ConnectOne Bancorp, Inc. — Q3 2014 Form 10-Q
Business context and period. The unaudited filing covers the quarter and nine months ended September 30, 2014. On July 1, ConnectOne completed its merger with Legacy ConnectOne, a merger of equals; the former Center Bancorp was the accounting acquirer. Q3 includes the combined company from the merger date, while prior-period comparisons largely reflect the predecessor company, limiting comparability. The bank operates in New Jersey.
Financial performance and position
| Metric | Q3 / September 30, 2014 | Comparable period / prior date |
|---|---|---|
| Net interest income (GAAP) | $27.5 million; $50.8 million for nine months | $11.7 million Q3; $34.3 million nine months in 2013 |
| Net interest margin | 3.66% Q3; 3.49% nine months | 3.31% Q3; 3.30% nine months in 2013 |
| Net income | $1.8 million Q3; $10.5 million nine months | $5.1 million Q3; $14.9 million nine months in 2013 |
| Net income available to common | $1.7 million Q3; $10.5 million nine months | $5.1 million Q3; $14.8 million nine months in 2013 |
| Diluted EPS | $0.06 Q3; $0.49 nine months | $0.31 Q3; $0.91 nine months in 2013 |
| Assets / loans / deposits | $3.36 billion / $2.43 billion / $2.47 billion | Assets $1.67 billion, loans $0.96 billion, deposits $1.34 billion at December 31, 2013 |
| Cash and cash equivalents | $138.0 million | $82.7 million at December 31, 2013 |
| Stockholders’ equity | $441.8 million; 13.2% of assets | $168.6 million; 10.1% of assets at December 31, 2013 |
Higher interest income and margin reflected the larger post-merger balance sheet; purchase-accounting accretion and amortization added $2.9 million to net interest income in the first nine months. Q3 and nine-month earnings nevertheless fell year over year, in part because of merger and debt-extinguishment costs. Q3 annualized return on average assets and equity were 0.21% and 1.59%, respectively.
Q3 noninterest expense was $25.4 million, including $8.8 million of merger-related expense and a $4.6 million pre-tax loss from extinguishing $70 million of FHLB advances. Merger-related expenses totaled $10.6 million for the nine months. Management said the debt repayment was intended to reduce future interest expense and improve interest-rate risk positioning. Nine-month noninterest income was $5.4 million, including $2.1 million of net securities gains; Q3 noninterest income was $1.2 million.
Operating cash flow was $10.4 million for the nine months; investing activities used $38.9 million and financing activities provided $83.8 million. Liquid assets were $417.8 million, or 12.4% of assets and 14.4% of deposits and borrowings. The Bank reported $515.3 million of available, unused borrowing capacity and $497.5 million of outstanding credit commitments.
Borrowings totaled $421.0 million, versus $146.0 million at year-end 2013; subordinated debentures were $5.2 million. Total regulatory risk-based capital ratios were 11.07% for the holding company and 11.04% for the Bank. The Bank exceeded the stated well-capitalized thresholds; management said the company and Bank met applicable capital requirements. Tangible book value per common share was $9.43, compared with $8.58 at year-end.
Material changes and credit quality
- The merger drove substantial balance-sheet growth: loans rose 152.5% from year-end, primarily from acquired balances. Goodwill recognized was $129.1 million and the core deposit intangible was $5.3 million. The company issued 13.2 million shares in the transaction.
- The allowance for loan losses increased to $12.1 million from $10.3 million; the nine-month provision was $2.2 million, versus none in the 2013 period. Allowance coverage was 0.50% of loans, compared with 1.08% at year-end. Net charge-offs were $424,000 for the nine months.
- Nonaccrual loans increased to $6.1 million from $3.1 million at year-end; nonperforming assets were $7.5 million, or 0.22% of assets. Troubled debt restructurings totaled about $2.8–$2.9 million in the filing’s disclosures, of which approximately $1.0 million was nonaccrual. Management considered the allowance adequate but noted estimates and New Jersey real estate and economic conditions could change.
- Deposits increased $1.13 billion from year-end, primarily reflecting the merger, alongside organic growth and use of brokered and listing-service markets. Time deposits increased to $673.0 million from $164.2 million.
Outlook, risks and unusual items
No numerical earnings or revenue guidance is provided. Management’s stated objectives include balanced asset and revenue growth, expanding its market presence and diversifying products. It identified competition, interest-rate changes, regional economic conditions, credit losses, regulatory changes, technology and integration execution as risks. The company said Basel III implementation was not expected to materially affect capital needs, subject to ongoing evaluation.
On November 5, after quarter-end, the company discovered fraudulent unauthorized transfers from a business customer’s account following compromise of the customer’s email; the filing said the company’s systems were not breached. The expected after-tax Q4 charge was no more than $1.5 million, with recovery avenues under review. Management identified a material weakness in controls over funds transfers and concluded disclosure controls and procedures were ineffective because the controls did not operate with sufficient precision. It was evaluating remediation and said previously reported financial results were unaffected.
Management also reported that merger revenue and earnings since the acquisition date could not be reliably separated after the systems conversion. Unaudited nine-month pro forma figures, assuming the merger from the start of the respective periods, showed net income of $26.5 million in 2014 and $26.1 million in 2013; these exclude specified merger expenses and do not include estimated synergies or revenue enhancements.
Important facts for investors to verify
- Progress and cost of integrating the merger, including whether expected synergies materialize and how post-merger earnings compare on a like-for-like basis.
- Q4 loss and recoveries related to the customer funds-transfer fraud, insurance coverage, and remediation of the disclosed control weakness.
- Credit performance of the acquired and broader loan portfolio, nonaccrual and restructured loans, and whether the allowance remains adequate as lending grows.
- Deposit mix and funding costs, reliance on brokered or listing-service deposits, borrowing needs, and liquidity against outstanding commitments.
- Effects of interest-rate changes and the $70 million debt extinguishment; the filing’s sensitivity analysis estimated one-year net interest income declines under both a 200-basis-point rate increase and a 100-basis-point decrease.
- The filing reports nine-month 2014 return on average equity as 5.25%, but its comparison text labels the 12.15% 2013 figure inconsistently; verify the intended comparator. Also verify the differing TDR totals reported in separate sections.