FinWise Bancorp (NASDAQ:FINW) Q2 2023 Earnings Conference Call July 27, 0000 5:30 PM ET
Company Participants
Kent Landvatter – Chief Executive Officer and President
Javvis Jacobson – Chief Financial Officer
Jim Noone – President, Chief Credit and Chief Strategy Officer
Brad Cohen – Partner ICR
Conference Call Participants
Andrew Terrell – Stephens, Inc.
Operator
Greetings and welcome to the FinWise Bancorp Second Quarter 2023 earnings conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Brad Cohen with ICR. Thank you, Mr. Cohen, you may begin.
Brad Cohen
Thank you, operator. Good afternoon, and welcome to FinWise Bancorp’s Second Quarter 2023 Conference Call. The earnings press release is available on the Investor Relations section of the company’s website at investors.finwisebancorp.com. Note that this conference call is being recorded. I would like to remind you that statements made in the course of this call are not based on historical information and may constitute forward-looking statements covered by the safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
These statements are based on management’s current expectations and beliefs and are subject to a number of trends and uncertainties that could cause actual results to differ materially from those described in the forward-looking statements. I refer you to the company’s filings made with the SEC, including its earnings press release issued earlier today for a more detailed discussion of the risks and factors that could cause actual results to differ materially from those expressed or implied in any forward-looking statements made today. The company undertakes no duty to update any forward-looking statements that may be made during the course of the call.
Additionally, certain non-GAAP financial measures will be discussed on this conference call. Our presentation of this information is not intended to be considered in isolation or as a substitute for the financial information presented in accordance with GAAP. Reconciliation of these non-GAAP financial measures to the most comparable measures prepared in accordance with GAAP can be accessed through our filings with the SEC, including the earnings press release issued earlier today at www.sec.gov.
Hosting the call today are Mr. Kent Landvatter, Chief Executive Officer and President of FinWise Bancorp; Mr. Javvis Jacobson, Chief Financial Officer; and Mr. Jim Noone, President of FinWise Bank.
With that, I will turn the call over to Mr. Landvatter. Thank you.
Kent Landvatter
Good afternoon, everyone. And thank you for joining us on the second quarter 2023 earnings conference call. On today’s call, we will provide some color on our second quarter financial results, discuss the impact of the macroeconomic environment on the company and our strategic priorities.
We delivered solid second quarter results notwithstanding the challenging macro headwinds. This is a testament to our resilient and differentiated business model. I am exceptionally proud of our team’s ongoing execution and dedication to providing our clients and customers with best in class value and service, especially during more challenging market conditions.
Our differentiated and diverse business model that focuses on leveraging strategic relationships with third party loan origination platforms utilizing proprietary automation and analytics technology along with a strong and growing balance sheet continue to deliver growth and profitability.
Together with our focused strategic priorities and strong execution, FinWise has been adept at effectively navigating a multitude of economic cycles. This was evidenced again in the second quarter, as we continue to generate positive results supported by prudent credit underwriting while we continued our investment in future growth opportunities.
For the second quarter of 2023, we generated revenue of $21.2 million led by growth in our loan portfolio and better than anticipated loan originations of $1.2 billion, producing a net income of $4.6 million or diluted earnings per share of $0.35 with return on average equity of 12.8%. While we recognize originations for the quarter was stronger than anticipated, most of the outperformance was driven by a single strategic platform that benefited from additional funding during the quarter.
We continue to believe that the interest rate outlook and tightness in the capital markets will weigh on our originations and that industry-wide softness in loan originations may persist through the remainder of 2023. Therefore, our near term outlook for loan originations remains cautious and unchanged. In addition, it is important to note that our long term strategy and focus have not shifted.
We continue to demonstrate that our business model is sound through various economic cycles and believe we are well positioned for growth when the market rebounds. We continue to prudently and conservatively manage capital. This included investing in our business to fuel future growth, as well as selectively repurchasing our shares below tangible book value.
At the end of the second quarter, the company’s tangible book value per common share was $11.59, as compared to $11.26 at the end of the prior quarter, and our bank capital levels remained significantly above well capitalized guidelines with a bank leverage ratio of 22.4%.
I will now provide an update on our key objectives as we move through the second half of 2023 and beyond. In our strategic programs business, we continue to support our current platforms while working to expand our strategic program to drive growth and diversify revenue streams. A wide dispersion in the performance of loan originations by various strategic platforms in the quarter continued, with some down while others did relatively better.
On the expenses front, we continue to demonstrate cost discipline with the second quarter efficiency ratio of 52.7% compared to 52.5% in the previous quarter. As previously communicated, we expect that our efficiency ratio will fluctuate and remain elevated as we invest to position the company for future growth.
We believe that investing in our team and infrastructure including administrative support, technology, systems, and the expansion of our Banking-as-a-Service product line is the best approach to secure future diversified growth. We believe these investments are crucial in expanding and deepening relationships with our current customers and in rolling out more products to meet client demand, and further diversify our revenue streams.
Turning into credit, we maintained our disciplined approach to growing our loan book. In the second quarter, overall credit performance of our portfolio has remained strong, with no significant deteriorations beyond the ongoing industry wide normalization of credit to pre-pandemic levels. Jim will provide further details regarding the credit performance later in this call.
We are excited to announce that subsequent to the end of the second quarter, we entered into a definitive agreement with BFG and four members of BFG to acquire an additional 10% of its membership interests, subject to regulatory approval, and other customary closing conditions. Upon closing, this will bring our total ownership to 20%. Increasing our equity ownership at BFG has been one of our long term initiatives. As outlined in our previous public filings, we have a right of first refusal, and an option to acquire 100% of BFG.
As we look ahead, we continue to manage the company for the long term. We’ve been proactively positioning the business to be flexible and responsive to the prevailing environment while pursuing opportunities. We will remain disciplined in our underwriting, invest for future growth, explore new opportunities, and manage capital prudently. We believe that these strategies have served us well thus far and we are laser focused on seeking to grow the business responsibly and maximizing shareholder value.
With that, let me turn the call over to Jim Noon, our bank President who will provide you with more detail on strategic program initiatives and credit performance.
Jim Noone
Thank you, Kent, and good afternoon. Given the market’s focus on credit quality and growth opportunities, I will take a few minutes to walk you through our strategic program initiatives, credit performance, and how we believe we are uniquely positioned to weather the current challenging environment and achieve long term growth.
As part of our strategy to increase and diversify revenue, we have continued to invest in new products such as card offerings and our payments hub. We believe that an integrated Banking-as-a-Service offering is core to our future and could provide FinWise with additional opportunities to offer lending, deposits, cards and payment services to our platforms. We are pleased with the progress we have made on these initiatives to-date.
Our SBA 7(a) loan originations remained solid for the quarter. Similar to the previous quarter, we continue to hold the majority of the guaranteed portion of these loans on our balance sheet, as gain on sale premiums are lower, and interest income had risen due to underlying adjustable rates. As a result, our SBA gain on sale revenue was much lower than in the same quarter last year. We continue to believe that over the longer term, this shift may benefit the company through a higher balance of government guaranteed loans in our portfolio, and the higher level of recurring interest income that this is expected to deliver.
Now, turning to credit, our loan book performed as anticipated, with non-performing loans to total loans held for investment of 0.3% at the end of the second quarter, the previous quarter and the same quarter last year. The company’s provision for credit losses was $2.7 million for the quarter, compared to $2.7 million for the first quarter, and a provision for loan losses of $2.9 million for the same quarter last year. The change in the provision over the same quarter last year was primarily due to a reduction in the balance of our strategic program loans held for investment.
During the quarter, net charge offs were $2.4 million, compared to $2.9 million in the first quarter, and $2.3 million during the same quarter last year. The company’s net charge off rate as a percentage of average loans held for investment was 3.4% compared to 4.5% in the first quarter, and 4.5% in the same quarter last year. The decrease in net charge offs compared to the prior quarter was primarily due to lower net charge offs in our strategic program loans. The increase in net charge offs compared to the same quarter last year was primarily due to higher net charge offs related to our SBA loans.
We believe we continued to be well reserved with an allowance as a percentage of total loans held for investment of 4.2% in the quarter, compared to 4.4% last quarter, and 5.3% in the same quarter last year. Overall, we believe our team’s extensive experience in the industry, along with our technology, automation, and underwriting, positions us well to manage potential credit risks.
Now, let me turn the call over to Javvis who will provide more detail on our financial results.
Javvis Jacobson
Thank you and good afternoon. I plan to discuss our financial results for the second quarter relative to the prior quarter and to the second quarter of the prior year.
Loan originations totaled $1.2 billion for the second quarter compared $0.9 billion for the first quarter and $2.1 billion in the prior year. Relative to prior quarter, the increase was driven by better than anticipated performance in our strategic programs, while the decrease from the prior year was primarily due to a continued contraction in the capital markets for certain loan assets as a result of the challenging macro environment and our conservative underwriting to manage credit risk.
Average loan balances comprising held for sale and held for investment loans were up 11.6% to $324.1 million during the quarter from $290.4 million last quarter, and up 16% from $279.3 million in the prior year. The increase from the previous quarter and the prior year period was primarily driven by continued growth in our SBA 7(a) program.
Despite industry wide liquidity pressure, our balance sheet and liquidity position remained strong during the quarter. Average interest bearing deposits were $219.1 million compared to $165.2 million in the first quarter and $127.2 million during the prior year period. The sequential quarter increase was driven primarily by an increase in certificates of deposits. The year-over-year increase was due mainly to increases in certificates of deposit and interest bearing demand deposits, partially offset by a reduction in money market deposits.
As we have noted previously, non-interest bearing deposit levels have historically had a high correlation with held for sale loan balances and origination volume from our strategic programs. As we highlighted last quarter, our differentiated business model has provided us with a stable and sticky deposit base. Specifically the origination platforms have been contractually obligated to maintain certain levels of deposits with FinWise while a significant portion of the uninsured deposits on the bank’s balance sheet have been our own capital. Taken together, as of the end of the quarter, approximately 85% of the bank deposits are either insured, are our own capital, or are contractually required in our strategic lending business.
Now turning to the income statement, net income for the quarter was $4.6 million compared to $3.9 million last quarter and $5.5 million in the same quarter last year. The improvement from the prior quarter was primarily due to an increase in net interest income, driven by growth in our loans held for investment portfolio. The decrease from the prior year period was primarily due to lower strategic program fees, higher interest expense on deposits and lower gain on sale, partially offset by higher interest income and a reduction in non-interest expense.
Net interest income for the quarter grew 13% to $13.7 million compared to $12.1 million last quarter and was up 7.1% over the $12.8 million in the same quarter last year. The improvement relative to the prior quarter and year was primarily due to increases in the bank’s average balances on loans held for investment portfolio, coupled with increasing yields on variable rate interest earning assets due to the rising rate environment partially offset by an increase in the interest rates being paid and average interest bearing liability balances over the same periods.
Net interest margin for the quarter was 37 basis points lower at 12.14% compared to 12.51% last quarter, and 155 basis points lower than 13.69% in the prior year period. The change from the prior quarter was mainly due to an increase in interest bearing liabilities primarily associated with a rise in our certificates of deposit balances and rates. The decrease from the prior year period was primarily due to a reduction in average balances in our loans held for sale portfolio along with the shift in our deposit portfolio mix from lower to higher costing deposits partially offset by an increase in average balances in our loans held for investment portfolio.
Non-interest income was $5.3 million in the quarter compared to $4.5 million in the first quarter and $8.4 million in the same quarter last year. The increase from the prior quarter was primarily due to an increase in the number of SBA 7 (a) loans sold. The decrease from the prior year period was primarily due to lower originations of strategic program loans and the associated strategic program fees, a reduction in gain on sale of loans primarily attributable to our increased retention of the guarantee portion of SBA loans to increase interest income, which resulted in a corresponding decrease in gain on sale income, partially offset by an increase in the fair value of our investment in BFG. We expect that the fair value of our investment in BFG will continue to experience quarterly fluctuations partially due to general market movements.
Non-interest expense during the quarter was $10 million compared to $8.7 million in the prior quarter and $11 million in the same quarter last year. The increase from the prior quarter was primarily due to an increase in salaries and employee benefits related to higher accruals for performance bonuses based on higher company profitability. The decrease from the prior year period was primarily due to a recovery on our SBA servicing asset during the quarter which did not occur in the prior year period.
The company’s efficiency ratio was 52.7% during the quarter compared to 52.5% during the prior quarter and 52% in the same quarter last year. As we’ve noted in past calls, we expect the company’s efficiency ratio to increase as we continue to build out our infrastructure to position the company for sustainable long term growth.
With respect to capital levels with a 22.4% leverage ratio, the bank remains significantly above the 9% well-capitalized requirement. The company’s effective tax rate was 26.1% for the second quarter, as it was last quarter. This compares to 24.6% for the same quarter last year. As part of our effort to be good stewards of capital, during the quarter we bought back a total of 269,690 shares for approximately $2.2 million.
With that, we would like to open up the call for Q&A. Operator?
Question-and-Answer Session
Operator
Thank you. We will now be conducting a question-and-answer session. [Operator Instructions]. Thank you. And our first question is from Andrew Terrell with Stephens, Inc. Please proceed with your question.
Andrew Terrell
Hey, good afternoon.
Kent Landvatter
Hey.
Andrew Terrell
Hey, can I maybe just start on the origination volume for the quarter came in a bit better than expected and was obviously up in the quarter. And Kent I heard your comments towards the beginning of the call about maybe some still kind of cautious outlook in the back half of the year, but I guess like, as you look at it today, does it feel like we’ve at least kind of relatively hit a trough around this billion dollar level in terms of originations?
Jim Noone
Yeah. Hey, Andrew, this is Jim. So, yeah, I mean, originations in the quarter were better than expected. But like Kent mentioned, on the script, most of the delta quarter-over-quarter came from a single partner rather than a broad trend across all of our platforms. And we don’t currently see enough broad strength in market conditions or across all of our partners that would change our outlook on originations for the rest of the year. And so we would continue to point you to Q1 origination levels as more likely than the current quarter’s.
Andrew Terrell
Yeah, understood, okay. And, in the charge off, stepped down pretty considerably again this quarter after kind of peeking out in the back half of last year, just on the overall loan portfolio. Just wanted to get maybe refreshed thoughts on incremental balance sheet retention of SBA loans here? I know you’re focusing on retaining more in SBA credit, but wanted to get the refreshed thoughts on the strategic partner or strategic program balance retention?
Jim Noone
Yeah, and I think specifically, you’re talking about like the SP HFI portfolio, right?
Kent Landvatter
Yep. Correct, correct.
Jim Noone
Yeah. Okay, so generally, you know, we’ve been measured and purposeful, on kind of how we grow the balance sheet. You know, not just in that program, but across our other portfolios as well. If you look at the SP HFI balance at the end of the second quarter of ’22, it was about $27.5 million. And then if you fast forward it to this quarter, that balance is about $20.7 million. So beyond remixing the composition there that we’ve talked about some in previous quarters, you also saw us reduce the out risk portfolio there by about $6.7 million, or about 25% over the last 12 months. So there’s not a specific balance or size to that SP HFI portfolio that we’re targeting. But we monitor and review the trends, just like we do with all the rest of our programs, to make decisions on what we’re comfortable retaining. And you can see how we’ve positioned that over the last 12 months.
Andrew Terrell
Got it. Okay. And then, Jim, going back to some of your prepared remarks about or some of the prepared remarks around the continued investment kind of in payments hub and card offerings, wanted to get maybe status update there, and anything you can share around maybe how the pipeline is looking in terms of the build out of some of that? Just any additional color there would be helpful.
Jim Noone
Yeah, it’s no problem. So we continue to make good progress with new lending partner launches, Andrew. And we’re comfortable with the stated goal of two to three launches in the second half of this year, on kind of new lending partners. And then you asked about kind of the new product initiatives as well. And it’s mostly processes and infrastructure for the new debit and credit card issuance business that’s being stood up as we speak. We think that, you know, and we believe this will be stood up in the next few quarters with our first customers soon thereafter. And then we’ve also started the diligence and scoping process on our payments hub. And we expect this to be operational in the next few quarters as well.
Andrew Terrell
Very good, I appreciate it. And then if I can just one more really quick. The increased investment in BFG, what are the net impacts from a financial standpoint of that increased investment? And can you just talk a little bit more about kind of the rationale there in terms of stepping up the investment?
Kent Landvatter
Yeah, maybe I could start just with rationale and then I’ll turn over to Javvis for some of those things. But BFG, as you know, it’s been a primary source of our SBA loan since 2014 and beyond that we’ve had a very synergistic relationship. And we believe that this was a very good acquisition, and they’ve been a very good partner to us. And so we were — the primary reasons behind the acquisition continue to be strategic. And so just strengthening this relationship as we move forward is very important to us and maybe Javvis, you can dig into the specifics.
Javvis Jacobson
Yeah, Andrew, the — probably the — maybe the place to start is on dilution. There will be a dilutive impact for existing shareholders as a result of the transaction when it closes. But we believe that it will be minor compared to the benefits we expect as a result of the transaction.
Andrew Terrell
Okay, and I guess more specifically on the benefits side, when the transaction closes, I guess what should we expect in terms of net financial impacts and benefits?
Javvis Jacobson
That’s a good question. Andrew, as you know, we carry our investment and BFG on our balance sheet at fair value. So this is a little different than the traditional bank acquisition or what have you in the Community Bank space. So once we close the transaction, we’ll update you on that the financial impact, but it isn’t expected to change from what we’ve been doing in the past as far as how we treat our investment.
Andrew Terrell
Okay. Very good, thank you for taking the questions. I’ll step back on the queue.
Javvis Jacobson
Okay.
Operator
Thank you. [Operator Instructions] There are no further questions at this time. We have a follow up question from Andrew Terrell with Stephens Inc. Please proceed with your question.
Andrew Terrell
Okay. Thank you. If I can ask a couple more really quick, just on the SBA loan servicing fees, what drove the step down in that line this quarter? It looks like it’s been riding around $500, 000 to $600,000 a quarter and it came down a fair amount in the second quarter. Just curious what drove the step down this quarter. And should we expected normalization higher there?
Javvis Jacobson
Yeah, Andrew, the step down, as we’ve talked about in the past, when rates continue to rise in the in the market, SBA loans tend to pay off. And that’s what we had occur during the second quarter, a couple of SBA loans paid off and the associated accruals and deferrals, all flushed through the income statement. So that’s what you’re seeing there.
Andrew Terrell
Okay, so fair to think a kind of run rates around this level moving forward, then?
Javvis Jacobson
It should be similar to the last couple of quarters.
Andrew Terrell
Okay, got it. And then maybe just I know, the compensation increase in this corner sounded like it was higher level of bonus accrual. And you guys do continue making investments in a franchise kind of positioning for future growth. Just can you help us out maybe with operating expense kind of run rate or target for the next couple of quarters?
Javvis Jacobson
Sure. As we’ve talked about in the past, Andrew, we do plan to continue to build our infrastructure. And as you noted, the major reason for the change between last quarter and this quarter is related to performance of the company and bonuses associated with that. So I think the relationships will stay consistent from that standpoint.
Andrew Terrell
Understood, okay. And then I might have missed it towards the end of the prepared remarks, but did you have the amount of shares bought back in the current quarter and the weighted average price and then expectations for the buyback moving forward? And then what amount you have left outstanding on the authorization?
Javvis Jacobson
I had that number Andrew, just have to find it. We purchased 269,690 shares during the quarter for about $2.2 million and I’m not sure what the — I’ll have to get back to you Andrew on the amount remaining.
Andrew Terrell
Okay, that’s fine. I can go back and find the initial one. But fair to assume you remain active on the buyback though?
Javvis Jacobson
Where we have opportunity, especially below book value, we will we plan to remain active. Yes.
Andrew Terrell
Okay. Very good. I will step back. Thank you for the questions.
Javvis Jacobson
No problem. Thanks, Andrew.
Operator
Thank you. There are no further questions at this time. I would like to turn the floor back over to CEO and President, Kent Landvatter for closing comments.
Kent Landvatter
Yes, thank you, everyone, for joining us on this quarter’s call. We’re very excited about the future of the bank and we appreciate your support and look forward to future growth in our company and shareholder value.
Operator
Thank you. This concludes today’s teleconference. You may disconnect your lines at this time. Thank you for your participation.
