ConnectOne Bancorp, Inc. — Q3 2016 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2016. ConnectOne is a New Jersey-based commercial bank operating through ConnectOne Bank and 21 banking offices. Financial statements are unaudited.
Financial performance
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Net interest income | $33.0 million | $29.7 million | $96.7 million | $86.7 million |
| Provision for loan losses | $6.8 million | $4.2 million | $13.5 million | $7.6 million |
| Net income | $11.9 million | $10.8 million | $33.1 million | $31.7 million |
| Diluted EPS | $0.39 | $0.36 | $1.09 | $1.04 |
- Tax-equivalent net interest margin was 3.32% in Q3 (3.50% prior year) and 3.39% for nine months (3.59% prior year). Management attributed compression to higher cash balances, deposit costs, the low-rate environment and, for the nine-month comparison, the 2015 subordinated debt issuance.
- Noninterest income was $5.6 million for Q3 and $8.3 million for nine months. Investment-security sale gains were $4.1 million and $4.2 million, respectively. Nine-month 2015 noninterest income included a $2.2 million insurance recovery; excluding it, 2016 noninterest income increased.
- Noninterest expense was $14.6 million for Q3 and $43.3 million for nine months, up 9.4% and 5.7%, respectively. Higher staffing and operating costs related to business growth contributed; 2015 nine-month expense included a $2.4 million debt-extinguishment loss.
Financial position, cash flow and capital
- Total assets were $4.33 billion at September 30, 2016, versus $4.02 billion at year-end 2015. Loans receivable were $3.45 billion, up 11.2%; commercial real estate and construction loans drove much of the growth.
- Deposits rose 17.1% to $3.27 billion. Borrowings declined to $481.3 million from $671.6 million; subordinated debentures were $54.5 million.
- Cash and cash equivalents were $233.8 million. Nine-month operating cash flow was $36.6 million, investing cash use was $274.0 million, and financing cash flow was $270.3 million. Financing included $478.2 million of net deposit growth and a $190.0 million net reduction in borrowings.
- Management reported $466.7 million of liquid assets, 10.8% of assets, and $805.8 million of available and unused credit capacity. Outstanding commitments to extend credit were $581 million.
- Stockholders’ equity was $499.6 million. The company reported a 8.39% tangible common equity ratio and $11.60 tangible book value per share. At quarter-end, the Bank’s total risk-based capital ratio was 11.57%; management stated the Company and Bank met applicable capital requirements.
- Common dividends were $0.075 per share for Q3. The $11.25 million SBLF preferred stock was redeemed during 2016.
Material changes, outlook and risks
- Credit quality and taxi medallions: The allowance for loan and lease losses rose to $37.6 million, or 1.09% of loans, from $26.6 million and 0.86% at year-end. Q3 provision was $6.8 million; net charge-offs were $1.9 million, including a $1.1 million lease-financing charge-off. Nonaccrual loans fell to $11.5 million from $20.7 million.
- Taxi-medallion loans totaled $102.7 million; $95.2 million were TDRs and specific reserves were $12.5 million. The estimated value of a New York City corporate medallion fell to about $700,000 from $750,000 at June 30. Total TDRs were $106.7 million, including $105.3 million performing under restructured terms.
- Control weakness: Management concluded disclosure controls and procedures were not effective. Material weaknesses were identified in controls for identifying and measuring taxi-medallion TDRs. A review found $75.4 million of loans modified in April 2015 should have been classified as TDRs. Controls were enhanced, but management could not conclude the weaknesses had been fully remediated by September 30 because there had been insufficient time to test them.
- Investment portfolio: In Q3, the Company transferred approximately $210 million of securities from held-to-maturity to available-for-sale, increasing accumulated other comprehensive income by $7.4 million after tax. Management said the change enhanced liquidity and asset-liability flexibility. It also recorded $4.1 million in Q3 securities-sale gains.
- Management expected the 2016 effective tax rate to remain about 31.5% and anticipated modest fee-income growth. It stated liquidity was adequate and interest-rate model results were within Board guidelines. A modeled +200 bp rate shock increased one-year net interest income by 8.38%, while a -100 bp shock reduced it by 4.19%; modeled economic value of equity declined 8.56% under +200 bp.
- Risks cited include competitive pressure, interest-rate and margin changes, credit losses and provisions, regional economic and real-estate conditions, regulatory changes, and legal or regulatory matters. The filing reported no legal proceedings expected to materially adversely affect results or financial condition and no changes to the 10-K risk factors.
Most important facts for investors to verify
- Progress in remediating and testing the TDR-control material weaknesses, and the accuracy of taxi-medallion loan classifications and impairment estimates.
- Further changes in medallion collateral values, TDR performance, specific reserves, charge-offs and overall allowance adequacy.
- Whether loan growth can continue without further margin compression or materially higher funding costs.
- The sustainability of earnings given the contribution of securities-sale gains and the prior-year insurance recovery comparison.
- Liquidity and funding capacity, including loan commitments, borrowing maturities and sensitivity to interest-rate changes.