Earnings Call Transcript - TBBK Q4 2021

Operator, Operator

Good day, and welcome to the Fourth Quarter 2021 The Bancorp Inc. Earnings Conference Call. As a reminder, this call is being recorded. I would now like to turn the call over to Andres Viroslav. You may begin.

Andres Viroslav, Conference Call Moderator

Thank you, operator. Good morning, and thank you for joining us today for The Bancorp's Fourth Quarter and Fiscal 2021 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 beginning at approximately 12:00 p.m. Eastern Time today. The dial-in for the replay is (855) 859-2056 with a confirmation code of 7390458. 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 occurrence of unanticipated events. Participants may discuss non-GAAP financial measures in this call. A copy of The Bancorp's press release containing financial information, other statistical information and a reconciliation of non-GAAP financial measures to the most directly comparable GAAP financial measure is attached to The Bancorp's most recent current report on Form 8-K available at our website under Investor Relations. Bancorp's other SEC filings are also available through this link. Now I'd like to turn the call over to The Bancorp's Chief Executive Officer, Damian Kozlowski. Damian?

Damian Kozlowski, CEO

Thank you, Andres. Good morning, everyone. In the fourth quarter, The Bancorp earned $27 million in net income or $0.46 per share from 7% year-over-year revenue growth and 3% expense growth. Interest income was flat, reflecting the impact of commercial real estate prepayments, while noninterest income increased 21% year-over-year, reflecting the impact of fees resulting from those prepayments. Total loan balances, excluding loans at fair value originally generated for sale, grew 41% year-over-year and 19% quarter-over-quarter. Balance growth year-over-year was led by Institutional Banking, which includes securities and insurance-backed lines of credit and registered investment adviser financing, with a 28% increase in balances. Quarter-over-quarter growth was led by new real estate bridge lending balances at 3% growth, institutional 7%, and leasing 3%, while Small Business Administration loans decreased slightly as a result of prepayments. Gross dollar volume from our cards business grew 11% year-over-year with payment-related fees approximately flat. For the full year 2021, GDV grew 12%, even with the net impact of nonrecurring stimulus and government payments in 2020. Our diluted EPS for 2021 was $1.88, exceeding our upward adjusted guidance for the year of $1.78 by $0.10 a share. With the many challenges of 2021, we kept focused on executing our strategic agenda, which we expect will drive long-term growth and innovation for our company. Even with the challenging interest rate environment, we were able to maintain stability in our net interest margin in 2021. Our balance sheet continues to show significant loan growth and new product innovation. For example, our relaunched commercial real estate business exceeded our expectations and closed approximately $622 million of new floating-rate loans. New products in our institutional wealth management business resulted in significant loan growth and the maintenance of net interest margins, unlike many of our competitors. We also continue to invest in our FinTech platform to create an ecosystem we believe is second to none in the industry. Our pipeline of new relationships and new products continues to grow with significant new implementations expected for 2022. Some of these relationships have been announced previously, but we expect others will be announced as new programs come to market this year. In addition, we continue to focus on controlling expenses and improving productivity while making significant investments in growth. For the full year 2021 compared to our prior year, our total expense base grew only 2%, and we will continue to be rigorous in creating value by finding new ways to be better organized and efficient through the use of enhanced technology, tools, and training. Lastly, we continue to see tailwinds that should drive continued growth in 2022 earnings and beyond. We are also issuing earnings guidance for 2022 of $2.15 per share, which excludes the net impact of share buybacks and the impact of rate increases. In addition, our Board increased the amounts we may spend to buy back our common stock to $15 million a quarter in 2022 from $10 million a quarter in 2021.

Paul Frenkiel, CFO

Thank you, Damian. Return on assets and equity for the fourth quarter of 2021 were, respectively, 1.7% and 17%, compared to 1.6% and 17% in Q4 2020. Net interest income in Q4 2021 was comparable to Q4 2020 at $52 million. In the third quarter of 2021, you'll recall that we resumed the origination of non-SBA commercial real estate loans, which are intended to offset the impact of prepayments and payoffs on such loans originally generated for sale. While there were approximately $500 million of such originations in Q4 2021, their impact on interest income was partially offset by approximately $4 million as a result of prepayments on the loans originally generated for resale. However, fees related to those prepayments are recorded in net realized and unrealized gains on commercial loans, which increased $4.5 million in Q4 2021 compared to Q4 2020. Even with the impact of the CRE prepayments, year-end 2021 period-end loans and loans at fair value increased 14% over year-end 2020. Interest income in Q4 2021 reflected a reduction of $3.5 million in securities interest compared to Q4 2020, reflecting lower securities balances, prepayments of higher-yielding securities, and lower reinvestment rates. Our interest expense was reduced from 24 basis points during Q4 2020 to 19 basis points during Q4 2021. Most of our deposit interest expense is contractually tied to a portion of changes in market interest rates. Our net interest margin of 3.51% for Q4 2021 was slightly down from 3.58% in Q4 2020. The reduction reflected a lower yield on the securities portfolio as higher-yielding securities matured or prepaid. While yields on loans were also lower, they comprised a greater portion of interest-earning assets in 2021, which contributed positively to the 2021 margin. In the third quarter of 2021, recall that our NIM was 3.35%, which reflected higher balances at the Federal Reserve, earning nominal rates. The provision for credit losses increased to $1.6 million in Q4 2021 from $554,000 in Q4 2020. The increase reflected the impact of loan growth on the CECL model, including real estate bridge loans, which grew almost $500 million during Q4 2021. Because SBLOC and IBLOC loans are respectively collateralized by marketable securities and the cash value of life insurance and have incurred only nominal credit losses, management excludes those loans from the ratio of the allowance to total loans in its internal analysis. We believe our loan portfolios generally are lower risk than other forms of lending as a result of their charge-off history, which reflects the nature of related collateral. Our non-SBA CRE loans at fair value and within real estate bridge lending are comprised primarily of apartment buildings, while our SBLOC and IBLOC portfolios are respectively collateralized by marketable securities with a cash value of life insurance. Our small business loan portfolio is comprised primarily of SBA loans, which are either 75% government guaranteed or have 50% to 60% origination date loan-to-value. For our leasing portfolio, we have recourse to underlying vehicles in a prolonged history of pricing leases to minimize losses. Tables contained in the earnings press release detail diversification of our loan portfolios. Prepaid debit and other payment-related accounts are our largest funding source and the primary driver of noninterest income. Total fees and related payments income in Q4 2021 were comparable to Q4 2020 as the exit of a client relationship offset growth in other relationships. Noninterest expense for Q4 2021 was $43 million, reflecting an increase of $1.4 million or 3% from Q4 2020. FDIC insurance expense was $1.8 million lower, primarily reflecting the cumulative impact of a lower rate resulting from the reclassification of certain deposits from brokered to non-brokered. The largest expense increase was $1.1 million in salaries, which were 4% higher than Q4 2020. Q4 2021 results also reflected the impact of a reduced tax rate of approximately 24% versus higher rates in recent years. The reduction resulted from excess tax deductions related to stock-based compensation. The large deductions and tax benefit resulted from the increase in the company's stock price as compared to the original grant date. Book value per share at 2021 year-end increased 13% to $11.37, compared to $10.10 a year earlier, reflecting earnings per share and the net impact of stock repurchases. I will now turn the call back to Damian.

Damian Kozlowski, CEO

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

Operator, Operator

Our first question comes from Frank Schiraldi with Piper Sandler.

Frank Schiraldi, Analyst

I was wondering if you could discuss your expectations for an increase in net interest income or margin resulting from a 25 basis point rate hike in 2022, especially considering the $2.15 figure without any buybacks or rate hikes.

Damian Kozlowski, CEO

The situation evolves throughout the year due to prepayments. We have floors on our legacy $1 billion securitization portfolio related to floating-rate loans. However, those will be rolling off quickly, which means the floors will be lifted. In a stable environment, the initial benefit from a 25 basis point increase isn't significant. Yet if we consider the scenario as the year progresses, it quickly improves. By the end of 2021, if we see three or four rate hikes, it could greatly influence our run rate profitability. For the first half of the year, it might balance out as we continue adding floating-rate assets, but as we reach the midpoint, we expect a substantial positive impact. Regarding buybacks and guidance, increases in interest rates could lead to an impact of anywhere between 3% to even 10% on profitability by year-end. There's considerable variability depending on how we acquire assets. If we keep adding floating-rate loans and aggressively pay down the commercial real estate legacy portfolio, the impact will be larger. We'll observe this over the next few months and will provide updates as the year unfolds.

Frank Schiraldi, Analyst

Got it. So when you mention a range of 3% to 10%, are you referring to a potential improvement in the run rate starting in 2023, implying that we could see a 10% better run rate by the end of this year? Is that correct, rather than indicating a 10% increase over 2022?

Damian Kozlowski, CEO

We are uncertain about how we will manage our assets and the timing of prepays. I want to emphasize that the $1 billion plus securitization portfolio that is prepaying includes embedded fees. As this portfolio is unwound, we expect to realize approximately $10 million to $12 million in fees. Regarding buybacks, this could result in an impact of a couple of percent up to around 3% on earnings per share. Depending on how the balance sheet evolves, the percentage of impact could be higher relative to our guidance for 2022. It will certainly have an effect. If interest rates rise in 2022, particularly if the 10-year rate reaches between 2.50% to 3%, it will significantly affect the fourth quarter and into 2023.

Frank Schiraldi, Analyst

Got you. Okay. And then just regarding the securitizations, when I combine those with the multi-family bridge loans you're offering, which I see as a replacement for the maturing items, can you remind us of the estimated total portfolio? I believe it's around $2 billion. If you consider both together, what kind of levels do you anticipate seeing later this year?

Damian Kozlowski, CEO

We anticipate ending the year with approximately $400 million remaining. The amount could be higher, around $600 million, depending on interest rate fluctuations since these loans have floating rates. A significant increase in interest rates would likely encourage early repayments. Thus, we're estimating around $400 million left in the legacy portfolio by year-end, with new originations expected to reach about $1.2 billion, effectively doubling our origination from this year, resulting in a total roll-off of about $600 million.

Frank Schiraldi, Analyst

Great. Okay. And overall, is the average balance sheet size here, a good bogey for where it will remain through 2022? Is there significant growth on that front seen to get to a guide?

Damian Kozlowski, CEO

I think if you add $600 million there, we have other growing portfolios, so there’s a potential increase of around $1 billion. It depends on various factors, including securities, because if the 10-year rate increases significantly, we might reinvest in our securities portfolio as well. So, it's likely to be around $1 billion.

Frank Schiraldi, Analyst

I understand. Lastly, regarding the payment-related fees, while you've indicated that significant growth in that area isn't necessary to meet your goals, I noticed an 11% year-over-year growth in GDV, which is quite strong following a solid 2021, yet the card payment fees remained flat. Can you provide some insights on this? I realize different programs have varying margins, but any details on the year-over-year performance and expectations for growth from this point forward would be appreciated.

Damian Kozlowski, CEO

Yes. There has been a general shift recently, particularly over the last 18 months. Two key factors contributed to this. First, we had programs reaching higher tiers due to their rapid growth and large volumes, which are priced lower. This was initially putting pressure on our margins. Second, we've seen a transition from general-purpose reloadable cards to debit cards. The general-purpose reloadable market is experiencing challenges as it's less efficient for customers due to higher fees. As a result, many programs, like Chime, are moving towards debit, which generally carries a lower margin. Additionally, we experienced a decrease in our gross dollar volume growth after the borrower left the bank in the first quarter of last year. The impact of stimulus also played a role. As we move past the first quarter of this year, we will no longer be affected by these two factors, and we anticipate the introduction of new products and services with the implementations we are working on. This should help alleviate margin compression as the year progresses. Moreover, we are pursuing credit sponsorship opportunities that may enhance gross dollar volume, as people tend to borrow within their accounts. There are many developments occurring, and we expect to see significant economic benefits from our payment activities in 2022 and into 2023.

Frank Schiraldi, Analyst

Got you. So just the first quarter is tough year-over-year comps and then we should see some better growth through the rest of the year, year-over-year. Is that reasonable?

Damian Kozlowski, CEO

Yes. The first quarter was significantly impacted by a large stimulus of $1.7 trillion that flowed through the economy, particularly hitting in March. This makes it a challenging comparison because we also had borrowing during that time. After that, both the stimulus and borrowing ceased, resulting in no more comparative data, which means we'll revert to trend growth, likely in the double-digit range.

Frank Schiraldi, Analyst

GDV, double-digit GDV or is that?

Damian Kozlowski, CEO

Yes.

Operator, Operator

Our next question comes from Michael Perito with KBW.

Michael Perito, Analyst

I wanted to touch on a couple of points. First, regarding costs, you mentioned in your prepared remarks the intention to limit significant cost growth, and I understand that driving efficiencies is vital for you. However, it seems somewhat challenging given the current environment. Many of your traditional banking peers are generally indicating an increase in expenses this quarter. I would appreciate any additional insight you can provide on how you anticipate the expense run rate might trend in light of the inflationary pressures and wage-related issues currently affecting the industry.

Damian Kozlowski, CEO

Yes. Well, so we've tried to build a very scalable platform. And some of those scalabilities, especially in the payments, but also in the tech-enabled businesses we run like the securities business. We've been focused on building an infrastructure that doesn't add a lot of incremental costs by using new tools and technology capabilities. And that's really been paying off for us. What we've said over the last 4 years is that we'll create a jaws between revenue and expense of 10%, and we were able to do it again this year. And most of the expense growth in the fourth quarter was compensation related to the large size of loan growth. So we think we can still have that hold true in '22 and maybe even '23, even with the current inflation in the workforce. So we saw a good improvement in our workforce. If you look at the percentage of net income that we use for employees, our employee costs have gone up over the last 4 years. But as a percentage of our operating expenses, it's not moved up that much and as a percentage of net income, obviously, it's moved way down. So we know it's still playing out. There's clearly going to be wage inflation, but we think we're going to be able to cover and maintain that jaws relationship even with the current inflationary environment.

Michael Perito, Analyst

Got it. If we consider your long-term targets, please correct me if I'm mistaken, but those targets do not really factor in interest rates, right? Without going into too much detail, can we assume that higher interest rates might help achieve some of those targets sooner, at least in theory?

Damian Kozlowski, CEO

Once we move beyond the first 100 basis points and enter the realm of 200 basis points, a normalization of interest rates would have a significant impact on us because we are highly sensitive to asset movements. Over 70 percent of our balance sheet consists of floating rates, and we do not engage in any CD funding; everything is linked to the Fed funds rate. Therefore, as interest rates rise, our return on equity would increase, likely accelerating the achievement of our targets. Our strategies for managing the balance sheet are designed to be interest rate neutral, and while we conduct scenario planning, we communicate our outlook to the market without assuming any rate hikes. Consequently, this would have a notably positive effect, particularly in 2023.

Michael Perito, Analyst

Got it. Helpful. And then just 2 more quick ones. One, Paul, I heard the commentary about some of the tax rate noise. I'm just curious if you had a number you were budgeting for 2022 that we could use, or a range?

Paul Frenkiel, CFO

I think around 25% is a reasonable place to be. We can't really predict the exact amount of the tax benefit because it depends on the stock price as of the date of the vesting. So I think 25% for next year is a reasonable place.

Michael Perito, Analyst

Got it. And then just lastly, and I don't know if you guys can comment, but since it's kind of public information at this point, I figure I'd ask. Just obviously, SoFi formally got approved for the charter. Just wondering if you could help kind of throw some parameters or expectations around what the potential, if at all, exit that relationship given that they'll have their own charter could mean for you guys moving forward?

Damian Kozlowski, CEO

I don't believe it will significantly impact us. We value our partnership with SoFi, as they are committed to growing their company responsibly through the right collaborations. Although we haven't finalized our plans, there are numerous ways we can work together to provide the necessary technology and middle office support for SoFi. I hope to develop a strong long-term relationship, and I believe some form of partnership will continue. However, regardless of the nature of that relationship, it’s not currently a major factor. Even if we lost this partnership entirely, it wouldn’t greatly influence our future plans. We have many other initiatives, not all of which perform equally well. Some are quite successful, while others are less so. Therefore, I don’t anticipate any impact on our growth or year-over-year comparisons if they choose not to continue our collaboration next quarter.

Michael Perito, Analyst

Got it. That's helpful. And then just one quick clarification on that too. I mean their deposit program is primarily sweep related, correct, right? So I think it's fair to assume that they're not a big balance sheet deposit partner of yours at this point? Is that kind of a fair comment? Or can you not say?

Damian Kozlowski, CEO

I am not sure if they have explained how that mechanism works, but their contribution to our liquidity is minor. Therefore, it wouldn't significantly affect our deposit base.

Operator, Operator

Our next question comes from William Wallace with Raymond James.

William Wallace IV, Analyst

I wanted to revisit Frank's questions regarding the CRE launch and the bridge loans. I want to clarify if my understanding is correct: if we combine the bridge loans with the held-for-sale loan portfolio, which totals around $2 billion, do you plan to eventually shift everything from held for sale and originate new loans amounting to about $2 billion?

Damian Kozlowski, CEO

Yes, we're looking at around 300%. It may be shorter in the near term due to these prepayments. Our target is really 300% of capital, which is growing. We're filling our balance sheet, and depending on the opportunities in other areas, this lending approach is quite flexible and low risk. These are short-term loans, typically for 3 years. They are floating and can be sold to other banks or institutions interested in this type of lending. This part of the balance sheet works well with our other businesses to manage total exposure up to the $10 billion limit.

William Wallace IV, Analyst

Okay. Great. And so you think that the held-for-sale portion, I believe I heard you think it would be down to about $400 million by the end of the year, but you're saying you might not necessarily be able to keep up with that pace in the origination side, but ultimately what is the fee exemption?

Damian Kozlowski, CEO

I think we can achieve double what we accomplished, reaching $600 million in 2022. Actually, we performed at $700 million due to future funding parts of these loans. We anticipate doubling that next year to around $1.2 billion, but it will effectively be $1.4 billion with future funding. We have broadened our capacity to originate loans across the United States and have entered additional markets, performing well in terms of quality and rates in a low-risk manner. Our target is approximately 300%, possibly a bit more over the next 12 months due to a roll-off we can't predict. However, we believe we can clear all $1 billion of those held-for-sale loans this year due to rising interest rates, which will drive demand for fixed funding products that we do not offer. This could result in about $12 million in fees flowing through the income statement, as there are still unamortized fees from those held-for-sale loans issued at a discount. We are in a strong position with that portfolio and are confident in originating roughly double what we did this year. Any spread differential will be compensated by the fees amortized through loan repayments, and if repayment takes longer, that's beneficial as it provides additional interest income. Overall, we are well-positioned with that portfolio.

William Wallace IV, Analyst

Okay. Great. Yes, all the new originations, they come on floating, right? They're not going to come on under floors or anything like that, right? They just come on basically on the floor.

Damian Kozlowski, CEO

Yes, there'll be a floor on it, but there's no way it can be under the floor, right? Because we're at 0 interest rates. I guess if we turn to Germany or Japan it's possible. But otherwise, I think our inflation expectations ruined any idea that we're going to be negative interest rates.

William Wallace IV, Analyst

Yes. Okay. And you just spoke a little bit about credit sponsor opportunities. You've mentioned it periodically over the last year or so as an opportunity for Bancorp. I'm wondering if you could maybe help us kind of start to focus in on that? Like I'm assuming that any partnership would most likely be with an existing partner on the card side, assuming you decide to implement a program. How long does it take to build out a program with an existing partner? And when do you think you might make an announcement of some sort of partnership?

Damian Kozlowski, CEO

Your assumption is correct. The partners we have had long-standing relationships with in payments would likely be the first candidates. As we've indicated, we are prepared to utilize our own balance sheet, under the right conditions, to support reasonable programs that benefit both our partners and the market, particularly by providing credit options for underbanked individuals. We expect to make announcements soon, but I cannot provide specific details at this time as we need to follow our marketing process and allow our partners to lead the communication.

William Wallace IV, Analyst

I guess maybe a different way of asking the question is, were there to be some sort of announcement would you expect that the capabilities would have already been built out and an announcement would be made when the program might be ready to go live rather than when an agreement was struck?

Damian Kozlowski, CEO

Oh, yes. With these types of programs, there's a lot of work. In most cases it's true, not always, but mostly even on the payment side, there's a lot of work that's already been done prior to an announcement, right? Because you have to work out all the different types of envelope of activities, processors, regulatory, what's your compliance, how are you going to handle compliance and BSA? So there's usually a lot of work for anything in the consumer space, where there's other regulatory guidance that you need to follow, a lot of work. You'll be at least in the beta phase, if not the full rollout by the time we announced it with a partner.

William Wallace IV, Analyst

We are looking forward to a potential announcement in the near future. I have a broader question regarding the recent charters granted to Varo and SoFi. Given your insights into the fintech sector, could you share your thoughts on whether there is a growing interest among fintech companies to pursue charters? Or do you believe that these two instances are more exceptional cases? I'm interested in your perspective on what the trend might look like in the next three, five, or ten years.

Damian Kozlowski, CEO

I believe there will be some significant players, possibly SoFi or others, that will strive to become large institutions. It's feasible that one of the top 10 banks may emerge from these newer fintechs, potentially evolving into a major universal bank in the United States and even challenging the larger banks. Comments from industry leaders, such as Jamie Dimon, indicate that this is a genuine threat. They will need to develop extensive capabilities in areas like deposits, lending, and possibly securities. This decade will be telling. Innovation will continue to flourish, with many not pursuing licenses in the banking sector, as partnering with entities like us might be more efficient. In other sectors like healthcare and government, there's no ambition or capacity to become a bank, meaning a substantial portion of our portfolio isn't influenced by a banking charter. Currently, I view the ongoing developments as practical test cases. There are significant costs associated with being a bank and strict capital restrictions. Navigating the interagency processes, like CAMELS ratings, adds complexity for rapidly growing institutions seeking to attract a large customer base while also functioning as a bank in their early stages. However, I don't perceive fintechs obtaining charters as a threat to banking-as-a-service or ecosystem providers like us. I don't believe it will significantly impact our growth potential.

William Wallace IV, Analyst

Okay. Great. And just one last little kind of housekeeping question. You guys bought a ton of stock during the quarter and plan to continue doing so. I did notice that the period in share count was actually up in the quarter slightly. I just wonder if you could tell us a little bit about what your expectations are on whatever vesting or issuance might be coming down the road? Or how much of the buyback should we anticipate can flow through the tangible book side?

Damian Kozlowski, CEO

Yes. I'll let Paul address that. What occurred early on when we remediated the bank was that we issued a significant amount of stock, which has led to ongoing investments in the company. This is why you may have noticed a slight increase in shares and might see some offset from the buybacks. However, we have been issuing much less stock recently and at higher prices, so the dilution moving forward will be considerably lower. Paul, would you like to add anything?

Paul Frenkiel, CFO

Yes. I would refer you to the stock compensation footnote, which we show every year and actually every quarter, detailing the originations and the vesting of RSUs over a 3-year period. So it's easily calculable. As Damian noted, we issued some in May 2020, when the stock price was low, around $7. This resulted in a larger number of shares. If you look at the current stock price of around $30, the number of shares being granted based on a specific dollar amount is only a fraction. Yes, there will be some impact this year, but it will continue to diminish because there are only a fraction of new shares being granted.

Operator, Operator

There are no further questions. I'd like to turn the call back over to Damian Kozlowski for closing remarks.

Damian Kozlowski, CEO

Well, thank you, everyone, for attending and especially to analysts of the stock, who asked some great questions today. I appreciate you all listening, and we'll talk soon. Thank you, operator. Have a nice day.

Operator, Operator

You're welcome. Ladies and gentlemen, this does conclude the program. You may now disconnect. Everyone, have a great day.