This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.
spk06: Following the presentation, we will conduct a question and answer session. If at any time during this call you require immediate assistance, please press star zero for the operator. This call is being recorded today, Friday, July the 28th, 2023. I would now like to turn the conference over to Andres Viroslav. Please go ahead, sir.
spk05: Thank you, operator. Good morning, and thank you for joining us today for the Bancorp's second quarter 2023 financial results conference call. On the call with me today are Damian Kozlowski, Chief Executive Officer, and Paul Frankel, our Chief Financial Officer. This morning's call is being webcast on our website at www.thebancorp.com. There will be a replay of the call available via webcast on our website beginning at approximately 12 p.m. Eastern time today. The dialing for the replay is 1-877-674- 7070 with a confirmation code of 720317. Before I turn the call over to Damien, I would like to remind everyone that when using this conference call, the words believes, anticipates, expects, and similar expressions are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to risks and uncertainties, which could cause actual results, performance, or achievements to differ materially from those anticipated or suggested by such statements. For further discussion of these risks and uncertainties, please see the Bancorp's filings with the SEC. Listeners are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Bancorp undertakes no obligation to publicly release the results of any revisions to forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Now I'd like to turn the call over to the Bancorp's Chief Executive Officer, Damian Kozlowski. Damian?
spk03: Thank you, Andres. Good morning, everyone. The Bancorp made $0.89 a share, 41% revenue growth and 17% expense growth. ROE was 27% and ROA was 2.6%. Core loan growth quarter-over-quarter reflected a reduction of 8% in institutional lending and respective increases of 2% and 4% for small business, commercial and real estate bridge lending businesses, which also show 10% and 65% growth year-over-year respectively. NIM increased to 483 from 467 quarter-over-quarter and 317 year-over-year. Gross dollar volume growth in our fintech solutions payments business was 15%. Continued strong growth across verticals with only general purpose reloadable showing a decline. New corporate payment programs continue to show growth significantly above expectations. The Bancorp continues to be well-positioned in the current environment. Our balance sheet flexibility, lower credit risk, and High level of core insured deposits support continued improvements in profitability, regardless of potential dislocations or weakening economic conditions. While the sharp increase in the Fed funds rate affected our growth in loans, this impact was mostly felt in our institutional business, which is comprised of our S-block and I-block variable rate consumer loans. Long-term historical growth trends seem to be normalizing, and pipelines across our businesses are increasing. Our fintech solutions business continues to show strength, supported by current programs, the addition of new products, and the implementation of new partners. Due to significant implementation times that can last 18 to 24 months, we have good visibility on the potential growth in 2024. Our current estimate is that we will have above-trend GDV growth in 2024 of more than 15%. Key areas of growth are neobanks, healthcare, and new corporate payment programs. In addition, we continue to strengthen our relationships with our key members of our ecosystem and recently signed a long-term extension and expansion of our partnership with Chime. We continue to invest a lot of time and energy across our company in the development of new products and services, especially expansion of fee businesses and the monetization of our core capabilities. As we approach the REG-II Durbin Amendment restriction on our balance sheet size of $10 billion, we believe we can successfully grow the business without needing additional balance sheet above that limit. Lastly, with continued strong business momentum and a favorable balance sheet position, we're confirming our 23 guidance of 360 a share without the impact of anticipated stock buybacks of approximately $25 million per quarter. In the third quarter earnings release, we will give both preliminary guidance for 2024 and indications of our buybacks for next year. And now, turn the call over to Paul Frankel, our CFO, for more color on the second quarter.
spk00: Thank you, Damian. As a result of its variable rate loans and securities, Bancorp continues to benefit from the cumulative impact of Federal Reserve rate increases. That factor was the primary driver in increases in return on assets and equity for Q2 2023, which were respectively 2.6% and 27% compared to 1.7% and 19% in Q2 2022. These increases reflected a 60% increase in net interest income. In addition to the rate sensitivity of the majority of our lending lines of business, management has structured the balance sheet to benefit from a higher interest rate environment. Accordingly, over a period of years, it has largely allowed its fixed rate investment portfolio to pay down, while limited purchases were focused on variable rate instruments. Additionally, the rates on the majority of loans adjust more fully than deposits to Federal Reserve rate changes. As a result, in Q2 2023, The yield on interest-earning assets had increased to 7 percent from 3.6 percent in Q2 2022, or an increase of 3.4 percent. The cost of deposits in those respective periods increased by only 2 percent to 2.3 percent. Those factors were also reflected in the 4.8 percent NIM in Q2 2023, which represented another increase over prior periods. The provision for credit losses was $361,000 in Q2 2023 compared to a credit of $1.5 million in Q2 2022. Q2 2023 net charge-offs amounted to $938,000. Prepaid debit and other payment-related accounts are our largest funding source and the primary driver of non-interest income. Total fees and other payments income of $25 million in Q2 2023 increased 10% compared to Q2 2022. Non-interest expense for Q2 2023 was $49.9 million, which was 17% higher than Q2 2022. The majority of the increase resulted from salary expense, which increased 28%, and which reflected higher numbers of staff in financial crimes compliance and information technology. Staffing increases reflected higher deposit transaction volume and the development of new products. The increase also reflected higher employee incentive and stock compensation expense as a result of a focus on stock ownership. Book value per share at quarter end increased 19 percent to $13.74 compared to $11.55 a year earlier, reflecting the impact of retained earnings. Quarterly share repurchases should continue to reduce shares outstanding. I will now turn the call back to Damien.
spk03: Thank you, Paul. Operator, could you open the lines for questions?
spk06: Thank you, sir. Ladies and gentlemen, we will now begin the question and answer session. If you would like to ask a question, please press star followed by the number one on your telephone keypad. If your question has been answered and you would like to withdraw from the queue, please press star followed by the number two. And if you are using a speakerphone, please lift your handset before pressing any keys. One moment, please, for your first question. Your first question will come from Frank Chiraldi at Piper Sandler. Please go ahead. Good morning.
spk01: Good morning, Frank. On GDV growth, you know, another strong quarter, and I think, Damian, you said that we should expect above 15% going forward. I'm not sure if I heard that right, but if I did, and any more color just in terms of, you know, if you could put some sort of guardrails around that statement.
spk03: Okay. I did say that, and I said that for 2024. So we have a very good understanding of the projects under implementation and new product expansions. So these implementations we've discussed this before can't take 18 to 24 months to fully implement into our ecosystem. So looking at that pipeline, we're fairly confident that we'll get, you know, above trend growth for 24. So above that 15% level, which has been kind of the historic breaking point between slower and kind of the trend line for the last seven years. which is actually 16%, but about 15% to make it easy.
spk01: And then in terms of just the new partnerships, new programs you're signing, is there any pressure on margins there? Just wondering what sort of the take rate is from 15% or above in terms of the revenue stream that provides through fee income?
spk03: No, it actually, for the new programs and stuff, it usually is more profitable in the early years because there's minimums and then there's tiers. For our larger clients, yes, they have so much volume that the incremental volume doesn't take a lot of cost. So we do give price breaks on tiers for our larger programs that are growing. But we have a lot of new projects and services. The relationship that we've had to GDV and fee growth should be maintained over the next couple of years. But I can't guarantee that. It totally depends on who's growing and when. And the outlook on this business has really never been brighter. It seems that we have a lot of very good business opportunities. a lot in new partnerships, but also the expansion of partnerships across all of our verticals. So we're in a very good position on the fintech solutions business.
spk01: Okay, great. And then on the S block, contraction balances as core, you talked about sort of normalization. So do you expect to see more runoff here? Can you offset that with other loan sources? Or what are your thoughts about both total S block and total loan growth here in the near term?
spk03: Okay, so our pipelines are increasing, so we should see less runoff on the institutional side. That was obviously with the historic rise in interest rates, the price sensitive clients who were borrowing against their securities insurance kind of fell out of the loop. And there's been some pricing pressure from industry players that we haven't chased. But we do see our pipeline growing and some competitors have raised their prices. So we should have less runoff in the third quarter. And that also depends, obviously, on how aggressive the Fed is, too. The other pipelines are fine. They continue to grow those books of business. And remember, we have two concerns. One is If we do get paid back on those loans, they go in the Fed funds, obviously, at 525, which we don't get hurt that much on the spread. And we're constantly repricing our portfolio as new loans. We do new loans and they run off our sheet. So it doesn't really hurt us. Plus, we're kind of husbanding cash right now on our balance sheet because we are ultimately going to buy bonds to... get a lot more fixed rate securities exposure. So we're not very concerned about the runoff of that business. It seems to be normalizing and it doesn't hurt us that much. So I think we're in a fantastic position on our balance sheet to be very responsive to the current environment.
spk01: Okay. And, you know, it seems like with the feds, you know, commentary and what the market's expecting. We're getting maybe pretty close to the end here in terms of Fed rates. And so would we, you know, do you think we expect to see securities purchases the back half of this year? Any sort of size range, you know, you think of when putting securities on the books here, what we could see in terms of securities asset ratio by year end? Any thoughts there?
spk03: I don't think we're going to buy securities This isn't a guarantee. I don't think it's going to happen to the end of this year. I think you're still going to have a fairly inverted yield curve and that's probably going to disinvert next year. So I don't think there's securities purchases will happen this year, but I, you know, we're being very nimble on this. We have to pay attention to what's going on in the marketplace. I mean, strange things happen. You saw the 10 year move last year on news in Japan. So you never know what's going to happen and we'll take advantage of those opportunities. Um, so i would expect them to happen uh probably midpoint next year and we are way our balance sheet is actually smaller than it should be if you look at the amount of securities we have versus our peer group and general and banks we have at least 15 percent room to add uh security so a billion a billion five we could add pretty easily and now that we have uh such great amount of liquidity on the balance sheet, we'll be able to do that very effectively without having to borrow into the market or anything. So I think we're going to keep it. We're being we're watch it every second of every day. We are in a fantastic position, obviously, because we had, you know, really anticipated the interest rate increases and we're slowly moving back up the fixed rate scale. So If you looked at what we did over the last four years is we went from the mid-30s to 26% fixed rate assets, and we're already back to 32% fixed rate assets and have taken 11% asset sensitivity off the board because now we're flexing the balance sheet back to a fixed rate structure with a target of 60% in order to mitigate our deposit beta, which is about that. So I think we're going to be very flexible over the next 18 months. I don't think there's going to be a big change in rates and we're going to have time to adapt to, you know, change our structure to be much more fixed to mitigate the downside impact if there's rate cuts. Right.
spk01: Okay. And so you're saying 60% fixed. I mean, the deposit beta is like 40%, right? In terms of... Yeah.
spk03: So it would basically wipe out, it would lock in the profitability up and down, by the way. So... That's why we're wait and see. So we could get to 6% on the Fed funds. Obviously, what happened just yesterday on continuing claims, on durable good orders, on GDP were all very big surprises that show that the economy is much more resilient. If you just look at our GDP growth, there's a lot of resiliency in the economy. And we still have an 8%. know we're over eight percent on the deficit too on fiscal spending so there's a lot of stimulus still in the economy also so we're going to just keep an eye on it and we're in such a good position that we don't it's kind of where we were with the bond we didn't buy a bond for four years because we're in we're in a good position on liquidity and deposits etc so we're doing the same thing in this case okay all right great thanks for all the color
spk06: Your next question comes from David Feaster at Raymond James. Please go ahead.
spk02: Hey, good morning, everybody.
spk06: Good morning, David.
spk02: Maybe just following up on one of the questions or one of the things you talked about in your prepared remarks, you talked about expanding relationships. Obviously, you extended and expanded the CHIME relationship, and you talked about going deeper with existing partners. Could you expound on that? Where are you seeing opportunity for expansion there? And what other initiatives do you have in place to continue to deepen relationships?
spk03: So generally, I think people have accepted that they've got to be broader fintech, especially neobanks, but also other vehicles outside of government. You have to expand your product set for profitability. So we're in discussions across all of our major clients. that uh they want to add services they want to add product capabilities so this is something that's happening across the entire franchise but if you take a large neo bank for example they're they're wanting to not just be a debit provider but they want to build a portfolio of products around their key clients and expend it to credit so that's exactly what we're doing so where we can support them in doing that uh we help them In many cases, innovate, but also they may be with another provider today that they want to put into our ecosystem. That's happening. But also in the obviously in the credit area where most of the debit providers want to build and start to build a both sides of the balance sheet business in order to increase their profitability. So we're, you know, with our partners, they're very deep relationships over very long terms. As I just said, we just expanded our relationship with Chime in those areas. And we'll continue to do that. I think that's where the, there's going to be a lot. In fact, we're not dealing with very many startups. Obviously there's going to be a lot less startups because of what's happened in FinTech and the dominant players now who are out there, which many of our clients are looking to significantly increase their profitability and deepen their relationships with their clients. And we're lockstep with them. Okay.
spk02: That's helpful. Maybe just touching on the pipeline of partners that you have, it sounds like you're still continuing to onboard folks at a pretty rapid pace. I'm just curious, has the pipeline, I guess, with the market dynamics, have you seen continued increases in the pipeline just as maybe this pushes more partners to you? And then maybe as you go through these negotiations, I guess, how... How is your pricing power? Are you seeing the competitive landscape heat up and maybe you're having to concede more or just given your dominance in the space and your reputation, are you able to kind of defend that in these negotiations?
spk03: You have to remember we're fairly a small piece of the pie when you're talking about when we're in negotiations. It's not like we're 50% of their cost structure. So, you know, and it's something that you can't mess up. You have to be right all the time, and you have to have a profile now, especially with regulatory scrutiny, where they're sure that they're not going to have a problem on the regulatory issues. So, you know, that's the main reason. We say no to a lot of smaller business that are going to banking as service providers because they don't have the scale and they don't have the sophistication. So we're only dealing with the large players in the industry. I think we see almost all the large engagements out there and talk to people about them. And they're names that you would know. So the ones that we don't have, we've probably been in discussions with. And those are potentially some of the programs that will be joining our ecosystem, which we will announce. But we obviously can't do that now. But our pipeline... is very consistent with our ideology of only servicing those larger, sophisticated clients that are broad in their product sets. We're doing very little startup or banking of service business. And that really supports, you know, ramping up quickly. So some in the past, maybe five, seven years ago, we had much more of that type of business. Chime, for example, was in its infancy at the time. And that was kind of our portfolio, though we do have healthcare and government cards and everything back then too. And then we also had a large general purpose reloadable platform, which has gone away across the industry. So now it's converted themselves into the large major players that want product expansion or security in execution or regulatory confidence where we clearly have an expertise in. So all that together has really played into all the investments we're making or have made in building this very unique, very robust, very forward-looking ecosystem for the payments industry, and we're continuing to invest in it, and we're focusing on the biggest players with the most sophisticated, complex needs who want to really change and grow their client relationships.
spk02: Okay. That's a good call, Eric. And then last one, maybe just touching on the expense front and to your point on the investments that you've made, I'm just curious how you think about the expense run rate. It sounds like the expense run rate may be relatively sticky just given the new hires. Is that fully reflected in here? How do you think about hiring and investments going forward? And then we talked about last quarter, I think, the efficiency ratio maybe dipping below 40%. Is that still in the cards from your perspective as you look forward?
spk03: Absolutely. So we built into the cost structure from, we knew that we were going to have significant revenue increases this year because we had to take a position on the yield curve, obviously, and we set the balance sheet purposely to benefit from it. So we looked into this year and said, we're going to make investments. So our people, number of people are up about 7%. and we've had very low attrition, and we're able to recruit great people, and we're going to take advantage. There's a little dislocation, obviously, in the banking industry, so we're taking a little bit of advantage of that to make sure we set the cost structure up for the next couple of years so that we don't have big increases. All the increases you see are we're still getting efficiencies on the operating level. All the increases are people. That's the big determinant in being able to innovate, but if you look year over year, we have about I'd say $3 million that really aren't run rate expenses. So when you see that increase of the mid-20s in employee costs, there's a couple categories there where it's not really like-like. First of all, we don't have the same origination, so there's about a million dollars of capital costs. You could capitalize the cost of origination that aren't in this year, over year, over year. Then we have about $2 million. Some of it is because of the proportion we pay in cash bonus versus equity is higher this year and we had some severance so there's about three million dollars that really isn't built in cost structure in this quarter so when you look year over year you see 17 percent total you see mid-20s in the employee cost the employee cost is really a little bit less but having said that next year we've built into this knowing about this you know once in a lifetime interest rate increase so we're trying to set ourselves up so that we have everything in place the people the project list and everything. So we know what we're going to build over the next couple of years so that our cost structure doesn't rise in the same way that it would during this, you know, historic rise in revenue here.
spk02: So kind of front running the expenses and investing on the front end and should start seeing the operating leverage, maybe start coming next year and really going forward after that.
spk03: Yeah, we're just not going to grow the employee cost that way. I mean, we've really invested in employees here. So once again, you look at the operating expenses, they haven't gone up. So you look on the, you know, other operating expenses, they're flat. I think they're actually down this quarter versus last year. It's all the real determination of innovation and being able to grow this franchise and really setting ourselves up for the next five years is going to be not, you know, determined with all the capabilities and platform and architecture we've built. but we have to have the best people in the industry and have to pay them well. And we're setting ourselves up to not have to experience the year-over-year increases over the next few years, but to have those people in place to make sure that we can guide the company forward. That's helpful. Thank you.
spk06: Ladies and gentlemen, once again, if you would like to ask a question, please press star 1 now. Your next question will come from Michael Perito at KBW. Please go ahead.
spk04: Hey, guys. Good morning. Thanks for taking my questions. Appreciate the call this morning. You guys covered a lot of it. Just a couple follow-ups. Just as we think about the balance sheet, with the S-block loans kind of taking a step down here and possibly being in this higher for longer rate environment, how do you guys think about other areas maybe to add on the loan portfolio side? I mean, are we getting closer to maybe, you know, kind of credit products taking up a little bit of that baton and starting to represent a portion of the loan portfolio? Did you guys look at maybe any other kind of lower risk verticals that are tangible to what you guys do because of all the disruption, whether it's like capital call lines, fund finance, any of that? Just kind of curious how you're thinking about it, if there's maybe room to add another layer or two to the loan portfolio to help you guys kind of hold those balances as
spk03: know one bucket might move up or down it's interesting you brought up capital call because we've done the people who run the company have done a lot of that in the past and other lives so it's interesting you bring that up but no the um we need the room if you look at we're very constrained on the balance sheet and we need to put in fixed rate securities for liquidity and other reasons right and to lock in profitability over the next uh 12 months Right. So we want to flip from this very variable rate balance sheet to the majority being fixed. So we're probably not going to add a traditional vertical, though we have product expansion. We've had some product expansion, institutional and commercial. We're not going to get out of our box in real estate, most likely of these transitional loans that we're doing of apartments and red and purple states that are really workforce housing. We're not going to get out of that space in a meaningful way. Where we will put on credit exposure is in credit sponsorship. So we don't know how big a part. I mean, that could be in five years, 25 or 30% of our entire $10 billion reg I limit. So that's where a lot of the product development is happening. That's where it's going to soak up some of the liquidity. So once again, we're in an extremely good liquidity position right now. We're not worried about the runoff in the S block. That's our lowest. coupon book, and that goes into Fed funds. And we need a bunch of cash in order to buy fixed rate assets. So we're not worried about it. We've looked at everything across the board. We understand the credit universe very well. Even the more esoteric areas like leveraged finance and everything, we're very familiar what we could do. But I don't think when I talk to investors, that's what they really want us to do. We have an extremely low risk credit profile. very short duration, very, very low default rates with very high recovery rates. The story here is our funding source, our FinTech solutions business, and how we're going to manage our business as more of a technology company as we hit $10 billion. That's the story that's going to really supersize investor value, plus with our high capital returns, rigorously returning that capital through buybacks over the next, five years. So that's the formula. That's where we're concentrated and that's where we think the most value is. And so we're not a traditional bank. We're not going to be growing our assets to 50 billion. We're focused on uniqueness and low event risk. I mean, in almost a religious way, we do not want to expose these type of returns to any type of credit risk that we think might have an exogenous shock if we have you know, a substantial change in economics going forward due to interest rates.
spk04: No, that all makes perfect sense, Damian. That was kind of why I mentioned the areas I mentioned. I mean, obviously, I totally agree. You don't want to add credit noise to an otherwise, you know, fairly clean credit story. So that makes sense. Maybe a follow-up, and you kind of mentioned it, but just I think to Dave Feaster's question earlier, you were talking about product expansion and Can you maybe get a little bit more specific about the products that you're looking at? Like, are we talking about point of sale finance solutions? Are we talking about like earned wage access or early wage access? Are we talking about, you know, maybe other like credit card or credit builder type products? Just curious what you guys are working on internally that your clients are looking to expand, you know, beyond kind of the debit card solutions that you're offering today.
spk03: That's exactly right. Those are the categories. So, you know, things like building people's ability to access the financial system. They're very important for the client sets of our neobanks, especially. So they want tools and those, and I think people, everyone's recognized that the life cycle and being the lead bank in the life cycle personally of a consumer is where you want to be. So as they grow their portfolio financially, you want to be with them and provide them tools. So Those are exactly right. Those are the areas where there's need building across the spectrum. I mean, we were one of the first, obviously, that did a couple days early to get paid. That's a Bancorp innovation with our partners. Things like overdrafts being free and limited, of course, not endless, but giving those tools are very important innovations that were, you know, some of those that came with our partnerships from our larger neobank partners. So, you know, we want to be there for, I think we've got a very good meeting of the minds between our partners and us. I mean, we've set ourselves up to try to help more than our peer group and the banking and service providers. And we're constantly in discussions across the board with our partners around looking at their product frameworks of where they want to go. And so that gives us incredible clarity as to what we need to build additionally to help them innovate. But it's all around for the neobank, mostly around the consumer, their life cycle of wealth, adding tools that helps them. And that also increases our partners' profitability. So it's a win-win. And then on top of that, we have all these other verticals in healthcare and government. All these are expanding. And then we have big new wins, like in corporate payments, where it's way above expectations. That's an area where we got into in a big way last year, and it's really exceeded our expectations. So it's very broad-based. It's very focused on what our partners want, and that's why we're investing in order to build the capabilities necessary to translate their ideas into real go-to-market products that are safe and sound and will add to the profitability of both the client and the business partner over time.
spk04: Perfect. Thanks for the call, Damian, and I appreciate you taking my question.
spk03: Thank you.
spk06: There are no further questions on the phone line, so I will turn the conference back to Damian Kozlowski for any closing remarks.
spk03: Thank you, Operator. Thank you, everyone, for joining us today. Appreciate your involvement in our earnings call. And, Operator, you can disconnect the call.
spk06: Thank you, sir. Ladies and gentlemen, this does conclude your conference call for this morning. We would like to thank you all for participating and ask that you please disconnect your lines.
Disclaimer