ConnectOne Bancorp Inc (CNOBP) 2018 Q1 法說會逐字稿

Good day, and welcome to the ConnectOne Bancorp, Inc. First Quarter 2018 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, sir.

Thanks, Todd. Good morning, and welcome to today's conference call to view ConnectOne's results for the first 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 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 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 SEC. 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, reconciliation 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 April 26, 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 Frank Sorrentino. Frank, please go ahead.

Thanks, Joe, and good morning. Thank you for participating in today's conference call. So while we're pleased with our continued progress of our disciplined growth strategy, the first quarter of 2018 included a number of items detracting from our underlying core earnings trend. So why don't we start by addressing those issues?

First, of course, the taxi medallion portfolio. The company took a significant charge, reflecting the combination of lower transfer values, rising interest rates and continued low lease rates affecting our valuation. While we're disappointed with this write-down, it does get us to, or at least close to, the bottom of the valuation.

Second, we had a slower-than-expected deposit growth, some of which was seasonal that weighed on a number of our metrics, including our net interest margin.

And third, we had a number of future-facing initiatives that are temporarily impacting some of the current metrics, including our margin and efficiency. However, we expect these initiatives to pay dividends in the future as we continue to proactively transition the company to enhance our banking relationships, strategically expand our footprint as well as face some of the evolving needs in the industry.

So cutting through the noise, on an operating basis, we delivered an adjusted return on average assets in excess of 1.35 and an adjusted return on tangible common equity in excess of 16%. We also continued to maintain a strong balance sheet and although seasonally a slow quarter for ConnectOne had solid 15% loan growth on an average basis.

We're achieving progress in deposit gathering within our Internet channel driven by additional online marketing and increasing interest by our clients. While this is still in startup mode, we continue to strongly believe that banks will require more confidence in this area in the future, and it will also provide a platform to build deposits profitably and grow client relationships.

From a lending perspective, we continue to have solid growth in a number of our key competencies. We continue to see expansion of our C&I client relationships realizing solid momentum with a focus on certain areas, including our independent schools and law offices. C&I remains very attractive for ConnectOne as this business channel offers attractive loan rates combined with deposit generation potential.

Our disciplined approach in construction lending provides a stable pipeline of new opportunities from existing clients, and we view our multifamily portfolio as a business line, complete with deposit relationships and banking service needs. While the loan pipeline has slowed a bit, we still see attractive opportunities to service this area of the market, and our clients continue to show willingness to pay a bit more for the service we provide.

We also made progress in reducing our CRE concentration down to 509% from 568% at the year-end of 2017. While a significant portion of this progress came from the subordinated debt issuance in January, our aim is to further reduce the concentration over time in a number of ways, including additional C&I origination, residential originations, and as we -- and as we've accomplished before, loan sales of non-relationship assets, along with higher capital accretion levels. Additionally, credit quality remained relatively stable during the first quarter outside of taxi.

Regarding the operating environment during the quarter, it was an extremely competitive marketplace, both on the deposit side and on the loan side. So our core net interest margin contracted a bit more than we expected for a number of reasons that Bill will get into in detail later.

To support our future growth, we remain committed to investing in our infrastructure and adding additional team members. Specific to the infrastructure investments, we completed the first phase of our nCino platform rollout, which included digitizing the entire loan process, everything from document management to approvals to collaboration. This initiative enhances our sense of urgency culture, an element that has been our competitive advantage. This allows us to continue our operate -- our efficient operating model while utilizing technologies to improve any existing inefficiencies caused by manual processes and offers a robust data management and gathering solution.

The second phase of our nCino rollout is now underway, which includes the addition of the deposit origination platform. We also remained on track with our planned expansion into new markets within the New York City region where we believe our business model resonates. Our new office center in Melville, Long Island, is now open and has already exceeded our expectations. We're planning to expand our New York City office later this year to accommodate additional staff and the growing importance of this location, and we're planning to further extend our geographic footprint by opening a new office center in Astoria, Queens, in the second half of '18.

Additionally, we continue to expand the knowledge base of the company by adding talent to our team. Key staff hires this quarter included experienced loan officers and deposit gatherers.

In summary, the decisions we're making position us to continue our prudent growth strategy, enhance our competitive position and create long-term value for our shareholders.

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

So thank you, Frank. Let me start off with taxi. We took a $17 million pretax charge this quarter, brings our exposure down to de minimis levels. Total carrying value is now just $29 million out of our $4 billion-plus loan portfolio. And valuation per medallion is now down to $216,000, reflecting our New York -- our all New York City medallion portfolio, 95% of which are so-called corporate. And the expected cash return is more than 7% on our new carrying value. The loans will remain on nonaccrual, and we'll continue to apply all payments of principal going forward.

As most of our investors are aware over the course of the past few years, we've tried to be as conservative as we can within what is proper from an accounting standpoint. A valuation is utilized at consistent approach. We've relied on TLC-reported transfers as well as our in-house cash flow model. What changed this quarter and what has led to the large charge is the number of transactions being reported as well as the lower valuation of those transferred. With these 2 factors, we can now rely more on recent transfer values, and therefore rely less on assumption-driven cash flow analysis. Our intent at the present time is to hold the loans and portfolio as they continue to cash flow well. That could change in the future, but there's nothing currently on the table. And although I can't guarantee that there will never be another charge here, if there were any charges, I do believe it would be very small.

Excluding the taxi charge now, our operating performance for the quarter reached record levels, reflecting return on tangible common equity that surpass 16%. We are, of course, aware that some of the improved performance is attributable to a lower corporate tax rate. But given what is typically a more challenging quarter, the first quarter for ConnectOne, we are pleased with these very strong results, reflecting continued growth, sound asset quality, apart from taxi, a healthy, albeit lower, net interest margin and operating efficiency that is among the best in the industry. My expectation is that, barring anything unforeseen, we are poised to approve on these results for the remainder of 2018, obviously on a GAAP basis, but on an operating basis as well.

Let me next tackle the net interest margin, which was a bit noisy for the quarter. Our NIM for the quarter contracted to about 3.25%, and most of that contraction resulted from items that we anticipate and disclosed a quarter ago. The expected variables included, first, purchase accounting. We always disclose the benefits of purchase accounting and take them out of our core NIM metrics. Purchase accounting contributed 7 basis points of the compression sequentially. Second, we issued a relatively large amount of sub debt, $75 million, just a few months ago in January. The cost was approximately $5.25 million. It slightly lengthened our funding sources and impacted our margin by about 5 basis points. Third was the taxable equivalent adjustment, and that contributed another 4 basis points. Not anticipated was a negative variance in yield-related fees on loans, which include prepaid fees as well as fees on lines of credit. These items fluctuate quite a bit from quarter-to-quarter, and then the sequential comparison contributed 6 basis points of contraction.

And then I'll tell you as a growth company, we're probably more negatively impacted than most from narrowing spreads. In other words, the marginal cost of funding increased at a greater rate than market yields on new business. And we calculate that this impacted our margin by about 3 additional basis points.

So digging a little bit further to our margin, we were hurt by deposit growth lagging loan growth. But our [paid on] interest-bearing accounts was below 25%, and the average coupon on our loan portfolio rose by about 7 basis points for the quarter. Both of these were in line with our expectations.

And looking to loan-to-deposit ratio, it's a ratio that gets a lot of investor focus, not so much a regulatory focus, but an investor focus. It increased to 113% at quarter end. We are comfortable at this higher level, but our goal remains to be at or near 110%.

Going forward, we are hopeful that spreads in our new business will expand, and there are some indication that this is already happening. However, should conditions persist, our core net interest margin could contract a point or 2 quarterly. I think some of those nonrecurring items can work to our advantage a little bit in the next quarter or 2.

Let's turn to the efficiency ratio, which rose sequentially from about 40% to 42.5% for the first quarter. Let me state emphatically, we remain an extremely efficient bank. Although up sequentially, the ratio was improved from 44% a year ago, and this is always a bit higher this ratio for us in the first quarter. We continue to leverage technology and rely on a branch slide model to drive economies of scale. We remain committed to investing in staff and technology and to geographic expansion, yet we still target revenue growth to exceed expense growth. This, in our view, will lead to an improving efficiency ratio on a year-over-year basis.

Wanted to mention the effective tax rate. I previously guided all of you to a 22% rate. I'm revising that guidance to 21%, and that's based on a reevaluation of company-wide sources of income. So for 2018, we expect to be at 21%. That's exclusive of any equity-based compensation tax benefits.

So to sum up, our operating performance continues to be outstanding with ROA of nearly 1.40% and return on tangible common equity surpassing 16% with an expectation that these returns will improve over the course of 2018. We lowered our CRE concentration by 60 percentage points and remain committed to managing our CRE to lower levels. We raised our total risk-based capital -- ratio by 150 basis points to 12.64%, further supporting future growth. The taxi medallion portfolio is now being written down to a near-bottom valuation with cash flow estimated to be 7% or 8% on a carry -- carrying value on a go-forward basis. Our loan and deposit growth outlook remains positive in the 10% to 15% range. And one last point, while we have recently experienced a little bit of margin compression, we think it's important to note that ConnectOne can drive superior returns that's ROE into the high teens with a margin in the 3.25% range.

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

Well, thanks, Bill. I just have a few closing remarks before we turn the conference call over to your questions. It was clearly a challenging quarter. As we assess our first quarter financial performance, we're certainly not pleased with the taxi medallion charge or the unanticipated portion of the margin compression. Nevertheless though, we are pleased with the groundwork we're laying for the continued success of the business and are confident ConnectOne will deliver strong financial performance as we remain on track to achieve our objectives for 2018, including strong deposit and loan growth. We're committed to enhancing our desirable franchise by expanding our geographic reach within the New York City metro region by attracting and retaining talent in the deposit and loan origination areas and by investing in technology to generate additional operating scale. We are poised to leverage off these key initiatives. And leading into the second quarter and the remaining -- remainder of the year, I'm very confident we will succeed through the disciplined execution of our strategies.

That include -- that concludes our formal remarks, and Bill and I look forward to answering any and all of your questions. Operator?

(Operator Instructions) Our first question comes from Matthew Breese with Piper Jaffray.

Maybe just starting with expenses. And just wanted to get a sense for what was core and expenses this quarter? What was seasonal? And how we should be thinking about the rest of the year given some of the investments you're making.

Well, we've been able to keep year-over-year expenses below 10% growth rate. That's been going on for many, many quarters, while our revenue has been increasing on a -- at above 10% clip. So that's not a bad place to start to look at where our expense growth is going forward, so not sequentially but from the prior year.

Okay, okay. I'll keep that one in mind. And then on the margin, I just wanted to get a sense for what you're seeing in terms of competition for deposits? How much more competitive has things gotten over the past 30, 90 days? And then maybe stepping away from the margin discussion for a second and focusing on net interest income, from here, what do you think the net interest income growth outlook for the year is like?

Yes. Let me just -- Matt, so our balance sheet as it stands today is -- has been acting pretty much the way we thought it would act, relative to both the rate increases and what's going on in the marketplace. But as a growth company and the fact that we're growing or trying to grow at higher rates, everything that we're putting on at the margin is at the margin. And in that space, things are quite competitive. And so we are seeing a lot of competition there. Seasonality does play a little bit of a role here. The first quarter is always difficult for us in the various niches that we have. And historically, you will always see that. We generally start off the year quite slow. A lot of the businesses from a seasonal perspective move DTA balances out right after the beginning of the year, and so those things impacted the margin numbers. We expect as the year goes on, we're getting the benefit of those rising rates on the asset side, and we should be able to combat the rising rates on the deposit side.

Okay, okay. And then on the loan growth outlook, it sounds like 10% to 15% is still intact. Could you give us some sense of the pipeline today and characterize what we saw during the quarter? How much of that was driven by a pull-forward in last year's numbers versus really any sort of stalling and growth for the year?

Again, I think if you look historically at the company over the last couple of years, actually, you would see that we generally get a big year-end crush to do a lot of business, typically for tax reasons on our borrowers' balance sheets. This year was no exception for that. We saw a lot of -- or very strong growth in the fourth quarter that typically moderates going into the first quarter and then generally picks up steam as time goes on. So I will tell you that I still feel confident about the guidance that we're giving here about strong loan and deposit growth going forward in 2018. We are and we have said for the last couple of quarters that we're seeing slower demand in the multifamily space. That's not making us unhappy at this moment. We're making that up in other places, and we're being much more focused in what we are doing in that particular bucket of loans.

Our next question comes from William Wallace with Raymond James.

Thinking about these -- the loan fees, what did they add to margin in the first quarter? What are the loan fees in the first quarter?

So the loan fees added about 15 basis points. They always add a lot in the fourth quarter and 12 basis points in the first quarter. And prepayment fees went from 9 to 6, so that's a total drop of 6 basis points in those 2 areas.

If you look over the course of the year, is there maybe like an average contribution that you get from the loan fees and the prepayments?

Yes, there is. And I don't have the number in front of me, but it was low in the first quarter.

Okay. So obviously, it's hard to predict, but all else equal...

Hard to predict, but -- right.

You expect some bounce back in the quarter.

Right. That's what I was -- yes. So that's what I was saying that it was below the run rate, and the fourth quarter is probably a little bit above the run rate.

Okay. And then in your commentary, Bill, you mentioned you could still see, kind of taking out the noise around loan fees and prepayments, 1 to 2 basis points of pressure on the margin. Does that consider what you're seeing in April? Or were you saying that if the environment worsens from where -- from what we saw curve-wise in the first quarter? In other words, at what you're seeing today or through April, could that 1 to 2 basis points pressure be flat?

You mean, flat at 1 to 2 basis points? Or go back from...

No, no. In other words, could your margin be flat if what you're seeing quarter to date holds true for the rest of the quarter, outside of the noise around prepayments and loan fees, stripping all that out?

No. Right now, I'm looking at 1 to 2 basis points of core compression. It really depends on what's going out with market rates on loans. We talked about this before about the beta on loans. And there has been a lag in repricing of loans, and that has been impacting the new business that we're putting on. And as I mentioned in my -- in the call, companies that are growing are going to be impacted by that more than companies that are not growing.

Right, right. Exactly. Okay. And then...

And these were -- and I want to add from an analytical perspective, we grew 15% in the first quarter. It's not really -- I know your model is based on what the month-end balance is, the year-end balance to today. But the margin is impacted by the average balance, and that was 15% growth in loans in the first quarter versus the fourth quarter angle.

Right, right. And so did you see the loan production picking up pretty strongly in March coming into the second quarter because the spot rate was less than 1%?

I'm not sure what was his question.

Yes. So I do think, Wally, that a lot of the loan growth came late in the quarter. And we still see a very strong and pretty much consistent pipeline going forward for the rest of the year.

Yes. Okay. Perfect. And then my last question. On the efficiency in the prepared remarks, you talked about an improvement year-over-year still on the efficiency ratio. If I look at what you did in the fourth quarter, the way I calculate, it was about 40%. Do you think you could -- you can drive efficiencies better than what we saw in the fourth quarter on an annual basis, maybe not this year, but just in general? Do you think you can beat that based on your current...?

I think, my best guess is to look at last year's second quarter, and I think we can improve on that. You'll see every year we get better each quarter, but it pops up in the first quarter. And this year, it popped up to 42.5% versus 44% last year's first quarter.

Wally, just -- if I just could add one thing to that. So while we can -- we certainly could, and we certainly would want to. Part of our strategy is also to look at how much investment we should make over time back into the company, around infrastructure, around some of the initiatives that we're putting in which will pay even larger dividends in the future. So we could clearly get our efficiency ratio significantly lower from where it is today, but that would mean gutting our ability to spend for new infrastructure for the future. And so we're constantly weighing those decisions over time. I think we've said in the past that we believe around the very high 30s, low 40s is the range in which we feel we should be operating at this moment in time, which provides the ability for us to invest in all those future-looking and forward-looking infrastructure builds.

(Operator Instructions) We'll take our next question from Collyn Gilbert with KBW.

Just following up on the discussion around the NIM, which realizing that it's -- there's lumpy. There is some variability to that. More broadly, though, Bill, how are you thinking about net interest income growth? I mean, I know, obviously, it fell this quarter. I mean, I would -- I presume that that's not going to be -- you're not anticipating declines going forward. So just...

No, no.

Okay.

No. But I think you got to project -- well, you got to project loan growth and then whether or not you have any margin compression in there. That's how you're going to have to model it.

Right, right, right. But you're anticipating as you kind of look at the broader balance sheet, like you will find a way to continue to grow net interest income growth, like that's going to be a strategic objective.

Absolutely, and that's going to drive our ROA and ROE up from the current 1.40% 16.5% or so up to the higher level and a lower efficiency ratio, yes.

Yes. Okay. And so -- and, Frank, I think you had said it. Maybe, Bill, you said it. But the fact that a 3.25% margin still allows you all to generate a high return on...

(inaudible)

Yes. Okay. What are the drivers of that, I guess? Like what's going to -- I mean, because there's not a lot of -- you don't have the leverage on the fee side. I'm just trying to sort of think about -- and this is, again, a little bit of a broader strategic question, right? Like so you guys are a growth company. The realization is that growth is being added at a marginally lower rate. And I'm just trying to understand where the levers are within the business model that really give you the confidence to get to that to still maintain that high ROE business?

Well, we're going to improve from where we are now - is by having a revenue increase, really, at a greater rate than the expense growth rate, and our projections still show that. So yes, there is going to be growth from increasing the loan portfolio, small increases in the securities portfolio. And if there's margin compression, that would take a little bit away from that revenue growth. We've had loan sales in the past, in the fourth quarter. We plan for some of those more going throughout the year. The tax rate is a little bit lower right now. And the way I'm looking at, it's going to drive ROE into the high teens.

Okay, okay. All right. That's helpful. And then just back to the loan pipeline, what -- do you have what the composition of the pipeline is in terms of between -- among CRE, multi, C&I?

Yes. So it's continued trends of what we've been seeing in the past few quarters, which is a deemphasis on multifamily. And so we'll continue to see growth in the -- a greater growth in commercial than you will in CRE, and that's going to lead to lower CRE concentration metrics as well as hopefully returns, yes.

Okay. And do you have -- I realize rates are going to vary among loan segments, but blended pipeline yield -- loan yield.

What was the loan coupon we had in the most recent quarter, 4.75%? So in the most recent quarter, the loan coupon was 4.75%.

Okay, okay. That's helpful. And then -- oh, go ahead.

No, no. I'm not sure on the pipeline because it's hard to say because there's timing of when loans are going to close, so...

I guess let me ask it differently...

Yes. Go ahead.

Just to reflect any improvement in loan pricing given the rate pickup in the last quarter, are you seeing your loan origination yields higher than you were in the fourth quarter? And if so, roughly how much higher?

Yes. Well, I think that's a good question, Collyn. We are seeing increases in the loan rates that we're booking as well as the pipeline. I think the issue has been it hasn't gone up as fast as it should, right. We talk about a beta on loans, so that's what's impacting some of the results. I don't think it's overly significant. It's a couple basis points of margin compression. And obviously, we're going to be mindful of that as we go forward, deciding what loans we're going to book, not book, what our growth rate is going be.

Okay, okay. And then I guess like part 2 of that question is just trying to reconcile and you guys aren't the only ones, right. So I'd be mindful of...

Right.

But the asset sensitivity, right. You've spoken about asset sensitivity, and I think what we're seeing -- and I know that it's a static analysis that quite frankly that disclosures we're finding are totally bogus. But even so, I think as you've described the balance sheet, you, yourself, has described it's somewhat asset sensitive. So just trying to reconcile that you're not -- you don't have that tailwind. And is it because what's driving the fact that you were not seeing that tailwind?

I think it's the so-called beta on the loans is what's driving it in the dynamic model.

Okay. So just competitive pressures are keeping loans not prepricing?

Yes. The loans are going on at a lower rate. And of course, liability mix affects the margin as well.

Yes. Okay, okay. All right. That's helpful. And then just one final question. Any thoughts -- let's just say this environment doesn't -- the competitiveness doesn't subside, and we're sitting in a similar situation at the end of the year that we're sitting in today. Do -- is there a point when you think about fee-based businesses or opportunities to sort of enhance that revenue mix a little bit more? Or do you feel like the efficiency the you get out of the branch network is truly legitimately enough to drive that high ROE?

Collyn, I think we always look at what else we could be doing and how we can provide a better experience for our clients, but we're also mindful. We are committed to running a very efficient organization, and we've made certain decisions based on that. And I think at the end of the day, that's going to be a better strategy for us than trying to pursue what sometimes we call around here some hobby-type businesses relative to us. There are other banks that maybe do these things well, but I don't see right at this moment any business that would significantly contribute to what the game plan is here for ConnectOne Bank. By the way, I don't want to give anyone the impression that our model is not functioning. We have a very strong pipeline going forward for the rest of the year. We've not only of clients and loans and deposits but of staff that want to join the company. We're expanding our market area. We're doing a lot of things right. 1 quarter's financial metric moving in a wrong direction doesn't completely change the business model here, and we think we'll be sitting in a better position as the year goes on as most years work. The first quarter is generally the weakest. Yes, with the flux in how interest rates have moved recently, it's negatively impacted ConnectOne's business model. We think that will subside as the rest of the year moves on, and we think our plan is intact.

And at this time, we have no further questions. I will now turn it back over to you for closing remarks.

Well, thank you. Thanks for joining us on our first quarter earnings call. We appreciate everyone's interest. We look forward to speaking to you again on our next conference call back in July. Thank you very much.

Thank you, ladies and gentlemen. This concludes today's conference. You may now disconnect your phone lines, and have the great rest of the day.