Esquire Financial Holdings, Inc. (NASDAQ:ESQ) is a financial holding company headquartered in Jericho, New York, that operates through its wholly-owned bank subsidiary, Esquire Bank, National Association. The company is dedicated to serving the financial needs of the legal and small business communities on a national basis, as well as commercial and retail customers in the New York metropolitan market.

Business Overview

Litigation Market Commercial Banking

The litigation market has been and will continue to be a significant growth opportunity for Esquire. The company offers focused and tailored products and services to law firms nationally. U.S. tort actions alone are estimated to consume 1.85%-2.13% of U.S. GDP annually, with a total addressable market of $443 billion for 2020. Esquire does not compete directly with non-bank finance companies, the primary funders in this market, and believes there are significant barriers to entry including its clear industry track record, extensive in-house experience, deep relationships with respected firms nationally, and unique products tailored to commercial law firms' needs.

Esquire currently has clients in 30 states, with larger markets including the New York metro area, California, Texas, Florida, Pennsylvania, South Carolina, and New Jersey. The company's success is tied to its unique ability to couple traditional commercial underwriting with non-traditional asset-based underwriting. Esquire's team understands law firms' contingent case inventory valuation process, as well as traditional hourly billing firms. These factors, coupled with the large total addressable market, create a unique and valuable opportunity for the company with minimal incumbent competition.

This unique risk profile translates approximately into a blended 10% variable rate asset yield on these commercial loans for the quarter ended March 31, 2023. More importantly, for every $1.00 Esquire advances on these loans, it receives on average $1.71 of low-cost (96 basis points for the quarter ended March 31, 2023) core operating and escrow deposits from these law firms through its branchless platform, fueling and funding additional growth in other asset classes. Esquire's extremely low historic delinquency rates and low charge-off rates clearly demonstrate its strong underwriting process and expertise in this vertical.

Esquire's longer duration escrow or claimant trust settlement deposits represent $709.5 million, or 50%, of total deposits. These law firm escrow accounts, as well as other fiduciary deposit accounts, are for the benefit of the law firm's customers (or claimants) and are titled in a manner to ensure that the maximum amount of FDIC insurance coverage passes through the account to the beneficial owner of the funds held in the account. Therefore, these law firm escrow accounts carry FDIC insurance at the claimant settlement level, not at the deposit account level. Coupling these types of commercial relationships with Esquire's off-balance sheet commercial litigation funds of $466.6 million at March 31, 2023 makes this litigation vertical a highly desirable core low-cost funding platform fueling growth in other lending areas.

Other Commercial Banking

In addition to its Litigation Commercial Banking business, Esquire also originates commercial loans to local small to mid-size businesses to provide short-term financing for inventory, receivables, the purchase of supplies, or other operating needs arising during the normal course of business, as well as loans made to its qualified independent sales organization (ISO) payment processing customers. The balance of these loans totaled $119.9 million at March 31, 2023 and represented approximately 9.8% of Esquire's total loans.

Payment Processing

The payment processing (merchant acquiring) market has also been and will continue to be a significant growth opportunity for Esquire, as the company offers focused and tailored products and services to small businesses nationally. The payment industry grew approximately 12% on a compound annual growth rate from 2019 to 2022, with payment volumes or total addressable market of $10.3 trillion. Esquire believes there are significant barriers to entry to this market, including its clear industry track record, extensive in-house experience, deep relationships with non-bank acquirers, and its unique approach to servicing small business merchants and their respective verticals.

Esquire uses proprietary and industry-leading technology to ensure card brand and regulatory compliance, support multiple processing platforms, manage daily risk across approximately 85,000 small business merchants in all 50 states, and perform commercial treasury clearing services for approximately $9 billion in credit and debit card processing volume across 151 million transactions in the quarter ended March 31, 2023.

Proprietary Technology

Esquire is currently a branchless digital-first company with best-in-class technology to fuel future growth with industry-leading client retention rates. The company has built a customized and fully integrated customer relationship management (CRM) platform, integrated into its digital marketing cloud and its nCino loan platform (all built on Salesforce for excellence in client service and operational efficiency) and invests in artificial intelligence (AI) to facilitate precision marketing and client acquisition across both national verticals with an initial focus on the litigation vertical.

Financials

The success of Esquire's national litigation and payment processing verticals, coupled with its branchless technology, has led to industry-leading performance. For the quarter ended March 31, 2023, the company produced industry-leading returns including a return on average assets and average equity of 2.59% and 20.14%, respectively; an industry-leading net interest margin of 6.06%; a strong efficiency ratio of 49.8%; and a diversified revenue stream as demonstrated by a strong net interest margin and stable fee income representing 22% of total revenue (the company's payment processing vertical has a compound annual growth rate of 22% since 2019).

Coupling these performance metrics with strong balance sheet management, including loan portfolio diversification, an asset-sensitive balance sheet with 60% of loans being variable rate tied to prime, interest rate floors in place on 90% of the variable rate loan portfolio, solid credit metrics with no nonperforming assets, a stable low-cost deposit base, and strong available liquidity of $822.6 million, or 57% of deposits, with no outstanding borrowings, ensures that Esquire is poised for future growth and success.

For the full year 2023, Esquire reported net income of $41.0 million on revenue of $109.0 million, with operating cash flow of $42.4 million and free cash flow of $39.4 million. For the quarter ended March 31, 2023, the company reported net income of $10.1 million on revenue of $28.5 million.

Esquire's litigation-related loans, which include commercial loans to law firms and consumer lending to plaintiffs/claimants and attorneys, totaled $636.6 million, or 51.8% of the total loan portfolio, at March 31, 2023, compared to $614.9 million, or 50.9%, at December 31, 2022. The company remains focused on prudently growing its litigation-related loan portfolio. Esquire also had $91.7 million in committed and $462.5 million in uncommitted undrawn lines of credit related to its commercial litigation-related loans at March 31, 2023.

Esquire's securities portfolio totaled $220.3 million at March 31, 2023, consisting of $142.2 million in available-for-sale securities and $75.2 million in held-to-maturity securities. The available-for-sale portfolio increased $20.1 million, or 16.4%, during the first quarter of 2023, driven by $25.0 million in purchases, partially offset by $3.3 million in paydowns and $1.6 million in unrealized losses.

Total deposits increased $26.8 million, or 1.9%, to $1.43 billion at March 31, 2023, from $1.41 billion at December 31, 2022. Core deposits, which the company defines as total deposits excluding time deposits, totaled $1.42 billion at March 31, 2023, or 99.0% of total deposits, compared to $1.40 billion, or 99.4% of total deposits, at December 31, 2022. Litigation and payment processing deposits represent $1.24 billion, or 87%, of total deposits at March 31, 2023.

Esquire's deposit strategy primarily focuses on developing full-service commercial banking relationships with clients in its two national verticals through lending facilities, payment processing, and other unique commercial cash management services, rather than competing on rate. The company's longer-duration interest on lawyer trust accounts (IOLTA), escrow, and claimant trust settlement deposits represent $709.5 million, or 49.5%, of total deposits.

As of March 31, 2023, uninsured deposits were $369.4 million, or 26%, of Esquire's total deposits of $1.43 billion, excluding $10.6 million of affiliate deposits held by the bank. Approximately 80% of the uninsured deposits represent clients with full relationship banking, including loans, payment processing, and other service-oriented relationships.

Risks and Challenges

Esquire's asset quality remains strong, with nonperforming assets consisting of one multifamily loan totaling $10.9 million as of March 31, 2023 and December 31, 2022. The company had no exposure to commercial office space, no construction loans, and only $15.3 million in performing loans to the hospitality industry. The allowance for credit losses was $17.5 million, or 1.43% of total loans, as of March 31, 2023, compared to $16.6 million, or 1.38% of total loans, at December 31, 2022. The increase in the allowance as a percentage of loans was general reserve driven, considering loan growth and qualitative factors associated with the current uncertain economic environment, including its potential impact on the New York Metro commercial real estate market.

At March 31, 2023, special mention and substandard loans totaled $4.0 million and $10.9 million, respectively, substantially unchanged from December 31, 2022. The ratio of nonperforming loans to total loans and total assets was 0.89% and 0.66%, respectively, as of March 31, 2023, compared to 0.91% and 0.68%, respectively, as of December 31, 2022. The allowance for credit losses to the nonperforming loans was 160% as of March 31, 2023, compared to 152% as of December 31, 2022.

Outlook

Esquire's capital ratios remain strong, with the bank exceeding all applicable regulatory capital requirements and being considered "well capitalized" under regulatory guidelines as of March 31, 2023. The bank's total risk-based capital ratio, Tier 1 risk-based capital ratio, common equity Tier 1 capital ratio, and Tier 1 leverage ratio were 15.66%, 14.41%, 14.41%, and 12.42%, respectively, at March 31, 2023.

Conclusion

In conclusion, Esquire Financial Holdings, Inc. is a branchless digital-first bank that is powering growth through its national litigation and payment processing verticals. The company's unique risk profile, industry-leading performance, and strong balance sheet management position it for continued success in the years ahead.