Customers Bancorp, Inc

Ladies and gentlemen, thank you for standing by and welcome to the Customers Bancorp Inc. Second Quarter 2020 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. If you are participating over the web, there is a Q&A box where you can type in and submit your questions. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Bob Ramsey, Head of Investor Relations for Customers Bancorp. Thank you. Please go ahead.

Thank you, Mariama, and good morning, everyone, and thank you for joining us for Customer Bancorp's second quarter 2020 earnings webcast. Our earnings release was issued this morning along with our investor presentations. Our investor presentation includes some important details that we'll be walking through on this morning's webcast, and I encourage everyone to pull up a copy. Before we begin, I 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 to differ materially from what is currently anticipated. 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 Customer Bank Wars CEO, Jay Sidhu. Jay, the floor is yours.

Thank you very much, Bob, and good morning. Welcome to our second quarter call. And joining me this morning are some of my colleagues, Dick East, President of Customers Bank and CEO of Customers Bank, Sam Sidhu, the Chief Operating Officer of Customers Bank, Carla Leibel, the Chief Financial Officer of Customers Bank Corp and Customers Bank, and Andy Bowman, the Chief Credit Officer of Customers Bank. Before I start, I would like to have you all join me in saluting our team members. You know, 85% of them are working remotely and have been working remotely, and we have decided not to even think about bringing them back till after all of them have been vaccinated. They have helped Customers Bank Corp and Bank Mobile not miss a beat. They have helped us maintain our high level of service standards and help the bank serve over 100,000 small businesses during the pandemic, survive, and save at least 1 million American jobs. We feel really privileged to be working with such an awesome team. This morning, our investor presentation, I'd like to urge everybody to please participate follow that because that will help us all understand clearly. We are delighted with a strong performance of our company, and we've organized this investor presentation over the next 25 minutes to 30 minutes or so into the following sections. I will give you a brief review of the overview of the company and how it's been built over the last 10 years. We're celebrating our 10th anniversary this year. And then We'll go over our second quarter highlights. We'll discuss with you our top priorities, especially focusing on the portfolio management as well as our digital activities. And then Carla will go over the financial results, and then we'll give you some of our thoughts on the outlook. If you go to slide five, you can see from a franchise overview point of view, we've been – Over the last 10 years, I've been very pleased to report that we've built a company with $12 billion of core assets, $10.5 billion of loans, excluding PPP, $11 billion of deposits with only 15 branches, with an average of $700 million per branch. And we are reporting in the second quarter, adjusted pre-tax, pre-provision ROA of about 1.4%. And if you think about it, this management team back in late 2009, early 2010, put in about $20 million of our own money into a problem bank, and that's how we got started. Our market cap today is, however, only $380 million. And Compared to other banks of our size, their market cap is in excess of about a billion dollars. So we think there is hopefully and going to be, we should be able to deliver above average shareholder returns over the next few years. And we are among the largest shareholders. This company, Customers Bank Corp, that's been built resembles that pretty much of a regional bank. and through very strong offerings in business banking, personal banking, and way above the rest of the industry on the digital front. And hopefully that will come across to all of you. If you move to slide six, some highlights. Like I said earlier, we've built a company, high-performing company, which is really not just in the Northeast and Mid-Atlantic, but we also have four national niches that we are serving throughout the nation. First one is our mortgage warehouse business that we call Banking the Mortgage Company. Another one is our SBA lending platform, which is really thriving right now. And so that's the SBA business. Third one is our commercial finance business, which we started from scratch and now is in excess of half a billion dollars in outstanding. And then our specialty finance and healthcare business, which is also thriving and has absolutely no deformants, no delinquencies, and it has about a billion dollars in outstandings right now. So from a startup of about $250 million problem-failing bank to today what we consider to be a $12 billion in core assets, strong, high-performing bank, we are poised very much to take advantage, and we are very mindful. of the challenges that this environment and we are dealing with both the challenges as well as looking at opportunities right now. And we believe that this very experienced management team and I'd match our team with anybody and is really poised for better times ahead for our company and for the shareholders of our company. From a credit point of view, our asset quality has performed consistently better than the rest of our peer group And we believe that it's expected to remain in this fashion, both during this down market as well as whenever we return. That's because of our conservative underwriting standards, our conservative credit culture, plus our specialized lower risk niches that we are focusing on as such. And clearly, we are very much strategically focused on the longer term, We understand that we've got to manage the company for certain shareholders on a quarterly basis, but we will never get away from running the company for the longer haul. And on the longer haul, our strategy is very clear. We built it on single point of contact, and we are emphasizing continuously improving our balance sheet, very focused on capital management, and we are well positioned, in our opinion, to seek to earn about $6 per share in core earnings with a potential of delivering five to six times money for our shareholders over the next five to six years. Moving on to slide seven, something very, very significant, and I just cannot overemphasize this, that every challenge also creates opportunities. We recognize that we needed to build and a stronger team tangible common equity ratio would be good for us and good for our shareholders, and at the same time taking advantage of opportunities that are available to us to serve Americans in need, American businesses in need. That's why, unlike many of our colleagues who may have looked at the PPP or the Paycheck Protection Program as a pain in the neck, we looked at it as a huge opportunity. So Customers Bank leveraged its technology platform to partner with leading fintechs and becoming one of the top PPP loan originators in the country. While others looked at their local geographic markets, we looked at as digital national market opportunity for customers. That's a very important distinction. And Customers Bank Corp. and Bank partnered with leading fintechs as of force multiplier for PPP, and I'm so pleased to report to you that we are number six in the nation as of July the 24th in terms of numbers of loans, and we are number two in the nation in terms of serving real small businesses. And it is to be ahead of companies like Citibank, TD, Truist, PNC, Citizen, Zions, Key, Fifth Third, Huntington, M&T, It really makes us feel very proud. And this wouldn't have been possible without the rapid digitization of our back office processes. We created speed, we created efficiency in the processing, and thousands of these PPP borrowers are also being contacted by us as part of our outreach campaigns to create deeper and more permanent banking relationships with these customers. So if you look at slide eight, if you're wondering what kind of businesses were these, these were really businesses where help was needed the most. It's small contractors. It's people in the food and accommodation, lodging services. There were healthcare and social assistance, professional scientific services, folks in retail trade, and such other services. That's what made up the 100,000 businesses that we helped. We are still in this process. We've originated about three to four hundred million dollars of PPP loans in this past 30 days. And we are not going to stop doing this because it is an absolute win-win opportunity for us. And that's why it's an example that differentiates us from other banks. We are high tech high touch opportunistic bank that really focuses on risk management while doing all this so moving on to slide 10 you can see from our earnings point of view it was 19 million dollars gap earnings were up 237 percent on a core earnings basis we are up 51 percent over last year and our pre-tax, pre-provision earnings are up 94% over last year. From an asset quality point of view, we've built our reserves by over $100 million since the end of last year. Our reserves today are 2.2% of our loans, taking a conservative viewpoint, versus about 1.6% to 1.7% for our good-performing peer group. And just from a perception point of view, we've set up the reserves with 6.3% for our other consumer loans, which are home equity loans, as well as home improvement loans, as well as personal loans, as well as student refinance loans. That's what pretty much makes up our other consumer loans and such. And from a loan portfolio point of view, our total loan balances have grown about 8% over last year, if you exclude PPP. and with the greatest percentage growth in the CNI category. And at the bank, we have no subprime loans at all. And from a deposit point of view, we've grown our total deposits by 34% over last year, and our demand deposits are up almost 100% over last year. From capital ratios point of view at the bank level, our CET1 is 10.6. Our tier one risk base was 10.6. Our risk base capital totaled It's 12.3, and our Tier 1 leverage was about 9.5, 9.6%. From a book value point of view, tangible book value is about $24.62, and we have tangible equity of about $1 billion, made up of about almost $800 million in common and the rest of the $200 plus minus million in preferred. And today we are trading at less than 49% of our $6.33. 2020 tangible book, really offering an incredible opportunity for certain investors. From moving to page 11, once again, very quickly, summary, 9% growth in our bank tier one capital, adjusted PTPP was 94% growth and adjusted pre-tax, pre-provision ROA, 38 basis points growth, Adjusted pre-tax, pre-provision, return on common equity, 24.6%. And you can already comment over the loans and the deposits. Once again, I can't overemphasize the 97% growth in DDA. So proud of our teams. And yes, everybody is doing well in deposits right now. But I think our team is no exception. And we did not take full advantage of all the deposits yet from the PPP loans because a lot of these customers were other banks' customers, and we shipped deposits to other banks. And we see that as an opportunity. So our deposit growth is core and not PPP-related only. Our non-interest income was 85%, and our net interest income was up 42% over last year. Moving to slide 12. You can see our loan portfolio, like I mentioned, it's at about 8.5% CAGR over the last five years and excluding PPP. And obviously, you can see over here, we've been very mindful of the risks inherent in the commercial real estate business, as well as the possible risks from the multifamily businesses. And that's why over the last couple of years, by design, we've been shrinking those portfolios. and really focusing on what we believe to be the higher quality portfolios, shorter duration, and dealing with prime customers and building our CNI and our mortgage warehouse business. And Andy Bowman, my colleague, our chief credit officer, will talk more about that. On the deposit side, you can see our DDAs, non-interest-bearing DDAs, went up about half a billion dollars over last year. And today, About 45% of our deposits are demand deposits, both of which approximately 19% are non-interest-bearing demand deposits, and the other 25% are interest-bearing demand deposits. Our loan-to-deposit ratio of loans held for investment to deposits because of our high level of liquidity is at 66% right now. Moving to slide 13, Our tangible common equity has over the last three years been around that 7% level. And we wanted to share with you that if you take out the PPP loans and you put in our expected earnings for the second half of the year, and you adjust for the excess cash that we are sitting on, it's very possible that our tangible common equity to asset ratio by the end of the year with assuming a majority of the PPP loans are off our balance sheet, which we believe will happen because we served small businesses and 90% of all these small businesses expect their loans to be forgiven. And so unlike other banks who are expecting 25% or so of their PPP loans to remain on our books, we are only expecting between approximately 10% to remain on our books and 90% to be off our balance sheet. So we expect our tangible common equity ratio to be in that seven and a half to perhaps 8% range by sometime end of this year or first quarter of next year. Same thing from a tangible equity to tangible assets. You can see we are expecting that to be in that 11 to 11 and a half percent range and tier one leverage to be in that 10.3 and total risk-based capital to be in that 14% range. A very significant improvement in this kind of an environment And that is where we created 100 million plus of pre-tax earnings. That's like issuing somewhere between 8 to 10 million new shares. That's how much equity would have come in. And we did it ourselves through serving our customers and serving America and improving our our tangible common equity to asset ratios. Moving on to slide 14, you can see our classified loans to total loans. And even though our classified loans ratio looks like somewhat of an improvement, what I want to emphasize, these are total loans and they are GAAP presentations, so this includes PPP. So if you take out the PPP loans, still our classified loans to total loans would be about flat. And you can see from a non-performing asset, the blips that you see a little bit, we expect in the second half of this year, both those two large isolated incidents will be behind us. Moving on to slide 15, look at the tangible book value for share growth. We think the real measurement of a company's opportunity to increase shareholder value is the consistency of performance in building your tangible book value. And you can see from our point of view, we built it by about 9.1% CAGR, excluding CECL, because that's still on our balance sheet, the $100 million that we've just transferred from the equity to reserve. But even if you take that out, still it's 7.5% CAGR. And like I said earlier, with a stock price, which was $12 a share, and on June 30th, we were trading at 49% of June 30th's tangible bond. We've identified three priorities as one of the most important things the management and the board is focused on. A is our portfolio management and maintaining superior asset quality. Second one, digital businesses and digital lending. So at this time, I'd like to hand it over to Andy Bowman, the Chief Credit Officer, to discuss our portfolio management performance. Andy?

Thank you, Jay, and good morning, everyone. I'd like to start on slide 18. As evidenced, the bank continues to have a highly diverse asset base comprised of approximately $2.6 billion in middle market, small business, and specialized C&I lending loans, $2.5 billion in mortgage warehouse loans, $2 billion in multifamily loans, $1.4 billion in non-owner-occupied investment pre-loans, $1.3 billion in consumer loans, and $681 million in investment securities. The CMI portfolio itself is also quite diverse in that it contains approximately $635 million in specialized lender finance loans and $566 million and commercial equipment, finance, leases, and loans. Meanwhile, the mortgage warehouse portfolio continues to be very strong and is generating excellent fee income and deposit gathering opportunities. We continue to rank as one of the top warehouse lenders in the nation, and overall credit quality of this portfolio remains extremely strong. Concerning the commercial real estate portfolio, we have moved to decrease our level of exposure in this segment, as evidenced by near 20% year-over-year decline, as this means to better balance the overall commercial portfolio. However, it is important to note that most of the portfolio remains comprised of lower-risk multifamily loans. Looking at the consumer side of the portfolio, our consumer portfolio, which includes personal, home improvement, and student refinance loans, carries a strong average FICO of around $750,000, and there were no subprime loans at time of origination. Our consumer portfolio has performed better than planned and remained in constant contact with each of our servicers. Finally, our investment securities portfolio possesses an average life of four and a half years and comprised of agency-backed MBS, high-quality investment-grade corporate bonds, and municipals. Moving on to slide 19, if I can. As Jay had mentioned previously, portfolio management is the key. And regardless as to the line of business, there's some key principles that drive our commercial lending culture. And I'd like to touch upon those. First, we are a business bank with a relationship banking strategy driven through our single point of contact model. Secondly, we value experience and have a highly seasoned teams and professionals. Third, a strong and diverse market presence as evidenced by LTOs in Boston, Providence, New York, Philadelphia, and Chicago. And four, also as Jay had mentioned, niche markets are important and allow us to lever our skill sets such as specialty finance, commercial equipment finance, mortgage warehouse lending, and small business administration lending, all of which we've been able to take and expand on a nationwide basis. And finally, consistent, effective, and efficient underwriting to a centralized source that is highly supported by regional and specialty credit officers who are in market and possess that specific market knowledge and experience. It's really been by levering these key principles that we've been able to effectively grow our various product lines in a consistent, controlled, and stable manner. Jumping over to page 20, page 20 basically outlines the protocols we utilize in assisting our customers during this time of crisis with payment deferments and how we did so in a very controlled and highly documented manner. Commercial loan deferments were handled in 90-day installments and each deferment had to be requested in writing by the customer using a standard request form ensuring that all the necessary information was received to evaluate the request, that the need was truly COVID-related, and that the customer was in good standing at the time of the request. Once granted, each deferment was carefully tracked to ensure the customer was actively managed with updates required at a minimum on a biweekly basis. A key component of the ongoing account management was the development of action plans supported by forward-looking cash flow analyses, which indicated as to how and when the customer would be able to once again make the regularly required monthly payments. On the consumer side, loan deferrals, we lowered our third-party servicers in deriving best practices and then moved to utilize those best practices across our entire servicer network. Secondary deferments were offered in 30-day additional increments. ACH payment plans were optimized and increased to approximately 85% of the portfolio for all personal loans. and we moved to offer deposit products through bank mobile to help deepen those relationships. I'd also like to note, in addition to the hands-on approach and the direct customer engagement that we've reinforced, we've also undertaken a bottom-up, data-driven approach in analyzing our commercial portfolio. This entails stress borrowers on liquidity, debt capacity, and profitability using forward-looking views of their sub-sectors, reflecting shock and new normal scenarios. This data-driven approach, coupled with our high-touch single-pointed contact model, best positions us to stay ahead of any deterioration in credit quality moving forward. Jumping over to page 21, which kind of gives an update on where we stand on the deferral at this time. This slide provides information as a 7.24 or 20% pertaining to the commercial loan deferments. Overall, we have witnessed a steady decline in deferment rates from a peak of approximately $1.2 billion, which comprised nearly 850 loans, down to approximately $691 million, or 244 loans, or roughly 8% of the total commercial loan portfolio as a 7.4%. This represents a decline of $509 million, or roughly 42% off the peak. Overall, the diversification of the commercial loan portfolio has positioned us well moving into COVID-19 as well, as significant portions representing lending activities to industries that have not been significantly impacted or impacted at all, such as mortgage warehouse lending, which comprised approximately 32% of the commercial portfolio as of June 30th. and specialty finance lending, which comprised roughly 7% of the commercial portfolio. In these two segments representing 39% of the commercial portfolio, there were no requests for deferrals. Regarding the remaining portion of the portfolio and our exposure levels to certain industry segments specifically impacted by COVID-19, I'm happy to report that our exposure was very modest as it pertained to certain industry segments such as retail sales at approximately only 54 million, entertainment at only 24 million, restaurants and dining at only nearly 52 million, energy generation and utilities at only 79 million, and colleges and universities at only 65 million. Concerning our hospitality exposure, which has been a key point of contact and focus during this troubled times, was approximately $413 million as of June 30th, or roughly 4.8% of the commercial portfolio, with nearly 73% requesting some form of deferral in terms of dollars. And that information is through July 24th. In addition, as to the hospitality portfolio, there's a couple of key notes I want to make at this time. Approximately 20%, or $84 million, is currently operating at 95% capacity under government contracts for transitional housing. And we've seen an increased number of our hoteliers moving in this type of direction during this time as a means to mitigate the decline in business travel. Roughly 19%, or approximately 75 million, is comprised of high-end destination hotels located in Cape May, New Jersey, Avalon, New Jersey, and Long Island, New York. They're now open and currently operating between 78% and 90% occupancy on a consistent basis. But also note that approximately 75% of the portfolio is supported by some form of recourse. And finally, excluding the destination hotels, approximately 82% of the portfolio is with a highly reputable flag. A second industry impacted swiftly by COVID was that of the healthcare, for which we had a modest level of exposure as of June 30th of approximately $290 million, which equated to only roughly 3% of the commercial portfolio. Our exposure is predominantly in skilled nursing arena, which has been deemed an essential business, and through various governmental actions, having provided immunity from liability for COVID-19-related deaths. I'm happy to report that of this entire portfolio, no deferments have been requested. Regarding our approximate $2 billion multifamily book, it is well-seasoned with an average debt service coverage ratio of 1.73, average vacancy rate of 3.4%, and an LTV of 56%. As of June 30th, 58% of the portfolio is housed in New York City, of which 69% It's rent-controlled and regulated and had a vacancy rate of below 1.8%. The average loan size is about $5.8 million in New York City and $4 million outside of New York City. And as of July 24th, roughly 10% of the portfolio was on some level of deferment. Our investment credit portfolio... is about $759 million as of June 30th, and had a debt service coverage ratio of approximately 2.2 times, and an LTV of approximately 51%, with nearly 63% of the portfolio housed in the New York, Philadelphia, and Boston metro and surrounding markets. I would also like to touch upon two high segments of that portfolio, and that is the retail and the office segments of that portfolio. The investment Cree retail portfolio was a modest $261 million with 34% of the entire investment Cree portfolio and only 3% of the total commercial portfolio. The charity debt service coverage ratio of 2.21 times and LTD of 52% and vacancy of 8.2% and carried a very modest average loan size of $3.5 million. And the investment Cree office portfolio was also a modest $192 million surprising 25% of the investment CRE portfolio and only 2% of the total commercial portfolio. The carry-to-debt service coverage ratio of 1.72 times and LTV of 50%, vacancy of 2.9%, and average loan size of only $3 million. Overall, as of July 24th, approximately 7.2% of the entire investment CRE portfolio, excluding multifamily, was on deferment.

Moving to page 22.

These page outlines our CECL methodology and our move to reserve and build our reserves at the bank. Outlining was predicated upon a detailed portfolio by portfolio assessment based upon various macroeconomic factors as impacted by COVID-19 and by a deep dive into individual portfolio attributes as impacted by said macroeconomic and COVID-19 factors. The reserve bill also took into account actual charge-off rates and level of non-performing assets, with the end result being a reserve bill to roughly $160 million, or 2.2% of loads held for sale, which equates to approximately 185% of the bank's total non-performing loans. When looking at the approximate $160 million or 2.2% of loan sales for sale reserve, NPAs as of 6-30-20 pull at approximately $86 million or 0.48% of total assets. This includes proactively addressing two large loans, one, an $18 million investment pre-loan and a $28 million hospitality loan in the first and second quarters of 2020. Both assets were struggling pre-COVID, and the bank opted to take a very proactive strategy in identifying and aggressively moving to address these assets. These two large NPLs equated to over 50% of the bank's total NPAs as of June 30th. We continue to actively move on these assets, but the intent is to move these assets off the books in the third or early fourth quarter of this year. Charge-offs decreased to $103 million in the second quarter of 2020, marking a decrease over the first quarter of 2020. The charge-offs in the first and second quarter were predominantly, again, associated with the two large NPAs I mentioned, as the assets were written down appropriately when placed on non-performing status.

And now I'd like to quickly jump over to page 22. Outlines our allowance. This outlines

I'm sorry, page 23. This currently outlines our allowance for credit losses for leases and loans as of 6-30. As this chart evidences, we continue to maintain a strong overall reserve position. The strong reserves in place are both commercial and consumer lines. The allocation of reserve levels among the different commercial and consumer classifications came through a thorough assessment of each of these lines of business. The composition of these sub-portfolios and the economic factors impacting them. This is indicative of the high level of detail and thought put into deriving our overall reserve provision. And at this time, we are extremely comfortable that at this reserve level, we have more than sufficient reserves to continue to move forward based upon the in-depth detail analysis we have performed of our commercial portfolio and consumer portfolios and how we anticipate them to react over the next two quarters and into 2021.

I'd now like to hand it over to Sam Sidhu, our vice chairman, the chief operating officer.

Sam, the floor is yours. Thanks, Andy. Good morning, everyone. We really appreciate the opportunity to build on the digital bank and digital lending strategy we began to walk you through last quarter. At the top of slide 25, I'll first talk about our overall fintech strategy. Customers Bank has an existing robust in-house technological capabilities, which Jay sort of alluded to earlier, and we've supported development of an in-house digital bank, which we've augmented by a FinTech partner ecosystem. These partnerships benefit us both from a loan and a deposit gathering perspective. Jay earlier shared our PPP success and the impact it's had on preserving jobs across the nation. We're incredibly proud of the achievements our team has had, and we which have provided us an opportunity to showcase our technological strength. For PPP, we leveraged our deep existing relationship with fintechs and supported them with application intake and API technology to provide broad national access to small businesses most in need, especially during the early days of the COVID crisis. We're continuing to originate, and I'm pleased to share that based on the data that we have access to as of this morning, Customers Bank appears to have increased in ranking to number five in the nation, which is a testament to our team's continued performance. Additionally, we expect that we'll be able to build off of our round one and round two successes with PPP loans to our existing borrowers in the event that Congress approves a re-up for another eight-week payroll period. While PPP is clearly a one-time non-recurring 2020 event, we have built and will continue to build deep relationships with fintech lenders to become a leader in assisting in lending and deposit partnerships on a recurring basis. Next, in terms of digital lending, our current program is focused on personal home improvement and student refinancing loans. In the coming pages, I'll walk you through some slides that support through data how through careful and disciplined growth, We have shown that through this recession, we are a clear market leader in terms of performance among banks and fintechs alike. Finally, to bring it all together, we will continue to grow our digital deposit gathering efforts with a focus on DBA accounts for digital-only deposit customers. We currently have approximately $1.8 billion in total digital deposits between our CB digital bank and bank mobile deposits, which represent about $700 million of that total. Going forward, we will continue to seek to self-fund our digital lending efforts through our digital deposit gathering efforts, including banking as a service offering to FinTech platforms. If you flip ahead to slide 27, we've shared this data last quarter on our consumer loan portfolio. We have a highly diversified portfolio with a 744 average FICO with no subprime loans, 21.9% debt-to-income ratio, over $100,000 in borrower income. We are well diversified from a geographic perspective. From an employment perspective, in the bottom center, we have over 90% of our borrowers employed in non-COVID impacted segments, which is very important as we think about unemployment insurance and stimulus lapsing. And finally, we're very diversified from a use of funds perspective. If you slip to slide 28, This is a very compelling slide, which shows our overall performance in our consumer portfolio, as well as our direct consumer lending portfolio, vis-a-vis the industry. At peak, our overall portfolio experienced deferrals at a rate less than half of the industry, and I'm pleased to say that our direct consumer lending was about 70% less than industry peak. The CB direct portfolio is currently around a third of the total 1.2, 1.3 billion portfolio, and are currently only at 42 basis points of loans in deferment versus a blended 1.8% overall basis in our total other consumer portfolio. We've increased our conviction in direct originations and plan to have our CB direct lending grow to the majority of the portfolio by 2021, while mostly maintaining current other consumer balances. Finally, delinquencies are less than 1% and in line with pre-COVID levels. If you flip to slide 29, as you heard Andy discuss our commercial loan-by-loan management of deferrals, we took a very similar approach with our consumer loan portfolio and did not take a portfolio-based approach for deferrals or even a servicer-based blanket approach. It was a bottoms-up approach. This is evidenced by the fact that we're currently converting nearly 85% of borrowers off of deferral back to current payments, far above the industry and, frankly, far above marketplace lender participants. With that, I'll pass it to Carla to walk through our financial highlights.

Thanks, Sam, and good morning, everyone. I'll begin my comments on slide 32. which really illustrates the significant progress we've made in preserving and expanding our net interest margin from a trough of 247 reported in third quarter 2018 up to the 2.99% reported in first quarter 2020, or 52 basis points of expansion. For second quarter 2020, our net interest margin was 2.65%. This includes $2.8 billion of the average balance for PPP loans with an average yield of 1.7% and an average cost of 35 basis points. Excluding the impact of PPP loans, our net interest margin was 2.97% in the second quarter. I'll note on this slide that the declining asset yields and funding costs in the second quarter reflect the full quarter impact of the 150 basis point rate cut in March. Focusing on the funding costs, you'll see a significant reduction in the cost of interest-bearing liabilities, dropping 86 basis points in the second quarter to about 1.1%. In the second half of 2020, we see considerable opportunities to further reduce our deposit costs as we run off higher-cost CDs and repriced digital assent deposits, excluding PPP loans, We are expecting margins to be between 2.9 and 3% for the full year 2020. Moving on to slide 33, you can really see our strong liquidity position, which we actively manage and monitor daily. Over the past two years, our total deposits have increased from $7.3 billion in second quarter 2018 to $11 billion in second quarter 2020, or a 50% increase. You can also see a decline in our core loan-to-deposit ratio, which has decreased to 66% at June 30, 2020. We also had average liquid assets of $3.5 billion for the second quarter, which included $2.5 billion of mortgage warehouse loans, which are self-liquidating assets that can be liquidated in less than 60 days under stress conditions. And from a borrowing capacity perspective, we have access to a total of $7.2 billion borrowing capacity with a remaining capacity of $2.3 billion. I'll also point out that of the $4.8 billion of PPP loans that we've originated as of June 30, 2020, 4.4 billion, or 93%, have been pledged to the Fed's PPP lending facility, so there will be no impact on our risk-based or leveraged capital ratios. Slide 34 presents our capital ratios for the bank and the Bancorp, both significantly above well-capitalized. And at the bottom of that slide on the left-hand side, you can see the bank's excess capital levels over well-capitalized, which includes $399 million of excess CET1 capital. Turning to our profitability on slide 35, both our GAAP and core earnings were $0.61 for the second quarter, which represented a 237% increase in GAAP earnings and a 52% increase in core earnings over the year-ago quarter. On an adjusted pre-tax pre-provision basis, earnings were $50.8 million, a 94% increase over the year-ago quarter. In addition, both the consolidated and the business banking efficiency ratios improved significantly from the year-ago quarter at 58 and 51.6% respectively. And lastly, slide 36 shows trends in the level of non-interest expenses over the past five quarters. In the latter half of 2019, you can see significant cost saves, and in the second quarter, 2020, you'll see another reduction of about $3 million. Going forward, we expect the level of non-interest expenses to remain relatively flat over the next few quarters. And with that, I'll turn it back to you, Jay, to wrap up.

Thank you very much, Carla. And in terms of I'm on slide 38, the key takeaways, as you heard from my colleagues, the company is very well positioned to execute on our 2020 as well as our 2026 long-term strategies. As Carla stated, we expect the NIM to remain between 2.9% and 3% for the full year, excluding PPP loans and operating expenses to be about flat or moderately higher over the next few quarters. Tax rate to be between 22% and 23%. And from a total assets point of view, we are going to be moderating our growth in our balance sheet, core balance sheet in this kind of an environment. And like we shared with you already, the PPP loan is expected to add about $100 million in origination fees, plus the interest revenues on top of it. And that's a very, very important point to note. And we are very comfortable that we are on a run rate of $6 a share for 2026. And depending upon the timing of the recognition of our PPP fees and the performance of the economy, we believe we should still be able to report about $3 in share in earnings. gap earnings in both 2020 as well as 2021. And if you look at 2021 numbers, we expect the tangible book value per share to be in that $30 range. And with $3 in earnings, we think there is a huge potential of increased shareholder value creation even in the short term for our shareholders. Just another comment. You should not expect a material addition to our allowance for credit losses due to CISO. unless there is a deterioration in the economic forecast because we've already built a very conservative, taken a conservative approach to build our reserves at 2.2% of our loans held for investment. Carla has already shared with you why our comfort level on our NIM is there because of the asset side of the balance sheet, we are maintaining or increasing our yield. And on the liability deposit side of the balance sheet, we have about $2.2 billion of deposits that are being repriced, which is 22% of our deposits approximately that are being repriced down at least 100 basis points in the second half of this year. From a capital point of view, we are on track to exceed, hopefully, the TCE target, excluding the PPP loans, because we can't estimate exactly when they'll be off our balance sheet, but they definitely will be off our balance sheet. And so you should expect that to be achieved by us. And we are, once again, stating to you that until this pandemic, until this crisis is over, we will not be considering calling our preferred equity. From a bank mobile point of view, two very important announcements I'd like to make. One is that we believe that divestiture is on target for execution by end of the year 2020. And And we hope also to be able to announce a very significant major partnership with a large technology company and global technology company over the next few days. So watch out and look out for those announcements coming from us over the next couple of days. So with that, I'd like to ask the operator to please open it up for questions.

As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound or hash key. Please stand by while we compile the Q&A roster.

Your first question comes from Michael Parita with KBW.

Your line is open.

Hey, good morning, everybody. I'm glad to hear everyone seems to be doing well. Thanks for taking my questions. I wanted to start on the balance sheet side. I guess a couple things. It seems like when you mentioned in the release that the total assets will be similar at year-end 2020 to year-end 2019, I guess kind of two clarifications on that. One, does that assume kind of the rundown of the 90% of PPP to get there, and are there Is there anything else? I mean, does that also assume some continued rundown in multifamily assets with kind of modest, if any, net growth X that in the back half of the year? Am I kind of capturing all that correctly, or is there anything that you guys could help clarify there?

Yeah, Mike, it's a good question. In addition to what you just articulated, there is also seasonality in the mortgage warehouse business, and the lowest point in the year is usually – at the end of the year and so when you put all that together uh we think there would be uh approximately a similar size it could be off by a couple hundred million dollars as you know and if ppp loans are not out of our off our balance sheet by the end of the year they are expected to be a maturity 90 of them off our balance sheet by sometime in first quarter next year okay and it

In terms of the mortgage warehouse business, though, I think I saw and I think you guys commented that it's elevated right now. I mean, as you talk to your partners there and look at, you know, kind of demand and activity there, I mean, do you think that there will be such a seasonal drop-off? I mean, I guess we're talking about period end balances, right? So maybe by December there will be. But it seems like there's probably a decent chance that those seasonal balances could probably be higher in the back half of the year than what they would be typically. Is that fair?

Yes. It's possible, and Mike, as you know, the mortgage banking business has been a big benefit to the banks, and we are also enjoying that, but we don't like the huge amount of cyclicality necessarily with being in that mortgage banking business, but we like it this way because approximately 10% of our mortgage warehouse business comes back to us in terms of non-interest-bearing deposits. as well as we get about 1% of our outstanding balances and fees. So that's why we like that business, and we expect to be growing our market share in that business. But that is a cyclical business, and we are expecting much lower levels on December 31st.

Okay. I wanted to transition to Cecil. You know, it's a little bit of a challenge for me because it's – I don't – I can't remember a situation where, you know, we have – kind of go-forward economic forecast, right, but the consumer health from a cash perspective is so high just because of all this stimulus and government forbearance and bank forbearance and all these programs. So I guess my question is, as you think about your seasonal reserve today, I was wondering if you could extrapolate any kind of thoughts on what the consumer health looks like going forward and the type of assumptions you've made. Because obviously right now the consumer health seems really high. I mean, you guys have those helpful charts in there, and they have a lot of cash today to consumer. But, you know, presumably once the stimulus ends, you know, I mean, that could change. I'm just kind of trying to gauge, you know, what your reserve is capturing in that regard as it stands today.

Sam, you want to take that on? Sure, absolutely. You know, Mike, I think you really hit the nail on the head in the overall consumer health of the nation. However, I would point you to a couple of comments. So one is that I think we shared a pie chart which showed the overlay of employment professions of our overall consumer portfolio, and we believe that a minimum of 90% plus of our borrowers are fully employed. I think that's evidence from our deferral numbers, which is more sort of a precautionary insurance plan versus actually a material impact. So we actually feel that stimulus is has been helpful. I think American savings have increased over the last 90 days on a broad-based basis because people were spending less plus receiving government stimulus. I think that's helpful, but it's not critical for the overall health of our borrowers. So I think we feel pretty good that even with stimulus lapsing and tapering off in the second half of the year, that we are hopefully in a much more stabilized basis from the peaks that we saw about six or eight weeks ago.

Is it fair to assume, too, that with the average salary, I think you said about $100,000, I mean, the majority of your consumer customers probably didn't really receive much stimulus anyway. Is that fair? I mean, it's probably hard to tell exactly, but did the balance kind of dictate that that's true or not?

Yeah, I think that's a fair assumption, Mike. You know, we don't have the exact data because stimulus is generally on household income, and this is borrower income. So, yes, you're right. If there is sort of another earner in the household, given the average age most folks are likely married, there was minimal stimulus.

Sorry, I didn't mean to cut you off. No, no worries. Going forward, Mike, you should expect our quarterly charge-offs to be in the consumer area to be a low of $6.5 million per quarter and to a high of about $8.5 or so million per quarter based upon all the analysis that we've done. And you asked us, you know, how about your own stress testing? And we believe when the CECL reserves are set up, so that we would be actually taking charge of which are about 25% greater than our expectations. So right now, our performance is running 20% to 25% better than where we thought we would be based on our models.

Very helpful. Just two more things I wanted to hit. One, on the deposit growth, Jay, you mentioned how while there was obviously some impact from liquidity bills and PPP and whatnot, that it wasn't you know, all that, and there was a lot of core growth. You know, I know with your fintech partners, the reality is that some of your PPP funds probably didn't go right to your balance sheet like a lot of other banks, so I think there's a lot of credence to that statement. I was just curious if you could provide maybe more color about where you saw kind of the core deposit growth, more specifically kind of X anything, you know, environmental-related.

In terms of our PPP deposits as such, we did for our own customers about $752 billion in range for our own customers. And so you can say, okay, all that money came back into our accounts and the rest of the $4 billion we shipped out to the other banks. So, but we have a relationship with these customers. So we have already today opened up approximately 1500 to 200 are in the process of opening up some of those cases, new commercial DDA relationships. And I think a lot of our deposit growth in DDA deposit growth is coming from three sources. One is new business opportunities through PPP and others. Number two is our mortgage warehouse business, which has given us, are DDA growth opportunities, like I mentioned to you, 10% DDA compensating balances. And number three is our digital businesses in this kind of an environment.

Okay. Helpful. And just lastly, and then I'll step back, just in the earnings release, there was a comment about a negative mark-to-market derivative credit valuation adjustment that was related to a non-performing borrower. I was wondering if you could just give us a little bit more color on what that means exactly and what exactly occurred that resulted in the loss?

Yeah, it was an interest rate swap that the customer had entered, and obviously when we put the loan on a non-accrual basis, we took and assumed that the swap is not going to be honored, and hence we just basically wrote off the value of the swap.

Okay, so...

All right, I guess that makes sense. I will leave it there and let someone else ask. Thank you, guys, and stay well.

Thank you. You too.

Your next question comes from Steve Moss with B. Riley SBR. Your line is open.

Good morning. Hello. Good morning, Steve.

Appreciate all the color on credit here. You know, two follow-ups here, or a follow-up in particular on the two NPLs here this quarter. Just kind of curious, it looks like the charge-off rate of, I assume, the charge-offs from commercial real estate was about 6% on those. Kind of wondering, are they under contract? Do you have letters of intent? And the type of loans there.

I think the first one is the same one that we announced in our first quarter. There was an office building, Class A office building, and that is under contract, and we expect it to close in the third quarter. And all our chargeouts were taken on that Class A office building, which was at one time corporate headquarters of a Fortune 500 company. And so that will be dissolved this quarter. And the second one is a flag. It's a Marriott flag hotel. And, you know, it was private equity owned. And we decided that either every single hotel property that we have, we are stressing it. that for one year period from middle of the year, you must have enough cash to be able to sustain it. We do not want them to become non-performing loans or TDRs if we can prevent it at the conclusion of the six-month deferment, which many of the hotels are taking. So anyway, we didn't see that happening at the end of the six months. We saw that as becoming a non-performing loan at the end of the six months. So rather than give them deferment, we decided to take over the loan and actively pursue the sale of the note. And that's why we are confident that we should be able to resolve that hotel in the second half of this year.

Okay, that's really helpful. And then in terms of the consumer loan originations, I think the press release says something to the effect of, managing the balance is relatively stable here. But it was interesting to hear that you guys plan on growing your own internal originations to the majority by next year. Kind of wondering if you could go through the plans on how you plan to grow that and the offering types you seek to offer.

Sure.

I'll take that. So, Steve, you know, I think in the last quarter, We had about $130 million of paydowns and charge-offs on our consumer loan portfolio, which is pretty typical. We had about $85 million of total originations, and over 50 of that was customers' bank direct. So these are predominantly personal loans, consumer loans. And we've crept up to just about a third of our overall portfolio. And our thought process is that we will continue to originate at a pace that would seek to maintain, you know, at a minimum maintain to slightly decline the card balances. So quarter over quarter, we actually declined, you know, to $1.25 billion in the portfolio.

And, Steve, looking ahead, you should expect our outstanding balances in the consumer loan portfolio over the next couple of quarters to range between $1.2 and $1.4 billion, and for us to be above $700 FICO. And as Sam said, most of them will be originated by us, and we are sharing with you the performance of our own originated loans are actually even better than what we've seen, significantly better performance. And from a CISO point of view, we estimated the CISO reserving based upon the industry averages or our FICO bands, and that's why we are running in charge of lower than what we've set up as reserves.

Okay, great. That's helpful. And then one last housekeeping item. In terms of just the amortization or the realization of the PPP fees, I take it By the disclosures here, it's a 24-month amortization, and you'll realize the fees as the loans are forgiven?

That's right. I would just caveat that with the extension of the second round of PPP loans, that predominantly most of our July originations and on a go-forward basis will be amortized over a 60-month period.

All right, great. Thank you very much. I appreciate all the callers. Cheers.

Your next question comes from Frank Chiraldi with Piper Sandler. Your line is open.

Good morning, guys. Good morning, Frank. I want to ask Jay on BankMobile. It seems like you guys have some confidence in divestiture by the end of the year. And just wondering if you can give any more color and thoughts on what this could do in terms of additional accretion to capital levels, and then also what goes along with this business in terms of, I realize some assets are going to go along with the deposits, but is there a specific lending business that is part of the consumer direct lending business likely to be divested along with the deposits?

We, as you can well imagine, Frank, I've already stated to you that over the next couple of days we should expect us to disclose hopefully some more details about the bank mobile divestiture. So please keep that in mind, so I'll be very general in my response to you. We look at bank mobile as two different types of businesses, as you kind of identified them. One is the technology platform, and that technology platform is the entire digital platform that we built, that we believe, is one of the best digital platforms for consumer business that exists in the United States right now. And that is the platform which has an onboarding, which is extremely, extremely robust from a risk management point of view and customer experience point of view. And we are using that platform for T-Mobile money right now and the like. We also have a technology platform which serves one third of every single college and university in the United States. It is a technology platform for those colleges and universities to manage their student loan disbursement, as well as the account management and opening for the disbursements business for the students. And on top of it, like I mentioned to you, you should expect us to announce a very significant, large collaboration with a technology company. So we are putting all that together under our technology company called Bank Mobile Technologies. Now, the deposits and loans are separate from that. There is a possibility that we could sell the technology or divest the technology company and then divest the deposits and loans, or there is a possibility we could keep all the deposits and loans and simply have a partnership and divest the technology company. You should be getting more details on all of that in the next, hopefully, next several days.

Okay, got you. So the deposits could remain housed at CUBi. That's the potential. So I guess that increases the number of potential buyers or doesn't need to be a bank, sounds like, in terms of divesting. charter wouldn't have to go along with it. Is that fair? That's right. Okay. And then, secondly, I just want to make sure I understand the deferrals. You guys gave the commercial deferrals down to 8%. Is that now what is in the or expected to be the second 90 days? So, you know, in other words, is that 8% deferral? basically going to be on for another 90 days, or is there continued contraction in deferrals as they come off the first 90 days, and we could see deferrals go lower in the near term?

Andy, do you want to take that on? Absolutely. Yeah, on page 21 of the slide, we have a deferment runoff position there. And actually, no, that 8% is a combination of Some that either went on a first deferral period later on in the year or are on a second deferral. And we expect that to continue to run off. We really do not expect really any deferrals to be on the books much beyond the end of September of this year. And I think what you'll see moving into the end of July and into the end of August, I think that 8% number will be down closer to about 4%. What we're seeing right now is really the only loans that are coming in in our portfolio for any second round of deferment continue to be those predominantly in the hospitality sector.

Okay, great. And then finally for me, just curious if you can see through to it what sort of rent collections percentage-wise you're seeing in the New York City multifamily portfolio.

Sure. This is Andy again. I can take that. The rent collections, as we said, we continue to stay in contact with our principals and our borrowers on a consistent basis. And they're actually seeing rent collections better than they had anticipated. They're still seeing rent collections hovering somewhere in that 70% to 80% range still in rent collection. The positive component of our portfolio, I think, And the why our rent collections are higher is, you know, that we're in predominantly the rent-controlled, rent-stabilized market. So traditionally, you know, some of that is obviously supported, as you talked about, by the stimulus transaction. But I think a lot of that, too, also has to do with government-assisted programs that continue to fund significant portions of that rental income.

Okay. Great. Thank you.

Your next question comes from Bill Desolin with Titan Capital Management. Your line is open.

Thank you. I want to circle back to some of the early comments about the back office digitization that you have done that allowed the interaction with the fintech partners to benefit PPP loans. To what degree is that technology enhancement something that will benefit the non-Fintech relationship part of the bank, meaning that it has spillover benefits to the core customer's bank work.

Bill, this is Sam. I'll take that. It's a great question. So in terms of the FinTech partnerships from a PPP perspective, to give you a sense of how complex this was, you know, we had APIs plugged into SBA, eTRAN system to submit. We were submitting bulk in bulk with the SBA as well. We were chaining through via API to, you know, a SBA system. LOS provider. We also, the SBA had created a software or rather a service called SBA Connect with Amazon's assistance. We also chained in through that. And then with each of our FinTech partners, we also chained through. So we had at any point in time six to seven different ways that we were submitting for eTRAN approval, just to give you a sense. So clearly our back office already had existing strong technological capabilities. To answer your question as to how we think about the impact for the future, as I mentioned, the origination fees and the loan balances are one time, but I think we've really been able to showcase our technological prowess. And I think that some aspects of what we initially even thought were very challenging to digitize, for example, the SBA 7A Express process, We're well underway on a proprietary basis as well as in some ways with our fintech partners in finding ways to automate as much of that process, at least the initial underwriting process, as possible. That's just one example. And then on the general small business side, we have over the last quarter developed in-house revamped commercial deposit gathering account opening capabilities. which we believe are best of breed, and that coupled with the ability to use technology to target customers similar to the way that we do on the personal loan side. For the small business side, which is smaller customers that would otherwise be unprofitable to service on a direct basis, we will continue to use technology to target them and get access to them and arguably get paid a better risk-adjusted return for those types of customers. So more to come.

Okay, so I'm going to play off that a little bit further. Thank you, Sam. Do you foresee this also in any way lowering your cost of doing business, say, as you would have versus how you would have done it one year ago?

Absolutely. You know, we have a number of initiatives in play, both from a loan origination standpoint as well as a deposit gathering standpoint. and then also from a credit and portfolio management perspective, you know, with the new FinTech partners. So we are using partners to help generate loans and deposits. We're also using FinTech partners as well as in-house sort of proprietary technology to completely digitize the way and rethink the way, you know, that we service and manage the risk of our customers.

And what quantification in terms of dollar benefits to, let's just say, shareholders or the P&L, do you anticipate or has that number been identified?

Our internal goal that the technology team and the credit team and the line is working towards is to be in a position, you know, within the medium term to be in the low 40s efficiency ratio on the business bank.

Great. Thank you for the time.

Absolutely. And, Mariano, we do have a couple questions that were submitted online.

Perhaps I'll read through those now as it doesn't appear there anymore in the live queue. The first one, I'll direct this to Carla Leibold. We have a question that says, how is your PPP fee income being distributed? realized what amount was realized in the second quarter and what amount is expected in future quarters.

Carla, are you coming off mute?

Yes. Thanks, Bob. So we are recognizing that interest income over the life of the loan, so at the coupon of 1%, and then the deferred origination fee is also being amortized over the two-year life or the five-year life. So we recognized about $9 million in the second quarter, and then we forecasted out based on our expectation of forgiveness and upon forgiveness that deferred origination fee will be accelerated and recognized in interest income.

Great. Thank you, Carla. We do have one other question which was sent in.

This question I will direct to Andy Bowman as it pertains to credit. The question is, regarding nursing homes, is there any color that you can provide around the operator's financial condition, debt service coverage ratios? Are there any below one times? Any other metrics that would be helpful?

Sure, I can answer that question. As I said before, that portfolio runs currently today slightly under $300 million. And it is predominantly comprised of skilled nursing facilities. It is a nationwide portfolio, so it has geographic diversification to the portfolio. All of the originators that we work with are seasoned originators, individuals predominantly, or smaller companies that may operate a number of skilled nursing facilities. We're not engaged in any of the large national REITs or anything such as that. All the loans are performed on a recourse basis to the individual principals. Debt service coverage ratios on those nursing homes currently today are all running in excess of 1.2 times. All those transactions have minimum required debt coverage ratios. We've tested them all as of 6-30. They are all in compliance with the debt service coverage ratios. And no, obviously then we have none running at a below a death service coverage ratio of one to one. It's a portfolio that we continue to stay on top of. As I mentioned before, we also went through and did a state by state analysis of each state in which we have skilled nursing facilities to make sure that the indemnification is in place for any type of COVID-19 related deaths that take place within those nursing facilities. So we're comfortable at this time. that they will continue to operate in a profitable manner as they are slowly now only starting to gear up and starting to bring in new patients. But there was a lot of assistance from the government to increase Medicare and Medicaid reimbursements that more than offset the increased costs related to staff overtime, staff shortages, et cetera. So we're not seeing a lot of stress in that portfolio at this time, and nor do we continue to think that there will be any significant stress in that portfolio.

Great. Thank you, Andy. At this time, that's all the questions that I see either in the live queue or online, so I'll turn it back over to Jay for any closing comments.

Okay. Well, thank you very much, everybody. Really appreciate you taking the time and your interest in Customers Bancorp, and please give us a call. If you have any other questions, we do intend to do an outreach to the various investors, our existing shareholders is what we will start with first. And then we will go out to other interested folks because we believe Customers Bank Corp offers tremendous opportunities for shareholder value creation. Thank you very much and have a good day.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.