ConnectOne Bancorp, Inc. (CNOBP) Q4 2020 Earnings Report, Transcript and Summary

Greetings, and welcome to the ConnectOne Bancorp, Inc. Fourth Quarter 2020 Earnings Call. [Operator Instructions] As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Siya Vansia, Chief Brand and Innovation Officer for ConnectOne Bancorp. Thank you, you may begin.

Good morning, and welcome to today's conference call to review ConnectOne's results for the fourth quarter of 2020 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 as of the date of this call, and the company is not obligated to publicly update or revise them. In addition, certain terms in this call are non-GAAP financial measures, reconciliations of which are provided in the company's earnings release and accompanying tables or schedules, which have been filed 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, everyone. As everyone knows, 2020 was an unprecedented year in which we faced a series of unexpected challenges. As the pandemic worked its way through our markets, we watched our communities demonstrate their resilience by continuing to respond and adapt, and I'm proud of the role that the ConnectOne team played in supporting these communities through these challenging times. Our team responded to the pandemic in a way that defines our core values, demonstrating through action, our commitment to our clients, our communities and our founding principles. This unwavering commitment, coupled with a tech forward operational environment, allowed us to continue business without skipping a beat and is clearly demonstrated in our metrics. Today, the outlook is better than when the pandemic first hit. We're certainly not out of the woods yet. However, we see strong signs that we're on track to continue to build positive momentum towards a robust economic rebound and strong performance. Understanding the challenges we faced during 2020, and that we did not achieve some of the strategic goals we had initially set for the company, I am extremely pleased with the continued execution of our operating strategies. Our financial metrics were, once again, industry-leading with pretax net revenue hitting a record for the second quarter in a row, exceeding 2% as a percent of assets. Bill will get into the details in a little bit. We're very proud of this accomplishment. With solid revenues, increased productivity from technological improvements and a continued focus on streamlining ConnectOne's retail brick-and-mortar footprint, our efficiency ratio improved to under 40%, a key metric that we've been focused on. Credit losses and delinquencies remained very low, while deferments and modifications continue their downward trajectory. At year-end, deferrals declined approximately $210 million or 3.5% of total loans, just as we projected. Turning to loan origination. Excluding PPP, our portfolio grew, especially in the latter part of the quarter as a result of continued increased demand from organizations that have enhanced their businesses through the pandemic. Our loan origination has been strong in the back half of the year. However, the growth was offset by significant payoffs. Looking ahead, our teams remain actively involved with our clients, our overall pipeline is quite solid and we continue to expect net loan growth over the next few quarters, accelerating in the back half of the year. We're optimistic that the operating environment will improve during 2021, resulting in opportunities for growth, favorable lending spreads and best-in-class performance metrics for ConnectOne. Over the past year, our capital and reserves have grown significantly, positioning us for organic growth, potential M&A and the return of excess capital. We continue to view share buybacks as an important component of our capital management strategy and with our capital ratios increasing, our Board of Directors has reinstated the stock buyback program. We have about 600,000 shares remaining under the current program and expect to opportunistically repurchase shares in the months ahead. Additionally, along with today's earnings release, our Board of Directors declared a $0.09 per share quarterly common dividend. With our growing capital base, ConnectOne has the capacity to sustain a higher dividend, and I expect our Board could revisit our dividend level soon. As we all know, banking is changing and the environment that COVID created has accelerated its transition with both clients and employees embracing the use of new tools. We've seen meaningful technological shifts, including automated and digitize financial processes, virtual deposits and reliance on remote mobile banking platforms. As many of you have heard me say before, it's really the year 2030, just 9 years early. Over the past few years, ConnectOne has made meaningful investments in adopting technology to remain competitive, creating efficiencies and getting closer to our clients. These investments played a critical role in competitively positioning ConnectOne as a modern financial services company. We're well positioned to move into the future state of banking in the new digital world. Toward this end, BoeFly, our fintech subsidiary, experienced a strong year, pivoting quickly to support both small businesses and banks in the rollout of the PPP program. BoeFly's involvement with PPP allowed them to further their marketplace model and expand their brand presence amongst banks, franchisors and small businesses. Simultaneously, BoeFly completed its infrastructure rebuild and now moves into 2021 with a stronger and more robust digital foundation. We're seeing increasing client acquisition on this platform as we invest for the future. We've nearly scratched the surface on the benefits gained from this bank-fintech alignment and look forward to working with our partners at BoeFly as they fuel their forward momentum. We also see attractive opportunities to work with fintech companies to both enhance our digital products as well as to expand BoeFly's platform. We remain committed to leveraging our strong technological foundation and look forward to updating you on new digital and tech investments in the quarter ahead -- quarters ahead, rather. Before I turn the call over to Bill, I would like to mention that in December, we further strengthened our management team. We promoted Elizabeth Magennis the President of the bank. As you all know, Elizabeth has been a critical part of the bank's growth and strategic direction and her appointment to President is a natural progression for our company. We also made an important hire with the addition of Michael O'Malley as Chief Risk Officer; Michael brings with him extensive risk and fintech experience, which will support the bank in building out a more robust risk framework, as our balance sheet and our complexity grows. These executive appointments allow us to further our competitive position, while supporting our growth into a modern financial services company. So in summary, we're pleased with our performance this past year. I'm exceptionally proud of our team and their continued resiliency, and we're excited about the prospects for growth in 2021. So with that, I'll turn the call over to Bill to provide some more details on the quarter's performance.

Thank you. Thank you, Frank, and good morning, everyone on the call. I too would like to very much thank our staff of a tremendous response and their efforts over the past year in the face of these difficult working conditions. And to that end, we finished the year with a very, very strong fourth quarter. Our preprovision net revenue as a percent of assets surpassed 2%, placing us again near the top of the industry. Some of our peers are releasing reserves, but we added another $5 million, the same as in the sequential third quarter. That amount is approximately $3 million to $4 million in excess of what we have historically provided for a quarter. So even with that elevated provision, we reported, on a GAAP basis, 1.35% ROA and a return on tangible common equity exceeding 15%. If you normalize our provision to what we've done -- put aside before, we would have had an ROA in excess of 1.5% and an ROE approaching 17%. I want to add, that's on a tangible equity basis, grown considerably over the past year. So very, very strong results on either a GAAP or an operating basis. Now as the path to economic recovery is becoming clearer, we see increased ability to return excess capital to shareholders. We plan to do that through a combination of share buybacks and higher dividends, of course, subject to our Board's approval. Supporting this course of action, our tangible book value per share and capital ratios have increased at a very nice pace over the past year. We're at about $17.50 per share, tangible book value close to a 10% increase from $16 a year ago and all of our capital ratios have increased measurably. Our common equity Tier 1 ratio at the holding company is 10.8% and at the bank, it's over 12%. And our dividend payout ratio is running below 15%, and there is ample room to increase our ratio even given due consideration for increased organic growth. Let me now turn it to credit and reserves. So bottom line, our credit is performing well. Our borrowers have benefited from the CARES Act and the accommodations we've afforded them. They have benefited from the ongoing fiscal and monetary stimulus and just in general, the improving economic outlook. So of the loans that would defer originally, some 80% have returned to invoicing and over 95% of those loans returned to invoicing are paying in full and are current. And I want to give you some details on what's left in the $210 million deferment bucket at year-end. And these details give us comfort. First off, more than 95% are collateralized. 70% of the $210 million continue to make some form of payment whether principal or interest. Now the largest subset, about 1/3 of the $210 million is New York City multifamily properties. The collateral is very strong on those properties with underwritten LTVs averaging below 60%. Debt service coverage ratio is no lower than 1.25, but actually quite a bit higher. And keep in mind, these loans are primarily used to fund purchases with significant equity invested by sponsors. We tend to do very little refinance lending in the multifamily space. And we've said this before, we have minimal exposures to hot line industries such as hospitality, travel, energy. Aside from the deferrals, overall credit quality metrics are stable or improving. Actual charge-offs and delinquencies continue to remain very low. Our level of nonperforming assets fell with those asset quality ratios each improving by about 6 basis points sequentially. Our reserve for loan losses as a percentage of the total loan portfolio, excluding the PPP, strengthened to 1.36%. That's nearly double where it was a year ago. And the $5 million we had in reserves this quarter reflects the continued uncertainty with respect to the timing and ultimate impacts of the pandemic. This thinking is consistent with the Fed's recent statements. And let me comment on CECL. I think you're aware with the most recent extension of the CARES Act, banks are allowed to postpone the implementation and we will do so. Our current thinking is we will postpone the implementation by just 1 day that is from year-end 2020 to the beginning of the year 2021. The rules actually allow for a deferral until 2022. Now we continue to run estimates under the CECL and don't believe there will be a material impact to our financial statements upon adoption, probably a slight increase to our allowance. Now let me get back to our operating performance. Especially, I want to talk about the net interest margin. Our net interest margin widened once again just by 1 basis point this time, but this was the fourth consecutive quarter of expansion. Our margin performance has been strong and stable up slowly and steadily by a total of 14 basis points from the year ago 20,194th quarter. As you know, there are a lot of moving parts with the margin, but we have benefited over the past year from the structure of our balance sheet from our overall earning asset structure, which reflects a relatively low amount of pure floating assets, combined that with liabilities that contractually reprice fairly quickly, combined with our proactive management of the pricing of non-maturity deposits. Now during the recent -- most recent fourth quarter, we did have a larger-than-normal level of prepayment income, but that was completely offset that benefit by increased liquidity and a slower amortization of PPP fees. We sold them down by about $1 million from the sequential third quarter. On the PPP, we've got another $5.7 million of nonamortized fees to go. I'd like to say that, that would be substantially paid up by midyear, but it is likely that a portion of PPP loans will remain outstanding beyond that. So let's look forward with regard to the margin. Over the past year, our originations have largely been at spreads well in excess of prepandemic levels. I think as we deploy our excess liquidity and grow, we will continue to do so at loan spreads, which have been wider, and this will continue to benefit the NIM. But notwithstanding what I just said, we are at the early stages of competition-based narrowing. History tells us these wider spreads will continue to narrow. But at the same time, banks will benefit from the CPO curve along with historically low short-term rates. There are also a couple of items working to our advantage as we start '21. First, we redeemed $50 million of high rate sub debt at the beginning of January. That, in and of itself, will help the margin by 3 to 4 basis points. And second, we continue to see significant repricing and reduction in our CD portfolio. We have another $600 million in that portfolio set to mature over the next 6 months. They're at rates at over 1.50. The volume of that maturity, those maturities will ramp down throughout the second half of the year. And now we're looking forward in terms of projecting our margin for future years. We have begun to lengthen our liabilities, locking in funding in the 5-year plus brackets at a very attractive cost of 50 to 60 basis points. So all in all, I see a fairly strong, stable margin for ConnectOne through 2021, possibly beyond that, although it is very challenging to project margins beyond the 1-year time frame. Now it was also a strong quarter for noninterest income, is driven by gain on sale of loans. This is not a big business for us, but we continue to have success on the commercial loan sales side largely on an opportunistic basis. For the quarter, residential loan sales also saw an uptick. As I've guided before, we will continue to see modest amounts of revenue here. On the expense side, we were flat sequentially. I think I did mention that in the prior call. My expectation going into next year is for mid- to single-digit expense growth. We continue to invest in people and technology. Now we did drive the efficiency ratio below 40% for the quarter. That is our goal to be sub-40%. But that will depend, in 2021, on revenue growth, which I think is likely to occur more towards the latter part of the year as the pandemic winds down. So I look forward to taking your questions after Frank's closing remarks. Back to you, Frank.

Thanks, Bill. So while we planned for a very different year in 2020, we adapted and ended the year on a very strong note at all levels. Our infrastructure and talent were able to respond to the challenges while also delivering solid returns. Our earnings profile is strong. Our balance sheet and credit are in a good place. Our already best-in-class efficiency improved even further and our capital position is solid. So as we look ahead, I'd like to reiterate a few key points. We continue to grow organically and see a strong growth rate for the coming year, which we expect to reach high single digits, if not possibly double digits, in the latter part of 2021. We have a valuable franchise, and we continue to benefit from multiple streams of income and increased momentum across the entire platform. We're a skilled acquirer with a track record of integrating both traditional and fintech-focused transactions quickly and effectively. We're continuing our digital enhancements and our investments and are excited about our future and remain confident in our ability to drive value for our shareholders, our team and our clients. We look forward to sharing updates with you as the year unfolds. And with that, I'd be happy to take any questions.

[Operator Instructions] Our first question comes from the line of Fred Cannon with KBW.

It's pleasure to cover you guys at least in the short-term and continue that. Just 2 kind of broad questions really. One is on PPP 2.0 and how you see that evolving versus the first round that we had during 2020?

Well, I would have to say that in PPP 1, I think we can confidently say we had no idea what we were doing going into that. But I think we have a much, much better handle this time around. I also think that it will be more commonplace in PPP 2 to deal with clients that have already been through the pipe with us on PPP 1. And so the vast majority of those clients will have already been through the process once. We have some new technology up and ready to simplify the process. We understand the process. So I think it will be a less stressful time, not -- no stress, but a lot less stress than the original process. I also think that there will be some opportunity to onboard some new clients that maybe were dissatisfied with the treatment that they received the first time around, and we're seeing some evidence of that as well. But I would say probably the vast majority will be existing clients.

And just as a clarification, do you see most -- a majority of clients who receive PPP 1 reapplying for PPP 2?

Right now, it's about half, and I just think that just maybe people need to assess what the program provides for. First time around, pretty much if you had a warm forehead, you could apply. This time around. I think you need to actually demonstrate what types of revenue declines that you could show between 2019 and 2020 and on to now 2021. So I do think there's a little bit more responsibility on the borrower to demonstrate the actual need. And so that will weed out some of the folks that will be entitled to PPP. But I think it's a little too early in the process to tell you what percentage is actually going to come through or not.

And then -- that's helpful. In terms of -- you mentioned fintech acquisitions.

Hold on. One last point going back to PPP was, I also think we're not going to see there was a mad rush in PPP 1 for very large borrowers that were trying to utilize the program. And I think that's pretty much all but gone.

Right. Hopefully, it will be less chaotic, as you said. In terms of fintech acquisitions, we've seen this -- in the last few months, we've seen the stack impact on fintech firms and driving acquisition prices up significantly. Do you see that -- what's going on with the stack market and the number of fintech firms coming to market affecting your acquisition strategy in that area?

Well, I think it's still right now in the fairway as far as we're concerned about evaluating, looking for good opportunities and looking for where we can work together with a fintech, either if it's in a pure acquisition, a JV partnership or some sort of strategic alliance. So yes, the valuations make it a little bit more difficult from my perspective. But I think at the end of the day, we'll still be able to accomplish the goals that we set out.

All right. Great to see the strong momentum coming into the new year.

Thank you.

Thank you.

[Operator Instructions] Our next question comes from the line of Frank Schiraldi with Piper Sandler.

I just want to start on -- Frank, on the momentum in loan growth you talked about, particularly your thoughts in the back half of the year. Is some of that acceleration based on the fact that the multifamily space has maybe gotten a little less competitive? Or just a little more color maybe if you could on what's driving your optimism there?

Well, as we -- as I spoke to in the -- in my comments, we did see strong growth and a strong pipeline, even in 2020. A lot of the businesses that we have a priority in have done quite well. Our construction portfolio and our builders, developers, managers, they are all hitting on quite a few cylinders, especially in the suburban markets here in New Jersey, Long Island and elsewhere. So unfortunately, that was offset by a lot of payoffs. But if you saw the real strength behind the number of loan originations we did in 2020, and that was in the teeth of the COVID pandemic, as we roll forward into '20, our expectation is a lot of the backdrop is going to fall away a bit. And the efforts we put in, in 2020 are just going to roll forward in 2021. We'll continue to see additional growth in our pipeline, but will have less in the way of payoffs. That's also against the backdrop of I believe -- we believe, collectively, that the economy is just going to get a little bit better and a little bit stronger, whether it's because of the vaccine, whether it's because we figured out how to live with COVID, whatever it is. I think all the really significant ups and downs in the economy are going to start to flatten out a bit. And I think people are going to start to realize that New York City is not going to empty out completely. They're not going to put a fence around it and close it. People are going to start to return to some semblance of normal life. And that's going to bode very well for us. Plus, we find ourselves in a variety of markets that have shown resilience and strength throughout the pandemic and we expect those to get even stronger as we move through 2021. So the combination of all those things gives us a lot of confidence to say that in 2021, our organic growth will continue to increase the net growth of the company.

Okay. And just as it pertains to the multifamily side of things, how do you see those loan balances flat, up, down? I mean, I know they've been kind of contracting over time. But what are your thoughts for 2021 as maybe the space has changed a little bit?

Yes. I think we'll see either flat or -- as far as percentage of portfolio, I think we'll see flat or possibly increasing slightly.

Okay. And then Bill, just on the deferral. Now that we're at year-end and we've gone through, I guess, pretty much 6 months, I know there's an extension now for the COVID deferrals. What are your thoughts for how this migrates over the next couple of quarters? Do we see a decent amount migrate into NPA status? And if so, just wondering -- it seems like you guys are pretty comfortable with your reserves to date here.

Yes. No, no, that's a good question. At some point, right, the deferrals can't go on forever. And then banks, including ConnectOne and old banks will have to make a determination for loans that are impaired to put them in those categories. So I think you're going to see industry-wide, at some point, an increase in impaired loans, potentially nonperformers. But I don't see the losses being all that big. The collateral is pretty strong. And I think we're well reserved at this point. So from a capital perspective, book value perspective, I don't think there's going to be much of an impact. But yes, it's possible that we'll see an uptick in those numbers across the industry.

[Operator Instructions] Our next question comes from the line of Matthew Breese with Stephens Inc.

I was hoping to get a -- I know you said spreads are wide, you expect compression. Maybe could you frame for us, as you look at the pipeline, what the blended loan yield is today versus a year ago and the extent of spread compression that we might see. Maybe you could give us an idea of what you're thinking there.

Well, first off, the spread expansion widening is in the order of 50 basis points or more when I'm looking at the past -- since the pandemic started compared to before. So right now, we're starting off with spreads that are typically wider than we've been used to in the years leading up to the pandemic. How fast it's going to compress? It's hard to say. But all things considered, I feel confident about the margin here at ConnectOne being able to stabilize it at these levels. And as I mentioned, there's a couple of reasons why our margin will improve. One being the repurchase of the sub debt; and two, we've got a lot of repricing going on with the CDs. So we'll be able to handle some compression on the asset generation side and still maintain our margin.

And as you think about the interest rate positioning of the balance sheet, can you just talk a little bit about where you stand today as far as asset-sensitive, neutral, liability-sensitive? And how you're kind of thinking about the next few years and where you want to be?

What was that? I think we're just -- we're in good shape right now to benefit -- look, if the yield curve steepens, that's going to help us. To the extent yields stay where they are, I see the margins staying within a band that I've been talking about, plus or minus 5 basis points.

Okay. And then -- I'm sorry, Bill, go ahead.

No, no, no. I wouldn't worry too much about rates rising or falling and what the impact is going to be on us. We're pretty well managed to try to maintain a stable margin.

Yes. Understood. And then beyond just the fundamentals of the bank, you guys have done a few deals more recently, whole bank deals. Just curious have conversation flows have been over the last handful of months as most banks have reported lower deferrals. I would assume conversation flows increased. Just want to get a sense and how you think about participating in M&A?

Yes. Matt, I would tell you that in the March-April time frame, nobody wanted to talk about M&A. And I think in the November-December time frame and January, everybody is talking about some form of M&A. I don't think it's lost on any bank's CEO today that the world is changing. My comments about it's not really 2021, it's 2030. We just got the opportunity to see it 9 years early. Has really awakened people to think about things that they probably didn't think about prior to the pandemic. And there's been a real acceleration in the marketplace and a dramatic shift in how people think about just ordinary everyday occurrences and the way they go through their lives. And banking is not immune from that. So I do think everyone's talking about it. I -- if you're asking me specifically, yes, there's definitely conversations or an increase in the number of conversations across the entire spectrum. So I think we're going to see very active -- as an industry, I think we're going to see a very active 2021.

That's great. Just last one. Bill, what was the accretable yield income this quarter?

On purchase accounting?

Yes.

13 basis points.

Ladies and gentlemen, that concludes our time allowed for questions. I'll turn the floor back to management for any final comments.

Well, I just want to thank everyone for tuning in here today for our fourth quarter report and year-end review for ConnectOne Bank. And I certainly look forward to being together with you again as we report on our first quarter. So thank you all, and enjoy the rest of your day.

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