Customers Bancorp Inc

NYSE:CUBI

Earnings Call Transcript 2019-Q4

[Operator]

Good morning, and welcome to the Fourth Quarter 2019 Customers Bancorp, Inc. Earnings call. At this time, I would like to turn the call over to Mr. Bob Ramsey. Please go ahead, sir.

[Robert Ramsey, Director, IR & Strategic Planning]

Thank you, Travis, and good morning, everyone. Customer Bancorp's fourth quarter 2019 earnings release was issued yesterday afternoon along with our investor presentation. Both are posted on the Investor Relations page of the company's website at www.customersbank.com. Similar to recent quarters, we will be speaking directly to our streamlined investor presentation, so I would encourage everyone to pull up a copy. Before we begin, I would like to remind you that some of the statements we make today will 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 Customer Bancorp's Chairman and CEO, Jay Sidhu. Jay, the floor is yours.

[Jay Sidhu, Chairman & CEO]

Thank you very much, Bob, and good morning, ladies and gentlemen. Thank you so much for dialing in for our Q4 2019 and the entire year 2019 financial results call. Joining me this morning here in Wyomissing, Pennsylvania are Dick Ehst, our President; and Carla Leibold, our Chief Financial Officer, Jeff Skumin, our Chief Accounting Officer; and a couple of other colleagues of mine.

Before we talk about the results, as you probably have noticed by now, we made a decision late in the fourth quarter to cross the $10 billion mark in total assets. We had planned all year to manage the balance sheet below this threshold to preserve our Durbin exemption and focus on optimizing our balance sheet. However, in the fourth quarter, we found ourselves looking at considerable opportunities for growth both in the short-term and the long term, and a clearer path forward for BankMobile as a separate company. And that is why we decided to do a very detailed review. And we also noticed that our highly profitable mortgage warehouse business was not experiencing the typical level of seasonal decline that you normally see at this time in the fourth quarter.

Additionally, looking at the implementation of CECL, we saw the opportunity to add loans this year in the fourth quarter at a fraction of the provision expense flowing through our income statement that we would have incurred considerably higher amounts flowing through our income statements for this very same asset next year.

Ultimately, we weigh the cost and benefits of remaining above $10 billion and concluded that the incremental revenues from about $1.5 billion plus of average earning assets far exceeded the cost of Durbin and the opportunities we see in the future. And as you know, the Durbin, we will now be affected by Durbin starting July 1. So late in the quarter, we decided that it made sense not to reduce our balance sheet as we were thinking about at some time. And as a result, in 2019, we grew our total assets, loans and deposits by 17%, 18% and 21%, respectively for the year, and we continue to see good growth opportunities ahead.

Now talking about fourth quarter 2019. As you know, net income to common shareholders was about $24 million or $0.75 per diluted share. And fourth quarter 2019 income is up about 70% year-over-year. And so far, our return on average assets was 97 basis points, up from 71 basis points in Q4 2018, and our adjusted return on average assets, which is pretax, pre-provision for fourth quarter 2019 was about 1.6%.

We are delighted to report that the margin continued to expand. It expanded 6 basis points in the quarter. It expanded 6 basis points even if you take out the prepayment income from both third quarter and fourth quarter. And for 2019, the NIM was 2.75% for the entire year, an expansion of 17 basis points over the 2018, and we expect to continue to see margin expansion, as Carla will talk about later on.

Our total deposits, as I mentioned earlier, grew 21% year-over-year. But more important is our demand deposits grew 34% year-over-year, a continuation of the growth that we've experienced over the last several quarters. From a loan mix point of view, we improved the overall loan mix. C&I loans continue to grow at a healthy a pace and we are pleased to report 26% year-over-year growth and 6% during Q4 2019. Q4 is always a very good quarter for our, what we call, our specialty finance or our equipment leasing business, and we are delighted to see that continued improvement and growth as a result of the 15-person team that we had recruited about 3 or 4 years ago, they have now reached about $400 million to $500 million in outstandings.

Commercial loans to mortgage companies, they increased $850 million - about $840 million or almost 60% year-over-year. And like I mentioned earlier, we did not have a seasonal decline fairly significant, but there was a $245 million decline or 10% during Q4 2019. Our other consumer loans increased about a little over $1 billion year-over-year as part of our strategy to diversify our balance sheet and to have financial technology-related opportunities in the consumer business, all of fintech business on both the deposit side as well as the lending side of it. And we think that is very important, and our entire emphasis on - in the consumer area are only for prime customers.

We had no subprime loans at all in our portfolio. The average FICO scores of this consumer loan in business is 744 and consumer loans, I'm pleased to report to you, are performing better than expectations, and if this continues in the CECL environment, don't be surprised if we have some releases of provisions.

Multifamily loan declined as planned, 27% year-over-year and 15% during fourth quarter 2019, and Carla will talk to you and give you more of a guidance on the various aspects of our loan portfolio going forward. From expense point of view, we - that's been a very important target for us. We decreased our noninterest expenses by almost $1 million during fourth quarter 2019 with significant improvement in efficiency ratios. Fourth quarter 2019 efficiency ratio was about 57%, down from about 70% in Q4 2018. And for the year, the efficiency ratio was 65%. And if you just look at customers bank alone, our efficiency ratio was just a tad over 50%.

Our BankMobile segment, we are very pleased to report to you, is continuing to progress in a nice way from a profitability point of view. And that earnings contribution by BankMobile was $0.05 per diluted share during the fourth quarter, and this is the second consecutive quarter of BankMobile segment profitability. And as you know, for the - during the last year, in 2018, BankMobile segment reported a loss of $0.42 a share. So it's a nice turnaround.

From a credit quality point of view, nonperforming loans were only 21 basis points of total loans and reserves equal 265% of nonperforming loans, and you would expect us to report higher charge offs. Generally speaking, with the mix of our loan portfolio and - but I am pleased to report to you that our charge-offs are running below our expectations, and we expect that to continue to remain in that same category.

Now before you hear from Carla to discuss our financial results further, let me briefly share with you deliberations our Board has been engaged with over the past year regarding Vision 2025 as well as succession planning. Our Board believes it is very prudent to go through a strategic options review on a regular basis with a goal of helping develop a strategy that is in the long-term and short-term in the best interest of our shareholders, our team members, our customers and the communities we serve. As a result of those deliberations, the Board and top management, after considerable amount of discussions, concluded that opportunity exist to execute a growth strategy that can produce double-digit growth rate in annual revenues over the next few years and potentially generate very significant returns for our shareholders.

We clearly saw an opportunity to execute, what we call, Vision 2025, resulting in $6 in core earnings per share by year-end 2025. However, to execute such a strategy in this rapidly evolving environment, it calls for a top team that has exceptional leadership and human skills, financial skills, technology skill set, experience in capital markets, in regulatory affairs, in risk management and alignment with our culture. The Board concluded that our next generation of management team was critical to be groomed for maximizing the chances of superior execution as both our President, Dick Ehst and I are expected to reach retirement ages in the next few years. We conducted a thorough review of our management and leadership talent and concluded we are really blessed by an exceptional team in practically all critical areas of the bank. As part of this process, we are - I'm delighted to share with you, as we reported yesterday that the Board gave the additional responsibilities of Chief Executive Officer of the bank to my partner, colleague and friend for many years, Dick Ehst charge both Dick and I to help groom the next generation of management and to make sure that we maximize the chances of considerably above-average generation of shareholder value over the years. So now let me hand over to Dick to tell you a bit more about the process that we followed.

[Richard Ehst, President & COO]

Thank you, Jay, and good morning, everyone. I'm delighted to have an opportunity to share with you our succession planning process. Over the past 12 months, we have been very focused on reviewing all the talent at the company to help us groom future leaders. As a result, this process has provided the opportunity to create appointments at the bank over the last several months. We have appointed Carla Leibold, who is our Chief Financial Officer, Treasurer. Carla brings about 30 years of experience in that field. And we are absolutely delighted that Carla has taken on the additional responsibility as our Treasurer. Jeff Skumin, who was formerly a partner with a regional accounting firm was appointed Chief Accounting Officer, for both the holding company and the bank.

And Jim Collins, who has been a partner of Jay's and mine for at least the last 20 years, 10 years here at the - at Customers and another 10 years at previous organization. Jim was appointed our Executive Senior Vice President and Chief Administrative Officer at both the bank and the holding company. And as Jay mentioned, the critical areas of the company, of course, are risk management. Risk management is led by our friend and colleague for many years, Tom Jastrem. Tom has - was formerly our Chief Credit Officer and that new responsibility has been transitioned to Andy Bowman. Andy also brings about 30 years of experience, both in major organizations as well as regional organizations.

Lyle Cunningham was recently appointed Head of Specialty Lending in our private banking group in New York, which is further expanding to the Chicago area. Lyle also comes with significant experience in both specialty lending as well as the responsibility to lead to significant groups in major banks over the last 25 to 30 years. Glenn Hedde, who heads up our banking for mortgage companies. Glenn has taken on the additional responsibilities of being assigned as President of the - of that group, but he also has responsibilities of the private banking opportunities for the banking mortgage companies, which includes deposit acquisition in addition to providing commercial loans to mortgage banking companies throughout the country. The - and Steve Issa, of course, continues to be our Chief Lending Officer. Steve is based up in our deployment market.

So I think at this point, normally the responsibility for really understanding the key roles in the company and how we can continue to attract talent in this ever-evolving environment.

The Board also mandated us to identify all the talent with varying skill sets who would become candidates to succeed Jay and I, as Jay mentioned, when we retire. We conducted a national search for that individual. The process did not result in what I would consider to be satisfactory candidates. So - but in our process, we focused on really what the skill set necessary, as Jay mentioned, that the capital markets are a critical skill that we continue to need here at Customers as well as the opportunity to really expand our revenue-generating businesses in the corporate development arena.

So we - at one point, I came to Jay and the Board and after this exhaustive search, both internally and externally, we've come up with a solution, which we believe will stay in the test of time. And as we announced yesterday in the press release, we have come to terms with Sam Sidhu. And I couldn't be happier with that opportunity and Sam has agreed to join us and he is actually in [indiscernible] today. But Sam will spend the next couple of years continuing to embed himself in the decisioning of our future, and we have a rather robust program set forth for Sam to make sure that as we transition to another life that Sam is in a position to lead this company into the future. So we all have read Sam's background in the press release, I don't need to repeat that. But we're absolutely delighted with that opportunity. So with that, I'm going to hand it back to Jay.

[Jay Sidhu, Chairman & CEO]

Good. Thank you, Dick. And I've got to share this with you that I - when Dick first brought Sam's name to the attention of the Board, I suggested and I have recused myself completely from any kind of involvement in that process. And it's really an independent Board decision. And - but I am so delighted that we have an exceptional management team here at the company. And that at the right time, the Board's biggest job is to recruit and to hire the top management team, and they take that responsibility very seriously. So we have several candidates now at our company to really take this company to the next level. So with that, I'd like to hand it over to Carla now to share with you a lot more details about our financial results.

[Carla Leibold, EVP, CFO & Treasurer]

Thanks, Jay, and good morning, everyone. I'll start off on Slide 5, which really highlights the significant improvements that we've seen in all of our profitability metrics across the board.

Beginning with our fourth quarter GAAP earnings, net income to common shareholders was $23.9 million or $0.75 per diluted share compared to the year-ago quarter, that's 68% growth in GAAP net income and 70% growth in diluted EPS. The return on average assets was 97 basis points in fourth quarter 2019, 37% higher than the 71 basis points that we reported in fourth quarter 2018. Also, our return on average common equity was 11.6% in fourth quarter 2019, up 53% from the year ago quarter. Consistent with that trend, you'll see similar improvements in all of our non-GAAP metrics year-over-year with core earnings for fourth quarter 2019 of $24.3 million or $0.76 per diluted share, a 43% increase in core EPS. As expected, we had further NIM expansion during fourth quarter 2019, increasing 6 basis points to 2.89%.

And lastly, on Slide 5, I'll just highlight the improvement that we had in the pretax pre-provision adjusted ROAA, which was up 42% in fourth quarter 2019. I'm pointing this out because close to $200 million of consumer loan growth in the fourth quarter closed within the last week of the year. Accordingly, we recorded provision expense in December but won't see the benefit to our revenue until the first quarter of 2020.

Moving on to Slide 6. You'll see that it was relatively a clean quarter from a notable items perspective. Our $0.75 of GAAP earnings for the fourth quarter equates to $0.70 of earnings from the business banking segment, while BankMobile earned $0.05 per diluted share, marking their second consecutive quarter of profitability.

I will also comment that included in our fourth quarter results is about an $800,000 loss from the sale of $230 million of non-qualifying residential mortgages, which is included in mortgage banking income on the face of our income statement. If you recall, in second quarter 2019, we recorded severance expenses as we made the decision to exit that business.

Moving on to Slide 7. Our net interest margin expanded 6 basis points to 2.89% in the fourth quarter, up from the 2.83% reported in the third quarter and up 42 basis points from the trough of 2.47% that we reported in the third quarter of 2018. Our interest-earning asset yield decreased 11 basis points when compared to the third quarter, but increased 30 basis points when compared to the year ago quarter. Our fourth quarter 2019 cost of interest-bearing liabilities decreased 16 basis points from third quarter 2019 to 2.17%, but was flat when compared to the fourth quarter 2018. The cost of our interest-bearing deposits was down 18 basis points from third quarter 2019.

We do see opportunities to bring our funding costs down further in 2020 as we continue our efforts to grow core low-cost deposits and run-off higher cost funding. Looking out into 2020, we think our net interest margin hasn't peaked. And while others are expecting flat to down margins, we're expecting another 20 basis points or so of net interest margin expansion in 2020.

Moving on to deposits on Slide 8. As Jay discussed, we decided to resume our balance sheet growth strategy, and we are really excited about the year-over-year growth that we saw. Total deposits were up approximately $1.5 billion or 21% over the year ago period with $0.7 billion of this growth coming from an increase in lower cost core demand deposits.

We also had strong loan growth and improved portfolio composition year-over-year, as shown on Slides 9 and 10. Our loan mix continues to improve year-over-year, as C&I loans increased $0.5 billion or 26%, as planned multifamily loans have decreased $0.9 billion or 27% year-over-year and will replace by about an equal amount of consumer loans. Year-over-year, our mortgage warehouse portfolio increased $0.8 billion or 58%. It did experience a seasonal decline of about $0.2 billion in the fourth quarter of 2019. Focusing on the loan composition at year end, we really like the balanced portfolio. Core C&I loans make up about 25% of the portfolio. Mortgage warehouse makes up close to 25% of the portfolio. Multifamily loans make up close to 25% of the portfolio. And investment CRE and consumer loans make up the remaining 25% or so. We're also really happy about the reduction in our multifamily portfolio from the 40% concentration that we had a year ago. We do expect this portfolio to run off even further in 2020, but would like to keep about 10% to 15% of our total assets and multifamily loans. We're also being very selective in the multifamily loans that we're trying to keep, focusing on the overall relationship with the borrower and retaining those that really build franchise value. When we think about the asset mix longer term, we are targeting asset composition of about 30% to 40% of core C&I loans, 10% to 15% of multifamily loans, 10% to 15% of the more - the banking mortgage companies, about 15% to 20% in investment CRE and structured commercial real estate and about 15% to 20% in consumer loans.

Moving on to operating costs and efficiency on Slide 11. We did see significant improvement in our fourth quarter 2019 efficiency ratio over the year ago quarter. For the business banking segment, operating expenses as a percentage of assets - as the average assets remained stable, about 1.5%, which is significantly lower than our peers and the industry overall. I will comment here that the assumption of our overall growth strategy will result in higher interest-earning assets as well as some expense growth to drive the overall balance sheet growth moving forward.

Turning to credit quality on Slide 12. Our portfolio continues to perform well. At December 31, 2019, nonperforming loans to total loans were only 21 basis points and on a year-to-date basis, net charge-offs to average loans were only 8 basis points. And lastly, before I turn it back over to Jay, I'll make a few comments about our CECL implementation efforts.

We are currently estimating that the day 1 effect would be an increase to our existing allowance for credit loss balance somewhere between $40 million to $60 million. On our commercial loan portfolio, our estimate is very consistent with the industry overall at an estimated increase ranging between 20% and 30%. Additionally, like most of the industry, the largest estimated impact of CECL is on our consumer loan portfolio. That being said, we are not expecting a material impact to our regulatory capital ratios, taking into consideration the after-tax effect of the day 1 impact and the 3-year phase in from a regulatory capital perspective. For 2020, we are not giving guidance on our provision expense. However, we are confirming our target of $3 of core EPS in 2020. We are also comfortable with the current range of analyst estimates in the first half of the year, but we do expect full year EPS to be $3. We're not giving quarterly EPS guidance, but expect our EPS to follow a typical seasonal pattern with lower mortgage warehouse balances and EPS in Q1, but EPS should build throughout the year. We expect to grow average earning assets at a mid-single digit pace. However, our loan growth will be more heavily weighted in the first half of the year, which means that our provision expense will drop in the second half of the year, allowing us to grow EPS even with the July 1 revenue headwind from the Durbin effect. And with that, I'll turn back over to you, Jay.

[Jay Sidhu, Chairman & CEO]

Well, thank you very much, Carla. So as Carla shared with you some of the details. So we are very pleased that we built a very strong foundation for the bank. And once again, I reiterate what Carla mentioned that we are comfortable with the $3 of EPS - core EPS for 2020.

Let me just summarize for you the status of what we shared with The Street in October of 2018 on our Analyst Day. And the basic theme on that day was that we want to build a bank, both for the short-term and long-term with a strong, very strong focus on risk management, and that risk management is a process that is embedded in everything that we do, and then we set some very clear cut articulated targets.

First one was that we want to achieve 1.25% or higher ROAA over the next 2 to 3 years. So as I shared with you and Carla shared with you, our ROAA was about 1% for the Q4 2019, and that's up significantly from 0.71%, and we are well on our way to achieve the 1.25% ROAA, and our adjusted ROAA, pretax and pre-provision in Q4 2019, was about 1.6%. So you can figure out the strong foundation that we built.

As Carla mentioned, there's going to be seasonality in our businesses, especially our mortgage warehouse business and also in some of our - the BankMobile business. So that'll have an effect. So don't expect this straight line quarter-by-quarter. But from a year-to-year basis, we are very comfortable with the $3 in earnings per share for 2020. Our second goal that we articulated to you was to achieve NIM expansion to $2.75 or greater by fourth quarter 2019. And I'm so pleased to share with you that we are at about 2.90 - 2.89% in fourth quarter 2019. And Customers has effectively restructured the balance sheet, but we are not done. And we believe that there is a lot of opportunity for us to lower the cost of our deposits further and to continue to improve the quality of our deposit franchise as we continue to have a very balanced loan portfolio with a strong focus on credit risk as well as other aspects of risk management.

The third priority we shared with you was that BankMobile segment would achieve profitability by year-end 2019, and that was at a time when we had lost $0.45 or so approximately over the previous 4 quarters in BankMobile. And this was the 1 that the majority of you were really suspected. So suspecting how are we going to achieve this. So I'm very pleased to share with you that with both noninterest income, net interest income and management of expenses and opportunities to grow that business, we worked on all the levels as well as at the same time, focusing on risk management that BankMobile achieved that profitability. Now that Customers Bancorp has crossed the $10 billion mark, I wanted to share with you, as you would expect us to, we are exploring every strategic option for BankMobile at this time. And you should look out for information from us over the next few quarters.

On the expense side, we had shared with you that it's going to be a very important focus for us, and you should not expect us to ever get away from that focus. So I'm pleased to share with you that the consolidated efficiency ratio was about 56%, and it was above 50% for just Customers Bank at the end of the year, and that's a pretty significant improvement in all areas because our efficiency ratio was about 70% at the end of Q4 2018. And that from that 70%, we took it down to about 57% in 1 year at the end of Q4 2019.

Then we talked about continued improvement in our franchise. I'm very pleased to share with you that our DDAs grew 34% year-over-year, and that we continue to execute on our strategy of reducing the concentration risk, especially the concentration risk in the multifamily loans, which we didn't - we like the credit quality of those loans, but that became a little bit - some clouds over that with some legislative actions. But still we do a very detailed review, and we don't see any concerns in the kind of multifamily loans that we have originated over the years in New York area. But it's the low-yield higher and the longer duration assets is the main reasons why we want to deemphasize that, and we like the shorter duration and also using financial technology and relationships, both with the fintech forms as well as using financial technology ourselves to originate ourselves high quality from prime customers consumer loans through various means. And today, we have - we are direct originators of student loan refinancing. We are direct originators of personal loans as well as we have partnered thus, especially with a couple of fintechs, the one that we have done the most with is Upstart and we plan to continue to take advantage of these opportunities.

The next item we talked about was maintaining a strong credit quality and superior risk management. I think Carla has shared with you enough about that. But we remain very focused on a strong risk management culture. It is obvious that you should not compare our charge-offs on a percentage increase quarter-to-quarter without looking at the margin expansion quarter-to-quarter because the mix change comes with some charge-offs, but it's the net interest income and the revenue growth and the profitability. And there's no question about it in isolation looking at charge-offs is not prudent in this kind of a structure where we are looking at restructuring our balance sheet.

And as I have stated earlier, our charge-offs are running below our expectation, and you shouldn't be surprised with the CECL, which we always question the sanity how fast being coming up with CECL, but it is what it is that you might see us to even come up with some releases in the future quarters. And we've continued to look at capital and the capital is very important for us, and capital allocation is a very important decision for us, and we will continue to always evaluate different options. And we have - we are sharing view that our goal is to, over a period of time, not to go below 7% in TCE, and that's what we are focused on, and at the same time, look at opportunities to redeem our preferred stock as it becomes callable over a period of time.

So now very quickly, I want to share with you a little bit about our recruitment of various teams. So we have already recruited with a tremendous amount of experience in structured real estate as well as in private equity ahead of our structured real estate team. We see opportunities to do some financing for commercial fence companies that are involved in the real estate sector. We do that in the C&I side anyway, that has - comes with a better credit quality. So that team is very experienced, and we are expecting some very good results out of that team over the next couple of years. At the same time, we are, at the present time, Dick and his colleagues are involved in active discussions with 3 or 4 other teams and we will report to you as we go forward on our results of the team. This is not the time to conclude on those teams because they all wanted - we are only recruiting the A teams, and they're all looking for their bonuses before they move over to us.

And last point I'd like to make is, I am so pleased to report on behalf of our entire management team that this year our management team elected to receive all their bonuses in Customers Bancorp stock. No cash bonuses for the annual bonus. So I'm pleased to report to you that including our top 3 and 5 executives, we paid out $8 million in bonus. And so our management team has acquired $8 million in Customers Bancorp stock. It's sort of equivalent to insider buying. And so we gave - they accepted no cash bonuses and took it all in stock, and they also agreed to hold that stock for up to 3 years because it will only vest over the next 3 years, and we are very pleased with that show of confidence by the entire management team and not just short term, but over the next 3 years to 4 years for the company. So what does that mean? What is the management looking at from an outlook, which makes them feel so optimistic about the future? As you know, saying, I'll say it again, that you should expect us to earn $3 a share over the year in EPS, and we are continuing to look at the profitability of the BankMobile segment. There will be some seasonality, but that's going to continue to remain profitable even after Durbin. And we - as I shared with you, the Durbin will affect us starting July 1., but you should expect us to announce some results from our strategic options review of BankMobile as we have more information to share with you. From a core EPS point of view, over the next 3 years, we expect $4 in earnings over - within the 3-year period and $6 in earnings by 2025, which technically is almost 6 years. And from a core ROAA point of view, again, we are looking at achieving 1.25% or higher ROAA within about a 2- to 3-year period. And if you look at the balance sheet of somewhere between $15 billion to $17 billion by 2025 and apply a 1.25% ROAA, you can do your numbers and come up with what that means for EPS along with assumption for share count.

The current valuation, as you all know, based upon the January 17's closing stock price of $22.56 is that we are trading at price-to-book - of the tangible book of 86%, and price-to-consensus 2020 EPS of 7.9x and price-to-management's goals for 2020 at 7.5x. So with that, Travis, if you can please open it up for questions.

[Operator]

[Operator Instructions]. We do have our first question.

[Stephen Moss, B. Riley FBR, Inc.]

It's Steve Moss with B. Riley FBR. I just want to start with maybe one follow-up on the path for BankMobile. Should we expect the transaction to be completed by year-end?

[Jay Sidhu, Chairman & CEO]

I would say so, Steve.

[Stephen Moss, B. Riley FBR, Inc.]

Okay. That's helpful. And then just on the growth opportunities you're seeing, Jay. Should we think about it being a little more consumer-oriented in the first half of the year and perhaps as the new hires come on, whether it's CRE or C&I see that growth in the latter half of the year? Just trying to think about how much you expect to see for growth and kind of what the mix of growth is?

[Jay Sidhu, Chairman & CEO]

Yes. Yes, Steve, we are - for C&I growth, second half is always stronger for us than the first half, also from banking the mortgage companies, mortgage warehouse business usually or the first quarter and the fourth quarter typically are the slowest, but then the C&I makes that up for that mortgage warehouse weaknesses in the fourth quarter. So you should expect us to stay within our target allocation. Now we are not talking about significant increases in the consumer business beyond where we are right now in terms of allocations. But Carla has given you the guidelines for our overall allocations, and you should expect that it'll be more of maintenance of our consumer business and some modest growth in our consumer business along with C&I business in the first half of the year. And then starting in second quarter, you should expect the C&I as well as the mortgage warehouse business to start to pick up more and you should not expect considerable amount of consumer business in the second half of the year. And that's why what the indications that Carla gave you, you should see our earnings really accelerate in the second half of the year compared to the $3 number.

[Stephen Moss, B. Riley FBR, Inc.]

Okay. That's helpful. And then in terms of the margin outlook, given there was an increase in consumer loan purchases and a lot of it was in the latter part of the quarter. What's with the near-term step-up in the margin? And just explain a little further on the consumer loans that were added this quarter. Could you give a little more detail on the type of loans? Was it more student or personal? And just what was the overall yield on the new consumer loans?

[Jay Sidhu, Chairman & CEO]

Let me just take that quickly. So the yield on the consumer loan for us, we are looking at it two ways. And the most important way that we're looking at it is enough yield to us after charge-offs, and also whether we acquire them at a discount or we acquire them at a premium, and the ones that we are originating ourselves, which is a considerable part of our business on the student refinancing side, and that is coming in at about 6% for us. And then we will - and we expect charge-offs on that side because it's student loan refinancing to be more so in the 30 to 40, 50 basis points. On the personal loan side, we are expecting charge-offs to be in the 2% to 3% range. And on the personal loan side, so obviously, if you are looking at minimum yields to us in the 5.5% range.

Now you can do your math overall. But that will result in higher charge-offs as a percentage of loan out standings going forward, but they will be more than offset by higher revenues going forward, but we still have - are going to be remaining very disciplined in terms of our focus on just the prime customers. We are also developing relationships with some marketplace lenders so that we would originate for them and then do what you see some of the fintechs like Cross River Bank and like the WebBank and others are doing. So that itself will help us in handling and keeping some of these loans for a shorter period of time on our portfolio and increase our revenue as well as increase our fee income. That's what we meant, and Sam is working very much on that side of the business, and we believe that, that will add to our revenues without adding to our credit risk profile. So those are the kinds of things, Steve, that we are working on right now when I mentioned to you that we are looking at fintech-related opportunities in the consumer sector.

[Stephen Moss, B. Riley FBR, Inc.]

Okay. And just in terms of the margin step-up here, should we look about perhaps 5 to 10 basis point increase quarter-over-quarter? Just kind of curious as to how we think about that 20 basis points or so of margin expansion in 2020.

[Carla Leibold, EVP, CFO & Treasurer]

So we are expecting a gradual increase each quarter throughout 2020 and commenting on the full year at 2.75%. So if we're expecting 20 to 25 basis points targeting at that 3% net interest margin range.

[Jay Sidhu, Chairman & CEO]

On an average for 2020.

[Operator]

[Operator Instructions]. Next question.

[Michael Perito, KBW]

It's Mike Perito form KBW. I wanted to start off just kind of with a conceptual question, maybe for you, Jay. I mean I appreciate that the color that you guys provided kind of on the Board review process. That sounds like you guys went through maybe in late November or December. It's a bit of a challenge question. But I just wonder - I was curious, why the fixation, I guess, on EPS targets that are so far out. I'm wondering if you could extrapolate that a little bit for me. I mean it seems like coming out of the Analyst Day, at least, my view was that you guys were we're really focused on the profitability and kind of blocking and tackling near term towards that target? And I guess, it just seems like that 2025 EPS target clouds that a little bit and then remove some of the focus there. I mean maybe not for you guys from The Street or the investor perspective. I was wondering if you could explore a little bit more like why the decision to provide that type of target at this point?

[Jay Sidhu, Chairman & CEO]

Yes. Very good question. I'm so glad you asked that question. Mike, the role of Boards of Directors is to look at both short term and long term. And when you look at the strategy is very important, not just to look at quarter-to-quarter and the annual earnings, but to also look at strategy, what kind of skill set do you need to achieve that strategy? What kind of staff levels do you need? What kind of systems and in banking business, very important to have risk management processes in place and that we have fully embedded out our strategies so that we are looking at it from what are the risks? What are the opportunities? What is the - we call it like becoming masters of the external environment as well as masters of our internal environment, which means an authentic self-assessment of what truly is our skill set? And what can we really do? So we had laid out to you that last - even at that Analyst Day, Mike, if you recall, that in 3 to 4 years, you should expect us to make $4 a share.

Now we've said is that the year has gone, it's now $2 to $3. So it is a stepping stone. We are not in the business of delivering shareholder value by focusing on quarter-to-quarter earnings. We are in the business of looking at long-term and short-term and building a company with strong foundation and strong risk management. That's why we decided that it was important when in a 5-year or so period that you would see a change in retirement of some top executives that it is the Board's responsibility, and this wasn't just done in the fourth quarter, this was done throughout the year. This process started in the beginning of the year. The search process that Dick mentioned and the review process for all the candidates and appointment of Carla as the CFO took place in the fourth quarter of 2018. So this is not just a knee-jerk reaction to come up with $6 plan. We presented - we have risk summits twice a year. At our risk summit in September or October, I think, we presented to the entire management team, our strategic plan, which then gave us the $3, the $4 and the $6 stepping stone.

And what are the risks involved in that? And what are the opportunities involved in that? And what are the other steps from an execution point of view that we are focusing on? And we shared that with our regulators also. And then with our management team and before we would make them public, we don't - we are not expecting to gain anything from telling the world that we are looking at $6 and - in 5 to 6 years and $4 in 2 to 3 years, that's up to The Street because we eventually feel it's execution that matters. But we feel that we ought to be transparent, and we ought to share with The Street, all the things that the Board of Directors, as their fiduciaries are expected to do from the shareholders' point of view, that they ought to know. How the Board is functioning and how the management is functioning and what are we thinking from a strategy point of view.

[Michael Perito, KBW]

Okay. Understood. And then maybe just a couple follow-ups off that. I mean one, it sounds like the - you guys launched kind of an external search initially when looking for - in your succession planning, I think it was explained again. And it sounds like that wasn't successful. I was just curious if you could maybe expand a little upon why you think that wasn't successful? Was it something skill-set driven? Was it culturally driven? And just seems like you guys casted a pretty wide net. I'm just curious what some of the holdups were there? And then secondly, just on a follow-up to the first question, I mean, obviously, the environment is dynamic, right? So it's hard to know who's going to be the next President? Or what the economy is going to be like, et cetera. And I guess, as you guys look out at those EPS targets, I mean, how do you kind of prioritize profitability versus the EPS targets? I mean, for example, if in 2023, you could hit your $4 EPS target, but your profitability won't reach your 3-year targets. Would you conversely flip it the other way? And is it a profitability target or a priority? I mean I understand in the ideal world, hopefully, both are achieved concurrently, but I'm just curious how you guys view it internally as what the biggest priority is? Is it the EPS or the profitability targets?

[Jay Sidhu, Chairman & CEO]

I'll answer the last one first. And then let Dick answer - talk about the details of the process. If you heard us, Mike, that our #1 strategic priority is targeting a return on average assets of 1.25% or higher. We are not backing away from that. We are not targeting $4 of EPS and 80 basis points ROAA. I want to make that very, very, very clear, all right? So we are now targeting a margin of 2% and an EPS of $6 a share. And like I gave you the examples. So profitability is more important for us than EPS, and we just - but good management teams to do both, and that's what we are focused on. I'll let Dick share with you a little bit about the process, and then we'll open it up for more follow-up questions that you may have.

[Richard Ehst, President & COO]

Thank you, Jay. The important issues to focus on is our banking model and our culture. Most of which we think are somewhat unique in our business. The banking model that we enjoy here at Customers, it's an on non-siloed, very flat single point of contact banking model. And it's very - it's difficult for anyone to not familiar with that banking model. The success of that banking model, the efficiency of that banking model to deliver the exceptional service to our customer base. It's very difficult for anyone to come into our organization who is not intimately familiar with how that model operates. So that is one issue. But the second issue and equally as important and in some cases more important, is our culture. We have all a non-siloed culture here at Customers. And that is a different model than most organizations of our size in the market.

So in order to really continue to deliver exceptional performance, which as Jay mentioned to you, we anticipate, over the next several years, it requires an absolute collaboration among the banking functions in the organization to deliver that exceptional customer experience. So - and to lead with dignity and to lead with trust in the process is critical. So when you look at the universe of opportunities out there and the universe can be a (expletive) out there, very few in our judgement that line up to both our banking model as well as our culture. So that really caused us to think differently about the search. Obviously, the skills required are and an exceptional understanding of the capital markets and exceptional understanding of the fintech and the dynamic changes that are taking place within the banking industry, especially as it relates to technology. And at the same time, we line that up with a cultural - the culture is what we consider to be equally as important, not more important in some cases. It was really that the best possible choice lines up with all of the critical factors in our search process of Sam Sidhu.

[Jay Sidhu, Chairman & CEO]

And I got to tell you, just to add, it is not easy to recruit talent in Wyomissing, Pennsylvania. I have done - had that difficulty when running Sovereign Bancorp. It is easier to recruit talent in certain metropolitan areas. And so that also became a little bit of a - somewhat of a hinderance for us when we were doing the search.

[Richard Ehst, President & COO]

So Mike, I think we're running out of time, but I wanted to let....

[Operator]

Next question.

[Frank Schiraldi, Piper Sandler & Co.]

Frank Schiraldi from Piper Sandler.

[Jay Sidhu, Chairman & CEO]

It sounded like you said Piper Sandler with Sandler O'Neill.

[Frank Schiraldi, Piper Sandler & Co.]

Hard to get used to it. Hard saying, but not much has changed, so I guess, that's a good thing.

[Richard Ehst, President & COO]

We're a good company.

[Jay Sidhu, Chairman & CEO]

Yes.

[Frank Schiraldi, Piper Sandler & Co.]

And I just wanted to - just a couple of questions. Just curious on, first, if you guys have some more detail you can provide on - I realize going through the $10 billion, given the size you are able to get to, you get that earnings stream and a partial offset is Durbin depending on what happens with BankMobile, I guess, through 2020. But if you could share with us as it stands, what the Durbin expense - the expense of going through $10 billion, what that revenue hit looks like for the back half of 2020?

[Jay Sidhu, Chairman & CEO]

I think as you know that in BankMobile's income statement, the card revenues, they include foreign ATM fees and Mastercard incentive fees and other types of income and still BankMobile had interchanged revenues of approximately $18 million or $19 million for the full year. And Durbin is expected to reduce that amount by somewhere in that - it depends upon the types of transactions who had a bare minimum 30%, and it could be as high as 40%, 50%. So you can figure that out. But we - as Carla shared this with you, you should not expect an impact on Customers Bancorp EPS in the second half of the year as a result of Durbin because we have strategies in place to overcome that, and many other banks use M&A to overcome Durbin. We do not believe in that just for Durbin to buy a bank, that to us makes no sense. So we are using our organic growth and that's why I went through a strategic process and maintaining that growth, capital is important for us. So we should not expect on an average to see a considerable growth in our assets, earning assets, but the continued mix shift to improve our margins and continue to improve our profitability metrics like Mike was asking us about and not just make our EPS goal by just blowing up our balance sheet. The main reason for increasing our growth in assets somewhat earlier than we expected was we do have a strategy so that you want The Street will not be disappointed because of Durbin.

[Frank Schiraldi, Piper Sandler & Co.]

Okay. And then - but just thinking about BankMobile, you mentioned you expect BankMobile to be profitable again in 2020. I would imagine that would be front loaded, just given that impact from Durbin, but do you think - I guess, could you share any more color on your expectations in terms of levels of profitability for BankMobile? And do you think it can remain profitable in the back half of the year?

[Jay Sidhu, Chairman & CEO]

Yes. I think BankMobile should be profitable in 2020. And like I mentioned earlier, Durbin should not be a factor until July 1. But because the business banking segment gets the benefit from the increases in the average earning assets, like I said earlier, the cost of Durbin in 2020 will be allocated to that business banking segment. But the earnings benefit from the extra $1.5 billion, like I said earlier, is expected to far exceed the 6-month cost for the Durbin. So that is really the way to look at it. And we are hopeful - like, I think, an earlier question by Steve that there should be an action taken by us on BankMobile divestiture sometime in 2020 and so that's why we are only commenting on the second half of 2020. And then Customers Bank will have a somewhat different fintech-related strategy. It is very important, very - I can't overemphasize how important technology is to the business of banking. In fact, I'm speaking at Paris Fintech Conference with the Barclays CEO talking about fintech and banking on Tuesday. And we are really devoting a lot of time to that. So it will evolve over a period of time, but we see huge opportunities to also develop technology-based services for business banking. And so Durbin will not be an issue for us after 2020.

[Frank Schiraldi, Piper Sandler & Co.]

And then just finally. Just wondering if you could comment at all on your targets in terms of capital levels? And also, given that 2020 is a year where you expect to have sort of the end game with BankMobile? Is this - would these targets be sort of less of a concern until you go through that process? So if you could just - any targets common - a common ratio and whatever you target in terms of capital? And then when you sort of expect to get there?

[Jay Sidhu, Chairman & CEO]

Again, like I said earlier, you should - we are targeting remaining at 7% or higher from a TCE point of view. And don't measure us on a quarter-by-quarter basis because we have seasonality - slightly above average seasonality in some of our businesses compared to the other banks. And we are also growing as such. So we will evaluate opportunities for the preferred as such also and look at their call dates. And so we - our capital allocation is very important for us. And by keeping our TCE float at about 7% or higher for 2020 on an average, I think, will give you a pretty good idea, and we can match our balance sheet to try to also achieve that by end of the year. We are pleased that the regulators are not looking at CECL charges as a real capital charge. And I'm sure, based upon the conversations we had with some of our investors, neither are they because it is something which is really which side - which portion of the balance sheet are you having the extra capital there. And rightfully so, when we have more consumer higher charge-off assets, we ought to have higher results. And that's what we are doing with CECL guidance that we gave to you. And so we are confident that capital allocation strategy will remain important for us, but we do not envision any common stock offerings at all, if that's your question? Don't expect that coming from us until we are creating at market multiples.

[Operator]

Next question.

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

It's Russell Gunther from Davidson. So I just want to start on consumer portfolio. Appreciate granularity you guys shared there in terms of the mix even within that. I was just hoping to get some color in terms of that $1 billion-plus portfolio as a whole, to how you were thinking about reserving for that? And what that implies or what you assume from a net charge-off perspective?

[Jay Sidhu, Chairman & CEO]

I think Russell, I'll let Carla add on to this. But like I shared with you earlier in one of the answers to one of the questions, you should expect, on an average, charge-offs of 2% to 3% for the consumer loans on an annual. So in CECL, that's why the number is high. That equates to about 6% CECL charge for the consumer loans. And because our duration is in the 2- to 3-year range for the kind of consumer loans that we are putting on. And - but our actual charge-offs are running somewhat lower. That's why I commented that don't be surprised with the CECL methodology that we are required to follow, which is kind of crazy, but it's going to make your life a lot more difficult, and it's going to make our life a lot more difficult, and I don't know what the hell is the benefit to it, but it is what it is. But - so that's why we cannot give you the guidance on this, and it will become much more difficult for us to predict because we have to look at quantitative factors and qualitative factors on a quarterly basis for our entire portfolio and we'll be talking a lot about unnecessary stuff, which doesn't - shouldn't affect shareholder value, but it is what it is. So I'm just giving you a simple answer. Less than 2% charge-offs for consumer loans, the way we are doing it is the way from an economic point of view is what you should see.

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

That's perfect. I was - I appreciate the clarification on the 2% to 3% on the whole portfolio and the dynamics there. So just some questions around what's going into the $3 earnings per share number just on a few line items, if you could. The first is what you guys assume from gain on SBA loan sales? How that would trend given what showed up in this quarter as well as whether or not the $3 assumed any contribution from preferred redemption in 2020 as well as considering buybacks?

[Jay Sidhu, Chairman & CEO]

No buybacks in 2020. I will make that very clear to you because from our capital allocation point of view, buybacks are less important things in achieving our capital targets. So no buybacks. I think we will look at capital allocation on a quarter-by-quarter basis and where do we really stand and what are the opportunities? We will only buyback preferred right now if that is the best option for us. And we will look at any other options available to us. And it's very difficult that we do not want to get into the business of giving line by line. Some estimates for you. And - but all I can say is from a sales seasonality also in the SBA lending business. And you should expect more of those gains to be coming in the fourth quarter for us. We are expecting good year in SBA. You can translate that into what good means. That means you should - If I were you, I would say, is it's going to be minimal least what you saw? Good is better than what you saw, okay? So - and that's what we are expecting in SBA gains in the third and the fourth quarter of next year.

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

Okay. Got it. Got it. No, very helpful, Jay. And then just to clarify, though, the $3. Does that include what the preferred would due for 2020? Or is that...

[Jay Sidhu, Chairman & CEO]

No.

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

Something - it does not. Okay. Got it.

[Jay Sidhu, Chairman & CEO]

And Durbin - But we factored Durbin costs. I just want to make that clear.

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

Yes. No, very clear. Appreciate it. And then just stepping back, it does sound like $10 billion is something that's in the rearview now kind of for good. And I want to be clear or have you guys comment if that is in fact the case? And then whether or not that changes anything as it relates to your relationship with T-Mobile. I was just trying to get a sense for that lost interchange revenue at least upfront, how that's going to play out? And what those dynamics are?

[Jay Sidhu, Chairman & CEO]

We have - $10 billion is definitely in the rear mirror and the way the regulations work is that if you are above $10 billion for fourth - four quarters, CFPB becomes our primary compliance regulator and Durbin exemption is no longer there. Small bank exemption is no longer there. That's pretty straightforward, and that will apply to us. For all our white label partners, we have committed - where we have committed that we will make up for the Durbin and let's - and until we find a banking partner that is acceptable to them and to us, so that they can - there is no interruption in the service, and that is the commitment we are making to all our white label partners.

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

And the duration of that relationship, is how long, Jay?

[Jay Sidhu, Chairman & CEO]

My believe, it's at least three years.

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

Three years. Okay. Great.

[Operator]

Next question.

[Matthew Dhane, Tieton Capital Management]

This is Matt Dhane from Tieton Capital Management. I have couple of questions. I wanted to start out. Now that you have crossed the $10 billion mark. How much of a focus is it on hiring additional teams to continue to grow, I guess, in particular, this is probably more focused on the C&I business, but just generally speaking as well?

[Jay Sidhu, Chairman & CEO]

I think as Dick shared with you Matt, that you have to constantly look at what kind of skill set and what kind of staffing levels do we need in every area of the company as we are growing, and Carla shared with you that you should expect some expense increases as we are continuing to increase, but we are looking at - there are 2 things, very important in our aspects from a strategy execution point of view, one is focus that you've got to be focused on doing a few things very well. And so we are remaining very, very focused on the business banking side and in the consumer side, it's all technology related. We are not getting into any businesses on the consumer side, which are not technology-driven. And on the business banking side, also, our focus is high touch supported with high tech. And so that's why you will see that focus continues.

Second thing is scale. We do need scale in the businesses. Okay? So that's why in businesses where we don't see an opportunity to scale up, it's better to get out rather than being in lots of businesses. So scale and focus are going to drive - are driving our strategy. So yes, there will be recruitment between where ever we see scale. There will be recruitment of teams, both on the deposit side as well as on the running asset side in those opportunities for scale. And at the same time, if we do see any businesses, like Carla gave you the example of the mortgage business for the non-qualified mortgage, we saw an opportunity, and we quickly decided we cannot get to scale over there, and it doesn't beat our profit hurdles. So we quickly decided to get out of it. Once in a while, it always happens that the things just don't work out. If they don't work out, get out of it and move on.

[Operator]

We have no further questions in the queue at this time.

[Jay Sidhu, Chairman & CEO]

Okay. Thank you very much. Sorry for going beyond our 1-hour time period, but we really appreciate you taking the time. I plan to be with Carla out to see many of you more actively this year. So look forward to enjoying some, hopefully, some quick growth in shareholder value in 2020 and beyond. Thank you so much.

[Operator]

Thank you, ladies and gentlemen. This concludes today's teleconference. You may now disconnect.