Bancorp, Inc. Q3 FY2022 Earnings Call

Good day, and welcome to the Bancorp, Inc.'s Third Quarter 2022 Earnings Conference Call. Please note today's event is being recorded. I would now like to turn the conference over to Andres Viroslav, Investor Relations. Please go ahead.

Thank you, operator. Good morning, and thank you for joining us today for the Bancorp's Third Quarter 2022 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 available via webcast on our website beginning at approximately 12:00 p.m. Eastern Time today. The dial-in for the replay is 1-877-344-7529 with a confirmation code of 5997176. 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 discussions 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 generated $0.54 per share earnings from 14% revenue growth and 9% year-over-year expense growth, exclusive of a $1.75 million SEC civil monetary penalty this quarter. Net income climbed 8% year-over-year with strong increases in net interest income and GDV, gross dollar value, of transactions with the impact of those increases partially offset by the SEC settlement. Pretax income rose 21%, excluding that settlement. Net interest income and net interest margin significantly increased this quarter. Net interest income was up 27%, driven by our 70% mix of variable rate loans and higher balances. NIM increased from 3.17% in Q2 to 3.69% in Q3, as Fed fund increases disproportionately affect loan rates versus funding costs, which are contractually contained. Period-end total loan balances, excluding those held for sale, increased 11% over the linked quarter, led by real estate bridge lending with 34% quarterly growth. GDV grew 15% compared to Q3 '21 with significant growth across most verticals with the exception of general purpose reloadable programs, which continue to show modest declines, due mostly to the adoption of debit by our fintech partners. Card fees year-over-year increased 5% and other payment fees increased 17%. For the total envelope of activities and fintech solutions group, fees in aggregate grew 6%. Due to product and customer expansion from our current partners and new members to our ecosystem, we returned to historical trend growth in the third quarter. The first quarter of '22 showed only 2% GDP growth over '21 due to the impact of stimulus in '21 and the loss of Varo. The second quarter showed improvement growing 5% over 2021 as these impacts lessened. We believe the third quarter reflected a more normalized GDV run rate and anticipate high single to mid double-digit growth rates to be sustained over the foreseeable future. Revenue growth continues across our platform as lending volumes steadily increased and new payment partners are added to our ecosystem. The expansion of both net interest margin due to rising rates and payment fees across our verticals should support significantly increased profitability in 2023. We are issuing preliminary guidance for '23 of $3.20 a share, excluding the net impact of future buybacks, but including the impact of rate increases based on Fed fund futures. We also reiterate $2.25 to $2.30 guidance for '22. The $3.20 guidance for 2023 would represent approximately a 40% increase in earnings per share over 2022 and result in an ROE percentage in the mid-20s and an ROA above 2%. We are also planning to increase our share repurchases to $25 million a quarter or $100 million in 2023 from $15 million a quarter or $60 million in 2022. I now turn the call over to Paul Frenkiel to give you more details on the third quarter.

Thank you, Damian. Return on assets and equity for Q3 2022 reflected the impact of the $1.75 million SEC settlement and were, respectively, 1.7% and 18% compared to 1.8% and 18% in Q3 2021. Q3 pretax income increased $6 million or 16% to $42 million compared to $36 million in Q3 2021. In addition to considering the current year $1.75 million SEC settlement in that comparison, the prior year included $1.2 million of PPP-related interest and fees, substantially all of which were eliminated in the current year quarter. Also reflecting the $1.2 million PPP reduction was $65 million of Q3 2022 net interest income, which nonetheless increased 27% over Q3 2021. Additionally, in Q3 2022, funding costs contractually adjusted immediately to Federal Reserve rate hikes and increased to 1.19% from 18 basis points during Q3 2021. While funding costs generally adjust immediately, they adjust to only a portion of rate increases, while loans, on a more lag basis, adjust more fully. The majority of these loan rate increases occur over a 90-day period. As a result, continuing quarterly rate hikes in the second and third quarters of 2023 led to an increase in our net interest margin to 3.69% in Q3 2022 from 3.17% for Q2 2022. As loans continue to reprice with continuing expected rate increases, we believe that increases in loan yields in Q4 2022 and 2023 will continue to exceed the increase in funding costs and continue to increase margins and net interest income. The provision for credit losses was $822,000 in Q3 2022 compared to $1.6 million in Q3 2021. However, a $3.3 million net unrealized fair value loss was reflected in net realized and unrealized gains on commercial loans at fair value, which reduced diluted net income per share by approximately $0.04. The loss resulted primarily from the only movie theater in the company's portfolios. That loan was originated in 2015 and was a legacy loan from the initial entry into the CMBS securitization business, which was subsequently discontinued. After discontinuance, non-SBA loan originations were primarily comprised of the $2.15 billion of non-SBA commercial loans at fair value and real estate bridge loans, which together comprise the non-SBA CRE portfolio; $2.05 billion are comprised of apartment building loans. Prepaid debit and other payment-related accounts are our largest funding source and the primary driver of noninterest income. Total fees and other payments income of $21 million in Q3 2022 increased 6% compared to Q3 2021. Noninterest expense for Q3 2022 was $45 million, a 14% increase over Q3 2021. Exclusive of the $1.75 million SEC settlement, noninterest expense increased 9%. The largest component of that increase was a 12% rise in salaries expense, reflecting higher incentives for business generation, financial crimes and compliance expense, and higher employee insurance expense. Book value per share at quarter end increased 6% to $11.81 compared to $11.13 a year earlier, reflecting retained earnings, partially offset by fair value adjustments to the investment portfolio resulting from the higher rate environment. Quarterly share repurchases should continue to reduce shares outstanding. I will now turn the call back to Damian.

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

Today's first question comes from Michael Perito at KBW.

So I wanted to start on the new guide. I appreciate that you guys probably aren't looking to give a lot of line-by-line color here, but I was wondering if you can maybe give us some flavor on what some of the key drivers are of that 40% EPS growth rate that the $3.20 EPS guide suggests. I mean I imagine the NIM probably is a key contributor.

Yes. Well, the NIM is a big driver.

The NIM is a big driver.

I'm sorry, we lost you a bit there. So the biggest driver is the net interest income. So as Paul was saying, we get the deposit, immediately reprice this, but we get this most of the loans repriced over a 90-day period. So we've got this lag that's building profitability that's going to happen over the next 6 months as they continue to raise rates. And we really won't feel the full profitability effect until somewhere between May and June of next year if the current Fed funds predictions hold. That's one main driver. The other main driver is just the payments continue to restore the trend. And we're seeing that fee growth come up. We expect it to better match the actual GDV growth over the next couple of quarters. So those two things combined will really have a large impact on the net income realization from our revenue.

And what's driving the pickup in card fees? I saw in the release, you guys mentioned there's a couple of new partners. Any other color there? I mean it sounds like you think that could get up to a double-digit rate maybe in the next quarter or two?

Yes, it really depends on the growth of our various programs. There is a slight delay, and we are seeing a decrease in gross deposit volume on our prepaid reloadable cards, which are more profitable, while we are also expanding our debit offerings. We have renegotiated the balance between interchange and deposit funding with some partners who preferred more interchange. Currently, we have been maintaining a deposit beta around 40% to 42%, with about 58% funding coming from deposits. We have seen this consistency this quarter, but the delay still exists. Some of those fees are factored into our net interest margin since we are receiving more deposit funding. Looking at our portfolio, we are expecting significant new partners to join, and we have stable profitability from our major accounts. We don’t anticipate many additional pricing tiers based on volume. We expect the gross deposit volume to remain in the double digits to mid-double digits over the next year, and we hope to see fee levels rise to around 9% to 11%, or possibly even higher. That is our estimate.

Great. Very helpful. Lastly, I'd like to hear Paul's thoughts on the OpEx side. There was some noise this quarter. Where do you think that might settle? Looking ahead to the first quarter of next year, should we anticipate some inflationary pressure regarding compensation, salaries, and benefits as we consider the run rate for 2023?

Yes. The statistics I've reviewed indicate that salary increases nationwide are around 5%. We are experiencing some pressure from this, which we consider to be fairly modest. However, we are aware that we are part of the same economy as everyone else, and inflation is increasing. Therefore, salary growth will likely exceed 3%, but we still believe it will remain modest, and our earnings will continue to be largely driven by substantial revenue growth.

We will not be increasing the platform significantly. We have focused extensively on improving efficiency. While we are still expanding our loan book by more than 10%, we do not expect to see a corresponding increase in headcount. Therefore, our headcount growth will be limited as a percentage, though we anticipate some inflationary pressure, likely not exceeding 5% on payroll. Other expenses have been tightly managed, with only a few instances where they may be impacted. We have long-term contracts for some of our services that are protected against inflation over the next couple of years.

And our next question today comes from Frank Schiraldi with Piper Sandler.

I would like to focus on the guidance, as I believe it's the most significant figure from the quarter, particularly given the strong growth we have seen. Regarding the pipeline and the card fee aligning with GDV, are you suggesting that you expect low double-digit growth in card fees moving forward? If there is a 10% to 11% increase in card fees over the next year, would that support the $3.20 target?

Yes. Regarding the $3.20 guidance, we are still a quarter away from the end of the year, and there is significant volatility in the marketplace. We are being cautious to ensure that our preliminary guidance is thoughtful and reflects the current market environment. There are many potential scenarios for next year, ranging from a significant recession to a soft landing. Our guidance is designed to be achievable regardless of market conditions, and we feel confident that the bank can meet it. The $3.20 figure includes a conservative and thoughtful scenario. We have the flexibility to adjust our operations to meet expectations. However, the fee portion is relatively small due to the large impact of interest rate increases. If the Fed reaches a stopping point between 450 and 475, and maintains at least 450 by year's end, meeting the $3.20 should be manageable for the bank.

Okay. So I guess that would be the risk to the $3.20 if we go into a deep recession and the Fed starts cutting rates because that's a significant part of the growth.

Yes, we have considered that, but any cuts would need to be significant. Many of our new loans, particularly in the real estate sector, have minimum rate protections. We will revise our guidance accordingly. We are attentive to the market, similar to how we approached the pandemic, to ensure we provide thoughtful guidance. We will update our outlook as we gain more clarity.

Okay. Great. Regarding the balance sheet, it has shifted over the last few years from lower-yielding securities to loans. As we consider the balance sheet for the coming year, do we believe the level of securities has stabilized, or will it increase, thus expanding the overall size of the balance sheet? Where do you see this positioned on the asset side over the next year?

We have significant potential to enhance our security holdings since we intentionally halted purchasing securities about three to three and a half years ago when interest rates peaked on the 10-year loan at approximately 3.30%. This decision was deliberate as we had accumulated a substantial amount of securities at that time and reduced our asset sensitivity. However, it did negatively impact our profitability. We believed, as Paul mentioned earlier, that both monetary and fiscal stimulus would eventually lead to inflation and much higher rates. Now, we have the opportunity to add fixed-rate assets as we approach the peak of the interest rate cycle. We are currently considering the timing, but it typically occurs before the final interest rate. We are monitoring the situation closely and plan to acquire a significant quantity of bonds, increasing from around $800 million back to our previous level of approximately $1.5 billion. This is primarily to secure fixed rates. There are also alternate strategies we can implement. Over the next year, we intend to increase our fixed-rate exposure on our balance sheet, which will depend on market conditions. Ideally, we are looking for a more normalized interest rate environment. If inflation is at 2.5% and rates remain at 0, we will experience inflation, and ideally, the Fed funds rate should be between 100 and 200 basis points above inflation for a balanced economy. We genuinely hope this scenario materializes because if it does, the bank is exceptionally well positioned for substantial earnings growth in the coming years.

Great. And then just last question on that front because you talked in the past about the consumer business, consumer lending. Does this guide have any sort of new business lines that you expect you're going to ramp up to in 2023 to help with this guide? Or is it really just the business that's on the bank now in terms of the growth rates, the margin to get to that $3.20?

The base estimate of $3.20 does not factor in many additional elements, particularly regarding lending, which we've reduced for our own reasons due to potential challenges in consumer lending for smaller amounts. We plan to remain in that market, but we are looking at lending a few hundred million rather than $600 million or $700 million. Therefore, we’ve significantly trimmed our expectations for the $3.20 guidance, which represents the total potential. We'll see if we can achieve higher loan growth. We've analyzed loan growth and identified specific areas, such as SBLOC, where consumer lending may be affected. Thus, we've taken a cautious approach with our preliminary $3.20 estimate. As we gain more clarity in this quarter, it's important to note that outcomes can be uncertain until they materialize. We have a complex funding structure involving various programs, so we need to monitor deposit growth and identify areas in the economy that may be slowing down. However, we still see strong demand in sectors like leasing, which offsets some concerns. Overall, the $3.20 estimate lacks embellishments and is not heavily dependent on large new programs.

Ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to Damian Kozlowski for any closing remarks.

We appreciate everyone attending. I want to thank you and talk soon. Operator, you can disconnect the call.

Yes, sir. Thank you. This concludes today's conference. You may now disconnect your lines and have a wonderful day.