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CNOB > SEC Filings for CNOB > Form 10-Q on 9-Aug-2013All Recent SEC Filings

Show all filings for CONNECTONE BANCORP, INC.

Form 10-Q for CONNECTONE BANCORP, INC.


9-Aug-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 10-K 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.

- 24 -

Operating Results Overview

Net income for the second quarter of 2013 was $2.5 million, an increase of $0.4 million, or 20.3%, compared to net income of $2.1 million in the second quarter of 2012. Net income available to common shareholders for the second quarter of 2013 was $2.5 million, an increase of $0.6 million, or 33.5%, compared to net income available to common shareholders of $1.9 million in the second quarter of 2012. Diluted earnings per share were $0.49 for the second quarter of 2013, a decline from $0.62 for the second quarter of 2012. Net income for the first half of 2013 was $4.8 million, an increase of $0.9 million, or 18.9%, compared to net income of $3.9 million in the first half of 2012. Net income available to common shareholders for the first half of 2013 was $4.8 million, an increase of $1.3 million, or 35.5%, compared to net income available to common shareholders of $3.6 million in the first half of 2012. Diluted earnings per share were $1.04 for the first half of 2013, a decline from $1.24 for the first half of 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 in 2013 were impacted by the 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 an improving economy and overall sound credit quality.

Net Interest Income

Net interest income for the second quarter of 2013 was $9.8 million, an increase of $1.0 million, or 11.5%, compared to net interest income of $8.8 million in the second quarter of 2012. Net interest income for the first half of 2013 was $19.2 million, an increase of $2.7 million, or 16.0%, compared to net interest income of $16.6 million in the first half of 2012. The increase in net interest income was largely attributable to growth in average interest-earning assets, principally loans, which increased by 27.9% and 27.6% in the second quarter and first half of 2013, respectively, from prior period amounts, and was partially offset by a 65 basis point contraction in the net interest margin, from 4.54% in the second quarter of 2012 to 3.89% in the second quarter of 2013 and by a 50 basis point contraction from 4.45% in the first half of 2012 to 3.95% in the first half of 2013. Although the Bank's cost of interest-bearing funds has declined, from 1.04% in the second quarter of 2012 to 0.86% in the second quarter of 2013, and from 1.07% in the first half 2012 to 0.88% in the first half 2013, the rate earned on interest-earning assets has declined to a greater degree, from 5.34% in last year's second quarter to 4.50% in the second quarter of 2013, and from 5.28% in the first half of 2012 to 4.58% in the first half of 2013. The Bank's net interest income has increased due to volume growth, despite continue margin compression resulting from the maturity, prepayment or contractual re-pricing of loans and securities in this extended period of low interest rates.

- 25 -

Average Balance Sheets

The following table sets forth certain information relating to our average assets and liabilities for the three months and six months ended June 30, 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
                                             June 30, 2013                                   June 30, 2012
                                  Average                      Average           Average                      Average
                                  Balance       Interest      Rate (5)           Balance      Interest       Rate (5)
Interest-earning assets:
Investment securities (1)       $    25,460     $     179          2.82 %       $  30,752     $     242          3.17 %
Loans receivable (2) (3)            923,841        11,139          4.84 %         715,710        10,114          5.68 %
Federal funds sold and
interest-bearing deposits
with banks                           63,061            34          0.22 %          34,677            13          0.15 %
Total interest-earning assets     1,012,362        11,352          4.50 %         781,139        10,369          5.34 %
Allowance for loan losses           (13,936 )                                     (10,598 )
Non-interest earning assets          21,270                                        26,421
Total assets                    $ 1,019,696                                     $ 796,962

Interest-bearing liabilities:
Savings, NOW, Money Market,
Interest Checking               $   330,289           257          0.31 %       $ 306,516           369          0.48 %
Time deposits                       304,429           892          1.18 %         213,744           799          1.50 %
Total interest-bearing
deposits                            634,718         1,149          0.73 %         520,260         1,168          0.90 %

Borrowings                           74,287           330          1.78 %          77,871           337          1.74 %
Capital lease obligation              3,160            47          5.97 %           3,233            48          5.97 %
Total interest-bearing
liabilities                         712,165         1,526          0.86 %         601,364         1,553          1.04 %
Noninterest-bearing deposits        179,084                                       125,723
Other liabilities                     4,119                                         3,230
Stockholders' equity                124,328                                        66,645
Total liabilities and
stockholders' equity            $ 1,019,696                                     $ 796,962

Net interest income/interest
rate spread                                     $   9,826          3.64 %                     $   8,816          4.30 %

Net interest margin (4)                                            3.89 %                                        4.54 %

(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.

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                                                             For the Six Months Ended
                                           June 30, 2013                                  June 30, 2012
                                Average                     Average           Average                      Average
                                Balance      Interest      Rate (5)           Balance      Interest       Rate (5)
Interest-earning assets:
Investment securities (1)      $  24,962     $     373          3.01 %       $  33,044     $     523          3.18 %
Loans receivable (2) (3)         898,830        21,835          4.90 %         683,304        19,120          5.63 %
Federal funds sold and
interest-bearing deposits
with banks                        57,278            55          0.19 %          32,749            30          0.18 %
Total interest-earning
assets                           981,070        22,263          4.58 %         749,097        19,673          5.28 %
Allowance for loan losses        (13,733 )                                     (10,249 )
Non-interest earning assets       19,725                                        34,692
Total assets                   $ 987,062                                     $ 773,540

Interest-bearing
liabilities:
Savings, NOW, Money Market,
Interest Checking              $ 330,099           516          0.32 %       $ 307,227           790          0.52 %
Time deposits                    291,228         1,778          1.23 %         199,757         1,574          1.58 %
Total interest-bearing
deposits                         621,327         2,294          0.74 %         506,984         2,364          0.94 %

Borrowings                        76,484           664          1.75 %          75,083           653          1.75 %
Capital lease obligation           3,169            95          6.05 %           3,242            97          6.02 %
Total interest-bearing
liabilities                      700,980         3,053          0.88 %         585,309         3,114          1.07 %
Noninterest-bearing deposits     180,807                                       122,091
Other liabilities                  4,267                                         3,294
Stockholders' equity             101,008                                        62,846
Total liabilities and
stockholders' equity           $ 987,062                                     $ 773,540

Net interest income/interest
rate spread                                  $  19,210          3.70 %                     $  16,559          4.21 %

Net interest margin (4)                                         3.95 %                                        4.45 %

(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 second quarter and first half of 2013 was $1.0 million and $1.9 million, respectively, compared to the provision for loan losses of $1.1 million and $1.9 million in the comparable 2012 periods. The provision for loan losses for all periods presented was largely related to loan growth and, to a lesser degree, specific reserves for impaired credits. In addition, 2013 provision for loan losses benefited from improving economic factors.

- 27 -

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 $301,000 and $561,000 for the second quarter and first half of 2013, respectively, up slightly from $277,000 and $522,000 in the comparable 2012 periods. Growth in service and card-related fees were partially offset by a decline in gains of sale of residential mortgage loans.

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 second quarter of 2013 were $4.9 million, a $0.5 million, or 10.5%, increase from $4.6 million in the second quarter of 2012, and were $9.7 million for the first six months of 2013, a $1.1 million, or 12.4%, increase from $8.6 million in the first half of 2012. The largest factor contributing to the increase was salaries and employee benefits expense, which increased by $0.3 and $0.7 million to $2.4 and $4.9 million in the second quarter and first half of 2013, respectively. This increase was primarily due to an approximinately 10% increase in our staff, which consisted of 97 full-time employees at June 30, 2013. 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 to 48.6% in the second quarter of 2013 from 49.0% in the second quarter of 2012.

Income Taxes

Income tax expense was $1.8 million for the second quarter 2013 and $3.4 million for the first half of 2013 versus $1.4 million for the second quarter 2012 and $2.7 million for the first half 2012. The effective tax rate, which is derived from both federal and New Jersey statutory income tax rates, was approximately 41.3% for 2013, an increase from 40.5% 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 June 30, 2013, total assets were $1.0 billion, a $100.6 million increase from December 31, 2012. The increase in total assets was due primarily to a $106.7 million increase, to $955.6 million, in loans receivable and a $4.6 million increase, to $25.8 million, in securities, partially offset by a $10.1 million decline in cash and cash equivalents. The growth in assets was funded by a $54.0 million increase in deposits and $47.8 million in net proceeds from our first quarter 2013 initial public equity offering.

Stockholders' Equity

Stockholders' equity totaled $124.6 million as of June 30, 2013, an increase of $52.2 million from $72.4 million as of year-end 2012, due primarily to the Company's first quarter IPO. As of June 30, 2013, the tangible common equity ratio and tangible book value per share were 12.07% and $24.76, 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. The tangible common equity ratio is calculated by dividing common equity, less goodwill by total assets less, goodwill. Tangible book value per share is calculated by dividing common equity, less goodwill, by common shares outstanding.

- 28 -

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:



                                                  June 30, 2013                                  December 31, 2012
                                                                      Well                                             Well
                                    Actual         Minimum         Capitalized       Actual         Minimum         Capitalized
                                    Ratio        Requirement       Requirement       Ratio        Requirement       Requirement
The Company:
Leverage ratio                        12.19 %            4.00 %             n/a         7.84 %            4.00 %             n/a
Tier 1 Risk-based capitalization      13.69 %            4.00 %             n/a         9.26 %            4.00 %             n/a
Total Risk-based capitalization       15.11 %            8.00 %             n/a        10.52 %            8.00 %             n/a
The Bank:
Leverage ratio                        12.18 %            4.00 %            5.00 %       7.84 %            4.00 %            5.00 %
Tier 1 Risk-based capitalization      13.68 %            4.00 %            6.00 %       9.26 %            4.00 %            6.00 %
Total Risk-based capitalization       15.10 %            8.00 %           10.00 %      10.51 %            8.00 %           10.00 %

On July 2, 2013, the Federal Reserve approved final rules that substantially amend the regulatory risk-based capital rules applicable to the Company and the Bank. On July 9, 2013, the FDIC also approved, as an interim final rule, the regulatory capital requirements for U.S. banks, following the actions of the Federal Reserve. The final rules implement the "Basel III" regulatory capital reforms, as well as certain changes required by the Dodd-Frank Act.

The final rules include new risk-based capital and leverage ratios that will be phased in from 2015 to 2019. The rules include a new common equity Tier 1 capital to risk-weighted assets ratio of 4.5% and a common equity Tier 1 capital conservation buffer of 2.5% of risk-weighted assets, which is in addition to the Tier 1 and Tier 2 risk-based capital requirements. The final rules also raise the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and require a minimum leverage ratio of 4.0%. The required minimum ratio of total capital to risk-weighted assets will remain 8.0%. The new risk-based capital requirements (except for the capital conservation buffer) will become effective for the Company on January 1, 2015. The capital conservation buffer will be phased in over four years beginning on January 1, 2016, with a maximum buffer of 0.625% of risk-weighted assets for 2016, 1.25% for 2017, 1.875% for 2018, and 2.5% for 2019 and thereafter. Failure to maintain the required capital conservation buffer will result in limitations on capital distributions and on discretionary bonuses to executive officers.

The following chart compares the risk-based capital ratios required under existing Federal Reserve rules to those prescribed under the new final rules under the phase-in period described above:

                                            Current Rules      Final Rules
             Common Equity Tier 1                   n/a               4.5 %
             Additional Tier 1                      n/a               1.5 %
             Tier 1                                 4.0 %             n/a
             Tier 2                                 4.0 %             2.0 %
             Common Equity Tier 1
             Capital Conservation Buffer            n/a               2.5 %

The final rules also implement revisions and clarifications consistent with Basel III regarding the various components of Tier 1 capital, including common equity, unrealized gains and losses and instruments that will no longer qualify as Tier 1 capital. The final rules provide that depository holding companies with less than $15 billion in total assets as of December 31, 2009, such as the Company, may permanently include trust preferred securities and certain other non-qualifying instruments issued and included in Tier 1 or Tier 2 capital before May 19, 2010 in additional Tier 1 (subject to a maximum of 25% of Tier 1 capital) or Tier 2 capital until maturity or redemption.

- 29 -

The final rules also set forth certain changes for the calculation of risk-weighted assets that the Company will be required to implement beginning January 1, 2015. Management is currently evaluating the provisions of the final rules and their expected impact on the Company. Based on the Company's current capital composition and levels, management does not presently anticipate that the final rules present a material risk to the Company's financial condition or results of operations.

Except as set forth above, management is not aware of any other events or uncertainties that are reasonably likely to have a material effect on the Company's liquidity, capital resources or operations.

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:

                                     June 30, 2013             At December 31, 2012
                                               Percent                         Percent
      (dollars in thousands)     Amount       of Total         Amount         of Total
      Commercial                $ 193,231          20.2 %   $    147,455           17.4 %
      Commercial real estate      597,126          62.4 %        549,218           64.7 %
      Commercial construction      42,261           4.4 %         36,872            4.3 %
      Residential real estate      90,465           9.5 %         82,962            9.8 %
      Home equity                  31,574           3.3 %         30,961            3.6 %
      Consumer                      1,556           0.2 %          1,801            0.2 %
      Total gross loans         $ 956,213         100.0 %   $    849,269          100.0 %

Asset Quality

Nonperforming assets totaled $10.0 million, or 0.97% of total assets, at June 30, 2013, up from $8.4 million, or 0.90% of total assets, at year-end 2012. The allowance for loan losses was $14.0 million, representing 1.46% of loans receivable and 146.5% of nonaccrual loans at June 30, 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 $0.6 million and $1.1 million in net charge-offs recorded during the second quarter and first half of 2013, representing an annualized rate of 0.26% and 0.25% for the second quarter and first half of 2013, respectively.

- 30 -

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)                                    June 30, 2013        December 31, 2012
. . .
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