Customers Bancorp, Inc. quarterly report, Q2 FY2016

Customers Bancorp, Inc. — Q2 2016 Form 10-Q

Reporting period: Three and six months ended June 30, 2016. Unaudited consolidated results; balance-sheet comparisons are to December 31, 2015. Customers Bancorp is a bank holding company operating through Customers Bank, including its BankMobile digital banking business.

Financial performance and position

Amounts below are in millions, except per-share data and ratios.

Metric	Q2 2016	Q2 2015	Six months 2016	Six months 2015
Net interest income	$63.2	$46.6	$120.8	$92.9
Provision for loan losses	$0.8	$9.3	$2.8	$12.3
Non-interest income	$8.3	$6.4	$13.8	$12.1
Non-interest expense	$38.2	$25.7	$72.1	$53.1
Net income	$19.4	$11.6	$37.1	$25.5
Net income available to common shareholders	$17.4	$11.0	$33.8	$25.0
Diluted EPS	$0.60	$0.39	$1.17	$0.88
Net interest margin	2.83%	2.73%	2.85%	2.81%

Q2 return on average common equity was 13.03%; return on average assets was 0.84%. Q2 effective tax rate was 40.1%; management estimated a full-year 2016 rate of approximately 38.0%.
At June 30, assets were $9.685 billion, up 15.3% from year-end; deposits were $6.751 billion, up 14.2%; and shareholders’ equity was $680.6 million, up from $553.9 million.
Total loans, including loans held for sale, were approximately $8.416 billion, up about $1.2 billion from year-end. Loans held for sale were $2.302 billion, primarily short-term mortgage warehouse loans; loans receivable, net of allowance, were $6.076 billion.
Cash and cash equivalents were $302.8 million, including $20 million restricted in escrow for acquisition payments. The allowance for loan losses was $38.1 million, or 0.62% of loans receivable; management reported non-performing loans at 0.17% of the total loan portfolio.
Borrowings totaled approximately $2.2 billion, including $1.907 billion of FHLB advances, $61 million of federal funds purchased, $86.8 million of other borrowings and $108.7 million of subordinated debt. Management reported $4.3 billion of FHLB borrowing capacity, of which $1.9 billion was borrowed and $1.6 billion was used to collateralize municipal deposits; Federal Reserve Bank borrowing capacity was $62.2 million.
Six-month operating cash flow was negative $491.5 million and investing cash flow was negative $663.2 million, reflecting loan growth and mortgage warehouse originations. Financing cash flow was positive $1.193 billion, led by $841.8 million of deposit growth and $79.7 million of preferred-stock proceeds. Cash and cash equivalents rose $38.2 million to $302.8 million.
At June 30, the Bank’s CET1, Tier 1 risk-based, total risk-based and Tier 1 leverage ratios were 8.856%, 8.856%, 10.755% and 7.385%, respectively. The company reported that the Bank and Bancorp met applicable capital requirements.

Material changes versus comparable periods

Q2 common earnings increased 57.2% year over year; first-half common earnings increased 35.1%. Growth in net interest income was primarily volume-driven, with higher average loan and securities balances; Q2 NIM expanded 10 basis points.
Provision expense fell substantially from 2015, which included a $6.0 million provision for a fraudulent loan subsequently charged off in full. Q2 2016 provision included loan-growth and specific-impairment provisions, partly offset by improved expected cash flows on acquired credit-impaired loans and a reduction in estimated FDIC amounts owed.
Non-interest expense rose $12.5 million in Q2 and $19.0 million in the first half. Factors included business growth, approximately $3.2 million of Disbursement-business operating expenses in Q2, and $0.9 million of Q2 acquisition costs. The 2015 comparison also benefited from a $2.3 million Pennsylvania shares-tax adjustment.
Customers acquired substantially all assets and assumed certain liabilities of Higher One’s Disbursement business on June 15. The preliminary allocation recorded $4.3 million goodwill. Cash consideration is $37 million, payable in installments, plus $5 million for transition services; additional contingent payments may apply if annual business revenue exceeds $75 million. No contingent consideration liability was recorded at June 30.
Customers issued Series D and Series E preferred stock in 2016, receiving net proceeds of $24.1 million and $55.6 million, respectively. The new preferred shares qualify as Tier 1 capital and carry fixed-to-floating, non-cumulative dividends.
On July 11, 2016, after quarter-end, Customers agreed to terminate its FDIC loss-sharing agreements and pay $1.4 million as final settlement. The amount was recorded as a liability at June 30.

Outlook, commentary and risks

Management said it planned to moderate balance-sheet growth in the second half of 2016. Mortgage warehouse balances had grown with refinance activity and low long-term rates; management expected growth to moderate and return toward seasonal patterns as rates and spreads normalized.
For the Disbursement business, management preliminarily anticipated approximately $65 million of revenue in its first full year, with operating expenses of a similar amount before allocated corporate overhead, and approximately break-even results over the next 12 months. Management cautioned that integration and implementation were ongoing and actual results could differ materially.
The combined BankMobile and Disbursement platform served approximately 2.1 million student bank customers. Management anticipated 500,000 or more new deposit accounts annually, but stated its intent to dispose of BankMobile within two years through a possible IPO, sale or spin-off, subject to market conditions and opportunities.
A key threshold is remaining below $10 billion in total assets as of each December 31 to retain the small-issuer debit-card processing fee treatment. The filing warned that losing the exception could reduce interchange fee income significantly—potentially by as much as 70% of the expected current amount—and could make the business unprofitable or require additional student fees.
Disbursement-related risks include changing Title IV and other federal or state requirements, potential joint liability with education-institution clients, restrictions on student marketing and fees, client termination, student adoption and financial-aid volumes, integration and retention challenges, and cybersecurity, fraud and service disruption. Management also cautioned that forward-looking statements are subject to risks and actual outcomes may differ.
Interest-rate modeling estimated net interest income changes of +1.9% for a 100-basis-point rate increase, +0.1% for a 200-basis-point increase, −5.0% for a 300-basis-point increase, and −1.9% for a 100-basis-point decrease. These are model estimates based on assumptions, not guidance.
Management reported adequate liquidity for short- and long-term needs. The filing provided no firm company-wide earnings or revenue guidance. No material changes to previously disclosed legal proceedings or other risk factors were reported, apart from the Disbursement-related risks.

Investor verification points

Track quarterly loan, deposit and funding growth, net interest margin, and whether growth moderation affects earnings and liquidity.
Assess credit performance as the portfolio expands, including non-performing loans, troubled debt restructurings, charge-offs, allowance adequacy and acquired-loan reserves.
Verify Disbursement-business integration costs, actual revenue and profitability against management’s preliminary break-even outlook, and progress in retaining student customers and education-institution clients.
Monitor year-end assets relative to the $10 billion debit-card fee threshold and the timing, feasibility and terms of any BankMobile disposition.
Review the effect of the FDIC settlement, acquisition payment schedule and any contingent consideration, as well as preferred dividends and regulatory capital headroom.
Consider exposure to interest-rate changes, municipal-deposit collateral requirements, off-balance-sheet commitments and the filing’s identified regulatory, cybersecurity and fraud risks.