Customers Bancorp, Inc. quarterly report, Q2 FY2018

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Customers Bancorp, Inc. — Q2 2018 Form 10-Q

Business context and reporting period. Unaudited results cover the three and six months ended June 30, 2018, compared with the same 2017 periods. Customers Bancorp operates through Customers Bank, with Community Business Banking and BankMobile as reportable segments. BankMobile remained classified as held and used while a planned spin-off and merger was pending.

Key financial metrics

  • Q2 earnings: Net income was $23.7 million and net income available to common shareholders was $20.0 million; diluted EPS was $0.62.
  • First-half earnings: Net income was $47.8 million and income available to common shareholders was $40.6 million; diluted EPS was $1.26.
  • Interest income and margin: Q2 net interest income was $67.3 million, down 1.9% year over year. Tax-equivalent net interest margin was 2.62%, versus 2.78%. First-half net interest income rose 1.0% to $132.4 million; tax-equivalent margin was 2.64%, versus 2.76%.
  • Non-interest income and expense: Q2 non-interest income was $16.1 million, down 12.3%, and expense was $53.8 million, up 6.6%. First-half non-interest income was $37.0 million, down $4.1 million; expense was $106.0 million, up $6.3 million. Comparisons are affected by the 2018 presentation of interchange costs net against revenue rather than in expense.
  • Assets and funding: Total assets were $11.09 billion at June 30, up 12.7% from year-end 2017. Deposits were $7.30 billion, up 7.3%; FHLB advances were $2.39 billion, up 48.3%. Total borrowings were approximately $2.8 billion, up 35.3% from year-end.
  • Loans and credit: Loans receivable, net of allowance, were $7.14 billion; loans held for sale were $1.93 billion, primarily mortgage warehouse loans. The allowance was $38.3 million, or 0.53% of loans receivable. Non-performing loans were $26.0 million, or 0.29% of total loans including held-for-sale loans; non-performing assets were 0.25% of total assets. Q2 provision was a $0.8 million benefit; first-half provision was $1.3 million.
  • Cash flow and liquidity: First-half operating cash flow was negative $71.9 million, investing cash flow negative $1.04 billion, and financing cash flow positive $1.22 billion. Cash and cash equivalents ended at $251.7 million. Available FHLB borrowing capacity was $4.9 billion, with $2.4 billion borrowed and $1.6 billion used to collateralize municipal deposits.
  • Capital and equity: Shareholders’ equity was $936.2 million. Bancorp common equity Tier 1 was 8.61%, Tier 1 capital 11.16%, total risk-based capital 12.55%, and Tier 1 leverage 8.87%; the filing states the Bank and Bancorp met applicable capital requirements.
  • Comprehensive income: First-half other comprehensive loss was $32.3 million, primarily reflecting unrealized losses on available-for-sale securities; accumulated other comprehensive loss was $34.0 million at quarter-end.

Material changes versus comparable periods

  • Q2 common earnings were nearly flat year over year; first-half common earnings declined 3.9%. Higher expenses and lower non-interest income weighed on results, partly offset by lower tax expense and lower loan-loss provision.
  • Funding costs rose faster than asset yields: management cited higher deposit and borrowing costs as the main reason for margin compression. Average borrowing balances increased to fund asset growth.
  • First-half assets expanded substantially, including a $689.6 million increase in investment securities and $405.8 million growth in total loans, including loans held for sale. Growth in securities was funded in part by higher FHLB borrowing.
  • BankMobile card and deposit-fee activity declined. On a comparable net-of-interchange-cost basis, management attributed much of the card revenue decline to lower BankMobile activity volumes.
  • Presentation of 2017 results was reclassified to reflect BankMobile as held and used, not discontinued operations. Adoption of revenue-recognition guidance also shifted debit and prepaid card interchange costs from expense to a reduction of revenue, limiting direct comparability.

Outlook, commentary, risks and unusual items

  • Management expected a more moderate pace of growth through the rest of 2018, emphasizing a shift from lower-yielding to higher-yielding assets and development of sustainable deposits to replace short-term borrowings.
  • The BankMobile spin-off and merger remained subject to closing conditions, with no assurance of completion by or shortly after September 30, 2018. On August 7, 2018, after quarter-end, the parties agreed to withdraw the merger application from the FDIC for further questions and comments; Flagship intended to resubmit it as soon as practicable and hoped to do so by September 30.
  • A key transaction risk is that the Federal Reserve could treat the post-merger BankMobile/Flagship company as affiliated with Customers Bancorp for Durbin Amendment purposes. If the combined company loses the small-issuer exemption, interchange revenue and its ability to attract or retain white-label partners could be materially affected.
  • Management reported that the 6.375% senior notes with $63.3 million aggregate principal matured on July 31, 2018 and that Bancorp had sufficient funds to repay them.
  • Interest-rate sensitivity modeling estimated net interest income decreases of 3.9%, 8.4% and 13.4% under immediate rate increases of 100, 200 and 300 basis points, respectively; a 100-basis-point decline implied a 1.2% decrease. These are model estimates, dependent on assumptions.
  • The filing identifies CECL adoption as a future uncertainty that may increase the allowance for loan losses. Management was evaluating the impact and did not intend to early adopt.
  • Other notable items include $0.9 million of Q2 merger-related expense, a $0.3 million unrealized loss on Religare equity securities recognized in earnings, and first-half net interest margin pressure from funding costs. Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.

Most important facts for investors to verify

  • Whether the BankMobile spin-off and Flagship merger received regulatory approval, closed, and met the agreement’s timing conditions—and the resulting Durbin Amendment treatment.
  • Whether deposit growth and mix can reduce reliance on FHLB and other wholesale borrowings, and whether funding costs continue to outpace asset-yield increases.
  • Whether expense growth, particularly staffing and technology costs, translates into improved BankMobile activity and sustainable operating leverage.
  • Whether loan growth, portfolio concentration, delinquencies and credit losses remain consistent with management’s asset-quality assessment, and how CECL affects reserves.
  • How securities-market value changes affect accumulated other comprehensive loss, equity and regulatory capital; confirm the effect of the July 2018 senior-note repayment on liquidity and capital.