Pathward Financial Q4 2023 Earnings Call Transcript

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October 25, 2023

There are 9 speakers on the call.

Operator

Ladies and gentlemen, thank you for standing by, and welcome to PathWord Financial's 4th Quarter and Fiscal Year 2023 Investor Conference Call. During the presentation, all participants will be in a listen only mode. Following the prepared remarks, we will conduct a question and answer session. As a reminder, this conference call is being recorded. I would now like to turn the conference call over to Darby Schoenfeld, Senior Vice President of Investor Relations.

Operator

Please go ahead.

Speaker 1

Thank you, operator, and welcome. With me today are Pathway Financial's CEO, Brett Farr and CFO, Glenn Herrick, who will Additional information, including the earnings release, the investor presentation that accompanies our prepared remarks and supplemental slides may be found on our website at passwordfinancial.com. As a reminder, our comments may include forward looking statements, including with respect anticipated results for future periods. Those statements are subject to risks and uncertainties that could cause actual and anticipated results to differ. The company undertakes no obligation to update any forward looking statements.

Speaker 1

Please refer to the cautionary language in the earnings release, investors' presentation and in the company's filings with the Securities and Exchange Commission, including our most recent filings for additional information covering factors that could cause actual and anticipated results to differ materially from the forward looking statements. Additionally, today, we will be discussing certain non GAAP financial measures on this conference call. References to non GAAP measures are provided only to assist you in understanding the company's results and performance trends. Reconciliations for such non GAAP measures are included in the appendix of the investor presentation. Now let me turn the call over to Brett Farr, our CEO.

Speaker 2

Thanks, Darby, and thanks everyone for joining us today and for your continued We've just completed a year of solid results, both financially and operationally. Remind you that we operate at the intersection of traditional banking and alternative delivery channels. And therefore, this year, we've had an These great results are in spite of When you combine these great results With the return of capital through share repurchase and dividends, we have delivered value to our shareholders in multiple ways. Specific numbers for the year, we reported net income of $163,600,000 An increase of 5% and $5.99 per diluted share, an increase of 14%. In the Q4, net income was $35,900,000 or $1.36 in diluted earnings per share.

Speaker 2

Our earnings growth was driven through expansion of our full year net interest margin to 6.04%, an increase of 120 basis points over fiscal year 2022. Our full year adjusted net interest margin, including rate related processing fees, grew 15 basis points to 4.83 from 4.68% in fiscal year 2022. Those metrics in the 4th quarter were 4.87% and 4.73%, respectively. Besides the financials, operationally, we have a lot to be proud of. Across the enterprise, our IT team delivered a reduction in run cost and we're utilizing these funds to help us to continue to focus on growth.

Speaker 2

We're also from a people standpoint certified by as a great place to work for And Newsweek ranked us among America's greatest workplaces along with some special distinctions for women, diversity and parents and families. To commercial finance specifically, we grew total loans and leases by 23%. This was driven by growth in our insurance premium finance business of 67% over the prior year. This was a direct result of us positioning the team to take advantage of opportunities and some market disruption in that particular vertical. We've also built several new relationships in our government guaranteed sectors talking about SBA and USDA that we believe will prepare us well for 2024.

Speaker 2

Also in Commercial Finance, we undertook a process To align teams that were operating vertically within their loan product into horizontally capable groups across the team. We believe this will drive a reduction in operating costs and will create a more efficient and streamlined organization going forward. Collateral managed loans provide us with tremendous safety, but it is people intensive and we are constantly seeking efficiency in that space. In Banking as a Service, we continue to expand and create new agreements with our existing partners. We extended 4 agreements.

Speaker 2

We launched a new acquiring sponsorship program and we expanded product offerings in 3 cases. We also worked with a new partner in their launch as a payment processor. And most recently, we signed a new agreement to launch a new demand deposit account program. We continue to evolve our BaaS organization to position us as the go to partner with a broad payment capability set And flexible solutions that deliver safe and sound infrastructure, simplicity and speed to market for our partners. Finally, regulatory news in the BaaS marketplace compels me to discuss compliance.

Speaker 2

I believe the strength of our regulatory risk and compliance Agencies have announced novel banking or a similar type of approach to address banking as a service business models like ours. Frankly, it is about time. We hope it will reduce the current environment of regulatory arbitrage. If it is similar to the 3rd party risk management that the agencies collectively leased in the last year, and I expect it will be, We already meet those heightened standards and have for some time. To exist in today's banking as a service regulatory world, You must have a culture of compliance and the human capital to power it.

Speaker 2

And we have worked very long and hard to create that. The password is job 1 in banking as a service. Going forward, heightened standards for banks that operate in the space will be the requirement. And we believe we have the culture and the commitment to maintain that level of risk framework. The best time to plant a tree is 20 years ago And that is exactly what we did when we entered the payment space back in 2004.

Speaker 2

As a result, We will not have to make significant investments to bring our BaaS program up to speed. Rather, we can focus on helping our partners adapt to today's ever changing financial services environment. So some key points. We believe we are entering a regulatory cycle That could fundamentally change the banking as a service banking space, drawing a regulatory moat around those who can operate within the heightened requirements. We believe others will decide to get out of the banking as a service space.

Speaker 2

And we believe we're extremely well positioned to thrive in this type of environment As a financial institution that generates sustainable recurring revenue and champions a strong culture of compliance We are built to thrive in all cycles. For fiscal 2024, you can expect us to continue on enhancing our company. We will have our teams continue to innovate and to improve efficiencies. In commercial finance, We want to drive smart balance sheet growth, ensuring appropriate yields for the current financial landscape. The BaaS team is Going to continue to emphasize being the one stop shop when partners are looking for a banking partner to work with them.

Speaker 2

We'll continue to win with our risk and compliance framework and culture and we will become and maintain our status as a Powerhouse Bank with a long track record of success through the cycle. All of these items have contributed to our ability to raise Our fiscal year 2024 guidance to a range of $6.20 to $6.70 per diluted share. Finally, we are very excited to announce the appointment of Greg Siegrist as our next CFO. Grant comes to us with a strong background, making him an excellent addition. He has over 20 years of banking experience with impressive leadership and financial and business acumen that we believe will keep Pathway on the way to continued success.

Speaker 2

We look forward to welcoming Greg in a few weeks. I also want to once again thank Glenn for all of his contributions over the last 10 years. There is not enough time on This call to detail everything Glenn has done for this organization in his time here. He was instrumental in the diversification and evolution into who we are today And built accounting, finance and treasury teams that I believe rival those of much larger institutions and any other banking as a service bank. Glenn, on behalf of the Board and our employees, thank you.

Speaker 2

We wish you well and hope you enjoy retirement.

Speaker 3

Thank you, Brett, And welcome aboard, Greg. I look forward to working with you on the transition. Before I sign off on my last 42 earnings, it has been an honor and a privilege to serve as CFO of this company for the last 10 plus years. It has been a joy to watch the company and the team transform into an innovative, entrepreneurial driven bank. Our annual net income has grown from $13,000,000 in fiscal year 2013 to over $160,000,000 this year.

Speaker 3

From my start date through mid October, our total shareholder return has exceeded 4 50% versus the NASDAQ Community Bank Index increase of about 80% and the Russell 2,000 Index increase of just over 110%. We've achieved a great deal and I look forward to cheering on the team to even greater accomplishments. Now on to the financial results. Net income for the quarter ended September 30 was $35,900,000 or $1.36 per diluted share, an increase of $12,500,000 compared to the prior year. For fiscal year 2023, Net income totaled $163,600,000 an increase of $7,200,000 relative to fiscal year 2022.

Speaker 3

Adjusting for various one time items, including the impacts of our rebrand, The increase would have been $32,900,000 or 25%. GAAP earnings per share of $5.99 increased 14% compared to last year. And when adjusting for the same items, core EPS increased In the Q4, net interest income totaled $104,900,000 an increase of 32% relative to the prior year. This year over year increase was driven by additional earning asset balances as well as greater yields across the loan and securities portfolios. Our NIM expanded to 6.19% in the 4th quarter.

Speaker 3

When accounting for the increase in rate related processing expenses, The company's adjusted NIM of 4.87 percent in the 4th quarter increased from 4.73% in the prior year quarter and was in line with 4.88 percent last quarter. As a reminder, our adjusted NIM does not include the servicing fees We also earned on our off balance sheet deposits. Also impacting the NIM was a mix shift in the loan base as we saw growth And our USDA loans, insurance premium finance and large ticket equipment finance loans, which are typically higher rated credits and thus lower yielding. In fiscal 2024, we expect our NIM, both GAAP and adjusted, to expand as we continue to optimize the earning asset mix. Provision for the quarter was $9,000,000 The provision increased when compared to the same period last year, largely due to the fact that the Q4 of fiscal 2022 included a $4,300,000 reversal of provision following the sale of the company's student loan portfolio.

Speaker 3

As of September 30, the company had an ACL coverage ratio of 1.14%, a decrease from 1.3% at the same time last year. Our Commercial Finance Group has an ACL coverage ratio of 1.26% compared to 1.35% in the last quarter and 1.46% in the Q4 last year. The successive declines are generally a result of the mix shift towards more insurance premium finance, USDA and Large Ticket Equipment Finance Loans, which have a relatively lower allowance rate. Non interest income of $56,100,000 in the 4th quarter grew $12,600,000 year over year. This increase was partially driven by $2,000,000 of additional card fee income related to the company's servicing of off balance sheet deposits.

Speaker 3

Additionally, the Q4 of fiscal year 2022 was hindered by a $4,800,000 pre tax loss on the sale of the student loan portfolio as well as a $1,900,000 pre tax loss on the sale of a venture capital investment. Non interest expenses increased 15% year over year to $118,200,000 This increase was primarily driven by rate related processing expenses as well as compensation expenses, partially offset by a decrease in legal and consulting expenses, primarily due to the impacts of rebranding activity in the prior year. During the Q4, We were able to capitalize on several renewable energy lending opportunities. These credits pushed our effective tax rate significantly lower. Total deposits, including on and off balance sheet, decreased $322,000,000 or 4% from the prior year quarter to $6,900,000,000 Total deposits decreased sequentially, primarily due to a reduction And the runoff EIP deposits as well as the continued decline in seasonal tax deposits.

Speaker 3

During the Q4, we maintained an average of $588,000,000 of deposits off balance sheet, Earnings fee income roughly equal to the effective funds rate. At September 30, there were $268,000,000 of deposits off balance sheet at Partner Bank. And to keep you up to date, at September 30, we are holding roughly 900,000,000 These deposits are being spent down, while unclaimed balances are being returned to the U. S. Treasury.

Speaker 3

During fiscal year 2024, we expect to return approximately $380,000,000 of unclaimed deposits. As of September 30, the company held $4,400,000,000 of loans, an increase of $830,000,000 were 24% compared to the end of fiscal year 2022. The growth in our loan portfolio stemmed primarily from our commercial finance division, particularly insurance premium finance, term lending and USDA and SBA. We also saw growth in consumer credit and warehouse lending. Credit quality across the portfolio remains strong.

Speaker 3

Non performing loans of 1.26% increased from 0.93% in the previous quarter. The largest increase was in Commercial Finance This was partially driven by the same relationship we mentioned last quarter, which is in the process of a workout. As we have said in the past, We do experience lumpiness in our non performing loans, particularly when we are in the process of a workout, but typically we recover at least a portion of the loan, if not all due to our collateral management. We remain confident in our collateral and the quality of our portfolio. As Brett said, we have built the company to be resilient through different cycles.

Speaker 3

From a liquidity perspective, CAPREIT continues to be in a good position. Our balance sheet is strong and when you factor in all of the sources, we have over $2,600,000,000 at available liquidity. These results continue to give us the ability to return value to shareholders. In the Q4, we repurchased approximately 312,000 shares at an average share price of $51.29 In October through October 16, we have repurchased an additional 233,000 shares at an average price of $47.25 In August, we announced that our Board of Directors authorized a new share repurchase program of up to 7,000,000 shares through September 30, 2028. As of October 16, We have 8,400,000 shares available for repurchase under the 2 current programs.

Speaker 3

As Brett stated, we are raising our fiscal year 2024 GAAP earnings per share guidance to a range from $6.20 to 6 point And $0.70 While the 4th quarter saw a healthy amount of renewable energy funding opportunities, We do not anticipate this to reoccur at the same pace in fiscal year 2024. As a result, We are reaffirming our effective tax rate to be in the 16% to 20% range. This concludes our prepared remarks. Operator, please open the line for questions.

Operator

Absolutely. Question. Our first question comes from the line of Mike Perito with KBW. You may proceed.

Speaker 4

Hi. This is Mike's associate, Andrew, filling in. Thank you for taking my questions. Hey, Mike. Just first off here, I was wondering Good.

Speaker 4

How are you guys doing? Just first off here, I was wondering if we could get some updated credit outlook commentary given some of the negative data points we've Seeing from other lenders, particularly in like the credit card and small business segments?

Speaker 2

Yes. So, of course, We don't have credit cards in the small business arena, commercial finance. As we've said, we're heavily collateral managed Loan lender and therefore, we tend to do very well through these kinds of times. And so we are not While we're having some companies are having some difficulties, we're not having any kind of loss So, we're feeling very confident about it. Don't expect to have any trouble.

Speaker 2

And we believe our collateral managed approach will put us in a better place going through the cycle than other lenders may have.

Speaker 3

Yes. And Andrew, I'd remind you that one thing that differentiates us, we no longer have a community bank. So we have a de minimis amount of commercial real estate on our books.

Speaker 4

Great. I appreciate the color there. And then just a quick follow-up on that. What are the provision assumptions that are going into the fiscal year 2024 guide?

Speaker 3

Well, It's based on our originations and the outlook for the economy and where our growth It's coming from, you've seen in the last couple of quarters, our growth has come from Higher quality, typically lower loss portfolios, SBA, USDA And insurance premium finance, so that factors into both where the allowance levels are at, it also drives your CECL provisioning.

Speaker 4

And then just lastly for me and then I'll step back. Near term, just A quick question on the margin. Do you believe the NIM will stabilize here if we're in a higher for longer environment kind of as predicted and there's no movement in the federal funds rate?

Speaker 2

I mean, if we have stability here higher for longer, our NIM will continue to widen. That's a key differentiator of our business model. It is we still have a lot more On the yield side versus the cost even the Fed funds stays flat.

Speaker 4

Appreciate all the color. Thanks for taking my questions.

Speaker 3

Thank you.

Operator

Thank you for your question. The next question comes from the line of Eric Spector with Raymond James. You may proceed.

Speaker 5

Hey, good afternoon. This is Eric on the line for David Feaster. Thanks for taking the question. Just kind of just hey, how's it going? Staying on a similar page on the NIM, just curious how you think about operations in a higher for longer environment.

Speaker 5

Obviously, there's tailwind to the margin, but just curious If you could elaborate on the margin trajectory and then just any broader perspective how you think that would impact loan growth and maybe any other impacts or Impact on any other business in a higher for longer environment?

Speaker 2

Well, so the first thing Kind of ties back to the previous question, as you offload longer duration loans That we're at lower rates and replace them with duration loans at higher rates, we're going to continue to grow NIM even if Fed funds and prime stay flat. So that's kind of obvious. Now the other element of your question is what's going on in the marketplace. And we're watching to see how much of a slowdown occurs in loan demand. Glenn noted particularly Yes.

Speaker 2

We're already migrated some in our growth to higher quality loans. Some of that is what's available in the marketplace. So we see that leasing portfolios and others. And so that may well be what happens. But also if the economy gets into a little bit more of a difficult time, we may see some growth in our working capital and factoring assets.

Speaker 2

We've talked about that for, I think, nearly a year now. So it hasn't materialized, but that would be the next thing that would happen if the economy really slows down as people are starting to talk about.

Speaker 5

Got it. That's helpful color. And then just kind of wanted to touch more on the capital side. So obviously regulatory Capital remains strong, but TCE is then just curious if you're hearing any pushback from regulators on that and that impacts your capital return opportunities at all. Looks like we already started to repurchase some shares during the quarter, so maybe that's the answer.

Speaker 5

But just curious if TCE plays into the equation at all at this point?

Speaker 3

We obviously watched that. And as you said, that's a factor. And We're comfortable. Our Board is comfortable. You could assume regulators have a say in your capital levels And share repurchases as well.

Speaker 3

And I would say In banking, 30 plus years, whereas liquid a bank as I've seen.

Speaker 5

Okay. And then just one last question. Just wanted to touch on what you're seeing on the SBA front. We're seeing growth opportunities. And Can you remind us like how much of that book is government guaranteed?

Speaker 5

That's my last question, I'll step back. Thanks for taking the questions.

Speaker 2

Yes. We talked about I mentioned in my comments that we've been identifying additional SBA partners Where we can get volume coming through. And so I would say the SBA business in general industry wide has slowed down, Well, we're able to get some more transactions because of new partners that we have brought on. So we're excited about that. The Exact percentage of how much is government guaranteed or not varies depending on market conditions.

Speaker 2

Sometimes we sell off the government guaranteed portion. So I Do we have those numbers? I didn't want to get to this.

Speaker 3

It usually rains about 2 thirds. It moves up and down, As Brett said, plus or minus 2 thirds of it would be typically guaranteed.

Speaker 5

Got it. Got it. All right. Well, that's it for me. Thanks again.

Speaker 2

Thank you. Thank

Operator

you. Thank you for your question. Our next question comes from the line of Frank Shiroldi with Piper Sandler. You may proceed.

Speaker 6

Hey, guys. Good afternoon.

Speaker 3

Hi, Greg.

Speaker 2

I wanted to ask

Speaker 7

on the Guide, the increase in guide, anything you can point to specifically? Is it just as simple as a bit of a change in rate outlook that's driving that increase here?

Speaker 2

Yes. I mean, I think the higher for longer what's going on Should help us with NIM and so we're feeling very comfortable about that. Obviously, we're just a few days into the year, so we're not getting carried away. But We felt like with the what we're seeing with the rate environment, we could bump it some and then we'll see what happens as we get through the year.

Speaker 7

Okay. And then in terms of the expense base, I got the card processing expense that increased there. As far as if you look at the other expense line It was a bit elevated. It bounced around a bit, but it was a bit elevated linked quarter and same with legal and consulting expense. So Any sort of color or range you can give in terms of anything one time sort of in the quarter and where you Expect a better run rate maybe to be on the expense side?

Speaker 3

Yes. I would say this quarter is a pretty good run rate, Frank, excluding the rate related processing expenses And our we are and I'll remind you, as you're aware, we do have a number of variable expenses. So Where our expenses go partially driven by where our revenues go, but again, we're

Speaker 5

All right.

Speaker 3

We'll grow revenue at least 2 times expense growth.

Speaker 7

Okay. And then just on credit, in terms of the NPA increase in the quarter, you mentioned the commercial Finance side of it. Also, it looked like the tax business and I think you noted in the release, the tax business drove some of that and it Looks like it's mostly or all in 90 days past due and accruing at least for the tax stuff. And I'm just kind of surprised Would think that at this point you just write anything off that's still outstanding. And so any color on that front?

Speaker 3

Yes. We had a mix shift in our tax lending this year from Our BaaS providers to more of the independents and obviously revenues related to that, but Also had higher loss rates, which we expected. So it's just Somewhat of a mix shift there and then timing of IRS refunds when they do their drops and There's still some of them coming, but that's where we're at today. It just seems like the cycle has gotten pushed back later this year in a lot of the processing.

Speaker 7

Okay. It just seems like based on where the reserves are on that business, It seems like you don't anticipate significant losses in this $5,000,000 bucket that's in NPA now. Is that fair?

Speaker 3

That's fair. Yes. I would not expect anything material From that. Okay.

Speaker 8

And then if I could just sneak in

Speaker 7

one last one. As you I know you tend to have longer term partnerships, so they I guess you don't have a ton renewing Every day, but in terms of the partnerships that have renewed, I'm just wondering, are you seeing better pricing? Are you seeing more narrow pricing given that We've seen some of these smaller banks entering the market and to Brett's point, maybe over time, they get crowded out. But that Given that they're in now, is that kind of what you're seeing as partnerships renew, tighter pricing?

Speaker 2

Well, I mean, there's been pricing pressure, but it's probably been driven more by the rise in interest rates The desire to focus on commission on deposits than anything else. And we don't you said, we don't have a whole lot of these going on at a time. So we'll see how it rates up. But I would not say that we have Experience any benefit of what I think will be a washout yet. We've experienced pressure on pricing somewhat because of the interest rate rise.

Speaker 3

Which is all factored into our guidance. Okay.

Speaker 2

Yes. It's in our guidance. Yes.

Speaker 7

Right. So you're basically seeing more of an ask on the depository side in terms of some sort of return there?

Speaker 2

Yes, that comes up. Now what we tend to do is there's a trade off of fees paid versus commission on deposits, etcetera, and that's all part Of the contract negotiations you go through. But again, we're predicting and feel solid about our guidance around expanding them And the result of that, so we're not too concerned about it.

Speaker 7

Okay, great. I appreciate all the color and Enjoy retirement, Glenn. Thanks.

Speaker 3

Yes. Thank you, Frank. I'll miss you.

Speaker 2

Thanks.

Speaker 5

You too.

Operator

Thank you for your question. I will now pass the line back to our CEO, Brett Farr.

Speaker 2

Thank you, everybody, for joining today. I do want to make one final comment. Today in Washington, The Federal Reserve held a hearing on the debit card interchange fee calculations. And I want to remind everybody that by legislation, the only authority they have for that calculation relates to banks Over $10,000,000,000 in asset size. And so there may be some confusion out there.

Speaker 2

I want to be sure we clear that up that It's a small issue where we are not impacted by that proposed change in rule by the Fed. So just want to make that clear. We appreciate everybody joining today and look forward to having direct conversations with you. Thank you.

Operator

That concludes Pathway Financial 4th quarter fiscal year 2023 investor conference call. Thank you for your participation. You may now disconnect your line.

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Key Takeaways

  • Pathward delivered record financial results for FY 2023 with net income of $163.6 million (+5%), diluted EPS of $5.99 (+14%), and expanded net interest margin to 6.04% (up 120 bps YoY); Q4 net income was $35.9 million or $1.36 per share.
  • The company raised its fiscal 2024 guidance to $6.20–$6.70 in diluted EPS, anticipating continued margin expansion in a “higher for longer” interest rate environment.
  • Commercial finance grew total loans and leases by 23%, driven by a 67% increase in insurance premium finance, new SBA/USDA relationships, and a horizontal team realignment to improve efficiency.
  • Banking-as-a-Service partnerships were expanded with four agreement extensions, a new acquiring sponsorship, enhanced product offerings for three partners, and a new demand deposit program, all underpinned by a strong compliance culture to capitalize on impending regulatory standards.
  • Operational highlights include significant IT run-cost reductions funding growth initiatives, recognition as a “Great Place to Work” and “America’s Greatest Workplaces,” plus ongoing shareholder returns via share repurchases and dividends.
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