First Internet Bancorp (INBK) Q4 2022 Earnings Report, Transcript and Summary

Good day, everyone, and welcome to the First Internet Bancorp Earnings Conference Call for the Fourth Quarter and Full Year 2022. [Operator Instructions] 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.

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.

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.

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. 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.

[Operator Instructions] The first question is from the line of Brett Rabatin with Hovde Group.

Wanted to start with the buyback and wonder firstly, I think you had the $25 million authorization how much is left and then how much or how active you think you might be this year, just given the opportunity with the stock where it is presently? Thanks.

Brett, we're in the market had been since the first of the year buying on average about 4000 shares a day and intend to continue that.

Would you have an idea, David, of how much you might purchase this year or retargeted capital ratio or how to think about the volume that you might do this year?

Well targeted capital ratio, we want to stay pretty close to that 8% level. So as Ken said, there's little noise here in the first quarter. So we'll definitely be in that $4,000 range, probably the same for the second quarter. And then we'll figure out as things start to come our way in the second half of the year. We're forecasting out of the 25 million probably by year end getting to 20 million and buybacks. But the balancing act, as you said between TCE and share buyback to.

And then you've made some progress on the fintech front, and just wanted to make sure I understood the implications of the two that you've got and then treasury prime as well as the two fintechs in the pilot phase and the four others that could be soon. Can you give us any call gave us a lot of color on expectations for various metrics? Any thoughts on what those fintechs might contribute or how to think about that this year?

Well, the one that we discussed in there that that came live back in November ramp, which is the National Credit Card program, we're doing their bill payments services, and between November and now we've converted about 30% of their customers onto our side. So that $10 million a day we're clearing and payments should go up to 30 million plus a day in the next few months. That deposit balance offsetting from them, it's going to triple down. The same way we have a clearing account. The two that are in pilot phase 1 is a small business payroll system, and the other is a Neobank that's launching and in pilot phase with kind of friends and family side of things that we hoped some live maybe beginning of the second quarter. So our overall forecasts being pretty conservative on the rollout of this stuff is probably about a million this year and income somewhere 750,000 to a million in income from the fintech side, and a couple 100 million in pretty low cost deposits to kick it off. The Neobank could be a homerun hit, it's backed up by some phenomenally strong VCs on the West Coast. That one could be an out of the park, play, but like you say, it's stable, it's running and we're really looking forward with treasury prime. They got a couple of good candidates for us, we're doing the final phase of testing on the, I think the credit card portion of their interface, and we'll be live with them hopefully in the second quarter with one or two opportunities as well.

And if I could sneak in one last one on the loan growth, the construction growth, specifically, where might you guys be on a risk adjusted basis to capital? Are you close to 100% and how much growth would you expect from here in the construction portfolio?

We won't even be close to the 100%, because I remember, that's done at the bank level, Brett. So I mean, we got well over half a billion in capital at the bank. But we do, obviously, we expect, we do have our construction team had a great year this year with originations and those will fund. We actually pulled forward some of that funding this quarter is some deals started a fund earlier than we expected. But we expect next year, I guess the good part about from the construction piece is that, historically we've had a maintain balances in the 50 million-ish range revolving around residential land development here around in our home market here. But as we build out construction, I mean, we're really starting from a low base. So, even if we hit our targets for next year, that construction portfolio is still under 10% of the total loan portfolio and well under capital limits.

The next question is from the line of George Sutton with Craig-Hallum.

I just wondered if you could walk through the decision to exit the mortgage business versus just pulling it back to a smaller level being able to reenter the market when that seemed to be the right thing to do?

George, we probably spent the last 60 days doing all kinds of configurations of cutting back on sales, marketing efforts, staffing, trying to hold a shell together. There was just no way to get there, we couldn't even get it close to breakeven basis. So staring at a solid 6 million potentially plus in losses over the next three years and no idea. I mean, that's as far forecasting out as Annie and Jenny and everybody's doing, they don't even know come 2026, whether mortgage is going to rebound or not. Consumers are getting used to a 6% interest rate, assuming that's all they can get. But it fell off so dramatically that we couldn't make sense out of it to have that kind of a loss for that long a period of time. And is that part about out on the other side when mortgages going great. The market doesn't give us credit for it and mortgage is bad everybody else at it. So it's kind of one of those products where you're damned if you do damned if you don't. So it was a, believe me from my perspective, probably the toughest business decision I've made in my 40-year career. It's been a tremendous group of individuals still loved working with them for some of them now almost 16 years. And it's tough, it is really, really tough. And as you know, the market nationally is just blowing up. So there's not a lot of great opportunities, staring them in the face in the industry they've been a part of for years and mortgage has been cyclical. I've been around it now for close to 25 years. And I've seen that three or four cycles but this is by far the worst that I've seen in my lifetime, and probably the worst we've seen in the country and 40 to 50 years.

I appreciate that perspective, one of the things I can mention, you're doing this act of buyback, which we love to see, but you mentioned you're doing it in part because you're well below what you find to be your franchise value, I just wanted to see if we get a picture and into what you believe your franchise value to be?

There, at least from my perspective, franchise value should be booked value. And that's almost on $40 will be $40 by the end of the year. And when we're below that, I think it's good use of capital. We don't want to put ourselves in a bad position, obviously with TCE and capital risk out here. But again, the quality of our portfolio who knows six months from now we might be in a full blown recession and the walls are coming down. But from everything we see, and we know of what we're doing today, we're comfortable to we're below 40 bucks to keep buying back shares as we think it's a great use of capital.

The next question is from the line of Nathan Race with Piper Sandler.

Apologize I paused a little late. As you're going through, can your comments around the margin? Look for the first half of the shooting? We get the grades twice. We know and then, I was worried

Hey, Nat, you're cutting out.

Yes. Again I apologize. I was just wondering. Can you hear me better?

Not really.

Yes, we get about every third word.

The next question is from a line of John Rodis with Janney.

Ken you said I think you said in your discussion, your comments about loan growth, you said loan growth for 23 would be less than 22. What loans were up? I think, by my math 20%, 21% and 22? I mean, can you narrow down the growth a little bit more? I mean, are we talking 10% to 12%? Are we talking 15%? Or what are we sort of talking about?

No, overall, John, we're probably talking in the range of 5% to 7%. And maybe I'll just elaborate on that a bit. I mean, we have we're, as we talked about focusing, kind of re mixing the composition of the loan book. I mean, we still have within construction and SBA and franchised and consumer we still have some great opportunities to put on, higher rate and variable rate and in both cases, both the variable rates that are higher rates. But a lot of that financing is going to be done through amortization and cash flows from other parts of the portfolio. There's just some of our lending areas right now the market is so the competition still has rates very, very low that just don't work for us. So we're going to see I mean, there's probably in combination within say residential mortgage and some other areas that there's going to be roughly $250 million of lower balances year over year. So, again, a lot of that focus on the higher yielding asset class is just going to be a reshuffling of the loan book, if you will.

One of the other issues out there, John is on the consumer lending side, we had tremendous growth in the RV horse trailers last year, a lot of that was pent up demand because of the pandemic and the demand for those units. The Elkhart, Indiana and Northern Indiana is kind of the heartland for the RV industry. Their pipelines are getting caught up, they're getting back to normal sales activity, I think fourth quarter '22 versus fourth quarter '21 sales are down 26%, there about close to 30%. So that's going to drop down tremendously to over the course of the next year, we were up 200 million plus over '21 and that'll follow-up. So as Ken said, between repayment of existing, again, the healthcare portfolios and a total wind down and repayment status that we could, we're still going to do a lot of volume of new loans, but the overall balance sheet growth is not going to be that huge.

And then Canada securities portfolio was down I think 10%, 12% this year, would you expect sort of a similar amount next year just to fund that loan growth too?

Well, I mean, we'll probably got to keep it. We got we kind of got to keep it somewhat flattish or better or perhaps down a little bit. Because right now, we still have to maintain a certain amount of liquidity on the balance sheet. But I'll tell you right now, we might be better off just keeping it in cash in fed funds than then buying mortgage backs. So I would expect, probably you might see higher cash balances at quarter end than what you've seen here, maybe in the past couple quarters.

And then Ken just a couple of other quick notes. On your expense guidance, you set up 2.5% to 3.5%, excluding the 3.3 million. Is that based on total expenses for the year, so 73 million?

Yes.

I'm sorry, just I was trying to write while you're talking, but on spread it net interest income? I think you said the first quarter, sort of flat with the fourth quarter and then sort of stable for the first three quarters. Is that right?

Yes.

And then I guess you would expect to see some ramp in the fourth quarters where you said?

Yes, that's what we said. We'd like it. Yes, we think is as the best, assuming the fed hit the terminal rate and keeps it there that deposit costs will stabilize and we'll be able to start kind of net interest income will begin to start growing again in the fourth quarter.

The next question is from the line of Tim Switzer with KBW. Please proceed.

I'm on for [indiscernible]. I had a clarifying question first real quick. You mentioned $250 million lower balances year-over-year and like the, some of the portfolios are paying off was that in reference to the residential mortgage portfolio only or all of like the like…

No, that probably spread among three or four different portfolios. That's, resi is going to be down. David talked about health care finance that's basically, we're not originating anything new there. I would expect to see balance declines in public finance and single tenant lease financing as well, just simply is my comments earlier that the some of those markets right now are just so competitive, we got price floors in there, and we might win a deal every now and then. But we're not chasing, we're not doing deals below 7%. So when you when we can't get that it's hard. So you'd expect to see some decline in those portfolios.

Okay, yes, just making sure that wasn't just the residential mortgage. That seems a little. That's like at the end of the year. So what you're talking about 250?

Yes, I just talking year-over-year.

And then, with all the actions, you guys have taken the initiatives you have going on the bass program, as we look out over the next few years, what is like a realistic mix of revenue? And if you have a target or anything and kind of like spreading Converse fee income, trying to get an idea of what that could look like over the long-term?

Well, Tim, if I had a crystal ball that could do that, I could make a small fortune on that prediction. The bass world, it was the darling of everybody 12, 18 months ago, now everybody's question is, should we be in there and two or three American Banker articles in last couple days mentioned run from the bass worlds and play. There is a tremendous opportunity to partnerships with great folks like the ramp organization that we're working with. Now, on the bill pay services. There's a lot of those out there. Obviously, there are banks and fintechs, getting in trouble with the regulators, because they're not doing the proper due diligence and the overseeing on the compliance issues, which is one of the reasons we're a little slower to market than a lot of other people because we wanted to make sure we had the house in order and we could handle it, our prior acquisition opportunity would have given us a great team, we had to build that. So we're very thoughtful, very judicious. I've used the term several times on the calls that were kissing a lot of frogs to find the princess. And we think very good companies in the pipeline. The one I talked about a minute ago, the Neobank can be an absolute, it can be the unicorn that just blows up. And that's deposits, that's fees, that limiting income, there's just a ton of things that could come out of that. So we were probably that half a million to a million in revenue for '23. That might be a little bit to the conservative side with some of the things that are in signed, sealed, delivered in, in the pipeline. But we'll have a better handle on that as the year goes by. And, again, we see how the market settled. There are some other institutions that might have to exit from some of their programs. And we could be in a position to pick up some very well established customers just because they got into regulatory issues that we could pick up and move forward. So we probably can't give him much more guidance, and that kind of 0.5 million to 1 million in revenue this year. And as these come on, and we get a handle for how they're going to grow and go, we'll have better numbers and we'll update you on a quarterly basis.

And if I get asked one more, you maybe need a crystal ball too. But what is a realistic expectation for how these vast deposits can help on the funding side? Or like, I know, it's still a small part of your business right now. But what is sort of the cost range? He's deposits are coming on at and they priced it fed funds minus something, or how should?

I would, I would tell you historically, the a lot of the bass funds were zero class. But much like HOA dollars, much like $1,031, all these funds that historically have never cost an institution anything. These folks are getting very smart. The bass companies and the fintech companies all have to make a profit. And for them to continue to survive and get VC money, they have to tow a path to profitability. So were they were giving away that deposit didn't have any value to them. They now know they do have value? I would say ours are somewhere between fed funds minus 50, minus 75. Most of them are not above fed funds. But yes, it's not free money. But I'd say -- well, I can't pay take that back on the other side. The two accounts that Ken talked about are both free. If it's a settlement account, where we're just drawing funds for payments against them, those are still free. But if we get the positive base with a Neobank, that's probably going to be somewhere in the range of Fed Funds minus 50, minus 75.

The next question is a follow-up question from the line of Nathan Race with Piper Sandler.

A lot of my questions have been asked and answered at this point. But just one to think about kind of the reserve trajectory, maybe on a percentage or absolute dollar basis after the CECL adjustment in the first quarter. I guess I'm just curious about if you get any major charge offs on the horizon, or how you guys are kind of think about the reserve trajectory over the course of 2023?

Well, I guess the question on the horizon is no. We continue to try to stay on top of the portfolio and have all of our teams and credit admin looking at things real closely given the uncertainty. If you, that's why I kind of threw the number in, in with everything we released, just so you guys out there would see that the reserve is going to go up, call it in the 98 basis point range or so, 98 - 99. I guess what I would also add to that though, is most banks, especially banks are size don't have a 20% of their loan portfolio that is in public finance. That is we've never had a credit loss, never had a delinquency, and the coverage ratio for that portfolio because of its nature and sources of repayment is very low. When you exclude the public finance portfolio, the coverage ratio is closer to 115 basis points. So I think even though again, maybe credit losses, the unforeseen none of us have a crystal ball, maybe credit losses or net charge offs take up a little bit, but I think, with the increase in where we're at with the increase with CECL plus factoring in what the coverage ratios are in our commercial lines and consumer lines, I think we feel pretty good about where that coverage is.

[Operator Instructions] The next question is a follow-up question from the line of Brett Rabatin with Hovde Group.

I just wanted to follow-up on a couple of topics if I could. One on the linked quarter increase in loan yields and funding costs. I guess first a 45 basis point increase in loan yields in the first quarter. Can you talk about how many loans or the bucket of loans it's repricing in the first quarter? How you get to that 45 basis points? I guess just the first part of that.

Well, I mean, it's a combination Brett. We do have construction, I mean, if you figure that right now, the markets got a couple fed increases in there, because you're talking about '23, correct?

Correct.

Okay. Yes, I mean, between, -- our construction portfolio is virtually all variable, the FBA is virtually all variable. There's a component of C&I, that's variable. And we also have pipelines in franchise finance that, again, that pipeline continues to remain strong. Those yields now are coming on high sevens, eights, and nines in some case. And again, we're not really lending in certain other areas, unless we can get really good pricing. So it's continued higher yield, new production, lower yielding stuff paying off or just amortize and cash flowing. So it's just, it's a combination of all those factors that should continue to drive the overall portfolio yield higher.

The other issue that's going to make it a little stronger in the first quarter Brett is a lot of those loans that we added in the fourth quarter came on in the last two weeks, everybody was trying to get things done before year end. So we'll have a full 90 quarter run on those balances, which we only had them for the last five to seven days of the fourth quarter. So that's part of that those two.

And then the same sort of topic on the funding side, the 60 to 65 basis points. When I look at the current rates, I see it looks like from an NMDA perspective, you're at 335, maybe retail and maybe 340-ish on the commercial for that, versus the 289 for the 1.4 billion average in the fourth quarter. Can you remind me how much of the money market is retail versus commercial? And then, that those rate, I assume you're kind of thinking those rates of close to have topped out on the money market, but any color on that would be helpful.

Yes. The breakdown is roughly 1/3 commercial -- maybe 1/3 to 40% -- excuse me, 1/3 to 40% consumer and the remainder is commercial. And we do have two tiers of pricing in there, we do have some that are, if your balance is above a certain amount you're getting higher rate. But probably the biggest single bucket in there is what we'll call small business and commercial money markets and those the current rate on that 280. I would say we, again, I know we got a fed rate hike here coming up in a week or expected, possibly another one. But I would say as of late, the pace of increase has slowed down. I mean, we still kind of run what I'll say, pretty high betas through our model. But the pace of increases seemed to slow a bit. So I don't think, obviously, we saw over 100 basis points of increase in the last quarter. Again, think about it yet 125 basis points of fed increases in the fourth quarter, whereas, this could be, I guess, a minimum of 50 and a maximum of 100, depending on your view on what the fed is going to do. So, I mean, just by virtue of, what the fed did is expected to do this quarter versus what they did in the fourth quarter. I would, our forecast suggests that the pace of increase shouldn't be as high quarter-over-quarter as it was last time.

That's helpful.

And I guess one thing, probably one more thing, I'd probably add to that as we did, you saw the balance of broker deposits go up. And I said in my prepared comments, what we probably pulled forward some deposit funding as well, just because of where the long rates were relative to, again, the short end of the curve continued to go up, we took advantage and did some three, four and five year brokered CDs that what else, at a blended rate that's lower than fed funds. So, some of that is good for long-term interest rate risk, but also good to give us some stability, pulling that funding forward, as opposed to trying to go out and do more in the fed funds plus wholesale market in the quarter.

And then maybe one last one. I was trying to keep up with the notes. I missed what the commentary around the SBA expectations were, for the full year. Any color on SBA, and I know that's not necessarily an easy business to predict, given lower gain on sound margins, et cetera. But any color on how much that might contribute to the income this year?

Yes. The thing is, we still have, we continue to bring on high performing videos. We brought some on within the later part of the year. You have staff in place to service and we have originations up year-over-year. But I will tell you that from our perspective, right now. I mean, gain on sale premiums in the fourth quarter net gain on sale premiums were very low. They're in the 6.5, 107 range. And our forecast, we're not making any assumptions that those go up. So we're just and for the full year of 2022 on the front end of the year. We were getting higher gain on sale premiums, we were getting 110, 109 in some cases higher than that, and that came down. So we're, while we do have origination growth for the year. A lot of that is really offset by just assuming lower gain on sale numbers for the full year. So I mean, we're probably right now modeling that number that we recognized for the full year for 2022, we’re probably think modeling right now that to be flat to down a little bit. But entirely driven by gain on sell premium.

Real quick. Just 10.5 million to 11 million.

Next question will be a follow up question from the line of John Rodis with Janney.

Ken just back on fee income, in my notes did you say fee income down 15% for the year is that total fee income? Or did I –

Yes. That is total non-interest income. So – if we take the 21.3 million for 2022 and just cut that 15% that’s probably – that’s we’re estimating. So we’re obviously we did have mortgage revenue that’s not going to be here this year. And as we talked about SPA here being flattish, David did talk about our – what we think our conservative expectations on some increase from revenue but for this year we’re forecasting that to be down just by, the biggest piece is just removing the mortgage number out.

And then just one other question Ken, the tax rate kind of made new low in fourth quarter what should we use for next year?

Yes. I’ll guide you back to about 12 to 13, the one reason why the tax rate was low in the fourth quarter is when we do taxes, I will tell you the calculation isn’t necessarily done for a quarter at a time, what we’re trying to do is forecast – we use earning taxable income estimates for the year and I will tell you back earlier in the year in the first couple of quarters before the Fed started rapidly raising rates and we’re having the subsequent impact on earnings in the back end of the year. Our taxes, we were estimating higher net income. So all it really – I don’t like to use the word true-up but maybe that’s the best term I can come up with is, that affective tax rate is really what it takes for us to get our taxes in line for the full year. So again, I probably just guide you back to the 12% to 13% and that will probably be a reasonable estimate.

Thank you, Mr. Rodis. There are no additional questions waiting at this time. So I will turn the call over to David Becker for any closing remarks.

Everyone I’d like to thank you for joining us on today’s call, we’ll continue to exercise discipline and use all of tools that are just falls out to preserve earnings in 2023. And fellow shareholders we remain very committed to driving improved profit ability and enhance shareholder value. Thank you again for your time and have a good afternoon.

That concludes today’s…