ConnectOne Bancorp, Inc. — Q3 2018 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2018; balance-sheet comparisons are with December 31, 2017. ConnectOne is a New Jersey bank holding company operating ConnectOne Bank, a community bank with 21 banking offices in addition to its headquarters. Financial statements are unaudited.
Key financial results
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Interest income | $55.4 million | $46.3 million | $158.9 million | $131.1 million |
| Net interest income | $40.0 million | $37.0 million | $117.1 million | $105.3 million |
| Provision for loan losses | $1.1 million | $1.5 million | $20.0 million | $4.0 million |
| Noninterest income | $1.4 million | $1.8 million | $4.2 million | $6.2 million |
| Noninterest expense | $18.3 million | $18.6 million | $52.5 million | $62.2 million |
| Net income | $19.9 million | $13.1 million | $41.7 million | $32.6 million |
| Diluted EPS | $0.61 | $0.41 | $1.29 | $1.01 |
- Tax-equivalent net interest margin was 3.30% in Q3, down 14 basis points year over year; for the nine months it was 3.29%, down 15 basis points. Tax-equivalent net interest income increased 6.6% in Q3 and 9.7% year to date, supported by loan growth; higher deposit costs and subordinated debt expense, among other factors, pressured margin.
- Effective tax rates were 9.6% for Q3 and 14.6% year to date, versus 30.0% and 27.9% in the respective 2017 periods. Management attributed the decrease to the federal Tax Act rate reduction and tax-related benefits, including stock-compensation effects.
Financial position, liquidity and credit
- Total assets were $5.37 billion, up from $5.11 billion at year-end 2017. Loans receivable were $4.46 billion, up 7.0%; deposits were $3.99 billion, up 5.1%. Interest-bearing deposits grew while noninterest-bearing deposits declined.
- Cash and cash equivalents were $155.8 million. Nine-month operating cash flow was $67.3 million; investing activities used $281.6 million, principally reflecting loan growth, and financing activities provided $220.5 million. Management reported $419.4 million of liquid assets, equal to 7.8% of total assets and 9.1% of deposits and borrowings, and approximately $1.0 billion of available and unused credit capacity.
- Borrowings totaled $630.0 million, down from $670.1 million at year-end; subordinated debentures were $128.5 million, up from $54.7 million following the January issuance of $75 million in subordinated notes. FHLB borrowing capacity was approximately $1.0 billion in the note disclosure.
- Stockholders’ equity was $594.9 million. Tangible common equity ratio was 8.56% and tangible book value per share was $13.87. The Bank’s total risk-based capital ratio was 12.57%; management said the Company and Bank met applicable capital requirements.
- The allowance for loan losses was $34.7 million, or 0.78% of loans. Nine-month provision was $20.0 million and net charge-offs were approximately $17.0 million, principally tied to taxi medallion loans. The $17.0 million medallion charge-off reflected lower transfer values and a reduced cash-flow valuation.
- Nonaccrual loans were $53.0 million, down from $65.6 million at year-end; management attributed much of the decrease to the medallion charge-off. Nonperforming assets were 0.99% of total assets. Troubled debt restructurings totaled $32.3 million, including $21.1 million on nonaccrual status.
- Net unrealized losses on available-for-sale securities, net of tax, increased to $8.2 million from $0.9 million at year-end, mainly reflecting market and interest-rate changes. Management did not consider the reported losses other-than-temporary, but noted future impairment charges remain possible.
Changes, outlook and notable matters
- Q3 net income rose to $19.9 million from $13.1 million. For the nine-month period, net income increased despite the higher credit provision; management cited stronger net interest income and lower tax expense, partly offset by medallion-related credit costs, lower noninterest income, and higher expenses excluding the prior-year medallion valuation charge.
- Prior-year comparisons include a $15.3 million valuation allowance on taxi medallion loans held for sale in the first nine months of 2017, and $1.6 million of securities gains in 2017. These items affect the comparability of expenses and noninterest income.
- Management anticipated an effective tax rate of approximately 26% for 2019, citing recent New Jersey corporate tax legislation. The filing does not provide earnings or revenue guidance for 2018 or later periods; management cautioned interim results are not necessarily indicative of full-year results.
- Interest-rate sensitivity modeling estimated that a 200-basis-point rate increase would raise one-year net interest income by 1.28%, while a 100-basis-point decrease would lower it by 1.44%. Under the same shocks, estimated economic value of equity would decline 13.09% or increase 3.49%, respectively. These are model estimates and are subject to assumptions.
- The Company entered into a merger agreement with Greater Hudson Bank in July 2018. Two shareholder complaints challenge disclosures and the sale process; one also alleges ConnectOne aided and abetted fiduciary breaches. ConnectOne and Greater Hudson said they were evaluating the complaints and intended to defend the allegations. The filing does not state a transaction completion date.
- Management was assessing the future expected-credit-loss standard (CECL) and could not yet estimate its impact. Adoption of the new lease standard in 2019 is expected to increase reported assets and liabilities.
Most important facts for investors to verify
- Whether credit quality and medallion-related exposure stabilize, including the adequacy of the $34.7 million allowance and trends in nonaccrual loans and TDRs.
- Whether loan growth can continue without further net interest margin compression as deposit and borrowing costs rise.
- The durability of unusually low 2018 effective tax rates and the expected approximately 26% rate in 2019.
- Liquidity and funding capacity relative to loan commitments of approximately $823 million, deposit trends, and borrowing collateral requirements.
- Developments in the Greater Hudson merger, including litigation, approvals and timing, and any resulting costs or changes to the transaction.
- The impact of CECL adoption and lease accounting on future financial statements and capital measures.