with FinTech programs, diversify our revenue, and improve our deposit costs. Now I'll turn the call over to our CFO, Bob Wahlman, to provide more detail on our financial results.

Good afternoon. Thank you, Jim. I'll now briefly review some key financial metrics and provide insight as appropriate. In the second quarter, we generated net income of $3.2 million, or $0.24 per diluted common share. Average loan balances comprising held for sale and held for investment loans were $449.9 million during the quarter compared to $429.8 million in the prior quarter. This increase was primarily driven by continued growth in our commercial lease programs, the SBA 7A program, and strategic program loans held for sale. Average interest bearing deposits were $318.9 million compared to $310.7 million in the prior quarter. The sequential quarter increase was driven primarily by an increase in broker time certificates of deposit. Moving to the income statement, net interest income for the quarter was $14.6 million compared to $14.0 million in the prior quarter, driven by increased volumes on loans held for sale and loans held for investment portfolios, partially offset by rate and volume increases on the bank's average balances of certificates of deposit. Net interest margin was 10.31% this quarter compared to 10.12% last quarter. The sequential quarter increase was due primarily to increased average balances of loans held for sale associated with partners with interest rates well above our average interest rate, partially offset by slightly lower average yield on our investment loan portfolio and an increase in our cost of funding the growing loan portfolio as competition for deposits continue. Non-interest income was $4.8 million in the quarter compared to $5.5 million in the prior quarter. The change from the prior quarter was due primarily to acceleration of servicing fee amortization due to increased payoffs in higher rate SBA loans. Positively, strategic program fees were up modestly compared to the prior quarter. Non-interest expense in the second quarter was $12.9 million compared to $11.8 million in the prior quarter. The sequential quarter change was primarily due to an increase in salaries and employee benefits and other operating expenses as we continue to build out of our business infrastructure to stand up the new initiatives and enhance our governance structure. We continue to expect the pace of growth in expenses to slow down in the second half of 2024 as we finish the build out of our new initiatives. Additionally, as we move into 2025, we also expect incremental head count related expenses to align more closely with increases in production. One other item I want to call out, we expect our fully diluted share count to increase modestly in Q3 due to deferred compensation awards that were made in mid-second quarter with some made at the tail end of the quarter. Finally, our effective tax rate was 23.9% for the second quarter compared to 26.5% in the prior quarter. The change from the prior quarter was due primarily to more favorable resolution of state tax matters than previously estimated. As of now, we expect the effective tax rate for the remaining two quarters of the year to be approximately at the level of the first quarter of 2024. With that, we would like to open the call for Q&A. Operator?

[Operator Instructions] Our first question is from Andrew Liesch with Piper Sandler. Please proceed.

Hey, guys. Good afternoon. The question here on the strategic program yield here, it sounds like a lot higher and it's looking at, on average, maybe 3 percentage points higher. Is this a shift in consumer demand that might continue here? Should this be a good, I guess, interest rate to use on an average basis for this product going forward?

So, if you take a look at the long-term trend, I'll answer this question. If you take a look at the long-term trend, NIM has been declining over time as we move to decrease our risk profile by expanding exposure and lower risk loans as we, -- such as the SBA portfolio. But it's not necessarily smooth and predictable path. But the long-term trend is, I think, the best indicator until something occurs to disrupt that plan. And, you know, what we saw on the second quarter appears to be a little bit unexpected behavior by two principal vendors that may be tied to, that looks like it is in part tied to the fact that charge-offs went down. So, the reversal of interest receivable is less because charge-offs were down.

Got it. Okay. That's helpful. So, really, the trend on the margin should be downward. It seems like a nice little benefit that you had in this quarter. Is that the right way to think about it?

Based upon the information we have available, that's the way I'm thinking about it. This is probably just an aberration because it's not a smooth path. Everything goes, you know, up and down, sometimes slower, sometimes faster.

Got it. And then on expenses, to back out the SBA servicing adjustment there, up about 10%. I know you've suggested that it's going to, the pace of increase is going to slow here in the back half. But is this a good run a good number to build off of going in there? Or do you think the expenses might be a bit lower here in the third quarter?

So, we don't provide official guidance. But I will provide a bit of insight on what we're thinking about the expense trends. I'm estimating that the growth in expenses in Q3 will run about half of what we experienced in the growth in Q2. And then Q4 will run about half of what we experienced in Q3. I do want to note that a significant portion of the increase that we experienced in Q3 and then the increase experienced in Q4 will be for the full quarter expense carry for new hires that we made in the prior quarter. And you'll see there are expense increases driven predominantly by increases in compensation expense.

Got you. Yes, I see that there. All right. Thanks for taking the questions here. I will step back.

Our next question is from Andrew Terrell with Stephens. Please proceed.

Hey, good afternoon. Maybe to start for me, it looks like, if I'm thinking about this right, the dwell times or hold times on the HFS loan portfolio moved up this quarter, so higher kind of average HFS loan balances. I know we discussed it a little bit last quarter, but is this kind of the right level of think about the HFS overall average balance? Or do you think there's still kind of tweaking you can do on hold times going forward so that we can actually see a lift in the average balance from here? Given a similar level of production.

Based upon our current clients and given our level of originations, I think that it's fair to say that this will be about the average run rate on those held for investments, I mean held of sale portfolio.

Okay, got it.

It'll be consistent.

Okay, very good. On the SBA loan servicing line item, I appreciate the color you guys kind of added there, but just how should we think about, I guess, like that normalized moving forward? Does it step back up to the kind of previous levels we had seen that line running at, call it $300,000, $400,000 a quarter?

So, what I'm seeing, this is the first period where we've had such a significant change or such behavior. At this point in time, I'm not anticipating that behavior to continue at the level that we saw here in the second quarter. I would expect to see that return to a more normalized positive net fees on that activity.

Understood. And then just broadly on fee income, I mean, it's really good to hear you guys kind of ahead of schedule in terms of some of the newer initiatives that we've spoken about for the past few quarters here. Curious on, you know, did that provide any contribution to the 2Q fee income amount? If so, is it a quantifiable amount? And then just how you're thinking about positive progression in terms of fee income recognition throughout the year?

In regards to the effect on the second quarter in these initiatives, pilots and the new initiatives as it relates to the credit enhanced program, the balance in the activities and those activities are, and those products and activities is low at this point in time, expected to build in the future, did not have a significant impact at all on the second quarter.

Yes. Okay. And I also wanted to ask just around, kind of the charge off level and kind of just more broadly what you're seeing from a credit standpoint. I mean, you guys have pretty intentionally taken risk out of the balance sheet by diversifying the loan growth for quite a while now, and it seems like it's manifesting itself within charge-offs. Just curious, like from your seed, did charge-offs come in abnormally low this quarter? Was there anything nuanced we should appreciate? And just more broadly, how are you thinking about charge-offs going forward?

Yes. Hey, Andrew, this is Jim. Basically, you hit everything in your statement, right, which is that, you know, those lower charge-offs this quarter, that's the result of decisions we made about two years ago. When we started purposefully reducing categories of that HFI portfolio and were simultaneously growing lower yielding and safer assets in the overall portfolio of the bank. And we continue to feel comfortable with that positioning. The general trend in NCOs has been, you know, downward and stable. But in this quarter, it was materially lower, quarter over quarter, and that's not a level that I would expect in the second half, specifically because SBA is a little chunkier, and you didn't see as much of that come through for that product in this quarter.

Right. Okay. And actually, just one more for me. I mean, this is the first quarter the strategic program HFI loans are up, I would call it modestly, quarter on quarter, but that kind of bucks a trend of we've seen them declining for the past couple of years now. Should we read into that at all as you're maybe a little more comfortable in holding specific pieces of credit? Does it have something to do with kind of some of the new partnership expansions you've talked about or just help us think about the kind of strategic program HFI balances specifically?

So that's exactly right. Like the couple programs that we had stopped retention with at this point, the numbers or the balances there are so low that, you know, as they continue to run off, you're not seeing material reductions in the overall balance of that HFI portfolio. And then the three active programs that we have, you know, continue to originate at very stable levels. So the overall balance in that HFI portfolio has basically now stabilized, right? You're not going to see much near term, either positive or negative changes there. None of the, so plenary was our, you know, first credit enhanced program, and none of the benefit of that program has come through in this quarter specifically.

Okay, understood. That's it for me. Thank you for taking the questions.

We do have some questions that we received via email. Juan, would you like to read those out for us?

Sure. We received three questions via email. The first one, can you clarify how many shares were repurchased in 2Q ‘24?

Yes. In the second quarter of ‘24, we bought 26,911 shares for a total of 44,608 shares, or roughly $460,000 through the second quarter.

Second question is, can you discuss the growth opportunities between your legacy business and the new initiatives?

Yes, sure. Our legacy business is more mature. It's differentiated, and we'll continue to offer a strong foundation for our future growth. But by adding the payments and cards business, we feel we're strengthening the synergies and diversification of the entire company. So we've invested a lot also in the compliance and regulatory oversight of that, so we think we're well positioned to further diversify the company.

And the last question is, can you discuss the appointment of a new Board member you recently announced?

Oh, sure. Yes, we're very excited to have Susan Ehrlich join our Board. We've always believed that a key component of effective governance is having a board with experience in the activities of the bank. So this was a natural for us as we enter in this next phase of our evolution. We felt it's important to have expertise in this area. And Susan brings specific FinTech lending and payments experience, as well as experience in growing businesses. So she, I think, really supports our philosophy of governance on the Board.