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spk07: Ladies and gentlemen, thank you for standing by. Welcome to Pathwork Financial's first 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 Q&A 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.
spk06: Thank you, operator, and welcome. With me today are Password Financial's CEO, Brett Farr, and CFO, Greg Sigris, who will discuss our operating and financial results for the first quarter of fiscal 2024, after which we will take your questions. Additional information, including the earnings release, the investor presentation that accompanies our prepared remarks, and supplemental slides 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 statements. 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 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 in the appendix of the investor presentation. Finally, all time 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 Farr, our CEO.
spk03: Thank you, Darby, and welcome everyone to our first quarter 2024 conference call. I want to provide a special warm welcome to Greg, our CFO, to his first earnings call with us. We're very pleased with our results in the quarter and have started off the year by laying the groundwork to deliver on our key goals for the year. Those are, number one, building BAS into a one-stop shop for our partners, and number two, smart growth in commercial finance to help ensure proper yields and a credit profile for this financial environment. Before I get into a deeper discussion of our business, I want to start out by providing some first quarter highlights. We reported net income of $27.7 million and $1.06 per diluted share. When you adjust the first quarter of 2023 for the gain on sale of names and trademarks, expenses related to rebranding, efforts and separation expense, what we will refer to collectively as rebranding for the remainder of the call, net income grew 19% and EPS increased 31%. Earnings growth was driven through expansion of our net interest margin to 6.23%, an increase of 61 basis points. Our adjusted NIM, including rate-related processing expenses, grew to 4.71% from 4.68%. Our return on average assets for the quarter was 1.46%, and return on average tangible equity was 33.95%. Remember that return on average assets is impacted by seasonality with tax season revenue and income occurring next quarter. For reference, ROA in the first quarter of last year was 1.71%, but if you adjusted for our rebranding efforts, it was 1.42%, which we are running slightly ahead of this year. Finally, we are reiterating our guidance range of $6.20 to $6.70 in earnings per share for the full year. Greg will give you more color on this in his remarks. On the asset side of the house, we saw pretty significant growth in total loans and leases, especially when compared to the first quarter of last year, with growth in nearly every loan category across the enterprise. Greg will get deeper into the details of the drivers of our year-over-year financial performance in a moment. But I did want to comment on some of these trends. After very strong growth in insurance premium finance in the third and fourth quarters last year, we're starting to see that business normalize, and we would expect to maintain balances near the December 31 levels. In structured finance, there's a strong pipeline, especially in the renewable energy and government guarantee verticals. However, these renewable energy deals are not the type of transactions that will generate income tax credits for us. As we have previously communicated, we believe our opportunity for ITC will be lower than last year, and this is included in our guidance. On credit, the quality of our portfolio remains steady. Our non-performing loans ratio has improved 38 basis points sequentially, primarily due to the work out of a deal a single deal that caused the increase in the last two quarters. We think this is a secret sauce of our business. Our non-performing loan ratio may increase from time to time, but we are typically in a position to resolve these loans and generally experience a recovery in the one or two quarters following the increase. This has generated an annual net charge off rate that trends in the 50 to 70 basis point range. And with our yields, we're very comfortable with that range. Finally, as we mentioned in the last call, our 2024 focus in commercial finance is smart balance sheet growth, and we're accomplishing this by ensuring that the loans we are adding to the portfolio have the proper risk-adjusted yields. This is an undertaking across all of our loan products, and we continue to evaluate all loans in this context. We are working on optimizing our capital and asset mix with an eye toward further expanding net interest margin. On banking as a service, our performance continues to be strong. As is typical this quarter, we saw growth in deposits from the end of fiscal year 2023. To remind you, our deposit base does experience seasonality. Our typical pattern is to see growth in the first quarter from the sale of gift cards during the holiday season. This then grows again in the second quarter with our tax season business. And then deposits typically trend down from there as the seasonal balances get spent. with the lowest level usually at fiscal year end. Additionally to seasonal trends, we have also seen increases in deposits from some of our current partners. This is translated to solid performance and core card fee income. From a business development perspective, we signed agreements with three new partners during the quarter. While the impact of this is already contemplated in our guidance today, it speaks to the strength of our pipeline, which we believe to be healthy. Additionally, on January 16th, we announced a multi-year extension with a long-standing partner that allows for collaboration on product innovation and expanded product offerings for a range of programs in market and under development. Regulatory environments put us in what we believe to be a strong competitive position in the BAS industry. However, these deals tend to have a much longer sales cycle. due in large part to the regulatory processes that are required before a program can go live. Deals we are working on now would benefit deposits and card fee income later this year and into fiscal year 2025. The value of our deposit base continues to put us in what we believe to be a position of strength, with the two sides of our balance sheet being well matched. Based on our decay model, our non-interest bearing deposits have a weighted average life of around five and a half years. Our loan portfolio's weighted average life is a little over two years, and our securities portfolio duration is around five years. We believe this to be particularly beneficial in today's environment. Now, I'd like to turn it over to Greg, who will take you through the financials.
spk05: Thank you, Brett. Adjusting for the impacts of rebranding activity in the first quarter of fiscal year 2023, net income grew $4.5 million, or 19%. EPS of $1.06 increased 25 cents, or 31% from the prior year quarter. These results were driven primarily by an increase in net interest income, which totaled $110 million during the quarter, an increase of 31% from the prior year. This is both rate and volume driven. We continue to see the impact of rate increases in the prior fiscal year flow through our portfolio as repricing occurs, and we remain focused on our pricing disciplines. The result has been an increase in yields across nearly all commercial finance lending categories. From a volume perspective, total loans and leases have increased almost a billion dollars since the end of first quarter of 2023. The quarter's net interest margin of 6.23% grew from 5.62% in the prior year's quarter. When accounting for the impacts of the company's contractual rate-related card expenses, the company's adjusted net interest margin increased to 4.71% compared to 4.68% in the prior year. Net interest margin has benefited from increasing the new production yields in commercial finance, which during the first quarter was a blended 8.93% versus a portfolio yield of 8.3% at the end of 2023. Wholesale deposits were used early in the quarter to bridge the seasonal low point for BAS deposits and more on BAS deposits in a moment. Looking ahead, our earning assets should continue to reprice at higher rates as loans and investments mature and we are able to replace them with higher-yielding assets, assuming the middle part of the rate curve remains fairly stable. Of course, any rate-sensitive deposits would reprice immediately with any FOMC rate cuts. As of December 31st, the company had an ACL coverage ratio of 1.22 percent, a decrease from 1.5 percent at the same time last year. Our commercial finance group has an ACL coverage ratio of 1.3% compared to 1.62% in the first quarter last year, and only a slight increase from last quarter's 1.26%. The year-over-year declines are generally a result of a mixed shift toward insurance premium finance and USDA, which have a relatively lower allowance rate. Non-interest income of $52.8 million declined $13 million from the prior year. In the prior year's quarter, the company recognized the final $10 million gain on sales stemming from the rebrand. Additionally, card and deposit fee income declined $7 million, driven primarily by lower service fee revenues related to lower levels of off-balance sheet deposits. As expected, our off-balance sheet deposits and corresponding service fee income related to those deposits declined from fiscal year 2023 as we hold higher levels on the balance sheet to fund loan growth and continue to return EIP deposits back to the Treasury Department. Non-interest expense of $119.3 million increased 14% year-over-year. The increase was driven primarily by contractual rate-related card expenses and higher compensation expenses. This was partially offset by legal and consulting related to the rebrand that did not recur in 2024. Rate-related card expenses increased primarily due to the higher rate environment. The seasonality that Brett described earlier also impacts our earnings. Our lowest earning quarter tends to be Q1, whereas Q4 tends to be our lowest deposit balance quarter. While deposit balances generally increase in Q1, this is largely due to gift cards that are oftentimes not utilized in the quarter. Moving into Q2, we see a larger spike in revenue and income when those balances start to get utilized and when tax season occurs. Finally, revenue and income tend to decline into Q3 and Q4. Deposits at December 31st reflected on the balance sheet increased $1.1 billion from last year's quarter. During the first quarter, the company maintained an average of $379 million of off-balance sheet deposits, servicing the income roughly equal to the effective Fed funds rate. On December 31st, there were $1.1 billion of deposits held at partner banks, increasing from last quarter due to seasonality. This brought total on- and off-balance sheet deposits to around $8 billion roughly flat to last year. However, at the same time last year, we were managing approximately double the deposits off balance sheet. And as expected, this balance shifting is contributed to our lower card and deposit fees this year. The difference this year is that we have increased our loan and lease balances by nearly a billion dollars, causing us to hold more of our deposits on balance sheet to fund that growth. And that impact can be seen in higher interest income. As an update, at December 31st, we're still holding roughly $838 million of deposits related to government stimulus programs. Through the remainder of fiscal 2024, we expect to return around $310 million of unclaimed deposits to the US Treasury. Total loans and leases at December 31st were $4.4 billion, a 26% increase from a year ago. The company saw strong growth across nearly every loan category, including over $700 million in commercial finance loan growth, with the largest increases in term lending, insurance premium finance, and structured finance. Sequentially, loan and lease balances increased slightly from 4.4 billion at September 30th. Growth in commercial finance was driven primarily by term lending and the SBA-USDA business, which was partially offset by expected declines in the insurance premium finance portfolio. From a liquidity perspective, the password continues to be well positioned. Our balance sheet is strong, and when you factor in all of our sources, we have over $3.8 billion in available liquidity. As Brett mentioned previously, the two sides of our balance sheet are well matched in weighted average life and duration. During the quarter, due to a decrease in longer-term rates, our accumulated other comprehensive loss position on the balance sheet largely related to the securities portfolio improved by nearly $70 million. we would expect the securities portfolio to continue drawing down with approximately $300 million of cash flows available for reinvestment over the next 12 months. Also during the quarter, we were pleased by KBRA's affirmed credit ratings for Pathwork, including the deposit and unsecured debt rating of A minus for our bank subsidiary, which highlights the strength and stability of our funding profile and business model. Finally, during the quarter, we repurchased approximately 233,000 shares at an average price of $47.25. From January 1st through January 19th, we have repurchased an additional 342,000 shares at an average price of $51.01. We are reiterating our fiscal year 2024 GAAP earnings per diluted share guidance of $6.20 to $6.70. This includes a number of assumptions. With growing loan balances causing lower off-balance sheet deposits, we expect the revenue mix to remain in favor of interest income in 2024. This is due to the fact that we expect deposits to largely fund loans, resulting in full-year average off-balance sheet deposits near the Q1 average of $379 million. We expect our full-year net interest margin and adjusted net interest margin to continue to expand when compared to the full-year 2023, given our continued focus on asset pricing along with the $300 million in annual securities cash flows reinvested into higher-yielding assets. With less opportunity for ITC, we estimate our effective tax rates to be in the range of 16% to 20% for the year. Lastly, I would like to point out that the fundamentals remain strong across our businesses, and we would expect to see the continued benefit in our financial results. Now, I'd like to turn things back to Brett for some closing comments.
spk03: Thanks, Greg. As I think about the remainder of fiscal 2024, I look forward to the opportunities PathWord is pursuing. We have a healthy pipeline in front of us in BAS and are looking to add recurring revenue that drives sustainable net income. Additionally, as I mentioned before, we are underwriting loans and leases but are maintaining a focus on risk-adjusted returns to ensure that when we are adding assets, they are the right ones for this environment. We believe this provides us with a highly differentiated business model from traditional banks that is not as reliant on capital or balance sheet to grow. It also puts us in the position of being able to enhance capital and earning assets in order to deliver balance sheet optimization. In addition, we continue to invest in technology and human capital across the organization in pursuit of delivering two to one operating leverage in the coming years. It is our belief that delivering on this strategy will put the company in an enhanced position of strength and give us the ability to drive further growth in revenue and earnings in the future. Finally, tax season has begun. While it is still very early, we did increase the number of independent tax providers utilizing our products and believe that we continue to grow market share. We look forward to giving you an update on our next call. This concludes our prepared remarks. Operator, please open the line for questions.
spk07: We will now begin the Q&A session. If you'd like to ask a question, please press star followed by one on your telephone keypad. To remove your question, press star followed by two. Our first question today comes from Frank Schiraldi with Piper Sandler. Please proceed.
spk02: Hey, good afternoon. Just wondering on the You guys reiterated obviously bottom line guide here for 2024, and obviously the rate outlook has changed a bit. So just wondering what's baked in in terms of rate cuts. And when you take into account, you know, deposit costs that run through non-interest expense, seems like you might be pretty fairly close to neutral in the down rate environment. So could you just speak to that, please?
spk05: Yeah, I mean, I'll start with the latter one. The balance sheet is pretty close to neutral, which, again, I think that gives us benefit as we move down the rates. And right now, in our guidance, we only have one rate cut in there, and it's really at the end of April, beginning of May. So to the extent that the forecast pulls forward, Frank, we probably have some upside from that, quite frankly.
spk02: Okay, great. And then you had pretty good growth in commercial finance. in-term lending and as the premium finance business maybe stabilizes here. Just wondering, I think, Brett, you spoke to a pretty good pipeline here. What sort of growth do you think are you targeting in the commercial finance business in the near term here?
spk03: Yeah, I think we're going to be thinking a lot more about asset-based lending. We've seen some increases in that. We're seeing more of that in the pipeline. And that's got pretty good yield with it. It's just the trick is to make sure you get the right transactions at the right price. So I would highlight ABL. I'd also say that in our structured finance area, and we mentioned it, that While it doesn't help with these tax credits, the solar business, alternative energy business has got a pretty good pipeline as well.
spk02: Okay, great. And then I know it's pretty early in the game here, but just any sense or any indication of how tax season might be the same might be different in 2024 as opposed to 2023. You know, any changes to economics or assumed loss rates here on the advanced product?
spk03: No, Frank. I mean, tax season always is an interesting question at this point. We already told kind of what we know, which is we signed up more EROs. Those are the independent tax preparers. which could speak to our market share opportunities. But there's, you don't know until you know. And it'll be, you know, when we come around to the end of the conversations at the end of the second quarter, we'll be able to give you a lot more impact and understanding of how it went. But there's nothing unique this year that we're seeing. So, you know, if you go back to the COVID years, there were unique things happening. So, so far, nothing unique. And I hope it to be, you know, business as usual kind of year.
spk05: Yeah, the only thing I'd probably add, Frank, is, I mean, I know since last year we've put a lot of effort internally into both underwriting and monitoring processes, and I do think we hope that that would help drive down some of the loss rates this year as well.
spk02: Got it. Okay. And then finally, if I could sneak in just one more on the consumer finance book. Outside of the tax holdings, it looked like reserve levels as a percentage of the book increased quarter over quarter. And just wondering if that indicates a change in demographic or type of credit you're putting on the books. Is that one area you expect you can pick up yield maybe or just any color there?
spk05: Well, that really is our partnership business there, Frank. So it actually does have a tax angle to it and seasonal. So I don't think it really speaks to broader dynamic than that, candidly.
spk02: Okay. All right. Fair enough. Thanks. That's all I have. Yep. Yep. Thanks for joining. Thanks, Ryan.
spk07: Our next question today comes from Eric Spector with Raymond James. Please proceed.
spk01: Hey. Good afternoon, everybody. This is Eric on the line for David Feaster. Thanks for taking the questions. Just wondering if you could touch on some of the growth initiatives and where we stand on those, whether it be early ACH, FedNow, embedded banking, early age wedge access, and I'm curious where you are on the product build-out and pipeline with those and where you're having the most success.
spk03: Yeah, I mean, we're very much involved with different partners co-creating unique solutions that are in all those, you know, quote, faster payments verticals. I would say that these things take time. We're getting some revenue from them, but not anything that we would report as material. And we'll keep growing. The beauty of that is that in most cases, that is non-interest income. And so that's very exciting for us. And that's one of the things we're continuing to focus on. is how we grow non-interest income with products like that in that arena, particularly as we think about, you know, where's NIM going to be two years from now or three years from now? We want to have a heavier dose of non-interest income.
spk01: Yeah, that's helpful. And then just one growth initiative we've talked about recently is potentially growing working capital. Just curious how you think about that and any other lending segments you might be interested in expanding into.
spk03: Yeah, that's kind of what I was telling Frank, was the working capital is an area, asset-based lending particularly, where we think there's some growth opportunities as, you know, there continues to be some stress in various types of industries where we can do some of these transactions that are higher yield. To remind everybody, you know, it's a heavily collateral-managed, using liquid collateral, and we're very good at that as part of our secret sauce. When I can get those and get the yield for the right kinds of transactions, I really like that asset class.
spk01: Okay. Again, that makes sense. And then just one last question. I'm just kind of curious. You talked about one rate cut in your assumptions. Just curious how you think about your operations if we begin to see a few rate cuts. Obviously, deposits will reprice lower, but loans will also. Just curious if you could provide some color on just the margin trajectory and then from a broader perspective how you think about how that would impact loan growth and maybe some of the other businesses assuming rates come down.
spk03: Yeah, so I think a few things. Remember that the cost of our deposits, the way our contracts are written and the accounting that we deal with it, if Fed funds goes down, the day it goes down, our cost goes down. So that's the first thing that helps us. Secondly, we've got a book that has some duration in it. And so, actually, in the short and intermediate term, a rapid drop in rates would be to our advantage on the NIMS side over a long time, obviously, then rates come down in general. So, from a rate and profitability standpoint, that's the picture. Rates dropping will likely foster more economic activity That doesn't bode as well for our working capital product, but other products that we have, they'll become more the thing. You might think about some leasing products and other term products. You know, our credit box view of that would be better, and so we would do more of those. And that's one of the beauties of our diversified loan product portfolio is when one is up, another may be down. When one's down, another's up. And we'll deal with whatever rate environment comes and take the opportunities the market gives us.
spk01: Yeah, that's helpful. Thanks for taking the questions, and I'll step back.
spk07: Our next question today comes from Michael Perretto with KBW. Please proceed.
spk04: Hey, guys. Good afternoon. Greg, welcome. Thanks for taking my question. Thank you. Yeah, I think a lot of the financial questions have kind of been asked and answered. And I apologize if I missed this, but just one quick maybe follow up just around the seasonality of kind of the EPS annually here and the expenses. You know, obviously there's the tick up in tax revenue is also the tick up in tax expense in the second quarter. But just wondering if there's any kind of additional guidance or guardrails you can give us on kind of the expense growth for Fiscal 24, I know you guys have the two-to-one operating leverage target kind of unchanged, but just, you know, if we're talking maybe just run rate here and any additional thoughts you can provide,
spk05: Well, I guess what I would say is, I think the Q1 is actually a pretty good run rate for us, understanding that we're always going to continue to invest in human capital and technology, which is that two-to-one operating leverage that you mentioned. I think there's really one other caveat, though, besides that, which is in the second quarter, you definitely have the tax pick up a little bit, but it's also a little bit of comp and benefits just above and beyond that, which I think you can track if you go back and look at the last couple years just the seasonality there but over the balance of the year other than some some modest continued investment i think that's the how i think about the run rate all right that's helpful and and is there any i think you mentioned um greg a comment about how you'd expect maybe some of the underwriting around some of the tax products to be improved is there any
spk03: efficiency that you would target in the tax business and if we look back to the prior year in terms of the pickup and cost or or is that pretty much as Efficient as it's going to get at this point You know, I just bread I think it's about as efficient is going to get We did, you know a lot of work around the operations of that several years ago and we've got that pretty main and main for what we get and we're pleased with the On the refund transfers and the approach with the ROs, it's about as good as it's going to get. We've made some investments in technology to stabilize that area and to keep it efficient. So I think, you know, past years on the expense run rate are pretty good indicators.
spk04: Great. And then, you know, just kind of a philosophical capital question, you know, as we – look at a few of the moving pieces here. I mean, you guys, particularly, you know, if the margin neutrality plays out, I mean, you're pretty consistently pumping out a well north of 20% ROE annually on a balance sheet that really is growing a ton. You know, and I don't necessarily, not suggesting a right answer or wrong answer to this, but At what point do the buybacks, when does there need to be more tools kind of or arrows in the quiver here in terms of capital deployment? I mean, how are you guys thinking about that? I'm sure you're budgeting out at least 24 months, if not longer. And I imagine the capital creation is pretty significant. Just would love some updated thoughts around that as we kind of start your fiscal 24 and as we think about estimates for the next couple of years.
spk03: Well, Mike, as you know, we're in an innovative business that is changing over time. There will be at some point some use of capital. But at these prices and for a while at this level of stock, there's not a better use of capital than to buy the shares. And You know, if we get up into a fee of 12 or something, then we'll have a different conversation. But right now, I can't get an ROE on capital that's better than what I'll get by buying back shares.
spk04: Okay. And is there, you know, as you guys think about, obviously not bank, but non-bank shares, M&A. Has that environment or your views on those types of opportunities that would be maybe interesting changed or altered at all? Is there You know, I guess one thing I would say is, you know, there's always kind of the constant thought of how you guys can, you know, not build on top of the regulatory advantage, right, which has been a great mode for you guys. And it feels like, you know, technology could be that next leg up. Just wondering how you guys are thinking about that. And is M&A a tool in that or not necessarily given where the market is today?
spk03: Well, I think it's a tool. I think it's a tool we've looked at. I would reiterate my prior comment about capital and the proper use of capital. But I have to tell you, you know, we're looking at all kinds of things as we invest in technology. We are in a fairly unique niche. And being able to go and buy something that properly, and I emphasize that word, properly does what we need it to do is fairly limited. There's a lot of, you know, fintech kinds of things that have put middleware or layer services in this industry, and it's actually caused a lot of problems. And we'd look at those, and they just didn't meet the standards that we had. So, So I think, you know, decision point one is what's the right use of capital? Decision point two, is there anything out there that actually would give us an advantage from a technology perspective?
spk04: Great. Thank you guys for taking the questions and for the color. Appreciate it.
spk03: Thanks, Mike.
spk07: Thank you for your questions. There are currently no questions in queue, so as a reminder, it is star one to ask a question. There are no questions waiting at this time, so I'll pass the conference back to the management team for any closing remarks.
spk03: Thanks for joining the call today, and this ends our call.
spk07: This will conclude today's conference call. Thank you all for your participation. You may now disconnect your line.
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