Summary
- Much discourse still centers on NewtekOne as an income investment. I think the market is way behind the curve. I write this article to set the record straight.
- NewtekOne has always been in practice a bank and business solutions company but spent the last few years with a BDC wrapper.
- NewtekOne's time inside the BDC wrapper proves its ability to generate distributable cash flow, yielding about 9% before its formal bank conversion. This proves the business model.
- The CEO Mr. Barry Sloane's vision is to convert from the BDC to bank legal form to flip NewtekOne's compound growth switch, by retaining operating cash flows for reinvestment.
- The Newtek Advantage, its patented NewTracker referral management technology, and operating leverage will be the wings to make NewtekOne soar.
I write this article to attempt to change investor discourse about NewtekOne (NEWT), because I continually encounter comments on Seeking Alpha that speak of Newtek as an income investment, and of how individual investors feel crestfallen about the bank conversion that has taken away the dividend punch bowl.
This is an opportunity to legitimately use the straw-man argumentation method. I will begin by creating a straw man, and then proceed to tear it down in order to illustrate what NewtekOne really is.
Straw Man: NewtekOne Was Primarily A BDC - An Income Generating Vehicle
From 2015 to 2022, NewtekOne paid a handsome dividend yield of about 9%, formally as a dividend. Shareholders enjoyed a very handsome income stream, see below.
NewtekOne was in many respects a model BDC - its underwriting record allowed it to trade far above book value, which meant that it could issue shares in a way that was accretive to existing shareholders: see below.
NewtekOne's small market capitalization meant that it was (and is) not well known, but during its time as a BDC it garnered a zealously loyal shareholder base who came to understand it as one of the best BDC's. For those of us who cared to read the 10-K filings, it was clearly written into the 2022 annual 10-K that NEWT was a BDC, page 10:
ITEM 1. BUSINESS. We are an internally managed non-diversified closed-end management investment company that has elected to be regulated as a BDC under the 1940 Act. Additionally, we have elected to be treated as a RIC under the Code for U.S. federal income tax purposes, beginning with our 2015 tax year.
For me as an existing shareholder, the real takeaway is this: the BDC form mandates that a formal BDC pay out 98%+ of its investment income. The fact that it paid a very substantial dividend, though variable in amount, is proof of Newtek's business model. We therefore have no reason to doubt Newtek's cash flow generation engine, even if I haven't explained it yet.
Unraveling The Straw Man: NewtekOne Is A Combined Bank & Business Solutions Company
For NEWT, this income was composed of three sources:
- Fully controlled portfolio companies, providing business services such as payment processing, insurance brokering, tech solutions, health benefit management, and payroll services. These wholly owned companies paid a quarterly dividend to NewtekOne, which then considered the dividends investment income.
- Sale of SBA guaranteed portions of loans on the open markets. The SBA guarantee, backed by real estate assets for security, meant that these portions of loans generally sold at 7 - 12% above par on the markets and were very liquid - a highly profitable line of business!
- Securitization Trusts containing the unsold loan "stubs", portions not under SBA guarantee, which pooled the "stubs" together in a way that allowed NewtekOne to sell them indirectly by selling asset backed securities against the pools, done in two tranches: A and BBB.
Note that sale of both the SBA guaranteed portions of the loans, as well as the asset backed securities against the pools of stubs allowed NewtekOne to recycle its working capital. This is the first important deviation from the BDC business model: NewtekOne issues loans and uses its moat as one of very few approved SBA lenders to earn a quasi-arbitrage profit between the market value of a run-of-the-mill small business loan, and the market value of what amounts to a AAA rated corporate loan, given the SBA guarantee and real estate collateral. This is different than the typical BDC model which is to earn interest income on loans, and recycle capital by holding loans to maturity. I have written extensively on this part of NewtekOne's business model in my article from 3 years ago .
Because NewtekOne was formally a BDC, it needed to structure itself in a way that conformed to the regulations of the BDC form. The most egregious example of NewtekOne fitting its square foot into the BDC form circular shoe is how it treated its fully owned portfolio companies.
The Corners: The Fully Owned Portfolio Companies
While formally a BDC, NewtekOne treated its fully controlled portfolio companies as though they were tangible BDC assets. They were carried on its balance sheet valued at about 11-12x EBITDA, called its "controlled investments". The following is a reproduction of a portion of page F-5 of the 2022 10-K:
ASSETS (In Thousands) | December 31, 2021 | December 31, 2020 |
Investments, at fair value | ||
SBA unguaranteed non-affiliate investments (cost of $431,970 and $420,400, respectively; includes $344,266 and $312,649, respectively, related to securitization trusts) | $424,417 | $407,748 |
SBA guaranteed non-affiliate investments (cost of $65,728 and $16,964, respectively) | $72,970 | $17,822 |
Controlled investments (cost of $157,289 and $138,891, respectively) | $260,398 | $239,171 |
... | ... | ... |
Now that the bank conversion has been completed, on the most recent investor conference call (on January 17, 2023 ), the CEO Mr. Barry Sloane stated that these would no longer be held on the balance sheet, and their operating revenues and profits would be directly incorporated into the income statement figures. Quote:
[Slide 8] As a matter of fact, when you look at the value of our merchant business and tech solutions business, as a BDC, those averaged about $150 million worth; those are going to be going into the new entity at a cost basis of what I'm going to say is plus or minus zero, using the accounting treatment. Those will not be part of our tangible book value.
Let's do some arithmetic on leverage. As of Dec 31, 2022, NewtekOne had $1,056,501,000 of assets and $652,674,000 of liabilities. If we strip away the $260,398,000 value of the controlled investments, we arrive at a debt to equity ratio of 4.55, or converted into a capital ratio as would be computed for a bank, it would be about 18%. This jives well with its reported CET1 ratio on that conference call:
Slide 8 - Shareholder Conference Call - January 17, 2023 (NewtekOne Investor Relations)
I like it when my estimations match with the reported figures.
Drivers Of Customer Acquisition & Deposit Growth
What will make NewtekOne stand out? What will drive deposit growth? That will be NewtekOne's suite of auxiliary services, the Newtek Advantage dashboard, and the NewTracker referral management technology.
Auxiliary Services
Even though NewtekOne is formally a financial holding company, Mr. Sloane still thinks in terms of customer service - how can NewtekOne help small businesses grow? A comprehensive suite of what I would call "effort saving" services:
The goal is simple: become sticky , by providing a full suite of ancillary services and satisfying service so that for any customer, swapping service providers becomes an unimaginable leap of faith into the unknown. If you've come to rely on NewtekOne for so many of these nuts-and-bolts parts of your business and you've become satisfied, the last thing you'd want to do is to rock your own boat. By providing these services to its customers, NewtekOne is also directly helping their businesses succeed by making sure that their management and executives are maximally focused on growing their business, and not on paperwork.
The Newtek Advantage
Every customer receives access to up to 6 professionals at Newtek who help navigate the auxiliary services, as well as a dashboard that provides the customer with real time updates on the financial status of their small business:
Newtek Advantage Dashboard (January 17, 2023 Shareholder Conference Call)
I am very fond of the dashboard as it simplifies how customers can navigate the large menu of auxiliary services, as well as seeming to be just very useful in general - again, reducing the complicatedness and headache of running a small business so that the business owner can focus on growth.
Newtracker - Referrals Management Technology
We probably have close to 80,000 clients that are paying us, and 2.2 million referrals in the database. - December 14, 2022 conference call
Hidden behind the scenes with no pictures for investors to see, is the Newtracker technology. For this part of the business, I will quote some relevant parts of past conference calls that mentioned the NewTracker technology. Its usefulness should be apparent from the quotes.
Obviously, we believe our growth is based upon technology. We have a frictionless way to acquire loan opportunities, our borrowers love it. They don't have to chase down bankers, brokers or BDOs. They put a referral in, they get a fact finder, it comes back almost depending on how quickly information passes back and forth, can come back within a half an hour or an hour. If they come back with the right answers, we immediately [technical difficulty] loan appointment when they're available. Not when we're available, when they're available.
We don't tell them we're showing up on Monday, Tuesday, Wednesday in the middle of their workday, we give them a calendar, and they've got the full gamut of calendar to pick to get a real live person on a camera to help them assemble their loan with our File Vault. No emails with PDFs attached, secured File Vault, it works really well, a frictionless way to get those best credits in real quick. We're getting 1,000 to 1,500 referrals a day. - Q3 2022 Earnings Call Transcript
The NewTracker technology doesn't have to be only used in-house. It might be licensed for third party use in the future.
We are also going to be evaluating licensing that post technologies such as NewTracker, which is our unique patented customer acquisition tool that allows us to acquire 1,000 to 1,500 clients a day without the use of bankers, brokers, branches, or BDOs as well as position the Newtek Advantage, the one dashboard that businesses will ever need. We hope to position ourself as the one company that our business clients will ever need to help them grow their business and become more successful. - Q2 2022 Earnings Call Transcript
Operating Leverage
I quote Mr. Sloane from the investor conference call (on January 17, 2023 ):
We've got the sophistication, the management team, the systems capabilities of a $3-5 billion bank. So, there's a tremendous amount of operational and financial leverage that are inherent in our start today.
NewtekOne is converting into the bank form with much redundancy in terms of leadership and management capabilities. This means that for the near future, while NewtekOne is scaling up its operations, it will encounter relatively few growing pains, and be able to hit the pavement on a running start.
The Bank & Business Solutions In Full Circle
I quote Mr. Sloane from the investor conference call (on January 17, 2023 ):
[Slide 11] And the deposit story, we think, will start to kick in out in the out years, possibly latter half of 2024, certainly in 2025, 2026, and I'll talk about the deposit strategies. The ability to get lower cost deposits from the payment processing business, the payroll business, and all the referrals that come into the network. So, there's a lot of levers to pull, a lot of growth opportunities in NewtekOne.
Banking is a famously competitive business - when you think about it in purely economic terms, banking is nearly a perfect competition business , because bank accounts and deposit rates are commodities, and banks can only really compete on their customer service. A new bank without an existing franchise or reputation is dead on arrival because it has nothing to draw deposits to it. I find this quote especially meaningful since the fully controlled investments of NewtekOne, its business services and its NewTracker technology are envisioned as a perfect way to turn referrals into banking customers.
This means that NewtekOne is an entirely self-contained operation, that does not need to rely on strategies such as advertising to attract new deposits. The proper functioning of its other business segments are a natural funnel of deposits towards Newtek Bank. Here comes the piece de resistance: NewtekOne's returns on assets & tangible equity:
Slide 9 - Shareholder Conference Call - January 17, 2023 (NewtekOne Investor Relations)
Note that these projections are not just pulled from thin air. NewtekOne's transformation from BDC to bank does not involve any substantial change in its business model. The 3-4% returns on assets is actually inherited from the BDC lending business model, where typical loans carry coupon rates of ~9% to 10%, and they are levered against bonds or baby bonds yielding about 6%. For NewtekOne, these interest margins are only possible because of the niche space that the lending occurs in: SBA lending.
The top 100 banks in the US by total assets are listed on bankregdata.com - I have compiled a list of the top 20 banks by name, ticker, Total Assets (in billions), and % Return on Assets. You will see why I say that NewtekOne has wings: none of these banks come close to having a 3% returns on assets.
Ticker | Total Assets | ROA % | |
JPMorgan Chase & Co | JPM | $3,202 | 1.30 |
Bank of America Corporation | BAC | $2,436 | 1.37 |
Citibank | C | $1,766 | 0.64 |
Wells Fargo & Company | WFC | $1,740 | 1.07 |
U.S. Bank | USB | $585 | 1.09 |
PNC Bank | PNC | $552 | 1.10 |
Truist Bank | TFC | $546 | 1.36 |
Goldman Sachs Bank USA | GS | $486 | 0.65 |
Capital One | COF | $453 | 1.09 |
Toronto-Dominion Bank | TD | $422 | 0.92 |
Morgan Stanley | MS | $411 | 1.79 |
Charles Schwab Corporation | SCHW | $393 | 0.79 |
Bank of New York Mellon Corporation | BK | $357 | 0.62 |
State Street Bank and Trust Company | STT | $298 | 1.08 |
Citizens Bank | CFG | $226 | 1.19 |
First Republic Bank | FRC | $212 | 0.75 |
Silicon Valley Bank | SIVB | $209 | 0.78 |
Fifth Third Bank | FITB | $206 | 1.53 |
M&T Bank Corp | MTB | $200 | 1.57 |
KeyBank | KEY | $187 | 0.96 |
Additionally, banks lever up to roughly 10-to-1 multiple, which means that their returns on assets of about 1% is typically amplified to a return on equity of 10%. NewtekOne will be leverage constrained at 10-to-1 also, implying that its anticipated 3% returns on assets will be levered up to a 30% return on equity. In the long run, share prices reflect the returns on equity of the underlying business. I think you can do the math and use your imagination here.
Conclusion
Any one of these pieces of the NewtekOne puzzle is not enough to get excited about, but it is the aggregation of all of them together into a coherent whole that excites me. The combination of all these parts are the wings, and I have a front row seat to the ride.
For further details see:
NewtekOne's Wings Will Likely Let Shareholders Soar