Triumph Financial - Q3 2023
October 20, 2023
Transcript
Luke Wyse (EVP and Head of Investor Relations)
one which we do not yet see improving. We remain excited about the possibilities and our progress in spite of that. Last evening, we published our quarterly shareholder letter. That letter and our quarterly results will form the basis of our call today. However, before we get started, I would like to remind you that this call may include forward-looking statements. Those statements are subject to risks and uncertainties that could cause actual and anticipated results to differ. The company undertakes no obligation to publicly revise any forward-looking statement. For details, please refer to the safe harbor statement in our shareholder letter published last evening. All comments made during today's call are subject to that safe harbor statement. With that, I'd like to turn the call over to Aaron for a welcome and to kick off our Q&A. Aaron?
Aaron Graft (Founder, Vice Chairman, and CEO)
Thank you, Luke, and good morning. Thank you all for joining us. We made significant progress in the Q3 on several fronts. Our financial results were also better than in prior periods. In the shareholder letter released last night, I outlined four things that I thought were important to communicate to our investors about the quarter. Those included, first, TriumphPay's momentum and financial performance has exceeded even our own expectations. Second, we had a unique quarter from an expense perspective that is unlikely to repeat in the near term. Third, the freight market has not rebounded, and it could get worse before it gets better. Finally, related to that, the things that make us uncomfortable in the short term, we believe will create value for us in the long term. As it relates to those third and fourth points, the last few days have produced some interesting headlines.
Two days ago, FreightWaves broke a story detailing that Convoy, a well-known tech-enabled freight broker, had pulled its loads and that an announcement was forthcoming. We now know that Convoy is in the process of shutting down without a sale. That is something that would have been hard to imagine just a few months ago. Additional stories have followed, speculating that several more freight brokers and carriers could face a similar fate. I'm friends with many people in this industry, and it saddens me to think about the disruption this will bring to many employees and customers. However I feel about it, that is the reality of how capitalism works. Companies that are not profitable will eventually fail.
One of the reasons I am bearish on freight over the short term is because I believe that private equity and venture capital have artificially propped up some companies that were attempting to bring disruption to the industry without ever achieving profitability. I believe a significant amount of money will exit the stage in the freight industry and may not return anytime soon. I also believe that Triumph Financial, and specifically what we're doing at TriumphPay, is bringing innovation to the industry, and I know that this change is another healthy force of capitalism. The difference is that we are able to earn our cost of capital while bringing about this advancement, instead of being beholden to additional outside funding.
My journey into banking started in 2008 and 2009, and going through that process leaves you with a deep appreciation of the need to remain profitable, even through the toughest cycles, and that is what we are built to do. As it relates to Convoy, Triumph has less than $300,000 of counterparty risk outstanding, some of which we expect to collect in short order. As additional brokers go through difficult times, we will continue to focus our attention on servicing the needs of the industry while we remain vigilant in protecting our own balance sheet, as we always have. Before turning it over for questions, let me explain that while my bearishness about the next 12 months or so is real, it also makes me extremely bullish on the long-term future for Triumph Financial.
We have a business plan and a balance sheet that is prepared for a soft freight market. We will be one of those companies who emerge stronger through this, and we should have a materially greater market share than we do now. We are receiving more inbound inquiries than I can recall at any time in the past, as companies in the industry look to partner with a known industry leader with the financial wherewithal, operational experience, and technology stack to help them navigate this market. If the market ends up performing better than I expected in the short term, we will be more profitable, and that would be great, but I am far more interested in creating value for the long term. In conclusion, Triumph Financial is not a typical bank, nor do we desire to be one.
We are building a payments network in a market that needs one now more than ever. Communicating that requires effort, so we put a significant amount of time and energy into our shareholder letters to help investors achieve an informed view. I hope you find those efforts valuable. With that, we're ready to take your questions.
Operator (participant)
We will now go to Q&A. If you have connected via Zoom and would like to ask a question, please use the Raise Hand feature at the bottom of your Zoom window, or if you have dialed in, press star nine. Once called upon, please feel free to unmute and ask your question. Our first question comes from Michael Perito from KBW. Michael, please go ahead.
Michael Perito (MD)
Hey, everybody. Good morning.
Aaron Graft (Founder, Vice Chairman, and CEO)
Good morning.
Michael Perito (MD)
I had a few things I wanted to touch on. Number one, just off of your comments, Aaron, the shareholder letter was very helpful, so thanks for all the color and thoughts around the current environment. On TriumphPay, obviously a very strong quarter. I know there were a couple things, it sounds like on the expense side you guys highlighted, but one comment in the release that I also noticed was around float. I was just curious, I imagine that's at pretty high margin.
I was wondering if you could maybe just dissect what the contribution of float was to TriumphPay in the quarter, and is it fair to think that that, you know, if rates stay at current levels, you know, more higher for longer, that that should be kind of a sustainable EBITDA margin contributor, or do you expect any volatility around that?
Aaron Graft (Founder, Vice Chairman, and CEO)
Sure. As we've explained in the past, how we calculate float for purposes of inter-segment accounting is at the Fed funds rate overnight. I believe that rate is roughly 5.4%, and so that contribution of that just under $300 million of float at the Fed funds rate would be $16 million in pre-tax revenue. That is very valuable for us. That is very high margin for us, and of course, it's going to track what Fed funds do. If we stay in a market that's higher for longer, then we expect that revenue component to grow because we expect our float will grow as our payment volume grows, and we definitely believe that
Michael Perito (MD)
Okay
Aaron Graft (Founder, Vice Chairman, and CEO)
Will happen over the next 12 months.
Michael Perito (MD)
Yeah, that was more the question, is just, does the volume? Obviously, the rates are the rates, but does the volume, you expect that to continue to grow as your network transaction volume grows?
Melissa Forman (EVP and President of TriumphPay)
Yes, we do. Especially as we move further upmarket into the shipper participants, we would expect that to have exponential growth.
Michael Perito (MD)
Okay. Secondly, I wanted to ask, you know, Aaron, I thought some of your comments around credit stood out. You know, I appreciate that for you guys, it's less of a percentage of your business and what you're trying to become, but, you know, still impactful near term. You know, I did see that the non-performing assets ticked up, but it looks like the reserve didn't really change much. I was just wondering if you could give us some color about what you saw on the credit side and, you know, maybe near-term expectations around any provisioning or reserve build that we should just factor in as we model out the early part of 2024.
Brad Voss (EVP and CFO)
Yeah, I'll take that one. On the tick up in the non-performing assets, those particular assets happen to be so well-covered that there was no reserve required. That's the short answer to that question. As we continue to look forward, if there are additional credits that need to be downgraded, we'll go through the same analysis, but we're already stress testing the portfolio, and we feel very good about secondary sources of repayment.
Aaron Graft (Founder, Vice Chairman, and CEO)
Mike, if I can just add, if you go back and look at our shareholder letters from a year or two years ago, that was the time to make sure you were being vigilant on credit when the market was far more competitive than it is now. I would never submit to you that we got it perfectly correct, right? That doesn't happen. What I do know is because we weren't obsessed with growing our balance sheet, and because we know this market operates in cycles, we were very disciplined. We are very thoughtful when we take credit on our books, and I believe that will serve us well. So we have some things I'm sure we will work through in this cycle. Do I expect there to be material losses?
I do not, because I know how our team has approached that and the discipline we brought to it in a market when a lot fewer people were thinking about that. We're gonna have to navigate these waters, and something may surprise us along the way, but I feel very good about where we sit relative to the collateral position we have in our loan book and the underwriting we did, you know, the two years ago when a lot of these credits would have showed up.
Michael Perito (MD)
Right. Just lastly, I'm sure there's a question, so I won't ask too much here. Just on the factoring outlook near term, as you mentioned, Aaron, it sounds like there continues to kind of be incremental events in the industry that kind of give you guys the clarity that you think the recessionary kind of trends could continue for some time. Do you have any near-term outlooks or expectations around kind of invoice volume and average invoice size that we should be thinking over? Even if it's just directionally, kind of what you think that the current environment could mean for you guys as we think about the model?
Speaker 10
Mike, I'll take that one. We still see the freight market very soft. One thing that we look at very closely to monitor that is how the freight market is reacting to fuel. In the Q3, fuel increased significantly, where it took a long time for rates to actually catch up. We didn't see improvement in the rate until late in the quarter. Even still, in a vibrant market, those items or those numbers will move more in lockstep. We see increase in the average invoice amount, not so much as demand-driven, as more expense-driven through the fuel side of the business.
Michael Perito (MD)
Got it. Okay. I guess in high level, it's good. The EBITDA margin improvement on TPay comes at a nice time for you guys to be able to sustain investment in that business, even if the factoring business is a little light for the near term.
Okay. Thank you, guys. I appreciate all the color.
Speaker 10
You're welcome.
Operator (participant)
Our next question comes from Thomas Wendler from Stephens. Thomas, your line is open. Feel free to unmute.
Thomas Wendler (Analyst)
Hey, good morning, everyone.
Speaker 10
Good morning.
Thomas Wendler (Analyst)
I just wanted to go back to TPay. Can you give us an idea of what the critical mass for the network volume looks like, and then maybe how the conversations are going with moving some of the legacy pricing up close to that $5 per transaction target?
Melissa Forman (EVP and President of TriumphPay)
Yeah, I think I can take that, Aaron. You know, our projections for critical mass, you know, we think that what the industry needs is for us to be processing and hopefully making payments on one out of two brokered freight transactions, over-the-road transactions. Right now, we are touching about one out of three. So our goal is to continue to build out the network and bring on clients to get to that one of two position and then further beyond. In terms of the $5 per transaction pricing, all of our pricing models for new business have been updated to include the per transaction pricing.
However, there are always going to be some cases where we have to be creative in how we price deals to get them on board onto the network and the value that they create for all the participants. There's creativity that happens there. But there has been substantial progress made in repricing existing clients as well as holding pricing on the new business that we are chasing today.
Thomas Wendler (Analyst)
Great color. Thank you. Sticking with TPay, can you give us some color around the expansion of network participants into verification-only brokers? What does that opportunity look like with your audit-only clients?
Melissa Forman (EVP and President of TriumphPay)
Yeah, that's a beautiful question. I'm glad you asked it. As we have expanded our technology and capabilities, the point of conforming transactions or network transactions is to provide the data that factors need in order to do their verification, validation, and cash application processes. TriumphPay, while we're making, you know, a little over $21 billion in payments, we are touching over $47 billion in carrier spend. We have data associated with the audit-only brokers on our platform that are very valuable to the factoring industry.
Over the last, you know, couple quarters, we've been working on our technology to be able to include those data sets into the conforming transactions or network transactions, so that they begin to see the value and are able to utilize that data on the front end, even though the payment data, you know, is not attached to it.
Thomas Wendler (Analyst)
Perfect. Thanks for that. Just moving over to credit, you've seen there some increased fears around CRE, and I noticed an uptick in the loan modifications for CRE. Was there any theme behind the loan modifications, any specific group of loans? Are you expecting to see any more modifications moving forward?
Brad Voss (EVP and CFO)
Yeah, we did allude a little bit to that in the shareholder letter. The theme is that those are variable rate credits, and so when you have a variable rate credit that prices up 500 basis points in a short period of time, obviously that puts some borrowers at stress. We had to make modifications to address that. We ended up at a rate that is still okay. Our economics are not as good as we would love, but it allows those loans to continue to perform. There's still equity in those properties, so the borrowers are willing to work with us on a long-term basis.
We expect more of that to occur over the course of the next few months, as more and more of those variable rate borrowers are dealing with the reality of the new environment.
Thomas Wendler (Analyst)
All right. I appreciate you answering all my questions.
Aaron Graft (Founder, Vice Chairman, and CEO)
Thank you.
Operator (participant)
Our next question comes from Joe Yanchunis from Raymond James.
Joe Yanchunis (Senior Equity Research Associate)
Good morning.
Brad Voss (EVP and CFO)
Morning, Joe.
Joe Yanchunis (Senior Equity Research Associate)
Kind of on expenses, you mentioned in your shareholder letter that you expect 5%, you know, non-interest expense growth in 2024, absent any, you know, ramping of large clients. I was wondering if you could flesh that out, that growth by different segments for payment factoring, community bank and corporate?
Aaron Graft (Founder, Vice Chairman, and CEO)
Bulk of the incremental spending that you'll see next year is likely to be in the payment side. You'll see a little bit in corporate, but I would probably couch it as 60% corporate, or excuse me, 60% payments, 40% corporate, roughly.
Joe Yanchunis (Senior Equity Research Associate)
Okay, perfect. Whether through deepening customer penetration or the onboarding of new brokers, you know, how much annualized payment volume is contracted to come onto the network in the next 6-12 months?
Melissa Forman (EVP and President of TriumphPay)
Yeah, the way I would describe that for you, Joe, is, you know, we speak only about brokers that are in active integrations. Those that are contracted and in active integrations represent, that's come onboard in Q2, Q3, and then what we expect to onboard in Q4, represents approximately $9 billion in annualized carrier payments amongst all of them. Some of them, they've been onboarded, and they're in their ramp-up stage, again, which takes 6-12 months for them to typically fully ramp.
Joe Yanchunis (Senior Equity Research Associate)
All else equal, if no other brokers or factors sign up on the network, you would have $9 billion in, you know, incremental volume. Okay. And then-
Melissa Forman (EVP and President of TriumphPay)
Assuming, Yeah-
Joe Yanchunis (Senior Equity Research Associate)
Lastly, just.
Melissa Forman (EVP and President of TriumphPay)
Assuming market conditions remain the same. Yeah, right.
Joe Yanchunis (Senior Equity Research Associate)
Of course. For TPay, you've announced a lot of major wins on the broker side, but we haven't seen the same type of momentum on the factoring side. You know, I think at this point, the quickest way to increase the network transaction penetration, which looks to be about 6% of all invoices in the quarter, would be to add some large factoring companies. Can you discuss the progress on that front and, you know, when we might see some large wins there?
Aaron Graft (Founder, Vice Chairman, and CEO)
Let me take that one. We allude to it if you read the factoring section of this letter. The gating issue, in my opinion, towards driving greater factor participation in the network has, to date, been the fact that we were making one out of every six payments to them, and then we were making one out of every four, or providing network data on one out of every four, and now we're at one out of every three. I believe a day is coming, sooner rather than later, where it will be one out of every two. Once you get to that level of penetration, factoring companies now can start to use your technology to change their processes. I mean, that is the brand promise that TriumphPay makes to the factoring industry.
If you look at our own factoring subsidiary, it costs us roughly $6 to do the back-office processing per invoice, and that's a generalization because it depends on whether it's a large fleet, a small carrier, but let's just use $6 as a good approximation. We need to, for our own benefit and for every other factor we want to join the network, we need to be able to demonstrate we can get that price down to $3. I mean, that would be a tremendous margin pickup for them. Well, you aren't going to be able to do that if you don't make a significant amount of their payments or provide a significant amount of audit data for conforming transactions. We are closing in on that mark.
The second gating issue is there is required technology improvement in most factoring management systems for them to be able to ingest load data before an invoice is created. No FMS was ever built to do that. Our own FMS had to be improved to be able to ingest that data. One of the things we talk about in this letter is we are thinking through how we can offer to the factoring industry the ability, some of the technology we have built and the operational expertise we have, so that they can more easily ingest that data, so that they can pick up the cost savings that is the brand promise of TriumphPay. It's the cost savings and the assurance of the validity of the invoice. That is our promise to them. We are delivering on that.
It's a very fair question, Joe. I think it comes in a much faster rate after we achieve that 50% penetration that Melissa alluded to, and we are working towards that.
Joe Yanchunis (Senior Equity Research Associate)
All right. Well, thank you much for taking my questions.
Aaron Graft (Founder, Vice Chairman, and CEO)
Sure.
Operator (participant)
As a reminder, if you have a question, feel free to use the raise hand feature, which can be found at the bottom of the Zoom application. And if you've joined us by phone today, you may dial star, nine. Our next question comes from Gary Tenner from D.A. Davidson. Gary, please go ahead. Thanks.
Gary Tenner (MD and Senior Research Analyst)
Thanks. Morning, everybody.
Aaron Graft (Founder, Vice Chairman, and CEO)
Morning, Gary.
Gary Tenner (MD and Senior Research Analyst)
Aaron, I wanted ask, you know, your comments in the letter regarding your pessimism or bearishness about the freight industry, you know, didn't sound like it was, you know, universal, but certainly your view of the world. As you looked at the data from, say, DAT, you know, you've seen spot rates for, you know, van spot rates move up a little bit from the summer lows. But over the last couple of weeks, after moving a little higher, the van load or load-to-van ratio seems like it's fallen a little bit. I mean, is that more recent data, is that kind of really big driver of your view going forward and the lack of capacity coming out of the system?
Aaron Graft (Founder, Vice Chairman, and CEO)
Yeah, I wouldn't tie it to that. That's just one data point. I start with the point, Gary, that I think any of us in the industry begin with the hope that we're wrong, right? We all want the industry to return to 2022 levels. Although, I think any of us who lived through that would acknowledge, I don't know that that was particularly healthy either. It was very profitable in the short term, in 2021 and in that time period. What I look at is, normally in this part of the season, you would see invoice, the spot rates moving, and those moves would certainly pick up a movement in diesel costs. Because if you think about what the spot rate is, it's just marking to market every night.
It's marking to market capacity, it's marking to market input cost, of which diesel is a very large one. At this point in the season, if we believe all that has been written about retailers are at the end of the destocking phase, that, you know, we went through this bullwhip effect, that some people were very right on, that of why the market got so tight for a while. If we believed we were coming to the end of that, we would see the spot rates more sensitive to the input costs in the system. We are not seeing that. That plus just all of the things we see, just leads me to believe we have excess capacity in the system. I would think that many, a very significant number of small carriers are unable to earn their cost of capital, taking spot rate loads right now.
Of course, there are exceptions if you're in a certain lane, but on the whole, I believe that to be true, and that is why you're seeing the attrition in our own factoring client base. That's why I think you're seeing softness across the market. My view is, it is what it is. What is it? I think the freight has not rebounded to the point where most carriers can earn their cost of capital, which means we need capacity to leave the system in order to recreate equilibrium. Hope we're wrong. I don't think we are. How long it takes to do that? There will be catalysts. You know, if you think about what's happened in the last few days with the announcements we've referred to, it seems like these things always start slow at first, and then they accelerate.
It may be that the industry recalibrates more quickly than I would expect. Right now, my own personal view is this takes the next 12 months for the industry to sort itself out and achieve equilibrium.
Gary Tenner (MD and Senior Research Analyst)
Appreciate that. Since you just kind of alluded to, you know, recent news and that Convoy wind down, I don't know that particular company particularly well, but was there anything, you know, what my understanding is they were a carrier that was kind of tech-enabled, but was there anything they were doing that you think was particularly interesting and that kind of plays into your longer-term view of the freight industry?
Aaron Graft (Founder, Vice Chairman, and CEO)
I think Convoy built tremendous technology. They were exceptionally talented and smart people. The problem that they and some of these other tech-enabled brokers have is that in order to go from just traditional brokerage. Like, if you think about what was traditional freight brokerage? It was contracting with shippers to move loads, and then using people and using phones to find carriers to haul those loads and make a 15% margin. Beautiful business model, highly scalable. A lot of freight brokers have done exceptionally well with that. Take the last 10 years, there has been this move to, "We should create digital freight marketplaces," and conceptually, I don't disagree with that. I think the idea is right. The execution is exceedingly hard.
It's exceedingly hard to get the scale and bring in all the dynamics that get priced into this very vibrant, very hard-to-predict trucking industry that is attached to the global supply chain. It's just hard. I think Convoy did great things. I think there are many other tech-enabled freight brokers who have built really cool technology. At the end of the day, cool technology and really good marketing will not make up for the inability to earn your cost of capital. This market, and where the capital markets are, has brought that to bear, and we've known that. None of us are surprised that this day is coming. We didn't know exactly when. We didn't know exactly what would cause it. It's our job at Triumph, because we've had freight brokers as our counterparties in our factoring business for over a decade.
Frankly, since the inception of our factoring business back in 2004, before we even bought it, it's our job to think about not who has the best technology or, you know, has the best user interface. It's who can afford to repay us when payment is due. That is a banking discipline, and that is a discipline we have never forgotten, because we know what it's like when it goes the other way. I suspect there will be some more. I suspect this technology will live on and will improve the industry for all of us. I hope that these really talented people I've gotten to know will land places and continue to make the freight industry better. It's just you have to do this. You have to build things.
For us, with TriumphPay, you have to build it in a way that when the market inevitably turns against you, you can afford to keep making investments, and that is a discipline we take very seriously.
Gary Tenner (MD and Senior Research Analyst)
I appreciate your thoughts on that. I'll just throw in one last really quick question, follow-up on the expense question. Really thinking about the Q4 and kind of modeling the jumping-off point there from a segment perspective, the return or normalization of expenses in the Q4 closer to the Q2, I assume that's similarly weighted towards the payments segment?
Brad Voss (EVP and CFO)
I would expect the.
Gary Tenner (MD and Senior Research Analyst)
Is that accurate?
Brad Voss (EVP and CFO)
Q4 to look pretty similar, Gary, to the Q2 across each of our segments.
Aaron Graft (Founder, Vice Chairman, and CEO)
Gary, one thing, if I may add on that. Those expenses, and I think we're all in a cycle where talking about expense control is appropriate, and that's what we should be talking about. Understand that those expense spikes that we sometimes have in TriumphPay that are tied to the onboarding of a large freight broker are the best kind of expense, because that is an investment in a long-term contractual relationship. We take a lot of that expense, not all of it, but we take a significant amount of that expense up front, and we have yet to have a large freight broker ever leave our ecosystems. The duration of those relationships is proving to be very long, and every quarter we go forward and do more for these customers, the relationship gets deeper. We want to be thoughtful about expenses.
We don't take it lightly. Those specific spikes, that part of the expense base, I will take all day, every day, because I know over the long term, it creates a lot of value for us.
Gary Tenner (MD and Senior Research Analyst)
Fair enough. Thanks, Aaron.
Aaron Graft (Founder, Vice Chairman, and CEO)
Thank you.
Operator (participant)
Our next question comes from Hal Goetsch from B. Riley Securities. Hal, please go ahead.
Hal Goetsch (Senior MD and Head of Fintech & Financials)
Hey, guys. Just wanted to ask about the core banking side of the business. You've been true to your word in not really growing the asset side of the balance sheet. One of the areas where it does appear to have grown is the commercial real estate year-over-year, and I just wanted to get your feel on, are you just seeing some great conditions right now to make some good loans to very selective opportunities for your team in that banking segment? Love your thoughts on that.
Brad Voss (EVP and CFO)
Yes, I think you characterized it really well. There are a lot of opportunities out there. Not all of them have adjusted to the new realities of this interest rate environment and this economy, but some have. Where we see, you know, really strong tenants, really strong borrowers, great risk-adjusted returns, we are still open for business, and we will continue to be so. Yes, that's what drove the growth last quarter.
Hal Goetsch (Senior MD and Head of Fintech & Financials)
Okay. Thanks, you guys asked all my questions. Thank you.
Aaron Graft (Founder, Vice Chairman, and CEO)
Thank you.
Operator (participant)
There are no other questions on this line at this time. Thank you.
Aaron Graft (Founder, Vice Chairman, and CEO)
Assuming that was my invitation to conclude the call. We thank you all for joining us today. We appreciate your attentiveness and interest in what we are doing, and we look forward to speaking with you soon. Have a great day.