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

Ladies and gentlemen, thank you for standing by, and welcome to Pathward Financial's Investor Call. [Operator Instructions]. As a reminder , this conference call is being recorded. I would now like to turn the conference over to Darby Schoenfeld, Senior Vice President, Chief of Staff and Investor Relations. Please go ahead.

Thank you, operator, and welcome. With me today are Pathway Financial's CEO, Brett Pharr; and CFO, Greg Sigrist, who will discuss the recent announcement, after which we will take your questions. Additional information, including the press release and the investor presentation that accompanies our prepared remarks 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 related press 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. As a reminder, all time periods referenced are fiscal quarters and fiscal years. Now let me turn the call over to Brett Pharr, our CEO.

Thanks, Darby, and welcome, everyone, today. In our most recent earnings call, we discussed our strategy to be the trusted platform that enables our partners to thrive. In order to accomplish this, we're focused on 4 areas: a right-sized balance sheet with an optimized asset mix, technology to facilitate evolution and scalability, people and culture as important assets; and finally, a mature risk and compliance framework. For a few quarters now, you've also heard us talk about our focus on balance sheet management led by risk-adjusted returns and the continued evolution of our product offerings. As a result, an after careful consideration, we've made the decision to sell our commercial insurance premium finance business to AFS IBEX Financial Services, a subsidiary of Honor Capital and expect the transaction to close by the end of fiscal year 2024. We purchased this insurance premium finance business in 2014 with a portfolio of approximately $77 million in loans at the time. In the decade since, we've grown that loan portfolio to $617 million as of June 2024. With our goal of having a right-sized balance sheet with an optimized asset mix, this transaction gives us the opportunity to maximize our balance sheet space and accelerate our rotation into higher-yielding assets by redeploying capital and liquidity into our other commercial lending portfolios where we believe we have a competitive advantage and can deliver a better risk-adjusted return on assets and can enable our customers and partners to thrive. Before I turn the call over Greg, I want to express my gratitude to our team members who will be transitioning upon the close of the transaction. Our insurance premium finance team is a world-class group and has made an invaluable contribution to the company over the past 10 years. While the transaction is bittersweet for Pathward, I'm excited for the opportunities ahead of the team. Can't wait to see what they accomplish next. Now Greg will provide an update on the financial details of the transaction.

Thank you, Brett. From a financial perspective, we expect the sale to generate a pretax gain of approximately $17 million in fiscal year 2024. Upon close of the transaction, our initial plan is to pay off any short-term borrowings and then we would likely hold the majority of the remaining funds off balance sheet until we can redeploy them into other commercial finance verticals and what we believe will be a higher risk-adjusted return. With the anticipated gain recognition, we may take the opportunity to realize some losses in our securities portfolio, and security sale would increase liquidity that could also be redeployed into higher-yielding assets in the future. Excluding the anticipated gain, we expect the impact on net income and earnings per diluted share to be fairly neutral to fiscal year 2024. However, we do expect the transaction will be increasingly accretive as we redeploy the capital and liquidity that has supported the insurance premium finance portfolio and plan to update fiscal year 2025 guidance upon close of the transaction. We would also expect to see an appreciable increase in capital ratios and tangible book value per share upon closing and presumably optimizing the securities portfolio. This concludes our remarks. And operator, you may please open the line for questions.

[Operator Instructions]. Our first question comes from the line of David Feaster with Raymond James.

Congrats on the deal. I did want to follow up on some of your commentary, though. You talked about this deal simplifying your business and allowing you to focus on verticals that you got more of a competitive advantage in. Could you elaborate on that? I guess what about premium finance, in your view, maybe complicated the business to an extent and why do you think you have more of a competitive advantage into these other verticals relative to the premium finance segment?

Yes. Let me answer the second part of that first, and then I'll come back to insurance premium finance. When we purchased Crestmark in 2018, we were able to buy a lending capability that is not frequently seen in the marketplace and not easily duplicated. Some of that has to do with the secret sauce that you find in some of the working capital areas. It's also some themes and relationships that we have in the alternative energy and structured finance group that give us some advantage. And so there, it's not just price. We have a right to win for reasons unrelated to pricing. Going back to insurance premium finance, it's a highly competitive business. The ROA for that business is below our hurdle rate, when you consider all the expenses included. And so it was time to migrate those assets to something else. And this point about simplification is, the more you have going on, the more complicated it is, right? So if you have 8 asset classes, that's more complicated than if you have 7 asset classes, and you get the point there. So that's really what we mean by some simplification. But it's more -- what drove this was, with this portfolio, we didn't have as much opportunity for pricing power. We weren't meeting our ROA hurdle through interest rate cycles. And we'll talk about this more and more. You can't get balance sheet velocity with assets that only have an 11-month life.

Okay. That makes sense. And to that point, I mean, I guess, could you talk, Greg, maybe a little bit on some additional [indiscernible] might be saved in this [indiscernible] and those types of things and just other overhead. Curious maybe some of the expense savings that you're expecting from us?

Yes. I got you there at the end, David, you'd cut up a little bit in the meantime. But direct expenses on the business, the annual run rate is around $13 million. So we would expect those direct expenses to drop out immediately. I think that answered the question.

Yes, yes. Perfect. And then, I guess, could you just touch on, you alluded to a little bit, maybe the time line for reinvesting the proceeds going to sit off balance sheet for the time being. How quickly do you expect to put that $600 million back to work? And in what segments are you seeing better risk-adjusted returns? Is it that the renewable energy kind of working capital, structured finance type stuff?

Well, first question on the time line. I mean, realistically, it could take 12 to 18 months, David, to get it redeployed. And in part, that's because we are going to be methodical and disciplined about how we deploy it. On the second point, I think it's all the above, right? I think the working capital is a very attractive business for us. And Brett's already touched on our risk capabilities there, we're very -- it's a business we really like. We also have the warehouse lending. We also have SBA, USDA as well as renewable which you touched on. I think the other component to this, though, is the ones I just mentioned are increasingly businesses we can originate for [ saleability ]. It doesn't mean we're going to sell them, but it means we're capable of selling all of those, and there are probably some other asset classes in there as well. So when I think about just the broader notion of optimizing the balance sheet, it's as important, what's not on the balance sheet and how quickly things move through the balance sheet as well. So I think over, call it, 12 to 18 months, you'll see us redeploy across those verticals and [indiscernible] potentially in some others with an eye towards both the interest rate environment and just opportunities in the marketplace.

Our next question comes from the line of Betty [indiscernible] with Piper Sandler.

Filling in for Frank Schiraldi today. I just had a question about the EPS guide. Is the sale already baked into the 2025 EPS guide given on the earnings call or is that not?

No. The guidance we gave on the call -- last call was I assume just a business as usual run rate that included this business as an operating business.

Got it. And I'm curious why you wouldn't update the guide? Or I'm assuming it's as you guys slowly redeploy it, that's when you would get a clearer picture of the updated guide?

Yes. There are several options for what we can do with the gain. And we will make those decisions at the time of the close. And those have, while they're all beneficial, they have varying degrees of short and intermediate term benefits. Some of it's going to depend what interest rates are at that moment and other kinds of things. So that's why we're waiting, so we can be a little bit more precise about what the impact would be.

And then lastly, I don't know if you're able to provide it, but what were the average yield on the insurance premium book?

Portfolio yield at the end of the June quarter is actually in our IR deck, and it was [ 8.59% ], I believe, was the portfolio yield.

Our next question comes from the line of Tim Switzer with KBW.

My first question is, were there any deposits associated with this business at all? And do you guys expect them to run off now that you've sold off the business and the associated loans at all?

Yes. There were no deposits with this business.

Okay. And if I'm trying to think about how it's accretive to 2025, this loan portfolio is doing about $50 million to $55 million of annual NII, it's about $13 million of annual expenses. What's the other difference there if it's going to take you 12 to 18 months to redeploy it?

Well, I think the first number you gave wasn't the NII, I think that was the interest income. So I think you've also got to factor and the interest expense to carry on this. And it does -- although the credit losses are pretty minimal, we do provision for the book. The 12- to 18-month timeline, candidly, I don't think it would be prudent for us to run out and build pipelines quickly and run through pipelines. I think that would be -- could run into some pricing challenges as well. So again, we want to be methodical and thoughtful about how we deploy it. And in doing that, we really can't start to build those pipelines until we know this deal is certain and ready to close. So now -- and this goes back to Brett's comment about we need the next couple of weeks or month or so to really make some decisions around the portfolio and the build, which is why, again, that's why I referred to it as increasingly accretive, you'll start to see some of that pull in, in our first fiscal quarter. But I think more realistically, it will start to pull in, in the latter half of the year as we are able to build pipelines and calibrate the balance sheet that we want to have kind of exiting the year. Hopefully, that answers the question.

Yes. I mean, I guess, I understand the interest expense side of things, you're going to -- you said earlier, you're going to pay down some debt. Can you provide any numbers around like what you'd like to be paying down the rates on those? And then if you're going to be lowering your deposit balances as well in relation to this move, where would we see that come through? And any magnitude you can provide on that?

Yes. I mean if you go back to the second quarter, the June quarter earnings release, you'll see the balance, the average balances, rates and yields. And you'll be able to see the total borrowings we had outstanding in the quarter. Average borrowings in the quarter, it looked like they were $85 million. And obviously, we're not going to repay the sub debt. But the average rate on what was left was around 5.6%, give or take. So that would come off immediately. Anything we move off balance sheet is the [indiscernible] deposits. Keep in mind, the total economics to us really don't change. It's actually more -- slightly advantageous to us to move deposits off balance sheet that we're not going to use and earn an interest rate calibrated and come on if that will come into noninterest income, as you know, it comes into our fee income line for the off-balance sheet deposits. But again, just because it's not showing up in interest income, were showing up in NIM, it doesn't mean we lost the economics, they just shifted on the income statement. And to answer your first question, maybe a little bit more fulsomely, just as we redeploy in these other verticals, and Brett's already touched on this, but I just want to hit it again. The [ IP ] of business is, it's a wonderful business, and it has a nice ROA. It's just not above -- it's actually below our hurdle rate. So the verticals we're looking at, particularly when you include the saleability aspect to things like SBA and USDA, those ROAs are substantially above the ROA of this business for us. So when you think about what's possible over a longer horizon, you can back and do some math from all the data points you've got on what the ROA on this business is. And then just think about what it would be, we took that same balance sheet and deployed it into some other verticals, which frankly have twice the ROA. And that's the way we're thinking about it. And it'd be doing it at a time when it is advantageous to us from an interest rate perspective as well. You touched on it, this is a short duration book. And just from an IRR and an asset liability management perspective, given where you are in the rate cycle, I think taking a little bit of asset duration off the table is a good thing. And the other benefit of the vertical you talked about is they are generally longer duration portfolios as well. That's the other dimension of this that I just wanted to mention.

Okay. Yes, I get you there. Last one if I could have one more. If you're going to be moving some of the deposits off balance sheet, modeling your off-balance sheet deposits is a little tricky. There's a lot of seasonality to it. Should we be, I guess in Q4, should we be modeling a larger -- a pretty large increase versus normal seasonality in Q4 would be lower.

Well, I think the seasonality truly is the ebbs and the flows in the underlying deposit base, which do grow in the fourth quarter as we head into the holidays. I would view this slightly different. I think the total deposits here are not really going to fluctuate just a matter whether on or off balance sheet. So I would almost view this as a fairly static layer of deposits that we would first pay down the borrowings, again at the end of the quarter, it was $60 million to $80 million. The balance of that I would view as being off balance sheet earning 5% plus until such time that we want to bring it back on balance sheet and deploy it into the lending book. I hope that helps, Tim.

We have another question from David Feaster with Raymond James.

Just wanted to follow up on the commentary about a potential securities repositioning and maybe using some of the proceeds for that. I mean, could you maybe talk about, I guess, the magnitude of what you would consider? Would you wait for rate cuts to start? Or do you think the -- it would be advantageous even today. Just kind of curious how you're thinking about potential securities you're positioning?

Yes. I mean, 2 things, maybe 3. One, we'll probably wait until closer to the close date on the transaction. Two, given that we'd be waiting a few weeks anyway, I can't predict the rate environment. And I think the amount of proceeds from rebalancing or optimizing the securities portfolio is going to be dependent more on the middle part of the rate curve, not the short end. So I really don't think any decreases in the overnight rate is going to impact this. But at today's rates, as long as we're fairly static, and I think rates are in our favor in this -- for this dimension, we could see upwards of $200 million of call it, up to $200 million plus of sales, so additional liquidity coming in that we could redeploy. And obviously, that $200 million would reprice immediately. Right now, the book yield on that is probably around 3%. Even with a 25 basis point rate cut, we could redeploy pretty quickly off balance sheet for 5%. That's part of the math here, David. And then over time, that's another $200 million plus that's going to be available to us to redeploy back into the loan book. And again, it's all rate dependent. If rates start to spike again between now and then, we're not going to hit that $200 million bogey. That number will come down but that's the order of magnitude where rates are today.

And then just -- that's helpful. And then with all these moves, I mean, your TCE is going to be increasing pretty nicely, right? I mean we should be back north of 7% and pretty quickly getting back to 8%. I guess how do you think about potential repurchases here? Do you expect kind of the pace to accelerate?

Well, in theory, we could. I mean we're going to have a smaller balance sheet. So leverage capital ratio is going to -- the optics on that's going to improve. I think we have the bandwidth to accelerate a little bit. But I would say the guidance and the conversation we had on the last earnings call will still prevail. I think we're still on the balance of the year looking to keep our payout ratio in that, call it, 60% to 70% range. But some of that could now be moved forward a little bit. That's one of the things we're looking at.

That concludes today's call. Thank you for your participation, and enjoy the rest of your day.

Thank you.