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The Bancorp Inc. (NASDAQ:TBBK)

Q4 2013 Earnings Call

January 24, 2014 9:00 am ET

Executives

Betsy Cohen – Chief Executive Officer

Frank Mastrangelo – President, Chief Operating Officer

Paul Frenkiel – Chief Financial Officer

Andres Viroslav – Investor Relations

Analysts

Matthew Kelley – Sterne Agee

Frank Schiraldi – Sandler O’Neill

William Wallace – Raymond James

Andrew Wessel – Sterling Capital

Jeffrey Bernstein – Barclays

Operator

Good morning and welcome to the fourth quarter and fiscal 2013 The Bancorp Inc. earnings conference call. At this time, all participants are in a listen-only mode. At the conclusion of today’s conference call, instructions will be given for the question and answer session. If anyone needs assistance at any time during the conference call, please press star followed by the zero on your touchtone phone. As a reminder, this conference call is being recorded today, Friday, January 24, 2014.

I would now like to turn the call over to Andres Viroslav. Over to you, Andres.

Andres Viroslav

Thank you Gary. Good morning and thank you for joining us today to review The Bancorp’s fourth quarter and fiscal 2013 financial results. On the call with me today are Betsy Cohen, Chief Executive Officer; Frank Mastrangelo, President, 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 12:30 pm Eastern time today. The dial-in for the replay is 888-286-8010 with a confirmation code of 20461868.

Before I turn the call over to Betsy, 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 filings with the SEC. Listeners are cautioned not to place undue reliance on these forward-looking statements that 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 would like to turn the call over to Betsy Cohen. Betsy?

Betsy Cohen

Thank you very much, Andres, and thank you all for joining us today. We’re delighted to be able to report to you what we consider a very solid quarter in the fourth quarter of 2013. Some of the highlights reflected both in the press release and in the increase in growth in the company, I think are very much in our favor. We have indicators not only of trends but also of solid achievements.

Earnings per share were up 32% even after a 13% increase in the average number of shares outstanding on a fully diluted basis. Operating earnings on a quarter-to-quarter basis, 2012 fourth quarter to 2013 fourth quarter, up 21%, and for the full year 2012 to 2013 up even more at 41%.

We’ve been talking to you over the course of the last several years about our intention to enhance what we think is the quality of earnings, and so in this—one of the measurements that we use is non-interest income as a percentage of net interest income plus non-interest income, and so in 2013 that ratio was 47% of that total being non-interest income. Another way to express it is non-interest income represented 88% of net interest income, even after the growth of 15% in net interest income. In 2012, that number was 24% and the comparable number was 70% as opposed to 88%. We think both of those are indicators of growth within our core businesses, and as I will talk about in a minute, a sign of diversification of our non-interest income stream.

During 2013, we concentrated on augmenting the streams of non-interest income, diversifying that portfolio of non-interest income, and thus we have certain elements to report. For example ACH, both volume and fees were up 80% over 2012, and for our CMBS group we really only began our securitization in the fourth quarter of 2012, so we can’t give you a year-to-year comparison, but in Q4 for example they were essentially equal to Q3 and we see very strong pipelines, and the spreads within the CMBS market, although subject to external factors, appear to continue to be strong.

Last quarter, we further discussed with you the fact that we were adding services as part of our prepaid income reported to you, so this quarter as promised we reported gross dollar volume – GDV – and for the fourth quarter, earnings were 15 basis points on that GDV as opposed to 14 basis points in the third quarter of 2013, and 13 basis points for the fourth quarter of 2012, so we have made progress.

On the other side of—on the asset side of the balance sheet, investments continued to grow and we therefore were able to have some further diversification within that portfolio. Loans were flat as a result of several very significant and anticipated pay-downs during December of 2013 in our commercial loan portfolio; however, growth in our targeted segment was still very strong. Additionally, one might note that net interest income (audio interference) grew 15%.

Return on average assets was up 27% while average assets themselves were up 17%, and return on average equity was up 17% while the average equity was up 21%, so both of those showing that we’re maintaining our growth as a result of our increase in average assets outstanding for equity. On the asset side, we are looking forward to the launches we have been discussing of our deposit sales program, probably end of first quarter or beginning of second quarter when we have our most significant need.

On the loan delinquency side, non-accruals were down from $48 million to $40 million. Ninety days-plus is down to a bare minimum 110,000. We had a loan transition into the 30- to 60-day category as a result in a change in manager and a missed income payment, which meant that the totals did not reflect the very significant decrease in non-accruals (audio interference) $48 million to $40 million.

On the expense side, roughly 8% to 10% of our personnel expenses are commissions, and so if you take a look at the growth in personnel expenses, it really has to be evaluated in terms of the significant growth in non-interest income which is producing. In Europe, we accelerated expenses in the fourth quarter—actually, I think in the third and the fourth quarter, so that we could complete all of our passporting by Q1, at the latest Q2, which involves upfront expenditures. During 2014, Europe, which was being built out from an infrastructure point of view, both passporting and personnel and a platform, was negative to the extent of about $3 million and we would expect that to turn to breakeven in the second or third quarter.

To talk a bit more about non-interest income portfolio, I would ask Frank to chime in.

Frank Mastrangelo

Thank you, Betsy. Thank you for joining the call everyone. Q4 was, as normal, a relatively strong quarter from the non-interest income standpoint. The bank achieved 40% year-over-year, increases in total non-interest income. Betsy has already touched on some of the drivers. (Audio interference) income increased 20% year-over-year. The CMBS team contributed, as Betsy mentioned, really not measurable as a percentage year-over-year but contributed $4.6 million non-interest income for the quarter and merchant income, which is inclusive of both the card and ACH transactions that Betsy had noted earlier, were up 47% year-over-year. So lots of contributors to the continued very strong non-interest income growth.

Betsy Cohen

Thank you, Frank. I think that all of our verticals appear to be growing. We suggested to you earlier in the year that in light of the introduction of Obamacare, we were not able to really make a prediction about healthcare, but it continues to be a very healthy business, and if anyone can figure out what people are going to do in healthcare, please do give us a call.

I think with that, I would like to open the floor to questions.

Question and Answer Session

Operator

[Operator instructions]

We have our first question from the line of Matthew Kelley. Over to you, Matthew.

Matthew Kelley – Sterne Agee

Yes, hi. Good morning. So give us some insights into where you are in the credit cycle. Is this the inflection point we’ve been waiting for? We’ve seen provisions go from $9.5 million to $8 million to $6.5 million. Is this the turn on provisions, would be the first question.

Betsy Cohen

Well let me answer them one at a time. You’ll remember your other questions. You know that we don’t make that kind of prediction. We believe that we have been aggressive in identifying credit issues, so we think that we’re getting ahead of the game. So that’s as much as I will say on that.

Matthew Kelley – Sterne Agee

Okay, what about just the tone of inflows versus outflows, resolutions? Maybe just give us a sense of how you feel this quarter about credit compared to when we spoke in October.

Betsy Cohen

Well, I think that the disposition cycle is always a long one. It takes time to take a project either into OREO or identify it as a non-accrual, and then to craft and complete a disposition. You know, we look to a six- to nine-month cycle for that kind of achievement, so I think that as we—we do believe that there are in process transactions which should reduce both the existing non-accruals and existing OREO, or those that are on the books today, within that period of time. So we’re optimistic that that’s in process, but giving you a timetable is just not something I can do.

Matthew Kelley – Sterne Agee

Okay, and then a question for Frank on the prepaid business. So we booked $31.5 billion in GDV for the year. What type of growth rate do you think we’ll see in ’14 on your domestic U.S. prepaid operation, and then how much of a lift do you get from the European operation as that comes in? Maybe you could split those two apart.

Frank Mastrangelo

Yeah, I think it’s tough to call what the lift will be in Europe right now. In ’14, as Betsy said, I think we’ll move the European business to a breakeven position. That will be a combination of the expense load will decrease because there’s been a lot of work going into licensing and passporting the past two quarters here, and then secondly by the ramp in some business. But you know, that’s not going to move the needle that much from an overall GDV standpoint.

In the U.S., I mean, we’d anticipate a—it’s going to be an upper teens to low 20’s growth rate, we believe, in calendar year ’14 just for the industry overall, and we’ll probably be benchmarked somewhere in that range or slightly above.

Matthew Kelley – Sterne Agee

And the 15 basis points this quarter, is that a new run rate we can use or do you think it’s back in the 12 to 14, or--?

Frank Mastrangelo

I wouldn’t expect it to be a run rate. I mean, you’ve seen it’s bounced around quarter to quarter this year. Last quarter, it was 14 basis points. While it certainly is 15 this quarter, it was 14 last quarter. I don’t think you can call it a run rate. I mean, we still have—there’s still competition and challenges maintaining margin and things like that, certain things we’re doing to offset that in the short term had been working, but there are still pressures on margin that could make it difficult to maintain 15.

Matthew Kelley – Sterne Agee

Okay.

Betsy Cohen

You know, Matt, it’s also a factor of what kinds of new growth come into that portfolio. If it’s from larger customers, there is more pressure on the margin; if it’s from smaller customers, less, and that’s a very hard thing to predict.

Matthew Kelley – Sterne Agee

Okay. And then the pace of securities purchases was pretty robust, kind of accelerated from 3Q. Can you talk about the pace going forward and then what you bought during the quarter – you know, new yields and types of securities?

Betsy Cohen

Sure. Paul?

Paul Frenkiel

Sure. I would really direct you to our last Q where we break down the sectors that we have. We pretty much stayed within those sectors. We’re very opportunistic, so we’re looking for value. If you’re in the securities markets on a daily and weekly basis, you see that as a result of supply and demand and other factors, you really have to search to find value. So we actually expanded virtually all our sectors last quarter. Rates are down a bit now, but now we’re looking more at variable rate instruments and we’ll continue to grow the portfolio, so you should see a net increase in income every quarter.

Matthew Kelley – Sterne Agee

And what was the average yield for the fourth quarter purchases?

Paul Frenkiel

They vary, but I would say they were in the 2% range.

Matthew Kelley – Sterne Agee

Got you.

Betsy Cohen

We’re mindful of the fact that we still are in a—we’ll be facing a new Fed chairman, that unemployment was down a bit, that the factors which lead to higher interest rates are uncertain at this moment, and so we are protection both, as Paul was saying, in terms of investing in floating rate instruments which don’t yield as much on a current basis, and in keeping durations short so that we’re not caught in a spike. So it’s a balancing act, a barbell portfolio.

Matthew Kelley – Sterne Agee

Got it. I’ll hop out and let some others ask questions. Thank you.

Operator

Thank you for your question. Next question comes from the line of Frank Schiraldi, Sandler O’Neill. Over to you, Frank.

Frank Schiraldi – Sandler O’Neill

Good morning. Just a few questions. First just on—I’m trying to think about modeling for 2014 with the deposit sale program up and running, as you noted Betsy, perhaps by the end of the first quarter. So how do we think about balance sheet growth year-over-year? Is it the goal to keep the balance sheet sort of flattish with this deposit sale program being implemented?

Betsy Cohen

You know, I can give you our aspirational answer and then tell you that it’s almost impossible to predict. Remember that the program will be new and so we have not yet measured market demand. We haven’t—also, we won’t be able to size the sale bucket until we see the inflow of deposits, so you have unknowns on both sides of that from an actual basis. Our continuing goal is to keep the bank someplace between $4 billion and $6 billion on an ongoing basis. How that will play out quarter to quarter with this sale program is really very hard to predict at this time, Frank, because we have no history with it yet.

Frank Schiraldi – Sandler O’Neill

Right, okay. And as you look at implementing it, do you see significant hurdles there to implementation, or are you confident that you will be able to get it up and running in some meaningful fashion this year?

Betsy Cohen

I’ll pass that to Frank.

Frank Mastrangelo

I’m confident we’ll have it running in a significant fashion this year.

Frank Schiraldi – Sandler O’Neill

Okay, great. And then Paul, I just wanted to ask, I might have missed some of your comments on securities purchases/NII. Did you note—it’s always tough with liquidity coming in and off the balance sheet with some of the seasonality to guesstimate the margin quarter over quarter, but did you note that you expected NII to be up sequentially from here? I don’t think you gave any numbers, but is that what you said or am I wrong there?

Paul Frenkiel

No, we didn’t talk about the margin in it, but we are—obviously we’re working on strategies, specifically really the loans that Betsy had mentioned that we targeted that support the interest margin, and obviously that’s our goal, to increase it. The markets in terms of securities, obviously the yield curve has got to cooperate and we’ve got to continue to manage to low interest rate risk. We are doing our best, but we’re not really predicting that now.

Frank Schiraldi – Sandler O’Neill

Okay. And then Frank, just back to prepaid growth, you mentioned high teens, low 20’s sort of growth rate for the industry. It doesn’t sound like that’s changed all that much from your comments on industry growth last quarter, and I wondered if—you know, I think you said you could continue to outstrip that, and I just wondered if in thinking about the magnitude about stripping that number, if the GDV growth year-over-year, which I think was about 26, 27%, if that might be a better indicator for growth going forward than the 20% prepaid fee growth year-over-year.

Frank Mastrangelo

Yeah, so GDV growth was up 26% year-over-year, so that certainly did outpace, I think, the industry growth rate. And then the reality is it depends on which relationships grew and how much revenue is driven related to how much non-interest income will grow year-over-year. So I mean, GDV is certainly one indicator of our ability to continue to outpace the growth of the market.

Frank Schiraldi – Sandler O’Neill

Okay. And then in the past, you’d also mentioned that prepaid might be growing a certain percentage, but there’s other ancillary businesses that are similar that you’re doing that aren’t necessarily captured in that prepaid growth number. Is that really—

Frank Mastrangelo

You know, we’re talking about 18 to 22%. I mean, what we’re really talking about there is general purpose reloadable growth in the U.S. There are already other sectors of prepaid, for example, that grow at far slower rates than that. Gift cards in the U.S., for example, grow at 9 to 12% year-over-year annual growth rate, because it’s a relatively mature sector of the prepaid business. There are other sectors in prepaid like that also that are far more mature and far more established and grow at far slower rates.

What people are normally talking about, and we’ve been talking in the past about this – you know, 25, 30% growth rates that’s now slowed, call it 18 to 22. We’re talking about general purpose reloadable growth, which has been the fastest growing sector in prepaid over the past handful of years.

Frank Schiraldi – Sandler O’Neill

Okay, but when you’re talking about prepaid processing fees, that line item, if we’re thinking about growth there, we might think of a lower bogey than that because obviously general reloadable doesn’t take up the entire pie.

Frank Mastrangelo

No, well it doesn’t. I mean, I believe we’ll continue to grow our—because of then the other items that are growing faster that are not in—that also are not in GPR, so all of mobile wallet initiatives and things like that. I believe we can continue to outpace just the general GPR growth rate.

Frank Schiraldi – Sandler O’Neill

Okay, that’s helpful. And then just following up on mobile banking, the idea of moving from card-based payments to mobile-based, as you look at that now, how far out is that in your opinion until that begins to take hold in a big way?

Betsy Cohen

I think that’s the $64 question for the world as opposed to for Frank individually. I think—or maybe for the U.S. You know, U.S. has lagged in terms of access or accessing—consumers accessing and using their mobile phones as their primary source of data communication, and in part it’s because the U.S. is a more mature computer-based or Internet-based market. T-Mobile has been working on this project for a very long period of time and what the adoption curve will be is probably more optimistic today than it would have been if it had launched two years ago. But what exactly it will be, I think is really an unknown, Frank.

Frank Schiraldi – Sandler O’Neill

Okay, all right. I guess I was just trying to get at if you are positioned in a way that—and I think Frank, you spoke to it, that growth in some of those businesses could be even greater, right, so if you are positioned in a way that that could help support your 20%-plus growth rate going forward.

Betsy Cohen

Well, I think that that’s not what we’re counting on. We’re looking at our traditional business, so T-Mobile and other opportunities, because you may or may not remember that we’ve been talking about investing in our capacity to support mobile banking for a long period of time, and recognizing that it was an area in which we needed to invest which in our case means expense investment early on to hold our market position. We have been investing in it. We have been holding our market position. This is an indication of that and of what we think of as the wisdom of that strategy. But as we cautioned all along, it will be—it’s hard to predict what the adoption rate will be and therefore the income impact over time that will be very positive, we believe, but the exact timing of that is really unknown.

Frank Schiraldi – Sandler O’Neill

Okay, all right. I appreciate it. Thank you.

Operator

Thanks for your question. Next question comes from the line of William Wallace, Raymond James. Over to you, William.

William Wallace – Raymond James

Thank you. Morning Betsy, morning Frank. A couple questions that I have. First, I wanted to talk a little bit on the fee income side. We’ve talked a lot about the prepaid business. I was wondering if we could get a little bit of color on the commercial mortgage-backed business. Can you talk to what the fee income was in that business this quarter?

Betsy Cohen

It was about $4.5 million, which was about equal to what it was in the third quarter. I think that we have been—remember, this is a business which is only maybe 15 months old, and so we have been making enormous progress in terms of both the stability and the growth of our pipeline. Again, in terms of predicting what the spreads will be in that market, neither we nor God, I guess, can do that with any certainty. We can tell you that the spreads will also be dependent upon the mix within that portfolio, large versus larger. We don’t do large, but larger versus smaller loans, so—and asset types. So any one quarter is hard to predict, but we believe that both volume and revenue from that segment will grow over the course of this year.

I know that was not a helpful answer. I’m sorry, Wally.

William Wallace – Raymond James

Well, it’s somewhat helpful but maybe we could take it a little bit deeper. Do you need to—it looks to me like perhaps you did two big securitizations in the quarter and that’s been what you’ve done the last two quarters. Can you do 4.5 to $5 million a quarter in that with who you have in staff now, or do you have to hire more productions to maintain that level?

Betsy Cohen

No, no. Our current level is very maintainable, and indeed the growth that we’re talking about is sustainable, I’d say, with our current staff. It may mean one lower level position gets added, but we don’t need any high level people to continue. We have senior people in place.

William Wallace – Raymond James

And if I look at your loans held of sale on the balance sheet, you had a significant upward move in that this quarter. Does that mean you’re setting up perhaps for a pretty strong first quarter?

Betsy Cohen

Well, I think that we believe that the pipeline is strong, as I said to you, and one reflection of that is what’s on the balance sheet and not sold as of the end of the year.

William Wallace – Raymond James

Okay, okay. Thank you for the color there. And then on the expense side, Betsy, in your prepared remarks and Frank you referenced it as well, you mentioned that you’ve accelerated some expense in Europe related to licensing and passporting, which I’m trying to get a sense maybe if you could help quantify that so we can get a sense as to maybe what some of the relief might be moving into 2014.

Betsy Cohen

Well, I think we gave it to you on an annual basis because that’s really the way to look at it. It’s what we’ve spent to get to where we are, and I think that if you divide it by four, you’ll be high some quarters and low others. It’s not a cookie-cutter expenditure.

William Wallace – Raymond James

What was that annual expense number? I missed it in the prepared remarks – I apologize.

Betsy Cohen

I’m sorry – about $3 million for 2013.

William Wallace – Raymond James

And that’s what was accelerated or that’s just what you’ve spent to get to—

Betsy Cohen

Oh, no, no. That’s what we’ve spent, and so I’m saying to you that it’s hard to predict what exact expense will fall within what quarter. We’ve been trying to move it forward to get it done quickly. That increased anticipated expenditures – I can’t give you that number off of the top of my head for this quarter. I just don’t have it right here, but Wally, I’ll get it to you.

William Wallace – Raymond James

That’s fine. I guess what I’m trying to get a sense—so that $3 million is expense that goes away now? You don’t have that, so you just have—

Betsy Cohen

We’ll have expenses in the first and probably in the second quarter. We’re looking at breaking even toward the end of the second quarter, but you won’t see that until the third quarter. So expense relief will be the second half of the year. It probably will not run at the same rate for the first half of the year, but I don’t have my arms around exactly what that number will be.

William Wallace – Raymond James

Okay, fair enough. And then I guess the last question I had is going to the loan portfolio. You referenced some large expected payoffs during the quarter. Maybe if we forget about the payoffs and look at the production during the quarter, how did that trend? Has that been accelerating nicely as the year has progressed, and do you expect that to continue into 2014?

Betsy Cohen

Yes and no, or yes and yes – I’m not sure which. During 2014, we will continue what we think is our growth within targeted segments of the business, in SBA, in wealth management, in leasing; and we see our way clear to having those segments grow. We have said to you in the past that we believe that barring opportunities, we may not see growth in the commercial sector, which we think is part of a plan that the alternative to that is to find additional verticals like those that we’ve identified to date – SBA and leasing and wealth management. (Audio interference) our portfolio of targeted segments, we have our arms around a couple of those but have not yet launched them. So we anticipate total loan growth will not be diminished, but it may be diminished in some categories and increased in others.

William Wallace – Raymond James

Okay, fair enough. And then the last question I have relates to that, is as you target the growth in these specific segments, will the yields on those loans drive an increase in the yield as the total portfolio as some of the commercial balances run off?

Betsy Cohen

Well, in SBA the yields have been in the 5 to 6 range, and in leasing in the 6.5-ish range, so we’re targeting our higher yield, lower credit expense segments. We’ve had significant growth in the wealth management portfolio over the course of this year and anticipate further growth. Although that’s a lower yield, it’s been for us over the last six or seven years that we’ve been doing it, virtually a zero (audio interference) – you can see Frank is not feeling well – a good risk adjusted yield for us, and we would hope to continue to grow that piece of the portfolio during the course of this year.

William Wallace – Raymond James

Okay, fair enough. So a lot of it will depend, then, on really if that growth is outstripping the SBA and leasing loan growth.

Betsy Cohen

Right.

William Wallace – Raymond James

Thank you. Appreciate it. I’ll let somebody else have the line.

Operator

Thank you. The next question is from the line of Andrew Wessel of Sterling Capital. Over to you, Andrew.

Andrew Wessel – Sterling Capital

Hey guys, good morning. So I had a couple questions. Frank, I guess the fee revenue breakout, can you give those numbers for the fourth quarter? I know you said CMBS is $4.6 million, merchant income was up 47% year-over-year, but what was merchant income—

Frank Mastrangelo

Yeah, merchant income was $1.1 million for Q4. Prepaid was a little shy of $11.7 million.

Andrew Wessel – Sterling Capital

Okay. And thanks for adding the GDV for—you know, at the bottom of the press release. I think that’s helpful, but can I get the full—what are the actual GDV numbers for total 2012 and 2013, because I know you gave the percentage growth but I don’t know what the actual numbers were.

Frank Mastrangelo

Hold on one second.

Andrew Wessel – Sterling Capital

In the press release, you have the last three quarters beyond the first quarter.

Betsy Cohen

Oh, I’m sorry. Okay.

Frank Mastrangelo

The GDV in Q4 was $7.7 billion. Q3 was a little shy of $7.2 billion.

Andrew Wessel – Sterling Capital

Right – you have all those numbers in there, but just for the actual year, for all of 2013 and all of 2012?

Frank Mastrangelo

Oh, I apologize. You know what, I don’t have that right in front of me. I can email you that.

Andrew Wessel – Sterling Capital

Great, yeah. I’ll just follow up with you, thanks. And then just the last question on—you know, just taking a step back on expenses, right? So you’ve got—because Europe spend is going to fall off a little bit, and you’re still growing the business and that’s great. But just as you look out, you’ve taken on some pretty big—Europe was a pretty big endeavor, I’m sure internally, and a lot of focus and a lot of—you know, a decent amount of spend there. But barring kind of an opportunity of that magnitude that you’d come across going forward, what would be—how can we kind of conceptualize what you expect your efficiency ratio to be as a kind of—I don’t even want to use normalized, but something that you kind of year-over-year was about flat. That was on pretty good revenue growth, but so at 61.5 kind of over the last year. You’ve had a lot of improvement over the years before due to, again, that revenue growth, but what do you see as kind of a normalized expense base and how can we think about that? Can we get to the mid-50’s? Is that ridiculous? I mean, I don’t know how your organization is set up.

Betsy Cohen

Frank, are you--? Maybe if you could just rephrase the question a little bit.

Andrew Wessel – Sterling Capital

Sure. If we’re looking for a normalized efficiency ratio, as your franchise is set up, barring some opportunity that you see that’s a great thing to go after and you want to spend money on it, but just—

Betsy Cohen

Yeah. I think that what we have tried to do is move away from your traditional efficiency ratio to share with you the relationship between non-interest income and expense. And so that ratio has moved up significantly. We are covering—I’ve lost the figure here, but I will get it in one minute. We are covering a significantly greater percentage of our non-interest expense with non-interest income. I think in 2012, that number might have been in the 50% range, and in 2013 in the 70-plus. So that’s how we’re—it’s a measure we think is more appropriate to our organization than looking at the traditional efficiency ratio.

Andrew Wessel – Sterling Capital

Yeah, and I totally respect that, and I think revenue growth obviously gives you opportunity to reinvest in the business; but we’re looking at expense growth in 2011 was 17%, 2012 was 22%, 2013 was 26%, and again, you’ve grown revenue aggressively against that so you have had operating leverage. But if you look out and you try to value cash flows, right, we can’t put on those new growth rates forever.

Betsy Cohen

No, but that’s why we’ve looked at what are we producing as a result of those increased expenditures, and so if we take a look at total expenses and we take a look at total non-interest income and that ratio of coverage continues to grow, we believe that we’re making expenditures which are generating a positive income relationship. It’s another way of expressing what we think is less applicable to us, which is that traditional efficiency ratio.

Andrew Wessel – Sterling Capital

Sure. So this year, then, taking it from that way, it was 74%, at least by the numbers I’m using. You covered 74% of your OPEX with non-interest income, and then last year it was 56%, so that was—you know, from 56 to 74, that was a huge move. Is there a point where you think you have—and again, positive operating leverage, but is there point where you think you’re covering all of your operating expenses just with non-interest income?

Betsy Cohen

Well, that’s an aspirational goal. That’s been our goal. We’ve been moving ourselves up over the course of the last couple of years. One must remember that a certain component of personnel expense – roughly 8 to 10% - is commission, so we will have expansion of that magnitude, not of total expenses but personnel expenses, related to the increased generation of non-interest income. But our aspirational goal is to move it to 100. We’ve moved it from 56 to 74. We may not be able to make that kind of leap next year, but we believe that we will be moving that number up.

Andrew Wessel – Sterling Capital

Okay, great. And can I just get that compensation—do you have the number for compensation for 2013?

Betsy Cohen

Paul, I’m pulling this out of my memory – the personnel cost was, I think, $53 million, of which $4 million was commission?

Paul Frenkiel

Correct.

Andrew Wessel – Sterling Capital

Okay, great. Thanks so much, guys. I appreciate it.

Operator

Thank you. Next question is from the line of Jeffrey Bernstein. Over to you, Jeffrey.

Jeffrey Bernstein – Barclays

Hi, good morning guys. I had a couple $64,000 questions for you. I wanted to see if we could just get an update on the evolution here of the private exchange provider market and where you guys are playing, and—

Betsy Cohen

In the healthcare area--?

Jeffrey Bernstein – Barclays

Yes – HSAs, yes, and if you could talk about kind of how you see things rolling out next year. I understand you’ve already said you think this is more of a ’15, ’16 opportunity in terms of financial results for you, but how do you see the kind of getting to market next year?

Betsy Cohen

Frank, do you want to try?

Frank Mastrangelo

Yeah, absolutely. So first of all, I would say open enrollments for the 2014 benefits year was slightly ahead of open enrollments ’13, which is a good sign, so you know, it does seem like things are moving along nicely there. As far as—you know, it’s an important part of our strategy to have product on both public and private exchanges. We have product on exchanges this year. We did some uptick, I think, in open enrollment, like I said, from ’13 to this benefit year as a result of that. It was—it’s a nominal uptick, a couple points, but not nothing. We still believe that benefit year ’15 is when this will really hit when there’s a full year’s worth of education for employees and more companies moving onto specifically the private exchanges.

Jeffrey Bernstein – Barclays

And any update on the relationships that you have there? Are all the ones that you expect to get in place, or how do you see that rolling out?

Frank Mastrangelo

No, we’ll continue—no, because even all the exchanges aren’t up yet. So there are still large brokerage and consulting firms, for example, contemplating or in the process of building and launching private exchanges, so I think we’re on the majority of meaningful exchanges that are already launched but we’ll continue to work to make sure that we’re on all the relevant exchanges, period.

Jeffrey Bernstein – Barclays

And then regarding FSAs, have you seen any impact from the improvement in the use-it-or-lose-it clauses, and will that be germane for you guys at all?

Frank Mastrangelo

You know, it might actually. This is something we’ve been talking about internally. The interesting thing is that the ability to carry over $500 year-over-year in an FSA rather than have it be completely use-it-or-lose-it, it may actually reduce card spend on a per-FSA basis. At the same time, that may be more than augmented by more people signing up for FSAs, so it will be interesting to see how all that plays out. So it may be good in the aggregate, but on a—but decrease revenue slightly per card.

Jeffrey Bernstein – Barclays

And I guess some people have talked about use-it-or-lose-it being a big barrier to adoption, and that they could see a pretty significant jump in that. Do you have any evidence of that yet, or when will we get some evidence of that?

Frank Mastrangelo

Well, there’s obviously no evidence of it yet because it just went into effect.

Jeffrey Bernstein – Barclays

So it’ll be the first quarter that you would see it?

Frank Mastrangelo

No, because I think there’s actually other—it’s not every FSA just automatically gets the $500 carryover. Also, there are actually some structural changes that are necessary to the product. Not every company may make those structural changes to the benefit plan—

Jeffrey Bernstein – Barclays

Got you.

Frank Mastrangelo

--to actually get that carryover.

Betsy Cohen

Yeah, I think, Jeff, that it’s really hard to predict employer behavior at this time. There’s been a lot of talk about large employers going to a stipend and let the employees go out and buy the—but it hasn’t really happened across the board. None of this has happened across the board yet because we’ve been in no man’s land. So I think we can talk about what we think or hope might happen, but we don’t have any evidence for it.

Jeffrey Bernstein – Barclays

Okay, that’s great. I guess we’re going to know when we know. So last thing just on—we’ve talked about the mobile wallet space and the players kind of feeling around for what’s going to be the right solution here that’s going to get traction and that they would finally really spend some marketing dollars behind, et cetera. I’m wondering in the aftermath of the Target problems and the discussion that, hey, in Europe and everywhere else they’ve adopted EMV and we have it here, we should turn it on, we should make things safer. Do we think that that Near Field Communications is the winner? Are we hearing from the Paypals or Googles that they’re excited about this, or really nothing yet in terms of solidifying around how this works?

Frank Mastrangelo

I think it’s way too early to call NFC the winner, and as a matter of fact I personally believe Bluetooth low energy – BTLE – may have every bit of a chance of being the primary protocol as NFC at this moment in time. That’s slightly separate than the question around maybe Target, Neiman Marcus and EMV. There’s no question – the associations are out beating the EMV drum, using Target and Neiman Marcus breaches as the driver to push that forward.

Interestingly, I don’t know whether any of you read this or not, but Target’s actually been one of the larger merchants who a number of years ago decided that they did not want to implement EMV, so that’s kind of an interesting turn of events now. Of course, they’re out, I think on board as others are, and I think we will see EMV finally get implemented in the U.S. in a relatively meaningful way by both issuers and acquirers.

Jeffrey Bernstein – Barclays

Okay, but you don’t see that (audio interference) precipitating a standard for mobile wallet yet?

Frank Mastrangelo

Not yet, no.

Jeffrey Bernstein – Barclays

Got you. Okay. All right, that’s great. Appreciate the time.

Operator

Thank you, and we have a question from the line of Matthew Kelley. Over to you, Matthew.

Matthew Kelley – Sterne Agee

Yeah, hi. Just to follow up on expenses. When we think about 2012, expenses were up about 22%. You were making big investments in new programs and market share in mobile wallet and Paypal and Google. In 2013, it was the big push into Europe and expenses were up 26%. The question is, as we head into ’14 here, are there any big initiatives that we’re going to hear about in the second half of the year that you’re investing in now, similar to what you were doing in ’12 and ’13, that will elevate expense growth?

Betsy Cohen

I will say that I don’t think that we have within our current strategy the magnitude of investment or the magnitude of programs into which investment is required as those that you’ve been describing.

Matthew Kelley – Sterne Agee

Okay, got you. So we should see expense growth slow at least into the mid-teens then in ’14? We’ll see a decline in the growth rate—

Betsy Cohen

We’re not saying that. We’re saying—I was answering a more specific question.

Matthew Kelley – Sterne Agee

Okay. But without those big investments, I guess one would expect to see a slowdown, that’s all.

Betsy Cohen

Without those big investments, one could see a slowdown; but again, part of the growth in non-interest income is commission-based, so if we have that, you might not see quite as much of a slowdown as you’re anticipating. But it will be accompanied then by an immediate response in the non-interest—in the revenue increase, because otherwise it wouldn’t be paid.

Matthew Kelley – Sterne Agee

Okay. And then a follow-up question on the deposit suite program. Now that that’s—you know, the confidence levels are higher, the tests have gone well, walk us through if you guys sell a billion dollars’ worth of deposits into—you know, through this market to smaller financial institutions who need funds, what are you selling at and what are the net economics for your balance sheet and your income statement? I assume you have a fee that’s generated, there’s FDIC insurance. Walk us through what happens to the P&L and the balance sheet if you sell a billion dollars of deposits on your suite program.

Betsy Cohen

Frank, do you want to--?

Frank Mastrangelo

Sure. There’s a couple components, Matt. So first of all, it alleviates the bank’s FDIC insurance cost, and the—so hypothetically, if the deposits were only sold for 25 basis points, within 25 basis points we were earning, selling Fed funds today, which we’re doing with our excess deposits, we’d alleviate 9 basis points in FDIC insurance costs and we’d also alleviate the capital allocation essentially to holding those deposits.

Matthew Kelley – Sterne Agee

Right.

Frank Mastrangelo

And we’d have the revenue generated selling those deposits to the other bank – 25 basis points.

Matthew Kelley – Sterne Agee

Right, but you don’t have the 250 basis points of spread income, so as this starts to get implemented—what’s that?

Frank Mastrangelo

We don’t have 250 basis points of spread income, anyway.

Betsy Cohen

Yeah, it’s a marginal analysis that you have to do if we had $900 million in Fed funds, so (audio interference) strongly offsetting. That’s the whole purpose. It will increase the margin on the remaining book because the non-earning or minimal earning component will be reduced.

Matthew Kelley – Sterne Agee

Okay. And then what deposits do you envision actually selling? Is it more the HSA? Will you be able to sell the prepaid types of deposits given the volatility, or what actually gets sold, do you think?

Frank Mastrangelo

Yeah, we will. There is a series of different types of deposits that—where it’s easy for us to bake in the proper disclosures and utilize those deposits. Those do include our prepaid and other types of commercial deposits.

Matthew Kelley – Sterne Agee

Okay. All right, got you. And then one other just clarifying question. On the CMBS business, it looks like 17.3 of total gains – I know there’s some fair value marks to think of, about a million dollars, so—and you sold some SBA loans as well. What are the gains you’re generating? What was the total dollar amount of loans sold to generate the roughly $14 million of gains on just traditional CRE loans sold into conduits?

Betsy Cohen

I’m going to have to send that to you offline. I just don’t have it in front of me and I don’t want to quote it incorrectly.

Matthew Kelley – Sterne Agee

Understood. All right, thank you.

Operator

Thank you, and a question from the line of Frank Schiraldi. Over to you, Frank.

Frank Schiraldi – Sandler O’Neill

Hi, just had a couple of follow-ups. First on the gain on loan sales, just to keep it there for a sec, I just wondered if you could share with us the expenses associated with the—or not necessarily quarter-over-quarter but just the commission that would be based on $4.5 million of gain on—

Betsy Cohen

I’m sorry, but we don’t break out that information for you.

Frank Schiraldi – Sandler O’Neill

Okay. Do you break it out in terms of not just commissions but some sort of efficiency in terms of the expenses associated overall, or no?

Betsy Cohen

We do not.

Frank Schiraldi – Sandler O’Neill

Okay. And then just following up on credit, I’m not sure if you talk about 30 to 89 days past due, and I just wondered how that had trended quarter over quarter.

Betsy Cohen

Thirty to 89 days, I thought that I said to you that it went from—I’m sorry if I didn’t say it, I meant to. Thirty to 89 days increased by $6 million, which was represented by a single loan that was in a transition period between managers where the interest got delayed because of the cash collections, but should be back on track.

Frank Schiraldi – Sandler O’Neill

Okay, you may have mentioned it. So that was the only uptick—that was really the uptick then?

Betsy Cohen

Yes.

Frank Schiraldi – Sandler O’Neill

And then I don’t know if you had classified totals, if that had sort of trended with total MPAs.

Betsy Cohen

I didn’t give you those numbers but can get them for you.

Frank Schiraldi – Sandler O’Neill

Okay, great. Okay, thank you.

Operator

Thank you. I would now like to turn the call back over to Betsy Cohen for closing remarks.

Betsy Cohen

Thank you. As always, we thank you for a series of very good and probing questions in which not only our current achievements but our predictions of times future are tested, and we’re delighted to have the opportunity to share our thinking with you. So thank you again, and we look forward to talking with you next quarter.

Operator

Thanks very much. Ladies and gentlemen, that now concludes your conference call for today. You may now disconnect. Thanks very much.

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