ConnectOne Bancorp, Inc.

Hello, and welcome to Connect One Bancorp third quarter 2024 earnings call. Please note that all lines are in listen-only mode. At this time, it is now my pleasure to turn the call over to Sia Vancea, Chief Brand and Innovation Officer. You may begin.

Good morning, and welcome to today's conference call to review Connect One's results for the third quarter of 2024 and to update you on recent developments. On today's conference call will be Frank Sorrentino, Chairman and Chief Executive Officer, and Bill Burns, Senior Executive Vice President and Chief Financial Officer. I'd also like to caution you that we may make forward-looking statements during today's conference call that are subject to risks and uncertainties. Factors that may cause actual results to differ materially from expectations are detailed in our SEC filings. The forward-looking statements included in this conference call are only made as of the date of the 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 or schedules, which have been filed today on Form 8K with the SEC and may also be accessed through the company's website. I will now turn the call over to Frank Sorrentino. Frank, please go ahead.

Thank you, Sia, and we appreciate everyone joining us this morning. So throughout 2024, we've remained committed to our strategic priorities, including supporting our clients, extending our competitive position, driving profitable growth, and investing in our valuable franchise. Before discussing our third quarter performance, I'd like to take a moment to review our recently announced merger agreement with First of Long Island Corporation. A prudently structured transaction brings two strong complementary financial institutions that are well positioned in their respective markets. Expected to close during the first half of 2025, we believe it's a compelling, financially disciplined transaction that creates meaningful synergies and a significantly enhanced platform for continued growth. The feedback so far has been excellent. Since the announcement, I've personally heard from many clients and shareholders from both companies, and the response has been overwhelmingly positive. With the transaction, Connect One will size up to more than $14 billion in assets and $11 billion in loans and deposits. In addition, we'll have an improved balance sheet mix and expanded market reach. The transaction increases our pro forma market cap to $1.3 billion, placing us in a larger, higher valuation peer group, while also leveraging the benefits of economic and market tailwinds already expected for our liability-sensitive positioning. Like ConnectOne, First of Long Island is commercially focused with a highly compatible client-first culture and a strong credit track record. The teams are energized and we expect to have a smooth process with integration planning already well underway. This combination meaningfully enhances Connect One's presence on Long Island, a region we've been organically focusing on over the past few years. As a result of the merger, the combined franchise in Nassau and Suffolk counties will immediately establish us as one of the top community banks on Long Island, furthering our position as a premier New York metro community bank. In addition, the transaction is ripe with potential revenue synergies. There's minimal client overlap, and First of Long Island's client base and operating area is likely to be a sizable source of new business opportunities, both spread and fee-based. Some of those areas will include additional products and services, including residential mortgage origination and SBA lending. deeper commercial lending expertise, which will round out their C&I relationships and offer robust treasury solutions to enhance commercial deposits. And finally, just like at Connect One, there are numerous opportunities to leverage geographical synergies between our Southeast Florida team and First of Long Island clients who have a presence in Florida. Next. Turning to our 2024 third quarter operating performance, we remained laser-focused and committed to our client-first culture and relationship banking model. As we previously reported, we've been actively reducing our non-relationship loans from our balance sheet during the first nine months of 2024, and these efforts have served to improve our loan-to-deposit ratio and lower our CRE concentration. As such, there was a slight reduction in our portfolio this quarter, which really doesn't tell the whole story. Loan originations remain solid, and we continue to build a steady and diversified loan pipeline. Going forward, we expect loan growth may be relatively muted, slightly up or slightly down during the next two quarters, and beyond that, we see a return to mid to high single-digit growth. Meanwhile, we continue to grow our core deposits through both existing and new client relationships. Average client deposits since the second quarter were up by approximately $100 million, $130 million, or 8% on an annualized basis, partially offset by a decline in average broker deposits of $60 million, and non-interest-bearing DBA continues trending upward. At the same time, the third quarter net interest margin on a core basis was flat. However, We ended the quarter with a spot margin wider, upwards of 10 basis points wider, as a result of the Fed's 50 basis point cut in September. Bill will provide some more detail on our current margin expansion in a few minutes. We're highly confident that Connect One is well positioned to drive increased profitability through the fourth quarter and into 2025 and post-merger completion. Turning credit, coming off a transition away from a zero-loss environment, the industry is starting to see isolated instances of credit impairment. At Connect One, we fared well, reflecting solid and consistent underwriting standards while also maintaining a proactive approach to portfolio management and selective credit resolutions. This lending and credit philosophy has served us very well. With that as a strategic overview, I'm going to turn the call over to Bill. Bill, take it away.

All right. Thanks, Frank. Good morning to everyone on the call. So I'm going to start right in there with the net interest margin. Try to give you some color both through the third quarter and where we are today post the Fed's first rate cut. On a reporting or gap basis, the margin did compress slightly during the third quarter from the sequential second quarter. However, On a core basis, the margin was actually up slightly. The gap to core adjustments for the sequential quarter comparison include higher average cash in the third quarter, which took the margin down by three basis points this quarter, And in the second quarter, we had unusually high prepayment fees and non-equal interest income recapture, which took the margin up by about four basis points in that second quarter. So taking those two items into account, we calculate our core margin up slightly from quarter two after being up two basis points from quarter one and three basis points from the fourth quarter of 2023. So the margin has been expanding at a modest clip over the past three quarters. And going forward, we are now seeing more meaningful margin winding as the Fed has begun its interest rate cuts. The spot net interest margin as of today is up approximately 10 basis points, putting our projected fourth quarter margin at about 280. Now, let me dive a little deeper into our margin projections. As of today, the spot cost of our total deposits is nearly 20 basis points lower than it was during the third quarter. That resulted from a 40 basis point lowering of rates on nearly $3.7 billion of non-maturity interest-bearing deposits, and that's about 50% of our total deposit base. On the asset side, we have a much lower amount that's repricing immediately. Just 19% of our loan book, or $1.5 billion, is pure floating rate, which repriced downward immediately by 50 basis points late in the third quarter. So if you do the math on just those two items, it calculates out to about 9 basis point margin improvement as of today. But that's not all. We have several other items working to our advantage, namely got continued growth in core deposits with non-interest-bearing demand growing since the end of the third quarter. CDs will continue to be renewed at lower rates over time with approximately 200 million maturing each month. The rates on CDs maturing over the next 12 months average 4.75, so you could figure about a 50 basis points improvement on that. And we have some 1.5 billion of adjustable rate commercial loans, which most commonly reset at five-year intervals. And they will reprice upward over the next couple of years. And then finally, the spread between newly originated loans recently being booked at rates above 7%, maybe 750 is about 100 basis points more than loans coming off. The impact so far has been less significant than it could be, but that's going to grow as loan originations increase. Other than that, I'm going to refrain right now from specific guidance for 2025. We've got a lot of tailwinds out here, which are helping, but I want to be cautious, especially in light of uncertain Fed cut timing, as well as competitive pressures that could slow down our deposit betas in a decreasing rate environment. I want to comment a little further on the transaction with First of Long Island. We've all seen a lot of mergers, but this one, in my opinion, is as compelling as they come. checks all the boxes, pricing discipline, acceleration of our strategy, and it's a great cultural fit. And adding to some of Frank's previous comments, the First Loan Island balance sheet is highly complimentary, accelerating the positive trends Connect One has been realizing over the past couple of years. This transaction lowers our CRE composition by five percentage points. It lowers our loan to deposit ratio by five percentage points. It improves our non-transparent deposit composition also by five percentage points from 17% to 22. And then our allowance for credit loss percentage will be strengthened. We are at 1.02 today, and that ratio jumps to 1.33 on a pro forma basis. And that higher loan loss ratio combined with First of Loans Islands, well-known for seeing asset quality, creates an enviable credit reserve position. Like Connect One, First of Long Island is also positioned to benefit from lower short-term rates, resulting in no change to our forecast of widening that interest margin. In addition, First of Long Island's 35-plus branch retail network will enhance our ability to drive additional revenue opportunities, particularly in residential and SBA lending. And lastly, I want to mention that that interest rate mark of 6.5% when we announce a deal is likely to improve to lower market rates today and the passage of time. And right now, we estimate a 1 percentage point drop in that rate mark. Now, turning back to ConnectOne on a standalone basis, I just want to comment on a few items. Core non-interest income and expenses are each expected to increase modestly in the fourth quarter and into early 2025. and our credit quality remained sound, with the level of non-accrual loans and fraud draws fluctuating but remaining within our expectations. We had a modest uptick in non-accrual loans. One loan was paid off while two were placed on non-accrual, but both of those are secured and appropriately valued. Criticized and classified totals increased to 2.2% of total loans, largely a result of loan modifications that were re-rated to special mention. Those loans are well secured and on a path to full restoration. And before turning back to Frank, I want to emphasize that our capital CRE concentration and loans deposit ratios have been trending in a positive direction over the past year. These favorable trends are expected to continue pre-merger and then accelerate post-closing. So Frank, back to you now.

Thanks, Bill. So to wrap things up, our earnings profile remains solid, our balance sheet and credit are in a good place, and we remain focused on our relationship-driven business model. We look forward to the transaction with First of Long Island, the growth opportunities related to that expansion, ongoing market opportunities that drive organic growth. Our combined efforts all contribute to building Connect One Bank into a highly valuable franchise that's well positioned to take advantage of our expanded market opportunities driving sustainable go-forward growth. I want to thank you again for joining us today, and now we'd be happy to respond to any questions. Operator?

Thank you. The floor is now open for questions. If you would like to ask a question and have dialed in, please press star and the number one on your telephone keypad to raise your hand to enter the queue. We will pause for just a moment to compile the Q&A roster. Great. Our first question comes from Matt Breeze with Stevens, Inc. Your line is now open. Hey, good morning.

Hi, Matt. Good morning, Matt.

Frank, just wanted to clarify, you had discussed, you know, loan growth being a bit muted here in your term before, you know, accelerating back to a mid-single-digit, high-single-digit pace. Could you clarify around timing? Is it more muted for another, you know, two, three quarters, or is it particularly longer than that?

Matt, I think there's a couple of things that go into that. One, I think as you've seen across the banking sector, the economy is a little bit on the slow side relative to loan growth. CNI generation is sort of slow, although it is beginning to come back to life. CRE originations are definitely down in a lot of different areas. We are seeing some increases in places like construction and some of the owner occupied areas. and we are because of our internal efforts in conjunction with that being a bit disciplined about renewals for non-relationship type clients so while we have a pretty strong pipeline and we see it growing over time we're also that's also being offset somewhat by some of the you know the relationships or non-relationships rather that we're trying to work out of the out of the I don't think that goes beyond another quarter or maybe two. I'm not even sure if it goes out that far. I do see signs of a pickup, both organically because of Connect One's efforts, but also because of the combined efforts with First of Long Island. So I would expect certainly by the second quarter of 2025 that we would again regain our more normalized growth path. It could come sooner. I could be wrong. You know, a lot of it depends on how quickly payoffs come in and how quickly loans close and what the balances are at closing date. But maybe I'm being a little bit conservative here, pushing out two quarters, but probably for the next quarter or so, I would say could be slightly up, slightly down.

Okay. And then, you know, Bill, just turn to the NIM. I would just love to hear your thoughts and expectations around loan and deposit betas if we follow kind of the Fed dot plot and whether or not you expect those figures to be fairly similar to what they were on the up cycle.

Yeah, you know, our betas were a little bit higher on the upside cycle, so it just gives us more room to keep those betas high on the way down. And we were, as I think I mentioned in the call, 80% beta for the first shift. Going forward, I forgot to get a question on that. It could range anywhere from 60 to 100 beta on the next cut, okay? So I'm sticking with the 80% beta for now.

Okay. And then last one for me, you know, with the deal, there was talk of, you know, I think it was $100 million sub-debt raised Could you just update us on whether this remains intact, timing, expectations on pricing, and whether or not this kind of remains the chosen course of capital, just given how expensive stuff that has been recently? Thank you.

Yeah. Look, the expectation is to do that transaction a little bit before closing, so sometime hopefully in the first quarter of next year. We have a $75 million contract. sub debt repricing um i think it's in june or july um and so we'll probably put those two together for 175 million dollar offering then i think right now the rates are 850 to 875 um hopefully they'll come down matt but whatever it is i think we'll be you know in your models i think we'd be committed to doing it at those levels okay i appreciate all that i'll leave it there thank you yeah thanks matt

All right, great. Thank you. The next question comes from Dan Tamayo with Raymond James. Your line is now open.

Thank you. Good morning, everybody. Good morning, Dan. Maybe first, just a clarification. I know you guys mentioned the spot and interest margin was up 10 basis points. Can you just give us a sense for what that was? I'm not sure if you were saying up from prior three months or from the third quarter average?

Yes, from the third quarter average is what I'm talking to. You know, there's always some fluctuation in non-core items, but I feel comfortable with the spot margin plus the way the other items are coming through that we could get to 280. for the for the third quarter and that so sorry the fourth quarter and that right now is assuming one more cut okay so so 277 end of the third quarter you're saying 280 in the fourth quarter with with one more cut so it seems like with one cut and other things that are working to our favor okay Because we have more CDs repricing. There's a whole bunch of things going into the margin. But when I put it all together, we're coming out as a projection of 280. So possibly a little bit lower, but also possibly a little bit higher. Okay. Okay.

Thank you. And I guess a related question in the third quarter. It looks like loan yields were actually down a little bit. Just curious what drove that.

Well, it wasn't really on a coupon basis, but it was because of having, we had a large non-accrual interest recapture. So that had a lot to do with that part. And obviously the cut in, you know, the 50 basis points cut did reduce loans, loan yields at the end of the quarter. So I think I said it, I may have said on the call, we had 20, like right now it's a 20 basis point reduction in the deposit costs. and a 10 basis point reduction in the loan from the cut. Okay.

All right. That's helpful. Thanks. And then finally, just moving over to credit. So just looking at the criticized loans, doing some back of the envelope math, it looks like that number was up a decent amount in the third quarter. I wonder if you could provide any color on the drivers of that number.

Yeah, we did some loan modifications that put the loans into special mention, which is the best of the classified and criticized categories. And those loans, we, in our view, are in a better position and will be restored in due course.

And these were, you mentioned a CRE loan, I think, relative to a year ago in the release. How much of that move was that one loan?

I don't recall, Dan, in this release or in a prior release.

This release, you said, increases primarily due to a loan modification of one CRE relationship that was in this special. Right.

Yes, that's what I'm talking about. It was one relationship with many loans.

Understood. Okay. So that was really the big driver on a quarter-to-quarter basis as well.

True. Well, yes. But as I said, the loans are valued appropriately on our books.

Got it. Okay. All right. Thank you for all the color. I'll step back. Appreciate it. Thanks. Thanks, Ben.

The next question comes from the line of Frank Chiraldi with Piper Sandler. Your line is now open.

Good morning. Good morning, Frank. Just on the, just another one on the margin bill, in terms of the 280, just curious if that 280 still assumes kind of similar liquidity levels to what we saw in 3Q.

We're going to pick up a couple of basis points because we've already begun to reduce some of that liquidity. So some of that is in there. I can't predict exactly what the margin is going to be, but we'll probably pick up a couple of basis points from reduced liquidity. Okay. And that's in my 280 projection, as I said before. It could be a little bit higher. It could be a tiny bit lower. It could be higher.

Sure. And then – Just that 80% beta you talked about, is that still basically, it seems like the MIM is troughed here, you know, even in a steady rate environment and with the rate cut. That's still a pretty immediate five basis point benefit per.

Yeah. We're still good with that. You know, we try to be as precise as we can. It's like four or five basis points on that. But the margin when we look at it on a core basis has actually been trending upward by a couple of basis points each quarter. So, yes, kind of flat in a way, but I'm willing to tell you that even with outcuts, our margin's going up slightly.

Got you. And then... And then just on the expenses, you mentioned moderately higher in the fourth quarter. Right. You know, any sort of guardrails you can put around that? Do you think you can hold it in sort of that $38 million range in the near term?

Well, it could be a 1% to 2% increase sequentially. Okay.

Great. And then I guess just lastly on the slick deal, obviously brings down the loan-to-deposit ratio a bit. William Newburry, M.D.: : I know there's there's less pressure or less focus on reducing that I mean seems like the kind of within your sweet spot or allowable range. William Newburry, M.D.: : The flip deal so is there would you say there's a little bit less emphasis on moving that lower in the near term.

No, I was going to say that I think this transaction with all the benefits on the balance sheet gives us more flexibility to opportunistically capitalize on growth opportunities in the marketplace in the second half of next year. So we're in a much better position than we were before, before the transaction from a balance sheet perspective.

Okay.

Yeah, I mean, it also gives us the capability to rely more on the core deposit base, which has a better pricing dynamic to it and, you know, reduce our reliance on brokered or, you know, borrowings or whatever and give us the firepower to continue to grow the balance sheet on the lending side, which we've really never really felt we've had a constraint before, but I'll tell you, it feels better with a lower loan-to-deposit ratio. Okay.

All right. Great. I appreciate it. All right. Thanks, Danny. Oh, Frank. That was Frank. Sorry.

And before we take our next call, I just want to remind you, if you would like to ask a question, please enter star 1 on your telephone keypad now. Star 1 to enter the queue. Our next question comes from the line of Tim Schweitzer with KPW. Your line is now open.

Hey, good morning. Thanks for asking my question. But I wanted to ask, is there any opportunity with the Flick merger and your guys' strong capital and the sub-debt raise to maybe do a little bit of securities restructuring, particularly with, you know, Flix portfolio that'd be taking on a fair value and, you know, what's the potential earnings upside you guys see there?

There certainly is some potential after their balance sheet is marked to do restructurings. I don't think it's necessary to make our numbers, but the extent it improves our ratios, it provides, you know, additional capacity to grow. that's something that we consider. So we're in a good position in that that portfolio is going to be mark-to-market. Both in terms of securities and loans.

Okay, that makes sense. I want to ask about Bowfly. What's kind of the long-term growth outlook and revenue potential here? You know, any updates you can provide? Like, does that improve at all with rates moving lower? And then, you know, like, is there any opportunity to kind of you know, leverage the Flick merger as well in some of their customer base in the new market?

I think the answer to that is yes on all counts. Lower rates obviously promote more business startups, which is, you know, with the business that Bowfly is really in. We've actually seen a fairly decent uptick recently in in the last quarter or so on franchisors that are utilizing the platform for BowFly. And then, you know, the pull-through business that winds up in the SBA portfolio will, I think, will dramatically be improved by the branch network that's available at First of Long Island and the fact that they do not do any or virtually no SBA lending. So I think there's a lot of great opportunities.

That's great. I appreciate it. Thanks for taking my questions. You're very welcome.

At this time, there are no further questions, so I would like to turn the call back over to the management team for closing remarks.

Well, thank you. I'd like to thank everyone for their time today, and of course, thank you for all the questions. We look forward to speaking with you again during your end conference call in early 25, so with that, have a great day.

This concludes today's conference call. You may now disconnect.