ConnectOne Bancorp Inc (CNOB) 2018 Q3 法說會逐字稿

Good day, and welcome to the ConnectOne Bancorp Third Quarter 2018 Earnings Call. Today's conference is being recorded.

At this time, I would like to turn the conference over to Siya Vansia. Please go ahead.

Good morning, and welcome to today's conference call to review ConnectOne's result for the third quarter of 2018 and to update you on recent developments. On today's conference call will be Frank Sorrentino, Chairman and Chief Executive Officer; and Bill Burns, Chief Financial Officer. The results as well as notice of this conference call on a listen-only basis over the internet were distributed this morning in a press release that has been covered by the financial media.

At this time, let me remind you that certain statements and assumptions in this conference call contain or are based upon forward-looking information and are being made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Such forward-looking statements are subject to numerous assumptions, uncertainties and known or unknown risks, which could cause actual results to differ materially from those anticipated. These risk factors are more fully discussed in the company's filings with the Securities and Exchange Commission. The forward-looking statements included in this conference call are made only as of the date of this call, and the company is not obligated to publicly update or revise them.

In addition, certain terms used in this call are non-GAAP financial measures, reconciliations of which are provided in the company's earnings release and accompanying tables or schedules, which have been filed on Form 8-K with the SEC on October 25, 2018, and may also be accessed through the company's website at ir.connectonebank.com. Each listener is encouraged to review those reconciliations provided in the earnings release, together with all other information provided in the release.

I will now turn the call over to Frank Sorrentino. Frank, please go ahead.

Thank you, Siya. Good morning, and thanks for joining us today. This was another strong quarter for ConnectOne. Third quarter net income totaled $19.9 million or $0.61 per diluted share, record quarterly earnings for ConnectOne. We also delivered solid deposit and loan growth and achieved a stable net interest margin despite challenging market conditions.

While deposit pricing remains competitive, total average deposits for the third quarter increased by nearly $150 million, which is more than 15% on an annualized basis, and average noninterest-bearing demand deposits increased by $42 million, which is in excess of 23% on an annualized basis. From a lending perspective, total third quarter loans increased sequentially by $102 million or more than 9% on an annualized basis, led by commercial loans, which supported 3/4 of the growth this quarter. And this commercial lending growth contributed to reducing our CRE concentration to 490% of capital.

Although third quarter loan growth was slightly lower than we projected, we're pleased given the market environment and adherence to our prudent underwriting standards and pricing disciplines. Overall, our loan pipeline remains full. However, against the backdrop of tighter spreads and somewhat subdued loan demand, we're expecting a growth rate of slightly less than 10% as we look ahead. With that in mind, we remain focused on serving new clients, deepening relationship with existing clients and entering into new markets.

We also continue to invest in our development of our organization and our infrastructure, including expanding into new digital offerings and empowering our clients with the latest technology to meet their evolving needs. Towards this end, we're happy to announce that our Zelle program recently launched on our ConnectOne mobile banking app. Our nCino platform rollout continues to be implemented. It is proving to be a powerful tool, allowing us to maintain our best-in-class efficiency metrics. Additionally, we're enhancing the knowledge base of the company by attracting new talent in the deposit and loan origination areas to our team while maintaining our existing staff with very little turnover.

We're also continuing to expand our operations within New York and believe ConnectOne is well positioned to capitalize on the opportunity to serve clients with larger banking needs. Earlier this month, we entered into the lucrative Queens market with the opening of an office in Astoria, home to a thriving but underserved small and midsized business community that can provide superior risk-adjusted returns. The new office will serve as a natural bridge between the recently opened Long Island location and our New York City market.

While we successfully implement our modern retail model, our -- and increase our presence, we also continue to seek efficiencies by rationalizing our physical footprint, including our hours, staff and overlapping branch offices. Great example of this would be the Astoria office, which is a second floor location with full deposit taking capability, housing our new lending and deposit team.

We also remain excited about our pending merger with Greater Hudson. As a premier community bank operating in Rockland, Orange and Westchester counties, Greater Hudson is a strong strategic fit and a financially attractive, compelling expansion opportunity for ConnectOne. The merger allows us to establish scale in the Hudson Valley region; add respected, talented bankers; retain and attract a strong, growing core deposit base in our market; and further enhance our commercial lending capabilities. Additionally, it will provide new opportunities for accretive growth by combining our operating model and our technological capabilities with Greater Hudson's solid deposits and commercial lending franchise.

Regarding timing, we recently received FDIC approval and remain on track to close the transaction in early '19. Additionally, I'm pleased to mention that we appointed a new independent director to ConnectOne's board this week. Katherin Nukk-Freeman has a strong corporate governance, employment law and human resource background, and her over 20 years of extensive experience, advising corporate leaders will enhance our board. I'm thrilled to welcome her.

Before turning the call over to Bill, I'd like to remind everyone that as we move forward in implementing our disciplined growth strategy, the decisions we're making position us to enhance our competitive advantage, expand our desirable franchise and create long-term value for our shareholders.

At this time, I'd ask Bill Burns, our Chief Financial Officer, to review the details of our third quarter financial performance. Bill?

Okay. Thank you, Frank. As Frank just mentioned, we had another record quarter, both for net income and EPS. A record quarter whether you look at it on a GAAP basis or on an adjusted basis. So adjusting for nonoperating items, the company earned $18.5 million in net income, and that represents a 25% increase from last year's third quarter and a very nice 23% annualized increase from the sequential quarter. So recurring theme for us is that we have very strong performance metrics, and we did again this quarter. Return on tangible common equity increased to 18% on a GAAP basis and to 16.7% on an adjusted basis. Our return on assets surpassed 1.5% under GAAP and 1.4% adjusted. The net interest margin, excluding purchase accounting, widened by 3 basis points, and our balance sheet growth was in all the right places.

On the deposit side, we had very, very strong growth in noninterest-bearing demand deposits. Annualized sequential growth was 24%. And with regard to lending, non-CRE loans contributed 75% of the growth for the quarter, increasing on an annualized sequential basis by 30%, and this helped bring our CRE concentration metric down significantly to 490% from 506% a quarter ago. Our efficiency ratio remained in the low 40s at 42.3%, one of the best in the nation, and it's especially good as it includes our investments in technology. Tangible book value per share has increased 7% over the past 6 months. When you combine that with the lower stock price, we're now selling at a very compelling 1.4x tangible book. And we continue to build capital. The holding company leverage ratio went above 9%, and this build of capital allows us to consider stock buybacks and a possible dividend increase in 2019.

Turning to operating expenses. We did see a sequential increase in expenses. The increase was due to merger expenses, a small loss on the sale an OREO property and there were some adjustments to equity-based compensation accruals. But excluding those items, the sequential annualized expense growth rate was about 8% annualized, that's been in line with our run rate. And going forward, I would expect operating expense growth to be at or slightly below that level.

And now to the tax line where there was a good deal of noise this quarter, so let me try to explain. First, we benefited from tax -- deferred tax asset adjustments to -- both to federal and state tax rate changes. The federal benefit was identified as we filed our 2017 return. Effectively, it's a partial reversal of the charge we took when the federal tax legislation was enacted in '17. The amount of this benefit recorded this quarter was $800,000. In regard to the recently enacted New Jersey tax legislation, our deferred tax asset was adjusted upward, which decreases income tax expense, and that was due to the 4 years of surtax implemented as of 1/1/2018. This benefit amounts to about $600,000.

We also benefited this quarter from option exercises, and that created an additional $300,000 positive adjustment. But separate from these tax expense adjustment, the unitary tax filing requirement to be put in place for New Jersey on January 1, 2019, makes our overall tax planning much more challenging. Under the new state tax code, I'm anticipating an effective tax rate of about 26% next year versus the 21% we were expecting for 2018. However, in anticipation of the new tax framework for New Jersey, we were able to lower the effective tax rate for the remainder of 2018. So in summary, I'm anticipating a 17% rate for the second half of '18. The full year '18 will be 19%. And for the full year 2019, it is expected to increase to 26%.

Now a few words on where I think things are headed. First off, all signs point to continued strong returns on assets and tangible equity. We continue to focus on leveraging technology to create even further operating leverage and efficiency for the rest of the year and into 2019. In addition, we will continue to pursue both organic balance sheet growth and acquisitions, but both in a very disciplined fashion.

Having said that, the difficult operating environment persists. Loan growth is likely to moderate. And although we've stabilized the net interest margin recently, I am going to project margin compression in the fourth quarter. That's due to continued deposit competition, narrowing lending spreads and a reduction of prepaid fees. Offsetting this, to some extent, will be some net interest margin benefits from the Greater Hudson deal, and that will begin in the first quarter of '19.

And just a few more comments about the pending merger with Greater Hudson. Still expecting to close the transaction very early January. So there'll be no impact on 2018 numbers and a full impact of the deal in '19. The strategic fit of this merger will continue to accelerate our key metrics, all in the right direction, with Greater Hudson's deposit-rich franchise; significantly lower loan-to-deposit ratio, which is below 90%; a diversified commercial lending portfolio, which contribute to a lower CRE concentration; and a net interest margin, which is above 3.65%. And the financial metrics we announced when the transaction was entered into remain on track and are very economically compelling. Expect only slight tangible book dilution, a very short earn-back period, EPS accretion, improvement of 5 basis points or more in net interest margin, identify an attainable cost saves, and that is all without taking into account any revenue synergies, which we are confident are attainable.

And with that, I'll turn it back over to Frank.

Thanks, Bill. As you can see, we reported another quarter that demonstrates prudent growth and increased financial performance. While we're mindful that the near-term operating environment remains challenging, we continue to benefit from increased momentum across our platform and through our client first, sense of urgency culture. I'm confident in our ability to continue to increase our size and scale in a disciplined fashion. As I've said, our priorities are solid execution, being successfully opportunistic in M&A, advancing our best-in-class efficiency and continue to make strategic investments for the future.

We're also moving ahead with a very strong capital foundation. As we've discussed, our earnings strength contributes to a solid, growing capital base. What this means is, we're going to continue to be well positioned to invest in our growth. And as Bill mentioned, we'll have the flexibility to consider stock buybacks or growing our dividend levels during 2019. In summary, we're pleased with the groundwork that we’re laying for the long-term success of the business and remain focused on delivering attractive, long-term returns for our shareholders. Thanks, again, for joining us today.

And now we'd be happy to respond to any of your questions. Operator?

(Operator Instructions) We will take our first question from Collyn Gilbert with KBW.

Just to start on the loan growth discussion, so as you had indicated, obviously, the -- this -- the composition this quarter was really strong away from CRE. Can you just give us a little bit of color how you see that sort of evolving as we move into next year? And if you think that C&I growth that you've been putting up is sustainable?

I'll take that, Collyn. Sure, I think directionally, certainly a focus of the company has been to reduce our CRE exposure over time. That doesn't mean we're not a CRE player. We will continue to originate loans in the CRE categories, including construction. But we've been building over time, and we've been telegraphing over time an increased capacity and capability to deliver higher balances in our non-CRE buckets. And I think we saw very good evidence of that pretty much last quarter and this quarter, and I think that trend will continue into the future.

And I'll just add. It's only been a month so far in this quarter, but our pipeline has the same trends away from CRE.

Okay. And in the less than 10% loan growth targets that you're now kind of thinking about for '19, how are you seeing maybe pay downs playing into that growth rate?

To me, that's the big wildcard as to whether or not we get to 10% or it's over 10%, it's really going to -- the one thing we can't judge or predict rather with a lot of certainty is the pay downs. Our pipeline remains fairly consistent and strong, but the pay downs are difficult to assess over time.

Okay, that's helpful. And then, Bill, just a little bit on the deposit side. So obviously, betas improved this quarter, but your thought is that maybe we don't see that same kind of improvement in the fourth quarter. Can you just talk about where you're seeing the incremental deposit growth? And what the rates are that you're paying? And then how you see sort of the deposit growth migrating in '19?

Well, the -- yes, the rates have been going up a little bit faster this quarter than the prior quarter, so I would expect the beta to increase a little bit. The overall cost of funds is always dependent upon the growth in noninterest-bearing demand. I saw in your report that you reported the deposits were down, that was point-to-point. On an average basis, we have a significant increase. So there's a lot of moving parts. It's hard to predict. We had a good quarter, but I'm just being a little conservative here in saying there's going to be continued pricing pressure on the deposit side.

Okay. And just in terms of what your -- maybe the -- what was the blended rate on the new CDs that you added this quarter?

3%?

2%.

2% to -- it's -- I don't know the exact answer to that, but it's a 2% to 3%, depending on what term is set.

Okay. And your -- I'm sorry, your -- the loan origination yields are running at what level?

Well, we continue to book loans. Each quarter, the loan origination is increasing. And this quarter, it was in the 5s. So up 25 basis points from the prior quarter in terms of the loans going into the portfolio.

Okay. And then -- so the goal will still be to try to have deposit growth match loan growth, it sounds like.

You mean in terms of pricing?

Well, no sorry, going back to the growth dynamic.

Yes. I -- yes, absolutely.

Right. Like, [if we still] loan-to-deposit ratio kind of within the [3%] range. Like, we're not going to -- okay.

Yes, our goal and -- we've been able to keep it in that low, 1.10% to 1.12% range.

Okay. And then just finally, obviously, the comments on capital are appreciated and indicating that maybe 2019 brings an opportunity to do either buyback or dividend. Any thoughts to accelerate the plans and do something in '18 or in like the next week or 2, given the market?

Have you been watching the market?

I haven't. I don't know what's going on, Frank. No.

Yes, exactly. Certainly, it's something we've been speaking about since last quarter, mostly because for the first time in ConnectOne's history, we're accreting capital in excess of our growth rate. But yes, I think those conversations may accelerate in light of recent events. It's definitely a hot topic at our board level.

Okay. Do you have a current authorizations outstanding? I should know this, but share authorization, repurchase authorization.

No, we don't.

(Operator Instructions) Our next question will come from Austin Nicholas with Stephens.

Maybe on the deposit growth, it was great to see the pretty strong deposit growth on a point-to-point basis overall. Can you maybe talk about what drove that deposit strength there? And maybe to what extent there's some seasonality within those numbers?

I think it's focus on our commercial clients and focusing on getting more deposits from that group, and that's really where -- we're not really a big retail bank, so most of our growth is coming on the commercial side.

Yes, actually the mix changed a bit in this quarter. It was actually a little bit perceptible as to the percentage of deposits that are coming from our retail operation versus those that are coming from the commercial operation.

Understood, that's helpful. And then maybe -- I appreciate the message on capital as you look out to '19. I guess as it pertains to M&A, with Greater Hudson closing in early '19, can you maybe give us a sense of what the message is on M&A as it kind of pertains to your priorities and the -- in terms of uses of capital?

I mean, I think we've always telegraphed that we would be opportunistic in the marketplace. I think we do have a strong capital base. I think we are an attractive franchise, and I think there will continue to be opportunities within the market that we're interested in for M&A, both upstream and downstream. So I think we're very well positioned for other opportunistic transactions that we may be looking at.

Right. And we're always going to be financially disciplined with regard to M&A. And we -- although growth is slower than it was, we don't feel a need that we have to do a deal.

Got it, okay. And then maybe just on the tax rate guidance that you gave for '19. I guess as you look out farther, is there -- should that start to step back down based upon some of the provisions within the bill, the New Jersey state tax bill?

That's a great question. Sure, as the surtax goes down, one would expect the overall rate to go down. But I don't want to project out further because it depends on what my effective federal tax rate is going to be. So for now, just sticking with the 26% for next year.

So thank you, everyone, for joining us on the third quarter earnings call. We appreciate your interest, and we look forward to speaking with you again on our year-end conference call in early 2019. Thank you.