Good day, everyone, and welcome to the First Internet Bancorp's Third Quarter 2019 Financial Results Conference Call. [Operator Instructions]. And please note that today's event is being recorded. I would like to now turn the conference over to Larry Clark from Financial Profiles Inc. Please go ahead, Mr. Clark.

Thank you, Operator. Good afternoon, everyone, and thank you for joining us to discuss First Internet Bancorp's financial results for the third quarter ended September 30, 2019. Joining us today from the management team are Chairman, President and CEO, David Becker; and Executive Vice President and CFO, Ken Lovik. David and Ken will discuss the third quarter results and 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 involves 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 be the 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 here today as well as the reconciliation of the GAAP to non-GAAP measures. At this time, I'd like to turn the call over to David.

Thank you, Larry, and good afternoon, everyone. Thank you for joining us today. We're very pleased with our results in the third quarter, which were driven by continued revenue growth and well-managed expenses. We continue to take a disciplined approach to capital deployment while implementing our balance sheet management strategies, which during the third quarter included the sales of lower-yielding and seasoned loans. Additionally, our direct-to-consumer mortgage business had another stellar quarter, driven by increased refinancing demand in the conventional mortgage market. Our performance highlights for the quarter include record net income of $6.3 million, an increase of 3.3% from the second quarter. Diluted earnings per share were $0.63, an increase of 5% from the second quarter, which benefited from a lower share count due to our share repurchase program. Total revenue was $20.8 million, a 6.4% increase from the second quarter and noninterest income was $5.6 million, up $2 million driven by the higher mortgage banking revenues. Furthermore, our tangible book value per share increased 2.5% to $29.82 quarter-over-quarter, which also benefited from our share repurchase activity. Ongoing balance sheet management continues to be a strong focus with the primary objective of managing our capital efficiently. One way that we achieve this is through the loan sales, either a seasoned lower-yielding public finance loans or single tenant lease financing loans. These sales enable us to enhance our profitability through additional fee revenue, while also increasing our margins as we redeploy the capital into higher-yielding loans. An added benefit is that it helps to keep our origination team’s asset in the marketplace by being able to fund new loans with the proceeds from the asset sales. During the quarter, we sold $53.4 million of loans, recognizing a net gain of $0.5 million allowing us to free up the liquidity to…

Thanks, David, and thank you, everyone, for joining us today. As David mentioned, we were very happy with our results for the quarter. We were especially pleased with the record net income and the EPS growth while demonstrating the ability to manage overall loan growth through the continued loan sale activity we conducted during the quarter. While total asset growth once again appeared strong for the quarter, I will point out that cash balances at quarter end were elevated as we received strong deposit inflows during the quarter, which outpaced loan production, net of loan sales and prepayment activity. Overall, total loans outstanding at the end of the third quarter were $2.9 billion, an increase of $20 million or 0.7% from the second quarter. In terms of portfolio composition, total commercial loans were up $11 million or 0.5% compared to the linked quarter driven largely by production in health care finance and single tenant lease financing, partially offset by the sale of $53 million of single tenant lease financing and public finance loans and prepayment activity. In particular, commercial and industrial loan balances declined $15 billion due primarily to an elevated level of early pay-offs. Total consumer loans were up slightly during the quarter, mainly due to new originations in the recreational vehicles, residential mortgage and trailers portfolios net of prepayment activity. As noted earlier, we sold $53.4 million of loans during the quarter in connection with our balance sheet management strategies. We sold two pools of loans. One was a $23.6 million pool of seasoned lower yielding public finance loans and the other was a $29.8 million pool of single tenant lease financing loans. Combined, we recognized the gain in excess of $500,000 from these transactions. As David mentioned, there is a healthy demand for both of these loans…

[Operator Instructions]. Our first question comes from Brad Berning with Craig-Hallum.

Congrats on the progress on the initiatives. I want to touch base on two issues real quick. And congrats on getting the SBA team stuff moving forward further. Can you touch a little bit more detail on what you expect the contribution from that business to be, both from a top and bottom line perspective fourth quarter as you get the team ramped, and in 2020 kind of some early thoughts on how much do you think you can contribute? And the second question is as you think about your excess liquidity that you have a little bit now and you think about some of the initiatives that you're working on, how do you think about CDs as a mix of your business, both from fourth quarter perspective, but also over the course of 2020?

Do you want to take the revenue side of SBA and I'll handle the cost side?

Yes. Sure thing. On the SBA side of the program as Ken outlined, we're going to pick up a portfolio, Brad, of about somewhere between $38 million to $40 million a month depending what closes in the next week or two. We'll pick up a little over $100 million in a servicing portfolio, which will pick up a 1% fee with that. We anticipate here in November/December we're probably with a couple of cost, we'll incur in getting the team onboard and getting everything setup. It'll probably be a breakeven proposition for us, but that portfolio alone and servicing and the team, and their production through the course of next year could -- we think bottom line should bring about $3 million to $4 million in earnings for, I think, calendar year 2020. We also anticipate with adding Mark and the other folks that we could originate somewhere in the vicinity of about $100 million during calendar year 2020 in the SBA portfolio, selling off, obviously, the insured portions and maintaining the uninsured portions on the balance sheet. Right now in the couple of loans we've sold recently we're getting somewhere in the 10% to 11% premium on the sales. So we're still kind of working through all the math, I can't give you a bottom line figure, but that's kind of the, as Ken said, the sales side and what we're looking at from the top end, he can fill in maybe a little more on the operational side.

Yes. I think on the cost structure here, we'll be bringing this team on mid-quarter. So probably, in terms of looking at models for the fourth quarter, we're probably talking about, call it $350,000 or so of overhead expense. And the Chicago team in total is all-in annually is probably depending on where the hiring initiatives shake out are probably somewhere between $2 million to $2.5 million on an annual basis for next year. So relatively low overhead for a lot of upside on the fee revenue and increased interest income side.

And then the other question you had, Brad, on the excess liquidity, at the current time to give you a feel for the kind of shuffle we're having, such a great success in the small business community. On a month-to-date basis here in October, we've only added from the outside world about $6 million in new CDs and we've brought in almost over $8 million in new checking and money market accounts balances in the small business community. We kind of introduced a new product service about six months ago, and that's been averaging north of $20 million a month in new deposit balances for us, so we have pull back significantly on the CD play. In fact, as Ken pointed out, we should have a net decline in CDs through the course of the fourth quarter. We still show brokered CDs when you get the detail of the quarter. Reality is we're not buying and going out and telling somebody give us $100 million on CDs. They're from a listing service that the regulators classify as a brokered CD, we don't have the same opinion they have, but that's the way they book it. So we're not out buying chunks of CDs to cover the cash side, it's all organically generated and the small business component has kind of taken away the need to really go after the CD market in the near term.

And so just -- that's awesome. And I think as far as just following up on that. So for over the course of 2020, do you see CDs coming down as a meaningful portion of your overall funding mix then, should I take it that way that the mix will come down materially?

Yes. I think it's going to -- it depends on how we come back to materially. Yes, there is no current end insight and as we continue to even expand our small business activity through the SBA team, I think we're going to see a significant uptick. We've done more in the small business community in the last six months than we've done in our 20 years of operation. So I think we'll see some nice play there. The checking account say 70 basis points, the money markets today are at the 2%, but if the interest rates continue to climb, we're going to drop them, money market will come down a little bit as well. So yes, as long as we can produce it on the checking and money market side, we'll let the CDs run off for the time being.

The next question comes from John Rodis with Janney.

Ken, can you maybe just give your thoughts on the margin going forward? I know you said you think it's bottomed and it can move up from here, but maybe just sort of as you see it right now the magnitude of the potential increase over the next few quarters, or do you think it sort of -- just sort of stay stable for a little while?

No. I think as of now, we're forecasting some nice incremental upticks. Is it -- are we going to get 20 basis points back next quarter? No, but I think fourth quarter and through 2020 on a quarterly basis we should see a steady increase of, call it, anywhere from, say, 4 to 8 basis points of expansion per quarter. So I think, again, it's -- some of this has to do with -- we do, as I said, we have $1.1 billion of CDs maturing over the next 12 months and to be honest, it's probably a fairly even distribution throughout the course of the year, call it anywhere $60 million to $80 million a month. So it doesn't all reprice immediately, it takes time to run those off. But as those come off the books and are either basically just use some excess liquidity to pay them down and delever a bit or replace with new CD volume at 60 basis point pickup we'll gradually see that improvement in deposit cost and play its way through NIM over the course of the next five quarters at least.

Ken, when you say up 4 to 8 basis points a quarter, does that assume any additional fed rate cuts?

Yes, that does. That assumes, I mean, we kind of model of the forward curve there. So that assumes -- there's -- pretty much baked in a rate cut next week. And as you look at forward rates over the next -- through the end of 2020, there are a couple more rate cuts baked into that forward curve -- forward implied curve.

Okay. Okay, good. Ken, your comment earlier on the call about TCE. Can you go back over that, the target? Just as it relates to that, your thoughts about doing another buyback.

Yes. I mean, our goal -- our objective is, again, as I said, TCE was a little bit lower than we were forecasting due to the higher-than-average cash balances. We expect to bring TCE back up into the range of, call it, say, 7.25% to 7.30% by the end of the year and our goal throughout all of next year is to really be self-generating on capital to support organic growth and keep TCE in that same range throughout the course of 2020. The share buyback we completed the Board approved $10 million this quarter. We're in the process of looking at our 2020 budget -- finalizing our 2020 budget. And for us, it's always a balancing act on the share repurchase versus maintaining TCE, because in our minds TCE ratio is solid, but we certainly don't have excess of capital there. So that's -- once we get through the forecast, we will revisit the share repurchase -- any share repurchase plan as part of that process.

The other side of that one -- real quick down the other side of that one. We want to keep a little powder grade too. Obviously, we're getting some great traction in the small business community, which hits all the high points whereas lower-cost deposits fee income from sale of loans and also higher yields shorter-term and adjustable rates on the loans that end up on our books. So we don't want to put ourselves in a position that we have to pull back on that if we need some excess capital to run that. We can obviously manage it by selling off other assets that are lower yield in play. But as Ken said, we're still formulating -- trying to put finishing touches on the 2020 budget, we need to get a couple of months in our belt here with the SBA team to see what they can really produce and get running. So we want to keep a little room that -- obviously, we can't -- we're not in a position and don't want to go back to the capital markets for the organic growth.

The next question comes from Michael Perito with KBW.

Couple of questions. I wanted to clarify a prior question on the margin. Just -- so that 4 to 8 basis points range is helpful, and I think make sense in the confines of some of the CD repricing data points you give us, Ken. But is there some additional snap back next quarter from liquidity playing out as well though or are you incorporating that in kind of that 4 to 8 basis point estimate?

That's incorporated into that estimate. And then it is good -- I mean, that's why as we forecasted out through 2020, what I try to do is provide a range on a quarterly basis. I mean, sometimes I think there is some quarters where we might get a little bit more, be closer to that eight than we are to the four. It's just going to have to do with balance sheet mix in any particular quarter.

So the right way to think about that next quarter there'll be some modest benefit from CD repricing, but also more benefit from the liquidity normalizing, but then as you get into 2020 and you get the full quarter's impact of some of those CD repricing events that 4 to 8 picks up and there's more liability repricing based driven rather?

Yes. I think that's fair to say.

Okay. And then if I drill down on the expense, the near-term expense run rate a little bit more. So you guys were at $11.2 million this quarter. You had, I think, 700 -- your normal FDIC expense was $600,000, $700,000 below. You have another $200,000 I think coming in from some of higher SBA hire. So I mean, Is 12 -- maybe closer to $12.5 million kind of the place to be for the fourth quarter and then you have to layer in the other $2 million to $2.5 million annual expense from the other team as well for 2020 in addition to any other growth that you guys might have beyond the SBA side, is that -- just to put some more numbers around it, the right way to be thinking about it?

I think so. I think the $12 million to $12.5 million is a fair estimate. And, again, I think as I mentioned in the comments that, had we reported FDIC expense this quarter it would have been about $550,000, which is down $200,000 from last quarter. So don't take second quarter and apply that because if -- any of you are familiar with the math in that calculation, year-over-year asset growth is a significant component to the math at which the FDIC uses to assess insurance. And as we've managed the balance sheet and overall balance sheet growth has continued to go down on a year-to-year basis we're getting a benefit from that on the insurance side. So if you want to plug a number in for that probably better using $550,000 than $750,000.

Got it. And I guess, just lastly on the single tenant leasing credit that you guys provided for in the quarter, can you give us a little bit more background, if I recall, to be honest I'm not -- I remember the details totally just because the portfolio has been so clean, we really haven't had to ask about it in a while. But if I recall there's kind of a few different steps that underwriting process the actual tenant I think, which is one of the last one, but then the borrower was one of the first ones. And I'm just curious to know, I mean, how many of those steps kind of have to go south before you think about migrating credits or providing extra reserve against them. And in this particular instance, what was kind of the back story of what drove you guys to do that?

The trigger on this one, Michael, is it's a loan that's going to mature October 31. It's been a three year loan with us. Customers never missed the payment. He is not delinquent today. He has not -- never had any issues on the loan all the way through the process. He did inform us that come October 31, he is not in a position to pay off the loan. And by our kind of Midwest conservativism and we're taking a precautionary move on our part to take the loan the stores are empty at the current time, there's two stores involved in this deal. He is trying to re-lease and trying to get new tenants in play, but he's not in a position. So we took a lights out valuation liquidation value on the properties, less his personal guarantee and that's what we put in as the reserve. It's -- obviously, stores are still there, we're still talking to the customer. He is still trying to market them on a daily basis. It might be something we completely reverse next quarter, but we thought it was prudent on our side because it is kind of the first one, we've had that's really gone south that we'd be ultraconservative and take ultimate caution. Even though it did have a $0.19 impact on the earnings per share this quarter, we thought it was the right thing to do. To give you a feel on the portfolio, we just had an external third-party audit come through. Had no concerns, questions about quality of portfolio. We completed our annual review by the regulators and they had absolutely no comments on the loan portfolios on any of the products, single tenant, municipal, health care, et cetera. So it's not a fundamental flaw or fundamental issue. It's just one of those that came up and we're being ultraconservative on how we're handling it.

And that's helpful, David. And then just actually I'm going to sneak one more in. Just on overall kind of balance sheet growth expectations. I mean, we talked about capital, we talked about buybacks, we talked about SBA, which really should have put too much pressure on the balance sheet I would think with the gain on sale aspect, but how do you guys -- what's the updated thoughts about overall balance sheet growth as we move into 2020? I mean, it would seem to me that it might make sense to limit that and that could help preserve some capital, maybe free up some capital for buybacks, which could be attractive at these levels. But I'm curious how you guys are kind of thinking about that conceptually and what are your expectations are?

Well, yes, Mike, and I'd go back to our -- to the comments I made earlier on capital, that our goal is to keep that TCE ratio, once we get it back to where we wanted it at end of the year here is to keep that relatively flat throughout the course of 2020. So maintaining that capital is going to be a bit of a governor on our growth in terms of our growth, our organic balance sheet going forward. But again, I think the ability to manage the balance sheet, conduct loan sale activity and perhaps even be a little bit more aggressive, say, in the single tenant business where we can sell loans at a nice premium to complement fee revenue. That -- we're going to do more of that next year just to maintain, make sure that the TCE ratio doesn't drift closer to seven.

Got it. I mean, I guess, conceptually balance sheet growth then should be fairly minimal, but not ready to kind of commit to a certain level?

Yes. I mean, I think if you look at that and you're probably talking somewhere probably between 5% to 10% growth in overall -- the overall balance sheet. There may be some migration, again, with the balance sheet management activities to kind of have some mix shift in the differences in the loan portfolio shifting from lower-yielding to higher-yielding products to help the profitability. And of course, making sure we're deploying the excess liquidity. But I think as I said, the main governor on the growth is going to be that TCE ratio and making sure, that what organic growth we retain on the balance sheet, we're self-financing that with internal capital generation.

The next question comes from Andrew Liesch with Sandler O'Neill.

Just kind of following up on the balance sheet section or discussion here. With the liquidity that you've had come on, you've had great deposit growth over the last few quarters and a lot of it's sitting in interest-bearing cash or maybe in some security and it's not that best environment to be buying securities, but how do you look at the liquidity on the balance sheet, I mean you could bring a case that you're probably carrying too much right now and that you maybe kind of blow all the securities book and the cash to dwindle and maybe lower deposit rates if you don't need as much funding and just kind of maintain capital that way. Just kind of curious how we should be looking at the size of the securities book and the cash you bring in?

Well, Andrew, obviously, we have to maintain a certain amount of liquidity on our balance sheet to satisfy our regulators, whether that's cash or investment securities, mortgage loans held-for-sale. And you make a good point that it's not really a great environment to be putting money into the securities portfolio. We did some purchases here in the third quarter, but I'll tell you that as myself and the treasury team look at opportunities to invest in securities out there, there's not a lot of great investments out there that don't come with a downside too, some are great for short term, some are great for long term and vice versa. Our goal is to kind of maintain what we'll call liquid assets kind of in that 20% of the balance sheet. So if you do the math on what we have here in the fourth quarter or excuse me, in the third quarter you'll see that, that number is a little bit higher than that. And again, this kind of comes back to our comments about being able to manage overall balance sheet growth and put some of that excess liquidity to use just through delevering and letting CDs just kind of roll off the books without necessarily replacing them. And that could -- I mean, we could very well have a scenario where at the end of the year our balance sheet is smaller than it is today. Probably not by a huge amount, but we could have some balance sheet contraction as we, again, continue to execute loan sales to provide liquidity to fund new business and put some of that excess liquidity to work.

Great. And if it's like some of the higher cost deposits you have rolling off, just not replacing them, that could alleviate some of the balance sheet as well and while the overall declines.

Yes. And additionally, that's a really nice pickup on the just the dollar amount of deposit costs.

Yes. So I mean, just looking then with your margin outlook, with the 4 to 8 basis points a quarter. I mean, it's pretty reasonable that we could get back to a 2% margin at some point next year. Is that reasonable?

I think so. Some of that will probably depend a bit on if we can get an added lift from the SBA business with the pieces that -- the unguaranteed loans that we retain on the balance sheet, those have very nice -- those are prime plus 1.75% and up depending on the nature of the borrower. So if we have a blowout, the sales team have a blowout year, and we build more balances thereby, by all means, we could be closer to that 8 basis points and that gets us closer to the 2% FTE margin.

This concludes our question-and-answer session. I would like to turn the conference back over to Mr. Becker for any closing remarks.

We appreciate everybody joining us today. Like we said, we think we had a good solid quarter, third quarter, lot of moving parts. We're excited about fourth quarter. We're excited about the great opportunities we're looking at in the SBA. Very thankful that we've gotten the Colorado deal, hopefully put to bed here early November. And if the Fed continues to move interest rates down, it's all positive for us. We're really, really well set for a down rate environment in the near term. So again, appreciate your time today. Look forward to talking to you again soon. Thank you.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.