ConnectOne Bancorp, Inc. — 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual filing, not a quarterly report; it also provides unaudited fourth-quarter results. Amounts below are in U.S. dollars.
Business context
ConnectOne is a bank holding company whose primary subsidiary, ConnectOne Bank, serves businesses and individuals in the New Jersey and New York metro area. Its main revenue source is net interest income. The Greater Hudson Bank acquisition closed January 2, 2019, after year-end; it added approximately $0.4 billion of loans, $0.4 billion of deposits and seven New York branches.
Financial performance and condition
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Total assets, year-end | $5.46 billion | $5.11 billion | +6.9% |
| Gross loans, year-end | $4.54 billion | $4.17 billion | +8.9% |
| Deposits, year-end | $4.09 billion | $3.80 billion | +7.8% |
| Interest income | $216.1 million | $181.3 million | +19.2% |
| Net interest income | $157.2 million | $145.1 million | +8.4% |
| Provision for loan losses | $21.1 million | $6.0 million | +$15.1 million |
| Net income | $60.4 million | $43.2 million | +39.6% |
| Diluted earnings per share | $1.86 | $1.34 | +38.8% |
- Margins: Net interest margin was 3.28%, down from 3.45%; management attributed the contraction to higher deposit costs, the 2018 subordinated-debt issuance, lower securities yields and tax-equivalent adjustments. Average interest-earning assets grew 12.8%.
- Profitability and expenses: Return on average assets was 1.17% versus 0.93%; return on average common equity was 10.29% versus 7.81%. Noninterest expense declined to $70.7 million from $78.8 million, but 2017 included a $15.6 million taxi-loan valuation allowance. Excluding that item, 2018 expenses increased $7.6 million, including higher compensation and $1.3 million of merger expenses.
- Taxes: Effective tax rate fell to 15.2% from 36.9%. The 2017 comparison included a $5.6 million deferred-tax charge related to federal tax reform; the 2018 rate also reflected the lower federal statutory rate and other tax items.
- Cash flow: Operating activities provided $89.1 million, compared with $131.1 million in 2017. Investing activities used $357.2 million, primarily reflecting loan growth. Financing activities provided $290.9 million, mainly from $297.0 million of deposit growth and $73.5 million of net subordinated-debt proceeds, partly offset by $70.0 million of net FHLB repayments. Year-end cash and cash equivalents were $172.4 million.
- Debt and liquidity: Year-end borrowings were $600.0 million, down from $670.1 million; subordinated debentures rose to $128.6 million from $54.7 million after the January 2018 $75 million note issuance. Liquid assets were $441.4 million, or 8.1% of assets. The filing reports approximately $1.0 billion of available and unused borrowing capacity and $858.0 million of off-balance-sheet credit commitments.
- Capital: Company regulatory ratios were 9.75% CET1, 9.86% Tier 1 and 13.15% total risk-based capital; the Bank was classified as well capitalized. The company’s common dividend remained $0.30 per share for the year.
Fourth-quarter results
Unaudited Q4 2018 net income was $18.7 million, or $0.58 diluted EPS, versus $10.6 million, or $0.33 diluted EPS, in Q4 2017. Net interest income was $40.2 million versus $39.8 million. The provision for loan losses was $1.1 million versus $2.0 million. Q4 2017 income tax expense was unusually high, primarily reflecting the $5.6 million deferred-tax charge from tax reform.
Material changes, outlook and risks
- Loan growth was primarily organic. Commercial real estate, including construction loans, represented about 71.4% of loans; under the regulatory concentration measure described by the company, CRE loans equaled 480% of total risk-based capital.
- Taxi-medallion exposure remained a notable credit issue: the portfolio’s carrying value was $28.0 million at year-end, and the company recorded $17.0 million of related charge-offs in 2018. Net charge-offs were $17.9 million, compared with net recoveries of $4 thousand in 2017.
- Asset-quality indicators improved year over year: nonaccrual loans were $51.9 million versus $65.6 million, and nonperforming assets were 0.95% of assets versus 1.29%. The allowance for loan losses was $35.0 million, or 0.77% of loans, compared with $31.7 million, or 0.76%.
- Interest-rate exposure remains material. The company estimated a 200-basis-point rate increase would reduce economic value of equity by 12.01%; its modeled one-year net interest income effect under that shock was a 0.40% increase. These are model estimates, not forecasts.
- Management provided no specific numerical earnings or growth guidance in the supplied filing text. It described continued growth as a strategic aim, with an opportunistic approach to acquisitions and a focus on organic growth. Future results are exposed to CRE concentration and economic conditions, funding costs and deposit competition, interest-rate changes, acquisition integration, regulatory requirements and the implementation of CECL. The company expected CECL adoption in 2020 to require a cumulative allowance adjustment, but could not estimate its size.
- The filing reports no significant pending legal proceedings beyond routine matters. The independent auditor gave an unqualified opinion on the financial statements and concluded internal control over financial reporting was effective as of December 31, 2018.
Important facts for investors to verify
- Whether the taxi-medallion portfolio and remaining nonaccrual credits result in further losses or reserve needs.
- How CRE concentration, including construction exposure and recently originated loans, performs as the portfolio seasons.
- Whether deposit pricing and funding mix continue to pressure net interest margin, and how actual results compare with interest-rate sensitivity estimates.
- The final purchase accounting, integration costs and contribution to earnings from Greater Hudson Bank, which closed after the reporting date.
- The eventual CECL transition impact and the company’s capital and liquidity position after acquisition and continued growth.