ConnectOne Bancorp, Inc. — Q1 2019 Form 10-Q
Business context and reporting period. This unaudited filing covers the three months ended March 31, 2019, with balance-sheet comparisons to December 31, 2018 and income-statement comparisons to Q1 2018. ConnectOne operates a community-focused commercial bank in New Jersey and nearby markets. Results include Greater Hudson Bank from its January 2, 2019 acquisition, which added seven branches in New York.
Key financial metrics
- Earnings: Net income was $11.6 million, or $0.33 per diluted share, versus $4.3 million, or $0.13, in Q1 2018. Income before tax was $14.1 million versus $4.7 million.
- Interest income and margins: Net interest income was $45.0 million, up from $38.1 million. Tax-equivalent net interest margin was 3.34%, compared with 3.26%; excluding purchase-accounting adjustments, management reported adjusted margin of 3.25% versus 3.24%.
- Other income and expenses: Noninterest income was $1.7 million versus $1.3 million. Noninterest expense rose to $28.1 million from $16.9 million, including $7.6 million of merger expenses. Income tax expense was $2.5 million; the effective tax rate was 17.6%, versus 9.5%.
- Balance sheet: Total assets were $6.05 billion, up from $5.46 billion at year-end. Loans were $4.97 billion, up $431.6 million; deposits were $4.59 billion, up $501.9 million. Stockholders’ equity was $682.4 million.
- Credit quality: The allowance for loan losses was $36.9 million, or 0.74% of loans, versus $35.0 million and 0.77% at year-end. Q1 provision was $4.5 million, down from $17.8 million; net charge-offs were $2.6 million, compared with $17.0 million. Nonaccrual loans were $47.7 million, down from $51.9 million.
- Cash flow and liquidity: Operating activities provided $13.0 million; investing activities used $35.3 million; financing activities provided $22.5 million. Cash and cash equivalents ended at $172.5 million, essentially unchanged from year-end. Management reported $556 million of liquid assets and approximately $1.0 billion of available, unused credit capacity; commitments to extend credit were approximately $954 million.
- Debt and capital: Borrowings were $603.4 million and subordinated debentures were $128.6 million. The company’s Tier 1 leverage, CET1, and total risk-based capital ratios were 9.12%, 9.68%, and 12.79%; the Bank’s were 10.43%, 11.17%, and 12.46%. Management said both met applicable capital requirements and the capital conservation buffer. Tangible common equity ratio was 8.83%.
Material changes versus comparable periods
- Net income improved chiefly because provision expense fell substantially from the prior-year period’s taxi-medallion-related provision, and net interest income increased. The comparison also reflects the Greater Hudson acquisition in 2019 but not in 2018.
- Management attributed higher net interest income to 15.1% growth in average interest-earning assets and an 8-basis-point increase in reported tax-equivalent margin. Higher deposit costs and competition partly offset these benefits.
- Gross loans increased 9.5% from year-end, primarily due to acquired loans. Commercial real estate represented 61.4% of gross loans at March 31.
- The company issued 3.03 million shares as acquisition consideration. Acquisition accounting recorded $10.3 million of goodwill and $5.1 million of core deposit intangibles; purchase-price estimates remain subject to adjustment through January 2020.
- Unrealized losses on available-for-sale securities declined: net-of-tax losses included in accumulated other comprehensive loss were $1.7 million, versus $5.8 million at year-end.
Outlook, risks, contingencies, and unusual items
- The filing provides no specific earnings or revenue guidance. Management cautions that quarterly results are not necessarily indicative of full-year results.
- Management said adjusted margin benefited from asset mix, higher asset yields, and noninterest-bearing deposit growth, partly offset by higher funding costs. Interest-rate modeling estimated that a 200-basis-point increase would raise one-year net interest income by 2.62%; a 100-basis-point decrease would reduce it by 2.00%. These are model estimates, not forecasts.
- Q1 included $7.6 million of merger expenses and a $3.0 million provision related to a single loan secured by a commercial office building. The prior-year quarter included $17.0 million of taxi-medallion-related net charge-offs and provision activity.
- Management considered the allowance adequate but noted that estimates are judgmental and additional provisions may be required. Credit risks include commercial real estate concentration and exposure to real estate and economic conditions, particularly in New Jersey.
- The company was preparing for the expected 2020 adoption of CECL and said the size of the resulting one-time allowance adjustment and overall financial-statement impact could not yet be determined.
- Management reported no material legal proceedings and no changes to the risk factors in its 2018 Form 10-K. Disclosure controls were considered effective; no material change in internal control over financial reporting was reported.
Important facts for investors to verify
- How Greater Hudson integration, acquired-loan performance, and final purchase-accounting adjustments affect future earnings and capital.
- Whether the $3.0 million commercial-office-loan provision signals additional credit deterioration, and how the allowance tracks loan growth and the portfolio’s commercial real estate concentration.
- Whether deposit competition and funding costs continue to offset asset-yield and margin gains, including under changing interest-rate conditions.
- The eventual CECL transition adjustment and any resulting effects on the allowance, earnings, and regulatory capital.
- Liquidity and capital headroom relative to the approximately $954 million of credit commitments and the company’s authorized share-repurchase program.