Customers Bancorp Inc (CUBI) 2018 Q2 法說會逐字稿

Good day, and welcome to the Second Quarter 2018 Customers Bancorp, Inc. Earnings Call. Today's conference is being recorded.

At this time, I would like to turn the call over to Bob Ramsey, Head of Investor Relations for Customers Bancorp. Please go ahead, sir.

Thank you, Elanda, and good afternoon, everyone. Customer Bancorp's third quarter earnings release was issued earlier this afternoon as well as an investor presentation. Both are posted on the company's website at www.customersbank.com. Representing the company on the call today are Jay Sidhu, Chairman and Chief Executive Officer; Bob Wahlman, Chief Financial Officer; Dick Ehst, Chief Operating Officer; and myself, Bob Ramsey, Director of Investor Relations and Strategic Planning.

Before we begin, we'd like to remind you that some of the statements we make today may be considered forward-looking. These forward-looking statements are subject to a number of risk and uncertainties that may cause actual performance results to differ materially, including the risk that results are different than currently anticipated. Please note that these forward-looking statements speak only as of the date of this presentation and undertake no obligation to update these forward-looking statements in light of new information or future events, except to the extent required by applicable securities laws. Please refer to our SEC filings, including a report on Form 10-K and also the 10-Q for a more detailed description of the risk factors that may affect our results. Copies may be obtained from the SEC by visiting the Investor Relations section of our website.

At this time, it's my pleasure to introduce Customer Bancorp's CEO, Jay Sidhu. Jay, the floor is yours.

Thank you, Bob, and good afternoon, ladies and gentlemen. Thank you for taking the time to join us for this call today.

I'd like to draw your attention to the slide that we have provided with the press release because I'm making an assumption that you've all had a chance to go through the press release. So I'd like to make some comments about the quarter and about some of our expectations for the future.

If you go to Slide 7, you can see that Customers reported consolidated net income to common shareholders of $0.62 a share, about $20 million, on a fully diluted basis and it was a $0.02 higher when you adjust for the merger-related charges.

It was -- these earnings were 10% over last year adjusted for merger charges and securities gains or losses, principally that took place last year in the first quarter.

Customers' Community Business Banking segment reported second quarter 2018 net income to common shareholders of $23.4 million or EPS of $0.72 and adjusted for security gains and losses this segment also generated $0.73, roughly the same amount as last year.

The BankMobile segment, as we expected due to seasonal patterns of the student business, reported a net loss of $3.3 million, which is about $0.10 a diluted share and adjusted for the merger-related charges of $0.02. This segment improved over last year where the loss was $0.14 in the second quarter of 2017.

Despite some temporary headwinds caused by our branch-like business model as well as the lack of branch-based consumer deposits and relatively flat curve, we believe this was a solid quarter for the company.

The spread between the 2 year and the 10 year as you know, fell down to 25 basis points, the narrowest level since 2007, and -- I believe this had an impact on us as well as the rest of many of the other community banks. But still in spite of this, the Community Business Banking segment still generated a return on average asset of just over 1%.

Our notable strength in the Community Business Banking segment this quarter included a robust 21% year-over-year growth in C&I loans. Pristine credit will justify the release of some reserves and a 7% sequential growth in deposit balances.

And I'm now on Slide 8. I feel -- we, from a -- on Slide 8, we also talk about outlook for 2018, and we now expect the Community Business Banking segment to generate EPS between $2.65 and $2.75 this year. The biggest driver in our more conservative outlook is our current expectation for a margin improvement not showing up till sometime next year as well as our decision to taper the growth in total assets between 10% to 12% in 2018 rather than the approximate 15% that we had initially signaled to you.

In this flat-curve environment, we believe this would be a prudent action on our part. The most notable change in this growth outlook is going to affect our multifamily business, where we have made a decision not to -- decision to be extremely selective in who we extend loans to this quarter and we believe this policy is going to remain intact till the yield curve normalizes.

Our net interest margin for this quarter was 2.62%. Slides 11 and 12 provide more details on the entire margin issue as well as the steps that we are taking to mitigate the core margin pressure that we've experienced in the first 6 months of this year.

The 5 basis points quarter-over-quarter compression included a 4 basis points headwind from the seasonal reduction of BankMobile noninterest-bearing deposit. So we expect to make this up next quarter.

Other actions to mitigate the margin pressures that we want to share with you are as follows: And you can see number 1, and I'm referring now to some of the items that we have disclosed on Slide 11. So you can see one of the first mitigants that we like to discuss with you is that we have very significantly limited origination of loans below 5%. In fact, our -- all our C&I loans that we originated in last quarter had a minimum rate of 5.17%.

Number two, we have basically stopped making traditional multifamily loans to new customers and this policy will remain intact till the yield curve normalizes.

Number three, we have executed approximately $1 billion in notional value of interest rate swap in the first 6 months of this year, tapping over a 3-year period or so our funding cost in the 2.7% to 2.75% range.

Number four, implemented new product and channel strategies to grow our core deposits and this includes launching of a digital bank that we launched on July 7 this year, and it's geared towards gathering deposits from consumers across the country.

Number five is that we have implemented even the more attractive compensation plans and attracted teams that are taking advantage of this to incentivize them to grow core deposits.

And number six is that we are seeking opportunities to originate higher-yielding assets from the commercial finance as well as the consumer sector as long as we are satisfied with the credit risk. This will also improve our asset mix going forward.

One of the positive trends this quarter that I don't want to be getting lost is, given the -- especially given the broader margin trend was increase in loan yields, which moved 25 basis points in just one quarter.

Slide 12, if you look at that, you can see some more details about our loan portfolio. You'll note that 84% of all our C&I loans repriced, most of them immediately, but all of them within 1 year. Some of them do reprice tied to a 3-month LIBOR. I would like to also note that C&I loans, including our loans to mortgage companies are our biggest portfolio making up 41% of our -- of all our loans. And our C&I loans grew by 21% year-over-year.

Now here's the breakdown of how our asset yield improved between Q1 and Q2. Our loans to -- commercial loans to mortgage companies, the average yield in the first 3 months of March -- ending March 31 was 4.69% that went up to 4.93% for second quarter. Our multifamily loan yields went up from 3.7% to 3.9% during second quarter.

Our C&I loans, other than loans to mortgage companies went up from 4.34% to 4.75% in one quarter.

Our nonowner-occupied commercial real estate loans went up from 3.93% average yield in the first quarter to 4.05% average yield in the second quarter. So all our total loan yields went up from 4.10% to 4.35% from first quarter to second quarter.

And as I stated earlier, the average yield on the C&I loans originated in Q2 2018 was almost 5.2% which was 42 basis points greater than our portfolio yields.

Also on Slide 12, we share with you our repricing schedule of our assets in more detail.

So you can see 84% of our C&I loans will reprice immediately or within 1 year for sure. And then if you look at our -- even our multifamily loan portfolio, we are looking at, without prepayments, about 60% to 70% of them repricing over the next 3 years. And even in our CRE, 43% of our loans will reprice within 1 year.

So taking the steps that we have taken to deal with the higher cost and our strategy, which is to always do what is the best for the customers, both borrowing customers as well as the deposit customers, we believe it's prudent to do what we've done and the short-term pressure that we have experienced in the margin is going to end. And you will see within a year, our margins starting to expand and our profitability starting to improve.

Next, credit. In this area, it bears mention this quarter, as disciplined underwriting has always been one of Customers critical factors.

In second quarter 2018, the provision decreased $1.3 million from a year ago. The reserve methodology remained unchanged, but we still were able to release some of the reserves. This is entirely due to the strong credit quality and better-than-expected resolution of specific problem loans and some of the charge-offs that we have taken in the past were -- created recoveries beyond what we were expecting. Net charge-offs were just 2 basis points. And in this quarter, nonperforming loans equaled just 29 basis points. So total loans and allowance equals 150% of nonperforming loans.

Regarding BankMobile spin-off, we continue down the path to the spinoff and all the confidential filings that have been submitted. Let me just give you an update on each one of them.

Flagship in -- back in April submitted Form 10 to FDIC. Flagship received no comments practically from FDIC and Flagship is in a position to do an IPO.

Number two, Flagship, in the month of April, filed an application with FDIC for approval of the purchase and assumption-related deposit acquisition of BankMobile and FDIC is in the process of reviewing that application and Flagship hopes to and expects to receive an approval from FDIC in due course.

At the Customers Bancorp level, Customers Bancorp filed a 500 Page Form 10 to the Securities and Exchange Commission in June, and we've already received comments back from the SEC. We are glad that they were very moderate comments. And so CUBI is in the position or Customers Bancorp is in a position to respond to SEC in a fairly rapid pace, so that the execution of the spin to our shareholders of the BankMobile Technologies business can be done.

We are hopeful that still, sometime shortly before or shortly after September 30, subject to the final regulatory approvals, this spin-merge can be executed and our shareholders can enjoy the benefit of the fastest -- one of the fastest growing digital banks in the country.

In conclusion, I would like to say that despite an unfavorable interest rate environment, we continue to focus on serving our customers, growing the right mix of loans and deposits and managing our cost to drive profitability higher.

We are also working to simplify our story and unlock the shareholder value that we believe still exists in our stock. As you know, the valuation is 1.3x book and 8.7x 2019 earnings. We've heard from several of the analyst that there are 3 things which affect this below-market valuation and we are very focused on them. If you believe there is something is beside these 3, please share that with us.

Number one is capital. So everybody is talking about that we should have a capital that's slightly higher capital ratios, capital ratios have improved. But we have set targets and we expect to get to those targets within the next 2 or 3 quarters.

Number two is divestiture of BankMobile. I've already shared with you that, that will get done.

Number three, that we should be tapering our growth somewhat. Well, the growth over the last couple of years was over 20%. Now we are telling you it to be 10% to 12%.

So with that, I'd like to open it up for questions. So if you can, please, operator, open it up for Q&A.

(Operator Instructions) We'll hear first from Michael Perito with KBW.

I actually have a handful of questions. I wanted to maybe start on -- Jay, you mentioned the online deposit gathering consumer platform, you guys launched in July. Can you maybe give us some more details around that? And what the mandate is there, moving forward?

Sure. Mike, right now it's only offering one product, which is a savings/money market account to consumers across the country. We've already in the first 10 days got $10 million in deposits. In our test period, we will be relaunching and going to a broader marketing, starting August 1, and we offered a 2% interest in -- for savings accounts, there's a $25,000 minimum deposit balance. So we are really going after consumers which -- where there is a benefit to us of at least 40 basis points today over our institutional marginal cost of funds. So there is definitely an opportunity for us to grow this into -- hopefully into $100 million plus average -- average of $100 million in deposits over a 30- to 60-day period. Every 30- to 60-day period, that is our plan.

So should we think about this kind of as a product that competes with like some of those other money market savings accounts from like Goldman Sachs or American Express, et cetera, some of those other like higher 150, 200 bps is that kind of the idea of the market you're trying to angle here or should we think about it differently?

No, that is correct. As you know, the difference between BankMobile. BankMobile was going after checking accounts for millennials. This is very, very different. This is going after the consumer money that the banks are hoping the consumers will never know how much money they have and what rate they are getting, we are instead taking a position where our positioning strategy is that we always want to do the right thing for the customer. And in our opinion, this is the way we will gather the deposits from the consumers across the nation.

And you guys feel -- is the mobile app, I guess at this point on the customer side up to the standard it needs to be to compete in that space? I'm assuming, yes, but just curious.

Yes. And it's a majority of the deposits the customers in this instance do not use a mobile app but they use desktop. But yes, we have our mobile app, which is in -- very appropriate for these kind. And we have -- had an advantage because we have experience in how to [indiscernible] loans deposit through the security checks and verifications for those who do want to open them over mobile. But so far we haven't had anybody open it over mobile. Wanted to share that with you. The people give you $100,000 or $50,000, they feel better sitting on a -- in front of a laptop.

Yes. I actually misspoke. I meant more like the online website access, et cetera. But like I'm assuming it's all online account opening and stuff like that, obviously.

Yes.

Okay. All right. I wanted to ask a question, so I mean obviously a theme that we've been hearing a lot from other banks is the asset pricing competition. Obviously, it seems like it's something you guys are trying to deal with directly, and I thought your comments about significant limiting originations of loans with yields below 5%. I guess my question is does that box you in a little bit from a credit perspective, I'm assuming a lot of the loans that are priced centered, not always obviously, but a lot of them, they were priced centered, higher quality credits. And secondly, I mean, as loans, kind of come up and you have all the data about repricing loans and et cetera, et cetera. I mean is there going to be -- is it going to be a challenge to maintain older relationships as well under that mandate? Or is that mandate really more for incremental originations at this point?

Mike, first of all, let me just try and answer that question by once again discussing our strategy. We recruit teams and every team has a goal, has a plan. And that plan is based upon reaching out to their clients and we have a private banking relationship-oriented business strategy. The reason why we are experiencing way-above-average C&I growth with high-quality and really being able to not compete on the basis of price at all is because of our business strategy. When you have a business strategy which is built around branches in a geographic market, there is a lot more competition, competition from community banks, from large banks. It's not to say, we are not experiencing competition. But we are seeing some stupid stuff going on in the banking sector right now. To give you an idea for a $200 million loan that we booked in one area, in C&I, we've looked at over a $1 billion worth of potential business. And so that's the kind -- this is our -- opportunities are there. But there is, you are absolutely right, what you're hearing from others, that pricing competition has increased. But we believe we can compete on the basis of price because of our superior long-term relationship that our bankers, private bankers have with those customers. But where we will not compete is structure.

Okay, sounds good. That makes sense. And then one just last one for me, just maybe for Bob Wahlman. But on the margin, I noticed a comment, the 4 basis point headwind from seasonal decreases in BankMobile and noninterest-bearing balances. When -- if the transaction goes as planned, all else equal and is gone by the end of the third quarter, the divestiture of BankMobile that is, what is the impact to the margin today from the loss of those DDA balances?

Sure, Mike. Right now, in the second quarter of 2018. And if you take a look at the Community Banking Business segment, we have a charge in Community Banking Business segment of approximately 3.02% for the quarter for that transfer pricing. So if we can replace those $400 million to $600 million to $700 million of deposits, which they would -- which they will be generating at a price, less than 30% and we are 100% confident that we will be able to do that by a significant margin, we will actually see some incremental benefit to the earnings that we are reporting from the bank perspective. We don't put that in our -- we don't talk about that in anything, but that's how the numbers would work out. We do a little bit better than the bank-only model.

Okay, I got you. So essentially you guys are already kind of in a way not giving yourselves credit for those deposits in the margin today. So there really shouldn't be any impact, if anything a slight tick up once that transaction is completed in September?

That's correct, Mike. As long as we can replace some of the cost less than 3%, and you know we've added swaps to capita, to 2.7 fixed basis for 3 years. So that's why we are pretty confident it's going to be somewhat of a benefit to online interest income.

Okay, okay. And then actually on those swaps, is that something -- I remember reading, I mean there was an accounting change that made swapping on the asset side a bit easier as well, right? I guess, is this -- can you just maybe give us a little bit more color about when that started? I know it says that the impact of those are going to start in the first quarter of '19. But when you start putting that $1 billion in value on and just maybe a little bit more color what exactly it is? And I'll step back after that.

Sure, we did early adopt the new accounting standard effective this year. But the swaps that we're talking about in this particular case are the traditional swaps we would've received in the same accounting had we done the swaps a year ago, 2 years ago, 3 years ago. So they are not -- it's not taking advantage of the new accounting rule at this point in time. We're hedging our liabilities.

Our next caller will be Steve Moss with B. Riley FBR.

On the multifamily business here, could you just discuss what you were seeing term a rate that caused you to pull back?

Steve, we are still seeing people making loans in multifamily somewhere between a low of 3.7% to a high in some cases where there is not necessarily absolute pristine credit to 4.25% range in New York market. And that to us is the reason why we will accommodate our existing customers. But we are not seeking new customers and we have a strategy to go to our existing customers in fact, with a lower rate. And then encourage them to look at locking up for the next 5 years at a rate which is in the upper end of that range and take away the risk that they are facing for a potential normalization of the yield curve. Or if there is a continued decrease in medium-term rates, they could -- they could really be negatively impacted. So our teams are very actively focused on contacting the customers, and doing what we believe is the right thing for the customers here. And at the same time that will benefit our bank because if we are able to reprice upwards in the next 3 to 6 months, $0.5 billion to $1 billion of our loans by 50 basis points up, that you know is multifamily loans, that would be very beneficial.

Okay. And in terms of the margin here as we think about it going forward, what does your guidance assume in terms of rate hikes? And let's say we get 2 more by year-end, what are we thinking about for '19?

We are assuming at least 2 more in '19.

And 2 -- we have 2 more in September -- for 2018 also into '19.

Okay. And so even if we had 2 this year and 2 into next year, you'd still be able to be at least at the low end, is your expectation for the margin?

That's correct.

Okay. And then on the fee size, just wanted to get some color, deposit fees and interchanging and card revenue were a bit lighter. Just wondering about the dynamics that were going on there?

One is an accounting change whereby last year, I think Carla, that's what you had mentioned to me, that last year we were looking at income, all being offset -- all coming into the income line and now we are reporting offsetting with some of the fees that we have to pay MasterCard. And so it's netted out, whereby your expenses go down but your fee income goes up last year and now it's start to wear off. Second thing is that we are really encouraging the customer for life business model so that these are not just refund deposits or the excess from the division. But we have $1 billion in the last 12 months of organic deposits, paychecks coming in into the account. Whereby you see slightly less activity on the deposit fund and the debit card than you see when they're just paying off -- using their money from the student loan to pay for the books and housing and those kind of things that is collectively. That's what's causing it in the BankMobile sector.

If I could just add to that just to define the netting that Jay described in the first part is a result of the revenue recognition standard that came into effect at the beginning of this year. This is one of the impacts for customers, the new accounting standard. We didn't do it by choice, we had to do it.

Right. And so as we think about third quarter, I guess, in particular on the interchanging cards, I know a lot of that is really driven by BankMobile. But since it's going to be hanging around, we should see a pretty meaningful rebound, I guess on the third quarter?

I think BankMobile -- we have given some indications to you that we think BankMobile loss will be in that $3 million to $4 million range max, in the third quarter. So I think we put that in the press release.

(Operator Instructions) We'll take our next question from Frank Schiraldi from Sandler O'Neill.

Just a few questions. I wondered, Jay, you talked about obviously moderating balance sheet growth here in the back half of the year. Do you have to slow C&I growth? Do you intend to slow C&I growth? Or is this mostly just getting there through a reduction in multifamily?

No, we are not slowing the C&I growth, Frank, as we shared with you that what we are seeing from all the teams that we recruited over the years, including in the last 12 months, we are seeing a very robust pipeline. And we are putting on the loans, in second quarter we put them on variable rate loans that start average rate of about 5.2%, starting. So it's a very attractive business for us. So the moderation of our growth rate is the result of continued decreases that you should see in our multifamily business portfolio.

Okay. And then you talked about the 3%, you're essentially -- the bank is giving or transferring to BankMobile. Do you think -- I mean, should bank deposits grow, especially given the moderation overall in loan growth or should bank deposits outpace the growth in loans? I guess what I'm trying to get at is -- do you think it'll be mostly wholesale that backfills once BankMobile leaves the balance sheet or do you think a healthy amount will be bank deposits, including maybe this new digital channel?

I think it's all the channels. And I think we've put in the press release. We believe that we -- should see about $600 million in our deposits in the second half of the year, as a result of all our strategies.

Okay. And that's in the those -- okay, so that would be core deposit growth?

That is correct.

Okay. And then just wondering on the NIM guidance. Does that include any prepayment penalty income and does the quarterly NIM -- the 2Q NIM, does that include any prepayment penalty income?

Yes, it did include a prepayment penalty income. Our NIM always includes a prepayment penalty which fluctuates quite a bit quarter-to-quarter. And this quarter, we did benefit.

Okay. I mean do you guys have handy what -- how much in prepayment penalty income was in this quarter versus the previous quarter?

I think it was over $1 million but I don't have the exact number.

It was $2 million this quarter.

$1 million -- it was $2 million this quarter and how about the first quarter?

The first quarter was very low. It was only about $250,000, $300,000 -- $500,000, I'm being corrected. It was very low in the first quarter.

So I would assume, I mean, you would expect especially if you're slowing multifamily, you'd expect a pretty healthy amount, prepayment penalty income coming through the NIM. So is there any -- does that $260 million to $275 million include a healthy amount of prepayment penalty income?

So Frank, what we do is, we take a look at historically what we've collected from prepayment. We then take a look at the rising interest rate environment and consider the probability of extensions that is the people going out further on their line. We recognize that multifamily does not behave like one-to-four family residential mortgage loans. And so we don't extend nearly to the extent you do on one-to-four family loans but we do, do that. And so what we're essentially doing is taking our historical averages, taking a haircut to that given the current interest rate environment and then using that number.

(Operator Instructions) We'll go next to Russell Gunther with Davidson.

Wanted to follow-up on the margin discussion. That $260 million to $275 million guide over the next year or so, does that include what you were talking about in response to Mike's question, the benefit from the transfer fund pricing if you can get funding below the 3%?

No.

So there's potential upside if that's achieved to that guide? Okay.

That's correct.

Great. And then on the non-QM resi mortgage, is that what we saw come through this quarter? Could you just kind of quantify where that stands and targets there?

Yes, that's correct. It was -- this one turned out to be purchase of a portfolio. And so we are continuing with those efforts. I think you'll see us continuing to see where we can acquire loans with the durations that matches or is better than what you see in the multifamily business and yields and the credit which is much better than that. That's what we are focusing on.

Okay, great. Last question for me on the better-than-expected resolution of specific problem loans. Could you guys just give us some color on the type of loans that secured better than expected, maybe type when they originated, any kind of color there?

Yes. Go ahead.

Yes, so some color on that. These loans are pretty significant loan balances, they were largely legacy loans, that is that they were acquired portfolios back in 2009, 2010, 2011 that had defaulted subsequent to that and we are working through. We had in the course of working through them, had written them down to our estimated net realizable value as required by the accounting guidance. But then in liquidation of those assets, we were able to realize more, and so we realized almost $1 million of benefit from that this quarter.

(Operator Instructions) We'll go next to Bill Dezellem with Tieton Capital.

A couple of questions. The first one is relative to the white label opportunities, would you please give us an update with that segment?

Yes. Tremendous progress has been made towards execution of the white label. We have an understanding with our white label partners that we want to delay disclosure as long as practically possible. So whenever we do our filing with the SEC, one of the comments we got from the SEC was to disclose their NIM. So obviously, before Flagship does their IPO, their NIM will be disclosed.

And has that relationship actually begun yet? Or is it still in a work-in-progress phase?

No, no. No, that hasn't begun yet. But that is expected to begin in the fourth quarter of this year, and so it is of the nature that it's going to be nationally known, so you will not miss it.

That is helpful. And you said Q4 is when it will launch, is that correct?

That's correct.

And then my other question is, if you slow your growth rate from that 20-ish percent level down to the 10% to 12% level, as you referenced, when you move your capital levels to the range that you want to be in, from that point forward, are you anticipating being self-sustaining in terms of those capital levels and not in need of additional capital raises after that? Or how are you conceptually thinking about future capital raises relative to that new 10% to 12% growth rate?

No, we are very hopeful that with the 10% to 12% growth rate there would be continued improvement in our capital ratios. And we will remain very disciplined from a capital allocation process point of view. And it all depends upon the external environment, you'll see the yield curve normalizing. We may be opportunistic and we see opportunities to create higher returns for our shareholders, we may even access the capital markets at that time. So those are the kinds of things that -- the commitment from us is that capital allocation, we take it very seriously and the management of capital very seriously. And so if you see an inversion in the curve, we might taper our growth rate even more rather than take short-term risk just to create profits in the short term with a very low quality balance sheet, that's not something we are doing. We are building a balance sheet which today has 42% of its loan as C&I loans. We haven't made an acquisition, this is organically grown business. And we think, there are very few companies which have -- 42% of their loans are C&I loans. And where we are different from others is, they are funding them with consumer deposits by hoping that the consumers will never ever, ever break up. Well, that's a strategy that's based upon hope, our strategy is based upon actions. So we are trying to keep our cost very low and continue to build our franchise and we have decided that C&I is the most important part of a business bank's franchise and we will continue to build it, but only in a way that is profitable for us and if this curve inverts, we might even start buying back stock.

Thank you. And it appears we have no further telephone questions in our queue at this time.

Okay. Well, thank you very much for taking the time. I really appreciate your interest and look forward to the next quarter. Have a good day.

That will conclude our conference. Thank you all once again for joining. You may now disconnect.