Pathward Financial Inc
SWB:FM7
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Ladies and gentlemen, thank you for standing by, and welcome to Pathward Financial's Second Quarter Fiscal Year 2024 Investor Conference Call. [Operator Instructions] 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.
Thank you, operator, and welcome. With me today are Pathward Financial's CEO, Brett Pharr; and CFO, Greg Sigrist, who will discuss our operating and financial results for the second quarter of fiscal 2024 after which we will take your questions.
Additional information, including the press release, the investor presentation that accompanies our prepared remarks, and the 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 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.
Thanks, Darby, and welcome, everyone, to our second quarter 2024 conference call.
We continue to produce strong results in the quarter by focusing on risk-adjusted returns and enhancing our Banking as a Service offerings. Additionally, tax season is shaping up nicely, especially since the steps we took in the off-season to enhance data analytics, underwriting and monitoring for refund advances are generating positive returns for us. We are very pleased with our performance thus far in the fiscal year.
This focus helped us to drive $65.3 million in net income, a 19% increase and $2.56 per diluted share, a 29% increase compared to the prior year's quarter. Earnings growth was driven through an increase in net interest income of 17% and 26% growth in pretax income in our tax business during the quarter. We also expanded net interest margin to 6.23% when compared to last year's quarter, and our adjusted net interest margin, including rate-related processing expenses was 4.65%.
Performance metrics remain strong, with return on average assets for the first 6 months of the year of 2.35% and return on average tangible equity of 51.09%. For reference, these metrics were 2.39% and 50.81%, respectively, for the same time period last year. Finally, we are narrowing our guidance range to $6.30 to $6.60 in EPS for the full year. Greg will give you more color on this in his remarks.
We are very pleased with our tax season results for the 6 months ending in March. The IRS opened a week later than last year. And because of the delay, we had more applications in our Refund Advance product, which gives customers access to a portion of the refund immediately. We originated almost $100 million more in tax services loans than we did last year. This helped us to increase refund advance fee income by 12% over the same 6 months in the prior year. As we often say, no two tax seasons are the same, and this was true again this year. However, our long tenured and talented team adjusted well and once again drove good results.
Total tax services revenues for the 6 months ended March 31 increased slightly. However, we were able to decrease both tax product expenses and the provision for credit losses resulting from some of the work I mentioned previously. And pretax net income for tax services grew 24% to $36.9 million.
On the asset side of the house, Pathward's Commercial Finance division is comprised of 4 primary asset classes: working capital, structured finance, equipment finance and insurance premium finance. Each asset class is built to perform through economic cycles with a strong foundation of specialized and unique risk mitigation techniques. Because of this, we are better positioned to help businesses that many traditional banks are uncomfortable or unwilling to serve.
For example, our working capital products consist of asset-based lending and accounts receivable factoring that provide businesses with the ability to obtain financing by leveraging assets as collateral regardless of profitability or cash flow. These products are supported by formulaic advances primarily related to accounts receivable and inventory. We analyzed the collateral's performance to determine the ongoing viability of converting these assets into cash. This helps to establish appropriate collateral advance rates which are monitored on a daily or weekly basis. It also helps us to understand our overall risk regardless of whether the borrowing company is profitably growing or experiencing financial stream.
Additionally, unlike traditional banks, we generally use stronger controls, including dominion of funds, demand notes and frequent field exams.
Our equipment finance team offers commercial lease and term loans for equipment needs. We typically focus on mission-critical items where the equipment is required to operate the business on an ongoing basis even in the event of a company restructuring. Each contract has ongoing financial reporting requirements and ongoing collateral reviews, which sometimes include physical inspection.
At the portfolio level, we monitor industry and collateral concentrations to manage our exposure. These examples help illustrate the work that goes into managing our portfolio and allows it to perform very well historically regardless of the macroeconomic environment. We believe it is the workload that is the primary driver of our higher yields.
When reviewing our portfolio and potential loan opportunities, it is with this lens that we underwrite. We take into account the FTE costs, the traditional net charge-off rates of our portfolio, not the traditional net charge-up rates for these types of loans in the industry and then arrive at a risk-adjusted return.
When you compare the end of this quarter to the same time last year, we are holding over $0.5 billion more in commercial finance loans and $160 million more in consumer tax services and warehouse finance loans, and this is helping to drive our performance and growth in earnings.
Our goal on the asset side is to continue to optimize the balance sheet. We intend to focus on adding loans and leases with the highest risk-adjusted returns and redeploying cash from our securities portfolio into higher-yielding loan verticals. While we believe there's still runway to continue expanding net interest income, we believe noninterest income will be the source of sustained earnings growth well into the future.
This growth can come from 2 avenues. First, you may see us increasingly utilize balance sheet velocity strategies, which come in a few forums to generate fee income including increased originations and sale of consumer loans, which we provide to support some of our Banking as a Service clients.
And second, we are extremely focused on growing fee income and banking as a service. We continue to be a beneficiary of a strong risk and compliance capability as our processes, procedures and programs are especially designed for the space. Recent industry focus by regulators specifically on BaaS banks, in our opinion, has only reduced regulatory arbitrage and enforces rules that have been a part of the requirements for more than a decade.
We expect that focus to continue, we are receiving more inquiries as other banks may be exiting or restricting their BaaS business. As a result, the pipeline in BaaS continues to be very healthy and includes expansion of products and services with existing partners as well as inquiries from new partners.
We continue to build on and invest in our people, risk culture, strong processes and technology to adapt and grow with demands of the business. We believe that the innovation that is occurring around the BaaS marketplace is incredible, and we intend to continue to be a trusted partner for the companies moving this industry forward.
Now I'd like to turn it over to Greg, who will take you through the financials.
Thank you, Brett, and good afternoon, everyone.
Net interest income continues to be a significant driver of our results and a higher percentage of revenues than last year. This is primarily due to increased yields and thus an improved earning asset mix as well as a significant growth in loans and leases that we have seen over the last 12 months. In addition, we have seen sequential increase in overall yield on the portfolio due to increased rates on new production as we remain disciplined in adding higher risk-adjusted return assets onto the balance sheet.
Our new production yield on commercial finance loans and leases in the quarter was 9.27% compared to quarterly yield on the same portfolio from the last quarter of 7.97%. Our adjusted net interest margin was 4.65%. And while this is slightly behind last year's quarter, we made the operating decision to hold deposits off balance sheet at certain points in the quarter as we have in the past, and instead utilize borrowings. This had the artificial impact of lowering both net interest margin and adjusted net interest margin since servicing fee income from off-balance sheet deposits is not included in either measure. However, the impact is relatively neutral to earnings. It simply shifts revenue from interest income into noninterest income.
Noninterest income grew 2%, primarily driven by increases in refund advance fee income. This was partially offset by lower card and deposit fees due to lower servicing fee income from reduced levels of off-balance sheet deposits when compared to the prior year quarter.
Provision in the quarter declined almost 30%, primarily due to decreases in provision for refund advances and commercial finance. Brett mentioned the work we did in tax, which led to improved credit performance, including recoveries in the quarter. The provision also reflects a mix shift in the loan portfolio and a benign credit environment.
Total noninterest expenses increased versus the same quarter last year primarily driven by higher rate-related card processing expenses due to the rate environment. Noninterest expenses, apart from rate related card processing costs continue to be well managed with an increase of just over 3% from the prior year quarter.
Deposits on balance sheet at March 31 totaled $6.4 billion, an increase of almost $0.5 billion from a year ago. We intend to hold higher relative levels of deposits on balance sheet to support the growth in loans and leases.
Off-balance sheet deposits on March 31 totaled $1.2 billion. As a reminder, while these values are elevated at the end of the quarter due to seasonal deposits related to tax season, they will gradually draw down toward a low point, which we usually see in the September quarter.
As of March 31, Pathward is still holding approximately $741 million of deposits related to government stimulus programs. Through the rest of fiscal year 2024, we expect to return approximately $219 million of unclaimed deposits to the treasury department. We now expect for the full year average off-balance sheet deposits to be around $440 million.
Total loans and leases at March 31 totaled $4.4 billion, an increase of 18% from a year ago. The company has experienced strong growth in the commercial and consumer portfolios, and we believe there are ample opportunities ahead, particularly in working capital and government-guaranteed loan products where we see healthy pipelines with strong risk-adjusted returns.
Compared to December 31, total loan balances declined slightly. We saw increases in asset-based lending, term lending and SBA and USDA loans, offset by a decrease in insurance premium finance and consumer finance.
From a liquidity perspective, we remain in a strong position with approximately $3.6 billion in available liquidity. As Brett mentioned, our goal is to optimize the balance sheet and rotate out of securities and into higher-earning assets. We still expect the securities portfolio to continue drawing down with close to $300 million of cash flows available for reinvestment over the next 12 months.
Finally, during the quarter, we repurchased approximately 764,000 shares at an average share price of $51.20. From April 1 through April 15, we have repurchased approximately 101,000 shares at an average price of $49.47. We are narrowing our fiscal year 2024 EPS guidance to a range of $6.30 to $6.60. This includes a number of assumptions in addition to those that I've already touched on.
We expect earning asset yields to continue to increase given our focus on risk-adjusted returns, continued pricing discipline and securities portfolio cash flows, which will be reinvested into higher-yielding loans. We expect core card fee income to follow normal historical seasonal patterns. We estimate our effective tax rate to be in the range of 16% to 20% for the year.
This concludes our prepared remarks. Operator, please open the line for questions.
[Operator Instructions] The first question is from the line of Frank Schiraldi with Piper Sandler.
Just wanted to start with the expense side of things. If you could provide maybe a little color and hopefully a little bit of outlook in terms of how you see the comp line. I know this quarter, obviously impacted by the seasonality of the tax business. So is it more reasonable to kind of return to nearer to fiscal 1Q levels in terms of thinking out through the rest of the year in terms of comp?
Frank, I appreciate the question. Yes, in the quarter, I mean, just to be clear, I think there was roughly $2 million of what I'd consider to be nonrecurring expenses in there. The rest really was related to your point, just the seasonality, higher levels of revenue, et cetera.
But you're spot on. I think might the starting point is going to be reverting back to that December quarter run rate. The one thing I would touch on, though, for comp and benefits is over the balance of the year, we are going to continue to invest in human capital. So I'm expecting $2 million to perhaps $2.5 million of additional run rate kind of building in over the balance of the year. And that will take some time to get there, but I think we'll exit September a little bit higher than the December quarter.
Okay. Great. And then just on the -- sorry, if I missed it earlier, but in terms of the -- what you would just consider nonrecurring the $2 million, any sort of additional color you can provide there? Is that just one-off in the quarter? And what was the driver there?
Yes. It was just some one-offs in the quarter. I mean we periodically have some things that will run through comp and benefits that are just bespoke. And they, again, they're just not going to recur. So...
Yes. Okay. And then just on the loan growth, the insurance premium finance business, obviously, you had an opportunity there. And you saw a significant pickup, maybe it was 6 months ago or so. And obviously, they are short-term loans, and we've seen that come back down. Any sort of thoughts around where that stabilizes -- normalizes because otherwise, you look like you have pretty good growth on the commercial finance side of things outside of that category.
Yes. I would expect the insurance premium finance to normalize back up in April and May back up to the levels we saw at the end of the year at the December quarter end. So I think that was roughly back up to $680 million frame. But that should build. Part of the reason for that is April and May are pretty heavy premium months renewal months for the underlying corporate. So that we do expect that portfolio to build again.
Okay. And then outside of that book, thinking about the rest of commercial finance, I think, was up close to double digits annualized. Is that kind of the rate of growth you're seeing in those other businesses?
This is Brett. In the working capital, I think we're seeing that in the pipeline is really big. We're being a little bit more selective on the equipment finance side and structured finance, it's a number of things that have various puts and takes. So -- so I do think we'll have -- continue to have pretty good growth but maybe not quite at the rate that we've had over the past year.
Okay. And then if I could just sneak in one last one. Just on the deposits that are subject to the contractual indexing. This quarter, you talked about 50% -- 56% of the deposits are subject to that indexing up from 53% last quarter. And just curious, is that going to be a continued trend, if you can kind of talk us through that a little bit.
Yes. I mean, as you can imagine, with the rate environment, as contracts come up, this is considerably more a part of the conversation than it was before. So it is a negotiation and sometimes it's -- you're trying to get more fees and then given on conditional deposits or whatever it might be.
So as long as rates are higher, there's going to be pressure to do some of that. And it's just -- it's a negotiation that we'll engage in and make sure we're getting good margin as we go through it. If rates stay higher for longer, you probably have more of those conversations, but you also will get more on the asset side.
The next question is from the line of Tim Switzer with KBW.
I wanted to follow up on your comments about the Banking-as-a-Service landscape and how some of the regulatory pressures are limiting the arbitrage that was previously occurring. Can you give us a description of the partner pipeline you have like the size of the partners, the industries they're in? The composition between if you'll be doing deposit or credit sponsorship, everything like that.
Yes. I don't know that we're going to highlight all the specifics of it, but sort of the macro piece of this, right? So we've been pretty clear in the last 3 years that we were turning away business. In many cases, it was business that did not fit our risk profile. Some were doing those kinds of businesses, and that's what's going on in the industry. And you kind of heard pretty clearly from my comments, my view of that where we stand versus others that are in the industry.
So the result of that is everybody is playing the quality. And that is true in the issuing space. That's true in the payment space. That's true as well in the marketplace lending space. And there are very public events in all those categories and people that already have a meaningful amount of business. So these are not start-ups, are coming our way and it might be in the form of [indiscernible] flips. It might be in the form of build from scratch with new programs. But their-- they find themselves in a situation where they can't do the next new program with their existing bank because of circumstances.
So we say this a lot, but I exponentially means that our pipeline has never been bigger and it's actually real stuff that we can do. And now people are beginning to listen to our requirements and that are requirements for their benefit and safety as well as ours. So I actually welcome the elimination of the regulatory arbitrage that was going on and focusing on what the rules actually say. And we're -- we believe we're in a good place for that.
Okay. Yes. And you kind of mentioned this, but are you able to qualitatively describe maybe -- in your partner pipeline, how many are coming from competitors versus people new to the industry?
I can talk about that in general terms. There's almost nobody new coming into this right now. They're all scared to death. So this is somebody that might be 3 to 5 years in the industry, and they were connecting with a different bank partner. They've got a workable business model that has enough scale to meet our minimums and they're coming.
The days of fintechs coming with venture capital and knocking on the door and saying, "Hey, I want to start and do this new cool idea." We're not seeing any of that. That's pretty much gone. And it's really the bigger ones that have already have some scale and volume that are trying to find a place to put it.
Very interesting. Have you found that this has helped with your pricing within your contracts as well?
Yes, it's all hand-to-hand combat, right? Because what you're sitting here doing is you're saying, okay, here are additional risk and compliance requirements you have to do. So that has a cost with a partner. We're in the advantaged position of you got safety here and there's fewer people that will take on this business. So yes, we can ask for margin. So it's not just price gouging kind of environment we're in, it's still in negotiation, but there's business now that has margin in it that's reasonable for risk and compliance processes we have to carry out. And there had been times in the past when that was not the case, and we walked away.
[Operator Instructions] The next question is from David Feaster with Raymond James.
I just wanted to touch on a few of the newer products that we've talked about, like early wage access and faster payments, for instance, more embedded finance. I'm curious maybe where we are in the product development and rollout of those? And kind of where we are? And when would you expect to see some more tangible benefits from those initiatives?
Yes. I mean those are all, for the most part, startup things, particularly early wage access. And those programs have to grow. And the partners have to connect with payroll companies, et cetera. So they're not at a scale that would reach any level of materiality yet but they seem to have a lot of promise. They are growing, and we're confident in it.
Faster payments and better finance, those are -- I mean, those are very broad terms for a whole bunch of little ideas and niches in each of them. The beauty of that is it's noninterest income fee income that we're talking about, which is something that we want to emphasize. But they're coming, but there's nothing in there that I would say it's going to show up with significant scale individually in the next year or 2. But collectively, I think you're going to continue to drive us more towards the noninterest income, which is what we need.
Yes. And maybe to that point, one other thing that we've talked about in the past is maybe some more managed services, especially just given the regulatory and compliance headwinds in the industry like we just talked about, right? It could be a huge opportunity I'm curious, is the investment in human capital like you guys alluded to, to support that or just your own back office? And so again, what is the investment in human capital that you guys are doing? What is that for? And then at what point does maybe some managed services become more interesting to you?
Yes. I mean, I think part of this is you need to have a mix of two things. You've got to have a mix of the right human capital that understands all the risk and compliance elements, which I would argue we have and we have the best in the industry.
The other side of that is having a technology that's coupled with that, so you can carry out these managed services. And we're investing a lot -- a lot of the people investments we're talking about are from a technology perspective, et cetera. And we're going to continue to do that and get it to where it's as automated and scalable as we can be. And then we will definitely be looking at what you're talking about because there are some target opportunities on different topics where we could do managed services. So it's not immediately on the horizon, but it is definitely something we're thinking about.
Okay. And then maybe last one for me, just touching on credit. You guys have done a great job managing credit nonaccruals have come down. Past dues did increase though a little bit. I just wanted to get your sense on credit more broadly. Expectations for credit going forward and the health of your clients from your perspective? You did touch on as being a bit more selective in equipment finance and structured finance. So maybe those are two segments where you're slowing down a bit. But I'm just curious your thoughts on credit more broadly.
Yes. I mean the structured finance and equipment finance for the most part are cash flow lending. Now they're all secured, but the cash flow lending. So you want to watch those our larger equipment finance things tend to be with the top Fortune 100, 200 kind of companies. And so we'll do those where the yield makes sense in a particular niche that we're interested in and it's mission-critical collateral, et cetera.
And so where I'm really excited is working capital because it's coming in. And the transactions are happening now. Now keep in mind there, that's not about the health of the client. That's about the health of the collateral. And we only get involved in those and stay involved with those if there's the health of the collateral. And lots and lots of opportunities there. And our pipeline there is bigger.
What typically happens this time of the year as companies get their financial statements come in, they've missed covenants, they go and talk to the traditional C&I. They get invited to find somebody else to finance them, and that's when we get opportunities, and that's going on right now. So feeling pretty good about that.
As I always say about our credit book, it's collateral managed, it's collateral covered, we may have workouts and we know how to work them out, and we do a pretty good job, but even if we have a loss of a recovery going forward. So we believe we're in good shape on credit.
Thank you. There are no further questions in queue. [Operator Instructions] There are no additional questions. I'd like to turn the call over to Brett Pharr for concluding remarks.
Thanks, everyone, for joining our call today. Have a great evening.
That concludes today's conference call. Thank you for your participation. You may now disconnect your lines.