ConnectOne Bancorp, Inc. — Q3 2020 Form 10-Q
Business context and reporting period. Unaudited results cover the three and nine months ended September 30, 2020; balance-sheet comparisons are with December 31, 2019. ConnectOne is a New Jersey-based commercial bank. The January 2, 2020 acquisition of Bancorp of New Jersey (BNJ) added nine branches and materially increased the company’s assets, loans, deposits and operating costs.
Key financial results
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Net interest income | $60.5 million | $48.4 million | $176.6 million | $138.9 million |
| Provision for loan losses | $5.0 million | $2.0 million | $36.0 million | $7.6 million |
| Noninterest income | $3.5 million | $2.1 million | $11.0 million | $5.8 million |
| Noninterest expense | $26.5 million | $20.4 million | $94.6 million | $70.0 million |
| Net income | $24.8 million | $21.7 million | $45.6 million | $52.6 million |
| Diluted EPS | $0.62 | $0.61 | $1.15 | $1.48 |
| Tax-equivalent net interest margin | 3.49% | 3.44% | 3.44% | 3.36% |
- Quarterly performance: Net income and diluted EPS increased year over year. Higher net interest income and noninterest income more than offset higher credit provisioning and operating expenses. Management attributed the increase in loan interest income partly to BNJ and lower deposit funding costs to interest-rate reductions.
- Nine-month performance: Net income and diluted EPS declined, primarily reflecting the substantially higher loan-loss provision and higher expenses, partly offset by increased net interest and noninterest income and lower income tax expense. PPP-related income included approximately $7.2 million of loan fees in net interest income and $2.3 million of BoeFly referral fees in noninterest income.
- BNJ merger and restructuring expenses were $14.6 million for the first nine months, including $11.6 million related to BNJ. The filing reports no merger expenses in Q3 2020.
Financial position, cash flow and credit
- Balance sheet at September 30: Total assets were $7.45 billion, up from $6.17 billion at year-end 2019. Gross loans were $6.26 billion, up $1.14 billion (22.4%); deposits were $5.80 billion, up $1.03 billion (21.6%). BNJ and PPP lending were major contributors to loan growth.
- Liquidity: Cash and cash equivalents were $256.1 million, versus $201.5 million at year-end. Management reported $615.3 million of liquid assets, equal to 8.3% of assets and 9.8% of deposits and borrowings, and approximately $1.0 billion of available and unused credit. Outstanding commitments to extend credit were approximately $0.9 billion.
- Cash flow, nine months: Operating activities provided $99.8 million; investing activities used $312.2 million; financing activities provided $267.0 million. Net cash increased $54.6 million.
- Debt and funding: Borrowings were $506.2 million and subordinated debentures were $202.6 million, compared with $500.3 million and $128.9 million, respectively, at year-end. The company issued $75 million of subordinated notes in June. Management anticipated redeeming the 2015 subordinated notes in full in the first half of 2021.
- Credit quality: The allowance for loan losses was $74.3 million, or 1.19% of loans (1.29% excluding PPP loans), up from $38.3 million and 0.75% at year-end. Nonaccrual loans increased to $65.5 million from $49.5 million. The company recorded $36.0 million of provision in the first nine months, citing COVID-19 uncertainty.
- At quarter-end, 199 loans totaling $355.2 million had payment deferrals, mostly for 90–120 days. PPP loans totaled $474.4 million; the company excluded them from its loan-loss allowance calculation because they were described as fully SBA-guaranteed.
- Capital: Stockholders’ equity was $890.7 million. Tangible common equity ratio was 9.28% and tangible book value per share was $16.87. The company reported Bank total risk-based capital of 13.70% and company total risk-based capital of 14.94%; management stated both met applicable capital requirements.
Outlook, risks and notable items
- The filing provides no earnings or revenue guidance. Management cautioned that interim results are not necessarily indicative of full-year results and that COVID-19’s duration and financial effects were uncertain.
- Management identified potential pandemic effects on borrowers, collateral values, credit losses, operations, liquidity and financial markets. It noted particular exposure to economic stress in its New Jersey/New York metropolitan market and industries including hospitality, retail and restaurants.
- The company deferred adoption of CECL under CARES Act relief and continued using the incurred-loss model at September 30. It expected a one-time cumulative adjustment upon adoption but had not finalized its impact.
- COVID-19 prompted a second-quarter quantitative goodwill impairment assessment; the company reported no impairment. Goodwill was $208.4 million at quarter-end, up from $162.6 million at year-end, largely reflecting BNJ.
- On October 26, 2020, the company agreed to sell two leased New York branches and associated deposits, with closing expected in Q1 2021 subject to approvals and customary conditions. Management did not expect the deposit premium gain to be material.
- Interest-rate models estimated that a 200-basis-point increase would raise one-year net interest income by 1.13%, while a 100-basis-point decrease would reduce it by 4.48%. These are model estimates, not guidance.
Important facts for investors to verify
- Whether deferred borrowers resume payments and whether nonaccrual loans, criticized assets or credit losses rise as pandemic relief expires.
- The adequacy of the allowance, especially given rapid loan growth, the $474.4 million PPP portfolio excluded from the allowance, and the company’s pending CECL adoption.
- BNJ integration progress, realized synergies and remaining acquisition-related costs; also confirm final acquisition-date fair-value adjustments.
- Funding, liquidity and interest-rate exposure, including the planned 2015-note redemption and the assumptions underlying rate-sensitivity models.
- Completion and financial impact of the planned branch-and-deposit sale, and the company’s capital and dividend capacity.
- Reconcile the MD&A’s Q3 noninterest expense discussion, which cites $21.4 million for Q3 2019, with the income statement’s $20.4 million. The MD&A also appears to reverse the labels for the 2020 and 2019 nine-month effective tax rates; the income statement values imply approximately 19.9% and 21.5%, respectively.