TBBK - NASDAQ

Good day and welcome to The Bancorp, Inc. Q2 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] Please note today's call will be recorded, and I will be standing by if you should need any assistance. It is now my pleasure to turn the call over to Andres Viroslav. Please go ahead.

Thank you, operator. Good morning, and thank you for joining us today for The Bancorp's second quarter 2024 financial results conference call. On the call with me today are Damian Kozlowski, Chief Executive Officer, and Paul 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 12:00 p.m. Eastern time today. The dial-in for the replay is 1-800-934-5153. Before I turn the call over to Damian, I would like to remind everyone that when used in this conference call, the words believes, anticipates, expects, and similar expressions are intended to identify forward-looking statements with 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 may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Now I'd like to turn the call over to the Bancorp's Chief Executive Officer, Damian Kozlowski. Damian?

Thank you, Andres. Good morning, everyone. The Bancorp earned $1.05 a share, or $1.07 adjusted for interest on a residual security from the securitization business exited in 2020. With revenue growth year-over-year of 7% and expense growth of 3%. ROE was 27%. NIM contracted to 4.97% from 5.15% quarter-over-quarter versus 48% year-over-year. This contraction was primarily due to the purchase of $900 million of long-term fixed rate securities in April at a 5.11% yield. These purchases have mostly been financed through ongoing FinTech program deposits with limited borrowings. Thus, the impact of NIM has been lower than anticipated. The FinTech Solutions Group continues to show significant growth momentum from the ramp up and expansion of new and existing programs broadly across the portfolio, and especially in B2B payments. GDV increased 13% year-over-year and total fees from all FinTech activities increased 13%. This quarter is the first where we will begin to break out our credit sponsorship loan balances and fees and our financial reporting with balances reported as consumer FinTech loans. As a key strategic initiative of the bank and objective of our APEX 2030 strategy, we have spent the last few years building a platform that will enable existing and new partners to issue credit solutions to their customers. These loans will be generally short-term and mostly secured by our partners or distributed to investors. Over the next five years, we intend to build a diversified group of regulator-compliant credit sponsor programs that will mirror our best-in-class innovative capabilities in our FinTech payments ecosystem. On the lending side, we had year-over-year growth across a portfolio of 6%, led by small business lending with growth of 16% year-over-year and 4% quarter-over-quarter. Most notably, our institutional book has continued to stabilize and showed incremental growth quarter-over-quarter of 1%. Concerning our commercial real estate portfolio of multifamily transitional loans, we continue to expect little or no losses due to the current portfolio and individual loan leverage and our underwriting standards for loans at their inception. We recently entered an agreement to sell our one OREO multifamily property expected to close in December ‘24 with a sales price to cover the current other real estate owned balance plus the forecasted cost of improvements in process. Lastly, with continued strong growth in our FinTech activities, including credit sponsorship and growth across our lending portfolio, we are lifting our guidance to $4.35 from $5.25 a share without the impact of $50 million per quarter of share buybacks in 2024. We intend to issue preliminary 2025 guidance in our third quarter press release. I now turn over the call to Paul Frenkiel for more color on the first quarter.

Thank you, Damian. As a result of its variable rate loans and securities, Bancorp performance continues to benefit from the cumulative impact of Federal Reserve rate increases. Additionally, as Damian stated, the purchase of $900 million of fixed rate U.S. Government sponsored agency securities in April 2024 has significantly reduced exposure to future Federal Reserve rate decreases. Overnight borrowings for the quarter averaged $92 million as the majority of the purchases were funded by deposits. While deposits generally decline in the second quarter with continuing reductions in tax refund-related balances, this quarter deposits on average increased over $200 million, compared to the first quarter of 2024. At an estimated average 5.11% yield, the securities purchases had only a modest impact on current income, while significant prepayment protection is reflected in estimated eight-year weighted average lives. Additionally, the bank continues to emphasize fixed-rate loans to continue to further reduce lower rate exposure to modest levels. In addition to the impact of the Federal Reserve rate increases, the company benefited from loan growth with year-over-year decreases in S-block and I-block, significantly offset by increases in other higher yielding lending categories. In Q2 2024, S-block and I-block reversed trend from net quarterly decline since the fourth quarter of 2022 to net growth in Q2 2024, notwithstanding the persistence of higher rates. We believe that higher rates have resulted in payoffs from customer rate sensitivity. The impact of the aforementioned Federal Reserve rate increases on variable rate loans and securities and lesser increases in deposit rates with growth in higher yielding loan categories was reflected in an 8% increase in net interest income in Q2 2024, compared to Q2 2023. As a result, in Q2 2024, the yield on interest earning assets had increased to 7.3% from 7% in Q2 2023, or an increase of 0.3%. The cost of funds in those respective periods increased by only $0.1% to 2.5%. Those factors were reflected in the 4.97% NIM in Q2 2024. The provision for credit losses was $1.3 million in Q2 2024, compared to $361,000 in Q2 2023. Provision for credit losses in Q2 2024 reflected the impact of $1.4 million of leasing net charge-offs, while the majority of such charge-offs had been previously reserved. The largest single component of leasing charge-offs was local trucking, transportation, and related activities for which total exposure was approximately $34 million at June 30, 2024. As described in our press release, the company entered into a purchase and sale agreement with a year-end 2024 closing deadline with a $39.4 million balanced apartment loan, which was reported as non-accrual last quarter and which now comprise the majority of other real estate owned. Non-accrual loans, loans 90-days still accruing and other real estate owned total $77.1 million at June 30 2024, compared to $76.7 million at March 31 2024. While a $12.3 million loan became delinquent during Q2 2024 after having been modified with a payment deferral, the as-is and as-stabilized LTVs for related collateral are 72% and 56% based on a May 2024 appraisal. While the macroeconomic environment has challenged the multifamily bridge space, the stability of Bancorp's rehabilitation bridge loan portfolio is evidenced by the estimated values underlying collateral. The $2.1 billion apartment bridge lending portfolio has a weighted average origination date as-is LTV of 70% based on third-party appraisals. Further, the weighted average origination date as stabilized LTV, which measures the estimated value of the apartments after the rehabilitation is complete, may provide even greater protection. One of the accounting estimates as described in the notes to our financial statements as the allowance for credit losses, which is sensitive to a variety of inherent portfolio and external factors. Rebel may be one of the more sensitive portfolios to such factors. In the second quarter of 2024, rebel loans classified as either special mention or substandard increased to $177.1 million from $165.2 million at March 31, 2024. Each classified loan was evaluated for potential increase in the allowance for credit losses on the basis of third-party appraisals of related apartment building collateral. On the basis of as-is and as-stabilized loan to values, increases in the allowance for specific loans were not required. The respected weighted average as-is and as-stabled LTVs of those classified loans were 81% and 69%. The current allowance for credit losses for rebel is primarily based upon historical industry losses for multifamily loans in the absence of significant historical losses within the company's rebel portfolio. However, as a result of increasing amounts of loan classified as special mention and substandard, the company will evaluate potential related sensitivity of that factor for rebel. This evaluation is inherently subjective as it requires material estimates that may be susceptible to change as more information becomes available. Non-interest expense for Q2 2024 was $51.4 million, which was 3% higher than Q2 2023. The increase included a 2% increase in salaries and benefits, higher FDIC insurance expense, reflecting higher levels of deposits and higher other real estate owned expense. Book value per share at quarter end increased 15% to $15.77, compared to $13.74 a year earlier reflecting the impact of retained earnings. In summary, The Bancorp's balance sheet has a risk profile enhanced by the special nature of the collateral supporting its loan niches and related underwriting. Those loan niches have contributed to increased earnings levels even during periods in which markets have experienced various economic stresses. Real estate bridge lending is comprised of workforce housing, which we consider to be working class apartments at more affordable rental rates in selected states. We believe that underwriting requirements provide significant protection against loss as supported by LTV ratios based on third-party appraisals. S-block and I-block loans are respectively collateralized by marketable securities and the cash value of life insurance, while SBA loans are either 7A loans that come with significant government-related guarantees or SBA 405 loans that are made at 50% to 60% LTVs. Additional details regarding our loan portfolios are included in the related tables in our press release as are the earnings contributions of our payments businesses, which further enhances our risk profile. The risk profile inherent in the company's loan portfolios, payments funding sources, and our earnings levels may present opportunities to further increase shareholder value, while still prudently maintaining capital levels. Such opportunities include the recently concluded share repurchases of $100 million for second quarter 2024 from the original $50 million. I will now turn the call back to Damian.

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

The floor is now open for questions. [Operator Instructions] Our first question will come from David Feaster with Raymond James. Please go ahead.

Hi, good morning, everybody.

Good morning, David.

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

So first part is -- it's on track. It's the property in Houston, and we should be pretty much finished with the work going through the summer to the close. And so the buyer is involved and has done due diligence on the property and is involved in the plan -- the executed plan. The trend in the book is really from that ‘21, ‘22 vintage. Once again, there's been stress because of the rise of interest rates and also the supply problems that were that happened during the pandemic. So you get it when you're not on plan and you're off that plan it could be time or cost. It will be have a weakness and that weakness may drive that loan into substandard. So that's the credit migration that we've seen. So we're working very diligently with our sponsors in order to help them. If they're off plan, usually if there's any significant off plan, the sponsor will put in additional equity or we won't disperse our own funds. So most of them are -- we don't have a lot of, you know, non-paying at this point, which is a very good sign. And there's clearly pools of capital and sponsors, who have -- or who are in the market now looking for these opportunities. When you have these low leverage levels, there is capital available to recap these loans as we've demonstrated here with that Aubrey loan. So there could be more credit migration, but we're not seeing,. you know, we're not seeing losses at this point.

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

Yes, and there's no doubt that's happening. We can't facilitate, there is broad dislocation across the entire banking as a service space and a lot of regulatory scrutiny. Things like third-party risk management, model risk management, fair lending, BSA, AML, all these things are under scrutiny with the regulators. And we've invested over the last seven years in building a portfolio and totally rebuilding our middle office and technology and compliance envelope to be compliant with regulatory expectations. So, but we can't take smaller programs. There's been incoming is substantial and we're working with large partners, who are potentially looking to move, because of the regulatory scrutiny. And no doubt it does have an effect, a positive effect on pricing. We've maintained basically our pricing over the last five years. It hasn't really moved very much. And -- but our costs have gone down because our platform is very scalable. So you don't see a big build in our cost structure. And that's due to the fact that we're incredibly scalable. So incremental programs do have a big impact on profitability, because of the scalability of the cost, but also the size of the programs we're putting on. Usually they're much more profitable up front too, and they bear the cost of implementation, and they're tiered. So as they grow their volume substantially the pricing will adjust, but you know it gets more profitable as the because of the scalability of the platform.

Okay.

Thank you. Our next question will come from Tim Switzer with KBW. Please go ahead.

Hey, good morning. Thank you guys for taking my questions. I have kind of a follow-up on the Vast regulatory landscape here. So the Fed and some of the other regulators published a joint press release yesterday kind of discussing the risk of what they call third-party deposit arrangements and they requested additional information from participants? Can you provide your thoughts on how regulator expectations are changing for these Vast partnerships? And if you think there are any significant rule changes coming, particularly given the developments over, when you say the last year, but particularly with the [Indiscernible] situation, it's kind of gotten a lot of media headlines and might start to get some politician attention as well?

The regulatory expectation is that if you're doing these banking and service arrangements, that you have to validate the operations on a third-party basis. So, they really think of it as you running the business, that it's not outside of you. So you have third-party risk management, BSA, AML, consumer compliance, [Regi] (ph), whatever it is, you have to overlook and assure that it's compliant. And I think that because the industry grew so quickly, there were a lot of small players, a lot of smaller players got into the market without building out sufficient infrastructure, that the regulators are now going back and ensuring that, that's true. And they've obviously gone back and there's been inadequacies and people's ability to demonstrate that validation. And so while we were under scrutiny, obviously years ago and under consent orders and we worked very closely with the FDIC and now with the OCC and the Novel Banking Group, I think we had a big head start on creating that compliant model and making sure that, that validation can happen. And that lowers, as far as the regulators view, you're more compliant and you're far lower risk. And so now, obviously, now that, that scrutiny has come to the industry, we are already at the finish line and people now have to catch up. The thing I would say is to be that compliant platform that can do that validation is incredibly expensive. So We have a fair amount of broad verticals 15. We have great positions across many industries. So we have the volume and the ability to invest in that platform. So it's unlikely that everyone in the industry would be able to do that, and some have exited. And so that dislocation will continue for some time.

Okay, understood. That was a great summary. I guess just to be a little bit more specific to The Bancorp, do you think there's anything, because the regulators have kind of had this expectation for a while that just really cracking down on it. Do you think there's anything new that would maybe, I know you're continuing to invest part of it. There's anything new the regulators might come out with their change of expectation a little bit that will change how you operate or require a little bit additional investment to stay ahead of it?

So we always invest in the front. So, you know, it took us years to -- we didn't get into credit sponsorship in three months. We've been investing in that platform for years. We're going to do the same thing with embedded finance as we now are starting to build that platform. And we worked very, very closely with the regulators to understand their expectations. And we adjust it ongoing, right? So of course, as a leader in this space, increased scrutiny will be placed on all our competitors, large and small, but also will be increased on us. But we've got such a multi-year head start in time and investment, that it's far easier for us to adjust. And this has been going on for years, because when we were in trouble with the consent orders, there wasn't great agreement at the time, I believe, in the regulatory bodies of exactly how you regulate that validation process, I was talking about, that compliant third-party risk management. And I think there's a lot more contextual understanding by both the industry and the regulators now. So that's some of the problem that the smaller players are having and be able to make those type of investments with much lower volume, much earlier stage programs. So they're going to have a greater dislocation between expectations and actuality. And so we don't expect to have a big dislocation. We're going to continue to prove our platform as regulators change your expectations. We will invest the necessary resources, whatever they are, in order to meet those expectations. However, if they change it too much, it's likely to affect everybody else more than us, because we're closer, by definition, we're going to be closer to those expectations on an ongoing basis.

Okay, totally understood. Thank you. I'll jump back in the queue.

Thank you. Our next question will come from Frank Schiraldi with Piper Sandler. Please go ahead.

Good morning.

Good morning, Frank.

Given the -- well, I think it's still limited supply for new credit in this rebel sector. Is it safe to assume that that Bancorp would be financing the sale of this property in Houston?

Oh, no, we'll be out of that property. There'll be new financing in place.

Okay, great. And then, Paul, I think you mentioned that, you know, you take a look at your criticized classifies here, even in lieu of any historic losses, you could -- would consider, I guess, and tell me if I'm paraphrasing correctly, that you consider reserve builds here in that book? And I'm just wondering how we would think about that as we sit today? Is that potentially meaningful or just incremental? Is that a potential risk to the $4.35 target? Just how we should think about the potential for any reserve bills over the next couple of quarters.

So we looked at each of the special mention and substandard loans and none of them required an individual reserve. So as we've been saying, we don't expect any losses, notwithstanding that our classified loans are up. But Cecil requires you to look at sensitivity to various factors and clearly if there are loans that have some type of issue, then you should take a special look at the trends in those loans and the possible impact on the allowance for credit losses. So that's what we're doing. And so yes it is possible that we would recognize some additional provision. And yes, that would impact the guidance. But as I said before, we don't really expect any losses. So I think you have to make that differentiation. If Cecil -- if there's some way that Cecil implies that there's additional allowance, then we would take that, but we don't expect any actual losses.

Okay, and I guess that's a process ongoing now. And well, just -- one last one before I re-queue. Just in terms of the move in the share price here, the new guy, just want to make sure just in terms of the current buyback, the plan, obviously you double it up in the second quarter, but the buyback to $50 million a quarter, is that still something you guys are very comfortable with through the back half of the year?

Yes, there are -- it'll -- we're very comfortable with the $50 million. The $100 million was a very unique opportunity. We bought the shares at $33, $13, I believe. But we'll probably do the $100 million, unless the board decides otherwise, but I think it'll be the $100 million. And then when we give guidance, we'll also mirror the buyback next year off the net income. Right now we have sufficient capital, even if extra $50 million didn't really change our ratio that much in the Tier 1 leverage ratio and the other ratio. So, we're extremely strong capital position. And we’re -- we pretty much have around the amount of capital we'll ever need, because of the Durbin Amendment limitation on the $10 billion bank. So we're in an incredibly good earnings and capital position. And we will continue to buy back the shares when they're undervalued, and we believe those shares are undervalued as of today.

Great. Thank you.

Thank you. Our next question will be a follow-up from David Feaster. Please go ahead.

Hey, thanks for taking the follow-up. You got a lot of pretty exciting initiatives going on. I was hoping to touch on some of them. We're starting to see the benefits of the credit sponsorship, which we talked about. You alluded to embedded finance, which you're rolling out. We've also talked about monetizing your risk and compliance functions. Just curious if you could give us an update on those and any other initiatives you're working on and maybe how AI could play into that, because that's a pretty big buzzword these days. Just hoping to get an update on some of the things you're working on and what you're excited about?

You're right about AI. We have a whole group that's working on how we're going to use AI in the future, including a technology vision. So we really have to really think about that. We've invested a lot in totally redoing our tech stack and redundancy and everything and strengthening our cybersecurity walls. All that stuff has been ongoing, but we're really thinking about as we transform the bank into really a FinTech centered platform and not just being you know a majority of our business, but really being focused on that we're of course thinking through the tech and AI requirements. It's incredibly exciting. And the credit sponsorship side, all the hard work is paying off. We have multiple programs and multiple partners that want to implement at The Bancorp. We could easily see this first Tier, we're in the 70s, it's growing now. We could see upwards towards $300 million to $500 million on the balance sheet at the end of this year and we could see $1 billion next year. So that's how fast growing that is. It's extremely a creative because with that business is a -- also the ecosystem for payments is also connected to that. So it's incredibly profitable business and very and many times the partners will have both the deposits at the bank already. So in essence, we're kind of using the liquidity of our partners to lend to their clients. That's very exciting. When we think about APEX 2030 balance sheet, five years from now, we hope to have 20 programs. It's going to mirror the banking as a service size, 20 programs. Most of it will be extremely balance sheet light. It'll be distributed, but also secured by many of our partners and provide the deposits. So that's incredibly exciting itself, but the ongoing now building is an embedded finance, which is a program management element, which we don't do today. That companies, retail companies that control their apps, that need a financial services capability within their app, and we would provide that, we would manage that part of it for them. That's a very, very, that's a -- it predicted to be a highly growing capability that people will want across the economy. And so we already have -- we think, the best banking and service ecosystem so that applying that to it will be kind of a no brainer, we think, for the marketplace. And by the way, we've been asked for it a lot already. So people have asked us, hey, can you do that element? We say, well, no, we don't. We don't do that today. We've actually partnered with other people in the space to talk about providing that in certain cases. So, you know, those two things alone are enormous fee opportunities and balance sheet opportunities in themselves. So, you know, when we say APEX, we're talking about a 3 times, 4 times on our current fees of $100 million in five to seven years. And that may be 100 to 200 of increase in the spread revenue. So it's very exciting, I think it's going to be played out for credit sponsorship in the near-term. You'll see those balances grow very aggressively. And then for embedded finance, we're going to walk and be very deliberate and make sure that we provide the best-in-class and that capability to the partners. And so we're not rushing anything. And our base business is growing very aggressively, so and we've been asked by the largest players in the marketplace to think about them joining our ecosystem. So we're very excited.

That's great. Thank you.

Thank you. We have a follow-up question from Frank Schiraldi. Please go ahead.

Thanks. Yes, just back to the increase in guide, is the primary driver of that credit sponsorship, and just when you talk about balances moving higher in the near-term, is something along the lines of $0.5 billion in balances, a reasonable place to land at the end of this year? And I assume that would be more than one program?

Yes, well, especially with credit sponsorship, yes. No doubt. If we're at $300 million to $500 billion in that alone, you're going to see that increase in balances. The game changer here is one thing that maybe we didn't emphasize enough is the deposits. So with the activity across all the verticals, we're seeing an increase in deposits we haven't really seen this time of year before. Taking away the stimulus checks and all that stuff that happened during the pandemic. Why that's so important is because we can facilitate a lower funding cost over time, because we can take the higher cost deposits and higher cost borrowings off the balance sheet. And so with interest rates dropping, you know, it's potential that we could drop our funding of the bank even more by having more demand non-interest-bearing deposits on balance sheets. So that is very supportive of the increases in profitability. So -- and the FinTech, you know, the incoming on the FinTech side is dramatic. So the addition of large programs, additional large programs is expected over the next 12 months. So all that combined supports the guidance, but also supports continued significant profitability increases over the next two years.

Okay, great. And then as we think about just near-term trends you talked about the deposits being a bit higher than you would have thought based on previous seasonality, I guess, end of period. And as I think about, as we think about NII for the third quarter, kind of, a good run rate, is it better to use kind of end of period balances or average balances for the court, any guardrails you guys can put around kind of NII expectations just because there's so many different things going on in terms of drivers?

Well, I'd go end of period and our NIM is going to be around 5% regardless of the loan type. So, it might even, it's going to be around, it could actually, we had that million dollars in there that we had to back out after tax, because of that one securitization that was a long time ago. And we do have plenty of coverage on that security, so we're not expecting a loss on that either. So 5-ish, it might take a little bit higher, depending on the class. But the issue with the loans that we're doing in certain cases on the FinTech side, some of that will be in fees, because of the way some of these loans work instead of in NIM. So you'll see some of the fees growing and some of that will actually be NIM related technically. But the 5% is I think a good, because we don't know exactly who's going to grow and in what cases, but in our modeling, that's kind of where it is.

Great. Okay. Thanks.

Thank you. At this time, I would like to turn the call back to Damian Kozlowski for any additional or closing remarks.

Thank you, everyone. We appreciate you attending our conference call. Operator, you may disconnect the lines.