Earnings Call Transcript - CASH Q4 2023

Operator, Operator

Ladies and gentlemen, thank you for standing by, and welcome to the Pathward Financial Fourth Quarter Fiscal Year 2023 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 Darby Schoenfeld, Senior Vice President of Investor Relations. Please go ahead.

Darby Schoenfeld, SVP of Investor Relations

Thank you, operator, and welcome. With me today are Pathward Financial’s CEO, Brett Pharr, and CFO, Glen Herrick, who will discuss our operating and financial results for the fourth fiscal quarter and full fiscal year 2023, after which we will take your questions. Additional information, including the earnings release, the investor presentation that accompanies our prepared remarks, and supplemental file 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 statement. 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. Reconciliations for such non-GAAP measures are included in the appendix of the investor presentation. Now, let me turn the call over to Brett Pharr, our CEO.

Brett Pharr, CEO

Thanks, Darby, and thanks everyone for joining us today and for your continued support. We've just completed a year of solid results both financially and operationally. I want to remind you that we operated at the intersection of traditional banking and alternative delivery channels, and therefore, this year we've had an expanding net interest margin, increased return on assets, and increased return on equity. These great results are in spite of a tough economy and especially what has been a challenging banking environment. When you combine these great results with the return of capital through share repurchase and dividends, we have delivered value to our shareholders in multiple ways. Specific numbers for the year: we reported net income of $163.6 million, an increase of 5%, and $5.99 per diluted share, an increase of 14%. In the fourth quarter, net income was $35.9 million or $1.36 in diluted earnings per share. Our earnings growth was driven through the expansion of our full year net interest margin to 6.04%, an increase of 120 basis points over fiscal year 2022. Our full year adjusted net interest margin, including rate-related processing fees, grew 15 basis points to 4.83% from 4.68% in fiscal year 2022. Those metrics in the fourth quarter were 4.87% and 4.73% respectively. Besides the financials, operationally we have a lot to be proud of. Across the enterprise, our IT team delivered a reduction in rent costs, and we're utilizing these funds to help us continue to focus on growth. We're also, from a people standpoint, certified as a Great Place to Work for the first time, and Newsweek ranked us among America's greatest workplaces, along with special distinctions for women, diversity, and parents and families. In commercial finance specifically, we grew total loans and leases by 23%. This was driven by growth in our insurance premium finance business of 67% over the prior year. This was a direct result of positioning the team to take advantage of opportunities and market disruptions in that vertical. We've also built several new relationships in our government guaranteed sectors, primarily SBA and USDA, that we believe will prepare us well for 2024. Additionally, in commercial finance, we undertook a process to align teams that were operating vertically within their loan product into horizontally capable groups across the team. We believe this will drive a reduction in operating costs and will create a more efficient and streamlined organization going forward. Collateral-managed loans provide us with tremendous safety, but they are people intensive, and we are constantly seeking efficiency in that space. In banking as a service, we continue to expand and create new agreements with our existing partners. We extended four agreements, launched a new acquiring sponsorship program, and expanded product offerings in three cases. We also worked with a new partner to help them launch as a payment processor, and most recently, we signed a new agreement to launch a new demand deposit account program. We continue to evolve our BaaS organization to position us as the go-to partner with a broad payment capability set and flexible solutions that deliver safe and sound infrastructure, simplicity, and speed to market for our partners. Finally, I need to discuss compliance due to recent regulatory news in the BaaS marketplace. I believe the strength of a regulatory risk and compliance infrastructure needs to be emphasized as a key differentiator for us. Recently, all the regulatory agencies have announced a novel banking approach to address banking as a service business models like ours. Frankly, it's about time. We hope it will reduce the current environment of regulatory arbitrage. If it is similar to the third-party risk management that the agency has collectively released in the last year, I expect it will be, and we already meet those heightened standards and have for some time. To exist in today's banking as a service regulatory world, you must have a culture of compliance and the human capital to support it, and we have worked long and hard to achieve that; compliance is job one in banking as a service. Looking ahead, heightened standards for banks operating in this space will be a requirement, and we believe we have the culture and commitment to maintain that level of risk framework. The best time to plant a tree is 20 years ago, and that is exactly what we did when we entered the payment space back in 2004. As a result, we will not have to make significant investments to bring our BaaS program up to speed; rather, we can focus on helping our partners adapt to today's ever-changing financial services environment. Some key points: We believe we are entering a regulatory cycle that could fundamentally change the banking as a service space, drawing a regulatory mode around those who can operate within the heightened requirements. We believe others will decide to exit the banking as a service space, and we believe we are well-positioned to thrive in that environment as a financial institution that generates sustainable recurring revenue while championing a strong culture of compliance built to endure any cycle, including credit, economic, or regulatory. Through the cycle matters, we are built to thrive in all cycles. For fiscal 2024, you can expect us to continue enhancing our company. We will have our teams continue to innovate and improve efficiencies and commercial finance. We want to drive smart balance sheet growth, ensuring appropriate yields for the current financial landscape. The BaaS team will continue to emphasize being the one-stop shop for partners looking for a banking partner. We’ll continue to win with our risk and compliance framework and culture, maintaining our status as a banking service powerhouse with a long track record of success through the cycle. All of these items have contributed to our ability to raise our fiscal year 2024 guidance to a range of $6.20 to $6.70 per diluted share. Finally, we are excited to announce the appointment of Greg Sigrist as our next CFO. Greg comes to us with a strong background, making him an excellent addition. He has over 20 years of banking experience with impressive leadership and financial and business acumen that we believe will keep Pathward on the path to continued success. We look forward to welcoming Greg in a few weeks. I also want to thank Glen for all of his contributions over the last 10 years. There's not enough time on this call to detail everything Glen has done for this organization during his time here. He was instrumental in the diversification and evolution into who we are today, building accounting, finance, and treasury teams that rival those of much larger institutions and any other banking as a service bank. Glen, on behalf of the board and our employees, thank you. We wish you well and hope you enjoy your retirement.

Glen Herrick, CFO

Thank you, Brett, and welcome on board, Greg. I look forward to working with you on the transition. Before I sign off on my last earnings call, it has been an honor and a privilege to serve as CFO of this company for the last 10 plus years. It has been a joy to watch the company and the team transform into an innovative, entrepreneurial-driven bank. Our annual net income has grown from $13 million in fiscal year 2013 to over $160 million this year. From my start date through mid-October, our total shareholder return has exceeded 450% versus the NASDAQ community bank index increase of about 80% and the Russell 2000 index increase of just over 110%. We've achieved a great deal, and I look forward to cheering on the team to even greater accomplishments. Now, on to the financial results. Net income for the quarter ended September 30th was $35.9 million, or $1.36 per diluted share, an increase of $12.5 million compared to the prior year. For fiscal year 2023, net income totaled $163.6 million, an increase of $7.2 million relative to fiscal year 2022. Adjusting for various one-time items, including the impacts of our rebrand, the increase would have been $32.9 million or 25%. GAAP earnings per share of $5.99 increased 14% compared to last year, and when adjusting for the same items, core EPS increased to $6.09 in fiscal year 2023 compared to $4.49 in fiscal year 2022. In the fourth quarter, net interest income totaled $104.9 million, an increase of 32% relative to the prior year. This year-over-year increase was driven by additional earning asset balances as well as greater yields across the loan and securities portfolios. Our NIM expanded to 6.19% in the fourth quarter when accounting for the increase in rate-related processing expenses; the company's adjusted NIM of 4.87% in the fourth quarter increased from 4.73% in the prior year quarter and was in line with 4.88% last quarter. As a reminder, our adjusted NIM does not include the servicing fees we also earn on our off-balance sheet deposits. Also impacting the NIM was a mixed shift in the loan base as we saw growth in our USDA loan, insurance premium finance, and large ticket equipment finance loans, which are typically higher-rated credits and thus lower yielding. In fiscal 2024, we expect our NIM, both GAAP and adjusted, to expand as we continue to optimize the earning asset mix. The provision for the quarter was $9 million. The provision increase when compared to the same period last year was largely due to the fact that the fourth quarter of fiscal 2022 included a $4.3 million reversal of provision following the sale of the company's student loan portfolio. As of September 30th, the company had an ACL coverage ratio of 1.14%, a decrease from 1.3% at the same time last year. Our commercial finance group has an ACL coverage ratio of 1.26% compared to 1.35% in the last quarter and 1.46% in the fourth quarter last year. The successive declines are generally a result of the mix shift towards more insurance premium finance, USDA, and large ticket equipment finance loans, which have a relatively lower allowance rate. Non-interest income of $56.1 million in the fourth quarter grew $12.6 million year-over-year. This increase was partially driven by $2 million of additional card fee income related to the company's servicing of off-balance sheet deposits. Additionally, the fourth quarter of fiscal year 2022 was hindered by a $4.8 million pre-tax loss on the sale of the student loan portfolio, as well as a $1.9 million pre-tax loss on the sale of the venture capital investment. Non-interest expenses increased 15% year-over-year to $118.2 million. This increase was primarily driven by rates-related processing expenses as well as compensation expenses, partially offset by a decrease in legal and consulting expenses, mainly due to the impacts of rebranding activity in the prior year. During the fourth quarter, we were able to capitalize on several renewable energy lending opportunities. These credits pushed our effective tax rates significantly lower. Total deposits, including on and off-balance sheet, decreased $322 million, or 4%, from the prior year quarter to $6.9 billion. Total deposits decreased sequentially, primarily due to a reduction in the runoff EIP deposits as well as a continued decline in seasonal tax deposits. During the fourth quarter, we maintained an average of $588 million of off-balance sheet deposits, earning fee income roughly equal to the effective funds rate. At September 30th, there were $268 million of deposits off-balance sheet at partner banks. To keep you up-to-date, at September 30th, we are holding roughly $900 million in deposits related to government stimulus programs. These deposits are being spent down while unclaimed balances are being returned to the U.S. Treasury. During fiscal year 2024, we expect to return approximately $380 million of unclaimed deposits. As of September 30th, the company held $4.4 billion in loans, an increase of $830 million, or 24%, compared to the end of fiscal year 2022. The growth in our loan portfolio stemmed primarily from our Commercial Finance Division, particularly insurance premium finance, term lending, and USDA and SBA. We also saw growth in consumer credit and warehouse lending. Credit quality across the portfolio remains strong. Non-performing loans of 1.26% increased from 0.93% in the previous quarter. The largest increase was in Commercial Finance, partially driven by the same relationship we mentioned last quarter that is in the process of a workout. As we've said in the past, we do experience lumpiness in our non-performing loans, particularly while we are in the process of a workout, but typically we recover at least a portion of a loan, if not all, due to our collateral management. We remain confident in our collateral and the quality of our portfolio. As Brett said, we have built a company to be resilient through different cycles. From a liquidity perspective, Pathward continues to be in a good position. Our balance sheet is strong, and when you factor in all our sources, we have over $2.6 billion available in liquidity. These results continue to provide us the ability to return value to shareholders. In the fourth quarter, we repurchased approximately 312,000 shares at an average share price of $51.29. From October through October 16, we have repurchased an additional 233,000 shares at an average price of $47.25. In August, we announced that our board of directors authorized a new share repurchase program for up to 7 million shares through September 30, 2028. As of October 16, we have 8.4 million shares available for repurchase under the two current programs. As Brett stated, we are raising our fiscal year 2024 GAAP earnings per share guidance to a range from $6.20 to $6.70. While the fourth quarter saw a healthy amount of renewable energy funding opportunities, we do not anticipate this to recur at the same pace in fiscal year 2024. As a result, we are reaffirming our effective tax rate to be in the 16% to 20% range. This concludes our prepared remarks. Operator, please open the line for questions.

Operator, Operator

Our first question comes from Michael Perito with KBW. You may proceed.

Unidentified Analyst, Analyst

Hi, this is Mike's associate, Andrew, filling in. Thank you for taking my questions.

Brett Pharr, CEO

Hey. How are you doing?

Unidentified Analyst, Analyst

I was wondering if we could get some updated commentary on the credit outlook, considering some of the negative data points we've seen from other lenders, especially in the credit card and small business segments?

Brett Pharr, CEO

Yes. So, of course, we don't have credit cards in the small business arena; we are a commercial finance lender. As we've said, we're a heavily collateral-managed loan lender, and therefore we tend to do very well during these kinds of times. So, while some companies are experiencing difficulties, we are not facing any losses associated with that out of any ordinary pattern. We feel very confident about it, don't expect to have any trouble, and we believe our collateral-managed approach will put us in a better place going through this cycle than other lenders may have.

Glen Herrick, CFO

And Andrew, I'd remind you that one thing that differentiates us is that we no longer have a community bank, so we have a minimal amount of commercial real estate on our books.

Unidentified Analyst, Analyst

Great. Appreciate the color there. And then, just a quick follow-up on that. What are the provision assumptions that are going into the fiscal year 2024 guide?

Glen Herrick, CFO

Brett, assumptions?

Brett Pharr, CEO

Well, it's based on our originations, the outlook for the economy, and where our growth is coming from. You’ve seen in the last couple of quarters that our growth has come from higher quality, typically lower loss portfolios, such as SBA, USDA, and insurance premium finance. So that factors into both where the allowance levels are at; it also drives your CECL provision.

Unidentified Analyst, Analyst

And then just lastly from me, and then I'll step back. Near term, just a quick question on the margin. Do you believe the NIM will stabilize here if we're in a higher for longer environment, kind of as predicted, and there's no movement at the federal funds rate?

Brett Pharr, CEO

I mean, if we have stability here, higher for longer, our NIM will continue to widen. That's a key differentiator of our business model; we still have a lot more upside on the yield side versus the cost, even if that one stays flat.

Unidentified Analyst, Analyst

Appreciate all the color. Thanks for taking my questions.

Brett Pharr, CEO

Thank you.

Operator, Operator

Thank you for your question. The next question comes from the line of Eric Spector with Raymond James. You may proceed.

Eric Spector, Analyst

Hey, good afternoon. This is Eric on the line for David Feaster. Thanks for taking the question.

Brett Pharr, CEO

Hey Eric.

Eric Spector, Analyst

Kind of just, hey, how is it going? Staying on a similar page on the NIM, just curious how you think about operations in a higher for longer environment? Obviously, there's a tailwind to the margin, but just curious if you could elaborate on the margin trajectory and then just any broader perspective on how you think that would impact loan growth? And maybe any other impacts or effects on any other business in a higher for longer environment?

Brett Pharr, CEO

Well, so the first thing kind of ties back to the previous question. As you offload longer-duration loans that were at lower rates and replace them with duration loans at higher rates, we're going to continue to grow NIM even if Fed funds and primes stay flat. So that's kind of obvious. Now, the other element of your question is what's going on in the marketplace. We're watching to see how much of a slowdown occurs in loan demand. Glen noted particularly that we've already migrated some of our growth to higher quality loans. Now, some of that is what's available in the marketplace. We may see, for example, leasing portfolios among others. So, that may well be what happens. But also, if the economy enters a more difficult time, we may see some growth in our working capital and factoring assets. We've talked about that for nearly a year now; it hasn't materialized yet. That would be the next thing to happen if the economy really slows down, as people are starting to discuss.

Eric Spector, Analyst

Got it. That's helpful color. And then just kind of wanted to touch more on the capital side. Obviously, regulatory capital remains strong. But TCE is just curious if you're hearing any pushback from regulators on that, and does it impact your capital return opportunities at all? Looks like we've already started to repurchase some shares during the quarter, so maybe that's the answer, but just curious if TCE plays into the equation at all at this point?

Brett Pharr, CEO

We obviously watch that. And as you said, that's a factor. We're comfortable; our board's comfortable. You could assume that regulators have a say in your capital levels and share repurchases as well. I would say that in my 30 plus years in banking, this is as liquid a bank as I've seen.

Eric Spector, Analyst

Okay. And then just one last question. I just wanted to touch on what you're seeing on the SBA front. We're seeing growth opportunities. Could you remind us how much of that book is government guaranteed? That’s my last question. I'll step back. Thanks for taking the questions.

Brett Pharr, CEO

Yes, we've identified additional SBA partners where we can get more volume. I would say the SBA business, in general, industry-wide has slowed down, but we're able to get more transactions because of new partners we've brought on. So we're excited about that. The exact percentage of how much is government guaranteed varies based on market conditions; sometimes we sell off the government guaranteed portion. So, I don't know, do we have those numbers?

Glen Herrick, CFO

It usually ranges about two-thirds; it moves up and down. But as Brett said, it's typically around two-thirds of it that would be guaranteed.

Eric Spector, Analyst

Got it. All right, well, that's it for me. Thanks again.

Brett Pharr, CEO

Thank you.

Glen Herrick, CFO

Thank you.

Operator, Operator

Thank you for your question. Our next question comes from Frank Schiraldi with Piper Sandler. You may proceed.

Frank Schiraldi, Analyst

Hey, guys, good afternoon.

Brett Pharr, CEO

Hey Frank.

Frank Schiraldi, Analyst

I wanted to ask about the guidance increase. Is there anything you can point to specifically, or is it just as simple as a bit of a change in rate outlook that's driving that increase here?

Brett Pharr, CEO

Yes, I think the higher for longer outlook should help us with NIM. We're feeling very comfortable about that. Obviously, we're just a few days into the year, so we're not getting carried away. But we felt like with the rate environment, we could bump it a bit, and we'll see what happens as we progress through the year.

Frank Schiraldi, Analyst

Okay. And then in terms of the expense base, I notice the card processing expense that increased there. As far as if you look at the other expense line, it bounced around a bit, but it was elevated link quarter and the same with the legal and consulting expense. So, any sort of color or range you could give in terms of any one-time items in the quarter and where you expect a better run rate on the expense side?

Brett Pharr, CEO

Yes. I would say this quarter is a pretty good run rate, Frank, excluding the rates-related processing expenses.

Frank Schiraldi, Analyst

Okay.

Brett Pharr, CEO

I'll remind you, as you're aware, we do have a number of variable expenses, so where our expenses go is partially driven by where our revenues go, but again, we're expecting to grow revenue at least two times the expense growth.

Frank Schiraldi, Analyst

Okay. And then on credit, with the NPA increase in the quarter, you mentioned the commercial finance side of it. It looks like the tax business also drove some of that increase, and I think you noted in the release that the tax business drove some of that. And it seems like it's mostly or entirely in the 90 days past due, at least for the tax stuff. I would think that at this point, you just write anything off that's still outstanding. Any color on that front?

Glen Herrick, CFO

Yes. We had a mixed shift in our tax lending this year from our BaaS providers to more independence. There are obviously revenues related to that, but we also had higher loss rates, which we expected. It’s just a mixed shift in there. The timing of IRS refunds is when they do their drops, and there are still some coming. That’s where we are today; it seems like the cycle has gotten pushed back later this year in a lot of the processes.

Frank Schiraldi, Analyst

Okay. It just seems like, based on where the reserves are on that business, it seems like you don't anticipate significant losses in this $5 million bucket that's in NPA now. Is that fair?

Glen Herrick, CFO

That's fair. Yes, I would not expect anything material from that.

Frank Schiraldi, Analyst

Okay. And then if I could just sneak in one last question. As you know, you tend to have longer-term partnerships. So, I guess you don't have a ton renewing every day, but in terms of the partnerships that have renewed, are you seeing better pricing? Are you seeing more narrow pricing, given that we've seen some of these smaller banks entering the market? And to Brett's point, maybe over time, they get crowded out. But given that they're in now, is that kind of what you're seeing as partnerships renew tighter pricing?

Brett Pharr, CEO

Well, I mean, there's been pricing pressure, but it's probably been driven more by the rise in interest rates and the desire to focus on commissions on deposits than anything else. Like you said, we don't have a whole lot of these going on at a time, so we'll see how it plays out. But I would not say that we have experienced any benefits from what I think will be a washout just yet. We've experienced pressure on pricing somewhat due to the interest rate rise; we are just all factored in.

Frank Schiraldi, Analyst

Okay. Yes, it's in your guidance.

Brett Pharr, CEO

Yes.

Frank Schiraldi, Analyst

Right. So you're basically seeing more of an ask on the depository side in terms of some sort of return there?

Glen Herrick, CFO

Yes, that comes out. Now, what we tend to do is there's a trade-off of fees paid versus commissions on deposits, et cetera. That's part of the contract negotiations you go through. Again, we're predicting, and we feel solid about our guidance regarding expanding margins, and the result of that. So, we're not too concerned about it.

Frank Schiraldi, Analyst

Great. I appreciate all the color, and enjoy retirement, Glen. Thanks.

Glen Herrick, CFO

Yes. Thank you, Frank. I'll miss you. Thanks.

Operator, Operator

Thank you for your question. I will now pass the line back to our CEO, Brett Pharr.

Brett Pharr, CEO

Thanks, everybody, for joining today. I do want to make one final comment; today in Washington, the Federal Reserve held a hearing on the debit card interchange fee calculations. I want to remind everybody that by legislation, the only authority they have for that calculation relates to banks that are over $10 billion in asset size. There may be some confusion out there; I want to be sure we clear that up. It's a small issue where we are not impacted by that proposed change in rule by the Fed. Thank you for joining today, and we look forward to having direct conversations with you.

Operator, Operator

That concludes Pathward Financial Fourth Quarter fiscal year 2023 investor conference call. Thank you for your participation. You may now disconnect your line.