First Internet Bancorp (NASDAQ:INBK) Q2 2024 Earnings Call Transcript

First Internet Bancorp (NASDAQ:INBK) Q2 2024 Earnings Call Transcript July 25, 2024

Operator: Good day, everyone, and welcome to the First Internet Bancorp Earnings Conference Call for the Second Quarter of 2024. At this time, all lines are in a listen-only mode. Following the presentation we will conduct a question-and-answer session. [Operator Instructions] This call is being recorded on Thursday, July 25, 2024. I would now like to turn the conference over to Larry Clark from Financial Profiles, Inc. Please go ahead, Mr. Clark.

Larry Clark: Thank you, Lara. Good day, everyone, and thank you for joining us to discuss First Internet Bancorp’s financial results for the second quarter of 2024. The company issued its earnings press release yesterday afternoon, and it’s available on the company’s website. In addition, the company has included a slide presentation that you can refer to during this call. You can also access these slides on the website. Joining us today from the management team are Chairman and CEO, David Becker; and Executive Vice President and CFO, Ken Lovik. David will provide an overview, and Ken will discuss the financial results. Then we’ll open up the call to your questions. Before we begin, I’d like to remind you that this conference call contains forward-looking statements with respect to the future performance and financial condition of First Internet Bancorp that involve risks and uncertainties.

Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in the company’s SEC filings, which are available on the company’s website. The company disclaims any obligation to update any forward-looking statements made during this call. Additionally, management may refer to non-GAAP measures, which are intended to supplement, but not substitute for the most directly comparable GAAP measures. Press release, available on the website, contains the financial and other quantitative information to be discussed today, as well as a reconciliation of the GAAP to non-GAAP measures. At this time, I’d like to turn the call over to David.

David Becker: Thank you, Larry. Good afternoon everyone, and thanks for joining us today as we discuss our second quarter 2024 results. To bring forward our commentary from last quarter, most of you will recall that three quarters ago we called the bottom. In late October, we predicted the third quarter of 2023 would mark the low point for net interest margin and net interest income. We also estimated net interest margin would turn higher from there regardless of whether or not and at what pace the Federal Reserve chose to start reducing short-term interest rates. Since then we have reported three consecutive quarters of double-digit earnings growth and improved profitability, driven in large part by the recovery in our margin and the growth in net interest income that we have projected.

This quarter results continue to demonstrate the meaningful progress we have made repositioning the loan portfolio, optimizing our overall balance sheet mix and further diversifying our revenue base while keeping deposit costs in check and improving our interest rate risk profile. Starting with the highlights on Slide 3, I would like to discuss some additional key themes for the quarter. As I just noted, we continue to transition the composition of our loan portfolio and optimize both sides of the balance sheet. We have had strong deposit growth through the first half of the year and we were able to deploy a portion of that liquidity to pay down a significant amount of higher cost broker deposits while also funding net loan growth of $51 million, or over 5% on an annualized basis.

The new funded loan origination yields were 8.88%, up 4 basis points from the first quarter and up 46 basis points from the second quarter of 2023. The yield on the overall loan portfolio increased 10 basis points from the first quarter, while deposit costs only increased 4 basis points. As a result, net interest income was up almost 3% and fully taxable equivalent net interest margin was up 1 basis point over the prior quarter. Compared to the third quarter of last year when we believe these metrics hit their low, net interest income for the second quarter was up 23% and net interest margin has expanded by 27 basis points. With our emphasis on improving the composition of the loan portfolio and stabilizing deposit prices, we remain confident that net interest income and net interest margin will trend higher for the back half of this year, which is consistent with the guidance we issued earlier this year.

Notably, I would remind you our estimates are based on short-term rates remaining flat through the end of the year. If we do get a cut from the Fed this year, and it’s looking increasingly likely that we will, that would only serve to improve our results. The continued performance of our SBA business has been a key driver in our efforts to reposition the loan portfolio and diversify revenue streams. The team continued to perform exceptionally well, delivering strong production and another record quarter of gain on sale. Compared to the first half of 2023 year-to-date SBA originations were up 15% and solid loan volume was up 58%, demonstrating the tangible results in the investment we have made in providing growth capital to entrepreneurs and small business owners throughout the country.

Small business pipeline continues to flourish and currently we are the sixth largest SBA 7A lender in the country year-to-date for the SBA’s 2024 fiscal year. Congratulations to our SBA team on another standout quarter. It is a combination of all these efforts, solid loan growth, net interest income growth, net interest margin expansion and non-interest income powered by record gains on sale revenue that drove an 11% increase in total revenue over the prior quarter, a third consecutive quarter of positive operating leverage and continued improvement in operating efficiency and profitability. The growth of our SBA business has also helped us to further diversify our revenue base, with noninterest income comprising nearly one third of our total revenues for the first half of this year, compared to just under one quarter of total revenues for the comparable period last year.

Credit quality remains healthy, with nonperforming loans to total loans at 33 basis points and nonperforming assets to total assets at 24 basis points at quarter end, both of which were relatively consistent with the first quarter. Net charge-offs remain relatively low at 14 basis points, mostly from the franchise finance and the small business portfolios. To provide an update on a topic from last quarter’s call, we continue to monitor and work to reduce our Red Lobster exposure as a result of its Chapter 11 bankruptcy filing. We have reduced our outstanding balances by $3 million in the second quarter. The average loan to value of these loans remains low at 52% and importantly, we have not experienced any delinquencies related to these properties.

As it relates to current industry concerns around office space, our exposure to office commercial real estate remains less than 1% of our total loan portfolio and does not include any central business district exposure. A key measure of shareholder value creation is growth in the tangible value per share. Ours increased over 1% during the quarter and is up over 6% year-over-year. Since 2018 First Internet has grown tangible book value per share in excess of 50% compared to an average of around 30% for all publicly traded banks. We are among just a small handful of banks that have grown tangible book value per share in each of the past five years, which is also in part a testament to our prudent balance sheet management and operational discipline through a very challenging period for the banking industry.

As a result of our continued improvement in operating performance, we reported net income of $5.8 million, up 11.5% and diluted earnings per share of $0.67, up 11.7% from the first quarter. Excluding $600,000 of non-reoccurring expenses, adjusted net income was $6.2 million and adjusted diluted earnings per share was $0.72. On an adjusted basis, this marks the third consecutive quarter of earnings growth in excess of 20%. I do not believe there are too many other banks that can make this statement and we are well ahead of other reporting banks thus far this quarter, with average growth rates in the low single digits. Turning to Slide 4, I will spend a couple minutes discussing our lending activity during the quarter. We produced solid overall loan growth in the quarter, led by our commercial lending teams where balances were up $47 million from the first quarter, or over 6% on an annualized basis.

Consistent with prior quarters, we produced growth in investor, commercial real estate, small business and franchise loans. Our construction team had another solid quarter originating over $115 million of new commitments, while quarter end balances were impacted by early paydowns. Average construction loan balances were up 16% compared to the first quarter as borrowers drew on existing lines to fund their projects. At quarter end, total unfunded commitments in our construction line of business were $529 million. Borrows on these lines in the upcoming months will play a meaningful role in the continued shift of our loan portfolio towards higher yielding variable rate loans. Additionally, the construction team sourced new deals in investor commercial real estate as those balances increased $60 million during the quarter.

However, one particular larger deal closed very late in the quarter, therefore had very little benefit to interest income for the quarter, yet was fully reserved for in the provision for loan losses. On the consumer side, balances were up modestly as new originations in our specialty consumer channels rebounded from the seasonal low during the winter months. We focus on super-prime borrower in our consumer lending and rates on new production were in the mid-8% range, consistent with the first quarter. Furthermore, delinquencies in these portfolios remain low at just 1 basis point of total loans. Before I turn the call over to Ken to cover our results in more detail, I want to provide an update on our fintech partnerships. We believe these partnerships are vital to the evolution of financial services.

We are committed to fostering these relationships to develop innovative solutions to the market, while also enhancing shareholder returns. As I mentioned last quarter, this isn’t a new concept for us, we have over 20 years of partnership experience, always with a focus on quality over quantity. Our total revenue for this line of business continues to grow and is up 300% for the first half of 2024 compared to the same period last year, and we expect to see further growth in the second half of the year. To wrap up my comments, we continue to deliver improved performance in the second quarter. We entered the second half of the year with momentum and confidence, liquidity and credit quality remains strong and capital levels are sound. With the continued evolution of our loan portfolio mix and stabilized deposit pricing, we believe we are well positioned to continue to achieve higher earnings and improve profitability for the remainder of 2024 and beyond.

Finally, I want to personally thank the entire First Internet team for their hard work and contributions towards our strong results. Our success is driven by their unwavering commitment to our four core competencies, customer focus, teamwork, adaptability and initiative. Now I’ll turn the call over to Ken for more details on our financial results for the quarter.

Ken Lovik: Thanks David. As David covered the loan portfolio, let’s turn to Slides 5 and 6 where I will cover deposits in more detail. While the average balance of deposits increased by over $185 million, or 4.7% during the second quarter, period end deposits were essentially flat with the quarter-over-quarter. Similar to the first quarter, we experienced continued growth in CDs and FinTech partnership deposits and used a portion of the liquidity provided by this growth to pay down $139 million of higher cost brokered deposit balances. Non-maturity deposits were up almost $55 million, or 2.8%, driven by increases in FinTech partnership deposits. Deposits from our FinTech partners, including those classified as broker deposits were up 34% from the first quarter and totaled $375 million at quarter-end.

Additionally, these partners generated almost $8.5 billion in payments volume, which was up 40% from the volume we processed in the first quarter. Total FinTech partnership revenue was $582,000 in the second quarter, down slightly from the linked quarter, with the majority of this revenue consisting of recurring interest income, oversight and transaction fees. Related to CD activity during the quarter, total balances were up $91 million from the linked quarter, driven by continued strong demand in the consumer channel. We originated $404 million in new production and renewals during the second quarter at an average cost of 4.97% in a weighted average term of 19 months. These were partially offset by maturities of $345 million with an average cost of 4.88%.

Looking forward, we have $397 million of CDs maturing in the third quarter of 2024 with an average cost of 5.05%, and $224 million maturing in the fourth quarter with an average cost of 5.03%. So assuming new production rates remain in line with those in the second quarter, we have reached an inflection point on CD pricing, which should contribute heavily to stabilizing and perhaps even reducing deposit costs in future periods under a higher for longer rate environment. Should the Fed begin to lower interest rates, there is potential for added benefit, but again, the commentary I provided is not dependent on that. Moving to Slide 6, at quarter-end, total liquidity remains very strong as we had cash and unused borrowing capacity of $1.7 billion.

As mentioned a moment ago, we deployed some of the liquidity provided by deposit inflows to pay down higher cost broker deposits as well as to fund loan growth and securities purchases during the quarter, with total loan balances up about $51 million. While deposit balances were flat quarter-over-quarter, the loans to deposit ratio increased modestly to 92.7% from 91.5% at the end of the first quarter. At quarter-end, our cash and unused borrowing capacity represents 150% of total uninsured deposits and 197% of adjusted uninsured deposits. Turning to Slide 7 and 8, net interest income for the quarter was $21.3 million and $22.5 million on a fully taxable equivalent basis, up 2.9% and 2.6%, respectively from the first quarter. The yield on average interest earning assets increased to 5.54% from 5.45% in the linked quarter, due primarily to a 10 basis point increase in the yield earned on loans and a 21 basis point increase in the yield earned on securities, partially offset by an eleven basis point decline in the yield earned on other earning assets.

The higher yields on interest earning assets combined with the growth in average loan and securities balances produced solid top line growth in interest income, increasing over 4% compared to the linked quarter, factoring in growth in average interest bearing deposit balances and a modest increase in the cost of deposit funds. Net interest income was up almost 3% during the quarter, building on last quarter’s increase and further distancing us from the low point of the third quarter of 2023 as shown in the bar chart on Slide 7. Net interest margin for the first quarter was 1.67% and 1.76% on a fully taxable equivalent basis, both increases of 1 basis point from the first quarter. The net interest margin roll forward on Slide 8 highlights the drivers of change in fully taxable equivalent net interest margin during the quarter.

One item I would like to point out on this chart related to the impact of deposits in the quarter is that the impact is really more a factor of volume than it is rate. That is, as I mentioned earlier, average interest bearing deposits were up over $185 million during the quarter, whereas average loan balances were only up $44 million. The pace of increase in net interest income and net interest margin was down compared to the past two quarters due primarily to lower growth in average loan balances as we experienced both early payoffs and later than expected funding of some larger balanced loans. Specifically, we saw paydowns of certain commercial and industrial and construction balances, all of which had attractive pricing, and we experienced a delay on a large investor commercial real estate deal that was supposed to fund early in the quarter but did not get closed until the last week of June.

In total, we estimate that these items negatively impacted net interest income by approximately $375,000 and net interest margin by 2 basis points. However, loan pipelines remain strong and with our focus on improving the composition of the loan portfolio and replacing lower yielding assets with higher yielding and variable rate production, we continue to forecast growth in total interest income throughout the rest of the year. Currently, we expect the yield on the loan portfolio to be up in the range of 10 basis points to 15 basis points in the third quarter and another 15 basis points to 20 basis points in the fourth quarter. Related to deposits, looking at the graph on Slide 8 that tracks our monthly rate on interest bearing deposits against the Fed funds rate, you can see the stability in deposit costs over the last several months.

So going forward, with short-term rates stabilized and CD pricing expected to reach an inflection point here in the third quarter, we anticipate that interest bearing deposit costs should be relatively consistent with the second quarter, which should be a catalyst in driving continued net interest margin expansion. Turning to non-interest income on Slide 9, non-interest income for the quarter was $11 million, up $2.7 million, or 32% from the first quarter. Gain on sale of loans totaled $8.3 million for the quarter, up 27% over the first quarter and setting another quarterly record for our SBA team. Loan sale volume was $98.6 million, up 19% and rebounding from the seasonally low first quarter, while net gain on sale premiums saw a modest increase of 6 basis points.

Other non-interest income was also up compared to the prior quarter, increasing $1.2 million due primarily to distributions received from fund investments. These increases were partially offset by a decline in net servicing revenue due to the fair value adjustment to the loan servicing asset. Moving to Slide 10, non-interest expense for the quarter was $22.3 million, up $1.3 million from the first quarter. Included in our results for the quarter were almost $600,000 of non-recurring expenses, consisting mostly of costs related to terminated technology contracts and to a lesser extent, expense associated with the 25th anniversary of First Internet Bank. Excluding these items, non-interest expense totaled $21.8 million for the quarter, up $700,000, or 3.5% from the first quarter and relatively in line with our forecast.

Turning to asset quality on Slide 11. David covered the major components of asset quality for the quarter in his comments, so I will just add some commentary around the allowance for credit losses and the provision for credit losses. The allowance for credit losses as a percentage of total loans was 1.10% at the end of the second quarter, up 5 basis points from the first quarter. The increase in the allowance for credit losses reflects the growth in the loan portfolio and the continued shift in the composition of the loan portfolio towards certain loan types with higher coverage ratios. The increase also reflected additional reserves related to small business lending, partially offset by the positive impact of economic data on forecasted loss rates in other portfolios.

The provision for credit losses in the second quarter was $4 million compared to $2.4 million in the first quarter. The provision for the second quarter was driven by loan growth and the changes in the composition of the loan portfolio, net charge offs and the additional reserves related to small business lending. If you exclude the balances and reserves on our public finance and residential mortgage portfolios, which have lower coverage ratios, given their lower inherent risk, the allowance for credit losses represented 1.32% of loan balances. Furthermore, with minimal office exposure, we do not require the excess reserves around that asset class that many other banks have. Moving to capital on Slide 12, our overall capital levels at both the company and the bank remained solid.

The tangible common equity ratio was 6.88%, a 9 basis point increase from the first quarter. If you exclude accumulated other comprehensive loss and adjust for normalized cash balances of $300 million, the adjusted tangible common equity ratio would be 7.59%. From a regulatory capital perspective, the common equity Tier 1 capital ratio remains solid at 9.47%. Before I wrap up, I would like to provide some updates on our outlook for the remainder of 2024. As a reminder, our approach to forecasting this year is to assume that the Federal Reserve maintains a higher for longer outlook and does not lower the Fed Funds rate during 2024 despite the increasing commentary that rate cuts may happen as soon as September. We still feel confident that annual earnings per share for the full year 2024 will be in the range of $3 per share.

With regard to net interest income, as I mentioned earlier, we expect loan yields to continue to increase while interest bearing deposit costs should be relatively flat for the remainder of the year. With annual loan growth in the range of 7.5% to 10% for the year, we still expect annual net interest income to be up 20% for 2024, with fully taxable equivalent margin continuing to increase throughout the year and be in the range of 1.90% to 2% in the fourth quarter. Related to non-interest income and non-interest expense, our view is fairly consistent with our comments on last quarter’s call. With the combination of our SBA team continuing to deliver consistently higher origination activity and stabilization in secondary market pricing, our outlook remains extremely optimistic.

And as a reminder, the expectations for higher fee revenue will be partially offset by higher expenses as we continue to add additional personnel in SBA and risk management, as well as make additional investments in technology and our risk management processes around our fintech partnerships program. With that, I will turn it back to the operator so we can take your questions.

Operator: Thank you, sir. Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Our first question comes from the line of Tim Switzer from KBW. Go ahead, please.

Q&A Session

Tim Switzer: Hey, good afternoon. Thank you guys for taking my questions.

David Becker: Hi, Tim.

Ken Lovik: Hi, Tim.

Tim Switzer: My first question is related to the reserve build this quarter. I mean, the credit performance overall looked pretty solid, and you guys provided a little bit of commentary about the reserve, and it was related to small business loans, all that. Could you provide just a little bit of more color, I guess, on what you’re seeing underlying all that? And it was this kind of more driven by the loan growth or some qualitative reserves you guys decided to take.

David Becker: It was probably a little bit of both. I would say, there is some – I mean, there’s several dynamics at play here. One, you just – you had growth to begin with, and some of it too is just the migration of the portfolio. If you look year-over-year, some of our portfolios that have lower coverage ratios like residential mortgage, public finance, even healthcare finance, I mean, those balances are down and they’re being replaced by construction and SBA and franchise that have higher coverage ratio. So some of that is just a migration there on a build there. And in SBA, too, we took a look at, we just looked at where our Q factors were and adjusted some of those upward just to start, just to be building some extra reserve there.

David Becker: We also, as Ken stated in the last couple of days of the month, we have like $60 million in loans closed on the last two days of the month, so we had – even though they didn’t show up and offset any of the interest income and we took the full expense for the loan loss reserve on those on the final two days. So that kind of convoluted things a little bit. But part of it was timing, as Ken just said. Part of it was re-evaluation on the portfolios. And again, the change in mix, SBA, commercial, real estate stuff had much higher reserving factors, C&I than the public finance and the other portfolios.

Tim Switzer: Got you. Okay. That’s helpful. And then I wanted to ask about with your fintech BaaS initiative, and you’re getting very good growth on the deposit side. We’re seeing it come through with the revenue. How is the more intense regulatory environment changed at all? How you have decided to run the business? And has it altered your investment plans at all? Or has it either maybe caused more customers to have either more caution, or maybe even some potential customers come to you given the difficulties some competitors are having.

David Becker: You hit just about everything there, Tim. I think you can hit that’s going on in the BaaS space. Regulatory scrutiny is off the charts, no question about that. 90% of that we were already doing, they have. I will tell you, finally, during this last quarter, defined guidelines a lot better as to how we should interact with the fintechs and the banking-as-a-service product. So we have a much better roadmap than we’ve had from the beginning of time in this space, which we’re complying with. And I will tell you, our due diligence has stepped up because of some of the things that are going on in the industry. If there’s a common theme from some of our prospects, it’s, oh, my God, nobody ever asked us this question.

Why are you guys digging in so deeply? And I’ve been in and around the software business, particularly software-as-a-service, my whole life, practically. So I understand where some of the pitfalls and issues are and where we’re digging in deeper. And as the market has changed, not to just pure growth, they want the fintechs to show a path to profitability that’s changed a lot of the focus and timing and play. I don’t think, until the debt settles on the Synapse issues and everybody gets a true handle on what’s going on there, I don’t see a lot of tremendous growth of people taking risk until they can kind of figure out what blew up and what went wrong there. But as I said in my comments, we’ve got some phenomenally good quality fintechs and banking-as-a-service clients, and they’re all growing.

We – $8 billion in ACH clearings, the lending side’s a little slower than the deposit side, but it’s catching up speed here quickly. So we got plenty on the plate. We’ll hit the numbers we had projected and we’re real comfortable where we’re at. You were spot on, on your kind of last comment. We are starting to get inquiries. As the dust is settling with Synapse and Evolve, people are looking for either a backup source or potentially a new source. We had a client, we were talking with Nicole and I just a couple days ago. They’re with another vendor. We’re getting about a third of their business. They’re thinking about moving – switching roles. We would get two-thirds, the other vendor would get a third. So everything’s on the table right now and we’re adjusting one by one as they come up.

Tim Switzer: Okay. Yes, that’s interesting. I appreciate your thoughts on it. I’ll get back in the queue.

Operator: Thank you. Our next question comes from the line of George Sutton from Craig-Hallum. Go ahead, please.

George Sutton: Thank you. Ken, I was pleased to hear that you still seem comfortable with the $3 number for the year, even with a zero rate change environment. I just want to clarify anything that you’re building into expectations that may be different in the second half?

Ken Lovik: Not really, George. I mean, I think we still, again, as we’ve seen the SBA business grow, we’ve seen the non-interest income continue to go up. Obviously, there’s a little bit of offset on the expense spent side with that. But what SBA is doing is tracking and exceeding, as we had – even exceeding to what we’d forecast. And on the non-interest income side as well, I mean, we continue to forecast that. That’s just going to continue to stir, step up through the rest of the year. So in terms of that outlook, there’s really not a lot has changed.

David Becker: One of the things that’s helping that forecast, and I guess just our confidence level, George, is the bump up on the commercial real estate quoted that we have $500 million in the pipeline. So that’s a big, big opportunity for us. A lot of that will start to actually be drawn down and put to work here in the second quarter of the year. What we hope doesn’t happen to us this past quarter, we had two or three that we were kind of anticipating, hanging on to for a few months that were bought in the secondary market. We’re doing the construction side. We’re not doing permanent finance on those products. So there’s still a good demand for, particularly warehouse refrigeration systems, et cetera, which is kind of the market we’re playing in.

So we lost a couple big assets. We were hoping to hang on to for a few more months. But we do have a great pipeline of activity coming up. We’ve grown that by over 25% just in the first half of the year compared to year end. We already talked a little bit about the fintech opportunities continuing to grow, so there’s a lot of positive in what we’re doing today. And if the Fed makes a move and that’s more and more dialogue on a daily basis, that would be just icing on the cake.

George Sutton: So, David, you keep building bigger and bigger goals for your SBA lending, and you’re now the sixth largest. I’m curious, how much bigger do you envision SBA could be for you?

David Becker: I just met with the two leads of that department yesterday, and they said, okay, what kind of number are you going to throw out here? I think we can very easily get to that probably $500 million mark this year, maybe a little higher. Foresee possibilities in the next 18 months to 24 months. That could move up to a $1 billion a year. We really have no limitations. And at the current time, we’re really spending a lot of time on the tech inside. If there’s any one piece of our business where tech is a little bit outdated, it’s in the SBA world. Nobody’s changed anything. Some of the subsystems are almost green screen capability. So we’re bringing in some new tools. We’re doing some pretty cool things with salesforce.

We’re doing some new things and spreading the loans. And so our efficiency is getting better day by day. And it’s a situation over the last couple years, as we’ve had tremendous growth, we kind of throw bodies at it. Now we’re starting to throw technology, so it’s getting easier. And bodies that really understand the SBA business are kind of hard to find in the marketplace. So we think the efficiencies we’ll gain with the new tech will allow us to continue to push that number up. Are we going to double year-over-year like we have been? No, that’s not going to happen. That would be kind of foolish on our part. We get out over our skis for sure, but picking up a couple hundred million a year in new productivity, that’s very, very doable.

George Sutton: Just one quick question for Ken. You mentioned the termination of some tech contracts under your one-time expenses. Can you just give us a sense of what kind of technology that is. And are you reducing capabilities or changing capabilities there? Thanks, guys.

Ken Lovik: Yes, no, these actually relate to one of the platform partners we were working with in the fintech partnership space, where they just, it was a company that changed its business model and we weren’t getting a lot of traction with them. So we just exited, exited the agreement and had to write-off some of our, some of the software investment in that. But has nothing to do with any of our internal bank tech or any of our investments in, account opening on the deposit side or small lending or anything like that.

David Becker: The other big piece of it, George, was a product. We, we’re in the queue from Fiserv, and we actually, over the almost years of installation on that, we found another alternative on a better product. We had a write down of that particular piece of software. They’re working with us to give us a credit against future maintenance. So there’s a chance that’s going to come back as a positive to us. But, yes, as Ken said, we’re not cutting back on any technologies. We had a third party vendor that just didn’t make any sense to keep the relationship going so.

George Sutton: Great. Thanks, guys. Appreciate it.

David Becker: Thanks, George.

Operator: Thank you. Our next question comes from the line of Nathan Race from Piper Sandler. Go ahead, please.

Nathan Race: Hi, guys. Good afternoon. Thanks for taking the question. Just curious, just going back to the SBA discussion, how you guys are thinking about that revenue trajectory in the back half of the year. I imagine it may be difficult to replicate the production in 2Q, but just any thoughts on how you guys are thinking about kind of year-over-year growth in SBA revenue in 2024?

David Becker: I think, obviously, we had a very, very strong quarter in this past quarter. And I think, right, our forecast right now for third quarter actually has that going up a little bit from there. Fourth quarter is sometimes a little bit softer there. So that’s probably not quite as high as the third quarter, but probably more in line. There may be a little bit higher than the second quarter. So I think as we’ve continued our origination volume, it’s not static throughout the year, it’s been continuing to grow. And so we’re just continuing to see that on the revenue side. But I think we feel really good that we’ve gotten to a level where we can just maintain a consistently higher level of originations. And the team continues to look at and add high quality salespeople.

Nathan Race: Okay. That’s great to hear. And then maybe just turn to expenses. If we exclude some of the one time items in the quarter, kind of around 22, heading in the back half of the year, how you guys kind of think about the run rate trending in 3Q and 4Q?

David Becker: It’s probably one of the things that you I like to remind you guys to factor in, though, is as that SBA continues to grow, there is a cost to that on the commission side. So we will see now, certainly it’s not dollar for dollar with revenue, but you will see the costs go up on the salaries and employee benefits line item. So you’re probably getting close to 22 to maybe a little bit over 22 in the fourth quarter as we continue to produce there.

Nathan Race: Okay, got it. Very helpful. And then just any updated thoughts on the buyback? Obviously, the stock still trading below tangible book value, but you guys also grown organically. Pretty nice clips. So just curious to hear how you guys are thinking about that appetite these days?

David Becker: Well, as we get closer and closer to 40, the trading side, we’re thinking less and less about the stock buyback side of things. Quite honestly, right now, we’re really kind of focused on getting the tier 1 capital back up above 7%, including the markdown on the security side. So unless rates really start to plummet on the Fed level, which brings down our mark-to-market, we probably won’t be doing any share buybacks in the – at least here in the third quarter. We’ll reevaluate when the fourth quarter comes around, but I wouldn’t forecast any for the third quarter.

Nathan Race: Okay, got it. And then maybe, Ken, can you just remind us in terms of the margin impact with each 25 cut from the Fed, particularly as it relates to what you have that moves immediately within the loan book, and then what also reprices down kind of one for one within deposits?

Ken Lovik: Yes, let me – yes, there’s a couple different ways to look at this and maybe just to think about. On the deposit side, we got about $1.1 billion of deposits that will have 100% beta with a Fed rate cut. And then we probably got another, I call it 800 million to 900 million. That’s maybe a 40% to 50% beta. And then we – then we have another 1.3 billion of CDs that mature over the course of the next year. So I think that provides a lot of earnings potential for rates if should and when and if the Fed begins to cut rates. If we kind of look at it over the course of a 12-month period, kind of an annualized 25 basis point cut, that could benefit net interest income as much as $2.8 million.

Nathan Race: Okay. Got it.

David Becker: We’ve given you guys the kind of $700,000 figure prior, which was really, as Ken said, just looking at the stuff that’s pegged off Fed funds, we really didn’t bring in the CD portfolio to that mix. But as – it’s getting more and more likely, something could happen here in September. Ken’s team dug a little deeper here in the last few days, anticipating this question was coming up. And when we throw in that CD repricing that would happen over the next 12 months. And the 2.8 million is not – you can’t split that into four equal quarters and have the impact. There’ll be 300,000 to 400,000 in the first quarter, six to seven in the second quarter, et cetera, as the CDS roll over. That’s where a big, big part of that impact is going to come in.

So just pure cash and the money markets and stuff that are pegged to fed funds, that’s worth 700,000 over the course of the year, and the rolling of the CDs will bring in another 2 billion or 2 million plus. So it’s a big number and if we can get a couple, two or three rolls here yet this year or early next year, it can be very impactful in 2025.

Nathan Race: Yes, definitely. Just one last housekeeping question. Any updated thoughts on the tax rate going forward? I think last quarter we’re talking somewhere in the 8% to 10% range?

David Becker: Yes. I would say that’s probably maybe as we kind of build income, as we get kind of into the fourth quarter with kind of that step up in earnings. That’s probably not, maybe the 8% would be good in the – in the fourth quarter. I think right now we still get a pretty nice benefit from the tax – the tax benefit from the public finance portfolio. So, fortunately, from a tax perspective, that’s been allowing us to keep the tax rate low, probably a 4% to 5% here in the next quarter is probably applicable, probably appropriate, and kind of just move that up as earnings go up.

Nathan Race: Okay, got it. And then, sorry, just one last clarifying question. Ken, your guidance for loan yields to expand. I believe it was 10 to,

Ken Lovik: Yes.

Nathan Race: I’m sorry, 15 to 20 basis points in the fourth quarter…

Ken Lovik: Yes.

Nathan Race: …that does not include the impact of a Fed rate cut on your floating rate book?

Ken Lovik: No, not at all. No, that does not.

Nathan Race: Okay. Great. Sounds good. I appreciate all the color. Thanks, guys.

David Becker: Thanks Nate.

Ken Lovik: Thank you, sir.

Operator: Thank you. Our next question comes from the line of Brett Rabatin from Hovde Group. Go ahead, please.

Brett Rabatin: Hey, guys. Good afternoon.

David Becker: Hey, Brett.

Ken Lovik: Hey, how are you doing, sir?

Brett Rabatin: Good. Wanted to go back to the NII guidance of 20% for the full year, and when I look at the margin guidance of 1.90% to 2% by the fourth quarter, I assume the high end of that range. And just a tiny bit of balance sheet growth, I’d be shy of that 20%. How much balance sheet growth? I know the balance sheet’s obviously been managed and you’ve had excess liquidity, but how much balance sheet growth you guys looking for in the back half of the year?

Ken Lovik: Well, I think – I think one of my comments earlier in the call was we’re forecasting loan balances to be up 7.5% to somewhere between 7.5% to 10%. And you’re probably, the model right now probably says it’s closer to, say, 9%-ish than the 7.5%. So that’s what we’re thinking about on the loan side. Overall balance sheet growth is going to be somewhat less than that just because cash balances will be lower. There’s probably a little bit of growth in securities balances as well, but I guess maybe if you plug in the loan growth, and I don’t know what that does for your average balances, but our average balances are probably up a little bit higher than perhaps what your model has.

Brett Rabatin: Okay. And then just going back to…

Ken Lovik: And I guess I will say, sorry, Brett, one thing I’d probably just say is to go back to the timing. This is a topic it was on one of George’s questions, and David talked about the loans that we had pay down in the quarter. So probably a little bit of there. There may be a little in between third quarter and fourth quarter, some timing difference. But I think by the time we get through the fourth quarter and feel really good about that and get to the end of the year, that 20% growth in NII is still what we’re on track to do. And that margin guidance I gave you for the fourth quarter is exactly where we are today in our models.

Brett Rabatin: Okay, that’s helpful. And then just wanted to go back to, I know you have the CDs maturing in the third quarter at 5.05%. Where are you guys being able to produce new CDs currently in terms of rate? And then just how do you fund the balance sheet growth from here? Is it going to be bass? Is it going to be CDs. Are you looking for growth in some of the lower cost pieces of the businesses?

Ken Lovik: On the, like brand new, like new production coming in the door for CDs is actually being, right now coming in at about 4.85% [ph]. And that’s across different, usually what we’re seeing is, there’s a big piece of that in one year, and then we’re seeing people go out four and five years on that. So it’s kind of a, call it a two-year average duration. And that’s been pretty consistent now for about four or five months. The one thing that does impact that is the renewal rate. And sometimes that’s a little bit hard to predict because not everybody renews. Sometimes we’ll see a one-year CD that they call in and they want to renew, but they move to a five-year product or vice versa. So that piece is a little bit hard to predict.

But new production coming in the door today is 4.85% [ph]. And I think what you’ll continue to see on the deposit side, I think with the CDs have been growing, probably slowed down a little bit of growth there, but there’s still production there. We’re still, we’re usually at the top of the rate board, but we’re competitive and we are seeing good production on the fintech partnership side. So I think again, that probably, probably going forward you might see a little bit more growth on the fintech side than the CD side. But maybe here in the near term, it might be a little bit balanced between the two.

Brett Rabatin: Okay. And then just lastly, for me, thinking about the back half of the year, you know, one of the headwinds to your loan growth has been single tenant lease financing, public finance, healthcare finance, having decreases. Are you expecting those to stop declining from here or any thoughts on some of the pieces of the portfolio that have been shrinking?

Ken Lovik: Well, some of that is, some of that’s by design a little bit, because with the inverted yield curve, doing longer term fixed rate product hasn’t made a whole lot of sense. And then you just have market competition too. This is a single tenants, a good example. You have other competitors in that space who are pricing deals that don’t make sense for us. I mean we have been opportunistic there. Our team is still out working. And if we can get a good deal that fits within our pricing parameters, we’ll do it. The same thing for public finance as well. It’s, there’s, supply in the public finance world is down. The municipalities just aren’t offering, issuing as much debt as they have in the past because they’re sitting on a lot of stimulus money.

So there just haven’t been a lot of opportunities there. And then what is there? You know, it’s really a lot of, it’s been going to the public market because people are starved to buy muni bonds and there’s a lot of competition. So I think when we know when and if, knock on wood, we eventually get to the point where we have a normalized yield curve and the activity in those, those channels is, picks up and is priced rationally, then I think we’ll be back in those markets.

Brett Rabatin: Okay, that’s helpful. Thanks for all the color, guys.

David Becker: Appreciate it. Thanks sir.

Operator: Thank you. There seems to be no further questions at this time. I’d now like to turn the call back over to Mr. David Becker for final closing comments.

David Becker: Thank you, Lara. Thank you for joining us on today’s call. Given our strong first half and current pipelines, we’re extremely optimistic about our outlook for the remainder of our year. Our commercial consumer teams are still working hard, as Ken just said, to drive revenue and growth greater diversification. When you add in the stabilized deposit costs, we really have a clear pathway to finishing the year really strong and profitable. The optimism is not considering Fed rate cuts, which when they do happen, could provide a really strong acceleration of growth in net interest income and net interest margin. As always, as fellow shareholders, we remain committed to driving the improved profitability and enhanced shareholder value. We thank you for your support, your time today and wish you a good afternoon. Thanks guys.

Operator: Thank you, sir. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.