Earnings Call Transcript - TBBK Q1 2023

Operator, Operator

Good morning ladies and gentlemen, and welcome to The Bancorp's First Quarter 2023 Earnings Conference Call. At this time, all lines are in a listen-only mode. Following the presentation we will conduct a question-and-answer session. This call is being recorded on Friday, April 28, 2023. I would now like to turn the conference over to Andres Viroslav. Please go ahead, sir.

Andres Viroslav, Executive

Thank you, operator. Good morning, and thank you for joining us today for The Bancorp's first quarter 2023 financial results conference call. On the call with me today are Damian Kozlowski, Chief Executive Officer; and Paul Frenkiel, our Chief Financial Officer. This morning's call is being webcast on our website. 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 423750. 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'd like to turn the call over to The Bancorp's Chief Executive Officer, Damian Kozlowski. Damian?

Damian Kozlowski, CEO

Thank you, Andres. The Bancorp earned $0.88 a share with 47% revenue growth and 25% expense growth. Net income grew 70% year-over-year. ROE for the first quarter was 28% compared to 18% in the first quarter of 2022. ROA for the first quarter was 2.6 compared to 1.6 in the first quarter of 2022. GDV growth was 19% year-over-year. Fintech Solutions fee growth was 24% year-over-year. NIM expanded quarter-over-quarter from 421 to 467. The efficiency ratio remained at 42% quarter-over-quarter and loan growth excluding loans held for sale was 29% year-over-year, with a slight 2% decrease quarter-over-quarter reflecting the steep increase in client borrowing costs. The recent dislocation in the banking market did not materially impact our company. With granular deposits spread across more than 130 million insured small accounts through our Fintech ecosystem, a lower risk variable rate and short duration credit book, and significant liquidity in borrowing capacity, TBBK is well positioned to manage the increased volatility at the beginning of 2023. Over the last three years, we have purposely and methodically built a platform that would benefit from rising rates and rigorously protect our company from an interest rate shock or systemic event risk created by a banking system dislocation. We have included two new schedules in our earnings release. The first provides more detail on our deposit base, which has an overwhelming majority of insured and low-balance stored value card accounts. The second is a review of our significant borrowing capacity. The first quarter significantly surpassed our expectations in ROE, ROA, GDV growth, Fintech Solutions fee growth, NIM efficiency ratio, net income growth, and EPS. Indications are that continued financial momentum will result in further improved metrics in 2023, moreover, other potentially positive tailwinds that might additionally improve performance in 2023. Number one, above trend payments GDV growth of more than 15%; two, Fed funds rate above 5%; three, increased NIM performance due to slower loan growth versus higher deposit growth; and four, the purchase of agency, treasury, and other securities not included in our forecast. We have not purchased significant long-term fixed rate securities since 2018. Due to these factors in our first quarter performance, we are raising guidance from $3.20 a share to $3.60 a share without including the impact of share buybacks of $25 million per quarter for 2023. I'll now turn the call over to Paul Frenkiel, our CFO for more on the first quarter.

Paul Frenkiel, CFO

Thank you, Damian. Before reviewing quarterly results, I would like to comment on the low risk liquidity profile of The Bancorp. As Damian noted, the bank's deposit base is largely comprised of small balance accounts, notwithstanding the corresponding unrealistic risk that our small depositors withdraw their funds in a short window. The Bancorp exceeds potential liquidity needs by maintaining lines of credit with the Federal Home Loan Bank and the Federal Reserve Bank of approximately $3.3 billion. The Bancorp's line with the Federal Home Loan Bank is collateralized by its apartment building loans, as residential collateral is mandated by that agency's charter. The Federal Reserve Bank also has collateral requirements which The Bancorp must satisfy with its line of credit with them. Additionally, The Bancorp has access to significant other institutional liquidity, which is periodically tested. The Bancorp has maintained a low interest rate risk profile and emphasized variable rate assets with policy mandated risk limits. As a result of its variable rate loans and securities, The Bancorp benefited from the higher rates this quarter, resulting in increases in return on assets and equity to 2.6% and 28%. These increases were significantly driven by a 62% 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 more normalized and 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. Accordingly, in Q1 2023, the yield on interest earning assets increased to 6.6% while the cost of deposits had increased to 2.1%. Those factors were also reflected in the 4.7% NIM in Q1 2023, representing another increase over prior periods. The provision for credit losses was $1.9 million in Q4 2023 compared to $1.5 million in Q1 2022. Of the $1.9 million, approximately $1.3 million resulted from the impact of historical net charge-offs applied to the estimated remaining lives of outstanding loans. The balance of the $1.9 million resulted primarily from first quarter charge-offs. Additionally, a $1 million charge against a movie theater property and other real estate owned was recognized in other non-interest expense. Prepaid debit and other payment-related accounts are our largest funding source and the primary driver of non-interest income. Total fees and other payments income of $25 million in Q1 2023 increased 24% compared to Q1 2022 and 14% after eliminating a $1.4 million termination fee and $600,000 of income related to Q4 2022. Non-interest expense for Q1 2023 was $48 million, which was 25% higher than Q1 2022. The majority of the increase resulted from salary expenses, which also increased 25% and reflected a larger number of staff in financial crimes, compliance and information technology. Staffing increases reflected increases in deposit transaction volume and the development of new products. The increase also reflected higher stock compensation expenses as a result of a focus on stock ownership. Book value per share at quarter-end increased 15% to $13.11 compared to $11.41 a year earlier, reflecting retained earnings partially offset by fair value adjustments to the investment portfolio resulting from the higher rate environment. Quarterly share repurchases should continue to reduce shares outstanding. I'll now turn the call back to Damian.

Damian Kozlowski, CEO

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

David Feaster, Analyst

Hey, good morning everybody.

Damian Kozlowski, CEO

Good morning, David.

David Feaster, Analyst

Maybe let's start with GDV. It's great to see the growth in the quarter and I know it can be really hard to dissect. But could you just maybe talk about some of the drivers of that and what you're seeing? You talked in the deck about growth at both existing clients and additions to new clients last year that are scaling up. Just curious maybe the attribution between the two and just any thoughts on GDV growth going forward as you look into your crystal ball?

Damian Kozlowski, CEO

It's been very broad-based across not only from neobanks but in healthcare, government, and new products in the corporate payment space. It was very broad—surprisingly robust, above trend when you get past that 15% as I mentioned, but it's not concentrated in one area. So we're very pleased with the broad-based nature of it, and also the new product sets and things like corporate payments have surpassed our expectations.

David Feaster, Analyst

That's great. And then maybe just kind of following on, just given the volatility in the market, I would probably think this pushes more clients to you just given the scale and stability of your platform. I know you've always got a lot of clients that are looking to join, but have you seen any shift in the kind of the pulse of the market or change in the increases in the pipeline? And maybe just how do you think about the pace of new client adds this year?

Damian Kozlowski, CEO

So we've had a very robust and steady pipeline for the last three years and we haven't seen any real change. As we mentioned before, there are many companies that come to us that we don't implement, and they go to one of our competitors because they're not of the size or maturity level to really take advantage of our ecosystem, and so we don't add those partners until they mature somewhere else. But it's been very stable and broad-based. It's the development of new areas and new product sets within our existing clients. We think the double-digit GDV growth is well supported, and we have pretty good visibility for the next 18 to 24 months. A lot of stability. And we don't, as you know, our partners, once they're here, they typically stay for at least a year, but often much longer. So we have a lot of visibility and stability in the portfolio and in the pipeline.

David Feaster, Analyst

Okay. And then maybe just touching on the loan portfolio for a second, and specifically, within the bridge, obvious the bridge, the real estate bridge, obviously, there's a hyper focus on CRE and I appreciate the color in the slide deck on the segment, but I'm just curious, what are you seeing in this segment? Obviously, you've got strong underwriting standards, but as you look broadly are, just curious your thoughts on that segment and then maybe any color on kind of what drove the S-block and I-block clients in the quarter? Was that just market volatility or any other trends you're seeing there?

Damian Kozlowski, CEO

Yes, well, the CRE is extremely stable. Now that the whole market has slowed down because there's been a huge repricing obviously due to the rise in interest rates. Our underwriting standards have not changed. We have interest rate caps on all the loans and floors in many instances. So we haven't had any dislocation whatsoever in that portfolio. We have had a lot of the wind down of the old portfolio, and people have been finding financing for their takeouts. So I can't really respond other than it has slowed down a bit. I think that will pick up once you stop seeing such a steep curve in interest rates. But we have nothing to report really. On the S-block side, that's about price sensitivity. We had a lot of price-sensitive clients, with the historic interest rate rise, and people simply experienced a bit of sticker shock. We've seen that slowdown substantially moderating, and we expect our pipeline has been growing this month in the S-block and I-block side. So we expect it to get back to normal for the same reasons as the interest rates top out. We are not concerned by that at all. We just got more liquidity from that business, and that went into fed funds at 475. It didn't have a significant impact. We want to have excess cash because we ultimately will lock in and buy fixed rate securities when the time is right. So I believe that will slow down a lot over this quarter and the next quarter; there won't be as many pay downs. Even if there are paydowns, they're not going to have a big impact on our financials.

David Feaster, Analyst

Yes. Okay. That's helpful. Thanks everybody.

Operator, Operator

Thank you. Your next question comes from Frank Schiraldi with Piper Sandler. Please go ahead.

Frank Schiraldi, Analyst

Thanks. Good morning.

Damian Kozlowski, CEO

Good morning, Frank.

Frank Schiraldi, Analyst

On the just follow up on the loan book, the S-block, so Damian, you talked about a stronger pipeline there. Is it still probably in the near-term sort of net pay downs, do you think, or do you think it's more stable that business at these levels?

Damian Kozlowski, CEO

Well, what we've seen this month is that stability is returning. The pipeline has been growing. It's just that the interest rate increases have been so steep over such a short period that people are adjusting their perceptions on borrowing against securities and insurance. It's been stabilizing this month, so it should moderate a lot. Once again, I don't think it will be anywhere near as high as it was in the first quarter, right? It would be more towards the flat side. I can't be certain, but it will be more towards the flat side. Even if we had pay downs that were half as much as we did in the first quarter, that would simply go into our cash position and it would be at 5% or 5.25% at fed funds.

Frank Schiraldi, Analyst

Right. Okay. And then on the multifamily bridge loans, if you add that to the legacy portfolio you still have on the books, is that sort of, are you at the limits of what you want to see on the balance sheet? Just curious if you have more room to grow that business overall or if loan growth will be driven more by SBA going forward?

Paul Frenkiel, CFO

Yes, Frank, I think that we do have some extra room there because the loans we're making now are apartment building loans. If you recall, when COVID was an issue, we cited the company, the consultants that went back all the way back to the Great Depression and documented that the type of lending that we do is one of the safest forms of lending. So we're confident we can increase that and have a measurable effect on the balance sheet.

Damian Kozlowski, CEO

Yes. And remember that we're generally at 300% of capital. We'll keep that book, but there are a lot of ways to recycle those loans. We're not going to do CLO type structures like we have done in the past, but there's a very large market for those types of loans to recycle, and we can take gains and fees for anything that we think is in excess of that. So we've got room, and obviously, even with our buyback, our capital is growing significantly this year.

Frank Schiraldi, Analyst

Okay. And then just lastly with the forward curves, sort of implying that we're near the peak of Fed funds, and implying, I mean, we'll see what happens, but implying that we get down significantly in rates in terms of fed funds in 2024. I know you have floors in these multi-family loans that protect you on the way down. Can you give any detail on other hedges you might have on the portfolio or what your expectations are for the NIM given, let's say, a 25 basis point contraction in Fed funds?

Paul Frenkiel, CFO

Yes, so as you saw, our mix is shifting every day now. We are putting out fixed rate exposure, excluding the bonds in all our programs at a greater rate. The new CRE loans obviously have very high floors on them. We're getting less asset sensitive by the day. If we see normalized rates over the next 18 months in the four-plus range, that will eliminate a lot of that asset sensitivity just with the loans that we're doing. If we add to that a substantial purchase of fixed rate bonds, as we top out our rates and they start to cut, the yield curve will disinvert hopefully. Then that's when we'll start the purchase program of fixed rate securities, which should really mitigate any downside. Our base case is that rates are not going to go far below, say in the 3.5% range for the foreseeable future. If they do, of course, more of the floors kick in in the loans, and we will, by then, be ready to buy a significant amount of fixed rate securities. We have just so much more flexibility than probably the average bank, just because we have such a large part of our balance sheet that has not been invested in long-term securities. It's kind of the opposite of where all the problems are in banking. We didn't do any of that. Now we can take full advantage of higher long-term rates, especially if the view and yield curve changes and we'll lock those rates in.

Frank Schiraldi, Analyst

Okay. So you think you can maintain a NIM in the mid-4s, 4% range. Do you think that's doable in a sort of a sub-4% Fed funds kind of outlook in 2024? If that's where we get?

Damian Kozlowski, CEO

Yes, we can’t be certain, but I think we’re going to be able to stay. It totally depends on whether the Fed overreacts to things and goes back to zero interest rates. We were at zero interest rates and we made a 19% ROE too. I think if you have any normal situation and we get normal fed fund rates, this is very sustainable. We did this in 2018; we became far less asset sensitive just at the right time, and I believe we've left ourselves immense flexibility to lock in long-term fixed rates in the portfolios.

Frank Schiraldi, Analyst

Great. Okay, thanks for all the color.

Operator, Operator

Thank you. Your next question comes from Tim Switzer with KBW. Please go ahead.

Tim Switzer, Analyst

Hey there, thanks for taking my question. I'm on for Mike Perito. I just wanted…

Damian Kozlowski, CEO

Good morning.

Tim Switzer, Analyst

Hey, good morning. Could you clarify real quick on the comments you just made about your plan to maybe start purchasing these treasury securities? Are you going to wait until you see the Fed starting to cut or are you going to be a little bit more proactive? It sounded like you're waiting until the Fed cut.

Damian Kozlowski, CEO

Well, usually that's the best time, but we'll start when we feel it's right. We're looking at this on a daily basis, with a lot of advisors and analyzing market conditions. We don’t have to do panic buying because we have a lot of flexibility. We can see how it plays out with interest rates and inflation numbers. We could easily buy $1.5 billion, $2 billion of fixed rate securities at a much higher rate than our peer group. We're going to watch it, and we’ll start nibbling when we feel the time is right, then fully allocate that part of the balance sheet to mitigate our variable rate exposure on some of our other assets like our institutional business. Once again, there are variable parts of our portfolio that aren't really variable because they have floors like the CRE loans. We are in a very good position and we will remain flexible as we did before to take full advantage of our current balance sheet position. It is much easier obviously in a higher interest rate to trade for fixed versus variable than the other way around. We're watching everything, and we will continue to put on loans that are fixed rate daily. Our asset sensitivity goes down, and we get the benefits of much higher rates on the loan side. We haven't changed any of our standards on underwriting. Some have, we have not. That will enable us to navigate and maintain our NIM.

Tim Switzer, Analyst

Okay. Yes, that's pretty clear. And let's say the Fed hikes one more time and then holds it right here. Would you expect continued NIM expansion over the rest of the year as you keep growing this loan book?

Damian Kozlowski, CEO

Yes, there still is some lag. Our funding costs adjust immediately, and it takes up to 90 days or more for our variable rate loan book to fully adjust. You’re going to have a wave of adjustments coming through the system. Plus every loan we put on has pricing above a 100% of the increase. We're getting over a 100% in the loan book because we're putting on much higher rate assets that are fixed. So yes, it should continue to expand for those two reasons.

Tim Switzer, Analyst

Okay, great. If we look at the loan portfolio, taking out the S-block and the runoff commercial portfolio, I think you did about 5% quarterly loan growth. Is that reasonable to expect over the rest of the year for the other categories?

Damian Kozlowski, CEO

Yes.

Tim Switzer, Analyst

Okay, great. Thank you. That's all from me.

Operator, Operator

Thank you. There are no further questions at this time. Looks like we have a follow-up question from David Feaster. Please go ahead.

David Feaster, Analyst

Hey, maybe just following up, kind of touching on the expense side. Obviously, there are some seasonally higher expenses. I'm just curious, considering the revenue strength, are we starting to accelerate some expenses or projects, or was there anything maybe more one-time in that other expense line item? And then just as we think about the efficiency ratio, it kind of sounds like with some of the initiatives that you're just talking about, do you think we kind of stay here in that low 40% realm, or given the stability and the growth opportunities? I mean, do we drop below 40%? Just curious how you think about that.

Damian Kozlowski, CEO

Yes, well it'll be around 40%, but it could drop below that obviously because of the revenue growth. But go ahead, Paul.

Paul Frenkiel, CFO

Yes, so the non-interest expense was driven largely by the number of employees and staff additions in terms of salary expense. Other expenses also increased. Those were volume-driven, associated with new customers and new accounts, the transaction influx, the increase in GDV, and other transactions. We expect that some of those expenses will moderate. There was some catch-up expense in terms of the number of employees; however, we have very good prospects, and there must be some anticipatory hires. We're looking at new products, and we want to be fully staffed for compliance reasons, financial crime support, and more. So we see the bank continuing to grow at least at double-digit rates, and we are staffing up for that.

David Feaster, Analyst

Okay, that makes sense. So continue, so this is kind of a good core run rate and again, expect some continued growth as we're just in the growth in the expense line on just as we're planning for the future growth that you're talking about.

Damian Kozlowski, CEO

Yes. And remember we had some real core inflation in the economy too, which hit us. We made salary adjustments for our employees and changed grades. It’s a good sign that attrition is down across the industry. Ours is about half of what the industry is, and we have incredible stability in our top 70 to 100 employees. We have virtually no attrition in that group, but that adds to it. We'll see how core inflation affects employee costs, but we do see a moderation, I think, Paul, right? We'll see a moderation.

Paul Frenkiel, CFO

Yes, I think we’ll still have, as Damian said, some inflation adjustments to our salary structure. So you'll still see some elevated increases compared to the prior year. But over the next year or so, it should moderate when we are more fully staffed up, which we need to do.

Damian Kozlowski, CEO

Yes. But we're investing a lot, I mean, from our whole tech stack to how we use the cloud across our entire portfolio, putting new systems, the best systems available for things like ACH. Those investments have been happening continuously for the last five years. That’s why we have our position in the marketplace; we really have built a substantially robust infrastructure and ecosystem across not only the tech aspects but all the compliance, third-party risk oversight, and everything important for our partner programs.

David Feaster, Analyst

Makes a lot of sense. Thank you.

Operator, Operator

Thank you. Your following question is from Tim Switzer. Please go ahead.

Tim Switzer, Analyst

Hey, thanks for taking my follow-up. I was actually going to ask about expenses, but since I'm on here, if I can get a quick one. The tax rate was just a little bit lower this quarter. What are your expectations going forward?

Damian Kozlowski, CEO

Ongoing, the tax accounting is a little bit confusing, and I won't go into the details here. We do talk about it in our 10Q and so forth, but I think for your models, the normal historical rate of around 26% is closer to an annualized rate.

Tim Switzer, Analyst

Okay. Perfect. Thanks. That's all from me.

Paul Frenkiel, CFO

Okay. Thanks Tim.

Operator, Operator

Thank you. There are no further questions at this time. Mr. Kozlowski, please go ahead.

Damian Kozlowski, CEO

Thank you for joining us today. We appreciate it, and we'll talk soon. Operator, you can disconnect the call.

Operator, Operator

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 great day.