Greetings, and welcome to FinWise Bancorp Fourth Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. At this time, I would now like to turn the floor over to the FinWise Bancorp team. Thank you. You may begin.

Good afternoon. Thank you for joining us today for FinWise Bancorp's fourth quarter 2023 conference call. Earlier today, we filed our earnings release and posted it to our investor 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, expectations, and beliefs, 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 Kent Landvatter, CEO and President of FinWise Bancorp; Jim Noone, President of FinWise Bank; and Javvis Jacobson, Chief Financial Officer. With that, I will turn the call over to Kent.

Good afternoon, everyone. And thank you for joining us on our fourth quarter 2023 earnings conference call. 2023 was another successful year as our differentiated business model, coupled with a disciplined approach and strong execution, continued to demonstrate resilience. We produced solid loan originations and delivered positive returns. Specifically, for the fourth quarter, we had approximately $1.2 billion in loan originations. Credit quality continued to perform as expected and generally in line with industry trends, notwithstanding an increase in non-performing loans in the fourth quarter. This increase was driven primarily by the continued impact of higher rates on our SBA loan portfolio. While our collateral and portfolio management processes continued to serve us well, the level of net charge-offs increased quarter-over-quarter. We continue to feel positive about the SBA portfolio, its growth and credit characteristics, and the level of net charge-offs at the bank, which have been generally in line with our expectations. Turning to capital. At the end of the fourth quarter, our bank leverage ratio remains significantly above well-capitalized regulatory guidelines, which we believe provides us with sufficient capital to continue to support growth. Tangible book value per common share also continued to increase this quarter. I would now like to provide a brief update on our key objectives for 2024 and beyond. Our previously communicated strategy of expanding into an integrated Banking as a Service bank or BaaS bank continues to make meaningful progress. To that end, we are very excited about our Payments Hub and BIN Sponsorship platforms, which are expected to be operational later in the year. This provides us with key pieces for an integrated BaaS offering. We firmly believe that an integrated BaaS infrastructure, coupled with the strength of our regulatory due diligence and oversight functions, are key differentiators in the market. Longer term, we also believe this expansion could create stickier relationships with our strategic platforms and offer multiple benefits to our business model. These could include additional recurring revenue, diversifying both revenue and deposit composition, more tools to manage our cost of funds through relationship banking, and providing additional flexibility to manage our loan mix. This past quarter, we also completed an internal core system conversion as part of our overall business evolution. We believe this conversion should increase our operational efficiency and better position us to meet the needs of our growing organization. Our team worked diligently to complete this process by quarter end, and I want to thank them for their effort. Turning to our SBA 7(a) loan program. We are pleased that the business continues to grow and perform as we expected, particularly amidst the higher rate environment that these credits have been managing through. While some market participants expect a potential economic soft landing, we believe uncertainties remain, at least through the first half of 2024, which could impact industry-wide loan originations across all the bank's lending products. The external environment, notwithstanding, we will remain disciplined and continue to actively manage areas of the business we can control, including our strict underwriting and collateral management processes. As we move ahead, we believe we're at an inflection point in the evolution of our model with the potential to enhance the company's long-term earnings power. We plan to continue our efforts to expand the business towards an integrated BaaS offering coupled with continued focus on our existing lending programs. In line with our culture, we will be patient and disciplined in our approach to rolling out the new businesses and expect the benefits to accrue over time.

Thank you, Kent. I will now walk through some additional detail on the quarterly originations, the growth and performance of our loan portfolio and credit quality, and then discuss progress on our business initiatives. Total loan originations were $1.2 billion in Q4 versus $1.1 billion in Q3. Our fintech lending continued a gradual recovery in origination levels during the fourth quarter. Our SBA 7(a) loan originations during the fourth quarter were lower on a sequential quarter basis, primarily due to reduced application demand for the types of transactions we generally finance as well as our continued adherence to disciplined underwriting. We did not chase loan volume, as we always focus on balancing loan growth with credit quality. And as a result, we saw our SBA pipeline contract some quarter-over-quarter. Moving to our portfolio. Our growth in earning assets has continued according to plan. We continued to retain the guaranteed portion of our SBA loans, given the current dynamics where the underlying note rates remained high and secondary market loan sale premiums remained low. On a sequential quarter basis, the 17.1% increase in guaranteed balances of our SBA loans was the primary driver of the 10.2% growth in total loans held for investment. Overall, we continue to be successful in identifying and funding creditworthy businesses in both our SBA and leasing lines, and both contributed meaningfully to our growth in earning assets. Turning to credit quality. The provision for credit losses was $3.2 million in Q4 compared to $3.1 million in the prior quarter. The sequential increase in provision was driven primarily by strict adherence to our CECL methodology, an increase in net charge-offs in our SBA portfolio, and an increase in the qualitative factor overlay that was implemented during Q3 and which remained in place due to the increase in special mention, nonaccrual, and nonperforming assets. During Q4, net charge-offs were $3.4 million compared to $2.2 million in the prior quarter. The increase was primarily related to our SBA portfolio. As a reminder, during Q3, we had a large recovery of $390,000. The net charge-off rate as a percentage of average loans held for investment was 3.8% in Q4 compared to 2.8% in the prior quarter. We continue to believe we are well-reserved for potential loan losses, with an allowance as a percentage of total loans held for investment of 3.5% at the end of Q4. Nonperforming loans at the end of Q4 were $27.1 million compared to $10.7 million at the end of the prior quarter. Of the $27.1 million, $15 million is guaranteed by the SBA, and $12.1 million is the balance of loans, which do not carry SBA guarantees. The increase in NPLs versus the prior quarter related primarily to our SBA portfolio, as this program continued to be impacted by the higher interest rate environment. As a reminder, our SBA note rates adjust quarterly based on a spread over the Wall Street Journal prime rate in place at quarter end. We expect to see additional increases in our NPL balances while the prime rate remains elevated. Further, while $12.1 million of our NPL balances do not carry SBA guarantees, we believe our strict collateral policies in this portfolio should continue to help mitigate net charge-offs. Finally, let me give you an update on our business initiatives. Within strategic program lending, we executed program agreements with Earnest, a subsidiary of Navient and a leader in the private student lending market. We are humbled by the trust the team in Earnest placed in FinWise to support their growth plans and believe this is a testament to the strength of our offering in the market. We look forward to working with the Earnest team and welcome them to the FinWise family. We are also quite proud of our continued investment in the compliance and risk management infrastructure at the bank. We believe this focus, which is at the core of our offering, is embedded in our systems, processes, and culture, allowing us to continue to provide strong support to our fintech lending platforms. Lastly, in anticipation of our further expansion into BaaS, we continued to make progress on our Payments Hub and BIN Sponsorship products. As Kent mentioned earlier, we anticipate them being operational later in the year. We will continue to provide you with additional details on these initiatives as certain milestones are achieved.

Thank you, and good afternoon. For the fourth quarter, we generated net income of $4.2 million or $0.32 per diluted common share. We posted solid profitability with a return on average assets of 2.9% and a return on average equity of 10.8%. These results were achieved while continuing to invest in infrastructure to support growth in key strategic initiatives. Average loan balances comprising held for sale and held for investment loans were $396.2 million during the quarter compared to $354.6 million last quarter. This increase was primarily driven by continued growth in our SBA 7(a) and commercial loan programs. Average interest-bearing deposits were $303.4 million compared to $255.8 million in the prior quarter. The sequential quarter increase was driven primarily by an increase in brokered certificates of deposit. As of the end of the quarter, approximately 87% of the bank's deposits are either insured or our own capital or are contractually required in our strategic lending business. Now turning to the income statement. Net interest income for the quarter was $14.4 million, nearly flat versus last quarter. Positively, the increase in average balances of loans held for investments substantially offset the impact of higher interest rates and average interest-bearing liability balances. Net interest margin was 10.61% this quarter compared to 11.77% last quarter. The decrease was mainly due to a loan mix shift towards loans carrying lower yields in the held-for-investment portfolio and an increase in the volume of CDs. Non-interest income was $6 million in the quarter compared to $5.2 million in the third quarter. The quarter-over-quarter increase was primarily due to the change in fair value of our investment in BFG, partially offset by a decline in other miscellaneous income related to the resolution of a forbearance agreement last quarter, resulting in income that did not recur in Q4. Non-interest expense in Q4 was $11.4 million compared to $10.1 million in the prior quarter. The sequential quarter increase was primarily driven by an increase in salaries and employee benefits due to an increase in headcount, as well as higher professional service expenses as we continue to build out infrastructure to accommodate our growth. The efficiency ratio was 55.8% in Q4 compared to 51.3% for the prior quarter. We continue to expect the efficiency ratio to remain elevated as we further build out our infrastructure to move forward with our strategic initiatives that position the company for long-term growth. With a 20.7% leverage ratio, the bank's capital remained significantly above the 9% well-capitalized requirement. The company's tangible book value per common share continued to increase to $12.41 compared to $12.04 at the end of the prior quarter. Lastly, the effective tax rate was 28.5% for Q4 compared to 26.1% in the prior quarter.

We would like to open the call for Q&A. Operator?

Maybe if I could start just on credit quality. Any allowance? I guess, I was surprised to see a modest move down in the allowance this quarter, just given we did see a lift in the nonperformers. And Jim, I appreciate the commentary. I think about $15 million of the NPLs are guaranteed by the SBA. It looks like if I back that $15 million out, you're essentially in your allowance covered one for one on NPLs versus kind of the non-guaranteed portion. I guess, one, is that fair? And then number two, if charge-offs are running at, call it, 3.8% or so this quarter, why not build the reserve to a level kind of higher than 350 basis points?

Let me break that down. Generally, the reserve at the end of the quarter will be slightly higher than the $12.1 million unguaranteed NPL balance, approximately $12.9 million in the reserve compared to $12.1 million in unguaranteed NPL balances. Regarding the trend this quarter, the NPL balances increased, with unguaranteed balances rising by $6.1 million. This mirrors the $6 million increase in unguaranteed NPL balances we experienced in Q3, primarily due to the SBA portfolio. This is a repricing issue, as these are adjustable-rate loans that reset quarterly. We anticipate continued normalization until the prime rate begins to decrease. In response to your question about the ACL rate, there are two key reasons. First, we have adhered to our CECL methodology rigorously, and second, the portfolio is lower risk compared to the same period last year. The risk has decreased due to changes in the portfolio throughout 2023. For example, SBA guarantee balances now account for 35% of the portfolio, up from 21% at the end of last year. Additionally, SP HFI balances, which require higher reserves, have decreased from about 10% to approximately 5% of the portfolio over the past year. This explains why the 3.5% figure for the ACL reserve is appropriate for our current portfolio.

I guess there's a lot of moving pieces there and then I wasn't totally contemplating the kind of positive credit mix shift seen throughout the year. So that makes sense. I appreciate it. If I could ask on just loan origination volumes. It was good to see a little bit of a step up in the fourth quarter. Can you remind us any kind of seasonality within any of your businesses, specifically some of the larger partners in the fourth quarter? And then just kind of outlook as you look into 2024 from an origination perspective, does it feel like we've kind of hit a relative trough here or we could still see some modest declines moving forward?

So on the seasonality piece, that's been pretty difficult for us to get a baseline on just over the last couple of years because there's been so much movement both on the upside and then with some of the larger partners on the downside. So really pulling out the seasonal factor is hard for us to do. But just generally on the originations in the quarter, that rebound in demand that we saw from the Q1 origination levels was a little more sustained than we expected. Originations were up a little quarter-over-quarter and generally stable over the last three quarters. We would just point out, it's still too early to say that it's likely to continue at that level throughout 2024. And then the reason is that delta from Q1 is mostly related to a sustained rebound from the one program we spoke about in Q2. And we don't see broad enough strength across all of our platforms and just the industry in general to change our outlook there.

I would like to get your perspective on retaining the incremental strategic program credit that is being generated today. It seems there is a broader market narrative suggesting that the origination vintage from late '23 could perform well from a credit standpoint, especially as underwriting has tightened with higher rates compared to previous years. Jim, do you agree with this narrative in the market? Also, is there any interest right now? I know you are experiencing success in the SBA business that is driving higher spreads. Are you considering enhancing the strategic program portion of the loan portfolio?

The loan composition we have been focusing on over the past year is likely to remain stable in the coming quarters. I do not anticipate any significant changes. Our SP HFI portfolio has maintained consistent dollar balances throughout the past year. Regarding your question about vintages, it's somewhat complex and varies across different programs. In general, the mid-2022 vintages have not performed as well as those from the first and second quarters of 2023, mainly due to tighter underwriting standards. However, performance can differ significantly between programs. Looking ahead, I expect our strategy and portfolio will not change in the upcoming quarters.

So really, the incremental balance sheet growth we should expect should still be more SBA driven?

Yes.

And Javvis, if I could ask a couple just on the expense base. One, it sounds like there was a core system conversion in the fourth quarter. I'm just curious, it looks like the other expense line was up a decent amount sequentially. Anything one-time from the core system convert or anything else either in the other operating expense or even in the salary and employee benefits in the fourth quarter we should appreciate? And then it looks like expense growth from an operating standpoint was about 10% in 2023. Is that the right level of operating expense growth you would expect moving forward? Just understanding that there's continued kind of reinvestment in the business?

Andrew, I think we've been talking for the last several quarters now about making additional investments to improve our business infrastructure. And what you're seeing in the non-interest expense now are investments in personnel, systems, processes, and the new core you mentioned. Those expenses aren't going to go away, and we're not quite there yet. We're excited about the progress we've made so far and about our plans to help position the company for long-term growth. I wouldn't really call out anything in the fourth quarter as one-time.

And then thoughts on just the overall level of expense growth going forward?

Again, when we're thinking about the right run rate for expenses, we continue to build, and we're not there yet. So '23 has been a build year for us; we expect that to continue in '24. So I don't think it's unreasonable to think about increasing expenses in '24.

Our next question comes from the line of Andrew Liesch with Piper Sandler.

Just want to talk about the BIN sponsorship and kind of how that's going to ramp up. I mean signing up partners can take some time and it sounds like it will be operational late this year. But when do you think we can start seeing revenue hit the bottom line? And I guess if you provide it at a high level, what sorts of partners are you targeting for that business?

Jim, do you want to take that one?

So right now, Andrew, we're looking to be operational later in the year. We don't have a timeline to kind of point to as far as identifying when to really be looking at meaningful revenue contribution. A lot of the work that's been done so far is really on the infrastructure and staffing side, and that will continue over the course of this year. We do expect to have our first handful of customers later this year, but it's really probably in 2025 that that becomes a more meaningful revenue item for us.

And then just on the originations. I know it's hard to say that this is—the environment's improved, but you still continue to put up decent numbers and the strategic program fee is still running pretty solidly. I mean—I guess I'm just trying to figure out like where do you think the low for that fee income item could be? Like what we saw in the first quarter of this year, it just seems like there's a lot of—there's more tailwinds out there that you guys might be expecting.

I can touch on the originations. I'll give—Javvis maybe want to touch on kind of the C side of that. So it's like the delta that you've seen between Q1 and the subsequent three quarters of '23, Andrew, really came from a rebound with one specific program in our fintech lending line. That rebound was sustained throughout the course of the year and that was certainly something that was good for us, but it wasn't something that we were expecting throughout the course of the year. And I think right now, while rate expectations have improved and some of the other macro clouds have been lifting, we still don't see broad enough strength across all of our platforms and kind of the industry in general to change our outlook. And so this is why we've continued to build our pipeline and launch new partners. And I would point you to Earnest and Navient in Q4 as really one of the goals that we really were trying to hit before the end of the year. So again, as far as origination levels over the course of the next couple of quarters, pointing you to Q1 as a good barometer is still something that we would do near-term.

And Andrew, as far as the fee income goes, I’d just point you to the high correlation between the strategic program fees and the line item or the originations, we're pretty close to last year's fourth quarter, and those fees are pretty similar. And the trend is there a little higher this quarter than last quarter, and that trend exists as well on the strategic program fees line item in other income.

We have a follow-up question from Andrew Terrell with Stephens.

I just had one around the capital position. It looks like over the past year or so, I mean, you've obviously had really impressive balance sheet growth. It looks like the leverage ratio is down about 450 basis points or so just throughout the year. I think if I recall, around the high teens, low 20s levels where you like to operate from a leverage perspective. Can you just talk about, one, comfortability with the current capital position today, and then maybe tie it into a discussion of where you see inorganic capital as a solution or as a slowdown in the cadence of near-term balance sheet growth more likely outcome?

So let me take a stab at that one, Andrew. The capital, as you know, last year we did some repurchases, and we thought those were good for values for the shareholders because we bought less than tangible book value. But we were always trying to walk the balance between the amount of capital we need to sustain our growth and keep regulators comfortable with our growth and the capital cushion. So we continually look at that. Right now, we feel we've got the right level of capital to burn through this while still allowing regulators a comfort of our capital levels being sufficient. So whether this is organic or inorganic for future capital needs, we're not to that point yet. But we feel comfortable with the capital position we have right now, and we'll keep you posted if our thinking changes.

Are there any further questions in the queue? There are no further questions over the phone?

Operator, we actually received a few questions via e-mail as we are now allowing investors to ask questions that way as well. So if there are no further questions on the call, I'll just read out these couple of questions. The first question reads, regarding the agreement you just announced with Earnest, when do you think that will start to contribute, and how big can that be?

I think first with Earnest, we're really excited about the relationship. We think it highlights the strength of our offering. And we're humbled that Earnest is trusting us to spearhead their growth plans. We're not going to provide any contract details today, and we generally don't disclose details of our program agreements for competitive purposes. Long term, though, we think Earnest could be a meaningful contributor. That relationship will take some time to ramp up. But we think we continue to have a strong opportunity to take share, particularly given our compliance and regulatory strength right now.

And there was one more. What's the opportunity in banking as a service, especially given the regulatory issues with some of your peers and across the industry?

We've been watching this. And as the industry evolves, so do the regulations that go along with it. And we see this evolution as a very positive outcome that's going to better protect the industry and the customer. We've always focused heavily on an appropriate compliance management system at the bank and we've tried to make certain that we're monitoring all of our relationships and their compliance with laws and regulations. Of course, it's almost impossible to be 100% immune from compliance issues as there are some bad actors in the industry. But I think having very proactive oversight is something that will further evolve the industry and specifically the space. Banks that will come out on top will have strong due diligence processes when they bring the partners on board; they've invested in building strong compliance and regulatory processes. And I think for us, we've worked on this for a lot of years, and these actually create competitive opportunities for us.

No more questions from e-mail.

With that, this concludes today's teleconference. You may disconnect your lines at this time. Thank you for your participation.