Customers Bancorp, Inc. — Q3 2014 Form 10-Q
Business context and period: Customers Bancorp is a bank holding company operating Customers Bank, which provides commercial and consumer banking, commercial lending and nationwide mortgage-warehouse financing. This unaudited filing covers the quarter and nine months ended September 30, 2014; balance-sheet comparisons are to December 31, 2013. Amounts below are in millions unless stated otherwise.
Financial results and position
| Metric | Q3 2014 / Sept. 30, 2014 | Comparable period / prior date |
|---|---|---|
| Net interest income | $40.2 | $27.2 in Q3 2013 |
| Provision for loan losses | $5.0 | $0.8 in Q3 2013 |
| Non-interest income | $5.1 | $4.7 in Q3 2013 |
| Non-interest expense | $24.7 | $18.3 in Q3 2013 |
| Net income | $11.7; diluted EPS $0.42 | $8.3; diluted EPS $0.30 in Q3 2013 |
| Net interest margin | 2.78% (2.79% tax-equivalent) | 3.11% in Q3 2013 (tax-equivalent) |
| Total assets | $6,532 | $4,153 at Dec. 31, 2013 |
| Loans receivable, net of allowance | $4,079 | $2,441 at Dec. 31, 2013 |
| Loans held for sale | $1,396 | $748 at Dec. 31, 2013 |
| Deposits | $4,284 | $2,960 at Dec. 31, 2013 |
| Cash and cash equivalents | $331 | $233 at Dec. 31, 2013 |
| Total shareholders’ equity | $426 | $387 at Dec. 31, 2013 |
For the first nine months of 2014, net interest income was $106.9 million versus $75.9 million, net income was $30.0 million versus $23.7 million, and diluted EPS was $1.08 versus $0.98. Operating cash flow was negative $445.6 million, compared with positive $588.0 million in the prior-year period; investing cash flow was negative $1.79 billion, while financing activities provided $2.33 billion. Cash increased by $98.2 million over the nine months.
At September 30, borrowings included $1.595 billion of FHLB advances, $88.3 million of other borrowings and $112.0 million of subordinated debt. Total liabilities were $6.11 billion. Management reported $2.9 billion of FHLB borrowing capacity, of which $1.3 billion was utilized in short-term borrowings, and $64.3 million of Federal Reserve borrowing capacity. Management believed liquidity was adequate for foreseeable requirements.
Regulatory capital ratios remained above well-capitalized thresholds. Customers Bank reported total risk-based capital of 11.81%, Tier 1 risk-based capital of 8.99%, and Tier 1 leverage of 7.55% at quarter-end.
Material changes and management commentary
- Management attributed substantial balance-sheet growth to organic lending and deposit growth. Total assets rose $2.4 billion from year-end; Q3 loan balances increased $0.8 billion and deposits $0.6 billion. Multi-family, commercial, and warehouse lending were significant contributors.
- Q3 net income rose 41% year over year, supported by a $13.0 million increase in net interest income. Growth in average loan balances drove income, but lower asset yields and a shift toward lower-yielding multi-family loans compressed the tax-equivalent net interest margin by 32 basis points.
- Provision expense rose to $5.0 million in Q3, primarily reflecting loan growth and a reduced expected benefit from FDIC loss-sharing arrangements. The nine-month provision was $12.3 million versus $2.7 million in 2013.
- Q3 expenses increased $6.3 million year over year, including higher staffing, regulatory assessments and fees, occupancy, professional services and technology costs. Management cited business expansion and infrastructure investment. The Q3 efficiency ratio was 54.5%, and return on average common equity was 11.0%.
- Nine-month non-interest income included a $3.2 million gain on securities sales and a $0.7 million gain on multi-family loan sales. Mortgage-warehouse transactional fees declined $4.5 million year over year, reflecting reduced activity and competition. A $1.5 million tax adjustment reduced Q3 tax expense; the reported Q3 effective tax rate was 25%.
Risks, contingencies and outlook
- The filing provides no specific earnings or operating guidance. Management described performance as strong but cautioned that forward-looking statements are subject to risks and uncertainties.
- Credit exposure is concentrated in commercial real estate and multi-family lending. The allowance for loan losses was $31.1 million; the reported non-performing-loan ratio was 0.25% at September 30, versus 0.60% at December 31, 2013. The allowance was 0.8% of non-covered loans, and total reserves were 246.4% of non-performing loans.
- Mortgage-warehouse lending carries risks including fraud, mortgage-company bankruptcy or default, and underlying borrower default. The filing also describes a suspected 2013 loan-fraud matter; a $2.0 million contingency had been recorded in 2013, with a net $0.7 million classified in other assets at September 30, 2014.
- Deposits include brokered funding, and the company used substantial FHLB borrowing to support asset growth. Interest-rate, funding and execution risks merit attention as the balance sheet expands.
- Non-single-family FDIC loss-sharing arrangements expire in Q3 2015; single-family arrangements expire in Q3 2020. Management noted reduced expected benefits as the earlier expiration approaches.
- The company issued $25 million of 4.625% senior notes due 2019 and $110 million of subordinated notes due 2029 in June 2014; the subordinated notes qualify as Tier 2 capital. The filing discussed forthcoming Basel III capital requirements and related potential constraints, but reported no material change in market-risk disclosures.
- Management stated disclosure controls were effective and there were no material changes in internal control over financial reporting. No material changes to previously disclosed legal proceedings were reported.
Important facts for investors to verify
- Whether rapid loan growth, especially in multi-family and commercial real estate, is sustainable without weakening underwriting or asset quality.
- Whether margin compression continues and how loan yields, funding costs and the mix of brokered deposits affect profitability.
- How the allowance and FDIC reimbursement estimates compare with subsequent credit performance, particularly as non-single-family loss-sharing coverage expires.
- Whether cash-flow volatility from mortgage-warehouse originations, loan growth and reliance on external funding remains manageable.
- The recurring earnings contribution from securities and loan-sale gains, mortgage-warehouse fees, and the one-time tax adjustment.