ConnectOne Bancorp Inc (CNOBP) 2017 Q4 法說會逐字稿

Good day, everyone, and welcome to the ConnectOne Bancorp Fourth Quarter 2017 Year-End Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Joe Calabrese with the Financial Relations Board. Please go ahead.

Thank you, Kim. Good morning, and welcome to today's conference call to review ConnectOne's results for the fourth 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 this conference call on a listen-only basis off 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 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 and schedules, which have been filed on Form 8-K with the SEC on January 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, Joe, and good morning, everyone, and thanks for participating in today's conference call. I'll read through some headline results, recapping another successful year for our business and will also provide some commentary regarding near-term operating objectives. Bill will review our financial performance in greater depth before we open the call for questions.

We delivered a very strong financial and operating performance for the fourth quarter and full year 2017, and we are very pleased with the groundwork we're laying for continued success of our business. We entered 2018 well positioned, driven by the diligent execution of key strategic objectives that we discussed on [private] calls. These include maintaining strong deposit and loan growth, delivering strong and sustainable earnings growth, improving return on equity, building our infrastructure, continued innovation and, of course, taking advantage of market opportunities. I'm also proud to announce that ConnectOne exceeded $5 billion in total assets at year-end 2017. This is a significant milestone for the company and provides further affirmation that ConnectOne's growth strategy and ability to capitalize on market opportunities has indeed been successful.

And as our return on tangible equity rises, we are increasingly able to support our growth with internally generated capital. As you saw in today's earnings press release, our 2017 financial results were solid. For the fourth quarter, ConnectOne earned adjusted net income of $16.3 million or $0.51 a share, while adjusted return on assets exceeded 1.3% and return on tangible equity surpassed 15% for the first time. Excluded from these performance results was the impact of tax reform, which resulted in an estimated fourth quarter deferred tax asset valuation adjustment of $5.6 million. Going forward, we expect that a lower effective tax rate will have a significant positive impact on our earnings in 2018.

Solid organic growth continues on both sides of our balance sheet. The principal focus of the company is accelerating core deposit growth so that it's commensurate with ConnectOne's strong loan growth. For the fourth quarter, on an annualized basis, our average total deposits grew by 19.6%, keeping pace with our 20% loan growth.

Specific to deposit growth, deposit pricing competition continues, which is reflected in increased funding costs. However, we have largely offset increased funding costs with higher rates and spreads on our new loan production, combined with strong growth in noninterest-bearing demand deposits.

At ConnectOne, we set ourselves apart by making it easier for our clients to do business with us. Over the past year, we've continued to extend our competitive position, attracting high-quality bankers, gain market share and achieve strong progress in our deposit-generation capabilities, reflecting operational excellence, high-quality client service and competitive rate structures.

For 2018, we believe ConnectOne remains well positioned to achieve continued deposit growth, driven by increasing and expanding our commercial client relationships; entering new markets within the New York City region, where we believe our business model will resonate; enhancing our cash management capabilities; utilizing a modern branch office model, which allows our staff to focus on sales; and continuing to enhance our digital channels.

From a lending perspective, we continue to build strong momentum in loan originations and loan growth during the fourth quarter. Additionally, we recently made significant strides in improving our CRE concentration metrics. This was achieved through increased C&I and residential loan growth, the sale of nonrelationship multifamily loans and the early January sub-debt offering.

Overall, our fourth quarter loan growth reflected strong performance across several lending sectors. Within our multifamily segment, we continue to be a significant player in originating high-quality, relationship-oriented loans in the New York and New Jersey metro market. Looking at our construction loans, we continue to see good opportunities. And while our construction portfolio may fluctuate quarter by quarter given the timing of draws, our disciplined approach has maintained this portfolio between $400 million to $500 million, with maybe a little bit of growth going forward.

We also continue to make progress in increasing our residential loans held in portfolio for select business clients. Historically, we've grown in the high teens or more, but our expectation for the coming year is more likely to be in the low to mid-teens, given our view of rising risks, pricing pressures and the law of large numbers. We are often asked our view on the impact of tax reform's SALT and mortgage deductibility provisions. So far, we haven't seen negative effects in the marketplace and continue to see brisk activity in our for-sale projects. This is an area we will continue to monitor over time.

Beyond the financial performance, we're committed to the future growth of our franchise and continue to prudently invest in process improvements in all areas of ConnectOne Bank. One example with this is the implementation of the nCino platform, which will streamline all aspects of loan and deposit origination. Additionally, we intend to continue to grow by attracting experienced bankers to our team, as evidenced by our new office center in Melville, Long Island, and the potential expansion into additional New York, New Jersey markets, while at the same time, maintaining our industry-leading low efficiency ratio.

In summary, we are diligently building an increasingly stronger company. The decisions we are making position us to continue our prudent growth strategy and create long-term value for our shareholders.

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

Thank you, Frank. Good morning, everyone. So the strong earnings growth continues at ConnectOne. Excluding the deferred tax charges impacting many banks and a very small amount of taxi charges this quarter, we earned $0.51, up more than 10% sequentially and 28% ahead of last year's fourth quarter. And on that same basis, return on tangible equity cleared the 15% hurdle for the first time at 15.6%. The return on assets was a very impressive 1.37%, up from 1.25% in the sequential quarter.

Meanwhile, tangible book value per share increased another $0.23 this quarter to $1.05 for the year to $13.01. That's despite the DTA charge in any taxi reserves we've taken over the course of '17. Our efficiency ratio remained below 40% for the second straight quarter, hitting a new record at 38%. That ratio typically increases during the first quarter each year, and I expect a similar trend this year.

So as Frank mentioned, we recently completed a subordinated debt offering, with the net proceeds to be downstreamed to our bank. The capital raise will cost us about $0.04 per share in EPS this year, but in my view, this is a very cost-efficient way to support our growth and reduces our CRE regulatory concentration metric by about 10% from 550 range to maybe a little bit below 500 on a pro forma basis.

And it was another quarter of strong organic balance sheet growth. For the second quarter in a row, average interest-earning assets and deposits both increased about 5% sequentially. Average noninterest-bearing deposits, a focus for our CRE ConnectOne, lagged a little but still increased about 3.5% sequentially. That's 14% annualized, and that's a growth rate we are very pleased with.

And despite increasing deposit costs, our margin has remained flat, with the margin, excluding the benefits of purchase accounting, remained at roughly 3.41% or 3.42% for the past 3 quarters. So deposit costs are rising, they rose by 7 basis points this quarter, but our core loan yields increased by 8 basis points. And the increase in loan yields for this quarter was primarily attributable to a more favorable loan mix. Average C&I loans were up 6% to 7% sequentially, while the rest of the portfolio increased by only 3%. C&I spreads can be well in excess of 300 basis points, while CRE yields, especially multifamily, are significantly tighter.

Now going forward, we are going to see some margin pressure, and I estimate about 10 basis points. And it sounds like a lot, but let me explain where it's coming from. The sub-debt offering on its own will contribute about 5 or 6 basis points of contraction. And secondly, the tax rate drop decreases the taxable equivalent yield. Doesn't decrease net interest income, but it changes the calculation of the margin, and that will hit us by about 3 basis points. And then maybe there's 1 or 2 basis points of core margin compression, but this last piece, the core piece, is dependent upon a number of factors, including our relative success at increasing demand deposits, our loan mix and, of course, how competitive deposit pricing remains.

Now just a couple of comments on our securities portfolio. Average balances grew at 5% sequentially, and for now, we expect our securities portfolio growth to approximately keep pace with loan growth. All our purchases are in noncredit securities, that is they're all government-backed.

The tax-adjusted yield on the portfolio fell modestly from 3.03% to 3%, and we will see as much as a 20 basis point drop in that rate due to the taxable adjustment factor. So on a substantive basis, the rate is holding constant, although the nominal rate that you see will drop by 20.

On the expense side, our efficiency ratio improved further. And as in past quarters, this is more a result of continued solid revenue growth as our expenses are increasing sequentially by 4.3% or more than 15% annualized in the last sequential quarter. Most of that increase, as expected, was on the employee expense line. We've added to staff in deposit origination functions as well as back-office support, and we also increased staff compensation accruals. Again, going forward, first quarter expenses are generally higher and revenue growth possibly a bit lower, so I wouldn't be surprised if our efficiency ratio increased in early 2018.

Now let me touch on taxi for the quarter. As most of our investors are aware, we have all New York City, all corporate medallions, and they're generally cash filling at about 4% to 5% on our carrying value, which is now $46.8 million. That represents about just 1% of the total loan portfolio. And during the fourth quarter, we returned the portfolio to held for investment from held for sale. Doesn't mean we can't sell it in the future, but for the time being, our plan is to work the loans down by applying any payments to loan balances. We've also had a good deal of success replacing any delinquent borrowers with stronger ones.

So while cash flows have been stabilizing in the industry, further weakness in valuations potentially could occur in 2018. And if -- with the loans in the held for investment portfolio, if there were any charges, they would run for a provision for loan losses. So outside of taxi portfolio, credit quality remained excellent as we had virtually no charge-offs for yet another quarter. Nonaccrual loans did tick up slightly. That was due to one loan, which is well secured. A couple of nonaccruals were resolved during the quarter. That brought the ratio down a little bit.

We added to the allowance to the tune of $2 million for the provision, which was strictly to account for growth in the portfolio. And as I've mentioned before, we are not releasing any reserves and expect to continue to increase reserves commensurate with growth.

And now let me turn to CRE concentration. We focus -- Frank mentioned this, but I'll say it again, we focused on this in 3 tangible ways recently. First, we continue to improve our origination mix, with non-CRE growth continuing to exceed CRE growth rate. Second, we sold a $50 million package of multifamily loans. These were to borrowers where we have no deposit relationships, and we recorded a $550,000 gain in the quarter. We plan to continue to use this tool to both manage our CRE concentrations in the future and to boost noninterest income. Third, we completed a $75 million sub-debt offering, and all these things helps to reduce our metric by about 60 percentage points on a pro forma basis.

And lastly, on the financial impact of tax reform, we recorded a $5.6 million -- estimated $5.6 million DTA charge in the fourth quarter. And our estimated tax rate for '18 is about 22%, approximately 10 percentage point decrease than '17. And a small amount of the tax savings will be used to enhance employee benefits. We're looking at boosting our 401(k) matching program, increasing our minimum wage and more investments in both training and employee education.

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

Thanks, Bill. Before turning the conference call over to you for your questions, I'd like to conclude our prepared remarks with a review of our 2018 strategic priorities.

We remain focused on achieving strong financial performance, delivering customized banking solutions to our clients and driving momentum in our businesses by balancing our growth, expenses and our investments. With a solid capital base and earnings strength, we remain well positioned to achieve those objectives by expanding the reach of our organization further into New York, 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 our personalized service, vacated by the largest institutions and by banks leaving our market due to consolidation; and by building a desirable and valuable franchise in the $5 billion to $10 billion category.

In summary, we're confident that ConnectOne's business model will continue to deliver strong long-term shareholder returns, and we look forward to updating you on our progress in the quarters ahead.

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

(Operator Instructions) Our first question today is from William Wallace from Raymond James.

So on taxi, I'm just curious maybe what we can read into the decision to move it back. Do we assume that there's just no market for those? Or that there's a market, but it's just too far below what your estimate of economic value of the portfolio is?

So I think it's 2 things. One, there really is no market, trading market, that's available to sell the portfolio at this time. And I think part of that is just because of the small size of our portfolio at this moment, although there haven't really been any other trades in the market. The second part is that we really have had good success in moving delinquent borrowers to stronger borrowers who are making the payments, and the loans are cash flowing as they were restructured.

Okay. Fair enough. So even though we see nonaccruals, I guess, going from, what, $47 million to -- staying about $47 million, I guess you still have some borrowers that are, I guess -- I'm not seeing it, I guess in the nonaccrual numbers.

They'll continue to remain on nonaccrual, which allows us to put all payments to principal. And that's the prudent thing to do.

You can -- even if you shift from one borrower to another?

Yes, you can't just put it back on accrual status because you shift to a new borrower. And based on the terms of the loan, it's a replacement borrower. (multiple speakers)

Okay, got you. Okay, fair enough. Okay. And then the $300,000 adjustment suggests that that's kind of representative of what you're seeing from the cash flows and the strengthening in the market on a cash flow perspective.

The $300,000?

Yes, the valuation adjustment that you took in the quarter versus the, what was it, $2 million last quarter?

Yes, it's just based -- it's based on our model, which is a combination of cash flows and trades that are reported by the TLC. So there can be fluctuation in that calculation from time to time.

Sure. Okay. On the accretion, you had a big jump in the fourth quarter. I assume that most of that was accelerated. Should we be thinking still around the kind of $300,000, $350,000 per quarter for the next few quarters?

Yes, that's about right. But because it was accelerated, it took away from future accretion, but not at time. $30,000 or $40,000 possibly of reduction going forward. And I haven't looked at the numbers exactly, but it's not much of a change on that line. But we're not going to see that $1 million quarter again.

Okay. So, Frank, you've done 20% basically loan growth the last 3 quarters, actually, kind of adjust for some of the noise. You're sticking to the low to mid-teens loan growth. You mentioned some of the risks that you see in the market with the potential for some core margin pressures, and obviously, we -- the sub-debt is what it is. It sounds like you're still anticipating that you can improve your returns on equity. So I'm just curious, does M&A play into the future of ConnectOne more so today than it did, say, a year ago, with loan growth expectations that are somewhat tempered compared to where you have been growing?

Well, I think the best way to answer that is we're always looking at opportunities in the market that make sense to us. At this moment, I don't see our business plan dictating that we need to do something. Clearly, we don't. But certainly, with a stronger currency, a stronger operating company, all the things that I think make ConnectOne somewhat unique, I think we can play in the marketplace and further improve what we're doing today. But I don't feel any pressure to do anything.

Has your desire to have conversations, has it -- I mean, has it stayed the same as it's always been? Or you've been maybe a little bit more active in communicating and meeting with and trying to build relationships with other potential partners?

Yes, I mean, I think on both sides of the equation, I think we continue to have conversations as I think I should. But as you know, as we sit here today, we have not found the right combination yet.

And moving on, our next question is from Matthew Breese from Piper Jaffray.

Just on the hiring front, I know you mentioned there were some new adds in Long Island, in Melville. Just curious if you're seeing any fallout from disruption tied to M&A in that market. And then as a follow-up, you also mentioned, Bill, New York and New Jersey. Just curious in terms of geography where you're most focused on there.

If you don't mind, Matt, I'll take that in reverse order. So we've always stated that ConnectOne is a New York, New Jersey, New York metro market bank. And so we continue to believe that that's the market that we will serve. I'm not saying we'll never be outside that. For the time being, though, that is our market. And so we look for opportunities within that market. As you know, we're pretty heavily concentrated in New Jersey, or have been in the past in New Jersey, and we are looking to expansion across the Hudson River. We entered into New York City 2 years ago. We opened the Melville office -- or will be opening it this quarter. And we're looking for additional opportunities there.

As far as where those opportunities will come from, we always like to lead with bankers. It's not necessarily geography. And certainly, the disruption that's going on in the marketplace, either from M&A, or in some cases, just larger banks not being able to service their clients appropriately, we are finding a tremendous amount of opportunity. I think there's actually more opportunity in the market than we can actually execute on. And so we see that as a pipeline going forward for as far as the eye can see.

Okay. Great. And then on the construction front, obviously balances were up quite a big quarter over quarter. Just curious, what kinds of projects are being underwritten? And are there any consistent themes on the types of things you're doing there?

Our portfolio hasn't changed that much, Matt, over time. We continue to underwrite owner-occupied type real estate, small residential for-sale projects, relatively small multifamily projects and a mix of all of those things. The balances do change, as I mentioned in the report, from quarter to quarter. The rise this quarter, a lot of it was due to construction draws. And -- but overall, the portfolio runs in about that $400 million to $500 million range. We could see a little bit of growth there. We are well known in the market for how we deliver the product. And we've had a lot of builders that we've done a good job for over the years continue to come back to us. The for-sale market, even with SALT -- the SALT tax discussion, is still pretty robust in the markets we serve. And we believe we'll continue to be a strong player in that market.

Okay. And then one last one for me, just on the expense front. Looking for a little bit of an outlook for 2018, given the move, especially with the move from taxi, from held for sale to held for investment. Just want to get a sense for where that year-over-year increase in expense could be.

Well, I mean, excluding the -- any valuation allowance, I would project about a 10% increase in OpEx.

Our next question today is from Collyn Gilbert from KBW.

Bill, so just quick for you, first. On the securities growth that you laid out, I presume that's within -- that's incorporated in your NIM guidance, right? Like just the lower related yields to that?

Yes.

Okay. And then also, too, you had indicated in opening remarks that loan growth, law of numbers, all sorts of things, might be a little bit lower. Can you talk about what the loan -- kind of the new loan pricing is that you're seeing and where maybe you're seeing stresses from a competitive standpoint that's causing you to sort of step away on some credits?

Yes, multifamily has gotten tighter over the last 6 months and to a point where, not that we're out of the business, but we're probably going to do a little bit less. So I would say in every category, we're actually seeing the ability to expand spreads.

Because you are seeing good movement in your loan yields, so just -- and I presume that means loan origination yields are obviously higher than portfolio yields. So just was trying to get a little bit more color as to some of the -- yes, the trends there.

Right. And I mentioned it was because of the change in mix. And of course, that change in mix is a change in spreads. So the C&I spreads are much higher than the multifamily spreads, with other types of loans somewhere in between.

Okay. Okay. All right, that's helpful. And Bill, you may have covered this on the first question, I apologize. But -- so the valuation allowance of that $343,000 that you guys are using, a lot of that -- it's a combination, I guess. I mean, the question maybe people ask is to look at transfer value. We go through this every time, and I really can't wait for us to have -- stop this conversation. But the -- for the transfer rates -- but it's much as the point that you're getting that 4% to 5% on those cash flows, I presume, that's allowing you to feel comfortable with that per medallion valuation level?

It's part of the analysis because it gives us an idea of what the cash flows are, but it's not the only component of the analysis.

Okay. Okay. Okay, that's helpful. And then, Frank, just to your initial comments talked about newer markets in New York City that you're looking to expand into. I mean, are there -- and I know you had said you guys were led more by the bankers and the lenders than you are by geographies. But is there an opportunity that you see in any of the boroughs? Or anything that's going on that makes you feel more encouraged in kind of a specific submarket? Where you maybe would set up an LPO?

Yes, sure, Collyn. We -- and typically, we don't set up an LPO. We do a full-service office, not necessarily a retail branch. As you know, they are generally more full-service, office-type operations. But there's lots of opportunity in every one of those markets. In every one of the other boroughs there is very little competition left from the smallest players. Bankers are available because of mergers, acquisitions and also I said law of large numbers. Well, that applies to some of the competition that we've had in the past that have now gotten so big that they may be crossing over the $50 billion mark or touching the $50 billion mark and so can't increase their loan volumes or don't want to or have regulatory pressure not to. And so we have the field pretty much wide open to us. And when you look at the other 4 boroughs we're not in, I mean, those are just incredibly deep markets. And if we just get a small sliver of any one of them, it's meaningful to ConnectOne Bank.

Okay. Okay, that's helpful. And then just a final question, Bill. Obviously, the cost of the sub-debt is going to raise the interest expense. But aside from that, what are you kind of anticipating even in a broader sense for what deposit pricing will look like in 2018?

Yes, well, I'm being conservative here in calling some margin compression solely based on the pricing pressures we're seeing on the deposit side. But I did say that it could -- right, it could -- depending on our ability to raise demand deposits and depending on our loan mix and loan spreads, it could be different than that. But I think that's a fair estimate.

And that concludes today's question-and-answer session. At this time, I'll turn the conference back to management for any additional or closing remarks.

Thank you all for joining us on this fourth quarter conference earnings call. We appreciate your interest and look forward to speaking with you again on our next call this spring.

And that does conclude our conference today. Thank you for your participation. You may now disconnect.