Description

I recommended in 2012.  Stock did well. Mini blow-up.  Now poised to do well again. New management cleaned up the mess on the lending side and now business is well-positioned to benefit from the ever changing fintech landscape.  All for the low price of ~10x earnings and ~1.1x tangible book value.

Summary: Traditional-ish banking business with upside of significant non-interest income.  Medium term earnings power in the $1.50 range with 20%+ ROE potential. Assuming a 10% deposit premium (arguably low), the stock is worth $13 - $15.  If TBBK remains independent, stock could be in the low $20s in 2-3 years. I like the risk/reward.

Business: We’ll discuss in two parts.  First, traditional banking.

Gather deposits, make loans and manage expenses.  A key to the story (which ties into the second part of the business) is a very cheap source of deposits.  TBBK is one of the leading backbone players in the fast-growing world of pre-paid stored value cards and alternative banking debit card programs.

[ASIDE: The pre-paid stored value cards business was traditionally dominated by store branded gift cards, tax rebate cards and Green Dot/Blackhawk type general purpose re-loadable (GPR) debit cards.  Think of the racks of cards you see at a Walmart, Walgreens, CVS, etc. The GPR cards were typically marketed as an alternative to more traditional banking to the unbanked. A consumer buys the card, deposits cash on the card via a retail store with the corresponding network and the customer uses like a traditional debit card.  The marketers of the card need a bank to house and manage the deposits, enter TBBK. Customers don’t demand interest (or demand very little interest), thus a very cheap source of deposits. Over the years and with the attention of the CFPB the industry came under some fire. Products charged fees to deposit funds, fees to withdraw funds, fees if balances were too low, fees on fees, etc.  The industry argued GPR cards even with all these fees were, in most cases, cheaper than a traditional bank account when you include minimum balance requirements, overdraft fees, etc. Regardless of the specifics the business had a somewhat seedy aspect to it – marketing to arguably the less sophisticated and not being fully transparent with the fee structure. Not payday lending bad but still kind of bad.

A funny thing happened.  Enter millennials, “fintech” and a re-emergence of pure online banking.  Instead of buying a debit card at Walgreens, a millennial can sign up for a Chime, Varo, PayPal (debit card), Venmo (debit card) account online and manage everything online/mobile app including direct deposits, savings account, checking account, etc.  Well, guess who is behind these and more? Yes, TBBK. The following article is a little dated but discusses the growth of the industry:

https://fin.plaid.com/articles/rise-prepaid-cards-america/

The narrative around hidden fees has been replaced with the potential excess fees of traditional banking accounts, maybe industry marketing worked.  Obviously don’t want to draw sweeping conclusions but safe to say the stigma around pre-paid debit cards is at the very least less than it was a few years ago.  TBBK wins two ways: 1) cheap deposits and 2) transaction fees. Back to the story.]

Deposit balances averaged $3.9 bn in 2Q2019, down slightly from 2Q2018.  Prepaid card deposits averaged $2.5 bn in 2Q2019, a 17% increase over the average of $2.1 bn in 2Q2018.  TBBK has two deposit line items: 1) Demand and interest checking and 2) Savings and money market. As of 2Q2019, nearly all their deposits were Demand and interest checking.  Add in negligible borrowings of ~$100 mm and TBBK had total deposits and borrowings of ~$4.0 bn at a blended cost of 96 bps. This was an increase of ~40 bps from a year ago when Fed Funds was 200 bps versus 250 bps during this year’s second quarter.  As short rates decline I would expect blended cost of funds to decline as well. But not much room to go given the already low cost of 96 bps.

There are ~$1.4 bn in deposits that aren’t related to the various debit card programs.  These are in the broad category of Affinity Banking. Essentially white label banking for financial services companies that aren’t deposit taking institutions.  Not as cheap a source of funding as the debit card programs but much cheaper than time deposits and other higher cost consumer banking products.

OK, now to the lending side.  Four primary lines of specialty lending:

1. Securities-backed lines of credit (SBLOC) – loans to individuals, trusts and entities that are secured by a pledge of marketable securities, typically 12 – 18 months.

2. Vehicle fleet and other equipment leasing – commercial and government vehicle fleets and, to a lesser extent, other equipment.

3. Small Business Administration (SBA)

4. Commercial Mortgage-Backed Loans, generated for sale into CMBS securities

Loan balances by category as of 2Q2019:

The IBLOC is Insurance Backed Lines of Credit which are collateralized by the cash surrender value of insurance policies.

Nothing too exotic.  Total loans were up ~4% through the first six months of the year and were 39% of total deposits.  Average loan balances during the quarter were $2.2 bn, higher average compared to ending balance is predominately a function of the timing of the CMBS securitizations.  Average yield on loans was 5.37%. Credit quality is very good; non-performing loans were 0.57% of total loans and 0.19% of total assets. Allowance for loan losses was $10 mm (0.64% of gross loans) and provision more than comfortably exceeds charge-offs.

Investment Securities totaled ~$1.4 bn at the end of 2Q2019; US Government, asset-backed, RMBS, collateralized mortgage obligations, CMBS, etc.  Nothing too crazy. Diversified. Yields in the 3.2% range. Opportunity to shift assets from securities to loans to enhance net interest margin.  Not central to the story, but an opportunity.

Average interest earning assets of $4.1 bn with a blended rate of 4.3%, up from $3.8 bn and 3.7%, respectively, in 2Q2018.  Assets should continue to increase, yield will depend on timing of loan re-pricing, shift from securities to loans and rate environment.  Net interest margin was 3.41% compared to 3.11% in 2Q2018. All things considered, will likely trend lower in the upcoming periods.

Second part, non-interest income.

Non-interest income over the last several years, highlighting key categories:

Stored Value Card Income
TBBK earns a share of the processing fees from the total Gross Dollar Volume transacted using issued debit cards.  The growth in GDV over the last four quarters has been 14.2%, 23.4%, 26.4% and 29.8%. Management does not talk about specific accounts but has stated that the significant growth has been largely the result of alternative banking products; i.e. the Chimes, Varos, Paypals, Venmos, etc. of the world.  Yes, the revenue share is less for these products than the historical products (evidenced by the declining blended share to TBBK) but the amount is still substantial given growth. On the latest call management said they expect the growth to continue and they have the infrastructure in place to handle ~$100 bn in GDV.  Using a 0.085% revenue share for the incremental ~$45 bn in GDV equates to ~$40 bn in additional non-interest income or roughly $0.50 per share.

Merchant Credit Card Deposit and ACH
ACH processing fees are pretty boring.  However, another trend is taking place in the fintech world; push payments.  Pull payments are what we all know. We swipe a credit card, the seller takes the information, routes it through the various networks to the issuing bank, the issuing bank approves, information is routed back to the acquiring bank and the transaction closes with the acquiring bank pulling the agreed upon amount from the issuing bank.  There are time lags, risks of fraud to the seller, etc. Push (buyer initiated) payments are the new rage. Primary advantages; buyer-initiated so no sharing of financial information and they are real time. Direct deposit and ACH were the traditional push payments. Think Venmo for peer to peer and extend to any number of use cases. One somewhat recent example is payments to Uber drivers.  Uber now gives drivers the option to receive payment after each ride as compared to every week, two weeks, etc. Uber introduced Instant Pay:

https://www.mastercard.us/content/dam/mccom/en-us/documents/mastercard-send-debit-lift.pdf

So, what does this mean for TBBK?  We don’t know yet but management plans to provide guidance in the next few quarters.  At the very least, management believes it will be an opportunity and at one level will appear in this non-interest income line item.  Also, as pointed out in the above article, debit card transaction volume is higher for push payment accounts. Makes sense I suppose. The direct impact will be higher processing income and with an indirect impact being increased GDV.  More to come.

Gain on Sale
TBBK typically does two securitizations per year, 1Q and 3Q.  The company accumulates the loans, earns interest, securitizes and then records a gain on sale.  Assuming securitization market remains open, this should generate $10 mm – $20 mm per year. Maybe you don’t pay a high multiple for this line item.  Fortunately, as the other non-interest income categories grow this should become less of a factor. Not a bad business.

One last piece to the income puzzle.  GDV growth does not happen in a vacuum.  Deposit growth is necessary for GDV growth.  I assume GDV volume is a function of stored value deposits.  It appears GDV is roughly 24x stored value deposits, on average, each year.  Makes some intuitive sense. If GDV increases $45 bn then deposit balances should increase close to $2 bn.  What is the incremental income from the $2 bn in deposits? Let’s assume all invested in securities yielding 3.0% at a cost of 0.5% for a NIM of 2.5%.  Add in some non-interest expenses for a blended NIM of 2.25%? Incremental pre-tax income of $45 mm or ~$0.50 per share.

On the non-interest expense side management has guided to ~$40 mm per quarter.  It will likely be lumpy throughout the year, but $160 mm is a decent run-rate for annual expense.

Valuation
Putting it all together, $4,050 in interest earning assets, 3.4% NIM, $4.5 mm in provisions, $98 mm in non-interest income, $160 mm in non-interest expense, 26% tax rate and 56.8 mm shares generates $0.93 in EPS for 2019.  I grow interest earning assets 5% into 2020, decrease NIM to 3.35%, increase provision to $5.0 mm, increase non-interest income to $107 mm, maintain non-interest expenses, tax rate and share count to generate $1.11 in EPS. Tangible book value per share, under this scenario should be around $9 with ROE 12%+.

Opportunities to invest at higher rates (shift investment securities to loans), growing non-interest income and expense control generates $2.00+ in earnings power, or 20%+ ROE.

Management & Investors

Damian Kozlowski (CEO) – has been in place for a little more than three years.  Big bank experience. Arrived and cleaned up mess on asset side. Laid out a plan and is delivering on that plan.  

Betsy Cohen is no longer involved but Daniel Cohen remains Chairman.  Would prefer no more Cohen involvement but decent Board turnover and addition of John Eggemeyer (Founder and Managing Principal of Castle Creek Capital) who has extensive experience in running, investing in and monetizing assets in the banking sector is encouraging.  Castle Creek is the #4 shareholder with 5%+ position. The largest shareholder is Frontier Capital with a 7%+ position. They initially became a shareholder in 2Q2017 and have been building their position over time. Stock hasn’t done well for Frontier to this point, but they have added and stuck with the position.

Summary
I like the risk/reward.  Poised to benefit from fintech trends, cheap, management team that gains credibility with each quarter and path to $2+ in earnings.

Catalyst

Continued execution

Take-out