Pathward Financial, Inc. (NASDAQ:CASH) Q2 2024 Earnings Call Transcript

Pathward Financial, Inc. (NASDAQ:CASH) Q2 2024 Earnings Call Transcript April 24, 2024

Pathward Financial, Inc. beats earnings expectations. Reported EPS is $2.56, expectations were $2.37. CASH isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Ladies and gentlemen, thank you for standing by, and welcome to Pathward Financial’s Second Quarter Fiscal Year 2024 Investor Conference Call. During the presentation, all participants will be in a listen-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 Darby Schoenfeld, Senior Vice President of Investor Relations. Please go ahead.

Darby Schoenfeld: Thank you, Operator, and welcome. With me today are Pathward Financial’s CEO, Brett Pharr and CFO, Greg Sigrist, who will discuss our operating and financial results for the second quarter of fiscal 2024, after which we will take your questions. Additional information, including the press release, the investor presentation that accompanies our prepared remarks, and supplemental slides 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 and anticipated results to differ materially from the forward-looking statement. 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 in the appendix of the investor presentation. Finally, all periods referenced are fiscal quarters and fiscal years, and all comparisons are to the prior year period, unless otherwise noted.

Now let me turn the call over to Brett Pharr, our CEO.

Brett Pharr: Thanks, Darby, and welcome, everyone, to our second quarter 2024 conference call. We continue to produce strong results in the quarter by focusing on risk-adjusted returns and enhancing our banking-as-a-service offerings. Additionally, tax season is shaping up nicely, especially since the pit steps we took in the off-season to enhance data analytics, underwriting, and monitoring for refund advances are generating positive returns for us. We are very pleased with our performance thus far in the fiscal year. This focus helped us to drive $65.3 million in net income, a 19% increase, and $2.56 per diluted share, a 29% increase compared to the prior year’s quarter. Earnings growth was driven through an increase in net interest income of 17% and 26% growth in pre-tax income in our tax business during the quarter.

We also expanded net interest margin to 6.23% when compared to last year’s quarter, and our adjusted net interest margin, including rate-related processing expenses, was 4.65%. Performance metrics remain strong, with return on average assets for the first six months of the year of 2.35% and return on average tangible equity of 51.09%. For reference, these metrics were 2.39% and 50.81%, respectively, for the same time period last year. Finally, we are narrowing our guidance range to $6.30 to $6.60 in EPS for the full year. Greg will give you more color on this in his remarks. We are very pleased with our tax season results for the six months ending in March. The IRS opened a week later than last year, and because of the delay, we had more applications in our refund advance product, which gives customers access to a portion of their refund immediately.

We originated almost $100 million more in tax services loans than we did last year. This helped us to increase refund advance fee income by 12% over the same six months in the prior year. As we often say, no two tax seasons are the same, and this was true again this year. However, our long-tenured and talented team adjusted well and once again drove good results. Total tax services revenues for the six months ended March 31st increased slightly. However, we were able to decrease both tax product expenses and the provision for credit losses, resulting from some of the work I mentioned previously. And pre-tax net income for tax services grew 24% to $36.9 million. On the asset side of the house, Pathward’s Commercial Finance Division is comprised of four primary asset classes, working capital, structured finance, equipment finance, and insurance premium finance.

Each asset class is built to perform through economic cycles with a strong foundation of specialized and unique risk mitigation techniques. Because of this, we are better positioned to help businesses that many traditional banks are uncomfortable or unwilling to serve. For example, our working capital products consist of asset-based lending and accounts receivable factoring that provide businesses with the ability to obtain financing by leveraging assets as collateral, regardless of profitability or cash flow. These products are supported by formulaic advances primarily related to accounts receivable and inventory. We analyze the collateral’s performance to determine the ongoing viability of converting these assets into cash. This helps to establish appropriate collateral advance rates, which are monitored on a daily or weekly basis.

It also helps us to understand our overall risk, regardless of whether the borrowing company is profitably growing or experiencing financial strain. Additionally, unlike traditional banks, we generally use stronger controls, including dominion of funds, demand notes, and frequent field exams. Our equipment finance team offers commercial lease and term loans for equipment needs. We typically focus on mission-critical items, where the equipment is required to operate the business on an ongoing basis, even in the event of a company restructuring. Each contract has ongoing financial reporting requirements and ongoing collateral reviews, which sometimes include physical inspection. At the portfolio level, we monitor industry and collateral concentrations to manage our exposure.

These examples help illustrate the work that goes into managing our portfolio and allows it to perform very well historically, regardless of the macroeconomic environment. We believe it is the workload that is the primary driver of our higher yields. When reviewing our portfolio and potential loan opportunities, it is with this lens that we underwrite. We take into account the FTE cost, the traditional net charge-off rates of our portfolio, not the traditional net charge-off rates for these types of loans in the industry, and then arrive at a risk-adjusted return. When you compare the end of this quarter to the same time last year, we are holding over a half billion dollars more in commercial finance loans and $160 million more in consumer tax services and warehouse finance loans, and this is helping to drive our performance and growth in earnings.

Our goal on the asset side is to continue to optimize the balance sheet. We intend to focus on adding loans and leases with the highest risk-adjusted returns and redeploying cash from our securities portfolio into higher-yielding loan verticals. While we believe there is still runway to continue expanding that interest income, we believe non-interest income will be the source of sustained earnings growth well into the future. This growth can come from two avenues. First, you may see us increasingly utilize balance sheet velocity strategies, which come in a few forms, to generate fee income, including increased originations and sale of consumer loans, which we provide to support some of our banking-as-a-service clients. And second, we are extremely focused on growing fee income in banking-as-a-service.

We continue to be a beneficiary of a strong risk and compliance capability, as our processes, procedures, and program are especially designed for the space. Recent industry focus by regulators, specifically on BaaS Banks, in our opinion, has only reduced regulatory arbitrage and enforces rules that have been a part of the requirements for more than a decade. We expect that focus to continue. We are receiving more inquiries as other banks may be exiting or restricting their BaaS business. As a result, the pipeline in BaaS continues to be very healthy and includes expansion of products and services with existing partners, as well as inquiries from new partners. We continue to build on and invest in our people, risk culture, strong processes, and technology to adapt and grow with demands of the business.

We believe that the innovation that is occurring around the BaaS marketplace is incredible, and we intend to continue to be a trusted partner for the companies moving this industry forward. Now I’d like to turn it over to Greg, who will take you through the financials.

Greg Sigrist: Thank you, Brett, and good afternoon, everyone. Net interest income continues to be a significant driver of our results at a higher percentage of revenues than last year. This is primarily due to increased yields, and thus an improved earning asset mix, as well as a significant growth in loans and leases that we have seen over the last 12 months. In addition, we have seen sequential increase in overall yield on the portfolio due to increased rates on new production as we remain disciplined in adding higher risk-adjusted return assets onto the balance sheet. Our new production yield on commercial finance loans and leases in the quarter was 9.27% compared to the quarterly yield on the same portfolio from the last quarter of 7.97%.

Our adjusted net interest margin was 4.65%, and while this is slightly behind last year’s quarter, we made the operating decision to hold deposits off balance sheet at certain points in the quarter as we have in the past and instead utilize borrowings. This had the artificial impact of lowering both net interest margin and adjusted net interest margin since servicing fee income from off-balance sheet deposits is not included in either measure. However, the impact is relatively neutral to earnings. It simply shifts revenue from interest income into non-interest income. Non-interest income grew 2%, primarily driven by increases in refund advance fee income. This was partially offset by lower card and deposit fees due to lower servicing fee income from reduced levels of off-balance sheet deposits when compared to the prior year quarter.

Provision in the quarter declined almost 30%, primarily due to decreases in provision for refund advances and commercial finance. Brett mentioned the work we did in tax, which led to improved credit performance, including recoveries in the quarter. The provision also reflects a mixed shift in loan portfolio and a benign credit environment. Total non-interest expenses increased versus the same quarter last year, primarily driven by higher rate-related card processing expenses due to the rate environment. Non-interest expenses apart from rate-related card processing costs continue to be well-managed with an increase of just over 3% from the prior year quarter. Deposits on balance sheet of March 31st totaled $6.4 billion, an increase of almost half a billion dollars from a year ago.

We intend to hold higher relative levels of deposits on balance sheet to support the growth in loans and leases. Off-balance sheet deposits on March 31st totaled $1.2 billion. As a reminder, while these values are elevated at the end of the quarter due to seasonal deposits related to tax season, they will gradually draw down toward a low point, which we usually see in the September quarter. As of March 31st, Pathward is still holding approximately $741 million of deposits related to government stimulus programs. Through the rest of fiscal year 2024, we expect to return approximately $219 million of unclaimed deposits to the Treasury Department. We now expect for the full-year average off-balance sheet deposits to be around $440 million. Total loans and leases at March 31st totaled $4.4 billion, an increase of 18% percent from a year ago.

The company has experienced strong growth in the commercial and consumer portfolios, and we believe there are ample opportunities ahead, particularly in working capital and government-guaranteed loan products where we see healthy pipelines with strong risk-adjusted returns. Compared to December 31st, total loan balances declined slightly. We saw increases in asset-based lending, term lending, and SBA and USDA loans, offset by a decrease in insurance premium finance and consumer finance. From a liquidity perspective, we remain in a strong position with approximately $3.6 billion in available liquidity. As Brett mentioned, our goal is to optimize the balance sheet and rotate out of securities and into higher-earning assets. We still expect the securities portfolio to continue drawing down with close to $300 million of cash flows available for reinvestment over the next 12 months.

Finally, during the quarter, we repurchased approximately 764,000 shares at an average share price of $51.20. From April 1st through April 15th, we have repurchased approximately 101,000 shares at an average price of $49.47. We are narrowing our fiscal year 2024 EPS guidance to a range of $6.30 to $6.60. This includes a number of assumptions in addition to those that I’ve already touched on. We expect earning asset yields to continue to increase given our focus on risk-adjusted returns, continued pricing discipline, and securities portfolio cash flows, which will be reinvested into higher-yielding loans. We expect core card fee income to follow normal historical seasonal patterns. We estimate our effective tax rate to be in the range of 16% to 20% for the year.

This concludes our prepared remarks. Operator, please open the line for questions.

See also 25 Richest Billionaires in Logistics Industry and 15 Best Avalara Software Alternatives in 2024.

Q&A Session

Operator: Absolutely. We will now begin the Q&A session. [Operator Instructions] The first question is from the line of Frank Schiraldi with Piper Sandler. Your line is now open.

Frank Schiraldi: Just wanted to start with the expense side of things. If you could provide maybe a little color and hopefully a little bit of outlook in terms of how you see the comp line. I know, this quarter, obviously impacted by the seasonality of the tax business. So is it more reasonable to kind of return to nearer to fiscal 1Q levels in terms of thinking out through the rest of the year in terms of comp?

Greg Sigrist: Yes. Hi, Frank. Appreciate the question. Yes, in the quarter, I mean, just to be clear, I think there was roughly $2 million of what I’d consider to be non-recurring expenses in there. The rest really was related to your point to just the seasonality, higher levels of revenue, et cetera. But you’re spot on. I think my starting point is going to be reverting back to that December quarter run rate. The one thing I would touch on, though, for comp and benefits is over the balance of the year, we are going to continue to invest in human capital. So I’m expecting 2 to perhaps $2.5 million of additional run rate kind of building in over the balance of the year. And that’ll take some time to get there. But I think we’ll exit September a little bit higher than the December quarter.

Frank Schiraldi: Okay, great. And then just on the — sorry if I missed it earlier, but in terms of what you would just consider non-recurring, the $2 million, any sort of additional color you can provide there? Is that just, one off in the quarter? And what was the driver there?

Greg Sigrist: Yes. It was just some one offs in the quarter. I mean, you periodically have some things that’ll run through comp and benefits that are just bespoke. And they, again, they’re just not going to recur.

Frank Schiraldi: Okay. And then just on the loan growth, the insurance premium finance business, obviously you had an opportunity there and you saw a significant pickup. Maybe it was six months ago or so. And obviously they are short-term loans and we’ve seen that come back down. And any sort of thoughts around where that stabilizes, normalizes because otherwise you’d look like you had pretty good growth on the commercial finance side of things outside of that category.

Greg Sigrist: Yes. I would expect the insurance premium finance to normalize back up in April and May, back up to the levels we saw at the end of the year, at the December quarter end. So I think that was roughly back up to 680 million, Frank. But that should build part of the reason for that is April and May are pretty heavy premium months — renewal months for the underlying corporate so that we do expect that portfolio to build again.

Frank Schiraldi: Okay. And then, outside of that book, thinking about the rest of the commercial finance, I think was up close to double digits on annualized. Is that kind of the rate of growth you’re seeing in those other businesses?

Brett Pharr: This is Brett. In the working capital, I think we’re seeing that in the pipeline is really big. We’re being a little bit more selective on the equipment finance side and structured finance. It’s a number of things that have various puts and takes. So, I do think we’ll have — continued to have pretty good growth, but maybe not quite at the rate that we’ve had over the past year.

Frank Schiraldi: Okay. And then, if I could just sneak in one last one, just on the deposits that are subject to the contractual the indexing this quarter, you talked about 56% of the deposits are subject to that indexing up from 53% last quarter. And just curious, is that going to be a continued trend? If you can kind of talk us through that a little bit.

Brett Pharr: Yes. I mean, as you can imagine with the rate environment, as contracts come up, this is considerably more part of the conversation than it was before. So it is a negotiation and, sometimes it’s, so you’re trying to get more fees and then giving on commission on deposits or whatever it might be. So as long as rates are higher, there’s going to be pressure to do some of that. And it’s just a negotiation that we’ll engage in and make sure we’re getting good margin as we go through it. If rates stay higher for longer, you’ll probably have more of those conversations, but you also will get more on the asset side.

Operator: Thank you. The next question is from the line of Tim Switzer with KBW. Your line is now open.

Tim Switzer: Hey, good afternoon. Thank you for taking my questions. I wanted to follow up on your comments about the banking as a service landscape and how some of the regulatory pressures are limiting the arbitrage that was previously occurring. Can you give us a description of the partner pipeline you have like the size of the partners, the industries they’re in, the composition between if you’ll be doing deposit or credit sponsorship, everything like that.

Brett Pharr: Yes. I don’t know that we’re going to highlight, all the specifics of it, but sort of the macro piece of this. Right. So we’ve been pretty clear in the last three years that we were turning away business. In many cases it was business that did not fit our risk profile. Some were doing those kinds of businesses and that’s what’s going on in the industry. And you kind of heard pretty clearly from my comments, my view of that and where we stand versus others that are in the industry. So the result of that is everybody’s playing the quality and that is true in the issuing space. That’s true in the payment space. That’s true as well in the marketplace lending space. And there are very public events and all those categories and people that already have a meaningful amount of business.

So these are not startups are coming our way and it might be in the form of [indiscernible]. It might be in the form of build from scratch with new programs. But they find themselves in a situation where they can’t do the next new program with their existing bank because of circumstances. So we say this a lot, but I exponentially mean this our pipeline has never been bigger and it’s actually real stuff that we can do. And now people are beginning to listen to our requirements and that our requirements for their benefit and safety as well as ours. So I actually welcomed the elimination of the regulatory arbitrage that was going on and focusing on what the rules actually say. And we believe we’re in a good place for that.

Tim Switzer: Okay. Yes. And you kind of mentioned this, but are you able to qualitatively describe maybe in your partner pipeline, how many are coming from competitors versus people new to the industry?