Earnings Call Transcript - CNOB Q3 2025

Operator, Operator

Thank you, and welcome to the ConnectOne Bancorp, Inc. Third Quarter 2025 Earnings Call. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Siya Vansia, our Chief Brand and Innovation Officer. Ma'am, 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 third 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. 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

Thank you, Siya, and good morning, everyone. Pleased to report that during the third quarter, we continued to build upon our strategic objectives, a clear reflection of our team's focus, client dedication and discipline. As a result, the integration of our merger is complete, credit quality remains solid and our margin continues to expand, all while organically growing our balance sheet. Our systems merger integration, which took place only two weeks after the legal close, went exceptionally well, driven by outstanding collaboration across our team. In our first full quarter post-merger, we're operating seamlessly. One organization, consolidated systems, strong cultural alignment and a unified client-first mindset. We have since built meaningful momentum across our markets, leading to accelerating performance metrics. We're seeing strong engagement, ongoing new client onboarding, and healthy growth in loans and deposits. This progress is especially evident on Long Island, where we're leveraging our strategy to drive growth and strengthen our business. An attractive market we entered several years ago, the merger has accelerated our goals. Importantly, the positive financial aspects of the transaction are beginning to take hold, and Bill will discuss a little bit more about that in a moment. Operationally, ConnectOne's ability to attract and retain deposits remains a strength. During the third quarter, our core deposits continued to grow across both established and newly acquired client relationships. Loan originations this quarter remained healthy with over $465 million in new funding. Our team is energized to leverage our expertise and attract growth opportunities across our portfolio. Looking ahead, we're well positioned for the balance of 2025 and into 2026 with a healthy and diversified pipeline for C&I, CRE, construction, and SBA lending, demonstrating the strength and reach of our franchise. Credit remains strong, supported by prudent and consistent underwriting standards and portfolio oversight. Our nonperforming assets were just 0.28% at the end of the quarter. Annualized net charge-offs remained below 0.20% and 30-day delinquencies were just 0.08% of total loans. Additionally, ConnectOne's capital and tangible book value grew meaningfully. Overall, our third quarter operating performance clearly demonstrates the strength and potential of this organization. And with that overview, I'll turn it over to Bill to walk through some of the performance details.

William Burns, Senior Executive Vice President and CFO

All right. Thank you, Frank. Good morning to everyone on the call. It was a great quarter, and our outlook remains very positive with strong performance anticipated across all of our operations. As Frank mentioned, the merger, which was finalized five months ago on June 1, is now fully integrated, and that was due to a swift seamless brand and back-office systems conversion completed within the very first month. That rapid integration has allowed our performance metrics to excel with further improvements expected in the fourth quarter and into 2026. Operating performance metrics already show significant year-over-year improvement. In the current quarter, our operating return on assets increased by over 30 basis points to 1.05%, while PPNR as a percentage of assets rose by approximately 50 basis points over the past year to 1.61%. Our earnings performance is being driven by the merger and a widening net interest margin, which grew to 3.11% from 3.06% in the sequential quarter and from 2.67% a year ago. The spot margin at quarter end was already higher than 3.20%. We expect the fourth quarter margin to be at 3.25% or even above. Now the current quarter's margin of 3.11% reflected two temporary factors. One was the $75 million of high-rate subordinated debt that was still outstanding but redeemed on September 15. We also had higher than typical average cash balances due to the large deposit growth that we've had, which exceeded $600 million. We anticipate average cash balances to be below $400 million in quarter four as that cash rotates into loan funding. So without those two items, which compressed the reported margin, the third quarter NIM would have been in excess of 3.50%. In terms of the balance sheet, we continue to observe robust deposit growth following exceptional organic growth in the second quarter. On a sequential basis, our client deposit growth was approximately 4% annualized, building on the second quarter's annualized growth of 17%. Annualized sequential loan growth for the quarter matched deposit growth, and that maintained our loan-to-deposit ratio below 100%. Now the loan pipeline is strong, and we expect loan growth to accelerate in the fourth quarter with average loans increasing by more than 2% quarter-to-quarter versus the sequential third quarter. Please keep in mind for your models that average cash is likely to decrease, which will slow the increase in total interest-earning assets. In 2026, we could easily see loan growth in the 5%+ range, dependent on the economy and loan demand. Additionally, strong performance this quarter was supported by two nonrecurring items that boosted pretax income by more than $10 million. First was a $6.6 million cash received this quarter from the employee retention tax credit that was conceived during the pandemic. This allowed ConnectOne to qualify based on our staff size, which has since grown to about 750 employees. The second nonrecurring benefit recognized during the quarter was a $3.5 million pension curtailment gain relating to the freezing of First of Long Island's pension plan effective September 30, with the shifting of those benefit values to our 401(k) match program. This realignment will result in merger net cost savings of $1 million annually, in addition to the one-time $3.5 million present value benefit recorded this quarter. Noninterest income was very strong this quarter due to those nonrecurring items, exceeding $19 million. The recurring level of noninterest income now remains at about $7 million per quarter. We expect growth in gains on sales as we continue to build out SBA, BoeFly, and residential mortgage. We anticipate SBA to add significantly to our noninterest income in 2026. Keep in mind, with the government shutdown, we could see a backlog building in the fourth quarter, which will be addressed after the government reopens. Operating expenses, net of merger and restructuring charges were $55.8 million, and our recurring run rate guidance remains approximately $55 million to $56 million for the fourth quarter and $56 million to $57 million per quarter during the first half of '26. The latter part of '26 could drift slightly higher. I'll keep you updated on our targets as we move forward. These amounts reflect normal expense growth, net of additional merger savings not yet realized. Turning to taxes, our tax expense line for the full year has been a little tricky, reflecting the merger and a second-quarter charge related to intercompany dividends. Our actual marginal tax rate has trended upwards, but our growth and geographic reach have impacted our traditional tax strategies. For '26, we plan to utilize new strategies, expected to result in an effective tax rate in the range of 28%, maybe a little higher. Let me turn to credit. As Frank mentioned, and I will repeat some of these numbers, credit quality remains sound by all measures. Our nonperforming asset ratio is at historical lows at 0.28%. Charge-offs for the quarter were just 18 basis points, while delinquencies more than 30 days were only 0.08% of total loans. The CRE concentration continued its downward trend, falling to 4.34% as of September 30. Our capital ratios continue to strengthen, and our tangible common equity ratio rose significantly to 8.4%. While our goal is to reach 9%, there's no immediate need to achieve this. Additionally, tangible book value has resumed its upward trend, with a 5% increase in tangible book value per share since the merger's completion. With a higher level of projected retained earnings, we expect to have enough room in '26 for a common dividend increase and opportunistic share repurchase. That's it for my introductory remarks, and back to you, Frank.

Frank Sorrentino, Chairman and CEO

Okay. Thank you, Bill. Simply put, we've built a premier commercial bank with the scale and talent to serve the largest and one of the best markets in the country. ConnectOne's franchise value is in its strongest position ever, driven by accelerating financial performance, prudent organic growth opportunities, a strong technological focus, and solid credit quality. Based on where our stock is trading today, we believe there's never been a more compelling time to invest in ConnectOne. 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 your questions.

Operator, Operator

Our first question comes from the line of Daniel Tamayo from Raymond James.

Daniel Tamayo, Analyst

Maybe starting on your profitability targets. I think last quarter, you talked about, Frank, hoping to hit 1.2% ROA and 15% ROTCE in 2026. Just interested in your current thoughts around profitability targets for next year.

William Burns, Senior Executive Vice President and CFO

I think those targets are still in line with what we said before. I easily see getting to 1.20% by the second quarter. My model at least is showing us getting close to 1.30% by the end.

Daniel Tamayo, Analyst

Okay. Great. And then a follow-up kind of unrelated, but we saw yesterday the announced end of quantitative tightening. I'm just curious about your thoughts on how that could impact deposit growth and/or pricing in your markets.

Frank Sorrentino, Chairman and CEO

Well, I think it will bode well for us going forward. Certainly, it appears the Fed believes the economy is going to continue to be somewhat robust and that more liquidity is needed in the marketplace, and that liquidity generally turns into deposits at banks. So I think across the spectrum of banks, you'll see deposits continue to grow, which is good. It will reduce some of the competitive pressures out there. I think everyone has seen over the last quarter or two, while short-term rates have gone down, there's been increased competition for deposits. So a steepening yield curve, more liquidity, and a robust economy that remains stable should bode well for ConnectOne and the industry.

William Burns, Senior Executive Vice President and CFO

I agree with what Frank said. The margin continues to expand for all the reasons we've talked about before. While we don't know exactly how many Fed cuts will occur by the end of next year, there are going to be a few. Our loans are repricing faster. Even in a down rate environment, our loans are repricing upward. So I expect margins approaching the 3.40% to 3.50% range by the end of next year.

Daniel Tamayo, Analyst

That's great. Yes, let's hope all of that works out in your favor. It seems like it's trending positively. I appreciate all that color, guys.

Operator, Operator

Our next question comes from the line of Tim Switzer from KBW.

Timothy Switzer, Analyst

The first question I have is now that you have closed the merger, full quarter in, how do you think about capital allocation and deployment going forward? Frank, you mentioned you think your stock is a value. Are share repurchases on the table here? I'd like to get some color on that.

Frank Sorrentino, Chairman and CEO

From my perspective, I know Bill made some comments about our ability to build capital. Capital is building quite quickly at the company from various areas, including the profitable growth we have. I do think we'll have a lot of flexibility in 2026 to make decisions regarding that capital. Of course, if we see higher growth rates and are opportunistic in organic growth at the higher end, that will leave slightly less for other opportunities. Overall, I think we can pursue anything in '26.

William Burns, Senior Executive Vice President and CFO

Yes. I agree with that. Our growth is going to be prudent and disciplined in terms of spreads. I’d like to see the capital ratios trend upwards. However, as I mentioned, because of our low dividend payout ratio and high earnings, we have room for opportunistic share repurchase.

Timothy Switzer, Analyst

Okay. Great. That's good to hear. I was also looking to get an update on BoeFly and maybe the growth outlook there, putting aside the government shutdown, the impact on SBA. I'd love to get some color on that and also on any recent rule changes governing smaller dollar loans in SBA.

Frank Sorrentino, Chairman and CEO

We'll start with BoeFly. Bill will talk more about the specifics of the various programs. BoeFly has continued its upward trend since its inception at ConnectOne. We now represent over 250 national franchise brands, which is an all-time high. Since we purchased the company, we focused on being the leading company that can validate franchisee applications in that space, leading to growth in our portfolio. We've made significant efforts to drive opportunities from that business to our growing SBA platform, and we are starting to see the financial benefits. You will continue to see this in the future through the expanding SBA revenue line. We are very happy about where we are and where we're headed.

William Burns, Senior Executive Vice President and CFO

To reiterate what Frank said, we have spent the past couple of years building and perfecting the platform for BoeFly, which led to a significant increase in participating franchisors. We are now translating that into more income through SBA sales. This growth was already reflected this quarter and is expected to accelerate. There is a longer timeline for franchise loans from inception to gain, but the pipeline is building heavily for next year, making me optimistic about gains on sale. In the meantime, we've been building our SBA lending capacity, and everything is working in our favor.

Operator, Operator

Our next question comes from the line of Matthew Breese from Stephens Inc.

Matthew Breese, Analyst

It was really nice to see those noninterest-bearing deposits up, I think, 3.7% quarter-over-quarter and CDs down 2.8%. Maybe just talk to us about what's going on there. Are these acquisition-related? Is the FLIC deal starting to bear fruit? Looking ahead, can we see deposit growth match or exceed loan growth for next year, maintaining that sub 100% loan-to-deposit ratio?

Frank Sorrentino, Chairman and CEO

I'll address your questions in reverse order. The goal is to match deposits with loans. There has been a focus here at ConnectOne over the last couple of years to really redefine our business to be a relationship bank that takes in deposits and makes loans. We prefer to take deposits from the same clients we lend to. We've worked hard to focus on clients that will bring us substantial depository relationships. This shift has slowed our growth because we've had to weed out clients who promised us depository relationships but never came through, or those who were merely transactional. With this focus continuing, I believe the merger we just completed has brought in clients with a history of being deposit-rich. The focus on high-quality relationship-type clients is driving profitable growth. Thus, we will maintain a loan-to-deposit ratio around today's levels.

Matthew Breese, Analyst

Great. And then, Bill, maybe you could help me out with a couple of things. What proportion of loans are now pure floating rate? And what did you see for roll-on versus roll-off dynamics this quarter regarding fixed-rate or adjustable-rate loans? Are you starting to see any spread compression?

William Burns, Senior Executive Vice President and CFO

To answer your first question, only about 15% of our loans are pure floating. We’re in good shape there. Regarding the roll-on and roll-off of fixed versus floating, I'm uncertain how dynamics have shifted. Typically, when considering drawdowns and pay downs, it has been high 6s going on and low 6s going off.

Matthew Breese, Analyst

Great. And then just two others for me. Firstly, regarding the reserve, you have a 1.35% reserve to loans ratio. Historically, ConnectOne has been lower, about 1% to 1.05%. With solid credit, should we expect that reserve to trend back towards where you were as FLIC loans reprice?

William Burns, Senior Executive Vice President and CFO

Yes, I think that’s how it will work. It will likely gravitate back towards the 1% level or maybe a little higher, depending on the economy and how CECL works at that time.

Matthew Breese, Analyst

Okay. Alright. And then last one, Bill, you mentioned elevated cash and that it could decrease next quarter. What should we think of as normalized cash to assets ratio?

William Burns, Senior Executive Vice President and CFO

For now, I would say $350 million to $400 million would be normalized. It could go lower than that. For this coming quarter, that's what I would suggest. If you look at our loan growth on an average basis, you're going to see slightly flat interest-earning assets, which is acceptable for my view on capital ratios.

Operator, Operator

Our next question comes from the line of Feddie Strickland from Hovde.

Feddie Strickland, Analyst

Just wanted to stick on the loan repricing opportunity. Bill, can you help us quantify the amount of fixed-rate loan repricing we could see over the next several quarters?

William Burns, Senior Executive Vice President and CFO

The opportunity is significant. We have about $1 billion in repricing in '26 and another $1 billion in '27.

Feddie Strickland, Analyst

And then I wanted to follow up on credit. It's good to see NPA stable and net charge-offs step down. Do we expect charge-offs to remain in the high teens to low 20s range as a percentage of average loans? Or does that step down?

William Burns, Senior Executive Vice President and CFO

It’s hard to predict, but we’ve been stable in that metric. So my model maintains that range for the next four quarters.

Operator, Operator

Our last question comes from the line of Daniel Tamayo from Raymond James.

Daniel Tamayo, Analyst

Just a follow-up. Please remind us of your balances of rent-regulated loans at the end of the quarter.

William Burns, Senior Executive Vice President and CFO

Our total aggregate exposure to majority-owned rent-regulated loans is $700 million. 60% or $400 million of that comes from First of Long Island, where we have a 20% mark against it. The rest of the ConnectOne portfolio accounts for about $275 million, which is less than 2.5% of our total loan portfolio and is conservatively underwritten with no value-add projects. It continues to perform well, experiencing moderate, not significant stress.

Frank Sorrentino, Chairman and CEO

As you can imagine, we get this question frequently, especially being centered in the New York Metro market. My response has been consistent: there are many variables that will determine how things unfold, regardless of whether Mamdani wins or loses. Let's not forget that the other alternative, Cuomo, is the individual who signed the significant 2019 rent regulation law that's caused many issues in the portfolio. So it’s not like we’re moving from one extreme to another. Rent regulations are here to stay. It has been a constant challenge in that market in relation to expenses versus revenue stream. On a positive note, we saw a 3% increase this year, following a 2.7% increase the year prior. It seems that for the next couple of years, the rent-regulated board will remain reasonable and account for inflation and other increasing costs. Some argue that a Mamdani administration could be beneficial for the rent-regulated portfolio, as they aim to reduce the expense base by reforming tax structures. Keep in mind that there are approximately 50,000 rent-stabilized units that are currently vacant due to changes in the 2019 law. However, the future remains uncertain, and it’s difficult to pinpoint specific outcomes. What I do know is that people will always need housing, and there will likely be programs to ensure the availability of that product in New York City. Changes may happen gradually, and it's hard to predict exactly how. However, we are exceptionally comfortable with the loans we underwrote. We never participated in the value-add strategy that sought to replace rent-stabilized tenants with market-rate tenants, so we hold a minimal risk in those lending opportunities. Therefore, we're closely monitoring developments; however, I believe this is a slow-moving process.

Operator, Operator

There are no further questions at this time. I'd now like to turn the call over back to management for closing remarks.

Frank Sorrentino, Chairman and CEO

I want to thank everyone for joining us today and for the insightful questions. We look forward to speaking with everyone during our year-end and fourth quarter conference call. Have a great day.

Operator, Operator

Thank you. You may now disconnect.