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Good day, everyone, and welcome to the First Internet Bancorp's Fourth Quarter and Full Year 2024 Conference Call. Please note that today's event is being recorded. I would now like to turn the conference over to Ben Brodkowitz, Financial Profiles, Inc. Ben, please go ahead.
Thank you, Jenny. Hello, everyone, and thank you for joining us to discuss First Internet Bancorp's Fourth Quarter and Year-end 2024 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. Joining us today from the management team are Chairman and CEO, David Becker; and Executive Vice President and CFO, Ken Lovik. David will provide an overview of the quarter and 2024; 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 involve 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. 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 the GAAP to non-GAAP measures. At this time, I'd like to turn the call over to David.
Thank you, Ben, and good afternoon, everyone. Thanks for joining us today for the fourth quarter and full year 2024 results. Our 2024 results reflect a year of remarkable growth. We entered '25 with strong momentum. We produced significantly improved financial results, marked by a recovery in net interest income and net interest margin. We generated strong loan growth while we focused on optimizing the composition of our interest-earning assets. Furthermore, our SBA lending business had an outstanding year that drove non-interest income substantially higher year-over-year and allowed us to achieve greater revenue diversification. To summarize some of the key achievements for the year, net income and diluted earnings per share tripled compared to 2023 at $25.3 million and $2.88, respectively. Net income of $87.4 million was up 17%. Gain on sale revenue was up more than 60%, fueling non-interest income growth of 81% from 2023.
Total adjusted revenue growth of almost 30% far outpaced the increase in expenses, creating significant annual positive operating leverage. On the balance sheet, we grew balances by $330 million, an increase of 9% over 2023, which we attribute to strong growth in construction, investor commercial real estate, and small business lending. We also produced continued strong deposit growth, which allowed us the balance sheet flexibility to pay down a significant amount of Federal Home Loan Bank borrowings while also maintaining a solid liquidity position. The loans-to-deposit ratio is relatively consistent with the prior quarter and is indicative of continued flexibility as we continue to optimize both sides of the balance sheet throughout 2025. I would note that many of these year-over-year trends were evident in our performance for the fourth quarter, which I'll now discuss in a little more detail.
If you're following along in the presentation, quarterly highlights are on Slide 3. It is only fitting that we would cap off a year with so much activity with a busy quarter. With a number of moving parts that impacted our results, our core business continued several of its upward trends. We drove an 8% increase in net interest income, making this our fifth consecutive quarter of growth in net interest income, notably a 5 basis point improvement in net interest margin. Even as the Federal Reserve rate cuts impacted the yield on new loan originations, the yield on the overall portfolio increased 3 basis points from the third quarter. The impact of the rate cuts was even more pronounced on deposit costs, which declined 17 basis points. At $24.7 million on an FTE basis, net interest income for the fourth quarter of 2024 was up 17% compared to the fourth quarter of 2023. We remain confident that net interest income and net interest margin will continue to trend higher throughout 2025 as we experience the full impact of the 2024 Fed rate cuts on deposit costs and continue to improve the composition of the loan portfolio.
Additionally, our balance sheet flexibility will allow continued opportunities to optimize our funding costs as higher-cost wholesale funding and CDs mature. Another positive trend is the continued strong performance of our small business lending team. As I noted earlier, gain on sale of SBA guaranteed loans is a critical component of our non-interest income. Loan originations in this line of business were strong, up over 2% compared to the prior quarter, which had previously been a quarterly record for us. Consequently, SBA gain on sale revenue, while strong on a historical basis, dipped slightly this quarter. Decline was really more of a timing issue as a large portion of the originations were closed during the second half of December, and there is a lag between closing the loan and being able to sell it in the secondary market in order to complete the necessary post-closing activities.
So while we didn't get to record revenue from those loan sales in the fourth quarter, the upside is we're very well positioned for a great start to 2025 for gain on sale revenue. Turning to the earnings for the quarter, we reported net income of $7.3 million, up 5% and diluted earnings per share of $0.83, up 4% from the third quarter's reported results. As I mentioned earlier, we had some moving parts that impacted the quarter's results. First, in connection with paying down Federal Home Loan Bank borrowings, we recognized $4.7 million of prepayment and terminated interest rate swap gains. When adjusting for this activity, revenue for the quarter totaled $34.8 million, an increase of almost 3% from the third quarter and 28% from the fourth quarter of '23. This marks the sixth consecutive quarter of increase in total revenue. During the quarter, we took steps to address certain problem loans and recognized $9.4 million in net charge-offs, most of which related to the SBA portfolio.
As a result, net charge-offs to average loans totaled 91 basis points. I would note that approximately $3.4 million of these charge-offs were related to loans that already had existing specific reserves. As with most small business loans, the issues with these credits were borrower-specific and not driven by any particular industry or geography, and nor are we seeing any significant trends of stress with certain industries or regions. We had certain problem credits in various stages of workout where the outlook for a positive outcome was becoming less likely, so we made the decision to charge these loans off and help derisk the portfolio going forward. Our overall credit quality remained sound. Non-performing loans to total loans were 68 basis points. Non-performing assets to total assets were 50 basis points at the end of the quarter. The increase in non-performing loans was due to additions in franchise finance and small business lending as we took action to get in front of some potential loans.
Despite the increase in non-performing loans, our asset quality metrics still compare favorably to all of our peers, and we have adequate resources on our loan servicing and special assets team as well as the processes in place to address any loans showing a sign of stress. At the moment, we have specific reserves on about 30% of the total non-performing loan balance. Another high-level point before I move on, and that is an update on our fintech partnership business. We told you at this time last year that we did not plan for rapid growth in the number of sponsored programs in 2024. We focused instead on nurturing the relationships we had already entered into, amid challenges in the bank fintech partnership space. This turned out to be a prudent decision. I'm pleased to report we have seen growth on both sides of the balance sheet and in non-interest income as well. I believe the partnerships between chartered institutions and solution-focused innovators is critical to the evolution of financial services.
Without it, customers would still be standing in teller lines to cash checks and get their savings passbooks updated. We are committed to exploring relationships with partners that advance the financial services landscape and doing so in a way that creates value for our shareholders. On the topic of shareholder value, I'll make one last point on this slide, and that is how keenly we monitor tangible book value per share as a key measure of our focus on shareholder value. Despite the sizable increase in intermediate and long-term interest rates during the quarter, tangible book value per share only experienced a slight decline and it's up nearly 6% on a year-over-year. Since 2018, our tangible book value per share is up more than 55%, which reflects our commitment to operational discipline, diligent balance sheet management through some very challenging periods for the industry. We like you, our shareholders in First Internet Bank.
Turning to Slide 4. I've already made some high-level comments about our lending activity. I'm proud of the work our lending teams did over the quarter to produce strong loan growth of 13% on an annualized basis. Virtually, all of our lines of commercial lending experienced growth with balances up almost $140 million from the third quarter or 17% on an annualized basis. Our small business lending team has been a key driver in our efforts to reposition the loan portfolio and diversify our revenue streams. For the full year 2024, SBA loan originations totaled almost $540 million, up 45% over 2023 with solid loan volume also up 45% year-over-year, demonstrating the measurable impact we can make by providing growth capital to entrepreneurs and small business owners across the nation. Following strong production in the fourth quarter, retained balances increased 11% compared to the linked quarter.
Our small business pipeline remains robust, and with the staffing investments we have made, we are targeting $600 million of SBA loan originations for 2025, and we are proud to be ranked as the eighth-largest SBA 7(a) lender in the nation for the SBA's 2024 fiscal year. The growth of our SBA business also drove a significant increase in non-interest income for the year, which comprised one-third of total adjusted revenue, up from 26% in 2023. Our construction and investor commercial real estate team had another solid quarter, originating over $70 million of new commitments, and the aggregate construction and investor commercial real estate balances increased by $81 million as we experienced strong growth activity on existing commitments. At quarter end, total unfunded commitments in our construction line of business were $480 million. As these 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 variable rate loans.
With a more favorable interest rate environment, our single-tenant lease financing team had an active quarter, originating almost $40 million of new loans, which translated into solid loan growth of $18 million over the linked quarter. Additionally, our public finance team had a solid quarter with balances up $23 million over the third quarter as it capitalized on some high-quality shorter duration opportunities with attractive tax-equivalent yields. On the consumer side, total balances were down as expected as declines in residential mortgage and home equity balances more than offset growth in our specialty consumer line, where originations were down due to seasonal factors. We focus on the super prime borrower in our consumer lending and rates on new production were in the mid-to-low 8% range. Furthermore, delinquencies in these portfolios remain extremely low at 10 basis points of total consumer loans.
I'm proud of the performance our lending teams turned in to finish the year strong. I'm proud of the work that all of the employees at First Internet Bank put in to deliver 12 months of improving performance and a five-quarter streak for growth in net interest income and net interest margin expansion. Combined with the ongoing investments we've made in small business lending, we remain confident in the earnings momentum we have built. Entering 2025, we are well positioned with solid liquidity and capital levels and asset quality metrics that compare favorably to peer institutions, all the while continuing to optimize both sides of the balance sheet and further diversifying our revenue streams. Our team is committed to delivering strong earnings, growth, and net interest margin expansion that will create meaningful value for our shareholders in the years ahead. Now I'd like to turn the call over to Ken.
Thanks, David. As David covered the loan portfolio, let's turn to Slides 5 and 6, where I will cover deposits in more detail. The average balance of deposits increased almost $344 million or 8% during the quarter, and period-end deposits were up $135 million or 3% from the prior quarter, driven primarily by growth in fintech partnership deposits. Non-maturity deposits were up $122 million or 6%, reflecting the increase in fintech partnership deposits. Additionally, total deposits from our fintech partners were up 27% from the third quarter and totaled $643 million at quarter end. During the fourth quarter, we submitted a notice of reliance on the primary purpose exemption with the FDIC related to fintech deposits that had been classified as brokered. And as of December 31, we reclassified these deposits to interest-bearing demand deposits. During the fourth quarter, these partners generated almost $16 billion in payments volume, which was up 38% from the volume we processed in the third quarter.
Total fintech partnership revenue was $880,000 in the fourth quarter, which was up over 14% from the linked quarter. Related to CD activity during the quarter, CD balances were relatively stable with balances increasing only $22 million over the quarter. Although medium-to-longer-term treasury rates increased during the fourth quarter, we held CD pricing constant through most of the quarter and further lowered CD rates in December following the Fed's rate cut that month. We originated $242 million in new production and renewals during the fourth quarter at an average cost of 4.23% and a weighted average term of 12 months. These were partially offset by maturities of $238 million with an average cost of 5.01%. Similar to last quarter, new CD production is coming on at lower rates than those maturing, which will continue to benefit our cost of funds going forward. Looking forward, we have $414 million of CDs maturing in the first quarter of 2025 with an average cost of 5.06% and $351 million maturing in the second quarter of 2025 with an average cost of 4.95%.
So, for the next several quarters, we expect a continued positive pricing gap between new production and maturing CDs. For example, January month-to-date new CD production has been at an average cost of 4%, which is a positive spread of 106 basis points over the weighted average cost of CDs maturing in the first quarter. Moving to Slide 6. At quarter end, total liquidity remained very strong, reflecting cash and unused borrowing capacity of $2.2 billion. We deployed a portion of the elevated liquidity we had at the end of the third quarter, supplemented by continued deposit growth during the quarter to pay off a significant amount of Federal Home Loan Bank borrowings and a smaller amount of maturing brokered CDs as well as to fund loan growth and securities purchases. As part of paying down certain structured FHLB advances, we were able to capitalize on favorable embedded prepayment features as well as paydown structures hedged with interest rate swaps.
We structured these borrowings prior to the Fed tightening cycle, and as a result, the positions had significant mark-to-market gains at the time of termination. In total, we recognized $4.7 million of gains on the repayment of $200 million of FHLB advances during the quarter. With total deposit balances increasing 3% and loan growth of $135 million or 3%, the loans-to-deposits ratio was relatively unchanged at 84.5% from the end of the third quarter. At quarter end, our cash and unused borrowing capacity represented 173% of total uninsured deposits and 222% of adjusted uninsured deposits. Turning to Slides 7 and 8. Net interest income for the quarter was $23.6 million and $24.7 million on a fully taxable equivalent basis, up 8.2% and 7.9%, respectively, from the third quarter. The yield on average interest-earning assets declined to 5.52% from 5.58% in the linked quarter due primarily to a 54 basis point decrease in the yield earned on other earning assets, which are predominantly cash balances impacted by the Fed's rate cuts, but partially offset by a 3 basis point increase in the yield earned on loans.
The higher yield on the loan portfolio, combined with higher average loan balances produced solid top-line growth in interest income, increasing almost 4% compared to the linked quarter, which far outpaced the increase in interest expense. As a result, net interest income was up over 8.2% during the quarter, building on last quarter's increase and further distancing us from the low point in the third quarter of 2023. Net interest margin for the fourth quarter was 1.67% and 1.75% on a fully taxable equivalent basis, both representing 5 basis point increases compared to the linked 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. The yield on funded portfolio originations was 7.26% in the fourth quarter, down from 8.85% in the third quarter, which reflects the 100 basis points of Fed rate cuts since September as well as a larger volume of originations in fixed-rate portfolios, which are priced at lower spreads over U.S. treasuries, but are still significantly higher than the current all-in yield on the loan portfolio.
Pipelines remain solid, especially in the construction and small business lending lines of business, and our focus on improving the composition of our loan portfolio gives us further confidence that net interest income will continue to increase in future quarters. 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 that our deposit costs are beginning to trend down along with the decline in Fed funds. At quarter end, we had $1.4 billion of deposits indexed to Fed funds, which when combined with the $765 million of CDs maturing over the next 2 quarters and an additional $200 million of higher-cost broker deposits maturing at the end of the first quarter, are expected to 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 $16 million, up $3.9 million or 32.5% from the third quarter. As I previously mentioned, non-interest income included $4.7 million of prepayment and terminated interest rate swap gains related to the paydown of Federal Home Loan Bank advances. Excluding these gains, adjusted non-interest income was $11.2 million, down 7% from the third quarter. Gain on sale of loans totaled $8.6 million for the quarter, down from $9.9 million in the prior quarter. Loan sale volume was $106.7 million, down 16% quarter-over-quarter, while net gain on sale premiums increased 30 basis points from the third quarter. As David mentioned in his comments, the decline in loan sale volume was mainly due to timing. We originated $167 million of SBA loans during the quarter, an increase of 2% over the linked quarter with over 1/3 of those closing late in the quarter. The decline in gain on sale revenue was partially offset by higher net loan servicing revenue, which totaled $1.4 million for the quarter due to growth in the servicing portfolio and a lower fair value adjustment to the servicing asset.
Moving to Slide 10, non-interest expense for the quarter was $24 million, up $1.2 million from the third quarter. The increase was driven in part by higher compensation costs due to staff additions in small business lending, risk management, and information technology as we continue to invest in key areas of our business. Additionally, other non-interest expense was up due to seasonal expenses and deposit insurance premium increased due to year-over-year asset growth. Turning to asset quality on Slide 11, David covered several of 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 1.07% at the end of the fourth quarter, down 6 basis points from the third quarter. The decrease in the allowance for credit losses reflects a decline in specific reserves related to charged-off SBA loans as well as the net charge-off activity David discussed earlier, partially offset by qualitative adjustments to the small business lending ACL and overall loan growth.
At quarter end, the small business lending ACL to unguaranteed SBA loan balances was 5.7%. Additionally, at a higher level, 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 1.27% of loan balances. Provision for credit losses in the fourth quarter was $7.2 million compared to $3.4 million in the third quarter. The increase in the provision for the fourth quarter reflects the elevated net charge-off activity, the qualitative adjustments to the small business lending ACL and overall growth in the loan portfolio, partially offset by the decline in specific reserves and adjustments to qualitative factors in other portfolios. Moving to capital on Slide 12, our overall capital levels at both the company and the bank remain solid. The tangible common equity ratio was 6.62%, an increase of 8 basis points from the third quarter as a smaller balance sheet more than offset the impact of higher interest rates on the accumulated other comprehensive loss.
If you exclude other accumulated other comprehensive loss and adjust for normalized cash balances of $300 million, the adjusted tangible common equity ratio would be 7.4%. From a regulatory capital perspective, the common equity Tier 1 capital ratio remained solid at 9.3%. Before I wrap up, I would like to provide some commentary on our outlook for 2025. While the market may be pricing in a rate cut or two over the course of the year, we are sticking with our conservative approach and assuming Fed funds and other short-term rates remain constant through 2025. When looking at the estimates for full year 2025, I think the consensus earnings per share number is within the range we are forecasting for next year. However, how we get to that range is a little different than what the current models are projecting. We expect loan yields to increase as we continue to originate new production at rates well above the current portfolio yield.
We also expect deposit costs to continue declining as: one, the last two Fed rate cuts get fully incorporated into quarterly run rates; two, the significant CD repricing gap on over $0.75 billion of CDs maturing over the next 6 months; and three, the paydown of higher cost broker deposits at the end of the first quarter. Assuming loan growth in the range of 10% to 12% for the year and deposit growth in the range of 5% to 7%, we expect that annual net interest income will increase in a mid-30% range over 2024 and fully taxable equivalent net interest margin will increase throughout the year and should be in the range of 2.20% to 2.30% by the fourth quarter of 2025. If the Federal Reserve were to begin reducing short-term interest rates, our net interest income and net interest margin would likely exceed these projections. With regard to non-interest income, as our SBA team continues to grow and deliver consistently higher origination activity, we expect annual core non-interest income to be up in the range of 9% to 12% over 2024.
A potential risk to this forecast will be loan sale pricing in the secondary market. While gain on sale premiums are currently attractive, if pricing were to soften, it may make more economic sense to hold a loan yielding 10% or more versus selling for a premium far below the annual spread income we would earn. Looking at the provision for credit losses, with quarterly provisions higher than what we have experienced on a historical basis, we are taking a conservative approach in our forecast for 2025 and are modeling an annual provision that is in the range of 15% to 20% higher than what we recognized in 2024. And finally, from a non-interest expense perspective, we added a number of personnel throughout 2024 to support growth in small business lending as well as in risk management and information technology. And with the planned growth in SBA originations and the continued investments in key areas of our business, we do expect compensation expense to increase in 2025.
All in, we expect annual non-interest expense to be up in the range of 10% to 15%. One additional point I would like to make, when looking at the quarterly earnings per share estimates for 2025, I think the distribution might be off a little. While the total for the year is in the range due to seasonal factors and the time that it takes CD repricing to work its way through, our forecast is a little lighter in the first and second quarters of the year and a little higher in the back end of the year. With that, I will turn it back to the operator so we can take your questions. Jenny?
分析師問答
And your first question is from Brett Rabatin from Hovde Group.
I wanted to start on the asset quality cleanup and then, any color that you can provide on the SBA charge-off and just what you're seeing in the SBA portfolio generally? And your guidance for provisioning to be 15% higher in '25, that's probably 45 basis points, 46 basis points. Are you expecting some continued charge-offs in the SBA portfolio?
Let's begin by discussing our assumption regarding increased provisioning for the year. Over the past few years, as our SBA business has expanded, we have experienced more charge-offs and, consequently, higher provisioning. This is largely due to the growth in the overall portfolio, which is why we are reserving at a greater rate for those loans. The charge-offs in this area are significantly higher compared to single tenant properties or others. We have observed a sustained increase in this rate over the last four to six quarters. Our strategy is to adopt a conservative approach, aiming to provision more than what we may need. We believe it's better to be cautious in our forecasts and to add a little extra given that our portfolio will continue to increase. Additionally, we have raised our overall Allowance for Credit Losses coverage, which is also contributing to this increase.
Okay. And then on the cleanup, what that entailed, and you had the one specific charge-off that had allocated reserves, but was just trying to get a little more color on what you were seeing in the SBA portfolio? I know that the credit trends in SBA for the industry have been a little softer, but I know everybody kind of does things differently and the rules changed two years ago on underwriting. Just any thoughts on the SBA portfolio as you see it from a credit perspective?
I’ll take that one, Brett. In the SBA portfolio and the bank overall, there is absolutely nothing causing me concern. As you mentioned, the SBA environment is a bit more challenging right now. We've thoroughly examined underwriting loan issues and looked at everything. Each loan is unique, and there is no significant concentration in any given state, product, or other factors. They are all individual cases. The only common thread is that about half of our delinquent accounts are somehow linked to the hurricanes that impacted Florida and North Carolina last year. These areas are struggling with rebuilding and recovering from losing two to three months of income. As you know, in the SBA world, there is a strong effort to support small business owners. SBA actively works through these situations, but as Ken pointed out, we are not entirely familiar with some processes, making it take longer to navigate both sales and recovery as well as collections.
So, we took advantage in the fourth quarter of looking at some of the loans. We might get some recovery, we might not get recovery. We were doing okay on earnings, and we just wanted to set a clean stage for going into '25. As Ken said, we bumped up reserves a little bit, because if you looked at our credit history for the last 5 years, we've done more outside of the Oahu experience we had in early '23. We charge off more loans over the past year than we probably have in the last 3 or 4 years put together outside of Oahu. But the bottom line is the SBA, even with those charge-offs, in the fourth quarter, we made $4 million more in SBA at the bottom line than we did a year ago. I find it a bit concerning to see others in the market selling substantial amounts of reliable but low-yield securities, incurring significant losses while aiming for a 3 to 4 year recovery. We’re being aggressive, reducing a few loans to position ourselves for a strong 2025, yet we face criticism in the market while their stocks rise.
It’s puzzling to me. However, I believe there's nothing fundamentally wrong with us. We have some of the top business development officers and a strong team in the SBA sector. We've built a great team over the last few years, and we see a tremendous opportunity ahead. While we anticipate more losses than usual and additional effort due to SBA regulations, our portfolio remains diversified and robust, and we will continue to push forward vigorously.
Okay. I have many questions, but I'll just ask this last one before returning to the queue. You achieved $540 million in SBA in 2024, and I believe the fee income guidance is projected at 9% to 12%. What are your assumptions for SBA production in 2025? Additionally, I was unclear about your comments regarding how gain on sale may introduce some variability, specifically what you are assuming for gain on sale margins.
Yes. Well, we are projecting $600 million in originations for next year. Currently, our gain on sale net premiums average around 1.08%, possibly a bit higher. In our forecast, we are assuming 1.08%. However, there is a variable factor to consider, which is that we have noticed some volatility in the gain on sale premiums over the past 18 months. For instance, if gain on sale premiums were to decrease to 1.06% and we had a loan with prime plus 2.75%, that would be a strong loan, and we might decide to keep it on our balance sheet instead of selling it. This means that the fluctuations in gain on sale premiums could pose a risk to our gain on sale income if we opt to hold onto the loan.
As Ken mentioned, we carried over $60 million in production from December into January, which we sold over the last couple of weeks, achieving a net of 1.08%. We had one loan that came in at 1.06%, but we decided to keep it on the books instead of selling it in the market. Everything seems to be stable. However, with the President stating today that he intends to push for lower interest rates, things could change quickly. Nonetheless, we feel confident that, as Ken said, we are not predicting any further rate decreases. Therefore, we expect to stabilize around the low 1.08% range for the rest of the year, which we have accounted for in our budget.
Your next question is from Tim Switzer from KBW.
I have a follow-up on the commentary around credit performance, particularly for the SBA. Are there any specific industries that you're seeing a little bit more pressure or types of borrowers at all?
No, not at all. As I mentioned earlier, we've examined that portfolio extensively to determine if there's any common theme, broker, BDO, underwriter, or anything similar. Aside from about half of the loans being impacted by hurricane issues, there is no common thread. One observation is that some loans we originated during COVID, particularly those with real estate components or substantial build-outs that faced delays due to supply and staffing shortages, consumed much of their excess working capital and cash over a 12 to 18 month period. We're currently assisting some of those clients to help them recover. However, aside from the hurricane and pandemic-related issues—which primarily affected borrowers with significant construction or build-out needs to open their businesses—there's no discernible pattern. As Nicole noted, each situation is unique: sometimes they succeed, sometimes they don't. Currently, things appear to be stabilizing, and we're not observing anything particularly alarming, but only time will tell. This is why we're taking a cautious approach by slightly increasing our reserves.
Okay. What impact do you anticipate on the outlook from the rate environment if rates remain high for an extended period? How do you see this affecting your SBA borrowers and the rest of your credit portfolio?
We've examined the rate environment. Since we started engaging with SBA, we've seen strong growth beginning in 2020, continuing through 2021, and increasing in 2022, 2023, and 2024. We've been originating loans in a high rate environment from the start. We conduct credit assessments and interest rate stress testing, raising rates by 200 to 300 basis points to ensure good debt service coverage and sufficient working capital. Therefore, many of our loans have been originated in a high rate environment. We have received 100 basis points of relief so far, but when calculating the impact on an average loan balance, a 25 or 50 basis point decrease doesn’t translate to a significant monthly adjustment in principal and interest. Consequently, none of the charge-offs we’ve encountered have been caused by high rates.
I don't think there's going to be any impact in our client base and/or our numbers, if it holds steady. What would impact us and I think would totally demoralize a lot of our commercial accounts is if the rates start to go up. If inflation blows up for whatever reason and the Fed makes a move the other way, that could have some significant impact. It's not us, it's going to be the whole industry. But I think as long as it stays stable, there's kind of a light at the end of the tunnel. As Ken said, a 100 point decrease last year is a couple of hundred bucks a month maybe on a loan payment, but it was positive news, inflation is coming down, employment is going up, consumers still spending. Day in and day out, the real economic news is pretty solid, and folks think there's a chance. Nobody is losing hope today. But I would tell you, the one to watch is if it turns and the Fed has to bump rates, then that could be a different story, but not only for us, for everybody in the industry.
Okay. Great. And the last question I had was in regards to your fintech deposits. Obviously, very good trends this quarter and the last few quarters. Can you provide some commentary on like how much of that deposit growth in some of the revenue is being driven by current customers you've had versus new onboardings? And then, can you give us an update on kind of the pipeline you see and what kind of customers you're looking to bring on board?
Yes. I think that on the fintech space, a couple of things out there. As we discussed several times here, we had a good core component of fintech customers. We have some folks a little irritated with us that the onboarding process instead of being 60 days has been 6 months to get through all the regulatory issues and stuff. I think we discussed a couple of calls back that after our spring exam last year, we finally got the working guidelines from the regulators of what they want us to do and how they interpret, I still call it BSA, whatever it is, AML, something or the other nowadays. We've got great customers that are growing significantly, literally, all the growth here over the past year. In 2023, we ended the year with a $1 million loss in the BaaS division. We incurred additional expenses and expanded our team, even quadrupling some positions. This year, we saw an almost $1 million increase in expenses related to BaaS, but by the end of the year, our earnings shifted to a positive $1.2 million.
This represents a $2.5 million turnaround in earnings, alongside our staffing increase. We have a strong team and solid clients who are beginning to grow significantly. On the West Coast, we've enhanced card opportunities for a key team member. I believe it’s realistic to expect that our $1 million in earnings could potentially reach $4 million by the end of this year given our current team. We have a robust pipeline and promising opportunities ahead. However, with the ongoing industry challenges from Synapse and associated issues, we are proceeding with extreme caution. There are a lot of people running for the hills in the banking world as well as the fintech world. So we want to make sure we're not taking on somebody else's problem. So our due diligence, which was very tough, everybody tells us, compared to peers to begin with, has gotten even tougher. So, we think we're going to have significant growth, and we could have exponential growth on a couple of them, but we're not going to go out just because the market is frothy now and sign up somebody else's problem. So, we're in it. We're going to stay in it, and we're going to grow it. And we think there's a heck of a future for us in the fintech space.
Your next question is from Nathan Race from Piper Sandler.
Not to beat a dead horse on the SBA front, but just thinking back to the call in October, it seemed like SBA delinquencies kind of peaked over the course of the summer. So, some of the charge-offs that we saw this quarter, a little surprising. So, just curious if you can shed any additional light in terms of what occurred between now and then to necessitate these charge-offs and the elevated provisioning. Was it more so just around getting some updated financials from clients? Or any other light you can shed on that would be appreciated.
Part of the situation was related to the large charge-offs, with $3.4 million associated with loans that already had reserves, either fully or partially. Some borrowers were attempting to reach a resolution, possibly through business sales, but it became clear that the outlook was less optimistic than we had hoped for. Consequently, we decided to charge off the loans, eliminate the specific reserve, and move forward. It was somewhat challenging to anticipate, but we observed a higher than usual number of borrowers who had been on deferral. Often, when they come off deferral, their businesses are back on track and they resume payments. However, this quarter, we noted a higher number of borrowers who struggled after coming off deferral.
And as David mentioned earlier, he referred to them as snowflakes. Much of it is really specific to each borrower. There isn't a common theme, no geographical or industry patterns. It just seemed like there was more variability than what we've typically seen in the past. One of the things we did, Nate, over the last few months is analyze that portfolio extensively. We had external reviews of the portfolio to ensure we hadn't overlooked anything, including poor decision-making or referral sources. Everything checked out perfectly. The current situation reflects the challenges in the industry; one of our competitors, a significantly larger SBA firm, reported disappointing numbers recently. Despite a smooth operation for many months, we faced some difficulties. However, with the earnings potential from this product, including gains on sale, servicing, and other revenue streams, we are optimistic.
Recall that earlier in '23, we absorbed a $9 million hit, ultimately closing the quarter with a $5 million loss. We managed this setback and improved our earnings in the fourth quarter compared to the third quarter. We had the opportunity to take a more aggressive approach in addressing some issues and clearing them out. And that's what we decided to do. I can assure you that we will experience more SBA losses over the next year. I hope it won't be $9 million every quarter, but if it turns out to be, we’ll still add another $10 million to $15 million to our bottom line. This is already factored into our pricing and structure, and as I mentioned earlier, I'm not concerned that there's anything fundamentally wrong with SBA or any of our other assets.
Got it. That's really helpful. I'm familiar with some other SBA lenders and typically, normalized charge-offs for them in this business is anywhere between 30 basis points to 40 basis points a quarter. Is that how you guys are thinking about the future charge-off trajectory?
We have already set aside $3 million in the second and third quarter for a couple of loans. This is our first negative experience with the SBA, and we've learned from it. We should have addressed some of these issues earlier. Moving forward, I expect our charge-offs to stay within the range of 30 to 40 basis points. We have a client with multiple businesses, which could lead to a higher amount, but I don’t think we will reach $9 million in the first quarter. We do believe the charge-offs will stabilize around that 30 to 40 basis point range. To be cautious, we've taken a slightly higher provision in our future projections. Overall, we think this is a prudent approach.
And that's just 30 basis points to 40 basis points off the SBA portfolio itself, not the entire portfolio?
Right, exactly. Exactly.
Okay. Got you. Just changing gears, thinking about the margin trajectory for this year. I appreciate the guide around 220 to 230 coming out by the fourth quarter. Just curious, in terms of kind of the cadence to get to that margin, do you think it's more kind of first half loaded just given some of the CD repricing that Ken described earlier? Just any thoughts on kind of the progression of the margin over the course of this year?
Yes. I think the first quarter might be a bit challenging to observe that because we typically see a significant improvement in the second quarter when we reduce some costly brokered funds and start benefiting from the timing of CD maturities. Those will begin to take effect more in the second quarter and definitely by the end of the year. As I mentioned, we are anticipating a good increase in the first quarter, but it can sometimes be somewhat difficult to pinpoint. The expected range is a bit broader. However, I truly believe we will see a strong improvement in the second quarter and towards the end of the year.
As Ken mentioned earlier, we believe that the average earnings forecast for next year is around $4.20, which we see as very attainable. We anticipate starting in the low to mid-$0.80 range for the first quarter and then increasing throughout 2025, adding another $13 million to $14 million in earnings in 2024. We are not altering our overall outlook and did not foresee any interest rate reductions last year, which is working in our favor. We are confident in maintaining the earnings growth trajectory we outlined for 2025. If we avoid the losses we expect in the SBA, our bottom line can improve even further. Being from the Midwest, we tend to be more cautious than others and won't claim we will reach $5 a share, but I can assure you that we’re aligned with your current estimates. While some components may have shifted from what your models indicated at the start of 2023, we firmly believe that 2025 is set to be a fantastic year for us.
Your next question is from George Sutton from Craig Hallum.
You did call out franchise finance in terms of the provisions or at least the delinquencies. Can you just give us a little bit more of a picture there? Is that still a program you're planning to continue to grow quite a bit?
No. We have about a $500 million portfolio that has grown significantly over the past few years. When considering capital allocation and growth in SBA and other areas, our growth may be significantly reduced compared to what you've seen in previous years. Year-over-year balances have actually decreased. We have noticed a slight increase in non-performers as we address challenges with certain struggling franchisees, and our team is working closely with our partner on this issue. Currently, we are probably generating around $6 million to $8 million a month in new originations, which is roughly the same amount offsetting paydowns in the portfolio. While the yields are favorable and it has contributed positively to our earnings, it is just one component of a much larger picture.
I want to highlight that the team at ApplePie has been collaborating with us and has made some changes. In previous earnings calls, I mentioned challenges with the servicer, but they now have a new one. Our team maintains regular communication with them and we're beginning to see progress. Although, as Ken pointed out, their volume has decreased slightly, we are still actively buying. While we do not anticipate significant growth, we currently have stronger channels. The relationship between us and ApplePie, as well as their customer base, has improved significantly over the past three months. Therefore, we are not overly concerned about the portfolio. There are challenges, particularly with some smaller coffee shop owners who had unrealistic expectations about making money while working limited hours. Many are putting in long hours but earning far less than anticipated, leading some to give up. This aspect touches on human nature, but we have made provisions for it. We are proactively engaging with those who are struggling much earlier, allowing us to provide assistance. And I will tell you, the franchisors are stepping up as well. They don't want a bad reputation in the market, so they're finding other servicers and players and people to help or take over stores. And when we're in there early on, we can do that before it becomes a crisis and everybody wins in the end.
So David, just one other question. If you've been paying attention to the news, we days ago entered a new golden age. I'm curious what you think that means broadly defined for your opportunities. Are you seeing a legitimate increase in enthusiasm, demand for growing businesses and loans? Just curious your thoughts there.
I haven't noticed any impact from the golden age yet. However, being in the Midwest, I'm hopeful you're experiencing something similar. One of the things I appreciate about our Midwest base is that we don't experience extreme fluctuations. Property values don't appreciate as much as in other regions, but we also don't face the same level of depreciation. When challenges arise, they are not as severe for us. While we may miss out on significant upsides, we also avoid dramatic downturns. I believe our businesses, aside from the super growth in SBA, have been strengthened by the strong team we've built over the last two or three years. We have some of the top-performing BDOs in the country, and due to our consistency and focus on the market, along with our Midwest values, we follow through on our commitments and complete tasks promptly. Our business is quite solid and dependable. We do not anticipate any significant spikes or major issues. We had a discussion earlier today about the commentary coming from Davos regarding the decline in oil prices, but we consider that chatter to be irrelevant. We do not give it much attention.
Your next question is from John Rodis from Janney.
Hey, Ken, what tax rate should we use for '25?
Yes. If you consider the earnings trajectory on a quarterly basis for next year, we expect a steady increase similar to this past year in 2024, but at a much higher level. From our perspective, looking at a tax rate of approximately 9% in the first quarter, rising to about 16% or 17% by the fourth quarter. On average, we anticipate it to be around 13% to 14% for the year. That's how we are currently modeling it.
Okay. Ken, could you clarify if the projected fee income growth of 9% to 12% for next year includes the $4.7 million gains from the fourth quarter?
It's without the gains. So back out the gains that gets you to, say $42.6 million and then go off of that.
There are no further questions at this time. I will now hand the call back to David Becker for the closing remarks.
Thank you, Jenny, and thanks, everybody, for joining us on today's call. As I said, we wrapped up '24 with some strong performance. We're entering '25 with a lot of great momentum and a lot of backlog and business and opportunity. We're highly optimistic about the future. Outstanding performance of the lending teams, along with emerging opportunities through the fintech and other partnerships positions us for a greater, more diversified revenue growth. We have the wind at our backs with a more favorable interest rate environment and an improving business climate. Adding all that together creates a great foundation to build on and deliver stronger earnings and profitability in 2025 and going forward. As fellow shareholders, we remain dedicated to maximizing shareholder value. We appreciate all your ongoing support and wish you a pleasant afternoon. Thank you.
Thank you. Ladies and gentlemen, the conference has now ended. Thank you all for joining. You may all disconnect your lines.