Customers Bancorp, Inc. annual report, FY2015

Business context and reporting period

Customers Bancorp, Inc. is a Pennsylvania bank holding company operating through Customers Bank. This Form 10-K covers the fiscal year ended December 31, 2015; the filing also provides unaudited fourth-quarter results. The bank focuses on commercial and specialty lending, including mortgage warehouse and multifamily lending, alongside branch banking and its BankMobile digital platform.

Financial results and key metrics

Unless otherwise noted, amounts are U.S. dollars. Full-year income and cash-flow figures are for 2015 compared with 2014; balance-sheet figures are at December 31.

Net income available to common shareholders rose 29.8%, mainly as net interest income grew 29.2% on higher average earning-asset balances, despite margin compression. The lower margin reflected growth in lower-yielding mortgage warehouse lending. Non-interest expense increased 16.2%, particularly from staffing, professional services and technology costs associated with business growth and BankMobile. Preferred dividends of $2.5 million were recorded in 2015 following the Series C issuance.

Fourth-quarter 2015 net income was $17.8 million, or $16.8 million available to common shareholders; diluted EPS was $0.58. Fourth-quarter net interest income was $53.5 million, the loan-loss provision was $6.2 million, and non-interest expense was $31.5 million.

• Loans and credit: Net loans held for investment were $5.42 billion, up from $4.28 billion. Total loans including held-for-sale balances were about $7.25 billion. Commercial loans were 94.6% of the total portfolio; multifamily loans were $2.9 billion.
• Asset quality: Non-performing loans were $10.8 million, or 0.15% of total loans, versus $11.7 million, or 0.20%, in 2014. Non-performing assets were $15.8 million, or 0.19% of assets. The allowance was $35.6 million, equal to 0.65% of loans held for investment; net charge-offs were $12.0 million, up from $3.1 million.
• Cash flow: Operating activities used $356.6 million, investing activities used $1.26 billion, and financing activities provided $1.51 billion. Operating cash use primarily reflected mortgage warehouse loan originations exceeding sale proceeds. Cash and cash equivalents ended the year at $264.6 million, down from $371.0 million.
• Funding and liquidity: Borrowings totaled about $1.89 billion, including $1.63 billion of FHLB advances, $70 million of federal funds purchased, $110 million of subordinated debt and $88.3 million of senior notes and other borrowings. Wholesale deposits, including brokered deposits, were 42.1% of deposits. Time deposits were 39.7% of deposits, and $1.8 billion of time deposits were scheduled to mature during 2016. Management reported $3.7 billion of FHLB borrowing capacity, of which $1.4 billion was used in short-term borrowings, and considered liquidity adequate for foreseeable needs. The gross loan-to-deposit ratio was 122.7%; excluding mortgage warehouse loans funded by short-term FHLB borrowings, it was 93.0%.
• Capital: Customers Bank’s common equity Tier 1 ratio was 8.62%, Tier 1 risk-based ratio 8.62%, total risk-based ratio 10.85%, and Tier 1 leverage ratio 7.30%. The Bancorp’s corresponding ratios were 7.61%, 8.46%, 10.62% and 7.16%. The filing states both met applicable capital requirements.

Material changes versus prior period

• Assets grew 23.1%, deposits 30.4%, and net loans held for investment 26.5%. Multifamily, commercial and industrial, and mortgage-company lending contributed significantly to growth.
• Net interest income increased with asset growth, but net interest margin declined five basis points to 2.81%. The average tax-equivalent margin was 2.81%, versus 2.87% in 2014.
• The loan-loss provision increased $5.8 million, substantially reflecting a $9.0 million fraudulent loan identified in July 2015. The loan was charged off in full during 2015: $5.3 million in the third quarter and $3.7 million in the fourth quarter. Management said it continued collection efforts and was optimistic about recovery.
• Net charge-offs increased to $12.0 million, largely due to that fraud. Excluding its effects, management cited lower historical loss experience on post-2009 originated loans and revised loss-estimation inputs.
• Series C preferred stock issued in May raised $55.6 million net of offering costs and added $2.5 million of preferred dividends. Tangible common equity to tangible assets declined to 5.89% from 6.44%, while tangible book value per common share rose to $18.39 from $16.43.
• BankMobile launched in January 2015 and had more than 100,000 new checking accounts at year-end. Management said its profitability depends in part on execution of the digital-bank strategy.

Outlook, commentary, risks and unusual items

Management forecast U.S. GDP growth of 2.5%–3.0% in 2016 and growth of 2.0%–3.0% in its markets, with improving housing and employment conditions. It expected the Federal Reserve could raise rates two to four times during 2016, subject to economic data, and reported improving loan demand in commercial and real estate portfolios. These are management’s economic expectations, not company earnings guidance.

• Higher One transaction and regulatory exposure: Customers agreed in December 2015 to acquire Higher One’s student disbursements business for $42 million, including transition-service payments. Closing was expected by July 1, 2016, subject to stockholder approval and other conditions. The business had approximately 2.0 million student deposit customers. Higher One agreed to pay penalties and student restitution under December 2015 consent orders. Customers Bank’s potential regulatory responsibility remained under discussion with the Federal Reserve; the company said the outcome and any penalties could not be predicted, but it did not then expect a material adverse effect.
• Concentration and funding risks: The portfolio is heavily weighted to commercial lending, multifamily real estate and mortgage warehouse facilities. Warehouse lending is exposed to fraud, borrower default, mortgage-market cycles and interest-rate-related volume changes. High reliance on wholesale and time deposits, including substantial 2016 maturities, may pressure funding costs and liquidity.
• Rate sensitivity: The company’s model estimated 2016 net interest income would change by +0.1% under an immediate 100-basis-point rate increase, −3.4% under a 200-basis-point increase and −10.2% under a 300-basis-point increase; a 100-basis-point decrease was estimated to raise net interest income 2.4%. These are modeled estimates based on assumptions, not forecasts.
• FDIC loss sharing: Covered loans fell to $13.8 million from $42.2 million. The company recorded a $2.3 million clawback liability and expected to collect $0.2 million from the FDIC, presenting the net $2.1 million liability in other liabilities. Non-single-family loss-submission periods expired in third-quarter 2015; the single-family period runs through third-quarter 2017, and the agreements mature in third-quarter 2020.
• Other legal matter: The Department of Justice completed its review of a Philadelphia fair-lending referral in 2014 without taking enforcement action; the Federal Reserve advised it would not issue a formal enforcement action on that matter.
• The auditors issued unqualified opinions on the financial statements and internal control over financial reporting. Management and the auditor concluded internal control was effective as of December 31, 2015.

Most important facts for investors to verify

• Progress and final terms of the Higher One acquisition, integration costs, customer retention, and the resolution of Customers Bank’s related regulatory discussions.
• Whether the 2015 fraudulent-loan loss is recoverable, and whether further fraud-related or other credit losses emerge.
• Loan concentrations and underwriting performance, especially multifamily and mortgage warehouse exposures, including subsequent delinquencies, charge-offs and allowance adequacy.
• Deposit composition and retention, brokered/wholesale funding dependence, 2016 time-deposit maturities, and available borrowing capacity.
• Whether margin and expense trends support earnings growth as the balance sheet expands and BankMobile develops.
• Capital ratios and distributions against phased-in capital conservation buffer requirements, and the terms and use of proceeds from the subsequent Series D preferred offering.