This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk01: Ladies and gentlemen, thank you for standing by and welcome to the Pathwork Financial Investor Conference Call for the third fiscal quarter of 2022. 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 Justin Schimpf, Vice President of Investor Relations and Financial Reporting. Please go ahead.
spk03: Thank you, and welcome to Password Financial's third fiscal quarter of 2022 conference call and webcast. On July 13th, the company legally changed its name to Password Financial, and we will refer to ourselves as such throughout today's call. Our CEO, Brett Farr, President Anthony Charette, and CFO Glenn Herrick will discuss our operating and financial results, after which we will take your questions. Additional information, including the earnings release and investor presentation, may be found on our website at passwordfinancial.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 pilings, for additional information covering factors that could cause actual results to differ materially from the forward-looking statements. Additionally, today we may 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. Let me turn the call over to Brett Farr, our CEO.
spk08: Thank you, everyone, for joining Pathwork Financial's third fiscal quarter 2022 earnings call. I am pleased to host this call today, our first, using our company's new corporate name, which reflects our continued commitment to providing a path forward to people and businesses so they can reach the next stage of their financial journey. As Justin mentioned, Our company legally changed its name to Pathwork earlier this month. While our corporate name has changed, the full transition to our new brand, including the launch of our new brand identity and website, is still underway, and we will complete it by calendar year end. Turning to our financial results, net income was $22.4 million, down $16.3 million compared to $38.7 million in the same prior year period. Earnings per share for the quarter was 76 cents as compared to $1.21 in the prior year. As previously disclosed, our earnings this year have been impacted by a slowdown in the renewable energy tax credit lending market, lower tax advance demand than we assumed, and certain one-time branding and separation agreement expenses. We continue to benefit from our business model of using low-cost deposits from our banking as a service business, lending them to a variety of commercial finance asset classes, allowing substantial return of capital to our shareholders. This model will generate higher returns once the market lending rates begin to reflect the higher rate environment. We anticipate that our net interest margin will continue to expand as a result of our ongoing mix shift into higher interest earning assets, coupled with higher overall rates on new business originations and increases to the variable loan portion of our existing portfolio. Our confidence in steadily growing earnings per share has never been higher. Like others in our industry, we are facing a challenging macroeconomic and geopolitical landscape. Third quarter expenses were higher compared to the previous year as we incurred higher employee compensation costs as well as higher technology-related spending to enhance our capabilities to get ahead of market expectations and respond to industry-wide inflationary pressures. In response to these headlines, we will concentrate our efforts to drive productivity and enhance efficiency. Our income tax rate was up compared to the second quarter due to delays in the development of renewable energy projects in our pipeline. As we've noted in the past, our income tax fluctuates primarily due to these projects. The solar construction market has been largely impacted by supply chain constraints, leading to volumes well below our expectations, and as a result, we anticipate our tax rate to be higher than previously expected in the short term. To address credit in the current environment, we are pleased that our growing commercial finance portfolio remains healthy, as reflected in our reduced allowance reserve rates. We continue to be confident in the ability of this well-diversified portfolio to perform even during a difficult economic environment, as it has done historically. Our team has deep experience in hands-on collateral management, which has helped mitigate losses during previous cyclical downturns. Because of this hands-on collateral management, our ability to manage losses in the downturn far exceeds traditional C&I lending. Given the dynamic economic environment, we believe it will be helpful to provide guidance for the current and next fiscal year. We expect fiscal year 2023 GAAP earnings per share to be in the range of $5.25 to $5.75. When adjusting for certain non-recurring items, net of tax, we expect an adjusted earnings per share to be in the range of $5.10 to $5.60. At this point, we will only be providing guidance for EPS and will not be addressing specifics on various income statement items. Glenn will discuss our broad assumptions in more detail later. Now, let me turn the call over to our president, Anthony Charette, to provide updates on our lines of business.
spk06: Thank you, Brett. Let me first update you on our banking as a service business, which includes our payments, tax services, and consumer lending capabilities. We are prioritizing relationships that have more favorable, sustainable economics, which often means longer-term agreements with partners that use a broader suite of capabilities and multi-product solutions that we provide. A great example of this is our relationship with H&R Block, with whom we have an agreement in place through June of 2025. Consistent with these priorities, we are not renewing agreements with Liberty Tax and Jackson Hewitt. As a result, We expect taxpayer advance volumes to decline roughly 30% next year, which will impact fiscal year 23 revenue, but also will help reduce the magnitude of the seasonal volatility in our business. We do not expect any material impact to our refund transfer volumes, which we view as our core tax services payment solution. By exiting these two limited partnerships, we expect to gain expense efficiencies over time And it will allow us to focus our resources on our growing H&R Block and other banking as a service partnerships. Changes in capital markets are also impacting our banking as a service business. Recent pullbacks and investment funding of neobanks and fintech firms are slowing opportunities in our pipeline. But new solutions and programs with legacy partners, which represent the majority of our banking as a service business, remain strong and ongoing. Moving to credit quality, our total non-performing loans and leases as a percentage of total loans and leases improved 24 basis points from the prior quarter to 0.71%. The allowance as a percentage of loans and leases decreased from 2.38% in the prior quarter to 2.04% in the current quarter, due in large part to the decrease in seasonal reserves for the tax services loan portfolio. Excluding the reserves for the tax loans, reserves dropped from 1.59% to 1.44%. As Brent mentioned, we are pleased with our team's ability to continue to grow the commercial finance portfolio. The loans and leases in the commercial finance portfolio were $2.9 billion at June 30, an increase of 14% from the third fiscal quarter last year. As we potentially enter a period of stagflation, characterized by low or negative growth coupled with higher interest rates and inflation, we continue to believe our commercial finance portfolio is well positioned. First, rising rates will result in higher yields on our new business and existing variable loan portfolios. Further, our customer base tends to expand as companies lose their traditional funding sources during the credit cycle, which favorably impacts our working capital lines, such as asset-based lending and factoring. For these reasons, we expect continued strong loan growth and higher yields on the commercial portfolio going forward. Now, let me turn the call over to Glenn Herrick, our CFO, to provide an overview of our financials.
spk05: Thank you, Anthony, and good afternoon, everyone. Net income for the quarter ended June 30th, totaled $22.4 million or 76 cents per share, a decrease of $16.3 million from the third quarter of fiscal year 2021. Excluding 3.4 million of rebrand related expenses and 3.1 million of separation expenses, net of tax impact, our adjusted net income, was $27.3 million for the quarter. The quarter's net interest income of $72.2 million represents a 5% increase from the prior year. Higher yields on the securities portfolio and greater commercial finance interest income more than offset the sale of the remaining community bank portfolio year over year. While we are seeing some growth in commercial finance yields, the yield beta to rate increases has been slower than we have expected thus far, likely due to excess liquidity in the market. In total, quarterly average loans and leases grew by $129 million, or 4%, driven by strong growth in the asset-based lending and factoring portfolios. Concurrently, interest expense was elevated this quarter beyond its traditional run rate as the company accelerated $900,000 of interest expense associated with the retirement of the subordinated debt. Our balance sheet optimization, combined with higher yields and a reduction in excess cash from stimulus payments, helped drive the third quarter net interest margin to 4.76% compared to 3.75% in the prior year. Non-interest income of $54 million was down $8.5 million from the prior year. As Brett mentioned, the prior year's quarter benefited from greater card fee income associated with stimulus activity, as well as timing of last year's tax season. Furthermore, the company recorded fewer gains on loan sales in the current fiscal year as the solar construction market has been impacted by supply chain constraints leading to extended construction terms. For the nine months ended June 30th, total tax product income, net of losses and direct product expenses was $43.5 million, up from $40 million recorded in the prior year period. While taxpayer advances came in below our expectations, overall refund transfer volume grew 9% year over year. Looking ahead to next year, We expect strong refund transfer volumes and greater efficiency in our tax line of business as we exit the two aforementioned partnerships. Total non-interest expenses for the quarter increased 19% year over year, excluding the $3.4 million of rebrand-related expenses, $3.1 million in separation costs, and $1.2 million in expenses related to the non-renewal of the two tax partner agreements. Core expenses increased 9% year-over-year. The increase in expenses generally stem from higher compensation caused by industry-wide inflationary pressures and greater technology spend to support current and future commercial finance growth. The company started to incur higher card expenses under the rising rate environment. As interest rates rise, we will experience elevated card expenses with some partners associated with certain contractual agreements. However, we do expect the higher variable card expenses to be less than the corresponding revenue gains as interest income benefits from the higher rate environment and through additional fee income from off-balance sheet deposits. Income tax expense in the third quarter increased to $7 million compared to $4.9 million in the prior year. These expenses correspond to effective tax rates of 22.6% and 11% respectively. As mentioned previously, the increase is driven by reductions in renewable energy investment tax credits compared to the prior year. To expand further on the guidance Brett provided earlier in the call, We estimate fiscal year 2022 GAAP earnings per share to be in the range of $5.04 to $5.24, and fiscal year 2023 GAAP EPS to be in the range of $5.25 to $5.75. When adjusting for gain on sale of trademarks, rebrand-related expenses, and separation expenses, the company expects fiscal year 2022 adjusted earnings per share to be in the range of $4.28 to $4.48, and fiscal year 2023 adjusted EPS to be in the range of $5.10 to $5.60. These estimates assume a Fed funds rate of 3.5% by September of 2023. Any increases above this level, could positively impact our earnings, while our earnings may be negatively impacted if rates do not reach that expected level. As we mentioned in last quarter's call, the company retired the outstanding $75 million subordinated debt on May 15, 2022. The debt had recently moved out of its fixed rate phase to a variable rate. As a result of the retirement, the company will save approximately $6 million of interest expense over the next year. Finally, the company remains well capitalized, with a regulatory leverage ratio for the bank of 8.2%, and we remain committed to returning capital to shareholders. In July, we repurchased 306,000 shares at an average price of $40.74 through July 22nd. That concludes our prepared remarks. Operator, please open up the line for questions.
spk01: Thank you. If you'd like to ask a question, please press star followed by 1 on your telephone keypad. If for any reason you would like to remove that question, please press star followed by 2. Again, to ask a question, press star 1. If you're using a speakerphone, please remember to pick up your handset before asking your question. We will pause here briefly as questions are registered. Our first question is with Frank Chiraldi from Piper Sandler. Frank, your line is open.
spk04: Hey, Frank. I wondered if, in terms of the EPS guide, you could just give a little detail on... you know, does that reflect sort of a steady state environment in terms of the macro? Does it assume some macro deterioration in line with, you know, the economic outlook? Or how do you think about that when you're given the 2023 guide?
spk08: Well, I think the first big picture piece of this is it's the yield question. And as we are helping everybody understand Our portfolio will not rise as quickly as some might have thought. And the other thing that's going on, and Glenn mentioned it in his comments, there's extreme liquidity in the market. And so even though rates have moved up in theory, they've not moved up in practice. And I'm talking about intermediate duration kinds. So we do believe we're going to get, obviously, a higher net interest margin, and we're going to get the benefit of the yield, perhaps not as aggressive as some might have thought. And then as we go through this period from a yield perspective, we'll sustain that benefit for a longer period of time than might have been thought, even as we come down to a lower rate environment. So not really about the macroeconomic environment as much as about the speed at which yield will pick up.
spk04: Okay, so it doesn't necessarily reflect an economic slowdown at all. It's just more so on the NIM side, I guess, of things. That's right. And then I guess maybe you could just talk a little bit to, you know, Brett, you noted that maybe yields have moved up. higher as much as some may have thought. Is it the liquidity? What is the main reason why the market lending rates haven't really reflected the increase in rates to date?
spk08: Yeah, and again, that's kind of what we were talking about is banks are flush with deposits and they continue to be flush with deposits. And so the rates are reflective of way I can put it out for versus having it sit in, you know, fed funds because I'm not having a problem gathering deposits. Now, I believe that's going to flip and this is going to quickly turn and then we'll have some pricing that's going on in the marketplace that's a little bit more like normal you have when there's a rate increase. We've never had a situation where you've had this kind of a rate increase with this much liquidity in the market. It's going to take a while for the system.
spk04: Okay, and then just on the announced exiting of those two relationships on the tax side, any sort of color you can give? I know you talked about the reduction in the refund advance product expected year over year, but you also talked about maybe picking up some efficiencies over time. So if we think about what the impact is to the bottom line on 2023 earnings, have you guys – Do you have that math for us?
spk08: Well, Anthony, why don't you talk a little bit about what we're doing there and why? Then maybe, Glenn, you can address any kind of a math question.
spk06: Sure. As we noted in our remarks, we really want to focus on partners in the space that have broad banking as a service opportunities for us. While we don't necessarily disclose partner economics, We do expect our taxpayer advance volumes to be reduced by about 30% as we talked about. But the impact of these exits included in 23 guidance. But we believe we'll be able to improve our efficiency over time by redeploying these resources to optimize our core, what we call our enterprise partners. And number two, do you think it will have the result of the impact of reducing ?
spk05: I think Anthony covered it there, Frank. We provided a fair amount of detail around the reduction in tax advances. We list out the components of the revenue and other items for our tax advances. Then all that is factored into our overall guidance for fiscal year 23 that we will not have Jackson, Hewitt, and Liberty going forward. And then, as you might assume, there are resources internally that we can either save or we can redeploy it to higher growth, higher margin type of businesses.
spk04: I guess that's what I'm kind of getting at. I guess that's more down the road as opposed to baked into the idea that there's some offset here because there's some ability to do some other things that's more sort of down the road. That's correct. To 2023. Okay. And then, you know, I think, Anthony, you mentioned this slowing pipeline as far as new partners, but the strength of existing partnerships on the banking as a service side. And, you know, just wondered if you guys maybe could give any color into growth from here on the card fee side.
spk08: Let me take a look at that, and then I'll get back to you, Anthony. So, Frank, what we're seeing with our current partners is a lot of new programs, a lot of new ideas coming out. Because of the sort of macroeconomic environment of what's going on that's pretty well understood in fintechs and some of the venture capital firms, um the neo banks um we're seeing a little bit of a slow down there um and that's got to play its way out i actually think there'll be some of them that survive and come back strong but we're still seeing interest in uh from our existing partners large programs new products new capabilities um and bringing those in so anthony what would you add to that i i think that's that's well
spk06: But again, as we look to optimize our core enterprise partners, even back to the last question, we're going to be either saving or redeploying resources to really grow and go wider and deeper with those partners. We have seen a pullback of neobank and fintechs because of the investments in those companies is declining. But we still do have a robust pipeline of opportunities. And those are the ones that we're really going to be focused on in our banking as a service pipeline.
spk04: Okay. Okay. Thanks for all the color.
spk01: Thanks, Ryan. Our next question is with Steve Moss from B Reilly Security. Steve, your line is open.
spk07: Good afternoon. Maybe just starting here on the tax side here, maybe just You know, were there any pricing demands from the tax partners that made the business less attractive and caused the change in business plans here?
spk08: Well, I would say it really wasn't a pure pricing conversation. We're really wanting to go to this portion of the industry where you're offering a breadth of products, not a single threaded product. through a partner. Having a partner is an administrative proposition, and if you can have two, three, or four products or capabilities going through the same partner, that gives you economies of scale that make sense. Both of those arrangements were single product arrangements, and that's what we're trying to get away from.
spk05: Steve, this is Glenn. Steve, this is Glenn. I think you can assume, though, that You know, these contracts came up for renewal and, you know, Brett addressed the strategic thinking there, but you could also assume that as a single-threaded product and a new contract renewal that perhaps the economics didn't, what the new economics might be would not clear our return hurdles.
spk07: Right. Kind of on that point to where I was going to go to next is just, is there a fundamental shift in the business outlook or maybe the business plans here after this year's unusual tax season?
spk08: I don't think I would say there's a fundamental shift except this, that we're thinking about the tax business as banking as a service, and we expect for our interactions with the tax business to be broader and to begin to address other kinds of consumer things. And as Anthony mentioned in his remarks, our relationship with H&R Block is exactly that nature, where it's broader than just a tax play.
spk07: Okay. And then on the tax credit side of the business, Glenn, I think it was you who mentioned that it's a short-term thing. going to be a short-term impact for the tax credits. Just kind of curious, you know, does it go into fiscal 23? And, you know, if so, kind of what are you guys assuming for a marginal tax rate in your guidance?
spk08: Go ahead, Glenn.
spk05: Sure. So, it's hard to predict, Steve, how long this goes. Now, MarketCaller says there's still demand for projects out there. Um, but either between, um, you know, projects getting delayed, primarily supply chain and, and, um, other perhaps permitting issues, um, the whole market has seen a slowdown. So we are, you know, we're projecting roughly a, um, low double digit type tax rate for next year.
spk07: Okay. And then in terms of, I guess the other thing I kind of want to ask on the efficiency initiative here, just kind of curious, you know, what are the type of cost saves you guys are seeking and just how to think about expenses here for the upcoming quarter?
spk08: Glenn, go ahead.
spk05: Yeah. You know, as we've talked about, we're continuing to look for expense efficiencies, being able to scale. I'm also tied with some of these, you know, the moving on from two of our tax partners. And so we expect to improve our efficiency ratio over time. Some of the lumpiness in our business could have some short-term ups and downs, but we are working hard to improve that over time.
spk07: Okay. All right. Thank you very much for all the color.
spk08: Thank you.
spk01: Our next question is from Michael Petticoat from KBW. Michael, your line is open.
spk02: Hi, this is my associate Andrew filling in for him. Thank you for taking my questions. First off, I just wanted to move to the credit side again. Are you making any changes to the underwriting process in the commercial finance or consumer loan portfolios yet? Or are you seeing any trends, whether it be inventory or cash flow or anything, starting to give you some concern given the macro uncertainty?
spk08: Well, if you remember, the majority of our exposure is in commercial finance, not traditional C&I, which is heavy collateral managed, and that is precisely what you want to have when you're entering into any kind of a downturn environment. So to answer your first question, are we changing anything? No, this is what you want to have in this particular period of time. We are not seeing any real deterioration in our borrowers. We are starting to see some borrowers trying to leave traditional commercial banks because they've had covenant issues, et cetera, some of which may go all the way back to COVID. And so we're picking up and some of our ABL growth has been precisely due to that. On the consumer lending side, I'll remind you that the majority of our consumer lending portfolio is in some way credit enhanced. meaning that there's a, you know, it's a waterfall approach or some other kind of arrangement. And again, with maybe one slight exception, we're not seeing much deterioration in that space either.
spk02: Great, thank you. I appreciate the color there. And then just lastly for me, what kind of a balance sheet size do you expect kind of in the near term here in the next quarter? So do you think assets might shrink a bit more or just any sort of color there.
spk08: Glenn, why don't you handle that?
spk05: Yeah, we've talked about this in the past too. You know, we expect to kind of move around between six and a half to $7 billion for the foreseeable future.
spk02: Great, thank you. I appreciate the time and thanks for taking my questions. Thank you, Mark.
spk01: At this time, there are no further questions, so I'd like to turn the conference back to the management team for any closing remarks.
spk08: We appreciate everybody attending today. Appreciate the questions.
spk01: That concludes the Password Financial third quarter fiscal year 2022 investor call. Thank you for your participation. You may now disconnect your lines.
Disclaimer