Q2 2019 Earnings Call

Good day, ladies and gentlemen, and welcome to the connect one Bank Corp.

Corporation second quarter 2019 earnings call. Today's conference is being recorded at this time I'd like turn the conference over to see events Senior Vice President of marketing. Please go ahead.

Good morning, and welcome to today's conference call to review connects one's results for the second quarter 2919 and to update you on recent developments.

This conference call will be free Sorrentino, Chairman and Chief Executive Officer, and Bill Burns Chief Financial Officer.

The results as well as notice on this conference call on a listen only basis over the Internet were distributed this morning, and the press release that has been covered by the financial media.

[laughter] time, let me remind you that certain statements and assumptions in this conference call contains RBC. 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 Companys filings with the Securities and Exchange Commission.

The forward looking statements included in this conference call are me as of the date of this call and the company is not obligated to publicly update or revise that.

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 people or schedules, which have been filed on form 8-K with the FTC on July 27, 2019, and May also be accessed from the company's website that IR dot connect one bank Uh huh.

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 bring Sorrentino Frank. Please go ahead.

Thank you Sarah good morning, everyone and thank you for joining US today. This was another strong quarter for conduct one 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 connect one.

However, our financial performance remains strong and we continue to take various steps to maintain or 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 I needed projects going forward.

Wrote for the quarter was also the result of strengthen our owner occupied commercial real estate lending segment.

Meanwhile, narrower spread multifamily lending it 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 trend remains strong.

Credit quality non performers and charge offs continue to improve.

Recently, a $4.7 million alone that went on non accrual 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 a nice way to charge related to a new Jersey commercial office building credit.

That's situation has been favorably resolved before close so the asset recorded a slight recovery in the second quarter.

Most of these resolutions reflect our philosophy to aggressively address and dispose of impaired assets in a timely fashion.

Let's turn to some new developments.

In June we closed on the previously announced strategic acquisition of the Boston, New York City, a no fly.

And online business lending platform, Oh flight helps connect small to mid size businesses with professional loan brokers and lenders across the United States with an emphasis on funding other financial services for franchise doors and franchisees.

The integration has gone smoothly, but Oh flight team is on board and we're experiencing strong cultural alignment.

In the quarters ahead, we plan to invest new resources that will enhance the functionality of the bowflex 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 on financial results for 2019 will be minimal, but we do expect the platform to augment connect ones fee income and generate profitable as FDA lending opportunities.

In summary, this is a compelling opportunity in the Fintech space as the combination of both lies 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 will continue to pursue traditional bank M&A is part of our expansion strategy to leverage our infrastructure and benefit from economies of scale are also embracing opportunities to expand our digital foundation.

As we scale and extend our competitive position. We also continue to invest and process improvements in all areas of connect one. This includes technology investments to enhance our sense of urgency culture and efficiency. While also supporting our clients demand for always on making services connect one'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 towards this end, we have announced the closing of an additional branch location in New Jersey, but other closures in the pipeline for the future. We're also converting a former branch in opening 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 will turn the call over to Bill.

Okay. Thank you Frank and good morning, everyone.

So this was another good quarter for connect one 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 34 cents 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 at stock repurchases during the quarter. 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 and first half of 19 for the current quarter. A total loan book grew just under 10% on an annualized basis reflected growth in higher spread segments, well now 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 the growth and cost perspective, and that is we're putting pressure on all net interest margins, including connect warrants.

Our net interest margin attracted by four basis points of Threethirty of the second quarter and by eight basis points, we exclude the accretion of purchase accounting marks.

The sequential margin contraction was attributable to a competition on the deposit funding side.

Yield curve and that was partially offset by some improving yields in the loan portfolio.

Also there were a couple of nonrecurring items that attributed to them contraction. Those were one reduction in prepayment fees and to a decline in securities portfolio yield did increase 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.

So 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, but see the competition moving lower as well. So we 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 that continues to be a lot of moving parts.

Next we recently restructured some wholesale borrowings replacing rates in excess of three and a quarter. We funded those first by selling some of our lowest yielding securities and then by utilizing swaps to bring in 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 borrowings for the earn back 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 floating and a portion of that benefits with floors. 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 metrics remain strong and with recent pay off of a larger non accrual loan Frank just mentioned, our nonperforming asset ratio declined to <unk>, 0.74%, that's where it is today from 0.82 reported at June Thirtyth and from 0.961 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.

They represent now only one half percent of our loan portfolio.

Let me talk a little about taxes as you may know, we've been taking a conservative middle ground approach to New Jersey 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 realized.

Next both light, which closed in the second quarter. So we don't expect any material impact to the bottom line for the first year of operations. 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 the 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 on organically driven company with strong performance metrics prudent growth targets solid asset quality and meaningful capital generation capability and with that Frank.

Turn it back over to you great. Phil. Thank you overall connect one 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 would like to reiterate a few key points connect one has an excellent foundation to build upon.

For skilled acquired with a track record of integrating transactions quickly and effectively.

We are 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 expanding our digital channels and becoming more technologically focus.

Connect one 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.

We're confident that this will ultimately translate into a higher valuation we strongly believe that connect one is a compelling investment.

And where buyers.

Thank you for listening we appreciate your interest in connect one and I'll open it up for any questions you may have.

Operator.

Thank you.

Ladies and gentlemen, if you would like to ask a question. Please signal by pressing star one on your telephone keypad, if you're using a speaker phone. Please make sure. Your mute function is turned off to like your signal to reach our equipment.

Again, Please press star one to ask a question well pause for just a few moments to allow everyone an opportunity to signal for questions.

Well take our first question from Collyn Gilbert with KBW.

Please go ahead.

Thanks, Good morning, guys.

Hi, Alan.

Bill maybe I'm, just just starting on the deposit side.

So you you gave some color as to what you're all doing some of 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 was some seasonal factors this quarter that caused the Pos 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 are right.

It depends on how the competition is.

And we do want to 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 the <unk>, we decreased our some of our deposit costs and didn't have any fall off in deposits and I see the competition is lowering deposits as well.

Okay. Okay. That's helpful and then.

Yep got it Okay, and then just on the NIM.

So the core NIM, so it sounds like and I know you know the variances from the first quarter, but it sounds like this this NIM is probably the corn in this quarter is it 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 I have this factors I know you said lower lot of the actions taken you know I think will help the margin.

But there there is still competition out there both in deposit costs as well as spreads on loans.

And on top of that don't forget you know there's a portion of deposits that ours are still low rate and so there is a risk that those will need to reprice as well. So I am confident I'm cautiously optimistic that we're going to belts maintain is here or possibly increase.

But.

Can't really can't say for sure.

Okay. Okay, and then can you just quantify what the accretion contract 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.

So while the accretion was a little bit higher this quarter. So they go back to some more towards the million million two range going forward. If you if you're trying to model it.

Okay.

Martin Im 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 know you guys are maintaining that kind of high single digit target can you just remind us what the multifamily I'm in New York City multifamily REIT 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.

And the New York City stabilized portfolio I believe is less than 8% of the portfolio.

Of the total loan book or the multi Buck.

Of the total loan portfolio okay.

Got to loans.

And then the ltvs of that are below 59%.

Okay, and any 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.

Yeah, I think I think the multifamily portfolio will will continue to grow somewhat but I think it will be at a much slower rate.

Okay, Okay, Okay, and I apologize I must have missed it. So you guys did buy back stock this quarter.

We did and it was about 250000 shares so I see you had the entire program we purchased in the first quarter.

That's going to take.

Three quarters or so physically.

Okay.

Okay.

Okay. So we'd have there been subsequent purchases since the 250 that you did in the second quarter.

Well I disclose at the end of each quarter. So okay, but all I can say, we're still in the market and got an overhang for us given our capital generation and the stock price.

We are buyers.

Okay. Okay.

Okay very good I'll leave it there thanks guys.

Thanks Hal.

Well take our next question from Austin Nichols with Stephens.

Hey, guys good morning.

Hi, good morning.

Maybe just a just on the multifamily question one 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 some players being or pulling back a bit.

So I think we're right where there is improvement in spreads were not interested.

Okay I I.

You know that the market in New York City in 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 then rate competition, there is pretty strong pretty fierce.

Got it.

Okay.

And then I I appreciate the comments on the the the floating rate portfolio on the on the asset side, but maybe on the well on the deposit side can you maybe just remind me of.

How to think about you know what percentage or deposits or maybe tied to just two short shortened indices Muni is municipal deposits those sort of things that could reprice upward.

Just spoke with many of the fed actually cut for it must be right.

Yeah, just in terms of liabilities that are contractually tied looking at four 400 450 million versus a billion on the asset side.

Okay, but again that doesn't mean that rates will move on.

On the on the ones that aren't untied.

Two.

Right.

For Piccolo rate.

Makes sense.

That is helpful. And then just on on both fly can you maybe just talk about how you're thinking about.

Using your balance sheet or on that platform. If you've started to do that yet and then.

You know any any expectations, you you'd have to Ted 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.

It's for the small business loans and the SB eight loans that are matched up on the both light platform and we've.

Some resources around building the infrastructure required to support those small business loans and those SP, a loans and we expect over time for that to be a contributor.

But the real excitement is the is the real is the bowflex platform itself and what that represents.

For the future of our entire franchise.

Makes sense and then you know Frank maybe I appreciated your both your comments on M&A, but maybe just broader picture, how you're thinking about.

You know that the M&A strategy just in terms of geographically, where where you are you more interested where you are less interested and just kind of thoughts on where where where you're seeing opportunities.

And just kind of in terms of the market overall, just from kind of whole bank M&A.

And any any comments alright, maybe non bank M&A too.

So let's start with all 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 first for for banks like Nick one where we can integrate those transactions and extract those efficiencies so from our perspective, we'd be looking at those.

Pretty.

Pretty heartily.

Adam market and.

When you say out of market I again, I I think the of the market of about a 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 non bank 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 with Oh fly and I think there is other opportunities both in that space and others that will augment what what we're trying to accomplish here.

Understood. Thanks for the questions.

Thank you.

And ladies and gentlemen, as a reminder start one for questions. Please.

Star one.

Thank you.

Well take our next question from William Wallace with Raymond James.

Thanks morning, guys.

One highlight morning.

One follow up question from Colin on the New York City rent regulated exposure that 8% of your portfolio. Bill you said that it was the average LTV TV 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.

Yeah, well, let you all know.

The vast majority is weighted in the middle.

Okay and between 80 and.

Yeah.

Maybe it's 10%.

But its we feel pretty comfortable with the portfolio, we underwrote that to existing cash flows.

Yes, low ltvs and so even if there is value pressure on those buildings, we think we're well we're well secured.

Quality in almost every case in our underwriting the debt service coverage always.

Limits the LTV.

And so if you if you underwrite to existing cash flow that exists on a property today, it's it's sort of hard to get hurt on LTV basis, Yes, yes, okay, sorry, so you're.

Your cash flow coverage is based on the current rents not any not any roll forward right in that and that constrains the underwriting and constrain the LTV generally we never get to.

An appraised LTV, we always wind up.

Mixing out dollars at a debt service coverage as opposed to the LTV.

Okay all right good thank you.

And then Frank just I'm kind of I was writing something when you. When you mentioned this so just wanted to make sure I understood Youve talked about a new facility that you're opening and something about a year in place being able to work in a flexible situation could you repeat that I'm, sorry, I didn't catch it. So we took that we took an existing branch that we had and we use that as a test study to develop a new office model.

If you walk into any bank M&A office is a pretty static cubicles everybody has it that's going to be as a phone.

You know exactly where to find people were finding that a large segment of our staff count can actually be I don't know call it remote but mobile there 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 a test office environment and we have a lending team thats going to be in there and they will 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 pipe 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 size.

Business owners and sometimes they need.

You know a conference room or they need space that meetings and whatnot and we're trying to foster that environment through our.

Through the real estate that we have.

Okay, alright people like that that flexible environment.

We're building something that a look and feel like that and will allow for the next generation of staff that we hire to be much more flexible with how they work.

And where they where they physically find themselves in the connect one environment.

Okay all right.

Thank you Thats all I had.

Thanks for calling.

Our next question is from Matthew Breese with Piper Jaffray. Please go ahead.

Hey, good morning.

Just wanted to pull part one and then after that.

Yes. Thank you I just wanted to pull apart the the margin a little bit what was the NIM benefit from the borrowing is being restructured this quarter and what does the full benefit of that for next quarter. So that's.

Well, we did late in the quarter. So there was no benefit from it.

In the second quarter, and I would say to that.

Two to three basis points 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 borrowing with 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 kick sanding and keeps things flat is that more or less how you feel about it.

I'm not sure I answered. The question are you, saying, if it's going to be it's going to be flat. The next quarter that would mean.

You have core different production offset by the restructuring.

Exactly yes.

You know, Matt its hard to say I think we are taking.

Lot of actions and I see a lot of good signs at point too.

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.

Yes, those two things off offsetting one another I'd rather not give guidance you know, it's more like a flat guidance because I don't really want to give any guidance right now.

Understood Okay.

Perhaps or we could dive into then is where you are seeing deposit opportunities.

What products are you seeing that it is still on the longer duration Cds are you starting to finally see the money market and high yield savings accounts.

Those promotional rate start to crack.

Yeah, well that's on a week that's on the retail side and as you know, it's only about 30, 35% of our balance sheet is retail so we're a little bit different we're continue to build relationships and build deposits through our lending.

Franchise commercial lending franchise, so really that's the key for US is funding going forward and profitable funding is continue to bring in core deposits through our lending relationships.

To that other stuff is important but probably less so for us and 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 it's not 100% funded right. So it's only say 30% of of.

Lending relationships are funded through deposits out of lending relationships.

But on a.

I'm I'm I'm not exactly sure, but it is below our you know the wholesale cost of funds right now is to 54 the fed cuts.

Where we're obviously doing better than that on a blended basis.

Okay.

Okay, and then just going back to your line of model are you trying to model what our margins innovate.

Of course.

Yeah.

Good luck [laughter].

Listen I think Theres a lot of good signs out there and there were a lot of there's a lot of pressure on the portfolio with a flat yield curve, there's lot of pressure with Cds repricing higher you know, it's starting to abate because the rates are getting to be at the at the highest point they could be.

And so there is reason to believe is 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 do you get the sense that construction growth will be no more normalized and multifamily growth given everything going on there will be slow. So what are the other areas of the portfolio you expect to be.

Growth to be robust could you just give us an idea of your residential your traditional CRM commercial outlook for the rest of the year.

I mean, we continue to grow our CNS portfolio, both in number of clients and outstanding balances that portfolio is somewhat seasonal at this point, but but its shows tremendous.

Progress for the sake of currently into the future.

We also do a fair amount of business.

In the owner occupied commercial real estate space in that 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 the growth our construction portfolios 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 who appreciate working with connect want and are willing to pay a little extra.

For the support that we provide there so.

I think there is.

The pipeline is quite full and we're not out of the multifamily space there are still opportunities there.

I think there is a lot of different we're building out our SPD.

Platform, although I don't expect that to add significantly to the bottom line this year.

But there is lots of other opportunities for us to continue to grow that loan portfolio with somewhere in the high single digits.

Understood. Okay. The last one is just on the 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.

You know.

So some of it and I know, we've kind of oscillated between that portfolio being held for sale or or on balance sheet, where do you currently stand and is your opportunity to get rid of it some of it.

Yes, I mean, right now that 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 pay downs.

I hate to sound surprised but there are people who have.

Adrian medallion loans off.

Or sold them for cash and we've accepted those payments. So that's always a good an encouraging sign.

We have not received an offer that Ed.

We believe makes sense for us at this point based on where we are the borrowers we have and what not but we continue to evaluate the entire portfolio over time and try to take advantage of any opportunities to lower our exposure there.

Okay understood Alright, great. That's all I had thanks for taking my question any economic impacts the loans I'll tell you that.

Fair enough.

Great. Thank you guys.

Okay. Thanks, Thanks, Matt.

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.