Customers Bancorp, Inc. — Q3 2018 Form 10-Q
Business context and reporting period
Customers Bancorp is a bank holding company operating Customers Bank and BankMobile. This unaudited filing covers the quarter and nine months ended September 30, 2018; the balance sheet compares September 30, 2018 with December 31, 2017.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Net interest income | $64.0m | $68.0m | $196.4m | $199.0m |
| Provision for loan losses | $2.9m | $2.4m | $4.3m | $5.9m |
| Non-interest income | $2.1m | $18.0m | $39.1m | $59.2m |
| Non-interest expense | $57.1m | $61.0m | $163.1m | $160.8m |
| Net income | $6.0m | $7.8m | $53.8m | $57.2m |
| Net income available to common shareholders | $2.4m | $4.1m | $43.0m | $46.4m |
| Diluted EPS | $0.07 | $0.13 | $1.33 | $1.42 |
- Q3 net interest margin was 2.47% on a tax-equivalent basis, down 15 basis points year over year; the nine-month margin was 2.58%, down 13 basis points. Higher deposit and borrowing costs outpaced improved asset yields.
- At September 30, assets were $10.62bn, deposits $8.51bn, shareholders’ equity $954.8m, and net loans including mortgage warehouse loans $8.72bn. Cash and cash equivalents were $666.0m.
- For the first nine months, operating cash flow was $98.4m, investing cash outflow $289.1m, financing cash inflow $710.4m, and cash increased $519.7m to $666.0m.
- Outstanding borrowings were approximately $1.07bn at quarter-end: $835m FHLB advances, $123.8m other borrowings, and $109.0m subordinated debt. The $63.3m senior notes matured and were repaid in July.
- Regulatory capital ratios exceeded applicable thresholds. Bancorp Tier 1 leverage was 8.91% and total risk-based capital was 12.69%; Bank total risk-based capital was 14.15%.
Material changes versus comparable periods
- Q3 common earnings fell 41.7% year over year; nine-month common earnings declined 7.3%. Q3 results included an $18.7m realized loss on the sale of $495m of lower-yielding securities, $2.9m in merger-related expenses, and a $1.2m equity-investment mark-down. Management said these charges reduced diluted EPS by $0.55 for Q3 and $0.57 for the nine-month period.
- Q3 non-interest income also reflected lower BankMobile card activity and lower deposit and mortgage-warehouse fees. Expense reductions, notably in professional services, partly offset these pressures.
- Deposits rose $1.71bn, or 25.2%, from year-end, while FHLB advances declined $776.9m and federal funds purchased were eliminated. Total assets increased 7.9% to $10.62bn.
- Non-performing loans were $23.6m, or 0.27% of total loans; non-performing assets were 0.24% of total assets. The allowance for loan losses was $40.7m, versus $38.0m at year-end.
Outlook, risks, contingencies, and unusual items
- Management expected assets to be below $10bn by December 31, 2018, partly due to seasonal contraction in mortgage warehouse balances. It cited the $10bn threshold as important to BankMobile’s debit-card interchange economics.
- Management planned to reduce lower-yielding multifamily lending and grow higher-yielding commercial-and-industrial and consumer lending, while replacing higher-cost funding with core deposits. It stated a 2.75% net interest margin goal within 12–18 months; this is a target, not a reported result.
- The BankMobile spin-off and Flagship merger agreement was terminated October 18, 2018. The company said it intended to retain and operate BankMobile for the next two to three years while spin-off plans were on hold. Management anticipated a T-Mobile white-label partnership launch in Q4 2018, with potential profitability benefits beginning as early as late 2019; realization is uncertain.
- A material weakness in internal control over financial reporting led to restatement of prior filings. Mortgage warehouse loans and related cash flows had been misclassified as held for sale/operating rather than held for investment/investing. The filing says the correction did not affect earnings, total assets, total loans, capital, or key performance metrics, but comparative cash flows changed; 2017 nine-month operating cash flow was restated to $30.3m from $185.9m. Management reported disclosure controls were ineffective and described remediation steps.
- The Department of Education issued a final determination alleging that students at certain partner institutions lacked required convenient fee-free ATM or branch access, and asserting related student costs as Customers’ financial liabilities. Customers appealed; it could not estimate likelihood of loss or a possible loss range. The filing also describes prospective ATM-access requirements.
- Interest-rate sensitivity modeling estimated net interest income changes of -3.0% under an immediate 300-basis-point increase and -4.4% under a 100-basis-point decrease. Estimated economic value of equity declined 21.2% under a 300-basis-point increase.
Important facts for investors to verify
- Progress and independent validation of remediation for the material weakness, and whether further restatements or control findings arise.
- Outcome and potential financial exposure of the Department of Education appeal, including implementation of any prospective requirements.
- Whether year-end assets fell below $10bn and the resulting effects on BankMobile interchange revenue and funding costs.
- Whether the T-Mobile partnership launched as planned and delivers the stated profitability benefits; monitor BankMobile losses and operating costs.
- Execution of loan-mix and deposit-funding plans, and whether margin pressure, consumer-loan growth, or credit quality changes.