NewtekOne, Inc. Q1 FY2024 Earnings Call

Good day and thank you for standing by. Welcome to the NewtekOne, Inc. 2024 First Quarter Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker for today, Barry Sloane, Chief Executive Officer. Please go ahead.

Thank you very much, and welcome, everyone, to our first quarter 2024 financial results conference call. We're very pleased to present our results to you today. Joining me on the call is Scott Price, our Chief Financial Officer of NewtekOne Inc., as well as Frank DeMaria, the Chief Accounting Officer and EVP for Newtek Bank, and Nick Young, the President and Chief Operating Officer of NewtekOne. For those who want to follow along with the PowerPoint presentation, you can do so on our website, newtekone.com. While you're there, you may also want to look at newtekbank.com and the Newtek Advantage for valuable information about our organization. We would also like to welcome the analyst coverage from various firms. This call today should illustrate a management company that is actively building a business. Take note of the various building blocks we've outlined in our presentation, from expanding our accounting and finance department to enhancing our deposit-taking capabilities at Newtek Bank, and increasing our lending operations while producing high-quality loans with strong risk-reward features. NewtekOne represents a long-term investment opportunity in a technology-enabled business offering solutions to the 30 million independent business owners across the United States. Please look at Slide #1 in the presentation deck on our website for a note regarding forward-looking statements. Moving to Slide #2, the significant takeaway from our results shared in last night's press release is that our first quarter 2024 core earnings reached $0.38 per basic and diluted common share, surpassing our previous guidance of $0.19 to $0.25. For comparison, in the first quarter of 2023, we reported earnings of $0.76 and $0.74. There was an income tax benefit of approximately $0.59 per basic share and $0.58 per diluted share, meaning that without this benefit, our EPS would have been $0.17 and $0.16. Thus, we achieved a core operating increase of about $0.20 year-over-year. We have conservatively raised our guidance for the fiscal year 2024 to a range of $1.85 to $2.05, up from $1.80 to $2. Importantly, our quarterly deposit growth at the bank is at 9%, whereas U.S.-based banks grew their deposits by only 1.2% in the same period. We take great pride in this deposit growth. Sequentially, our loan growth is also up 11% on a consolidated basis over Q4 2023. It's noteworthy that regarding the SBA 7(a) business, we typically sell 75% of government-guaranteed loans within the quarter they are produced, indicating the growth could have been higher. Our organization, with a consolidated total asset base of $1.4 billion and around $700 million held by the bank, demonstrates a loan generation capability akin to institutions 4 to 5 times larger. Additionally, the interest margin at Newtek Bank improved by 37 basis points from 4.43% to 4.80%, an extraordinary accomplishment given the difficulty of achieving growth in net interest margins at banks. We are proud of growing loan loss reserves alongside profits. We also increased our quarterly dividend in the first quarter by 5.5% to $0.19 a share, reflective of our confidence that these dividends will be sustainably funded by earnings. Both the Board and management feel assured about our consistent and stable performance, which we expect to maintain. On Slide #3, we present Newtek Bank's financial summary highlights, including a ROAA of 5.8%, ROTCE of 37%, and an efficiency ratio of 50%. Such performance metrics are rare in the financial institution landscape. Despite skepticism regarding sustainability, we are in the middle of the quarter and continue to generate these numbers. Our net interest margin stands at 4.8%, which has increased from 4.43%. The average yield on loans has also risen, primarily due to strong performance in the 7(a) business. We will explore other loans that, while they may offer lower margins and yields, will have fewer charge-offs. Deposit rates have slightly risen from 4.4% to 4.48%, a trend that we expect to maintain without greatly affecting net interest margins. Ultimately, net interest margins will be more influenced by diversifying into lower-risk, standard bank-type loans. Regarding capital and credit, our institution remains well-capitalized. Q1 returns were affected by increased loan volumes and higher expenses in comparison to Q4 2023. It's essential to note that NewtekOne is positioned to grow well beyond being a $1.5 billion financial holding company, and we are laying the groundwork to sustain growth rates in deposits, lending, and ancillary services that set us apart. The net interest margin and yields on loans are primarily due to a higher concentration of SBA 7(a) loans, as we're a Prime plus 3 lender. Today, that would be 11.5%. So once again, we're very, very proud of the results and performance at Newtek Bank. Consolidating it up to the holding company, the ROAA 2.8%, ROTCE still very high at 20%. And obviously as you take a look at the difference between the holdco and the bank, clearly we've got institutional funding of the holding company. So less opportunity to take advantage of deposits which are lower costs down in the bank. We do our alternative loan program funding at the holding company, first on the balance sheet and then into joint ventures. But once again, important to note for a financial holding company, these are still extraordinary numbers that you can't find when you run your finger down the page of other financial holding companies and Newtek. Towards the bottom of the page, you could see on Slide 4, the core EPS non-GAAP. Last year, if you took out the tax benefit from the first quarter, about $1.30-ish. We're looking at a revised forecast for 2024 of $1.85 to $2.05. Clearly some nice growth there, particularly in core. We think that that growth should start to seep into the investor and analyst community and to start to achieve a more normalized market multiple as the market and investors start to get a better understanding of our financials, our balance sheet, our income statement, and how we project going forward. Slide #5. I think this is important. I get asked, as does Scott Price, a lot of questions. Once again, very hard to compare us to a traditional bank. First of all, we offer so much more to our clients. And we do this without branches, brokers, and bankers on a traditional sense, and BDOs. We're more focused on return on tangible common equity and return on average assets, not assets under management. I use the term coupon clipping. Our competitors in the banking industry make loans, try to get as much noninterest-bearing deposits as they can, and they are clipping that coupon. Clearly, we have an overweighting of noninterest income versus traditional bank interest income, which we think is the envy of most other banks. But this has been inherent in Newtek and in its business model for over the course of 25 years and since it became a public company in September of 2000. Our margins and returns are higher than a traditional bank and bank holding company. Important to note, we believe our credits remain strong lending to small and medium-sized businesses. Now some people say, 'Gee, these small business loans, aren't these really bad credits? Aren't these the credits that are going to go bad first?' Well, first of all, we've been doing this for 20 years. We've been through '08, '09. We did it through the pandemic. We understand this. But our investors are rewarded from the programs that generate an 11.5% coupon and even net of the expectation, which we believe our history and our management team has very good knowledge of how this portfolio is going to perform, provides excessive returns. That's why our ROAAs and ROTCEs are much, much higher than our competitors even while we're posting loan loss reserves that are north of currently of 4%, which we think will modify down to 3.5% when we start to diversify the portfolio into some more traditional banking types of loans. When we evaluate our banking operations from a risk standpoint, we are more confident in our business model compared to the low-risk, low-margin loans that our competitors are pursuing. They are attempting to prevent their noninterest-bearing deposits from moving to money market accounts, a trend we foresee continuing. It's increasingly simple for individuals to transfer money via mobile apps into the most favorable accounts. For instance, someone might choose not to keep $250 million in the bank, but instead, leave $250,000 in a money market fund and frequently move funds. This trend is what we anticipate. We believe we are well-prepared for it. Despite the higher costs associated with consumer deposits, and while we will address reducing commercial deposit costs, our position is solid concerning the risks inherent in the business landscape. We have successfully raised deposits, acquiring around 6,000 deposit accounts in our early phases. Gains on sale recur and provide consistent income; I have a compelling presentation slide that illustrates this. Even though some may dislike gains on sale, we have been profitable in this area for 20 years. We originate loans and sell them, resulting in superior returns on equity and assets, making it a more effective strategy. Can a bank hold a growth mindset? Absolutely. How others manage this within their framework is uncertain, but we are confident in our capacity to do so. Our alternative loan program has shown previous success, yielding a 20% to 30% return on equity for our company. It was slower in 2023 due to the issues that were occurring in the market with respect to rates, volatility, and capital availability for banks. It's an important growth aspect and you could see we had a great first quarter, have a great pipeline, and we think we're in pretty good shape going forward. I'd like to turn the next few slides over to Scott Price to go over 6, 7, and 8.

Thanks, Barry. Good morning, everyone. Turning to Slide 6, our net interest income expanded 16 basis points during the quarter despite higher deposit costs. Average earning assets increased $31.1 million, and we experienced a sizable mix shift with average cash balances declining $45 million and average loans increasing $73 million. A higher percentage of the loan portfolio in the SBA 7(a) product versus last quarter drove the increase in yields on loans. On the funding side, our cost of deposits on a consolidated basis increased 20 basis points as the acquired CD portfolio continues to mature at lower costs. Separately, our interest expense on borrowings was lower as we experienced swift prepays on the NSBF 7(a) portfolio, which led to reductions in notes payable to securitization trusts. Slide 7 is a graphical representation of the ins and outs of net interest income, most of which I've already covered. To summarize, we were able to increase our balance sheet efficiency by deploying excess funds to originate loans. I do expect higher levels of leverage at the bank as we roll out our business checking products and continue our retail deposit gathering. Shifting to Slide 8, our deposit mix was relatively unchanged, sans our high-yield savings balances staying relatively stable and CD portfolio balances increasing. We expect our business checking account product and business money market product to increase at lower balances, to increase at lower rates, as we move into the last 3 quarters of the year, the maturing digital CDs during the quarter largely relevant to the same product at similar rates. Important to note, our retention that we've experienced on CDs maturing in the last few months, March and April, have been above industry standards at 90%. Barry, I'll turn the call back to you.

Thank you, Scott. Slide #9, the Newtek Advantage. This is our advantage in the marketplace. We believe that the Newtek Advantage will become a marketplace destination for our clients. We offer customers more than just taking their deposits with the hope that they can get a loan. When a client opens up an Advantage account, they get free unlimited document storage, they get free real-time updated web traffic analytics. If they're processing payments with us, they're going to receive real-time chargeback and batch information. They can get same-day funding. If they're a payroll client, they can make payroll directly from the business portal, the New Tech Advantage. Extremely valuable. We believe this technology that we've developed is also something that we can package white label and resell to other financial institutions within their marketplace. We are very excited about the Newtek Advantage. We believe it gives us the ability to gather more deposits from verticals like payroll, insurance and payment processes. Slide #10, artificial intelligence. AI is going to change all companies in the United States and across the world. Where businesses have the opportunity to utilize AI, it's going to be extremely beneficial. It's in NewtekOne's DNA. We're disruptors, we're entrepreneurial, but importantly we're prudent, but not afraid to use these types of technologies when they could really provide tremendous efficiencies. And the way the company is positioned, we're in a unique position to take advantage of these opportunities. The process of gathering data without the use of brokers, bankers, branches, and BDOs is inherent to our model, utilizing that data to futuristically be able to mine the data and make decisions about which clients we should contact for various opportunities with an email message or a phone call to provide additional services. To use AI to manage our remote customer-facing staff, labor management is key. We currently use certain software within our organization that does this today to basically ensure that our staff is consistent and comprehensive in their messaging with our existing and prospective customers. Going forward, utilizing AI to aggregate and analyze data to be able to assist in making credit decisions and opening up a bank account is clearly within our future plans. On Slide #11, relative to the financial first quarter highlights, most of this data you'll be able to read in our press release. We're very, very pleased with how it rolled out. Once again, most importantly is the quarter-over-quarter comparison, '24 versus '23, $0.38 versus a core of $0.17 and $0.16 per basic and diluted common shares for Q1 2023. Important slide on #12, credit and risk management. Clearly, something that based upon our legacy history as a BDC using fair value and certain limitations to being able to move Newtek's Small Business Finance in the bank leaves us with accounting that needs a little bit further explanation. Newtek's small business finance is currently and formally the nonbank SBA 7(a) lender, which does not make any more 7(a) loans. All those loans are now made down in the bank. So Newtek's small business finance sits up with the holding company, has about $633 million of total assets at 12/31/2023, and has a capital book of $300 million. And the important aspect, if you want to track credit and trends, take a look at the fair value adjustment, sliding all the way across the 5 quarters, $33 million. Well, that's a big number. Here's the good news. It's already been written off. It's been written off the book. It's been written off earnings. It's already affected our past earnings, and you're left with a fair value of $37 million. If you run your finger back across the page, it's fairly stable over 5 quarters, hasn't moved very much. These are loans that most likely will, A, re-perform and get back into payment status, yes. Nonaccrual small business loans frequently do come back into payment status. They still sit in this particular category or may sit. However, the important part is they may come back. Why? There's multiple joint and several personal guarantees on these loans, something that is not quite familiar to most banks or analysts or investors in this particular space. Also the $37 million most likely will, if it doesn't come back, the other choice is to liquidate the collateral. These are evaluated every quarter. We marked the collateral of the market. We estimate how long it's going to take to liquidate. Is it 6 months? Is it 18? Is it a tough state like in Illinois that might be 24? Is it a bankruptcy? We look at the fair value, we put the cost to liquidate, and we come up with a price. So nobody needs to go crazy over this if, in fact, these numbers do increase, that this is a portfolio that's trading down. So as a percentage of the total assets in NSBF, arguably this is only going to get bigger because the portfolio is paying down quite rapidly of the performing loans. Here's the important part. We have this in our capital plan. We have this in our financial projections. This is not something that we're not new to. We own Newtek small business finance since January of 2003. So that's important to understand the nonaccrual portfolio, which is at fair value in NSBF. This is the nonaccrual. When you look at the accrual portfolio, it's priced assuming an approximate 8% charge-off over the life on a new loan. A seasoned loan could be 5% or 6% because we've already experienced most of the charge-offs in the first 36 or 48 months. I would say 35% to 40% of the portfolio is, I'll say, 4-plus years old, all sitting in securitizations. The rest are probably vintage '21, '22 and a little bit in '23. Now let's go down to the Newtek Bank. So past due, 31 to 89, $12 million. Oh my God, it's $12 million. It's really not that big of a number. It's 3% of total. Mind you, we sell off the government-guaranteed piece. So if you would have kept that on the books and you used your percentages, it would probably be 2% or some 1% number. The other thing to point out is we make loans in the bank that we sell. We originate 504 loans, which we've never had a charge-off on to date. Those loans go out of the bank. We originate them and sell them. The firsts and the seconds are taken out by debentures. The alternative loan program loans also are originated, and they go on the balance sheet briefly, then they go into joint ventures. So when you look at these numbers, these numbers are consistent with our projections. They're consistent with our plans. You'll see our current rate is, I think, 95.5% at the bank. Look, that current rate could go down much lower. That does not return because we've had current rates of 88% or 89%. Small businesses fall behind. Sometimes the owner gets sick and they fall behind. So these numbers are not extraordinarily high, and they're within our expectations. The nonaccrual loans at $8 million in the bank. A little over $5 million of those are old National Bank of New York City loans. We'll discuss the character of those loans. We've looked at these loans. We've analyzed them with a $369,000 allowance for credit losses. It's not a big number. It is going to get bigger, okay? However, the benefit of this is you get a big gain on sale, and you get a servicing asset and the performing loans are on the books at 11.5% floating a prime quarterly adjust. And once again, our loan loss reserves north of 4%, more than adequate to be able to hold this. And we will be and have been looking at this every single quarter. I would say credit is not understood by the market for SBA 7(a) loans. We've been doing this for 20 years. We know it. We understand it. And we're very comfortable managing the greater reward that you get for the charge-offs and delinquencies that you're going to have in this type of portfolio. Slide #13 talks about quarterly lending activity. Obviously we crushed it in the 7(a) space, an increase of 35.9% over the prior quarter and the prior year. The alternative loan program, which is important to us, starting to get some nice traction, $53.8 million in Q1. We see that continuing to ramp as well our profitability. And in the total loan area, you're going to see in the bank, hopefully in the second quarter but certainly in the third or fourth, the bank's going to put on the more traditional vanilla, low margin, low risk, low loan loss reserve, low charge-off types of loans that most of the banks lend to. But that's not our thesis. We do believe in a diversified portfolio. We think that's important, and we will have it through the purchase or origination of what I call conforming CRE and conforming C&I loans in the bank. Slide #14 addresses the loan pipeline growth. Clearly, when you look at the alternative loan program on Slide 14, that's obviously our biggest delta that we have there. So as of the end of April, it's a nice pipeline of approved pending closing of $48.5 million. The 7(a) business looks pretty good. I feel very, very good about where we are. At the bottom of Slide #14, you could see the alternative loan program closings through the first 4 months of the year, $61 million. You could straight line that and annualize it. We think it will wind up growing to bigger numbers. And that's part of our forecast. But we actually have forecasted that pretty conservatively going forward. Slide #15. Once again, the makeup of the portfolio is important at the bank. We talk about our current rate, percentage of CRE composition. Obviously the National Bank of New York City portfolio continues to get diluted as a percentage. We believe in geographic and industry diversification through our Newtek sourcing. And clearly, our lending operation is very scalable, that will continue to grow year after year. Slide #16 talks about that CRE portfolio at Newtek Bank. I'd like to draw your attention towards the bottom end of Slide 16, once again, important. There are a lot of banks out there that would certainly trade by weighted average LTV for a CRE portfolio at 59.4%, and look at these lower numbers on multi, office and retail. That's driven up a little bit by the 504 lending of which the second lien gets taken out by debentures. Is the gain on sale a recurring event? The numbers speak for themselves. Let's take a look at the recent history: 2021, 2022, 2023. These figures are substantial, and suggesting that they won't be recurring in 5, 10, or 20 years seems unlikely. You'll continue to see these numbers at NewtekOne. Our business model involves making loans and selling them. If the dynamics change—though I haven't seen it in my 20 years in the industry where selling the government piece didn’t prove beneficial—we might consider holding for income. However, the best returns on assets and equity come from selling the government guaranteed piece. The cash premiums are significant. Additionally, for those not familiar with SBA 7(a) intricacies, anything sold to the 11 pool assemblers above 110 entails a split of premiums 50-50. Looking at the weighted average net sales price, as shown in the far right column, the average during this period is 111.34%. Moving on to the next slide, we see that the first quarter aligns with the 10-year average. It can fluctuate slightly, but it's all manageable for our operations. Slide #19, everybody always forgets about the payments business. It just generates a lot of income and a lot of cash. The forecast for 2024, which we're comfortable with pretax income, $16 million; EBITDA, $16.6 million. So nice growth from the prior year. Also important to note, this business is not factored into our tangible book. That's just accounting. It was basically put in pretty much close to zero. I'll just leave it at that. And when we were holding this as a BDC and it was being marked to the market, I think we had valuations net of its debt on NAV of about $115 million. So I had one investor say, 'Well, gee, did you lose all that money in equity?' No, that's just a change of accounting from NAV to bank accounting or book value accounting. And obviously it's one of the reasons why we continue to educate our analysts, our investors on a regular basis. There are a lot of accounting changes. But I think people are starting to get a handle on this and it's going to become easier to follow. Slide #20 is a breakdown within Merchant Solutions. Slide #21 is indicative of the dollars that we've recently spent to bolster our accounting, finance, and compliance team. I think you could add about another $800,000 of expense to this number, which is factored into our projections. Once again, we don't aim to be a $1.5 billion bank alone. This is a business that is built for scale. It's a business that industry participants are going to look at and go, how do they raise deposits without bankers, branches, brokers, or BDOs? How do they make those loans the way they do? How do they make those loans at those prices? How do they do this business? It's technology. The utilization of technology and dedicated staff willing to adopt that technology or I should say adapt to the technology and continuing to add to make sure that we could manage our risk, be compliant, and have the right policies and procedures in place. I will point out, once again, when you think about where we started with a 61-year-old bank that had really no ability to open up the deposit account unless you went into the bank, loans were made primarily through a brokered network, so we had to put a lot of things in place. Well, that was 2023. We're still doing it. So against the backdrop of a lot of headwinds, this is a company that's building a business for the future to be a technology-enabled organization that could provide superior solutions to a huge economic engine and demographic in the marketplace, the independent business owner. Scott, if you can go over to Slide #22 on the financial projections, that will be appreciated.

Sure, Barry. Slide 22 outlines our updated guidance for the remainder of 2024. Many of the KPIs that we assumed and disclosed in our call in March remain unchanged. Our forecast assumes no change in interest rates, consistent with the prior quarter, and we expect loan demand to hold in. We did widen the ranges for Q3 and Q4 in light of the soft landing the Fed is trying to pull off, again the future of interest rates being data dependent. There are 2 items I want to point out regarding our results relative to our March forecast. First, our net interest income and provision expense came in on top of our expectations. And second, our noninterest expenses for the quarter came in slightly better than we forecasted. Barry, I'll turn it over to you.

Thank you. Slide #23. I did make some comments about the 2023 calendar year and the investments that we made. I think I've covered most of this. Once again, against a lot of headwinds in 2023, we are very pleased and proud of our performance and the fact that we could now, with a little bit less on the headwinds, continue to grow the business with a forecast of $1.85 to $2.05, which we think is conservative for the calendar year 2024. 2024 initiatives will continue to grow the Newtek Advantage and increased impressions. That's going to go along with our ability to bring in commercial transaction deposits. We added about 17 heads in the commercial deposit area in Q1 2024 with another 2 coming in April. Most of those heads are used for the back office of accepting transactional deposits, customer service, teaching people how to use the technology, making sure we're compliant, and making sure we can surveil, all that stuff. So a major investment, all of these expenses are part of it. What will that lead to? Future growth in 1% commercial DDA and 3.5% commercial money market, which will come in from our payroll businesses, and our merchant businesses, and our lending business, which we started to get some traction towards the tail end of the first quarter 2024. You can't just be in that business without having the people, process, and the technology in order to make sure we were able to do this in a compliant manner because you don't want to make a mistake in this particular early stage. I know financial people, and I happen to be one of them, so now, why can't you bring in more of this cheaper deposit money? Well, we will be. It will be. And it's something that we will be delivering on, and we talked about this in previous calls, modestly in Q2 in 2024. But you'll start to see those numbers turn in Q3 2024 and Q4 2024. And we believe that our account, which charges no service fee for the account, no ACH fee, no wire fee, will earn that business from the customer with an interest-bearing rate. Our competitors can't do this. Why? They don't have the asset that they could put on the books on a risk-adjusted basis that are floating rate asset liability manage to make this thing work. So our business model is unique. It works. It's worked historically in our career for those shareholders that have been patient. You've got to please excuse the transition, but it is working, and our first quarter results are indicative of that. We also look forward to NetSuite, a new financial reporting platform, that will enable us to close our books earlier. I think that's the second half of the 2024 initiative and continuing to add high-quality people. In '24, we're obviously going to be attending investor conferences. We plan on hosting an Analyst Day. I would say the date will be June 13, 2024. We'll put out a press release. We'll give people the opportunity to register, ask as many questions as you like. And we look forward to getting together with analysts and investors in our corporate headquarters in Boca Raton. We also believe in the second quarter of 2024 we'll be able to show a cleaner, more normalized year-to-year growth comparison without the tax effect that we dealt with in Q1. Continuing to maintain our dividend policy, and I think importantly, we exist to make our clients more successful. We exist to have a better experience for our clients. We exist for our clients to interact with their important business and financial solutions provider in a way that has less friction and to improve their business regularly. Otherwise, we haven't earned it. Slide #25 gives a comparison of where NewtekOne sits on market multiples, yield. Obviously, if we look at these things, with the exception of the transition and a lack of understanding, to us these things don't make sense, but these have a way of working themselves out. Today's conference call is a way to get these things to work out, to get people to have a better understanding of who we are, what we do, what our numbers mean, and to stick to it. Slide #26. Most banks desire what we already have. They love to have a lot of noninterest income. They love to not have the interest rate risk management. They love to have NIMs that we have. They like to have the loan, but we've got all these things. Now it's important to continue to operationally execute on the strategy and get the message out. We're very, very excited about our future business. Raising commercial core deposits will increase margins and lower the cost of funds. We do believe the Newtek Advantage, once we have those deposits, will become the gold standard in banking for deposit gathering because the customers want more from the institutions they do business with. They just don't want to give their money up and not get paid a fair rate of interest. We've overcome a lot of difficult hurdles. And while there are a few left, the finish line is in sight. Slide #27, before we go to Q&A, I mean you can't ignore these numbers. I mean you can, but I don't see how that's very helpful to ignoring the profitability of the bank and of the holdco versus our competitors in the marketplace. Eventually, there'll be a better understanding. People will get comfort that we can continue to raise deposits, continue to make loans, make sure that we're managing our risk and we have the right amount of reserves. Even though our losses are higher, our income is materially higher. And on a net-net basis, we have higher ROAAs and ROTCEs. We are excited about being able to bump our guidance up a little bit. We think that's conservative. We look forward to continuing to pay dividends, which will be declared by the Board out of earnings. We have a current dividend yield of 6.8%. That's a bit of a head scratcher for me, but get it while it's hot. And I think it's important to note, Newtek is a growth-oriented, differentiated, technology-enabled business solutions company, and it's also a depository. And we look forward to opening up the Q&A. Thank you, operator.

Thank you, Mr. Sloane. Our first question comes from the line of Crispin Love of Piper Sandler.

This is Brad for Crispin Love. Can you just remind us some of the economics on the nonconforming loans that you're earning on day 1 in terms of fees you are generating there? And how much CECL reserves are you putting up as well on these loans?

On the alternative loan program, which we previously called nonconforming, we've rebranded it to enhance understanding. I apologize for not covering the MD&A earlier. Let me address your question before we return to that. Currently, the ALP loans are at about 3.5 points gross. We service them for 100 basis points, and the loans net to the joint venture at a price of 12%, resulting in around 13% gross. We categorize our loans into A, B, and C credits, with gross returns of 12%, 13%, and 14% respectively. Regarding CECL reserves, they are managed at the holding company level. Historically, we've estimated charge-offs on those loans to be over 3%. Given the profitability from fees, servicing, and funding from our joint venture partners, this structure yields a favorable return to NewtekOne.

And then just following up, I know you guys mentioned on the call, but on the SBA gain on sale margins, can you speak a little more on what is cap gain on sale margins elevating even north of 11% in the first quarter, which is higher than most peers? And how is the demand for your paper? How would you expect margin to trend through 2024 in the current rate environment?

So if you look at, say, primary competitor Live Oak who doesn't have the gain on sale margins, when you're basically originating loans through brokers and bankers, they work for the borrower. And it's much more competitive. It's much more manual. And because we're incredibly efficient, work closely with our borrowers, we're able to get better margins. We've been matching rate for 12 years. We don't cut it. We get to the borrower quickly. We get the data processed quickly. We make them an offer, and that's why our margins are better. Operator, I've got to apologize to the group. I messed up my order. So Scott was supposed to do his MD&A, and I'd like to revert back to Scott Price, if I can, before I do any more questions.

Yes, Barry, thanks. Real quick, I just wanted to head off the potential question. I just wanted to cover the changes in provision expense for the quarter. The provision expense is lower as a result of the 7(a) production at the bank. We did have some first quarter charge-offs that we covered in our provision expense, but the majority of the provision expense, at least almost $3 million, was driven by higher loan balances. The remainder between provision for balances and charge-offs was some specific reserves. We feel like we're prudently reserved and are not concerned about the nonaccrual loans that we have in the portfolio. Operator, we'll turn it back to you for the next question.

Please stand by for our next question. Our next question comes from the line of Tim Switzer of KBW.

My first question is, could you expand on your comments about the gain on sale premiums here? And were there certain trends in Q1 that may be elevated the premiums and margins you guys are able to receive as the forward rate expectations moved lower earlier in the quarter? And did that cause you to maybe sell more loans than you typically would to take advantage of that? And should we expect to kind of step back down a little bit in Q2 since rate expectations have moved back up?

I appreciate the question. We monitor the markets regularly, and currently, they appear quite stable. If you look at our cash premium, it varies based on whether we have longer-or shorter-dated paper. Notably, even with rising rates, the prices of SBA 7(a) paper have increased due to strong demand for floating rates, especially at the short end of the curve. Predicting premium prices can be challenging. An earlier question about our competitive edge is significant; we conduct our business in a more efficient and swifter manner, which allows us to offer a competitive price to clients and close deals despite price fluctuations. As I mentioned earlier, we are in the middle of the 10-year range for prices, which can vary widely based on whether we are dealing with 10-year paper or 25-year paper backed by commercial real estate, with differing price ranges. I hope that clarifies your question. I encourage you to follow the guidance Scott provided for future reference.

We exceeded our sales expectations due to increased production. This improvement is not related to market conditions but rather our operational strategies. We are focused on enhancing our business model to increase output, and we expect that our production capacity will expand. The production this quarter was driven by demand and ongoing efficiency improvements, not influenced by market prices or dynamics you mentioned.

And could you guys also expand on your comments around the credit performance of the portfolio? And could you maybe review how the seasoning of an SBA portfolio trends over time as the portfolio matures? How should we expect delinquencies and NPAs to trend for the bank portfolio that has more recently originated versus the NSBF portfolio that's currently held for sale?

Yes, I believe that the loss curve for a 7(a) portfolio, which we have two decades of experience with, is at its highest between 18 months and 40 months. This is typically when most loans begin to default. Based on our bank's accounting practices, this would then reflect as an unrealized loss on our financials. The timeliness of this assessment depends on whether we think these loans are noncollectible due to collateral issues or their inability to perform as expected. It's also important to clarify that on the 7(a) portfolio, our Current Expected Credit Loss (CECL) calculation is a provision for future events, and we use approximately 8% that is discounted. This evaluation is updated each quarter based on various complex processes, models, and assessments from third-party consultants. This ties directly into the bank's CECL reserves, which are notably higher than our competitors in the industry. Scott, would you like to add or clarify anything?

No. The only thing I'd add is that we project our losses based on probabilities of default and losses given default that we anticipate. This projection is informed by almost 20 years of historical data, while the bank portfolio is nearing one year old. To connect the dots, with credit peaking for a loan between months 24 and 40, we expect an increase in nonaccruals, nonperformers, and past dues. This is anticipated, and we are prudently reserved for those scenarios. In contrast to a traditional bank accounting model, our fair value accounting model allows us to project losses. When we fair value our loans, we account for these losses, adjust cash flows accordingly, and then discount them. Therefore, the losses are already incorporated in the fair value marks, particularly concerning nonaccrual loans. Moreover, our loss rates for the performing portfolio align with the same rates used for our CECL reserves.

Yes. I want to give you an example of a situation. A borrower takes a loan in 2021 or 2022. It's a floating rate loan. They've now experienced a significant rise in interest rates, and they haven't been able to adjust to it. Recently, the prolonged higher rates have added stress. However, it's important to note that this business owner has personally guaranteed the loan along with other owners. There are multiple guarantors on many of these loans. In some cases, they have personal assets as well as business assets backing them. So even if they are delinquent, as we engage with borrowers, we have a knowledgeable and proactive servicing team. We'll encourage individuals to liquidate collateral and stay up to date because the business itself serves as a form of repayment. This situation is quite different from a commercial real estate loan that isn't recourse, where if it goes south, it's just a matter of walking away. Or a consumer loan on a car where the car’s value has dropped and the borrower is unemployed, leaving them with no option to recover. Our 20 years of experience in managing these portfolios, understanding that these are businesses backed by personal assets, is crucial. We do expect some challenges, and I'm glad Scott mentioned this. First of all, this is a new portfolio. Given that we've now seen some delinquencies and problematic loans, it makes sense as we started with all new loans and they are expected to experience issues over time. But this is not an area we are inexperienced in managing. We have been handling it for 20 years, and our loan loss reserves are prepared for the next year or two for the duration of the loan. We have also conducted numerous securitizations in this space that use models providing us the data necessary to understand performance scenarios. I hope that clarifies things. I acknowledge it may be challenging for you and others to forecast how this will unfold. However, the management team is fully aligned with shareholder interests. You can review our proxy and last year’s bonuses, as well as our stock ownership, which reflect our commitment. Building this business over the past two decades is very important to us.

Can you provide an estimate of the rate of increase in charge-offs over the next few years, given that your loan portfolio has a weighted average life of less than 12 months and that charge-offs don't typically peak until around 24 months? Additionally, where do you anticipate charge-offs will peak? Is it at the 350 ACL mark mentioned in the press release, or how should we consider this?

I anticipate that you will see about 70% of the charge-offs occur within 18 to 40 months. If I had made that statement before COVID, I would have been completely mistaken because COVID introduced programs like PPP, tax credits, and EIDL loans. However, in terms of the loss curve, new businesses generally do not default early. From a seasoning perspective, assuming all else remains constant, that’s when you will see most of the write-downs.

And just to tack on to that, Tim, we would expect the charge-offs to kind of level out and stop increasing if all economic conditions are equal.

Our next question comes from the line of Bryce Rowe of B. Riley.

Sorry to belabor the call here, but I do want to try to get a couple of questions in. Number one, I mean, I think you guys alluded to this in some of the prepared remarks, but expenses have gone up as you kind of built out the infrastructure. Is there any maybe like nonrecurring in this level of expenses, whether it be in the salary and benefits line or in that professional services line? Just trying to get a good feel for how the operating expenses are going to run obviously acknowledging that the balance sheet is going to continue to grow. But just trying to calibrate what the expense growth might look like.

I think price is important, and I'll let Scott elaborate on this. This year, as a percentage of revenue, we're likely reaching our peak expenses, and we hope this will be the highest point as we enhance our processes and ensure we have everything necessary for a scalable technology-enabled bank to compete differently in the market. We are optimistic about seeing the benefits of operating leverage starting in 2025 and beyond. When considering the new staff we're hiring, along with the software and consultants assisting us, I mentioned that the challenges we faced in 2023 are somewhat reduced but still significant in 2024. This has been incorporated into our EPS forecast. We anticipate improved margins in 2025. Scott, do you have anything to add or change regarding this?

Yes, Bryce, that's a great question. I want to emphasize what Barry mentioned: we have an expense forecast that is included in our guidance. This forecast covers both the current and future quarters. I would like to expand on Barry's comments and note that our expenses will increase from this point onward. However, we expect that the returns we generate will significantly exceed any increases in expenses. This situation isn't unexpected for us. As I mentioned earlier, our performance is slightly better than we had anticipated. I want to highlight that we are actively investing in our operations teams across various areas like lending, deposit operations, and fee-generating businesses, which has resulted in a rise in our workforce. We're making these investments to prepare for the future and to achieve higher margins, particularly through the rollout of our business deposit products, ensuring compliance with regulations. It's important to note the seasonal factors we're facing, such as payroll tax resets this quarter and one month of merit increases, which will contribute to future increases. We are also anticipating significant earnings per share growth this year. To maintain our competitive edge, we must attract top talent, and we have accounted for this in our forecast. This is neither a surprise to me nor to Barry, and we are effectively managing it. Regarding one-time items, I would mention a slight increase in professional expenses quarter-over-quarter, primarily due to our annual audit. We are optimizing our expenses related to audits, financial accounting, and compliance, and we expect that this won't happen again moving forward.

Can you discuss the capital structure on a consolidated basis? You mentioned good deposit growth at the bank and increases in the alternative loan program, which I assume will eventually reflect on the holding company's balance sheet rather than remaining at the bank. How do you plan to fund that at the holding company level, considering that the deposits likely need to remain at the bank?

Yes, they do. And I think, Bryce, that we have expectations of being able to use debt up at the holding company. We do have room to be able to do that and that's where we'll be able to fund our growth in addition to creating new joint ventures to be able to fund the alternative loan program business. The capital is primarily needed for that and not much else at this point in time.

And then, Barry, when I look at the balance sheet that you lay out on a consolidated basis, and you've got several different buckets of loans, a couple of which are held for sale, I think we can all identify what is held at the bank and held for investment bucket, amortized cost. But will those migrate eventually into the balance sheet of the joint venture? Just trying to identify what each of those buckets actually are.

Yes. And Bryce, it's a good question. I think that our goal, sans the alternative loan program, is to have all the lending done in the bank, all right? Very little, we have some legacy loans still at the holding company that will pay off or get sold, or filed for construction. But for the most part, the only thing that would be at the holdco in lending would be ALP, and the rest of the activity will be down at the bank where we get lower cost of funding and obviously better leverage.

Our next question comes from the line of Christopher Nolan at Ladenburg Thalmann.

Thank you for including the detail in the asset quality in this quarter. Very helpful information. Barry, from your perspective, where do you see the bank sector going in general?

It's a tough industry. I'm just going to be frank with you, and this is from somebody that just got into it. So I always try to answer honestly and transparently. It's an industry currently that right now, it's feasted on low-cost deposits. And it's far easier to move money today from bank to bank and doing it on your phone. And even corporate treasurers are realizing, I only need to keep a couple of bucks in my checking account, and I can move the rest of it into a money market account. I can just get the money back and forth so that the deposit side is where banks have made money, not on the asset side. And what happened in '08, '09 is the regulators in the banking industry said, 'Okay, we've just got to really tighten up on the risk profile for credit.' So everyone's piled into the small bucket of car loans, residential mortgage loans, CRE loans, C&I loans that don't have a lot of margin. So I think I'm talking about an interest rate I just got into. It's going to be an easy industry to make a lot of money in.

I was thinking more along lines sort of where do you see the healthy industry in terms of asset quality and so forth, given there are a lot of concerns about commercial real estate in general?

I believe the industry will secure its capital soon. I don't think short rates will stay at their current levels for much longer, which will alleviate some pressure on commercial real estate assets, where the current issues in the industry are primarily linked to interest rates. Another significant factor is asset liability management; as long as bills are yielding 5%, there will be increasing motivation to move funds into government-guaranteed money market options rather than keeping them in bank accounts.

Our next question comes from Steve Moss of Raymond James.

Barry, you mentioned, or maybe it was Scott, regarding SBA originations and the impact of driving efficiencies. Considering your guidance to maintain stability after a strong quarter for SBA originations, I am curious if you are at capacity in the short to intermediate term for these originations. I'm also interested in why that number is being revised higher.

Yes. No, Steve, I'm looking for the loan pipeline for 7(a). And it's up on prequal 15%, in underwriting 54%. Now the accrued pending closing is pretty flat. That's because we're becoming more efficient, and we're getting the loans in and out quickly. But no, we are not at capacity. We've gotten more alliance partners that are realizing we could help put them in the business, help them make loans either for their license or ours, and the business model of us using alliance relationships and getting referrals continues to grow and outperform the BDO broker and banker model.

I would like to add that it's a good question regarding the current situation of a potential soft landing. At this stage, it seems premature to ramp up our production for the year considering the uncertainty. Therefore, we believe this is the most sensible approach. While there may be potential for growth, the economy's direction could also lead to a decline. That was the reasoning behind our decision.

I want to revisit the seasoning of the portfolio regarding the 8% loss content discounted back. Looking at delinquencies over the past 12 months from loan balances around 9%, I'm curious about our expectations as these loans season, particularly within the 18- to 40-month timeframe. What do you anticipate as the peak delinquency and peak nonperforming numbers for the originations or the portfolio?

I mean you could see what I'll call the currency rate on that portion of the portfolio. By the way, that's going to be blended in with the AAA quality loans that banks normally do that have got low margins, etc. But I mean, you could see the currency rate at 90 plus or minus. We hope it doesn't get there, but that's not inconceivable. But that's over time. And I would tell you for doing this for 20 years on lower volumes in the earlier phases of our life, we've seen it. That doesn't mean that you're going to have extraordinary charge-offs. I think it's just trying to say that if you do see it, you don't need to head for the balcony or the window to focus because the loans are purse-guaranteed, there's collateral behind it, and it's within the realm of what these charge-offs are. The other thing too, Steve, is when you look at the charge-offs, these are spread out. It's a big number, right? But these are spread out. These are not bank loans that are doing 2 years, 3 years, or 5 years. These are spread out over fairly lengthy periods of time, and we're actually putting new business on an old business on. Once again, we've got all the models after 20 years of doing this to be able to really analyze the static pool to make sure that we've got the right reserves against these loans.

And then just one more question on the business checking and business money market you guys are rolling out here. Just kind of curious did you share any thoughts on internal targets you may have for those products? Or how you're thinking about that performance over the next 12 months?

Scott, do you want to share some of those numbers if you have them?

Yes, we plan to fully launch soon. We conducted a pilot with a few selected customers and currently have $20 million in balances at the end of the quarter. We anticipate generating around $150 million in business deposits, which may be a conservative estimate. On the higher end, it could even reach $300 million. The key issue we need to address is understanding how this product will perform with our customers and what level of retention we can expect on those funds. We're learning as we go. We've made our best estimate of how much a typical customer will retain in our bank, and we believe this will be crucial for improving profitability. To Barry's point, our focus is on providing products and services to support small businesses. We are committed to investing in America and are confident in the continued innovation of American entrepreneurs. Our goal is to offer competitive features, especially in price. While we may not have the budgets for flashy apps like larger competitors, we believe we can compete on price and provide business owners with the ability to focus on their operations. We project potential deposits to range from $150 million to $300 million, and we'll keep the market updated as we progress.

This does now conclude our question-and-answer period. I would like to pass it back over to Barry Sloane for closing remarks.

Well, we certainly appreciate everyone's attendance, the thoroughness of the questions. We've obviously tried to work hard to condense it, but there's a lot of information that, obviously, the marketplace wants. We want to make sure that you have that. And feel free to email or call with any other questions you might have. But once again, thank you for your attention and your thoughtful questions. We appreciate it. Thank you very much.

Thank you. This does conclude today's presentation. You may now disconnect.