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CNOB > SEC Filings for CNOB > Form 10-Q on 10-May-2013All Recent SEC Filings

Show all filings for CONNECTONE BANCORP, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for CONNECTONE BANCORP, INC.


10-May-2013

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

Some of the statements in this document discuss future expectations, contain projections or results of operations or financial conditions or state other "forward-looking" information. Those statements are subject to known and unknown risk, uncertainties and other factors that could cause the actual results to differ materially from those contemplated by the statements. We based the forward-looking statements on various factors and using numerous assumptions. Important factors that may cause actual results to differ from those contemplated by forward-looking statements include those disclosed under Item 1A
- Risk Factors included in the Company's Annual Report Form 10K filed for the year ended December 31, 2012 and the following:

the success or failure of our efforts to implement our business strategy;

the effect of changing economic conditions and, in particular, changes in interest rates;

changes in government regulations, tax rates and similar matters;

our ability to attract and retain quality employees; and

other risks which may be described in our future filings with the SEC

We do not promise to update forward-looking information to reflect actual results or changes in assumptions or other factors that could affect those statements.

Critical Accounting Policies and Estimates

"Management's Discussion and Analysis of Financial Condition and Results of Operations," is based upon our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. Note 1 to our audited consolidated financial statements included in our Annual Report on Form 10K contains a summary of our significant accounting policies. Management believes our policy with respect to the methodology for the determination of the allowance for loan losses involves a higher degree of complexity and requires management to make difficult and subjective judgments which often require assumptions or estimates about highly uncertain matters. Changes in these judgments, assumptions or estimates could materially impact results of operations. This critical policy and its application are periodically reviewed with the Audit Committee and our Board of Directors.

The allowance for loan losses is based upon management's evaluation of the adequacy of the allowance, including an assessment of known and probable incurred losses included in the portfolio, including giving consideration to the size and composition of the loan portfolio, actual loan loss experience, level of delinquencies, detailed analysis of individual loans for which full collectability may not be assured, the existence and estimated net realizable value of any underlying collateral and guarantees securing the loans, and current economic and market conditions. Although management uses the best information available, the level of the allowance for loan losses remains an estimate which is subject to significant judgment and short-term change. Various regulatory agencies, as an integral part of their examination process, periodically review our allowance for loan losses. Such agencies may require us to make additional provisions for loan losses based upon information available to them at the time of their examination. Furthermore, the majority of our loans are secured by real estate in the State of New Jersey. Accordingly, the collectability of a substantial portion of the carrying value of our loan portfolio is susceptible to changes in local market conditions and may be adversely affected by declines in real estate values, or if the Central or Northern areas of New Jersey experience an adverse economic shock. Future adjustments to the allowance for loan losses may be necessary due to economic, operating, regulatory and other conditions beyond our control.

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Operating Results Overview

Net income for the first quarter of 2013 was $2.3 million, an increase of $0.5 million, or 26.8%, compared to net income of $1.8 million in the first quarter of 2012. Net income available to common shareholders for first quarter of 2013 was $2.3 million, an increase of $0.6 million, or 37.7%, compared to net income available to common shareholders of $1.7 million in the first quarter of 2012. Diluted earnings per share were $0.56 for the first quarter 2013, a decline from $0.62 for the first quarter 2012. Net income available to common shareholders and diluted earnings per share in 2012 were impacted by three series of convertible preferred stock issued at various times between 2009 and 2012. During 2012, all three series of preferred stock were converted into common shares and, as of December 31, 2012, stockholders' equity was comprised solely of common equity. In addition, earnings per share were impacted by our issuance of 1.8 million shares in the first quarter of 2013 as part of our initial public offering.

The increases in net income and net income available to common shareholders were primarily attributable to significant increases in net interest income due to the Company's rapid growth in loans and deposits, and in its customer base. Partially offsetting the revenue increases were higher noninterest expenses, largely staff-related, commensurate with the Company's growing infrastructure. Credit costs have kept pace with both loan growth and a changing mix in the loan portfolio, while benefitting from overall sound credit quality.

Net Interest Income

Net interest income for the first quarter of 2013 was $9.4 million, an increase of $1.6 million, or 21.2%, compared to net interest income of $7.7 million in the first quarter of 2012. The increase in net interest income was largely attributable to growth in average interest-earning assets, principally loans, which increased by 28.8% to $950.2 million in the first quarter of 2013 from $737.6 million in the first quarter of 2012, and was partially offset by a 21 basis points contraction in the net interest margin, from 4.22% in the first quarter of 2012 to 4.01% in the first quarter of 2013. Although the Bank's cost of interest-bearing funds has declined, from 1.10% in last year's first quarter to 0.90% in the first quarter of 2013, the rate earned on interest-earning assets has declined to a greater degree, from 5.07% in last year's first quarter to 4.66% in the first quarter of 2013. The Bank's holdings of loans and securities continue to re-price lower as a result of maturities and prepayments.

- 23 -

Average Balance Sheets

The following table sets forth certain information relating to our average assets and liabilities for the three months ended March 31, 2013 and 2012, and reflect the average yield on assets and average cost of liabilities for the periods indicated. Such yields are derived by dividing income or expense by the average balance of assets or liabilities, respectively, for the periods shown.

                                                             For the three months ended
                                               March 31, 2013                           March 31, 2012
                                                               (dollars in thousands)
                                     Average                    Average       Average                    Average
Interest-earning assets:             Balance      Interest     Rate (5)       Balance      Interest     Rate (5)
Investment securities (1)          $  25,216     $    195          3.14 %   $  35,335     $    281          3.20 %
Loans receivable (2) (3)             873,557       10,696          4.97 %     671,395        9,006          5.40 %
Federal funds sold and interest-
bearing deposits with banks           51,431           21          0.17 %      30,821           17          0.22 %
Total interest-earning assets        950,204       10,912          4.66 %     737,551        9,304          5.07 %
Allowance for loan losses            (13,545 )                                 (9,899 )
Non-interest earning assets           19,364                                   22,467
Total assets                       $ 956,023                                $ 750,119

Interest-bearing liabilities:
Savings, NOW, Money Market,
Interest Checking                  $ 329,906          259          0.32 %   $ 309,094          421          0.55 %
Time deposits                        277,882          887          1.29 %     185,771          775          1.68 %
Total interest-bearing deposits      607,788        1,146          0.76 %     494,865        1,196          0.97 %

Borrowings                            76,019          334          1.78 %      72,294          316          1.76 %
Capital lease obligation               3,172           48          6.14 %       3,251           49          6.06 %
Total interest-bearing
liabilities                          686,979        1,528          0.90 %     570,410        1,561          1.10 %
Noninterest-bearing deposits         164,403                                  118,063
Other liabilities                      7,706                                    3,755
Stockholders' equity                  96,935                                   57,891
Total liabilities and
stockholders' equity               $ 956,023                                $ 750,119

Net interest income/interest
rate spread                                      $  9,384          3.76 %                 $  7,743          3.97 %

Net interest margin (4)                                            4.01 %                                   4.22 %

(1) Average balances are calculated on amortized cost.

(2) Includes loan fee income.

(3) Loans receivable include non-accrual loans.

(4) Represents net interest income divided by average total interest-earning assets.

(5) Rates are annualized.

Provision for Loan Losses

In determining the provision for loan losses, management considers national and local economic trends and conditions; trends in the portfolio including orientation to specific loan types or industries; experience, ability and depth of lending management in relation to the complexity of the portfolio; effects of changes in lending policies, trends in volume and terms of loans; levels and trends in delinquencies, impaired loans and net charge-offs and the results of independent third party loan and lease review.

The provision for loan losses for the first quarter of 2013 was $0.9 million, an increase of $0.2 million, compared to the provision for loan losses of $0.7 million in the first quarter of 2012. A majority of the provision for loan losses in both periods was attributable to loan growth.

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Non-Interest Income

Non-interest income represents a relatively small portion of the Bank's total revenue as management has made a strategic decision to de-emphasize fee income, focusing instead on customer growth and retention. Non-interest income totaled $259,000 for the first quarter of 2013, up slightly from $245,000 in the first quarter of 2012. Growth in service and card-related fees were partially offset by a decline in residential mortgage income.

Non-Interest Expense

Non-interest expenses have increased significantly since inception of the Bank as we have expanded our geographic reach and invested in our infrastructure to support our strong asset growth. Non-interest expenses for the first quarter of 2013 were $4.7 million, a $0.6 million, or 14.3%, increase from $4.1 million in the first quarter of 2012. The largest factor contributing to the increase was salaries and employee benefits expense, which increased by $0.4 million to $2.5 million in the first quarter of 2013 from $2.1 million in the first quarter of 2012. This increase was primarily due to an increase in the number of full-time employees. Also contributing to higher non-interest expenses were increased costs associated with being a publicly-traded entity and a general increase in other operating expenses related to a significantly increased volume of business.

Management continues to focus efforts on supporting growth primarily by adding to staff, investing in technology, and by enhancing risk controls. At the same time, management seeks to contain costs whenever prudent. Our success in this regard is evident in the recent improvements in our efficiency ratio, a widely-followed metric in the banking industry which measures operating expenses as a percentage of net revenue. The ratio is computed by dividing total noninterest expense by the sum of net interest income and noninterest income less securities gains/(losses). The Company's efficiency ratio improved from 49.2% in the first quarter of 2013 from 51.9% in the first quarter of 2012.

Income Taxes

Income tax expense was $1.6 million for the first quarter of 2013 versus $1.2 million for the first quarter of 2012. The effective tax rate, which is derived from both federal and New Jersey statutory income tax rates, is approximately 41% for 2013; an increase from 40% for 2012, as the Company's growth and increase in earnings has placed it into the 35% federal bracket. Management has thus far taken a conservative approach to the Company's tax position and is currently exploring various strategies to maximize the tax efficiency of operations.

Financial Condition Overview

At March 31, 2013, total assets were $1.0 billion, a $75.8 million increase from December 31, 2012. The increase in total assets was due largely to a $52.4 million increase in loans receivable, reflecting growth in commercial, commercial real estate, and residential real estate loan portfolio classes. Also contributing to growth in total assets was a $25.9 million increase in interest-bearing deposits with banks. The growth in assets was funded by a $29.8 million increase in deposits and $47.7 million in net proceeds from our aforementioned equity offering.

Stockholders' Equity

Stockholders' equity totaled $122.4 million as of March 31, 2013, an increase of $50.0 million from $72.4 million as of year-end 2012, due primarily to the Company's first quarter IPO. As of March 31, 2013, the tangible common equity ratio and tangible book value per share were 12.15% and $24.33, respectively. As of December 31, 2012, the Company's tangible common equity ratio and tangible book value per share were 7.76% and $22.77, respectively.

- 25 -

Capital



The following table summarizes the risk-based and leverage capital ratios for
the Company and the Bank as well as the required minimum regulatory capital
ratios for the following periods:



                                                   March 31, 2013                                 December 31, 2012
                                                                       Well                                            Well
                                     Actual         Minimum         Capitalized      Actual         Minimum         Capitalized
                                      Ratio       Requirement       Requirement       Ratio       Requirement       Requirement
The Company:
Leverage ratio                         12.74 %            4.00 %             n/a        7.84 %            4.00 %             n/a
Tier 1 Risk-based capitalization       14.18 %            4.00 %             n/a        9.26 %            4.00 %             n/a
Total Risk-based capitalization        15.43 %            8.00 %             n/a       10.52 %            8.00 %             n/a
The Bank:
Leverage ratio                         12.71 %            4.00 %            5.00 %      7.84 %            4.00 %            5.00 %
Tier 1 Risk-based capitalization       14.17 %            4.00 %            6.00 %      9.26 %            4.00 %            6.00 %
Total Risk-based capitalization        15.43 %            8.00 %           10.00 %     10.51 %            8.00 %           10.00 %

Loan Portfolio

The Bank's lending activities are generally oriented to small-to-medium sized businesses, high net worth individuals, professional practices and consumer and retail customers living and working in the Bank's market area of Hudson, Bergen and Monmouth Counties, New Jersey. The Bank has not made loans to borrowers outside of the United States. The Bank believes that its strategy of high-quality customer service, competitive rate structures and selective marketing have enabled it to gain market entry.

Commercial loans are loans made for business purposes and are primarily secured by collateral such as cash balances with the Bank, marketable securities held by or under the control of the Bank, business assets including accounts receivable, taxi medallions, inventory and equipment and liens on commercial and residential real estate. Commercial construction loans are loans to finance the construction of commercial or residential properties secured by first liens on such properties. Commercial real estate loans include loans secured by first liens on completed commercial properties, including multi-family properties, to purchase or refinance such properties. Residential mortgages include loans secured by first liens on residential real estate, and are generally made to existing customers of the Bank to purchase or refinance primary and secondary residences. Home equity loans and lines of credit include loans secured by first or second liens on residential real estate for primary or secondary residences. Consumer loans are made to individuals who qualify for auto loans, cash reserve, credit cards and installment loans.

The following table sets forth the classification of our gross loans held for investment by loan portfolio class as of the periods indicated:

                                      March 31, 2013             December 31, 2012
                                                 Percent                      Percent
        (dollars in thousands)     Amount       of Total        Amount       of Total
        Commercial                $ 168,172          18.6 %   $  147,455          17.4 %
        Commercial real estate      580,362          64.4        549,218          64.7
        Commercial construction      29,096           3.2         36,872           4.3
        Residential real estate      91,148          10.1         82,962           9.8
        Home equity                  31,325           3.5         30,961           3.6
        Consumer                      1,721           0.2          1,801           0.2
        Total gross loans         $ 901,824         100.0     $  849,269         100.0

- 26 -

Asset Quality

Nonperforming assets totaled $7.9 million, or 0.79% of total assets, at March 31, 2013, down from $8.4 million, or 0.90% of total assets, at year-end 2012. The allowance for loan losses was $13.6 million, representing 1.51% of loans receivable and 181.9% of nonaccrual loans at March 31, 2013. At year-end 2012, the allowance was $13.2 million representing 1.56% of loans receivable and 166.8% of nonaccrual loans. There were $0.5 million in net charge-offs recorded during the first quarter of 2013, representing an annualized rate of 0.25%.

The following table sets forth information concerning our non-performing assets, TDRs, and past-due accruing loans as of the periods indicated:

(dollars in thousands)                             March 31, 2013         December 31, 2012
Nonaccrual loans                                              7,498                    7,939
Other real estate owned                                         433                      433
Total non-performing assets (1)                   $           7,931      $             8,372
Loans past due 90 days and still accruing         $               -      $                 -
Performing troubled debt restructured loans       $           2,996      $             2,996

Nonaccrual loans to loans receivable                           0.83 %                   0.93 %
Nonperforming assets to total assets (1)                       0.79 %                   0.90 %
Allowance for loan losses to loans receivable                  1.51 %                   1.56 %
Allowance for loan losses to non-accrual loans                181.9 %                  166.8 %
Net loan charge-offs to average loans                          0.25 %                   0.05 %

(1) Non-performing assets are defined as nonaccrual loans plus other real estated owned.

- 27 -

Allowance for Loan Losses



The following is a summary of the reconciliation of the allowance for loan
losses for the periods indicated:



                                                 Quarter Ended       Quarter Ended
 (dollars in thousands)                         March 31, 2013      March 31, 2012
 Balance at beginning of period                 $        13,246     $         9,617
 Provision charged to operating expenses                    925                 750
 Recoveries of loans previously charged-off:
 Commercial                                                   -                   1
 Consumer                                                     -                  30
 Residential real estate                                      -                   -
 Total recoveries                                             -                  31
 Loans charged-off:
 Commercial                                                (452 )               (16 )
 Consumer                                                   (82 )                 -
 Residential real estate                                      -                   -
 Total charge-offs                                         (534 )               (16 )
 Net (charge-offs)/recoveries                              (534 )                15
 Balance at end of period                       $        13,637     $        10,382
 Net charge-offs to average loans outstanding              0.25 %             (0.01 %)

 Allowance for loan losses to total loans                  1.51 %              1.51 %

Liquidity

Liquidity is a measure of a bank's ability to fund loans, withdrawals or maturities of deposits, and other cash outflows in a cost-effective manner. Our principal sources of funds are deposits, scheduled amortization and prepayments of loan principal, maturities of investment securities, and funds provided by operations. While scheduled loan payments and maturing investments are relatively predictable sources of funds, deposit flow and loan prepayments are greatly influenced by general interest rates, economic conditions and competition.

At March 31, 2013, the amount of liquid assets remained at a level management deemed adequate to ensure that, on a short and long-term basis, contractual liabilities, depositors' withdrawal requirements, and other operational and customer credit needs could be satisfied. As of March 31, 2013, liquid assets (cash and due from banks, interest-bearing deposits with banks and unencumbered investment securities) were $95.3 million, which represented 9.5% of total assets and 11.9% of total deposits and borrowings, compared to $71.5 million at December 31, 2012, which represented 7.7% of total assets and 9.3% of total deposits and borrowings on such date.

- 28 -

The Bank is a member of the Federal Home Loan Bank of New York and, based on available qualified collateral as of March 31, 2013, had the ability to borrow $336.7 million. In addition, at March 31, 2013, the Bank had in place additional borrowing capacity of $12.0 million through correspondent banks. The Bank also has a credit facility established with the Federal Reserve Bank of New York for direct discount window borrowings, although no collateral was pledged at year-end 2012. At March 31, 2013, the Bank had aggregate available and unused credit of $274.3 million, which represents the aforementioned facilities totaling $348.7 million net of $74.4 million in outstanding borrowings. At March 31, 2013, outstanding commitments for the Bank to extend credit were $135.7 million.

Cash and cash equivalents totaled $76.4 million on March 31, 2013, increasing by $25.7 million or 50.8%, from $50.6 million at December 31, 2012. Operating activities provided $5.0 million in net cash. Investing activities used $51.6 million in net cash, primarily reflecting an increase in loans. Financing activities provided $72.4 million in net cash, primarily reflecting a net increase of $29.8 million in deposits and net proceeds of $47.8 million from our initial public offering, partially offset by net repayments of $10.1 million long-term borrowings.

Interest Rate Sensitivity Analysis

The principal objective of our asset and liability management function is to evaluate the interest-rate risk included in certain balance sheet accounts; determine the level of risk appropriate given our business focus, operating environment, and capital and liquidity requirements; establish prudent asset concentration guidelines; and manage the risk consistent with Board approved guidelines. We seek to reduce the vulnerability of our operations to changes in interest rates, and actions in this regard are taken under the guidance of the Bank's Asset Liability Committee (the "ALCO"). The ALCO generally reviews our liquidity, cash flow needs, maturities of investments, deposits and borrowings, and current market conditions and interest rates.

We currently utilize net interest income simulation and economic value of portfolio equity ("EVPE") models to measure the potential impact to the Bank of future changes in interest rates. As of March 31, 2013 and December 31, 2012 the results of the models were within guidelines prescribed by our Board of Directors. If model results were to fall outside prescribed ranges, action, including additional monitoring and reporting to the Board, would be required by the ALCO and Bank's management.

The net interest income simulation model attempts to measure the change in net interest income over the next one-year period, and the next three-year period on a cumulative basis, assuming certain changes in the general level of interest rates.

In our model, which was run as of March 31, 2013, we estimated that, over the next one-year period, a 200 basis-point increase in the general level of interest rates will decrease our net interest income by 0.9%, while a 100 basis-point decrease in interest rates will also decrease net interest income by 0.9%. As of December 31, 2012, we estimated that, over the next one-year period, a 200 basis-point increase in the general level of interest rates will decrease our net interest income by 1.6%, while a 100 basis-point decrease in the general level of interest rates will decrease our interest rates by 0.5%.

In our model, which was run as of March 31, 2013, we estimated that, over the next three years on a cumulative basis, a 200 basis-point increase in the general level of interest rates will increase our net interest income by 0.1%, while a 100 basis-point decrease in interest rates will decrease net interest income by 3.4%. As of December 31, 2012, we estimated that, over the next three years on a cumulative basis, a 200 basis-point increase in the general level of interest rates will decrease our net interest income by 0.9%, while a 100 basis-point decrease in interest rates will decrease net interest income by 2.8%.

- 29 -

An EVPE analysis is also used to dynamically model the present value of asset and liability cash flows with rate shocks of up 200 basis points and down 100 basis points. The economic value of equity is likely to be different as interest rates change. Our EVPE as of March 31, 2013, would decline by 14.26% with a rate shock of up 200 basis points, and increase by 7.10% with a rate shock of down 100 basis points. Our EVPE as of December 31, 2012, would decline by 19.37% with a rate shock of up 200 basis points, and increase by 9.73% with a rate shock of down 100 basis points.

- 30 -

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