ConnectOne Bancorp, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. ConnectOne is a New Jersey-chartered community commercial bank operating from its headquarters and 20 other banking offices. Figures below are in U.S. dollars; financial statement amounts are in millions unless noted.
Financial performance and condition
- Profit: Q2 net income was $10.9 million, versus $10.5 million in Q2 2015; diluted EPS was $0.36 versus $0.35. First-half net income was $21.3 million versus $20.9 million; diluted EPS was $0.70 versus $0.69. Common dividends were $0.075 per share in Q2.
- Interest income and margin: Q2 GAAP net interest income was $32.4 million, up from $28.7 million; first-half net interest income was $63.7 million, up from $57.0 million. Tax-equivalent net interest margin was 3.40% for Q2 and 3.42% for the first half, down from 3.60% and 3.63%, respectively, in 2015. Management cited loan growth as the principal driver of higher net interest income, partly offset by margin compression.
- Provision and credit costs: Provision for loan and lease losses was $3.8 million in Q2 and $6.8 million for the first half, compared with $1.6 million and $3.4 million in 2015. The allowance was $32.8 million, or 0.97% of loans, versus $26.6 million, or 0.86%, at year-end 2015. First-half net charge-offs were $0.6 million.
- Noninterest items: Q2 noninterest income was $1.6 million, down from $3.4 million; the prior-year quarter included a $2.2 million insurance recovery for a wire-fraud loss. First-half noninterest income was $2.8 million versus $5.0 million. Q2 noninterest expense was $14.4 million versus $15.0 million; first-half expense was $28.7 million versus $27.6 million. The 2015 comparisons included a $2.4 million loss on extinguishment of debt; excluding that charge, expenses increased, principally reflecting staffing and business growth.
- Loans and deposits: Gross loans grew 8.9% from year-end to $3.38 billion, with growth in commercial, commercial real estate and construction lending. Deposits rose 14.7% to $3.20 billion, led by money-market and time deposits. Commercial real estate represented 61.3% of gross loans.
- Cash flow and liquidity: First-half operating cash flow was $24.5 million; investing activities used $269.8 million, principally reflecting loan growth; financing activities provided $219.6 million, primarily from deposit growth. Cash and cash equivalents were $175.1 million, down from $200.9 million at year-end. Management reported liquid assets of $429.9 million, 10.1% of assets, and aggregate available and unused credit of $837.8 million.
- Debt and capital: Borrowings were $496.4 million, down from $671.6 million at year-end; subordinated debentures were $54.4 million. Stockholders’ equity was $484.4 million. At June 30, the Company’s total risk-based capital ratio was 11.44%; the Bank’s was 11.30%. Both were above applicable well-capitalized requirements, according to the filing. The Company redeemed $11.25 million of preferred stock during the first half.
Material changes, outlook, and risks
- Taxi-medallion exposure: Taxi-medallion loans totaled $103.1 million. Related TDRs were $88.0 million, and $3.9 million was nonaccrual. Specific reserves for the portfolio were $7.8 million; management lowered its estimated value for corporate medallions to approximately $750,000 from $800,000 at year-end and recorded an additional $3.3 million specific allocation during the first half. Total TDRs were $99.2 million, including $97.8 million performing.
- Control weakness: Management identified material weaknesses in controls for identifying and measuring taxi-medallion TDRs. A $75.4 million loan balance modified in April 2015 was determined to have been misclassified and should have been treated as TDRs. The Company enhanced procedures and oversight and engaged a valuation firm, but stated the weaknesses could not yet be considered remediated because the controls had not been tested for sufficient time. Management concluded disclosure controls and procedures were not effective as of quarter-end.
- Interest-rate sensitivity: Management’s model estimated that a 200-basis-point rate increase would raise one-year net interest income 7.73%, while a 100-basis-point decrease would lower it 3.81%. A 200-basis-point increase was estimated to reduce economic value of equity 10.29%. These are model estimates, not forecasts.
- Outlook: No numerical earnings or growth guidance was provided. Management expected the 2016 effective tax rate to remain approximately 31.5% and anticipated modest future fee-income growth. It cited margin pressure from elevated cash balances, deposit costs, subordinated debt and the prolonged low-rate environment.
- Other risks and contingencies: The filing highlights credit, real estate and economic conditions in the Bank’s market area; interest-rate and securities-market changes; competition; and regulatory or legal developments. No legal proceedings expected to materially adversely affect results or financial condition were reported. Management stated there were no changes to the previously disclosed risk factors.
Important facts for investors to verify
- Track taxi-medallion collateral values, TDR and nonaccrual balances, and whether the $7.8 million specific reserve remains adequate.
- Follow remediation and testing of the TDR control weaknesses, including any further accounting or disclosure consequences of the $75.4 million reclassification.
- Assess whether loan and deposit growth can continue without further net interest margin compression or increased credit costs.
- Monitor liquidity and funding costs as cash declined and deposit growth was concentrated in money-market and time deposits.
- Reconcile apparent MD&A inconsistencies against the financial statements: the Q2 EPS comparison is misstated in the narrative, and the stated Q2 2015 income tax expense differs from the income statement. The financial statements report diluted EPS of $0.36/$0.35 and tax expense of $5.003 million/$5.069 million for Q2 2016/2015, respectively.