First Internet Bancorp Q4 FY2024 Earnings Call

Thank you, Jenny. Hello, everyone, and thank you for joining us to discuss First Internet Bancorp's Fourth Quarter and Year-end 2024 Financial Results. The company issued its earnings press release yesterday afternoon, and it is available on the company's website at www.firstinternetbancorp.com. In addition, the company has included a slide presentation that you can refer to during the call. You can also access these slides on the website. Joining us today from the management team are Chairman and CEO, David Becker; and Executive Vice President and CFO, Ken Lovik. David will provide an overview of the quarter and 2024; and Ken will discuss the financial results. Then we'll open up the call to your questions. Before we begin, I'd like to remind you that this conference call contains forward-looking statements with respect to the future performance and financial condition of First Internet Bancorp that involve risks and uncertainties. Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in the company's SEC filings, which are available on the company's website. The company disclaims any obligation to update any forward-looking statements made during the call. Additionally, management may refer to non-GAAP measures, which are intended to supplement, but not substitute for the most directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be discussed today as well as the reconciliation of the GAAP to non-GAAP measures.

Thank you, Ben, and good afternoon, everyone. Thanks for joining us today for the fourth quarter and full year 2024 results. Our 2024 results reflect a year of remarkable growth. We entered 2025 with strong momentum. We produced significantly improved financial results, marked by a recovery in net interest income and net interest margin. We generated strong loan growth while we focused on optimizing the composition of our interest-earning assets. Furthermore, our SBA lending business had an outstanding year that drove non-interest income substantially higher year-over-year and allowed us to achieve greater revenue diversification. To summarize some of the key achievements for the year, net income and diluted earnings per share tripled compared to 2023 at $25.3 million versus $2.88, respectively. Net income of $87.4 million was up 17%. Gain on sale revenue was up more than 60%, fueling non-interest income growth of 81% from 2023. Total adjusted revenue growth of almost 30% far outpaced the increase in expenses, creating significant annual positive operating leverage. On the balance sheet, we grew balances by $330 million, an increase of 9% over 2023, which we attribute to strong growth in construction, investor commercial real estate, and small business lending. We also produced continued strong deposit growth, which allowed us the balance sheet flexibility to pay down a significant amount of Federal Home Loan Bank borrowings while also maintaining a solid liquidity position. The loans-to-deposit ratio is relatively consistent with the prior quarter and is indicative of continued flexibility as we continue to optimize both sides of the balance sheet throughout 2025. I would note that many of these year-over-year trends were evident in our performance for the fourth quarter, which I'll now discuss in a little more detail. If you're following along in the presentation, quarterly highlights are on Slide 3. It is only fitting that we would cap off a year with so much activity with a busy quarter. With a number of moving parts that impacted our results, our core business continued several of its upward trends. We drove an 8% increase in net interest income, making this our fifth consecutive quarter of growth in net interest income, notably a 5 basis point improvement in net interest margin. Even as the Federal Reserve rate cuts impacted the yield on new loan originations, the yield on the overall portfolio increased 3 basis points from the third quarter. The impact of the rate cuts was even more pronounced on deposit costs, which declined 17 basis points. At $24.7 million on an FTE basis, net interest income for the fourth quarter of 2024 was up 17% compared to the fourth quarter of 2023. We remain confident that net interest income and net interest margin will continue to trend higher throughout 2025 as we experience the full impact of the 2024 Fed rate cuts on deposit costs and continue to improve the composition of the loan portfolio. Additionally, our balance sheet flexibility will allow continued opportunities to optimize our funding costs as higher-cost wholesale funding and CDs mature. Another positive trend is the continued strong performance of our small business lending team. As I noted earlier, gain on sale of SBA guaranteed loans is a critical component of our non-interest income. Loan originations in this line of business were strong, up over 2% compared to the prior quarter, which had previously been a quarterly record for us. Consequently, SBA gain on sale revenue, while strong on a historical basis, dipped slightly this quarter. The decline was really more of a timing issue as a large portion of the originations were closed during the second half of December, and there is a lag between closing the loan and being able to sell it in the secondary market in order to complete the necessary post-closing activities. So while we didn't get to record revenue from those loan sales in the fourth quarter, the upside is we're very well positioned for a great start to 2025 for gain on sale revenue. Turning to the earnings for the quarter, we reported net income of $7.3 million, up 5% and diluted earnings per share of $0.83, up 4% from the third quarter's reported results. As I mentioned earlier, we had some moving parts that impacted the quarter's results. First, in connection with paying down Federal Home Loan Bank borrowings, we recognized $4.7 million of prepayment and terminated interest rate swap gains. When adjusting for this activity, revenue for the quarter totaled $34.8 million, an increase of almost 3% from the third quarter and 28% from the fourth quarter of '23. This marks the sixth consecutive quarter of increase in total revenue. During the quarter, we took steps to address certain problem loans and recognized $9.4 million in net charge-offs, most of which related to the SBA portfolio. As a result, net charge-offs to average loans totaled 91 basis points. I would note that approximately $3.4 million of these charge-offs were related to loans that already had existing specific reserves. As with most small business loans, the issues with these credits were borrower-specific and not driven by any particular industry or geography, and nor are we seeing any significant trends of stress with certain industries or regions. We had certain problem credits in various stages of workout where the outlook for a positive outcome was becoming less likely, so we made the decision to charge these loans off and help derisk the portfolio going forward. Our overall credit quality remained sound. Non-performing loans to total loans were 68 basis points. Non-performing assets to total assets were 50 basis points at the end of the quarter. The increase in non-performing loans was due to additions in franchise finance and small business lending as we took action to get in front of some potential loans. Despite the increase in non-performing loans, our asset quality metrics still compare favorably to all of our peers, and we have adequate resources on our loan servicing and special assets team as well as the processes in place to address any loans showing a sign of stress. At the moment, we have specific reserves on about 30% of the total non-performing loan balance. Another high-level point before I move on, and that is an update on our fintech partnership business. We told you at this time last year that we did not plan for rapid growth in the number of sponsored programs in 2024. We focused instead on nurturing the relationships we had already entered into, amid challenges in the bank fintech partnership space. This turned out to be a prudent decision. I'm pleased to report we have seen growth on both sides of the balance sheet and in non-interest income as well. I believe the partnerships between chartered institutions and solution-focused innovators is critical to the evolution of financial services. Without it, customers would still be standing in teller lines to cash checks and get their savings passbooks updated. We are committed to exploring relationships with partners that advance the financial services landscape and doing so in a way that creates value for our shareholders. On the topic of shareholder value, I'll make one last point on this slide, and that is how keenly we monitor tangible book value per share as a key measure of our focus on shareholder value. Despite the sizable increase in intermediate and long-term interest rates during the quarter, tangible book value per share only experienced a slight decline, and it’s up nearly 6% on a year-over-year. Since 2018, our tangible book value per share is up more than 55%, which reflects our commitment to operational discipline, diligent balance sheet management through some very challenging periods for the industry. We, like you, our shareholders in First Internet Bank. Turning to Slide 4. I've already made some high-level comments about our lending activity. I'm proud of the work our lending teams did over the quarter to produce strong loan growth of 13% on an annualized basis. Virtually all of our lines of commercial lending experienced growth with balances up almost $140 million from the third quarter, or 17% on an annualized basis. Our small business lending team has been a key driver in our efforts to reposition the loan portfolio and diversify our revenue streams. For the full year 2024, SBA loan originations totaled almost $540 million, up 45% over 2023, with solid loan volume also up 45% year-over-year, demonstrating the measurable impact we can make by providing growth capital to entrepreneurs and small business owners across the nation. Following strong production in the fourth quarter, retained balances increased 11% compared to the linked quarter. Our small business pipeline remains robust, and with the staffing investments we have made, we are targeting $600 million of SBA loan originations for 2025, and we are proud to be ranked as the eighth largest SBA 7(a) lender in the nation for the SBA's 2024 fiscal year. The growth of our SBA business also drove a significant increase in non-interest income for the year, which comprised one-third of total adjusted revenue, up from 26% in 2023. Our construction and investor commercial real estate team had another solid quarter, originating over $70 million of new commitments, and the aggregate construction and investor commercial real estate balances increased $81 million as we experienced strong growth activity on existing commitments. At quarter end, total unfunded commitments in our construction line of business were $480 million. As these projects progress, draws on these loans in the upcoming months, combined with the optionality to deploy excess liquidity to hold a portion of our SBA originations on our balance sheet will play a meaningful role in the continued shift of our loan portfolio towards higher-yielding variable rate loans. With a more favorable interest rate environment, our single-tenant lease financing team had an active quarter, originating almost $40 million of new loans, which translated into solid loan growth of $18 million over the linked quarter. Additionally, our public finance team had a solid quarter with balances up $23 million over the third quarter as it capitalized on some high-quality shorter-duration opportunities with attractive tax-equivalent yields. On the consumer side, total balances were down as expected, with declines in residential mortgage and home equity balances more than offsetting growth in our specialty consumer line, where originations were down due to seasonal factors. We focus on the super-prime borrower in our consumer lending, and rates on new production were in the mid-to-low 8% range. Furthermore, delinquencies in these portfolios remain extremely low at 10 basis points of total consumer loans. I'm proud of the performance our lending teams turned in to finish the year strong. I'm proud of the work that all of the employees at First Internet Bank put in to deliver 12 months of improving performance and a five-quarter streak for growth in net interest income and net interest margin expansion. Combined with the ongoing investments we've made in small business lending, we remain confident in the earnings momentum we have built. Entering 2025, we are well positioned with solid liquidity and capital levels and asset quality metrics that compare favorably to peer institutions, all the while continuing to optimize both sides of the balance sheet and further diversifying our revenue streams. Our team is committed to delivering strong earnings growth and net interest margin expansion that will create meaningful value for our shareholders in the years ahead. Now I'd like to turn the call over to Ken.

Thanks, David. As David covered the loan portfolio, let's turn to Slides 5 and 6, where I will cover deposits in more detail. The average balance of deposits increased almost $344 million or 8% during the quarter, and period-end deposits were up $135 million or 3% from the prior quarter, driven primarily by growth in fintech partnership deposits. Non-maturity deposits were up $122 million or 6%, reflecting the increase in fintech partnership deposits. Additionally, total deposits from our fintech partners were up 27% from the third quarter and totaled $643 million at quarter end. During the fourth quarter, we submitted a notice of reliance on the primary purpose exemption with the FDIC related to fintech deposits that had been classified as brokered. And as of December 31, we reclassified these deposits to interest-bearing demand deposits. During the fourth quarter, these partners generated almost $16 billion in payments volume, which was up 38% from the volume we processed in the third quarter. Total fintech partnership revenue was $880,000 in the fourth quarter, which was up over 14% from the linked quarter. Related to CD activity during the quarter, CD balances were relatively stable with balances increasing only $22 million over the quarter. Although medium-to-longer-term treasury rates increased during the fourth quarter, we held CD pricing constant through most of the quarter and further lowered CD rates in December following the Fed's rate cut that month. We originated $242 million in new production and renewals during the fourth quarter at an average cost of 4.23% and a weighted average term of 12 months. These were partially offset by maturities of $238 million with an average cost of 5.01%. Similar to last quarter, new CD production is coming on at lower rates than those maturing, which will continue to benefit our cost of funds going forward. Looking forward, we have $414 million of CDs maturing in the first quarter of 2025 with an average cost of 5.06% and $351 million maturing in the second quarter of 2025 with an average cost of 4.95%. So, for the next several quarters, we expect a continued positive pricing gap between new production and maturing CDs. For example, January month-to-date new CD production has been at an average cost of 4%, which is a positive spread of 106 basis points over the weighted average cost of CDs maturing in the first quarter. Moving to Slide 6. At quarter end, total liquidity remained very strong, reflecting cash and unused borrowing capacity of $2.2 billion. We deployed a portion of the elevated liquidity we had at the end of the third quarter, supplemented by continued deposit growth during the quarter, to pay off a significant amount of Federal Home Loan Bank borrowings and a smaller amount of maturing brokered CDs as well as to fund loan growth and securities purchases. As part of paying down certain structured FHLB advances, we were able to capitalize on favorable embedded prepayment features as well as paydown structures hedged with interest rate swaps. We structured these borrowings prior to the Fed tightening cycle, and as a result, the positions had significant mark-to-market gains at the time of termination. In total, we recognized $4.7 million of gains on the repayment of $200 million of FHLB advances during the quarter. With total deposit balances increasing 3% and loan growth of $135 million or 3%, the loans-to-deposits ratio was relatively unchanged at 84.5% from the end of the third quarter. At quarter end, our cash and unused borrowing capacity represented 173% of total uninsured deposits and 222% of adjusted uninsured deposits. Turning to Slides 7 and 8. Net interest income for the quarter was $23.6 million and $24.7 million on a fully taxable equivalent basis, up 8.2% and 7.9%, respectively, from the third quarter. The yield on average interest-earning assets declined to 5.52% from 5.58% in the linked quarter, due primarily to a 54 basis point decrease in the yield earned on other earning assets, which are predominantly cash balances impacted by the Fed's rate cuts, but partially offset by a 3 basis point increase in the yield earned on loans. The higher yield on the loan portfolio combined with higher average loan balances produced solid top-line growth in interest income, increasing almost 4% compared to the linked quarter, which far outpaced the increase in interest expense. As a result, net interest income was up over 8.2% during the quarter, building on last quarter's increase and further distancing us from the low point in the third quarter of 2023. Net interest margin for the fourth quarter was 1.67% and 1.75% on a fully taxable equivalent basis, both representing 5 basis point increases compared to the linked quarter. The net interest margin roll forward on Slide 8 highlights the drivers of change in fully taxable equivalent net interest margin during the quarter. The yield on funded portfolio originations was 7.26% in the fourth quarter, down from 8.85% in the third quarter, which reflects the 100 basis points of Fed rate cuts since September as well as a larger volume of originations in fixed-rate portfolios, which are priced at lower spreads over U.S. treasuries, but are still significantly higher than the current all-in yield on the loan portfolio. Pipelines remain solid, especially in the construction and small business lending lines of business, and our focus on improving the composition of our loan portfolio gives us further confidence that net interest income will continue to increase in future quarters. Related to deposits, looking at the graph on Slide 8 that tracks our monthly rate on interest-bearing deposits against the Fed funds rate, you can see that our deposit costs are beginning to trend down along with the decline in Fed funds. At quarter end, we had $1.4 billion of deposits indexed to Fed funds, which when combined with the $765 million of CDs maturing over the next 2 quarters and an additional $200 million of higher-cost broker deposits maturing at the end of the first quarter, are expected to drive further net interest income growth and provide a strong catalyst for net interest margin expansion. Turning to non-interest income on Slide 9. Non-interest income for the quarter was $16 million, up $3.9 million or 32.5% from the third quarter. As I previously mentioned, non-interest income included $4.7 million of prepayment and terminated interest rate swap gains related to the paydown of Federal Home Loan Bank advances. Excluding these gains, adjusted non-interest income was $11.2 million, down 7% from the third quarter. Gain on sale of loans totaled $8.6 million for the quarter, down from $9.9 million in the prior quarter. Loan sale volume was $106.7 million, down 16% quarter-over-quarter, while net gain on sale premiums increased 30 basis points from the third quarter. As David mentioned in his comments, the decline in loan sale volume was mainly due to timing. We originated $167 million of SBA loans during the quarter, an increase of 2% over the linked quarter with over 1/3 of those closing late in the quarter. The decline in gain on sale revenue was partially offset by higher net loan servicing revenue, which totaled $1.4 million for the quarter due to growth in the servicing portfolio and a lower fair value adjustment to the servicing asset. Moving to Slide 10, non-interest expense for the quarter was $24 million, up $1.2 million from the third quarter. The increase was driven in part by higher compensation costs due to staff additions in small business lending, risk management, and information technology as we continue to invest in key areas of our business. Additionally, other non-interest expense was up due to seasonal expenses and deposit insurance premiums increased due to year-over-year asset growth. Turning to asset quality on Slide 11, David covered several of the major components of asset quality for the quarter in his comments, so I will just add some commentary around the allowance for credit losses and provision for credit losses. The allowance for credit losses as a percentage of total loans was 1.07% at the end of the fourth quarter, down 6 basis points from the third quarter. The decrease in the allowance for credit losses reflects a decline in specific reserves related to charged-off SBA loans as well as the net charge-off activity David discussed earlier, partially offset by qualitative adjustments to the small business lending ACL and overall loan growth. At quarter end, the small business lending ACL to unguaranteed SBA loan balances was 5.7%. Additionally, at a higher level, if you exclude the balances and reserves on our public finance and residential mortgage portfolios, which have lower coverage ratios given their lower inherent risk, the allowance for credit losses represented 1.27% of loan balances. Provision for credit losses in the fourth quarter was $7.2 million compared to $3.4 million in the third quarter. The increase in the provision for the fourth quarter reflects the elevated net charge-off activity, the qualitative adjustments to the small business lending ACL, and overall growth in the loan portfolio, partially offset by the decline in specific reserves and adjustments to qualitative factors in other portfolios. Moving to capital on Slide 12, our overall capital levels at both the company and the bank remain solid. The tangible common equity ratio was 6.62%, an increase of 8 basis points from the third quarter as a smaller balance sheet more than offset the impact of higher interest rates on the accumulated other comprehensive loss. If you exclude other accumulated other comprehensive loss and adjust for normalized cash balances of $300 million, the adjusted tangible common equity ratio would be 7.4%. From a regulatory capital perspective, the common equity Tier 1 capital ratio remained solid at 9.3%. Before I wrap up, I would like to provide some commentary on our outlook for 2025. While the market may be pricing in a rate cut or two over the course of the year, we are sticking with our conservative approach and assuming Fed funds and other short-term rates remain constant through 2025. When looking at the estimates for full year 2025, I think the consensus earnings per share number is within the range we are forecasting for next year. However, how we get to that range is a little different than what the current models are projecting. We expect loan yields to increase as we continue to originate new production at rates well above the current portfolio yield. We also expect deposit costs to continue declining as: one, the last two Fed rate cuts get fully incorporated into quarterly run rates; two, the significant CD repricing gap on over $0.75 billion of CDs maturing over the next 6 months; and three, the paydown of higher-cost broker deposits at the end of the first quarter. Assuming loan growth in the range of 10% to 12% for the year and deposit growth in the range of 5% to 7%, we expect that annual net interest income will increase in a mid-30% range over 2024 and fully taxable equivalent net interest margin will increase throughout the year and should be in the range of 2.20% to 2.30% by the fourth quarter of 2025. If the Federal Reserve were to begin reducing short-term interest rates, our net interest income and net interest margin would likely exceed these projections. With regard to non-interest income, as our SBA team continues to grow and deliver consistently higher origination activity, we expect annual core non-interest income to be up in the range of 9% to 12% over 2024. A potential risk to this forecast will be loan sale pricing in the secondary market. While gain on sale premiums are currently attractive, if pricing were to soften, it may make more economic sense to hold a loan yielding 10% or more versus selling for a premium far below the annual spread income we would earn. Looking at the provision for credit losses, with quarterly provisions higher than what we have experienced on a historical basis, we are taking a conservative approach in our forecast for 2025 and are modeling an annual provision that is in the range of 15% to 20% higher than what we recognized in 2024. And finally, from a non-interest expense perspective, we added a number of personnel throughout 2024 to support growth in small business lending as well as in risk management and information technology. And with the planned growth in SBA originations and the continued investments in key areas of our business, we do expect compensation expense to increase in 2025. All in, we expect annual non-interest expense to be up in the range of 10% to 15%. One additional point I would like to make, when looking at the quarterly earnings per share estimates for 2025, I think the distribution might be off a little. While the total for the year is in the range due to seasonal factors and the time that it takes CD repricing to work its way through, our forecast is a little lighter in the first and second quarters of the year and a little higher in the back end of the year.

I wanted to start on the asset quality cleanup and then, any color that you can provide on the SBA charge-off and just what you're seeing in the SBA portfolio generally? And your guidance for provisioning to be 15% higher in '25, that's probably 45 basis points, 46 basis points. Are you expecting some continued charge-offs in the SBA portfolio?

Let's begin with our assumption regarding increased provisioning for the year. Over the past several years, as the SBA business has expanded, we’ve seen an increase in charge-offs and provisioning. The overall portfolio has grown, and we are reserving at a higher rate for those loans, particularly because the charge-offs in that area are higher compared to single-tenant properties or others. We have observed a higher run rate in this regard over the last four to six quarters. Therefore, we are adopting a conservative approach. Ideally, we are provisioning more than necessary, but we believe it is better to err on the side of caution in our forecasts and add a little extra. It’s important to remember that the portfolio will continue to grow, and we have also increased the overall allowance for credit losses coverage, which is a contributing factor as well.

Okay. And then on the cleanup, what that entailed, and you had the one specific charge-off that had allocated reserves, but was just trying to get a little more color on what you were seeing in the SBA portfolio? I know that the credit trends in SBA for the industry have been a little softer, but I know everybody kind of does things differently and the rules changed 2 years ago on underwriting. Just any thoughts on the SBA portfolio as you see it from a credit perspective?

I’ll handle that, Brett. In the SBA portfolio and the bank overall, there's nothing that worries me. As you mentioned, the SBA environment is a bit challenging right now. We've thoroughly examined our underwriting loan issues and reviewed everything. Each loan is unique, like Nicole often says—no two are alike. There are no concentrations in any state, product, or other aspects; it's just individual cases. The only commonality is that about half of our delinquent accounts are somehow related to the hurricanes that impacted the country last year, particularly in Florida and North Carolina. Those areas are struggling to rebuild and recover from a loss of 2 to 3 months of income. In the SBA realm, there is a strong effort to support small business owners, and we're addressing those complexities. As Ken mentioned, we're not as familiar with some processes, and it takes longer to navigate the sales, recovery, and collection efforts. In the fourth quarter, we reviewed some loans, uncertain if we'd see recovery or not. Earnings were stable, so we aimed for a clean start heading into 2025. We did increase reserves a bit because, if you look at our credit history over the last 5 years, aside from a specific issue in Oahu early this year, we charged off more loans in the last year than in the previous 3 or 4 years combined, excluding that situation. However, despite those charge-offs, we still earned $4 million more in SBA in the fourth quarter compared to last year. Watching the market reaction today is a bit frustrating when I see competitors selling off low-rate securities and taking significant hits while their stock rises. It doesn't make sense to me. Nevertheless, there’s nothing fundamentally wrong. We have some of the top business development officers in the SBA industry and have built an excellent team over the past few years. We believe this presents a great opportunity moving forward. While we anticipate more losses than usual, the work involved will increase due to the rules and regulations in the SBA. Nonetheless, our portfolio is well-diversified and solid, and we will continue pushing forward.

Okay. I have a lot of questions, but I'll just ask this last one before I get back in the queue. You completed $540 million of SBA in 2024, and I believe the fee income guidance is between 9% and 12%. What are your production assumptions for SBA in 2025? I'm also not quite sure what you meant about the gain on sale potentially affecting that, so I would like to understand your assumptions for gain on sale margins.

Yes, we are projecting $600 million in originations for next year. Currently, our gain on sale net premiums have averaged around 1.08%, possibly a bit higher, and we are assuming 1.08% in our forecast. However, one variable to consider is the recent volatility in gain on sale premiums over the past 18 months. If the premiums were to decrease to 1.06% and we received a loan at prime plus 2.75%, which is a solid loan, we might opt to retain that on our balance sheet instead of selling it. This fluctuation in gain on sale premiums could pose a risk to our gain on sale income if we decide to hold the loan.

As Ken mentioned, we had $60 million in production carried over into January from December, which we sold in the past couple of weeks, achieving a net of 1.08%. One loan came in at 1.06%, but we decided to keep it on the books since there was no need to sell it in the market. Everything appears stable at the moment. However, with the President's announcement today about potentially forcing us to lower interest rates, things could change quickly. Despite that uncertainty, we are confident that, as Ken noted, we do not anticipate any further rate decreases. This should allow us to stabilize around the low 1.08% range for the rest of the year, which we have accounted for in our budget.

I have a follow-up on the commentary around credit performance, particularly for the SBA. Are there any specific industries that you're seeing a little bit more pressure or types of borrowers at all?

No, not at all. As I mentioned earlier, we've thoroughly analyzed that portfolio from multiple angles to identify any common themes, brokers, BDOs, underwriters, or anything similar. Aside from about half of the loans being affected by hurricane-related issues, there is no common denominator. However, for the loans we originated during COVID, especially those involved in real estate or significant construction, delays in supplies and teams consumed a lot of their excess working capital and cash due to a 12 to 18 month hold-up. We're currently assisting some of those borrowers to help them recover. Aside from the hurricane and pandemic-related problems, particularly among those with extensive build-outs or construction, we cannot find any pattern. It really varies, as Nicole says, some succeed while others struggle. Currently, things appear to be stabilizing, and we’re not observing any drastic issues, but time will tell. That’s why we are being cautious and slightly increasing our reserves.

Okay. What impact do you see looking ahead on the outlook from the rate environment? If rates remain high for an extended period, how do you see that affecting your SBA borrowers and your overall credit portfolio?

We've evaluated the current rate environment. Since we entered the SBA space, we've experienced strong growth starting in 2020, continuing through 2021, and then more significantly in 2022, 2023, and 2024. Our loan origination has occurred in a high rate environment from the start. We conduct credit assessments and stress tests on interest rates, increasing them by 200 or 300 basis points to ensure adequate debt service coverage and available working capital. Consequently, many of our loans were initiated in this high rate environment. To date, we've seen a 100 basis point relief. However, when calculating the impact on an average loan balance, a decrease of 25 or 50 basis points does not result in a significant change on a monthly principal and interest basis. Therefore, I can confidently say that none of the charge-offs we've faced can be attributed to high rates.

I don't think there's going to be any impact in our client base and/or our numbers, if it holds steady. What would impact us and I think would totally demoralize a lot of our commercial accounts is if the rates start to go up. If inflation blows up for whatever reason and the Fed makes a move the other way, that could have some significant impact. It's not us, it's going to be the whole industry. But I think as long as it stays stable, there's kind of a light at the end of the tunnel. As Ken said, a 100-point decrease last year is a couple of hundred bucks a month maybe on a loan payment, but it was positive news, inflation is coming down, employment is going up, consumers still spending. Day in and day out, the real economic news is pretty solid and folks think there's a chance. Nobody is losing hope today. But I would tell you, the one to watch is if it turns and the Fed has to bump rates, then that could be a different story, but not only for us, for everybody in the industry. Yes. In the fintech space, we've had a solid base of customers, but some are frustrated with our onboarding process, which has stretched from 60 days to 6 months due to regulatory challenges. We previously mentioned that after our spring exam last year, we received the regulatory guidelines clarifying what is expected from us regarding compliance. Despite these hurdles, we have strong customers who are experiencing significant growth. For instance, in 2023, our BaaS division ended the year with a $1 million loss. We increased our expenses and expanded our staff, even quadrupling some positions, which contributed to nearly a $1 million rise in BaaS-related expenses this year. Nonetheless, we achieved a turnaround in earnings, posting a positive $1.2 million by year-end, resulting in a $2.5 million swing. We have an excellent team and solid clients that are also growing. For example, we've expanded card opportunities for a client on the West Coast. This growth could potentially increase our earnings from $1 million to $4 million by the end of the year, given our current clientele. We have a robust pipeline and plenty of opportunities ahead. However, considering the challenges in the industry, particularly with Synapse and other issues, we are exercising caution. Many in the banking and fintech sectors are hesitant, and we want to avoid taking on risks that are not ours. Our due diligence process, which was already demanding compared to peers, has become even more stringent. While we anticipate significant growth and even exponential growth in some areas, we are committed to being prudent and not rushing to take on other people's problems. We are dedicated to growing our presence in the fintech space and believe there is a promising future for us here.

Not to beat a dead horse on the SBA front, but just thinking back to the call in October, it seemed like SBA delinquencies kind of peaked over the course of the summer. So, some of the charge-offs that we saw this quarter, a little surprising. So, just curious if you can shed any additional light in terms of what occurred between now and then to necessitate these charge-offs and the elevated provisioning. Was it more so just around getting some updated financials from clients? Or any other light you can shed on that would be appreciated.

Yes, part of it was related to the significant charge-offs, with $3.4 million associated with loans that already had reserves set aside, either fully or partially. Some borrowers were in the process of seeking a resolution, such as selling their business, but it became clear that the situation was not as favorable as we had hoped. Consequently, we decided to charge off the loans, remove the specific reserve, and move forward. It is sometimes challenging to assess, but we noticed a slightly higher number than usual of borrowers who had previously deferred payments. Typically, these borrowers return to making payments after the deferral, but this quarter, we encountered more struggling businesses than expected when they came off deferral. As David mentioned earlier, the circumstances are very borrower-specific, with no overarching theme linking them in terms of geography or industry. There appeared to be a unique situation for several borrowers compared to what we have experienced in the past.

In recent months, we thoroughly analyzed our portfolio and had external reviews to ensure we didn't overlook any fundamental issues with decision-makers, referral sources, or business development opportunities, and everything came back clean. The current situation reflects broader industry challenges, as evidenced by a larger SBA competitor releasing disappointing results recently. We were on a solid trajectory for a long time, but things have shifted a bit. However, with the earnings potential from our product related to gain on sale, servicing, and interest revenue, we’re prepared for fluctuations. Earlier this year, we absorbed a $9 million hit but managed to end the quarter with only a $5 million loss, and we've since improved our earnings from the third to the fourth quarter. We decided to be proactive in addressing these issues and will likely experience more SBA losses in the upcoming year. While I hope we won't see $9 million losses each quarter, I am confident that even if we do, we can contribute an additional $10 million to $15 million to our bottom line. This is already factored into our pricing and structure, and I’m not concerned about any fundamental problems with our SBA or other assets.

Got it. That's really helpful. I'm familiar with some other SBA lenders and typically, normalized charge-offs for them in this business is anywhere between 30 basis points to 40 basis points a quarter. Is that how you guys are thinking about the future charge-off trajectory?

Yes, we also have that in mind. As Ken mentioned, we had already set aside $3 million in the second and third quarter for a few loans. This is our first experience with the negative side of the SBA, and we realized we should have addressed some of these issues sooner. Moving forward, we expect to remain in the 30 to 40 basis point range. We do have one client with a few businesses involved, which could affect us. However, I don't believe we will see $9 million in the first quarter. We do anticipate stabilizing around 30 to 40 basis points. We've also taken some additional provisions in our future estimates just to be cautious. Overall, we believe this is a smart approach. Just changing gears, thinking about the margin trajectory for this year. I appreciate the guide around 220 to 230 coming out by the fourth quarter. Just curious, in terms of kind of the cadence to get to that margin, do you think it's more kind of first half loaded just given some of the CD repricing that Ken described earlier? Just any thoughts on kind of the progression of the margin over the course of this year?

Yes, the first quarter may present some challenges in visibility, but we expect a significant improvement in the second quarter as we reduce some costly brokered funds and begin to benefit from the timing of CD maturities. These maturities will have a greater impact in the second quarter and certainly towards the end of the year. While we anticipate a positive increase in the first quarter, it can be somewhat difficult to predict accurately. Thus, the range is a bit wider, but I genuinely believe we will see a substantial boost in the second quarter and towards the end of the year.

As Ken mentioned earlier, we believe that the average earnings forecast for next year is around $4.20, which we see as very attainable. We expect to start in the low to mid-$0.80 range in the first quarter and increase throughout 2025, with an additional $13 million to $14 million in earnings over 2024. We are maintaining our current outlook and did not anticipate interest rate decreases last year, which is benefiting us. We are confident in our earnings growth trajectory as we projected for 2025. If we avoid the losses we expect in SBA, our bottom line will improve even further. Being from the Midwest, we tend to be conservative in our estimates. While we are not promising $5 per share, I can assure you that we have a solid foundation based on where we are today. Some variables may have shifted from your models at the beginning of 2023, but we anticipate 2025 will be a great year for us.

You did call out franchise finance in terms of the provisions or at least the delinquencies. Can you just give us a little bit more of a picture there? Is that still a program you're planning to continue to grow quite a bit?

No. I mean, we have a portfolio of about $500 million, which has grown significantly over the past several years. However, when considering capital allocation and growth in the SBA and other initiatives, our growth in this area will likely be much lower than in previous years. Year-over-year balances have actually decreased. We've noticed a slight increase in the number of non-performing loans as we've engaged with some struggling franchisees, and our team is closely collaborating with our partner on this issue. Currently, we're probably seeing around $6 million to $8 million a month in new loans, which roughly matches the amount of paydowns in the portfolio. While it's generated nice yields and contributed positively to our earnings, it's just one part of a much larger picture.

I want to mention that our team has been collaborating with the folks at ApplePie, who have recently made some changes. I previously spoke about some issues with their servicer. They now have a new servicer, and our team maintains regular communication with them. We're beginning to see progress in that area. As Ken mentioned, their volume has decreased slightly, but we are still making purchases. While we don't expect significant growth, we currently have some stronger channels available. The partnership with ApplePie and their customer base has significantly improved over the past 90 days, so we're not overly concerned about the portfolio. There are challenges, especially with some smaller coffee shops where owners expected to earn $250,000 a year while working 6 hours a day but are instead working 12 to 14 hours for only $40,000, leading some to give up. This reflects human nature, but we have made provisions for it. We are collaborating with these owners and addressing issues with those facing difficulties much earlier, allowing us to provide assistance. I want to highlight that franchisors are also taking proactive measures because they want to maintain a good reputation. They are seeking other servicers and resources to help or take over stores. By intervening early, we can resolve issues before they escalate, which benefits everyone involved. So, we've got about a quarter of the portfolio that we are specifically focused on, and we feel good about the focus we have in monitoring that closely. We are hopeful that we'll be able to work through the portfolios, and when you're talking about guys that are on their third restaurant, and they can't get to the finish line, those are the ones that really draw the headlines. But, I think in totality, we've got the powder here to make sure that we can manage it out.

And your first question is from Brett Rabatin from Hovde Group. There are no further questions at this time. I will now hand the call back to David Becker for the closing remarks.

Thank you, Jenny, and thanks, everybody, for joining us on today's call. As I said, we wrapped up '24 with some strong performance. We're entering '25 with a lot of great momentum and a lot of backlog and business and opportunity. We're highly optimistic about the future. Outstanding performance of the lending teams, along with emerging opportunities through the fintech and other partnerships positions us for greater, more diversified revenue growth. We have the wind at our backs with a more favorable interest rate environment and an improving business climate. Adding all that together creates a great foundation to build on and deliver stronger earnings and profitability in 2025 and going forward. As fellow shareholders, we remain dedicated to maximizing shareholder value. We appreciate all your ongoing support and wish you a pleasant afternoon. Thank you.

Thank you. Ladies and gentlemen, the conference has now ended. Thank you all for joining. You may all disconnect your lines.