The Bancorp, Inc. (TBBK) Q3 2020 Earnings Report, Transcript and Summary

Good afternoon, ladies and gentlemen, and welcome to the Quarter 3 2020 The Bancorp, Incorporated Earnings Conference Call. At this time, all participants are in listen-only mode. Later, we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host, Mr. Andres Viroslav. You may begin.

Thank you, operator. Good morning, and thank you for joining us today for The Bancorp’s Third 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 PM Eastern Time today. The dial-in for the replay is 855-859-2056 with a confirmation code of 5682938. Before I turn the call over to Damian, I would like to remind everyone that when using 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, performance, or achievements to differ materially from those anticipated or suggested by such statements. For further discussion of these risks and uncertainties, please see The Bancorp’s filings with the SEC. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Bancorp undertakes no obligation to publicly release the results of any revisions to forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Now I’d like to turn the call over to The Bancorp’s Chief Executive Officer, Damian Kozlowski. Damian?

Thank you, Andres. Good morning, everyone. The Bancorp earned $0.40 a share on revenue of $74 million and expenses of $42 million. Revenue climbed 28%, driven by a 33% year-over-year increase in net interest income and fee growth of 19% after removing our third quarter 2019 securitization gain. The fee growth was supported by 20% growth year-over-year on card fees. Cost of funds was down 77% year-over-year, illustrating the benefits of our payments funding model. Expenses were flat year-over-year, and cost control and efficiency continue to be a main focus of management. Net income from continuing operations grew 13%, best in 2019 third quarter, even without securitization gain revenue. Loan deferrals for our total loan portfolio dropped to 1.2% from 7.5%, driven by our leasing business that saw a drop to 1% of the portfolio from 19% at the end of the second quarter. In the third quarter, we saw continued business momentum led by gross dollar volume, GDV and our cards business of 39%. We also added assets led by 58% year-over-year growth in our securities insurance and adviser financing lending platforms. Additionally, our commercial business has renewed momentum with SBA and leasing, respectively growing 5% and 2% quarter-over-quarter. In this quarter, we raised approximately $98 million net of fees and new senior secured debt at the holding company to support the continued growth of our company. This debt can be applied to the bank as equity to support regulatory ratios. We continue to add new card programs into our payments ecosystem in the third quarter as well as adding several new direct rapid funds partners. These new relationships will be announced as products and services into the marketplace. Our pipelines continue to be very robust and significantly above historic norms, suggesting continued growth in transaction volumes. In the third quarter, we made a strategic determination as to our securitization business. As discussed in previous calls, we have been evaluating our securitization platform and its loan portfolio. After assessing its current profitability, market conditions and credit risk, we have decided to discontinue future securitization activity. The loan portfolio comprised almost entirely of multifamily loans that have experienced few deferrals and delinquencies will amortize over the next three to five years and be replaced by loans originated in other areas. We expect income from the portfolio to be stable over the first two years. A portion of the portfolio may be sold as whole loans as spaces needed on our balance sheet for other lending activities. Our real estate team and our commercial SBA business will continue to originate transactions. Lastly, we now believe we have enough information to issue preliminary guidance for 2021. We expect to earn between $1.65 and $1.70 a share, $1.70 a share or approximately $100 million in net income is currently our company budget for 2021. I now turn over the call to Paul Frenkiel, our CFO, to give you more color on the third quarter.

Thank you, Damian. Return on assets and equity for the quarter were, respectively, 1.5% and 17%, which represented increases from second quarter asset and equity returns of 1.3% and 16%. The increases were driven by a $12.4 million increase in net interest income and a $3.3 million increase in prepaid and debit card fee income. While as Damian noted, we are retaining the commercial real estate loans we previously had been securitizing, those loans will continue to be fair valued. 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 or lower and have a weighted average rate floor of 4.8%. Please see the new tables in the press release for CRE and other loans with a breakdown by loan type and other characteristics. Commercial real estate loans, which were originally originated for sale and which now will be held on the balance sheet, totaled $1.6 billion and represent the largest loan portfolio with the aforementioned 4.8% weighted average rate floor. The next largest portfolio is the combined $1.5 billion SBLOC, IBLOC, and adviser financing portfolio, the yield for which is approximately 2.5%. We generated $208 million of PPP loans, earning approximately $5.5 million of fees, which is being 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 loan reimbursements, which have now commenced. Including those short-term PPP loans, small business loans, substantially all SBA, total $841 million, excluding – and excluding PPP loans, have an estimated yield of 4.9%. New vehicle production ramped up in the third quarter, and we were able to increase leasing balances to $430 million from $422 million at the prior quarter end. Leases have an estimated yield in the 6% range. The $12.4 million increase in net interest income reflected increases in average quarterly CRE loans to $1.6 billion, while related interest income increased $7.8 million. Interest on SBA loans increased $2.1 million, including approximately $1.5 million of recognized PPP fees. While combined SBLOC and IBLOC loans increased 55% over these periods, related interest income decreased $1 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 $8.3 million lower and the cost of funds was 18 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 net interest margin in Q3 was 3.37%, down from 3.53% in Q2, as securities with rates tied to LIBOR experienced a full quarter of lower LIBOR rates. Additionally, prepayments of higher-yielding securities increased. The provision for credit losses was $1.3 million and resulted primarily from SBA loans. Because SBLOC and IBLOC loans are respectively collateralized by marketable securities and the cash value of life insurance and have not incurred credit losses, management 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 20% to $19.4 million in Q3 compared to $16.1 million in the prior year quarter. Card payment and ACH processing fees include rapid funds revenue and decreased $830,000 to $1.8 million, reflecting the exit of non-strategic higher risk ACH customers. Non-interest expense for Q3 2020 was $42 million, which was comparable to the same period in 2019, which also included a $1.4 million SEC settlement. Excluding that settlement, non-interest expense increased 3.4% compared to Q3 2019. Book value per share increased to $9.71 compared to $8.52 at September 30 of 2019, reflecting earnings per share and the increased value of the investment portfolio in the current rate environment. The Q3 2020 consolidated leverage ratio, which is based upon average quarterly assets was approximately 8.6% and risk-based ratios approximated 14%. In closing, there are certain characteristics of our loan portfolios, as shown in the new tables in the press release, which I would like to highlight. As previously mentioned, the vast majority of our largest $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. These loans are already on our books at levels reflecting that discount. Our next largest $1.5 billion loan portfolio consists of SBLOC and IBLOC loans, which have not incurred losses, notwithstanding the recent historic declines in equity markets. Approximately 65% of the $836 million small business loan portfolio, including PPP loans is U.S. government guaranteed. The majority of the other remaining loans consist of commercial mortgages with 50% to 60% origination date loan-to-value. For leases which experienced credit issues, we have recourse to the leased vehicles. While there is uncertainty related to the future, we believe these are positive characteristics of our loan portfolios, which demonstrate lower risk than other forms of lending. I will now turn the call back to Damian.

Okay. Thanks a lot, Paul. We’re going to – operator, we’re going to open the line for questions.

[Operator Instructions] Your first question comes from the line of Frank Schiraldi from Piper Sandler. You may ask your question.

Thank you, good morning. Just starting out with – Damian, I wonder if you could put any sort of parameters around – you gave your preliminary expectation for 2021 EPS. Any parameters around how you get there in terms of what the growth outlook is for things like the SBLOC business and GDV.

Okay. So we put a new investor presentation on our site last night. So we updated all the prospective analysis and everything. So you may want to refer to that if you haven’t seen it. And we – I think we’ve got – what we do when we do budgeting is we look at a bunch of different scenarios and think through what are the likely cases on each business line and the under driving macroeconomic indicators like interest rates. And we run these scenarios. And like I did when we maintained our guidance at the beginning of the year, we were fairly confident that we would get to that $125 million number. And obviously, now with $0.40 this quarter, that looks likely at this point. So we do the same thing here. And we’re looking for continued robust growth on the SBLOC business and the mid-teens on things like SBA and leasing. And our GDV growth has – it had a bump in July, but it settled into the 35% or range, and we expect that kind of growth to continue next year with 15% to 20% fee growth. So when you put that together with the fact that we were controlling expenses, it’s very easy to come to that $170 million figure, considering we just printed $0.40 a share in the third quarter, which is usually our weaker quarter.

Okay. And then – yes, I did not see the investor presentation. So just curious, do you guys provide or I thought – I know you’ve talked in the past about perhaps trying to provide some more detail around the makeup of the current growth and/or the size of your largest relationships. I realize there’s competitive reasons and partner reasons that you can’t go too far into it. But is there any more detail on that? Or can you share any further color there?

It’s the usual, I’m going to say is because we don’t want to disclose what our partners want to own. They want to own their information around the growth of their businesses and everything. We let them do that. But we’re seeing – once again, it’s a macro. We’re seeing growth across the entire spectrum of use cases and payments period. So the devices that we use, the payment devices and the different types of relationships, whether they’re government’s gift card, corporate incentive, health care, like FSA accounts and fintech debit cards are all growing. They’re disproportionate in the fintech area, but they’re not the only place that it’s growing. That’s why – and if you look at our competitor set, and you understand the makeup of the type of programs we have, you see that we’re growing disproportionately to the market by using something like the Nielsen ratings, which is the market standard for reporting these competitive data. And it’s really being driven by the fact that there’s this macro trend, but also because we’ve built what we think is a best-in-class compliance and BSA infrastructure that overlooks all the different use cases and payments. So people feel increasingly comfortable to come to The Bancorp and know that they’re going to have the platform that they need to do business and not have to worry about any regulatory concerns.

Okay. Just a quick follow-up on that front. Would you be able to say or just given your point on how diverse the growth is – and I know you’ve added a lot of new partners. Can you say – when I think about the largest partnerships you have, the largest relationships you have, are those becoming less concentrated in terms of a total percentage pie of a total percentage of revenue pie or deposit pie? Are those becoming less concentrated, those largest relationships, or more concentrated?

It just goes back and forth depending on – we’ve had a lot of dislocations this year. So you’ve had things go up and down. So there – I think over time, it will actually become – because we know – we do have visibility on the programs we’re adding. Over time, it will be – we’re very diversified now. So we’re extremely diversified across the products and use cases now. But even if you look in the fintech area with the larger programs that we’ve added and some we’ve added recently, which we haven’t announced, it’s likely to become less concentrated even in that space.

Okay. And then just lastly on the direct rapid funds business. Is anything baked into – meaningful baked into 2021? Is that still more of along the horizon in terms of revenue growth?

Well, that’s – we’ve definitely investigated and signed partners. That’s also in the investor deck. So you’ll see some new partners in that investor deck, there’s a page dedicated to that. So it’s expanding. So there’s a couple of million in there when we look at fees, $2 million, $2.5 million or so. So it’s – and that’s the direct, not the indirect, which is the Venmo type of stuff. So we’re still expecting to grow that business. It could be much larger than that. But we’re very conservative when we put estimates in for that product set.

Got you. Okay, thank you.

Your next question comes from the line of William Wallace from Raymond James. Your line is open.

Thanks, good morning, guys. Damian, maybe staying with rapid funds, should we think about new customers in that, just like we would any other program where there’s a ramp period, et cetera? Or is the rapid funds product really more of a kind of instantaneous boost to revenue as the customers are turned on to the product?

Okay. So you’re going to hate this answer. It’s both. So there are some clients – in the past, it was more of a ramp. We’re looking at several large partnerships now that would be more instantaneous, resulting in significant fees immediately. So there’s kind of two direct types of partnerships. One are more corporates and more are system-wide, either a tech or network platform. So we have both those discussions, although we haven’t announced it, but they’re both. There could be substantial revenue immediately, and then there’s ones that are more corporate focus that are – have a little bit higher of a – longer of a ramp time.

Okay. Okay. Fair enough. And then on the loan portfolio, you’re obviously experiencing very significant growth in the SBLOC line of business, and you had mentioned that remaining robust and in mid teens, I believe, you said in SBA and leasing, and then we’ve got the runoff of the unsecuritized multifamily portfolio. Can you talk a little bit about – maybe let’s think kind of three years down the road when the multifamily loans are mostly gone. What’s the mix of your loan portfolio that you would target? And then what are the margin implications in a zero interest rate environment?

Well, the loan portfolio, first of all, with the securitization, it should be very stable. We still have future funding to do in the portfolio. So you’re going to get consistent income for at least two years, if not more. They could potentially turn into longer-term fixed rate loans. So what happens is those is those loans will seek permanent financing after a stabilization program. So we may continue to hold a set of those loans into the future. So we have – we’re developing a credit road map around what we’re going to be invested in three years from now to that very question. We’re going to be expanding two sets. One in our SBLOC, IBLOC, our adviser loans, all those, we’re building out the product set on the institutional business. We’re also establishing a much broader commercial business where we do business in SBA and leasing. So there’s a lot of opportunities there. So we don’t – remember, in three years, we don’t want to balloon the balance sheet probably beyond an 8.5% level. And we have some, I think, very good ideas of when those loans do roll off, how to put that capital to work and increasing other parts of the business. But it will be more – it will be an SBLOC. It will be in institutional. It’ll also be in our commercial businesses. And remember, as our – we probably will continue to hold, in some form, 200% to 300% of some type of real estate going into the future, whether they’re fixed rate loans or other type of exposure within our commercial business. So we haven’t decided what that’s going to be, but we feel very confident that we’ll be able to replace those loans as they roll off with good lending opportunities.

Am I hearing that you could be replacing them with another business line? Is that reading…

Yes, we haven’t – well, we’re expanding our products. We haven’t finalized what we’re going to do. And we’re creating a three-year credit road map, and we are very rigorous about it. So there’s a bunch of products that we’re going to create that are in the market today that we’re going to participate in as extensions on our current platforms. So we’re kind of devising of how that’s all going to dovetail. If we need the space sooner because of the lending initiatives that we’re creating, we can always sell a portion of the multifamily loans in the marketplace. Those are extremely – they’re not hard to sell. Even in this environment, we’ve had people who would want to buy substantial parts of our multifamily portfolio at par. So we’re not worried about replacing that lending revenue. And it’s something that multiple years down the road. So we still have $2 billion of room, and we still have $1.5 billion of securities and stuff. So we’ve got plenty of room to expand our current platforms into the next three years. And then as they – as those loans roll off on the CRE side, we’ll decide at that time whether or not there’s – we should keep that type of exposure and turn it into fixed rate, longer-term exposure or we need that room in order to build the other businesses.

Okay. And so – and then just sort of stepping back to the SBLOC, I mean, the growth in the SBLOC loan portfolio is twice or more any other line items. So is there a limit as to what portion or mix of the loan portfolio you would have with the SBLOC? Or would you just let that go however it’s going to go and be fine with the 50%?

So that – we think of that as a platform. So we’re not only – we’re raising in a very difficult time. IBLOC is a 3% loan over funding. SBLOC is more like 2.5%. And then RRA financing can be 6% or 7% over funding. So we’re slowly raising the total effective yield on the institutional business and the new lending businesses that we do or products and services we sell, like banking as a service to other companies who want SBLOC capability will raise the effective yield on that platform over time over the next three years. So the SBLOC, we could easily double the size of the business to $3 billion over the next couple of years and have enough room. That’s what I mean. We would want to put that on. And the reason is, even though it would lower our effective margin on our lending portfolio, we are growing fees very aggressively across the entire business. So it’s very profitable at zero risk basically and – for the SBLOC business. So if you can got an effective yield of above 2.5% and 3% on IBLOC and raise that over time to, say, 3% on the whole portfolio over funding cost, you would double the size of that business without even thinking about it because it just doesn’t have a lot of credit risk. And you might not do that if you were a different business and you were branch funded. But because our payments business is driving such large fee growth, the overall enterprise is obviously going to return – continue to increase its return on equity during that time. So we just don’t think of it as one business, and we have a unique business model. So we can actually engage in a larger business in a non risky lending line and still have increases in margins over the entire enterprise, even though we might lose some in NIM.

Okay. All right. Thanks. And my last question is just thinking about the expense base and growth. I know you’ve got your jaws targets there, and there’s a lot going on in the business. So help us think about kind of a reasonable growth expectation in the expense line as you unlock some of the leverage in the business, but make decisions to reinvest in the platform just kind of this…

Well, this is going to be an easy one. We’re looking at between $305 million and $310 million of revenue right now for next year. And we’re going to have $100 million of net income. So as you know, we’re very rigorous about delivering what we say. So it depends, and we have variable costs involved in compensation and stuff. So if we do a little bit better next year and say we have $315 million or $320 million, some of that will go into net income. Some probably will go into reinvestment in the business around building the platforms that we want to build. And if we don’t meet that revenue number, we’re more like $300 million, we will make sure that we are very rigorous about meeting our earnings per share target. So as much as you can, obviously, we don’t control everything, but we’re very rigorous about matching revenue and expense and keeping that jaws relationship constant. And luckily, we have sizable amounts of compensation and discretion here that we can make sure that we can manage the entire cost base depending on what the revenue environment is.

Okay. Thank you, Damian. I’ll step out and let somebody else to ask a question. I appreciate it.

Your next question comes from the line of Bradley Ness from Choral Capital. You may ask your question.

Well, guys, thanks for the question. So how does buybacks fit into the equation as I look out into the next 12 months or so?

Okay. So in previous earnings calls, I said that during the COVID situation that we weren’t contemplating at that time, the last couple of quarters, saying that because of the dislocation, and we wanted a very good visibility on what was happening in the overall economy, we would not – we would wait to do that. We don’t – with the raising of $100 million of capital at the holding company and holding $113 million in cash and with our performance on deferrals and across the credit spectrum on our portfolio, we no longer have that reservation about doing something on the return of capital to shareholders. That’s the only comment I can make on that.

Okay, thanks. Regarding you getting out of the multifamily securitization business, did that have any one-time costs associated with it that was in the third quarter? And yes, I’ll just start with that.

Okay. So the – we did take marks on some of those hoteling. It’s a small fraction of the portfolio, but there were some fair value marks that were taken in the first quarter. The total – and I’ll turn it over to Paul on this, too. But there is not a significant amount to get out that we don’t have an offset for. There is a cost savings, though, where we’ve trimmed the team down to about 30% of what it was to manage the book. And we no longer have, obviously, the cost of the people, but also the cost of origination, these we were paying based on origination and then securitization of the assets and the gain. So there will be a cost impact around $10 million, probably over a full year in 2021. So you have to think about it on a run rate. We didn’t have all those costs in 2020, but we did in 2019. Would you like to add anything, Paul?

Only that you won’t see a material charge in this quarter or the next related to the discontinuance of that business. And as Damian noted, there will be some cost reductions in 2021.

Okay. Great. Last question here. It seems like you guys have a lot of momentum on the card side and the gross dollar volume side is – sounds like it should be up in the 10% to 20% range. But it looks like it was kind of flattish for the quarter versus the second quarter. Can you just put some color on that?

Yes. So there was a big – the reason it’s flattish is because of the whole stimulus. There was a huge wave that came in through the stimulus to us. And if you saw our deposit substantially is gapped up. And we – it’s hard to understand exactly what’s going on, but it happened over multiple programs. And you saw another – that’s when we closed the economy and everything went virtual. We saw this big bump due to the stimulus, but also unemployment. And then we saw another even increased bump in July, and that was due, it looked like, to the economy opening up again, the tax – fact that taxes were delayed and the end of the stimulus funds that were in our major programs. That has settled down again. And so you’re comparing two quarters where there was this huge governmental and very extraordinary situation to this quarter. And the third quarter is usually our weakest quarter. And the reason is because that’s prior – we have two strong quarters. We have the fourth quarter, which is really driven by gift cards and stuff and some health care and corporate incentive. And then you have the first quarter, which is driven by tax season. So third quarter is usually light, quarter-over-quarter, second to third quarter. This year, it wasn’t as light because you had the bump – the double bump. And so the like comparison is a little difficult to make. But what we’re seeing now is continued year-over-year growth in the mid-30s. If we do get another stimulus, the same thing will happen. It’s – our client accounts are really where stimulus payments go. So you’ll see another bump like that. So it will be hard to really decipher, but it will be over our current growth rate, which is in the 30s already. So it would be a significant impact. We’re assuming though that’s not built into any of our forecasts at this point. We just don’t know what’s going to happen. But we’re seeing – we can look at the base programs and everything and know our pipeline. There is sustainable – 20% to 30% GDV growth at the minimum in that portfolio going into the next, we think, a couple of years. We think it’s going to be high-growth for a while.

Great. Thanks, guys. I’ll let someone else ask a question.

I am showing no further question at this time. I would now like to turn the conference back to CEO, Damian Kozlowski. Sir?

Okay. Thank you, everyone. Have a great day, and thanks for joining the call today, and I’ll talk to you soon. Thank you, operator.

You’re welcome. Ladies and gentlemen, this concludes today’s conference call. Thank you for your participation, and have a wonderful day. You may all disconnect.