Business context and reporting period
ConnectOne Bancorp, Inc. is a New Jersey bank holding company whose principal subsidiary, ConnectOne Bank, serves businesses, professionals and individuals in northern and central New Jersey and Manhattan. This Form 10-K reports the fiscal year ended December 31, 2015; it also provides unaudited fourth-quarter results. The July 1, 2014 merger substantially affects year-over-year comparisons: 2015 includes a full year of the combined company, while 2014 includes the merged bank only from July onward.
Financial results and condition
| Metric | 2015 | 2014 |
|---|---|---|
| Net interest income | $117.2 million | $79.4 million |
| Net interest margin | 3.55% | 3.57% |
| Provision for loan losses | $12.6 million | $4.7 million |
| Noninterest income | $11.2 million | $7.5 million |
| Noninterest expense | $54.5 million | $54.8 million |
| Net income | $41.3 million | $18.6 million |
| Diluted EPS | $1.36 | $0.79 |
| Operating cash flow | $52.3 million | $30.6 million |
Net income rose 123.4%; management attributed the increase principally to higher net interest income from the merger and organic growth. Net interest margin edged down two basis points as funding costs increased. Noninterest income included a $2.2 million insurance recovery and $3.9 million of net investment securities gains. The 2014 expense base included $12.4 million of merger costs and a $4.6 million debt-extinguishment loss.
At year-end, total assets were $4.02 billion, deposits $2.79 billion, gross loans $3.10 billion, and borrowings $671.6 million. Loans grew 22.1% during 2015, primarily organically; deposits increased $315 million. Cash and cash equivalents were $200.9 million. Liquid assets were $466.5 million, or 12.2% of assets. The Bank reported $635 million of available, unused credit capacity and $626 million of outstanding commitments to extend credit.
Regulatory capital ratios at year-end were 9.14% CET1, 9.61% Tier 1 and 11.77% total risk-based capital for the Company; the Bank’s corresponding ratios were 10.55%, 10.55% and 11.31%. The Bank was classified as well capitalized. Common dividends were $0.30 per share for the year. The Company issued $50 million of subordinated notes in 2015, bearing 5.75% fixed interest through June 2020 and then a floating rate.
Material changes and asset quality
The loan-loss provision increased to $12.6 million, including specific reserves of $4.5 million related to taxi medallion loans and $1.3 million for a lease-financing receivable. The allowance rose to $26.6 million, or 0.86% of loans, from $14.2 million, or 0.56%. Net charge-offs were $0.2 million. Nonaccrual loans increased to $20.7 million from $11.6 million, while classified substandard loans rose to $130.3 million from $42.3 million.
Commercial real estate loans totaled $2.0 billion, 63.4% of loans and 492.3% of risk-based capital. Taxi medallion loans totaled $103.2 million; $78.5 million were reported as troubled debt restructurings (TDRs), and $3.3 million were 30–60 days past due. TDR modifications generally deferred principal payments to interest-only, increased rates to 3.75%, and did not forgive principal or extend contractual maturities. The filing states the modified loans were performing at year-end.
Outlook, risks and unusual matters
The filing provides no specific earnings or growth guidance. Management describes a strategy centered on organic growth, relationship banking and selective acquisition opportunities. It expects to redeem the $11.25 million SBLF preferred stock by March 31, 2016; if still outstanding, its dividend rate was scheduled to rise to 9% on March 15, 2016.
Key risks include concentrated commercial real estate lending, loan growth and limited seasoning, taxi medallion values affected by ride-share competition, interest-rate and funding-cost exposure, competition for deposits and loans, and reliance on alternate deposit channels. A modeled 200-basis-point rate increase was estimated to raise one-year net interest income 5.65% but reduce economic value of equity 9.65%; these are model estimates, not forecasts.
The Company disclosed a material weakness in controls for identifying and measuring TDRs in its taxi medallion portfolio. It determined that $75.4 million of loans modified in April 2015 had initially been incorrectly treated as non-TDRs; the filing elsewhere reports $78.5 million of taxi medallion TDRs at year-end. Management enhanced controls but had not fully tested remediation by year-end. The auditor issued an adverse opinion on internal control over financial reporting, while issuing an unqualified opinion on the financial statements. Management reported no significant pending legal proceedings and no material adverse effect expected from ordinary-course claims.
Important facts for investors to verify
- Reconcile the $75.4 million of loans identified in the control review with the $78.5 million year-end taxi medallion TDR balance, and monitor collateral valuations, reserves and subsequent loan performance.
- Track remediation and independent testing of the TDR control weakness and the effectiveness of disclosure controls.
- Assess whether CRE concentration, rapid loan growth and rising classified and nonaccrual balances lead to further provisions or charge-offs.
- Monitor deposit mix and pricing, borrowing needs, liquidity capacity and sensitivity of earnings and equity to changing interest rates.
- Confirm the planned SBLF preferred-stock redemption and its effect on capital, funding costs and shareholder distributions.
- Interpret year-over-year earnings growth in light of the merger timing and identify the contribution of one-off insurance recoveries and securities gains.