Customers Bancorp Inc

NYSE:CUBI

Earnings Call Transcript 2019-Q2

[Operator]

Good afternoon, and welcome to the Second Quarter 2019 Customers Bancorp, Inc. Earnings Call. Today's call is being recorded. At this time, I would like to turn the call over to Bob Ramsey, Director of Investor Relations. Please go ahead.

[Robert Ramsey, Director, IR & Strategic Planning]

Thank you, Melissa, and good afternoon, everyone. Customers Bancorp's second quarter earnings release was issued this afternoon along with our investor presentation. Both are posted on the Investor Relations page of the company's website at www.customersbank.com. As our site changed this quarter, we have streamlined our investor presentation and we will be speaking directly to it on this call. So I'd encourage everyone to pull up a copy. Representing the company on the call today are Jay Sidhu, Chairman and Chief Executive Officer; Dick Ehst, Chief Operating Officer; Carla Leibold, Chief Financial Officer; Luvleen Sidhu, President and Chief Strategy Officer of BankMobile; and myself, Bob Ramsay, Director of Investor Relations and CFO of BankMobile.

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

[Jay Sidhu, Chairman & CEO]

Thank you very much, Bob, and good afternoon, ladies and gentlemen. Thank you so much for joining us for the second quarter 2019 call. As Bob mentioned, I'm joined over here at our offices by Dick Ehst, President of Customers Bank; and also our CFO, Carla Leibold. And as Bob mentioned, Luvleen Sidhu is also here and she will also make some comments about BankMobile sometime during this presentation. I will first make some introductory comments and provide highlights for the quarter and year-to-date financials. Carla will then take over and go over the financials with you in much more detail. I will then provide some guidance for the second half of 2019 and 2020. And followed by Luvleen, going over some BankMobile highlights and then we'll open it up for Q&A.

Overall, we are pleased to report a pretty good quarter, which is -- the most important thing is that it's building a strong foundation for much stronger core earnings growth for the second half of 2019 of about $1.45 per share, with the fourth quarter clearly being our strongest quarter of the year. This foundation further increases our confidence, and we are once again confirming our guidance for 2020 of $3 in core earnings per share.

Our GAAP earnings for second quarter 2019, as you know, were $0.18, and these are $0.20 below the first quarter earnings of $0.38 per share. This was almost entirely due to unusual items that Carla and I will discuss with you later on during this call. Also seasonally, the second quarter is the weakest quarter of the year for BankMobile, BankMobile especially regarding noninterest income and also for the lowest level of deposits during the year. That along with upfront provision expense of about $5.5 million, which we -- when we had absolutely insignificant charge-offs, clearly would reflect the strength of our core underlying business. We ended second quarter with assets of $11.2 billion, quite a bit higher than our expectations, primarily due to strong growth in our banking for mortgage companies or our mortgage warehouse business.

However, we did not enjoy much revenues and a lot of this growth as it was loaded up more so closer to the end of the quarter. Hence our average assets for quarter 2 were $10.3 billion, almost $400 million less than the period and assets.

In addition, we closed about $150 million of our consumer loans on the last business day of the quarter. So you can clearly see we are very well positioned for our third quarter, fourth quarter and the second half of the year.

Let me provide some second quarter 2019 highlights for you. Please, I'd like for you to look at Page 5 of our second quarter deck, which goes -- which provide you some of this information. So for net interest margin, we expanded our margin by about 5 basis points during the quarter. And by the way, we are very well positioned on the margin front. You should now expect NIM expansion of at least 15 basis points during the second half of 2019. Total deposits also grew 12% year-over-year and 10% during second quarter 2019. DDAs grew 35% year-over-year.

Next item is our loan mix continued to improve. As we had stated to you, multifamily loans were expected to decline, and we are pleased to share with you that they declined 15% year-over-year and 6% during second quarter 2019. C&I loans, as we were expecting, they grew 21% year-over-year and 7% during second quarter 2019. As we had shared with you, consumer loans grew about $400 million during the second quarter, equal to about now 6% of total customers Bancorp loans at June 30, 2019.

Average consumer loans equaled approximately 60% of average BankMobile deposits for Q2 2019. Approximately $200 million of these consumer loans came from closings in June, of which about $150 million closed on June 28, 2019, the last business day.

None of the consumer loans are subprime loans, the average FICO score for the consumer loans is 745, and the loans are well diversified. Currently, we are directly originating about $20 million to $25 million a month in consumer loans from our unique platform, about equally between personal loans and student loan refinancing.

The next item on the -- is about our expectations for expenses. Expenses were a bit ahead of our plan during the first half of this year. However, expenses are expected to be flat to down in the second half of 2019. So for the year, they should be absolutely aligned with the guidance that we had provided to you. For our BankMobile segment, Q2 2019 showed a net loss of $0.22 a share, however, this included a $7.6 million provision or $0.19 per diluted share.

In addition, as I'd stated earlier, I believe, second quarter is seasonally the weakest quarter for BankMobile. BankMobile is on target to generate positive earnings contribution by fourth quarter 2019. On the credit quality front, we remain very strong in the credit quality area.

Nonperforming loans were only 15 basis points of total loans at June 30, and reserves equaled 330% of nonperforming loans. Our consumer loan portfolio is performing better than expectations with average 30-day plus delinquency is below 2% at this time. We are on track to achieve the guidance that we have provided to you. So again, you should expect core 2019 earnings, excluding certain notable items that we will be covering with you today, expected to exceed $2.20 per share, ahead of most analyst's estimates. Hence, core EPS is expected to be about $1.45 per share in the second half of 2019, with fourth quarter being the highest. And once again, core earnings for 2020 is expected to be over $3 per share.

Now before I hand it over to Carla for her comments, let me provide you some information about our unusual items this quarter. As noted in today's earnings release as well as the 8-K that we've put out a few weeks ago, we are extremely disappointed by the abrupt, unexpected shutdown of one of our mortgage warehouse customers this May. They were very profitable and had been in the mortgage business since 2005, and a customer of ours since 2011. We had personal guarantees, corporate guarantees, as well as certain GNMA securities as additional collateral for the extension of our loan. After thoroughly investigating this abrupt closing, we took possession of these securities, which were held as collateral and immediately got bids for a quick sale through an auction and then decided to keep them, hold on to them and write them down to the levels, which were indicated to us for a quick sale.

The only good news here is that we view this as an isolated event and not indicative of any broader trends in the industry or any underlying risks. The bad news is that we will incur a loss. Our valuation of this collateral after that auction resulted in a $7.5 million write-down from the carrying value of these securities. Customers has been and we expect to continue receiving cash for -- from these interest-only GNMA securities in excess of the interest hold on the loans, and we are very confident that eventually, we should be able to get out of this without having any additional surprises. Customers no longer has any credit exposure to this formal commercial mortgage warehouse customer and does not have any other loans in its commercial mortgage warehouse, loan portfolio that are collateralized by interest-only GNMA securities. We have, as I mentioned earlier, corporate guarantees and personal guarantees of the principal owner and Chief Executive Officer of the mortgage company, and we plan to aggressively pursue all efforts to collect this deficiency.

Since the company has declared bankruptcy, we unfortunately will not be able to answer any additional questions on this matter. On the severance cost, we examined the bottom 5% to 10% of all our teams, which we have been doing on an annual basis for several years now, and we also saw areas and I looked at areas that were not aligned with our overall strategy going forward. This resulted in about 35 positions being totally eliminated by us that should save us about $3 million in annual compensation expense. However, we recorded about $400,000, onetime severance cost or $0.01 a share. Now I'm going to hand it over to Carla to provide with -- to you some more details about the quarter. So Carla?

[Carla Leibold, EVP, CFO & Treasurer]

Thanks, Jay, and good afternoon, everyone. I'll start off with our second quarter 2019 consolidated results referenced on Slide 6. On a consolidated basis, our second quarter GAAP net income available to common shareholders was $5.7 million or $0.18 per diluted share. From a segment perspective, the Business Banking segment earned $12.8 million or $0.40 per diluted share and BankMobile reported a net loss of $7.1 million or $0.22 per diluted share. As Jay mentioned, our second quarter GAAP results include certain notable charges, the first being the $7.5 million loss realized upon the acquisition of interest-only GNMA securities from the mortgage warehouse customer that Jay described earlier. This had a negative effect on our GAAP earnings of about $0.18. There was also $500,000 of severance expense for reductions in headcount, primarily in less profitable lines of business, which reduced the earnings by $0.01, and a negative mark-to-market adjustment on equity securities of about $350,000, which also reduced our second quarter earnings by about $0.01. Excluding these items, our core earnings for second quarter were $12.1 million or $0.38 per diluted share, up from the $11.8 million of core earnings reported in the first quarter of 2019, which also rounded up to $0.38 per diluted share.

Moving on to Slide 7. Our net interest margin expanded 5 basis points to 2.64% in the second quarter, up from the 2.59% reported in the first quarter of 2019, and up 17 basis points from the trough of 2.47% that we reported in the third quarter of 2018.

Our interest earning asset yields increased 15 basis points over the prior quarter, while our funding cost increased 9 basis points. Our loan yields increased 14 basis points, driven by increased consumer loan yields of 26 basis points and higher multifamily loan yields of 5 basis points, partially offset by a 29 basis point decline in commercial mortgage warehouse yield due mainly to declining market interest rates during the quarter.

Of note related to net interest margin is that we took advantage of the decrease in interest rates during the quarter, particularly in the 2 to 3 year's space and extended out some of our borrowings. In our first quarter Form 10-Q, we reported that we were slightly liability-sensitive, and in our second quarter 10-Q, you'll see that we'll be slightly asset-sensitive.

Overall, we've managed to a relatively neutral position such that a decrease or increase in rates is not expected to negatively effect on margin going forward. We anticipate the restructuring efforts that we've made over the past 9 months along with our projected growth in consumer and C&I lending will allow us to achieve our continued expansion in margin.

Moving on to deposits on Slide 8. We are excited about the growth that we saw in the second quarter. Total deposits were up $890 million or 12% over the year ago period, and close to $600 million of this growth was from lower costs demand deposits with 35% growth year-over-year. We also had strong loan growth in the second quarter, as shown on Slide 9. From first quarter 2019, our commercial mortgage warehouse loans grew about $500 million or 34%, consumer loans grew about $400 million, and C&I loans grew just under $150 million. These increases were offset in part by a $200 million decline in multifamily loan balances as planned.

Moving on to operating costs and efficiency on Slide 10. We did see an increase in noninterest expenses in the second quarter, but are expecting expenses to be flat to down in the second half of 2019. For the Business Banking segment, operating expenses as a percentage of average assets remained stable at 1.5%, which is significantly lower than our peers and the industry overall.

Turning to credit quality on Slide 11. Our portfolio continues to perform remarkably well. At June 30, nonperforming loans to total loans were only 15 basis points and on a year-to-date basis, net charge-offs to average loans was only 4 basis points. It's important to reiterate that we don't have any remaining exposure on our balance sheet to the mortgage warehouse customer discussed earlier. We are comfortable with the estimated fair value of the interest-only GNMA securities that we acquired on June 28, and ultimately used to record the charge in our second quarter earnings. And with that, I'll turn it back to you, Jay.

[Jay Sidhu, Chairman & CEO]

Good. Thank you very much, Carla. Let me now provide to you some further guidance for the rest of 2019 and also for 2020. Hopefully, you will note that all the items that I will cover are very consistent with what we outlined to you on our Analyst Day in October 2018, and at the various quarterly calls since then. We are pleased to report that we have already achieved practically all of our priorities that we had outlined for you. There were, as you would know, expansion of margin to at least 2.75% by the end of the year, and we think our margin should be at least 2.80% now by the end of the year. We have talked about a mix change in our loan portfolio, decreasing dramatically our reliance on multifamily loan or dependency on multifamily loans and diversifying the loan portfolio into multifamily being 10% to 15% of the portfolio and C&I and -- being the majority of our portfolio and consumer loans being about 10% or less of our portfolio. That's exactly where we are today. And from a capital point of view, we've said that we wanted to be by the end of this year and end of 2018 at much higher capital ratios. We believe that you should expect our capital by the end of 2019 to be equal to if not it's had higher than where we were at the end of 2018.

Another priority we shared with you was to show dramatic improvements in BankMobile, to get our White Label partner working and to make BankMobile profitable. We are on track to achieve that. And lastly, we shared with you our priority that we wanted to be at 1% or so ROA, at least, by the fourth first quarter of 2019, and that is what you should expect from us. And since that time, we've updated for you that you should expect $3 in earnings per share in 2020. That is the number, which is -- I want to emphasize at least $3 a share in 2020, and that is exactly where we are. And then we are also adding that you should expect eventually our company to get to 1.25% ROA within 2 to 3 years, and we are on target for that.

So now just talking about 2019, with some little bit more details, as I stated earlier, you should expect our margin and I'll -- please refer to Slide 12, you should expect our margin to be at least 2.80% by the fourth quarter, with full year net interest margin above 2.70%. On the deposit front, you should expect the same kind of a pace that you saw in the first half of 2019. And from a loan portfolio point of view, average interest earning assets for this year, you should expect them to be roughly equal to last year's average earning assets, with C&I loans and excluding the loans to the mortgage companies, which move -- which are more seasonal in nature, they are expected to grow -- these C&I loans are expected to grow about $500 million in 2019. Consumer loans are expected to be approximately 80% of average BankMobile deposits by the end of this year, and less than 7.5% of consumer bank's Business Banking segment loans. We like this consumer loan business, the more we've been in it, we've analyzed everything in great detail. We are only focusing on the prime sector. We want diversification in this portfolio, and we will be -- remain optimistic and over a period of time, hope to get the Customers Bank Business Banking segment to be about 7.5% in consumer loans.

We currently have about $1.9 billion in loans, principally multifamily loans, with yields below 3.75%. During the second half of 2019, we plan to continue reducing these loans perhaps in much more aggressively, focusing on reducing our multifamily loan portfolio by about $1 billion during second half of 2019. This curve, the slope of the curve is going to be helpful to us, and we welcome that. From a noninterest income point of view, you should expect 10% to 20% growth from 2018, and excluding any security gains, losses, impairment during this period. From a core noninterest expense point of view, our efficiency ratio is in about the mid-60s, very modest expense growth or flat to down growth in expenses as expected during the second half of 2019. And we recognize that the first half of 2019, our expenses were somewhat ahead of our plans. But we will make that up.

On the capital front, like I mentioned earlier, we will be in -- we -- they are a little bit stressed right now principally due to the seasonal mortgage banking, mortgage warehouse business, but we are very comfortable that our capital ratios will be equal to or perhaps somewhat better than the -- close to 7.5% TCE range that -- where we ended 2018. We will consider stock buybacks from time to time. And we are very focused on being in the position to perhaps retire the -- some of the preferred if not all the preferred stock that we have as it becomes callable.

From a tax rate point of view, you should expect our effective tax rate to be 22% to 24%, and from BankMobile's point of view, as I mentioned to you earlier, they should be reporting a profit in the fourth quarter. We continue to get a lot of questions about BankMobile. And -- so now I'm going to hand over to Luvleen to discuss BankMobile's performance and priorities for your review. Luvleen?

[Luvleen Sidhu]

Thank you, Jay. I would like to give a brief update on the BankMobile business. We just passed the 3-year mark since we acquired the student business and have experienced many significant wins since then. For example, we have added 88 new school contracts, which gives us access to over 880,000 new enrolled students to offer the Vibe checking account tool. Today, approximately 1 in every 3 college-going students goes to school at 1 of the approximately 800 campuses we have relationships with, which helped our brand equity and also helps us solidify significant market share in student segment.

Over the last three years, we have also increased our product set from just a simple checking account to a product suite that includes savings account, personal loans, credit cards and student refi loans. We have opened approximately 150,000 savings accounts since the launch of the product in May 2018, and are opening about 11,000 savings accounts a month. 54% of new customers are also choosing to open a savings account when they open their Vibe checking account. We have also seen that those customers who have opened a savings account increase their usage of their checking accounts both in terms of increased balances and point-of-sales transactions.

We have also seen origination volumes of our credit products grow with personal loan originations at $12 million to $15 million, approximately $12 million to $15 million a month through a referral program we have with Upstart. And approximately $7 million to $10 million a month through a partnership with OneKey. Although year-over-year, our overall deposit base has stayed relatively flat for the student segment. We are seeing the engagement of our active account base increase through our marketing and product development. Year-over-year, our balances per active account have increased by approximately 5%, our strength per active account has increased by approximately 8%, and our organic deposits, which are deposits above and beyond the refund coming in have increased by approximately 22% per active account.

Additionally, our total noninterest income had increased by about 10% year-over-year, primarily driven by the introduction of our monthly fee, which can be waste for customers who are actively using the accounts and are depositing $300 or more per monthly statement cycle. These metrics show that engagements and therefore, profitability of our active accounts have been increasing over time, which has been our goal. We're also seeing improvements in customer service. When we acquired the student business, our NPS score was in the 30s, and it has now jumped to 60, which is significantly above average for the financial services industry and something we are very proud of and continuously looking to still improve. We have made these improvements all while reducing our overall cost and to cost. Our B2B2C strategy continues to expand with the public announcement of T-Mobile MONEY in April. Today, the partnership has generated nearly $50 million in deposits. We are continuing to look for new White Label opportunities and are in discussions with several potential partners, and we'll keep you posted on any significant updates here.

I often get the question, what does the future of BankMobile looks like and how should we think about valuation? There are growing number of digital banks emerging in the U.S. There are fintech companies that have bank -- that have partner bank relationship. For example, Chime works with Bancorp bank and today is valued at around $1.5 billion. Number 26 partners with Axis Bank and most recently was valued at $3.5 billion. And Revolut is still looking for the U.S. Bank partner and today is valued close to $3 billion. In these examples, the banks hold the deposits but the fintech company access the interface between the customers and the bank and uses their brand and innovative products and technology to attract millions of customers. We view ourselves in a similar way as a fintech company with Customers Bank as our bank partner. As a fintech company, we have developed modern technology that powers our White Label banking service and also the disbursement engine that serves our 800 campuses in the higher education space.

We continue to invest in our technology to help our White Label partners attract, engage and retain customers. Today, we have over 250 team members, with over 40% focused on technology development, UX designs and data analytics. Going forward, we continue to focus on improving our student account metrics through a combination of marketing efforts, product development and exceptional customer service. We are focused on growing deposits with the T-Mobile money account and are looking to add additional White Label partners and launch a workplace banking initiative in the fall. We have many exciting initiatives in the pipeline as we grow the business, and look forward to keeping you updated on our progress. Now I would like to pass it back to Jay. Thank you.

[Jay Sidhu, Chairman & CEO]

Thank you very much, Luvleen. That's exciting. And since I shared with you that we have already achieved practically all the strategic priorities that we had outlined for you, at our -- at last Analyst Day, so I thought that before we open this call for Q&A, let me kind of summarize for you the investment highlights that we see at our company because you should start to now experience much more rapid and consistently higher earnings from Customers Bancorp. So number one, as you know, we are dramatically improving the quality of our franchise and our balance sheet. We believe that Customers Bank is today a very strong business bank and that using a very unique private banking single-point-of-contact model. We have highly skilled teams, with every team leader having 15 years plus experience serving our clients.

Number two, we have a strong organic growth and what we believe to be much more into a bank of the future model that relies more on people and technology and less on branches. And number three, we are significantly improving our margins like we've discussed with you so far. And we think our profitability during this time period in the past has struggled because of our margins being impacted by our interest rate risk position. And as you heard from Carla, we are very neutral right now to any kind of changes in interest rates, and we've also factored in the impact of flat curve, and we do not believe it should have a significant -- any significant impact on our guidance that we've provided to you. As I stated earlier, you should expect us to report about 1%, or perhaps higher ROA by Q4 2019, and 2.80% or higher margin even with gradually decreasing rates. We have a goal to get to 1.25% margin within two years or so, as I've stated earlier.

Number four is we believe very strongly about risk management, and risk management begins with maintaining strong credit quality, having lower interest rate risk, strong operational risk controls and a strong focus on compliance. We will never deviate from that. Number five is BankMobile is one of the very few disruptive digital bank that is attracting hundreds of thousands of consumers across America, as you heard from Luvleen, and we are not focused on high rate deposits. That is easy to do. We are focused on attracting the checking accounts and ongoing relationships and getting demand deposits into our bank. That's not easy to do. This digital consumer bank will become profitable within few months and create substantial shareholder value for all coming shareholders, and we hope you have an appreciation that we are -- we look at BankMobile as a separate tech company that happens to be using Customers Bank as their banking platform or a banking partner right now. We are currently trading at 90% or less of book value and only about 7x or $3 per share guidance for 2020. And we think that creates a very attractive opportunity.

With that, now I will ask the operator to open it up for questions. So Melissa, can you help us please?

[Operator]

[Operator Instructions]. And we'll take our first question.

[Michael Perito, KBW]

It's Mike Perito from KBW. I wanted to start on the margin commentary. I wanted to reconcile a couple of things. I -- if I look at the investor deck from the Analyst Day, there are a handful of slides that kind of show the loans and the repricing, the maturity date and quite a bit of the commercial book if I recall, both the C&I -- on owner-occupied CRE but also the non-owner-occupied CRE, where prices are in under 1 year, and so I was just trying to get a better understanding of how the potential for a couple of cuts in Fed funds later this year, would it necessarily impact margin based on the disclosures from that Analyst Day?

[Jay Sidhu, Chairman & CEO]

It's a very good question, and I will request Carla to add to any of the comments I will make to you. As you know, Mike, that 35% of our portfolio at that time was a multifamily portfolio. The average yield of that portfolio has gone up since that time because we have been gradually working on getting rid of the lowest yielding. So one of the ways that we are going to minimize any kind of a negative impact on the margins with a change in the timing of our deposit cost and funding cost coming down and our loan yields coming down perhaps quicker is going to be by continuing to aggressively decrease the lower-yielding multifamily loans in our portfolio and continuing to replace them with higher-yielding portfolios.

Second thing is, like Carla mentioned to you, we actually in the second quarter, extended a lot of our liabilities. You saw our funding costs go up more than what you may have expected. That was all done by our -- getting to a neutral position so that we are not either liability-sensitive or asset-sensitive. So that is going to have an impact, maybe you could have expected if we were liability-sensitive to our margin to be benefiting more than what you will see just from the rate decreases.

And one last item on the margin is that we are very well positioned, and compared to our disclosures to you in October of last year, we are ahead of plan and in terms of changing the mix of our assets as well as the growth rate of our funding sources, especially since we've extended a good portion of our liability, several hundred million of our liabilities. So both assets and liability mix change is such that we don't see any significant impact from lower rates on our margins.

[Michael Perito, KBW]

So to kind of summarize I guess, the -- being ahead of the plan and the asset remixing plus the extension of some of the liabilities that you've taken, you think, kind of neutralizes any risk if we start to get in an environment where the short term part of the curve moves down?

[Jay Sidhu, Chairman & CEO]

That is correct and a lot more I've shared with you.

[Michael Perito, KBW]

And then I wanted to spend some time on this mortgage warehouse credit. I know you can't talk about the credit specifically, given the bankruptcy proceedings, I want to talk about the portfolio in general. I guess for starters, and I apologize I do have a handful of questions, but just for starters, can you give us a little bit more information about the mix of that portfolio? How much is corporate versus noncorporate in the warehouse? I guess, let's start there.

[Jay Sidhu, Chairman & CEO]

I don't know what you mean by corporate or noncorporate, they are all warehouse loans, all for single-family mortgage loans. And we are basically...

[Michael Perito, KBW]

That's what I thought you guys did, but I was a little confused by the corporate terminology that you guys included.

[Jay Sidhu, Chairman & CEO]

Yes. Mike, sorry about that, but the reason we include the terminology is because we call them commercial loans now. So that's why...

[Michael Perito, KBW]

Okay. So your entire mortgage warehouse portfolio is just residential mortgages?

[Jay Sidhu, Chairman & CEO]

Yes.

[Michael Perito, KBW]

Okay. And what was the size of this credit? And do you have any other color on how that compares to the typical size of the credit and your mortgage warehouse for?

[Jay Sidhu, Chairman & CEO]

The size of this credit was in the low 30s million, and our average size of the mortgage warehouse credit because we are dealing with midsize, highly profitable, well-run mortgage companies who are ethical in nature other than this one turned out to be perhaps using some unethical means, but anyway -- so our size is about the $35 million in that range.

[Michael Perito, KBW]

So this credit was about at the midpoint?

[Jay Sidhu, Chairman & CEO]

That is correct.

[Michael Perito, KBW]

Okay. And just a couple more for you here. I noticed in the 10-Q, I was reading about it, it says that you don't carry any allowance against loans in these businesses, given the nature of them and I'm just curious if an event like this makes you kind of rethink the underwriting and the allowance aspect of that portfolio?

[Carla Leibold, EVP, CFO & Treasurer]

Yes. I'll take that one. We're under a different accounting model. So these mortgage warehouse loans are at their fair value. So it's not appropriate to take an allowance on that type of asset under this accounting model. And that's why you'll see the charge ultimately that we brought is recorded through noninterest income.

[Michael Perito, KBW]

Why do you believe that some of your peers can hold allowances or do hold allowances against this portfolio, I mean, is that an accounting -- is there a different ways to do that?

[Carla Leibold, EVP, CFO & Treasurer]

There are different ways to do that. The fair value option is an accounting election that we've made and some of our other peers have not made a similar election.

[Michael Perito, KBW]

Okay. And then lastly, you mentioned that this is the only loan in the portfolio that has this specific type of collateral. I was wondering if you could just give us a sense of what may be a more common type of collateral that you're holding against these credits are?

[Jay Sidhu, Chairman & CEO]

Yes. Yes. The common collateral, in fact, that is the only collateral against all our mortgage warehouse loans is, mortgage loans that are closed and sold and we hold the collateral where we hold the title of those loans, those loans when they are delivered to the buyer, that's when the money comes directly to us. We keep our money and then we send the money to the mortgage company. In this instance, we did have a few more loans to them, which they were looking at more than just the mortgage warehouse line and for that, we've required additional collateral. And we took that collateral in the form of GNMA securities. On top of that, we required corporate guarantees. On top of that, we were the only bank in this whole consortium to our -- best of our knowledge, they are also got personal guarantees. That's why we got hold of our collateral already, which we don't believe perhaps everybody has been able to do because it was out of the bankruptcy proceedings. So our structure give us an ability to collect this collateral ahead of other people and then get a valuation on this collateral. And we are lucky over here and good that we were able to deal with it and move on. And wait till we start working with all the partners, and we are going to make that gentleman's life miserable and that company is going to have to provide every single penny that they have to all their creditors including us.

[Michael Perito, KBW]

Okay. Got it. Sorry, [indiscernible. I just wanted to make sure I understood the credit and some of the background better. So I appreciate all the color.

[Operator]

We'll move on to our next question.

[Stephen Moss, B. Riley FBR]

It's Steve Moss with B. Riley FBR. I guess, I want to start with the consumer loan purchases here this quarter. Just wondering what type of consumer loans did you purchased? And what is the rate on those loans?

[Jay Sidhu, Chairman & CEO]

Steve, what we do is that we look at -- we are in the personal loan business. We are in the student loan refinance business, and we have been concentrating and looking at models that we use and we have our criteria that we adopt. We want to -- wanted to have somewhere around 80% loan-to-deposit ratio on BankMobile. We realized that it would take us quite a bit of time but we are building that sort of a thing to do it on our own.

So we decided to follow our credit criteria, our experience and our model and see where we can in a very well-diversified way, be able to get to a portfolio of consumer loans that then we can continue to replace hopefully, majority of those with our own originations under our own model. And -- so that's where we are. These are all either personal loans or student loan refinancing. And they are from about 6, 7 different sources. The biggest ones being Upstart and then SoFi, it's another big one partner of ours. And also Prosper is another partner of ours...

[Stephen Moss, B. Riley FBR]

Okay. And I guess just the rate on the loans is in a high single digit, I assume?

[Jay Sidhu, Chairman & CEO]

Yes. Yes, sorry, yes. That is correct. High single digits.

[Stephen Moss, B. Riley FBR]

Okay. And then on the multifamily side, I saw from the disclosures regarding the portfolio there. Just wondering do you guys have any major capital improvement loans if you could quantify that? And what is the geographic exposure of the properties?

[Jay Sidhu, Chairman & CEO]

No, we don't have any significant or any capital improvement loans, and 65% of our multifamily loan portfolio is New York.

[Stephen Moss, B. Riley FBR]

Okay. And I guess, I'm sorry, I should have clarified, perhaps by -- within New York City like, is the bulk of it in Manhattan or is it in the other boroughs?

[Jay Sidhu, Chairman & CEO]

In the five boroughs, not a bulk of it is not just -- not Manhattan.

[Stephen Moss, B. Riley FBR]

Okay. And then on the deposit side, I was just kind of curious here what the Feds had to cut rate, I hear you guys on the neutral position of the balance sheet, but just kind of wondering what -- how you guys are thinking about your interest-bearing deposits if we get 50 basis points this quarter, where do you think the rates on those will go?

[Jay Sidhu, Chairman & CEO]

First of all, our belief is there will be a 25 basis points Fed cut, not 50. So in our modeling, that's what we've assumed. And for the 50 basis points rate cuts, we are going to be opportunistic wherever we see an opportunity to increase market share we will follow, we will not lead. Where we don't think it's a relationship we will lead and not worry about following. So we think it's the business strategy should -- that should drive our rate strategy and not maximization of short-term margin increase. We are doing other things to increase margin rather than just short-term maximization of profits. Sometimes it works, it will work. I love it when I hear from every other bank that they can't wait to cut deposit rates because they are seeing nothing other than margin compression. I love it, please go ahead, do it tomorrow, gives us an opportunity right away.

[Stephen Moss, B. Riley FBR]

Okay. That's helpful. And then in terms of the interest-only strip you acquired from the borrower default, just wondering what drove the strategy to retain it versus just selling the position? In other words, taking the potential mortgage risk with declining rates.

[Jay Sidhu, Chairman & CEO]

Yes. We took those strategies, they are -- I'm sorry, we took those securities, they are different securities for different folks who are engaged with this credit. In our case, we went out and we got bids for these securities. We saw the cash flow. That cash flow was significantly higher than the interest. So we stress-tested them. And yes, we will look at them on a regular basis and if we ever see there are assumptions not paying out, we will -- we know we can sort them. Now at the market value that we are working them down to. So we will continue to evaluate, and we are not holding them to maturity. These will be mark-to-market or sort of a fair value on a regular basis.

[Stephen Moss, B. Riley FBR]

Okay. And now I guess, one last question I apologize if I missed this on -- just on a commercial loan origination to your C&I originations in particular, I was just wondering what the rate was on originations this quarter?

[Jay Sidhu, Chairman & CEO]

About between 5% to 5.25%.

[Operator]

And we'll move on to our next question.

[Jay Sidhu, Chairman & CEO]

Who is this?

[Russell Gunther, D.A. Davidson & Co.]

Yes. It's Russell Gunther with D.A. Davidson. I just had a couple of questions I wanted to clarify, comments made around some of the expense initiatives this quarter. I think you guys referenced additional material savings in the back half of 2019. So I just want to make sure that those are in addition to the $3 million of annual you'd expect from the staff reductions? And then maybe just get some color around where those cost savings would be coming from?

[Jay Sidhu, Chairman & CEO]

Also, we are going through a process of digitizing the entire bank, we are looking at all expenses. We have looked at areas, which -- where technology can be improved, we are looking at that technology expenses also. So when you combine all of them that's what gives us the confidence that beyond $1.5 million of lower comp expense in the second half, that will be offset. We are going to be -- we are much more confident about the future earnings, so we have to build up our incentive comp expense. So when you see the comp expense go up in the second half, it just don't look at that line because we have to build the comp expense based upon meeting or exceeding our own goals and right now, we are on target to exceed our own goals. Yes, but the other areas besides comp is where you will see quite a bit of expense management results in the second half of the year.

[Russell Gunther, D.A. Davidson & Co.]

And so -- okay. Is that -- can we maybe then quantify what the net cost savings would be if so comps are going up because you guys are hitting your boogies but you got this efficiency initiatives, what kind of falls to the bottom line?

[Jay Sidhu, Chairman & CEO]

I think we are saying to you flat to little bit down. So if you just look at first half of the expenses and you -- depending up on your model, just keep them at the highest would be flat to that number. If it's down, it's going to be maybe $5 million down or less.

[Russell Gunther, D.A. Davidson & Co.]

Okay. Okay. And then last one for me is whether or not you guys expect the consumer loan balances to grow significantly from here, either purchased or organic -- organically?

[Jay Sidhu, Chairman & CEO]

So organic growth is running around $20 million to $25 million a month. So that's -- our pay-offs are going to be less than that. So there will be nothing significant. But like I shared with you, the more we are getting into this business and just looking at the prime market and prime credits, we are seeing opportunities and we like what we see from a risk-adjusted reward, we see major weaknesses in the credit profile of consumer loans in the subprime area or near prime area. We are staying away from that. Our definition of prime is 6.80% and above. So we are really -- 6.60% and above, sorry. So we are really -- we have hardly anything between 6.60% and 6.80%, but we have a little bit. That's why our average is 7% -- close to 7.50%. So I don't think you should see a significant increase but we have targeted part of the Customers Bank segment outside of BankMobile, somewhere in the 5% to 7.5% of that loan portfolio over a period of time to be consumer loans. And we'll be opportunistic as to how we do it and when we do it.

[Operator]

And we'll move on to our next question.

[William Dezellem, Tieton Capital Management]

It's Bill Dezellem at Tieton Capital. I have 2 questions. The first one is what you've seen in terms of trends with deposits coming in from T-Mobile MONEY? And secondarily, preferred redemption, what assumptions are you making with your $3 estimate for next year?

[Jay Sidhu, Chairman & CEO]

I think as Luvleen shared with you for the T-Mobile MONEY in the last 3 months or so, we've brought in about $50 million in deposits, and as far as the redemption, we have $245 million -- $225 million, excuse me, which is going to become callable over the next -- by the end of 2021, next year, it's about, what Carla, $50 million?

[Carla Leibold, EVP, CFO & Treasurer]

$50.75 million.

[Jay Sidhu, Chairman & CEO]

$50-some-whatever-million, so we've made an assumption next year only for the redemption of the $50 million or so.

[William Dezellem, Tieton Capital Management]

And of the $50 million deposits that Luvleen in the press release referenced, did you see those numbers increasing throughout the quarter? And talk about the trend versus the first quarter if you would please?

[Jay Sidhu, Chairman & CEO]

Well, the growth really happened in the latter part of the second quarter. And this is limited introduction and limited digital Phase I introduction by T-Mobile, and we are very much engaged with them. So we don't want to comment anymore other than that.

[Operator]

And we'll take our next question.

[Frank Schiraldi, Sandler O'Neill + Partners]

It's Frank Schiraldi from Sandler. Just starting with the consumer, just kind of curious if you could talk about why the consumer came on so late in the quarter, was that all by design? Was there deposit funding that came on late in the quarter? Just kind of wanted to get little bit of color on that front.

[Jay Sidhu, Chairman & CEO]

No, Frank. None of the above. What happened is that we do a very thorough diligence, and we completed our diligence and then we go through a process that we follow of various groups of the company, including compliance area, doing a thorough diligence and it just so happened as that -- it took longer to close. We obviously, would have love to have had some revenues coming from this earlier during the quarter. And we did not want to push it into the third quarter and so it just so happened that we work together with the seller to try to close it on the last business day. That's what happened.

[Frank Schiraldi, Sandler O'Neill + Partners]

Okay. And then I think in the release you talked about $8 million in reserves for C&I and the consumer that was on boarded in the quarter net of the multifamily run off. Could you just -- what was the reserves taken for specifically the consumer book?

[Carla Leibold, EVP, CFO & Treasurer]

It was about $7.5 million.

[Frank Schiraldi, Sandler O'Neill + Partners]

So that actually seems like a much lower number than I would have anticipated just going into the quarter, can you just talk about why the reserves were 2% versus I think in the past, you've talked about maybe average reserves coming out around the 4% levels, just higher FICOs than you had initially anticipated?

[Carla Leibold, EVP, CFO & Treasurer]

Part of the reason but also what we've seen is the portfolios are performing better than what we were initially expecting. So that was part of the consideration in determining the reserve rate for the second quarter.

[Jay Sidhu, Chairman & CEO]

Yes. We do a very thorough review and analysis and for the appropriate accounting is that you do not -- you'll have appropriate reserves and not over reserve and definitely not under reserved. So yes, we had assumptions like you said that, hey, the charge-offs are going to be higher and we were using conservative assumptions. And like we've shared with you, there are consumer segments, some of the banks traditionally who have been in the consumer business are just ignoring it. And the quality customer -- everybody assumes marketplace lenders are subprime lenders or low-prime lenders and -- but if you can be selective, you can pick up the top tranche of the business and that is performing much more bank like and we had assumed it would perform much more consumer finance type.

[Frank Schiraldi, Sandler O'Neill + Partners]

Okay. And then -- so I guess you mentioned the high -- the yield on these consumer loans are in the high single digits, so we're talking about -- I assume that yields here of 6%, 7% with reserves baked in. What is -- I also wanted to ask about the reserve releases in the quarter, the $2.9 million you talked about better-than-expected credit results. And I wonder if you can just talk about why now and where was this allocated to, this $2.9 million that was reversed?

[Jay Sidhu, Chairman & CEO]

Carla, you want to take it?

[Carla Leibold, EVP, CFO & Treasurer]

Yes. When you say allocated, it was on the business and banking segment and it was really in the residential real estate portfolio and we had initially estimated a higher loss on those loans than what ultimately we think we're going to have incurred. And so that resulted in a release.

[Jay Sidhu, Chairman & CEO]

And I think if you recall we had reported, and Carla, help me if I'm wrong on this, we had mentioned to you last quarter that for CRA, we acquired quite a bit of CRA loans. And generally, without -- and that was close to the end of the year, so generally without doing a thorough analysis we take a conservative view on reserves. We'd rather do that but we are required to then do a review and if you're conservative you better adjust it. And that's exactly what we did. And that's exactly what Carla mentioned, that we expected that portfolio to be a CRA portfolio usually means, high charge-offs, well, not all CRA portfolios. So this one is not as bad as we thought it would be.

[Frank Schiraldi, Sandler O'Neill + Partners]

Okay. And then just following up with that on -- just wonder when you expect or anticipate you'll be able to provide some detail on Cecil implementation, specifically what sort of additional reserving, if any, will take place under Cecil?

[Carla Leibold, EVP, CFO & Treasurer]

So we're not giving any guidance at this point in time, but what we can say is that we're confident we're going to be ready by the January 1, 2020. We've got a team dedicated working on that, going through our parallel phase right now. We've got good partners. Potentially, in our third quarter queue, you might see some more disclosures around potential effect, but we're not giving that estimate at this point in time.

[Jay Sidhu, Chairman & CEO]

And Frank, my best guess right now, in addition to Carla's comments is that you're seeing banks, say, about a 30% plus/minus reserving. I don't see a reason why you'll find a lot of banks who are any different from that. So your comment that you made, if any, well, I can guarantee you, you will see a higher provision. So for us, it's guaranteed to be movement of -- in that range or so at this time but like I agree with Carla completely, we are unable to give you numbers that are kind of meaningless at this time. We'd rather be absolutely accurate and be able to substantiate that and we are -- we have numbers, we have done the model, we are just stress testing it. So it's well in control. And it's going to be in that range.

[Frank Schiraldi, Sandler O'Neill + Partners]

Okay. And then if I can sneak one last one in, just on the BankMobile business. Just curious, I know you talked about some of the -- and I know your fee structure has been very, very low compared to competition and you've talked about increasing some of the student disbursement fees. I just wonder as you do that, if you can share what sort of additional revenue stream you anticipate that will create?

[Jay Sidhu, Chairman & CEO]

Frank, sure. Originally, we were hoping to get that implemented in the first quarter then it got kind of forced into the second and we did get some fees in the second, but majority of the fees went into effect on June 1, I believe. And so at this time, we've had only a few million dollars. Bob, how much approximately have we gathered from these fees incremental numbers so far?

[Robert Savino, Chief Product Officer, BankMobile]

Yes. I mean I think if you look at the second quarter, we're up about $1.5 million over the second quarter last year. So you definitely can see the impact. As Jay said, June, we did have the full impact of the new fee structure. We had a partial impact during the first 2 months of the second quarter. So you definitely do see the lift in those deposit fees, but we will get a little bit more in the third and the fourth. Keep in mind, we do have the normal seasonality in our business. So the first and fourth quarters are going to be much bigger because of activity than the second and the third. But the third quarter is not quite the full run rate but is approaching what would be a full run rate, if you were to normalize for seasonality.

[Jay Sidhu, Chairman & CEO]

And I'd like to just make 1 final comment on BankMobile that Luvleen articulated so well and that is, you've got to look at BankMobile as a tech company, the technology, which is developing a lot of very interesting, unique products. And that we are not interested in maximizing fees. And we are mainly interested in having this be one of the best performing digital banks in the nation. We are not interested in getting just hundreds and thousands of customers who do nothing with us. And so very exciting developments coming up, and so that's why we put the commenting that we will be able to hopefully give you a little bit more guidance about the status of our tech company in the fourth quarter.

[Operator]

And we do have another question in the queue.

[Michael Perito, KBW]

It's Mike Perito. Sorry, I just had a quick follow-up. I was wondering if you could just give us a little color or outlook commentary around kind of how you expect assets to trend over the balance of the year? Obviously, there was nice growth this quarter but I'm not -- I'm forgetting something. I thought that you guys have mentioned that you still want to try and keep it under $10 billion through year-end. So can you just give us maybe a little bit more color on how you're thinking of the trajectory of assets? And what some of the moving pieces are there as the back half of the year unfolds?

[Jay Sidhu, Chairman & CEO]

Sure. Sure. I'll try that and again, Carla, please add to my comments. In this kind of a rate environment, we expect our mortgage warehouse business to continue to remain strong from the entire third quarter, helping our average earning assets to be higher than what you've noticed in the first half of the year. So you should expect the average earning assets to be continuing to provide incremental earnings to us in the second half of the year in addition to the expanded margin. And then we are looking at reducing our balance sheet potentially in the fourth quarter by about $1 billion through or to some may be even as high as $1.5 billion. We are looking at so many different ways to do that, and we hopefully, will be able to give you more guidance on that sometime in the latter part of the third quarter or in the beginning of fourth quarter as to how we are executing that.

[Michael Perito, KBW]

Okay. Great. So I guess from a modeling perspective, the average balances are going to be fundamentally above $10 billion, but at the end of the year on a period-end basis, you guys are going to take action to keep the bank under $10 billion. Is that...

[Jay Sidhu, Chairman & CEO]

Yes. And Mike, all you got to assume is that earning asset will be -- could be at least $0.5 billion or so higher, could be as much in the second half, earning assets and that's going to add to the earnings for modeling purposes. Melissa, are there any more questions?

[Operator]

I show no further questions at this time.

[Jay Sidhu, Chairman & CEO]

Okay. Well, thank you very much, ladies and gentlemen. Sorry, this is a little bit longer, but we appreciate your questions. Thanks so much, and have a good day.

[Operator]

That does conclude our conference for today. Thank you for your participation.