Good day, ladies and gentlemen, and welcome to the ConnectOne Bancorp, Inc. Second Quarter 2019 Earnings Call. Today's conference is being recorded. At this time, I'd like to turn the conference over to Siya Vansia, Vice President of Marketing. Please go ahead..

Good morning, and welcome to today's conference call to review ConnectOne's results for the second quarter of 2019 and to update you on recent development. 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 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 on July 25, 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..

Thank you, Siya. Good morning, everyone, and thank you for joining us today. This is another strong quarter for ConnectOne, highlighted by nearly double-digit annualized growth -- loan growth, continued strong performance metrics and solid asset quality. Challenging interest rate environment is negatively impacting the industry, including ConnectOne.

However, our financial performance remains strong, and we continue to take various steps to maintain our superior returns on invested capital, which Bill will provide some additional details in a few minutes. Loan growth for the quarter was solid and in line with our expectations.

Contributing to the growth was construction lending, which reflected mostly advances on existing facilities. We're expecting a more normalized growth rate with increased payoffs on completed projects going forward. Growth for the quarter was also the result of strength in our owner-occupied commercial real estate lending segment.

Meanwhile narrower spread multifamily lending was about flat. We're pleased with our continued success in growing our more profitable lending segments, and we believe this will continue to support returns going forward. Moving on to asset quality. The trend remains strong. Credit quality, nonperformance and charge-offs continues to improve.

Recently, a $4.7 million loan that went on nonaccrual during the second quarter was paid off in full early in the third quarter. Finally, as you may recall, in the first quarter, we had an isolated charge related to a New Jersey commercial office building credit.

That situation has been favorably resolved before closed, sold the asset, recorded a slight recovery in the second quarter. Both of these resolutions reflect our philosophy to aggressively address and dispose of impaired assets in a timely fashion. Now I'll start with some new developments.

In June, we closed on the previously announced strategic acquisition of the Boston- and New York City-based BoeFly.

An online business lending platform, BoeFly helps connect small- to mid-sized businesses with professional loan brokers and lenders across the United States, with an emphasis on funding and other financial services for franchisors and franchisees. The integration has gone smoothly.

The BoeFly team is onboard, and we're experiencing strong cultural alignment. In the quarters ahead, we plan to invest new resources that will enhance the functionality of the BoeFly platform while making it scalable. We are at the very beginning stages and continue to be excited about the prospects of this going forward.

The impact of -- on financial results for 2019 will be minimal, but we do expect the platform to augment ConnectOne's fee income and generate profitable SBA lending opportunities.

In summary, this is a compelling opportunity in the fintech space as the combination of BoeFly's entrepreneurial team and dynamic patented technology provides us with an avenue to leverage the digital foundation we're building while also expanding and diversifying our revenue sources.

This integration, along with our Greater Hudson Bank merger, demonstrates our dynamic M&A capability. Looking ahead, we'll continue to pursue traditional bank M&A as part of our expansion strategy to leverage our infrastructure and benefit from economies of scale. We're also embracing opportunities to expand our digital foundation.

As we scale and extend our competitive position, we also continue to invest in process improvements in all areas of ConnectOne. This includes technology investments to enhance our sense of urgency culture and efficiency while also supporting our clients' demand for always-on making services.

ConnectOne's performance, especially our operating efficiency, reflect the benefits of these initiatives. As part of this always-on investment, we continue to evaluate our brick-and-mortar strategy, and toward this end, we've announced the closing of an additional branch location in New Jersey, with other closures in the pipeline for the future.

We're also converting a former branch in Oakland, New Jersey into a modern style shared office space for not only our employees but also for our clients.

Expected to open in the third quarter, it'll allow a segment of our workforce to work in a flexible environment and include conference space that our clients can reserve and utilize for their businesses. We're pretty excited about this development.

Operationally, we remain a growth company committed to our people-first culture and focused on investing in financial technology to stay ahead of the competition. So at this time, I'll turn the call over to Bill..

Okay. Thank you, Frank, and good morning, everyone. So this was another good quarter for ConnectOne. We had continued strong operating performance, 1.35% return on assets, 15.5% return on tangible common equity and, again, one of the best-in-class efficiency ratios of 41%. Tangible book value per share increased by $0.34 to more than $15 per share.

Our holding company tangible common equity ratio increased for the fifth consecutive quarter to 8.9%. Now this increase in capital is net of about $5 million in stock repurchases during the quarter, and we expect to continue with the stock repurchases to manage our capital position. We also believe the stock is currently very inexpensive.

We're particularly pleased with our loan growth for the quarter in first half of '19. For the current quarter, our total loan book grew by just under 10% on an annualized basis and reflected growth in higher spread segments, while narrow spread multifamily is flat to down over the same period. Turning to deposits.

As you know, the deposit environment has been challenging industry-wide both from a growth and cost perspective, and that has been putting pressure on all net interest margins, including ConnectOne's.

Our net interest margin contracted by four basis points to 3.30% in the second quarter and by eight basis points when you exclude the accretion of purchase accounting marks.

The sequential margin contraction was attributable to the competition on the deposit funding side and flat yield curve, and that was partially offset by some improving yields in the loan portfolio. Also, there were a couple of nonrecurring items that contributed to the contraction.

Those were, one, the reduction of prepayment fees; and, two, a decline in securities portfolio yield that increased payments -- prepayments fees and premium amortization. Those two items contributed about three basis points to the overall contraction.

Overall, the NIM performance was satisfactory, we believe, given market conditions, growth in our balance sheet and continued increases in net interest income. Going forward, I believe competitive pressures will persist, but we do see positive signs and are taking steps to maintain our margin.

First, we recently have begun the process of lowering interest rates on some of our deposits in anticipation of Fed cuts. Taking a careful approach, we see the competition moving lower as well, so I expect more deposit rate relief going forward, especially with regard to attracting new deposits.

Keep in mind, of course, some of our lower rate deposits will continue to reprice higher, so there continues to be a lot of moving parts. Next, we recently restructured some wholesale borrowings, we're placing rates in excess of 3.25%.

We funded those first by selling some of our lowest yielding securities and then by utilizing swaps to bring wholesale funding at sub-2% levels. There was an approximately $1 million loss taken during the quarter related to the prepayment of the federal home loan bank borrowing, but the earnback on that is under a year.

Let me now comment briefly on the expected impact of probable Fed rate cuts. So only about 20% of our loan book is pure floating, and a portion of that benefits from [indiscernible]. So the actions I just mentioned, along with any further flexibility to lower deposit pricing, should allow us to offset any reduced loan yields. Turning to asset quality.

Our metrics remain strong, and with the recent payoff of a large nonaccrual loan that Frank just mentioned, our nonperforming asset ratio declined to 0.74%. That's where it is today from 0.82% reported at June 30 and from 0.96% one year ago.

And even with that isolated charge taken in the first quarter, our trailing 12-month charge-offs are below 0.1%, just eight basis points. And taxi medallion loans outstanding declined once again. It represents now only 0.5% of our loan portfolio. Let me talk a little bit about taxes.

As you may know, we've been taking a conservative middle ground approach to New Jersey's state tax accruals, and this, in fact, appears to be the correct approach. There are still some open issues. I hope they get completely resolved, say, in the next quarter.

But for now, we're going to stick with an effective tax rate of about 22% to 23% for the remainder of 2019. Talk a little bit about M&A. First, with regard to Greater Hudson, that transaction is completely integrated, the deal closed and all systems were converted during the first quarter. And during the second quarter, all cost saves were realized.

Next, BoeFly, which closed in the second quarter.

So we don't expect any material impact to the bottom line for the first year of operations, but we are in the process of developing some financial metrics, possibly gross revenue or what the reach of the platform is in terms of number of clients in order to track the progress and the value of this subsidiary.

As we forge ahead, we continue to look opportunistically for attractive franchise that will increase shareholder value. And as always, we want to remain an organically driven company, one with strong performance metrics, prudent growth targets, solid asset quality and meaningful capital generation capabilities.

And with that, Frank, let me turn it back over to you..

Great, Bill. Thank you. Overall, ConnectOne had a very solid second quarter, and we made meaningful progress on our key priorities. Our capital position remains strong, and we're confident that the actions we're taking will increase long-term shareholder value. As we look ahead to the second half of 2019, I'd like to reiterate a few key points.

ConnectOne has an excellent foundation to build upon. We're a skilled acquirer with a track record of integrating transactions quickly and effectively. We're well positioned to continue to grow organically even in a tough environment and still see our growth rate in the high single digits for the year.

We have a valuable franchise and believe there is meaningful organic growth potential in our markets. At the same time, as we successfully implement our modern retail model, we also continue to seek efficiencies by rationalizing our physical footprint, including our hours, staff and overlapping branch offices.

And we're continuing to transform by expanding our digital channels and becoming more technologically focused. At ConnectOne, significant progress has been made building our tangible book value per share, and our shareholder returns continue to be in the upper tier amongst our peers.

I'm confident that this will ultimately translate into a higher valuation. We strongly believe that ConnectOne is a compelling investment, and we're buyers. Thank you for listening. We appreciate your interest in ConnectOne, and I'll open it up for any questions you may have.

Operator?.

[Operator Instructions]. We'll take our first question from Collyn Gilbert with KBW..

Bill, maybe just starting on the deposit side.

So you gave some color as to what you're all doing from the strategies you guys are doing from a pricing standpoint, but how do you think that will impact just overall deposit growth for the rest of the year?.

Well, I think there were some seasonal factors this quarter that caused the deposit growth to be a little bit lower than it had been. So I'm hopeful that the growth will be a little bit higher going forward. But you're right. It depends on what -- how the competition is.

And we do want to have deposit growth, so we're going to have to listen to what the market gives us. I just feel that there is some rate relief ahead looking at the drop in -- we decreased our -- some of our deposit costs and didn't have any falloff in deposits. And I see the competition is lowering deposits as well..

Okay. Okay. That's helpful. And then just on the NIM. So the core NIM -- so it sounds like -- and I know the variances from the first quarter, but it sounds like this NIM is probably -- the core NIM this quarter is maybe perhaps a good starting point from where we should think about it going in the back half of the year.

Is that right?.

Sure -- there's factors going both ways....

I mean, I know you said lower....

And a lot of the actions taken, I think, will help the margin. But there is still competition out there both in deposit cost as well as spreads on loans. And on top of that, don't forget there's a portion of deposits that are still low rate, and so there's a risk that those, we'll need to reprice as well.

So I am confident, I'm cautiously optimistic that we're going to be able to maintain it here or possibly increase but can't really -- can't say for sure..

Okay. Okay.

And then can you just quantify what the accretion -- or, I'm sorry, what your outlook is for accretion, and then if you said it, I missed it, the specific amount of prepays that you saw this quarter?.

Well, the accretion was a little bit higher for this quarter. So we go back to -- towards the $1 million, $1.2 million range going forward, if you're trying to model it, okay, the margin. As far as prepayment, we normally get about three basis points a quarter, and maybe it was only one for this quarter..

Okay. Okay. And then just on the loan growth. Frank, I know you guys are maintaining that kind of high single-digit target.

Can you just remind us what the multifamily -- New York City multifamily rent-regulated exposure is and just what your outlook is for multifamily growth altogether? I know it was a slowing component this quarter but just how you're thinking about that going forward..

The New York City-stabilized portfolio, I believe, is less than 8% of the portfolio..

Of the total loan book or the multibook?.

Total loan portfolio. So less than [indiscernible] total loans. And then the LTVs of that are below 59%..

Okay. And in the expectation of that kind of mid- to high or high single-digit loan growth, is that assuming multifamily portfolios kind of hold where they are now? Are you thinking you can get some growth there? And I'm talking more broadly, not just within....

Yes. I think the multifamily portfolio will continue to grow somewhat, but I think it'll be at a much lower rate..

Okay.

And I apologize, I must have missed it, so you guys did buy back stock this quarter?.

We did, and it was about 250,000 shares. So I see you have the entire program repurchased in the first quarter. That's going to take three quarters or so to complete..

Okay.

So has there been subsequent purchases since the 250,000 that you did in the second quarter?.

Well, I disclose that at the end of each quarter. So -- but all I can say, we're still in the market, and there's no reason for us -- given our capital generation and the stock price, we are buyers..

We'll take our next question from Austin Nicholas with Stephens..

Maybe just on the multifamily question one more time, I guess, just in the growth that you're seeing.

Are you seeing any improvement in spreads there just given what's going on in the market and maybe some players being -- pulling back a bit?.

I think where there is improvement in spreads, we're not interested. I -- the market in New York City and the rent-stabilized area is still in a state of flux, not something we're big proponents of right at the moment. There are opportunities in other markets for multifamily still today, but the rate competition there is pretty strong, pretty fierce..

Got it. Okay.

And then I appreciate the comments on the floating rate portfolio on the asset side, but maybe on the deposit side, can you maybe just remind me of how to think about what percentage of your deposits are maybe tied to short-end indices, munis, municipal deposits, those sort of things, that could reprise upward, just -- but would need the Fed to actually cut for it?.

Yes. Just in terms of liabilities that are contractually tied, we're looking at $400 million, $450 million versus $1 billion on the asset side. But again, that doesn't mean that rates won't move on the ones that aren't tied to our [indiscernible] rate..

Makes sense. That's helpful.

And then just on BoeFly, can you maybe just talk about how you're thinking about using your balance sheet on that platform if you started to do that yet? And then any expectations you'd have to lever that?.

Right. So I don't think we're going to see anything meaningful in 2019. But as we previously reported, we will be one of the financial institutions that bids for the small business loans and the SBA loans that are matched up on the BoeFly platform.

And we've put some resources around building the infrastructure required to support those small business loans and those SBA loans, and we expect over time for that to be a contributor. But the real excitement is the BoeFly platform itself and what that represents for the future of our entire franchise..

Makes sense.

And then, Frank, maybe -- I appreciated both of your comments on M&A, but maybe just broader picture, how you're thinking about the M&A strategy just in terms of, geographically, where you're more interested, where you're less interested and just kind of thoughts on where you're seeing opportunities in -- just kind of in terms of the market overall just from kind of whole bank M&A and any comments on maybe nonbank M&A, too..

So let's start with the whole bank M&A first. I think for any opportunities that might be in market, I think those are really terrific opportunities for us because as you can see with the merger with Greater Hudson, we've been able to return back to and maybe even get better in our efficiency.

And so to me, the financial benefits of those types of transactions are tremendous for a bank like ConnectOne where we can integrate those transactions and extract those efficiencies. So from our perspective, we'd be looking at those pretty heartily.

Out of market, and when you say out of market, again, I think of the market of about 100-mile radius of New York City. I think there may be opportunities that are beginning to present themselves. As the world becomes more digital, I think geographic footprint is becoming less relevant.

And so if there are opportunities, we -- there may be things that we might want to look at today. On the nonbank M&A, sure, we continue to look for opportunities that would augment what we think we can do with our digital strategy, our digital platform and some of the thought that went into why we decided to merge with BoeFly.

And I think there's other opportunities both in that space and in others that will augment what we're trying to accomplish here..

[Operator Instructions]. We'll take our next question from William Wallace with Raymond James..

One follow-up question from Collyn on the New York City rent-regulated exposure, that 8% of your portfolio. Bill, you said that it was -- the average LTV was less than 59%.

Just to get a gauge of any tail risk, is there -- if any, what portion of that is greater than 80% LTV?.

The vast majority is weighted in the middle..

Okay. In between 80% and....

Yes. Maybe it's 10%. But we feel pretty comfortable with the portfolio. Now we underwrote that to, just in cash flows, low LTVs. And so even if there is value pressure on those buildings, we think we're well secured..

Wally, in almost every case in our underwriting, the best service coverage always limits the LTV. And so if you underwrite an existing cash flow that exists on property today, it's sort of hard to get hurt on an LTV basis..

Yes. Okay.

So your cash flow coverage is based on the current rents, not any roll forward?.

Right. And that constrains the underwriting and constrains the LTV, generally. We never get to an appraised LTV. We always wind up maxing out dollars at a debt service coverage as opposed to the LTV..

Okay. All right. Good. And then, Frank, just I'm kind of -- I was writing something when you mentioned this, so just wanted to make sure I understood. You've talked about a new facility that you opened and something about your employees being able to work in a flexible situation. Could you repeat that? I'm sorry I didn't catch it..

Yes. So we took an existing branch that we had and we used it as a test study to develop a new office model. If you walk into any bank today, offices are pretty static, cubicles, everybody has a desk, everybody has a phone, you know exactly where to find people.

We're finding that a large segment of our staff count can actually be, I don't want to call it remote, but mobile. They don't need to be in a specific office, and so we wanted to develop that strategy a little bit further. We took one of these branches, and we're building out a test office environment.

And we have a lending team that's going to be in there, and they'll be able to utilize that as well as a number of other office locations to be in a more mobile-type environment and more flexible-type environment. And I'm pretty excited about that. Also, we provide facilities for our clients to use.

As you know, we do a lot of small- to medium-sized business owners, and sometimes they need a conference room or they need space to have meetings and whatnot, and we're trying to foster that environment through our -- through the real estate that we have. I think we were, right? People like that flexible environment.

We're building something that'll look and feel like that and will allow for the next generation of staff that we hire to be much more flexible on how they work and where they physically find themselves in the ConnectOne environment..

Our next question is from Matthew Breese with Piper Jaffray..

Just wanted to pull apart the margin a little bit.

What was the NIM benefit from the borrowings being restructured this quarter? And what is the full benefit of that for next quarter?.

Well, we did it late in the quarter, so there was no benefit from that in the second quarter. And I would say two to three basis points of that restructuring is the benefit..

So if I'm reading into that right, does that mean, in the near term, you would expect, let's just take the borrowings restructuring out of it, the core NIM pressure to be two to three basis points, but longer term, as we get to the end of the year, that's when the lowering of deposit cost kicks in and keeps things flat? Is that more or less how you feel about it?.

I'm trying to understand the question.

You're saying if it's going to be flat the next quarter, that would mean you have core compression offset by the restructuring?.

Exactly. Yes..

Matt, it's hard to say. I think we're taking a lot of actions, and I see a lot of good signs going to stable margin, if not, hopefully improving. But on the other hand, I am concerned that there's still pressure for deposits, not a ton of liquidity out there.

And then on the lending side, we're seeing it's getting tougher and tougher and that the spreads are narrowing there. So those two things offsetting one another, I'd rather not give guidance. It's more like a flat guidance because I don't really want to give any guidance right now..

Understood. Okay. Perhaps what we could dive into then is where you are seeing deposit opportunities.

What products are you seeing that? Is it still on the longer-duration CDs? Or are you starting to finally see the money market in high-yield savings accounts, those promotional rates start to crack?.

Yes. Well, that's on the retail side. And as you know, it's only about 30%, 35% of our balance sheet is retail, so a little bit different. We're continuing to build relationships and build deposits through our lending franchise -- or commercial lending franchise.

So really, that's the key for us in funding going forward and profitable funding, is continue bringing core deposits through our lending relationships. True, that other stuff is important but probably less so for us than other institutions..

Got it. Okay.

Could you just characterize what the incremental cost of funds on the commercial side has been and where you expect it to trend over the next couple of quarters?.

Well, you're asking some tough questions, Matt. Well, first off, it's not 100% funded, right? So it's only, say, 30% of lending relationships are funded through deposits out of the lending relationships. But on a -- I'm not exactly sure, but it is below our -- the wholesale cost of funds right now is 250 before the Fed cuts.

We're obviously doing better than that on a funded basis..

Okay. And then just going back to your....

Are you trying to model what our margin is going to be?.

Of course..

Yes. Well, good luck. No. Listen, I think there's a lot of good signs out there. There are a lot of -- There's a lot of pressure on the portfolio with the flat yield curve. There's a lot of pressure with CDs repricing higher. It's starting to abate because the rates are getting to be at the highest point they could be.

And so there's reason to believe there's going to be less pressure going forward..

Okay. And then just thinking about the loan growth guidance and your positive stance towards that. However, I did get the sense that construction growth will be more normalized than multifamily growth, given everything going on there will be slow.

So what are the other areas of portfolio you expect to be -- growth to be robust? Could you just give us an idea of your residential, your traditional CRE and commercial outlook for the rest of the year?.

I mean we continue to grow our C&I portfolio both in number of clients and outstanding balances. That portfolio is somewhat seasonal at this point, but it shows tremendous progress both currently and for the future. We also do a fair amount of business in the owner-occupied commercial real estate space, and that continues to strengthen.

We have done some residential lending, although that has slowed a little bit. I think there's lots of opportunities for us to continue to get to growth. Our construction portfolio has performed well. We have developed a very, very good track record there with one of the best technological platforms relative to our construction portfolio.

And so we've attracted some very sophisticated borrowers who will appreciate working with ConnectOne, and they're willing to pay a little extra for the support that we provide there. So I think there's -- the pipeline is quite full. But we're not out of the multifamily space. There are still opportunities there.

I think there's lot of different -- we're building out our SBA platform, although I don't expect that to add significantly to the bottom line this year. But there's lots of other opportunities for us to continue to grow that loan portfolio at somewhere in the high single digits..

Understood. Okay. The last one is just on the taxi portfolio. We've heard of competitors being able to sell some of that product. So just curious where you stand in terms of wanting to keep it or perhaps sell some of it. I know we've kind of oscillated between that portfolio being held for sale or on balance sheet.

Where do you currently stand? And is there opportunity to get rid of it, some of it?.

Yes. I mean, right now, Matt, the portfolio is very stable. Everybody's paying. It's actually yielding at a pretty good rate. We have experienced in the last quarter or two a number of paydowns. I hate to sound surprised, but there are people who have paid their medallion loans off or sold them for cash, and we've accepted those payments.

And so that's always a good and encouraging sign. We have not received an offer that we believe makes sense for us at this point based on where we are, the borrowers we have and whatnot. But we continue to evaluate the entire portfolio over time and try to take advantage of any opportunities to lower our exposure there.

We're not making any new taxi loans; I'll tell you that..

Ladies and gentlemen, this concludes today's question-and-answer session. At this time, I'd like to turn the conference back to your presenters for any additional or closing remarks..

Thank you so much, and thank you, everyone, for joining us here today on our second quarter earnings call, and I certainly look forward to speaking with you again the next time. So thank you, and have a great day..

Ladies and gentlemen, this concludes today's conference. We appreciate your participation..