Earnings Call Transcript - CUBI Q2 2021

Operator, Operator

Good day, and thank you for standing by. Welcome to the Customers Bancorp Incorporated Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker’s presentation there will be a question-and-answer session. Please be advised that today’s conference is being recorded. I would now like to hand the conference over to your speaker today, David Patti. Please go ahead.

David Patti, Speaker

Thank you, Alicia, and good morning, everyone. Thank you for joining us for the Customers Bancorp's earnings call for the second quarter of 2021. The presentation deck you will see during today's webcast has been posted on the Investor Relations page of the Bank's website at www.customersbank.com. You can access the deck by clicking a red button marked 'latest earnings presentation.' Our investor presentation includes important details that we will walk through on this morning's webcast. I encourage you to use, download, or print 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 Form 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, the audience is yours.

Jay Sidhu, Chair

Thank you very much, David, and good morning, everybody. I do want to welcome you to Customers Bancorp's Q2 earnings call. We really appreciate your interest in Customers Bancorp. Before we begin, please join me again in saluting my friend and the bank's former Chief Executive Officer, Rick Esht, who retired effective July 1st after an illustrious and very meaningful 50 years in banking and other related financial services. Please join me also in congratulating Sam Sidhu on being named Customers Bank's President and Chief Executive Officer upon the retirement of Rick. Sam is also the President and Head of Corporate Development at Customers Bancorp. Today also happens to be Sam's birthday. Sam's vision, leadership, and passion are already making a huge positive difference at Customers Bancorp. And we encourage you to really follow us very closely as we start to execute on all the things that we will be discussing today. So, besides Sam joining me today for this call is Carla Leibold, our Chief Financial Officer; Andy Bowman, our Chief Credit Officer. And all four of us will participate in this call and we’ll be available to answer your questions at the conclusion of our initial remarks. Q2 2021 was another exceptional quarter for us, helping us build a very strong foundation. We have a clear and unique strategy that is being executed both for the short term and for the long term in building a high-performing, high-tech, forward-thinking bank that is also supported by a high-touch relationship banking strategy. I'd like to now draw your attention to Slide 4, and just to give you an idea of where we stand today at a glance. You can see besides community banking we are really positioning ourselves to be a niche bank with aspirations to become a national player, and right now, we are a regional player. Besides community banking, we have developed very successful specialty lending or niche businesses as well as simultaneously both for the consumer and for businesses a digital banking platform. And we believe that this is absolutely critical for success, both in the short term and long term for midsized banks. Now moving on to Slide 5, talking about our exceptional profitability and growth. As you know, our core earnings were $1.76, up 182%. Our double WPS and core earnings were about $59 million, up another similar 177%. Our return on capital common equity was 23.7%, and that's up from 11.1% last year at the same time. Talking about profitability, our core return on average assets was 1.3% this quarter, up from 68 basis points in the same quarter last year. From a pre-tax pre-provision return on average assets, it was 1.8% at Q2, and that's up from 1.5% in the same quarter last year. We've intentionally kept our balance sheet for the core businesses reasonably flat at about $13.5 billion and been focusing on having an allocation of balance sheet to lower-risk, higher-quality, higher-yielding assets. And in spite of that, we've managed to show a slight increase in loans and leases. You will hear from my colleagues that we should expect an acceleration of that growth in the second half of this year. Leading on to deposits has been a very big story for the industry, and for us, it's been exceptional. We've seen a $2.9 billion growth in deposits over the last year, of which $2.4 billion were demand deposits. From a credit perspective, our nonperforming asset ratio was only 24 basis points, which we believe compares with about 70 basis points for our peers. From our reserves as a percentage of our loans held for investment, we were at 1.61% at June 30, and again, in our opinion, equal to if not better than our peers. So, now besides going over the second quarter highlights, we will also cover with you where we sort of came from, where we are heading and our strategic priorities along with the general guidance for both the short term and long term.

Sam Sidhu, President and CEO

Thanks, Jay. Good morning, all, and thank you for your time today and interest in Customers Bank. Let me briefly summarize our results. Our strong momentum has continued in 2021 with our third record quarter in the last year that has benefited from continued growth across the company, highlighting the broad-based strength of the franchise. From an earnings perspective, Jay covered the highlights. In terms of PPP revenue, we expect to recognize over $400 million from our efforts in PPP net of expenses. Of that, we have only booked approximately $118 million of that revenue with substantial fees yet to be accreted. Strong asset quality is at the core of our franchise, and we continue to have superior credit quality to peers. We had a provision expense of $3.3 million in the quarter compared to a benefit of $2.9 million in the first quarter. Additionally, our COVID-19 related payment modifications are mostly behind us with only $91 million remaining on deferral, which is less than 1% of loans excluding PPP at quarter end. In terms of loan growth, total loans outstanding, including funded PPP loans were up $1.7 billion over the second quarter ’20 or 11%. Core C&I growth was up 13.1% year-over-year and consumer installment growth was 25% over the same period. In terms of funding, we had another incredible quarter. Total deposits grew $2.9 billion or 26.5% and our demand deposits grew by over 50%. Total cost of deposits are down 44 basis points to 47 basis points. We will touch on some strategic actions we have and will continue to take to plan for a potentially rising rate environment. Now looking at capital, we are experiencing tremendous capital build, thanks to both strong core earnings as well as PPP revenues. We ended the quarter with TCE excluding PPP increasing to 7.7%.

Carla Leibold, CFO

Thanks, Sam, and good morning, everyone. I'll focus my comments today on two main topics. The first is capital. Second is tangible book value, and the third is our 2021 year-end outlook. Beginning with capital on Slide 21, this slide shows the significant capital accretion resulting from the recognition of deferred origination fees for PPP loans and strong core earnings. Starting at the end of Q2, our total risk-based capital was estimated at about 13.2% and our TCE ratio, excluding PPP loans, was 7.7%. Fast forward to the end of this year, and our total risk-based capital is expected to be approximately 14% and our TCE ratio, excluding PPP loans is expected to be around 9%. Now with the pro forma full recognition of the $400 million of pre-tax PPP revenue by the end of 2021, you will see that the estimated total risk-based capital increases to about 16%. And the TCE ratio, excluding PPP loans, increases to about 10%. Whether the income is recognized in 2021 or 2022, it is still significantly accretive to our capital ratio.

Andy Bowman, Chief Credit Officer

Thank you, Sam, and good morning, everyone. Starting on Slide 14 outlines the quarter end, credit quality remains extremely strong, and we're very pleased with how the portfolio has performed, despite the economic, social, and political pressures brought on by COVID-19, as evidenced by NPAs to total assets of only 24 basis points, which is less than half of peer averages. Total 30-to-89-day delinquency stood at only 7 basis points or 0.07%, marking a five-year low and annualized net charge-offs to average total loans and leases of only 16 basis points or 0.16%. Given the bank's continued commitment to sound credit quality and limited exposure that we have to at-risk industries, we expect the near-term credit outlook to remain stable.

Sam Sidhu, President and CEO

Flipping to Slide 18, I want to spend some time talking about our digital banking capabilities and business model. We execute on a high-tech, high-touch single point of contact community banking model, as you know, complemented by our niche specialty businesses. These are in all cases supported by our best-in-class technology capabilities. Digitization and technology expertise are improving our performance in existing businesses like our consumer installment portfolio and small business lending, while also opening up greenfield opportunities like our small balance SBA loans, which we previously discussed. Our strategy is a hybrid model of bringing the best of the community bank along with the best of the fintech.

Jay Sidhu, Chair

Thank you very much, Carla. Thank you, Andy. Thank you, Sam. If you look at Slide 25, you will appreciate how that sums it all up. We have a very clear unique strategy, and we have a very experienced and talented management team that I feel very privileged to be working with. Our strategy is very high-tech forward-thinking, and it's supported with high touch, and it’s broken into these objectives which are broken into key results. We follow the OKR for those of you who are familiar with our management system and the processes to really drill down each one of these objectives into actionable results and then have alignment, and that's the way we look at things.

Peter Winter, Analyst

Good Morning.

Jay Sidhu, Chair

Hi, Peter.

Peter Winter, Analyst

Good morning. I wanted to start with the margin. If you could talk about some of the drivers to the increase in the core margin of 31 basis points. I was curious if anything was unusual in the quarter? And then just the outlook as to why the low end of updated NIM guidance of 3.25 is below the second quarter results?

Jay Sidhu, Chair

I think Carla, if you can take it. But let me just share one thing with you, Peter. We always want to provide general overall guidance rather than very specific guidance, and we always have a style of exceeding expectations. So, with that, Carla can talk about specifics.

Carla Leibold, CFO

Yeah. Thanks, Jay. So, I'll start Peter just to describe the balance sheet restructuring that occurred in the first quarter of 2021, in which we terminated some of our cash flow hedges. This opportunity has allowed us to reduce our overall funding costs. That action alone was expected to provide at least 15 to 20 basis points going forward. So as expected, we saw that margin expansion coming through in the second quarter as we continue to make efforts reducing our deposit costs. The last thing I would say is just the mix in the portfolio helped to increase our overall loan yields, which obviously drove the margin expansion. For the rest of this year, again, we are focused on our funding costs and bringing those down and being very disciplined in our pricing strategy such that we are not forecasting any margin compression and really for the rest of the year, expected to be within that 3.25 quarter and 3.50 range.

Peter Winter, Analyst

Okay. Thanks. Could I ask, end of period commercial loan growth if excluding the multifamily mortgage warehouse, really nice growth. You mentioned on the call that pipelines are at all-time highs. I was wondering if you could give a little more color on the commercial side, where the growth is and what you're hearing from the clients.

Jay Sidhu, Chair

I think Sam and Andy, that’s a perfect question for you guys.

Sam Sidhu, President and CEO

Sure, absolutely. I'll start off, and then Andy, let me know if I missed anything. The overall pipeline is pretty broad-based. Our local geographic teams are seeing record pipelines in our lender finance business, our commercial finance business. A lot of this is pent-up demand carried forward from a softer first and second quarter. We expect that the growth will be accelerating throughout the year. Given the seasonality of our business and some likely reductions in our commercial mortgage warehouse business, we think it's just a nice remix of both loan growth and yield remixing spread, but also an opportunity to really show far above our loan growth. Andy, did I miss anything?

Andy Bowman, Chief Credit Officer

I believe it's worth noting that even with our geographic expansion in core commercial and industrial lending, we're experiencing strong penetration. We've capitalized on recent bank mergers in the market that have caused disruptions, allowing us to build relationships we've been pursuing for a while. This growth is evident not only in specialty areas but also in our core commercial and industrial lines of business, which are performing well in terms of margins. Overall, our pipelines remain strong, particularly in specialty and commercial and industrial sectors.

Peter Winter, Analyst

That's great. Just my last question, and I understand that you guys like to be conservative, but just that $6 guidance for the full year this year, it does imply earnings flat for the second half of the year. Is it just the timing issue of the PPP? I would assume most of that $300 million should be recognized over the next three or four quarters.

Sam Sidhu, President and CEO

Peter, I'll take that question. Yes, absolutely, Peter. It's a timing issue. It's not if, but rather, when. I think the operative word is at least or a minimum of $6 in both years. You're absolutely right that if we're saying at $4 a core, core EPS, excluding PPP, it would mean that there's limited forgiveness in 2021, which is not our anticipation.

Carla Leibold, CFO

Sure, Sam. So as Sam mentioned, we are projecting at least $400 million of pre-tax net revenue. So to give some perspective of how that breaks down. It's a total of about $335 million of net deferred origination fees, roughly $100 million from round 1 to 2 and about $235 million related to ground fees. For PPP round 1 and 2, to date, we've recognized about $75 million of that $100 million. So about 75% of that has already been recognized. $25 million is still expected to come in at some point during 2021. On round 3, the $235 million of deferred origination fees, $10 million of that has been recognized so far. There's still a lot of upside to come into our NII based upon the timing of the forgiveness. Now to date, we've recognized a total of $118 million. I'll focus just on the year-to-date 2021. We recognized about $70 million through our first quarter and second quarter margin table. That gives a bit of perspective to help your models, Peter.

Jay Sidhu, Chair

Thanks, Peter.

Operator, Operator

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

Steve Moss, Analyst

Good morning.

Jay Sidhu, Chair

Good morning Steve.

Steve Moss, Analyst

That closed really helpful. Maybe just in terms of on the capital front here, you guys announced a preferred redemption later this year. Just kind of curious, will that be all preferreds? And also, if you can just discuss your appetite for a stock buyback here and how aggressive you want to be?

Jay Sidhu, Chair

Steve, we have shared with you that once we have crossed the 7.5% TCE ratio, we want to make that the absolute floor for us. We've also shared with you today that once all these PPP revenues have been recognized, we could be at 10% TCE. That gives us a tremendous ability to look at all options. At the same time, we are a growth-oriented company, so we don't want to show earnings growth just by buying back stock. That is the only option available to no growth franchises. We continuously look at options for us, and we are very optimistic that we will be trading at higher multiples over a short period of time. However, if there are any market disruptions and our common equity becomes attractive, to buy back rather than to accept a lower stock price, we will not hesitate to institute a common stock buyback. At this time, we think it would be most prudent for us to consider preferred buyback.

Steve Moss, Analyst

Okay. So, I guess with PPP building intangible book here toward the mid-40s. If your stock is in the high 30s to $40 range, should we expect a repurchase program maybe next quarter? Is that kind of how to think about that?

Jay Sidhu, Chair

I would say that you should expect us to first follow through on what our Board of Directors has decided, which is probably the purchase of preferred. You should expect us to get the PPP revenues in-house rather than projected TCEs. Once that's done, whether it's the fourth quarter or next year, if there are any weaknesses in our stock price, we will look at that at that time.

Steve Moss, Analyst

Okay. In terms of the margin, when I exclude PPP, it looks like they're around a 4.5% loan yield and funding costs are decreasing. Is the 3.25 to 3.50 range reflective of some of your expectations for liquidity with the upcoming initiatives?

Jay Sidhu, Chair

I couldn't understand that part.

Sam Sidhu, President and CEO

That's definitely a factor that could reduce margin. We're also noticing that, while we are maintaining loan yields, there has been increased competition in the last 60 to 90 days affecting loan yield, and our spreads have remained stable. However, we are starting to see some compression in floors. We aim to keep our options flexible regarding the range we are offering.

Steve Moss, Analyst

Okay. Got it. And in terms of the gain on sale, you mentioned the consumer held-for-sale initiative. Should we consider that a 2022 event, or can we expect it in the second half of this year?

Sam Sidhu, President and CEO

A portion of that will be in the second half of this year. Our plan is to see to do this with regularity quarterly. This is not an initiative we just turned on in the last couple of weeks; it's something that's been in the works for six plus months. So this is part of our guidance for 2021 and also part of our guidance for 2022. If it ramps up sooner or faster, we'll be in communication regarding the impact for next year.

Mike Perito, Analyst

Hey, good morning guys, how are you? I wanted to start on just kind of a simplistic question. I want to make sure that I was understanding it right. I was looking at the outlook slide. You talked about asset growth. I want to make sure I was thinking about the baseline on that asset growth near term correctly. I know it's just a range, but is it still fair to consider the mortgage warehouse guidance for 1.6 billion to a little over 2 billion, calling the midpoint, say, 2 billion, alongside about 900 million of validation there and a little over $6 billion of PPP? Is it fair to think of the core balance sheet today at about that $12 to $12.5 billion asset level as we consider long-term asset growth?

Carla Leibold, CFO

Yeah, Mike, I think that's a fair estimate to do that.

Jay Sidhu, Chair

Just to put a fine point on that, we're $13.3 billion at the end of June 30. The loan growth in the second half of the year will mitigate the prospective midpoint of the range of mortgage warehouse drops.

Michael Perito, Analyst

Got it. So obviously, it's not unreasonable. We'll make our own assumptions around PPP forgiveness and the warehouse activity within the range you provided. Beneath that, it's not unreasonable to consider that the $12 to $12.5 should grow 7% to 10% over a multi-year period. Is that how you’re thinking about it today?

Sam Sidhu, President and CEO

That's correct.

Michael Perito, Analyst

Okay. So it's a little higher. Got it. Thank you, guys. And then as we think strategically longer term, this slide appears on the outlook is really helpful. Thank you for putting that together. As I think about the balance sheet mix, right. I mean, presumably for the next year, mortgage warehouse could be high. PPP will still be around. But as I think about late 2022 and 2023 and beyond, it seems like a lot of the commercial type stuff seems a little bit more focused on lending and some of the fintech partnerships are lending focused. Is the thought process that the real-time payments initiative and some of the digital small business banking stuff. Will that be more of where the kind of hopefully lower-cost liability growth will come to fund some of the consumer and other fintech partnerships and geographic expansion on the commercial side that will drive the 7 to 10 asset growth over a multi-year period of time? Or are there other elements that we should consider in terms of how the mix of growth and funding of that growth will evolve once some of these temporary programs like the PPP run their course?

Sam Sidhu, President and CEO

Sure, absolutely. I'll take a stab at that. From a funding perspective, yes, we do anticipate that some of our digital initiatives should help fuel some growth. Having said that, we also have strong growth across the franchise from a geographic perspective, including in some of our new geographic markets, which are starting to really move the needle from a funding perspective. Most of what we discussed on Slide 12 is reasonably balance sheet light. The SBA business combines retaining a portion and gain on sale business, and the digital SMB business will take time to ramp up. But the majority of uses in the near term have already guided toward.

Jay Sidhu, Chair

No, I was just going to add, you know what real-time payments did for Signature and you can make assumptions about the opportunity that sort of thing can have for our core low-interest cost deposit franchise.

Michael Perito, Analyst

Yeah and Jay that was going to be my next question right. The technology stood up, you guys did fairly quickly launching in the next 60 days, which is great. I think I asked a version of this question where I asked Carla but I’d love an update or some specifics now that you’re close to that launch. What’s the roadmap or the plan? I think when I think about Signature and Silvergate as you mentioned, they created strong networks which are necessities for these RTP networks to really take off and get the customers under the deposit flow. What’s the sales plan? I think last quarter you had quite a few different industries targeted in the deck but would love just some additional color on where you’re going to focus your efforts and the process of trying to get people onboard to see deposit growth take off?

Jay Sidhu, Chair

Sure. I’ll start on this question. In terms of the verticals we are focused on, we’re prioritizing some of the verticals that would have the highest ROI from a deposit growth perspective and a customer acquisition perspective. There are digital asset ecosystems for example that we’ve seen Silvergate and Signature focus on. Similarly, we’re in advance discussions with many of our existing customers. For the soft launch, which is a combination of existing customers plus counterparties and a network creation, and also with new customers, you have to bring on the network altogether. That’s why we would do a soft launch at the end of the third quarter, early fourth quarter and then within 90 days to sort of a broader launch.

Michael Perito, Analyst

Very helpful. And then just one last one for me. Sorry to keep going here. But just on capital, as I think back to the company history, right, you guys have always had pretty decent growth. And certainly, now just looking at Slide 12, there's no shortage of opportunities for you guys to grow, and it's clearly been a really great 12 to 18 months for Customers Bancorp and a lot of progress. However, as we think longer term, what's the right capital ratios for us to think about you guys wanting to run the bank? I guess it seems like with some of the ROA targets and certainly with the PPP near term, you'll be able to remain well in excess of those targets without external capital. Just as we think long term out into 2023 and beyond, do you guys have any updated sense of what the right capital ratios or position is for the organization that we should be mindful of?

Sam Sidhu, President and CEO

Yeah Mike, that's a good question. Historically, I think we've operated below peer capital levels, but we’ve been very open as to why that makes sense for our organization based on our asset and liquidity profiles. With the benefit from all of the PPP capital accretion, our range that we've previously guided toward has shifted to more than 7% to 8% to now 7.5% to 8.5%, where 7.5% serves as a minimum and there's a bias toward the high end of that range in the medium term.

Michael Perito, Analyst

Absolutely right. Got it. So, if I can summarize, it sounds like you guys aren't looking to run around with a 9% or 10% handle on your capital. But relative to historical levels, it’s fair to consider that you’re likely to run with a bit more capital than the peer group, which makes sense, right? Because historically, you had a larger multifamily book, and now you're looking at some higher-yielding assets. I just want to ensure I'm conceptualizing this the way you are.

Jay Sidhu, Chair

That's right.

Frank Schiraldi, Analyst

Hi. Good morning.

Jay Sidhu, Chair

Hello, Frank.

Frank Schiraldi, Analyst

Just wanted to hit on one thing. On the geographic expansion, I wondered if you could share specific portfolio size, specific pipelines for some of the new geographies you guys have announced over the last few months?

Jay Sidhu, Chair

I'll start on that and Sam, if you can help finish that up, because I was out visiting our team in Chicago just a couple of weeks ago. To give you an idea, in Chicago, our deposit franchise exceeds $750 million today, and our loan book is in excess of $100 million. You can see that it’s opportunistic, and we are taking advantage of wherever the opportunity is. It’s not just lending driven; it’s also relationship-driven, targeting certain niches which were historically unserved. We believe we can duplicate this across various markets in the country without resorting to M&A.

Sam Sidhu, President and CEO

Yeah, I would just add, Frank, it's a deposit-driven strategy followed by loans. Each of our geographies, Chicago, Dallas, and Florida, are typically at least 75:25 deposits to loans. The majority coming from deposits. We’re tracking on a 9-figure deposit growth already in just a short period, and from an asset generation perspective for new geographies, we appreciate that a threshold of at least $50 million to $75 million of loan growth is expected in the first year, with an upside goal higher than that.

Bill Dezellem, Analyst

Good morning. I had a couple of questions. The first one is relative to the SBA forgiveness platform that you announced yesterday. Can you discuss what that does for you that's different from your current approach?

Sam Sidhu, President and CEO

Sure. What the SBA is seeking to do in partnership with banks and new SBA lenders is to create a more borrower-friendly SBA platform that allows a sort of programmatic relationship with a bank or a lender, as opposed to needing a two-tiered process. It enables a more collaborative and streamlined approach. The SBA has also developed a data analysis to make some automatic determinations, especially for second-draw loans, which will automate processes for loans below $150,000 — about 99% of our loans. Larger loans will still go through a traditional process, but this tech platform should significantly streamline operations.

Bill Dezellem, Analyst

That is helpful. Thank you. Also, your redemption of the preferred was not included in your EPS guidance. Is that correct, and is it also the case that you're still not including that in your guidance today?

Carla Leibold, CFO

That is correct, Bill.

Sam Sidhu, President and CEO

That is correct.

Operator, Operator

There are no further questions from the phone. We really appreciate your interest in Customers Bancorp. If there are any follow-up questions, please don't hesitate to give us a call. Thank you, and have a good day.