Andres Viroslav - Director, IR Damian Kozlowski - CEO Paul Frenkiel - CFO

William Wallace - Raymond James Frank Schiraldi - Sandler O'Neill Matthew Breese - Piper Jaffray

Good day, ladies and gentlemen, and welcome to The Bancorp Incorporated First Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, this conference call may be recorded. I would now like to turn the conference over to Andres Viroslav. You may begin.

Thank you, Nicole. Good morning and thank you for joining us today for The Bancorp's first quarter 2017 financial results conference call. On the call with me today are Damian Kozlowski, Chief Executive Officer; and Paul Frenkiel, our Chief Financial Officer. This morning's call is being webcast on our website at www.thebancorp.com. There will be a replay of the call beginning at approximately 12.00 PM Eastern Time today. The dial-in for the replay is 855-859-2056 with a confirmation code of 6292817. Before I turn the call over to Damian, I would like to remind everyone that when used in this conference call, the words believes, anticipates, expects and similar expressions are intended to identify forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements are subject to risks and uncertainties which could cause actual results to differ materially from those anticipated or suggested by such statements. For further discussion of these risks and uncertainties, please see The Bancorp's filings with the SEC. Listeners are cautioned not to place undue reliance on these forward-looking statements which speak only as of the date hereof. The Bancorp undertakes no obligation to publicly release the results of any revisions to forward-looking statements, which may be made to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events. Now, I would like to turn the call over to The Bancorp's Chief Executive Officer, Damian Kozlowski. Damian?

Thank you, Andres. Good morning and thank you for joining us today. My name is Damian Kozlowski, I'm CEO of Bancorp and the President of The Bancorp Bank. I've been in these positions since June 1, 2016. I welcome you to our first quarter 2017 earnings call. While 2016 was a very typical year for our company first quarter 2017 financial results reflected our planned return to profitability while we did incur financial losses in 2016 it did set the stage to make progress on many key issues that faced the company. We believe that the actions taken in 2016 have resulted in a much stronger platform and the first quarter 2017 was the start of what we believe will be a year of improving performance. In the quarter The Bancorp earned $8 million in net income or $0.14 a share of $49 of total revenue net of interest expense. Our earnings showed substantial improvement and revenue momentum continues while expense cuts and restructuring had a noticeable impact on profitability. Here are some of the highlights from the first quarter that underpin our progress. Our integrated business plan has been completed and we are now in full execution stage with a copy of the plan on our website. As part of the plan [indiscernible] we created a detailed 2017 budget and strategic agenda for the company. This budget has been approved by our board and is consistent with the three-year plan. In the first quarter we exceeded our internal budget and are tracking well with all our key initiatives. We see opportunity on the upside of our financial targets with potential recoveries upon the disposal of certain assets such as the Florida mall which we hold as other real estate owned. Interest rate increases in December and March are having a positive impact on operating revenue. Future consensus increases are also expected to have a significant positive impact. Our expenses continue to show improvement. Our cost reduction effort has identified approximately $20 million operating cost savings from 2017 over 2016 a portion of which we began to realize in the first quarter. European prepaid operations have been sold. The transaction closed April 3rd and our operating expenses by an estimated $400,000 per quarter. The sales of the remainder of our HSA business was approved by the OCC and all accounts are to be transferred by the end of the second quarter. The related gain on sales anticipate to significantly offset costs associated with the European prepaid operations sale and also reduced run rate operating costs. All the cost savings are on target with about 60% completion of the phase 2 cost restructuring implemented. Projecting the realization of the savings on a quarterly basis is difficult. Our progress in reducing expense should continue throughout 2017. Core revenue continued to growth both quarter-over-quarter and year-over-year. The year-over-year business growth was led by leasing the balances for which increased 51%. Quarter-over-quarter business growth was also led by leasing the balances of which increased in percent on an annualized basis. Our other lending products also continue to show growth and our business leaders report that continuing prospects remained very positive. We are continuing to make headway concerning our regulatory situation. We made significant progress in creating a new integrated compliance program that will build off our work in BSA-AML third-party risk and consumer compliance. This project is on track to be fully completed by the end of the second quarter and should substantially improve our compliance operating environment. We continue to work closely with our regulators to meet their expectations and resolve the root causes of any issues. We also continued to hire key new management in the last quarter that have already been announced and more new key executives will be announced soon. In summary, I believe the first quarter is a turning point. We have a long way to go to fully implement our integrated business plan, but we are on track to deliver better results for all the constituencies that comprise the Bancorp community. I'm now turning the call over to Paul Frenkiel our CFO who will review the financial results in more detail.

Thank you, Damian. Consistent with our business plan and budget Bancorp returned to profitability in the first quarter of 2017. Net income was $8 million for the quarter reflecting both revenue growth and progress in expense reduction in addition to a significant gain on sale of loans into securitization. A significant contributor to first quarter earnings was a $5 million gain on sale of loans into a variable rate commercial loan securitization. Through 2017 additional loans are expected to be originated with at least one additional securitization anticipated by year-end. While the $5 million gain on sale was a major contributor to the first quarter, the balances of the loans sold no longer earn interest for the company, therefore related interest income was reduced during the quarter and will be lower and total loans are replaced by new originations. Accordingly the company earned $1.3 million dollars less interest on such loans in Q1, 2017 compared to Q1, 2016. Nonetheless net interest income for the company as a whole grew 21% to $24.9 million between those periods. The increase in net interest income reflected growth in leasing, SBA and SBLOC loans and the impact of the 25 basis point rate increase in December 2016. Since the first quarter 2017 rate increase occurred in mid-March, the full quarter positive impact will not be realized until the second quarter. Although linked quarter net interest income was comparable it similarly reflected $1.6 million reductions in interest on loans held for sale into securitizations. Excluding that factor, net interest income on a linked quarter basis also grew at an annualized rate in the 20% range. Our largest percentage increase in loan balances was in leases which grew organically 25% over the year with 51% overall growth after considering a purchase portfolio. In the first quarter 2017 the leasing portfolio yielded approximately 6.3%. Purchases of lease portfolios while maintaining yield levels continue to confirm the viability of this growth strategy. Loan balances excluding loans held for sale grew 22% year-over-year. The lines of business comprising these totals have historically had low charge-offs. Our cost of funds grew minimally reflecting only a partial adjustment of rates on our prepaid card deposits to changes in market interest rates. Prepaid card deposits are our largest funding source and should continue to adjust to only a portion of future increases in market interest rates. The interest margin will benefit accordingly with the impact of market interest rates on variable rate SBLOC and SBA loans and the significant portion of the investment portfolio which is also rate sensitive. Prepaid cards are the primary driver of noninterest income. In the first quarter of the year prepaid card fee income is traditionally higher reflecting these related to tax refund prepaid cards. Accordingly in Q1 prepaid fees were $1.5 million higher than the linked quarter. Compared to the prior year first quarter prepaid fees were flat reflecting the impact of a client that exited as a result of its sale. Reflecting that factor and the decision of several other clients to terminate their pre-paid card programs altogether, the total amount spent on prepaid cards or gross dollar volume was down slightly compared to Q1 2016. Growth in other programs significantly offset the impact of those changes resulting in that slight volume decrease. Reductions in noninterest expenses also contributed to first quarter results. Noninterest expense of $37.7 million for the quarter was lower than 2016 quarters and reflected progress in implementing expense reductions in several areas. As Damian noted, additional reductions have been identified and should be realized throughout 2017. Net interest margin for the quarter was 2.70% compared to 2.56% in Q1 2016 and 2.84% to the linked quarter. Seasonal deposit inflows reduced net interest margins in the first quarter of the year as the temporary excess liquidity earns a nominal rate at the Federal Reserve Bank. The improvement in net interest margin over Q1 2016 reflected the impact of the rate increase in December 2016 which resulted in higher asset yields versus the lesser increase in deposit costs as noted earlier. The $1.7 million net income from discontinued operations reflected the results of the discontinued Philadelphia commercial loan division. In addition to the interest which continues to be earned on those loans the quarter benefited from $1.4 million of loan recoveries primarily on the Florida mall loan. A significant write-down to apprise value was made on that mall loan in third quarter 2016. We took ownership of the Florida mall property during the quarter and we are marketing it for sale. Based on market indications we anticipate a recovery upon its anticipated sale later this year, but the amount of such recovery and timing are difficult to predict. While the financial results for the quarter reflected federal income tax expense at statutory rates, reversal of valuation allowances are expected later in 2017. Leverage of capital ratios are impacted by seasonal tax refund deposit inflows in the first quarter of each year which temporarily distort capital ratios. Notwithstanding that first quarter distortion the leverage ratio at the bank and holding company were respectively 6.7% and 7% at quarter end. In the coming quarters after that temporary distortion the leverage ratio should increase and increase further with earnings accretion. Our capital plan projects an 8% leverage ratio later in 2017. Risk-based capital ratios are not impacted by the first quarter tax refund deposit inflows as related funds are maintained at the Federal Reserve Bank which has a zero risk rating. Those ratios immediately benefited from the first quarter earnings and exceeded 14% at quarter end. That concludes my comments and I will turn the call back to Andres.

Thank you. Operator, please open up the call for questions.

[Operator Instructions] our first question comes from the line of William Wallace of Raymond James. Your line is now open.

Thanks, good morning guys.

Hey how is it going?

Good, thank you. Paul, I'll start with your last commentary and your remarks about the distortion related to the tax refund deposits that pressured the leverage ratio, how much comes bounce back do you expect from the normalization of that kind of seasonality?

We went up in deposits about 5% over what we were running. It is really difficult to predict because it is hard to predict when those tax refund prepaid cards are spent. But in all likelihood we'll get to 7% fairly quickly and as I said our plan and our projections show 8% later in 2017.

Okay, so are you anticipating that you'll get to 8 in the second half now at all I was thinking that you guys were modeling by the end of the second quarter, but I might be wrong?

We have a significant valuation allowance which is you know after the company has not performed well over the last three years and taking losses, management and also the people who provide support to us, our accountants I think believe it's prudent to show profitability for longer term than one quarter before we were to reverse that allowance. But that's likely to happen and that will be a significant impact of that 0:1 leverage ratio or probably in the $20 million range.

Yes so what is the – what's the dollar amount of the valuation allowance as of March 31st?

It is in excess of $20 million.

Yes the actual dollar amount?

It is a difficult computation because there multiple items, as Damian noted we sold the foreign operation, there are some tax implications of that. So I think we're right now…

It's at least 20, it's in the $20 million to $25 million range.

Yes.

And you say you'll have the final number by the time you follow the Q is still being calculated?

It is actually trued up at year end, all our cashes are trued up at year end. Yes we'll have an estimate by the Q.

Okay, so the 309, 769 equity balance might not be what you end up reporting? I confused, I'm sorry. I thought that the DPA [ph] is not in the equity?

Yes, when we reversed the valuation allowance it's actually going to be a credit to tax expense with flows directly to the bottom line and directly to equity. There are some twists in terms of how that translates to capital and it depends on timing of deductions and so forth. So but as I said before what we do through that up at year-end, the actual interim period tax calculations are based on your estimates for the year. So I can't give you an exact number because the accounting rules just don’t work that way. They don’t…

And it won't impact the first quarter, it's likely a second or third quarter event when we will change that. And then you would take into that impact into net income there, so for adjusting the ratios.

Okay, so assuming that you were to have reversed the allowance this quarter, do you know how much you could have put in the tier 1 capital calculation without tripping over the 10% threshold?

As I said before, it’s not a meaningful calculation because you do it based on what you estimate for the year. The accounting rule says you estimate what your tax situation is for the year and then you allocate that to the quarter.

So what about for the call report rules, so you have to, I mean you have to put a number in the call report when you are calculating your tier 1 capital, right?

You have to do an estimate, that’s true.

So if you were to have been able to reduce it, how much room is there for DTA in your tier 1 capital? What I am trying to get at is how much of brisk is the tier 1 leverage are you going to get when you reverse the allowance, just trying to figure out.

I can go through it with you. It’s actually not final until we do our tax return. We actually have two sets of tax advisors that work with us. So, I think there are some, it depends on the timing of deductions and the character of the deferred tax assets. I can go through with you, I can show you, I can explain to you offline the difficulties and the estimation, but we can’t, the $20 million is a good estimate.

Okay, so I can assume as I model my own calculation of capital that $20 million will be recaptured into tier 1 capital when you reverse the allowance, $20 million to $25 million?

That is within our planning and it’s subject to eventual with the tax.

But that also accounts for showing continued profitability which we believe we will reverse.

Right, of course.

That's why it wasn’t reversed in the first quarter though because it was the first quarter profitability really demonstrated the last three years. So the advisors and collective with management of the board believe that it was prudent not to reverse it until there was a better track record of performance.

Okay, and I believe last quarter you guys stated that you anticipated reversing it in the second quarter, is that still the case or is this more likely to be a third or fourth quarter event?

As Damian said we use multiple advisors, yes, it’s possible the second quarter that like we are – that's in our thinking but it could be the third quarter.

Okay, and then for the tax rate that you recorded in the first quarter, are you, is 100% of that go get in allowance against it?

Yes, but there are few caveats as I said before, because there are implications connected to the sale of our European operations that will impact that somewhat. So, I would just stick for now with the $20 million.

Okay. And then what’s the assets related to the European business that will come off the balance sheet or are they off already?

They are fairly minimal under you know like 1% to 2% of assets, some liabilities, you know so it’s not a significant impact. The more significant impact to us is it’s going to further reduce our overhead we are estimating in the 400,000 a quarter range.

Yes, this was not a business that was creating operating profitability. So, there was 400,000 more expense than revenue coming.

When will this sale close?

April it's already closed, they are already closed.

So we see that in the run rate for the second quarter there?

Absolutely.

There will be a restructuring charge associated with that sale and that will be offset by the HSA sale. You see we are getting there.

Okay.

It’s going to be around, it’s somewhere between $2 million and $3 million.

But that's the restructuring charge?

Yes, it hasn’t been calculated yet, so we don’t know what the final charge will be and what we'll be able to take, but that on an economic basis it will offset by the HSA gain.

Okay. Okay, great. So, and in the HSA you've got, it’s about $400 million of deposits that will come off the balance sheet?

No, the HSA is about $100 million, most of which will be off by the end of this quarter.

Yes, we just received final approval from the OCC in this quarter, a letter approval and we weren’t able to act on transferring the accounts until that was finalized, which it was. And so we have a plan in place to get that transfer completed by the end of the quarter, therefore taking the gain at the same time we lower our operating expense by having less accounts.

Okay. Have you identified additional opportunities for deleverage outside of just one-off of the tax deposits?

Yes, we’re still targeting around a $4 billion balance sheet at the end of the second quarter, 4 to 4.1, so that’s where we should be around there depending on the business volumes and everything, but that’s where we are hoping to be.

Okay. So, in the loan sale gain that’s your commercial mortgage business, you didn’t wrap loans out of the commercial, out of the discontinued portfolio, did you?

No, we are, we - because of the market conditions in CMBS there is a whole bunch of changes that happened including the retention of risk strips, but the market has significantly changed over the last couple of years. We discontinued our CMBS program. So, we are not originating for sale fixed rate loans anymore for the CMBS market. These are floating rate loans that go into securitization, CLO like securitization we did last year that are and then we are also doing institutional sales of those loans to third parties. So, we are focused on that program, that program does not have a hedge obviously because it's floating rate, and so you don’t take gains and losses on the hedge either, so it’s a less volatile business in addition to being – it's in the less challenged part of the market.

Okay, and is it the same team or did you change teams?

No, the underwriting teams we're doing both types of loans, so you know we're an integrated group and that integrated group is really a marketing decision, so with our network of brokers and other sales force now we're just focusing on one side of the house. Really, we don’t think after talking broadly in the marketplace it will affect our ability to originate the floating rate side. We are targeting one more, at least one more securitization such as we’ve done previously this year in the floating rate side and on a run rate basis we'll probably do two securitizations and/or our large sales of loans in the $200 million range per year on a go forward basis. They will not be in the CMBS market.

Okay, oaky, all right.

So we've narrowed focused the business and I think we’ve reduced the volatility based on hedging in that business, consistent with the rest of the business plan to increase the transparency of the company and lower the volatility of earnings.

So, the $37.8 million dollar expense booked in the first quarter was obviously a significant improvement over the fourth quarter and third quarters, so it’s good to see very good movement towards the expense initiative. I assume there is probably some variable comp in there also associated with that sale for that securitization, is that, so what, if you stripped out the variable comps issue with that what will the rate have been, what would the expense have been, how much variable comp was in that?

It doesn’t necessarily hit the same quarter, it’s accrued. The variable comp is somewhat independent of that timing, so it’s difficult to match it up.

Yes, but there are, what we can say about the expense run rate is that we are very pleased with that. We are getting better cost reductions then we expected at this time. Our own budget had it at significantly higher rate, so our significant cost saves that haven’t even - we've negotiated many of our providers to significant cost saves, they haven’t come through the HSA saves because of the number of accounts. There are other accounts that are exiting the business, so we find the platform, the European cost saves, there is a whole list of things we’ve done on T&E and others costs saves. So there is - while it's about 60% completed the initiative phase 2 which remember phase 1 was reducing people, phase 2 is reducing operating costs and phase 3 will kick off in October, November which will be a reengineering of the back end of the business. But we are very happy with where we are on the expense side and we have still a lot of expenses that will be reduced in the second and third quarters. So we are very optimistic that we will continue to open the jaws of the business and reduce cost.

Would you care to update your expectations for cost saves, it sounds as if that $20 million…?

Yes, we will, Wally we will, we still haven’t fully bridged it out. We are in the process of really understanding this. Things like CNE [ph], or just to give an example that we were targeting to do it half, but it’s even coming in better than that. So, you know there are some of these buckets that we’re trying to understand exactly why. When you cut 20% of the people we were at over 700 people, this time last year, I think it was almost 720 people. And we are now running at below 550 people, right. And that’s, if you take Europe out of it, and you take the restructuring that we did, people tend to draw cost, and so we are trying to understand exactly what the cost structure is, why is it different than the saves we have in there and we’re bridging it out, and then we will probably give better guidance as we go into the second or the end of the second quarter and see where we are. But right now, we are very optimistic that we will be able to beat our own internal budgets on the cost side.

Okay, well, Damian, it’s pleasing to see a quarter that doesn’t have noise related to credit and I'll hop out and let somebody else ask questions and maybe which may someone else will ask about the credit and the other portfolios, so thanks for taking my questions.

Thanks, Wally.

Thank you. [Operator Instructions] Our next question comes from Frank Schiraldi of Sandler O'Neill. Your line is now open.

Hey, Frank.

Good morning. Just follow up on capital, I just - the 8% tier 1 leverage by, I guess it’s by year-end, is that what you said Damian, is that the feeling, the thinking?

Definitely, by year end we'll probably be, we do have when we read our own scenarios we want to get back to our capital minimum that we've stated to our regulators which is 8.5% of tier 1 capital. I want to also emphasize that the risk based measures are very, very healthy for the company for various reasons. But we do have visibility to an 8.5 by the end of the year. We think we will hit the 8% before that probably in some time in the third quarter. It depends on the valuation allowance and our continued profitability. Once taking that in the capital ratios will improve dramatically. And as our cost saves continue to be realized net income will be generated, so you can see an 8% happening after the second to third quarter timeframe.

Okay, and then you get up to 8.5% by when did you say you think that’s possible by year end?

Yes, we think we do have visibility to 8.5 by the end of the year when we do our own projections. I'd say this in the most likely range. We are not being aggressive with the way we are looking at the pro forma forecast of the business. It does and you've got to remember we have certain assets hanging out there. The Florida mall is a good example. We are all ready; we were able to monetize part of it. We sold an out parcel of the mall which will actually help the value of the mall because it’s for residential development in that marketplace, so it actually increases the value we believe of the sale. Our marketing assessment of the property does forecast a gain on that property. We don’t know if that will actually happen of course, but that’s also another source of net income potential in the numbers that would be additive. And we also budget ourselves without interest rate increases. So, when we do our pro forma budget we don’t really impact the run rate based on interest rate increases. Those interest rate increases are having an impact and as our loans re-price will have a greater impact, because we have lot of variable rate loans and security by the way. So, there is lot of tailwinds that if they play out with any reasonable modeler would expect them to play out we should be in the comfortable range of 8% plus within the next two quarters.

Okay, I guess, just thinking about the 8.5%, is there a time period in which you have to, you know you want to get or you have to get to that number and if you don’t internally then you look externally no?

No. We are in discussions with the many parties that regulate the bank. We've proposed, we give them very, very detailed information around our business plan and our capital plan. At the current time, I don’t want to disclose anything too much, but I think people are generally, this could change tomorrow of course, but people are generally pleased with the progress we’ve made to de-risk the bank. So, how do we de-risk the bank, well part of it is accretion of capital through restructuring the business to create earnings. But they are also looking at the sources of risk that might have been viewed previously as sources of volatility and we are talking about the things we did and discontinued in Walnut Street to make sure that future earnings weren’t impacted. So, there has been a program here to - within this time last year, if you look at the bank there is lot of sources, for example discontinued is down 36% at assets levels. We’ve strengthen the credit risk management practices of the banks and we have a pretty sizable initiative to have an integrated compliance plan done by the end of the second quarter which will change our compliance operating environment substantially, and we are making great progress on the findings of our regulators in closing out those and validating those issues. So, you know, it’s not one area of risk. We are trying to hit every area of risk of the bank and that’s really colors the view of any regulator as to whether or not you have sufficient capital and a plan to have sufficient capital. They agree with our capital minimum and they I think they believe, so, I can’t really speak for them, but I believe right now we are all on the same page as to how do we grow the tier 1. Remember risk-based capital isn’t a problem, it is tier 1 capital and get it to the right level by the end of the year.

Right, and that $20 million valuation allowance would help a lot, I guess, what is it like 50 basis points. But…

Yes.

So I guess on that allowance, I wonder and I don’t know how to get to it, but in terms of being able to get that off in the coming quarters, particularly I will reverse that, I should say in the coming quarters, it seems to me like an issue is not only going to be the number of positive operating quarter, you know operating earnings quarter you are able to put up, but also the fact that if you look over the last two or three years there is this still coming a flip, June losses because of some of the March you've taken on discontinued ops book, so is that going to be an issue or if you could just may be walk through a couple of the triggers?

It’s actually a forward-looking analysis. So, because the bank has strong quarter earnings and that’s demonstrable and we will have two quarters of validated budget that earnings projections, the analysis is looking forward to several periods. So, if you look our budget our projections will be able to use the accumulated, the deferred tax assets then NOL carryovers in a very short period of time. So, while it’s prudent to wait a quarter or two, I don’t see anything standing in the way of taking those later in the year and that’s been baked into our planning.

Yes, once again we provide pro forma forecasted budget and we’ve exceeded that where we thought we would be and it’s happening on both sides of the table. We are continuing with the revenue momentum. Our balance sheet businesses are growing nicely. You have the tailwind of the interest rate increase that really fundamentally changes. We are an asset sensitive bank. We are probably one of the most asset sensitive banks in the United States. And all those things combine to give a very positive pro forma outlook for the company, especially, look you can’t control revenue all the time but you can control expense. And we are only half way done with the process, right. So we did people. We are half way done with the - 60% done with the operating cost reduction and then we are not even started on the reengineering which will happen at the end, there will be additional sales with that process to an much more efficient company. So, you know there is lot on the table for the next 18 months to two years around being able to maintain and reduce our cost base and actually be more productive.

Okay, so and I guess the accounts, so you’ve gotten feedback from the accounts on that that it's really just forward looking and it seems like if it all goes according to plan a couple of one or two quarters and you'll be able to reverse, so that's...?

Yes, there is – for every accounting firm there's a different way to handle, the evaluation of the deferred tax assets, this is a, this is truly an art form and it's always a collective determination of multiple parties as to what exactly do you do and when. And you know we've had a dramatic change, there's been three years of pretty poor profitability of the company. And if you - this quarter was exceedingly positive and so people are guarded as to they want to see more obviously and we do too. So even if you think about the Tier I leverage ratio we did, we do have the federal tax in there, but if you back the federal tax out and we actually realized net income of $0.22 a share instead of $0.14 a share, well our Tier I leverage ratio wouldn't even deteriorated in the first quarter and by the way that never has happened in the history of Bancorp since its inception. I haven’t been here the whole time, but I'm pretty sure that's true and that’s an incredibly positive sign. It's also a positive sign that we did have some changes and programs and there was a sale of a major client where we transferred the account and the organic growth in the GDP was able to cover that. So there, it's not just the lending business is growing, it's just not the interest rate, it's just not the cost reduction, it's all the things working together to improve the forward looking profitability. I mean we weren't in any shape and form June of this year, we had all this stuff to accomplish, all these assets that we weren't really productive to get rid of and the environment has changed a lot since that, the macro environment. So all those things go into the pro forma forecast and that's how you at the end of the day rate whether or not that valuation and allowance will be reversed.

Okay and then just in terms of, if credit of the discontinued ops book and Walnut Street is there any update you can give in terms of current versus delinquencies any migration within those portfolios in the quarter in 1Q and any negative migration?

Yes, there hasn’t really been any negative migration. The big story this quarter was that we moved and Frank, I'll direct you, I added some new charts pursuant to your request from prior quarters I added a couple more. So you can see the graphically the non-performing loans and you compare it to the last quarter and so forth. The big - so there was no big migration except for the mall that we took into OREO which is a big positive because we can't be sure of the timing, but it should sell later this year, there should be a recovery. It's right now a non-interest earning asset so...

And it's not a drag on - the mall has not been a drag on earnings. We now have somebody in place running the mall and it won't be - if anything it'll be a slight positive even if we retain the mall it won’t be at a big loss, say we're not losing $3 million or $4 million a year operating it. It is actually operating at a gain now. So whether we sell it or not which we believe we will it won't hurt, it will hurt the company for us running the mall. We have professional management in there who are running it.

Okay, so it's not a drag on our earnings running it right now?

No, actually if anything it's going to be $1 million to $2 million profit from running that mall.

Okay, that's not a bad return actually.

We were very aggressive to hang on to it.

Frank, we've been very, very aggressive and proper under the GAAP rules of course to this, this there's been volatility in the earnings of this bank and we've been very focused on reducing, de-risking and decreasing the earnings volatility of the bank. And the only way to do that is to make sure you put the processes in place. For Walnut Street we've talked about this, there's we've put three lines of credit. With discontinued ops this is an extremely tightly managed process now where we've got the full participation of all the constituents here at Bancorp and we're going to, we're going to work out of the portfolio as quickly as possible. We're already down 36% year-over-year. A lot of that has happened since June including a $65 million sale that went, that actually had a gain in it. So I think we’ve got visibility. We want to continue to do the same things, so we want to this time next year hopefully we are down another 30%, 40% in that portfolio, I believe we will be. And as the Walnut Street security amortizes once again we've built in discount rates, so forget all our cash flows back that we anticipate on that, we will actually have gains in there. So – we - I think we have done everything possible under the rules that are set out by GAAP to contain the risks of the banks and get out of those things that might cause future, look at this Europe, it’s not there. Right? HSA it’s not there. You have a lot of other activity where we simply not - we're not - like CMBS is in the U.S. right, we're not there anymore. That's probably the risky part of the securitization market. So a lot of these things have been done purposely to lower the volatility of earnings and lower the risk profile of the bank.

Okay, okay. Last question just in terms of on the credit side, so obviously you're down 36% year-over-year, you would be hopeful or you would expect that maybe down 30% to 40% with run-off and of course you're always looking to sell pieces of this, but is there anything on the immediate horizon there you see kind of bulky that you think you might be looking at selling that might be close to just moving a large chunk or a larger sized chunk off in the coming months?

We’re very active talking to people across a broad spectrum of partners from the investment banks to investment firms around this disposition of those assets. Right? Whenever you have a unique portfolio, even if it's marked correctly, that is the mark of the value of the loan over time. So to dispose of the entire portfolio you might have to take a substantial loss and that wouldn't be prudent for investors because that would be wasting value for them. So if we do get an opportunity to sell one or two that we don't, we don't have anything on the horizon for next quarter, I don't believe, but we're actively managing that portfolio in the sale category too and as you know last quarter we did have a sale. So we don't have anything on horizon for the next quarter though.

I appreciate it, thanks. Thanks guys.

Thank you very much, Frank.

Thank you. Our next question comes from the line of Matthew Breese of Piper Jaffray. Your line is now open.

Good morning guys.

Good morning, Matt.

Just wanted to follow up on the mall comment and just wanted to get a sense for thinking about discontinued operations in Walnut Street what is your other exposure to big box retail mall, strip mall, some of the riskier retail asset classes?

Yes, so that really was the big one. If you look at the charts, we have a chart that gives the composition at the end of the press release, so that will give you the information, it's a new table that gives you the type of collateral, so you can refer to that Matthew.

Okay. So the non-owner occupied retail we should assume that's kind of mall properties?

Yes but we do start exposure, so we have many, we don't really have anything that large, I mean the mall was basically it. We do have some other large exposures, but no other malls that are comparable to the risk that we had in the Florida Mall.

Got it, okay and then geographically the discontinued operations, the $340 million of it, just thinking of it where it is across the country, is it pretty widespread or is it most of it in your core markets?

The majority, the Florida mall was an outlier, the majority is Pennsylvania, New Jersey.

Yes it was a community banking portfolio really and it was a very generalized one. So it was - a lot of different unique assets and it was generated from the Delaware Philadelphia area, that's where the originators were. And then there's as always in this area there's always a connection to Florida, there's like, all the states between they don't even exist. People only fly over them. Nobody drives through and they only fly over them. So that's why there's Florida properties and stuff in there. And then with the mall leaving the greatest source of risk is obviously that was a number one risky retail property by far. We were aggressive making sure that was resolved and look we got it. The sponsor declared bankruptcy and we got everything back very, very quickly. That was by far the best interest of the shareholders and of the bank's stability and now we get to be able to monetize that and hopefully for a gain.

Understood and then Damian in the past you suggested, how quickly and to what level you think you can reduce the discontinued ops, could you update us on what your projections are there?

It's the same thing you know. You want to - we now want to reduce it by 50% over the next year or 18 months. Right? So if I - look to be honest if we get 36% per year from now it's in that 30, 40% range that would be fantastic, with it being about 50 in the 18 months that's kind of the minimal we want to see. Some of these loans have natural terminations, so that we know when they're going to. We have a few chunky loans. I believe the top eight loans in discontinued is like half or so. Right? So it's in that range, so there's some chunky ones in there that we don't have anything right now that would be this mall like, they are - we have great visibility to it. Some of these are just performing loans and they have termination dates and they will terminate over the next couple of years and they'll be gone and they'll be at other banks and some of these loans we've had actually participated out to other banks. So, there are some bonafide sponsors in here that you actually could up some of the paper to other banks who are interested in having them as clients. So, I think we, it's very tightly managed. The risk is down substantially from where we were just considering the marks over the last six months and what we've done around credit defence and then visibility to these assets through tight governance and management. I think a 30%, minimum 30 over a year but hopefully 50.

Okay and then I wanted to get a sense for your loan growth outlook for the remainder of the year where we continue to see, the security portfolio come down a loan growth? And then secondly on the auto fleet leasing segment, can you talk about some of the protections you have in place in that portfolio and given some of the auto headlines which have been the negative can you talk about lower used car prices and lower residual values, are those risk factors to you in that portfolio?

Well, the outlook for the lending business is very positive. Right? So, we have a very strong pipelines and it should grow, show positive momentum because we're growing the balance sheets and the businesses are fairly low risk compared to, you know we're not growing commercial real estate portfolios. So I think we have good positions in these businesses. We have a national SBA platform where we were doing a lot of franchise lending now we're doing a very diverse business with our new leader Jeff Nager who came to us when I started the business, excuse me, when I came to this business I didn’t start it obviously. But and so, what we're going to do is see that momentum we're doing things in our SBLOC business. We think we'll continue to increase the volumes in a very, very low risk business. As for the auto business, once again we're not lending or leasing autos to individuals. 40% of the business is to high credit rated government agencies and municipalities. So every - usually AA, AAA municipalities that need very small part of their budget for vehicles, that's 40% of the business. It could be a big government agency too like a part of the military and sometimes they don't pay on time, but they always pay. So sometimes their delinquencies will grow up a little bit. That's usually a municipality that has decided that they are not going to pay us for three weeks because they have to pay their teachers or something, but they always pay. So they are very low credit risk. The other side of business is corporate. So we do full underwriting as we're lending them the money, but it's fully securitized against the title of the car. The history of the leasing business is, we have a little bit of extra coverage because in many of our clients' situations we're wholesaling, we're a registered dealer and in Florida so we're wholesaling cars. And then that margin is being built in at the end of day in some cases to the just a slight air ball you might have as in any equipment lease that's the difference between the value and the amount of amortization and lease before you get to the disposal value. And historically we've had about a $2 million gain yearly on the residual value when we sell vehicles and we have a very broad process through auctioning and through connections into the used car market that makes that possible. So I feel extreme - if this was a business where we're doing personal leases to individuals it's a very different business and in many cases we even tailor the cars. So we're putting the, for a police car say we're putting the sticker on it and the gun holster and all those things that that police car needs, so it's a tailored business. Another thing to say that because it's a lot of specialty cars there's a couple of things that happen. There is a broad market. Some municipalities and people only buy used cars and only some buy new cars. So there is a very, very broad market for these products and they historically have had no trouble disposing of them at a slight gain. So, we feel fairly comfortable with the fleets that we have. And remember in many cases we're underwriting the entity which might be a government or a corporate. We have collateral that's a car, but that doesn't mean they're not on the hook. They're still on the hook for any loss. So we're in a very good position and we've had very few losses in that business.

So what is your overall percentage of the municipalities and corporate, is it nearly...?

40%, I think it's a little bit higher now, but it's around 40% is municipality, government agencies, federal government and then 60% you have quasi, there is a lot of quasi organizations. I would say there are almost agency government like, for example like an NRA [ph] or something that would have a huge budget and but the pure corporate is probably 40%, 40% municipalities and government and then the 20% are very large organizations that lease cars that aren’t really corporate, but they're not really government either.

Understood. Okay, very helpful and then, going to the prepaid card business can you give us an update there and the outlook for gross dollar volume on those prepaid cards? It sounded like there's a couple of entities that might have shut down, so I just wanted to get a sense for...?

Yes, we have two programs from major providers they decided to for their own business reasons to close them down and then we had one big sale of a client, so they took that volume in house and there was a smaller one that sold, that wasn't as dramatic, but when you look at our GDV of our base business it made up for all that activity which was very encouraging. Internally we were hoping that that would happen. Would we be surprised if we were down a couple million in the first quarter for fees in that space we wouldn’t have been surprised. So our team has done a wonderful job replacing that revenue with organic growth. I think the prospects for that business now that we were through this little dislocation it just happened to happen now are very good for the rest of the year for GDV growth, consistent with this for the base business, consistent there will be some over and - year-over-year impact because we've lost some stuff, but the GDV of the base business, new clients et cetera, should as we go through the year be shown to be true as the numbers continue to move in the right direction.

I think in that past you mentioned high single maybe low double-digit GDV growth is that still good?

Yes, I mean that’s consistent, that's the past. Right? That's where we've been year-over –year. It jumps up and down depending on the quarter and everything. We don't think there is anything what's happening in the market is volume is consolidating to the few top providers. I think as we're stronger institution we're, we did not have a good time over the last three years as we're stronger institution and close out our regulatory issues but also appear to be a stronger player, I think that will support historical volumes.

Okay and maybe hop into the margin, what is the outlook for the NIM, I think in the past you noted that could expand towards 3% by the end of the year, do you still feel like that's, that's a reasonable goal?

Certainly the increases in the interest rates with consensus will help us get there. We don't actually predict that. There are some dynamics. The highest yielding assets we have are the leasing and the SBA loans. If you go to SBLOCs the yield somewhat less. So, it depends somewhat on the mix of those. We're hopeful that we can continue the leasing growth and the SBA under the leadership of Jeff Nager our new leasing, Head of Leasing. We are hopeful that those two will help push, continue to push up the net interest margin.

Okay, what's a good tax rate from here, should we keep this 38% for next quarter or…?

Yes, I think the way, the way from a modelling point of view is keep that rate in place. More likely than not, the reversal of the valuation allowance will be the - all of it or the majority of it and in one quarter. So I think that's a fair way, plus it in terms of really understanding the profitability right now that's what we're looking at. We don't really have a big municipal portfolio as we had in the past. Obviously given the political climate and some possibility of a lower tax rate we're probably not going to do anything in that area until that settles out. So I think that's the best way of looking at it.

Go ahead Damian. I’m sorry.

No, when you look at our website we said the near term goal for this year was to get at least 5% ROE and 50 basis point ROA. So, we're going to update that presentation as we go through the year. Right now we clearly have beaten that. And we think, we do have the economics to potentially be higher than obviously with one-time gains that's off the table. Obviously we will exceed that. Without one-time gains we still have the operating performance here that would exceed that substantially. And when we did that 5% we did a tax effect and so we put that 38% in for our own planning we just assumed we paid tax. So, I think that the outlook is good for the company.

Right, okay and then just one final one, the sale of the European operation sounds like a $2, $3 million gain there and largely offset by the HSA. Is that to say that the sale of the HSA, I’m sorry. Is that to say the gain on the HSA is $2 to $3 million as well?

Yes.

Okay.

It should be a total of around $3 million and it will be monetized probably two-thirds or more this quarter and then the rest of it in the next quarter.

But that will offset the any restructure, we don't know exactly what that restructuring charge and how it will be taken for the European sales, but we're working on that now, but it's in the same range. So, they basically offset each other and so the operating performance should come through.

That’s all I had. Thank you.

Where did you get the gain?

By the way you get at least $400,000 of lowering of expenses too. I mean that’s $400,000 of a loss, so that's after the revenue adjustments. So that at least $400,000, that European expense will be reduced by the fact that, there's $400,000 less expenses in this quarter and that will continue forever. So the payback on the sale of that thing getting a final deal that was the right thing for that company too. It survived by the way it's not closed down. There's a purchaser. You know when I go through regulatory approval we made sure it was capitalized correctly with both our own funds and the funds of the purchaser. So we're really, there are three or more clients in there that we wanted to make sure that were taken care of and we want to make sure we were a good partner to our friends in Europe and we want to make sure the Fed who govern that business from a regulator point of view were happy and we had everything we wanted to. We limited the losses, we got a great future for that company and we also get the expense saves in the future, so we're very happy how it turned out.

Understood, all right, thanks guys.

Thank you. And our next question comes from the line of William Wallace of Raymond James. Your line is now open.

Thanks guys. Just one followup question on the credit side. Just looking at the non-accruals on the continuing portfolio they seemed to have jumped up in the first quarter. I'm just wondering if you could talk a bit about what drove that?

Yes, we had some increases in the non-accruals primarily in SBAs. So we did have a little bit of an uptick there. We're monitoring that portfolio very carefully.

We don't think will continue next couple quarters. We've started a process through all the businesses to look at portfolio review in a more tighter way and so Jeff who has led that effort who came in June. We did have a lot of franchise based loans historically and so we're diversifying that business and so we just wanted to make sure. We don't think that trend will continue. We don't think there's big numbers going to pop, but that was around a little bit of a cleanup of not that it should have been taken in previous quarters, but that's just the result of as we've gotten a tighter I think around the credit mismanagement process there was a little bit of a make sure that there were the right credit ratings on the broad portfolio. So it's a little bit, if you look at our metrics generally you have to takeout discontinued, our metrics are extremely attractive. And if you take our commercial loan, if you look at our a LLL. and you take out obviously it's not the discontinued is not in there, but if you just look at the commercial activities our reserve is over 1%. It's very comparable to our competitors around 120. Obviously the SBLOC - businesses like the SBLOC business have no losses historically due to the fact that we have $5 billion of collateral and $600 million of outstanding. It's almost, the market has to totally melt down to a ridiculous level. But we feel good about where we are in the credit risk management and as good as we can feel about things at our discontinued portfolio. We think we have done a lot of good work. We don't think there's going to be big hits. It looks like some gains in the future for us. So we're – there was a lot of work, I will be honest with you and there always is in these situations it's a lot of work to reduce expenses. It's a lot of work from our businesses to create revenue. So there's a lot, the team has done a great job I think to change performance for the company.

Thanks and Damian you mentioned kind of a target range of 30% to 50% production in the discontinued portfolio for the year, do you think that is the Walnut Street is that going to be a longer dated asset or do you think that, that you know the work out of that or they won't?

Yes the Walnut Street is different.

Yes, Walnut Street is different. It’s actually we’re not in control of Walnut Street. It was actually a true sale. That said, over the next few years, so we're not going to have like at the end of next year we can't really predict or set a goal. But if you look at the maturities over the next - of the loans over the next several years I think it's going to pay down on its own. And if you look at the makeup of it only about 20% is non-performing. It was marked independently and so forth the rest of it is performing and so as Damian said, we've taken, we did three things, we made sure that the loans were marked down. It's in nonaccrual and accounting actually requires you to discount it. So we've got a lot of protection in there, so in the same way that we think we've done everything possible to reduce volatility in the discontinued operations, we feel the same way about Walnut Street.

Okay. Thanks Paul and then just one last question on the tax rate. So Paul, you suggested that after, even after recovery the valuation allowance you still think a 39% tax rate is the rate to model and then if there's any kind of tax reform you will at that point decide whether or not to invest in municipals or whatever it seems?

Yes, it's interesting, so what happens if there's tax reform. That changes the whole picture because all your deferred tax assets get re-valued. So there's actually an accounting implication, but it's significantly offset by the fact that instead of 35% federal rate you go to 15%. So long-term let’s say that tax bill get passed, banks will be significantly better off, that in essence returns into its bottom line, it increases returns to shareholders by 20% doing nothing. So, that would change it, but so we'll have to be careful. We'll have to watch the political environment and so forth, but historically the bank and other banks with the highest yielding portfolios in those tax rates investing heavily in municipals we had a fairly big, one of the biggest in the country actually portfolios. So, we are watching that, so that’s a possibility for the future.

Right, so the problem is, if there is tax reform and the corporate rate goes to I mean 15% then you've got, if you recover the DTA, you actually didn’t have to write it back down.

Exactly.

Right, so if I look at the $54 million balance that’s reported in the press release on the balance sheet for net deferred tax asset and I add say $20 million to that, if the tax rate is reduced from 35 to 15 I would then write down that $75 million by the corresponding percentage, is that the right way to think about it?

Exactly. That’s exactly, you defined the percentage tax rate.

Regardless of the accounting reducing the taxes by that amount is economic, its unbelivable…

Well, I agree, I agree.

You will be determining how much you want to increase the earnings of the bank rather the vise versa.

Right, and so…

Okay, so what’s going to happen, nobody is going to buy municipal bonds because there is such limited taxes. It’s going to be very difficult tax bill to pass, because all the municipalities that’s what they live off of is what in essence is the subsidy. So, that’s going to be a difficult constituency to overcome.

Right, and then Damian, early in the conversation you said there is not, you don’t have a specific time line to achieve the 8.5% leverage with the regulators?

No, no, I miss spoke. We think we will be, this is my definitive statement.

Okay.

I think we can make it a case, a most likely case that 8% will happen somewhere between the second and third quarter, based on all the things we know. I could be wrong. But based on the profitability and the other things like the DTAs and stuff, if the world stays the way it is without additional interest rate cuts and all, increases and stuff we should be able to get in that range by somewhere between the second and third quarter. We do have visibility and we will be close to if not at the 8.5 level if that’s true the 8.5 level will come at the close to the year-end or in the first quarter of next year, but there are scenarios that are clearly would get us to the 8.5 very quickly depending on the disposition of assets and things. So, we feel, I think everyone, like I said before, I think the constituencies involved feel comfortable with continued performance that we can close that gap pretty quickly and get to that capital minimum. Long term, I want to be more than 8.5, so I want to be in the 9 plus level, the 9, low 9 level at least long-term. You know it doesn’t mean we always will be there. We may have a bump in the first quarter due to the reasons we said, but you know that’s kind of the range we're thinking longer term and that should happen over the year so next year, right.

Okay, thank you, Damian, I appreciate you guys. Thanks for all the time.

Very welcome, Wally.

Thank you. That is all the time we have for questions. I’d like to hand the call back over to Damian Kozlowski, for any closing remarks.

Yes, I want to thank everyone. Great questions and we are very focused and continue to execute our business plan and making sure we are a good partner to all constituencies in our community, The Bancorp community, so I thank everyone for being on the earnings call today and we will talk soon.

Ladies and gentlemen, thank you for participating in today’s conference. This does conclude today’s program. You may all disconnect. Everyone have a great day.