ConnectOne Bancorp, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018; balance-sheet comparisons are with December 31, 2017. ConnectOne operates a community-based commercial bank headquartered in New Jersey, with 22 banking offices. Financial statements are unaudited.
Financial performance and position
| Metric | Q1 2018 / March 31, 2018 | Comparable period / December 31, 2017 |
|---|---|---|
| Net interest income | $38.1 million | $33.1 million, Q1 2017 |
| Net interest margin, tax-equivalent | 3.26% | 3.40%, Q1 2017 |
| Net income | $4.3 million | $11.9 million, Q1 2017 |
| Diluted earnings per share | $0.13 | $0.37, Q1 2017 |
| Provision for loan losses | $17.8 million | $1.1 million, Q1 2017 |
| Total assets | $5.16 billion | $5.11 billion |
| Gross loans | $4.21 billion | $4.17 billion |
| Total deposits | $3.75 billion | $3.80 billion |
| Borrowings / subordinated debentures | $695.0 million / $128.3 million | $670.1 million / $54.7 million |
| Cash and cash equivalents | $142.8 million | $149.6 million |
| Operating / investing / financing cash flow | $20.2 million / $(77.8) million / $50.8 million | $24.8 million / $(87.0) million / $23.6 million, Q1 2017 |
Net interest income increased 13.7% on a tax-equivalent basis as average interest-earning assets grew 18.4%, primarily from loans. Margin contraction reflected higher deposit costs, the recent subordinated debt issuance and tax-equivalent adjustments, partly offset by higher loan yields. Noninterest income was $1.4 million versus $3.0 million, mainly because Q1 2017 included $1.6 million of securities-sale gains. Noninterest expense was $17.1 million versus $18.2 million; the prior period included a $2.6 million valuation allowance on taxi-medallion loans held for sale. The Q1 2018 income tax expense was $0.4 million, including a $0.5 million share-based compensation tax benefit.
Material changes and credit quality
- A $17.0 million charge-off on New York City taxi-medallion loans drove most of the $17.8 million loan-loss provision and reduced reported commercial loans. Management attributed the charge-off to lower medallion transfer values and a lower cash-flow valuation.
- The allowance for loan losses ended at $32.5 million, or 0.77% of loans, compared with $31.7 million, or 0.76%, at year-end. Net charge-offs were $17.0 million; the allowance increased only modestly after the charge-off.
- Nonaccrual loans were $50.0 million, down from $65.6 million at year-end, primarily because of the taxi-medallion charge-off. Nonperforming assets were $51.1 million, or 0.99% of assets, versus $66.2 million, or 1.29%.
- Troubled debt restructurings rose to $24.7 million from $20.5 million; $10.4 million were on nonaccrual status. The filing reports no defaults within 12 months following Q1 modifications.
- Deposits declined $45.5 million (1.2%); decreases in demand and money-market balances were partly offset by $75.7 million growth in time deposits. Loans increased $30.7 million, led by commercial real estate.
- Stockholders’ equity was $564.3 million, down $1.2 million. Tangible common equity ratio was 8.31% versus 8.41%, and tangible book value per share was $12.93 versus $13.01.
- Net unrealized losses on available-for-sale securities, after tax, were $4.8 million versus net unrealized gains of $0.9 million at year-end; management attributed the change primarily to market conditions and interest rates and did not consider the losses other-than-temporary.
Liquidity, debt, outlook and risks
Management considered liquidity adequate. Liquid assets were $397.6 million, 7.7% of total assets and 8.9% of deposits and borrowings, compared with $423.4 million, 8.3% and 9.5%, respectively, at year-end. The Bank reported approximately $770 million of aggregate available and unused credit, alongside $679 million of outstanding commitments to extend credit. It also reported approximately $762 million of remaining FHLB borrowing capacity. Deposits, loan repayments, securities maturities and operating cash flow are principal funding sources.
In January, the company issued $75 million of fixed-to-floating subordinated notes, bearing 5.20% fixed interest through January 2023 and then three-month LIBOR plus 2.84% through maturity in 2028. FHLB borrowings carried a 2.07% weighted-average rate, up from 1.76% at year-end. The company and Bank met applicable capital requirements and capital-conservation-buffer requirements; the Bank’s total risk-based capital ratio was 12.31%.
Management projected an approximately 21% effective tax rate for 2018, excluding share-based compensation tax benefits. No earnings or revenue guidance was provided. Interest-rate modeling estimated that a 200-basis-point rate increase would raise one-year net interest income by 1.24%, while a 100-basis-point decrease would reduce it by 1.55%. A 200-basis-point increase was estimated to reduce economic value of equity by 14.15%. Model results were within Board guidelines.
Key risks include credit losses and uncertainty in the taxi-medallion portfolio, interest-rate and securities-market movements, funding competition and deposit costs, economic conditions in the company’s markets, and regulatory or legal developments. Management’s estimates of loan-loss reserves, securities impairment, goodwill and deferred taxes involve judgment; actual outcomes may differ. The company is assessing the future expected-credit-loss standard (CECL); it could not yet estimate the adoption adjustment. Management expects lease accounting adoption to increase assets and liabilities. The filing reports no legal proceedings expected to have a material adverse impact and no material change to previously disclosed risk factors.
Important facts for investors to verify
- Subsequent taxi-medallion loan performance, collateral valuations, remaining exposure and any additional reserve or charge-off needs.
- Whether the $32.5 million allowance remains adequate as loans grow and credit quality or regional economic conditions change.
- Deposit mix, deposit pricing and the effect of funding costs on net interest margin and earnings.
- Available liquidity and borrowing capacity relative to the $679 million of lending commitments and future funding needs.
- Interest-rate sensitivity assumptions, securities’ unrealized losses and any change in management’s impairment conclusions.
- Actual tax rate, CECL implementation impact and the continuing effects of the subordinated notes on funding costs and capital.