FinWise Bancorp - Q3 2024

Transcript

Operator (participant)

Greetings, and welcome to the FinWise Bancorp Third Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce Juan Arias, Head of Corporate Management and Investor Relations. Thank you. You may begin.

Juan Arias (Head of Investor Relations)

Good afternoon, and thank you for joining us today for FinWise Bancorp's Third 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 Waldman, CFO.

With that, I will turn the call over to Kent.

Kent Landvatter (CEO)

Good afternoon, everyone. Our results during the third quarter of 2024 reflect the resiliency of our existing business, as well as the actions we have taken to enhance the company's long-term growth. Loan originations during the quarter grew to $1.4 billion, a notable step up from the approximately $1.1 billion in average originations of the prior five quarters. Furthermore, we generated solid revenue, particularly strategic program fees, coupled with a deceleration of our expense growth. Moreover, we continue to gain traction with new strategic programs. During the quarter, we announced one new lending program, which brings our total to three so far in 2024, and we are optimistic about our pipeline. These programs with leading fintech companies are a testament to the strength of the FinWise Multi-Product Platform, which includes lending, deposit, payments, and card products.

As more fintech companies increasingly recognize the benefits of our enhanced product offering, coupled with our strong compliance oversight and risk management, we see the opportunity to expand our market share with new and existing strategic programs, as well as through product cross-selling. The company's tangible book value per common share increased to $12.90 from the prior quarter's $12.61. As a reminder, our company's profitability over the past year has been partly impacted by planned infrastructure investments to support organic growth and the build-out of key strategic initiatives. Similarly, our return on average equity is also partly suppressed by our high capital levels. We are optimistic that as we have completed most of the incremental investments on strategic initiatives, as we continue to utilize capital effectively, these metrics will gradually improve. Overall, I am pleased with the operational performance of our company and am excited about the outlook.

Specifically, our strategic lending business continues to gradually rebound after facing industry-wide pressures in 2023. We are delivering tangible results on our new strategic initiatives ahead of schedule, and we are seeing a deceleration in expense growth. With that, let me turn the call over to Jim Noone, our President.

James Noone (President)

Thank you, Kent. I will now provide some color on originations, review the portfolio trends, and then close with an update on our product initiatives. Third quarter originations totaled $1.4 billion, a solid step up compared to the $1.1 billion average of the prior five quarters and the $1.2 billion in Q2 of 2024. This quarter includes the first meaningful contribution from Earnest and Plannery, which we announced earlier this year, as well as a gradual rebound from our legacy programs. Specifically, of the incremental quarter-over-quarter change in originations, roughly one-third is from the new programs, and the remainder of the increase is from the legacy strategic programs. Through the first three weeks of October 2024, originations are tracking at a pace modestly lower than the third quarter 2024 originations.

As a reminder, Q3 included an expected seasonal pickup from Earnest, our student loan program, and we do not expect the same level of contribution in Q4. Also, the first three weeks of October do not include any contribution from PowerPay, the agreement that we announced during Q3, as there is typically a lag of a couple of quarters until we see a notable contribution from new programs. Our SBA 7(a) loan originations increased this quarter versus last quarter, driven by a gradual pickup in qualified applicants as rates have started to move lower. We are cautiously optimistic about the outlook for SBA volumes if we continue to see a decisive reduction in interest rates. We also continue to see solid origination levels in our equipment leasing and owner-occupied commercial real estate loans, both of which contribute meaningfully to our overall portfolio diversification.

During the quarter, we continued to retain all of the guaranteed portion of our SBA loans. On a sequential quarter basis, these guaranteed balances increased 5.8%. Our commercial leases increased 13.7% quarter over quarter, and along with the SBA guaranteed balance increase, were the primary drivers of the 4.9% growth in total loans held for investment. At the end of Q3, our SBA guaranteed balances and our strategic program loans held for sale, both of which carry lower credit risk, made up 46.4% of our total portfolio, including HFS loans. Moving to credit quality, the provision for credit losses was $2.2 million in Q3, compared to $2.4 million in the second quarter.

The decrease was due primarily to the company's periodic assessment of the qualitative factors, resulting in the removal of the factor related to COVID and its implications, partially offset by an increase in other qualitative factors and slightly higher charge-offs, stemming mostly from the SBA HFI portfolio. The net charge-off rate, as a percentage of average loans held for investment, ticked up slightly to 2.3% in the third quarter from 1.9% in the second quarter, and was lower than the 2.8% for the same quarter last year. NPL balances were up modestly this quarter to $30.6 million, versus $27.9 million in the prior quarter. Of the total $30.6 million, $17.8 million is guaranteed by the federal government.

Importantly, our unguaranteed NPL balances only increased modestly to $12.8 million this quarter versus $12.1 million in the prior quarter. As discussed on prior calls, we have expected to see some sporadic increases in NPLs as rates were elevated, and this will likely lead to an increase in NPLs in the next two quarters. While the total NPL balances have an impact on our NIM, the bank's credit risk is limited to the $12.8 million in unguaranteed NPL balances, and we believe our strict collateral policies should help mitigate net charge-offs. Positively, if interest rates continue to decline, we are optimistic that over time, it could gradually have a positive impact on our NPL metrics.

In terms of an update on our strategic lending programs, we continued to build on the string of success this year by announcing our third new lending program this year with PowerPay during Q3. As part of our agreement, the bank will offer consumer loans for home improvement and elective healthcare purchases. We welcome PowerPay to the FinWise family and thank them for the trust they placed in us. To summarize, we are very proud of what we have accomplished so far in twenty-four in terms of strategic initiatives, and as Kent mentioned earlier, we're optimistic about the pipeline. I will now turn the call over to our CFO, Bob Waldman, to provide more detail on our financial results.

Bob Waldman (CFO)

Thank you, Jim and good afternoon. I will now briefly review some key financial metrics and provide insight as appropriate. In the third quarter, we generated net income of $3.5 million, or $0.25 per diluted common share. Average loan balances comprising held for sale and held for investment loans were $492.9 million during the quarter, compared to $449.9 million in the prior quarter. This increase was primarily driven by continued growth in our commercial lease programs, SBA 7(a) program, and consumer and strategic program loans held for sale. Average interest-bearing deposits were $341.2 million, compared to $318.9 million in the prior quarter. This sequential quarter increase was driven primarily by an increase in interest-bearing demand deposits and brokered certificates of deposit.

Moving to the income statement, net interest income for the quarter was $14.8 million, compared to $14.6 million in the prior quarter, driven by increased volumes in the loans held for sale and loans held for investment portfolios, partly offset by yield decreases in both portfolios. During the third quarter, we had a one-time adjustment for accrued interest associated with loans that were determined to be non-performing in prior periods, which decreased net interest income in Q3 by approximately $500,000. Our net interest margin was 9.7% this quarter, which includes this one-time adjustment just mentioned, compared to 10.31% last quarter. The change from the prior quarter is attributable to the company's continued strategy to reduce average credit risk in the portfolio, as well as the previously described one-time adjustment that decreased net interest income.

There are two items that will affect next quarter's NIM that I want to highlight due to the Federal Reserve's fifty basis point reduction in interest rates during September. First, our SBA portfolio generally floats with prime rate and resets at the beginning of each quarter. Second, early in Q4, we initiated a program to call our callable CDs and replace them with lower-rate wholesale funding. Non-interest income was $6.1 million in the quarter, compared to $5.2 million in the prior quarter. The sequential quarter increase was driven primarily by an increase in origination fees related to our strategic programs. Non-interest expense in the second quarter was $14 million, compared to $13.2 million in the prior quarter. The sequential quarter change was primarily due to an increase in salaries and employee benefits.

which included a one-time catch-up in bonus accrual expense of approximately $400,000 to reflect updated performance award estimates. The pace of growth and expenses decelerated in the third quarter, as we discussed what happened on our second quarter call, even including the one-time catch-up and bonus accrual expense. We continue to expect the pace of growth and expenses to further decelerate in the fourth quarter of 2024 as we finish the build-out of our new initiatives. As we move forward through 2025, we also expect incremental head count-related expenses to be more aligned with increases in production. Finally, our effective tax rate was 25.1% for the third quarter, compared to 23.9% in the prior quarter.

As of now, we expect the effective tax rate for Q4 2024 to run around 25.1% and full year 2024 to run around 25.5%. With that, we would like to open the call for questions and answers. Operator?

Operator (participant)

Thank you. We will now be conducting a question-and-answer session. Please wait while we poll for questions. Our first question comes from Andrew Liesch, Piper Sandler. Please proceed with your question.

Andrew Liesch (Senior Equity Research Analyst)

Thanks. Hey, everyone. Thanks for taking the questions here. Just on the loan production so far, what you've seen this quarter, I know in the past there's been some seasonality to the benefit in the fourth quarter. Is that gonna be offset by the seasonality that's gonna flow out from Earnest? I'm just trying to get a sense of if we could see production pick up here in the next couple of months.

James Noone (President)

Yeah. Hey, Andrew, this is Jim Noone. So we're really excited about the trends that we're seeing in originations. You know, even backing out the expected seasonality of Earnest during the third quarter, you know, we're optimistic about the step up in originations that happened again this quarter and the outlook going forward. I'd say, you know, as far as specific trends, you know, we're starting to see the benefits of the announced programs from earlier in the year. The environment's also improving, you know, for some of our legacy programs, and then we're optimistic about the pipeline for new partners. If you take all of that, you know, within the strategic programs, you know, the lower rates, we're also seeing some early signs of increased activity in SBA originations.

So I'd say overall, we're optimistic, but there is some seasonality in that third quarter from Earnest and, you know, the student loan or academic year.

Andrew Liesch (Senior Equity Research Analyst)

Got it. All right. That's helpful. And then, Bob, on the commentary on the early fourth quarter actions on the margin, do you think, though, that the callable CDs and the SBA are those gonna be offsetting? And then, I guess, what other rate moves have you done on maybe other deposit accounts? Will there be a lag on the CDs? I'm just trying to get a sense on how the margin and net interest income can trend here with these actions.

Bob Waldman (CFO)

Yeah, sure, Andrew. And NIM is always a complicated area to take a look at, and it's hard to forecast what's gonna happen because there are so many things that will affect it, particularly here at FinWise. The origination volume on our higher rate loan programs, how quickly we're growing the higher quality, lower rate portfolios, significant increases in non-performing assets with related at, you know, interest reversals that we saw in this quarter. You know, what happens to the SBA loan funding and what happens to the prime rate? And, you know, how we're replacing this with our callable CDs. And these things work in opposite directions. I do expect, overall, that absent any, you know, any future Federal Reserve actions, we would expect the NIM to continue to decline during the fourth quarter.

I just can't, you know, stick a fork in it and tell you and say, "This is how much it's gonna be," because of all these different variable activities. But I will tell you a little bit more about the callable CDs that we have done. Of our $262 million of CDs, $205 million of those are callable CDs, of which $160 million we can call currently, and the rest of them will be called during the first and second quarters of next year. And of those that we have called, we've called about half of those that we had the ability to call. About $80 million is what we have called to date.

And of those, the average interest rate on those was about 5.6%, and we were able to replace that funding at a cost of about 3.7%. I'm not sure, you know, the market has moved. We were able to take advantage of the quick dip in the market after, you know, in early October. Not sure we can do the rest of them at that rate, but we're sure gonna take a look at it and try to.

Andrew Liesch (Senior Equity Research Analyst)

Got it. Yeah, that, that's very helpful. Thanks for that commentary there. And then just one last question for me, just on the payments and the card revenue. Obviously, a lot of investments have gone in there. Any sort of update on when we could start to see revenue fall to the bottom line? Just something that folks have been waiting for a while and hope to get an update there. Thanks.

Kent Landvatter (CEO)

I'll take a first stab at that. This is Kent. Hi, Andrew. We're still on track to complete the payments hub by the end of this year. As a reminder, we have launched one partner earlier this year, also one card partner earlier this year. We take some time to pilot those before we really expand them, and we want to do an external readiness assessment before we do full expansion. But we expect full year of twenty twenty-five to be ready for a full year of launching and seeing the revenues from those. We don't have specific KPIs or anything for you at this quarter. We hope to have a little more insight on what this looks like in our Q4 earnings call, but I hope that helps.

Andrew Liesch (Senior Equity Research Analyst)

Yeah, sure does. Look forward to it. Thank you so much for taking the questions. I will step back.

Kent Landvatter (CEO)

Okay.

Operator (participant)

Thank you. Our next question comes from Andrew Terrell, Stephens Inc.

Andrew Terrell (Managing Director and Research Analyst)

Hey, good afternoon.

Bob Waldman (CFO)

Hey.

James Noone (President)

Hey, Andrew.

Andrew Terrell (Managing Director and Research Analyst)

Man, you guys have it easy with both of us named Andrew here. I can't mix up any names.

Bob Waldman (CFO)

Yeah.

Andrew Terrell (Managing Director and Research Analyst)

Hey, just a few questions for me. So the 80 million that you have been able to call on the brokered CD side, you know, I think you said 205 million of total. Can you just give us a sense for the incremental of what's callable but you have not yet called? You know, timing, potentially, you could kind of look to replace some of that higher-cost funding.

Bob Waldman (CFO)

A few other facts about the other $80 million that we can call today. It carries about the same average interest rate, about 5.6%. They're eligible to call today. We'll probably do them in two buckets. We just don't want to be doing everything at one point in time, and one bucket will probably go out in November and one in December, unless we choose to change the timing, depending upon what market circumstances are at that point in time.

Andrew Terrell (Managing Director and Research Analyst)

Got it. Okay, that's helpful. And then, you know, I'm looking at the average balance of the HFS loans this quarter, and this is a point we've talked about some, you know, in the past. The average balance really stepped up quite a lot this quarter. And just curious, you know, if that's intentional, you're increasing kind of hold times on loans, whether, you know, it's related to some of the new partner launches that contributed to the origination increase this quarter. And then just kind of overall, you know, should we expect this, like, this $70 million of per quarter of average HFS loans is kind of a new normal?

I know it was, you know, it was hovering around the $40 million territory for a while, so is 70 kind of the new average balance we should think about?

James Noone (President)

Yeah. As far as the HFS balance, Andrew, you know, that's mostly a derivative of the origination volume in the quarter. So I would go back to the comments there. You know, we're optimistic. We did see another step up, in kind of baseline originations from legacy programs. But there's also some seasonal, you know, factor with the student loan program and the two new partners. I think we talked about, you know, in our prepared remarks, that about a third of the incremental quarter over quarter change in origination was from the new programs. And to kind of help with your modeling, you know, Earnest will still generate originations in Q4.

They're just not going to be at the same level as Q3, since that's the start of the school year, and that's really the key point that we wanted to highlight.

Andrew Terrell (Managing Director and Research Analyst)

Got it. Okay, so maybe some moderation there, just predicated around the kind of tracking of the loan originations.

James Noone (President)

Correct.

Andrew Terrell (Managing Director and Research Analyst)

Okay, got it. You know, I wanted to ask on the fee income side, the change in fair value on investment in BFG, that's... You know, it's been negative the past few quarters. I'm just curious what the kind of current baseline valuation is, or the value of your investment is, and, you know, should we expect continued- I get that it can kind of fluctuate some, but, you know, it seems like it's been a drag on the fees every quarter this year. So any kind of updated expectations there?

Bob Waldman (CFO)

A significant amount of that program or the revenue that they generate relates to the generation of SBA loans and the fees that are paid, the origination fees that are paid for the generation of those SBA loans. And it has been a slower market for the SBA loans, so that the revenues that they have generated has been running a little bit behind what they had generated in past years and a little bit below budgeted expectations. And so it's that revenue generation that is the driver to the valuation. And then but we are seeing signs of SBA lending picking up.

And so while it's been a negative the last few quarters, you know, as that activity picks up and as they develop other business activities, we do expect to see that valuation turn around and go the other way.

Andrew Terrell (Managing Director and Research Analyst)

Yeah. Okay, makes sense. The expense side of the house, you know, I think it was pretty impressive, the moderation and expense growth, even acknowledging the, you know, the one-time incentive accrual catch-up this quarter. I think if you, if you back that out, obviously an even lower level of expense growth this quarter. You know, with that in mind, like, if I'm just going back to some of your comments in the prepared remarks about, you know, continued declines in the pace of operating expense growth. I guess if we're to normalize, you know, $400,000 out of the run rate in the fourth quarter, it seems like you've got a decent shot at only expenses flat if the kind of core rate of reinvestment is also slowing.

Is that an unfair assumption going to the fourth quarter, or should we expect expenses to continue to build off this 3Q base?

Bob Waldman (CFO)

Well, and, during the second quarter call, what we said to anticipate for the third quarter is about half the growth rate of what happened in the of what happened in Q2. And we said looking forward to Q4, about half the growth rate of what we expected to happen in Q3. And so that would leave us with a little bit of growth, not flat, but a little bit of growth in Q4. You know, so, so I don't think. I mean, what you model, I guess, is what you choose to model. But, but I think, no increase in expenses might be a little bit aggressive.

Andrew Terrell (Managing Director and Research Analyst)

Okay. Got it. I appreciate it. Thank you guys for taking the questions. I'll step back.

Operator (participant)

Thank you. If there's anyone that would like to ask a question, please press star one on your telephone keypad. Confirmation tone will indicate your place in line. You may press star two to remove yourself from the queue. Okay. It doesn't look like we have any more questions at this time. I would like to turn the floor back to Juan Arias for any further remarks.

Juan Arias (Head of Investor Relations)

Thanks, operator. We did receive a few questions via email, so I'll just read those out. Can you provide us with some detail on the potential increase in the amount of NPLs for 4Q 2024?

James Noone (President)

Yeah. Hey, Juan, this is Jim. You know, aside from the high rate environment, you know, what we would point to as far as NPL balances in the portfolio is, you know, there's no broad-based areas of stress in the portfolio. This is mostly lingering stress from the higher rates. If you look at the quarter over quarter uptick, you know, an unguaranteed balance of NPLs, those are modest moving from 11.9 to 12.8. And then if you look at the NCOs, you know, those are relatively flat year over year. But, you know, in addressing your question on outlook, you know, what you'll see is about $9 million in 30-plus day delinquencies for SBA coming through on the call report.

I'd say something around $10 million total is what you could expect to migrate into NPL in the fourth quarter. You know, this is in line with our expectations, and you know, prior comments about sporadic pickups in NPLs due to the higher rates. As rates have now started to decline, you know, we're optimistic this may start to provide some relief to borrowers.

Juan Arias (Head of Investor Relations)

Great. A couple more questions via email. What's the opportunity to cross-sell different product offerings to new and existing partners, giving your expanded product platform?

James Noone (President)

Sure, I can take that one. Yeah, we're really excited about the multi-product platform. You know, we now have lending payments and cards, and we've had a lot of discussions with both new and existing partners, and most of these are really reverse inquiries coming in, so it's something that we're very happy to see continue to build on, you know, our leadership position in the industry. It's also the rationale for the investments that we made. It's really to expand our product set, increase the stickiness of the relationship, and ultimately increase revenue.

Juan Arias (Head of Investor Relations)

And the last question that came in: You've accomplished quite a bit in twenty twenty-four. How do you feel about twenty twenty-five, and what should we expect to see from FinWise?

Bob Waldman (CFO)

Yeah, I'll take that one, Juan. We're very proud of what we've accomplished in 2024. We have done everything we said we did, would do, and a lot of it ahead of schedule. But importantly, that leads to a very strong foundation for 2025. So for 2025, we expect to start reaping some of the benefits from the initiatives, including now a stronger multi-product platform, which we, you know, originally set out to diversify and stable revenue stream. So we're very excited about what we've created and the foundation has created for 2025.