From time to time I will write about client positions, not as investment advice but to share some of the lessons we learn from inside the sector. Your comments or outreach are welcome via our contact page.
As flexes go, the above paragraph above, hidden at the bottom of slide 14 of Customers Bancorp’s 3Q slide deck, isn’t much.
The company could have mentioned that shares have now more than quadrupled from the third quarter of 2020, but this understated disclosure is one of many changes in the company’s culture and direction over the past two years.
Customers is a unique company in a unique period, but there are lessons we may be able to apply at a few similar situations in its sector.
It helps to start from a position of weakness. As shown in the chart below, Customers shares stagnated from $15 in 2004 to $15 by the pandemic. Among several reasons (thin capital, wholesale lending), the most common issue we hear is governance. To share one typical story, I was recently sitting next to an analyst from a large institutional investment firm focused on banks, and shared that I was about to meet with Customers management. My neighbor wasted no time sharing the buyside bank analyst consensus: “(Customers CEO) Jay Sidhu will (take advantage of) you.” he shared bluntly. “Give him time.” He then rattled off 2-3 instances where Sidhu had surprised the board or ownership (related party SPAC, tech investments, comp). This issue arguably still impacts shares.
In this backdrop, as what was a hated stock inside a disliked sector, a year ago Customers was priced as if a highly dilutive capital raise was in the near future.
So why has CUBI outperformed Tesla by over 100% in this period?
Multiples Before diving into the drivers, this part is impressive. Book value per share has grown by 35% and the multiple expanded from 43% of tangible at 9/30/20 to 174% today. Similarly the earnings multiple expanded from ~6x to 12x while EPS expectations roughly doubled. It’s worth considering that Customers’ multiple is still nearly half that of the market.
Money flows CUBI has triggered a “money flow snowball” in which the ownership base expanded from insiders and a small band of dedicated value investors to subsequently include fundamental growth investors, financial sector fund managers and advisors investing in innovation (my hand is raised), quant funds chasing earnings growth, and of course index funds gloming onto performance. In the first “free gift” of its rally, perhaps CUBI could soon be a candidate for the S&P 600.
Not a story stock One item that has been missing from the 400% is mindless speculation. Few options trade at CUBI; it is not a Reddit forum stock; the story is not driven by potential products coming online in 2025, and as mentioned it has not been added to any indexes.
So, let’s examine the why in addition to the how.
Changing the perception: As mentioned, Wall Street has a shaky relationship with Customers’ Bancorp CEO Jay Sidhu. Yet the managers I have spoken with have an open mind and growing respect for subsidiary Bank CEO Sam Sidhu. So, this year Sam has put his stamp on operations and become the face of the company’s investor relations effort. Is this a veneer, as we saw with the Levans at BankAtlantic, or a transformation, such as at UMB with the Kempers? My sense is that Sidhu elder is on board with the message that the market rewards a partnership mentality. Time will tell, but the likelihood of corporate governance snafus seems to have fallen.
PPP and the power of intelligent planning. Commercial banking isn’t known for poaching from Goldman or private equity, but Customers is an exception – Sam traveled through Wharton / HBS / Goldman and Providence Equity Partners before he landed at Customers. Providence focuses on technology, media, and IRRs and Sidhu’s education there seems to have been helpful prior to arriving full-time to Customers in 2020. Sam arrived as COO just prior to the company’s massive tech-driven PPP loan efforts, which should generate the company ~$350 million in pretax income. For comparison, Customers entered 2020 with just over $800 million in tangible common equity.
Repaired balance sheet: Since the end of 2020,
- Tangible book has risen from $26.66 to $35.24 (or $40 when PPP gains are added).
- Tangible common equity / assets, which is basically the company’s solvency cushion, will have risen from a 2020 low of ~4% to 8% post PPP,
- Loans / deposits from a “hot” 111% eoy 2019 to 91% and falling at end of 3Q.
Forward Estimates, and Spreads, are rising because Customers has migrated from wholesale lender to technology platform In 2019, Customers’ focus was lending consumer installment (used by Upstart et al), mortgage warehouse lines and multi-family / CRE, funded primarily with borrowings, money market, and bankrate.com CDs. This combination isn’t particularly compelling, leading to 2.75% margins even in 2019 when rates were accommodating.
In contrast, today the company has received $1.5bn of 0% funding from crypto on-ramp banking, funds high-premium small SBA loans through a digital channel, and has entered the same VC-lending vertical that has driven Silicon Valley shares to 12x gains over the last decade, among other businesses.
The margin is now 3.24%, which is impacted by 10bp due to cash, and seems likely to expand despite no help from interest rates. Management also helped launch and spin off a digital bank. One gets the sense management is thoughtful about using technology ventures to drive option value in the shares.
What are the lessons?
– There is ample capital for tech-forward banks. While I’m not sure another 4x is available, if it were to occur, Customers would be trading at a similar multiple to one of its direct competitors for crypto on-ramp deposits – Silvergate Bank (SI).
– First, do no harm. Gradually rebuilding the market’s trust has been materially additive to the company’s multiple.
– Spread’s dead baby, Spread’s dead (a Pulp Fiction pun). Spread is very much alive, but competing on price for deposits and multi-family loans, plus giving your capital to Upstart instead of creating your own engine is a dead end if a bank wants a premium multiple. Customers is getting appropriate credit for a transition to 0% token funding and a “digital asset banking” suite comparable to Signature and Silvergate, which may further benefit loan spreads.
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