Earnings Call Transcript - TBBK Q4 2022

Operator, Operator

Good morning, ladies and gentlemen, and welcome to The Bancorp Inc.'s Q4 and Fiscal 2022 Earnings Conference Call. This call is being recorded on Friday, January 27, 2023. I would now like to turn the conference over to Andres Viroslav. Please go ahead.

Andres Viroslav, Investor Relations

Thank you, operator. Good morning, and thank you for joining us today for The Bancorp's fourth quarter and fiscal 2022 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 1-877-674-7070 with a confirmation code of 735961. 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. Good morning, everyone. The Bancorp earned $0.71 a share in the fourth quarter, driven by 28% revenue growth, while expenses were approximately flat year-over-year. Gross dollar volume, transaction growth accelerated to 30% year-over-year, driven by continued double-digit growth in most categories. Core loan growth, which excludes loans previously generated for securitization, was 4% quarter-over-quarter, led by floating rate commercial real estate multifamily with 12% growth. Year-over-year core loan growth was 45% with 168% growth in commercial real estate multifamily; 22% growth in Institutional, which includes SBLOC and IBLOC, plus IRA financing; and 14% growth in commercial, which includes fleet leasing and SBA loans, excluding PPP loans. Net interest margin grew dramatically quarter-over-quarter from 3.69% to 4.21% compared to 3.51% in the fourth quarter of 2021, driven by the impact of Federal Reserve rate hikes. Efficiency and productivity continue to be a key focus of management, with expenses approximately flat year-over-year. Return on equity rose significantly over prior periods to 24%. 2022 was another year of strategic and financial progress for The Bancorp. We continue to improve our ecosystem for our fintech partners while investing across our platform to improve functionality and efficiency in all business lines. 2023 should show continued financial and operational improvement with a focus on continued rigorous risk management and credit oversight. In addition, our focus in '23 will be determining our next strategic steps as a company. After having established exemplar performance, we are now turning our attention to major initiatives, which will sustain profitability and growth as we approach the regulation II, Durbin balance sheet limit of $10 billion. We believe that TBBK's unique capabilities can be monetized more broadly and that the $10 billion limit will not restrict our ability to generate increased profitability. This incremental profitability will be generated from fees by distributing both assets and liabilities. Gross dollar volume growth and the sale of unique technology services and other platforms that will drive sustained EPS growth and return on equity. For 2023, we are confirming our guidance of $3.20 a share, not including the net impact of share buybacks of approximately $25 million a quarter or $100 million for the full year. We will update our guidance as we learn more in the coming months. However, we believe our guidance is attainable even with significant economic ambiguity and potential stress in the macro environment. I now turn the call over to Paul Frenkiel, our CFO, for more details on the fourth quarter and full year '22.

Paul Frenkiel, CFO

Thank you, Damian. Return on assets and equity for Q4 2022 were respectively 2.1% and 24% compared to 1.7% and 17% in Q4 2021. These increases were significantly driven by a 47% 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 more from a normalized and higher interest rate environment. Accordingly, over a period of years, it has largely allowed as 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 Q4 2022, the yield on interest-earning assets increased to 5.9%, while the cost of deposits increased to 1.7%. These factors were also reflected in the 4.2% net interest margin in Q4 2022 which represented a significant increase over prior periods. The provision for credit losses was $2.8 million in Q4 2022 compared to $1.6 million in Q4 2021. The $2.8 million included an upward adjustment of approximately $900,000 in the qualitative economic factor in our CECL model, which is forward-looking, to the extent that economic uncertainties resulted in the future, a reversal of that provision component would result. Conversely, deterioration in the economy could result in additional forward-looking provisions. Prepaid debit and other payment-related accounts are our largest funding source and the primary driver of noninterest income. Total fees and other payments income of $22 million in Q4 2022 increased 10% compared to Q4 2021. Noninterest expense for Q4 2022 was $43 million, which was comparable to Q4 2021, a decrease in legal reflecting the resolution of various matters and a decrease in salary expense offsetting increasing FDIC insurance and travel expense. Book value per share at quarter-end increased 10% to $12.47 compared to $11.30 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 will now turn the call back to Damian.

Damian Kozlowski, CEO

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

Operator, Operator

Will do. Your first question comes from Frank Schiraldi.

Frank Schiraldi, Analyst

Could you provide your thoughts on the strong quarter we had regarding gross dollar volume growth year-over-year? You've been guiding towards this outcome, so what's your perspective on the future potential? Also, how much of that growth contributes to card fee income growth?

Damian Kozlowski, CEO

Yes. I think this was a very good, normalized quarter. We had the stimulus. We never gapped down and we've been building all year back to trend. So we had 1%, I think it was 5%, and now we're at 13%. I think you're going to see this range, 12% to 15% gross dollar volume growth going forward this year. I think you're going to see around 9%, 10%, maybe even 11% translation into fees year-over-year. That was before the big stimulus bump. So very encouraging. When we look at our pipeline, we've got some real successes in corporate payments that have ramped up very quickly. So it looks like it's going to be at that level. Hopefully, we'll get a bit more, but it looks like it's going to be a strong year.

Frank Schiraldi, Analyst

Great. And then just on loan growth, the SBLOC, IBLOC portfolio growth has slowed a little bit, certainly over the last couple of quarters. And I just wondered if you could talk about your outlook for growth in that portfolio?

Damian Kozlowski, CEO

Yes, that seems likely. We've seen this before. A rapid change in liquid borrowing can shock people, but it’s somewhat reassuring that we were only down 1%. While there were more payoffs, they were balanced by more originations. By mid-year, as interest rates stabilize, borrowing will shift from liquidity needs to other requirements. We are nearing our balance sheet limit, so we may not see the historic 20% growth, but there will still be some growth, though not as dramatic as before until things normalize. Once they do, we can expect a return to the previous growth trend.

Frank Schiraldi, Analyst

Okay. And then finally, I just wondered if you could talk about things that you're doing to protect margin here as we perhaps come to the peak of this rate cycle. And what sort of margin reaction do you expect if we get a rate cut or two at the end of 2023 or into 2024?

Damian Kozlowski, CEO

Yes. As Paul mentioned, we've fully opened our balance sheet to the variable side. We anticipated a rise in interest rates, which ended up being more pronounced than we expected. However, we've quickly adapted our strategy. We have initiated a project called Project Flex, which aims to increase our fixed-rate exposure. Currently, we have a fixed-rate program in our commercial real estate business and are adding more fixed-rate exposure to our commercial segment. So far, we haven't purchased any bonds. One straightforward method to achieve this is by locking in forward rates using agency securities with terms of 3, 5, 7, and 10 years. We are closely monitoring the situation and plan to significantly reduce the variable portion of our balance sheet as interest rates peak. Initially, we were around 55% variable when we started this process, and with the growth of those variable rate businesses, that percentage increased since we weren't acquiring any fixed-rate exposure. Now we need to reverse that trend. Fortunately, as rates decrease, balances will increase in areas such as IBLOC and SBLOC. We are running those models to mitigate the impact of interest rate fluctuations, and we are well-positioned to do so. We forecast being able to lock in an increasing amount of fixed-rate exposure. It's important to note that our current financials do not factor in bond purchases, and we have not included the fixed-rate exposure on the bond side in the $3.20 earnings per share estimates.

Frank Schiraldi, Analyst

Okay, all right. That's helpful. And just as you're thinking about fixed rate exposure in the loan book, can you talk about what sort of products are you looking at? Or are you thinking about permanent financing on the multifamily side?

Damian Kozlowski, CEO

There is a market for fixed rate loans and commercial real estate transitional loans, although it is not permanent. This is particularly true for lower dollar amounts since interest rate caps have become quite costly. We need to use interest rate caps on our loans to safeguard against interest rate volatility, and we usually maintain reserves for this. Currently, there aren't many programs available for fixed rate transitional loans. We've already completed over $50 million in this area after a recent launch, which provides a three-year cushion. Additionally, it's important to note that our portfolio includes floors on all our loans. While we can benefit from variable rates on the upside, much of our exposure is not subject to downside fluctuations. Therefore, even if there is a significant decline in rates set by the Fed, our rates will not be greatly impacted.

Operator, Operator

Your next question comes from Michael Perito with KBW. Please go ahead.

Michael Perito, Analyst

I wanted to follow up on that kind of margin line of questioning a little bit and maybe drill down on the liquidity position a bit more specifically. Damian, I know you mentioned some high-level stuff. But so would you guys say it's fair for us to assume that over the next 6 months or so, the excess cash position you guys will probably start putting to work a bit more on the bond book side? I mean I think it's been, what, like three years since you bought a bond which obviously looks really good now. But just curious kind of functionally how we should think about the investment portfolio? Does it kind of trough out here in the next quarter or two and then start growing? Or what you guys are thinking there?

Damian Kozlowski, CEO

Yes, we're closely monitoring everything, including yield curves, on almost a daily basis. Our balance sheet has significant flexibility since we have many options for obtaining deposits and we can operate well within the Durbin limit. This allows us to make precise decisions on how much fixed-rate exposure to take and the timing of those decisions. While we may sacrifice a small margin, we're not willing to sacrifice a substantial amount. Additionally, our commercial real estate loans have floors that protect us for three years. We're managing the SBLOC portfolio, which adjusts quickly with interest rates and consists entirely of demand loans. Although we're not focused solely on demand loans, our balance sheet offers exceptional flexibility for adding fixed-rate exposure. It's worth noting that our loan yields are generally lowest in this portfolio, while our higher-yielding portfolios include fixed-rate protections. Overall, we are well-positioned to adjust our balance sheet and increase our fixed-rate exposure significantly.

Michael Perito, Analyst

That's very helpful. Regarding loan growth, what is the current status of the pipelines across the various business lines? Additionally, was any of the slowdown this quarter a deliberate choice? It seems there was a significant improvement in deposits. The balance sheet appears to be better positioned to support growth in 2023. I'm interested in understanding the dynamics at play and your near-term expectations for loan growth.

Damian Kozlowski, CEO

Yes, we did experience some catch-up, which has economically benefited us, although it wasn't intentional. We are not compromising on credit quality at all. In times of low volumes, there can be tendencies for people to explore commercial options, but that might not be advisable right now. We are being extremely cautious and adhering to our consistent underwriting standards. The market is influenced by interest rates, but we have observed strong growth in leasing. There remains a significant backlog in car deliveries on the commercial side. We are being very careful about the ongoing slowdown due to increased interest rates and uncertainty in new business investments despite having government guarantees on the SBA. Even if we finish 2023 with flat growth or an increase of 5% to 10%, that would still align with our earnings per share expectations. We see a lot of potential for upside. If we experience trend growth, the potential would be even more significant. We have approached our guidance cautiously and have considered various scenarios while excluding some historical growth metrics and bonds. Previously, we thought our net interest margin would top out around 4%, but we've exceeded that benchmark. This quarter, we've seen a substantial increase in net interest income, and our gross dollar volume has returned to trend. There are many positive indicators, and we will have more information to share in January. By the end of the first quarter, we will have a clearer understanding, and if we need to adjust our guidance, we will be better informed about the rates as well. It should be an exciting quarter, and I look forward to finding out what lies ahead, just as you do.

Michael Perito, Analyst

Lastly, I want to point out that you have managed to keep expenses steady for over two years. With the net interest margin exceeding 4%, your profitability outlook seems structurally stronger. I understand you are working on several initiatives. There has been some disruption on the customer side due to regulatory actions affecting competitors. I'm wondering if, as we consider the pace of investment and growth in operating expenses, there is potential for that growth to be more pronounced this year compared to the last two years. Did you identify any opportunities, or how should we approach this?

Damian Kozlowski, CEO

We are always focused on efficiency and productivity, but there is definitely core inflation that will impact us next year. One area affected is employee costs. For nearly five years, we have maintained flat expenses, largely due to the restructuring in our operations. Historically, we are not going to experience zero growth, nor will we stick to a 2% increase. We want to keep investing in our people. The costs will not arise from regulatory issues since we have made substantial investments in that area. Instead, they will stem from embedded core inflation. Currently, we benefit from pricing and inflation, leading to an increase in our gross dollar volume. This year, there will be a significant difference between revenue growth and expense growth, exceeding our historical trend of flat expenses. We anticipate at least a 10% gap between revenue and expenses, likely more, but we won't maintain flat expenses this year, primarily due to employee costs and core inflation.

Operator, Operator

There are no further questions at this time. I will now turn the call over to Damian Kozlowski for closing remarks.

Damian Kozlowski, CEO

Thank you, operator. It's been a really good quarter for us. We made a lot of progress. As I said, we're looking forward to the next quarter to really tell us a lot more about 2023. So as we get information, we will continue to talk with everyone on the phone. And when we get to the end of the first quarter, I think we'll have a lot more information to share about how 2023 might ultimately end on the metrics in which we measure this business. So thank you, everyone and have a great day.

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.