FINW - NASDAQ

Greetings, and welcome to the FinWise Bancorp Third Quarter 2025 Earnings Conference Call. [Operator Instructions] Please note, this conference is being recorded. I would now like to turn the conference over to your host, Juan Arias. Please go ahead.

Good afternoon, and thank you for joining us today for FinWise Bancorp's Third 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 investor website, as previously mentioned. 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, including factors that may negatively impact them 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 Noone, Bank's CEO; and Bob Wahlman, CFO. Kent, please go ahead.

Good afternoon, everyone. Our strong third quarter results demonstrate that the strategic investments we have made over the past 2 years are starting to deliver meaningful results. During the quarter, we posted robust loan originations of $1.8 billion and credit enhanced balances reached $41 million. Revenue growth was solid, driven by both fee and spread income growth and disciplined expense management further supported profitability. Tangible book value per share continued to increase to $13.84 compared with $13.51 in the prior quarter, reflecting ongoing value creation for our shareholders. Following the close of the third quarter, we announced 2 additional strategic program agreements that we are very excited about. The first is with DreamFi, a start-up financial technology company that will provide financial products and services to under-banked communities. The second is with Tallied Technologies, a program manager and network issuer processor, which will bring FinWise a substantial credit enhanced portfolio balance in Q4 2025 to support both business and consumer credit card programs. As a reminder, while the credit enhanced loans acquired in the Tallied transactions will increase our balance sheet, the credit risk is low because of the guarantee provisions of the agreement supported by the cash loss reserve deposit account that Tallied must maintain at FinWise to absorb credit loss as well as the cash flows generated by the assets. We remain actively engaged in discussions with several other potential strategic partners to further expand our strategic initiatives, and our pipeline continues to be strong. Importantly, this partnership with Tallied underscores the uniqueness of our one-to-many business model, which we've outlined previously. While our model can appear lumpy as securing strategic agreements may sometimes take longer than anticipated, each completed agreement has the potential to unlock substantial value for us. These agreements can drive meaningful increases in portfolio balances and accelerate revenue growth, reinforcing the scalability and strength of our approach. As we discussed last quarter, we are carefully evaluating a measured increase in dollar balances of higher-yielding loans, particularly as our loan portfolio continues to grow. However, we will remain within the internal limits established in 2018 as our policy restricts these loans to less than 10% of the total portfolio. Overall, we are very pleased with our performance this quarter and the solid momentum we're seeing across the business. These results underscore the strength of our strategic execution and our unwavering commitment to long-term value creation rather than prioritizing short-term gains. As we move forward, we will continue to focus on disciplined growth and operational excellence, key drivers of sustained progress and meaningful returns for our shareholders. With that, let me turn the call over to Jim Noone, our bank CEO.

Thank you, Kent. The strong momentum from recent quarters continued into Q3 as evidenced by loan origination volume totaling $1.8 billion, a 21% increase quarter-over-quarter and a 24% increase year-over-year. Key drivers included a seasonal uptick from our largest student lending partner in line with the academic calendar and continued ramp and maturation from new programs we have launched over the past several years. While macroeconomic conditions and demand trends may shift intra-quarter, originations through the first 4 weeks of October 2025 are tracking at a quarterly rate of approximately $1.4 billion. This reflects the expected seasonal deceleration from our largest student lending partner and fewer business days in the quarter due to multiple holidays. We expect a 5% annualized rate of growth in originations from this $1.4 billion quarterly level during 2026 is appropriate based on organic growth right now. We are also pleased that credit enhanced balances reached $41 million at the end of the third quarter. To support the modeling efforts of these assets, let me provide an outlook for the remainder of 2025 and into 2026. Incremental organic growth in credit enhanced balances is running at approximately $8 million in October, and we are currently comfortable projecting $8 million per month in incremental organic balances for each November and December of 2025. Additionally, as previously mentioned, our recently announced agreement with program manager, Tallied Technologies, is scheduled to close on December 1. We anticipate this transaction to contribute approximately $50 million in credit enhanced balances late in the quarter. for a projected total of approximately $115 million in credit enhanced balances by the end of the fourth quarter. This compares to our prior expectations for $50 million to $100 million by the end of the fourth quarter this year. Looking ahead to 2026, we are currently comfortable with organic growth in credit enhanced balances of $8 million to $10 million per month right now. Quarterly SBA 7(a) loan originations declined 7.8% quarter-over-quarter and are up 68% year-over-year. The quarter-over-quarter decrease primarily reflects typical third quarter seasonality. Importantly, the recent federal government shutdown may impact FinWise's SBA lending operations in the following ways: First, loan approvals. While FinWise can work with applicants to prepare documentation and complete bank underwriting, all new loan approvals for the 7(a) and 504 loan programs are currently suspended. Second, loan closings. FinWise can close previously approved loans if there are no change actions requiring SBA approval, but some loan closings will be impacted until the government reopens. Third, secondary market sales. Loan sales require approval by the fiscal transfer agent, and this is currently suspended during the government shutdown. Loan servicing is not materially impacted by the shutdown, and we also do not anticipate the government closure will be detrimental to credit quality as FinWise does not need SBA approval for most of the actions we take in servicing and liquidation. While our SBA lending is impacted by the current government shutdown, this has happened in the past when Congress was unable to agree on budgetary matters. And FinWise was successful in managing its pipeline of loan applicants, loan closings and loan sales through similar periods. We continue to monitor the situation closely and remain focused on maintaining strong pipeline activity heading into Q4. During the past quarter, we continued to sell guaranteed portions of our SBA loans as market premiums remained favorable. We will continue to follow this strategy as long as market conditions remain favorable. That said, the current government shutdown may impact the amount of loans that we can sell in the fourth quarter. Importantly, our SBA guaranteed balances and strategic program loans held for sale, both characterized by lower credit risk, collectively represent 40% of our total portfolio at the end of Q3, underscoring the lower risk composition of our loan portfolio. Turning to credit quality. The total provision for credit losses was $12.8 million in the third quarter, of which $8.8 million is attributable to growth of credit enhanced balances in the quarter. This compares to a total provision of $4.7 million in the prior quarter, of which $2.3 million was attributable to growth of credit enhanced balances. As a reminder, the provision for credit losses associated with the credit enhanced loan portfolio is different from core portfolio provisions because it's fully offset by the recognition of future recoveries pursuant to the partner guarantee of an exact amount described as credit enhancement income in our noninterest income. Quarterly net charge-offs were $3.1 million in the third quarter versus $2.8 million in the prior quarter. For modeling purposes, we continue to believe that approximately $3.3 million is a good quarterly number to use. This level has remained consistent on a quarterly basis over the last 2 years, and it's in line with our expectations following the portfolio derisking initiative we implemented a little over 2 years ago. During Q3, only $3 million in loans migrated to NPL, bringing our total NPL balance to $42.8 million at the end of the quarter. This modest increase was mostly due to SBA 7(a) loans classified as NPL and compares to guidance on our prior call that up to $12 million in balances could migrate during the third quarter. The lower-than-expected migration reflects the team's proactive efforts in selling collateral, securing paydowns and receiving reimbursements on the guaranteed portions of SBA loans that have become classified. Of the $42.8 million in total NPL balances, $23.3 million or 54% is guaranteed by the federal government and $19.4 million is unguaranteed. Looking ahead, while we expect a gradual moderation in NPL migration as loans underwritten in lower interest rate environments continue to season, migration may remain lumpy. For the fourth quarter, we anticipate that approximately $10 million to $12 million in watch list loans could migrate to NPL. I will now turn the call over to our CFO, Bob Wahlman, to provide more detail on our financial results.

Thanks, Jim, and good afternoon, everyone. We reported net income of $4.9 million for the third quarter, representing a 19% increase from the $4.1 million reported in the prior quarter and a 42% increase year-over-year. Diluted earnings per share rose to $0.34, up from $0.29 in the previous quarter and $0.25 in the same quarter last year. These results reflect strong operational execution and sustained business momentum across our core segments. Our strong performance was driven by several factors, including a notable increase in loan originations and a significant rise in credit enhanced balances. These trends contributed to higher net interest income, reflecting increased average loan balances across both our held for investment and our held-for-sale portfolios. This was partially offset by the reversal of interest income on newly classified nonaccrual loans. We also posted solid noninterest income, largely driven by a substantial increase in strategic program fees and higher gain on sale of loans. As a reminder, for accounting purposes, credit enhanced income is an offset to the provision for credit losses on the credit-enhanced loan balances and net does not have an effect on net income. On the expense side, the increase in credit enhanced expenses is for the servicing and the guarantee on the credit enhanced loans, so reflects the growth in the credit enhanced loan portfolio. Excluding the credit enhanced expenses, we remain disciplined with our compensation and other operating expenses. Total end-of-period assets reached nearly $900 million for the first time in the company's history. This achievement reflects robust balance sheet expansion fueled by sustained loan growth and our disciplined approach to capital deployment. Average loan balances, including held for sale and held for investment loans totaled $683 million for the quarter compared to $634 million in the prior quarter. This increase included notable growth in strategic program loans with credit enhancements, commercial leases, residential real estate and owner-occupied commercial real estate. Average interest-bearing deposits were $524 million compared to $494 million in the prior quarter. The sequential quarter increase was driven mainly by an increase in wholesale time certificate of deposits, but we also had a modest pickup in other deposit categories, including demand, savings and money market deposits. Net interest income increased to $18.6 million from the prior quarter's $14.7 million, primarily due to an increase in credit enhanced balances and rates in the held-for-investment portfolio and the higher average balances in the strategic program loans in the held-for-sale portfolio, partially offset by higher average balances of brokered CD accounts. Net interest margin increased to 9.01% compared to 7.81% in the prior quarter, driven mainly by growth in the credit enhanced portfolio, offset in part by accrued interest reversals on loan migrating to nonaccrual during the prior quarter. As a reminder, the net interest margin can be affected by specific terms of each new credit enhanced loan program or by the mix of loan growth of existing credit enhanced portfolio. While generally, new credit enhanced agreements will expand the NIM from the current levels, some agreements could cause NIM to compress. In terms of a net interest margin outlook, for the fourth quarter, we could see some compression in the margin relative to Q3. This is primarily driven by the onboarding of a substantial volume of average balances through our new strategic partnership with Tallied. While this initiative supports overall revenue growth, the revenue contribution from these balances is bifurcated between net interest income and interchange fees. As a result, a portion of the revenue generated by this agreement will be captured in net interest income and a portion will be captured in noninterest income. As a portion of the economic benefit to FinWise will be captured in noninterest income, the resulting net interest margin from adding this program may be lower than expected. Looking beyond the fourth quarter, we suggest thinking about our net interest margin in 2 distinct ways, including and excluding credit-enhanced balances. When including credit enhanced balances, the margin is projected to increase, supported by the continued expansion of our credit-enhanced loan portfolio and strategic efforts to lower our cost of funding. This upward trend is expected to persist until growth in these balances begins to moderate. Conversely, excluding credit enhanced balances, we anticipate a gradual decline in margin consistent with our ongoing risk reduction strategy. Fee income was $18.1 million in the quarter compared to $10.3 million in the prior quarter. The sequential quarter increase was primarily driven by the substantial increase in credit enhancement income, continued growth in strategic program fees due to stronger originations and gains on sale of loans. As noted earlier, credit enhancement income is fully offset by the provision for loan losses related to credit enhanced loans and increases as we grow our credit enhanced loan balances outstanding each quarter. Noninterest expense for the quarter totaled $17.4 million, an increase from $14.9 million in the prior quarter. The pickup was primarily driven by higher credit enhancement expenses, including the servicing and cost of the guarantees on the credit enhanced loans, reflecting the continued growth in the credit enhanced loan portfolios. Importantly, when excluding credit enhancement costs, operating expenses increased only modestly with the uptick largely concentrated in other operating expenses. This was mainly due to servicing expenses associated with the balance sheet programs of our strategic programs. The reported efficiency ratio is 47.6% versus 59.5% in the prior quarter. The decline was due mainly to the increase in credit enhanced fee income and gain on SBA loan sales previously discussed. Removing the income statement effects of the credit enhanced loans, a non-GAAP measure, the efficiency ratio was 59.7% versus 65.3% in the prior quarter, implying solid operating leverage in the quarter due to strong revenue growth and disciplined expense management. Although further improvement in the efficiency ratio may be less pronounced in future periods, we remain focused on driving sustainable positive operating leverage with a long-term goal of steadily lowering our core efficiency ratio. That said, there may be periods in which the efficiency ratio may increase. Our effective tax rate was 23.7% for the quarter compared to 24.5% in the prior quarter. The decrease in the prior quarter was due primarily to the increase in deferred tax assets related to restricted stock, increased allowances for loan losses and accrued bonuses. While multiple factors may influence the actual tax rate, we currently expect fourth quarter of '25 tax rate to be approximately 26%. With that, we would like to open up the call for questions and answers. Operator?

[Operator Instructions] and our first question will come from Joe Yachunis with Raymond James.

So as you outlined in your prepared remarks, credit enhanced loan balances are going to exceed your year-end target, largely due to receiving the tallied loans. Given your outlook for credit enhanced loans, can you discuss what level of concentration you're comfortable with in your loan portfolio?

Yes. So some of the concentration policies, Joe, really are limited by percent of the portfolio by program. And I would tell you that they top out at about 15% per program.

Okay. That's per program, not for loan type.

That's correct.

And then can you talk a little more about the net reductions in FTEs and compliance and risk functions? I understand the percent of employees in these oversight roles remained unchanged, but is there any new systems that you put in place to automate certain functions to allow fewer employees to ever see more volume?

The employee right now, the number has dropped a little bit. It's not due to any AI or what have you in the system. It's just us being very disciplined about what we're doing here. However, we are analyzing as many other banks, our potential efficiency impacts from AI.

Okay. I appreciate it. And then just a couple kind of clarification questions for me. And forgive me if this has already been covered, but what is the difference between credit enhancement program expenses and credit enhancement guaranteed expenses?

So we're just being more specific. What was in previous periods referenced as credit enhancement expenses is referring to the actual amount that we're paying for guarantees on those credit enhancement programs. The other component piece that's included in the expense section but is not specified was not being included in what was previously described as credit enhanced expenses is a servicing costs related to those credit enhancement loans. But that's rather insignificant relative to the guarantee amounts that are being paid.

Okay. Perfect. And then just kind of last clarification question for me. You talked about some accrued interest reversals in the quarter. Can you quantify that impact?

Could you repeat the question, please?

The accrued interest reversals in the quarter that boosted loan yields and the NIM?

Yes. That was -- the accrued interest reversal during the period was about $175,000. So that is when a loan goes nonperforming, and we have to reverse the interest that had previously been accrued on the loan when it reaches 90 days past due. That was $175,000 in this quarter compared to $514,000 last quarter.

Our next question comes from Andrew Terrell with Stephens Inc.

Just thinking about kind of net growth of the balance sheet into the coming year. Jim, I appreciate the guidance you gave around the credit enhance. That's really helpful. But should we expect the entirety of your loan growth going forward to come from that credit enhanced product or products? Or should we expect growth in any areas outside of that?

I think you'll see growth across the board, Andrew. I think that would be the primary driver, though. That's where you'll see the biggest tick up. If you look at our SBA portfolio, we've kind of been selling about as much production as we're putting on, on the guaranteed portions, at least in the last quarter or 2. You're getting -- in the equipment leasing, you see upticks each quarter. But yes, generally, the credit enhanced portfolio is where the meaningful growth on the portfolio side will come from.

Okay. Got it. And then you're going to outperform this $50 million to $100 million guide. It sounds like by the time we end this year. And if we kind of extrapolate the baseline you're talking of monthly growth for 2026, it implies just a little more than $100 million of credit enhanced growth in 2026. I'm just curious what could cause you to deviate either positively or even negatively versus kind of this established baseline we're thinking about for 2026?

Yes. So yes, we're looking at about $115 million by the end of the year, and that's above previous guidance of the $50 million to $100 million. So we're happy about that. Like you mentioned, we're currently comfortable with organic growth there, call it, starting January 1 of about $8 million to $10 million based on what we're currently seeing in trends. So what would cause us to outperform that? It would be an acceleration. There's 4 live programs today, Andrew, and then there's the fifth program coming online in December with Tallied. Of the 4 live programs, 2 have kind of good established trends month-over-month. I would say 2 are still kind of lagging as far as just growth. So if you have those 2 programs start to hit more of the stride, you could have upside. On the downside, I would say, really, if you have some material weakness in performance. When we underwrite these, we stress we stress them pretty highly, both with 50% and 100% stress on charge-off rates and then we look at high watermarks. But if we have meaningful deterioration in performance there and we have to stop originations for one of those programs, that's where you would see underperformance versus the kind of trend that we're talking about $115 million to start of the year and then $8 million to $10 million of organic growth monthly throughout the year.

Got it. Okay. And if I could clarify one on the expenses. I'm looking at the credit enhancement guarantee expense of $1.720 million in the quarter compared to in the adjustment section, you're breaking out the total credit enhancement program expense of $1.968. Is the delta of that what you're referring to is the kind the incremental servicing costs that I'm assuming would be kind of variable as this loan portfolio grows?

Yes, it is. That would be the difference.

Okay. And it is variable, so increases going forward?

The servicing cost is typically stated as a percentage of the assets. And so that will vary as the program matures and grows.

Yes. Okay. And so if I look at that, that was in kind of the other expense line in the third quarter that stepped up. It essentially implies the other expense stepped up $400,000 or so in the quarter. I'm just curious, any other specific drivers to the step-up in the other expense? I'm just trying to get kind of a clean run rate.

Well, the largest one that you noted there was the servicing expenses on these credit enhanced portfolios. The other changes that are included in there is deposits are higher. So we have a little bit higher FDIC deposit insurance assessment. And then just generally, data services and software costs are included in there that also increased.

And we'll go next to Brett Rabatin with Hovde Group.

I wanted to ask a question on the credit enhancement. Some of the loans that you're adding through these programs are credit enhanced and some are not guaranteed. Can you maybe break apart the decision on what you're doing with the 2 pieces there and why there's 2 buckets?

Yes. So I think you're probably looking at the table on Page 5 of the earnings release, Brett. Is that right?

Yes. Yes.

Yes. Okay. So you've got 2 kind of sub-line items there under strategic program loans, one with credit enhancement, and that's the credit enhancement program that we've been talking about, and it's been a meaningful, starting to become a meaningful growth driver of assets in the portfolio. Without credit enhancement, those are -- you can call them like full risk retention programs that we have. We have 3 -- there's 4 active programs there. Most of them were retention programs that we've been active with really over the last 4 or 5 years. Those balances have been pretty stable. We talked in the last quarter or 2 about the fact that they may start ticking up here. And so you see them -- they were pretty flat in the June quarter versus the same period last year. But you did see them tick up a little bit, $3 million or so in this quarter. And we had talked about that. In that program, you're getting full yield, but you're taking full NCO exposure as well. And so with a few of our partners, we've got anywhere from 2% to 5% retention rates. So every loan that comes through that we originate at the bank, we will hold 2% to 5% of the receivable, and then we sell 98% to 95% of the receivable to an SPV or back to the partner. And then that loan balance will stay on our balance sheet through payoff or charge-off. And so we're capturing all of the yield. We're capturing all of the credit risk, but that it's been a fairly stable number. It's starting to tick up a little bit. And I think Kent, in some of his remarks over the last quarter or 2 has mentioned that we're looking at potentially growing that a little bit here. Does that help?

Okay. Yes, that's helpful. For some reason, I was thinking that you guys were going to transfer those programs into the strategic with credit enhancement. And so those balances were going to go down instead of up. That makes sense.

Yes, difference [indiscernible].

Right, right. Wanted to ask, you mentioned the margin down in the fourth quarter with continued derisking. Can you maybe talk about the -- how much you're expecting? And then when I look at the CDs that cost $422 in the third quarter with rate cuts, I'm wondering if the CD book might be an opportunity on the margin.

Sure. Let me tackle that one. So what I was referring to in my comments was that we have Tallied coming on and during the fourth quarter, late in the fourth quarter. And Tallied is a little bit of a different structure of transaction where the revenue is in part related to interest income, which is a -- which is going to be only part of the revenue we collect from it, and then we're also going to collect from that portfolio, the additional fees, the Interchange fees, thank you. So depending upon when that program comes on and how quickly these other programs continue to wrap up, that could result in a little bit of a toss-up in regards to whether we end up with margin increase or margin decrease during the fourth quarter.

Okay. That's helpful. And then on money rails and payments, do we have to wait to January for some, maybe some thoughts on potential revenue in '26? And if we do, okay, but I was hoping for maybe any early color you could give? And then just particularly money rails and payments, just maybe any pipeline on potential partners from here?

Sure. So as far as cards go first, we just announced DreamFi and Tallied. We actually expect DreamFi will generate some deposits for us in latter half of 2026, especially. But also, we have the standard banking behind that. So we would be moving money back and forth on money rails with them. We also have additional partners that are -- that we expect to generate not only deposits, but money rails fee income as well as some BIN opportunities as well in the pipeline right now. So does that answer your question?

Yes, that's helpful. And then just -- I don't know if you want to give any kind of early thoughts around potential revenue magnitude, but that would be helpful as we think about the coming year.

I don't think we're ready at this time, but what we said before is it will become more meaningful in the latter half of '26, and we think you'll get more of a steady state in '27 that's more predictable. But as we get more information here, we'll share that with you.

Okay. Last one for me, just around expenses. And you mentioned earlier that AI was not a driver for 3Q. But I know 36% of your FTE count is in compliance, IT, et cetera. Is that an opportunity you guys think over the next year?

That's a great question. The way we kind of think of it is we have built a platform to continue to launch partners. And we really don't look at it in terms of headcount reduction. What we do look at it as is the ability to moderate headcount, especially production-related headcount as we grow. And so that's really where we see the lift there because we do have a lot of requirements and oversight and so forth that we think we're rightsized there, but future growth is where we see the opportunity.