Customers Bancorp, Inc. Q3 FY2020 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the Customers Bancorp, Inc. Third Quarter 2020 Earnings Conference Call. [Operator Instructions]. I would now like to hand the conference over to your speaker today, Dave Patti, Director of Corporate Communications. Thank you. Please go ahead.

Thank you, Raquel, and good morning, everyone. Thank you for joining us for the Customers Bancorp Third Quarter 2020 Earnings Webcast. Our earnings release was issued last night, along with our investor presentation. Both are posted on the Investor Relations page of the company's website at www.customersbank.com. Our investor presentation includes important details that we will walk through on this morning's webcast, and I encourage everyone to pull up the topic. Before we begin, we would like to remind you that some of the statements we make today may be considered forward-looking. These forward-looking statements are subject to a number of risks and uncertainties that may cause actual performance results to differ materially from what is currently anticipated. Please note that these forward-looking statements speak only as of the date of this presentation, and we undertake no obligation to update these forward-looking statements in light of new information or future events except to the extent required by applicable securities laws. Please refer to our SEC filings, including our Form 10-K and 10-Q for a more detailed description of the risk factors that may affect our results. Copies may be obtained from the SEC or by visiting the Investor Relations section of our website. At this time, it's my pleasure to introduce Customers Bancorp's CEO, Jay Sidhu. Jay, the floor is yours.

Thank you very much, Dave, and good morning, ladies and gentlemen. Thank you so much for taking the time to join us for the call this morning. Joining me today are Dick Ehst, our President and Chief Executive Officer of Customers Bank; Carla Leibold, our Chief Financial Officer of Customers Bank Corporate bank; Samvir Sidhu, who is our Vice Chairman and Chief Operating Officer of Customers Bank; and Jim Collins, who is our Chief Administrative Officer of Customer Bank; and Andy Bowman, our Chief Credit Officer, of Customers Bank. We are really thrilled to report another strong quarter of financial results despite a challenging economic environment. As you know, our GAAP income of $47 million or $1.48 per diluted share is up 100% over Q3 2019. And our revenues are up 42% over last year while we've held our expense growth to 10%, and this is during a time period when we faced headwinds from the Durbin, application of the Durbin on our interchange income. Before I open up and discuss a little bit of our results, I'd like to recognize our team members as well as our executive management team. I'm so privileged and we are also privileged to be working with an exceptional team and really want to thank them and recognize them for their absolute commitment and hard work to help produce this kind of results. Today, we will organize our presentation into these five or six subsections. First, we will discuss our financial highlights. Then, we will talk about capital trends as well as our strategy to improve our capital. Then a major strength of our company is our credit quality, and Andy Bowman will discuss that in detail with you. We will briefly discuss our strategic priorities. And then we will, before question and answer, discuss our outlook as well as the guidance for you for 2020, 2021, as well as the longer-term guidance. At this time, if you look at Page five of our investor deck, just a very brief overview of Customers Bancorp and our franchise. So, we concluded at September 30 with $13.8 billion in core assets, $11.6 billion in loans and leases, $10.8 billion in total deposits, of which 21% were non-interest-bearing demand deposits, 1.43% of adjusted pre-tax pre-provision ROA. And unlike many institutions in our peer group who are trying to rationalize their branch offices, we only operate with very few of them and we are actually shrinking 20% of the branches or the dots that you see on this page. We are a high-performing, unique community bank in a regional bank with a very strong business banking focus as well as personal banking. And then of course, you all know about the bank mobile technologies. And I'll talk about that a little bit later. If you look at Slide 6 on our investor deck, like I mentioned to you, our company today, unlike many others, has been built by organic growth into a very relationship-driven commercial bank. We started off just about 10 years ago by this management team taking over a $250 million asset failing bank with 40% non-performing loans. From that kind of a foundation, we've grown today to this $14 billion high-performing bank. And that’s why I want to really emphasize and recognize the exceptional and highly experienced management team that's running Customers Bank. From a credit and a risk culture, that's been a strength of ours because we have lived with it. We believe that credit culture is developed by having a tremendous emphasis on the credit side of the balance sheet in good times, and that is the only way you come across well during tough times like today and I'm sure you will see that when Andy makes his presentation. From our longer-term strategy point of view, this company's strategy is built upon a single point of contact model or private banking for privately held businesses. Sometimes, we also call it high touch supported with high tech. We think this is a unique, differentiating approach. We believe this applies both to businesses as well as to consumer banking. We think this is a model which, when you combine it with a digital world and digitization that's taking place in every single industry, creates a very franchise-enhancing platform. That's why we are building, and we have already built an in-house digital bank and digitizing every single operation in the company based upon this high touch supported by high tech approach. We are totally committed to continuously improving our balance sheet, and capital allocation is a key component of our asset and earnings generation strategy. As you know, we are very, very committed to also, at the same time, to set short-term and long-term goals. We do not run this company on a quarter-to-quarter basis. We run this company to build short-term as well as long-term shareholder value. That is why we have been consistent in sharing with you our short-term and long-term goals. And our long-term goal is $6 per share and annualized recurring EPS with improving metrics as such and hence increasing significant value over the coming years. If you look at Slide 8 on the investor deck, you can see the earnings, like I mentioned, of $1.48 and core earnings of $1.20. Durbin is expected to impact us by $7 million to $10 million in the second half of 2020. So many other institutions had to go through M&A and all that kind of stuff to overcome Durbin, while we have been able to successfully deal with it and stay on course. We expect to earn, in fact, well over $100 million in pre-tax income as a result of our PPP loans. Majority of this, we believe, will now be recognized in the first half of 2021. From an ROA point of view, I've already gone over that. One other thing I'd like to add is our efficiency ratio was 15.7% at September 30, and we intend to improve the product over the next couple of quarters. Andy will be talking a lot about asset quality. But let me share with you because we are so proud of it that at 9/30, our NPAs were 34 basis points, with reserves to loans in excess of 2%. Our loan loss provision, even though it was decreased a little bit in the third quarter, we took a more conservative approach by having 100% emphasis on our base case scenario from Moody's. We believe a conservatism is relevant and very important in this kind of environment. We could have justified having no reserve this quarter but chose to be more conservative. Our commercial criticized loans were only 2.5% of total loans. Our deferrals, which Andy will talk about, have significantly improved, they were only 2.6%. From a loan portfolio point of view, we continue to improve our franchise and enhance it, having a different composition of our loan portfolio with more diversification. But loans and leases, excluding PPP, increased $1.4 billion. C&I loans grew by 23% over the year, which is over $400 million. As part of our strategy, we continue to decrease the multifamily loan balances. However, they will stabilize at these kinds of levels. We are very proud to report to you our improvement in franchise value by the quality of our deposits. Our demand deposits were up 71%, and non-interest-bearing demand makes up 21% of our total deposits. From a capital point of view, our bank capital ratios are expected to grow very meaningfully over the next two to three quarters. Still at 9/30, the CET1 was a little over 10%. The total risk-based capital was over 11.5%, and our Tier 1 leverage was over 9%. Our tangible book value at 9/30 was about $26, and our tangible equity is over $100 billion because we were successful over the last few years to raise preferred equity in a very opportunistic way. When you combine our components and the preferred, we are well over $1 billion in tangible equity. We are trading at about 43% of September 30 book value and only at about four times 2020 and 2021 earnings. If you look at Slide 9, talking about capital, we have hit the low point of our capital, which was very interestingly, we did this because it is going to position us for a slingshot effect on growth of capital over the next few quarters. Our participation in the Paycheck Protection Program is going to add significant value for our shareholders. The tangible common equity ratio is currently deflated primarily due to the temporary large balances tied to PPP loans as well as temporarily inflated warehouse loans to mortgage companies. We expect the loans to mortgage companies to decrease over $1 billion within the next two to three months, which will materially improve our capital ratios. Our TCE ratio to total assets is expected to be about 8%, and our total capital ratio organically by the end of 2021 is expected to reach about 14%. The TCE ratio, excluding PPP loans, is expected to reach about 7% by the end of the fourth quarter of 2020, up from a low of just under 6% at September 30, 2020. Moving on to Slide 10, I mean, like I mentioned, maintaining strong credit quality remains a priority for Customers Bancorp. At this time, I'd like to reintroduce Andy Bowman, our Chief Credit Officer, a colleague of ours for the last about 10 years, experienced in the business, to go over some of the credit metrics with you. Andy?

Alright, thank you, Jay. And good morning, everyone. I'd like to take a few minutes and share with you some slides evidencing our continued strong credit performance and continued commitment to overall sound credit quality throughout the organization. As outlined on Slide 10, our credit quality remains strong, and we feel very good about how our portfolio is holding up against the many economic, social, and political pressures brought about by COVID-19. As Jay has already mentioned, our NPAs have decreased only 34 basis points, mainly due to the successful sale of a large Class A commercial office building NPA in the third quarter. At this time, we do not see any significant NPA increases moving forward. In addition, we continue to aggressively move for the dissolution of our sole remaining large NPA of approximately $18 million and hope to have the matter resolved by the end of the first quarter of 2021. Although we are extremely pleased with our NPA performance, we've opted, as Jay has mentioned, to retain a strong reserve position given the continued uncertainties associated with the social and economic impacts of COVID-19 and the political landscape. This is a perfect transition moving on to Slide 11. Slide 11 outlines our CECL and reserve build, which is predicated upon a detailed portfolio-by-portfolio assessment based on various macroeconomic factors impacted by COVID-19 and a deep dive into individual portfolio attributes impacted by said macroeconomic and COVID banking factors. The reserve build also takes into account actual charge-off rates and the level of nonperforming assets, resulting in a reserve of nearly $155.6 million or just over 2% of loans held for sale. This equates to an approximate 245% coverage of nonperforming loans, and we are confident that with this level of reserves we're well-positioned to deal with the residual effects of COVID-19 moving into 2021. Moving on to Slide 12. The bank's criticized and classified loan levels remain modest and have remained fairly consistent over the past four quarters, standing at 2.56%, excluding PPP loans, as of quarter end. We're expecting some modest increases in our criticized and classified numbers moving forward primarily due to the bank's conservative approach in rating any deferrals under Section 4013 of the Cares Act as criticized and classified assets. Although this is a conservative approach and is one we feel strongly about as it accurately depicts the higher level of risk associated with such a deferment and allows us to factor into our CECL reserve calculation, said deferrals and the elevated level of risk associated therewith. More importantly, we continue to carefully assess our criticized and classified assets on an ongoing basis. At this time, we do not see any real level of migration into a nonperforming status. Transitioning to Slide 13. Overall, we have witnessed a steady decline, as Jay has mentioned, in deferment rates with a peak of almost $1.2 billion declining to $750.5 million as of July 24, and declining even further to $302 million or 2.6% as of the third-quarter end. We have seen steady declines in virtually all loan and industry classifications with the sole exception being within our commercial finance group's Motor Coach portfolio, which only consists of the total aggregate portfolio of only $37 million, which in retrospect is only a minor component of the overall bank's portfolio. When looking at the individual commercial portfolios, we noted that 36% of the C&I deferrals were principal only, and 93% of the investor CRE and multifamily deferrals were principal only. More importantly, 53% of our hospitality deferrals are also principal only. Overall, when looking at total commercial deferrals, approximately 61% of all of our commercial deferrals were principal only, continuing to pay interest. In addition to the great progress we've made within our commercial portfolio, all three of our consumer lines have posted significant declines in deferment over the past months as well. Moving forward, we look for a continued decline in deferments within both our commercial and consumer portfolios. Moving to Slide 14. I firmly believe, and we all believe in the organization that the diversification of our commercial loan portfolio positions us well moving into COVID-19. Significant portions represent lending activity to industries that have not been significantly impacted or impacted at all, such as mortgage warehouse lending, specialty finance lender financing, as well as significant portions of our C&I and owner-occupied CRE portfolios such as manufacturers, wholesalers, service companies, and professionals. This slide outlines our exposure to industries identified as at risk due to COVID-19. The good news is that these industries equate to only 5.8% of our total loan book at quarter end. The bank's greatest at-risk exposure is that of the hospitality industry, which at quarter end, we had $404 million in aggregate exposure but comprising only 3.5% of the bank's total loan portfolio with $126 million in deferred, or 31.3%. Again, as outlined on Slide 13, the hospitality deferments have continued to climb, and 53% of those deferrals are principally deferrals. In addition to client deferment, we've also seen gradually improving occupancy rates, and I'm happy to report that no hospitality loans transitioned to nonperforming status in the third quarter of this year. Slide 16. Although not deemed in at-risk industry segment, there has been considerable focus around the performance of healthcare loans throughout this pandemic, and we wanted to share with you that our healthcare portfolio, which equates to approximately $310 million, has performed very well with no requests for deferred payments and no delinquencies. At this time, the portfolio encompasses approximately 5,500 beds and is geographically dispersed, with the majority being in the New York, New Jersey, and Pennsylvania markets given the bank's traditional trade area. Although the insurance payer mix is both private and government, the majority is comprised of Medicaid and Medicare, which both increased reimbursement rates to help skilled nursing centers offset the increased costs associated with the COVID-19 pandemic, such as PPE needs, staffing needs, and decreased occupancy rates. Finally, the portfolio is predominantly real estate secured, with the majority of loans backed by personal guarantees. Moving on to Slide 17, very similar to Slide 16, we thought it prudent to share some key characteristics around our multifamily and investment CRE portfolios. As evidenced on this slide, the bank has gradually moved to reduce its overall multifamily and investment CRE exposure over the past few years, and this trend continued throughout 2020. The decision to reduce this exposure was driven by the desire to create a more balanced credit portfolio. The portfolio has performed well mainly due to the use of conservative underwriting standards as evidenced by low LTVs in place, conservative debt service coverage ratios, and financing of assets housed in historically strong urban settings, such as New York and Philadelphia. The portfolios are well-seasoned with an average weighted life since origination of 3.5 years and, from a multifamily perspective, are centered around historically less volatile workforce housing. Again, deferment has steadily decreased as collection rates have improved, and based upon current trends, deferments in this portfolio should continue to decline. Overall, the portfolio is predominantly comprised of satisfactory, well-stabilized properties owned and managed by experienced professionals, and we have very little construction exposure. Despite the impact the pandemic has had on urban areas, we are pleased to share how well our New York City and Philadelphia multifamily portfolios have performed, and we feel this is indicative of our strong underwriting process and focus on only linking business with seasoned and highly experienced owners and operators. Wrapping up my side of the presentation and moving on to Slide 18. On this slide, we played out some key statistics within our banking to mortgage companies portfolio, which was extremely robust in the third quarter, as evidenced by the approximate 55% book increase year-over-year, with the volume increase coming from both refinance and purchase activity given the current rate environment. It's also worth mentioning that this line of business has a fairly low credit risk profile given the relatively minimal hold period of loan averages at 20 days, a sub-100% financing rate versus traditional market sale rates of between 102% and 105%. On average, 90% to 95% of the loans are deemed conventional and Fannie, Freddie, or Ginnie eligible. Overall, we are extremely pleased with our performance in this line of business and anticipate some decline in volume in the fourth quarter and into '21 due to seasonal runoff and a slowdown in refinance activity and the introduction of the adverse market, be it 50 basis points by Fannie and Freddie beginning December 1 of this year, which will impact the refinance business. In closing, I'd like to thank you for your time this morning. At this time, I'll be turning the presentation over to Samvir Sidhu, our Vice Chairman and Chief Operating Officer. Sam, the floor is yours.

Thanks, Andy. Good morning, everyone. Beginning with Slide 19, we wanted to take an opportunity to continue to update you on previously disclosed information on our consumer installment portfolio. As discussed, we have a very highly diversified portfolio with over a 740 average FICO, no subprime loans, a 21% debt-to-income ratio, and over $100,000 in borrower income. Flipping to Slide 20. Here, you will see that our CB direct and CB marketplace on our portfolios continue to remain strong and perform materially better than the industry. At peak, our portfolio has remained less than half of the industry average, and CB direct loans are approximately 70% below the industry average. As Andy referenced earlier, our installment loan COVID deferrals were down to 1.2% at quarter end and since then have dropped further to 1% as of last week. Our CB Direct forbearance is now down to just nine basis points with 30-day plus delinquencies at only 60 basis points. Both of these numbers are on top of where we were at the end of February pre-pandemic. Finally, charge-offs are trending approximately 40% better in the portfolio than we had projected year-to-date at only $21.4 million versus about $35 million, which, as you can appreciate, is significantly less than our 6.5% CECL reserve. As you can see, we continue to be very pleased with overall portfolio performance and the data-driven approach to onboarding new customers and portfolios the bank has proven to be industry-leading and franchise enhancing. Moving to Slide 21. We highlight one of our biggest achievements over the past one to two years, which has been the improvement in our deposit mix. We are and will continue to be less reliant on borrowings going forward than we have been historically, although this may not be fully apparent today due to the PPP liquidity facility. Our borrowings to asset ratio should settle in the mid- to high single-digit range as PPP pay downs, which is a fraction of our historic levels. Finally, our cost of deposits has dropped further to 67 basis points versus 1.82% in the year-ago quarter and is expected to continue to drop further in the coming quarters, initially assisted by approximately $500 million of CDs maturing in the fourth quarter, which we would expect to reprice with at least a 100 basis point reduction. Moving to outlook on Slide 23. we will continue to focus on building franchise value by leaning into and expanding our community banking strategy using our single point of contact, high touch supported by high tech model. We expect approximately 7% to 10% overall C&I loan growth, led by approximately 10% plus in our national low-risk businesses. Our SBA lending, specifically 7A lending, which is a hybrid national and community banking business assisted by the government guarantee, is a business line that we love. Given the adoption of technology and experience of working with the PPP program, we expect this low-risk business line to grow by approximately 50% or more in 2021. Additionally, we expect multifamily to manage to about the $1.5 billion balance, and as Jay mentioned, loans to mortgage companies are projected between a $2 billion to $2.5 billion balance in 2021. Moving to Slide 23, this slide reinforces our fintech and technology-related priorities. Customers Bank has strong and agile technological capabilities, and our team has helped create a digital banking platform that we have augmented with a fintech partner ecosystem. From a digital lending perspective, we are expanding our direct-to-consumer installment lending strategy by adding new product lines there as well as expanding into commercial lending in 2021. Our PPP efforts have shown us that small and medium-sized businesses around the country are being underserved, and we're working on advancing our proprietary platforms to develop an industry-leading digital lending platform to serve them. Our first expected material commercial launch will be with a digital front end to augment our robust in-house 7(a) lending business, where we have already built a reputation for expedited processing. We will achieve this through the use of a smart credit box and scoring model along with workflow automation and processing. With that, I'll pass it on to Carla to discuss our financial guidance.

Thanks, Sam, and good morning, everyone. Moving on to the financial guidance on Slide 25. We believe we are well-positioned to execute on our 2020, 2021, and 2026 objectives. Loan growth, excluding PPP and mortgage warehouse balances, are expected to average in the mid to high single digits over the next several quarters. Total assets are projected to be between $12 billion and $13 billion at year-end 2020, excluding the PPP loans and subject to refinance activity impacting our loans to mortgage companies. Our total risk-based capital ratio is expected to exceed 12% by year-end 2020 and to be around 14% by year-end 2021. Our preferred equity will not be called in 2020 or 2021. We project the NIM to be in the 2.90% to 3% range for the full year 2020, excluding PPP loans. Operating expenses are expected to be flat to up moderately over the next few quarters, excluding the impact of the BankMobile divestiture. We will maintain discipline in controlling our operating expenses while continuing to invest in the future, improving positive operating leverage. The effective tax rate is forecast to be between 20% and 21% for 2020. Our PPP revenues are on target, and the program is expected to earn about $100 million in pre-tax origination fees. A run rate of $3 in core EPS is expected for 2020 and 2021, and we're still on track for $6 in core EPS for 2026. Our 2020 NIM expansion and profitability targets will be achieved by maintaining or improving asset quality even in stressed periods, reducing future allowance for credit losses, provision expenses. On the asset side, measured growth will focus on maintaining or increasing asset yields, disciplined pricing on the origination of high credit quality loans, and protecting spreads by building into floors. On the deposit side, we will continue to grow core deposits and continue to experience repricing in 2020. Beginning in the third quarter of 2020, our digital expense deposits repriced down in excess of 100 basis points. We have $466 million of CDs that mature in the fourth quarter of 2020 and are expected to reprice down significantly. Our goal remains to bring down the total cost of deposits to less than 50 basis points in the near future. Lastly, on Slide 26, we wanted to provide a path to the core EPS target of $6 by 2026. Assuming a position of $12 billion to $13 billion in assets and 31.7 million diluted shares outstanding by the end of this year, we've assumed a growth assumption of 7% to 10% per year on average through 2026, a 1% per annum increase in diluted shares, and a return on average assets between 1% and 1.1%. This would generate about $200 million in net income or $6 in core EPS, which we believe is a significant value proposition. With that, I'll turn it back over to you, Jay.

Thank you. Thank you very much, Carla. Before we open it up for Q&A, I'd like to touch very briefly on a few points. Number one is we are in some negotiations with very attractive teams that we expect to onboard in the next few months. Some of them are related to some bonuses that they will be taking from their previous employer. We see this as a very, very opportunistic time to attract tremendous talent to support the execution of our strategies, so look for that news coming from us over the next few months. Number two is we touched on the digitization of the bank. If you have any questions, Jim Collins, our Chief Administrative Officer, would be happy to discuss that with you. This has been a very significant effort. It's not just new; it's been going on for a while. We have been expensing and investing towards achievement of our objectives in that area. We have also combined that with a zero-based budgeting initiative that is going on throughout the company, and that's why we are very hopeful that we'll be able to moderate the core expense growth, excluding BankMobile technology-related expenses. We should still be able to add and absorb additional incremental expenses for revenue generators that we are attracting. From a credit quality point of view, I couldn't agree more with Andy that the strength of our company is credit quality, and you should not expect any surprises based upon what we see today. Our data-driven analytical analysis is bottomed up, and we stress test at the loan level as well as stress test from a COVID impact point-of-view of the entire portfolio, and we are very confident about the quality of our assets. The next item is BankMobile Technologies. BankMobile Technologies is on target and is expected to close that divestiture sometime in quarter four. We have no intentions of owning any equity or having any influence in BankMobile Technologies at all over an extended period, and it is going to be developed by us and supported by us to be a totally independent company devoid of influence from Customers Bank, and it is an entity and organization that continues to support the underbanked as well as other tremendous opportunities that they see going forward. We believe this will add significant value for our shareholders over a longer period. The last item I'd like to touch base on is stock buybacks before we open it up for Q&A. As you can well imagine, there is not a significant opportunity for us in the very near future to think about stock buybacks, but our Board of Directors and management is looking at various scenarios. If the environment and the market continue to not value our Customers Bancorp stock at the appropriate peer levels, we are working on scenarios to shrink the company and have massive stock buybacks so that the appropriate valuation of the company is being reflected in the value of the organization. We believe that the company should be valued at peer level, and we are not looking at above peer levels; that’s why Carla shared with you our 2026 core EPS targets as well as our 2020 and 2021 targets, along with the improvement in our capital ratios. We believe every option is on the table for us to take steps to increase our shareholder value, including stock buybacks at a significant discount to tangible book. With that, Raquel, I'd like to request you to open it up for questions and answers.

[Operator Instructions] Our first question comes from the line of Steve Moss with B. Riley Securities.

If we could start with the PPP applications. I'm curious about the level of forgiveness you've seen and how you're thinking about the process?

Steve, this is Sam. I'd be happy to take that. As you can appreciate, there have been some delays from the SBA's perspective regarding forgiveness acceptance, as well as from Congress regarding putting out a potential blanket forgiveness for smaller loan sizes. Our projection that we had shared in the previous quarter still holds — we expect approximately 90% of loans to be forgiven, approximately 95% of our loans, and about half of our loan balances are below $150,000. As Jay mentioned, we would expect, given where we are at the end of the year and with the election coming up, that the forgiveness will likely be a first-half, more likely a Q1, hopefully, event.

In terms of applications being processed at the different time, it's pretty minimal.

It's minimal. Yes, it's less than 5% of our overall loans, which are above $100,000.

Okay, that's helpful. Then in terms of the mortgage warehouse, I mean peer was big, but the average balance was pretty good as well. Just curious, what was the percentage funding refis? And how are you thinking about those balances in 2021? I think you guys implied it coming down probably after the first half of 2021?

Yes. Steve, it will be, like we mentioned, it's about 65% buying activity right now and 45% purchase activity. We have been committed to this business. This business is generating over 20% compensating non-interest-bearing deposit balances for us. As we shared with you, it's over $3 billion in non-interest income this past quarter. For us, this is a core franchise business, but it's seasonal. We think it will be like we gave you the guidance between $2 billion to $2.5 billion in that range for next year.

Okay, that's helpful. And then regarding consumer loans, balances are down a touch, reserves can flat up a little bit here. Do you expect those balances to remain steady for the next several quarters?

Yes. We have managed to keep it approximately flat. We have been originating direct north of $40 million a month on average, about $120 million a quarter in addition to some small flow arrangements that we still have with some of our marketplace lenders. We have experienced faster-than-expected payoffs in 2020. So I would anticipate that we would continue to originate at the pace we've been originating, and that we would slightly increase and resume growth of the portfolio.

Sorry. And Steve, like we've shared with you, we do not envision the portfolio to be greater than 50% to 20%, and that will be over a period of time. A detailed review will be conducted to ensure that the credit quality remains as strong as possible. We think this is a business which banks have totally given up to the marketplace lenders, other than credit cards remaining pretty much in the banking space. We are selectively looking at how we do direct originations and how we sell digital deposit services to all of these consumer loan customers.

Okay. And just regarding reserves, with charge-offs trending better, what's the potential for reserve releases in upcoming quarters here?

I'll take that — at this point in time. Go ahead, Jay.

Okay. Sorry. I think we mentioned Carla and Andy and I that our exposure needs to be conservative in reserving, and we cannot comment on future reserve levels. But you can imagine that a conservative approach in these uncertain times is prudent. We will still be monitoring and using the Moody's analytical model to determine our future reserving. But we are reserving at levels that are greater than what Moody's models would show, all based on taking a conservative, qualitative adjustment to it. We do not envision that there would be higher reserves for consumer loans. If anything, your guess is as good as ours that there could be some releases in the future.

Our next question comes from the line of Michael Perito with KBW.

I wanted to just — I had a couple of questions, but I wanted to start actually following up on some of your last few comments there, Jay, regarding shrinking the balance sheet and buying back. I'm wondering if we could spend a minute just to kind of get your heads a little bit more. I mean, obviously, Sam, you mentioned kind of the growth expectations and guidance. But I guess, as we try to understand how you guys are thinking about it, it would seem like if the valuation doesn't improve, you guys would be willing to kind of walk back those loan growth guidance to shrink the balance sheet and build capital or buy back stock. Is that kind of the right way to capture what you guys are trying to emulate?

Yes, that is obviously, Mike, a scenario, and you can imagine that one can take an approach of temporarily shrinking your balance sheet, freeing up the capital, and buying back the stock until we are trading above tangible book value or at peer levels. That could be a very prudent strategy on our part. We have enough opportunities, and our balance sheet is very liquid to be able to pull that off. But in the core businesses of C&I lending, franchise lending, we do not envision touching those, and so the growth opportunities that exist over there — recruiting of teams to continue to improve our franchise value — we think that creating value by buying back stock is temporary. But if we can do it in a way that continues to improve your franchise value, improve the quality of your deposits, improve the kind of customers you have, continue to create the digitization efforts we're on — combining it all can really build franchise value. That’s one of the reasons we decided to keep the technology of BankMobile Technologies for use by us and to let BankMobile be a totally independent company with no influence from us at all so that they can grow. But at the same time, we can utilize that technology in ways that can benefit our shareholders.

Yes. Thanks, Jay. I would just add, Mike, to wrap a bow around it. Our base case is to proceed along the asset generation growth levels that I walked through. Our second option is — and the hope is that we return to market multiples. The second half would be sort of a moderate stock buyback in sort of the mid-next year. If we don't have a convergence to market multiples, then the third option would be on the table.

Okay, that's helpful insight. As we think about, Sam, some of the things you talked about on slide give me a second, 23 here, some of it was helpful, some of the growth things you are looking at. I was wondering if you could spend another minute on two things for me here. One, on the niche businesses, I know you guys have talked about some of these in the past, but I was wondering if you could rehash a bit more specifically what are two or three of the bigger growth opportunities there, and what those credits look like that you guys are taking advantage of? Secondly, on the SBA side, I feel like historically, that business was very asset-oriented for most banks, but it seems like now, with the digital movement, there's more of an opportunity to capture some of the liabilities of these smaller businesses and be able to service them more effectively without actually being close by? How do you see the liability opportunity from the SBA build-out in terms of the impact on your deposit base?

Sure, absolutely. Starting with the niche businesses, our specialty lending and lender finance business is the largest component of that. It's approximately a $1 billion business for us today, and that will be driving the majority of the growth. This business is predominantly at approximately 65% advance rates on a pool of collateral with collateral swaps in the event that there's ever an issue. As we've modeled it out, you'd have to be at a recession multiple times larger than the great recession to ever experience a dollar of loss. So that's the biggest component of our specialty niche businesses. The healthcare business, I think Andy already walked through earlier today. Lastly, from our commercial finance business, which is our equipment finance business, that business is expected to grow about 10% to 15%, again a business that generally experiences very low loss rates, and our business has experienced essentially zero losses to date. To your question on the SBA side, absolutely, our existing business today would not have been able to pivot so quickly to take advantage of the PPP efforts without the strong in-house SBA 7(a) lending team we have. That business currently is a direct business with BDOs nationally around the country, and they do bring on deposits. A typical BDO brings in about $10 million a year, and we have about 10 BDOs. So it's about $120 million a year. Those businesses are great; they come with deposits. Now we're expanding that into a higher volume, lower ticket size, less bespoke, more down the middle, using technology to originate and process. That will give us a higher volume, not so dissimilar to our PPP efforts, higher volume or ticket size but rich in sort of initial deposits. From a medium to long-term perspective, those are potentially very valuable customers for the franchise in addition to being profitable customers upfront, especially with the SBA guarantee. Hopefully, that answers your query.

Yes. No, that's really helpful. Lastly, on the expense side of the equation... I want to backtrack a little bit and ask something different. On loan growth, the 7% to 10%, the margin and balance sheet have other items that will impact it near term with PPP and excess liquidity in the elevated work from home, etc. As we try to get to a more normalized view and run rate for maybe the middle of next year and beyond, can you provide a bit more color on where some of the origination yields on these portfolios today are, and how you expect them to trend? Do they seem pretty stable? Or is there room for competition to increase in some of these or risk asset classes that are growing, which could compress? How are you thinking about that dynamic today?

Mike, this is Carla. I can add some commentary on that. Broadly, for 2020 and 2021, we are expecting a stable margin from where we are going to be from 2020. From a loan yield perspective, what we're seeing right now on average coming in is in the 3.5% to 3.75% range. We are expecting to continue to have some repricing downward on the deposit side. We do not anticipate any margin contraction next year.

Our next question comes from the line of Russell Gunther with D.A. Davidson.

I did have a question on the expense side of things. Carla, I heard the guidance for flat to up in the near term. Could you clarify the comment around what that considers for BankMobile that ex all BankMobile expenses? Or is there a different interpretation?

Yes. That does not include any BankMobile-related expenses as part of the divestiture transaction. To give some comments on that, some forward-looking, we are expecting 2021 to get into that efficiency ratio around the low 50s. We're focused on controlling our expenses. That said, it's a sea opportunity for revenue growth. We will invest, and we are spending some time investing in our digital transformation efforts.

It's very helpful. I appreciate the clarification there. You mentioned it's a branch-light model at Customers, and you mentioned still able to tighten that up a little bit by about 20%. Given the tougher revenue environment and some of the franchise investment you just mentioned, are there potential other offsets within the legacy customer business model from an expense perspective? Just give us a sense for how you would what those might be to achieve that low 50-efficiency ratio target?

We're really not going into that level of detail at this point in time, just managing to be flat to moderately increasing expenses and staying within the low 50s efficiency ratio.

I’d like to add to that, and I agree with Carla that rather than line by line... The zero-based budgeting initiative we shared with you about, as well as the digitization of the bank, looking at every single process and using technology in every area of the company. I'll just give you an example. We are incorporating technology into our credit approval, credit administration, portfolio management, and interaction with our borrowers, which will free up an extensive amount of time for our private bankers, relationship bankers, and portfolio management. This is something we expect to operationalize by the end of this year; it will also give us a huge improvement in our overall franchise, where our measurement of success will reflect a customer who says ‘wow.’ This is how we are measuring that, not just for expense reduction. If you can improve productivity and customer service, it is a winner. We think that banks have not changed their credit administration, credit approval, and portfolio management processes over the last 25 to 30 years. Technology today really helps you a big time. We're using similar approaches throughout the company. That's why we're seeing moderate growth because the traction of the teams is bound to be expensive for us in the beginning, but it will pay off.

Got it, okay. Switching gears with a final question. To the extent you're able, could you share the types of teams you've gone after, what lending verticals, geographic concentration— any insight into where you're bolstering the bank going forward with some team lift up?

They are to support what Sam shared with you on our strategic initiatives. It's really not entering into any significantly new verticals. We're just looking at one very low-risk vertical, which it's premature for me to disclose. But otherwise, it's really building on our community banking and niche business model. We're recruiting very, very successful experienced teams who can help us continue to propel the growth we've experienced in those niches. We think that within the next 60 days, you'll start to see us putting press releases out on those teams, and you will be very impressed with what we are attracting. We think there is a lot of disruption taking place in the marketplace right now. Every bank is trying to reduce costs, and they aren't retaining some of their top producers. We see an opportunity to recruit talent in this remote working environment, using our equity-based compensation and team-based compensation plans to build a strong franchise. We are very optimistic. Yesterday, our entire Board and top management team participated in a planning session. It was wonderful for the Board to hear from our entrepreneurial as well as risk-related colleagues present their plans.

Your question comes from the line of Frank Schiraldi with Piper Sandler.

I just wanted to ask about your expectations on capital. You've got some nice levers here to accrete capital levels. There can be opportunities on the growth side, but you talked about the potential for shrinking and buying back stock. Just wondering, as we think about those potentials, what is the right level in your mind now to operate the company? You've talked about getting to that 8% TCE. Are you focused on staying at those levels? Or could we see the company get back down? Just wanted your thoughts.

No. I think capital is king, and capital has always been significant for us. Still, capital has to be adjusted to the kind of risk profile of the company as well as your short-term and long-term strategy. Our minimum acceptable standards for us, which we are somewhat below that for this quarter, is a 7% TCE. We hope to take it up to 7.5% before we consider stock buybacks seriously. We have shared different scenarios. All of those assume maintaining the TCE levels where they are. In the regional banking, community banking sectors, smaller banks, preferred equity hasn't received the recognition that larger banks have. However, we believe that many small regional banks are now following our path and are getting credit for building their preferred equity. Adding 7.5% TCE makes the total capital ratio seem promising alongside preferred equity, which we've decided to maintain in this low-rate environment as it provides low-cost capital for us. This capital is lower than the cost at which banks are raising their preferred equity right now. This gives us many opportunities. From a preference perspective, we prefer to maintain moderate growth and be cautiously growing the company. However, we won't accept trading at 43% of tangible common equity; we aim for 55% minimum appreciation from a valuation point of view. We believe our peer group trades at somewhere within 90% to 110% of tangible book, and we are determined to reach that level.

Okay, fair enough. Then regarding expenses... just following up on the idea of flattish expense growth. As you build out the banking, while continuing to build out the banking as a service business, is there a meaningful expense linked to compliance and back-office functions, and does that have to be offset elsewhere? Or is that expense already baked in for significant growth?

From our existing expense level, we materially have all of those resources in-house already.

Got you, okay.

I will now turn the call over to David Patti for our web questions.

Thanks, Raquel. Let me remind everyone who's on the webcast there is still time to submit a question if you'd like to do so through the function on your screen. Our first question — I'm going to combine two from Daniel Grossman of Danlos Corporation. On PPP, asked in two parts. First, of the $100 million in PPP origination fees, how much was recognized as income in the third quarter? How will the remainder of that origination fee income be recognized in the next four or five quarters? While you're thinking about that, let me also add that Daniel would love to have some information on our attempts to seek deposits from the PPP borrowers and transition them to permanent customers of Customers Bank, wondering how that's going and how much of those deposits we think we will retain. I'll turn it over to the panel for a response.

Sam, do you want to take that up?

Sure. Carla, I'll start with the deposits then if you could share the specific numbers on PPP in the last quarter. From a deposit perspective, we have had good success over the past few quarters. As you can appreciate, we have multiple touch points with the PPP borrowers as it relates to the length of time as well as the changes and delays in forgiveness. Any deposits that we brought in to date, we expect to remain with the bank. Furthermore, many of these borrowers, as you can appreciate, are holding a bated breath waiting for an additional PPP round. We think the nearest opportunity with these borrowers is on the SBA side, regardless of whether there is another stimulus targeted toward small and medium-sized businesses.

Regarding the deferred origination fees, we recorded about $12 million in the third quarter. The remaining will be recognized over the estimated life of the PPP loans. However, it will be accelerated upon forgiveness. We are anticipating that about 90% of these loans will be forgiven in the first half of 2021, creating significant accretion to our capital levels. In the third quarter, we also recognized interest income that we earned about 1% on those loan balances. All in, the interest income is probably around $25 million.

Thanks, Carla. I’ll add just from a NIM perspective to one of the earlier questions: given the 1% interest rate on the PPP loans, to clarify, our PPP NIM ex-PPP was 2.86% in the third quarter. We want to reiterate our guidance of 2.9% to 3% NIM. As Carla mentioned, we expect to be in that range with a slight positive bias.

Thanks, Sam and Carla. Mr. Resmon has another question on a different topic. Let me read that to you. Please explain why your 2021 projections of $3 per share use core rather than GAAP earnings. It also seems to be used by various financial outlets and analyst estimates.

I'll start off. Please help me fill in anything on this. The main thing is that we remain opportunistic to try to take advantage of market disruptions for security gains and those kinds of things. An example is the $10 million of security gains, which was totally created by management being opportunistic and buying back some very small securities in March and early April. Management is rewarded for finding ways to improve our capital and our earnings. However, the Street, rightfully so, does not recognize those as recurring earnings. Most of the time in the banking industry, core earnings are the kind you can count on, and generally, you can rely on those to be recurring. That's the reason we use those terms, allowing you to look at sustainable earnings you can count on for valuations of our stock price as multiples of core earnings.

Okay. Any other response from our panel for that question? If not, Raquel, I have no one further in the web queue. I see no one on your telephone queue.

Therefore, Jay Sidhu, the floor is yours for any closing remarks.

Thanks, Raquel, and thank you so much everybody for joining us today. We really appreciate your interest in Customers Bancorp, and we look forward to staying in touch with you. Thank you, and have a good day. Stay safe, please.

Thank you ladies and gentlemen, this concludes today’s conference call. Thank you for participating. You may now disconnect. Presenters please remain online.