The Bancorp, Inc. — Q3 2014 Form 10-Q
Reporting period: Quarter ended September 30, 2014; comparative results are for Q3 and the first nine months of 2013. Amounts below are in U.S. dollars; financial-statement amounts are in millions unless stated otherwise.
Business context and reporting period
The Bancorp is a financial holding company whose bank provides prepaid and debit cards, payment processing, healthcare accounts, private-label banking and specialty lending. In Q3 2014, the company decided to discontinue commercial lending operations and sell the related loan portfolio. It expects to focus on specialty finance and payments; the portfolio was classified as held for sale and discontinued operations.
Financial performance and condition
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Net interest income | $15.4 | $10.7 | $44.1 | $29.4 |
| Non-interest income | $20.3 | $19.2 | $67.2 | $60.1 |
| Non-interest expense | $33.1 | $26.4 | $98.4 | $74.7 |
| Provision for loan and lease losses | $1.0 | $0.4 | $3.4 | $0.5 |
| Continuing-operations net income | $1.5 | $2.2 | $9.3 | $10.0 |
| Discontinued-operations income (loss), net of tax | $(18.3) | $2.6 | $(25.5) | $7.8 |
| Net income (loss) available to common shareholders | $(16.8) | $4.8 | $(16.2) | $17.8 |
| Basic and diluted earnings (loss) per share | $(0.45) | $0.13 | $(0.43) | $0.48 basic; $0.47 diluted |
Net interest margin, on a fully taxable-equivalent basis, was 2.81% in Q3 2014 versus 2.53%; for the nine-month periods it was 2.59% versus 2.41%. Management attributed improvement mainly to shifting funds from overnight balances into loans and securities and exiting less profitable deposit relationships. Average loan yields declined as existing loans repriced and new loans were made at lower rates.
- Balance sheet at September 30: Assets were $4.30 billion, down from $4.71 billion at December 31, 2013. Total loans, excluding loans held for sale, were $866.8 million versus $655.3 million; investment securities totaled about $1.54 billion versus $1.35 billion.
- Liquidity and funding: Cash and cash equivalents were $495.5 million, down from $1.236 billion at year-end. Deposits were $3.654 billion, down 9.1% from $4.020 billion, reflecting deposits transferred to held-for-sale operations and exits from less profitable relationships. The company reported no outstanding borrowing-line advances; available facilities included a $430 million FHLB line and $49 million of correspondent-bank lines.
- Cash flows, nine months: Operating activities provided $23.1 million; investing activities used $397.7 million; financing activities used $365.8 million. Cash and cash equivalents declined $740.5 million.
- Debt and capital: The balance sheet included a $13.4 million subordinated debenture and $21.5 million of repurchase-agreement liabilities. At September 30, Bancorp’s Tier 1 leverage, Tier 1 risk-based and total risk-based capital ratios were 8.10%, 12.95% and 13.11%; the Bank’s were 7.51%, 12.03% and 12.19%. Both were above the stated “well-capitalized” thresholds.
- Credit quality: The allowance for loan and lease losses was $4.4 million, or 0.51% of loans, versus $2.2 million, or 0.33%, at year-end. Nonperforming loans were $4.8 million versus $1.6 million at year-end; nonperforming assets were $5.5 million, including $0.7 million of other real estate owned. Nine-month net charge-offs were $1.2 million.
Material changes and unusual items
- The Q3 and nine-month net losses were driven principally by a $38.9 million fair-value reduction on the discontinued commercial, construction and commercial-mortgage loan portfolio. The resulting discontinued-operations losses were $18.3 million for Q3 and $25.5 million year to date, after tax.
- The company reported $1.143 billion of assets and $227.9 million of liabilities held for sale at September 30. Loans in the portfolio were being disposed of to independent purchasers; actual sale prices could differ from the valuation estimate.
- Continuing-operations net income was lower year over year despite stronger net interest income and non-interest income. Higher loan-loss provisions, BSA-related consulting and lookback costs, and broader operating expenses offset revenue growth. Prepaid-card fees rose to $12.3 million in Q3 and $38.7 million year to date.
- The Bank entered an FDIC consent order effective June 5, 2014, concerning its Bank Secrecy Act compliance program. The company recorded $2.7 million of BSA and lookback consulting expense in Q3 and $4.9 million year to date, and reported about $6.3 million of additional consulting obligations expected to be expensed as services are performed. It estimated future annual compliance staffing expense of about $2.7 million.
Outlook, risks and contingencies
Management expects to use proceeds from the commercial-loan dispositions to acquire investment securities and support growth in continuing specialty lending. It cautioned that reinvestment yields depend on market conditions and may not replace income from the loans sold. Management expected the consent-order consulting costs to be recognized over the following two quarters and did not believe the order’s specified growth restrictions would materially affect current revenue; restrictions remain pending regulatory approval of a BSA report.
- The consent order restricts adding new independent sales organizations, issuing new non-benefit reloadable prepaid-card programs and originating ACH transactions for new merchant-related payments until the required report is approved.
- The FDIC was scrutinizing certain third-party card-program practices. The Bank is contractually indemnified for related losses, but civil money penalties are not indemnified. If certain deposits are classified as brokered, FDIC assessments could rise by up to 10 basis points annually, and other regulatory or liquidity consequences are possible.
- A securities class action filed in July 2014 alleges, among other things, inadequate loan-loss reserves and BSA-related disclosure failures. The company considers the claims without merit and intends to defend itself; the litigation was at a preliminary stage.
- Management said disclosure controls were effective at a reasonable-assurance level except for a previously identified material weakness concerning accruals for consent-order expenses. A new review procedure was implemented, but remediation remained subject to satisfactory design and effectiveness testing.
- The filing gives no full-year earnings guidance. Management cautioned that interim results may not indicate full-year results.
Most important facts for investors to verify
- Progress, timing and realized proceeds from selling the held-for-sale commercial loan portfolio, including any further valuation adjustments.
- FDIC and state-regulator acceptance of the BSA report, the duration and business impact of restrictions, and total compliance costs and potential penalties.
- Whether deposit classifications, FDIC assessments or funding access change as a result of the brokered-deposit issue.
- Trends in nonperforming loans, charge-offs, reserve adequacy and independent loan-review coverage after the portfolio transfer.
- Resolution and potential financial exposure of the securities class action, and whether the new expense-control procedure remediates the reported material weakness.
- Actual yields and earnings contribution from reinvesting loan-sale proceeds, compared with the income generated by the disposed portfolio.