Bancorp, Inc. Q3 FY2024 Earnings Call

Good day, and welcome to The Bancorp, Inc. Third Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the prepared remarks, we will open the floor for questions. Please note, today's call will be recorded, and I will be standing by if you should need any assistance. It is now my pleasure to turn the call over to Andres Viroslav. Please go ahead.

Thank you, operator. Good morning, and thank you for joining us today for Bancorp's third 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 1-800-839-1162. Before I turn the call over to Damian, I would like to remind everyone that our comments and responses to questions reflect management's view as of today, October 25, 2024. Yesterday, we issued our third quarter earnings release and updated investor presentation. Both are available on our Investor Relations website. We will make certain forward-looking statements on this call. These statements are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions we mentioned today. These factors and uncertainties are discussed in our reports and filings with the Securities and Exchange Commission. In addition, we will be referring to certain non-GAAP financial measures during this call. Additional details and reconciliations of GAAP to adjusted non-GAAP financial measures are in the earnings release and the investor presentation. Please note that 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 $1.04 a share in the third quarter. Revenue growth was led by our FinTech Solutions Group. GDV growth was 15%, while total fee growth from FinTech payments fees and credit sponsorship fees was 22%. We continue to grow total credit sponsorship balances, which were $280 million at the quarter end compared to $70 million at the end of the second quarter. We are excited about the prospects for newly added and prospective payments clients and expect our non-interest income to reflect their impact in 2025. On the lending side, our substandard multifamily loan assets continue to be elevated. We believe we are at or close to peak in substandard assets and are employing multiple strategies to reduce that number without incurring losses. We also had the portfolio reviewed by an independent third party to validate our internal ratings. The substandard assets continue to be centered in our 2021 and 2022 vintage that was impacted by supply delays and a sharp rise in rates. We continue to believe that we will have little to no losses on this portfolio due to the conservative leverage of the loans. Anticipated rate decreases should also aid in reducing the amount of substandard assets. In addition, the Abry property in Houston continues to be on track for the December 2024 close with our deposit on the property growing from $125,000 to $375,000 currently. The other lending lines were led by our small business lending with 14% year-over-year growth. Moreover, our institutional business continues to stabilize and quarter-end balances were essentially flat to the prior quarter. In other matters, due to the potential repayment of outstanding senior secured debt of $96 million, planned buybacks will be reduced to $150 million in 2025, or $37.5 million a quarter from a total of $250 million in 2024. Our 2024 buybacks included a $50 million special buyback in the second quarter. Depending on prevailing rates, we may reissue debt of $100 million or more to replace existing senior debt. In that event, we would likely use all or most of the proceeds to increase our stock buyback. Also in our financial reporting, we will be breaking out more detailed business segment profitability for the first time. As you will see, the majority of our economics originates from the non-interest income and deposit funding generated by our payments ecosystem. The methodology we used was simple. We charged interest expense to the lending businesses using a three-year average market rate, while our FinTech payments business received the resulting interest income. Those allocations are shown in the interest allocation line. The actual cost of our deposits was charged to our FinTech Solutions business as their interest expense. The corporate segment includes our bond portfolio and was charged the actual cost of our deposits as interest expense. Expenses for each business are driven by both direct expenses incurred and allocated expenses based on estimated usage. This methodology better explains how our best-in-class returns are generated and the central role of Bancorp's FinTech payments franchise to our profitability. A schedule summarizing this view of our business appears at the end of the press release. Lastly, we are issuing 2025 preliminary guidance of $5.25 a share supported by our continued double-digit growth in FinTech fees and credit sponsorship. Our 2025 guidance does not include the impact of planned stock buybacks of $150 million that I previously mentioned. I now turn the call over to Paul Frenkiel for more color on the third quarter.

Thank you, Damian. While the Federal Reserve began to reduce rates in September, the purchase of $900 million of long-term fixed-rate U.S. government-sponsored agency securities in April 2024 significantly reduced exposure to Federal Reserve rate decreases. Additionally, an emphasis on fixed-rate loans continues in the company's efforts to optimize its margins. The majority of the increase in loans compared to June 30, 2024, was comprised of consumer FinTech loans. We are proceeding prudently in our FinTech credit strategies and currently are generating balances with lower potential loss exposure. We believe we will be able to originate loans with higher yields and/or fees in the future. The third quarter net interest margin of 4.78% compared to 4.97% for second quarter 2024 and reflected $1.6 million, or $1.2 million after tax, of prior period interest reversals on rebel loans, either transferred to non-accrual or related to loan modifications. Reflecting those rebel prior period interest reversals, net interest income increased 5% in Q3 2024, compared to Q3 2023. As noted in our last press release, the company examined the sensitivity of its allowance for credit losses to increases or decreases in its rebel loans classified as either special mention or substandard. As a result, a new CECL factor resulted in a $2 million increase in the quarterly provision or $1.5 million after tax. At September 30, 2024, rebel loans classified as special mention and substandard, respectively amounted to $84.4 million and $155.4 million, compared to $96 million and $80.4 million at June 30, 2024. Notwithstanding, the increase this quarter in loans so classified, the respective weighted average as is and as stabilized loan to values of 77% and 68% based on appraisals performed within the past 12 months continue to provide significant protection against loss. Each classified loan was evaluated for a potential increase in the allowance for credit losses on the basis of the aforementioned third-party appraisals of apartment building collateral, which was updated and performed in the past 12 months. Average Fintech Solutions Group deposits for the quarter increased 11% to $6.64 billion from $6.01 billion in the third quarter 2023. The provision for credit losses was $3.5 million in Q3 2024 compared to $1.8 million in Q3 2023. In addition to the aforementioned impact of the new REBEL factor, the provision for credit losses in Q3 2024 reflected the impact of $1.3 million of leasing charge-offs. Of those charge-offs, $600,000 resulted from transportation and trucking for which total outstandings amount to $34 million. While the macroeconomic environment has challenged the multifamily bridge space, the stability of Bancorp's rehabilitation bridge loan portfolio is evidenced by the estimated values of underlying collateral. The $2.2 billion apartment bridge lending portfolio has a weighted average origination date as is LTV of 70% based on third-party appraisals. Further, the weighted average origination date as stabilized LTV, which measures the estimated value of the apartments after rehabilitation, may provide even greater protection from losses. Non-interest income for Q3 2024 was $32.1 million, which was 20% higher than Q3 2023. Prepaid, debit card, ACH, and other payment fees increased 16%, accounting for the majority of the increase. Those increases reflected both higher rapid funds transfer income and higher prepaid and debit program sponsorship income, driven by both new client relationships achieving scale year-over-year and the continued organic growth of long-standing client relationships. For the consumer fintech loans noted previously, the income statement reflects a new line item, consumer credit fintech fees, which generated $1.6 million of quarterly fees. As previously noted, we believe we will be able to originate loans with higher yields and/or fees in the future. Non-interest expense for Q3 2024 was $53.3 million, which was 12% higher than Q3 2023. The increase included an 11% increase in salaries and benefits, the $892,000 after-tax loss mentioned earlier by Damian, and increased other real estate owned expense. Book value per share at quarter end increased 18% to $16.90 compared to $14.36 a year earlier. That reflected the impact of retained earnings and also the impact of the unrealized gains on the securities portfolio, primarily as a result of the 2024 securities purchases. In summary, Bancorp'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 believe and consider to be working-class apartments at more affordable interest rates in selected states. We believe that our underwriting requirements provide significant protection against loss as objectively supported by LTV ratios based on third-party appraisals. Further, S-block and I-block loans are respectively 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 portfolio 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 stockholder value while still prudently maintaining capital levels. Such opportunities include stock repurchases, which are planned to be continued for the remainder of the year with additional repurchases in 2025. I will now turn the call back to Damian.

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

Yes. At this time, the floor is open for your questions. Our first question will come from Frank Schiraldi with Piper Sandler. Please go ahead.

Good morning.

Good morning, Frank.

Just wanted to start with, Damian, I believe I heard you mention a new partnership on the FinTech side. You didn't name the partner. I don't know if that's by design or this is just previously announced. But can you just give a little more color and if it is a new partner, any guardrails around potential bottom line impact?

So our pipeline is extremely strong right now, even more than I've said in the past. And we're seeing implementations over the last year, which is continuing to show momentum in our GDV even in this month, in October. So nothing to announce. However, we're continuing to expand our long-term relationships with new product sets, including credit sponsorship. There's a lot going on there, and we're in discussions with new partners that want to move to our platform. So it's extremely robust at this time, but nothing to announce.

Considering the guidance for 2025, we previously mentioned that a historical growth level for GDV might be around 15%, with fee growth expected to be slightly lower. In this quarter, we achieved 15% GDV growth and over 20% growth in fees. Given the strength of our pipeline, do we still anticipate GDV growth of 15% or more? Additionally, could you provide insight into how this translates to fees?

So I can give you a couple of insights. These programs take a long time to implement. And sometimes they pay off all at once. So if you're looking at our GDV and we were saying we're going to be above trend this year. Now, this is an estimate, and this moves around a lot, but we're experiencing above 20% now GDV growth in the month of October. And we think that you just don't know how that's going to play out, but our transactions tend to be base transactions like payments that happen continually for the customers of the applications, and program managers. So it seems once we have a bump up in that volume, it doesn't go back down again. So we're experiencing that now. I would think that 15% number plus is also a good number for next year and could be a bit higher, more towards the 20% range, but we'll have to see. It can be very volatile.

Okay. Regarding the Rebel book, I noticed that rates declined significantly in the middle part of the curve and then bounced back a bit during the quarter. I'm interested in understanding the trends related to balances transitioning to permanent financing and moving off your balance sheet. Did that process accelerate? Can you provide any specific numbers related to this?

I think we haven't seen enough progress yet. It's clear that there's increasing liquidity in this niche with the outlook on rates. The market had been somewhat stalled for a time with new deals, but that's starting to open up. There are now pools of capital forming. When we evaluate our strategies, whether it's through certain loan modifications we've made on the Rebel book, there's simply more capital available. The market conditions have definitely improved, with new investors entering and existing ones looking to expand their portfolios. The situation we experienced in 2021 and 2022 has significantly improved in the marketplace. People now have a much more optimistic view on rent growth and cap rates, which are essential for a favorable market, and this has alleviated some of the market congestion.

Okay. And then just lastly on that front, you talked in the release about the expectation, I think the wording was nearing peak in terms of criticized balances. And just trying to think through timing there, I mean, if it's late 2021, early 2022 vintage, these things come up three-year initial term, it would seem to me that maybe early 2025 would be a point you could expect maybe a peak in criticized? Or is it that the rates coming down here in the near term have you feeling better about maybe peak earlier than that? Just trying to think through that. Thanks.

We strongly believe we are at or close to the peak, which is why we brought in a third party to validate our assessments of the loans and confirm that our downgrades are reasonable and in line with market standards. We have a strategy to reduce this within the next two quarters. We have identified properties and are cooperating with sponsors to modify certain loans, and we are also looking to offload or finance these loans. Overall, we believe we are near the peak and anticipate that the balance of substandard, criticized, and classified assets can be reduced in the next two quarters. The complete resolution of that loan group may take longer, extending into 2025, and by the end of that year, we expect to have refinanced all or most of those loans.

Great. Okay. Thanks for the color.

Thank you. Our next question will come from David Feaster with Raymond James. Please go ahead.

Hi, good morning everybody.

Hey, how are you doing, David?

I wanted to understand the progress on the credit sponsorship, which has clearly gained some traction. How has the rollout been so far? What are your initial thoughts as you begin to enhance the infrastructure you've developed? Additionally, what does the pipeline look like and what growth outlook are you anticipating? Could you also remind us of the yields from that production?

We are currently collaborating with several partners to launch new programs. There are three well-known providers aiming to implement their programs at the Bancorp. The primary focus at the moment is on Chime, across four product areas. By year-end, we anticipate this will reach approximately $400 million in footings. The loan velocity is notably high, with around $1.6 billion processed despite lower balances; the quick repayment and recycling of these loans are why fees have increased rapidly. By the end of next year, depending on implementation timing, we expect balances to be between $900 million and $1 billion. Following that, we foresee substantial growth, potentially doubling those balances by the end of 2025, which would generate a significant amount of spread and fee revenue due to the loan velocity. This reflects the momentum in our business, indicating that we believe we can meet our full-year guidance with our fourth quarter, although our current run rate, excluding one-time items, is about $1.11. In the credit sponsorship segment, we see a $1 million to $2 million opportunity for the fourth quarter. We have just completed the full implementation of rapid funds transfer balances, which presents another opportunity of $1 million to $2 million. Our gross dollar volume is significantly above trend, and while these figures are subject to volatility, they represent potential opportunities. So, if we consider the $1.11 figure, that translates to about $0.07, which puts us at around $1.18 for the fourth quarter. Additionally, since our deposit balances are higher than anticipated, we can fund our bond purchases without any borrowings, representing yet another $1 million to $2 million opportunity. Overall, the FinTech space is demonstrating rapid growth beyond our expectations with new fee sources, which is very encouraging.

Okay. That's helpful. And maybe to some of the points you just made, I mean, you've been active managing rate sensitivity ahead of potential cuts. Obviously, there's prospects more on the horizon. I'm curious, how do you think about the margin trajectory looking forward, assuming the forward curve comes to fruition, contemplating better yields from credit sponsorship? And just what rate outlook is embedded into your 2025 guide?

Our asset sensitivity has decreased significantly, moving from 8% to below 2% due to bond purchases and fixed-rate exposure. We expect our net interest margin for 2025 to remain quite stable. We need to consider some reversals from the third quarter, but we anticipate the net interest margin will be in the high 4s, likely between 4.90% and 5% for 2025. We do not agree with Goldman’s forecast of 3% to 3.25%, as we believe the Federal Reserve will remain around the 4% range for federal funds. If this scenario holds and we continue to increase our deposit sources and other fee income, reaching the 5.25% target we have set for 2025 should be manageable.

Okay. And then last one, I just saw that loss from the transaction processing delay. I was just hoping you could touch on what drove that and just curious what...?

Yes, there was an application issue that required us to manually rename files. Due to the naming conventions and several coincidental factors that we had implemented multiple controls to prevent, we experienced a loss related to non-sufficient fund files, specifically four of them. As a result, there were delays. To prevent any confusion, we collaborated with our partner to share the costs instead of submitting the files late, which could have confused consumers. We believe this is a one-time occurrence, caused by a series of coincidental events, and we have addressed the gaps. We have even updated the naming convention to ensure this doesn't recur in case of another application failure. This situation is not something that has occurred previously during my eight years here. We have significantly enhanced the platform, and this is not a systemic issue.

Okay. That's helpful. Thank you.

Thank you. Our next question will come from Tim Switzer with KBW. Please go ahead.

Hey, good morning guys. Thank you for taking my questions.

Good morning.

I had a quick follow-up on the NIM trajectory. With the Fed rate cuts, your deposits kind of reprice immediately almost with a contractual beta basically that's near 60%. So should we see maybe margin expansion initially before then the margin kind of, I guess, moderates and comes back down a little bit as we start to see pressure from the loan repricing, like how should we think about that over the course of the year? Or is it just stable every quarter?

It's difficult to determine because, for example, we had fixed-rate exposure during the pandemic in activities like SBA, with leases initiated at the start or end of the low interest rate period. As those leases expire, we're seeing higher rates in some of our businesses. In contrast, some new Rebel loans may come with lower rates. Overall, I think it will balance out. The key factor is non-interest-bearing deposits. Although we can't predict our deposit levels precisely, they are currently well above our estimates from the beginning of the year. This is beneficial for funding bond purchases and increasing areas where we don't pay interest. I believe it will level out around that 490 to 5% range without significant fluctuations unless there is an unexpected event, like we experienced last quarter. Overall, I anticipate it will remain relatively stable, although it may have minor fluctuations. Ultimately, we expect it to remain fairly flat.

Okay. That's helpful. And then I was looking at your regulatory ratios. Your TCE went up over 50 basis points, but your regulatory ratios went down a little bit. Was there a change in like the risk weighting of your assets? And was that related to some of the credit migration? Or can you guys walk us through that?

I'll give that to Paul. Paul, would you like to opine?

Yes, we have 100% for the consumer loans, which total $280 million. There has been some movement, as you pointed out, but the quarterly changes have been quite minimal. We keep an eye on our capital and make projections from quarter to quarter. These won't change significantly because we are generating a substantial amount of earnings. We have this planned out to maintain our ratios, and this is factored into our guidance estimates, so it won't have any impact.

Okay. And I'm curious, this is a question I've been getting from a few other investors, but why did you guys decide like now is the time to add to the Rebel reserve? If we're nearing kind of peak classified loans, what was the thinking and maybe a little more explanation on what drove that?

Well, that's exactly why it's really theoretical. The current CECL stands for Current Expected Credit Losses. We don't actually anticipate any losses, primarily based on the LTVs of the as-is and as-stabilized properties. Therefore, we don't expect any losses on the portfolio, which makes it challenging to set reserves when there's no objective basis. However, if there is an objective measure, such as the level of classified assets, theory would indicate that some level of reserve should be added. We are being disciplined and adhering to the theory. Based on the strength of the LTV, it's a modest increase, and as the number of substandard and special mention loans decreases, we should consider that it could get reversed. Ultimately, it's a theoretical accounting requirement, and we are committed to following it.

Okay. Okay. And we appreciate all the updated credit metrics you provided in the release. Is there any kind of like update you can provide on the loans that have modifications, and if you expect that to be peaking as well? And it sounds like you expect a lot of them to be resolved over the course of 2025?

Yes, we do expect that the modifications are at their peak. We have multiple levels of review. The department, with its in-depth knowledge of each loan, has to send a quarterly certification to us and executive management, along with various control parties, identifying all the problem loans. Additionally, we have a layer of credit and loan review. As Damian mentioned earlier, this quarter, due to the elevated number of substandard loans, we engaged a third party to review a significant number of the loans to ensure proper identification. This is why we believe that the loans with issues have been identified and are at their peak.

Okay. And if I could ask one more, please. Can you guys explain what's all captured in that $1.6 million of consumer credit FinTech fees? Is that like interchange? And then have you guys started selling any for gain on sale revenue at all? Or is that in your plans?

We haven't sold any gains on sale, so everything is on our balance sheet. In this situation, most of the fees come from customers who want their money early. Surprisingly, while we earn a spread on the loan, our business partner provides free advances. Some customers choose to pay a fee to access their funds immediately, even if they could wait a couple of days. For instance, if they want $50 right away, they will pay a fee for that convenience. This is a type of rapid loan, and customers are willing to pay a small fee to receive their money sooner. The majority of the $1.6 million in fees comes from these early withdrawals, with customers opting to pay for immediate access to their funds.

We also have secured credit cards. And while you don't see fee income for that benefit to the bank is significantly reflected in greater deposits and lower cost of funds.

Okay. And how do you guys see the composition of that revenue changing over time?

The structure will evolve as our partners grow these types of programs. Currently, we have four product variations related to credit-like products with our partner, Chime. However, our new partners will need to implement a business model that enables the distribution of loans. We plan to hold assets for 3 to 30 days before distributing them to investors. Additionally, depending on the program, we may retain 5% or 10% of certain assets for a longer period, particularly those that yield higher spreads compared to our traditional lending. Therefore, we will have three categories: assets secured on our balance sheet with high fees; fully distributed loans with a 3 to 30-day underwriting risk, which will generate several fees but smaller spreads; and a small portion of various programs will remain on our balance sheet, ensuring diversification. Looking ahead, as we’ve discussed, we foresee this expanding significantly in the next five years, but we believe it will happen sooner due to the strong pipeline and success of the programs we’ve initiated. We aim for around 15 to 20 programs that will resemble our Banking as a Service model in the debit deposit sector, maintaining a diverse range of business models. Importantly, we will also capture all payment activities, which will enhance velocity and fees. When we retain assets, we benefit from higher rates supported by our Banking-as-a-Service debit infrastructure, making this an exceptionally profitable business.

That’s great. Appreciate all the details. Thanks for taking my question.

Thank you. At this time, there are no further questions in queue. I will turn the call back to Damian Kozlowski for any additional or closing remarks.

Thank you, everyone, for joining us today. Have a great day. And operator, could you please disconnect the call?

Yes. This does conclude The Bancorp Third Quarter 2024 Earnings Conference Call. Please disconnect your line at this time, and have a wonderful day.