Earnings Call Transcript - CASH Q3 2021

Operator, Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Meta Financial Group Third Quarter 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, the conference call is being recorded. I would now like to turn the call over to 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 President and CEO, Brad Hanson; and Executive Vice President and CFO, Glen Herrick, will discuss the results of our third fiscal quarter ended June 30, 2021. 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 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 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 Brad Hanson.

Brad Hanson, President and CEO

Good afternoon, and thank you for joining our call today. Net income for the quarter was $38.7 million or $1.21 per diluted share, compared to $18.2 million or $0.53 per diluted share generated in the third quarter last year. Various timing items including tax season delays, additional card fee income from government stimulus programs, and reduced provision drove the enhanced performance year-over-year. Year-to-date, net income was $125.8 million, a 37% increase compared to the prior year, driven primarily by the additional card fee income and net interest income from government stimulus programs, along with lower provisioning. Our results demonstrate how Meta’s mission of financial inclusion for all is creating value for all stakeholders: our customers, our employees, and our shareholders. This mission is embedded in our vision to increase the availability of financial products that offer social benefit and produce economic opportunity for people. We empower individuals and organizations by expanding financial availability, choice, and opportunity. We use our national bank charter to offer banking-as-a-service or what we call sponsorship to fintechs and third-party providers, helping them access financial networks, navigate risk and compliance, and we monitor their activities to ensure quality, security, and fairness across a number of relationships and a variety of products. One example of how we empower consumers is our sponsorship of Coinbase, a fintech company working to build the crypto economy. The Coinbase card issued by MetaBank in partnership with Marqeta is a Visa debit card that allows customers to instantly convert any asset in their Coinbase portfolio to spend at Visa-accepted locations earning rewards for each purchase. Partnering with Coinbase helps to empower consumers with ways to manage and spend these emerging assets. Our mission also drives our environmental, social and governance efforts. ESG is embedded in our strategy, aligning our business activities with our purpose and culture. We advanced our ESG efforts during the quarter by publishing our inaugural ESG report highlighting the efforts we have undertaken and outlining our future ambitions across five critical pillars: governance, customers, employees, the community, and the environment. As part of our ESG reporting process, we also completed a materiality assessment to determine the topics that are most important to our stakeholders. This assessment will help further develop our ESG strategy, including the establishment of quantitative goals that we publish in future reports and use to guide our efforts. Also during the quarter, we launched our Community Impact Program to support the ways in which our employees and our companies show up in the communities we serve. This program includes matching gifts, paid time off for volunteering, and exploring partnerships with non-profits with which our employees can engage. With that, I am turning the call over to Brett to share some additional thoughts.

Brett Pharr, Co-President and COO

Thanks, Brad. Today, I would like to provide an overview of our banking-as-a-service business lines, which encompass our payments, tax services, and consumer finance activities, along with our other mission-supporting business, Meta Ventures. Meta has been at the forefront of providing banking-as-a-service, offering financial solutions to third parties and fintechs, including regulatory and compliance services since 2004 when we signed our first prepaid sponsorship agreement. Years of experience along with substantial investment in compliance, infrastructure, and people have positioned Meta well to partner with numerous third-party providers. Over that time, we have achieved significant scale and developed the user-friendly infrastructure that allows third parties to choose the solutions that work best for their business needs. We also expanded our solutions to include all facets of the payments ecosystem from issuing to acquiring in ACH and Faster Payments enablement. We have relationships with more than 30 processors and 21 credit and debit card networks, and we have launched over 9,000 prepaid and debit programs with more than 50 program managers and payment service providers. Our tax services division works with the largest tax preparation companies in the country, along with thousands of small independent tax preparers to bring necessary financial products and services to the millions of hardworking people they serve. We enabled these companies to provide consumers with refund advanced loans and the ability for unbanked filers to receive refunds by direct deposit instead of by check. These services provide consumers with significant benefits including speed, safety, and cost savings. Our consumer finance division works with third parties to help consumers better control their finances with empowered spending options and reliable access to funds. We are currently piloting a new direct line of credit, which we hope will enhance the products offered to many of our existing banking-as-a-service partners. We believe that responsible credit options are core to our mission, creating pathways towards upward mobility by establishing credit histories and building credit scores. Meta Ventures complements our banking-as-a-service activities, allowing us to make direct investments in select fintechs and funds that share our social commitment and add key capabilities to the payments ecosystem or serve key consumer segments. During the quarter, we made a minority investment in Greenwood, a mobile banking platform aimed at serving the Black and Latino communities. Meta Ventures has committed more than $25 million to 18 businesses, and we believe our investing activities make us a more attractive partner to fintechs seeking a financial services partner that can also provide regulatory and compliance oversight. The outlook for banking-as-a-service is robust, and we are fortunate to have been able to select partners that complement our mission and create opportunities and value for consumers. Glen, over to you to review our third quarter’s financial results.

Glen Herrick, CFO

Thank you, Brett. And as Brett noted, GAAP net income for the quarter was $38.7 million or $1.21 per share, representing a year-over-year increase of 113% and 128%, respectively. Our strong revenue generation included growth in card fee income and refund transfer fees compared to the same quarter last year. Card fees benefited from increased activity related to government stimulus programs. Refund transfer fee income in this quarter was higher compared to last year, due in part to a volume shift from the second fiscal quarter because of delays in the 2021 tax filing season. As we wrap up tax season, we are pleased with the results, especially given that government stimulus programs reduced demand for the refund advance product. Year-to-date, pre-tax net income contribution from the tax business was up 19% compared to last year. This was largely generated by our new relationship with H&R Block, and we expect overall earnings from our tax business to be up even further next year. A detailed breakout of net tax product income can be found on slide 13 of our quarterly investor deck. We are starting to see demand rebound within our working capital loan portfolio, which includes asset-based lending and factoring. These grew 11% on a linked-quarter basis and 51% year-over-year. The insurance premium finance portfolio also experienced strong loan growth, increasing 21% during the quarter and 16% year-over-year. The continued remix of the balance sheet supported net interest margin improvement year-over-year. This highlights the momentum of our efforts to grow our commercial loan portfolio and continue to replace lower return assets with higher return assets. Expenses increased compared to the prior year, driven by increases in compensation due to a return to more normalized incentive accrual levels in fiscal year 2021, along with additional employees to support growth. We also saw higher refund transfer expenses this quarter compared to the prior year due to the volume shift into the third fiscal quarter as a result of the delayed IRS filing date. As we start to plan for the upcoming year and our strategic priorities, we are focusing investments and further improving our technology stack to position us for future success. We are starting to see total assets returning to expected levels, allowing us to reduce our stimulus-related cash holdings as consumers spend their stimulus dollars and we utilize third-party bank relationships to move deposits off balance sheet. Going into the fourth quarter, we will likely see elevated deposits related to the 2021 advance child tax credit payments being loaded onto partner cards, similar to what we saw within the indirect impact of the previous three rounds of economic impact payments. You will see in our earnings release that Meta is now revising its credit administration policies and completing a review of its loan portfolio to better align with OCC guidance for national banks, a process we expect will take place during the second half of fiscal 2021. We expect these credit policy revisions will have an impact on our loan and lease risk ratings, resulting in the downgrade of certain credits in several categories. We expect this process will result in setting a new baseline for portfolio metrics going forward, but it does not indicate a deterioration in expected portfolio performance. Further, these changes do not reflect an increase in 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. Our loan and collateral management practices have proven effective in managing losses through economic cycles over the last 20 years. The expected impact to our financial position is minimal, if any, including the allowance and provision impact. As you can see, no adjustments to provision or allowance were made this quarter. We have included two tables in our earnings release that show the changes from the March quarter based on these revised credit policies. Overall, our credit metrics remained stable. Allowance for credit losses totaled $91.2 million at June 30, 2021, a decrease from the linked quarter. However, it is up 39% compared to the prior year, driven by impacts from the pandemic, the adoption of CECL and year-over-year loan growth. Provision expense was lower compared to the prior year due in large part to the increase in allowance as part of the company’s response to the emerging COVID-19 pandemic during the third quarter of fiscal 2020, along with strong credit performance. In a further positive development, our theater borrower received in July over $7 million in shuttered venue operator grants funds, which they used to bring all payments current. Since June, they have reported theater attendance sufficient to support all operating expenses and debt service, and our outlook is cautiously optimistic. Thank you all for joining. That concludes our prepared remarks. Operator, please open up the line for questions.

Operator, Operator

Sure, sir. Your first question comes from the line of Steve Moss with B. Riley Securities. Your line is now open.

Steve Moss, Analyst

Hi. Good afternoon, guys.

Brad Hanson, President and CEO

Hi, Steve.

Steve Moss, Analyst

Maybe just starting here with loan demand in the pipeline, you have seen improvements in commercial finance loan growth. I am kind of curious as to how the pipeline is shaking out and what your thoughts are going forward there?

Brett Pharr, Co-President and COO

Well, this is Brett. First, as we noted, there’s been a dramatic increase in our asset-based lending and factoring, which if you think about it as the economy ramps up makes a lot of sense because that’s the need in the pull for working capital. We had situations back a year ago where balances were dropping to half of available lines. Now the balances are coming back up to 85%, 90% of available lines, which is more abnormal. So we are seeing a lot of growth there. We have had new deal pipelines coming in there as well. Some of the term deals, we are still doing those, the rates are obviously lower, and so it’s highly competitive, but we are having good closings there. So I would say it’s strong in some areas and moderate in others.

Steve Moss, Analyst

Okay. And where are our origination yields these days, generally speaking?

Brett Pharr, Co-President and COO

I believe that each asset class responds differently to that question. In factoring, yields range from 8% to 14%, which are quite high. For some of our larger five-year equipment lease agreements, the yields are around 4.5% to 5%.

Steve Moss, Analyst

Okay. I'm curious if you have estimated how much of the card fees were related to stimulus and how we should consider that growth moving forward.

Brad Hanson, President and CEO

Hi, Steve. It's difficult to quantify since cash is interchangeable and many of these stimulus funds were loaded onto our partner cards like NetSpend or H&R Block. It's really challenging to determine if the increase was due to the stimulus or other spending, especially given that we are observing rising balances. There are holding deposits that do not contribute to our fee income growth. We wish we had a definitive answer, but we just don’t know where things stand.

Steve Moss, Analyst

Okay. And then, if I could just squeeze one last one in just in terms of expenses here, just kind of first quarter I think versus expectations, just kind of curious how we think about expenses now that tax is fully behind us for the third quarter?

Glen Herrick, CFO

Yeah. So, I think this was a good run rate quarter for us, plus or minus $80 million outside of tax season. You will see our biggest increase year-over-year was in compensation. We have added employees, which is variable to support our growth. But the biggest increase in compensation was the change in incentive accruals for team members, where last year we were taking significant haircuts due to the pandemic, and this year we are accruing incentive accruals at more normal levels.

Steve Moss, Analyst

Okay. All right. Thank you very much for all that. Nice quarter. I will step back.

Brad Hanson, President and CEO

Thanks, Steve.

Brett Pharr, Co-President and COO

Thanks.

Operator, Operator

Your next question comes from the line of Michael Perito with KBW. Your line is now open.

Michael Perito, Analyst

Thank you. Good afternoon, guys.

Brad Hanson, President and CEO

Hey. How are you doing?

Michael Perito, Analyst

Good. I wanted to spend a minute on slide 12 here. You guys kind of pull out the payments growth in BaaS revenue, 82% prepaid, 8% checking, and 10% banking services. I am curious if you could maybe expand on how that’s trended over the last couple of years. I mean, is it fair to think that the dispersion amongst that is improving or maybe not improving, but just accelerating as your type of partners diversifies? And is that a trend you expect to continue going forward, putting less concentration around some of the prepaid legacy relationships?

Brett Pharr, Co-President and COO

Yeah. I think so…

Brad Hanson, President and CEO

Brett?

Brett Pharr, Co-President and COO

I think as things are evolving here, we are seeing more opportunities arise with the checking and core banking kind of products, and then also in our faster money. We have talked about those. So when you are looking at revenues, you are seeing banking services increased. I think that should continue as well. So I think you are calling it right.

Brad Hanson, President and CEO

Yeah. I would say, that’s on an absolute level. We would expect all of them to grow over time, but we would expect the checking and the banking services segments to grow faster.

Brett Pharr, Co-President and COO

And that’s a good call-out. And from a revenue perspective also the banking services are and most of this is heavily fee-oriented as well, right? So, especially the banking services, so we are concentrating there pretty heavily.

Michael Perito, Analyst

And then it sounds like the consumer finance, which sounds like it’s kind of lending focused on financial inclusion. I mean that sounds like it’s something that’s not necessarily new, but maybe new in the way you are selling it to your fintech partner. So is that another area where maybe the growth rate going forward could look stronger than what it was historically where I think most of your consumer lending was just kind of referral through partnership; correct me if I am wrong?

Brad Hanson, President and CEO

I think that’s an opportunity but I think that’s going to ramp up over a longer period of time as we continue to develop those products and fill them into those other channels. We do have our partnership lending or consumer lending that we have been doing in the past, and we have a pipeline there as well. So we may see consumer lending still see some growth. But into the other channels you are talking about I think we will still take a bit of time to develop.

Michael Perito, Analyst

I have a couple more questions. First, I want to ask about the card fee, if it's okay to comment on that. It's significantly higher than I expected. A third of the way through the third quarter, is the run rate lower than that? I'm trying to understand the quarterly run rate. I realize it’s difficult to project the long-term growth rate, but should we expect that to decrease if we want to establish a conservative base case for the fourth quarter?

Glen Herrick, CFO

I think that's reasonable, Mike, and Steve is still considering that. Last year, our card fee income was about $21 million. We don't expect it to have increased to $29 million significantly, but we don't have precise figures. However, we believe our core fee income business outside of stimulus likely grew by double digits. I'm not sure if that's around 10% or 18%, but it's probably somewhere in that range.

Michael Perito, Analyst

Got it. No. That’s excellent. That’s very helpful. And then just lastly for me, I mean, obviously, it was a tremendous opportunity to partner with the treasury, but I am sure you guys are relieved to see the balance sheet kind of approach more normal levels again and capital go back off. I mean, last quarter your leverage ratio was 4.5%, by the end of the calendar year could be north of 10%. But it seems like we are approaching, if not — pretty quickly approaching here a more normalized balance sheet and capital position, maybe you are a quarter or two out still. But just wondering, Brad, if you can just update us on, once that does happen, how should we think about capital deployment? I mean, the balance sheet shouldn’t really be growing a ton and what the fee and ROE generation you guys have, I mean you will be accumulating capital pretty quickly. Just was wondering if you would be willing to kind of refresh us on your thoughts there?

Brad Hanson, President and CEO

Yeah. I mean, you are looking at the same things we are and capital is returning to more normal levels, and we do set off a lot of excess capital over time. So, we are definitely looking at how to deploy that and we will probably use similar methods we have in the past.

Michael Perito, Analyst

So, I mean, definitely some buybacks would be a part of that equation?

Brad Hanson, President and CEO

That’s a good possibility.

Michael Perito, Analyst

Okay. Excellent. Thank you, guys, very much for taking my questions. I appreciate it.

Glen Herrick, CFO

Thanks, Mike.

Brad Hanson, President and CEO

You bet.

Operator, Operator

Your next question comes from the line of Frank Schiraldi with Piper Sandler. Your line’s now open.

Frank Schiraldi, Analyst

Hey, guys. Just wanted to ask...

Brad Hanson, President and CEO

Hi, Frank.

Frank Schiraldi, Analyst

...trying to get a sense, I know it’s been asked already, but in terms of the fee income that the payments-related fee income and you noted that you guys were at $21 million a year ago. And I’d assume and ex-stimulus maybe you have got a double-digit run rate and you mentioned 18%. It’s tough to tell. But you have also inked some pretty big deals, some big partnerships over the last 12 months or so. And so I wanted your guys' thoughts on whatever that is 10%, 15%, should we expect that sort of core run rate to accelerate just given what the partnerships you guys have signed into the back half of the calendar year?

Glen Herrick, CFO

Calendar year 2021. I am not so sure yet. These larger partnerships take a little time to ramp up to get the distribution out there. We have been very efficient at building the pipes to the partners, but it’s also how fast they build it on their interfaces on their side as well. So we have a really robust pipeline, really pleased with the quality and the distribution that some of these new partners bring us, and that’s how fast do they get market acceptance and start making headway in the market.

Brad Hanson, President and CEO

And I think you still have a good upside potential on the ramp going into next fiscal year, and throughout next fiscal year, some of the deals we have announced recently are going through the final stages of implementation, and this will coincide and start to ramp up. But as you can imagine, once those things do ramp up, they start compounding on each other and continue to increase that growth rate.

Frank Schiraldi, Analyst

Okay. And then, I just wondered, I know you guys are higher rates would be very welcome. Any updated expectations or thoughts on what you would expect to get in a given rate move, call it 50 bps or 100 bps, any updated thoughts there?

Glen Herrick, CFO

Higher is better anywhere on the curve for us, is what I would say. Our liability side is still virtually fixed at zero. We broke out the distribution of our price resets for our loans and as we add new ones. And so anywhere across the curve is helpful, but no, we haven’t guided on a specific rate scenario.

Frank Schiraldi, Analyst

Okay. Lastly, regarding the re-risk weighting of some loans, I understand that this does not indicate any deterioration in the portfolio. However, I am curious if there are any other operational impacts, such as changes in risk appetites for certain loan categories or adjustments to matters like FDIC assessments.

Brett Pharr, Co-President and COO

Yeah. This is Brett. There’s no change in our underwriting approaches. We've always had solid underwriting. We have made some administrative changes to how we will monitor things on an ongoing basis, and it doesn’t affect any FDIC charge. This is simply an administrative adjustment to align with regulatory expectations and apply these standards to our loan portfolio.

Frank Schiraldi, Analyst

Okay.

Glen Herrick, CFO

And Frank, this is Glen, I would add, if you look and you will see in our earnings release, our past dues are actually down on a linked-quarter basis. And so this doesn’t change our expectation for the portfolio. We didn’t increase the allowance. We didn’t take additional provisions. So it doesn’t change our outlook at all nor have we changed our underwriting. This is the same underwriting that we have structurally been doing.

William Wallace, Analyst

Thanks. Most of my questions have been answered, but as a follow up to the last line of questioning. I am just curious with some of the shifts in the risk rating. I would have anticipated that just the function of the plugging in the new risk rating into the fast five models you would have seen your reserve levels had to go up?

Brad Hanson, President and CEO

Well, hi, Will. It depends on your expectations at each risk rating level, and there isn’t a one-size-fits-all approach. We reviewed everything, and we are very comfortable with the current allowance levels we have.

William Wallace, Analyst

Okay. And what was the genesis of this kind of decision?

Glen Herrick, CFO

Well, I think I mentioned that we need to ensure alignment with the OCC’s guidance regarding commercial lending and portfolio management practices. We're focused on adhering to their recommendations, which concentrate mainly on cash flow analysis and the financial performance of borrowers. Our approach involves closely managing our collateral. For instance, you might have a lease with consistent payments over the years, yet if the underlying company experiences financial stress, it could fall into a different category despite never missing a payment. This does not mean we anticipate a higher risk of loss for that lease. Moving forward, we will apply more conventional commercial lending methodologies, which is why we say this will establish a new baseline for measurement. However, we don’t expect the outcomes to be significantly different from what we have experienced in the past.

William Wallace, Analyst

Okay. All right. Great. Thank you for that.

Operator, Operator

And that concludes the Meta Financial Group third quarter fiscal year 2021 investor call. Thank you.