The Bancorp, Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Unless otherwise noted, amounts are in U.S. dollars; financial statement amounts below are in millions. Prior-year comparison figures are restated where indicated.
Business context
The Bancorp is a financial holding company whose main subsidiary is The Bancorp Bank. Continuing operations include specialty lending (securities-backed lines of credit, leasing, SBA and loans originated for sale) and payment services, including prepaid cards and payment processing. The company is winding down its commercial lending business, reported as discontinued operations, and was seeking to sell the remaining portfolio.
Financial and operating results
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net interest income | $17.8 | $15.3 | $51.3 | $43.7 |
| Provision for loan and lease losses | $0.6 | $0.2 | $1.8 | $2.6 |
| Non-interest income | $17.3 | $20.3 | $62.8 | $67.4 |
| Non-interest expense | $47.8 | $33.1 | $135.1 | $98.4 |
| Continuing-operations net income (loss) | $(7.6) | $5.8 | $(11.9) | $10.7 |
| Discontinued-operations income, net of tax | $2.0 | $19.1 | $6.7 | $26.2 |
| Net income (loss) available to common shareholders | $(5.6) | $25.0 | $(5.2) | $36.9 |
| Basic and diluted EPS | $(0.15) | $0.66 | $(0.14) | $0.98 basic; $0.96 diluted |
Q3 net interest margin was 2.34%, down from 2.81%; the nine-month margin was 2.32%, versus 2.59%. Management attributed the margin pressure to lower loan and securities yields and increased balances of low-yielding Federal Reserve deposits. No consolidated operating margin measure is stated in the filing.
For the first nine months, operating cash flow was a use of $140.9 million, investing activities provided $325.0 million, and financing activities used $260.9 million. Cash and cash equivalents declined $76.8 million to $1.04 billion.
Balance sheet, liquidity and capital
- Total assets were $4.71 billion, down from $4.99 billion at December 31, 2014. Total deposits were $4.38 billion, down $242.6 million, or 5.2%; the company attributed the decline to exits of less profitable deposit relationships.
- Cash and cash equivalents were $1.04 billion, including $995.4 million in interest-earning Federal Reserve deposits. Available-for-sale securities were $1.32 billion; held-to-maturity securities were $93.6 million.
- Loans, net of the allowance, were $990.3 million, up from $871.0 million. Commercial loans held for sale were $354.6 million. Remaining discontinued-operation assets held for sale were $611.7 million, down from $887.9 million at year-end.
- The allowance for loan and lease losses was $4.2 million, or 0.42% of loans. Nonperforming loans were $2.45 million; the filing reports no other real estate owned at September 30, 2015.
- Subordinated debentures were $13.4 million. No FHLB advances or correspondent credit-line borrowings were outstanding; available lines included $478.7 million from the FHLB and $34.0 million from correspondent banks. Undrawn loan commitments, including lines of credit, totaled $833.9 million.
- Shareholders’ equity was $313.7 million. Bancorp and the Bank were reported as well capitalized. At September 30, the company’s Tier 1 leverage, Tier 1 risk-based, total risk-based and common equity Tier 1 ratios were 6.27%, 14.07%, 14.27% and 14.07%, respectively; the Bank’s were 5.97%, 13.47%, 13.67% and 13.47%.
Material changes and management commentary
- Interest income and net interest income grew with higher loan balances, particularly SBLOC, SBA and leasing. The average yield on loans fell, in part because SBLOCs made up a larger share of lending.
- Reported non-interest expense increased $14.7 million in Q3 and $36.7 million year to date. BSA lookback consulting accounted for $11.7 million in Q3 and contributed to a $21.7 million year-to-date increase in BSA-related consulting costs.
- Q3 loan-sale results shifted from a $2.8 million gain in 2014 to an $0.8 million loss in 2015; management cited lower margins associated with wider credit spreads. Prepaid-card fees also declined, while salaries, FDIC insurance and other compliance-related costs increased.
- The company disclosed a restatement of prior periods through September 30, 2014, primarily related to discontinued commercial lending. It included $28.5 million of previously unreported discontinued-operation losses and moved $12.7 million of 2015 loan losses, resolved before financial-statement issuance, into 2014.
- Management said it planned to exit certain higher-cost deposits. In October 2015 it reported exiting approximately $485 million of such relationships; these outflows, alongside the planned transfer of HSA deposits, could reduce Federal Reserve balances and may require FHLB advances or brokered certificates of deposit to manage liquidity.
Outlook, risks and unusual items
- Guidance: The filing provides no numerical earnings or revenue guidance. Management said it expected BSA lookback work to be completed in Q2 2016, but could not estimate the remaining related expense. Management also anticipated that growth in continuing businesses could eventually offset increased compliance costs; this is not assured.
- Regulatory restrictions: The Bank is subject to an FDIC Consent Order and August 2015 amendment. The Bank may not pay dividends without prior FDIC approval; a Federal Reserve supervisory letter also restricts company dividends, certain distributions, new debt and share redemptions without approval. Restrictions on certain prepaid-card, ISO and ACH activities remain tied to remediation and regulatory approval.
- Controls: Management concluded disclosure controls and procedures were ineffective at September 30, 2015. Previously identified material weaknesses involved credit-file maintenance and evaluation and discontinued-operations classification. Remediation steps were underway, but management said effectiveness testing remained necessary.
- Legal and compliance exposure: A securities class action alleges misleading disclosures concerning problem loans, loan-loss reserves and BSA compliance. The matter was preliminary and reasonably possible losses could not be estimated. The FDIC was also reviewing certain third-party card-program practices for potential unfair or deceptive acts; any civil money penalties would not be indemnified.
- Subsequent HSA sale: On October 23, 2015, the Bank agreed to sell certain health savings account assets and related contracts to HealthEquity for $34.425 million. The company expected to record the gain, net of transaction and disposition expenses, in Q4 2015; approximately $400 million of related deposits were planned to transfer in December.
- Other exposures: Fair values for several material assets, including held-for-sale loans and notes from the unconsolidated entity, rely on unobservable inputs. The investment portfolio had unrealized losses, but the company reported no other-than-temporary impairment charges for the first nine months.
Investor verification priorities
- Verify the status and cost of BSA remediation and lookback work, and whether required FDIC and Federal Reserve approvals or restrictions change.
- Track deposit runoff, the planned HSA deposit transfer, liquidity needs, and any subsequent use of borrowing lines or brokered funding.
- Confirm the HSA sale’s final net gain and timing of deposit transfer, and the pace and proceeds of sales or paydowns of discontinued commercial loans.
- Assess whether loan-sale margins, prepaid-card fees, net interest margin and elevated operating expenses improve or deteriorate in subsequent periods.
- Review progress in remediating material weaknesses and the outcome, potential exposure and developments in the securities litigation and FDIC review.
- Reconcile the restated comparative results and monitor credit quality, reserve adequacy and the valuation assumptions used for Level 3 assets.