Bancorp, Inc. Q1 FY2020 Earnings Call

Thank you for joining us today. Welcome to the Bancorp, Incorporated First Quarter 2020 Earnings Conference Call. I will now turn the call over to your speaker, Andres Viroslav. Please proceed.

Thank you, operator. Good morning. And thank you for joining us today for the Bancorp's First Quarter 2020 Financial Results Conference Call. On the call with me today are Damian Kozlowski, Chief Executive Officer; and Paul Frenkiel, our Chief Financial Officer. This morning's call is being webcast on our website at www.thebankcorp.com. There will be a replay of the call beginning at approximately 12:00 p.m. Eastern Time today. The dial-in for the replay is 855-859-2056 with a confirmation code of 8676348. Before I turn the call over to Damian, I'd like to remind everyone that when used in this conference call the words 'believes,' 'anticipates,' and 'expects' are similar expressions intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to risks and uncertainties, which could cause actual results, performance, or achievements to differ materially from those anticipated or suggested by such statements. For further discussion of these risks and uncertainties please see the Bancorp's filings with the SEC. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Bancorp undertakes no obligation to publicly release the results of any revisions to forward-looking statements which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Now I'd like to turn the call over to The Bancorp's Chief Executive Officer, Damian Kozlowski. Damian?

Thank you, Andres. Good morning. And thank you for joining us today. While we observe work from home and ensure our people are safe, we have continued to experience momentum in our core earnings regardless of the current COVID-19 developments. In the first quarter of 2020, Bancorp earned $0.22 per share from both increased fee and spread revenue. Total loans increased 9% quarter-over-quarter and 31% year-over-year. Loan interest, including loans held for sale, increased 25% and 29%, respectively. Payment card gross dollar volume, GDV, increased 36% year-over-year while fees increased 15%. Expenses were down 2% year-over-year as our unit transaction costs dropped with higher volumes resulting in increased efficiency. Pre-tax income decreased 25% year-over-year, but excluding the gains and losses on loans originated for sale, which vary with market conditions, pre-tax income increased 79%. While the pandemic continues to be fast-developing and could be prolonged, we've evaluated the impact of lower interest rates and potential lower business funds on our profitability for 2020. We believe that the previously announced $1.25 minimum earnings per share guidance for 2020 is still attainable, while $1.34 earnings per share has become less likely. Accordingly, the $1.25 earnings per share now constitutes our guidance for the full year 2020. We have removed the range of earnings performance and made $1.25 our target. There are some key developments in the first quarter worth noting. These events are listed in the earnings release. In addition, we continue to expand our key relationships and add additional business partners. In the first quarter, we announced an extension with Chime and the addition of SoFi to our client portfolio. We currently have 20 products in implementation in our cards franchise; expect to execute three to four new program contracts in the second quarter. Overall, Bancorp could choose to concentrate on building its payment ecosystem to support changes in financial services driven by FinTech digitalization in the gig economy. We continue to make key payments investments and are making progress even in this turbulent time. In addition, our niche lending businesses are focused on helping our clients during this dislocation and then long-term growth of what we have been traditionally lower-risk credits in our lending lines. The capital base is strong and we continue to closely monitor the fast-developing situation and will advise of any changes to our earnings outlook. I now turn the call over to Paul Frenkiel, our CFO, who will detail more about this first quarter.

Thank you, Damian. Excluding $5.2 million of unrealized losses related to commercial real estate (CRE) loans held for sale, first quarter pre-tax income was $22.7 million and the adjusted return on assets and equity for the quarter was 1.19% and 13.4%. Of the $5.2 million unrealized losses, approximately $2.2 million resulted from hedges related to $44 million of fixed-rate CRE loans held for sale. Substantially, all of that $2.2 million unrealized loss related to swaps maturing from December 2025 through December 2026. Thus, there remain five to over six years during which some of these losses might reverse should interest rates increase over that period. The majority of the remaining $3 million of the unrealized loss resulted from estimated fair value adjustments to loans in the held-for-sale CRE portfolio, primarily for $58 million of hotel loans. These hotel loans may reflect an elevated risk compared to the rest of the $1.5 billion CRE portfolio, the vast majority of which consists of multi-family loans. Expected cumulative losses for multi-family loans resulting from COVID are projected by nationally recognized analytics firms to be below 1%. These loans are generally on our books at a $99 price net of fees and have weighted average floors in the 4.8% range. Please see the new tables for CRE loans in the press release, which provide a breakdown by loan type and other characteristics. If not sold, these loans will be retained as interest-earning assets. In addition to the $5.2 million of unrealized losses in continuing operations, there were approximately $819,000 of unrealized losses in discontinued operations. So there was a total of approximately $6 million in unrealized losses relating to fair value. Additionally, based upon economic uncertainty in the Current Expected Credit Loss (CECL) model, an additional $850,000 was added to the first quarter 2020 loan loss provision, bringing the total of unrealized loss to approximately $7 million. Those losses could reverse in the future, but if COVID-related losses materialize, the $7 million represents potential future offsets against such losses. The approximate 4.8% weighted average floor on the CRE loans, less the cost of funds estimated to have fallen below 0.4%, results in a spread of 4.4%. That significantly exceeds the 3.34% overall net interest margin (NIM) in Q1. The $1.5 billion CRE loan total compares with $1.11 billion for the first quarter average, and the 4.8% floor will have a full quarter impact on that higher balance in Q2. The largest variable rate portfolio is the combined $1.2 billion S block and I block portfolio, the yield for which is estimated at 2.3% after the stated reserve reductions compared to 3.5% for first quarter 2020. Our participation in the Paycheck Protection Program (PPP) is estimated to generate $200 million of fundings with an estimated $5.5 million earned as fees and interest, which we believe will be recognized primarily in the second quarter. Those estimates include both the first and second rounds of funding. The Q1 2020 pre-tax income of $22.7 million, excluding the $5.2 million of unrealized losses, compares to $12.7 million for Q1 2019 after adjusting that quarter for $10.8 million of net realized gains on a CRE securitization. The resulting $10 million increase in pre-tax income resulted primarily from an $8.8 million increase in net interest income, primarily due to higher loan balances. Average quarterly CRE loans approximately doubled to $1.1 billion, and related interest income increased by $5.6 million. Interest on SBA loans increased by $1.6 million, while interest on leases increased by $1.2 million reflecting respective period-end balance increases of 21% and 16%. While combined, S block and I block increased 46% over those periods, related interest income increased by less than $1 million reflecting the impact of 75 basis points of Federal Reserve interest rate reductions in 2019. S blocks are secured by marketable securities, and I blocks are secured by the cash value of life insurance and losses have not been incurred. Overall, the cost of funds was 0.70% for the quarter and, as noted, is expected to decrease below 0.40% in the second quarter of 2020. We implemented CECL accounting as of January 1, 2020. As a result, we booked a $2.6 million cumulative increase to the allowance for loan losses and $569,000 to other liabilities for unfunded commitments. The combined total of these items was offset through retained earnings, which was net of their future tax benefit. The provision as determined through the CECL model resulted in a $3.6 million provision for credit losses for the quarter ended March 31, 2020. The majority of the $3.6 million provision resulted from a higher provision for leases which had greater charge-offs during the quarter. Because S block and I block loans are respectively collateralized by marketable securities and cash value of life insurance, management excludes those loans from the ratio of the allowance to total loans in its internal analysis. As adjusted, that ratio is 1.79%. Prepaid accounts, our largest funding source, were also the primary driver of non-interest income. These and related income on prepaid cards were up 15% to $18.5 million in Q1 2020 compared to $16.2 million in Q1 2019. Card payment and ACH processing fees include rapid funds revenue and decreased by $457,000 to $1.8 million reflecting the exit of non-strategic high-risk ACH customers. Non-interest expense for the quarter was $38.9 million, or 2% below the prior year and below the $40 million quarterly target discussed in prior calls. That reduction was driven primarily by lower salary expense, which reflected lower incentive compensation expense. A significant portion of the Q1 2019 incentive compensation expense was related to the net $10.8 million realized gain on the loan sale in that quarter. Book value per share increased to $8.69 compared to $8.52 at the prior year end, primarily reflecting first quarter earnings per share. The Q4 2019 consolidated leverage ratio, which is based upon average quarterly assets, was approximately 8.9%, and the risk-based ratio is approximately 17%. In closing, there are certain characteristics of our loan portfolio as shown in our new tables in the press release which I would like to highlight. As previously mentioned, the vast majority of our $1.5 billion of commercial loans held for sale are multi-family loans, which, by a nationally recognized analytics firm, have an expected cumulative loss rate of less than 1% in their COVID projections. Our next largest $1.2 billion loan portfolio consists of S block and I block loans, which have not incurred losses, notwithstanding the recent historic declines in equity markets. Approximately half of the SBA loan portfolio is U.S. government guaranteed, and the U.S. government is paying principal and interest on those loans for a six-month period. The majority of the other SBA loans consist of commercial mortgages with 50% to 60% origination date loan-to-value ratios. For leases that experience credit issues, we have recourse to the lease vehicles. While there is uncertainty related to the future, we believe these are positive characteristics of our portfolio which demonstrate lower risk than other forms of lending. That concludes my comments. And I'll turn it back to Damian.

Okay. Thanks a lot, Paul. We're going to open up for questions, operator.

Thank you. Our first question comes from Frank Schiraldi with Piper Sandler. Your line is now open.

Good morning, everyone. First, I'd like to hear your thoughts on the held-for-sale book now that the deal did not proceed and you have adjusted your fair value mark. It appears that you also retained a significant deposit. Are you actively trying to sell this? Is it fully open for these types of sales now, or do you anticipate it will remain on the balance sheet for a while?

No, we'll keep it. We have not looked to sell for the next 90 days and then we're going to review how the market is at that time. There really isn't a lot being issued right now. So we're going to wait 90 days and see if the market firms up. We're still getting very good performance, as we've disclosed. I think the last disclosure we made, there have been very few requests for deferrals from the portfolio. So it's generally performing across the board. From what we've seen in the marketplace, the collections are very strong, especially in the markets that we're participating in. So it’s early days though; we have to really see what happens in April, May, and June. So we're just holding them for now and hopefully if the market gets better, we will continue to do what we've done historically.

Okay. And then just in terms of credit, obviously areas like S block create a fortress balance sheet for a big portion of your loan book. Just curious if you could talk about where you see the greatest risks outside of that portfolio and outside of the $58 million, I guess you mentioned in the hotel on the held-for-sale book? Is it the SBA book, is it the hotel portion within SBA or is those LTVs low enough where you feeling pretty good about that? Thanks.

Yes. Well, I think what you said is correct. I think where we don't have a government guarantee, and we have exposure to assets that are dependent on the economy being open, such as travel. The good part of that is it’s very low exposure for us and the LTV ratios, like you said, are low. We have not taken historically many losses in the leasing area, which most people would focus on since it's card-based, but the auctions are starting to open and we haven't taken losses during any other cycle, so that would be the second area of concern. My first would be the SBA unguaranteed portion, especially in hotels. Then it would be wait and see on the leasing, but then also the small amount of hotel exposure we have in the CRE securitization portfolio. The S block and I block were stressed substantially and they didn't incur any losses recently, and obviously, the guaranteed portion of our loan portfolio from SBA is not a concern at all.

And when you think about the leasing book, you offer these deferrals for I guess 90 days. Do you expect to do a deeper dive or take a harder look after 90 days and maybe some of these things will take the leases – the leased vehicles back or do you just assume that you probably offer another 90 days for a total of six months in deferrals at least?

Well, that's the guidance now from FASB to do the six months, and when it is seen as a total debt restructuring. So we're going to follow the guidance like everyone else is. If people need another deferral due to their businesses being shut down because of COVID, we definitely will do that. It's really difficult to gauge when credit events in the portfolio will occur; that's probably going to be in the fourth quarter at the earliest or the first quarter of 2021 where you will really start seeing that, not only with us but with other banks too.

Right. And then just finally for me. If you think about some of the new partnerships you put on, obviously tremendous GDV growth in the first quarter. There are some questions about how the debit usage holds up in the second quarter with the economy shuttered, and certainly shouldn't hold up better than credit, I would think. But I'm trying to get your sense if you can in terms of your thoughts on GDV growth from here.

Yes, it is kind of a wildcard. One of the things we noticed is that we started getting stimulus payments onto our debit cards. So we had over $1 million in stimulus payments, and over $1.6 billion, you could see our funding. That impact on that funding has been very positive for us at the end of the first quarter and now in April. What we're seeing is the only area where we saw a decrease in the first quarter was gift cards, and in a couple of rapid funds programs the growth was negative. If the economy reopens sooner rather than later, it may mitigate some of that downturn because I think people currently have money they need to spend, and we're seeing the same trends as others where spending is shifting but hasn't slowed down significantly yet. We do have a lot of programs and new products being implemented that might also mitigate that decline. As I mentioned, we have 20 products we're implementing and we expect to sign three or four major programs in the second quarter, as well as – for example, SoFi is a good example where the volume is just beginning to be realized from their program. So it seems there are business initiatives from new business and from things like the stimulus which will at least impact the second if not the third quarter. Hopefully by the third quarter, the economy will be open again.

And those stimulus payments just came onto cards, I guess, that people had filed with the IRS. And is that $1.6 billion mostly...?

Yes, most of it was in the first quarter and extended into the second quarter. We are expecting an additional $300 million in these types of deposits, and we are actually receiving checks now as well. The impact of the stimulus will continue into the second quarter. All of this was deposited in accounts that represented a Bancorp account when they filed their taxes.

Right. Okay. And just to follow up on your comments about prepaid categories. You noted gift cards were really the only place where you saw weakness within prepaid. I know there's a lot of detail that you guys offered in the release which is great, but I don't know if you broke out types of prepaid. Can you talk about how big gift cards as a total percentage of prepaid?

I'm not sure if Paul is aware of that statistic.

No. We actually don't. We've looked at that, Frank, in terms of giving detail, but because it can be specific information that's relatable to a certain third-party, we're reluctant to release third-party information, so we don't disclose that.

Okay. All right. That's all I have. Thanks.

Okay. Thank you very much, Frank.

Thank you. And the last question comes from the line of William Wallace with Raymond James. Your line is now open.

Thanks. Good morning, guys.

Good morning.

Maybe just as a quick follow-up to the last question. The gift card, just kind of anecdotally do you feel it's 50% of the business or is it bigger...?

No, it's hard. No, no, no. We don't give that out, but it's less than 50%. It's far less than that.

Okay. So you kept the low end of your guidance intact, which is maybe a bold move given the uncertainty. I'm curious if you could just talk a little bit about the confidence that you have and the visibility to your ability to achieve the target and then maybe if you'd help us with some of the moving parts to get you there?

So what we did was we ran the situation and then we ran the numbers a bunch of different ways, whether we securitize loans, if we don't, and if we get growth in certain areas. Of course, the impact of interest rates at a very low level, and we ran it with our new outlook for expense growth. And consider things like the Paycheck Protection Program fees that will come in, and we became comfortable with the $1.25. We ran it enough times in different scenarios to conclude that $1.25 is a reasonable target to continue with the bank. So it’s a little bold, I guess. I guess it’s easy just to throw up your hands and say we don’t know what’s going to happen. But we think we have a responsibility to investors to say what we really believe is going to happen if we have put guidance out there. We don’t know about the credit shock that might occur to the financial services industry, but there seems to be; that's why we have reserves, and that’s why we’ve implemented CECL. We can’t second guess that either, that’s obviously there for a reason. So we tried to provide the best guidance we could and did it through modeling various scenarios with different outcomes. The $1.25 comes out of us considering all different potential outcomes, and that’s how we became comfortable with the $1.25.

Thanks for that. Is there an expectation for growth in the balance sheet related to the loan portfolio that you might have encountered?

There are some, yes. Yes. Yes, there are some, but we've ratcheted them down from where they were for the original target of $1.34. So they are factored in there, but they’re lower. And as Damian would add...

Yes.

Okay. It seems like you might have mentioned it in your prepared remarks; I apologize for joining the call a bit late. Did you provide any insights regarding the expense expectations?

$38.5 million.

Okay. So you said you're going to review the market and you'll revisit the market in 90 days and see if it's opened back up. Is there a point where if the market remains closed that these loans become too old or seasoned to sell and you just have to make the decision to move them into the held-for-investment portfolio? And if so, what would the CECL reserve be as of today that you'd have to put on those?

For securitization, if you're planning to securitize the loans and they go beyond six to nine months, it's unlikely you'll be able to do that, although there is still a market for those loans. This doesn’t rule out selling them to an institutional investor, such as an insurance company, interested in that type of exposure. Therefore, while securitized loans would not be sold, we have previously acted as a seller for another party to securitize in the last transaction, which would also prevent that loan sale. However, there are other buyers interested in purchasing loans. What was the second part of your question? I apologize.

Yes. I can answer this. It was on the loan loss reserve implication.

Oh, okay. Yes. That seems like something you can't sell to an institutional investor like an insurance company that wants that kind of exposure. So yes, for securitized loans, the loan sale won't happen. Of course, we were selling the loans for another party to securitize in the last transaction, so in that case, that would also preclude that loan sale. But there are other buyers who would want to purchase loans. And what was the second part? I’m sorry.

Yes. You would keep the fair value accounting regardless of where you hold it, and you cannot change that. Also, we own those loans net of fees at $99. Therefore, I don't think that will be an issue, and we haven't seen significant losses in that portfolio for the multi-family loans, which make up the majority of it. So I don’t believe that will be a problem.

So the $5 million loss you reported this quarter, do you think that would be sufficient or do you believe it would be wiser to consider more?

No, we don't predict it. What I'm basing this on is primarily the $58 million and a small amount from retail and other areas that we've disclosed in the tables. The majority is in multi-family. Even during COVID, according to the analytics firm we use, multi-family is expected to have less than 1% cumulative losses, so there doesn't seem to be any issues anticipated there.

Okay. The last question I have on this portfolio is about the $12.5 million deposit. You mentioned that it is booked based on accounting standards. Can you explain how that works?

Yeah. We can’t really comment. That was a legal disclosure, so the only comment we can have is what’s in the press release.

Okay.

As always, just to be clear, that $12.5 million is not in our $1.25 guidance.

Okay. Thank you.

I think that's why you're probably into that.

I was wondering if you could look at the fee income over the next year or two and whether it would be beneficial. Thank you, that was helpful. Lastly, can you provide an update on the situation with the regulators? Last quarter you mentioned that you felt you had met all the requirements related to the consent order. Given the changes in the environment since then, any information you can share about the consent order and its restrictions would be really useful.

If you can imagine, the world has changed dramatically, and we're not the bank that the regulators are concerned about, so maybe we're not such a priority as we used to be. But we still expect, as we said before, that we are in full compliance. And we expect hopefully that our regulators will agree with our assessment and will acknowledge that soon. We think that will happen in a fairly short period.

Okay. Yes. So they did come in and do their review; I don't know if it's an annual or a…?

Yes, they did come in.

Okay. Yes, okay.

We still believe that we are in full compliance, and we hope our regulators will confirm this assessment soon. We anticipate that this will happen in a relatively short timeframe.

Thank you. It seems like there are no more questions, so I will step out. Thanks, everyone.

Thank you. And this does conclude today's question and answer session. I would now like to turn the call back to Damian Kozlowski for closing remarks.

Okay. Thank you, everyone. We appreciate you being on the earnings call today. Be safe, of course; that's most important I think, obviously in these very interesting times. And we'll talk soon. Thank you, operator.

Thank you. Ladies and gentlemen this concludes today's conference call. Thank you for participating, and you may now disconnect.