The Bancorp, Inc. (TBBK) Q1 2016 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the First Quarter 2016 The Bancorp, Inc. Earnings Conference Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mr. Andres Viroslav. Sir, you may begin your conference.

Thank you, Chelsea. Good morning, and thank you for joining us today for The Bancorp's First Quarter 2016 Financial Results Conference Call. On the call with me today are John Chrystal, Interim Chief Executive Officer; and Paul Frenkiel, our Chief Financial Officer. This morning's call is being webcast on our website at www.thebancorp.com. There will be a replay of the call beginning at approximately 12 p.m. Eastern Time today. The dial-in for the replay is (855) 859-2056, with a confirmation code of 90268500. 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 expressions are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to risks and uncertainties which could cause actual results to differ materially from those anticipated or suggested by such statements. For a further discussion of these risks and uncertainties, please see The Bancorp's filings with the SEC. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Bancorp undertakes no obligation to publicly release the results of any revisions to forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Now I'd like to turn the call over to The Bancorp's Interim Chief Executive Officer, John Chrystal. John?

Thank you, Andres. Good morning, everyone. Thank you for joining the first quarter 2016 earnings call for The Bancorp. We will hear later from Paul Frenkiel, our Chief Financial Officer, who will cover in detail the company's financial results. I'd like to update you about the strategies and priorities I outlined at year-end. As mentioned in January, shortly after being named Interim CEO and President, my focus has been, and will continue to be, on those items that are the most critical for the company's performance. These include managing the bank's capital ratios, growing earning assets, improving regulatory performance and shrinking discontinued operations. The company's wholly owned FDIC-insured bank closed the first quarter as well capitalized, experienced solid growth, progressed according to plan with the HSA exit and made significant progress towards resolving its regulatory challenges. The core of the company's franchise, the payments business, experienced greater than 15% year-over-year growth in gross dollar volume, and the bank continues to be a leader in the prepaid card industry. Active accounts grew from roughly 80 million at year-end to over 86 million at quarter end. We expect continued robust growth in prepaid card volume and profitability. As planned, the bank managed seasonal deposit fluctuations by exiting higher-cost, nonstrategic deposits, and the quarter end balance sheet is slightly smaller than at year-end. We expect Q2 average total assets to decrease by another $200 million to $300 million. The bank experienced a solid quarter in its specialty lending and leasing businesses. These lower-risk, well-secured, asset-generating businesses helped drive a 24% year-over-year increase in net interest income. Asset growth remained strong. Relative to year-end, institutional banking grew outstanding balances on security-backed lines of credit by 2.9%. Typically, Q1 is a lower-growth quarter for this business line, and we expect strong growth for the remainder of the year. Year-over-year growth was 32%. The commercial fleet leasing business grew outstanding loan and lease balances by almost 4% since year-end and year-over-year growth was over 9%. In addition, the bank expects to continue to supplement its organic growth in this business line through periodic acquisition of assets. The SBA lending business grew 9% during the quarter and better than 50% year-over-year. Across all 3 of these specialty lending and leasing businesses, portfolio quality continues to be strong and losses have been minimal. The bank continued to execute its previously disclosed plan to exit tax-exempt securities and replace them with highly rated taxable securities with lower duration. The reinvestment process was deliberate and methodical, and the bank was able to add to the portfolio during the spread-widening environment we witnessed mid-quarter. The bank has added over $200 million of highly rated, well-secured, highly diverse assets with a weighted average spread over LIBOR of roughly 2%. Paul can certainly provide more detail if desired, but this demonstrates that attractive, low-risk investments with minimal associated expenses in credit risk can supplement the bank's organic asset growth. The CMBS business line showed a loss in the quarter, but the bank was able to exit all commercial real estate CLO loan inventory originated prior to early December via sale of over $200 million of floating rate loans. While loan sales from continuing operations generated a small loss, the sale of the CRE CLO loan inventory in a difficult market reaffirmed the bank's risk management discipline and should be taken in the context of $12.4 million of 2015 interest income from this business line. While we are only partially through the year, the bank expects much stronger performance on an annual basis. This sector has been, and we believe will continue to be, an attractive source of net interest income and noninterest income with manageable risks. Shifting gears slightly, I'd like to give an update on discontinued operations. The bank continues to be focused on containing and reducing credit exposure. The primary objective is to reduce uncertainty by shrinking this portfolio via loan sales, payments, refinancing and resolution of problem credits. While the reduction in principal balance will reduce net interest income, risk reduction is a higher priority. As outlined in the January call, as of year-end, the unpaid principal balance of loans in discontinued operations was roughly $611 million, with a mark of roughly $43 million and nonperforming loans of $44 million. Bringing things forward to 3/31/2016, the unpaid principal balance of loans in discontinued operations was roughly $569 million, with a mark of $46 million and nonperforming loans of slightly over $60 million, which is up by $16 million due to credit migration. The $42 million reduction in the unpaid principal balance was in line with expectations. Included in these totals are roughly $72 million of unpaid residential mortgage balances, which declined by $3 million during the quarter. The year-over-year decline in residential loans was roughly $8 million. The quarter end unpaid principal balance of commercial loans in discontinued operations was $497 million. Let me address that portfolio in more detail. I'll first address the largest credit relationships. Year-end balances of the 16 largest relationships totaled $373 million, with a mark of $29 million and nonperforming loans of $17 million. At the end of the first quarter, one of those 16 largest relationships paid off. The balance of the 15 remaining relationships were $337 million, with a mark of $31 million and nonperforming loans of $31 million. With respect to the smaller credit relationships, the unpaid principal balance declined from $163 million to $160 million. The mark increased from $14 million to $15 million and nonperforming loans increased from $27 million to $29 million. Net, with respect to this portfolio, it was a mixed quarter. Progress is made on shrinking the portfolio but the independently derived credit marks increased over year-end. The bank expects significant progress towards shrinking the discontinued operations portfolio. Over the next 6 months, both categories, the largest relationships and the pool as a whole, could decline by 20% to 25% from current levels. Finally, I'd like to give you an update on progress against the bank's 2014 AML/BSA consent order. As outlined in the January call, the majority of work and expense stream associated with the consent order is related to the historical transaction review, or look-back. This is expected to be largely completed towards the end of the second quarter with a smaller -- or a similar to slightly smaller expense drag in the second quarter. Some residual work and much smaller expense items will fall in Q3. While uncertainty remains, we remain positive about the trajectory. First quarter expenses related to this consent order, not including the expense of ongoing operations, were roughly $15 million. The AML/BSA system validation and AML/BSA audits are now complete, and the bank is well along in addressing the issues in -- noted in each. The bank expects the audit items will be largely closed and the look-back completed by early third quarter. In summary, I'd like to highlight many of the items mentioned in my prior call. First, the bank is committed to becoming a leader in regulatory compliance in third-party management. If the bank wishes to continue to be a leader in its core franchise, payments and prepaid cards, it must be a world-class leader in these areas, and considerable resources are being devoted to this goal. Second, the bank is well capitalized and expects to remain so. Third, our strategy of growing assets in lower-risk, highly granular, specialized lending markets and supplementing this growth with a deliberate securities investment process is generating solid increases in net interest income, and we continue with this growth and income-generation strategy. Fourth, the bank remains committed to shrinking discontinued operations and expects good progress with this over the next 2 quarters. All in all, I believe there's a clear path forward, one that makes sense and where -- one where the bank has demonstrated success. Simply put, it's up to us to execute. With that, I'll conclude my remarks and turn things over to Paul Frenkiel, our CFO.

Thank you, John, and good morning, everybody. Two significant factors were reflected in the reported net loss for continuing operations. The vast majority of the loss resulted from $14.3 million of BSA look-back expense. As John has previously indicated, we believe that BSA look-back expense will substantially conclude in second quarter 2016, based on updated input from the third party performing the vast majority of that work. Additionally, the first quarter loss reflected a $4.7 million linked-quarter swing in CMBS loan sales income, from a $3.3 million gain on sale in Q4 2015 to a loss of $1.4 million in the current quarter, which reflected exceptional volatility in credit spreads during the first quarter. However, on an annual basis, for each of the past 3 years since inception, such loan sales have been a meaningful contributed -- contributor to earnings. First quarter 2016 results for discontinued operations reflected an approximate $3 million reduction in loan interest income compared to first quarter 2015. Discontinued loan interest income has decreased as a result of discontinued loan sales and pay-offs. Related proceeds are being invested in "continuing line of business" loan growth and investment securities balances. Continuing quarterly increases in all of our primary lending lines of business were reflected in a 24% increase in net interest income. Year-over-year increases for SBLOC, our largest lending line, was 32%, with 51% and 9% growth for SBA and leasing, respectively. Loans held for sale to secondary markets also contributed significantly to net interest income. As previously noted, these lines of business have historically had low charge-offs. Bancorp has increased its period-end investment balances over the linked quarter primarily with highly rated variable-rate securities, which we believe will grow interest income from current levels. Prepaid deposits are the largest funding source and should adjust only a portion of future increases in rates. Net interest income should similarly benefit from the impact of rate increases on variable-rate SBLOC and SBA loans. The net interest margin for the quarter was 2.56% compared to 2.26% in Q1 2015. The increase reflected a reduction in balances at the Federal Reserve Bank earning a nominal rate and a 25 basis point increase in rates in December 2015. Noninterest income reflected a return to year-over-year growth in the largest driver of noninterest income, prepaid fees. Bancorp supports many of the industry's leading players and payments. Continuing initiatives are projected to contribute to double-digit gross dollar volume growth and single-digit fee growth. Additionally, we have executed contract extensions with some of our largest partners with terms as long as 2022. Noninterest expense, excluding BSA look-back for Q1 2016, increased to $40.8 million from $35.1 million in Q1 2015. The largest component of the increase was in salaries and reflected increases in regulatory compliance and loan production and other staffing additions.

Thank you, Paul. Operator, let's go ahead and open up the call for questions. Thank you.

[Operator Instructions] And our first question comes from the line of Frank Schiraldi with Sandler O'Neill.

Just a couple of questions on -- first, John, you mentioned on the validation of the BSA/AML systems. It sounds like that process is the third party has completed that process. Just can you give some more color there and what the next steps are?

So the system that we're using -- we were transitioning systems for AML/BSA monitoring. A new system is in place. It's a regulatory requirement that one goes through a validation process and running those systems in parallel. The new system is in production; the old system is in the process of being sunsetted. And while there's still some residual work to be done specifically related to account opening, we fully expect, over the course of the year, to sunset -- fully sunset the old system for transaction monitoring and to largely move, if not completely, close to completely to the new system.

Okay. So the validation process that has to take place with a third party, that comes -- that would come, then, after you've completed the system overhaul?

The validation process has been completed with respect to transaction monitoring. The account opening and some of the initial due diligence, that's a slightly different process, but one that is coming close to conclusion as well.

Okay. And you have to wait -- and that is the -- a step you have to take before you bring it -- the validation to the FDIC, and then, I guess, wait on that -- their response, essentially?

One of the requirements of the consent order.

Right, okay. But you're not there yet, you still have to -- it sounds like there's more step to come before you take it to the FDIC, thus, this validation amount of the systems. Does that sum [indiscernible]

If you're asking more broadly when we're able to go to the FDIC and certify, in a very broad way, that we're happy with our AML/BSA operation and believe that it meets every requirement of the consent order, that's expected to be later this year. I anticipate, but -- and not certain that, that'll be early third quarter.

Okay. And then just on the -- if you could just give us -- sorry if I missed it, but a reminder or just an update on where Bancorp is in the process of the permanent CEO search and the timing there.

Okay. So I will make a few comments. First is, CEO search, as Daniel Cohen had outlined on the prior call, will be deliberate, will be focused. I would expect to have greater visibility into this by quarter end, and that's as much color as I can give at this point.

So we'll expect another update maybe at quarter end or thereafter. Okay. And then on the -- and then just finally, on prepaid card growth. I think you suggested, John, that it should pick up from here on a year-over-year basis. If we think about prepaid -- if we think about the industry growing in the high single digits, I don't know if that's accurate anymore, but if we think about the industry in -- growing high single digits year-over-year, is that a reasonable place to assume Bancorp's growth will trend to? And is that something you anticipate we'll see in -- before the end of 2016?

So if I could comment on that. First, our quarter over -- year-over-year growth, when we compare Q1 2015 with Q1 2016, was about 15%. That's higher than what we had expected. We expect our own portfolio to grow very low double digits for the year and to tend towards that. Our growth will, to a large extent, mirror our business partners' growth, and we expect that to be very low double digits. Frank, if I can add one more thing. Certainly, when the consent order is lifted, or the restriction on new business is lifted, that should help improve our growth in the prepaid segment. However, that being said, we're doing quite well even with that consent order in place.

Right. Okay. And then it looks like -- I mean, I thought prepaid, sort of quarter-over-quarter, was up that 15%, 16%. Is that -- it's still a better way to look at it...

[indiscernible] in gross dollar, yes. So that's in the gross dollar volume. And John, when he was talking about the fee income growth, that was in the single digits. And he's kind of voicing the conservatism of the leader of that department, who, like all of us, is fairly conservative in his projections. But we're not really -- we're just going to say at this time that it's single-digit growth, and so we're just going to leave it there.

Okay. But that's -- and that's on a year-over-year basis, right? Or am I...

Year-over-year. So in every -- in each quarter, we're looking to single-digit growth over the same quarter in the prior year.

And I am not showing any further questions at this time. I would now like to hand the call back to Mr. John Chrystal, Chief Executive Officer, for closing remarks.

Well, thank you, first of all, Chelsea, and thank you, everyone, for participating in on our call today and your -- for continued interest in The Bancorp story. We look forward to talking with you again next quarter.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program, and you may all disconnect. Everyone, have a great day.