Q4 2023 Pathward Financial Inc Earnings Call

Participants

Brett L. Pharr; CEO & Director; Pathward Financial, Inc.

Darby Schoenfeld

Glen William Herrick; Executive VP & CFO; Pathward Financial, Inc.

Eric Spector

Frank Joseph Schiraldi; MD & Senior Research Analyst; Piper Sandler & Co., Research Division

Michael Anthony Perito; MD; Keefe, Bruyette, & Woods, Inc., Research Division

Presentation

Operator

Ladies and gentlemen, thank you for standing by, and welcome to Pathward Financial's Fourth Quarter and Fiscal Year 2023 Investor Conference Call. (Operator Instructions) 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.

Darby Schoenfeld

Thank you, operator, and welcome. With me today are Pathward Financial's CEO, Brett Pharr; and CFO, Glen Herrick, who will discuss our operating and financial results for the fourth fiscal quarter and full fiscal quarter of 2023, 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 pathwardfinancial.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 provided only 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.
Now let me turn the call over to Brett Pharr, our CEO.

Brett L. Pharr

Thanks, Darby, and thanks, everyone, for joining us today and for your continued support. We've just completed a year of solid results, both financially and operationally. I remind you that we operate at the intersection of traditional banking and alternative delivery channels. And therefore, this year, we've had an expanding net interest margin, increased return on assets and increased return on equity. These great results are in spite of a tough economy and especially what has been a tough banking environment.
When you combine these great results with the return of capital through share repurchase and dividends, we have delivered value to our shareholders in multiple ways. Specific numbers for the year, we reported net income of $163.6 million, an increase of 5% and $5.99 per diluted share, an increase of 14%. In the fourth quarter, net income was $35.9 million or $1.36 in diluted earnings per share. Our earnings growth was driven through expansion of our full year net interest margin to 6.04%, an increase of 120 basis points over fiscal year 2022.
Our full year adjusted net interest margin, including rate-related processing fees, grew 15 basis points to 4.83% from 4.68% in fiscal year 2022. Those metrics in the fourth quarter were 4.87% and 4.73%, respectively. Besides the financials, operationally, we have a lot to be proud of. Across the enterprise, our IT team delivered a reduction in rent cost, and we're utilizing these funds to help us to continue to focus on growth. We're also, from a people standpoint, certified by as a Great Place to Work for the first time and Newsweek ranked us among America's Greatest Workplaces, along with some special distinctions for women diversity and parents and families. To Commercial Finance, specifically, we grew total loans and leases by 23%.
This was driven by growth in our Insurance Premium Finance business of 67% over the prior year. This was a direct result of us positioning the team to take advantage of opportunities and some market disruption in that particular vertical. We've also built several new relationships in our government guaranteed sectors talking about SBA and USDA that we believe will prepare us well for 2024. Also in Commercial Finance, we undertook a process to align teams that were operating vertically within their loan product into horizontally capable groups across the team.
We believe this will drive a reduction in operating costs and will create a more efficient and streamlined organization going forward. Collateral managed loans provide us with tremendous safety, but it is people-intensive, and we are constantly seeking efficiency in that space. In Banking-as-a-Service, we continue to expand and create new agreements with our existing partners, we extended four agreements. We launched a new Acquiring Sponsorship program, and we expanded product offerings in three cases. We also worked with a new partner in their launch as a payment processor. And most recently, we signed a new agreement to launch a new Demand Deposit Account Program.
We continue to evolve our BaaS organization to position us as the go-to partner with a broad payment capability set and flexible solutions that deliver safe and sound infrastructure, simplicity and speed-to-market for our partners. Finally, regulatory news in the BaaS marketplace compels me to discuss compliance. I believe the strength of our regulatory risk and compliance infrastructure needs to be emphasized as a key differentiator for us. Recently, all the regulatory agencies have announced novel banking or a similar type of approach to address Banking-as-a-Service business models like ours. Frankly, it is about time.
We hope it will reduce the current environment of regulatory arbitrage. If it is similar to the third-party risk management that the agencies collectively released in the last year, and I expect it will be, we already meet those heightened standards and have for some time. To exist in today's Banking-as-a-Service regulatory world, you must have a culture of compliance and the human capital to power it. And we have worked very long and hard to create that. At Pathward it is job one in Banking-as-a-Service. Going forward, heightened standards for banks that operate in this space will be the requirement.
And we believe we have the culture and the commitment to maintain that level of risk framework. The best time to plan a tree is 20 years ago, and that is exactly what we did when we entered the payment space back in 2004. As a result, we will not have to make significant investments to bring our BaaS program up to speed. Rather, we can focus on helping our partners adapt to today's ever-changing financial services environment. So some key points; we believe we are entering a regulatory cycle that could fundamentally change the Banking-as-a-Service banking space, drawing a regulatory moat around those who can operate within the heightened requirements.
We believe others will decide to get out of the Banking-as-a-Service space. And we believe we are extremely well-positioned to thrive in this type of environment as a financial institution that generates sustainable recurring revenue and champions a strong culture of compliance built to endure any cycle, including credit, economic or regulatory to name a few. Through the cycle matters, we are built to thrive in all cycles. For fiscal 2024, you can expect us to continue on enhancing our company. We will have our teams continue to innovate and to improve efficiencies. In Commercial Finance, we want to drive smart balance sheet growth, ensuring appropriate yields for the current financial landscape.
The BaaS team is going to continue to emphasize being the one-stop shop when partners are looking for a banking partner to work with them. We'll continue to win with our risk and compliance framework and culture, and we will become and maintain our status as a Banking-as-a-Service powerhouse bank with a long track record of success through the cycle. All of these items have contributed to our ability to raise our fiscal year 2024 guidance to a range of $6.20 to $6.70 per diluted share.
Finally, we are very excited to announce the appointment of Greg Sigrist as our next CFO. Greg comes to us with a strong background, making him an excellent addition. He has over 20 years of banking experience with impressive leadership and financial and business acumen that we believe will keep Pathward in the way to continued success. We look forward to welcoming Greg in a few weeks.
I also want to once again thank Glen for all of his contributions over the last 10 years. There's not enough time in this call to detail everything Glen has done for this organization in his time here. He was instrumental in the diversification and evolution into who we are today and built accounting, finance and treasury teams that I believe rival those of much larger institutions and any other Banking-as-a-Service bank.
Glen, on behalf of the Board and our employees, thank you. We wish you well and hope you enjoy retirement.

Glen William Herrick

Thank you, Brett, and welcome aboard, Greg. I look forward to working with you on the transition. Before I sign off on my last 42 earnings, it has been an honor and a privilege to serve as CFO of this company for the last 10-plus years. It has been a joy to watch the company and the team transform into an innovative entrepreneurial-driven bank. Our annual net income has grown from $13 million in fiscal year 2013 to over $160 million this year. From my start date through mid-October, our total shareholder return has exceeded 450% versus the NASDAQ Community Bank Index increase of about 80% and the Russell 2000 Index increase of just over 110%.
We've achieved a great deal, and I look forward to cheering on the team to even greater accomplishments. Now on to the financial results. Net income for the quarter ended September 30 was $35.9 million or $1.36 per diluted share, an increase of $12.5 million compared to the prior year. For fiscal year 2023, net income totaled $163.6 million, an increase of $7.2 million relative to fiscal year 2022. Adjusting for various onetime items, including the impacts of our rebrand, the increase would have been $32.9 million or 25%. GAAP earnings per share of $5.99 increased 14% compared to last year.
And when adjusting for the same items, core EPS increased to $6.09 in fiscal year 2023 compared to $4.49 in fiscal year 2022. In the fourth quarter, net interest income totaled $104.9 million, an increase of 32% relative to the prior year. This year-over-year increase was driven by additional earning asset balances as well as greater yields across the loan and securities portfolios. Our NIM expanded to 6.19% in the fourth quarter. When accounting for the increase in rate-related processing expenses the company's adjusted NIM of 4.87% in the fourth quarter increased from 4.73% in the prior year quarter and was in line with 4.88% last quarter.
As a reminder, our adjusted NIM does not include the servicing fees we also earned on our off-balance sheet deposits. Also impacting the NIM was a mix shift in the loan base as we saw growth in our USDA loans, insurance premium finance and large ticket equipment finance loans, which are typically higher rated credits and thus lower yielding. In fiscal 2024, we expect our NIM, both GAAP and adjusted to expand as we continue to optimize the earning asset mix. Provision for the quarter was $9 million. The provision increased when compared to the same period last year, largely due to the fact that the fourth quarter of fiscal 2022 included a $4.3 million reversal of provision following the sale of the company's student loan portfolio. As of September 30, the company had an ACL coverage ratio of 1.14%, a decrease from 1.3% at the same time last year.
Our Commercial Finance Group has an ACL coverage ratio of 1.26% compared to 1.35% in the last quarter and 1.46% in the fourth quarter last year. The successive declines are generally a result of the mix shift towards more insurance premium finance, USDA and large ticket equipment finance loans, which have a relatively lower allowance rate. Non-interest income of $56.1 million in the fourth quarter grew $12.6 million year-over-year. This increase was partially driven by $2 million of additional card fee income related to the company's servicing of off-balance sheet deposits.
Additionally, the fourth quarter of fiscal year 2022 was hindered by a $4.8 million pretax loss on the sale of the student loan portfolio as well as a $1.9 million pretax loss on the sale of the venture capital investment. Non-interest expenses increased 15% year-over-year to $118.2 million. This increase was primarily driven by rate-related processing expenses as well as compensation expenses, partially offset by a decrease in legal and consulting expenses primarily due to the impact of rebranding activity in the prior year. During the fourth quarter, we were able to capitalize on several renewable energy lending opportunities.
These credits pushed our effective tax rate significantly lower. Total deposits including on- and off-balance sheet decreased $322 million or 4% from the prior year quarter to $6.9 billion. Total deposits decreased sequentially, primarily due to a reduction in the runoff EIP deposits as well as a continued decline in seasonal tax deposits. During the fourth quarter, we maintained an average of $588 million of deposits off balance sheet, earning fee income roughly equal to the effective funds rate. At September 30, there were $268 million of deposits off balance sheet at partner banks. And to keep you up-to-date at September 30, we are holding roughly $900 million in deposits related to government stimulus programs.
These deposits are being spent down while unclaimed balances are being returned to the U.S. Treasury. During fiscal year 2024, we expect to return approximately $380 million of unclaimed deposits. As of September 30, the company held $4.4 billion of loans, an increase of $830 million or 24% compared to the end of fiscal year 2022. The growth in our loan portfolio stemmed primarily from our commercial finance division, particularly insurance premium finance, term lending and USDA and SBA. We also saw growth in consumer credit and warehouse lending. Credit quality across the portfolio remains strong. Non-performing loans of 1.26% increased from 0.93% in the previous quarter.
The largest increase was in commercial finance, and this was partially driven by the same relationship we mentioned last quarter, which is in the process of a workout. As we have said in the past, we do experience lumpiness in our non-performing loans, particularly when we are in the process of a workout, but typically we recover at least a portion of a loan, if not all, due to our collateral management. We remain confident in our collateral and the quality of our portfolio. As Brett said, we have built the company to be resilient through different cycles. From a liquidity perspective, Pathward continues to be in a good position.
Our balance sheet is strong. And when you factor in all of the sources, we have over $2.6 billion of available liquidity. These results continue to give us the ability to return value to shareholders. In the fourth quarter, we repurchased approximately 312,000 shares at an average share price of $51.29. In October through October 16, we have repurchased an additional 233,000 shares at an average price of $47.25. In August, we announced that our Board of Directors authorized a new share repurchase program of up to 7 million shares through September 30, 2028.
As of October 16, we have 8.4 million shares available for repurchase under the two current programs. As Brett stated, we are raising our fiscal year 2024 GAAP earnings per share guidance to a range from $6.20 to $6.70. While the fourth quarter saw a healthy amount of renewable energy funding opportunities, we do not anticipate this to reoccur at the same pace in fiscal year 2024. As a result, we are reaffirming our effective tax rate to be in the 16% to 20% range.
This concludes our prepared remarks. Operator, please open the line for questions.

Question and Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Mike Perito with KBW.

Michael Anthony Perito

This is Mike [associating], Andrew filling in. Just first off here, I was wondering -- just first off here, I was wondering if we could get some updated credit outlook commentary given some of the negative data points we've seen from other lenders, particularly in like the credit card and small business segments?

Brett L. Pharr

Yeah. So of course, we don't have credit cards. In the small business arena, commercial finance, as we said, we're a heavily collateral managed loan lender and therefore, we tend to do very well through these kinds of times. And so we are not -- while we're having some companies that are having some difficulties, we're not having any kind of losses associated with that of any ordinary pattern. So we're feeling very confident about it. I don't expect to have any trouble and we believe our collateral managed approach will put us in a better place going through the cycle than other lenders may have.

Glen William Herrick

Yeah. And Andrew, I'd remind you that one thing that differentiates us we no longer have a community bank. So we have a de minimis amount of commercial real estate on our books.

Michael Anthony Perito

Great. I appreciate the color there. And then just a quick follow-up on that. What are the provision assumptions that are going into the fiscal year '24 guide?

Glen William Herrick

Well, it's based on our originations and the outlook for the economy and where our growth is coming from. You've seen in the last couple of quarters, our growth has come from higher quality, typically lower loss portfolios, SBA, USDA and insurance premium finance. So that factors into both where the allowance levels are at, it also drives your CECL provisioning.

Michael Anthony Perito

And then just lastly for me and then I'll step back. Near term, just a quick question on the margin. Do you believe the NIM will stabilize here if we're in a higher-for-longer environment kind of as predicted and there's no movement in the Federal Funds rate?

Brett L. Pharr

I mean if we have stability here, higher-for-longer, our NIM will continue to widen. That's a key differentiator of our business model is we still have a lot more upside on the yield side versus the cost even if Fed Fund stays flat.

Operator

The next question comes from the line of Eric Spector with Raymond James.

Eric Spector

This is Eric on the line for David Feaster. Kind of just -- hey, how is it going? Staying on a similar page on the NIM just curious how you think about operations in a higher-for-longer environment? Obviously, there's a tailwind to the margin, but just curious if you could elaborate on the margin trajectory? And then just any broader perspective how you think that would impact loan growth? And maybe any other impacts or impact on any other business in a higher-for-longer environment?

Brett L. Pharr

Well, so the first thing kind of ties back to the previous question, as you offload longer-duration loans that were at lower rates and replace them with duration loans at higher rates, we're going to continue to grow NIM, even if Fed funds and Prime stay flat. So that's kind of obvious. Now the other element of your question is what's going on in the marketplace. And we're watching to see how much of a slowdown occurs in loan demand. Glen noted particularly that we're already migrated some in our growth to higher quality loans.
Some of that is what's available in the marketplace. And so we see that in leasing portfolios and others. And so that may well be what happens. But also if the economy gets into a little bit more of a difficult time, we may see some growth in our working capital and factoring assets. We've talked about that for, I think, nearly a year now. So it hasn't materialized, but that would be the next thing that would happen if the economy really slows down as people are starting to talk about.

Eric Spector

Got it. That's helpful color. And then just kind of wanted to touch more on the capital side. So obviously, regulatory capital remains strong, but TCE [spend] just curious if you're hearing any pushback from regulators on that and that impacts your capital return opportunities at all. It looks like you've already started to repurchase some shares during the quarter, so maybe that's the answer. But just curious if TCE plays into the equation at all at this point?

Brett L. Pharr

We obviously watch that. And as you said, that's a factor. And we're comfortable. Our Board is comfortable. You could assume regulators have a say in your capital levels and share repurchases as well. And I would say in banking 30-plus years, we're as a liquid a bank as I've seen.

Eric Spector

Okay. And then just one last question. Just wanted to touch on what you're seeing on the SBA front. We're seeing growth opportunities. And can you remind us like how much of that book is government guaranteed? My last question, I'll step back.

Brett L. Pharr

Yeah. We talked about -- I mentioned in my comments that we've been identifying additional SBA partners where we can get volume coming through. And so I would say the SBA business in general, industry-wide has slowed down, but we're able to get some more transactions because of new partners that we've brought on. So we're excited about that. The exact percentage of how much is government guaranteed or not varies depending on market conditions, sometimes we sell off the government guaranteed portion. So I don't know, do we have those numbers, I didn't want to get to.

Glen William Herrick

It usually rains about two-thirds. It moves up and down, as Brett said, but plus or minus two-thirds of it would be typically guaranteed.

Operator

(Operator Instructions) Our next question comes from the line of Frank Schiraldi with Piper Sandler.

Frank Joseph Schiraldi

I wanted to ask on the guide, the increase in guide. Anything you can point to specifically, is it just as simple as a bit of a change in rate outlook that's driving that increase here?

Brett L. Pharr

Yeah. I mean I think the higher-for-longer, what's going on should help us with NIM. And so we're feeling very comfortable about that. Obviously, we're just a few days into the year. So we're not getting carried away. But we felt like with the -- what we're seeing with the rate environment, we could bump it some, and then we'll see what happens as we get through the year.

Frank Joseph Schiraldi

Okay. And then in terms of the expense base, I get the card processing expense that increase there. As far as -- if you look at the other expense line was a bit elevated, it bounced around a bit, but it was a bit elevated linked quarter and same with legal and consulting expense. So any sort of color or range you can give in terms of anything onetime sort of in the quarter and where you expect a better run rate maybe to be on the expense side?

Glen William Herrick

Yeah. I would say this quarter is a pretty good run rate, Frank, excluding the rate-related processing expenses. And our -- we have -- and I'll remind you, as you're aware, we do have a number of variable expenses so where our expenses go partially driven by where our revenues go. But again, we're -- we'll grow revenue at least 2x expense growth.

Frank Joseph Schiraldi

Okay. And then just on credit, in terms of the NPA increase in the quarter, you mentioned the commercial finance side of it. Also it looked like the tax business, and I think you noted in the release, the tax business drove some of that. And it looks like it's mostly or all in 90 days past due and accruing at least for the tax stuff. And I'm just kind of surprised would think that at this point, you just write anything off that's still outstanding. And any color on that front?

Glen William Herrick

Yeah. We had a mix shift in our tax lending this year from our BaaS providers to more of the independents. And obviously, revenue is related to that, but also had higher loss rates, which we expected. So it's just somewhat of a mix shift there and then timing of IRS refunds when they do their drops and there's still some of them coming, but that's where we're at today. It just seems like the cycle has gotten pushed back later this year in a lot of the processes.

Frank Joseph Schiraldi

Okay. It just seems like based on where the reserves are on that business, it seems like you don't anticipate significant losses in this $5 million bucket that's in NPA now. Is that fair?

Glen William Herrick

That's fair. Yeah. I would not expect anything material from that.

Frank Joseph Schiraldi

And then if I could just sneak in one last one. As you -- I know you tend to have longer-term partnerships. So they -- I guess, you don't have a ton renewing every day. But in terms of the partnerships that have renewed, I'm just wondering, are you seeing better pricing? Are you seeing more narrow pricing given that we've seen some of these smaller banks entering the market? And to Brett's point, maybe over time, they get crowded out. But given that they're in now, is that kind of what you're seeing as partnerships renew, tighter pricing?

Glen William Herrick

Well, I mean, there's been pricing pressure, but it's probably been driven more by the rise in interest rates and the desire to focus on commission on deposits than anything else. And we don't -- like you said, we don't have a whole lot of these going on at a time. So we'll see how it rates up. But I would not say that we have experienced any benefit of what I think will be a wash out yet. We've experienced pressure on pricing somewhat because of the interest rate rise, which is all factored into our.

Brett L. Pharr

Yeah, it's in our guidance. Yeah.

Frank Joseph Schiraldi

Right. So you're basically seeing more of an ask on the depository side in terms of some sort of return there?

Brett L. Pharr

Yeah, that comes up. Now what we tend to do is there's a trade-off of fees paid versus commission on deposits, et cetera. And that's all part of the contract negotiations you go through. But again, we're predicting and feel solid about our guidance around expanding NIM and the result of that. So we're not too concerned about it.

Frank Joseph Schiraldi

Okay, great. I appreciate all the color and enjoy retirement Glen.

Glen William Herrick

Yeah. Thank you, Frank. I'll miss you.

Operator

I will now pass the line back to our CEO, Brett Pharr.

Brett L. Pharr

Thank you, everybody, for joining today. I do want to make one final comment. Today, in Washington, the Federal Reserve held a hearing on the debit card interchange fee calculations. And I want to remind everybody that by legislation, the only authority they have for that calculation relates to banks that are over $10 billion in asset size. And so there may be some confusion out there. I want to be sure we cleared that up that it's a small issue where we are not impacted by that proposed change in rule by the Fed. So I just want to make that clear. We appreciate everybody joining today and look forward to having direct conversations with you. Thank you.

Operator

That concludes Pathward Financial fourth quarter fiscal year 2023 investor conference call. Thank you for your participation. You may now disconnect your lines.