Bancorp, Inc. Q3 FY2023 Earnings Call

Good morning everyone and welcome to The Bancorp Inc. Q3 2023 Earnings Conference Call. This call is being recorded on Friday, October 27, 2023. I will now hand it over to Andres Viroslav. Please proceed.

Thank you, Jerry. Good morning and thank you for joining us today for The Bancorp's third quarter 2023 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) 674-7070 with a confirmation code of 043391. Before I turn the call over to Damian, I would like to remind everyone that in this conference call, the words 'believes', 'anticipates', 'expects' and similar expressions are intended to identify forward-looking statements within the meanings 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 $0.92 a share with revenue growth of 31% and expense growth of 6%. ROE was 26%. The NIM expanded to 5.07% from 4.83% quarter-over-quarter and 3.69% year-over-year. GDV increased 17% year-over-year and total fees from all of our FinTech activities increased 12%. The Bancorp continues to produce record core profitability and demonstrates our financial performance in a challenging interest rate and macro environment for most financial institutions. We continue to invest heavily in the development of new products and services, especially in our FinTech Solutions Ecosystem. These investments should have a meaningful impact on performance in gross dollar volume growth in 2024 and beyond. As I stated in our last earnings call, we expect to have above-trend GDD growth in 2024 of more than 15% and increasing participation in providing credit sponsorship solutions to our business partners. We also opened our new FinTech center focused on a collaborative space for our Bancorp team and business partners, while providing best-in-class workspace to innovate and create the future of banking solutions. As a result of our investments in growth and efficiency, our ROE is driving a continued increase in our regulatory capital ratios. With the regulatory balance sheet limit of $10 billion, The Bancorp is fast approaching the maximum equity capital needed to support our business growth into the future. Therefore, we are significantly increasing our buyback in 2024 by $100 million to $200 million or $50 million a quarter. Since the inception of our buyback in 2021 through September 2023, we have purchased 6.4 million shares at an average cost of $27. We believe our stock continues to be significantly undervalued when considering our long-term equity returns and EPS growth prospects. Therefore, our capital return policy will remain focused on stock buybacks rather than dividends. In addition, in our 2023 4th quarter full year conference call, we will announce our new strategic framework that will propel our company forward to 2030. We will outline how The Bancorp will continue to grow revenue and profitability and announce new long-term targets. Having already achieved remarkable bank performance with robust growth with little need for new capital, The Bancorp can produce future performance that is truly extraordinary in the financial services industry. We are reiterating our guidance for 2023 at $3.60 a share. We are also initiating 2024 preliminary guidance of $4.25 a share without including the impact of share buybacks. This does not include bond purchases where we would normalize our balance sheet similar to peer banks. This is approximately a 15% earnings growth over 2023 guidance. We expect The Bancorp to continue to meaningfully outperform our peers and deliver superior growth and continued improvements in ROE and ROA. I now turn the call over to our CFO and my colleague, Paul Frenkiel, for more color on the third quarter.

Thank you, Damian. As a result of its variable rate loans and securities, Bancorp continues to benefit from the cumulative impact of Federal Reserve rate increases. That factor was the primary driver in increases in return on assets and equity for Q3 2023 which were respectively 2.7% and 26% compared to 1.7% and 18% in Q3 2022. These increases reflected an increase of 37% in net interest income. In addition to the rate sensitivity of the majority of our lending lines of business, management has structured the balance sheet to benefit from a higher interest rate environment. Accordingly, over a period of years, it has largely allowed its fixed rate investment portfolio to pay down while limited purchases were focused on variable rate instruments. Additionally, the rates on the majority of loans adjust more fully than deposits to Federal Reserve rate changes. As a result, in Q3 2023, the yield on interest-earning assets has increased to 7.4% from 4.8% in Q3 2022, an increase of 2.6%. The cost of deposits in those respective periods increased by only 1.4% to 2.5%. Those factors were reflected in the 5.1% NIM in Q3 2023, which represented another increase over prior periods. The provision for credit losses was $1.8 million in Q3 2023 compared to $822,000 in Q3 2022. Q3 2023 net charge-offs amounted to $922,000, substantially all of which were in leasing. 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 $24 million in Q3 2023 increased 12% compared to Q3 2022. Noninterest expense for Q3 2023 was $47.5 million, which was 6% higher than Q3 2022. The majority of the increase resulted from salary expense which increased 9%, reflecting higher numbers of staff in financial crimes, compliance, and information technology. Staffing increases reflected higher deposit transaction volume and the development of new products. The increase also reflected higher stock compensation expense as a result of a focus on stock ownership and lower expense deferrals as a result of lower loan production. Book value per share at quarter end increased 22% to $14.36 compared to $11.81 a year earlier, reflecting the impact of retained earnings. Quarterly share repurchases will continue to reduce shares outstanding. I will now turn the call back to Damian.

Operator, would you please open the lines for questions.

Our first question comes from Michael Perito of KBW.

I wanted to start just kind of on the state of the banking-as-a-service environment here. Obviously, I think we've talked about this in prior quarters, you guys are well positioned and have a strong balance sheet. Just curious, though, if you can give us some flavor on what the kind of incremental growth opportunities that you're looking at, especially if you think about the earnings growth that you're expecting next year? Are there new partnerships? Are there new products with current partners? Or are there any kind of growth assumptions embedded in that, that we should be thinking of?

We add about 5 or 6 major partners each year and plan to continue doing so. There has been significant regulatory pressure on the banking-as-a-service sector, prompting individuals to switch to more advanced platforms that prioritize safety and soundness. This transition is helping to sustain our pipeline. We are selective and mostly decline new business opportunities due to the current stage of those programs, only pursuing the most established ones. This approach gives us clear visibility for the next 18 months, as we understand these programs well and often have signed contracts indicating their projected volume. While newer programs may have increasing volume, mature programs provide a solid grasp of their economics. We have observed competitors looking to reduce their involvement, and we maintain a diverse presence across various sectors beyond neo-banks, including health care and government cards. Thus, our pipeline remains strong as we focus solely on the most substantial and mature programs.

Perfect. That's helpful color. And then just as we think about the loan portfolio here, are there any other levers that you guys can or expect to pull in '24 to potentially offset the smaller SBLOC portfolio that might persist for a bit if rates stay higher, which obviously would be good for margin? And not kind of a huge NII problem, but I'm just wondering if there's any other levers to pull to replace that? Or if you expect any rebound in that portfolio going forward?

It's definitely slow right now. The increase in interest rates is really hitting consumers hard. Moving from a zero-rate environment to a Fed funds target of around 5.30% is a big change for many. Those who can reduce their debt are doing so, but this trend is decreasing. We've noticed that the rate of portfolio runoff has decreased over the past three quarters, indicating a normalization. This is also evident in our other business sectors, including leasing. We managed to avoid issues from the UAW strike, which seems to be on track for resolution. If that strike had lasted longer, it could have negatively affected our leasing operations. Our pipelines in SBA and real estate are growing, and we anticipate a loan book growth of around 12% to 15%, with closer to 12% in SBLOC and IBLOC, and over 15% in the CRE multifamily sector. The significant roll-off in our legacy portfolio is no longer an issue, so while our total footings didn't see much growth, our new footings did. We expect about 15% growth in that segment and around 13.5% in leasing and SBA, which we believe we can achieve. A key factor in our strategy is that we haven't purchased any bonds yet, which isn’t part of our current guidance. If we don't meet our targets and the interest rate environment remains favorable, we would consider buying more bonds. In a typical situation where we reach our expected footings and begin bond purchases mid-year, we could see an 80 basis point premium over Fed funds. This could lead to an additional $0.15 impact on earnings per share, giving us considerable flexibility in our earnings forecast. We are quite confident in providing this preliminary guidance.

Got it. That's helpful. And then just lastly for me and I'll let someone else jump in. Just on the credit side, Damian or Mark, whoever is on, just curious about the multifamily bridge product. Any updates on kind of the performance there? I know we've discussed that portfolio quite a bit over the last 9 months in terms of its makeup, geographic entities, etc. But just curious, any updates on your end in terms of the performance of that book? Or are you guys altering any of the underwriting as we get deeper into this kind of commercial real estate environment?

No, the market has definitely shrunk for these types of deals. It's clear that the market is smaller. However, we've been very cautious. We had a remarkable event with how we positioned our balance sheet and have taken advantage of the situation. Mark Conley, our Chief Credit Officer, and I met with our commercial team leaders and emphasized that this is not the year to take risks. We need to tighten our credit underwriting. While not much has changed, we ensured we didn't push at all. This is why you've observed some less-than-trend growth in the roll-off of the SBLOC portfolio, where we might have matched other companies' price cuts. We want to be well-prepared for 2024 and 2025, and we have considerable flexibility. We've seen no deterioration at all in the multifamily sector. Once again, we are not underwriting in areas where there are market problems. We don't have subordinate debt in our deals, and we have reserves and interest rate caps on our floating rate loans. Our cap rates are around 8%, while some have dropped to 6%. We don't participate in that, which is why we haven't experienced any credit deterioration.

Excellent. Thank you guys for taking my questions. Have a good day.

Our next question comes from the line of Frank Schiraldi of Piper Sandler. Please go ahead.

Just on the 12% fee income growth year-over-year and is that a reasonable kind of translation rate going forward on 17% GDV growth? Just curious as you renew partnerships and sign new ones, if there's any change to the economics there between what you guys get in terms of fees and the deposit benefit? And if you're seeing tighter spreads or better pricing as you renew and again signed new ones?

No, we're not getting any pricing pressure for our larger programs. So when we do negotiate because of the incremental expense differential between an older and newer program, we do give large volume discounts but that kind of falls more to the bottom line for us. I know what's coming in; there are several large new programs coming on. They will have higher fees in the beginning for the first couple of years as they grow in volume. But the thing to note is that we have 12% in there as kind of the base of GDV of that lease range. We might see more than 17% growth next year. But we're expecting 2% or 3% this year from more of the credit sponsorship fees. So we think total fees will increase from 12% to the lower end, and we might even reach 15% next year for total fee growth in all FinTech activities including new credit sponsorship activity. So we think it's going to be a really great year. We've got great visibility. Our base is dramatically higher than it was even a few years ago. Growing at that rate is a challenge but it's exciting because they're large programs, and we're adding 5 or 6 a year. They're exciting organizations with great volume and they're early in their lifecycle, so they haven't broken through those tiers like we've had for a very long relationship like with PayPal. So we're very excited about 2024 and 2025.

Great. Given the current uncertainty surrounding interest rates, what are your thoughts on margin dynamics moving forward, perhaps even beyond the next couple of quarters? Do you believe you are approaching peak margins, and can you maintain these levels going forward?

Yes. Our portfolio has a relatively short duration by design. Our net interest margin (NIM) is influenced not only by the increases in federal funds rates but also by the repricing of our credits. We have seen our NIM rise from 6% to over 8.5%, and we are now achieving a new NIM of over 6.5%. Currently, we are placing new loans at rates significantly higher than our previous levels. You can expect our NIM to continue to increase. The turning point will be when we purchase long-term securities and normalize our balance sheet, which will affect NIM. Even though our net income may rise due to the spread over federal funds, the impact on NIM may be lessened depending on our deposit levels at that time. While we cannot predict the exact timing, we anticipate that with a reversal of the yield curve, we may see an increase of 80 to 100 basis points on longer-term bonds. To align our balance sheet with our peers, we will need to purchase at least $1 billion to $1.5 billion in securities. We can't model this out precisely as we do not know when it will occur, but our base case suggests this will happen around mid-year, starting with bond purchases of about $250 million per quarter. This will have an incremental impact on our NIM relative to our deposit levels and will also affect our net income. With our significant capital returns, we expect a positive effect on our return on assets (ROA) and return on equity (ROE).

Great. And then just lastly, I know there are several scenarios for next year to reach that $425 million. But in terms of the most likely outcome, how do you see it? Obviously, revenues are going to outpace expenses. Do you believe we are at a point of scale where we will see low single-digit expense growth? Or do you anticipate that we’ll still see double-digit expense growth given the number of new partnerships you are forming? Any guidance on that front?

Yes, single. We had an adjustment year due to inflation this year and a lot of investment in our ecosystem, including new office space to have collaborative space. So that will be more normalized. We're going to try to maintain 10%. We're at such a high profitability level that if you can get 10% between revenue and expense growth, it has a dramatic impact. That's why we're fairly comfortable with that $425 million number; we'll still be able to do that. So we'll have low, in a conservative view without the bond purchases and without the impact of buybacks, we think we can maintain a mid to lower single-digit expense growth with low teens revenue growth. That will obviously have a significant impact on earnings per share.

And there are no further questions at this time. Damian Kozlowski, please proceed.

Well, thank you so much, operator. Thank you to everyone for joining us today. Operator, you can disconnect the call.

Ladies and gentlemen, this concludes your conference call for today. We thank you for your participation, and we ask that you please disconnect your lines.