Business context and reporting period
Customers Bancorp, Inc. is a bank holding company operating Customers Bank and digital banking platform BankMobile. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2019. Comparisons below are with Q3 or the first nine months of 2018 for operating results, and with December 31, 2018 for balance-sheet changes.
Financial performance and condition
- Q3 earnings: Net interest income was $75.7 million, up 18.3% year over year. Net income was $27.1 million; net income available to common shareholders was $23.5 million, or $0.74 diluted EPS, versus $2.4 million, or $0.07, in Q3 2018. Pre-tax income was $35.1 million versus $6.1 million.
- Nine-month results: Net interest income was $199.7 million, up 1.7%; net income was $51.8 million versus $53.8 million. Common net income was $41.0 million, or $1.30 diluted EPS, versus $43.0 million, or $1.33.
- Margins: Tax-equivalent net interest margin was 2.83% in Q3, compared with 2.47% a year earlier; the nine-month margin was 2.69% versus 2.58%. Funding costs rose, partly offsetting stronger asset yields.
- Balance sheet: Total assets were $11.72 billion, up $1.89 billion from year-end 2018. Deposits were $8.93 billion, up 25.0%; shareholders’ equity was $1.02 billion. Loans and leases, including mortgage warehouse balances and loans held for sale, totaled about $10.3 billion.
- Portfolio shifts: Mortgage warehouse loans at fair value rose to $2.44 billion from $1.41 billion at year-end. Other consumer loans grew to $643.6 million from $74.0 million, while multi-family loans declined to $2.30 billion from $3.29 billion; $499.8 million of multi-family loans were reclassified as held for sale.
- Credit: The allowance for loan and lease losses was $51.1 million, or 0.70% of loans and leases receivable, versus $40.0 million, or 0.56%, at year-end. Nine-month provision was $14.5 million versus $4.3 million; net charge-offs were $3.5 million versus $1.5 million. Non-performing loans were $17.6 million, or 0.17% of the reported total loan and lease portfolio.
- Cash flow and liquidity: For the first nine months, operating cash flow was $34.7 million, investing cash flow was negative $1.67 billion, and financing cash flow was positive $1.75 billion. Cash and cash equivalents ended at $182.2 million. The company reported $3.9 billion of FHLB borrowing capacity, of which $1.0 billion was borrowed and $1.8 billion of capacity supported state and municipal deposits; FRB borrowing capacity was $183.9 million.
- Debt and capital: FHLB advances were $1.04 billion, federal funds purchased $373.0 million, other borrowings $123.5 million, and subordinated debt $109.1 million. The company issued $25 million of 4.50% senior notes due 2024 in September and contributed net proceeds to the Bank as Tier 1 capital. At September 30, the Bank’s CET1, Tier 1, total capital, and leverage ratios were 10.847%, 10.847%, 12.421%, and 9.829%, respectively; the company reported compliance with applicable capital requirements.
Material changes versus comparable periods
- Q3 common earnings rose sharply, aided by higher net interest income and the contrast with Q3 2018’s $18.7 million securities-sale loss. The nine-month common earnings comparison remained lower year over year.
- Q3 2019 non-interest income included a $1.0 million securities-sale gain and $1.3 million of unrealized investment-security gains. Nine-month non-interest income also included a $7.5 million loss on acquiring interest-only GNMA securities after a mortgage warehouse customer ceased operations.
- Loan-loss provision increased materially year over year, reflecting portfolio growth, particularly in commercial and industrial and other consumer loans, as well as identified credit exposures. Multi-family runoff and the transfer of loans to held for sale partly offset the provision.
- Non-interest expense increased 4.4% in Q3 and 6.1% for the first nine months. Higher professional-services costs, operating-loss provisions, and commercial-lease depreciation were partly offset by lower technology costs in Q3, lower regulatory assessments, and no 2019 merger-related expense.
- Deposits grew substantially from year-end, including demand deposits; the company said its funding strategy sought to expand lower-cost core deposits. A digital savings product had generated $534 million in retail deposits by September 30.
Outlook, commentary, risks and unusual items
- Management targeted full-year 2019 net interest margin of at least 2.70%, with further Q4 expansion expected. It expected year-end assets below $10 billion, average 2019 interest-earning assets comparable to 2018, and planned about $300 million or more of additional multi-family runoff in Q4 alongside the planned sale of approximately $500 million of multi-family loans. Management noted Q3 asset growth was boosted by seasonal mortgage warehouse activity and expected its Q4 contraction to help reduce total assets.
- Over the next two to three years, management’s stated priorities included core return on average assets of at least 1.25% and double-digit return on tangible common equity. BankMobile reached profitability one quarter earlier than expected; management expected it to remain profitable in Q4 2019 and 2020.
- Q3 results included $2.0 million of legal contingency accruals related to the Halbreiner and Department of Education matters. The Halbreiner matter had a preliminary $1.0 million settlement agreement and reserve. For the DOE matter, the company appealed asserted liabilities of $6.5 million, estimated a possible loss range of $1 million to $3 million, and recorded a $1.0 million reserve.
- A mortgage warehouse customer’s shutdown led to acquisition of collateral GNMA securities and a $7.5 million loss; the securities were subsequently measured at fair value, with $17.1 million fair value at quarter-end.
- The company reported that an internet-based organized crime ring targeted BankMobile checking accounts, contributing to higher operating-loss provisions.
- The company disclosed a disputed U.S. Treasury check reclamation demand of approximately $5.4 million. It had protested the demand and could not estimate the likelihood or range of loss; it stated it did not believe the matter would materially affect the financial statements.
- Management identified potential risk to New York multi-family collateral and property income from the 2019 Housing Stability and Tenant Protection Act. New York multi-family exposure was approximately $1.7 billion. The filing’s stated rent-regulated exposure (“$1.2 million, or 68%”) appears internally inconsistent; the value is not clear from the filing text.
- Customers planned to adopt CECL on January 1, 2020 and expected an increase in the allowance, but did not quantify the amount. It was running parallel models and evaluating assumptions.
- Management stated that disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether the planned multi-family loan sale and runoff occurred, and whether total assets fell below $10 billion as projected.
- Whether management achieved its full-year NIM outlook and whether deposit-cost trends and funding mix supported profitability.
- Credit performance and reserve adequacy in the rapidly expanded other-consumer and commercial-and-industrial portfolios, including actual charge-offs and CECL adoption impact.
- Final outcomes and any additional accruals for the Halbreiner, DOE, and Treasury reclamation matters; clarify the inconsistent New York rent-regulated exposure disclosure.
- Whether BankMobile’s profitability persisted and whether fraud-related operating losses moderated.
- Liquidity and capital headroom after balance-sheet growth, debt issuance, and any changes in borrowing capacity or pledged collateral.