NewtekOne, Inc. Q2 FY2021 Earnings Call

Your call is scheduled to begin shortly. Thank you for standing by. We do appreciate your patience. Good day. Thank you for standing by and welcome to the Newtek Business Services Corporation Q2 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. I would now like to hand the conference over to your speaker today, Barry Sloane. Thank you. Please go ahead.

Thank you very much, operator, and welcome everybody to the Newtek Business Services Corp. Second Quarter Financial Results Conference Call. I would also like to announce and welcome Nick Leger, our EVP and Chief Accounting Officer, who will share the presentation with me today. I'd like to point out to all listeners that they can follow the presentation by going to our website, NewtekOne.com. Go to the Investor Relations section and there actually are two decks as part of the presentation. Deck number 1 will be the Second Quarter 2021 Financial Results Conference Call. Deck number 2 will be the Second Addendum to the Investor Presentation dated August 3rd with the current date of August 10th on it. So we'll be using both of those decks today. We're excited to report our first-half earnings as well as our forward look for the second half of the year. Our company is doing really, really well. We have a bright future. Company in business is extremely well-positioned. We have also addressed some slides to talk about talent pool that we've recently added. And obviously a lot of people are intently focused on the results that we put out last night through the first half and the second half, as well as the recent announcement of a contract to acquire National Bank of New York City. Before I get into our focus today, which obviously we'll be focusing on the Company's performance as well as the acquisition, I do want to point out that there clearly has been more activity and questions coming into the Company relative to the acquisition. Broadly speaking, because we'll get into this a little bit deeper, we've got the same business, Newtek was the same business a month ago, it will be the same business a month forward. We basically—if in fact the transaction goes through and we expect that it will, which is why we moved forward on the transaction and will be recommending it most likely to shareholders—it's the same business in a different structure. I think that's what's really, really important. This business has been built over a long period of time; we do most of the things that banks currently do. We were excited about converting to a BDC in November of 2014, when that made the most sense for the Company and its shareholders, and we're excited about the potential conclusion of the transaction, subject to regulatory approval and shareholder vote. So we look forward today to discussing our earnings in the first six months of the year, recent quarter, projections going forward, and the real strong performance that we've had. I'd like to call everyone's attention to Slide number 2 of the conference call Review Earnings deck. On slide number 2, we talk about proven shareholder value creation and track record of successful growth. Important to note, Newtek has always been a growth company. When I say growth company, growth in revenue and growth in earnings. When you take a look at our stock price, year-to-date through August 5th of 2021, up 42% for the year. Ten-year return, 754%; 5-year 222%; 3-year 71%; and 1-year over the last 12 months from that particular date, 50%. I think it's once again important to note that the reason why we're able to generate these returns, and these include dividends plus share appreciation, is the Company is a growth company, it's always been a growth company. And we believe that despite the fact that the Business Development Company structure has been a good vehicle, our ability to grow the business and grow the cash flows are better suited, from a total rate of return basis, in a bank holding company. So we believe that the transaction that we have announced and hope to proceed forward with is a great transaction for all shareholders. I have to point out that if you would have earned a 10% dividend with no appreciation over a 10-year period of time, that's a 200% return. Obviously, there are dividend-oriented shareholders that are somewhat concerned about not getting that regular cash flow. Well, if you've got share appreciation, you could just get that cash flow by periodically selling off pieces of your shares. At the end of the day, Newtek Business Services Corp., in its form, will continue to be going forward and has always been a growth company, growing its cash flows. We're excited about reporting our third quarter results, our first-half results, and projections. Let's go to Slide number 3. Important adaptability of Newtek business model. Well, nobody expected a pandemic to really wreak havoc on our health and business in 2020 and 2021. So clearly these were extremely challenging years in our 23-year operating history. We were able to demonstrate the ability to shift our business model quickly. I think that's really important: being able to transform to current market conditions and position yourself so you could provide good results for all of our stakeholders. We've also proven that Newtek, in its current form, is vital to the economy. You could look at what we have done particularly with respect to our SBA activity. We partnered with the government. And for all of us who can see going forward, particularly in the foreseeable future, government keeps getting larger and larger; partnering with the government is not a bad position to be in, and I think the financial results that we've been able to deliver through a tough 2020 and 2021 have demonstrated that. We believe the Company's firing on all cylinders. What does that mean? As the economy opens up, we believe that we'll be able to grow our payments business, our tech solutions business, insurance agency, payroll, and shift the lending focus from PPP, which is a product that is effectively unsettled with the exception of forgiveness, which we're working on with our customers, and shift the lending focus back to 7(a), 504, non-conforming and secured lines of credit. We think Newtek is extremely well-positioned to capture those market opportunities. For those investors that aren't totally familiar with our model—and there are many new investors attending today's call—when we go out to the marketplace, we have a big funnel. Businesses come to us not for a PPP loan or 7(a) loan—they come to us for financing. And we'll talk about the amount of referrals that we get. The referrals come in the funnel; we use technology to purge that funnel out to get borrowers prequalified quickly, and then figure out which product is right. So for us, shifting from PPP to 7(a) to 504 to secured lines of credit or non-conforming—that's just what we do. It's what we've always done. This is not a big issue for us and we're excited about being able to continue the success, the profits, and the capability that we've demonstrated over the last one year, two years, and actually 10 years over the course of time. We will provide forecasts across several key metrics for 2021, and really reflect the growth of our many-faceted earnings streams, whether it's from payments, tech, gain on sale income, servicing income or spread income. We're very excited about what we are doing and our position going forward. We're also indicating that on a going-forward basis, given the potential change to a bank holding company, our forecast in 2022 will be limited to a quarterly basis. So approximately 30 to 45 days, we hope to give some additional transparency and forecast a dividend for Q1 2022. Going to slide number 4, 2021 key metrics, we've clearly positioned ourselves for a midpoint dividend of $3.15 for the year. That would be a 53% increase over the year prior. Our SBA 7(a) loan forecast for the year is 550 to 600; we dropped the lower-end from 580 to 550. From our perspective, there's been tremendous receptivity for price appreciation, which we'll talk about. So our gain on sale metrics can easily be met within this new forecast range. This isn't necessarily indicative of anything like a slowdown or a change in growth. As a matter of fact, we outperformed in the second quarter on our PPP fundings where we funded $722 million worth of loans instead of a previously forecast analyst review of $600 million worth of those loans. This is just a little bit of shifting around, and we feel very comfortable with these changes. Our 504 business, we're forecasting $125 million to $150 million, that's up from a previous forecast of $125 million. We'll also talk about our non-conforming conventional loan business going forward—clearly a growth engine, particularly in 2022 and beyond. Slide number 5. On August 10th, our Company's Board declared a third-quarter dividend of $0.90 a share; that's a 55% increase over the same quarter last year of $0.58. And with the payment of the third-quarter dividend that was paid out, $2.10 over the first three quarters of 2021, that would be a 32% increase. If our forecast is accurate, the fourth quarter should deliver $1.50 dividend or a 123% increase over the fourth quarter of the prior year. So we're prior year and prior quarter. Once again, we're reaffirming our dividend forecast range with a midpoint of $3.15, and we look forward to continuing to be on all cylinders as we go through the third quarter and the fourth quarter. Moving to Slide number 6, the second-quarter financial highlights. The difference between the second quarter and the first quarter are primarily dominated by a shift in PPP revenue recognition, where we had in 2020 more PPP revenue recognized in Q2 than Q1. In 2021, there was more PPP income from the first quarter to the second quarter, so you could see there was a little bit of shifting around. I think it's important to note adjusted ANII for this recent quarter that we're reporting today came in at $27.1 million, $1.20 a share; although it was a decline from the year prior, it was clearly a stronger number than consensus estimates by about $0.46. We had a $0.77 guess, a $0.65 guess and $0.81 guess; a fourth analyst didn't guess, but we were able to beat the numbers primarily based on the outperformance of the PPP business and the ability to actually close and fund, I believe, close to 16,000 units for the year in this particular round of PPP funding. Net Asset Value also increased at June 30th from $15.45 on December 31st, 2020 to $16.38 per share at June 30th. On Slide number 7, we're talking about PPP resources which are really important. We're estimating, and obviously this is subjective, about 65% to 70% of our resources in lending were focused on PPP financing and now are going to be shifted to the other four product lines. Once again, I'll go into this a little bit further in the presentation, but in calendar year 2019 there was no PPP. It was a very clean year and we're going to look to give analysts and investors somewhat of a base of what we think we can project going forward, taking some of the PPP noise out. We're excited about the shift of resources. The shifting of the resources will give us the ability to do more business in 7(a), in 504, non-conforming, and secured lines of credit. I should also note that given the volumes that we did, particularly with respect to units, we wound up making 46 net new hires in the calendar year of 2021 and that's not over yet, about a 25% increase in staff. For those of you trying to figure out, are expenses going up, are we able to handle it? We're very comfortable as we're growing our revenue size to be able to grow our headcount. We also believe that we are getting greater returns on our equity and our assets by doing this, as we make technological changes. One of the technological changes that we've made is we're pushing out fact-finders to referral partners early, and we're giving referral partners the ability to set calendar invites for our internal staff. These are all things that are expediting our ability to get loans into pre-qualification and underwriting sooner and earlier to get to these borrowers very quickly. Moving to Slide number 8, our six-month comparison ended June 30, 2021 versus June 30, 2020. There are increases in total investment income and ANII; I'll point out that ANII was up 43% year over year. Net investment income actually was a slight decrease. I will comment that in Q1 and Q2, we did not distribute any income coming up from the portfolio companies to the BDC to be paid out in the form of a dividend. That we held back. That was a conscious decision at each particular portfolio company. That cash and earnings still reside at the portfolio company which can be divided or distributed out in the future when needed. In the meantime, it's good to have that cash. We can use that cash to lend to the BDC to make loans or provide greater returns on capital. But I think it's important to note that withholding that dividend does provide a negative drag on net investment income. Once again, we're excited and we believe that the six-month results will give us a more accurate depiction of the Company's performance, particularly due to the uneven distribution of PPP income between Q1 and Q2. On slides number 9 and 10, they go together a little bit. There has been obviously a lot of discussion on forecasting. We try to be conservative in that; we try to give as much transparency and ideas for the investment community and analysts to base some of the forecast on, particularly given things are changing and potentially capital structures and legal structures are changing. As I mentioned, we plan on issuing 2022 Q1 dividend guidance in the next 30 to 45 days to give greater transparency to the market relative to our next few quarters of operations. I think it's important to note that in 2019 the full-year NII was $2.33, and I bring that up and people have said, 'Why are you bringing that up?' Well, you've got PPP noise in 2020 and you've got PPP noise in 2021; when I say noise, that was good noise—a very good indication of how the Company is able to shift through change of conditions, change in market conditions, as well as changing technology and structure. So we look at that as a good base ANII to try to establish a projection in the future for what gross earnings can be. I'd like to draw everyone's attention to Slide Number 10. You can take a look at the adjustment of ANII and the trends in the forecast. As I said at the beginning of the presentation, Newtek Business Services Corp. is a growth company. It's been able to grow its earnings on a regular basis. As you could see, the trend here is clearly up. You could put some fairly high numbers when you actually calculate what the trend is over that period of time. Obviously, we were affected by the pandemic in 2020, primarily relying on PPP and taking a hiatus in some aspects of our business lending with an uncertain view towards credit, which I think at this point in time has largely corrected itself. But I think it's important to note that the street estimates for 2022 going forward as a BDC are approximately $2.29, as the average amongst the four different participants. I look at the $2.29 and look at what we did in 2019, and I'd say that there's no growth. Frankly, I just don't see it. So whether you put a 25% number of growth a year, or you put a 15% number, 10%, 5%, 0% or negative, put whatever number you like on it. I think this is a good way for all of us to try to calculate what our earnings capability is going to be as we go forward. We want to be careful not to confuse the market too much relative to the transition of becoming a bank holding company versus a BDC, so we'll do this in bite sizes. But for many of you, hopefully this will give you a good base to configure what we'd look like. The one thing I feel fairly strongly about is we are a significantly bigger, better, stronger, more efficient company in 2021 going into 2022 than we were in 2019, and I feel great about our prospects. I hope that analysis is helpful to investors and the analyst community. Going forward to Slide number 12, we talked about our PPP results: $722 million of loans, 15,800 units on an aggregate basis in 2020 and 2021, 26,000 PPP customers that are all available for discussion about other things that we can do for them—$1.9 billion worth of loans. I will point out that in excess of 99.6% of all these loans were sold to third parties. So no balance sheet implications; it's just income and they move off the balance sheet. I think most people on this call are familiar with all the PPP information. There's information on our website to take a look at what the PPP program was about, which we talked about extensively in prior calls if you need to get that data. On slide number 13, we talk about our SBA 7(a) fundings, which we're transitioning back into on a full basis: $94 million of loans during the three months ended June; $198 million for the first six months; forecasted range 550 to 600. Once again, reshifting or redeploying of assets. We have held over approximately $26.7 million of guaranteed portions of SBA loans that are available for sale going forward. Slide number 14 covers some information on other portfolio companies, particularly NBL, Newtek Business Lending. Ditech Business Lending is our origination unit that does the 504 loans and also originates non-conforming loans for the joint venture. We funded or closed $49 million of 504 loans for the three months ended June; there was nothing done in that quarter in the year prior. $72 million for the first six months—that's an $18 million increase over the six months of last year. We bumped our fundings up in a range of $125 million to $150 million. Our credit facilities of $175 million with Deutsche Bank and Capital One Bank respectively are in place. On Slide 15, there's a good snapshot of our pipeline. You can see it's real strong and robust, which puts us in a great spot to be able to fund and close 7(a) loans in Q3 and Q4 and well beyond that. We're really excited about the shift back to regular courses of business as business owners look forward to getting back on track and growing through the effects of the pandemic. On Slide 16, obviously COVID-19 and the pandemic affected our workforce; we were able to shrink our real estate footprint by closing offices in Milwaukee, Irvine, San Antonio, Dallas and New York City. We demonstrated the Company has been able to manage our employees efficiently, working remotely through our time tracker program, which gives us the ability to monitor and manage remote workers with respect to time on the phone, who they're calling, outbound calls, inbound calls, as well as knowing which customers they service within different hours of the day. Our staff has been able to benefit by not having long commutes, so we have adapted well to the remote work environment. We do believe going forward we will operate on some kind of a hybrid structure. We thought that return to office might begin September 1; given the current conditions, that might get pushed back another month or so, but we do plan on getting back into the office and develop a great environment for people to work out of their house while still having camaraderie, coordination and communication by coming to the office a couple days a week. Slide 17 for those that aren't familiar with our ability as an SBA lender under the 7(a) program contains good data. It talks about the profitability of the program and the ability to access the markets through rated securitizations, with average uninsured but non-subordinated participation certificates of $170,000 and attractive coupons on the uninsured of 6% floating with no caps. Slide number 18 talks about growth in loan referrals through our patented NewTracker system, which would be something that clearly would carry over to the bank and the bank holding company. Once again, getting 109,000 loan referrals—many of these loan referrals are qualified for more traditional types of bank lending, C&I loans, commercial real estate loans—that we're able to fund with our lower cost of retail deposits. I think it's important to note that we don't see the National Bank of New York doing car loans or consumer credit cards; we will be focused on the things that we currently do best, which is lend money, process payments—which we do through our payment processor—provide payroll and other cash management systems for our business clients. We'll talk about the NewtekOne Dashboard, which we discussed in previous presentations. Once again, not a major change or shift in business, but important to note. We get lots of referrals. We have a database in near-time of 1.5 million customers in our database: 1.5 million that have passed a referral to Newtek seeking a product or a solution in one particular area or another. The cross-selling efforts should be enhanced significantly through the NewtekOne Dashboard, which is clearly a bank product that we'll be rolling out—the one solution for all your business needs. To be able to go to that dashboard, see your deposits, see your loan information, be able to make your payroll, get HR tools right on the dashboard, have all of your important organizational documents saved and stored there. Obviously, a lot of these forward-looking comments relative to the bank are subject to regulatory review and approval by our application through the Federal Reserve and the OCC. These are the things that we believe and are hopeful we'll be able to do if the regulators approve our transaction and if the shareholders vote for the conversion into a Bank Holding Company. Our 18-year track record of loan assembly, underwriting, and technological expertise has made us a leader in the areas of lending, and we look forward to getting through this pandemic and finally getting back to a more normalized business process. Slide 19 talks about premium trends. One of the reasons why we were able to cut back on the amount of loans we're doing is because of these higher prices that we're getting, and these higher prices should go away by September 30th. I say that because, due to the COVID relief bills passed in Congress, some of the fees that were charged to borrowers and originators like ourselves were waived, which enabled us to effectively sell higher coupons. Projecting forward, I would look at the numbers from 2016 to 2020 and maybe even part of 2021 to give us a more normalized type pricing for gain on sale. Clearly this has been helpful to us; we've taken advantage of it, and we realize that based on our projections we'll go back to a more normalized market, which we saw as a Company in 2019. Slide 20 shows the seasoning of our portfolio—this is important. We have a portfolio that's primarily sitting in securitized structures, which is good. We have an analysis in our deck from Standard & Poor's that shows when defaults are particularly occurring or accelerating. We're comfortable that obviously we're doing new loans to put on the books, but our seasoned portfolio hopefully has experienced a good portion of the stress relative to seasonality. With that said, we're still going through the effects of the pandemic. A lot of businesses coming out of the pandemic are struggling somewhat, but so far we feel pretty good about how our portfolio is performing as evidenced by our currency analysis on Slide number 21. We see from 3/31/2021 to 6/30/2021 slight deterioration but not significant. Obviously, we've had the reduction of 1112 payments for a quarter. So we were comfortable that there wasn't a major shift in those particular metrics. Slides 22 and 23 are slides we've used for about 15 years in these calls. For those unfamiliar, they show how an SBA 7(a) loan is funded, how the guaranteed piece gets sold, how income is booked, and how cash is created. Slide 24 goes into the portfolio company review: these are our controlled portfolio companies. Our 504 loan program did well this year versus last, particularly with growth in originations, looking for $125 million to $150 million. I do not believe we sold money out from NCL in the first or second quarter, and that's dollars that will go back into making additional loans that potentially can be distributed in Q3 or Q4. Slide 26 demonstrates for those that aren't familiar with 504 lending that it gives the ability to make a 90% LTV loan to a business owner that's fully personally guaranteed. When we make the loan with respect to our underwriting guidelines, the SBA and the CDC have already approved it—therefore, the 40% second lien gets taken out by the government; we're left with a 50% first lien, which we typically sell into the market for gain on sale. Slide 27 is illustrative of that. When you look at our 7(a) business getting high returns in equity and assets, our 504 business also has high returns in equity and assets. You can see why we were able to generate larger returns, obviously as a BDC and we do believe that will carry over into a Bank Holding Company and bank structure, once again subject to regulatory review and shareholder vote. Slide 28, we talk about our conventional loan program. We are working at the moment on a potential small private securitization with our partner in the first JV; we're excited about that and think it will give us good validation. On Slide number 29, we signed up a second joint venture partner and are currently working on a third. These programs do take a while to put into place with respect to getting a securitization done and getting our leverage lines in place. But we feel pretty good about the program and we expect to fund up to $50 million of non-conforming conventional loans either through JV or on our balance sheet through the second half of the year. Slide number 30, we talk about our payment processing companies, that being Mobil Money and Newtek Merchant Solutions. We've come up with a total enterprise market multiple value of 8.5 times 2021 EBITDA numbers; we feel good about that. I also want to note that we did not distribute earnings out of NMS or NTS through the first half of this year, and that's something that can be done; it could provide funding to the BDC for making loans. We have a lot of flexibility in our business model—that's an important aspect of investing in Newtek—to have many different levers and diversified streams of income, and we try to be as transparent as we can to our analysts and the investment community. Slide 31, we talked about our payments business in the prior slide; we have an increase and record volume coming off of the pandemic, and we anticipate continued growth in processing volumes for the remainder of 2021. Slide 32, we talk about one of our important solutions that'll be particularly valuable in the Bank Holding Company or bank structure: being able to provide POS software directly to a customer to enable them to do their payroll, e-commerce, integrate to their accounting GLs, integrate e-commerce and in-store, integrate to food delivery services. We already have an existing book of business in this space and we're very excited about everything we're doing in the payment space, particularly with our software solutions. Slide 33, technology portfolio companies: we have a real nice turnaround in NTS; we're forecasting revenue between $40 million and $50 million for 2021, and EBITDA about $6.2 million, a realistic multiple of 6.7 times, particularly for a growing tech business. This business had consolidated EBITDA in 2020 of about $4.3 million, so we're looking at $6.2 million for this year, and we're excited about what we're doing in tech solutions. I want to encourage listeners and analysts to go to our website and see what we do there. We're not just a value-added reseller; we provide great solutions to our customers and manage their technology 24/7. Moving to Slide 35, we've recently embarked on several broker-dealer initiatives. As more broker-dealers and RIAs and their brokers work remotely, we give them their total solution, charge them on a per-seat basis, and enable people to work at home safely and securely with a 24/7 help desk and remote compute. We see cloud services as a significant market opportunity and Newtek is very well-positioned for that. Slide 36, we talk about our payroll and insurance solutions; we're excited about the performance of those businesses. They have historically been slow growth, but they're growing nicely this year. We'll probably have some more information at the end of the third quarter, and we look for them to finally begin to contribute to earnings and dividends to the BDC. Slide number 37, in summary of our earnings report for the first half of this year without forecast of the second half as a BDC, we've demonstrated a diversified business model, a proven track record, and the ability to take a business that's consistently outperformed the Russell 2000 and the S&P 500 for over a decade. We have over a 19-year history through lending cycles and deep management experience. I think it's important to note that management's interests are very much aligned with shareholders. We own about 5.1% of outstanding shares; we love dividends and share appreciation. We are an internally managed BDC; that's important to note, so we're not getting paid for growth in assets—we're getting paid for performance. I will comment that from an individual perspective, my cash bonus for last calendar year was zero; I did get long-term compensation in the form of stock for 12, 24 and 36 months worth of work. At Newtek you perform, you get paid; you don't perform, you don't get paid. We believe that what we're suggesting is not self-enriching for any of the executives, or people making this decision. We believe this is in the best interest of all of our shareholders and stakeholders, and that's why we've contracted to buy National Bank of New York City and look forward to discussing that transaction a little bit further. I'd like to turn everyone's attention to the second deck, the second addendum of the investor presentation dated August 10th. I want to relay that information regarding the proposal to withdraw Newtek's election to be treated as a Business Development Company will be contained in the Newtek proxy statement when that document becomes available. Stockholders should read the proxy statement when such document becomes available. The proxy statement may be obtained free of charge when available from the SEC EDGAR website and the Company. With that said, I'd like to turn everyone's attention to that particular deck. I will probably read this again at the conclusion of this discussion just to make sure everyone's heard it. Looking at the information in the second deck for today, the purpose of this deck is to separate some very important salient facts and provide more information why we think it makes sense dropping our business into a Bank Holding Company and subsequently buying a bank. I've had people say, 'Why are you buying banks? Banks are out of favor; who likes banks?' Well, being that banks are out of favor and being able to buy a bank at 100% of book is a good thing. Why sell out of a BDC? Interest rates are low, people are buying. Well, that may not last forever. Particularly given our current business model, which is a growth business model, we are better situated in a financial structure to benefit from a better growth structure than a BDC, which is not typically situated as a growth structure. Let's go to slide 3. This slide talks about the actual transaction to acquire National Bank of New York City, basically a $20 million cash price for book. We intend to buy at 100% of book. We believe we can add to National Bank of New York City a great digital platform to provide financing and digital solutions. We believe we can transform our combined entities into a technology-enabled bank. We don't need nor do we want a large real estate footprint, nor do we want commercial bankers all over the U.S. We are a technology-enabled bank utilizing technology to provide the best products, services, and solutions to our customers. Newtek has approximately 450 employees, so we're not short of human capital to work with clients digitally or telephonically to provide solutions for loan assembly, payment processing, tech solutions, insurance or payroll. Slide 4 shows an anticipated well-capitalized institution, that being Newtek Bank and Trust and the potential Holding Company. You can see the ratios, and again this is illustrative of what our current capital base looks like plus a projection or an estimate of what the bank will look like going forward. When we said the other day this is a well-capitalized bank, some people asked 'is it 10, 11, or 12?' We have a lot of capital going into this institution. The holding company and the bank will prospectively, on an educated assumption, start up well-capitalized. Slide number 5 displays potential profitability targets for the bank holding company. For those that invest in banks, banks with strong ROA at 1.5% to 2% are attractive. Why are we able to achieve these? We have a business model that is growth-oriented and one we've managed and perfected where others have not done as well in SBA 7(a) lending, 504 lending, payment processing, payroll solutions, and can put those into this structure. We will diversify our cost of funds, continue to use some commercial sources of funding, and use core retail deposits, which tend to be sticky and lower cost. By increasing deposits we'll be able to generate higher rates of return. You can see these profitability targets on an after-tax basis and we believe it keeps us competitive with market multiples on similar institutions and product categories, which you can assess yourselves. Even in a stress case where deposit costs are higher than we currently estimate, we're still able to generate attractive ROAs and returns on average tangible common equity. Slide 6 addresses profitability targets where many bank holding companies love to get non-interest income versus spread income. Most banks are primarily driven by interest income less cost of deposits, which is fairly stable and not very exciting, which is why banks typically trade at book and can't grow much. But the world is changing, and tech-enabled banks such as Live Oak, Square and SoFi are positioning themselves to grow the book and earnings. On Slide 6, the pre-tax income other business lines include payments, tech, payroll, gain on sale and servicing income. We target this Bank Holding Company and bank to be a growth vehicle. Slide 7 benchmarks where we'd like to take the institution. You can see ROAs significantly higher than traditional banks not tech-enabled, and a higher return on average tangible common equity. We will start with a higher tangible common equity ratio compared to most institutions. So when you hear comparisons to NAV and tangible book, fine. Others may compare differently; some may look at growth of earnings over time which we anticipate and potentially project. All of that will show up in the proxy prospectus. Slide Number 8 illustrates what we think the Bank Holding Company or Financial Holding Company might look like—again, well-capitalized. I want to point out the note about $173 million of goodwill. Now, where does that come from? In the BDC we have our payments business with approximately $100 million valuation, our tech solutions business and other portfolio companies. In total, the value of those businesses is around $250 million; net of debt it gets down to $173 million. In the BDC those assets are on our books at zero. When they get transferred to the bank using purchase accounting, this will likely result in GAAP-based goodwill. These statements are not audited and are forward-looking. But relative to that $173 million number, it's essentially typical goodwill where you buy assets and pay a premium above book. Most likely this will be GAAP goodwill. These assets are throwing off EBITDA and cash flow and that's different than just paying a premium above book value of assets. Slide 9 addresses costs of advisory work. One comment I've heard is 'you're going to need to add all these people and expenses.' We have the mother of all advisory teams, from legal to individual advisors to prospective bank boards. I've got a large consulting team and we've factored these bank startup expenses into our projections in the proxy prospectus. Many of these people currently work for the Company. We do most things that banks do today; when you look at the resumes of our team—Brian Schulman, EVP Chief Credit Officer; Al Spada who ran the ABL business at Banco Santander; Bryan Rowland, SVP in commercial real estate; Mike Ovitz; Peter Downs, our Chief Lending Officer with 20 years of bank experience; and Nick Young, who will be the President—we've got the talent, so please don't underestimate Newtek. Slide 10 is unusual but important: past stock performance and circumstances aren't indicative of future results. This shows our history particularly as a BDC when we completed the conversion on November 12th. We did a re-IPO transaction and at that point it looked transformative. There were questions then as there are today, but we believed that particular capital structure would work for us. We were able to raise more equity and debt and became a larger and better-capitalized company. As we look forward, we see continued growth and a structure that enables us to grow efficiently. Moving to Slide 11, in summary we have a diversified business model providing multiple streams of income: gain on sale, servicing income, payments, tech. Many of these businesses will be sitting at the Bank Holding Company and we appreciate that diversified stream of income. It's not our first rodeo; we've been publicly traded since September 2000 and have consistently outperformed the Russell and the S&P. We believe the Bank Holding Company will be in the best long-term interest of the Company and stakeholders. It's the same company, dropped into a different structure. You're not going to see us sell toasters or make consumer car loans. We will round out our product offering by being able to offer the NewtekOne Dashboard to clients and resell that to other financial institutions. Our interests are aligned with shareholders—if you think the dividend is going to get cut, we're cutting our own dividend as well. We believe in this transformation just like we believed in the conversion to a BDC in 2014. By changing our corporate structure, we're going to broaden and enhance access to financing and growth and actually reduce the risk of the overall company. We believe we'll be in a structure more readily accepted by a bigger pool of investors. This is not designed to alienate existing shareholders who have benefited from historic capital gains and dividends. At this point we can't comment on magnitude, but we plan to continue our business model to grow cash flow over time. We're excited about the NewtekOne Dashboard; we'll talk more as it develops. I appreciate everyone's attention; we've covered a lot of information today. I'd now like to pass the presentation to Nick Leger. One other thing I want to repeat: information regarding the proposal to withdraw Newtek's election to be treated as a Business Development Company will be contained in Newtek's proxy statement when such document becomes available. Stockholders should read the proxy statement when such document is available. The proxy statement may be obtained free of charge and will be available from the SEC EDGAR website and the Company. Go ahead, Nick.

Yes, sir.

Okay. Nick, scroll that—he's not even back yet. Okay. Operator, any chance you could—could you try to give him a call?

Hey, Barry. I just thought we could—

Nick is back online.

Okay. Right, Nick. You're up.

Thank you, Barry. Good morning, everyone. You can find a summary of our second-quarter 2021 results on Slide 39, as well as a reconciliation of our adjusted net investment income, or adjusted NII, on Slides number 41 and 42. For second-quarter 2021, we had a net investment income of $15.5 million, or $0.69 per share, as compared to net investment income of $29.7 million, or $1.42 per share, in the second quarter of 2020. Please note that income related to the PPP is included in investment income. Adjusted NII, which is defined on Slide 40, was $27 million, or $1.20 per share, in the second quarter of 2021 as compared to $28.5 million, or $1.37 per share, for the second quarter of 2020. Focusing on second-quarter 2021 highlights, we recognized $36.6 million in total investment income, a 21.6% decrease versus the second quarter of 2020 total investment income of $46.7 million. Interest income related to fees from the PPP was the primary driver for the decrease. We recognized $25.5 million of income related to the origination of PPP loans on $297.6 million of PPP loan originations during the second quarter of 2021, as compared to $34.7 million of income related to $1.1 billion of PPP loan originations in the second quarter of 2020. The distributions from portfolio companies for the second quarter of 2021 were $0.9 million as compared to $2.3 million in the second quarter of 2020. Total expenses increased by $4.1 million quarter-over-quarter, or 24.2%, mainly driven by an increase in SBA 7(a) loan referral fees due to the higher loan origination volume, also compensation-related costs and other loan administrative expenses. Realized gains recognized from the sale of the guaranteed portions of SBA loans sold during the second quarter totaled $14.1 million as compared to $1.7 million during the same quarter in 2020. In the second quarter of 2021, NSBF sold 142 loans for $87.4 million at an average premium of 14% as compared to 20 loans sold during the second quarter of 2020 for $19.1 million at an average premium of 7%. The increase in realized gain was attributed to higher SBA 7(a) loan origination volume in the second quarter of 2021 combined with higher average premium prices when comparing to the second quarter of 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 second quarter of 2021 were $2.7 million as compared to $2.9 million in the second quarter of 2020. Overall, our operating results for the second quarter of 2021 resulted in a net increase in net assets of $17.4 million, or $0.77 per share, and we ended the quarter with NAV per share of $16.38. I'd like to turn the call back over to Barry.

Thank you, Nick. Operator, we'll take questions now.

We will pause for just a moment to compile the Q&A roster. And your first question comes from the line of Mickey Schleien from Ladenburg.

Yes. Good morning, Barry. I hope you're well. Barry, a high-level question about the conversion to a Bank Holding Company. My understanding as part of the rationale for that is to lower your cost of capital by collecting deposits. Could you describe to us how Newtek will compete for those deposits? For example, do you see yourself competing with online banks who tend to pay more for those deposits than brick-and-mortar banks?

Sure. I think first of all, Mickey, there is such a delta between currently financing growth with $1 of equity issuance and a significant amount of debt where our baby bonds are 5% or 6%, to being able to raise money at core retail deposit rates, whether they're at 1% or 1.5% or even 2%, and using the capital base and leverage. How do we go after that? We've got 100,000 referrals a quarter—that's 400,000 a year. When you look at that NewtekOne Dashboard, which is an aggregating tool for a business, it's the single sign-on: deposits, loans, payroll, analytics, Visa, MasterCard, this day this year, this day last year, this quarter this year. We will have the tools that others are imagining. These capabilities are currently being worked on and are not a fantasy. These are tools that we currently use today; it's a function of putting them together and presenting them. This is going to unlock shareholder value that you can't see in a BDC. Most BDC investors don't see us as an operating business.

I understand, Barry. So if I want to make sure I have your thesis correct: are you going to go after the small business borrowers that are your target market in terms of their cash management, or are you also going to go after the owners of these businesses in terms of their personal cash as well?

That's a great question, Mickey. We're not intending to be a consumer bank. However, a majority of deposit money in this country is from business owners who have both a commercial account and a personal account at the bank. We might do some accommodations here or there, but we want the business banking relationship. We want to provide business solutions. We're not going into the securities business at all. We'll stick to the core things we do today: lending, payments, insurance, payroll, health and benefits, HR solutions and related services. So from that perspective, not much of a change.

That's helpful. If we think about all those borrowers that are already existing customers of Newtek, you've underwritten their loans—you know their balance sheets. Any scope of how much cash is on all those balance sheets that you might be able to capture, at least partially, as deposits?

I can't give a specific number, but it's substantial. I want to be careful not to step on our alliance partners and we won't do that, but we have a large base: 25,000 PPP loans and 100,000 referrals a quarter—big numbers. We've developed effective viral marketing due to what we're doing. The concept of getting $300 to $500 million of deposits in the near term is within our imagination and should not be a big deal over a fairly short period of time.

Okay. That's helpful. I understand. I'm wondering—switch gears a bit—toward the 7(a) market. As we know, the federal government temporarily suspended the 50 to 55 basis point guarantee fee and increased the guarantee to 90%—if I'm not mistaken, that expires next month. That's helped drive up secondary market prices. So given your experience, when you think about the 7(a) market next year with the economy doing well but without those catalysts, and with the potential for interest rates to climb, how do you see 7(a) pricing developing next year and how do you see 7(a) volumes next year versus this year, which will be a phenomenal growth year?

I'll give you a fairly wide range, Mickey. If you go back and look at the history, it's been roughly a 110.5 to 112-type market and it depends on whether you're doing 10-year or 25-year paper in the mix. From our standpoint, we expect to enjoy the benefit of expanding our loan products. Those referrals don't come to us for a specific program; they come for loans and many would qualify for bank loans. With lower cost of deposits you can put that business on and make good money. I think the market next year could be strong. People are talking about GDP growth; there's a lot of stimulus in the system. Rates rising is actually good for banks; that is one reason buying an out-of-favor bank can be beneficial. Regulators, like the OCC, have indicated an interest in banks being involved in SBA and small business lending. So we see opportunity rather than a major headwind.

Thanks for that, Barry. My last question: comparing next year versus 2019 as a base, how would you compare the time and resources it takes to underwrite a PPP loan versus your non-PPP loans? And how much unit volume do you think the Company can support now with current headcount and more employees working remotely compared to 2019?

Good question. PPP loans to assemble and fund probably took 30% to 50% of the labor compared to traditional loans. The backend—the credit memo, the committee and funding—still requires substantial work. PPP loans had a lower fallout rate once activated. We've improved capacity with technology and process changes, which is why I referenced the 2019 adjusted NII to current dates. The ability to do significantly more loans has been enhanced and the loans are larger in size as well. For context, the average PPP loan was about $50,000; our 7(a) average is about $800,000 and non-conforming averages much higher. With the advancements in technology and management, we've grown capacity significantly and are well-positioned for future growth.

I appreciate your time, Barry. That's it for me this morning. Thank you for taking my questions.

Thank you, Mickey.

And your next question comes from the line of Paul Johnson from KBW.

Good morning, Barry. Thanks for taking my questions. Congrats on a good quarter and obviously being an important facilitator of a critical program for the U.S. economy. As you approach the proposed closing date of the acquisition of the bank, do you expect to make any changes to your capital structure along the way in anticipation of the conversion?

No, Paul, I don't expect to make changes in the capital structure.

Okay. What about loan originations? Is it business as usual or do you expect to change the types of yields or loans that you're underwriting or any changes to underwriting practices?

We are a bit more selective in categories that were COVID problematic—things like gyms and hair salons. So we're cautious in certain industries and more favorable in others. The mix will align with the guidance we've given on 7(a), 504 and non-conforming loans. This is the same business essentially dropped into a different structure with a few added product lines. Newtek Bank and Trust and the Bank Holding Company will be viewed differently by customers, particularly with the dashboard.

Understood. On salary expense for the quarter, higher quarter-over-quarter due to increased headcount—do you expect salary expense to continue around these levels into the acquisition or moderate post-PPP?

What you've seen in Q1 and Q2 is already embedded. We've added staff for growth, including to support PPP. I don't expect major changes. In fact, some expenses could be reduced in a bank structure versus a BDC structure as some entities convert into the bank, and certain duplicative costs get eliminated. So I don't see expenses going crazy.

Do you think you'll need additional hires prior to closing for the bank?

Maybe one or two. But we’ve already hired experienced people like Nick Young and others with decades of bank experience. We have in-house talent and external advisory help. We’ll adjust as needed with regulator feedback, but I don’t expect significant additional hiring.

That makes sense. Thanks for that. Last question: regarding the decision to retain income at the control investment level this quarter, I see roughly $8 million of unrealized depreciation in affiliate investments this quarter. Was anything specific driving that depreciation?

Nick, can you answer that one?

Yes. That adjustment was based on reviewing run rates on some of the portfolio companies and ensuring multiples are in line with forecast. Nothing out of the ordinary.

Got you. Okay, thanks. That's all for me.

Thank you, Paul.

And your next question comes from the line of Scott Sullivan from Raymond James.

Good morning, and congrats on a good quarter.

Thank you, Scott.

You're breaking some interesting barriers in the fintech space here. Pro forma, how do you compare Newtek versus LendingClub, SoFi, Square or even Live Oak?

They're interesting comparisons. LendingClub and SoFi were non-bank lenders that acquired banks; Live Oak started as a bank with a technology bent and is probably the closest to us given its footprint in government-guaranteed loan programs and minimal branches. LendingClub and SoFi are consumer-focused. Expense ratios and operating models differ among them. What unites them is the shift toward a banking structure to diversify funding and growth capacity. We view ourselves as similar to the tech-enabled lenders and fintechs in that respect, but with a strong SBA and commercial lending footprint and diversified income streams beyond spread income, which positions us differently than a traditional bank.

Thanks. I also wanted to confirm CapEx is not going to be materially higher. Can you speak to any development costs for the dashboard or other tech enhancements?

We will have development work with our core platform provider to integrate components into the dashboard. Payroll software, insurance agency integrations, our FileVault and NewTracker are pieces we already have. It's a function of our internal development team putting the product together. We have some time before opening day—our forecast is six to 12 months out—and we've been able to develop good technology without spending excessive dollars. So CapEx won't be runaway; it's a managed, bootstrap approach.

That's terrific. Thank you and congratulations. Good luck.

Thank you, Scott.

And your next question comes from the line of Robert Dodd from Raymond James.

Hi—Barry. Sorry.

It's all right.

My question: one of the slides notes that in 30 to 45 days you'll give preliminary guidance for the Q1 2022 dividend and the footnote says presuming you're still a BDC. If things go according to your expected timeline—which I recognize is tricky—would you actually expect to still be a BDC in Q1? You said the bank approval could take six to 12 months. Would you leave the BDC election to the very end or anticipate doing it earlier?

Without getting into precise timing, I think it's more likely than not that we'll be a BDC for that dividend. It's a probability; it could go either way, but more likely than not we'll probably be paying a BDC dividend in the first quarter.

Understood. Follow-up on baby bonds: your BDC baby bonds are relatively expensive versus traditional bank funding. When might you anticipate refinancing those, or do you expect to roll them into the bank liability structure?

Great question. My belief is the covenants in those bonds are leverage covenants. Theoretically, as long as we don't violate the leverage covenant on a consolidated basis, they can remain outstanding. One bond is fully callable; the other is callable after February with a make-whole provision for a 12-month window. We'll work with bondholders and have options. We've also had conversations with several bank lenders. So I'm not overly concerned about the baby bonds or our position with our other lenders at this point.

I appreciate that, Barry. On deposit sourcing: most business deposits aren't time-locked CDs. Would you target short-term callable deposits or expect CDs to play a material role? Where will you source CDs if you plan to use them?

I think we'll have a mix of both. The dashboard relationship and the ability to offer more than just a rate will help. Some fintech lenders have tapped into brokerage and ILC-like structures; we'll pursue a mixture: core retail deposits and other funding sources. We expect to bring in core retail deposits and a balanced funding mix.

Got it. Thank you.

Thank you, Robert.

And your next question comes from the line of Rob Brock from Partners.

Congrats on a great quarter and congrats on your decision to change your corporate structure. I think it's going to create value for your investors. My question: regarding operating businesses like your Cloud business and payroll business, how might these change or benefit as part of a Bank Holding Company?

All of the portfolio companies are projected to be part of the Bank Holding Company. Merchant solutions, payroll, insurance and tech solutions will be part of the BHC. We'll discuss it with regulators but we feel these businesses will fit into the BHC or Financial Holding Company structure. It's conceivable regulators might have different views and we'll adapt if needed. Bringing customers’ organizational documents, operating agreements, lease information, insurance policies, employment agreements and other core documents into a secure file vault is a value-add. Remote work, mobile computing and managed tech solutions are especially valuable to small businesses that can't afford a CTO or CIO. Those businesses benefit from our managed services and these businesses typically trade well as recurring revenue businesses that provide diversified non-interest income to a bank structure. We're excited about integrating solutions and expect strong traction.

Great, thanks Barry. Good luck.

Thank you, Rob.

And your next question comes from the line of Arham Khan.

Hi. Good morning. This is Khan. How are you doing?

Good morning, sir.

How's everything? I wanted to start with some high-level questions about diversification as we move out of COVID. Are there opportunities you're looking at now that you might not have looked at 12 months ago that are starting to become attractive, from a lending perspective?

From a lending perspective, we remain cautious because of the delta variant. Speculatively I think the delta wave will come and go given vaccination levels, but consumers are still changing behavior in travel and entertainment. We still maintain a caution flag on sectors like travel and entertainment. As a lender, if we get an appropriate coupon we can underwrite, but we remain cautious in specific categories.

Okay. Follow up on geographic diversification: are there regions you're targeting given demographic shifts or relocation trends?

Diversification has been an asset for Newtek. We don't have an overly concentrated exposure to any single state. We like diversification and are not looking to concentrate in any one market. That approach helps manage risk, particularly in unexpected events like the pandemic.

Got it. A follow-up on fintech competitors like LendingClub and others: many tout predictive modeling and streamlined underwriting. You're a technology-enabled lender with a more full underwriting process. How do you ensure those fintech players don't erode your spread or market?

Those competitors are often addressing low-hanging consumer or small business use cases and leveraging algorithms to underwrite consumer-style loans. We do full underwriting for loans over our thresholds—20 to 25-page credit memos for larger loans. We use technology to accelerate processes, but we don't have a black-box approach. Our advantage is the combination of technology to acquire and service clients and rigorous underwriting, lien perfection, legal documentation and closing processes. That differentiated approach helps protect spreads and manage credit risk. We also use technology to reduce losses and improve customer experience while maintaining strong credit standards.

Okay. Thanks very much and best of luck.

Thank you for your interest, I appreciate it. Operator, any more?

Yes, sir. Your last question comes from the line of Mickey Schleien from Ladenburg.

Barry, just a quick follow-up. Do you think the federal regulators are going to require Newtek to appoint a CFO to meet regulatory requirements?

Yes. We will most likely have a CFO at the bank level for sure.

Do you have candidates inside the organization who could take that role?

Yes. We have internal and external candidates. The person needs substantial experience dealing with bank regulation and compliance. We have a good pool of applicants ready if required.

I understand. That's it. Thank you for the update.

And there are no further questions at this time.

Okay. Well, I want to thank everyone for joining the call. I greatly appreciate the interest. I know this was a long one, but very worthwhile and gave us a good opportunity to disseminate a lot of information under Fair Disclosure to all the investors and analysts out there. Thank you very much. Look forward to reporting the third quarter. Have a good day.

This does conclude today's conference call. Thank you for your participation. You may now disconnect.