CUBB - Customers Bancorp: Floating Preferred Share Yielding 13.5%

2023-05-11 11:50:40 ET

Summary

• Customers Bancorp is a small regional bank located in Pennsylvania.
• Shares of the bank have come under pressure, including preferred shares.
• Despite the challenges in the sector, Customers Bancorp is set up to persevere.

Customers Bancorp ( CUBI ) is a small Pennsylvania based regional bank. Like the sector, the bank has seen a tremendous selloff of its shares in the last two months. The selloff also impacted the bank's preferred shares, with the F series falling to around $18 per share ( CUBI.PF ). With a floating payout, the bank recently announced an increase in its F series dividend to over 61 cents per share . Based on today's prices, the current yield is 13.5%. I believe the risk/reward for investors creates a buying opportunity in the F series.

The bank's F series preferred share are floating, meaning that it has passed its call date (December 2021) and is now subject to fluctuations in the interest rate markets. The quarterly payout is equivalent to three-month LIBOR plus 4.762%. If interest rates were to go back to zero, at today's share price, the dividend yield would still be over 6.5%.

Customers Bancorp first quarter financials were mixed. Like all other banks, interest expenses rose as the cost to carry deposits increased, but the bank's interest income seemed to be close to keeping pace. In fact, the net interest income (interest income less interest expense) rose nearly $15 million from the fourth quarter of 2022, but conversely is down $15 million from the same quarter last year.

When examining interest income, it's important to look at the loan yield (loan income divided by total loans) the bank is generating. In the case of Customers Bancorp, the loan yield is nearly 6.5%. This would indicate that the bank's loans portfolio is not burdened by tons of low interest rate mortgages/loans made during the pandemic. The higher loan yield brings optimism that the bank can ride out higher borrowing costs. An examination of the bank's loan composition finds that a big part of the bank's book of business is in commercial specialty loans, multifamily, and commercial real estate. The bank also started issuing and holding personal consumer loans in the fourth quarter of 2022.

An examination of the bank's balance sheet shows that Customers Bancorp took the problems occurring in the regional banking sector seriously in March. The bank increased its cash position by $1.5 billion to over $2 billion by borrowing $1.2 billion from the FHLB and allowing its loan balance to decline. Deposits declined, but only modestly, and remained above where they were two quarters ago. Despite the capital shuffling, shareholder equity increased to $1.42 billion, 3% higher than a year prior.

Despite the increase in borrowing, Customers Bancorp still has plenty of liquidity. The bank did not draw on any of the Federal Reserve's Bank Term Funding Program and has not borrowed from the discount window. In fact, the bank has $9.4 billion in available liquidity between all the lending facilities available to it. For every $1 in uninsured deposits at Customers Bancorp, the bank has $2.72 in available liquidity.

Comparing some of the bank's financial ratios to its peers provides additional insight. The bank saw a bigger decline in lending than its peers, but that was due to the reduction of PPP loans from its balance sheet. Deposit declines were better than the commercial banking sector and while the loan to deposit ratio is higher than the sector, it matches what can be expected from a smaller bank.

The bank's above average leverage ratio of 14.3 to 1 highlight where investors should be monitoring risk. A higher leverage means that the bank is susceptible to problems should its loan portfolio begin to underperform. While all the buzz is around commercial real estate, and the bank has $2 billion in those loans ($895M in owner occupied, $1.2B in non-owner occupied), there are other big categories to watch out for. The bank has over $5.5 billion in specialty lending to commercial and industrial entities. The bank's multifamily exposure is as large as its CRE exposure. Any stress in these areas is going to place strain on the balance sheet.

While risks are present, the decline in the bank's preferred shares present a great buying opportunity. While Customers Bancorp does offer a baby bond alternative ( CUBB ) yielding above 8%, I believe the F series preferred shares present the best risk/reward opportunity in the current environment.

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