Earnings Call Transcript - CASH Q4 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Meta Financial Group Fourth Quarter and Fiscal Year 2020 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 Brittany Kelley Elsasser, Director of Investor Relations. Please go ahead.

Brittany Kelley Elsasser, Director of Investor Relations

Thank you, and welcome to the Meta Financial Group conference call and webcast. Our President and CEO, Brad Hanson; and Executive Vice President and CFO, Glen Herrick will discuss the results of our fourth quarter and fiscal year ended September 30, 2020. Also participating in the call is Brett Pharr, Co-President and COO of MetaBank. 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 a 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 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 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 Brad Hanson.

Brad Hanson, CEO

Thank you, Brittany. Everyone I know is talking about what a crazy year 2020 has been. So I want to start by recognizing the exemplary performance of my team during this difficult time and express my appreciation to our dedicated staff for continuing to serve our customers and shareholders from a remote working environment. Despite some of the challenges including substantial rate cuts and sizable loan loss provisions, we reported net income of $104.7 million for fiscal year 2020, an increase of 8% compared to fiscal 2019. And earnings per share increased 18% to $2.94 over the same period. While the share price is down considerably from pre-COVID-19 levels, our strong operating performance has afforded us the opportunity to start buying back shares at what we believe are favorable prices. In September, we reinstated our previously announced share repurchase program and bought back approximately 898,000 shares through October 23, at a weighted average of $21.80 per share. During the past year, we were able to close on the sale of our retail community bank just before implementing our pandemic plan in response to COVID-19. We funded $219 million of PPP loans to 689 borrowers and partnered with the U.S. Department of the Treasury's Bureau of the Fiscal Service and Fiserv to further support the government stimulus package by distributing $6.4 billion of economic impact payments on 3.6 million prepaid cards. At the same time, we closed several new relationships and extended existing relationships, while maintaining focus on our three strategic initiatives: increasing the percentage of funding from low-cost core deposits in exchange for higher cost deposits, optimizing our interest-earning asset mix by replacing lower return assets with higher return loans and improving our efficiency ratio by managing expenses and improving operating leverage. In addition to this, we have been working hard to solidify the foundations of our company by further enhancing operating procedures, governance programs, organizational structure, our talent pool and pay-for-performance programs. We are getting faster, safer, and more efficient. We are also focused on developing our aspirational culture, corporate and social responsibility programs and diversity and inclusion initiatives. In the year ahead, we expect to see progress in our messaging and communications, our websites and our technical capabilities, as we strive to upgrade and enhance the competitive advantages that our platform gives us, in enabling fintech providers at scale, entering new product segments and looking for ways to leverage the vast amounts of data accumulated over the years. Now let me turn the call over to Brett Pharr.

Brett Pharr, Co-President and COO

Thank you, Brad. In the fiscal fourth quarter of 2020, we took a provision for loan and lease losses of $9 million. Our allowance for loan and lease losses was $56.2 million as of September 30, a 15% reduction compared to June 30, 2020, due in large part to anticipated seasonal charge-off activity within our tax services business. Credit quality remains good with no material deterioration in past dues. Non-performing loans and leases were 0.97% of total loans and leases at quarter end, 13 basis points lower than the previous quarter. We are closely monitoring our small ticket equipment finance portfolio. However, modifications in that portfolio are now just $21.8 million and we believe reserves are adequate to cover any associated risk. We have seen no measurable change in performance in our consumer lending portfolios due to COVID-19. Our student loan portfolio has continued to pay down to $115 million at quarter-end, and now accounts for just 3% of total loans and losses. Movie theater and hospitality loans in our legacy Community Bank portfolio are still a concern, accounting for roughly 50% of our total deferred balances. Movie theaters have been heavily impacted by the COVID-19 pandemic, and we have approximately $18 million of exposure in this category. While these credits are currently on a three-month deferral of principal and interest, we have taken additional reserves against them to reflect the elevated level of risk. Hotel loans are trending positive, but far from fully recovered. Most are in the third round deferrals, generally making interest-only payments. Excluding PPP loans, total deferments across all portfolios decreased to $193.3 million in the quarter, down from $326.9 million and now account for just 6% of total gross loans. As of September 30, 2020, we had 689 loans outstanding, totaling $219 million in loans under the Paycheck Protection Program and have recognized approximately $1.8 million in total fees from the SBA. The remaining fees will be amortized over the remaining lives of the loans. The average fee rate of approximately 2.5% equates to approximately $5.4 million of net fees on an average loan size of $318,000. We are closely following the development of the Small Business Administration PPP forgiveness rules. Now let me turn the call over to Glen Herrick, our CFO.

Glen Herrick, CFO

Thank you, Brett, and good afternoon, everyone. Today, we reported our results for the fourth fiscal quarter and full fiscal year 2020. On a GAAP basis, we generated net income of $13.2 million for the quarter or $0.38 per diluted share and $104.7 million or $2.94 per diluted share for the year. Full year earnings per share growth of 18% included the one-time gain on the sale of the Community Bank division, a key strategic accomplishment along our path to optimize our balance sheet. Despite the current rate and loan demand environment, we generated net interest income of $259 million, a decrease of only 2% compared to fiscal year 2019. We believe this reinforces our focus on remixing our balance sheet. United States Treasury, EIP stimulus card deposits continue to be a drag on net interest income in the quarter, albeit at a lower level than the prior quarter. Net interest margin was 3.77% for the fiscal 2020 fourth quarter, an improvement of 49 basis points over the linked-quarter. Excluding the impact from EIP deposits, NIM was 4.87%, compared to 4.95% in the fiscal 2019 fourth quarter. While slower loan demand and lower yields will continue to pressure net interest income in the near term, the ongoing shift in our earning asset mix likely leads to higher net interest margins over time. Our cost of funds improved by 94 basis points compared to the same quarter in the prior fiscal year, largely as a result of the EIP card deposits, which reduced wholesale funding needs and an overall lower rate environment. Meta continues to generate above industry levels of non-interest income, and total non-interest income for the fiscal year was $240 million, an 8% increase compared to the prior year, influenced by the gain on sale of the Community Bank division. Non-interest income now represents 48% of total revenue in fiscal year 2020. For the fourth quarter, non-interest income was $41 million, an increase of 13% compared to the same quarter in the prior year. The increase can be attributed to gain on sale of SBA loans, other income and an increase in payments fee income. For the fiscal year, non-interest expense was down 4% to $319 million, as a result of our ongoing efficiency initiatives, including the sale of the Community Bank division. Non-interest expense was $80 million for the quarter, a 5% increase compared to the prior year. Fourth quarter expenses included a $1.7 million prepayment penalty to extinguish long-term debt and employee separation-related expenses of $1.5 million. Turning to the balance sheet, total assets at September 30 were $6.1 billion reflecting a more normalized level as EIP card balances were spent down and the remaining cash balances were used to pay down borrowings and reduce wholesale funding. Total gross loans and leases held for investment decreased 5% on a linked-quarter basis to $3.3 billion at fiscal year-end. The decrease was primarily related to legacy Community Bank loans that were sold or refinanced away and loans that were classified as held for sale which we expect to sell this quarter. Commercial finance loans, which comprise 70% of the company's loan and lease portfolio, totaled $2.3 billion reflecting growth of $149 million or 7% from June 30 2020. Growth in the commercial finance portfolio is a result of some rebound of demand in the factoring and leasing business lines. Average payments deposits were billion for the quarter which were inflated by $1.6 billion on EIP stimulus cards issued by MetaBank. As of October 23rd, $829 million in EIP balances remained outstanding. Excluding the impact from EIP cards, average payments deposits increased 60% compared to the same quarter in the prior fiscal year. A large component of the increase was driven by stimulus payments that ended up on various program partner cards and lower overall consumer spending levels. As Brad mentioned, during the quarter, we reinstated our share repurchase program. Since restarting our share repurchase program in September we have repurchased 898,416 shares through October 23rd at a weighted average price of $21.80 per share. The company has approximately 3.5 million shares remaining under its authorized share repurchase program which is scheduled to expire on December 31 2022. We will consider further share repurchase activity within the context of our overall capital deployment strategies, including funding growth initiatives and returning excess capital to shareholders. Finally we have adopted CECL effective October 1, 2020 and expect our day one entry to increase the allowance for credit losses by approximately $13.5 million. As it relates to regulatory capital the day one adjustment will not impact our regulatory capital ratios in the short term as we have elected the two-year delay in the five-year total transition period to minimize the impact. We intend to disclose further details of CECL adoption in our 10-K. With that I will turn the conversation back to Brad for closing comments.

Brad Hanson, CEO

Thanks Glen. I'd like to thank our employees, our partners and our shareholders for all their hard work and support during the past year. Despite missing a few pre-COVID targets, we made significant progress on multiple fronts and delivered solid results for the year. We are looking forward to the New Year and all the opportunities that lie ahead. With that I'll have the operator open up the line for any questions.

Operator, Operator

Thank you. Our first question comes from Michael Perito with KBW. Your line is now open.

Michael Perito, Analyst

Good afternoon, and thank you for taking my question. I wanted to discuss the earnings outlook for 2021. If we consider the core earnings power from fiscal 2020, I believe it was in the range of $93 million to $96 million. As we think about the transition into 2021, is it still accurate to say that the annual income of $15 million to $20 million from the H&R Block partnership will add to that core fiscal 2020 run rate? Additionally, will there be growth opportunities within the core business as you move forward? Is this a reasonable way to approach the potential earnings profile for next year? Are there any other thoughts or items you would highlight as we consider the upcoming trends?

Glen Herrick, CFO

Mike this is Glen. I'll take a shot at that. So, yes, H&R Block will be additive in 2021. And as it relates to our other businesses we would certainly expect organic growth in a number of them. I would also point we have some runoff portfolios though primarily in the Community Bank and also the student loan portfolio that year-over-year will be a drag on absolute dollar earnings and what we've also talked about is remixing our balance sheet. And we think that will drive earnings increase without increasing the overall size of our balance sheet.

Brad Hanson, CEO

And remember that we will have a full year coming in September. We had six months of earnings at a higher interest rate than in 2020, and we will experience a full year of the impact from the reduction in interest rates in 2021.

Michael Perito, Analyst

That's very helpful. Thanks. For my follow-up, Brad, could you comment on Crestmark and pipelines? There's the balance sheet aspect to consider, but regarding the fees and payments side of the business, what are the one or two biggest growth opportunities you see for 2021 that could be most impactful for Meta at this point?

Brad Hanson, CEO

We have signed some new deals, and the partnership with H&R Block will certainly impact our business since we took over a significant portion of their operations, including their card programs, tax loans, and other services. This will affect our portfolio positively. We are also beginning to see progress in our faster payments business, which I believe will be a key income opportunity for us. We have several programs set to launch, and while there will be a ramp-up period, we expect to start seeing results by the end of 2021, with further growth in 2022 and beyond. There is significant interest in the marketplace, and we are optimistic about the future of that business line. Additionally, we've entered new business areas in acquiring, which will also take some time to develop meaningfully. However, when we combine these new opportunities, I believe they will have an earlier aggregate impact. Do you have any follow-up questions, Brett?

Brett Pharr, Co-President and COO

I think it's it.

Michael Perito, Analyst

Okay. Do you believe that some of those broader initiatives will be reflected in the fiscal 2021 financials to some extent?

Brad Hanson, CEO

And there's also other business, we've signed and are continuing to sign. So there's MoneyLion launching, which we was announced that we'll start to see that ramp up. And we're excited about the prospects of that business. So there's a number of new initiatives, I think that have come on recently as well that will start to have an impact as the year progresses.

Michael Perito, Analyst

Great. Thank you guys for taking my questions, I appreciate it.

Brett Pharr, Co-President and COO

Thanks Mike.

Operator, Operator

Thank you. Our next question comes from Steve Moss with B. Riley Securities. Your line is now open.

Steve Moss, Analyst

Good afternoon guys.

Brett Pharr, Co-President and COO

Hello?

Steve Moss, Analyst

Starting with just kind of like loan yields they were up nicely over quarter-over-quarter and definitely seeing a remixing within the portfolio here this quarter especially on an EOP basis. Just kind of curious, how you're thinking about loan yields going forward here just into the fourth quarter? It seems like a potential for decent leg up.

Glen Herrick, CFO

Yes. Sorry Steve, your last part cut out on you there.

Steve Moss, Analyst

It seems like there could be another increase in loan yields for the upcoming quarter given the EIP that you mentioned.

Glen Herrick, CFO

Yes. So we would agree with that. It's in certain portfolios are going to come in higher than others or lower given the rate environment. But as we continue to shift that mix the Community Bank has lower yields those run off. We do more commercial finance. So we run off the securities portfolio and Community Bank. Just that swap set will help the overall yields.

Steve Moss, Analyst

Okay. And then just on the business front just kind of curious, as to what you're seeing for non-interest-bearing deposit growth from your card business? I know the EIP deposits kind of steer, what's going on there.

Brad Hanson, CEO

Yes. This is Brad. When we take out the EIP piece, we still have some growth that has occurred year-over-year the last couple of years and would expect that to continue to go. We're in that business. We're seeking that business and we'll be picking more up. The EIP bubble just hides it a little bit.

Glen Herrick, CFO

Yes. What's hard though Steve is, so we have the very discrete card, the stimulus cards that were loaded on our cards that were issued from Treasury so those are the numbers we've been calling out, we've also called out we've seen above-normal growth in overall deposits twofold, a little bit slower consumer spending we believe, but also folks that are getting stimulus money and then taking it and putting it on one of our partner GPR cards. And so it's hard to tell exactly that the money is fungible where that came from, but that's pretty consistent with what talking to our peers across the industry that everyone is at elevated levels of deposits. So in absolute terms probably card deposits will come down year-over-year. If you try to back out our core business, we would still continue to expect some growth there.

Brad Hanson, CEO

There are new programs I mentioned, including H&R Block and MoneyLion. H&R Block is converting a portfolio, so we will see immediate effects from that business, while the others will also grow throughout the year. We anticipate continued strength, opportunities, and growth in our payments business in the coming years.

Steve Moss, Analyst

Okay. And then I'm not sure that this was answered. Just on the commercial finance portfolio, you had good quarter-over-quarter growth. I know you guys alluded to more normalization in certain portfolios. But how is that pipeline looking? And how are you thinking about loan growth? You tend to see pretty good growth in the December quarter.

Glen Herrick, CFO

Yes. I mean, I think we're seeing more transactions to take a look at in the pure commercial finance. So you're talking about your asset-based lending and your factoring some of the other things because of yield, the markets are coming down and there are some cases where we're choosing not to play because the yield is too low. So I think you're going to have some mix in that. But if you think naturally through the economic cycle this is the time that commercial finance starts to build and shine.

Steve Moss, Analyst

Okay. Thank you very much. I appreciate that.

Glen Herrick, CFO

Yes. Thanks Steve.

Operator, Operator

Thank you. And our next question comes from Frank Schiraldi with Piper Sandler. Your line is now open.

Frank Schiraldi, Analyst

Hey, everyone. Regarding the deferrals at the end of the quarter, can you share any insights or expectations based on your discussions with borrowers about what percentage of that 6% might require additional attention once the deferral period concludes?

Glen Herrick, CFO

The main issue we’re focusing on is the hotel-motel portfolio within the residual Community Bank. We’re seeing improvements, especially with the types of properties we hold. However, they will require ongoing support through the winter months. In the spring, we will assess the situation to see if they are nearing normal levels and can begin making traditional principal and interest payments again. That’s a key point. We also have a minor theater relationship and some small ticket finance elements, though these are not significant. The situation varies significantly across the country regarding what businesses are open or still shut down, and those that remain closed will face challenges for a while longer. We’ll monitor how these developments unfold.

Brad Hanson, CEO

It’s important to note that many hotels are making some interest payments, and it’s not just full principal and interest being deferred. They are contributing in some capacity.

Frank Schiraldi, Analyst

Okay. You mentioned that Crestmark's cumulative net charge-offs during the last downturn in the Great Recession were around 2.5%. Considering the current uncertainty in the credit market, do you anticipate that this will be lower or higher this time, or is it too early to tell? What are your thoughts on this?

Glen Herrick, CFO

Well, one of the things that's a good indicator of how that's going to go is the pure commercial finance. I'm talking about asset-based lending and factoring. You'll notice the balances have gone down considerably, which means that those products are working exactly as designed, which as the volume comes down you collect the receivables you pay down the debt. And that's why you have even in a downturn environment such a low loss rate. So if the balances help you that gives you some indicator of where we think that's headed. We're continuing to watch delinquencies in that space other than the areas that I called out, there's no specific thing that's happening. You're not seeing much of a change at all. So we feel pretty good about where that portfolio is today.

Brad Hanson, CEO

However, our crystal ball isn't any better than yours, Frank. So we continue to monitor the portfolios very closely and we'll react to their performance as is required.

Frank Schiraldi, Analyst

Okay. And then just finally, I wondered if you could provide any help with the run rate on the expense side, particularly, I don't know if there's anything you can break out of other expense and where that might trend going forward.

Glen Herrick, CFO

Yes. We mentioned a few one-time items. We prepaid $110 million of long-term debt that is no longer necessary along with our borrowings. Additionally, there were some employee severance costs and other year-end expenses as we got ready to invest for 2021. I expect that, aside from the March quarter, our expenses in the remaining three quarters of 2021 will be lower than they were in this quarter. Therefore, they should be certainly under $80 million outside the tax quarter.

Frank Schiraldi, Analyst

Okay. I'm sorry if I missed it, but could you clarify if the other expense line is closer to $9 million or $10 million, rather than $15 million or $16 million going forward? Or did you separate a one-time item from that?

Glen Herrick, CFO

Well, what we called out for again in the earnings release and in the script was $1.7 million prepayment penalties for paying down long-term debt at the FHLB, and then $1.5 million of severance costs.

Frank Schiraldi, Analyst

Okay. All right. Thank you.

Operator, Operator

Thank you. And our next question comes from William Wallace with Raymond James. Your line is now open.

William Wallace, Analyst

Yes. Good evening, everyone. I would like to discuss some aspects of the net interest margin. Could you clarify what the purchase accounting accretion was for the quarter? Also, what expense savings can we expect from the FHLB prepay? It appears that of the 110 basis points of pressure from the EIP deposits, you're likely to recover about half of that, given that balances are around $829 million as of October 2020. Do you think those deposits will eventually go to zero, or will they stabilize and allow you to deploy that liquidity elsewhere on the balance sheet?

Glen Herrick, CFO

Hey, Wally, this is Glen. We believe they will pay down another portion this quarter, but some people are using them for savings accounts. We expect to maintain some level of those deposits throughout fiscal year 2021 and we'll utilize them as opportunities arise with earning assets. The purchase accounting accretion has run its course, so we won't be getting any more benefit from that. The Crestmark portfolio is mainly short-term in nature, so there might be just a basis point left from that. What was the third part of your question, Wally?

William Wallace, Analyst

The FHLB expense.

Glen Herrick, CFO

Yes. So it's about a 10-month payback. So we'll benefit all things being equal save about $2 million of interest expense next year.

William Wallace, Analyst

Okay. And then my follow-up question. On the buyback you said, I believe that your appetite would be governed by your internal capital constraints. Any commentary you could provide around, what capital levels would make a buyback unlikely or however you could frame the capital conversation? And then also, are there any constraints at the holding company as it relates to just cash on hand to continue to buyback or plenty of opportunity to dividend up et cetera?

Glen Herrick, CFO

Yes, there are currently no constraints. We've indicated that our capital ratios may fluctuate throughout the year, particularly during tax season. However, on average, we expect to maintain around 9% leverage or higher, and 12.5% to 13% on a risk-weighted basis.

William Wallace, Analyst

Okay. Okay. All right. Thank you.

Glen Herrick, CFO

Thanks, Wally.

Operator, Operator

Thank you. And I'm showing no further questions in the queue at this time. I'd like to turn the call back to the speakers for any closing remarks.

Brad Hanson, CEO

I'd like to thank everybody for joining the call today, and I hope you have a great evening. Thank you so much.

Operator, Operator

Ladies and gentlemen, thank you for your participation on today's conference. This does conclude your program. You may now disconnect.