Pathward Financial Inc
SWB:FM7
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Earnings Call Analysis
Q1-2024 Analysis
Pathward Financial Inc
In anticipation of future shifts in the net interest margin (NIM), executives expressed the need for a wider base of noninterest income. The rationale behind this is to cushion the potential volatility that could arise from changes in interest rates in the next 2 to 3 years. Their strategy includes an emphasis on products that don't depend on interest income, which could be beneficial in various rate environments. A growth initiative highlighted in the discussions revolved around working capital and asset-based lending. They identified this as a high-yield opportunity that leverages one of the company's strengths, managing loans with liquid collateral. This specialized approach to lending is seen as an important part of their competitive advantage and an area poised for expansion due to ongoing industry stress.
The executive team discussed the potential impacts of rate cuts on operations. The contractual structure of their deposits is such that a decrease in Federal funds rates would immediately lower the cost of their deposits. They also mentioned a 'book' with some duration, suggesting that short to intermediate term rate drops could be advantageous from a NIM perspective. However, they acknowledged that a long-term general reduction in rates would ultimately compress margins.
Moving on to fiscal management, the conversation on the call indicated that the first quarter's expense growth might be indicative of the run rate stakeholders can expect going forward. The company targets a 2:1 operating leverage, staying committed to it even as they continue to invest in human capital and technology. In the context of operational efficiency, executives felt confident that the efficiency reached in certain business operations, specifically mentioned were refund transfers, is as good as it can get. Investments will remain focused on technology to maintain and perhaps improve that efficiency further, with past years providing a reliable indicator for expense run rates.
When discussing capital deployment, the leadership team defended the decision to repurchase shares, suggesting that, at current stock prices, buybacks deliver the maximum return on equity (ROE) compared to other uses of capital. The executive was clear to point out that should their stock reach a higher valuation benchmark, they would reevaluate their capital allocation strategy. They also entertained the potential for mergers and acquisitions (M&A) but expressed caution ensuring that any investment or acquisition especially in technology, properly alines with the company's needs and standards.
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Ladies and gentlemen, thank you for standing by. Welcome to Pathward's Financial's First Quarter Fiscal Year 2024 Investor Conference Call. [Operator Instructions]
Following the prepared remarks, we will conduct a Q&A session.
As a reminder, this conference call is being recorded. I would now like to turn the conference call over to Darby Schoenfeld, Senior Vice President of Investor Relations. Please go ahead.
With me today are Pathward Financial's CEO, Brett Pharr; and CFO, Greg Sigrist, who will discuss our operating and financial results for the first quarter of fiscal 2024, after which we will take your questions. Additional information, including the earnings release, the investor presentation that accompanies our prepared remarks and supplemental slides may be found on our website at pathwardfinancial.com.
As a reminder, our comments may include forward-looking statements, including with respect to anticipated results for future periods. Those statements are subject to risks and uncertainties that could cause actual and anticipated results to differ. The company undertakes no obligation to update any forward-looking statements.
Please refer to the cautionary language in the earnings release, investor presentation and in the company's filings with the Securities and Exchange Commission, including our most recent filings for additional information covering factors that could cause actual and anticipated results to differ materially from the forward-looking statements. Additionally, today, we will be discussing certain non-GAAP financial measures on this conference call.
References to non-GAAP measures are only provided to assist you in understanding the company's results and performance trends. Reconciliations for such non-GAAP measures are included in the appendix of the investor presentation. Finally, all time periods referenced are fiscal quarters and fiscal years, and all comparisons are to the prior year period unless otherwise noted.
Now let me turn the call over to Brett Pharr, our CEO.
Thank you, Darby, and welcome, everyone, to our first quarter 2024 conference call.
I want to provide a special warm welcome to Greg, our CFO, to his first earnings call with us. We're very pleased with our results in the quarter and have started off the year by laying the groundwork to deliver on our key goals for the year. Those are, number one, building bath into a one-stop shop for our partners. And number two, smart growth in commercial finance to help ensure proper yields and a credit profile for this financial environment. Before I get into a deeper discussion of our business, I want to start out by providing some first quarter highlights.
We reported net income of $27.7 million and $1.06 per diluted share. When you adjust the first quarter of 2023 for the gain on sale of names and trademarks, expenses related to rebranding, efforts and separation expense, what we will refer to collectively as rebranding for the remainder of the call, Net income grew 19% and EPS increased 31%.
Earnings growth was driven through expansion of our net interest margin to 6.23%, an increase of 61 basis points. Our adjusted NIM, including rate-related processing expenses grew to 4.71% from 4.68%. Our return on average assets for the quarter was 1.46% and return on average tangible equity was 33.95%. Remember that return on average assets is impacted by seasonality with tax season revenue and income occurring next quarter.
For reference, ROA in the first quarter of last year was 1.71%, but if you adjusted for our rebranding efforts, it was 1.42%, which we are running slightly ahead of this year. Finally, we are reiterating our guidance range of $6.20 to $6.70 in earnings per share for the full year.
Greg will give you more color on this in his remarks. On the asset side of the house, we saw pretty significant growth in total loans and leases, especially when compared to the first quarter of last year, with growth in nearly every loan category across the enterprise. Greg will get deeper into the details of the drivers of our year-over-year financial performance in a moment, but I did want to comment on some of these trends. After a very strong growth in insurance premium finance in the third and fourth quarters last year, we're starting to see that business normalize and we would expect to maintain balances near the December 31 levels.
In structured finance, there's a strong pipeline, especially in the renewable energy and government guarantee verticals. However, these renewable energy deals are not the type of transactions that will generate income tax credits for us. As we have previously communicated, we believe our opportunity for ITC will be lower than last year, and this is included in our guidance.
On credit, the quality of our portfolio remains steady. Our nonperforming loans ratio has improved 38 basis points sequentially, primarily due to the workout of a deal, a single deal that caused the increase in the last 2 quarters. We think this is a secret sauce of our business. Our nonperforming loan ratio may increase from time to time, but we are typically in a position to resolve these loans and generally experience a recovery in the 1 or 2 quarters following the increase. This has generated an annual net charge-off rate that trends in the 50 to 70 basis point range. And with our yields, we're very comfortable with that range. Finally, as we mentioned on the last call, our 2024 focus in commercial finance and smart balance sheet growth, and we're accomplishing this by ensuring that the loans we are adding to the portfolio have the proper risk-adjusted yields.
This is an undertaking across all of our loan products, and we continue to evaluate all loans in this context. We are working on optimizing our capital and asset mix with an eye towards further expanding net interest margin. On Banking-as-a-Service, our performance continues to be strong. As is typical this quarter, we saw growth in deposits from the end of fiscal year 2023. To remind you, our deposit base does experience seasonality. Our typical pattern is to see growth in the first quarter from the sale of gift cards during the holiday season. This then grows again in the second quarter with our tax season business. And then deposits typically trend down from there as the seasonal balances get spent with the lowest level usually at fiscal year-end.
Additionally, to seasonal trends, we also have seen increases in deposits from some of our current partners. This has translated to solid performance in core card fee income. From a business development perspective, we signed agreements with 3 new partners during the quarter. While the impact of this is already contemplated in our guidance today, it speaks to the strength of our pipeline, which we believe to be healthy.
Additionally, on January 16, we announced a multiyear extension with a long-standing partner that allows for collaboration on product innovation and expanded product offerings for a range of programs in market and under development. The regulatory environment has put us in what we believe to be a strong competitive position in the BaaS industry. However, these deals tend to have a much longer sales cycle due in large part to the regulatory processes that are required before a program can go live. Deals we are working on now with benefit deposits and card fee income later this year and into fiscal year 2025. The value of our deposit base continues to put us in what we believe to be a position of strength with the 2 sides of our balance sheet being well matched. Based on our decay model, our noninterest-bearing deposits have a weighted average life of around 5.5 years.
Our loan portfolio's weighted average life is a little over 2 years and our securities portfolio duration is around 5 years. We believe this to be particularly beneficial in today's environment.
Now I'd like to turn it over to Greg, who will take you through the financials.
Thank you, Brett. Adjusting for the impacts of rebranding activity in the first quarter of fiscal year 2023, net income grew $4.5 million or 19%. EPS of $1.06 increased $0.25 or 31% from the prior year quarter. These results were driven primarily by an increase in net interest income, which totaled $110 million during the quarter, an increase of 31% from the prior year. This is both rate and volume driven. We continue to see the impact of rate increases in the prior fiscal year flow through our portfolio as repricing occurs, and we remain focused on our pricing discipline. The result has been an increase in yields across nearly all commercial finance lending categories.
From a volume perspective, total loans and leases have increased almost $1 billion since the end of first quarter of 2023. The quarter's net interest margin of 6.23% grew from 5.62% in the prior year's quarter. When accounting for the impacts of the company's contractual rate related card expenses the company's adjusted net interest margin increased to 4.71% compared to 4.68% in the prior year.
Net interest margin has benefited from increasing the new production yields in commercial finance, which during the first quarter was a blended 8.93% versus a portfolio yield of 8.3% at the end of 2023. Wholesale deposits were used early in the quarter to bridge the seasonal low point for BaaS deposits. and more on BaaS deposits in a moment.
Looking ahead, our earning assets should continue to reprice at higher rates as loans and investments mature and we are able to replace them with higher-yielding assets assuming the middle part of the rate curve remains fairly stable. Of course, any rate-sensitive deposits would reprice immediately with any FOMC rate cuts.
As of December 31, the company had an ACL coverage ratio of 1.22%, a decrease from 1.5% at the same time last year. Our commercial finance group has an ACL coverage ratio of 1.3% compared to 1.62% in the first quarter last year and only a slight increase from last quarter's 1.26%. The year-over-year declines are generally a result of a mix shift toward insurance premium finance and USDA, which have a relatively lower allowance rate. Noninterest income of $52.8 million declined $13 million from the prior year.
In the prior year's quarter, the company recognized the final $10 million gain on sales stemming from the rebrand. Additionally, carbon deposit fee income declined $7 million, driven primarily by lower service fee in fee revenues related to lower levels of off-balance sheet deposits. As expected, our off-balance sheet deposits and corresponding service income related to those deposits declined from fiscal year 2023 as we hold higher levels on the balance sheet to fund loan growth and continue to return EIP deposits back to the Treasury Department. Noninterest expense of $119.3 million increased 14% year-over-year.
The increase was driven primarily by contractual rate related card expenses and higher compensation expenses. This was partially offset by legal and consulting related to the rebrand that did not recur in 2024. Rate related card expenses increased primarily due to the higher rate environment. The seasonality that Brett described earlier also impacts our earnings. Our lowest earnings quarter tends to be Q1, whereas Q4 tends to be our lowest deposit balance quarter. While deposit balances generally increased in Q1, this is largely due to gift cards that are oftentimes not utilized in the quarter.
Moving into Q2, we see a larger spike in revenue and income when those balances start to get utilized and when tax season occurs. Finally, revenue and income tend to decline into Q3 and Q4. Deposits at December 31 are reflected on the balance sheet increased $1.1 billion from last year's quarter.
During the first quarter, the company maintained an average of $379 million of off-balance sheet deposits, earning -- servicing fee income roughly equal to the effective Fed funds rate. On December 31, there were $1.1 billion of deposits held at partner banks, increasing from last quarter due to seasonality. This brought total on and off-balance sheet deposits to around $8 billion, roughly flat to last year. However, at the same time last year, we were managing approximately double the deposits off balance sheet. And as expected, this balance shifting has contributed to our lower card and deposit fees this year. The difference this year is that we have increased our loan and lease balances by nearly $1 billion causing us to [indiscernible] of our deposits on balance sheet to fund that growth and that impact can be seen in higher interest income.
As an update, at December 31, we are still holding roughly $838 million of deposits related to government stimulus programs. Through the remainder of fiscal 2024, we expect to return around $310 million of unplanned deposits to the U.S. Treasury. Total loans and leases at December 31 were $4.4 billion, a 26% increase from a year ago. The company saw strong growth across nearly every loan category, including over $700 million in commercial finance loan growth, with the largest increases in term lending, insurance premium finance and structured finance.
Sequentially, loan and lease balances increased slightly from $4.4 billion at September 30. Growth in Commercial Finance was driven primarily by term lending and the SBA USDA business which was partially offset by expected declines in the insurance premium finance portfolio.
From a liquidity perspective, Pathward continues to be well positioned. Our balance sheet is strong, and when you factor in all of our sources, we have over $3.8 billion in available liquidity. As Brett mentioned previously, the 2 sides of our balance sheet are well matched in weighted average life and duration. During the quarter, due to a decrease in longer-term rates, our accumulated other comprehensive loss position on the balance sheet, largely related to the securities portfolio improved by nearly $70 million. We would expect the securities portfolio to continue drawing down with approximately $300 million of cash flows available for reinvestment over the next 12 months.
Also during the quarter, we were pleased by [ KBRA's ] affirmed credit ratings for Pathward, including the deposit and unsecured debt rating of A- for our bank subsidiary, which highlights the strength and stability of our funding profile and business model. Finally, during the quarter, we repurchased approximately 233,000 shares at an average price of $47.25. From January 1 through January 19, we have repurchased an additional 342,000 shares at an average price of $51.01. We are reiterating our fiscal year 2024 GAAP earnings per diluted share guidance of $6.20 to $6.70. This includes a number of assumptions.
With growing loan balances causing lower off-balance sheet deposits, we expect the revenue mix to remain in favor of interest income in 2024. This is due to the fact that we expect deposits to largely fund loans resulting in full year average off-balance sheet deposits near the Q1 average of $379 million. We expect our full year net interest margin and adjusted net interest margin to continue to expand when compared to the full year 2023, given our continued focus on asset pricing, along with the $300 million in annual securities cash flows reinvested in higher-yielding assets.
With less opportunity for ITC, we estimate our effective tax rate to be in the range of 16% to 20% for the year. Lastly, I would like to point out that the fundamentals remain strong across our businesses, and we would expect to see the continued benefit in our financial results.
Now I'd like to turn things back to Brett for some closing comments.
Thanks, Greg. As I think about the remainder of fiscal 2024, I look forward to the opportunities Pathward is pursuing. We have a healthy pipeline in front of us in BasS and are looking to add recurring revenue that drives sustainable net income. Additionally, as I mentioned before, we are underwriting loans and leases, but are maintaining a focus on risk-adjusted returns to ensure that when we are adding assets, they are the right ones for this environment. We believe this provides us with a highly differentiated business model from traditional banks. That is not as reliant on capital or balance sheet to grow. It also puts us in the position of being able to enhance capital and earning assets in order to deliver balance sheet optimization.
In addition, we continue to invest in technology and human capital across the organization in pursuit of delivering 2:1 operating leverage in the coming years. It is our belief that delivering on this strategy will put the company in an enhanced position of strength and give us the ability to drive further growth in revenue and earnings in the future. Finally, tax season has begun. While it is still very early, we did increase the number of independent tax providers utilizing our products and believe that we continue to grow market share. We look forward to giving you an update on our next call. This concludes our prepared remarks. Operator, please open the line for questions.
We will now begin the Q&A session. [Operator Instructions] Our first question today comes from Frank Schiraldi with Piper Sandler. Please proceed.
Just was wondering on the -- you guys reiterated obviously bottom line guide here for 2024 and obviously, the rate outlook has changed a bit. So just wondering what's baked in, in terms of rate cuts. And when you take into account deposit costs that run through noninterest expense seems like you might be pretty fairly close to neutral in the down rate environment. So could you just speak to that, please? .
Yes. I mean I'll start with the latter one. The balance sheet is pretty close to neutral, which again, I think that gives us benefit as we move down the rates. And right now, in our guidance, we only have one rate cut in there, and it's really at the end of April, beginning of May. So to the extent that the forecast pulls forward, Frank, we probably have some upside from that, quite frankly.
And then you had pretty good growth in commercial finance in term lending and as the premium finance business maybe stabilizes here. Just wondering, I think, Brett, you spoke to a pretty good pipeline here. What sort of growth you think are you targeting in the commercial finance business in the near term here? .
Yes. I think we're going to be thinking a lot more about asset-based lending. We've seen some increases in that. We're seeing more of that in the pipeline and that's got a pretty good yield with us. It's just the trick is to make sure you get the right transactions at the right price. So I would highlight ABL. I'd also say that in our structured finance area, we mentioned that while it doesn't help with these tax credits. The solar business, alternative energy business has got a pretty good pipeline as well.
And then I know it's pretty early in the game here, but just any sense or any indication of how tax season might be the same, might be different in 2024 as opposed to 2023? Any changes to economics or assumed loss rates here on the Advanced product? .
No, Frank. I mean, tax season always is an interesting question at this point. We already told kind of what we know, which is we signed up more EROs, those are the independent tax preparers which could speak to our market share opportunities. But there's -- you don't know we think you know. And it will be -- when we come around to the end of the conversations at the end of the second quarter, we'll be able to give you a lot more impact and understanding of how it went. But there's nothing unique this year that we're seeing. So if you go back to the cougars, there were unique things happening. So far, nothing unique, and I hope it to be business the usual kind of the year.
The only thing I'd probably add, Frank, is, I mean, I know since last year, we put a lot of effort internally into both underwriting and monitoring processes. And I do think we hope that, that would help drive down some of the loss rates this year as well.
And then finally, if I could sneak in just one more on the consumer finance book outside of the tax holdings, it looked like reserve levels as a percentage of the book increased quarter-over-quarter and just wondering if that indicates a change in demographic or type of credit you're putting on the books. Is that one area you expect you can pick up yield maybe or just any color there? .
Well, that really is our partnership business there, Frank. So it actually does have a tax angle to it -- seasonal. So I don't think it really speaks to broader dynamic than that candidly.
Our next question today comes from Eric Spector with Raymond James. Please proceed.
This is Eric on the line for David Feaster. Just wondering if you could touch on some of the growth initiatives where we stand on those, whether it be early [indiscernible] embedded banking [indiscernible] access and the like cures where you are on the product build-out and pipeline with those where you're having the most success? .
Yes. I mean we're very much involved with different partners, co-creating unique solutions that are in all those faster payments verticals, I would say that these things take time. We're getting some revenue from them, but not anything that we would report as material and we'll keep growing. The beauty of that is that in most cases, that is noninterest income. And so that's very exciting for us. And that's one of the things we're continuing to focus on is how we grow noninterest income with products like that in that arena, particularly as we think about where is NIM going to be 2 years from now or 3 years from now, we want to have a heavier dose of noninterest income.
And then just one growth initiative we've talked about recently has potentially grown the working capital. Just curious how you think about that and any other lending segments you might be interested in expanding into?
Yes, it's kind of what is still on Frank was the working capital is an area of asset-based lending, particularly where we think there's some growth opportunities as there continues to be some stress in various types of industries where we can do some of these transactions that are a higher yield. To remind everybody, it's a heavily collateral managed using liquid collateral and we're very good at that as part of our secret sauce. And when I can get those and get the yield for the right kind of transactions, I really like that asset class.
Okay, that makes sense. And then just one last question. I'm just kind of curious, you talked about one rate cut in your assumptions. Just curious how you think about your operations as we begin to see a few rate cuts. Obviously, deposits will reprice lower, but loans will also. Just curious maybe if you could provide some color on just the margin trajectory. And then from a broader perspective, how you think about how that would impact loan growth and maybe some of the other businesses assuming rates come down? .
Yes. So I think a few things. Remember that the cost of our deposits, the way our contracts are written in the accounting that we deal with it. If Fed funds goes down, the day it goes down, our cost goes down. So that's the first thing that helps us. Secondly, we've got a book that has some duration in it and so actually, in the short and intermediate term, the rapid drop in rates would be to our advantage on the NIM side over a long time, obviously, then the rates come down in general. So from a rate and profitability standpoint, that's the picture. Rates dropping will likely foster more economic activity that doesn't bode as well for our working capital product, which -- but other products that we have, they'll become more of the thing you might think about some of the leasing products and other term products our credit box view of that would be better. And so we would do more of those. And that's one of the beauties of our diversified loan product portfolio is when one is up, another may be down, and one down and others up. And that's we'll deal with whatever rate environment comes and take the opportunities the market gives us.
Next question today comes from Michael Perito with KBW.
Yes, I think a lot of the financial questions have kind of been asked and answered, and I apologize if I missed this, but just one quick maybe follow-up, just around the seasonality of kind of EPS annually here and the expenses. Obviously, there's the tick up in tax revenues, also the tickup in tax expense in the second quarter. But just wondering if there's any kind of additional guidance or guardrails you can give us on kind of the expense growth for fiscal '24. I know you guys have the 2:1 operating leverage target kind of unchanged, but just if we're talking maybe just run rate here. Any additional thoughts you can provide? .
Well, I guess what I would say is I think the Q1 is actually a pretty good run rate for us, understanding that we're always going to continue to invest in human capital and technology, which is that 2:1 operating leverage that you mentioned. I think it was really one other caveat that besides that, which is, in the second quarter, you definitely have the tax pick up a little bit, but it's also a little bit of comp and benefits just above and beyond that, which I think you can track, if you go back and look at the last couple of years, is the seasonality there.
Over the balance of the year, other than some modest continued investment, I think that's how I think about the run rate.
That's helpful. And is there any -- I think you mentioned, Greg, a comment about how you'd expect maybe some of the underwriting around some of the tax products to be improved. Is there any efficiency that you would target in the tax business? And if we look back to the prior year in terms of the pickup in cost? Or is that pretty much as efficient as it's going to get at this point? .
I think it's about as the fish is going to get. We did a lot of work around the operations of that several years ago and we've got that pretty main [indiscernible] for what we get, and we're pleased with -- on the refund transfers and the approach of the ROs. It's about as good as it's going to get. We make some investments in technology to stabilize that area and keep it efficient. So I think past years on the expense run rate are pretty good indicators.
Great. And then just kind of a philosophical capital question. As we look at a few of the moving pieces here. I mean you guys, particularly the margin neutrality plays out. I mean you're pretty consistently pumping out a well north of 20% ROE annually on a balance sheet that really isn't growing a ton. And I don't necessarily -- not suggesting a right answer or wrong answer to this, but at what point do the buybacks, when does there need to be more tools kind of or arrows in the quiver here in terms of capital deployment? I mean how are you guys thinking about that. I'm sure you're budgeting out at least 24 months, if not longer. And I imagine the capital creation is pretty significant. Just would love some updated thoughts around that as we kind of start your fiscal '24 and as we think about estimates for the next couple of years? .
Well, Mike, as you know, we're in an innovative business that is changing over time. there will be, at some point, some use of capital. But at these prices and for a while at the -- this level of stock, there's not a better use of our capital than to buy the shares. And we get up into a B12 or something, then we'll have a different conversation. But right now, I can't get an ROE on capital that's better than what I'll get by buying back shares.
And is there -- as you guys think about, obviously, not bank, but non-bank M&A. Has that environment or your views on those types of opportunities that would be maybe interesting changed or altered at all? Is there I guess one thing I would say is there's always kind of that the constant thought of how you guys can not build on top of the regulatory advantage, right, which has been a great move for you guys. And it feels like technology could be that next leg up. Just wondering how you guys are thinking about that? And is the M&A tool in that or not necessarily given where the market is today? .
Well, I think it's a tool. I think it's a tool we've looked at. I would reiterate my prior comment about capital and the proper use of capital. But I have to tell you, we're looking at all kinds of things as we invest in technology. We are in a fairly unique niche and being able to go and buy something that properly, and I emphasize that word, properly does what we needed to do is fairly limited. There's a lot of Fintech kind of things that have put middleware layer services in this industry, and it's actually caused a lot of problems. And we looked at those and they just didn't meet the standards that we had. So I think decision point #1 is what's the right use of capital. Decision point 2 is there anything out there that actually would give us an advantage from a technology perspective? .
Thank you for your questions. There are currently no questions in queue. [Operator Instructions]. There are no questions waiting at this time. So I'll pass the conference back to the management team for any closing remarks.
Thanks for joining the call today, and this ends our call.
This will conclude today's conference call. Thank you all for your participation. You may now disconnect your lines.