Tag Archive Betsy Z. Cohen

The Bancorp: A Test for Post-Enron GAAP

Lawrence Abrams No Comments

Summary

Based on details presented below, we believe that The Bancorp is not in compliance with Post-Enron GAAP (specifically FASB 46R amended by SFAS 167, also know today as FASB ASC Topic 810-10) 

Introduction

Generally accepted accounting principles (GAAP) relating to consolidation of subsidiaries have changed dramatically in response to the Enron scandal of the late 90s. Pre-Enron, GAAP for consolidation was specified in ARB No. 51. It said to the effect that an enterprise must consolidate all subsidiaries in which it had a controlling financial interest as defined quantitatively by a majority voting interest.

Between 1998 and 2001,  Enron’s CFO Jeffrey Fastow exploited that rule mercilessly by creating a number of minority equity interest LLCs  to buy Enron oil and gas assets that had not been fully marked down to market.  Enron did not consolidate these LLCs citing ARB No. 51.  

Nevermind if Enron had total power to direct the activity of the LLC with Fastow himself as managing director paid millions of dollars a year.  Nevermind if Enron had a majority financial interest when debt was considered due to loans from banks secretly secured by Enron common stock.  

Post-Enron in 2003, the Financial Accounting Standards Board (FASB) issued FIN 46R – an interpretation ARB No. 51. The simple majority interest rule was complete scraped.  

Instead, FASB said that an enterprise must consolidate a variable interest entity (VIE)  — variable shares of equity and debt   — when it had a controlling financial interest as defined quantitatively by the obligation to absorb the major share of losses or the right to receive the major share of benefits.

In 2009, FASB amended FIN 46R to take into account the valid criticism from lenders to VIEs who had to consolidate because they had a majority financial interest but absolute no power to direct the activities that affected the financials.

FASB 46R – amended by SFAS 167 (today called FASB ASC Topic 810-10) added a qualitative stipulation that a corporation must consolidate a VIE if it had most of the power to direct the activities as well as a majority interest in the resulting financial gains and losses.

Majority financial interest can be determined quantitatively and has been relatively easy to evaluate for compliance.   But, as PwC lamented in a bulletin, the qualitative question of who has the most decision-making power  “will require considerable judgment.”

The purpose of this paper is to review a late 2014 non-consolidation decision of The Bancorp (NASDAQ:TBBK),  a Philadelphia area bank regulated both by the FDIC and the Federal Reserve with a diversified loan portfolio, but also known for being one of largest issuers of reloadable prepaid debit and gift cards in the country.  

The non-consolidation decision has been reviewed and approved by its outside auditor Grant Thornton LLP.  

We are not sure if the FDIC or Federal Reserve has reviewed this particular non-consolidation decision.  However, the SEC is currently reviewing The Bancorp’s financials for the years 2010-4 in conjunction with the bank’s handling of mark-to-market accounting of the now discontinued commercial loan portfolio.  

The Bancorp case is important for two reasons, one general and one specific:

First, banks are highly leveraged entities (low capital / asset ratios) subject to strict mark-to-market accounting principles for their loan and asset portfolios.   In response to the subprime mortgage meltdown a decade ago, the US Congress passed the Dodd-Frank Act of 2009-2010 which, among other things, required  FDIC-insured banks to maintain a Tier 1 leverage ratio (capital / average assets) greater that 5%.

This means that a relatively small (e.g. 5%-10%) mark down of a major asset class — whether it be loans outright or collateralized debt obligations — could wipe out a third or more of a bank’s capital. This would almost always cause a bank to fall below the Dodd-Frank standard for a “well-capitalized bank”.

Falling below the Dodd-Frank standard would trigger an existential crisis for any bank, forcing a merger or a private placement, often coupled with a massive shake-up of management and the board.

Because of Dodd-Frank, the temptation is greater than ever for a bank to offload troubled assets not fully marked to market to a non-consolidated VIE. 

Second, The Bancorp in particular has a two and a half years running history of erratic mark-to-market accounting of troubled loans, followed by a series of moves to avoid falling below the Dodd-Frank standard.

In August, 2016, The Bancorp reversed a downward spiral toward the Dodd-Frank standard by securing an additional $74 Million in capital from two new investors with terms and conditions suggesting that the bank was desperate to get a deal done.

The Bancorp’s 2 ½ year history of dealing with its troubled loan portfolio has been documented by us in four previous articles for SeekingAlpha:  The Bancorp: Bad Moon Rising (January 2015); The Bancorp: Continuing Problems with a Discontinued Operation (March 2015); The Bancorp: Why the Continuing Delays in Filing Its 10-K (May 2015); and The Bancorp: Private Placement Needed to Shore Status as Well-Capitalized Bank (August 2016).

Finally, The Bancorp case study has an interesting human interest angle as there is a single mastermind behind the dealings and questionable accounting.  For Enron, it was CFO Jeffrey Fastow, “the smartest guy in the room”, who began his career at a big bank in the 1980s working in the nascent market for CDOs.

The Bancorp’s  “smartest guy in the room” with a history of  testing the limits of GAAP is its long-standing Chairman of the Board, Daniel G. Cohen.  The Bancorp was founded by his mother, the legendary Betsy Z. Cohen, but it is her son that controls the bank.

A majority of the bank’s Board has worked directly for Cohen or served on Boards of financial intermediaries he has created over the years.  This includes 6 of the 9 bank Board Members —  Chairman Daniel Cohen along with Beach, Bradley, Kozlov, Lamb, and McEntee III.  

In researching articles we have written about The Bancorp, we discovered that Cohen has been the CEO of a number of companies that create and trade CDOs, most of which imploded in the financial crisis of 2008-10.

The Bancorp Case

In its  3Q14 10-K, The Bancorp announced that it was discontinuing its $1.2 Billion commercial lending operation.  It set aside this portfolio on its balance sheet,  claimed it was marked-to-market, and that the bank was actively seeking buyers.  Since that announcement,  the bank has had considerable trouble selling off the most troubled segments to third-parties.  

As we have said in earlier papers, “fairly marked assets sell fairly quickly”.  A corollary is that failure to sell fairly marked assets is an indicator that the assets are not marked-to-market.

On the next to the last trading day of 2014 when most of us are making New Year’s plans, The Bancorp issued a terse 8-K saying it had made the first sale to a partnership called Walnut Street 2014-1 Issuer, LLC.  

Nine months later when it finally issued its 2014 10-K (another bank debacle detailed by us elsewhere), the bank revealed that it did not consolidate this LLC into its balance sheet despite the fact that the overwhelming proportion of the LLC’s financing came from the sale of notes back to The Bancorp itself.  

What caught our eye initially in early 2015 was NOT the financing structure.  That came out nine months later.  What caught our eye initially was the stark contrast in markdown between the sale portion and the remaining portion of the discontinued loan portfolio. (see table below) (click to enlarge)

markdown-comparison

We speculated in an January 2015 article The Bancorp: Bad Moon Rising that the remaining portion might not be fully “marked to market” and fairly valued.  Our speculation was validated 1 ½ years later in 2Q16  when the The Bancorp was forced by independent auditors to take an additional $32 Million in combined market-downs of the remaining portfolio on its books and write-offs of the notes received from the LLC to pay for the portfolio segment bought.

In electing not to consolidate, The Bancorp cited almost verbatim in Note H of its 2014 10-K (filed 9 months late), and in its 2015 10-K,  the criteria for consolidation specified in FASB 46R – Statement 167:

“(1) the power to direct the activities of the VIE that most significantly impact the VIE’s economic performance; and

(2) through its interests in the VIE, the obligation to absorb losses or the right to receive benefits from the VIE that could potentially be significant to the VIE.”

The table below is our presentation of the variable interests in the LLC as detailed in Note H of the bank’s 10-Ks: (click to enlarge)

The Bancorp VIE: Walnut Street 2014-1

The fact that bank waited until the day before New Year’s to disclose this sale in a terse 8-K plus the fact that the structure of the deal was so convoluted,  giving its partner 51% of the voting stock despite practically no “skin in the game”, alone suggests right from beginning that The Bancorp is testing the limits of Post-Enron GAAP.  

The Bancorp’s partner here  is Angelo, Gordon & Co (AG & Co.)  out of New York City.  According to its website, AG & Co. is a large $26 Billion manager of  “alternative investments” including commercial real estate mortgage-backed securities (CDOs).  

Legally speaking, AG & Co. is an unrelated, third party to The Bancorp and its the Chairman Daniel G. Cohen.  But, AG & Co. is listed as a “banner investor” of a firm that merged into Cohen’s latest concoction — a “blank check” IPO called Fintech Acquisition Corp, which we have written about in our paper Fintech Acquisition “Blank Check” IPO: Buzzy Name Fuzzy Aim.

Also, the founders of  AG & Co. — Michael Gordon and the late John M. Angelo — must have had direct meetings with Cohen over the years as both AG & Co. and various Cohen controlled companies —IFMI, Cohen & Co., Alesco Financial, Taberna Realty Finance, and RAIT Financial Trust  —  create and trade CDOs.

The fact that AG & Co has practically no “skin in the game” plus the fact that its founders had prior dealings with Cohen suggest that the bank’s sale to the LLC was barely an arm’s length sale to an unrelated third-party.

In Note H of its 10-K, the bank at least acknowledges that it has the most exposure to LLC losses:  “The Company’s maximum exposure to loss is equal to the balance of the Company’s loans, or $178.5 million.”

In terms of criteria (2) alone, the bank should have consolidated.  But what about criteria (1) above?

In Note H of its 10-K, the bank has nothing to say about who has the most power to make decisions that affect the performance of the LLC.  It just ends the note abruptly with this conclusion:  “The company is not the primary beneficiary, as it does not have the controlling financial interest in WS 2014 (the LLC)  and therefore does not consolidate.”

The purpose of the rest of the paper is provide evidence in support of our contention that it is high level executives at The Bancorp who make the key operating decisions that affect the LLCs financial performance and therefore The Bancorp should have consolidated.

Before we start, we just want to mention first that the very name for the LLC — Walnut Street 2014-1 Issuer, LLC. — marks its as The Bancorp’s venture, not some true partnership.

The Bancorp’s founder, Betsy Z. Cohen, the mother of Bancorp Chairman Daniel G. Cohen, was instrumental  reviving the Walnut Street area of downtown Philadelphia in the 1970s by making risky loans to startup restaurants in the area.  It is ironic that the same Walnut Street name that was associated with a civic-minded banker/mother in the 1970’s is now associated with a rule-bending banker/son now.

Officers and Directors

When trying to determine who controls the operations of an LLC, the usual place to start is a listing of the officers.  Unfortunately, but not unexpectedly,  Walnut Street LLC was formed in Delaware where such information is not publicly available.

Fortunately, we have found on-line a copy of the Purchase Agreement between The Bancorp and the LLC.  It yielded two names associated with the LLC.

The  LLC’s “Directing Holder”  is Jonathan Lieberman, head of AG & Co’s considerable commercial and real estate loan trading operations.  He is based in New York City.  One has to wonder how much time Lieberman puts into an LLC where AG & Co.’s investment is mere $16 Million, or less than .5%  of the Billions of real estate  investments he must be managing.

The LLC’s  “Designated Manager”  is Kenneth L. Tepper, head of Kildare Financial Group, an independent contractor that has been used by the FDIC to sort bankruptcy messes.  The initial address for the LLC was his office address in Gladwyne, PA.

It turns out Tepper has close ties to The Bancorp. According to a Bloomberg bio, Tepper has served as Managing Director of Financial Institutions Group at Cohen & Co, a firm founded by the family of Chairman Daniel G. Cohen.

Also, there is a 2012 article that says Tepper has worked on bankruptcy cases with Hersh Kozlov, a managing partner of the Philadelphia area law firm Duane Morris LLP.   It turns out that Hersh Kozlov has been a  Board Member of The Bancorp since 2014 and The Bancorp uses his law firm Duane Morris LLP.

In short, Kenneth L. Tepper was a front for The Bancorp when it set up the LLC in 2014.

Legal Activity

In trying to answer the question of who makes the key decisions that affect the LLCs financials, we start by asking what are the activities of this LLC that most significantly affects its performance?

The business of the LLC is managing an existing, troubled commercial loan portfolio already marked down 28% from principal. There is no need for loan officers to drum of new business,  get appraisals, or to create new loan documents.  

There is a need for servicing existing loans — posting remittances, checking certificates of insurance, sending out routine delinquency notices. etc. The Bancorp discloses in Note H of its 10-Ks that it has a contract to service the LLC’s loans.  But, servicing existing loans does not have material impact on financial performance.

The really important decisions of the LLC involve the handling of delinquent accounts.   This involves face-to-face meeting with borrowers who are mostly in the Philadelphia area.  It involves facilitating refinancing with other banks.  It involves directing lawyers to file documents in area courts to recover from borrowers who have defaulted on their loans.

Here is an a quantitative estimate of how many loans are involved in the LLC portfolio. The Bancorp’s CFO Paul Frenkiel gave some detail in a 2Q16 conference call regarding the concentration ratio in the discontinued operations portfolio.   By applying the same ratios to the LLC loan portfolio, (see below) we can get some idea of the number of large loans in the LLC portfolio: (click to enlarge)

The Bancorp: Walnut Street LLC Loan Portfolio

The core of the LLC activity is working with approximately 29 total customers, concentrating on about 5 customers with outstanding loans principals averaging $20 Million.  Losing one to default would be impactful. Losing two would be disastrous.

Below are links to two 2016 filings by lawyers on behalf of the LLC to recover from borrowers who have defaulted.  The total claims amount to $28.2 Million, or 14.6% of the total loan portfolio.  In both cases, the lawyers are based in the Philadelphia area and have close ties to The Bancorp.

In June 2016, a suburban Philadelphia paper reported a sheriff’s sale of a suburban shopping center where the owners were in default of loans held by the LLC. “According to a schedule of the Schuylkill County Sheriff’s Sale of Real Estate, the mall has been listed for sale based on a judgment of $27,428,876.”  This single default represented 13% of the LLC’s total portfolio.

The article mentioned that the LLC’s claim for damages was filed by Dana B. Klinges.

It turn out that Klinges is with the law firm Duane & Morris LLP. where Hersh Kozlov, a Board Member of  The Bancorp’s is a managing partner.

In May, 2016, a lawyer for the LLC filed in Pennsylvania court a plea to recover $822,053 in loan principal plus interest from owners of another Philadelphia area shopping center.  The lawyer was with the law firm  Spector, Gadon & Rosen P.C.

It turns out that  Spector, Gadon & Rosen P.C. was co-founded 35 years ago by Betsy Z. Cohen, founder of  The Bancorp and mother of Chairman Daniel G. Cohen.

Finally,  the LLC’s corporate attorney  — Dechert LLP — has close ties  to The Bancorp as Dechert LLP is listed as one of the Bancorp’s corporate attorneys and defended them in an investor lawsuit.

While we have evidence that all of these outside lawyers have close ties to The Bancorp, we have no hard evidence as who specifically gives them high-level direction.  Who do these lawyers discuss strategy with in face-to-face meetings in the Philadelphia area?  Who reviews their invoices? Who signs their checks?   

Based on court documents in connection with the shopping center case cited above, The Bancorp executive that lawyers report to is Daniel Sacho, current Executive Vice President of Commercial Lending and Real Estate.

The Bancorp’s Headquarters is in Wilmington, Delaware.  The Bancorp maintains a large office at 1818 Market Street, 28th Floor  in downtown Philadelphia. Of note, several other companies controlled by Daniel G. Cohen — Rait Financial Trust and Cohen Bros. & Company —  also maintain offices on the same 28th floor.  

A high level bank executive based in Wilmington at The Bancorp’s HQ is only 37 miles and a 40 minute ride by train or car away from their downtown Philadelphia office.

Finally, here is an example of an  assignment document transferring a loan from The Bancorp to the LLC.  The address used for the LLC was ℅ The Bancorp Bank, 712 Fifth Avenue 8th Floor, New York, NY 10019.  This is the same address used by Chairman Daniel G. Cohen for his Fintech Acquisition Corporation.

Accounting Activity

By selling a segment of its discontinued operation’s loan portfolio to an unconsolidated LLC, The Bancorp escaped rigorous, transparent, and periodic examination of mark-to-market GAAP for its troubled commercial loans.

But, those troubled loans were largely replaced on the bank’s balance sheet by $193.6 Million in notes issued by the LLC.  The Bancorp has chosen to label these notes an “investment in unconsolidated entity.”  While not subject to the same rigorous and periodic examination as direct loans, nevertheless this investment is subject to review as to value.

Normally, mark-to-market accounting of loan portfolios and investments are reviewed by a bank’s independent auditor, in this case, Grant Thornton LLP.  

However, on July 28, 2016 in its 2Q16 conference call, The Bancorp disclosed that it had engaged several independent auditors to review both the on-balance sheet portfolio and the off-balance sheet portfolio of the LLC.  Per their recommendation, the bank took a total of $32 Million in combined mark-downs of its on-balance sheet portfolio and write-off of its on-balance sheet investment in the LLC.

This surprised Wall Street and sent the bank’s stock down for a 14% one-day loss. This was the first time The Bancorp’s financials took a hit from its commercial loan operations since it declared it a discontinued operation nearly 2 years ago.

The bank must have known ahead of time that this disclosure would would cause  investors to worry about how close the bank was to the Dodd-Frank standard.  Two weeks later, on Monday August 8, 2016, The Bancorp announced a private placement of combined common and convertible preferred stock for a total gross consideration of $74 Million.

The Bancorp’s 2Q16 conference call revealed how deeply it was involved in its non-consolidated LLC.  Here is an exchange revealing that The Bancorp had hired  independent auditors for both portfolios and that, in particular, it had hired one independent auditor to work on both:

        William Wallace (Analyst, Raymond James & Assoc.)

         Okay. And do you have the same person or firm or company that’s valuing the value of those loans  versus the         ones that are in your discontinued ops.

        Paul Frenkiel (CFO, The Bancorp)

       We actually use multiple companies, but our primary loan review company, we have one loan review company         for discontinued ops and we have another one that also does work on that, but it is more specific to the one             that’s [doing] the investment in that [un]consolidated entity.

Conclusion

Investors eventually sense when a publicly-held company pushes GAAP to the limit. It’s stock price begins to fall long before any outside auditor or the SEC steps in to question its accounting publicly.  

The stock market has already punished The Bancorp for its handling of mark-to-market accounting and its painfully slow disposition of its discontinued commercial loan operations.  Between March, 2014 when it first announced an unexpected additional mark-down of its loan portfolio and June 12, 2016, the stock has fallen 69.3%  from $19.98 a share to $6.12 a share.

The Bancorp Stock Performance

Even though The Bancorp has moved a segment of its troubled loans off its balance sheet,  its balance sheet  eventually took a hit anyway.  Pressure from investors eventually forced the bank to accept an independent auditor’s recommendation to write-off a portion of the notes it took back from the LLC.

The problem is “eventually”  is not good enough.

In July, 2016, The Bancorp announced that it had settled a class action suit brought by investors who had lost $100+ Million during the past two year.  The settlement was for a paltry $17. 5 Million, of which the bank said that 100% was covered by insurance.

The Bancorp’s outside auditor Grant Thornton LLC needs to force the bank to explain in greater detail in its Note H why it believes it is in compliance with both criteria specified in  FASB 46R – Statement 167.  The SEC, FDIC, and the Federal Reserve need to review this case of non-consolidation.  

Allowing The Bancorp to get away with this non-consolidation sends a signal to banks that they can avoid falling below the Dodd-Frank standard by setting up blatantly convoluted VIE’s similar to Walnut Street 2014-1.

 

The Bancorp: Continuing Problems With A Discontinued Operation

Lawrence Abrams No Comments

  • The Bancorp filed a NT 10-K recently notifying the SEC that it had failed to file its 2014 10-K within the allowed 75 days.
  • We believe that the reason for this failure has been a reconsideration of the markdown of the loan portfolio associated with its discontinued commercial lending operation.
  • The Bancorp has until March 31st to file a 2014 10-K. We present the case that the bank will be booking an alarming 5% to 10% additional markdown.
  • As a result, we believe that the stock will drop another 15% in the next week and will test its 52-week low of $7.81 a share.

On October 31, 2014, The Bancorp (NASDAQ:TBBK) announced that it was discontinuing its commercial lending operations. Based on an independent third party review, it set aside for sale a loan portfolio with a fair market valuation of a 6.8% discount from its $1.2 Billion principal.

Two months later, on the next to the last business day of the year when most of Wall Street was home making New Year plans, the bank issued a terse 8-Kstating that it had sold a partial $267.6 Million loan package that had been marked down in October to $213.5 Million. The sale was to a newly created LLC, financed largely by the bank itself, (more on that later) for $209.6, resulting in a small loss on sale of $3.9M.

This end of year transaction caught our eye. We did the numbers and found a huge discrepancy between the overall loan portfolio markdown of 6.8% and the 20.2% markdown of the piece sold in December. The December partial sale implied that the remaining 78% of the portfolio still on the bank’s balance sheet was covered by only a 3.0% markdown.

Below is a spreadsheet, which shows how we arrived at this implication. An earlier version was presented in our January 2015 SA article on The Bancorp.

tbbk-discontinued-1

As a consequence of this lack of communication, the stock dropped 22.8% from $10.89 on December 31, 2014 to $8.41 on February 2, 2015.There was nothing in the terse December 8-K to assure investors that the remaining portfolio on its books was marked fairly. Management should have told investors that it had a plan to sell the portfolio in pieces with the most toxic piece sold first.

TBBK Chart

TBBK data by YCharts

Only during its Q4’14 conference call, thankfully transcribed by SA, did the bank make it clear that it had a plan. It also reassured investors that the remaining 78% piece was fairly marked.

Finally, the CEO Frank Mastrangelo offered investors a time frame during which the bank hoped to complete the sale,

… we will have some of the sales bleed into Q2 although it’s certainly possible and plausible that some will still occur this quarter.

As a result of these February clarifications, the stock has recovered somewhat rising 11.2% to $9.35 a share as of the date of this paper. Fast forward to today (3-24-15) and still no sale. The longer this continues, the greater will be the bank’s problems.

While the problems are general to cases of continuing discontinued operations, we will argue below that they are worse for a highly leveraged, regulated bank like The Bancorp. Furthermore, we will argue that The Bancorp specifically has made a bad situation worse.

Management, including the bank’s former long time CEO Betsy Z. Cohen and its current, long time Board Chairman Daniel G. Cohen have to be held accountable for this continuing problem. The problem can be broken down into interrelated issues with pricing, accounting, and management. We detail below The Bancorp’s problems:

Pricing and Accounting Issues

The speed at which assets are sold is a function of price. Fairly marked assets should sell fairly quickly. In turn, price is a function of terms. Set a high nominal price but offer liberal seller financing and the sale closes faster at the high nominal price. As evidenced by the December sale, The Bancorp will go to great lengths to extend terms to close a loan sale without dropping price below its prior mark (more later).

Lack of time to shop this portfolio or lack of time for potential buyers to perform “due diligence” cannot be the reason for this delay as it has been 5 months since this portfolio was first officially marked “for sale.” The conclusion has to be that our estimated 3% markdown of remaining portfolio is insufficient to close a sale. If it were a matter of having to concede 1% or 2% more, the bank would have done so and booked a small loss in 2015.

For most corporations, conceding an additional 5% to 10% markdown to sell a discontinued operation would be bad, but not catastrophic. Not so for regulated, highly leveraged commercial banks. Especially not so for The Bancorp, who already is at the low end of various bank equity/asset ratios.

The Bancorp’s Q4’14 simple equity/asset ratio was 7.64% (359.6/4,706) Having to close a sale by taking an additional 10% markdown on a $955 Billion loan principal would cause a $95.5 Million hit to the balance sheet. This would represent a 27% reduction in its equity.

Also, taking this kind of hit upon sale now would taint 2015 earnings. The bank would have been better off taking the hit in 2014. But wait a minute… On March 16, 2015 the bank filed something called an NT 10-K – A Non-Filing Notice to the SEC stating why it failed to file its Annual 10-K report within the allotted 75 days.

It now has until March 31, 2015 to submit a final 10-K. Doing this allows the bank to record any additional markdown as a loss in 2014 rather than 2015. The reason given for this failure was that it needs more time to finalize its accounting for the Q3’14 discontinuation event and for the Q4’14 sale of the toxic piece.

Filing an NT-10 is a significant event. It can signal the existence of a major accounting debate between management and its auditors. It also can signal a last minute capitulation and reversal internally over how a company accounted for a prior event.

We have called investor relations at TBBK and left a message, asking for a comment to our estimation that they will be making a significant 5% to 10% additional markdown by March 31st. They did not return our call.

We view the Bancorp’s filing as a signal that by March 31st, they will be recording an additional 2014 markdown loss, thus sparing a hit to 2015 earnings. In light of how long this has dragged on without a sale, our belief is that the bank will be taking an additional 5% to 10% markdown needed to close a cash sale within the next month.

But, this additional markdown will not mark the end of The Bancorp’s continued involvement with its discontinued operation. It had to resort to seller financing to close the sale of the toxic piece in December. See the spreadsheet below of how The Bancorp financed this sale:

tbbk-discontinued-2

When asked in the February 2015 conference call whether the bank would resort to seller financing again, CEO Frank Mastrangelo said

It’s certainly not the first option or priority, would we consider it in the right transaction, possibly but just not certain there is going to be a need to do that.

Remember price is a function of terms. You can always get your asking price if you are willing to provide liberal seller financing. If the remaining portfolio does close without significant additional markdowns, our bet is that the bank accomplishes via continuing involvement (off-balance sheet, of course) in this discontinued operation.

Management Issues

Employees can be expected to jump ship when any corporation declares an operation “discontinued.” And if the discontinued operation is “knowledge worker” intensive, as is the case with a commercial loan operation, resignations can result in a significant deterioration in financial metrics.

This has been the case in spades with The Bancorp. On January 8, 2015, the bank’s Executive Vice President, Arthur Birenbaum, who had been in charge of this discontinued operation, handed in his resignation. He had served the Cohen family, founders of The Bancorp, for the last 25 year in various capacities.

Four days later, it was reported that Mr. Birenbaum had been hired by the Cape Bank of Atlantic City to set up a new commercial loan operation in The Bancorp’s home territory of Philadelphia. It can be assumed that since the middle of January 2015, Mr. Birenbaum has been contacting and later hiring loan officers from The Bancorp’s discontinued operation.

This means that for the past 3 months, The Bancorp’s commercial loan operation has had no experienced manager and few engaged loan officers. Surely, this lack of management has increased servicing and collections problems.

Additional disclosure: On Thursday, at the suggestion of our SA editor, I called Investor Relations at TBBK and left a message asking specifically if they intended to make an additional mark down to their discontinued loan portfolio in the range of 5% to 10% by March 31st. They did not return my call and I noted that in the article

The Bancorp: Bad Moon Rising

Lawrence Abrams No Comments

  • The Bancorp is a Philadelphia area bank whose stock has fallen 50% in 2014 due accounting and regulatory surprises.
  • On top of that, it announced it was discontinuing its commercial lending operations and set aside a $1.2 Billion portfolio for sale with an overall 6.5% mark-to-market discount.
  • An 8-K filed on the last business day of 2014 revealed a partial sale with a mark-to-market discount of 20.2%.
  • Another 8-K filed 3 days ago revealed that the EVP of commercial loans resigned effectively immediately.
  • Until there are assurances from management as to the quality of the remaining portfolio for sale, we rate this stock a sell.

The Bancorp (NASDAQ:TBBK) is a Philadelphia area bank founded in 2000 by the pioneering banker and lawyer Betsy Z. Cohen. A few bullet points from her resume:

  • Second female law professor on the East Coast after Ruth Bader Ginsberg
  • Founded Jefferson Bank in 1974; Sold it in 1999 for $370M
  • Instrumental in financing Philly’s Walnut Street downtown revival
  • Board Member – Aetna US Healthcare, Philadelphia Museum of Art, Bryn Mawr

Since inception, the bank’s Chairman has been her son, Daniel G. Cohen. A few bullet points from his resume:

  • CEO of three publicly-held companies whose market values crashed due to CDO investments
  • CEO, IFMI, 2010-12 when market value crashed 91%
  • CEO, Alesco Financial Trust 2007-10, when market value crashed 87%
  • CEO, RAIT Financial Trust, 2006-9 when market value crashed 98%

2014 was a bad year for The Bancorp as the bank was rocked by a series of surprise accounting and regulatory disclosures resulting in a 50% drop in its stock price.

TBBK Chart

TBBK data by YCharts

First there was an April 18, 2014 8-K disclosure in conjunction with the release of its 1Q14 results that “newly identified adverse classified loans”, caused a one-time addition to its loan loss reserve of $11.8 Million. The next trading day the stock dropped 14.9% from $18.60 to $15.84.

Then there was a June 10, 2014 8-K disclosure that the FDIC found that bank was in violation of the Bank Secrecy Act — namely that reloadable prepaid cards issued by The Bancorp were being used for extensive money laundering. The next trading day the stock dropped 30.3% from $16.36 to $11.40.

On December 1, 2014, there was 8-K disclosure that CEO Betsy Z. Cohen, 72, would be retiring at the end of the year.

Her son, Daniel G. Cohen, 42, remains Chairman of the Board. Four other Board members are Board members of other companies that Daniel G. Cohen has at one time controlled.

We see a “bad moon rising” for The Bancorp in 2015. We see “trouble on the way”.

In its 3Q14 10-Q, the bank announced that was discontinuing it commercial lending operations. Based on an independent third party review, it marked down the portfolio by an additional $38.9M to a fair market carrying value of $1.2 Billion:

” In addition to $44 million in the allowance for loan losses which was net against those loans, an additional $38.9 million expense resulted from the valuation to estimated sales price, which was also net against those loans. “

Here is a 3Q14 conference call exchange, as transcribed by SA, confirming the view of $82.9M as the difference between the outstanding principal and the fair market carrying value of the portfolio at that time.

Paul Frenkiel– Chief Financial Officer

Sure. Yes, those actually are separate, so maybe the easiest, I think the way you are trying to look at it was that at the end of the second quarter we had a reserve of about $46 million. We had some activity during the quarter, so we ended up with the reserve about $44 million and $38 million was basically in addition to that.

Matthew Kelley– Sterne Agee

Got you. So we can really think about it as an $82 million write-down or 7% or 8% of the unpaid principal balance. Is that the right way to think about it?

Paul Frenkiel – Chief Financial Officer

By 38 in addition to the 44 that had accumulated over a period of many years.”

On the next to the last business day of the year, December 30, 2014, the bank issued an 8-K stating that it had sold a portion of its $1.2 Billion commercial loan portfolio:

“The sold loan portfolio had an outstanding principal balance of approximately $267.6 million, which had been adjusted on the books of the Bank to estimated fair market value in the third quarter of 2014 upon the classification of the Bank’s related commercial lending operation as a discontinued operation and the transfer of the related portfolio to “held for sale” status. As a result of the estimated fair market value adjustment, the carrying value of the portfolio, as of September 30, 2014, was $213.5 million.”

Several things about this first sale caught our eye. The first thing was the mark-to-market discount associated with this relatively small piece of the portfolio:

(267.6 – 213.5) / 267.6 = 54.1 / 267.6 = 20.2%

This was way out of line with the overall average discount of 6.5% established just two months earlier.

Second, the sale was not for cash nor to an established third-party. It was for note receivables issued by a newly created LLC with the bank itself as 49% minority partner.

We ask ourselves, “How toxic can the full portfolio really be if this is what the bank had to do to sell just a portion of it?”

Maybe, they planned on an asymmetric sequence of sales, with the very toxic piece cut out first and sold to a related party at a steep discount.

Then they would sell the remaining clean piece with a mark-to-market discount of only 3% to an established third party willing to pay cash for a clean bundle.

But if this were so, why did The Bancorp not include an explicit statement in the late December 8-K of the planned asymmetric sale sequence?

Another 8-K has been just filed by The Bancorp on January 9, 2015 reporting that Arthur Birenbaum, EVP, commercial loans has resigned, effective January 8, 2015.

Investors need to get straight answers to the following questions now or during the bank’s 4Q14 earning conference call:

  • What is the overall mark-to-market discount on the remaining $900M commercial loan portfolio?
  • Can the bank give assurances that the remaining portfolio is fairly valued in light of the 20% mark-to-market discount associated with the piece just sold?

Below is a spreadsheet summarizing our view of the accounting of the two transactions to set aside the commercial loan portfolio in 3Q14 and then to sell the first piece on December 30, 2014.

It also includes a “what if analysis?” as to future mark-downs of the remaining portfolio for sale

Bancorp Sale of Loan Portfolio

Additional disclosure: Investors are always reminded that before making any investment, you should do your own proper due diligence on any name directly or indirectly mentioned in this article. Investors should also consider seeking advice from a broker or financial adviser before making any investment decisions. Any material in this article should be considered general information, and not relied on as a formal investment recommendation.