Business context and reporting period
The Bancorp, Inc. is a financial holding company whose bank provides regional commercial and retail banking and nationwide affinity, prepaid-card, healthcare-account, payment-processing and private-label banking services. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2014; balance-sheet comparisons are to December 31, 2013. Unless stated otherwise, financial amounts below are in millions.
Financial performance and position
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Net interest income | $27.9 | $23.6 | $54.5 | $46.3 |
| Provision for loan and lease losses | $15.5 | $9.5 | $32.8 | $15.0 |
| Non-interest income | $23.7 | $22.4 | $47.9 | $41.5 |
| Non-interest expense | $35.8 | $27.6 | $68.8 | $52.1 |
| Net income | $0.34 | $5.59 | $0.64 | $13.00 |
| Diluted earnings per share | $0.01 | $0.15 | $0.02 | $0.34 |
| Net interest margin | 2.69% | 2.46% | 2.48% | 2.35% |
- For Q2, net interest income rose 18.4%, but higher credit-loss provision and operating expenses more than offset revenue growth. Management cited a $2.2 million BSA/lookback consulting charge and higher loan charge-offs. Q2 return on average assets was 0.03% and return on average equity was 0.35% (0.56% and 6.45% in Q2 2013).
- For the first half, net income fell by $12.4 million. Higher net interest income and non-interest income were outweighed by a $17.8 million increase in provision and $16.7 million increase in non-interest expense.
- At June 30, total assets were $4.32 billion, down from $4.71 billion at year-end; net loans were $2.00 billion, up from $1.92 billion. Available-for-sale and held-to-maturity securities totaled $1.56 billion, versus $1.35 billion at year-end. Commercial loans held for sale were $154.5 million, versus $69.9 million.
- Deposits were $3.88 billion, down $391.2 million (9.2%) from year-end, which management attributed primarily to planned exits from higher-cost relationships. Cash and cash equivalents fell to $472.5 million from $1.24 billion, mainly as funds were deployed into loans and securities and certain deposit relationships were exited.
- Six-month operating cash flow was negative $64.7 million, compared with positive $18.6 million a year earlier. Investing cash outflow was $305.9 million and financing cash outflow was $394.8 million; cash declined $765.4 million. The cash-flow statement reports a $391.2 million net decrease in deposits.
- At quarter-end, total liabilities were $3.94 billion and shareholders’ equity was $372.5 million. Subordinated debenture was $13.4 million and repurchase-agreement funding was $17.5 million. The Bank reported no outstanding borrowing-line balances; available lines included $430 million with the FHLB and $49 million with correspondent banks.
- Regulatory capital ratios remained above “well-capitalized” thresholds: Bank Tier 1 leverage 6.89%, Tier 1 risk-based 11.17%, and total risk-based 12.42%. Thresholds were 5%, 6%, and 10%, respectively.
Material changes, risks and outlook
- Credit costs rose sharply: the first-half provision was $32.8 million versus $15.0 million, and net charge-offs were $24.0 million. The allowance was $46.9 million, or 2.29% of loans, compared with $38.2 million, or 1.95%, at year-end. Management described significant charge-downs involving commercial and construction-related credits.
- Non-performing assets were $66.5 million, including $39.7 million of non-performing loans and $26.8 million of other real estate owned. The prior-year June figure was $48.8 million; year-end 2013 was $67.0 million. Six-month annualized net charge-offs to average loans were 2.21%, versus 0.79% in 2013.
- An FDIC consent order effective June 5, 2014 requires enhancements to the Bank’s Bank Secrecy Act/anti-money-laundering program. Pending regulatory approval of a BSA report, the Bank is restricted from onboarding new independent sales organizations, issuing new non-benefit reloadable prepaid programs, and originating ACH transactions for new merchant-related payments. Management said it did not expect these limits to materially affect revenue, but they may constrain growth.
- Management identified approximately $7.04 million of additional lookback and consulting costs expected to be expensed as services are performed, anticipated mainly in Q3 and Q4 2014. Additional annual BSA-related software, staffing and office costs were estimated at $3.5 million, including spending already planned.
- The FDIC may view certain third-party card-program deposits as “brokered,” contrary to the Bank’s position. If classified that way, management said annual FDIC assessments could increase by up to 10 basis points of average liabilities; other regulatory consequences are possible. The filing also notes scrutiny of third-party card operations and potential non-indemnified civil money penalties.
- A securities class action filed July 17, 2014 alleges, among other things, inadequate loan-loss reserves and BSA-related violations. The company said it considers the complaint meritless and intends to defend it; the outcome and potential damages are uncertain.
- Management reported disclosure controls were not effective at the reasonable-assurance level and identified a material weakness in internal control over financial reporting. The company said the weakness related to accounting for professional-service costs required by the regulatory order.
- No formal earnings guidance is provided. On July 10, 2014, after quarter-end, the company entered into agreements permitting up to $50 million of common-stock sales through at-the-market offerings.
Important facts for investors to verify
- Whether loan-loss provisions and charge-offs adequately reflect credit risk, particularly in commercial, construction and commercial-real-estate exposures, and how asset quality develops.
- Progress toward satisfying the FDIC consent order, timing of BSA-report approval, and actual lookback and ongoing compliance costs.
- Whether any deposits are ultimately classified as brokered and the resulting effect on FDIC assessments, liquidity or operating restrictions.
- Deposit stability and liquidity following the $391.2 million first-half deposit decline, and the sustainability of the company’s shift from overnight balances into loans and securities.
- Resolution and potential financial impact of the securities class action and any further regulatory findings or penalties.
- Remediation of the disclosed material weakness and the terms and potential dilution from any at-the-market share issuance.