Customers Bancorp, Inc. (NYSE:CUBI) Q3 2023 Earnings Call Transcript October 28, 2023
David Patti: Thank you for joining us for the Customers Bancorp Earnings Call for the Third Quarter of 2023. The presentation deck you will see during today’s webcast has been posted on the investors web page of the bank’s website at www.customersbank.com. You can scroll to Q323 results and click Download Presentation. You can also download a PDF of the full press release at this 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.
A smiling customer exiting the bank, indicating the customer’s satisfaction with the bank’s services.
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 10K and 10Q, 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 is my pleasure to introduce Customer’s Bancorp Chair Jay Siddhu. Jay?
Jay Siddhu: Thank you, Dave, and good morning, ladies and gentlemen. Welcome to Customers Bancorp. third quarter 2023 earnings call. Joining me this morning are Customer’s Bank’s President and CEO, Sam Siddhu. Customer’s Bankcorp. CFO Carla Leibold. Customer’s Bank CFO Phil Watkins. And our Chief Credit Officer, Andy Bowman. I would really want to thank Andy for all his service to the company, and as you all know, he is retiring from the bank after an exceptional service to us, and he’ll be leaving us end of the year. We are pleased to share Customer’s Bancorp’s results with you this morning. This quarter’s results demonstrate the strength of our franchise with continued positive momentum across all our top financial priorities that include deposits, margin, liquidity, profitability, and capital.
All of this while maintaining our strong risk management principles. We salute our team members throughout the bank, whose commitment and hard work makes our success possible. I also want to thank our clients who place their trust in Customer’s Bank every day as we try to execute flawlessly in serving their banking needs. Looking at slide three, we wish to again demonstrate how Customer’s Bank is a forward-thinking bank with strong risk management. We will cover five major topics in this morning’s presentation. I’ll cover a few highlights, and my colleagues will cover each topic in more detail. First, in terms of quarterly performance, we delivered another strong quarter that significantly exceeded street estimates across every metric based on strong underlying performance, as measured by return on assets, return on equity, margin expansion, control of our expenses.
All of these while materially improving our capital ratios. Second, we continue to create franchise value across the bank. We saw the market disruption as an opportunity to create and deepen client relationships. As an example, we are so proud of our team members in the Tech Inventure Banking Group that have not only met, but exceeded our expectations. As a result of strong deposit growth from our borrowers, the acquired Tech Inventure Banking portfolio is already self-funded one quarter ahead of our schedule. And there is excellent momentum to build our client base, our brand, and generate attractive deposit and loan opportunities going forward. We would also like to once again welcome these fantastic new clients to our firm who are driving innovation and progress in our economy.
We generated $1.3 billion of core deposit growth in the quarter. As promised, we use these deposits to improve the overall quality of our funding base by paying down high-cost wholesale deposits and redeeming some of our high-cost outstanding federal home loan bank advances. Importantly, our deposit jazzing was granular and diverse across our franchise and our non-interest-bearing deposits increased to 26% of our total deposit. Third, we significantly increased our capital levels for second quarter in a row. Carla and Sam will provide much more details, but I wanted to mention that with a controlled balance sheet, we were able to increase our TCE ratio by 50 basis points this quarter. Our CET-1 ratio went up by 100 basis points this quarter to 11.3% and our risk-based capital ratio also went up by slightly over 100 basis points to 14.3% at the end of this quarter.
We are committed to maintaining or further improving these ratios. Fourth, credit quality, which is always a key focus and part of our DNA at customer’s bank remains incredibly strong. Recent areas of focus in office as well as retail, commercial real estate are absolutely immaterial components of our balance sheet. Our NPA ratio has remained stable and we are confident in the future performance of our loan portfolio. Finally, we remain very optimistic about our future performance. We are pleased with our quarter’s results and expect to significantly exceed our 2023 full-year core EPS guidance of $6 a year and report stronger core results in 2024 and beyond. Now turning to slide four, let me briefly reiterate our priorities which remain unchanged.
We have and will continue to moderate growth and ensure we are capturing franchise enhancing full banking relationships. We will continue to fortify our balance sheet and improve our capital ratios because that is a prudent thing to do in this uncertain environment. As always, risk management remains at the core of our bank’s DNA and we are unchanged in our commitment to our critical success factors. These critical success factors have been in place since the day we started the bank. They are, first, managing credit and interest rate risk, secondly, maintaining robust liquidity and capital levels with strong asset liability management principles. Third, always making decisions that drive positive operating leverage. We believe our unique mix of size and sophistication creates a competitive advantage to many of our regional bank peers.
We are seeing attractive new loan and deposit growth opportunities. We believe we should be able to show high single digits to low double digit loan growths next year, assuming stable economic environment. We have ample liquidity and strong capital to support moderate growth. As the quality remains exceptional as I stated earlier, with our NPA ratios remaining roughly flat at just 14 basis points. Office and retail commercial real estate each represent less than 1% of our total loans. Before I pass on the call to Sam, I want to welcome to the call Steve Moss, our new research analyst from Raymond James. Steve joins an already extremely talented group of research analysts who follow customer’s bank or story. We are excited for the insights that Steve will add to the discussions each quarter and to his regular reports.
With that, I’d like to turn it over to Sam to cover the key activities and results of the quarter in more detail, Sam.
Sam Sidhu: Thanks, Jay, and good morning, everyone. We’re pleased to report that our team again delivered one of our best quarters yet, especially in an uncertain macroeconomic and geopolitical environment. In the third quarter of 2023, we produced extremely strong gap results across all profitability metrics, earning $2.58 in gap EPS on net income of $83 million. Our ROA was 1.57% and ROE was 24%. We continued to buck the industry trends and increased our net interest margins significantly in the quarter to 3.7%. From a balance sheet perspective, we maintained a disciplined, roughly flat balance sheet. Total deposits were up 1% in the quarter as we continued to transform the quality of our deposit franchise, which I’ll provide more detail on shortly.
Credit quality remained benign, as evidenced by the NPA ratio Jay walked us through. Reserve levels remained robust at 466% of NPLs. We do not see any signs of weakness in our book, but remain hyper-focused on portfolio management. Before we dive into more detail, I wanted to take a moment to put our quarterly performance into context. We grew our core earnings by 60% in the quarter. We expanded margins significantly and reported net interest income well above expectations and significantly above industry trends. We earned more than 20% return on common equity, and we achieved all of this while building our capital base by 100 basis points. We’re extremely proud of what the team was able to accomplish and appreciative of all of their hard work in producing these extraordinary results.
Moving to slide six, in a challenging deposit environment for the industry, we were able to grow our deposits by a net $200 million, even after significant wholesale deposit payouts. From a core deposit perspective, we had $1.3 billion of growth. I’ll say that again, $1.3 billion of growth. This represents over $100 million of deposit generation per week throughout the quarter. When combined with last quarter’s growth, this is over $2.1 billion in core deposit growth, which is a significant growth in our core deposit franchise. I want to highlight not just the quantity, but also the quality of this growth. The deposit growth we have achieved was a team effort across the franchise. For additional context, about two dozen of our deposit channels saw solid growth in the quarter, with most of them up $25 million or more, demonstrating the broad-based nature and quality of our deposit transformation.
This growth was also very granular, as we added over 1,000 new high-quality commercial client relationships in the quarter. This caliber of deposit growth represents true franchise value creation and continues to strengthen our deposit base. Our core deposit growth in the quarter was once again used to pay down higher cost, as well as wholesale funding, with the reduction of over $900 million in wholesale CD balances, which totals over $1.5 billion of pay down over the last two quarters. While the industry has been steadily losing non-interest-bearing deposit balances, year to date, we’ve increased our non-interest-bearing deposits by $2.9 billion. Non-interest-bearing deposits now comprise 26% of our total deposits. This is the third consecutive quarter of increasing non-interest-bearing deposits, which we believe is a testament to the strengthening of our deposit franchise.
As a result of these efforts, in spite of the Fed again increasing rates, our average cost of deposits increased by only 13 basis points in the quarter, which we believe is one of the lowest increases in the entire industry. Since the first quarter, our average cost of deposits declined eight basis points this year. This is in the most challenging deposit environment that the industry has seen in recent history. We can say certainly, with certainty, we are the only bank in the industry to accomplish this decline. We remain deeply focused on the quality and stability of our deposits, and at the end of the quarter, 78% of our deposits were either insured or collateralized. This metric keeps us in a very strong position relative to regional bank peers.
Our core deposit pipeline remains robust with at over $1.5 billion, which we anticipate onboarding over the next three quarters or so. We would note that we expect the student portion of the deposits managed by BMTX of over 500 million plus to move to their new partner bank, likely sometime in the month of December. We are one of the biggest beneficiaries in the industry of the significant customer and deposit disruption earlier this year. 2023 will be a transformative year for our deposit franchise and one marked by increasing the diversification, granularity, and overall strength of the franchise. Moving to slide seven, $200 million of net interest income in the quarter represents a second quarter in a row of record net interest income, ex-PPP.
The more than 20% increase in net interest income had roughly $27 million of outsized discount accretion from the acquired venture banking loan portfolio. Even after adjusting for the outside discount accretion, this would be a record quarterly NII ex-PPP, and we continue to have positive momentum for expansion off of this normalized base. While much of the industry continues to face headwinds, our net interest margin expanded to 3.7% in the quarter, benefiting from our deposit transformation, the floating rate composition of our interest earning assets, and was enhanced by the outsized accretion. Normalizing for the accretion, our NIM would have been about 3.2% versus 3.15% last quarter and we expect this upward trajectory to continue in the fourth quarter and into 2024.
Similar to the story on deposits, this is the second quarter where we had one of, if not the best performances in the industry with sequential continued improvement. 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. I’ll begin on slide eight. We continued our strategy of improving the overall quality of our loan portfolio during the third quarter. As we’ve stated previously, our focus remains on building holistic client relationships. Loans held for investment declined modestly by about $250 million in the third quarter, with decreases in our mortgage warehouse, consumer, commercial real estate, and multifamily portfolios from clients where we did not have meaningful deposit relationships. While we continuously evaluate our loan portfolio to ensure capital is generating the best possible risk-adjusted returns, I am pleased to say that we don’t see the need for additional remixing in the loan portfolio.
We also continue to maintain strong liquidity as our loan to deposit ratio improved by two percentage points to end the third quarter at 75%, putting us in the top quartile of our regional bank peers. As a result of core deposit growth and selective loan originations, our 75% loan to deposit ratio provides a significant flexibility heading into 2024. Turning to slide nine, core non-interest expenses were roughly flat in the third quarter at $89 million, consistent with our guidance. We believe we have significant opportunities to generate positive operating leverage with the current expense base. We are proud of our ability to operate the bank at one of the lowest levels of core non-interest expenses to average assets among our regional bank peers And we are in the top decile of all publicly traded U.S banks for the efficiency metric.
As we’ve discussed with you in the past, we are confident in our ability to operate the bank at a mid-40s efficiency ratio over the medium term. We remain committed to our business model of providing high touch client service with tech enabled capabilities and a limited physical branch network. This is the true differentiator of the customer’s bank franchise. Moving to slide 10, as many of you may remember, we purposely took action throughout 2022 to proactively reposition our securities portfolio during a time when most of the industry had become complacent about securities portfolio management. That forward-looking strategy continues to pay dividends to our bank today. Without taking undue credit risk, we continue to generate approximately two times the yield on securities relative to regional bank peers.
We accomplish this while taking only one third of the duration risk that those peers have exposed themselves too. As a result of the strong interest rate risk management, despite the increase in rates during the third quarter, our AOCI as a percent of TCE actually declined by about 225 basis points during the quarter. And the low level of unrealized losses in our AFS and HTM portfolios relative to tangible common equity is top quartile among our regional bank peers. Over on slide 11, our liquidity position remains robust and best in class with $11.7 billion in total liquidity, $9.7 billion in immediately available liquidity, including $3.4 billion of cash on balance sheet. As a result of strong core deposit growth and excess liquidity, we repaid $510 million of callable federal home loan bank advances at the end of the third quarter.
This helps reduce interest expense going forward while also freeing up incremental off-balance sheet liquidity. Immediately available liquidity as a percentage of uninsured deposits grew over 15% during the third quarter and is now almost 240%, putting us at the very high end of our regional bank peers. We will continue to monitor market conditions to determine the appropriate level of balance sheet cash. However, we continue to believe it is prudent from a risk management perspective to operate with higher levels of cash. Turning to slide 12, we added more than $3 per share to our tangible book value in the third quarter, which benefited from strong organic capital generation and a positive impact to AOCI from our available for sale securities portfolio, which is in stark contrast to the industry.
We are very pleased to report that we already achieved our tangible book value target of $45, with one quarter remaining in 2023. While a higher for longer rate environment may continue to cause industry headwinds, we do not expect to be meaningfully impacted by such a rate outlook because of the short duration on our securities portfolio. Over the last five years, we have increased our tangible book value per share by 15% on an annualized basis. We have already exceeded that 15% growth during 2023, with one more quarter to go. We are on track to grow our tangible book value by more than 20% this year, subject only to external market impacts. Moving on to slide 13, our TCE ratio ended the third quarter at 6.5%, which was an increase of 50 basis points in a single quarter on a relatively flat balance sheet.
This is a testament to our strong earnings power and balance sheet discipline. AOCI continues to negatively impact this ratio by about 70 basis points. I’ll also point out that $3.4 billion of balance sheet cash has a material impact on this ratio. Our estimated CET1 ratio ended the third quarter at 11.3%. This is the second consecutive quarter that we’ve been able to materially increase our CET1 ratio. We’ve grown our CET1 ratio by 170 basis points this year. And with one more quarter to go in 2023, we have already achieved our previously guided range. I will also highlight that our AOCI adjusted CET1 ratio is 10.2%, which is top quartile of all banks from $10 billion to $100 billion in assets. Turning to slide 14, credit quality in our portfolio remains strong across all metrics.
Non-performing loans ended the third quarter at $30 million, and our non-performing asset ratio was low at just 14 basis points. Both metrics are in line with the levels we’ve experienced over the past four quarters. Consumer charge-off declined by about $1.1 million in the third quarter. While the consumer charge-off ratio appears higher, the decline is skewed by the $550 million consumer loan sale we executed at the very end of the second quarter. This sale led to roughly 25% lower average consumer balances quarter over quarter. We remain extremely well positioned for the potential challenges ahead for the commercial real estate market. Commercial real estate, excluding multifamily, comprises only 14% of our loan portfolio, while our regional bank peers have about 30% exposure.
Furthermore, as Jay noted, the office and retail sectors of commercial real estate each only account for approximately 1% of our total loan portfolio. I’ll also highlight that our provision expense of $18 million came in at the very low end of our guidance of $18 million to $22 million per quarter. Our reserve level was roughly flat quarter over quarter, and we feel we are well reserved at 110 basis points of total loans held for investment. Superior credit quality is in the DNA of Customers Bank. We are firm believers that management must remain highly focused on credit risk during strong economic times, which is why we feel we are very well positioned despite the uncertain macroeconomic environment today. With that, I’ll pass the call back to Sam to address our outlook and provide some concluding thoughts.
Sam?
Sam Sidhu: Thank you, Carla. I would like to wrap up with a brief update on our expectations for the remainder of 2023. Before going through the details, I want to reiterate that our top focus areas remain strengthening our balance sheet, improving our deposit franchise, as well as maintaining industry-leading levels of liquidity with a strong and growing capital base. We continue to perform against our previous loan and deposit guidance. As Carla mentioned already, the remixing of our loan portfolios complete the transformation of our deposit franchise through taking market share due to market disruption as I described earlier, is well underway and has a fantastic runway ahead. For an interest margin, normalized NIM was approximately 3.2% in the third quarter, and we expect continued expansion from there.
We set an ambitious goal of $6 in EPS at the beginning of this year, and I’m pleased to report that we anticipate significantly exceeding that target. And finally, we are very proud that we have already achieved our CET1 intangible book value per share targets. We look forward to providing you our financial outlook for 2024 and the new-year, but as you can imagine with the results we’ve achieved so far this year, we are very optimistic about our prospects in 2024. To conclude, to wrap up, this was clearly an incredibly strong quarter. Here are some takeaways. Number one, as we’ve said numerous times in this call and throughout the course of the year, risk management is and will always be our top priority. Number two, despite industry headwinds, we continue to materially improve the quality of our deposit franchise.
Over the last two quarters, we’ve grown core deposits by $2.1 billion and reduced our wholesale funding by $2.1 billion. Our deposit growth was broad-based and granular. We continued to grow our non-interest-bearing deposits, demonstrating primacy and importance of relationships. The pipeline remains strong at approximately 10% of core deposits and we’re just getting started. Number three, our recurring net interest margin improvement this year is significant and sustainable. Number four, we achieved tremendous improvement in our capital ratios. Our TCE to TA ratio increased by 50 basis points in a single quarter on a relatively flat balance sheet and our CET1 increased by 100 basis points and as you heard Carla say, adjusted for AOCI, Customers Bank is in the top quartile of all banks between $10 billion and $100 billion on this metric.
Lastly, as we look towards 2024, despite the challenges in the banking industry today, the future is very bright for Customers Bank. Our loan portfolio remix is complete and we’re well positioned for growth over the next year. We have strong opportunities to further strengthen our deposit franchise. Our platform is extremely efficient and at current levels is able to drive positive operating leverage and profitability. We have capital and liquidity to support our clients’ needs. Thank you very much and with that, we’ll now be happy to open up the line for questions.
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