Ladies and gentlemen, thank you for standing by, and welcome to the Pathward Financial Third Quarter Fiscal Year 2023 Investor Conference Call. During the presentation, all participants will be in a listen-only mode. Following the prepared remarks, we will conduct a question-and-answer 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, Head of Investor Relations. Please go ahead.

Thank you, operator and welcome. With me today are Pathward Financial’s CEO, Brett Pharr and CFO, Glen Herrick who will discuss our operating and financial results for the third fiscal quarter of 2023, after which we will take your questions. Additional information, including the earnings release, the investor presentation that accompanies our prepared remarks and supplemental file 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 statement. Please refer to the cautionary language in the earnings release, investor presentation, and 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. Now, let me turn the call over to Brett Pharr, our CEO.

Thanks, Darby, and thanks, everyone, for joining us. As we start today, not news to anyone, the banking industry as a whole has come through some turbulent times. Last quarter, we talked about how our business model differentiated us, especially in these times. This quarter, I really want to share how those differentials translate into our strengths. Just a few examples. The industry has suffered from unstable deposits. We have not. Compression on net interest margin from rising interest rates throughout the industry. But even counting the increase in card expenses, we have a growing net interest margin, not a lower one. There are general loan-related concerns, both demand and credit. But we have a collateral managed portfolio with diverse asset classes built for whatever may come. And importantly, we typically do not do CRE purpose lending. During these times, our business model puts us in the envious position of allowing us to be defensive while still having increasing returns. More about some details of this in the next few minutes. But first, the third quarter. Pathward once again produced solid results consistent with our performance so far in fiscal year 2023. Our net income for the quarter was $45.1 million or $1.68 per diluted share. Both were significant increases when compared to the same quarter last year. We did this by growth in both net interest income and noninterest income. Our net interest margin grew to 6.18%, it's an increase of six basis points from last quarter. And a significant expansion, 142 basis points from the third quarter last year. While six basis points and sequential quarter NIM growth doesn't seem as large as you might expect. Remember that last quarter includes the impact of our seasonal tax business which can temporarily boost the net interest margin. Our adjusted…

Thank you, Brett. For the quarter ended June 30th, net income totaled $45.1 million or $1.68 per share and increased from $22.4 million or $76 per share in the prior year's quarter. Net interest income was $97.5 million for the third quarter of fiscal year 2023, an increase of 35% from the prior year quarter. This was driven by expansion in the net interest margin to 6.18% from 4.76%. NIM expansion was driven by 162 basis points expansion in loan and lease portfolio yields and an 82 basis point expansion in the yield on the securities portfolio. Remember, the bulk of our deposit costs are recorded as card processing expenses. If you include those expenses in our net interest margin calculation, our adjusted NIM would have been 4.88% compared to 4.89% last quarter and 4.62% in the third quarter of last year. Also, keep in mind that the revenue we are earning on our off balance sheet deposits is not shown in the NIM, but in fee income. We expect our net interest margin to continue to expand as we deliver on our strategic initiative of optimizing the interest earning portfolio and repricing our assets in the current rate environment targeting appropriate yields. Provision expense was $1.8 million in the third quarter. During the prior year quarter, the business recorded a credit of $1.3 million to provision primarily due to releases in the commercial finance portfolio. As of June 30th, the company had an ACL coverage rate of 2.01% compared to 2.04% at the same time last year. ACL coverage in our commercial finance group was 1.35% compared to 1.56% in the third quarter last year and 1.53% last quarter. The sequential decrease was driven by a mixed shift towards insurance premium finance and SBA loans which have a lower…

[Operator Instructions] Our first question comes from the line of Frank Schiraldi with Piper Sandler.

Hi, everyone. I wondered if you could talk about, in terms of the 2024 guide, the initial guide here, can you share with us any sort of macro backdrop that assumes including interest rate outlook? If you just sort of follow the forward curve in terms of outlook here, and does it also include the potential for continued capital return through the buyback?

Hi, Frank. This is Glen. I could start. Yes. It does include generally the forward curve. We were anticipating today's action by the Fed as part of that. That obviously factored into our guidance. We talked about we're being a little cautious on investment tax credits and renewable energy lending for next year. So we wanted to call off that component in our guide as well as then the other business conditions and macro events that Brett touched on in his section.

It's about capital and buybacks.

Yes. And our plan, you could assume we continue to try to maintain, or plan to maintain a consistent balance sheet. And so with the return levels that we have, we would like to do continue buybacks at these price levels.

Okay. And that's fact, so that would be factored into guidance, whatever your plans are there on the buyback.

Yes, that's correct.

Okay. And then just touching on a couple of those things, the fewer renewable energy projects in 2024. I guess I understand the higher interest rates and what that does for demand, but I thought that there was this backlog maybe given that there wasn't anything getting done for a while that might sort of offset or overcome that. Is that just any more color on just your thoughts, what's driving you guys to decrease your expectations or give these expectations for decreased energy projects and tax credits next year?

Yes, and Frank this is Brett. I mean, what we're seeing is a lot of these deals were funded with a mix of equity and debt, the tax equity components of it. And what's happening is because there are higher rates in the marketplace, they'd have to have a whole lot more tax equity in it. And investor capital is just not coming into it, at least of the size transactions that we generally operate with. So that's why the pipeline is slowed down. And these things, as you can imagine they have a fairly long pipeline before they actually turn into a project. And so we're just looking at our pipeline and having sort of realistic expectations about how much of that's going to happen next year.

Okay. All right, fair enough. And then on the interest rate outlook and the margin, just wondering if you can talk about what sort of things, you're doing to protect the margin here from a potential down rate environment. Or, are you at the point now with where the variable loan book is and where the floors are that you can get some additional NIM expansion even in some downward movement in rates if it comes to that next year? Just any color on directionally, if we do get the forward curve, that if we do get rates sort of lining up with where the forward curve is now, what are your thoughts on margin?

Yes, so Frank, it’s Brett, so one of the things that we like about our business models, we've got different asset classes and those different asset classes have different duration elements of it. You'll note that we've been a little lean on the longer duration assets like equipment leasing, and what I would expect to happen as we go into the year, we'll start trying to figure out how to do more of those because they have a longer life to do it. And keep in mind, I think round numbers, only about 25% of our assets repriced in a given year or less. And so you've got quite a bit of opportunity to bring on a longer term asset that have a longer duration to help. So we were pretty clear we were slow on the way up and getting the margin and we should be slow on the way down on losing the margin. And so that's and Glen anything you'd add.

No, and then the other thing is, recall Frank, as if and when rates do come down, our card processing expenses that are rate related, those fall off immediately. So there's no lag to those. So those reset real time, which certainly give us a little tailwind as well.

Okay, great. And then just last if I could, I was just trying to get a handle on long growth here. I think the linked quarter growth in the commercial finance side was mostly insurance premium finance, which I assume that sort of growth rate isn't sustainable in that piece of the business. And we all hear about the manufacturing slowdown on the macro side. So how is that impacting the commercial finance business? Your expectations are for growth here particularly in that business going forward.

Yes, I think there's a few things, one is banks are pulling back. And we think of that as being an opportunity. So we are seeing a little bit of that. So hopefully, that's why I mentioned, for example, equipment leasing at the right time, we might be able to get into that a little more. I've been saying for some time, the working capital class should pick up as this slowdown goes on. And we're not seeing it in the pure numbers yet, but we're starting to see it in opportunities for origination. And those because of the diligence involved in them, you can take 90 to 120 days to start showing up as actual assets. So, so I mean, I think there's opportunity, the insurance free finance group did very well this time, very impressed with what they've done. That kind of grows, you're correct, not sustainable. But we'd like to, particularly with the yield, we're getting to stay at that level for what is such a low risk asset class. So I think it's more of a steady as it goes, we'll be picking the asset classes that where we can get the yield and get the business, and certainly thinking about that duration opportunity before a race starts going down.

Okay, so it sounds like you still expect growth in the commercial finance business going forward. Is that fair? Probably next year.

I think that's right. I just don't know which asset classes to be in. Yes, that's right.

The next question comes from the line of Michael Perito with KBW.

Hey, guys. Good afternoon. Thanks for taking my questions. I had a couple, a few things I wanted to touch on with you guys. Number one, appreciate some of this color on some of these new partnerships you guys are launching. I was wondering if you could maybe, and I realize this might be a little hard since there aren't a lot of them yet. But just on the line of credit for consumers with propel and just generally on credit agreements or contracts that you guys maybe are starting to consider a bit more than you have historically. Can you give us a sense of how you're trying to structure the credit risk within these? Is there a lot of indemnification built in? Should we expect kind of, as these things ramp up over time, that there'll be some noise in the income statement in terms of maybe like higher yields on the NII but then some indemnification on losses to like expense or fees? Just trying to get a better sense of how you're structuring these and how we should think about them as they ramp, realizing there's some time but just trying to get ahead of it.

Yes, Mike, I appreciate the question. We've been very consistent that we do not want to be exposed to naked consumer credit risk. And so these agreements and any agreements like that that we're going to enter into are going to have appropriate credit enhancements. Those might be of a different variety. Some might be, they're just short term on a balance sheet and then they get securitized away. Some might be waterfall structures. Some might actually have credit enhancement guarantees that we can rely on. We do this because these consumer credit products are needed by our partners in the marketplace and they want to have a way to offer it. And we don't want to get disintermediated with our other products because we don't have one. And so that's one of the main reasons we're in it. Now we're very optimistic about, for example, the propel holdings of partnership and what it's going to do. And we do make some economics on it. But as you fully understand, when you give up the credit risk, you also give up the bulk of the economics. It will be an income stream for us but it won't be huge.

Got it. And then I was also interested to see, you guys mentioned the earned wage advanced space with Clair. It's an interesting space. I've been spending some more time there over the last nine months or so. It seems like there's not a lot of bank market share. I know there's daily pay. There are a couple guys, non-banks, that have some share. I know Green DOT talked about doing stuff. But can you maybe give us a sense of, is that a sizable opportunity for you guys? Do you think there's room for a bank to kind of take some share and make some money in the EWA space? And just would love some high level thoughts as we think about you guys growing maybe with other partnerships in that area and that type of magnitude of that opportunity.

This is a new business. And I think there's a lot yet to be learned in the industry. How big is it going to be? How well it's going to be received? I think there are certain regulatory questions that are going to be around it. I think employers are going to have some perspective on it. We like Clair as a partner. They're one of the few fintech startups that we engage with. And right now we're just going to ride this out with them and understand how well they can grow. Obviously, it turns into a huge industry and huge business. We might take those learnings and do it with others. But right now these are the things we do. We watch things. We plant seeds. We let them grow for a long time. And that's why we're thinking in five, seven years, not necessarily next year for a lot of these programs, what they're going to produce.

Yes. So it sounds like between some of the current stuff you're doing in the EWA, at this point it's more about protecting your share with critical customers that you have. But eying for the future you're certainly keeping a pulse on how the products perform and how the market evolves. And you would be willing to push forward in a larger way with some of those things if you felt the opportunity was worthwhile.

Yes, I think that's right. And we're also, we're placing a bet on what we think is a really good partner that has the potential to grow significantly. But it's yet to be seen if that happens.

Yes. Cool. Thanks, Brett. That's a good color. And then just on the, maybe a question for Glen, since we only get to test you with these questions for so much longer here. Just on the OpEx side. You've got one more quarter in fiscal ‘23 here. Obviously, you guys are giving the guide. My guess is you're looking to reasonably hold the efficiency ratio fairly stable, maybe improve it a little bit. But just what's kind of the order of magnitude of things on the list to invest in for next year? Like, what are some of the key areas where you are allocating dollars? And just generally, I mean, how are you thinking about expense growth? As an industry, obviously, there's been a pretty tight lid on it. But as Brett, as you pointed out, I mean, you guys really are insulated from a lot of these pressures. So there's definitely room to invest. I am just curious what you guys maybe might be investing in as we think to next year and what that rate of growth could look like.

So we, as you recall, Mike, we really think about operating leverage here and at least over time, growing our revenues at least 2x of expenses. Now, certain periods and some of the spaces that we plan, yes, we have to make investments in those. But I think in this environment, at least as it's just today, you could expect us to maintain expenses fairly tight to where we're at today. And they will slowly grow as our revenues grow, but not get too far ahead of that. Many of our expenses are variable in nature. And so those will go consistently with revenue. And then the rest of our expenses and where we make investments, you can think of technology and risk management, primarily compliance. And has the, sorry, go ahead.

Oh, just going to add on, staying on top of both of those and a lot of the technology investments are made in the compliance space as more and more attention is focused on banking as a service providers and consumer protection and small business protection, making sure you have up-to-date compliance systems, we believe is going to continue to be a competitive advantage and incredibly important.

Yes, I mean, certainly seems that way when you just look at the headlines. So that makes sense. And then just lastly for me, one kind of financial follow-up to Frank's line of questioning, and I apologize if I missed this, but just are you able to give us just kind of like a broad indication of the type of provisioning you assume in that ‘24 guide? Is it reasonable to assume, it's similar year-on- year plus or minus to ‘23 based on kind of the macro and the forward curve and everything you're assuming? Is that a reasonable assumption without getting too specific round numbers or is there something that could alter that? Go ahead.

Now, we feel really good about, yes, no, thanks, Mike. We feel really good about our credit positioning today. And we are looking hard to see if there's something we're missing, but we feel comfortable. I think Brett did a good job explaining we're not taking credit risk in the consumer space. We feel confident in the way we manage our collateral and the commercial finance space. So, yes, roughly similar levels of provisioning as some of that will depend on loan growth with the CECL. It'll take a lot of that up front. So, where that lands will depend on how new originations are a little bit year-over-year. But, yes, similar provisioning is a good assumption.

The next question comes from the line of David Feaster with Raymond James.

Hey, good afternoon, everybody. Maybe just kind of following up on that last line of questioning. Obviously, so just looking at the 2024 guidance, I'm curious from your perspective, obviously, I mean, look, your crystal ball is as clear as mine is right now. And appreciate the commentary about assuming the forward curve and some of the thoughts on provisioning and expenses, but I'm just curious what you think of is really the key driver of the differences between the achievability of the top end versus the low end of the range. Is it growth? Is it this credit cycle? I'm just curious, what do you see as the biggest drivers between the top end and the low end of that range?

David, there's so many factors, which is the reason we have that kind of a wide of a range. But I would say, the first thing is yield and margin. Throughout this particular cycle, I think we've been surprised on how thin we had to price loans compared to the way rates had risen. And so it took a while for yield to really show up. If in fact banks are slowing down on our lending and we're able to do the kind of living I want to do, which I would say is working capital. We will get the margin and we will be at the higher end of that and that’s one big thing. I am not worried about credit, if there is ever time that we are strength for credit it’s our collateral, no one secured debt, we collateral manage everything. I don’t have any particular concerns about that. And I did mention the banking as a service partner, and putting pressure on us. We have long-term contracts but it’s a function of them bringing new business. And do we have to make some concessions for them to get new business in here that might impact margins as well. So those are my big ones. Glen, anything you add?

Yes, I think you are right. The macro is if we start seeing more normalized loan beta yields then that that will certainly drive us to that top end as well as just where demand for loan volume is and when that picks up and so we are certainly been somewhat cautious on how much loan demand there will be in this environment. And so kind of what you would your typical drivers, David.

Okay. Then maybe just following upon conversation, yes.

So I just want to point out, the income tax credit obviously, we are pretty cautious there, that’s a pretty good chunk of earnings there year-over-year and so to extent that renewable energy projects pick up the pace again, that could be an opportunity as well.

That’s helpful. And may just switching gears to the partner conversation again, I'm just curious, have you seen any impact on your partners from the bank failures at all and just the impact of the venture capital side? And may be just more broadly, how does the pipeline of partnerships look at this point and how negotiations for contracts are going today? It sounds like, just listen to you, Brett, that maybe the partners to some extents are getting a little bit more aggressive in terms of maybe a bit more pricing power. Is that a fair characterization?

Yes, I think in my comments, what I was alluding to is there's a lot more competitors that had jumped into the banking as a service business and they've done some thin pricing. Now, a lot of cases they did it with fintech startups and fairly small things. And we'll see kind of what happens there, but some of the bigger partners are one seeing some of the thin pricing that's out there. And two, the fact that rates have moved up gives them a greater interest in the deposits we have. All of a sudden, they care about that a whole lot. So I think those are the things that are kind of putting pressure on it. Now, I mentioned and I believe this, that part of this is going to be a regulatory cycle. You can read all the newspaper articles about what's going on in this and some of the things that have happened that are even very public reflected. So I think there'll be a reversion back to the mean in 12 to 18 months, but in the short term, there's certainly some pressure here. Yes, we have partners in the pipeline. We have them all the time. We have some running to us because of regulatory issues at other institutions. And so we try to take advantage of that. One of the problems for them when they come to us though is they get a bit of sticker shock because we don't do it as cheaply as people that did it before because they don't have the risk and compliance framework. So there's negotiations that go on in that. So it's not all doom and gloom. We just want to be sure people understood there is some margin pressure going on in the short term.

That makes sense. And then I'm just curious, you've got a unique and interesting perspective. You play in a very broad set of segments across the country. I'm just curious, maybe as you step back and look at some of the trends and consumer behaviors maybe within your fintech partnerships, the demand that you're seeing for credit from SBA and the commercial finance portfolio, is there anything interesting that you're seeing just, I guess in terms of the health of the consumer or the economy more broadly? I'm just curious, as you look at teal leaves just how do you think the health of the economy is and anything interesting, you're seeing?

On the consumer side, what I would say is remember that the bulk of our business is at the lower end of the economy. As one of my consumer credit people once told me, they're always in a recession. And so there's no real difference in the transactions. They're still buying their groceries, still going to the drugstore, buying gas, et cetera. So we're not really seeing anything particular around that. The deposits that are coming down are more because of EIP and the runoff of tax deposits than anything else. Conversely, on the commercial finance side, there are industries that we serve where they're not borrowing as much because they don't have as much activity going on. Our transportation factoring business is off a bit and it's not because there's not available to borrow, there's just less business that's out there and less need for it. And you see some of that in certain areas, seeing some slowdown. But I would not say we see anything that is dramatic or certainly not anything that we saw like when COVID first hit. It's fairly mild.

Thank you. And that concludes the Pathward Financial Third Quarter Fiscal Year 2023 Investor Conference Call. Thank you.