ConnectOne Bancorp, Inc. — Q3 2015 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2015. Unaudited consolidated results; dollar amounts below are in millions unless stated otherwise. ConnectOne is a New Jersey community bank with 22 banking offices. The July 2014 merger affects comparability: Q3 2015 and Q3 2014 include the combined company, while the nine-month 2014 period includes the predecessor only from July 1 onward.
Financial performance and condition
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Net interest income | $29.7 | $27.5 | $86.7 | $50.8 |
| Provision for loan losses | $4.2 | $1.3 | $7.6 | $2.2 |
| Noninterest income | $3.8 | $1.2 | $8.8 | $5.4 |
| Noninterest expense | $13.3 | $25.4 | $40.9 | $39.6 |
| Net income | $10.8 | $1.8 | $31.7 | $10.5 |
| Diluted EPS | $0.36 | $0.06 | $1.04 | $0.49 |
- Margins: Tax-equivalent net interest margin was 3.50% in Q3, down from 3.66% a year earlier; excluding purchase-accounting adjustments, management reported an adjusted margin of 3.35% versus 3.29%. For the first nine months, tax-equivalent margin was 3.59% versus 3.49%; adjusted margin was 3.41%, 11 basis points higher year over year.
- Balance sheet at September 30: Total assets were $3,838.3, up from $3,448.6 at year-end 2014. Gross loans were $2,955.7, up 16.4%; deposits were $2,666.6, up 7.7%. Stockholders’ equity was $471.1, versus $446.2. Allowance for loan losses was $21.5, or 0.73% of loans, compared with $14.2, or 0.56%, at year-end.
- Cash flow and liquidity: Nine-month operating cash flow was $36.2; investing activities used $366.3, principally reflecting loan growth; financing activities provided $361.7. Cash and cash equivalents ended at $158.5, up $31.7. Management reported $466.5 of liquid assets and $686.3 of available, unused borrowing capacity. Outstanding commitments to extend credit were $589.
- Debt and capital: Borrowings were $621.7 and subordinated debentures $55.2, versus $495.6 and $5.2, respectively, at year-end 2014. The company issued $50 of fixed-to-floating subordinated notes at a 5.75% initial fixed rate, with proceeds intended in part to redeem $11.3 of preferred stock by January 2016. Company total risk-based capital was 11.94%; the Bank’s was 11.47%, above the stated 10.00% well-capitalized threshold.
Material changes and unusual items
- Q3 net interest income rose 7.9% year over year, with average interest-earning assets up 12.8%; margin contraction partly offset the growth. Management attributed improved adjusted margin to loan mix and lower borrowing costs.
- Q3 noninterest income included $2.1 of securities gains and an approximately $0.7 fee from an equity participation in a credit extension. Nine-month noninterest income included a $2.2 insurance recovery and $2.8 of securities gains.
- Q3 2014 expenses included $8.8 of merger-related costs and $4.6 of debt-extinguishment charges; the nine-month 2014 period included $10.6 and $4.6, respectively. These unusual prior-year charges explain much of the reported earnings improvement. Nine-month 2015 expenses also reflect higher staffing and operating costs associated with merger integration and growth.
- Average interest-earning assets and loans grew substantially; management attributed year-to-date growth to the merger and organic expansion. Investment securities were sold in part to fund loan growth.
- Other comprehensive loss was $2.3 for the first nine months, including unrealized losses on securities and cash-flow hedges, partly offset by pension-related gains.
Credit quality, risks, and outlook
- Taxi medallion exposure: $103.3 of loans secured by New York City taxi medallions were reported 100% current, with an estimated average loan-to-value ratio of 92.7%. Of these, $75.4 was restructured as troubled debt in Q2, principally by deferring principal amortization to interest-only payments; rates increased to 3.75%, with no principal forgiveness or maturity extension. The company recorded a $2.0 specific allocation, based on a medallion valuation of $814,000. Management warned that volatile collateral values could cause additional provisions and earnings volatility even if loans remain current.
- Special-mention loans increased to $105.7, or 3.6% of loans, from $19.3, or 0.8%, at year-end. Nonaccrual loans were $12.9 and other real estate owned $3.2; total nonperforming assets were $16.1, up from $12.7. Net charge-offs remained low at $0.2 for the nine-month period.
- Controls: The company reported a restatement of its Q2 2015 report and concluded disclosure controls were ineffective regarding identification and measurement of taxi-medallion TDRs. It identified material weaknesses after determining the $75.4 of modified loans should have been classified as TDRs. Management said it was enhancing individual-loan documentation, impairment calculations, and oversight; it cautioned that additional issues could be found.
- Interest-rate risk: The company’s model estimated a 3.84% increase in one-year net interest income under an immediate 200-basis-point rate rise and a 3.78% decrease under a 100-basis-point decline. A 200-basis-point rise was estimated to reduce economic value of equity by 10.95%. These are model estimates, not forecasts.
- Outlook: No specific earnings or financial guidance was provided. Management expected fee income to increase modestly and stated the allowance was adequate, while noting actual credit losses and future provisions could differ materially from estimates. Disclosed risks include competitive pressure, interest-rate and economic changes, credit losses, regulation, and securities-market volatility. The filing reported no legal proceedings expected to have a material adverse effect.
Important facts for investors to verify
- Track taxi-medallion collateral valuations, the performance and impairment analysis of the $75.4 TDR balance, and any change in the $2.0 specific allowance.
- Review remediation of the disclosed material weakness and confirm whether subsequent filings report effective controls or further restatements.
- Assess whether loan growth, special-mention loans, nonaccrual assets, and provision expense continue to rise, and whether the allowance remains adequate.
- Monitor deposit funding costs, reliance on borrowings, liquidity capacity, and the planned preferred-stock redemption following the subordinated-note issuance.
- Separate recurring operating performance from securities gains, the insurance recovery, purchase-accounting effects, and prior-year merger and debt-extinguishment charges when comparing periods.