MainStreet Bancshares, Inc. (NASDAQ:MNSB) Q3 2024 Earnings Call Transcript

MainStreet Bancshares, Inc. (NASDAQ:MNSB) Q3 2024 Earnings Call Transcript October 28, 2024

Jeff Dick: Good afternoon, and thank you for joining our Virtual Earnings Webcast. My name is Jeff Dick, I’m the Chairman and CEO of MainStreet Bancshares Inc. and MainStreet Bank. I’m joined here today with our CFO, Tom Chmelik, our Chief Lending Officer, Tom Floyd, and our Chief Accountant, Alex Vari. If you’d like, you can submit written questions throughout the presentation using the viewing portal. If we miss your question during the discussion, please reach out after the webcast. We’ll open for questions after the presentation. We have two analysts on the webcast with us today. Chris Marinac from Janney Montgomery Scott and Matt Breese from Stephens, Inc. Both gentlemen will be able to ask their questions and share their comments directly following the presentation.

As a point of pride, on October 20, Director Darrell Green had his NFL Jersey officially retired by the Washington Commanders. Above and beyond the amazing athleticism Darrell constantly displayed on the field, he is a highly successful entrepreneur, and he’s led a life of service to all segments of our community. We’re very proud and fortunate to have him as a director. But moving into the slide deck, we’d be remiss, if we didn’t point you to our safe harbor page that describes the context of forward-looking statements. We use certain non-GAAP measures, which are identified as such, within our presentation materials. We are a Virginia Community Bank serving the Washington D.C. Metropolitan area, and we have a great organic growth story using a branch-light strategy.

We’ve always been a tech-forward bank with strong online and mobile banking technology. We trade on the NASDAQ Capital Markets Index. The DC market is a great place to do business. We always talk about the strength of our market because we are in a region that hosts the federal government. But we have world-class universities, hospital systems, airports, tourism, data centers, and at least 16 Fortune 500 companies. As such, we also have low unemployment and a very high median household incomes for our workforce. During today’s presentation, we’re going to be sharing three key takeaways. These are based upon the assumption that the Fed has done raising interest rates and that rates will either remain the same or go down in the future. The first takeaway is that our financial performance for 2024 is not indicative of our future expectations.

We have been working to lower our deposit costs, which will translate into net interest margin expansion. We’ll hear from Alex on this topic later. We continue to fund the allowance for credit losses in a way that is directionally consistent with the volume and quality of our loan portfolio. To that end, the loan portfolio remains strong. You’ll hear from Tom Floyd that we are dealing decisively and successfully with problem loans, and we should see the trend of criticized, classified and non-performing loans reduce. We’ll also hear from Alex on the allowance for credit losses as well. The second takeaway is that traditional deposit growth is a challenge in our market. Actually, it’s not only in our market. In reality, it’s a challenge in many markets across the country.

The Board and management continue to be engaged and enthusiastic in our pursuit of a banking-as-a-service solution, because we believe that it is a strong solution for acquiring low-cost deposits and it is consistent with our digital strategy. Nevertheless, based upon recent investor comments and feedback, the Board thought it would be appropriate to engage an independent consulting group for a pulse check on our Avenu solution. I’ll share some of their findings later in the presentation. The third takeaway is that Avenu version 1 is now in service. I’ll talk more about this later in the presentation as well. At this point, I’ll turn the presentation over to Alex Vari. Alex is our Chief Accountant. He works closely with Tom Chmelik to ensure the accuracy of all our books and records.

Q&A Session

Alex is going to talk you through our financial performance.

Alex Vari: Thank you, Jeff. On Slide 6, we summarize our financial performance over the past 4 quarters, as well as our 2024 year-to-date performance. As we previously disclosed, we are reporting an earnings per common share loss of $0.04 in the third quarter as a direct result of taking action on a handful of problem loans. The loss for the quarter impacted several quarterly financial ratios, particularly earnings, our net interest margin and efficiency ratio. But these are not indicative of our year-to-date or future performance expectations. And I’d like to spend a few minutes breaking down why. Impacting the third quarter’s earnings, we charged off $1.9 million as we transferred ownership of $21.8 million of real estate loans and $1 million in provision expense was added to ensure the allowance for credit losses remains directionally consistent based on current levels of classified and nonperforming loans.

However, we will see later in the presentation that we expect improved metrics throughout our loan classifications going forward. Our third quarter annualized net interest margin was impacted by $984,000 in accrued interest income that was reversed in relation to loans placed on nonaccrual status. This resulted in a quarterly net interest margin of 3.05% and a year-to-date net interest margin of 3.19%. Anecdotally speaking, without these interest reversals, our net interest margin would have been 3.25% for the quarter and 3.32% year-to-date. That really speaks to how the core earning engine, our net interest margin is stable and improving. During the third quarter, our core deposits were 78% of total deposits, highlighting our community engagement and building new relationships.

Elaborating a little further on future net interest margin expansion, specifically on how we are addressing the funding costs, we previously talked about how our business banking team are getting new low-cost deposit opportunities, and I’m excited to share that of the $95 million in new core deposits during the quarter, 35% were noninterest-bearing. However, these new relationships were primarily built towards the end of quarter 3, so we will see the full effect of these new deposits during quarter 4. We also have access to wholesale funding to supplement strategic growth, if needed. Our noncore deposit balances increased strategically to capitalize on market conditions that will reduce funding costs and shorten the duration of our term deposits.

It’s important to point out that 55% of our noncore deposits can be adjusted immediately. So we are well positioned to replace these funds quickly with new lower rate deposits. Additionally, as the Fed begins its rate reduction cycle, we will be adjusting our variable rates swiftly, and we have $183 million in callable CDs that we will be strategically calling away entirely or replacing at more attractive rates, having a positive impact on funding costs and expanding our net interest margin. Lastly, and contributing to future net interest margin expansion, we are continuing to fund new quality loans that are underwritten and stress tested in the current rate environment. Gross loans were relatively flat for the quarter with new loan fundings of $82 million, which will point to continued interest income growth, further enhancing our future net interest margin expectations.

We expect low single-digit loan growth during the fourth quarter. Now, I would like to talk about our expense run rate and what we are expecting going into quarter four. Non-interest expenses decreased slightly quarter-over-quarter after excluding $594,000 in non-recurring expenses related to loan sales and disposition. Management remains focused on expense control and efficiency. The run rate for the fourth quarter will be 50 basis points per month. In addition, with Avenue Version 1 in service, we will begin amortizing the intangible software at $150,000 per month and incurring $385,000 in additional non-capitalized expenses per month. While the additional non-interest expenses will put some pressure on earnings, it is temporary and necessary as Avenue builds and gains momentum in the marketplace and will earn back its cost in fee revenue and deposit balances.

It is important to reiterate that these expenses are intentional and very specific investments in people and in technology. Through these investments in innovation, the Board and management are building something unique that will enhance earnings ability and create shareholder value. We have been able to bring this innovation to life, while continuing to operate a profitable company, build tangible book value, and further fortify capital. The bottom-line is we are well-positioned for future quarters, and I look forward to keeping you updated as we execute on this strategy. At this point, I’ll turn the presentation over to Tom Floyd, our Chief Lending Officer, to discuss our loan portfolio and loan performance.

Tom Floyd: Thank you, Alex. When we spoke with you last quarter, we highlighted our commitment to lending discipline. This approach has enabled us to develop a deep understanding of the local market, provide valuable insights, and a unique position that influences the entire life cycle of our credits. Typically, these disciplined trades lead to successful and profitable exits for our clients. However, there have been rare instances of liquidations. As we will discuss later, our local knowledge and our specialized niche have enabled us to navigate some of these liquidation situations swiftly, recovering at par. In the next few minutes, I’m excited to share these stories and provide an overview of our portfolio, our quarterly production, and a measure of our stability going forward.

We finished the third quarter with $1.8 billion in outstanding loans, which is roughly the same level as the end of the second quarter. Our legal lending limit remained at $47 million and our average new loan size was $1.9 million. This highlights that as we’ve grown in our capacity, we continue to serve the smaller-sized capital formation needs in our market. We’re very comfortable in our niche. What I’m most proud about in this slide is that through an independent valuation of our loan portfolio by Abrigo, even after all the interest rate rises and factors impacting commercial real estate, the liquidation exit price net of our credit mark on our loan portfolio is 100.23%. Building off what Alex shared, as our deposits reprice, we stand to benefit because 61% of our loan portfolio has rate resets beyond six months.

For those 39% of loans that have rate resets within the next six months, 55% have weighted average floors of 6.65%. We’re well-positioned to maintain our superior yields on earning assets. Slide 15 demonstrates our skill at managing our concentration in investor commercial real estate and construction. Our concentration in construction decreased from 130% of capital at the end of the second quarter to 118% at the end of the third quarter. This is attributable to the origination of a lower volume of large construction projects due to current market dynamics, the completion and transition of existing projects and the sale of completed projects. In the next few slides, I’ll provide an overview of our criticized, classified and non-performing loans.

The key point you’ll see is that the identified problems have positive outlooks. Our criticized loans are either multifamily or hospitality assets with healthy loan to values. The projects are supported by sponsors that have continued to make payments to meet their obligations. We’re encouraged by recent changes to the emergency rental assistance program in D.C. that will enable landlords to better handle tenant attempts to gain the program. Not only are we pleased by these changes, but also by the steps of our sponsors to ensure that they can continue to provide suitable rental units and additionally, for repayment of our loans. For the hospitality asset, the sponsors have begun marketing under the Marriott Bonvoy program, and we’re encouraged that this will lead to stabilization.

Slide 17 highlights our current classified loan levels, which are 4.3% of total loans. The first line is comprised of two income-producing multifamily properties that are paying as agreed with a high degree of being upgraded. The second line is two projects that the borrower is selling out of where there have been recent sales that have taken place and the sale prices support a full repayment of our loan. The third is two multifamily projects that are well located in D.C., where the certificate of occupancy is expected in the next 60 days. Current rental rates support the full amortizing debt levels at an appropriate margin. The $4 million relationship is a government contractor that is pursuing several liquidity events that we repay our loan in full.

We’re working with the borrower to structure the loans on an amortization schedule that will repay principal and interest in the interim period. As you can see, the common thread here is that there is a high probability of a successful outcome. Slide 18 provides details of our non-performing loans. The first line highlights properties that are complete or near completion. We project the debt levels are fully supported at current market rental rates. The next category is two construction loans in the process of liquidation. These two projects are being actively resolved, one of which is expected to be resolved in the next 30 days and the other is a high-profile foreclosure that I’ll touch on later in the presentation. The remainder of the NPAs are small balances that we expect full repayment after liquidation.

Slide 19 highlights the vigorous management of our non-performing loans. The results of our dispositions resulted in a 9% loss in principal value. Our niche in our market and our knowledge of the projects we finance were instrumental in being able to achieve this outcome. Within the dispositions summarized, three note sales took place at par. The three notes are representative of three different projects that were in various stages of the development process. The note sales at par value highlight the underlying health of our market, the remaining viability of the respective projects and our ability to market the opportunities to the right investors and sponsors that will take the projects to full completion. As summarized at the bottom of the slide, total principal losses in 2024 are 0.1% of total loans.

Slide 20 highlights the cumulative losses through the interest rate cycle remain below peer average. As stressors began to impact our market following unprecedented increases in interest rates, our peers began accruing losses. We did not. As we near the end of the rate cycle, we are experiencing some losses, but comparatively, our losses are significantly lower than peer averages. he next slide shows a rendering of a luxury condo building for the highly public foreclosure I mentioned a few slides back. We have received an extremely high level of interest in this asset and are confident that after the end of liquidation and collection process, we will be made whole. The owners filed a Chapter 11 bankruptcy to prevent the bank from holding an auction, which had received a very strong level of interest.

There are several groups interested in the property and the current appraised value and guarantor recourse point to a full recovery for the bank. We intend to aggressively pursue our rights and remedies in the bankruptcy proceeding. While we diligently work through our credits that present elevated levels of risk, we don’t neglect our commitment to healthy growth. Illustrated on this slide, you see that we originated $82 million in new loans in the third quarter with a well-diversified mix. It’s worth noting that we’re not stretching for growth, but rather focusing on supporting our existing stable of clients that have proven track records in market and strong deposit relationships with the bank. Our weighted average rate for new loans originated is 7.8% and the weighted average maturity is 44 months.

To reiterate points made earlier, this will help us with our net interest margin in a down rate scenario. Slide 23 highlights that our exposure to traditional office rents remains extremely low. As I mentioned before, we’re very comfortable in our niche. Slide 24 highlights that our construction loans are performing with strong metrics. 87% of our construction loans have a customer funded payment reserve account with an aggregate balance of roughly $15 million. As you can see, the loan to values are strong on a weighted basis, and the weighted average interest rate is healthy at 8.24%. Slide 25 provides details on our non-owner occupied commercial real estate metrics. Our portfolio is well-diversified by type and location with good interest rates, loan to values and occupancy.

In addition, our owner-occupied loans also reflect excellent diversification with a weighted average rate of 6.03% and solid loan to values. Slide 27 shows the trend in stress tests over the past seven quarters and the resulting impact to capital. The Q3 stress test for all earning assets reflects a worst-case stress loss estimated at $42.4 million. In all quarters, we remain strongly capitalized. The stress test includes loan level testing for all construction and investor commercial real estate. For all other loan categories, we use the balance in each call report category multiplied by our worst ever loss for that call report category. For investments, we use the market price. And finally, for bank-owned life insurance, we determine the liquidation value.

In summary, our loan portfolio has broadly seen an increase in problem loans, but we expect these levels to decrease in the coming quarters. Our lending team has done an excellent job carving out a niche in our market that has resulted in a superior yield on earning assets and in more times than not, a demonstrated ability to exit relationships without loss to principal values. We remain well-capitalized and are working vigorously with our borrowers where there remain positive potential outcomes. We’re passionate about serving our community. We love seeing it thrive, and we’re optimistic about the future. That wraps it up for our loan presentation. Back to you, Jeff.

Jeff Dick: Thanks, Tom. In 2021, the Board and management decided to make an investment in technology that would best serve clients requiring banking-as-a-service in order to generate low-cost deposits and fee income. The Board and management remains unified in our belief that the ability to support growth through traditional low-cost deposits has changed, perhaps permanently. The Avenu BaaS solution was placed in service just prior to the end of the third quarter. The ability to digitally offer banking services in a safe and compliant manner allows the company to reach new customer deposit segments, diversify revenue streams and generate additional income. The Banking-as-a-Service market is currently underserved and the opportunities for a well developed solution are robust.

Again, the Avenu business model is consistent with our digital strategy. Avenu provides a full-stack embedded banking solution that connects our partners and their apps directly and seamlessly to our purpose-built Avenu core. With Version 1 of Avenu in-service, the team is focused on getting our first fintech to general release in early November and another four fintechs to follow soon thereafter. But just as with any business expansion opportunity, the expenses associated with launching Avenu will impact our profitability until we reach breakeven. After that point, Avenu’s ability to digitally scale can far surpass anything that a comparable bricks-and-mortar growth profitability would allow for. Avenu’s clients are fintechs, social media solutions, application developers, money movers and entrepreneurs.

They all have one thing in common. They’re searching for a reliable partner to help innovate how money moves. They’re solving real-world issues and helping communities thrive. MainStreet Bank is that reliable partner dedicated to providing a best-in-class solution to sustain those long-term business relationships. On our last call, we explained why the team delayed placing Version 1 of Avenu in-service earlier, which was to ensure that we had addressed everything from the 12 consent orders that had been issued by the prudential regulators. Because of the manner with which the team addressed those findings, the Board remains fully engaged and steadfast in its support of the Avenu solution in order to achieve good growth in low-cost deposits and fee income.

But as indicated earlier, the Board also engaged FS Vector, an independent consulting group, to provide a pulse check on the Avenu solution. FS Vector is based in Washington, D.C. and focuses on compliance, public policy and business advisory. They serve banks, fintechs, reg techs and other innovative companies. Clients gain the benefit of an extensive industry network that provides valuable insights, resources and partnership opportunities. So we engaged FS Vector to determine Avenu’s fitness for purpose in the current regulatory environment. And we asked them to comment on the fintech landscape and provide us with their projections for deposit and fee income opportunities. FS Vector describes Banking-as-a-Service partnerships in three broad categories.

They differentiate them by who owns the key infrastructure and how oversight is performed. They determined that we are a full-stack bank. We own and control the infrastructure, and we exercise direct oversight of our fintech partners. Along with the full-stack, they also provided descriptions for middleware providers and fintech-owned infrastructure. FS Vector indicates that the Avenue platform compares favorably with peers in its ability to help MainStreet Bank meet the expectation of regulators. They also noted that Avenue is designed to directly control several aspects of customer onboarding for clients. They go on to say that the platform is designed so that the bank owns the sub-edger, giving the bank a distinct advantage in meeting current and emerging rules and regulatory expectations.

The last paragraph on this slide shows that the suite of products offered by Avenue is currently limited in scope and that some fintechs are unlikely to align with our offering, but also that the fintech ecosystem includes many companies that are seeking just such a relationship. FS Vector concludes that the bank pursued an efficient approach for the development and launch of Avenue. They go on to indicate that Avenue’s development cost places it among the most economical of similar bank and non-bank Banking-as-a-Service platforms, and its development time line places it squarely in the middle of the pack. On Slide 33, FS Vector states that the bank will not need to build any new solutions or onboard any new service providers to meet the requirements of the FDIC’s proposed deposit insurance recordkeeping rule for banks regarding third-party accounts.

So as FS Vector then turned to projections, they indicated that their approach on projections is consistent with what they’ve done for similar exercises for others in the past. While every fintech is different, using a representative set of client profiles has proven to be a useful way for them to think about the ultimate shape in terms of underlying products and volumes of a Banking-as-a-Service program. Because Avenue’s official launch was October 1, FS Vector used that date as a start for their projections. We pushed it forward and use the data that they provided, but rather than starting on October 1, we started for the financial reporting on January 1, 2025, to be consistent with our calendar year. We also included the $20 million of Avenue’s legacy deposits in the projections.

The slide deck that we issued this morning recaps the quarterly balances for each of the three years in their projections, along with the Fed funds rate that they provided for each of those quarters. Again, for this purpose, the Fed funds rate is applied as a bogey in order to calculate the balance credit. So then to fully load the expenses, we annualized Avenue’s expenses for 2024. We added the amortization of the intangible asset and added the projected expenses. Using this methodology with FS Vector’s numbers and our legacy balances, the solution becomes profitable in 2026. It is important to note that as we start accumulating deposits, we will determine the stickiness or the duration of deposit subsets. Our goal is to provide an accurate balance credit rate that is tied to the earning assets that we fund with Avenue deposits.

As we determine this, we’ll be able to use a more precise rate to calculate the credit balance. Additionally, we’re not constrained by FS Vector’s projections. Our fintech partners may outperform their representative client profiles. The Avenue balance sheet shows the intangible computer software with a balance of $18.8 million, and that will start to amortize October 1. Total deposits are $30.6 million with the element of low interest rate deposits earning 2%. We continue to benefit from the Legacy Avenue client deposits, which effectively offset roughly 50% of our year-to-date 2024 expenses. PaySii, formerly SafariPay, has been successful now, processing beta transactions for 500 clients and is expected to go to general release in mid-November.

We have two clients that are in alpha testing right now. And they’re both anxious to move to beta and then go on to general release themselves. Two more clients are currently writing to our APIs. And we will proceed to alpha testing when they’re ready. As we start rolling out clients to general release, we’ll have a strong story for the market. We expect we’ll see even more interest in our solution, at that point. To conclude, the team is relentless in its endeavor to position MainStreet Bank’s earnings and asset quality for strong future performance. Avenue is in service. The Board received independent validation of the solution and the opportunities. The Avenue team is working equally hard to process each of our fintech partners toward a successful general release.

We’ll address the questions you submitted through the portal after we hear from our analyst. At this point, we’ll start with Chris Marinac from Janney Montgomery Scott. Chris?

Q – Chris Marinac: Good afternoon team. I wanted to start with the loan that was in the pre-announcement a few weeks ago. What industries were [indiscernible] those loans?

Jeff Dick: Just want to make sure we’re talking about the right loan here, Chris. Is that what we referenced on the slide on the highly public foreclosure?

Chris Marinac: Yeah. Loans that were sold at par.

Jeff Dick: Okay. I’m sorry, the loans sold at par. Those were investor commercial real estate. One of them was a for-sale condo project. The other one was a multifamily project. The condo project hasn’t started construction yet. The multifamily project was a number of nine-unit buildings that were going to be converted into condos, but it also has a lot of uses that could be just used as a rental in its current form. It doesn’t need any construction to be viable, but that’s what that is.

Chris Marinac: Got it. Okay. Thank you for that. Can we go back to the cost of funds? Am I correct that you had a small decline from June to September with all everything included?

Jeff Dick: Yes, that’s right. Cost of funds is coming down. That’s right.

Chris Marinac: And where would you pinpoint that we have quarters with adjusted Fed funds. Is it going to be sort of a similar beta on the way down than it was on the way up?

Jeff Dick: Sorry, Chris, I was having a little bit of a hard time hearing you with some feedback. Can you run that by me one more time?

Chris Marinac: What would the beta be on your funding as Fed funds declines, particularly if we look out a few quarters?

Jeff Dick: Sure. Yeah. So as we’re looking out a few quarters, we’re still putting together our budget projections for 2025. So once we have a Board-approved budget with our projections in there, we’ll be able to share a little bit more with you on that particular front. I don’t know, Tom, you…

Tom Chmelik: Yeah. Right now, I mean, obviously, the beta will start to come down as obviously, we see funds come down. It probably will not match what it was going up. But we would anticipate because of all of the fallables that we have in place, that will actually help us out immensely.

Jeff Dick: Yeah. Typically, in community banking, you know the drill, the beta for deposits in a going down environment is much higher and stronger than in a going up environment. We try to lag as much as we can going up. So I do think that with the 55% of the non-core deposits being able to re-price, we’ll be able to control that fairly quickly. And then on top of that is a function of how well Avenue does with the fintechs as they reach general release. The first couple I know, are going to be a little bit slower. But yeah, I think we’ll see a good direction.

Chris Marinac: Okay. And then if we go to Avenue, we’re still — is the expense the same? Or is it higher in terms of your thinking in the next few quarters?

Jeff Dick: So I’ve taken the actuals for this year, which will stay fairly consistent. That probably will come down slightly, but not enough to adjust. And then going forward, I pretty much dialed in the numbers that Alex and Tom provided. The amortization of the software is what it is and then the other expenses should be fairly consistent for the next several quarters.

Alex Vari: Yeah, that’s right. So the — if you’re — particularly you’re asking about just avenues, that will be consistent. And of course, we’ve provided the additional information with the amortization and the capitalized expenses. But you could take year-to-date as a good run rate for going forward.

Chris Marinac: Okay. And then last question for me just goes back to FDIC costs. Are those changing at all in terms of premiums? Or is that kind of set at this current rate?

Jeff Dick: Which costs?

Chris Marinac: FDIC.

Jeff Dick: FDIC, okay.

Tom Chmelik: Yeah, the FDIC costs are staying pretty consistent. They’re not really — obviously, with an increase in deposits, they’ll go up slightly because of the increase in deposits, but the actual overall costs will stay constant.

Chris Marinac: Okay.

Tom Floyd: Chris, can I just — it occurred to me that I only answered two of the notes that were sold at par. One was multifamily. The other one was — is currently one to four being converted to condos. The third is mixed-use CRE. It’s residential units over top of retail that also is pegged for future development. Just wanted to make sure I got that out.

Chris Marinac: Perfect. Thank you all for the useful color. I’ll stand back and let Matt jump in.

Jeff Dick: Matt, are you on with us…

Matt Breese: Can you hear me?

Jeff Dick: Yeah.

Matt Breese: Great. I wanted to start on Avenue. Maybe just an update on growth expectations. We stand at $30 million deposits today. If I go through the presentation, it suggests that we hit the breakeven $225 million. It looks like at this point in 2026 versus prior estimates by year-end 2024. So I just wanted to, one, make sure that this is, in fact, your estimates, not the consultants or the two things are in line. And what changed that pushed the breakeven point, at least as measured by deposits out so far?

Jeff Dick: So good question. Obviously, the launch being delayed from what we thought was going to be much earlier this year to October 1. These are — I did use FS Vector’s numbers as I put this together. The only variable I added was, as I said, the legacy Avenue deposits. We are going to — I wanted to use something that had a — what I would call a high degree of substance behind it. It’s really — it’s difficult as we try to explore what the options are for Avenue as we launch because every — as I said before, every fintech client has an opportunity to do average to knock it out of the park. It’s just so many variables. But — so right now, I’m relying on — we are relying on FS Vector’s, sort of, kind of median look at things, which we are going to continue to try to put more meat on those bones, especially as we go to project for 2025 as we get a couple off the ground now.

But as I said, there’s two significant variables in there. One is just how well the fintechs do when they hit the general release level, how well they’re accepted in the market. And then the other is how we determine what the deposits in Avenue are actually earning from a funds transfer pricing model or however we’re going to do that because for lack of a better way going forward, Fed funds has been a good bogey. But as we’re able to determine the duration, the stickiness of those deposits, we will also be able to sort of say what class are we investing those in, in a safe way, and that’s going to further enhance the yield. So in answer to your question, we’re sort of — we’re taking what FS Vector has given us because we feel like that’s a conservative outlook, and it gives us some comfort and confidence to project what Avenue can do over the next three years.

We’re going to continue to work and develop as we get the first few Avenue clients, as I said, launched into general release, see what they can do, see what other opportunities come by. Oftentimes, it’s not just the app itself where consumers are loading, it’s also keeping compensating balances from some of the other clients in it as well. So conservatively, Matt, it’s this is what we’ve provided. We’re trying to be as open as honest as transparent as we can with this. We think that there’s a lot of great opportunity, and we’re going to continue to try to pursue that to overtake these numbers.

Matt Breese: If I go to Page 39 in the presentation, you show the fintech — the various fintech partners joining Avenues and what various stages they are in. How much do those account for in deposits? And do they support kind of the early outlook that FS Vector has provided?

Jeff Dick: Okay. Sorry, I’m just trying to grab that page. Okay. So right now, they are not part of the program. I mean there’s one company we didn’t talk about today, you may have seen something issued on Flutterwave. There is $14 million of deposits from Flutterwave — excuse me, $12.5 million from Flutterwave. We’re working through some things with them. We’re trying to decide the best way forward. So they’ve provided some deposits for us. But the rest of them, D.C. has got a compensating balance right now that’s — top of my head, I would suggest it’s probably $0.5 million, and there will be more to come as they go to general release.

Matt Breese: Okay. Can we talk about the cost of these deposits? You have a nominal funds rated in here. You have a footnote that says, this is a conservative bogey, meaning Fed funds. What does the current $30 million of deposits costs? And is Fed funds actually the right bogey for the cost of incoming deposits here?

Jeff Dick: So that depends on how you look at. I mean, if you’re looking at this, as Alex has said earlier, as an investment, if you want to totally load that, it’s a ridiculous number. But that — you don’t look at it that way. It’s an absolute investment for what we’re trying to achieve. That would be like saying, the first dollar you got into a new branch, the cost of that dollar is everything that you’d incurred in putting that branch, opening it up for business. And so — it’s — I mean your question is fine. It just — that’s really not an answerable question for us at this point in time. We’re really looking at what is the opportunity, not just what’s the cost of that one deposit or those couple of deposits.

Matt Breese: I do think it’s an appropriate question. I mean we break this thing in components of the balance sheet and the income statement. And we have a fee income guide here that we can kind of look at separately, but I’m just curious what the cost of these deposits are?

Jeff Dick: So I mean, intuitively, like I said, part of those deposits, the $10 million, I think, is at 2%. That was not included in our projections for going forward for Avenu. And I may have misunderstood your question, so I apologize, Matt. But the other deposits are — they’re DDA accounts.

Matt Breese: Okay. So right now, the interest-bearing component is less than half of Fed funds, but the projections are based on a full Fed funds. I just want to get a sense for how concerned are.

Jeff Dick: Yes. So again, I apologize. I completely misinterpreted your question. Yes, going forward, the goal with Avenu, one of the things that the FS Vector report said, I didn’t include in this is that our fee structure for Avenu is also slightly on the lower end, but it’s indicative of a banking-as-a-service provider that is more interested in low-cost deposits than in fees. And so we’ll be making some adjustments to that fee structure, so we don’t leave money on the table. But it is appealing for the companies that we work with to forego any interest earning on the account then to get the cheaper fees to be able to offer embedded banking or whatever the products they want to offer to their customers. So yes, we’re not going to be chasing opportunities where they want to earn a lot of money. Everything stands on its own we would look at it, but that doesn’t really fit the model that we’ve put out there.

Matt Breese: Do these deposits fit the definition — the regulatory definition of volatile? And is it more than likely that as balances start to accumulate that we see the cash position on the balance sheet start to grow in kind? And how long do you think you have to kind of demonstrate behavior before these are deposits that can be deployed into securities or loans?

Tom Chmelik: Yes, that’s an excellent question, and that’s one that we’re focusing on with the analysts that we’re working with internally. And from a volatility standpoint, some of the fintechs that we use will be — money will be more in and out, and those will have more fees associated with it to handle that. But we will start to determine the sort of — will be — we’ll be doing — performing decay rate analysis sort of on each individual fintech as we start to go forward as well as the fintechs and mass because you’ll see — you’ll find sort of that the stickiness of those deposits within each fintech, which could be more, especially after we offer the debit card and the RDFI, which allows their clients to direct deposit some of their money into the account, so they might keep larger balances that way.

So we’ll be looking at the decay rate analytics on the client, like I said, each fintech, but also across the spectrum because there are some additional timeliness of deposits staying on the books. So…

Alex Vari: Yes. And I’ll just add to that. We have a very robust liquidity management plan with several lines available to us, which are part of looking at deposits like that and making sure that we understand the stickiness and what’s part of our liquidity strategy as we go forward.

Matt Breese: Okay. That’s all I had. I’ll my questions there

Tom Chmelik: Thanks, Matt. Appreciate it. We did have one question, how much of the FS Vector — how much of that cost, I’m not going to tell you because it’s proprietary to them. We have an NDA in place. But I can tell you, it’s not. It was very efficient.

Unidentified Analyst: We have a couple of more questions. Okay. Regarding expectations for positive resolution for most problem loans, does that mean no losses?

Tom Chmelik: Yes. So if you look at the slide deck, on Slide 19, we provided an estimate of the losses that would come from the current nonperforming loans. We estimated that at 1.25%. So that’s roughly $250,000, $300,000 range. We do feel like we have a handle on our nonperforming loans with current valuations. It does not indicate any impairment. And then we’re very encouraged by the 3 note sales of par, which we discussed earlier and talked about briefly in the question. So we’re comfortable where we are, and we continue to diligently look to resolve all these issues.

Unidentified Analyst: For the fourth quarter, you are looking for Q4 expenses to be $13.2 million?

Tom Chmelik: Yes. That’s — looking at that, that looks in line with the guidance that we gave, backing out the nonrecurring expenses and then the run rate of 50 basis points per month for the quarter, that looks very close.

Unidentified Analyst: Looking at FS Vector’s projections, do you agree with the financial projections provided?

Jeff Dick: I think that they’re a reasonable place to start. I very much appreciated the perspective that FS Vector gave us, again, sort of coming up with that — the sense of what the average or the standard Fintech or client can produce. So, it gave me — it gave us, I think, comfort to see — they see a lot of Fintechs. They work with Fintechs directly. They help Fintechs to find banking relationships. They work also with banks. So, they see every side of this. And like I said, what they’re providing, though, is — they’re not providing the edge cases, if you will, good or bad. And so I do agree that it’s a great place to start and to focus on. We’re still very focused on trying to get to the numbers faster.

Unidentified Analyst: With the FS Vector analysis, was there anything that it told you that you previously did not know?

Jeff Dick: Great question. Yes, the concept that they use of full stack was, I think, a very valuable insight as we market avenue going forward as a better descriptor of what we provide to the industry. They’ve also given us good insights into really the numbers. I mean we’ve struggled with it in the past, we’ve always tried to be an extremely transparent company. But — and the question has been asked in the past, but we just didn’t have the sort of the — we’ve tried to do a lot of research, but we didn’t have the data elements that they had to provide that color to give us some comfort. So, that was extremely valuable. And it was also good to see the opportunities that they affirmed. And we talk to a lot of Fintechs, the sales part of this team where they’re going to Fintech meet us all the time and everything.

These — the FS Vector folks have really gelled that there is an extreme need. They solidified that and confirmed what we have researched ourselves. So, it’s always good to have validation. I think that in and of itself is worth an awful lot.

Unidentified Analyst: And are any of the potential partners for Avenue U.S. domiciled and domestic payments businesses?

Jeff Dick: So, they’re all U.S. domiciled in one way or form. And yes, there are some that are domestic payments as well. And they’re exciting stories. Hopefully, we’ll be able to tell before too long. But yes, no, definitely all U.S. domiciled. And their clouds are also U.S. domiciled. There’s another question there from Benjamin, I think I’m not sure. Avenue list the bank, I think find opportunities yet since its inception, it is unprofitable and entirely on the come. You are good and sincere community bankers. You have proven not to be at all good and increasingly not sincere tech entrepreneurs. You have virtually no customers and keep pushing back profits. So the advent of the consultant is just another expensive screen.

It’s not what investors want to hear. It is very much time to sell the business to someone who can exploit. So I guess I’ll just take exception with that on a few different levels because it has taken us — probably the biggest mistake that we made as we’ve gone through this process is being overly optimistic on when it will be ready. It takes time. We’re in a regulated environment, and we have been extremely responsive to that regulated — those regulatory requirements. I was a regulator in my first life. I know that it takes five years at least to get out of a consent order, and we didn’t want to go down that path. What FS Vector has confirmed for us is that our build has been efficient on the low end of the spectrum of cost and that we’re right in the middle of the pack when it comes to the time it takes to get it out.

They showed in their report, I didn’t share it here, but maybe I did. Some of the companies have spent well over $100 million and have taken almost six years plus. So forgive the optimism. We do have this opportunity. We have a great team. I know I’ve heard in the past that Jeff Dick doesn’t have technology experience. I understand a lot about technology, but the more important thing is I have a team that does. And we have a team that’s extremely talented from the leaders through the engineers, all the code writers, the QA, everything that needs to be done, and we’re doing it. We’re doing it correctly. And we are at a launch point. So from my perspective, I’m an investor — everybody at this table is an investor, and we believe in what we’re doing.

And we know that this is a great opportunity. We know that when fintechs see that our solution is everything that we said it is and that they see the quality. That’s what they’re looking for right now. They’re not — not every fintech is a Maverick. Those — the Mavers that were in the space were early days. They came, they conquered and a lot — to a big degree, they’ve been dealt with. The people that are going into the space now, they want permanence. They don’t want to have three relationships with three different banks because every day they wake up and think that they’re going to lose one of the relationships because the regulators have come in and said, you really don’t know what you’re doing or you shouldn’t be doing that. We’re better than that.

We are working very hard. We have the right mix of the technology with really smart people. We’ve got good technology oversight on our Board from a corporate governance standpoint. We also know what regulatory expectations are, not just today, but into the future. One of the things that you saw from the FS Vector report was that even with the FDIC’s proposal, we’re okay with that. There’s other proposals that are out there right now. We are still okay because there’s two aspects of volatility when it comes to a customer relationship, whether it’s a fintech or not. But the one that the FDIC spoke to as well is what happens? Is there somebody else that’s in control of where that fintech deposit goes. And in that middleware relationship, absolutely, that’s the case.

In our relationship, they’re on our ledger. So if you think about it, as a bank, we use a third-party. We use Jack Henry to process every day. We can go to Fiserv or FIS or several different other options, but we would have to deconvert from Jack Henry and then convert to whatever the new player. Our fintechs are going to need to do the same thing. So we need to be able to give them the comfort and confidence that when they come with us, we’re not charging them, there’s no middle mouths to feed in this process, its Main Street Bank and it’s the fintech. We provide the compliance training. We have an element of right tech and what we do as well. So it’s taken a little bit longer. It’s the knock on wood, best investment that we’ll ever make for our investors as we see the returns into the future.

So I just — I take [indiscernible] with the comment and everybody’s got to write to their opinion, and I don’t deny that. But I think that this is going to be a terrific opportunity for us to get out there and start to get these deposit relationships and show what a well-run community bank can do with a good technology bent to it.

Jeff Dick: We don’t see any other questions that have come up. So with that in mind, I really want to thank everybody for listening today. I think we’ve got a great story to tell. The lending team has done a terrific job. Asset liability management have really been positioning us for good quality into the future. And I think Avenue is at launch point, and we’re going to see good things going in the future. So thank you very much. We’re always available if you want to talk offline with any further questions or comments that you have that we didn’t answer today that you thought of later. I appreciate it, and I hope everybody has a great rest of their week. Thank you.