The Bancorp, Inc. — Q1 2018 Form 10-Q
Reporting period: three months ended March 31, 2018; balance-sheet comparisons are to December 31, 2017. The Bancorp is a financial holding company whose bank subsidiary operates specialty lending and payments businesses. Financial results are unaudited. Amounts below are in U.S. dollars; financial statement figures are generally in millions unless otherwise indicated.
Financial performance and position
- Earnings: Net income from continuing operations was $14.0 million, versus $6.3 million in Q1 2017. Net income including discontinued operations was $14.1 million, versus $8.0 million. Diluted EPS was $0.25, compared with $0.14.
- Revenue and margins: Net interest income was $30.1 million, up 20.9%; non-interest income was $29.1 million, up from $24.2 million. Together, these totaled $59.2 million. Net interest margin rose to 3.12% from 2.70%. Loan yield increased to 4.73% from 4.25%; total deposit and interest-bearing liability cost rose to 0.52% from 0.35%.
- Profitability drivers: Loan-sale gains rose to $11.7 million from $5.4 million, principally reflecting higher market spreads on the 2018 sale. Prepaid card fees grew 5.4% to $14.3 million. Non-interest expense increased 3.4% to $39.0 million; salary expense increased 17.0% to $21.1 million, partly due to incentive compensation related to revenue and the loan-sale gain. Continuing-operations tax expense was $5.4 million; the effective tax rate was 27.8%, versus 38.8% in Q1 2017.
- Cash flow and liquidity: Operating cash flow was $143.0 million, versus cash used of $66.2 million in Q1 2017; investing activities used $171.2 million and financing activities used $305.6 million. Cash and cash equivalents declined $333.8 million during the quarter to $575.2 million. Deposits fell $305.7 million to $4.0 billion, which management attributed largely to seasonal year-end gift-card balances. The Bank reported no borrowings outstanding on its $469.6 million FHLB and $1.0 billion Federal Reserve credit lines.
- Balance sheet and debt: Total assets were $4.37 billion, down from $4.71 billion at year-end; total loans were $1.46 billion, up from $1.39 billion. Available-for-sale securities were $1.38 billion. Long-term borrowings were $42.2 million and subordinated debentures were $13.4 million. Shareholders’ equity was $329.9 million.
- Capital: The Bank reported a 7.31% Tier 1 leverage ratio, 17.82% Tier 1 risk-based capital ratio, and 18.22% total risk-based capital ratio; management stated it was “well capitalized.” The holding-company leverage ratio was 7.69%.
- Credit quality: The allowance for loan and lease losses was $7.3 million, or 0.50% of loans, versus $7.1 million, or 0.51%, at year-end. Nonperforming loans were $6.2 million, up from $4.2 million at year-end; loans 90 days past due and still accruing rose to $2.6 million from $0.2 million. Net charge-offs were $511,000, versus $38,000 in Q1 2017.
Material changes and management commentary
- Management attributed earnings improvement to growth in interest income and loan-sale gains. Average loans and leases increased 18.9% year over year, supported by growth in leasing, SBA lending, and securities-backed lines of credit (SBLOC). Federal Reserve rate increases contributed to higher asset yields; deposit costs adjusted more slowly, partly because prepaid-card deposits contractually reprice only partially.
- Commercial loans held for sale declined to $349.8 million from $503.3 million following a securitization. Management expects commercial mortgage-backed loan interest income to decrease after the quarter-end sale, partly offset by new originations.
- Management described the decline in assets and deposits from year-end as largely seasonal. It also reported a planned exit from certain less-profitable deposit relationships and a tax-preparation program-manager relationship; prepaid-card fee growth partly offset the latter’s impact.
- Available-for-sale securities had $21.0 million of gross unrealized losses at March 31, versus $9.5 million at year-end; net-of-tax other comprehensive loss for the quarter was $9.3 million. The company reported no other-than-temporary impairment charges and attributed most securities losses to market interest-rate changes.
Outlook, risks, and contingencies
- The filing provides no specific earnings or revenue guidance. Management cautioned that interim results may not indicate full-year results and that forward-looking statements are subject to risks.
- The Bank remains subject to FDIC consent-order requirements, including restrictions on certain new payment-processing and prepaid-card activities pending regulatory acceptance of a BSA compliance report. Restrictions could constrain deposit and fee growth. The Bank may not pay dividends without prior FDIC approval, and the holding company may not pay common dividends or make trust-preferred interest payments without Federal Reserve approval. The Federal Reserve approved the March 2018 trust-preferred interest payment; future payments require approval.
- A March 2018 FDIC restitution order concerns fees charged to consumers from 2010 to 2014 due to a third-party processor programming error. The processor reimbursed impacted consumers at its expense; the Bank is completing documentation and audit requirements. A separate $2 million civil money penalty had been paid and recognized in 2017.
- The SEC investigation into the company’s prior financial-statement restatement remains ongoing; related legal costs have been material and are expected to continue. An IRS audit of tax years 2011–2014 is also in process. The company is cooperating with both inquiries.
- Discontinued commercial lending assets held for sale totaled $289.0 million. A $36.9 million loan secured by a hotel under construction and a parking lot became delinquent and the borrower filed for bankruptcy; management said it currently believes there will be no loss of principal. A separate $8.0 million held-for-sale loan matured delinquent, with renewal or disposition under review.
- The company had $1.48 billion of loan commitments, primarily SBLOC commitments; it said historical draws have been only a fraction of total commitments. It warned that future credit-loss provisions may be needed as conditions, delinquencies, or credit performance change. Adoption of the expected-credit-loss standard in 2020 is expected to increase the allowance, but the amount is not yet clear.
Investor verification priorities
- Confirm the sustainability of Q1 earnings growth, particularly the contribution and repeatability of the $11.7 million loan-sale gain and incentive compensation costs.
- Track deposit trends and composition, seasonal balances, brokered-deposit status, and the effect of regulatory growth restrictions.
- Review delinquency and nonperforming-loan trends, especially the increase in loans 90 days past due and still accruing, and the adequacy of the allowance.
- Monitor the distressed discontinued-operation loans, remaining assets held for sale, and the Walnut Street investment, including valuation assumptions and recoveries.
- Follow progress on FDIC consent orders and the BSA report, consumer restitution documentation, SEC investigation, and IRS audit; assess potential costs and any impact on business growth or capital distributions.
- Assess liquidity and interest-rate exposure, including the substantial quarterly cash decline, pledged securities, deposit seasonality, and the sensitivity of asset yields and funding costs to rate changes.