ConnectOne Bancorp, Inc. (NASDAQ:CNOB) Q2 2018 Earnings Conference Call July 26, 2018 10:00 AM ET
Siya Vansia - IR
Frank Sorrentino - Chairman, President & CEO
William Burns - EVP & CFO
Collyn Gilbert - KBW
William Wallace - Raymond James & Associates
Good day, and welcome to the ConnectOne Bancorp, Inc. Second Quarter 2018 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Siya Vansia. Ma'am, please go ahead.
Good morning, and welcome to today's conference call to review ConnectOne's results for the second quarter of 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 provision 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 release and accompanying tables and schedules, which have been filed on Form 8-K with the SEC on July 26, 2018, 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, and good morning, everyone, and welcome to ConnectOne's earnings conference call. The company had a solid quarter. We achieved strong performance metrics in several key areas, including deposit and loan growth, net interest margin, return on assets, tangible common equity and credit quality, despite challenging market conditions.
Net income was $17.5 million or $0.54 per diluted share for the second quarter. These are record quarterly earnings for ConnectOne. We delivered return on average assets of 1.38% and return on tangible common equity of 16.6%. In addition, our tangible book value per share grew nicely in the quarter, increasing to $13.38 per share. While deposit pricing remains extremely competitive, total deposits increased by $156 million for the quarter. As discussed, we're focused on growing client relationships and accelerating core deposit growth, so that it's commensurate with ConnectOne's organic loan growth.
On the lending side, total second quarter loan growth is at double digits, increasing by $112 million or more than 10% on an annualized basis from the prior quarter end. Over 50% of the quarter's growth was in non-CRE segments, which grew at approximately 17% on an annualized basis. We reduced our CRE concentration to 506% at the end of the second quarter and we expect this downward trend to continue over time in a number of ways, including continued growth in our C&I portfolio as well as owner-occupied and residential originations. Furthermore, our merger with Greater Hudson will accelerate our growth in non-CRE segments. Additionally, the credit profile of the bank remained strong. We're committed for the long-term proving growth of our franchise as we continue to invest in process improvements in all areas of ConnectOne.
Turning to infrastructure investments. ConnectOne had a strong track record of offering our clients the latest technology to meet their evolving needs. Phase 1 of our nCino platform rollout is complete and workflow is fully implemented. We're beginning implementing Phase 2, which entails building enhancements and adding on technology to create efficiencies in our lending process. Further, our SALT platform will be launched to our clients in the coming weeks. Additionally, we continue to diligently expand the knowledge base of our company by adding talent in the deposit and loan origination areas to our team, as well as expanding into new markets within New York in several tangible ways. First, our new office center in Melville, Long Island, which opened during the second quarter, is serving as a business banking hub for the Long Island market. It continues to exceed our expectations. Second, we'll be expanding into the lucrative Queens market during the third quarter, with an opening of an office in Astoria. And third, with the closing of the Greater Hudson merger early next year, we'll have an immediate presence in Rockland, Orange and Westchester counties, including a team of experienced bankers, C&I lenders and deposit gatherers.
Before I turn the call over to Bill, I'd like to comment on the operating environment. It's competitive out there. Spreads on new business remain tight from a historical standard and in response, we're managing the company carefully, balancing our growth, expenses and investments. Despite this environment, we've achieved record performance. The decisions we're making, whether it be organic growth, M&A or infrastructure investments, position us to continue our disciplined growth strategy, enhance our competitive position and create long-term value for our shareholders.
At this time, I'll ask Bill Burns, our Chief Financial Officer, to review the details of our financial performance. Bill?
Thank you, Frank. Good morning, everyone. So as Frank mentioned, we had a record quarter, both for net income and diluted earnings per share. The $17.5 million in net income or $0.54 per diluted share we earned in the second quarter represented a more than 30% increase from last year's adjusted second quarter earnings, and that was 8% annualized increase from the sequential quarter. For the quarter, we posted across-the-board sequential improvement in many performance metrics. Return on tangible common equity increased to 16.6%; our net interest margin expanded both on a GAAP basis and on an adjusted basis; the efficiency ratio improved, 41.9%; loan-to-deposit ratio declined; our CRE concentration continued to trend lower; and all asset quality metrics trend in the right direction. And our tangible book value per share increased $0.45 or 3.5 percentage in just 1 quarter.
Meanwhile, as we've mentioned in the past, our goal has been to fund growth solely through retained earnings, and this was the first quarter ever where our capital ratio has increased without a capital offer. All of our capital ratios ticked up sequentially anywhere from 10 to 30 basis points, and the increase in capital this quarter reflected a strong ROE combined with an annualized growth rate above 10%.
Let's now take a closer look at our net interest margin. Many of you may be aware, we had a good deal of NIM compression in the first quarter. Most of that was expected primarily coming from the January sub-debt issuance, but there was also some core margin compression. Now during the second quarter, we halted that downward trend with our margin expanding by 5 basis points. Some of this expansion was due to purchase accounting, resulting from prepayments on loans in the acquired portfolio as well as a better asset mix, but the core margin was essentially flat. And while I'm pleased with the margin performance in this quarter, I'm still going to be conservative by projecting some core margin compression for the remainder of the year as we continue to see significant competition on the funding side and loan spreads, although slightly wider than earlier this year, are still tight from a historical perspective. One thing investors should be aware of, although our funding costs may be increasing faster than the average bank, the same thing can be said for asset yields. They too are increasing faster than average.
Now speaking of loan spreads, we have previously communicated a strategy of selling some non-relationship multifamily loans. It's still something we would like to do, but the pricing is just a little too tight at the present time. So maybe in the future, but currently, I'm not expecting much in the way of gains on sale.
Now let's turn to expenses, where we're essentially flat from the first quarter. Our efficiency ratio improved 41.9%, and that reflected the flat expense growth but also revenue growth of about 2% sequentially. I expect that efficiency ratio to trend lower in the future, with a slight pickup in growth rates for both net interest income and operating expenses.
Now just want to make a few comments about the recent merger announced with Greater Hudson. First off, we expect the closing of the transaction in very early January, so the merger will have absolutely no impact on 2018 numbers but will have a full impact to the full year 2019. And this deal was very compelling from a financial perspective. The purchase price was only 1.35x tangible book. That led to just 1% tangible book dilution, with only a 2-year earn back and 2.5% earnings accretion, all great numbers, and I think we can do even better. The Greater Hudson brings a solid balance sheet that further improves financial metrics I just spoke to. For example, Greater Hudson has a lower loan-to-deposit ratio, 85% versus our 112%. It has a significantly lower CRE concentration metric, 336% of capital versus our 500%, and Greater Hudson has a wider net interest margin, wider by about 35 basis points. And that wider net interest margin should result in NIM expansion. We estimate that to be at least 5 basis points beginning in the first quarter of 2019.
So to sum up, we were very pleased with the quarter. We had record earnings with no special items, point-to-point deposit of loan growth was strong, return in tangible common equity exceeded 16.5%, all our financial metrics headed in the right direction and we penciled a low-risk accretive merger deal. And going forward, the difficult operating environment we're in will likely keep our organic growth at lower levels than we were used to while also pressuring net interest margins, but notwithstanding this environment, we remain committed to executing on our business plan, utilizing technology to remain one of the most efficient banks in the nation, driving shareholder returns and increasing franchise value.
And with that, Frank, I'll turn it back over to you.
Thanks, Bill. As you can see, we're pleased with our record second quarter results. Our ability to successfully execute demonstrates that our disciplined growth strategy is paying off, and that's driven by our solid execution, being successfully opportunistic in M&A, advancing our best-in-class efficiency, continuing to make strategic investments for the future. While we're mindful that the near-term operating environment will remain challenging, we continue to focus on creating a desirable franchise while increasing momentum across our platform through our client-first sense of urgency culture. And looking ahead, our earnings trend contribute to a solid growing base. We believe this approach will help us achieve her goal of attractive long-term returns for our shareholders. We remain on track to achieve our objectives for '18 and look forward to working together with the Greater Hudson team on our integration plans.
So I want to thank you again for joining us today and now, we'd be happy to respond to any questions. Operator?
[Operator Instructions]. Our first question is coming from Collyn Gilbert, KBW.
I just wanted to clarify or just kind of walk through some of the comments on the loan side. So Bill, you had said, when you said multifamily, pricing was such that you would not be looking to do any loan sales. You were talking about multifamily, right, not resi?
Yes, multifamily, correct. Just a little tight in the -- the pricing's tight and there's not really enough gain in there, and that's why we're holding off for a while.
Okay, okay. And then, just in your sort of, towards the end of the comment, just you had indicated that growth would be perhaps lower than where you guys had been historically, which makes sense obviously. But just wanting to kind of fine tune what that means. Are you guys still thinking you can get into that low to mid-teen loan growth rate? Or is that closer to 10% or just tying, Frank, your comments about the competitive outlook staying disciplined on pricing, what that might mean for loan growth going forward?
I think our position right now was that low teen growth from now through the end of the year. So one other comment about our growth. The distinction is between what it's going to be total for the year versus where we're going until the end of the year. And I think we can hit that low teen rate for the second half of '19.
Wait, low teen growth rate for second half of '19?
Sorry, second half of '18.
Okay, okay. So you're saying -- so the full year will likely be lower than low teen because you're -- but in the 6 months, if we annualize that growth rate...
Possibly because the first quarter was a little slow.
Okay, okay, got you. And was there any pre-pay income in the margin this quarter?
There was a couple of basis points, but no different from the first quarter.
Okay, okay. And then just finally, deposit trends. So you guys had a great quarter of deposit growth. Can you -- obviously, competitive environment, but just sort of talk about sort of your outlook for deposit growth kind of where you see that mix go in and where you're seeing the most intense pricing pressures and maybe where you're seeing the most successes on the deposit side?
Well, any interest-bearing transaction account and CDs are on the retail side, on the core side, are going to be competitive. Obviously, there's a portion of our deposits that are wholesale, so those reprice quickly. The key is going to be the ability to maintain and growing non-interest-bearing demand. And although they were up from the quarter, if you look on the average, it's more flat. But we're off to a pretty good start in the third quarter.
And the increase, Collyn, in the C&I lending is helping in that regard as well as the new locations and new people that we've hired for different markets that we're expanding into. So all those things are positives, and I think a lot of those things came together this quarter to help with the total overall deposit growth.
[Operator Instructions]. Our next question comes from William Wallace, Raymond James.
Maybe on the expense side, Frank, you mentioned the Queen's entry in the third quarter, I apologize, I missed if you mentioned there was another branch that you're opening. But I'm curious how the new branches are going to impact the expense base and maybe, bigger picture, just how you kind of think about the efficiency ratio in the back half?
Yes. So these office branch locations are not the typical retail location that you would find. They're more typical for what ConnectOne has been transitioning into, going forward. And so it is my belief, the expense of adding those offices is quite minimal relative to the size that they can achieve over a short period of time. Our Melville location, as I said, exceeded our expectations for growth. So we don't -- we see the ability to continue to lever our expense base, create operating leverage and drive our efficiency ratio sequentially lower and, even with the addition of additional offices in the future.
And I just wanted to add, yes, I do see -- we were flat expenses versus second quarter. I do see an uptick in expenses in the third or fourth quarter, but I also see a little bit stronger growth in net interest income. We started the quarter at a much higher loan volume than we started the second quarter at.
And Wally, just lastly I know Bill has mentioned this on many other calls and I certainly said it in a number of meetings, it's not that we are in any way retarding our growth of expenses. It's -- we are growing the expense base and we are investing in the future and whether that's people, locations, technology, whatever, it's just that we're able to grow that expense base at a slower rate than what the revenue is growing, and that's what's creating the operating leverage.
Right. That's the highlight of the bank. I'm going to be the one to ask, but could we maybe get an update on what you're seeing in the taxi portfolio, what you're seeing overall with the TLC and any changes in New York?
Just from my portfolio -- from my perspective, the TLC continues to look for ways to help the taxi industry. I think they've made a number of changes that have been positive for the industry as a whole. I think all that's basically done is recover some damage that's been done in the past and allowed for some level of stability in the marketplace today. All I would further say is that there's probably been more transactions recently than there have been in the last 3 years. And so it appears there is some stability relative to pricing and lease rates and the number of driver imbalance and all those things are starting to come more into balance. And so from our perspective, I just see a much more stable operating environment.
And I think it's so small, it doesn't warrant too much time talking about it. But we're disciplined with how we value that portfolio. The trades that were reported by the TLC were a little bit higher, and that caused our valuations, if anything, to go up. We didn't take a writeup because of it but our calculation comes out a little higher this quarter. They continue to pay as before. We're earning in excess of 6.5% on the portfolio as it stands at the $27 million, $28 million level.
I see there's no other questions. I want to thank everyone for joining us on our second quarter earnings call. We appreciate your interest, and certainly look forward to speaking with you again on our next quarterly conference call on October. Thank you, everyone.
Ladies and gentlemen, this concludes today's teleconference. You may now disconnect.