Earnings Call Transcript - DCOM Q2 2020

Ken Mahon, CEO

Thank you for joining us this morning. This year has been quite eventful, and there are still five months left until the year concludes. With me on the call today are our President, Stu Lubow; Chief Financial Officer, Avi Reddy; and Chief Accounting Officer, Leslie Veluswamy. In my remarks, I'll share some company-wide insights and then discuss the key themes from our earnings release this quarter. As you've seen, we had a robust quarter ending in June with a core EPS of $0.39. This figure includes a $6.1 million increase to our general loan loss allowance, a prudent move given the potential pandemic impacts. Our strong core EPS benefited from expanded net interest margins, growth in fee income, and effective expense management. For those who have followed our journey over the years, we initiated a shift towards a commercial bank model in early 2017 to diversify our assets and revenue streams. The positive effects of this transformation are now evident, especially in this quarter's results. This also answers the question about the duration of the transition, which we can now confidently say took three years. We've recently crossed that three-year threshold, and we anticipated this strong performance a year ago. On a linked-quarter basis, non-performing loans decreased by about 15% to $15.3 million from our $5.5 billion portfolio. Loan deferrals also fell to around $916 million at June 30 from the peak of approximately $1.1 billion in May. Encouragingly, 40% of the $489 million in loans granted forbearance in April have resumed full payments, and around 25% are now making full interest and escrow payments where applicable. In total, about 65% of the deferred loans from April have transitioned back to performing status. From 2007 to 2013, Dime's cumulative net charge-offs were only 130 basis points of the initial loan balances at the start of the crisis, about five times lower than the overall bank index during that period. Given the low loan-to-value ratio of our multifamily portfolio, which was 50% at June 30, we expect our solid track record to continue. Multifamily apartment buildings are the primary housing type in New York City due to its limited geography, and many of our borrowers have remained with us through various economic challenges. I trust these property owners will continue to manage well through the pandemic. New York City's housing market has experienced many cycles and, despite COVID being a unique challenge, significant investments have occurred in the technology, advertising, media, and information sectors over the past decade. At Dime, we believe in the long-term demand for New York City housing stock, and given our low LTV loans, we are optimistic about our credit performance over time. Our focus right now is to support our borrowers through this challenging environment while enhancing their payment profiles, as evidenced in this quarter’s results. We are actively monitoring all portfolio areas, including our hotel exposure of about $173 million and restaurants at about $27 million. We have a strong balance sheet with significant capital strength. In the second quarter, we raised $44 million in net proceeds from the issuance of perpetual preferred stock, sourced from many of the same investors familiar with us from a previous issuance in February. This has improved our capital ratios, positioning us at the top end of our peer group. Our leverage ratio exceeds 10%, the Tier 1 risk-based ratio is above 13%, and our total capital ratio exceeds 16%. This capital base, along with our low LTV ratios and improved core profitability, will serve us well in this environment. Additionally, I want to highlight Dime's involvement in the Paycheck Protection Program. Three years ago, we did not have an SBA program at Dime, but we've made considerable progress. In the second quarter, we originated $319 million in PPP loans, with related deposit balances approximately $104 million as of June 30, translating to potential unrecognized income of $8.9 million from loan processing. Many of these clients are new relationships for us, and they will remember how we supported them during their time of need. Dime’s strategic plan focuses on improving five key metrics: growing total checking account balances, increasing low-cost business deposits, expanding relationship-based commercial loans, boosting non-spread revenue, and maintaining strong liquidity while reducing our commercial real estate concentration and upholding robust capital ratios. In terms of checking account growth, we increased average noninterest-bearing and interest-bearing checking accounts by 54% year-over-year to $841 million. Business banking division deposits, including our legacy multifamily division, grew nearly 37% year-over-year to $675 million. Our relationship-based commercial loans currently sit at around $1.6 billion, excluding PPP loans, contributing to seven consecutive quarters of core net interest margin expansion. Non-spread revenue, excluding security gains and losses, rose approximately 83% year-over-year, primarily driven by increased swap fee income. Our capital ratios remain strong, with our commercial real estate concentration ratio now at 545%, significantly down from over 900% a few years ago. In summary, we are making measurable progress across all five strategic objectives. I find the advancement in our deposit base particularly satisfying, with noninterest-bearing deposits now representing 15% of our total. While we still have room for improvement, this figure is a significant change from the 6% it once was, and our goal remains to reach best-in-class standards. The deposits to loans ratio for our business banking division stands at 26%, compared to around 6% for our legacy multifamily business. Enhancing our deposit quality has been a guiding principle in our transformation. Finally, regarding our merger with Bridge Bancorp, we have made important strides in our integration efforts over the past four weeks. We aim to finalize the merger in early January, and I am excited about the opportunities that lie ahead for our combined franchise. This merger presents a unique chance for both companies to build a leading New York community banking franchise.

Avi Reddy, CFO

Thank you, Ken, and good morning, everybody. Included in this quarter's reported results was $3.9 million of severance expense related to an organizational restructuring, $1.1 million of merger-related expenses, and $3.1 million of securities gains. Excluding these noncore items, core EPS was $0.39 per share. The $6.1 million loan loss provision we took this quarter was entirely associated with an increase in the general loan loss reserve due to the adjustment of qualitative factors tied to the bank's existing incurred loss framework to account for the effects of the COVID-19 pandemic and related economic disruption. Excluding PPP loans, our reserves to loans at June 30 would have been 83 basis points. As Ken alluded to earlier, we raised $44 million of net proceeds from the issuance of perpetual preferred stock. This is the second time this year we've accessed the capital markets. It's been very rare for banks with less than $10 billion of assets to be able to access the capital markets for perpetual preferred stock, which, as you know, is included in both Tier 1 and total capital. We view this as a testament to Dime's favorable perception by the capital markets. During the quarter, we repurchased approximately 975,000 shares at a price of $14.62. Our share repurchases were supported by our internal stress testing analysis. Upon the announcement of our merger with Bridge on July 1, we proceeded to suspend our existing 10b5-1 plan and are currently not repurchasing any shares. We ended the second quarter with a tangible equity ratio of 9.76%. Excluding the PPP loans from the numerator of the ratio, the adjusted tangible equity ratio would have been approximately 10.25%. This is a full 100 basis points above the minimum tangible equity ratio of 9.25%, which we mentioned on the prior call in terms of where we feel comfortable operating the company. Excluding the merger-related expenses, severance expenses, and securities gains, core pretax pre-provision earnings for the second quarter of 2020 was $24.5 million, representing 26% linked quarter growth and 43% year-over-year growth. The core NIM, which excludes the impact of $1.7 million of prepayment fees, increased by 16 basis points on a linked-quarter basis to 2.75%. Driving a structurally higher net interest margin is one of the key tenets of our business model transformation, and we are pleased with this quarter's results. The increase in core NIM was driven by a 27 basis point linked quarter decline in our cost of deposits. The period end weighted average rate on our loan portfolio, excluding PPP loans, declined by 6 basis points on a linked-quarter to 3.94%. The presence of PPP loans, while additive to net interest income in the amount of approximately $1 million, was dilutive to our second quarter core margin by 2 basis points. For the second half of 2020, we have approximately $875 million of CDs at a weighted average rate of 1.52 that are maturing. Repricing these CDs at lower rates provides us a meaningful opportunity to continue reducing our cost of deposits and maintaining the upward bias in our core NIM. Our charter conversion from a thrift to a commercial bank has enabled us to accept municipal deposits. And in a short span of time, we have built the municipal deposit portfolio to $351 million at quarter end. The weighted average rate on this portfolio was 51 basis points at June 30. The growth in the municipal portfolio has helped to reduce our loan-to-deposit ratio to 122.7% at the end of the second quarter on a reported basis. And excluding the PPP loans from the numerator, the ratio would have fallen even further to 115.7%. Our core efficiency ratio was 50.3%, and the expense to assets ratio of 1.52% remained relatively well controlled compared to other commercial banks. Expenses related to COVID-19 in terms of additional pay to our branch staff, business development staff, cleaning-related expenses, and PP&E and other items totaled approximately $1 million in the second quarter. We expect these expenses to abate over time as we are in Phase IV here in New York and the lockdown conditions of March and early April are in the rearview mirror. A critical part of the business banking build-out is the addition of noninterest income. In 2019, we saw promising early signs of increasing noninterest revenue, and this trend continued in the first quarter as we recognized $2.5 million of customer-related loan-level swap income. This helped year-over-year core fee income to grow by approximately 83%. As you well know by now, we don't provide quantitative NIM guidance. That said, in the third quarter, there will be a few items impacting the NIM. First, the additional average balances of PPP loans, that is the full quarter impact will likely have an additional 2 to 3 basis point negative impact on the NIM. This is assuming forgiveness does not take hold in the third quarter, and the unrecognized processing income does not accelerate. Second, we typically have an outflow of escrow deposits at June 30, and the balances build back up over the next 6 months. This will probably have a 0.5 to 1 basis point negative impact on the third quarter margin. And finally, approximately $600 million of our borrowings are tied to LIBOR, where we receive 3-month LIBOR and pay FHLB the corresponding 3-month rate and extend durations via the swap market. Given the increase in LIBOR rate in the month of March, we benefited from receiving an elevated level of LIBOR in the second quarter. With LIBOR rates going down after April, when these borrowings reset, we will see an increase in costs. This is expected to have a 2 to 3 basis point negative impact on the third quarter margin. All that said, we continue to drive our deposit costs lower and as mentioned previously, we have a significant amount of CDs coming due in the second half of the year. This deposit repricing opportunity should enable us to continue growing the core net interest margin for the remainder of the year despite the 3 unusual items I mentioned above. On a related note, and while we said this last quarter too, but it did not play out as we thought, we may see more of our real estate borrowers waiting until their reset period before refinancing or taking the option to reprice their loans rather than prepaying early. While this could lead to a decline in prepayment fee income from the $1.7 million figure we saw this quarter, it will mean we retain solid credits at low LTVs for longer with a coupon rate that's fairly attractive in the current low rate environment. In terms of noninterest expense guidance, we are projecting noninterest expenses for the second half of 2020 to be approximately $50 million. That is for the 6 months ended. And finally, with respect to the effective tax rate for the remainder of 2020, we expect it to be approximately 22%. With that, we can turn the call over for questions.

Mark Fitzgibbon, Analyst

I wondered if you could give us a sense for what rent collections look like today for your multifamily book, both rent-regulated and non-rent regulated. What you're hearing anecdotally from your customers?

Stuart Lubow, President

Yes, Mark, it's Stu. Generally, you need to assess the situation on a detailed, building-by-building basis because most of our customers are not in deferral, and that's the majority of our loans that are still collecting rents. Their actual collections are fairly normal for pre-COVID levels, ranging from 85% to 90%, which is consistent with what we saw before the pandemic. However, there are some customers who are in forbearance or who have mixed-use and retail components that are operating at lower levels, prompting their requests for forbearance. So, it really presents two distinct situations. The majority are collecting close to their historical rates, while a smaller segment has been more impacted by COVID. Although those percentages are significantly lower, they are improving, especially as we see the first group of forbearance loans that came due on July 1 start to receive payments. Collections are indeed driving those payments, so the situation is quite divided in that respect.

Mark Fitzgibbon, Analyst

Okay. And also, I was curious, the yield differential between business banking loans today and your core sort of multifamily commercial real estate stuff has really collapsed the difference between the 2. So I guess I'm curious, does that mean you'll probably do more traditional multifamily stuff again or not necessarily?

Avinash Reddy, CFO

So Mark, there was a bit of a mix shift this quarter because we did more of the back-to-back swap loan. So it's not really an apples-to-apples comparison. So we're putting on floating rate assets on the balance sheet that have a fee income component associated with that. So in this quarter, we did around $150 million of loans that were swapped. So obviously, we have floating rate there. So it needs to be viewed in that context. Obviously, on the multifamily portfolio, we're retaining clients, and we're trying to keep some of them out over there. But over time, given the opportunity on the deposit side to lower costs over there, I think we're also trying to get the balance sheet more to a neutral perspective. And so that's what's kind of driving that. Also on the business banking side, we've reduced the cost of those deposits as well. So when you think about the net interest margin of that business, it's still in that 3.70% to 3.75% area, and we really manage that business on a NIM perspective, keeping in mind what percentage of floating rate assets we have on the books over there.

Stuart Lubow, President

Mark, just to go further on that, in a lot of what we booked in the second quarter in terms of early in the second quarter were loans that were committed pre-COVID and those swap transactions were committed pre-COVID as well. Since that time, we have instituted floors on LIBOR on our swaps and have actually increased those LIBOR floors and our spread over LIBOR on those swaps. So you're going to see higher yielding. It was just a group of loans that were committed and closed just after the COVID and were committed pre-COVID. So we've taken steps to ensure that we maintain our spread and our NIM.

Mark Fitzgibbon, Analyst

Okay. And then just one point of clarification, Avi. I think you said there was $875 million of CDs that were scheduled to reprice at a yield of 1.52%. Is that in the third quarter or in the back half of the year?

Avinash Reddy, CFO

No. So it's the second half of the year. Over the course of the next 6 months.

Mark Fitzgibbon, Analyst

And those realistically reprice sub-minus 1%, I assume?

Avinash Reddy, CFO

Our highest rack rate right now is 45 basis points. We typically see around 75% retention on the CDs, so we expect to retain about 75% at 45 to 50 basis points. The remaining 20% can be managed with borrowings, which currently have a cost of 40 to 50 basis points as well. Therefore, I anticipate a full 100 basis points on that $875 million.

Mark Fitzgibbon, Analyst

Okay. And then finally, I wondered if we should expect stock buybacks to continue in the third quarter? Or will you be precluded because of the merger from doing more buybacks?

Avinash Reddy, CFO

Sure, Mark. So in the prepared remarks, I mentioned that we suspended our 10b5 plan on July 1 in with the merger announcement. So obviously, until the shareholder vote, we will be out of the market, given some of the rules out there. So we're not in the market right now and do not expect to be in the third quarter at this point.

David Bishop, Analyst

Just a quick question. Obviously, you guys have been very successful in layering in some of these additional commercial loan products, the back-to-back swaps or so. Just curious maybe what your outlook is for continued growth or a level of commercial swap loan fees heading into the back half of the year?

Stuart Lubow, President

Yes, business remains very strong. We have a solid pipeline, and this quarter was exceptionally robust. I anticipate that our swap fee income will return to levels similar to the first quarter, though it will still be strong. Our pipeline continues to look good, and we expect it to grow throughout the year. It may not be as substantial as the second quarter, but it should align with our first quarter results and our budget for the future.

Avinash Reddy, CFO

And Dave, it's also going to be a function of the rate environment, right? If the curve is flat, this is what the customers want at this point in time. So in our internal budgets, we're probably seeing on the real estate side, probably half of our transactions are going to be swapped loans in the second half of the year. I mean that's the current expectation. But it's obviously in response to what the customers want.

Stuart Lubow, President

Yes. And I think we do see an uptick in SBA related fee income with the focus on PPP lending at the SBA moving back toward traditional SBA lending. We had a significant pipeline of loans waiting to close. But since the SBA was so involved in PPP, those things were delayed. So we see a significant positive impact of normalized SBA gains on sale, and that's a positive for the remaining 6 months of the year as well.

David Bishop, Analyst

Got it. That's good information. Avi, could you clarify if there are several factors affecting the reported margin next quarter? I would like you to go through some of those challenges in a bit more detail. Additionally, does this suggest that the margin for the third quarter could be relatively flat to down, based on what you're considering in terms of reported versus core?

Avinash Reddy, CFO

Yes. I'll begin with the fundamental aspects, Dave. In my prepared remarks, I mentioned the CD repricing opportunity and our deposit costs, which were 73 basis points as of June 30, already lower than the quarterly average of 88 basis points. There's significant potential there. For Q3, I identified three unusual items. The first is the full quarter impact of PPP loan balances; we have more average loans on the balance sheet, which may negatively affect the margin by 2 to 3 basis points. Then, there are escrow deposits that typically leave the bank at the end of June and December. As we rebuild those balances, we need to replace non-interest funding with interest-bearing funding, likely resulting in a 0.5 to 1 basis point impact. Lastly, some of our borrowings are linked to LIBOR. We create long-term advances through the swap market, receiving 3-month LIBOR and paying the FHLB the corresponding rate. This could lead to a negative impact of 2 to 3 basis points because LIBOR was high in Q1. Adding these up, we can expect a negative impact of around 5 to 6 basis points on the core margin for the third quarter. However, the deposit costs we expect to reduce should more than counterbalance some of these unusual items. Reported on a net interest margin basis, we had prepayment fees of $1.7 million. While we've indicated we expect those fees to decrease, we still see them in the $1.5 million to $2 million range quarterly, often not below $750,000 to $1 million recently. Hence, that may represent the lower end. Despite these factors, I still anticipate the reported margin to trend upwards, with a positive bias in the core margin for both the third and fourth quarters.

David Bishop, Analyst

Got it. That's good color. And then I guess one final question. You sort of broke out the amounts reaching the end of deferment. Just curious some of the more recent conversations here. Any sort of insight in terms of sort of the rate that you're expecting for this next tranche that are coming off their first initial period?

Stuart Lubow, President

We're certainly expecting at least a similar migration. What we are seeing is positive trends in terms of New York City coming back to life. We're obviously entering Phase IV. And you can see in our reports that even COVID-related industries are beginning to come back and pay. So at a minimum, we expect the same 40% and 65%, if not better.

Christopher O'Connell, Analyst

This is Chris filling in for Collyn. So I just wanted to start, I guess, with loan growth. And maybe for the second quarter, how much of this quarter's growth or origination activity had come from the pre-pandemic era and just how the loan growth pipeline and the composition of that pipeline is going forward?

Stuart Lubow, President

Yes, as I mentioned earlier, we are still experiencing significant business activity and a robust pipeline. We provided growth guidance earlier this year, and we feel confident about that guidance. We anticipate originations to remain steady. Therefore, we are very comfortable with our initial growth projections.

Christopher O'Connell, Analyst

Okay. Great. And then on the deposit side, you noted that, I think, just over $100 million or so were PPP related deposits. But obviously, overall deposit strength this quarter was extremely strong. Have you seen any of those PPP deposits roll out as we head into the third quarter or any of the outsized strength this quarter kind of start to fall off as customers deploy those funds?

Stuart Lubow, President

We expect that trend. Over time, we've deposited nearly $325 million in total deposits, but as of June 30, that figure has decreased to $104 million. The PPP loans were primarily used by businesses to cover employee wages. We anticipate this downward trend to continue, and it has. However, our non-PPP commercial deposit growth has remained robust. We're continuing to build new business relationships through our commercial bankers, as well as retaining some permanent customers from the PPP loans, which is contributing to consistent growth and stability in our commercial deposit base.

Christopher O'Connell, Analyst

Okay. Great. That's good to hear. And then finally, on the service fees. And obviously, the impacted by customer activity and branches being closed, etc. during the crisis. How do you see those rebounding in the second half of the year?

Stuart Lubow, President

Well, I mean, at this point, service fees truly are a function of transactions. And it's also a function of the amount of deposits that customers are keeping. So we have significant customers that have higher balances. So we're seeing less in terms of analysis, fee income, NSF charges, etc. because they have the balances. So I do see that recovering somewhat as businesses begin to open up and transactions continue to increase, but we do expect it to trail what we expected, say, from the first quarter on. But the offset to that is higher balances and lower cost of funds.

Howard Henick, Analyst

I've had a question actually about the merger. I apologize if that's a little off topic. But my understanding, and correct me if I'm wrong, is that both parties are taking change of control provisions. And I didn't think that was customary in a merger of equals when the party is taking the change of controls are maintaining their jobs. And I'm curious what the rationale for that was. And also, was it taken in cash or stock and why?

Ken Mahon, CEO

Howard, all that information, I'm afraid you'll have to wait for the merger proxy, which will have the background for all that stuff.

Howard Henick, Analyst

So that hasn't been publicly announced either way?

Avinash Reddy, CFO

No, Howard, it has not.

Ken Mahon, CEO

Okay. Thank you, operator, and thank you, everyone, once again for joining. Thank you for your questions, and look forward to speaking with you on our next conference call in October. Have a good day.

Operator, Operator

Thank you very much, sir. Ladies and gentlemen, the conference call has now concluded. Thank you for attending today's presentation. You may now disconnect.