The Bancorp, Inc. TBBK
December 07, 2014 - 10:23am EST by
leafs93
2014 2015
Price: 10.02 EPS 0.15 0.83
Shares Out. (in M): 38 P/E NMF 12.0
Market Cap (in $M): 378 P/FCF N/A N/A
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT N/A N/A

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  • Regional Bank

Description

 

Investment Return Profile – 60% upside likely with only 15% downside potential

We believe that a confluence of negative events has pushed the share price of The Bancorp, Inc. (Nasdaq: TBBK) (“TBBK”) down to a level where there is limited fundamental downside left in the stock. Once TBBK is able to overcome these issues, or provide the visibility to give investors confidence that the end is in sight, the stock should begin to trade at multiples reflective of its peer group which we believe will put the stock at $15-17 per share vs. the current $10.02 today. This should happen over the next 12-24 months for an IRR of 25-60% depending on how quickly the catalysts materialize. In a worst case scenario we have a hard time envisioning a downside scenario where the valuation of the company would be any more than 15% below current levels, and even that seems unlikely. None of this factors in various potential elements of upside optionality or a takeout premium, both of which are possible. This 9-to-1 up-to-down ratio is what excites us about TBBK.

 

Company Description

TBBK is a branchless chartered commercial bank located in Wilmington, Delaware. The primary business line of TBBK which makes it attractive is its central role in the growing stored value card industry. This segment provides it with a very valuable deposit-gathering franchise (43% of current deposits) and material non-interest income (25% of net revenue). In addition, the bank has a number of lending operations which have all been growing and going forward should provide ample return without meaningful provisions.

 

Recent Stock Performance – The Opportunity is Created

TBBK’s share price has been under significant pressure in 2014 as a result of two primary fundamental issues, and what appears to be technical selling follow-ons. The stock began trading in 2014 at $18 per share, and rose above $20 at the highs in March before falling drastically and currently sits at $10, nearly 50% below its highs, yet there has been nothing existential or permanent in the way of developments to cause that much investor concern.

 

The stock took its first leg down in April, dropping 15% from ~$18.60 to ~$15.80 after its Q1 2014 earnings release. The company had a provision expense of $17 million in the quarter which was unusually high compared to historical annual provisions of $20-$30 million. The nonperforming loans surfaced in the community bank’s commercial loan portfolio, a portfolio that the company is currently in the process of selling.

 

Then TBBK shares fell another 30% from ~$16.30 to ~$11.50 on June 11th after management disclosed an order from the FDIC (Federal Deposit Insurance Corporation) regarding controls needed for BSA (Bank Secrecy Act) regulation that affects part of its prepaid cards business. In essence, the regulator required TBBK to improve its regulatory technology controls and staffing around this business, something which will create slight additional expense (we estimate after tax cost of 7 cents per share) and in the interim, it forces TBBK to suspend growth in one segment of the prepaid business.

 

The stock further declined another ~15% from ~$11 to $9.45 after Q2 earnings release on July 24th due to further provisions taken in the commercial loan book. We believe that management tried to “kitchen-sink” this second quarter. Given the weak share price leading into the report and the decision to exit the community lending business line, management had every incentive to do so.

 

The stock has further trended downward, reaching lows of $8 and is currently at $10.02 (as of December 5). We believe that tax loss selling is in full force for a stock down 45% year-to-date.

 

Target Valuation

TBBK is a typical value opportunity which is trading at a significant discount to peers in the market, and to our estimate of intrinsic value. TBBK is trading at 1x Price to Tangible Book Value, while the majority of its peers are trading above book value between 1.3-2.0x with one of its most comparable peers focused on higher-tech banking trading at 2.8x (BOFI). Also, TBBK is trading at 10.4x 2016E consensus EPS and at 8.3x 2016 our internal modeled normalized EPS, while peers are trading on average at 12x 2016 (and generally these peers have a more volatile earnings stream).

 

TBBK currently has a book value of $9.45/share and tangible book value of $9.25/share. Our 2015E EPS is $0.83/share and our normalized estimate EPS is $1.20/share which should be achievable in 2016. It is important to note that despite being the focus area for consensus forecasts, 2015 is not a relevant year as the proceeds from the commercial loan portfolio sale (close to $900 million or about 20% of assets) will be reinvested at the temporary lower rate of 1.75%. However, our steady-state 2016 forecast is based on 2015 with the main difference being the proceeds reinvested at 4%, which is consistent with management guidance and the current lower-risk business lines the bank has focused on. Management believes that the reinvestment can be done over a 6-12 month period which should provide for a cleaner 2016 EPS, representative of normalized earnings power. We also believe that the BSA order will be lifted on the prepaid card business close to the start of 2016 (or end of 2015) which will allow investors to reapply a more appropriate market multiple of 12.5-14.5x EPS arriving at our $15-17 price target.

 

Main Catalysts and Rationale for Near-term Future Share Appreciation

TBBK will benefit from several upcoming catalysts that should lift up the share price:

 

  1. The commercial loan portfolio will likely be sold in the next two quarters. The net proceeds should be at a minimum, the marked-down book value of $900 million, which factors in a cumulative loss-to-date on the portfolio of 15%. It is possible that the bank will be able to sell the portfolio at a premium to its marked value given what we believe were management’s intentions to be conservative. Once this occurs, the current tangible book value of $9.25/share will be validated and could even grow if the mark taken was too aggressive. This sale will create a floor for the share price at 1x P/TBV. The sale should also alleviate some current “soft costs” related to running the portfolio that are not yet separated into discontinued operations. These costs are related to the processing system of loans and head-count of the commercial group and should provide some relief to non-interest expense which we have not yet modeled.

 

  1. Proceeds from the sale of the commercial loan portfolio will be fully reinvested at historical 4% yield within the next 18 months. This should create a recovery in NIM to 2.70% from current levels of 2.3% from continuing operations and interim ~2.2% in 2015 while proceeds are reinvested quickly at the lower rates. Furthermore, the remaining loan portfolio has had insignificant losses and there should be minimal risk going forward. For example, non-performing loans are only 0.55% of remaining portfolio vs. historical levels of ~2% and net charge-offs should be in the 15-16bps range as a percent of average loans. This lower risk portfolio of assets should yield a higher multiple.

 

  1. The BSA order should be lifted in the next 12-18 months. While we feel the BSA order will require TBBK to halt growth in 35% of its prepaid business and incur slightly higher costs, we do not believe the BSA will have as meaningful an impact on the business as was suggested by the $185 million drop in market cap on the BSA announcement. However, the lifting of the order will allow TBBK to maintain its market leading position in the prepaid cards business as the #1 player in what is essentially a duopoly. But more importantly, it will remove the overhang that investors have put on the stock and allow the multiple to revalue toward the level of its peer group. (See “Prepaid Card Business” section below)

 

Additional Upside Optionality – Free Options that Provide Potential for a $20+ stock within 3 years

 

There are a number of other levers which have not been factored into our base case analysis and would likely drive the stock to a price above $20 if they came to fruition:

 

  1. Growth in the Prepaid business is large – open loop prepaid cards were projected to grow globally at a 22% CAGR from 2010 to 2017 and a 16% CAGR in US. In comparison, TBBK’s growth in prepaid GDV (Gross Dollar Volume) has been a 74% CAGR from 2009 to 2013. Additionally, the BSA order only affects TBBK’s general purpose cards. These are a sub-segment that only represent 35% of the total prepaid business and are still allowed to grow at national average growth rates. The remaining 65% of the prepaid business will be allowed to continue to grow at historical higher growth rates. Once the BSA is lifted, TBBK will be capable of acquiring new customers and the remaining 35% of the business should see a recovery in growth rates as well. TBBK is also the bank used in emerging payment systems such as Paypal and Google Wallet as well as Simple.

 

  1. European prepaid business will breakeven by the end of the year and has potential to add significant growth to prepaid fees. The current drag on operations was disclosed to be ~$5 million/year and yearly EPS could improve by at least ~9 cents once this business becomes profitable. In addition, the European business is not impacted by the BSA order and there are no growth constraints. This is all upside to both our modeled normalized forecasts and street analysts’ estimates.

 

  1. In a rising interest rate environment, TBBK should outshine its peers as its interest-earning assets will generate yields that are significantly higher than its low costs on prepaid deposits, which will stay sticky at low rates. For example, for every 50 bps increase in yields across the board for both interest-generating assets and interest-bearing deposits, our modeled normalized EPS of $1.20 increases by 10 cents. Using steady-state EPS and a 1.5% Fed Funds rates, should yield EPS of $1.45 or ~25 cents increase. This change would not happen instantly but over time in a couple of years as loans are gradually re-priced. In the short-run, the EPS should see a 10 cents lift immediately. While today’s environment seems to rule out any rate increases, we believe they will come and TBBK contains a very nice asymmetric upside to that environment – an option investors are not paying for today.

 

  1. There is a potential M&A opportunity for the entire business or the prepaid cards franchise. Betsy Cohen (current CEO until January 1st) is currently in her early 70s and recently announced her retirement. She is a significant insider shareholder with $1 million of recent stock purchases and there is speculation that she could still sell the business as an exit. Her husband has just sold his energy company (ATLS). The prepaid cards franchise has significant value as mentioned above and a strategic buyer could easily extract significant operating costs out of the entire business. Betsy has a history of realizing shareholder value in an exit, having sold her previous bank Jeff Banks for 2.5x P/BV in 1999.

 

  1. The company recently announced a CEO change that is viewed as positive and appears to be a logical step in transforming TBBK into a financial-tech company. Betsy Cohen is retiring and will be replaced by the current President and COO, Frank Mastrangelo. Frank has been the “go-to” person for answering prepaid cards-related questions on investor calls and is also very knowledgeable about the growth opportunities in Europe. If TBBK changes its focus towards the prepaid cards industry it should have a re-rate in multiples that are closer to financial-tech companies, in the range of 20-25x NTM P/E.

 

Why We Believe the Downside is Priced In – At Worst Another 15% of Downside

We believe that management has taken a “kitchen-sink” approach for 2014 and the current tangible book value of $9.25/share reflects drastic mark-downs to the commercial portfolio being sold, which are further discussed below in “Commercial Loan Portfolio – The Worst is Over”. Also, during the Q2 announcement, management tried to charge off the entire $9 million of consulting costs related to the BSA order; however, this was later revised to be spread over the last three quarters in 2014 and $5 million has been expensed to date as such conservative accounting was not approved by the auditor, but it does speak to management intentions. In situations like this with banks, where loan portfolios have not been performing for a prolonged period, they become show-me stories and management has credibility issues until negative development stops or until the problems loans are sold. In TBBK’s case, the announcement of the sale of commercial loans indicates that all major marks should have been taken. Management is essentially opening kimono to anyone willing to sign a CA and if there were any other major problems with the portfolio, they would come up during the sale process and would risk completing a sale. If that were to happen, the market would assume the worst.

 

Even with all the mark-downs, the company remains well-capitalized and management has indicated that they absolutely do not need more capital. Adding more margin of safety, large portions of the SBA loans on the balance have government guarantees and would trade at a 10-12% premium to par value if they were needed to be sold.

 

In addition to the announced sale of the community bank operations, the CEO (who announced her resignation on Monday) has purchased $1 million worth of shares in the open market since Q2 reporting and the announced markdowns. We believe the portfolio sale and insider purchases are both good indicators that Betsy believes there isn’t another shoe to drop. As for her deciding to leave the company, we aren’t overly concerned. Betsy is in her early 70s and independently wealthy – her husband is CEO of Atlas Energy LP (ATLS) and Atlas Pipeline Partners (APL), which are currently being sold to Targa for ~$8 billion. Also, the new CEO is internal and unlike the classic case of an outsider coming in, he will not be incentivized to take a big bath up front on more write-downs to show subsequent operational improvements.

 

On the prepaid cards segment, we believe the overhang of the BSA order is already priced in and going forward it should have a minimal impact on the business. The order limits growth on only 35% of the prepaid business and there will be ~$4 million of annual incremental pre-tax operating costs related to BSA infrastructure and personnel (this is 7 cents per share after tax in EPS). Furthermore, TBBK benefits from a duopoly in the prepaid industry with its main competitor MetaBank, a division of Meta Financial (CASH), and should see a minimal change to its customer base and market share. We believe the prepaid business has been a misunderstood asset in the past, overshadowed by TBBK’s commercial loan portfolio. The entire prepaid card franchise, however, is worth significant money in addition to the book value it provides. Given the nominal cost of deposits in the prepaid business, re-investment at higher rates would generate material NIM, especially if rates ever rose. Additionally, the prepaid card business provides meaningful non-interest income which is more akin to the payment processing fees that drive VISA and MasterCard, both of which trade near 25x EPS. Management, who has recently purchased $1 million of stock has indicated that this business as a stand-alone could be worth $300-400 million. These management purchases, which have come since Q2 earnings, give us confidence that there is not significant downside potential in the valuation from current levels.

 

Valuation and Comparison to Peers

TBBK currently trades at a discount to peers at 1.06x P/BV and 1.08x P/TBV based on a price of $10.02/share (December 5). Also, on an EPS basis, TBBK is at 8.3x our normalized EPS which should be achievable by 2016.

 

Our 2015 forecasts are based on asset yields and deposit costs that are flat from 2014 and do not assume any change in the interest rate environment. We have assumed that TBBK will be able to sell the commercial loans for $900 million of net proceeds at the end of Q4 2014 and reinvest them at 1.75%. We have assumed modest growth rates in the interest-generating assets compared to growth in previous quarters. The largest portion of interest generating assets consists of ~$1.5 billion of investment securities generating a 2.6% yield. We have grown this segment at 10% YoY compared to historical yearly rates of 60-80%. The remaining loan portfolios are individually grown by segment with an aggregate growth of 10%. On the non-interest income side, we have grown prepaid fee income at 12% YoY based on management’s guidance. However, we believe this could be higher once the BSA order is lifted.

 

Below is a summary of the multiples of its closest regional banks peers and competitors in the prepaid cards industry. We have also included multiples of “financial-tech” companies such as VISA and MasterCard. Once the BSA order is lifted and the commercial loan portfolio is sold, we believe that TBBK should trade somewhere between the regional banks and financial-tech companies in the long run at 12.5-14.5x our steady-state EPS of $1.20 at the end of 2015. This would imply a target range of $15-$17/share, which is 60% IRR to current share price if realized within one year and 25% IRR within two years.

 

Pennsylvania / Philadelphia C&I Comps

Price

Mkt Cap
($ mm)

P/BV

P/TBV

Sun Bancorp Inc/NJ (SNBC US)

$19.08

355

1.44x

1.70x

Fox Chase Bancorp Inc (FXCB US)

$16.71

201

1.13x

1.13x

Republic First Bancorp Inc (FRBK US)

$3.90

147

1.32x

1.32x

Average

 

 

1.30x

1.38x

 

Prepaid Cards Comps

Price

Mkt Cap
($ mm)

P/BV

P/TBV

2015
P/E

2016
P/E

Meta Financial Group Inc (CASH US)

$35.13

217

1.24x

1.29x

10.7x

9.8x

Green Dot Corp (GDOT US)

$22.45

1,044

1.90x

2.13x

13.1x

13.1x

BofI Holding Inc (BOFI US)

$77.30

1,145

2.80x

2.80x

15.7x

13.2x

Average

 

 

1.98x

2.08x

13.2x

12.0x

 

Financial Tech Comps

Price

Mkt Cap
($ Bn)

2015
P/E

2016
P/E

MasterCard Inc (MA US)

$89.08

103.0

24.7x

20.9x

Visa Inc (V US)

$263.35

163.7

25.3x

21.8x

Total System Services Inc (TSS US)

$33.63

6.3

15.2x

13.9x

Average

 

 

21.7x

18.9x

 

Overview of TBBK’s Business

TBBK provides retail and commercial banking services in Philadelphia, Pennsylvania and Wilmington, Delaware and areas in Florida as well as related other banking services nationally, including private label banking, institutional banking, health savings accounts and prepaid debit cards. The company has also recently ventured into Europe and is looking to expand the prepaid cards business there.

 

TBBK’s has two main sources of revenue: net interest income from its loan book and investment securities, and non-interest income from the prepaid cards business, leasing income, gain on sale of loans, and commissions and fees earned from affiliates and processing of card payments. Net interest income accounted for 53% of total net revenue in 2013 (~$96 million) vs. non-interest income contributing 47% (~$83 million).

 

TBBK provides a breakdown of its interest-generating assets and deposits in their quarterly presentation (slides 12 and 14): http://www.snl.com/Cache/1001190304.PDF?Y=&O=PDF&D=&FID=1001190304&T=&IID=4054569

 

In our forecasts we have kept these yields and costs flat as they have been fairly steady over the past quarters. The only exception is to the proceeds from the Community Bank portfolio, which we forecast at 1.75% in 2015 and re-invested at 4% in our normalized year.



Primary Interest-Generating Assets

 

2015

 

Balances

Q1

Q2

Q3

Q4

2016

Investment Securities

1,660

1,712

1,693

1,634

1,634

Reinvestments - MBS

900

900

900

900

 

Inst Banking (SBLOC)

432

454

481

494

494

Leasing

204

204

212

212

212

Govt Guaranteed Lending (SBA)

210

239

248

250

250

Reinvestments – Loans

900

CMBS

142

142

142

142

142

Total Interest Assets

3,547

3,652

3,675

3,632

3,632

Total Loans

987

1,039

1,083

1,098

1,998

 

 

 

 

 

 

Average Yields

 

 

 

 

 

Investment Securities

2.60%

2.60%

2.60%

2.60%

2.60%

Reinvestments - MBS

1.75%

1.75%

1.75%

1.75%

Inst Banking (SBLOC)

2.60%

2.60%

2.60%

2.60%

2.60%

Leasing

6.76%

6.76%

6.76%

6.76%

6.76%

Govt Guaranteed Lending (SBA)

4.52%

4.52%

4.52%

4.52%

4.52%

Reinvestments - Loans

4.00%

CMBS

3.55%

3.55%

3.55%

3.55%

3.55%

Average Yield

2.77%

2.79%

2.80%

2.80%

3.36%

Average Loans Yield

4.00%

3.99%

3.98%

3.96%

3.98%

 

Income Statement

 

Steady-State

 

2015

2016

Interest Income

101

122

Interest Expense

12

13

Net Interest Income

89

109

Provisions for Loan and Lease Losses

2

5

Net Interest Income after Provisions

87

103

Non-Interest Income

94

101

Non-Interest Expense

133

135

Income Before Income Tax Benefit

48

70

Income Tax

17

24

Net Income - Continuing Ops

31

45

 

 

 

EPS

$0.83

$1.20

 

Commercial Loan Portfolio – The Worst is Over

Before announcing the discontinuation and sale of its commercial portfolio in the latest quarter, TBBK had several significant charge-offs and provisions related to the Commercial and Construction loans. In 2013 there were $29.5 million of provisions and $24.4 million of net charge-offs of which $14.6 million of NCOs were related to Commercial loans and $9.3 million to Construction loans. In the first half of 2014, problems with these portfolios continued and TBBK charged off a further ~$23 million and expensed $33 million of provisions on the income statement.

 

Before the Q3 announcement, management disclosed that the commercial loan problems were isolated to legacy loans from 2009 and a significant proportion had already been charged off. In 2009, there were $1.5 billion in loans of which ~$1.2 billion were related to the commercial portfolio. From 2010 to Q2 2014, $90 million of the commercial loans were charged off and in the Q3 release, a further $82 million mark down was mentioned. That would imply that 15% of the initial 2009 commercial loans has been charged off.

 

The discontinued loans are currently valued at $1.1 billion on the book and the remaining continuing portfolio is ~$870 million. Management is currently reviewing options for selling the commercial loans and has indicated on calls that there is significant interest from other parties. However, they are looking to maximize proceeds and they will be deciding between (1) selling the loans in bulk to one or two sellers or (2) breaking them apart by geography.

 

Management expects to sell the portfolio within the next 90 to 120 days and we expect them to sell most of the loans at marked-down book or even a premium to that. The banks that will be buying these loans will get a benefit from growing their portfolios in a very short period of time, incurring little to no origination costs, and instant valuation bump to those trading above book. However, our model takes a conservative approach and assumes there will be $900 million of net proceeds that management will be able to re-invest.

 

Once the loans are sold, management has guided to a 1.75%-2% immediate reinvestment rate. However, this rate was established during a much lower 10 Year bond yield so we would expect a higher reinvestment rate. They expect to quickly invest the proceeds primarily in mortgage-backed securities within weeks of selling the loans. In the long-run, they will be capable of reinvesting these proceeds into their loan portfolio at historical yields of ~4%. We expect the proceeds to be fully reinvested at 4% by mid-2016 and at the very latest by end of 2016. For 2015, we have taken the lower end of management’s guidance and assumed a temporary re-investment of $900 million of proceeds at 1.75%.

 

Our 2016 EPS of $1.20/share is an estimated “steady-state” EPS based on the full 4% reinvestment and we have kept other yields and interest-generating assets sizes constant to 2015. The brokers who cover TBBK have not provided normalized estimates and the only two brokers that provide 2016 estimates do not forecast full redeployment of proceeds at 4% until the end of or after 2016. After contacting several of them, we have learned that most of the analysts are waiting until the commercial loans are sold before re-visiting their analysis to provide “steady-state” estimates.

 

Non-Interest Expense

The last earnings call created some confusion on what is included and not included in the non-interest expense line and what the run-rate expense would be going forward. Most of the street analysts updated their models and published reports before the detailed 10Q was filed, and it is our impression that some are being overly-conservative with the run-rate cost of continuing operations. Based on our discussion with management, the incremental costs from BSA and compliance personnel should be $4-$5 million/year for a total of ~$33 million in non-interest expense per quarter on a run-rate basis. This results in modeled forecasts of $133 million in 2015E and $135 million in 2016E, which includes some modest growth. This is significantly lower than some brokers’ estimates at $139 million/year. The delta results in a 10 cent impact on our 2015 EPS estimate of 0.85/share.

 

Prepaid Cards Business

TBBK’s prepaid cards business is the main growth story of the company and gives a free option on a rising interest rate environment. The industry has grown significantly in the last few years, especially in North America, and TBBK has quickly become the leading bank issuer. TBBK generates fees based on the dollar amount loaded on each prepaid card and the number of prepaid cards sold or reloaded. Its affiliates are the ones who run and market the various prepaid programs, while deposits are held with TBBK. Fees are reported as a percent of GDV (Gross Dollar Volume), which is the total dollars spent on all cards in a given period and the metric used by its peers in the prepaid industry.

 

Growth in prepaid cards GDV and fee income has been significant in the past few years. GDV has grown at a ~74% CAGR from 2009 to $32 billion in 2013 and as of Q3, TBBK has already generated $31 billion of GDV in 2014 YTD. In the last few quarters, YoY growth in GDV has been ~30%.

 

Prepaid card fees currently contribute ~60% of total non-interest income and 25% of total net revenue (net interest income + non-interest expense) in the past few years. Fees have grown at a 60% CAGR from 2010 to 2013; however, they are expected to be 12% YoY going forward due to the BSA order and market slowdown.

 

Margins are 13bps and management expects these to remain flat in the next year.

 

The main advantage of the prepaid cards business is the low cost of deposits. These deposits only have an average cost of 2bps and can be invested in securities or loans at much higher yields in addition to TBBK earning non-interest income fees. Prepaid card deposits have grown from $781 million in 2010 to ~$1.7 billion in 2014 and represent approximately 40% of TBBK’s total deposits. These low-cost deposits have kept the average costs down to ~25bps of total deposits. Other deposits, such as institutional banking and healthcare, have higher costs at 40-50bps. While the benefit of low-cost deposits cannot be fully seen today when competitors are able to attract funds at rock bottom rates, a more normalized interest rate environment will show the value of this deposit-gathering franchise.

 

Aside from its significant growth and profit contribution, the prepaid business also has the advantage of being well diversified. TBBK’s largest customer in prepaid cards only contributes 6% of prepaid non-interest income, while the top 10 contribute ~40% and top 20 contribute ~70%. On a prepaid program basis, TBBK is even more diversified with the largest program contributing 4.5-5%. In the past, TBBK has not been afraid of ending relationships with un-profitable customers and management states that they have never had a large customer leave on their own. If this were to happen though, most contracts have a notice clause of 6-9 months. The recent departure of their customer UniRush was confirmed to have been a decision by TBBK and was press-released before the BSA order was in place. To date, there has been no material impact from the BSA order on any of TBBK’s largest customers. Switching costs remain high for program issuers which solidify TBBK’s market leadership in this space.

 

Background on the Prepaid Industry and Trends

According to a MasterCard industry report, global prepaid market size is expected to reach US$822 billion by 2017 of which the US will represent 51% ($421 billion). Open loop prepaid cards are projected to grow globally at a 22% CAGR from 2010 to 2017, 16% CAGR in US, 27% CAGR in Europe and 38% CAGR in Canada.

 

TBBK is the market leader in U.S. and was the largest issuer both by purchase volume and active cards in circulation in 2012 (Nilson Report). They had a purchase volume market share of 20.71% and a purchase volume of $20 billion and 44.6 million cards.

 

MetaBank (CASH) is its closest competitor in this space; they had #1 market share in 2011 and dropped to second place in 2012 with a purchase volume of $15.8 billion and 26.3 million cards. MetaBank had a consent order issued by OTS (Office of Thrift Supervision) in July 2011 that was terminated on Aug 7, 2014. Despite the cease and desist order, MetaBank was still able to grow stored value deposits by ~30% during that period.

 

Bank of Internet (BOFI) became a new player with the recently announced acquisition of the Prepaid Cards business of H&R Block (Emerald Advance Prepaid MC) in April. They acquired $450-500 million of deposits with no deposit premium that will have 11-15bps of cost. The business has ~3 million of active cards and H&R block was in 5th spot in terms of purchase volume market share in 2012, at $9.4 billion. BOFI expects $26 million of annual revenues and a pre-tax profit of $19-22 million from this business. The transaction is still pending and subject to regulatory approval.

 

Regulatory Environment

Through the Dodd-Frank Act, the Federal Reserve established rules regarding interchange fees charged for electronic debit transactions by payment card issuers. The rule limited interchange fees to a maximum of 21 cents plus 0.05% of the transaction value plus a 1% fraud-prevention adjustment, if eligible. However, this rule exempts any debit card issuer that, together with its affiliates, has assets of less than $10 billion. As a result, companies such as TBBK and CASH have been able to enjoy large market shares in the prepaid cards industry as they both have assets less than $10 billion, while larger players have stayed away. We assume that any change to this rule will make TBBK’s prepaid card franchise an attractive acquisition as many larger banks would try to pursue a buy vs. build strategy.

More information on the exemption, along with a list of exempt institutions, can be found here:

http://www.federalreserve.gov/paymentsystems/regii-interchange-fee-standards.htm

 

European Division

TBBK purchased certain software rights and personnel of a prepaid program manager in Europe on Nov. 29, 2012 for $1.8 million to establish a European prepaid card presence. In 2013 they continued infrastructure spend and continued to bridge licenses across the EU. Operations consist of three operational service subsidiaries and one subsidiary that offers prepaid card and electronic money issuing services.

 

Although European operations contributed less than 2% of total prepaid card revenue in 2013, they are expected to have a breakeven rate in Q4 2014. In the second quarter earnings call, it was disclosed that the European business had a drag of $1-1.5 million/quarter of operating expenses. This implies that once the business is breakeven there should be a lift of $5 million/year pre-tax and a ~9 cents contribution to yearly EPS. Furthermore, on the latest earnings call management mentioned that they expect to have a number of clients fully boarded and integrated by end of Q4 2014. This side of the business could be a potential driver for profitability and GDV going forward. However, this is all upside to the current base story and none of the analysts have modeled in contribution from Europe yet – and in fact many have the drag of the losses unknowingly baked into their models.

 

BSA Consent Order

TBBK received the consent order in Q2 2014 related to enhanced controls needed for BSA. The order restricts TBBK from signing new clients and launching new programs in certain prepaid businesses. However, management has indicated that only the general purpose (open loop) prepaid cards are affected by the order. This sub-segment represents 35% of the current prepaid business and can still grow at national average growth rates. The remaining 65% of the business consists of benefits cards, gift incentives, and non-reloadable cards, which are not affected by the order and can grow at normal YoY growth rates.

 

TBBK management has taken immediate action and is expanding the BSA team to meet the order requirements. They hired external consultants to help with the order and will take a one-time $9 million consulting charge in 2014. TBBK will be expanding the team dedicated to BSA from 25 to 55-60 people and the estimated incremental personnel costs will be $3.5 million/year. However, regulators have also requested more staffing for non-BSA compliance and total incremental costs are expected to be $4-5 million/year including the BSA personnel.

 

After speaking with several analysts and industry experts, we have confirmed that the BSA order is less restrictive than the one CASH had and it should take less time to be lifted (CASH order took 3 years). Management has guided to as early as H1 2015; however, research analysts believe this is too optimistic and should be closer to H1 2016. Also, once the order is lifted, it will take roughly one year for the fee income growth rate to see any meaningful impact as it usually takes about a year of lead time from signing on new contracts to full implementation and launch of prepaid programs. Nonetheless, the termination of the order should cause a substantial lift in TBBK’s share price.

 

Summary

The company’s stock has been depressed due to a series of recent negative events. However, there are many catalysts in the next year and a half that should reverse the overhang on the company and lift the trading multiple in line with its peers. In addition, a steady-state scenario of the company has yet to be analyzed by the street and once investors realize the full potential of the business, the share price should trade at $15-17/share by the end of 2015, at a ~60% premium to current levels. On the downside, we believe that TBBK’s current tangible book value of $9.25/share factors in a “kitchen sink” approach to write-downs and is an appropriate measure of the “floor” of the future share price at a 1x P/TBV multiple.

 

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

Sale of commercial loan portfolio

Reinvestment of proceeds at historical rates

BSA order lifted

Expansion of prepaid business in Europe

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