The Bancorp, Inc. (TBBK) Q4 2015 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to The Bancorp Q4 and Fiscal 2015 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, today's conference is being recorded. I'd now like to introduce your host for today's conference, Mr. Andres Viroslav. Sir, please go ahead.

Thank you, Liz. Good morning and thank you for joining us today for The Bancorp's fourth quarter and fiscal 2015 financial results conference call. On the call with me today are John Chrystal, Interim Chief Executive Officer; Daniel Cohen, Chairman of the Board; and Paul Frenkiel, our Chief Financial Officer. This morning's call is being Webcast on our Web-site 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 31514831. Before I turn the call over to John, I would like to remind everyone that when used in this conference call, the words believes, anticipates, expects and similar impressions 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 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 would like to turn the call over to The Bancorp's Interim Chief Executive Officer, John Chrystal. John?

Good morning. Thank you, Andres, and thank you everyone for tuning into our earnings call. I'm pleased to be here with you today, and as you know, this is my first earnings call as Interim Chief Executive Officer. We will hear later in the call from Board Chairman, Daniel Cohen, on the progress of the search committee for our next CEO. Also with us is Paul Frenkiel, our Chief Financial Officer, who will address the details of our financial report. As a result of my day to day operating role, I have acquired a unique inside-out perspective on our Company and the dynamics that drive our enterprise. I'm looking forward to sharing more about this experience during this and future calls, the first one to expand upon several items that remain of concern to the marketplace. First and foremost, the Company's wholly-owned FDIC-insured bank closed the year as well capitalized, and begins 2016 with a clear view on advancing core earnings power. We are and expect to remain a leading innovative force in the fast-growing payments space, we enjoy a pole position in the prepaid cards industry, and we are expanding other high-growth, low-risk, asset generating businesses that have performed very well over the past few years. These core businesses provide a positive backdrop and speak to the strengths of our franchise as we manage through recent challenges that have restricted growth, reduced profitability, and been a source of uncertainty. These challenges include our BSA/AML corrective action steps and our discontinued lending operations. We now have good visibility into these sources of uncertainty. They have been substantially compartmentalized, and we have realized tremendous progress. While there is still much to do and despite the enormous and unforeseen expense associated with the BSA/AML lookback transaction review, over the fourth quarter we increased book value and enhanced our earnings capacity. We end the year more than well-capitalized and our core earnings power will emerge as the headwinds abate. I'm excited about the future of the Bank. Despite our growth restrictions, please remember our existing clients are growing at a very fast pace as is the financial technology sector as a whole. Our growth will mirror the growth of this sector. Simply put, we are in the right place at the right time. Every business line has demonstrated positive growth, process streamlining, and compliance improvements. The Bank punches well above its weight, and I expect it will continue to do so. We are also well on our way to becoming the role model for solutions to the challenges we have faced. Over the course of this call, I'd like to discuss our challenges in more detail and then highlight the strong earnings and growth trajectory of our normalized business. I'd also like to highlight the strategic opportunities we are pursuing. With respect to the BSA/AML consent order signed in 2014, the key items we are working through include the finalization of the lookback and upgrading our ongoing monitoring capabilities. Progress on these items will lead to a lifting of the provision of the 2014 consent order that restricts the growth of the Bank's prepaid segment. Specifically, over the course of 2015, we spent more than $41 million on BSA/AML lookback expenses, a significant portion falling in the fourth quarter. Of course this is an area of increased intensive senior management focus. These expenses relate to roughly 1.5 billion transactions covering the 18 month period starting Q1 2013. Based on detailed feedback and week by week projections from the independent third-party performing the review, we believe that the majority of the heavy-lifting on those items is complete, and we anticipate a significant reduction in lookback expenses during the second half of the year. Key of course is that this review is done independently and that the results are robust. A detailed action plan and monitoring process is in place and efficiency and effectiveness have greatly improved. Today, the Bank's ongoing BSA/AML monitoring is exceptionally robust. We have already implemented the majority of our BSA infrastructure, including Actimize, a Bank-wide holistic system for monitoring BSA/AML compliance. We built the infrastructure for and staffed our customer due diligence, we built the infrastructure for and staffed our enhanced due diligence, and we built the infrastructure for, staffed, and fully trained a financial intelligent unit which examines transactions. We will not rest here. We constantly look to enhance the Bank's capabilities to maintain a leading BSA/AML and financial crimes prevention function. I, our Board of Directors, and the entirety of the senior management team are fully committed to this goal. With respect to compliance, the Bank is intensely focused on improvement. In December, the bank consented to an amended order related to compliance, which included a civil monetary penalty in the amount of $3 million. This fine was principally related to alleged violations of Section 5 of the FTC Act. The Bank did not admit or deny liability but agreed to settle the matter to avoid additional litigation. The fine was primarily related to the actions of several third parties, some of whom are no longer our customers. We've reorganized the department, tripled staff, and have increased our focus on preventive compliance. We can and will become best-in-class at compliance management. Discontinued operations continue to be an area of focus where risk remains. Market participants may be heavily discounting its value. No portfolio is without risk. So please understand that the Bank's assessment is not certain. I would like to share a fair amount of detail with you. The Bank discontinued commercial loan operations in the third quarter of 2014. Upon discontinuance, the portfolio consisted of approximately $1.1 billion of commercial loans and almost $100 million of residential loans. The majority of commercial loans were secured by senior lien mortgages and collateralized by commercial real estate located within the Greater Delaware Valley. The Bank's goal is to contain and reduce credit exposure. Loans identified as fully performing were designated for sale and marketed to qualified financial and institutional buyers at a minimum price at par. Loans identified as impaired or nonperforming were designated for workout, restructure, or liquidation in order to maximize recovery and minimize loss. We have reduced our discontinued portfolio from slightly over $1.2 billion to $568 million, net of the mark of roughly $43 million. That reduction reflects loans with a principal balance of $267 million sold to Walnut Street in a private securitization financed by the Bank during the fourth quarter of 2014, and another $329 million of loan sales, repayments, and previously taken marks. The remaining portfolio consists of residential mortgages and commercial loans. The number of borrowers has dropped by over 50% and the credit mark has increased to just over 7% of the remaining $611 million in principal, resulting in the net $568 million of loans on the books. Of the $611 million of principal, residential mortgages totaled roughly $75 million. The payment history of these mortgages is quite good. There is only one loan of less than $550,000 that is in non-accrual and no other loans are more than 90 days past due. However, these residential loans are not easily securitized and the return is good. The weighted average coupon on these loans is roughly 3.8%. We may sell a subset of these loans if the opportunity presents itself but we will not rush to do so. At the present time, they seem very attractive assets. These residential mortgage balances declined by roughly $10 million in 2015. The $611 million total principal for discontinued loans, less the $75 million in residential loans, leaves a $536 million balance of commercial loans. Please note, as mentioned earlier, these loans have roughly $43 million in reserves against them. Roughly 70% or $373 million of the commercial loans fall into 16 large relationships which exceed $10 million each. There is a mark of $29 million against that $373 million and $17 million of this population is in nonperforming status. The $163 million balance of the remaining relationships, all under $10 million, carried the remaining mark of $14 million. $27 million of this population of smaller loans is in nonperforming status. While some of these loans have longer maturities, we believe that the portfolio will decline by roughly one-third per year through prepayments, loan sales, collections and scheduled maturities. By the end of the year, the loans will have a smaller impact on their balance sheet and therefore less risk. As we downsize this portfolio and we move through our BSA/AML situation, we are a bank that has strong earnings potential. Our continuing lending businesses have grown substantially. Contributing to core earnings capacity is an 18% increase in net interest income as our focused areas of lending grew outstanding balances by 44% year-over-year. This growth was led by our security backed lines of credit, SBA lending and our Commercial Fleet Leasing business lines, which grew 37%, 45% and 19% respectively. We see that growth as something that will be reflected in our continuing operations throughout 2016 and beyond. These businesses have performed well for their entire history and will continue to add to net interest margin. Credit quality has been maintained as net charge-offs for the year were less than 5 basis points of average assets and nonperforming loans just 5 basis points of total assets at year-end. Over the past three years, total charge-offs in these business segments have averaged less than $300,000 per year and were even lower last year. Let me highlight just a few of the accomplishments of our continuing operations. In our Payment Solutions Group, we ended 2015 with more than 80 million active cards and approximately $41 billion of gross dollar volume. After normalizing for the Bank's decision to exit a large relationship in 2014, fourth quarter 2014 to fourth quarter 2015 metrics demonstrated 15% growth in gross dollar volume and that compares very favorably to an industry average which I believe is just below 11%. In our Institutional Banking Group, we experienced a 37% year-over-year increase in loan outstandings, ending the year at approximately $576 million. In commercial mortgage-backed securitization, we grew our floating rate CLO portfolio from $40 million in 2014 to $295 million in 2015. Floating rate CLO interest income also increased from $789,000 in 2014 to over $8 million in 2015. In government guaranteed lending, we achieved year-over-year growth of approximately 45% and finished the year ranked 31st in national production volume. In Commercial Fleet Leasing, we achieved approximately 20% year-over-year growth and continued geographic expansion, evidenced by the acquisition of assets of Ellis Brooks Leasing, an existing portfolio based in San Francisco. In the short-term instance, we have accelerated growth and have more than doubled the size of the assets in that location. We continue to look for similar opportunities across the country. As we look to the future, we have an impressive list of targeted operational initiatives well underway. We expect them to be key drivers of double-digit annualized cost efficiency improvements. Over the course of 2015, we made strategic hires of senior operations leaders from top 10 banks. Each of these leaders has come to our organization with proven track records of designing and managing change and back-office transformation. In the third quarter of 2015, we initiated core platform evaluations, including a thorough assessment of present and future functionality, cost effectiveness and technical architecture. We expect resulting platform improvements will boost capacity, simplify processing and lower costs. Entering 2016, we are making great progress toward a new target operating model. This progress includes identifying and prioritizing opportunities in process and supplier consolidation and simplification of call centers. As we continue to manage our businesses and grow book value, we are being strategic about our business mix and our balance sheet use. The disposition of our HSA business was a strategic decision that was accretive to our earnings and capital. While we recorded roughly $33 million gain and boosted future income estimates, we reduced our deposits by over $385 million. Through the sale we should realize on an annual basis approximately $4 million of additional pre-tax earnings. We remain well-capitalized and we plan to exit additional higher cost volatile deposits with limited reinvestment opportunities. While deposit exits may have been partially offset by deposit growth, more exits are planned. These moves will boost capital ratios, reduce costs and help earnings. Finally, I would be remiss if I did not speak to further opportunities that lie ahead of us. These extend well beyond business as usual, which on its own is exciting. First and foremost, we are in a unique position. The Bancorp is both a bank and a premier business process outsource platform. We are not sitting still and plan to leverage this strategic strength. I'd like to share with you the things on my longer-term agenda. First, we need to accelerate government guaranteed lending and SBLOC loan growth in a deliberate, thoughtful manner. This is straightforward, we have the people in place and we have [indiscernible] our ability to execute well. We also have the opportunity to become the leading banking backbone and the catalyst for digital lending. The possibilities are widespread. Our expertise in business process, compliance, BSA/AML monitoring, plus our desire to employ more funds in lending markets makes us an ideal partner for digital lending platforms. We are actively exploring the opportunities in this marketplace. Our leasing business is world-class. Our track record with leasing acquisitions is good and the stability of our funds and the scale of our businesses make this a natural area for expansion and we intend to further pursue opportunities as they arise. Finally, private wealth platforms, especially for the younger generation, are becoming more digital. We will grow with these platforms. The technology-driven algorithmic wealth advisors, all will benefit from seamless connections to banking and lending services and we are well-positioned to capture additional fees and banking opportunities as these platforms grow. We must explore each of these opportunities as we position the Bank for growth. This is very doable for us and I will be focused on each of these opportunities over the coming months. We therefore look forward to a bank that is repositioned in the second half of 2016, has good regulatory relationships and is well-capitalized for returning value to investors. At this point, I'd like to turn the call over to Daniel Cohen to discuss the progress on the search for a permanent Chief Executive Officer. Daniel?

Thank you, John, and thank you for your leadership during this transition. As those of you listening could hear, John's command of the Bank is substantial and leads us to somewhat regret that we will be replacing him hopefully in the near future. While the businesses that John's predecessors have built, as you've heard, continue to be an engine of strength during the challenges we face, our Board's search committee has been very active in finding and evaluating candidates for the position of CEO to lead the Bank going forward. I'm glad to report that we have a rich roster of candidates, most with both banking and payments experience. The most serious we are considering have long track records of success in public companies in the banking and payment spaces. We want to conclude our search for our permanent CEO as quickly as possible and believe that during the first half of this year we will do so. As you have heard, the Bank is poised to clear its challenges in the next year and permanent leadership should be in place to lead the Bank forward, although the current interim leadership has been quite strong. With that update, I will turn the call back to John.

Thank you, Daniel. I would like to turn the call over to Paul Frenkiel at this point to go through the financials.

Thank you, John, and good morning. Notwithstanding BSA lookback expense of $41.4 million in 2015, the Bank realized net income available to shareholders of $14.4 million, with $0.38 per share. Those earnings not only include the $33.5 million HSA gain on sale and approximately $14 million of security gains, but also reflect the significant progress in the transition to continuing lines of business. Continuing quarterly increases in all of our primary lending lines of business resulted in an 18% annual and quarterly increase in net interest income. Year-over-year increases for SBLOC, our largest lending line, was 37%, with 45% and 19% growth for SBA and leasing respectively. Loans held for sale also continued to grow and also contributed significantly. As John noted, these lines of business have historically had low charge-offs. The net interest margin for the quarter was 2.52% compared to 2.62% in the prior year quarter. The reduction reflected a slightly higher cost of funds and a higher average balance maintained in Fed funds at the Federal Reserve Bank which earns nominal rates. Non-interest income reflected the two large aforementioned items. In addition to the $33.5 million gain on sale for the HSA business, for tax reasons we sold $400 million of tax-exempt municipal bonds which are being reinvested in taxable bonds at slightly higher yields. Those sales resulted in an additional $14 million of gains. Non-interest expense excluding BSA lookback for fourth quarter 2015 increased $11 million over fourth quarter 2014, which reflected a $3 million civil money penalty. Other items in the increase were $3 million for salaries and benefits and $1 million each for FDIC insurance and software expense. Depending on future assessments of the institution, FDIC expense may decrease in the future. Risk-based capital ratios represent the company's highest capital ratios relative to well-capitalized standards. Those ratios reflect a significant amount of lower risk-weighted loans and investments and were increased during the quarter through retained earnings. The leverage ratio was also increased over the linked quarter through earnings and reductions in low rate balances maintained at the Federal Reserve Bank. John, this concludes the financial report.

Thank you, Paul. Liz, at this time, please open up the call for questions, if you could.

[Operator Instructions] Our first question comes from the line of William Wallace with Raymond James. Your line is now open.

First question, maybe just real quick on Paul's prepared commentary, there's the highlight of the $920,000 of additional FDIC expense in the quarter highlighted as nonrecurring. Was that a catch-up for a higher assessment rate for 2015 or is there something else that drove that?

That was actually as a result of the restatement. You're required to go back and file amended call reports. So the FDIC actually runs them through their computer system, they look at all the factors going into that assessment. So that is the one-time going back to pre-2014 call reports, which is why we show it in the nonrecurring schedule.

Okay, perfect, thank you. So if I back out all of the expenses that you guys pulled out in the release, I come up with $39.8 million, and what I'm trying to figure out is whether or not there's going to be additional investments related to the BSA compliance, building up systems, hiring people, or if all those expenses are baked in with the fourth quarter numbers?

In terms of the BSA/AML, as we all know, those expenses have been outsized and much bigger than expected. We hired approximately 70 people. Actually, I believe that the count is up to 71 in the BSA/AML. And speaking with our BSA/AML expert and head of that area, she's actually going to try to slightly reduce that count this year. So in terms of that salary expense, we see that as having plateaued and now it's a question of optimizing and managing it better. We do have some ongoing expense, but the vast, vast majority has been baked in with the exception of the lookback expense, which will still be extremely high, at least for January, and as we said, we believe that based on the third-party, they will complete virtually all of that work in the second quarter, and in the second half of the year we'll have much, much less of that expense.

Okay, so two kind of follow-ups to that answer. One, is the more appropriate way to think about the expenses then, maybe take that $39.8 million, which excludes the lookback consulting stuff, and rather than give credit for maybe reducing some expense in headcount, just kind of hold the line and…?

Yes, I think that's – I would not take exception to that approach.

And then – I just lost my train of thoughts. Hopefully it comes back to me, but I have a question on the prepaid. In the prepared remarks, I believe you said it was 15% growth in GDV. That's excluding the relationship that you guys exited towards the end of last year?

This is John. So it's after adjustment for the exit of that relationship. The year on year growth just in absolute numbers is pretty close to flat.

Okay, all right, perfect. So 15% though is kind of maybe a core growth?

Realize that, I mean just emphasizing, while we have growth restrictions in terms of adding new partners, our existing partners have significant growth trajectories. So to a large extent our growth will mirror their growth, and we certainly expect further growth in 2016.

Okay. And my other question that I lost my train of thoughts on came back to me. So, Paul, the expenses that we just kind of talked about as $39.8 million maybe holding the line, does holding the line also anticipate the savings that you would expect to get from the severance, I mean the comp line, from the HSA business that you guys sold?

In our projections, once we've captured all those savings which we are looking through the first half of the year, more toward the second half, you'll be able to start that annualized calculation and the projected goal of approximately $4 million. In terms of – you can't just use that number because it's an amalgam of items in interest expense and FDIC insurance would go in there, but it's kind of a separate analysis in other items. So I would actually have to take just the cost saves out of that picture, and remember it won't be until the latter half of the year that we'll begin to get the full annualized benefit.

So the $4 million though – I guess what you're saying is that the cost saves should actually be more than that though, right, because the $4 million anticipates also the lost revenues that you guys were generating or no?

Yes, the $4 million is net of the revenues that we're giving up.

Okay. So we should see some large benefit in the second half of the year on the expense line?

The HSA will have that benefit on an annualized basis in the second half of the year, and we are working, our Chief Operating Officer and the rest of our department are committed on to holding the line and optimizing expense. So that is our goal, yes.

Okay. Thanks, Paul. And then my last question is just turning to the balance sheet and looking at the leverage ratio, you guys have hinted at some anticipated relief from exiting additional deposit relationships. Is there any color you could give, I know you don't want to give too much, but what the opportunity is there? Are these prepaid businesses, are you talking about the deposits associated with the loans held for sale, how big is the opportunity, just would help to get a little bit of a framework around how we can think about what your capital levels might do moving forward?

This is John. Let me start and then I'll turn it over to Paul. Our first focus is what I'll call low hanging fruit. There are deposits that we had brokered deposits to start with. That's pretty easy decision. We then look at deposits that have no strategic value. So they have very little if any non-interest income associated with them. That's probably the next level of deposits to touch. From there, it gets a bit more complicated, but everything's being closely evaluated. There will be some deposit exits related to discontinued operations that's in process. It is very difficult, particularly with some of the deposits where the balances can fluctuate dramatically day to day, to reinvest those funds in anything other than Fed funds. That's a money losing proposition for us. We pay more in deposit insurance and costs and other things than we can possibly earn selling those Fed funds. So again, we are taking a hard look at all of that, particularly at a time where we want to boost our leverage ratio.

In the first half of the year, there's a lot of seasonality, especially in the first quarter, as it relates to the onboarding of deposits from the prepaid businesses. I don't know how to frame this question. I'm just trying to think, what is the opportunity, how much relief can you get to your leverage ratio with the three different strategies that you highlighted as far as looking at your deposit base and trying to offload some?

Okay, so we have projected and we have in place exits in the first quarter that will be a significant offset to the seasonality that you are exactly on point with. So you won't see the decrease in the ratio to the extent you might have seen that in prior years, because we will have an offset to that. We still have a some seasonality in the second quarter but you will be able to see progress to leverage ratio because, A, we'll have the full quarter effect of the exits in the first quarter, and we're additionally planning some other exits and you have less seasonality. By the third quarter, you'll see the most significant progress in the leverage ratio. And yes, we're not going to get specific, although we do project those internally. So you will see a measurable improvement in the leverage ratio.

Okay. And my last question is just are we thinking about you guys probably managing towards about an 8% leverage ratio?

8% seems to be a regulatory threshold over the years that tend to be a pure benchmark. So, yes, 8% is utilized in our thinking.

If I could make one more comment, exiting these deposits to a large extent just by the way they are reinvested and also their fluctuating nature, I think by and large these deposits that we exit are probably losing us money. So you see very little, if any, negative earnings impact through slimming down the balance sheet.

Right. I appreciate the commentary. I'll let somebody else ask you questions. Thanks guys.

Our next question comes from the line of Frank Schiraldi with Sandler O'Neill. Your line is now open.

Just want to start with just on the exiting of deposits side, the potential for that sounds like over the next six months or so, is there anything that regardless of maybe they are not – maybe not even making money for you guys, but you could see gains attached to any of these exits, could any end up being a sales or like the HSA business?

There is always that possibility but I certainly wouldn't attach much, if any, value to that. Certainly the brokerage CDs, I think that would be zero, and the remaining deposits I think if there is a premium paid, it will be – at this point, I do not anticipate that being a significant number and we're budgeting zero for it.

Okay, great. Okay thanks. And then just thinking about the prepaid business and prepaid fees in general, are there any larger sized fee revenue relationships on the prepaid side, call it your largest 5 or 10 partnerships, that may be up for renewal in the short term over the next 12 months or have you locked most of those up to multiyear contracts at this point? I'm just wondering, trying to figure out if there's any potential attrition from large relationships as a possibility this year?

We're not projecting any. We work very closely with the head of that department and look at his projections. He is not projecting that and he is very focused on relationships. One of the reasons for our growth is the exceptional customized service that he and his department and his program managers provide, and really the whole staff. So I think he's very confident that he has solid footing with his customer pool.

But I guess generally these are locked up to five year commitments, five-year contracts. Is there anything large coming up for renewal over the next 12 months?

I don't have the specific contracts and renewal dates but I can tell you that we just reviewed actually several times the list of the top 10-12 customers and we are on very solid footing. So I don't see any issues there.

Okay great. Thanks. And then just on the larger size loans, greater than $10 million loans in the discontinued book, is there any more detail, John, you can give? I think you said there were 16 large relationships of over $10 million. Is there any more detail you can give in terms of maybe the few largest within that pool and how those are performing specifically?

I certainly have that. I'm not comfortable sharing that at this moment. I will assure you that we are – I would call it hand to hand combat on each one of those. We anticipate the largest ones are expecting very significant paydowns this year. In fact I think of the largest one, we just received a very significant paydown for this quarter, like the money is supposed to come in today if I'm not mistaken. So I think what we will see is much more – by year end, a much more, I wouldn't call it homogeneous large loan pool, but one where the outliers are less so.

And, Frank, finance relies on the third-party. We have a firm that's well known and considered extremely good within the industry to do the loan reviews. So that's what we're really relying on to take the marks and make sure that they've been marked down appropriately, and they do that quarterly.

And they just finished that for the fourth quarter.

Okay. And then if I look at that portfolio, in terms of just the impaired balances, I mean what's the total impaired and what has that been marked to as a percentage of par?

Total impaired is $44 million. They are impaired if they are nonperformers less non-accruals. They've got approximately $13 million of marks against that $44 million.

Okay.

So if you go back through, just pulling back the earnings announcement, so let's break that down, of the $44 million, these are nonperforming loans, there's $17 million that's in the large population and $27 million in the small population. So back to your question, Frank, of I think what you're digging at is, where is the ugly stuff? So there is more ugly stuff in the small pool, the $163 million of smaller loans, than there is in the $373 million pool of large loans. The total amount of reserves against the entire portfolio is $43 million. While internally, it's allocated literally credit by credit, the money is fungible. So if it turns out, we're going to have positive surprises and negative surprises, but if you thought about it the way many people would think about it, we have $44 million in nonperforming loans and we have $43 million in reserves.

Okay. Yes, for some reason I thought, I heard your commentary on the nonperforming that obviously added up to $44 million, and I guess I just thought there was a larger number of impaired. Maybe I was thinking of classified loans. But how has that migration been over the last quarter in terms of nonperforming/classified and has those balances remained sort of steady or they even decreased as you've gotten some paydowns?

That change is reflected in the mark. The total of – it all basically runs through the mark, Frank. I'm not aware of large paydowns in that total from the most recent quarter that you might have been looking at to this quarter.

I think the important thing to track, and we will share this with you on a quarterly basis, is I fully intend to continue to give you similar statistics quarter by quarter. So what you'll see is, right now we have a nonperforming population of $44 million and marks of $43 million. That will change as we sell some of those ugly credits. Both the balance for the ugly credit will decline but so will the marks because it may take some of that mark to realize the disposition of that credit. There will also be adjustments quarter to quarter just due to third-party's re-evaluation of the portfolio. The other way to think of it is, so there's $43 million in marks against the total portfolio. The marks are almost exclusively against the commercial loan portfolio as opposed to the residential portfolio. So the gross balance pre-mark of the commercial loan portfolio is $536 million and there are $43 million in marks against that. So whatever that math works out to be, I think it's about 7% and change.

Correct.

I'm not smart enough to do that one in my head, but you have calculators in front of you. And if you believe that there's a better way we could share this, please contact me privately and I'm happy if you think there's a less confusing or an easier to understand format, we're happy to attempt to go down that road.

Great. Okay, I appreciate all the color. Thank you.

Our next question comes from the line of Matt Kelley with Piper Jaffray. Your line is now open.

Just a question on the plan with $0.5 billion of commercial loans that you've been trying to dispose off and kind of work down here, is it more likely or less likely to see a bulk sale for more than a couple of hundred million over the next 6 to 12 months or are you heading down a path of really just trying to run it down over the next couple of years?

This is John. And first, thank you for joining. I think a bulk sale of several hundred million is unlikely for a number of reasons. First, large loans don't lend themselves to that. We could do a bulk sale of the residential loans, but we kind of like them, to be honest. Would we sell some of those in a local transaction, we may very well just reduce the balance. It's I think from an OpEx standpoint that would be helpful. But they are great earning assets. You and I would buy those on our own balance sheet. With respect to the commercial loan portfolio, the top 16, the sweet 16, I think that is a strategy. In some cases, we will get repaid at maturity, and a lot of those maturities are coming up, and so there's no reason to do anything other than just wait for the money. There is another subset that we're aggressively working out of. Believe me that's where I am spending probably 20% of my time. And we have a small army of people that are intensely focused on that. There is potential for sale again I would say anywhere from 25 million to 50 million performing commercial loans, [by the] [ph] sale most likely to a regional bank in this area. What I think is unlikely is, particularly in this marketplace, I think is CLO is unlikely, and you never say never, but I think it's unlikely. So if you think about the balances, the resi will take care of itself either through sales or paydowns, and it's a performing portfolio. Of the 16 large loans, there is a big decline in that balance expected over the course of this year, mainly through payments, in a couple of cases workouts. And then of the $163 million, if we could knock 50 million of that out through a sale to another institution, we would do that, and we have people working on that.

And have there been real bids at the net carrying values? I mean on the $536 million gross kind of pre-mark balance, $493 million net of the reserves, there was 7% to 8% mark. The last six, nine months, have you received kind of real bids around those types of levels to move stuff or those have not come in?

Part of the process has been the same people that were working on selling the portfolio were also working on financial restatement and the scrub of the loan files for that financial restatement. Remember, these loans were not originated with the intent to sell. So to a large extent they were not ready to be sold. The documentation while appropriate may not be what you would put together if you were planning to originate for sale. We're in much better shape on that front and that's why we've restarted the sales effort.

Got you. And then just switching gears a little bit, you mentioned that you're bringing kind of the municipal balances down and then the floating-rate CLO balances up. Can you give us a little bit of a profile of the credit risk of some of those types of securities that are going on to the balance sheet in the CLO bucket?

All the securities that we have reinvested the municipals into are also deemed low risk by Basel and they get the lower risk weighting, generally 20%. So we probably began purchasing taxable munis to make them taxable, but again because they are municipals, they get the lower risk weighting. We also bought agencies, fixed rate agency mortgages. But we're also at the same time we are actually reducing duration to getting slightly higher yields by also investing in CLOs. John Chrystal has a unique experience with that in his resume and really allowed the Bank to and provided an additional source of expertise and comfort to allow that. So we're investing a significant portion of those municipal sale proceeds into CLOs. They yield between 2.9% to 3% for the AA, for the AAA approximately 2.5%. We're not going to go below. We're just sticking to the very top credits. So we don't believe we're having credit risk.

If I could expand on that a bit, just so you can rest assured it's more than just [indiscernible]. We have a Chief Investment Officer who is actually very good at this, very knowledgeable about it. Second, we've limited our purchases to what I would consider to be the top tier CLO managers with top-tier transactions and we'll continue to do that. We definitely are positioning ourselves on the conservative side of things, at least I believe we are. We are not reaching for yield in that space. It's a market that I not only know well but our Chief Investment Officer knows very well. I feel comfortable with his execution in that area. I would also add that our chairman, Daniel Cohen, is very knowledgeable about that sector. So there's no shortage of expertise at a senior level and the person on the ground certainly knows his stuff.

Got you. And then last question, I know it's very difficult to handicap timing in terms of regulatory orders, but all the areas that you've talked about having a desire to go into personal financial management, kind of new [indiscernible] ways to provide advisory type work on the wealth front, digital lending, and even the core business of deposit sponsorship, do you feel like the restrictions on growth will be lifted in 2016 or is that a 2017 event on the [indiscernible]?

Let me address two things in your question. First, the restrictions on growth are very targeted, specific to our prepaid business and then to a limited extent our payment acceptance business. So those restrictions do not necessarily extend to the items we've spoken about. As an example, we are certainly expanding our leasing business. We are expanding our SBLOC business, we're expanding our SBA government guaranteed lending business. So much of what I've spoken about is not subject to a consent order. That being said, we are not doing anything without being very deliberate and thorough and fulsome in our analysis to make sure that we have compliance in order, the AML/BSA effort in order, that we have the infrastructure, that we have the technology. We're not jumping into something where the rest of the bank is catching up. So that being said, the consent order that does restrict our growth is very specific. It's the 2014 AML/BSA consent order, and it's a specific part of that order that restricts our growth. I'm going to use my words, not the words in the consent order, but what we have to do before that consent order gets lifted is demonstrate to the FDIC, and they'll have to validate this, that we are fully operational, best in class, with respect to BSA/AML monitoring. What that means is a few things. One is the Actimize system, which is bank-wide, enterprise-wide, it's our AML/BSA transaction monitoring system as well as the Know Your Client system for customer due diligence and enhanced due diligence, that has to be fully operational, has to be validated by a third-party and it has to be operational for some period of time so that people can see whether it works through stress periods. We do have a third party validating the model now, we are using it in production in parallel with our other models and we're going to see some great efficiency gains once we can turn off the switch within some of those older models. So we have to have validation of that. In addition, we will need an external audit of our entire BSA/AML effort. That's going on now. I fully expect, as with any audit, there will be a few findings that come out of the back end of that. I have periodic conversations with that auditor. I want to be ahead of the recommendations and be in the process of taking the actions necessary to address the recommendations hopefully before they even leave the building and file their final report. We will invite them back in for a second mini audit to verify closure of those recommendations. We will then file a report with the FDIC stating that we think we have everything in place. They will then have to come in and validate that. So to answer your question, I don't think that's a first half of year event. I think my own estimation and regulatory actions are very hard to estimate and predict. My best estimate is, it's second half 2016, but it certainly could be early 2017. I am hedging all of that because as you and I both know, the regulators are going to want to assure themselves that everything is perfect and that we've gone from being an organization where things were deficient to an organization that's best in class, and we're fully committed to getting there.

Fair enough. Thank you very much.

I'm showing no further questions in queue at this time. I'd like to turn the call back to Mr. John Chrystal for closing remarks.

My closing remarks, I'll just add a couple of things just from a personal standpoint. One, although interim, I'm very much enjoying this role and I have found the leadership team of the Bank to be even better than I thought it was sitting at the Board level. This is an amazing team and one that I bet on every day and would encourage people on the phone to bet on as well. So, I thank you for your participation. I encourage you to reach out to me personally if you have follow-up questions. So thank you everyone and we look forward to updating you with our progress next quarter. Thank you, Liz.