Customers Bancorp, Inc. Q2 FY2023 Earnings Call

Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Customers Bancorp Second Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. Thank you, David Patti, Director of Communications. You may begin your conference.

Thank you, Rob, and good morning everyone. Thank you for joining us for the Customers Bancorp's earnings call for the second quarter of 2023. The presentation deck you will see during today's webcast has been posted on the Investor Relations page of the bank's website at customersbank.com. You can scroll to Q2 2023 results and click Download 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 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 to you, Customers Bancorp Chair, Jay Sidhu.

Thank you, Dave, and good morning, ladies and gentlemen. Welcome to Customer Bancorp's second quarter 2023 earnings call. Joining me this morning are President and CEO of our bank, Sam Sidhu; Customers Bancorp's CFO, Carla Leibold; Chief Credit Officer, Andy Bowman; and our bank CFO and Head of Corporate Development, Phil Watkins. We are very pleased with our second quarter results as we executed seamlessly on our strategic priorities and delivered one of the strongest quarters to date. Despite all of the challenges banks are facing this year, we are pleased that we are not only delivering on our promises to our clients and to our investors, but finding opportunities in these challenging times. Please join me in thanking all of our team members across the bank, who will continue to work tirelessly every single day on executing superbly on our short-term as well as our long-term priorities. As you can see, we believe our presentation today will again demonstrate why we believe we are truly a forward-thinking bank with strong risk management capabilities. We will cover six key topics today. I will provide you with the highlights, and my colleagues will cover them in more detail. We are again comfortably beating street estimates on our core basis. While our industry is facing margin headwinds, we demonstrated our ability to improve net interest margin, which expanded by 19 basis points to 3.15% during the quarter. Hence, our net interest income was up 10% during the quarter on a smaller loan base. We are well positioned to achieve the full year net interest margin guidance we previously provided to you. Second, we executed on several strategic transactions in the quarter to accelerate our financial and strategic priorities. The Venture Banking portfolio acquisition from the FDIC represented a once-in-a-cycle opportunity to recruit a phenomenal team and will serve as another avenue to continue to improve our deposit franchise. We followed through on the commitment we communicated to you last quarter to exit non-strategic relationships and to continue to derisk the balance sheet by executing on two non-core loan sale transactions during the quarter. Sam will provide more detail on each of these transactions later on in the presentation. Third, we have a high-quality, diversified, loyal customer base and are laser-focused on continuing to improve our deposit base in 2023 and beyond. Evidence of the continued success can be seen in the $1 billion or 29% quarter-over-quarter increase in our non-interest-bearing deposits. We reduced our average cost of deposits in the quarter by 21 basis points, despite an increase in interest rates and significant deposit pressures experienced by the entire industry. Fourth, our liquidity and capital position remained best-in-class. We continue to maintain immediately available liquidity of more than 200% of our uninsured deposits, in recognition of the uncertain times that remain for the industry. We also significantly improved our common equity Tier 1 ratio by 70 basis points during the quarter and have a clear path towards the 11% plus target we stated to you last quarter. Lastly, and perhaps most important is credit quality. This is always a key focus at Customers Bank. We were well ahead of the industry in tempering balance sheet growth, which we discussed with you on our Q4 2022 earnings call. Recent areas of credit focus in office and retail commercial real estate are absolutely minimal components of our loan portfolio. This was obviously intentional and will pay dividends going forward. We are pleased with what we've accomplished this quarter, but even more excited about what we can do going forward. Let me briefly share with you again our priorities, which remain unchanged. We have and will continue to moderate growth to build a stronger balance sheet during this time period because of the uncertain environment and assure ourselves that we are actually capturing holistic banking relationships while continuing to build our franchise. We will continue to fortify our balance sheet and maintain our capital ratios above peer levels.

Thank you, Jay, and good morning, everyone. I want to echo Jay's sentiment. We are so proud of our team's efforts in delivering one of our best overall quarters yet, especially under such a challenging backdrop for the industry. In the second quarter of 2023, we earned $1.39 in GAAP EPS on net income of $44 million. On a core basis, we earned $1.65 in EPS and our core earnings were $52.2 million. Our core ROA was over 1%, and our core ROE was 15.7%. Our improvement in net interest margin to 3.15% was a function of best-in-industry improved deposit costs supported by the repricing of our interest-earning assets, which, as you know, are largely floating rates. From a balance sheet perspective, deposits were up a net $227 million, but this does not fully reflect the significant improvement in our deposit mix and cost, which I'll discuss further in a few minutes. Loan balances were tactically reduced as we actively exited non-strategic credits in the quarter to free up balance sheet capacity for franchise-enhancing deposit-led lending opportunities. Credit quality remained benign with NPAs declining by 2 basis points to 13 basis points of total assets and NPLs declined by 12% to $28 million. Reserve levels remained robust at nearly 500% of NPLs, and we continue to closely monitor the portfolio for any signs of weakness given the uncertain macroeconomic backdrop. I'll provide some more detail here on the Venture Banking FDIC transaction completed in the quarter. Firstly, let me start off by saying that we are thrilled to welcome our new team members and clients to Customers Bank. This acquisition was a perfect addition to our existing Venture Banking vertical and comes with an exceptional 20-year track record in the space. I know that the team and the clients are extremely excited to get back to working together, driving their respective businesses forward. Customers Bank is now immediately being recognized as a leading bank partner for venture-backed companies serving customers from early stage all the way to IPO. Our nationwide presence and customized best-in-class technology platform will provide truly unique service and experience for those innovation and technology companies. Our acquisition of the FDIC portfolio and the parallel recruitment of the team will bring significant near and medium-term deposits to our franchise. We expect that the new portfolio will be self-funded this year. Historically, these clients have deposit balances that are generally twice their loan balances. We expect that this will provide tailwinds to our already robust deposit gathering momentum.

Thank you, Sam, and good morning, everyone. We continued our strategy of improving the overall quality of our balance sheet and loan portfolio during the second quarter. Total loans held for investment declined by approximately $800 million quarter-over-quarter, with roughly $300 million of the reduction coming from our consumer installment portfolio. Another $300 million coming from our corporate and specialized banking portfolio, primarily from the syndicated capital call line of credit sale, net of the impact of the acquired Venture Banking portfolio from the FDIC, and the remaining $200 million coming from our community banking portfolio. These reductions were tactical to free up balance sheet capacity for more strategic relationships that come with corresponding deposits. Our net interest margin benefited 7 basis points from the increasing yield on our interest-earning assets, reflecting the floating rate nature of our assets, including our loan portfolio, which is approximately 70% floating rate and a 13 basis point reduction in our total cost of funds. The average yield on loans in the second quarter increased to 6.83%. Our loan-to-deposit ratio ended the quarter at 77%, indicating a conservative approach in comparison with our regional bank peers. Core non-interest expenses increased to $89 million in the second quarter, primarily related to higher insurance expenses and higher incentive accruals associated with performance and onboarding of our new Venture Banking team members.

Hi. Good morning guys. Thanks for taking my questions. I wanted to start on just a couple of clarity. Obviously, a lot happened this quarter, right, and a lot is happening this year. I have a couple of questions on that line of questioning. So I want to start on the loan portfolio side. Carla, you mentioned there might still be some actions you take. But is the end of period mix kind of indicative of what you guys think going forward, about 50% C&I, maybe 5% to 10% CRE, 5% to 10% mortgage warehouse, the balance CRE and multifamily. Is that – does that feel kind of like the right mix, given where you're at now? Or how should we think about that moving forward? That's perfect. And then switching to the deposit side though, I imagine there's still – and you guys kind of alluded to this, but that mix still should change a bit over the next four quarters, right? I mean, you have at least $0.5 billion targeted to come over on the Venture side. I imagine that will be a blend of kind of low and no-cost deposits. I guess just as you look ahead on that side, do you guys have kind of a targeted range of mix on the deposit portfolio that you're hoping to be able to achieve by the end of next year?

Yes. So Mike, it's a great question. In the second quarter, we had several $100 million in Fund Finance & Tech & Venture over the last quarter or so. Having said that, there was a huge acceleration after the FDIC deal announcement in the second half of June. And that pace has continued of approximately $100 million or so, plus or minus, of core low-cost deposit growth in July as well. You had obviously dramatic DDA growth. None of those deposits came in by June 30th. Those – the loans were – the credits came on by June 15th and it took a couple of weeks to discuss with the customers, move over some of the servicing and the ACH and to begin those account openings. We're seeing that really in earnest right now.

We can get there from organic generation alone considering on a core basis we made 290 so far in 2023. So this additional retained earnings generation could get you to our targeted 11% to 11.5% without any additional balance sheet optimization strategies.

Thanks for all the color, Sam.

Thanks, Bill.