Earnings Call Transcript - NEWT Q4 2020

Operator, Operator

Ladies and gentlemen, thank you for standing by and welcome to the Newtek Business Services Corp. Full Year 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speakers' presentation there will be a question-and-answer session. Please be advised that this call is being recorded. I would now like to hand the call over to Barry Sloane, President and CEO of Newtek Business Services Corp. Please go ahead.

Barry Sloane, President and CEO

Thank you, operator, and I wanted to welcome you to our full year 2020 financial results conference call. I'd first like to also welcome Nick Leger to the call. Nick is our new Chief Accounting Officer and Nick, I'd like to thank you and your entire team, particularly Elise Chamberlain for helping us obviously get this 10-K out the door and helping us close out our year. We had a pretty quick transition in February, but we're thrilled to have you in this position and you joining me for the call today.

Nicholas Leger, Chief Accounting Officer

Thank you, Barry, and good morning everyone. You can find a summary of our fourth quarter 2020 results on Slide 39, as well as a reconciliation of our adjusted net investment income or adjusted NII on Slide 41. For the fourth quarter 2020, we had net investment income of $850,000, or $0.04 per share, as compared to a net investment loss of $3 million or $0.15 per share in the fourth quarter 2019, a 126.7% increase on a per share basis. Adjusted NII which is defined on Slide 40 was $9.6 million, or $0.44 per share in the fourth quarter 2020 as compared to $13.5 million or $0.68 per share for the fourth quarter of 2019. Focusing on fourth quarter 2020 highlights, we recognized $14.8 million in total investment income, a 3.9% decrease over the fourth quarter of 2019. The decrease was driven by a decrease in interest income, which was attributed to the decrease in the primary and a decrease in other income which is attributed to the decrease in fourth quarter loan origination volume year-over-year. Servicing income increased by 7.7% to $2.8 million in fourth quarter 2020 versus $2.6 million in the same quarter last year. Distributions from the portfolio of companies for the quarter included $2.35 million from NMS, $1.6 million from NBL our 504 business, $75,000 from IPM, $150,000 from Sidco, and $393,000 from Newtek Conventional Lending, our joint venture with BlackRock TCP. Total expenses decreased by $4.5 million quarter-over-quarter or 24.5%, mainly driven by a decrease in interest expense, loan referral fees, and other G&A expenses such as advertising. Realized gains recognized from the sale of a guaranteed portion of SBA loans sold during the fourth quarter totaled $11.4 million as compared to $17.3 million during the same quarter in 2019. In the fourth quarter of 2020, we sold 123 loans for $85.1 million at an average premium of 11.42% as compared to 199 loans sold during the fourth quarter of 2019 for $135.1 million at an average premium of 10.73%. The decrease was attributed to lower loan origination volume in the fourth quarter of 2020 offset by higher average premium prices when comparing to the prior year fourth quarter. Realized losses on SBA non-affiliate investments for the fourth quarter 2020 were $2.7 million as compared to $1.7 million in the fourth quarter of 2019. Overall, our operating results for the fourth quarter resulted in a net increase in net assets of $15.9 million or $0.73 per share and we ended the quarter with NAV per share of $15.45. I would now like to turn the call back to Barry.

Barry Sloane, President and CEO

Thank you, Nick. Operator, I would like to open up the call to any questions.

Operator, Operator

Our first question comes from Robert Dodd with Raymond James. Your line is open.

Robert Dodd, Analyst

Hi guys, and congrats Barry on you and your team getting through a very tricky year. Some questions on multiple elements of lending, on PPP first if I can. You've given the fee structure now where, it can be above 5% if the loan is small enough effectively, do you expect your blended fee rate on those loans to be north of 5%? I mean, you said in your comments, you expected that the loans to be on the smaller side?

Barry Sloane, President and CEO

Yes, I think that, Robert, a better way to think about it without having everything signed, sealed and delivered at this point, I think we were about 3.2% in 2020 on a weighted average. I wouldn't skew it north of the 5%, but I'd say somewhere between the 4% and the 5% is probably not a bad way to guess at this point.

Robert Dodd, Analyst

Got it. Thank you for that. Regarding the 7(a) side, with the reactivation of the PPP programming in Q1, should we expect the 7(a) originations to be somewhat subdued in Q1 and possibly more concentrated later in the year, considering that last time the PPP affected your capacity to originate 7(a) loans due to time constraints, or will it be a more typical 7(a) year in addition to the PPP?

Barry Sloane, President and CEO

That's an important question. We usually have a back-ended 7(a) year anyway, and the reality of the PPP is that it consumes a lot of resources. This year was similar to previous years, including 2020, where the forms, rules, and calculations changed. I do believe there will be a traditional back-ended emphasis, but we've also implemented some process changes. We've made efforts to hire and increase staffing, which is challenging in the current market. I think your observation that it will be more back-ended is spot on. We expect less PPP activity in the latter half of the year, and while we will continue servicing, it may begin to decline around May or June. Overall, the 7(a) narrative will indeed be more back-ended.

Robert Dodd, Analyst

I got it, I appreciate it. And then the tough question there to your point that I mean, pricing in 7(a) the premium today is extremely attractive it’s high right? I mean, what's your view on how that could go? I mean, there's a lot of moving parts as we go through the year, but any idea how that's going to shake out?

Barry Sloane, President and CEO

Sure. So a couple of factors, Robert. I know you've developed a nice model in this particular area. Number one, think about the difference between the 75 and the 90 for the whole calendar year, you're going to get 90s through September, and then you probably go back to 75. The second item was some of the pricing issues are based upon the fact that some of the fees that are normally charged by the government, the borrowers have gone by the wayside so that it creates higher coupon. The third item is the CP, this prepayment speed expectations which were muted in 2020 as people didn't think that there would be a lot of prepays. We actually saw some decent prepayments, believe it or not. We're in a strange scenario. Unfortunately, we all get glued into the TV set, and it's like, oh my God, the world's coming to an end. A lot of people have a lot of cash in the bank because of government programs, and I'll just leave it at that. And I do expect speeds to increase and that could depress prices. I do not expect these prices to continue at this level and Robert, that could be the first time you've ever heard me say that. Usually, I tend to be a bit of a pricing bull, but no, there is reason to think that prices will not hold the levels that they will in the first quarter. And we'll disclose what those levels are obviously in our upcoming call in five or six weeks.

Robert Dodd, Analyst

Got it. I appreciate it. One more on lending if I can and then, I’ll get back in the queue.

Barry Sloane, President and CEO

Sure.

Robert Dodd, Analyst

On the 504 side, I mean, $87 million closed in 2020, your target is obviously for that to go up. Can you reconcile for me though, with the $87 million close that NBL generated a $1.6 million dividend, but you said in your prepared remarks, the target is 125 for this year, but the dividend could be in the 5 to 6 range. Obviously, that's a much greater increase in dividend than it is in closing. So is that related to obviously these loans have to season in certain ways? Is it related to that or is it just the dividend is going to increase because now you've kind of covered the cost now, if you will, NBL?

Barry Sloane, President and CEO

Yes, so the income stream comes from origination fees, which you get on the first and the second at the time of the loan closing, whether it, there's some construction in there or not, so that that's earned up front. Then you've got the carried interest, which now with additional warehousing lines in a bigger portfolio will be able to carry those assets. And then you've got the third aspect, which is the amount of seasoning. So, the sooner the loans are fully funded, seasoned up, typically within a quarter, then the debentures take out a second loan that's basically government funding. And then we sell the first loan and there is an insatiable appetite right now, but 50%, LTV, multiple guarantor, 1.2 debt service coverage or greater, once we've been able to sell those at net prices of 104 to 104.5.

Robert Dodd, Analyst

Got it. Yes, there's a bunch of attractive markets out there right now for those loans. Thank you.

Barry Sloane, President and CEO

Thank you, Robert.

Operator, Operator

Our next question comes from Harold Elish with UBS. Your line is open.

Harold Elish, Analyst

Good morning, Barry, congratulations.

Barry Sloane, President and CEO

Thank you, Harry.

Harold Elish, Analyst

Question sort of, in a bigger picture sense. I mean, Newtek has had extraordinary success in joint venturing and in partnering with its various banks and financial institutions in order to generate the leads that it's been successful in closing. And I guess the question is, as the financial world changes, and there are more online vendors, are there still potential new partners that you could add to the platform that you think would be accretive or sort of has all the low hanging fruit been picked and is a question of just generating leads out of the existing relationships?

Barry Sloane, President and CEO

Yes, Harry, I think that we like to look at ourselves as somebody that's not just come to the party lately and put up some software and say, hey, we could do this stuff. Making a loan is an algorithm. I think people that lent based on instant algorithms, they got hurt in 2020. Many of them wound up getting sold or merged, like OnDeck. There was another lender too, I can't remember which one it was. So I think that there's plenty of growth opportunity for us in this space. Because, number one, it's constantly evolving and the other important aspect of what we do is, it's not just software. And it's easier to make a PPP loan that doesn't have a credit aspect to it than what we do in 504 and 7(a) and in nonconforming. Also, if you look at the network of referrals that we have, those are not referrals that are coming from keywords or paid for search, that's stuff that's just coming to us reputationally. So I think we're very well positioned for growth. And then you put the other solutions on top of it, which historically, we haven't done the best job in monetizing, but that's clearly on the plate and some of the people that we will bring into the organization in hiring. This is going to be our year to make major investments in talent, to be able to reinvest back into the business environment. So no, I'm not concerned about the competition at all. Matter of fact, I particularly don't think the competition performed that well. And the big financial institutions are realizing it's much easier to partner with or look at the asset creation that we have than try to start it from scratch.

Harold Elish, Analyst

All right. I appreciate it, take care.

Barry Sloane, President and CEO

Thank you. Thank you, Harry.

Operator, Operator

Our next question comes from Paul Johnson with KBW. Your line is open.

Paul Johnson, Analyst

Hey, good morning guys. Thanks for taking my questions. I just have a few. I was wondering if you can just kind of broadly comment on PPP this time around versus the first round last year. And how that's gone and any of the changes that have been made to the qualifying borrowing base, if that's increased demand this time around or any changes you'd like to talk about there?

Barry Sloane, President and CEO

Yes, Paul. It's been a, you'd like to think that it's gotten significantly better second time around, and there were parts of it that did get better and there were parts of it that, I think the government and lenders like ourselves still struggle with. I think the part that got significantly better was the fact that we were able to pretty much automate at the inception of the program, to be able to get certain customers into the system that didn't have complicated structures. A lot of these independent business owners have got multiple LLCs with multiple tax IDs, and they use social security code in different places. And what it did was it put from a software perspective, to get the guaranteed number, very difficult, and a lot of error messages popped up and it was hard, it was kind of harder to get people qualified this time than last time. On the other hand, last time we had to stand this program up from a dead start. So we had a lot of things already built so that the client experience of filling out an app and filling up a file vault and having our closers trained and staff trained to use the software and know what it takes to get the thing through is much, much better. So I think that the ability to get the dollars and put them out much better, the changing landscape, for example, independent contractors and sole proprietors, the changing rules, being able to go from one set of funding guidelines to a much higher evaluation in midstream, saying today's the forum, and then 45 days later changing the form. So, in most aspects of this, once again I think will be a successful opportunity for us. I did believe and predicted that this would not be and it is not I mean, from a funding standpoint, and dollars out the door, much less, there will be much fewer dollars out the door in what they call funding program 3 than in funding program 1 and 2. That's just the fact. And why is that? Why these businesses are okay? They're doing fine. I mean, they're in regions that didn't shut down. They're in certain industries that are doing well. So it will be interesting. We look forward to reporting our numbers in the first quarter that will shed a little bit of a light on exactly what happened and the breakdown. A lot of smaller borrowers came in this time that did not participate in round 1. And in round 1, 2, a lot of bigger borrowers did not participate, because they couldn't qualify for the revenue decline.

Paul Johnson, Analyst

Okay, yes, thanks. I appreciate that. And then just, you partly touched on this in your answer to Robert's question, but I'd just like to get your thoughts around the possible extension of the higher guarantee rate for the 7(a) loans as well as the support for challenged borrowers, P&I payments, if that's possible, or if you expect that to revert back to the normal levels as scheduled?

Barry Sloane, President and CEO

I would say and this is a total guess on my part, it's speculation, but most people that know me, I never have a hard time making a speculative guess. I just want to emphasize, it's just a guess. I think that we're going to return to normal levels post the end of September. I think we see a very robust economy. We see an economy that is unbelievably stimulated with more to come with infrastructure. So I think that there will be tensions on the right versus the left to further provide financing in this area. Now, let me do on the other hand, there are certain businesses and categories that have gotten hurt pretty bad and you kind of can't deny that. There are restaurants, dry cleaners, gymnasiums, maybe there's some special carve out. But one positive thing I could say and relative to our demographic that we serve, it's probably the only area in Washington where there's bipartisan support. Democrats and Republicans love small business. They typically get along well together on the committee's, and they're typically both in favor of doing things to help out independent business owners. So that's something that we came from, but I do not think past September 30 will be a 90, nor do I think and if I guess, on my part particularly the way, I mean if you would have asked me, would there be another PPP program with the first one I might have said, no. So I think we'll go back to a more normalized environment and that's what we're preparing for. We're also expecting the unexpected, as always.

Paul Johnson, Analyst

Sure, sure. I appreciate that as well. And two more, if I may, just on that point for some of the more challenged borrowers, like restaurants, any sort of entertainment company or hotel, I'm just curious, do you have any kind of like high-level comments on the underlying performance of those borrowers in those sort of challenged COVID impacted sectors and what you're seeing?

Barry Sloane, President and CEO

Well, yes. I mean, look, we are very aggressive in conversations with our clientele and so we've got a pretty good feel for it. I think that a lot of the restaurants in particular, entrepreneurs where they could do outdoor dining, they did it, and it got them through. A lot of them received a lot of aid. There's actually a very large grant program that will be administered by the SBA for restaurants and hospitality, and category they called shuttered venues. So that was legislated in the last COVID bill, I believe, so that there's still a lot of financial aid available to those seriously affected industries. And the PPP program actually gave a little bit of a higher advance rate to restaurants and hospitality. I think that what these businesses did, they worked out deals with the landlord, they reduced all the expenses that they could to survive and get to the other side. And in our world, we look at lending and our lending criteria it is important that the guarantors have got additional liquidity, additional resources of personal assets, which are pledged, effectively to the loan through the guarantee. In some cases, they're secured by a lien to be able to get them through the tough time. Well, we're happy about, is it does appear that most of these markets are open, we're also happy that we have like, our motel portfolio, I think in the 7(a) is less than 2%. Our convenience store and gas station, I think is less than 2%. We're probably bigger in restaurants, but our restaurants tend to be not franchise but secured by real estate. So we've got that behind it. I think we're going to, what's going to happen, everyone, I think is surprised at how resilient the economy has been and how quickly it's bounced back and that's kind of what we've seen in the portfolio. Not to say that we won't see adverse effects throughout the calendar year 2021, but it's not going to be as bad as we once thought.

Paul Johnson, Analyst

Sure, thanks for that and that's obviously positive to hear for that sector, specifically. And last one, kind of a broader question. But just curious kind of where the small business owner kind of stands today, in terms of like investments in technology, tech solutions, we've obviously had a rapid acceleration of tech adoption, pretty much over every facet of the business today due to COVID. And, small businesses that probably were not already making these investments before COVID might have a harder time doing so today. I'm just curious, does the opportunity still exist and perhaps where does it exist to offer these kind of solutions to your borrowers today, and have you seen increased demand from business owners for these types of business services that you guys provide?

Barry Sloane, President and CEO

Yes, capital has a cost and it's limited. When we consider the tech solutions we provide, we enable businesses to manage their hardware and software over time, rather than having their CTO or CIO purchase servers and PCs and manage software installations in-house for security. Instead, they can pay us monthly for these services. In the payment sector, point-of-sale solutions are increasingly common, similar to what companies like Square offer, but we believe our solutions are more comprehensive, offering human talent alongside great software and hardware. As independent business owners, they will need to innovate, such as developing e-commerce sites. Many businesses in 2019 hesitated to invest in an e-commerce site for food delivery or curbside pickup, and now they regret that decision. Our solutions allow creditworthy entities to finance these innovations over time, helping them recover. For restaurants, if you’re not delivering food or offering curbside pickup, your returns are significantly lower compared to dining in. The potential return on equity for delivery and pickup is much higher. Quality products that can be delivered or picked up are essential for growth, and that’s how we position ourselves as a solutions provider.

Paul Johnson, Analyst

Sure, okay. I appreciate your answers and that's all I have today. Thanks.

Barry Sloane, President and CEO

Paul, thanks for joining us. I appreciate your coverage. Thank you.

Operator, Operator

There are no further questions on the phone.

Barry Sloane, President and CEO

Okay, operator, I've got one more analyst, Mickey Schleien from Ladenburg wasn't able to make the call. So I'm just going to read off his questions quickly and try to answer them. Mickey Schleien’s first question. How does the potential for workers to remain working at home beyond the pandemic permanently affect your outlook for credit quality for those borrowers dependent upon their demand, for example, dry cleaners and restaurants focused on lunch? Those are challenged businesses of the honestly the dry cleaner thing, the tough one that I've thought about and examined because at the end of the day, people just they're not dressing up. They're wearing sweatpants, t-shirts, jeans, restaurant. On the other hand, as I just discussed with Paul, they're going to have the ability to adapt and do something differently. But those restaurants that lived off of the lunch in crowd in New York City or in a Chicago, they're going to have a challenge because we don't see that size of the commuter base coming back into those offices in the near term. How do you expect to manage credit risk in the gasoline station segment? Very carefully. I think this is a segment I haven't loved for 10 years, because I do believe in the growth of the electronic car, electronic vehicle and we have very little exposure. And we only typically look at these stations to the ones that are the best of breed, best and biggest quality, so very difficult to manage, not a fan of credit to gas stations. How do you expect the 7(a) and 504 pricing environment to behave once the Fed starts raising rates? I think that the 7(a), as we discussed with Robert, might come under pressure if the economy strengthens and the speeds increase, which could change the prepayment expectations and lower prices. However, I believe that 504 pricing will remain very strong. There will be significant demand from borrowers since they can access fixed-rate borrowing at very low rates. Currently, banks need to lend money, and there is a strong appetite from banks and insurance companies. The BB high yield bond spread is around 2.5%, indicating a substantial demand for loans, and our loans present a favorable risk-reward situation, which we are pleased about. What causes NBL dividend to be higher than the anticipated would sell it for 2021? We did chat about that on the call. Basically, it's called execution, getting the borrower, getting the loan closed working with the SBA to get them to approve it and the CDC, so it was really execution. And we look forward to Tony's Zara's team continuing to execute and bring us these loans. What is driving the higher dividend forecast for 2021 and what changed from your previous guidance? The main factor here is effectively leveraging our contribution from the PPP. What equity level do you expect in 2021? I believe we'll be around 1.3 to 1.35. It might vary each quarter, but we raised some capital in the first quarter, which should help, and the income from PPP in Q1 compared to the $0.50 dividend will also support this. We're not overly worried about leverage; we manage it well. As a BDC, we constantly address leverage issues. However, if we weren't a BDC, an entity like ours would likely be leveraged multiple times more comfortably, but we will not pursue that. We are not concerned about reaching 1.35 or any fluctuations around that.

Operator, Operator

We actually have a question from Scott Sullivan with Raymond James. Your line is open.

Scott Sullivan, Analyst

Congratulations on the call and thanks for taking my question.

Barry Sloane, President and CEO

Thank you, Scott.

Scott Sullivan, Analyst

We know you don't or really can't give guidance out over a year. But how can we think about business in 2022 possibly without PPP? And to that what areas of your business are showing really the best growth and potential from your perch?

Barry Sloane, President and CEO

Great. Look Scott, I think that right now we are in a good spot, particularly for 2021. We've got this new guidance out there. We'll be updating that guidance on a regular basis as we go through the year. My focus right now is actually on 2022 and I say that from the standpoint that I feel real good about 2021 in what we have in the pipe and in what we have out there, particularly given all the ranges very, very, very, very comfortable with it. Going out in 2022, I've got to make sure that we are more efficient in 7(a), that we're more efficient in 504, that we launched NCL, that we get the payments business back on the growth track, that our cloud computing in managed tech solutions business gets on a growth path, that we can get the payroll and the insurance agents to be contributors, we certainly have a lot of customers, we got 200,000 to 300,000 referrals last year, a lot of people have talked to a lot of conversations and if the staff does what they need to do when they contribute, which is what we've experienced over 20 years. And they're going to build Newtek into a much bigger and better company, not only for its shareholders, but for themselves, because they're going to participate in that. And for our customers, they will also participate in our ability to fund them so they can grow and hire more people. It's a good story if you think about what we do. But we are definitely focused on 2022 right now.

Scott Sullivan, Analyst

That's great. Can you give us any color on what percentage of your customers use more than one product beyond the loans?

Barry Sloane, President and CEO

Scott, I would probably say it's still at a low level, maybe 5%, 10%. I think that we have got to develop the ability to outbound call and communicate. And that's easier said than done. You could do it digitally; you could do it with video. But at the end of the day, in my opinion, people don't buy stuff off of an email, they might bite off a video and call you back or if you're contacting them digitally, they might come to you when they need it. But at the end of the day, we have got to talk to clients and they know us. We're connected. We're there. That is the biggest thing that needs to improve. By the way, you and I probably say that to our kids. I don't know if you've got kids, maybe you need to send that person how about talking to them? I still think that maybe I'm a little old school, but I still think our business owners want to have a conversation; I don't think, and I say this to my insurance agency, people aren't buying insurance policies just by sending them an email. I mean, they want to talk to you. So that's something we've got to work on, and I think if we get there, I think the sky is the limit. Because we've got a lot of relationships right now that we can capitalize on. We're just scratching the surface.

Scott Sullivan, Analyst

That's great. And could you put some flesh on the bones on the JV comments, please?

Barry Sloane, President and CEO

Yes, I mean, I'm excited about them. They're two major institutional players, we may never be able to release the name, not sure about that, but significant capital contributions. And we're just finishing up the JV documents. People have tremendous appetite right now, as you could imagine for assets, and we could make them. And not only can we make them, but the risk reward and the returns are great, as evidenced by what we've done from a stock price perspective that, the purpose of the JVs is, never taking capital for granted as I certainly look at our stock trading pattern over the last year because of the pandemic. This gives us the ability to partner with great institutions, sharing the benefits of the systems and the team that we put up over 20 years and share on the returns. So that's the purpose of these ventures to go work with people that have got unlimited amounts of capital and need to put it up. And they also give us, different smart people. They give us different ideas and thought processes and it helps grow the business. So we're excited about that. I hope these can, I hope we can announce somewhere in the second quarter that we're open for business and up to $15 million loans with $10 million minimal amortization schedules up to 25 years. No financial covenants. Obviously, we charge healthy rates for those benefits, but we're comfortable with it.

Scott Sullivan, Analyst

That's terrific. Thanks again and congrats.

Barry Sloane, President and CEO

Thank you. Thank you, Scott. Operator, anybody else?

Operator, Operator

There are no further questions.

Barry Sloane, President and CEO

Well, operator, thank you. Nick, thank you and your team and I want to thank all of our analysts and investors that listened in today and followed us, and we certainly appreciate your loyalty and your investment. We look forward to being right back here in five to six weeks and giving you a good report for Q1. Thank you very much.

Operator, Operator

Ladies and gentlemen, this does conclude the program. You may now disconnect. Everyone, have a great day.