FinWise Bancorp (NASDAQ:FINW) Q4 2023 Earnings Call Transcript

FinWise Bancorp (NASDAQ:FINW) Q4 2023 Earnings Call Transcript January 29, 2024

FinWise Bancorp beats earnings expectations. Reported EPS is $0.32, expectations were $0.3. FINW isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Greetings, and welcome to FinWise Bancorp Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation [Operator Instructions]. As a reminder this conference is being recorded. At this time, I would now like to turn the floor over to the FinWise Bancorp team. Thank you. You may begin.

Unidentified Company Representative: Good afternoon. And thank you for joining us today for FinWise Bancorp’s fourth quarter 2023 conference call. Earlier today, we filed our earnings release and posted it to our investor Web site 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 and President of FinWise Bancorp; Jim Noone, President of FinWise Bank; and Javvis Jacobson, Chief Financial Officer. With that, I will turn the call over to Kent.

Kent Landvatter: Good afternoon, everyone. And thank you for joining us on our fourth quarter 2023 earnings conference call. 2023 was another successful year as our differentiated business model, coupled with a disciplined approach and strong execution, continued to demonstrate resilience. We produced solid loan originations and delivered positive returns. Specifically, for the fourth quarter, we had approximately $1.2 billion in loan originations. Credit quality continued to perform as expected and generally in line with industry trends, notwithstanding an increase in nonperforming loans in the fourth quarter. This increase was driven primarily by the continued impact of higher rates on our SBA loan portfolio. While our collateral and portfolio management processes continued to serve us well, the level of net charge-offs increased quarter-over-quarter.

We continue to feel positive about the SBA portfolio, its growth and credit characteristics and the level of net charge-offs at the bank, which have been generally in line with our expectations. Turning to capital. At the end of the fourth quarter, our bank leverage ratio remains significantly above well capitalized regulatory guidelines, which we believe provides us with sufficient capital to continue to support growth. Tangible book value per common share also continued to increase this quarter. I would now like to provide a brief update on our key objectives for 2024 and beyond. Our previously communicated strategy of expanding into an integrated Banking as a Service bank or BaaSBank, continues to make meaningful progress. To that end, we are very excited about our Payments Hub and BIN Sponsorship platforms, which are expected to be operational later in the year.

This provides us with key pieces for an integrated BaaS offering. We firmly believe that an integrated BaaS infrastructure, coupled with the strength of our regulatory due diligence and oversight functions, are key differentiators in the market. Longer term, we also believe this expansion could create stickier relationships with our strategic platforms and offer multiple benefits to our business model. These could include additional recurring revenue, diversifying both revenue and deposit composition, more tools to manage our cost of funds through relationship banking and providing additional flexibility to manage our loan mix. This past quarter, we also completed an internal core system conversion as part of our overall business evolution.

We believe this conversion should increase our operational efficiency and better position us to meet the needs of our growing organization. Our team worked diligently to complete this process by quarter end, and I want to thank them for their effort. Turning to our SBA 7(a) loan program. We are pleased that the business continues to grow and perform as we expected, particularly amidst the higher rate environment that these credits have been managing through. While some market participants expect a potential economic soft landing, we believe uncertainties remain, at least through the first half of 2024, which could impact industry wide loan originations across all the bank’s lending products. The external environment, notwithstanding, we will remain disciplined and continue to actively manage areas of the business we can control, including our strict underwriting and collateral management processes.

As we move ahead, we believe we’re at an inflection point in the evolution of our model with the potential to enhance the company’s long term earnings power. We plan to continue our efforts to expand the business towards an integrated BaaS offering coupled with continued focus on our existing lending programs. In line with our culture, we will be patient and disciplined in our approach to rolling out the new businesses and expect the benefits to accrue over time. With that, let me turn the call over to Jim Noone, our Bank President.

Jim Noone: Thank you, Kent. I will now walk through some additional detail on the quarterly originations, the growth and performance of our loan portfolio and credit quality and then discuss progress on our business initiatives. Total loan originations were $1.2 billion in Q4 versus $1.1 billion in Q3. Our fintech lending continued a gradual recovery in origination levels during the fourth quarter. Our SBA 7(a) loan originations during the fourth quarter were lower on a sequential quarter basis, primarily due to reduced application demand for the types of transactions we generally finance as well as our continued adherence to disciplined underwriting. We did not chase loan volume as we always focus on balancing loan growth with credit quality.

And as a result, we saw our SBA pipeline contract some quarter-over-quarter. Moving to our portfolio. Our growth in earning assets has continued according to plan. We continued to retain the guaranteed portion of our SBA loans, given the current dynamics where the underlying note rates remained high and secondary market loan sale premiums remained low. On a sequential quarter basis, the 17.1% increase in guaranteed balances of our SBA loans was the primary driver of the 10.2% growth in total loans held for investment. Overall, we continue to be successful in identifying and funding creditworthy businesses in both our SBA and leasing lines, and both contributed meaningfully to our growth in earning assets. Turning to credit quality. The provision for credit losses was $3.2 million in Q4 compared to $3.1 million in the prior quarter.

The sequential increase in provision was driven primarily by strict adherence to our CECL methodology, an increase in net charge-offs in our SBA portfolio and an increase in the qualitative factor overlay that was implemented during Q3 and which remained in place due to the increase in special mention, nonaccrual and nonperforming assets. During Q4, net charge-offs were $3.4 million compared to $2.2 million in the prior quarter. The increase was primarily related to our SBA portfolio. As a reminder, during Q3, we had a large recovery of $390,000. The net charge-off rate as a percentage of average loans held for investment was 3.8% in Q4 compared to 2.8% in the prior quarter. We continue to believe we are well reserved for potential loan losses with an allowance as a percentage of total loans held for investment of 3.5% at the end of Q4.

Nonperforming loans at the end of Q4 were $27.1 million compared to $10.7 million at the end of the prior quarter. Of the $27.1 million, $15 million is guaranteed by the SBA and $12.1 million is the balance of loans, which do not carry SBA guarantees. The increase in NPLs versus the prior quarter related primarily to our SBA portfolio as this program continued to be impacted by the higher interest rate environment. As a reminder, our SBA note rates adjust calendar quarterly based on a spread over the Wall Street Journal prime rate in place at quarter end. We expect to see additional increases in our NPL balances while the prime rate remains elevated. Further, while $12.1 million of our NPL balances do not carry SBA guarantees, we believe our strict collateral policies in this portfolio should continue to help mitigate net charge-offs.

Finally, let me give you an update on our business initiatives. Within strategic program lending, we executed program agreements with Earnest, a subsidiary of Navient and a leader in the private student lending market. We are humbled by the trust and the team in Earnest placed in FinWise to support their growth plans and believe this is a testament to the strength of our offering in the market. We look forward to working with the Earnest team and welcome them to the FinWise family. We are also quite proud of our continued investment in the compliance and risk management infrastructure at the bank. We believe this focus, which is at the core of our offering, is embedded in our systems, processes and culture and allows us to continue to provide strong support to our Fintech lending platforms.

Lastly, in anticipation of our further expansion into BaaS, we continued to make progress on our Payments Hub and BIN Sponsorship products. As Kent mentioned earlier, we anticipate them being operational later in the year. We will continue to provide you with additional details on these initiatives as certain milestones are achieved. Now, let me turn the call over to our CFO, Javvis Jacobson, to provide more detail on our financial results.

Javvis Jacobson: Thank you, and good afternoon. For the fourth quarter, we generated net income of $4.2 million or $0.32 per diluted common share. We posted solid profitability with a return on average assets of 2.9% and a return on average equity of 10.8%. These results were achieved while continuing to invest in infrastructure to support growth in key strategic initiatives. Average loan balances comprising held for sale and held for investment loans were $396.2 million during the quarter compared to $354.6 million last quarter. This increase was primarily driven by continued growth in our SBA 7(a) and commercial loan programs. Average interest bearing deposits were $303.4 million compared to $255.8 million in the prior quarter.

The sequential quarter increase was driven primarily by an increase in brokered certificates of deposit. As of the end of the quarter, approximately 87% of the bank deposits are either insured or our own capital or are contractually required in our strategic lending business. Now turning to the income statement. Net interest income for the quarter was $14.4 million, nearly flat versus last quarter. Positively, the increase in average balances of loans held for investments substantially offset the impact of higher interest rates and average interest bearing liability balances. Net interest margin was 10.61% this quarter compared to 11.77% last quarter. Decrease was mainly due to a loan mix shift towards loans carrying lower yields in the held-for-investment portfolio and an increase in the volume of CDs. Noninterest income was $6 million in the quarter compared to $5.2 million in the third quarter.

The quarter-over-quarter increase was primarily due to the change in fair value of our investment in BFG, partially offset by a decline in other miscellaneous income related to the resolution of a forbearance agreement last quarter, resulting in income, which did not recur in Q4. Noninterest expense in Q4 was $11.4 million compared to $10.1 million in the prior quarter. The sequential quarter increase was primarily driven by an increase in salaries and employee benefits due to an increase in the headcount as well as higher professional service expenses as we continue to build out infrastructure to accommodate our growth. The efficiency ratio was 55.8% in Q4 compared to 51.3% for the prior quarter. We continue to expect the efficiency ratio to remain elevated as we further build out our infrastructure to move forward with our strategic initiatives that position the company for long term growth.

With a 20.7% leverage ratio, the bank’s capital remained significantly above the 9% well capitalized requirement. The company’s tangible book value per common share continued to increase to $12.41 compared to $12.04 at the end of the prior quarter. Lastly, the effective tax rate was 28.5% for Q4 compared to 26.1% in the prior quarter. With that, we would like to open the call for Q&A. Operator?

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Q&A Session

Operator: [Operator Instructions] Our first question comes from the line of Andrew Terrell with Stephens.

Andrew Terrell: Maybe if I could start just on credit quality. Any allowance? I guess, I was surprised to see a modest move down in the allowance this quarter, just given we did see a lift in the nonperformers. And Jim, I appreciate the commentary. I think about $15 million of the NPLs are guaranteed by the SBA. It looks like if I back that $15 million out, you’re essentially in your allowance covered one for one on NPLs versus kind of the non-guaranteed portion. I guess, one, is that fair? And then number two, if charge-offs are running at, call it, 3.8% or so this quarter, why not build the reserve to a level kind of higher than 350 basis points?

Jim Noone: So let me just kind of piece that apart quickly. So yes, generally, the reserve at the end of the quarter is going to be slightly higher than that $12.1 million unguaranteed balance — unguaranteed NPL balance, but it’s close, right? It’s like 12.9 in the reserve versus 12.1 in unguaranteed NPL balances. And then just as far as the — like the trend this quarter, the NPL balances were up. The primary figure to point out is the unguaranteed balances increased by $6.1 million in the quarter. That was similar to the $6 million incremental increase in unguaranteed NPL balances that we saw in Q3, and that quarterly increase was primarily attributable to the SBA portfolio, Andrew. It’s really a repricing issue. Remember, these are adjustable rate loans that reprice on a calendar quarterly basis, and the speed of those rate increases has been impacting that portfolio.

So we’ll expect to see continued normalization here until the prime rate starts declining. But then your question about the ACL rate, really, there’s two reasons there. First is we’ve been disciplined in our CECL methodology and then the second is because it is a lower risk portfolio than the same time last year. It’s lower risk because of the remixing of the portfolio that’s happened throughout 2023. And the two examples that I’d give you are the SBA guarantee balances are now 35% of the portfolio versus 21% at the end of last year. And then the SP HFI balances, which carry a much higher reserve rate that’s the fintech lending balances that we retained have declined from about 10% of the portfolio to about 5% of the portfolio over the last year.

So that’s why that 3.5% figure on the ACL reserve is the right figure for the current portfolio.

Andrew Terrell: I guess there’s a lot of moving pieces there and then I wasn’t totally contemplating the kind of positive credit mix shift seen throughout the year. So that makes sense. I appreciate it. If I could ask on just loan origination volumes. It was good to see a little bit of a step up in the fourth quarter. Can you remind us any kind of seasonality within any of your businesses, specifically some of the larger partners in the fourth quarter? And then just kind of outlook as you look into 2024 from an origination perspective, does it feel like we’ve kind of hit a relative trough here or we could still see some modest declines moving forward?

Jim Noone: So on the seasonality piece, that’s been pretty difficult for us to get a baseline on just over the last couple of years, because there’s been so much movement both on the upside and then with some of the larger partners on the downside. So really pulling out the seasonal factor is hard for us to do. But just generally on the originations in the quarter that rebound in demand that we saw from the Q1 origination levels was a little more sustained than we expected. Originations were up a little quarter-over-quarter and generally stable over the last three quarters. We would just point out, it’s still too early to say that it’s likely to continue at that level throughout 2024. And then the reason is that delta from Q1 is mostly related to a sustained rebound from the one program we spoke about in Q2. And we don’t see broad enough strength across all of our platforms and just the industry in general to change our outlook there.

Andrew Terrell: If I could maybe just take your temperature on — or maybe just wanted to maybe appreciate your line of taking around retaining incremental strategic program, credit that’s being generated today. It feels like there’s maybe a broader narrative in the market today, the late ’23 or current origination vintage paper might end up being some of the better performing from a credit standpoint, just as underwriting has tightened with higher rates relative to prior years. So Jim, I’d kind of appreciate your thoughts on that kind of narrative in the market, one, do you agree? And then any appetite right now? I know you’re seeing a lot of success in the SBA business, and it’s really driving higher spread there. Any appetite to bolster the strategic program portion of the loan portfolio?

Jim Noone: So the loan composition that we’ve been trending towards or that you’ve seen over the last, call it, year, Andrew, I think you should continue to expect from us over the next few quarters. I don’t think you’ll see any material change there. The SP HFI portfolio has been fairly stable as far as dollar balances over the course of the last year. When you — the question that you had about vintages, it’s hard to answer like succinctly. And the reason is it varies across programs. There are programs where I would say generally, yes, mid-22 vintages to make a general statement are some of the — they’re worst performing generally than what you saw kind of Q1, Q2 of ’23. And I think a lot of the reason for that is the tightening in underwriting, but it varies markedly across programs. And just as far as outlook from us and our portfolio, I don’t think that you’ll see anything different over the next few quarters as far as our strategy.