Customers Bancorp, Inc. Q2 FY2024 Earnings Call

Good morning. My name is Briana and I will be your conference operator today. At this time, I would like to welcome everyone to the Customers Bancorp, Inc. Q2 2024 Earnings Webcast. I will now turn the call over to David Patti with Customers Bancorp. You may begin your conference.

Thank you, Briana and good morning, everyone. Thank you for joining us for the Customers Bancorp earnings webcast for Q2 of 2024. The presentation deck you will see during today's webcast has been posted on the Investors webpage of the bank's website at customersbank.com. You can scroll to Q2 24 results and click download presentation. You can also download a PDF of the full press release at this 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 is my pleasure to introduce Customers Bancorp Chair, Jay Sidhu. Jay?

Thank you, Dave and good morning, ladies and gentlemen. Welcome to Customers Bancorp's 2024 second quarter earnings call. Joining me this morning are President and Chief Executive Officer of Customers Bank, Sam Sidhu and Customers Bancorp CFO, Phil Watkins. I'll provide some introductory comments and then my colleagues will provide the details of the quarter. At the conclusion of our prepared remarks, we look forward to answering your questions. Let's move to Slide 3. I will briefly touch on the highlights from this quarter, especially noting where our results are positively differentiated from industry trends. First, please note that we again delivered strong earnings per share in the quarter, exceeding consensus estimates on both GAAP as well as core basis. Again, the trends that many banks are experiencing right now, against those trends, we generated strong high-quality loan growth in the quarter, at an 11% annualized pace. We continue to execute on the company's deposit transformation in the quarter. We used over $600 million of core commercial deposit growth to repay higher-cost consumer deposits and further reduced wholesale CDs. We also reduced our average cost of deposits during the quarter. In contrast to most in the industry, our net interest margin expanded by a healthy 19 basis points and we expect continued expansion by the end of the year. Tangible book value per share exceeded $50 after generating 13% annualized growth in the first half of 2024. We achieved our previously stated 7.5% tangible common equity to tangible asset target in just 2 quarters of 2024. We remain very optimistic about the year with strong loan and deposit pipelines. We believe we are in an enviable position to continue to take market share. Our new business and commercial banking teams are off to a great start and will serve to further accelerate and enhance those prospects. Now turning to Slide 4; we again reiterate our priorities to you which broadly remain unchanged. Having achieved both our CET1 and our TCE to TA capital targets, we are well positioned to execute the disciplined loan growth we have previously shared with you as well as continue to generate strong core deposit growth and remain focused on holistic client relationships, strengthening our balance sheet, continuing to improve our liquidity and maintaining or expanding, as I said earlier, our margins. I will now turn the call over to Sam to talk about what makes Customers Bank a unique franchise.

Thank you, Jay and good morning, everyone. I want to first start off by thanking all of our team members for helping Customers Bank to be named the number one bank by American Banker among all banks between $10 billion and $50 billion in assets just this month. This is a testament to the hard work and contributions from our team members across the entire bank around our clear and simple strategy. Banking is a highly competitive industry and long-term success is dependent upon being able to differentiate the company especially in the eyes of clients. We wanted to take a moment to convey what we believe makes us different. We have a unique operating model anchored around a culture of exceptional customer service delivered by entrepreneurial-minded professionals, a focused product offering and a unique strategy. Client service is a key differentiator for Customers Bank. It's in our company's name for a reason and has always been at the very heart of why we exist as an organization. We firmly believe that if our clients are successful and our team members are successful, when both of these groups say, 'wow', that will result in success for our company and its shareholders. We believe that our entrepreneurial culture has been and will continue to be critical to our success. But we won't ask you to take our word for it. The incredible talent we've been able to recruit over the past year shows this. The top-tier professionals who had their pickup banks chose to join our company in large part because of the unique culture at Customers Bank. While other banks of our size have long relied on more commodity-oriented lending verticals like small to middle-market commercial and industrial franchise, thanks to our strategic moves over the past few years to start verticals, build out technology and treasury products, and attract incredible talent, we are driving incredible deposit momentum and profitability across the franchise. We deliver the product breadth and sophistication of a larger bank and a level of service beyond what the large banks can realistically offer. We believe being a top 3 to 5 national competitor in any niche verticals in which we participate is imperative as we can't be all things to all people like the money center banks. We are seeking to be a bank with a breadth of products and services where a client we serve never has to leave our institution. Diversification has always been a key component of our business model. Recent history has shown that no matter how strong any given vertical seems, concentration can cause challenges for banks. We have proactively limited loan and deposit levels across our franchise to ensure our growth will be broad-based, diversified and deliver consistent returns for our shareholders. Our branch-light model allows us to invest in the people and technology that clients desire both today and into the future without being burdened with an expensive legacy branch network as well as, frankly, a technology stack. And we can do this while still operating with a top quartile efficiency ratio. Financial results are an output of the unique set of inputs that a company chooses to employ. As we've discussed on previous calls, we believe revenue, earnings per share and tangible book value per share growth are key metrics for shareholder returns in the banking industry. The unique combination of the attributes I just discussed is what has resulted in a 5-year compounded annual growth rate of 21% in revenue, 33% in earnings per share and 15% in book value through 2023 compared to just 12%, 7% and 8%, respectively, for the top quartile of all banks with $10 billion to $100 billion in assets. As you can see, our performance is multiples, not just above the industry average but also above the top quartile performing banks as well. On Slide 6, we've provided the quarter's financial highlights on a GAAP basis. And on Slide 7, we have provided our results on a core basis. We had a really solid financial quarter across the board. This is a function of years of investment paying off. In the quarter, we earned $1.66 in GAAP EPS on $54.3 million of net income. Core EPS was $1.49 on $48.6 million of net income and our core ROCE and ROA were 12.4% and 1%, respectively. Our net interest margin expanded 19 basis points to 3.29%. The primary difference between our GAAP and core earnings was a positive benefit from a gain we realized on a Fintech investment purchase at a discount in the quarter as well as severance-related expenses. Credit quality remained strong as evidenced by our NPA ratio of just 23 basis points. Moving to Slide 8; our top financial priority remains continuing to execute on the next leg of our deposit franchise transformation. We are thrilled with our deposit trend performance to date. As Jay mentioned, we generated approximately $600 million in gross commercial deposits per quarter which will be used to similarly remix and strengthen the franchise. While total deposits were down modestly, this is due to a timing lag of remixing. Growth was once again broad-based with more than 20 deposit channels growing in the quarter. About half of these channels experienced growth of $25 million or more. As a result of these incredible efforts from our team members, our average cost of deposits actually declined in the quarter by 5 basis points to 3.4% as we continue to buck industry trends. Non-interest bearing spot deposits were down modestly but stable as of Friday, June 28 and continue to represent about 25% of total deposits at quarter end. Average balances were actually up modestly as we continue to see tailwinds here with deposit generation from the new teams coming in at, at least our current mix with a bias to somewhat higher levels. Importantly, we continue to focus on the stability of the deposit franchise as insured and collateralized and affiliate deposits ended the quarter at 76% of total deposits which is at the high end of the industry. Moving to Slide 9. In line with our discussion last quarter, the next phase of our deposit transformation involves replacing less strategic and higher-cost deposits with higher quality deposits. By quality, we mean a focus on some combination of depth of relationship, cost and granularity. We want to provide you with a brief update on the performance of the teams that joined us over the last year, including the 10 new banking teams that joined the bank in April. We are extremely thrilled with their progress to date. Since the first quarter of 2023, newly hired banking teams have generated about $900 million of growth in granular low-cost relationship-based deposits averaging about a 3% blended rate or 2.5% below Fed funds. I'll take a moment to give more detail on the early performance of our newest teams that joined us just last quarter in the month of April. We knew when we hired the banking teams that they were highly experienced and talented bankers but we have been amazed at the strength of the relationships that these bankers have with their long-standing clients. I have personally participated in more than 175 in-person meetings with customers and prospects since the new teams joined. The receptivity from clients has been nothing short of fantastic. We have the capabilities to deliver for these clients and we believe nearly all of them are looking to join the bank, thanks to our best-in-class customer service and financial strength. In fact, all but two of the client prospects I personally met with are already customers or expected to become customers. We are thrilled to welcome these new clients to our bank. The teams hired in April generated more than $250 million of new deposit balances with about 30% being non-interest bearing at a blended cost of approximately 3%. Of the more than 1,400 accounts that we've opened, approximately 20% have been funded in a meaningful way. This is as of July 23, 2024. The primary operating account nature of these relationships takes time to transition but also signifies the quality and stickiness of these accounts. Just to put that account opening into context; on March 31, 2024, we had around 15,000 commercial customers. So these new teams have increased our commercial account franchise by almost 10% in approximately 100 days of business development. Over the last year, we've recruited over $2 billion which we expect to convert over the next few quarters. Importantly, we remain on track for the newest recruited teams to be breakeven by the end of the first quarter of 2025 as we previously guided to which is going to be an incredible feat in just a few short quarters. On Slide 10, you can see that we generated $358 million of held for investment net loan growth in the quarter, an impressive 11% annualized growth rate at a time when industry loan demand is tepid. This production came from our corporate and specialized banking verticals. Our largest contributors were fund finance, health care and equipment finance. Given the high commercial real estate concentration of regional banking peers, our relative low CRE concentration is proving to be a competitive advantage. With the pullback of competitors, there may be select opportunities for us to add some volume in the back half of 2024 to support our best clients where we have a primary relationship and substantial deposits. New loan production came in at highly attractive yields with floating rate loans pricing all in around SOFR plus 300 basis points. Our loan pipelines remain strong and our outlook of 10% to 15% loan growth in 2024 remains intact. We will remain disciplined and focus on selective full relationship, franchise-enhancing loan growth. We again have visibility into a pipeline of roughly $400 million to $500 million getting booked in the third quarter as we are seeing and converting great opportunities across the franchise. Our new banking teams are also contributing to the pipeline and as a note, these are highly granular relationships with a typical average balance of roughly only $2 million to $3 million. With that, I'd like to turn the call over to Phil to provide additional detail.

Thanks, Sam and good morning, everyone. On Slide 11, we have provided the components of our net interest income which grew by over $7 million or about 5% in the quarter. Net interest margin expanded by 19 basis points to 3.29%, outpacing what much of the banking industry is experiencing right now. Included in the expansion was an approximately 5 basis point impact of prepayment income on loans and securities. Even adjusting for this, we still would have experienced about 14 basis points of NIM expansion in the quarter. For the third quarter in a row, we had a decline in our interest expense this quarter by $5 million. We are the only bank in our proxy peer set that has reduced interest expense for 3 quarters in a row. While period-end loan balances were up $358 million in the quarter, net interest income was only impacted by an average loan balance increase of $223 million. In the third quarter, we will benefit from those additional balances that came on late in Q2. We also completed some strategic hedging activity in the quarter. We executed a forward starting swap converting in excess of $1 billion of our fixed rate liabilities to floating in order to reduce our overall asset-sensitive position. The transaction will impact NIM by an estimated 1 basis point for full year 2024 with an estimated 4 basis point impact in Q4. While our sensitivity position has been accretive, we believe it was prudent to continue bringing our interest rate positioning closer to neutral. With continued positive catalysts, we remain confident in our ability to achieve our previous NIM target guidance with Q4 being impacted by the hedging I just discussed. Moving on to Slide 12; we'll discuss some of the components of our second quarter expenses. Our core non-interest expenses increased to $101 million in the second quarter. The primary driver was higher expenses of roughly $10 million in compensation, technology, and business development. We were able to more than offset the costs associated with the new teams this quarter from a gain we realized on a purchase of an equity investment at a discount in the quarter. Other drivers of the increase in core expenses in the quarter included about $1.2 million of increased reserves for unfunded loan commitments from increased loan balances which we record in non-interest expense, and about $1 million of increased expense in connection with our consumer held for sale program which came with associated revenue. We would note that even with this higher level of non-interest expense, our core non-interest expense as a percent of average assets is still top quartile among our regional bank peers. We believe it is prudent to invest in the business in a disciplined way to generate long-term shareholder value and we continue to invest in our current and future team member and technology infrastructure. Finally, as we previously stated, the investment in the new teams will temporarily elevate our efficiency ratio for a few quarters but we remain on track to generate incremental revenues to fully offset these expenses within 12 months of their onboarding. We are confident in our ability to return to a mid-40s efficiency ratio over the medium term. On Slide 13, we focus on a key driver of shareholder value, tangible book value per share growth. Our tangible book value exceeded $50 this quarter, ending at nearly $51 per share and we still have more than $4 per share of AOCI anticipated to be recovered over time. Tangible book value per share grew by an impressive 20% year-over-year. This compares extremely favorably to our peers with a comparable number in the low single digits. Our 15% CAGR over the last 5 years ranks in the top 5 among all U.S. banks with assets between $10 billion and $100 billion. We expect to continue to deliver these types of growth metrics over time. Moving to Slide 14. We are thrilled to announce that just halfway through the year, we have achieved our 7.5% TCE to TA ratio target. This ratio increased by approximately 40 basis points in the quarter and has increased by approximately 170 basis points over the last year. Our risk-based capital levels continued to be very strong as evidenced by CET1 of 12.8%, providing us with ample capacity to deploy risk-based capital into strategic franchise-enhancing loan growth. Our Board of Directors authorized a share repurchase plan for approximately 500,000 shares last month. This authorization was for an equal number of shares unused under the previous program that expired last September. We continue to believe the most valuable form of capital deployment for the bank is franchise-enhancing organic growth and we have tremendous opportunities that we are currently executing on. We will continue to closely monitor the best opportunities to deploy capital for our shareholders and now once again have a share repurchase program in our toolkit. Turning to Slide 15. We remain focused on maintaining robust levels of liquidity. While we did utilize some excess cash balances to fund loan growth and reduce higher cost deposits, our liquidity ratios remain robust. Our coverage of immediately available liquidity to uninsured deposits is extremely strong at 193%. Our loan-to-deposit ratio continues to provide us funding flexibility at only 75% compared to peers at 89%. Our borrowings as a percent of total liabilities declined from 8% to 7% in the quarter and remains in line with peers. Moving to Slide 16. NPAs as a percentage of total assets ended the quarter at 23 basis points and remained low. We did see a modest uptick in the quarter off of an extremely low base. Our 23 basis point NPA ratio is below the 43 basis points of our regional bank peers. Additionally, our level of criticized and classified loans was down for the second consecutive quarter by about $35 million or 7%. Q2 levels are down 18% from the level we had in the fourth quarter of 2023. Consumer installment held for investment loans now account for about 6% of total held for investment loans and Office commercial real estate, a perceived area of higher risk accounts for only about 1% of our loan portfolio. With that, I'll now pass the call back over to Sam before we open up the line for Q&A.

Thanks, Phil. On Slide 17 I wanted to wrap up with a few concluding themes. Firstly, we emphasize relationships. Next, our net interest margin expanded and this trend is outpacing the broader industry because of the opportunities we have on both the asset and liability sides of our balance sheet. Fourth, our deposit transformation story continues to progress incredibly well. The reduction in wholesale CDs is largely complete. The next chapter of our deposit transformation is to continue improving the cost and granularity and mix of our deposit base. We're well on our way but have a significant opportunity ahead of us. The momentum from the new team is exceptional and we look for this to significantly enhance the efforts. Next, as Jay and Phil previously noted, our tangible book value increased to over $50 this quarter, growing 20% year-over-year. And sixth, we have achieved the capital targets we previously stated. We believe operating at these higher levels of capital is prudent in an uncertain environment and are excited for the opportunity to deploy the incremental capital we are generating to further drive shareholder value. And finally, we added a share repurchase program to our capital toolkit. With that, we'd be happy to take any questions.

Our first question comes from Peter Winter with D.A. Davidson.

It was nice to see loan growth after 5 quarters of loans declining. Can you just talk about the loan composition and kind of drivers of loan growth going forward?

Yes. Peter, yes, I know our team members across the organization were excited as we talked about last quarter to really be able to restart a lot of that franchise relationship-based loan growth. As you saw in the materials, in the quarter, it was really driven in large part by our corporate and specialized verticals, so we really saw good activity across that organization but the largest components coming from fund finance which is both lender finance and capital call, equipment finance, and healthcare but we really saw some contributions across that portfolio. And then when we look forward, candidly, it's probably more of the same. We're seeing good opportunities across that entire franchise. Sam mentioned, we could look for some of our strongest relationships for a little bit of commercial real estate in the back half of the year. And then I'd say the one change from the second quarter looking forward is obviously the new teams that were onboarded while, again, they're predominantly deposit-focused, there are obviously credit needs for holistic relationships and instances as well. So we will look for them to contribute to some of that growth in the second half of the year.

Got it. And just regarding the 10 banking teams, could you discuss whether you need any additional products or services to meet customer needs? Also, with the new teams expected to break even by the end of the first quarter next year, what level of deposit growth is required to achieve that?

Peter, this is Sam. And I apologize if I missed part of the question, please let me know at the end. We had a little bit of a break on our side here. But I believe you asked about breakeven of the new deposit teams. And just to sort of recap, we've opened over 1,000 accounts, just a small amount are funded with material balances and we continue to be adding significant account growth as well as unfunded deposit accounts being funded and new accounts being opened at a faster pace than even that. Last quarter, if you recall, we shared a little bit of a matrix which had deposits on the left side and cost deposit savings on the right side. I think that gives you a really good sense. It's conservative from the perspective that it's really just focusing on interest expense reduction as a driver of revenue growth as opposed to also including, as you heard from Phil, there's a little bit of interest income as well that's coming. I think as an example, we had about $30 million or so just in the second quarter that came from new relationships associated with the new teams. So a long way of saying that the breakeven is expected to be closer to the top right end of that matrix which is lower on the deposit range because we are currently seeing, based upon the information we have, both on what has been booked as well as the pipeline, about 30% of deposits being non-interest bearing and the blended cost being at or around 3%.

Got it. Just one last question. Just expenses came in a little bit higher than I was forecasting this quarter. Do you still think you can get to near a 50% efficiency ratio by year-end?

Peter, yes, we're still targeting that. But as you can appreciate, there's a lot of moving pieces with these investments. And as Sam mentioned, there are a number of steps in taking market share. The exact timing can be challenging to predict. So while obviously, the timing could move around by a quarter, we think we're going to be making good progress towards that and then that ultimate step down as we've talked about towards a mid-40s efficiency ratio over the medium term.

Our next question comes from the line of Steve Moss with Raymond James.

Just going back to the deposits, Sam, could you share your thoughts on the potential for interest rate cuts? I'm interested in how you are considering your deposit beta in the event we see some cuts in the future.

Sure. I'd be happy to take that. So Steve, I think our cumulative deposit beta blending to especially some of the positive mix shifts we've seen over the last year really peaked somewhere in that 55% to 60% range. We'd expect something similar on the way down from a deposit perspective. The X factor is the continued mix shift that we're also seeing. So independent of a rate cut, we're actually seeing our deposit costs go down. In fact, we've seen our interest expense reduced for 3 quarters in a row as an example.

Okay, great. And then in terms of just the ongoing remixing, just curious about where your broker deposit levels are these days, Sam. I mean just kind of how you're thinking about the goal as the year progresses.

Sure. So Steve, as I walked through, as we look forward, we talked about from a remix perspective, our primary focus is reducing deposits that are higher cost and also in some cases, classified as brokered. Our desire is to remix these deposits in the coming quarters in addition to sort of the higher cost and more concentrated deposits that we talked about before. At the end of the day, what we're seeing is a 30% non-interest bearing mix within the new customers that are being onboarded and they're being used to remix 100% interest-bearing deposits, as an example which includes our broker deposits. Our broker deposits are expected to increase slightly this quarter but they will have peaked and will be reduced significantly in the coming quarters. That's our expectation.

Okay, great. And if I can sneak one more in here. I just wanted to clarify, I wasn't sure if you said in your prepared remarks, Sam, about on the 30% non-interest bearing deposit mix, if that's kind of what you guys are expecting going forward or if it's going to be a little bit higher? Just one clarification there.

Sure. I think we guided last quarter. We talked about at least in range with our current mix which is 25% of an overall franchise perspective. We're seeing it coming in a little bit higher which is better than expectations. Having said that, this is just on a couple of hundred million dollars of balances. So we don't want to overread I think the main focus, what's interesting from a tailwind perspective is that if these are being used at 25% or 30% or 33% non-interest bearing to remix interest-bearing deposits, that's going to have a tailwind on our mix shift.

Our next question comes from the line of David Bishop with Hovde Group.

Sam, could you discuss the potential delays or longer process involved in onboarding new clients? From an outsider's viewpoint, what is the typical lead time and lag time for bringing these new clients on board, and might this take longer than expected?

Sure. Absolutely, Dave. So I think what's interesting is I think we know as individuals, if we had to change our bank account from bank X to bank Y, you have to sort of think about your W-2, your payroll, your auto pays, etc. For commercial customers, that's a lot more complicated because there are different sources of revenue and a lot more complex payables as well as recurring costs. And then you add on sort of technology complexities as well as, in some cases, cash management and check deposits and you can appreciate that's a complicated effort. The good news is our team really is an extended back office for many of our customers to really help them with this onboarding integration. Typically, we're seeing as short as 30 days and as long as 90 days for customers for the bulk of customers to be able to migrate and move over balances to the bank.

Got it. The call broke up a little when you were discussing expected inflows. I'm just curious about the inflows from these new teams, which are expected to be in the billions of dollars over the next couple of quarters.

That's right in aggregate. Dave, what I said on the call was, if it broke up, was $500 million to $1 billion per quarter. And to put that in perspective, we were $600 million of commercial inflows this quarter and $1 billion or more the previous 4, so it kind of gives you a sense where we expect this pace that we've been on for the last year, more than a year to continue.

Okay, got it. And then, any details you can provide on the swap later on this quarter? Are you there?

Sure, Dave. It's Phil. Yes, as I mentioned, it was about a little over $1 billion of fixed rate liabilities that we converted to floating and so that was a forward starting swap that we executed early in the second quarter. So that will take effect starting in the fourth quarter.

And it was the basis point impact in the fourth quarter and four basis points next year?

No. With four basis points in the fourth quarter, which would be a full year 2024 basis, full year 2024 impact of about 1 basis point. Obviously, the exact impact on '25 will be dependent on where the rate trajectory goes but we'd actually expect it to be roughly breakeven in 2025 and then obviously accretive from there.

Got it. And then final question. Any color on the DDA outflows we saw this quarter? I was curious if any of that related to the digital asset segment effects.

Yes Dave, I'll take that. I think the way to think about this is sometimes our period-end balance is based on customer activity increasing in your favor, and sometimes it decreases. In this case, it slightly decreased quarter-over-quarter. I think the key important thing here is that non-interest bearing operating accounts grew in the quarter and our pipelines continue to be robust. So we're seeing tailwinds, as I talked about before. So this is really just a factor of clients, client activity as opposed to customer growth or negative mix shift. We're actually seeing the opposite.

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

I was hoping just given the prepayment income commentary you could give us just a little more sense for the NIM cadence through year-end. It sounds like from now until year-end, we'll see some expansion but the third quarter, I could use some help with the third quarter and where you expect that exit into.

Yes, certainly. Matt, it's Phil. If we adjust for the prepayment income to establish that baseline, it would have been around $325 million in the second quarter. We mentioned aiming for the higher end of our range by Q4, though Q4 will be somewhat affected by the hedging. Many, possibly including you, might have been expecting a steady increase. So, we might see less in the third quarter, followed by a stronger rebound in the fourth quarter.

Got it. Okay. And then I was hoping you could talk a little bit about the deposits coming in balance sheet size expectations. And then as you fund loan growth, there's still excess cash, securities rolling off. So I would love a few different guardrails, one being expectations around cash to assets, securities to assets, and an overall balance sheet size over three year-end and maybe in 2025?

Yes, we previously reported being well above 30% last quarter, but we've since decreased to around 30%. We believe staying in the 25% to 30% range seems reasonable, and we'll keep an eye on that. While there is some additional capacity, we aim to maintain higher liquidity levels. Regarding the balance sheet size, as Sam mentioned, we will continue to adjust our deposits accordingly. Overall, we expect the balance sheet to remain generally flat, with perhaps some modest growth, but primarily stable in 2024.

Got it. Okay. And then turning to expenses. Does this quarter's operating expense base, does that fully reflect the new teams or do we continue to expect a little bit of upward migration? If so, to where?

Yes, it does include the new teams, although some joined a couple of weeks into April. We consider it a reasonable run rate. There may be typical inflationary pressures, such as mid-year merit increases, but overall it should be a reasonable run rate.

Okay. My last question is about Michael Barr's testimony in May where he discussed what needs to be done in response to last year’s March balance events and the unexpected deposit outflows. He specifically mentioned deposits from crypto, venture capital firms, and high-net-worth individuals. I would like an update regarding crypto exposure and the plan there. Additionally, since he highlighted venture capital deposits, are there any balance sheet limitations as you consider growing that business? Did that comment resonate with you in any way? I would appreciate some insights on this.

Sure, Matt. Regarding our cryptocurrency balances, there has been no change to our previous guidance or our self-imposed limit of approximately 15% overall, including any digital asset customers. This quarter was consistent with our past performance, so no changes there. More broadly, I mentioned in my prepared remarks that we have self-imposed limits on both sides of the balance sheet, particularly concerning concentration. This decision comes from our perspective at Customers Bank, informed not only by the events last March but also by our proactive approach in setting these limits, which we established earlier in the quarter, around January or February of '23. This indicates that our management team and Board were ahead of the curve regarding concentration levels. Specifically concerning our venture banking, this is a robust business for us, strengthened by deep customer relationships. When we launched this endeavor, we aimed to be a top 10 business within five years. I'm pleased to report that we are already recognized as a top 5 player in the industry. We are achieving win rates around 30%, reflecting the success of our talented team and the positive reception in the market. It's important to consider the concentration of deposits, focusing on households and networks instead of being reliant on specific industries, which aids in diversification. These deposits have proven to be stable due to their relationship-oriented nature and are insured at levels comparable to our institution's overall insurance, marking a significant shift from our historical approach.

Our next question comes from the line of Kelly Motta with KBW.

I was hoping to circle back on the expense side. I appreciate the commentary that you've obviously added a lot of teams and there could be some timing with that with regards to achieving your efficiency targets. But as you look at the expense base and it was running still a bit higher than where I had expected. Just wondering if there were any other things not related to teams that also maybe driving those a bit higher than we initially thought at this time last quarter?

Thanks for the question, Kelly. Yes, as I mentioned, most of the increase is related to the teams, which was the largest factor. However, I did point out two other items in my prepared remarks that contributed this quarter. One was linked to our loan growth, where we account for reserves for unfunded commitments as part of non-interest expense. The higher loan volume, particularly in our specialized commercial and industrial categories, contributed to this, with about $1.2 million in the quarter. Additionally, there were about $1 million in expenses related to one of our held-for-sale programs, which is similar to our equipment finance business, where increased expenses can occur along with increased revenues. These were two significant factors driving expenses this quarter.

Got it. Phil, that's helpful. It's really nice to see both capital ratios at or above the targets you've set. I'm curious about your thoughts on capital moving forward. I know you introduced the buyback program. What are your views on balancing capital build versus capital return options and utilizing the buyback after the recent stock price increase?

Sure, Kelly. I believe having a buyback option is always beneficial. Looking back, when we first proposed this to the Board, our share price was significantly lower than it is today. Nevertheless, it's important for maintaining consistency in our share issuance year over year. From a capital planning standpoint, achieving these targets was crucial, and we were very disciplined in ensuring that we met them. Our capital strategy remains the same for Customers Bank, concentrating on organic growth opportunities and being reactive with buybacks when necessary, always looking for opportunities. There haven't been any changes in our approach to capital; we're pleased not only to meet but to exceed these targets. Our organic growth from retained earnings across the franchise continues, and as Phil mentioned earlier, we aim to keep our balance sheet relatively stable, with fluctuations happening within the $20 billion to $21 billion range that we currently have. I hope this provides you with more insight.

Our next question comes from the line of Harold Goetsch with B. Riley Securities.

Terrific quarter. My question relates to the loan growth. You've been very consistent this year for 10% to 15% loan growth. But in your comments today, you said that your low commercial real estate exposure is becoming a competitive advantage and more visible and that may allow you to add more volume. I was just curious if you could elaborate on that more? Or is this more of a momentum into 2025 type comment?

Sure. I'm happy to address that. In our primary markets, where we have experienced bankers, particularly in the Northeast and New York City, as well as to a lesser extent on the West Coast, there are often several competitive banks catering to these clients. As I mentioned earlier, these banks face challenges related to concentration, provisioning, and credit that will take time to resolve. It's not something that can be fixed in just one or two quarters, which presents an opportunity for us. While these banks strive to serve their customers, their capacity to do so may be limited. This scenario allows us to step in, leveraging our relationship-building capabilities, platform strength, and financial stability. In the latter half of this year, we will selectively pursue attractive opportunities that benefit both current and potential customers who might have fewer options. This approach not only enhances our franchise but also leads to credit relationships that align with our conservative underwriting standards, which remains a significant advantage in today’s market.

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

I would like to clarify, Sam. Can you confirm if the deposits that are part of these teams reflect a 3% blended rate? Does that rate include non-interest bearing deposits, or is it exclusively for interest-bearing ones?

It's a blend, Frank. That includes the non-interest rate.

Do you have any reason to believe this will be much different in terms of sensitivity to rates? Do you still think these betas will not significantly impact your total deposit beta as you grow? Also, following the hedging, how close are you to neutral? What effect would a 25 basis point rate cut have in the near term?

Sure, I'll begin and then Phil can address the hedging aspect of the question. From a beta sensitivity viewpoint moving forward, we believe we will generally maintain a similar position with these new relationships. Specifically regarding interest-bearing deposits, while they are lower on an average weighted basis compared to our franchise, they will still respond to rate changes as they decrease. This is a key point to consider overall. I'll let Phil provide additional insights on our hedging strategy.

Yes, Frank. On the hedging side, it was a significant effort to bring us closer to neutral. We also rotated some of our AFS securities, which helped reduce our sensitivity by moving from floating rate AFS to HQLA-based securities. We made some progress there. We will provide more details in the upcoming Q. There is likely still some work to do, but we believe we have accomplished a lot. We felt it was the right decision at the right time.

Okay. So it's just not that important now in terms of near-term impact to the margin for a given rate cut given what you guys have done on?

Yes, I think that's right. I mean, obviously, we were just modestly asset-sensitive to start and we brought it even closer to neutral. So again, not saying that it won't have any impact but we continue to bring that down closer to neutral.

Great. And then just lastly on the reserve. Just curious kind of broad strokes as you continue to build these specialty verticals, I guess you continue to run down the consumer installment net-net, what do you think we should expect from the reserve to loan ratio moving forward here?

Yes, Frank, you really captured the essence of the situation. We are clearly seeing a shift from higher reserve consumer loans towards our commercial growth, particularly in specialty verticals that generally carry the lowest risk profile, although they do not have the lowest reserves. I believe this trend will have an ongoing impact. Additionally, we always need to consider macroeconomic factors, which can fluctuate each quarter. This quarter, we noticed that levels on the commercial side were influenced by a modest improvement in the macroeconomic outlook. While some aspects are beyond our control, we aim to provide a breakdown by type to illustrate how changes in mix shifts might affect the reserve levels, assuming static coverage ratios for those loan types. This analysis helps clarify how reserves may vary with shifts in the loan portfolio, all else being equal concerning macroeconomic conditions.

This will conclude our question-and-answer session. Thank you all for your patience while we worked through our technical difficulties. I would now like to turn the call back to Sam Sidhu for any closing remarks.

Thanks, everyone. Really appreciate your interest in Customers Bank and please reach out with any questions. We look forward to speaking next quarter.

This concludes today's conference call. Thank you all for your participation. You may now disconnect.