Customers Bancorp, Inc

Ladies and gentlemen, thank you for standing by. My name is Brent and I will be your conference operator today. At this time, I would like to welcome everyone to the Customers Bank Corp third quarter 2022 earnings call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question at that time, simply press star followed by the number one on your telephone keypad. If you would like to withdraw your question, Again, press star 1. Thank you. It is now my pleasure to turn today's call over to Mr. David Patti. Sir, please go ahead.

Thank you, Brent, and good morning, everyone. Thank you for joining us for the Customer Bank Corp earnings call for the third quarter of 2022. The presentation deck you will see during today's webcast has been posted on the investor relations page of the bank's website at customersbank.com. You can scroll to Q3 22 results and click download presentation. You can also download a PDF of the full press release at that spot. Our investor presentation includes important details that we will walk through on this morning's webcast. I encourage you to download and use the document. 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 Form 10-K and 10-Q, for a more detailed description of the risk factors that may affect our results. Copies may be obtained from the SEC or by visiting the Investor Relations section of our website. At this time, it's my pleasure to introduce Customers Bank Corps Chair, Jay Sidhu.

Jay, the audience is yours. Thank you, David, and good morning, ladies and gentlemen. It's really a pleasure to welcome you to our third quarter 2022 earnings call. Joining me here today from Malvern, Pennsylvania, the new headquarters of Customers Bank are Sam Sidhu, a president of our holding company, as well as the CEO of our Customers Bank subsidiary, Carla Leibold, our chief financial officer, and Andy Bowman, our chief credit officer. As you can see on slide three, Customers Bank is a digital-focused super community bank with diversified niches, several with a nationwide footprint, that supplements our community banking business platforms located in Rhode Island, New York, Pennsylvania, North Carolina, and Florida. We operate our $20 billion asset bank with only 672 team members. working out of 39 private banking offices or loan production offices located across many states, from Portsmouth, New Hampshire, to Boston, to New York, to Greater Philadelphia, and then on to Wilmington, North Carolina, in Florida, as well as Dallas, Texas. We are pleased this morning to present to you another solid quarter, despite the challenging interest rate and economic environment. We remain laser-focused on our responsible organic growth strategy and have taken prudent risk management strategic actions over the past several quarters to ensure that we are well positioned from a capital, credit, liquidity, and earnings perspective in this challenging environment. We are also pleased to report that we have already beaten our 2022 core earnings per share guidance, excluding PPP, of between $4.75 to $5 in earnings per share for 2022. Our Q3 core earnings, excluding PPP, were $2.30, up 135% over Q3 2021. Our core ROAA, or return on average assets, was 1.64%, and core return on common equity was 25.9%. All these numbers are excluding PPP, and that's a good way to look at our numbers. Year-to-date, September 30, 2022, core earnings per share, excluding PPP, were $5.15. Q3 2022 net interest income generated by the core bank was up 38% year-over-year, while our total operating expenses were down by $4 million year-over-year. Core loan growth this quarter was led by increases in low-risk variable rate specialty lending verticals of $500 million, which were largely offset by an expected decline in loans to mortgage companies of $300 million and a sale of $500 million of consumer installment loans at a net gain to the company of about $13 million. This was executed as part of our balance sheet optimization and capital enhancement strategy. Asset quality remains exceptional and credit reserves are robust. Our loan and deposit pipelines remain strong and we are very focused on maintaining our margins, moderating our growth, improving our capital ratios while controlling our expenses, and meeting or beating what the street expects from us in earnings per share. We remain very optimistic about our future. I would now like to hand it over to Sam Sidhu, President and CEO of Customers Bank, to describe in detail our strategic initiatives and our results for Q3. Sam?

Thank you, Jay. Good morning, everyone. I'm thrilled to walk you through another strong quarter at Customers Bank Corp. Building off of the momentum of industry-leading, responsible loan growth in our variable rate, low-to-no-loss specialty lending verticals in the first half of the year, in the third quarter, the team focused on disciplined balance sheet management, which helped deliver strong net interest income growth and record recurring earnings, even after backing out the benefit of PPP. Given the uncertain environment, we believe that moderating our growth and focusing on maintaining an expanding margin, improving our capital ratios, all while further growing recurring revenues, is how we will be measured and how our shareholders will be rewarded. Let me briefly summarize our results. From an earnings perspective, we earned $1.85 in GAAP EPS, which represented net income of $61.4 million. Core earnings were $2.48. After stripping out the benefit of PPP income, we earned $2.30. As I mentioned earlier, a record and an incredible feat, all thanks to the incredible efforts of our team members. Net interest margin came in at the higher end of the guidance we provided on last quarter's call, lending to the prudent portfolio remix we have undertaken into lower risk and lower yielding but variable rate loans. This strategic portfolio remix will be mostly complete by year end, and our margin, after incorporating the full impact of the consumer portfolio reduction, will begin to increase again in 2023 as we have been very disciplined on loan and deposit pricing strategies. Now moving to the balance sheet. We ended the quarter with $19.2 billion in core assets excluding PPP, up 36% over the year-ago quarter. Our loan book grew an impressive 34% year-over-year to $14.2 billion excluding PPP at quarter end. Total deposits grew 3% to $17.5 billion and have more than doubled over the last three years. Going forward through the remainder of the year and into 2023, we believe it's prudent to prioritize adding high-quality deposit customers first to provide the funding base for continued measured loan growth, as well as, importantly, NII expansion over the next few quarters. From a profitability standpoint, adjusted pre-tax, pre-provisioned ROA was 1.95%. Strong asset quality is a pillar of our franchise, and we are an inherently low credit risk institution. We continue to deliver on superior credit quality versus peers, the industry, as well as our own historical averages. As a reminder, at the start of the year, we disclosed that we proactively and frankly, in hindsight, smartly tightened credit underwriting and shifted loan growth mix in an effort to continue to maintain a pristine credit book as we wait to see the full impact of the Fed's actions and inflation on the economy. Importantly, our book value has been successfully defended in 2022 and has grown significantly, about 9% year over year, as well as through 2022 bucking the industry trend, thanks to strong recurring organic growth and securities book optimization. Importantly, our TCE to TA ratio is at the high end of industry peers lending to our prudent optimization. Moving to slide six, strategic initiatives we've implemented to best position us for the current and future external environment. As early as the first quarter, we started taking a number of actions to position the company to successfully navigate a challenging macroeconomic environment. This started with a mixed shift in our loan portfolio toward low to no credit risk verticals, which represented 90% of our year-over-year loan growth. Our low to no loss specialty verticals now represent 63% of total loans, up significantly over the last year as well as the last several years, with our consumer installment portfolio declining from 15% to 10% of total loans over the same time period. This is excluding our government-guaranteed PPP loans, which when included, further increase this number. And as you can appreciate from a reinvestment perspective, this number will continue to increase in 2023. The focus on lower credit risk verticals has not changed our discipline and commitment to maintain at least 3% to 3.5% spread over our funding costs, allowing us to maintain our commitment to continue to meet and beat our short and long-term guidance in a rapidly evolving environment. I'm happy to address this more during Q&A. Our agile pricing discipline has more recently assisted our strategic moderation in the growth of our balance sheet as we continue to prioritize profitability, margin, and lowering overall risk at the bank. We will not ever chase growth for growth's sake alone, especially in conditions like the industry is facing today, where margin, capital, and credit are king. For example, we employed a strategy which both increased pricing thresholds for the top of the funnel and also repriced hundreds of millions of dollars of in-flight pipeline to prioritize margin and capital. Additionally, it's worth reminding you that on margin, the continued reinvestment of proceeds from our PPP loan runoff and our securities book, Amortization and Cash Flows, provide significant runway to grow our loan portfolio and continue to increase margin in the coming quarters. Strategic efforts such as the $500 million sale of a consumer loan portfolio this quarter and the transfer earlier this year of available for sale securities to held to maturity in the second quarter had meaningful positive impacts on our capital ratio, and we will continue to evaluate opportunities for additional action. On the consumer sale, We are pleased that the market validated our conservative underwriting, allowing us to sell $500 million of our customer's bank direct portfolio for nearly a 3% net gain. Moving on, the company remains extremely liquid, with approximately $10 billion in liquidity. This is further supported by our core deposit pipeline from our existing verticals, evidenced by our financial institutions group growth, as well as driven by our differentiated technology capabilities like CBIT and our technology-enabled transaction banking platform, which is already bringing in significant low-cost deposit opportunities, which we expect to onboard in 2023. As we have demonstrated and have delivered, unhandedly over the past several years, we have established ourselves as a leader in technology and innovation in the digital banking and fintech space, as well as in the banking industry more broadly. This is not just lip service. We are absolutely a top 10 tech forward bank in the nation out of thousands of institutions, and I'm happy to answer any questions to explain further. In terms of the customer's bank instant token on the next page, I'll spend a minute talking about this in a few pages. We continue to scale our business at a pace that is far greater than we had projected. Our banking-as-a-service marketplace lending pilot is kicking off this quarter as planned, and we expect it to generate as much as $10 million in annual revenue based on current and pipeline partnership opportunities. We are pleased to report that we are continuing to innovate and adding to our digital SMB small-medium-sized business bundle offering next year, as well as rolling out an equipment financing pilot launch as we look to build off of our success and learnings in the digital 7A space and roll into a revolving line of credit, term loan, as well as credit card offerings. Finally, at the bottom of the page, we strive for operational excellence and feel that companies must continually evaluate their structure and processes for greater efficiencies. In that honest self-assessment, we uncovered ways in the quarter to simplify and streamline our organization and to better position ourselves to serve our customers while reducing overhead which are all in addition to the branch closers which we announced last quarter. Combining these initiatives over the past two quarters, we will be reducing our headcount by 8% while making us more effective for future growth at the right time. Through these efforts, we are able to maintain an industry-leading efficiency ratio of 43%. Improving efficiency while also improving experience supported by truly best-in-class technology allows us to continue making our customers say wow. Flipping to our tech-enabled banking on slide 7, so we can update you on major technology-led strategic priorities at Customers Bank. Building off of our success and platform innovation on CBIT, we will be seeking to disrupt the transaction banking space by helping our current and future customers build a modern, cloud-based, API-enabled treasury product suite, which is being built to anticipate our customers' current and, importantly, future needs. Our best-in-class tech team is enabling us to expand our commercial, Treasury and payments capabilities, which now includes a customer-facing API library with documentation enabling simple and robust treasury and payments services. This is all in addition to the API-led banking as a service FinTech partnerships, of which the first fee income marketplace lending partner was signed last quarter and is launching this quarter after complex tech and operational integration. Our treasury and payments platform is being built from the ground up with input from dozens of interviews with customer end users and decision makers, reinforcing our customer-centric service and experience approach, which we hope will continue to build tremendous customer loyalty and enhance our brand by driving new product and service offerings. While most banks are focused on digital transformation and digitizing internal processes, we are looking to leapfrog forward and working to package and productize our tech by tailoring it to our customers' current and anticipated needs. Said another way, we are focusing our tech spend on innovation for our customers who now view us as a technology partner by choice rather than a banking partner out of necessity. This may seem nuanced, but it's critical to the future of banking. Transaction banking will enhance the customer's bank, customer-focused value proposition, and facilitate significant low-cost deposit gatherings, as well as fee income opportunities in commercial and large corporate high-growth verticals led by Fund Finance, Financial Institutions Group, Digital Assets, as well as Tech & Venture. As we have previously stated, our Fund Finance business, which crossed over a billion dollars in outstandings this year, We expect to be 100% self-funded and supported by these efforts. Similarly, our tech and venture business on a steady state, we expect to be at least 100% funded, supported by our tech enablement. Flipping to slide eight on customer's bank instant token. An update on the instant payments platform which we launched which tokenizes deposits on the blockchain on an instant payment rail that is available 24 by 7, 365. Despite significant market volatility in the digital asset space during the quarter and frankly over the last few quarters, we are proud to report that we accelerated customer growth significantly. once again beating our internal target through the onboarding of 111 new customers and crossing 300 total customers as of the end of the quarter. The onboarding and compliance team continues to meet best-in-class SLAs for onboarding timeline and compliance risk management. Our industry-leading technology infrastructure platform is forcing basic and long-needed innovation and calling out service challenges from the incumbent banking institutions. Our customer backlog remains robust, and to be clear, we have no exposure to underlying cryptocurrency assets of our customers, just their fiat dollar deposits used for operating accounts, payments, and trading. CBIT transactions continue to ramp up significantly and more than doubled in the quarter, and the fourth quarter is already ahead with just a month of transactions of last quarter. Our digital asset customer base is diversified, and in just a few quarters, Customers Bank already banks many of the largest in each of the major customer categories. Customers continue to progress in moving their primary banking relationships to us, which speaks to our innovative take-on service and experience high-tech, high-touch banking model. Now I'd like to hand it over to our Chief Financial Officer, Carla Leibold.

Thanks, Sam, and good morning, everyone. I'll keep my comments focused on five key themes. Number one, organic, low-risk loan growth and positive loan mix shift. Number two, growing deposit franchise with a significant and growing proportion of transaction-related DDAs. The third, net interest income growth from the core bank with margin expansion opportunities. Number four, strong liquidity and capital position. And five, tangible book value accretion, all combined with effective and disciplined expense management. Turning to slide nine, I'll start with low risk loan growth and positive shift in loan mix. Our organic core loan growth in the third quarter of 2022 was about 100 million, up approximately 1% over the prior quarter. Importantly, this included approximately 500 million of growth in our specialty C&I lending business, up approximately 10%, led by our low-risk variable rate lender finance vertical, which has been a vertical of ours for the past seven years, in which we've experienced no losses or even a single delinquency. We've also had about $300 million of growth in our lower-yielding relationship-based multifamily business, largely from Q2 production that didn't close until Q3. As expected, our loans to mortgage banking companies declined about $300 million and our consumer installment loans decreased by $500 million due to the consumer installment loan sale that we reported earlier this month. Overall, we are extremely pleased with the results of the consumer sale transaction for a number of reasons. One, it de-risked the loan book in that we now have less than 10% of core loans in consumer installment loans, which equates to less than 7% of total assets. Execution at a slightly less than par price in this rapidly changing environment is a testament to the superior credit quality of our consumer installment loan book. As a reminder, these are fixed rate loans that despite the 300 basis point increase in rates are still trading at 99.5% of par. And third, it was the significant financial benefits in Q3 resulting from, one, lower risk-weighted assets of approximately $420 million, which is expected to benefit our regulatory capital ratios between 30 and 40 basis points. And secondly, our CECL reserve release or benefit of approximately $37 million, net of a loss on sale of roughly $2.5 million, unamortized customer acquisition costs of $18.6 million, and other deal costs of about $2.4 million, or a net benefit of about $13 million. Moving on to deposits on slide 10. We increased total deposits by about $600 million in the third quarter, while also experiencing some shift in mix and higher deposit costs, which was not unexpected given the 300 basis points of rate hike we've had so far this year. Considering the vast majority of our customers are corporate or institutional clients, these deposit balances are more sensitive to changes in market rates. What you can see from this slide is that our sticky transaction-related DDAs have been steadily increasing over the past five years. Since September 30th, we've had CBIT-related customers move funds from money market accounts into interest-bearing operating accounts, further increasing our proportion of DDAs to about 67%. Given our strong deposit pipelines in the digital asset space, financials institution group, and other channels, we are expecting this trend to continue over the next several quarters. Slide 11 shows the repricing characteristics of our interest earning assets and overall core loan mix, excluding PPP. Approximately 62% of our interest earning assets are market sensitive, which is greater than the proportion of our market sensitive liabilities, leaving us modestly asset sensitive. From a loan mix perspective, the $500 million sale of consumer installment loans at the end of Q3 reduced our consumer installment portfolio by about 21%, ending the third quarter at approximately $1.4 billion. This action, combined with the fact that approximately 73% of our core loan growth year over year has been in low-risk, variable-rate, specialty lending verticals, such as lender finance and fund finance. has improved our loan mix by reducing overall credit risk while increasing asset sensitivity. We do expect the loan mix shift to be largely complete with the $500 million of low-risk variable rate specialty lending growth expected in the fourth quarter. Moving to slide 12, this slide shows a trend of increasing net interest income, excluding PPP, over the past five quarters, largely driven by strong organic growth in our specialty lending C&I business. Compared to the prior quarter, our net interest income, ex-PPP, increased 2% or 10% on an annualized basis. Year over year, our net interest income from the core bank increased 38%. Over the past five quarters, you can see that we have been very disciplined in keeping our margin above 3%. Consistent with our prior guidance, our third quarter net interest margin, XPPP, was 3.18% toward the upper end of the three and three and a quarter range we communicated last quarter. The $500 million sale of consumer installment loans and subsequent purchase of $400 million of investment securities secured by the sold loans at a 5.5% yield negatively impacted our net interest margin in the third quarter by about two basis points. Considering the timing of the loan sale late in Q3, we do expect to see another 10 basis points or so of net interest margin compression in the fourth quarter, all else equal. Upon completion of our low mix shift in the fourth quarter, we do believe that our net interest margin will likely trough this year within the previously guided range with NIM expansion opportunities in 2023. Turning to slide 13, PPP loans totaled $1.2 billion at the end of September. There was approximately $400 million of forgiveness in the third quarter of 2022. This resulted in deferred fee recognition of about $11 million, which was approximately $4 million lower than the amount recognized in the second quarter. At the end of September, approximately 91% of PPP loans originated under Rounds 1 and 2 had been forgiven, and approximately 80% of PPP loans originated under Round 3 had been forgiven. To date, we've recognized about $318 million of deferred origination fees, leaving approximately $30 million to be recognized in the fourth quarter of 2022 and early 2023. As we've said previously, it's difficult to predict the timing of these fees, but we are expecting the majority of the fees to be recognized over the next one to two quarters. Turning to slide 14, you can see tremendous growth in our liquidity position over time. The growth in our held to maturity investment portfolio was driven by the $400 million purchase of securities backed by the sold consumer installment loans late in Q3. When adding our committed borrowing capacity to our cash and investment portfolio, we have close to $10 billion of liquidity sources available to us, leaving us very well positioned to fund organic, low-risk growth, as well as the outflow of deposits resulting from the expiration of the deposit service agreement with BMTX. On the right side of that slide, you can see some key characteristics of our available for sale investment portfolio, which is approximately 50% floating rate, has an effective duration of 1.7 years, and a book yield of approximately 3.7%. Moving to slide 15. We continue to maintain strong capital levels. The estimated total risk-based capital ratio at the end of September was approximately 12.8%. Our TCE ratio, excluding PPP, was around 6.5%, and our estimated CET1 ratio was 10.1%. Our TCE ratio was negatively impacted by about 156 million of after-tax unrealized losses deferred in AOCI at the end of September. This negatively impacted our TCE ratio by about 80 basis points. Without this impact, our TCE ratio would have been roughly 7.3% at the end of the third quarter, close to the midpoint of our internal targeted range between 7 and 8%. It's important to note here that the AOCI impact is an accounting fair value adjustment that has no permanent impact on capital if the securities are held on balance sheet. As stated earlier, our third quarter 2022 estimated CET1 ratio was approximately 10.1%, significantly above the required regulatory well-capitalized minimums. Despite a similar impact of AOCI on our tangible book value, which was negatively impacted this quarter by about 96 cents, we saw tangible book value accretion of close to 3% as our gap earnings more than offset the further deterioration in AOCI. Looking forward to the end of 2022, we are still expecting our tangible book value to be over $40. We also expect our TCE ratio to be above 7.5% over the next three to four quarters, supported by growth and retained earnings and balance sheet management. And with that, I'll turn it over to Andy to talk more about asset quality.

Thanks, Carla, and good morning, everyone. As noted on slide 16, credit quality remains strong as evidenced by NPLs of only 28 million or 18 basis points of total loans. NPAs to total assets of just 14 basis points. a 9% decline in the percentage of loans classified special mention or substandard to total loans, and most importantly, as it represents a real-time assessment of portfolio strength, total 30- to 89-day delinquencies were only 17 basis points. The increase in NCOs was predominantly due to a decision after having completed a detailed forward-looking loan level stress test analysis to exit a performing non-multifamily commercial real estate credit that was heavily impacted by COVID-19 and failed to recover to an operating performance level that clearly evidenced an ability to sustain operations moving forward. For over a year now, we've been performing this same detailed, forward-looking analysis on all credits recovering from COVID-19, as well as credits deemed highly susceptible to any level of deterioration in discretionary spending given ongoing inflationary pressures and the high probability of a recession in late 2022 to early 2023. Adjusting for this unique $7 million charge-off, Q3 commercial NCOs to total average commercial loans was just one basis point, and overall NCOs to total average loans was 29 basis points, both of which are in line with historical levels and actually mark an improvement over Q2 of this year. From an overall consumer loan book perspective, NCOs to total average consumer loans of 180 basis points for Q3 marked a modest improvement from 197 basis points in Q2. In addition, we remain pleased with how well our consumer installment loan book continues to perform. with annualized charge-off rates running at less than half of the fully reserved lifetime loss rate of 5.13% when factoring in a weighted average life of just 1.7 years. In addition, after adjusting for the successful $500 million Q3 consumer installment loan sale, the underlying credit metrics of the remaining portfolio improved over that of Q2 and remained strong as noted on slides 24, 25, and 26 in the appendix. Although we are pleased with how well our portfolios have performed, we remain committed to the following. First, maintaining a strong reserve position, given continued uncertainty in the social, economic, and political climates, as evidenced by a solid coverage ratio of 1.03%, which equates to 465% coverage of total NPLs. Secondly, adhering to our strong underwriting and portfolio management standards, which is evidenced by consistently solid NPL, NPA, NCO, and delinquency performance. And finally, adhering to a strategy of enhancing loan portfolio mix with greater concentrations in low credit risk segments and as evidenced by 63% of our loan portfolio, excluding PPP, being in core low-risk lending segments at the end of Q3. Based on strong credit metrics, a loan mix comprised predominantly of low-credit risk loans, strong portfolio management with ongoing loan-level stress testing, limited exposure to higher risk loan segments, such as investment Cree office at only 132 million, investment Cree retail at only 172 million, and hospitality at just 452 million, of which 75% carry recourse and 77% are flagged. and finally, a continued focus on not lending into discretionary spending-dependent industries, we feel strongly that our loan portfolio is well-positioned to weather the current market volatility and what appears to be an almost certain upcoming recession. I'd like to thank you for your time this morning, and I'd now like to turn the presentation back over to Jay Sidhu.

Thanks Andy. Before we open it up for questions, let me summarize what my colleagues have already shared with you. As you can see from slide 17, we have shown industry-leading core loan growth and deposit growth supported by best-in-class digital banking. Since about the middle of last year, our loans, excluding PPP, are up about $5 billion, all organic growth, and deposits are up about $3 billion, and we have funded other loan growth from cash received from PPP loan forgiveness. We in this rapidly changing environment intend on continuing with the same, but moderating our growth so as to maintain or expand our margins and further improve our capital ratios. We remain on track to report $6 or higher in core EPS in 2023 in spite of a sale of $500 million of our consumer loans. As you heard from Andy, exceptional credit quality has been one of our hallmarks, and we are confident and we intend to remain that way. Our customer-centric business models are letting us get premium pricing, and we are committed to maintaining our advantages and technological capabilities over our peers. Speaking as one of the largest individual shareholders of the company, I can say our valuation is extremely attractive, trading at only 80% of tangible book and about five times 2023 consensus estimates. You should expect us to buy back our authorized 2 million share authorization over the next few months if we remain trading below tangible book. So Brent, please open it up for any questions from the audience.

At this time, I would like to remind everyone, in order to ask a question, press star followed by the number one on your telephone keypad. Your first question comes from the line of Michael Carito with KBW. Your line is open.

Hi, this is Andrew filling in for Mike. Thank you for taking my questions. First off, I just wanted to see how you guys will prioritize growth versus capital building in the near term and then into 2023 and beyond.

Yeah, so I can take that question. So first, when we're thinking about capital, we're always thinking about the best strategies to optimize capital. Supporting organic loan growth is always a priority. That said, we will be opportunistic in using our allotted 2 million share repurchase program. And as Jay just said, to the extent we are below tangible book value, you may see us buy back some common shares.

Great, thank you. And then turning to CBIT, how do you expect the mix of the deposit customers to be going forward? And then with that diversification, like how will that change as customers continue to grow in the future?

Sure. So this is Sam. Good morning, Andrew. Thanks so much for the question. So from a CBIT perspective, I think it's important to remind everyone that when we started the customers bank instant token platform and our digital asset banking deposit gathering vertical, we set out to build a low to no cost deposit acquisition franchise. And that's really what we're doing. So to put a finer point on that, well over 90% of our client accounts today are non-interest-bearing operating accounts, but we do have a small handful of larger cornerstone depositors that are earning interest. But these customers tend to hold larger balances with us, but they also happen to be, as I mentioned, anchors to the CBIT payments platform. So said differently, the CBIT platform, new customer growth allows us to increase the network effect. Increasing the network effect increases payments volumes, and payments volumes increases the overall deposits flow there. So as we look at this platform, you should expect that majority of the clients that come on in the digital asset space will be non-interest bearers.

Great. Thanks, Sam. And then just last one for me here. I know you mentioned the consumer loan sale and the prepared remarks on there, but do you have any plans to sell any more consumer loans in the near term?

So, Andrew, on the consumer loan sale, I think that I'll add a little bit of color on the transaction there. So as we mentioned, this is a CB direct originated portfolio. We actually ran an interesting marketed process where we put our entire portfolio out to receive bids. We had multiple bidders bid at or close to par. We decided on selling a smaller amount, as you can appreciate. We've created a tremendous amount of franchise value in that platform. We have acquired hundreds of thousands of customers. We let go about 35,000 plus or minus of customer principal. However, we maintained master servicing on that relationship. So at this point in time, we have no further plans to sell more of the portfolio. We plan to manage the portfolio to a size that's approximately where we are today. It's about 70% of risk-based capital. which feels like a very—and less than 10 percent of total loans, which feels like a very appropriate level given the diversification of our overall franchise. But we are interested in potentially evaluating strategic-type partnerships where we could be in an originate-for-sale-type position, but that's something that's on the horizon, not something that we are working on actively in the very near term.

Great. Thanks for all the color and thank you for taking my questions.

Sure. Your next question is from the line of Peter Winter with DA Davidson. Your line is open.

Thanks. Good morning. I wanted to ask about some of the drivers to the margin expansion outlook for next year.

Sure, Peter. Good morning. Great to see you in your new seat. So I think it's important to understand how we think about not just margin but also net interest income and more broadly what actions we've taken over the past six months to better position ourselves from a profitability perspective without taking unnecessary credit or interest rate risk, especially considering the level of market volatility that we're all experiencing in 2022, which is likely going to continue into next year. So first of all, we're focused on growing net interest income through the responsible low-risk loan growth that we've talked about extensively. Rather than focusing on a specific net interest margin, even though we have provided guidance, or an ideal deposit beta, our growth is going to be on top of a static balance sheet plus the modest asset sensitivity will allow us to continue to expand our margin throughout next year. Carla, maybe you could talk a little bit about the PPP loans, the payoffs that we expect next year, the securities book cash flows, and how we think about reinvestment as well on top of the modest asset sensitivity.

Sure, Sam, and good morning, Peter. Regarding the margin expansion, there are a couple of big drivers here. First, we are very unique in that we have over a billion dollars of cash that can be reinvested over the next couple of quarters at market-based rates solely from the PPP loan forgiveness process. Approximately 23% of our interest earning assets are invested in lower yielding assets, which can ultimately be redeployed to generate higher NII over the next 12 to 24 months. And third, We're still not seeing the full benefit of our asset sensitivity because of a lag in the repricing of our variable rate assets compared to our market sensitive deposits. This lag goes away when the Fed pauses rate hikes and the repricing of the assets increases. catches up to market-sensitive funding. And lastly, as Sam just talked about, we still have significant opportunities to generate very low to no-cost core deposits over the next several quarters.

Okay. Thank you. Just on that point, that last point, Carla, I did see that deposits grew quarter to quarter. But, you know, there was a big mix shift from DBA into interest bearing and deposit costs increased pretty rapidly. Can you just talk about, you know, this mix shift in deposits and maybe the outlook for deposit growth?

Sure. I'll talk about the mix shift and then I'll turn it back over to Sam to talk about some of the deposit generating opportunities. So to be competitive in this rapidly changing environment, we moved most of our CBIT related deposits to money market accounts and paid some market based rates in the third quarter. Having said that, as of October 1st, all of the CBIT-related money market counts have been moved to interest-bearing DDAs. Currently, our total demand deposits make up roughly 67% of our total deposits. And Sam, do you want to talk back about the deposit-generating strategies? Yes.

Yep, absolutely. And let me just add a little bit just before I move on this non-interest-bearing deposit migration. As Carla stated, this is related to our digital assets, CBIT deposits. This is one time it's behind us as payments volume was up significantly. at Cubby in the quarter for CBIT. It obviously has been muted for the industry over the last couple of quarters, but there has been a tremendous amount of competitive pressure, which is why we thought it was important to strategically make the decision to pay interest to some of our key anchor clients. We also saw a small amount of non-interest-bearing outflows, which is really just expected from a quarter-to-quarter type variability as opposed to a migration that Carla just mentions. No customers closed accounts. And in our digital asset business or otherwise, we're protecting important customers across our franchise. And it would behoove us to not be able to take some of these types of actions. Now, you also asked about deposit growth. And what I would say is, to reiterate, we talked about some of this in the transaction banking slide, but sort of the waterfall of our important deposit growth initiatives is, number one, high quality deposit growth in our commercial verticals. Number two, growth in our new lending verticals that we've discussed that are not yet self-funded. For example, our fund finance and technology and venture groups in aggregate are $1.3 billion in loans, and we expect those to be self-funded. in the medium term, and our pipelines for those deposits are strong. Number three, our newly launched technology-enabled transaction banking platform, which is going to enable treasury and payment services, and then obviously the CBIT platform, which we've talked about. The customer growth leads to stronger and broader network effect, leads to CBIT integrations, leads to CBIT payments floats, leads to deposits, and those deposits that are payments floats have no associated interest expense when they sit in the Omnibus account.

That's really helpful. And just one last question. I appreciate all this color. But you sold the $500 million in consumer installment loans almost essentially at par. But you did take a $23 million loss from the sale. Can you just give some color what that loss entailed?

Sure, Peter, I can take that one. So there were a couple of components to it. First, there was a $2.5 million loss on sale just resulting from the sales price at $99.5. But secondly, there was $18.6 million of unamortized customer acquisition costs that needed to be written off at the time of sale. And then there were some other deal-related costs around $2.5 million. Got it.

Okay. Thanks for the questions. Taking my questions. Absolutely.

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

Good morning. Just wondering on the growth, I want to make sure I have it right for the fourth quarter. You talked about the $500 million in specialty lending vertical growth. Is that net of anything, or do you basically expect the rest of the portfolio to be fairly flat?

I will add that we are expecting a decline, a seasonal decline in the mortgage warehouse book to end the year somewhere between $1.2 to $1.4 billion.

Okay, so outside of, yeah, I should have said outside of mortgage warehouse, the idea would be largely that you know, receive $500 million in net growth. That's kind of the thinking.

That's right.

Okay. And then as a follow-up, just if you do make the decision to buy back stock and you do get aggressive on that front in the fourth quarter, what would be sort of the give in terms of, you know, would you be willing to accept maybe slightly lower capital levels? than you had otherwise anticipated to do that? Or would you, do you think slow down, you know, that growth in your specialty lending?

This is Jay. I'll take that, Frank. We will balance growth, like you said, moderating our growth with a maximization of capital, liquidity, margin, and profitability, and it's a balancing act. And from a timing point of view, even if we have to take a little bit of a hit to our capital ratios for one quarter, we will do that if it makes more sense to buy back stock in a certain quarter. We think that our opportunities for growth are enormous, but at this time in the cycle, it makes more sense to be moderating the growth and improving the quality of our balance sheet and at the same time trading at multiples, which our shareholders should expect us to trade at with the kind of returns that we are providing in terms of earnings, in terms of ROA, in terms of return on equity.

Frank, I would just add that if you look at our broader peer group, our TCE is in the top quartile of the banks out there right now. So even if we did decide to take action, which we would only do if there's an underappreciation of a lot of the efforts that we have underway, we do have adequate capital levels relative to our peers and the industry.

Got it. Okay, thank you.

Your next question is from the line of David Bishop with the Hovde Group. Your line is open.

Yeah, good morning. Hey, speaking with the deposit equation here, am I reading things wrong? It looks like you guys onboarded 111 new customers in the CVIT platform, but deposit spell? Were these customers just not bringing in deposits yet? Just curious why the big earthen accounts with a decline in deposits. Thanks.

Yeah, sure. Absolutely. David, good morning. So we onboarded over 100 customers. About 75 percent of those have already funded. Some of them closed, you know, opened up accounts towards the end of the quarter. And average account balances are approximately one to one and a half million. So there's a slow growth and ramp up. At the end of the day, deposits get funded into these accounts. when it is either A, a primary operating account, or B, it is a payments account. And CBIT integration sometimes takes times for some of those, you know, key customers. So it's a leading indicator of future deposit growth. But the accounts are very active and funded immediately.

Got it. And then any sense or maybe – scale or just size in terms of just, you know, payments activity across the platform?

Yeah, our all-in payments activity continues to grow, and I referenced some of my prepared remarks, but what I would say is it's several billion dollars in the quarter, all-in payments volume.

Got it. Then one final question on the expense front. Good cost containment there. Did see a decline in the tech expense. Is that a good run rate? Just curious what sort of drove the interquarter decline and the technology expense run rate.

Yeah, so that is largely impacted by the deposit services agreement that we currently have in place with BMTX. As we said previously, that runs around $15 million on a quarterly basis, up or down maybe a million dollar quarter, depending upon some seasonality of the deposits that are serviced by BMTX. This quarter, it was roughly $13 million.

Your next question is from the line of Matthew Breeze with Stevens. Your line is open. Good morning.

I apologize. I'm having a tough time hearing you guys. What was the remaining cost tied to BM Technologies that should come out here?

So roughly, that's about $15 million a quarter. And this quarter, it was $13 million. On an annual basis, it's roughly $60 million.

Okay. And then similarly, I think last I had it, there was about $2.2 billion of deposits tied to BMTX. That's still expected to fall off at the end of the year. What's the offset to that? Is it going to be higher borrowings or some sort of lower assets. And if it's lower assets, where do you expect the offset to be?

So a couple things on that. So currently the deposit service by BMTX is about $1.6 billion. And I would point you to two things. One, Sam described earlier the strong pipelines for core organic deposit growth. And two, we had some comments in our strong liquidity position and the fact that we have liquidity sources of close to $10 billion. So that gives us some options on how we fund the actual outflow of the BMTX service deposits.

Okay. And can you remind us the cost of the deposits versus the incremental cost of replacements?

Yeah, so right now those costs are around 3%, and to the extent that they would be replaced, we'd first go to organic, low-to-no-cost deposit channels, and then any shortfall could be based on market rates.

Okay. And then going back to the NIM, I just wanted to make sure I had the cadence right. The core NIMs expect to be down 10 basis points in the fourth quarter. And then do I have this right? It'll be stable slash expanding from there. And then if it's expanding, I just wanted some frame of reference, you know, the extent of expansion you expect off of a bottom.

So on the NIM for, we said on a static balance sheet, the impact of the consumer sale transaction would be roughly 10 basis points in the fourth quarter. And what we guided to is that we will be within a three and three and a quarter for the fourth quarter. And then we have the margin expansions opportunities based on the items that we described earlier on the call.

Okay. And maybe just a follow-up to that, where do you expect deposit costs to peak if we have another, call it 150 basis points of Fed Fund hikes, or ask another way, what is your full cycle deposit beta estimate at this point?

So we're not giving specific beta guidance. I think we're not focused on an ideal or an optimal deposit beta. But what we can say and what we've said previously is our deposit franchise, it's just largely built on commercial and institutional clients. When rate goes up, they expect the banks to pay them some rate.

And what I would just add to that, Matt, is I think that at the end of last quarter, we talked about what we were seeing in the market from a competitive standpoint related to deposit betas in the industry. Our view has not changed at all over the past 90 days, whereas I think we've seen some folks in the industry continue to raise their deposit beta estimates.

And I think what we are focusing on is the consistency of net interest income. And net interest income growth is what we believe everybody should be looking at and expecting so that if we see a deposit betas going up and we see deposit costs going up, we better have a balance sheet which will show our earning asset yields going up too. And that's what we would like for you to focus. I think you should be asking us lots of questions about our asset betas also.

Understood. Okay. I appreciate. That's all the questions I had. Thank you.

Thanks, Matt.

Your final question comes from the line of Bill DeZellum with Teton Capital Management. Your line is open.

Thank you. That's Tietan Capital. And let me start. Sam, I will take the bait. You said that we should ask you about the digital technology initiatives. and being in the top 10 banks. I'll turn that over to you without any specific question, and just what would you like to highlight there?

Sure, absolutely. Good morning, Bill. Great to speak to you, and thanks so much for the question. You know, we talked a lot last year about a number of initiatives that we had in terms of coupled along with the rebranding of the organization to be able to take the technology development that we had in this franchise, thanks to our predecessor subsidiary, Bank Mobile, five plus years ago, where we started to build a bank of the future on top of the traditional legacy technology. Once that organization was lifted out and divested last year, we had that DNA in our organization. We've added 60 to 75 team members into technology and innovation. Our security department is separate from our IT department, is separate from our technology department. And the way that we think about information technology is run the bank, which helps facilitate the left hand with the right hand of changing the bank. And our technology team, the change-the-bank type team of developers, engineers, work hand-in-hand with our folks in the marketing, the digital marketing side, CRM, Salesforce, Encino, product management side. They're the folks that are helping to continue to innovate at this organization. We don't just have a small innovation team. We have 60 to 75 team members that are fully dedicated to changing the bank and changing the industry. So hopefully that's helpful. And the types of initiatives that we have underway are not roadmap initiatives. We're not focusing on digitizing. We're not focusing on removing paper. We're not focusing on reducing costs. We're focusing on delivering a best-in-class customer experience that really delights the customer and is an effortless and frictionless experience. And the ability to talk to a large commercial customer that has an ability to move over, say, $100 million in deposits to you but needs to be able to have X, Y, and Z in terms of reporting, virtual account capabilities, ERP integration, and to have our team be able to roadmap that out and do that in a matter of days as opposed to a matter of months – The types of banks that can compete against us in these types of capabilities, you can count them on one or two hands, and they tend to be larger and a lot less agile than us.

That is helpful. Thank you, Sam. And you talked about the number of CBIT transactions doubling recently. Is there any revenue, or for that matter, any cost associated with transactions in the CBIT arena, or is it really entirely the deposit benefit?

Sure. So we don't charge revenue for the tokenized deposit instant payments transfer and settlement. We do have traditional commercial banking fees for ACH wire, etc., which are the on and off ramps outside of our bank before we use the on and off ramp to the to the digital blockchain based payments. services. So we don't charge the customer for the instant payments, but the ins and outs do derive fee income for the organization. But really, again, the main purpose of our CBIT platform, which is starting today in the digital asset industry, is to bring and create a large deposit-gathering vertical of low- to no-cost deposits that will continue to improve the margin and reduce volatility, you know, in the medium term.

And then lastly, banking as a service, would you please discuss the initial interest that you all are seeing there? Maybe it's too early to know, but interest in your perspective.

Sure, absolutely. So banking as a service, really you think of it as three pillars. There's loan services and loan origination, which is what we're referring to, and I'll come back to that. There's deposit-taking capabilities, and deposit-taking capabilities typically are handled by the smaller sub-$10 billion banks because of their Durban exemption, so less relevant for a customer's bank today. And finally, payments, which we've talked about, whether it's CBIT, whether it's other forms of real-time payments, B2B payments and, you know, as well as API enabled, you know, ACH wire, Fed wire, and eventually FedNow. These are the types of capabilities that we have today or will have in the very near future. So going back to our marketplace lending partnership, as you know, as we built our consumer lending platform, initially, we were partnering and purchasing You know, loans as long as five plus years ago. And we have a number of servicing and originator relationships of the top, you know, half a dozen or so of longstanding experience fintech marketplace lending platforms. So we have already onboarded them from a risk and compliance perspective. In many cases, we still have existing relationships with them, and there's enough opportunities in that small handful of customers who generally originate billions of dollars of annual loans, whereby we have an opportunity to lend our technology and risk and compliance platform to as well as some liquidity to be able to help them run their business. And for that, we get paid a significant amount of high ROA interest and fee income. Thank you.

Thanks, Bill. There are no further questions at this time. I'll now turn the call back over to Mr. Jay Sidhu.

Yeah, thank you very much. Really appreciate your interest in customers. So please give us a call anytime. We are always there to hear your ideas, and we are committed to meeting or beating the consensus estimates you have for us for 2023. Thank you.