The Bancorp, Inc. (TBBK) Q2 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Second Quarter 2018 The Bancorp, Inc. 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 be given at that time. [Operator Instructions] As a reminder, this call is being recorded. I would now like to turn the call over to Andres Viroslav. You may begin.

Thank you, Michelle. Good morning, and thank you for the joining us today for The Bancorp’s second quarter 2018 financial results conference call. On the call with me today are Damian Kozlowski, Chief Executive Officer; and Paul Frenkiel, our Chief Financial Officer. This morning’s call is being webcast on our website at www.thebancorp.com. There will be a replay of the call beginning at approximately 12:00 p.m. Eastern Time today. The dial-in for the replay is 855-859-2056 with a confirmation code of 1095334. Before I turn the call over to Damian, I would like to remind everyone that when used in this conference call, the words believes, anticipates, expects and similar expressions are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to risks and uncertainties, which could cause actual results to differ materially from those anticipated or suggested by such statements. For further discussion of these risks and uncertainties, please see The Bancorp’s finance 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 results of any revisions to forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to the reflect the occurrence of unanticipated events. Now I’d like to turn the call over to The Bancorp’s Chief Executive Officer, Damian Kozlowski. Damian?

Good morning, and thank you for joining us today. My name is Damian Kozlowski. I’m the CEO of The Bancorp and the President of The Bancorp Bank. I’ve been in these positions since June 1, 2016, and I welcome you to our second quarter earnings call. The second quarter show that Bancorp is still on track with progress on building a more productive and efficient company. Our revenue continued to show improvement while we controlled expenses and executed on our business plan. Bancorp earned $0.11 a share on net revenue of $47 million, expenses of $37 million. In this quarter, we had certain onetime items that did result in lower total net income. But these items help us to continue the process of improving our operating performance and resolving past credit exposures from discontinued operations in Walnut Street. Walnut Street is comprised of notes and investment owned by the company as a result of the sale of certain discontinued loans to a third party. The adjustment to Walnut Street valuation of $1.7 million was driven by both negative and positive items. The main driver was an impairment to one asset offset by several gains and settlements. And discontinued the sale of the Fort Lauderdale hotel note impact of $1.9 million was almost totally offset by other positive dispositions in non-interest income. We will continue to work down these exposures and hope to reduce our discontinued commercial loan balances by 50% by 2Q 2019. This would leave the company with about $110 million of total commercial loan exposure combined from both discontinued operations and Walnut Street, a decrease of over 75% from the second quarter of 2016. Revenue continued to grow this quarter. Our combined payments business revenue grew 9%, while our lending businesses were led by our SBA institutional product line. They respectively grew their year-over-year loan balances 17% and 11%, while respective interest income showed greater improvements of 27% and 43%, reflecting the rise in interest rates. Expense growth was continued – was contained this quarter. Our operating run rate continues to be approximately $12 million a month from continuing operations. So we have stated in the past, our expenses should be contained over the next 24 months, while improving efficiencies and with ebbing remediation costs. We are also investing creating new revenue opportunities with the same considerations for containing costs. Lastly, we sold our safe harbor IRA portfolio that generated $6 million in 2017 fees. The economics of this transaction will appear on our third quarter result. The sale price was $65 million and will add approximately $0.85 a share to book value. The sale of our Safe Harbor IRA portfolio concludes our divestiture of non-core assets started when our new business plan was approved by our board in the third quarter of 2016. Like our European and HSA franchises, our Safe Harbor portfolio was upscale, carried regulatory risks and was unlikely deliver long-term growth or innovation to our business model. Therefore, it’s sale for $65 million or over 10 times 2000 fees will allow our company to likely hit long-term capital targets in the third quarter of this year and provide capital management focus for growth of our core strategic businesses. I now turn over the call to Paul Frenkiel, our CFO, who will detail more about the first quarter.

Thank you, Damian. In the second quarter of 2018, Bancorp increased its pretax profitability by 9% over second quarter 2017, with pretax income of $8.4 million compared to $7.7 million in the second quarter of 2017. Second quarter 2018 non-interest expense also reflected a $400,000 charge to terminate the lease, which will result in future savings. Quarterly results reflected continuing revenue growth in Bancorp’s major lending lines. A $2.3 million or 9% increase in net interest income compared to second quarter 2017 reflected double-digit growth in both security-backed lines of credit, or SBLOC, and SBA period-end loan balances. Interest income on SBLOC increased $2.2 million or 43% between those respective quarters, while interest on loans held for sale and securitizations decreased approximately $1.8 million. Because the last securitization closed at the end of March 2018, related interest income decreased in the second quarter, but should increase in the third quarter with new originations. The next sale is expected to be in September 2018. In addition to loan growth, the increases in SBLOC, SBA and other loan interest income reflected the impact of the Federal Reserve 25 basis point increases in March, June and December 2017 and March 2018. There was also a 25 basis point increase in June 2018, the positive impact of which should be realized in future quarters. Our largest percentage increase in loan balances was in SBA loans and SBLOC, which respectively, grew 17% and 11% year-over-year. On an annualized linked quarter basis, SBLOC’s grew 19% and SBA grew 14%. The SBLOC portfolio is currently yielding approximately 3.8%, while SBA loans are yielding approximately 5.2%. Period-end loan totals, excluding loans held for sale and securitization, grew 10% year-over-year. The lines of business comprising these totals have historically had low charge-offs. Overall, cost of funds grew 22 basis points to 59 basis points in second quarter 2018 compared to 37 basis points in second quarter 2017. Prepaid card deposits are our largest funding source and should continue to adjust to only a portion of future increases in market rates. The net interest margin of 3.11% for the quarter was comparable to the 3.10% in second quarter 2017 and also comparable to the first quarter 2018 net interest margin of 3.12%. While the yield on interest-earning assets and continuing operations increased 28%, the cost of deposits and interest-bearing liabilities increased 22 basis points. Larger increase in yield on interest-earning assets was also partially offset by a reduction in yield on the discontinued loan portfolio. The margin in second quarter 2018 was also impacted by securitization of higher rate loans in March 2018. Those loans yield in excess of 5.5% and accordingly have a positive impact on net interest margin. Non-interest income on all payment-related fees increased 9% to $16.1 million. Prepaid card accounts, in addition to being our largest funding source, are also the primary driver of non-interest income. Fee income on prepaid cards increased 6.3% in second quarter 2018 compared to second quarter 2017, while the total amount spent on prepaid cards or gross dollar volume increased approximately 7.6% to $12.8 billion. Non-interest expense of $37.3 million was flat over second quarter 2017, reflecting management’s efforts to control expenses. Data processing expenses were $1.3 million lower than second quarter 2017 and additional expense reduction opportunities in other categories continue to be pursued. At quarter end, consolidated leverage ratio stood at approximately 8%. The after-tax impact of the $65 million gain on sale of the Safe Harbor IRAs expected to be realized in third quarter 2018 is approximately $50 million, which should significantly increase all capital ratios in the coming quarter. That concludes my comments, and I will turn the call back to Damian for questions.

Okay. Operator, if you could open the lines, we can take questions.

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

Thanks. Good morning, guys.

Hey, how are you?

Good, thanks. Damian, maybe just to try to get a little more color on the expense base. You mentioned the $12 million a month run rate. I’m curious if there’s room for that to come down more with the sale of the Safe Harbor IRA business and any other offsetting investments or cuts that you identified?

I don’t – there’s going to be further cost reductions, not only – there’s only about $1.5 million that’s tagged to – that’s a yearly number that’s tagged to that business. So that won’t be a big impact. But we continue to get out of contracts and things that have been causing inefficiencies, just for example, the $400,000 write-off we took. That’s going to be realized in future quarters. We’re hoping to keep the expense base at this level for the next two years. There’s additional investments we’re going to make for new product revenues, but they should be covered by the remediation costs ebbing and things like regulatory costs also going down as soon as we exit from the consent order hopefully next year. So I think this is a – the 12 range is something that we’re going to be able to maintain for at least 18 months. And the only thing that’s going to be – there’s onetime items, such as comp expense that is tied to the securitization of our CRE assets. That’s the only thing that we see right now that would increase the run rate that we’re experiencing.

Okay. And the four – what are you telling about the $400,000 write-down. What’s that?

Yes. We terminated the lease, Paul said earlier in his comments, but we’ve been doing that all along. I mean, it’s just – it’s been over the last 18 months especially going and once we did our restructuring of people in September of 2016, we’ve been working on just becoming much more efficient. Like I’ve said before, we’re doing this whole reengineering exercise. We’ve moved all our people from Tampa now into Wilmington and creating, et cetera, excellence for BSA/AML activities. So we’re doing that at every part of our business. It has ultimately a big impact on productivity and can reduce the cost base more. We just don’t know what that is likely to be. It doesn’t reduce people. It actually reduces process steps and those types of activities and sometimes leads to going to third parties to get, which usually that 20% to 40% lower price point on certain operating activities. So we’re going to that process. Right now, the best visibility I can give you is that – I think that our expense base is locked in for the next 18 months.

Okay, thank you for that. And then it’s not material, but there was a $454,000 loss recorded in the gain on sale of loans line. I’m curious what was that?

Yes. Paul, do you want to?

That was a valuation adjustment. So when you have loans held for sale and the market value changes slightly then you have to pick that up. So it’s not I think for…

These are loans that you’re carrying as part of the sales that you expect to occur in September?

Yes. The loans we carry are held – the which are held for sale, and we value them every quarter. So if you have a little blip, then you have to recognize that.

Okay. So should we infer that when that sale occurs in September that we should expect the premium on that sale should be significantly lower than what we saw in the first quarter?

Yes. The current guidance, Wally on that is, our current numbers have more than $5 million of a gain. So it’s – right now, the envelope is between $5 million and $8 million on the gain of the securitization, which will happen at the end of September, but that can change tomorrow. So right now, it’s five-plus. It could be as high as eight. But that’s as tight as we can be the levels. We have to go through rating agency levels and then market spreads adjust as you know up to the time of sale. So we have – that’s the best guidance we can give. It probably is unlikely to be less than $5 million, and it’s probably not going to be an oversized gain that we had in the last two times over $10 million. It’s probably going to be a little bit lower in the $5 million to $8 million range.

Okay, thank you. On the loan side of the balance sheet, the core balance sheet – the core businesses you guys are focused on, I’m looking now at about 10% year-over-year growth in all of those loan categories. I’m curious where you think that goes in the back half of the year? If there’s any change in focus amongst the different business lines. Any update you can provide us on those lines of business would be appreciated.

No. We’re still seeing very good SBA especially. It has a lot of momentum. We did a lot of restructuring over the last year, we bought in a new team and made it much more of a generalist business. So that’s going to continue to have higher than 10% growth likely. We’re coming into the leasing cycle for new cards. So having the loan growth as a portfolio between on a low double-digit is probably what the back end of the year will look like. But there is the institutional SBLOC business that has a way of moving around a lot depending on the market for equities generally or – and interest rates fixed income. So you couldn’t have a volatility in that business, which would reduce it. But the underlying number of accounts and everything is growing at more than 10%. So we’re – the amount of clients, the pipeline and then, ultimately, the outstandings are growing at a low double-digit number.

Okay. And are there any other opportunities that you may have identified or early on and it’s tempting to identify as asset-generation opportunities?

No. We’re working on a whole bunch of different initiatives and partnerships across the businesses. We’re not going to get into any new lending areas until next year, which we haven’t announced. But we’re going to be expanding the businesses. We wanted to make sure that we have the right because we’re going to be levering up now obviously, we had – we just got a significant amount of capital. So we need to either invested in nonrisky assets or investing it in lending opportunities. We ultimately have to get our loan deposit ratio. We still are sitting at that 40% of continuing operations is moved up a little less couple of quarters, but we really have to get it to the 50% or 60% range. And that’s, obviously, going to have a big impact on profitability. And I think we’re going to be able to do that over the next 18 months.

Okay. I’ll hop back and let somebody ask questions. Thanks, Damian.

Thank you, Wally.

Our next question comes from Frank Schiraldi of Sandler O’Neill. Your line is open.

Good morning.

Good morning, Frank.

Just – I want to start with the NIM mechanics, Paul, you gave a good explanation, I think, why asset yields or loan yields weren’t as much – up as much I would have thought linked quarter. But as I think about the NIM going forward, we know how much is variable rate. We know how the deposits were priced. Do you have – or I think, you might have talked about the average yields on the discontinued book as that rolls of, what sort of headwind that would be to the NIM?

Yes, I’ll let Paul mention – take that, but this becoming less and less of a drag obviously. There was – as you think about our discontinued Walnut Street books, they were a big drag as they are winding down when two years ago when it was over 450. So now as we approach $100 million by the end of next year, that drag is ebbing, but I’ll let Paul take you through the calculation.

Sure. So if you look at the average balance sheet Frank, it validates what Damian is saying. You can see the average of discontinued operations, which we break out separately and you can see tracing it over the last few periods that it is, in fact, a declining factor, but it does have some impact since we included in that computation. It is – it can be a little choppy depending and it was this period because we had – actually this period end and last quarter because we had some big dispositions and those can result in reductions in interest income. So we got rid of the hotel that was in there, so that would impact that computation. And as we do these other large – as we do large dispositions like that, that has an impact. So we don’t really predict it. It’s really difficult to predict. But as Damian said, it will have a declining effect.

Okay. Talk about when you do those dispositions, you have to – it’s more than one quarter that gets stuffed into one quarter? Or you’re just saying you get…

Yes. That’s right. Okay. So if you’ve had loan that has been accruing and like, for instance, the hotel loan and you sell it at par, you may not get the full amount of interest on that loan. But obviously, the reduction – it’s a major reduction in discontinued assets that will have no further future impact.

Okay. Do you have handy like how much of an impact that would have been to loan yields and the average loan yields in the quarter, just so we can kind of pull that out for a mall going forward?

Well, it’s not just that loan. We would really have to look at all the loans that impacted that. And no, I don’t have that right now, but I’ll look to see if we can do anything for the 10-Q, that makes sense.

And remember, you have the securitization cycle we’re under, so we did the last securitization. It’s off year-over-year because we have done the securitization before – quarter before last time. So on a year-over-year impact, we had less of the loans that are higher rate in the floating rate secularizations we put together. So if you add those two things and the back out of some of the interest from discontinued, you know having a flat or slightly up NIM is actually very positive.

Okay. And then if you – and then just on Walnut Street, the revaluation there, that’s just market-driven, rate-driven, I should say?

Well, no, that was not. That was because of one asset. So one asset was – is in a process of being worked out, and it was driven by one asset that market. It was not a modeling. Last time, it was mostly due to a modeling change based on market rates. This was not. This was due to one asset. It was – there’s offset some the stuff. There’s always adjustments in Walnut Street structure, but this was really driven by one asset.

Okay. And is that getting – and I guess, is that – so that’s because of a new appraisal, I guess on one of the assets in Walnut Street as far as the best explanation then or no?

Yes. It’s more complicated than that, but a new appraisal was involved. It was a loan that was paying, and it’s that usual credit story, where you now have to work it out with the sponsors. And it usually entails an appraisal and a discount to that appraisal based on the assessment by the credit risk management process of what you think you definitely can get back on a conservative basis from the assets, so.

Got you. Okay, and just wanted to – if you – sorry, if I missed it, but just – is there any update on the mall property in Orlando?

Yes. We’re probably – it will be this quarter. This is a big development now. I’m not sure exactly. We haven’t finalized our participation in it. But that asset – this is a big project. This is going to be a very large project. This is a multi-year development, phase development. So that transaction will likely close in the third quarter.

Okay. But you may still have some piece of the funding in that when…

Well, we’re considering it. We’re looking at it because it’s going to be very – we are a participant in Orlando and this is a very important part of Orlando’s development. We work closely with the city today. We have our facility, our card facility right next to the mall. So we’re, from a strategic and public policy perspective and relationships with very important client of ours Orlando, we’re looking to maybe participate at some level just so that we can be part of the success of the project. But we will be doing the project. We’re simply being a very passive investor potentially, but at a much smaller amount than what we have it on the books today for.

Okay. Okay, great. Thank you.

Our next question comes from Matthew Breese of Piper Jaffray. Your line is open.

Good morning, guys.

Good morning, Matt.

Just a few quick ones for me. What’s the estimated size of the securitization in terms of what roll-off out is held for sale?

$350 million. It will be a little bit larger than our previous ones.

Okay. And so as we think about the NIM trajectory through the end of the year, will it look similar to last year where we see some expansion in 3Q with those loans on the books for the majority of the quarter, and then a reduction 4Q as they come off. Is that the way to think about it?

Paul, you want to handle that?

Yes. Yes. So as the loans come on, that’s a positive for NIM. And after the securitization and those loans rolls off the money goes into that fund interest-bearing balances fed reserve bank, which now would be currently 2%. So you have 5%-plus money going to 2%. And then as the originations increase that improves the margin.

Okay. So the one thing that you won’t have, Matt, probably that you had this year, was that it will be probably do a securitization at the end of September and then we’ll do a securitization at the end of the first quarter next year, which will match up with what we did this year. So you won’t have – at least, you won’t have this problem where you’re quarter off and that quarter off creates this distortion in NIM over a year-over-year basis. So hopefully that will be more helpful, plus you’ll have less of a drag as discontinued portfolio is being wound down. We look – it looks like another $25 million will roll-off in quarter three, hopefully. We have a path to resolve about $25 million over the next couple of months. So all that will hopefully take noise out of the system.

Okay. My last one is just to get a sense or more color on the growth and the health of the prepaid business. Year-over-year fees are in the 4% – up 5% or 6% range, it seems pretty good, but I wanted your perspective on is that a sustainable growth number.

Yes. There were some headwinds that we had over the last 18 months. There was a acquisition from a bank, and we lost a big client. So it’s – the mix is important, but our volumes are growing year-over-year, which is a good. It’s in that range that we talked about high single digits, it’s the volume side. We’re – the ACH acquiring business is growing very rapidly. It was up 20%. That’s coming from our debit-to-debit product. It’s using the Visa, MasterCard rails. It’s called Rapid Funds. That is growing very, very quickly. So that – while you may get 6% or 7% prepaid, you’re probably going to get double-digit growth from that side of the business. But we’ve said it on this call before that fees on the envelope of our payment activities if we get high single digits in this quarter year-over-year, we got 9%. That’s probably what it’s going to grow with volumes being slightly higher as volumes were slightly lower. I looked at some of the competitors of the market. You’re seeing kind of that in the marketplace right now, over the last couple of quarters. So this is – I think, our growth is consistent with where the consolidated market is going. So I was very encouraged. I thought it was a very good third quarter. Our revenue is doing very good this year and third quarter was very encouraging from the prepaid side also.

Understood. And then there was a headline or a news article that said you’re partnering with Venmo. Can you go into that a little bit?

Yes. We’re the debit issuer for you know PayPal. Venmo is really PayPal, and Rapid Funds product that I just described, is the functionality of the Venmo app when you can deliver funds within 15 minutes that’s using the debt-to-debit system. It’s similar to Zelle. And we, last quarter, talked about we’re going to be the issuer of the PayPal, the Venmo debit card. So that’s likely to be a fairly large product. I already had calls. People have asked me about that particular debit card and they didn’t even know that it was us. So it’s obviously, a high-profile product, and we’re just – we’re very happy that we can partner with PayPal to provide that capability to them.

Understood. All right. Thank you very much. There are no further questions. I’d like to turn the call back over to Damian Kozlowski for any closing remarks.

Well, thank you for joining us today. I appreciate all the questions, and we look forward to talking to you on our next quarter, third quarter earnings call.

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.