First Internet Bancorp (NASDAQ:INBK) Q4 2022 Earnings Call Transcript
First Internet Bancorp (NASDAQ:INBK) Q4 2022 Earnings Call Transcript January 26, 2023
Operator: Good day, everyone, and welcome to the First Internet Bancorp Earnings Conference Call for the Fourth Quarter and Full Year 2022. Please note that today's event is being recorded. I would now like to turn the conference over to Nick Talboys from Financial Profiles, Inc. Please go ahead, Mr. Talboys.
Nick Talboys: Thank you, Hanna. Good day, everyone, and thank you for joining us to discuss First Internet Bancorp's financial results for the fourth quarter and full year 2022. The company issued its earnings press release yesterday afternoon and is available on the company's website at www.firstinternetbancorp.com. In addition, the company has included a slide presentation that you can refer to during the call. You can also access these slides on the website. Joining us today from the management team are Chairman and CEO, David Becker; and Executive Vice President and CFO, Ken Lovik. David will provide an overview and Ken will discuss the financial results. Then we'll open the call up 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. Additionally, management may refer to non-GAAP measures, which are intended to supplement, but not substitute the most directly comparable GAAP measures. The press release available on the website contains the financial and other quantitative information to be discussed today, as well as a reconciliation of the GAAP to non-GAAP measures. At this time, I'd like to turn the call over to David.
David Becker: Thank you, Nick. Good afternoon, everyone. And thanks for joining us today as we discussed our fourth quarter and full year 2022 results. For the fourth quarter 2022 we reported net income of $6.4 million in earnings per share of $0.68. For the full year in 2022, we reported net income and diluted earnings per share of $35.5 million and $3.70 respectively, compared to $48.1 million and $4.82 respectively for full year 2021. Most of our lending teams had strong production in 2022. Net interest income for the year was up 12.1% compared to '21. As we deploy cash balances to fund loan growth, driving average loan balances higher along with higher loan yields from the rise in interest rates throughout the year. Loan demand was particularly strong in the fourth quarter as portfolio balances totaled 3.5 billion at year in increasing 7.5% compared to the third quarter and 21% compared to one year ago.
During the quarter, we both posted strong across the board growth led by our commercial lending areas where balances were up 184 million or 7.3%. And we're up 350 million or 15% for the year. We saw growth in printouts for the construction, single tenant leasing, small business lending, and commercial and industrial. Our consumer loan balances increased 61 million or 9% compared to the prior quarter and grew by 263 million for the full year 2022. Or 56% with residential mortgage trailers and RVs leading the way. We achieve this exceptional loan growth without sacrificing our proven commitment to credit quality, for the provision for loan losses in the fourth quarter was higher than in our prior quarters, the increase was due primarily to the strong loan growth as net charge offs remained low, or about 3 basis points of average loan balances, and only 1.1 million throughout all of 2022.
Again, only about 3 basis points for the entire year. In fact, our asset quality improved on a year-over-year basis, with nonperforming assets representing just 17 basis points of total assets at year end and nonperforming loans representing just 22 basis points of total loans, both of which are well below industry averages. With the increase in interest rates throughout the year, we have been able to increase rates on loans, as new portfolio origination yields increased 84 basis points during the fourth quarter as compared to the prior quarter. Resulting in a total portfolio yield increasing 39 basis points quarter-over-quarter. However intense competition for deposits through the most rapid set of federal funds, rate hikes and decades has also driven interest expense higher pressuring net interest margin.
To defend net interest margin on the asset side, our 2023 loan origination efforts will be focused on variable rate loan products, notably commercial construction and small business lending. And then other high yielding portfolios such as franchise finance and consumer lending. We believe the increasing mix of variable rate loans combined with new loan production coming on at higher rates will help to offset the pressure of higher deposit costs. If interest rates follow the market expectations, deposit costs should stabilize later this year in decline thereafter. Setting the stage for us to achieve higher earnings and profitability in 2024. Turning to mortgage, while other lending lines has strong demand, the combination of housing prices, housing supply, economic uncertainty, and interest rates have caused mortgage applications nationally to plunge to the lowest level in 26 years.
Due to the steep decline in mortgage volume, the unfavorable outlook for mortgage lending over the coming years, we announced yesterday that we are exiting our consumer mortgage business. This includes our direct-to-consumer mortgage business that originates residential loans nationwide for sale in the secondary market, as well as our local traditional consumer mortgage and construction to firm business. This was a difficult but ultimately necessary decision. Given every economic outlook we have reviewed the points to prolong sluggishness across mortgage banking. Excluding onetime costs, we estimate we will deliver approximately 2.2 million and higher pre-tax income in 2023. And over a longer horizon remove an element of volatility from our earnings and be a stronger, more efficient company.
I want to thank everyone on the mortgage team for the hard work and dedication to homeowners. We are providing each of them with tools and resources to help them transition into new opportunities. I would also like to note that our commercial construction and land development business will not be affected by this decision, and remains an important part of our lending strategy. To wrap up the lending discussion one final point I want to make is that we have never wavered from our underwriting and credit standards regardless of market conditions. We believe our excellent asset quality and strong credit culture, in addition to our strong capital levels, positions as well to weather any economic slowdown that might be on the horizon. Lastly, I want to provide an update on our banking as a service and fintech partnership initiatives.
During the fourth quarter we went live with our platform partner increase and launch our first program through that partnership with ramp, the corporate card and spend management fintech. We are providing payment services to ramps bill payment offering for about 30% of their customers currently, and are now processing between $8 million to $10 million a day in daily volume. We also have two other fintechs, a payroll provider and a neobank in the pilot phase, and we have four more fintechs that are approaching the pilot phase, and one in due diligence. We are also betting new opportunities with increase on a weekly basis. We also expect our other partnerships with a platform treasury prime to be fully implemented in the first quarter of '23.
With the first fintech partner to be on boarded in the second quarter. Similar to our partnership with increase, we are looking at new opportunities regularly as we get ready to go live with treasury crime. To wrap up my prepared comments this past year was a mixture of both successes and challenges. I'm proud of the business that we have built over the last two decades. And of course, there is always still work to do. We are focused on controlling what we can control to build an earnings stream that is resilient to changes in the economic and interest rate environment. We have a strong balance sheet and are well capitalized, allowing us to withstand whatever challenges the economy may throw at us. Like you we are shareholders and we are committed to continuous improvement and creating shareholder value.
Before I turn it over to Ken, I'd like to thank the entire first internet team for their hard work and commitment to both our customers and our shareholders. We have developed a culture that fosters and champion teamwork and innovation. That is why we were named one of the best banks to work for by American Banker for the ninth consecutive year, and that's why I'm confident in our collective ability to identify compelling new opportunities that will further diversify our business lines, improve our funding profile, and elevate our status as a leading technology forward financial services provider. With that, I'd like to turn the call over to Ken to discuss our financial results for the quarter.
Ken Lovik: Thanks, David. The first thing I will start with is discussing the financial impact of the decision to exit the mortgage business that David spoke about earlier. We expect this to reduce total annual noninterest expense by approximately $6.8 million in increase annualized pre-tax income by approximately $2.7 million. We expect to realize about 80% of the annualized improvement in 2023 and 100% in subsequent years. Additionally, we estimate that we will incur a total pre-tax expense of approximately $3.3 million associated with the exiting of this line of business. The majority of this is expected to be recognized in the first quarter of 2023 with the remaining amount in the second quarter. Therefore, the Aaron Beck in this decision will be between four and five quarters to exit a line of business that is otherwise forecast to remain subdued for the next three years.
Now turning to Slide 7, David covered the highlights for the quarter from a lending perspective, including the growth across the board in all active lines of business. Throughout 2022, we increased rates on new loan originations, our fourth quarter funded portfolio origination yields were up 84 basis points from the third quarter and up 118 basis points year-over-year. We did fund certain loans during the quarter that were in the pipeline before the Fed, September fed rate increase and were therefore priced at lower rates, which created a drag on new origination yields. The majority of these loans have been cleaned out of the pipeline, with our focus on higher yielding asset classes new production is coming on with yields north of 7% and in many cases much higher, setting the stage for higher average loan yields in 2023 and beyond.
While loan growth was very strong during the fourth quarter, we expect overall portfolio growth in 2023 to be lower than it was for 2022. Our higher yielding and variable rate channels continued to have solid pipelines. But much of that growth is expected to be financed by cash flows from other portfolios over the course of the year as we remixed the composition of the total loan book. Moving on to deposits on Slide 8, overall deposit balances were up $249 million, or 7.8% from the end of the third quarter. Non-maturity deposits, excluding banking as a service broker deposits increased by 64 million compared to the linked quarter, with money market accounts leading the way which were up $41 million. We also had a nice increase in noninterest bearing deposits of almost $33 million, the majority of which were driven by deposits from our commercial construction borrowers.
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As we previewed in the third quarter earnings call we expected and we experienced a significant decline in bass broker deposits during the quarter due to the winding down of a fintech deposit relationship. However, this was partially offset by just over $13 million of new deposits related to the payment services were providing to ramp that David referred to earlier. We also brought in about $18 million of deposits from our relationship with increase, which are classified within the interest-bearing demand deposit line item. As we grow the number of fintech partners we expect these types of deposit opportunities to expand in the future. CD balances were up over $100 million compared to the prior quarter due to new production in the consumer channel, while broker deposits increased $166 million as we access the wholesale market for longer duration funding to take advantage of the inverted yield curve and help to offset the impact of continued fed rate hikes on deposit costs.
Competition in the digital checking and money market space combined with ongoing fed rate increases and the continued trend of overall deposits leaving the banking system continue to present challenges to grow non maturity deposits. In both the digital bank and small business markets we saw appear betas in the fourth quarter range from 80% to 100%. With the 425 basis point total increase in the fed funds rate since March 2022, including 125 basis points in the fourth quarter. Our current pricing and money market products results in a cycle to date beta of about 70%. As a result of all the deposit and interest rate activity during the fourth quarter, the cost of our interest bearing deposits increased by 104 basis points from the third quarter.
Turning to Slides 9 and 10. Net interest income for the quarter was $21.7 million and $23.1 million on a fully taxable equivalent basis, down 9.6% and 8.7% respectively from the third quarter. Our yield on average interest earning assets increased to 4.40% from 3.91% in the linked quarter, due primarily to a 39 basis point increase in the average loan yield a 60 basis point increase in the yield earned on securities and 103 basis point increase in the yield earned on other assets. The higher yields on interest earning assets combined with the growth and average loan balances produced solid top-line growth and interest income increasing 16.5% compared to the linked quarter. Deposit cost however increased at a faster pace, resulting in the decline in net interest income.
We recorded net interest margin of 2.09% in the fourth quarter, a decrease of 31 basis points from the third quarter. And fully taxable equivalent net interest margin was also down 31 basis points to 2.22% for the quarter right in the middle of the range that we guided to on last quarter's call. The net interest margin roll forward on Slide 10 highlights the drivers of change in the fully tax equivalent net interest margin during the quarter. For 2023, we continue to feel confident that the combination of higher priced new loan originations variable rate assets repricing higher and additional draws on the high level of construction commitments will drive strong growth and total interest income. Currently, we expect the yield on the loan portfolio to be up around another 40 to 45 basis points for the first quarter of 2023.
With loan interest income up in the range of 10% to 12% compared to the fourth quarter, and for the full year do increase 35% to 40%, compared to 2022. On the funding side with higher forward rate expectations based on the feds continued language regarding rates and inflation. We also expect deposit costs to increase. The pace of increases will depend heavily on price competition and the magnitude of fed rate increases, as well as for how long it maintains the terminal rate. Assuming the fed continues to increase rates early in 2023, we expect the cost of deposit funding to increase 60 to 65 basis points in the first quarter with total interest expense up in the range of 25% to 30%. In terms of how this impacts fully taxable equivalent net interest margin, we expect elevated deposit costs will compress margin further for much of 2023.
However, as we improve the composition of the loan portfolio, margins should stabilize and be in the range of 2.05% to 2.15% through the first three quarters of the year. If the fed hits its terminal rate during 2023, we should see the dollar amount of interest expense stabilized in the fourth quarter, which would get us back to a higher fully tax equivalent net interest margin in the range of what we realized during the fourth quarter of 2022. Turning to noninterest income on Slide 11. Noninterest income for the quarter was $5.8 million up $1.5 million from the third quarter. Gain on sale of loans totaled 2.9 million for the quarter up slightly over third quarter and consisting entirely of gains on sales of U.S. Small Business Administration 7A guaranteed loans.
Our SBA team closed out the year well as sold loan volume was up 23% over the third quarter. Net gain on sale premiums were down almost 120 basis points, however, offsetting the impact of greater sales volume. Mortgage banking revenue totaled $1 million for the fourth quarter of 2022 and other income totaled $1.5 million for the fourth quarter, up significantly over the third quarter due to distributions received uncertain SBIC and venture capital fund investments. Moving to Slide 12, noninterest expense for the fourth quarter was $18.5 million up $500,000 from the third quarter. Now let's turn to asset quality on Slide 13. As David mentioned earlier, credit quality continues to remain excellent as nonperforming loans and nonperforming asset ratios remain low.
Net charge offs of $238,000 were recognized during the fourth quarter, resulting in net charge offs to average loans of 3 basis points as David referenced earlier. Total delinquencies 30 days or more past due were 17 basis points of total loans as of December 31, compared to 6 basis points at September 30th. When delinquencies are this low, it takes just one loan to make the difference. In this case, we had to delay converting a C&I construction loan to a 504 loan for its permanent mortgage when it was determined there was a mechanic's lien on the property. However, subsequent to year end, the construction loan was brought current. The provision for loan losses in the quarter was $2.1 million, up from about $900,000 in the third quarter. As David commented earlier, the increase was driven primarily by overall growth in the loan portfolio.
This was partially offset by a reduction in specific reserves related to positive developments on a certain monitored loan. The allowance for loan losses increased $1.9 million, or 6.3% to $31.7 million at quarter end, while the ratio of the allowance to total loans decreased 1 basis point to 0.91%. While growth in the allowance was generally in line with overall loan growth, the slight decline in the coverage ratio also reflects the removal of the specific reserve I just mentioned. Growth in the residential mortgage portfolio that has a lower coverage ratio and the continued decline in health care finance balances that have a higher coverage ratio. We will be implementing the current expected credit losses or CECL model during the first quarter of 2023.
As a result, we expect our initial adjustment to the allowance for credit losses to be in the range of $2.5 million to $3 million. With respect to capital, as shown on Slide 14. Our overall capital levels and both the company and the bank remain strong. While total shareholder's equity increased in terms of dollar amount, our tangible common equity ratio declined to 7.94% as the combination of balance sheet growth and share repurchases, offset the effect of net income earned during the quarter, and the decrease in the accumulated other comprehensive loss. During the fourth quarter we repurchase 284,286 shares of our common stock at an average price of $25.16 per share as part of our authorized stock repurchase program. For the full year 2022, we repurchase just over 800,000 shares at an average price of $34.62 per share.
Along the lines of controlling what we can control. Our solid capital position allowed us the flexibility to be in the market repurchasing our shares at a price far below what we believe to be our franchise value, helping to increase tangible book value per share to $39.74 at quarter end, up 3.7% over the third quarter. Before I wrap up my comments, I would like to provide some comments on our forward outlook for earnings. Earlier I provided some thoughts on loan yields, deposit costs and net interest margin. With the plan to exiting of the mortgage business, there will be some noise in the first quarter's results. But going forward from there, the impact should be accretive to earnings in the range of $0.25 to $0.26 on an annualized basis, so around 20 cents for 2023.
The largest impact of exiting mortgage will be a non interest expense, when excluding the onetime costs of $3.3 million. We expect total non-interest expense for 2023 to increase in the range of 2.5% to 3.5%. Compared to 2020 twos full year results, which is much lower than the previous guidance we gave on expense growth for the year. On the flip side, non-interest income will be down from the original forecast in the range of a 15% decline from 2020 two's total non-interest income. In line with the fully tax equivalent net interest margin expectations discussed earlier. We expect net interest income to remain consistent with the fourth quarter's results and remain stable from the first quarter through the third quarter 2023 as earning asset growth and higher loan yields help to offset the increased deposit costs.
If deposit costs stabilize in the fourth quarter as the forward curve suggest, we would expect to see low double digit growth in net interest income during the back end of the year. For the full year, we are expecting operating earnings per share excluding the mortgage exit cost to be in the range of $2.55 to do $2.75 per share with the first quarter to be roughly in line with the average estimate and improving in the second and third quarters. As deposit costs stabilize and loan income continues to grow. Combined with the seasonality of the SBA business, we are expecting significantly improved results in the fourth quarter with earnings per share in the range of $0.92 to $0.98. Looking ahead to 2024, if you simply take the low end of that range and annualize it, the results are significantly higher than the current 2024 estimates.
Some factors that might provide additional upside to 2024 results may include the pace of fed reductions should they follow the market's expectations as opposed to the fed dot plot. SBA gain and sale premiums reverting to historical averages as rates and prepayment speeds decline and higher than expected noninterest income from banking as a service activities. To wrap up well, the next several quarters may continue to provide challenges from an earnings perspective, we're beginning to see light at the end of the tunnel. When the fed begins to bring rates back down whether in line with the forward curve expectations or the fed dot plot, deposit costs should come down significantly, with a meaningful and positive impact on net income and earnings per share.
With that, I'll turn it back to the operator so we can take your questions.
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