The Bancorp, Inc. (TBBK) Q3 2022 Earnings Report, Transcript and Summary

Good day, and welcome to the Bancorp, Inc.'s Third Quarter 2022 Earnings Conference Call. [Operator Instructions]. Please note today's event is being recorded. I would now like to turn the conference over to Andres Viroslav, investor Relations. Please go ahead.

Thank you, operator. Good morning, and thank you for joining us today for the Bancorp's Third Quarter 2022 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 available via webcast on our website beginning at approximately 12:00 p.m. Eastern Time today. The dial-in for the replay is 1-877-344-7529 with a confirmation code of 5997176. 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, performance or achievements to differ materially from those anticipated or suggested by such statements. For further discussions 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 generated $0.54 per share earnings from 14% revenue growth and 9% year-over-year expense growth, exclusive of a $1.75 million SEC civil monetary penalty this quarter. Net income climbed 8% year-over-year with strong increases in net interest income and GDV, gross dollar value, of transactions with the impact of those increases partially offset by the SEC settlement. Pretax income rose 21%, excluding that settlement. Net interest income and net interest margin significantly increased this quarter. Net interest income was up 27%, driven by our 70% mix of variable rate loans and higher balances. NIM increased from 3.17% in Q2 to 3.69% in Q3, as Fed fund increases disproportionately affect loan rates versus funding costs, which are contractually contained. Period-end total loan balances, excluding held for sale, increased 11% over the linked quarter, led by real estate bridge lending with 34% quarterly growth. GDV grew 15% compared to Q3 '21 with significant growth across most verticals with the exception of general purpose reloadable programs, which continue to show modest declines, due mostly to the adoption of debit by our fintech partners. Card fees year-over-year increased 5% and other payment fees increased 17%. For the total envelope of activities and fintech solutions group, fees in aggregate grew 6%. Due to product and customer expansion from our current partners and new members to our ecosystem, we returned to historical trend growth in the third quarter. First quarter of '22 showed only 2% GDP growth over '21 due to the impact of stimulus in '21 and the loss of Varo. The second quarter showed improvement growing 5% over 2021 as these impacts lessened. We believe the third quarter reflected a more normalized GDV run rate and anticipate high single to mid double-digit growth rates to be sustained over the foreseeable future. Revenue growth continues across our platform as lending volumes steadily increased and new payment partners are added to our ecosystem. The expansion of both net interest margin due to rising rates and payment fees across our verticals should support significantly increased profitability in 2023. We are issuing preliminary guidance for '23 of $3.20 a share, excluding net impact of future buybacks, but including the impact of rate increases based on Fed fund futures. We also reiterate $2.25 to $2.30 guidance for '22. The $3.20 guidance for 2023 would represent approximately a 40% increase in earnings per share over 2022 and result in an ROE percentage in the mid-20s and an ROA above 2%. We are also planning to increase our share repurchases to $25 million a quarter or $100 million in 2023 from $15 million a quarter or $60 million in 2022. I now turn the call over to Paul Frankel to give you more details on the third quarter.

Thank you, Damian. Return on assets and equity for Q3 2022 reflected the impact of the $1.75 million SEC settlement and were, respectively, 1.7% and 18% compared to 1.8% and 18% in Q3 2021. Q3 pretax income increased $6 million or 16% to $42 million compared to $36 million in Q3 2021. In addition to considering the current year $1.75 million SEC settlement in that comparison, the prior year included $1.2 million of PPP-related interest and fees, substantially all of which were eliminated in the current year quarter. Also reflecting the $1.2 million PPP reduction was $65 million of Q3 2022 net interest income, which nonetheless increased 27% over Q3 2021. Additionally, in Q3 2022, funding costs contractually adjusted immediately to Federal Reserve rate hikes and increased to 1.19% from 18 basis points during Q3 2021. While funding costs generally adjust immediately, they adjust to only a portion of rate increases, while loans, on a more lag basis, adjust more fully. The majority of these loan rate increases occur over a 90-day period. As a result, continuing quarterly rate hikes in the second and third quarters of 2023 led to an increase in our net interest margin to 3.69% in Q3 2022 from 3.17% for Q2 2022. As loans continue to reprice with continuing expected rate increases, we believe that increases in loan yields in Q4 2022 and 2023 will continue to exceed the increase in funding costs and continue to increase margins and net interest income. The provision for credit losses was $822,000 in Q3 2022 compared to $1.6 million in Q3 2021. However, a $3.3 million net unrealized fair value loss was reflected in net realized and unrealized gains on commercial loans at fair value which reduced diluted net income per share by approximately $0.04. The loss resulted primarily from the only movie theater in the company's portfolios. That loan was originated in 2015 and was a legacy loan from the initial entry into the CMBS securitization business, which was subsequently discontinued. After discontinuance, non-SBA loan originations were primarily comprised [Technical Difficulty] the $2.15 billion of non-SBA commercial loans at fair value and real estate bridge loans, which together comprise the non-SBA CRE portfolio, $2.05 billion are comprised of apartment building loans. Prepaid debit and other payment-related accounts are our largest funding source and the primary driver of noninterest income. Total fees and other payments income of $21 million in Q3 2022 increased 6% compared to Q3 2021. Noninterest expense for Q3 2022 was $45 million, a 14% increase over Q3 2021. Exclusive of the $1.75 million SEC settlement, noninterest expense increased 9%. The largest component of that increase was a 12% rise in salaries expense, reflecting higher incentives for business generation, financial crimes and compliance expense and higher employee insurance expense. Book value per share at quarter end increased 6% to $11.81 compared to $11.13 a year earlier, reflecting retained earnings, partially offset by fair value adjustments to the investment portfolio resulting from the higher rate environment. Quarterly share repurchases should continue to reduce shares outstanding. I will now turn the call back to Damian.

Thank you, Paul. Operator, could you please open the line for questions?

[Operator Instructions]. Today's first question comes from Michael Perito at KBW.

So I wanted to start on the new guide. I appreciate that you guys probably aren't looking to give a lot of line-by-line color here, but I was wondering if you can maybe give us some flavor on what some of the key drivers are of that 40% EPS growth rate that the $3.20 EPS guide suggest. I mean I imagine the NIM probably [Technical Difficulty].

Yes. Well, the NIM is a big driver.

[Technical Difficulty].

I'm sorry, we lost you a bit there. So the biggest driver is the net interest income. So as Paul was saying, we get the deposit, immediately reprice this, but we get this most of the loans repriced over a 90-day period. So we've got this lag that's building profitability that's going to happen over the next 6 months as they continue to raise rates. And we really won't feel the full profitability effect until somewhere between May and June of next year, if it's the current Fed funds predictions. That's 1 main driver. The other main driver is just the payments continues to restore the trend. And we're seeing that fee growth come up. We expect it to better match the actual GDV growth over the next couple of quarters. So those 2 things combined will really have a very large impact on the net income realization from our revenue.

And what's driving the pickup in card fees? I saw in the release, you guys mentioned there's a couple of new partners. Any other color there? I mean it sounds like you think that could get up to a double-digit rate maybe in the next quarter or two?

Yes. So it totally depends on which programs grow. After -- you still have a little lag. GDV is going down on prepaid reloadable which is more profitable, and we're building more debit. So there's still a little bit of that in there. But we renegotiated, over the last couple of years, the proportion of interchange versus deposit funding we get from some of our partners because they wanted more interchange. And so right now, you saw, we've been predicting around 40%, 42% deposit beta with us getting about 58%. But we had that pretty much this quarter, but we still have that lag. So some of that fee is being taken into the NIM because we're getting more of the deposit funding. However, when we look at our portfolio, we've got a couple of new big partners coming in. We have sustained profitability from some of our large accounts, and we don't have a lot of additional tiers that we're going to break through where there's pricing lower based on volume. So we should see that 6% get up closer to the -- whatever the GDV is. So we expect the GDV still to be double digit to mid-double digits over the next year. And we're hoping that those -- that fee level is going to be more like 9% to 11%, maybe even a little bit more percent. That's kind of where our estimate is.

Great. Very helpful. And then just lastly for me on the OpEx side, maybe for Paul, any thoughts on where that -- there was a little noise this quarter. Any thoughts on where that might settle? And if you look ahead to kind of the first quarter of next year, should we expect some kind of inflationary pressure around comp and salaries and benefits and things of that as we think about the run rate for 2023?

Yes. I think the statistics I've been looking at where -- is that nationally salary increases are in the 5% range. So we have some pressure on us. We think it's fairly modest. So -- but we're not -- obviously, we live in the same economy as everybody else, and there is more inflation. So it will increase more than -- a little bit more than 3%, but we still think that it's going to be modest and that our earnings will continue to be driven by the significant growth in revenues.

And we won't -- we're not going to add -- the platform across has -- we've done a lot of work on the efficiency side. So there -- while we're still adding volumes, greater than 10% in the loan book, you're not going to get the same growth in head count. So we're going to have limited head count as a percentage, but we'll have absolutely some inflationary pressure, probably not more than 5% on the payroll side. Now the other expenses have been very controlled. So there might be a few instances where those are going to be, in fact, affected, but we have some long-term contracts with some of the services that are provided to us. So some of those are inflation protected over the next couple of years.

And our next question today comes from Frank Schiraldi with Piper Sandler.

I also just want to try and focus, if I could, a little bit on the guide because I think that's the most important number that we saw in the quarter, just given what is really big growth obviously. What -- the -- when you talk about the pipeline and the card fee kind of matching GDV, so are you saying that you really only need or you're only sort of indicating maybe low double-digit growth in card fees going ahead? So if you get 10%, 11% card fee growth over the next year, that's supportive of that $3.20 number?

Yes. But there -- we're being -- on the $3.20, just to make a general statement, we're still a quarter away from the end of the year, and there's a lot of volatility in the marketplace. So we're very careful to make sure that if we're going to put out a preliminary guidance that it is a guidance that we think is thoughtful depending on the market environment. So there's a wide ranging scenarios on what could happen next year, including both a significant recession to a soft landing, right? We're definitely put a guidance in that we feel regardless of the market conditions that the bank will be able to meet. So there -- it's a conservative, thoughtful scenario built $3.20 that we think we'll be able to meet because we have the ability to adjust what we're doing as a company in order to make sure that we can meet those expectations. But the guide itself -- the fee part of it is a small part of it, just proportionately, just because of the significant impact the interest rate increases. So if we're anywhere near that Fed futures, which right now is between 450 and 475 where the Fed will stop raising, and that raise will at least maintain 450 at the end of the year, that $3.20 should be easy for the bank to meet.

Okay. And -- so I guess that would be the risk to the $3.20 if we do go into a deep recession and the Fed turns around and starts cutting rates because that's a big part of the growth.

Yes. So we -- yes, we modeled that out, but you would have to cut it. It would have to be severe. And a lot of our loans -- new loans we have, have floors, like for the real estate portfolio. So it would be -- we'll update the guidance. We're listening just like everybody else. Everybody -- you could turn on CNBC for 30 minutes and have such wide opinions on what's going to happen with the economy that we're being careful as we were during the pandemic to ensure that we're not giving -- the best thoughtful guidance that we can, and we'll update it as we get more clarity.

Okay. Great. And then just on, I guess, a similar line of questioning, but just in terms of the balance sheet. It's -- historically -- last several years have been sort of a mix shift into loans and out of lower-yielding securities. As we think about the balance sheet over the next year, do we think that level of securities balances has sort of stabilized? Are you going to start moving higher? Or -- and so increase the overall level of size of the balance sheet? And where do you kind of see that over the next year kind of falling out in terms of total asset side?

Yes. So we have a lot of room on the security side because we purposely stopped buying securities 3 years ago -- 3.5 years ago, when the interest rates kind of topped out on the 10-year loan at 3.30%, I think, and that was purposeful. We bought a lot of securities at that time and took some asset sensitivity off the table. But we really did put a drag on profitability. We just thought, as Paul was saying before, we really took a position that both the monetary and fiscal stimulus was going to lead to significantly -- ultimately to inflation and significantly higher rates. So we have a lot of room to put on fixed rate assets as we top out an interest rate cycle. So we will be -- we're not sure when. Usually, it's somewhere prior to the last interest rate. We're keeping our eyes on it, but we will add a significant amount of bonds. We are around $800 million. We used to be around $1.5 billion. So regardless of that -- and that's really to take a lock in the -- obviously, the fixed rates. So we -- and there's other ways to do it, too. So we're definitely going to take fixed rate exposure on our balance sheet over the next year, and it totally depends on how -- what's going on in the marketplace. But we're hoping -- to be honest with you, we're hoping for a more normalized interest rate situation. We're hoping that we don't -- if your inflation is 2.5% and you're at 0 interest rates, you're going to have inflation and you probably should have your Fed funds somewhere between 100 and 200 basis points higher than inflation in order to have a normalized economy. We sure hope that's what happens. If that happens, the bank is incredibly well positioned for the next couple of years to generate significant earnings growth.

Great. And then just last question on that front because you talked in the past about the consumer business, consumer lending. Does this guide have any sort of new business lines that you expect you're going to ramp up to in 2023 to provide sort of -- to help with this guide? Or is it really just the business that's on the bank now in terms of the growth rates, the margin to get to that $3.20?

Yes. The base $3.20 doesn't include a lot of extras to the point that certain lending, we've cut back for our own purposes based on the fact there might be a hard consumer lending to more nominal amounts. We're going to be in that business, but we're talking a couple of hundred million instead of $600 million or $700 million. So we've really pared that back in the $3.20 guide. That's total upside. We'll see if we get -- that's part -- we'll have higher loan growth. We've kind of looked at the loan growth and said that there's obvious areas where we're doing some consumer lending like SBLOC that might be impacted. So we've been very conservative on our $3.20 preliminary estimate. And as we get more clarity going into this quarter -- and it's -- you never know until you see it. We've got a complex funding source from many different programs. So we have to see the deposit growth, and we have to see where in the economy things are slowing down, though we have some areas like in leasing, we still have a tremendous amount of demand from backlog for new leases. So there's offsets there. So we're -- we don't have a lot of fanciness in the $3.20, let's put it that way. So it's fairly insulated from reliance on big new programs.

Ladies and gentlemen, this concludes our question-and-answer session. I'd like to turn the conference back over to Damian Kozlowski for any closing remarks. End of Q&A:

We appreciate everyone attending. I want to thank you and talk soon. Operator, you can disconnect the call.

Yes, sir. Thank you. This concludes today's conference. You may now disconnect your lines, and have a wonderful day.