Prepared remarks
Greetings, and welcome to the FinWise Bancorp Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance, please press 0 on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to turn the call over to the speakers. Please go ahead.
Good afternoon, and thank you for joining us today for FinWise Bancorp's Second Quarter 2020 Earnings Conference Call. Earlier today, we filed our earnings release and investor deck and posted them to our investor website at investors.finwisebancorp.com. Today's conference call is being recorded and webcast on the company's investor website. As previously mentioned, on today's call, management's prepared remarks and answers to your questions may contain forward-looking statements that are subject to risks and uncertainties that could cause actual results to differ from those discussed today. Forward-looking statements represent management's current estimates, expectations and beliefs and FinWise Bancorp assumes no obligation to update any forward-looking statements in the future. We encourage listeners to review the more detailed discussions related to these forward-looking statements, including factors that may negatively impact them, contained in the company's earnings press release and filings with the Securities and Exchange Commission. Hosting the call today are CEO James F. Noone, CFO Robert E. Wahlman, and Executive Chairman Kent R. Landvatter. Jim, please go ahead. Good afternoon, everyone. Our second quarter earnings of $0.15 per share were short of our expectations, driven by higher provision expense on the loans where we retain credit risk. We are proactively managing these credit trends, and will continue to empower our credit and compliance teams to identify and reduce risk across the portfolio, as they did during the second quarter resulting in meaningful reductions in our NPA balances. I would like to start by giving you more detail on credit quality. Total provision for credit losses was $22.7 million for the second quarter, compared to $10.6 million in the prior quarter. Of the $39.4 million related to credit enhancement loans, which is offset by corresponding credit enhancement income and does not affect net results, the remaining $6 million in provision reflected increased provisioning in the core loan portfolio, driven by losses recognized on the liquidation of nonperforming loans, higher reserves on nonperforming and classified loans, and the more conservative servicing standards we have implemented. As noted earlier, nonperforming loan balances declined in the second quarter, from nearly $50 million last quarter to approximately $38 million this quarter. A meaningful improvement driven primarily by a reduction in SBA 7(a) loans classified as non-accrual. This was the result of loan collateral resolutions and paydowns. Of this $38 million approximately $19 million is guaranteed by the federal government and the remaining $19 million is unguaranteed. Total net charge-offs, excluding those from loans with credit enhancement, were $5.2 million, slightly above our guided range of $4 million to $5 million. Net charge-offs within the core portfolio remain concentrated in the loans with the identified attributes we discussed last quarter. Approximately 80% of this quarter's charge-offs within the core portfolio came from this legacy pool. This is a finite well-defined pool with approximately $50 million in performing balances outstanding at the end of the quarter. We are proactively managing this portfolio and will provide additional updates in future quarters as we continue to make progress. Let me walk through net charge-offs in each of our three key portfolios in more detail. First, SBA net charge-offs were $2.9 million versus $2.2 million in the prior quarter, with the vast majority tied to the legacy credits referenced earlier. This largely reflects specific industry and loan attributes which we have materially tightened by policy changes. These charge-offs are likely to remain elevated over the next few quarters. Second, net charge-offs on strategic programs with credit enhancement were $7.9 million versus $4.8 million in Q1. The sequential increase continues to reflect normal seasoning of a larger credit-enhanced portfolio, and FinWise is fully reimbursed for any losses. Finally, net charge-offs on strategic program loans without credit enhancement were $2.3 million in Q2, versus $2.3 million in Q1, reflecting normal repayment behavior across the balances we manage here. To summarize, we remain very comfortable with the overall quality of our portfolio. The issues we have described are ring-fenced, understood, finite, and being actively managed. Outside of this pool, credit performance across the book remains healthy and as generally expected. In terms of originations, we delivered $1.6 billion this quarter, ahead of our expectations for $1.4 billion and down modestly from an elevated $1.7 billion in the prior quarter. The sequential change reflects seasonally lower volume in the student loan program, partially offset by growth across several of our established programs. This resilience in origination reflects the benefit of a more diversified partner base, which is a deliberate part of our strategy and increasingly lets us absorb variability in any single program. We are also pleased to announce on this call the contract signing of a new strategic partnership subsequent to the end of the second quarter, and we expect to share the partner's name in the coming quarters as we get closer to launching the products with them. This is a well-established prepaid card provider that will use a combination of our BIN sponsorship and money rail services. The cards issued under this program will be offered on the Mastercard network, and based on the current pace of implementation, we expect the program to go live during the fourth quarter. This partner chose FinWise for our expertise in BIN sponsorship and our disciplined approach to program execution — the same qualities that continue to differentiate us in the market. Our sales pipeline remains very strong, and we anticipate signing additional and more meaningful deals before year-end. It is worth putting this in context: the pipeline we are seeing today, built by our expanded sales team and led by our Chief FinTech Officer, Sarah Greta, is materially stronger and potentially more meaningful to our bottom line than the pipeline we had just a few years ago. This quarter, we also welcomed a new salesperson with years of industry experience across both lending and cards, bringing our business development team to five, including our Chief FinTech Officer. Turning to our credit-enhanced product, balances were $121 million at the end of the second quarter. As we noted in the Tallied press release last week, our prior guidance of approximately $217 million in credit-enhanced balances by year-end 2026 no longer applies, reflecting the change in how those balances are now structured. We are pleased with the trade off, since we retain the full and higher economics described earlier. Importantly, we still expect some further growth in credit-enhanced balances in 2026. The largest partner we mentioned last quarter, whose pace had slowed, is picking back up. We also remain in active discussions with several prospects. We will continue to provide quarterly updates going forward. Looking ahead, meaningful credit-enhanced balance growth, beyond 2026, will come from new partner additions. The product continues to be a meaningful growth driver for our long-term plans, and building that pipeline is where our focus needs to be. In closing, taken together, this quarter reinforces our conviction in the company's strong long-term trajectory and in our three key priorities. First, we will continue to empower our credit and compliance teams to prune risk proactively, as you are seeing us do within the legacy pool within our core portfolio. Second, we will continue to support the momentum in our sales pipeline that is already coming through from our business development team and which we highlight in the investor deck this quarter. Finally, we will continue to support the multiproduct platform we have built at FinWise because we believe this carries enormous value for both potential partners and our shareholders. That same model that took us from $100 million in credit-enhanced balances in six months — build the infrastructure, pilot it, market it, then launch the right partners — is now turning the corner in cards, payments, and deposit sponsorship. So in the same way that our compliance investments positioned us during a previous cycle, these product investments are positioning us for exactly the cycle we are now entering. I believe we will have a very strong period for new partnerships over the next 12 to 24 months. The strategic plan we set out on three years ago has not changed; what is changing is the pace of opportunity in front of us. My job is to make sure we capitalize on it for the long-term benefit of our shareholders. I will now turn the call over to our CFO, Robert E. Wahlman, to provide more detail on our financial results.
Thanks, Jim, and good afternoon, everyone. FinWise reported second quarter net income of $2.1 million and diluted earnings per share of $0.15. Results were driven by strong loan originations, growth in net interest income and disciplined expense management, partially offset by a large provision for credit losses in our traditional banking portfolio. Net interest income was $28.7 million for the second quarter of 2020 compared to $28.1 million for the prior quarter. The increase from the prior quarter was primarily due to growth in the credit-enhanced loan portfolio and a decrease in nonperforming loans, which resulted in a lower reversal of interest on non-accrual loans and contributed to an increase in the average yield on loans held for investment. Net interest income also improved as a result of a decrease in average interest-bearing liabilities and the related cost of funds. These increases were partially offset by a decline in average balances within the traditional loan portfolio. Net interest margin for the second quarter of 2020 was 13.69% compared to 12.90% for the prior quarter. This sequential quarter increase is in line with growth in the credit-enhanced loan portfolio, a decrease in non-accrual loans, and a decrease in the yield on interest-bearing liabilities. As we have said before, we suggest thinking about net interest income and net interest margin in two ways: including and excluding excess credit-enhanced income. Noninterest income was $25.6 million versus $14.6 million in the prior quarter, primarily due to an increase in credit enhancement income, which corresponds to the provision for credit losses on credit-enhanced loans and resulted from the credit enhancement portfolio growth. In addition, the company prevailed in litigation with an off-boarded strategic partner, which resulted in an increase in miscellaneous income of $450 thousand and a decrease in other expenses of $300 thousand. Noninterest expense was $28.9 million versus $28.3 million in the prior quarter, primarily due to increases in credit enhancement guarantee and servicing expenses largely resulting from an increase in interest income attributable to the credit-enhanced loan portfolio growth. Otherwise, operating expenses were flat quarter over quarter. The efficiency ratio was 53.1% versus 66.3%. Excluding the offsetting credit-enhanced accounting effects, the efficiency ratio was 63.9% in the second quarter versus 65% in the first quarter of 2020. Let me briefly review the financials of the Tallied acquisition. As noted in last week's release, we expect roughly $4 million in total integration and transition costs over the coming year, weighted toward the next two quarters and narrowing thereafter as we eliminate duplicative vendor and platform expenses. These estimates exclude amortization of the acquired platform intellectual property and customer relationships. These are noncash items requiring that the assets be marked to market and amortized. We expect to complete the initial purchase accounting including the asset valuations by the end of the third quarter of 2020 and we will provide an update then. Total assets were $925 million, up from $899 million, primarily due to increases in the company's credit enhancement loans, the credit enhancement asset, and the loans held for sale portfolio, partly offset by a decrease in other loans held for investment. Deposits increased to $694 million versus $675 million, driven by growth in interest-bearing demand deposits and time certificates of deposit, partially offset by a decrease in noninterest-bearing demand deposits reflecting a shift in customer partner balances toward the interest-bearing products. We also continue to operate from a very strong capital position, with a bank leverage ratio of 18.1%, over double the well-capitalized minimum, and a holding company leverage ratio of over 22%. Finally, as of 06/30/2026, the company has repurchased a total of 29.7 thousand shares for approximately $400 thousand under the company's share repurchase program announced in May 2026, which provides for the purchase of up to 685 thousand of the company's issued and outstanding shares. Outside of blackout periods, we prioritize repurchases when our shares trade below tangible book value, reflecting our conviction that this is an attractive use of capital at those levels. Let me provide forward outlook on some key metrics as we have done in prior quarters. Loan originations for the second half of 2020: while there may be variability quarter to quarter, we believe originations can come in around $1.6 billion in the third quarter reflecting the typical seasonal pickup in student lending. For the fourth quarter, we are comfortable with a baseline estimate of $1.4 billion. SBA loan sales: we will continue to follow our strategy of selling guaranteed portions of our SBA loans as long as market conditions remain favorable. The average gain on sale of loans over the past two quarters is a reasonable proxy for the quarterly run rate we would expect for the remainder of the year. Quarterly net charge-off: we anticipate an approximate range of $4 million to $5 million in net charge-offs for noncredit-enhanced loans as a good quarterly number to use in your models for the remainder of this year. Nonperforming loan balances for Q3 2020: we anticipate a migration to nonperforming loans of approximately $7 million in the third quarter. Net interest margin: we are maintaining our prior outlook that when including credit-enhanced balances, the net interest margin is expected to increase, driven by growth in credit-enhanced balances and efforts to lower funding cost. Conversely, excluding excess credit-enhanced income, we anticipate a gradual decline in margin consistent with our ongoing risk reduction strategy. Efficiency ratio: we remain focused on driving sustainable positive operating leverage, with a long-term goal of steadily lowering our core efficiency ratio, which excludes credit enhancement accounting effects. That said, there may be periods in which the efficiency ratio may increase. Tax rate: while multiple factors may influence the actual tax rate, we suggest using 27% in your modeling. With that, we would like to open the call for questions and answers. Operator?
Questions and answers
Thank you. We will now be conducting a question-and-answer session. If you would like to ask a question, please press 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press 2 to remove yourself from the queue. For participants using the speaker equipment, it may be necessary to pick up the handset before speaking. Our first question will come from Joseph Yanchunis with Raymond James.
Hey, good afternoon. Thanks for taking my questions. The first is on credit. So NPL declined by $12 million this quarter. I was just curious how much of that improvement came from collateral liquidations versus upgrades or payoffs? And then should we expect a similar pace of resolution over the next few quarters? Thanks.
Yeah, no problem, Joe. We were really happy to have reduced by roughly a quarter our NPA balances during the second quarter. It reflects active resolution work; it is not a one-time swing. So I think just generally, the direction is favorable there. Our total risk exposure at quarter end was $19 million of the total $38 million in NPA balances. Similar to our NCO comments, we know the loans at risk, the restricted attributes, and we are actively managing that segment of the portfolio. As far as guidance, I would just point to Bob's comments on, you know, $7 million of potential net migration in Q3. And then just another question for me. Are you thinking about the $50 million credit card portfolio you acquired from the Tallied acquisition? Has your thinking evolved regarding retaining versus selling those receivables? Since going public, Joe, we have talked a number of times about our interest in acquiring technology platforms that fit our suite of services that we take to market with fintechs. The Tallied acquisition fits this strategy really well. Credit card processors do not come on the market very often. As you saw in the press release, we acquired the platform and the related assets of Tallied. Owning the credit card operating system provides the core component for the credit card tech stack, and it fits neatly with what we have built historically with FintechConnect for lending and MoneyRails for payments. So we look at this really as a technology platform acquisition, rather than a business acquisition. It fits well with the scope of services that we offer our partners.
Next, we will hear from Andrew Terrell with Stephens Inc.
Hey, good afternoon.
Hey, Andrew.
Just to start, Bob, I think you mentioned $3 million to $4 million of charge-offs in the prepared remarks — was that kind of expectation? And then is that relative to the core portfolio? I think it was $2.93 million charge-off for this quarter.
I can take it, Andrew. Most of the $2.9 million in NCOs in the core portfolio came from the legacy pool that had those defined attributes and cohorts. We anticipate that we will continue to have NCOs from that group until we fully work through them. As we have noted, we expect elevated charge-offs over the next few quarters as we work through those loans. As far as guidance, the non-credit enhanced NCOs did come in slightly above the high end of the range, which was the $4 to $5 million number I think you are referencing. It is kind of normal quarter-to-quarter timing on individual resolutions rather than a deterioration there. So we still see $4 to $5 million as the right normalized run rate for that segment.
So $4 million to $5 million is the core portfolio plus strategic loans without credit enhancement?
That is correct.
And as you are working through some of these portfolios, I know you are giving kind of explicit backup guidance. When do you feel like you have reached or worked through the majority of this portfolio? When should we start anticipating improvement sequentially in credit quality?
This is Bob. I cannot put a specific quarter count or point to a quarter when we will be through that. We have guided to $4 to $5 million of noncredit-enhanced charge-offs per quarter for the remainder of 2026, and we expect the SBA vintage-driven elevation to persist over the next few quarters as those vintages continue to season and we work through them. But the pool is finite and identified, roughly about $50 million, and that is what informs this guidance. So it is a bounded pool with a guided range, but I cannot give you a fixed number of quarters or an exact amount. I would say a lot of it is going to come through in the next couple of quarters and taper as we go into 2027.
Yep. Okay.
Can you talk about the Tallied acquisition — is that included? Moving from a credit-enhanced position to non-credit-enhanced would assume, with the acquisition, that loss rates against that portfolio are baked into your guidance here or would that be incremental? And just talk about the credit quality of the loan portfolio that you will be acquiring.
The credit quality is really high, Andrew. We have experience with this, including during the due diligence when we onboarded that portfolio that extended back to the original US Bank loan tapes and there are a couple decades' worth of performance data, so we know the performance really well. It is really high quality; there are not meaningful charge-offs in that portfolio. So is it baked into the NCO guidance? Yes, but it is not material to that number.
I appreciate it. Also, the Slide 12 in the presentation showing the pipeline for FinTech partners — since it is the first quarter you have shown this, can you characterize how robust this pipeline is compared to the past couple of quarters where we couldn't necessarily see this level of disclosure?
We thought that would be a helpful slide this quarter. I mentioned last quarter that the pipeline was stronger than I had seen in the eight years I've been at the bank, and it is continuing to compound. We added that slide to the investor deck to give detail on expected launch dates and the breadth of product. It gives color on why I was so bullish on fintech sales last quarter. I expect that to continue to grow both in number and in breadth of product. Sarah Greta and her team are doing a great job and we intend to keep executing to convert those into contracts and announcements. The announcement we did with the prepaid partner as part of our earnings call this quarter is just the first one, and you will see more coming in the back half of the year.
Thank you so much for taking the questions.
Next, we will move to Manuel Navas with Piper Sandler.
I also appreciate Slide 12. Are the new partner types considered new partner additions or extra programs with current partners?
They are both shown there, Manuel. If you look on that far left-hand column, you can see we put the partner type. While a majority are certainly new partners to the bank, there are two existing partners on there where we are adding new products for those two partners — slots two and three there.
The launch dates show three programs in the fourth quarter. Would that mean revenue would hit on the launch date or a little bit after?
Launch means we are operationally live and revenue would begin accruing at that point. Two things to note: one, when we make the announcement, that is typically upon contract signing. There might be a few weeks between when we sign a contract and when we are ready to go live because due diligence is happening concurrent to the contract negotiations. Two, while we are live and revenue-producing on day one of the launch, there is generally a piloting and scaling period with the fintech as their volumes pick up. There are typically a few quarters between when we go live and when we are comfortable updating origination guidance or other metrics because we want a track record to point to.
So since you have announced one new partner at the beginning of this call, there are five further partners in the pipeline that are on the term sheet side that should hopefully pull through — is that the right way to read that?
Yes. I think four of them are signed term sheets — fully new partners. Another one is where we have commercial terms agreed to, but not necessarily a signed term sheet by the time we went to press with the deck.
Tallied just happened. Has its improved product offering and platform enhanced your ability to compete or land any of this pipeline of deals? Is it already relevant or is it still too early?
It is already relevant in conversations and calls, but it is not yet demonstrated in the slide we referenced. So it is definitively relevant, but not part of what is on that slide.
How quickly could you act on the buyback? You said tangible book value is key. When can you start from today?
We will have a short period to allow the earnings to disseminate. This is Wednesday, and I believe we start on Friday.
Originations were solid. Can you break down how it built and why it beat expectations this quarter, and why not a little bit higher going forward?
Originations were strong at $1.6 billion in the quarter, exceeding our guidance of $1.4 billion and up roughly 8% year over year. The student lending seasonality was the main program-level change; the reduction in Q2 was offset by measured increases across our programs. We're really happy with originations. One other point: in March 2023 our originations troughed at $850 million. We said then the fundamentals were sound, and we are consistently originating at about twice those levels now. That context is important as we work through the legacy SBA portfolio.
We have been through similar cycles before, whether with fintech credit that we retained and experienced NCOs in 2022, or the origination trough in 2023 with some fintech partners. None of this alters our trajectory; we are comfortable with how things are trending and how we are managing originations and the legacy SBA pool.
Where should balance sheet loan growth go going forward? You pulled the guidance on credit-enhanced loan growth because a portion of it is Tallied. Where should balance sheet loan growth go and describe some of the credit-enhanced growth on a quarter-to-quarter basis?
We are seeing more measured growth in a number of our portfolios. SBA balances were down quarter over quarter due to loan sales and working through nonperformers. As for the credit-enhanced balance sheet, we grew that from 0 to $100 million in a couple of quarters. We withdrew guidance mainly because Tallied converted a portfolio from credit-enhanced to direct, which changes how it sits on the balance sheet and makes guidance more difficult. We beat expectations early, but to grow meaningfully from here we need additional partners. We have some growth with existing partners, but it is more gradual, which is part of why we pulled guidance on credit-enhanced balances this quarter.
I appreciate the commentary.
We have a question that has come in via email. We will let Juan Arias handle that. Please go ahead, sir.
Thanks, operator. The question is for Bob. How should we think about the earnings trajectory in the second half of 2020 and into 2027 relative to the first half of 2020? What are the key earnings and growth drivers investors should be focused on?
That's a great question. It's driven by a lot of considerations, key assumptions and variables as to what drives our revenues and expenses. One way to approach it is to go through the key drivers: First, originations — we provided color today: Q3 we expect around $1.6 billion and Q4 a baseline of $1.4 billion, but variables like lending season and the economy affect that. Second, the credit portfolio — while we lose Tallied from credit enhancement, it moves into the core portfolio where we pick up additional revenue related to interchange; we don't pick up additional interest income but we pick up interchange. We expect credit-enhanced portfolio growth to be more muted than a year ago, but existing partners continue to expand. Third, provision for loan loss — we have said about $4 to $5 million on the noncredit-enhanced portfolio, with the strategic partner retained portfolio running just over $2 million. The core traditional portfolio has been running high this year, but we see that tapering as we leave 2026 and move into 2027. Fourth, expenses — excluding the Tallied transition expenses, we expect operating expenses to remain flat or flattish through 2026 but to grow as we bring on additional partners. Summing that up: our core business is generating a consistent level of profitability; what is hurting us now is the provision for loan loss driven by charge-offs in the traditional loan portfolio. For the second half of 2020 you can view the first half as a proxy for Q3 and Q4; it has been a stable environment and the provision is probably going to be around there, with adjustments for other portfolios, originations growth and credit-enhanced momentum. That is how I would frame it.
We do have a follow-up question. We will hear from Manuel Navas with Piper Sandler.
I want to make sure I understand the progression well. The core portfolio provisioning rose this quarter on some heightened losses. The expectation is that while the heightened losses might be a little higher in the second half than previously expected, they should be lower than the second quarter. Is that the right projection?
From a provisioning perspective, yes. Provisioning in the second quarter was about $6 million excluding the credit-enhanced portion, which is above the $4 to $5 million you should think of as the run rate. So yes, we expect the second quarter to be a bit of an outlier.
Got it. And regarding the shift of the credit-enhanced portfolio with Tallied now direct, is Tallied going to have less growth than what it could have had if it had continued independently? Or is there no change to the expected growth rate?
No, there is no change to the expected growth rate with Tallied. It simply became a direct portfolio versus a credit-enhanced portfolio. In conjunction with another partner whose growth had slowed earlier in the year, it made sense to pull guidance.
Thank you for the clarification.
You are welcome.
That will conclude today's conference call. We thank you for your participation. You may disconnect your lines at this time.