The Bancorp, Inc. (TBBK) Q3 2018 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Third 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 introduce your host for todays for conference Mr. Andres Viroslav. Sir, you may begin.

Thank you, Julie. Good morning, and thank you for joining us today for The Bancorp's third 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 9061088. 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 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?

Thank you, Andres. Good morning and thank you for joining us today. My name is Damian Kozlowski. I'm CEO of The Bancorp and the President of The Bancorp Bank. I've been in these positions since June 2016 and I welcome you to our third quarter earnings call. This quarter was very important in the continuing process of improving our performance of running our enterprise in a safe and sound manner while boosting our value to shareholders. Bancorp earned $1.07 a share on net revenue of 122 million and expenses of 37 million. Exclusive of the 65 million gain on sale of the Safe Harbor IRA portfolio, net revenues amounted to 57 million. As previously announced we sold our Safe Harbor IRA portfolio that generated 6 million in 2017 fees. The sale price was 65 million and added $0.84 of share to book value. The sale of our Safe Harbor IRA portfolio concludes our divestiture of noncore 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 subscale, carried regulatory risks and would unlikely deliver longer term growth or innovation to our business model. Therefore its sale for 65 million or over ten times 2017 fees allowed us to complete the process of focusing on our primary payments and lending businesses and derisking our institution. The sale also enhanced our capital position without diluting the equity ownership of our shareholders. In the third quarter of 2018 the Bancorp grew revenue, controlled expenses and accreted capital from non Safe Harbor related sources. These increases more than offset the third quarter loss of most of the revenue from the exit of the Safe Harbor portfolio and higher funding costs partly due to the increased cost of Safe Harbor deposits temporarily held for the acquirer. Core revenue increased 10% from net interest income and payment fees. This revenue growth year-over-year was led by increases in SBA and SBLOC loans of 19% and 8% respectively. Our payments business grew revenue 10% year-over-year reflecting increase in GDV of 14%. We also continue invest in new revenue producing capabilities that will help drive sustainable organic revenue growth. Here are just a few examples of these critical initiatives. The first example is a rapid funds payment capability that utilizes the credit card network rails of VIS and MasterCard to facilitate disbursements. It allows money to be transferred in minutes, debit to debit rather than through bank ACH. Volumes in the third quarter of 2018 were 9.1 billion compared to 750 million in the third quarter of 2017, an increase of 1,100%. We anticipate continued strong growth throughout 2019 and beyond has programs with partners such as PayPal's Venmo show significant commercial progress and as new companies adopt the capability. Another example is Toliyo [ph] an automated lending portal being rolled out to our partners on our non-purpose securities platform that reduces loan origination from over twenty days to less than three by automating underwriting collateral management. This was the significant impact on our ability to grow our volume beginning in 2019 when the platform is fully implemented with each of our partners. These investments in new revenue opportunities along with investments in appliance and other infrastructure such as our Financial Crimes Center of Excellence in Wilmington, Delaware have been self-funded to cost saves and productivity enhancements, thus reallocating our expense base to be clearly focused on making us more productive and more efficient and thus a more profitable company. As we continue to grow our revenue base pretax margin should consistently show improvement boosting our RO E and ROA into the future. I'll now turn the call over to Paul Frenkiel, our CFO who will detail more about the first quarter.

Thank you, Damian. In the third quarter of 2018 exclusive of the $65 million gain on IRA sale, Bancorp increased its pretax income by 49% to 18.2 million compared to 12.2 million in the third quarter of 2017. That increase resulted notwithstanding a $2.4 million reduction in gain on sale of loans and reflected a $2.7 million increase in net interest income with a $6.6 point six million decrease in noninterest expense. That $6.6 million decrease included the impact of a $2.5 million civil money penalty in third quarter of 2017. Quarterly results reflected continuing revenue growth and Bancorp's major lending lines. The $2.7 million or 10% increase in net interest income compared to third quarter of 2017 reflected double digit growth in SBA period end balances and 8% growth in SBLOC balances. Interest income on SBLOC increased $1.8 million or 30% between those respective quarters to 7.7 million, while interest on loans held for sale and securitizations remained constant at approximately 4.7 million. Because the last securitization closed at the end of the quarter, related interest income will decrease in the fourth quarter. The next sale is expected to be in the first quarter of 2018. In addition to loan growth, the increases in SBLOC, SBA, and other loan interest income reflected the impact of the Federal Reserve rate increases in 2017 and 2018. There was also a 25 basis point increase in September, the positive impact of which should be realized in future quarters. Our largest percentage increase in loan balances was in SBA loans and SBLOCs, which respectively grew 19% and 8% year-over-year. On an annualized linked quarter basis, SBA grew 18%, while leasing grew 7%. Approximate yields on the loan portfolio are 4.1% for SBLOC, 5.4% for SBA and 6.2% for leasing. Period-end loan totals excluding loans held for sale and securitization grew 9% year-over-year. The lines of business comprising those totals have historically had low charge offs. Overall, cost of funds grew 40 basis points to 83 basis points in the third quarter 2018, compared to 43 basis points in the third quarter 2017. Prepaid card deposits are our largest funding source and should continue to adjust only a portion of future increases in market rates. The net interest margin was 3.22% for the quarter, compared to 3.26% in the third quarter 2017 and 3.11% for the second quarter 2018. Compared to third quarter 2017, the yield on interest earning assets and continuing operations increased 34 basis points, while as noted; the cost of funds increased 40 basis points. The margin in the third quarter 2018 was also impacted by the timing of the securitization of higher rate loans at the end of September 2018. Those loans yield in excess of 5.5% and accordingly have a positive impact on net interest margins with loans total peaking immediately before the securitization. The net interest margin was negatively impacted by the interest paid on Safe Harbor IRAs to their acquirer prior to the transfer. Non-interest income on all payments related fees increased 10% to 15.5 million. Prepaid card accounts our largest funding source are also the primary driver of non-interest income. The income on prepaid cards increased to 13.2 million or 5.7% in the third quarter 2018 compared to third quarter 2017. Card payment and ACH processing fees, including the rapid transfer of revenue, which Damian discussed earlier, increased 46% to 2.3 million, which increased the overall payment revenue growth to 10%. Non-interest expense of $37.3 million was $4.1 million lower than third quarter 2017, after excluding a $2.5 million civil money penalty into 2017. The $4.1 million reduction reflected a $2.5 million reduction in salaries, which reflected a lower quarterly incentive related expense. Legal expenses were $1.1 million lower while data processing expenses were $546,000 lower in third quarter 2017. Additional expense reduction opportunities in other categories continue to be pursued. Year-to-date, non-interest expense was 5% lower than 2017. As a result of third quarter earnings and the gain on IRA sale, both the bank and consolidated leverage ratios exceed 9% and book value per share has increased to $6.95. That concludes my comments, and I will return the call back to Damian for questions.

Okay. Operator, if you would please open the line for questions.

Thank you, ladies and gentlemen. [Operator Instructions] Our first question comes from William Wallace with Raymond James. Your line is now open.

Thank you. Good morning, guys.

Good morning.

Maybe starting on net interest margin, there were some commentary in the prepared remarks about some pressure on cost of funds related to funds that you were holding for the purchaser of the Safe Harbor IRA. Can you talk a little bit more about that and maybe what the impact was?

It was about $1 million. And so what happened was the sale concluded pretty early in the quarter and we were holding the majority of the deposits. We negotiated a more market rate for when we held those deposits until we transferred them to a new bank that they had selected. We didn't want to keep those deposits because they were actually being priced higher in the marketplace. We have other alternative sources of funding. So it is about $1 million in our interest expense from that.

And these deposits they're now all - they're now all out of the bank?

They were transferred, I think, on the second day of the fourth quarter.

Okay. And if I look, so I can see that if I'm looking at the cost of the savings and money market accounts that was up close to 100 basis points quarter-over-quarter?

Correct.

Okay, great. Okay. Thank you. That's helpful. On the loan growth, I think you're maybe speaking to average balances, when I look at the period-end balances, they were down quarter-over-quarter and the SBLOC looks like it shows the biggest - the biggest decline. Maybe just talk a little bit about what you're seeing in that business, I know you're rolling out truly to keep them, how you say it, but to lay the - to lay - can you maybe talk about what you saw in that line and what you're seeing now with that rollout of the software underwriting package?

Well, the full rollout will be in the - will be pretty much the end of the first quarter, some will lag to the mid-year for the rollout of that portfolio, I think, excuse me, platform. We just saw more people repaying. We have the same - we have a great pipeline in the business that would suggest the same type of growth that we've experienced, but we just had more pay downs. This happens sometimes when you see a rise in the interest rate, as you can see that our coupon on the portfolio, its variable and it's risen because of interest rate increases. And so you get some pay-offs, but people realize after a while that it is - the probably the cheapest source of funding, so you get a little bit more pay-offs, but you're originations continue to be in line with your past history. So it should rebuild fairly quickly and show growth again.

So, kind of holistically excluding the loans held for sale, what do you think is a fair kind of target for loan growth and yeah, maybe annualized?

Well, we want to do 10%, right. So we want to do 10% on both sides. So if we get 10%, there are some areas where we think we will grow higher SBA, we've been growing higher. We may in the future look for leasing opportunities that are inorganic to buy portfolios, which we have done in the past. The SBLOC business hopefully will get greater than 10% growth, as we implemented to lay a platform. But 10%, we don't - could we get higher? Yeah, we can fund it obviously. So if we got 15%, I don't want to grow it too aggressively, I don't want to our balance sheet or our fee income to be much less than 40% of the bank's revenue. I want it to be balanced. I think that's part of the attractiveness of our portfolio. So I want those two things to grow in tandem. So we have a target of 10% we'd like to see. And, obviously, for growing our revenue 10%, we're still thinking of fairly flat expenses, we're expecting significant increases in margin.

Okay. Good. And taking to the balance sheet and the discontinued portfolio looks like that Orlando property is still on the balance sheet, can you just update us on the status of that property?

We're still operating them on a profit. What happened is that it's fairly complicated, but there's a ground lease under the property. So we're still in the process of negotiating the final like there's multiple buyers involved. We did have - after 18 months we did have the mall reappraised and it's good to announce that that appraisal fully supports the value on our balance sheet. We ultimately will get it off our balance sheet off the cliff [ph]. It has a lot of twists and turns, but it is not a drag on economics of the company and we continue to produce positive income from the mall.

Okay, moving on to the expenses. Expenses came in better than I was anticipating given the loans sales, especially with the loan sales generating more revenue than I was anticipating. So, is that to assume that the kind of base run rate expense is coming in better than - than what you have maybe been speaking about the past couple of quarters?

It goes up and down, so we were still saying that where that 12 to 13 a month on run rate expenses. So 150 to 160 if it's variable depending on revenue. Part of the reason was that we've been much more productive and profitable this year. Last year, we didn't know at the beginning of the year whether or not we would be paying bonuses and other incentive comp. So we didn't have great visibility. So we had a greater expense accrual for bonus payments in the third quarter of last year than we did this year partly because we've been eating those costs all the way through the year, because now we have much greater visibility on the fact that we will pay those incentive comp. So that's part of the reason. But obviously that payment is in the numbers from the other quarters.

Okay. Okay, alright. That's helpful. Thank you. Maybe my last question just kind of bigger picture, you highlighted the rapid funds business, we see on the ACH fee line that that line is up 45% year-over-year, it's up over 10% quarter-over-quarter. Could you - I mean, I know it's early and I know that Venmo the number on transactions that continues to grow. But how do you think about the opportunity, the revenue opportunity from that one product and how we might see that flow through in this ACH fee line?

Well, we'll see, it will have - continue that part of it - there's two parts, one is the end direct business, so there's people on our platform like Venmo and there are others that want the capability also. We also work with other partners I can't disclose, but there are third parties that are working with other third parties. And that is the explosive growth is just the adoption from people who don't want to wait three to four days for their money and they can have it in a couple minutes and this is the same thing as [indiscernible] obviously. So these type of platforms are gaining more acceptance. So you can expect we don't know what the growth will be, but we're seeing growth every month. And obviously if the base growth the growth will slow down on an absolute basis, but we should consider that that volume will continue to explode and when you just look at you-over-year, we virtually had no - we only had 750 million of transactions last year and now we're already up to 9 billion. And we expect the trajectory to be very sizable from that indirect business. But there's another business that we're looking at is the direct business where you look work with merchants and staff and give them the capability with vendors in order so they can get their money paid more quickly. And so it's a whole and another type of transaction that's not going through a network through consumers, but through businesses and work, and that's another initiative we have, we don't have any revenue from the - but we expect sizable revenue from that. The difference is pricing, if you do at the direct model the pricing can be significant. So it could be 10, 20, 30 times higher than the transactional fees that we get from the indirect business. But we don't have any guidance on that. We don't have any revenue on that. But that's clearly the second opportunity as we've now established this product in the market, the second opportunity now is a higher spread opportunity that's a direct relationship.

Maybe do you have any - the volume in the second quarter?

The volume in the second quarter, I don't think we have it on as we can - we haven't announced it. Do you have the percentage?

We only have the third quarter.

No, we only have the third quarter volume, right now.

You can look at that income category and the increase over the prior year and just do a proportion as -

Okay.

Because the pricing doesn't change.

Okay, great. Thank you so much. I'll let someone else ask a question.

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

Good morning.

Hey, Frank.

Just a couple of follow ups, I guess on the deposit costs, Paul, I understand the money market bucket and just thinking about the larger prepaid bucket, it looks to me like just betas were like 60% in the quarter. And I'm just wondering, it's just the timing thing and should we still expect sort of 40% of fed funds to kind of roll into deposit costs is that sort of the most reasonable estimate?

Historically it's been close to 40%, I think it's gone up a little bit now. So I think closer to the 50% range of future - future Fed increases is more realistic.

Okay, and is that - as the Fed funds rate has moved higher, there's something in the contracts that increases the percentage of payment.

So, some of contracts, yes, so we have a fair number of contracts and each of them is unique and they have different triggers and it really depends on the costs involved with the fixed costs involved in terms of how we structure the contract. And there's a cost - there are some rollover in new contracts and old contracts. So it's somewhat of a moving target but if you use 50% rather than - it's very difficult to model every contract, in fact, it's impossible. So I think if you use 50% for now, that's closer than 40%.

And there's obviously more pressure. There's things built in at higher rates and some of these contracts, and as we renegotiate, obviously, interest - interest in these - interest expense is higher than it has been previously, but there's still there's not - remember, it's a step function once the rate happens and re-prices immediately, we don't have to lag like other banks. So we don't get future increases in the funding costs, because our CDs reprice et cetera, et cetera. So it's a step function once the interest rate increase happens, our funding expense grows and then it waits for the next interest rate increase.

Okay. So do you think 50% - because we've got a couple of Fed fund hikes expected over the next six months or so and do you think that we should do consider a step up from that 50% for every rate hike or 50% probably makes the most sense here? How would you think that in terms of modeling?

50% and it may creep - as the rate hikes continue, it might creep a little bit higher than that. But then I think at 50%, you're not too far away from the top.

Okay, alright, great. And then just thinking about it, Damian, talking about the - thinking about the 10% growth on both sides of the balance sheet and if you can get - maybe that can accelerate on the SBLOC side or through SBLOC block growth. Remind me, I think, I believe that you just keep the whole SBA loan on balance sheet, right? So as growth perhaps starts to pick up, are you considering starting to securitize it off as well?

No. We like to keep the guarantee portion for liquidity reasons; also it's a great to guarantee thing that there are any incredible rates of interest, so we like to keep it on the balance sheet. We - people sell it because they have funding issues, generally and we don't have those issues. So if you want to create a lot of fees, you can monetize those guaranteed portions for if the market fluctuates, but 6%, 7%, 8%, 9%, and even 10% premiums, we don't need to do that. So we like to keep the asset. We think it's a great asset we keep it on our balance sheet and we have no funding issues.

Right. Okay. I guess I'm just - so you're feeling that 10% to 15% growth on long books are pretty expectation, I mean, you know - I'm just trying to think if you know at some point you do get funding issues, right, I mean, if loan growth gets high enough. So -

No, I don't think we've - well, I don't think we do. So we already have 40% loan to deposit ratio, that would be - and we - and our deposits have been growing on the prepaid side, so I don't think we would - and we - our structure, our balance sheet, I don't think we would run into issues for a very long period of time.

Yeah, that's fair.

If ever, I think the bigger issue is that maybe 10 years from now will be less - will be hitting against that $10 billion interchange that frank limit, but on the funding side I really don't - I think we've got - we remember we have almost 1.8 billion in bonds too, so - and a lot of our loans are liquid variable rate loans that we've actually pledged to the Fed for liquidity reasons, so I think we've got a very strong asset side of the balance sheet.

That's fair, okay. And just wondering just more sort of bigger picture in terms of conversations - comments you made in the past about credit sponsorship. I'm just wondering - obviously you talked about that being something for the future and wondering if you still - how you think about that here if you've changed your thinking at all. Just given some have pulled back a little bit, there's been some talk of maybe it getting a bit frothy in some areas, so I just wanted to see if you had any update commentary on that.

No, we still want to participate. We're waiting to finally conclude our regulatory remediation which I believe we're doing really well on. I think we're making the progress we need to do. That's only resolved the issues, but SEDAR sells up for two or three times the volume. We have almost $600 billion of transactional volume that sort of an immense amount of volume for any bank, even a large bank and we're a $5 billion bank, $4.5 billion bank, so we're building something that's very robust in order for us to grow the business. So we were waiting to participate in that part of the market for a couple of things. One, for it to be fully secure in our PSA envelope and compliance envelope focusing on consumer compliance, but also to make sure that we have any other credit risk disposed off. Obviously, we've done a tremendous job on the discontinued Walnut Street portfolios. So I think going into - whether it's next year or even earlier the year after, we definitely want to participate in that space, but we're going to be very selective. We're not doing subprime, we're not doing - we're going to focus on corporate, we're going to focus on higher end consumer, but that market is still exploding and there is a real need for a safe and sound bank with a robust platform to participate.

Okay, great. Thank you.

You're welcome.

Thank you and next question comes from Matthew Breese with Piper Jaffray. Your line is now open.

Good morning.

Hey, how are you Breese?

I'm doing fine, thank you. I guess one of the focus on really just one area which is the prepaid business. I wanted to your outlook for how the fees and gross for dollar volumes are going. And then I also wanted to just understand, how much of the business is still tied today to the tax providers?

Well, the industry is growing, the envelope of activities are still growing double digit. I've said this before, we'd be happy with high single digit fee growth and a couple percent higher in volume, GDV growth. It does look like we have some product areas that will exceed that. So I think we feel comfortable that we can grow the envelope around 10% in fees. The prepaid area is a little bit slower growth than some of the other areas that we're not participating in, so you might see lower single digit prepaid growth. And we had some headwinds, we lost some programs in that area previously and these were because of acquisitions and other reasons. I know our pipeline for the foreseeable future, we've got some major contracts that are recently finalized in other programs that we're looking to participate in, so I think we've got some - we've had some headwinds. I think we have some tailwinds to meet that target, so we should see pretty good growth in 2019 on that side in that in that range. Depending on the adaption of the rapid funds product that or the instant transfer product, I think the applicability through the direct channel is something that is enticing types and could add significant growth, but once again we don't have a guidance on that and we don't have any estimate at this point. Paul, you want to - second part was the - what percentage do we have it.

We don't really - we're not really predictive, but I think you can go with what Damian just reviewed for you and really the best indicator is what we've done quarter over prior year quarter for the tax refund in terms of how important that is to the business. The best way to look at that is compare as Damien mentioned we - several relationships exited and that was already reflected in last year's first quarter. So if you go to last year's first quarter GDV and prepaid fees and compare to the prior and the prior one to that you'll see that - that's where you see the impact, so that differential between those quarters largely reflects the reduced impact of the tax program. So it's not nearly as significant as it used to be.

Right, I guess my follow up question to that is, the tax laws have changed, a lot of single filers, married filers are going to be getting better or higher standard deductions which I would assume flow through to your prepaid business and I want to get a sense for the positive impact from that going into next year.

But it's still based on the deposit. I think your question is more or less directed at the deposit element of it. The deposit element of it - our deposits do increase in the first quarter and the second quarter as a result of tax refunds they've reduced. In the same way the fees were impacted in the first quarter of last year and second quarter. Similarly, the balances where, but the balances also are not a significant impact because they're relatively short term.

Got it, okay. So you don't –you think we're - as it currently stands, we should not expect any sort of material change given the new tax laws, that's my read here.

I don't see how they would specifically impact tax refunds. I suppose if certain higher wage earners lose some of the deductions and so forth then the refunds would be decreased, but that shouldn't have a material impact.

But the other side [ph] of that the lower end will have an increase. We don't we don't have a prediction for that. I don't think it'll be much different.

Okay, okay, that's a sufficient intellect.

And there are variables that have resulted in fluctuations in the past given the timing of how long it takes the IRS to process. They have - they've had delays at certain times because they've - they're increasing their fraud protections and so forth, so that actually has the potential of affecting it more I think.

And Damian, I just want to clarify, so your expectations are that gross dollar volume can continue to increase at a high single low double digit rate, but the fees themselves will be a little bit lower than is that - is that what you mentioned to us.

Yes, yes, because when you have - it's a Boeing Airbus, it's only a few banks left in this space that are primary supporters if you look to add some data with [ph] are kind of concentrating the market and there's a few other players. There's not a lot of new entrants just because of the cost of being able to do the compliance part of it. So you do see in those cases slow erosion of fees and higher growth like the securities industry just experienced 25, 30 years ago with Pershing and State Street. So, but there's new areas that show extreme high growth like that rapid funding product, so I think any slowdown will be offset by those new areas. So I think we could - I love 10% growth in fees in that business. Obviously that would be, if you can marry that with 10% growth of minimum of revenue growth on the balance - on the balance sheet side and hold your expenses relatively flat that's - has a huge impact obviously on your ability to generate net income. So that's our general - what we'd like to see, I think we might see higher lending growth next year based on the player thing and based on the rapid funds product going from both indirect to director of might also add substantial fees to it, but it might not. So that's the areas of opportunity and we kind of would like to - would be happy to grow in a safe and sound manner and add volume in the - because we're talking not a few billion dollars, we're talking about of billions and billions of dollars of transactions here. So we're ready to 600 billion practically, so, yeah, we have room to grow obviously, but there's just so much growth in the overall market and we have a big proportion of that already.

Right, great, understood. Alright, that's all I had. Thank you very much.

Okay, thank you.

Thank you. I'm not showing any further questions at this time. I would now like to turn the call back over to Damian Kozlowski for any further remarks.

Okay, thank you everyone for joining us today. We appreciate it. We'll keep on working to build a successful company. And I think we've made progress this quarter and I like just to thank everyone in the Bancorp community including our shareholders for having the trust in us to safeguard their investment and produce positive returns. Thank you everyone.

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.