Customers Bancorp, Inc. quarterly report, Q2 FY2015

Customers Bancorp, Inc. — Second Quarter 2015 Form 10-Q

Reporting period: Three and six months ended June 30, 2015; unaudited. Customers Bancorp is a bank holding company operating through Customers Bank, with commercial, consumer, and mortgage warehouse lending businesses.

Financial results and position

Metric	Q2 2015	Q2 2014	Six months 2015	Six months 2014
Net interest income	$46.6 million	$36.9 million	$92.9 million	$66.7 million
Provision for loan losses	$9.3 million	$2.9 million	$12.3 million	$7.3 million
Net income	$11.6 million	$10.2 million	$25.5 million	$18.4 million
Net income available to common shareholders	$11.0 million	$10.2 million	$25.0 million	$18.4 million
Diluted earnings per common share	$0.39	$0.37	$0.88	$0.66

Q2 net interest income rose 26.1%, principally from loan growth. Tax-equivalent net interest margin was 2.73%, down from 2.94%; the six-month margin was 2.81%, versus 2.93%.
Q2 non-interest income was $6.4 million, down from $6.9 million; non-interest expense was $25.7 million, versus $25.2 million. Six-month non-interest income declined to $12.1 million from $14.2 million, while expense increased to $53.1 million from $46.4 million.
At June 30, total assets were $7.62 billion, up 11.6% from year-end 2014. Loans held for sale were $2.03 billion, including $1.94 billion of mortgage warehouse loans; net loans receivable were $4.49 billion.
Total deposits increased 20.8% from year-end to $5.48 billion. Cash and cash equivalents were $391.6 million. FHLB advances were $1.39 billion; other borrowings were $88.3 million and subordinated debt was $110.0 million.
Shareholders’ equity was $523.5 million. The Bank’s common equity Tier 1 ratio was 9.13% and total capital ratio was 11.65%; the filing states the Bank and Bancorp met applicable capital requirements and were well capitalized.
Operating cash flow was negative $582.9 million for the six months, primarily reflecting mortgage-loan-held-for-sale originations exceeding sale proceeds by $613.8 million. Investing cash flow was negative $167.4 million; financing cash flow was positive $770.8 million, led by deposit growth. Cash and cash equivalents increased $20.6 million to $391.6 million.

Material changes versus comparable periods

Six-month common earnings rose 36.1% year over year, supported by $26.2 million higher net interest income, substantially offset by higher credit provision, operating costs, and taxes.
Loan balances, including loans held for sale, grew 14.0% from December 31, 2014, largely due to mortgage warehouse lending. Deposits grew 20.8%; FHLB advances declined $230 million.
Q2 diluted EPS included a $0.13-per-share after-tax effect from a $6.0 million specific allowance tied to potentially fraudulent activity at one commercial borrower. Management reported non-GAAP core earnings of $14.9 million, or $0.52 per diluted share, excluding that item; this measure is not GAAP and may not be comparable to other companies’ measures.
The Company issued 2.3 million Series C preferred shares in May, receiving $55.6 million net proceeds. The shares carry a 7.00% non-cumulative dividend through June 14, 2020, then a floating rate of three-month LIBOR plus 5.30%, subject to declaration and other terms.

Outlook, risks, contingencies, and unusual items

The filing provides no specific earnings or balance-sheet guidance. Management said it believed available funding sources were adequate for short- and long-term requirements for the foreseeable future; forward-looking statements are subject to substantial risks and uncertainties.
On July 22, after quarter-end, the Company identified potentially fraudulent activity involving one Pennsylvania commercial customer. It said the matter was isolated to one loan, reserved $6.0 million in Q2, continued its investigation and collection efforts, and enhanced related controls. The reported $10.6 million in non-performing loans at June 30 was 0.16% of the $6.6 billion loan portfolio.
The allowance for loan losses was $37.5 million, versus $30.9 million at year-end. Management cited the specific loan reserve, portfolio growth and mix, collateral valuation changes, and FDIC-related estimates. It also revised its general allowance methodology to use industry and peer loss data for certain portfolios.
Customers recorded a $2.4 million estimated FDIC clawback liability, reflecting expected repayment under loss-sharing agreements; the net liability after the related receivable was $1.5 million. Loss-submission deadlines for non-single-family covered loans were approaching in Q3 2015; final loss-sharing arrangements mature in Q3 2020.
Troubled debt restructurings were $10.0 million at June 30, up from $5.0 million at year-end. The filing reports defaults on several recently modified TDR loans during the quarter and first half.
Outstanding off-balance-sheet commitments included $317.3 million to fund loans, $737.0 million of unfunded mortgage warehouse commitments, $368.4 million of unfunded lines of credit, and $35.2 million of letters of credit. Amounts may not all be drawn.
Management reported effective disclosure controls at June 30 and no material change in internal control over financial reporting during the quarter. It reported no material change in previously disclosed legal proceedings.

Investor facts to verify

How the fraud investigation, collateral recovery, and enhanced controls develop, and whether additional losses or disclosures result.
Whether loan growth and mortgage warehouse volumes can be sustained without further margin compression or greater funding costs.
Credit quality trends, especially TDR defaults, commercial and industrial exposures, allowance adequacy, and the impact of the revised loss-estimation methodology.
Actual FDIC clawback payments and recoveries as loss-sharing deadlines approach.
Deposit composition and concentration, including municipal and time deposits, plus available borrowing capacity and collateral requirements.
Series C dividend declarations and the effect of preferred dividends and potential dilution on common-shareholder returns.