ConnectOne Bancorp Inc (CNOB) 2022 Q1 法說會逐字稿

Greetings, and welcome to ConnectOne Bancorp, Inc. First Quarter 2022 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Ms. Siya Vansia, Vice President of Marketing. Thank you, and over to you.

Good morning, and welcome to today's conference call to review ConnectOne's results for the first quarter of 2022 and to update you on recent developments. On today's conference call will be Frank Sorrentino, Chairman and Chief Executive Officer; and Bill Burns, Senior Executive Vice President and Chief Financial Officer. These 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 that 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 only made 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 today on Form 8-K with the SEC 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.

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

Thank you, Siya, and good morning, everyone. We appreciate you joining us today. We're very pleased to report another strong quarter delivering solid financial performance, significant organic balance sheet growth and strong performance metrics here at ConnectOne. While Bill will discuss our financial highlights in some more detail, I'd like to highlight that our PPNR as a percentage of assets, again, exceeded 2% for the seventh consecutive quarter.

Return on assets was again above 1.5%, and our return on tangible equity was greater than 15%, all while our efficiency ratio remained below 40%. Our tangible book value per share was up again this quarter, increasing by 2% since the beginning of the year, and that's in an interest rate environment where others have experienced significant dilution from reduction in fair value of their securities portfolios. However, these once again, impressive financial results really don't tell the whole story of what we're building here at ConnectOne.

So first, we continue to invest in and strengthen our origination franchise, sorry. By leveraging our strong franchise and client-centric culture, we're gaining new clients as well as hiring experienced bankers from revenue generators to tech talent. We are a destination of choice for some of the best business generating talent in the industry, and a lot of that is stemming from the marketplace disruption created by M&A.

We've also taken proactive measures to retain our top talent with attractive compensation packages. So as we sit here today, we clearly see those efforts have enhanced an already solid team and are paying dividends with yet another quarter of annualized sequential growth in loans, exceeding 10% and nearly 15% growth in deposits.

Secondly, our pipeline remains near historic levels with strong demand and favorable pricing characteristics across all business lines in our markets. An important part of this success is attributable to expanding our presence and proactively following our clients into new and growing markets. As you know, we recently hired a great team to lead our Florida office.

And already at this early stage, we're seeing very promising results. Traction is exceeding our initial expectations. And the factors that made it successful in the New York metropolitan area translate very well to the growing Florida market, and our culture with a client-based focus is a clear differentiator.

We've already originated approximately $150 million in new commercial loans, some from our existing ConnectOne clients with business opportunities in Florida and some from new clients based in Florida. Deal structures and opportunities are both favorable and in line with the lending to which we have extensive experience and expertise. So with that, let's move on to some other initiatives ConnectOne has been focused on.

We're continuing to successfully adopt and expand our utilization of technology to remain competitive to create efficiencies and to provide real-time solutions. This includes improvements to internal workflows to support our hybrid work environment and support scale, along with our investments to enhance our data infrastructure, including digital initiatives that also enhance risk management tools and processes.

Look over at BoeFly. Even as the number of our franchisor brands on that platform increase, we're turning our efforts towards automated underwriting to improve functionality for the franchisor and franchisee and ultimately increase the profitability of the core business line. These continued investments ultimately allow BoeFly to build for scale. We're continuing to -- we're continuously improving the client experience while also achieving greater efficiency and revenue generation to that platform.

We're also creating additional opportunities beyond the SBA vertical with the loyal client base that BoeFly has built. Shifting gears, as you may have seen, ConnectOne became an early member bank in the USDF Consortium, which is an association of U.S. banks with a mission to build a network to further the adoption of USDF which is a tokenized deposit. This is an early step in employing blockchain within the regulatory perimeter in order to offer enhanced solutions for our commercial banking clients. We're also happy to announce that we recently signed an agreement with Nymbus, a leading fintech company to provide cloud-based banking and core services.

Working in partnership with Nymbus, we'll be building a niche-focused offering, providing us a new avenue to collect deposits. We're set to kick this project off in the near future, and we'll share more details as we progress. Supporting our industry-leading efficiency ratio is our ability to leverage technology and streamline internal processes. A great example of this, you've heard me discuss before, is our partnership with nCino, which has been instrumental in this regard.

We partnered with nCino in 2017 when our total asset size was just $4 billion to help deploy a single cloud-based platform throughout the organization and business lines. And today, we've more than doubled in size and yet we've been able to create efficiencies as we continue to build scale. So we look forward to sharing our progress in the quarters ahead. In summary, this has been an exciting time at ConnectOne.

We're well positioned, our capital position remains strong and we continue to internally generate capital to support growth. As you saw in our press release this morning, the Board of Directors today announced another increase to our common dividend, an increase of nearly 20%. Also, we continue to be opportunistic with share repurchases, having about $2 million in authorized capacity at the present time.

So with that, I'll turn it over to Bill to give us a little more depth and some color on our results.

Okay. Thank you, Frank. Good morning, everyone. So there continues to be a tremendous amount of excitement and optimism here at ConnectOne. Frank just mentioned, we've been focusing our resources on accelerating organic growth. At the same time, we're embracing technology and making investments in progress on several fronts. But even with that increased investment and the associated additional expense, we continue to produce superior financial metrics with stability across the board.

The PPNR as a percent of average assets actually exceeded 2.15% for the fourth consecutive quarter. Our return on tangible common equity again exceeded 15% and that was without the benefit of any reserve releases. Our efficiency ratio for the quarter was 38.7%, and that's improved from just slightly above 40% in the prior year first quarter. Our net interest income contracted by just 4 basis points but remained above 3.70 near historic highs for ConnectOne.

And tangible book value per share increased by 2%. The fact that our tangible book value increased while most of the industry saw decreases was due to a disciplined approach to securities investments during the low rate environment of the pandemic. We chose to stay out of the market and let securities run down. Combined with that, we were effective at hedging most of the existing portfolio. And really behind all of this is the strong organic loan growth we maintained at good spreads, which enabled the investment discipline and hedging strategies I just mentioned.

I just want to make one more point here. All of our securities are in the available-for-sale category. So complete transparency there. There's no hiding in the fair value adjustment. So all in all, ConnectOne is faring quite well in a rising rate environment. The NIM remains high, and we continue to grow per share book value. Now let me turn to the income statement and give you guys some color.

Net interest income was flat sequentially. That I expected but was up a significant 15% from the first quarter of last year. Average loans for the quarter grew by 10% from the year ago quarter. And combined with that, the margin expanded by 15 basis points over the past year. In terms of the net interest margin, just to repeat, our margin has been expanding throughout the pandemic and today remains at or near historic highs, and we continue to originate loans at favorable rates and spreads on the asset side are improving in my view.

Loan origination for the quarter was an average weighted rate of about 3.8%. But based on our pipeline, indications are for origination yields to be above 4% for the second quarter, could be as high as 4.5%. Our dynamic modeling continues to show asset sensitivity. And although I expect the margin to remain relatively flat for the remaining 9 months of the year, I just want to remain cautious with respect to any guidance as we are seeing competition for deposits heating up.

Now let me turn to noninterest income. This line item came in lighter than I expected and the Street expected. But most of that was due to a valuation charge against the CRA fund that we hold. So excluding that valuation charge because of the rise in interest rates, we were about $300,000 to $400,000 below expectations. But BoeFly had a good quarter. They recorded fees in excess of $400,000. The franchisers utilizing this platform have increased significantly over the past few quarters. So I can't promise exactly what that will translate into, but the trend is clearly positive.

Gains on sales loans were down. Some of that was residential and some of the decline was commercial. And I've mentioned this before that there will be some volatility and gains on sale numbers. But my expectation for the rest of '22 is for that number to increase from the first quarter levels. And just one last item, and there's going to be some additional BOLI this quarter. So we're going to probably add about $200,000 per quarter going forward.

Turning to expenses. We grew 4% sequentially. As I did indicate in the last call, most of that increase is on the comp line, that reflects new hires, salary increases, wage inflation, and the assertive stance we've been taking to both add to and retain our team. A couple of other items I want to mention. These 2 things, special items essentially offset 1 another. There was an additional earn-out charge for the BoeFly acquisition. And that was offset by a favorable lease termination. That was something we had written off at a higher level as a merger charge in the Bank of New Jersey deal.

In terms of any additional future BoeFly charges, we've still got a little to go later this year, but it's under $1 million, and that would be the last of any expense associated with the BoeFly earnout. Also wanted to make you aware that we reorganized the OpEx section of the financials. So we have now one line item that now essentially is technology expense. I think that will be helpful and add some transparency going forward.

I want to add our operations and tech teams have done a great job of strategic spending on technology, but they also reduced the cost of core and legacy systems. Going forward, I think some of the same trends will continue, quarterly sequential growth in expenses probably in the 2% range. I will give you guys an update on that after the second quarter.

I just want to talk a little bit about CECL provisioning. Many banks released reserves in the quarter, while others added modest amounts. We were in that latter category, adding a small amount of reserves, $1.5 million. The reserving first reflected loan growth but it also reflected that we made some minor qualitative adjustments to our CECL model, and that reflects an expectation that economic forecast could trend in a negative direction.

Keep in mind, these are macro forecasts. It is not an indication at all of credit quality here at ConnectOne. Our nonaccrual assets have declined for the second straight quarter, while delinquencies and charge-offs remain very, very low. Before turning back to Frank, I want to add a couple of things. Look, we're very optimistic about performance in 2022. Strong loan growth is anticipated and marginal pressure is likely to be moderate.

We're building noninterest income at BoeFly and through SBA and CRE loan sales. Expenses do continue to grow to support our growing businesses and the investments that Frank's been highlighting. But as always, we aim to grow revenues faster than expenses. And I'll just wrap up with a final few comments. Given the strength of our earnings and capital position, we have a great deal of financial flexibility. First, we have the capital to support double-digit organic growth. Along with that, there's still room for continued dividend increases and share repurchases. And as always, although our strength is organic growth, we continue to opportunistically explore growth through M&A.

As you know, deals are hard to come by, but we have a track record of being financially disciplined, and we're going to stick to that. And with that, I'll turn it back to Frank.

Thank you, Bill. In closing, ConnectOne delivered strong performance for this first quarter. And more importantly, we expanded our market presence and we continue to invest in top talent to support our clients as they expand in capability and in reach. We also launched several initiatives to extend the technological foundation we've built while also exploring new opportunities as we participate in shaping the future of Commercial Banking. As we move through the rest of 2022, I'd like to reiterate that we're projecting strong organically driven growth, which will be supported by the investments we've made in our talent and our technology infrastructure, and we expect our financial performance to remain among the best in the industry. We're excited about our future, and we look forward to updating you in the quarters ahead. And with that, I'd be happy to take your questions.

(Operator Instructions) The first question comes from the line of Matt Breese with Stephens.

Bill, I want to go back to your comments on new loan yields being at 4%, 4.5% range. Are we essentially nearing the point of it being positive to the core portfolio? And then maybe along the same lines, could you just give us some color on commercial real estate, multifamily spreads. I've been hearing that there had been some spread compression through March, but it sounds like it's starting to reverse.

Yes. True to all of that. We are seeing the point where the loan yields are adding to our portfolio. So that obviously helps us as rates are rising. And then yes, spreads were very tight on multifamily. We're seeing some relief there. And so even on that and the expectation is for higher yields. As you know, multifamily is typically lower spreads for the rest of the business. And depending on the mix of originations and what -- in terms of loan growth that can affect the total yield on our portfolio.

Okay. And then the other thing is, one thing that stands out is despite on paper, the balance sheet being relatively interest rate neutral, the loan-to-deposit ratio is on the fuller side. So could you talk to me about the incremental funding sources and the ability to protect and maintain just an overall lower cost of funds? And maybe along those lines, what are expectations for betas through the first 100 or 200 hikes?

No, good question, a lot to the question there. It's a little bit of a moving target. Right now, deposit rates are -- we're starting to feel pressure. However, even those higher deposit rates are lower right now than our wholesale cost of funds. So I typically use a very conservative approach when I look and analyze spreads using our highest wholesale cost of funds to calculate spreads. That's usually the Federal Home Loan Bank but we're picking up spread in that we can use deposits to fund more of the growth right now.

I think that will work itself out and we'll get back to a normal place. But I hope I answered your question, but it's like kind of a mix right now. Deposit rates are going up, but they're actually helping to add to the spreads.

Got it. I mean maybe going down a different path, but getting to the same outcome. If we do get a plus 200 basis points of Fed hikes by the end of the year, could you provide some longer-term core net interest income guidance by the end of this year? I'm assuming the outlook is NIM flat, but what is NII going to actually do?

Yes. No, our models are showing like a 2% to 3% increase with a 200 basis point rate shock.

Got it. Okay. And then...

There's different ways people look. I think we've had this discussion before offline. Banks look at it differently, some do static, some do dynamic. It's hard to compare apples-to-apples. But I just feel comfortable that we're going to be able to maintain our margins one way or the other through this.

And that -- and since we never -- our margin never got compressed; in fact, it widened over the last year. So I just feel comfortable that we're going to have stable margins and stable returns in the coming year.

Understood. Frank, you had mentioned Nymbus as a third party that you were using. Their suite of products and services is pretty robust and includes core systems. Have you taken it that far and considered using them as a core system provider? And what do they offer versus the traditional big 3 on that regard?

I think that Nymbus offers us an opportunity to custom design a vertical for a new line of business potentially where we will use their core, and we will use their ability to really with laser focus, identify what a particular client niche needs and how to attack that particular vertical. And the purpose here is certainly for deposit gathering but there'll be some lending opportunities there, too.

And I don't think that any of our existing capabilities can do what we anticipate doing together with Nymbus. So I'm pretty confident that it's going to allow us to be very, very hyper focused in a particular client vertical.

Over time, I mean, I forget who you use right now as a core provider. But over time, do you anticipate fully moving to Nymbus in that regard?

It's hard to say, Matt, I think you realize the entire world of the core is moving around pretty dramatically. It used to be pretty easy to take the top 3 and use them as punching bags. I don't think you can do that today. I think even companies like FIS and Fiserv and others, Jack Henry are being pretty progressive about how they're thinking about the future. What I do think I see is, in the past, it was -- you had to identify a core and you ran everything on your bank in concert with 1 basic operating system.

Today, it's just not that way. And it started when -- once APIs came out, you could now start with actual different products and services to whatever core you have. But now it's not uncommon for banks to run multiple cores. And so I think that's what we're going to see going forward.

Interesting. Okay. Excited to see where you go with this. That's all I had.

(Operator Instructions) Next question comes from the line of Michael Perito with KBW.

I wanted to start on BoeFly. Bill, you mentioned that it had a nice quarter. I was wondering if you guys could maybe just give us an update on kind of the product road map there on that platform. I think when we had had some conversations in the past, there was discussions about adding some new layers to that and maybe even some other fee income opportunities like interchange or cards or deposits or things of that nature. Just curious where you guys are in that thought process? And maybe just a broader comment overall about how we think the fee income growth could trend in that -- for that business specifically over the balance of this year.

I would start and maybe Bill can add some color. But I would say that what we're doing with BoeFly today is thinking about the entire client journey that enters through the BoeFly platform and where they ultimately want to go and how we can support the needs that they have and do it in either a frictionless or a lot less friction than exists today on the platform.

So the first thing we're looking at is what does the core platform to do, which is to supply an opportunity for a franchisee applicant to obtain financing. And how do we do that in the most cost-efficient and highest revenue-producing way for us. And I think we're doing that today. We're actually building out the entire loan pipeline from beginning to end for anyone that enters the BoeFly platform. But that's the core business. I think as you mentioned before, there are lots of other things we can do there.

There are a number of opportunities that don't necessarily need to go through the SBA program, which is where BoeFly really cut its teeth. There are repeat clients who come back to BoeFly for additional funding opportunities where they didn't have product before. And now we're building that capability to be able to fund that second, third, fourth request, which would definitely not go through the SBA. There's opportunities on the franchisor side. And then when you think about BoeFly having a loyal client, of course, we can start to think about all the other products and services that a financial company would want to provide the first -- or the next most logical being all the payments capabilities. So that's what's on our sort of near or long-term radar. But the first part is really getting this whole loan product set really done in an automated way, in a way that the client really feels almost no friction where we pretty much eliminate most of the competition that's out there for that type of business.

And do you have any sense of the timing of all that being rolled out and launched? And I mean, obviously, you don't have to be too specific, but just can you give us some general indication of where you guys feel like those things are in the varying stages of rollout or exploration?

Well, all the lending product discussion that I just had is all being done this year, and we're actually piloting right now some of the complete loan product. We're working with technology vendors to complete that whole process. So within this year, we're going to see -- or we'll be able to discuss exactly how that entire loan pipeline works for all the products that we supply at BoeFly.

Simultaneous to that, we're working on some of the other products. I would say by year-end, we'll have better discovery around what those things will be, what they'll look like and what we'll be working on next. But we really want to get this entire loan pipeline under wraps and working well and be able to demonstrate to the marketplace what's coming through there, what the pull-through rate is, what the profitability of that line of business is and what it looks like. And I fully expect before year-end, we will have those discussions.

But Mike, this is Bill. I just wanted to add that behind it all, the volumes through BoeFly are increasing. And I think when we bought them, they were -- they had 30 franchisors in the market. I think last time we spoke with you a few months ago, it was 80 or 90. We're well over 100 now. So that's the key towards the traditional income at BoeFly, which is getting a referral fee for another bank to place the loan. The other things we're talking about are just going to be additive to that, which includes franchisees that are a little bit bigger, some business with franchisors and potentially doing the entire underwriting process at ConnectOne, which right now we -- for the most part, we don't do that. I hope that's helpful.

It is. And we often -- you guys often talk about your profitability. And obviously, it's top quartile, very strong, and I think investors sometimes wonder like what could make it improve. Is it fair to say that BoeFly could be an area of possible improvement? I mean it sounds like you guys are investing pretty heavily today. I don't know if you guys break out or are willing to break out kind of what the return metrics of that platform look like. But is it fair to say that it's probably from a net bottom line standpoint, not contributing as much as it could in future periods as some of these initiatives take hold that you're investing in today?

I think it will be significant in the future. Right now, there's a lot of revenues, but we're also building platform. So we're probably at a breakeven, even though that's $400,000 this quarter of revenue.

Great. And then just one last one for me. Just on the loan growth side, the pipeline commentary is strong. I imagine you guys feel pretty confident on the line of sight for the next quarter or 2. As we move beyond that, obviously, the economic outlook becomes a little bit more subject to opinion and challenging to pin down. I'm just curious how you guys are feeling overall about loan growth opportunities in your markets longer term? And any maybe kind of qualitative feedback you're getting from commercial customers that might be helpful around their -- whether it's their outlook or their positive outlook or their concerns or just anything of that nature would be great.

I think it's a tale of 2 stories. We're certainly seeing things, I don't want to say slow down, but people are being a little bit more thoughtful about whether they're entertaining a construction project or buying commercial property or starting a business or buying a business.

There's talk in the news about a possible recession and so people certainly are being more thoughtful. But that -- we also have to -- and look, my own personal belief is with the amount of money that's in the economy today, the health of the consumer today, how much liquidity still exists both on business balance sheets and personal balance sheets, I think the risk of an outright recession is low. I think we are going to have a reset. I think we are going to slow down the inflation rate. I think we are going to see a higher interest rate environment, which is going to force people to make different financial decisions.

But the backdrop to that is that the markets in which we're in, all of them are seeing tremendous M&A going on. And so there's an enormous amount of disruption. And so we're picking up some great talent today which is going to offset any bit of that slowdown because we're going to organically grow new business from new sources. And to me, it feels like could be one of the best times you've ever been in relative to our ability to grow.

I think we're in some of the best markets in the country. We're in New York, New Jersey, the entire New York metropolitan area and Florida. So I think there's -- and every one of those markets is being affected by what I said before about the M&A. So I feel pretty good about overcoming the slowdown that's just naturally happening in the economy and taking a bigger piece of the pie.

Ladies and gentlemen, we have reached the end of question-and-answer session. And I would like to turn the call back to the management for closing remarks.

Well, thank you, everyone, for joining us today for our first quarter report. We certainly look forward to coming back to you in future quarters and speaking about our results as we move through 2022. So again, thank you.

Thank you. This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.