Customers Bancorp, Inc. quarterly report, Q3 FY2017

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Customers Bancorp, Inc. — Q3 2017 Form 10-Q

Business context and reporting period. This unaudited filing covers the quarter and nine months ended September 30, 2017. Customers Bancorp is a bank holding company operating Customers Bank, including community business banking and nationwide digital banking and disbursement services through BankMobile. Unless noted otherwise, amounts below are in U.S. dollars.

Financial performance and position

  • Q3 earnings: Net income was $7.8 million versus $21.2 million a year earlier. Net income available to common shareholders was $4.1 million, or $0.13 per diluted share, versus $18.7 million, or $0.63 per diluted share.
  • Nine-month earnings: Net income was $57.2 million versus $58.9 million; income available to common shareholders was $46.4 million versus $53.0 million. Diluted EPS was $1.42 versus $1.80.
  • Interest income and margins: Q3 net interest income increased 5.3% to $68.0 million; tax-equivalent net interest margin declined to 2.62% from 2.83%. Nine-month net interest income rose 7.4% to $199.0 million, while tax-equivalent margin declined to 2.71% from 2.84%.
  • Non-interest items and costs: Q3 non-interest income declined to $18.0 million from $27.5 million, including an $8.3 million Religare investment impairment; non-interest expense rose 8.6% to $61.0 million. For nine months, non-interest income rose 43.5% to $59.2 million, while expenses increased 25.3% to $160.8 million, substantially reflecting a full nine months of BankMobile Disbursements operations in 2017 versus three months in 2016.
  • Assets and lending: Total assets were $10.47 billion, up 11.6% from year-end 2016. Loans receivable, net of allowance, were $7.02 billion, up from $6.12 billion; loans held for sale were $2.11 billion. The allowance for loan losses was $38.3 million, or 0.54% of loans receivable.
  • Credit quality: Management reported non-performing loans of $29.8 million, or 0.33% of the total loan portfolio including loans held for sale, and non-performing assets of 0.30% of total assets. Nine-month net charge-offs were $4.9 million, up from $0.9 million. The filing cites $1.6 million and $1.8 million of Q3 and Q2 charge-offs, respectively, tied to two commercial and industrial relationships.
  • Deposits, debt and capital: Deposits were $7.60 billion, up 4.0% from year-end. Total borrowings were approximately $1.90 billion, up 65.9%; FHLB advances were $1.46 billion. The company issued $100 million of senior notes in June 2017, bearing a 3.95% coupon and maturing in June 2022. Shareholders’ equity was $910.6 million. At September 30, the Bancorp’s CET1, Tier 1, total risk-based and Tier 1 leverage ratios were 8.28%, 10.94%, 12.40% and 8.36%, respectively; the Bank exceeded regulatory well-capitalized thresholds.
  • Cash flow and liquidity: Nine-month operating cash flow was $185.9 million, investing cash outflow was $1.27 billion, and financing cash inflow was $1.04 billion. Cash and cash equivalents ended at $219.5 million, down from $264.7 million at year-end. The company reported $4.7 billion of FHLB borrowing capacity, of which $1.5 billion was borrowed and $1.9 billion used to collateralize municipal deposits; it also had $151.1 million of Federal Reserve Bank borrowing capacity. Management said resources were adequate for foreseeable cash needs.

Material changes versus comparable periods

  • Q3 common earnings fell sharply, principally because of BankMobile-related reclassification and tax effects and the Religare impairment, alongside higher loan-loss provision and operating expenses. Higher securities-sale gains and net interest income partly offset these pressures.
  • Q3 net interest income benefited from growth in average earning assets, but margin compressed as funding costs rose, multi-family prepayment penalties declined, and the new senior notes added interest expense.
  • For the first nine months, loan growth and a full-period contribution from BankMobile increased net interest income and interchange/card revenue. Those benefits were offset by higher BankMobile operating costs, provision expense, preferred dividends and Religare impairment charges.
  • Compared with December 31, 2016, loans receivable increased about $906 million, deposits increased $293 million, and borrowings rose about $800 million.

Outlook, notable items and risks

  • BankMobile transaction: In Q3, the company changed its planned disposition to a tax-free spin-off to shareholders, followed by a merger of its BankMobile Technologies subsidiary with Flagship Community Bank. Shareholders were expected to receive collectively more than 50% of the merged company, valued at approximately $110 million. The company expected a mid-2018 closing, subject to definitive agreements, regulatory and shareholder approvals, Flagship raising approximately $100 million, and other conditions. A definitive agreement had not been executed as of the filing date. The transaction was not assured.
  • Asset reduction plan: With assets above $10 billion, Customers planned to reduce them by approximately $500 million by year-end 2017, including through seasonal mortgage warehouse runoff and sales of multi-family/residential loans or securities, to preserve small-issuer treatment under the Durbin Amendment. Failure to fall below the threshold could reduce interchange fee income beginning July 1, 2018.
  • Unusual Q3 tax and accounting effects: The BankMobile classification change brought previously unrecognized depreciation and amortization into the period, including a $4.2 million pre-tax catch-up charge. The revised disposition strategy also led to a $4.6 million reversal of previously recorded deferred tax assets and no recognition of $3.1 million of deferred tax benefits related to the Religare impairment. Management attributed $7.7 million of after-tax Q3 earnings reduction to these BankMobile-related tax effects and $5.2 million after tax to the Religare charge.
  • Religare investment: The company recorded $8.3 million of Q3 impairment, reducing the investment’s carrying value to $2.3 million. Further declines, foreign-exchange changes or inability to exit on expected terms could adversely affect results.
  • Interest-rate sensitivity: Model estimates showed net interest income down 0.3% under an immediate 100-basis-point increase, 3.0% under a 200-basis-point increase, and 8.2% under a 300-basis-point increase; a 100-basis-point decline implied a 2.4% decrease. Management cautioned that outcomes depend on modeling assumptions and actual experience.
  • Other risks and contingencies: The filing identifies transaction execution and customer/employee-retention risks, market-value and impairment risks for securities, credit and funding risks, and off-balance-sheet commitments. At quarter-end, commitments to fund loans were $261.9 million, unfunded mortgage warehouse commitments $1.39 billion, unfunded lines of credit $498.3 million, and letters of credit $38.8 million. The filing reported no material change in previously disclosed legal proceedings or other risk factors beyond the newly described BankMobile and investment risks.

Important facts for investors to verify

  • Whether the BankMobile spin-off/merger agreement was executed, approvals and Flagship capital-raising conditions were met, and the expected timing and value remained achievable.
  • Whether Customers reduced assets below $10 billion by December 31, 2017, and the resulting impact on interchange income and asset mix.
  • How much of reported earnings and future profitability depends on one-time tax, impairment, reclassification and securities-sale effects versus recurring operations.
  • Whether rising deposit and borrowing costs continue to pressure net interest margin as the loan portfolio grows.
  • Whether credit trends, including commercial and industrial charge-offs, impaired loans and the allowance, remain consistent with management’s asset-quality assessment.
  • Whether BankMobile’s revenue, operating losses, transaction costs and potential contingent acquisition payments develop as expected; the filing recorded no liability for contingent consideration at September 30, 2017.