Bancorp (TBBK) Q2 2023 earnings call transcript

Thank you, Operator. Good morning, and thank you for joining us today for the Bancorp's second 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 720-317.

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. 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. Inc. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Bancorp undertakes no obligation to publicly release the results of any revisions to forward-looking statements, which may be made to reflect events or circumstances after the date hereof, or to reflect the occurrence of unanticipated events.

Now I'd like to turn the call over to the Bancorp's Chief Executive Officer, Damian Kozlowski. Damian?

Thank you, Andres. Good morning, everyone. The Bancorp made 89 cents a share on 41% revenue growth and 17% expense growth. ROE was 27% and ROA was 2.6%. Core loan growth quarter-over-quarter reflected a reduction of 8% in institutional lending and respective increases of 2% and 4% for small business, commercial, and real estate bridge lending businesses, which also show 10% and 65% growth year-over-year, respectively. NIM increased to 483 from 467 quarter over quarter and 317 year over year.

Groves dollar volume growth in our fintech solutions payments business was 15%. Continued strong growth across verticals with only general purpose reloadables showing a decline. New corporate payment programs continue to show growth significantly above expectations. The Bancorp continues to be well positioned in the current environment. Our balance sheet flexibility, lower credit risk, and high level of core insured deposits support continued improvements in profitability, regardless of potential dislocations or weakening economic conditions. While the sharp increase in the Fed funds rate affected our growth in loans, this impact was mostly fell on our institutional business, which is comprised of our S-block and I-block variable rate consumer loans.

Long-term historical growth trends seem to be normalizing, and pipelines across our businesses are increasing. Our fintech solutions business continues to show strength, supported by current programs, the addition of new products, and the implementation of new partners. Due to significant implementation times that can last 18 to 24 months, we have good visibility on the potential growth in 2024. Our current estimate is that we will have above-trend GDV growth in 2024 of more than 15%. Key areas of growth are neobanks, healthcare, and new corporate payment programs. In addition, we continue to strengthen our relationships with our key members of our ecosystem and recently signed a long-term extension and expansion of our partnership with Chime. We continue to invest a lot of time and energy across our company in the development of new products and services, especially expansion of fee businesses and the monetization of our core capabilities.

As we approach the Reg. II. Durbin amendment restriction on our balance sheet size of $10 billion, we believe we can significantly grow the business without needing additional balance sheet above that limit.

Lastly, with continued strong business momentum and a favorable balance sheet position, we are confirming our 23 guidance of 360 a share without the impact of anticipated stock buybacks of approximately $25 million per quarter. In the third quarter earnings release, we will give both preliminary guidance for 2024 and indications of our buybacks for next year. And now, turn the call over to Paul Frankel, our CFO, for more color on the second quarter.

Thank you, Damien. As a result of its variable rate loans and securities, Bancorp continues to benefit from the cumulative impact of Federal Reserve rate increases. That factor was the primary driver in increases in return on assets and equity for Q2 2023, which were respectively 2.6% and 27% compared to 1.7% and 19% in Q2 2022. These increases reflected a 60% 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 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 rates. As a result, in Q2 2023, the yield on interest-earning assets had increased to 7% from 3.6% in Q2 2022, or an increase of 3.4%. The cost of deposits in those respective periods increased by only 2% to 2.3%. Those factors were also reflected in the 4.8% NIM in Q2 2023, which represented another increase over prior periods.

The provision for credit losses was $361,000 in Q2 2023, compared to a credit of $1.5 million in Q2 2022. Q2 2023 net charge-offs amounted to $938,000. Prepaid debit and other payment-related accounts are our largest funding source and the primary driver of non-interest income. Total fees and other payments income of $25 million in Q2 2023 increased 10% compared to Q2 2022.

Non-interest expense for Q2 2023 was $49.9 million, which was 17% higher than Q2 2022. The majority of the increase resulted from salary expense, which increased 28%, and which reflected higher numbers of staff in financial crimes, compliance, and information technology. Staffing increases reflected higher deposit transaction volume and the development of new products. The increase also reflected higher employee incentive and stock compensation expense as a result of a focus on stock ownership. Book value per share at quarter end increased 19% to $13.74 compared to $11.55 a year earlier, reflecting the impact of retained earnings. 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 lines for questions?

So we have a very good understanding of the projects under implementation and new product expansion. So these implementations, we've discussed this before, can't take 18 to 24 months to fully implement into our ecosystem. So looking at that pipeline, we're fairly confident that we'll get above trend growth for 24, so above that 15% level, which has been kind of a historic breaking point between slower and kind of the trend line for the last seven years, which is actually 16%, but about 15% to make it easy.

No, it actually, for the new programs and stuff, it usually is more profitable in the early years because there's minimums and then there's tiers. For our larger clients, yes, they have so much volume that the incremental volume doesn't take a lot of cost, so we do give price breaks on tiers for our larger programs that are growing. But we have a lot of new products and services. The relationship that we've had to GDB and fee growth should be maintained over the next couple of years, but I can't guarantee that. It totally depends on who's growing and when. And the outlook on this business has really never been brighter. It seems that we have a lot of very good business opportunities, a lot in new partnerships, but also the expansion of partnerships across all of our verticals.

So we're in a very good position on the FinTech Solutions business.

Okay, so they are, our pipelines are increasing, so we should see less runoff on the institutional side. You know, that was obviously with the historic rise in interest rates, the price sensitive clients who were borrowing against their securities insurance kind of fell out of the loop. And there's been some pricing pressure from industry players that we haven't chased. So, but we do see our pipeline growing, and some competitors have raised their prices. So we should have less runoff in the third quarter. And that also depends, obviously, of how aggressive the Fed is, too. The other pipelines are fine. They continue to grow those books of business. And remember, we have two concerns. One is, if we do get paid back on those loans, they go in the Fed funds, obviously, at 525, which we don't get hurt that much on the spread.

And we're constantly repricing our portfolio as new loans. We do new loans, and they run off our sheet. So it doesn't really hurt us. Plus, we're kind of husbanding cash right now on our balance sheet because we are ultimately going to buy bonds to get a lot more fixed rate securities exposure. So we're not very concerned about the runoff of that business. It seems to be normalizing, and it doesn't hurt us that much. So I think we're in a fantastic position on our balance sheet to be very responsive to the current environment.

I don't think we're going to buy securities. This isn't a guarantee. I don't think it's going to happen to the end of this year. I think you're still going to have a fairly inverted yield curve, and that's probably going to disinvert next year. So I don't think there's securities purchases will happen this year, but we're being very nimble on this. We have to pay attention to what's going on in the marketplace. I mean, strange things happen. You saw the 10-year move last year on news in Japan, so you never know what's going to happen, and we'll take advantage of those opportunities.

So I would expect them to happen probably midpoint next year, and we are way – our balance sheet is actually smaller than it should be. If you look at the amount of securities we have versus our peer group and general and banks, we have at least 15% room to add security. So a billion, a billion five we could add pretty easily. And now that we have such a great amount of liquidity on the balance sheet, we'll be able to do that very effectively without having to borrow into the market or anything. So I think we're going to keep it. We're being, we're watching it every second of every day. We are in a fantastic position, obviously, because we had, you know, really anticipated the interest rate increases.

And we're slowly moving back up the fixed rate scale. So if you looked at what we did over the last four years is we went from the mid-30s to 26% fixed rate assets, and we're already back to 32% fixed rate assets and have taken 11% asset sensitivity off the board because now we're flexing the balance sheet back to a fixed rate structure with a target of 60% in order to mitigate our deposit beta, which is about that. So I think we're going to be very flexible over the next 18 months. I don't think there's going to be a big change in rates, and we're going to have time to adapt to, you know, change our structure to be much more fixed to mitigate the downside impact if there's rate cuts.

I mean, the deposit rate is like 40%, right, in terms of… Yeah, so it would basically wipe out, it would lock in the profitability, up and down, by the way. So, you know, that's why we're waiting to see. So, you know, we could get to 6% on the Fed funds. You know, what happened, obviously what happened just yesterday on continuing claims, on durable good orders, on GDP were all very big surprises that show that the economy is much more resilient. If you just look at our GDV growth, there's a lot of resiliency in the economy, and we still have an 8%. We're over 8% on the deficit, too, on fiscal spending. So there's a lot of stimulus still in the economy also.

So we're going to just keep an eye on it, and we're in such a good position that we don't – it's kind of where we were with the bond. We didn't buy a bond for four years because we're in a good position on liquidity and deposits, et cetera. So we're doing the same thing. In this case.

Your next question comes from David Feaster at Raymond James Please go ahead Hey good morning everybody Good morning, David.

So generally, I think people have accepted that they got to be broader fintech, especially neobanks, but also other verticals outside of government. You have to be, you have to expand your product set for profitability. So we're in discussions across all of our major clients that they want to add services, they want to add product capabilities. So this is something that's happening across the entire franchise. But if you take a large neobank, for example, they're, they're wanting to not just They want to build a portfolio of products around their key clients and expand it into credit. So that's exactly what we're doing. So where we can support them in doing that, we help them in many cases innovate, but also they may be with another provider today that they want to put into our ecosystem.

That's happening. But also, obviously, in the credit area, where most of the debit providers want to build and start to build both sides of the balance sheet business in order to increase their profitability. So we're, you know, with our partners, they're very deep relationships over very long terms. As I just said, we just expanded our relationship with Chime in those areas, and we'll continue to do that. I think that's where there's going to be a lot. In fact, we're not dealing with very many startups, obviously. There's going to be a lot less startups because of what's happened in fintech, and the dominant players now who are out there, which many of our clients are looking to significantly increase their profitability and deepen their relationships with their clients, and we're lockstep with them.

You have to remember we're fairly a small piece of the pie when you're talking about when we're in negotiations. It's not like we're 50% of their cost structure. So, you know, and it's something that you can't mess up. You have to be right all the time, and you have to have a profile now, especially with regulatory scrutiny, where they're sure that they're not going to have a problem on the regulatory issues. So, you know, that's the main reason. We say no to a lot of smaller business that are going to banking and service providers because they don't have the scale and they don't have the sophistication. So we're only dealing with the large players in the industry.

I think we see almost all the large engagements out there and talk to people about them. And they're names that you would know. So the ones that we don't have, we've probably been in discussions with, and those are potentially some of the programs that will be joining our ecosystem, which we will announce, but we obviously can't do that now. But our pipeline is very consistent with our ideology of only servicing those larger, sophisticated clients that have broadened their product sets. We're doing very little startup or banking service business, and that really supports ramping up quickly. So in the past, maybe five, seven years ago, we had much more of that type of business. The Chime, for example, was in its infancy at the time, and that was kind of our portfolio, though we do have healthcare and government cards and everything back then, too.

And then we also had a large general purpose reloadable platform, which has gone away across the industry. So now it's converted themselves into the large major players that want product expansion or security in execution or regulatory confidence, where we clearly have an expertise in. So all that together has really played into all the investments we're making or have made in building this very unique, very robust, very forward-looking ecosystem for the payments industry, and we're continuing to invest in it, and we're focusing on the biggest players with the most sophisticated, complex needs who want to really change and grow their client relationships.

Sure.

Absolutely. So we built into the cost structure. We knew that we were going to have significant revenue increases this year because we had to take a position on the yield curve, obviously, and we set the balance sheet purposely to benefit from it. So we looked into this year and said we're going to make investments. So our number of people are up about 7%. And we've had very low attrition, and we're able to recruit great people. And we're going to take advantage. There's a little dislocation, obviously, in the banking industry. So we're taking a little bit of advantage of that to make sure we set the cost structure up for the next couple of years so that we don't have big increases.

All the increases you see are, we're still getting efficiencies on the operating level. All the increases are people. That's the big determinant in being able to innovate. But if you look year over year, we have about, I'd say, $3 million that really aren't run rate expenses. So when you see that increase of the mid-20s in employee costs, there's a couple categories there where it's not really like-like. First of all, we don't have the same origination, so we can't, there's about a million dollars of capital.

You can capitalize the cost of origination that aren't in this year, over year, over year. Then we have about $2 million. Some of it is because of the proportion we pay in cash bonus versus equity is higher this year, and we had some severance. So there's about $3 million that really isn't built-in cost structure in this quarter. So when you look year over year, you see 17% total. You see mid-20s in the employee cost. The employee cost is really a little bit less. But having said that, next year, we've built into this knowing about this once-in-a-lifetime interest rate increase. So we're trying to set ourselves up so that we have everything in place, the people, the project list, and everything, so we know what we're going to build over the next couple of years so that our cost structure doesn't rise in the same way that it would during this historic rise in revenue here.

Yeah, we're just not going to grow the employee cost. We've really invested in employees here. So once again, you look at the operating expenses, they haven't gone up. So you look on the other operating expenses, they're flat. I think they're actually down this quarter versus last year. It all the real determination of innovation and being able to grow this franchise and really setting ourselves up for the next five years is going to be not determined with all the capabilities and platform and architecture we built but we have to have the best people in the industry and have to pay them well And we're setting ourselves up to not have to experience the year-over-year increases over the next few years, but to have those people in place to make sure that we can guide the company forward.

Good morning, Mike.

Very variable rate balance sheet to the majority being fixed. So we're probably not going to add a traditional vertical, though we have product expansion. We've had some product expansion, institutional and commercial. We're not going to get out of our box in real estate, most likely, of these transitional loans that we're doing of apartments in red and purple states that are really workforce housing. We're not going to get out of that space in a meaningful way. Where we will put on credit exposure is in credit sponsorship. So we don't know how big a part, I mean, that could be in five years, 25 or 30% of our entire $10 billion rank II limit. So that's where a lot of the product development is happening.

That's where it's going to soak up some of the liquidity. So once again, we're in an extremely good liquidity position right now. We're not worried about the runoff in the S block. That's our lowest coupon book, and that goes into Fed Fund. And we need a bunch of cash in order to buy fixed rate assets. So we're not worried about it. We've looked at everything across the board. We understand the credit universe very well. Even the more esoteric areas like leveraged finance and everything, we're very familiar what we could do. But I don't think when I talk to investors, that's what they really want us to do. So we have an extremely low risk credit profile, very short duration, very, very low default rates with very high recovery rates.

The story here is our funding source, our fintech solutions business, and how we're going to manage our business as more of a technology company as we hit $10 billion. That's the story that's going to really supersize investor value, plus with our high capital returns, rigorously returning that capital through buybacks. over the next five years. So that's the formula. That's where we're concentrated, and that's where we think the most value is. And so we're not a traditional bank. We're not going to be growing our assets to $50 billion. We're focused on uniqueness and low event risk. I mean, in almost a religious way, we do not want to expose these type of returns to any type of credit risk that we think might have an exogenous shock if we have You know, a substantial change in economics going forward due to interest rates.

That's exactly right. Those are the categories. So, you know, things like building people's ability to access the financial system. They're very important for the client sets of our neobanks especially. So they want tools. And I think everyone's recognized that the life cycle and being the lead bank in the life cycle personally of a consumer is where you want to be. So as they grow their portfolio financially, you want to be with them and provide them tools. So those are exactly right. Those are the areas where there's need building across the spectrum. I mean, we were the one of the first, obviously, that did, you know, a couple days early to get paid. That's a Bancorp innovation with our partners.

Things like overdrafts being free and limited, of course, not endless, but, you know, giving those tools are very important innovations that were, you know, some of those that came with our partnerships. From our larger neobank partners. So, you know, we want to be there for, I think we've got a very good meeting of the minds between our partners and us. I mean, we've set ourselves up to try to help more than our peer group and the banking and service providers. And we're constantly in discussions across the board with our partners around looking at their product frameworks of where they want to go. And so that gives us incredible clarity as to what we need to build additionally to help them innovate.

But it's all around the, for the neobank, mostly around the consumer, their life cycle of wealth, adding tools, that helps them, and that also increases our partner's profitability. So it's a win-win. And then, on top of that, we have all these other verticals in healthcare and government. There's all these are expanding. And then we have big new wins, like in corporate payments, where it's way above expectations. You know, that's an area where we got into in a big way last year, and it's really exceeded our expectations. So, you know, it's very broad-based. It's very focused on what our partners want, and that's why we're investing in order to build the capabilities necessary to translate their ideas into real go-to-market products that are safe and sound and will add to the profitability of both the client and the business partner over time.

Thank you.

Thank you, Operator. Thank you, everyone, for joining us today. I appreciate your involvement in our earnings call, and Operator, you can disconnect the call.