First Internet Bancorp (INBK) Earnings Call Transcript & Summary

Good day, everyone, and welcome to the First Internet Bancorp conference call to discuss the termination of the merger agreement with First Century Bancorp. [Operator Instructions] Please note that today's event is being recorded. I would now like to turn the conference over to Larry Clark from Financial Profiles, Inc. Please go ahead, Mr. Clark.

Thank you, Hanna. Good afternoon, and thank you for joining us to discuss the termination of the merger agreement with First Century Bancorp. The company issued a press release yesterday, and it's available in the Investor Relations section of the company's website. Joining us today from the management team are Chairman and CEO, David Becker; and Executive Vice President and CFO, Ken Lovik. Management will provide some detail behind the termination of the merger agreement, and then we'll open up the call to your questions. Before we begin, I'd like to remind you that this conference call contains forward-looking statements with respect to the future performance and financial condition of First Internet Bancorp that involve risks and uncertainties. Various factors could cause actual results to be materially different from any future results expressed or implied by such forward-looking statements. These factors are discussed in the company's SEC filings, which are available on the company's website. The company disclaims any obligation to update any forward-looking statements made during the call. At this time, I'd like to turn the call over to David.

Good afternoon, everyone, and thank you for joining us to discuss the termination of the merger agreement with First Century Bancorp. As many of you have seen from the press release we issued last night, we received notice from First Century that it terminated the agreement and plan of merger between our 2 companies, effective Sunday, May 1. One of the terms of the agreement was that it contained an outside date of April 30, 2022, for closing. Unfortunately, the regulatory approval process took longer than expected. While we received approval of the transaction from the Federal Reserve on April 29, we would still have statutory waiting periods to satisfy before we could close the holding company transaction. When we announced the transaction back in November, the original terms, which included a purchase price of $80 million, were attractive because of the multiple lines of business First Century had built and the revenue potential that we could scale based on our expertise and larger balance sheet. We believe we were paying a full premium for the First Century franchise but were comfortable with that because of the diverse revenue streams and low-cost deposits First Century brought to the table. When it became evident in mid-April we would need more time, First Century used extension requests to demand a punishing increase in the premium. Over the weeks that followed, we attempted to negotiate. We offered an increased purchase price of $85 million, which we felt was more than fair. We recognize the value of First Century's cash balances in a rising rate environment even as First Century shareholders' equity at closing would have been lower than the initial projections which would have increased goodwill and tangible book dilution to our shareholders. Our offer was rejected. We attempted to close the gulf. We tried to justify their ask. We repeated our request for direct access to decision-makers at 2 key relationships in an effort to seek assurances of the likelihood of continued or even expanded revenue. Our requests were rejected. From the first time we looked at this transaction, we always believed in the core rationale that future revenue growth and opportunities would be a true partnership between First Internet and First Century, a whole that is greater than the sum of its parts. However, we could not get comfortable that the additional consideration that would have been required to get the deal done would be anything other than a distribution to First Century shareholders at the expense of our own. The higher price would be given disproportionate credit to First Century for future value that we believe would only be created through the combination of our organizations. We are disappointed we could not come to an agreement with First Century. However, we have continued to source and evaluate additional strategic opportunities to keep building the First Internet franchise even as we have been working diligently on the integration of First Century. As we discussed a couple of weeks ago in the earnings call, we have a number of initiatives we are working on that we fully expect to help drive higher earnings over the next several years. Specifically, we are continuing to build out our fintech and banking-as-a-service platform, and the pipeline continues to grow with opportunities that provide low-cost deposits, fee revenue and lending capabilities. Additionally, we have projects in the commercial finance space that hold a high degree of upside as we pair our balance sheet, capital and nationwide lending expertise with specialized lending platforms. Furthermore, our existing core lines of business are performing very well. In some respects, our business is as strong as it has ever been. Pipelines and SBA, single-tenant lease financing, construction and finance -- franchise finance are growing every day, all of which will be funded on a lower-cost deposit base driven by our success in growing small business accounts and our growing banking-as-a-service deposit platform. Additionally, with the termination of the First Century transaction, we now have the opportunity to direct that capital towards an asset we like even more. That's First Internet. With the equity markets down over the last month, we have an opportunity to redeploy our capital in a way that is highly accretive to earnings per share without the tangible book dilution and execution risk associated with an acquisition. As we mentioned on the earnings call, we have repurchased shares for approximately $11.4 million of the $30 million authorized under our existing program. We plan on repurchasing the remaining amount in short order, and they will approach our Board to authorize another stock repurchase program with consideration to balance sheet growth and the strategic initiatives we have in place. To wrap up my comments, I want to reaffirm that we feel very good about being able to meet earnings expectations for this year, especially since the First Century transaction was not expected to have a significant impact on our 2022 performance. Furthermore, with the attractive opportunities we have in front of us, combined with the ability to accelerate our share repurchase activity, we strongly believe that we are well positioned to be in the range of estimates for 2023, notwithstanding the impact of First Century. With that, I'll turn it over to Ken to add some more color around the financial impact and the opportunities we have in front of us.

Thanks, David. As David mentioned earlier, we continue to feel very good about the forecasted results for 2022, which again were forecasted to not be significantly impacted by First Century. So to provide some color on projected 2023 results, I will break it into a few components. First, we expect the existing First Internet franchise to be in the range of $5.10 to $5.20 of earnings per share, which includes the deposit portion of our banking-as-a-service initiatives. Second, based on our outlook right now, we expect an additional $0.35 of earnings per share from the actionable initiatives we have underway. And third, assuming we repurchased a total of 550,000 shares under our existing program, the effect from share repurchases could contribute an additional $0.30 of earnings per share. And that could increase should our Board authorize an additional share repurchase program. So as you can see, we have clearly defined a path to earnings per share for 2023 in the range of $6. And the exciting part is that the strategic initiatives we are acting on today have strong growth potential beyond what we have forecasted. I'm now going to turn it back to David to wrap up our prepared comments.

Before we conclude our prepared comments, I would like to take a moment to offer our heartfelt thanks to all the employees of First Century for their openness, hospitality and collaboration throughout the integration process. When we announced this transaction back in November, one of the key themes we hit on was that this, more than anything else, was a people transaction. We were not acquiring First Century to grow earnings based on cost savings or headcount reduction. We were acquiring a team that had built the infrastructure to support some exciting lines of business, and we would continue to grow together. We wish all of them the best in their future endeavors. And of course, I want to thank all the team members here at First Internet, who worked tirelessly on the opportunity and integration process while continuing to serve our customers and enhance our capabilities. Our team's unwavering commitment fuels our confidence in the strength of our franchise and ability to seize potential growth opportunities ahead. With that, I'll turn it back to the operator so we can take your questions. Hanna?

[Operator Instructions] The first question is from the line of Michael Perito with KBW.

Thanks for hosting the call and providing the extra information in light of the events last night. A few different questions for me. First, I wanted to start and just ask if you guys have any insights on whether -- when I think of someone taking a cash deal, I mean, that -- that's -- it doesn't seem to be very kind of long term in terms of why a company is selling. And so I'm just curious, I mean, did you guys sense or think that the motivation of the transaction was kind of working against you as well? Or was it purely financial decisioning that drove them to decide to terminate the transaction?

We've spent a lot of time and I talked to a lot of people, made a lot of trips back and forth between Georgia, and folks in Georgia coming up to Indiana. I think it was just a window of opportunity when the regulators didn't sign off until the end of April, and we needed to get an extension. When we started the question, it was dead silence for quite a period of time. And then we got a pretty outrageous offer that we just could not get to. So yes, I don't -- I'm hoping and I would hope to respect the team at the First Century, that they just saw a window of opportunity, jumped on it, but we couldn't get there. So I don't think it was set up from the get-go. I think it's just a matter of circumstance. They made a shot and we couldn't get there.

And are there any, I guess, opportunities from your familiarity doing the due diligence and planning for the integration with this platform that could be opportunities in the future as you guys consider talent and partners and things of that nature?

I think without question, we learned a lot through the process. I don't think it's really -- we assisted them with the tax loans and stuff through the season this year, which is the first time we've had experience there. We've done banking as a service a half a dozen times over our 20-year history, so this wasn't the first. It won't be the last. And I think what this proves to us is that we have a great team on our side that can do, really lay out an integration plan and process to bring somebody on board. So this one didn't get over the finish line, but it won't be our last attempt by any means. And I think what we came away with was a really good understanding of the quality of our team and the ability to execute on opportunities. From a business perspective, it's kind of same old, same old, a lot of stuff we'd already been doing. So I don't think we really garnered anything there. But it was a good testament to the quality of our team and the great work that they did.

Got it. Okay. And then just 2 last ones for me. Just on the $6 EPS trajectory, I guess, number one, are you guys making the same assumptions around your own kind of deposit portfolio and mortgage fees to get to the $5.10 to $5.20 that you were a couple of weeks ago when you reported earnings? And secondly, does the $0.35 from additional initiatives, are those all initiatives that have been announced already? Or does that include some that haven't been announced but you're projecting potential benefit?

No, those are all ones in the pipeline that are sitting out here, Michael. From our level to get to the year-end numbers that we're staring at, that is kind of business as usual within First IB. We have a couple of things we'll get over the finish line kind of mid-summer. So we've got a couple of big opportunities, both on the deposit side as well as the loan side that will come to fruition by year-end. So we're very comfortable as they get cranked up, picking up that extra $0.35 in earnings next year on new opportunities.

And Mike, I'd only add to that, that I think we've taken a very conservative look at mortgage in the wake of where interest rates are, with projections revised amounts that obviously are much lower than what we've seen over the last several quarters on an annualized basis.

Got it. And then just last one, and sorry I asked so many, but just the delay in regulatory approval, was that -- anything you can provide us on why that occurred? I mean the deal itself seemed fairly small for the -- at least for the -- some of the deals that have been delayed by the Fed. And I know you guys have been pretty good standing, at least as long as I can remember. So I'm just curious if there's any color you could provide on why the deal was delayed in the first place.

A couple of things happened. One, obviously, and it's in the American Banker Magazine, that's a magazine, that the Fed is just running really slow at the current time. Obviously, they kind of shut everything down last fall, opened up this spring. So it just put them behind in April on everything. We did have an outside inquiry about a CRA potential concern. We cleared that probably 45, 60 days ago. We were informed -- the state actually approved the deal in February. We were informed by both FDIC and Federal Reserve kind of mid-March that they had everything that they needed. And we have no real explanation as to why they didn't get it over the finish line sooner. They came back to us for no additional information after kind of mid-March.

The next question is from the line of Nathan Race with Piper Sandler.

So it looks like there's kind of a belabor -- the deal now is in the rearview mirror. But I guess I'm just curious what changed between when the agreement was signed in November to late last week that necessitated First Century demanding a much higher price than what was agreed upon in November?

That's a good question. I do give them credit in one area that obviously changed because of what's happened in the market over the last 6 months. The cash deposit base had additional value, no ifs, and or buts about it because of the low-cost component. And when we countered their offer and bumped it up, we took that into consideration, even though their AOCI had a $3 million-plus in their first quarter call report as published. Their AOCI got whacked down $3 million which obviously, as we stated in the comments, would affect the goodwill and the cost to our shareholders. We gave them credit for that -- or didn't hold that against them. We gave them credit for the upside on the cash. But the other business components really hadn't changed in value. They put forth some details about why they were trying to justify their price, but it was all future opportunities. We did give them an opportunity, an unlimited opportunity on price based on performance and an earn-out but that was rejected. They wanted hard cold cash up-front. So we thought we did everything we could. We were trying to be as open as possible. But like I say, the gap between where they were at and where we were at with all the components, we just couldn't get there.

Understood. That's really helpful color. Just going back to kind of the guidance for $6 in earnings in 2023. Maybe, Ken, what kind of margin assumptions are you layering on to get there? And how should we just generally be thinking about your guys' deposit betas with these banking-as-a-service deposits coming on board over the next several quarters and just the other factors at play there in the margin?

Yes. I mean we -- obviously, being able to grow the banking-as-a-service deposits helps quite a bit on the funding side. And again, kind of going back to what we've done over the last several years in terms of reconstituting, remixing the deposit base and going more towards small business checking and consumer and small business money markets and kind of letting the CDs, the higher-cost CDs roll off and be replaced by these other types of deposits. I think the deposit beta is much lower for us when compared to the last rate tightening cycle. Right now, kind of looking at the combination of the deposit base along with kind of some of the other asset opportunities we have in the hopper, I think we see a significant opportunity for net interest margin expansion for '22, probably put that somewhere in the range of, call it, 2.75 or 2.80 to 2.95, somewhere in that range. Again, just picking up a little bit extra yield on the lending side with rates up and having a little bit lower beta on the deposit side and just lower-cost banking-as-a-service deposits overall.

Understood. And just within that context on earning asset side of the equation, can you just remind us what amount of your loans are floating rate or variable in nature?

Well, currently, about 15% of the portfolio is floating rate, but I'll keep in mind that amount has been growing, and that's what we -- in terms of the asset classes that are driving it on the core First Internet franchise, the construction loans, the construction balances, those are all floating rate and the SBA that's being retained are all floating rate, and those have continued to grow as a percentage of the overall loan book. So that percentage continues to grow. And in the rising rate environment and the pricing on franchise finance, which is one of our higher growth engines, that pricing is kind of priced off a spread on 3- to 5-year swaps. And new production there is coming on at a higher rate daily as well as in the single-tenant space too, new production there is coming on at much higher rates than we saw just 1.5 months ago.

In the pipelines out there on all of our internal products, for example, last month, we did $13.5 million in the RV horse trailer, and that's generally been quarterly numbers for us. So kind of all across the pipeline, the commercial real estate, over $200 million in the Q. It's kind of back to not -- I would say, at least business as usual, prepandemic, if not a little higher. We're seeing a lot of pent-up demand out there from both consumer and commercial that's really got us excited about the numbers and then growth for the balance of the year.

Okay. Great. And while loan growth was a little soft in the first quarter, I imagine you guys are still thinking kind of low double digits going forward.

Yes, absolutely. I think we feel good about that number. And just as we've gotten through kind of the first month here, I'll tell you that some of our franchise finance had a hell of an April, single-tenant put on some good production, construction's up. I mean, in April, we got off to a really good start for the first part of the second quarter here.

And I'll tell you, the way mortgage started out in the first few days in the month as the rates were flip-flopping all over the place, and it actually finished fairly strong as well. We were pleasantly surprised how they ended up the month in April.

Got you. That's great to hear. And if I could just ask 1 more question on just the expense outlook. I'm not sure if with this deal not getting done, if you guys are maybe thinking a little bit more around some cost containment efforts relative to kind of the historical low double-digit increases that we've seen in operating expenses.

I guess you can look at it a couple of different ways, Nate. The expenses are going up. Part of that is investment in the banking-as-a-service platforms and the people as well as the SBA team continues to grow. Pretty much everything is ultimately an income producer, but we are kind of ahead of where we were kind of outside investment in both tech and bodies than we've done historically. But we're pretty comfortable with the expense numbers for the balance of the year. I think we're solid. And obviously, the investments we're making now will make returns for years to come. So we're going to keep on pace. We're not really looking to cut back on anything or slow anything down from what we've been doing with or without the merger.

The next question is from the line of George Sutton with Craig-Hallum.

David, I wondered if you could talk about the sourcing of other opportunities and whether this now opens you up a little bit to pursue more of those or more quickly than prior. Can you just give us an iterative sense there?

Yes. I would tell you, George, it probably gives us more opportunity to do things in the short term. Obviously, First Century wasn't a huge organization, but they are on the East Coast, we're in the Midwest, the distance, the time back and forth with people that we don't have to deal with now. So a couple of other things that were in the pipeline, we can probably move them up a little bit. But I would tell you, just the whole demeanor of the bank has changed from the market scope. And as I mentioned during the quarter end call, we are getting inquiries on a daily basis. We've got a lot of opportunities in the hopper and more coming in every day. So obviously, not completing this gives us resources we would not have had and will allow us to look at more and possibly expedite some other opportunities.

Got you. I don't want to give away anything relative to your plans, but you've talked in the past about your willingness or your eagerness to buy your stock under book value is a very key point to how you think about it. Is that still how you generally are thinking about it?

Without any question. I mean, in reality, I would much rather spend $90 million-plus on First IB than anything else in the outside world. So my wife and family would tell you I've invested in myself for the last 40 years, and we'll continue to do that. So at the price point we're at right now, I intend to get back into the market, and we think the stock is a box. So we will complete the buyback that's hanging out here today and we will go to the Board for additional opportunity. Depending on what's in front of us as far as potential acquisitions or investments, we'll give you guys more color on that when we get to it. But we do intend to go full charge and wipe out the $30 million outstanding today and anticipate more before year-end. So you're spot on. As we stated and as we approved earlier in the year, we are buying stock at the $48, $49 a share. We kind of had an internal cap of 1.5x book, so we're below book. I think I made the comment more than once, we'll buy like a drunken sailor. So we'll be out there, for sure.

Got you. Well, I would like to publicly congratulate the Indiana regulators for their timeliness on this deal.

You and me both. I tell you that's -- they literally jumped a lot of hoops for us. They anticipated they would go into March. They really rallied up the troops, got behind us 110% and punched it through in February. So the DFI did a tremendous job. And technically, the other guys were done in mid-March. And why it dragged on, nobody knows. But thank you. We'll pass that on to Chris and the team at the DFI. Appreciate the comment.

[Operator Instructions] There are no additional questions waiting at this time. So I will turn the call over to David Becker for closing remarks.

We would like to thank everybody for being on the call with us today. While we are disappointed that we couldn't come to an agreement with First Century and close the transaction, we continue to believe the future is bright. Our capabilities, combined with the opportunities we have in front of us, give us a recipe to produce outsized growth, earnings and profitability in future periods. Thank you for your support of First Internet, and we look forward to speaking with you again soon. Thank you.

That concludes today's conference call. Thank you for your participation. You may now disconnect your lines.