ConnectOne Bancorp Inc (CNOBP) 2017 Q3 法說會逐字稿

Good day, and welcome to the ConnectOne Bancorp, Inc. Third Quarter 2017 Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Mr. Joe Calabrese with the Financial Relations Board. Please go ahead, sir.

Thanks, David. Good morning, and welcome to today's conference call to review ConnectOne's results for the third quarter of 2017 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 the accessibility of this conference call on a listen-only basis over the Internet, was 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 disclosed 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 and schedules which have been filed on Form 8-K with the SEC on October 26, 2017, 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, Joe, and good morning, everyone. Welcome to our third quarter 2017 earnings call. During the call, I'll outline some of the highlights of our operating performance, and Bill will take us through some of the numbers in a little bit more detail. We'll then turn the call over for any Q&A.

This quarter produced very solid operating and financial results, highlighting our consistent execution against key operating objectives and continued ability to capitalize on opportunities in serving our growing client base.

For the quarter, ConnectOne earned net income of $13.1 million, or $0.41 per share, which on its own is impressive. However, excluding taxi, we earned $0.46 per share, up 10% sequentially from $0.42 last quarter and up 15% from the year-ago quarter on an operating basis.

Our operating results were very strong by any measure, with return on tangible equity surpassing 14% and return on assets of 1.25%. Importantly, our third quarter and year-to-date results reflect our continued success in executing against key objectives, which include maintaining strong organic loan and deposit growth, delivering accelerated and sustained earnings growth, improving return on equity and building and refining our infrastructure.

As for the deposit growth, as we've talked about before, a principal focus of this company is to further -- is further developing our ability to accelerate core deposit growth so that it is commensurate with ConnectOne's strong loan growth. We achieved that this quarter, with total core deposits increasing by 17.5% on an annualized basis. We've extended our competitive position gaining market share and achieved strong progress in our deposit growth in part through operational excellence and our strategy of high-quality client service as well as our competitive rate structures.

At ConnectOne, we set ourselves apart by making it easier for our clients to do business with us, providing the right level of interaction with the client and the banker. We are relentlessly focused on providing quality service, great convenience, simplicity and access.

We're also expanding our New York footprint, with a planned opening of an additional office center in Melville, Long Island, which continues to move the center of our organization further east.

Two years ago, we opened our first office in Midtown Manhattan. And now New York represents a growing portion of our balance sheet. Our expansion to Long Island is a natural extension of our in-market focus, and we continue to see opportunities in those markets that mirror our New Jersey presence.

As discussed last quarter, we have bolstered our team with cash management specialists, whose deep experience will create additional opportunities for deposit gathering at ConnectOne. The opportunity to expand into Long Island will support this focus.

Looking ahead to the remainder of 2017 and into 2018, we believe ConnectOne is positioned to achieve continued deposit growth by increasing our commercial loan portfolio, by expansion into new markets, becoming devoid of like-minded companies, by enhancing our cash management service capabilities, by expanding our municipal and private school relationships and by utilization of our modern branch model, which allows our staff to focus on sales.

During the quarter, we also continued to build momentum in loan originations and loan growth. Our loans receivable of $3.9 billion at September 30 reflected loan growth of approximately $130 million, and loan growth year-to-date is more than $400 million or 16% on an annualized basis.

Our third quarter loan growth was consistent with historical levels and reflect strong performance in both the CRE and non-CRE segments. Consistent with the ongoing potential of our strategic focus, growth by non-CRE loans increased at an annualized pace of 21.7%. In terms of our CRE lending, our multifamily segment exhibited a large increase, as we were able to take advantage of increasing rates and capitalize on the lack of client service by competitors to onboard some new relationships.

Due to that substantial growth, we earmarked approximately $40 million of non-relationship multifamily loans to be sold in order to maintain diversified portfolio growth and generate some additional income.

Meanwhile, consistent with our disciplined approach, our construction book paid down slightly during the quarter as expected, as projects were successfully completed. Our construction pipeline remains solid and strong with new projects, which we expect to be funded in the near future.

We also continue to make progress in increasing our residential loans held in portfolio for our selected business clients. Looking ahead, the expectation over the coming quarters is for loan growth to remain at historical low- to mid-teen levels, which will reduce higher pressure on our loan-to-deposit ratio.

Beyond the financial performance, as a technology forward bank, we continue to invest in tools that help us to improve our processes and create additional operating leverage while also allowing us to better serve and broaden our relationships with our clients.

By leveraging our platform, we're continuing to support our best-in-class efficiency metrics and at the same time enhancing our excellent reputation for sense of urgency with those clients.

Our previously mentioned nCino implementation is going well, which provides ConnectOne with one of the most efficient and streamlined deposit and loan operating systems in the industry. By investing in continual process improvement in all areas of the bank, we're continuing to position the company for the future. However, I think it's important to note, we do not see these initiatives as cost-cutting but rather as a strategy to run a highly efficient model that reduces friction and pain points with our clients.

In summary, we're diligently building an increasingly stronger company, and that strength is reflected in our year-to-date operating results. We are well positioned to take advantage of the market disruption resulting from the recent M&A wave. This disruption continues to provide an enormous pipeline of potential clients as well as a steady stream of highly qualified team members who feel that dislocation.

We are creating value for our shareholders by approaching our stated objective of earning sufficient capital to self-fund our growth. As we move towards the end of the year and into 2018, we continue to manage the company carefully, balancing our growth, expenses and investments and maintaining a strong balance sheet and continually innovating to ensure the future growth.

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

Thank you, Frank. So as Frank just mentioned, we had another great quarter by all measures, reflecting the continued strength of our operating model. On an operating basis, which excludes taxi, we earned $0.46 for the quarter, up about 10% sequentially, and that's a couple of pennies ahead of where the Street was expecting us on an operating basis.

Return on tangible common equity nearly hit our 15% objective, reaching 14.5%, and operating return on assets was 1.25%, that's among the very best in our peer group.

Tangible book value per share increased another $0.36 this quarter and $0.82 for the first 9 months to $12.78, that's despite all the reserves we've taken. And our efficiency ratio improved to below 40% for the first time. And although we may be above or below that 40% threshold for the near future, the objective down the road is to remain below 40%.

So how did we accomplish this, this quarter? First and foremost, it was through strong organic balance sheet growth. Average interest-earning assets, primarily loans and deposits, both increased 5% sequentially. Meanwhile, the net interest margin was essentially flat, compression of just 1 basis point.

On the positive side regarding the NIM, our loans are being originated at rates slightly higher than they are maturing or prepaying. There's couple of drivers to these rising loan yields. One is, we're continuing to get better spreads today than we did earlier this and last year when competitive pricing was very aggressive. And secondly, our focus has been on C&I, where we're getting really good rates and fees above 5% total return, with spreads pushing 4% or higher.

Offsetting the loan yield increases, we're experiencing a good deal of rate competition for deposits. And like most banks, we've been forced recently to raise rates at the retail level for short and protected deposits we have and to gather more deposits and same (inaudible) holds for some select business deposits.

Meanwhile, we're continuing to show progress in attracting and retaining noninterest-bearing demand balances and that offset some of the pressure from higher deposit rates. Naturally, we're going to try to focus on building noninterest-bearing demand.

Now on to our securities portfolio, where volumes were flat over the last quarter. However, I do see securities purchases in the fourth quarter as investment rates have become a little more attractive. We had been on the sidelines temporarily.

Our investment focus will continue to be on government-backed mortgage-related securities, with the yields of approximately 3%. The tax-adjusted yield on the portfolio fell this quarter to 3.03% from 3.16%, and that was due to increased prepayment activity. This could continue into the fourth quarter, then most likely stabilize.

Going forward, I'm projecting, naturally, continued increases in net interest income, and that's going to be driven by loan growth, with the margin being flat to slightly down, especially in a flattening yield curve environment. And the net interest margin, I think, you all know, was hard to predict precisely. It is impacted by loan mix, our success in raising low-cost relationship deposits as well as competitive forces, which we can't always control.

On the expense side, we continue to have one of the most efficient banking models, with about 50% less branches than a typical bank our size. So when you combine that with the management team and staff that focuses on technology and cost control, we're able to generate best-in-class efficiency metrics.

And expense growth has been quite contained, especially recently. Our expense base has been flat the past 2 quarters, and that's one of the driving forces behind earnings momentum. So efficiency drives returns, obviously, but, in my opinion, there's an indirect benefit here, and that's it positions us to be less pressured to take undue credit risk or interest rate risk to drive earnings.

And notwithstanding all these remarks, I do expect expenses to start increasing at a rate in the high single digits annualized for the next couple of quarters. We have recently added the staff, especially around our deposit generation initiatives as well as in the back office.

And let me touch on taxi a little bit for this quarter. We did take a $3 million charge, and that brings our valuation for medallion down to $348,000 per medallion.

Meanwhile, we've had considerable success in renegotiating payment terms with several taxi medallion owners, and the portfolio continues to cash flow well. And as such, we are considering returning these loans back to the held for investment portfolio, although no decision has been made at the current time.

Outside of the taxi portfolio, credit quality remained excellent. We had 0 charge-offs in the third quarter and nonaccrual loans declined.

And let me turn to CRE concentration. While we remain a disciplined and established commercial real estate lender, our goal is to reduce our regulatory-defined CRE concentration metrics.

Ideally, we'd like to see our ratio, now at about 540% after the loan sale, drop to below 500% over time, and we believe there are a few ways we can achieve this. The best way is to continue to build on our momentum coming from our C&I team. There's attractive loan rates combined with deposit generation potential, and this makes this a very attractive business on a risk-adjusted ROE basis. But in addition, we plan to continue to sell non-relationship CRE. We have $40 million in held-for-sale portfolio right now and expect some more of this going forward. And secondly, given the current favorable pricing in the sub-debt markets in the low-interest rate environment, we could do another issuance of sub-debt. And that issuance would serve to reduce our concentration by anywhere from 25 to 50 percentage points. And the cost, I think, would be minimal, probably $0.02 or so of EPS per year.

And with that, I will turn the call back over to Frank. Frank?

Thank you very much, Bill. Before turning the conference call over to your questions, I'd like to take a moment just to review our strategic priorities and outlook for the remainder of 2017 and into 2018.

ConnectOne's management team continues to believe the overall environment provides significant opportunity to increase size and scale in a disciplined fashion.

Our continuing momentum has provided enhanced earnings, building of book value and, in turn, better value for our shareholders. As we said last quarter, ConnectOne's strategic position provides a very strong competitive advantage to deliver on our near-term priorities by expanding the reach of our organization into New York and attracting new bankers and expanding our product offerings, by focusing on strong deposit growth in the commercial market, by maintaining a disciplined approach to our loan growth, by continued focus on personalized service vacated by the largest institutions and by banks leaving our market due to consolidation and by building the company with the operational excellence that creates scarcity value in the marketplace.

We're moving ahead with a very solid capital foundation, and we remain on track to achieve our objectives to further strengthen our balance sheet, grow profits and book value per share for the full year.

Looking ahead, our strategy remains consistent, and we're confident that ConnectOne's business model will deliver strong long-term shareholder returns.

I would also like to mention that the banking market continues to consolidate and potentially new tailwinds in the regulatory framework may be at our back. While our organic growth can sustain our plans, ConnectOne is creating an organization well suited to take advantage in the M&A environment either by combining with a well-suited partner or providing a near unique platform in the market we serve.

This concludes our prepared comments. We're now going to turn the call over to the operator and open it up to any questions you may have.

(Operator Instructions) And we'll take our first question from Collyn Gilbert with KBW.

Bill, just to go -- to clarify some of the comments you made. First on the expenses. So did you say that you expect expense growth to be in the high single digits annualized for the next few quarters? Is that what you said?

Yes, that's what I said.

Okay. All right. And then on the CRE plans. So I know you -- obviously, you've tagged the $40 million to sell in the fourth quarter. Do you have -- have you bracketed kind of a dollar amount of what you think you could sell going forward?

Not exactly. And I don't think we're going to necessarily do it every quarter, but probably a couple of times in the next year. We'll do another portfolio -- sorry, group of loans similar in size to what we did this quarter.

Okay. And is that -- the motivation of that, I mean, obviously, to get the level lower. But beyond that, is it just internally driven by you all or is it regulatory driven? Or what's pushing you to do this?

No, no. It's totally internally driven. It's -- and again, it's non-relationship, multifamily in this case, and so there are no deposits associated with it. And our origination franchise is so strong, it's just another way for us to earn more money with -- we will get some slight gains from signing these loans. And then it has the added benefit of reducing the CRE concentration.

Okay. Okay. That's helpful. And then on the taxi side, interestingly, you're considering putting it back to the loan -- into the loan book. And I know you had indicated that the performance of it is improving. But can you just talk a little bit more about that decision or how you are thinking about that?

Collyn, I'll take it first. But we're seeing lots of progress with some of the loans that we have today either in restructuring those transactions with existing borrowers or in the case where there is a default, moving that -- fairly easily moving that defaulted loan to a good operator under good terms for us and generating nice cash flows for us. And so we're seeing more and more of that happen over time. And so the natural conclusion is these are loans we may either need to keep or want to keep in our portfolio.

And I think I was wanting to add. At the same time, the institutional players we've been talking to are really not quite ready to buy portfolios. And so a combination of those 2 things is leading us towards looking at a higher probability of keeping the loans in portfolio.

Okay. And the intention is still to have that portfolio run down? Or are you originating new loans?

No, we're not originating new loans. And because the loans are nonaccrual, all payments apply to principal and the loans are cash flowing. We've talked about that before, 5% or 6% on the outstanding. So we continue to pay the loans down every quarter.

Okay. Okay. That's helpful. And then Frank, just you dig a little bit deeper in your comment on M&A, obviously, as you indicated, creating a model here that could be suited either way. If we think about targets, potential targets for you all, what would be the type of institution that you would be looking at? And do you see a change in the market in terms of potential available banks?

No. I'll start with the last part first. I think there is a change. I think there -- people -- other banks are realizing there is a great benefit to size, scale, technological efficiency. Efficiency is becoming the new buzzword in the entire industry. We've always believed in being a very efficient organization. I think there are other organizations out there that are having difficulties getting to the efficiencies that, I believe, are going to be required to generate the right capital creation over time. And so in some cases, it'll just be easier for people to partner up and take advantage of things we've already implemented here as opposed to reinventing the wheel. I think at the same time, though, we have to be realistic to the extent that we can have this organization that's very well suited relative to the geography be in right smack in the middle of the New York metro market. I think we are an attractive target to someone who wants to enter the space or will be as we continue to grow.

Okay. Do we read into the sort of rightsizing of the CRE portfolio, giving you kind of more flexibility should you acquire another CRE heavy lender? Or that's not -- those 2 things are not...

Sure. I think that's a...

Yes, I think that's a great comment. I think we are -- so look, we stated earlier in the year that we were going to focus on our deposit gathering, we were going to focus on the diversity in our loan portfolio. We said these were business objectives. We've accomplished those things. And we're continuing to work towards getting to a place where we're more comfortable. I think if we were to look at someone who was heavier in CRE, certainly, we'd be able to continue to work on whatever those issues were. So we -- I believe we have -- management has the focus to be able to parse what we think is appropriate. And I think that's another reason we make a good partner for a number of people.

(Operator Instructions) We'll take our next question from Matthew Breese with Piper Jaffray.

Just on the commercial real estate sale. What is the anticipated gain there?

Not a ton, but, say, about 0.5% to 1% in that range.

Okay. And then thinking about the margin, Bill, obviously, it held up pretty well this quarter. But if you look behind the hood, deposit costs were up a little bit more than loan yields were. And I just wanted to get a sense for which one of those trends is going to continue more so than the other. Are we going to see a pickup in loan yield depreciation or deposit cost increase is going to slow down? I just wanted to take apart those 2 items as we think about the margin guide.

First off, you're looking at the interest-bearing deposits. So right, we also need to look at the total cost of the deposits, including noninterest-bearing demand. So still seeing some pressure on rising rates, probably a little bit less now than it was a couple of months ago. And on the loan side, continued increase in the loan yields. It's really -- Matt, it's really hard to predict because there's so many factors. But there could be some contraction in the next quarter, but don't shoot me if we actually have expanding margins.

Got it. Got it. Okay. And then also, behind the scenes, you mentioned you've hired some folks particularly focused on deposit gathering. It sounds like loan growth and deposit growth will be more or less matched. Can you talk about some of the incentive structures and the folks that you did hire focused on that? And in terms of maybe the loan-to-deposit ratio, where we should be modeling that out to?

I'll take the incentive part of the question. It's not typical at ConnectOne Bank to have pretty much anybody here on an incentive program strictly dependent on their volume production. That's just not the way we've built the company. So yes, people get incentives, but it's generally -- it generally revolves around the success of the entire organization. And that's just been how we've created our compensation schedules and plans. I don't really love mercenary tactics where people tend to run their own businesses within the business. And so we want everyone rowing in the same direction.

And in terms of the trends in loan-to-deposit, we were a little below 110% this quarter, 108% or so. I'm hopeful we'll keep it at 108%, maybe a little bit lower, but I'd like to always see it at 110% or better.

Okay. And then last one's really just ticky-tacky. BOLI -- the BOLI income was up a little bit this quarter. Was there a death benefit or anything more on in that?

Yes, there was just one death -- there was one death benefit, yes. We did purchase some more BOLI at the end of the quarter. So there's going to be about $100,000 in income per quarter extra from the new BOLI we just purchased, and that would be recurring.

Okay. Okay. And then actually, on the growth side, you guys are still forecasting pretty robust growth. But as I think about some of the other commentary, especially in regards to the New York City transaction volumes being down, can you tie that into your growth commentary and then how you plan to offset such large headwinds with solid growth?

Matt, it's Bill. Even with a lowered or slower growth rate, there's still growth going on in the New York City market. We're just able to take a portion of that growth. It's a very, very small portion. And there's still very high demand for sense of urgency type of transactions. We just had this discussion last night with a group of clients that they're just -- the banks in the market are just getting bigger. And the client service levels just aren't there like they used to be. And so a bank like ConnectOne really spans out. Our name is getting out into the marketplace. We're becoming a known entity in that New York City market and the boroughs. And so we're -- again, if you look at it relative to the size of the loans that we're booking there, it's tiny relative to the entire market. So the whole market doesn't dictate whether or not we can increase or decrease our loan growth. We're finding great opportunities, and we continue to execute on our strategy of providing a very high level of client service, and that's generating increased loan production.

Got it. Okay. Great. And then, Bill, last one. Just the tax rate came in a hair lower than what I -- at least what I was thinking for the quarter. Is 30% what we should be figuring on for the next year.

No. It's -- on the operating basis, we are at 31.5%, but the taxi charges are taxed at a marginal rate of 40%. And so that's what causes the rate to be lower. But even with that 40% rate, we still, for the foreseeable future, meaning next year, I'm still going to comment at 31.5% on our operating basis.

And we'll take our next question from William Wallace with Raymond James.

Maybe just going to the CRE sales and then focus on getting that CRE concentration sub-500%, is there a time line in mind that you guys have that you'd like to get there?

Not really. It depends how things shake out in terms of building our C&I business as well as the -- a sub-debt transaction when we decide to pull the trigger on that would affect the timing of the CRA -- CRE concentration level.

Okay. Would a sub-debt raise and the raise that you're thinking, would it drop you below the 100% on the construction concentration?

Probably. And I think we're a little bit lower this quarter than we were last quarter already.

Should we be thinking about maybe staying below 100%? Or is that not necessarily something that you guys are focused on as it relates to the construction...

No one is forcing. You know what, nobody is forcing us to do anything in this regard. We just think it makes sense, especially with all the investor commentary around and concern about CRE concentrations to show a trend in the right direction lower. We think that's important. And it'll translate into more value for our shareholders.

Okay. On the -- on kind of interest rate positioning of the bank, I feel like, historically, you've always kind of classified the bank as being asset-sensitive. But it seems like maybe your -- you're more positioned now for kind of neutral. Is there -- how do you position your interest rate sensitivity?

Yes, it's a good point. We were overly asset-sensitive before, and we've reduced that somewhat. But we still remain asset-sensitive, and we'll benefit from rising rates.

So kind of all else equal, if we get a move in December, what impact do you think that would have to the core margins?

Just to move on the short end, we'd have a very slight benefit, not a negative impact, but a slight benefit. But of course, when we talk about interest sensitivity, it means the whole yield curve shifting out. I don't know if that's happening.

Yes. I mean, it's obviously -- so assuming a shift, what kind of benefit would you anticipate?

Like 100 basis point shift of the whole curve. 2% or so, about 2% in interest income. That will be out in our Q when we finish and review the analysis, yes.

Okay. But if it hasn't changed really from the last Q, is that fair?

Yes.

Okay. Frank, if you have remarks in your prepared commentary on M&A, I'm curious, as you think about ConnectOne as a partner of choice, what's the ideal candidate that you think would be somebody that you would be interested in acquiring, one of the characteristics?

Yes, again...

We're not naming names.

Yes, we're not naming names. So I think I've made it pretty clear over the last year or sometime that we are still very, very much focused in this New York metropolitan market. And there are a number of names there of companies that would allow us to continue to increase our scale. We'd be able to take advantage of our loan efficiency ratio where we think we could make a really terrific financial transaction that would increase our ability to have a bigger legal lending limit, so we can get in front of maybe even bigger clients than we have today. So capital would be an important part of it. And of course, ideally, we'd like for someone to have a really strong deposit franchise. But with the deposit gathering that we're getting today, we think we could also augment if that was not a top strength in another organization. So to me, I just think size matters in this environment. And as you look around us, there are a number of other either like-sized or somewhat smaller organizations that, I think, if you put those 2 organizations together, you wind up with a significantly better combined entity.

Okay. Last question. Frank, you've always been pretty close to what's going on in New York City around the TLC and Uber and other share-ride platforms. I'm curious if you just kind of update us on what you're seeing? Are there any changes coming out of TLC that could be beneficial to the medallions or vice versa?

It certainly appears that the pendulum is beginning to swing in the other direction. There's a lot of negative news today about TNC for a while, and it sounded like everything was going great on the TNC platform. That's no longer the case today. Certainly, there's been a tremendous amount of negativity around some of those companies, whether from internal issues or even just quality of service in the marketplace. It's not the new shiny thing anymore. The quality of the drivers has gone down dramatically. The quality of the cars have gone down dramatically. And just the quality of service, in general, has gone down. On the other side, taxi has done a decent job of bringing a better client experience. The TLC has been very active over the last, let's call it, 6 months or so and, certainly, there's a number of proposals on the table today that are all beneficial to taxi and taxi operators. As I predicted almost 2 years ago, there is a consolidation going on in the taxi industry, although small mom and pops are basically being consolidated with the bigger operators. And I think that will continue to occur. So we're in -- we're certainly in a state of transition, but I think it's going a little bit better than maybe what was being experienced 6 months or a year ago.

And there are no further questions at this time. I will turn the call to management.

So I want to thank everyone for joining us on our third quarter earnings call. We appreciate your interest and look forward to speaking to you again on our next call in early 2018. Thank you.

Thank you.

This does conclude today's program. Thank you for your participation, and you may disconnect at any time.