FINW - NASDAQ

Greetings, and welcome to the FinWise Bancorp Second Quarter 2025 Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce Juan Arias, Head of Corporate Development and IR. Please go ahead.

Good afternoon, and thank you for joining us today for FinWise Bancorp's Second Quarter 2025 Earnings Conference Call. Earlier today, we filed our earnings release and investor deck and posted them 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, Chairman and CEO; Jim Noon, Bank CEO; and Rob Wahlman, CFO. Kent, please go ahead.

Good afternoon, everyone. We continue to successfully execute our business strategy and built solid momentum into the second quarter. We delivered strong loan originations, maintained solid revenue and remain disciplined on expense management, all of which contributed to growing profitability. Tangible book per share also continued to increase, ending the quarter at $13.51 versus $13.42 in the prior quarter. Additionally, we are proud that our publicly traded stock was recently added to the U.S. Small Cap Russell 2000 Index. We are also encouraged by the early traction of our new products and remain highly confident that the infrastructure investments we have made over the past 2 years will support strong long-term growth at FinWise by steadily enhancing both the asset and liability side of our balance sheet. Looking ahead, we continue to look for growth to progress gradually through 2025 and throughout 2026, driven mainly by our credit enhanced product, originations from existing SP programs and incremental growth from programs that were signed late in 2024 and early in 2025. We are also optimistic about SBA lending as the overall environment remains stable, and we continue to see healthy demand from qualified applicants. Furthermore, as our overall portfolio grows, we are also evaluating a measured increase in dollar balances of higher-yielding loans within the limits that have been in place since 2018. That said, exposure to these loans will remain modest in relation to the overall loan portfolio as our policy restricts these to less than 10% of the portfolio. As we look further ahead to 2026, we're also excited about the potential benefits our BIN and payment products are poised to deliver, particularly the opportunity to enhance profitability by gradually shifting our deposit mix away from higher cost CDs and reducing the cost of funds. While we expect these benefits to ramp gradually with more material impact in the latter part of 2026, we believe they offer meaningful earnings leverage over time and are important differentiated offerings in a bank sponsorship ecosystem that continues to mature. Overall, -- as the various elements of our strategy continue to come together over the next 12 to 18 months, we believe 2027 could begin to reflect the growth benefits of our broader banking and payments offering following the significant infrastructure investments made over the last 2 years. While multiple variables can impact this outlook, including target capital levels and the pace of our balance sheet growth, in this scenario, we see potential for our return on average equity to start rebounding back into the low to mid-teens range initially, along with a return on average assets that exceeds 2%. Over the long term, there could also be opportunities to enhance our operating leverage by integrating artificial intelligence into the key parts of our operations. Lastly, while we remain committed to balancing short-term performance with long-term strategy, we measure our progress by the strength of the longer-term growth trajectory we have established, which we believe benefits the company and our shareholders. With that, let me turn the call over to Jim Noone, our bank CEO.

Thank you, Ken. The strong second quarter results were driven by the progress we continue to make towards our long-term goals, along with the continued upward trend in origination volume, totaling $1.5 billion in Q2, which is a 17% increase quarter-over-quarter and a 27% increase from the same quarter last year. Key drivers of the continued ramp in originations quarter-over-quarter were strategic programs we announced late in 2024 and a seasonal rebound from our higher-yielding partners. Key drivers of the 27% increase from the same quarter last year with the new programs mentioned as well as new products with existing programs and continued maturity of the programs we launched in '22 and '23. Our origination numbers in the quarter also include the expected seasonal deceleration from our student lending programs, which we expect will reverse in the third quarter, in line with academic calendars. Although demand trends and macro conditions could change intra-quarter through the first 4 weeks of July 2025, loan originations are tracking at a quarterly rate of approximately $1.5 billion. The second quarter results also reflect the first material funding for our credit enhanced balance sheet program outside of some piloting we have been doing. The funding started in the last week of the second quarter, and this brought our credit enhanced balances to $12 million at the end of the second quarter. We continue to have strong demand for this product, and we are working to get more programs live with this in the next 2 quarters. We expect credit enhanced assets to reach $50 million to $100 million by the end of the fourth quarter this year, consistent with our prior guidance, and we are well positioned for this to be a core generator of interest income growth for us in the coming years. Quarterly SBA 7(a) loan originations increased 24% quarter-over-quarter and are up over 140% from the same quarter last year. The quarter-over-quarter change is primarily the result of a return to normal loan sizes from the aberration that we mentioned in Q1 and the growth from the same quarter last year is from an increase in both units and loan size as small business confidence has rebounded. We also continue to see demand in equipment leasing and owner-occupied commercial real estate products, both of which remain key contributors to portfolio growth. During the quarter, we continued to sell guaranteed portions of our SBA loans at a slightly faster clip because market premiums remain favorable and because we've seen a step-up in qualified loan demand. Our near-term plans for selling SBA loans will remain tied to market conditions and the origination levels for the product. Our SBA guaranteed balances and our strategic program loans held for sale, both of which carry lower credit risk, in aggregate made up 43% of our total portfolio at the end of Q2. Moving to credit quality. The provision for credit losses was $4.7 million in Q2 compared to $3.3 million in the prior quarter. Of the $4.7 million, $2.3 million is attributable to growth of credit enhanced balances in the quarter. As a reminder, the provision for credit losses associated with the credit-enhanced loan portfolio is fully offset by recognition of future insurance recoveries of a like amount in noninterest income. Quarterly net charge-offs were $2.8 million this quarter versus $2.2 million in the prior quarter. On our prior call, we provided guidance that up to $12 million in balances could migrate to NPA during Q2. The Q2 actual NPA balances increased by $9.9 million to $39.7 million. Of the $39.7 million in total balances, $21.2 million or 53% is guaranteed by the federal government and $18.6 million is unguaranteed. For Q3, there could be up to $12 million of loans that could migrate to NPA. Most of these past due balances relate to variable rate SBA loans that were originally underwritten when rates were much lower and consumer stimulus was flush. As these loans continue to season, we expect moderation to occur in NPA migration, though it will always be lumpy. We are very encouraged by the momentum in our business, and we expect to continue the steady progress. While the growth trajectory may not be linear, we are excited about the platform we are building and the long-term potential of the bank. The strategic investments we made during the low point in originations 2 years ago are beginning to yield results. And with continued strong execution, we expect to realize meaningful benefits over the next 2 years. I will now turn the call over to our CFO, Rob Wahlman, to provide more detail on our financial results.

Thanks, Jim, and good afternoon, everyone. For the second quarter, we reported net income of $4.1 million or $0.29 per diluted common share. Key items that drove results were strong originations, a pickup in net interest income due to higher average loan balances in both our held-for-investment and held-for-sale loan portfolios, solid fee income and well-contained expense growth. Also in the second quarter, certain of our financial metrics began to reflect the accounting treatment from the growing balances of our credit enhanced portfolio as we had previously communicated would happen, and I will highlight these impacts where appropriate. Average loan balances, including held for sale and held for investment loans totaled $634 million for the quarter compared to $565 million in the prior quarter. This increase included growth from credit enhanced commercial leases, owner-occupied commercial real estate and consumer loan programs. Average interest-bearing deposits were $494 million compared to $430 million in the prior quarter. The sequential quarter increase was driven primarily by an increase in brokered time certificates of deposits. Net interest income was $14.7 million versus the prior quarter's $14.3 million, primarily due to an increase in average balances in the held for investment and held-for-sale loan portfolios, partially offset by accrued interest reversal of nearly $600,000 on loans migrating to nonaccrual and higher average loan balances in brokered CD deposits. Net interest margin was 7.81% compared to 8.27% in the prior quarter, driven primarily by the previously mentioned accrued interest reversals as well as further additions of higher quality but lower-yielding loans as we continue to diversify the loan portfolio. The impact on net interest margin from the higher credit enhanced balances was relatively small this quarter as balances just began to build in the last week of the quarter. That said, as these balances are expected to increase in the coming quarters, it's worth noting that net interest income and net interest margin net of credit enhancement expense are non-GAAP measures that include the impact of credit enhancement expenses on net interest income and net interest margin, the most directly comparable GAAP measures. As we've noted on prior calls, while our focus is on growing net interest income, we continue to expect the net interest margin to decline gradually over time due to our risk reduction strategy, while the volumes of earning assets increases. However, the downward progression in margin could decelerate in future periods if we decrease the rate of balance sheet asset diversification or we have stronger origination volume from higher-yielding held-for-sale loans or both. Conversely, our margin could see a further gradual decline if we fund large amounts of lower risk and lower-yielding loans such as the credit-enhanced assets. Fee income was $10.3 million in the quarter compared to $7.8 million in the prior quarter. The sequential quarter increase was primarily driven by an increase in credit enhancement income, strategic program fees and gain on sale of loans. As noted earlier, credit enhancement income mirrors the provision for credit losses on credit enhanced loans, an increase due to the higher credit enhanced loan balances outstanding at the end of the second quarter. Noninterest expense in the quarter was $14.9 million compared to $14.3 million in the prior quarter. The modest increase was primarily due to increases in salaries and employee benefits due to annual performance reviews, incentive estimates and deferred compensation programs. Our reported efficiency ratio was 59.5% versus 64.8% in the prior quarter. Adjusting for credit enhancement-related accounting gross-ups to noninterest income and noninterest expense, a non-GAAP measure, the efficiency ratio was 65.1% for 2Q '25 or flat versus the prior quarter. We remain focused on driving sustainable positive operating leverage with a long-term goal of steadily lowering our efficiency ratio. Important to achieving these goals, incremental headcount increases will continue to be driven primarily by higher revenue production. Our effective tax rate was 24.5% for the quarter compared to 28.1% in the prior quarter. The decrease from the prior quarter was due primarily to the change in estimated disallowed compensation expense relative to full year net income expectations. While multiple factors may influence the actual tax rate, we currently expect it to be around 27% for 2025. With that, we would like to open the call for Q&A. Operator?

[Operator Instructions] First question comes from Brett Rabatin with Hovde Group.

I wanted to start with the credit enhanced income from here. And just given the balances that you expect of $50 million to $100 million by the fourth quarter, the related revenues in 2Q were a little higher than I would have expected. Can you maybe talk about the relationship between the fees and the balances as we get later into the year?

Certainly, certainly, Brett, and good to hear from you. The -- on the credit enhanced balance sheet, the main fee that you see is this credit enhanced income is what I assume that you're taking a look at, which looks big this period. And what that relates to is the -- it is the dollar-for-dollar offset for the provision for credit losses related to the credit enhanced portfolio. So as the balances increase, you will see, again, this large -- this fee income because of what will happen to credit enhance -- what will happen to the allowance for credit losses. And we have to -- according to the accounting guidance, we need to reserve for these loans as if they were part of our regular portfolio. And so we have the same methodology, apply the same rigor as we do with the rest of our CECL portfolio, and then we calculate that reserve. And so that fee will be a reflection of that balance. So as that balance increases, you're going to see that fee go up. Likewise, I should say the other fee that you will -- not another fee, but the other interesting thing that you'll see in the financials is this credit enhancement expense. And what that relates to is it is the amount that we are passing through to the -- on an accrual basis to the counterparty, and it shows up as an expense item. And it's a reflection of the excess, call it, the excess spread that is retained -- that is passed on to the fintech.

Okay. Yes, that's all straightforward, I think, and what I was hoping for from an explanation perspective. So I appreciate that. And then just on the funding costs from here, obviously, a little pickup linked quarter. I was just curious with the continued strong loan growth and the production, what you're planning on doing to fund the growth from here? And if basically the cost of funds is bottomed out and might increase a little bit.

So at this point, long term, there's a short-term answer and a long-term answer to this question. The short-term answer is that we are dependent upon wholesale funding, principally certificates of deposits. And since we are dealing with a lot of variable rate portfolio, we're trying to keep the duration on that short to about 1-year CDs. So as the market moves, that's going to hit our cost of funds. Longer term, we are working diligently to bring some of the payments business into our -- into the bank. A lot of the payments business will be a source of lower cost deposits that will be more floating rate deposits as well as noninterest-bearing deposits. So short-term answer, long-term answer. I hope that's helpful, Brett.

Yes. Yes, that's really helpful. And then if I can just ask one last one around net charge-offs. This quarter, the strategic plan or strategic platform were a little lower, but some of the other categories were a little higher this quarter. And just wanted to make sure I wasn't missing anything in terms of trend migration outside of the strategic programs.

Yes. Brad, you're not missing anything there. The NCOs moved up in the quarter from 2.2% to 2.8%. And the quarter-over-quarter difference is really just some SBA charge-offs that came through in the quarter. But this level is in line with our comments. The way we typically look at it is if you look at the kind of LTM quarterly over the last 2 years, you'll see generally, it's right around the $2.8 million level in aggregate. Last quarter, we had mentioned $3.3 million in NCOs was a good number for modeling. We continue to think that's the case just because it's in line with our expectations from when we derisked the portfolio a little over 2 years ago. But there's no like trend there.

Next question, Joe Yanchunis with Raymond James.

So I wanted to start kind of high level here. So Ken, you touched on a bit in your prepared remarks. I was hoping you could dive a little bit deeper. So 2 themes playing out across the broader market have been AI and stables. So as a tech-enabled bank that recently rolled out a new payments platform, I'm curious to hear your thoughts on how you expect these trends will impact the broader banking industry over the intermediate term? And then if you have a strategy on how you'll engage with these trends.

Yes, that's great. So we really welcome the clarity that the Genius Act provides. One of the primary, I think, inhibitors for people to get started in the stablecoin was the lack of regulation and the perceived protections and so forth that regulated banks have. And so the clarity that's provided by the Genius Act is something that we very much welcome. Now stablecoins for us specifically are not a near-term initiative, though we're looking into various potential opportunities. Of course, since one of FinWise's key products is settlements, we think of stablecoin and that in that context. But what we're really watching for is a strong domestic use case. We see cross-border use cases as low-hanging fruit. And there are some other strong use cases as well. Business-to-business seems to look good. But what we're trying to see is how to prioritize our efforts here. And I think seeing the strong domestic use case is one of the triggers for us since we don't right now engage in cross-border. Does that help?

Yes, that helps. And then how about on the AI trends? -- and how you think that could improve the efficiency of the bank?

Yes, that's a great question. We look at AI a little differently. A lot of banks look at it for customer acquisition and cross-selling and that type of thing. What we really use AI for in -- first, we use it in our IT development, but we also think of that in fraud -- think of it in fraud protection. So through our payment rails and through our lending programs and so forth, we have the AI built in for fraud detection. And then finally, some of the opportunities that we think about would be opportunities to make it more efficient within. I mentioned in my prepared remarks, looking at key operational functions. For example, when you're bringing a fintech partner on, there's a lot of work that goes into analysing the policies, comparing those to federal regulation and the bank's policy. And AI seems to be something that could facilitate the comparison of those documents and identifying any gaps fairly quickly. There are some other things too as well, the complaint management and so forth. So most of our AI would be back office focused.

Perfect. I appreciate that answer. And I also want to dive a little bit into your credit enhanced loans this quarter. And I apologize if I missed this in the materials, but what was your average credit enhanced loan balance in the quarter? And kind of piggybacking off that, if you added a little over $10 million in credit enhance ending loan balances and reserve a little over $2 million, should we expect that 20% to 25% kind of provision ratio should kind of hold as we move forward throughout the year?

Yes. Joe, this is Jim. So just generally, so if you look at the balances on the credit enhanced product at the end of Q1, it's about $2 million or so at the end of Q2, it was about $12 million. So from an average balance standpoint, a midpoint there, but most of that incremental $10 million came on in the last week of the quarter. So it's very -- it's going to be a much lower number. It's going to be closer to like the $2.5 million because most of that incremental balance came on in the last week of Q2. As far as the provision and the reserve there, so we reserve for those programs just like we do for any of our fintech programs, which is use of the high watermark. And then there's a qualitative overlay. Every program is going to be different, and it's going to be based on the loan tapes and the loss rates, the monthly cohort loss rates that we've seen for each of those programs. So you can't extrapolate out for one program, what that provision will look like as additional programs come in.

All right. Understood there. And then kind of last one for me here. In relation to your partners, can you provide us an update with the health of your partners? And separately, what does your current partner pipeline look like today?

Yes, sure. As far as the health of the partners, I would say it's really outstanding at this point. If you just look at origination levels, we had pretty solid growth across the board. Really, that's come from -- those origination numbers have come from kind of 3 components. The first is a lot of the change came from recently announced programs that were ramping up out of their piloting stages earlier in the year. Second, just generally, and I think this answers your question more specifically, consumer loan demand is just up. So almost all of our nonstudent lending programs grew materially in the quarter. And then the third component as far as just origination levels was we did have the expected rebound in the second quarter on the higher-yielding partners. So again, just across the board, partners are healthy, loan demand is healthy. And as a result, originations are up.

Yes. And you asked about pipeline.

Yes. Yes. the partners in there and how that compares to the current partners that you work with?

Yes. The pipeline is really good. If we just step back here for a second and kind of split it between pipeline and then kind of like where the current impact is coming from. We launched 4 new programs in '24, and you're starting to see that impact come through now. As far as '25 guidance for new partners, we point to our target, which has been 2 to 3 new lending partners every year is the right number for modeling for us. And then those programs typically begin contributing a couple of quarters after we announce them. So we've announced -- we announced the one new partner in May with Bakkt, and they're just starting to ramp up here. And then -- so our target would be for another 1 to 2 lending partners before year-end, and we look good there.

Next question, Andrew Terrell with Stephens.

I just want to ask around the SP held for investment, specifically credit enhanced. You added $10 million in the last week or so of the quarter. You're targeting $50 million to $100 million still by end of year. The kind of math on that suggests that you could add a lot more than $50 million to $100 million. I guess, can you help us think -- are you guys just trying to kind of manage to a certain figure and kind of slow play the kind of pace of credit enhanced additions? Or just how should we -- are you just, I guess, trying to be conservative? How should we think about that?

Yes. So as far as like the production year-to-date, Andrew, like we're a little ahead of schedule as far as kind of internal gating items and dates. The product has really strong demand. And we knew the growth in balances was all going to occur in the second half of the year. I think you guys have all kind of modeled it that way. And we knew it would really ramp up into the fourth quarter. So we're happy that a little bit of growth came through right at the end of this quarter. And kind of where we're at is we're live with 3 programs so far. We have a fourth program going live with that today. And so we've got 4 partners live and filling balances and should have a fifth by the end of the year. And so that $50 million to $100 million target is still what we would point to as a good end of year level for modeling purposes.

Perfect. Okay. And then another one just on the average held-for-sale balances up quite a bit this quarter. I know you guys at one point, we were talking about extending some of the hold times. So I guess the question is kind of is this a fair level of average held-for-sale loans to contemplate? Or is there any material fluctuation we should be considering?

So the -- I mean, you're spot on in that the increase in that balance really relates to the extended held-for-sale program, and it filled up largely during the first month of the quarter. So the average balance, I think, is a fair representation of what we should expect on a going forward basis, maybe just a tick or 2 higher.

Okay. Awesome. I appreciate it. And then, Ken, in your prepared remarks, you mentioned just the payoff from payments and BI contributing more heavily in the back half of 2026. And you talked about some financial targets in 2027, exceeding a 2% ROA, and I think it was a low teens ROE. But if I look this quarter, you did a 2% ROA. And I think if I were to normalize your capital to kind of the lower end of where you generally target leverage at, it would probably imply in that low teens ROE level. So I'm just trying to get a sense on what's kind of underpinning that 2% ROA commentary, keeping in mind that you guys, I think, just delivered a pretty strong quarter and are putting up pretty strong profitability already.

Yes. I'll start, and then I'll let Rob jump in on that as well with any color. But yes, we try and be careful in assessing a lot of characteristics of what this looks like in 2027, for example, like the capital needs of the bank, how fast we're growing. There are a lot of factors that could play into that. But we're thinking that two is a good conservative number that we've modelled out and the low teens, all things being equal, would be a good number as well. Once again, those can vary if the bank grows faster, there's need for additional capital or what have you or if it's slower in the growth. So what we've tried to do is approximate through some probability approaches, what we feel safe in saying. And Rob, I don't know if you want anything.

I think you've covered a lot of it. Just when we're looking at these numbers, I guess, the way the key assumptions are what is the level of capital, which we talked about is a 14%, 15% level of capital. We've taken a look at historically where we've been recently, and we think that certainly 2% is sustainable. And with a fully leveraged balance sheet then at the target level, you can easily come up with this low to mid-teens type number. Then the question that we have, and it's a question, I think, maybe you're leaning towards, but can we do better than that? And my answer to that question is, I'd say, in all likelihood, yes, we can do better than that. But right now, it's based upon what we feel that we can support.

Yes. Okay. Totally appreciate it. And yes, that's kind of where I was going with that one. Just the last for me. Anything on expenses? I mean, up $600,000 or so this quarter. It feels like expenses are kind of playing out kind of as we talked about where we're getting better efficiency here. But any notable investments we should be aware of for kind of back half of the year?

I'm not aware of -- I'm not thinking of anything at this point in time. The bump up that you saw in the second quarter really had to do with the annual review and salary adjustments and raises process that we go through first quarter of every year. And there was a few benefits changes, a little bit of increase in costs and benefits that everybody is experiencing. But other than that, there's really nothing notable, and I don't see anything notable on the horizon. We have cautioned that as revenues increase, right, as production increases, there will be a need to hire some additional people. We have been largely flat on our headcount for at least the last 3 quarters. As we ramp up production in some of these areas, we will be adding a few headcount, but I think we're in pretty good shape right now.

Got it. Okay. But still expecting positive operating leverage on a go-forward basis?

Absolutely. Thank you.