NewtekOne, Inc. Q4 FY2023 Earnings Call

Good day and thank you for standing by. Welcome to the NewtekOne Inc. Fourth Quarter 2023 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Barry Sloane, Chairman, President and CEO of NewtekOne. Please go ahead.

Good morning, everyone, and welcome to our fourth quarter and full year 2023 Financial Results Conference Call. We're pleased to report our results to you this morning. My name is Barry Sloane, CEO and President and Founder of NewtekOne Inc. Joining me today on the call for presentation purposes is Scott Price, our Chief Financial Officer of Newtek Bank, National Association, and NewTek, Inc. In addition, we also have Nick Young, President and CEO of Newtek Bank, NA; and Nick Ledger, EVP and Chief Accounting Officer for NewtekOne Inc. I'd like to draw your attention to slide number one, which is our fourth quarter reporting as a financial only company. Slide number one is the forward-looking statement. Please take a moment to absorb that. Now go to slide number two. This is our fourth quarter and third full quarter reporting as a financial holding company. We acquired National Bank of New York City on January 6th. So it took some time for us to integrate many of the assets and employees into Newtek Bank, National Association. So I think it's important to note that when you look at year-over-year comparisons, the Q1 2024 comparison might be a bit choppy versus the Q1 2023. Additionally, when we analyze our 2023 performance, it's challenging to conduct comparisons as a prior BDC. However, it’s essential to emphasize the quarter-over-quarter sequential comparisons. We had a really good year and quarter-over-quarter comparison when you consider metrics like portfolio loan growth, expanding net interest margins, and deposit growth. We now have six analysts covering NewtekOne as a financial holding company. We demonstrated the ability to raise insured deposits quickly with a rapid growth rate through digital account openings. Also important to note, we don’t face the interest rate risk issues currently present in the industry, as our assets’ liabilities are very well matched. We believe that when you compare our return on average assets, return on tangible common equity, and capital ratios to the banking industry, we are well capitalized, very high, and also well reserved. Now, I would like to draw everyone's attention to slide number three. Newtek Bank, National Association summary financial highlights focusing on Q3 to Q4 growth and the fiscal year 2023. Return on average assets for the year was 5.76% at the bank, which is obviously very, very high for a bank. As we progress through the presentation, I will explain why we're able to generate such high returns. Return on common equity was 35%. The efficiency ratio was approximately 50%. These are ratios you do not typically see in the banking industry, largely due to a very unique business model focused on returns on shareholder equity and return on assets, rather than simply growing a book of business, which is conventional in the banking sector. We have achieved this efficiency at a very competent basis. On slide number three, it's also important to note the margins; we obviously had increasing yield on loans as we began to integrate more of our Newtek-type traditional loans into the bank's portfolio. Average rates on deposits were fairly stable from Q3 2023 to Q4 2023. We might see a slight uptick next year as some older, low interest bearing CDs mature, but we feel optimistic about the future. Scott Price will provide more details about that shortly. Importantly, our net interest margin at the bank increased from 3.49% to 4.43%, a significant rise. Most banks currently are lucky to maintain stable margins, let alone improve them. We are very proud of this achievement in terms of margins. Our capital ratios remain strong, with CET1 at the end of the year at 20.94%, total capital at 22%, and leverage at 16.4%. This robustness and our reliance on the digital deposit channel for funding have suited us well in 2023, and we’re excited about the prospects of adding low-cost deposits by 2024. We have maintained a very strong capital position with a prudent risk-based tolerance. Our reserves grew to 310 basis points at the end of the year, and we hope to gradually increase this to 350 basis points in 2024, which is notably six or seven times the normal reserve for a bank in our space. When reviewing our loan portfolio, especially in the 7(a) category, we’re a prime plus three lender and can sell three-quarters of the loan at a 10% to 11% gain on sale. As we move forward, we'll explain why we believe the risk-reward of those loans is well calculated and documented, and we are confident in our ability to maintain these types of returns while also managing delinquencies or charge-offs moving forward. Slide number four highlights the summary financial metrics for NewtekOne, the publicly traded holding company. We're transitioning more operational opportunities down into the bank where we have lower cost of funds and leverage ability. That said, the holding company continues to operate at a higher cost of funds traditionally. We still see attractive metrics, with a return on average assets for the year at 3.2%, and a return on tangible common equity of 22.7%. The average yield on loans reached 9.25%. Net interest margin expanded from Q3 2023 to Q4 2023, increasing from 2.62% to 2.78%. We're proud of these strong figures. Taking a look at our capital ratios, we remain well capitalized as a financial holding company, with CET1 at 16.49%, total capital at 19.6%, and leverage at 15.6%. Importantly, we were able to deliver $1.70 on diluted earnings per share and $1.71 on basic earnings per share for the calendar year, marking the midpoint of our guidance. 2023 posed unique challenges, particularly mid-year related to issues in the banking sector such as those with Silicon Valley Bank, Signature Bank, and First Republic. This led us to slow down our alternative loan program, though I can report that this program is now back to full operation, restoring growth. In subsequent slides, you can see these numbers demonstrate the significant growth we’re achieving. On slide number five, I will address common questions we've received from investors, particularly regarding our stock's trading multiple and market perception. We do not wish to operate as a traditional bank; we offer much more than just accepting deposits and hoping for returns. Therefore, we don’t resemble the operations of a small community bank. As an OCC-chartered national bank, we utilize digital account opening and remote deposits to attract customers in a compliant, cost-effective manner. Our focus remains on maximizing returns on tangible common equity and return on average assets. It's important to note we possess a greater share of non-interest income compared to traditional banks, deriving income from gains on sale, payment processing, servicing, and our insurance agency, which is growing through our bank relationship. We're excited about future prospects as we further integrate these operating segments. Many view our move into small business lending as a risk, but our 20 years of experience equips us with insight during economic downturns. To reassure, we have statistically backed our projections going as far back as the financial crisis, with 12 securitizations of various configurations. We’re confident that our reserves are sufficient to cover expected losses, and we’re successfully raising deposits—$340 million last year compared to about $140 million previously. We placed a strong focus on building a robust team to strengthen our operational capabilities. Hiring Jennifer Merritt as COO with Digital Bank has significantly upgraded our team, as has the inclusion of our compliance department led by Sarah Limones and Julio Hernandez. We are eager to grow this area of our business, ensuring every step we take is prudent and well-informed, dropping our cost of funds over time while enhancing our margins. Regarding gains on sale—these are not fleeting and have been consistently realized over two decades. Our approach to originating and selling loans creates a broad revenue stream that we believe is vital for our sustainability. On slide number six, we discuss our diversified earnings engines across various areas. Small business finance remains our legacy with minimal operating expenses. Each business line is robust and adequately described on our website. I will now turn slide number seven and eight over to Scott Price, who will discuss the data contained in these two slides. Scott?

Thanks, Barry, and good morning, everyone. I want to focus most of my comments this morning on slide eight given the time constraints we have. We observed a nice expansion in our net interest margin during the quarter, driven largely by lower funding costs on a net basis relative to our balances. We issued debt in the third quarter, using those proceeds to pay down higher-cost debt. Deposits costs increased by 40 basis points, mainly due to $92 million of CDs that repriced in the fourth quarter. We had good retention on our retail CDs that re-priced, and we expect loans to re-price in the first and second quarters as we stabilize our CD portfolio. It's noteworthy that our loan portfolio yield included a prepayment penalty in the third quarter, leading to some lumpiness between the two quarters. We have maintained reliance on our high-yield savings product with stable deposits and minimal closures. As Barry mentioned regarding business checking and business accounts, we expect these to roll out in 2024, offering optimal pricing and funding costs for our deposit portfolio. We anticipate net expansion throughout the year. Barry, I’ll turn it back over to you.

Thank you, Scott. Moving to slide number nine, the NewTek Advantage. We aim to present this information concisely. Feedback indicates that while many appreciate the extensive data, others prefer a more condensed presentation. It's paramount in our inaugural year to provide comprehensive data to analysts to enhance understanding of our distinct business model. We will strive to streamline this in future sessions. The NewTek advantage matters significantly to our core operations, encapsulating the reasons we opted to own a bank. Consumers and businesses frequently interact with their deposits for transactional purposes, seeking comfort in checking their balances. What separates us is the client experience through the NewTek Advantage business portal, which offers features such as unlimited document storage, real-time traffic analytics, same-day money deposits for merchant clients, and the ability for payroll clients to process payroll directly from the business portal. While we remain technology-driven, maintaining personal relationships with clients is essential—we offer 24/7 support across different verticals. On slide number 10, we note that we have about 340,000 users with access to the NewTek Advantage, including approximately 5,000 monthly active users logging in at least once a month. This consistent engagement allows us to conduct webinars, podcasts, and position NewTek as a destination for clients' business needs, whether they relate to taxes, payroll initiatives, or other relevant topics. We are not your average community or major money center bank; we offer small business owners essential services they typically lack. Regarding slide 11, we summarize the fourth quarter and full year 2023 highlights. I'm proud to report that we reached a diluted EPS of $1.70 and a basic EPS of $1.71, achieving the midpoint of our guidance. Predicting outcomes in our first operational year is undoubtedly challenging, especially with significant transitions from BDC to banking accounting. Nevertheless, we successfully navigated these hurdles, and I’m proud of what we’ve accomplished this year. On slide 12, we discuss enhancements made to our management team. I'd like to highlight that Scott Price joined us as Chief Financial Officer in May 2023, along with other essential talents such as Nick Ledger, our EVP and Chief Accounting Officer, and others who strengthen our capabilities in accounting, reporting, and compliance. Ultimately, this is a management team equipped for much larger operations than our current size. These impressive talents come at a cost, affecting short-term returns, but I believe our efforts will lead to sustainable growth.

I wanted to illustrate how our deposit mix has shifted quarter-over-quarter. Notably, we brought in over $40 million of deposits from other banks, thus moving from lower earnings rates to earning Fed funds and deploying them into higher-yielding assets, avoiding the need to raise outside deposits. We reopened our high-yield savings product last August, leading to a substantial impact on net interest margin and deposit costs this quarter. As we move forward, we're committed to optimizing our funding base through a combination of retail and wholesale deposits. Relationships remain vital for us, as we emphasize the importance of business checking accounts that establish sticky client relationships. Barry, I'll turn it back to you.

Thank you, Scott. On slide number 14, we highlight lending activity; our pipeline continues to expand based on our unique business model of acquiring referrals alongside smart technology-driven efficiencies in loan origination. We funded $260 million in SBA loans, marking a 24.2% increase over the previous quarter and confirming our position as the top originator by loan volume for SBA 7(a) in Q4 2023. We're proud of this achievement. Our SBA loan portfolio reached $169.6 million, reflecting our attractive floating rates and gains on sale once sold to the government. Our forecast anticipates $925 million in 7(a) loan fundings in 2024, a 13.5% increase from the previous year, complemented by $60.5 million in 504 loans for the three months, culminating in a record $1.1 billion of loans closed across all products in 2023. Looking ahead to calendar year 2024, we aim for approximately $1.4 billion in loans. On slide number 15, our pipeline looks promising across diverse sectors, particularly with our alternative loan program, which is vital for our extended growth strategy. Addressing slide number 16, we have total outstanding balances of $401 million in our loan portfolio, with unfunded commitments of $46 million. It's crucial to clarify that 504 loans are originated and sold; the second lien is funded through government debentures. We also maintain strong recoverability measures through personal guarantees and proper loan structuring. Thus, while many discuss commercial real estate challenges, they don’t concern us as our portfolio is relatively insulated and well-managed. Within our SBA portfolio since 2017, we have originated $555 million in 7(a) loans with zero charge-offs to date. In our alternative loan program, which has transitioned from a nonconforming model to ALP, we have also experienced no charge-offs to date. Moving to slide number 19, we've reviewed the gain on sale from the SBA 7(a) program, finishing the year at 110.2. The first quarter outlook appears promising as we’ve seen favorable market conditions with rising prices encouraged by investor interest. Slide number 20 covers our payments business, which is projected to produce around $16 million in pre-tax income, up from $12.9 million year-over-year. Our insurance agency and payroll services will benefit greatly from the bank relationship as we expand our accounts and customer base. I have addressed our financial projections for 2023 in slide 23—in 2024, we anticipate diluted EPS between $1.80 to $2, expanding over consecutive quarters. There is inherent seasonality within this sector. With respect to company investments for growth in 2023 and 2024, we are committed to enhancing the NewTek Advantage through compliance infrastructure, software, and hardware. These investment initiatives require substantial funding upfront, which may influence initial financial outcomes. However, we firmly believe that these strategic investments will enable us to leverage our scale moving forward. Our leadership is equipped to handle operations substantially larger than our current scale. We aim to engage investors continuously in understanding our numbers quarter by quarter. We expect to host an analyst day in the second quarter to facilitate this continuous engagement while addressing growth comparisons year-over-year. While Q1 2024 might show some variability due to non-operating losses, we foresee solid performance previews in our diluted earnings per share of $0.22 to $0.23. We are optimistic about our market situation, and our prospects remain bright. Slide 27 and 28 provide strong indicators of our positioning; there is excitement surrounding these opportunities. Notably, for fiscal year 2023, we delivered substantial improvement metrics: ROAA at 5.76%, ROTCE at 35%, and an efficiency ratio at 50%, which are not typical for community banks. As a dividend-paying company, we maintain a solid yield, demonstrating our commitment to growth-oriented operations and diverse business solutions. With that, I would like to return the floor to Scott Price for the MD&A.

Thank you, Barry. I will keep my remarks concise. Year-over-year comparisons are challenging due to the shift in our accounting model and consolidating previously unconsolidated investments. I wish to focus on non-interest revenue components of our P&L as we've adequately covered net interest margins. We observed a quarter-over-quarter increase in non-interest revenue majorly fueled by higher loan volumes and origination fees. However, non-interest expenses saw upticks due to prepayment penalties and increased salaries, along with higher loan origination expenses. I will now turn it over to the operator for questions.

Thank you. Our first question is from Crispin Love with Piper Sandler. Your line is open. Please go ahead.

Thanks. Good morning, Barry and Scott. Hope you're both well. First, regarding your guidance on page 23, your EPS projections indicate a substantial ramp through the year, which is typically built on in EPS across the year. However, I noticed last year included elevated expenses due to your banking transition. Could you identify any key factors potentially affecting expense or revenue for Q1 2024 prior to the anticipated ramp in the year? Is it business as usual?

Certainly, Crispin. For Q1 2023, the non-operating loss impacted earnings. Additionally, loans originated in Q1 2023 were processed through Newtek small business finance without a CECL reserve. Thus, being a bank and observing CECL reserve requirements caused an immediate impact on early earnings, but we have rising earnings potential later on. Scott, do you have anything to add?

Indeed, Crispin, natural slowness in business activity during Q1 results in reduced loan production volumes, which we've observed historically. Nevertheless, we aim to provide an accurate depiction to guide your modeling efforts. It's a typical trend we've witnessed over time.

Thanks! I appreciate the detailed response regarding seasonality. My second inquiry revolves around credit quality. While you commented that it remains strong, could you quantify this? Specifically, can you discuss non-accruals and any potential losses within the consolidated portfolio as we move through the next few quarters?

Certainly! In our consolidated portfolio, it’s crucial to break it down. The NSBF portfolio consists of a large volume of loans secured through securitizations, and we have assessed around $400 million of current pay loans. Regarding defaults, we currently foresee a 19% default rate with a 45% to 50% severity from those loans. It’s significant to mention we account for this risk in our strategic planning while continuing with our lending model. I can assure you that the loans on the books already factor these defaults in terms of our valuations and reserves.

Thank you, Barry, for that context. I also appreciate your transparency on credit metrics and the expectation of charge-offs. One more call out: can we get more details on 60 days plus delinquencies and charge-offs for future reports?

Noted, Chris.

Thank you, Chris.

Thank you. Our next question will come from Tim Switzer with KBW. Your line is open. Please go ahead.

Good morning, thanks for taking my questions. You provided good insights on guidance; earlier you touched on it. Could you elaborate on the factors that might drive results from the low end to high end over the year?

Tim, from an asset perspective, the alternative loan program largely influences our goals. I'll let Scott elaborate on deposit factors. We may need to provide in-depth explanations, via an analyst day if necessary, about this program as it’s crucial for understanding capital utilization and funding strategies for the business.

Thanks, Barry. Tim, keep in mind that we have a unique business model. The changes in NSBF securitizations may prompt a cleanup call during the quarter, leading to potential shifts in funding mix. We must carefully assess our funding strategies for these processes. As far as deposit costs are concerned, we have a substantial number of matured deposits, with varying maturity timelines, affecting our refinancing rates based on the current curve. We aim to roll out business checking this year, which is vital to our performance. Although it’s uncertain how it will impact our clients and costs, our focus remains risk-management and stability.

That was comprehensive, and thank you. Last question: could you expand on what's driving the high SBA premium guides you’re earning this year and how competition appears in that space? Is that sustainability worried?

In the government-recognized market, we emphasize the short end of the yield curve where we currently thrive with floating rates, so our competitive position is favorable. Factors like supply and demand play crucial roles—essentially, larger sellers can heavily influence prices. Nevertheless, as of now, we believe we are sufficiently priced and have a solid foundation. Given our proactive positioning and operational structures, we expect to gain market share through methodical growth based on steady resource allocation.

Thank you, team, for the detailed responses.

Thank you, Tim.

One moment as we move on to our next question from Christopher Nolan with Ladenburg Thalmann. Your line is open. Please go ahead.

Hi, am I correct that there were no net charge-offs in the quarter?

Scott, would you like to tackle this?

In the bank portfolio, that is correct. We did encounter some loans, including a few microloans that are showing weakness. However, again, no charge-offs have occurred in the bank.

With respect to the first-quarter guidance, is the CECL reserve impacting small business lending?

Yes, that CECL reserve is a significant factor impacting forecasted earnings for 2023 as opposed to the previous non-bank model.

We want to ensure clarity—our primary focus is the 7(a) loans we retain with a reserve ratio of roughly 6.75%. Given our expectations for volumes and overall loan performance, our reserves may continue to grow, representing prudent risk management.

Ultimately, we have sufficient reserves to cover expected losses; I hope everyone recognizes we are prudently managing risk.

Thanks, both of you. I look forward to more detailed metrics in future reports.

Duly noted.

Thank you, Chris.

Thank you. Our next question is from Steve Moss with Raymond James. Your line is open. Please go ahead.

Good morning! I wanted to talk about the SBA loans. Your pre-qualifications appear to have increased, but your approved loans and underwritings seem significant. I am curious if you see any impact on mix shift or what drivers could be behind this?

I appreciate your question. We've deployed technology to efficiently process pre-qualifications with speed. While the numbers may indicate they appear weak, it reflects our strength in selecting promising credits for underwriting. To put it plainly, we've achieved far more loan completions and units in 2023 than 2022 to date. Our efficiency is higher, and we’re confident in our ability to deliver loans more expediently.

To that point, we've experienced about a 50% increase in unit volume over the year. Technology has been key in maximizing our throughput.

Thank you for that insight. In regard to the cleanup call, could you confirm the potential size of this—specific to the total mentioned earlier?

Yes, the potential cleanup call could involve bonds around the $40 to $45 million range, contingent upon meeting SBA requirements for approval. Loan values and conditions will dictate the approval and structuring. Once executed, it will enhance our operational capital utility across other initiatives.

Thank you for answering my questions.

Thank you!

I would now like to hand the conference back over to Barry Sloane for closing remarks.

We appreciate everyone's participation. We attempted to optimize the pace of our presentation. Scott and I will reassess for the next quarter to ensure we condense further and offer an appendix with detailed information. The depth of data reflects our competitive advantage, characterized by diverse business lines producing cash flow that supports our strategic goals. We look forward to sharing our journey with you each quarter. Thank you again, and we look forward to a successful first quarter.

This concludes today's conference call. Thank you for participating. You may now disconnect.