FinWise Bancorp

Greetings and welcome to the FineWise Bancorp third quarter 2024 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, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce Juan Arias, head of corporate management and investor relations. Thank you. You may begin.

Good afternoon and thank you for joining us today for FinWise Bancorp's third quarter 2024 earnings conference call. Earlier today, we filed our earnings release and posted it to our investor website at investors.finwisebancorp.com. Today's conference call is being recorded and webcast on the company's website, investors.finwisebancorp.com. On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ from those discussed today. Forward-looking statements represent management's current estimates, expectations, and beliefs, 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. Hosting the call today are Kent Landvatter, CEO, Jim Noon, President, and Bob Wallman, CFO. With that, I will turn the call over to Kent.

Good afternoon, everyone. Our results during the third quarter of 2024 reflect the resiliency of our existing business, as well as the actions we have taken to enhance the company's long-term growth. Loan originations during the quarter grew to $1.4 billion, a notable step up from the approximately $1.1 billion in average originations of the prior five quarters. Furthermore, we generated solid revenue, particularly strategic program fees, coupled with a deceleration of our expense growth. Moreover, we continue to gain traction with new strategic programs. During the quarter, we announced one new lending program, which brings our total to three so far in 2024, and we are optimistic about our pipeline. These programs with leading fintech companies are a testament to the strength of the FinWISE multi-product platform, which includes lending, deposit, payments, and card products. As more FinTech companies increasingly recognize the benefits of our enhanced product offering, coupled with our strong compliance oversight and risk management, we see the opportunity to expand our market share with new and existing strategic programs, as well as through product cross-selling. The company's tangible book value per common share increased to 1290 from the prior quarter's 1261. As a reminder, our company's profitability over the past year has been partly impacted by planned infrastructure investments to support organic growth and the build-out of key strategic initiatives. Similarly, our return on average equity is also partly suppressed by our high capital levels. We are optimistic that as we have completed most of the incremental investments on strategic initiatives, as we continue to utilize capital effectively, these metrics will gradually improve. Overall, I am pleased with the operational performance of our company and am excited about the outlook. Specifically, our strategic lending business continues to gradually rebound after facing industry-wide pressures in 2023. We are delivering tangible results on our new strategic initiatives ahead of schedule, and we are seeing a deceleration in expense growth. With that, let me turn the call over to Jim Noon, our president.

Thank you, Kent. I will now provide some color on originations, review the portfolio trends, and then close with an update on our product initiatives. Third quarter originations totaled $1.4 billion. a solid step up compared to the $1.1 billion average of the prior five quarters, and the $1.2 billion in Q2 of 24. This quarter includes the first meaningful contribution from Earnest and Plenary, which we announced earlier this year, as well as a gradual rebound from our legacy programs. Specifically, of the incremental quarter-over-quarter change in originations, Roughly one-third is from the new programs, and the remainder of the increase is from the legacy strategic programs. Through the first three weeks of October 2024, originations are tracking at a pace modestly lower than the third quarter 2024 originations. As a reminder, Q3 included an expected seasonal pickup from Earnest, our student loan program, and we do not expect the same level of contribution in Q4. Also, the first three weeks of October do not include any contribution from PowerPay, the agreement that we announced during Q3, as there is typically a lag of a couple of quarters until we see a notable contribution from new programs. Our SBA 7 loan originations increased this quarter versus last quarter, driven by a gradual pickup in qualified applicants as rates have started to move lower. We are cautiously optimistic about the outlook for SBA volumes if we continue to see a decisive reduction in interest rates. We also continue to see solid origination levels in our equipment leasing and owner-occupied commercial real estate loans, both of which contribute meaningfully to our overall portfolio diversification. During the quarter, we continue to retain all of the guaranteed portion of our SBA loans. On a sequential quarter basis, these guaranteed balances increased 5.8%. Our commercial leases increased 13.7% quarter over quarter, and along with the SBA guaranteed balance increase, were the primary drivers of the 4.9% growth in total loans held for investment. At the end of Q3, our SBA guaranteed balances and our strategic program loans held for sale, both of which carry lower credit risk, made up 46.4% of our total portfolio, including HFS loans. Moving to credit quality, the provision for credit losses was 2.2 million in Q3, compared to 2.4 million in the second quarter. The decrease was due primarily to the company's periodic assessment of the qualitative factors, resulting in the removal of the factor related to COVID and its implications, partially offset by an increase in other qualitative factors, and slightly higher charge-offs stemming mostly from the SPHFI portfolio. The net charge-off rate as a percentage of average loans held for investment ticked up slightly to 2.3% in the third quarter from 1.9% in the second quarter and was lower than the 2.8% for the same quarter last year. NPL balances were up modestly this quarter to $30.6 million versus $27.9 million in the prior quarter. Of the total $30.6 million, $17.8 million is guaranteed by the federal government. Importantly, our unguaranteed NPL balances only increased modestly to $12.8 million this quarter versus $12.1 million in the prior quarter. As discussed on prior calls, you have expected to see some sporadic increases in NPLs as rates were elevated, and this will likely lead to an increase in NPLs in the next two quarters. While the total NPL balances have an impact on our NIM, the bank's credit risk is limited to the $12.8 million in unguaranteed NPL balances, and we believe our strict collateral policies should help mitigate net charge-offs. Positively, if interest rates continue to decline, we are optimistic that over time it could gradually have a positive impact on our NPL metrics. In terms of an update on our strategic lending programs, we continued to build on the string of success this year by announcing our third new lending program this year with PowerPay during Q3. As part of our agreement, the bank will offer consumer loans for home improvement and elective healthcare purchases. We welcome PowerPay to the FinWise family and thank them for the trust they placed in us. To summarize, we're very proud of what we have accomplished so far in 24 in terms of strategic initiatives, As Kent mentioned earlier, we're optimistic about the pipeline. I will now turn the call over to our CFO, Bob Wallman, to provide more detail on our financial results.

Thank you, Jim, and good afternoon. I will now briefly review some key financial metrics and provide insight as appropriate. In the third quarter, we generated net income of $3.5 million, or $0.25 per diluted common share. Average loan balances comprising held-for-sale and held-for-investment loans were $492.9 million during the quarter compared to $449.9 million in the prior quarter. This increase was primarily driven by continued growth in our commercial lease programs, SBA 7A program, and consumer and strategic program loans held for sale. Average interest-bearing deposits were $341.2 million compared to $318.9 million in the prior quarter. This sequential quarter increase was driven primarily by an increase in interest-bearing demand deposits and broker time certificates of deposits. Moving to the income statement, net interest income for the quarter was $14.8 million compared to $14.6 million in the prior quarter, driven by increased volumes in the loans held for sale and loans held for investment portfolios, partly offset by yield decreases in both portfolios. During the third quarter, we had a one-time adjustment for accrued interest associated with loans that were determined to be non-performing in prior periods, which decreased net interest income in Q3 by approximately $500,000. Our net interest margin was 9.7% this quarter, which includes this one-time adjustment just mentioned, compared to 10.31% last quarter. The change from the prior quarter is attributable to the company's continued strategy to reduce average credit risk in the portfolio, as well as the previously described one-time adjustment that decreased net interest income. There are two items that will affect next quarter's NIM that I want to highlight due to the Federal Reserve's 50 basis point reduction in interest rates during September. First, our SBA portfolio generally floats with prime rate and resets at the beginning of each quarter. Second, Early in Q4, we initiated a program to call our callable CDs and replace them with lower rate wholesale funding. Non-interest income was $6.1 million in the quarter compared to $5.2 million in the prior quarter. The sequential quarter increase was driven primarily by an increase in origination fees related to our strategic programs. Non-interest expense in the second quarter was $14 million compared to $13.2 million in the prior quarter. The sequential quarter change was primarily due to an increase in salaries and employee benefits, which included a one-time catch-up in bonus accrual expense of approximately $400,000 to reflect updated performance award estimates. The pace of growth in expenses decelerated in the third quarter as we discussed what happened on our second quarter call. even including the one-time catch-up and bonus accrual expense. We continue to expect the pace of growth in expenses to further decelerate in the fourth quarter of 2024 as we finish the build-out of our new initiatives. As we move forward through 2025, we also expect incremental hit count-related expenses to be more aligned with increases in production. Finally, our effective tax rate was 25.1% for the third quarter, compared to 23.9% in the prior quarter. As of now, we expect the effective tax rate for Q4 2024 to run around 25.1% and full year 2024 to run around 25.5%. With that, we would like to open the call for questions and answers. Operator?

Thank you. We will now be conducting a question and answer session. Please wait while you poll for questions.

Our first question comes from Andrew Leash, Piper Sandler.

Please proceed with your question.

Thanks. Hey, everyone. Thanks for taking the questions here. Just on the loan production so far of what you've seen this quarter, I know in the past there's been some seasonality to the benefit in the fourth quarter. Is that going to be offset by the seasonality that's going to flow out from earnest? I'm just trying to get a sense of if we could see Jim Noonan- Production pickup here in the next couple months.

Jim Noonan- yeah Andrew this is Jim noon um so we're really excited about the trends that we're seeing in originations. Jim Noonan- You know even backing out the expected seasonality of earnest during the third quarter, you know we're optimistic about the step up and originations that happened again this quarter. and the outlook going forward. I'd say, you know, as far as specific trends, you know, we're starting to see the benefits of the announced programs from earlier in the year. The environment's also improving, you know, for some of our legacy programs. And then we're optimistic about the pipeline for new partners. And if you take all of that, you know, within the strategic programs, you know, the lower rates, we're also seeing some early signs of increased activity in SBA originations. So I'd say overall we're optimistic, but there is some seasonality in that third quarter from earnest and, you know, the student loan or academic year.

Got it. All right. That's helpful. And then, Bob, on the commentary on the early fourth quarter actions on the margin, do you think the callable CDs and the SBA, are those going to be offsetting? And then I guess what other rate moves have you done on maybe another deposit account? Will there be a lag on the CD that's trying to get a sense on how the margin and net interest income can trend here with these actions?

Yeah, sure, Andrew. And NIM is always a complicated area to take a look at, and it's hard to forecast what's going to happen because there are so many things that will affect it, particularly here at Fenwise. The origination volume on our higher rate loan programs, how quickly we're growing the higher quality, lower rate portfolios, significant increases in non-performing assets with related, you know, interest reversals that we saw in this quarter, you know, what happens to the SBA loan funding and what happens to the prime rate and, you know, how we're replacing this with our callable CEDs. So, and these things work in opposite directions. I do expect overall, that absent any future Federal Reserve actions, we would expect the NIM to continue to decline during the fourth quarter. I just can't put a stick a fork in it and tell you and say this is how much it's going to be because of all these different variable activities. But I will tell you a little bit more about the callable CDs that we have done. Of our $262 million of CDs, $205 million of those are callable CDs, of which $160 million we can call currently, and the rest of them will be called during the first and second quarters of next year. And of those that we have called, we've called about half of those that we had the ability to call, about $80 million is what we have called to date. And of those, the average interest rate on those were about 5.6%. And we were able to replace that funding at a cost of about 3.7%. I'm not sure, you know, the market has moved. We were able to take advantage of the quick dip in the market after, you know, in early October. Not sure we can do the rest of them at that rate, but we're sure going to take a look at it and try to.

Got it. Yeah, that's very helpful. Thanks for that commentary there. And then just one last question for me, just on the payments and the card revenue. Obviously, a lot of investments have gone. gone in there. Any sort of update on when we could start to see revenue fall to the bottom line?

Just something that folks have been waiting for for a while and hope to get an update there. Thanks. Well, maybe I'll take a first stab at that.

This is Kent. Hi, Andrew. We will, we're still on track to complete the payments hub by the end of this year. As a reminder, we have launched one partner earlier this year, also one card partner earlier this year. We take some time to pilot those before we really expand them and we want to do an external readiness assessment first. before we do full expansion, but we expect a full year of 2025 to be ready for a full year of launching and seeing the revenues from those. We don't have specific KPIs or anything for you this quarter. We hope to have a little more insight on what this looks like in our Q4 earnings call, but I hope that helps.

Yeah, sure does. Look forward to it. Thank you so much for taking the questions. I will step back.

Okay.

Thank you. Our next question comes from Andrew Terrell, Stevens Incorporated.

Hey, good afternoon.

Hey, Andrew.

Man, you guys have it easy with both of us named Andrew here. I can't mix up any names. Yeah. Hey, just a few questions for me. So the 80 million that you have been able to call on the brokered CD side, you know, I think you said 205 million of total. Can you just give us a sense for the incremental of what's callable but you have not yet called? You know, timing, potential you could kind of look to to replace some of that higher cost funding?

So a few other facts about the other $80 million that we can call today. It carries about the same average interest rate, about 5.6%. And the eligible to call today will probably do them in two buckets. We just don't want to be doing everything at one point in time. And one bucket will probably go out in November and one in December unless we do choose to change the timing depending upon what market circumstances are at that point in time.

Got it. Okay. That's helpful. And then, you know, I'm looking at the average balance of the HFS loans this quarter. And this is a point we've talked about some, you know, in the past. the average balance really stepped up quite a lot this quarter. And just curious, you know, if that's intentional, you're increasing kind of hold times on loans, whether, you know, it's related to some of the new partner launches that contributed to the origination increase this quarter. And then just kind of overall, you know, should we expect this like this $70 million per quarter of average HFS loans is kind of a new normal? I know it was, you know, it was hovering around the $40 million territory for a while. So it's 70 kind of a new average balance, uh, we should think about.

Yeah. Um, as far as the HFS balance, Andrew, you know, that's mostly a derivative of the origination volume in the quarter. Um, so I would go back to the comments there, you know, we're optimistic. We did see another step up, um, in kind of baseline originations from legacy programs, but there's also some seasonal factor with the student loan program and the two new partners. I think we talked about, you know, in our prepared remarks that about a third of the incremental quarter over quarter change in origination was from the new programs. And to kind of help with your modeling, you know, earnest will still generate originations in Q4. They're just not going to be at the same level as Q3 since that's the start of the school year. And that's really the key point that we wanted to highlight.

got it okay so maybe some moderation there just predicated around the the kind of tracking of the loan originations correct okay got it um you know i wanted to ask on um on the fee income side that the change in fair value on investment in bfg um that's you know it's it's been negative the past few quarters. I'm just curious what the kind of current baseline valuation is or the value of your investment is. And, you know, should we expect continued? I get they can kind of fluctuate some, but, you know, it seems like it's been a drag on the fees every quarter this year. So any kind of updated expectations there?

Well, a significant amount of that program or their revenue that they generate relates to the generation of SBA loans and the fees that are paid the origination fees that are paid for the generation of those SBA loans. And it has been a slower market for the SBA loans so that the revenues that they have generated has been running a little bit behind what they had generated in past years and a little bit below budgeted expectations. And so it's that revenue generation that is the driver to the valuation. But we are seeing signs of SBA loans lending picking up. And so while it's been a negative the last few quarters, as that activity picks up and as they develop other business activities, we do expect to see that valuation turn around and go the other way.

Yeah. Okay. Makes sense. The expense side of the house, I think it was pretty impressive, the moderation expense growth, even acknowledging the you know, the one-time incentive accrual catch-up this quarter. I think if you back that out, obviously an even lower level of expense growth this quarter. You know, with that in mind, like if I'm just going back to some of your comments and the prepared remarks about, you know, continued declines in the pace of operating expense growth, I guess if we're to normalize, you know, 400 grand out of the run rate in the fourth quarter, it seems like you've got a decent shot at only expenses flat if the kind of core rate of reinvestment is also slowing. Is that an unfair assumption going into the fourth quarter, or should we expect expenses to continue to build off this 3Q base?

Well, during the second quarter call, what we said to anticipate for the third quarter is about half the growth rate of what happened in Q2. And we said looking forward to Q4, about half the growth rate of what we expected to happen in Q3. And so that would leave us with a little bit of growth, not flat, but a little bit of growth in Q4. So I don't think – I mean, what you model, I guess, is what you choose to model. But I think no increase in expenses might be a little bit aggressive.

Okay. Got it. I appreciate it. Thank you guys for taking the questions. I'll step back.

Thank you. If there's anyone that would like to ask a question, please press star 1 or your telephone keypad. Confirmation tone will indicate your place in line. You may press star 2 to remove yourself from the queue. Okay. It doesn't look like we have any more questions at this time. I would like to turn the floor back to Juan Arias for any further remarks.

Juan Arias Thanks, operator. We did receive a few questions via email, so I'll just read those out. Can you provide us with some detail on the potential increase in the amount of NPLs for 4Q24? Yeah. Hey, Juan. This is Jim.

You know, aside from the high rate environment, you know, what we would point to as far as NPL balances in the portfolio is, you know, there's not really, there's no broad-based areas of stress in the portfolio. This is mostly lingering stress from the higher rates. If you look at the quarter over quarter uptick, you know, an unguaranteed balance of NPLs, those are modest, moving from 11.9 to 12.8. And then if you look at the NCOs, you know, those are relatively flat year over year. But You know, in addressing your question on outlook, you know, what you'll see is about $9 million in 30-plus day delinquencies for SBA coming through on the call report. And I'd say something around $10 million total is what you could expect to migrate into MPL in the fourth quarter. You know, this is in line with our expectations and, you know, prior comments about sporadic pickups in MPLs. due to the higher rates. And as rates have now started to decline, we're optimistic this may start to provide some relief to borrowers.

Great. A couple more questions via email. What's the opportunity to cross-sell different product offerings to new and existing partners, given your expanded product platform?

Sure, I can take that one. Yeah, we're really excited about the multi-product platform. We now have lending, payments, and cards. And we've had a lot of discussions with both new and existing partners. And most of these are really reverse inquiries coming in. So it's something that we're very happy to see continue to build on our leadership position in the industry. It's also the rationale for the investments that we made. It's really to expand our product set. increase the stickiness of the relationship, and ultimately increase revenue.

And the last question that came in, you've accomplished quite a bit in 2024. How do you feel about 2025 and what should we expect to see from FinWISE?

Yeah, I'll take that one, Juan. We're very proud of what we've accomplished in 2024. have done everything we said we would do and a lot of it ahead of schedule. But importantly, that leads to a very strong foundation for 2025. So for 2025, we expect to start reaping some of the benefits from the initiatives, including now a stronger multi-product platform, which we originally set out to diversify and stable revenue streams. So we're very excited about what we've created and the foundation is created for 2025.

Thanks, operator.

There are no more questions.

Okay. Thank you. And thank you for today's participants. This does conclude today's teleconference. You may disconnect your lines at this time.