Earnings Call Transcript
PATHWARD FINANCIAL, INC. (CASH)
Earnings Call Transcript - CASH Q2 2022
Operator, Operator
Ladies and gentlemen, thank you for standing by, and welcome to the Meta Financial Group Investor Conference Call for the Second Fiscal Quarter of 2022. During the presentation, all participants will be in a listen-only mode. Following the prepared remarks, we will conduct a question-and-answer session. As a reminder, this conference call is being recorded. I would now like to turn the conference call over to Justin Schempp, Vice President of Investor Relations and Financial Reporting. Please go ahead.
Justin Schempp, VP of Investor Relations and Financial Reporting
Thank you. And welcome everyone to the Meta Financial Group’s second fiscal quarter of 2022 conference call and webcast. Our CEO, Brett Pharr; President, Anthony Sharett; and CFO, Glen Herrick will discuss our operating and financial results, after which we will take your questions. Additional information, including the earnings release and investor presentation may be found on our website at metafinancialgroup.com. As a reminder, our comments may include forward-looking statements. These 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 statement. Please refer to the cautionary language in the earnings release, investor presentation, and in Meta’s filings with the Securities and Exchange Commission, including our most recent filings for additional information, covering factors that could cause actual results to differ materially from the forward-looking statements. Additionally, today, we may be discussing certain non-GAAP financial measures on this conference call. References to non-GAAP measures are only provided to assist you in understanding Meta’s results and performance trends. Reconciliations for such non-GAAP measures are included within the appendix of the investor presentation. Now, let me turn the call over to Brett Pharr, our CEO.
Brett Pharr, CEO
Thank you, everyone for joining Meta Financial Group's second fiscal quarter 2022 earnings call. I want to begin by referencing the exciting news of our new name, Pathward Financial, which we announced last month. Pathward is born out of our company's purpose to power our financial inclusion for all and our commitment to providing a path forward to people and businesses so they can reach the next stage of their financial journey. The name reflects our dedication to removing barriers that prevent millions of Americans from achieving access to the financial system and will serve as a constant reminder of our mission to create a path forward for the unbanked, under-banked, and under-served to help them achieve economic mobility. We will make some changes immediately to integrate the Pathward name and work with our partners in the coming months to ensure a successful transition for each of them. We will complete the transition to Pathward by calendar year-end including the launch of a new brand identity and website. Until then we will continue to serve our customers under existing brand names. During the second quarter, we recognized $2.8 million of pretax expenses related to these rebranding efforts and we continue to estimate our total rebranding expenses to a range between $15 million to $20 million. Turning now to our financial results for the second quarter, net income was $49.3 million, down $9.8 million compared to $59.1 million in the prior year. Earnings per share for the quarter was $1.66 as compared to $1.84 in the prior year. Our income taxes and tax rate were up significantly compared to last year, as uncertainty around government infrastructure funding and supply chain constraints delayed the development of renewable energy projects in our pipeline. While this is beginning to return to normal, our fiscal 2022 tax rate will be higher than expected. In addition, the 2022 tax season results had mixed results. Year-over-year total tax product revenue was up slightly, while total tax services product expense was approximately flat. However, we believe child tax credits and excess liquidity from various stimulus programs reduced our expected year-over-year increase for our taxpayer advanced product. Otherwise, the balance of our businesses posted good results. Our commercial finance portfolio saw continued healthy loan growth from satisfying the robust demand of small and medium-sized businesses for credit. We believe our collateralized commercial finance portfolios are especially well-positioned for any potential down economic cycles, as they have demonstrated during prior cycles. Our core banking-as-a-service business continues to grow, with increased activity from both new and existing partners, and our pipeline of opportunities remains strong. Looking ahead, we are optimistic about the prospects of a rising rate environment. Our low cost of funds deposit base, combined with the mix of our earning assets, position Meta for meaningful interest income growth under a rising rate scenario. Now, let me turn the call over to our President, Anthony Sharett to provide updates on our lines of business.
Anthony Sharett, President
Thank you, Brett. During the quarter, we have further refined how we innovate and co-create with our partners and clients across our businesses to foster and deepen our relationships. We remain focused on executing on our strong pipeline of banking-as-a-service opportunities, building out new and enhanced products and capabilities to serve a broad variety of Fintechs, Neobanks, Challenger banks and others wishing to offer banking services through their distribution channels. Turning to commercial finance, we were pleased with how well the division performed during the quarter. Our commercial finance loan portfolio totaled $2.9 billion at March 31, an increase of 4% on a linked-quarter basis, and a 16% increase year-over-year, reflecting growth across our product lines. We continue to see strong demand for our commercial credit with a healthy pipeline of loans and leases. Total non-performing loans and leases as a percentage of total loans and leases improved 21 basis points from the prior quarter to 0.95%. The allowance as a percentage of loans and leases increased from 1.84% in the prior quarter to 2.38% in the current quarter due to the increase in the seasonal reserves for the tax service loan portfolio. Excluding the reserves for tax loans, reserves dropped from 1.84% to 1.59%, primarily driven by a reduction in commercial finance specific reserves. As the portfolio remains healthy. Overall, net charge offs for the quarter were $11.2 million, primarily attributed to the charge offs on two commercial finance relationships. Let me briefly touch on today's macro-economic environment. Historically, our commercial finance portfolio has performed well during recessionary cycles in periods of economic stress, both as it relates to demand as well as credit losses. In fact, we found such periods have opened up further opportunities for us in particular for our working capital lines, such as asset-based lending and factoring. Lastly, I want to highlight the continued progress in our environmental, social, and governance efforts. Earlier this week, Meta published its second annual ESG report. In addition to detailing our Community Impact Program and our diversity, equity, and inclusion initiatives, it contains enhanced quantitative reporting, which we will use to measure our ESG progress. Now, let me turn the call over to Glen Herrick, our CFO to provide an overview of our financials.
Glen Herrick, CFO
Thank you, Anthony and good afternoon everyone. Net income for the quarter ended March 31st totaled $49.3 million, or $1.66 per share, a decrease of $9.8 million from the second quarter of fiscal year 2021. Excluding $2.8 million of rebranding expenses and $900,000 of severance expenses, our adjusted net income for the second quarter net of taxes was $52.1 million. The second quarter's net interest income of $83.8 million represents a 13% increase from the prior year's $73.9 million. Net interest income benefited from strong and long lease growth, favorable shifts in our earning asset mix, and additional tax loan interest. Quarterly average loans and leases grew $124 million or 3% compared to the prior year, driven by growth across our operating units, which was partially offset by the sale of the remaining community bank portfolio, lower average tech services loans, and Payment Protection Program loan pay downs. Continued balance sheet optimization combined with the reduction in excess cash from stimulus payments helped improve the second quarter net interest margin to 4.8% compared to 4.59% in the linked-quarter, and 3.07% in the prior year. Non-interest income of $109.8 million is down slightly from the $113.5 million recorded in the prior year. Payments fee income was $26.3 million, declined from $29.9 million in the second quarter of fiscal year 2021, which was inflated due to several rounds of stimulus payments. Core payments and deposit fee income remained strong. In addition, the quarter's non-interest income included a $1.3 million loss on the MoneyLion investment during the second fiscal quarter, Meta sold the entirety of its equity investment in MoneyLion. In total, we recognized a cumulative loss of approximately $400,000 on the investment dating back to the fourth quarter of fiscal 2021. This sale is in no way a view on MoneyLion's future and we continue to serve as MoneyLion's banking-as-a-service partner and anticipate growth in this relationship in the years ahead. Net total tax services product income, net of losses, and direct product expenses was approximately flat for the quarter. Fiscal year-to-date, it was up 6% over the prior year. Refund advance originations for the 2022 tax season were $1.83 billion as compared to $1.79 billion last year. We expect refund transfer volumes and product income for the overall tax season to end the season similar to last year. We also expect taxpayer advanced volumes to return to more normalized levels in the 2023 tax season, absent further stimulus or additional changes to tax credit payments. Non-interest expenses increased 7% year-over-year, excluding the $2.8 million of rebranding expenses and $900,000 in separation costs, core expenses of $99.5 million increased 4% from the prior year. The year-over-year increase in expenses reflects additional spending supporting the company's growth as well as overall compensation and other inflationary pressures. Income tax expense increased to $8 million for the quarter, representing an effective tax rate of 13.8% as compared to $1.1 million, with an effective tax rate of 1.9% for the prior year. As previously noted, the increase was due to a reduction in renewable energy investment tax credits. When comparing to the prior year period, we repurchased 736,000 shares during the quarter at an average price of $57.01. As of March 31, we have 4.9 million shares remaining under the current repurchase program. At the end of March, we submitted the necessary notifications of our intention to retire our floating rates subordinated debt of $75 million at par in order to reduce interest expense, which is now set for redemption on May 15, 2022. The company remains well capitalized, with a regulatory leverage ratio for the bank of 7.8%. As a reminder, our March quarter leverage ratios are seasonally lower as a result of the higher average assets during the tax season. When using end of period assets, the bank's leverage ratio was 8.9%. That concludes our prepared remarks. Operator, please open up the lines for questions.
Operator, Operator
Yes, thank you. Our first question comes from Frank Schiraldi with Piper Sandler. Frank, your line is now open.
Frank Schiraldi, Analyst
Hey guys.
Brett Pharr, CEO
Hey, Frank, how are you doing?
Frank Schiraldi, Analyst
Good. How are you doing?
Brett Pharr, CEO
Good.
Frank Schiraldi, Analyst
Well, just starting with the card fee income. I wonder if it would be possible just given the pipeline you guys have currently. And then considering the stimulus last year and year-over-year limitations from that. Any color you can provide in terms of where you expect that to trend for the remainder of the fiscal year?
Brett Pharr, CEO
Hey, Anthony, why don’t you talk about our business pipeline, and then Glen you might just give him any information on the fee income specifically?
Anthony Sharett, President
Sure. Thanks Frank. As you noted, fiscal year 2021 was elevated due to the numerous rounds of stimulus. So, we certainly recognize that. Going forward, we expect continued growth from both existing and new partnerships with a focus on fee income generating opportunities. So, our pipeline remains strong. Glen?
Glen Herrick, CFO
Hi, Frank, what we would expect, as you know, the March quarter is seasonally our highest quarter of card fee income, not only for our activities and directly in the tax space, but many of our partners have customers that love their tax refunds on their card. So, we would expect card fee income to be a little lower in the coming quarters compared to tax season, but then reset that base for growth from there.
Frank Schiraldi, Analyst
Okay. Regarding expenses, I noticed the rebranding efforts mentioned in the release. Was there anything else aside from the tax business that temporarily increased expenses? I'm also curious about the expense base and any insights on where it might settle in a more typical quarter.
Brett Pharr, CEO
Yes, Frank, of course, we reported the amount that was associated with the rebrand. I'll tell you we're experiencing inflationary pressures like everybody else in some of these categories, particularly around compensation and some of our particular disciplines are hot right now and so some of that has to do with the inflationary pressures there.
Glen Herrick, CFO
And, Frank, we also noted, we have $900,000 of separation expense this quarter.
Frank Schiraldi, Analyst
You have the separation expense, the rebranding costs, and there is a considerable amount that impacts this quarter due to the tax season. Is that correct?
Glen Herrick, CFO
Sure. Comp expense will be lower the next three quarters.
Frank Schiraldi, Analyst
Okay, so I guess I'm thinking about the comparison from the December quarter, which is at a better run rate than something in March.
Glen Herrick, CFO
It's a good starting point. We'll see how things develop. As Brett mentioned, there's a lot of pressure on compensation, and given our history in banking-as-a-service, there is considerable pressure on our staff, especially as new entrants in this market seek talent.
Frank Schiraldi, Analyst
Sure. I noticed something in the model that caught my attention regarding the tax services. The yield from tax services in the quarter was significantly higher than the same period last year. Could you discuss why those yields were so much higher year-over-year, especially since this is primarily an issue we see in the March quarter for the tax business?
Glen Herrick, CFO
One of our tax partners, there was a new product or sub-product that had an interest component to it. I have not been there.
Frank Schiraldi, Analyst
So, I mean, I guess, thinking about next year, as we do our modeling for next year, it's not unreasonable to assume that that product would be back again. It's not a temporary blip, I guess.
Glen Herrick, CFO
No, that's not temporary.
Frank Schiraldi, Analyst
Could you provide an update on the $1.85 billion in customer deposits at other banks mentioned in the release? I assume this is still related to the direct stimulus, but have you expanded these to include additional partnerships?
Brett Pharr, CEO
Yes, Frank, one of the things that we learned through the stimulus program is really how to better exercise our deposit transference capability, which is what you're talking about. And we continue to expect to maintain a flat balance sheet. And the way we'll do that and still generate meaningful growth and card fee income, is by increasing our use of deposit transference. So, I don't know that we have disclosed any numbers on it, but not all those deposits that are off the balance sheet are stimulus related.
Frank Schiraldi, Analyst
Okay, great. Well, I'll let someone else jump in and ask a question. Thanks guys.
Brett Pharr, CEO
Thank you.
Operator, Operator
Thank you, Frank. Our next question comes from Michael Perito with KBW. Michael your line is now open.
Michael Perito, Analyst
Hey, good afternoon, guys.
Brett Pharr, CEO
Hey, Michael.
Michael Perito, Analyst
Regarding the tax season, I believe you mentioned in the release that you anticipate total season revenues to be similar to last year. My specific question is about last year's fiscal third quarter, where you had significantly higher refund transfer volume than usual. There may have been some delays at that time. It feels like a long time ago, so it's hard to remember. Essentially, I want to confirm if I'm understanding correctly that a similar situation might happen again this year.
Brett Pharr, CEO
Hey Glen, why don’t you take that?
Glen Herrick, CFO
Sure. Hi, Mike. We are talking about net tax business earnings. We are 6% ahead of last year year-over-year. But to address your specific question, we think that will contract a little bit because last year, while we will still have some carryover into the third quarter, there was a higher percentage of carryover last year in the third quarter due to more delays on a relative basis than the delays this year by the IRS.
Michael Perito, Analyst
Got it. Okay. So, you're referring to something more similar to the fiscal third quarter of 2020 rather than the unusually high fiscal third quarter of 2021. Not to imply that this will be the exact level, but that's the general direction.
Glen Herrick, CFO
Yes.
Michael Perito, Analyst
Yes, I understand. Great. Regarding the margin, I noticed in the presentation that you have the updated parallel and ramped shock. Given the current dynamic rate environment, Glen, could you share your thoughts on how we might progress from the 478 or the 441 today? Specifically, if we encounter a situation with a 50 basis point hike in May, I would like to clarify if my understanding is correct. It seems that with your funding, you might experience less diminishing returns as we go further into the tightening cycle. Would you anticipate maintaining your benefits per hike at a better rate than other banks, whose deposit betas could increase as interest rates rise? Does that make sense? Also, can you provide any insight into where the net interest margin might head based on the current consensus outlook on the forward curve?
Brett Pharr, CEO
Mike, this is Brett. I believe you described the situation accurately. We need to undergo a brief repricing period. Although variable rate transactions and short duration items should adjust more quickly, it still requires some time. Your description highlights that this is our optimal moment since interest rates are increasing. Unlike others, we stand to gain significantly from rising rates, and we will experience substantial benefits from it. However, most of these advantages will manifest in fiscal year 2023 and beyond due to the time it takes for repricing, even for short duration instruments.
Glen Herrick, CFO
And then, Mike, I would add specifically that we talked about 4% in the ramp model, and we're comfortable with that at 100 basis points. As Brett mentioned, it all depends on where the demand is. For us, it's less about the deposit beta and more about the loan pricing beta, as well as where competition goes, how quickly the liquidity decreases, and how other banks or finance companies respond. But it should certainly be a net positive for us.
Michael Perito, Analyst
Lastly, regarding the non-tax related charge-offs in the quarter, I noticed in the presentation that there were a few factoring relationships that you charged off. Could you provide more details on that? Additionally, any comments on credit as you look ahead? There are growing concerns about the deterioration of consumer and small business health later this year into 2023. What are you observing on this front?
Brett Pharr, CEO
Yes, so it's a good question. So, we have a very robust collateral management process. That is the last part of your question, as we go into a recession benefits from two things. One is, we will have much more control of collateral and therefore, any potential losses. Secondly, particularly our working capital lines, are going to get the opportunity to grow quite a bit because others will be fleeing traditional banks. And they'll need our collateral managed process, which, throughout multiple cycles has done extremely well with very low loss rates. What happens in some of these is everyone saw you get a one-off. And we got a couple of one-offs through this. But there's the portfolio is very strong, it's performing well. All of our collateral management controls are executing as they have been for a decade in that business. So, even as we enter into what could be a recessionary environment, we're very confident about the control environment we have there.
Glen Herrick, CFO
And I would add our non-performing loans are a low point of the last 18 months.
Michael Perito, Analyst
Great. Thank you guys for taking my questions. Appreciate it.
Brett Pharr, CEO
Thank you.
Operator, Operator
Thank you, Michael. There are no further questions in the queue. Our next question comes from Steve Moss with B. Riley Securities. Steve, your line is now open.
Steve Moss, Analyst
Good afternoon, everyone. I'm not quite sure what happened there. I wanted to touch on your expectations for taxes in the upcoming season. I'm a bit surprised by the weakness we're seeing. We've experienced significant inflation over the past nine to 12 months, and while I know there was stimulus, I'm curious about what gives you confidence that we will see a rebound next year. I had thought that the higher inflation would have impacted consumers more, leading to better demand.
Brett Pharr, CEO
Hey, Glen, you want to take that?
Glen Herrick, CFO
Yes. Steve, are you talking to specific like that the tax rate and the investment tax credits or are you talking about no card activity?
Steve Moss, Analyst
The refund advanced product?
Glen Herrick, CFO
The refund advances. A significant portion of the customers served by our partners in the tax business are those who receive earned income tax credits, which provide them with substantial refunds each year. This year's refunds were lower on average due to the child tax credits issued throughout 2021. Consequently, our payment processing product for tax payments performed well and is expected to see some year-over-year growth. However, the refund advances, which are more closely linked to the refund amounts, remained largely unchanged compared to the previous year, even though we anticipated they would be higher this year.
Steve Moss, Analyst
Okay, that's helpful. I just appreciate that clarity there. And then maybe just on the changing environment here with rates moving kind of curious. I mean, obviously, you guys benefit from rate hikes. Just kind of curious, are you seeing any changes in loan pricing already here? Just given, moves in the curve and if there's any dislocation, that's already creating some maybe some extra activity for you guys?
Brett Pharr, CEO
Yes, so a couple things. One, obviously, variable rate items that did not have floors. Now, some of them do have floors, but ones that have floors, obviously, we're getting more on it right now. So, I think that's going on. There still is excess liquidity out there. So, particularly on some of the fixed rate stuff, we're seeing some pricing that we're not willing to chase. So, you might see that more in like the leasing portfolio, et cetera. The last thing I would say is, the migration out of banks, traditional lenders is already starting. We are looking at more ABL deals, dollars-wise than we have in a long time. And so we're going into those and picking and choosing which ones that we want to do that meet our credit profile, and our pricing profile. We think that's just the beginning, as rates have their impact and goes to the economy, I think we'll get a lot more opportunities to grow the working capital. If you look at our asset based lending and factoring line growth over the last 12 months link quarter, it's already had significant growth, but most of that was through same client additional sales, post COVID. Now we're getting new lines, but on the books as well. So, I expect to see that line to be growing quite a bit over the next few quarters.
Steve Moss, Analyst
Thank you for the information. Regarding the pressures on the system, I'm interested in how we should approach reserve modeling going forward with CECL. Is this potentially the lowest point for reserves, and what are your thoughts on that?
Brett Pharr, CEO
Glen, I'll let you take that one.
Glen Herrick, CFO
Yes, hard to predict, Steve. If this recession actually occurs or not, certainly that's where bets are going. If you're a bank investor, it seems like everyone's assuming there's going to be a recession. And even if there is some pullback in the economy, given that we still haven’t unwound all our COVID pandemic CECL factors, I wouldn't think this would be a bottom necessarily, for us at all. In fact, again, depending on how bad it gets, there could still be some room for us to bring down allowance levels, but I wouldn't expect them to head higher from here unless things get really bad.
Steve Moss, Analyst
Could you please share the duration of the securities portfolio? I'm interested in your thoughts on cash flows and the current reinvestment rate, especially considering the increased customer demand. We might want to keep in mind the ongoing adjustments to the loan mix.
Glen Herrick, CFO
Yes, we plan to remix again this year. Our duration is around four to four and a half years, and we hope to have absorbed the majority of the OCI impact, targeting the five-year measure. We are also positioned to amortize over $30 million a month, and we have several variable rate securities that we could liquidate as our commercial finance portfolio expands.
Steve Moss, Analyst
Okay. And then lastly, I’m curious about your willingness to buy back the subordinated debt going forward.
Brett Pharr, CEO
Yes, I mean, obviously, we talked about the sub debt. We have to remember, as I alluded to earlier, we're going to manage as best we can to a flat balance sheet, which means unlike other financial institutions, we don't have to grow capital to grow income. And so as it is available, we will distribute it to our shareholders in a tax efficient way. And right now, the best way for that to happen is through stock buybacks when we can.
Steve Moss, Analyst
All right. Thank you very much. Appreciate all that.
Operator, Operator
Thank you, Steve. Our next question comes from William Wallace with Raymond James. William, your line is now open.
William Wallace, Analyst
Thank you. Hi, everyone. I have a question regarding your loan growth, which seems to be a bit lower than I expected based on industry trends. It appears that consumer products may be experiencing slower growth. Is this something that is intentional, or is it simply how things are at the moment? Could you provide more insight into the loan growth and how it aligns with your expectations?
Brett Pharr, CEO
Yes, I mean, I'd hit a few things depends on which line you're looking at. But if you'd look linked-quarter to linked-quarter, remember, we're down to 150 million in PPP loans from a year ago, we got rid of the entire community bank portfolio, which is document and presentation, which was pretty big. And last year, the tax refund pay downs came slower. And so you know, you had a little bit more of a hangover there. So actually, we cleaned all that up. Total loans, we had a pretty good growth rate.
William Wallace, Analyst
Well, I guess I'm looking at it on a sequential basis in the fourth quarter, excluding the community bank impact, it looks like you are growing in the 20% annualized, and then in the fiscal first quarter, it looks like it was even in the 30% annualized. And this looks pretty clean to me, it's low single-digits. So that's where my question is. Questions being derived from, it's really more sequential than year-over-year.
Brett Pharr, CEO
Yes, Glen, anything you want to add to that?
Glen Herrick, CFO
No, I mean, there's some seasonality in some of commercial finance, we're never targeting 20%-plus loan growth, so I think annualized will be in the mid-teens, as we talked about off of a larger denominator in our commercial finance and so it's what's we expected, consumer we're not in a rush, a lot of those are forward flow commitments. And so depending on the timing of the sales, those will move up, up and down, we're never going to hold a lot of consumer loans on balance sheet. And then you've got various timing in your government guaranteed, your SBA loans as well. So, we're happy with commercial finance loan growth, and we're very optimistic about opportunities there over the next couple of quarters for sure.
William Wallace, Analyst
Okay, do you all look for other avenues to deploy liquidity into other higher yielding assets other than your commercial finance business? Is that you know, maybe credit sponsorship or with some of your Fintechs or anything like that?
Brett Pharr, CEO
Go ahead, Glen.
Glen Herrick, CFO
Our consumer credit products are essentially focused on banking-as-a-service partnership lending. We aim to be more than just operating a charter, and we believe we've demonstrated that by introducing various capabilities and products. Our warehouse finance portfolio allows us to allocate liquidity into very attractive risk-adjusted returns compared to the securities portfolio. As our commercial finance loan portfolio expands, we'll leverage this flexibility. So yes, Wally, we are optimistic about our growth in commercial finance loans and see opportunities in the coming quarters.
William Wallace, Analyst
Okay. I appreciate that. That's all I had. I'll step out. Thank you.
Glen Herrick, CFO
Yes. Thanks.
Brett Pharr, CEO
Thanks, Wally.
Operator, Operator
Thank you, and that concludes the Meta Financial Group second quarter fiscal year conference call. Thank you for your participation. You may now disconnect your line.