Earnings Call Transcript - CASH Q2 2025

Operator, Operator

Ladies and gentlemen, thank you for standing by and welcome to Pathward Financials’ Second Quarter 2025 Earnings 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 like to turn the conference call over to our host, Darby Schoenfeld, Senior Vice President of Investor Relations. Please go ahead.

Darby Schoenfeld, Senior Vice President of Investor Relations

Thank you, operator, and welcome. With me today are Pathward Financials’ CEO, Brett Pharr; and CFO, Greg Sigrist, who will discuss our operating and financial results for the second quarter of fiscal year 2025, 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 only provided to assist you in understanding the company's results and performance trends, particularly in competitive analysis. Reconciliations for such non-GAAP measures are included in the earnings release and the appendix of the investor presentation. Finally, all time periods referenced are fiscal quarters and fiscal years, and all comparisons are to the prior year period unless otherwise noted. Now, let me turn the call over to Brett Pharr, our CEO.

Brett Pharr, CEO

Thanks, Darby, and welcome, everyone, to our earnings call. At the halfway point of the fiscal year, we have just completed a fantastic quarter. Our businesses are healthy, and we are optimistic about the future. We've made some significant progress on our goals, especially on our successful execution of our balance sheet strategy. This is allowing us to generate revenue above our asset size, meaning we do not need to grow our balance sheet to grow revenues. This is clear in our financial performance during this quarter. We are also having a great tax season, which led the way to non-interest income growth during the quarter. We reported earnings of $3.11 per share for the March quarter, representing year-over-year growth of 21% and net income of $74.3 million. Our results were driven in part by an increase in non-interest income of 7% and net interest income of 5% compared to the same quarter last year. We also expanded our quarterly net interest margin and adjusted net interest margin. Year-to-date, non-interest income now represents 45% of our total revenue, and it is our goal to continue to grow this over time. Performance metrics were strong for the first six months of the year with a return on average assets of 2.69% and a return on average tangible equity of 43.79%. Remember that due to tax season, these metrics generally reached our high water point during this quarter. We are also pleased to revise our fiscal 2025 guidance to $7.40 to $7.80 earnings per diluted share. Tax season has been really strong, with the team doing a fantastic job of expanding our reach. We operated with over 42,000 independent tax offices, a new record for us. As a reminder, our results include not only the independent tax offices but also tax partnerships. For the six months ended March 31, 2025, we increased non-interest income related to refund transfer products and refund advance products by 13% each. Refund advance origination increased over $100 million this year, representing 7% growth. This brought total tax services revenues to $85 million, a growth of 17% compared to the prior year period. Loss rates are also favorable compared to last year due to our continued work on our underwriting models and data usage to originate refund advances, so the slight dollar increase in provision you see in our results is volume driven. Pre-tax income for tax services grew 29% to $47.6 million, and we are very pleased that this team has been able to produce stable growth and solid results. We continue to make significant progress on our strategy of optimizing the balance sheet. Last quarter, we entered into a strategic partnership to support renewable energy loan growth, and that is going very well. This can be seen in our results with strong originations and structured finance during the quarter and a pipeline that continues to be robust. Our partner BridgePeak brings strong industry experience to the table, and we expect that co-innovation in this partnership will accelerate efficient, scalable, and predictable growth within Pathward's renewable energy initiative. During the quarter, we also took advantage of a premium in the marketplace and sold a portion of our working capital loan portfolio. Greg will go into more detail in a moment on how this further accelerates our optimization strategy. Opportunities in the partner solutions pipeline remain strong. These deals can have protracted timelines, and we are tracking each of them with precision and care. Our team is working hard to further the opportunities in front of us by tirelessly working with both new and existing clients to ensure we are providing them with the best solutions and capabilities to fit their needs. Our credit solutions team continues to explore growth and new opportunities. After the quarter ended, we signed a contract with a new partner to originate loans through their lending marketplace. Recently, we've talked about our strategy to be the trusted platform that enables our partners to thrive and how we intend to accomplish it. I've mentioned in a few places today how we are delivering on this, and in order to continue delivering shareholder value, we stay laser-focused on accomplishing these goals. Now, I'd like to turn it over to Greg, who will take you through the financials and guidance in more detail.

Greg Sigrist, CFO

Thank you, Brett. We're very pleased with a record second quarter, characterized by solid revenue growth, particularly in net interest income and tax service revenues, while expenses continue to be well managed. Our focus on balance sheet optimization has contributed to our ability to do more with less. This can be seen in our net interest income, which grew 5% and was primarily driven by an improved earning asset mix and higher profitability. As a result, the net interest margin of 6.5% in the quarter increased from 6.23% in the prior year period, and our adjusted net interest margin expanded 33 basis points. Provision in the quarter totaled roughly $30 million in line with volumes in tax refund advances and commercial finance. Non-interest income grew 7% from the prior year, driven primarily by higher secondary market revenues from loan sales and higher tax product fee income, partially offset by loss on sale of securities. Secondary market revenues were elevated as we had an opportunity to sell the transportation portfolio within working capital, in addition to sales from structured finance. This also gave us an opportunity to further optimize the securities portfolio. We expect secondary market revenues to run in the $4 million to $6 million range per quarter for the remainder of the year. These actions freed up close to $190 million in liquidity, which we expect to redeploy by the end of the year into other asset classes with either higher risk-adjusted returns or those with optionality and improved return on assets. Expenses in the quarter grew $2.1 million from the prior year, reflecting a modest 1% increase. As we have mentioned previously, we continue to invest in our technology infrastructure, which can be seen in the occupancy and equipment expense line. This increase was partially offset by lower compensation and benefits reflecting a modestly lower FTE count. Deposits held on the company's balance sheet at March 31 declined from a year ago, and custodial deposits held at partner banks on March 31 were $1.1 billion, a slight decrease from $1.2 billion a year ago. The year-over-year decline in total deposit balances primarily reflects a return of EIP deposits to the Treasury Department during last year, as well as over $100 million fewer wholesale deposits on the balance sheet. Over the second quarter, the company averaged approximately $606 million in deposits at partner banks compared to $783 million last year that are earning a rate roughly equal to the effective Fed funds rate. Loans and leases at March 31 were $4.5 billion, a slight increase from the $4.4 billion last year. This represents pretty significant growth since the prior year's total loan balance included insurance premium finance loans. If you exclude these balances in the prior year, loans and leases would have grown 15% year-over-year. We are not seeing signs of economic slowdown in our portfolio, and performance metrics remain within our historical ranges. Our allowance for credit losses, excluding our seasonal tax service lending, was 101 basis points in the quarter with an annualized net charge-off rate in the quarter of 61 basis points. Our liquidity remains strong with almost $3.9 billion available. This is higher than where we were last year at this time, and we're extremely pleased with our position. The strong performance during the quarter allowed us to be opportunistic with our share repurchases. As a result, we repurchased roughly 576,000 shares at an average price of $78.11. This brings year-to-date repurchases to almost 1.3 million shares. As Brett mentioned, we are revising our fiscal year 2025 EPS guidance range to $7.40 to $7.80. This includes the following assumptions: no rate cuts for the remainder of the year; we expect net interest margins to exceed those of fiscal year 2024 as a result of our balance sheet optimization. We now expect an effective tax rate of 17% to 21%. Guidance also includes expected share repurchases. Lastly, we expect our businesses to be well-managed in the back half of the year, though we will continue to invest in technology as well as risk and compliance. This concludes our prepared remarks. Operator, please open the line for questions.

Operator, Operator

Our first question is from Frank Schiraldi with Piper Sandler.

Frank Schiraldi, Analyst

Hey, good afternoon. You guys, when you think about, it seems like the tax business was obviously or is highly scalable here. Just wondered how you would characterize that going forward? Does that continue to be the case? And as you look out at the competitive landscape out there, any confidence around continuing to grow those independent tax offices at a good clip here as we think about next tax season?

Brett Pharr, CEO

Yes. Thanks, Frank. The tax business, for the last four to five seasons, we have continued to improve our operational effectiveness and our penetration in market share, etc. I think a couple of things happened this year. One was we've continued that, and so we are capturing some percentage points of market share. Also, it is fairly well-publicized by the IRS that the amount of refunds this year was higher than normal. I think we will continue to do well in that business. I don't know that year-over-year we will continue to show the increases that we did this year, but we had a good year, and we continue to improve our operations in our underwriting models. So I’m positive about its continuation, maybe just not growth as fast as it did this year.

Frank Schiraldi, Analyst

Okay. I appreciate that. And then just general thoughts on the commercial finance business here. The macro environment has significant uncertainty. If you could just talk about how you get comfortable if there are areas that you're shying away from. Obviously, we saw the contraction in the factoring and asset-based categories. Just trying to sense your thoughts around growth from here, given all the uncertainty out there.

Brett Pharr, CEO

It's interesting. Of course, we see the same uncertainty, and that impacts the way we think about forward-looking guidance, etc. We're not seeing any deterioration at all in the credit quality that we have. Even the same client funding is still staying pretty good. One of the things that is starting to happen that is an indicator of perhaps some tightening is we're getting more and more inquiries on transactions in our pipeline that previously would have been done by traditional C&I. We are seeing some of that. Remember, in a downturn, our working capital group will perform the best because there will be more higher-quality companies coming in the door to us because they've been turned away from traditional C&I. So I'm pretty optimistic about that going forward. We'll see how, for example, equipment lending, the cash flows, which are a higher-rated credit, might be impacted over time. But again, our portfolio is very secured, and we're not seeing any cracks whatsoever.

Frank Schiraldi, Analyst

Okay. Great. And then just lastly, on capital return, obviously, continue to be aggressive on buybacks here just given the focus is more on balance sheet optimization than growth, I would say. Given that equities overall pulled back, maybe there's more value there. Any thoughts about further accelerating the buyback program? I guess, could you talk about what you target or expect to target from here in terms of capital return in terms of percentages of total income?

Greg Sigrist, CFO

Yes, thank you for the question. We initially anticipated reducing the payout ratio to around 70%. However, one of the metrics we are focusing on is increasing our capital on the balance sheet. To clarify, we are not intending to grow total assets; it's really about adding operational capital. Therefore, we are aiming for a Tier 1 leverage ratio closer to 10%. Given our profitability, we believe we can maintain our buybacks at the current level and reach that target by the end of the year. This is encouraging for us as we can achieve that capital target without significantly reducing buybacks. Consequently, I expect buybacks to remain around 80% to 90% for the remainder of the year, and we will evaluate the situation moving forward. I feel very confident about continuing this year.

Operator, Operator

Our next question is from Joe Yanchunis with Raymond James.

Joe Yanchunis, Analyst

Thank you. So I want to ask one of the first questions a little differently. Given the amount of payment volume that runs through your company, have you seen any particular change in activity or behavior since Liberation Day?

Brett Pharr, CEO

No, not at all. One of the things you have to remember about our book of business with our partners is a large percentage of it is at the bottom of the economy. This includes groceries, gas, and similar necessities - it's not high-end retail. We have not seen any measurable change in that and really wouldn't expect to, regardless of the economic circumstances because even when people do not have jobs and they have benefit payments, they are still buying gas and groceries.

Joe Yanchunis, Analyst

Understood. And then kind of pivoting over here. In your prepared remarks, you discussed the signing of a new partnership to originate loans through a marketplace. Can you provide a little more detail on that partnership and what kind of loans will be the focus?

Brett Pharr, CEO

We have several partners that do online consumer term loans that can range from six months to five years. These loans tend to be near-prime or subprime. The key to remember is that there is a very structured approach to any exposure to credit losses. We constantly monitor the underwriting models to ensure that any loans on the balance sheet are adequately covered by reserves. This is very similar to other partnerships we've done for many years, and we have a lot of confidence in it. We will watch it closely and do not expect any problems.

Operator, Operator

Our next question is from Tim Switzer with KBW.

Tim Switzer, Analyst

The first question I have is regarding the margin outlook, particularly the adjusted margin. Your slide indicates that there isn't much of an impact on the margin regardless of where rates move. Can you walk us through the various factors that could influence reported NII and the adjusted number if we see more cuts than expected?

Greg Sigrist, CFO

Yes, sure Tim. Happy to take that one. I think the story remains the same as we've discussed the last couple of quarters. The curve has been really dynamic lately, particularly just the volatility in the middle part of the curve. The starting point at overnight rate and to your question, we are still very close to neutral in relation to the overnight rate. Each 25 basis point rate cut has an annual pretax impact around $500,000. You would need quite a few of those, plus some changes in our balance sheet composition, to have any meaningful impact. Over time, the overnight rate deepens the curve, which benefits us. However, we continue to rotate liquidity and assets as we think is appropriate. This quarter, we took an opportunity to sell part of our working capital line, which freed up $190 million. In addition, we're looking at roughly $200 million of securities principal paydowns over the next 12 months. This gives us around $400 million of additional liquidity that we can utilize. Coming off of really low roll-off yields on all of that, we plan to redeploy it partly into duration assets and loans, which will maintain stability in both our net interest margin and adjusted margin. Considering all these factors, I think we're close to neutral regarding how we're managing the balance sheet and the potential impacts of a realistic set of interest rate assumptions over the next couple of quarters. I hope that helps.

Tim Switzer, Analyst

Yes, that was really helpful. There's been a lot of disruption in the past space, with some smaller competitors looking to exit or pull back at least. There's another competitor exploring strategic alternatives. Has this created any opportunities for you that you would be interested in pursuing, maybe acquiring some new programs or portfolios, entire business lines? What's your approach to this right now?

Brett Pharr, CEO

Yes. For the most part, our approach has been that our phone is ringing, and our pipeline is full. The strategy is to wait for opportunities that will naturally come to you. We're continuing to see that. Many of the things you're describing are generating some opportunities for us, and we can be selective about what we take on. I expect this trend to continue due to the current regulatory cycle and the market dynamics you've described.

Operator, Operator

There are no more questions waiting at this time. So I'll pass the call back over to the management team.

Brett Pharr, CEO

It's Brett Pharr, thank you for joining today. Have a great day.

Operator, Operator

And that concludes the conference call. Thank you for your participation. Enjoy the rest of your day.