Thank you for standing by, and welcome to the Newtek Business Services Corp. Q2 2020 Earnings Conference Call. At this time, all participants are in listen-only mode. After the speakers presentation there will be a question-and-answer session. Please be advised today’s conference is being recorded. [Operator Instructions] I would now like to hand the conference over to your speaker today, Mr. Barry Sloane. Thank you, sir. Please go ahead.

Thank you very much, and welcome, everyone, to our second quarter 2020 financial results conference call. Joining me on today’s presentation is Chris Towers, our Executive Vice President and Chief Accounting Officer. Also, for those of you that would like to follow in on the conference call’s presentation, you can go to our website, newtekone.com, N-E-W-T-E-K-O-N-E.com, your business solutions company. You can go to the Investor Relations section and go to Presentations. You’ll be able to follow along on the PowerPoint. I’d like to point everyone’s attention to the forward-looking statement comment on Page number 1 and then move forward to Page number 2. Our second quarter 2020 financial highlights. Newtek reported at the market close yesterday record financial results across several key metrics for the three and six months ended June 30, 2020. This was a great quarter for us. We’re extremely proud of the way our company shifted due to the pandemic. We had to immediately change and focus our business model to accommodate the altered economic landscape. We basically ceased our forward movement on our pipeline of SBA 7(a) loans, which has obviously been our steady business for over 17 years, and positioned ourselves to participate in the SBA and Treasury and a federally sponsored PPP program. We obviously look at the shifting, and our performance is the mark of a company that is able to excel under adverse circumstances. As we go through this presentation, please note that we’ve got a great second half to go through in 2020. And we also encourage our shareholders to look at Newtek on a long-term basis. We look forward to giving a forecast for 2021 that will be a little bit more normalized than the lumpy forecast that we will – or the lumpy results that we’ll have in…

Thank you, Barry, and good morning, everyone. You can find a summary of our second quarter 2020 results on Slide 36 as well as a reconciliation of our adjusted net investment income or adjusted NII on Slides 38 and 39. For the second quarter of 2020, we had net investment income of $29.7 million or $1.42 per share as compared to NII of $1.1 million or $0.06 per share in the second quarter of 2019. Please note that income related to the PPP is included in investment income in 2020. Adjusted NII, which is defined on Slide 37, was $28.5 million or $1.37 per share in the second quarter of 2020 as compared to $11 million or $0.57 per share for the second quarter of 2019, so 140% increase on a per share basis. Focusing on second quarter 2020 highlights. We recognized $46.7 million in total investment income, a 230% increase over the second quarter of 2019. Interest income related to fees from the PPP was the primary driver for the increase. We recognized $34.7 million of income related to the origination of PPP loans on $1.1 billion of PPP originations during the quarter. Servicing income increased by 10.9% to $2.8 million in the second quarter of 2020 versus $2.5 million in the same quarter last year, which was attributable to the average servicing portfolio growing from $1.1 million at June 30, 2019, to $1.3 billion at June 30, 2020. Distributions from portfolio companies for the quarter included $1.65 million from NMS, $75,000 from IPM, $250,000 from SIDCO and $293,000 from Newtek Conventional Lending, which is our joint venture. Total expenses increased by $1.7 million quarter-over-quarter or 11.3%, mainly driven by increases in professional fees, compensation-related costs and other loan administrative expenses. Realized gains recognized for the sale of the guaranteed portions of SBA loans sold during the second quarter totaled $1.7 million as compared to $13 million during the same quarter in 2019. In the second quarter of 2020, NSBF sold 18 loans for $1.7 million at an average premium of 7% as compared to 170 loans sold during the second quarter of 2019 for $96 million at an average premium of 11.52%. The decrease was attributed to our shift to PPP originations during the second quarter of 2020. As I mentioned earlier, income related to the PPP is included in investment income, not in realized gains. Realized losses on SBA non-affiliate investments for the second quarter of 2020 were $2.9 million and $971,000 during the second quarter of 2019. Overall, our operating results for the second quarter resulted in a net increase in net assets of $25.5 million or $1.22 per share, and we ended the quarter with NAV per share of $15.66. I would now like to turn the call back to Barry.

Thank you, Chris. Operator, I’d like to open it up to questions.

[Operator Instructions] And your first question comes from the line of Mickey Schleien with Ladenburg.

I hope everything is well on your end. Barry, there was a strong rally in 7(a) prices in the second quarter, although I didn’t see it in Slide 14. How much of that do you think may have been due to a scarcity factor? And how do you see the supply-demand equation unfolding as you and other lenders restart your 7(a) originations?

Sure. Mickey, there is a scarcity factor. I think you’re going to have a scarcity factor as far as the eye can see. I think that the other thing that – let me take those in pieces. I would say the most dominant issue for pricing is that new loans that are made are also made currently with six months of principal and interest, so that – there’s very few prepayments in the first six months. So prepayments have dramatically slowed, and that’s bolstered the market. I think that from a supply and demand perspective, because of PPP, a lot of the assets that were drawing to making 7(a) loans are being pushed into this segment. I don’t really see that supply and demand changing. The other thing I would point out is, in the current interest rate environment, that’s very flat. These particular bonds offer very good yields to other structured products or other investments that financial institutions have to make. So I think I see decent price stability for a while. Now these aren’t off-the-charts prices. Prices have been higher than this in the past. But I think that – I think this is decent. By the way, there’s also, Mickey, factors in the fact that there are people who think that default rates will spike down the road, too. So you kind of have – you do have two dynamics in here. But I think steady prices on a net basis for us between, I’m going to say 1 10 and 1 12, I think are on the horizon.

I understand. Just one follow-up question. Commercial real estate makes up over half of your collateral. I’d like to understand what the typical loan to value is on those loans. And how concerned or what is your level of concern that the pandemic may permanently impair at least some of their value, such as restaurants, which is your third largest segment?

Sure. So a couple of things. One, focusing on restaurants as the third largest segment, it’s still a small piece of the portfolio. And not all restaurants are created equal. I would say probably greater than 50% of our restaurants have got commercial real estate behind it. And that’s valuable because the restaurants that are thriving have their own lots, have pickup at the curb and drive-through. And that’s the trend going forward. As a matter of fact, if you look at a company like Dickey’s Barbecue, their revenues are up 17% because they don’t have most of the real estate for in-room dining. I think that our commercial real estate sector from a collateral perspective is totally different than an income-producing piece of real estate like an office building or a strip mall, multi-tenanted. Ours are very much tethered to the business. So the valuations haven’t soared with excess leverage going into securitizations, and they typically don’t decline as much either because they’re very much tied to the operating business. So we’ve liquidated. And to be honest with you, I’ve been surprised, like Peter Downs, Chief Lending Officer, has mentioned to me over the last 4 months that we’ve had these contracts on businesses, commercial real estate and loans and ongoing, that stuff’s not closed. It closes. It’s closing. It’s like, wow, like they’re sticking to the valuations, they’re sticking to the bid because there is a very significant portion of the United States of America that’s got – there’s $5 trillion or $6 trillion of liquidity sitting out there, looking to put money to work. So there’s money coming in the stuff, money coming out of the stuff. So we feel pretty good. We’ve been able to liquidate things at very good values in the last 4 months when you figured people would walk or reneg. No, not the case. As a matter of fact, with all this liquidity out there, and we could argue, who’s going to pay for it down the road, there’s a good bid for things. And even for some of these restaurants, new people are going to want to come in when things open up and take over the infrastructure and start up again because the demand is there. There’s a ton of money and liquidity sitting for when the government opens things up, people adhere to doing things safely and the fear of going outside is reduced. So we’re – we know we’re going to take a hit here like everybody else. But when I say that, we’ve already marked the portfolio down, which is a seasoned portfolio of 32.6 months to a 30% cumulative gross default from here with a 40% severity. I think we – our balance sheet is a very, very well-adjusted balance sheet.

That’s helpful color, Barry. And may – it just generated another question in my mind. Is there a geographic component to your answer? In other words, I’m down here in South Florida. And frankly, there was a lot of boarded-up stores. And I don’t know if they’re ever going to be filled again. Now there’s a staples that’s been empty for years, not far from my location. So are you – when you underwrite loans that are collateralized by commercial real estate, are there parts of the country that you’re avoiding or parts of the country that you prefer?

Diversification, diversification, diversification. It’s funny. Mickey, I couldn’t predict the pandemic. Nobody was able to predict this. So we love diversification. And when you look at our geographies and you look at our industries, I’m pretty sure, and this does vary. Sometimes it’s a little bit over 10%, but mostly everything is under 10%. And we’ve been blessed, like look at my merchant portfolio, you think about merchant portfolio, you think about restaurants and retail, those things are crushed. But look at my merchant portfolio. So the value to our business model, getting referrals in – from financial institutions, not brokers, not bankers, not – diversification is the greatest. We’re not that smart to be able to predict that Governor Murphy is going to say, "You can’t go in a gym." And then Cuomo’s going to say, "I can’t go in a restaurant. Broadway is not opening." Who would have ever predicted that New York City would be shut down from world travelers? So based upon that, we live and die based upon diversification. We have a diversified portfolio. We diversify our risk, and that enables us to stay in the game. And we’ve got loans in many states and many jurisdictions, and thank God, we’re pretty spread out. And also, importantly, we’re not dominated. Our portfolio is not an urban portfolio. That’s not to say that I don’t have some things in some of the urban areas. But most of these loans are not in – and I’m obviously familiar with Miami and New York City, for sure. But no, they’re not – we do not have concentrations there.

And your next question comes from the line of Fred Cannon with KBW.

Barry, first of all, I’m glad to hear things are going well during this difficult time. I wanted to talk – if you could talk a little bit about the outlook for further PPP lending. We had tremendous takeup with the first round. Then when Congress extended, it slowed down. Curious what your thinking is in this next bill, what would be necessary to kind of kick start real volume growth back into the PPP program.

Sure. So the good news, Fred, is I have – as a CEO, I spend an inordinate amount of time reading every single article I can find on the Internet and watching all mediums on TV. So I read this, I look at the – and I try to gather a consensus. It is apparent to me from Mitch McConnell, Pelosi, Mnuchin and the President, this program, although it has flaws, is deemed to be a success, and they realize that this is the quickest way to get the money in the hands of the SMB market, and they realize how vital it is. And yes, I heard Ron Johnson on TV this morning talk about there’s plenty of people that have got the money, and they haven’t spent it, which is apparently true. But it definitely liquefies a part of the economy, which, according to the Small Business Administration, is 50% of non-farm GDP. So that Senator Cardin, Senator Rubio, who chair small business in the Senate, very much for the program, Chabot, Velázquez in the House, positive. This is part of the Heroes Act. It’s part of the Senate Bill. Under the assumption, something is going to get done, which I have to say is more likely than that despite the posturing. I just – I can’t fathom both parties not getting some things done despite the fact both seem to be dug in. With that said, I think you wind up with $190 billion program. It gives businesses a second bite of the apple, if their revenues are down 50%, which I think a large amount of them can do. I think if there were 4,000 to 5,000 lenders the first time around, they’re only going to be 60% of the lenders this time around. I think some lenders won’t participate again, which is probably good for us. I can’t see this being as, I’d say this, attractive because the universe is smaller, fees have been cut, but it will still provide a very good return on equity for the work that we have to put in because of the 17-year investment that Newtek has invested in its infrastructure and technology and staffing. We do earn the money here. This is not a gift. There was 10 weeks where 180 people who work in seven days a week in 14, 16 hours a day. But I think that this is more likely than not, we’ve had to give fairly wide range of guidance here. And we do move 100% of the assets off the books.

I guess just as part of that, what do you think this $190 billion needs to be part of the package, so the $190 billion actually gets lent?

Yes. Great question. Here’s the key. Instead of a 50% reduction, make it 25%. That’s the best – and by the way, the House Bill says 10, I think the Rubios got it at 50. So if they were able to get that down from 50, that money is going to get put into the market.

Okay. That’s very helpful because that’s something to watch out for, Barry. The only – kind of another big question. It looks like the fed is going to keep rates down for an indefinite period at least in the next couple of years and including the long end of the curve, which is floating around 50 basis points. If we have this structure of the yield curve for the next, I don’t know, through 2022, how do you feel that affects your business?

Okay. So Fred, I am the contrarian. And I hate to say it, but I know what the fed governor is saying. I might be the only person in the world that actually thinks rates are primarily driven by market participants. I realize that the fed can push things around. But with the amount of borrowing that needs to be done, I – first of all, I don’t think rates are going to skyrocket, but I think you’re going to get – listen, we’ve seen fed chairman change rates quickly, changes mind quickly in a period of a quarter or two. It’ll go from tightening to easing. So let me say this. You – we’ve been around for 17 years. There are certain things that work better with rates rising. With rates rising, I get higher interest income. I don’t have a lot of leverage. That’s a good thing because they don’t have the debt. Prospectively, if the economy gets heated, speeds pick up, I get less of a gain on sale. And maybe when servicing income goes down with a better economy, maybe I get less defaults, higher liquidation value. It doesn’t – to be honest with you, and we’ve been through cycles up and down, we’re pretty well-matched. It doesn’t lean one way or another for us. I do believe that.

Okay. So you feel like in some ways, you’re somewhat hedged in terms of what goes up and what goes down if we have rates in this event.

No question about it. If you got inflation, my fee-oriented businesses do better, too.

[Operator Instructions] Your next question comes from the line of Matt Tjaden with Raymond James.

First question on the $180 million to $230 million adjusted NII range. I know you said that embedded some level of a PPP renewal. Does that also embed a renewal of the six-month P&I coverage by the SBA?

Not really. And I say that, Matt, from a standpoint that if we didn’t get additional P&I coverage, the businesses would be on their own. And I don’t think it would affect 2020 numbers at all. It may affect 2021. I shouldn’t say it may. It probably will. But it wouldn’t affect 2020.

Great. I think then kind of as a follow-up to that. If that six-month P&I coverage isn’t extended, is there any color you can give on kind of how we would expect delinquencies to shake out? Would that be an immediate spike right after the extension runs out or kind of a gradual buildup?

Yes. Matt, I want to change my answer to the first question. As I thought about it, once again, it all depends on the variability, vaccine, no vaccine. It’s really hard to guess. But it could affect – it could slightly affect interest income. It could slightly affect servicing income. As you go from a 99% currency rate to a lower number, it’s just – I don’t see it making an immediate adjustment, but I kind of want to try to be factual on that. Now what was the second question again?

Just specifically on the delinquency front, if that P&I coverage isn’t extended, kind of how would we expect that to shake out?

I think you would see – well, there’s two ways to think about it. And I tell this to people and I don’t think it absorbs, but that’s okay. A business that’s gotten six months of principal and interest, okay, the debt’s taken care of. It’s like a capital infusion. They’re getting their principal paid, they’re getting their interest paid for six months. We’ve spoken to our clients. They are managing this situation. The entrepreneurial ones, first of all, they’ve all partially guaranteed the loans in multiple ways. And many of them have downsized their business, they’ve reduced their expenses, so that a lot of them are getting rid of excessive things that they were using for growth, which is, frankly, the reason why most of these entities don’t make it is because they overextend themselves. They positioned themselves for growth that isn’t there. I think that what you would see is a gradual reduction of the currency rate over the course of time. This would not affect our balance sheet. And over the course of multiple years, it prospectively would have some weight on our charge-offs. But frankly, we looked at this. We’ve modeled it and doesn’t – we think we have it. I think the big issue is, we’ve taken it on the – we think we’ve taken the right measure on the balance sheet. But relative to affecting income over time, we think that our business will be able to grow through it, even if there is no more PPP.

Okay. And then just last question for me on the $150 million in SBA 7(a) loans. Any color you can give on how you arrived at that number? And kind of what underlying economic and government stimulus assumptions are embedded within that?

So first, I’ll make a joke. Pete Downs and I took out a coin and flipped it in the air. No, I hate to say that – let me tell you, look, I’ve been doing this for 20 years of public company. Forecasting today in this environment, it’s almost impossible. I don’t know, is New York open/closed? Is New Jersey open/closed? Is California open or closed? It’s just – it’s almost impossible to determine. So we looked at the pipeline. We looked at what we think is going to close this quarter. There’s plenty of demand. That’s not a problem. I’m very comfortable with the $150 million. I hope I don’t regret that I’ve said that because we got to pick and choose. By the way, we’re going to be sitting here in December or November ready to close loans, and all of a sudden, I got an appraisal in a business that’s different, or something popped up from the customer that they didn’t relay to us because of what’s happened in COVID. You know what I’m saying? So really hard to tell. I think when we look at the $150 million, it’s half of what we did last year. Now we’ve also arguably started a little bit later. I think it’s the number we are comfortable with, and that’s why – that’s how we came to it. A number that we were comfortable doing without having to stretch for credits or make loans in segments that we don’t particularly like, which – I mean, we had a pipeline in March. We just decided we’re not going to close those. And some of those loans, we’re not closing. I mean loans that we were prepared to move forward with in March, some of them, they’re not happening. They’re in bad geographies. They’re in bad businesses. But more importantly, the business owners have not shown the entrepreneurial instincts to be able to manage the environment, and that’s what we look for.

[Operator Instructions] And at this time, there are no further audio questions. Are there any closing remarks?

None, whatsoever. I clearly wanted to thank everybody, particularly the analysts for the questions. They were great. We certainly appreciate the interest in the company and the stock. This is a tough time. We’re in a tough market. We are dealing with a business segment and sector that does and has received and acquired government help. I think that will happen. I think that we are positive on things going forward because we believe that the economy being properly bridged will come out of this with minimal amounts of damage and actually wind up moving forward because we’re transitioning into a more efficient economy. And this has forced businesses to change the way they do things, to get rid of non-productive processes, software’s, technologies and assets and be leaner for the going forward. Let’s just hope we can grow through this, pay off the debt and move on to happier times. Stay healthy, everyone. Thank you, operator.

And thank you. This concludes today’s conference call. Thank you for your participation. You may now disconnect.