Q4 2022 ConnectOne Bancorp Inc Earnings Call

Speaker 1: Our originations were spread amongst all segments of our markets, including Southeast Florida and eastern Long Island, with additional synergies driven through boat fly and both SBA and non-SBA lending verticals. NEC 1's strong performance in 2022 is a testament to the success of our culture.

Speaker 2: the technological foundation we built, and our relationship-focused origination franchise. That said,

Speaker 3: It's important to note that despite consistent performance, each quarter has its own set of challenges and opportunities.

Speaker 4: Like many banks, we had a challenging quarter with respect to net interest margin, as deposit competition significantly increased, reflecting the Fed's intensified battle with inflation.

Speaker 5: In addition to the rapid and significant rise in short-term interest rates, quantitative tightening has removed liquidity from the financial markets even if the economy continues to grow.

Speaker 6: As a result, by decreasing the money supply, there's an overall decline in deposits within the banking system. In this case, the bank's

Speaker 7: and this has led to historically fierce competition for interest fair and deposits among both large and small banking institutions.

Speaker 8: While our loan portfolio rates are increasing at a nice pace, around 50 basis points sequentially, credit spreads for bank loans continue to remain low from a historical perspective.

Speaker 9: Finally, while the inverted yield curve puts additional, albeit temporary, pressure on the NIM, we made the decision to maintain and support our client relationships.

Speaker 10: We remain focused on serving our clients, supporting our staff, delivering value to our shareholders and improving and building upon our distinctive operating platform.

Speaker 11: all while maintaining our results-oriented, client-centric culture.

Speaker 12: Our business model has performed well across a variety of economic interest rate environments.

Speaker 13: We always set ourselves apart by making it easier for our clients to do business with us while empowering them with the latest technology to meet their evolving needs. And we enter 2023 well positioned to build on our strengths and achieve our long-term objectives.

Speaker 14: Speaking of technology, several of our investments are moving through to implementation and are focused on providing a better experience for our clients while driving increased productivity and efficiency.

Speaker 15: A partnership with Mantle to deploy a new modern omni-channel deposit origination platform is underway, and this tech partnership allows us to expand our reach in supporting commercial, small business, and consumer clients while optimizing our workflows.

Speaker 16: Our partnership with Nimbus to launch Venture On.

Speaker 17: The new branded business vertical on a lean and nimble cloud-based tool is nearing launch and will provide bespoke banking services designed to meet the demands of high-growth venture-backed technology companies.

Speaker 18: Turning to Bowfly, our online business lending marketplace, we continue to enhance its infrastructure, add new users, increase our clients' overall workflow efficiency, and drive revenue.

Speaker 19: Now turning to credit, our credit performance remained strong, and while Bill will provide some additional detail shortly, we saw improving credit metrics during the fourth quarter. Our MPAs declined by more than 20%. Our delinquencies as a percentage of total loans remain near zero.

Speaker 20: and we continue to prudently maintain reserve levels commensurate with our organic growth and the changing macroeconomic forecast.

Speaker 21: End of the year with a very strong capital position across all regulatory ratios, in addition to the tangible common equity ratio, which has hardly been impacted by AOCI.

Speaker 22: We've also been investing in our business and as we enter 2023, I'm excited to build on the early successes we've seen from the launch of our new healthcare team and our expansion into Southeast Florida and eastern Long Island markets.

Speaker 23: With that, we remain confident in our ability to drive value for our shareholders, and similar to previous years, that could include our board evaluating future dividend increases And a

Speaker 24: reinforcing our belief that Connect One shares are undervalued, potentially utilizing share repurchases, all subject to market conditions.

Speaker 25: So to wrap things up, we're a dynamic, highly valuable franchise, and we're pressing forward leveraging our client first operating model.

Speaker 26: Enter 2023 with a deep capital base, strong earnings, and that can support multiple growth initiatives. And in short, I'm confident that we'll continue to produce opportunities for our clients, our team members, and our shareholders.

Speaker 27: We look forward to sharing our progress in the quarters ahead. And with that, I'll now turn the call over to Bill.

Speaker 28: All right, thank you, Frank. Good morning, everyone. I'm sure many of you are awaiting my commentary on the net interest margin, both for the current quarter and give you some guidance for 2023. But before I get there, I'd like to review what was a stellar year for Connect One. Our operating earnings for a record.

Speaker 29: representing 2.2% of average assets and they were up nearly 12% from the prior year. Period end loans grew by 19%.

Speaker 30: and deposits by more than 16%.

Speaker 31: Our tangible book value per share increased another 8% in 2022 after increasing by 15% in 2021. That's close to 25% in two years. And that reflects not only our strong core earnings but also effective management of our securities portfolio and the results in AOCI.

Speaker 32: and the fact that we've grown organically and not through M&A.

Credit quality, those metrics improved even further with our non-performing asset ratio decreasing for the fifth consecutive quarter to 0.46.

And as many of you are aware, some of those non-performing assets include a small and declining exposure we have to taxi medallions, which, by the way, already have a very comfortable reserve and carrying value. Excluding those taxi loans, our MPA ratio is cut in half to 23 basis points.

In delinquencies, that is loans passed to 30 days or more, we're next to nothing, just two basis points of total loans.

Our net interest margin, which has been under pressure recently, came in at 370 for the entire year. That's a record for Connect One and higher than most in the industry.

And our efficiency ratio was 39% for the year, even as we invest in technology, reward and build our staff.

and prepare for crossing the $10 billion threshold. So when you combine our strong growth with a wide margin, an efficient back office, strong credit and balance sheet management, the result is upper quartile if not higher returns on asset equity and tangible book value for shared growth.

And that kind of performance gives us the flexibility to manage for the long term, which is nothing new at ConnectOne. For example, while some of the industry achieve efficiency by cutting costs.

Connect One's best-in-class efficiency is based on strong revenue and a scalable operating platform as we invest opportunistically and where needed to ensure the long-term success of the company. In a similar light, in turning to today's challenges, we reviewed the landscape and made a strategic decision to be more aggressive with deposit rate competition.

ancillary business lines that can be both volatile and troublesome, rather those businesses, segments and clients we know and serve best.

Now let's dive a little deeper into some of the factors impacting our margin, many of which either have or will be impacting many others in the banking industry. And as I said before, we had previously anticipated pressure on the margin, given that we were already operating at record highs.

Now let's talk about the two primary tools at the Fed's disposal for payment inflation, which are one, increasing the Fed's fund's target rate, and second, open market actions to contract money supply.

First, that rising short-term rates has provided a greater incentive to depositors to transfer balances out of non-trust bearing accounts. We are seeing this, the whole industry is experiencing it.

and that intentional upward push on short term rates had the effect of inverting the yield curve. And that too is putting pressure on loan spreads and margins.

Second, the tightening of money supply, which results in increased competition for deposits, competition that heated up during the fourth quarter, and that is essentially what is accelerating deposit betas. The second, the tightening of money supply, which results in increased competition that heated up during the fourth quarter, and that is essentially what is accelerating deposit

One more item impacting the margin is the significantly lower level of loan prepayments, and therefore the associated prepayment penalty income is lower. These items have combined to cause a larger than expected compression to our margin.

But keep in mind that net interest income for the quarter was about flat sequentially and is up 11% from a year ago.

Now, going back to some of Frank's comments, I want to reiterate that although we carefully watch and are cognizant of Federal Reserve policy and do all we can to lessen the impact of economic condition, those things are somewhat out of our control and tend to be temporary.

where we are keenly focused.

is on managing things in our control, which more specifically are serving our clients. We've been extremely effective at maintaining and solidifying strong client relationships and in capturing new market share, especially where clients are feeling particularly displaced by M&A.

Ultimately, that will continue to make us a consistent earner.

maintaining a prudent approach to growth in terms of both credit and spreads, managing our expenses and maintaining our culture. All those together over the long term will continue to drive shareholder value. Now looking ahead, we're going to continue to focus on gaining market share of market rates.

We do believe things have calmed down slightly. However, there is still potential for several rate hikes and continued contraction liquidity So there will likely be continued pressure on the NIM in the short term However, when conditions settle down when the old curve resumes its normal upward slope We aim to be back to where we are today or even slightly above

Now, moving to other items impacting the financials, we saw modest seasonal provisioning. This quarter related to both organic loan growth and a slightly continued deterioration in movies economic forecasts across a range of specific metrics.

The quarter's charge-offs relate to the successful workout of non-accrual loans identified in reserve form previous periods and therefore did not materially impact the provision this quarter and certainly are not any indication of an upward trend in charge-offs. The net charge-off rate for the year was just seven basis points.

And just to reiterate, all indications at the present point to solid asset quality metrics.

As far as non-interest income, we're probably just a little light versus street estimates, but we have a pipeline of SBA loan sale gains building through both Bow Fly and traditional sources, and we are optimistic that that will be increasing source of revenue for ConnectOne.

In terms of other expenses, inflationary pressures persist and are impacting our numbers to some degree. As is typical for ConnectOne, there usually is an increase in sequential expenses heading into a new year. I'm estimating that to be about 4% for quarter one. I'm targeting relatively minor expenses in the remainder of the year.

and sub-debt on February 1st in just a few days. We prefunded that in 2021 with a non-cumulative preferred stock issuance.

So we end the year with a nice capital level and assuming slower growth, we would plan to recommend dividend increases in stock repurchases for 2023. And that concludes my remarks. Thank you for your time and have a great rest of your day.

Thank you, Bill. So, as you all heard, we made some significant strides in 2022 and from market expansions to the addition of new talent and business lines and leading investments in technology and infrastructure. We certainly laid a lot of groundwork to capitalize on new growth opportunities in 2020.

Even with the number of uncertainties hanging over the industry, our strategic priorities for 2023 are very clear.

We're prepared and geared to continue to smartly gain market share.

We have a dynamic team of bankers with a proven ability to execute.

And I'd be remiss if I didn't acknowledge all of our team members who made 2022 the success that it is.

We have a scalable operating model that continuously evolves by leveraging technology.

We continue to view 2023 as a year that will be ripe with opportunities for continued expansion.

Thank you.

Particularly given the M&A disruption.

and our proven success at capitalizing in these moments.

So we're excited for the future ahead and in our view Connect1 continues to generate meaningful shareholder value and remains a very compelling investment opportunity.

Thanks again and we're happy at this time to take your questions. Operator?

at this time to take your questions. Operator? Thank you.

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One moment please while we poll for questions. Thank you.

Thank you and our first question is from the line of Frank Schiraldi with Piper Sandler. Please proceed with your questions.

Morning.

Just wanted to start with the margin and you know always looking for any color I can get but Bill in terms of mentioning we got it looks like another couple of rate hikes potentially here early in 2023 at least that's what the forward curve saying and you know you mentioned additional contraction from here just

I'm wondering if you can give any color on your thoughts, either just the deposit data you guys are using now through cycle or alternatively where you expect the NIN could kind of bottom out if that's the trajectory of things in sort of the rate outlook. Yes first. Listen first.

I think the major concern is the contraction of liquidity, which is forcing competition. And we monitor that all the time and it continues to shrink the balance sheet and decrease the money supply even as the economy is growing. So everyone is facing that competition. They haven't faced it.

or their deposit baters are slow today, I believe that they will start to increase if the Fed continues that. In terms of our margin depression going forward, I think it's going to abate a little bit. I just want to be conservative here. We're putting loans on at 7%. We are still funding anywhere from $3.50 to $3.50.

about that 350 to 450 level of funding, you know, just curious if we can put a little bit more color around what sort of duration you are focused on in terms of the CDs you're putting on the books and if that's you know what it was in the quarter and if that's

likely to continue.

Right, right. It's hard to say what the duration of all funding is going to be in the future, but what we're going to have in the marketplace is in the one to two year range for those CDs.

Okay. And has pricing kind of stabilized there at those levels?

I'm sorry, what would stabilize the deposit pricing? Yeah, for that level. Yeah. I appreciate it.

Listen, I believe so. There could be continued.

competition that can make things a little bit more difficult. And you know, there's always a potential for outflows of non-interest bearing deposits, but I see it, you're seeing all the banks recovering as the same sort of situation is happening.

And then lastly, just on capital return, you mentioned the stronger capital side of things. You mentioned buybacks and potential dividend increases. Is there, where we sit today, what the stock rate is today, is there a preferred method of capital return? And also, can you just remind us?

any sort of targets you have on the either the TCE or regulatory capital side.

targets you have on the either the TCE or regulatory capital side for 2023.

Well, without getting into a specific target, I think that our capital generation is going to exceed our asset growth. So there's going to be the ability to return capital. The second thing is our dividend payout ratio remains one of the lowest out there around 19 or 20%. So we have room to move that dividend up just on that basis.

Thanks for taking my questions.

I follow up to kind of the last line of questioning around And you know bill taking into account your expense guys kind of thoughts You know I mean it is it fair to kind of summarize that by saying obviously you know this was the first quarter in a while You guys saw the efficiency ratio dip over 40%

but it seems like it's going to be in that low 40% range for this year with the hope that maybe you could improve that a bit once the rate environment stabilizes and the NIB rebounds as you kind of gave the build out towards Bill. Is that generally kind of a fair way to be thinking about it at this point? I think it could be that we are...

to my comments, you know, when the yield curve returns to its natural state, you know, we'll be a lot better off and our margin will expand at that point.

quick.

And

Just on the growth piece, you know, I...

I apologize if I missed a specific number or view, but I felt like I kind of heard two different tones. There was a comment, I think, Bill, you made about how you guys are going to be aggressive at maintaining customers and kind of building share. But then I think there was also a comment about.

environmentally like scaling growth back a bit because of the funding environment and maybe I've just heard that that latter one but just can you remind us what the growth expectations are for 23 just you know more specifically take into account those kind of broader backdrops

Yeah, Mike, I'm sorry if there was any confusion, but from our perspective, we're not looking at growth as a function of the NIM. We're looking at supporting the existing clients we have, taking opportunities in the marketplace to grow new clients.

and the NIMLB with the NIMLB. I know there are a number of institutions that have made the decision to allow large amounts of deposits to walk out the door. We just seem to feel that we're working too hard to gain high quality clients. We're not gonna let them walk out the door and there's a price to pay for that.

That being said, if you look at this economy and where we are and where we do see growth opportunities, there's just less of them in totality. We see opportunities within the marketplace, but I think 2023 is going to be a more challenging year for not just us, it's the economy, it's the interest rate environment, it's the lack of liquidity, it's......

business formation, you name it, it's going to be a challenging year. I think we'll do well in it, but I don't know at what level. I wouldn't want to predict that we'd grow faster this year than last year or anything like that. So I think it's a combination of those things. But I think the fundamental...

message we want to get out and that both Bill and I talked to was this idea that we are going to stand by our clients irrespective of where the interest rate environment is.

Got it. No, it's a helpful clarification, Frank. Thanks. Where is the pipeline today and how does it...

look kind of by product or geography. Just curious if there's any more detail you can provide there.

Yeah, I mean I would say that our pipeline is quite strong even today and it's still pretty well diversified across the various aspects of the different verticals that we typically lend in. There is a little bit more emphasis in the CNI space. We're seeing some improvements there, but...

I'm not sure it's big enough to make enormous change in the balance sheet, but there's definitely a higher focus there. And we are seeing... discuss we're going to bring it to you...

probably more opportunities in some of those newer markets that we put some resources around or that we've made investments in, you know, namely the Florida market which has been performing extremely well for us, both in the size of the market we've created there and the, you know, loan to deposit ratio within that specific market.

as well as the eastern Long Island market. Those markets have been pretty exciting for us to watch grow and we're expecting really good things from both of those as we move into 2023 and additionally all the other projects that we have around whether it be a new vertical or

you know, a new place where we're putting emphasis. The healthcare business being, you know, an example of that.

Perfect. Thank you guys for addressing those. I appreciate it.

Thank you.

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The next question is from the line of Daniel Tamayo with Raymond James.

Daniel Tamayo with Raymond James. Please receive your questions.

Hey guys, good morning.

on credit quality, reserves down to 112 here, just to get your thoughts on where you could see that ratio trending through the year given the economic uncertainty and the loan growth you're expecting. Dear Organizers, thank you for being here to support This Minute Live here.

Well, listen, with CECL, it's really contingent upon where the forecasts come out. And for now, although some of those metrics, those forecasts are declining, especially in terms of projected GDP growth, sales.

Those were the negatives are, but the unemployment rate is not really changing much in terms of economic forecast. Until you see that, you're not going to see a ton of provisioning around the industry. So I think there's a lot of misconceptions out there, but I'll see still work. Some people think that it's how we feel.

about where reserve levels should be and I think most bankers would agree yeah, it wouldn't hurt to add to reserves, but that's not what CSL is really allowing these days. So other than having specific reserves for specific credits, which we don't have any, it's all really contingent upon this black box model.

So if you think that at some point the unemployment rate forecast is going to increase then you'll see, you know, fairly significant increases in reserving. If you don't, it's probably going to be pretty much benign.

Okay, great. I appreciate that. My only other question.

Is that is just around the 10 billion in asset threshold and you're thinking that was likely you would cross this year That's still the case or if that's changed at all with the economic forecasts

I think there's a good chance we cross the $10 billion threshold. We've been preparing for it for a while. There are some costs associated with going over, but it's pretty small for ConnectOne, those costs, and we've been building for this along the way. So we don't really see too much change in our financial performance.

And regardless of what's going on, one of the things I just want to add here is that we've entered times before where things are a challenge, but we continue to produce year in, year out very strong return metrics and credit quality metrics. And I see no difference this coming year.

Great, I appreciate the color.

The question is from Matthew Breese with Stevens.

Matthew Breese with Stevens. Please proceed with your questions.

Good morning. Hey, Matt. Good morning, Matt. I wanted to go back to the NIM and NII. You know, Bill, historically we've discussed kind of, you know, in a higher rate environment where the NIM floor could be. I think you've mentioned that, you know, perhaps in that 350 range was a good floor. Right. Feels a bit lower now and, you know, just out, you know, touching on your incremental loan yields.

as the money supply continues to contract and it still is. I watch this every week as the numbers come out. And so you have a couple of things. You continue to have more competition for interest-bearing deposits. And secondly, there continues to be a flow out of non-interest-bearing deposits. This is for all banks, not just us. And so when we were doing examinations on new deep-otta consultants before cars, they told us

This happened, really started taking effect in the middle of the fourth quarter, and it was much more severe than I expected, the competition for deposits. And I'm sure you're seeing in some of the other banks that you cover. So yes, I'm on the margin right now.

The new book, the new business we're putting on is that spreads that are going to maintain our margin. I'm just concerned about those other factors that could cause a little bit of pressure. But you know, this is a temporary situation. Things should settle out. The yield curve being inverted does not help anybody.

If the yield curve goes back to its normal shape and the long end remains higher than it was a year ago, the banking industry and margin should be in good shape.

You had mentioned that incremental low-neal during that 7% range. I'm curious, what are they rolling off at?

The rolling offering about the high five to six percent.

Okay.

The other question just around NII, you know, just thinking about 4Q-NII, 78 million.

a little over 300 million annualized.

you know

Is that a number you think you can grow off of in 23?

Yeah, I would expect that we will grow that.

That the growth and the balance sheet will exceed, you know, any percentage decline in the net interest margin. Okay. I'm sorry if I missed this, Frank, in your earlier commentary around, did you mention any loan growth guidance for the year? I did not. I mean sitting here, I would tell you that based on our pipeline, based on what we see relative to payoffs, I would tell you that it would be my anticipation. We'd be growing in the...

single digits. Okay. Other question is, I know credit quality metrics today look look very solid. As I think about, you know,

new paper coming out at 7%, I would think there's also changes in cap rates. I mean, do you have any underlying concerns with the ability to keep MPAs and charge-offs at these levels just given the higher interest rate environment, or should we expect some normalization in those figures? I would tell you that this doesn't appear normal to me, that all banks have virtually no delinquencies. I do think that there has to be some normalization around delinquency metrics and that...

There will be some level of credit issues going forward. I think it would be unrealistic to expect them to remain at zero. However, I do believe this is a very different environment than what we saw in 2008. I think real estate acts differently in this particular environment.

I think there's a lot more capital in real estate transactions than there were before. I think the inflationary environment has put a lot more money in people's pockets. So I just think we're going to see different types of credit issues. Just don't have my crystal ball polished up to figure out where exactly that's going to happen. But I just...

just from history, it just can't stay at zero. Something's got to break.

As you're underwriting new real estate, how have cap rates changed or trended and debt service coverage ratios changed or trended? How have cap rates changed or trended and debt service coverage ratios changed or trended and debt service coverage ratios changed or trended?

performance change or MPA increase here, I'm just not quite sure.

Where it is on the valuation reset or the fundamentals of the property? Yeah, I think there has been a valuation reset And I do think that cap rates have gone up, and I think that's pretty apparent in a lot of places But you know debt service coverage ratios have remained pretty strong You know rent rent

have gone up in the residential arena. The places where there is some weakness is obviously an office, not necessarily that the lease rates have come way down, but that the occupancies are lower and businesses are cutting back on the number of square feet that they need to operate their business efficiently.

I don't know that there's been a whole lot of movement around that debt service coverage ratio. I mean ours has been pretty consistent pretty much since we started the bank at the end north of 125 and I think our average on the portfolio is closer to 150. So there's a lot of room in there for some level of weakness or temporary weakness.

I think one of the areas that of course we watch very intently because it's a good part of our business is construction because there's a lot going on there, not only with the cap rates, not only with what the potential debt service coverage ratio will be at completion, but the cost of the construction, inflationary pressures on the...

Thank you. At this time, I'll turn the floor back to management for closing remarks.

Well, I want to thank everyone for taking the time today to hear our remarks about the fourth quarter of 2022. And we're excited to speak to you in the future quarters of 2023 as we continue our journey. Thank you all.

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