Bancorp (TBBK) Q1 2023 earnings call transcript

Thank you, Operator. Good morning, and thank you for joining us today for the Bancorp's first quarter 2023 financial results conference call. On the call with me today are Damian Kozlowski, Chief Executive Officer, and Paul Frankel, our Chief Financial Officer. This morning's call is being webcast on our website at www. thebankcorp. com. There will be a replay of the call available via webcast on our website beginning at approximately 12 p. m. Eastern Time today. The dial in for the replay is 1-877-674-7070 with a confirmation code of 423-750.

Before I turn the call over to Damien, 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. I'm going to turn the call over to management for the Bancorp.

Now I would like to turn the call over to the Bancorp's Chief Executive Officer, Damian Kozlowski. Damian? Thank you, Andres. The Bancorp earned 88 cents a share on 47% revenue growth and 25% expense growth. Net income grew 70% year-over-year. ROE for the first quarter was 28% versus 18% in the first quarter of 22. ROA for the first quarter was 2.6 versus 1.6 in the first quarter of 22. GDV growth was 19% year-over-year. Fintech Solutions fee growth was 24% year-over-year. NIM expanded quarter-over-quarter from 421 to 467. Efficiency ratio remained at 42% quarter-over-quarter, and loan growth, excluding loans held for sale, was 29% year-over-year, with a slight 2% decrease quarter-over-quarter, reflecting the steep increase in client borrowing costs.

The recent dislocation of the banking market did not materially impact our company. With granular deposits spread across more than 130 million insured small accounts through our fintech ecosystem, a lower risk variable rate and short duration credit book, and significant liquidity and borrowing capacity, TBBK was well-possessioned to manage the increased volatility in the beginning of 23. Over the last three years plus, we have purposely and methodically built a platform that would benefit from rising rates and rigorously protect our company from an interest rate shock or systemic event risk created from a banking system dislocation. We have included two new schedules in our earnings release. The first is more detail on our deposit base that has an overwhelming majority of insured and low balance stored value card accounts, and the second is a review of our significant borrowing capacity.

The first quarter significantly surpassed our expectations in ROE, ROA, GDV growth, fintech solutions fee growth, NIM efficiency ratio, net income growth, and EPS. Indications are that continued financial momentum will result in further improved metrics in 2023. Moreover, other potentially positive tailwinds that might additionally improve performance in 2023. Number one, above-trend payments GDV growth for more than 15%. Two, a Fed fund's rate above 5%. Three, increased NIM performance due to slower loan growth versus higher deposit growth. And four, purchase of agency, treasury, and other securities which have not been included in our forecast. We have not purchased significant long-term fixed-rate securities since 2018. Due to these factors in our first quarter performance, we are raising guidance from $320 a share to $360 a share, without including the impact of share buybacks of $25 million per quarter for 2023.

I now turn the call over to Paul Frankel, our CFO, for more on the first quarter.

Thank you, Damian. Before reviewing quarterly results, I would like to comment on the low-risk liquidity profile of Bancorp. As Damian noted, the bank's deposit base is largely comprised of small balance accounts. Notwithstanding the corresponding unrealistic risks that our small depositors withdraw their funds in a short window, Bancorp exceeds potential liquidity needs by maintaining lines of credit with the Federal Home Loan Bank and the Federal Reserve Bank of approximately 3.3%. Bancorp's line with the Federal Home Loan Bank is collateralized by its apartment building loans as residential collateral is mandated by that agency's charter. The Federal Reserve Bank also has collateral requirements which Bancorp must satisfy for its line of credit with them. Additionally, Bancorp has access to significant other institutional liquidity which it periodically tests.

Bancorp has also maintained a low interest rate risk profile and The Bancorp emphasized variable rate assets with policy mandated risk limits. As a result of its variable rate loans and securities, Bancorp benefited from the higher rates this quarter, and that resulted in the increases in return on assets and equity to 2.6% and 28%. These increases were significantly driven by a 62% increase in net interest income. In addition to the rate sensitivity of the majority of our lending lines of business, management has structured the balance sheet to benefit from a more normalized and higher interest rate environment. Accordingly, over a period of years, it has largely allowed its fixed rate investment portfolio to pay down, while limited purchases were focused on variable rate instruments.

Additionally, the rates on the majority of loans adjust more fully than deposits to Federal Reserve rate changes. Accordingly, in Q1 2023, the yield on interest-earning assets had increased to 6.6%, while the cost of deposits had increased to 2.1%. Those factors were also reflected in the 4.7% NIM in Q1 2023, which represented another increase over prior periods. The provision for credit losses was $1.9 million in Q4 2023 compared to $1.5 million in Q1 2022. Of the $1.9 million, approximately $1.3 million resulted from the impact of historical net charge-offs applied to the estimated remaining lives of outstanding loans. The balance of the $1.9 million resulted primarily from first quarter charge-offs. Additionally, a million dollar charge against a movie theater property and other real estate owned was recognized in other non-interest expense.

Prepaid debit and other payment related accounts are our largest funding source and primary driver of non income Total fees and other payments income of million in Q1 2023 increased 24 compared to Q1 2022 and 14 after eliminating million termination fee and of income related to fourth quarter 2022 Non-interest expense for Q1 2023 was $48 million, which was 25% higher than Q1 2022. The majority of the increase resulted from salary expense, which also increased 25%, and which reflected higher numbers of staff in financial crimes, compliance, and information technology. Staffing increases reflected increases in deposit transaction volume and the development of new products. The increase also reflected higher stock compensation expense as a result of a focus on stock ownership.

Book value per share quarter end increased 15% to $13.11 compared to $11.41 a year earlier, reflecting retained earnings partially offset by fair value adjustments to the investment portfolio resulting from the higher rate environment. Quarterly share repurchases should continue to reduce shares outstanding. I will now turn the call back to Damian.

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

Morning, David. Maybe let's start with GDV. Great to see the growth in the quarter, and I know it can be really hard to dissect, but can you just maybe talk about some of the drivers of that and what you're seeing? You talked in the deck about growth at both existing clients and in addition to new clients last year that are scaling up. Just curious, maybe the attribution between the two, and just any thoughts on GDV growth going forward as you look into your crystal ball?

It's been very broad-based across, you know, not only from neobanks, but in healthcare, government, and new products in the corporate payment space. So it was surprisingly robust, above trend, when you get past that 15%, as I mentioned, but it's not concentrated in one area. So we're very pleased with the broad-based nature of it, but also the new product sets and things like corporate payments have surpassed our expectations.

That's great. And then maybe just kind of following on, you know, just given the volatility in the market, I would probably think this pushes more clients to you, just given the scale and stability of your platform. I know you've always got a lot of clients that are looking to join, but have you seen any shift in kind of the pulse of the market or change in the increases in the pipeline? And maybe just how do you think about the pace of new client ads this year? So, we've had a very robust and steady pipeline for the last three years, you know, and we haven't seen any real change. As we mentioned before, there's many companies that come to us that we don't implement, and they go to one of our competitors, because they're not of the size of the maturity level to really take advantage of our ecosystem.

And so we don't add those partners to it until they mature somewhere else. But it's been very stable. It's been very broad-based. It's, you know, development of new areas and new product sets within our existing clients. We think the double-digit GDV growth is well-supported, and we have pretty good visibility for the next 18 to 24 months, a lot of stability.

And we don't, as you know, our partners, once they're here, to stop using us takes at least a year, but multiple years if they're going to leave. So we have a lot of visibility and stability in the portfolio and in the pipeline. Okay. And then maybe just touching on the loan portfolio for a second, and specifically, you know, within the bridge, the real estate bridge, obviously there's a hyper focus on CRE. I appreciate the color and the slide deck on the segment, but I'm just curious, what are you seeing, you know, in this segment? Obviously, you've got strong underwriting standards, but as you look broadly, just curious, your thoughts on that segment, and then maybe any color on what drove the S-block and I-block declines in the quarter.

Was that just market volatility or any other trends you're seeing there? Yeah, well, the CRE is extremely stable. Now, the whole market has slowed down because there's been a huge repricing, obviously, because of the rise of interest rates. Our underwriting standards have not changed. We have interest rate caps on all the loans and floors, and many times reserves. So we haven't had any dislocation whatsoever in that portfolio. And we've had a lot of the wind down of the old portfolio, and people have been finding financing, takeout financing. So we haven't had any, I can't really respond other than it's slowed down a bit. I think that'll pick up once you have, you stop having the steep curve in interest rates.

But we have nothing to report really. On the S-Block side, that's about price sensitivity. So we had a lot of price-sensitive clients. You had the historic interest rate rise, and people simply got a little sticker shock. We've seen that slow down, though, substantially in moderating. And we expect our pipeline has been growing this month in the S-block and I-block side. So we expect it to get more normal for the same reasons with the interest rate as the interest rates top out. So we're not concerned by that at all. We just got more liquidity from that business, and that went into, obviously, Fed funds at 475. So it didn't really have an impact. It didn't really have an impact.

And we want to have excess cash because we ultimately will lock in and buy fixed rate securities when the time is right. So we're, we were, I think that's going to slow down a lot. And, you know, over this quarter and the next quarter, there won't be as many paydowns. And even if there was paydowns, it's not going to have a big impact on our financials.

Morning, Frank. Just a follow-up on the loan book, the F-block, so, Damon, you talked about a stronger pipeline there. Is it still probably in the near-term sort of net paydowns, do you think, or do you think it more stable that business at these levels Well what we seen up this month is that there stability returning So and the pipeline been growing It just that they were so steep the interest rate increases over such a short period of time people you know opening their getting their what they had to pay for their coupon all of a sudden radically changed their perception of maybe borrowing against securities and insurance But it's been stabilizing this month, so it should moderate a lot.

And once again, I don't think it'll be anywhere near as high as it was in the first quarter, right? It'd be more towards the flat side. I can't be sure of that, but it'll be more towards the flat side. And even if we did have pay down, say, half as much as we did in the first quarter, once again, that would just go into our cash position, and it would be at 5% or 5.25 at Fed funds.

Yeah, Frank, I think that we do have some room, extra room there, because the loans we're making now are apartment building loans. And if you recall, when COVID was an issue, we actually cited the company, the consultants that went back, all the way back to the Great Depression, and documented that the type of lending that we do is one of the safest forms of lending that we can do. So we're confident we can increase that and have a measurable effect on the balance sheet.

Yeah, and remember that generally it's 300% of capital. We're going to keep that book, but there is a lot of ways we can recycle those loans. We're not going to do CLO-type structures like we've done in the past, but there's a very large market for those type of loans to recycle, and we would take gain in fees for anything that we thought was in excess of that. So we've got room, and obviously our capital is growing. Even with our buyback, our capital is growing significantly this year. So we do have room. Okay, and then just lastly, with the forward curve, you know, sort of implying that we're near peak of Fed funds and implying, I mean, we'll see what happens, but implying that we get down, you know, significantly in rates in terms of Fed funds in 2024.

I know you have floors in these multifamily loans that protect you on the way down. Can you give any, you know, any sort of detail on other hedges you might have on the portfolio or, you know, what your expectations are for the NIM, given a, you know, let's say a 25 basis point contraction in Fed funds?

Yes, so as you saw in our mix is shifting every day now. So we're putting out fixed rate exposure, excluding the bonds in all our programs at a greater rate. And the new CRE loans obviously have very high floors on them, right? So we're getting less asset sensitive by the day. And if we have normalized rates over the next 18 months in the 4-plus range, really we'll lock in a lot of, get rid of a lot of that asset sensitivity just through the loans that we're doing. Now, if we add to that a substantial purchase and fixed rate bonds, obviously as we top out our rates and they start to cut, the yield curve will disinvert, hopefully.

And then that's when we'll start the purchase program of fixed rate securities, and that should really mitigate any downside. Our base case is that rates are not going to go far below, you don't know this, but far below, say, in the 3.5% range for the foreseeable future. If they do, of course, more of the floors kick in in the loans, and way before that, we'll buy a substantial amount of, We have just so much more flexibility than probably the average bank just because we have such a big part of our balance sheet that has not been invested in long-term security. So it's kind of the opposite. It is the opposite situation of where all the problems are in banking.

Obviously, we didn't do any of that. So now we can take full advantage of higher long-term rates, especially if the view and yield curve changes, and we'll lock those rates in.

Yes. We can't be sure, but I think we're going to be able to stay. It totally depends on the Fed net overreacting to things and going back to zero interest rates, even though we were at zero interest rates and we were making a 90% ROE, too. So I think if you have any kind of normal situation and we get normal Fed fund rates and they're in the – this is very sustainable. And if we have a little bit of time, we're going to get far less asset sensitive. We did this in 2018. We got far less asset sensitive just at the right time. And I think we've left ourselves immense flexibility to be able to lock in, you know, long-term fixed rates in the portfolios.

Well, usually that's the best time, but we'll start when we feel, and we're looking at this on a daily basis, we're looking at and have a lot of advisors on this and looking, obviously, at all the market color, but we don't have to do panic buying because we've got a lot of flexibility. So we can see how it plays out, the interest rates on a long – we have to see inflation numbers. There's some this morning, probably in a few minutes. And we're just going to watch it. We have so much room, we could easily buy $1.5, $2 billion of fixed-rate securities at a much higher rate than, obviously, our peer group. And we going to constantly watch it and then start nibbling when we think the time is right and then fully allocate that part of the balance sheet in order to mitigate our variable rate exposure on some of our other assets like our institutional business And once again there variable parts of our portfolio that aren really variable because they have floors like the CRE loans So we in a very good position and we going to remain flexible like we did before and take full advantage of our current balance sheet position And it's much easier, obviously, in a higher interest rate to trade for fixed versus variable than it is the other way around, as we all learned, obviously.

So we're watching everything. We're going to continue to put on loans that are fixed rate. Every day our asset sensitivity goes down and we get the benefits of much higher rates on the loan side. We haven't changed any of our standards on underwriting. Some people have. We have not, and that will, over the next year, especially if rates don't have a drastic change, we should be able to navigate it and maintain our NIM.

Well, you're going to, yes. So there's still some lag, as we've discussed before. Our funding costs adjust immediately, and then it takes up to 90 days or more for our, to fully adjust in our variable rate loan book. So you're still having a wave of adjustments come through the system. Plus, every loan we put on, I think people in the marketplace see that our loans are even a pricing above 100% of the increase, and that's because we're putting on, which is really strange to get that kind of bump in the revenue numbers, but we're getting over 100% in the loan book because we're putting on these much higher rate assets that are fixed. So yeah, it should continue to expand for those two reasons.

Yes. Okay, great.

Yeah, it'll be around 40%, but it could drop below that, obviously, because of the revenue growth.

But go ahead, Paul. Yes, so the expenses, the non-interest expense was driven largely by number of employees and staff additions in terms of salary expense. Other expenses also increased. Those were volume driven, volume driven by new customers, new accounts, the transaction, the increase in GDV and other transactions. We expect that some of those expenses will moderate. There was some catch-up expense in terms of number of employees, but we have very good prospects. We have really good growth, and there has to be some anticipatory hires, so we're looking at new products. We want to be fully staffed, and we need to be fully staffed for compliance reasons, for financial crime support, and so forth. So we see the bank continuing to grow at least at double-digit rates, and so we're staffing up for that.

Yeah, and remember, we had, yes, but remember, there's some real core inflation in the economy, too, which hit us. So, you know, we made salary adjustments for our employees. We've changed grades. It's a good sign that attrition is down across the industry. Ours is about half of what the industry is, and we have incredible stability in our top 70 to 100 employees. We had virtually no attrition in that group of individuals.

But that adds to it, you know. So, you know, we'll see what happens with core inflation, how that affects employee costs and stuff. But, you know, we definitely see a moderation, I think, Paul, right?

We'll definitely see a moderation. I think we'll still have, as Damien said, we had some inflation adjustments to our salary structure. So you'll still see some elevated increases compared to the prior year. But over the next year or so, it should moderate when we have more fully staffed up, which we need to do.

Yeah, but we're investing a lot. I mean, from our whole tech stack to how we use the cloud to across our entire portfolio, putting new systems, you know, the best systems there are for things like ACH, et cetera. Those investments have been happening continuously for the last five. That's why we have our position in the marketplace, because we really have built a substantially robust infrastructure and ecosystem across not only the tech aspects of it, but all the compliance, third-party risk, oversight. All those things are incredibly important for the programs that are our partners.

Ongoing. The tax accounting is a little bit confusing, and I won't go into the details here. We do talk about it in our 10Q and so forth, but I think for your models, the normal historical rate of around 26% is closer to an annualized rate.

Okay, thanks, Tim. Thank you.

Mr. Kozlowski, please go ahead. Thank you for joining us today. We really appreciate it, and we'll talk soon.