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CNOB > SEC Filings for CNOB > Form 10-Q on 12-May-2014All Recent SEC Filings

Show all filings for CONNECTONE BANCORP, INC.



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, 2013 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 2014 was $ $2.6 million, or $0.50 per diluted share, compared with net income of $2.3 million, or $0.56 per diluted share, for the prior year period. The first quarter 2014 results include $0.7 million in after-tax merger expenses related to the pending merger-of-equals with Center Bancorp, Inc., announced during the first quarter of 2014.

The increases in net income, excluding merger charges, 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

Fully taxable equivalent ("FTE") net interest income for the first quarter of 2014 totaled $11.7 million, an increase of $2.3 million, or 24.6%, from the year ago period. The increase in net interest income was primarily due to a 33.9% increase in average interest-earning assets, which grew to $1.3 billion in the first quarter of 2014. This was partially offset by a 28 basis points contraction in the net interest margin, from 4.01% in the first quarter of 2013 to 3.73% in the first quarter of 2014. Average total loans increased by 35.9% to $1.2 billion in the first quarter of 2014 from the prior year period. Prepayment fees contributed 10 basis points to the net interest margin for the first quarter of 2014, and 7 basis points to the net interest margin for the first quarter of 2013. Management expects net interest income to continue expanding as a result of solid loan growth, while margin compression is likely to moderate in future periods as the Company's loan origination mix changes and the loan portfolio fully re-prices.

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Average Balance Sheets

The following table sets forth certain information relating to our average assets and liabilities for the three months ended March 31, 2014 and 2013, and reflects 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, 2014                               March 31, 2013
                                    Average                      Average         Average                     Average
                                    Balance       Interest      Rate (7)         Balance      Interest      Rate (7)
Interest-earning assets:
Investment securities (1) (2)     $    37,122     $     233          2.55 %     $  25,216     $     195          3.14 %
Loans receivable (3) (4)            1,186,847        13,455          4.60 %       873,557        10,696          4.97 %
Federal funds sold and
interest-bearing deposits with
banks                                  48,463            22          0.18 %        51,431            21          0.17 %
Total interest-earning assets       1,272,432        13,710          4.37 %       950,204        10,912          4.66 %
Allowance for loan losses             (16,450 )                                   (13,545 )
Non-interest earning assets            37,977                                      19,364
Total assets                      $ 1,293,959                                   $ 956,023

Interest-bearing liabilities:
Savings, NOW, Money Market,
Interest Checking                 $   340,125           225          0.27 %     $ 329,906           259          0.32 %
Time deposits                         436,820         1,176          1.09 %       277,882           887          1.29 %
Total interest-bearing deposits       776,945         1,401          0.73 %       607,788         1,146          0.76 %

Borrowings                            166,226           561          1.37 %        76,019           334          1.78 %
Capital lease obligation                3,098            47          6.15 %         3,172            48          6.14 %
Total interest-bearing
liabilities                           946,269         2,009          0.86 %       686,979         1,528          0.90 %
Noninterest-bearing deposits          209,303                                     164,403
Other liabilities                       5,897                                       7,706
Stockholders' equity                  132,490                                      96,935
Total liabilities and
stockholders' equity              $ 1,293,959                                   $ 956,023

Net interest income/interest
rate spread (5)                                   $  11,701          3.51 %                   $   9,384          3.76 %
Tax equivalent effect                                    (6 )                                         -
Net interest income as reported                   $  11,695                                   $   9,384

Net interest margin (6)                                              3.73 %                                      4.01 %

(1) Average balances are calculated on amortized cost.
(2) Interest income is presented on a tax equivalent basis using 35 percent federal tax rate.
(3) Includes loan fee income.
(4) Loans receivable include non-accrual loans.
(5) Represents difference between the average yield on interest earning assets and the average cost of interest bearing liabilities and is presented on a fully tax equivalent basis.
(6) Represents net interest income divided by average total interest-earning assets.
(7) Rates are annualized.

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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 2014 was $1.3 million, an increase of $0.4 million, compared to the provision for loan losses of $0.9 million in the first quarter of 2013. A majority of the provision for loan losses in both periods was attributable to loan growth.

Non-Interest Income

Non-interest income represents a relatively small portion of the Bank's total revenue as management has historically made a strategic decision to de-emphasize fee income, focusing instead on customer growth and retention. Non-interest income totaled $0.3 million in each of the first quarters of 2014 and 2013. Bank owned life insurance ("BOLI") income in 2014 (there was no BOLI outstanding during the first quarter of 2013) was largely offset by declines in gains on sale of residential mortgage loans.

Non-Interest Expense

Non-interest expenses for the first quarter of 2014 increased by $1.9 million to $6.7 million, from $4.7 million in the prior year period. Non-interest expenses, excluding merger-related expenses, totaled $5.7 million, representing a $1.0 million or 21.3% increase from 2013, and was essentially flat from the linked fourth quarter of 2013. The primary factor contributing to the increases in total non-interest expenses from last year was salaries and employee benefits expense, which increased by $0.6 million to $3.1 million in the first quarter of 2014 from $2.5 million in the first quarter of 2013. The increase was primarily due an increase in the number of full-time equivalent employees and higher incentive-based compensation. Also contributing to higher non-interest expenses were increased costs associated with being a publicly-traded entity, higher professional fees, snow-removal costs and a general increase in other operating expenses related to a significantly increased volume of business. Management continues to focus on expense control, balancing its investment in infrastructure with prudent and sustainable growth.

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 47.7% in the first quarter of 2014 from 49.2% in the first quarter of 2013. The Company uses this ratio because it believes that the ratio provides a good comparison of period-to-period performance and because the ratio is widely accepted in the banking industry.

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The following table shows the calculation of the efficiency ratio for the periods presented:

                                                       Three Months Ended
                                                    March 31,       March 31,
                                                      2014            2013
       Efficiency Rato
       Non-interest expense                        $     6,672     $     4,741
       Less: merger related expenses                      (923 )             -
       Adjusted non-interest expense (numerator)   $     5,749     $     4,741

       Net interest income                              11,695           9,384
       Non-interest income                                 349             259
       Operating revenue (denominator)             $    12,044     $     9,643

       Efficiency Ratio                                   47.7 %          49.2 %

Income Taxes

Income tax expense was $1.5 million for the first quarter of 2014 compared with $1.6 million for the first quarter of 2013. The effective tax rates were 36.0% and 41.3% for the first quarters of 2014 and 2013, respectively. The effective tax rate for 2014 reflects a reorganized operating structure effective October 1, 2013. The Company's effective tax rate is projected to be approximately 36% in future periods, although it is likely to fluctuate depending upon future levels of taxable and non-taxable revenue.

Financial Condition Overview

At March 31, 2014, the Company's total assets were $1.35 billion, a $104.5 million increase from December 31, 2013. The increase in total assets was primarily due to a $93.5 million increase, to $1.25 billion, in loans receivable, and $11.0 million increase, to $45.3 million, in cash and cash equivalents. The growth in assets was funded by a $61.9 million increase in deposits, a $39.7 million increase in Federal Home Loan Bank borrowings, and a $2.6 million increase in retained earnings.

Stockholders' Equity

Stockholders' equity totaled $133.0 million as of March 31, 2014, an increase of $2.9 million from $130.1 million as of December 31, 2013, primarily due to the retention of earnings. As of March 31, 2014, the tangible common equity ratio and tangible book value per share were 9.85% and $25.92, respectively. As of December 31, 2013, the Company's tangible common equity ratio and tangible book value per share were 10.45% and $25.43, respectively. Tangible common equity ratio and tangible book value per share are non-GAAP financial measures. The following table shows the calculation of these ratios for the periods presented:

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                                                                      As of
                                                          March 31,        December 31,
                                                            2014               2013

Tangible Common Equity and Tangible Common
Equity/Tangible Assets
Common equity                                            $   133,008      $      130,128
Less: intangible assets                                         (260 )              (260 )
Tangible common equity                                   $   132,748      $      129,868

Total assets                                             $ 1,347,723      $    1,243,228
Less: intangible assets                                         (260 )              (260 )
Tangible assets                                          $ 1,347,463      $    1,242,968

Tangible Common Equity/Tangible Assets                          9.85 %             10.45 %

Tangible Book Value per Common Share
Book value per common share                              $     25.97      $        25.48
Less: effects of intangible assets                             (0.05 )             (0.05 )
Tangible Book Value per Common Share                     $     25.92      $        25.43


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, 2014                                  December 31, 2013
                                                           Well                                              Well
                         Actual         Minimum         Capitalized        Actual         Minimum         Capitalized
                         Ratio        Requirement       Requirement        Ratio        Requirement       Requirement
The Company:
Leverage ratio             10.25 %            4.00 %             n/a         10.74 %            4.00 %             n/a
Tier 1 Risk-based
capitalization             10.94 %            4.00 %             n/a         11.68 %            4.00 %             n/a
Total Risk-based
capitalization             12.20 %            8.00 %             n/a         12.91 %            8.00 %             n/a
The Bank:
Leverage ratio             10.25 %            4.00 %            5.00 %       10.71 %            4.00 %            5.00 %
Tier 1 Risk-based
capitalization             10.95 %            4.00 %            6.00 %       11.65 %            4.00 %            6.00 %
Total Risk-based
capitalization             12.19 %            8.00 %           10.00 %       12.88 %            8.00 %           10.00 %

The Group of Governors and Heads of Supervision, the oversight body of the Basel Committee on Banking Supervision, adopted Basel III in September 2010, which constitutes a set of capital reform measures designed to strengthen the regulation, supervision and risk management of banking organizations worldwide. In order to implement Basel III and certain additional capital changes required by the Dodd-Frank Act, on July 9, 2013, the Federal banking agencies, including the FDIC the Federal Reserve and the Office of the Comptroller of the Currency, approved, as an interim final rule, the regulatory capital requirements for U.S. insured depository institutions and their holding companies.

The interim final rule includes new risk-based capital and leverage ratios that will be phased-in from 2015 to 2019. The rule includes 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 Total risk-based capital requirements. The interim final rule also raises the minimum ratio of Tier 1 capital to risk-weighted assets from 4.0% to 6.0% and requires 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 on January 1, 2015. The capital conservation buffer will be phased in over four years beginning on

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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 required under existing rules to those prescribed under the interim final rule under the phase-in period described above:

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

The interim final rule also implements 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 interim final rule also sets forth certain changes for the calculation of risk-weighted assets that we will be required to implement beginning January 1, 2015. Management is currently evaluating the provisions of the interim final rule and its expected impact. Based on our current capital composition and levels, management does not presently anticipate that the interim final rule presents a material risk to our financial condition or results of operations.

These provisions, as well as any other aspects of current or proposed regulatory or legislative changes to laws applicable to the financial industry, may impact the profitability of our business activities and may change certain of our business practices, including the ability to offer new products, obtain financing, attract deposits, make loans, and achieve satisfactory interest spreads, and could expose us to additional costs, including increased compliance costs. These changes also may require us to invest significant management attention and resources to make any necessary changes to operations in order to comply, and could therefore also materially and adversely affect our business, financial condition and results of 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.

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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, 2014               December 31, 2013
                                                 Percent                       Percent
      (dollars in thousands)      Amount         of Total        Amount        of Total
      Commercial                $   223,324           17.9 %   $  147,455           17.4 %
      Commercial real estate        835,169           67.0 %      549,218           64.7 %
      Commercial construction        69,420            5.6 %       36,872            4.3 %
      Residential real estate        83,243            6.7 %       82,962            9.8 %
      Home equity                    32,665            2.6 %       30,961            3.6 %
      Consumer                        2,348            0.2 %        1,801            0.2 %
      Total gross loans         $ 1,246,169          100.0 %   $  849,269          100.0 %

Asset Quality

Nonperforming assets, which includes nonaccrual loans and other real estate owned, totaled $9.7 million at March 31, 2014, down from $10.5 million at December 31, 2013 and up from $7.9 million at March 31, 2013. Nonperforming assets as a percent of total assets declined to 0.72% at March 31, 2014 from 0.84% at December 31, 2013 and from 0.79% at March 31, 2013. The allowance for loan losses was $17.0 million, representing 1.37% of loans receivable and 192.5% of nonaccrual loans at March 31, 2014. At December 31, 2013, the allowance was $16.0 million representing 1.39% of loans receivable and 174.2% of nonaccrual loans, and at March 31, 2013 the allowance was $13.6 million representing 1.51% of loans receivable and 181.9% of nonaccrual loans. The provision for loan losses was $1.3 million for the first quarter of 2014, $1.4 million for the fourth quarter of 2013, and $0.9 million for the first quarter 2013. The provision for loan losses has remained relatively constant, although the level is contingent upon many factors including, but not limited to, loan growth, the Company's historical loss experience, macroeconomic conditions and reserves required for specific credits. The annualized rate of net loan charge-offs was 0.08% for the first quarter of 2014, 0.03% for the fourth quarter of 2013 and 0.25% for the first quarter of 2013.

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

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(dollars in thousands)                              March 31, 2014        December 31, 2013
Nonaccrual loans:
Commercial                                         $          3,512      $             3,582
Commercial real estate                                        2,434                    2,445
Commercial construction                                           -                        -
Residential real estate                                       2,137                    2,381
Home equity                                                     765                      767
Consumer                                                          -                        -
Nonaccrual loans                                              8,848                    9,175
Other real estate owned                                         870                    1,303
Total non-performing assets                        $          9,718      $            10,478
Loans past due 90 days and still accruing          $              -      $                 -
Performing troubled debt restructured loans        $          2,925      $             2,934

Nonaccrual loans to loans receivable                           0.71 %                   0.80 %
. . .
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