Customers Bancorp Inc
NYSE:CUBI
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Customers Bancorp Inc
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Good morning and welcome to the third quarter 2018 Customers Bancorp Incorporated earnings call. Today’s call is being recorded. At this time, I would like to turn the call over to Mr. Bob Ramsey. Please go ahead, sir.
Thank you and good morning everyone. Customers Bancorp’s third quarter earnings release was issued yesterday evening, as well as an investor presentation. Both are posted on the company’s website at www.customersbank.com.
Representing the company on our call today are Jay Sidhu, Chairman and Chief Executive Officer; Bob Wahlman, Chief Financial Officer; Dick Ehst, Chief Operating Officer; Carla Leibold, our Chief Accounting Officer, and myself, Bob Ramsey, Director of Investor Relations and Strategic Planning.
Before we begin, we would 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 or 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 law. 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.
Thank you very much, Bob, and good morning ladies and gentlemen. Thanks for calling in of our third quarter earnings call. The corporation reported diluted operating EPS of $0.62, which was 29%, and operating return on average assets of 88 basis points based on an average common equity of about 11%. The community business banking segment continues to perform very well and we reported operating diluted EPS for that segment, which is our core bank, of $0.73, which are up 14% over last year, and operating return on average assets of a little over 1% and return on average common equity of about 13.5%, and efficiency ratio of 50%, which we expect to get down in the low 40s within a 24-month period.
From an earning asset point of view, we reported 15% year-over-year growth in C&I lending, which excludes our loans held for sale in the mortgage warehouse category. As you would expect based upon the guidance that we had provided, we are reporting a 7% year-over-year decline in multi-family loans, and that decline will increase over the next couple of quarters.
On the liability side, we achieved $1.2 billion, which is 17% quarter-over-quarter deposit growth, and I’ll talk a little bit more about that in a minute, and simultaneously we are totally balanced on an interest rate risk point of view at September 30 since we sold about $500 million of low-yielding securities and repaid a similar amount of borrowings, significantly improving the interest rate risk profile and putting an absolute floor on our margin. Credit quality remains very strong and basically no change in our pristine credit quality.
From a deposit point of view, as I mentioned, core deposit growth as part of strategy accelerated immensely in Q3 2018. We did that for three reasons. Number one was that for the year, we’ve been planning and executing on many improvements in our deposit generation and product offering capabilities. All of those were implemented starting Q3, and the ending result is that our escrow balances increased significantly, as an example, starting Q3. Also we launched CB digital bank, which is a direct bank for high income, high net worth individuals across America, and that’s generating approximately between $52 million to $100 million a month in core deposit growth. Then thirdly, the BankMobile deposits continued to increase, so as a result of all these activities, demand deposits increased 38% quarter over quarter, money market and savings increased 19% quarter over quarter, and time deposits increased 25% quarter over quarter.
From a loan growth point of view, as I mentioned to you earlier, C&I grew 15% year over year and multi-family declined 7% year over year. We launched our consumer loan offerings in partnership principally with Upstart this quarter, and as a result of that we showed some modest increases and you should expect over the next 12 to 18 months that consumer loans will become a bigger and bigger part of our earning asset base. The yields that we are getting on the consumer loans right now are ranging between 8% to 12 or 13%.
From a margin point of view, the yield on the loans increased in this quarter only three basis points but up 44 basis points from last year same period, and this was due to seasonality--seasonally lower balances in our mortgage warehouse business as well as a fairly significant impact to lower prepayment fees in all our loan categories, including C&I loans as well as some multi-family loans. We believe that prepayment fees will stay low in this rising rate environment.
From a NIM point of view, we hit a trough. We don’t believe you’re going to experience any NIM compression from here on out. You should expect us to report higher, gradually higher NIM, and we are shooting of a NIM of 2.75% within the next 12 to 18 months. Some of the steps which give us this confidence is that as I shared with you earlier, we sold $495 million of securities at 2.67 yield, and we exited approximately $500 million of borrowings at a 2.85 cost, which obviously this transaction is NIM positive and frees up capital for deployment in much higher yielding assets. We expect significant growth in low cost BankMobile white label deposits starting sometime in next year, and we think that within 12 months after the launch of our relationship with our white label partner, which is T-Mobile, that we expect deposits to be about $500 million, and these will be very low cost deposits.
We expect multi-family loans to end 2018 at about $3.3 billion and continue to head lower, and next year we believe they could be down at least 20%. We will grow our C&I loans next year as well as consumer loans. From an originations point of view, the company today in the fourth quarter is not originating any loans below 5.25%. From a product and channel strategy, including the digital channel for our direct bank, we are continuing to experience--we did not increase any rates after the last Fed increase, but we are still experiencing between $50 million to $60 million inflow of core deposits at this time.
From a loan re-pricing characteristics, 85% of our C&I loans re-price immediately or within one year, and this includes our loans to mortgage companies; but on the multi-family side, as you would expect, only 13% will re-price within one year. On the commercial real estate side, it’s 40%. Multi-family and commercial real estate in our opinion are assets which do not do well at all in a rising rate and a flat environment and hence they will be significantly--we’ll be reducing our exposure on those assets significantly over the next several quarters. Within a three-year period, we expect multi-family loans still--we like that asset category to be approximately a billion dollars in outstandings, and we will selectively book those loans at higher yields and get the lower yielding loans off our balance sheet. From a C&I point of view, they today make up 38% of our loans, and you should expect that percentage to increase to over 50% within a three-year period.
From a BankMobile business segment point of view, the BankMobile reported a loss--adjusted operating loss of $3.6 million or $0.11 per diluted share. We expect the fourth quarter loss not to exceed this number. We are totally laser focused on making BankMobile profitable by end of next year. BankMobile deposits averaged about $500 million in Q3, and in spite of lots of regulatory department of education headwinds, we are very encouraged that our new customers that we are attracting in the student business view our product offering as a core product the majority of them do, and hence we continue to see average deposits grow. We are looking at all sorts of strategies to improve the performance of BankMobile and get to the profitability, including assessing higher fees wherever we see unprofitable customer segments. It’s much more important for us to improve profitability than just get more accounts, and then whatever we get, we want to make them customers for life. The BankMobile segment reporting reflects a margin of only 3%, the low of 3%, and we believe that it should--it can easily earn a margin of well over 6% with consumer loans, and that itself on a standalone basis would significantly improve the profitability of BankMobile.
Our operating expenses decreased to 17% over the prior year, and this includes some subsidies towards our technology expenses from our white label partners, but still our investments in research and development and technology investments have been fairly significant to support the expected white label partnership of BankMobile. We are very confident that in 2020, BankMobile will definitely be very profitable, leading to within a two to three year period a return on assets which we expect to be greater than the average return on asset of our community business segment.
Given that somewhat of a shift in our strategy that we announced on our analyst day a few weeks ago, I’m now going to discuss with you our strategic priorities.
Number one clear is to create shareholder value through significantly improved profitability. The consumer business segment of our business supported an operating ROA of a little over 1%. We are not happy with that, and we target a return on average assets of at least 1.25% within three years. Perhaps it could take five years, but we are shooting for it as quickly as possible within a three to five year period. We are targeting a continuation of our double digit return on tangible common equity as well as a NIM of 2.75%, and we hope to get that done by end of next year, perhaps by middle of the following year at the latest. As I mentioned earlier, we hit a trough in Q3 on the margin, and you should expect margin to gradually expand starting with the fourth quarter.
At the same time, the community business banking segment, we are launching several initiatives, including a total digitization of all our activities at the community business bank, and hence you should expect that we will maintain expense growth to an absolute minimum. Any expense growth will be tied directly to revenue growth.
Number two priority that we shared with the investment community on our analyst day was a focus to grow core banking while we gradually exit what we consider to be non-core banking. We expect to grow our core franchise, which is low cost core deposits, and from those categories just for next year you should expect about a $600 million increase in deposits from our core franchise. On top of that, you should expect another about $500 million to $600 million increase to what we call our CB digital direct bank, which is the bank we started in the third quarter aiming towards the high income, high net worth individuals throughout the country. Thirdly, you should expect after the launch of our white label partner on an annual basis about $500 million growth through BankMobile, and that is expected to be very low cost deposits or zero cost deposits.
From a balance sheet point of view, we expect to manage the consolidated balance sheets under $10 billion and significantly improve capital and profitability while preserving, in our opinion by staying below $10 billion, the full interchange income from the debit cards that we have, well over a million already being used by our customers.
Number three strategic priority we shared with the investment community was that we expect to grow BankMobile for the next two to three years before we expect to spin it off, because we are excited about BankMobile’s profitability and we will do everything humanly possible to make our student business profitable by end of next year and we expect to generate significant low cost core deposits through our white label partnership.
Why are we doing this? Because like I mentioned, we are excited about the BankMobile new white label partnership and we are excited about turning around the existing student disbursement business. At the same, we believe strongly that the only way our shareholders could enjoy in the upside of BankMobile was if they own a significant portion of BankMobile, and that’s why the spin merge made a lot of sense to us. However, we were very disappointed with the regulatory complications which clearly stated that if our Customers Bancorp shareholders collectively owned more than 24.9% of the company called BankMobile, the new company called BankMobile, then the Federal Reserve determined they will consider us as affiliates and take away the advantage of Durbin for BankMobile. There is no way we can guarantee what our shareholder, whether they’ll hang onto the stock or they’ll sell the stock or they’ll trade the stock, and that made the spin merge option totally--it created inability for us to execute that.
So now, what we are looking at is while we grow BankMobile, you should expect us within the next 12 to 24 months to continue to look at every option, including the option of Customers Bancorp becoming a two bank holding company and then doing an IPO for the BankMobile part of our two bank holding company. The board will be looking at and assessing the options available to us on a regular basis, but we believe it will take us two to three years while we are very focused on improving our shareholder value and improving our core banking business, improving our capital ratios, improving our margins, and really improving the franchise value of our company, that we will be very well positioned at that time to spin off and do an IPO for BankMobile, assuming that it really continues to grow its white label business. That’s on our third strategic priority, which is BankMobile.
Our fourth strategic priority is strengthening our mix, so in September we sold about $500 million of our low yielding securities, as I shared with you earlier, and these were funded towards the borrowings at a cost higher than what these securities were yielding. Like I mentioned earlier, we expect to grow C&I lending. You should expect about a $500 million increase in C&I loans next year at about 5.25%, and you should expect somewhere around a $400 million increase in our consumer loan portfolio next year, which will yield about 8 to 12%. Then how would we create an opportunity or space on the balance sheet? That’s going to be through similar reductions between multi-family and commercial real estate assets on our balance sheet.
I’ve already given you some of the guidance on our deposit side, and we continue to focus on generation of low cost core deposits where the all-in costs should be significantly below the interest expense on our balance sheet right now, and we currently have over $700 million of deposits as an example with a cost of over 2.5%, and we expect to get those off our balance sheet.
The number five strategic priority we shared with the investment community was deploying our excess capital to benefit our shareholders, and today we already have a TCE ratio of approximately 7.5%, and today our balance sheet is slightly below $10 billion already. We are targeting to always maintain a TCE ratio about 7% target, so as we retain our earnings and we manage our balance sheet, you should expect obviously our capital ratios to continue to build and our board will always on a regular basis evaluate various options for capital allocation, including potentially buying back our preferred shares when they become callable.
I personally, along with many of the colleagues whom I have spoken to, we can’t wait for the blackout period to end, and with the company right now trading at about in the mid-80s of tangible book value and about 8.5 times last 12 months earnings, we are obviously very bullish on our stock, and you should expect some insiders to be buyers this quarter at these levels. Also, I want to share with you that all management is taking at least 70% of their bonuses this year in CUBI stock.
With that, I’d like to open it up, Nick, for any questions from anybody who is on the call.
[Operator instructions]
Our first question comes from Steve Moss of B. Riley FBR. Please go ahead, sir.
Good morning. I wanted to talk about the 2.75 NIM target here. Just wondering if you assume any additional rate hikes in 2019 in that number.
Yes, we do. We assume three to four rate hikes between now and second half of next year.
Okay, and then in terms of running off the multi-family loans, do you expect to undertake a securitization in the next 12 months?
Steve, I think Dick mentioned on the analyst day that over the next couple of months, we will be looking at some partnership with some funds or working with an investment bank for continuing with our originations and getting into the securitization business, but that would be for the new originations because as you know, the average yield on our existing portfolio will create some losses which are not acceptable to us because our multi-family business is still a profitable business. It’s just that when you assume four or five Fed rate hikes, it will become not profitable, and that’s where we don’t want to be sitting here four quarters from now blaming why our profitability is what it is, because 34% of our balance sheet today is in the multi-family business. So we will be proactively encouraging our customers to find another home and hanging onto our core customers, and that’s why we are sharing with you that we expect our commercial real estate portfolio to be down about 20% or so by the end of next year and then gradually continuing with that, but the securitization opportunity will be for new business.
Okay. I guess my third question here is on the potential for capital deployment and being above your tangible common equity target of 7% at year end. Will you consider doing share repurchases ahead of that?
Our board probably will put on the agenda capital management options for us at our November meeting. Yes, I would expect that to be on the agenda.
All right, thank you very much.
Thank you. If you find that your question has been answered, you may remove yourself from the queue by pressing star, two. Our next question comes from Michael Perito from KBW. Please go ahead.
Good morning.
Hey Mike, good morning.
Thanks for the strategic rundown, Jay. I just have a couple modeling questions that I wanted to touch base on. One, with the good C&I and consumer growth we saw in the quarter, would you guys say that all else equal from a loss perspective, that this provisioning run rate is a good level as you continue to remix the loan portfolio as we move into next year?
I think, Mike, consumer loans, we are looking at a reserve and provisions based upon historical losses of similar assets that we are putting on the books, and they are ranging between a low of 3% to a high of 8%. It depends on the quality of those. We will do what is appropriate from a reserving point of view and we are well underway in preparation for CECL also, and at the right time we will give the appropriate guidance to the marketplace. But our reserving will be in accordance with the normally accepted regulatory guidelines as well as GAAP.
Okay. Jay, can you remind us, now that you guys will be potentially holding onto BankMobile for the next couple years here, I know there is a bit of seasonality in their business, I think if I remember correctly the third and first quarters typically have the highest deposit balances. But can you just walk us through and remind us about some of the fee expense and deposit seasonality that BankMobile has as we try to think about our models for the next couple years?
Mike, you’re right - from a deposit side of it, it’s the third quarter and the first quarter, and the same thing goes for debit card interchange income, which is from a non-interest income point of view the greatest contributor in that area. The students are hardly around in the summer time, and that’s why when you see a majority of the third quarter and majority of the second quarter, they are not even on campus and that’s why seasonally those happen to be the weaker quarters of non-interest income, as well as net interest income revenue.
However, contrary to what we shared with you based upon feedback that we got from many of the investors and analysts, we are seriously looking at continuation of our segment reporting in 2019, and when we share with you our fourth quarter results, we will give you our final decision. It will make it hopefully easier for you to model where Customers Bank business banking segment is going, and as you know, the Customers Bank business segment contains two divisions by us - one is what we call the CB private and commercial banking division, and the second one is our direct digital bank division. The BankMobile segment will have consumer loans as well as deposits as well as non-interest income.
In terms of a couple of years for BankMobile, you’re absolutely right. What I would say is we expect it to be no more than three years.
Mike, I would point you too to Slide 16. It’s got, I think, 11 quarters of BankMobile segment results, so that should give you a good feel of the historical seasonality in the disbursement business, which will continue in future periods, and as we add white label, that’s not going to have the same seasonality so that will be a change as we go as well.
And that was in the investor day deck, Bob?
Yes, it is.
All right, perfect. I’ll look at that.
Of the deck we’ve got out yesterday for the third quarter, not the investor day deck but the deck for [indiscernible].
Thank you. Then just lastly, I saw the comment in the earnings release that the tax rate is going to be--you expect it to be around 24% for fourth quarter. Does that persist into next year as well?
It’s very interesting, we are one of the few banks that are investing in research and development, and so the tax rate is going to be now dependent also on our R&D expenses. Our Chief Accounting Officer just this morning was sharing with us that in 2018, tax rates will be impacted because we have quite a bit of investment in research and development in the year 2018, and what you notice impacting our tax rate in the third quarter was a true-up from some of the adjustments, including a little bit of R&D that we had. So we are looking at lowering a little bit our tax rate, but you should assume the guidance that we’ve given to you.
Okay, thank you for taking my questions, guys. Appreciate it.
Thank you. Our next question comes from Russell Gunther of DA Davidson. Please go ahead.
Hey, good morning guys.
Morning, Russ.
I wanted to ask a question on the margin guide, that 2.75. Jay, does that include the benefit you would expect from the new white label partnership and those low to no-cost deposits you highlighted earlier, or would you expect potential upside to that 2.75 as those deposits begin to come in?
Russell, we said 2.75 plus, and we are laser focused on getting to 2.75, but that did assume the white label being launched in the first quarter. If for whatever reason that timing gets affected, then it can affect a little bit, but we are working on in every area of the company. I’ve already shared with you we are not booking any loans below 5.25 as an example, and we are paying off and letting deposits run off. We are not chasing anything like that, and we are developing deeper relationships with our consumer as well as predominantly our business customers, because we are a business bank. But our strategy is very clear - we expect lots of headwinds in the industry from a continuation of a reasonably flat curve, which could invert, in our opinion, in the second half of next year because the Fed is totally focused on fighting inflation and continuing to increase short term rates, and we want to be ahead of the curve. While the industry is going to experience margin compression, we want to be the outlier which is gradually showing margin expansion. So asset liability management is being managed by us actively on a weekly basis and we have very, very focused execution strategies in place over the years. Yesterday management spent all day at an offsite meeting with every leader of the company, and we will be having these kinds of meetings on a regular basis. We are laser focused on getting to the 2.75 margin.
Great, thank you for your thoughts on that, Jay. Last one is on the community business bank expenses. I think they’re about $36 million this quarter. I heard you say you guys are laser focused at keeping that flat, but how should we think about the 36 going forward? Is it safe to annualize that number and hold it flat? Is it safe to annualize that and assume some sort of growth rate? Just appreciate any thoughts you guys could share on that line item, thank you.
Yes Russ, this is Deck Ehst. The opportunities that we’ve got in front of us to digitize this company certainly will have an impact on our opex. We do expect that throughout the entire year, we will not increase our opex beyond what the amount was for 2018, but how we continue to manage, we’ve instituted several cost saving initiatives throughout the company, we’ve dug very deep into the organization to try to find every place where we can save money, and we’ll continue to do that, it’s part of our DNA.
One of the things that we--back many years ago, in fact I think four or five years ago, we were operating at an opex of about 213 to 215, and we put a stake in the ground that we were going to get to 165 by 2016 and the street thought we were nuts, and so did the employees. We managed to get that point - in fact, we’re going to finish out this year at about 135. But we will continue to work on that relationship, and I think from your perspective, you should expect that--you can straight line the numbers, but you should expect that we will not increase our opex in 2019 over what we experienced in 2018.
I appreciate the color there. Thank you for taking my questions, guys.
Thank you. Our next question comes from Bill Desellum from Titan Capital. Please go ahead.
Thank you. I have a couple of questions. First of all, relative to your deposit growth, would you talk about how you accomplished the deposit growth that you had here in this quarter? You gave some guidance for the coming year for deposit growth that seemed quite strong, so I suspect whatever you did to grow deposits this quarter, you view as replicable, but would you address that also, please?
We grew deposits in three areas this past quarter. Like I shared, that was in our private banking groups - we have deposit teams in our private banking group which are totally focused on generating deposits. We have what we call hybrid teams in our private banking group which are focused on both gathering deposits as well as earning assets, and then we have of course some teams which are very much focused on the earning asset side. Our comp plans are such that if you run--if every team runs a balanced bank, their incentive compensation is the highest, so we have a laser focus on generating core deposits through our private banking operations and providing them with all the products that are needed, so that they can sell in the marketplace and attract the kind of clients that we want to attract, both on the liability and the asset side.
As Dick had shared on the analyst day, we needed to develop a lot of products as well as continue to recruit the teams. We are in active discussions right now on a very attractive deposit team from a very good deposit generator in New York, and we think that those kind of things will continue on top of the normal activities and that’s why we are shooting for approximately $600 million deposit growth through our various teams next year.
The second area happens to be our consumer business, and in the consumer business we see that as an opportunity both on the liability and the asset side, so I think with the digitization of the delivery channels, it is in our opinion very appropriate to expect us to continue to focus on the high income, high net worth individuals because we are a private business bank and we are now also creating a private consumer bank.
We are starting with the deposits, but we are not going to have just one product. We will be offering through the digital channels consumer checking accounts as well as investment accounts. I think at the analyst day, I shared with you by the end of the year you should expect us probably to get into a partnership with somebody to offer wealth management services also, so when you combine all that, that’s how I gave the guidance that next year you should expect about $600 million deposit growth through digital channels from the consumer sector.
That’s really in the core bank, and in the BankMobile it’s very much oriented towards continuation of having--retaining the customers we are attracting in the student business, as well as getting the white label partnerships launched and signing up more white label partners next year. That’s what gives us the confidence level of building low cost, very low cost deposits at the BankMobile.
That’s helpful, Jay. At the analyst meeting, did we hear correctly that you are really hoping that BankMobile will be profitable in all of 2019, both on the student disbursement side and on the white label-slash-T-Mobile side of the business?
We expect the white label side of the business to be profitable for all of 2019. I think we said, and if I wasn’t clear let me make it clear now, we said that we expect the student business to be profitable by end of 2019. When you combine the two, we are hopeful that the student--that the BankMobile may not have any losses, but it all depends upon the timing of the launch of our white label partner as well as our ability to attract new white label partners in accordance with our plan.
The target for student banking to stop the bleeding is by end of next year.
That is helpful, so basically a super simplistic way to look at Customers today is that the traditional bank earned $0.73 or so this quarter, and next year you would have that rate of earnings plus the BankMobile loss going away and, if you’re lucky, some level of profit, and the bank itself growing a bit. But even if you did not, that $0.73 is there any reason that one couldn’t annualize that at--what’s that work out to be, something in the $2.90 range?
Bill, we are not giving guidance, earnings guidance. I’ll leave that up to you to determine that. That’s what we had stated on the analyst day, and like I said, student banking will continue to lose money but we expect the losses to stop by end of next year.
Great. Thank you for taking the questions, Jay.
Thank you. We have no additional questions at this time.
Well ladies and gentlemen, once again thank you very much for taking the time. We are going to be out aggressively meeting with the investment community over the next couple of months - KBW and Sandler, and I think also Davidson is taking us out in the month of November, so we look forward to meeting many of you. Thanks so much. Have a good day.
Thank you all for your attention. This concludes today’s conference call. All participants may now disconnect.