The Bancorp, Inc. (TBBK) Q2 2020 Earnings Report, Transcript and Summary

Ladies and gentlemen, thank you for standing by. And welcome to the Q2 2020 The Bancorp, Inc. Earnings Conference Call. At this time, all participant lines are in a listen-only mode. After the speakers' presentation, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the conference over to your speaker today, Andres Viroslav. Thank you. Please go ahead, sir.

Thank you, operator. Good morning. And thank you for joining us today for the Bancorp's second quarter 2020 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 2755988. Before I turn the call over to Damian, I'd like to remind everyone that when used in this conference call the words believes, anticipates, expect 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, performance, or achievements to differ materially from those anticipated or suggested by these 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 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 Chief Executive Officer, Damian Kozlowski. Damian?

Thank you, Andres. Good morning, everyone. And thank you for joining us. We have continued to experience momentum in our quarter earnings driven by higher interest income with falling interest expense, increased loan balances and higher payments volumes. In the second quarter 2020, Bancorp earned $.035 a share from both increased fee and spread revenue. Some of the highlights. Total loans increased 49% year-over-year, loan interest including loans held for sale increased 39%, total revenue increased 30% year-over-year with net interest income climbing 45%. Net interest margins increased quarter-over-quarter 19 basis points to 3.53%. Payment card gross dollar volume, GDV, increased 43% year-over-year, while fees increased 18%. Non-interest expense was up 8% year-over-year as expenses continued to be tightly managed even at total revenue climbed 30%. Pre-tax income increased 91% year-over-year and 55% quarter-over-quarter. While the pandemic continued to be a significant source of market uncertainty, we have been able to achieve better revenue productivity and operating efficiency during this time. We also are making investments in our platform. In addition, the impact of Fed actions, the government’s SBA support, the macro retail trend from the physical to the virtual and financial services, and the removal of the BSA order restricting the bank’s activities have all provided additional tailwinds to our businesses. Moreover, our traditionally low risk business sites have continued to grow and gain momentum. This is apparent in our SBLOC, IBLOC loans, which grew 11% quarter-over-quarter and 50% year-over-year, as our digital Talea origination platform has enabled our clients more quickly access to liquidity from investment insurance assets. Our payments business also continued to experience GDV growth, significantly above the historical trends through increases in both, existing and new programs across the payment spectrum. Our pipeline of new products and programs continues to be extremely robust compared to historical norms. Lastly, we are closely monitoring the fast developing situation relative to COVID-19. We are emphasizing safety and implementing guidelines consistent with governmental agencies to reduce exposure and protect our staff. We are currently at approximately 25% staff levels in the office, with our remaining staff fully engaged in a work from home model. We are putting employee concerns first in determining when returning to our office locations is appropriate. I now turn the call over to Paul Frenkiel, our CFO, who will detail more about the second quarter.

Thank you, Damian. Return on assets and equity for the quarter were respectively 1.3% and 15.6%, which exceed both first quarter 2020 and second quarter 2019. The increases were driven by a $15.7 million increase in net interest income, and a $2.8 million increase in prepaid and debit card fee income. These revenue increases were partially offset by approximately $1 million in unrealized losses on commercial loans originated for sale, primarily on the small hotel and retail portfolio in that portfolio. The vast majority of that portfolio is comprised of multifamily loans with cumulative COVID losses estimated by a nationally recognized analytics firm at 1.2%. These loans generally are on our books at a $99 price net of fees and have a weighted average floor of 4.8%. Please see the new tables for CRE loans in the press release which provide a breakdown by loan type and other characteristics. If not sold, these loans will be retained as interest earning assets. Commercial real estate loans originated for sale total $1.6 billion and represent the largest portfolio with the aforementioned 4.8% weighted average rate floor. The next largest portfolio is the combined $1.3 billion SBLOC and IBLOC portfolio, the yield for which is estimated at 2.5%. We generated $208 million of PPP loans with approximately $5.5 million to be earned as fees, which has been recognized over 11 months, beginning in April 2020. The actual recognition period may be less, depending on the completion of applications for forgiveness, and the timing of the SBA’s loan reimbursements. Including those short-term PPP loans, small business loans substantially all SBA totaled $809 million and have an estimated yield of 5%. Leasing balances declined slightly to $422 million with an estimated yield of 5.8%. The decrease reflected the COVID impact of reduced new vehicle availability as vehicle production continues to be inconsistent. The $15.7 million increase in net interest income reflected increases in average quarterly CRE loans to $1.5 billion while related interest income increased $11.3 million. Interest on SBA loans increased $2.2 million, including $1.2 million of recognized PPP fees. While combined SBLOC and IBLOC loans increased 54% over these periods, related interest income decreased $1.6 million, reflecting the impact of 75 basis points of Federal Reserve interest rate reductions in 2019 and additional historic reductions of 1.5% in Q1 2020. SBLOC loans are secured by marketable securities and IBLOC are secured by the cash value of life insurance, and credit losses have not been incurred. Interest expense was $7.9 million lower and the cost of funds was 12 basis points for the quarter, reflecting the impact of the Federal Reserve interest rate reductions. The vast majority of our deposit interest expense is contractual and tied to market interest rates. The provision for credit losses was approximately $1 million, compared to $3.6 million in Q1 2020, which was elevated as a result of leasing losses, because SBLOC and IBLOC loans are respectively collateralized by marketable securities and the cash value of life insurance and have not incurred losses, management includes -- excludes those loans from the ratio of the allowance to total loans in its internal analysis. Accordingly, the adjusted ratio is 1.4%. Prepaid accounts, our largest funding source are also the primary driver of non-interest income. Fees and related income on prepaid cards were up 18% to $18.7 million in Q2 2020, compared to $15.8 million in Q1 2019. Card payment and ACH processing fees include rapid funds revenue and decreased $814,000 to $1.8 million, reflecting the answer of non-strategic higher risk ACH customers. Non-interest expense for Q2 2020 was $42.6 million or 8% higher than the prior year. The increase reflected higher salary, legal and FDIC expense. Salary expense reflected higher incentive compensation expense and higher business development, compliance, risk management and IT expense, primarily related to the payments business. Year-to-date non-interest expense was $81 million, so still in the $40 million average quarterly range. Book value per share increased to $9.28 compared to $8.07 at June 30, 2019, reflecting earnings per share and the increased value of the investment portfolio in the current rate environment. The Q2 2020 consolidated leverage ratio, which is based upon average quarterly assets, was approximately 8.5% and risk base ratios approximated 15%. In closing, there are certain characteristics of our loan portfolios as shown in new tables in the press release, which I would like to highlight. As previously mentioned, the vast majority of our $1.6 billion of commercial loans held for sale are multifamily loans for which a nationally recognized analytics firm has estimated a cumulative loss of 1.2% in their COVID projections. Our next largest $1.3 billion loan portfolio consists of SBLOC and IBLOC loans, which have not incurred losses notwithstanding the recent historic declines in equity markets. Approximately half of the SBA loan portfolio is U.S. government guaranteed. And the U.S. government is paying principal and interest on those loans for a six-month period. The majority of the other SBA loans consist of commercial mortgages with 50% to 60% origination date loan to value. For leases which experience credit issues, we have recourse to the lease vehicles. While there is uncertainty related to the future, we believe these are positive characteristics of our portfolio, which demonstrate lower risk than other forms of lending.

Thank you, Paul. Operator, can you open the lines for questions?

[Operator Instructions] Our first question comes from the line of Frank Schiraldi from Piper Sandler.

Just on the -- first on the NIM. Obviously, all of us think you guys as sensitive and rates came down but the NIM bounced up linked quarter. So, Paul, could you just talk about the sustainability there and some of the expectation going forward?

Yes. So, the primary reason for that, Frank, is actually what we highlighted in the last call and in the first quarter too, which is that our CRE portfolio has interest rate floors. While they rate sensitive, you're right, like the vast majority of our balance sheet is very sensitive, that particular portfolio has floors of 4.8% that was also highlighted in a table. Obviously that floors is still in place. So, that speaks for stability within and maintenance of relatively of a NIM that’s comparable to the one we have now. On the other side of the coin, we have the SBLOC and IBLOC portfolios. They are at 2.5%. So, to the extent that portfolio grows faster than the higher yielding SBA and leasing that could have a slight decrease -- that could result in a slight decrease. But overall, I believe the NIM is relatively stable because of those floors.

Okay. And then, when you said the SBLOC is at 2.5%, is that where -- that's where they are today? Is that fully captured and the average yields for the second quarter?

Yes. All the yields, if you recall, dropped in March, the Fed lowered, everything went down based on prime. So, prime went down in March. So, it was in fact a full quarter.

Frank, we're not -- we kind of held the line too. So, we're not expecting for any business reasons for that to go lower. In fact, the insurance fact, lines of credit, really originate more at a 3% level, so. And they're being disproportionately originated. So, you might actually see the yield on that portfolio tick up a touch over time.

And then, if you could just in broad strokes, I know you don't give detail on the breakout of these things. But, in terms of the 40% plus GDV growth year-over-year, could you maybe just kind of talk about that the main drivers of that?

Well, the main is the macro driver definitely. So, you saw Amazon's earnings last night. There's just a -- across retail, obviously because of the pandemic, there's just more use of noncash payment types, not only through FinTech companies, but across the board. So, you're seeing elevated rates of adaption. And that's really driving it. It's not only the FinTech space, it's across our programs. The leading is definitely FinTech. And this doesn't -- this quarter doesn't really even account for some of the new products and programs, such as SoFi, which really hasn't been implemented yet fully here at The Bancorp. So, there's just a rapid adoption. In fact, I'll give you a little teaser. We're actually seeing that climb. So, our first indication for July is that it's above the second quarter rate and it's more in the low 50% of GDV growth. So, it's going to be sustained. Everything we see, our pipeline, everything says, this is sustained. This is going to last a while and it's a generational shift in the use of these type of products.

Great. And then, just finally, you mentioned SoFi. Obviously, they announced this last quarter, they're again, pursuing a -- I guess, pursuing a commercial bank charter this time around. But, what are your thoughts just overall on the challenger bank space on that avenue? And then how do you protect yourself in terms of -- I know it's a pretty a long tail to get one of these -- to get a bank charter probably talking two years plus, maybe three years plus. But, in terms of potential hole down the road, is it just not a concern given some of the other business gains you're seeing in some of the other relationships in terms of the growth you're seeing there?

Yes. It's very few programs. And mostly, these are -- remember we're in healthcare and we're in government and gift cards and incentive cards. None of those are going to get a license. That's number one. You're right about it. It takes a while. We support all our programs. We're trying to build a scalable, leverageable, low-cost and best-in-class consumer compliance and BSA platform, period. And we think that will, at the end of the day, entice, even if people can do the licensing, it may be a lower cost option, even if they do get the license and they use it for something like lending, and they don't use it necessarily for the payments or deposit side of the business. So, we don't think it's going to meaningfully impact us. If somebody believes that -- we're not picking winners or losers, we think if somebody wants to do this, they should go ahead. That's a very difficult track to go down. And I think valuations are very different in the FinTech market than they are in the banking markets. So, all those things have to be considered in getting a license. But, Varo was one of our -- they're still in the process of finalizing their license and everything. And, they've been a great partner. It doesn't mean we can't do something else with them in the future. But, there are so many opportunities that are greater than this marketplace today. Virtual credit cards, credit sponsorship, other types of processing or expansion of our BSA activities for non-current partners that there's plenty of opportunities out there if one or two programs in the future, which don't have a impact today on our volume. SoFi really hasn't taken off yet and implemented in rotation at the bank. So, we wish everybody luck and we want to give them flexibility to follow their own strategy, but also recognize that we're trying to build the best scalable -- best scale and scope because of our capabilities and technology BSA and compliance, to provide an incentive to stay with The Bancorp, or as your BIN sponsor -- as your financial sponsor.

Our next question comes from the line of William Wallace from Raymond James.

Maybe start on the expense side. There was some commentary in the prepared remarks about some incentive -- higher incentive comp and then higher expenses on the payments business. Are those expenses that you anticipate come back out, so that $40 million run rate continues in the back half, or are these expenses, especially on the payment side here stay?

Well, some of them are one-time expenses to legal. So, it should be -- when you look at the year, will be close, I think, to the 40 run rate, maybe a little bit -- totally depends a little bit on revenue, of course. So, we're just seeing this unbelievable revenue trend. So, we need to make sure that we -- and volume trends, so we got to make sure we strengthen our platform, but also compensate people. In the third quarter of last year, I remember, it’s 40 -- you're going to see a single-digit growth rate because we had, I think, 3% in the first quarter, 8% in the second quarter this year. And last year, we had about a 42-plus-million expense rate in the third quarter of last year. We should be at that level or lower in the third quarter of this year. So, you're going to see maybe the 5% range or so in expense. And you'll see that obviously the substantial revenue growth on our core revenue. Does that help?

Yes, it does. In the CMBS portfolio that you've put on balance sheet, there was commentary about if they don't sell. Is there still some expectation that you could package and sell those?

Yes. But, we're not -- the thing -- we want to run it -- we really -- we're looking at it from all sides. There's really only two decisions. Either we stay in the business, we sell most of the portfolio, and then we continue the business or we keep the portfolio. And the reason is, we don't want to be half in and half out and retain half the loans and then still be in the business. So, it's either stay with the loans or sell the vast majority of loans and continue to do the business now. So, the issue right now is, we don't believe, we could get a gain on the sale. So, we do have indication right now that we might be able to get to par from third parties, if we sold a sizable proportion of the loans, and we just don't think that's economic. We think those loans are absolutely worth par, if not more. Like Paul's comments, that portfolio is booked at 99. So, we do have coverage compared to national recognized credit estimators, loss estimators. So, we think we're -- we want to make an informed decision based on -- we had an exogenous shock, it may change the market like when we exited CMBS. We originate those loans to hold if that became necessary in two cases. One is, there was a exogenous shock, which meant we have to hold the loans, or number two, we lost the gains, because without the gains, then it's very uneconomic to do it versus holding the asset. So, we've worked really hard over the last three years to put ourselves in this position. Originally, we started securitization, because we had the community bank portfolio and that's pretty much gone. So, we're very comfortable holding the credit risk if we decide to.

Okay. And is that to say then that you are no longer originating loans in that business at present with these loans, as long as these loans are on balance sheet?

Correct. And we won't -- and we're not going to sell half the loans. So, it's either we keep the whole portfolio, or -- by the way, we have a moratorium until the end of this year. So, there won't be any CRE securitization loans done till the end of this year. We do have a window in the first quarter of next year, we could distribute the loans. So that's where we are right now. So, but we're not going to be distributing the loans without what we think are gains. So, it just changes the whole economics of the business, if you're not getting those 10 million to 15 million gains on these portfolios. Obviously, if you're not getting $25 million a year in gains, then the spread revenue is much more attractive.

Yes, okay. And then, as you close the books each quarter, how are you determining the market value? Is it one external third-party or do you have two or three parties that are valuing these for you?

Yes. I’ll let Paul handle it.

Yes. We use a number of resources. But, we're relying on the 1.2% estimate for the vast majority of the portfolio for several of -- for the small retail hotel, we take some of those and we have one-third party that does those. And of course, internally, we look at those loans ourselves in the event there any issues. Clearly, there was some, if you recall, in the first quarter, we took more marks, in this quarter we took another 1 million. Part of that -- the majority of all those marks is market based, based on interest rates. There is a little bit of credit in there, but really not significant. You will you'll read about that in 10-Q. And we'll continue to do that. So, I think we're doing everything we possibly can to properly value those loans.

So, right now, there's really not much credit in that 1% discount?

Correct. Yes. That’s about correct.

Yes. And if you look at just that, it's not being impacted at least now except for some hotels. It's not being impacted with deferrals or anything. We're seeing very strong sponsors that are -- and remember, these are interesting properties because they are new money in, these are repositioning properties where people are doing some -- there's future funding pieces to it. And real estate developers hate to walk away from when they just put money in. So, they are -- these are fairly large sponsors, so, they may have had multiple multi-family properties and other properties that they are -- have already refinanced three times. So, those are the type of sponsors we're dealing with. And number two is the markets that we've been in tend to be away from some of the dislocations that are happening around the country. So, they tend to be in the southern portion, mid portion of the country. That's where you can look at the disclosures where they are, again, near army bases and big auto plants and where there has been historically 96% of occupancy rate. So, we think the portfolio -- I sit on the credit committee, I have approved every deal in that entire portfolio and read every credit memorandum myself with my Chief Credit Officer. And we are voting members of that. So, we feel very comfortable with the portfolio we have. And we don't feel like we should give it away. I think, it's especially because if we went back in the market today, we wouldn't get that much better than what we have. So, we would trade assets for deals that aren't really that much better. Once again, decisions haven't been made. We have a moratorium on origination. We may restart the business depending on what happens in the marketplace. But, holding the portfolio is definitely an option.

On the SBLOC and IBLOC business, is the demand -- is it a market share gain, or are you just -- do you think that there is just a lot more demand for that product in general?

It's definitely both, because -- well, obviously, if you're growing 11% quarter-over-quarter and 50% year-over-year, there's probably some market share gain. Though, I haven't done the math. There's only a few providers, like TriState and Goldman. I think there's a lot of -- if you have the right mix in order to provide the product seamlessly to the client and now we do with the Talea platform, we talked about this years ago that we were developing this platform and that it would revolutionize the way we do business, and it seems to be correct, it has, because it's just so much simpler to get people’s money. The fact that with the tax changes and second mortgages are no longer tax efficient and it's easy to get this money in a couple of days, it just seems to be supportive. The market is massive -- so the penetration is still percentages in the single digits, under 5%. So, there is a massive market to use these type of securities or investment assets as liquidity. So, I just think there is a long future ahead with this platform to be -- continue to have rapid growth. Our pipeline, by the way, is stronger than it's ever been. So, it's not only that we've seen this growth. It's kind of like the GDV growth we're getting. And we have more partners than we ever have before. Plus, several providers of this product, some of them captive, have come to us and say they want to actually rent our platform. So, I think that business particularly has a lot of growth potential over the next couple of years.

Okay. And just to be clear. So, you're not winning the business by undercutting on price. It's really a function of the ease of getting through the process for your product versus the competitors?

We are absolutely not cutting price. We set an economic floor. We're at -- and we're not going below that. So, there is a couple of situations where because of revenue share -- we have just small revenue shares with some of our clients on certain deals that we might have got a few basis points lower. But no, if anything, you're going to see, like I said before, tick up of that portfolio over the next three to six months probably, not a tick down. We're absolutely holding line, we walk away. And I look at all those things. And to be honest, I'm on the credit committee for them too. I look at every larger deal. And I've said no to deals that were lower. And, it's frustrated my team, but we're not eroding the price.

One last question, Damian. This question that I've never asked before, but now that the order has been lifted, I guess, it can be a relevant question. You've always spoken about trying to identify low-risk businesses that Bancorp can be in that would help deploy your deposits with good risk-adjusted returns. Now that the order is lifted, does M&A come into the equation? Are there businesses out there that could be of interest that Bancorp might consider buying or would you think that order growth will be organic?

Of course. We don't...

Could you talk a little about what types of business lines might...

Yes. There are always going to be -- there is the philosophy [ph] has, but things change. But it’s a add -- we don't add core capabilities, we build them. So, we bought leasing portfolios, a new technology that might enhance our payments. We're expanding our payments platform. Is there a potential to expand with somebody who is already into credit sponsorship, an area that we're moving into? Yes. So, we look at our map of where our product services are and where our core capabilities are and that's the way we attack the M&A, thinking about M&A. We don't buy a company -- an unrelated company to fill in our balance sheet. We don't try to buy a core capability that we don't know how to manage as well as our other parts and are relying on other people. So, that's our mentality. But, that absolutely, we're accreting a lot of capital. We want to continue to build our capital base and we want to expand our map. So, absolutely, that's always in the equation. But now obviously with lifting of orders, with healthy capital ratios, that's always part of the discussion and should be part of discussion of any board and any management team. So, we're -- and obviously, what's coming out of this is going to be opportunities, because not everybody was as well capitalized and people have that dislocation. So, you just don't -- you never know. But we don't -- we do not want to do a dilutive acquisition. That's not strategically aligned with what our strategy is today.

Thank you. At this time, I'm showing no further questions. I would like to turn the call back over to Damian Kozlowski for closing remarks.

Thank you for joining us today. Really appreciate all the questions. And we will talk soon at the end of the third quarter. Operator, we're all set.

Ladies and gentlemen, this concludes today's conference call. Thanks for participating. You may now disconnect.