Pathward Financial - Earnings Call - Q1 2019
January 28, 2019
Transcript
Speaker 0
Ladies and gentlemen, thank you for standing by and welcome to the Meta Financial Group Fiscal Year twenty nineteen First Quarter Investor Conference Call. During the presentation, all participants will be in a listen only mode. Following the prepared remarks, we will conduct a question and answer session. As a reminder, this conference call is being recorded. I would now like to turn the conference call over to Brittany Alsasser, Director of Investor Relations.
Please go ahead.
Speaker 1
Thank you, and welcome to Meta's conference call and webcast to discuss our financial results for the first fiscal quarter ended December 3138 released earlier this afternoon. Additional information, including the earnings release and investor presentation may be found on our website at metafinancialgroup.com. President and CEO, Brad Hanson and Executive Vice President and CFO, Glenn Herrick will be sharing some prepared remarks today before we open up the call for questions. Today's call may contain forward looking statements, including statements related to Meta and its operating subsidiaries, which may generally be identified as describing the company's future plans, objectives or goals. We caution you not to place undue reliance on these forward looking statements, which are subject to risks and uncertainties that could cause actual results or outcomes to differ materially from those currently anticipated or that we otherwise discuss today.
These forward looking statements are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. For further information about the factors that could affect Meta's future results, please see the company's most recent annual and quarterly reports filed on Forms 10 ks and 10 Q and its other filings with the Securities and Exchange Commission. Forward looking statements speak only as of the date on which they are made. Meta expressly disclaims any intent or obligation to update any forward looking statements on behalf of the company or its subsidiaries, whether as a result of new information, changed circumstances, future events or for any other reason. At this time, I would like to turn the call over to President and CEO, Brad Hanson.
Speaker 2
Thank you, Britney. I want to welcome everyone to our fiscal twenty nineteen first quarter earnings call. Today, I'm going to provide an overview of the quarter before highlighting our increasingly differentiated business model and outlining our top priorities. Afterwards, Glenn will provide an update on our financial performance and earnings guidance for fiscal year twenty nineteen. We are very pleased to report strong fiscal twenty nineteen first quarter results, including earnings of $15,400,000 representing growth in earnings per share of 144% over the prior year's first quarter.
The successful addition of Crestmark, a national commercial bank, which the company acquired in the previous quarter is enhancing our net interest income growth as we more fully leverage our low cost funding base to fund higher yielding commercial finance loans and leases. To the point, our net interest margin on a tax equivalent basis expanded by 170 basis points over the prior year quarter and 49 basis points on a linked quarter basis. We expect that this expansion will have a meaningful impact as we continue to generate growth across our multiple lending activities, which Glenn will discuss further in his remarks. Over the past few months, I've had the opportunity to engage with our management team and Board and collectively we have formulated a plan to address our top priorities for the company. Today, I'm excited to share what we feel are the most important points of emphasis.
Starting on Slide four of the investor presentation, let's focus on three key elements to Meta's near term plan and related initiatives that we believe will bring a differentiated approach to value for our shareholders. First, as shown on Slide five, we intend to increase the percentage of balance sheet funding from core deposits. Our payments division remains focused on client and partner engagement and we have been pleased to see continued growth in our low cost deposits as shown on the chart on the bottom left. In addition to pursuing a greater share of partner relationship deposits, we are continuing to evaluate additional products and flexible services to deepen relationships and grow our customer base. We expect this to include expansion of banking as a service deposit products.
Second, turning to Slide six, we intend to optimize the earnings asset mix of the balance sheet. We've taken a meaningful stride forward with the company's acquisition of Crestmark and over time we intend to grow the commercial finance segment of our earnings assets from approximately 30% as of the end of the first fiscal quarter to above 55% of the total earning asset mix. Importantly, we are also targeting the investments securities portfolio to trend below 20% of the mix over time. We expect this shift will enable us to replace lower yielding securities with higher yielding loans and leases, while maintaining our high credit quality. I also want to be clear that we intend to limit consumer finance activities, which includes the consumer credit products we have introduced over the last year to less than 15% of on balance sheet earning assets.
We will focus our consumer lending partnerships to those relationships that exhibit a high potential for strategic cross selling opportunities, particularly with our payments business. As this component of our lending activities grows, we plan on utilizing the secondary market as needed, including the use of participations or sales to limit our on balance sheet exposure. And third, as noted on Slide seven, we intend to improve operating efficiencies. This will likely be increasingly impactful as we integrate and optimize recent acquisitions. We have a deep and experienced team in place to lead this company forward and we will focus on expense management and generating positive operating leverage through technology as we further automate and utilize productivity enhancements to drive sustainable revenue and earnings growth.
Turning to M and A, we have built or acquired the operating business platforms, which we believe offer high returns for our clients and shareholders. As such, we intend to take a pause on material merger and acquisition activity and will concentrate our efforts on maximizing value from the existing platforms. We believe that these three priorities from the Meta playbook will increasingly differentiate our business model and in turn enhance our long term value for shareholders. As shown on Slide nine, we expect to generate excess capital as our earnings power builds reflecting a more potent earnings asset mix. And in the longer term, we are targeting an ROA that exceeds 2% and an efficiency ratio less than 65% as the initiatives we highlighted today increasingly take hold.
Given our strong platform and talented team, I believe Meta remains poised to deliver significant value for our shareholders in the years ahead. Now I'll turn it over to Glenn Herrick, our CFO, to provide an overview of our fiscal twenty nineteen first quarter financials. Thank
Speaker 3
you, Brad, and good afternoon, everyone. Starting on Slide 11, for the first quarter of fiscal twenty nineteen, we reported net income of $15,400,000 as earnings per share more than doubled to $0.39 per diluted share over the same quarter in the prior year. Earnings growth from the prior year quarter was largely driven by an increase in net interest income related to the expansion of the commercial finance portfolio. Net income growth also reflected $35,600,000 in solar leasing initiative originations in the quarter and the related income tax benefit from those. The impact of the tax benefits will vary from period to period as they are recognized ratably based on the pre tax net income throughout the fiscal year.
For the remainder of fiscal twenty nineteen, we anticipate further tax credits which are built into our EPS outlook and the tax rate used in determining our EPS outlook. More specifically, we continue to anticipate the company's effective tax rate for the fiscal year to settle in the single digits. Turning to Slide 12. Gross loans and leases increased $383,000,000 to $3,300,000,000 at December 31, an increase of 13% during the first quarter. Our national lending portfolios generated 314% growth year over year led by our acquisition of Crestmark.
Asset based lending portfolio grew $76,000,000 an increase of 16% from the previous quarter. In the quarter ended in December, factoring into a lesser extent asset based lending typically experienced a seasonal slowdown as there is a buildup prior to the Christmas season. In addition, the automotive industry essentially shuts down in December and into early January. We expect activity in those areas to regain momentum in the fiscal second quarter. We also saw solid opportunities in our warehouse lending portfolio and were able to grow the portfolio by $111,000,000 from the preceding quarter.
During the quarter, Meta participated as a first out participant in two highly secured asset based warehouse lines of credit. Our senior position is supported with significant subordination. The warehouse finance portfolio is made up of commercial and consumer asset based lines of credit. There were $65,000,000 of new originations during the quarter from our two consumer credit programs in which we hold a senior position and we designated $24,000,000 of loans as held for sale at December 31. On Slide 13, we have provided an example of what a cash flow waterfall looks like as well as the expected cumulative loss rates that would be required to render our allowance for consumer loan losses reserve insufficient.
It is important to note that each of our consumer programs is different. However, we provided the key attributes we look for when structuring our programs in the example. The example consumer credit waterfall shows that once a consumer payment is put into a collection account, we then receive the principal portion of the payment and protection from loan losses. Once our losses and principal are covered, we then receive our agreed upon interest target and the program partner company receives its servicing and marketing fees. The remaining fees and interest flow to a Meta owned escrow account and billed to an agreed upon level or a time period lapses before additional funds are released to the program partner company.
After extensive stress testing, we have concluded that cumulative net loss rates would have to range between 1520% for the prime program and between 2530% for the non prime program for the 1% reserve at December 31 to be insufficient. During the quarter, community banking loans grew $80,000,000 or 7% with the majority of the growth occurring in commercial real estate. A renewed focus for Meta is to grow our non interest bearing deposit base, which currently represents 55% of total deposits. For the fiscal twenty nineteen first quarter, we grew average non interest bearing deposits by 7% compared to the average for the same quarter in the prior fiscal year. Overall, our cost of deposits during the quarter was 91 basis points, an increase of 67 basis points compared to the prior year quarter.
And when excluding wholesale deposits, our cost of deposits was just 14 basis points, an increase of seven basis points over the prior year quarter. Meta's net interest margin on a tax equivalent basis was 4.76% for the fiscal twenty nineteen first quarter, improving by 49 basis points from the fourth quarter of fiscal twenty eighteen. As expected, we benefited from a full quarter's contribution from Crestmark's higher net loan and lease yields. Net purchase accounting accretion contributed 18 basis points to the net interest margin in the first quarter of fiscal twenty nineteen. Meta's provision for loan and lease losses was $9,100,000 for the fiscal twenty nineteen first quarter.
The increase in provision was primarily driven by growth in our commercial finance and tax advanced portfolios as well as provision expense to maintain allowance levels. Net charge offs were just $849,000 for the quarter. We expect to see a higher provision in the second fiscal quarter related to the seasonality of our tax refund advance business. Turning to Slide 14, metrics, which remain well within our risk tolerance levels. Non performing assets represented just 73 basis points of total assets at December 3138.
Of note, the company's outstanding foreclosed real estate and repossessed assets balance is primarily related to a non performing agricultural loan relationship that we've discussed previously and the land is actively being marketed for sale. In regard to commercial finance credit, I wanted to note that the recent overall three year historical net charge off rate was 63 basis points for the Crestmark loan and lease portfolio. And over the past ten years, net charge offs averaged 41 basis points and were just 166 basis points during the Great Recession, a time when Crestmark loans consisted of primarily asset based lending and discount factoring. The Crestmark team consists of an experienced management team that consistently follows a conservative credit culture as evidenced by their strong performance across cycles. Non interest income was up $13,000,000 from the fourth quarter to $37,800,000 The increase was primarily driven by recognizing a full quarter of rental income from the Crestmark division, higher tax product income and increasing gain on sale of loans and higher deposit fees over the previous quarter.
Card fee income was flat on a linked quarter basis and declined by $5,900,000 compared to the prior fiscal year first quarter, reflecting the continued year over year reduction in residual fee income related to a wind down of the company's relationships with two of our non strategic payments partners and the transition of certain card fees to deposit fee income, which we previously discussed. The effects of the wind down as compared to the prior fiscal year are expected to continue through the second and third quarters of fiscal twenty nineteen. Turning to expenses, the year over year increase in non interest expense primarily reflects the addition of compensation and benefits costs for Crestmark division employees as well as fiscal twenty eighteen hires in support of Meta's national lending and other business initiatives. Other year over year and quarter drivers of non interest expense included step ups in operating lease equipment depreciation, occupancy and equipment and loan and lease expenses related to the Crestmark acquisition. As Brad previously mentioned, one of the areas of focus is improving operating efficiencies to accelerate operating leverage in fiscal twenty nineteen and to a greater degree in fiscal twenty twenty.
Related initiatives include integrating and optimizing our recent acquisitions and incremental focus on more fully extracting value from our existing platforms and enhancing automation and productivity across the company. Let me discuss our previously disclosed earnings per share outlook for fiscal twenty nineteen. For fiscal year twenty nineteen, excluding the effects related to company executive transition agreement costs in Q2, we continue to anticipate earnings per share to be in the range of 2.3 to $2.7 We currently estimate executive transition agreement costs to be $6,100,000 pretax, which we expect to incur in the quarter ending March 3139. This is expected to reduce the 2019 full year GAAP earnings per share to be in the range of $2.18 to $2.58 per share. With that, I'll turn the conversation back to Brad now for closing comments before we open it up for questions.
Speaker 2
Thanks, Glenn. As we conclude our prepared remarks, I'd like to provide a brief update on the 2019 tax filing season currently upon us. This season is marked by a bit of uncertainty based on the unknown effects of the government shutdown and the potential impact to IRS processing times, even though we have all seen the news that the IRS intends to process returns. It is difficult to predict the impact to Meta at this time. However, we've worked hard preparing and are closely monitoring any developments which may affect our tax service business.
Based on what we know today, we expect any impact to be immaterial overall and as Glenn mentioned, we are reiterating our fiscal year earnings guidance. Let me conclude by recapping what I believe are four sustainable competitive advantages that position Meta for future growth as shown on Slide 16. First, our diversification across payments and banking businesses, platforms and fee structures remains a key differentiating factor that we intend to increasingly leverage. Second, our payments platform delivers low cost funding and we are focused on shifting the deposit mix more in favor of core deposits. Third, our scalable lending platforms are set for profitable growth given ample low cost funding.
And fourth, accelerating cross selling across business lines drive stepped up client acquisition and retention with related financial benefits. That completes our prepared remarks. So I'll ask Glenn to join me for Q and A. Operator, please open the lines for any questions.
Speaker 0
Thank you, you.
Speaker 4
Press 1 for yes or 2 for no.
Speaker 0
Management asked that you ask one question and one follow-up
Speaker 4
for Press the one for yes or 2 for no.
Speaker 0
Our first question comes from the line of Steve Moss of B. Riley FBR. Your line is open.
Speaker 5
Good afternoon.
Speaker 3
Hi, Steve.
Speaker 5
Hi. I was wondering if you just talk about the
Speaker 4
give us a
Speaker 5
little more color around the expected earning asset mix shift that you mentioned, Brad, in your opening remarks. Just kind of how do we think about the rundown in securities over the next twelve months? And does that go to pay down brokered deposits? Or is that just more to fund loan growth?
Speaker 3
Hi, Steve. This is Glenn. So in our deck, we put out some aspirational goals. We really look at it will be a replacement we'll replace securities with loans, primarily the growth in the commercial finance loans. And the pace of that will depend on how fast we grow our loan volumes.
And in essence, we'll be swapping lower yielding securities loans for higher yielding, primarily commercial and some consumer loans.
Speaker 5
Okay. And so just as we think about total assets over the next twelve months, probably modestly increasing is a fair way to think about things?
Speaker 3
Correct.
Speaker 5
Okay. And I guess just with regard to expenses and the efficiency ratio target, I believe sub-sixty five was the number. Just kind of wondering, I hear you're it's aspirational, is that probably like a fiscal twenty twenty type target?
Speaker 2
Yes. That is not a near term target. Obviously, that will take some time. So over the next several years of our planning, we that's the goal we have.
Speaker 3
What we would expect, Steve, is that from where we're at today is continue to make progress against both that goal and an improved ROA goal that we've set. And we will continue to provide updates on our progress against those longer term goals we've set for the company.
Speaker 5
Thank you very much.
Speaker 3
Thanks Steve.
Speaker 0
Thank you. Our next question comes from the line of Michael Perito of KBW. Your line is open.
Speaker 4
Hey, good afternoon guys.
Speaker 2
Good afternoon.
Speaker 4
So I guess a couple of questions. Glenn, can you give us a little bit more detail about how those two larger loans just kind of impacted everything this quarter ranging from provision to NII. And I guess given the size and where the margin went to, was kind of surprised that the net interest income didn't see a little bit more of a bump. So I was curious, I mean, those loans booked later in the quarter? Any more additional kind of details around that would be helpful.
Speaker 3
Yes. Which two loans are you talking about the warehouse finance
Speaker 4
I'm sorry, facilities, yes. Yes.
Speaker 3
So they were booked late in the quarter. Those were net those will be net positives to our yields going forward.
Speaker 4
So I mean, it's the right way to think about it that the since they were booked late in the quarter, obviously, provision all came in the first fiscal first quarter, but a lot of the kind of yield or NII, so to speak, from it will benefit in future second quarter and beyond once it has a full three month impact?
Speaker 3
Correct. You'll see a full clean quarter of that in the March here. The we incurred the upfront origination and structuring costs as well in the December.
Speaker 4
Okay, helpful. Thank you. And then on the this slide on the consumer kind of waterfall is helpful. And I guess the question I have is, if I look at this last bullet here with the cumulative net loss rates, would you guys kind of provide where they'd have to range for the reserve to be inadequate? I'm wondering if you could maybe give us a little bit more color.
I mean, I'm sure when you guys kind of launched this platform, you had historical perspective on where credit losses on similar type of products have gone. And I guess the more relevant question is, where do you see those loss rates going in a more stressed scenario? I mean, is it 25% to 30%? Or is that just simply where they have to get for the reserve to be inadequate? Don't if that makes sense.
Hope we clarify if I have to, but
Speaker 2
Yes, those loss rates were actually stressed at multiple times the expected loss rate. So we would not be planning on those reaching those levels.
Speaker 3
We think a normal stress environment is going to be from our expected rate, could go 25% from the expected rate increase. Maybe 8% goes to 10% or 11%, but we don't see it getting to given the senior position and our position in the waterfall, we feel pretty comfortable about our position today.
Speaker 4
Helpful disclosure. Thank you.
Speaker 3
Thanks, Mike.
Speaker 0
Thank you. Our next question comes from the
Speaker 5
line
Speaker 0
of Your line is open.
Speaker 6
Hey guys. Just on the commercial finance business, just given the growth you saw in the quarter and the expectations of how big you expect that to get as a percentage of the whole pie. Just wondering what sort of growth expectations or opportunities you think you have there in terms of what could that commercial finance business grow by on a quarterly or annual basis here?
Speaker 3
Hi, Frank. This is Glenn. You'll recall from the merger announcement and the thesis behind the merger, we were estimating roughly 15% annualized growth. We felt very comfortable with the commercial finance lines of business. We have exceeded that in these first two quarters, and we feel very confident with that 15 plus percent level, certainly for the next three or four quarters going forward.
Speaker 6
I mean, is there anything seasonal in the first in the December here that would lead us to believe that growth is going to slow closer to what would be an annual rate of 15% plus?
Speaker 3
No, it could slow to 15% plus. We wouldn't see that in the near quarter. There was some pent up demand, having the ability to have higher loan limits and slightly improved funding costs. What piece of the business could slow or is harder to predict on timing would be tax credits. Those we saw quite a few of those come through in the December quarter.
Speaker 6
And then you talked about
Speaker 3
It will change the mix will change between the various commercial finance lines of business.
Speaker 6
And then you talked about for the consumer business, the 1% reserves. What sort of reserve or if you could remind us, are you generally on average putting against the commercial finance
Speaker 3
loans? Plus roughly 1% for that. So our book allowance is less than that because of the purchase mark. But that's what you should expect it to build towards as that purchase mark portfolio trades off.
Speaker 6
And just to follow-up quickly on the consumer credit products. I'm not sure I totally understand why you have that, what is it, dollars 24,000,000 in held for sale?
Speaker 3
Sure. So some of our programs, the relationships with our partners, they have the right to purchase some of the loans from us, and in essence share in some of those economics. And as we structured those, we factored that so those are the loans that are held for sale, knowing per our agreements that there will be a takeout by our program partner.
Speaker 6
And how is that decided, the level of is that on a sort of a per quarter basis? Or how do you come up with that number, the $24,000,000
Speaker 3
It's individually negotiated. These have been upfront So we know well ahead of time based on volume levels, how much the partner intends to take out with other committed facilities that they have. Okay.
Speaker 6
Okay, thank you.
Speaker 3
And you will see more of that in the future. It's one of the ways we'll manage our on balance sheet exposure to consumer loans.
Speaker 4
Thank
Speaker 0
you. That concludes the question and answer session. I will now turn the call back to CEO, Brad Hanson.
Speaker 2
Thank you. I'd like to close by thanking all of you for participating in Meta's quarterly investor call. We truly appreciate your support, and thank you for taking time to listen in today. Have a great evening.
Speaker 0
Ladies and gentlemen, that does conclude your program. Thank you for your participation and have a wonderful day. You may disconnect your lines at this time.