CUBI: Removal of Growth Constraints, NIM Expansion Lead to Increased EPS Estimates; Maintaining Target Price; Reiterating Outperform Rating.
Customers Bancorp, Inc (CUBI – NYSE – Recent Price: $23.53)
Rating: Outperform / Buy Price: $30.00 / Target (Sell) Price: $34.00
4Q19 Results: Customers Bancorp reported 4Q19 net income of $23.9 million, up 2.0% from the $23.5 million recorded in 3Q19. On a per share basis, 4Q19 results were $0.75 compared to $0.74 in 3Q19. There were only a few small unusual or irregular items in 4Q19 results, including $0.3 million in securities gains and $0.06 million in losses on the sale of non-QM mortgages. Together, these items reduced 4Q19 EPS by $0.01. In 3Q19, the Business Banking segment recorded a $1.0 million legal accrual and posted $2.3 million of securities gains that provided a net boost of $0.04 to EPS. The BankMobile segment recorded a $1.0 million legal reserve that reduced EPS by $0.02. Excluding these items from both periods, adjusted 4Q19 EPS was $0.76 compared to 3Q19 adjusted EPS of $0.73. The adjusted 4Q19 per share results exceeded our $0.73 estimate by $0.03 and the $0.72 median Street estimate by $0.04. The Business Banking segment posted 4Q19 adjusted segment EPS of $0.71 versus $0.68 in the prior quarter. The BankMobile segment posted adjusted segment EPS of $0.06 versus $0.05 in 3Q19. A higher-than-expected loan loss provision, and higher noninterest expenses were offset by higher net interest income, higher noninterest income, and a lower effective tax rate, resulting in the better results versus our projection. Some of the highlights from the quarter include:
· Loans: Loans held-for-investment declined $17 million or 0.2% sequentially, while loans held-for-sale fell $209 million or 7.1% linked-quarter. Management reports that the seasonal 4Q decline in mortgage warehouse lending did not occur to the normal extent this year. CUBI continued its push to diversify its loan portfolio, as C&I loans grew $129 million or 5.7% sequentially. Consumer loans climbed $279 million or 20.7%. Residential mortgages declined $254 million or 40.1%. Multifamily loans continued their decline, falling $408 million or 14.6% after a $218 million drop in the prior quarter. This is part of a planned de-emphasis of this segment. The CRE segment declined 3,5% while the construction segments posted a 5.7% sequential increase. Mortgage warehouse loans fell $193 million or 7.9%.
· Total Assets: Total assets decreased $203 million or 1.7% sequentially to $11.5 billion. Management recognized several attractive growth opportunities and made the decision to abandon plans to reduce the balance sheet below $10 billion. The income available from an extra $1.5 billion in assets was determined to exceed the cost of losing some interchange revenue as a result of triggering the Durbin amendment.
· Funding: Total deposits declined $277 million or 3.1% LQ to $8.6 billion. The decrease was driven by the normal seasonal trends at BankMobile, which saw total deposits fall $265 million or 39.7% from $666 million at September 30, 2019 to $401 million at December 31, 2019. This decrease was the result of a normal seasonal decline in the disbursement business, which fell $279 million LQ, offset by growth of $14 million from the bank’s white label partnership with T-Mobile. The jump in total deposits at CUBI was driven by money market accounts, which spiked $609 million or 16.0% sequentially, and interest bearing demand accounts, which climbed $96 million or 8.4%. Noninterest bearing checking accounts, which are affected by the seasonality of the BankMobile disbursements business, declined $227 million or 14.4%.
· Capital: During 4Q19, CUBI’s regulatory capital ratios grew modestly, as the total capital ratio climbed to 12.21% from 11.36% at September 30, 2019, while the CET1 ratio advanced to 8.00% from 7.81% and the leverage ratio rose from 9.01% at the prior quarter-end to 9.26% at December 31, 2019. Tangible book value (TBV) per share grew to $26.17, an $1.01 increase from the $25.16 posted at September 30, 2019. CUBI’s TCE ratio rose to 7.13% from 6.71% over the same period.
· Net Interest Income and NIM: Net interest income grew $1.9 million or 2.5% LQ, as a 0.1% jump in average earning assets was complemented by 6 bps of NIM expansion to 2.89% (on a tax equivalent basis). The margin expansion was driven by an 18 bps drop in average deposit costs, which offset a 5 bps advance in the average cost of borrowings and led to a 16 bps reduction in the average cost of interest bearing liabilities. Meanwhile, the loan mix continued to improve, as consumer, C&I, and non-owner occupied CRE loans, the three highest yielding loan segments, grew substantially during the quarter, while the lowest yielding loan segment, multifamily loans, fell noticeably. Despite this mix shift, average loan yields declined 11 bps, pushing average earning asset yields down 11 bps. The reported NIM was 3 bps lower than our expectations.
· Fee Income: Noninterest income advanced $2.4 million or 10.5% sequentially. The drivers of the increase were $2.8 million in gains on the sale of SBA loans and a $3.2 million rise in “other” noninterest income. These increases were partially offset by a $1.0 million drop in securities gains, a $1.0 million decline in unrealized securities gains, and a $0.9 million reduction in mortgage banking income.
· Noninterest Expenses: Noninterest expenses fell $0.9 million or 1.4% in 4Q19. There were substantial movers masked by this modest change. On one side was an increase of $1.6 million in technology costs to support white label and digital transformation efforts, and a $3.3 million swing in FDIC and regulatory expenses following the $2.6 million FDIC credit received in the prior quarter. On the other side was a $4.1 million drop in “other” noninterest expense and $1.9 million drop in professional fees. Customer’s efficiency ratio improved to 56.98% from 61.58% in 3Q19, though, if we exclude the irregular items, the “core” efficiency ratio was 56.45% in 4Q19 compared to 59.51% in 3Q19.
· Asset Quality/Loan Loss Provision –Despite further growth in NPAs and NCOs, overall asset quality figures remain very strong. Nonaccrual loans grew $3.8 million or 21.4% from the prior quarter while OREO decreased $31k or 15.2%. As a result, nonperforming loans-to-total loans held for investment rose to 0.21% from 0.17% at September 30, 2019 while reported NPAs/Assets climbed to 0.19% from 0.15%. Net charge-offs of $4.4 million amounted to 0.18% of average loans on an annualized basis, up from the 0.07% figure posted in 3Q19. The company recorded a $9.7 million loan loss provision in 4Q19 compared to a $4.4 million provision in the prior quarter. It appears that roughly half of the provision was related to loan growth during the quarter, with the rest replenishing charge-offs. The increase in charge-offs was largely in the consumer loan segment. Reserve coverage of loans held-for-investment climbed to 0.77% from 0.70% at September 30, 2019, while coverage of NPLs fell to 264.7% from 290.4%.
Earnings Estimates: Along with the better-than-expected earnings announced for 4Q19, Customers also announced several other significant changes. The bank has been struggling to remain under the $10 billion in assets mark at year-ends for the past several years in order to keep from triggering Durbin amendment reductions in interchange fees. These fees are a critical component of BankMobile’s profitability structure. The company has now decided to cease the balance sheet gymnastics necessary to keep assets under $10 billion. This means that, starting in July 2020, the company’s interchange revenue, which amounted to roughly $19 million at the BankMobile unit in 2019, will be reduced by 30%-50%. However, the net income derived from an additional $1.5 billion or more of earning assets should more than compensate for the sacrifice of this interchange revenue. Management also hinted at a disposition of the BankMobile unit in 2020, a much sooner event than they have suggested in previous quarters. With BankMobile now showing two profitable quarters in a row, any disposition should prove easier than previous attempts to sell or spin-off this unit. While we believe separating BankMobile to allow it to continue receiving a full slice of interchange revenues would be beneficial to all involved, we will await a more definitive announcement before incorporating any separation into our earnings model. Finally, CUBI has ramped up its consumer loan portfolio growth. This has boosted earning asset yields and the NIM, while also causing an increase in charge-offs.
We have adjusted our earnings model to account for the removal of constraints on asset growth. With the ongoing shift in asset mix toward higher yielding commercial and consumer loans, we still expect CUBI to achieve modest quarterly growth in the NIM, despite the current low interest rate environment. We have also boosted our charge-off and loan loss provision estimates to reflect the greater proportion of consumer loans in the portfolio. We have cut our forecast for noninterest income in 2H20 to show the decline in interchange revenue, and we have boosted our expense projections to reflect the greater balance sheet growth we are assuming.
After adjusting our model, we are raising our 2020 EPS estimate from $2.83 to $3.04, and our 2021 EPS estimate from $2.96 to $3.26.
Stock Price Implications:
Peer banks are trading at a median valuation of 14.6x trailing twelve-months EPS, while CUBI is trading at an 11.5x TTM EPS multiple. On a price-to-2020 consensus EPS basis, peers are trading at 13.7x while CUBI trades at a steeply discounted 8.0x. The stock also trades at a steep discount in terms of price-to-tangible book value, with peers trading at 166.3% while CUBI trades at just 89.9%. We believe the discounted valuation reflects the uncertainty and complexity created by the combination of a fledgling digital bank (BankMobile) and a more traditional commercial bank, as well as the constrained growth the bank has pursued in order to avoid Durbin Amendment restrictions. We believe the removal of these growth restrictions should make a material difference in the bank’s valuation. The move to separate BankMobile in some manner should also improve valuation, but after several previous aborted attempts to complete such a separation, investors are likely to remains somewhat skeptical about this divestiture. As 2020 progresses and CUBI shows significant progress toward achieving its $3.00 EPS target, we believe the discount on the stock should narrow significantly. Our $34.00 price target translates to a P/E multiple of just 11.3x our $3.00 EPS estimate for the next four quarters (1Q20-4Q20). This multiple is consistent with the current stock valuation and still represents a considerable discount to peer valuations. Our target price suggests upside of 44.5% from the current price. While noting the higher than usual uncertainty in this name, we are reiterating our Outperform rating on CUBI stock.