Bancorp, Inc. Q2 FY2021 Earnings Call

Good morning, ladies and gentlemen, and welcome to the Second Quarter The Bancorp Incorporated Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host Mr. Andres Viroslav. Please go ahead.

Thank you, Jorel. Good morning, and thank you for joining us today for The Bancorp's second quarter 2021 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.thebancorp.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 2868852. Before I turn the call over to Damian, I would like to remind everyone that when used in this conference call, the words believes, anticipates, expects and similar expressions are 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, everyone. The Bancorp earned $29 million in net income or $0.50 a share from 13% year-over-year revenue growth and 3% expense growth. Interest income increased 10% year-over-year. Total loan balances grew 12% year-over-year. Loan balance growth was led by institutional banking, which includes SBLOC, IBLOC and RIA financing with a 38% increase in balances. Quarter-over-quarter institutional grew 7%; SBA excluding PPP and a related non-recurring line of credit 2.5%; and leasing 5%. Gross dollar volume from our cards business grew 15% year-over-year with fee growth of 5%. Total non-interest income grew 27% year-over-year. Our Fintech Solutions Group, previously named Payment Solutions and Payments Acceptance, continues to have a robust business development implementation pipeline. We announced the addition of Current in the quarter as another major partner in our ecosystem. The newly named Fintech Solutions Group was created to enhance solutions integration to our expanding partner base. This group not only enables us to challenge our bank market, but also now includes all our verticals in corporate gift, healthcare and government with an expanding set of card, virtual card, debit prepaid and other payment capabilities such as push-to-card rapid funds. In addition, we also announced the creation of our new Fintech hub in downtown Sioux Falls. The named Bancorp Building will create an integrated innovation environment for our team members and partners. We expect to fully occupy the new facility in 2023. We launched a new expanded website this quarter to reflect our progress as a company. On the site, you can find useful information about the company including our new investor presentation and educational and industry insights from our team who are always focused on helping to build success for our partners. In the new investor presentation, we are introducing Vision 500, a four-year plan to achieve $500 million in revenue with a sustainable 22% return on equity or better by 2025. Also in the second quarter, we were honored to be selected to be included in the S&P 600 Small-Cap Index. This index is a set of representative public small-cap companies in key industries that power our economy. Lastly, based on our year-to-date performance of $0.94 a share and our 2021 outlook, we are increasing our 2021 guidance to $1.78 from $1.70. We continue to see tailwinds that should drive continued growth in 2021 earnings and beyond. We will give preliminary per share guidance for 2022 with the third quarter earnings release. Current trends would suggest income growth for 2022 of 20% or more over our revised 2021 guidance.

Thank you, Damian. Return on assets and equity for the second quarter were respectively 1.7% and 19% compared to 1.3% and 16% in Q2 2020. The increased returns reflected a $4 million year-over-year increase in net interest income, a negative provision for credit losses, increases in non-interest income and a lower tax rate. The increase in net interest income reflected loan growth and $3 million of fees related to a line of credit to another institution to fund PPP loan originations which are not expected to recur. SBLOC, IBLOC and adviser financing interest increased $3.4 million, while leasing and SBA each increased approximately $1 million. The SBA increase excludes PPP and the $3 million of non-recurring fees. While interest on commercial real estate loans at fair value decreased slightly, non-interest income reflected $2.6 million in net realized gains on commercial loans primarily resulting from exit and prepayment fees on loan payoffs. We have begun generating new commercial real estate loans with the first closings occurring in July. Total interest income reflected a reduction of $3 million in securities interest reflecting lower securities balances, prepayments of higher-yielding securities and lower reinvestment rates. Our average loans for the quarter of $4.6 billion represent growth of 16% over Q2 2020. We believe our loan portfolios generally have lower risk than other forms of lending as a result of their charge-off history, which reflects the nature of related collateral. Our non-SBA $1.5 billion of commercial real estate loans at fair value are comprised primarily of apartment buildings, while our SBLOC and IBLOC securities are respectively collateralized by marketable securities or the cash value of life insurance. Our small business loan portfolio is comprised primarily of SBA loans which are either 75% government-guaranteed or have 50% to 60% origination date loan-to-values. For our leasing portfolio, we have recourse to underlying vehicles and a prolonged history of pricing leases to minimize losses. Tables contained in the earnings press release detailed the diversification of our loan portfolios. Loan deferrals, which have been encouraged by COVID legislation, substantially all expired as of July 5, which was the due date for the vast majority of small business loan payments. Of the $48 million of deferrals at March 31, 2021, small business loans with an unguaranteed principal balance of only $2.6 million had not made their July payment and only $968,000 of all loans remained in deferral. The $1.3 million increase in interest expense compared to Q2 2020 resulted primarily from the senior debt issuance in Q3 2020, while Q2 2021 cost of funds was 18 basis points. Most of our deposit interest expense is contractually tied to market interest rates. The net interest margin was 3.19% compared to 3.53% in Q2 2020. The reduction reflected the impact of 2021 stimulus payments, which temporarily increased average balances at the Federal Reserve earning nominal rates. As funds were spent, these balances were reduced; and by June 30, 2021, total assets decreased to $6.5 billion compared to an average of $7 billion for the quarter. The net interest margin benefited from the aforementioned $3 million of non-recurring credit line fees, which served to offset the impact of reductions in loan and securities yields. The provision for credit losses was a negative $951,000, which reflected the reversal of certain pandemic-related economic risk factors in the CECL model and the recovery of an allowance on a loan payoff, because SBLOC and IBLOC loans are respectively collateralized by marketable securities and the cash value of life insurance and have incurred only nominal credit losses. Management excludes those loans from the ratio of the allowance to total loans in its internal analysis. The adjusted ratio is approximately 1.2%. Prepaid debit and other payment-related accounts are our largest funding source and the primary driver of non-interest income. Total fees and related payments income was up 5% to $21.4 million in Q2 2021 compared to $20.4 million in Q2 2020. Leasing income increased $1.3 million, reflecting the impact of the reopening of vehicle auctions after pandemic shutdowns and higher vehicle market prices due to vehicle shortages. Non-interest expense for Q2 2021 was $43.9 million, or an increase of 3%. The increase reflected higher salary expense, including incentive compensation and equity compensation expense. We continue to focus on expense management, especially in relation to revenue growth. Second quarter results also reflected the impact of an approximate 21% tax rate versus higher rates in recent years. The reduction resulted from excess tax deductions related to stock-based compensation. The large deductions and tax benefit resulted from the increase in the company's stock price as compared to the original grant date. Book value per share increased 16% to 10.77 compared to $9.28 a year earlier, reflecting earnings per share and the impact of stock repurchases. Capital ratios continue at satisfactory levels primarily as a result of retained earnings, notwithstanding the second quarter impact of stimulus payments, which temporarily increased average assets. I will now turn the call back to Damian.

Thank you, Paul. Operator, could you open it up for questions?

Your first question comes from Frank Schiraldi with Piper Sandler. Your line is open.

Good morning.

Good morning, Frank.

Just got a few questions. I wondered if you could talk about, and I know you're going to give preliminary guidance on 2022 next quarter, which I'm sure you'll have more detail to offer. But is there any more color you can give in terms of the drivers to get to the 20% plus? And I guess more so I'm just kind of curious about the growth rates you anticipate getting in the payments fee income.

Yes, we still think with our pipeline on the payment side that we'll get the gross dollar volume. It's been very bumpy the last couple of years obviously. It's real extremes over particular months, because of stimulus, but also because of consumer buying behavior. But with the pipeline we have, we still think we can sustain that 20% gross dollar volume growth over the next couple of years as there's a transition in the economy. So that's from the payment side. From the lending side, it's still between 10% and 15% on the commercial side and the SBLOC side. IRA and IBLOC side we've been growing disproportionately so 20% to 30% growth there as we have been demonstrating. And on the real estate side we restarted that business in the multifamily. We already have a very robust pipeline. We already closed or are about to close $25 million in deals and we have another $125 million in the pipeline to close. So we're experiencing not a lot of weakness across the board. We've got a lot of strength and tailwinds. And I think we'll give a lot more color when we give per-share guidance. And you can look at our new investor presentation, which we issued yesterday, which has a lot of additional facts about where we are today and where we think we can go as a company.

Okay. And then on the gross dollar volume side, generally we've been seeing, if I just look at my model, we've been seeing margins come down. I know a lot of that is related to volume discounts with big partners. It did at least in this quarter look like the margin has stabilized. So when you think about 20% gross dollar volume growth, are you still thinking half of that in terms of fee income growth, or if margins stabilize do you kind of get one-for-one?

I still think half, because we have a lot of new partners Current being a real high-profile one that just joined our ecosystem. But we have partners like SoFi, which just started last year, which is still ramping up. So we have to face obviously the dominant players in the industry too like PayPal and Chime. So I still think it's half maybe a little bit more than that. But it will be chunky again for the rest of this year. For the third quarter, we have a year-over-year with the stimulus comparison. And then in the fourth quarter, we had a really bad November last year, which we should excel this year. So there'll be bumpiness this year. We'll still maintain gross dollar volume and fee growth. And I think you're going to see more stability next year in what you see from the growth in gross dollar volume and the fee growth.

Okay. And then you mentioned a couple of partners there. So on the Current front, usually TBBK seems to be the first bank partner and the primary bank partner. And I know Current has had a couple of other banking partners in the past. So I wonder if there is anything, I apologize if there was more detail out there I missed, but anything you can say about your relationship with Current? Is it new business? Is it taking over some of the old business? How does that work versus some of their other partnerships that were in place?

Part of what makes TBBK attractive is our investment in technology and product capabilities, as well as our compliance and BSA processes. This approach helps us draw in more established programs that have previously worked with other partners, who now see these qualities as significant advantages of partnering with us. It's beneficial for a fintech company to have one or more partners to maintain a diversified processing base or banking relationship. However, there is often a lead bank relationship in many banking sectors. We are increasingly becoming that leading partner. Sometimes we form this relationship first, but through our partnerships, we typically evolve into the primary player within the ecosystem for our partners, building that relationship over time. Many of our partners, like Current, have their own strategies and plans. While I don't want to speak for them, our business model focuses on being a valuable partner across various activities for each partner in the ecosystem, allowing us to develop a competitive advantage over time.

Okay. Lastly, you mentioned that SoFi's business is still ramping up, and they've pursued their own bank charter. I know that you can maintain partnerships even after that, similar to Borrow. Could you elaborate on this? When you refer to ramping up, do you mean that the business and revenues for TBBK are still growing? Additionally, could you discuss Galileo and how it fits into this situation? Will they potentially become a competitor, or how should we view that?

Galileo was acquired by SoFi. Galileo's capability is processing. We're not a processor. There are occasions where a processor can also be a program manager. So if you think of the three parties involved, there's the bank, there is the processor and then there's the program manager. Those are the three main partners. And they're generally not a competitor to the bank. They can be a competitor depending on if they're captive with other program managers; if you have a processor and program manager together, but they're not a competitor of ours generally.

Okay. Okay. I just wondered if they were expanding at all.

I don't expect that we will have a long-term relationship with SoFi, but that decision is ultimately theirs. However, I believe the services we can offer SoFi over time will be valuable to companies like them, regardless of whether they obtain a charter. We are not in competition with Galileo; they are part of the same ecosystem. There can be competition among different roles, but being a bank does not prevent someone from also being a program manager. We focus solely on one role; we are neither a program manager nor a processor, which allows us to collaborate with anyone in the ecosystem without being seen as a competitive threat.

Sure. I was just thinking with Galileo being owned by SoFi, SoFi getting a bank charter now they are a bank as well. But it doesn't sound like you believe that they're looking to push into that side of the business.

Well, I'm not going to speak for SoFi, but I think that we have the scale and sophistication and the understanding of the whole envelope of activities including the scope across so many different large partners that there's real value to partners in our ecosystem to using our platform. And they're going to decide long-term whether they do that or not, but I think we can make that case too. Just as we've added Current to our platform just recently, we see a lot of the opportunities out there. And more and more we're seeing those partners that are at other institutions contacting us or at least having a discussion about what the differences are and whether or not they would be better using our capabilities.

Thank you. Good morning guys.

Good morning, Wallace.

Excuse me. Damian, you mentioned restarting the multifamily lending business with $125 million just closed and another $125 million in the pipeline. Is this correct?

No, we've closed or soon to close $25 million. And then we have another $25 million that we should close within the next 60 to 90 days.

Okay. Thank you. Is this meant to be a securitization business or a balance sheet business?

These are all new deals. This is replacing the securitization business. So if you think on the spectrum between community banking all the way to the securitization activity, which was more conduit business which was investment banking. This is really mainline commercial banking in one asset class which is this floating rate multifamily properties which have very low loss rates. That's where most of our securitization loans were created, but it takes away the securitization element, but it's not really a community banking local business either. It's a national business.

Are the deals that you closed and the deals in the pipeline are these coming out of that portfolio that's already on the balance sheet from the broken securitization or are these all new?

These are all new loans, but it's with a part of that team that was retained after we shut that business down. So these are people that are experienced with this type of asset class, with our broker and other direct contacts within the national framework of doing these loans. So we were able to restart the business very quickly. We really initiated this in the beginning of May. And we rapidly got a very good pipeline going. So if you think about 18 months, that old portfolio is going to roll off. Remember, we have a 1% fee that will be realized at that time maybe some exit fees too. And then we will put on this new portfolio of these floating rate loans at about 300% of capital. So as the company's capital base grows, we will hold that portfolio. It's an extremely good asset class to have, but also very flexible. They're fast amortizing loans. And there are also other distribution channels and sale opportunities, so we can sell it to insurance companies or other types of people who may want to put these loans into conduits. So this is very flexible. So if we need to reduce because of the growth of other businesses reduce that portfolio, it's very easy to do it.

Okay. And so, you mentioned in your prepared remarks, the - I can remember you called it the five-year plan to get to 20% return on equity?

The four-year plan, it is called Vision 500, and it appears in our Investor presentation, that's just been released.

Okay. So this $1.7 billion portfolio of multifamily loans is yielding, well, above market rates, correct, due to the timing of when these loans were underwritten with floors?

Correct. Yes. They're approximately at 4.8%, but the portfolio is a little smaller than $1.7 billion, but you're in the ballpark. But they're 4.8% loans and they have floors, so they're very accretive. But we are originating in the low 4% now. There's not a big difference about a 60 basis points difference between where we're originating loans as replacements and where they were before. But we'll make up for that by holding the portfolio. I think we're at about 265% of capital. But we'll max out at 300% of capital. And we'll continue to originate loans. So if we have excess origination, we'll sell those loans for a 1% fee, right, so we can originate more. So we'll be able to cover the interest income that's coming off those loans with both the transitional fees and then also excess loans, if we need to originate excess loans in order to make up any difference between the roll-off.

Okay. So, you will need this line of business then to hit that return on equity target then presumably, just given you need yield, right? I mean, you've kind of managed your business to a much lower risk asset generators, excluding now this product. Is that correct?

When we did the credit roadmap, which is part of Vision 500, so there's three elements you'll see in Vision 500. There's the ecosystem of payments, there's the credit roadmap and then there's the strategy around return of capital and buybacks. All those things are embedded in the main tenets of Vision 500. And through the credit roadmap process, which is an ongoing process, we looked at the balance sheet over the next four years and said what are the asset classes we're going to hold and it's a scenario planning exercise that looked at a payments-heavy business, and then a commercial-heavy business to really understand how the balance sheet should grow. And the good news was, whether it's commercial-heavy or payments-heavy, or somewhere in between, we're still able to maintain this very high returns on equity over a long period of time. I mean, the real key to this at the end of the day is growing revenue faster than growing expenses, and we've been able to maintain this positive Jaws or the difference between revenue expense now sustainably for the last four years and believe that we can continue that into the future, and that will drive obviously income per share but also return on equity.

Okay. You did mention the buybacks, and it was good to see another over 400,000 bought back in the quarter. Is it safe to assume that one that those buybacks will continue, that you'll exhaust the existing buyback? But two, I noticed that, even with those buybacks, the period-end share count went up. I believe that, usually the first half of the year is when a lot of the stock grants etc. are booked. So would we see a more favorable impact to the share count in the back half of the year should the buyback continue at roughly that $10 million per quarter range that you had mentioned before?

I'm going to give that to Paul.

You're absolutely right, Wally that the first half of the year represents more grants divesting of more grants. There are typically fewer, but there will be some in the last half of the year. But over time we're planning. We've announced the buyback. It's going to continue at $10 million a year. There's no reason to think that we wouldn't continue that or something similar in 2022. And so yes, over time you should see a reduction.

Now we're rigorous with the Board around buybacks and we're at 40%. That was the target or $40 million this year. The industry is between 40% and 50% of returning capital through dividends and buybacks and we'll continue on a quarterly and yearly basis making sure that we're consistent with the market but also choosing the right mix between buybacks and dividends depending on where our stock price is.

Okay. Thank you. And I mistakenly asked this question on the wrong call earlier this week, so I'm going to ask it on the right call this time. Earlier this week there was some noise around the Senate Banking Chair sending a letter to the CFPB to investigate the Chime account closures. There's been a large amount of complaints supposedly. And I'm just curious to what extent you can comment on how account closure decisions are made. I think you mentioned it in one of your answers to one of Frank's questions about the policies and procedures that you guys have around rules and regulations and making sure that everybody is compliant. So any comment that you could make, and it doesn't have to be specific to Chime, but maybe just generically around how you might help a partner make decisions on account closures, etc.?

So first of all, we take our regulatory responsibilities extremely seriously. And as has been covered in the press, the US government was defrauded on both the state and federal level literally billions of dollars and we were able to recover almost $1 billion for state and federal governments. And we're very proud of that. We follow the rules. I can't really comment on any specific case, but we are part of that decision-making process. And obviously because we have a platform that not only looks at one program but across all our programs, we see things that maybe other institutions don't. We are required to do certain activities in a certain way, report things when they are reportable. And we try to file the letter of the law but also to do it in a practical way. It's not knee-jerk or anything. We go through a process to identify fraudulent accounts, and they can have effects across clients. So you can have activity in one partner and you can have an account in another program and we will see that that individual may be doing multiple activities across our ecosystem. So, I can't comment on that other than we're part of the process. We take it really seriously. We're required to do it by law and we do it when it's necessary.

Thank you, Damian. Very helpful. That’s my last question. I will step out. Appreciate it.

I'm showing no further question at this time. I would now like to turn the conference back to Damian Kozlowski.

Thank you, operator. Thank you everyone for joining us. I think we continue to see a lot of growth and profitability over the next few years and we're going to continue working hard for everyone in our community. Thank you for joining us today.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.