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October 26, 2020
ConnectOne (“CNOB”) is a $7 billion bank with 28 branches mostly in northern New Jersey. ConnectOne has a strong management team led by CEO Frank Sorrentino. The bank has a history of strong organic growth. In recent years, it has become a skilled consolidator of other banks. With the pandemic, investors sold the stock due to general concerns regarding credit risk. We think the valuation is too low given the bank’s history of solid credit and strong growth.
- Strong loan & deposit growth – Since 2010, CNOB has grown loans per share by 14% annually and deposits per share by 11% annually. We look at the loan and deposit growth per share to account for both organic growth and shares issued through acquisitions.
- Solid credit – CNOB has a history of good credit quality. Other than taxi medallions, CNOB has had minimal losses throughout its history. We think the bank has a solid credit culture.
- Favorable deferral trends – Like many other regional banks, CNOB issued an 8-K during September showing that a large majority of customers who took loan deferrals in March and April are returning to normal payments. On June 30th, 17.2% of CNOB’s loans had deferrals. As of September 16th, loan deferrals dropped to 5%. We spoke with the bank on September 23rd, their construction loan portfolio has performed very well with a high level of residential demand in the Jersey suburbs.
- Bank of New Jersey cost saves – CNOB closed the Bank of New Jersey (“BNJ”) acquisition in January of this year. This was a great deal because CNOB layered BNJ’s loans and deposits onto its balance sheet, but eliminated almost all of BNJ’s expenses. In fact, 8 of 9 BNJ branches have closed. This merger closed on January 2nd, so the financial benefits of this merger are obscured by loan loss provisions from the pandemic. If we look at the Pre-Provision Net Revenue/Net Assets, it increased to 1.96% in Q2 from 1.84% in Q4.
- NIM stable in current environment – CNOB was able to maintain its net interest margin (“NIM”) over the last two quarters. Management expects the margin to remain stable as deposits reprice lower. CNOB’s loans are mostly fixed-rate assets or are floating-rate loans with floors that will reprice more slowly. CNOB benefits from all the liquidity in the financial system as the banking industry has a significant amount of excess deposits.
- Valuation – CNOB trades at 85% price-to-tangible book ratio and 7.2x 2021 earnings estimate. Peer banks in New York metro trade at 1.1x tangible book and 9.2x 2021 earnings estimates.
- Not widely followed by sell-side – Only Keefe, Bruyette & Woods (“KBW”), Stephens, and Raymond James write research on CNOB. We like stocks like CNOB where there is little to no research coverage.
- No well-known short thesis – As far we can tell, there is no controversial short thesis on CNOB which would justify its low valuation. CNOB only has 1.1% of its shares sold short. CNOB shares sold short has ranged between 0.5% to 3.0%.
- Loan-to-deposit ratio >100% – CNOB’s loan-to-deposit ratio is 103%. We prefer banks with loan-to-deposit ratios of 95% or lower. We think a lower loan-to-deposit ratio proves the stability of the franchise. CNOB had a lower loan-to-deposit ratio prior to its merger with Center Bancorp.
- Commercial Real Estate concentration – CNOB has a concentration of Commercial Real Estate (“CRE”) loans. Regulators have a long history of wanting to limit CRE concentrations. However, regulators have softened this guidance in the last several years to take into account strong collateral and a history of low credit losses. We think this applies directly to CNOB as their credit losses have been well-below banking industry averages.
We think CNOB is too cheap for a growing, profitable bank with a history of low credit risk. From an 0.85x price-to-tangible book ratio, we believe CNOB can trade up to a 1.6x price-to-tangible book level. This is the average level that CNOB traded from 2013 to 2019. In fact, CNOB traded up to 2.2x tangible book in 2017-2018.
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