Customers Bancorp, Inc. (NYSE:CUBI) Q4 2022 Earnings Call Transcript

Customers Bancorp, Inc. (NYSE:CUBI) Q4 2022 Earnings Call Transcript January 26, 2023

Operator: Good morning. My name is Rob, and I will be conference operator today. At this time, I would like to welcome everyone to the Customers Bancorp Fourth Quarter and Year-End Earnings Report 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. Thank you. David Patti, Director of Communications, you may begin your conference.

David Patti: Thank you, Rob. Good morning, everyone. Thank you for joining us for the Customer Bancorp’s earnings call for the fourth quarter and full year of 2022. The presentation deck you will see during today’s webcast has been posted on the Investor Relations page of the Bank’s website at www.customersbank.com. You can scroll to Q4 2022 and year-end 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’d 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 risks 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 Customers Bancorp Chair, Jay Sidhu.

Jay Sidhu: Thanks, Dave. Good morning, ladies and gentlemen. Now welcome to Customers Bancorp Q4 2022 and year-end 2022 earnings call. Joining me this morning is our President and CEO of our bank, Sam Sidhu; Customers Bancorp CFO, Carla Leibold; our banks CFO and Head of Corporate Development at Customers Bancorp, Phil Watkins; and the company’s Chief Credit Officer, Andy Bowman. As some of you may know, we are actually pleased to share with you again that about 10 years ago, Customers Bancorp became a publicly traded company using what was a troubled small $150 million asset Pennsylvania based bank as our charter and we invested our personal money into it and today this little troubled bank has been transformed into one of the 100 largest banks in the country.

As you can see on Slide 3 of our deck, we are today a $20 billion asset super community bank focused on superior customer service by executing on our high touch supported by high tech model. Today, we have a very simple but unique business model, operating with community banking, corporate banking, which is €“ which includes specialty banking and then last digital banking franchise. It is our belief that forward thinking banks must be execution driven, clearly defined the markets that they wish to focus on as well as what they will not focus on and have a superior tech forward digital strategy. These are the things that we are focusing on every single day. It is by sticking to these fundamentals that customers has grown its assets, its loans, its deposits, its income and shareholder value by an average of 20% to 30% a year since becoming a public company just 10 years ago.

I’d like to take a minute to provide the perspective on the current external environment. As you all know, the historic base of interest rate increases by the Fed inverted yield curve as well as the quantitative tightening has created a very challenging environment, especially as it relates to deposits and especially for institutions or banks like ours, which are principally focused on serving business customers. All of these factors have led to an increase in our deposit cost over our expectations and the sophisticated nature of our primary depositor base expects market rate deposit. So we have focused tremendously on also market rate lending and our loan data is far in excess of what you normally see in the banking sector. We expect this challenging environment, however to persist and with the Fed fund rate peaking at for about 5% in the first half of this year.

As a result, there may be very temporary some pressure on our margin for just a quarter or so hitting an inflection point as the Fed tapers followed by NIM expansion beginning sometime in the second half of the year. We will go over our guidance with you today in some detail. In this challenging rate and inflationary environment, we believe that we €“ that you need an explanation of some of the few non-recurring items and Carla, our CFO will go over those items with you in some detail. Now onto our current performance, we are pleased to report to you that Q4 2022 earnings from the core bank were $1.37 per diluted share and that beat our internal targets and we believe they’re beat by about $0.10 the normalized consensus estimates. This brings our full year 2022 core earnings per share to $6.51, and when you exclude PPP and the provision release benefit from the sale of $500 million of consumer installment loans in Q3 our adjusted earnings per share for the year were $5.65.

Our reported earnings beat the upper end of our own 2022 core earnings per share guidance of $4.75 to $5, and we beat that by about 13%. Our responsible organic growth strategy is laser focused on credit quality with 90% of our growth over the past year in very low credit risk as well as variable rates, specialty lending verticals, and that’s resulted in us achieving an above average asset beta. Asset quality remains exceptional and credit reserves are extremely robust at 425% of total non-performing loans. We’ve taken prudent risk management strategic actions over the past several quarters to ensure that we are well-positioned from a capital point of view, credit, liquidity as well as earnings, and we will believe we are very well-positioned as we head into this uncertain 2023 and beyond.

We are very focused on improving our margins, improving our capital ratios, and we will do that by moderating our growth in 2023, improving the quality of our balance sheet while we control our expense base, and we are going to be very actively buying back stock common stock to the extent that we are trading below book value and we believe that will result in creating exceptional value for our shareholders. Like I said earlier, we are very optimistic about our future. I’ll now turn it over to Sam to talk about the performance of our franchises in this as well as some key financial highlights. Sam?

Sam Sidhu: Thank you, Jay, and good morning, everyone. At Customers Bank are differentiated but simple business model is built on two foundational principles. First, we are a client-centric, high-tech, high-touch organization. Second, we are committed to industry-leading credit quality. I’d like to take a few minutes to walk you through the franchise we have created across our community, corporate and digital verticals over the past few years and recap how franchise growth has delivered outsized financial results for our shareholders. Moving to Slide 4 and starting with our community banking franchise. This is where clients are service to our single point of contact model by relationship managers who have years, if not decades of experience in their local markets.

On the loan side, this is led by our regional C&I, multifamily investment CRE, and SBA products. We ended the year with about $5.9 billion in community banking loans. Our deep relationships and network in these markets lends to a lower cost sticky depositor base. We have significant market share in many of our northeast home markets and are selectively looking to expand this model nationally into higher growth markets over time, beginning first in the southeast. Now moving on to our corporate and specialty banking franchise. Teams here service sophisticated corporate clients across complementary products. This vertical ended the year with $7.2 billion in loans and the mix has increased from 25% of total loans just a few years ago to nearly half of total loans today.

This growth has helped transform the organization we were just a few years ago. Importantly, we have focused our efforts on floating rate low to no credit risk verticals. The largest component, which we call our fund finance vertical includes our capital call and lender finance line businesses. The fund finance, tech and venture and financial institution group teams are leading the growth of our lower cost deposit pipelines. Moving to Slide 6, our digital banking team has organically built a franchise that has acquired over half a million profitable digital customers since 2019. We are leveraging our deep FinTech relationships and industry-leading technology capabilities to build out our FinTech banking revenues, otherwise commonly referred to as Banking-as-a-Service.

In the fourth quarter, we successfully onboarded a major customer and as previously stated, we expect revenues in this business to reach a $10 million run rate this year. We are currently in discussions with new partners regarding further opportunities. Additionally, building off of the demand around our consumer installment portfolio sale in the third quarter, we are developing a held for sale origination strategy, which we will have more to report on in the next quarter or two. Finally, I’m pleased to report that our tech-enabled deposit and transaction banking customer pipeline is strong, by merging the product innovation of a tech company with the expertise of a bank. We expect these initiatives will help our deposit mix in the latter half of 2023.

Now turning to Slide 7. I’d like to take a few minutes to reflect back on the dramatic transformation that this organization has had over the past few years. At the beginning of 2020, our balance sheet was just $11.5 billion, and as of year-end 2022, we are now just under $21 billion. We’ve gathered over $5 billion in deposits in 2021 alone. This allowed us to self-fund our PPP loans and as those loans were forgiven, we deployed that cash into securities and low risk loan growth. Following the deposit growth in 2021, we grew total loans excluding PPP by an impressive 30% while maintaining our credit discipline. In 2023, securities book cash flows and PPP forgiveness, which you’ll hear from Carla in a minute will provide significant fuel for higher margin reinvestment without the need to increase the size of our balance sheet.

We expect this will set us up for a strong second half of 2023 and an even stronger 2024. Moving on to Slide 8, you’ll see the real cumulative power of our three franchises. While PPP was understandably viewed as one-time in nature, we focused our efforts on using the benefit of this business line to build recurring earnings power. Our net interest income excluding PPP has more than doubled from 2019 from $277 million to an impressive $565 million in 2022. And our associated recurring earnings power has dramatically increased with our EPS, excluding PPP increasing by over 2.5 times during the same time period. We achieved this growth without raising $1 of equity in diluting our shareholders. All of this came through organic growth supported by PPP revenues.

With that, I’d like to pass it to Carla to walk through our financials in more detail.

Carla Leibold: Thanks, Sam, and good morning, everyone. I’ll begin by briefly summarizing our fourth quarter and full year 2022 results as shown on Slides 9 and 10. From an earnings perspective, in fourth quarter 2022, we earned $0.77 in GAAP EPS on net income of $25.6 million. For full year 2022, we earned $6.51 on net income of $218.4 million. Our fourth quarter GAAP results were negatively impacted by two items. The first after tax net losses realized from the sale of available for sale investment securities of $13.5 million or $0.41, which benefits net interest margin in the short-term and only has a one-year earn back. And the second after tax net losses on PPP loans of $6 million or $0.18, primarily caused by slower forgiveness than expected, leading to higher funding costs and one-time charge-offs of $11 million net of a $7.5 million gain recognized upon settlement with a PPP loan servicer.

To provide additional perspective, PPP related income contributed a positive $0.18 in the third quarter compared to the negative $0.18 this quarter. I’ll also highlight that the $11 million of gross charge-offs are before the impact of any contractual indemnities or recoveries we may receive in future periods. After adjusting for these two items, Q4 2022 core earnings were $1.37 on $45.3 million beating internal targets and estimates adjusted for PPP. This brings our full year 2022 core earnings to $6.51. As a reminder, included in this amount was a pre-tax provision benefit of $36.8 million or $0.86 from the loan sale that Jay mentioned earlier, leaving $5.65 of sustainable core earnings for full year 2022, significantly higher than our $4.75 to $5 target and the $4.44 we made in 2021.

Photo by Mathieu Stern on Unsplash

Net interest margin excluding PPP was 2.87% for fourth quarter lower than our previously guided range of 3% for two primary reasons. First, challenges impacting the mortgage industry as a whole led to an unexpected large outflow of non-interest bearing deposits from clients in our mortgage warehouse vertical, which negatively impacted our fourth quarter margin by roughly 12 basis points. And two, higher average cash balances compressed margin by approximately 3 basis points. Turning to the balance sheet, we ended the year with $19.9 billion in core assets ex-PPP, up 22% over the prior year. Our core loan book ex-PPP grew an impressive 31% year-over-year ending 2022 at $14.8 billion. This growth was primarily in the low risk variable rate corporate and specialty banking vertical I’ll discuss in more detail later.

Total deposits grew by 8% to $18.2 billion and have more than doubled over the last three years. From a profitability standpoint excluding PPP, our Q4 2022 core ROA was 93 basis points and our adjusted pre-tax pre-provision ROA was 1.67%. Turning to Slide 11 on loan growth. In fourth quarter 2022, we purposely moderated loan growth that we intend to retain on balance sheet, as we think about optimization strategies over our planning horizon. Our Q4 2022 held for investment loan growth was about 300 million of which $200 million was in our low risk variable rate, corporate and specialty banking vertical, which prices at roughly 300 basis points over SOFR. Year-over-year, this vertical increased $2.2 billion and ended 2022 at $7.2 billion. Moving on to deposits on Slide 12.

Total deposits increased $1.4 billion in 2022 and ended the year at $18.2 billion, up 18% year-over-year. Notably, 57% of total deposits are sticky transaction related DDAs consistent with the challenging deposit environment industry-wide, we experienced a negative mix shift and higher funding costs in the fourth quarter, primarily from several larger institutional customers that we were previously able to hold at lower levels. Our core deposit pipelines remain robust, particularly in the verticals that Sam mentioned earlier as we continue to build out our relationship-based deposit franchise. Turning to Slide 13, we had another strong year of interest earning asset growth with interest earning assets up 22% year-over-year. Notably, we have $1.5 billion of lower yielding PPP loans and available for sales securities, which can be reinvested at roughly a 400 basis point higher yield in 2023.

Moving to Slide 14. This slide shows a trend of increasing net interest income excluding PPP over the past five years, largely driven by strong organic growth in our corporate and specialty banking vertical. In 2022, we continued to experience strong growth in our NII ex-PPP, which was up 33% year-over-year. This growth outpaced the 22% annual growth rate we experienced over the past four years. The right side of that page also shows significant margin expansion since 2018 and highlights our disciplined loan pricing strategy despite the remix into lower credit risk lending verticals. Turning the Slide 15, this slide really showcases our effective and disciplined expense management. Despite significant asset and NII growth, we’ve more than doubled our asset size since 2018.

Our core non-interest expenses have only increased 9% annually. This has resulted in a significant decrease in our efficiency ratio down from 63% in 2018 to 43% in 2022, highlighting our positive operating leverage. Moving to capital on Slide 16, our regulatory capital levels remain within our targeted operating ranges and well above required regulatory well capitalized minimums. Our TCE ratio was down slightly during the quarter given loan growth and slightly higher AOCI losses. Our AOCI adjusted TCE ratio was 7.2% at year end. Slide 17 highlights significant tangible book value accretion over the past five years, despite $165 million of increased unrealized losses deferred in AOCI. Our tangible book value at year-end 2022 was just under $39, up approximately 5% from last year despite nearly $5 of negative impact from AOCI.

This significantly outpaces our midcap peers. Without AOCI, we would’ve ended this year at nearly $44. And with that, I’ll turn it over to Andy to talk more about asset quality.

Andy Bowman: Thanks, Carla, and good morning everyone. As Sam and Carla referenced earlier, the bank’s organic loan growth has been in low-to-no credit risk verticals as noted on Slide 18. 70% of the bank’s total loan book and 90% of its loan growth is in verticals that have experienced low-to-no credit losses. And this remains our strategy moving forward. By continuing to lever our strong underwriting standards and remaining focused on these strong credit segments, we are confident that our performance within these verticals will remain extremely strong as evidence to date by the limited lifetime loss rates noted for our funds finance, multifamily, mortgage warehouse, and equipment finance business lines, all of which are mature and have been in existence at the bank for at least seven years.

Moving to Slide 19. Credit quality remains strong as evidenced by NPLs of only $31 million or 19 basis points of total loans. NPAs to total assets of just 15 basis points and continued decline in total special mention and substandard loans in both a dollar and percentage of total loans perspective. And most importantly, as it represents some more real-time assessment of portfolio performance. Total 30 day to 89 day delinquencies were a modest 35 basis points. Looking solely at the commercial loan portfolio, which comprises over 85% of the bank’s total loan book, total 30 day to 89 day delinquencies were minimal 24 basis points. Moving to net charge-off. Net charge-off figures in the core commercial and consumer portfolios were in line with expectations.

Total net commercial charge-offs were only 8 basis points. While the 2.53% net charge-off rate for the consumer portfolio was higher than that of Q3, it is well in line with our portfolio by portfolio vintage loss curves and was fully anticipated as the underlying portfolio’s naturally seasoned. Although pleased with how well our commercial consumer portfolios have performed, we remain committed to the following. First, maintaining a strong reserve position is evidenced by a robust 425% coverage of total NPLs. Second, adhering to our strong underwriting and portfolio management standards. And third, remaining committed to our low-to-no credit risk portfolio strategy I previously noted. Wrapping up based on continued strong credit metrics and a portfolio comprised predominantly of loans to no-to-low credit risk verticals, strong portfolio management with ongoing loan level stress testing, limited exposure to high risk credit segments such as investment CRE office and investment CRE retail, which standard only $132 million and $180 million in total exposure respectively and continued strategy of not lending into discretionary spending dependent verticals.

We are confident that our loan portfolio is well positioned moving forward. Again, thank you for your time this morning and I’d now like to team turn the presentation over to Sam.

Sam Sidhu: Thanks, Andy and Carla. Now to connect some of the dots and bring it all together on Slide 20, we wanted to provide a fair amount of guidance in our 2023 outlook to assist with modeling. While much uncertainty remains in the coming year, we believe we are very well positioned to navigate the environment we see ahead. Although our lending opportunities remain strong, you’ve heard we will be looking to even further moderate our overall growth and project low-to-mid single-digit loan growth in 2023. This is excluding PPP. We expect a relatively flat balance sheet overall as we will reinvest cash from PPP loans and securities runoff as they roll into higher yielding loans. On the deposit side, our growing pipelines will help us remix as we expect to shed higher cost deposits throughout the year.

It is worth noting that in January we informed the material amount of our market sensitive depositors that we will be €“ we will not be increasing their rates any further in 2023 and so far we have not seen any related outflows. Moving to full year NIM. We see this in the 2.85% to 3.05% range. We expect our non-interest expense to decline in the year, including the effect of BMT and expect to deliver $6 to $6.25 in EPS. On our core non-interest expense excluding BMT, we would expect that to be less than 10% growth for the year. I would note that NIM and EPS are expected to be lower in the first half of the year with margin and earnings expansion expected in the second half of the year. Even with the limited growth, we expect over a 15% ROE with capital ratios in line with the industry and well above regulatory thresholds.

While a share buyback is typically lowest in our waterfall of capital actions, we want to reiterate that we are committed to materially improving our valuation by moderating our growth, focusing on capital, profitability and funding cost, all while buying back stock likely aggressively. We plan to begin buying soon, as soon as our trading window opens on Monday. As a reminder, we have 1.9 million shares remaining under our previously authorized program and through our guidance you can see we have ample capital available through organic growth and retained earnings to complete the program without growing our balance sheet. We expect our tangible book value to be above $45 by year-end, which is a 15% growth rate over the next few quarters, and a CUBI valuation convergence to book value or higher due to these action implies at least a 50% valuation upside from recent trading levels.

To wrap it up on Slide 21, let me summarize what we’ve shared with you this morning. As you’ve heard today, we are well positioned to manage the risks of the dynamic market environment. We will be moderating our growth to improve our margins, capital ratios and profitability. Credit quality, as you heard from Andy, has and will be at the center of every decision we make and our capital ratios are very much in line with our peer group. We have a formidable balance sheet with available liquidity of over $9 billion and are well positioned to support our buyback. I’m proud to work with a very forward thinking management team that has a proven track record of driving exceptional financial performance and we are proud that we have leapfrogged the industry in tech strategy and tech capabilities.

We will have an opportunity to showcase this by delivering on fee income and low cost deposit generation. Finally, as we’ve said a couple of times, we have to take firm action with conviction and we will be commencing what we expect will be a significant buyback immediately. We are hopeful that this will lay the foundation for a significant share price out performance in 2023 for our investors. I’ll now turn it back to Jay for a few concluding comments.

Jay Sidhu: Yes, thank you very much Sam. And before we open it up for Q&A, I’d also like to recognize our team members who are executing superbly and are €“ they are helping us build this very strong foundation for continued exceptional performance and we are delivering outstanding shareholder performance over the next couple of years. In 2022, we delivered, as you heard, another outstanding year of financial performance and with the strength of our credit profile, as you heard from Andy, the capital and liquidity position as Sam just summarized as a differentiated model that all of my colleagues talked about, we believe we are very welcome . With that operator will you please help to open the Q&A.

See also 11 Most Undervalued Natural Gas Stocks To Buy and 10 Biggest HVAC Companies in the US.

Q&A Session

Operator: Your first question comes from a line of Michael Perito from KBW. Your line is open.

David Patti: Hi Rob, you’re breaking up a little bit. Hey, Mike.

Unidentified Analyst: Hi. Good morning. This is Mike’s associate Andrew filling in. Thank you for taking my questions. I just wanted to ask for a little more color on the margin guide in 2023. Is it just the slower growth that you mentioned that as you’re feeling like you can stabilize the NIM? Or are you expecting relatively €“ to relatively lower your incremental funding costs near-term beyond just that core customer base that you mentioned that you’re holding at their current rate?

Carla Leibold: Good morning, Andrew. I can give some background on that. First of all, when we are thinking about margin and net interest income, we’re really focused on growing net interest income based on low risk growth rather than focusing specifically on a NIM target or an ideal beta. Practically all our deposits are corporate or institutional deposits and only a very small percentage are consumer deposits that have virtually no corresponding branch expenses, which in our opinion should be factored into the total cost of deposits. To put some specificity around this, our non-interest expense to average earning assets was 50 basis points below the mid-cap bank average, highlighting that our structural cost advantages and most rate environments.

With higher deposit costs in mind, we’ve continued our discipline pricing strategy requiring a spread between 300 basis points and 350 basis points over the projected funding costs. As we’ve referenced before, we have $1.5 billion of lower yielding PPP loans and AFS securities that can be reinvested in the coming year at 400 basis points incremental spread. Now specific to our guidance, we’re expecting the full year to be between 2.85% and 3.05% with tighter margins in the front half of the year and expansion margins in the back half of the year.

Unidentified Analyst: Great. Thanks, Carla. And then secondly, Sam, I was wondering if you had any additional update on CBIT? Are you guys slowing down there and kind of seeing how the regulatory piece plays out or are the deposits just kind of less valuable here because you can’t leverage them?

Sam Sidhu: Sure. Yes, so on our CBIT balances actually grew by about $400 million in the quarter. So, we ended with $2.3 billion at the end of December. And as you can probably appreciate given some of the industry dynamics, we saw significant customer interest and also that sort of translated into growth and activity on CBIT. To your question about sort of waiting and scene, our related deposits are under 15% of total deposits. We did add 90 new customers in the fourth quarter ending at 391 total customers, but importantly, we’re growing some of our, our key anchor customers there and payments activity and associated non-interest bearing deposits, will €“ that will translate into better deposit costs as the year progresses.

Unidentified Analyst: Awesome. Appreciate the color there. And then just lastly from me. What would you outline at the if the priorities for the next year, given it was a pretty volatile Q4 for many fintech and digitally focused companies and the macro for 2023 kind of remains uncertain at this point?