First Internet Bancorp Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
October 24, 2024

There are 7 speakers on the call.

Operator

Good day, everyone, and welcome to the First Internet Bancorp Earnings Conference Call for the Q3 of 2024. And please note that today's event is being recorded. I would now like to turn the conference over to Ben Ratkogwitz from Financial Profiles Inc. Ben, please go ahead.

Speaker 1

Thank you, Sylvie. Hello, everyone, and thank you for joining us to discuss First Internet Bancorp's 3rd quarter financial results. The company issued its earnings press release yesterday afternoon, and it is available on the company's website at www.firstinternetbancorp.com. In addition, the company has included a slide presentation that you can refer to during the call. You can also access these slides on the website.

Speaker 1

Joining us today from the management team are Chairman and CEO, David Becker and Executive Vice President and CFO, Ken Lubbock. David will provide an overview and Ken will discuss the financial results. Then we'll open up the call to your questions. Before we begin, I'd like to remind you that this conference call contains forward looking statements with respect to the future performance and financial condition of First Internet Bancorp that involves risks and uncertainties. Various factors could cause actual results to be materially different from any future results expressed or implied by such forward looking statements.

Speaker 1

These factors are discussed in the company's SEC filings, which are available on the company's website. The company disclaims any obligation to update any forward looking statements made during the call. Additionally, management may refer to non GAAP measures, which are intended to supplement, but not substitute, for the most directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be discussed today as well as the reconciliation of GAAP to non GAAP measures. At this time, I'd like to turn the call over to David.

Speaker 2

Thank you, Ben. Good afternoon, everyone, and thanks for joining us today as we discuss our Q3 2024 results. We have turned in 4 consecutive quarters of double digit earnings growth and improved profitability for the company, driven in large part by the recovery in our margin and the growth in net interest income that we projected at this time last year. Our Q3 results were strong in virtually all areas. Increase in net interest income was driven by solid loan growth, a larger balance sheet and higher yields on our earning assets, anchored by continued stabilization in funding costs.

Speaker 2

Strong growth in non interest income was powered by continued expansion of our national SBA platform with a record gain on sale revenue. In short, the revenue side of the equation is firing on all cylinders with total operating revenue growth of over 4% compared to the prior quarter and up over 36% year over year. At the same time, our efforts to improve the risk profile of the company are also bearing fruit. The exceptionally strong deposit growth in conjunction with the ongoing and deliberate shift in our loan mix have increased our balance sheet flexibility. Our balance sheet liquidity as measured by the loan to deposit ratio is the strongest it's been in recent history.

Speaker 2

Starting with the highlights on Slide 3, I would like to discuss some key themes for the quarter in more detail.

Speaker 3

As a

Speaker 2

result of our continued improvement in operating performance, we reported net income of $7,000,000 up 21 percent and diluted earnings per share of $0.80 up over 19% from the 2nd quarter's reported results. Compared to the 2nd quarter's adjusted results, net income was up over 12% and earnings per share was up over 11%, which as I noted a moment ago marks the 4th consecutive quarter of double digits earnings growth. Our earnings growth was driven by continued expansion of non interest income and gain on sale revenue to complement our sustained growth in net interest income. The excess liquidity created by the robust deposit growth caused a short term drag on net interest margin, but it provides us a great deal of balance sheet flexibility that will be useful to us over the next two quarters. On the lending side, new funded loan origination yields were 8.85% consistent with the prior quarter.

Speaker 2

The yield on overall loan portfolio increased 7 basis points from the 2nd quarter with deposit costs increased only 1 basis point. As a result, net interest income was up over 2% from the prior quarter. Furthermore, compared to the Q3 of 2023, net interest income was up 25% and net interest margin expanded by 21 basis points on a fully taxable equivalent basis. We remain confident that net income will continue to trend higher in the 4th quarter as we experienced a full quarter's impact of the September Fed rate cut on deposit costs and we continue to improve the composition of the loan portfolio. We also expect that net interest margin will rebound as we deploy liquidity to fund both loan growth and maturing higher cost CDs and wholesale funding.

Speaker 2

A key driver in our efforts to reposition the loan portfolio and diversify our revenue is our small business lending team, which delivered another standout quarter. The team continues to perform remarkably well, delivering strong production volume and another record quarter of gain on sale revenue. Compared to 2023 year to date SBA loan originations are up 35% and sold loan volume is up almost 60%, demonstrating the tangible results of the investment we have made in providing growth capital to entrepreneurs and small business owners throughout the country. Our small business pipeline continues to flourish and we are proud to announce that we were the 8th largest SBA 7 lender in the country for the SBA's 2024 fiscal year, which ended on September 30. And congratulations to our SBA team on another impressive quarter.

Speaker 2

The growth of our SBA business propels non interest income, which now comprises 1 third of total revenue year to date compared to 25% for the comparable period last year. Bankwide, we drove a 4% increase in total revenue over the prior quarter, our 5th consecutive quarter of revenue growth and continued improved profitability. Moving to the asset quality, our overall credit quality remained sound despite an increase in non performing loans during the quarter. Non performing loans to total loans were 56 basis points and non performing assets to total assets were 39 basis points at quarter end. The increase in non performers due to additions in franchise finance, small business lending and residential mortgage.

Speaker 2

Our metrics still compare favorably to similar sized banks. Furthermore, we have specific reserves on about 45% of the total non performing loan balance. Net charge offs to average loans remain low at 15 basis points and were driven primarily by SBA charge offs. A key measure of our focus on shareholder value creation is growth in the tangible book value per share, which increased by 3.6% in the 3rd quarter and is up almost 11% year over year. Since 2018, PercenterNet has grown tangible book value per share by more than 55%.

Speaker 2

We are among just a handful of banks that have grown tangible book value per share in each of the past 5 years, which is a testament to our prudent balance sheet management and operational discipline through some very challenging periods for the industry. Turning now to Slide 4, I'll spend a couple of minutes discussing our lending activity during the quarter. We produced solid loan growth of 7.5% on an annualized basis for the quarter. Growth was led by our commercial lending teams where balances were up almost $75,000,000 from the 2nd quarter or 9.6% on an annualized basis. Our construction team had another solid quarter originating over $94,000,000 in new commitments.

Speaker 2

Late in the Q3, dollars 71,000,000 of construction balances converted to investor commercial real estate due to the projects being substantially complete. In the aggregate, construction and investor commercial real estate balances grew $84,000,000 At the quarter end, total unfunded commitments in our construction line of businesses were $515,000,000 As those projects progress, draws on these loans in the upcoming months combined with the optionality to deploy excess liquidity to hold a portion of our SBA originations on our balance sheet will play a meaningful role in the continued shift of our loan portfolio towards higher yielding, favorable rate loans. On the consumer side, balances were up modestly as new originations in our specialty consumer channels were offset by declines the residential mortgage and home equity balances. We focus on the super prime borrower and our consumer lending and rates on new production remained in the mid-eight percent range consistent with the 2nd quarter. Furthermore, delinquencies in these portfolios remain extremely low at under one basis points of total loans.

Speaker 2

To wrap up my comments, we continue to build off the last 9 months of improving performance and delivered another solid quarter. We remain confident in the earnings momentum we have built and are excited to end of the year on a high note. Liquidity, asset quality and capital levels remain sound with the continued evolution of our loan portfolio and greater revenue diversification combined with expected declines in deposit costs following the 1st wave of Fed rate cuts, we believe we are well positioned to continue to achieve higher earnings and improved profitability in the Q4 and into 2025. Now I'd like to turn the call over to Ken for more details on our financial results for the quarter.

Speaker 4

Thanks, David. As David covered the loan portfolio, let's turn to Slides 56 where I will cover deposits in more detail. The average balance of deposits increased over $211,000,000 or 5% during the Q3 and period end deposits were up almost $524,000,000 or 12% from the prior quarter driven by growth in CD production and FinTech partnership deposits. Non maturity deposits were up almost $123,000,000 or 6%, which reflects the increase in FinTech partnership deposits. Additionally, total deposits from our FinTech partners, including those classified as broker deposits, were up 35% from the 2nd quarter and totaled $507,000,000 at quarter end.

Speaker 4

Additionally, these partners generated almost $11,400,000,000 in payments volume, which was up 34% from the volume we produced in the 2nd quarter. Total FinTech Partnership revenue was $771,000 in the 3rd quarter, which was up over 30% from the Q2 as contributions from one of our key partnerships began to scale up during the quarter. Related to CD activity during the quarter, total balances were up $281,000,000 or 15% from the linked quarter, driven by continued strong demand in the consumer channel. We originated $697,000,000 in new production and renewals during the Q3 at an average cost of 4.77 percent and a weighted average term of 21 months. These were partially offset by maturities of $391,000,000 with an average cost of 5.05%.

Speaker 4

Looking forward, we have $238,000,000 of CDs maturing in the Q4 of 2024 with an average cost of 5.01 percent and $407,000,000 maturing in Q1 of 2025 with an average cost of 5.08 percent. CD pricing broke through its inflection point during the Q3 as the weighted average cost of new CDs was 28 basis points lower than the cost of maturing CDs. As interest rates across the yield curve began falling ahead of the expected cut in the Fed funds rate, we reduced CD rates significantly throughout the quarter. Accordingly, the weighted average cost of CD production during the month of December was 4 point 4 5% or over 30 basis points lower than the average cost of new CDs for the quarter. This is also 56 basis points lower than the rates on CDs maturing in the Q4 of 2024.

Speaker 4

With the combination of CDs repricing at lower rates and the cost of high beta deposits coming down 50 basis points, we feel confident that deposit pricing has hit its peak and will trend downward in the 4th quarter. Moving to Slide 6. At quarter end with the heightened level of deposit growth, total liquidity remained very strong reflecting cash and unused borrowing capacity of $2,100,000,000 We deployed some of the liquidity to pay down FHLB borrowings as well as to fund loan growth and securities purchases during the quarter. With total deposit balances increasing 12% and loan growth of $75,000,000 or about 2%, the loans to deposits ratio declined to 84% from 93% at the end of the 2nd quarter. At quarter end, our cash and unused borrowing capacity represented 179% of total uninsured deposits and 2 30% of adjusted uninsured deposits.

Speaker 4

Turning to Slide 7 and 8. Net interest income for the quarter was $21,800,000 $22,900,000 on a fully taxable equivalent basis, up 2.1% and 1.8%, respectively, from the 2nd quarter. The yield on average interest earning assets increased to 5.58% from 5.54% in the linked quarter, due primarily to a 7 basis point increase in the yield earned on loans, but partially offset by a decline in the yield earned on other earning assets. The higher yield on the loan portfolio combined with higher average loans, securities and cash balances produced solid top line growth in interest income increasing 5.7% compared to the linked quarter. Factoring in the strong growth in average interest bearing deposit balances, net interest income was up over 2% during the quarter, building on last quarter's increase and further distancing us from the low point in the Q3 of 2023 as shown in the bar chart on Slide 7.

Speaker 4

Net interest margin for the Q3 was 1.62 percent and 1.70 percent on a fully taxable equivalent basis, decreases of 5 6 basis points respectively from the 2nd quarter. The net interest margin roll forward on Slide 8 highlights the drivers of change in fully taxable equivalent net interest margin during the quarter. Similar to last quarter, I'd like to clarify one item on this chart. The impact on deposits the impact of deposits on net interest margin is more a factor of dollar volume than rate. That is, as I mentioned earlier, average interest bearing deposits were up over $211,000,000 during the quarter, whereas average loan balances were up only $93,000,000 As David referenced in his comments, net interest margin for the quarter was impacted by carrying higher cash balances.

Speaker 4

We estimate that the excess liquidity negatively impacted net interest margin by 6 basis points. However, the elevated on balance sheet liquidity also provides a great deal of flexibility going forward. As I mentioned moments ago, we have over $600,000,000 of higher cost CDs over $600,000,000 of higher cost CDs maturing over the next two quarters as well as nearly $250,000,000 of higher cost broker deposits maturing over that same time period. Furthermore, we estimate that loan activity primarily early payoffs of higher yielding loans and loans with premiums had an additional negative impact on net interest margin of 6 basis points. However, loans pipelines remain solid, especially in the small business lending and construction lines of business and our focus improving the composition of our loan portfolio gives us further confidence that net interest income will continue to increase in future quarters.

Speaker 4

Related to deposits, looking at the graph on slide 8 that tracks our monthly rate on interest bearing deposits against the Fed funds rate, you can see the stability in deposit costs over the last several months. As I mentioned a few minutes ago, with the recent cut in the Fed funds rate and other short term rates following suit as well as lower CD pricing across the maturity curve, we anticipate that interest bearing deposit costs will begin trending downward in the Q4. This should also drive further net interest income growth and provide a strong catalyst for net interest margin expansion. Turning to non interest income on Slide 9. Non interest income for the quarter was $12,000,000 up $1,000,000 or 9% from the 2nd quarter.

Speaker 4

Gain on sale of loans totaled $9,900,000 for the quarter, up 20% over the second quarter, setting another quarterly record for our SBA team. We originated over $163,000,000 of SBA loans during the quarter, an increase of 42% over the linked quarter. Furthermore, loan sale volume was $126,500,000 up 22%, while net gain on sale premium saw a decline of 65 basis points. Other non interest income declined from the prior quarter to $1,100,000 due primarily to lower distributions received from fund investments. These decreases were partially offset by a modest increase in net loan servicing revenue.

Speaker 4

Moving to Slide 10. Non interest expense for the quarter was $22,800,000 up $450,000 from the 2nd quarter. When you exclude non recurring costs of almost $600,000 from the 2nd quarter's results, operating expenses were up $1,000,000 or 4.7 percent. The increase was due almost entirely to an increase in salaries and employee benefits, driven by higher small business lending commissions in line with the higher volume of originations. Additionally, we added staff to our small business lending and risk management teams as we continue to build bench strength to support further growth.

Speaker 4

Turning to asset quality on Slide 11. David covered the major components of asset quality for the quarter in his comments, so I will just add some commentary around the allowance for credit losses and provision for credit losses. The allowance for credit losses as a percentage of total loans was 1.13% at the end of the 3rd quarter, up 3 basis points from the 2nd quarter. The increase in the allowance for credit losses reflects growth in the loan portfolio and continued shift in the composition of the loan portfolio towards certain loan types with higher coverage ratios. The increase also reflected additional reserves related to small business and franchise loans.

Speaker 4

Provision for credit losses in the 3rd quarter was $3,400,000 compared to $4,000,000 in the 2nd quarter. The provision for the 3rd quarter was driven by loan growth and changes in the loan portfolio composition, net charge offs and the additional reserves related to small business and franchise lending. If you exclude the balances and reserves on our public finance and residential mortgage portfolios, which have lower coverage ratios given their lower inherent risk, the allowance for credit losses represented 1.35 percent of loan balances. Furthermore, as a reminder, with minimal office exposure, we do not have the excess reserves for that asset class that many other banks require. Moving to capital on Slide 12.

Speaker 4

Our overall capital levels at both the company and the bank remained solid. The tangible common equity ratio was 6.54 percent, which experienced a decline due primarily to the strong deposit growth during the quarter and the increase in cash balances. If you exclude accumulated other comprehensive loss and adjust for normalized cash balances of $300,000,000 the adjusted tangible common equity ratio would be 7.49%. From a regulatory capital perspective, the common equity Tier 1 capital ratio remains solid at 9.37%. Before I wrap up, I'd like to provide some updates on our outlook for the Q4 of 2024.

Speaker 4

With regard to net interest income, as I mentioned earlier, with a solid loan pipeline, we expect loan balances to be up another 1.5% to 2 percent in the Q4, while the all in yield on the portfolio should be up a few basis points as origination volume is expected to outweigh the impact of recent rate cuts. Additionally, we expect the rate cuts to have a positive impact on the cost of funds related to deposits, although dollars of interest expense may be up a little bit due to the increase in average balances. However, top line interest income growth should far outweigh the dollar growth in deposit costs with net interest income increasing in the range of 10% to 15% on a quarterly basis. We also expect net interest margin to rebound and resume an upward trajectory. While the elevated cash balances will still weigh on margin expansion in the near term, we expect fully taxable equivalent net interest margin to be in the range of 1.8% to 1.85% for the 4th quarter.

Speaker 4

And related to non interest income and non interest expense, our view remains consistent with our comments on last quarter's call. With the combination of our SBA team continuing to deliver consistently higher origination activity, our outlook remains extremely optimistic and we expect gain on sale revenue to be in the range of this quarter's elevated results. On the expense side, we expect continued growth in the salaries and employee benefits line item as we build further bench strength in risk management and small business lending, especially as we plan for SBA origination growth in the range of 15% to 20% for 2025. Furthermore, we have technology investments slated for the Q4, many of which pertain to further enhancing the digital experience and adding product features for our consumers and small business. With that, I will turn it back to the operator so we can take your questions.

Operator

Thank you, sir. And your first question will be from Brett Rabatin at Hovde Group. Please go ahead.

Speaker 5

Hey guys, good afternoon.

Speaker 2

Hi Brett. Hey Brett.

Speaker 5

Hey, I wanted to start with just the comments or the franchise finance and the small business loans that were either past due or moved to non accrual. Can you give us some additional color on what components of franchise finance that was? What small businesses is doing? And then just maybe any comments on the RV portfolio and I know like Walgreens and CVS have also had some recent mentions of store closures, etcetera.

Speaker 4

With regards to like in the franchise and small business, Brett. So on the franchise side, we've just had a handful of delinquencies there, mostly having to do with certain brands and closures of units, trying to work with the borrowers to get them to the table to restructure loan, pay off the loan that we just we've had to take some action on and move to non accrual since they went 90 days past due. Probably not a common theme other than what you're hearing across the industry as far as restaurants and other retail entities struggling a bit. But we just had to take action on a pool of those loans that hit 90 days. On small business, there's really no consistent theme amongst them.

Speaker 4

In small business, it's like every credit is a story. But kind of similar along the lines of franchise just had either businesses closing or struggling, again, where we've had to kind of take action and maybe where we've offered a deferral or 2 and the borrower is struggling. So we just have to move it to non accrual and work with the SBA to repurchase the loan and work with the borrower to finalize an exit strategy.

Speaker 2

Yes, the apple pie stuff is really our internal policy. When it hits 90 days, as Ken said, we move it to non accrual, we take a specific reserve against it. I don't know that the portfolio as he said the loans are that bad. It's a more an internal policy. We've had a tough time working with they service the loans or have a third party servicer work on the loans.

Speaker 2

They're not really incented to do anything until the loans hit that 90 day bucket and they get $0.35 on the dollar of everything they recover. So we're coming at this from different viewpoints. They wanted to get delinquent so they can pick up a little income. We want to be at the front of the pooching when things go south. So we're renegotiating currently a servicing agreement with them.

Speaker 2

So we're in the deal and have an opportunity to get involved much earlier in the process, not waiting until it gets to 90 days. The SBA side of things kind of peaked in July. The outstanding problem loans dropped in August September, not tremendously, but they're not continuing to climb period over period. So SBA is, as Ken said, there is no specific industry or type of loan or location anything. It's a very diversified nationwide, no real common themes within.

Speaker 2

On the consumer side of things, we have less than 1% delinquency. Horse trailers, RVs are not a problem. The resale value, they were selling at a premium during COVID when nobody could get a new one. Resale has come down if we happen to have one come back to us. But outside of that, we're not seeing any cracks whatsoever there.

Speaker 2

The CVS and the Walgreens is kind of the same story that we had with the Red Lobster when everybody's worried about them 90, 120 days ago. We have about 35 CVS stores. Nothing is delinquent at the current time. Nothing is closed. Most of those are still in the middle of 5 year plus lease agreements.

Speaker 2

We're not hearing from anybody. We have a service at Chex like we just recently put on 4 CVS stores taking us up to I think 31 or 32 outstanding. And in their region, they were all 4 in the top performers and they were in the upper 4% of performance within CBS. So again, because we have the national footprint and the play, we're buying grade A quality locations, loan to value still in that 47%, 50% range and good solid sponsors behind them. Walgreens, the same boat.

Speaker 2

We've not had anything go dark on us. We haven't got any notices of closure. We did have a Rite Aid where they had 2 in a town and they opted to close the new one on the outskirts versus the older one that was kind of in the heart of town. But again, the sponsor on that is continuing payments and is repurposing the store. So the STL product right now, we don't have a delinquent account.

Speaker 2

And if you remember over the years, we've gone through all kinds of crisis over the last 12 years. We've only had 2 loans go bad and on $2,000,000,000 in originations, our total losses have been a little over $1,000,000 So we're not worried about the STL products nor the consumer side. Time will tell. Obviously, rates going down, particularly on the SBA will help. That does they're adjustable on a quarterly basis.

Speaker 2

So that will help lower payments and help the cash flow. And I think just give the SBA and the small business owner just a kind of a light at the end of the tunnel that things are getting better and rates are coming their way. Inflation continues to slow. Obviously, there's certain spots that are still high, but as a whole, it's coming down. So I think everything is going in the right direction for them as well.

Speaker 5

That's a lot of great color. And just to clarify, if I heard you correctly, kind of the peak of SBA delinquencies in your portfolio was in July. There is another competitor that is out today with some adverse migration in their non guaranteed SBA book and so they made a big provision. I know you can't comment on someone else's portfolio, but I think that might be weighing somewhat on your stock as well as theirs.

Speaker 2

We had that same thought this morning when we saw the same thing you did. Yes, from our standpoint, we're as Ken said, we've taken specific provisions that we think if it's over 90 days past due and we think we're going to have some kind of impairment on that non guaranteed part. We've already taken a provision against it. So we evaluate them as they kind of break that barrier. But yes, we hit the top and it's come down a little bit.

Speaker 2

Who knows what we're still early in October here to 15th is kind of a universal payment date, so we'll have a better handle in another week to 10 days. But yes, we seem to be headed in the right direction, at least stabilizing, I guess, if nothing else. So yes, we read the same thing you read this morning and that was kind of a shock to us. We're not experienced anything like they're experiencing.

Speaker 5

Okay. So we're talking about the same institution. Okay. And then the other question I had was just, I kind of figured you guys might wait a quarter or 2 for rates to come down, possibly a little more before you went and maybe built some liquidity and put on more CDs, but you seem to do that a little earlier. And if I heard right, the production on CDs in the last month of the quarter was $445,000,000 Was that correct?

Speaker 5

I'm just curious why you guys are maybe building a little That's correct.

Speaker 2

Okay. It was not intentional. We had been lowering rates. We actually started lowering rates probably about a month before the Fed made a cut anticipating we were thinking it'd be 25 and we had lowered rates about 40 basis points on the 45 day period prior to the cut. But when it hit 50 basis points, The good and bad part about being an Internet institution as experienced by Silicon Valley and First Republic when they started to hit the wall, all the deposits called in 24 hours, 36 hours.

Speaker 2

On our side, when the consumers and the business folks thought, oh my God, the bottom is falling out on the savings rates, they slammed in and bought CDs faster than we could lower the rates. We took them down another 40 basis points on the consumer side and 50 basis points on the commercial. We've cut off the inflow, but in that 24, 36, 48 hour period, post the Fed announcement, they were flying through the door faster than we could lower the rate. So lesson learned that that cord cuts both ways on withdrawals as well as deposits.

Speaker 5

Yes. Okay. That makes sense. Great color guys. Thanks.

Speaker 2

Appreciate it. Thanks, Brett.

Operator

Thank you. Next question will be from Tom Spitzer at KBW. Please go ahead.

Speaker 6

Hey, good afternoon. Thanks for taking my questions.

Speaker 5

Hey, Tim.

Speaker 6

I wanted to ask about the SBA origination outlook. I think you have a pretty wide range of 15% to 25% in 2025. What are some of the factors that could drive it to the low or high end of that range? Is it mostly rate driven? And then what are your expectations for pricing as we get into next year?

Speaker 4

Well, our expectation right now is that we'll somewhere be in the range of say $525,000,000 to $530,000,000 of originations for this year. And we're targeting $600,000,000 for next year. So you do the math on that and you're probably in the range of $15,000,000 I think for us, I think we've just we've put together just a really good team. We have a great team of BDO's out there and we have a great support team behind them on credit, servicing, closing. And it is reflected, we've made this comment in the past couple of quarters.

Speaker 4

We continue to build the bench strength to support that growth. And that will be key to achieving it. But I think we feel again, we feel really good about the folks we have out there sourcing deals for us And expect, I guess, if you look at kind of we have grown each quarter this year. So when you look at what we've done in the Q4 or excuse me, the Q3 and what we're looking at for the Q4, it's not I don't think it's an unreasonable jump to get to that $600,000,000 target for next year.

Speaker 2

Tim, one of the uncertainties is the sales price in the secondary market, that I think Ken made a comment that it had dropped 65 basis points 3rd quarter over Q2 as people try to get comfortable with what the Fed is going to do. Do we do 2 more quarter point drops in this quarter? The excess liquidity that we have on the balance sheet as I stated in my comments gives us a position if the bottom falls out in the secondary market. We have cash and liquidity rather than sell a 10.5%, 11% yearly loan in the secondary market for 5.5%, 6% carried on the books and we'll make up that difference in a 5, 6 month window of time. So we've got a lot of optionality and a lot of flexibility going into 2025 and we can handle kind of whatever the market gives us on the SBA side.

Speaker 2

As Ken said, we've got a team and an organization out here now that is just a pretty well oiled machine that can produce the product and the volume we're looking for. I think I made a comment in the last call probably somewhere in that $600,000,000 range might be kind of our cap looking at annual sales growth. But if we get it, we can hold it on the books, we can sell it in the secondary market, we'll do whatever is in the best interest of the institution. The good part about the excess cash is it gives us an awful lot of flexibility.

Speaker 3

Okay, great. Yes, that was really helpful.

Speaker 6

And then I wanted to ask about, the NIM trajectory, obviously pretty good expansion expected in Q4. How should we think about 2025, particularly the Fed cutting rate? I think last quarter you guys said each 25 basis points is about a $2,800,000 annual benefit. Is that still the right range? And with the loan growth you're expecting to put on, how should we expect them to move next year?

Speaker 4

Well, I think the last quarter that math was based on a static balance sheet. I think the wild card for this is just the cash balance that we have and how that's deployed. I mean, I think about if you just I'm going to give you some numbers here to think about that you can run some math on. But we got about $1,300,000,000 to $1,400,000,000 of what I'd call high beta or 100 percent beta deposits that are a combination of some brokered and some of our own deposits that are higher balance. But those reset immediately.

Speaker 4

So for every you can do the math on every 50, 100, 25, 50, 75 basis points of cuts. Really offsetting that, we probably got about 760,000,000 dollars of loans that would reprice either immediately or within 3 months in the case of SBA loans. We do have more variable rate loans on our balance sheet, but some are at price ceilings already. So you have that going one direction. But then we also have $1,400,000,000 of CDs with an average cost of close to 5% that mature over the next 12 months.

Speaker 4

And new production right now coming in the door in the month of October is 4.19%, 4.2%. So there's a lot of dollars of NII that we expect that we will pick up over the course of next year. How that translates exactly into margin is a little bit hard to project in terms because of the excess liquidity and what you're going to run it off at. But I just sitting here thinking about it, I mean, I would think that we would be able to at least expect perhaps 10 basis points of margin expansion a quarter just depending on how we get the liquidity out the door. And as David said too, if there's optionality for holding SBA loans, for example, that would be incredibly accretive to net interest margin and net interest income.

Speaker 4

So we're still working on our forecast for next year. It's hard to you got the long rates that are doing something different than the short rates right now and we got an election to get through. So I guess we'll see what rate happens to long rates after that. But I think all in all, doing math and what we have today for just dollars of net interest income, I think we see a significant pickup next year.

Speaker 2

We still think we're going to hit the $3 mark that we had forecasted for this year. Closing out here in the Q4 will be pretty close to almost $1 in income. We had forecasted $4 for next year. Obviously with the Fed starting to move, that's a lock on our side and it could depending on as Ken just outlined for you how the Fed rates move over the course of the year that could move from 4 up to 5 pretty quickly. So we think we're going to finish strong here for this year and 2025 looks real, real good.

Speaker 2

Political and 3rd world or overseas wars off the table. If everything stays fairly stable in the political arena and the world arena, we should have one bang up year in 2025.

Speaker 3

Yes. We'll all pray for that.

Speaker 6

But thank you guys for the commentary.

Speaker 2

I appreciate it. Thank you. Thanks, Tim.

Operator

Next question will be from Nathan Race at Piper Sandler. Please go ahead.

Speaker 3

Hey, guys. Good afternoon. Thanks for taking the questions.

Speaker 1

Hi, Nathan.

Speaker 3

Ken, I just want to clarify on the loan growth expectations for 4Q. Did you mention 1% to 2%? And then also be curious to get your preliminary thoughts on overall balance sheet growth expectations next year as well?

Speaker 4

Yes. I think I said 1.5% to 2%, which probably is kind of in the range of where we were in the second or excuse me, the Q3 for loan growth.

Speaker 3

Okay. So that's not a I think

Speaker 4

as you said, maybe the wild card for that could be if we don't like what we see in the secondary market for SBA retaining some SBA loans, that could boost that a bit. But yes, probably in the range of growth that we saw this quarter.

Speaker 3

Okay. So that's 1% to 2% not annualized?

Speaker 4

No, no, no, no. Yes, that's not annualized. That's just gross for the quarter.

Speaker 3

Got you. Okay. And then just any thoughts on how you see organic balance sheet growth in terms of both loans and deposits playing out next year as well, just given the fluid curve as well?

Speaker 4

I think, yes, again, it kind of come back to with the liquidity we have on the balance sheet. And if I'll go I guess I'll go back to my comments earlier about over $600,000,000 of well, you got $600,000,000 of CDs maturing next 6 months, dollars 1,400,000,000 maturing next year, dollars 250,000,000 of higher cost brokered deposits maturing over the next 6 months. I mean, I expect that our balance sheet will be down in the Q4 at the end of the year relative to where we were at the end of the Q3 as we deploy some of that cash to just again pay down higher cost deposits. I think year over year we're our total loan growth for this year 2024 will probably be somewhere in the range of 7% to 9%. I think if we're doing what we're doing today that number might be still the same.

Speaker 4

But again, I'll come back to what David said with the optionality we have on SBA loans and some other initiatives that we're working on that can drive further growth beyond that.

Speaker 2

We've been working with some of our Fintechs. We have Jairus in particular that we kept thinking we would get the loan program up and running during the Q3. We just made a small purchase here in October, just to kind of validate and test everything to make sure all the mechanics and stuff are in play. They've got a couple of new clients coming their way. That one could jump up pretty quickly.

Speaker 2

We brought on 2 new programs here in the last 30 to 45 days in the FinTech space that could have some opportunities for us. So as Ken said, there's a lot of options and a lot of play and we're just kind of taking stuff day by day, but it's everything really does look good for us going forward.

Speaker 3

Got it. That's helpful. And then just within that context, a high level strategic question, just with the momentum you're seeing on the SBA side of things and with some of the partnerships, just curious if it makes sense maybe slow balance sheet growth, particularly just given coming out of 3Q, it seems like the loan and deposit growth is margin dilutive and that may change and should change with bed cuts and depending on the forward curve or depending on how the yield curve plays out. But just curious on your thoughts around slowing balance sheet growth and just leaning on some of those more profitable lines of business? And then just build capital and perhaps resume buying back the stock just given where it's trading relative to tangible book?

Speaker 2

Well, hopefully, you're spot on. We have a lot of flexibility without growing the balance sheet to kind of remix things and get higher earnings and higher yield. We can get that 10% growth technically right now with the cash we have on the balance sheet. So there's no need to bring in deposits for the sake of deposits or grow the balance sheet. So we agree with you 100%.

Speaker 2

It's kind of remix things a little bit, maximize earnings and not necessarily pump up the balance sheet and we're spot on. I would hope that the stock appreciates quickly as we add better earnings to the bottom line and gets back towards that book value plus. But I don't think being real honest in 2025 that I don't want to set the stage that we're going to go back and do a big stock repurchase because if we get into that 40 range, it doesn't make a lot of sense. I'd rather build capital and save that for a rainy day or save it for a position we got a couple sub debt items coming up. We could take the extra capital and pay down some sub debt and get the stability in the capital network.

Speaker 2

So we might have other options for it versus buying back stock.

Speaker 3

Understood. Very helpful. And Ken, I think you mentioned expenses should be up a little bit just based on some commission costs tied to the similar SBA revenue expectations and some other investments. But just curious how you're preliminary thinking about expense growth in 2025? I know it's going to be contingent on the SBA revenue side of things, but assuming SBA revenue continues to ramp up by maybe at least 5%, just curious how you're thinking about the overall expense trajectory within that context?

Speaker 4

Yes. Well, I think we're we've done quite a bit of hiring this year to build out the SBA platform and enhance risk management and kind of add some positions around the country that is, I'd like to say, add bench strength. So we'll have kind of a full year's run rate of folks there. But if I'm thinking about next year, you're probably 7% to 8% expense growth for next year for the year?

Speaker 2

I was going to guess 9% to 10%. So blend this together and you're coming in

Speaker 4

for the year.

Speaker 2

I mean, if you

Speaker 4

get the ball out of the park on SBA, then we'll be closer to that 9% to 10%.

Speaker 3

And it's in the ballpark out on SBA, is that growing SBA revenue 5%, 10% next year? How do you quantify that, I guess?

Speaker 2

Well, I guess on the sales volume side of things, as Ken said, we're going to end up a little over 500,000,000 dollars probably this year and we're looking at $600,000,000 next year. So we got a nice bump up, which also if you take a look where we're at this quarter, it's only going to get bigger through the course of the year as long as premiums don't fall apart on us. And as they start to or we take that excess growth into next year and put it on the balance sheet, we got a real chance of picking up a nice uptick in earnings out of SBA either way it goes in the secondary market or on the balance sheet. So it will compensate for the growth in the expense side.

Speaker 3

Got it. And then just one last one, just for a housekeeping perspective, any thoughts on the tax rate going forward?

Speaker 2

Depends on who wins the election.

Speaker 4

You know what, I think right now we're probably thinking that probably like Q4 will be kind of in the same tax rate area as it was in the Q3. With higher earnings, we do get a very strong benefit from our public finance portfolio. But as our just our pretax earnings continue to grow that benefit on a percentage basis is less. So I would think our tax rate for next year with higher earnings is probably going to migrate over the course of the year from maybe ranging from anywhere from call it a high 8% to somewhere perhaps as high as 11% to 12% by the end of the year. It's kind of the way I would look at it.

Speaker 3

Got it. Very helpful. I appreciate all the color. Thanks, guys.

Speaker 2

Thank you. All right. Thanks, Nate.

Operator

Next question will be from George Sutton at Craig Hallum. Please go ahead.

Speaker 2

Thank you. David, I wanted to test one statement you made in your prepared comments. You mentioned we in Q3 were firing on all cylinders. I think if you really thought about it that might you might say firing on many cylinders. I'm just curious what you think firing on all cylinders should look like?

Speaker 2

I think it's the bump up, George, that we have coming here for the Q4. And then if the Fed continues to drop rates significantly through the course of 2025, we're going to just kind of blow the roof off in earnings and structure here in the institution. We'll taking it back to the racing analogy, we'll set a track record by the end of the year. So we just got a lot of good things going every place and we got it for us and our balance sheet historically has been unbelievably pristine and we've got a bump or 2 on the little bit on the SBA side and a little bit on the franchise end, but that's all manageable. We'll get a handle on it.

Speaker 2

So I think the future is really, really looking good for us. The gentlemen you headed my way, we've had a good conversation. I think there might be some opportunities there. We're getting a lot of good inquiries from people kind of the dust is just settling. The fintech space, we wound down a client here over the last quarter who just cannot raise any additional capital.

Speaker 2

They had a great program, they had a great product, but they just couldn't get the capital to get there. And as the institutions kind of pull back on some of the BC stuff, there might be opportunities to actually pick up a FinTech or 2 and put that product into our mix. There are other very solid programs that are looking for solid players that understand and can provide the services they're looking for. So I just think we have an awful lot of good things going on within our product mix and good things coming to us from the outside world. So 25 looks really strong.

Speaker 2

Fabulous. I did want to say congratulations to Ken and Nicole and Anne and Tim and Nick and Dustin and Maris, fellow Indiana graduates on the 7 and 0 start to the year. Yes. Believe me, they had their 1st sell out football game last year in like 50 years. So it's a very a lot of cheering for basketball over the years, but it's been very rare.

Speaker 2

A lot of good tailgating, but most people just tailgate and pass on the gains. They got a full house now. So that's great. Thank you.

Speaker 3

Thanks, guys.

Speaker 4

All right. Thanks, George.

Operator

At this time, I would like to turn the call back over to David Becker for closing remarks.

Speaker 2

Thank you, Sylvie. Thanks everybody for joining us today. As I said, we've kind of produced some really consistent improving results throughout 2024. We're extremely confident in our ability to deliver a strong finish to the year. And as we look to 2025 and beyond, we're extremely excited about what the future holds.

Speaker 2

Strong performance of the lending teams including continued execution in the SBA and construction area, emerging growth opportunities with key fintech partnerships are expected to drive greater and more diversified revenue growth. We combine that with the prospects for a more favorable interest rate environment and the positive impact that will have on deposit costs. We believe we are very well positioned to achieve stronger earnings over the several quarters. As fellow shareholders, we remain committed to driving improved profitability and enhanced shareholder value. We thank you for your support and wish you a good afternoon.

Operator

Thank you, sir. Ladies and gentlemen, this does indeed conclude your conference call for today. Once again, thank you for attending. And at this time, we do ask that you please disconnect your lines.

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Earnings Conference Call
First Internet Bancorp Q3 2024
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