ConnectOne Bancorp, Inc. — Q1 2016 Form 10-Q
Reporting period: Three months ended March 31, 2016; balance-sheet comparisons are to December 31, 2015. ConnectOne is a New Jersey-chartered community commercial bank operating through 21 banking offices.
Financial results and condition
| Metric | Q1 2016 | Comparable / prior period |
|---|---|---|
| Net interest income | $31.3 million | $28.3 million, Q1 2015 |
| Net income | $10.4 million | $10.4 million, Q1 2015 |
| Net income available to common shareholders | $10.4 million; diluted EPS $0.34 | $10.4 million; diluted EPS $0.34, Q1 2015 |
| Provision for loan losses | $3.0 million | $1.8 million, Q1 2015 |
| Noninterest income / expense | $1.2 million / $14.4 million | $1.6 million / $12.6 million, Q1 2015 |
| Total assets | $4.091 billion | $4.016 billion, Dec. 31, 2015 |
| Gross loans / deposits | $3.266 billion / $2.893 billion | $3.102 billion / $2.791 billion, Dec. 31, 2015 |
| Cash and cash equivalents | $118.3 million | $200.9 million, Dec. 31, 2015 |
| Borrowings / subordinated debentures | $646.5 million / $54.4 million | $671.6 million / $54.3 million, Dec. 31, 2015 |
- Revenue and margins: Tax-equivalent net interest income rose 10.7% to $32.0 million, while average interest-earning assets increased 17.2%. Net interest margin declined to 3.45% from 3.68%; excluding purchase-accounting adjustments, adjusted margin was 3.31% versus 3.46%.
- Profitability: Net income was essentially unchanged year over year. The effective tax rate was 31.5%, compared with 32.6% in Q1 2015.
- Cash flow: Operating activities provided $7.3 million; investing activities used $153.6 million, primarily for loan growth; financing activities provided $63.6 million. Cash and equivalents fell $82.6 million during the quarter.
- Liquidity: Liquid assets were $368.2 million, or 9.0% of assets and 10.4% of deposits and borrowings, down from $466.5 million at year-end. The company reported $696.4 million of available and unused borrowing capacity and $584 million of commitments to extend credit.
- Capital and shareholder returns: Company and Bank regulatory capital ratios exceeded minimum requirements and applicable capital-conservation-buffer levels. The common dividend was $0.075 per share. The company redeemed $11.25 million of preferred stock in March. Book value per common share was $15.74 and tangible book value per share was $10.78.
Material changes versus comparable periods
- Gross loans grew $164.0 million, or 5.3%, from year-end; the largest increases were in construction ($73.8 million), commercial real estate ($61.6 million), and commercial lending ($31.6 million). Deposits increased $102.1 million, led by time deposits; noninterest-bearing deposits declined $36.3 million.
- Net interest income benefited from asset growth, but margin contracted as loan yields declined and funding costs rose. Management cited competitive deposit pricing, the 2015 subordinated-debt issuance, and longer-duration liabilities as contributing factors.
- Noninterest expense rose 13.6% year over year, principally due to higher salaries and benefits and increased professional, occupancy, and data-processing costs associated with business growth. Noninterest income declined largely because Q1 2015 included $506,000 of securities gains; no securities were sold in Q1 2016.
- The allowance for loan and lease losses increased to $29.1 million from $26.6 million at year-end; allowance coverage rose to 0.89% of loans from 0.86%. Net charge-offs were $498,000 versus $52,000 in Q1 2015.
Outlook, risks, contingencies, and unusual items
- Management expected the full-year 2016 effective tax rate to be approximately 31.5%. No broader earnings or revenue guidance was provided. Management intended to keep multifamily loans at 25%–30% of total loans while growing commercial-and-industrial and construction lending.
- Taxi-medallion credit risk: Taxi-medallion loans totaled $103.2 million; $86.4 million were troubled debt restructurings (TDRs), and $1.9 million were nonaccrual. The average net loan-to-value ratio was about 92%, using management’s medallion valuations. The company recorded $6.0 million of specific allocations for modified TDRs, including an additional $1.5 million following a lower estimated medallion valuation; the cited corporate-medallion valuation was approximately $775,000.
- Control weakness: The company identified material weaknesses in controls for identifying and measuring taxi-medallion TDRs. It determined that $75.4 million of taxi-medallion loans should have been classified as TDRs when modified in April 2015. Controls were enhanced, but management could not conclude the weaknesses were fully remediated as of March 31, 2016. Management concluded disclosure controls and procedures were not effective.
- Interest-rate exposure remained material. The company’s model estimated that a 200-basis-point increase would raise one-year net interest income 5.82%, while a 100-basis-point decrease would lower it 3.51%. A 200-basis-point increase was estimated to reduce economic value of equity 10.32%.
- Cash-flow hedges had a $1.568 million negative fair value at quarter-end; a $1.437 million pretax unrealized loss was recorded in other comprehensive income in Q1. Management expected the hedges to remain effective.
- Management reported no material legal proceedings and no changes to the risks described in the 2015 Form 10-K. Forward-looking risks include interest-rate and margin changes, competition, credit losses, economic conditions, regulation, and legal or regulatory proceedings. A $2.0 million pension-plan contribution was made in April 2016.
Important facts for investors to verify
- Progress in remediating the TDR identification and impairment-measurement control weaknesses, and whether any further restatement or disclosure consequences arise.
- Taxi-medallion collateral values, borrower performance, TDR status, and adequacy of the $6.0 million specific allocation and overall loan-loss allowance.
- Whether rapid loan growth can be sustained without further margin compression, higher funding costs, or deterioration in credit quality.
- Liquidity trends and the availability and cost of funding, including the effect of deposit mix and outstanding lending commitments.
- Actual results versus the approximately 31.5% tax-rate expectation and the stated interest-rate sensitivity estimates.