ConnectOne Bancorp, Inc. (NASDAQ:CNOB) Q3 2023 Earnings Call Transcript

ConnectOne Bancorp, Inc. (NASDAQ:CNOB) Q3 2023 Earnings Call Transcript October 26, 2023

ConnectOne Bancorp, Inc. misses on earnings expectations. Reported EPS is $0.51 EPS, expectations were $0.52.

Operator: Hello and welcome to the ConnectOne Bancorp Incorporated Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I’ll now turn the conference over to Siya Vansia, Chief Brand and Innovation Officer. Please go ahead.

Siya Vansia: Good morning, and welcome to today’s conference call to review ConnectOne’s results for the third quarter of 2023 and to update you on recent developments. On today’s conference call will be Frank Sorrentino, Chairman and Chief Executive Officer; and Bill Burns, Senior Executive Vice President and Chief Financial Officer. I’d also like to caution you that we may make forward-looking statements during today’s conference call that are subject to risks and uncertainties. Factors that may cause actual results to differ materially from expectations are detailed in our SEC filings. 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.

Close up of a smart-phone displaying a bank’s online banking platform.

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 or schedules, which have been filed today on Form 8-K with the SEC and may be also accessed in the Company’s website. I will now turn the call over to Frank Sorrentino. Frank, please go ahead.

Frank Sorrentino: Thank you, Siya, and good morning, everyone. We appreciate you joining us today as we discuss ConnectOne’s recent quarterly performance. Before we take your questions, I’ll review some of the challenges and opportunities that we’re seeing, while Bill will review our third quarter in more detail. With that said, let’s jump right to the point. While we’re proud of our determination to serve our clients in this challenging time, it has been a difficult operating environment. Our operating results remain solid. However, these are not the financial results we’re accustomed to. We remain confident that we will return to our historical level of profitability based on the strength of our franchise. We understand that putting our clients first and putting our people first has a short-term cost in this difficult environment.

We also understand that continuing to make investments in our talent, technology and systems at this time is a choice we make. Nonetheless, as we collectively navigate near-term headwinds, ConnectOne remains resilient and committed to maintaining and in fact improving our business model. Importantly, we have the financial strength, balance sheet and capital structure to support this with both strong liquidity and a fortified tangible common equity position. We also continue to generate a sound operating profit, which when coupled with our solid capital levels, provides us with the flexibility to repurchase shares, pay dividends, invest in infrastructure and grow prudently. We’re seizing opportunities to strengthen our teams by adding high performing talent across the organization, and we made some notable hires this quarter.

This includes the appointment of a leading financial services executive as Chief Strategic Operations Officer and the addition of a seasoned technology executive as Chief Digital Officer to further leverage technological innovations. At the same time, we remain one of the industry’s most efficient banks nationwide as we continue to optimize operations, staff count and our footprint. Demonstrating the diligent execution of our operating model, we continue to support the needs of our clients and build opportunities in new markets and new verticals. To that end, our teams in South Florida and Long Island continue to build momentum as they capture market share. Operationally, we continue to expand through digital enhancements, including MANTL’s omnichannel deposit origination platform, BoeFly’s franchise referral and lending marketplace and our SBA lending platform.

Turning to credit. ConnectOne’s credit metrics remain stable and sound. We have a high quality client base. And during the third quarter, delinquencies and non-accruals remained low, reflecting prudent underwriting, strong portfolio oversight and a resilient economy. Regarding our CRE portfolio, our Manhattan office exposure is less than one-half of 1% of total loans and our entire New York City office exposure is less than 1% of total loans. Our office exposure in New Jersey is less than 4%, which includes high tenancy special services and multiuse buildings. And looking at our multifamily, as we’ve emphasized before, our Manhattan portfolio was less than 2.5% of total loans and only 5.5% in the other 4 New York boroughs. We’re predominantly focused in purchase money loans within suburban and commuter oriented areas in New Jersey.

So to wrap things up, we remain very optimistic and committed to building ConnectOne’s highly valuable franchise. We believe that the actions we’ve taken over the past 12 to 18 months position the Company for sustainable, profitable and rewarding growth going forward. With that, I’ll turn it over to Bill for the details.

Bill Burns: Okay. Thanks, Frank, and good morning, everyone. I’m not going to take lot of time this morning, but wanted to highlight some of the more important third quarter metrics and also provide you all with some estimated forward guidance. Let me start off with deposits. Our client deposits continued to grow sequentially. Excluding brokered, which declined by approximately $125 million, client deposits increased by $150 million on an average comparison and by about $50 million on a point to point basis. Our liquidity remains very strong by any measure. Readily accessible liquidity remains nearly 2.5 times adjusted uninsured deposits. The liquidity consists largely of on-balance sheet cash, unencumbered available for sale securities and we have unused lines of credit Federal Home Loan Bank and the Fed.

Each of those are well in excess of $1 billion. Adjusted uninsured deposits, which excludes collateralized municipal deposits as well as intercompany deposits represents 21% of total deposits. Onto the net interest margin, which contracted sequentially by 5 basis points and that is in line with our previous guidance. Our cost of interest-bearing deposits increased by 28 basis points this quarter, reflecting a cumulative beta of about 50%. Average non-interest-bearing declined by about $70 million, some due to seasonality and it’s more than we had anticipated. However, those balances have remained somewhat consistent over the past 60 days and in fact have grown since quarter end. We are cautiously optimistic that deposit costs have nearly maxed out, but there still could be competitive and funding mix pressures, so we could still see a modest amount of margin compression for another quarter.

As I’ve mentioned before, we are in a liability sensitive position and would benefit materially, I believe, from a decline in short-term rates and an upward sloping yield curve. In terms of loan repricing, fixed rate loans went on the books this quarter, were in the 8% to 9% range, while about $75 million of fixed rate loans exited at about 5.5 and the loan pipeline is predominantly wider spread C&I and construction, while the tighter spread multifamily originations are quite limited. Onto non-interest income, it continues to increase from SBA loan sales and we expect revenue here to accelerate in the fourth quarter and beyond. I don’t want to give you exact guidance right now because it’s a little too early in the quarter, but I’m confident of the upward trajectory.

And in addition, BoeFly is expected to be a further contributor to this line item. In terms of operating expense, as you know, we are already one of the most efficient banks. So efficiency is not a project for us, it is a way of life at ConnectOne. And so, notwithstanding our success of bringing in new talent, sequential expense growth was less than 1% this quarter and expect the same level of expense growth for the fourth quarter. Our efficiency ratio has increased to about 50% from 40% historically and that’s largely due to margin compression, but our operating expense percentage of average assets remains less than 1.5%, and that is among the best in the industry. Next, I want to talk a little bit about capital. Our tangible common equity ratio at the holding company was 9.1%, while at the bank level it is even higher at 10.7%.

And the tangible equity ratio at the holding company, which includes perpetual non-cumulative preferred is 10.3%. So, this strong capital gives us significant financial flexibility. And even though we’d still like to see our capital building, we also have room to moderately grow the balance sheet and continue our share repurchase program. Repurchases for the third quarter were about 300,000 shares. We bought those back below tangible book value and that makes those repurchases accretive to tangible book per share. And tangible book value per share was about flat from 6/30, but up 7% from a year ago. I expect continued growth in the tangible book value per share, a hallmark of ConnectOne Bank. On credit quality metrics, non-accrual loans ticked up slightly due to one multifamily loan that is well secured.

And if you exclude the taxi medallion loans, which are more than adequately reserved for that non-accrual ratio is 50 basis points, which is right on our historical average. We also had approximately $2 million commercial loan charge-offs that have largely been reserved for, and that led to 12 basis points of annualized charge- offs for the quarter. But our delinquencies of 30-89 days were virtually non-existent at just $3.5 million, that’s just 0.04% of total loans. And criticized and classified fell by more than 15% to just 1.4% of total loans, this was the 4th consecutive quarter of improvement. Rollover risk, it’s being well managed with majority of loans repricing without any potential downgrades. Going forward to the end of next year, we have about 10% of the portfolio rolling over to a higher rate with $350 million coming in the fourth quarter and about $650 million for all of 2024.

Obviously, we are proactively managing this group and again have been largely successful. And before I end, I just want to reiterate that our exposure to New York City office is minimal, a less than 1% of total loans. So with that, Frank, back to you, and then we’ll get to questions.

Frank Sorrentino: Great. Thanks, Bill. To wrap up, as we move through the fourth quarter and into 2024, let me once again reiterate that we have the financial strength, balance sheet, capital structure and talent to support our future growth. We’re confident in our direction and optimistic about our position. We look forward to updating you in the quarters ahead. With that, happy to take your questions.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Nick Cucharale of Hovde Group.

Nick Cucharale: The relatively flat loan portfolio has been well telegraphed throughout the year, although growth is in the DNA of the franchise. Can you help us think about the conditions where a return to growth is more plausible and when we may see that?

Frank Sorrentino: I think there’s two parts to that, Nick. Bill, maybe you have additional thoughts. But the first part is just the economy in general. We’re seeing less opportunities that we think make sense for us in the various lines that we’re in. Our pipeline is still quite strong. We do see payoffs coming out of the portfolio that sort of mitigate a lot of the new business that comes on board. And we’re being somewhat cautious looking at different ways of enhancing our underwriting relative to what we see. But the demand has definitely come down quite a bit. And certainly in a lot of the segments that we were the most active in, we’ve seen less demand. I think we are actually building more ability to grow the portfolio over time as more and more competition is walking away from a lot of the lines of businesses that we’re bullish about.

So, yes, I think all things being equal, notwithstanding any news that’s in the macro environment that could impact the economy, I think we will continue to have forward momentum relative to the loan portfolio and the entire balance sheet as a whole.

Bill Burns: Yes. Nick, I think it’s hard to always predict all the things going on, but we are going to remain disciplined in terms of pricing. So one thing that can impact how much we grow is what the competition is doing and how aggressive the competition is being because we base our loan growth based on pricing in terms of discipline, getting the right price, as well as bringing on relationships and deposits along with those. So, hard to say for sure, but as you know, our growth rate is typically pretty good in a growing economy.

Nick Cucharale: That’s very helpful. You also mentioned the pipeline in the wider spread businesses of C&I and I and construction. Is there a clear geography that’s driving pipeline activity as well, especially just noting your more recent investments in Long Island and Florida?

Frank Sorrentino: I think the pipeline — more than 90% of the pipeline is in our — right in our wheelhouse. It’s within the New York metro market and growing a bit in Florida as well. So we’re very happy about where the business is coming from. It’s not coming from areas we’re not familiar with. It’s actually the reverse of that. We’re doubling down in the areas that we are the most confident about and cherry picking for the best client relationships and the best loan opportunities.

Operator: Your next question comes from the line of Daniel Tamayo of Raymond James.

Daniel Tamayo: Maybe, Bill, just if you could just start on the margin, I appreciate your guidance for the fourth quarter for maybe a little bit more contraction. But just wanted to get your updated thoughts on, I guess, past that bottom in the fourth quarter, the type of expansion that you might be expecting next year, if we’re in this higher for longer type of rate scenario?

Bill Burns: Well, I think higher for longer is a negative for the industry, and that banks benefit from upward sloping yield curves. And the only comment I want to reiterate is that a return to lower short-term rates and upward sloping yield curve is going to help ConnectOne more than other banks in my view.

Daniel Tamayo: Okay. I think last quarter — maybe I’m wrong, but I thought we talked about, even in that scenario, some expansion for the margin, is that not the case in terms of how you’re thinking about it now?

Bill Burns: Yes, I think it’s possible as we get through into the beginning of next year that we can stabilize and start to increase the margin, but not in a dramatic way.

Daniel Tamayo: And then, I guess, just quickly on brokered deposits, did you have that number what that was in a period?

Bill Burns: Well, it was — in terms of reduction, it was $125 million. It depends whether you look at on average or an as of basis.

Daniel Tamayo: I was wondering as of.

Bill Burns: What the total?

Daniel Tamayo: Yes.

Bill Burns: The total brokered is $1.1 billion. And there is some confusion out there because reciprocal balances, typically ICS and CDARS are included in some measures of brokered, but this $1.1 billion we call true brokered and that’s what our level is.

Daniel Tamayo: And then, the borrowings that you have on your balance sheet, it looks like there was a difference in the end of period and the higher. I was wondering if some of those were replaced in the third quarter and then what maturities on those might be if you do have any plans to replace them?

Bill Burns: Well, the borrowings we replace as they mature. So, we’re not sure if you’re talking about doing anything ahead of time and paying a penalty. So, we’re not contemplating that. But yes, there could be increases in the borrowing costs as some of those rollover. Although some of them are short term and they were at high rates, so they’ll be gone. And if rates do decline, you’ll see lower rates on the borrowing line as well. So, it’s a little bit of a mixed bag, Dan.

Daniel Tamayo: Okay. Yes. I guess I was referring to the yield — or the cost on those is pretty low at 2.41 in the quarter and the average came down. So, I was just wondering if that — but if I think the end of period went up. So, it looks like you’re replacing — sorry, go ahead.