NewtekOne, Inc. Q1 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to Newtek Business Services Corp. First Quarter 2021 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. Please be advised that today's conference may be recorded. I would now like to hand the conference over to your speaker host today Mr. Barry Sloane, President and CEO of Newtek Business Services Corp. Please go ahead, sir.

Thank you very much, operator, and good morning everybody and welcome everyone to our first quarter 2021 financial results conference call. It seems like yesterday we were just doing our annual call, obviously the first quarter catches up pretty quick after we produce the annual results, and that obviously, I wanted to put a special thanks out to our accounting team led by Nick Leger, who will be joining me on the call today, Executive Vice President and Chief Accounting Officer, did a tremendous job obviously in a transition with Nick picking up the responsibilities from Chris Towers and Elise Chamberlain and their entire team working very hard to get us out, get results out and get us into the market with all of our filings.

Thank you, Barry, and good morning everyone. You can find a summary of our first quarter 2021 results on slide 39, as well as a reconciliation of our adjusted net investment income or adjusted NII on Slide 41. So the first quarter 2021, we had a net investment income of $16.2 million or $0.68 per share as compared to a net investment loss of $280,000 or negative $0.01 per share in the first quarter 2020. This represents a 126% increase on a per share basis. Please note that the income related to the PPP is included in investment income in 2021. Adjusted net investment income, which is defined on Slide 41 was $23.5 million or $1.05 per share in the first quarter 2021 as compared to $4.3 million or $0.21 per share for the first quarter of 2020. Focusing on our first quarter 2021 highlights, we recognized $34.7 million in total investment income, a 119% increase over the first quarter of 2020 total investment income of $15.8 million. Interest income related to fees from the PPP was primarily the driver for the increase. We recognized $24.2 million of income related to the origination of approximately $425 million of PPP loans during the first quarter of 2021. There were no distributions from portfolio companies for the first quarter of 2021 as compared to $4.4 million in the first quarter of 2020. Moving on to expenses. Total expenses increased by $3.4 million as compared to the same quarter in 2020 or 21%, which was mainly driven by an increase in the SBA 7A loan referral fees, compensation-related costs and a one-time loss on extinguishment of debt. Moving on to realized gains, realized gains were recognized from the sale of the guaranteed portions of SBA loans sold during the first quarter totaled $8.9 million as compared to $5 million during the same quarter in 2020. In the first quarter of 2021, we sold 107 loans for $57.8 million at an average premium of 30.3% as compared to 67 loans sold during the first quarter 2020 for $38.1 million at an average premium of 10.9%. The increase in realized gains was attributed to higher SBA 7A loan origination volume in the first quarter combined with higher average premium prices when comparing to the first quarter 2020. As I mentioned earlier, income related to the PPP is included in investment income, not in realized gains. Realized losses on SBA non-affiliate investments for the first quarter of 2021 was $1.5 million as compared to $447,000 in the first quarter 2020. Overall, our operating results for the first quarter 2021 resulted in net increase in net assets of $30.1 million or $1.35 per share and we ended the quarter with NAV per share of $16.28. I'd now like to turn the call back over to Barry.

Thank you, Nick. Appreciate that. Operator, I would love to open it up for Q&A.

Thank you, ladies and gentlemen. Now, first question coming from the line of Paul Johnson. Your line is open.

Good morning, guys, thanks for taking my questions. The first question. Today, I'd just like to get maybe a little bit of commentary on just the lack of income from the control companies this quarter and I guess just what drove that and whether that was due to retaining earnings or if that's something we could expect going forward, but any color there would be helpful?

Sure, I appreciate that, Paul. There was no lack of income. There was just no distributions. The portfolio companies independently make decisions whether to distribute income and dividends or to retain the capital for other uses. So, we did forecast earnings from entities like NBC, we forecasted earnings on NMS, we forecasted earnings on Managed Tech Solutions, which are three of the larger entities that typically do dividend out. So, no, there was income, but those entities decided not to distribute.

Okay, thanks for that. And then, maybe just get a little bit more. I mean, I know you touched on it a little bit more commentary on your decision to hang on to some of the guaranteed loans that were originated this quarter, do you think you would expect to continue kind of doing that here in the quarters ahead or is this more of a just sort of a one-time thing that you chose to do just given the strength of the premiums?

Yes, I would say, and that's a good question. But we are classically originate and sell. We're in a market that is classic these days. A couple of things, one we have excess capital and our belief regarding pricing, which is that these particular securities are very attractive, not highly likely to prepay quickly and the current price movements, so. We just hang onto the coupon. I think it’s likely we will take advantage of the strong pricing that the 7A market will have all the way through September 30 where the 55 basis points will be taken out of the coupon, okay? Will ultimately reduce prices on October 1 versus September 30. So that’s about as best I can do. I think the important aspect of the question is we have not changed our methodology. We have a lot of excess capital and a 6% coupon is better than keeping it at zero.

Sure. Yes, it's understandable. And then lastly, maybe just kind of like to get your sense of the borrowers in your portfolio, and possibly also just companies or loans that you've looked at here recently. Have you noticed, especially for small businesses, businesses that are more labor intensive, have you noticed any sort of inflation or wage pressures on these businesses cropping up? Again within your portfolio or sort of across the landscape of borrowers that you looked at?

I think that we definitely hear and see part of it, you hear and see it on TV. Right? And the reality of it is it's true. Labor is tight right now, which has a lot to do with a reasonably high unemployment rate. I do believe this is a short-term phenomenon. When I say short-term phenomenon, we've got another couple of months to go through it. I think people are figuring it out. To be frank with you, some of these owners are not going to report it on their books, rather than on the books to make things work, but the thing about our customer base is they are resilient and they don't go down very easily. But there is no question there is a bit of a labor shortage, but I think 90 days down the road that will go away, as these unemployment benefits unwind.

Thanks for that. It's helpful; you answered all my questions.

Thank you. I appreciate that. Thank you.

Our next question is coming from the line of Robert Dodd with Raymond James. Your line is open.

Good morning, everyone, and congratulations on the quarter, regardless of PPP. I want to follow up on Paul's question about dividends from the portfolio companies. I understand that they chose not to distribute in Q1, and you've provided us with some earnings outlooks that will impact NAV or dividends. Is there any insight you can share about whether you expect the non-distribution pattern of dividends to persist for an extended period, possibly throughout the year? It seems like there are many investment opportunities, so do you think it's likely they won't distribute this year and may do so next year? Any longer-term insights would be appreciated.

Robert, it's a great question and we probably won't know that for sure until we keep moving through the quarter. However, from your perspective, I would think history is a reasonable guide to look at and from that perspective, I think you could consider that we've laid guidance out there, that's important for us to be able to deliver in our current format on between $3 and $3.30 of dividends out of income. I think historically, those companies have distributed their income, but right now, some of them are looking at reinvesting in new loans, like an NBL through some very interesting technologies that are available in some of these entities, and the M&A side of things has clearly loosened things up and there are winners and losers. So, I think looking at history is a guide would be good for you going forward. I can’t determine that; it's a great question, and I understand what you need to do on your side of it, as you look at the company and reforecast, but I would I would use history as a guide; I think you will be okay with that.

Okay, I appreciate that. Thank you. On the conventional engine JVs. I'm sorry, I don't have the presentation etc. in front of me. I mean, are these expected to be 50:50 JVs? Are you going to give us any high-level view on what you expect the structures to be? I just don't have that kind of information in front of me, if it's in the presentation that even though it's that, but it's obviously it's going to grow, but what's the rough economics for you?

Sure. The original structure was a 50:50 arrangement, and this is publicly available information. We can discuss the deal that was finalized; it remains unchanged. The joint venture that is currently operational is a 50:50 joint venture. I want to emphasize that all the joint ventures we establish are true partnerships with a 50:50 split in decision-making. It’s crucial that we choose partners who share our vision and viewpoints since we are interconnected. The financials for that joint venture are also evenly divided at 50:50.

Got it, got it. Thank you. There’s one more if I can on the 504, I mean your guidance is 125 for the year. You've done 52 already through April. Is this a counter-cyclical business? I mean over 7A is tend to be more back-loaded. Is the 504 front-end loaded or more even distribution or is the 125 just a very conservative number?

Yes, I think it's a fair question. And so, here's my sitting in the seat. If you look at what we did in April versus what I did in the first quarter, I mean we funded more loans in April than I did in the first quarter, right? So I really think if you stick to the 125, you'd be good.

Okay. So, you know. Yes, I mean that's what did April was the genesis of the question after all.

Yes, it's very hard to gauge the 504 business, because in the 7A business, we have full delegated underwriting. In the 504 business, the CDC has to approve it, the SBA has to approve it and then you're good to go, and depending on supply and demand that stuff gets tied up, slowed down, and impacts all your numbers. So that's why having these differentiated business lines and models has enabled us to do okay, things are moving around. I think if you stick to the 125, it's a good, yes.

Okay, got it. I appreciate it. Thank you. And again, congrats on the quarter.

Thank you, Robert. Thank you very much.

And our next question coming from the line of Richard Greenspan with UBS. Your line is open.

Thank you. Good work. Barry, how are you doing?

Thanks, Rich. Thank you.

I wanted to just ask how important the portfolio companies as a contributor to total earnings, say versus the SBA 7A lending?

Yes, look, I think that for the long-term investors and holders of Newtek, hopefully it's readily apparent that we believe in all 5 silos and historically as a percentage of the dividend income, the portfolio companies contributed, with the exception of last year, which I'll go into for a second, somewhere between 35% and 30% of the income that rounds up being distributed. Now that's beneficial because that income is taxed. So, in the distribution that income comes through as qualified. So for those holding the stock in a taxable account, it's beneficial; for those that income comes through as qualified, for those holding the stock in a taxable account, it's beneficial. For those in a retirement account, it's irrelevant. Those businesses are very important. We're going to continue to dedicate ourselves to growing them, making them pertinent; that's what prospectively increases the net asset value of the company, amongst other things in addition to growing the dividend. I think for investors that are trying to figure out on a going forward basis, I would suggest we go back to the 2019 numbers, take a look at where we were, where there was no PPP, we’re two years down the road, we’re two years better. Our technology is better, our human capital is better, our alliance partners are better, and it's a good base to begin to forecast where we might be without PPP, but we have exciting futures ahead for payments, tax and ultimately payroll and insurance. I appreciate the question, Rich. Thank you.

Thanks, Barry.

Our next question is coming from the line of Scott Sullivan with Raymond James, your line is open.

Sorry, I had mute on there, apologies.

That's just the 2021 version of the conference call questions.

Exactly, user error. My question also centers around where you see Newtek after the windfall, PPP business and can you give us some color on the improved resources in some of the other areas for 2022 and beyond?

Sure. In 2020 and 2021, we processed nearly 24,000 units, leading to close to $1 billion in aid from PPP funded loans. This involved significant resources in terms of management time, software development, and client interactions, alongside acquiring 24,000 new units during this process. Those resources will be redirected towards 7A, 504, and non-conforming loans, as they all feed into the initial stages of our operations. Furthermore, my management team, including Accounting, Legal, Sales, and Marketing, will now focus on all five areas to help us grow payments, technology, insurance, payroll, enhance the NewTracker system, and establish new partnerships. We are enthusiastic about our current position. Although we do not anticipate any new PPP loans, there is still some processing to complete, and we have made significant strides in automating the forgiveness process for clients who engaged with us. I am confident in our ability to maintain solid income levels without PPP loans. Referring back to our adjusted EBITDA number from 2019, which was $2.31, I believe we are well-positioned for the future, particularly with NCL coming into play. I'm optimistic about our prospects and feel that our standing in comparison to other BDCs is drastically different.

Totally agree; that's very helpful. So given the impressive growth metrics and what I'd like to call the FinTech side of your company, how scalable is this model? In other words, would it be an attractive thing potentially for M&A and what is, separately, what is the greatest post PPP opportunity?

So, I think that from our standpoint we got to do what's best for all of our stakeholders. And I think that we've built a model business that works great in the BDC construct but it could also work well in other constructs, and that's why when everybody else is doing five-year fully locked out notes, we're willing to give up some coupon to have that flexibility. I just think that we owe that to people to do what's best for everybody that's involved. Relative to when you look at what we're involved with, and it’s funny you mentioned the word FinTech. So I don't think we're a FinTech. I think we're Newtek; so I like to use that word. I don't know what the FinTechs are doing to be honest with you. I say that euphemistically, but I know what Newtek is doing. In Newtek we take real smart technologies and apply them to real challenges. Let me be clear, you could do payroll by going to QuickBooks, not talking to anybody, putting in a little bit of data and getting some kind of result, but God forbid if you've got a question or problem or concern, you've got nothing to do. Same thing I guess you can go by an insurance policy from Lemonade and go online with nobody to talk to, or for that matter you can try to go online and loan from Lending Club and you might get a personal loan, I don't know whether they are doing business or not, but there is nobody to talk to. Our business model is there to provide technology and a human being associated with the solution because our business clients, particularly the larger ones. I see the larger ones. We service two-employee companies, we service 20, we service 200, we service 2,000. We're there for all of them, and in many instances, the two or five-person companies ultimately grow significantly larger and we’re able to keep them and retain them. So, we're very excited about our business model, how we're positioned; where we sit today, we've got the right capital structure, our equity is in good shape, our liquidity is in good shape, but what a difference a year makes. Right?

Absolutely. Well, it's great. Thank you, again, and congratulations.

Thank you. I appreciate, Scott. Thank you very much.

Our next question is coming from the line of Merrill Ross with Compass Point. Your line is open.

Hi, good morning. Congratulations, it's a good quarter. I am new to the story, so I may ask a question. It's very naive but do you provide those business services to customers that are not applying for credit?

Yes, thank you, Merrill. I appreciate you picking up coverage on us. Absolutely, yes. I think it's important to note that there is no requirement to take two products. Very important, we don't tie. Many of our clients that are dealing with us in payroll or tech don't borrow any money at all. That's actually almost more of the rule than the exception. I mean we like to do multiple things, and in many cases, they do, but no, there is no tie between the two.

Okay. So, if you were to look at the opportunity to continue to deepen your client list, it's not tied to the referrals to your credit programs?

Not at all. The one skill we need to improve on, which we've acknowledged, is the ability to reach out to our existing customer base and introduce ourselves. Many times when we speak to our clients, they express surprise by saying, "I didn't know you did that." This is the one area where we currently lack proficiency, but it is a key focus for us, and I truly appreciate the question.

Okay. This question is truly the question of analysis. You're looking at rapid ramp in the second half of the year and you mentioned that the net premiums will go down in at the September and two kind of work against each other, so aside from the dividends from the portfolio companies, what gives you the confidence that the year will end with a higher dividend run rate?

That's a great question. First, we have 23 years of experience with our pricing model, which gives us confidence. We intend to sell as much as possible by September 30th. Regarding the 7A market, our analysis shows its historical trends over the past 5 or 6 years. While anything can happen, we don't anticipate it dropping significantly, for instance, going from around 113 to 109. If, hypothetically, it were to go to 101.5, we've already incorporated such scenarios into our internal forecasts. We've factored in that when we provide dividend guidance, the pricing might not be as favorable in the fourth quarter. Additionally, post-September, the 90% guarantees will reduce to a 75% guarantee. All these elements are included in our forecasting. Historically, we've observed that significant loan volumes typically occur in Q4, and this pattern has continued for 17 years.

The seasonality of small business, right?

Exactly, I can make about our fund in September when they want to fund in December.

All right. Well, thank you. I appreciate that.

Thank you, Merrill.

Our next question is coming from the line of Paul Johnson from KBW.

Yes. Hey guys, thanks for taking my questions. Again, I just had sort of one modeling follow-up for you guys. I was just wondering about sort of like G&A expenses, comp expenses just quarter-over-quarter, year-over-year. Obviously up, you guys are coming off a pretty successful year, so maybe no surprise there. But I'm just curious kind of from this level, $4.5 million this quarter for salaries and comp expense, should we kind of expect this sort of level from here going forward or is there any kind of one-time items in there that would maybe come down to a more normalized level in the quarters ahead?

Yes, Paul. I'm glad you brought that up because that is something to think about, it also gives you insight into our thought process, and that is we think that this particular calendar year given PPP, given the economy, given the way our staff has worked incredibly hard, we felt it important to reward them. Now the comp expense was very broken out that way but it was very bonus related, and it was also offered what I’ll call in a meritocracy. So in addition to our shareholders benefiting and our creditors benefiting and our suppliers benefiting, we wanted to make sure that our staff benefited. So I think that it's reasonable to assume, not on a straight-line basis, however, that we will have an elevated level of comp in 2021 versus 2020, but you won't see that going out unless it's sort of commensurate with what we're doing. So, I don't know if I would if that was helpful. I didn't put numbers around it, but I think it's an important note that our comp jumped. It's not because my total salaries jumped by say 50%. It was that we wanted to make sure that other stakeholders, which is our staff equally benefited because they were producing the results at the end of the day, so that's where it is helpful, but hopefully somewhat.

Yes, that's helpful for me. Thanks for taking my questions. Again, congrats on the good quarter.

Thank you. I believe I have one more analyst who couldn't join the call due to a scheduling conflict, Mickey Schleien from Ladenburg. I'll read his questions. First, regarding the pricing outlook for 7A, it has been very strong. We've discussed that, and it's related to the 55 basis point government guarantee fee that will be reintroduced after September 30, which will decrease the coupon. How can we leverage this, especially since the fourth quarter is typically our strongest? Generally, we aim to close as many loans as possible in the third quarter. The last question from Mickey is about the pro forma results without PPP. My suggestion, though you have to wait till last for a response, is to use the 2019 base, considering our significant growth since then, looking at historical distributions from various entities and growth rates to project forward. It's important to keep in mind that executing $1.8 billion in loans across 24,000 to 25,000 units is quite an undertaking. I appreciate the questions and the insights shared, and we look forward to delivering strong results for the remainder of the year and beyond. So, operator, are there no further questions?

I'm showing no further questions on the phone lines.

Thank you very much, everyone. Have a great and healthy day.

Ladies and gentlemen, that concludes our conference for today. Thank you for your participation. You may now disconnect.