Bancorp Inc (TBBK) 2016 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to The Bancorp Incorporated Second Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. (Operator Instructions) As a reminder, this conference call may be recorded.

I would now like to turn the conference over to the Andres Viroslav, Director of Investor Relations. You may begin.

Thank you, Nicole. Good morning and thank you for joining us today for The Bancorp's Second Quarter 2016 Financial Results Conference Call. On the call with me today are Damian Kozlowski, Chief Executive Officer; and Paul Frenkiel, our Chief Financial Officer.

This morning's call is being webcast on our website at www.thebancorp.com. There will be a replay of the call beginning at approximately 12.00 PM Eastern Time today. The dial-in for the replay is 855-859-2056 with a confirmation code of 47292256.

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 impressions 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 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 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 would like to turn the call over to The Bancorp's Chief Executive Officer, Damian Kozlowski. Damian?

Thank you, Andres. Hello, good morning and thank you for joining us today. My name is Damian Kozlowski, I'm the CEO of The Bancorp and the President of The Bancorp Bank. I've been in these positions since June 1 and I welcome you to my first earnings call.

Our second quarter earnings were disappointing, but I believe there are significant positives that will improve our earnings and lower our earnings volatility on a go-forward basis. First, we have revenue momentum across our lines of business. In time when banks are struggling for single-digit revenue growth, The Bancorp delivered revenue growth across its lines of business and grew net interest income 23% on aggregate year-over-year. There are several positives to highlight that support our continued growth. We closed on a $60 million leasing acquisition that will be accretive to revenue. We hope to do similar transactions in the future to grow our leasing business through acquiring new clients and entering new geographic markets. We also hired a new leader of our SBA business, Jeff Nager, who comes to us from SunTrust where he had lead and built their SBA business. And lastly, despite regulatory constraints, the gross dollar volume generated by our payments business continues to experience double-digit growth by retaining and growing our client relationships.

Second, expenses will decrease in the coming quarters. Our BSA related lookback has now been completed and additional [K through] expenses should be significantly less in the third quarter versus approximately $13 million in the second quarter. I expect lower volatility from our discontinued operations that had been a drag on earnings.

We are looking to realign our expense base and focus our businesses. We believe we can substantially lower our operating run rate by 20% to 25% without significantly affecting revenue and then long-term have a healthy operating leverage with double-digit business revenue and single-digit expense growth. In addition, as we resolve regulatory and performance issues, I believe we will also find additional opportunities to streamline our platform, reduce the reliance on consultants and lower our regulatory costs.

Third, we are very focused on addressing all regulatory issues quickly. We have made significant progress in this area, but a new focus has been placed on dealing with all issues that face the Bank and resolving them comprehensively. We are developing an integrated plan to deal with all issues in a systematic process. This process will be institutionalized to prevent further issues with our regulators.

Four, we are currently creating an integrated and comprehensive business plan for the Company. The plan will be completed by September and many of its provisions will be implemented by the end of this year. The plan focuses on reducing costs and maintaining business momentum, while significantly increasing our platform's productivity. The plan will include an enterprise view of both strategic priorities and risk management. And the plan will help us realize our earnings potential over the next three years and have a significant impact on the 2017 results.

In summary, I believe that Bancorp has a unique opportunity for success. We have significant fees as a percentage of revenue, higher spread, low risk, specialty lending businesses and a low funding base. The Bancorp should simply be more profitable. I believe we can make significant progress in creating returns for our shareholders over the next year and I look forward to updating you on our progress in these earnings calls. Now, I'm turning the call over to Paul Frenkiel, our CFO. He will review the financial results in more detail.

Thank you, Damian, and good morning.

Two significant factors were reflected in the reported net loss for the second quarter. First, charges related to discontinued operations loans, based on quarterly valuations by third-party loan review company, was $17 million. An additional $15 million of charges were taken on discontinued loan which were financed by the Bank and recorded as investment in unconsolidated entity on the balance sheet.

Second, lookback expense during the quarter amounted to $13.4 million. However, lookback expenses were concluded in July, so post-second quarter expenses should be significantly less. As a result of the above charges after-tax income was additionally reduced during the quarter by $3 million in additional deferred tax valuation allowances. In addition to that allowance, $5 million of previous year's allowances are also projected -- are projected to reverse in 2017. Thus, in 2017, net income should benefit by a total of approximately $8 million, based on those projections.

Sales of discontinued loans continue to be pursued. Notwithstanding that there were no sales during the quarter, discontinued loan balances continue to be reduced. At June 30, 2016, unpaid discontinued loan principal of $494 million includes $70 million of residential mortgages, which may either be sold or retained. That leaves $424 million of commercial loan principal less a mark of $23 million or approximately $401 million of net discontinued commercial loan balances, which compared to $451 million at March 31, 2016.

The reductions reflect loan pay-offs and loan charges of $17 million in the second quarter. The $23 million mark at June 30, 2016, compared to a $46 million linked quarter mark. The difference reflects that loan balances and marks which were offset based on review of the underlying loans.

At June 30, 2016, the largest 15 discounted loan relationships amounted to $300 million and had a mark of approximately $11 million. Of the $300 million, approximately $37 million are non-performing. Those non-performing loans had minimal mark, as the accumulated marks were largely offset against principal, based upon the review of individual loans as noted earlier. The $300 million principal for the 15 largest relationships compared to $337 million at March 31, 2016.

Year-over-year increases in our primary lending lines of businesses were reflected in a 23% increase in net interest income. The year-over-year increase for SBLOC balances, our largest lending line, was 18% with 40% and 42% growth for SBA and leasing respectively. The leasing increase reflected a $60 million purchase of small fleet lease receivables similar to those we originate. Loans held for sale for the secondary markets continued also to contribute significantly to net interest income.

Linked quarter change in certain loan categories were modest, reflecting seasonality and organizational changes in the SBA department. These lines of businesses have historically had low charge-off. Bancorp increased its period end investment balances over the linked quarter by approximately 6%, primarily with highly rated variable rate securities. Investment securities are not planned to be increased significantly as a result of continuing loan growth. Prepaid deposits are the largest funding source and should adjust to only a portion of future increases in market interest rates. Prepaid deposits at June 30, 2016, amount to $1.9 billion or approximately 17% higher than the $1.6 billion at June 30, 2015. The interest margin should also benefit from the impact of rate increases on variable rate SBLOC and SBA loans.

The net interest margin for the quarter was 2.73% compared to 2.23% in Q2 2015. The increase reflected a reduction in balances at the Federal Reserve Bank earning nominal rate and the 25 basis point increase in rates in December 2015. The reduction in Federal Reserve Bank balances and improvement in net interest margin reflected the full quarter impact of the exit of nonstrategic deposits in first quarter of 2016.

Bancorp supports many of the industry's leading players in payment. Continuing initiatives are projected to contribute to double-digit GDP growth and corresponding fee growth. Prepaid card fee income increased approximately 21% to $13.5 million for the quarter compared to $11.1 million in Q2 2015. Non-interest expense excluding BSA lookback for Q2 2016 increased to $43.7 million from $37.2 million for Q2 2015. As Damian indicated, detailed planning for expense reduction is well underway and is expected to significantly impact 2017 results.

Damian, this concludes the financial report.

Thank you very much, Paul. Operator, please open the call for questions.

Thank you. (Operator Instructions) William Wallace, Raymond James.

I guess it's probably early to talk about the kind of ongoing operations. Damian you're putting together a pretty comprehensive plan, as your expectation that you will announce the plan with specifics on target metrics, whether it's efficiency ratios, dollar expense levels, ROA, ROE, what's -- how should we expect to learn about this plan?

Well, we're going to detail through -- in different formats to different audiences. We're going to provide where we expect to be over the next three years. We're not obviously going to predict earnings, but we'll give you targets around the ratios that we're looking at, how we'll sit in the market versus overall profitability in the market and also above -- compared to our competitor set. So, we'll give you a lot of transparency around which businesses we'll be in and what are targets, what we expect growth to be, but we won't expressly predict earnings.

And we'll get this next quarter?

Yes, we'll get -- we'll be pretty much done. We -- in September, we'll have this plan reviewed and approved by our Board of Directors and we will release parts of that to the marketplace after that, probably at the end of the third quarter.

So, you haven't had a lot of time to dig into the discontinued portfolio, but to the extent that you have knowledge, I would -- I'm a little bit confused as to exactly what happened, and Paul, you went through it pretty quick in the prepared remarks, but you have $494 million of unpaid principal as of the end of the second quarter, $424 million of that is commercial, and has a $23 million mark against it, is that correct?

Correct.

And that mark was $46 million last quarter?

Correct

So, what happened to the $23 million?

So, what we did was, we reviewed individual loans within discontinued operations that had marks against them. So, I'll give you an example, if you have a loan that was marked down to the appraisal and we expect, based on current planning, to sell at the appraised amount, we would then offset the accumulated marks against both the loan principal and the marked account. In other words, it's a better presentation to reflect the loan balance at what you really expect to collect.

Just to add to that -- go ahead, ask the question.

So, but then there was a $17 million charge in the quarter.

Yes, so, here is the math --

Are you writing down --

Yes. Here's the math. We had $46 million in accumulated mark at the end of the third quarter. We added $17 million and we subtracted $40 million and the $40 million was basically what we offset against principal. And that was based on situations like the one I just described that, if at this point in time, based on our review of the loan, we're going to get the net amount -- it's a better presentation to show the loan principal net of the reserve. So, you basically reduce the mark -- the accumulated mark and you reduce the principal.

And the thing I was going to add is that I have spent a lot of time since I joined on June 1 with our third party but also internally to review those loans. It's one of the things that were the highest priorities when I came into the institution. So, I feel comfortable that the process is in place to review them adequately and make sure that the marks are correct. I have even gone to the extent of visiting some of our collateral to make sure that I felt comfortable with the appraisals.

So, why -- I guess, if these are quarterly appraisals, these seem like big moves, especially given what was said last quarter about the confidence in the carrying values of these loans. So, I mean, you got to get rid of these loans, right. So, how can you get rid of them? Is there a plan in place that you can get rid of them quickly? Is this -- did you take the last hit this quarter, can we -- I mean, just how do you get rid of these things?

Well, we do think -- I do personally believe that we'll have less volatility out of this portfolio. Having done these workouts before, I think we're looking at a three-year period where these loans will run down. There are portions of the loan book that are performing well. So, if you can think about the -- we think we'll be able to have the exposure in the next year and a half and then get down to a small -- under $50 million within the next two-and-a-half years, that's the plan. What we've done is Gantt chart each loan to make sure we know the timeline when we can pay down principal and make either dispose of the loan by getting the collateral or giving the borrower the opportunity to refinance the loan, that's generally.

So, was there any change in the firm that was hired to do the appraisals this quarter versus last quarter?

No. There was a third party provider and then it's reviewed by our auditors.

Okay. So, in one quarter the value of these loans deteriorated $17 million -- was this the collateral value or was this the cash flow value?

Yes. We're looking into some -- possibly giving more detail in the 10-Q. I would say that loan charges during the quarter partially reflected strategy to liquidate certain unique collateral and properties to expedite resolutions. In other words, we want to put these loans behind us and get on with our continuing operations. So, there were some strategies to do that.

Okay. I think it would be helpful as an outsider looking in, if we could see -- it sounds like you're writing down principal balance. So, what's the original contractual balance of these loans? You're writing down principal, am I correct? Is that what -- that's what --

Correct. In sense you're correct, we're writing down the principal to the amount that we believe we'll actually collect and the example I gave on the sale of the underlying property.

So, the $424 million, if you net out the $23 million mark on that, you have $401 million. What is that value versus the original contractual value? How much have you written these down to, is that something that you can provide --

I don't that right now. We actually have [to get that].

No, but maybe you could put it in the Q?

Yes. I'll make a note and look to see how practical that is, some of these loans go back a considerable amount of time. So, it actually would -- it is not an easy thing to do. I think the significance -

I mean, look -- I guess, I can't figure out of if you're trying to say that maybe you guys ripped the Band-Aid off this quarter and you're trying to take a hit now to not have to take another hit in the future and if so whatever color you can provide around how low these things are being carried now versus some level of value [par] is probably the best way that we can look at it as outsiders?

Okay. I will look at that issue. That's a fair point. I will look at that issue. Understood.

Okay. And then can you talk a little bit about the charge on the off-balance sheet trust that you guys financed when you moved what was the bad part of the portfolio at that time. What's going on there?

Well, it was related -- the largest portion -- the largest component of that charge was actually related to a loan relationship that we took in the charge from discontinued operation. So, it reflects, as I mentioned before, strategy to liquidate unique collateral and properties to move on and resolve those loans.

I thought that there was another party that was managing that cost as for that part.

Yes, so you are right, because there was an independent investor and the loan -- the charge that we did take was partially absorbed. Our target is to reflect our portion of the loss, but the independent investor also realized the loss in those properties.

So, don't you have a loan financing that trust?

Correct. Yes. It appears on the balance sheet as investment in unconsolidated entity.

And so this doesn't flow through as a charge-off. You just write down the value of the investment.

Exactly, that's exactly right. And that appears as a separate line. That appears in a separate line item in the income statement.

And is there -- is that -- do you have the same person or firm or company that's valuing the value of those loans versus the ones that are in your discontinued ops?

We actually use multiple companies, but our primary loan review company -- we have one loan review company for discontinued ops and we have another one that also does work on that, but also -- but it is more specific to the Walnut Street investment in an unconsolidated entity.

And then my last question and then I'll hop out. On the balance sheet, where should we see the carrying value of that? You said it's an investment in an unconsolidated entity, but where is the line item for the loan?

Well that is the loan, in essence, that is the financing, it appears -- (multiple speakers).

But that's the one you are speaking to?

Yes, exactly.

So, there is no -- there was no principal pay-off in the quarter, just the $15 million -- ?

It was minimal during the quarter. The principal pay-off was minimal during the quarter.

I mean, obviously, I think for us as outsiders looking at stock, it would be helpful to have some view of where these things are being carried relative to par, just to get a sense as to how much of a discount you have taken and then any color you can provide on non-accruals, delinquencies, inflows into non-accrual, just to get a sense of this, because I think we would like to -- as you mentioned, we would like to put it behind us as well as outsiders, I know everybody would like to put it behind us. There is some level of comfort around whether or not we're close as much as you can provide, I think, would help us. So that's all. I'll hop out and let somebody ask a question.

Frank Schiraldi, Sandler O'Neill.

I got -- for the value off of par, I mean, I think it was 93% last quarter, even marked off of par and so I'm just getting like 87% now on this discontinued ops book, is that reasonable or do you have -- does that sound right?

I'm going to look at the original mark, because there is movement during the quarter where we made some adjustments in prior quarters, where we offset the mark against the loan principal. So, I'll look at that and we'll have to report back to you.

Okay. So you've done that in the past, where you've offset, where part of the mark has reduced the principal and so (multiple speakers).

Yes.

Okay. And then I guess in terms of like this additional mark it seems like, and then correct me if I'm wrong, maybe this mark is sort of bringing these items down to where the market is and you could potentially be able to move a decent amount of this off-balance sheet through sales in the short term or is that not what you're saying?

Yes, I think that's what the numbers say, in other words we've reduced principal to the amount that based on the current plans to dispose the property, which may change, but as of now, we offset the mark against the principal to reflect what we believe we'll actually receive in terms of payback.

Well, in terms of payback or what you could get in the market now for if you --?

They're the same, because there is -- in the example I gave, it was written down to the appraised amount. The current plan would be to sell the property and so that's what we think we can get and it is current market value.

Okay. And then, would the same be for the investment in the unconsolidated entity. Is that -- could we start seeing more of that be liquidated as well given these marks do you think?

That depends on individual loan-by-loan analysis, we have a company that's doing that and they are pursuing. Clearly everybody wants to dispose of those loans on an accelerated timeline, but as Damian mentioned, it's a multi-year process, it's not going to happen -- and it's going to be spotty.

And then just a question on the size of the balance sheet. I think end of period, the balance sheet was pretty similar in size to where you were end of period last quarter and the average size of the balance sheet was a bit lower through the quarter. So, I'm just wondering what's the better way to look at the size of the balance sheet going forward, because I know with deposit inflows and outflows it can move significantly into or out of the end of a quarter. Is it a $4 billion average balance sheet at this point, have you -- is that a better way to think about it going forward and is there more that you see coming off in terms of deposits that shrink the balance sheet further?

So, the only -- really the only way to look at it is to look at the average balance sheet, which we disclosed in the earnings release in the 10-Q, because we're in the payments business, we have certain very large customers that have significant fluctuations, for instance payroll providers, their deposits tend to fluctuate on payroll days once a week, twice a month, end of the month and so forth. So, if the quarter end happens to hit one of those days, which on a random basis they will, that distorts the deposit levels and the asset levels, which actually happened on June 30. So, June 30, the total assets were $4.4 billion, but the average is really the only way to look at it. So, we averaged in the quarter $4.1 billion as you can see on the average balance sheet that compares with about $4.4 billion in the first quarter. And to answer the second part of your question, yes, we are looking at other non-strategic deposits and certain other exits that's one of the tools that we manage -- basically manage our assets with. So, we are looking at that, and that is a definite possibility.

Okay. So, like you finished the quarter with 6.5% TCE ratio, which I think is a pretty good proxy for Tier 1 leverage, and obviously, if you just think about the average balance sheet, you said you're up over 7% there. So, where do you guys need to be on a Tier 1 leverage ratio at the Bank in the short term and can you get there with just further shrinking of the deposit base on the balance sheet?

Well, I think the short- to medium-term we have to be in the 8% Tier 1 leverage ratio. So, there is a gap and as you know, there are three ways to close that gap. We can either delever, reduce the balance sheet, we can accrete significant earnings or we could raise capital and those are the three ways -- tools we can to raise that leverage ratio.

I mean do you think you can do that just with delevering or will you need one of those other tools to get to 8% in the short-term?

I can't comment on which tools we are specifically going to use, but we need to be at a higher -- we believe the Board of Directors, myself, the CFO, all believe that we need to be at a higher Tier 1 leverage ratio in order to support the business that we run and to be fully viewed by our regulators as -- make sure that we have enough capital for our business.

Okay. And then just wondering if you could talk a little bit about the prepaid growth -- fee income growth; it was really strong this quarter and year-over-year basis; it was close to around 20%. I've been looking for low-single digits. So, if you could just talk about what's driving or drove that and maybe your expectations. I know it can be choppy, but your expectations for run rate going forward?

We actually have numerous types of fee income that gets reflected in the fee income account; as you correctly stated, it is somewhat choppy. So, we're not really predictive other than to grow -- the GDV growth, we don't really predict the fees. It's very difficult to predict. So, --

We do have a lot of client stability. We are growing individual -- our top client -- the part of the business where we can accept new clients, we're getting new clients. And so you're getting this double-digit GDV growth in the teens to mid-teens. And with all the types of fees, transaction fees, incentive fees and everything else we get, those come a little bit spotty, but generally the volume goes up, your revenue is going to go up. And so, we're still having strong client relationships. This payments industry is maturing. They are players that are exiting. You can expect consolidation in the industry in these product sets, but also you can expect slightly lower fees over time. So, it's something that's been played out so many times in financial services; the lifecycle matures, there are bigger players, they get more scale, they get more efficient and fees drop. So, we think we can be one of those players long-term and so I think you'll continue to see us increase our volumes.

Okay. And then have you talked about GDV -- I mean, GDV grew in the double digits. Have you guys guided to any level of growth, I can't remember, going forward there, is that kind of a pretty good consistent expectation of GDV growth? Any sort of I guess deposit relationships you exit out of?

We continue to believe that we're going to experience double-digit growth based on our knowledge and the department head who is very, very good in that business. So, that's what we're anticipating.

And then plus the macro environment is playing out. It supports continued GDV growth.

I just wanted to make sure I didn't have anything wrong. I mean, I saw prepaid processing fees were up 20% year-over-year. Is that -- you didn't change the way you calculate that at -

No.

No.

We actually received that income monthly. There's no accounting for it in essence. We received, we performed the services -- whatever income we received, it is actually received.

So, I mean, I guess, not to beat a dead horse, you would think, in the past, GDV kind of has grown at a more accelerated rate than the prepaid processing fees because -- I think in part because of their big partnerships and there's volume discounts. So, that would -- you would expect the relationship going forward? Are you on --

Yes. I think what you're seeing is the timing of incentive fees and that's what you are seeing the difference between revenue growth and GDV growth. Generally, what you'll see going forward is that revenue growth should slightly trail GDV growth as pricing continues to compress slightly. And I would underline slightly over time, for the next three-year time horizon of our business plan there probably will not be substantial price compression, but there will be over the next 5 or 10 years, as there's a lot more of convergence in the payment space between this type of delivery system and others. So, you will see a continued pressure for leaving this part of the industry, volumes going up and pricing compression over time.

Okay and then just finally, Damian, you referenced a couple of times resolving all regulatory issues is obviously something you guys are focused on, but when you say all regulatory issues, I mean, you're really just talking about BSA, AML, right. I mean is there anything -- ?

No, I'm talking about all issues that (inaudible) bank across --. As you know, the regulatory environment has substantially changed over the last 10 years and so the standards for all banks are very high. So, we're focused on the enterprise risk management. We're focused on every finding that our regulators have regardless of the regulator to make sure we're tracking that, resolving it, explaining it comprehensively within our business model and making sure the regulators proactively are up-to-date on the strategic moves of the organization. And that's very systemic and we're going to make it very institutionalized, so that when there is a finding from our regulators, we can interact with them in a way in order for us to understand together how we need to resolve it so they are comfortable and we can do business.

Okay. I mean obviously the big outstanding issue still is the BSA, right, I mean that's the--?

Yes, of course -- of course, but it's not -- as banks have changed, it's the entire -- the whole -- there are many areas in this bank that are, I would say, they are at the state of the art for the industry, but things change very quickly nowadays and we have to have a process in place to deal with them, as they're uncovered or as our guidance changes and we just want to make sure that's institutionalized. Most organizations do get in trouble because they wait for the regulators to find things rather than you find them yourself and you deal with them collectively. And that's maybe not a change in the way this bank is, but that's how it's going to be done going forward.

Thank you. And I'm showing no further questions at this time. I'd like to hand the call back over to Damian Kozlowski for any closing remarks.

Okay, thank you. I just want to thank everyone for attending today. We appreciate your interest in our Company and look forward to speaking with you again. This completes The Bancorp Bank's earnings call. Thank you very much.

Ladies and gentlemen, thank you for participating in today's conference. That does conclude today's [presentation]. You may all disconnect. Have a good day, everyone.