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spk01: Welcome to the FinWise Bancorp Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. Please note this conference is being recorded. The presentation will now begin.
spk08: Good afternoon, and thank you for joining us today for FinWise Bancorp's Second Quarter 2022 Conference Call. In addition to this call, we issued an earnings press release earlier this afternoon and posted it to the investor relations section of our website at investors.finwisebankcorp.com. Today's conference call is being recorded and webcast on the company's website, investors.finwisebankcorp.com. On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements that are subject to risk and uncertainties that could cause actual results to differ from those discussed today. Forward-looking statements represent management's current estimates, and FinWise Bancorp assumes no obligation to update any forward-looking statements in the future. We encourage listeners to review the more detailed discussions related to these forward-looking statements contained in the company's earnings press release and filings with the Securities and Exchange Commission. Posting the call today are Mr. Ken Landvater, CEO and President of FinWise Bancorp, and Mr. Javis Jacobson, Chief Financial Officer of FinWise Bancorp. With that, I will turn the call over to Mr. Landvater.
spk04: Good afternoon, everyone, and thank you for joining us on our second quarter 2022 earnings conference call. Our results for the second quarter further validate the differentiated business model we have built over the past several years, including continued strength in our risk management and profitability. Despite a very challenging economic environment that deteriorated rapidly throughout the quarter and also factoring in the typical seasonal slowdown in originations, the resilience of our business model was evident as during the quarter end of June 30, 2022, we generated total revenue of $21.4 million, led by loan originations of $2.1 billion. Our results for the quarter also included net income of $5.5 million, or $0.41 per diluted share. Net income during the quarter was primarily impacted by a decline in non-interest income from lower gain on sale of loans due to a decrease in the number of SBA 7A loans sold and an impairment of the company's SBA servicing asset. As we've noted on our prior calls, irrespective of the results of any single quarter, our primary focus remains on generating sustainable net interest income growth over the long term, driven by continued loan growth. Furthermore, loan originations generally have driven strategic program fees, which enhance our non-interest income, a key differentiating factor of our business model. Importantly, given that all strategic platforms fund deposit reserve accounts tied to total held-for-sell loan outstanding, deposits have generally declined as origination volume slowed. We are pleased with our credit quality, which remains strong. Non-performing loans decline to a total of $0.6 million as of June 30, 2022, compared to $0.7 million at March 31, 2022. The ratio of non-performing loans was 0.3% of total loans at the end of the second quarter compared to 0.2% the previous quarter. The small increase in our non-performing loans ratio this quarter is primarily due to total loan balances being lower during the quarter. Net charge-offs declined 18.4% to $2.3 million during this quarter from $2.8 million during last quarter. This strong credit quality is a testament to our prudent risk management approach, including maintaining tight underwriting standards. We have also slowed retention to better assess and manage economic risks, One point I'd like to make clear, we have not adjusted our lending standards to reach for growth. Overall, we believe these attributes of our risk management process are best in class and enhance our ability to sustain sound credit quality through varying credit cycles. During the quarter, we had an additional impairment of our SBA servicing assets. as the market was impacted by rising market interest rates and SBA loan prepayment speeds. Importantly, we remain significantly above well-capitalized guidelines with a bank leverage ratio of 21.4%. Furthermore, we believe that our relationship with existing strategic platforms remains strong, as does the interest of potential new platforms in entering into relationships with the bank. This again validates our business model and brand as an innovative technology-enabled bank that efficiently serves a wide array of clients. As we've noted in the past, these strategic lending programs have been a key driver to continued loan growth for Finwise in various ways. Through accelerating volumes from existing platforms, sourcing of new loan origination platforms, and our exceptional ability to efficiently scale through our technology-driven and robust infrastructure. Against a significantly more challenging economic backdrop, we are committed to staying the course in managing the business for the long term while continuing to closely monitor economic trends. However, while we believe our business model lends itself to flexibility in both weakening and strengthening economic conditions, If current adverse macro trends were to persist, we believe there would be a greater risk that the seasonal rebound in loan originations that we traditionally see in the second half of the year could be tempered this year. Looking ahead, despite challenging external macro factors, we will remain focused on what we can influence, providing best-in-class service to our clients and customers while prudently managing risk and controlling costs. We also continue to enhance our business model by exploring ways to deploy our capital into opportunities that allow us to remain well positioned to take advantage of growth opportunities when the environment improves. We believe these actions bolster our strategy to continue to generate solid, long-term operating efficiency and profitability. Overall, we remain exceptionally proud of our differentiated business model, which continues to provide our clients and customers with best-in-class value and service, particularly during more challenging conditions. With that, I would now like to turn the call over to our Chief Financial Officer, Javis Jacobson, who will discuss our financial results for the quarter in more detail.
spk03: Thank you, Kent. Despite facing an economic environment that deteriorated quickly during the quarter, loan originations were $2.1 billion down from $2.5 billion in the prior quarter and higher compared to $1.4 billion in Q2 2021. Average loan balances comprising held-for-sale and held-for-investment loans were $279.3 million during Q2 2022. a decrease of 5.9% from 296.7 million in Q1-22, and an 11.8% increase from 249.7 million in Q2-21. Total average interest earning assets declined 3.8% to 373.2 million during Q2, compared to 387.8 million for Q1-22, and increased 24% from 301.1 million for Q2 21. As we've mentioned on the past calls, our loan originations and balances have tended to decelerate in the first and second quarters of the year due to typical seasonality, and this quarter was no exception. Generally, we have seen a rebound in the third and fourth quarters of the year, but as Kent mentioned, if economic conditions remain challenging or deteriorate further, we believe there would be a greater risk that the seasonal rebound in originations could be more muted this year. Average interest-bearing deposits declined 4% to $127.2 million during Q2 compared to $132.5 million during Q1-22 and increased 41% compared to $90.2 million during Q2-21. The decline as compared to Q122 was driven mainly by a decrease in certificate of deposits and money market accounts. Compared to Q221, the significant increase in average interest-bearing deposits was driven mostly by higher certificate of deposits, money market accounts, and demand deposits. As Kent mentioned earlier, due to the relationship between strategic platform deposit reserve accounts and total held-for-sale loans outstanding, Our deposits have generally declined as our origination volume slows. Positively, our cost of funding declined modestly during Q2. The rate on average interest-bearing liabilities decreased three basis points to 76 basis points from Q1-22 and was down 20 basis points from 96 basis points during Q2-21. The primary reason for both period declines is a continued drop in the rate on new or renewing certificate of deposits. Net interest margin for Q2 was 13.69%, representing a 32 basis point increase from 13.37% in Q1-22 and down compared to 20.29% in Q2-21. The increase from the previous quarter was primarily driven by a loan mix shift away from loans carrying lower yields within the strategic program held for sale portfolio. The net interest margin decrease from the second quarter of 2021 was driven mainly by a substantial increase in lower yielding cash and cash equivalents raised in the company's IPO and a loan mix shift towards loans carrying lower yields within the strategic program held for sale portfolio. As we've highlighted on prior calls, we expect shifting asset mix to drive quarterly fluctuations in the NIM from quarter to quarter. Importantly, as we've noted on prior calls, our primary focus is on generating solid and sustainable net interest income growth over the long term, driven by continued growth in originations. Let's turn to the income statement. Net income for Q2 was $5.5 million, compared to $9.4 million for Q1-22, and $7.7 million for Q2-21. The sequential quarter decline was primarily driven by lower gain on sale of loans and an impairment of the company's SBA servicing asset. The decline compared to the prior year period was primarily driven by an increase in non-interest expenses and a decrease in the fair value of the company's investment in business funding group LLC, BFG. partially offset by increases in non-interest income and net interest income. Net interest income for Q2 was $12.8 million compared to $13 million for the previous quarter and $10.8 million for Q2-21. The modest decline on a sequential basis was primarily due to lower average loans held for sale balances. Growth over the prior year period primarily reflects strong loan growth resulting in higher average balances and an increase in the other interest earning asset classes. Non-interest income was $8.4 million in Q2 2022 compared to $11.7 million during the previous quarter and $8.2 million in Q2 2021. The sequential quarter decline was driven primarily by a lower gain on sales loans due to a decrease in the number of SBA 7 loans sold. The increase compared to the prior year period was primarily due to an increase in strategic program fees due to significant loan origination volume growth partially offset by a decrease in the fair value of the company's investment in VFG. As we've highlighted on prior calls, we expect general market movements to drive quarterly fluctuations in the value of VFG. Non-interest expense during Q2 was $11 million compared to $9 million in Q1-22 and up from $7.1 million during Q2-21. The sequential quarter increase was primarily due to an impairment of the company's SBA servicing asset in Q2-22, driven by rising market interest rates and market-wide increasing prepayment speeds on SBA loans. Compared to Q221, the increase was primarily due to higher expenses from incremental employee headcount related to an increase in strategic program loan volume and an impairment of the company's SBA servicing asset. The company's efficiency ratio for Q2 was 52% as compared to 36.7% for Q122 and 37.3% for Q221. Although we look to make long-term investments in our technology platform and our workforce, we will do so carefully, particularly if the economic environment were to further deteriorate. We also plan to make continued investments to expand our strategic program infrastructure and to enable growth in our market share. Credit quality remains strong, with non-performing loans representing 0.3% of total loans receivable compared to 0.2% for the previous quarter and 0.3% for Q2-21. The provision for loan losses was $2.9 million for Q2 compared to $2.9 million for Q1-22 and $1.5 million for Q2-21. The provision for Q2-22 reflected growth of unguaranteed loans held for investment and lower net charge-offs compared to the first quarter. The increase in the company's provision for loan losses compared to the year-ago period was primarily due to substantial non-PPP loan growth and an increase in net charge-offs. Net charge-offs for Q2 were $2.3 million compared to $2.8 million for Q1-22 and $0.5 million for Q2-21. Our net charge-off rate as a percentage of average loans for Q2 was 3.3% compared to 3.8% for Q1-22 and 0.8% for Q2 21. The decrease in net charge-offs for Q2 22 compared to Q1 22 was primarily driven by lower gross charge-offs and increased recoveries related to our strategic programs. The increase in net charge-offs compared to Q2 21 was mainly driven by growth in the company's health for investment balances and some normalization of credit losses to pre-pandemic market conditions. We continue to be pleased with the performance of these portfolios as they remain in line with management expectations, and we remind everyone that our reserve levels for these strategic programs are set according to high water charge-off rates by vintage and program plus additional factors. Moreover, as we've noted previously, in March 2020, we proactively increased environmental factors that impact our reserve levels in conjunction with the heightened economic uncertainty at the start of the COVID-19 pandemic, and we have not lowered these environmental factors since. Overall, we remain confident in our portfolio underwriting and overall risk management, and while we expect credit quality to continue to normalize in line with industry trends, our relatively high reserve levels provide us with a formidable cushion. Our capital levels remain strong with a 21.4% leverage ratio. which keeps the bank significantly above the 9% well-capitalized requirement. Lastly, our effective tax rate was approximately 24.6% for Q2, compared to 25.4% for Q1-22 and 25.2% for Q2-21. With that, I would like to open up the call for Q&A. Operator? Thank you. At this time, we will be conducting a question and answer session.
spk01: If you'd like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two if you'd like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question comes from the line of Andrew Terrell with Stevens. Please proceed with your question.
spk02: Hey, good afternoon.
spk03: Hello, Andrew.
spk02: Hey, maybe I just wanted to start on the origination volumes. Are you able to bifurcate just how originations progress kind of by month throughout the quarter? Just trying to get a sense of where the monthly kind of run rate is heading into 3Q.
spk03: So we haven't disclosed the run rate by month, but I think you can just kind of look at the economic, general economic conditions that we're operating under right now and kind of assume a trend.
spk02: Okay. And then I guess maybe just a bit more, I hear some of your comments around kind of caution on originations rebounding like you might expect in the back half with normal seasonality, but Should we expect origination volumes declining from this $2.1 billion level in the back half of the year?
spk04: It's hard to look into the second half of the year because things are happening so quickly in the economy right now, but we do not look at that as something that's out of the realm.
spk02: Okay. And I understand you slowed down retention this quarter. Makes sense given the backdrop we're in right now. I guess what would you need to see in order to kind of step the retention rate on loans back up?
spk05: Stabilization in capital markets, I think, Andrew, I think is a fair first indicator. I think we track all of this on a monthly basis, both monitoring and review of it. It's not just the performance of the static pools, but also early indicators of those, whether it's first payment default, frequency level, et cetera. All of those are data points that we track regularly in deciding how much more retention we're going to add or additional programs we may add.
spk02: Got it. Thank you. And if I could ask one more just on the SBA gain-on-sale line item. I might have missed it, but did you disclose the dollar amount of SBA loans that were sold this quarter?
spk03: No, we didn't disclose the dollar amount.
spk02: Okay.
spk03: Can you speak to that? Go ahead. Sorry, Andrew. It was less than it was in the first quarter, fewer dollars.
spk02: Okay. Are you able to speak to just trends you're seeing in SBA right now and maybe provide any kind of expectation you have for sold production volume or gain on sale income from SBA specifically? And then should we expect it to contribute to balance sheet growth in the back half of the year as well?
spk05: So let me touch on like the pipeline and origination volumes. You know, we continue to have good origination volumes in the SBA product line. We have, you know, we're just a small you know, piece of that market, right? We're like probably less than 1% of the total market. And so our ability to attract, you know, qualified applicants for that product continues to be strong. As far as the secondary market and margins there, I'll defer to Javis.
spk03: Yeah, I think the conditions are deteriorating slightly on the premium amounts. But our big... A driver for the fluctuations quarter to quarter is not the premium amount necessarily. It's more focused on the number of loans that we sell. As we mentioned in the call, last quarter, it was an unusually high number of loans that we sold in Q1 of 2022. This quarter is pretty consistent with what we've seen in the past.
spk02: Okay. Great. Got it. Thank you for taking my questions. I'll step back on the queue.
spk07: Thank you. Thanks, Andrew.
spk01: Our next question comes from the line of Andrew Leash with Piper Sandler. Please proceed with your question.
spk06: Hey, guys. Good afternoon. Just want to talk about some of the investments that you have planned, and I recognize in the face of slowing revenue growth, it seems like some of these may be pushed out, but I'm just curious, like, what are the things that are most important for you right now that you're going to continue to invest in even in the face of slowing revenue? And then what things might get pushed out and where ultimately do you think the efficiency ratio could end up in the near term with slower revenue but also rising expenses given some of the investments you want to make?
spk04: Yeah, Andrew, that's a great question. I appreciate that. There are certain types of expenses that we can pull back fairly easily. Those would be like production-related expenses, number of bodies per production that we have. The ones that we're less inclined to pull back on right now would be those that further our strategic positioning. We want to make certain that we are ready when a rebound comes, that we can take full advantage as soon as possible of that. So continued investment in the basics such as BSA, compliance, oversight, IT, and continuing to build and evolve the platform to become more scalable, those are more strategic for us, and we'd be reluctant in the short term to do something there. Of course, you know, if things seriously deteriorate, you know, we always take a look and everything's on the table, but more so in the production-related and less so in the strategic foundational aspects of the bank. Does that help?
spk06: Yeah, absolutely. Thank you. And then, Javis, if you can give us some thoughts on how you look at the efficiency ratio in managing expense growth versus revenue trends.
spk03: Sure. The expense, obviously the efficiency ratio this quarter isn't where we'd like to see it, and it isn't where it's been in recent quarters. I think as far as giving you some goalposts on the efficiency ratios, I would say it's somewhere between where we've been in previous quarters, you know, in the mid to upper 30s and the industry. Somewhere in that range is good goalposts for the efficiency ratios. But more specifically to us, the other expenses line item, you might have seen a slight tick up in that category. That's where a lot of our public expenses are rolling into. the legal and professional fees are going into that. And we don't think that we're gonna see any softening in those expenses going forward. We have those obligations going forward. So that's probably not where we're gonna see any changes there. And then, as Kent mentioned, related to headcount and salaries, we'll be very careful as we expand into the areas that he described.
spk06: Got it. All right. That's helpful. And then just following up on the loan origination question and the outlook there, what's the pipeline for new strategic programs? Are you still thinking two to three new programs a year? What's been the thought process and what are prospective programs telling you about their outlook?
spk05: Sure. So our pipeline remains full. We also continue to deliver value and build on the relationships that we have with existing programs. So even though you've seen some dislocations in capital markets, it's important to note that our partners come to Finrise because there's a market need for a tech-enabled bank program. And we've been delivering this since 2016 and continue doing so today.
spk07: Got it. Thanks for taking the questions. I'll step back. Thanks, Andrew. Thanks, Andrew.
spk01: Ladies and gentlemen, we have reached the end of the question and answer session. Please disregard. It does look like we have a follow-up from Andrew Turow with Stevens. Please proceed with your question.
spk02: Hey, thank you for the follow-up. Just one quick one maybe for Jim. I think you're required to adopt CECL starting in 2023, and I heard the comments earlier about the the allowance ratio and kind of the qualitative or environmental factors that are in there. But I was curious, if you're running parallel CECL right now, do you have what the allowance ratio would have been under kind of a CECL framework this quarter? And was it relatively in line with kind of the reserve you put up this quarter?
spk05: Sure. So we are running it side by side, and we're planning to do that for the duration of this year. We're on track to adopt in January of 2023. But I do not have that number for you, Andrew.
spk02: Okay. No problem. I appreciate it.
spk07: Yep.
spk01: Thank you. Ladies and gentlemen, I am now showing no further questions in the queue. I would now like to turn the call over to management for closing remarks.
spk04: Yes, thank you. We just want to thank all of you for attending the call and your interest in FinWise Bank and wish you a wonderful afternoon.
spk01: This concludes today's conference and you may disconnect your lines at this time. Thank you for your participation and have a wonderful day.
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