Customers Bancorp, Inc. (NYSE:CUBI) Q2 2023 Earnings Call Transcript

Customers Bancorp, Inc. (NYSE:CUBI) Q2 2023 Earnings Call Transcript July 28, 2023

Operator: Good morning. My name is Rob, and I will be your conference operator today. At this time, I would like to welcome everyone to the Customers Bancorp Second Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you David Patti, Director of Communications. You may begin your conference.

David Patti: Thank you, Rob, and good morning everyone. Thank you for joining us for the Customers Bancorp’s earnings call for the second quarter of 2023. The presentation deck you will see during today’s webcast has been posted on the Investor Relations page of the bank’s website at customersbank.com. You can scroll to Q2 2023 results and click Download Presentation. You can also download a PDF of the full press release at the spot. Our investor presentation includes important details that we will walk through on this morning’s webcast. I encourage you to download and use the document. Before we begin, we would like to remind you that some of the statements we make today may be considered forward-looking. These forward-looking statements are subject to a number of risk and uncertainties that may cause actual performance results to differ materially from what is currently anticipated.

Please note that these forward-looking statements speak only as of the date of this presentation, and we undertake no obligation to update these forward-looking statements in light of new information or future events except to the extent required by applicable securities laws. Please refer to our SEC filings, including our Form 10-K and 10-Q for a more detailed description of the risk factors that may affect our results. Copies may be obtained from the SEC or by visiting the Investor Relations section of our website. At this time, it’s my pleasure to introduce to you, Customers Bancorp Chair, Jay Sidhu.

Jay Sidhu: Thank you, Dave, and good morning, ladies and gentlemen. Welcome to Customer Bancorp’s second quarter 2023 earnings call. Joining me this morning are President and CEO of our bank, Sam Sidhu; Customers Bancorp’s CFO, Carla Leibold; Chief Credit Officer, Andy Bowman; and our bank CFO and Head of Corporate Development, Phil Watkins. We are very pleased with our second quarter results as we executed seamlessly on our strategic priorities and delivered one of the parts strongest quarters to date. Despite all of the challenges banks are facing this year, we are pleased that we are not only delivering on our promises to our clients and to our investors, but finding opportunities in these challenging times. Please join me in thanking all of our team members across the bank, who will continue to work tirelessly every single day on executing superbly on our short-term as well as our long-term priorities.

Beginning on Slide 3. As you can see, we believe our presentation today will once again demonstrate why we believe we are truly a forward-thinking bank with strong risk management capabilities. We will cover six key topics today. I will provide you with the highlights and my colleagues will cover them in more detail. First, in terms of quarterly performance, we are, again, comfortably beating street estimates on our core basis. While our industry is facing margin headwinds, we demonstrated our ability to improve net interest margin, while expand – which expanded by 19 basis points to 3.15% during the quarter. Hence, our net interest income was up 10% during the quarter on a smaller loan base. We are well positioned to achieve the full year net interest margin guidance we previously provided to you.

Second, we executed on several strategic transactions in the quarter to accelerate our financial and strategic priorities. The Venture Banking portfolio acquisition from the FDIC represented once-in-a-cycle opportunity to recruit a phenomenal team and will serve as another avenue to continue to improve our deposit franchise. We followed through on the commitment we communicated to you last quarter to exit non-strategic relationships and to continue to derisk the balance sheet by executing on two non-core loan sale transactions during the quarter. Sam will provide more detail on each of these transactions later on in the presentation. Third, we have a high-quality, diversified loyal customer base and are laser-focused on continuing to improve our deposit base in 2023 and beyond.

Evidence of the continued success of the efforts can be seen in the $1 billion or 29% quarter-over-quarter increase in our non-interest-bearing deposits. We reduced our average cost of deposits in the quarter by 21 basis points despite an increase in interest rates and significant deposit pressures experienced by the entire industry. Fourth, our liquidity and capital position remained best-in-class. We continue to maintain immediately available liquidity of more than 200% of our uninsured deposits, in recognition of the uncertain times that remain for the industry. We also significantly improved our common equity Tier 1 ratio by 70 basis points during the quarter and have a clear path towards the 11% plus target we stated to you last quarter.

Lastly, and perhaps most important is credit quality. This is always a key focus at Customers Bank. We were well ahead of the industry in tempering balance sheet growth, which we discussed with you on our Q4 2022 earnings call. Recent areas of credit focus in office and retail commercial real estate are absolutely de minimis components of our loan portfolio. This was obviously intentional and will pay dividends going forward. We are pleased with what we’ve accomplished this quarter, but even more excited about what we can do going forward. Turning to Slide 4. Let me briefly share with you again our priorities, which remain unchanged. We have and will continue to moderate growth build a stronger balance sheet during this time period because of the uncertain environment and to assure ourselves that we are actually capturing holistic banking relationships and continuing to build our franchise.

We will continue to fortify our balance sheet and bring – and then bring our capital ratios and then maintain those capital ratios above peer levels. As always, risk management remains at the core of the bank’s DNA and we are unchanged in our commitment to what we call our critical success factors. These are that we will never take our eye off the credit risk. We will always focus on superior interest rate risk management. We will continue to monitor liquidity daily and maintain robust liquidity under stress scenarios. We will have above average peer capital ratios, and we will always ensure our growth initiatives will generate positive operating leverage. With that, I’d like to turn it over to Sam to cover the key activity and results for the quarter in much more detail.

Sam?

Sam Sidhu: Thank you, Jay, and good morning, everyone. I want to echo Jay’s sentiment. We are so proud of our team’s efforts in delivering one of our best overall quarters yet, especially under such a challenging backdrop for the industry. In the second quarter of 2023, we earned $1.39 in GAAP EPS on net income of $44 million. On a core basis, we earned $1.65 in EPS and our core earnings were $52.2 million. Our core ROA was over 1% and our core ROE was 15.7%. Our improvement in net interest margin to 3.15% was a function of best-in-industry improved deposit costs supported by the repricing of our interest-earning assets, which, as you know, are largely floating rates. From a balance sheet perspective, deposits were up a net $227 million, but this does not fully reflect the significant improvement in our deposit mix and cost, which I’ll discuss further in a few minutes.

Loan balances were tactically reduced as we actively exited non-strategic credits in the quarter to free up balance sheet capacity for franchise-enhancing deposit-led lending opportunities. Credit quality remained benign with NPAs declining by 2 basis points to 13 basis points of total assets and NPLs declined by 12% to $28 million. Reserve levels remained robust at nearly 500% of NPLs, and we continue to closely monitor the portfolio for any signs of weakness given the uncertain macroeconomic backdrop. Turning to Slide 6. I’ll provide some more detail here on the Venture Banking FDIC transaction completed in the quarter. Firstly, let me start off by saying that we are thrilled to welcome our new team members and clients to Customers Bank. This acquisition was a perfect addition to our existing Venture Banking vertical.

The recruited team comes with an exceptional 20-year track record in the space and is widely regarded as one of the top-performing teams in the industry. I know that the team and the clients are extremely excited to get back to working together, doing what they do best, which is driving their respective businesses forward. And we’re so happy to be able to support them. Customers Bank is now immediately being recognized as a leading bank partner for venture-backed companies serving customers from early stage all the way to IPO. Our nationwide presence and customized best-in-class technology platform will provide truly unique service and experience for those innovation and technology companies. Our acquisition of the FDIC portfolio and the parallel recruitment of the team will bring significant near and medium term deposits to our franchise.

We expect that the new portfolio will be self-funded this year. And a reminder that historically these clients have deposit balances that are generally 2x their loan balances. We expect that this will provide tailwinds to our already robust deposit gathering momentum. Finally, the transaction is immediately accretive to both tangible book value and earnings per share, and we expect it to be at least 5% accretive to earnings in 2024, lending to the meaningful approximately $95 million discount. Moving to Slide 7. In an effort to maintain our deposit remix goals and capital target commitment to our stakeholders, and shareholders, we successfully executed on two loan sales at the end of the quarter to free up balance sheet capacity for the FDIC deal announced on June 15 late in the quarter.

First, we fully exited the non-bilateral portion of our capital call fund finance credits. These did not have any meaningful deposit relationships and are with very large fund managers and reminder, this is a one-time event. We remain highly committed to the direct capital call line lending vertical and are seeing incredible bilateral opportunities and are excited to add clients to the portfolio that bring full deposit operating account relationships. It is worth noting that we have already added about $100 million in very granular non-interest-bearing operating accounts in the vertical over the past few months with a big pipeline being onboarded as we speak. Additionally, we sold about $550 million of consumer installment loans at a slight premium and ahead of plan.

This transaction validates our strategy to increase the velocity of assets in our digital lending business and generate fee and fee-like income with limited to no credit risk. The combination of these two transactions will provide us balance sheet capacity to grow our partnership with strategic clients with primary banking relationships that support our funding and liquidity goals of the bank, all while continuing to meet the targeted increase in our capital levels. Moving to Slide 8. This was clearly a fantastic quarter for Customers Bank for many reasons, but we’re most proud of our deposit successes. These wins are a true testament to the strength of the relationship-based banking supported by best-in-class technology product and solutions that we are delivering to our customers.

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In an environment where many banks are struggling to attract deposits, let alone low-cost deposit gathering, Customers Bank onboarded over $900 million of net core deposits in the quarter, while increasing the level of non-interest-bearing deposit mix by another $1 billion, bringing the total to now 25% of total deposits. This already as of today makes up for the late 2022 negative mix shift that both we and the industry as a whole experienced. I’m extremely pleased to report that our average cost of deposits declined by 21 basis points, and our spot cost of deposits also declined by 1 basis point. These declines were despite the rate increase that importantly highlights our unique ability to add low-cost and non-interest-bearing deposits used to remix our high-cost and wholesale deposits.

We have been able to achieve this in one of the most challenging and competitive deposit gathering environments in modern banking history. We remain deeply focused on the quality of our deposits and the year – and at the end of the quarter, 77% of our deposits were either insured or collateralized. This metric keeps us in a very strong position relative to our regional bank peers. We are a beneficiary of a significant customer disruption and frustration in the industry, and we hope to look back on 2023 as a year of growing, diversifying and transforming our deposit base with high-quality, low-cost, sticky and granular franchise-enhancing deposits. Moving to Slide 9. As we discussed earlier, the strength of our deposit franchise drove record net interest income in the quarter of $160 million ex-PPP.

And I repeat record NII with the lowering of quarter-over-quarter interest expense being the main driver. As mentioned, our net interest margin increased significantly to 3.15%. The continued improvement in our deposit franchise and the strength of our interest-earning asset positions us to perform best-in-class despite the headwinds facing the industry. With that, I’d like to turn the call over to Carla to discuss additional highlights from the quarter.

Carla Leibold: Thank you, Sam, and good morning, everyone. Beginning on Slide 10. We continued our strategy of improving the overall quality of our balance sheet and loan portfolio during the second quarter. Total loans held for investment declined by approximately $800 million quarter-over-quarter, with roughly $300 million of the reduction coming from our consumer installment portfolio. Another $300 million coming from our corporate and specialized banking portfolio, mainly from the syndicated capital call line of credit sale, net of the impact of the acquired Venture Banking portfolio from the FDIC and the remaining $200 million coming from our community banking portfolio. These reductions were tactical to free up balance sheet capacity for more strategic relationships that come with corresponding deposits.

We continue to be excited about our positioning in the fund finance business and will pursue new business opportunities going forward. But our focus will be on opportunities that create holistic banking relationships for us across deposits and treasury management as well as credit facilities. Our net interest margin benefited 7 basis points from the increasing yield on our interest-earning assets, reflecting the floating rate nature of our assets, including our loan portfolio, which is approximately 70% floating rate and a 13 basis point reduction in our total cost of funds. The average yield on loans in the second quarter increased to 6.83%. Our loan-to-deposit ratio ended the quarter at 77%, 9 percentage points lower than our regional bank peers.

We’ve operated the bank at around 80% loan-to-deposit ratio over the last five quarters. We believe operating at these levels is prudent, especially in an environment where liquidity in the banking industry is becoming increasingly scarce. Turning to Slide 11. Core non-interest expenses increased to $89 million in the second quarter. The increase was primarily related to two items. The first and largest component of the increase resulted from higher insurance expenses. Second, higher incentive accruals were recorded during the quarter tied to performance and the onboarding of our new Venture Banking team members. While our efficiency ratio may be slightly elevated for a quarter or two, our business model is highly efficient. This is evidenced by the level of non-interest expense to average assets relative to our regional bank peers.

We were able to deliver high-touch client service while managing non-interest expenses because of our limited physical branch network and tech-enabled capabilities. This is the true differentiator of the Customers Bank franchise. Moving to Slide 12. We continue to proactively monitor our interest rate risk position with all the moving pieces in this dynamic interest rate environment. Without taking undue credit risk, we continue to generate almost 2x the yield on securities relative to our regional bank peers. The spot book yield on our available for sale securities portfolio increased to 5.38%, given that nearly 50% of the portfolio is floating rate. Even more importantly, we’ve been able to generate that return by taking only one third of the duration risk that our regional bank peers have exposed themselves too.

As a result of the strong interest rate risk management, the unrealized losses in our securities portfolio relative to our tangible common equity is significantly lower than our regional bank peers. Turning to Slide 13. Our liquidity position remains robust and best-in-class with over $11 billion in total liquidity and over $9 billion in immediately available liquidity. The net interest margin results we shared with you earlier are even more impressive when you recognized. We finished the quarter with over $3 billion of cash on the balance sheet. We will continue to monitor market conditions to determine the appropriate level of balance sheet cash. That said, we continue to believe it is prudent from a risk management perspective to operate with higher levels of cash.

There were modest reductions in our available committed capacity during the quarter, primarily resulting from our loan sales and the collateral value or pledging capacity associated with those loans. Immediately available liquidity as a percentage of uninsured deposits remains in excess of 220%, putting us at the very highest end relative to our regional bank peers. Moving to Slide 14. We added another $1 per share to our tangible book value in the quarter despite continued AOCI headwinds, the acquisition and onboarding of the Venture Banking loan portfolio, the one-time expense associated with the early surrender of BOLI policies and the onetime loss associated with the exit of the non-strategic short-term syndicated capital call lines of credit.

Over the last 4.5 years, we have increased our tangible book value per share by 14% on an annualized basis. That pace of tangible book value accretion is significantly more than our regional bank peers. Importantly, we remain on track to achieve a tangible book value of at least $45 by the end of this year. Despite the significant improvement in our stock price during the quarter, we continue to trade at very attractive PE multiples, especially for a franchise that is consistently generating returns on capital of roughly 15%. Turning to Slide 15. Our estimated CET1 ratio ended the quarter at 10.3%. That was up an impressive 70 basis points compared to last quarter. We accomplished this despite the acquisition of a $631 million Tech & Venture loan portfolio through strong organic capital generation and the loan sales previously discussed.

Our TCE ratio was 6% at the end of the second quarter. This ratio was negatively impacted by approximately 80 basis points of AOCI, the more than $3 billion of balance sheet cash also negatively impacted this ratio. Excluding this increased balance sheet cash, our TCE ratio would have been around 6.8%. We remain on track to achieve the year-end CET1 target of 11% to 11.5% that we disclosed last quarter, having achieved nearly 50% of that increase in a single quarter. While this can be largely accomplished through organic capital generation alone, we are continuing to evaluate a modest amount of incremental balance sheet optimization alternatives to the extent we see opportunities to exit additional non-strategic assets and relationships. Moving on to Slide 16.

Credit quality in our portfolio remains incredibly strong across all metrics. Non-performing loans fell to $28 million in the quarter. Commercial charge-offs were de minimis at just 6 basis points and consumer and total net charge-offs remained in line with our expectations. The leading indicator of non-performing assets to total assets decreased 2 basis points to the quarter to just 13 basis points at June 30th. Commercial real estate exposure continues to capture the attention of bank executives and investors. We are extremely well positioned for the potential challenges ahead for the commercial real estate market. CRE comprises only 15% of our loan portfolio, excluding multifamily, compared to our regional bank peers that have about 30% exposure.

More specifically, our office and retail sector, commercial real estate, each only account for approximately 1% of our total loan portfolio. They are both very granular portfolios with an average loan size of under $5 million. We closely monitor the minimal exposures that we do have and are pleased with our credit performance. Credits in these two sectors have an average loan-to-value of less than 60% and debt service coverage ratios of 1.5 to 1.6 times. As Jay mentioned in his opening remarks, superior credit quality has and always will be a core risk management principle that dictates how we operate the bank. We are firm believers that management must remain diligent about credit risk during the good times, which is why we are confident that we are very well positioned despite the uncertain economic environment today.

Turning to Slide 17. As we touched on earlier, we further derisked the balance sheet in the second quarter through our continued reduction in the consumer installment loans held for investment. We have reduced the balances in our held for investment consumer installment portfolio by 47% over the last year and now accounts for just 7% of our total loan balances. The portfolio we continue to hold is very high quality and short duration. The average FICO score is 733 with no credit extended to consumers with FICO scores below 680. The duration of the portfolio is approximately 1.3 years. Going forward, we continue to see opportunity in the consumer space. We have developed differentiated origination capabilities and a robust network of partners.

In our held-for-sale portfolio, we take very limited credit risk and currently are able to generate significant fee like interest income, in addition to the potential fee income opportunities we have identified going forward. With that, I’d like to pass the call back to Sam to address our outlook and provide some concluding remarks. Sam?

Sam Sidhu: Thank you, Carla. Before we wrap our prepared remarks, I want to provide a brief update on our expectations for the full year 2023. To reiterate, our top focus areas for the year are strengthening our balance sheet led by our improving deposit franchise, maintaining industry-leading levels of liquidity and significantly building our capital base. We are maintaining our loan guidance and our deposit strategy will continue to be focused on further remixing and improving the quality of our deposit base with significant core deposit growth used to pay down high cost and wholesale deposits. It’s worth mentioning that despite the $900 million plus of core deposit growth in the quarter, our pipeline remains at or above $2 billion today.

We are maintaining our full year net interest margin guidance but now have a bias towards the top end of our range. We’re revising our non-interest expense guidance to reflect the higher level of expenses inclusive of the Venture Banking Group, as Carla discussed. And we’re reaffirming our core EPS guidance of about $6 per share for 2023. Finally, as Carla shared with you, we’re well on our way in position to achieve $45 or more of tangible book value by year-end. Lastly, on Slide 9, before we open it up to Q&A, I want to conclude with the takeaways from the quarter. Firstly, we materially improved the quality of our deposit base, and we bucked the industry trend by lowering our deposit cost, increasing our non-interest-bearing deposit mix and improving the mix led to relatively low cost deposit generation in the quarter with a $2 billion plus low-cost deposit pipeline for continued improvement.

Our net interest margin, number two, expansion was differentiated versus the rest of the industry and positions us to meet or beat our full year guidance for 2023. Number three, we remixed the loan portfolio to emphasize strategic deposit-led relationships and provide capacity for multiproduct relationship opportunities across all of our lending franchises. Fourth, we meaningfully improved our capital base by an industry-leading 70 basis points despite the acquisition, lending to our balance sheet discipline and are well on track to deliver our promise to exceed 11% CET1 by year-end. And finally, we accomplished all of this in the quarter while never deviating from our core risk management principles. Our interest rate risk and liquidity positions remain best-in-class and our loan portfolio is positioned to weather whatever macroeconomic environment may be ahead.

Thank you. Let’s now open it up to questions.

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Q&A Session

Operator: [Operator Instructions] And your first question comes from the line of Michael Perito from KBW. Your line is open.

Michael Perito: Hi. Good morning guys. Thanks for taking my questions. I wanted to start on just a couple kind of clarity. Obviously, a lot happened this quarter, right, and a lot is happening this year. And I wanted to maybe kind of level set how you expect the business to look in 2024 and beyond. And so I have a couple of questions on that line of questioning. So I want to start on the loan portfolio side. I guess, Carla, you mentioned there might still be some actions you take. But is the end of period mix kind of indicative of what you guys think going forward, about 50% C&I, maybe 5% to 10% CRE, 5% to 10% mortgage warehouse, the balance CRE and multifamily. Is that – does that feel kind of like the right mix, given where you’re at now? Or how should we think about that moving forward?

Carla Leibold: Yes, Mike, I think that’s right. One of the things we wanted to reiterate is our loan guidance is really anchored back to the end of last year, at the beginning of this year. So when we’re talking to a flat to declining balance sheet, really focusing on year-over-year, but I think the mix that we currently have is good to think about what it looks like going forward.

Michael Perito: And then – that’s perfect. And then switching to the deposit side though, I imagine there’s still – and you guys kind of alluded to this, but that mix still should change a bit over the next four quarters, right? I mean you have at least $0.5 billion targeted to come over on the Venture side. I imagine that will be a blend of kind of low and no-cost deposits. I guess just as you look ahead on that side, do you guys have kind of a targeted range of mix on the deposit portfolio that you’re hoping to be able to achieve by the end of next year?

Sam Sidhu: Yes. So Mike, it’s a great question. And I would sort of say, firstly, just as a reminder, we had obviously the low-cost deposits this quarter. In the press release, we talked about the $660 million plus or minus of wholesale and brokered CDs that were paid down. There’s an additional almost $2 billion approximately in the second half of this year. And our anticipation is, is that if the core deposit pipeline continues to come in at the pace that it’s coming in today would be used to continue to pay off high cost and also pay down those brokers. So the remix would actually be significant not just by the end of next year, but would really accelerate this year and continue at the pace that we’re in. And just to kind of go back for a second to our growth, we also had a couple of $100 billion in the second quarter of high-cost digital deposits, consumer-related deposits that declined.

And so our core deposit generation of actual new customer growth was approximately $1.3 billion to over about $100 million a week on average. Having said that, there was a huge acceleration after the FDIC deal announcement in the second half of June. And that pace has continued of that approximately $100 million or so, plus or minus, of core low-cost deposit growth in July as well.

Michael Perito: And Sam, if you had to try to like just give us a rough indication of the key verticals that drove and are driving that incremental low-cost deposit growth going forward. How would you kind of break that out? You had obviously dramatic DDA growth. There wasn’t a color in the release about where that came from. I know we could probably guess, but just would love like maybe a layer deeper on that just we have an idea of what businesses you are really driving this?