Bancorp, Inc. Q3 FY2021 Earnings Call

Ladies and gentlemen, thank you for standing by, and welcome to the Q3 2021 The Bancorp, Inc. Earnings Conference Call. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Andres Viroslav. Thank you. Please go ahead, sir. Thank you, Lisa. Good morning, and thank you for joining us today for The Bancorp's Third 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 9257937. 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 $28.3 million in net income or $0.48 per share from 4% year-over-year revenue growth with a 6% expense decrease. Interest income increased 2%, while net interest income increased 9% year-over-year. Loan balances grew 26% year-over-year and 8% quarter-over-quarter. Balance growth year-over-year was led by institutional banking, which includes SBLOC, IBLOC and RIA financing, with a 32% increase in balances. All businesses continue to grow quarter-over-quarter, with institutional growing 6%, SBA 3% and leasing 2%. Gross dollar volume from our cards business grew 2% year-over-year, while payments related fee income decreased slightly. Both GDP and fee income were impacted by the loss of RO volume. This quarter also had a year-over-year impact of 2020 stimulus that contributed to slower growth. Our relaunched commercial real estate business exceeded our expectations and has already closed approximately $200 million of our new floating rate loans with at least another $300 million set to close in the fourth quarter. Our current estimate is approximately $550 million for the full year 2021 in new CRE loans. These loans, like our previous securitization business credits which were marked-to-market, are reserved against and will not be securitized, but may be sold to institutions. Our current target is approximately 300% of capital for CRE floating rate exposure in aggregate. Due to changes in FDIC guidance regarding the definition of broker deposits, FDIC insurance costs have been meaningfully reduced from 16 to 10 basis points. This may reduce total expense by approximately $4 million a year or $1 million a quarter. The majority of our deposits are no longer classified as brokered, and our insurance costs for the quarter were very close to the minimum cost of 9 basis points per $1 of deposits. We also announced the departure of our Chairman, Daniel Cohen, who has been a member of the TBB community since its founding. The Board would like to thank Daniel for all his contributions and wish him great success on its many ventures. I would additionally like to thank Daniel personally for his significant support during our company's transformation into a leader in the fintech industry and across our thriving specialty lending businesses. The Board has selected Board Member Jay McEntee III to succeed Daniel as Chairman effective November 1. In addition, Cheryl Creuzot has been appointed as a new director, and John Chrystal has notified the Board of his plans to resign effective February 28, 2022. Lastly, based on our year-to-date performance of $1.42 a share, in our 2021 outlook we now believe that exceeding our 2021 guidance of $1.78 is likely. However, we are not issuing new guidance, but note that the bias is toward overperformance. We continue to see tailwinds that should drive continued growth in 2021 earnings and beyond. We are also issuing preliminary guidance for 2022 of $2.15 a share. This 2022 guidance does not include stock buybacks. This is approximately 21% income growth over 2021. I now turn our call over to CFO, Paul Frenkiel, to give more details about the second quarter. Paul?

Thank you, Damian. Return on assets and equity for the third quarter were, respectively, 1.8% and 18% compared to 1.5% and 17% in Q3 2020. The increased returns reflected a $2.2 million increase in noninterest income, a $2.6 million decrease in noninterest expense, and a lower tax rate. A $900,000 increase in net interest income reflected loan growth but was significantly offset by the $1.9 million impact of prepayments on commercial real estate loans. However, net realized and unrealized gains on commercial loans increased $3.6 million, which resulted primarily from fees related to those prepayments. In the third quarter of 2021, we recommenced the origination of such loans, which are intended to offset the impact of such prepayments and payoffs. Interest income reflected a reduction of $1 million in security interest, reflecting lower securities balances, prepayments of higher-yielding securities, and lower reinvestment rates. Our average loans for the quarter of $4.6 billion grew 9% over Q3 2020. We believe our loan portfolios generally are 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 portfolios are respectively collateralized by marketable securities or the cash value of life insurance. Our small business loan portfolios are 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 in a prolonged history of pricing leases to minimize losses. Tables contained in the earnings press release detail the diversification of our loan portfolios. Substantially, all loans with COVID payment deferrals have recommenced payments and only $1.3 million of non-U.S. government-guaranteed principal remained in deferral at September 30. Interest expense was comparable to Q3 2020, while the Q3 2021 cost of funds was 18 basis points. Most of our deposit interest expense is contractually tied to a percentage of changes in market interest rates. The net interest margin was 3.35% compared to 3.37% in Q3 2020. While yields on loans were lower at 4.05% compared to 4.22%, they comprised a greater proportion of interest-earning assets in 2021, which contributed positively to the 2021 margin. The Q2 2023 NIM of 3.19% reflected the impact of 2021 stimulus payments, which temporarily increased balances at the Federal Reserve earning nominal rates. As recipients spent their stimulus, average interest-earning assets were reduced from $6.8 billion last quarter to $6.1 billion this quarter. The provision for credit losses increased to $1.6 million, which reflected the impact of the charge-off of the nonguaranteed portion of an SBA loan on the CECL methodology as well as loan growth. 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 was approximately 1.2%. Prepaid debit and other payment-related accounts are our largest funding source and the primary driver of noninterest income. Total fees and related payments income decreased 5% to $20.1 million in Q3 2021 compared to the prior year, reflecting the exit of the single relationship Damian mentioned previously. Noninterest expense for Q3 2021 was $39.4 million, reflecting a decrease of $2.6 million or 6% from the prior year. The decrease reflected a $1.9 million decrease in FDIC insurance, which reflected the lower insurance rate noted earlier in the call. While the future impact may be $1 million per quarter, the current quarter impact was higher due to the cumulative effect of the change. Multiple factors are considered in the FDIC insurance assessments, which also may be modified by the FDIC in the future. We continue to focus on expense management, especially in relation to revenue growth. Third quarter results also reflected the impact of an approximate 23% tax rate versus higher tax 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 of the stock compensation. Book value per share increased 15% to $11.13, compared to $9.71 a year earlier, reflecting earnings per share and the impact of stock repurchases. I will now turn the call back to Damian.

Thank you very much, Paul. Operator, could you please open the line for questions?

Your first question comes from the line of Frank Schiraldi with Piper Sandler.

Just on the $2.15 next year, the guidance, just wondered if you could share any drivers of that 20% EPS growth, such as expectations on GDV or any ramp-up in those loan gain, gain on sale loans. Just curious if you could drill down into any color there.

The GDV is expected to return to its trend. The stimulus made predictions challenging due to its uneven impact. Additionally, we experienced a loss from one specific program, which affected the GDV growth this quarter. If we exclude these two factors, we would see double-digit GDV growth. This reflects the significant impact of these elements. We anticipate improved growth in the fourth quarter and even stronger growth in 2022. We are aware of our pipeline and have introduced some major programs, so GDV growth should align more closely with trend levels. Furthermore, we have several initiatives in the credit area related to payments, which should lead to increased fee growth. Our pricing tiers for large programs have reached their limits, and as we introduce new programs, we can expect fees from the credit sector to be robust in 2022 and build momentum into 2023. We are confident this will bolster our earnings per share. Across the board, our credit programs will continue to grow in double digits. We are in the mid-range for SBA, although leasing faces some challenges due to vehicle availability. However, our strong market presence allows us to secure vehicles, and as availability improves, leasing growth is expected to increase as well. The timing of our commercial real estate (CRE) program is a key consideration, as we are currently collecting fees from our securitization portfolio while transitioning to slightly lower spread loans for floating-rate multifamily properties. We believe we can generate the necessary income, offsetting it with fees as loans are paid back. The new CRE portfolio is performing very well, and we anticipate reaching about $550 million by year-end. If necessary, we can generate more loans and sell them directly, realizing fees immediately instead of through securitization. Overall, we see strength in various areas, particularly in our institutional business, CRE, and SBA, making us comfortable with the $2.15 per share estimate. However, there may be some variability, especially if we surpass the $2.15, which would depend on the timing of loan payoffs and how many loans mature in the fourth quarter. We are closely monitoring this situation, but we currently believe that $2.15 per share is a solid estimate.

Okay. Thanks for all the color. And then in terms of GDV going back to run rate, in the past I guess a good rule of thumb as you have these volume discounts, is that card fees will grow maybe half of GDV growth. Is that kind of leveling out now that you're adding these new programs? And could we see more sort of similar to GDV growth in terms of card fee growth going forward?

Yes. I'm not certain about the specifics, but during this period of volatility, some card types, such as commuter cards, have seen less usage. The calculation involves two primary sources: new programs and credit initiatives associated with our major programs. We've begun to leverage our balance sheet in a low-risk manner with our significant partners. These initiatives are not dependent on gross dollar volume. Therefore, we anticipate that growth from new programs and fees related to credit sponsorship rather than payment sponsorship will increase that proportion over the next 18 months. While I can't specify exactly when or how, we expect to see a higher realization rate as we progress through 2022.

And when you say credit sponsorship, are you talking mostly originate and sell? Or could you hold some of this on balance sheet?

No, it's a combination of those things. In the early stages, we're not going to securitize. So it will involve utilizing our balance sheet with major partners by providing loans that may actually be booked on our balance sheet, making us the true lender. These arrangements are very beneficial for us. We have a lot of liquidity, and I believe they will significantly enhance the fee base we're generating in that area.

Okay. And then you mentioned the $2.15 doesn't include stock buybacks. You guys have been pretty religious about completing your quarterly authorization here in 2021. Given where the stock is now, do you see the same sort of game plan for 2022?

Yes, this is all based on a thorough understanding of PE market to book multiples. When we reach the ideal range, which we are at with an 18% ROE and moving above 20%, around 5% of banks really achieve excellent shareholder returns. We currently believe we should be at an 18% trailing PE. Ultimately, we expect to reach 20% in a forward-looking sense, and that is where we believe our stock price ought to be. If we are at 20 times whatever our guidance is, and our stock is not at that level, we will consider buying back shares.

Got you. Okay. Great. And then just one last one. People are beginning to look beyond the guidance for 2022. If you consider the long term, you have set a goal of exceeding $500 million in revenues by 2025. This suggests double-digit revenue growth over several years. The question is whether the scale story will continue to support revenue growth outpacing expense growth, and if so, could it be reasonable to expect a 20% EPS growth moving forward?

Well, we haven't given guidance, but in our investor presentation where we reissued, we've been very rigorous about those three tenets of our strategy. One is the whole payments, the Fintech Solutions Group, where we're trying to really look forward and turn ourselves not into a bank with a technology company, but a technology company with a bank. And so there's a whole envelope of middle office activities that we're investing in, not only for our partners, but hopefully to monetize out in the marketplace as we approach the end of that four-year period. We're very optimistic about where we are right now. We had this bumpy ride on GDV with stimulus. We also are in an extremely low-interest rate environment and have been able to adapt to it. In a more normalized environment and having just those supporting tailwinds, the virtualization of banking, all those things, plus our focus on not the use of the balance sheet, but the use of our capabilities to produce fee income, should really have a long-term impact on our ability to generate above-market returns and also return significant amounts of capital to shareholders.

Your next question comes from the line of William Wallace with Raymond James.

I wanted to just dig into some balance sheet questions here. Why take on the $300 million of short-term borrowings in the quarter?

I can respond to that. It was periodically to manage our Federal Reserve requirements and test our liquidity. We test that line from between like $100 million to $300 million. And we average, on average, we were a lot lower. It was a small fraction of that $300 million. It just happened on the last day that we had done that; we weren't really planning to keep that $300 million. So on a daily basis, you might see a fraction of that $300 million that, as I said, we used to manage reserve requirements.

Okay. So we expect most of it to be resolved by the end of the year.

We have a lot of flexibility. We are one of the few banks that over time, that over time has actually exited deposit relationships. So we have a lot of flexibility. So we can actually determine the size of our balance sheet, the size of our deposits. So that's really going to be what we determine it should be. And as I said before, there may be some borrowings. It's really just to manage our daily cash. We do have, being a payments company and having a lot of inflows and outflows that have different timing elements to them, you might see deposits, and therefore cash, fluctuate on a daily basis. So the lines are helpful in managing cash on a daily basis.

I've noticed that your deposits have decreased by over $550 million this quarter, which brings the total decline to about $1.8 billion since the first quarter. Does this relate to the program you lost?

A fraction. I'll let Paul take it, but a fraction of it does. But that's mostly driven by our own actions to lower the size of the balance sheet and the stimulus. But Paul, why don't you take that?

Yes, it is basically those two factors. The biggest single factor was the stimulus that resulted in taking us from like a low $6 billion bank to a high, to almost a $7 billion bank. As the stimulus got spent throughout the year, as I said in my comments, in the third quarter things normalized and we're closer to a $6 billion bank. But yes, obviously, that one relationship did have an impact. In addition to that, we exited some other deposits. The way we basically determine which ones to exit are based on cost. So we've been calling actually for years the higher cost deposits, and that's left us with the cost of funds of 18 bps.

Yes, we just have a lot of flexibility on deposits, so we had no problem adjusting. Even through getting a lot of excess deposits, it did obviously hurt some of our ratios, but we managed through it very quickly and rightsized the bank. But with our partner base, it's very easy to get additional deposits if we need them. But sometimes, you don't want to pay up for them. We want to have the lowest cost possible, and that's why we use the lines and that's why on a long-term basis, we want to make sure that we have the right partners and the right agreements in place. But we're very comfortable with the funding of the bank.

Can you quantify how much of the deposits were related to the one program? And was this program associated with a customer that had higher cost deposits which were less profitable compared to the overall relationship?

The program we mentioned before, it's borrow. Remember, they got a bank license and so they're not the majority of those deposits. They're less than 30% of that excess deposit base.

Okay. And the nature of these programs is such that they can't just cancel the contract or wait till the end of the contract and then walk away and take deposits with them, is that correct? Or…

No, they're longer. We always understood the intentions of that program. It was designed as a multiyear transition plan, and we were fully aware of what to expect. The timing of events depends on when they recard, as they need to redo everything we've done. They aimed to approach this in a more aggressive manner, which is acceptable. This did affect 2021, but that impact will clearly be over at the beginning of next year. That's why we're confident in returning to trend growth with new programs. The deposit was not significant, and while we won’t specify the amount, you can estimate it by referring to the publicly available call report, and by adjusting for some perceived growth that may have stemmed from their communications to the marketplace.

Yes, thank you, Damian. Looking at GDV on a year-over-year basis, the growth in the third quarter was approximately 2%. If we consider a return to trend over the next three quarters, we should ideally see some year-over-year growth. However, I think we can aim to get back to the prior guidance of around 20%, which has been discussed in earlier calls.

Yes. The growth we anticipate is influenced by various factors related to virtualization. We expect to see growth for several reasons in the fourth quarter, and we're already noticing positive trends. Last November was particularly challenging, especially with the election affecting the performance compared to the previous year's fourth quarter. Therefore, we predict significantly higher growth than what we observed in the third quarter, though we can't be certain about consumer spending due to the uncertainty in the market. However, we expect much improved growth in the fourth quarter. Additionally, the first quarter of next year will still benefit from the stimulus that was introduced in March. While our primary programs and some new initiatives are starting to ramp up, we anticipate significant growth. This will likely mark the end of the year-over-year effects from government stimulus. It will be the last instance where we have to estimate program growth based on uncertain factors like how much was driven by stimulus versus regular spending.

And then back to one of Frank's questions talking about the GDV margin, you started talking about other types of programs that are maybe more along the lines of credit sponsorship, etc. That sounds like it would be a new line-item business, not necessarily a GDV margin type. Like it wouldn't go in the prepayments business, would it? I mean, maybe help me understand what you were…

It depends on how we approach it. At the end of the day, it might or might not add to profitability, as you mentioned. We haven't finalized the structure of that program or how it will be recorded, but when we do, we will announce it, and it may not be reflected in that category, which is correct.

Okay. So is it fair to then maybe classify what we are hearing today at suggesting that we'll return to trend growth on GDV, which I believe you have stated think about maybe 20% is type volume growth with about a 10% type revenue growth that now perhaps there could be some tailwinds to that 10% level due to some new partnership opportunities and structures?

Yes, I believe that regardless of how we account for the business, whether it's through a credit line or another category, it should be combined. I suggest that they should be aggregated because they are fundamentally connected within that entire ecosystem. You can analyze it any way you prefer, but even if we do not categorize it in that specific line, it's reasonable to consider it together and examine it in that context, as there are strong synergies involved.

Yes, the new classification of the deposits is expected to save around $1 million each quarter. This implies that the ongoing expense is likely around $1.5 million, ranging between $1 million and $1.5 million, which is different from the expense level in the third quarter.

Yes. The easiest way to do that in your model is to look at the rates. The rate for us will be approximately 10 basis points. So just take that 10 basis points times your average liabilities for the quarter. And that comes out, as Damian mentioned, to about $1 million a quarter.

At this time, there are no further questions. I would now like to turn the call back over to Damian Kozlowski for closing remarks.

Thank you, Operator. Thank you, everyone. We're making a lot of progress. We're very optimistic about our progress in 2021. It looks like a lot of tailwinds for 2022 and beyond, and we're going to just keep on working very hard to realize those opportunities in the marketplace. Thank you, everyone. Operator, you can disconnect the call.

This concludes today's conference. You may now disconnect.