Description

I am recommending a long position in Customers Bancorp.  The bank currently trades for ~1x projected year end 2021 tangible book value per share and less than 10x 2021 core EPS, excluding the impact of PPP loans.  Customers is a combination of a regional commercial bank and a higher-growth digital bank; the increasing digital strategy should appear more meaningfully in financial results.  A reasonable path to ~$6.00 in EPS in 3-4 years with a low-mid teens ROE suggests a stock price in the low $70s in 2-3 years.  I like the risk/reward.

Casper719 submitted the idea in August 2014.  I refer to the write-up for the history and detailed information regarding Jay Sidhu.  He stepped down as CEO this summer and remains Chairman.  Sam Sidhu, Jay’s son, is the new CEO.  I understand if management questions/concerns make the investment a non-starter.  I am comfortable with management although I recognize that this could be a reason for a semi permanent valuation discount, and therefore a risk to the investment.

Background
Customers Bancorp is headquartered in West Reading,PA with $19.6 bn in total assets ($13.3 bn excluding PPP loans), 12 branches mostly in the Philadelphia area and loan production offices in Boston, New Jersey, New York, Portsmouth, Providence, Suffolk County, Westchester County and Chicago.  Total deposits were $13.9 bn as of June 30, 2021, so >$1 bn per branch; noninterest demand deposits are 19.5% and CDs are 4.5%.  Non-performing assets were 0.24%.  Total loans grew 11% y-o-y in 2Q with 25% growth in installment loans.

As of June 30, 2021, the $10.5 bn in total loans were split between mortgage warehousing (27%), commercial (56%) and consumer (17%).  The commercial loans are split between traditional commercial categories while 80%+ of consumer are installment loans.  The installment loans are a relatively new business for Customers and are representative of a product/offering consistent with their digital strategy.  Customers has a relationship with Upstart (recently expanded and extended) whereby Customers receives loan referrals and is able to make better and faster credit decisions.  Further, the lending relationship can lead to deposit relationships.  Consumer installment loans are obviously risky and we haven’t experienced a down credit cycle recently but early relative credit performance appears good.  Customers also ultimately makes the credit decision.  The growth and relationship illustrates the possibility.  Customers will continue to grow in this area and will develop relationships with other fintech companies and market place lenders. In addition, they plan to roll our other digitally sourced loan products in the next several quarters including SBA loans, term loans and credit cards.

The deposits per branch, tech focus, fee income generation and changing asset mix should all lead to better efficiency, operating leverage and attractive returns on capital.  Management needs to execute but the pieces are in place.

PPP

As of June 30, 2021, Customers had $6.3 bn in PPP loans outstanding and $3.9 bn in an FRB PPP lending facility.  Customers anticipates generating $400 mm+ in pre-tax revenue in total from the program and has recognized $118 mm to date.  For purposes of my analysis I exclude the PPP loans, the related income and the FRB PPP lending facility.  To Customers, and most participating banks, the PPP program will ultimately create a boost to capital and likely an increase in deposits.

Historical Financials:

Recent returns have been underwhelming.  The elevated provisions and surprisingly high efficiency ratios are the primary causes.  I say surprisingly high because with >$1 bn of deposits per branch one would expect much more operating leverage.  Two possible explanations: 1) the BankMobile business, which they sold at the beginning of this year, was likely a profitability drag and ) investments in the digital banking platform.  Over time the efficiency ratio should improve with elimination of BankMobile and roll-out of digital products.

The improving deposit mix (increasing demand deposits and decreasing time deposits) has helped net interest margin.  As the PPP loans roll off and installment loans grow as a share of assets, the net interest margin should continue to expand. 

Average balance sheets::

Installment Loans

Given growth and focus, probably worthwhile to take a closer look at the installment loan portfolio.  Management highlights in their filings that they do not originate or purchase any installment loans that are considered sub-prime (less than 660 FICO score) at the time of origination.  The following two slides are from Customers’ most recent investor presentation.

I take performance with a grain of salt given we have not experienced a meaningful credit cycle since they entered the business; althoug all things being equal I would prefer the above characteristics and relative performance.  Time and experience will tell.  As you would imagine 80%+ of the installment loans mature within five years.  Given Upstart’s potential (and other fintech related opportunities), this should be a meaningful growth area over the next several years.

Strategic Plan

Grow assets mid-high single digits through geographic and product expansion.  Net interest margin increases by decreasing funding costs and remixing loan portfolio to higher yielding assets.  Noninterest income should benefit from increased gain on sale activity and fee growth.  Rolling assumptions forward adds $15 - $20 to tangible book value and results in a +1% ROA and low double digit ROE bank with close to $20 bn in assets by 2025.  With tangible book value close to $60, $6.00+ in earnings power and attractive ROE a 1.2x book multiple and 12x earnings multiple are more than reasonable.

All of this sounds good on paper, why am I willing to invest?  Well, one can argue they have delivered on their plans up to this point so there is a good probability in management meeting their goals and second, I am paying 1x tangible book to take the risk.  The market is implying no premium for the strategy.

Other

In late August, management announced a share repurchase plan of up to 10% of shares outstanding over the next year and that they expect tangible book value per share to be $37 at year end without contemplating the share repurchase program.  The company retired $82.5 mm of preferred equity; series C and series D. Both actions will result in higher tangible book value per share over time.  

Catalyst

Executing on stated plans

Time