Customers Bancorp, Inc. — Q2 2019 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2019. Unaudited consolidated results. Amounts below are in millions of dollars except per-share data and ratios.
Business context
Customers Bancorp is a bank holding company operating Customers Bank and BankMobile. Its businesses include commercial and consumer lending, mortgage warehouse financing, equipment finance, and digital banking. BankMobile provides digital banking and disbursement services, including through white-label partners.
Financial performance
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Net interest income | $64.7 | $67.3 | $124.0 | $132.4 |
| Provision for loan and lease losses | $5.3 | $(0.8) benefit | $10.1 | $1.3 |
| Non-interest income | $12.0 | $16.1 | $31.8 | $37.0 |
| Non-interest expense | $59.6 | $53.8 | $113.6 | $106.0 |
| Net income | $9.3 | $23.7 | $24.7 | $47.8 |
| Net income available to common shareholders | $5.7 | $20.0 | $17.5 | $40.6 |
| Diluted earnings per common share | $0.18 | $0.62 | $0.55 | $1.26 |
| Net interest margin, tax-equivalent | 2.64% | 2.62% | 2.62% | 2.64% |
- Q2 common earnings declined 71.7% year over year; first-half common earnings declined 56.9%. The company cited lower net interest income, higher credit provision and expenses, and a $7.5 million loss related to collateral acquired from a mortgage warehouse customer.
- Q2 net interest margin expanded five basis points from Q1 2019 to 2.64%, the third consecutive quarterly increase from the 2.47% trough in Q3 2018. Year-to-date margin was below the prior-year period as funding costs rose faster than asset yields.
- BankMobile reported a Q2 net loss of $7.1 million and a six-month net loss of $7.3 million. Management expected the segment to become profitable in Q4 2019.
Financial position, liquidity, and capital
- At June 30, 2019, total assets were $11.18 billion, up 13.7% from year-end 2018. Total loans and leases, including mortgage warehouse loans, were $9.67 billion; deposits were $8.19 billion; shareholders’ equity was $991.4 million.
- Cash and cash equivalents were $95.8 million. Total borrowings were approximately $1.88 billion, comprising federal funds purchased of $406.0 million, FHLB advances of $1.26 billion, other borrowings of $99.1 million, and subordinated debt of $109.0 million.
- Six-month operating cash flow was $3.1 million, down from $65.5 million in 2018. Investing activities used $1.21 billion, largely reflecting net mortgage warehouse loan originations and loan purchases; financing activities provided $1.24 billion, principally from deposit growth and borrowings.
- FHLB borrowing capacity was $4.2 billion, with $1.3 billion drawn and $2.0 billion of capacity used to collateralize state and municipal deposits. FRB borrowing capacity was $129.7 million.
- The Bank reported a common equity Tier 1 ratio of 11.19%, total capital ratio of 12.84%, and Tier 1 leverage ratio of 10.32%. Bancorp ratios were 8.04%, 11.76%, and 9.51%, respectively. The filing states both entities met applicable capital requirements.
Material changes and asset quality
- Deposits rose $1.04 billion from December 31, 2018. Loans and leases increased, while multi-family loans declined $267.8 million to $3.02 billion. Mortgage warehouse balances rose $596.1 million to $2.00 billion, partly reflecting seasonal refinancing activity.
- Other consumer loans increased sharply, reaching $552.8 million, following purchases of third-party originated unsecured loans. Management described a strategy of growing C&I and consumer lending while running off lower-yielding multi-family loans.
- Non-performing loans were $14.8 million, or 0.15% of loans and leases, versus $27.5 million, or 0.32%, at December 31, 2018. The allowance for loan and lease losses increased to $48.4 million from $40.0 million; net charge-offs were $1.7 million for the first half, versus $1.1 million in 2018.
- Reported Q2 non-interest income included the $7.5 million GNMA collateral acquisition loss. The acquired interest-only securities were valued at $17.2 million at quarter-end and are measured at fair value using significant unobservable inputs.
Outlook, risks, and contingencies
- Management targeted full-year 2019 net interest margin above 2.70% and a 2.80% margin by Q4 2019. It also expected year-end 2019 assets below $10 billion, citing plans to reduce multi-family loans by at least $1 billion in the second half and normal winter seasonality in mortgage warehouse lending.
- Longer-term targets included approximately 1.25% return on average assets and double-digit return on tangible common equity within two to three years. Management expected average 2019 interest-earning assets to be comparable to 2018.
- Management was implementing CECL for expected credit losses, running the new model in parallel during Q2, and anticipated an increase in the allowance at adoption. The amount depends on portfolio composition and economic forecasts at adoption; the company did not provide a clear estimate.
- Interest-rate models estimated net interest income changes through June 2020 of -1.0% under an immediate 300-basis-point increase and -1.9% under a 200-basis-point decrease. Management cautioned that actual outcomes depend on model assumptions and market conditions.
- Legal and regulatory matters include a Department of Education determination asserting $6.5 million of liabilities, which Customers is appealing; a Treasury check reclamation demand of approximately $5.4 million, which it protested; and two lawsuits for which the company could not estimate the likelihood or range of loss. Customers stated it did not expect the DOE or Treasury matters to materially affect the financial statements.
- The filing reported no material changes to previously disclosed risk factors. Management stated disclosure controls were effective and there were no material changes in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether planned multi-family loan runoff and mortgage warehouse seasonality achieve the year-end asset target below $10 billion.
- Whether margin expansion offsets deposit and borrowing cost pressure and supports the stated 2019 margin objectives.
- Performance, credit losses, and returns on the fast-growing unsecured consumer loan portfolio, and the path to BankMobile profitability.
- Valuation and any subsequent fair-value changes in the $17.2 million GNMA securities, as well as developments concerning the mortgage warehouse customer exposure.
- CECL implementation assumptions and the resulting allowance increase, plus outcomes of the DOE appeal, Treasury protest, and pending lawsuits.
- Cash-flow volatility, funding mix, available borrowing capacity, and capital ratios as the balance sheet changes.