Earnings Call Transcript - CNOB Q2 2025

Operator, Operator

Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the ConnectOne Bancorp, Inc. Second Quarter 2025 Earnings Call. Today's conference is being recorded. After the speakers' remarks, there will be a question-and-answer session. At this time, I would like to turn the conference over to Siya Vansia, Chief Brand and Innovation Officer. Please go ahead.

Siya Vansia, Chief Brand and Innovation Officer

Good morning, and welcome to today's conference call to review ConnectOne's results for the Second Quarter of 2025 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. 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 also be accessed through the company's website. I will now turn the call over to Frank Sorrentino. Frank, please go ahead.

Frank Sorrentino, Chairman and CEO

Thanks, Siya, and thank you all for joining us this morning to discuss ConnectOne's Second Quarter, which reflects continued momentum in executing our strategy alongside successful integration of the largest merger in our company's history. On June 1, ConnectOne Bank officially launched as a unified entity completing the legal close of our merger with First of Long Island Bank. This milestone marks the beginning of an exciting new chapter for us, one that significantly enhances our scale and positions us to accelerate growth across all our markets, especially on Long Island. In line with ConnectOne's unique approach to M&A, we deployed a deliberate and focused effort to maximize energy both in preparation for and immediately following the close of the combination. The results are already clear, compelling and a direct reflection of our ability to execute an overwhelmingly strong client retention, demonstrating the success of our integration efforts and the continued loyalty of our combined client base. We're gaining momentum in new client onboarding as well as meaningful traction on new business opportunities. We had strong core deposit growth, including gains in DTA balances from both existing and newly acquired relationships. We're also seeing strong loan demand as we combine ConnectOne's deep expertise with significant growth opportunities across our new market. We entered the back half of 2025 with a solid diverse pipeline, which includes C&I, construction, SBA, and residential lending growth. Prior to Bill providing additional details about the merger and its positive impact on our financials and performance metrics, I'd like to emphasize a few things. Our assets now stand at nearly $14 billion, $11.2 billion in loans, and $11.3 billion of deposits, while our market capitalization today exceeds $1.2 billion. This quarter, we organically grew client deposits by a record amount, improving our loan-to-deposit ratio to 99% at the end of the second quarter, down from 106% as of March 31. The noninterest-bearing demand composition now exceeds 21% of total deposits, up from 18% as of year-end, reflecting both the merger and our client-focused relationship-based approach. Additionally, while this transaction propelled us above the $10 billion asset threshold, ConnectOne was already well prepared to cross this hurdle. We proactively managed the associated regulatory requirements and, as a result, anticipate only modest expense growth while remaining well-positioned to continue our growth trajectory. Next, I'm also extremely pleased to welcome our newest members to our talented team. Their deep expertise in community banking aligns with our client-first culture strategy. I'm equally proud of the commitment and dedication shown by our team, who immediately came together as one organization. The energy and collaboration of our combined team is palpable, and our bench strength and momentum position us to execute on the opportunities in our market. We had a flawless day-one brand transition, followed by the successful completion of a full systems conversion just two weeks later. Leading up to and throughout the transition, we placed a strong emphasis on delivering a seamless client experience. We proactively tripled our call center capacity to ensure responsiveness and continuity to address client needs in real time. Our clients were provided with broad access to the team, and I personally met with many, reinforcing our commitment to the relationship banking that defines ConnectOne. As a result, not only did we manage the conversion in under 30 days, we did so with excellent client and deposit retention while also growing balances and setting the stage for enhancing those relationships. Today, we're operating as one unified company with a single culture, consistent brand presence, and a shared vision. We are one team fully aligned and better positioned than ever to drive organic growth and create long-term shareholder value. And with that, I'll turn it over to Bill.

William Burns, Senior Executive Vice President and CFO

All right. Thank you, Frank. Good morning to everyone on the call. I want to start by reiterating that we are truly thrilled with the First of Long Island merger. It's strategic in that it expands our geographic footprint and client base. It's also financially disciplined and compelling, strengthens our balance sheet, enhances our key financial metrics, and ultimately boosts our franchise value. Now with any merger, particularly in the early stages of a transaction that closed mid-quarter, it can be challenging to digest what's going on behind the numbers. Therefore, I want to delve into some key areas to provide greater clarity. First and foremost, I want to highlight the exceptionally strong deposit and funding trends that ConnectOne is generating right out of the gate. On a combined company basis, noninterest-bearing demand deposits increased by more than $100 million since March 31 or approximately 15% annualized. And over the same timeframe, total deposits were up an annualized 8%, which reflects solid performance. But it's even more encouraging that when you factor in a $200 million decline in brokered deposits, our true core balances have increased by more than $500 million or 17% annualized. And with that robust deposit growth, we have been able to reduce wholesale Federal Home Loan Bank borrowings by about $200 million. Another point we want to highlight is the loan-to-deposit ratio improvement. Pre-merger, our first quarter loan-to-deposit ratio was 106%, declining to 101% on a pro forma combined basis at March 31. Fast forward to today, with strong deposit growth, the ratio has improved even further to a couple of percentage points below 100%. Going forward, we expect to operate at about that 100% threshold. The deposit growth is a testament to the success across the entire organization, particularly with a healthy contribution from the Long Island market. Many bank mergers often face challenges with deposit attrition. However, our unwavering focus on client retention has led to accelerated growth. Let me now turn to our purchase accounting entries. Now we're going to aim for full transparency regarding the merger's purchase accounting adjustments, both now and in the future to ensure our core underlying trends remain clear. The merger has a total loan mark of $250 million. That's comprised of a $207 million fair value accretable mark and a $43 million nonaccretable mark. The fair value mark of $205 million reflects a 6.6% discount to First of Long Island's $3 billion loan portfolio. A good portion of that is attributable to the $1.1 billion of residential loans we're taking on, which have a relatively longer duration. The $43 million nonaccretable mark on $270 million of PCD loans largely reflects a portion of First of Long Island's New York City regulated portfolio. When you combine that nonaccretable mark with the accretable mark on the PCD loans, those loans are now being carried on our balance sheet at about $0.70 of the dollar. I want to remind you that First of Long Island had a long-standing track record of credit quality; nearly all of the REM-regulated loans are performing. Nevertheless, under GAAP, we conservatively and appropriately allocated a healthy reserve due to the higher cap rates currently being applied to the subsegment. Now earnings accretion will be considerable. We are projecting them to be approximately $9.8 million per quarter for 2025, declining to $9.2 million per quarter in '26 and $7.9 million in '27. I'll address the impact of the accretion on our margin. Now the provision and allowance, I'm going to talk about that a little bit. The total provision for credit losses for the second quarter was $35.7 million, including a day-one provision for First of Long Island of $27.4 million and an operating provision of $8.3 million. Now that $8.3 million is higher than usual for ConnectOne. It was largely due to upward adjustments in our quantitative loss factors resulting from the merger, particularly attributable to the longer duration loan portfolio acquired. So in my view, the impact to CECL modeling is more or less a onetime adjustment. All things equal, we expect lower levels of quarterly provisions for the remainder of '25. As many of you are aware, there is a pending rule change that would eliminate the day-one provisioning. We will be able to reverse that charge in the future should it become effective, and that would flow through earnings and add about 15 basis points to the TCE ratio. Let me review the merger charges and cost-saving so far. So far, we've recognized $40 million in aggregate merger charges, and my expectation is we'll record up to an additional $10 million over the next quarter or two. The target was approximately $52 million, so I expect to remain below that after the full recognition. In terms of cost saves, we are on track. The second quarter was a mixed bag, just one month of the combined expense base and significant merger charges. Calibrating for those items, our expense base is what I expected. Going forward, as a 100% combined company, 2025 quarterly expenses are projected in the $55 million range, while in '26, the quarterly run rate is likely to be slightly higher, at $56 million to $57 million. These projections are consistent with the achievement of our 35% previously announced target. Just the other income line for a moment. Pre-merger, ConnectOne stand-alone was running at $4 million to $5 million. On a merged basis, that's going to go up to $6.7 million per quarter for the next few quarters, reflecting continued build of our SBA business in the Long Island market, while we also expect BoeFly to be an increasing source of gains on sale. Let me talk a little bit about the net interest margin. As always, there are many moving parts, but overall, we expect continued expansion. Those moving parts include the merger and purchase accounting. Organic widening as our deposit mix and loan pricing continue, sub debt issuance we just did, redemptions coming up, and Fed rate cuts. So a lot of moving parts there. Our conversations call for an approximate increase in our margin of 10 basis points for each of the third and fourth quarters versus the 3.06% reported in quarter 2. That results in a net interest margin of about 3.25% for further expansion expected through '26. That estimate assumes just one rate cut in '25. In terms of projected return on assets and return on tangible common equity, we're still comfortable with the previously announced 1.2% ROA and 15% return on tangible common equity as we enter '26, but we will refresh that analysis once we have a full quarter behind us. I'm hopeful for an even better outlook. Credit quality metrics saw significant improvement due to the merger and the workout on the sale of certain impaired loans. Our nonperforming asset ratio improved dramatically, to just 0.28% from 0.51% a year ago. The ACL as a percentage of loans jumped to 1.4% from just 1%, although the significant increase reflects the nonaccretable mark. Charge-offs remained in a reasonable range of 22 basis points in the quarter, with no significant increase expected. The CRE concentration ratio, as expected, ticked up slightly to 438%. But with the merger reducing CRE composition in the loan portfolio and higher earnings projections, we anticipate a sub-450% level by the end of 2025. I know you'll have questions about loan growth. Frank spoke to it a little bit. Organically speaking, the loan portfolio has recently remained relatively flat, largely due to elevated payoffs. Having said that, we continue to see solid demand as the pipeline continues to grow. Our capital remains strong to support growth. The Bancorp tangible common equity ratio stands above 8% at 8.1%, and it will trend upwards with strong levels of retained earnings, while the bank CET ratio today remains above 12%, just a little lower than before the acquisition, reflecting First of Long Island's lower risk-weighted assets. And with that, I'll turn it back over to Frank, and we'll take some of your questions.

Frank Sorrentino, Chairman and CEO

Thank you, Bill. As you just heard, I'm proud that we've been able to successfully close and immediately integrate this merger while also delivering on our strategic objectives as planned. We acquired a culture-complementary turnkey organization in an adjacent market with an enviable client base and a proven track record. Our markets are ripe with opportunities for a truly client-focused bank, and our expanded footprint and team, coupled with the momentum we've built, lay the foundation for a strong second half. As we move through the second half of the year, we look forward to driving growth and creating long-term value for our clients, team members, and our shareholders. Let me close by saying that our company was undervalued before, but today, I truly believe our valuation is even more compelling, making ConnectOne one of the best investments. As always, we appreciate your interest in ConnectOne Bancorp. Thanks again for joining us today, and with that, I'd like to turn it over for some questions.

Operator, Operator

We will now begin the question and answer session. We'll go first to Feddie Strickland at Hovde.

Feddie Strickland, Analyst

Great to see the criticized and classified loans as well as the NPAs down in the quarter. Are there any other opportunities in the back half of the year to maybe reduce those even a little further? They're already pretty low, but I'm just wondering if there are any big bogeys there.

William Burns, Senior Executive Vice President and CFO

That's asking about our projection for classified and criticized. I don't see any major change from where we are today. There are some stresses out there in the marketplace. I have classified loans that wouldn't be unexpected. With the write-downs, there are opportunities for us to potentially unload some loans there. So we'll watch that number, but I wouldn't expect any change.

Feddie Strickland, Analyst

Got it. And then just switching gears to capital with the deal behind you now and the likelihood of pretty good capital generation in the next couple of quarters, how do you think through the dynamic between capital deployment and managing CRE concentration?

William Burns, Senior Executive Vice President and CFO

Well, the numbers pan out very nicely to see CRE concentration. That's based on continued origination, which is part of it. And then because of the accretion of the deal and our relatively low dividend rate, we are really adding capital quickly. So I think I answered your question. We're going to see that go down on its own. Are you asking about stock repurchases and growth?

Feddie Strickland, Analyst

Yes. I'm just curious if there's a target level of common equity Tier 1 or any other metric where you'd be a little more likely to engage in share repurchases.

William Burns, Senior Executive Vice President and CFO

There's always a possibility. I mean, we came out of the gate when we talked about the deal that we would hold off on share repurchases at the beginning. In my view, the capital ratios are looking a little stronger than I originally anticipated. So I'll just leave that open for now, and we continually look at that in terms of share repurchases. It obviously depends on growth in the loan portfolio.

Operator, Operator

We'll move next to Daniel Tamayo at Raymond James.

Timothy DeLacey, Analyst

This is Tim DeLacey filling in for Danny. Just shifting to the margin here. I saw a really nice pickup in the securities portfolio this quarter. I'm curious what the drivers were there? And were there any actions taken on the legacy portfolio that you did?

William Burns, Senior Executive Vice President and CFO

Well, the securities portfolio increased because of the acquisition. So you see as of the balances on an average basis, it's less because it's only one month. But we did do some restructurings. We think we improved our interest sensitivity and earnings from those restructurings. So you'll see the benefits of those going forward.

Timothy DeLacey, Analyst

Understood. And kind of following up on that, there was a 5 basis point positive impact from a 25 basis rate cut previously. Should we kind of be thinking about that somewhat differently now, kind of post-merger here?

William Burns, Senior Executive Vice President and CFO

No, we're still maintaining that estimate; it's approximately 5 basis points for each cut. The estimates I provided were based on one cut. Therefore, it could vary depending on the number of cuts we experience through 2026. As we increase our noninterest-bearing deposit base, this will lessen the benefits of rate cuts, but it will enhance the overall interest rate profile of the company.

Timothy DeLacey, Analyst

Okay. Understood. Great color there. And then finally, just looking at reserve levels here going forward, standing at 140 here, obviously, a little bit elevated relative to historical levels. So how should we be thinking about those levels kind of trending from here?

William Burns, Senior Executive Vice President and CFO

Well, I mentioned that we had a slight increase, not counting the nonaccretable reserve, which explains the rise. I don’t want to speculate on how much of that reserve we will utilize, but we have established a rather conservative reserve. If we continue to be conservative and perform well, we will have the opportunity to increase our core reserves in the future.

Operator, Operator

We'll go next to Tyler Cachutore at Stephens Inc.

Unknown Analyst, Analyst

This is Tyler on for Matt Breese. Sorry if I missed it. I think you said the reserve was a bit higher due to increased cap rates on regulated housing. Do you know the cap rates that you ever used for that?

William Burns, Senior Executive Vice President and CFO

Well, this is in our purchase accounting, okay? And when you look at purchase accounting, you have to look as a buyer, as we do— that's what purchase accounting means for buying those loans. So you use cap rates that a buyer would use— so they probably ranged anywhere from 6.5% to 8.5% for the purchase accounting adjustment. If you get the loan appraised, you might see lower cap rates, but we used higher cap rates as a potential buyer of loans.

Unknown Analyst, Analyst

Okay. Great. That helps. And then— moving on to deposits. I see DTAs above 20% with the deal. How do you feel about that number going forward? And is growing that realistic given the current environment? If you could just talk a little bit about overall composition and growth heading forward.

Frank Sorrentino, Chairman and CEO

Yes. I think there's a lot of opportunity to continue the trend of growing DTA higher relative to the entire portfolio. And part of that is the mix of the loan portfolio. As we continue to execute on C&I and other opportunities in the marketplace that come naturally with deposits, and having what is a pretty substantial presence on Long Island, that had a higher DTA balance to begin with, we think there are some great opportunities to enhance many of the relationships that we formed there over the years. So I would say, we're really looking forward to continuing to build the book in a way that helps to keep the loan-to-deposit ratio low and the DTA balance is growing at a very well-diversified level.

William Burns, Senior Executive Vice President and CFO

We say we were certainly off to a really great start. So I'm pretty optimistic.

Unknown Analyst, Analyst

Okay. Great. And then if I could just squeeze one more in. I know you talked about the loan pipeline heading forward. What are the yields you're seeing on that right now? And then if you could give us some sense for near-term growth projections. I think on last quarter's call, you spoke about 5% for the year. What do you see heading forward?

William Burns, Senior Executive Vice President and CFO

Well, first on—sorry, the loan rate on our pipeline is 6.77%, okay? That's a weighted average rate. In terms of the growth rate, I want to tell you that we are originating a lot of loans. And so there's still a lot of demand out there. The reason for the lower than anticipated growth has been payoffs. So it's hard to say going forward, but I'd say we'd be in the single digits going forward for the next six months. It could be in the low single digits to mid-single digits. Frank, do you agree with that?

Frank Sorrentino, Chairman and CEO

Yes. Again, I'd like to characterize it as strong loan demand, whether that translates into actual balance sheet growth is still a little subject to some of the payoffs. By the way, a number of the payoffs we're seeing, we're happy to see. So overall, I think it gives us a better balance sheet going forward. I have to tell you, we seem to be very happy with both what's in the pipeline, what's coming off, and what the balance sheet should look like at year-end, both from a composition standpoint, earnings yield, and depository relationships— all the things that we've been working for. Whether we grow at 2%, 5%, or 6%, I don't want to say it doesn't matter, but to the extent that we can get the balance sheet that we want and we can continue to focus on treating our clients in the way that they want to be treated and being the bank that they choose as their number one institution, that's where we see success coming from, and that will translate into a profitable model.

Operator, Operator

And that concludes our Q&A session. I will now turn the conference back over to management for closing remarks.

Frank Sorrentino, Chairman and CEO

Well, I want to thank everyone again for your time today. We look forward to speaking with you again during the third quarter earnings call. With that, everyone, enjoy your summer.

Operator, Operator

And this concludes today's conference call. Thank you for your participation. You may now disconnect.