Customers Bancorp, Inc. Q2 FY2022 Earnings Call

Hello and welcome to Customers Bancorp Inc.'s Second Quarter 2022 Call. All lines have been muted to avoid background noise. Following the speakers' presentations, we will have a question-and-answer session. This call is being recorded. Thank you. I will now turn the call over to David Patti. Please proceed.

Thank you, Tameka, and good morning, everyone. Thank you for joining us for the Customers Bancorp's earnings call for the second quarter of 2022. The presentation deck you will see during today's webcast has been posted on the Investor Relations page of the Bank's website. You can scroll to Q2 '22 results and click on the earnings presentation. You can also download a PDF of the full press release at the spot. Our investor presentation includes important details that we will walk through on this morning's webcast. I encourage you to download and use the document. 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 security laws. Please refer to our SEC filings for a more detailed description of the risk factors that may affect our results.

Okay. Thank you, Dave, and good morning, ladies and gentlemen. Thank you for joining us for this second quarter 2022 investor call. Joining me this morning from New York is Sam Sidhu, the President of Customers Bancorp, as well as the CEO of our principal subsidiary Customers Bank. And here with me in Reading, Pennsylvania is Carla Leibold, our Chief Financial Officer, as well as Andy Bowman, our Chief Credit Officer. We continued to perform well in the second quarter and are extremely pleased with our results for the first half of 2022. Despite this challenging macro and geopolitical environment, we remain laser-focused on executing our strategy, which has not changed. Our core earnings per share, excluding PPP this quarter were up 32.3% year-over-year. Our core return on average asset was 1.23% and our core return on common equity was 19.1%. We continued to responsibly deliver remarkable organic loan growth without sacrificing credit quality. Our core loans increased by $2.2 billion in the second quarter, up 18.7% from the first quarter of 2022, and well above the $500 million average quarterly target that we shared with you. Nearly all of this growth was in market rate, low-risk specialty lending verticals and was predominantly, as I mentioned earlier, floating rate loans, and that helped us to manage our overall asset sensitivity. Asset quality remains exceptional and credit reserves are strong. Continuing the momentum from our record 2021 performance and strong results for the first half of 2022, our loan and deposit pipelines remained robust—a testament to our customer-centric business model supported by best-in-class service and technology. We remain very excited and optimistic about our future. As you can see in Slide three, what we are building is a digitally-paced forward-thinking super community bank with a focus on community banking, specialty banking, and digital banking and our digital banking covers consumer businesses, commercial businesses, transaction and payment businesses that we are really building strongly right now, as well as banking-as-a-service business. I'd like to now hand it over to Sam to discuss with you our accomplishments and strategic priorities and all of these businesses. Sam?

Thank you, Jay. Good morning, everyone. I'm pleased to walk you through another solid quarter and first half of the year at Customers Bancorp. Our team capitalized on the momentum built over the last two quarters and delivered industry-leading responsible loan growth led by variable rate lending and low-risk specialty lending verticals, which is diversifying and strengthening our franchise. Let me briefly summarize our results. From an earnings perspective, we earned $1.68 GAAP EPS, which represents a net income of $56.5 million. Moving to core earnings, they were $1.77, and stripping out the benefit of PPP income, we earned $1.38, which includes the significant growth-related provision impact. Net interest margin came in at $3.32 for the quarter. Now moving to the balance sheet, we ended the quarter with $18.7 billion in core assets, excluding PPP, up 40% over the year-ago quarter. Our loan book, as you heard from Jay, grew an impressive 32% year-over-year to $14.1 billion ex-PPP at quarter end. Total deposits grew by 22% or $3.1 billion year-over-year, driven by monumental efforts from our commercial teams, amplified by our digital bank team's success in deposit gathering associated with our Customers Bank Instant Token or CBIT launch. It is worth emphasizing and reiterating that $2 billion of this growth came from non-interest bearing deposits. Strong asset quality is at the core of our franchise and we continue to have superior credit quality versus peers and saw improvement in the quarter off of an already low base. As discussed at the start of the year, we proactively tightened credit underwriting and shifted loan growth mix in an effort to continue to maintain a pristine credit book as we wait to see the impact of the Fed’s action and inflation on the economy. Flipping to Slide six, let me update you on our business line accomplishments and strategic priorities for 2022. This page helps to visually simplify our strategy and explains what makes Customers Bank so unique. Firstly, on community banking in the quarter, we focused on strengthening our presence and reputation in our expansion geographies, laying the foundation for future loan growth and team recruitment. We expect to actively recruit new teams as the year progresses. We are also focused on growing our existing community-focused business lines. We've added several new relationship managers and executives to our existing teams, leading to strong end market growth. We added a team in New York, one in Boston, and also added to our Florida team. From a loan growth perspective, our largest community bank, the C&I Group in the Mid-Atlantic, grew by 8% quarter-over-quarter. We also continued to grow the multifamily book back to targeted levels and our SBA production grew 29% quarter-over-quarter and 88% year-over-year. Our digital small ticket 7A product pilot continues to show promise as part of our digital SMB bundle. As we guided at the beginning of the year, in anticipation of margin compression on gains on sale income and a shift in the business model going forward, we expect to hold a majority of our government guaranteed growth on balance sheet. Finally, as you may have seen in the recent announcement, we are better aligning our branch network with our expansion and digital strategies and announced the closure of the majority of our legacy Pennsylvania branches that were most impacted by declining industry trends, and we will be moving these customer accounts to other local branches. These five branches represented about 45% of our total existing branches on top of the three that we closed during the pandemic. Moving to Specialty Lending, we continue to recruit specialty lending teams and add to existing teams to support future growth. In the quarter, we added to our fund finance team, our tech and venture team, our financial institutions team, which included a lead for the securities-based lending sub-vertical launch, our healthcare team with a new lead coming from a top five bank, and finally onboarded a team to launch another technology-enabled digital SMB small medium-size business lending product within our equipment finance specialty business. For the third quarter in a row, we've delivered industry-leading low-risk variable-rate loan growth. Our new lending verticals have already achieved outstanding balances of well over $1 billion since inception, surpassing our full-year 2022 goal, led by our fund finance team and well secured assets with a deposit-rich customer base. This growth has been supported by significant customer referrals and cross-sell and is well diversified across existing and new verticals. Moving to Digital Banking, we've established ourselves as a leader in technology and innovation in the banking and fintech space. In terms of our digital consumer business, we continue to progress our digital-first consumer business cross-sell offerings by expanding into multi-product relationships with our existing customers. We're pleased to report that our digital SMB bundle will be in a pilot launch this quarter as we look to build our success and learnings in the digital 7A space and roll into revolving line of credit term loans, equipment finance loans, and credit card offerings. In terms of CBIT, I'll spend some more time talking about this in a minute, but we continue to scale our business at a pace far greater than what we had projected. We are on track to launch our banking-as-a-service business with our first customer on board this quarter, which is expected to add significant income growth potential in 2023. Finally, I'm pleased to announce that we will be formally launching a transaction banking platform if you please flip to a tech-enabled banking Slide seven to provide more detail. Building off of our on CBIT, we will be seeking to disrupt the transaction banking space by helping our current and future customers build a modern cloud-based API-enabled treasury product suite, built for where our customers are going, not just for their needs today. Our best-in-class tech platform will enable us to expand our commercial treasury and payments capabilities to include the customer-facing API library with documentation, enabling simple and robust treasury services, including digital account onboarding, real-time reporting, and account payments with API connectivity into ERPs and internal treasury management software platforms, as well as analytics, payments including ACH, wire, Fedwire, FX, CBIT instant payments, as well as crypto on and off ramps and stablecoin infrastructure services, including minting and burn. This is all in addition to the API-led banking-as-a-service, fintech partnerships, which we've already discussed. Our tech-enabled platform has been built with input from dozens of interviews with customer end-users and decision-makers, reinforcing our customer-centric and service experience approach, which we hope will continue to build tremendous customer loyalty and enhance our brand. While most banks are rightfully focused on digital transformation and digitizing internal processes, we are looking to leapfrog forward and working to package and productize our tech by tailoring it to customers’ current and anticipated needs. Said another way, we're focusing our tech spending on innovation for our customers. We expect transaction banking to enhance the Customers Bank customer-focused value proposition and facilitate significant low to no-cost deposit, as well as fee income opportunities in commercial and large corporate high-growth verticals led by digital assets, FIG, fund finance, and tech and venture. As an example, our fund finance business, which crossed over $1 billion as you heard, will be expected to be 100% self-funded and supported by these efforts. Similarly, our tech and venture business on a steady state, we expect to be at least 100% funded supported by our tech enablement. Moving to loan growth summary on Slide eight. We’re pleased to be benefiting from our 2021 efforts to establish new lending verticals, which has led to a well-diversified loan growth in the quarter. Our teams have posted $2.2 billion of total loan growth with $1.6 billion of that coming from our specialty lending verticals. And our mortgage banking business, we now have achieved our goal of less than 15% to 20% of loans with that business at 13% of loans, making PPP, which will significantly reduce some of the seasonality we experienced historically. Our very well-secured and well-structured fund finance business that has been led by a team of senior executives from top five banks led the growth with $700 million added in the quarter. Our matured, well-secured and structured lender finance business that was started more than seven years ago has never experienced a loss of delinquency, also grew by more than $500 million in the quarter. As we previously guided, our consumer business remained flat to declining as we guided last quarter as we seek to further improve our credit risk profile and focus on low-risk verticals. Flipping to Slide nine on CBIT, a quick recap on the instant payments platform we launched, which tokenizes deposits on the blockchain for providing an instant payment rail that is available 24/7/365. Despite significant market volatility in the digital asset space during the quarter, building off of our significant customer growth in the first quarter, we are proud to report that we accelerated customer growth once again, beating our internal target through the onboarding of 90 new customers, nearly doubling to 190 total customers at the end of the quarter. This is a testament to our compliance-first best-in-class onboarding process and again a recognition of our industry-leading technology infrastructure platform, which is forcing basic and long-needed innovation by the incumbent commercial and digital asset banking institutions. Our customer backlog remains robust and to be clear, we have no exposure to underlying cryptocurrency assets of our customers, just banked fee up dollar deposits used for operating accounts, payments, and trading. All in, customer payments more than doubled in the quarter and deposits increased with the growth being led by new customers funding their opened accounts with about $400 million added in non-interest bearing deposits. Our total CBIT-related deposits reached $2.1 billion in the quarter. As a reminder, our digital asset customer base is diversified and led by exchanges, OTC desks, institutional investors, and stablecoin issuers. In just a few months, Customers Bank already banks several of the largest needs of these categories. Customers continue to progress in moving over their primary banking relationships to us, which speaks to our innovative take on service and experience-based high-tech, high-touch banking model. Our focus in 2022 will be on growing and strengthening our network effect by driving customer growth, API connectivity for multiple payment rails, as well as stablecoin infrastructure leading to more engagement and thus more inflows into our ecosystem. We continue to expect CBIT-related deposits to grow through the year as our pipeline remains strong, supported by customer referrals, which give us an opportunity to further transform and improve our deposit franchise. With that, I'd like to hand it over to our CFO, Carla Leibold.

Thanks, Sam. And good morning, everyone. I'll keep my comments focused on five key topics. The first strong organic growth resulting in improvements in loan and deposit mix. The second asset sensitivity and being well-positioned for future rate hikes. Third, continued strong growth in net interest income generated by the core bank. The fourth ample liquidity combined with a well-diversified and managed investment portfolio, including strategic actions taken to mitigate further material negative AOCI book value impact. And number five, strong capital position. Turning to Slide 10. I'll start with strong organic growth resulting in improvements in loan and deposit mix. As Sam mentioned earlier, we continue to see remarkable organic core loan growth in the second quarter of 2022, up $2.2 billion from the prior quarter and up $3.4 billion year-over-year. This equates to a 19% increase quarter-over-quarter, significantly higher than our peers, as well as most of the industry. In total, our specialty lending C&I verticals ended the quarter at $4.8 billion, an impressive 50% growth over the prior quarter and 192% growth year-over-year. We also continue to build our relationship-based multifamily business, which increased 18% quarter-over-quarter, while our consumer installment portfolio stayed flat at $1.9 billion. Overall, our loan mix continues to improve as we increase the percentage of the portfolio in low credit risk lending verticals such as lender finance, fed fund finance. I'll also point out that over $800 million of our loan growth came in June, meaning we will see the full net interest income benefit in the third quarter. Moving to deposits, we had $529 million of growth in the second quarter, up 30% over the prior quarter. Year-over-year, deposit growth was $3.1 billion, up 22%. Notably, total demand deposits increased $4.4 billion or 64% year-over-year. We continue to make progress in the remixing of our deposit franchise as the percentage of non-interest bearing deposits to total deposits increases. At the end of June, 28% of our total deposits were non-interest bearing, a significant improvement from 16% back in 2018. In addition to our digital asset-related deposit, we see significant opportunity to grow our core deposit base through our financial institution group, as well as other channels. Slide 11 shows the repricing characteristics of our interest-earning assets, approximately 65% of our interest-earning assets are market sensitive and will benefit from a rising rate environment. Nearly all of the growth I described earlier was in low credit risk, special lending verticals and with predominantly floating rate in nature as we continue to manage and remain moderately asset sensitive. Moving to Slide 12. This slide shows a trend of increasing net interest income, excluding PPP over the past five quarters, largely driven by strong organic growth in our specialty lending C&I business. Compared to the prior quarter, our net interest income increased 12%; year-over-year our net interest income from the core bank increased 42%. You can also see that we have increased our spread 13 basis points from the year-ago quarter. Going forward, we remain very focused on disciplined pricing and preserving net interest margin, but not at the expense of sacrificing credit quality. For the second half of this year, we are expecting our net interest margin, excluding PPP, to be between 3% and 3.25%. I'll point out that approximately $1.3 billion of loan growth added during the second quarter was in very low credit risk lending verticals. And accordingly, yields tighter spreads above so far. Turning to Slide 13. PPP loans totaled $1.6 billion at the end of June. There was approximately $6 million of forgiveness of repayments in the second quarter of 2022. This resulted in deferred fee recognition of about $15 million, which was approximately half of the amount recognized in the first quarter. At the end of June, approximately 91% of PPP loans originated under rounds one and two had been forgiven and approximately 73% of PPP loans originated under round three had been forgiven. To-date, we've recognized about $307 million of deferred origination fees, leaving approximately $43 million to be recognized throughout the second half of 2022 and into 2023. As we've said previously, it's difficult to predict the timing of these fees, but we are expecting approximately two-thirds of the remaining fees to be recognized later this year. Turning to Slide 14. You can see tremendous growth in our liquidity position, particularly in the second half of 2021 and ultimately peaking at $4.4 billion at the end of last quarter. During the second quarter, we took two strategic actions impacting liquidity and the investment portfolio. The first, we sold $400 million of available-for-sale securities and redeployed those proceeds to fund organic loan growth in very low-risk variable rate specialty lending verticals. This resulted in approximately $3 million of realized losses during the quarter, which we estimate can be earned back in less than three months. The second is we reclassified $550 million of investment securities with an unrealized fair value loss of $50 million from available for sale to held-to-maturity on June 1. This essentially locked the $50 million or $37 million of after-tax unrealized losses in AOCI with approximately $8 million of estimated reversals annually until the securities payoff. We did this to prevent further material AOCI losses from our available-for-sale investment portfolio from impacting our TCE ratio and book value. We purposely reclassified longer duration fixed-rate MBS and CMOs to held-to-maturity as they were most vulnerable to fair value losses driven by rising interest rates. Post this reclass, our net yield on the AFS book was 2.9%, the effective duration is approximately 1.6 years and approximately 52% of the securities are floating rate. Moving to Slide 15. We continue to maintain strong levels of capital. The estimated total risk-based capital ratio at the end of the second quarter was approximately 12.6% and our TCE ratio excluding PPP was 6.5%. Our TCE ratio was negatively impacted by about $125 million of after-tax unrealized losses deferred in AOCI at the end of June. This negatively impacted our TCE ratio by approximately 70 basis points. Without this impact, our TCE ratio would have been approximately 7.2% at the end of the second quarter. We saw a similar impact on our tangible book value, which was down about $0.15 from the first quarter as the $1.68 of second quarter GAAP earnings was more than offset by a negative AOCI impact of about $1.80. It's important to note here that the AOCI impact is an accounting fair value adjustment that has no permanent impact on capital if the securities are held on balance sheet. Looking forward to the end of 2022, we are still expecting our tangible book value to be over $40. We also expect our TCE ratio to be above 7.5% over the next three to four quarters. And with that, I'll turn it over to Andy to talk about asset quality.

Thank you, Carla, and good morning, everyone. Moving to Slide 16, credit quality remains strong as evidenced by a decline in NPLs by $28 million or 18 basis points of total loans, a correlating decrease in NPAs to only 14 basis points of total assets. More importantly, as it represents a real-time assessment after the performance of the loan portfolio, 30 to 89-day delinquencies stood at just 13 basis points. The $11.5 million in charge-offs for the quarter after adjusting for the approximate $2 million cleanup of overdrawn consumer deposit accounts managed by a third-party servicer was comprised of $9.9 million in consumer loan charge-offs and $1.6 million in commercial loan charge-offs, equating to an annualized net charge-offs to average total loans and leases of approximately 31 basis points. The $9.9 million of consumer loan charge-offs presented an increase over prior quarters, but remained in line with prior shared guidance of increased charge-off rates as the portfolio naturally seasons. Most importantly, the 2.1% annualized charge-off rate is well below the lifetime loss rate of 5.85% and the weighted average life remains very short at just 1.7 years. From a commercial loan perspective, charge-offs were only $1.6 million, equating to annualized net charge-offs to average total commercial loans and leases of just 5 basis points. The charge-offs were tied to the sale of four related multifamily loans that have been in non-performing status for some time and therefore is not at all indicative of the solid ongoing performance of the multifamily portfolio, as evidenced by the NPA, NPL and delinquency stats I previously noted. As outlined on Page 23 in the appendix and in line with prior quarters, the consumer installment loan portfolio continues to evidence strong credit characteristics as evidenced by weighted average FICO score of 729, with 99% of all FICO scores greater than or equal to 680. The weighted average DTI of 17.4% with 72% of all borrowers having a DTI of less than 30% and a weighted average borrower income of $102,000 with 83% of the borrower incomes greater than or equal to $50,000. The portfolio also remains geographically dispersed and is comprised predominantly of borrowers employed within non-discretionary spending dependent industries. Additionally, as outlined on Page 26 in the appendix, the consumer installment portfolio allowance for credit losses remains robust by $111.2 million based on the previously stated 5.85% lifetime loss rate. And although there will inevitably be increased charge-off rates, the portfolio continues to naturally season, we are more than confident that based on the portfolio's strong credit attributes and strong performance to-date, reserves are more than adequate at this time. Overall, although we're extremely pleased with how well all of our portfolios have performed and continue to perform, we remain committed to maintaining a strong reserve position given the continued uncertainties associated with the current social, economic, and political climates and remain committed to adhering to our strong underwriting standards. Following this theme, we did post a reserve build in Q2, predominantly due to very strong loan growth as mentioned by both Sam and Carla, resulting in a continued strong coverage ratio of 1.28%, which equates to 557.8% coverage of NPLs. It's important to note that the reserve build is 7.3% when compared to the core loan growth of 18.7%, clearly evidencing that the growth came through lower credit risk lines of business. Thank you for your time this morning. And now I'd like to turn the presentation back over to Jay Sidhu.

Okay. Thanks, Andy. And before we open the call for Q&A, let me briefly share with you what we are seeing in our local, regional, and some national markets that we are operating in. So far, our businesses and consumers remain concerned about inflation and higher rates. They believe they can deal with them. It seems like the impact of the Fed's policies has yet to be felt by them. The mortgage market is really suffering, with dramatic reductions in sales and refinances for many mortgage bankers today being less than 5% of their businesses. We have believed actually since last year that, due to the United States fiscal policy and extremely accommodating monetary policy, the risks of recession and inflation in 2022 were very high. We had shared back with you, including during our calls in the third and fourth quarters last year. We have been hoping that would not happen, but hope cannot be a strategy. Since Q4 2021, we have adopted the following five initiatives. Number one, build our floating rate low-risk loan portfolios, where to date those floating rate loans now make up more than 70% of our loans. In addition, we have a very disciplined pricing strategy, as well as management of our fixed-rate loan portfolios and have no loans on our books that are greater than five years in duration. Number two, we are focused on maintaining a margin of 3% to 3.25% in different scenarios, as you’ve heard from Carla. This will keep the bank somewhat asset sensitive because we expect the Fed to continue to increase rates gradually, at least in 2022. Number three, we continue to build upon our digital capabilities, and you heard a lot about that from Sam. Especially, we believe this will help us in our low-cost deposit gathering initiatives and help us continue to grow deposits consistently every single quarter. Number four, we are conducting a complete reorganization review at our company, resulting in consolidating operations and reallocating safe resources to digital technology and other related areas. And last but not least, we once again commit to meeting or beating our EPS goals for 2022 and 2023. Just looking at the last slide, which is Slide 17, we hope you can see the alignment of our strategic initiatives and tactics with our key investment highlights for Customers Bancorp. Number one is, we believe we have industry-leading loan and deposit growth supported by best-in-class digital banking. Number two, we believe we are maintaining above average and intend to keep it in terms of exceptional quality as you heard from Andy. Number three, we believe we remain well-positioned for higher interest rates and are expecting to fit to continue to raise rates until the inflation numbers come down, and we don't believe that will happen until 2023. Number four, we have demonstrated industry-leading proprietary tech capabilities, and we focused on all of these while offering a very attractive valuation for our investors. So with that, we'd like to open it up for Q&A. Tamika, can you please help us?

Our first question comes from Peter Winter with Wedbush Securities.

Good morning. I wanted to start off with the margin outlook. The second quarter on a core basis was $3.32. You guys mentioned you have a slightly asset-sensitive balance sheet, but the outlook in the second half of the year is 3% to 3.25%. Can you just give some color around that?

Carla?

Yes. So Peter, one of the things that we're adding is increasing the percentage of our portfolio that is very low credit risk, variable rate, which is part of our lender finance and fund finance business. I included in my prepared remarks that those portfolios yield tighter spreads overall. So when you consider that, there is that decrease in margin to 3% and 3.25%.

Okay. But what I guess if you could talk about then the outlook for deposit growth in the second half of the year? And how you're thinking about deposit betas through the end of the year?

Sure, absolutely. I can take that question. So from a deposit growth perspective, we continue to— as you heard, work on technology-enabled initiatives to help us gather low to no-cost deposits. CBIT was step one in serving a narrow digital asset industry, but we're looking to broaden that to all commercial and corporate clients. So as we think about deposit growth, we have sort of talked at the beginning of the year about taking a look at various balance sheet optimization led by our large deposit servicing arrangement, then seeking to number one, bringing deposits to make up for that potential 12/31 transition. But also to continue to improve the deposit mix, so you may see us add gross deposits and continue to improve the overall mix of funding as we take a look at some of our larger non-operating account commercial depositors. So to pivot towards deposit betas, if you look at the quarter through June 30, we experienced a beta that's right around 45%, which is at the low end of our range guidance. Having said that, as you heard from Jay and from Carla, we believe in delivering earnings and margin that are sustainable versus going long on short-term benefits and margins. So if you look at this quarter, we've had, as an industry, over 2% higher in Fed funds rates. We're a business bank, and our non-operating account commercial depositors have and will be seeking higher rates from the industry. So as such, we are anticipating, and in some cases have proactively moved our deposit rates up to retain and support our client base. But will remain asset sensitive through the cycle, and have a goal of that minimum margin range that you heard from Carla.

And Sam, just what are you thinking about deposit betas in the second half of the year? Would that go up too?

Yes, it's very difficult to fully forecast, and some of this is dependent upon competitor actions, as well. We will— for some of our— for some of the clients specifically that I mentioned, we will be supporting— retaining them and providing them market rates. So I think that the rapid increase in rates has resulted in a change in view of the industry; the deposit betas or commercial depositors will likely be higher than last cycle.

Okay. If I could just ask one more question. Just loan growth was pretty impressive. It came in actually above that mid-quarter update of $1.5 billion with that strong growth in June. But you maintained that quarterly average loan guidance of $500 million, which seems like you can beat that just given the momentum. I was just wondering if you could talk about that?

Sure. You know, I think from a loan growth perspective, we had some verticals that were started evergreen in the last couple of quarters. So the teams were bringing over relationships, as well as benefiting, for example, in the Fund Finance business from large fundraising and deployment trends that continue through the first quarter. Last year, the second quarter from equity deployment into private equity venture has sort of stabilized to 2021 mid-year levels. But if you look at our mortgage warehouse business as an example, it was actually slightly up quarter-over-quarter, and that reflects a convergence, while line utilization overall is down, there's a convergence to focusing on relationship banks. If someone had—let's say three to five banks, it will lead down to one to three, as an example. So that has sort of helped us maintain balances, despite our loan guidance, which included projected declines in our mortgage warehouse business. Going forward, as you heard from Jay, the mortgage market is suffering. In the beginning of the year, we were something along the lines of less than 50% purchase in the month of June. That was approaching 80% purchase, and we think that trend is going to continue. That will likely result in the mortgage warehouse business declining in the second half of the year. Having said that, we're still maintaining the upper end of our guidance, net of those potential declines through 2022.

Your next question is from the line of Steve Moss with B. Riley Securities.

Good morning.

Good morning, Steve.

Maybe just following up on loan growth here. I've seen the desk looking for growth of about $1 billion, I think in finance. Just kind of curious on the other specialty verticals that you have there? What are you thinking for if you could kind of quantify the growth there? I mean, I hear you on the mortgage warehouse headwinds but just more on the specialty side?

Sure. So on the specialty lending verticals, we're ramping up in our financial institutions business. I think we're still under $100 million, somewhere around $60 million or so of total balances in that business. Our real estate specialty finance business grew modestly from a dollar amount perspective by about $40 million or so within the quarter. However, as you know, these are typically construction projects, and the fundings will— the commitments are significantly larger than what the growth is. So we'll experience more growth in 2022 and mostly in 2023. And those are the other main drivers, the specialty verticals, which as you can see here, in some cases still ramping up and in other cases have issued commitments, but the projects will take time to ramp up and increase outstandings.

Okay. That's helpful. And then in terms of the consumer loan portfolio, I appreciate the clarification on the charge-offs here. Just in terms of how do we think about the balance of that portfolio going forward?

So as we go forward, we'd like to reiterate that we have sort of a bias towards flat to declining in that business. Over the past 90 days or so, we've experienced in the low end $45 million on the high end $60ish million or so of natural runoff in that portfolio. And we continue to see that in the third quarter. So going forward, I think we've reached a dollar ceiling on the portfolio, at least for the near to medium term.

Okay. And then on CBIT, curious as to how many customers you expect to onboard this quarter? And just maybe size up the pipeline of customers over the remainder of the year?

Sure. So in our CBIT platform, because there's a tremendous amount of strategic evaluation as well as compliance first evaluation of these customers. What I can say is that the folks—the number of clients that are in the pipeline is greater than it was at the beginning of last quarter. However, we're still sort of working out how the pipeline translates into backlog. So it's safe to say definitely don't expect slowdowns in client growth, especially as the network effect continues to pick up. One of the things that we've seen accelerate over the past couple of months has been client referrals, bringing in important counterparties to join the platform.

Okay. That's helpful. And then just the last one for me. What was the bank's mobile expense for the quarter here?

Yes, it was $16 million.

$16 million, okay. Thanks, Carla. And thanks very much for all the color, guys.

No problem.

Your next question is from the line of Michael Perito with KBW.

This is Mike's associate Andrew filling in for him. Thank you for taking my question. First off, I just wanted to ask about the appetite for digital asset lending given everything that has occurred in the crypto ecosystem here in the second quarter? And how you approach that lending opportunity surrounding digital assets?

Sure. And absolutely, good morning, Andrew, and thanks for the question. So in terms of digital asset lending, we had talked about launching as early the second quarter. Given all of the market volatility that occurred in April, May, and through June, we have continued our diligence and engaged in deeper customer conversations, as well as wanting to be sure that other banks in the space had no liquidations, which they didn't. So we're very pleased to hear that, and that is consistent with the channel checks that we had throughout the quarter. As we look into the second half of the year, this is still a very important product for our digital asset banking customers and will lead to further support the strength of the CBIT platform. So if anything, we probably have a much more conservative view on how we'll approach the low LTC nature of these loan products. However, just as a reminder, the way that we're approaching this is lending to customers that we otherwise would have already lent to with crypto, specifically Bitcoin at a low LTC, as secondary collateral.

Great. Thanks for all that color, Sam. And just lastly for me, what growth and buyback assumptions are being made on that TCE target of 7.5% in the next three to four quarters you said? And will that be a priority? Or kind of, as growth accelerates here, do you think if that target might get pushed out a little bit further?

Sure. So let me just take a step back and address capital more broadly. So we ended the quarter with 6.5% TCE to provide a little bit of a bridge. This was impacted about 70 basis points of organic asset growth in our balance sheet. As you heard from Carla, about 70 basis points of cumulative AOCI impact and about 10 basis points of impact due to our capital deployment and the buybacks. So adjusting for these, you see we could have been at 8% in the quarter, but we're not sacrificing organic growth, so organic growth is going to be at the top of the capital waterfall. However, excess capital could be used in the future for buybacks if appropriate, and we will be tactical as we think about the balance sheet size over the next couple of quarters. We've talked about the service deposits that we have provided a termination notice to, but we'll wait to see where things settle over the next couple of quarters.

Great. Thanks for all the color and appreciate you taking my questions.

No problem.

Your next question is from the line of David Bishop with Hovde Group.

Hey, good morning, Sam.

Good morning, David.

First question, obviously a lot of moving parts here looking for. But I apologize if I didn’t hear this on the call. But the outlook for operating expenses, how should we think about that moving into the back half of the year into 2023?

Yes. So I can add some color there. Included in our press release, we did give some guidance on our efficiency ratio. We think that's a better way to look at expenses versus just flat level change quarter-over-quarter. Would you change that guidance to be plus or minus 45% in the back half of this year and into early 2023.

And that captures the branch closures, correct?

The branch closures were included in our second quarter numbers. There's about $1 million in there. And there were other one-time charges that there was another $0.5 million of professional services related to EPP forgiveness activity.

Okay. The 45% for the back half, that captures the expense savings from the anticipated branch closures?

That's right. Excluding PPP and BMTX as well.

Got it. And then I think I heard in the preamble of the multifamily segment, obviously some growth there. As a percent of loans, just curious where you want to sort of grow that to or keep that at? Is this a sort of a good—I think it's up to about 13% or so? Is that sort of the range you want to keep that at? Or do you want to grow that even more?

Yes, that's a good question. Plus or minus, we've guided to about 15% as sort of targets that we're reaching. So our loan book does continue to increase, but so you may see a little bit of growth we are seeing high quality borrowers in the 5% rate range. Interestingly, around 70% of our originations were from relationships and existing borrowers.

Your next question is from the line of Matthew Breese with Stephens Inc.

Good morning. I wanted to go back to the discussion. I guess I'm struggling a little bit with the incremental growth driving that level of compression. And at the same time, you're sticking with the high-end, but you're sticking with the $500 million of quarterly loan growth. So I was hoping you could just be a bit more specific on the outlook for fund banking loan growth throughout the end of the year? And maybe provide the exit margin for this quarter either June 30 or for the month of June just to give us some idea of what the launch point is as we head into the third quarter?

Sure. So I'll start with the fund banking, and then Carla maybe if you want to address the question related to June 30 or at least directionally how we're thinking about it. So from a fund finance perspective, we do anticipate that approximately 35% to 50% of our growth should come from the fund finance business based upon the guidance we provided in the second half of the year.

Yes. And on top of that, I'll just add that we remain very disciplined in achieving the 3% target. And as we think about adding those lower credit risk, we understand that there are tighter spreads associated with that business. But we're focused on maintaining a moderately asset-sensitive business so that we won't have a significant impact on our NII from changing ways. But it will really be driven by volume increases.

Okay. Maybe we could turn to the deposit cost discussion. Cost of deposits were up a bit more than I expected this early in the cycle. And you had mentioned that you expect the commercial deposit betas to be a bit higher this cycle than last just given the extent we're seeing rate increases. Could you define for us how much of your deposit base is commercial and expectations around deposit betas this time versus last?

Yes, sure. I think that we're commercial-based; we're predominantly a commercial deposit base. So we have a little bit of retail deposits sitting in some of our branches, but that's hundreds of millions, not billions. And we do have our service deposits, which are consumer in nature, which are under $2 billion plus for us, but transitory in nature. So that basically gives you a sense of the overall commercial book. You know, focusing on the profit — yes, go ahead.

No, no, no, I interrupted you, I'm sorry. You were going to talk about commercial betas.

Yes. So commercial betas, we had started to see beginning early in the quarter some very aggressive actions by some competitors in the space on large commercial depositors in our financial institutions group, as well as the digital asset space to the tune of including operating accounts linking to Fed funds in an effort to retain relationships with clients. So that goes back to the comment that I made earlier about, sort of, in some cases very strategic move to proactively move deposit rates to retain and support our clients while being moderately asset sensitive to the cycle. And one of the things that I would just sort of reemphasize is that it's nice to be extremely asset sensitive on the way up and going long. However, we've talked about in the past how we would think about hedging strategies, as well depending on how the forward curve progresses. And we'll continue to evaluate those types of opportunities as the year progresses, and those are types of things that could have a short-term impact on margin their long-term preservation.

Got it, okay. Last one for me, just first guarantee with the bankruptcy this quarter. Customers was listed in the bankruptcy filings, could you just give us some sense of the nature of that loan and the ultimate ability to be paid back? And from our end, how should we be thinking about that loan making its way through the balance sheet timeframe and ultimate outcome?

Sure. This is Andy Bowman, I can handle that. Regarding First Guarantee, we've gone through our traditional process and completed the full legal assessment, and we've undertaken all the actions to protect the bank's interests and have already commenced with the sale of the underlying loan mortgage portfolio, which at time of the original filing was about $90 million. We continue to liquidate that collateral and we continue to pursue the payment guarantee for the line of credit facility. And really at this time, everything is progressing well. The timeframe expectation is to have this completely wrapped up and fully addressed by the end of Q3 of this year. And at this time, we do not anticipate any transition of this relationship to a non-performing status, nor do we anticipate any loss at this time on the relationship based upon the valuations we've obtained and based upon success we've had so far in ratcheting down that $90 million mortgage warehouse exposure.

Got it. Okay, that's all from me. Thank you for taking my questions.

Thanks, Matt.

At this time, there are no further audio questions. I'll hand the call back over to our speakers.

Okay. Well, thank you very much for dialing in today. If you have any other questions, please can reach any of us anytime. And so thank you so much for your interest in Customers Bancorp. Have a good day.

Thank you. This concludes today's call. You may now disconnect your lines.