Earnings Call Transcript - CASH Q4 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Fourth Quarter and Fiscal Year 2021 Investor Conference Call. 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 your host Brittany Kelley Elsasser, Director of Investor Relations. Please go ahead.

Brittany Kelley Elsasser, Director of Investor Relations

Thank you. I would like to welcome everyone to the Meta Financial Group conference call and webcast, where CEO, Brett Pharr; President, Anthony Sharett and CFO, Glen Herrick, will discuss the results of our fourth fiscal quarter and year ended September 30, 2021. 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. 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 Meta’s filings with the Securities and Exchange Commission, including our most recent filing 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, I will turn the call over to Brett Pharr.

Brett Pharr, CEO

Thank you everyone for joining us this afternoon. Before we discuss the results for the fourth quarter and fiscal 2021, I want to thank Brad Hanson for his contributions to Meta for nearly 20 years. His efforts together with those of our team built the leadership position that Meta enjoys today. Under Brad's direction, Meta was an early entrant in the payments industry and pioneered banking as a service. During the period he was CEO, Meta expanded the range of financial services we offer to our partners, and the company significantly outperformed the S&P 500 and Russell 2000 Indices. Brad surrounded himself with talented executives and created a strong leadership team. We benefit from the deep bench of experienced and highly qualified senior level executives he attracted who are executing our strategy and taking the company forward. At the same time, I also want to recognize Brad's commitment to Meta’s mission of financial inclusion for all, which has powered our business and inspired our ESG and DE&I efforts. To facilitate a smooth transition, Brad will serve as a strategic adviser to Meta and the Board until the end of 2022. Brad will remain on the Meta Financial Group Board until the next annual stockholders meeting, which we expect will take place in February 2022. Having completed the leadership transition to Anthony and myself, our Board affirms that Meta’s corporate strategy and mission remain the same. Our strategy will continue to center around optimizing three key metrics; our mix of earning assets with an ongoing emphasis on growing our portfolio of higher return assets, maintaining a high percentage of lower cost stable core deposits, and continuing to improve operating efficiencies and simplify the way we run our business. Turning to our results, during fiscal year 2021, Meta generated revenue of $550 million, and net income of $141.7 million, or $4.38 per share. The fiscal year 2021 earnings per share represent an increase of 49% over fiscal year 2020. We are pleased to achieve a return on average assets of 1.74% despite the large cash balances held due to our participation in the U.S. government's economic impact payment program and a recorded return on average equity of 16.84%. Our banking as a service pipeline has never been stronger. And we serve as the backbone for financial technology companies and others who offer innovative financial services while supporting our established partners with their programs. We believe Meta is well positioned to continue generating value for all stakeholders as we execute our strategy and build upon our ESG and DE&I efforts. I’d now like to provide an update on our process to better align our credit administration policies with OCC guidance for national banks, which we discussed last quarter. During the fourth quarter, we completed our review of our loan portfolio and established a new baseline for portfolio metrics going forward. This resulted in the downgrade of certain credits in several categories. But these downgrades do not indicate a deterioration in these credits' expected performance. Further, these changes do not reflect an increase in overall credit risk for past or future periods and we do not expect any increase in losses as a result of these one-time administrative adjustments to risk ratings. I want to reiterate; our loan and collateral management practices have proven effective in managing losses through economic cycles over the last 20 years. Excluding approximately $1.5 million of professional expenses to assist with the comprehensive review of our portfolio and set this new baseline, the impact to our financial position is minimal. Following the end of the fourth quarter, we had a couple of positive developments, I’d like to brief you on. In October, we sold $30 million of legacy community banking loans to central bank and have agreements in place to sell approximately $161 million more. Following the sales, the legacy Community Bank portfolio will be less than $8 million, as these sales will wind down nearly all of our legacy community bank loan portfolio. Included in the loan sales are approximately $108 million of substandard and doubtful loans, of which $15 million are non-accrual loans as of September 30, 2021, representing 39% of substandard and doubtful loan and lease balances and 44% of non-accrual balances. We expect community bank balances to be zero at the end of the first fiscal quarter of 2022. This will mark the successful conclusion of the first phase of our ongoing effort to deploy our capital in higher return assets. The net pre-tax impact of the sales will be recognized in the first fiscal quarter of 2022 and is expected to be roughly breakeven. In summary, Meta performed well in fiscal 2021 as we recorded record earnings and executed efficiently on our strategy and made progress against our three key initiatives. We are well positioned as we head into the next fiscal year. Let me now turn the call over to our new President, Anthony Sharett.

Anthony Sharett, President

Thank you, Brett. And it's a pleasure to meet all of you in today's call. I look forward to talking with you in person in the quarters ahead. If I may, let me give you a brief introduction to my prior P&L and leadership roles. Prior to joining Meta in 2019, I served as President or acting President of business units at Nationwide Mutual Insurance Company. I led the transition of Nationwide Bank, which at the time was a $7 billion in assets institution, from a full-service direct to consumer bank to a trust-only charter. I was responsible for all the activities and business lines, including credit, risk management, operations, marketing, compliance, legal, and human resources, and developed a strategic roadmap and action plan for the transition, working closely with its Board of Directors. I then served as President of Nationwide Pet, the largest pet health insurer in the United States before transitioning to Meta. Previously, I was in private practice, most recently with the law firm of Baker and Hostetler, where I co-chaired its financial institutions practices group. Meta is a mission-driven organization. As we look forward to fiscal year 2022, we want to ensure that all decisions we make about new capabilities fit within our mission of financial inclusion for all, which continues to be our North Star. We will continue to work at increasing our efficiency, making our processes as straightforward as possible, so we can better serve our partners and customers. And we will focus on optimizing our interest earning asset mix in our core deposits, which results in better financial performance. Our board and management team believe Meta's strategy has much further to run and we are excited about these prospects. Glen, over to you to review our financial results.

Glen Herrick, CFO

Thank you, Anthony and good afternoon everyone. Let me briefly summarize our results. We achieved another quarter and a year of solid earnings. For the quarter ended September 30, net income totaled $15.9 million, or $0.50 per share, an increase of $2.7 million from the fourth quarter of fiscal 2020. For the fiscal year, net income totaled $141.7 million, or $4.38 per share, an increase of $37 million from fiscal 2020. Net interest income grew $20 million during the year to $279 million, an increase of 8% year-over-year, mainly attributable to the continued optimization of our balance sheet and higher loan balances. Non-interest income increased to $50 million for the quarter aided by strong payments fee income and an approximately $4 million gain on an equity investment. For the fiscal year, non-interest income grew 13% to $271 million, driven by strong payments fee income growth of 23%, which was aided by an increase in payments activity related to government stimulus programs. Non-interest income represented 49% of total revenue in fiscal year 2021. During the quarter, one of our banking as a service partners, MoneyLion, completed its de-SPAC process and became publicly traded on September 22. Meta, through our venture capital arm Meta Ventures, made a $3 million investment in MoneyLion in May 2019. As of September 30, we are recognizing a net unrealized gain of approximately $4 million on the investment. We hold approximately 950,000 shares of this public equity, which we will measure at fair value and recognize the mark-to-market adjustments in non-interest income while we hold the position. Non-interest expense grew $25 million to $344 million in fiscal 2021, while producing an improved efficiency ratio of 62.5%, as revenue growth exceeded expense growth. A large portion of the expense increase occurred in the fourth quarter, where total non-interest expense of $93.6 million increased $13.3 million year-over-year. During the quarter, Meta incurred one-time spend of $9 million related to investments in our technology and product stack to support future growth. Furthermore, the company recognized $1.3 million of expense associated with the CEO transition. Outside of these items, traditional expenses remained within historical levels, and we expect total expenses to be in the low $80 million range for the first quarter of fiscal year 2022. Turning to net interest margin, net interest margin continues to benefit from our approach to optimizing our balance sheet. During the quarter, we had strong loan growth, while we continue to optimize our loan mix away from lower yielding assets, evidenced by growth in the commercial finance portfolio. We are seeing momentum in our asset-based lending and factoring portfolios as the economy ramps up and there is renewed customer demand for working capital. These factors contribute to a robust commercial finance pipeline and we expect to see continued loan growth in fiscal 2022. The community bank loan sales are also a direct effort to optimize earning assets and, as Brett noted, we expect community bank balances to be at zero at the end of the first fiscal quarter of 2022. Turning to capital, in September, we announced that our Board authorized a new share repurchase program of up to 6 million shares of the company's outstanding common stock expiring on September 30, 2024. During the fiscal fourth quarter, we repurchased nearly 235,000 shares and have purchased an additional 636,000 shares in October through October '22. The Board's share repurchase authorization and recent purchases reflect the momentum of the business and confidence in the company's outlook and growth trajectory. The company remains well-capitalized with the regulatory leverage ratio for the bank increasing to 8.7% from 7.8% the prior quarter. This concludes our prepared remarks. Thank you all for joining us today. Operator, please open up the line for Q&A.

Operator, Operator

Certainly, we will now begin the question-and-answer session. The first question comes from Frank Schiraldi with Piper Sandler.

Frank Schiraldi, Analyst

I wanted to start with the expenses, Glen, you mentioned in the release, you mentioned on the call the $9 million in one-time expense, could you dive into that a little further in terms of what's in that one-time expense? And then, just any color on why it was taken all up front, as opposed to maybe being amortized over time?

Glen Herrick, CFO

Hi, Frank. Sure, there are certainly ongoing investments that we make and development efforts that we do that are capitalized and are amortized over time or ongoing projects. We saw some opportunities, really related to the strong pipeline and business opportunities that we saw, and felt it was worth making a larger investment in a shorter period of time. So we could be prepared to serve the customers that we want to serve. So you'll see a lot of it in the legal and consulting line, and then some other expense. So, think of contractors, consultants, staff augmentation type of expenses to pass through on a number of items.

Frank Schiraldi, Analyst

So this partially reflects a larger, FTE count, or is it generally?

Glen Herrick, CFO

No, in fact, yes, if you look at our compensation cost, it is down on a linked quarter. This is really external expenses that are one-time that we know, well, we've guided to where we think expenses will be next year, or next quarter in the low $80 million range back into our normal run rate. But we had an opportunity to prepare for the growth we see coming down the pipeline, and we wanted to push through that bubble and be able to serve more banking as a service customers in particular.

Frank Schiraldi, Analyst

Okay. And then, in terms of the timing of it, with Brett taking over the CEO spot, this in some ways reflects a change in thinking about consulting fees versus FTEs or, is this timing just coincidental?

Brett Pharr, CEO

Yes, Frank. This is Brett. I think it's purely coincidental. As it relates to our sort of strategy and our approach and even some of the deeper tactics around banking as a service. There's no change and we are completely aligned. What we're seeing is just a continual ramp-up of revenue opportunities. And we felt like we needed to do some things quickly to be prepared to handle the additional volume that's coming our way. So that's purely what it was, had nothing to do with the CEO switch. In fact, a lot of this was already in place before the CEO switch was being announced. So we've been talking about these things for a time and that's the reason we decided to invest in the quarter.

Frank Schiraldi, Analyst

Okay. And then, just thinking about, you mentioned Glenn, you guys gave your expectations for first quarter expenses. Wondering if you can give any color, I think I would expect in terms of bottom-line growth year-over-year kind of 2021 creates some tough comps, just given what a strong year it was. But any color you can provide either in 2022 expectations, or maybe even beyond that just thinking about the payments niche, you guys have created in banking as a service, and the moat, as far as other banks taking advantage of it. So maybe, either some guidance for 2022, or even just your expectation of what the core growth rate could be in this business, bottom-line coming over the next couple of years.

Glen Herrick, CFO

We are not offering specific guidance at this time, but we continuously discuss our strong pipeline in both payments and commercial finance. It's important to note that in payments, predicting the timing with larger partners and program managers can be challenging due to the necessary upfront investments and the time needed for customer acceptance. This makes predictions a bit difficult. However, if we consider a three to five-year outlook, we are optimistic about achieving double-digit earnings per share growth over an extended period.

Operator, Operator

Thank you, Mr. Schiraldi. The next question comes from the line of Steve Moss with B. Riley Securities.

Steve Moss, Analyst

Maybe just following up on Frank's line of questioning in terms of growth here. Card fees. I understand you had obviously some extra momentum in the prior quarters numbers but figure this is probably a good baseline. How are you guys thinking about the growth in terms of revenue there in fiscal '22?

Glen Herrick, CFO

Yes, hi Steve. We expect that the growth rates for payments fee income will be lower year-over-year unless there is a significant increase in government stimulus. The decline we experienced in fiscal year '21 was largely due to a reduction in our cash fee income, which was impacted by government stimulus measures that directed funds to consumers who might have otherwise used our tax products. We anticipate a return to normal conditions, and under those circumstances, payments fee income will likely not see as much growth. However, we are hopeful for a substantial increase in our tax fee income in 2022. If the government introduces additional stimulus programs, such as extending child tax credits or other social initiatives, we may see ongoing strength in payments income, with potentially less growth in tax income. There is a natural hedge in having both areas of the business to offset government stimulus impacts, and it appears to have worked out that way.

Steve Moss, Analyst

Okay, fair enough. In terms of the robust loan pipeline for commercial bank loans, I'm curious about your expectations for robust, double-digit growth for fiscal '22. Have you encountered any supply chain issues or disruptions within your line of business? I'm looking for more insight into the drivers behind this growth.

Brett Pharr, CEO

This is Brett. I think your double-digit growth rate is a good place to look. It's consistent across many of our asset classes, so feel pretty good about that. The interesting thing, particularly in our working capital areas, factoring and asset-based lending, we have pretty good insights into what's actually happening moment by moment, and we're seeing good growth there. It is a highly diversified set of customers, so we're not seeing any impact from the supply chain pieces that are slowing things down for us. Our customers seem to be going pretty well and are not experiencing that; there may be one or two very specific pockets where that's happening, but we're not having supply chain issues at all.

Steve Moss, Analyst

Okay. So that's helpful. And then maybe just one last one for me, excluding tax on the provision line here, just kind of think about the provision more or less matching charge-offs going forward. Just kind of curious as to how you guys are thinking about that dynamic?

Glen Herrick, CFO

I think that's fair depending on our loan growth rates, and then obviously, what the seasonal factors are for every bank we use some of the similar services. Seasonal factors are starting to come back down, so that will be a tailwind to the provision. Our headwind would be just loan growth and having to provide upfront for larger amounts of loans. But we would expect overall lower provisioning numbers than we've had in the past.

Operator, Operator

Thank you, Mr. Moss. The next question comes from the line of Michael Perito with KBW.

Michael Perito, Analyst

I apologize for going over the $9 million again, but I'm not completely clear on what this amount was spent on. To rephrase my question, I understand this is classified as a one-time technology expense, but it seems more related to consulting and legal matters. Could you provide a more detailed breakdown? Were there platform upgrades involved? Did you seek additional opinions on certain technology or compliance protocols? I'm just trying to gain a better understanding of how the money was allocated.

Glen Herrick, CFO

Yes, it was all that, Mike. It involved some extra consulting and services to help us analyze a few things we had been planning for. The opportunities arose faster than we were prepared for, and our existing team's capacity was stretched due to other responsibilities. This included a lot of technology, staff augmentation, and consulting, as we were considering how to scale this product or area significantly. These elements came together this quarter. As Brett mentioned, they were in progress and part of the overall plan we aimed to execute under his leadership, with no disruption during the transition.

Michael Perito, Analyst

Is the situation changing because the pipeline has been quite strong in the bank as a service business for a while? Are the types or sizes of companies becoming more complex, or is it just that the quality of the companies in the pipeline is improving, leading you to feel like you might be missing out on valuable business due to a lower close rate, or is it something else?

Glen Herrick, CFO

It's all of that, Mike, anywhere from what's the onboarding time and experience like versus some of the things you said, how do you scale up, do we just keep adding FTE and compensation? Our compensation expenses have increased a lot over the last few years. Now our revenue has grown faster than that, but we thought there were opportunities to get even more scale and we wanted to break through it. Now, we wouldn't be making these investments if we didn't think there is a return on them. And I would also point that we're managing this and you can see that in our guidance of expenses returning to the low $80 million in the December quarter.

Michael Perito, Analyst

Yes, okay. No, that's helpful. Thanks for spending an extra minute on it.

Glen Herrick, CFO

Yes, we knew it was an outlier, and that's why this is one instance; we thought we just want to be very clear and put a stake in the ground of what our expenses are going to be here in the December quarter.

Michael Perito, Analyst

The mix of the BaaS business still leans heavily towards prepaid revenue, which I believe you mentioned is about 79% according to the slide deck. I wanted to hear any broader comments you might have. It seems that the growth momentum in prepaid has slowed down, and there are significant member growth opportunities with checking-oriented debit card neobank platforms. Does your pipeline indicate this? Are there more opportunities, particularly with debit-focused clients, such as sponsor credit cards, compared to the more traditional prepaid model, which had limited sources of revenue? I'd appreciate any thoughts you might have on this.

Brett Pharr, CEO

Yes, this is Brett. I believe you're categorizing it correctly. The neobanks are looking to provide a wider range of financial products for their customers, and we're involved in those efforts. A lot of it revolves around remittances and various types of payments, as well as potentially broader consumer products they are discussing with us. This is likely to develop further, and the good news is that, in many cases, these can generate fee income rather than relying heavily on our balance sheet. We are likely to observe an increasing blend of these developments. However, predicting the pace of this transition is quite challenging, which complicates our modeling efforts. Nonetheless, it's a clear trend; I recently returned from a conference where this was the main discussion topic—implementing banking as a service across many additional products in which we are participating. So, you will see this mix shift, though I can't provide a specific timeline for how quickly it will happen.

Glen Herrick, CFO

Hence some of the reasoning behind the investment that we wanted to get moving on.

Brett Pharr, CEO

Investment, that's right. Yes.

Michael Perito, Analyst

Got it, okay. And then just lastly, I apologize if I missed this. But just would love an additional comment on kind of the buyback appetite from here. I mean, you have some room on the authorization, the stock has obviously had a nice move and the valuation has kind of moved up a bit. But just, if you don't mind just making a specific comment or just more broadly refreshing us on kind of how you think about buybacks as a form of capital deployment, that'd be great?

Glen Herrick, CFO

Yes, we continue to believe we're going to generate excess capital for the foreseeable future. And our best opportunities are still with the platforms we have, making those more efficient, making them more scalable. And, but our earnings ROA is 1.75, and we're only going to head up from there. We're holding the balance sheet flat. And so with that excess capital right now, management and the board believe the best use of that is to repurchase shares, providing the best value for our shareholders. A lot of factors go into that as you can assume, including what we think our outlook is for not only '22's earnings, but '23 through '25 and beyond. And so we're very comfortable buying shares at today's price.

Michael Perito, Analyst

Great. Thank you, guys. Appreciate it.

Operator, Operator

Thank you, Mr. Perito. The next question comes from the line of Wally Wallace with Raymond James. You may proceed.

Wally Wallace, Analyst

Hi. Following up on Mike's questions about the expected growth from the banking as a service segment, we're seeing an increase in press coverage regarding new entrants. I'm curious if the competitive landscape is shifting. Are you noticing more smaller banks trying to leverage their charters to capture business from you and other larger competitors, or do you believe that you and Bancorp essentially have a strong hold on this area due to the regulatory challenges?

Brett Pharr, CEO

I think, in many ways you partially answered your own question. I would say, the regulatory requirements and also the operational history, we've got a long history of doing these things, learning how to do them well and building a talent base, based on clear pathing capabilities internally should allow us to constantly win in this marketplace. Are there going to be people who dip their toe in it? Yes, they will and then most of them will get in trouble and they'll get back out. So very few competitors really at the end of the day; there are two of us. Others that come in are going to be short-lived or they're going to have to invest a whole lot to be able to do it. So I'm not worried about it. I think now, as sort of the neobanks are coming in and the market is expanding into other products, it just positions us in a better place to be able to not provide them just the prepaid sponsorship pieces, but all the other components that you bolt on with it as they want to serve their consumers. So I think you've got it right; it's just pretty tough for others to play.

Wally Wallace, Analyst

I mean, did the regulators make that clear to others or is it you have to find that out the hard way?

Glen Herrick, CFO

Yes. And what I would say, Wally is, we've never had more opportunities than we have today. So yes, clearly there's some banks doing some good stuff and Bancorp is obviously very capable, but our pipeline has never been stronger.

Wally Wallace, Analyst

I apologize if I missed this in the release, but how much of the EIP deposits are remaining on the balance sheet? Based on the cash balances, I’m guessing there may not be much left. Additionally, do you believe you are close to the optimal asset size range right now, considering the chance to adjust the earning asset mix?

Glen Herrick, CFO

Yes, I think in our investor deck we talked about some of the balances. I mean, we don't have many left from EIP. We have moved some balances off-balance sheet in partnership with some other banks that we've developed this year, and that seems very efficient and will help us going forward. Yes, $6.5 billion is a kind of a good number for us. It will move up and down between $6 billion and $7 billion just given the flows of some of our money movement business. Outside of tax season, February and March will be larger than that. But we think we can run this plus or minus $6.5 billion for a couple of years when you look at how we want to remix the left-hand side of our balance sheet.

Wally Wallace, Analyst

Okay, great. That's helpful. And then just one last, just kind of stinky question. But what was the nature of the insurance recovery? I think you said student loan insurance recovery, and is that something that could recur?

Glen Herrick, CFO

You'll remember that a number of years ago, we purchased student loan portfolios that were insured by a private insurer. Unfortunately, that insurer became involved in some unrelated issues and eventually went bankrupt or was liquidated by the state insurance regulator in South Dakota. As a result, we now classify those as unsecured loans. Over time, we have received some claims back from that situation. The state is finalizing its processes, and we received another claim this quarter. We may expect one more claim, but it is unlikely to be significant. We anticipate getting one final claim before the state concludes its activities.

Wally Wallace, Analyst

Okay, yes, thanks for refreshing my memory, I do remember that now. That's all my questions. I appreciate your time.

Operator, Operator

Thank you, Mr. Wallace. There are no additional questions waiting at this time. That concludes the Meta Financial Group fourth quarter and fiscal year 2021 investor call. I hope you all enjoy the rest of your day.