Bancorp, Inc. Q4 FY2023 Earnings Call

Good morning ladies and gentlemen and welcome to the Bancorp Inc. Q4 and Fiscal 2023 Earnings Conference Call. This call is being recorded on Friday, January 26, 2024. I would now like to turn the conference over to Mr. Andres Viroslav. Please go ahead, sir. Thank you, operator. Good morning and thank you for joining us today for Bancorp's fourth quarter and fiscal 2023 financial results conference call. On the call with me today are Damian Kozlowski, Chief Executive Officer; and Paul Frenkiel, 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 545154. Before I turn the call over to Damian, I would like to remind everyone that when using 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 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 Bancorp's Chief Executive Officer, Damian Kozlowski. Damian?

Thank you, Andres. And good morning, everyone. Excluding the tax affected impact of a one-time write-off of the company's only trust preferred security purchased in 2006, The Bancorp earned $0.95 a share with year-over-year revenue growth of 16% and expense growth of 5%. Excluding the trust preferred write-off, ROE was 26%. NIM expanded to 5.26% from 5.07% quarter-over-quarter and 4.21% year-over-year. GDV increased 13% year-over-year and total fees from all fintech activities increased 15%. For the full year 2023, The Bancorp generated $3.63 per share, excluding the net of tax $0.14 impact of the trust preferred write-off. First and foremost, we have completed a major year-long strategic review and built a new business plan for our company. We are pleased to announce APEX 2030; details of this strategy appear in our investor presentation on our website. The strategic blueprint includes the monetization of our capabilities in middle office technology and infrastructure and the ability to keep our balance sheet under $10 billion by recycling both our assets and liabilities off balance sheet. These enhanced capabilities will create significant fee generation opportunities in services, credit sponsorship, and asset distribution. As I discussed in our last earnings call, as a result of our investments in growth and efficiency, our ROE is driving a continued increase in our regulatory capital ratios. With the Durbin 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 2019, we have created approximately $75 million of value for our shareholders based on our December 31, 2023 share price. 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. We are also confirming 2024 guidance of $4.25 a share without including the impact of share buybacks. This is approximately 17% earnings growth over 2023 earnings per share, excluding the impact of the trust preferred write-off, and we expect The Bancorp to continue to meaningfully outperform our peers and deliver superior growth and continued improvements in ROE and ROA. I'll now turn the call over to Paul Frenkiel for more color on the fourth quarter and full year 2023.

Thank you, Damian. As a result of its variable rate loans and securities, Bancorp's performance continues to benefit from the cumulative impact of Federal Reserve rate increases, while 2023 decreases in SBLOC and IBLOC balances offset the impact of other loan growth. Total related net paydowns in the fourth quarter were significantly lower than in every other quarter of 2023. The impact of the Federal Reserve rate increases was reflected in the 20% increase 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 Q4 2023, the yield on interest-earning assets had increased to 7.5% from 5.9% in Q4 2022 for an increase of 1.6%. The cost of deposits in those respective periods increased by only 0.8% to 2.5%. Those factors reflected in the 5.26% NIM in Q4 2023 which represented another increase over prior periods. The provision for credit losses was $4.3 million in Q4 2023 compared to $2.8 million in Q4 2022. Of the total $4.3 million, approximately $1 million resulted from growth in loan principal between the third and fourth quarters of 2023, against which cumulative CECL loss and qualitative percentages are applied. An additional $1 million resulted from increasing the CECL economic factor on real estate bridge loans. The balance of the provision primarily reflected the impact of leasing-related charges, approximately $900,000 of which were in long-haul and local trucking. Total principal exposure in those and related categories was approximately $39 million at December 31, 2023. 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 $25 million in Q4 2023 increased 15% compared to Q4 2022. Noninterest expense for Q4 2023 was $45.6 million which was 5% higher than Q4 2022. Salaries and benefits expense was flat year-over-year, reflecting a reduction in incentive compensation expense. Book value per share at quarter end increased 22% to $15.17 compared to $12.46 a year earlier, reflecting the impact of retained earnings. Quarterly share repurchases should continue to reduce shares outstanding. I will now turn the call back to Damian.

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

Our first question comes from the line of Michael Perito from KBW.

I have a couple of shorter-term questions and a couple of longer-term ones. To start with the 2024 guidance, Paul, could you provide more context on two things? First, what rate assumptions are included in the latest guidance and how might variations in those rates affect the guidance, not considering buybacks? Secondly, I would appreciate your thoughts on operating expense growth for 2024 and whether you anticipate any increase in headcount, along with an update on that front.

Okay. So Mike, before I turn it over to Paul, there are a couple of things. Our base case is not the market's view of six interest rate cuts. We think there might be a couple, maybe starting in June. But our forecast of the $4.25 does not include any bond purchases. So we're expecting a normalization of the yield curve and a significant amount of bond purchase in order to mitigate our 60% deposit beta. We've already made a lot of progress on that by adding fixed-rate exposure in our loan portfolio. So we're far less asset sensitive than we were at the beginning of the year, I think about 14% less as a percentage of our balance sheet. Our expense growth is going to be much less than this year. There was a big impact across the entire economy, especially on employee pay. We felt that also but we're talking mid-single-digit type of expense growth this year, not the double-digit employee growth rates that we saw on base pay in 2023. Paul, would you like to add something?

I think that's a good summary. I would also add that we're relatively conservative in terms of really every aspect of the budget. So we feel that even if we get a little bit more of the rate cuts and so forth, we have enough flexibility in some of our other categories to make up that shortfall. And again, we don't include the impact of share repurchases. We think that's another cushion. And if you look at the history of our budgetary projections on which our guidance is based. We've been pretty accurate and fulsome and that sense of conservatism in the budget has really served us well in terms of meeting the expectations.

That's helpful. Can we take another minute to discuss the margin and rate aspects? Do you have an idea of the immediate impact of a rate cut on net interest margin? Additionally, what other plans do you have for the next quarter or two before rate cuts begin? Is there something specific you are waiting for to purchase more bonds? I would appreciate a bit more insight if you can provide it.

The answer is we want to negate that we remember opening our balance sheet after buying bonds in 2018. With the pandemic bringing interest rates down to 0, we became very asset sensitive. We let the bond portfolio run down to under $800 million and waited for the majority of interest rate increases to finish before adding fixed-rate exposure. This has occurred over the last year, and we've significantly closed that gap. With the purchase of bonds between $1 billion to $1.5 billion, we might still be a little asset sensitive, but we will close most of the deposit beta. We believe that as we approach the real rate hike, likely in June, you will see a dis-inversion of the yield curve, at which point we will add very low-risk agency and mortgage-backed security exposure, thus reducing our asset sensitivity. Therefore, you should not see a significant impact on our profitability. However, it is important to note that net interest margin will decrease because the bond purchases will probably have a lower coupon compared to some of our loan portfolio. Nevertheless, our profitability will remain stable on a run rate basis, and if the yield curve disinverts, it will contribute to additional net income and enhance returns on equity and assets.

Okay, that makes sense. So you guys are going to be patient on the bond side until there's more clarity.

Super patient. We can only go ahead by...

Some margin downside on an absolute basis but with the actions you've taken already and then the flexibility still to buy more bonds, you feel like you can neutralize a vast majority of that asset sensitivity?

Yes. The net interest margin is crucial for traditional banks. However, in our unique situation, we can reduce our net interest margin and significantly boost our net income by getting a favorable spread on our bond purchases. Typically, when net interest margin declines, profitability decreases, but in our case, profitability will actually increase. We believe we are being very cautious. This is a continuous assessment for us, as we rely on historical data. There should come a point when we begin increasing our bond exposure, which will provide a positive spread for the bank; they will secure long-term rates, and this will help mitigate our deposit beta, which is influenced by our program management and our long-term contracts. We understand our funding position, so I think we are in a very unique and flexible position on the balance sheet. This strategy has been developed over the past five years, not just the last five months, and we have been very careful. I believe we are well positioned to close that gap and deliver incremental profitability to our shareholders.

Agreed, that's all very helpful. I wanted to ask a couple of questions about the APEX 2030. I suspect there will be a significant increase in fee contributions to meet these targets. Do you have an estimate for that? By the time revenue reaches over $1 billion, will fees account for more than half of the revenue pool? Are you willing to provide any guidelines on that? Is most of the fee growth opportunity from off-balance sheet deposit earnings and gain-on-sale-type earnings from credit-as-a-service that will keep the balance sheet under $10 billion? Is there anything else we should consider as you increase the noninterest income portion to reach that $1 billion target?

Yes, we have identified the areas we want to focus on. We provided some general guidance in our updated investor presentation available on our website, and we will offer more details soon. In the short term, we have an additional $3 billion of credit capacity on our balance sheet. Although our fees are growing rapidly, we anticipate that interest income will also grow, but eventually, it will plateau as we use up our balance sheet capacity. At that point, interest income growth will moderate, and fees will become the primary source of revenue. This will come from credit sponsorship, but it will involve a diverse range of programs, some supported by our balance sheet while others will involve lighter, underwritten assets sold in the market. We're not just focusing on one or two programs but envisioning a diversified mix of 20 to 25 programs over the next five years, some of which won't involve any credit risk on our part. Part of our balance sheet will be dedicated to that, and all other services we provide will be fee-based, including compliance services and transaction monitoring, as well as middle office technology services. We will offer more guidance as we gain clarity on our plans. So far, we've established a framework for our future vision and how we want our bank to fit into the competitive landscape. We’ve accomplished a lot in building our ecosystem and are aiming toward 2030 to define what our company will look like while considering significant trends like AI. We have much more to share. The primary areas for fee and spread generation will be in credit sponsorship, but it will take a couple of years before we see substantial use of our balance sheet for these sponsorships or new fees from other services, and we'll provide more insights as the year progresses. The opportunities ahead are significant, especially in banking as a service and offering middle office technology and services, which we can sell for fees across financial services and to our partners in the payments ecosystem. We are currently in Miami, where our senior management is discussing these matters, and the entire team is very optimistic about the future. We look forward to building upon our past achievements and embracing a new future that promises greater profitability, faster growth, and increased reliance on fee-based revenue.

We have our next question coming from the line of Frank Schiraldi from Piper Sandler.

Just looking at the presentation and looking at some of the numbers here and the long-term financial target of greater than 40% ROE, 4% ROA. Obviously, some pretty impressive numbers. I guess, in terms of the long-term aspect, if you were to put a timing on it. I guess that 2030 year is when do you think you could get to those sort of numbers? Is that reasonable?

Yes. To be honest, that gives us a bit more time. We're not particularly patient. If you view us solely as a bank, you might overlook the larger narrative. In this quarter, our efficiency ratio was 38%, and we have $3 billion on our balance sheet to invest in growing our business. Therefore, the return on equity isn’t purely a banking figure in many respects. It pertains more to our services and distribution; I believe we can achieve these goals sooner. The ramp-up time, as Mike mentioned earlier, will likely take a couple of years to become significant. By that time, our balance sheet will be fully utilized. However, I can envision us reaching those goals within the next 3 to 5 years. Furthermore, it is possible we could be in an even stronger position by 2030. By then, I would be quite pleased to achieve those numbers that any bank would strive for. We are quite conservative and rigorous in our approach. We recognize we have real niches and opportunities to develop, but we also understand the need for management focus, investment, and patience. So yes, by 2030, we would be extremely pleased to reach those targets, but I am confident we can do it sooner.

Okay. And then just thinking about, again, the balance sheet staying below $10 billion. And so no need for additional capital. I guess the next question is, when you get to those numbers, I mean, what do you do with all that capital? It seems like you're going to run out of shares to buy. Is it special dividends that you look at? I mean, any sort of thoughts on when you're generating that sort of capital and the balance sheet isn't growing?

It's not our money. We see ourselves as advocates for our shareholders. We are borrowing from our shareholders. We aim to provide economic advantages to our investors at our current price-to-earnings ratio through buybacks. When the stock reaches a proper valuation, accounting for high multiples for successful banks and added value from our fintech activities, we will return capital. If the stock is fairly valued or overvalued, we'll deliver a substantial dividend. We do not aim to create a large institution with low performance or pursue acquisitions that aren't beneficial. Any acquisitions we consider will be smaller and value-adding. We approach this rigorously, and I want to express my gratitude to all the shareholders for temporarily allowing us to use their money, and I assure you we will return it.

Okay, fair enough. Regarding the GDV for the upcoming '24, are you still anticipating it to exceed historic levels? Specifically, would that be around 15% or more? Is that still a reasonable expectation?

Yes, for the full year. So as you know, it bounces around. But I think 15-plus looks very doable. And we think we're going to see higher fee growth than we have; the difference between GDV and fee growth. We saw it in the fourth quarter, 15% with 13% and that's because we're getting other services like in that ACH line and push-to-card line, we'll see higher growth this year. So on an aggregate basis, we could see extremely good. Instead of the 9%, 10%, 11%, we could see more like 12%, 13%, 14% fee growth; so excited about those lines to it. And as you know, we've got great visibility and we've been adding partners and we'll make announcements. And there's been a lot of regulatory pressure within the banking as a service space, something that we've avoided by making all the investments we did over the last five years. So we've got a great position. We've got a very broad rigorous ecosystem. We have a majority of the large players in the industry. And all those things work together there in order to add an increasing amount of volumes from larger players that are established and are now working with other banks.

I noticed in the release that you mentioned moving deposits and loans off balance sheet over time to stay under the $10 billion mark. I thought I read that you had $300 million in deposits off balance sheet at the end of the period. Is that correct? Are those deposits generating fees?

We have moved those higher-cost deposits off with our partner, as they do not generate fees and would actually result in a cost to keep on the balance sheet since they are savings-like deposits. Currently, we have significant liquidity available to invest in bonds, so we do not want to hold onto excess deposits that are unnecessary. We strive to align our assets, liabilities, and liquidity appropriately. While there may be some economic downsides in the short term, we are committed to maintaining rigorous fiscal management and effectively matching our assets and liabilities as a fundamental principle of running the bank.

In terms of asset sensitivity, you mentioned a potential reduction of about 14%. Considering the numbers, it seems that for deposits, you essentially get 40% of the moves in Fed funds reflected in deposit costs. Is it currently around 60% for the earnings assets in relation to Fed funds? What exactly is the figure for the asset side?

On the deposit side, it's 40%, which means we receive 60% and our clients get 40%. Therefore, our deposit beta is 60%. We reduced our fixed-rate assets, including bonds, to under 25% at one point, and we are now approaching 40%. We’ve closed that gap and need to reach 60%, so we have 20% left to cover, nearly all of which can be achieved through bond purchases. Each day, we become less asset sensitive as we continue to add fixed-rate instruments in loans. This also affects our net interest margin. Our portfolio has a longer duration and is significantly more fixed compared to a year ago. I believe we are on the verge of closing this gap, especially with the narrowing yield curve and expectations of interest rate cuts.

Okay. And do you still think you can lock in a 5% NIM in this environment? I know there's a lot of variables there but is that kind of a target?

That would be great, but it really depends on how many bonds we purchase at what price and how much origination we have in our other businesses that will involve fixed-rate, longer-term loans. It's quite challenging to predict. I would be satisfied with a 4.50% or even a 4% rate because it won't impact our profitability since we are not a traditional bank. When we see a reversal of the situation, our bond purchases will lead to an increase in net income, return on equity, and return on assets because we face different constraints. There's no need for us to grow the balance sheet, and even if the net interest margin was at 1%, our return on equity would still be 28%. The math simply differs from that of a conventional bank. Ideally, you would secure it above 1%, which would be significantly higher than the current market. Presently, some large banks are around 1.80% while the overall market is just above 3%, and we've added over 20 basis points this quarter, with expectations of further increases until we buy the bonds. This aspect is very difficult to forecast.

And then just lastly, I know you got a lot of questions on the Rebel loans. People look at that industry, they've seen some pain elsewhere away from you guys. And you did see some migration into criticized and classified last quarter. Just wondering what you saw this quarter on that front. And then any change to your general thoughts on that paper?

I think we have a more secure portfolio because there was a real lowering of cap rates and structure structurally in the multifamily market, things like subordinate debt, lower reserves not buying the proper interest rate. We didn't do any of that. We were very strict in the underwriting. Our portfolio has matured. So we do have some deferments. This is very natural, though. No write-offs. No, we don't believe any substantial risk of default and loss, but as you mature that portfolio, it's hard to know whether it's just a maturing portfolio where you have some people who have finished the projects or it's more based on the economy; it's not abnormal. We're not seeing anything abnormal yet from ours. Now you hear a lot of these stories in the market, but those aren't our type of deals. Those aren't with our type of structures in the markets that we inhabit with the type of developers that we have. So we haven't seen the same stress that you might have read about in other areas.

Sure. I mean just thinking about, is it fair to assume that classified assets will increase in this business for you guys but just you won't see the losses. Is that kind of a reasonable expectation of coming quarters?

Yes, we anticipate that due to the typical transition of a fixed-to-floating rate portfolio. We collaborate with the sponsors of these projects, and they often aim to enhance the property. Occasionally, they face delays in obtaining appliances, or the project takes longer to complete even if they are leasing the space. This situation is not unusual. While there are economic influences, we do not consider them to be the primary cause. It's challenging to provide a definitive answer because there is no straightforward explanation. However, there remains a considerable demand for workforce housing, which is the focus of our business. The economy is strong, as indicated by a 3.2% GDP growth, and vacancy rates are significantly high in our operating locations. Our projects do not involve amenities like pickleball courts or new developments in Philadelphia. Thus, we have not encountered those specific challenges.

There are no further questions at this time. I'd now like to turn the call back over to Mr. Kozlowski for final closing comments.

Thank you, operator. It’s a great year for The Bancorp. We're going to be focused on delivering in 2024. Thank you so much for your time. Operator, you can disconnect the call.

Thank you, sir. Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines. Have a lovely day.