Customers Bancorp, Inc

Ladies and gentlemen, thank you for standing by and welcome to the Customers Bank Corp, Inc. Third Quarter 2020 Earnings Conference 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. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Dave Paddy, Director of Corporate Communications. Thank you. Please go ahead.

Thank you, Raquel, and good morning, everyone. Thank you for joining us for the Customers Bank Corp. Third Quarter 2020 Earnings Webcast. Our earnings release was issued last night along with our investor presentation. Both are posted on the investor relations page of the company's website at www.customersbank.com. Our investor presentation includes important details that we will walk through on this morning's webcast, and I encourage everyone to pull up a copy. Before we begin, we would like to remind you that some of the statements we make today may be considered forward-looking. These forward-looking statements are subject to a number of risks and uncertainties that may cause actual performance results to differ materially from what is currently anticipated. Please note that these forward-looking statements speak only as of the date of this presentation and we undertake no obligation to update these forward-looking statements in light of new information or future events, except to the extent required by applicable securities laws. Please refer to our SEC filings, including our Forms 10-K and 10-Q, for a more detailed description of the risk factors that may affect our results. Copies may be obtained from the SEC or by visiting the investor relations section of our website. At this time, it's my pleasure to introduce Customers Bank Corp CEO, Jay Sidhu. Jay, the floor is yours.

Thank you very much, Dave. And good morning, ladies and gentlemen. Thank you so much for taking the time to join us for the call this morning. Joining me today, Dick East, our President and Chief Executive Officer of Customers Bank. Carla Leibold, Chief Financial Officer of Customers Bank Corp and the bank. Sam Sidhu, who is our Vice Chairman and Chief Operating Officer of Customers Bank. And Jim Collins, who is our Chief Administrative Officer of Customer Bank. And Andy Bowman, our Chief Credit Officer of Customers Bank. We are really thrilled to report another strong quarter of financial results, despite a challenging economic environment. As you know, our gap income of $47 billion million or $1.48 for diluted share is up 100% over Q3 2019. And our revenues are up 42% over last year while we held our expense growth to 10%. And this is during a time period when we faced headwinds from the Durban, application of the Durban on our interchange income. Before I open up and discuss a little bit of our results, I'd like to recognize our team members as well as our executive management team. I'm so privileged and we are also privileged to be working with an exceptional team and really want to thank them and recognize them for their absolute commitment and hard work to help produce these kind of results. Today, we will organize our presentation into these five or six subsections. First, we will discuss with you our financial highlights. Then we will talk about capital trends and as well as our strategy. to improve our capital, then a major strength of our company is our credit quality, and Andy Bowman will discuss that in detail with you. We will briefly discuss our strategic priorities, and then we will, before question and answer, discuss our outlook as well as the guidance for you for 2020, 2021, as well as the longer-term guidance. At this time, if you look at page five of our investor deck, just a very brief overview of customers, Bancorp and our franchise. So we concluded at September 30th with a $13.8 billion in core assets, $11.6 billion in loans and leases, $10.8 billion in total deposits, of which 21% were non-infrastrating demand deposits. 1.43% of adjusted pre-tax pre-provision are away. And unlike many institutions in our peer group who are trying to rationalize the branch offices, we only operate with very few of them, and we are actually shrinking 20% of the branches or the dots that you see on this page. We are a high-performing, unique organization. Community Bank, a regional bank with very strong business banking focus, as well as personal banking. And then, of course, you all know about the bank mobile technologies. And I'll talk about that a little bit later. If you look at slide six on our investor deck, Like I mentioned to you, our company today, unlike many others, has been built by organic growth into a very relationship-driven commercial bank. And we started off just about 10 years ago by this management team taking over a $250 million asset-fueling bank with 40% non-performing loans. And from that kind of a foundation, we've grown today to this $14 billion high-performing bank. And so that's why I want to really emphasize and recognize the exceptional and highly experienced management team that's running customers' banks. From a credit and a risk culture, that's been a strength of ours because we have lived with it. And we believe that credit culture is developed by having a tremendous emphasis on the credit side of the balance sheet in good times. And that is the only way you come across well during tough times like today. And I'm sure you will see that when Andy makes his presentation. From our longer-term strategy point of view, this company's strategy is built upon a single-pointer contract model. or private banking for privately held businesses. Sometimes we also call it high touch supported with high tech. We think this is a unique differentiating approach. We believe this applies both to businesses as well as to the consumer banking. And we think This is a model which, when you combine it with a digital world and a digitization that's taking place in every single industry, we think it creates a very franchise-enhancing platform. And that's why we are building and we have already built an in-house digital bank and digitizing every single operation in the company based upon this high-touch, supported by high-tech approach. But we are totally committed to continuously improving our balance sheet and capital allocation is a key component of our asset and learning generation strategy. And as you know, we are very, very committed to also at the same time, set short-term and long-term goals. We do not run this company on a quarter-to-quarter basis. We run this company for building short-term as well as long-term shareholder value. And that is why we have been consistent in sharing with you both our short-term as well as our long-term goals. And our long-term goal is $6 per share in annualized recurring EPS with improving metrics. as such, and hence increasing significant value over the coming years. If you look at slide eight on the investor deck, you can see the earnings, like I mentioned, of $1.48 and core earnings of $1.20. And like I said, Durban is expected to impact us by $7 to $10 million in the second half of 2020. And so many other institutions had to go through M&A and all that kind of stuff to overcome Durban. And we have been able to and we intend to be able to successfully deal with that and stay on course. We expect to earn, in fact, well over $100 million in pre-tax. income as a result of our PPP loans. And majority of this, we believe now, will be recognized in the first half of 2021. From an ROA point of view, I've already gone over that. But one other thing I'd like to add is our efficiency ratio was 15.7% at September 30th. And we have intentions of improving upon it over the next couple of quarters. Andy will be talking a lot about asset quality, but let me share with you, because we are so proud of it, that at 9.30, our NPAs were 34 basis points with reserves to loans in excess of 2%. And our loan loss provision, even though it was decreased a little bit in the third quarter, we actually took a more conservative approach by having 100% emphasis on on the base case scenario of Moody's, and we believe conservatism is relevant and very important in this kind of an environment. We could have justified having no reserve this quarter, but we chose to be more conservative. Our commercial criticized loans were only 2.5% of total loans, and our deferrals, which Andy will talk about, are significantly improved, and they were only 2.6%. From a loan portfolio point of view, we are continuing to improve our franchise and enhancing and having a little bit of a different composition of our loan portfolio with more diversification. Loans and leases excluding PPP increased 1.4 billion. CNI loans over the year grew by 23%. or over $400 million. And as part of our strategy, we continue to decrease the multifamily loan balances. However, they will stabilize at sort of these kind of levels. We are really, really proud to report to you our improvement in franchise value by the quality of our deposits. Our demand deposits were up 71%, and non-inclusivating demand makes up 21% of our total deposits. From a capital point of view, our bank capital ratios are expected to grow very meaningfully over the next two to three quarters. And still at 9.30, the CEP1 was a little over 10%. The total risk-based capital was over 11.5, and our tier one leverage was a little over 9%. Our tangible book value at 9.30, as you know, was about $26.00. And our tangible equity is over $100 billion because we were successful over the last few years to raise preferred equity in a very opportunistic way. And when you add our common and our preferred, we are well over $1 billion in tangible equity. And we are trading at about 43% of the September 30th book value and only at about four times 2021. and 2021 earnings if you look at slide nine talking about capital We have hit the low point of our capital, which is actually very interestingly, we did this because it is going to position us for a slingshot effect on growth of capital over the next few quarters. Our participation in the Paycheck Protection Program is going to add very significant value for our shareholders and the tangible common equity ratio is deflated right now, primarily due to the temporarily large balances tied to PPP loans, as well as temporarily inflated warehouse loans to mortgage companies. And we expect the loans to mortgage companies to be down over $1 billion within the next two to three months. And that will materially improve our capital ratios. Our TCE ratio to total assets is expected to be about 8%, and our total capital ratio organically by the end of 2021 is expected to be about 14%. And the TCE ratio, excluding TPG loans, is expected to actually reach about 7%. by the end of fourth quarter 2020, and that's up from a low of just under 6% at September 30th, 2020. And moving on to slide 10, like I mentioned, maintaining strong credit quality remains a priority for customers, Bancorp. And at this time, I'd like to, I'm so pleased to reintroduce to you Andy Bowman, our Chief Credit Officer, a colleague of ours for the last about 10 years, very, very experienced in the business, to go over some of the credit metrics with you. Andy?

All right. Thank you, Jack. Good morning, everyone. I'd like to take a few minutes and share with you some slides evidencing our continued strong credit performance and continued commitment to overall sound credit quality throughout the organization. As outlined on slide 10, our credit quality remains strong, and we feel very good about how our portfolio is holding up against the many economic, social, and political pressures brought about by COVID-19. As Jay has already mentioned, our MPAs have decreased to only 34 basis points, mainly due to the successful sale of a large Class A commercial office building NPA in the third quarter, and at this time, we do not see any significant NPA increases moving forward. In addition, we continue to aggressively move for the dissolution of our sole remaining large NPA of approximately $18 million and hope to have the matter resolved by the end of the first quarter of 2021. Although we are extremely pleased with our NPA performance, we've opted, as Jay has mentioned, to retain a strong reserve position given the continued uncertainties associated with the social and economic impacts of COVID-19 and the political landscape. And this is a perfect transition moving on to slide 11. Slide 11 outlines our CECL and reserve build. which is 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 takes into account actual charge-off rates and the level of non-performing assets. with the end result for Q3 being a reserve of nearly $155.6 million, or just over 2% of loans held for sale. This equates to an approximate 245 coverage of non-performing loans. And we are confident that with this level of reserves, we're well positioned to deal with the residual effects of COVID-19 moving into 2021. Moving on to slide 12. The bank's criticized and classified loan levels remain modest and have remained fairly consistent over the past four quarters, standing at 2.56%, excluding PPP loans as of quarter end. We're expecting some modest increases in our criticized and classified numbers moving forward, primarily due to the bank's conservative approach in rating any deferrals under Section 4013 of the CARES Act as criticized and classified assets. Although this is a fairly conservative approach, it is one we feel strongly about as it accurately depicts the higher level of risk associated with such a deferment and allows us to factor into our season reserve calculations, said deferrals, and the elevated level of risk associated therewith. More importantly, we continue to carefully assess or criticize and classify assets on an ongoing basis, and at this time, we do not see any real level of migration into a non-performing status. Transition to slide 13. Overall, we have witnessed a steady decline, as Jay has mentioned, in deferment rates from a peak of almost $1.2 billion, gradually declining to $750.5 million as of July 24th, and declining even further to $302 million, or only 2.6% as of third quarter end. We have seen steady declines in virtually all loan and industry classifications, with the sole exception being within our commercial finance group's motor coach portfolio, but that does only consist of a total aggregate portfolio of only $37 million, which in retrospect is only a minor component of the overall bank's portfolio. When looking at the individual commercial portfolios, it's important to note that 36% of the C&I deferrals were principal only, and 93% of the investment-free and multifamily deferrals were principal only. And more importantly, 53% of our hospitality deferrals, once again, are principal only. Overall, when looking at total commercial deferrals, approximately 61% of all of our commercial deferrals were principal only before it was continued to pay interest. In addition to the great progress we've made within our commercial portfolio, all three of our consumer lines have posted significant declines in deferment over the past months as well. Moving forward, we look for continued declining deferments within both our commercial and consumer portfolios. Moving to slide 14. I firmly believe, and we all believe as an organization, that the diversification of our commercial loan portfolio positioned us well moving into COVID-19. as significant portions representing lending activity to industries that have not been significantly impacted or impacted at all, such as mortgage warehouse lending, specialty finance, lender financing, as well as significant portions of our C&I and owner-occupied free portfolios, such as manufacturers, wholesalers, and service companies and professionals. This slide outlines our exposure to industries identified as at-risk due to COVID-19, and the good news being that these industries equate to only 5.8% of our total loan book at quarter end. The bank's greatest at-risk exposure is that of the hospitality industry, which at quarter end, we had $404 million in aggregate exposure, but comprised only 3.5% of the bank's total loan portfolio. With $126 million in deferment, or 31.3%, but again, as I outlined on slide 13, 53% of those deferrals were principal only. And other than hospitality, the bank remains very little exposure to at-risk industries, such as energy utilities, colleges, universities, retail sales, dining and entertainment. And we have no active deferments at this time in these industry segments. Sticking with the hospitality industry and moving on to slide 15, we deem it appropriate to share with you some key characteristics around our hospitality portfolio and why we are bullish as to its ability to further weather the pandemic. First, nearly 19% or roughly 82 million are operating at 95 or greater capacity under government contracts for transitional housing. Another 18 percent, or roughly 76 million, are comprised of high-end destination hotels located predominantly in Cape May, New Jersey, Avalon, New Jersey, and Long Island, New York, and operated at near capacity levels throughout the summer and possess ample liquidity to continue to support operations. Seventy-four percent, or roughly 318 million, is supported by some form of personal recourse under guarantee agreements, And finally, approximately 81%, or roughly $349 million, represent flagged facilities, with the majority of the non-flagged facilities being the destination hotels I noted previously. Again, as noted on slide 13, the hospitality deferrals have continued to climb, and 53% of those deferrals are principal only deferrals. In addition to client deferment, we've also seen gradually improving occupancy rates, and I'm happy to report that no hospitality loans transitioned to non-performing status in the third quarter of this year. Slide 16, although not deemed an at-risk industry segment, there has been considerable focus around the performance of healthcare loans throughout this pandemic, We wanted to share with you that our healthcare portfolio, which equates to approximately $310 million, has performed very well, with no requested deferred payments and no delinquencies. At this time, the portfolio encompasses approximately 5,500 beds and is geographically dispersed, with the majority being in New York, New Jersey, and Pennsylvania markets, given the bank's traditional trade area. Although the insurance payer mix is both private and government, the majority is comprised of Medicaid and Medicare, which both increased reimbursement rates to help skilled nursing centers offset the increased costs associated with COVID-19 pandemic, such as PPE needs, staffing needs, and decreased occupancy rates. Finally, the portfolio is predominantly real estate secured, with the majority of loans backed by personal guarantees. Moving on to slide 17, very similar to slide 16, we also thought it proved to share some key characteristics around our multifamily and investment-free portfolios. As evidenced on this slide, the bank has gradually moved to reduce its overall multifamily and investment-free exposure over the past few years, and this trend continued throughout 2020. The decision to reduce its exposure was driven by desire to create a more balanced credit portfolio. And overall, the portfolio has performed well, mainly due to the use of conservative underwriting standards, as evidenced by low LTV, in-place conservative debt service coverage ratios, and the financing of assets housed in historically strong urban settings, such as New York and Philadelphia. The portfolios are well-seasoned, with an average weighted light since origination of three and a half years, and from a multifamily perspective, are centered around historically less volatile workforce housing. Again, deferments have steadily decreased as collection rates have improved, and based upon current trends, deferments in this portfolio should continue to decline. And overall, the portfolio is predominantly comprised of satisfactory, well-stabilized properties owned and managed by experienced professionals, and we have very little construction exposure. That said, despite the impact the pandemic has had on urban areas, we are pleased to share with you how well our New York City and Philadelphia multi-family portfolios have performed, and we feel this is indicative of our strong underwriting process and focus on only doing business with seasoned and highly experienced owners and operators. And wrapping up my side of the presentation and moving on to slide 18, On this slide, we've laid out some key statistics within our banking to mortgage company's portfolio, which was extremely robust in the third quarter, as evidenced by the approximate 55% book increase year over year, with the volume increase coming from both refinance and purchase activity, given the current rate environment. It's also worth mentioning that this line of business has a fairly low credit risk profile, given the relatively minimal hold period of, on average, 20 days, a sub-100% financing rate versus traditional market sale rates of between 102% and 105%, and on average, 90% to 95% of the loans are deemed conventional and thus Fannie, Freddie, or Ginny eligible. Overall, we are extremely pleased with our performance in this line of business and are anticipating some decline in volume in the fourth quarter and into 21 due to seasonal runoff and a slowdown in refinance activity and the introduction of the adverse market fee at 50 basis points by Fannie and Freddie beginning December 1st of this year, which will impact the refinance business. In closing, I'd like to thank you for your time this morning, and at this time, I'll be turning the presentation over to Sam Studeau, our Vice Chairman and Chief Operating Officer.

Sam, the floor is yours. Thanks, Andy. Good morning, everyone. Beginning with slide 19, we wanted to take an opportunity to continue to update you on previously disclosed information on our consumer installment portfolio. As discussed, we have a very highly diversified portfolio with over a 740 average FICO, no subprime loans, a 21% debt-to-income ratio, and over $100,000 in borrower income. Flipping to slide 20, here you will see that our CD direct and CD marketplace lender portfolios continue to remain strong and perform materially better than the industry. At peak, our portfolio has remained less than half of the industry average and CB Direct loans are approximately 70% below the industry average. As Andy referenced earlier, our installment loan COVID deferrals were down to 1.2% at quarter end and since then have dropped further to 1% as of last week. Our CB Direct forbearance is now down to just nine basis points with 30-day-plus delinquencies at only 60 basis points. Both of these numbers are on top of where we were at the end of February pre-pandemic. Finally, charge-offs are trending approximately 40% better in the portfolio than we had projected year-to-date, at only $21.4 million versus about $35 million, which, as you can appreciate, is significantly less than our 6.5% CECL reserve. As you can see, we continue to be very pleased with overall portfolio performance, and the data-driven approach to onboarding new customers and portfolios to the bank has proven to be industry leading and franchise enhancing. Moving to slide 21, we highlight one of our biggest achievements over the past one to two years, which has been the improvement in our deposit mix. We are and will continue to be less reliant on borrowings going forward than we have been historically, although this may not be fully apparent today due to the PPP liquidity facility. Our borrowings-to-asset ratio should settle in the mid-to-high single-digit range of PPP paydowns, which is a fraction of our historic levels. And finally, our cost of deposits has dropped further to 67 basis points. versus 1.82 percent in the year-ago quarter and is expected to continue to drop further in the coming quarters initially assisted by approximately 500 million dollars of cds maturing in the fourth quarter which we would expect to reprice with at least 100 basis point reduction moving to outlook on slide 23 We will continue to focus on building franchise value by leaning into and expanding our community banking strategy using our single point of contact, high touch supported by high tech model. We expect approximately 7% to 10% overall CNI loan growth, led by approximately 10% plus in our national low risk businesses. SBA Lending, 7A Lending, which is a hybrid national and community banking business assisted by the government guarantee, is a business line that we love and given the adoption of technology and experience of working with the PPP program, we expect this low-risk business line to grow by approximately 50% or more in 2021. Additionally, we expect multifamily to manage to about a $1.5 billion balance, and as Jay mentioned, loans to mortgage companies between a $2 to $2.5 billion balance in 2021. Moving to slide 23, this slide reinforces our fintech and technology-related priorities. Customers Bank has strong and agile technological capabilities, and our team has helped create a digital banking platform that we have augmented with a fintech partner ecosystem. From a digital lending perspective, we are expanding on our direct consumer installment lending strategy by adding new product lines there, as well as expanding into commercial lending in 2021. Our PPP efforts have shown us that small, medium-sized businesses around the country are being underserved, and we're working on advancing our proprietary platforms to develop an industry-leading digital lending platform to serve them. Our first expected material commercial launch will be with a digital front end to augment our robust in-house 7 lending business, where we have already built a reputation for expedited processing. We will achieve this through the use of a smart credit box and scoring model, along with workflow automation and processing. With that, I'll pass it on to Carla to discuss her financial guidance.

Thanks, Sam, and good morning, everyone. Moving on to the financial guidance on slide 25, we believe we are well positioned to execute on our 2020, 2021, and 2026 objectives. Loan growth, excluding PPP and mortgage warehouse balances, are expected to average in the mid to high single digits over the next several quarters. Total assets are projected to be between 12 and 13 billion at year-end 2020, excluding the PPP loans and subject to refinance activity impacting our loans to mortgage companies. Our total risk-based capital ratio is expected to exceed 12% by year-end 2020 and to be around 14% by year-end 2021. Our preferred equities will not be called in 2020 or 2021. We project the MIM to be in the 290 to 3% range for the full year 2020, excluding PPP loans. And operating expenses are expected to be flat to up moderately over the next few quarters, excluding the impact of the bank mobile divestiture. We will maintain discipline in controlling our operating expenses while continuing to invest in the future, improving positive operating leverage. The effective tax rate is forecast to be between 20% and 21% for 2020. Our PPP revenues are on target, and the program is expected to earn about $100 million in pre-tax origination fees. A run rate of $3 in core EPS is expected for 2020, and 2021, and we're still on track for $6 in core EPS for 2026. Our 2020 NIM expansion and profitability targets will be achieved by maintaining or improving asset quality, even in stress periods, reducing future allowance for credit losses, provision expenses. On the asset side, measured growth while focusing on maintaining or increasing asset yields, disciplined pricing on new originations of high credit quality loans, also protecting spreads by building into floors. And on the deposit side, we will continue to grow core deposits and continue to experience repricing in 2020. Beginning in the third quarter of 2020, our digital ascents Deposits repriced down in excess of 100 basis points. We have 466 million of CDs that mature in the fourth quarter of 2020 and are expected to reprice down significantly. And our goal remains to bring down the total cost of deposits to less than 50 basis points in the near future. Lastly, on slide 26, we wanted to provide a path to the core EPS target of $6 by 2026. Assuming a position of $12 to $13 billion in assets and 31.7 million diluted shares outstanding by the end of this year, we've assumed a growth assumption of 7% to 10% per year on average through 2026, a 1% per annum increase in diluted shares and a return on average assets between 1 and 1.10%. And you can see that that would generate about $200 million in net income or $6 in core EPS, which we believe is a significant value proposition. And with that, I'll turn it back over to you, Jed.

Thank you. Thank you very much, Carla. Before we open it up for Q&A, I'd like to touch very briefly on Viewpoints. Number one is we are in some negotiations with very attractive teams that we expect to onboard in the next few months. Some of them are related to some bonuses that they will be taking from their previous employer. So we see this as a very, very opportunistic time to attract tremendous talent to support the execution of our strategies. And so look for that news coming from us over the next few months. Number two is we touched on digitization of the bank. And if you have any questions, Jim Collins, our Chief Administrative Officer, would be happy to discuss that with you. And that has been a very significant effort. It's not just new. It's been going on for a while. And we have been expensing and investing towards achievement of our objectives in that area. And we have also combined that now with a zero-based budgeting initiative that's going on throughout the company. And that's why we are very hopeful that we'll be able to moderate the core expense growth, excluding bank mobile technology-related expenses and we should still be able to add and absorb the additional incremental expenses for revenue generators that we are attracting. From a credit quality point of view, I couldn't agree more with Andy that the strength of our company is credit quality. And you should not expect any surprises based upon what we see today. And it's our very data-driven analytical analysis, bottoms-up, and stress testing that we do at the loan level, as well as stress testing from a COVID impact point of view. of the entire portfolio, and we are very confident about the quality of our assets. The next item is on bank mobile technologies, and bank mobile technologies, as we stated, is on target, and it's expected to close that divestiture sometime in quarter, fourth quarter. We have no intentions of owning any any equity or having any influence in bank mobile technologies at all over an extended period of time at all. And it is being developed by us and supported by us to be a totally independent company, totally independent of customers' Bancorp with no influence whatsoever by customers' Bancorp and an entity and an organization that continues to support the underbanked as well as other opportunities, tremendous opportunities that they see going forward. And we believe this will add significant value for our shareholders over a longer period of time. And the last item I'd like to touch base on is stock buybacks. before we open it up for questions and answers. As you can well imagine, there is not a significant opportunity for us in the very near future to think about stock buybacks But our board of directors, as well as the management, is looking at various opportunities. If the environment and if the market continues to not value customers' Bancorp stock at the appropriate peer level, we are working on scenarios to shrink the company and have massive stock buybacks. so that the appropriate valuation of the company is being reflected into the value of the organization. We believe that the company should be valued at peer level, and we are not looking at above peer levels. And that's why when Carla shared with you our 2026 core EPS targets, as well as our 2020 and 2021 targets, as well as the improvement in our capital ratios, we believe every option is on the table for us to take steps to increase our shareholder value, including buying stock back at significant discount to tangible book. So with that, Raquel, I'd like to request you to open it up for questions and answers.

As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. Please stand by while we compile the Q&A roster. Our first question comes from the line of Steve Moss with B Reilly Securities.

I just think we could start with the PPP applications. Kind of curious here as to what level of forgiveness applications you've seen and just kind of how you think about that process.

Hey, good morning, Steve. This is Sam. I'd be happy to take that. So as you can appreciate, there have been some delays from the SBA's perspective from forgiveness acceptance, as well as from Congress's perspective from putting out a potential blanket forgiveness for smaller loan sizes. So our projection that we had shared previous quarter still holds is that we expect approximately 90% of loans to be forgiven, approximately 95% of our loans and about half of our loan balances. are below $150,000. And as Jay mentioned, we would expect, given where we are at the end of the year and with the election coming up, that the forgiveness will likely be a first half, more likely a Q1, hopefully, event.

Okay. So just in terms of applications being processed at the current time, it's pretty minimal?

It's minimal, yeah. It's less than 5% of our overall loans, which were north of $100,000.

Okay, that's helpful. And then in terms of just on the mortgage warehouse, I mean, EOP never was big, but the average balance was pretty good as well. Just kind of curious, what was the percentage that was funding the refis and kind of how – How are you guys thinking about those balances in 2021? I think you guys are planning on coming down probably after the first half of 2021.

Yeah, Steve, it'll be, like you mentioned, it's about 65% key buy activity right now and 45%, uh, uh purchase activity you know we are uh we have been in this business committed to be in this business so this business is generating over 20 percent uh compensating non-infrastrating deposit balances for us and as we shared with you it's over three million dollars in non-interest income uh this past quarter for us this is a core franchise business But it's a seasonal business. And so we think it'll be likely we give you the guidance between two to two and a half billion dollars in that range for next year.

Okay. That's helpful. And then in terms of the consumer loans, you know, balances down a touch, reserves maybe flack up a little bit here. Just kind of curious as to, you know, do you just continue to expect those balances to remain more or less steady? for the next several quarters?

Yes, so I think that we have managed to approximately flat. We have been originating direct north of $40 million a month, on average about $120 million a quarter, in addition to some small flow arrangements that we still have with some of our marketplace funders. um so you know we have experienced uh you know faster than expected payoffs in 2020 so um i would anticipate that we would you know continue to originate the pace that we've been originating and that we would slightly um you know increase and and resume growth of the portfolio okay

Go ahead, Jack. Sorry, Steve. And Steve, like we've shared with you, we do not envision this portfolio to be greater than 50% to 20%. And that will be over a period of time. And that will be very, very, you know, Detailed review will be conducted to make sure that the credit quality remains as strong as possible. We think this is a business which banks have totally given up to the marketplace lenders other than credit cards remaining pretty much in the banking space. And so we are very selectively looking at how do we do direct originations and how do we sell digitally deposit services to all of these consumer loan customers.

Okay. And just as we think about reserves, you know, with charge-offs trending better than you guys had modeled, you know, what's the potential for reserve releases in upcoming quarters here?

At this point in time, go ahead, Jay. Okay, sorry. I think we mentioned, Carla and Andy and I mentioned our posture to be conservative and reserving, and we cannot comment on future reserve levels, but you can imagine that a conservative approach in these uncertain times is prudent. And we will still be monitoring and using the Moody's analytical model to determine our future reserving. But we are reserving at levels which are greater than what Moody's models would show. And that was all based upon taking a conservative course. qualitative adjustment to it. So we do not envision that there would be higher reserves for consumer loans. If anything, your guess is as good as ours that there could be some releases in the future.

All right. Thank you very much. I appreciate all the color.

Our next question comes from the line of Michael Perito with KBW.

Hey, Jay. Good morning. How's everybody?

Good morning. Great. Yourself? I grew up in the family and I was a little baby.

He's doing well. He's grown pretty quick. So let's just try to stay alive over here. Thanks for the time. I had a couple questions. I wanted to start actually following up on some of your last few comments there, Jay, regarding kind of shrinking the balance sheet and buying back. And I was wondering if maybe we could spend a minute just to kind of get in your heads a little bit more. I mean, obviously, you know, Sam, you mentioned kind of the growth expectations and guidance, but I guess as we try to understand, you know, how you guys are thinking about it. It would seem like maybe if the valuation doesn't improve, you guys would be willing to kind of walk back those loan growth guidances to shrink the balance sheet and build capital and buy back stock. Is that kind of the right way to capture what you guys are trying to emulate?

Yeah, that is obviously – Mike, a scenario and, you know, you can imagine that one can take an approach of temporarily, you know, shrinking your balance sheet and freeing up the capital and buying back the stock till we are trading above tangible book value or at peer levels. And that could be a very prudent strategy on our part. And we have enough opportunities and our balance sheet is very liquid to be able to pull that off. But in the core businesses of CNI lending, franchise lending, we do not envision touching those. And so the growth opportunities that exist over there, recruitment of teams to continue to improve our franchise value, we think that just Creating value by buying back stock is temporary, but if you can do it in a way that you continue to improve your franchise value, continue to improve the quality of your deposits, continue to improve the kind of customers you have, continue to create the digitization and effort that we are on, combine it all, it can really build franchise value. That is one of the reasons why we decided to keep the technology of bank mobile technologies for use by us and let bank mobile be a totally independent company with no influence by us at all so that they can grow, but at the same time, we can use that technology in ways that can benefit our shareholders.

Thanks, Jay. And I would just add, Mike, to wrap a bow around it, our base case is to proceed along the asset generation growth levels that I walked through. Our second option is, you know, and the hope would be that we return to market multiples. You know, second option would be, you know, sort of a moderate stock buyback in the sort of mid next year. And then in the event that we don't have a convergence to market multiples, then I think that the third option would be on the table.

Okay. That's helpful insight. Thank you. And then as we think about, Sam, some of the things you talked about on slide one, 23 here, which was helpful, some of the growth things that you guys are looking at. I was wondering if maybe you could spend another minute on two things for me here, just one on the niche businesses. I know you guys have talked about some of these in the past, but I was wondering if you could maybe just rehash a bit more specifically what two or three of the bigger growth opportunities there are and what those credits kind of look like that you guys are taking advantage of. And then secondly, on the SBA side, I feel like historically that business was very asset-oriented for most banks, but it seems like now with the digital movement, there's more of an opportunity to maybe capture some of the liabilities of these smaller businesses and to be able to service them more effectively without actually being close by. And I guess, how do you kind of see the liability opportunity from the SBA build-out in terms of the impact on your deposit base?

Sure, absolutely. So starting with the niche businesses, you know, our specialty lending lender finance business is the largest component of that. It's an approximately billion dollar business for us today. And that will be driving, you know, majority of the growth at the business that is predominantly at approximately 65% advance rates on a pool of collateral with collateral swaps in the event that there's ever an issue. And as we've modeled it out, you'd have to be at a recession multiple times as big as a great recession to ever experience a dollar of loss. So that's the biggest component of our specialty niche businesses. The healthcare business, I think Andy already walked through earlier today. And then lastly, from our commercial finance business, which is our equipment finance business, that business is expected to grow about 10% to 15%. Again, a business that has experienced, an industry that generally experiences very low loss rates, and our business has experienced essentially zero loss. you know, losses to date. You know, again, to address your question on the SBA side, you know, absolutely. Our existing business today, you know, really, you know, would be without the existence of our strong in-house SBA 7A lending team, we would not have been able to pivot so quickly to take advantage of the PPP efforts that we had a huge success in. um that that business currently um you know is a direct business with videos nationally around the country and they they do bring on deposits a typical video brings in about you know 10 million or so a year and we have approximately 10 videos so it's approximately about 120 million dollars a year those businesses are great they come with deposits and now we're expanding that into more of a higher volume that lower ticket size, less bespoke. more down the middle using technology to originate as well as to process. That will give us a higher volume, not so dissimilar to our PPP efforts, higher volume, lower ticket size, but rich in sort of initial deposits. But from a medium to long-term perspective, those are potentially very valuable customers to the franchise in addition to being profitable customers up front, especially with the SBA guarantee. Hopefully that answers your question.

Yeah, no, that's really helpful. Thank you. And then, you know, just lastly here on the expense side of the equation, Actually, I want to backtrack a little bit and ask something different. On the loan growth, the 7% to 10%, obviously the margin and the balance sheet have some kind of other items that are going to impact it near term with PPP and excess liquidity in the elevated and worked warehouse, et cetera. But just as we try to get to a more normalized view and run rate for for maybe the middle of next year and beyond and we think about kind of the incremental loan yields that you guys are getting on some of those those portfolios that we just discussed can you maybe provide a little bit more color on on where some of the origination yields are on these portfolios today and and how you expect them to kind of trend um or do they seem like they're pretty stable or their room maybe for competition increase in some of these or risk asset classes that are growing and they could compress or how are you guys thinking about that dynamic today

Hey, Mike, this is Carla. I can add some commentary on that. So just broadly for 2020-21, we are expecting a stable margin from where we are going to be from 2020. From a low-meal perspective, what we're seeing right now on average coming on is between the 3.5 to 3.75 range, and we are expecting to continue to have some repricing downward on the deposit side. We do not anticipate any margin contraction next year.

Okay. Helpful. Thank you guys for taking my questions. Appreciate it.

Our next question comes from the line of Russell Gunther with DA Davidson.

Hi. Good morning, guys.

Good morning, Russell. How are you?

I'm fine. Thanks, Jay. I hope you guys are all well. I did have a question on the expense side of things. Carla, I heard the guide for flat to up in the near term. Could you just clarify the comment around what that considers for bank mobile? That's X all bank mobile expenses, or is there a different interpretation?

Yeah, so that does not include any bank mobile related expenses as part of the divestiture transaction. And just to give some comments on that, some forward looking, we are expecting 2021 to get into that efficiency ratio around the low 50s. We're going to stay focused on controlling our expenses. That said, if we see opportunity for revenue growth, we will invest, and we are spending some time investing in our digital transformation efforts, if that's helpful.

No, it's very helpful. I appreciate the clarification there. And then, you know, you mentioned, obviously, it's a branch-like model at customers, and you mentioned still able to, you know, tighten that up a little bit, about 20%, but Given the tougher revenue environment and some of the franchise investment you just mentioned, Carla, are there potential other offsets within the legacy customer business model from an expense perspective? Just give us a sense for what those might be to get that low of 50 deficiency ratio target achieved.

Yeah, we're really not going into that level of detail at this point in time, just managing to be flat to moderately increasing expenses and staying within that low 50s efficiency ratio.

Okay. I think, Russell, I'd like to add to that, and I completely agree with Carla, that rather than line by line, but the zero-based budgeting initiative that we shared with you about, as well as the digitization of the bank and looking at every single process, and you using technology uh in every single area of the company i'll just give you an example uh you know we are incorporating technology into our credit approval credit administration portfolio management interaction with our borrowers that we will free up extensive amount of time for our private bankers our relationship bankers and in portfolio management And that is something which will be operational by the end of this year and also will give us a huge improvement in our overall franchise where our measurement of success is the customer should say, wow. And that is the way we are measuring that, not just for expense reduction. But if you can have improvement in productivity and improvement in customer service, It is an absolute winner. And we think that the banks have not changed their credit administration, credit approval, and portfolio management processes over the last 25 to 30 years. And technology can today really help you big time. We are using similar approaches throughout the company. That is why we are saying, a moderate growth because the traction of the teams is bound to be expensive for us in the beginning. But it is something which we will spend money on, and no question about it, and we are very focused on positive operating leverage.

I got it. Okay. Thank you, Jay. Thanks, Carla. And then just switching gears with a final question, you know, to the extent you're able, could you share, you know, where those – What type of teams you've gone after? What lending verticals? What geographic concentration? Any insight into where you're bolstering the bank going forward with some team lift-ups?

I think they are to support what Sam shared with you on our strategic initiatives. And so it's really not entering into any significantly new verticals. We're just looking at one very low-risk vertical, which it's premature for me to talk about that. But otherwise, it's really building on our so-called community banking and our niche business model. And it's recruiting very, very successful experienced teams who can help us continue to propel the growth that we've experienced in those niches. and and i think we think that within the next 60 days you'll start to see us put press releases out on those teams and you will be very impressed with what we are attracting we think there is a lot of disruption taking place in the marketplace right now every single bank is trying to to really uh uh you know found their chest on cost reductions. And they're taking an eye off of taking care of and retaining some of their high producers. And we believe that opportunity to recruit talent in this kind of a remote working environment and using our equity-based compensation plan as well as our team-based compensation plan is very attractive to really build a very strong franchise. So we are very upbeat. Yesterday, in fact, our entire board and top management team were involved in a planning session, and it was wonderful for the board to hear from the entrepreneurial as well as risk-related colleagues of ours present to the board their plans.

Thanks for your thoughts there, guys. That's it for me. I appreciate it.

Your next question comes from the line of Frank Chiraldi with Piper Sandler.

Hello, morning. Hey, Jerry. How are you? Great. Thank you. Just want to ask you about your expectations on capital. You've got some really nice levers here to create capital levels. And then, you know, obviously there can be opportunities on the growth side, but then you also talked about maybe you know, potential for shrinking and buying back stock. Just wondering, as we think about those potentials, you know, what is the right sort of level in your mind now to operate the company at? You've talked about getting to that 8% PCE. Are you focused on staying at those levels, or, you know, could we see the company dip back down?

No, I think capital is king, and capital has always been very, very important. For us, but at the same time, capital has to be adjusted to the kind of risk profile of the company, as well as your short-term and long-term strategy of the company. Our minimum acceptable standards for us, which we are somewhat below that for this quarter, is a 7% TCE. And we are hopeful of picking it up to seven and a half before we look at seriously stock buyback option. And then we've done, as Sam and I shared with you, different scenarios. And all of those make an assumption of maintaining the TCE levels where they are. For whatever reason, in the regional banking, community banking sector, small cap banks, preferred equity has not been given the kind of credit that the larger banks have been given. But we believe with a lot of the smaller regional banks following the route that we followed and building up their preferred equity, that they are getting their credit for that. And so when you add a seven and a half TCE plus, you look at one or two percentage of capital over that through preferred equity, which we've decided in this low rate environment to definitely keep because it's very low cost capital for us. It's lower than what banks are raising their preferred equity at right now. We think it gives us a lot of opportunities. In terms of which preference we would have, we would We are a growth company, and a growth company with a strong emphasis on risk management. Our preference would be to continue to be a moderately growing company, and this can cautiously growing the company. we will not accept 43% tangible common equity. I'm sorry, 43% to tangible book value, and that is leaving 55% minimum appreciation from a valuation point of view on the table. We think our peer group is trading at somewhere in the 90 to 110% of tangible books, and we are not going to be satisfied until we get there. And we will get there one way or another.

Okay, fair enough. And then just on expenses, just following up on the idea of sort of flattish expense growth, as you continue to build out the banking as a service business, Is there meaningful expense linked to compliance and back office function, and then that has to be, you know, offset elsewhere, or is that expense already baked in, you know, for significant growth here?

I'll take that, Frank. Yep. You know, from our existing expense level, we materially have all of those resources in-house already.

Gotcha. Okay. Okay.

And I would add, you know, just, Frank, on your question on capital, you know, our regulatory capital is going to strengthen significantly regardless of whether we buy back or not.

No, understood. Thank you. Thank you.

I will now turn the call over to David Paddy for our web questions.

Thanks, Raquel. And let me remind everyone who's on the webcast, there's still time to submit a question if you'd like to do so through the function there on your screen. Our first question, I'm going to combine two from Daniel Grossman of Dan Liz Corporation on PPP. He asked in two parts, first, of the $100 million in PP origination fees, how much was recognized as income in the third quarter, and how will the remainder of that origination fee income be recognized in the next four or five quarters? While you're thinking about that, let me also add that Daniel would love to have some information on our attempts to seek deposits from the PPP borrowers and transition them to permanent customers of Customers Bank, people who would now be a part of our Customers Bank family. And he's wondering how that's going and how much of those deposits we think we'll retain. I'll turn it over to the panel for a response.

Sam, do you want to take that on? Sure, Carla. I'll start with the deposits. Then if you could sort of share the specific numbers on PPP in the last quarter. So from a deposit perspective, we have had a good success over the past couple of quarters. As you can appreciate, we have multiple touch points with the PPP borrowers as it's related to the length of time as well as the changes and delays in forgiveness. So any deposits that we brought in to date, we expect to remain with the bank. And I would further add that many of these borrowers, as you can appreciate, given the small loan size, were holding a bated breath, waiting for an additional PPP round. And as such, we think that the nearest opportunity with these borrowers, frankly, is going to be on the SBA side, regardless of whether there is another stimulus targeted to one of the small and medium-sized businesses.

And I'll just add the commentary on the PPP interest income. Regarding the deferred origination fees, we recorded about $12 million in the third quarter. The remaining will be recognized over the estimated life of the PPP loans. However, it will be accelerated upon forgiveness. We are anticipating that About 90% of these loans will be forgiven in the first half of 2021, and that's what's creating the significant accretion to our capital level. In the third quarter, we also recognized interest income. They earn about 1% on those loan balances. So all in, the interest income was probably around $25 million.

Thanks, Carla. And I would just add, you know, just from a NIM perspective to one of the earlier questions, you know, given the 1%, you know, interest rate on the PPP loans, you know, to clarify our PPP, our NIM ex PPP was 2.86% in the third quarter. And we want to take this opportunity to reiterate our guidance of 2.9 to 3% NIM. And as Carla mentioned earlier, you know, we expect to be in that range with a slight positive bias.

Thanks, Sam and Carl. Mr. Gressman has another question on a different topic. Let me read that to you. Please explain why your 2021 projections of $3 per share use core rather than gap earnings. It also seems to be used by Yahoo Finance, et cetera, and analyst estimates.

I'll just start off, and please help me by pulling up anything on this. The main thing is, like you know, we remain opportunistic to try to take advantage of market disruptions for security gains and those kind of things. And as an example, the $10 million of security gains was totally created by management being opportunistic and buying some securities back in the end of March, early April. And that is something management gets paid for in looking at ways to improve our capital and improve our earnings. But the street right police, in our opinion, does not recognize that as recurring earnings. So most of the time in the banking industry, core earnings are something which you can count on. And it's pretty much, generally speaking, recurring earnings. And that is the reason why we use those kind of words so that you can look at sustainability of those earnings and you can count on valuations of our stock price as a multiple of core earnings.

Okay. Any other response from our panel to that question? If not, Raquel, I have no one further in the web queue. I see no one on your telephone queue.

Therefore, at day to do, the floor is yours for any closing remarks.

Thanks, Raquel, and thank you so much, everybody, for joining us today. We really appreciate your interest in Customers Bancorp, and we look forward to staying in touch with you. Thank you, and have a good day. Stay safe, please.

Thank you, ladies and gentlemen. This concludes today's conference call. Thank you for participating. You may now disconnect. Presenters, please remain online.