Pathward Financial, Inc. (NASDAQ:CASH) Q1 2023 Earnings Call Transcript

Pathward Financial, Inc. (NASDAQ:CASH) Q1 2023 Earnings Call Transcript January 25, 2023

Operator: Ladies and gentlemen, thank you for standing by, and welcome to the Pathward Financial’s First Quarter Fiscal Year 2023 Investor Conference Call. During the presentation, all participants will be in listening-only mode. Following the prepared remarks, we will conduct a question-and-answer session. As a reminder, this conference call is being recorded. I would now like to turn the conference call over to Justin Schempp, Vice President of Investor Relations and Financial Reporting. Please go ahead.

Justin Schempp: Thank you, operator, and welcome. Pathward Financial’s CEO, Brett Pharr; CFO, Glen Herrick; and Deputy CFO, Sonja Theisen will discuss our operating and financial results for the first fiscal quarter of 2023, after which we will take your questions. Additional information, including the earnings release and a supplemental investor presentation may be found on our website at pathwardfinancial.com. As a reminder, our comments may include forward-looking statements, including with respect to anticipated results for future periods. Those statements are subject to risks and uncertainties that could cause actual and anticipated results to differ. The company undertakes no obligation to update any forward-looking statement.

Please refer to the cautionary language in the earnings release, investor presentation, and in the company’s filings with the Securities and Exchange Commission, including our most recent filings for additional information covering factors that could cause actual results to differ materially from the forward-looking statements. Additionally, today, we will be discussing certain non-GAAP financial measures on this conference call. References to non-GAAP measures are only provided to assist you in understanding the company’s results and performance trends. Reconciliations for such non-GAAP measures are included within the appendix of the investor presentation. Now, let me turn the call over to Brett Pharr, our CEO.

Brett Pharr: Thank you, everyone, for joining Pathward Financial’s first quarter 2023 earnings call. The company performed well during the quarter. Core net income excluding the impacts of rebranding was $23.2 million compared to $24 million in the prior year and core earnings per share of $0.81 was up 4% compared to $0.78 per share in the prior year quarter. Our continued focus on our key strategic pillars of asset optimization, deposit optimization and operational simplification, helped drive further expansion of our net interest margin, which rose over 100 basis points to 5.62% for the first fiscal quarter compared to 4.59% in the prior year quarter. Our strategy also enabled us to achieve return on average assets and return on average tangible equity that are amongst the top in the industry.

Photo by Carlos Muza on Unsplash

Our commercial finance portfolio grew 7% year-over-year and totaled $3 billion at quarter end. Total loans and leases on December 31, were $3.5 billion, a decrease of 5% from $3.7 billion in the prior year. The year-over-year decline in total loans and leases reflects the sale of the student loan portfolio, timing of tax season loans and a few relationship pay downs in our warehouse lending portfolio. Credit quality across the portfolio remains strong as nonperforming loans of 1.16% were the same as a year ago. As we head into a potential recessionary environment, we remain confident in our active collateral management and the quality of our loan portfolio. On the liability side of the balance sheet, the company continues to demonstrate its proficiency in managing excess deposits by storing them at our program banks.

In the first quarter, off balance sheet deposits averaged $1.4 billion, earning revenue roughly equivalent to the federal funds effective rate. In addition to generating revenue, these excess deposits also serve as a readily available source of liquidity. As of December 31, we had $2.2 billion of customer deposits stored off balance sheet with program banks, a level that is seasonably elevated due to holiday related gift cards and other products. As we have indicated during the two previous quarters, the landscape of the banking-as-a-service market is changing. While we continue to see fewer start-ups receive funding, our legacy partners are launching new programs and using our services to attract new customers. With our diversified clientele and our long history and experience in banking-as-a-service, we steer clear of the current turmoil experienced by others in the industry.

We believe our strong risk and compliance capabilities continue to serve us well during this time of industry transition. Regarding our rebrand, I’m happy to announce that company completed the remaining efforts during the quarter. Consequently, we’ve received the final $10 million of the original $60 million sale associated with our Meta trademarks. We are pleased to be serving our customers under our new Pathward name, which has been well received by our customers and partners. We look forward to building upon the brand value it provides. Looking ahead to the remainder of fiscal year 2023, we believe our unique business model allows us to benefit from rising rates, positioning us well to continue delivering solid financial results. Consequently, we have increased our fiscal year 2023 GAAP earnings guidance range which we now expect to be between $5.55 and $5.95 per share.

Finally, we are well prepared for tax season, which is kicking off in the second fiscal quarter. We have a long history of operational success are leader in supporting the independent tax industry and serve a major franchise in the business. Our historical experience and operational excellence position us to succeed in the unique economic environment of this year’s season. We look forward to sharing more on our next earnings call. Now, let me turn the call over to our Chief Financial Officer, Glen Herrick, who will provide additional detail on the quarter’s financials.

Glen Herrick: Thank you, Brett. Total GAAP net income for the first quarter was $27.8 million or $0.98 per share, down from the $61.3 million or $2 per share recorded in the prior year quarter. As a reminder, the last fiscal year’s quarter included an initial $50 million gain on sale of the Meta trademarks and this fiscal year’s first quarter included the remaining $10 million gain associated with the sale. Excluding the onetime gains and expenses associated with rebrand related activity and severance expenses, core net income of $23.2 million decreased slightly compared to the $24 million in the prior year. Adjusted earnings per share of $0.81 for the quarter represents a year-over-year increase of 4%. The business does not expect to report any additional rebrand related financial impacts moving forward.

Net interest income grew 17% year-over-year, driven by expansion in Pathward’s net interest margin. Total net interest margin for the first quarter of 5.62%, increased substantially relative to the 4.59% recorded in the first quarter of fiscal year 2022. We expect our net interest margin to continue to expand, given the current rate environment and ongoing optimization of our balance sheet. Provision expense in the first quarter of $9.8 million is a $9.6 million increase from the prior year. However, the prior year benefited from a $12.7 million provision reversal associated with the disposal of the bank’s remaining community bank portfolio. GAAP noninterest income declined from $86.6 million in the prior year quarter to $65.8 million in fiscal year 2023.

Excluding the $50 million and $10 million trademark sale gain in the first quarters of fiscal years 2022 and 2023, respectively, noninterest income increased 52% year-over-year. The large increase was attributed to fiscal year 2022’s losses on the community bank portfolio sale and money line investment write-off. Meanwhile, the current year benefited from revenues associated with off balance sheet deposits servicing. On the expense side, total GAAP noninterest expense of $105.1 million represents an increase of 27% from the prior year quarter. When adjusting for $3.7 million of rebrand related items in 2023, expenses of $101.3 million grew 23% year-over-year. This increase resulted primarily from $15.5 million of additional card processing expenses, mostly attributable to the higher rate environment.

Other expenses excluding rebrand related items, grew at a 4% pace year-over-year. The company remains well capitalized, while continuing to return value to shareholders. During the fiscal 2023 first quarter, the company repurchased 654,000 shares at an average price of $38.10. Through January 20, the company repurchased an additional 478,000 shares at an average price of $45.45. As Brett mentioned, we are increasing our guidance for fiscal year 2023. For the year we expect GAAP earnings per share between $5.55 and $5.95. This guidance assumes the federal funds target rate rises to 5% in the second half of fiscal year 2023 and remains flat thereafter. That concludes our prepared remarks. Operator, please open the line for questions.

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Q&A Session

Operator: Thank you. Our first question comes from the line of Frank Schiraldi of Piper Sandler. Please proceed.

Frank Schiraldi: Hi guys.

Brett Pharr: Hey, Frank.

Frank Schiraldi: Just wanted to ask — I wanted to ask about higher guide. Can you talk a little bit about what is driving that? Is it just early thoughts on tax season are shaping up pretty good or what’s kind of driving the change linked quarter?

Brett Pharr: Well, I think the big thing is, there is a slight increase in Fed funds beyond what our original basis was. And so, we expect that to show up in — are experiencing that starting to show up in higher yields. We think we’re well prepared for the tax season as we always are. This is one of our core competencies. And the macro environment for the tax season is positive, but we haven’t made any bets on that yet. So it’s too early. I mean, the IRS just opened up for return this week. So it’s too early for us to make any prospective views of what’s going to happen in tax season.

Frank Schiraldi: Okay. And then, can you talk a little bit about what the guide might imply for loan growth here, just given overall commercial finance was kind of flattish linked quarter and I know the ABL and factoring balances have declined. Not sure what you’re thinking, that was a good kind of run rate for commercial finance growth from here.

Brett Pharr: Again, it’s a mix of asset classes that are going to behave differently. Working capital is where we’re hoping for the growth as we get into a more recessionary style environment. There likely will be some slowdown in various kinds of term lending. Conversely there seems to be a bit of uptick in the — in our solar financing and other alternative energy financing opportunities. So, I think we’re going to be continually plotting forward as we have been, making that rotation from one asset class i.e. securities to another, I don’t expect it to take off and I don’t expect it to dive or anything like that either.

Frank Schiraldi: Okay. And I think in the past you might have talked about sort of double-digit growth overall in commercial finance. I don’t know if that’s still kind of reasonable bogey going forward?

Brett Pharr: Yeah, I mean I think low-double digits overtime through economic cycles is quite reasonable for us. We want to make sure that we have the yield in it and that’s been some of the challenge and we’ve talked about that from a liquidity perspective, that’s gradually getting washed out. But, I mean, I think, long term, that is a reasonable assumption.

Frank Schiraldi: Okay. And then in terms of the — on the depository side, unless I heard wrong, it sounded like the off balance sheet deposits maybe are boosted a bit linked quarter given some seasonality. So in such case, maybe those come down from whatever, this is $2 billion plus at the end of the quarter. Just wondering, how to think about the rest of that I guess? Do you continue to think you — that remains off balance sheet and you pick up Fed funds on it? Is there opportunity or thoughts to bring it back on balance sheet, and given some of the opportunities you can get in terms of yields on the asset side? What’s sort of the strategy there overall?

Brett Pharr: Well, a couple of things. You’re correct. There is some seasonality in the fourth quarter and I think in my comments, I highlighted a level that’s probably more like core. We do think that — and this is one of our advantages that the liquidity is gradually wiping out in the general economy and there may be some minor shrinkage even in that core just because of what’s going on in the economy. I don’t — because we have plenty of money in the securities portfolio, I don’t need to pull those deposits back on to the balance sheet to fund the next asset rotation. We’ve got plenty on the balance sheet to do that and there is no sense in inflating the size of our balance sheet until we kind of keep working through that asset rotation.

Frank Schiraldi: Okay. That makes sense. And then just lastly on credit. You talked in the release about the increase in provisioning and increase in NPA. I assume it was kind of part and parcel same, I think you talked about one relationship on the commercial finance side. Any additional color you can give on that relationship and hopefully your comfort in limiting losses there?

Brett Pharr: Yeah, one of the things I talk about all the time is, we are a collateral managed credit facility. We don’t do unsecured credit. And even though something might be in a nonperforming, there is collateral behind it. We’re kind of experts at liquidating that, whether it’s working capital or working with partners on equipment and those kinds of things. And so just because you see in nonperforming doesn’t mean that’s a loss. What that means is, we’re working it down with the collateral that we have. We’re seeing continued good performance in the credit portfolio. We’re not seeing any negative impacts as of yet. You always have companies coming and going, that’s true, but we’re not seeing any trends to the negative side at all.

Frank Schiraldi: Okay. But can you say where that — is that in working capital, or is that a term loan? Just trying to get a little bit more color on

Brett Pharr: Glen, do you want to respond to that. I mean we know, but I don’t know what we can disclose on that.

Glen Herrick: Yeah, that’s a term loan, Frank. And I would also note that, for us, NPLs is a better metric than NPAs. As we continue to mix shift earning assets in the loans from securities, our NPAs are going to go up, just as we reduced the securities percentage. And our numbers are pretty low. And so, if we get $1 million, $3 million or $4 million loan, it can spike up short term, but we feel real confident about our outlook.

Frank Schiraldi: Okay, great. Thank you.

Brett Pharr: Thanks, Frank.

Glen Herrick: Thanks, Frank.

Operator: Thank you. Our next question comes from Tim Switzer of KBW. Please proceed.

Tim Switzer: Hey, good afternoon. I’m on for Mike Perito. Thanks for taking my question.

Brett Pharr: How are you doing?

Tim Switzer: Good. On the — I guess just on prior conversation that we’re having, could you walk us through some of the collateral you have in different pieces of your loan book, particularly some of the higher loss categories, such as like the term lending, and factoring and I guess kind of like run through the terms, you have on those as well?

Brett Pharr: So, on the working capital arena, these are accounts receivable and inventory. In those kinds of transactions, we either have a borrowing base of receivables where we’ve pre-approved the debtor, which is the one that owes our customer money. In many cases depending on the situation, we actually have dominion of funds, where all the payments are coming straight to us. And obviously, you have a security interest in those things. And we do some things that are kind of unique, at least for bank, in the way that we manage those. In the inventory cases, we have pre-planned buyers often for the inventory or at least appraisals on it. So we know what we would do in the event of liquidation. In equipment arena, it varies a little bit about what it is.

Some of it is mission critical equipment, which means that even in the event of a reorganization bankruptcy its mission critical, and they’re going to reaffirm the debt and pay us. So we emphasize that a lot. Or in other cases, we have relationships with third parties who are ready buyers for that and we regularly work on and cultivate those relationships, so that we can take advantage of them. So, it’s not like a traditional C&I lending. It’s — we go in assuming there’s going to be a default and then how would we get out, if there was a default and not lose money. So generally, particularly in the working capital, where there is a problem, it’s because of fraud, not because of an actual weakness in the collateral position.

Tim Switzer: Okay. And you

Glen Herrick: And, Tim

Tim Switzer: Oh, yeah. Go ahead.

Glen Herrick: Tim, this is Glen. I would also refer to Page 16 of our investor presentation on the deck. Some additional information around our different types of commercial finance and then at the end of the deck, we have some industry concentration information.

Tim Switzer: Great. Yeah, that’s helpful. And when you guys stress the portfolio run in your stress test, what are some of the scenarios you use and like, which variables are you focusing on? We’re just trying to get an idea of like how different parts of the loan book would react to certain stressed environments?

Brett Pharr: Yeah. So, Glen, I’ll let you answer here in a second. What I would tell you is that, we’re always looking at every transaction as if it’s stressed. We certainly look at industry concentrations, what can happen in that industry and adjust appropriately. Particularly strong thing that we do is, we look at the debtor credit book, that again, that’s the people that are paying our borrower and make regular decisions about that. And so, examples of some fairly common high named bankruptcies that have occurred recently, 18 months ago we were out and wouldn’t accept receivables from them. So that’s more of a kind of thing we do. Each transaction is so unique in this space. It’s really not conducive to a portfolio stress type arrangement that you might be used to in a traditional C&I.

Tim Switzer: Okay. I got you. Going back to the guidance a little bit. What is sort of the NIM expectations you have for like Q1 and Q2, like you’re through all the interest rate floors, right, and I mean you had like 40 basis points of NIM expansion for the last two quarters in a row basically. Like, is it reasonable to expect that again or should it start slowing down?

Glen Herrick: Tim, this is Glen.

Brett Pharr: Glen, you want to take that?

Glen Herrick: Yeah. Like all things, it depends on the mix where the growth comes from. That said, we will gain NIM just by continuing to remix our balance sheet if rates didn’t move at all. But we are comfortable that NIM will pass through 6% in our fiscal year 2023.

Tim Switzer: Okay. All right. Great. And could you provide a little bit of color on, like the expectations you have within the guidance, assuming like there isn’t like a serious economic deterioration?

Glen Herrick: We’re not guiding by line item on our income statement. And so our expenses, we have — for a bank, we have a fair amount of variable expenses that are driven by activity which relates to revenues. And so, those are correlated with the revenue expenses that we have. And our goal is to grow our core expenses at less than half the rate of our revenue growth and then that’s what’s factored into our guide.

Tim Switzer: Okay, that’s helpful. Thank you, guys. I’ll get back in the queue.

Operator: Thank you. And that concludes the Pathward Financial first quarter fiscal year 2023 investor conference call. You may now disconnect. Thank you.