Trading at just a fraction of its tangible book value, Northfield Bancorp, Inc. (NASDAQ: NFBK) is one of the best banks to invest in, according to community bank stock-picking expert, Tim Melvin.

With executives owning a large portion of shares, nonperforming assets dwindling and other growth initiatives, there is much more to the Northfield story than vaulation.

To garner better insight into the company’s future, Melvin spoke with Chairman and CEO John Alexander and President and COO Steve Klein. Note: Alexander is speaking unless otherwise noted.

Business Conditions

It has been a tough time for banking in the economy, how are conditions in your service area right now?

There is still some stress in the economy. At one point we did a lot of non-multifamily CRE lending. We had many owner-operated businesses to which we lent money. When times got tough, a lot of those businesses were severely affected and a few are still trying to recover.

We stopped our CRE lending early in the down cycle, moved into multifamily loans. As to other CRE lending, that market has not fully recovered, and there is still a lot of vacant office and retail space.

Going into the economic downturn, we had very strong capital and subsequently raised even more capital as we converted into a fully public company. So we have come through the past few years in great shape.

We have strong loan growth, good credit quality, but I would say that there is still a lot of room of improvement in the economy but clearly things appear to be moving in the right direction.

You are in one of the strongest real estate markets in the country. Are conditions still pretty good there on both the residential and commercial side?

I would say very strong, particularly on the multifamily side. I think that residential is improving, but from what we see and hear, New Jersey continues to have challenges on the residential side.

M&A

I am hearing that there is going to be a huge acquisition wave in the banking industry because of regulatory costs and concerns. Do you see that developing?

In large part, I think it is already here. If you look at the number of transactions in 2014 and even in 2013, it has been increasing. One thing to keep in focus too is that back two, three, or four years, many banks were selling below tangible book value. As things have improved, banks are beginning to sell in the 130 to 160 percent of tangible book value range, with some even higher.

Think about the current environment -- yields are low, lending rates are super competitive, and costs are rising – cost such as compliance, Bank Secrecy Act and Anti-Money Laundering, and more recently risk management. The pressure on earnings is endless. A lot of smaller banks are looking at all of this and coming to the conclusion that it makes sense to sell or “partner up.”

Klein: With this low rate environment, interest rate risk also has become a significant concern, particularly as we are getting closer to the point when the Federal Reserve will begin raising interest rates. Clearly this is an item that the regulators will be focused on and will be asking tough questions for all banks. If you need another reason, add this to the list.

Alexander: Also, if you have a low loan to deposit ratio, you also are having trouble earning a decent yield on your excess funds, with investment yields as low as they are. Chasing yields may exasperate an already tough interest rate risk profile. In this environment, net interest margins and thus earnings are tough to maintain.

As your price to tangible book hopefully goes higher over the next year or two, are acquisitions something that you might consider?

We look at a lot of opportunities but we are also conscious of what the investor community expects as it relates to dilution of tangible book value and the estimated earn-back period.

Klein: We are interested since acquisitions can be a good way to deploy capital. I would add that we also evaluate opportunities to purchase loans and acquire branches. To increase our chances of success in making acquisitions, we must reduce capital ratios and increase share price.

Currently we trade in the 105 to 110 percent of tangible book value range, which reflects the effect excess capital has on our share price. It is very dilutive to use a stock trading at a low multiple to acquire a stock trading at a significantly higher multiple. Therefore, our challenge is to reduce capital ratios, which should translate into higher trading multiples.

Alexander: To summarize, we are open to M&A but the transaction needs to be earnings accretive and any dilution needs to have a fairly short earn-back period.

Balance Sheet

In 2011 you were had about 2.76 percent nonperforming assets in the fourth quarter. Last quarter, you were down to just 63 basis points of nonperforming assets. That is an incredible job. Was that a result of renewed focus or did things just generally get better?

The answer is yes. First we did not really become a lender until around 2005 and we began with CRE loans, many of which were owner operators. So when things go bad in 2008, we didn’t have a large portfolio so anything that went bad caused the percentage to spike. We also were very conservative in evaluating our loans and in treating loans as troubled debt restructurings when we modified them, both of which caused our numbers to spike when compared to peers.

We have since worked out for most of those loans, sold a few troubled loans, focused on lower risk loans such as multifamily, and the overall portfolio has grown significantly. So as you see there are a lot of pieces moving around in there but clearly we have strong credit quality at this point.

You really have a very high capital level; I think your equity to asset ratio is somewhere in the 20-22 percent range right now and you have been doing a great job returning that to shareholders. Tell us about that.

A couple points to note. Before doing our second step conversion and becoming a fully public company, we were paying dividends of six cents per quarter. The second step stock offering resulted in a 1 to 1.4 exchange of shares to adjust for the offering. Following the exchange, we maintained the six cents per share dividends thus resulting in a 40 percent increase in dividends.

Additionally, we did a special dividend of 25 cents per share. In the last quarter we again raised the dividend almost 17 percent.

Klein: I would also note that there was a one-year regulatory moratorium on us doing share repurchases. That lapsed in January 2014. We are now working on our third five-percent share repurchase program. In reducing the number of shares and reducing capital, we are improving earnings per share, which helps us improve our metrics relative to our peers.

Growth

You are heavily weighted with commercial and multifamily in your loan portfolio. Are there plans to diversify away from that or are you pleased with the mix?

We are continuing to focus on multifamily. In our marketplace, there is significant volume, and the asset quality has been very good. Losses in the multifamily segment are historically low; also, rents have remained strong and are continuing to escalate.

We would love to diversify. Everybody says multifamily lending is very competitive so go where it is not so competitive. If you know where that is, call us. Everyone is doing C&I lending now, it’s probably as competitive as multifamily. It is tough to find a product where others are not already competing.

You are also going after the home equity business, correct?

Klein: Yes, absolutely, it is an area on which we are focused, again another competitive product. From a consumer's perspective, there does not appear to be a lot of appetite right now to get back to higher debt levels.

Our portfolio continues to grow but we aren’t seeing double digit growth. That is one of the reasons we are looking to expand into the C&I lending arena.

There are hundreds of billions of dollars in the larger banks within miles of your locations. Do you have a specific plan to market against them, or do you just go “heads up” and let day-to-day operations take care of it?

Klein: We compete, as you say, “heads up” day by day, doing our blocking and tackling. We compete by being in our communities developing relationships.

Right now, interestingly, because rates are so low, it is almost impossible to get people to pay attention even if you are dangling a one plus percent rate. Since it is difficult to get people to pay attention to that, we have to have business development officers in every marketplace.

They are involved in the business community, local chambers, support local charities with their time and talents, and really are part of the community. So we are going head to head and we believe we are being successful.

Any thoughts of expanding by opening new branches?

Klein: Not at this point. Six or seven of our branches were opened in the last five years or less and our focus is on growing these and all our branches.

Given the evolution of technology, we also want to take advantage of remote deposit capture, and online banking and on-line deposit gathering. We have all the channels that allow you to choose how you interact with us, be it via the branch, online, telephone, or through your mobile device. We have the full suite of products.

Alexander: We continue to assess whether we need or want to open new branches. Until recently our loan to deposit ratio was less than 100 percent. If you open a new branch and have to pay promotional rates to attract deposits, unless you can lend the money out, it is difficult to invest the funds and make a spread without taking on a lot of interest rate risk.

Now with our loan portfolio growing significantly we can reassess our branch strategy.

Shareholders

I noticed you have a “skin in the game” policy. All of your officers and directors have to own a certain amount of stock.

Klein: Yes, our directors and our named executive officers must maintain a minimum stock ownership. In fact their ownership is well in excess of that which is required by our policy.

The ESOP has 7.08 percent too, is that correct?

Klein: That is correct, the directors believe very strongly the ownership and stockholder alignment is important throughout the company. The ESOP serves to ensure that most of our employees have an ownership interest.

You have been with the bank since 1997, now you have pretty much seen the best of times and the worst of times in the banking industry and the financial markets. What do you see over the next several years for the industry in general and your bank in particular?

As we have spoken today, consolidation is continuing to occur. Competition in the banking industry is continuing to expand beyond traditional banking channels.

Cyber threats are a growing threat. The business is not getting easier. However, I am sure we can manage through it.

As to our bank, we run a very conservative shop. We believe it is our obligation to safeguard your money and return it to you when you want it – it is not the government’s responsibility. My father in law was a former chairman of the bank and used a great baseball analogy. He always reminded me that they were not paying us to hit home runs; they were paying us to move the runners around the bases. Stay conservative, do the right thing, and good things will happen.

I don’t see community banking going away and I believe Northfield has the people, the capital, and the knowledge to be a survivor.

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