Earnings Call Transcript - CNOB Q4 2020

Operator, Operator

Greetings, and welcome to the ConnectOne Bancorp, Inc. Fourth Quarter 2020 Earnings Call. 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.

Siya Vansia, Chief Brand and Innovation Officer

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.

Frank Sorrentino, Chairman and CEO

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 digitized 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 nine 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 quarters ahead. 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 to 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 grow. 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.

Bill Burns, Executive Vice President and CFO

Thank you, Frank, and good morning, everyone. I would like to express my gratitude to our staff for their outstanding response and efforts over the past year amidst challenging working conditions. We wrapped up the year with a very strong fourth quarter. Our pre-provision net revenue as a percentage of assets exceeded 2%, keeping us near the top of the industry. While some of our peers are releasing reserves, we added another $5 million, the same as in the previous quarter, which is approximately $3 million to $4 million more than our historical quarterly provision. Even with this elevated provision, we reported a GAAP basis return on assets of 1.35% and a return on tangible common equity exceeding 15%. If we normalize our provision to historical levels, our return on assets would be over 1.5%, and our return on equity would be nearly 17%. This is based on tangible equity, which has grown significantly over the past year. We have achieved strong results on both a GAAP and operating basis. As the economic recovery becomes clearer, we see an increased opportunity to return excess capital to shareholders through share buybacks and higher dividends, pending Board approval. Our tangible book value per share has increased to about $17.50, a nearly 10% rise from $16 last year, and our capital ratios have also shown significant improvement. Our common equity Tier 1 ratio at the holding company stands at 10.8%, and at the bank, it's over 12%. Our dividend payout ratio is below 15%, providing ample room for increases while considering organic growth. Turning to credit and reserves, our credit performance is solid. Our borrowers have benefited from the CARES Act and our accommodations, alongside the ongoing fiscal and monetary stimulus and an improving economic outlook. Eighty percent of the initially deferred loans have returned to invoicing, and over 95% of those are current and paying in full. In the $210 million deferment bucket at year-end, over 95% are collateralized, and 70% continue making some form of payment. The largest portion consists of New York City multifamily properties with strong collateral, having low loan-to-value ratios and high debt service coverage ratios. We have minimal exposure to sectors like hospitality, travel, and energy. Overall credit quality remains stable or is improving, with low charge-offs and delinquencies. Our nonperforming assets have decreased, and our reserve for loan losses as a percentage of the total loan portfolio, excluding the PPP, has strengthened to 1.36%, almost double from a year ago. This quarter's $5 million in reserves reflects ongoing uncertainty regarding the pandemic's timing and impact. Our perspective aligns with recent statements from the Fed regarding CECL. With the latest CARES Act extension, we are allowed to postpone the implementation, and our current plan is to delay it by one day to early 2021. We believe adopting CECL will have a minimal impact on our financial statements. Regarding our operating performance, our net interest margin widened by one basis point for the fourth consecutive quarter, increasing a total of 14 basis points compared to last year. We have benefited from a solid balance sheet structure, including a lower proportion of floating assets and liabilities that reprice quickly. While we experienced a higher-than-normal level of prepayment income recently, it was offset by increased liquidity and slower amortization of PPP fees. As for the PPP, we still have $5.7 million in non-amortized fees to go, likely to be paid by mid-year, though some loans may remain outstanding longer. In terms of future margins, our originations have mostly been at spreads exceeding pre-pandemic levels. As we utilize our excess liquidity and grow, we expect to continue benefiting from wider loan spreads. However, we anticipate some competition-based narrowing of spreads, while banks will benefit from the current yield curve and low short-term rates. A couple of factors will work in our favor as we move into 2021. We redeemed $50 million of high-rate subordinated debt in January, which will help our margin by 3 to 4 basis points. Additionally, we expect significant repricing and reductions in our CD portfolio, with $600 million maturing over the next six months at rates above 1.50%. These maturities will decline in the second half of the year. As we project future margins, we are lengthening our liabilities to secure funding at attractive costs of 50 to 60 basis points. Overall, I foresee a robust and stable margin for ConnectOne throughout 2021 and possibly beyond, though it is challenging to forecast margins beyond a year. Non-interest income also performed well this quarter, driven by gains from loan sales, which remain modest but successful, particularly in commercial loan sales. Our residential loan sales have also increased. I expect mid- to single-digit expense growth as we continue to invest in talent and technology. We managed to maintain an efficiency ratio below 40% for the quarter, a goal we aim to sustain, contingent on revenue growth, which is anticipated more towards the end of the year as the pandemic subsides. I look forward to your questions after Frank's closing remarks. Back to you, Frank.

Frank Sorrentino, Chairman and CEO

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, and 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, Operator

Our first question comes from Fred Cannon with KBW.

Fred Cannon, Analyst

It's pleasure to cover you guys at least in the short-term and continue that. Just two 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?

Frank Sorrentino, Chairman and CEO

In the first PPP, we certainly didn’t know what to expect. However, this time we have a much better understanding. It’s likely that in PPP 2, we will be working with clients who have already experienced PPP 1, so most of them will be familiar with the process. We’ve developed new technology to streamline things, and we have a clearer grasp of the entire process. Therefore, I anticipate it will be a much less stressful experience compared to the initial rollout. Additionally, there may be opportunities to bring on new clients who were dissatisfied with their previous experience, and we're already noticing signs of that. Nonetheless, I believe the majority will be returning clients.

Fred Cannon, Analyst

And just for clarification, do you see most clients who received PPP 1 reapplying for PPP 2?

Frank Sorrentino, Chairman and CEO

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.

Fred Cannon, Analyst

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

Frank Sorrentino, Chairman and CEO

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.

Fred Cannon, Analyst

Hopefully, it will be less chaotic, as you mentioned. Recently, we have observed the impact of the market on fintech firms, which has significantly driven up acquisition prices. Do you see the current conditions in the stock market and the increasing number of fintech firms going public influencing your acquisition strategy in this sector?

Bill Burns, Executive Vice President and CFO

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 joint venture 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.

Fred Cannon, Analyst

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

Frank Sorrentino, Chairman and CEO

Thank you.

Bill Burns, Executive Vice President and CFO

Thank you.

Operator, Operator

Our next question comes from Frank Schiraldi with Piper Sandler.

Frank Schiraldi, Analyst

I want to start by asking about the momentum in loan growth that you mentioned, especially your views on the second half of the year. Is some of the acceleration due to the multifamily space becoming a bit less competitive? Could you provide more insight into what is driving your optimism in this area?

Bill Burns, Executive Vice President and CFO

We experienced significant growth and a robust pipeline, even in 2020. Many of our priority businesses performed exceptionally well. Our construction portfolio, along with builders, developers, and managers, has been thriving, particularly in the suburban markets of New Jersey, Long Island, and beyond. Unfortunately, this growth was tempered by a number of payoffs. However, if you look at the real strength of the loan originations we achieved in 2020, particularly amidst the COVID pandemic, we expect that as we move into 2021, some of the challenges will lessen. The efforts we implemented in 2020 will carry over into 2021, and we anticipate continued growth in our pipeline with fewer payoffs. Additionally, we collectively believe that the economy will improve, whether due to the vaccine or our adaptation to living with COVID. We expect the significant fluctuations in the economy to stabilize somewhat. Moreover, people will realize that New York City will not completely empty out; it won’t be closed off. There will be a gradual return to normalcy, which bodes well for us. We are positioned in various markets that have shown resilience throughout the pandemic, and we expect that strength to increase as we progress through 2021. All these factors lead us to confidently assert that our organic growth will continue to enhance the net growth of the company in 2021.

Frank Schiraldi, Analyst

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?

Frank Sorrentino, Chairman and CEO

Yes. I think we'll see either flat or possibly a slight increase in the percentage of the portfolio.

Frank Schiraldi, Analyst

Okay. Bill, regarding the deferral, now that it's year-end and we've nearly completed six months, I understand there's an extension for the COVID deferrals. What do you think will happen in the next few quarters? Will a significant amount move into NPA status? If that's the case, I'm curious if you are comfortable with your current reserves.

Bill Burns, Executive Vice President and CFO

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, Operator

Our next question comes from Matthew Breese with Stephens Inc.

Matthew Breese, Analyst

I was hoping to get your perspective on the current pipeline. Could you share what the blended loan yield is today compared to a year ago and the expected spread compression? It would be helpful to understand your thoughts on this.

Bill Burns, Executive Vice President and CFO

First of all, the spread expansion has widened by about 50 basis points or more since the start of the pandemic compared to before. Currently, we are starting with spreads that are generally wider than what we have been accustomed to in the years leading up to the pandemic. It’s difficult to predict how quickly this will compress, but overall, I am confident that ConnectOne can stabilize its margin at these levels. There are a couple of reasons for our expected margin improvement. One is the repurchase of the subordinated debt, and the other is that we have significant repricing happening with the CDs. This will allow us to manage some compression on the asset generation side while still maintaining our margin.

Matthew Breese, Analyst

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?

Bill Burns, Executive Vice President and CFO

I believe we are currently well-positioned to take advantage of potential changes. If the yield curve becomes steeper, it will be beneficial for us. If yields remain steady, I expect our margins to stay within the range I have previously mentioned, with variations of around 5 basis points.

Matthew Breese, Analyst

Okay. I'm sorry, Bill, please continue.

Bill Burns, Executive Vice President and CFO

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.

Matthew Breese, Analyst

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?

Frank Sorrentino, Chairman and CEO

In the March-April period, there was little interest in discussing mergers and acquisitions. However, by November-December and into January, the conversation has shifted significantly, with many discussing various forms of M&A. It's clear to bank CEOs that the landscape is changing. My earlier remark that we’re not in 2021 but rather in 2030 reflects how the current situation has prompted a rethinking among many, leading to an acceleration in the market and a notable change in perspectives on everyday events and life in general. Banking is experiencing this shift as well. So, to answer your question, yes, there has been a noticeable increase in discussions about M&A across the industry. I anticipate that we will see strong activity in this area moving forward.

Matthew Breese, Analyst

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

Bill Burns, Executive Vice President and CFO

On purchase accounting? 13 basis points.

Operator, Operator

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

Frank Sorrentino, Chairman and CEO

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.

Operator, Operator

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