Bancorp (TBBK) Q2 2024 earnings call transcript

Thank you operator. Good morning and thank you for joining us today for the Bancorp's second quarter 2024 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. thebancorp. 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 1-800-934-5153.

Before I turn the call over to Damian, 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 from the meaning of the private security litigation reform act of 1995. Set statements are subject to risk 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 of the DTRF. 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 DTRF 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 earned $1.5 a share or $1.7 adjusted for interest on a residual security from the securitization business exited in 2020. With revenue growth, year over year of 7% and expense growth of 3%, ROE was 27%. Nim contracted to $4.97 from $5.15, quarter of a quarter versus $43 year over year. This contraction was primarily due to the purchase of $900 million of long-term fixed rates securities in April at a $5.11 yield. These purchases have mostly been financed through ongoing FinTech program deposits with limited borrowings, thus the thus the impact of Nim has been lower than anticipated. The FinTech Solutions Group continues to show significant growth momentum from the ramp-up and expansion of new and existing programs broadly across the portfolio and especially in B2B payments.

GDB increased 13% year over year and total fees from all FinTech activities increased 13%. This quarter is the first where we will begin to break out our credit sponsorship loan balances and fees in our financial reporting with balances reported as consumer FinTech loans. As a key strategic initiative of the bank and objective of our Apex 2030 strategy, we have spent the last few years building a platform that will enable existing and new partners to issue credit solutions to their customers. These loans will be generally short-term and mostly secured by our partners are distributed to investors. Over the next five years, we intend to build a diversified group of regulator-compliant credit-sponsored programs that will mirror our best-in-class innovative capabilities in our FinTech payments ecosystem.

On the lending side, we had year over year growth across the portfolio of 6%, led by small business lending with growth of 16% year over year and 4% quarter. Most notably, our institutional book has continued to stabilize and showed incremental growth quarter and quarter of 1%, concerning our commercial real estate portfolio of multifamily transitional loans. We continue to expect little or no losses due to the current portfolio and individual loan leverage and our underwriting standards for loans at their inception.

We recently entered an agreement to sell our one Oreo multifamily property, expected to close in December 24, with a sales price to cover the current other real estate owned balance plus the forecasted cost of improvements in process.

Lastly, with continued strong growth in our FinTech activities, including credit sponsorship and growth across our lending portfolio, we are listing our guidance to 435 from 525 a share without the impact of 50 million per quarter of share buybacks in 24. We intend to issue preliminary 2025 guidance in our third quarter press release. I now turn over the call to Paul Frankel for more color on the first quarter.

Thank you, Damien. As a result of its variable rate loans and securities, bank court performance continues to benefit from the cumulative impact of Federal Reserve rate increases. Additionally, as Damien stated, the purchase of $900 million of fixed rate U. S. government sponsored agency securities in April 2024 has significantly reduced exposure to future Federal Reserve rate decreases. Overnight borrowings for the quarter averaged 92 million as the majority of the purchases were funded by deposits. While deposits generally decline in the second quarter with continuing reductions in tax refund-related balances, this quarter deposits on average increased over 200 million compared to the first quarter of 2024.

At an estimated average 5.11 percent yield, the securities purchases had only a modest impact on current income while significant prepayment protection is reflected in estimated eight-year weighted average lives. Additionally, the bank continues to emphasize fixed rate loans to continue to further reduce lower rate exposure to modest levels. In addition to the impact of the Federal Reserve rate increases, the company benefited from loan growth with year-over-year decreases in S-block and I-block significantly offset by increases in other higher yielding lending categories. In Q2 2024, S-block and I-block reversed trend from net quarterly decline since the fourth quarter of 2022 to net growth in Q2 2024, notwithstanding the persistence of higher rates. We believe that higher rates have resulted in payoffs from customer rate sensitivity.

The impact of the aforementioned Federal Reserve rate increases on variable rate loans and securities and lesser increases in deposit rates with growth in higher yielding loan categories was reflected in an 8% increase in net interest income in Q2 2024 compared to Q2 2023. As a result, in Q2 2024, the yield on interest-earning assets had increased to 7.3% from 7% in Q2 2023 for an increase of 0.3%. The cost of funds in those respective periods increased by only 0.1% to 2.5%. Those factors were reflected in the 4.97% NIMM in Q2 2024.

The provision for credit losses was 1.3 million in Q2 2024 compared to 361,000 in Q2 2023. The provision for credit losses in Q2 2024 reflected the impact of 1.4 million of leasing that charge offs while the majority of such charge offs had been previously reserved. The largest single component of leasing charge offs was local trucking transportation and related activities for which total exposure was approximately $34 million at June 30, 2024. As described in our press release, the company entered into a purchase and sale agreement with a year-end 2024 closing deadline for the $39.4 million dollar balance apartment loan which was reported as non-acrual last quarter and which now comprised the majority of other real estate owns.

Non-acrual loans, loans 90 days still accruing and other real estate owned, total $77.1 million at June 30, 2024 compared to $76.7 million at March 31, 2024. While a $12.3 million loan became delinquent during Q2 2024 after having been modified with a payment deferral, the as is and as stabilized LTVs for related collateral are 72% and 56% based on a May 2024 appraisal. While the macroeconomic environment has challenged the multifamily bridge space, the stability of bank corps rehabilitation bridge loan portfolio is evidenced by the estimated values underlying collateral. The $2.1 billion apartment bridge lending portfolio has a weighted average origination date as is LTV of 70% based on third-party appraisals. Further, the weighted average origination date as stabilized LTV which measures the estimated value of the apartments after the rehabilitation is complete may provide even greater protection.

One of the accounting estimates is described in the notes to our financial statements is the allowance for credit losses which is sensitive to a variety of inherent portfolio and external factors. Rebel may be one of the more sensitive portfolios to such factors. In the second quarter of 2024, Rebel loans classified as either special mention or substandard increased to $177.1 million from $165.2 million at March 31, 2024. Each classified loan was evaluated for a potential increase in the allowance for credit losses on the basis of third-party appraisals of related apartment building collateral. On the basis of as is and as stabilized loan to values increases in the allowance for specific losses in the allowance for specific loans were not required.

The respected weighted average as is and as stabled LTVs of those classified loans were 81% and 69%. The current allowance for credit losses for Rebel is primarily based upon historical industry losses for multifamily loans in the absence of significant historical losses within the company's Rebel portfolio. However, as a result of increasing amounts of loan classified as special mention and substandard, the company will evaluate potential related sensitivity of that factor for Rebel.

This evaluation is inherently subjective as it requires material estimates that may be susceptible to change as more information becomes available. Non-interest expense for Q2 2024 was 51.4 million, which was 3% higher than Q2 2023. The increase included a 2% increase in salaries and benefits, higher FDIC insurance expense reflecting higher levels of deposits and higher other real estate owned expense. Book value per share quarter end increased 15% to $15.77 compared to $13.74 a year earlier reflecting the impact of retained earnings.

In summary, the bank corps balance sheet has a risk profile enhanced by the special nature of the collateral supporting its loan niches and related underwriting. Those loan niches have contributed to increased earnings levels, even during periods in which markets have experienced various economic stresses. Real estate bridge lending is comprised of workforce housing which we consider to be working class apartments at more affordable rental rates in selected states. We believe that underwriting requirements provide significant protection against loss as supported by LTV ratios based on third-party appraisals. S block and I block loans are respectively collateralized by marketable securities in the cash value of life insurance, while SBA loans are either 7A loans that come with significant government related guarantees for SBA 405 loans that are made at 50 to 60% LTVs.

Additional details regarding our loan portfolios are included in the related tables in our press release as are the earnings contributions of our payments businesses which further enhances our risk profile. The risk profile inherent in the company's loan portfolios, payments funding sources and our earnings levels may present opportunities to further increase shareholder value while still prudently maintaining capital levels. Such opportunities include the recently concluded share repurchases of $100 million for second quarter 2024 from the original 50 million.

I will now turn the call back to Damien.

Thank you Paul. Operator please open the line for questions.

Good morning David. I wanted to first touch on the Rebel book quick. I was hoping to get a bit more update on that Rebel Oreo loan. It's great to see the buyer lined up. Still a decent amount of time for that to close though. I guess could you talk about the plans in the intermediate term with the construction and timeline for that and then just with the non accrual migration you see more broadly. Is there any commonality with where you're seeing that migration from a regional or perspective or anything? So first part is it's on track.

It's the property in Houston and we should be pretty much finished with the work going through the summer to the close and so the buyer is involved and has done due diligence on the property and is involved in the plan, the executed plan. The trend in the book is really from that 21-22 vintage once again. There's been stress because of the rise of venture rates and also the supply problems that were that happened during the pandemic. So you get when you're not on plan and you're off that plan it could be time or cost. It will be have a weakness and that weakness may drive that loan into substandard. So that's the credit migration that we've seen.

So we're working very diligently with our sponsors in order to help them. If they're off plan usually if there's any significant off plan the sponsor will put in additional equity or we won't disperse our own funds. So most of them are, you know, we don't have a lot of non-paying at this point which is a very good sign and there's clearly pools of capital and sponsors who are in the market now looking for these opportunities. When you have these low leverage levels you know there is capital available to recap these loans as we've demonstrated here with that Aubrey Long loan. So there could be more credit migration but we're not seeing losses at this point.

Okay that's helpful. And then obviously the regulatory backdrop is challenging. We've seen some competitors under pressure but I'm curious how does this benefit you and your pipeline? I mean you're understanding your pipeline is always full. We've talked about that in the past but have you seen any shift? Are you seeing maybe stronger or higher quality partners come to you and is this giving you maybe more pricing power? Just kind of giving the strength of your platform. Curious what you're seeing?

Yes and there's no doubt that's happening. We can't facilitate there is broad dislocation across the entire banking as a service space and a lot of regulatory scrutiny. Things like third party risk management, model risk management, fair lending, BSAML, all these things are under scrutiny with the regulators and we've invested over the last seven years in building a portfolio and totally rebuilding our middle office and technology and compliance envelope to be compliant with regulatory expectations. So but we can't take smaller programs. There's been incoming is substantial and we're working with large partners who are potentially looking to move because of the regulatory scrutiny and no doubt it does have an effect, a positive effect on pricing.

We've maintained basically our pricing over the last five years. It hasn't really moved very much but our costs have gone down because our platform is very scalable so you don't see a big build in our cost structure and that's due to the fact that we're incredibly scalable. So incremental programs do have a big impact on profitability because of the scalability of the cost but also the size of the programs we're putting on. Usually they're much more profitable upfront too and they bear the cost of implementation and they're tiered. So as they grow their volume substantially the pricing will adjust but you know it gets more profitable as the because of the scalability of the platform.

Okay. Okay. Thank you.

The regulatory expectation is that if you're doing these are banking and service arrangements that you have to validate the operations on a third-party basis. So they really think of it as you running the business that it's not outside of you. So you have third-party risk management BSA, AML, consumer compliance, reggae whatever it is you have to overlook and assure that it's compliant.

And I think that because of the industry grew so quickly there were a lot of small players a lot of smaller players that players got into the market without building out sufficient infrastructure that the regulators are now going back and ensuring that that's true. And they've obviously gone back and there's been inadequacies and people's ability to demonstrate that validation.

And so while we were under scrutiny obviously years ago and under consent orders and we worked very closely with the FDIC and now with the OCC and the Novel Baking Group I think we had a big head start on creating that compliant model and making sure that that validation can happen and that lowers as far as the regulator's view you know you're more compliant in your far lower risk. And so now obviously now that scrutiny has come to the industry we're already at the finish line and people now have to catch up. The thing I would say is to be that compliant platform that can do that validation is incredibly expensive. So you know we have a fair amount of broad verticals 15 we have great positions across many industries so we have the volume and the ability to invest in that platform so it's unlikely that everyone in the industry would be able to do that and some have exited and so that dislocation will continue for some time.

Okay understood that was a great summary I guess just to be a little bit more specific to the bank court do you think there's anything because the regulators have kind of had this expectation for a while it's just not really tracking down on it. Do you think there's anything new that would maybe I know you're continuing to invest quite a bit there's anything new the regulators might come out with or change the expectation a little bit that will change how you operate or require a little bit additional investment to stay ahead of it. So we always invest in the front so you know it took us years to we didn't get into credit sponsorship in three months we've been investing in that platform for years we're going to do the same thing with embedded finance as we're we now are starting to build that platform and we're we work very very closely with the regulators to understand their expectations and we adjusted ongoing right so of course as a leader in this space increased scrutiny will be placed on all our competitors large and small but also will be increased on us but we've got such a a multi-year head start in time and investment that it's far easier for us to adjust and this has been going on for years because when we were in trouble with the consent orders there wasn't great agreement at the time I believe in the regulatory bodies exactly how you regulate that validation process I was talking about that compliant third-party risk management and I think there's a lot more contextual understanding by both the industry and the regulators now so that's some of the problem that the smaller players are having and be able to make those type of investments with much more lower volume much earlier stage programs so they're going to have a greater dislocation between expectations and actuality and so we don't expect to have a big dislocation we're going to continue to prove our platform as regulators change your expectations we will invest the necessary resources whatever they are in order to meet those expectations however if they change it too much it's likely to affect everybody else more than us because we're closer we're by definition going to be closer to those expectations on an ongoing basis okay totally understood thank you I'll also back in the queue thank you our next question will come from Frank Scoraldi with Piper Sandler please go ahead morning good morning Frank given the where I think it's still limited supply for new credit in the in this rebel sector is it safe to assume that that bank corps would be financing the sale this this property in Houston oh no we're we'll be out of that property there'll be new financing in place okay great and then Paul I think you you mentioned that you know you take a look at would consider I guess and tell me if I'm on power phasing correctly that you consider reserve builds here in that book and I'm just wondering how we would think about that as we sit today is that potentially meaningful or just incremental is that a potential risk to the to the four dollars and thirty five cent target just how we should think about the potential for any reserve builds over the next couple of quarters so we we looked at the each of the special mention and substandard loans and none of them required an individual reserve so as as we've been saying we we don't expect any losses notwithstanding that our classified loans are up but Cecil requires you to look at sensitivity to various factors and clearly if there are loans that have some type of issue then you should take a special look at the trends in those loans and the possible impact on the on the on the allowance for credit losses so that's what we're doing and so yes it is possible that we would recognize some additional provision and yes that would impact the the guidance but as I said before we don't really expect any losses so I think you have to make that differentiation if Cecil there's some way that Cecil implies that that there is additional allowance then we would take that but we don't expect any actual losses okay and and I guess that's a process ongoing now and and well just just one one last one before I recue just in terms of the the move in the share price here the the new guy just just want to make sure just in terms of the current buyback the plan obviously double it up in the second quarter but the buyback the 50 million a quarter is that still something you're you guys very comfortable with through the back half of the year yes they're they're they're it'll we're very comfortable with the 50 the 100 was a very unique opportunity we bought the shares at 33 13 I believe but we'll probably do the 100 million the unless the board decides otherwise but I think it'll be the 100 million and then when we give guidance well so mirror the buyback next year off the net income right now we have sufficient capital even if extra 50 million didn't really change our ratio that much and the tier one leverage ratio and the other ratio so which is extremely strong capital position and we're we pretty much have around the amount of capital we'll ever need because of the uh Durban Amendment uh limitation on the 10 billion bank so we're in a incredibly good earnings and capital position uh and we will continue to buyback the shares when they're undervalued and we believe those shares are undervalued as of today right thank you thank you our next question will be a follow up from David Feaster please go ahead hey sorry thanks for digging the follow-up um you've got a lot of pretty exciting initiatives going on um I was hoping to touch on some of them we we're starting to see the benefits of the credit sponsorship which we've talked about you alluded to embedded finance which you're rolling out we've also talked about monetizing your risk and compliance functions um I'm just curious if you could give us an update on those and any other initiatives uh you're working on and maybe how AI could play into that because that's a pretty big buzzword these days just open again an update on some of the things you're working on and what you're excited about well you're right about AI so we have a whole group that's working on how we're going to use AI in the future including a technology vision so we really have to really think about that we've invested a lot in totally redoing our tech stack and redundancy and everything and strengthening our cybersecurity walls all that stuff has been ongoing but we're really thinking about as we transform the bank into really a of fintech centered platform and not just being you know a majority of our business but really being focused on that we're of course thinking through the tech and AI requirements the incredibly exciting and the credit sponsorship side all the hard work is paying off we have multiple programs and multiple partners uh that want to uh implement at the bank core we could easily see this first tier we're in the 70s it's growing now we could we could see upwards towards uh three to five hundred million on the balance sheet at the end of this year and we could see a billion next year so that's how fast growing that is it's extremely accretive because with that business is a also the uh the ecosystem for payments is also connected to that so it's incredibly profitable business and very and many times the partners will have both the deposits at the bank already so we're in essence uh we're kind of uh using the liquidity of our partners to lend to their clients uh that that's very exciting you know when we think about Apex 2030 uh balance sheet uh five years from now we'll probably we hope to have 20 programs it's going to mirror the banking as a service size 20 programs most of it'll be extremely balanced sheet light it'll be distributed but also secured by many of our partners uh and provide the deposits so that's that's incredibly exciting itself but the ongoing now building is an embedded finance which is a program management element which we don't do today uh that companies uh retail companies that control their apps um that need a financial services capability within their app and we would provide that we would manage that part of it for them uh that's a very very that's a uh it predicted to be a highly growing uh capability that people will want across uh the economy and so we already have we think the best banking and service ecosystem so that applying that to it will be kind of a no brainer we think for the marketplace and by the way we've been asked for it a lot already so people have asked us hey can you do that element we say well no we don't we don't do that today and we've actually partnered with other other people in the in the space to talk about providing that in certain cases uh so you know those two things alone uh our enormous fee opportunities and balance sheet opportunities in themselves uh so you know when we say apex we we're talking about a three four x on our current fees of a hundred million and five to seven years and that may be a hundred or two hundred of increase in the spread revenue so uh it's very exciting i think um it's going to be played out uh for credit sponsorship in the near term you'll see those balances grow very aggressively and then for embedded finance we're gonna we're gonna walk and be very deliberate and make sure that we provide uh the best in class and that capability uh to the partners and so we're not rushing anything uh and our base business is growing very aggressively so uh and we've been out of them joining our ecosystem so we're very excited that's great thank you thank you we have a follow-up question from Frank Steraldi please go ahead thanks you're just um just back to the uh the increase in guide um is the primary driver of that um credit sponsorship and and just when you talk about um balances moving higher in the near term is something along the lines of of you know half a billion in balances a reasonable place to land at the um at the end of this year and and i assume that would be you know more than one um one program yeah well especially with credit sponsorship yes no doubt if we're at three to five hundred billion in that alone you're gonna see that increase in balances the game changer here is one thing that maybe uh we didn't emphasize enough is the deposits so with the activity across all the verticals we're seeing an increase in deposits we haven't really seen this time of year before uh you know taking away the stimulus checks and all that stuff that happened during the pandemic why that's so important is because we can facilitate a lower funding cost over time because we can take the higher cost deposits and higher cost borrowings off the balance sheet and so with interest rates dropping you know it's potential that we could drop our funding of the bank even more by having more demand not interest bearing deposits on balance sheets so that is very supportive of increases and profitability uh so and and the syntax you know the incoming on the syntax side is dramatic uh so the addition of large programs uh additional large programs is it is expected over the next 12 months so all that combined uh supports the guidance but also supports continued significant profitability increases over the next two years okay great and then as we think about um just near term trends um you know you talked about the deposits being a bit um as i think about as we think about nii for the third quarter kind of the good run rate is it better to use kind of end-of-period balances um or average balances for the court any guard wheel you guys can put up around um kind of nii expectations just because there's so many different things going on um in terms of drivers well i'd go end-of-period and i and our dim is going to be around five percent regardless of the loan type so it might even it's going to be around it could actually we had a million we had that million dollars in there uh that we had a back out after tax um because of that one securitization that was a long time ago and we do have plenty of coverage on that security so we're not expecting a loss on that either but the um so five five ish it might take a little bit higher depending on the class but the the um the and the the issue with the uh the loans that we're doing in certain cases on the fintech side some of that will be in fees uh because of the way these some of these loans work instead of in nim so you'll see some of the fees growing and some of that will actually be nim related uh technically so but the five percent is i think a good because we don't know exactly who's going to grow and in what cases but in our modeling that's kind of where it is great okay thanks thank you at this time i would like to turn the call back to damian koslowski for any additional or closing remarks thank you everyone we appreciate you attending our conference call operator you may uh disconnect the lines thank you this does conclude the bank corp eq2 2024 earnings conference call you may disconnect your line at this time and have a wonderful day