Q4 2023 Finwise Bancorp Earnings Call

Participants

Kent Landvatter; CEO & President; FinWise Bancorp

Jim Noone; President, Chief Strategy Officer, & Chief Credit Officer; FinWise Bancorp

Javvis Jacobson; CFO & EVP; FinWise Bancorp

Andrew Terrell; Analyst; Stephens Inc.

Andrew Liesch; Analyst; Piper Sandler & Co.

Presentation

Operator

Greetings and welcome to the FinWise Bancorp fourth quarter 2023 earnings conference call. (Operator Instructions) As a reminder, this conference is being recorded. At this time, I would now like to turn the floor over to the FinWise Bancorp team. Thank you. You may begin.

Good afternoon, and thank you for joining us today for FinWise Bancorp's fourth quarter 2023 conference call. Earlier today, we filed our earnings release and posted 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 and President of FinWise Bancorp; Jim Noone, President of FinWise Bank; and Javvis Jacobson, Chief Financial Officer. With that, I will turn the call over to Kent.

Kent Landvatter

Good afternoon, everyone, and thank you for joining us on our fourth quarter 2023 earnings conference call. 2023 was another successful year as our differentiated business model, coupled with a disciplined approach and strong execution continue to demonstrate resilience. We produced solid loan originations and delivered positive returns. Specifically for the fourth quarter, we had approximately $1.2 billion in loan originations. Credit quality continued to perform as expected and generally in line with industry trends. Notwithstanding an increase in nonperforming loans in the fourth quarter. This increase was driven primarily by the continued impact of higher rates on our SBA loan portfolio. While our collateral and portfolio management processes continued to service well, the level of net charge-offs increased quarter over quarter. We continue to feel positive about the SBA portfolio. It's growth in credit characteristics and the level of net charge-offs at the bank, which have been generally in line with our expectations.
Turning to capital at the end of the fourth quarter. Our bank leverage ratio remains significantly above well-capitalized regulatory guidelines, which we believe provides us with sufficient capital to continue to support growth. Tangible book value per common share also continued to increase this quarter.
I would now like to provide a brief update on our key objectives for 2024 and beyond. Our previously communicated strategy of expanding into an integrated banking as a service bank, our Bask Bank continues to make meaningful progress. To that end. We are very excited about our payments hub and BIN sponsorship platforms, which are expected to be operational later in the year. This provides us with key pieces for an integrated VAS offering. We firmly believe that an integrated vast infrastructure coupled with the strength of our regulatory due diligence and oversight functions, are key differentiators in the market longer term. We also believe this expansion could create stickier relationships with our strategic platforms and offer multiple benefits to our business model. These could include additional recurring revenue, diversifying both revenue and deposit composition, more tools to manage our cost of funds through relationship banking and providing additional flexibility to manage our loan. This past quarter, we also completed an internal core system conversion as part of our overall business evolution. We believe this conversion should increase our operational efficiency and better position us to meet the needs of our growing organization. Our team worked diligently to complete this process by quarter end, and I want to thank them for their efforts.
Turning to our SBA seven loan program, we are pleased that the business continues to grow and perform as we expected, particularly amidst the higher rate environment that these credits have been managing through. While some market participants expect the potential economic soft landing, we believe uncertainties remain at least through the first half of 2024, which could impact industrywide loan originations across all the bank's lending process. The external environment, notwithstanding, we will remain disciplined and continue to actively manage areas of the business we can control, including our strict underwriting and collateral management processes. As we move ahead, we believe we're at an inflection point in the evolution of our model with a potential to enhance the company's long-term earnings power we plan to continue our efforts to expand the business towards an integrated VAS offering, coupled with continued focus on our existing lending programs. In line with our culture, we will be patient and disciplined in our approach to rolling out the new businesses and expect the benefits to accrue over time. With that, let me turn the call over to Jim Noone, our Bank President.

Jim Noone

Thank you, Kent. I will now walk through some additional detail on the quarterly originations, the growth, and performance of our loan portfolio and credit quality, and then discuss progress on our business initiatives. Total loan originations were $1.2 billion in Q4 versus $1.1 billion in Q3. Our fintech lending continued a gradual recovery in origination levels during the fourth quarter. Our SBA seven loan originations during the fourth quarter were lower on a sequential quarter basis, primarily due to reduced application demand for the types of transactions we generally finance as well as our continued adherence to disciplined underwriting. We did not chase loan volume as we always focus on balancing loan growth with credit quality and as a result we saw our SBA pipeline contract some quarter over quarter.
Moving to our portfolio, our growth in earning assets has continued according to plan. We continued to retain the guaranteed portion of our SBA loans, given the current dynamics where the underlying note rates remained high and secondary market loan sale premiums remained low on a sequential quarter basis, the 17.1% increase in guaranteed balances of our SBA loans was the primary driver of the 10.2% growth in total loans held for investment. Overall, we continued to be successful in identifying and funding creditworthy businesses in both our SBA and leasing lines in both contributed meaningfully to our growth in earning assets.
Turning to credit quality, the provision for credit losses was $3.2 million in Q4 compared to $3.1 million in the prior quarter. The sequential increase in provision was driven primarily by strict adherence to our CECL methodology, an increase in net charge-offs in our SBA portfolio and an increase in the qualitative factor overlay that was implemented during Q3 and which remained in place due to the increase in special mention nonaccrual and nonperforming assets. During Q4, net charge-offs were $3.4 million compared to $2.2 million in the prior quarter. The increase was primarily related to our SBA portfolio. As a reminder, during Q3, we had a large recovery of $390,000. The net charge-off rate as a percentage of average loans held for investment was 3.8% in Q4 compared to 2.8% in the prior quarter. We continue to believe we are well reserved for potential loan losses with an allowance as a percentage of total loans held for investment of 3.5% at the end of Q4. Non-performing loans at the end of Q4 were $27.1 million compared to $10.7 million at the end of the prior quarter. Of the $27.1 million, $15 million is guaranteed by the SBA and $12.1 million is the balance of loans which do not carry SBA guarantees, the increase in NPLs versus the prior quarter related primarily to our SBA portfolio. As this program continued to be impacted by the higher interest rate environment. As a reminder, our SBA. note rates adjust calendar quarterly based on a spread over the Wall Street Journal prime rate in place. At quarter end, we expect to see additional increases in our NPL balances while the prime rate remains elevated further, while $12.1 million of our NPL balances do not carry SBA guarantees, we believe are strict collateral policies in this portfolio. It should continue to help mitigate net charge-offs.
Finally, let me give you an update on our business initiatives within strategic program lending, we executed program agreements with Ernest, a subsidiary of Navient and a leader in the private student lending market. We are humbled by the trust the team at Ernest placed in FinWise to support their growth plans and believe this is a testament to the strength of our offering in the market. We look forward to working with the owners team and welcome them to the FinWise family. We are also quite proud of our continued investment in the compliance and risk management infrastructure at the bank. We believe this focus, which is at the core of our offering, is embedded in our systems processes and culture and allows us to continue to provide strong support to our fintech lending platforms.
Lastly, in anticipation of our further expansion into Bass. We continue to make progress on our payments hub and BIN sponsorship product. As Ken mentioned earlier, we anticipate them being operational later in the year. We will continue to provide you with additional details on these initiatives as certain milestones are achieved. Now let me turn the call over to our CFO, Javvis Jacobson, to provide more detail on our financial results.

Javvis Jacobson

Thank you and good afternoon. For the fourth quarter, we generated net income of $4.2 million or $0.32 per diluted common share. We posted solid profitability with a return on average assets of 2.9% and a return on average equity of 10.8%. These results were achieved while continuing to invest in infrastructure to support growth and key strategic initiatives. Average loan balances comprising held for sale and held for investment loans were $396.2 million during the quarter compared to $354.6 million last quarter. This increase was primarily driven by continued growth in our SBA 7(a) and commercial loan programs. Average interest-bearing deposits were $303.4 million compared to $255.8 million in the prior quarter. The sequential quarter increase was driven primarily by an increase in brokered certificates of deposit. As of the end of the quarter, approximately 87% of the bank deposits are either insured or our own capital or are contractually required in our strategic lending business.
Now turning to the income statement, net interest income for the quarter was $14.4 million, nearly flat versus last quarter positively. The increase in average balances of loans held for investment substantially offset the impact of higher interest rates and average interest bearing liability balances. Net interest margin was 10.61% this quarter compared to 11.77% last quarter. The decrease was mainly due to a loan mix shift towards loans carrying lower yields in the held-for-investment portfolio and an increase in the volume of CDs.
Non-interest income was $6 million in the quarter compared to $5.2 million in the third quarter. The quarter-over-quarter increase was primarily due to the change in fair value of our investment in VSG, partially offset by a decline in other miscellaneous income related to the resolution of a forbearance agreement last quarter, resulting in income, which did not recur and Q4.
Non-interest expense in Q4 was $11.4 million compared to $10.1 million in the prior quarter. The sequential quarter increase was primarily driven by an increase in salaries and employee benefits due to an increase in the headcount as well as higher professional service expenses as we continue to build out infrastructure to accommodate our growth. The efficiency ratio was 55.8% in Q4 compared to 51.3% for the prior quarter. We continue to expect the efficiency ratio to remain elevated as we further build out our infrastructure to move forward with our strategic initiatives that position the Company for long-term growth with a 20.7% leverage ratio of the bank's capital remained significantly above the 9% well-capitalized requirement. The company's tangible book value per common share continued to increase to $12.41 compared to $12.04 at the end of the prior quarter. Lastly, the effective tax rate was 28.5% for Q4 compared to 26.1% in the prior quarter. With that, we would like to open the call for Q&A. Operator?

Question and Answer Session

Operator

(Operator Instructions) Andrew Terrell, Stephens.

Andrew Terrell

Hey, good afternoon. Maybe if I could start just on credit quality and the allowance. I guess I was surprised to see a modest move down in the allowance this quarter just given we did see a lift in the nonperformers. And Jim, I appreciate the commentary, I think about $15 million of the NPLs were guaranteed by the SBA. It looks like if I back that $15 million out, you're essentially and your allowance covered one for one on NPLs versus kind of the nonguaranteed portion, I guess one, is that fair? And then number two, if charge-offs are running at, call it 3.8% or so this quarter when I build a reserve to a level kind of higher than you're going to [350 basis points].

Javvis Jacobson

Yeah, no problem. So let me just kind of piece that apart quickly. So yeah, generally, the reserve at the end of the quarter is going to be slightly higher than that $12.1 million on guaranteed balance -- on guaranteed NPL balance but it's close, right? It's like [$12.9 million in the reserve versus $12.1 million] in unguaranteed NPL balances. And just as far as the on like the trend, this quarter, the NPL balances were up on the primary figure to point out is the unguaranteed balances increased by $6.1 million in the quarter. That was similar to the $6 million incremental increase in unguaranteed NPL balances that we saw in Q three adds that quarterly increase was primarily attributable to the SBA portfolio.
Andrew, it's really a repricing issue. Remember these are adjustable rate loans on that reprice on a calendar quarterly basis. And the speed of those rate increases on has been impacting that portfolio. So we'll expect to see continued normalization here until the prime rate starts declining. But then your question about the ACL rate, really there's two there's two reasons there. First is the we've been disciplined in our CECL methodology. And then the second is because it is a lower risk portfolio than the same time last year on its lower risk because of the remixing of the portfolio that's happened throughout 2023.
The two examples that I'd give you are the SBA guaranteed balances are now 35% of the portfolio versus 21% at the end of last year. And then the SPHFI. balances, which carry a much higher reserve rate on the fintech lending balances that we retain have declined from about 10% of the portfolio to about 5% of the portfolio over the last year. So that's why that 3.5% figure on the ACL reserve is the right figure for the current portfolio.

Andrew Terrell

Understood. Yeah. I guess there's a lot of moving pieces there, and I wasn't totally contemplating the kind of positive credit mix shift seen throughout the year. So that makes sense. I appreciate it. And if I could ask on the loan origination volumes, was it good to see a little bit of a step up in the fourth quarter? Can you remind us any kind of seasonality within any of your businesses, specifically some of the larger partners in the fourth quarter? And then just going to outlook as you look into 2024 from an origination perspective, does it feel like we've kind of hit a relative trough year, we could still see some modest declines moving forward?

Javvis Jacobson

Sure. So on the seasonality piece, that's been pretty difficult for us to get a baseline on just over the last couple of years because there's been so much movement, both on the upside and then some of the larger partners on the downside. So really pulling out the seasonal factor is hard for us to do some. But just generally on the originations in the quarter, you know, that rebound in demand that we saw from the Q1 origination levels was a little more sustained than we than we expected. Originations were up a little quarter over quarter. And generally stable over the last three quarters on we would just point out it's still too early to say that it's likely to continue at that level throughout 2024 and the reason is that delta from Q1 is mostly related to a sustained rebound from the one program we spoke about in Q2, and we don't see broad enough strength across all of our platforms and just the industry in general to change our outlook there.

Andrew Terrell

Okay. Got it. I appreciate it. If I could maybe just take your temperature on maybe just wanted to maybe appreciate your line of thinking around retaining incremental strategic program credit that's being generated today. It feels like there's maybe a broader narrative in the market today that got into late 20, 30-year current origination vintage paper might end up being some of the better performing from a credit standpoint just as underwriters and underwriting has tightened with higher rates relative to prior years? And gentlemen, can I appreciate your thoughts on that and kind of narrative in the market one, do you agree and then any appetite right now I know you're seeing a lot of success in the SBA business, and it's really driving higher spread there, any appetite to bolster the strategic program, personal loan portfolio.

Javvis Jacobson

So the loan composition that we've been trending towards or that you've seen over the last call it year, Andrew, I think you should continue to expect from us over the next few quarters. I don't think you'll see any material change there. The SPHFI portfolio has been fairly stable on as far as dollar balances over the course of the last year when you the question that you had about vintages, it's hard to answer like like. So simply and the reason is it varies across programs and there are programs where I would say generally, yes, you know, mid-22 vintages to make a general statement are, you know, some of the there were worse performing generally than what you saw on kind of Q1, Q2 of '23. I think a lot of the reason for that is the tightening in underwriting arm, but it varies markedly across programs and is just as far as outlook from us in our portfolio, I don't think that you'll see anything different over the next few quarters as far as our strategy.

Andrew Terrell

Okay. Perfect. So really the incremental balance sheet growth we should expect should be more SBA-driven?

Javvis Jacobson

Yes.

Andrew Terrell

Okay, Javvis, if I could ask a couple just on the expense space. One, it sounds like there was a core system conversion in the fourth quarter. I'm just curious now from looks like the other expense line was up a decent amount sequentially. Anything one-time from the core system conversion or anything else either in the other operating expense or even on the salary and employee benefits in the fourth quarter, we should appreciate. And then it looks like expense growth from an operating standpoint was about 10% in 2023. Is that the right level of operating expense and growth you would expect moving forward? Just understanding that there's continued kind of reinvestment in the business?

Javvis Jacobson

Yeah, Andrew, I think we've been talking for the last several quarters now about making additional investments to improve our business infrastructure and what you're seeing in the in the noninterest expense now investments in personnel systems processes in the new core you mentioned this does those expenses aren't going to go away and we're not quite there yet, but we're excited about the progress we've made so far and about our plans to help position the Company for long-term growth. I wouldn't really call out anything in the fourth quarter as one-time.

Andrew Terrell

Understood. Okay. And then thoughts on just the overall level of expense growth going forward.

Javvis Jacobson

Again, when we're thinking about the right run rate for expenses, we continue to build and we're not there yet. So '23 has been a build year for us. We expect that to continue in '24. So I don't think it's unreasonable to think about in increasing expenses in '24.

Andrew Terrell

Okay. I appreciate it, and I will jump back in the queue. Thank you.

Operator

(Operator Instructions) Andrew Liesch, Piper Sandler.

Andrew Liesch

Good afternoon. Just wanted to talk about the BIN sponsorship and kind of how that's going to ramp up in funding partners can take some time and it sounds like it will be operational late this year. But when do you think we could start seeing revenue hit the bottom line? And I guess if you can it at a high level, what sort of partners are you targeting for that business?

Kent Landvatter

Jim, do you want to take that one?

Jim Noone

Yeah, no problem. So right now, Andrew, we're on we're looking to be operational later in the year. We don't have a time line to kind of point to as far as on identifying when to really be looking at with a meaningful revenue contribution, a lot of the work that's been done so far is really on the infrastructure and staffing side on. And that will continue over the course of this year on. We do expect to have our first handful of customers later this year, but it's really probably in 2025 that, that becomes a more meaningful revenue item for us.

Andrew Liesch

Got it. And then just the -- so I'll start on the originations. I know it's hard to say that this is as the environment improved, but you still continue to put up decent numbers and the strategic program fee is still we're running pretty solidly. I mean, shouldn't I guess I'm trying to just trying to figure out like where do you think the low for that fee income item could be like what we saw in the first quarter of that of this year. It just seems like there's a lot of -- there's more tailwinds out there than you guys might be expecting?

Jim Noone

Yeah, I can touch on the originations. I'll give, Javvis, if you want to touch on some of the fee side of that for us like the delta that you've seen between Q1 and the subsequent three quarters of '23, Andrew, it really came from a rebound with one specific program on in our fintech lending line. That was that rebound was sustained throughout the course of the year. And that was, you know, certainly something that you know of it was good for us, but it wasn't something that we were expecting throughout the course of the year. And I think right now, while rate expectations have improved and some of the other like macro clouds have who have been lifting, we still don't see broad enough strength across all of our platforms and kind of the industry in general to change our outlook. And so this is why we've continued and continued to build our pipeline and launch new partners. And I would point you to earnest on Navient this quarter in Q4 as really one of the goals that we really were trying to hit before the end of the year. So again, as far as origination levels over the course of the next couple of quarters, you know, pointing you to Q1 as a good barometer is still something that we would do near term.

Javvis Jacobson

And Andrew, as far as the fee income goes, I'd just point you to the high correlation between the strategic program fees and the line item or the original originations, we're pretty close to last last year, fourth quarter, and those fees are pretty similar and the trend is there you know, a little higher this quarter than last quarter and that trend exists as well on the strategic program fees line item in other income.

Andrew Liesch

Got it. That's helpful. I kind of covered the questions I had. I'll step back here.

Operator

Andrew Terrell, Stephens.

Andrew Terrell

Hey, thanks for the follow-up, I just had one around the capital position. It looks like the past past year or so. You've obviously really impressive balance sheet growth. Looks like the leverage ratios down about 450 basis points or so just throughout the year. I think if I recall the around the high teens, low 20s levels where you'd like to operate from a leverage perspective. Can you just talk about one comfortability with the current capital position today and then maybe tie it into discussion of what do you see your inorganic capital as a solution or a slowdown in the cadence of near term near term balance sheet growth, more likely outcome?

Kent Landvatter

So let me take a stab at that one, Andrew. The capital, as you know, last year we did some repurchases and we thought those were good for values for the shareholders because we bought it less than tangible book value, but we were always trying to walk the balance between the amount of capital they need to sustain our growth and keep regulators comfortable with our growth and the capital cushion. And so we continually look at that right now, we feel we've got the right level of capital to burn through this while still allowing regulators the comfort of our capital levels being sufficient. So whether we whether this is organic or inorganic for future capital needs, we're not to that point yet, but we feel comfortable with the capital position we have right now and and we'll keep keep you posted as if our thinking changes.

Andrew Terrell

Great. I appreciate. You answered, I think the second part of that question, I was going to be on the buyback, so I appreciate it Kent.

Kent Landvatter

Yeah.

Operator

Thank you. Are there any further questions in the queue? There are no further questions over the phone.

Operator we actually received a few questions via e-mail as we are now allowing investors to ask questions that way as well. So if there are no further questions on the call, I'll just read out these couple of questions. The first question reads regarding the agreement you just announced with Earnest. When do you think that will start to contribute? And how big can that be?

Javvis Jacobson

Sure. Thanks, Lauren. I think you know, first with Earnest, we're really excited about the relationship. We think it highlights the strength of our offering, and we're humbled that Ernest is trusting us to spearhead this growth plans. We're not going to provide any contract details today and we generally don't disclose details of our program agreements for competitive purposes. On long term, though we think earnings could be a meaningful contributor and that relationship will take some time to ramp up on. But we think we continue to have a strong opportunity to take share, particularly given our compliance and regulatory regulatory strength right now.

Okay, and there is one more what's the opportunity in banking as a service, especially given the regulatory issues with some of your peers and across the industry?

Kent Landvatter

Yeah, that's a very good question. We've been watching this. And as the industry evolves, sort of the regulations that go along with it, and we see this evolution as a very positive outcome that's going to better predict the industry and the customers. We've always focused heavily on an appropriate compliance management system at the bank, and we've tried to make certain that we're monitoring all of our relationships and their compliance with laws and regulations.
Of course, it's almost impossible to be 100% immune from compliance issues or some bad actors in the industry. But I think having a very proactive oversight is something that will further evolve the industry and specifically the space banks because banks that will come out on top, we will have strong due diligence processes when they bring the partners onboard. There is invested in building a strong compliance and regulatory processes. And I think for us, we've worked on this for a lot of years, and these actually create competitive opportunities for us.

No more questions via e-mail.

Operator

Thank you. With that, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.