Triumph Financial Inc
NASDAQ:TFIN
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Earnings Call Analysis
Q3-2023 Analysis
Triumph Financial Inc
Showcasing a notable momentum, TriumphPay has surpassed its own financial performance expectations. Despite a turbulent market phase, the company managed to reduce expenses although this situation is considered unique and not expected to persist in the near future.
The freight market continues to experience a slump, and the potential for further decline exists. However, Triumph views these short-term market discomforts as seeds for long-term value creation. The company maintains a long-term focus by preparing for the softer market conditions and eyeing a material increase in market share as it maneuvers through the challenging period.
Triumph Financial is distinct in its strategy; while some industry players, propped up by private equity and venture capital, struggle to achieve profitability, Triumph Financial is focusing on sustainable business practices. With only a small amount of counterparty risk outstanding and a robust balance sheet ready for a softer freight market, the company is poised to emerge stronger than before.
Triumph Financial is actively constructing a payments network tailored for market demands, which involves considerable effort in communicating its vision and value to shareholders through detailed shareholder letters.
The company benefits from float revenue, which is computed at the overnight Fed funds rate, currently around 5.4%. With approximately $300 million in float, this translates to a substantial $16 million in pretax revenue. Should the higher interest rate environment persist, this high-margin revenue stream is anticipated to further expand along with growing float volumes, especially as TriumphPay scales up to engage shipper participants.
In the face of increasing nonperforming assets, Triumph has not required additional reserves due to strong collateral coverage. The company remains vigilant and prepared through stress-testing of its loan portfolio and feels confident in its secondary repayment sources.
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[Audio Gap] One, we do not yet see improving. We remain excited about the possibilities and our progress in spite of that. Last evening, we published our quarterly shareholder letter. That letter and our quarterly results will form the basis of our day. However, before we get started, I would like to remind you that this call may include forward-looking statements. Those statements are subject to risks and uncertainties that could cause actual and anticipated results to differ. The company undertakes no obligation to publicly revise any forward-looking statement.
For details, please refer to the safe harbor statement in our shareholder letter published last evening. All comments made during today's call are subject to that safe harbor statement. With that, I'd like to turn the call over to Aaron for a welcome and to kick off our Q&A. Aaron?
Thank you, Luke, and good morning. Thank you all for joining us. We made significant progress in the third quarter on several fronts. Our financial results were also better than in prior periods. In the shareholder letter released last night, I outlined 4 things that I thought were important to communicate to our investors about the quarter. Those included: First, TriumphPay's momentum and financial performance has exceeded even our own expectations. Second, we had a unique quarter from an expense perspective that is unlikely to repeat in the near term. Third, the freight market has not rebounded and it could get worse before it gets better.
And finally, related to that, the things that make us uncomfortable in the short term, we believe will create value for us in the long term. As it relates to those third and fourth points, the last few days have produced some interesting headlines. Two days ago, FreightWaves broke a story detailing that Convoy, a well-known tech-enabled freight broker had pulled its loads and that an announcement was forthcoming. We now know that Convoy is in the process of shutting down without a sale. That is something that would have been hard to imagine just a few months ago. Additional stories have followed speculating that several more freight brokers and carriers could face a similar fate. I'm friends with many people in this industry, and it saddens me to think about the disruption this will bring to many employees and customers. But however, I feel about it, that is the reality of how capitalism works.
Companies that are not profitable will eventually fail. And one of the reasons I am bearish on freight over the short term is because I believe that private equity and venture capital have artificially propped up some companies that were attempting to bring disruption to the industry without ever achieving profitability. I believe a significant amount of money will exit the stage in the freight industry and may not return anytime soon. I also believe that Triumph Financial and specifically what we're doing at TriumphPay is bringing innovation to the industry. And I know that this change is another healthy force of capitalism. The difference is that we are able to earn our cost of capital while bringing about this advancement instead of being beholden to additional outside funding. My journey into banking started in 2008 and 2009 and going through that process leaves you with a deep appreciation of the need to remain profitable even through the toughest cycles, and that is what we are built to do.
As it relates to Convoy, Triumph has less than 300,000 of counterparty risk outstanding, some of which we expect to collect in short order. And as additional brokers go through difficult times, we will continue to focus our attention on servicing the needs of the industry, while we remain vigilant in protecting our own balance sheet as we always have. Before turning it over for questions, let me explain that while my bearishness about the next 12 months or so is real, it also makes me extremely bullish on the long-term future for Triumph Financial.
We have a business plan and a balance sheet that is prepared for a soft freight market. We will be one of those companies who emerge stronger through this, and we should have a materially greater market share than we do now. We are receiving more inbound inquiries than I can recall at any time in the past. As companies in the industry look to partner with a known industry leader with the financial wherewithal operational experience and technology stack to help them navigate this market. And if the market ends up performing better than I expected in the short term, we will be more profitable and that would be great. But I am far more interested in creating value for the long term.
In conclusion, Triumph Financial is not a typical bank nor do we desire to be one. We are building a payments network in a market that needs one now more than ever. communicating that requires effort. So we put a significant amount of time and energy into our shareholder letters to help investors achieve an informed view. I hope you find those efforts valuable. With that, we're ready to take your questions.
We will now go to Q&A. [Operator Instructions] Our first question comes from Michael Perito from KBW.
Hi, everybody. Good morning. I had a few things I wanted to touch on. Number one, just off of your comments, Aaron, the shareholder letter was very helpful. So thanks for the color and thoughts around the current environment. On TriumphPay, obviously, a very strong quarter. I know there were a couple of things. It sounds like on the expense side, you guys highlighted. But one comment in the release I also noticed was around flow -- and I was just curious, I mean I imagine that's at pretty high margin. So I was wondering if you can maybe just dissect what the contribution of float was to try and pay in the quarter. And is it fair to think that, that freight stay at current levels were higher for longer that, that should be kind of a sustainable EBITDA margin contributor? Or do you expect any volatility around that?
Sure. The -- as we've explained in the past, how we calculate float for purposes of intersegment accounting is at the Fed funds rate overnight. So I believe that rate is roughly 5.4%. And -- so that contribution of that just under $300 million of float at that -- the Fed funds rate would be $16 million in pretax revenue. That is very valuable for us. That is very high margin for us. And of course, it's going to track what Fed funds do. So if we stay in a market that's higher for longer, then we expect that revenue component to grow because we expect our float will grow as our payment volume grows and we definitely believe that will happen over the next 12 months.
Yes, that was more of the question to the volume -- obviously, the rates are the rates, but does the volume, you expect that to continue to grow as your network transaction volume grows?
Yes, we do. Especially as we move further upmarket into the shipper participants, we would expect that to be -- have exponential growth.
Okay. And then secondly, I wanted to ask, Eric, I thought some of your comments around credit stood out. And I appreciate that for you guys. It's less of a percentage of your business and what you're trying to become, but still impactful near term. And so I did see that the nonperforming assets ticked up, but it looks like the reserve didn't really change much. I was just wondering if you could give us some color about what you saw on the credit side and maybe near-term expectations around any provisioning or reserve build that we should just factor in as we model out the early part of '24?
Yes, I'll take that one. So on the tick up in the nonperforming assets, those particular assets happen to be so well covered that there was no reserve required. That's the short answer to that question. As we continue to look forward, if there are additional credits that need to be downgraded, we'll go through the same analysis, but we're already stress testing the portfolio and we feel very good about secondary sources of repayment.
And Mike, if I can just add, if you go back and look at our shareholder letters from a year or 2 years ago, that was the time to make sure you were being vigilant on credit when the market was far more competitive than it is now. And I would never submit to you that we got it perfectly correct, right? That doesn't happen. But what I do know is because we weren't obsessed with growing our balance sheet.
And because we know this market operates in cycles, we were very disciplined. We are very thoughtful when we take credit on our books. And I believe that will serve us well. And so we have some things. I'm sure we will work through in this cycle. Do I expect there to be material losses? I do not. Because I know how our team has approached that and the discipline we brought to it in a market when a lot fewer people were thinking about that. But we're going to have to navigate these waters and something may surprise us along the way, but I feel very good about where we sit relative to the collateral position we have in our loan book and the underwriting we did when we were -- 2 years ago when a lot of these credits would have showed up.
And then just last, I'm sure there's questions so I want to ask too much here. But just on the factoring outlook near term. As you mentioned, Darrin, it sounds like there continues to kind of be incremental events in the industry that kind of gives you guys the clarity that you think the recessionary kind of trends could continue for some time. How do you -- do you have any near-term outlook or expectations around kind of invoice volume and average invoice size that we should be thinking of? Or even if it's just directionally kind of what you think that the current environment mean for you guys as we think about the model?
Mike, I'll take that one. We still see the freight market very soft. And one thing that we look at very closely to monitor that is how the freight market is reacting to fuel. In the third quarter, you fuel increased significantly, where it took a long time for rates to actually catch up. We didn't see improvement in the rate until late in the quarter. and even still in a vibrant market, those items or those numbers will move more in lockstep. So we see increase in the average invoice amount, not so much as demand driven as more expense driven through the fuel side of the business.
Got it. Okay. But I guess in high level, it's good. The EBITDA margin improvement on TPA comes at a nice time for you guys to be able to sustain investment in that business even if the factory business is a little light for the near term? Okay. I appreciate all the color.
Our next question comes from Thomas Wendler from Stephens.
Good morning, everyone. I just wanted to go back to TPA. Can you give us an idea of what the critical mass for the network volume looks like? And then maybe how the conversations are going with moving some of the legacy pricing up closer to that $5 per transaction target?
Yes. I think I can take that, Aaron. My -- our projections for critical mass, we think that what the industry needs is for us to be processing and hopefully making payments on 1 out of 2 brokered freight transactions over the road transactions. Right now, we are touching about 1 out of 3. And so our goal is to continue to build out the network and bring on clients to get to that position and then further beyond.
In terms of the $5 per transaction pricing, all of our pricing models for new business have been updated to include the per transaction pricing. However, there are always going to be some cases where we have to be creative and how we price deals to get them on board onto the network and the value that they create for all the participants, there's creativity that happens there. But there has been substantial progress made in repricing existing clients as well as holding pricing on the new business that we are chasing today.
Great color. And then sticking with TPay, can you give us some color around the expansion of network participants into verification only brokers? What does that opportunity look like with your audit only clients?
Yes. So that's a beautiful question. I'm glad you asked it. So as we have expanded our technology and capabilities -- the point of conforming transactions or network transactions is to provide the data that factors need in order to do their verification, validation and cash application processes. TriumphPay, while we're making 21 -- a little over $21 billion in payments, we are touching over $47 billion in carrier spend.
And so we have data associated with the audit only brokers on our platform that are very valuable to the factoring industry. And so over the last couple of quarters, we've been working on our technology to be able to include those data sets into the conforming transactions on network transactions so that they begin to see the value and are able to utilize that data on the front end, even though the payment data doesn't -- is not attached to it.
And then just moving over to credit. You've seen to have some increased fears around CRE, and I noticed an uptick in the loan modifications for CRE -- was there any theme behind the loan modifications, any specific group of loans? And then are you expecting to see any more modifications going forward?
We did allude a little bit to that in the shareholder letter. The theme is that those are variable rate credits. And so when you have a variable rate credit that price is up 500 basis points in a short period of time, obviously, that puts some borrowers at stress. And so we had to make modifications to address that. We ended up at a rate that is still okay. Our economics are not as good as we would love, but it allows that loan to continue -- those loans to continue to perform. And there's still equity in those properties. So the borrowers are willing to work with us on a long-term basis. So we expect more of that to occur over the course of the next few months as more and more of those variable rate borrowers are dealing with the reality of the new environment.
Our next question comes from Joanne Tunis from Raymond James.
Good morning, all. So kind of on expenses. You guys had -- you mentioned your shareholder letter that you expect 5% noninterest expense growth in 2024, absent any ramping of large clients. I was wondering if you could flesh that out that growth by different segments for payment factoring Medibank and corporate?
Bulk of the incremental spending that you'll see next year is likely to be in the payment side. You'll see a little bit in corporate, but I would probably couch it as 60% corporate, 60% payments, 40% corporate, roughly.
And then whether through deepening customer penetration or the onboarding of new brokers, how much annualized payment volume is contracted to come on to the network in the next 6 to 12 months?
Yes. So the way I would describe that for you, Joe, is we speak only about brokers that are in active integrations. And so those that are contracted and in active integrations represent that's come on board in Q2, Q3 and then what we expect to on board in Q4 represents approximately $9 billion in annualized carrier payments amongst all of them. Some of them, they've been onboarded and they're in their ramp-up stage, again, which takes 6 to 12 months for them to typically fully ramp.
So all else equal, if no other brokers or factor signed up on the network, you would have $9 billion in incremental volume. Okay. And then I mean.
Yes, autos remains the same. Yes, right.
Of course. So for TPay, you've announced a lot of major wins on the broker side, but we haven't seen the same type of momentum on the factoring side. I think at this point, the quickest way to increase the network transaction penetration which looks to be about 6% of all invoices in the quarter would be to add some large factoring companies. Can you discuss the progress on that front and when we might see some large wins there?
Let me take that one. So the -- and we allude to it if you read the factoring section of this letter. -- the gating issue, in my opinion, towards driving greater factor participation in the network has to date been the fact that we were making 1 out of every 6 payments to them. And then we were making 1 out of every 4 or providing network data on 1 out of every 4 and now we're at 1 out of every 3. I believe a day is coming sooner rather than later where it will be 1 out of every 2.
And once you get to that level of penetration, factoring companies now can start to use your technology to change their processes. I mean that is the brand promise that TriumphPay makes to the factoring industry. If you look at our own factoring subsidiary, it costs us roughly $6 to do the back-office processing per invoice. And that's a generalization because it depends on whether it's a large fleet, a small carrier, but let's just use $6 as a good approximation. We need to, for our own benefit and for every other factor we want to join the network, we need to be able to demonstrate we can get that price down to $3. And that would be a tremendous margin pickup for them. Well, you aren't going to be able to do that if you don't make a significant amount of their payments or provide a significant amount of audit data for conforming transactions. We are closing in on that mark.
The second gating issue is there is required technology improvement in most factoring management systems able for them to be able to ingest load data before an invoice is created. No FMS was ever built to do that. We are having to -- our own FMS had to be improved to be able to ingest that data -- and so 1 of the things we talk about in this letter is we are thinking through how we can offer to the factoring industry, the ability -- some of the technology we have built and the operational expertise we have, so that they can more easily ingest that data so that they can pick up the cost savings that is the brand promise of TriumphPay. It's the cost savings and the assurance of the validity of the invoice. That is our promise to them. We are delivering on that. It's a very fair question, Joe. I think it comes in a much faster rate after we achieve that 50% penetration that Melissa alluded to, and we are working towards that.
[Operator Instructions] Our next question comes from Gary Tenner from D.A. Davidson.
Aaron, I wanted to ask your comments in the letter regarding your pessimism or bearishness about the freight industry didn't sound like it was universal, but certainly your view of the world. As you look at the data from, say, DAT, you've seen spot rates for van spot rates move up a little bit from the summer lows. But over the last couple of weeks, after moving a little higher, the van load or load to man ratio seems like it's want cliff. I mean is that more recent data? Is that kind of really a big driver of your view going forward and the lack of capacity coming out of the system?
I wouldn't tie it to that. That's just 1 data point. I start with the point, Gary, that I think any of us in the industry begin with the hope that we're wrong, right? We all want the industry to return to 2022 levels, although I think any of us who lived through that would acknowledge, I don't know that, that was particularly healthy either. It was very profitable in the short term in 2021 in that time period.
What I look at is normally in this part of the season, you would see invoice the spot rates moving and those moves would certainly pick up a movement in diesel cost. Because if you think about what the spot rate is, it's just -- it's marking to market every night. It's marking to market capacity. It's marking-to-market input cost, of which diesel is a very large one. And at this point in the season, if we believe all that has been written about retailers are at the end of the destocking phase that we went through this bullwhip effect that some people were very right on that -- of why the market got so tight for a while. If we believed we were coming to the end of that we would see the spot rates more sensitive to the input costs in the system. We are not seeing that. And that, plus just all of the things we see just leads me to believe we have excess capacity in the system.
I would think that many, a very significant number of small carriers are unable to earn their cost of capital, taking spot rate loads right now. Of course, there are exceptions, if you're in a certain lane. But on the whole, I believe that to be true. And that is why you're seeing the attrition in our own factoring client base. That's why I think you're seeing softness across the market. And so my view is it is what it is. So what is it? I think freight has not rebounded to the point where most carriers can earn their cost of capital, which means we need capacity to lead the system in order to recreate equilibrium. And I hope we're wrong. I don't think we are. How long it takes to do that, there will be catalysts. If you think about what's happened in the last few days with the announcements we've referred to, it seems like these things always start slow at first and then they accelerate. And so it may be that the industry recalibrates more quickly than I would expect. But right now, my own personal view is this takes the next 12 months for the industry to sort itself out and achieve equilibrium.
I appreciate that. And since you just kind of alluded to recent news and that Convoy wind down, I don't know that to company really well. But -- was there anything at my understand they were a carrier that was kind of tech-enabled, but was there anything they were doing that you think was particularly interesting, and that kind of plays into your one-term view of the freight industry?
I think Convoy built tremendous technology. They were exceptionally talented and smart people. The problem that they and some of these other tech-enabled brokers have is that in order to build -- go from just traditional brokerage. Like if you think about what was traditional freight brokerage, it was contracting with shippers to move loads and then using people and using phones to find carriers to haul those loans and make a 15% margin, beautiful business model, highly scalable. A lot of freight brokers have done exceptionally well with that.
Take the last 10 years, there has been this move to we should create digital freight marketplaces. And conceptually, I don't disagree with that. I think the idea is right. The execution is exceedingly hard -- it's exceedingly hard to get the scale and bring in all the dynamics that get priced into this very vibrant, very hard-to-predict trucking industry that is attached to the global supply chain. It's just hard. So I think Convoy did great things. I think there are many other tech-enabled freight brokers who have built really cool technology. But at the end of the day, cool technology and really good marketing will not make up for the inability to earn your cost of capital. And this market and where the capital markets are, has brought that to bear. And we've known that none of us are surprised that this day is coming. We didn't know exactly when. We didn't know exactly what would cause it -- but it's our job at Triumph because we've had freight brokers as our counterparties in our factoring business for over a decade, frankly, since the inception of our factoring business back in 2004 before we even bought it.
We -- it's our job to think about not who has the best technology or who's in has the best user interface, it's who can afford to repay us when payment is due. That is a banking discipline and that is a discipline we have never forgotten because we know what it's like when it goes the other way. So I suspect there will be some more. I suspect this technology will live on, and we'll improve the industry for all of us I hope that these really talented people I've gotten to know will land places and continue to make the freight industry better. It's just you have to do this. You have to build things for us with Triumph. You have to build it in a way that when the market inevitably turns against you. You can afford to keep making investments. And that is a discipline we take very seriously.
I appreciate thoughts on that. I just threw in 1 last really quick question, a follow-up on the expense question. Really thinking about the fourth quarter and kind of modeling a jumping up point there from a segment perspective. the return or normalization of expenses in the fourth quarter, closer to the second quarter, I assume that's similarly weighted towards the Payments segment.
I would expect the fourth quarter to look pretty similar, Gary, to the second quarter across each of our segments.
And Gary, one thing if I may add on that, those expenses -- and I think we're all in a cycle where talking about expense control is appropriate, and that's what we should be talking about. But understand that those expense spikes that we sometimes have in TriumphPay that are tied to the onboarding of a large freight broker are the best kind of expense. Because that is an investment in a long-term contractual relationship. And so we take a lot of that expense, not all of it, but we take a significant amount of that expense upfront.
And we have yet to have a large freight broker ever leave our ecosystems. The duration of those relationships is proving to be very long. And every quarter, we go forward and do more for these customers, the relationship gets deeper. So we want to be thoughtful about expenses. We don't take it lightly. But those specific spikes, that part of the expense base, I will take all day every day because I know over the long term, it creates a lot of value for us.
Our next question comes from Hal Goetsch from B. Riley Securities.
Just want to ask about the core banking side of the business. You can true your word of not really growing the asset side of the balance sheet. One of the areas where does growth real estate year-over-year. And I just wanted to get your feel on are you just seeing some great conditions right now to make some good loans to very selective opportunities for your team in that banking segment. love your thoughts on that.
Yes, I think you characterized it really well. There are a lot of opportunities out there. Not all of them have adjusted to the new realities of this interest rate environment in this economy but some have. And where we see really strong tenants, really strong borrowers, great risk-adjusted returns. We are still open for business, and we will continue to be so. So yes, that's what drove the growth last quarter.
There are no other questions on this line at this time. Thank you.
Assuming that was my invitation to conclude the call. We thank you all for joining us today. We appreciate your attentiveness in what we are doing, and we look forward to speaking with you soon. Have a great day.