The Bancorp's (TBBK) CEO Damian Kozlowski on Q1 2020 Results - Earnings Call Transcript

The Bancorp, Inc. (NASDAQ:TBBK) Q1 2020 Earnings Conference Call May 1, 2020 8:00 AM ET

Company Participants

Andres Viroslav - Director, IR

Damian Kozlowski - CEO

Paul Frenkiel - CFO

Conference Call Participants

Frank Schiraldi - Piper Sandler

William Wallace - Raymond James

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the Bancorp, Incorporated First Quarter 2020 Earnings Conference Call.

[Operator Instructions]. I would now like to hand the conference over to your speaker today, Andres Viroslav. Thank you. And please go ahead, sir.

Andres Viroslav

Thank you, operator. Good morning. And thank you for joining us today for the Bancorp's First Quarter 2020 Financial Results Conference Call. On the call with me today are Damian Kozlowski, Chief Executive Officer; and Paul Frenkiel, our Chief Financial Officer. This morning's call is being webcast on our website of www.thebankcorp.com. There will be a replay of the call beginning at approximately 12:00 p.m. Eastern Time today. The dial-in for the replay is 855-859-2056 with a confirmation code of 8676348.

Before I turn the call over to Damian, I'd like to remind everyone that when used in this conference call the words "believes," "anticipates," and "expect" are similar expressions are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to risks and uncertainties, which could cause actual results, performance, or achievements to differ materially from those anticipated or suggested by such statements. For further discussion of these risks and uncertainties please see the Bancorp's filings with the SEC. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as 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?

Damian Kozlowski

Thank you, Andres. Good morning. And thank you for joining us today. While we observe work from home and making sure our people are safe, we have continued to experience momentum in our core earnings regardless of the current COVID-19 developments. In the first quarter 2020, Bancorp earned $0.22 of share from both increased fee and spread revenue. Total loans increased 9% quarter-over-quarter and 31% year-over-year. Loan interest including loans held for sale increased 25% and 29% respectively.

Payment card gross dollar volume, GDV, increased 36% year-over-year while fees increased 15%. Expenses were down 2% year-over-year as our unit transaction costs drop with higher volumes resulting in increased efficiency.

Pre-tax income decreased 25% year-over-year, but excluding the gains and losses on loans originated for sale which vary with market conditions pre-tax income increased 79%. While the pandemic continues to be fast developing and could be prolonged, we've evaluated the impact of lower interest rates and potential lower business funds on our profitability for 2020. We believe that the previously announced $1.25 minimum earnings per share guidance for 2020 is still attainable, while $1.34 earnings per share has become less likely. Accordingly, the $1.25 earnings per share now constitutes our guidance for the full year 2020. We have removed the range of earnings performance and made the $1.25 our target.

There are some key developments in the first quarter that are worth noting. These events are listed in the earnings release. In addition, we continue to expand our key relationships and add additional business partners. In the first quarter, we announced an extension with Chime and the addition of SoFi to our client portfolio. We currently have 20 products in implementation in our cards franchise; expect to execute three to four new program contracts in the second quarter. Overall the Bancorp could choose to concentrate on its building of its payment ecosystem to support changes of financial services driven by FinTech digitalization in the gig economy.

We continue to make key payments investments and are making progress even in this turbulent time. In addition, our niche lending businesses are squarely focused on helping our clients during this dislocation and then long-term growth of what we have been traditionally lower credits -- lower risk credits in our lending lines. The base -- capital base is strong and we continue to closely monitor the fast developing situation and will advise of any changes to our earnings outlook.

I now turn the call over to Paul Frenkiel, our CFO, who will detail more about this first quarter.

Paul Frenkiel

Thank you, Damian. Excluding $5.2 million of unrealized losses related to CRE loans held for sale, first quarter pre-tax income was $22.7 million and the adjusted return on assets and equity for the quarter was 1.19% and 13.4%. Of the $5.2 million of unrealized losses, approximately $2.2 million resulted from hedges related to $44 million of fixed rate CRE loans held for sale. Substantially, all of that $2.2 million unrealized loss related to swaps maturing in December 2025 through December 2026. Thus, there remain five to over six years in which some of these losses might reverse should interest rates increase over that period.

The majority of the remaining $3 million of the unrealized loss resulted from estimated fair value adjustments to loans in the held for sale CRE portfolio, primarily for $58 million of hotel loans. These hotel loans may reflect an elevated risk compared to the rest of the $1.5 billion CRE portfolio, the vast majority of which consists of multi-family loans.

Expected cumulative losses for multi-family loans resulting from COVID are projected by nationally recognized analytics firm to be below 1%. These loans generally are on our books at $99 price net of fees and have weighted average floors in the 4.8% range. Please see the new tables for CRE loans in the press release, which provide a breakdown by loan type and other characteristics. If not sold, these loans will be retained as interest earning assets.

In addition to the $5.2 million of unrealized losses in continuing operations, there were approximately $819,000 of unrealized losses in discontinued operations. So there was a total of $6 billion in unrealized losses relating to fair value. Additionally, based upon economic uncertainty in the CECL model an additional $850,000 was added to the first quarter of 2020 loan loss provision bringing the total of unrealized loss to approximately $7 million. Those losses could reverse in the future, but if COVID related losses materialize the $7 million represents potential future offsets against such losses.

The approximate 4.8% weighted average floor on the CRE loans less the cost of funds estimated to have fallen below 0.4%, results in a spread of 4.4%. That significantly exceeds the 3.34% overall NIM in Q1. The $1.5 billion quarter and CRE loan total compares with $1.11 billion first quarter average and the 4.8% floor will have a full quarter impact on that higher balance in Q2.

The largest variable rate portfolio is the combined $1.2 billion S block and I block portfolio the yield for which is estimated at 2.3% after the -- at better reserve reductions compared to 3.5% for first quarter 2020.

Our participation in the Paycheck Protection Program is estimated to generate $200 million of fundings with an estimated $5.5 million earned as fees and interest, which we believe will be recognized primarily in the second quarter. Those estimates include both the first and second rounds of funding.

The Q1 2020 pre-tax income of $22.7 excluding the $5.2 million of unrealized losses compares to $12.7 million for Q1 2019 after adjusting that quarter for $10.8 million of net realized gains on a CRE securitization. The resulting $10 million increase in pre-tax income resulted primarily from an $8.8 million increase in net interest income, primarily due to higher loan balances. Average quarterly CRE loans approximately doubled to $1.1 billion and related interest income increased $5.6 million.

Interest on SBA loans increased $1.6 million, while interest on leases increased $1.2 million reflecting respective period end balance increases of 21% and 16%. While combined, S block and I block increased 46% over those periods, related interest income increased by less than $1 million reflecting the impact of 75 basis points of Federal Reserve interest rate reductions in 2019. S blocks are secured by marketable securities and I block are secured by the cash value of life insurance and losses have not been occurred -- incurred. Overall, cost of funds was $0.70 for the quarter and, as noted, is expected to decrease below 40.40% in second quarter 2020.

We implemented current expected credit loss, CECL, accounting as of January 1, 2020. As a result, we booked $2.6 million cumulative increase to the allowance for loan losses and $569,000 to other liabilities for unfunded commitments. The $3.2 million combined total of these items was offset through retained earnings, which was net of their future tax benefit.

The provision as determined through the CECL model resulted in $3.6 million provision for credit losses for the quarter ended March 31, 2020. Majority of the $3.6 million provision resulted from a higher provision for leases which had greater charge-offs during the quarter. Because S block and I block loans are respectively collateralized by marketable securities and cash value of a life insurance, management excludes those loans from the ratio of the allowance to total loans in its internal analysis. As adjusted, that ratio is 1.79%.

Prepaid accounts, our largest funding source, were also the primary driver of non-interest income. These and related income on prepaid cards were up 15% to $18.5 million in Q1 2020 compared to $16.2 million in Q1 2019.

Card payment and ACH processing fees include rapid funds revenue and decreased $457,000 to $1.8 million reflecting the exit of non-strategic high risk ACH customers.

Non-interest expense for the quarter was $38.9 million or 2% below the prior year and below the $40 million quarterly target discussed in prior calls. That reduction was driven primarily by lower salary expense which reflected lower incentive compensation expense. A significant portion of the Q1 2019 incentive compensation expense was related to the net $10.8 million realized gain on the loan sale in that quarter.

Book value per share increased to $8.69 compared to $8.52 at the prior year end, primarily reflecting first quarter earnings per share. The Q4 2019 consolidated leverage ratio, which is based upon average quarterly assets, was approximately 8.9% and risk base ratio is approximated 17%.

In closing, there are certain characteristics of our loan portfolio as shown in our new tables in the press release which I would like to highlight. As previously mentioned, the vast majority of our $1.5 billion of commercial loans held for sale are multi-family loans, which by a nationally recognized analytics firm have an expected cumulative loss rate of less than 1% in their COVID projections. Our next largest $1.2 billion loan portfolio consists of S block and I block loans, which have not incurred losses, notwithstanding the recent historic declines in equity markets.

Approximately half of the SBA loan portfolio is U.S. government guaranteed and the U.S. government is paying principal and interest on those loans for a six-month period. The majority of the other SBA loans consist of commercial mortgages with 50% to 60% origination date loan to value. For leases which experience credit issues, we have recourse to the lease vehicles. While there is uncertainty related to the future, we believe these are positive characteristics of our portfolio which demonstrate lower risk than other forms of lending.

That concludes my comments. And I'll turn it back to Damian.

Damian Kozlowski

Okay. Thanks a lot, Paul. We're going to open up for questions, operator.

Question-and-Answer Session

Operator

Thank you. [Operator Instructions]. And our first question comes from the line of Frank Schiraldi with Piper Sandler. Your line is now open.

Frank Schiraldi

Good morning, Kay.

Damian Kozlowski

Good morning, Frank.

Frank Schiraldi

First, I just wanted to get your thoughts on the held for sale book now that the deal didn't go through and you made your fair value mark. And it seems like you had a pretty nice deposit that you get to keep as well. Are you actively marketing this to sell? At this point -- is it wide open for these sort of sales at this point or you think it'll be at least on balance sheet for some time?

Damian Kozlowski

No, we'll keep it. We have not looked to sell for the next 90 days and then we're going to review how the market is at that time. There really isn't a lot being issued right now. So we're going to wait 90 days and see if the market firms up. We're getting -- we're still getting very good as we've disclosed. I think the last disclosure we made, there have been very little to date requests for deferrals or anything from the portfolio. So it's generally performing across the gamut. Early what we've seen in the marketplace, the collections are very strong especially in the markets that we're participating in. So there are -- it's early days though, we have to really see what happens in April and May, May especially and June. So we're just holding them for now and hopefully if the market gets better we will continue to do what we have done historically.

Frank Schiraldi

Okay. And then just in terms of credit, obviously areas like S block just sort of create a fortress balance sheet for a big portion of your loan book. Just curious if you could talk about where you see the greatest risks outside of that portfolio and outside of the $58 million I guess you mentioned in the hotel on the held for sale book? Is it the SBA book, is that the hotel portion within SBA or are those LTV is low enough where you feeling pretty good about that? Thanks.

Damian Kozlowski

Yes. Well, I think what you said is correct. I think where we don't have a government guarantee and we've got exposure to obvious assets that are dependent on the economy be open and things like travel. So the good part of that is it's very low exposure for us and the LTV like you said are low. We have not taken historically a lot of losses in the leasing area, which would -- I guess most people would focus on since it's card based, but the auctions are starting to open and we haven't taken losses during any other cycle, so that would be the second. My first would be the SBA unguaranteed portion, especially in hotels. Then it would be wait and see on the leasing, but then also the small amount of hotel exposure we have in the CRE securitization portfolio. The S black and I block was stressed substantially and it didn't even incur any losses recently. And obviously, the guaranteed portion of our loan portfolio from SBA is not a concern at all.

Frank Schiraldi

And when you think about the leasing book, you offer these deferrals I guess for 90 days. Do you expect to do a deeper dive or take a harder look after 90 days and maybe some of these things will take the leases -- the leased vehicles back or do you just assume that you probably offer another 90 days for a total of six months in deferrals at least?

Damian Kozlowski

Well, we're -- well, that's the guidance now from FASB to do the six months and when it be seen as a total debt restructuring. So we're going to follow the guidance like everyone else is. So if people need another deferral due to their businesses being shut down because of COVID, we definitely will do that. It's -- we're really not going to know probably for six months when those deferrals and if they're not extended again. So this is -- if there is credit events in the portfolio, that's probably going to be fourth quarter at the earliest or probably first quarter 2021 where you really start seeing that, not only us but other banks too.

Frank Schiraldi

Right. And then just finally for me. If you think about some of the new partnerships you put on obviously tremendous GDV growth in the first quarter, there's some questions about how the debit usage holds up in the second quarter with the economy shuttered, certainly shouldn't hold up better than credit I would think. And -- but trying to get your sense if you can in terms of your thoughts on GDV growth from here.

Damian Kozlowski

Yes. So –

Frank Schiraldi

I know it's just kind of a wildcard. Thanks.

Damian Kozlowski

Yes. It is kind of a wildcard. So one of the things that's in those, we started getting stimulus payments into our debit cards. So we had over $1 million stimulus payments and over $1.6 billion, you could see our funding. That impact on that funding has been very positive for us in the end of the first quarter and now in April.

What we're seeing, the only area that we've seen in the first quarter that was actually down was gift card. And in certain a couple of the rapid funds programs the growth was negative, right? One other was positive. I think it's just too early. If the economy reopens sooner rather than later it will be mitigated by that because I think people have money right now across, at least our deposit base that they need to spend on something and we're seeing the same things that other people are seeing there, it's on more of a necessity basis, not a lot of restaurants, et cetera. So the spend has shifted, but it hasn't slowed down yet like you'd expect and that's going into April. So we don't know. We do have a lot of programs and new products that are being implemented that might mitigate that too. Like I already said, there's 20 products we're implementing and we expect to sign three or four major programs in the second quarter, as well as -- for just example, SoFi is a good example where the volume is just starting to hit now from their program. So it looks like there's for the -- there looks like there's business litigants from new business and from things like the stimulus that will at least have an impact on the second if not the third quarter. And by the third quarter, hopefully the economy will be open again.

Frank Schiraldi

And then -- so those stimulus, those just came on to cards, I guess, that people had filed with the IRS. And is that $1.6 billon mostly --

Damian Kozlowski

Yes, that's all through -- yes, that was -- some of it was -- most of it was quarter one, it lagged into quarter two. There's probably another $300 million we were expecting in these type of deposits -- and we're actually getting checks now too. So that stimulus impact is going to carry through into the second quarter. But that was all like on a Chime card or anybody who has given a -- that account number that represented a Bancorp account when they filed their taxes it came onto our platform.

Frank Schiraldi

Right. Okay. And just the follow-up, I need on your comments about prepaid categories. You noted gift cards were really the only place where you saw weakness within prepaid. I know there's a lot of detail that you guys offered in the release which is great, but I don't know if you broke out types of prepaid. Can you talk about how big gift card as a total percentage about prepaid?

Damian Kozlowski

The total amount of gift card -- I'm not -- I don't know if Paul knows that statistic.

Paul Frenkiel

No. We actually don't. We've looked at that, Frank, in terms of giving detail, but because it can be specific information that's relatable to a certain third-party we're reluctant to release third-party information, so we don't we don't disclose that.

Frank Schiraldi

Okay. All right. That's all I have. Thanks, Kay.

Damian Kozlowski

Okay. Thank you very much, Frank.

Operator

Thank you. And the last question comes from the line of William Wallace with Raymond James. Your line is now open.

William Wallace

Thanks. Good morning, guys.

Paul Frenkiel

Good morning.

William Wallace

Maybe just as a quick follow-up to the last question. Is -- the gift card, just kind of anecdotally do you feel is it 50% of the business or is it bigger --

Damian Kozlowski

No, it's hard. No, no, no. We don't give that out, but it's less than 50%. It's far less than that.

William Wallace

Okay. So you kept your -- you kept the low end of your guidance intact, which is maybe a bold move given the uncertainty. I'm curious if you could just talk a little bit about the confidence that you have and the visibility to your ability to achieve the target and then maybe if you'd help us with some of the moving parts to get you there?

Damian Kozlowski

So what we did was we ran -- we did what we're supposed to do. So we looked at the situation and then we ran the numbers a bunch of different ways whether we securitize loans, if we don't, if we get growth in certain areas. Of course the impact of interest rates at a very low level and we ran it with our new outlook for expense growth. And things like the payment protection loans fees that would come in and we became comfortable with the $1.25. So we ran it enough times in different scenarios to think that $1.25 is a reasonable target to continue with the bank. So it's not one thing, we ran it a whole bunch of different ways with different things being down and up based on our assumptions and we kept on coming in that range. So we decided it is a little bold I guess. I guess it's easy just to throw up your hands and say we don't know what's going to happen. But we think we have a responsibility to investors to say that what we really think is going to happen if we have put in guidance out there.

We don't know about the credit shock that might occur to all the financial services industry, but there seems to be, that's why we have reserves and that's why we've implemented CECL. So we can't second guess that either, that's obviously there for a reason. So it seems we can't just say we'll screw up our heads and say that, oh, our reserve and CECL that is all doesn't matter because there might be some event in the future, well that's always true. So we try to give the best guidance we could and we did it through doing the model over and over again with different scenarios around product seg growth. With not one, like we were more deterministic I would say in our $1.25 to $1.34 guidance where we -- in our presentation, which will be updated on our website gave real targets for each of the businesses. The $1.25 comes out of us looking at all the different possible outcomes, that's how we became comfortable with the $1.25.

William Wallace

Okay. Thanks. That's interesting. It's an interesting approach. Maybe hope. Is there a balance sheet growth expectations in that on the -- in the loan portfolio growth I should say that you would've hit very hard --

Paul Frenkiel

There are some, yes. Yes. Yes, there are some, but we've ratcheted them down from where they were for this -- for the original target of $1.34. So they are in there, but they're lower. And as Damian would add --

Damian Kozlowski

Yeah.

Paul Frenkiel

Yes. Go ahead.

Damian Kozlowski

Okay. No. And while it was things like the I block and S block portfolio where we're still seeing very good growth. So people are looking at their securities and they need liquidity. So we're having very good pipeline in certain areas of the business. So no, it's lower spread than say our leasing business where we don't expect as much growth, so we've ratcheted down those forecasts. And we've -- when we were modeling this we took some things down to zero just because it's easy to think that look nobody is going to be refinancing right now and you've got a six months deferral, so it's easy to think that you're not going to have a lot of prepayment. So you've got probably a lot of asset stability, so you really take a hard look at each product line and look at the pipeline and see how reasonable it is and what the renewed growth rate would be.

William Wallace

Okay. And so -- and it sounds like maybe you said it in your prepared remarks I apologize I got on a little bit late. Did you give some commentary around the expense expectation?

Damian Kozlowski

Yeah. Well, right now we're -- its right around this level, the -- we're at $38.5 million or so in the first quarter. That's where we expect kind of the stay until the situation improves, so the second quarter looks similar. And then -- well, it will depend on how the world opens up for business. And once again we have a lot of or at least enough tied to the revenue in the business, so we're going to maintain that 10% between revenue and expense growth. Right now it seems like the expenses are going to stay at this level until revenue growth would improve.

William Wallace

Okay. Great. In the CMBS business, are you -- have you continued to CECL all originations and underwriting, are you kind of continuing to underwrite but waiting to see if the market opens? Can you just talk a little bit about what you're doing with that business now?

Damian Kozlowski

Yes. So there was a tail end of transactions once we were -- it was clear that we weren't -- the loans weren't going to be sold. And we dramatically changed the terms. So there was about $75 million, I think we're down to about $35 million now of transactions that we committed to prior to the loan sales not going through, but they're substantially different, they're lower LTV and they have a one-year reserve in them. So they are extremely -- if I could do $1 billion of those loans I would love to, but we obviously have to -- too much CRE has a proportion right now to do that. We wouldn't put $1 billion on these, we wouldn't want to go over 300% of capital. But they're extremely attractive loans now and we're just finishing a few left from previous commitments. Many have just dropped out from it, so a lot of deals just died. And then with our new terms, which are pretty restrictive, if you're going to have to put up a year reserve debt and principal -- principal and interest reserve that's very difficult to do.

William Wallace

Okay. And then -- so you said you're going to review the market and you'll revisit the market in 90 days and see if it's opened back up. Is there a point where if the market remains closed that these loans become too old or seasoned to sell and you just have to make the decision to move them into the held for investment portfolio? And if so, what would the CECL reserve be as of today that you'd have to put on those?

Damian Kozlowski

Well, the first -- and to securitize, yes. So the -- if you're going to securitize the loans if they go past six, nine months you're probably not going to securitize those loans though there is still a market for those loans. So that doesn't mean you can't sell it to an institutional investor like an insurance company that wants that kind of exposure. So the loan -- the securitized, yes, the loan sale, no. Of course we were selling the loans for someone else to securitize in the last transaction. So in that case, that would also preclude that loan sale. But there are other investors who would want to buy loans.

The -- and what was the second part? I'm sorry.

Paul Frenkiel

Yes. I can answer this. I can answer the second part. It was on the loan loss reserve implication.

Damian Kozlowski

Oh, okay. Yes. That seems -- that's something you anyway.

Paul Frenkiel

Yes. So you would actually retain the fair value accounting regardless of where you hold and you can't switch that. And bear in mind that we own those loans net of fees at $99. So I don't think it's -- that would be an issue and we have the -- we don't have significant loss experience for those loans for the multi-family families which comprised the vast majority of the portfolio. So I don't believe that's going to be an issue.

William Wallace

So the $5 million loss that you booked this quarter, you think would basically cover -- with cover, you don't think that' be more prudent.

Paul Frenkiel

No, we don't predict as if -- what I'm basing it off of is virtual -- aside from the $58 million and a small other, so there's a little bit of retail and a small other tail with which we have disclosed in the tables, the vast majority is multi-family. Multi-family even in COVID according to the analytics firm that we use will have less than 1% cumulative losses. So it doesn't appear that there's going to be an issue there.

William Wallace

Okay. And then the $12.5 million -- the last question I have on this portfolio. The $12.5 million deposit, how you said you book it based on accounting standards? Nut can you tell us how that works?

Paul Frenkiel

Yeah. We can't really comment. That was a legal disclosure, so we -- the only comment we can have is what's in the press release.

William Wallace

Okay.

Damian Kozlowski

As always just to be clear, that $12.5 million is not in our $1.25 guidance.

William Wallace

Okay. Thank you.

Damian Kozlowski

I think that's why you're probably into that.

William Wallace

Okay. Well, and I was just curious if you were going like look at through fee income over a year or two and then it would be a booster or not. So thank you. That's helpful.

Last question. Can you update, I believe last quarter you said there was -- the regulators were coming in and you felt like you had checked all the boxes as it relates to the consent order. Can you give us an update on where you stand? I know obviously the world has changed since then. So any update you can help us to think about the consent order and the restrictions et cetera would help?

Damian Kozlowski

If you can imagine the world has changed dramatically and we're not the bank that the regulators are concerned about, so maybe we're not such a priority as we maybe used to be. But we still expect, as we said before that we are in full -- we believe we are in full compliance. And we expect hopefully that the -- our regulators will agree with our assessment and very soon will -- you'll acknowledge that. We think that will happen in a fairly short period.

William Wallace

Okay. Yes. So they did come in and do their review I don't know if it's an annual or a...?

Damian Kozlowski

Yes, they did come in.

William Wallace

Okay. Yes, okay.

Damian Kozlowski

I can't speak more on that, that's all I can really say --

William Wallace

Understand. Understand. Thank you. Okay. I -- it sound like there's nobody else to ask questions, but I've probably kind of asked enough so I'll step out. Thanks guys.

Operator

Thank you. And this does conclude today's question and answer session. I would now like to turn the call back to Damian Kozlowski for closing remarks.

Damian Kozlowski

Okay. Thank you everyone. We appreciate you being on the earnings call today. Be safe of course, that's most important I think obviously in these very interesting times. And we'll talk soon. Thank you, operator.

Operator

Thank you. Ladies and gentlemen this concludes today's conference call. Thank you for participating. And you may now disconnect.