Customers Bancorp, Inc. quarterly report, Q3 FY2016

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Customers Bancorp, Inc. — Q3 2016 Form 10-Q

Business context and period. This unaudited filing covers the quarter and nine months ended September 30, 2016, with comparisons to 2015. Customers Bancorp operates Customers Bank, serving commercial and consumer customers, and BankMobile, its nationwide digital banking business. In June 2016, the company acquired Higher One’s student disbursement business and combined it with BankMobile; beginning in Q3 it reported Community Business Banking and BankMobile as separate segments.

Financial performance and position

  • Q3 earnings: Net income was $21.2 million versus $15.3 million a year earlier. Net income available to common shareholders was $18.6 million, up 30.3%; diluted EPS was $0.64 versus $0.50.
  • Nine-month earnings: Net income was $58.3 million versus $40.8 million. Net income available to common shareholders was $52.4 million, up 33.3%; diluted EPS was $1.81 versus $1.37.
  • Net interest: Q3 net interest income rose 29.3% to $64.6 million; tax-equivalent net interest margin was 2.83%, up 4 basis points year over year. Nine-month net interest income rose 29.8% to $185.4 million, with a 2.84% tax-equivalent margin, also up 4 basis points.
  • Non-interest results: Q3 non-interest income increased to $27.5 million from $6.2 million, largely reflecting BankMobile interchange, deposit and university fees, plus a $2.2 million recovery of a previously recorded loss. Q3 non-interest expense rose to $56.2 million from $30.3 million, including higher BankMobile and growth-related costs and a $3.9 million one-time technology expense. Nine-month non-interest income was $41.2 million versus $18.3 million; expense was $128.3 million versus $83.4 million.
  • Credit costs and asset quality: Q3 loan-loss provision was $0.1 million versus $2.1 million; nine-month provision was $2.9 million versus $14.4 million. The allowance was $37.9 million, or 0.63% of loans receivable. Management reported non-performing loans at 0.16% of total loans and non-performing assets at 0.18% of total assets. TDRs totaled $14.2 million, up from $11.4 million at year-end 2015.
  • Balance sheet and funding: Assets were $9.60 billion, up 14.3% from December 31, 2015. Deposits rose 25.0% to $7.39 billion; loans receivable, net of allowance, increased to $5.98 billion, while loans held for sale grew to $2.40 billion, primarily mortgage warehouse loans. Shareholders’ equity was $789.8 million versus $553.9 million.
  • Debt and liquidity: Total borrowings were approximately $1.28 billion, down from approximately $1.89 billion at year-end, mainly as deposit growth reduced short-term funding needs. Cash and cash equivalents were $265.6 million, including $20 million restricted in escrow for the acquisition. The company reported $4.1 billion of FHLB borrowing capacity, with $1.0 billion borrowed and $1.6 billion used to support municipal deposits; Federal Reserve Bank capacity was $58.7 million.
  • Cash flow: Nine-month operating cash use was $528.7 million and investing cash use was $507.4 million; financing provided $1.04 billion, and cash increased $1.0 million. Operating cash flow reflected mortgage warehouse loan originations exceeding related sale proceeds by $619.1 million.
  • Capital: The company raised net proceeds of $162.0 million from preferred stock offerings in the first nine months and $5.5 million through its ATM common-stock program. At September 30, the Bank’s CET1, total risk-based capital and leverage ratios were 9.97%, 11.87% and 8.23%, respectively; the Bancorp’s total risk-based capital ratio was 11.63%. Both met applicable capital requirements.

Material changes and unusual items

  • Q3 growth in net interest income was principally volume-driven, with average loan and securities balances about $2.0 billion higher year over year; funding costs also rose.
  • BankMobile recorded a Q3 net loss of $1.2 million and a nine-month net loss of $2.5 million. Community Business Banking reported Q3 net income available to common shareholders of $19.8 million.
  • BankMobile had 1.5 million-plus deposit accounts at quarter-end. Since the acquisition, it added more than 200,000 accounts and converted 300,000 accounts at students’ election from a prior Higher One partner.
  • The FDIC loss-sharing agreements were terminated in July 2016; Customers paid $1.4 million in final settlement and reported no remaining related receivable or liability.
  • Preferred stock dividends increased, reflecting 2016 issuances; Q3 preferred dividends were $2.6 million. The nine-month effective tax rate rose to 38.9% from 35.5%, partly due to a greater share of income-producing assets in New York and an $0.8 million tax-return true-up.

Outlook, commentary and risks

  • Management said it intended to moderate balance-sheet growth and multi-family loan growth. It expected BankMobile and the acquired disbursement business to operate at approximately break-even by year-end 2016. Management’s preliminary estimate for the disbursement business’s first full year was approximately $60 million in revenue, with expenses of a similar amount before corporate overhead allocations; actual results could differ materially.
  • Customers stated an intent to sell BankMobile within 12 to 24 months, depending on market conditions and opportunities. The company warned that a sale is not assured and that a process could disrupt customer and employee relationships, distract management, incur costs, or affect share value.
  • A key constraint is remaining below $10 billion in total assets as of each December 31 to retain the small-issuer debit interchange treatment. Exceeding the threshold before BankMobile is sold could significantly reduce interchange revenue and make the segment unprofitable absent replacement fees. Assets were $9.60 billion at September 30.
  • Interest-rate modeling estimated net interest income increases of 4.2%, 5.1% and 2.6% under immediate +100, +200 and +300 basis-point shocks, respectively, and a 4.1% decline under a -100 basis-point shock. Estimated economic value of equity declined 20.4% under +300 basis points. These are model estimates dependent on assumptions.
  • Off-balance-sheet commitments included $163.5 million to fund loans, $747.4 million of unfunded mortgage warehouse commitments, $511.4 million of unfunded credit lines and $40.6 million of letters of credit. Management stated it believed available funding was adequate for foreseeable needs.
  • After quarter-end, Customers agreed to sell 2.1 million common shares at $25 per share, with estimated net proceeds of $50.8 million; underwriters had a 30-day option for 315,000 additional shares.

Most important facts for investors to verify

  • Whether BankMobile’s integration achieves the stated break-even outlook and whether a sale is completed on acceptable terms and timing.
  • How asset growth is managed against the $10 billion year-end threshold, and the resulting impact on debit interchange economics.
  • The sustainability of loan growth, net interest margin, deposit growth and funding costs, including mortgage warehouse exposure and the concentration in commercial lending.
  • Credit trends, especially the rise in TDRs and risk-rated loans, adequacy of the allowance, and whether reported low non-performing ratios persist.
  • The recurring cost base after acquisition-related and one-time expenses, including technology, professional services and staffing, and the effect of preferred dividends and future common-share issuance on per-share returns.