FinWise Bancorp (NASDAQ:FINW) Q2 2022 Earnings Conference Call July 27, 2022 5:30 PM ET
Company Participants
Kent Landvatter – President and Chief Executive Officer
Javvis Jacobson – Chief Financial Officer
Conference Call Participants
Andrew Terrell – Stephens
Andrew Liesch – Piper Sandler
Operator
Greetings. Welcome to the FinWise Bancorp Second Quarter 2022 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded.
The presentation will now begin.
Unidentified Company Representative
Good afternoon, and thank you for joining us today for FinWise Bancorp’s second quarter 2022 conference call. In addition to this call, we issued an earnings press release earlier this afternoon and posted it to the Investor Relations section of our website at investors.finwisebancorp.com. Today’s conference call is being recorded and webcast on the company’s website, investors.finwisebancorp.com.
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, 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 contained in the company’s earnings press release and filings with the Securities and Exchange Commission.
Hosting the call today are Mr. Kent Landvatter, CEO and President of FinWise Bancorp; and Mr. Javvis Jacobson, Chief Financial Officer of FinWise Bancorp.
With that, I will turn the call over to Mr. Landvatter.
Kent Landvatter
Good afternoon, everyone, and thank you for joining us on our second quarter 2022 earnings conference call. Our results for the second quarter further validate the differentiated business model we have built over the past several years, including continued strength in our risk management and profitability.
Despite a very challenging economic environment that deteriorated rapidly throughout the quarter and also factoring in the typical seasonal slowdown in originations, the resilience of our business model was evident as during the quarter ended June 30, 2022, we generated total revenue of $21.4 million led by loan originations of $2.1 billion.
Our results for the quarter also included net income of $5.5 million or $0.41 per diluted share. Net income during the quarter was primarily impacted by a decline in non-interest income from lower gain on sale of loans due to a decrease in the number of SBA 7(a) loans sold and an impairment of the company’s SBA servicing asset.
As we’ve noted on our prior calls, irrespective of the results of any single quarter, our primary focus remains on generating sustainable net interest income growth over the long-term driven by continued loan growth. Furthermore, loan originations generally have driven strategic program fees, which enhance our non-interest income, a key differentiating factor of our business model.
Importantly, given that all strategic platforms fund deposit reserve accounts tied to total held-for-sale loan outstanding, deposits have generally declined as origination volumes slowed. We are pleased with our credit quality, which remained strong. Non-performing loans declined to a total of $0.6 million as of June 30, 2022, compared to $0.7 million at March 31, 2022.
The ratio of non-performing loans was 0.3% of total loans at the end of the second quarter, compared to 0.2% the previous quarter. The small increase in our non-performing loans ratio this quarter is primarily due to total loan balances being lower during the quarter. Net charge-offs declined 18.4% to $2.3 million during this quarter from $2.8 million during last quarter.
This strong credit quality is a testament to our prudent risk management approach, including maintaining tight underwriting standards. We have also slowed retention to better assess and manage economic risks. One point I’d like to make clear, we have not adjusted our lending standards to reach for growth. Overall, we believe these attributes of our risk management process are best-in-class and enhance our ability to sustain sound credit quality through varying credit cycles.
During the quarter, we had an additional impairment of our SBA servicing asset as the market was impacted by rising market interest rates and SBA loan prepayment speeds. Importantly, we remain significantly above well-capitalized guidelines with a bank leverage ratio of 21.4%.
Furthermore, we believe that our relationship with existing strategic platforms remain strong as does the interest of potential new platforms and entering into relationships with the bank. This again validates our business model and brand as an innovative technology-enabled bank that efficiently serves a wide array of clients.
As we’ve noted in the past, these strategic lending programs have been a key driver to continued loan growth for FinWise in various ways through accelerating volumes from existing platforms, sourcing of new loan origination platforms and our exceptional ability to efficiently scale through our technology-driven and robust infrastructure.
Against a significantly more challenging economic backdrop, we are committed to staying the course in managing the business for the long-term while continuing to closely monitor economic trends. However, while we believe our business model lends itself to flexibility in both weakening and strengthening economic conditions if current adverse macro trends were to persist, we believe there would be a greater risk that the seasonal rebound in loan originations that we traditionally see in the second half of the year could be tempered this year.
Looking ahead, despite challenging external macro factors, we will remain focused on what we can influence, providing best-in-class service to our clients and customers while prudently managing risk and controlling costs. We also continue to enhance our business model by exploring ways to deploy our capital into opportunities that allow us to remain well-positioned to take advantage of growth opportunities when the environment improves.
We believe these actions bolster our strategy to continue to generate solid, long-term operating efficiency and profitability. Overall, we remain exceptionally proud of our differentiated business model, which continues to provide our clients and customers with best-in-class value and service, particularly during more challenging conditions.
With that, I would now like to turn the call over to our Chief Financial Officer, Javvis Jacobson, who will discuss our financial results for the quarter in more detail.
Javvis Jacobson
Thank you, Kent. Despite facing an economic environment that deteriorated quickly during the quarter, loan originations were $2.1 billion, down from $2.5 billion in the prior quarter and higher compared to $1.4 billion in Q2 2021. Average loan balances comprising held-for-sale and held-for-investment loans were $279.3 million during Q2 2022, a decrease of 5.9% from $296.7 million in Q1 2022 and an 11.8% increase from $249.7 million in Q2 2021.
Total average interest-earning assets declined 3.8% to $373.2 million during Q2, compared to $387.8 million for Q1 2022 and increased 24% from $301.1 million for Q2 2021. As we’ve mentioned on the past calls, our loan originations and balances have tended to decelerate in the first and second quarters of the year due to typical seasonality, and this quarter was no exception.
Generally, we have seen a rebound in the third and fourth quarters of the year. But as Kent mentioned, if economic conditions remain challenging or deteriorate further, we believe there would be a greater risk that the seasonal rebound in originations could be more muted this year.
Average interest-bearing deposits declined 4% to $127.2 million during Q2 compared to $132.5 million during Q1 2022 and increased 41% compared to $90.2 million during Q2 2021. The decline as compared to Q1 2022 was driven mainly by a decrease in certificate of deposits and money market accounts.
Compared to Q2 2021, the significant increase in average interest-bearing deposits was driven mostly by higher certificate of deposits, money market accounts and demand deposits. As Kent mentioned earlier, due to the relationship between strategic platform deposit reserve accounts and total held-for-sale loans outstanding. Our deposits have generally declined as our origination volume slows.
Positively, our cost of funding declined modestly during Q2. The rate on average interest-bearing liabilities decreased 3 basis points to 76 basis points from Q1 2022 and was down 20 basis points from 96 basis points during Q2 2021. The primary reason for both period declines is a continued drop in the rate on new or renewing certificate of deposits.
Net interest margin for Q2 was 13.69%, representing a 32 basis point increase from 13.37% in Q1 2022 and down compared to 20.29% in Q2 2021. The increase from the previous quarter was primarily driven by a loan mix shift away from loans carrying lower yields within the strategic program held-for-sale portfolio.
The net interest margin decrease from the second quarter of 2021 was driven mainly by a substantial increase in lower-yielding cash and cash equivalents raised in the company’s IPO and a loan mix shift towards loans carrying lower yields within the strategic program held-for-sale portfolio.
As we’ve highlighted on prior calls, we expect shifting asset mix to drive quarterly fluctuations in the NIM from quarter-to-quarter. Importantly, as we’ve noted on prior calls, our primary focus is on generating solid and sustainable net interest income growth over the long-term, driven by continued growth in originations.
Let’s turn to the income statement. Net income for Q2 was $5.5 million compared to $9.4 million for Q1 2022 and $7.7 million for Q2 2021. The sequential quarter decline was primarily driven by lower gain on sale of loans and an impairment of the company’s SBA servicing asset. The decline compared to the prior year period was primarily driven by an increase in non-interest expenses and a decrease in the fair value of the company’s investment in Business Funding Group LLC, BFG, partially offset by increases in non-interest income and net interest income.
Net interest income for Q2 was $12.8 million compared to $13 million for the previous quarter and $10.8 million for Q2 2021. The modest decline on a sequential basis was primarily due to lower average loans held-for-sale balances. Growth over the prior year period primarily reflects strong loan growth, resulting in higher average balances and an increase in the other interest-earning asset classes.
Non-interest income was $8.4 million in Q2 2022 compared to $11.7 million during the previous quarter and $8.2 million in Q2 2021. The sequential quarter decline was driven primarily by a lower gain on sale loans due to a decrease in the number of SBA 7(a) loans sold.
The increase compared to the prior year period was primarily due to an increase in strategic program fees due to significant loan origination volume growth partially offset by a decrease in the fair value of the company’s investment in BFG. As we’ve highlighted on prior calls, we expect general market movements to drive quarterly fluctuations in the value of BFG.
Non-interest expense during Q2 was $11 million compared to $9 million in Q1 2022 and up from $7.1 million during Q2 2021. The sequential quarter increase was primarily due to an impairment of the company’s SBA servicing asset in Q2 2022, driven by rising market interest rates and market-wide increase in prepayment speeds on SBA loans. Compared to Q2 2021, the increase was primarily due to higher expenses from incremental employee headcount related to an increase in strategic program loan volume and an impairment of the company’s SBA servicing asset.
The company’s efficiency ratio for Q2 was 52% as compared to 36.7% for Q1 2022 and 37.3% for Q2 2021. Although we look to make long-term investments in our technology platform and our workforce, we will do so carefully, particularly if the economic environment were to further deteriorate. We also plan to make continued investments to expand our strategic program infrastructure and to enable growth in our market share.
Credit quality remains strong with non-performing loans representing 0.3% of total loans receivable compared to 0.2% for the previous quarter and 0.3% for Q2 2021. The provision for loan losses was $2.9 million for Q2 compared to $2.9 million for Q1 2022 and $1.5 million for Q2 2021. The provision for Q2 2022 reflected growth of unguaranteed loans held for investment and lower net charge-offs compared to the first quarter.
The increase in the company’s provision for loan losses compared to the year ago period was primarily due to substantial non-PPP loan growth and an increase in net charge-offs. Net charge-offs for Q2 were $2.3 million compared to $2.8 million for Q1 2022 and $0.5 million for Q2 2021. Our net charge-off rate as a percentage of average loans for Q2 was 3.3% compared to 3.8% for Q1 2022 and 0.8% for Q2 2021.
The decrease in net charge-offs for Q2 2022 compared to Q1 2022 was primarily driven by lower gross charge-offs and increased recoveries related to our strategic programs. The increase in net charge-offs compared to Q2 2021 was mainly driven by growth in the company’s held-for-investment balances and some normalization of credit losses to pre-pandemic market conditions.
We continue to be pleased with the performance of these portfolios as they remain in line with management expectations, and we remind everyone that our reserve levels for these strategic programs are set according to high water charge-off rates by vintage and program plus additional factors.
Moreover, as we’ve noted previously, in March 2020, we proactively increased environmental factors that impact our reserve levels in conjunction with the heightened economic uncertainty at the start of the COVID-19 pandemic and we have not lowered these environmental factors since.
Overall, we remain confident in our portfolio underwriting and overall risk management. And while we expect credit quality to continue to normalize in line with industry trends, our relatively high reserve levels provide us with a formidable cushion. Our capital levels remain strong with a 21.4% leverage ratio, which keeps the bank significantly above the 9% well-capitalized requirement. Lastly, our effective tax rate was approximately 24.6% for Q2 compared to 25.4% for Q1 2022 and 25.2% for Q2 2021.
With that, I would like to open up the call for Q&A. Operator?
Question-and-Answer Session
Operator
Thank you. At this time, we will be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Andrew Terrell with Stephens. Please proceed with your question.
Andrew Terrell
Hey, good afternoon.
Kent Landvatter
Hello. Hey, Andrew.
Andrew Terrell
Hey. Maybe I just wanted to start on the origination volumes. Are you able to bifurcate just how originations progress kind of by month throughout the quarter? Just trying to get a sense of where the monthly kit of run rate is heading into 3Q.
Javvis Jacobson
Yes. So we haven’t disclosed the run rate by month, but I think you can just kind of look at the economic – general economic conditions and that we’re operating under right now and kind of assume a trend.
Andrew Terrell
Okay. And then I guess maybe just a bit more explicitly. I hear some of your comments around kind of caution on originations rebounding like you might expect in the back half with normal seasonality. But should we expect origination volumes declining from this $2.1 billion level in the back half of the year?
Kent Landvatter
It’s hard to look into the second half of the year because things are happening so quickly in the economy right now, but we do not look at that as something that’s out of the realm.
Andrew Terrell
Okay. And I understand you slowed down retention this quarter, makes sense, given just the backdrop we’re in right now. I guess, what would you need to see in order to kind of step the retention rate on loans back up?
Javvis Jacobson
Stabilization in capital markets, I think, Andrew, I think it’s a fair first indicator. I think we track all of this on a monthly basis, both monitoring and review of it. It’s not just the performance of the static pools, but also early indicators of those, whether it’s first payment to [indiscernible] level, et cetera. And so all of those are data points that we track regularly and deciding how much more retention we’re going to add or additional programs we may add.
Andrew Terrell
Got it. Thank you. And if I could ask one more just on the SBA gain on sale line item. I might have missed it, but did you disclose the dollar amount of SBA loans that were sold this quarter?
Javvis Jacobson
No, we didn’t disclose the dollar amount.
Andrew Terrell
Can you speak – go ahead.
Javvis Jacobson
It was flat – sorry, Andrew. It was less than it was in the first quarter, fewer dollars.
Andrew Terrell
Yes. Are you able to speak to just trends you’re seeing in SBA right now and maybe provide any kind of expectation you have for sold production volume or gain on sale income from SBA specifically? And then should we expect it to contribute the balance sheet growth in the back half of the year as well?
Kent Landvatter
So let me touch on like the pipeline and origination volumes. We continue to have good origination volumes in the SBA product line. We have – we’re just a small piece of that market, right? We’re like probably less than 1% of the total market. And so our ability to attract qualified applicants for that product continues to be strong. As far as the secondary market and margins there, I’ll defer to Javvis.
Javvis Jacobson
Yes. I think it’s – conditions are deteriorating slightly on the premium amounts. But our big driver for the fluctuations quarter-to-quarter is not the premium amount necessarily. It’s more focused on the number of loans that we sell. As we mentioned in the call last quarter, it was an unusually high number of loans that we sold in Q1 of 2022. This quarter is pretty consistent with what we’ve seen in the past.
Andrew Terrell
Okay. All right. Great. Got it. Thank you for taking my questions. I’ll step back in the queue.
Kent Landvatter
Thank you.
Javvis Jacobson
Thanks, Andrew.
Operator
Our next question comes from the line of Andrew Liesch with Piper Sandler. Please proceed with your question.
Andrew Liesch
Hey, guys. Good afternoon. Just want to talk about some of the investments that you have planned, and I recognize in the face of falling revenue growth, it seems like some of these may be pushed out. But I’m just curious like what are the things that are most important for you right now that you’re going to continue to invest in even in the face of slowing revenue? And then what things might get pushed out and where ultimately do you think the efficiency ratio could end up in the near-term with lower revenue, but also rising expenses and given some of the investments you want to make?
Kent Landvatter
Yes, Andrew, that’s a great question. I appreciate that. We’ve – there are certain types of expenses that we can pull back fairly easily. Sometimes those would be like production-related expenses, number of bodies per production that we have. The ones that were less inclined to the pull back on right now would be those that further our strategic positioning. We want to make certain that we are ready when a rebound comes that we can take full advantage as soon as possible of that.
So continued investment in the basic such as BSA, compliance, oversight, IT and continuing to build and evolve the platform to become more scalable, those are more strategic for us, and we’d be reluctant in the short-term to do something there. Of course, things seriously deteriorate, we always take a look at everything is on the table. But more so in the production-related and less so in the strategic foundational aspects of the bank. Did that help?
Andrew Liesch
Yes, absolutely. Thank you. And then the Javvis, give us some thoughts on how you look at the efficiency ratio in managing expense growth versus revenue trends?
Javvis Jacobson
Sure. The expense, obviously the efficiency ratio this quarter isn’t like – isn’t where we’d like to see it. And it isn’t where it’s been in recent quarters. I think as far as giving you some goalposts on the efficiency ratios, I would say it’s somewhere between where we’ve been in previous quarters in the mid to upper 30s and the industry.
Somewhere in that range is good goalpost for the efficiency ratios. But more specifically to us, the other expenses line item, you might have seen a slight tick up in that category. That’s where a lot of our public expenses are rolling into. So the legal and professional fees are going into that. We don’t think that we’re going to see any softening in those expenses going forward.
We have those obligations going forward. So that’s probably not where we’re going to see any changes there. And then as Kent mentioned, related to headcount and salaries, we’ll be very careful as we expand into the areas that he described.
Andrew Liesch
Got it. All right. That’s helpful. And then just following up on the loan origination question and the outlook there. What’s the pipeline for new strategic programs? Are you still thinking two to three new programs a year? What have been – what’s been the thought process and what our perspective program is telling you about their outlook?
Kent Landvatter
Sure. So our pipeline remains full. We also continue to deliver value and build on the relationships that we have with existing programs. So even though you’ve seen some dislocations in capital markets, it’s important to note that our partners come to FinWise because there’s a market need for a tech-enabled bank program and we’ve been delivering this since 2016 and continue doing so today.
Andrew Liesch
Got it. Thanks for taking the questions. I’ll step back.
Kent Landvatter
Thanks, Andrew.
Javvis Jacobson
Thanks, Andrew.
Operator
Ladies and gentlemen, we have reached the end of the question-and-answer session. Please disregard, it does look like we have a follow-up from Andrew Terrell with Stephens. Please proceed with your questions.
Andrew Terrell
Hey, thank you for the follow-up. Just one quick one maybe for Jim. I think you’re required to adopt CECL starting in 2023. And I heard the comments earlier about the allowance ratio and kind of the qualitative or environmental factors that are in there. But I was curious if you’re running parallel CECL right now, do you have what the allowance ratio would have been under kind of a CECL framework this quarter. And was it relatively in line with kind of the reserve you put up this quarter?
Jim Noone
Sure. So we are running it side by side, and we’re planning to do that for the duration of this year. We’re on track to adopt in January of 2023. But I do not have that number for you, Andrew.
Andrew Terrell
Okay. No problem. I appreciate it.
Kent Landvatter
Yes.
Operator
Thank you. Ladies and gentlemen, I am now showing no further questions in the queue. I would now like to turn the call over to management for closing remarks.
Kent Landvatter
Yes. Thank you. We just want to thank all of you for attending the call and your interest in FinWise Bank and wish you a wonderful afternoon.
Operator
This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation and have a wonderful day.
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