Good day, everyone, and welcome to the First Internet Bancorp Earnings Conference Call for the first quarter of 2023. My name is Jayson, and I'll be the moderator for today's call. [Operator Instructions] Please note that today's event is being recorded. I would now like to turn the conference over to Larry Clark, from Financial Profiles. Please go ahead, Mr. Clark.

Thank you, Jayson. Good day, everyone, and thank you for joining us to discuss First Internet Bancorp's financial results for the first quarter of 2023. The company issued its earnings press release yesterday afternoon, and it's available on the company's website. 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 then discuss the financial results. Then we'll open the call to your questions. Before we begin, I'd like to remind you that this call, 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, Larry. Good afternoon, everyone, and thanks for joining us today as we discuss our first quarter 2023 results. Before we walk through the financial and operating results for the quarter, I would like to start with some comments regarding the sustainability and resilience of our business in light of the stunning external events during March and the challenges faced by the banking system. You'll find these points on Slide 3 in the earnings presentation. First, continued outflow to deposits in the banking sector during the quarter have brought deposit retention and liquidity to the forefront. First Internet Bank increased deposits by $181 million, or 5.3%, from year-end. Earlier in the quarter, we took advantage of consumer demand for CDs and brought in over $200 million in new CD volume, allowing us to build liquidity at pricing below forecasted increases in the fed funds rate. The demand for CDs remained fairly strong later in the quarter as well, and we also had the opportunity to increase certain larger deposit relationships. This calculated growth allowed us to easily absorb a decline in money market balances, some of which was due to outflows to money center banks in the U.S. Treasury market. While we experienced a modest decline in deposits from mid-March to quarter-end, balances have rebounded and are up $135 million thus far in the month of April. As of March 31, nearly 75% of our deposits were covered under FDIC insurance. The percentage increases to over 80% when you exclude public fund deposits that are either insured or collateralized and other deposits under contractual agreements. Despite the volatility in the banking industry during March, our balance sheet liquidity remains strong, in that we did not need to access any additional borrowings from either the Federal Home Loan Bank or…

Thanks, David. Now turning to Slide 5. David covered the highlights for the quarter from a lending perspective. So I will just add some additional color. In line with our focus on higher-yielding asset classes, we were pleased to see that our first quarter funded portfolio loan originations continued to increase from the fourth quarter. Because of the fixed-rate nature of some of our larger portfolios, there is a lagging impact of the higher origination yields on the overall loan portfolio. However, these originations should have a positive impact on the loan yields in future periods. Our SBA, construction and franchise finance channels continue to have healthy pipelines. Our intent is to fund the majority of this production using cash flows from other loan portfolios as we continue to rebalance the composition of our total loan book. Moving on to deposits, on Slide 6 through 8, for the quarter our deposit balances were up $181 million, or 5.3%, from the end of the fourth quarter. As David mentioned, early in the first quarter we took advantage of strong consumer and small business demand and pulled forward deposit growth, primarily with CDs, which increased $296 million from the prior quarter, locking in rates ahead of the expected March Fed rate hike. Additionally, brokered deposits increased $69 million from the end of 2022 as we proactively expanded existing contractual deposit relationships with certain customers and issued long-term fixed-rate callable brokered CDs. Non-maturity deposits, excluding BaaS deposits, decreased by $227 million compared to the linked quarter, with money market accounts, noninterest-bearing and interest-bearing demand deposits declining $165 million, $35 million and $23 million, respectively. We estimate that about half of the decline in money market balances was the result of outflows of uninsured deposits in mid-March, while the other portion of the decline…

[Operator Instructions] Our first question is from Nathan Race, with Piper Sandler.

A question just on the margin guidance. I appreciate all the details in terms of kind of the trajectory for 2Q. And it sounds like you guys think you can kind of keep the margin stable in the back half of the year. So I guess I'm just curious, what kind of rate environment does that contemplate? Does that just assume the Fed hikes in May and then is on hold from there? And I guess, what kind of gives you guys confidence that the deposit pricing pressures may moderate or at least the margin can stabilize with the Fed on hold in 3Q and 4Q?

Nate, at this point, we're not -- we don't -- we kind of model out several different scenarios. So we're -- again, I think we're in line with the Fed raising one more time, perhaps another, but perhaps being done with that. But you've got the forward curve that says rates are going to come down at the back end of the year. I don't know if we're convinced that that's going to happen. So we look at a few different sets of scenarios. But I think when -- I think the wild card, Nate, with deposit pricing and why it's hard to pin it down exactly is what's going to -- is you've got the effect of interest rates on deposits, but you also have deposits coming out of the system and a scarcity value for deposits. So as you've seen with your banks and others who've had to go to different deposit markets than they're used to, I mean, the cost, and whether it's fed funds or a spread to fed funds, seems to vary by channel. But I think as we model it out, once the Fed stops, and again assuming that spreads aren't really widening in that, we feel pretty good that the cost of deposits, whether it's the cost itself in percentage terms or the dollar amount, is going to stabilize. And then it will be stable. And once rates start coming down, whether it's this year or next year, we're going to pick up a lot of leverage on earnings because those deposit costs are going to come down pretty rapidly.

One comment on that, Nate. We started a little higher than the rest of the folks did in. Coming into this marketplace, our rates were higher to begin with. We haven't seen -- obviously, we had big jumps in the last couple of quarters, but on a percentage basis it's not -- some folks are looking at triple-digit increases in cost of funds. And as Ken made in his closing comment, we've been doing this for 2 decades. So we're pretty adept at moving and adjusting rates when need be. And we've increased deposits outstanding without going to the extremes of the market. As he stated, we did not go to any third parties to borrow funds to get it up there. So our world is pretty stable. We've also increased the loan rates on the other side, and we're funding a lot of that activity through repayments from longer-term, lower-cost loans. The real guess and hedge for us is how much liquidity do we need to hold on the balance sheet. We don't have to go back out to additional deposits at this point. We have [Indiscernible] in CDs and stuff, and that will work and we think the worst is kind of behind us by far. So we have to see what happens. If First Republic blows up, it might send another shock wave through the system and have people clamoring, but yet to be seen.

Right. Got it. That's helpful. And just turning to credit, you mentioned in the release, David, that your exposure to similar type loans is very limited. So I was wondering if you could just size up kind of what the participation C&I loan portfolio looks like, what credit quality metrics are trending there in terms of criticized, classified trends and so forth and just maybe if you could shed any more light in terms of some of the uniqueness around the specific charge-offs in 1Q.

That loan through Bank Alliance, a partnership we've been a part of for 9, 10 years. It was a company that during COVID was absolutely booming. And unlike other companies when COVID started to go away they readjusted the business model and slowed down, this company kept building product and got kind of out over their skis on development of product. And really the biggest issue they got internally today is phenomenal excess inventory and then spending millions of dollars on consultants trying to figure out how to solve the problem. And that's why -- it's a good company. We had write-ups from S&P and Moody's. We've been privy to some potential sales discussions about the company. So there is still value there, but its management team just did not keep track with what was going on post-COVID and wound up getting in over their head. The rest of the loan portfolio, we still have about $4 million, a little over $4 million of those loans on the books. We've got about $10 million in 4 or 5 other loans. They've all been on the books for years, performing as agreed. Never had a problem. They're all pass, except for this one loan is on nonaccrual. The rest of our C&I portfolio had no degradations during the quarter. Everything is kind of running kind of business as usual. So had we not moved this one to nonperforming, if this one hadn't gone bad, we would have actually seen a $1 million decrease in nonperforming assets over fourth quarter. So literally, the bump up in all of the statistics is due to this one loan. And as I've forecasted for the last couple of quarters, I'm not in the mindset of Jamie Diamond, thinking that we're looking at a hurricane, but there would be a tornado or 2 that might come through and blow them up, and that's exactly what happened on this one. It's a little bit of the interest rate move, but more importantly, it's just somebody that didn't follow up post COVID like they should have on the operations that got them into trouble.

Got it. That's very helpful. And it sounds like just the broader participation book where you guys are the non-agent is fairly small.

Very, very small. We've got a couple of C&I loans that we've done with a couple of other banks [Indiscernible], some construction, but they're all as agreed. And I couldn't even hazard a guess, Nate, but it's in the, I'm going to say, $25 million, $30 million in total exposure on participations with other financial institutions, above and beyond Bank Alliance. It's a small number.

Okay. Got it. And then just maybe lastly, with the mortgage rightsizing seemingly largely behind you guys at this point, how should we be thinking about the tax rate, going forward? Any other onetime costs in 2Q and beyond?

Nate, are you asking if there's any more onetime costs in 2Q and beyond?

Yes. And just the tax rate, going forward. And obviously, you have the tax reversal in the quarter.

Well, the first question, no. With mortgage, we took all of our onetime costs in the first quarter. So there should be no more additional costs associated with exiting the mortgage business or any other onetime costs that we see on the horizon right now. I'd say in a more normalized environment, I'd say that tax rate is probably closer to the 12% to 15% that we've had. But with earnings being a bit lower than what they were a year ago, the tax rate, I'm going to tell you, we model internally at 12%. But reality, it's probably somewhere maybe 9% to 12%, only because it's lower because we get a benefit from the tax-exempt public finance portfolio we have. So as earnings are a little bit lower, the impact of that is much greater. So that's probably the way that I'd look at it.

Our next question is from Brett Rabatin, with Hovde Group.

I wanted just to start strategically and just thinking about the balance sheet options. Is it not under consideration to maybe shrink down some of the balance sheet? Are there pieces of the loan book that maybe you could sell and, just given the stock price, maybe retrench and buy back more stock? Or just any thoughts on the strategic opportunities that your stock price here might be giving you relative to the balance sheet.

At the current time, Brett, we do intend to continue the stock buyback, particularly at the price it's at today. It's ludicrous not to. On the sell-off on some of the balance sheet, a point back, you'll note if you compare individual categories to last quarter or even back into fourth quarter, single-tenant leasing, some of the stuff that we have on the municipal lending, there are segments of the market that we're out of in total because the pricing is so low it makes no sense for us to compete. When we're bringing in funds at a 4% level and we're putting it back out the door in the 8%, 9%, 10% level through the commercial side, municipal – excuse me, not municipal -- SBA and the consumer, it makes sense to continue. And it's good quality lending. We're not buying business, and we're not growing the balance sheet for the sake of growth. But if we can get a 300- to 400-point spread over what the cost of the funds versus what we're able to reloan at, we're positioning it. We've tested the market throughout the quarter to sell segments of the portfolio, but we can't justify the hit we would take in the recycle to put it back to work. If you take that cost of the hit on the loss on the portfolio, we're making a better spread doing what we're doing. So we'll just weather it out. And when we come out the other side, then we'll have value, and we could shrink a little bit if we need to. But we're still rock-solid on the capital requirement. So we view it as kind of business as usual. We've been through these cycles, as Ken stated, several times over the last 20 years, and we survived them all and we come out stronger on the other side, and we're going to do that again.

Okay. And then from a repricing perspective, is it -- can you give us -- I think you said 15 basis points of improvement in asset yields in 2Q, if I caught that right. And just wanted to make sure I had...

Sorry, Brett, that's more like the loan book, 15% to 20%. And I think one of the -- I mean, some of that is obviously -- that's really new loan yield generation. That's new loans coming on the books, not necessarily repricing, if you will. That's just new origination yields being up.

Okay. Okay. That's helpful, Ken. And on the CD book, how much do you have maturing in the next 2 quarters? And it looks like you're paying a little over 5% for the 1-year CD, but it looks like your money market rate is actually 3.56% on consumer. I'd be curious to hear what it is on the commercial.

It's 3.20% on the commercial side.

And we also pay -- and one thing on the money markets, too, if you have a balance above certain amounts we'll pay a higher rate as well. But in terms of what's maturing, say, over the next 2 quarters, we've got about $360 million of CDs maturing with kind of at an average rate. Those are going to be rolling off in kind of the, call it, 2.70% to 3% range.

Okay. Okay. And then just last one, on the BaaS platform. How many people have you guys added in compliance? I'm just curious, thinking about that platform and how you've built that out over the past year or so, in particular.

In the past year, on the compliance side, we've added about 6 individuals, more than doubled the team that we had on board. Part of it was setting the stage, obviously, watching some of our peers get in trouble for relying on the third-party vendor or the fintech to do compliance efforts. We knew that wasn't the smart business play. So we built out both [Indiscernible] technology and bodies, internal tracking, to be better positioned for BSA, KYC, KYB, all the regulatory play. And even though some of our fintech partners do check some of that and kind of comply to banking standards, we double-check everything. We have some good automation tools to process the volume and transactions back through our proposals and programs. We were audited by the FDIC and the DFI when they came through last fall. And the comment from one of those, it's one of the stronger programs that they've seen internally in banks for the BaaS services. So we're comfortable that we've got the t's crossed and i's dotted, and we're continually reviewing and looking at it. But right now, we think it's very strong, very stable. And we're literally picking up some of the activity we're getting of folks leaving other financial institutions where they've gotten sideways with the regulators.

[Operator Instructions] Our next question is from George Sutton, with Craig-Hallum.

David, I wondered if you could just go further on what you were just referring to relative to the fintech update. Just to take this a little higher level, the idea of creating this was to bring in low-cost deposits. Do you feel like this area can achieve that, going forward? And can you give us a little bit more detail on the scarcity of the deposit sort of importance relative to bringing these potential partners in?

George, as you well know in the marketplace today, I don't think there is a free deposit of any kind out there as we were analyzing and looking at all the stuff in preparation for the call and just getting a handle on our deposits. I'll give you a couple, for instance. We were looking at the First Century deal because we're going to get $300 million in cheap deposits from them from the HOA side of things. We actually -- when we went through and did an analysis by NAICS codes, we actually have more HOA deposits on the books today than First Century had. And they're not free, but they are lower-level money market, there are services provided with them, and we're not reimbursing them for their accounting services that the HOA firm is having performed. So when you put the 2 together, kind of the net cost for us on those deposits is equal or lower than what would have been at First Century. The other side, there's still good money coming in on that end, but all bets are off after the first quarter here. Everybody understands what money market rates are. Everybody understands what the fed fund program is today. So we're not paying that. We're getting discounted below fed funds on everything that's coming in. With the BaaS deposits, depending on services and products, and part of it is in pricing, part of it is in yielded rate, but we're getting them anywhere from 50 points below fed funds to -- really, we do have some 0-cost deposits. But it's growing quickly. Fee income is coming on strong. We have one group on a monthly basis now we're processing over $500 million in ACH transaction activities. So we've got the increased customer base is…

One other thing. Have you put in a reciprocal deposit program? And my assumption is you probably have. I'm just curious the feedback you've gotten in terms of keeping some of those uninsured deposits.

We have. We've been part of IntraFi for the last couple of years. And obviously, when Silicon Valley blew up, we had virtually no request for it. And it's kind of interesting. The fact that we offer it has taken the edge off a lot of our larger depositors. I think the last number I saw, and George, this is going to be probably 2 weeks old, we have about $60 million, $60 million to $70 million, now that has moved to the IntraFi and spread their monies across multiple institutions. But again, it's still low cost. The service fee for that is nominal. It's one of those things I think the comfort that we have it available kind of took the edge off from the consumer. And really, some of the deposits we did lose in March, we've regained. That's part of the deposit growth here in April, are some of the customers looking for that have come back to us and have spread the moneys through InfraFi. So it's a nice tool. And again, if First Republic or another big bank goes down, I think it will be a necessary tool for probably everybody in the industry to retain deposits. But right now, it's more of a safety net than it is a true selling point.

[Operator Instructions] Our next question is from Nathan Race, with Piper Sandler.

I appreciate you taking the follow-up. And I apologize if I didn't catch it in your prepared comments, Ken, but can you guys just remind me kind of what your outlook is for core deposit growth and loan growth over the next couple of quarters?

I think one of the things, Nate, that we've kind of talked about a couple of times here is it's the concept of kind of remixing the loan book and having the idea that I think overall loan balances over the course of the next 2 to 3 quarters really aren't expected to grow tremendously. It's really just more remixing it and using cash flows from public finance and healthcare and single-tenant and mortgage to fund growth in construction and ICRE and franchise and SBA and our consumer channels, where we're getting certainly the variable-rate portfolios and a little bit more yield. So that's really the way that I would look at it.

Okay. So kind of a flat earning-asset base, give or take, from the level in 1Q is the way to think about it?

Yes, maybe just a -- yes, a little to maybe some slight growth. But again, it's really the concept of remixing the book organically versus growing the overall balance sheet. The only -- again, the caveat to that, as David said in his comments, was what is the right amount of liquidity to maintain on the balance sheet. Because with unforeseen events going forward, it probably is prudent to maintain more liquidity right now. And as we all know, balance sheet growth isn't really driven by loans; it's driven more by deposits. So that's just the one wild card on that.

One real quick comment on the deposit side, Nate. I know one of the things that the investor community folks getting antsy about that's bothered us over the years, when the loan-to-deposit ratio gets north of 100%, everybody gets pretty nervous. So if you want to factor the positive side of things, we're now in a position where we're under 1:1. It's still 98%, 99%. But we'll focus on the deposit side to keep it at par with the loan growth or a little above so that we stay under that 100% loan-to-deposit ratio. And that's how I would kind of model it. As Ken said, I'd see low single digits, 2%, 3% probably, max, in loan growth in future quarters.

Our next question is from Ross Haberman, with RLH.

I just had a quick question. I got on a little late. Could you touch upon any weakness in any of the loan categories which you are beginning to see? Or like a lot of banks, you're not seeing any cracks yet.

Ross, at the current time, we're not seeing any cracks, per se. Like I said, we had the one-off on this participation loan that we discussed earlier, but the overall delinquency is down this quarter over last quarter. We do have 1 REO property. It's a home in Vermont. It's less than $200,000, and that's been in foreclosure process for 3.5 years. It has nothing to do with the current economy. So overall, the portfolio is staying solid, no pending losses. Even the SBA world, which is kind of new to us, is staying phenomenally stable, working really solid. The small business community is doing what they always do: they're just knuckling down and keeping the work going on. So yes, across the board, we're not seeing any cracks yet at all. And this one loan is truly a one-off. So we're pretty confident that unless the Fed really goes nuts and ratchets us up to a 6%, 6.5% interest rate which causes some pretty massive unemployment across the country, we're not worried about anything in the portfolio today.

And just one follow-up. Could you refresh us how big is your total loan participation book as a percentage of the total loans?

We have about $15 million through the Bank Alliance program, which is where this one C&I loan was. That's what's left after we took the write-down. And then we -- as I said earlier, I think we're somewhere in that range of $20 million to $30 million, max, with other banks in the state of Indiana that we do a couple of participations with. It's a real small percentage of our book. We like to control our assets in the...

So you're saying a total of $45 million about, in total? Does that sound right?

Yes, in total. Yes.

Actually, it's about -- it's closer to $30 million in total. It's about $15 million and $15 million. So $15 million with our existing program and another $15 million with the partner banks.

Our next question is from Brett Rabatin, with Hovde Group.

On the buyback, I missed if you gave it for remaining authorization. And then just, I know it probably depends on a lot of factors, but any kind of broad color on how much you think you might buy back the rest of the year and if there are capital ratios that would constrain that, that you wouldn't want to go beyond. Just how you're thinking about the buyback specifically from here.

At the current time, Ken, correct me if I'm wrong, but I think we have a little over $19 million left on the $25 million that we started the year with. And we're in the market buying today. And particularly at this price, we'll continue to do that. We're not going to push ourselves below 7%, I guess if you want to look at a capital marker, by buying back the stock. But shy of that, we'll -- we're in consistently, and we'll stay there when the price is at this level. If it starts to climb back up again, we might reevaluate in the second half of the year, but we're set to continue buying at this quarter, at this price. We can't afford not to. It's the best use of capital that we have.

Okay. And 7%, David, is that TCE, I assume?

Yes. Yes. Correct.

Our next question is from Howard Henick, with Scurlydog Capital.

I have a quick question. I've seen other banks in the past have issues with Bank Alliance loans. I never really understand their originating C&I loans through the consortium anyway. Because, obviously, it's to some extent a character loan. Are you still originating loans through Bank Alliance? Or is that program shut down?

I can't tell you the last one we've done with them. It's been several months. Obviously, the experience of this loan has tainted us on the program. But we've been in it 9 years, and we've only had 20 basis points of losses over 9 years. We obviously don't participate in every loan that they do, by any means. We probably over the years have looked at maybe 1 in 20 of what's presented that we would take advantage of. We have not done anything in the last 6, 7 months. So what's out there today and just kind of that whole leverage market, as crazy as the capital markets and the industry is with the future of the economics, we kind of backed off purposely. And then taking the hit on this loan will make it even tougher for us to make a decision to go forward. We've got good opportunities with our existing clients and demand out here that we don't have to go through the third parties. So I could tell you, I'm not going to say we would never ever do another one, but it would have to be golden for us to take a look at it. We've got enough opportunity ourselves. We don't need to backfill the balance sheet with any more of their product.

Yes, I agree.

There are no more questions. So I'll pass the call back over to David Becker.

Everybody, we thank you for joining us on today's call. We will continue to use all of the tools at our disposal to maintain a strong balance sheet and liquidity position as well as drive for more resilient earnings, going forward. Again, as fellow shareholders, we remain very committed to driving improved profitability and enhanced shareholder value. We thank you for your time today, and have a good afternoon. Appreciate it much.

That concludes the conference call. Thank you for your participation. You may now disconnect your lines.