Earnings Call Transcript - TBBK Q1 2022

Operator, Operator

Good day and welcome to the First Quarter 2022, The Bancorp, Inc. Earnings Conference Call. As a reminder, this call is being recorded. I would like to turn the call over to Andres Viroslav. You may begin. Thank you, operator. Good morning and thank you for joining us today for The Bancorp's first quarter 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 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 6984967. 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. 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. In the first quarter, The Bancorp earned $29 million in net income or $0.50 a share from 5% year-over-year revenue growth, excluding the impact of PPP-related interest and fees with an 8% reduction in expense. Loan interest income, excluding PPP and discontinued loans increased 12%, while non-interest income increased 4% year-over-year. Total loans excluding loans at fair value and reclassified discontinued operations loans grew 45% year-over-year and 10% quarter-over-quarter. Balance growth year-over-year was led by Institutional Banking which includes our securities backed line of credit, insurance backed line of credit and RIA financing and Real Estate Bridge Lending. Real Estate Bridge Lending has generated over $800 million in loans since inception, while Institutional Banking balances increased 32% year-over-year. All businesses continue to grow quarter-over-quarter with Real Estate Bridge Lending growing 29%, Institutional 8% and Leasing and SBA each growing 1%, excluding PPP loans. Gross dollar volume from our cards business grew 2% year-over-year, even with the impact of one-time stimulus and other government payments in '21. Payments fees decreased 2%, reflecting the impact of Varo which exited the Bank in the second quarter of '21. GDV grew 15% over Q4 '21, reflecting the impact of first quarter tax refund spending and other growth. We continue to experience business momentum in '22. Loan pipelines across our businesses remain robust and should offset any repayments in our loan book due to increasing interest rates. Our mostly floating rate Real Estate and Institutional businesses grew significantly in the quarter. Our Commercial business which includes SBA and Fleet Leasing was mostly flat during the quarter due to some maturities and repayments but we should have growth in those portfolios for the balance of the year. With the predicted rise in interest rates throughout 2022, our lending portfolios which are 70% floating will increase net interest income after the impact of rate floors are exceeded. Our Payments business showed resilience in the first quarter. In 2021, significant government stimulus in the first quarter made the 2021 GDVs hard to beat. However, due to continued growth in our existing and new programs, '22 first quarter was able to show a year-over-year increase of 2% in GDV even without this stimulus and additionally, with our Varo volume that exited the Bank in the second quarter. We continue to see significant opportunities to grow in '22 and beyond and should show increasing growth as the year progresses. Lastly, we have previously announced both our new FinTech Hub in Sioux Falls and our proposed switch to licensing to an OCC regulated national bank. We believe these changes solidify our commitment to the economic development of Sioux Falls and more appropriately reflect our nationally based franchises and help align regulatory oversight with our primary competitor set. We look forward to completing the construction and build-out of our facilities in '23 and our regulatory changes by the end of this year. I now turn our call over to our CFO, Paul Frenkiel, to give more details about the first quarter.

Paul Frenkiel, CFO

Thank you, Damian. Return on assets and equity for first quarter 2022 were respectively, 1.7% and 18% compared to 1.6% and 18% in Q1 2021. Loan interest income in each quarter to 2021 was impacted by repayments of CRE bridge loans previously originated for securitization but now held on the balance sheet. In Q3 2021, we began originating new such loans under the Real Estate Bridge Lending caption. Q1 2022 was the first quarter in which there was a net increase in related interest as the impact of new originations exceeded the decreases resulting from repayments. Fees related to those repayments are recorded in net realized and unrealized gains on commercial loans which increased $1.4 million year-over-year. Notwithstanding the impact of the CRE repayments, loans and commercial loans at fair value at quarter end had increased 15% over the past year. Interest income in Q1 2022 reflected a reduction of $3.9 million in securities interest compared to Q1 2021, reflecting lower securities balances, repayments of higher-yielding securities and lower reinvestment rates. Our interest expense was reduced from 21 basis points during Q1 2021 to 19 basis points during Q1 2022. Most of our deposit interest expense is contractually tied to a portion of changes in market interest rates. The Federal Reserve's March 2022 rate hike of 25 basis points is projected to be followed by additional increases throughout the year. Initial rate hikes are not projected to increase net interest income until the impact of rate floors is exceeded. We estimate that rate hikes will have to approach 2% before their impact will increase net interest income. Our net interest margin of 3.12% for Q1 2022 was down from 3.34% in Q1 2021. The reduction reflected a lower yield on loan and securities portfolios as higher-yielding loans and securities matured or repaid. The provision for credit losses increased to $1.5 million in Q1 2022 from $822,000 in Q1 2021. The increase reflected the impact of loan growth and allocations on specific loans. 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, 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. Our non-SBA CRE loans at fair value and within Real Estate Bridge Lending are comprised primarily of apartment buildings. 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 values. For our Leasing portfolio, we have recourse to underlying vehicles and 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 non-interest income. Total fees and related payments income in Q1 2022 decreased 2% compared to Q1 2021 as the impact of Varo offset growth in other relationships. Non-interest expense for Q1 2022 was $38 million, reflecting a decrease of 8% from Q1 2021. The decrease reflected lower incentive compensation and legal expenses and lower FDIC expense resulting from the reclassification of certain deposits from brokered to non-brokered. Q1 2022 results also reflected the impact of a reduced tax rate of approximately 24% versus higher rates in other recent years. The reduction resulted from the impact of increases in the company's stock price on tax deductions related to stock compensation. Book value per share at quarter end increased 10% to $11.41 compared to $10.42 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

Thank you, Paul. Operator, would you please open the line to questions.

Operator, Operator

Our first question comes from Michael Perito with KBW.

Michael Perito, Analyst

Hey, good morning.

Damian Kozlowski, CEO

Good morning, Mike. How are you?

Michael Perito, Analyst

Good. How are you doing?

Damian Kozlowski, CEO

Good. Thank you.

Michael Perito, Analyst

Cool. I had a couple of things I wanted to hit on. It was good to see the card fees come in pretty strong. I guess kind of a two-part question here. Number one, what's the outlook on some of your larger partners, what's the volume you guys are seeing? And then how do we kind of marry that with the pipeline of new partners you guys are launching and just would love some color there? And then secondly, there were a couple of other items in the non-interest income that took a step down ex loan sales and leasing income. Just curious if you guys could provide any context around that and any near-term outlook thoughts would be great?

Damian Kozlowski, CEO

The GDV has been challenging to forecast over the past two years due to various stimulus measures and lockdowns affecting the economy. There was a significant increase in virtualization, but the stimulus introduced some fluctuations. In the realm of virtual payments, demand accelerated, leading to higher volumes recently. However, this has resulted in year-over-year comparisons being complicated. Last year, in December and January, a significant government stimulus of $1.7 trillion affected the economy, which benefited us greatly. Initially, we anticipated a slight decline in GDV for this quarter, but to our surprise, it increased by 2%, which we believed was unlikely. We're pleased with this GDV figure, driven by consistent growth from several major partners. Although we've seen a dip in GDV related to prepaid cards, much of that has already been factored into previous figures. As the year progresses, we expect to return to trend growth levels seen before the pandemic. Although predicting double-digit growth is challenging, our pipeline is strong, and while it may take time for new programs to generate volume, we anticipate aligning more closely with trend growth as the year advances. Before the pandemic, we saw GDV growth of 15% to 20%, and we believe we can achieve that again. Regarding fees, they can be quite variable. For instance, leasing fees from used car sales depend on when contracts end and whether we retrieve and sell those vehicles. Real estate fees relate to the early repayments from our securitization portfolio, which is still winding down. We expect to realize those fees over the next eight months, approximately $800 million, though we cannot predict exactly when they will materialize quarter-to-quarter.

Michael Perito, Analyst

Very good. I couldn't tell if it was my line, but you seemed to break up a bit in the middle. Regarding the GDV comment, I think I missed whether you mentioned that you are budgeting for a year-on-year growth while still being somewhat conservative next quarter, but then expect to return to a more steady GDV growth rate in the latter half of the year. I just want to ensure I didn't overlook anything.

Damian Kozlowski, CEO

Yes, the next quarter is easier to predict than the first quarter, but there are still some lingering effects from the timing of tax due dates and when the stimulus was utilized. I believe the impact won't be as significant as it was in the first quarter, although you might see slower growth in the second quarter. By the third and fourth quarters, since the stimulus effect will be gone and Varo is out, any minor programs will have little impact compared to the previous two quarters. Overall, those factors should be absent from the numbers in the third and fourth quarters, leading to a solid run rate in the fourth quarter. The third quarter should also show similar results, but by year-end, all the noise will have been cleared from the system.

Michael Perito, Analyst

Got it. Regarding the margin, there are a couple of factors at play. My first question is, how long do you expect the liquidity you built up in the first quarter from loan growth to remain elevated? Additionally, how does deploying that liquidity affect the margin? Let's start with that, and then I have a follow-up.

Paul Frenkiel, CFO

A significant portion of the liquidity we experienced in the first quarter is temporary, which is a situation we see annually. Even without last year's stimulus, we observe an increase in deposits due to tax refunds that inflates our accounts temporarily in the first quarter. Although this money will exit fairly quickly, some residual will carry into the second quarter, meaning there won't be much excess left by that time. However, we have a strong track record of deposit growth that we anticipate will continue across all our programs.

Michael Perito, Analyst

If the liquidity were to normalize, would that bring you back to the level of NIM seen in the fourth quarter, or were there other factors that could have significantly altered that?

Paul Frenkiel, CFO

No, there are other factors to consider. When looking at securities income from Q4 to Q1, the balances remained relatively unchanged, but income decreased by about $900,000. Although we've managed the balance sheet with significant protection against declining rates—largely thanks to the floors and the securities in our investment portfolio—we are not entirely shielded from the eventual prepayment of higher-rate securities and loans. The positive aspect is that as the interest rate environment stabilizes to a level closer to the inflation rate of 2% or 3% by the end of the year, we anticipate a substantial benefit to net interest income as the Federal Reserve completes its rate increases.

Michael Perito, Analyst

Understood. Finally, I just want to clarify regarding margins. I believe you mentioned that you expect Federal funds to increase by 200 basis points before you start seeing any benefits. Is that a static analysis? It seems that most of the higher floors are in the portfolio you're selling. As those work down, could that potentially reduce that figure as you progress?

Damian Kozlowski, CEO

Yes.

Paul Frenkiel, CFO

Yes, it does. Each quarter, we observe that threshold decreasing from around 2% to below 1.5%. As Damian mentioned, it's challenging to predict when higher-rate loans will prepay, making it really difficult to estimate the exact quarter.

Damian Kozlowski, CEO

When they repay, we receive fees, typically around 1% to 1.5% from various sources. One reason is that we booked the loans at 99 and we amortize the fee at that time, which provides a nice offset to the loss of interest income in that quarter. We're rapidly building our CRE portfolio and have already replaced $800 million. At a 4% rate, that would have resulted in a $32 million loss in interest income had we been reflecting on this year compared to last year without establishing that new portfolio. Currently, we have about a $350 million pipeline of CRE transactions expected to close in the next 60 to 70 days, adding another $300 million in new loans priced above 4% for the second quarter.

Michael Perito, Analyst

And do you have an estimate per hike on what your NII would benefit once through floors, Paul, by chance?

Paul Frenkiel, CFO

Yes. We currently estimate that an increase of $200 million could represent a 5% or 6% rise, which is a conservative figure based on our model. We will certainly aim to maximize that.

Damian Kozlowski, CEO

Yes. It's important to note that we haven't invested in securities for almost two years. We decided to focus on generating loans through origination instead of seeking yields by adjusting our investment strategy. This approach has resulted in over a 40% decline in investment-related income because we believed that pursuing that income in the current interest rate environment wouldn't have been beneficial for the bank. However, we have significant capacity to reinvest in securities for both liquidity and income purposes as interest rates increase.

Michael Perito, Analyst

Very good. Thank you, guys. Sorry for the long one but thanks for taking all my questions. Appreciate it.

Damian Kozlowski, CEO

Thank you, Mike.

Operator, Operator

Our next question comes from William Wallace with Raymond James.

William Wallace, Analyst

Good morning. How are you guys doing?

Damian Kozlowski, CEO

Good morning, Wally. We are good. Thank you. Hope everything is well.

William Wallace, Analyst

Yes, thank you. To summarize this last line of questioning, in the first 200 basis points, net interest income does not benefit, but you are not sensitive to liabilities, correct? This should be considered neutral, but since most of the remaining loans in your portfolio are floating, they will help counterbalance the increases in deposit costs. Is that accurate?

Damian Kozlowski, CEO

Yes.

William Wallace, Analyst

Okay.

Damian Kozlowski, CEO

Yes, we are being cautious. You want to avoid being trapped in this situation. It's unclear what will run off and what will be created. However, it’s ultimately a positive scenario. There’s no way to view it otherwise. Paul’s cautious approach is understandable, though it’s possible we may see benefits earlier in the interest rate cycle. The positive impact could start becoming noticeable around 125 to 150 basis points, with a significant effect occurring at 200 basis points. Regardless of interest rate hikes, it's hard to see how this would negatively impact the bank. Given the current floors and the fact that our portfolio is approximately 70% variable, coupled with our ability to reinvest in longer-term securities, all these factors are very favorable for net interest income and margin.

William Wallace, Analyst

If the Fed raises rates significantly, we could potentially see a 200 basis point increase this year according to the futures market. Does this affect the borrowers' decision to prepay? Essentially, once they move off the floors, they would reprice at the same rate if they chose a different option. Does this potentially slow the transition from held for sale to the balance sheet portfolio?

Damian Kozlowski, CEO

It could. And we've already seen our rates in the marketplace start to climb. So...

William Wallace, Analyst

Yes.

Damian Kozlowski, CEO

But it's quite high, around the 470 basis points level which aligns with the rest of the portfolio floors. If the market is now above 4% for most deals, it could have an impact, but there are maturities coming up soon. Remember, this portfolio was essentially frozen two years ago with three-year loans that might be refinanced. Most people who have completed their projects prefer not to have a variable rate loan in this climate; they are looking to secure fixed financing if their projects are finished. I believe there will be repayment. I can’t guarantee that nothing will be extended, but the current environment strongly encourages locking in longer-term financing if the project is complete. There is ample bank liquidity available, providing alternatives for these borrowers.

William Wallace, Analyst

And presumably, it doesn't really matter once they come up floors, you're happy to keep them anyway, right? These are all good loans from a credit perspective, correct?

Damian Kozlowski, CEO

You remember during the pandemic, we had virtually no issues, a few hotel issues that I mean, we really had amazing credit performance from that portfolio. I think there was some worry from because we couldn't securitize it that there might been some credit issues in there but the performance of it speaks for itself.

William Wallace, Analyst

Moving on, I wanted to address the expense part of the equation. I noted that your revenue was below expectations, but your expenses were adjusted down. My question is whether this is due to variability in the expense base or whether the significant decline in salary benefits was due to bonus accruals and just a random occurrence, or if you truly have that much variability, and if so, what drives that?

Damian Kozlowski, CEO

Two of the categories were straightforward. There was about $2.5 million in reduced legal costs, which are just legal bills. The other significant reduction was in FDIC insurance fees. We transitioned from being 80% brokered to 100% core, leading to these reductions. We're not increasing other expenses because we've made many investments in scalability. Personnel costs are tied to performance, with some compensation plans being more formulaic for the sales force, making them performance-based. Everything we do is centered on performance, growth, and targets. Consequently, if performance falls short of predictions, there will be a lower accrual in those areas, creating an offset. Together, these factors reduced our expense base this quarter. However, FDIC insurance is tied to deposits, while legal costs depend on ongoing legal issues. Last year, we had SEC matters that increased our costs, along with another costly employee lawsuit. These legal expenses fluctuate. Compensation will be adjusted upward, so if we exceed performance expectations by year-end, driven by interest rates and other factors, you will see an increase in that line item based on our performance metrics and the bonuses accrued.

Operator, Operator

Our next question comes from Frank Schiraldi with Piper Sandler.

Frank Schiraldi, Analyst

I would like to follow up on the compensation line. It appears that the fourth quarter was somewhat inflated by incentive compensation. Is there a direct connection between the gains on sale when they are realized and any variable compensation in the compensation line, or is there not a real correlation?

Damian Kozlowski, CEO

No.

Frank Schiraldi, Analyst

Okay.

Damian Kozlowski, CEO

No, not the gain. It might be in a very abstract sense if, for instance, the Leasing business had significant gains, which could lead to a discretionary bonus difference, but there isn't a formulaic connection to the gains.

Frank Schiraldi, Analyst

Okay. Regarding the gain on sale, you mentioned a potential of up to $12 million this year. Can you share what level is expected in your $2.15 guidance for the year in terms of the gain on sale?

Damian Kozlowski, CEO

Well, we thought we would have about four. Are you referring to the CRE gains or the vehicle gains from the lease?

Frank Schiraldi, Analyst

Yes. I was just talking about CRE but...

Damian Kozlowski, CEO

We believe it will be about $400 million by the end of the year. However, it could range from $0 million to $800 million. So, we estimate it will be around $400 million, which makes it straightforward to compute the fees. What is our current status?

Paul Frenkiel, CFO

About $800 million about...

Damian Kozlowski, CEO

Yes, $800 million. When you consider 400 times 1.5%, that will indicate the fees from the gains on sale for the remainder of the year. However, it could be double that amount. This situation has been very positive; if we reflect on our position compared to last year, we are indeed in a strong position this quarter. Last year, we had the PPP in the first quarter, along with spreads and fees, and we experienced a significant roll-off and build in the CRE portfolio, leading to many changes. We also had stimulus effects on the GDV and bond runoff to manage. Thankfully, we've addressed most of these factors successfully. Our current standing is robust, particularly with regards to interest rates and buybacks, allowing us to perform well as we progress through the year. While there is some variability, we are pleased with this quarter and where we stand.

Frank Schiraldi, Analyst

Great. I just want to revisit the rate situation for a moment. You mentioned the cautious stance behind the 2% number that Paul provided. Is there a specific reason for being more cautious this quarter compared to previous ones? It seems that number has increased. I'm curious if there are any factors in loan pricing that might delay the boost in net interest income, or if it's simply a matter of being more conservative this quarter.

Damian Kozlowski, CEO

Frank, we believe that as we move forward, this will prove to be a significant advantage for the Bank. By 2023, if all these developments take place, the Bank will be in a strong position. However, we cannot forecast precisely how interest rates will be raised, which loans will be affected, or how we will originate new loans with varying terms. For example, we have an IBLOC with a floor of 3% and a SBLOC without a floor. We also have fixed-rate IRAs and roll-offs for commercial real estate, making it difficult to predict any outcomes beyond conservative guidance. If we see a 2.50% rate increase in the next two Fed meetings, it may signal a starting point for us. This next increase is likely to have a considerable impact on the Bank. With rates at 200, we have clarity on the prior increases that will eliminate any uncertainties. We are navigating a range of 125 to 200, making it challenging to predict the ultimate impact on revenue and net income, so we cannot provide guidance on that front. As the year progresses, we find ourselves in a very favorable situation since we have addressed the four issues I mentioned earlier. Those challenges are now behind us, and we are looking at much better performance prospects than we had at this time last year.

Frank Schiraldi, Analyst

Okay. And then just lastly, just a broader question on the consumer side of things. You've talked about maybe some announcements on that side. Just wondering if anything on the macro front has kind of changed your calculus there or if we should still expect to see you enter that side of things sometime soon?

Damian Kozlowski, CEO

I think you're talking about credit sponsorship, correct?

Frank Schiraldi, Analyst

Yes.

Damian Kozlowski, CEO

Yes, we are moving forward intentionally and are very excited, although we cannot announce anything at this moment. We are waiting for our partners to take the lead on this, but we truly believe it will be significant. While I can't provide specific guidance, I anticipate that we will have something exciting to share in the near future, although nothing is confirmed until it's officially announced. We are enthusiastic about this opportunity and believe it will greatly benefit the Bank.

Frank Schiraldi, Analyst

Okay. All right, great. Thank you.

Damian Kozlowski, CEO

You're welcome. Thank you.

Operator, Operator

This concludes the Q&A session. I'd like to turn the call back over to Damian Kozlowski for any closing remarks.

Damian Kozlowski, CEO

Yes. Thank you for joining us today. We really appreciate your interest in the Bank. And thank you, operator. You can disconnect the call.

Operator, Operator

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