ConnectOne Bancorp, Inc. — Q2 2019 Form 10-Q
Business context and reporting period. This unaudited quarterly report covers the three and six months ended June 30, 2019. ConnectOne operates a New Jersey-chartered commercial bank serving New Jersey and the New York metropolitan area. The results include Greater Hudson Bank (GHB), acquired January 2, 2019, and BoeFly, acquired May 31, 2019.
Financial and operating performance
Amounts below are in millions, except per-share data and ratios.
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Interest income | $67.9 | $53.1 | $133.1 | $103.6 |
| Net interest income | $45.5 | $38.9 | $90.5 | $77.1 |
| Provision for loan losses | $1.1 | $1.1 | $5.6 | $18.9 |
| Noninterest income | $1.9 | $1.3 | $3.7 | $2.6 |
| Noninterest expense | $21.6 | $17.1 | $49.7 | $34.0 |
| Net income | $19.3 | $17.5 | $30.9 | $21.8 |
| Diluted EPS | $0.54 | $0.54 | $0.87 | $0.67 |
- Tax-equivalent net interest margin was 3.30% for Q2 2019 versus 3.31% a year earlier; for the first half it was 3.32% versus 3.29%. Excluding purchase-accounting accretion and amortization, adjusted margin was 3.17% in Q2 and 3.21% for the first half, both lower year over year, primarily reflecting higher deposit funding costs.
- At June 30, total assets were $6.109 billion, net loans $5.053 billion, deposits $4.641 billion, borrowings $597.3 million, subordinated debentures $128.7 million, and stockholders’ equity $699.2 million. Compared with December 31, 2018, loans rose 12.1% and deposits 13.4%, largely due to GHB.
- Cash and cash equivalents were $185.7 million, up $13.3 million from year-end. For the first half, operating activities provided $35.3 million, investing activities used $76.8 million, and financing activities provided $54.8 million.
- Management reported liquid assets of $512.7 million, or 8.4% of assets and 9.8% of deposits and borrowings. It reported approximately $1.0 billion of aggregate available and unused borrowing capacity, and approximately $1.0 billion of outstanding commitments to extend credit.
- The allowance for loan losses was $37.7 million, 0.74% of loans, versus $35.0 million and 0.77% at year-end. Nonaccrual loans were $49.9 million, down from $51.9 million; nonperforming assets were 0.82% of assets versus 0.95% at year-end. Total TDRs were $39.1 million, including $22.8 million on nonaccrual status.
- The Bank’s regulatory capital ratios included a 10.42% Tier 1 leverage ratio, 11.12% CET1 ratio, and 12.40% total risk-based capital ratio. The filing states that the Company and Bank met applicable capital and capital-conservation-buffer requirements.
Material changes versus comparable periods
- Q2 net income increased to $19.3 million from $17.5 million, while diluted EPS was unchanged at $0.54. First-half net income rose to $30.9 million from $21.8 million, and diluted EPS increased to $0.87 from $0.67.
- Higher net interest income reflected a larger average earning-asset base, principally from GHB. However, the adjusted net interest margin contracted year over year as deposit funding costs increased.
- First-half provision expense fell to $5.6 million from $18.9 million. The prior-year period included a $17.0 million taxi-medallion-related provision; 2019 included a $3.0 million provision associated with one commercial office building loan. First-half 2019 net charge-offs were $2.9 million, including a $2.1 million partial charge-off on that loan.
- First-half noninterest expense rose to $49.7 million from $34.0 million. The 2019 total included $7.9 million of merger expenses and a $1.0 million loss on extinguishment of debt. Excluding those two items, the filing reports an increase of $6.7 million, primarily associated with GHB-related staffing, professional services, and occupancy costs.
- GHB added seven branches and was funded with ConnectOne common shares; the acquisition recorded $10.3 million of goodwill and $5.1 million of core deposit intangibles. BoeFly is expected to generate fee income and small-business lending opportunities; its acquisition recorded $6.3 million of goodwill and included cash, restricted stock, and a potential cash earn-out.
Outlook, commentary, risks, and unusual items
- Management projected a 2019 combined federal and state effective tax rate of approximately 22%, subject to change. New Jersey tax legislation requiring combined filing may increase the rate; implementing regulations were not yet available, so the precise impact was undetermined.
- No specific earnings, revenue, or margin guidance is provided. Management said operating results for the interim periods are not necessarily indicative of full-year results.
- Management considered the allowance adequate, but emphasized that estimates depend on loan quality, economic conditions, collateral values, and other assumptions; actual losses or required provisions could differ. The loan portfolio is concentrated in commercial and real-estate lending in the New York metropolitan area.
- Interest-rate modeling estimated that a 200-basis-point increase would raise one-year net interest income by 1.91%, while a 100-basis-point decrease would reduce it by 1.46%. Under the same shocks, estimated economic value of equity would decline 8.40% and rise 3.26%, respectively. These are model estimates, not forecasts.
- The filing identifies LIBOR cessation and transition uncertainty as a risk to the value and returns of LIBOR-linked assets and liabilities and potentially to contracts, systems, and processes. The Company’s subordinated debt and interest-rate arrangements include LIBOR references.
- The Company was preparing for CECL, effective for it in 2020, but could not yet estimate the one-time allowance adjustment or overall financial-statement impact. Securities with unrealized losses were judged not to be other-than-temporarily impaired; management cautioned that its judgments could change.
- The Company repurchased 240,018 shares in the first half under a program authorizing up to 1.2 million shares; 959,982 remained available at June 30. It declared $0.18 per share in first-half dividends.
- The Company reported no legal proceedings expected to have a material adverse effect. Management concluded disclosure controls were effective and reported no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- How much of loan, deposit, and earnings growth reflects GHB acquisition effects versus organic growth, and what integration costs or synergies remain.
- Whether the commercial office building exposure, taxi-medallion portfolio, nonaccrual loans, and TDR balances lead to further charge-offs or reserve increases.
- Whether deposit repricing and funding competition continue to pressure adjusted net interest margin.
- The eventual effect of New Jersey combined-filing tax rules and the actual 2019 effective tax rate.
- The final CECL transition adjustment and readiness for the expected 2020 adoption, as well as plans for LIBOR-linked contracts and instruments.
- Whether liquidity, unused borrowing capacity, capital ratios, and share repurchases remain consistent with loan commitments and growth needs.