Customers Bancorp, Inc. — FY 2018 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2018; it is not a standalone fourth-quarter filing. Customers Bancorp is a Pennsylvania bank holding company operating Customers Bank, with two reportable segments: Business Banking and BankMobile. Its branch-light commercial banking business serves the Northeast and Mid-Atlantic, while BankMobile provides digital banking, student disbursement services and white-label banking nationwide.
Key financial results and condition
| Metric | FY 2018 / year-end | FY 2017 / prior year-end |
|---|---|---|
| Interest income | $418.0 million | $372.9 million |
| Net interest income | $257.9 million | $267.3 million |
| Net interest margin, tax-equivalent | 2.58% | 2.73% |
| Provision for loan losses | $5.6 million | $6.8 million |
| Non-interest income | $59.0 million | $78.9 million |
| Non-interest expense | $220.2 million | $215.6 million |
| Net income | $71.7 million | $78.8 million |
| Net income available to common shareholders | $57.2 million | $64.4 million |
| Diluted EPS | $1.78 | $1.97 |
| Total assets | $9.83 billion | $9.84 billion |
| Deposits | $7.14 billion | $6.80 billion |
| Shareholders’ equity | $956.8 million | $921.0 million |
| Cash and cash equivalents | $62.1 million | $146.3 million |
- Profitability and margins: Pretax income was $91.1 million, down 26.5%. Return on average assets was 0.69% versus 0.77%; return on average common equity was 7.90% versus 9.38%. Funding costs rose 64 basis points, outpacing the 37-basis-point increase in asset yields and compressing margin.
- Cash flow: Operating activities provided $97.5 million, investing activities used $104.1 million and financing activities used $77.6 million. Cash and cash equivalents fell $84.2 million during the year. Management said available funding sources were adequate for foreseeable needs.
- Loans and credit: Loans, net of allowance and including mortgage warehouse loans, were $8.50 billion. Non-performing loans were $27.5 million, or 0.32% of total loans, compared with 0.30% a year earlier. The $40.0 million allowance equaled 0.56% of loans receivable excluding mortgage warehouse loans; net charge-offs were $3.7 million, or 0.05% of average loans.
- Funding and liquidity: Gross loans to deposits were 119.6%; excluding mortgage warehouse loans funded partly by short-term FHLB borrowings, the ratio was 99.96%. Wholesale deposits, including brokered and municipal deposits, were 28.7% of deposits. FHLB advances were $1.25 billion, federal funds purchased $187.0 million and total borrowings $1.67 billion. The Bank reported $4.1 billion of FHLB borrowing capacity, with some capacity pledged to secure municipal deposits.
- Capital: At year-end, Bancorp CET1, total risk-based capital and Tier 1 leverage ratios were 8.96%, 13.01% and 9.67%; the Bank’s corresponding ratios were 12.82%, 14.62% and 10.70%. Both met applicable capital requirements. Tangible common equity to tangible assets was 7.36%, up from 7.00%.
Material changes versus prior period
- Net income available to common shareholders declined 11.1%, principally reflecting a $19.9 million decline in non-interest income and lower net interest income, partly offset by lower tax expense and loan-loss provision.
- Non-interest income included an $18.7 million loss on the sale of $495 million of lower-yielding securities, compared with $8.8 million of securities-sale gains in 2017. BankMobile interchange and card revenue declined $10.8 million; deposit fees fell $2.2 million. Commercial lease income increased $4.7 million.
- Interest expense rose $54.6 million, substantially more than the $45.1 million rise in interest income. The company grew transaction deposits and reduced FHLB advances by $363.8 million, while deposits increased $342.1 million.
- Portfolio mix shifted toward commercial and industrial and consumer lending. Consumer loans rose to $721.8 million from $329.8 million; multi-family loans fell to $3.3 billion from $3.5 billion. Mortgage warehouse balances decreased to $1.4 billion from $1.8 billion as mortgage origination activity slowed.
- BankMobile generated a $13.5 million net loss in 2018, compared with a $13.2 million loss in 2017. A white-label partnership entered beta in late November 2018.
Outlook, commentary, risks and unusual items
- Management projected U.S. GDP growth of 2.00%–2.50% in 2019, moderate growth in its markets and unemployment near then-current levels. It expected the Federal Reserve to stabilize rates without further increases during 2019. These are management expectations, not company earnings guidance.
- Management’s strategy is to grow relationship-based commercial and consumer lending, reduce lower-yielding multi-family exposure and operate BankMobile. Customers said it intended to retain and operate BankMobile for the next two to three years. The planned BankMobile spin-off and merger with Flagship Community Bank was terminated in October 2018; $2.7 million of previously expected reimbursable costs were recognized as expense.
- Interest-rate sensitivity modeling estimated 2019 net interest income would fall 4.5% under an immediate 100-basis-point rate increase and 9.8% under a 200-basis-point increase; a 300-basis-point increase implied a 15.7% decline. These are model scenarios, not forecasts.
- Reporting-control issue: The company restated prior-period cash-flow classifications for mortgage warehouse lending after loans had been incorrectly classified as held for sale rather than held for investment. It reported no effect on cash balances, loans, assets, capital, earnings, EPS or stated key performance metrics. Management said the material weakness was remediated by year-end 2018; the auditor gave unqualified opinions on the financial statements and internal control over financial reporting.
- Contingencies: The Department of Education asserted $6.5 million of financial liabilities related to fee-free ATM access for students and required prospective access improvements. Customers disputes the assessment and appealed; management said it could not predict the outcome, while stating it did not expect a material financial-statement effect. Two related civil lawsuits remained unresolved, with loss likelihood and range not estimable.
- Key risks: Funding-cost pressure, reliance on wholesale funding and time deposits, concentrated commercial and real-estate lending, mortgage warehouse fraud and volume risks, credit deterioration, interest-rate exposure, technology and cybersecurity threats, BankMobile adoption and university-partner dependence, and regulatory or litigation outcomes. Management also highlighted the coming transition away from LIBOR and the possible increase in reserves under the future CECL expected-credit-loss standard.
- The company does not expect to pay common-stock cash dividends in the foreseeable future. Preferred dividends were $14.5 million in 2018; they are non-cumulative and subject to board declaration.
Important facts for investors to verify
- Whether the reported margin and earnings trends continued after year-end, especially deposit pricing, funding mix and securities-related gains or losses.
- BankMobile’s operating losses, transaction volumes and the commercial progress and economics of its white-label partnership; also confirm the status of any spin-off or strategic plans after this filing.
- The resolution and potential financial impact of the DOE assessment and the two lawsuits.
- Loan quality by segment, particularly special-mention and substandard exposures, consumer-loan growth, and commercial real-estate concentrations; assess the allowance separately from fair-value mortgage warehouse loans.
- Liquidity under deposit runoff or increased commitment drawdowns, given wholesale funding reliance and $1.54 billion of unfunded mortgage warehouse commitments.
- Whether the remediated cash-flow classification controls remained effective and whether CECL adoption materially changes the allowance or regulatory capital.