Profile: Cross River Bank

January 19, 2022 | What is the best performing bank in the US between $10 billion and $100 billion in total assets? Answer: Cross River Bank in Teaneck, NJ. Readers of the Premium Service of The Institutional Risk Analyst know Cross River for its role as the lender behind Upstart Holdings (UPST), which we profiled last month (“Update: Block Inc. & Upstart Holdings”). But we also are reminded of another small, volatile bank, Lehman Brothers FSB, which we described to readers of The IRA nearly 20 years ago. That outlier bank once featured 50% equity returns as the conduit for a subprime mortgage issuer, Lehman Brothers, but is no more. If we told you that Cross River Bank has grown 400% in the past three years, mostly on PPP loans and mostly funded with non-core deposits, would that dampen your enthusiasm? Just for giggles, below are the top-ten performing bank units in the $10 billion to $100 billion group:

Source: FDIC

Not only does Cross River Bank currently have the best nominal equity returns in Peer Group 1 or 2, but it outperforms leaders like American Express (AXP) and Discover Financial (DFS). More, when you examine the bank’s credit performance, the balance sheet seems pristine. The bank rates an “A+” from Total Bank Solutions Bank Monitor and has a return on economic capital of over 80%, but Cross River Bank was not always so righteous. Indeed, as recently as March 2020 the bank was reporting almost 200bp of defaults vs just 25bp in March 2021.

Source: FDIC

Cross River Bank was founded in 2008 and until 2015, had no credit losses. From June of 2016 onward, however, Cross River Bank went on a wild roller coaster of rising credit losses, peaking at 187bp in December 2017 and remaining elevated through 2020, when defaults abruptly declined to just above the Peer Average. In the world of financial analytics, that’s what we call “movement.”

Cross River Bank sells unsecured consumer loans to UPST, for which it receives an upfront fee of as much as 8%, according to a presale report from Kroll Bond Rating Agency. KBRA reports in a presale for Upstart Pass-Through Trust, Series 2022-ST1 (“UPSPT 2022-ST1”), a consumer loan ABS transaction:

Just imagine what sort of borrower would agree to take an unsecured consumer loan with an eight-point discount to par. If you have seen the 2013 movie "American Hussle," then you get the idea. Somehow KBRA managed to assign a "BBB-" rating to this transaction, just on the bleeding edge of investment grade.

CRB Group Inc. (CRB), the parent of Cross River Bank, reported an ROE of 32% and ROA of 3.2% in Q3 2021, and an efficiency ratio of just 32.2% vs a Peer Group 2 average closer to 55%. CRB generated a gross loan yield over 500 bp in Q3 2021 and a return on investment close to 2.4%. And of note, CRB has 21% risk weighted capital and a 14% Tier 1 leverage ratio as of Q3 2021. The fact that this relatively new $11 billion asset bank does not yet need to file a Y-9C speaks to the velocity of change since the end of 2018, when Cross River Bank had just $1.3 billion in average assets.

Source: FDIC

So, what’s not to like? Well, for one thing, Cross River Bank had $1 billion in assets four years ago. The originate-to-sell business model was clearly not working given the elevated credit losses, then suddenly the bank shifted focus to underwriting PPP loans. Today, Cross River Bank is the largest PPP lender in the US. This hyper-aggressive strategy is funded via hot money rather than core deposits. The bank manages this outlier business model by keeping risk weighted assets (RWA) at just $2.6 billion or less than 25% of the nominal balance sheet.

Even with the change in strategy, the bank's losses are still above Peer Group 2 and with half the earnings coverage of similar banks. The rest of the bank’s assets include $8 billion in C&I (aka PPP) loans, which are government guaranteed via the SBA and thus carry a zero Basel risk weight. And given the volume of PPP loans processed by Cross River Bank, no surprise that the bank has been caught up in congressional investigations into the program. At the end of Q3 2021, the bank had $9.1 billion in loans held in portfolio and not available for sale.

The bank funds these assets with $1.4 billion in brokered deposits and other borrowed money. Core deposits equaled just 19% of total deposits at the end of Q3 2021 vs almost 80% on average for banks in Peer Group 2. Total other borrowings were 62% of assets compared with 0.45% average for Peer Group 2. The interest expense of Cross River Bank is 4x the Peer Group 2 average but so are the asset returns. Is this bank idiosyncratic? Yes, very and now faces a new challenge, namely what to do after PPP.

One big driver of returns for Cross River Bank is a large investment in mortgage-backed securities of $1.8 billion, an apparently highly leveraged position that generated a yield of 17.8% in Q3 2021 vs 1.57% for similar assets held by members of Peer Group 2. In terms of return on earning assets, Cross River Bank reported total interest income of 7.8% vs the Peer Group 2 average of 3.1%. Again, the bank is an outlier vs banks of similar size.

Bottom line, when a bank seems to be doing much better than other banks, there is usually a reason and that reason is almost always bad. The Lehman Brothers FSB example should be recalled. In Q3 2021, Cross River Bank reported net income to average total assets of 3.9% vs 1.28% for Peer Group 2. Today everything looks great, indeed, too good. We wonder how this bank will look this time next year when both interest rates and loss given default (LGD) are rising.

The chart below shows LGD for all US banks. The fact that Cross River Bank has seen no improvement in LGD at a time when other banks are experiencing sharp downward skews in post-default loss due to FOMC policy is remarkable. Now that Fed policy is changing, we expect LGD to rise accordingly. In Q3 2021, of note, loss given default for Cross River Bank's loan portfolio was 86% of the original principal amount vs only 54% for all FDIC-insured banks.

Source: WGA LLC

The originate-to-sell model built around the relationship with UPST during the period of ultra-low interest rates maintained by the FOMC is an obvious point of focus in the future for risk managers, ratings analysts and counterparties. If the bank has an 85% LGD on non-PPP loans today, how will those credit exposures look in a year or two? At a minimum, as interest rates rise, we look for the credit performance of both retained loans and loans sold to investors via UPST to deteriorate. Both direct credit loss from portfolio loans and potential repurchase claims are areas of concern for the future.

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