Earnings Call Transcript - CASH Q4 2022

Operator, Operator

Ladies and gentlemen, thank you for standing by. Welcome to the Pathward Financial Fourth Quarter and Fiscal Year 2022 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. And as a reminder, this conference call is being recorded. I would now like to turn the conference call over to Justin Schempp, Vice President of Investor Relations and Financial Reporting. Please go ahead.

Justin Schempp, VP of Investor Relations and Financial Reporting

Thank you, operator and welcome. Pathward Financial's CEO, Brett Pharr; and our CFO, Glen Herrick will discuss our operating and financial results for the fourth fiscal quarter and fiscal year ended September 30th, 2022, after which we will take your questions. Anthony Sharett, President is currently attending the Money20/20 Industry Conference this week and he will be unable to join today's call. Additional information, including the earnings release and a supplemental investor presentation 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 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 the company's results and performance trends. Reconciliations for such non-GAAP measures are included within the appendix of the investor presentation. Now, let me turn the call over to Brett Pharr, our CEO.

Brett Pharr, CEO

Thank you everyone for joining Pathward Financial's fourth fiscal quarter 2022 earnings call. I am excited to announce that earlier this month we unveiled our new corporate brand and launched our new website pathward.com. Our redesigned website highlights the products and services we offer and our commitment to providing a path forward to people and businesses so they can reach the next stage of their financial journey. You'll notice we've also updated our Investor Relations page to provide more information to current and potential shareholders. Turning to our financial results, during fiscal 2022, Pathward generated GAAP net income of $156.4 million or $5.26 per share compared to $141.7 million or $4.38 per share in the prior fiscal year. Fiscal year 2022 GAAP earnings per share, including the one-time gain on the sale of our former brand's trademarks represent an increase of 20% over fiscal year 2021. We are pleased to have achieved a return on average assets of 2.2% and recorded a return on average tangible equity of 35.4% for the fiscal year. For the fourth fiscal quarter, GAAP net income was $23.4 million, up $7.5 million compared to $15.9 million in the same prior year period. Earnings per share for the quarter was $0.81 as compared to $0.50 in the prior year. During the fourth quarter, several events transpired that we believe will positively impact Pathward's financials going forward. First, the company sold the remaining $82 million of its student loan portfolio. Including the release of the portfolio's reserves and the corresponding loss on sale, the company recorded a net economic loss of $500,000 from the transaction. This sale allowed the company to take on additional commercial finance loans as we continue to execute on our core strategic pillar, optimizing interest earning assets to emphasize higher return assets. Next in September, we completed a $20 million subordinated debt offering. The proceeds will be used to strengthen our capital levels allowing for continuous return of capital to shareholders through share repurchases and dividends. Finally, the United States federal government recently passed the Inflation Reduction Act. A key item of this legislation is increased incentives for green energy projects including solar panels. Pathward is a leading lender in the solar industry and we believe this legislation will benefit our business going forward. During our last quarter's update, I mentioned the strain on our solar lending volumes due to supply chain issues impacting the industry. As these issues continue to improve, coupled with these enhanced incentives from the Inflation Reduction Act, we anticipate our solar lending volumes could be revitalized in the years ahead. Turning to our commercial finance portfolio, our team continues to deliver strong loan growth. As of September 30th, 2022, commercial finance loan balances totaled $3 billion, representing an 11% increase from last year and a 3% increase from the end of the third quarter. With fears of a stagflation economy lingering, we want to reiterate our confidence in our loan portfolio and yields in such an environment. First, rising rates will provide higher yields as our variable loans reprice and new business comes in at greater interest rates. We are starting to see the benefits of the rising rate environment in our yields, especially now that almost all our variable rate loans are through their floors. However, given how quickly and sharply rates have risen, we expect the full benefits will take some time to be realized. Second, as we move through the credit cycle and companies lose access to their traditional funding sources, we have the opportunity to fill their lending needs and provide a financial path forward for these businesses. In summary, our financial results continue to demonstrate that our optimization strategy will produce outsized returns of capital to our shareholders. Moving into fiscal year 2023, we remain focused on our key strategic pillars of asset optimization, deposit optimization, and operational simplification. With respect to our financial expectations for fiscal year 2023, we are affirming our guidance of 2023 GAAP earnings per share in the range of $5.25 to $5.75. Adjusting for non-recurring items, net of tax, this translates to an adjusted earnings per share between $5.10 to $5.60. We expect to wrap-up all rebranding related expenses in the first quarter of fiscal year 2023. In total, we continue to expect rebranding expenses to be between $15 million to $20 million. Finally, before I turn it over to Glen Herrick, our CFO, I want to comment on the CFO succession plan we announced today in conjunction with our earnings release. The company has appointed Sonja Theisen, currently Executive Vice President of Governance Risk and Compliance and previously Pathward's Chief Accounting Officer and then Chief of Staff to succeed Glen as CFO. Glen and Sonja will work together over the next six months to ensure a seamless transition effective April 30th, 2023. The Board and I have complete confidence in Sonja to take the reins of CFO given her track record of achievement in her near decade at Pathward. Glen, on behalf of the entire Pathward team, I want to thank you for your invaluable contributions to the company over the last decade. You played an essential role in building Pathward into a leading banking-as-a-service company, while molding a world-class finance and accounting team. I want to personally thank you for your years of experience and your insights and for your help to me as CEO. I, your colleagues, and our Board express our sincere appreciation for your efforts and wish you continued success. With that, over to you Glen to provide an overview of our financials.

Glen Herrick, CFO

Thank you, Brett and good afternoon, everyone. Before I talk about our results, I want to thank Brett, our Board, and my entire team for the opportunity to be part of an amazing journey at Pathward over the last 10 years. It's been a privilege to work alongside you all and I could not be prouder of our achievements. I would also like to thank our former CEO, Tyler Haahr, who first gave me the opportunity to join this company. During my tenure, I worked closely with Sonja to shape and execute on our strategic and financial priorities. She is extremely qualified to assume the CFO role, the next logical step in her evolution at the company, and I look forward to working closely with her to ensure a smooth transition. As Brett mentioned, I will serve as CFO until April 30th, 2023 and therefore fiscal Q2 2023's earnings in April will be my last earnings call. As an ongoing shareholder, I believe Pathward's best days still lie ahead and I am looking forward to seeing what this team will do. Now, on to our results. Net income for the quarter ended September 30th, totaled $23.4 million, or $0.81 per share, an increase of $7.5 million from the prior year. For fiscal year 2022, earnings of $156.4 million or $5.26 per share increased $14.7 million compared to fiscal year 2021. Adjusting for one-time items net of their tax impact, earnings were $30.3 million or $1.04 per share and $133.6 million or $4.49 per share for the fourth quarter and fiscal year respectively. For reconciliation to GAAP earnings, please see the appendix of the investor presentation. Relative to the prior year, net interest income in the fourth quarter increased 13% to $79.8 million. The year-over-year increase was driven by greater yields on our loan and investment securities portfolios and an improved earning asset mix. At the end of fiscal year 2022, the company had $3.5 billion of loans, down from $3.6 billion in the prior year. The decline was due to the sales of the Community Bank and the student loan portfolios. Overall, net interest margin in the fourth quarter expanded to 5.21% from 4.35% in the prior year. During the fourth quarter, the company recorded a reversal of provision for credit losses of $2.6 million. This reversal was driven by a $4.3 million reserve release related to the sale of the student loan portfolio. In addition, our commercial finance loan and lease portfolio remains healthy with strong asset quality metrics, especially after resolving a few troubled assets. Despite uncertainty throughout the broader macroeconomic environment, we remain comfortable with our reserve levels and will continue to diligently monitor and adjust in future periods as necessary. Non-interest income of $43.5 million in the fourth quarter declined $6.1 million from the prior year. The decrease was primarily driven by reductions in the gain on sale of government guaranteed loans and due to the initial investment gain on the company's investment in MoneyLine following their SPAC merger in the fourth quarter of fiscal year 2021. In addition, the fourth quarter included a pre-tax $1.9 million loss on sale of a venture capital investment, as well as a pre-tax $4.8 million loss on the sale of the student loan portfolio. Offsetting the reductions was payments fee income, which grew $3 million from the prior year. Total non-interest expenses for the quarter increased 10% from the prior year, adjusting for $6.9 million of pre-tax rebranding related expenses and $1 million in separation related costs, core expenses increased 2% year-over-year. The expense increase stemmed from greater compensation and card processing expenses. As interest rates rise, the company will incur higher card processing expenses due to contractual agreements with some of our banking-as-a-service partners. For the fiscal 2022 fourth quarter, card processing expenses related to the structured agreements were $7.4 million. That being said, we expect the increase in this expense to be lower than the corresponding revenue lift and as a result, the company expects to expand earnings as interest rates rise. At the end of September, we closed a large solar loan that provided significant tax credits on our quarterly and full-year financials. Due to this transaction, our effective tax rate of 15.2% in fiscal year 2022 was below our previous guidance assumptions and consequently pushed our earnings above the high end of our guidance range. As Brett stated in his remarks, we are reiterating our guidance for fiscal year 2023. GAAP earnings for 2023 are expected to be between $5.25 and $5.75 per share. Adjusting for the remaining gain on the trademark sale and its corresponding expenses, we expect adjusted earnings per share between $5.10 and $5.60. We remain confident about this guidance and plan to update our fiscal year 2023 outlook if needed, at our next quarterly earnings call. On September 26th, we announced the issuance of $20 million of subordinated debt to further strengthen our capital levels. In the quarter we repurchased 573,000 shares at an average price of $37.05. Through October 13th, we repurchased an additional 396,000 shares at an average price of $35.16. There are 3.9 million shares left for repurchase under our currently authorized plan. Finally, the company remains well-capitalized with a regulatory leverage ratio for the bank of 8.2% and we remain committed to returning capital to shareholders. That concludes our prepared remarks. Operator, please open up the line for questions.

Operator, Operator

Thank you. We will now start today's Q&A session. Our first question today comes from Tim Switzer from KBW. Your line is now open.

Tim Switzer, Analyst

Hey, good afternoon. I'm on for Mike Perito. Thank you for taking my question.

Brett Pharr, CEO

Hey, good afternoon.

Tim Switzer, Analyst

My first question was with you guys reiterating guidance, and a little bit move up in expenses this quarter, what is the kind of like embedded expense guide you guys have in there? And what are really the big drivers near-term? Sounds like the card processing might be one of them. But what about some of the other large items?

Brett Pharr, CEO

Yes, Glen why don’t you take that. I mean, I think card processing is part of it, but you even talk about that.

Glen Herrick, CFO

Yes, hi Tim. As we’ve discussed, we will see higher card processing expenses in a rising interest rate environment. However, we anticipate even greater income from both interest and fee revenue in this environment. We are confident in our current guidance and plan to provide an update during our January call. One aspect that is quite unique this quarter is that our rates have not increased at this pace since the early 1970s. We would like to have a better outlook on loan demand, but higher rates will be beneficial for us.

Tim Switzer, Analyst

It seems you need to evaluate how the economy is trending in 2023 before you can determine where things will land. Is there an efficiency ratio you think you can aim for? Would that be a better question?

Glen Herrick, CFO

Our efficiency ratio varies depending on the mix of our earnings. Our lending businesses maintain efficiency ratios well below 50%. In contrast, our payments businesses, which include core card, prepaid, and tax payments, have typical efficiency ratios in the high 70% range and do not have provisioning. We expect our expenses to cause some fluctuations in the efficiency ratio, but it will likely remain close to what it has been over the last couple of quarters.

Tim Switzer, Analyst

That's helpful. There has been good margin expansion this quarter, and we've reached the interest rate floors. Were the floors still significantly impacting the net interest margin in the last quarter? Can we expect even more expansion next quarter? How should we approach that?

Brett Pharr, CEO

There are many factors to consider here. We have moved beyond the floors, with some being as high as 7%, which supports your point. However, many of our transactions are shorter duration fixed rate. What we are beginning to observe is that rates are actually increasing in the market. Last quarter, we noted that many deals were being priced with thinner margins due to the abundance of liquidity, causing us to either refrain from participating or to participate at lower prices than expected. This trend is starting to shift, and we are beginning to see changes, but we are not ready to confidently predict widespread expansion of net interest margins just yet. We need to continue observing the marketplace.

Glen Herrick, CFO

But overall, Tim, our net interest margin will increase next quarter. It's just a matter of time.

Tim Switzer, Analyst

Right. Okay. Understood. And then just a broader question for you guys. Can you talk a little bit about what you're seeing in kind of the best competitive landscape, and which opportunities seem most attractive to you? And how does the pipeline look?

Brett Pharr, CEO

We've been in a phase where the entire market has been focused on neobanks and FinTechs, which are indeed fascinating and create a lot of buzz. However, as we've mentioned, 80% to 90% of our revenue comes from larger, established participants in program management within the industry, and that remains true. We have observed a few developments, which aren’t surprising. Those companies backed by venture capital are hesitant to engage in new initiatives, and it's understandable given the circumstances. Additionally, some banks that have recently explored banking-as-a-service are beginning to face regulatory challenges. We believe we are well-positioned to move forward; there are still strong programs in place. We recently returned from Money20/20, where there was significant enthusiasm, particularly from our established partners and major players in the consumer sector. Overall, we feel optimistic about our pipeline, but I wouldn't say it's overwhelmingly positive since it includes fewer FinTechs.

Tim Switzer, Analyst

Great. I appreciate the color. Thank you guys.

Operator, Operator

Now, our next question today comes from Frank Schiraldi from Piper Sandler. Please go ahead.

Frank Schiraldi, Analyst

Hey guys.

Brett Pharr, CEO

Hey Frank.

Frank Schiraldi, Analyst

I'm curious about the guidance for next year. You reiterated your expectations, but I noticed there seems to be minimal growth anticipated in the renewable energy sector, especially considering the recent legislative updates. Given the signs of improvement in that area, why do you think those positive developments aren't leading to higher expectations for next year? I'd appreciate your thoughts on this.

Brett Pharr, CEO

Yes, I mean, I think that legislation gives us intermediate to long-term optimism for it. You still have a couple of other things going on. You still have some supply chain issues that are going on and that are impacting some of these projects. I'm hopeful that that will eventually get washed out, but that's been going on for quite a while. The other thing is because this is becoming more mainstream, we're getting more players. And so the pricing and the yield of these transactions is not as high as it once was. And so we're going to continue to watch it. I think we will have more than we had during the dry spell during this year. But I'm not sure it's going to return to the former glory that we had in years past.

Frank Schiraldi, Analyst

Okay. And in terms of growth on the commercial finance side, obviously, there's a lot of macro uncertainty over the next six months, a year. But just curious in the past, you've talked about sort of a mid-teen growth rate in that business. You were a little below that this quarter, I know the factoring in ABL balances can jump around a bit, they were down last quarter. So, just curious if that still as a bogey, kind of, makes sense to think about in terms of growth on the commercial finance?

Brett Pharr, CEO

Yes, I mean your growth percentage there, you're starting to have a much larger base. So, it might be in the low two-digits like we had this past year, some of that depends on what happens in working capital. ABL and factoring, the same client sales as we go into the slowdown are going to drop. The real secret for growth there is going to be migration of companies from traditional C&I, down to our ABL and factoring types of transactions. That's where we will get the growth and I anticipate over the next year and 18 months, and that could be significant. But I don't know, we have to wait to see it. Everybody's talking about problems, nobody's seen problems yet. And so that's where we're waiting to find out.

Frank Schiraldi, Analyst

Right, okay. And then just given the size of your portfolio, obviously, you had an additional mark AOCI, which doesn't do anything to regulatory capital, but reduces the TCE ratio and tangible book value per share. So, just wondering how you guys look at that, if at all, in terms of does that impact your appetite for buybacks at all? And is it just strictly accounting in your minds? How do you think about that?

Brett Pharr, CEO

Glen, go ahead.

Glen Herrick, CFO

Sure. Regulatory capital, both leverage and risk weights is really our driver that we look at. We keep an eye on the tangible capital, we have ongoing discussions with our regulators. AOCI and the calculations for tangible capital are, to me, antiquated; they don't value the whole balance sheet. You think of the value of our deposit base today and other things that sit on both sides of the balance sheet. And then you look at the liquidity we have, we have $1.3 billion of off-balance sheet deposits that are callable by us at any time at zero cost back to us. We feel really good about our liquidity position, securities portfolios kicking off almost $300 million a year in just scheduled amortization. So, we really don't see it impacting anything that we do in business operations or capital management in our outlook.

Frank Schiraldi, Analyst

That's reasonable. Lastly, I noticed that in your commercial finance book, there was some movement into substandard classifications this quarter. I'm curious if this trend raises any concerns for you or if it's just noise. Any insight on that?

Brett Pharr, CEO

Yes, we disclosed about a year ago that we adjusted our risk rating approach to be more sensitive to fluctuations in cash flow. There are a few transactions that, while they are well-secured and highly collateralized, experienced a cash flow issue. As a result, we adjusted their risk rating downwards, which I believe was around a $20 million change. However, there is nothing significant in that. I want to emphasize that we are a highly secured collateralized lender, so we do not have unsecured debt that is below standard.

Frank Schiraldi, Analyst

Right, okay. Okay, great. Thanks for all the color.

Brett Pharr, CEO

Thank you.

Operator, Operator

There are no further questions at this time. I will now hand you back over to Brett Pharr for closing remarks.

Brett Pharr, CEO

All right. Well, thank you. We appreciate everybody listening today and your interest in our company, and I look forward to talking to you again soon. Thanks so much.

Operator, Operator

That concludes today's Pathward Financial fourth quarter and fiscal year 2022 investors conference call. You may now disconnect your line.