Pathward Financial, Inc. (CASH) Earnings Call Transcript & Summary

Ladies and gentlemen, thank you for standing by, and welcome to Pathward Financial's First Quarter Fiscal Year 2023 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 Justin Schempp, Vice President of Investor Relations and Financial Reporting. Please go ahead.

Thank you, operator, and welcome. Pathward Financial's CEO, Brett Pharr; CFO, Glen Herrick; and Deputy CFO, Sonja Theisen, will discuss our operating and financial results for the first fiscal quarter of 2023, after which we will take your questions. Additional information, including the earnings release and the supplemental investor presentation, 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 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 within the appendix of the investor presentation. Now let me turn the call over to Brett Pharr, our CEO.

Thank you, everyone, for joining Pathward Financial's First Quarter 2023 Earnings Call. The company performed well during the quarter. Core net income, excluding the impacts of rebranding, was $23.2 million compared to $24 million in the prior year, and core earnings per share of $0.81 was up 4% compared to $0.78 per share in the prior year quarter. Our continued focus on our key strategic pillars of asset optimization, deposit optimization and operational simplification helped drive further expansion of our net interest margin, which rose over 100 basis points to 5.62% for the first fiscal quarter compared to 4.59% in the prior year quarter. Our strategy also enabled us to achieve return on average assets and return on average tangible equity that are amongst the top in the industry. Our commercial finance portfolio grew 7% year-over-year and totaled $3 billion at quarter end. Total loans and leases on December 31 were $3.5 billion, a decrease of 5% from $3.7 billion in the prior year. The year-over-year decline in total loans and leases reflects the sale of the student loan portfolio, timing of tax season loans and a few relationship paydowns in our warehouse lending portfolio. Credit quality across the portfolio remained strong as nonperforming loans of 1.16% were the same as a year ago. As we head into a potential recessionary environment, we remain confident in our active collateral management and the quality of our loan portfolio. On the liability side of the balance sheet, the company continues to demonstrate its proficiency in managing excess deposits by storing them at our program banks. In the first quarter, off-balance sheet deposits averaged $1.4 billion, earning revenue roughly equivalent to the federal funds effective rate. In addition to generating revenue, these excess deposits also serve as a readily available source of liquidity. As of December 31, we had $2.2 billion of customer deposits stored off balance sheet with program banks, a level that is seasonably elevated due to holiday-related gift cards and other products. As we have indicated during the 2 previous quarters, the landscape of the Banking as a Service market is changing. While we continue to see fewer startups receive funding, our legacy partners are launching new programs and using our services to attract new customers. With our diversified clientele and our long history and experience in Banking as a Service, we steer clear of the current turmoil experienced by others in the industry. We believe our strong risk and compliance capabilities continue to serve us well during this time of industry transition. Regarding our re-brand, I'm happy to announce the company completed the remaining efforts during the quarter. Consequently, we received the final $10 million of the original $60 million sale associated with our Meta trademarks. We are pleased to be serving our customers under our new Pathward name, which has been well received by our customers and partners. We look forward to building upon the brand value it provides. Looking ahead to the remainder of fiscal year 2023, we believe our unique business model allows us to benefit from rising rates, positioning us well to continue delivering solid financial results. Consequently, we've increased our fiscal year 2023 GAAP earnings guidance range, which we now expect to be between $5.55 and $5.95 per share. Finally, we are well prepared for tax season, which is kicking off in the second fiscal quarter. We have a long history of operational success, are a leader in supporting the independent tax industry and serve a major franchise in the business. Our historical experience and operational excellence position us to succeed in unique economic environment of this year's season. We look forward to sharing more on our next earnings call. Now let me turn the call over to our Chief Financial Officer, Glen Herrick, who will provide additional detail on the quarter's financials.

Thank you, Brett. Total GAAP net income for the first quarter was $27.8 million or $0.98 per share, down from the $61.3 million or $2 per share recorded in the prior year quarter. As a reminder, the last fiscal year's quarter included an initial $50 million gain on sale of the Meta trademarks, and this fiscal year's first quarter included the remaining $10 million gain associated with the sale. Excluding the onetime gains and expenses associated with rebrand-related activity and severance expenses, core net income of $23.2 million decreased slightly compared to the $24 million in the prior year. . Adjusted earnings per share of $0.81 for the quarter represents a year-over-year increase of 4%. The business does not expect to report any additional rebrand-related financial impacts moving forward. Net interest income grew 17% year-over-year, driven by expansion in Pathward's net interest margin. Total net interest margin for the first quarter of 5.62% increased substantially relative to the 4.59% recorded in the first quarter of fiscal year 2022. We expect our net interest margin to continue to expand given the current rate environment and ongoing optimization of our balance sheet. Provision expense in the first quarter of $9.8 million is a $9.6 million increase from the prior year. However, the prior year benefited from a $12.7 million provision reversal associated with the disposal of the bank's remaining community bank portfolio. GAAP noninterest income declined from $86.6 million in the prior year quarter to $65.8 million in fiscal year 2023. Excluding the $50 million and $10 million trademark sale gain in the first quarters of fiscal years 2022 and 2023, respectively, noninterest income increased 52% year-over-year. The large increase was attributed to fiscal year 2022's losses on the Community Bank portfolio sale and MoneyLion investment write-down. Meanwhile, the current year benefited from revenues associated with off-balance sheet deposit servicing. On the expense side, total GAAP noninterest expense of $105.1 million represents an increase of 27% from the prior year quarter. When adjusting for $3.7 million of rebrand-related items in 2023, expenses of $101.3 million grew 23% year-over-year. This increase resulted primarily from $15.5 million of additional card processing expenses, mostly attributable to the higher rate environment. Other expenses, excluding rebrand-related items, grew at a 4% pace year-over-year. The company remains well capitalized while continuing to return value to shareholders. During the fiscal 2023 first quarter, the company repurchased 654,000 shares at an average price of $38.10. Through January 20, the company repurchased an additional 478,000 shares at an average price of $45.45. As Brett mentioned, we are increasing our guidance for fiscal year 2023. For the year, we expect GAAP earnings per share between $5.55 and $5.95. This guidance assumes a federal funds target rate rises to 5% in the second half of fiscal year 2023 and remains flat thereafter. That concludes our prepared remarks. Operator, please open the line for questions.

Our first question comes from the line of Frank Schiraldi of Piper Sandler.

I just wanted to ask about higher guide. Can you talk a little bit about what is driving that? Is it just early thoughts on tax season are shaping up pretty good? Or what's kind of driving the change linked quarter?

I think the big thing is there's a slight increase in Fed Funds beyond what our original basis was. And so we expect that to show up and are experiencing that starting to show up in higher yields. We think we're well prepared for the tax season as we always are. This is one of our core competencies. And the macro environment for the tax season is positive, but we haven't made any bets on that yet. So it's too early. I mean the IRS just opened up for returns this week. So it's too early for us to make any prospective views of what's going to happen in tax season.

Okay. And then can you talk a little bit about what the guide might imply for loan growth here? Just given overall commercial finance was kind of flattish linked quarter. And I know the ABL and the factoring balances have declined. I'm not sure what you're thinking is a good kind of run rate for commercial finance growth from here.

Again, it's a mix of asset classes that are going to behave differently. Working capital is where we're hoping for the growth as we get into a more recessionary-style environment. There likely will be some slowdown in various kinds of term lending. Conversely there seems to be a bit of uptick in our solar financing and other alternative energy financing opportunities. So I think it's going to be continually plodding forward as we have been, in making that rotation from 1 asset class, i.e., securities to another. I don't expect it to take off, and I don't expect it to dive or anything like that either.

Okay. I think in the past, you might have talked about sort of double-digit growth in -- overall in commercial finance. I don't know if that's still kind of a reasonable bogey going forward?

Yes. I mean I think low double digits over time through economic cycles is quite reasonable for us. We want to make sure that we have the yield in it, and that's been some of the challenge. And we've talked about that from a liquidity perspective that's gradually getting washed out. But I mean, I think long term, that is a reasonable assumption.

Okay. And then in terms of the -- on the depository side, unless I heard wrong, it sounded like the off-balance sheet deposits maybe were boosted a bit linked quarter given some seasonality. So if that's the case, maybe those come down from whatever this is, taking the $2-billion plus at the end of the quarter. Just wondering how to think about the rest of that, I guess. Do you continue to think you -- that remains off balance sheet and you pick up Fed Funds on it? Is there opportunity or thoughts to bring it back on balance sheet and given some of the opportunities you can get in terms of yields on the asset side? What's sort of the strategy there overall?

Well, a couple of things. You're correct. There is some seasonality in the fourth quarter. And I think in my comments, I highlighted a level that's probably more like core. We do think that -- and this is one of our advantages -- that the liquidity is gradually wiping out in the general economy, and there may be some minor shrinkage even at that core just because of what's going on in the economy. I don't -- because we have plenty of money in the securities portfolio, I don't need to pull those deposits back on to the balance sheet to fund the next asset rotation. We've got plenty on the balance sheet to do that. And there's no sense in inflating the size of my balance sheet until we kind of keep working through that asset rotation.

Okay. That makes sense. And then just lastly on credit. You talked in the release about the increase in provisioning and the increase in NPAs. I assume was kind of part and parcel the same -- I think you talked about one relationship on the commercial finance side. Any additional color you can give on that relationship and hopefully your comfort in limiting losses there.

Yes. One of the things I talk about all the time is we are a collateral-managed credit facility. We don't do unsecured credit. And even though something might be in a nonperforming, there is a collateral behind it. We're kind of experts at liquidating that, whether it's working capital or working with partners on the equipment and those kinds of things. And so just because you're seeing nonperforming doesn't mean that, that's a loss. What that means is we're working it down with the collateral that we have. We're seeing continued good performance in the credit portfolio. We're not seeing any negative impacts as of yet. You always have companies coming and going. That's true. But we're not seeing any trends to the negative side at all.