TBBK - NASDAQ

Good morning, ladies and gentlemen and welcome to The Bancorp Second Quarter 2023 Earnings Conference Call. [Operator Instructions] This call is being recorded today, Friday, July 28, 2023. I would now like to turn the conference over to Andres Viroslav. Please go ahead, sir.

Thank you, operator. Good morning and thank you for joining us today for The Bancorp’s second quarter 2023 financial results conference call. On the call with me today are Damian Kozlowski, Chief Executive Officer; and Paul 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 available via webcast on our website beginning at approximately 12 p.m. Eastern Time today. The dial-in for the replay is 1-877-674-7070, with a confirmation code of 720317. 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 within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to risks and uncertainties, which could cause actual results, performance or achievements to differ materially from those anticipated or suggested by such statements. For further discussion of these risks and uncertainties, please see The Bancorp’s filings with the SEC. 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 maybe made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Now, I’d like to turn the call over to The Bancorp’s Chief Executive Officer, Damian Kozlowski. Damian?

Thank you, Andres. Good morning, everyone. The Bancorp made $0.89 a share, 41% revenue growth and 17% expense growth. ROE was 27% and ROA was 2.6%. Core loan growth quarter-over-quarter reflected a reduction of 8% in institutional lending and respective increases of 2% and 4% for our small business, commercial and real estate bridge lending businesses, which also showed 10% and 65% growth year-over-year, respectively. NIM increased to 4.83% from 4.67% quarter-over-quarter and 3.17% year-over-year. Gross dollar volume growth in our fintech solutions payments business was 15%, continued strong growth across verticals with only general purpose reloadable showing a decline. New corporate payment programs continue to show growth significantly above expectations. The Bancorp continues to be well positioned in the current environment. Our balance sheet flexibility, lower credit risk and high level of core insured deposits support continued improvements in profitability regardless of potential dislocations or weakening economic conditions. While the sharp increase in the Fed Funds rate affected our growth in loans, this impact was mostly following our institutional business, which is comprised of our SBLOC and IBLOC variable rate consumer loans. Long-term historical growth trends seem to be normalizing and pipelines across our businesses are increasing. Our fintech solutions business continues to show strength, supported by current programs, the addition of new products and the implementation of new partners. Due to significant implementation times that can last 18 to 24 months, we have good visibility on the potential growth in 2024. Our current estimate is that we will have above trend GDV growth in 2024 of more than 15%. Key areas of growth are neobanks, healthcare and new corporate payment programs. In addition, we continued to strengthen our relationships with our key members of our ecosystem and recently signed a long-term extension and expansion of our partnership with Chime. We continue to invest a lot of time and energy across our company in the development of new products and services, especially expansion of fee businesses and the monetization of our core capabilities. As we approach the Reg II Durbin Amendment, restriction on our balance sheet size of $10 billion. We believe we consistently grow the business without needing additional balance sheet above that limit. Lastly, with continued strong business momentum and a favorable balance sheet position, we are confirming our ‘23 guidance of $3.60 a share without the impact of anticipated stock buybacks of approximately $25 million per quarter. In the third quarter earnings release, we will give both preliminary guidance for 2024 and indications of our buybacks for next year. I will now turn the call over to Paul Frenkiel, our CFO, for more color on the second quarter.

Thank you, Damian. As a result of its variable rate loans and securities, Bancorp continues to benefit from the cumulative impact of Federal Reserve rate increases. That factor was the primary driver in increases in return on assets and equity for Q2 2023, which were respectively 2.6% and 27% compared to 1.7% and 19% in Q2 2022. These increases reflected a 60% increase in net interest income. In addition to the rate sensitivity of the majority of our lending lines of business, management has structured the balance sheet to benefit from a higher interest rate environment. Accordingly, over a period of years, it has largely allowed its fixed rate investment portfolio to pay down while limited purchases were focused on variable rate instruments. Additionally, the rates on the majority of loans adjust more fully than deposits to Federal Reserve rate changes. As a result, in Q2 2023, the yield on interest-earning assets, have increased to 7% from 3.6% in Q2 2022 or an increase of 3.4%. The cost of deposits in those respective periods increased by only 2% to 2.3%. Those factors were also reflected in the 4.8% NIM in Q2 2023, which represented another increase over prior periods. The provision for credit losses was $361,000 in Q2 2023 compared to a credit of $1.5 million in Q2 2022. Q2 2023 net charge-offs amounted to $938,000. Prepaid debit and other payment-related accounts are our largest funding source and the primary driver of non-interest income. Total fees and other payments income of $25 million in Q2 2023, increased 10% compared to Q2 2022. Non-interest expense for Q2 2023 was $49.9 million, which was 17% higher than Q2 2022. The majority of the increase resulted from salary expense, which increased 28% and which reflected higher numbers of staff and financial crimes compliance and information technology. Staffing increases reflected higher deposit transaction volume and the development of new products. The increase also reflected higher employee incentive and stock compensation expense as a result of a focus on stock ownership. Book value per share at quarter end increased 19% to $13.74 compared to $11.55 a year earlier, reflecting the impact of retained earnings. Quarterly share repurchases should continue to reduce shares outstanding. I will now turn the call back to Damian.

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

Thank you, sir. [Operator Instructions] Your first question will come from Frank Schiraldi at Piper Sandler. Please go ahead.

Good morning.

Good morning, Frank.

On the – on GDV growth, another strong quarter. And I think, Damian, you said that we should expect above 15% going forward. I am not sure if I heard that right, but if I did, anymore color just in terms of – if you could put some sort of guardrails around that statement?

Okay. I did say that and I said that for 2024. So we have a very good understanding of the projects under implementation and new product expansions. So, these implementations, we have discussed this before, can take 18 to 24 months to fully implement into our ecosystem. So looking at that pipeline, we are fairly confident that we will get above trend growth for ‘24. So above that 15% level which has been kind of a historic breaking point between slower and kind of the trend line for the last 7 years, which is actually 16%, but above 15% to make it easy.

And then in terms of just the new partnerships, new programs you are signing, is there any pressure on margins there? Just wondering what sort of a take rate is from 15% or above in terms of the revenue stream that provides through fee income?

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

Okay. Great. And then on the SBLOC contraction balances this quarter, you talked about sort of normalization. So do you expect to see more run-off here? Can you offset that with other loan sources? Or what are your thoughts about both total – SBLOC and total loan growth here in the near-term?

Okay. So they are – our pipelines are increasing, so we should see less runoff on the institutional side. That was obviously with the historic rise in interest rates, the price-sensitive clients who are borrowing against their securities insurance kind of fell out of the loop. And there is been some pricing pressure from industry players that we haven’t chased. So – but we do see our pipeline growing and some competitors have raised their prices. So we should have less runoff in the third quarter. And that also depends, obviously, how aggressive the Fed is too. The other pipelines are fine. They continue to grow those books of business. And remember, we have two concerns. One is those – if we do get paid back on those loans to go and the Fed funds obviously at 5.25, which the – we don’t get hurt that much on the spread. And we’re constantly repricing our portfolio as new loans. We do new loans and they run off our sheet. So it doesn’t really hurt us. Plus, we’re kind of husbanding cash right now on our balance sheet is, we are ultimately going to buy bonds to get a lot more fixed rate securities exposure. So we’re not very concerned about the run-off of that business. It seems to be normalizing and will – and it doesn’t hurt us that much. So we’re – I think we’re in a fantastic position on our balance sheet to be very responsive to the current environment.

Okay. And it seems like with the Fed’s commentary and what the market is expecting, we’re getting maybe pretty close to the end here in terms of Fed rates. And so would we – do you think we expect to see securities purchases at the back half of this year? Any sort of size range you think of when putting securities on the books here, what we could see in terms of securities to asset ratio by year-end? Any thoughts there?

I don’t think we’re going to buy securities. This isn’t a guarantee. I don’t think it’s going to happen to the end of this year. I think you’re still going to have a fairly inverted yield curve, and that’s probably going to disinvert next year. So I don’t think the securities purchases will happen this year, but I – we’re being very nimble on this. We have to pay attention to what’s going on in the marketplace. I mean strange things happened. You saw the 10-year move last year on news in Japan. So you never know what’s going to happen, and we will take advantage of those opportunities. So I would expect them to happen probably midpoint next year. And we are way – our balance sheet is actually smaller than it should be. If you look at the amount of securities we have versus our peer group and general and banks, we have at least 15% room to add security. So $1 billion, $1.5 billion we could add pretty easily. And now that we have such a great amount of liquidity on the balance sheet, we will be able to do that very effectively without having to borrow into the market or anything. So I think we’re going to keep it. We’re being – we’re watching every second of every day. We are in a fantastic position, obviously, because we had really anticipate the interest rate increases. And we’re slowly moving back up the fixed rate scale. So if you looked at what we did over the last 4 years as we went from the mid-30s to 26% fixed rate assets, and we’re already back to 32% fixed rate assets and have taken 11% asset sensitivity off the board because now we’re flexing the balance sheet back to a fixed rate structure with a target of 60% in order to mitigate our deposit beta, which is about that. So I think we’re going to be very flexible over the next 18 months. I don’t think there is going to be a big change in rates, and we’re going to have time to adapt to change our structure to be much more fixed to mitigate the downside impact that there is rate cuts.

Right. Okay. And so you’re saying 60% fixed. I mean the deposit beta is like 40%, right, in terms of the...

Yes. So it would basically wipe out – it would lock in the profitability up and down, by the way. So that’s why we’re wait and see. So we could get the 6% on the Fed funds. But that – what happened – obviously, what happened yesterday on continuing claims, durable good orders on GDP were all very big surprises that show that the economy is much more resilient. If you just look at our GDV growth, there is a lot of resiliency in the economy. And we still have an 8% – we’re over 8% on the deficit, too, on fiscal spending. So there is a lot of stimulus still in the economy also. So we’re going to just keep an eye on it. And we’re in such a good position that we don’t – it’s kind of where we were with the bond. We didn’t buy a bond for 40 years because we’re in a good position on liquidity and deposits, etcetera. So we’re doing the same thing in this case.

Okay. Alright, great. Thanks for all the color.

Your next question comes from David Feaster at Raymond James. Please go ahead.

Hi, good morning, everybody.

Good morning, David.

Maybe just following up on one of the questions or one of the things you talked about prepared remarks, you talked about expanding relationships. Obviously, we – you extended and expanded the Chime relationship, and you talked about going deeper with the existing partners. Could you expound on that? Where are you seeing opportunity for expansion there? And what other initiatives you have in place to continue to deepen relationships?

So generally, I think people have accepted that they got to be broader fin-tech, especially neobanks, but also other verticals outside of government. You have to be – you have to expand your product set for profitability. So we’re in discussions across all of our major clients that they want to add services. They want to add product capabilities. So this is something that’s happening across the entire franchise. But if you take a large neobank, for example, they are wanting to not just be a debit provider, but they want to build a portfolio of products around their key clients and expand it into credit. So that’s exactly what we’re doing. So where we can support them in doing that, we help them, in many cases, innovate, but also they may be with another provider today that they want to put into our ecosystem that’s happening, but also in the – obviously, in the credit area, where most of the debit providers want to build and start to build both sides of the balance sheet business in order to increase their profitability. So we’re – with our partners, they are very deep relationships over very long-terms. As I just said, we just expanded our relationship with Chime in those areas, and we will continue to do that. I think that’s where the – there is going to be a lot – in fact, we’re not dealing with very many start-ups, obviously, there is going to be a lot less startups because of what’s happened in fin-tech. And the dominant players now who are out there, which many of our clients are looking to significantly increase their profitability and deepen their relationships with their clients, and we’re lockstep with them.

Okay. That’s helpful. Maybe just touching on the pipeline of partners that you have. It sounds like you’re still continuing to onboard folks at a pretty rapid pace. I’m just curious, did has the pipeline, I guess, with the market dynamics, has the pipeline – have you seen continued increases in the pipeline just as maybe this pushes more partners to you? And then maybe as you go through these negotiations, I guess, how is your pricing power? Are you seeing the competitive landscape heat up and maybe you’re having to conceive more? Or just given your dominance in the space and your reputation? Or are you able to kind of defend that in these negotiations?

You have to remember, we’re fairly a small piece of the pie when you’re talking about when we’re in negotiations, it’s not like we’re 50% of their cost structure. So – and it’s something that you can’t mess up. You have to be right all the time, and you have to have a profile now, especially with regulatory scrutiny, where they are sure that they are not going to have a problem on the regulatory issues. So that’s the main reason. We say no a lot of smaller business that are going to banking as a service providers for – because they don’t have the scale and they don’t have the sophistication. So we’re only dealing with the large players in the industry. We – I think we see almost all the large engagements out there and talk to people about them. And there may that you would know. So the ones that we don’t have, we’ve been – probably been in discussions with and – those are potentially some of the programs that will be joining our ecosystem, which we will announce. But we obviously can’t do that now. But our pipeline is very consistent with our ideology of only servicing those larger sophisticated clients that are broadening their product sets. We’re doing very little start-up or banking as service business and that really supports ramping up quickly. So some – in the past, maybe 5, 7 years ago, we had much more of that type of business. Chime, for example, was in this infancy at the time, and that was kind of our portfolio, though we do have healthcare and government cards and everything back then too. And then we also had a large general purpose reloadable platform, which has gone away across the industry. So now it’s converted themselves into the large major players that want product expansion or security in execution or regulatory confidence where we clearly have an expertise. So all that together has really played into all the investments we’re making or have made in building this very unique, very robust, very forward-looking ecosystem for the payments industry, and we’re continuing to invest in it, and we’re focusing on the biggest players with the most sophisticated complex needs who want to really change and grow their client relationships.

Okay. That’s good color. And then last one, maybe just touching on the expense front and to your point on the investments that you’ve made. I’m just curious how you think about the expense run rate. It sounds like the expense run rate may be relatively sticky just given the new hires. Is that fully reflected in here? How do you think about hiring and investments going forward? And then we talked about last quarter, I think the efficiency ratio maybe dipping below 40%. Is that still in the cards from your perspective as you look forward?

Absolutely. So, we have built into the cost structure from what we knew that we were going to have significant revenue increases this year because we had to take a position on the yield curve, obviously, and we set the balance sheet purposely to benefit from it. So, we looked into this year and said we are going to make investments. So, our people – number of people are up about 7%. And we are able – we have had very low attrition, and we are able to recruit great people. And we are going to take advantage. There is a little dislocation, obviously, in the banking industry. So, we are taking a little bit of advantage of that to make sure we set the cost structure up for the next couple of years so that we don’t have big increases. All the increases you see are – we are still getting efficiencies on the operating level, all the increases of our people. That’s the big determinant and being able to innovate. But if you look year-over-year, we have about, I would say, $3 million that really aren’t run rate expenses. So, when you see that increase of the mid-20s in employee costs, there is a couple of categories there, where it’s not really like, like. First of all, we don’t have the same origination, so we can’t have – there is about $1 million of capital costs. You could capitalize the cost of origination that aren’t in this year over year-over-year. Then we have about $2 million. Some of it is because of the proportion we pay in cash bonus versus equity is higher this year, and we had some severance. So, there is about $3 million that really is a built-in cost structure in this quarter. So, when you look year-over-year, we see 17% total. You see mid-20s in the employee costs. The employee cost is really a little bit less, but having said that, next year, we have built into this knowing about this once in a lifetime interest rate increase. So, we are trying to set ourselves up so that we have everything in place, the people, the project list and everything, so we know what we are going to build over the next couple of years so that our cost structure doesn’t rise in the same way that it would during this historic rise in revenue here.

So, kind of front run in the expenses and investing on the front end and we should start seeing the operating leverage maybe start coming next year and really going forward after that?

Yes. We are just not going to grow the employee costs that we have really invested in employees here. So once again, you look at the operating expenses, they haven’t gone up. So, you look on the other operating expenses are flat. I think they are actually down this quarter versus last year. It’s all the real determination of innovation and being able to grow this franchise and really setting ourselves up for the next 5 years is going to be not – determined with all the capabilities and platform and architecture we have built, but we have to have the best people in the industry, we have to pay them well. And we are setting ourselves up to not have experienced the year-over-year increases over the next few years, but to have those people in place to make sure that we can guide the company forward.

Okay. That’s helpful. Thank you.

[Operator Instructions] Your next question will come from Michael Perito at KBW. Please go ahead.

Hey guys. Good morning.

Good morning Mike.

Thanks for taking my questions. Appreciate the color this morning. You guys covered a lot of it. Just a couple of follow-ups. Just on the – as we think about the balance sheet, with the SBLOC loans kind of taken a step down here and possibly being in this higher for longer rate environment, how do you guys think about other areas maybe to add on the loan portfolio side. I mean are we getting closer to maybe kind of credit products taking up a little bit of that baton and starting to represent a portion of the loan portfolio. Did you guys look at maybe any other kind of lower-risk verticals that are tangible to what you guys do because of all the disruption, whether it’s like capital call lines, fund financing like that? Just kind of curious how you are thinking about it if there is maybe room to add another layer to the loan portfolio to help you guys kind of hold those balances as one bucket might move up or down?

It’s interesting you brought up capital call because we have done the people who run the company have done a lot of that in the past and other lives. So, it’s interesting you bring that up, but no. The – we need the room – if you look at – we are very constrained on the balance sheet, and we need to put in fixed rate securities for liquidity and other reasons, right, and to lock in profitability over the next 12 months, right. So, we want to flip from this very variable rate balance sheet to the majority being fixed. So, we are probably not going to add a traditional vertical though we have product expansion. We have had some product expansion, institutional and commercial. We are not going to get out of our box in real estate, most likely of these transitional loans that we are doing of apartments and red and purple states that are really workforce housing. We are not going to get out of that space in a meaningful way. Where we will put on credit exposure is in credit sponsorship. So, we don’t know how big a part – I mean that could be in 5 years, 25% or 30% of our entire $10 billion Reg II limit. So, that’s where a lot of the product development is happening. That’s where it’s going to soak up some of the liquidity. So, once again, we are in an extremely good liquidity position right now. We are not worried about the runoff in the SBLOC, that’s our lowest coupon book and that goes into Fed funds. And we need a bunch of cash in order to buy fixed rate assets. So, we are not worried about it. We have looked at everything across the board. We understand the credit universe very well. Even the more esoteric areas like leveraged finance and everything, we are very familiar with what we could do. But I don’t think – when I talk to investors, that’s what they really want us to do. We have an extremely low risk credit profile, very short duration, very, very low default rates with very high recovery rates. The story here is our funding source, our fintech solutions business and how we are going to manage our business as more of a technology company as we hit $10 billion. That’s the story that’s going to really super size investor value, plus with our high capital returns, rigorously returning that capital through buybacks over the next 5 years. So, that’s the formula. That’s where we are concentrated, and that’s where we think the most value is. And so we are not a traditional bank. We are not going to be growing our assets to $50 billion. We are focused on uniqueness and low event risk. I mean in almost a religious way, we do not want to expose these type of returns to any type of credit risk that we think might have an exogenous shock if we have a substantial change in economics going forward due to interest rates.

No, that all makes perfect sense, Damian. And that was kind of why I mentioned the areas I mentioned. I mean obviously, I totally agree, you don’t want to add credit noise to an otherwise fairly clean credit story, so that makes sense. Maybe a follow-up and you kind of mentioned it, but just I think to Dave Feaster’s question earlier, you were talking about product expansion. And can you maybe get a little bit more specific about the products that you are looking at? Like are we talking about point-of-sale finance solutions? Are we talking about like earned wage access, or early wage access, are we talking about maybe other like credit card or credit builder type products? Just curious what you guys are working on internally that your clients are looking to expand beyond kind of the debit card solutions that you are offering today?

That’s exactly right. Those are the categories. So, things like building people’s ability to access the financial system are very important for the client sets of our neobanks, especially. So, they want tools. And those – and I think people – everyone recognize that the life cycle and being the lead bank and the life cycle personally of a consumer is where you want to be. So, as they grow their portfolio financially, you want to be with them and provide them tools. So, those are exactly right. Those are the areas where there is need building across the spectrum. I mean we are one of the first, obviously, that did a couple of days early to get paid, that’s The Bancorp innovation with our partners. Things like overdrafts being free and limited, of course, not endless, but giving those tools are very important innovations that were – some of those that came with our partnerships from our larger neobank partners. So, we want to be there for – I think we have got a very good meeting of the minds between our partners and us. I mean we have set ourselves up to try to help more than our peer group and our – the banking and service providers. And we are constantly in discussions across the board with our partners around looking at their product frameworks of where they want to go. And so that gives us incredible clarity as to what we need to build additionally to help them innovate. But it’s all around the – for the neobank, mostly around the consumer, their life cycle of wealth, adding tools that helps them, and that also increases our partners’ profitability, so it’s a win-win. And then on top of that, we have all these other verticals in healthcare and government. There is all these that are expanding. And then we have big new wins like in corporate payments, where it’s way above expectations. That’s an area where we got into in a big way last year, and it’s really exceeded our expectations. So, it’s very broad-based. It’s very focused on what our partners want and that’s why we are investing in order to build the capabilities necessary to translate their ideas into real go-to-market products that are safe and sound and will add to the profitability of both the client and the business partner over time.

Perfect. Thanks for the color Damian and appreciate you taking my questions.

Thank you.

There are no further questions on the phone line. So, I will turn the conference back to Damian Kozlowski for any closing remarks.

Thank you, operator. Thank you everyone for joining us today. Appreciate your involvement in our earnings call. And operator, you can disconnect the call.