TBBK - NASDAQ

Good day, and welcome to The Bancorp, Inc. Third Quarter 2024 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the prepared remarks, we will open the floor for questions. [Operator Instructions] Please note, today's call will be recorded, and I will be standing by if you should need any assist. 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 third 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 1-800-839-1162. Before I turn the call over to Damian, I would like to remind everyone that our comments and responses to questions reflect management's view as of today, October 25, 2024. Yesterday, we issued our third quarter earnings release and updated investor presentation. Both are available on our Investor Relations website. We will make certain forward-looking statements on this call. These statements are subject to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995 and are subject to risks and uncertainties that could cause actual results to differ materially from the expectations and assumptions we mentioned today. These factors and uncertainties are discussed in our reports and filings with the Securities and Exchange Commission. In addition, we will be referring to certain non-GAAP financial measures during this call. Additional details and reconciliations of GAAP to adjusted non-GAAP financial measures are in the earnings release and the investor presentation. Please note that 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 $1.04 a share in the third quarter. Revenue growth was led by our FinTech Solutions Group. GDV growth was 15%, while total fee growth from FinTech payments fees and credit sponsorship fees was 22%. We continue to grow total credit sponsorship balances, which were $280 million at the quarter end compared to $70 million at the end of the second quarter. We are excited about the prospects for newly added and prospective payments clients and expect our non-interest income to reflect their impact in 2025. On the lending side, our substandard multifamily loan assets continue to be elevated. We believe we are at or close to peak in substandard assets and are employing multiple strategies to reduce that number without incurring losses. We also had the portfolio reviewed by an independent third-party to validate our internal ratings. The substandard assets continue to be centered in our 2021 and 2022 vintage that was impacted by supply delays and a sharp rise in rates. We continue to believe that we will have little to no losses on this portfolio due to the conservative leverage of the loans. Anticipated rate decreases should also aid in reducing the amount of substandard assets. In addition, the Abry property in Houston continues to be on track for the December 2024 close with our deposit on the property growing from $125,000 to $375,000 currently. The other lending lines were led by our small business lending with 14% year-over-year growth. Moreover, our institutional business continues to stabilize and quarter end balances were essentially flat to prior quarter. In other matters, due to the potential repayment of outstanding senior secured debt of $96 million, planned buybacks will be reduced to $150 million in 2025, or $37.5 million a quarter from a total of $250 million in 2024. Our 2024 buybacks included a $50 million special buyback in the second quarter. Depending on prevailing rates, we may reissue debt of $100 million or more to replace existing senior debt. In that event, we would likely use all/or most of the proceeds to increase our stock buyback. Also in our financial reporting, we will be breaking out more detailed business segment profitability for the first time. As you will see, the majority of our economics originates from the non-interest income and deposit funding generated by our payments ecosystem. The methodology we used was simple. We charged interest expense to the lending businesses using a three-year average market rate, while our FinTech payments business received the resulting interest income. Those allocations are shown in the interest allocation line. The actual cost of our deposits was charged to our FinTech Solutions business as their interest expense. The corporate segment includes our bond portfolio and was charged the actual cost of our deposits as interest expense. Expenses for each business are driven by both direct expenses incurred and allocated expenses based on estimated usage. This methodology better explains how our best-in-class returns are generated and the central role of the Bancorp's FinTech payments franchise to our profitability. A schedule summarizing this view of our business appears at the end of the press release. Lastly, we are issuing 2025 preliminary guidance of $5.25 a share supported by our continued double-digit growth in FinTech fees and credit sponsorship. Our 2025 guidance does not include the impact of planned stock buybacks of $150 million that I previously mentioned. I now turn the call over to Paul Frenkiel for more color on the third quarter. Paul?

Thank you, Damian. While the Federal Reserve began to reduce rates in September, the purchase of $900 million of long-term fixed rate US government-sponsored agency securities in April 2024, significantly reduced exposure to Federal Reserve rate decreases. Additionally, an emphasis on fixed rate loans continues in the company's efforts to optimize its margins. The majority of the increase in loans compared to June 30, 2024, was comprised of consumer FinTech loans. We are proceeding prudently in our FinTech credit strategies and currently are generating balances with lower potential loss exposure. We believe, we will be able to originate loans with higher yields and/or fees in the future. The third quarter net interest margin of 4.78% compared to 4.97% for second quarter 2024 and reflected $1.6 million or $1.2 million after tax of prior period interest reversals on rebel loans, either transferred to non-accrual or related to loan modifications. Reflecting those rebel prior period interest reversals, net interest income increased 5% in Q3 2024, compared to Q3 2023. As noted in our last press release, the company examined the sensitivity of its allowance for credit losses to increases or decreases in its rebel loans classified as either special mention or substandard. As a result, a new CECL factor resulted in a $2 million increase in the quarterly provision or $1.5 million after tax. At September 30, 2024, rebel loans classified as special mention and substandard, respectively amounted to $84.4 million and $155.4 million, compared to $96 million and $80.4 million at June 30, 2024, notwithstanding, the increase this quarter in loans so classified, the respective weighted average as is and as stabilized loan to values of 77% and 68% based on appraisals performed within the past 12 months continues to provide significant protection against loss. Each classified loan was evaluated for a potential increase in the allowance for credit losses on the basis of the aforementioned third-party appraisals of apartment building collateral and again, which was updated and performed in the past 12 months. Average Fintech Solutions Group deposits for the quarter increased 11% to $6.64 billion from $6.01 billion in third quarter 2023. The provision for credit losses was $3.5 million in Q3 2024 compared to $1.8 million in Q3 2023. In addition to the aforementioned impact of the new REBEL factor, the provision for credit losses in Q3 2024 reflected the impact of $1.3 million of leasing charge-offs. Of those charge-offs, $600,000 resulted from transportation and trucking for which total outstandings amount to $34 million. While the macroeconomic environment has challenged the multifamily bridge space, the stability of the Bancorp's rehabilitation bridge loan portfolio is evidenced by the estimated values of underlying collateral. The $2.2 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 from losses. Non-interest income for Q3 2024 was $32.1 million, which was 20% higher than Q3 2023. Prepaid, debit card, ACH, and other payment fees increased 16%, accounting for the majority of the increase. Those increases reflected both higher rapid funds transfer income and higher prepaid and debit program sponsorship income, driven by both new client relationships achieving scale year-over-year and the continued organic growth of long-standing client relationships. For the consumer fintech loans noted previously, the income statement reflects a new income statement line item, consumer credit fintech fees, which generated $1.6 million of quarterly fees. As previously noted, we believe we will be able to originate loans with higher yields and/or fees in the future. Non-interest expense for Q3 2024 was $53.3 million, which was 12% higher than Q3 2023. The increase included an 11% increase in salaries and benefits, the $892,000 after-tax loss mentioned earlier by Damian, and increased other real estate owned expense. Book value per share at quarter end increased 18% to $16.90 compared to $14.36 a year earlier. That reflected the impact of retained earnings and also the impact of the unrealized gains on the securities portfolio, primarily as a result of the 2024 securities purchases. 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 believe and consider to be working-class apartments at more affordable interest rates in selected states. We believe that our underwriting requirements provide significant protection against loss as objectively supported by LTV ratios based on third-party appraisals. Further, S-block and I-block loans are respectively collateralized by marketable securities and the cash value of life insurance while SBA loans are either SBA 7(a) loans that come with significant government-related guarantees or SBA 504 loans that are made at 50% to 60% LTVs. Additional details regarding our loan portfolio 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 earnings levels may present opportunities to further increase stockholder value while still prudently maintaining capital levels. Such opportunities include stock repurchases, which are planned to be continued for the remainder of the year with additional repurchases in 2025. I will now turn the call back to Damian.

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

Yes. At this time, the floor is open for your questions. [Operator Instructions] Our first question will come from Frank Schiraldi with Piper Sandler. Please go ahead.

Good morning.

Good morning, Frank.

Just wanted to start with, Damian, just I believe I heard you mention a new partnership on the FinTech side. You didn't name the partner. I don't know if that's by design or this is just previously announced. But can you just give a little more color and if it is a new partner, any guardrails around potential bottom line impact?

So our pipeline is extremely strong right now, even more than I've said in the past. And we're seeing it -- and there's been a lot of implementations over the last year, which is continuing to show momentum in our GDV even in this month, in October. So nothing to announce. However, we're continuing to expand our long-term relationships with new product sets, including credit sponsorship. There's a lot going on there. And we're in discussions with new partners that want to move to our platform. So it's extremely robust at this time, but nothing to announce.

And then just thinking about the 2025 guide, and we used to talk about perhaps 15% GDV growth being a historic sort of growth level and maybe being able to exceed that and then the pickup on fees would be something a little less than that. This quarter, you put up 15% GDV growth and 20% plus fee growth. So just kind of if you could just -- your updated thoughts there around just given how strong the pipeline is, are we still thinking 15% plus GDV growth? And any color on what that translates to in terms of fees?

So I can give you a couple of insights. Our -- these programs take a long time to implement. And sometimes they kind of pay off all at once. So if you're looking at our GDV and we were saying we're going to be above trend this year. Now, this is an estimate, and this moves around a lot, but we're experiencing above 20% now GDV growth in the month of October. And we think that you just don't know how that's going to play out. But our transactions tend to be base transactions like payments that are -- that happen continually for the customers of the applications, the program managers. So it seems once we have a bump up in that volume, it doesn't go back down again. So we're experiencing that now. I would think that 15% number plus is also a good number for next year and could be a bit higher more towards the 20% range, but we'll have to see. It can be very volatile.

Okay. And then just on the Rebel book, given that just in the quarter, obviously, rates fell -- they fell significantly in the middle part of the curve kind of bounced back a bit. But just curious, given where rates were where -- what sort of trends you saw in the quarter in terms of balances moving to permanent financing moving off the balance sheet -- off your balance sheet. Any -- did that accelerate? Any numbers you can put behind that?

I don't -- we really haven't -- it's not been enough yet, I think. It's clearly that, there is building liquidity in this niche with the forward look on rates. So the market was a bit stalled for a while with new deals, and that's starting now to unclog a bit. So there is forming pools of capital. So when we're looking to -- whether it was the -- are or with certain loan modifications we've done on the Rebel book, there's just more capital available. The market conditions have definitely improved as well as new investors coming in, or existing investors who look to add to their portfolio. So the environment that we had in 2021 and 2022 is kind of on the -- that is something that's been repaired a lot in the marketplace. People have a much better perspective on rent growth and cap rates, all the things that you want in a good market, and that's unclogged the market a bit.

Okay. And then just lastly on that front, you talked in the release about the expectation, I think the wording was nearing peak in terms of criticized balances. And just trying to think through timing there, I mean, if it's late 2021, early 2022 vintage, these things come up three-year initial term, it would seem to me that maybe early 2025 would be a point you could expect maybe a peak in criticized? Or is it that the rates coming down here in the near-term have you feeling about -- better about maybe peak earlier than that? Just trying to think through that. Thanks.

Yeah. So we really believe we're at or near peak, and that's why we had a third party come in to validate and look at all the loans and ensure that we weren't being too aggressive in downgrades, and that it was right where it should be at the standard of the market. We have a plan in place. We believe that we can reduce it in the next two quarters. So we have identified properties working with the sponsors. We've modified certain loans, and we're looking to offload or have those loans financed. So we're hoping to make -- first of all, we think we're at the peak, near the peak. We think there won't be a lot more, and we think we can reduce that balance number on the substandard criticized and classified assets over the next two quarters. If you look to the full resolution of that group of loans. That will take a little bit longer, but that will be throughout 2025. And by the end of 2025, we should have all or most of those loans refinanced.

Great. Okay. Thanks for the color.

Thank you. Our next question will come from David Feaster with Raymond James. Please go ahead.

Hi, good morning everybody.

Hey, how are you doing David?

I wanted to get a sense -- let's touch on the credit sponsorship, right? I mean that's clearly gained some traction. I'm curious how that rollout has gone? And your sense -- your initial sense as you're starting to ramp that up of the infrastructure that you've built? And then just what's the pipeline like, the growth outlook you're thinking? And could you remind us of the yields on that production as well?

Okay. So, right now, we're working with multiple partners to implement new programs. I would say there are three that are well-known providers that are looking to implement their programs at the Bancorp. The ramp-up is primarily with Chime now in four product areas. And it will probably be $400 million-ish, we're thinking by the end of the year in footings. Now, the velocity of those loans is very high. So, we've had about a $1.6 billion actually went through -- even though the balances are not very high, it's the repayment and recycling of those loans that's very quick, and that's why those fees grew so quickly. So, at the end of next year, with -- depending on the time of implementation, we expect the balances to be around $900 million to $1 billion by the end of next year. And it does look like the growth after that could be substantial. We are not putting a number on it, but we're talking about a doubling of those balances, we think, at the minimum by the end of 2025. So that obviously would generate a lot of spread and fee revenue because of the velocity of the loans. So, it's like that's -- it's a good example to show that our guidance, if you look at our guidance for this year, right, there's a lot of momentum in that business that we think we'll be able to meet our full year guidance with our fourth quarter, even though our run rate right now, even though you take out those one-time items we mentioned is more like $1.11. So, we do -- we definitely have a $1 million to $2 million opportunity just in that bucket in the credit sponsorship in the fourth quarter. Our -- we haven't -- we just finished our full implementation of something we mentioned before, which is the rapid funds transfer balances, RFT balances for block that we've mentioned in the past. That is a $1 million to $2 million opportunity. And our GDV, as I mentioned below -- before, is significantly above trend. Though -- all this is volatile. So, these are just estimates, and that is a $1 million to $2 million opportunity. So, you have a situation where if you look at that $1.11, that's about $0.07. So, you're already at $1.18 for the fourth quarter. But then because our deposit balances are much higher than expected, we're able to fund our bond purchases without any borrowings right now. So that's another $1 million to $2 million opportunity. That's how we -- so this area, the FinTech space is showing rapid above trend growth with new fee sources, and it's very encouraging.

Okay. That's helpful. And maybe to some of the points you just made, I mean, you've been active managing rate sensitivity ahead of potential cuts. Obviously, there's prospects more on the horizon. I'm curious, how do you think about the margin trajectory looking forward, assuming the forward curve comes to fruition, contemplating better yields from credit sponsorship? And just what rate outlook is embedded into your 2025 guide?

So our asset sensitivity has continued to decline. We moved it from 8% to under 2% with the bond purchases and putting on fixed rate exposure. So our NIM for 2025 should be very stable. So you have to add back some of the reversals we had in the third quarter. So the NIM should be in the high 4s, probably in the 4.90% to 5% range for 2025. And depending on -- we don't think it's the Goldman forecast of 3% to 3.25%. We still think the Fed will be around the 4% range on Fed funds. If that happens and we continue to grow our deposit sources and the other fee income, it's fairly easy to get to that 5.25% number we put on the table for 2025.

Okay. And then last one, I just saw that loss from the transaction processing delay. I was just hoping you could touch on what drove that and just curious what...?

Yes, there was an application glitch where in those situations, we have to rename files and do it manually. And because of a naming convention and a whole bunch of serendipitous things that we've all put in multiple controls to prevent, we had a loss on return -- like non-sufficient fund files, four of them. And so they got delayed. And to avoid confusion, working with our partner, we decided to share the cost and not submit the files late, which might have caused consumer confusion. So this is, we believe, a one-time event, very -- a whole list of serendipitous events happened, and we've closed those gaps. And we've even changed the naming convention to ensure that can't happen again if there's another application failure. So this is -- this hasn't happened before. I've been here eight years. We've significantly improved the platform. It's one of those things, and we don't -- it's not systemic.

Okay. That's helpful. Thank you.

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

Hey, good morning guys. Thank you for taking my questions.

Good morning.

I had a quick follow-up on the NIM trajectory. With the Fed rate cuts, your deposits kind of reprice immediately almost with a contractual beta basically that's near 60%. So should we see maybe margin expansion initially before then the margin kind of, I guess, moderates and comes back down a little bit as we start to see pressure from the loan repricing, like how should we think about that over the course of the year? Or is it just stable every quarter?

Well, it's hard to know because, for example, in the -- where we had fixed rate exposure that we put on, during the pandemic, for example, in our activities like SBA, but leases that were done at the beginning of the low interest rate or at the end of the low interest rate environment. So that's burning off. So you are getting higher rates in some of our businesses. And then I'd say, in some new Rebel loans, they would actually be lower rates. So it's hard to tell. I think it will be basically a wash. The real game changer is non-interest-bearing deposits. So as I said, the thing that we can't predict is our deposit levels, even though they're very -- they're well above where our estimates were at the beginning of the year. So that's helping things like the funding of the bond purchases and then also, obviously, the amount of areas where we don't pay that share are growing. So I think it will be basically a wash. I don't think it will -- I think you're going to stay in that 490 to 5% range. I don't think there's going to be wild swings unless we have a onetime event or like we've had a reversal in the previous -- in the last quarter. So it will be -- I think it will be fairly stable. It's hard to predict. It might move around a lot, but it's -- there's just -- there's ins and outs basically. So you can't really give a good estimate. So we've estimated that it's going to be fairly flat.

Okay. That's helpful. And then I was looking at your regulatory ratios. Your TCE went up over 50 basis points, but your regulatory ratios went down a little bit. Was there a change in like the risk weighting of your assets? And was that related to some of the credit migration? Or can you guys walk us through that?

I'll give that to Paul. Paul, would you like to opine?

Yes, sure. So we do have 100% like, for instance, the consumer, the $280 million of consumer loans, those go in at 100%. So there was some movement, as you suggested. But really, the changes -- the quarterly changes were really kind of minimal. We monitor the capital and we do those projections quarter-to-quarter. And they won't -- they're not going to change meaningfully and because we're generating so much earnings, like we have that scheduled out so that we'll maintain those ratios, and that's taken into consideration when we estimate the guidance. So it won't have any impact.

Okay. Okay. And I'm curious, this is a question I've been getting from a few other investors, but why did you guys decide like now is the time to add to the Rebel reserve? If we're nearing kind of peak classified loans, what was the thinking and maybe a little more explanation on what drove that?

Well, that's exactly why because it's really theoretical. The current CECL stands for Current Expected Credit Losses. So we don't really expect any, and that's based primarily on the LTVs of the as is LTVs and the as-stabilized LTVs. And so we don't really expect any losses on the portfolio. And that kind of is difficult to reserve against when you don't really have any objective means of doing so. But to the extent you do have an objective means, which is the level of classified assets, then theory would suggest you would add some level of reserve. So we're being disciplined. We're staying with the theory. But on the basis of the strength of the LTV, it's a modest increase, which, by the way, as the level of substandard loans and special mention loans goes down, that actually gets -- you have to consider that, that should get reversed. But it really is a theoretical accounting requirement, and we're staying disciplined to it.

Okay. Okay. And we appreciate all the updated credit metrics you provided in the release. Is there any kind of like update you can provide on the loans that have modifications, and if you expect that to be peaking as well? And it sounds like you expect a lot of them to be resolved over the course of 2025?

Yes. We do expect -- yes, we do expect that the modifications are peaking. We have multiple levels of review. We have the department itself based on its detailed knowledge of each loan, has to send a quarterly certification to us, to executive management and a whole host of control parties that identifies all the problem loans. On top of that, we have a layer of credit review, loan review. And as Damian mentioned earlier, this quarter, because we do have an elevated amount of substandard loans. We called in -- you had a third-party to review all -- to view a very significant amount of the loans just to make sure that they had all been identified. So that really is the basis of why we think that the loans with issues have been identified, and we think they're peaking.

Okay. And if I could ask one more, please. Can you guys explain what's all captured in that $1.6 million of consumer credit FinTech fees? Is that like interchange? And then have you guys started selling any for gain on sale revenue at all? Or is that in your plans?

It is -- we haven't sold any gain on sale. So this is all on balance sheet. And in this case, it's mostly fees for getting the money early. So believe it or not, while we get a spread on the loan, our business partner is giving free advances, of which the source of income is actually if somebody wants it, even though they can get it in two days or three days at the most, they want it immediately. And so they -- it could be a $50, they want it and they pay a fee based on getting that money early. And because it's -- once again, this is a kind of a rapid loan, and they need the money at that point. And so they're willing to pay a small fee in order to get that money. And that's the majority of those fees is that $1.6 million is the early basically getting the money a little bit early and the client -- the customer is willing to pay a small fee to get that.

We also have secured credit cards. And while you don't see fee income for that benefit to the bank is significantly reflected in greater deposits and lower cost of funds.

Okay. And how do you guys see the composition of that revenue changing over time?

Well, it will change because the partners that were -- will there be an expansion of these type of program. We have kind of 4 product types now, kind of variations of credit-like products with one of our partners, Chime. But our new partners that we're implementing will need to -- or have the business model to distribute the loans. We will hold assets for 3 to 30 days, and then they will be distributed to investors. Now, there will be also certain assets that we like or depending on the program, we will hold 5% or 10% of those assets longer term. And those are very high spread loans, obviously, compared to our traditional lending. So there'll be 3 types, right, secured on balance sheet, heavy fees. There'll be fully distributed 3 to 30-day underwriting risk. But once again, there'll be small spread, but a lot of fees, a lot of velocity, and then there'll be a small portion of multiple different programs that will be on balance sheet. So it will be very diversified. Our future look, as we've said to the market in 5 years, but we think it's going to be sooner now, because the balances, we think there's just such a large pipeline and the programs that we've already implemented are going so well that we want 15, 20 programs. It will look similar to our Banking as a Service on the debit deposit side. It will be diversified with the 3 business models that I've already detailed. But in this case, we also get all the payments activity, too. So this activity is high velocity, high fees. And when we hold it higher rates off the back of our Banking-as-a-Service debit infrastructure. So it's extremely profitable business.

That’s great. Appreciate all the details. Thanks for taking my question.

Thank you. At this time, there are no further questions in queue. I will turn the call back to Damian Kozlowski for any additional or closing remarks.

Thank you, everyone, for joining us today. Have a great day. And operator, could you please disconnect the call?