Good day, and welcome to the ConnectOne Bancorp, Inc. Fourth Quarter 2018 Earnings Call. Today’s conference is being recorded. At this time, I would like to turn the conference over to Siya Vansia. Please go ahead..

Good morning, and welcome to today’s conference call to review ConnectOne’s results for the fourth quarter 2018 and to update you on recent developments. On today’s conference call will be Frank Sorrentino, Chairman and Chief Executive Officer; and Bill Burns, 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 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 and accompanying tables or schedules, which has been filed on Form 8-K with the SEC on January 24, 2019, 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..

lending, deposit gathering and the back office to determine where technology can create efficiencies while also supporting our clients’ demand for always on banking services.

Over the past year, as we’ve discussed, we implemented a new loan operating system to digitize our loan process, and today, we have a faster, more streamlined process at scalable. The world is changing and the future of banking is less brick-and-mortar and this is the first of many digital enhancements and investments.

We also remain committed to enhancing the knowledge base of the company by attracting new talent, while maintaining our existing staff with very little turnover. Toward this end, we made several key hires to lead our initiatives in the New York market on both the deposit and loan origination fronts.

Additionally, we opened an office in Astoria, Queens on with thriving, but underserved small and midsized business community that can provide superior risk-adjusted returns.

We’re already seeing strong traction from these actions and believe there are other attractive opportunities to grow responsibly within our target market surrounding New York City. Turning to Greater Hudson, merger established an immediate presence in the lower Hudson Valley region, including Rockland, Orange and Westchester counties.

We’re excited to welcome our new team of season lenders and core deposit gathering specialists and look forward to serving this new market. The transaction closed only three weeks ago and together, we’ve already seen successful client synergies and opportunities to expand in these markets.

Bill will speak a little more to the metrics of the deal momentarily. But before I turn the call over to him, I’d like to take the opportunity to thank our Board of Directors, executive management team and our entire staff for the efforts, which led to our success in 2018, as well as to our clients for their continued partnership with ConnectOne.

At this time, I’d ask Bill Burns, our Chief Financial Officer, to review the fourth quarter financial highlights.

Bill?.

So thank you, Frank and good morning, everyone. We once again had a strong quarter. On an operating basis, diluted EPS increased to $0.59 per share, that’s an increase of more than 15% from last year’s fourth quarter and $0.02 higher sequentially.

And for the full-year 2018, diluted operating EPS increased to $2.24 per share, that’s a greater than a 25% increase from 2017. For the current quarter, on an adjusted basis, our return on assets reached a new high at 1.45% and so did return on tangible common equity, which increased to 16.7%.

And with these strong returns, a tangible book value per share has increased to $14.42 over the course of the past year, which is up 11%. So despite the challenging operating environment, where we had seen slower growth than we’re used to, and on top of that, we’ve seen pricing pressures on both sides of the balance sheet.

Our performance metrics continued to accelerate due to improving loan mix and continued core deposit growth. Now some color around our balance sheet growth. Total loans increased for the year by 8%, while our C&I segment grew by more than double that on a percentage basis at 18%.

And that combined with the sub debt issuance early in 2018 contributed to a very pronounced improvement in our CRE concentration metric, which is now down to 480% from 568% one year ago.

On the deposit side, total average deposits for the fourth quarter were up 9% from last year’s fourth quarter average, and average noninterest-bearing demand also increased by 9%. So our deposit and core deposit growth is keeping pace nicely with loan growth.

And with that, we’ve been able to maintain a relatively stable loan-to-deposit ratio that’s helped to maintain our margin in the 3.25% to 3.30% range. Our net interest margin for this quarter did compress slightly by 3 basis points sequentially, that was due to slightly lower prepayment fees and also continued deposit pricing competition.

Offsetting pricing pressures, we’re beginning to see loan spreads widen a bit, that’s bolstered our continued success in the C&I lending space. Looking ahead to next year, again, I think, we’re going to see some margin compression maybe on the order of 1 to 2 basis points per quarter.

All that will depend as always on many factors such as loan-to-deposit mix and our growth rate. Turning to expenses. We did see a sequential decrease in other expenses. Let me explain, because there was some noise there.

Third quarter expenses were elevated due to a small loss in the sale of an OREO property, as well as we had some adjustments to equity-based compensation accruals. On top of that, the fourth quarter benefited from gains on equity-based investments marked to fair value.

But excluding those items, the sequential annualized core operating expense growth rate was about flat, reflecting continued prudent expense management. And going forward, excluding the addition of Greater Hudson, our first quarter expense levels are likely to increase in the range of 2% to 4% sequentially, that’s typical for the first quarter.

Gross additional quarterly operating expenses for the Greater Hudson Bank are about $3.5 million, and that’s before any expense saves and we had announced cost saves of 40%. And speaking to the merger that transaction closed on January 2, so our year-end financial statements other than some merger expenses exclude any impact of the deal.

However, 2019 will include the full benefit of the Greater Hudson franchise. We are on track to meet and in some cases beat the financial targets set at deal announcement.

Tangible book value per share dilution will probably be a little less than we projected and earnings accretion probably greater due to more cost saves and some revenue enhancements and realization of those cost saves are ahead of schedule.

On the tax side, I want to get to adjust the guidance we previously gave, we’ve projected a 26% effective tax rate for 2019. The latest reading on that is that although we expect our effective tax rate to increase in 2019, we are not sure as it will be as high as 26%.

It’s all pretty technical, we’re waiting clarification from New Jersey, as well as from our tax advisers before commenting any further. I want to now talk a little bit about our capital position. Given our consistently strong financial performance and rising capital levels, capital ratios have increased now for the three consecutive quarters.

As well as our confidence in the future, we believe returning a portion of our capital to shareholders will enhance our market valuation. So now with the completion of the Greater Hudson acquisition behind us, we are in a position to consider stock repurchases and possibly a dividend increase later this first quarter.

So in conclusion, 2018 was a very strong year and we’re confident going into 2019. We see benefits from the Greater Hudson Bank acquisition, continued solid loan and deposit growth and continued strong return on assets and tangible common equity. And with that, Frank, I’ll turn it back over to you..

Great, Bill. Thanks. In conclusion, this was a strong, solid quarter and led to a strong end to the year. While 2019 will undoubtedly provide challenges, we are well-positioned for continued success.

We have a strong capital foundation and continue to benefit from increased momentum across our platform and through our client-first and sense-of-urgency culture.

As we look ahead, excuse me, our priorities remain focused on solid organic execution, supplementing our growth with M&A, advancing our best-in-class efficiency, being good stewards of our shareholders’ capital and continuing to make strategic investments for the future.

As always, we appreciate your interest in ConnectOne and thanks again for joining us today. We’ll now take your questions.

Operator?.

Thank you. [Operator Instructions] And we’ll now take a question from Matthew Breese with Piper Jaffray..

Good morning, everybody..

Good morning, Matt..

Hi, Matt..

Bill, I appreciate the color on the NIM for 2019 compression of 1 to 2 basis points organically.

I was hoping just to level set with Greater Hudson, where do you expect the margin to shake out for the first quarter?.

Well, I do see some benefits from Greater Hudson. We’re still working on the purchase accounting adjustments, but on balance, Greater Hudson will serve to help the margin..

Okay.

And could you kind of comment on the deposit gathering environment or are things changing? Is it any more or less competitive? We’ve heard varying commentary on that front, but I want to get your sense in your market for how that’s shaking out?.

Matt, I would say, it’s still pretty competitive. I think, we – we’re winning some of the battles. In that, our C&I growth has been pretty strong, and with that come really good, solid core deposits. Just on the margins, the interest sensitive products are pretty much following the market.

I don’t think anybody has a tremendous advantage there and it’s pretty fierce. It feels like the pie is shrinking a little bit and everybody is chasing after the same deposits. I think, we’ve done a pretty good job of matching the deposit growth together with the loan growth.

And so I think overall, from ConnectOne Bank’s perspective, it’s working well for us. But it’s challenging, I wouldn’t say anything less..

And then on the loan growth side, any updates in terms of your forward guidance? And Bill, you mentioned spreads widening out, is that true for both C&I and CRE and to what extent?.

Yes, a little bit. I would say, on the order of 25 basis points wider spread. So not as good as it was a year ago, but better than it was three months ago..

a, the environment; b, our discipline, a very, very strong proponent of quality over quantity..

Understood. Okay. Just my last one, I know you mentioned the capital has been building last few quarters and there are some other options potentially on the table.

If you had to give us a range of where you want to manage that capital, perhaps as measured by tangible common to tangible assets, what should we be thinking about there? Where are you comfortable running it?.

Well, I wouldn’t want to go below 8%. I think, we’re in 8.75% or so. It’s – I’m really looking to tangible common equity at the holding company, the other ratios are higher. We’re over 10% leverage at the bank.

But just looking at tangible common equity at the holding company, I wouldn’t want to see it go below 8%, but I’m fine in the 8.25% to 8.50% range..

Okay. Okay, great. That’s all I had. Thank you..

Thanks, Matt..

Thanks, Matt..

We’ll now take our next question from William Wallace with Raymond James..

Thanks. Good morning, guys..

Hi, Wally..

Hi, Wally..

Just a quick follow-up to that last question.

How much cash do you guys have at the holding company that you could potentially use for stock buyback, like you had mentioned in your prepared remarks?.

Well, we always have excess cash at the holding company. But I wouldn’t want to draw that down, so most of the cash for any stock buyback or dividends ultimately come from the bank. And the bank has more capital than the holding company. So. I think, we’re in a good position there..

Would you use the CRE concentration metric as kind of a – would you dividend up enough that, that would go back up at the bank level?.

Well, you’re right. Mechanically, that ratio would go up. We’re managing all our metrics. So, look, I think there is enough earnings power to support growth in the balance sheet and some of the actions we’re talking about taking..

Okay. Okay, I appreciate that. The – it was – I was hesitant to even say this, but it was nice to see a reversal of an allowance on the taxi portfolio.

I’m just kind of curious what you’re seeing in that – in the taxi medallions over the past quarters? Is it just a function of the sales that are going off, or are you seeing actually any changes on the underlying cash flow metrics?.

Well, one, we continue to have them on non-accrual. So any payments that come in are applied to principal. The yield on that portfolio as it’s written down from where it is, is order of 8% or 8.5%, so that’s pretty strong. I think, in terms of the valuation, it seems to be stabilizing out there.

There have been trades all around the level that we have them at, and I think the industry is doing pretty well compared to last year..

I mean, Wally, I would definitely say that, there has been some stability in the marketplace relative to the medallions. And for the first time in a very long time, there are a lot of trades happening some for cash, some for – with financing. There’s actually talk of some banks now starting to provide financing at these levels.

So, I think it’s all quiet on the western front there..

Okay. Yes, that’s what I figured, great. Last question, just kind of thinking about the expense as it relates to the Greater Hudson deal, maybe thinking about it from the efficiency ratio perspective, I think you had 43% roughly in 2018 the way we calculate it.

I anticipate that, that would be ticking up at least in the first quarter, if not the first-half.

Can you talk a little bit about where you think you could get back to, maybe in the back-half of the year to help us in the process?.

Because the expense saves are not fully realized, is that how you’re coming up with that?.

Right, that’s….

…is that the situation?.

…that’s rationale..

I mentioned, we’re kind of ahead – we’re ahead of where we said we’d be, which is 75% of the cost saves in the first year. We probably had a run rate of 90% starting in the second quarter. So I think, we can get back to where we want to be, which is the low-40s pretty easily.

And also, again, having said that, in the first quarter, we tend to pick up in our efficiency ratio anyway..

Right. Wally, one thing, just point to mention and we get asked this question a lot.

In that low efficiency ratio or all the other initiatives that we’re doing, both from the technology front all the investments we’re making, the expansion into other geographic markets, the hiring of talent, the initiatives in whether it’s AI or robotics or cloud-based systems, some of these things have significant investments and it’s all baked into that low efficiency ratio..

Yes, understood. I appreciate that. I’ll step out and let somebody else ask a question. Thanks. Thanks, Bill. Thanks, Frank..

Okay, Wally..

Right. Take care, Wally..

[Operator Instructions] We’ll now take a question from Austin Nicholas with Stephens..

Hey, guys, good morning..

Good morning, Austin..

Good morning, Austin..

Maybe just on M&A with Hudson close, can you just maybe refresh us on your appetite for M&A and kind of geographically and maybe financially what are the kind of parameters that you look for?.

I’ll take the geographic part. [Multiple Speakers] Certainly, we telegraph – we like the geography that surrounds New York City. I think the size of the radius maybe increasing somewhat, we used to say 50 to 75, maybe it’s more like 75 to 100 miles from New York City.

So every – and that’s a big area and there’s a lot of opportunity in that area as we see it. So, we’re looking for places that make sense for us. We’re looking for big teams of people. We’re looking for good market opportunities. We’re looking for banks that are aligned with the type of business we want to do.

And, of course, it has to make financial sense, which I’ll let….

First off, I think we’re operationally ready for another deal. But, of course, we have to find something that fits strategically, as well as financially. And it’s pretty easy these days, because the market is focused on tangible book dilution and a quick earn back.

So, we wouldn’t be doing any deal that, that has an extended earned back period and wouldn’t do any deal we thought was going to cause our stock price to fall as a result of announcing. So that’s kind of the keys that I look for from a financial perspective.

Generally speaking, the 40% cost saves, the accretion is usually conservative estimates, so we usually can do even better than what we announced. But I would expect us to be disciplined from a financial perspective..

Got it, thanks. That’s helpful. And then maybe just heading back on the NIM guidance of kind of 1 to 2 basis points a quarter.

I guess, my first question there, what kind of rate hike scenario or yield curve scenario does that contemplate and how would that maybe change if we had more or less rate hikes than what you’re kind of expecting?.

Well, first of all, probably have well one more rate hike in our estimates. It depends on the long end of the curve as well. So I can’t really give you a great answer on what rise in the short-term rate would do, it wouldn’t be much..

Got it. That’s helpful. And then just to be clear, though, the 1 to 2 basis points kind of going into the first quarter, that would be excluding kind of the benefit that you would see from Hudson.

Is that correct?.

No, I don’t want to – what – it’s really hard to project it, because from one quarter to the next, we have repricing of deposits and we have a deal coming on and we’ve got purchase accounting and we have some changes in their securities portfolio that we’re going to put into place. So it’s more like a 1 to 2 basis points.

It’s more like 4 to 8 basis points over the course of the year.

It’s what my guidance is, okay?.

Got it. Okay, yes. That’s helpful. Okay, great. That’s all I got. Thanks, guys..

Thank you..

We’ll now take a question from Collyn Gilbert with KBW..

Good morning. This is Chris, filling in for Collyn..

Hi, Chris..

Hi, Chris..

So I just wanted to touch upon the tax rate.

I guess, if you could just maybe go through what has changed in terms of what you guys are hearing in the outlook for 2019? And is there a little bit of a tighter range, maybe above or below 20% is the thought now or…?.

Well, I really don’t want to give a range right now. What happened was the tax legislation was not clear, and the state has announced, they’re going to come out with a clarification, but it is quite technical. And I think there are a number of men looking at it in different ways.

We’ll have to make some decision as we close the first quarter, but we haven’t made a decision yet as to what effective tax rate we’re going to use for our financial statements..

Okay. Thank you. And then if you could just touch upon the growth environment and you guys are targeting 10% plus, I guess, for 2019 if possible given the environment where you’re seeing the most demand in the most competition? The construction balances fell down a little bit this quarter and maybe some of that went into CRE.

But just what you think or what you’re seeing differently this year than in 2018?.

I think 2019 should be a good year for us. We have some new markets to penetrate, where we’re seeing some great opportunities. We are seeing some natural synergies in the Greater Hudson market, where clients there could not borrow what they wanted to from Greater Hudson because of legal lending limit concerns, where we can fill a lot of those gaps.

We’ve brought on – we – and – we’re continuing to invest in additional talent here at the company with various different lines of businesses that we’re exploring. I think, when you put all of that together, we should be able to get to those double digits. The market we’re in is, there’s plenty of business here.

It’s just a question of being in a better position than some of our competitors. One of the good things I like is, some of our competitors in the market are – either have gone away or potentially going away as time goes on. So there’s less competition as time goes on.

And I think our investments in providing a really superior level of service with our clients is beginning to show some great benefits. The pay downs that you saw in the construction portfolio, we’re actually happy about that. When we lend money in construction projects, we do want to get paid back.

And I think our disciplined approach has slowed down the pipeline a little bit in construction. But we are seeing other opportunities specifically in some of those new markets that we weren’t in before. So I have a pretty good level of confidence that we will achieve those targets in 2019 with all of those initiatives underway..

Great. Thank you for your time. I appreciate it. I’ll step out..

Great. Thank you..

Thanks, Chris..

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

Hey, great. Well, thanks, everyone, for joining us on the fourth quarter earnings call. We certainly appreciate everyone’s interest and look forward to speaking with you again during our next quarterly conference call. Have a great day..

And once again, that does conclude today’s conference, and we thank you all for your participation. You may now disconnect..