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The Bancorp Inc. (NASDAQ:TBBK)

Q2 2014 Results Earnings Conference Call

July 24, 2014 8:00 AM ET

Executives

Andres Viroslav - Investor Relations

Betsy Cohen - Chief Executive Officer

Frank Mastrangelo - President

Paul Frenkiel - Chief Financial Officer

Analysts

William Wallace - Raymond James

Frank Schiraldi - Sandler O’Neill

Matthew Kelley - Sterne Agee

Frank Schiraldi - Sandler O’Neill

Operator

Good day, ladies and gentlemen. And welcome to the Q2 2014 The Bancorp Inc. Earnings Conference Call. My name is Adrian, and I will be your operator for today. At this time, all participants are in listen-only mode. We will conduct a question-and-answer session toward the end of the conference. (Operator Instructions)

As a reminder, this call is being recorded for replay purposes. I would like turn the call over now to Andres Viroslav. Please go ahead.

Andres Viroslav

Thank you, Adrian. Good morning. And thank you for joining us today to review The Bancorp’s second quarter 2014 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 1:00 p.m. Eastern Time today. The dial-in for the replay is (888) 286-8010 with a confirmation code of 81705798.

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 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 maybe 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 Betsy Cohen. Betsy?

Betsy Cohen

Thank you, Andres, and thank you all for joining us today. I'm going to cover three major items in my introduction and overview today of credit issues, the impact of the BSA order since those are two of the drivers of our loss this quarter and the third will be capital/balance sheet management and the flexibility that we have with regard to that.

But before I start, addressing those three definitive issues, I would like to just remind us all, why we think as management and as the company that the long-term prospect of The Bancorp are significant and the works that we have done in the last 14 years has put us in a very good position as a long-term player in a very important field, despite what we hope to be short-term setback.

Over the 14 years that we have been in business, we have built a series of businesses. We first had the insight I think that community banks over the course of the years following our beginning were going to change, that consumer patterns were changing and that we needed to find the model for operating that with different (indiscernible) which had been in place before. I think, that has been recently supported by the fact that today community banks hold only 30% of the nation’s deposits, whereas they held 70% some 10 or 15 years ago.

So we were right in making that prediction. The way in which we choose was based on our insights and skill sets which were based on technology and we found ways to introduce programs in the areas of prepaid issuance, and Frank, will give you more metrics around these, just speak about.

And generally prepaid issuance where we have achieved the position of leadership by significant margin in that field, as well as in healthcare, debit issuance is HSA accounts, institutional, banking as we call it the SBLOC and deposits account, private label business.

And have taken the approach on a private label basis which has been our so focus and we hope and think that it is part of the reason that we have been successful in building substantial stable customers with rate retention over a long period of time. We think that this will put us in a position over the next several years of significant impact in our industry.

On the asset side, we have -- we began with what we thought is we new and which we are now -- an area in which we are experiencing loss, which is community banking with customers that we knew which we thought was in fact the appropriate approach.

Over the course of the last maybe eight to 10 years, we believe the community bank lending has in fact changed and so as we discussed over many calls, we had concerns about our community bank portfolio in terms of credit quality but we were shifting -- the shift, so to speak, to focus on a series of targeted lending opportunities, that we felt were more programmatic and have a lower risk profile.

And I will talk about the growth in this areas and our success in being able to do that in over time having the impact of those businesses which we have identified and built over the last several years, and those which we have in our side will in fact become more prominent.

Let me start with loans which caused a significant lost this quarter. We are -- we have been talking about over -- again over several calls and in certainly many other areas when we speak about credit, about the reassessment of our portfolio both internal and external.

We have been working at that very hard and continue to believe that we will have that completed within the third quarter and be able to provide to you a plan in conjunction with the end of the third quarter.

Net charge-offs for this quarter totaled $15 million, comprised of several large situation, which made up about $13 million of it. The first is a $6.4 million charge-off related to a series of receivables from the group of hospitals.

Having been unsuccessful in collecting those receivables, although, we continue to work at it and hope to be making progress. We felt it was important to write them all since we had met resistance in terms of the collection progress and so we did that this quarter.

We had wrote-off the balance of a loan against which we had reserved in the past, which related to a series of properties in Atlantic city where information as we were gathering it that the development plan which originally has being pursued was for municipal reasons no longer viable we charge that also as well.

The same reasoning apply to third property which again we had reserve, partially reserved again, where we decided that rather than pursue a sale, which we required us to do further support in terms of development that we would try to pursue a -- and we are pursuing and as is sale without that.

Of these $6.9 million of charge-off of the $15 million was not previously, so $7 million of the $15 million was not previously reserve, in other word look at it, $8 million of the $15 million was previously reserve.

But there was an additional impact which occurs from write-offs on the historical loss averages which added in access of $3 million to the reserve requirement and we classified new loans, non-equivalent the amount is approximately $3 million and substandard in the amount approximately $10 million, resulting in a reserve requirement of about $5 million. As a result of this we added $10 million beyond that which we had reserve.

But on the positive side of credit if we can find our way there, the growth in the targeted lending areas was significant. Growth in both SBA and SBLOC portfolios were 69% and 53%, respectively, leasing grew at more modest rate, I think we had a large payoff there, reducing the rate of growth to about 8% and those portfolios now approximate $750 million.

Invest net, excuse me, interest income with respect to those portfolios grew about a $1.7 million, but was offset by a $700 million -- excuse me, $700,000 decrease in interest income from the community bank portfolio -- for the was the balance of the community bank portfolio. Additional income was generated by investment income and so the total increase in interest income was $4.3 million over the second quarter of 2013.

On the prepaid side, there on the processing -- electronic processing side of the business. We have continued to increase during what we consider to be are least -- our quarter of least growth.

We continue to increase that income, Frank, will again give you a specific metrics. But some of the increase was offset by our intensified risk measures, which allowed us to or process to return a greater number of items than we otherwise would have on a normal basis, whether they will come back into earnings in item in other quarter, Frank will speak to in just a moment.

We are in the process of complying with the BSA order which was prescriptive in nature and spoke to the fact that we had grown our portfolio at a significant pace and that infrastructure to support that growth had not kept up it, probably, was something that -- was something that we were working on and that we had begin to build but not as quickly as would have been desired.

And so we are now in the process of investing in and that was the $9.2 million number represents services contracted for but estimated cost which we determine would be best to be look like it all in a single quarter, because the work will go on but the services have been contracted for.

Building out a substantial infrastructure, both electronic and human personnel base, we are building BSA center in Tampa, Florida. We hope to be in a position in January or February to invite you all to visit for an Investor Day there and to see the impact of both our new, what will be newly installed being completed, implementation of software together with our personnel whom we are gathering at that location for this purpose in a reorganization, which we think will give us better control over the BSA review issues and therefore, the allowed the policies and procedures, which we have in place to have a sharper execution. We have been, as we have said before, we have been addressing these issues but not at this case.

We have the third issue I would like to address is capital or balance sheet management when we filed or at the market offering or ATM offering. Many of you asked whether we would need new capital and I continue to say that I believe that we would not.

Part of the leasing is that we have enormous flexibility in our balance sheet. You can see just the beginning of that impact in this quarter as a result of pulling in a bit net interest margin moved on a year-to-year basis to 269 from 246 and on a linked-quarter basis to 269 from 230. Both of which are a result of the accordion nature of the investment portfolio as well as the reduction in excess deposits that we always experienced in the first quarter.

We think we have a number of tools in place to manage capital adequacy and appropriateness, deposit sales, runoff of short-term investment securities, loan sales, security sales, a whole range of tools that are in our tool box to which we added for, around precautionary thinking, the asset market offering because we wanted to have a full tool box in the events that we had made for its use.

Among the businesses that continues to add to our ongoing both interest income and non-interest income which is right on track today. And I didn’t mention if the CMBS business which is on track in terms of the continuing non-interest income that it generates and it upticked about $0.5 million over the 2013 quarter in terms of interest income. All of these new businesses and many of the businesses that have been in development are making their contributions.

The last new business that I’d like to mention in that regard is Europe which continues to make progress. We have customers ready to go live with us in the fourth quarter. We have spoken about before and that will enable us to have a run rate breakeven as opposed to a drag of somewhere -- supporting operations of somewhere between $1 million to $1.5 million a quarter.

So all of these elements that are -- that we’ve discussed before, regulatory risk, credit quality, investment in Europe and as a result of -- and the investment in infrastructure as well as the use of excess deposits being the deposit sale program. And so we’re now showing you that they all are coming together, hopefully to good effect in the third and fourth quarter.

I’d like to turn the call over to Frank Mastrangelo, who is going to put some metrics around the electronic processing businesses. Frank?

Frank Mastrangelo

Yeah. Thank you Betsy. And good morning everyone. The prepaid business continue to achieve relatively good growth, just 12% year-over-year increase in non-interest income as we talked about last quarter. We did see the typical seasonal rebound on the relationship between non-interest income and gross dollar volume bounce back to roughly 13 basis points and we should see continued strength there, we believe through the remainder of the year.

The businesses of course are impacted somewhat by the BSA orders that Betsy spoke about -- spoke about earlier. As we've discussed with, a number, you, the order itself impacts primarily three businesses prepaid with the majority of that -- majority of that impact.

Betsy touched on the one-time costs of about $9.2 million, which will -- we are charging this quarter. The ongoing incremental operating costs related to the investment in BSA infrastructure to allow us to continue to exercise the big lead we have in this particular area. It should be in the ballpark of $3.5 million annually. We believe that we’ll have just in organic growth in calendar year of 2015 more than 50% margin, actually on that incremental cost increase.

So we believe it’s an infrastructure investment that’s well worth making and that we will be able to leverage for continued growth in these areas. The lead we have in this particular business line is just in using prepaid alone, almost 2x our next nearest competitor. And when you overlay debit programs on top of that comes closer to 2.5 times.

So there is a significant opportunity for continued organic growth in these portfolios to not only pay for but achieve significant margin for these infrastructure investments that we’re making.

Betsy Cohen

Frank, did you want to discuss healthcare and attached with growth in those businesses as well.

Frank Mastrangelo

Yeah, sure. Absolutely, Betsy. So other businesses continue to achieve decent year-over-year growth rates. Our HSA business, Q2 is typically not the strong quarter for growth, Q1 and the Q4 are strong quarters area. We continue to add accounts. We continue to add non-interest income in that business. Our merchant processing business which both encompasses ACH origination and merchant acquiring grew 26% year-over-year.

All these businesses continue to be good contributors to low cost stable deposits. Do remember that from Q1 to Q2, we have seasonal runoff of deposits because of the big build-in tax refund processing in Q1 that rolls off with relatively significant velocity in Q2. Betsy mentioned the number of balance sheet management tools on top of that seasonality of deposits ledges the rebound of an increase in net interest margin in quarter and we do have many tools available to us to manage that.

But Betsy did touch us on the credit side for one moment, the focus lines of business leasing, the SBA business, the institutional banking business that generates the securities backed lines of credit generated north of $75 million in outstanding loans this particular quarter with very healthy year-over-year growth rates. We’ve got good traction in these businesses and the ability of course to absorb some of those excess deposits.

Betsy Cohen

Thank you, Frank. Some of you touching that for a moment on the BSA order, some of you have asked us how long we think the order will be outstanding and questions of that. So there are things that we do, in fact, control which is how fast we can move through our building of infrastructure which we've made tremendous progress, I believe.

And things that we cannot control with our decision-maker -- decisions made by others. And so we can tell you that we are doing as much as we can do as quickly as we can do it in order to being -- to put us out in the situation of our position in which we can one, submit a report for the review of our processes in certain areas and two, have in fact attested program.

We don't control the decision-making timeline. And so it would -- it would be -- I think, this in January for us to provide an estimate in terms of time. We just don't control it. And so we -- and I think the statistics or the averages that come out of how long does an order stay in place are really so order specific and bank specific, that it's really I think very, very hard to find a meaningful pattern.

We continue to do what we think are the things we should be doing in the marketplace, providing opportunity for us to be in contact with all of our customers, understanding their needs and touching them in ways that we think are helpful. We've gotten very positive response, we can tell you. We think that -- and may be I’ll pass this back to Frank for further information. The questions come out how much of the new product or new customer pipeline is affected by restrictions. And Frank I’ll just ask you to answer that and the question of how we need to -- growth needs of our existing customers.

Frank Mastrangelo

Sure. Absolutely, Betsy. So first of all, the order restricted us from signing new clients and launching new programs in certain businesses. The order itself was relatively unimpactful to our acquiring businesses as the restrictions really weren’t relevant to the drivers of our growth strategy in the merchant acquiring the business.

The prepaid business, the area that is primarily affected is reloadable -- General Purpose Reloadable Cards that comprises roughly 35% to our prepaid portfolio today. 65% of that portfolio which is benefit cards, gift, incentive, non-reloadable, some reloadable payroll, which was carved out and defined as -- defined as benefit are unrestricted and can continue to grow at the normal year-over-year growth rates. That 35% of the portfolio will likely grow organically at something close to the year-over-year national averages we believe.

Betsy Cohen

Thank you. I would now like to ask for questions.

Question-and-Answer Session

Operator

(Operator Instruction) The first question comes from William Wallace of Raymond James. Please go ahead.

William Wallace - Raymond James

Good morning Betsy and Frank.

Betsy Cohen

Good morning.

William Wallace - Raymond James

So Betsy as you look at the community bank portfolio, look like it’s about $1.3 billion right now. I know you’ve got, it’s sound like you got external review and internal review ongoing right now?

Betsy Cohen

Yeah, that’s correct.

William Wallace - Raymond James

Of the entire portfolio, correct?

Betsy Cohen

That’s correct. Well of that $1.3 billion.

William Wallace - Raymond James

Right .Yeah, so your expectation is that you’ll -- that will be completed some point this quarter and then you will tell us what your plan with that portfolio is when your report third quarter results or as soon as you determine?

Betsy Cohen

I would thinking that as soon as we make a decision, we will communicate that to you, but we want to have a firm plan in place.

William Wallace - Raymond James

Okay. And is the potential for the entire portfolio to be sold? Is that a potential that that would be considered?

Betsy Cohen

Probably not the entire portfolio, Willy, I would think that there are a few areas that might have some, I mean, for example, one to four family. Construction is now $38 million or $38 million to $40 million in approximation. But has some future funding, modest future funding needs in it rather than take a discount on future funding. We might keep that portfolio and just work it down as we have been.

So just by way of example, all portfolios are not the same. There are potentially a core customer base, a small -- very small core customer base that we might decide to retain. So we’re still looking at all the component.

William Wallace - Raymond James

Okay. And have you started to get any, I guess, feedback from the external review or will they wait till they’re entirely done to give you any report there?

Betsy Cohen

I think that we’re trying to wait until we’re entirely done, since it’s not such a long period of time. There maybe information that we get, which helped us with our thinking to our plan, obviously, but we won’t have it completed. We won’t have the plan completed until, probably, toward the end of the third quarter.

William Wallace - Raymond James

You said in your prepared remarks that you classified, I think, new sub-standards of about $10 million and now its $3 million into non-accrual? Was any of that as a result of…

Betsy Cohen

No.

William Wallace - Raymond James

… getting from external that was all from internal?

Betsy Cohen

Yes. That was all internal. Sorry, if I was unclear about that.

William Wallace - Raymond James

Okay. And then as we kind of think about the potential for moving some of the noise from a credit perspective out of the bank, I would expect that that if you were to do some sort of bulk loan sale, there would be a discount associated with that above whatever the potential credit mark would be? How do you think about what level of hit you're willing to take? You did say that you do not think there's any potential credit need but, I mean, capital need to fill any hole that might arise. But how would you think about weighing the decision to issue new capital to support moving a bulk sale of loans off your balance sheet versus ….

Betsy Cohen

I hear you and I know you’re asking about thinking and not about numbers. But I think until we have all the numbers it’s really hard to articulate the plan and that why I was differentiating the review from the plan and telling you that I thought that we could give you better information about that toward the end of the third quarter.

William Wallace - Raymond James

Okay. But you did say in your commentary that you don't think there's any need. There would be any need for capital.

Betsy Cohen

I said that, I believe that’s the case and I pointed out several balance sheet tools that we have from deposits sales to short-term rentals to et cetera to manage the size of the balance sheet.

William Wallace - Raymond James

Okay. And then so if we think about your -- maybe your capital ratios, maybe TCE or your leverage ratio, what’s the level that you -- that management is comfortable with and the regulators are comfortable with?

Betsy Cohen

We continue to, if you look at this quarter to be comfortable where we are and would anticipate meeting all the regulatory capital expectations that we've met in the past.

William Wallace - Raymond James

Okay. So if you were to move loans, you could -- you would manage the balance sheet through your other tools that you discussed around the 7.5% to 8% TCE ratio where you been in the past couple of quarters?

Betsy Cohen

Correct.

William Wallace - Raymond James

Okay. Okay. I'll hop off and let somebody else ask question.

Betsy Cohen

Thank you for your good questions, William.

William Wallace - Raymond James

Thank you, Betsy.

Operator

Your next question comes from the line of Frank Schiraldi of Sandler O’Neill. Please go ahead.

Frank Schiraldi - Sandler O’Neill

Good morning. Just want to ask about the internal loan review. I believe last quarter, Betsy, you said you’re about 90% of the way through and on the construction book about 95% of the way through. So just wondering -- it sound like that’s not completed yet. Is that right and then where you are in terms of maybe percentages at this point?

Betsy Cohen

I think that we are re-reviewing, Frank Schiraldi, we’re re-reviewing. We’re starting again from scratch and re-reviewing. So the whole process, I would think we’re about halfway through on the internal re-review and I don't know what the percentages on the external.

Frank Schiraldi - Sandler O’Neill

Okay. Can you just talk why the needs to go back and then rereview the stuff, if I think the internal review is certainly ongoing over the last couple of few quarters. So it seems like its fairly new appraisal, updated appraisals and the like. So what is the need to go back and do a second…

Betsy Cohen

We’re concerned that maybe we miss something. We’re concerned that maybe external factors -- external facts, in effect, have changed from our prior review. We're just trying to be thorough.

Frank Schiraldi - Sandler O’Neill

Okay. So…

Betsy Cohen

We don’t like -- we don’t want surprises for you and we don’t want them for ourselves. When we’re finished, we want to be finished.

Frank Schiraldi - Sandler O’Neill

So there is a way to characterize them as you went through. You completed the initial loan review. You’re going through a second time and can you kind of describe in this sort of second pass through, how much has -- is this the $10 million, it’s a classified and a $3 million, it’s a non-performing. Is that sort of the result of the second look through?

Betsy Cohen

I can't. I think that all that these reviews are not so easily divided into first and second. It’s an ongoing process. We’re taking -- going back and doing what I would recall lease grub, I think the $10 million in sub-standard is a result of ongoing factors, which caused increased weakness in that $10 million in loan. They could have been reviewed a year ago or two years ago and there could have been no indication of weakness, but loans are not static or dynamic, and circumstances are dynamic and something may have occurred in those loans in that $10 million, which caused a higher level of concern.

Frank Schiraldi - Sandler O’Neill

Right. So it wouldn’t be an issue of…

Betsy Cohen

Its not a difference in underwriting standards of that. I’m just trying to put is in a way that I think answers your question, although I may not be doing a good job, but its not a difference in underwriting standard, but a difference in the fact surrounding the particular transaction.

Frank Schiraldi - Sandler O’Neill

And you wouldn’t expect to see different appraisals at this point, right from the first …

Betsy Cohen

No, appraisals are done on an ongoing basis as loans either are renewed or extended. If there is a problem that we see from external information or a lower loan review rating and at the current certain event that would might indicate that appraised values, even those done a year ago, might be in jeopardy such as the large -- the loss of the large employer in the area there etcetera. They’re both external and internal.

Frank Schiraldi - Sandler O’Neill

But so the inflows into the quarter and to non-accrual was $3 million, is that right?

Betsy Cohen

That’s correct.

Frank Schiraldi - Sandler O’Neill

Okay. And then just on the charge-offs, the $7 million that you described that had not previously been reserved for. It sounded like that's more reflective of charges taken in credits that were already a non-accrual status, is that the case?

Betsy Cohen

Yes. But they had been -- the level of write-off had not been reserved for it.

Frank Schiraldi - Sandler O’Neill

Right. Okay. So and actually it sounds like there is just one really large group of receivables there, 6.4, right? That was already in non-accrual.

Betsy Cohen

Right.

Frank Schiraldi - Sandler O’Neill

Okay. And then…

Betsy Cohen

So we thought it was collectible when we determined from some external sources. When we had resistance there, then we wrote it off.

Frank Schiraldi - Sandler O’Neill

Okay. And just one question on the consent order and expenses from here. So I want to make sure I understand that. So it’s $9 million accrued upfront for consulting basically. And then that should falloff, I guess, completely next quarter, right. That just one-time in nature and then we’ll have this…

Betsy Cohen

We have contract -- yes, we have contracted for the services, which is why we took the charge, but they cover work that will be performed over time.

Frank Schiraldi - Sandler O’Neill

Okay. And I guess, it's possible certainly that there could be greater consulting fees needed. But do you feel in the short term here that this is the bulk of the one-time items associated with BSA?

Betsy Cohen

We do. There could be more, there could be less, but we’re trying, for example, to replace consultants by having our own personnel in place that takes time. It could go faster, it could go slower, so just by way of example.

Frank Schiraldi - Sandler O’Neill

Got you. And then could you just go through the -- just wondering what the total headcount is right now in the risk management compliance area? And where you believe that has to go to? Maybe where it is now and where it was -- let's say, not specific dates, but where it was a few years ago and where you think it has to go to?

Betsy Cohen

Well, I would just -- before I turn this over to either Frank or Paul, I would just say that you can see across the industry, the banking industry that there has been a growth in hires to support BSA function. In the newspaper you can read that JPMorgan is hiring 13,000 people and somebody else is hiring 7,000 people. We don’t have aspirations to that level nor do we have needs. But it’s certainly a trend in the industry.

As to the specific numbers currently and that may not be a helpful piece of information Frank, because I think that we’re in the process of building out the department. So it might be that the build out should be complete by the end of the third quarter. They’re giving you that information when we have the final build out would be more helpful. But I pass this to Frank or Paul.

Paul Frenkiel

Sure. I mean, I have some of the numbers related to this Betsy. Frank, let’s take a period, roughly a year ago, we had ballpark 25 people dedicated to BSA, though at that moment in time, I believe at the end of the process, the current plan which again may change. As we continue to build out the infrastructure here, we would have somewhere closer to 55 to 60 people probably in this area.

Primarily dedicate -- the primary ads dedicated to transactional monitoring and other like functions in the BSA area. Many of those new ads as Betsy noted being made in the market where there's significant talent available, trained by larger institution specific to this function.

Frank Schiraldi - Sandler O’Neill

Okay. So that sort of the entire risk management compliance and a big chunk of that is specific to the bank.

Paul Frenkiel

No, actually that’s all BSA. Our BSA team will be larger than virtually every other banks and prepaid team inclusive of all these other things. That is just our BSA function. That does not include compliance, third-party risk management, or those in the business lines themselves, because remember what we’re doing here is one of the changes that we’ve made is centralizing the BSA function and operation rather than having decentralized and insider business units.

So that’s allowed us to elevate the infrastructure and platforms and thinking around the function. The original theory was closer to the business line. They could be more intuitive about specific things in that business line. New structure completely centralized and the broad bank-wide view, end to end view.

Frank Schiraldi - Sandler O’Neill

All right, I will hop back up. Thank you.

Betsy Cohen

Thank you.

Operator

Your next question comes from the line of Matthew Kelley from Sterne Agee. Please go ahead.

Matthew Kelley - Sterne Agee

Hi, just to continue on the credit discussion here. So I am looking at $33 million of provisions year-to-date and $67 million of provisions since 2012. And so my question is, it sounds like a lot of the credits that you’re taking write-downs and that they are moving from performing to nonperforming are actually more reasoned. Is that true or are these charge-offs and provisions related to loans originated prior to 2010-2011?

Betsy Cohen

They are primarily, Matt loans, 2000 -- where credit decisions were made 2009 and backward. The loan is self made going on in 2010, but the credit decision was 2009 and backward.

Matthew Kelley - Sterne Agee

So if you go back to 2011 -- year end 2011, your community bank portfolio was $1.42 billion. And again over the last 10 quarters, you’ve now charged off $67 million. So you’ve written that down 5%. Can you give us a breakdown of where the carrying values are on your community back performing and your nonperforming community bank loans? We understand where you’re carrying those loans relative to unpaid principal balance. It’s been a 5% markdown on everything, given the fact it’s all legacy loans, but break it down between performing and nonperforming?

Betsy Cohen

Matt, I have to say that I don’t have those figures in front of me on the breakdown, but I will get them to you.

Matthew Kelley - Sterne Agee

Okay. All right. And then the $3.5 million increase in annual kind of ongoing expenses related to the order, how much of that is already in the 2Q run rate? Or how much build is coming to get to the $3.5 million left?

Betsy Cohen

I think that we believe that very little is in Q2 and that you will see this increase to that level over the next two quarters.

Matthew Kelley - Sterne Agee

Okay. And then the $9 million kind of the one-time charge related to consulting fees and legal, etcetera. Who exactly are you paying, like what types of consultants have you hired and what are they doing for you?

Betsy Cohen

I think they have a variety of expertise from infrastructure building, as we didn’t want to wait for analysis of the current infrastructure and infrastructure building. Since we didn’t want to wait for the staffing up of that to do this to the look-back provisions and the order because of different a big data skill set, I mean they have different skill sets. Frank, would you like to add to that?

Frank Mastrangelo

No, I think that’s absolutely right. I mean, part of it is sort of audit oversight function. There is, as Betsy mentioned, a firm that has a big data skill set. There is a lot of analytical skill necessary to look at the level of transactions that we process and hone in on behavioral patterns that fall out of norm, and there is just the overall framework of BSA. So, different firms in helping us with those various aspects of the remediation process.

Betsy Cohen

As we said before, certain of those things will be -- we will do at a lesser expense as we staff up, but we did not want to be Penny Wise and Pound Foolish so to speak and not accelerating the process because in the interim that would cost more.

Matthew Kelley - Sterne Agee

Got you. Now it’s a pretty quick timeframe, I mean the order came down mid June, so it’s been five or six weeks here to make the assessment, hire the people, sign the contracts. Were you planning to do a lot of that work before the order?

Betsy Cohen

Absolute, Matt, we said, and I think in our last call that we had been working on building the infrastructure and planning the building of the infrastructure. This accelerates the process. We might have done it over two to three periods. We didn’t have that luxury.

Matthew Kelley - Sterne Agee

Got you. How much of the $9 million is actually to buying and building on a new location in Tampa?

Betsy Cohen

Very little.

Matthew Kelley - Sterne Agee

The $9 million charge that happened this quarter that was going to happen even without the order.

Betsy Cohen

No, I think that some portion, yes and no. We would have needed help to look at and systematically build what we think will be the best-in-class BSA center. We would have needed help. We always need help doing that kind of thing. So a portion of it, would we have in order to implement, write the rules and implement the software, which will automate many of these functions, we may have needed the analytic work, but maybe not to the extent that we are doing it now.

Matthew Kelley - Sterne Agee

Okay. Got you. And then one last one, the $1.4 billion community bank portfolio, how does that break down between commercial real estate, C&I, single family, give us the breakdown of that commercial bank for us, the community bank portfolio?

Betsy Cohen

I think you have it in your information, Matt. I mean, if you wait a minute, I will get to it and I can reside it, but I think it’s in the press release, in material and in the last -- and nothing much has changed since the last 10-K -- the last 10-Q -- this is the 10-K, sorry.

Matthew Kelley - Sterne Agee

Right. But a lot of the commercial loans there, I assume are part of your ongoing, you have $480 million as a commercial loans, but that includes community banks, C&I loans, and the kind of the ongoing SBA?

Betsy Cohen

No, I think -- and Paul you might answer the categorization issue. We have assumed under the regulatory category of consumer loans. We may have subsumed SBLOC loans, but Paul do you want to talk to those categories?

Paul Frenkiel

Yes, sure. The SBLOC loans are actually in the consumer loan total in the press release income comprised the vast majority of those. The SBA loans, they are both in the commercial and commercial mortgage classifications, and we don’t actually report those -- break those out separately. Actually, this is first time I have ever got the question Matt, but I would be happy to get that to you.

Matthew Kelley - Sterne Agee

Okay.

Betsy Cohen

I think that’s right Matt. We aggregated the -- what we consider to be the targeted growth areas and gave you an aggregate number, which we thought was helpful.

Matthew Kelley - Sterne Agee

Okay. Thank you.

Operator

Your next call comes from the line of Frank Schiraldi of Sandler O’Neill. Please go ahead.

Frank Schiraldi - Sandler O’Neill

Hi, just one follow-up on prepaid fees year-over-year. So growth was 12%. We saw a similar growth last quarter, year-over-year and GDV’s obviously growth year-over-year is a lot higher. So it seemed thinner margins year-over-year both 1Q and 2Q. Just wondering where you anticipate margins could come in? I mean, should we assume now that we are in the back of the year and the tax business is fully out of sort of the numbers for 3Q? Should we assume that margins hold up year-over-year for 14 basis point margin in this quarter and so prepaid fee growth could better track GDV growth or how should we think about that?

Paul Frenkiel

Yeah, sure. I think it’s definitely safe assumption that the tax business has been -- is now being rung out of the prepaid business that the deposit runoff happens with pretty high velocity in Q2, or pass the impact of that through Q3, Q4 and will obviously spike back up in Q1. We did see normal seasonal rebound, not a strong as last year from Q1 to Q2 as you know. At the same time, there has always been movement in the relationship between non-interest income and GDV.

You look back over history the difference between the 13, we’ve traditionally averaged and let’s say the 15 peak that we’ve managed in certain quarters is related to non-interest income from non-transactional activity. Some of those third party services that we’ve overlaid on certain programs and fees we are doing or providing on an integrated basis. Those can be inconsistent from in any given quarter and that’s primarily the difference between what you see in this quarter 13 versus 15 last year. The margin on the transactional components has actually been relatively stable year-over-year.

Frank Schiraldi - Sandler O’Neill

Okay. So it sounds like maybe the 12% growth year-over-year for prepaid fee income is the reasonable place to be then going forward?

Paul Frenkiel

Yes. I think that’s a reasonable place, yes.

Frank Schiraldi - Sandler O’Neill

Okay. So would you characterize that at this point? It seems like that’s come down a bit. I know industry growth has come down as well off of as we’ve always know would. But is that sort of industry growth now? And I know there’s different measures, but what are your thoughts there, are you guys basically able to match industry growth at this point?

Paul Frenkiel

I think we are probably doing better than matching industry growth and I think industry growth is probably lower than it was expected this calendar year. I do still think that we are outperforming the general industry.

Frank Schiraldi - Sandler O’Neill

Okay. And then just finally, my last question was on the yields in the securities book. Look like yields ticked up pretty significantly and it looks like the muni securities book quarter-over-quarter come in correctly. So just wondered if you could maybe talk about what went to the book and what sort of average yields in 2Q?

Paul Frenkiel

Sure. We actually -- there are a couple reasons for the uptick in the yield. One reason is that we took advantage of some increases in yields in 8 to 12-year municipal securities. So we bought a modest amount of those and that helped out. And we also added -- or excuse me let lower yielding shorter municipals run off. So we’d placed longer, higher yielding and especially higher yielding since we’re fortunate enough to hit the market at the right time because we watch the market continually. So they contributed to that higher yield.

Frank Schiraldi - Sandler O’Neill

Okay. So basically an extending out of that portfolio then to a degree.

Paul Frenkiel

Yes. We have very, very low interest rate risk profile I would say one of the top among our peer groups, because we make -- in our loan portfolio we make either loans that we priced in clearly short periods and a very large percentage is variable rate. So we’ve never incurred a lot of interest rate risk, but occasionally and as part of our strategy we are -- we do want to protect ourselves in rate environments like this when rates are low. So we want to protect the margins and so forth, and so it’s a prudent thing to do.

Frank Schiraldi - Sandler O’Neill

Okay. Thank you.

Operator

Ma’am we have no more questions at this time. I would now like to hand the call over to Betsy for closing remarks.

Betsy Cohen

Thank you, Adrian. And thank all of you for as always your good questions, to which I hope you found the adequate answers. And we look forward to providing you additional information as we understand it and have it in hand, and welcome any further questions from you individually. Thank you again.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Good day.

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