Bancorp, Inc. Q1 FY2024 Earnings Call

Good day, and welcome to The Bancorp Inc. Q1 2024 Earnings Conference Call. Please note today's call will be recorded. It is now my pleasure to turn the conference over to Andres Viroslav. Please go ahead.

Thank you, operator. Good morning, and thank you for joining us today for The Bancorp's First Quarter 2024 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 (800) 938-2241 with a confirmation code of BANCORP. 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 would 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 $1.6 a share with revenue growth of 8%, while expenses were 3% lower than the first quarter of '23. ROE was 28%, NIM was 5.15% compared to 5.26% quarter-over-quarter, mostly due to an increase in Fed funds sold, and 4.67% year-over-year. The efficiency ratio improved from 42% in the first quarter of '23 to 38% in '24. The Fintech Solutions Group continues to expand relationships and show continued progress. GDV increased 12% year-over-year and total fees from all fintech activities increased 7%. After adjustment for a client termination fee and the realization of '22 revenue in the first quarter of '23 due to a processing delay, fee growth was 16% year-over-year. We continue to add new partners and expand our product capabilities with existing partners. Some of the highest growth areas are our fintech neobank portfolio and corporate payments. We are pleased to announce Block as a new partner to our Fintech Solutions ecosystem. The addition of this new relationship, as well as the continued organic growth of the current portfolio, should result in meaningful increases to the ACH card and other processing fees line item. In a regulatory environment where many of our competitors have come under significant scrutiny, our focus continues to be helping our partners innovate with the product sets while maintaining a rigorous approach to meeting regulatory requirements and improving the robustness of our ecosystem. On the lending side, we had growth across the portfolio of 2% quarter-over-quarter. While our institutional book decreased quarter-over-quarter by 3.6%, the rate of decrease was less than in the past year and was more than offset by growth in other higher-yielding categories, which are mostly fixed. Lastly, with continued strong growth in our Fintech Solutions group and growth across our lending portfolio, we are reaffirming our guidance of $4.25 a share without the impact of $50 million per quarter of share buybacks in '24 and the additional second-quarter buyback of $50 million.

Thank you, Damian. As a result of its variable rate loans and securities, Bancorp performance continues to benefit from the cumulative impact of Federal Reserve rate increases. In April 2024, the bank purchased approximately $900 million of fixed-rate U.S. government agency securities to significantly reduce exposure to future Federal Reserve rate decreases. At an estimated average 5.11% yield, such purchases have a modest impact on current income while significant prepayment protection is reflected in estimated 8-year weighted average lives. Additionally, the bank continues to emphasize fixed-rate loans to further reduce its exposure to rate changes to modest levels. In addition to the impact of the Federal Reserve rate increases, the company benefited from loan growth, with decreases in SBLOC and IBLOC significantly offset by increases in other higher-yielding lending categories. Accordingly, while SBLOC and IBLOC loans decreased $782 million in the past 15 months, other loan growth approximately offset those reductions by March 31, 2024, at which date total loans amounted to $5.5 billion. The impact of the aforementioned Federal Reserve rate increases on variable rate loans and securities, growth in higher-yielding loan categories, and lesser increases in deposit rates was reflected in a 10% increase in net interest income in Q1 2024 compared to Q1 2023. As a result, in Q1 2024, the yield on interest-earning assets increased to 7.4% from 6.6% in Q1 2023, an increase of 0.8%. The cost of deposits in those respective periods increased by only 0.3% to 2.4%. Those factors reflected in the 5.15% NIM in Q1 2024. The provision for credit losses was $2.2 million in Q1 2024 compared to $1.9 million in Q1 2023. The provision for credit losses in Q1 2024 reflected the impact of $919,000 of leasing charge-offs, primarily in long-haul and local trucking and related activities, for which total exposure was approximately $39 million at March 31, 2024. Nonperformers increased during the quarter by $7 million for leasing and SBL but mostly as a result of an apartment building loan for $39.4 million, which compares to a September '23 independent as-is appraisal of $47.8 million or an 82% as-is LTV, with additional potential collateral value as rehabilitation progresses and units are re-leased at stabilized rental rates. For the $2.1 billion apartment bridge lending portfolio as a whole, the weighted average origination date as-is LTV is 70% based on third-party appraisals. Further, the weighted average origination date as-stabilized LTV, which measures the estimated value of the apartments after the rehabilitation is complete, may provide even greater protection. That origination date as-stabilized LTV based on the third-party appraisals for the portfolio was 61%. For the bank's rebel loans classified as substandard, recent third-party appraisals of those loans reflect a weighted average as-is loan-to-value ratio of 79% and an as-stabilized LTV of 76%. Accordingly, even with a higher interest rate environment and other stresses, we believe LTVs based upon third-party appraisals continue to provide significant protection against potential loss. Noninterest expense for Q1 2024 was $46.7 million, which was 3% lower than Q1 2023. A 2% increase in salaries and benefits was more than offset by decreases in other categories, including a $1.3 million decrease in other real estate-owned related charges. Book value per share at quarter-end increased 19% to $15.63 compared to $13.11 a year earlier, reflecting the impact of retained earnings. In summary, the bank's balance sheet has a risk profile enhanced by the special nature of the collateral supporting its loan niches and related underwriting. Those loan niches have contributed to increased earnings levels even during periods in which markets have experienced various economic stresses. Real estate bridge lending is comprised of workforce housing, which we consider to be working-class apartments at more affordable rental rates in selected states. We believe that underwriting requirements provide significant protection against loss as supported by LTV ratios based upon third-party appraisals. SBLOC and IBLOC loans are collateralized by marketable securities and the cash value of life insurance, while SBA loans are either SBA 7(a) loans that come with significant government-related guarantees or SBA 504 loans that are made at 50% to 60% LTVs. Additional details regarding our loan portfolios are included in the related tables in our press release, as are the earnings contributions of our payments businesses, which further enhances our risk profile. The risk profile inherent in the company's loan portfolios, payments funding sources, and earnings levels may present opportunities to further increase shareholder value while still prudently maintaining capital levels. Such opportunities include the recently increased planned share repurchases of $100 million for the second quarter 2022, up from the original $50 million. I'll now turn the call back to Damian.

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

Our first question will come from David Feaster with Raymond James.

Maybe let's just start with the elephant in the room and touch on this rebel credit. It looks like you all took that into OREO this month and are planning to finish the rehab yourself. Could you maybe just talk about what led you to that decision rather than just selling it today? And any specifics that you can with this credit? What you need to do, the expenses maybe that will come from that and just the timeline of when you think it can be stabilized and sold at no losses?

Okay. So yes. Well, in situations like this, we go through a process. And when the sponsor, in this case, has an inability to raise more additional capital to finish the project, and they've already put additional in. And so it goes through a process of whatever needs to be fixed over the next 6 to 12 months in order to lease up the entire property. So we're working with the property manager, we have a project plan in place and we'll finish it as quickly as possible. During that entire process, we're not looking to monetize it for a gain. So if somebody would, we're in discussions with people about taking over the property and completing the project. So that's ongoing. Paul?

I would add that we took immediate action to preserve the value, which is crucial because we want to maintain construction and release the apartments as soon as possible. Construction and rehabilitation efforts have already commenced. There is some construction involved in the rehabilitation, and while it's tough to predict the timeline, it will require at least several quarters to complete.

Okay. And any estimates on capital that you might have or reserves that you've already got against this that you could use to fund it? Just kind of curious that side of it.

Well, if you look at the LTV as-is on which you would base potential losses, the value continues to be there. So that's why we're going to finish up the construction ourselves and preserve that value and actually potentially increase the value as the property gets stabilized.

Okay. Could you maybe touch on the rebel book maybe more broadly? Are you anticipating more issues like this one? Are you hearing similar pressures from other borrowers? And maybe just touch on how debt service and LTVs are broadly on this book? And maybe what gives you confidence in the remainder of the portfolio?

First, there was a bit of what I would characterize as a wave that you see in our numbers today. And this was originated mostly from the '21 and '22 vintage of loans. So we started this. We've been in this business since 2016. We've had very good performance. We even issued securities. And what happened was there were a couple of shocks that occurred. We had the big inflation shock, and then we also had this interest rate shock. Now the inflation shock, obviously, for the business plans of people doing these deals changed how much they had to pay for the materials in order to go in to upgrade these apartments. And generally, people worked with that. Some people got off plan, some people added additional capital. And then you had this interest rate shock. So where that came in, it wasn't a takeout even though it's maybe less sales of these properties, it's still there's a GFC where you're going to have refining rates in the 6%. It was where if you got into trouble with your project, because of the inflation shock, you had to raise more money, you probably did it once or twice. At the higher interest rate level, it became very expensive to add more capital to finish the project. So that's where we've been working with our borrowers in order to help them with their business plans and make sure the property gets stabilized and then can be refinanced. So that wave has kind of come through. There might be some more. We haven't experienced a second wave, so there is some stabilization taking place. Paul?

Yes, I would add that if you look at the substandard loans classified as substandard, which means they have some kind of an issue, even after all the stresses that Damian just went through, given the extra equity and the original LTVs, the updated and more current appraisals still show an LTV as-is of 79% and slightly better as-stabilized. So again, we have significant protection against loss.

That's very helpful. Let's shift our focus to the core business. It's great to hear about the new partnership with Block. That's significant. Can you elaborate on what that relationship entails? When do you expect it to start contributing to growth? Also, could you provide some insight into the pipeline of new partners and how that's progressing? Given the regulatory challenges in the industry and your position, I imagine you're seeing more partners looking in your direction. I'm curious if that's accurate and how the pipeline is developing.

The rapid funds ecosystem is where our relationship with Block stands. In the first quarter, we've only seen a small fraction of that volume come in, less than 15%. You can expect to see this roll out over the next couple of quarters. Our pipeline is extremely strong, and there are exciting developments across our portfolio. We will continue to announce these partnerships at the appropriate times, similar to how we announced Block. The partnerships are primarily with very large providers that currently handle significant volumes. When we do add three to five new partners each year, they contribute substantially to our economics. This dynamic hasn't changed; the last few years have seen ongoing scrutiny of the industry, which gives us visibility into nearly all major programs considering a change in their provider. Overall, the prospects for the business remain very strong.

Our next question will come from Tim Switzer with KBW.

I wanted to follow up on the rental portfolio and the credit performance we've observed. There has been an increase in nonperforming assets. There's approximately $6 million that has moved into nonperforming, in addition to the $39 million loan. Could you provide some insights on what has contributed to the increase beyond that? Additionally, are there any noteworthy loans that have ceased payments but are not yet classified as nonaccrual or reflected in other credit metrics? Please share any information you have on that.

The $6 million you mentioned comes from a mix of leasing and small business loans across various industries. We have a significant level of diversification within our portfolio. The main challenge we've encountered concerning charge-offs has been in the trucking and long-haul transportation sectors, with a few cases occurring this quarter. We do not foresee any systemic issues that could raise the levels of nonperforming small business loans or leasing, but we monitor the portfolio closely. More detailed information will be included in the 10-Q report as required.

Okay. Great. Appreciate the color there. And it's good to see you guys starting to purchase the securities, $900 million in April. How much do you plan to do more? I think last quarter, you guys said anywhere between $1 billion to $1.5 billion. Is that still kind of the target? And what's your new asset sensitivity as you're trying to close the gap to that 60% deposit beta you have?

Okay, so these are general observations. We run models to assess our asset sensitivity in different environments. That said, when we opened our balance sheet and had not purchased any bonds, we found ourselves at about 25% fixed. The interest rate increases had a significant impact on our profitability. Since the beginning of last year, after acquiring fixed-rate assets and purchasing $900 million in bonds, we are now approximately 50% fixed. We have made considerable progress in closing that gap. Initially, we aimed for 60% fixed-rate because our deposit beta was 40%, which would fully offset our asset sensitivity. To give you an idea, previously we were looking at around 7% or 8% for net interest income with a 100 basis point decrease, and we have reduced that to about 2% or 3%. This shows how much we have lowered our asset sensitivity. We waited a long time to make these purchases, analyzing various indicators which recently showed very favorable signs. We began purchasing when we anticipated that the CPI might be slightly higher than expected, leading to a market overreaction, which indeed occurred. However, that CPI increase was largely due to housing and insurance. Overall, the economy appears to be slowing, as reflected in the recent GDP report. We believe interest rates have likely peaked, but they could still rise. This is why we remain asset sensitive. If the 10-year treasury reaches the 5% range, we would likely acquire an additional $500 million in treasury securities, which would nearly close the gap. If we do not pursue that in the next six months with our existing loan products and new credit offerings, we will still significantly reduce that gap without needing to purchase additional securities. We are not focused on maximizing profit; rather, we sought to mitigate our asset sensitivity appropriately, which is what drove us to make the $900 million in purchases.

Our next question will come from Frank Schiraldi with Piper Sandler.

I'm curious about the fee income growth and the year-over-year changes in gross dollar volume growth. Based on your pipelines, are you still confident that your gross dollar volume growth will be in the 15% range? Or, considering some of these partnerships in other areas, is growth starting to come from outside that gross dollar volume framework?

GDV is very difficult to predict in any single quarter. We believe it will remain above trend, exceeding 15%. The fee growth of 16% is quite strong, particularly with GDP growth at 12%, which aligns with what you mentioned. This growth is also coming from ancillary businesses like the rapid funds environment, leading to increased ancillary revenues. I would definitely prefer to see 16% fee growth rather than 16% GDV growth. Initially, we anticipated 16% GDV growth alongside 12% fee growth, but the current situation is the opposite, which is beneficial for profitability. We still expect a positive trend, especially with new partnerships like Block, which will enhance fee growth in relation to GDV. It's been surprising to see fee growth surpass GDV, largely due to the expansion of our product offerings, particularly in the rapid funds area.

And then just on the rapid funds and on the Block partnership, sorry, just curious if you can provide a little more color on what is the timing usually? I know it takes a while to get these partnerships up and running after announcement. So is this more of a 2025 maybe incremental boost to revenue growth, the Block partnership?

No, this is happening now. Fifteen percent or less of the transactional volume occurred in the first quarter, and it has been increasing since then. You will notice an impact this quarter, which will continue to grow throughout the year. However, keep in mind that Block is a large and leading fintech with substantial volume already. This adjustment involves integrating them into our ecosystem and their ongoing growth.

Got you. Okay. And you said some of that revenue was actually in the first quarter? Or are you saying in the first quarter now?

The first quarter, there was a small amount of that revenue, yes.

Okay. Regarding the rebel book, it was expected that bringing that loan into nonperformers would happen, and now it's in OREO. You mentioned it's stabilizing over time. I’m curious about your thoughts on this situation. It seems you’re open to selling if it can happen quickly, but based on the as-is LTV, it doesn’t seem like you think selling it in the near term before completing the improvements is likely. Could you elaborate on this?

We explore all options. Since 2016, we have provided loans with very few similar issues arising. The challenges we faced in 2021 and 2022, coupled with higher market rates, have resulted in fewer buyers compared to the past. However, we continue to pursue all avenues, and there is interest in our assets. If we can achieve a reasonable sale, we will, but we cannot wait for that. It is crucial for us to assess the property's value and monetize it as quickly as possible. When challenges arise, we must act swiftly to protect the property and quickly complete necessary work. This is a project that has faced some difficulties but is quite advanced. Some work remains to be done. We do not want to find ourselves in this situation; we prefer our borrowers and sponsors to finish the project and realize its value through a sale or refinancing with a bank or GSEs. We need to intervene as we approach the final third of the project to complete it and generate revenue. If we can sell it sooner, we would be pleased to do so.

Okay. As you stabilize and complete improvements, what are the costs involved? How is the expense for construction and the carrying cost of the building accounted for? Also, what are your expectations regarding those numbers?

Okay. Paul?

Yes. So we have a budget, a detailed budget. So we have the estimated cost. And in fact, even after those expenditures, the 82% loan-to-value will be preserved. So the costs, they get capitalized. There are some reserves available, so it won't be dollar for dollar. But as I said, the LTV will still be maintained. And as Damian said, as construction, as rehabilitation progresses, as units are released, the value to prospective buyers increases dramatically and that's how we're planning to dispose of the property.

Okay. So are you saying just given the capital expenditures budget, the reserves that are still there in that plan, that we really shouldn't expect to see a tick up anywhere else in terms of carrying cost?

There will be some increase to the amount we have recorded because those expenses will be capitalized to the extent that we don't have reserves, but it won’t be disproportionately large. It will be under 10% at most.

Yes. And remember, as you lease up, obviously, the LTV actually goes down because as you expand, you release units and they kind of offset each other.

Right. Okay.

By the end of the process, these portfolios prove valuable because issues with loans typically arise later in the project rather than at the start. If we acquire a position after a few years, it means significant work has likely been completed and there may have been some challenges along the way. Additionally, the sponsor has probably already invested more capital and is now facing difficulties in raising further funds. When we get involved, it's not our preference; we want our borrowers and sponsors to succeed in renovating these crucial workforce housing units, which are tough to replace. This rehabilitation process is necessary, whether through our involvement, government efforts, or third-party agencies. It's vital for us as a bank to participate, and we aim for our sponsors to thrive so they can continue to restore other buildings. While it's regrettable that intervention is necessary at times, we do not anticipate any losses in the portfolio as we thoroughly examine it.

And then, just lastly on that front, obviously, we'll get more information in the Q, which is a little ways out. But in terms of any specifics you can give us on the rebel book in terms of any other additional delinquencies you're seeing in that book that will pop up in numbers in the Q? And any guide or any sort of detail you can give us around criticized, classified balances quarter-over-quarter?

So, as I mentioned earlier, I'll let Paul elaborate as well, but we've experienced a significant wave, stemming from the shocks I previously discussed. This occurred during the final third of these projects, where the takeout isn't an issue since GSEs continue to take out loans in the 6% range, slightly above that now. The real challenge was the inflation shock and the difficulty in raising funds in a higher interest rate environment, particularly after already securing additional capital to address that inflation impact. Fortunately, that wave has significantly diminished. While we might see another wave, any further credit migration should stabilize as we finish these projects and start to monetize these assets.

Yes. The loans of concern are the substandard ones, which have some issues. When we encounter problems, we obtain an updated appraisal. Based on this appraisal, the loan-to-value (LTV) for our substandard loans remains at 79% as-is and 76% as stabilized. This provides us with significant protection against loss. Historically, and as supported by statistics, during challenging economic times, there may be an increase in classified loans and delinquencies. However, the losses are not as severe as one might expect, as evidenced by third-party appraisals that show these assets still hold value. In the context of commercial real estate, while certain sectors may struggle, workforce housing appears resilient due to housing shortages and reasonable rent levels compared to higher-end properties. We intentionally chose to invest in this category to mitigate losses. We’ve consistently shared that our LTV at origination is 70%, and despite the pressures on substandard loans, it has remained at 79%. Therefore, we agree with Damian’s assessment that we do not anticipate losses in the portfolio.

Yes, I appreciate it. NPA migration is certainly something that attracts attention, and people will be curious about what NPA balances might look like next quarter. Delinquencies today could lead to NPAs tomorrow. I'm trying to understand if there are any significant delinquencies that might transition to nonperforming or OREO status next quarter, especially since you've mentioned a large delinquency that moved into NPAs recently.

The $39.4 million is significant. We have discussed this matter, and I believe you have all the information needed to understand that there is no loss indicated for that property.

Okay. So I guess we'll get the criticized classified, the delinquency numbers, we'll get that with the Q?

Yes, of course, yes.

Yes. We have a strong capacity to generate capital, and our ratios have improved even with the increased buyback. We use a systematic approach by involving a third party to buy shares daily without affecting the market. It became evident that we had sufficient capital and a significant improvement in our metrics, particularly return on equity. Our current price-to-earnings ratio is under 10%, while our return on equity stands at 28%, and our efficiency ratio is at 38%, with return on assets at 3%. These figures do not historically correspond with P/E ratios at this level of profitability. Therefore, we found it appealing to boost our buyback since we had ample capital available. Even with an additional $900 million for share repurchase and the growth in our balance sheet, we will maintain healthy capital ratios. It became clear that this was the right decision for us, even though we typically avoid one-time actions, it felt appropriate to proceed this quarter.

At this time, I would like to turn the call back to Damian Kozlowski for any additional or closing remarks.

Thank you, operator. Thank you, everyone, for joining us today. Operator, you can disconnect the call.

This does conclude The Bancorp Q1 '24 Earnings Conference Call. You may disconnect your line at this time, and have a wonderful day.