Customers Bancorp, Inc. (CUBI) Q3 2022 Earnings Report, Transcript and Summary

Jay Sidhu - Executive Chairman Sam Sidhu - Vice Chairman, President, Chief Executive Officer Carla Leibold - Executive Vice President, Chief Financial Officer Andrew Bowman - Executive Vice President, Chief Credit Officer David Patti - Communications Director

Ladies and gentlemen, thank you for standing by. My name is Brent and I will be conference operator today. At this time I would like to welcome everyone to the Customers Bancorp Third Quarter 2022 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions]. Thank you. It is now my pleasure to turn today’s call over to Mr. David Patti. Sir, please go ahead.

Thank you, Brent, and good morning everyone. Thank you for joining us for the Customer Bancorp's earnings call for the third quarter of 2022. The presentation deck you will see during today's webcast has been posted on the Investor Relations page of the Bank's website at www.customersbank.com. You can scroll to Q3 2022 results and click download presentation. You can also download a PDF of the full press release at the spot. Our investor presentation includes important details that we will walk through on this morning's webcast. I encourage you to download and use the document. Before we begin, we would like to remind you that some of the statements we make today may be considered forward-looking. These forward-looking statements are subject to a number of risks and uncertainties that may cause actual performance results to differ materially from what is currently anticipated. Please note that these forward-looking statements speak only as of the date of this presentation, and we undertake no obligation to update these forward-looking statements in light of new information or future events, except to the extent required by applicable securities laws. Please refer to our SEC filings, including our Form 10-K and 10-Q for a more detailed description of the risk factors that may affect our results. Copies may be obtained from the SEC or by visiting the Investor Relations section of our website. At this time it's my pleasure to introduce Customers Bancorp Chair, Jay Sidhu. Jay, the audience is yours.

Thank you, David, and good morning ladies and gentlemen. It's really a pleasure to welcome you to our Third Quarter 2022 earnings call. Joining me here today from Melbourne, Pennsylvania, the new headquarters of Customers Bank are Sam Sidhu, our president of our Holding Company as well as the CEO of our Customers Bank subsidiary, Carla Liebold, our Chief Financial Officer, and Any Bowman our Chief Credit Officer. As you can see on slide 3, Customers Bank is a digital focused super community bank with diversified niches, several with a nationwide footprint that supplements our community banking business platforms located in Rhode Island, New York, Pennsylvania, North Carolina and Florida. We operate our $20 billion asset bank with only 672 team members working out of 39 private banking offices or loan production offices located across many states from Portsmouth, New Hampshire to Boston to New York to Greater Philadelphia and then on to Wilmington, North Carolina and Florida as well as Dallas, Texas. We are pleased this morning to present to you another solid quarter despite the challenging industry and economic environment. We remain laser focused on our responsible organic growth strategy and have taken prudent risk management strategic actions over the past several quarters to ensure that we are well positioned from a capital, credit, liquidity and earnings perspective in this challenging environment. We are also pleased to report that we have already beaten our 2022 core earnings per share guidance, excluding PPP of between $4.75 to $5 in earnings per share for 2022. Our Q3 core earnings excluding PPP were $2.30, up 135% over Q3 2021. Our core ROAA or Return On Average Assets was 1.64% and core return on common equity was 25.9%. All these numbers are excluding PPP and that's a good way to look at our numbers. Year-to-date September 30, 2022, core earnings per share excluding PPP were $5.15. Q3 2022 net interest income generated by the core bank was up 38% year-over-year, while our total operating expenses were down by $4 million year-over-year. Core loan growth this quarter was led by increases in low risk valuable rates specialty lending verticals of $500 million, which were largely offset by an expected decline in loans to mortgage companies of $300 million and a sale of $500 million of consumer installment loans at a net gain to the company of about $13 million. This was executed as part of our balance sheet optimization and capital enhancement strategy. Asset quality remains exceptional and credit reserves are robust. Our loan and deposit pipelines remain strong and we are very focused on maintaining our margins, moderating our growth, improving our capital ratios, while controlling our expenses and meeting or beating what the Street expects from us in earnings per share. We remain very optimistic about our future. I would now like to hand it over to Sam Sidhu, President and CEO of Customers Bank to describe in detail our strategic initiatives and our results for Q3. Sam.

Thank you, Jay. Good morning, everyone. I'm thrilled to walk you through another strong quarter at Customers Bancorp. Building off of the momentum of industry leading, responsible loan growth and our variable rate, low to no loss specialty lending verticals in the first half of the year, in the third quarter the team focused on disciplined balance sheet management, which helped deliver strong net interest income growth and record recurring earnings, even after backing out the benefit of PPP. Given the uncertain environment, we believe that moderating our growth and focusing on maintaining and expanding margin, improving our capital ratios, all while further growing recurring revenues is how we will be measured and how our shareholders will be rewarded. Let me briefly summarize our results. From an earnings perspective we earned $1.85 in GAAP EPS, which represented net income of $61.4 million. Core earnings were $2.48. After stripping out the benefit of PPP income we earned $2.30. As I mentioned earlier, a record and an incredible feat, all thanks to the incredible efforts of our team members. Net interest margin came in at the higher end of the guidance we provided on last quarter's call, lending to the prudent portfolio remix we have undertaken and to lower risk and lower yielding, but variable rate loans. This strategic portfolio remix will be mostly complete by year-end and our margin after incorporating the full impact of the consumer portfolio reduction will begin to increase again in 2023 as we have been very disciplined on loan and deposit pricing strategies. Now, moving to the balance sheet. We ended the quarter with $19.2 billion in core assets excluding PPP, up 36% over the year ago quarter. Our loan book grew an impressive 34% year-over-year to $14.2 billion, excluding PPP at quarter end. Total deposits grew 3% to $17.5 billion and have more than doubled over the last three years. Going forward through the remainder of the year and into 2023, we believe it's prudent to prioritize adding high quality deposit customers first to provide the funding base for continued measured loan growth, as well as importantly NII expansion over the next few quarters. From a profitability standpoint, adjusted pre-tax, pre-provisioned ROA was 1.95%. Strong asset quality is a pillar of our franchise and we are an inherently low credit risk institution. We continue to deliver on superior credit quality versus peers, the industry, as well as our own historical averages. As a reminder, at the start of the year, we disclosed that we proactively and frankly enhanced asmartly tightened credit underwriting and shifted loan growth mix in an effort to continue to maintain a pristine credit book as we wait to see the full impact of the fed's actions and inflations on the – and inflation on the economy. Importantly, our book value has been successfully defended into 2022 and has grown significantly, about 9% year-over-year, as well as through 2022 bucking the industry trend, thanks to strong recurring organic growth and securities book optimization. Importantly, our TCE to TA ratio is at the high end of industry peers lending to our prudent optimization. Moving to slide six, strategic initiatives we've implemented to best position us for the current and future external environment. As early as the first quarter, we started taking a number of actions to position the company to successfully navigate a challenging macroeconomic environment. This started with a mix shift in our loan portfolio toward low-to-no credit risk verticals, which represented 90% of our year-over-year loan growth. Our low-to-no loss specialty verticals now represent 63% of total loans, up significantly over the last year as well as the last several years, with our consumer installment portfolio declining from 15% to 10% of total loans over the same time period. This is excluding our government guaranteed PPP loans, which when included further increased this number. And as you can appreciate from a reinvestment perspective, this number will continue to increase in 2023. The focus on lower credit risk verticals has not changed our discipline and commitment to maintain at least 3% to 3.5% spread over our funding cost, allowing us to maintain our to continue to meet and beat our short and long term guidance in a rapidly evolving environment. I'm happy to address this more during Q&A. Our agile pricing discipline has more recently assisted our strategic moderation in the growth of our balance sheet as we continue to prioritize profitability, margin and lowering overall risk at the bank. We will not ever chase growth for growth sake of loans, especially in conditions like the industry is facing today, where margin, capital and credit are king. For example, we employed a strategy which both increased pricing thresholds for the top of the funnel and also repriced hundreds of millions of dollars of in-flight pipeline to prioritize margin and capital. Additionally, it's worth reminding you that on margin, the continued reinvestment of proceeds for our PPP loan runoff and our securities book, amortization and cash flows, provide significant runway to grow our loan portfolio and continue to increase margin in the coming quarters. Strategic efforts such as the $500 million sale of a consumer loan portfolio this quarter, and the transfer earlier this year of available for sales securities to held to maturity in the second quarter, had meaningful positive impacts on our capital ratio, and we will continue to evaluate opportunities for additional actions. On the consumer sale, we are pleased that the market validated our conservative underwriting, allowing us to sell 500 million of our Customers Bank direct portfolio for nearly a 3% net gain. Moving on, the company remains extremely liquid, with approximately $10 billion in liquidity. This is further supported by our core deposit pipeline from our existing verticals, evidenced by our financial institutions group growth, as well as driven by our differentiated technology capabilities like CBIT and our technology enabled transaction banking platform, which is already bringing in significant low cost deposit opportunities, which we expect to onboard in 2023. As we have demonstrated and have delivered one handedly over the past several years, we have established ourselves as a leader in technology and innovation in the digital banking and Fintech space, as well as in the banking industry more broadly. This is not just lip service, we are absolutely a top 10 tech-forward bank in the nation out of thousands of institutions and I'm happy to answer any questions to explain it further. In terms of the Customers Bank Instant Token on the next page, I'll spend a minute talking about this in a few pages. We continue to scale our business at a pace that is far greater than we have projected. Our Banking As A Service, marketplace lending pilot is kicking off this quarter as planned and we expect it to generate as much as $10 million in annual revenue based on current and pipeline partnership opportunities. We are pleased to report that we are continuing to innovate and adding to our digital SMB small-medium size business bundle offering next year, as well as rolling out an equipment financing pilot launch as we look to build off of our success and learnings in the digital 7A space and roll into revolving line of credit, term loan, as well as credit card offerings. Finally, at the bottom of page, we strive for operational excellence and feel that companies must continually evaluate their structure and processes for greater efficiencies. In that honest self-assessment, we uncovered ways in the quarter to simplify and streamline our organization and to better position ourselves to serve our customers while reducing overhead, which are all in addition to branch closures which we announced last quarter. Combining these initiatives over the past two quarter, we will be reducing our headcount by 8%, while making us more effective for future growth at the right time. Through these efforts, we are able to maintain an industry leading efficiency ratio of 43%, improving efficiency while also improving experience supported by truly best-in-class technology allows us to continue making our customers say Wow! Flipping to our tech-enabled banking on slide seven, so we can update you on major technology led strategic priorities at Customers Bank. Building off of our success and platform innovation on CBIT, we will be seeking to disrupt the transaction banking space by helping our current and future customers build a modern, cloud based API enabled treasury product suite, which is being built to anticipate our customers current and importantly future needs. Our best-in-class tech team is enabling us to expand our commercial, treasury and payments capabilities, which now includes a customer facing API library with documentation, enabling simple and robust treasury and payments services. This is all in addition to the API led Banking As A Service Fintech partnerships of which the first fee income marketplace lending partner was signed last quarter and is launching this quarter after complex tech and operational integration. Our treasury and payments platform is being built from the ground up, with the input from dozens of interviews with customer end users and decision makers, reinforcing our customer centric service and experience approach, which we hope will continue to build tremendous customer loyalty and enhance our brand by driving new product and service offerings. While most banks are focused on digital transformation and digitizing internal processes, we are looking to leapfrog forward and working to package and productize our tech by tailoring it to our customers' current and anticipated needs. Said another way, we are focusing our tax spend on innovation for our customers, who now view us as a technology partner by choice, rather than a banking partner out of necessity. This may seem nuanced, but it's critical to the future of banking. Transaction banking will enhance the Customers Bank, customer focused value proposition and facilitate significant low cost deposit gatherings, as well as fee income opportunities in commercial and large corporate high growth verticals led by Fund Finance, Financial Institutions Group, Digital Assets, as well as Tech and Venture. As we have previously stated, our Fund Finance business which crossed over a $1 billion in outstanding this year, we expect to be 100% self-funded and supported by these efforts. Similarly our Tech and Venture business on a steady state we expect to be at least one 100% funded, supported by our tech enablement. Flipping to slide eight, on Customers Bank Instant Token, an update on the instant payments platform which we launched, which tokenizes deposits on the block-chain on instant payment rail that is available 24/7/365. Despite the significant market volatility in the digital asset space during the quarter and frankly over the last few quarters, we are proud to report that we accelerated customer growth, once again beating our internal target through the onboarding of 111 new customers and crossing 300 total customers as of the end of this quarter. The onboarding and compliance team continues to meet best-in-class SLAs for our onboarding timeline and compliance risk management. Our industry leading technology infrastructure platform is forcing basic and long needed innovation, and calling out service challenges from the incumbent banking institution. Our customer backlog remains robust and to be clear, we have no exposure to underlying crypto currency assets of our customers, just their fiat dollar deposits used for operating accounts, payments and trading. CBIT transactions continue to ramp up significantly and more than doubled in the quarter and the fourth quarter is already ahead, with just a month of transactions of last quarter. Our digital asset customer base is diversified, and in just a few quarters Customers Bank already banks many of the largest in each of the major customer categories. Customers continue to progress in moving their primary banking relationships to us, which speaks to our innovative service take on service and experience, high-tech, high touch banking model. Now, I'd like to hand it over to our Chief Financial Officer, Carla Leibold.

Thanks, Sam, and good morning everyone. I'll keep my comments focused on five key things. Number one, organic low risk loan growth and positive low mix shift. Number two, growing deposit franchise with a significant and growing proportion of transaction related TDS. The third, interest income growth from the core bank with margin expansion opportunity. Number four, strong liquidity and capital position. And five, tangible book value accretion, all combined with effective and disciplined expense management. Turning to slide nine, I'll start with low risk, low growth and positive shift in loans. Our organic core loan growth in the third quarter of 2022 was about $100 million, up approximately 1% over the prior quarter. Importantly, this included approximately $500 million of growth in our specialty C&I lending business, up approximately 10%, led by our low risk, variable rate, lending finance vertical, which has been a vertical of ours for the past seven years in which we’ve experienced no losses or even a single delinquency. We've also had about $300 million of growth in our lower yielding relationship that is multi-family business, largely from Q2 production that didn't close until Q3. As expected, our loans-to-mortgage banking companies declined about $300 million and our consumer installment loans decreased by $500 million due to the consumer installment loan sale that we reported earlier this month. Overall, we are extremely pleased with the results of the consumer sale transaction for a number of reasons. One, it de-risked the loan book, and that we now have less than 10% of core loans and consumer installment loans, which equates to less than 7% of total assets. Execution at a slightly less than par price in this rapidly changing environment is a testament to the superior credit quality of our consumer installment loan book. As a reminder, these are fixed rate loans that despite the 300 basis point increase in rates are still trading at 99.5% at par. And third, it was the significant financial benefits in Q3 resulting from, one, lower risk weighted assets of approximately $420 million, which is expected to benefit our regulatory capital ratios between 30 and 40 basis points; and secondly, our Cecil reserve release of benefit of approximately $37 million, net of a loss on sale of roughly $2.5 million, unamortized customer acquisition costs of $18.6 million and other deal costs of about $2.4 million or a net benefit of about 13. Moving on to deposits on slide 10, we increased total deposits by about $600 million in the third quarter, while also experiencing some shift in mix and higher deposit costs, which was not unexpected given the 300 basis points of breakout we’ve had so far this year. Considering the vast majority of our customers, our corporate or institutional funds, these deposit balances are more sensitive to changes in market rates. What you can see from this slide is that our sticky transaction related DVAs have been steadily increasing over the past five years. Since September 30 we’ve had CBIT related customers move funds from money market accounts into interest bearing operating accounts, further increasing our proportion of DVAs to about 67%. Give our strong deposit pipelines in the digital asset space, financial institution group and other channels, we are expecting this trend to continue over the next several quarters. Slide 11 shows the re-pricing characteristics of our interest earning assets and overall core units excluding PPP. Approximately 62% of our interest earning assets are market sensitive, which is greater than the proportion of our market sensitive liabilities, leaving us modestly asset sensitive. From a loan mix perspective, the $500 million sale of consumer installment loans at the end of Q3 reduced our consumer installment portfolio by about 21% ending the third quarter at approximately $1.4 million. This action, combined with the fact that approximately 73% of our core loan growth year-over-year has been in low risk, variable rate, specialty lending verticals such as Lender Finance and Fund Finance, has improved our loan mix by reducing overall credit risk while increasing asset sensitivity. We do expect the low-mix shift to be largely complete with the $500 million of low risk, variable rate specialty lending growth expected in the fourth quarter. Moving to slide 12, this slide shows a trend of increasing net interest income, excluding PPP over the past five quarters, largely driven by strong organic growth in our specialty lending C&I business. Compared to the prior quarter, our net interest income ex-PPP increased 2% or 10% on a normalized basis. Year-over-year our net interest income from the core bank increased 38%. Over the past five quarters you could see that we have been very disciplined in keeping our margin above 3%. Consistent with our prior guidance, our third quarter net interest margin ex-PPP was 3.18% for the upper end of the three and three and a quarter range we communicated last quarter. The $500 million sale of consumer installment loans and subsequent purchase of $400 million of investment securities secured by the sold loans at a 5.5% yield negatively impacted our net interest margin in the third quarter by about two basis points. Considering the timing of the loan sale late in Q3, we do expect to see another 10 basis points or so of net interest margin compression in the fourth quarter, all else equal. Upon completion of our loan mix shift in the fourth quarter, we do believe that our net interest margin will likely trough this year, within the previously guided range with NIM expansion opportunities in 2023. Turning this slide 13, PPP loans totaled $1.2 billion at the end of September. There was approximately $400 million of forgiveness in the third quarter of 2022. This resulted in deferred fee recognition of about $11 million, which was approximately $4 million lower in the amount recognized in the second quarter. At the end of September, approximately 91% of PPP loans originated under Rounds 1 & 2 have been forgiven and approximately 80% of PPP loans originated under Round 3 have been forgiven. To-date we’ve recognized about $350 million of deferred origination fees, leaving approximately $30 million to be recognized in the fourth quarter of 2022 and early 2023. As we’ve said previously, it's difficult to predict the timing of these fees, but we are expecting the majority of the fees to be recognized over the next one to two quarters. Turning to slide 14, you can see tremendous growth in our liquidity position over time. The growth in our held to maturity investment portfolio was driven by the $400 million purchase of securities act by the sold consumer installment loans, late in Q3. When adding our committed borrowing capacity to our cash and investment portfolio, we have close to $10 billion of liquidity sources available to us, leaving us very well positioned to find organic lowest growth, as well as the outflow of deposits resulting from the expiration of the deposit service agreement with BMTX. On the right side of that slide, you can see some key characteristics of our available for sale investment portfolio, which is approximately 50% floating rate, has an effective duration of 1.7 years in book yield of approximately 3.7%. Moving to slide 15, we continue to maintain strong capital levels. The estimated total risk-based capital ratio at the end of September was approximately 12.8%. Our TCE ratio excluding PPP was around 6.5% and our estimated CET1 ratio was 10.1%. Our TCE ratio was negatively impacted by about $156 million of after-tax unrealized losses deferred in AOCI at the end of September. This negatively impacted our TCE ratio by about 80 basis points. Without this impact, our TCE ratio would have been roughly 7.3% at the end of the third quarter, close to the midpoint of our internal targeted range between 7% and 8%. It's important to note here that the AOCI impact is an accounting fair value adjustment that has no permanent impact on capital if the securities are held on balance sheet. As stated earlier, our third quarter 2022 estimated CET1 ratio was approximately 10.1%, significantly above the required regulatory, well-capitalized minimums. Despite a similar impact of AOCI on a tangible book value which was negatively impacted this quarter by about $0.96, we saw tangible book value accretion of close to 3% as our GAAP earnings more than offset further deterioration in AOCI. Looking forward to the end of 2022, we are still expecting our tangible book value to be over $40. We also expect our TCE ratio to be above 7.5% over the next three to four quarters, supported by growth in retained earnings and balance sheet management. And with that, I'll turn it over to Andy to talk more about asset quality.

Thank you, Carla, and good morning everyone. As noted on slide 16, credit quality remains strong as evidenced by NPLs of only $28 million or 18 basis points of total loans. NPAs total assets of just 14 basis points, a 9% decline in the percentage of loans classified special mention or substandard to total loans, and most importantly as it represents a real-time assessment of portfolio strengths, total 30 to 89 day delinquencies were only 17 basis points. The increase in NCOs was predominantly due to a recession. After having completed a detailed, forward looking, low-level stress test analysis to exit a performing non-multifamily commercial real estate credit that was heavily impacted by COVID-19 and failed to recover to an operating performance level that clearly evidenced an ability to sustain operations moving forward. For over a year now we've been performing this same detailed forward-looking analysis on all credits recovering from COVID-19, as well as credits being highly susceptible to any level of deterioration and discretionary spending, given ongoing inflationary pressures and the high probability of a recession in late 2022 to early 2023. Adjusting for this unique $7 million charge off, Q3 commercial NCOs that total average commercial loans was just one basis point, and overall NCOs that total average loans was 29 basis points, both of which are in line with historical levels and actually mark an improvement over Q2 of this year. From an overall consumer loan growth perspective, NCOs to total average consumer loans of 180 basis points for Q3 mark a modest improvement from 197 basis points in Q2. In addition, we remain pleased with how well our consumer installment loan book continues to perform with annualized charge off rates running at less than half of the fully reserved lifetime loss rate of 5.13% when factoring in the weighted average life of just 1.7 years. In addition, after adjusting for this successful $500 million Q3 consumer installment loan sale, the underlying credit metrics of the remaining portfolio improved over that of Q2 and remained strong as noted on slides 24, 25 and 26 in the appendix. Although we are pleased with how well our portfolios have performed, we remain committed to the following. First, maintain the strong reserve position given continued uncertainty in the social, economic and political climates. As evidenced by solid coverage ratio of 1.03%, which equates the 465% coverage of total NPAs. Secondly, adhering to our strong underwriting and portfolio management standards, which is evidenced by consistently solid NPL, NPA, NCO and delinquency performance and finally, adhering to a strategy of enhancing loan portfolio mix with greater concentrations in low credit risk segments as evidenced by 63% of our loan portfolio, excluding PPP being in core low risk lending segments at the end of Q3. Based on strong credit metrics, our loan mix comprised predominantly of low credit risk loans, strong portfolio management with ongoing low level stress testing, limited exposure to higher risk loan segments such as investment CRE office at only $132 million; investment CRE retail at only $172 million, and hospitality at just $452 million, of which 75% carrier recourse and 77% are flagged. And finally a continued focus on not lending into discretionary spending dependent industries, we feel strongly that our loan portfolio was well positioned to weather the current market volatility, and what appears to be almost certain upcoming recession. I'd like to thank you for your time this morning, and I would now like to turn the presentation back over to Jay Sidhu.

Thanks Andy. Before we open it up for questions, let me summarize what my colleagues have already shared with you. As you can see from slide 17, we have shown industry leading core loan growth and deposit growth supported by best-in-class digital banking. Since about the middle of last year our loans excluding PPP are up about $5 billion, all organic growth and deposits are up about $3 billion, and we have funded other loan growth from cash received from two to three loan beginnings. In this rapidly changing environment the intent on continuing was the same, but moderating our growth so as to maintain or expand our margins and further improve our chapter wide ratios. We remain on track to report $6 or higher in core EPS in 2023, in spite of the sale of $500 million of our consumer loans. As you heard from Andy, exceptional credit quality has been one of our hallmarks and we are confident and we intend to remain that way. Our customer centric business models are letting us get premium pricing and we are committed to maintaining our advantages and technological capabilities over our peers. Speaking as one of the largest individual shareholders of the company, I can say our valuation is extremely attractive, trading at only 80% of tangible book and about 5x 2023 consensus estimates. You should expect us to buy back our authorized $2 million share authorization over the next few months if we remain trading below tangible book. So Brent, please open it up for any questions from the audience.

[Operator Instructions] Your first question comes from the line of Michael Perito with KBW. Your line is open.

Hi! This is Andrew filling in for Mike. Thank you for taking our questions. First off, I just wanted to see how you guys will prioritize growth versus capital building in the near term and then into 2023 and beyond.

Yeah, so I can take that question. So first, when we're thinking about capital, we're always thinking about the best strategies to optimize capital. Supporting organic loan growth is always a priority. That said, we will be opportunistic in using our allotted $2 million share repurchase program. And as Jay just said, to the extent we are below tangible book value, you may see us buyback some common shares.

Great, thank you. And then turning to CBIT, how do you expect the mix of the deposit customers to be going forward? And then with that diversification, like how will that change as customers continue to grow in the future?

Sure. So this is Sam. Good morning, Andrew. Thanks so much for that question. So from a CBIT perspective, I think it's important to remind everyone that when we started the customer banking platform and our digital asset banking deposit gathering vertical, we set out to build the low-to-no cost deposit acquisition franchise and that's really what we're doing. So to put a finer point on that, well over 90% of our client capital today are not only just varying operating accounts, but we do have a small handful of larger cornerstone depositors that are earning interest. But these customers tend to hold larger balances with us, but they also happen to be as I mentioned, anchors to the CBIT payers platform. So this said differently you know, the CBIT platform allows here new customer growth. It allows us to increase the network effect. Increasing the network effect increases payments volumes and payments volumes increases the overall deposits flow there. So as we look at this platform, you should expect that majority of the clients that come on to the dividend [ph] class space will be non-interest bearing.

Great, thanks Sam. And then just the last one for me here. I know you mentioned the consumer loan sale and the prepared remarks on there, but you have any plans to sell any more consumer loans in the near term?

So Andrew, on the consumer loan sale, I think that you know I’ll add a little bit of color on the transaction there. So as we mentioned, this is the CD direct originate portfolio. We actually you know ran an interesting market process where we put our entire portfolio out to receive bids. We had multiple bidders, you know bit at or close to par. We decided on selling a smaller amount. As you can appreciate, we've created a tremendous amount of franchise value in that platform. We have acquired hundreds of thousands of customers. You know we let go about 35,000 plus or minus of customer principal; however, we maintained lots of servicing on that relationship. At this point in time we have no further plans to sell more of the portfolio. We plan to manage the portfolio to a size that's approximately where we are today. It's about 70% of the space capital, which feels like a very – and less than 10% of total loan, which feels like a very appropriate level given the diversification of our overall franchise. But we are interested in potentially evaluating strategic partnerships where we could be an originate for sale type position, but that's something that's on the horizon, not something that we are working on actively in the very near term.

Great! Thanks for all the color and thank you for taking my questions.

Sure.

Your next question is from the line of Peter Winter with D. A. Davidson. Your line is open.

Thanks. Good morning. I wanted to ask about some of the drivers to the margin expansion outlook for next year.

Sure Peter, good morning. Great to see you in your new seat. You know so I think it's important to understand how we think about not just margin, but also net interest income and more broadly what actions we've taken you know over the past six months to better position ourselves from a profitability perspective without taking unnecessary credit for interest rate risk, especially considering the level of market volatility that we're all experiencing in 2022, which is likely going to continue into next year. So first of all, we're focused on growing net interest income through this responsible low risk growth yield that we talked about extensively. Rather than focusing on a specific net interest margin, even though we have provided the guidance or an ideal deposit data, our growth is going to be on top of – you know our growth is on top of a static balance sheet that will allow us plus or minus assets and sensitivity will allow us to continue to expand our margin throughout next year. You know Carla, maybe you can talk a little bit about the PPP loans, the payoffs that we expect next year, the securities book, you know cash flows and how we think about reinvestment as well on top of the asset, the modest asset sensitivity.

Sure Sam and good morning Peter. Regarding the margin expansion, there are a couple of big drivers here. First, we are very unique and that we have over $1 billion of cash that can be reinvested over the next couple of quarters, at market based rates solely from the PPP loan forgiveness process. Secondly, approximately 23% of our interest earning assets are invested in lower yielding assets, which can ultimately be redeployed to generate higher NII over the next 12 to 24 months. And third, we're still not seeing the full benefit of our asset sensitivity, because of a lag in the repricing of our variable rate assets compared to our market sensitive deposits. This line goes away when the planned causes rate hikes and the repricing of the assets catches up to market sensitive funding. And lastly, as Sam just talked about, we still have significant opportunities to generate very low-to-no cost core deposits over the next several quarters.

Okay, thank you. Just on that point, that last point Carla, I think you meant deposits grew quarter-to-quarter. But you know there was a big mix shift from DDA into interest bearing and deposit costs increased pretty rapidly. Can you just talk about this mix shift in deposits and maybe the outlook for deposit growth?

Sure, I'll talk about the mix shift and then I'll turn it back over to Sam to talk about some of the deposit generating opportunities. So to be competitive in this rapidly changing environment, we moved most of our CBIT related deposits to money market accounts and paid some market based rates in the third quarter. Having said that, as of October 1 all of the CBIT related money market accounts have been moved to interest bearing DDAs. Currently our total demand deposits make up roughly 67% of our total deposits. And Sam, do you want to talk about the deposit generating strategies?

Yeah absolutely, and you know let me just add a little bit, just before I move on this non-interest bearing deposit migration. As Carla stated, you know this is related to our official asset CBIT deposits. This is one-time it's behind us as payments volume was up significantly and probably in the quarter for CBIT. It was obviously, it has been new to us given the last couple of quarters, but there has been a tremendous amount of competitive pressure, which is why we thought it was important to strategically make the decision to pay interest to some of our key anchor points. We also saw a small amount of damage [ph] bearing outflows, which is really just expected from a quarter-to-quarter type variability as opposed to a migration that Carla just mentioned. No customers closed accounts and in our digital asset business or otherwise we're protecting important customers across our franchise, and you know it would be – you know it would be – it would move us to not be able to take some of these steps of actions. Now you also talked – asked about deposit growth, and what I would say is to reiterate we talked about some of the business transaction banking slides. Sort of the waterfall of our important deposit growth initiatives is number one, high quality deposit growth in our commercial verticals; number two, growth in our new lending verticals that we've discussed that are not yet self-funded. For example, our fund financing technology and venture groups in aggregate are $1.3 billion in loans and we expect those to be self-funded in the medium term and our pipelines for those deposits are strong. And number three, our newly launched technology enabled transaction banking platform, which is the enabled treasury and payment services, and then obviously there’s the CBIT platform which we talked about. The customer growth leads to stronger and broader network that leads to CBIT integrations and to see the payments flow through to deposits and those deposits are again associated with potentially [inaudible].

All right, that’s really helpful and just one last question. I appreciate all this color, but you sold the $500 million in consumer installment loans, almost essentially at par. You did take a $23 million loss from the sale. Can you just give some color what that loss entailed?

Sure Peter, I can take that one. So there were a couple of components to it. First, there was a $2.5 million loss on sale, just resulting from the sales price at 99.5, but secondly, there was $18.6 million in the unamortized customer acquisition cost that needed to be written at, at the time of sale and then there was some other deal related costs around $2.5 million.

Got it, okay. Thanks for the questions, taking my questions.

Absolutely.

Your next question is from the line of Frank Schiraldi with Piper Sandler. Your line is open.

Good morning. Just wondered on the growth. I want to make sure I have a right sort of fourth quarter. You talked about the $500 million in specialty running vertical to growth, is that net of anything or you know you basically expect the rest of the portfolio to be fairly flat.

[inaudible] that we are expecting a decline, a seasonal decline in the mortgage warehouse book, to end the year somewhere between $1.2 billion to $1.4 billion.

Okay, so outside of – yeah, I should have said outside of mortgage warehouse, the idea would be largely that we see $500 million in that growth is kind of the thinking.

That's right.

Okay, and then as a follow up, just if you do make the decision to buy back stock, and you do get aggressive on that front in the fourth quarter, what would be sort of the gig in terms of - would you be willing to accept maybe quite a lower capital level than you’ve otherwise anticipated to do that or would you – do you think slowdown, you know that growth in your specialty lending?

Frank, this is Jay. I’ll take that Frank. We will balance growth, like you said you know moderating growth for the maximization of capital, liquidity, margin and profitability and it's a balancing act. And from a timing point of view, even if we have to take a little bit of a hit to our capital ratios for one quarter, we will do that if it makes more sense to buy back stock, I think it's very important. We think that our opportunities for growth are enormous, but at this time in the cycle it makes more sense to be moderating the growth and improving the quality of our balance sheet and at the same time training at multiples which our shareholders should expect us to trade at with the kind of returns that we are providing in terms of earnings, in terms of our way, in terms of return on that.

And Frank, I would just add that we are – if you look our peer group, you know we are trading the top – sorry, rather our TEC is up in the top quartile of the banks out there right now. So even if we did decide to take action, which we would only do if there is under appreciation of the efforts that we have underway, we do have adequate capital levels relative to our peers in the industry.

Got it, okay. Thank you.

Your next question is from the line of David Bishop with The Hovde Group. Your line is open.

Yeah, good morning. Sticking with the deposits that’s in here, am I reading things wrong. It looks like you guys on-boarded 111 new customers in the CBIT platform, but deposit sales were they – to these customers this client is not bringing in deposits yet. Just curious why that’s the big growth in accounts, the decline in deposits. Thanks.

Yeah, sure. Absolutely David, good morning. So we on-boarded over a 100 customers, about 75% of those already funded, some of those you know opened up accounts towards the end of the quarter, and the average account balances are approximately $1 million to $1.5 million. So there is a slow growth and ramp up. At the end of the day deposits get funded into these accounts when it is either (a) a primary offering account or (b) it is a payments account and CBIT integration sometimes takes times for some of those key customers. So it's a leading indicator of future deposit growth, but the accounts are very active and funded.

Got it. And then any sense or maybe scale or just size in terms of just you know payments activity across the platform?

Yeah, our online payments activity continues to grow, and I referenced on my prepared remarks. What I would say is its several billion dollars in the quarter, all paid for.

Got it. And one final question on the expense front. Good cost containment there. You did see a decline in the tech expense. Is that a good run rate just here as that sort of drove the inter quarter decline in the technology expense run rate. Thanks.

Yes. So that is largely impacted by the deposit services agreement that we currently have in place with BMTX. As we said previously, that runs around $50 million on a quarterly basis. Up and down maybe $1 million quarter depending upon some seasonality of the deposits that are serviced by BMTX. This quarter was roughly $30 million.

Got it, thanks.

Your next question is from the line of Matthew Breese with Stephens. Your line is open.

I apologize, I’m having a tough time hearing you guys. What was the remaining cost tied to BM Technologies that should come out here?

So roughly that's about $50 million a quarter, and this quarter it was $30 million. On an annual basis its roughly $60 million.

Okay. And then you know similarly, you know I think last I had it there was about $2.2 billion of deposits tied to BMTX. That's still expected to fall off at the end of the year. What's the offset to that? Is it going to be higher borrowings or some sort of lower assets? And if it's lower assets, where do you expect the offset to be?

Well, a couple things on that. So currently the deposit service by BMTX is about $1.6 billion and I would point you to two things. One Sam described earlier the strong pipelines for core organic deposit growth and two, we had some comments in our strong liquidity position and the fact that we've had liquidity sources of close to $10 billion. So that gives us some options on how we find that the actual outflow of the BMTX service deposits.

Okay, and can you remind us the cost of the deposits versus the incremental cost of replacement.

Yes. So right now those costs are around 3% and to the extent that it would be replaced, we first go to organic low-to-no cost deposit channels and then any shortfall could be based on market rates.

Okay. And then going back to the NIM, I just wanted to make sure I had the cadence right. You know the core NIM is expected to be down 10 basis points in the fourth quarter and then do I have this right, it will be stable/expanding from there. And then if it's expanding, I just want some frame of reference, the extent of expansion you expect off of a bottom.

So on the NIM where we said on a static balance sheet, the impact of the consumer sale transaction would be roughly 10 basis points in the fourth quarter and what we guided to is that we will be within a three and three and a quarter for the fourth quarter, and then we have the margin expansion opportunities based on the items that we described earlier on the call.

Okay. And maybe just a follow-up to that. You know where do you expect deposit costs to peak if we have another call it 150 basis of fed fund hikes or asked another way, what are your full cycle deposit data estimate at this point?

So we're not giving out specific data guidance I think, and we're not focused on an ideal or an optimal deposit data, but what we can say and what we said previously is our deposit franchise, it's just largely built on commercial and institutional clients. When rate goes up, they expect the banks to pay them some money.

And if I would just add to that, is I think that at the end of last quarter we talked about what we were seeing in the market from a competitive standpoint related to deposit data in the industry. Our view has not changed at all you know over the past 90 days, whereas you have seen some folks in the industry continue to raise their cost with their estimates.

And I think…

Okay.

Matt, I think what we are focusing on is the consistency of net interest income, and net interest income growth is what we believe everybody should be looking at and expecting. So that if we see the deposit beta is going up and we see deposit costs going up, we better have a balance sheets which will show our earning asset yields going up too, and that's what we would like for you to focus. It's – I think you should be asking us lots of questions about our assets fee as well.

Understood, okay. I appreciate it. That's all the questions I had. Thank you.

Thanks Matt.

Your final question comes from the line of Bill Dezellem with Tieton Capital Management. Your line is open.

Thank you. That's Tieton Capital and let me start Sam. I will take the bait. You said that we should ask you about the digital technology initiatives and being in the top 10 banks. I’ll turn that over to you without any specific question and just what would you like to highlight there?

Sure, absolutely. Good morning, Bill. Great to speak to you and thanks so much for the question. You know we talked a lot last year about a number of initiatives that we had in terms of a couple along with the rebranding of the organization to be able to take the technology development that we have this franchise, thanks to our predecessor Subsidiary Bank Mobile, five plus years ago where we started to build the bank of the future on top of the traditional legacy technology. Once that organization was lifted out and divested last year, we had that DNA in our organization. We’ve added 75 team members and technology information. Our security department is separate from our IT department, is separate from our technology department. And the way that we think about it, Information Technology is run the bank, which helps facilitate the left hand with the right hand of changing the bank. And our technology team, the change the bank tech team of developers, engineers, work hand-in-hand with our folks in the market the digital market side, CRM, sales force, it's you know product management side. They are the folks that are helping to continue to innovate at this organization. We don't just have a small innovation to – we have you know 60 to 75 team members that are fully dedicated to changing the bank and changing the industry. So hopefully that's helpful and of the types of initiatives that we have underway are not roadmap initiatives. We're not focusing on digitizing, we're not focusing on the moving paper, we're not focusing on reducing costs, we're focusing on delivering a best-in-class customer experience that really delights the customer and it's an effortless and frictionless experience. And the ability to talk to a large commercial customer, that has an ability to move over say $100 million of deposits to you, but need to be able to have X, Y and Z in terms of reporting virtual account capabilities, ERP integration and have our team be able to roadmap that out and do that in a matter of days as opposed to a matter of months. The types of banks that can compete against us and these types of capabilities, you can count them on one or two ends, and they tend to be larger and a lot less agile.

That is helpful. Thank you, Sam. And you talked about the number of CBIT transactions doubling. Is there any revenue or for that matter, any cost associated with transactions in the CBIT arena or is it really entirely the deposit benefit.

Sure. So, we don't charge revenue for the tokenized deposits and payments transfer and settlement. We do have traditional commercial banking fees for ACH wire, etcetera, which are the on and off vents outside of our bank, before we use the on and off vent to the digital block chain based payments services. So we don’t charge the customer for the instant payments, but the in and outs, we do derive fee income for the organization. But really again, the main purpose of our CBIT platform, which is starting today in the digital asset industry, is to bring and create a large deposit gathering vertical of low-to-no cost deposits. That will continue to improve the deposit franchise and improve margin and reduce volatility you know in the medium term.

And then lastly, banking as a service, would you please discuss the initial interest that you all are seeing there and maybe it's too early to know, but interest in your perspective?

Sure, absolutely. You know so banking as a service, really we think of it as three pillars. There's loan services and loan origination, which is what we're referring to and I’ll come back to that. There is deposit taking capabilities and deposit taking capabilities typically are handled by the smaller sub $10 billion banks because of their Durban exemption, so that’s relevant for Customers Bank today. And finally payments, which we talked about, whether it’s CBIT or there is other forms of real time payments, B2B payments and as well as BTI enabled, you know ACH Wire, Fed Wire, actually FedNow, these are the types of capabilities that we have today or will have in the very near future. So going back to our marketplace lending partnership, as you know, as we built our consumer platform, initially we were partnering and purchasing loans just as long as five-plus years ago, and we have a number of servicing and originator relationships of the top of half a dozen or so of long-standing experienced Fintech Marketplace and platforms. So we have already onboarded them from a risk and compliance perspective. In many cases, we still have existing relationships with them and there's enough opportunities in that small handful of customers who generally originate billions of dollars of annual loans, whereby we have an opportunity to lend their technology and risk compliance platform, as well as some liquidity to be able to help them run their business, and for that we get paid a significant amount of high ROA interest and fees.

Thank you.

Thanks Bill.

There are no further questions at this time. I will now turn the call back over to Mr. Jay Sidhu.

Yeah, thank you very much. I really we appreciate your interest in Customers. So please give us a call anytime. We are always there to hear your ideas and we are committed to meeting or beating the consensus estimates you have for us for 2023. Thank you.

Ladies and gentlemen, this concludes today's call. You may now disconnect your lines.