Customers Bancorp, Inc. — Q3 2012 Form 10-Q
Business context and reporting period. Unaudited consolidated results for the quarter and nine months ended September 30, 2012. Customers Bancorp is a bank holding company whose business includes commercial and consumer lending, mortgage warehouse lending, deposits, and FDIC-assisted acquired loans. Comparisons of balance-sheet figures are to December 31, 2011; income and cash-flow comparisons are to the corresponding 2011 periods. Dollar amounts below are in millions unless noted.
Key financial metrics
| Metric | Q3 2012 / September 30, 2012 | Comparable period / prior date |
|---|---|---|
| Net interest income | $22.6 | $9.7 in Q3 2011 |
| Net interest margin | 3.80%; 3.04% excluding the $4.5 million PCI-loan estimate adjustment | 2.48% in Q3 2011 |
| Provision for loan losses | $10.1 | $0.9 in Q3 2011 |
| Non-interest income | $9.8 | $3.2 in Q3 2011 |
| Non-interest expense | $12.0 | $8.7 in Q3 2011 |
| Net income / diluted EPS | $6.6 / $0.51 | $2.3 / $0.23 in Q3 2011 |
| Nine-month net income / diluted EPS | $16.3 / $1.35 | $0.8 / $0.08 in 2011 |
| Total assets | $2,654.1 | $2,077.5 at December 31, 2011 |
| Deposits | $2,348.2 | $1,583.2 at December 31, 2011 |
| Loans held for sale | $1,187.9, including $1,063.7 of warehouse loans at fair value | $175.0 at December 31, 2011 |
| Net loans receivable / allowance | $1,062.1 / $25.0 | $1,326.4 / $15.0 at December 31, 2011 |
| Cash and cash equivalents | $157.5 | $73.6 at December 31, 2011 |
| Borrowings / subordinated debt | $36.0 / $2.0 | $331.0 / $2.0 at December 31, 2011; federal funds purchased were zero versus $5.0 |
| Shareholders’ equity | $261.5 | $147.7 at December 31, 2011 |
| Nine-month operating cash flow | $(994.1) | $(24.8) in 2011 |
Changes and drivers
- Q3 net interest income rose 133% year over year, mainly from growth in warehouse and commercial real estate lending and higher average loan balances. Reported Q3 NIM also benefited from the $4.5 million PCI-loan interest adjustment.
- Q3 non-interest income increased by $6.5 million. Drivers included warehouse transaction fees, $1.3 million of FDIC loss-sharing receivable accretion, and $4.4 million of other income from revised PCI cash-flow estimates. For the nine months, non-interest income included a $9.0 million securities-sale gain.
- The loan-loss provision rose sharply. Management attributed approximately $7.5 million of the 2012 provision to the PCI cash-flow re-estimation process. The allowance increased to $25.0 million from $15.0 million at year-end.
- Non-interest expense rose with staffing and infrastructure growth, including 66 additional full-time-equivalent employees since September 2011; nine-month expense also included $1.4 million of costs related to the postponed stock offering.
- Assets increased 27.8% from year-end. Warehouse loans were a major driver, while the reported decline in net loans receivable partly reflects moving eligible warehouse loans into loans held for sale under the fair value option. Deposits increased $765.1 million, and the company repaid $300.0 million of short-term borrowings.
- Shareholders’ equity increased substantially, including $94.8 million of net proceeds from third-quarter private common-stock offerings.
Liquidity, capital, outlook, and risks
- Management said liquidity was adequate for foreseeable needs. At September 30, borrowing capacity was $556.7 million at the FHLB, of which $36.0 million was used, and $112.9 million at the Federal Reserve Bank of Philadelphia.
- Both the Bancorp and the Bank met applicable capital adequacy requirements. The Bank’s ratios were 11.28% total capital to risk-weighted assets, 10.05% Tier 1 risk-based capital, and 8.48% Tier 1 leverage; it also met the stated “well-capitalized” thresholds.
- No specific earnings or financial guidance is provided. Management described loan growth as a strategic priority and expected the Acacia acquisition to close in Q4 2012 and the CMS Bancorp merger in the first half of 2013, subject to approvals and other conditions. Acacia’s stated purchase price was $65.0 million; CMS transaction value was approximately $20.8 million.
- Credit remains a material risk, particularly in legacy and acquired commercial real estate and construction loans, acquired nonperforming assets, manufactured housing, and nationwide mortgage warehouse lending. Non-covered nonaccrual loans were $32.8 million; nonperforming non-covered assets were $41.1 million. Covered nonaccrual loans were $47.6 million, with FDIC loss-sharing arrangements applicable to covered loans.
- The filing reports $8.2 million of TDR loans; $1.5 million was performing under modified terms. Management warned that further real estate deterioration could require increased reserves. Five corporate bonds had been downgraded by Moody’s; management said they remained current on interest and did not expect to sell them before recovery.
- The filing discusses proposed Basel III capital rules and potential compliance costs, as well as uncertainty from Dodd-Frank implementation, interest-rate and economic conditions, and forward-looking estimates. Management reported no material change in risk factors from the 2011 Form 10-K, no material legal proceedings, and effective disclosure controls.
Unusual items and matters to verify
- PCI estimate change: The new valuation system and initial cash-flow re-estimation increased Q3 income by $4.4 million in non-interest income and $4.5 million in interest income; management said the net after-tax earnings increase was $0.911 million, or $0.08 per share. The filing is inconsistent on the related loan-loss provision: the notes and some MD&A passages say approximately $7.5 million, while another MD&A passage says $5.7 million. Verify the correct amount and the accounting impact.
- Operating cash flow: The cash-flow statement reports $(994.1) million of operating cash flow, with $7,305.3 million of loan originations for sale and $6,292.5 million of sale proceeds. The MD&A describes the excess as $1.0 million, which does not align with the cash-flow figures; verify the narrative amount and interpretation.
- Warehouse lending and fair value: Verify the scale, funding, counterparty and fraud controls, and credit-risk treatment of the $1.1 billion warehouse portfolio, including the new fair value election and its effect on balance-sheet comparisons.
- Asset quality and reserves: Review trends in nonaccruals, TDRs, acquired-loan credit marks, FDIC recoveries, and the adequacy of the increased allowance—especially for construction, commercial real estate, and manufactured housing exposures.
- Nonrecurring earnings and funding: Distinguish recurring earnings from the PCI estimate adjustments and the $9.0 million securities gain; assess deposit growth, including the increase in jumbo and wholesale certificates, alongside private-placement capital proceeds.
- Pending acquisitions and regulatory changes: Confirm closing status, consideration and approvals for Acacia and CMS, and assess their capital, integration and dilution effects. Monitor final capital-rule requirements and implementation.