ConnectOne Bancorp, Inc. (CNOB) Q4 2019 Earnings Report, Transcript and Summary

Greetings. And welcome to the ConnectOne Bancorp Incorporated Fourth Quarter 2019 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions]Please note this conference is being recorded. I would now like to turn the conference over to your host today, Siya Vansia, Vice President of Marketing. Please proceed.

Good morning. And welcome to today’s conference call to review ConnectOne’s results for the fourth quarter of 2019 and to update you on recent developments. On today’s conference call will be Frank Sorrentino, Chairman and Chief Executive Officer; and Bill Burns, Executive Vice President and Chief Financial Officer.The results as well as notice of this conference call on a listen-only basis over the Internet were distributed this morning in a press release that has been covered by the financial media.At this time, let me remind you that certain statements and assumptions in this conference call contain or are based upon forward-looking information and are being made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995.Such forward-looking statements are subject to numerous assumptions, uncertainties and known or unknown risks, which could cause actual results to differ materially from those anticipated. These risk factors are more fully discussed in the company’s filings with the Securities and Exchange Commission. The forward-looking statements included in this conference call are made only as of the date of this call and the company is not obligated to publicly update or revise them.In addition, certain terms used in the 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 provided in the release.I will now turn the call over to Frank Sorrentino. Frank, please go ahead.

Thank you, Siya, and good morning to everyone. Fourth quarter for -- was another productive quarter for ConnectOne, capping one of our strongest and most successful years. Throughout 2019, we executed against key operating objectives and entered 2020 well-positioned to capitalize on meaningful organic growth, as well as potential M&A opportunities.On January 2nd, we completed the acquisition of Bancorp of New Jersey, ahead of schedule. This financially savvy accretive acquisition of an end market $1 billion commercial bank brings a high level of efficiency opportunities.It’s also a very low risk transaction that enhances our powerful franchise, given our overlapping geographic footprint, cultural alignment and deep knowledge of the institution, the market and the client base.While we closed the acquisition only a few weeks ago, we are already developing client revenue synergies, as well as opportunities to drive the economies of scale. Conversion is expected to occur this May, at which point all Bank of New Jersey clients will be transitioned to the ConnectOne platform. In a few minutes, Bill will provide you with some current estimates of the projected cost saves. Additionally, the transaction increases our total assets to over $7 billion, another meaningful milestone for ConnectOne.I’d now like to review some key fourth quarter financial highlights. Aggregate new loan originations for the quarter were $243 million. Contributing to the growth was strong activity in our C&I segment, reflecting our highly seasoned C&I team and their deep commercial lending experience.Our strong originations were offset by expected behavioral activity especially in our construction portfolio, which reduced sequential growth in average total loans to 2.1% annualized. While this is well below our historical trend, our loan pipeline remains strong and we are targeting a growth rate in the high-single digits for 2020. Having said that, we cannot control the market and should spreads tighten further, we may see lower growth and/or more loan sales.On the funding side, we grew deposit -- client deposits to $4.8 billion at year end and we were particularly pleased with the solid improvement in the deposit mix, which Bill will also discuss shortly.Our CRE regulatory concentration metric improved again to 450% from 480% a year ago. For the fourth quarter, return on assets reached 1.4% and return on tangible common equity exceeded 15%, performance metrics we continue to be very pleased with.We remain one of the industry’s most cost efficient banks with an efficiency ratio of 41.8%. Credit trends remain solid and our capital ratios increased once again, while tangible book value per share increased by 2.9% in one quarter to $16.06.I am extremely pleased with our fourth quarter results and our continued outstanding execution. Operationally, we are gaining market share, developing strong client relationships and enhancing ConnectOne’s digital strategy.Towards this end, in early January, we expanded our presence in The Ironbound section in New York, featuring intense growing number of small- to medium-size businesses. We have done well in this market and believe there are opportunities to take additional market share, while building the location into a hub office.Turning to BoeFly, our online business lending marketplace, we continue to enhance its infrastructure, add new users and drive revenue. Looking ahead, we expect the platform to augment ConnectOne’s fee income in 2020, as well as generate profitable SBA lending opportunities.We also remain focused on investing in financial technology to stay ahead of the competition. As part of our approach, we continue to work with FinTech companies to enhance our digital products, streamline and enhance back-office processes, as well as offer the competitive suite of consumer products. Specifically, we see opportunities in the payments and lending spaces.So, in summary, 2019 was a very strong year for ConnectOne and it was highlighted by profitable organic growth, execution on a disciplined M&A strategy, prudent credit underwriting, investments in technology, and of course, continued stewardship of our shareholders capital.I am now going to turn the call over to Bill, who will provide a few more details on the quarter’s performance. Go ahead, Bill.

Great. Thank you, Frank, and hello, everyone. So, as Frank mentioned, it was another great quarter for ConnectOne and let me start with some overall highlights for the year. First off, our stock price performed very well, gaining 40% over the course of the year, beating both the general market and bank-specific indexes. Still, our stock trades at just 11.2 times 2020 street estimate, which is still a 15% discount to that peer group.Also this year, we commenced the stock repurchase program, increased our dividend and still our tangible book value per share increased by 11.3% to $16.06. Earnings per share increased by 10.3% over 2018 and balance sheet growth was 13%, reflecting a combination of organic business generation and M&A.And speaking of M&A, we announced or completed three transactions during the year. One was a geographic expansion in our footprint, another was strictly an end-market deal, and the third, BoeFly was FinTech. And through all the negotiations, due diligence, regulatory processes and conversions and integration, we continued to grow organically without skipping a beat.So 2019 was a year where we focused on strengthening our balance sheet. Over 50% of the year-over-year loan growth was in non-CRE segments, as we benefited from our deep and experienced C&I team members. They continue to drive value on both sides of our balance sheet and proven that the foundation we began building over five years ago is hitting on all cylinders.And with this year’s growth, our CRE concentration improves to about 450% at year-end reflecting a fundamentally stronger and valuable balance sheet. And through continued focus on commercial banking relationships, we are driving our core deposit base, lowering our loan-to-deposit ratio and positioning us to generate even stronger earnings to build capital and that capital fuels organic growth and supports other value enhancing uses of capital such as stock repurchases, dividend increases and cash acquisitions.So let me talk a little bit about net interest margin, continues to be an investor focus. Sequentially, our net interest margin contracted by about 7 basis points, both on a pre- and post-purchase accounting basis, it may seem like a lot for one quarter, but actually I was pleased with where the margin ended up, which is 3.36% on a GAAP basis, up 9 basis points from last year’s fourth quarter.The decline for the sequential quarter was almost entirely due to lower prepayment and other fees. Meaning the declining yields on loans, after you back out purchase accounting and fees was virtually matched by an improvement in funding costs. And those funding cost benefits came from a shift in our funding mix with demand and interest-bearing transaction accounts increasing and CDs and borrowings decreasing. And one more point I want to make, we were intentionally less aggressive in lowering deposit rates after the October fed rate cut. So we still have some arrows in our quiver.Keep in mind also, we were coming off a quarter where the margin had just expanded by upwards of 15 basis points and the 3.36% GAAP and 3.26% adjusted this quarter net interest margin is still above the first half of this year of 2019. So going forward from what I can see right now and it is still early in the first quarter, the margin is looking stable.Let’s now move onto non-interest income. We continue to make strides in deposit fee income. For the year, core deposit fees are up 50% from 2018 results and some of that came from the acquisition of Greater Hudson.We also had higher than usual residential loan sale gains and going forward in 2020, I expect continued residential and an increase coming from commercial loan sales. And BoeFly is now contributing about $200,000 per quarter, a level we expect to improve upon this year based on a recent increase in the number of franchisors using the platform.So I want to close with some guidance on the amount and timing of merger cost saves with the Bank of New Jersey deal. So we originally estimated 60% cost saves. I think many of the times that -- thought that seemed aggressive. Well, as we disclosed when the deal was announced, there was a lot of branch overlap and we recently made a decision to close as many as seven of the nine branches and that 60% cost saves number is probably closer to 70%.We are converting Bank of New Jersey back-office to ConnectOne in early May, so the timing of save is a little spread out, so I am estimating right now a third of the saves coming in the first quarter, a second third in the second quarter and the full complement of saves by the beginning of the third quarter.So, all-in-all, it was a very good quarter and full year. We remain optimistic for continued superior financial performance in 2020.And Frank, I will turn it back to you now.

Great. Well, thanks, Bill. And so looking back on 2019, I am very pleased with what we have accomplished. As we look ahead to 2020, I’d like to reiterate a few key points. We continue to grow organically even in tough environment and see a strong growth rate for the coming year. We have a valuable franchise and continue to benefit from multiple streams of income and increased momentum across the platform.We are skilled acquirer with a track record of integrating both traditional and FinTech focus transactions quickly and effectively. We have established ConnectOne as an employer of choice in the market and continue to attract high quality talent to the culture and opportunities ConnectOne offers.We continue to enhance our efficiency to reduce friction from the banking process for the benefit of our clients and we are continuing our digital enhancements and investments. We are well-positioned to grow our lucrative franchise, while at the same time, building a valuable industry-leading company in the New York Metro market.With that, we are happy to take your questions. Operator?

Thank you. [Operator Instructions] Our first question comes from Matt Breese with Stephens. Please proceed with your question.

Good morning, everybody.

Good morning, Matt.

Hi, Matt.

I appreciate the loan growth commentary and the outlook. Can you just give us a sense as we think about not just the next quarter, but the next year? Can you give us a sense of composition, your expectations for composition and whether or not we should expect a continued trend, a relatively balanced C&I and commercial real estate growth in 2020?

I would say, Matt, organically the answer to that would be, yes, we believe we will continue the trend, approximately 50% of the asset growth coming from C&I segments and the other 50% coming from more traditional CRE, including construction and other.However, the numbers might be a little bit skewed with the acquisition of Bank of New Jersey, who was a little bit more real estate focused, but the organic growth will definitely be continuing the trend that we have set forth thus far.

And Frank, not too long ago, you were pretty bullish on single-family housing inside your market, just noticing supply/demand dynamics of younger folks that need houses. Do you still feel that way? We have seen a couple of quarters where resi has declined. Can we see a pickup there?

I -- I am still bullish. I think we have low interest rates. There is clearly not enough inventory in the marketplace. The inventory that is being built that’s, I don’t want to call it affordable, but that’s relevant to the marketplaces that we serve, flies off the shelf.But on the other side of that, the approval processes are incredibly long. It takes a very long time for anyone to get anything to get shovels in the ground. It takes even longer to get things built and so, I think, we will see a longer lead-up time, but all the projects that we have been involved in, we have seen sales actually -- that actually was part of the reason the construction portfolio sold off as quickly as it did in the fourth quarter. Those were successful projects. We like to see construction loans get paid off. So, yeah, I still see great opportunities in this marketplace.

Okay.

Rents continue to decline making house affordability even better.

Just on the C&I front, we have seen a lot of your peers turn from heavy commercial real estate concentrations looking to C&I for a source of growth to diversify, reduce CRE concentrations. We have also seen more recently a hiccup or two from some of your peers, not from you. Could you just give us an idea in your C&I book of the types of industries you are exposed to, the types of underwriting you are doing, collateral values and a general idea of the quality of underwriting that you are putting on the books?

So, Matt, as you know, we didn’t just wake up last year and decided to go into C&I. This is something that was started back at the old Center Bancorp, Union Center National Bancorp. They had a very large focus in the independent school space. We have taken that and moved that across a few other lines.We still are probably the largest provider of independent school loans in the State of New Jersey. We are expanding that market into New York, as well as looking at other opportunities, whether they are in the healthcare space, the foodservice space, there are certain segments that we like to play in.I would consider our underwriting standards to be quite conservative. We don’t do the full complement of all types of C&I lending that get lots of people in trouble. That’s just not where we are. We are generally there to support growing businesses through either acquisitions and/or lines of credit to support their businesses.So, overall, I mean, the entire thrust of the C&I program here has been to develop deep fee relationships with those clients. It’s been probably the largest driver of our deposit growth on our balance sheet and it’s been -- while the growth has been somewhat, we could say, it’s been fast -- it’s been fast relative to that portfolio, which has been really slow towards at the entire balance sheet of the growth -- growth of the entire balance sheet here at ConnectOne.

Understood.

We are still a pretty significant player. We are still -- we also do provide a lot of services -- banking services and C&I type loans for industries that are related to construction, something we have a lot of knowledge about. So, I think, we are about as conservative as you can be in that space.

Okay. And then just two more from me, you mentioned fee income, especially in regards to the BoeFly acquisition as a potential line item that could see some improvement in 2020. Could you just give us an extent of how much opportunity there is stemming from BoeFly and other fee income sources and to what extent maybe the revenue pie starts to change as they start to kick in?

So, I would say, a good objective for us is to double that income over the course of the next year, where we are continuing to have more users, franchisors using the platform and that’s directly leads to revenue out two months or three months or four months. So that would be my target.

So do you mean on a quarterly basis, meaning, if this quarter was $2.3 million in operating fees, we should look for $4.6 million a year from now?

Yeah. No. I am saying in -- for BoeFly you had asked about, where we are earning $200,000 a quarter…

Understood.

…doubling of that by the end of this year would be a good target for us.

Okay. And then just my last one is on CECL. I am sorry, did I interrupt you, Frank?

No. I was going to say, we do expect some commercial loan sales. So I do see that loan sale income increasing in 2020 versus 2019.

Okay. With that in mind, do you expect net loan growth to be 7.5% to 10% or with the loan sales below that?

I still think we are targeting high-single digits. Just it depends on those spreads and if the spreads are narrower and we don’t want to put them in portfolio, we might opt to sell more loans.

Okay.

But I don’t think it’s significant enough to change the target for growth.

Okay. That’s all I had. I appreciate taking my questions. Thank you.

Sure.

Great, Matt.

[Operator Instructions] Our next question comes from Collyn Gilbert with KBW. Please proceed with your question.

Thanks. Good morning, guys.

Good morning, Collyn.

Maybe I will start with where Matt left off that I think he was going to ask about CECL. But just curious…

Okay.

… if you could give us an update on that, Bill.

Well, we are going to be compliant and we will have fiscal charge with, I am not -- I don’t want to give out the amount right now. And we will probably be -- when we do determine the amount, we will probably put it out with the possibility of a changing.There are three different ways you can go with this. You can come out with an amount and say it’s definitive. You can come out with a range or you can come up with specific amount and say that it’s not definitive. But as you know, there’s lots of work going into that calculation, but I think we will be in the same ballpark as most other institutions.

Okay. Okay. All right. And then going back to the NIM and I appreciate your comment that the NIM came in better than what you were thinking. I don’t know maybe there was an interpretation or perception that the NIM was going to be quote-unquote stable for the fourth quarter. So just -- and I -- and you had indicated that you intentionally did not push deposit costs down after the October cut. So just maybe walk through a little bit of how you are thinking about kind of the components of that. And I guess especially how aggressive you think you could be going forward on deposit cuts, and perhaps, what didn’t happen this quarter that maybe the rest of us thought would happen?

Right. Well, first off, there are lot of components of the NIM that are choppy. And so when I said stable last quarter, it was really a core NIM is the way I look at it. We -- there is a bunch of different ways to look at it, with purchase accounting, it’s without purchase accounting, there are prepayment fees, so there’s different ways of looking at the NIM.But when we analyzed what happened in the fourth quarter, the decline in rate on interest earning assets basically matched the decline and the benefit in funding costs. So to me, the margin really was stable.We did have a decline in some choppy fees in prepayments that caused that margin to compress in the fourth quarter. But you could see it was probably more than average, right, above average in the third quarter with a jumping by 15 basis points. So…

Okay.

… looking forward, I believe the same thing is true. There are some things that are pushing the margin down. One of them is the Bank of New Jersey transaction, where they had a margin of 2.75% to 3%. So that sounds like it could be a lot, but it really isn’t, because it’s not that bigger component of our balance sheet and we already are working on ways to restructure their margin.But secondly, we still have room, as I said to lower our deposit rates. We have CDs that are re-pricing. So, and on the assets side, we are being disciplined and continuing -- we had fairly decent spreads on the assets.So all those things together, there’s a lot of moving parts leads me to the conclusion that it’s stable. But, yes, we could go up and down by 6 basis points to 7 basis points each quarter and that wouldn’t bother me as long as we are driving our ROA over 15%.

Okay. Okay. All right. That’s helpful. And I apologize if you included in the release. What was the -- what were the prepays this quarter and then what were they in the third quarter?

You mean in terms of basis points?

Yeah. Or dollar amount.

I think we lost about 4 basis points or 5 basis points quarter-over-quarter -- quarter-to-quarter.

Okay. Okay. Okay. And then, just on the expense side, so for the FDIC expense, again, perhaps, it’s interpreted, so there was obviously the credit didn’t come through in the fourth quarter, you are beginning to pay. But what’s the outlook for the FDIC expense line as we look forward?

So, I believe it’s the right accounting, although, some banks have done it differently. We didn’t get all the cash related to the rebate in the third quarter, but we took the entire benefit, because it was just a receivable.

Okay.

So we took the entire benefit -- third quarter had a negative expense in the third quarter, which we took out of our core earnings, but that’s not core operating earnings.

Yeah.

So I think it’s just a miscommunication about the timing of recognizing it versus realizing it.

Okay.

So, going forward, I think, it’s about $800,000 a quarter. That’s the run rate more or less.

Okay. Okay. Okay. Okay. That’s helpful. I will leave it there. Yeah. I will leave it there. Thanks guys.

Thanks, Collyn.

Sure. Thanks.

Thank you. At this time, I would like to turn the call back over to management for closing comments.

Okay. So thank you everyone for joining us on this fourth quarter conference call. We look forward to speaking to everyone next time, either on our next quarterly conference call or maybe before. Have a great day.

This does conclude today’s teleconference. You may disconnect your lines at this time and thank you for your participation.