Finwise Bancorp Q4 FY2022 Earnings Call

Greetings and welcome to the FinWise Bancorp Fourth Quarter 2022 Earnings Conference Call. All participants are currently in a listen-only mode. A question-and-answer session will take place after the formal presentation. This conference is being recorded. I will now turn the conference over to management.

Good afternoon, and thank you for joining us today for FinWise Bancorp's fourth quarter 2022 conference call. In addition to this call, we issued an earnings press release earlier this afternoon and posted it to the Investor Relations section of our website at investors.finwisebancorp.com. Today's conference call is being recorded and webcast on the company's website investors.finwisebancorp.com. On today's call, management's prepared remarks and answers to your questions may contain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ from those discussed today. Forward-looking statements represent management's current estimates and FinWise Bancorp assumes no obligation to update any forward-looking statements in the future. We encourage listeners to review the more detailed discussions related to these forward-looking statements contained in the company's earnings press release and filings with the Securities and Exchange Commission. Hosting the call today are Mr. Kent Landvatter, CEO and President of FinWise Bancorp; Mr. Javvis Jacobson, Chief Financial Officer; and Mr. Jim Noone, Chief Strategy and Chief Credit Officer. With that, I will turn the call over to Mr. Landvatter.

Good afternoon, everyone, and thank you for joining us on our fourth quarter 2022 earnings conference call. On today's call, we will provide an update on our financial results and share some perspective on the current operating environment and the continued evolution of our business model. During 2022, we executed well in substantially all facets of our business even in its rapidly deteriorating economic environment. Our differentiated and diverse business model coupled with strong execution by our team members allowed us to navigate these macro headwinds and continue to deliver solid loan originations, profitable growth, and industry-leading returns. Specifically for the full-year 2022, we generated revenue of $89.7 million, net income of $25.1 million, and diluted earnings per share of $1.87. We also ended the year with solid Q4 results, particularly given the more challenging macro environment. Total revenue was $23.0 million during Q4, led by loan originations of $1.2 billion. Net income for Q4 was $6.5 million, compared to $3.7 million in the prior quarter, and diluted earnings per share were $0.49 for Q4, compared to $0.27 for the previous quarter. We also maintained robust profitability measures, including a return on average equity of 19.1% during the quarter. We were also good stewards of capital as we continued to buy back our stock below tangible book value, which is accretive to earnings per share and tangible book value per share. Overall during ‘22, we bought back a total of 120,000 shares for approximately $1.1 million. We plan to continue to be opportunistic with our capital deployment strategy, including our share buyback strategy. Positively in Q4, the company's tangible book value per common share continued to grow to $10.95 per share, a 21.1% increase over the prior year period. Although the macro environment is widely expected to remain challenging in 2023, we plan to continue to proactively build on our success and reinvest in the company to help build diversity of income and funding streams, so that we can remain well-positioned for continued sustainable and profitable long-term growth, particularly once the environment improves. This includes identifying different ways to utilize our balance sheet, including prudently adding credit risk in a way that gives us more stability in earnings. To that end, I'd like to provide you with some thoughts to help you understand how we are thinking about key objectives, including how we plan to continue to navigate a potentially challenging macro environment in 2023. As we highlighted on prior calls, the environment for loan originations decelerated rapidly throughout 2022 across the industry, and FinWise was not immune. This same pattern continued in Q4 2022, and without a significant improvement in the macro environment, we would expect this trend to continue into 2023. Going forward, we plan to remain focused on our strategic programs business where I am pleased to say that our relationships with existing platforms remain strong. This also includes engaging with and working towards launching additional strategic programs, particularly as we continue to see strong interest from potential new platforms. However, it is important to highlight that in addition to the previously mentioned pressure on originations from a tougher macro environment, the revenue benefit of FinWise from potential new strategic programs in any given year is typically delayed due to: one, the 90 to 120 days it has generally taken to launch a strategic program; and two, the normal operating period before we start seeing originations come through for the new program. As we also mentioned on last quarter's earnings call, we expect to continue to originate and hold the guaranteed portion of certain SBA 7(a) loans, which, although a headwind to the company's SBA gain on sale, we expect will result in stronger held for investment loan growth and an incremental tailwind to our net interest income over the long term. We are also looking to further develop our leasing business, which would be an expansion of the line of business we have had in place since 2011. We see this as a great opportunity to expand our traditional product set and further diversify our revenue model. During Q4, we experienced a pickup in expenses driven partly by higher employee headcount and increased business infrastructure spend, which, along with a deceleration in originations and revenue, caused our efficiency ratio to increase. As we have mentioned on prior calls, our efficiency ratio is likely to increase as we expect to continue to build out infrastructure, including back office, and also expand our FinTech offerings. Our team will continue to assess the natural evolution of our business model, including three components of banking-as-a-service: lending, deposits, and payments. We have also made some key hires to support the growing bank. For example, Meg Taylor joined us recently as Senior Vice President and Chief Accounting Officer. We plan to remain opportunistic in terms of hiring best-in-class talent, especially as we evolve towards more banking-as-a-service products. Importantly, we intend to focus on making investments in the company that are carefully designed to deepen relationships with our current customers, while helping us to be well prepared to quickly capitalize on growth opportunities, particularly when the macro environment becomes more supportive. Having said that, we will also focus on managing expenses prudently and making decisions accordingly, keeping in mind tougher economic conditions. We also plan to maintain our disciplined approach to underwriting and overall strong risk management in order to sustain sound credit quality through varying credit cycles. So far, we remain pleased with the overall credit performance of our portfolios, as we have not seen any outsized deterioration aside from the expected gradual industry-wide normalization of credit to pre-pandemic levels. All of you on this call, who have been following our story, may recall that we proactively slowed strategic program loan retention in our sub-36% held for investment portfolio early in 2022. Importantly, while reducing these balances has the effect of increasing our ratio of net charge-offs as a percentage of total loans given the denominator effect of lower balances, it does not necessarily imply that we are seeing significantly faster-than-expected credit normalization. As I have mentioned before, we do not intend to sacrifice credit quality for the sake of growth. That said, any further deterioration to the U.S. economy from current levels could drive faster-than-expected industry-wide credit quality normalization. Overall, while we acknowledge the risk of further economic deterioration, we believe that we are well positioned to navigate such a scenario. Moreover, we remain focused on maximizing long-term shareholder value. But in order to do that, we plan to proactively build for the long-term, while continuing to work with our strategic programs and serve our clients. By doing this, we believe we will position the company to capitalize on growth opportunities that emerge once the market environment stabilizes. With that, let me turn the call over to Javvis Jacobson, our CFO, who will provide you with more detail on our financial results.

Thank you, and good afternoon. As Kent mentioned, for the full-year 2022, we grew our balance sheet and delivered meaningful net income of $25.1 million, or $1.87 per diluted common share. We also posted solid profitability as we generated a return on average assets of 6.4% and return on average equity of 19.6% for the year ended December 31, 2022. Let's turn to Q4 results. Loan originations totaled $1.2 billion during Q4, compared to $1.5 billion in Q3 ‘22 and $2.3 billion in Q4 ’21. Average loan balances comprising held for sale and held for investment loans were $261.4 million during Q4, as compared to $263.6 million in Q3 ‘22 and $286.8 million in Q4 ’21. Total average interest-earning assets were $354.4 million during Q4, compared to $335.4 million for Q3 ‘22 and $367.6 million for Q4 ’21. As Kent noted earlier, the industry-wide deceleration in originations continued in Q4, and FinWise generally follows a similar pattern. Without a significant improvement in the macro environment, we expect this trend to continue as we move into 2023. Average interest-bearing deposits were $126.1 million during Q4, compared to $104.8 million during Q3 ‘22 and $148 million during Q4 ‘21. The increase from Q3 ‘22 was driven mainly by an increase in interest-bearing demand deposits, partially offset by a decline in money market deposits and certificates of deposit. The decrease from the prior year period was driven primarily by a decline in certificates of deposit and money market deposits, partially offset by an increase in interest-bearing demand deposits. As we have noted previously, non-interest-bearing deposit levels generally have a high correlation with origination volume. Let's look at the income statement. Net income was $6.5 million in Q4, compared to $3.7 million in Q3 ‘22 and $10.1 million in Q4 ’21. The sequential quarter increase was primarily driven by a higher gain on sale of loans, lower provision for income taxes, and a lower provision for loan losses, partially offset by higher non-interest expense. Net interest income for Q4 was $12.6 million, compared to $12.5 million for the previous quarter and $15.3 million during Q4 ‘21. The change relative to the prior year period was driven primarily by lower average loans held for sale balances. Net interest margin for Q4 was 14.27%, compared to 14.93% in Q3 ‘22 and 16.62% in Q4 ‘21. The sequential quarter decline was primarily driven by lower average balances in the loans held for sale portfolio and a shift of the deposit portfolio mix from lower-cost deposits to higher-cost deposits. The net interest margin decreases from Q4 ’21 were driven mainly by lower average loans held for sale balances and an increase in higher-rate deposit balances. As we've noted on prior calls, we expect our net interest margin to fluctuate from quarter to quarter due to shifts in our asset mix. Non-interest income was $9.8 million in Q4, compared to $7.5 million during the previous quarter and $9.1 million in Q4 ‘21. The sequential quarter change was driven primarily by a one-time gain on sale of loans recorded to establish a new loan trailing fee asset of approximately $2.3 million, and an increase in the fair value of our business funding group, LLC, BFG investment, partially offset by lower strategic program fees due to a decrease in loan origination volumes. Certainly, this one-time adjustment impacted some of our after-tax metrics during the quarter. This increase compared to Q4 ‘21 was primarily due to an increase in gain on sale of loans, partially offset by a decline in strategic program fees resulting primarily from lower originations. We expect the fair value of our investment in BFG will continue to experience quarterly fluctuations, partially driven by general market improvements. Loan trailing fees refer to revenue generated from sold strategic program loans that are still performing. Non-interest expenses rose to $10.2 million, compared to $8.5 million in Q3 ‘22 and $8.4 million during Q4 ’21. The pickup compared to the previous quarter was primarily due to an impairment on the company's SBA servicing asset in Q4 and higher employee headcount related to developing and upgrading new and existing technology and business infrastructure. Relative to Q4 ‘21, the increase was mostly due to increased professional services relating to primarily to an increase in consulting fees and increased depreciation from the build-out of our corporate office, which was partially offset by a decrease in salaries and employee benefits. The company's efficiency ratio was 45.6% during Q4, versus 42.3% in the prior quarter and 34.3% during Q4 ’21. As we've noted in past calls, we expect the company's efficiency ratio to continue to increase gradually as we continue to build out our infrastructure to position the company for sustainable long-term growth. We will strive to be prudent with expenses in light of a tougher macro environment. Credit quality remained solid with non-performing loans to total loans of 0.1% at the end of Q4, compared to 0.25% for Q4 ’21. The company did not have any non-performing loans as of September 30, 2022. The company's provision for loan losses was $3.2 million for Q4, compared to $4.5 million for Q3 ‘22 and $2.5 million for Q4 ‘21. The sequential quarter decline in provision was primarily driven by a decrease in strategic program loans held for investment. The increase compared to the previous year is primarily driven by higher net charge-offs and growth of unguaranteed loans held for investment. Net charge-offs for Q4 were $30.2 million, compared to $3.1 million in the prior quarter and $2.3 million for Q4 ’21. The company's net charge-off rate as a percentage of average loans for Q4 was 4.9%, compared to 4.7% for Q3 ‘22 and 3.2% for Q4 ’21. The change in net charge-offs for Q4, compared with the prior quarter, was primarily driven by higher net charge-offs related to strategic programs. The change in net charge-offs for Q4 compared to Q4 ‘21 was primarily driven by some normalization of credit losses to pre-pandemic market conditions and growth in unguaranteed loans held for investment balances. Importantly, while net charge-offs this quarter represent the higher end of our historical range over the past several years, they remain in line with our expectations. As Kent mentioned earlier, the primary reason for the pickup in our ratio of net charge-offs to average loans is due to our proactive effort to lower balances of sub-36% held for investment loans since early 2022, as we deemed the risk-reward on these loans to be less favorable compared to the rest of our portfolio rather than faster-than-expected credit quality normalization. Given our team's experience and the data advantages of our business model, we have been exposed to credit across a wide range of different quality tranches and segments, which has enhanced our ability to price risk appropriately and create value through the underwriting process. Overall, we remain prudent in our underwriting process and we expect to maintain our already tight underwriting standards that impact our reserve levels. As of the end of Q4, the bank's capital levels remained strong and significantly above the 9% well-capitalized guidelines, with a 25.1% leverage ratio. The company's effective tax rate was 27.3% for Q4, compared to 48.7% for Q3 ‘22 and 25.3% for Q4 ’21. With that, I would like to open up the call for Q&A.

Thank you. We will now be conducting a question-and-answer session. Our first question comes from Andrew Liesch with Piper Sandler. Please proceed.

Hey, good afternoon, everyone.

Hi. How are you doing?

Hi, Andrew.

Thank you, everyone. I want to discuss the construction of the balance sheet. Given that production from strategic programs is likely to decrease, are you anticipating that the held-for-sale portfolio will keep declining? Where do you see a good level for that to stabilize? Additionally, regarding the held-for-investment portfolio, which is showing strong growth, is it expected to continue increasing at a double-digit non-annualized rate?

Andrew, this is Javvis. I'll address that question. The loans held for sale are closely linked to our loan originations, and we can discuss that further later. We've observed a decline in loan originations from one quarter to the next, which you might want to consider as a reference point. Regarding the loans held for investment, we are still experiencing robust originations, particularly in areas like SBA lending and our local lending product. This growth has been strong, and as long as conditions remain stable, it seems likely that this trend will continue.

I see. If I look at production, total originations have decreased by 19% from the previous quarter, and the portfolio held for sale has nearly halved. At some point, I would expect this to reach a floor level, or might it continue to trend towards zero given the current trajectory of originations? Or is the plan to sell everything and not retain any as origination levels decline?

Yes, Andrew. I think it's more insightful to look at the average loans than the ending balance as we've talked about before on those held for sale balances that could just have been dependent on the day of the week where the quarter ended. But if you look at the loans held for sale average balances quarter-over-quarter, we went from $50.5 million to $43.7 million, not quite has decreased, not a drastic decrease. And then I don't know, you wanted to talk about, Jim?

Yes, sure. On originations, Andrew, they continue to be challenged just because of the impact of capital markets on our larger partners. So also many of our partners proactively pulled back on originations. I think we talked about some last quarter due to the uncertainty around inflation and the rate environment. But I think as Javvis was referencing, there was a quarterly decrease we saw in Q4 that slowed versus the prior quarter. But it's tough to say whether the deceleration in the trend line will continue, or whether there will be renewed pressure on originations. But we're keeping an eye on it and proactively work with our partners to support them.

Got you. And then just a question on expenses here recognizing the hiring and building for the future. But if I take out the fair value SBA servicing asset mark, about $9.4 million, is that a good number to build off of going into ‘23?

Yes. As we've mentioned in the past, we plan to continue to invest in the company. So we're ready for this spring back when the macro becomes more supportive. So yes, I think the way you're thinking about it makes sense.

Got it. All right. Thanks for taking the questions. I'll step back here.

Thanks, Andrew.

Yes.

Our next question comes from the line of Andrew Terrell with Stephens, Inc. Please proceed.

Hey, good afternoon.

Hey, Andrew.

Hey, Andrew.

Hey, maybe if I could start with Kent, I think you gave a lot of good color in some of the opening remarks just around, how you're thinking about the business model into future years. I was hoping just to maybe get a little more color there. I don't know the best way to phrase the question from a timing standpoint, but if we look over the next kind of one, three, five years, I know we talked about, you mentioned the three components of that including payments, you mentioned the leasing business, there are obviously incremental partners that you would like to bring onboard? I'm sure, can you just talk about over the next kind of few years how we should be thinking about the growth and the development of your franchise?

Yes, absolutely. To start, I want to emphasize that despite the challenging economic conditions in the past year, we are confident that our business model will continue to perform as expected. We believe that maintaining our execution strategy will be beneficial for us moving forward. When I mention investing in the company, it aligns with the evolution of our business model that we have outlined since going public. Importantly, we have not changed our approach due to the current macro environment; we view this as a natural progression in our development. As we consider this, we aim to build an infrastructure that not only integrates us further into the banking-as-a-service sector but also positions us to excel when the market rebounds. I want to add from my experience that banks that are well-prepared before a downturn and continue to build during it generally emerge stronger when the economy improves, and that is what we are aiming for. Regarding your question about specific outcomes and timing, we cannot provide precise guidance at this time, but I can share that this year we are keenly focused on deposits, payments, and enhancing the lending features of our banking-as-a-service offerings. We will keep you updated on our progress, as it remains a primary focus in the natural evolution of our bank.

Understood. That's very helpful. I appreciate it. As we think about kind of specifically in the payments arena. Would you be interested in acquisitions or in order to kind of develop the payments type offering? Or are we talking more just kind of incremental partnerships with the bank?

We are considering not only new partnerships at the bank that will allow us to strengthen our existing relationships but also exploring additional opportunities beyond that. For now, our focus is on what I just mentioned.

Understood, okay. Can you maybe just speak briefly about appetite for capital return, I saw you were active on the buyback in the fourth quarter. I'm presuming just given where capital levels are at today and the valuation that that would remain the case moving forward, but I would love to hear just updated capital kind of return thoughts?

Yes. So let me start, and Javvis, if you want to add anything, please feel free to do so. But we feel that when you're buying yourself, investing in yourselves basically as especially at the low tangible book value, that was a really good move for the bank and for the shareholders. I think that we will consider that strongly going forward. This is a decision made by the Board, but we've been very active, and the one thing, as I've mentioned before, is we just want to make certain that we have enough capital should some opportunity arise and that we don't find ourselves short on something like that.

Okay. Got it. And then last one for me, just on the SBA gain on sale. I think once I make the $2.3 million adjustment this quarter, I get the run rate of call it $1.9 million or so for the fourth quarter. I guess just with incremental SBA loan retention, I presume going forward. Is that a fair way to think about the quarterly cadence of SBA gain on sale income throughout 2023 that kind of $1.9 million level?

So Andrew, we're not giving the forward guidance, but I think that you can look at our trend and see that it is declining quarter-over-quarter and has been declining quarter-over-quarter. As the interest rates continue to increase, we saw another bump in the interest rate for that portfolio on the first of January 2023; it just makes it that much more compelling to retain those loans without selling them.

Okay. Understood. All right. Thanks for taking the questions, and I'll step back.

There are no further questions at this time. This will conclude today's conference. You may disconnect your lines now. Thank you for your participation.

Thank you.